Economic Implications of Japan’s Earthquake

Japan copes with the aftermath of its biggest earthquake on record. What effect will the disaster have on its economy?

The full effects of the devastating tsunami that hit Japan after its biggest earthquake on record struck Friday were still difficult to gather three days later. Based on the experience of past disasters though, analysts expect that a burst of reconstruction activity could boost the Japanese economy near the end of this year.

Entire towns along Japan’s northeastern coast were swept away by the tsunami. Thousands of people were still missing as relief efforts were underway. Auto plants, electronics factories and energy plants were closed. Millions of homes and businesses were left without electricity.

Several of the nation’s airports, including Tokyo’s Narita, and all sea ports suspended operations while partial rail service resumed on Sunday. At least one bullet train carrying hundreds of passengers in Miyagi Prefecture had been derailed while four went missing in the coastal areas.

Prime Minister Naoto Kan said that the country hadn’t faced a larger crisis since the end of World War II. After months of political gridlock, Japan’s two main political parties came together to enact an emergency budget, probably including a temporary tax hike to fund reconstruction.

In the short run, Japanese companies are expected to divert resources back home for recovery, strengthening the yen and undermining the competitiveness of Japanese exports. While immediate growth is likely to stall as a result of the massive damage incurred on infrastructure and housing, their rebuilding will effectively amount to a massive stimulus, said Ian Bremmer of the Eurasia Group on the Fox Business Network this week.

Analysts have attempted to draw lessons from the 1995 Kobe earthquake. That disaster caused some ¥10 trillion, or $120 billion in today’s exchange rates, in damage. At the time, it equaled 2.5 percent of Japan’s GDP but it devastated a major port and a larger chunk of Japan’s industrial output than Friday’s catastrophe.

Kobe, moreover, was built on sand. “They didn’t know there was a fault line under it,” said Bremmer. “While this was a many, many, many times greater magnitude earthquake, the likely impact on the actual infrastructure is considerably lower.”

Japan is one of the most heavily indebted nations in the world. The long-term effects of repeated short-term government interventions in the private sector during the “lost decade” of the 1990s have resulted in a huge public debt that exceeds GDP twofold.

Trapped in low growth and a corrosive downward spiral of deflation, the economy has contracted significantly in recent years despite being one of the world’s largest. The bulk of Japanese debt is held domestically however. The global implications of its recession and recent devastation will likely be limited therefore.

Japan accounted for $5.4 trillion, or almost 9 percent, of the world’s GDP last year. Its economy contracted mildly at the time but was expected to expand by 1.5 percent this year.