Earthquake and Economy

I've spent a couple hours watching the news from Japan, switching between TBS and NHK, both available via internet. Having watched footage, it's still unimaginable. The tsunami hit Rikuzentakata, population 23,000. It just … vanished. Hopefully most fled between the short interval between the initial quake and the tsunami, but aerial photos of occupied cars being washed off a highway in the initial wave suggest that interval was too short for some.

The magnitude of the damage is unknown; the focus remains basic rescue. A quick check of the Japan Meteorological Agency web site shows over 150 aftershocks big enough to be listed, many over Magnitude 6 – under normal circumstances strong enough to have made the news. It's not clear yet whether cooling can be restored at the Fukushima nuclear power plant before a partial meltdown – the initial reports suggest "no". Elsewhere fires burn out of control, with no ability to do more than watch from a distance. Amazingly, many elevated roads seemed to have survived both the quake and the tsunami passing underneath; wooden structures hit with water however just … disappeared into debris.

Indeed, writing 12 hours after the above -- 10 am US East Coast on Sat 12 March, midnight of 12 March in Japan -- power is already back on in parts of Sendai, with traffic lights operating amid light traffic. Japan's earthquake codes seemed to have done their job: no scenes of the pancaked buildings familiar from Haiti or New Zealand. Indeed, at least some ferro-concrete structures appear to have remained standing in areas otherwise swept clean by the tsunami. The earthquake itself seems to have caused damage far less than the size of the quake might suggest; it was the tsunami that was inexorable in force. Disruptions there will be, but there is nothing to suggest wholesale destruction of physical productive capacity. Factories will likely stay shut until aftershocks die down – one friend was kept awake all night yesterday by the constant shaking 150 miles away in Chiba. The worst damaged nuclear power plant has managed to start pumping in sea water; it will never operate again, but a catastrophic meltdown now appears less likely.

For now the productive capacity that matters are the hospitals: they're accepting patients on a triage basis in all but the worst-hit places along the coast. And the information is getting out, it seems the internet remains operable in areas away from the coast, even while electricity remained cut.

So what to make of it as an economist? Here are quick thoughts.

First and foremost, this wasn't the big earthquake that everyone feared: it was not a repeat of the Great Kanto earthquake that hit at 12:01 pm on September 1, 1923. The city erupted in flames, as charcoal was the primary fuel for cooking lunch; tens of thousands were asphyxiated in the following firestorm. On average the Tokyo area has been hit by a major quake once every 50 years -- it's now been almost 90. So while there were casualties in Tokyo proper, and not all the subways are operating, Japan's major population center effectively escaped damage. The other two major centers, Nagoya and the Osaka-Kyoto area, were unaffected -- with Tokyo, those three metropolitan areas account for over half of Japan's population. Nevertheless, Sendai is a city of 1.0 million, so the earthquake may have produced tens of thousands of casualties.

This will obviously have a short-term effect on the economy; production in the region will cease for some time to come. Initial very partial reports suggest damage at factories in the area, including several Toyota subsidiaries that specialize in small cars. Ports facilities are damaged (or just gone) while roads are impassible. Given the complex overlay of supply chains in many areas of manufacturing, this will hit production elsewhere in (and outside of) Japan in a manner that is yet impossible to delineate. Now many plants were away from the coast and designed to withstand moderate earthquakes. This one was not moderate. So between clearing roads and making basic repairs, it may be a couple weeks before anything can restart. It's not possible to do more than note the issue – it could be much worse.

This is in a context of recovery from a recession. The most recent data, for Oct-Dec 2010, showed negative growth; projections (e.g., Morgan Stanley MUFG) were of 1.5% growth this quarter. The short-term impact will be small this quarter, because it's largely over. Nevertheless the disruption to manufacturing throughout the country, and the short-run loss of most output for the remainder of March in the northeast, could push the economy back to nearly zero. The short-run impact will appear mainly in next quarter's data.

Japan however is not a manufacturing power – or not primarily one – but a service economy, as is true of the US and the European economies. Hospitals in most of the country will continue to treat patients as always, restaurants will continue to serve lunches and dinners, schools will do their thing. There is no particular reason that the Sendai earthquake and tsunami will change those in the (economic) majority of Japan. Indeed, refugees may boost demand elsewhere, partially offsetting the collapse of activity in the areas directly affected by the temblor.

Then the rebuilding will begin. Since the Japanese economy operates below capacity, and youth in particular are underemployed, this won't be at the cost of other production, or at least not on a one-for-one basis. In other words, on a net basis the boost in employment would offset most if not all of the jobs lost. Of course Japan is running a large deficit, but unlike the US there is no unreasoned panic about debt and deficits. Interest rates remain close to 1% on government and high-quality corporate bonds. If the government needs to 10% of GDP, then it can probably do so without much problem. Yes, in the long run the deficit needs to be turned into a surplus. Short-run needs will dominate for another year or so. And since the Kan government was close to collapse, unable to pass legislation, trimming the deficit wasn't going to happen anytime soon.

So a year from now … the economy will be back on track. There are uncertainties. What will be the impact on markets of insurance companies liquidating portfolios to pay claims? Or (my at present uninformed guess) will they be partially bailed out? Beside China, the economies of Japan's major trading partners are growing slowly; next year will surely be better... Will the disaster speed political realignment? My guess is it will – after all, Japan's politics can't get worse, can they?

This isn't good news. It's just not as bad as the news could have been.

Mike Smitka, Lexington VA