JAPAN CAN MEET THE EARTHQUAKE TEST / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Japan can meet the earthquake test

By Martin Wolf

Published: March 15 2011 22:06

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“Whereof one cannot speak, one must pass over in silence.” Thus did the philosopher Ludwig Wittgenstein set limits to our speech. Of the pain and anxiety of the human beings buffeted by the forces of nature, I will not write. Yet the need to assess the consequences for Japan and the rest of the world remains. It has postponed my plan to comment on the eurozone’s efforts at reform.

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If any civilisation is inured to such tragedies it is Japan’s. Its people will cope. This seems certain. A bigger question is whether something more positive might emerge from the tragedy. Japan’s bickering politicians are on trial. Can they sustain the mood of national unity? If so will they use it to take Japan out of the doldrums of the past two decades?

What, then, are the economic consequences of a calamity on this scale? Most directly, it destroys wealth and disrupts the economy. Noteworthy, in this case, is the impact of the calamity on attitudes towards – and the future of – the global nuclear industry.


Losses must also be shared between those directly affected and insurers, both private and public. Then will come a surge of reconstruction, which reallocates spending and, at a time of economic slack, is likely to raise it, too. The impact on spending will, in turn, affect the country’s monetary and fiscal positions and external balance.


All this is clear, qualitatively. It is far harder to make reasonable quantitative estimates, not least because the nuclear crisis is ongoing. In its thorough way, Goldman Sachs has produced an estimate of the total cost of damage to buildings, production facilities and so forth of some Y16,000bn ($198bn). That would be 1.6 times the destruction from the 1995 Hanshin earthquake, which devastated Kobe. Since this quake was more powerful, that is hardly surprising. If this sum were to be correct, the cost would be 4 per cent of gross domestic product and less than 1 per cent of national wealth. Yet the Japanese stock market has lost $610bn since Friday, 12 per cent of GDP – probably an overreaction.
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The economic disruption this time will be more severe than in 1995, partly because of the interruptions in electric power. Much depends on how long these last. If they continue to the end of April, argues Goldman Sachs, a decline in real GDP in the second quarter is likely to be followed by a rebound in the third quarter. If they continue throughout 2011, GDP is likely to contract throughout the year.


Nevertheless, it seems extremely unlikely that the impact will be of the same order of magnitude as that of the global financial crisis. That drove down Japan’s GDP by 10 per cent between the first quarters of 2008 and 2009, the steepest decline  in the Group of Seven leading high-income countries. The impact of this shock will certainly be far smaller.


The hit to insurers will be large. Early estimates for losses cover a range of $10bn to more than $60bn. These estimates have been rising steadily since the quake struck. It could be among the most expensive disasters in history. Moreover, it follows two large earthquakes in New Zealand and floods in Australia. The global insurance industry will be tested. But governments are the insurers of last resort. This will also be true in Japan. The banking industry will also lose money. But the figures for losses do not suggest this will be too hard to bear.


The fiscal outlays related to the Hanshin earthquake amounted to Y5,200bn ($64bn) over five years. If the cost to the government after the current earthquake reached 1.6 times that earlier cost, the total would be about $100bn or 2 per cent of a year’s GDP and an annual average of 0.4 per cent of GDP over, say, five years. There will also be some impact on fiscal revenues. It is far too early for confidence on these magnitudes. Even so, these sums are too small to have any meaningful bearing on fiscal solvency.


The Organisation for Economic Co-operation and Development forecasts Japan’s gross government liabilities at 204 per cent of GDP at the end of 2011 and net liabilities at 120 per cent. The government fiscal deficit is also forecast at 7.5 per cent of GDP this year. Against such vast numbers, the prospective cost of reconstruction after the earthquake looks almost a bagatelle. Moreover, the short-term impact of any burst in spending should be benign. In the fourth quarter of last year, GDP was 4 per cent below where it had been in the first quarter of 2008. There is substantial room for increases in demand and corresponding rises in output.


Some outsiders do wonder whether Japan’s government can afford additional spending. They need not do so: Japan can and unquestionably will pay these relatively modest sums. The Japanese private sector runs a financial surplus large enough to cover the government’s deficit and export substantial capital abroad. Japan as a whole is the world’s largest creditor, with net external assets equal to 60 per cent of GDP. In short, the assets of Japan’s private sector vastly exceed the liabilities of its public sector.


The government’s debt is a way for the Japanese to owe money to themselves. At some point, no doubt, that debt will turn into taxation, either overt or covert (the latter via inflation and reductions in the value of Japanese government debt). Since total government receipts are still only 33 per cent of GDP, raising taxes should really not be so hard. The idea that the government confronts an imminent fiscal crisis strikes me as quite bizarre.


The central bank has an important role to play in providing liquidity, which it has done. As Japanese capital comes home, the yen will rise. The authorities should respond by trying to keep it down. My long-held view is that the yen should never have been allowed to rise so high. Enforced with determination, that would have halted the deflation.


Meanwhile, the government has an opportunity to bring the country together around a programme of reform and retrenchment. The focus of such a programme would not be efforts to raise productivity growth. Since 1990 Japan’s output per hour has risen by as much as that of the US. A bigger problem for Japan lies in surplus corporate savings. A policy that encouraged corporations to distribute far more income to shareholders would help. If that happened, plans to cut fiscal deficits in the longer term should also work.


It is in adversity that a country shows its mettle. The Japanese will surely do just that, on this occasion. It is for the leaders to match the mettle of the people. If they are able to do so, out of a great disaster may yet come a rebirth.
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Copyright The Financial Times Limited 2011