Shadow Government

Economic aftershocks: 4 big repercussions

A calamity like Japan’s massive 9.0 earthquake last week is certain to rock Japan’s economy and, in turn, global commerce. There is no good way to put a number on this coming shock, though one early assessment was the fall of more than six percent in Japan’s Nikkei stock market index on Monday. Instead, we ...


A calamity like Japan’s massive 9.0 earthquake last week is certain to rock Japan’s economy and, in turn, global commerce. There is no good way to put a number on this coming shock, though one early assessment was the fall of more than six percent in Japan’s Nikkei stock market index on Monday.

Instead, we can sound a general alarm and suggest where the impacts are most likely to appear. Here are four broad areas likely to see significant repercussions:

Several years ago, there was talk of whether Asia’s flourishing economies had "delinked" from the consumer-driven economies of the West. That talk faded away with the global financial crisis. A sharp downturn in the United States and Europe depressed global trade and buffeted Asia.

Now the question is how shocks are transmitted from Asia back to the West. Japan, a trade surplus country, has not been a major source of net demand for the world economy. But it is tightly interwoven into the global manufacturing network. It demands parts from around Asia and the rest of the world and is a supplier of key components. Thus, when Japanese factories shut down and supply chains are temporarily broken, this could well leave factories elsewhere with either a slimmed-down order book or with critical ingredients out of stock.

The nuclear plant crises that followed the tsunami damage have inevitably rekindled debates about the safety and desirability of nuclear power. These debates come at a time of high oil prices and a sustained push to move away from carbon fuels for environmental reasons. The problem is that modern economies run on energy, demand is expected to boom, and there are a finite number of economically viable alternatives. There have been arguments that rational economic calculations will drive decisions and that we just need to be cautious about the design maintenance and siting of nuclear reactors. As we all familiarize ourselves with the various degrees of nuclear plant meltdown, it will be interesting to see if the debate remains this dispassionate. A turn away from nuclear energy would effectively curtail global energy supplies in the medium to long run and have a negative effect on global growth.

Political economy
Several weeks ago I was in Tokyo at an economic conference. Some distinguished Japanese described economic reforms they felt the country should undertake (e.g. budget moves, trade liberalization for the agricultural sector) but questioned whether Prime Minister Kan would even last a month in office.

One way or the other, this persistent debilitated state should change sharply in the near future. Prime Minister Kan’s feeble government has been presented with enormous challenges. If it handles them deftly, support for the government could build. If it stumbles, that increases the odds of a quick fall. In either case, there will be ramifications for the role Japan plays in undertaking G20 commitments, crafting an agreement at the World Trade Organization, or joining the Trans-Pacific Partnership.

Macroeconomics and deflation
Japan has experienced slow growth and deflation for roughly two decades now. How to interpret this experience is something of a Rorschach test for economists. The Japanese case is simultaneously held up as an example of how ineffective Keynesian stimulus policies are ("look how much they spent and what little they have to show for it!") and of the validity of Keynesian analysis ("they raised taxes and never spent enough!").

Whatever the interpretation, Japan has built up an extraordinary pile of public debt (approximately 200 percent of GDP) and has nonetheless managed to remain in an extended deflationary slump. This puts Japan in an odd position as it faces massive rebuilding costs. On the one hand, this looks like a burst of needed economic activity (fixing Bastiat’s figurative broken windows). On the other hand, the prospect of borrowing more money looks daunting, given the enormous debt burden. But it has been unclear for years why Japan would not monetize its debt and just print money. It has provided the world’s leading recent example of a liquidity trap (interest rates stuck at zero) but it has always had the ability to do its version of quantitative easing. It could print yen and buy foreign currency.

There are two standard arguments against doing this. First, printing money tends to cause inflation. After the last two decades, though, Japan could use a little inflation. Second, Japan could be accused of currency manipulation. Yet the yen has appreciated from 123 yen/dollar in June 2007 to 81 yen/dollar now.

After the 1995 Kobe earthquake, money flooded back into Japan and the yen rose. Today, in the wake of last week’s quake, the Bank of Japan poured the equivalent of over $180 billion into money markets to ease concerns. That was not an explicit move to depreciate the currency, but Japan may well be faced with the choice of whether to allow the yen to rise as money repatriates or to break out of its slump by depreciating the currency.

There are more questions than answers about how a shaken Japanese economy will respond to last week’s quake. Given Japan’s central position in the global economy, the economic shock waves can be expected to emanate out from the epicenter like their physical counterparts.

Phil Levy is Senior Fellow on the Global Economy, The Chicago Council on Global Affairs, and teaches strategy at Northwestern University’s Kellogg Schoool of Management.
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