March 28, 2011

Japan’s Economy: What Now?

As a nation begins to rebuild, Chazen Senior Scholar David Weinstein sizes up the likely impact to Japan’s fiscal growth prospects.


The losses are still being counted and mourned. Lives, homes, and geography were consumed by the earthquake that tore through northeast Japan at 2:46 p.m. local time on March 11, 2011. As a beleaguered nation begins to assess the damage to its infrastructure and morale, another calculation begs to be made: What will be the long-term impact on Japan’s economy, and how quickly will it recover?

David Weinstein, a Chazen Senior Scholar and Associate Director of Research for the Center on Japanese Economy and Business (CJEB) at Columbia Business School, offered a data-driven prognosis at a CJEB panel presentation on March 22. His conclusion: “We shouldn’t be worried about a major collapse of the Japanese economy as a result of this.”

Historical context shows why. Over the last century, Japan has suffered several catastrophic events, including World War II and the Great Hanshin earthquake of 1995. In the aftermath of such major disruptions, populations and industries have tended to return to their original locations, he noted. In the year following the Hanshin quake, for example, the city’s population fell to 1.42 million, a loss of about 60,000 people. By the year 2000, it had risen to 1.49 million people and has remained stable ever since. As long as an area suffers no permanent physical damage, as happened in Chernobyl, to cite another example, where large swaths of land were rendered unusable from nuclear fallout, “cities bounce back,” said Weinstein.

But what about the economy? Again, the Hanshin disaster proves instructive. In 1995, industrial production for all of Japan fell 2.6 percent in the month following the quake. But output rebounded 2.2 percent the following month, and 1 percent the month after that. Aggregate growth for all of Japan showed a similarly negligible effect: Before the earthquake occurred, GDP growth was forecasted at 1.9 percent for 1995 and 3.1 percent for 1996. Actual growth turned out to be 1.9 percent and 2.6 percent, respectively, so the disaster’s effect was minimal. Said Weinstein, “We are likely to see a similar pattern this time.”

It hardly seems possible that such a catastrophic event could cause such a tiny economic ripple, but Weinstein noted that media coverage after the quake has thus far tended to focus on destruction of capital, particularly on the fact that factories have been shut down and the supply chain has been interrupted. “There has been a reduction in capacity,” he acknowledged. “But a rise in demand offsets that.” In Japan, he said, 120,000 households must now rebuild or repair their homes, and government at all levels must step in to repair infrastructure. “All of that tends to cause GDP growth to rise,” he says.

Still, as Weinstein noted, Japan was grappling with multiple economic challenges even before the disaster hit, including high unemployment and the lingering effects of the 2009 financial crisis. The country's capital utilization rate was 85 percent, meaning that plant and equipment were running below capacity. With simultaneously low levels of aggregate demand, any increase in demand will offset reductions on the supply side. “That doesn’t mean wealth hasn’t been destroyed,” says Weinstein. “It surely has. But it tells you something about how GDP is measured.”

The upshot: “One-time catastrophic events may have big short-term impacts,” he said. “But their long-run impacts tend to be quite small. While the human toll is truly horrible, the aggregate economic effects tend to be much less severe.”

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