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Japan fallout: economic cost

By   /   March 31, 2011  /   Comments

Editor’s note: This the second of a three-part series.

In my first segment, an assessment of Japan’s earthquake dealt with environmental cost. As the crisis continues, we learn more specifics, such as radiation possibly affecting water supply. As time passes, we will continue to assess the damage on the overall environment. Now let us shift our thoughts to the possible economic damage to Japan and the global economy.

Certainly, this tragedy will negatively impact Japan’s economic growth as reconstruction efforts stretch their declining credit status. The possible damage to food and water will impact their domestic industries and their level of exports. In addition, their fiscal problems are much greater than the U.S. and cleanup efforts will exacerbate their debt issues that supersede the U.S. Their public debt is extremely high at $10.84 trillion in 2011, which remarkably represents 202.5% of GDP. For comparison purposes, the U.S. is at 64.9 percent of GDP. Additionally, Japan’s credit rating was already downgraded to AA- by Standard & Poor’s and remains far below the U.S. credit rating of AAA, which is the highest possible rating. This is important because it will be more costly for Japan to service their debt and resulting higher interest costs will hamper future investment and job creation.

The Bank of Japan, Japan’s version of the U.S. Federal Reserve, embarked on an aggressive monetary policy campaign that have implications to the U.S. economy. Soon after the earthquake, many Japanese insurance companies, sold significant portions of their U.S. dollar holdings for yen because they anticipated making large payouts to destroyed residences and businesses, who were covered through insurance. This event caused the yen to dramatically appreciate and the U.S. dollar to depreciate.

That actually was a worst-case scenario for Japan because they are an export-oriented economy with the U.S. being able to take advantage of a cheaper dollar to increase their exports at Japan’s expense. In order to prevent this from happening, the Bank of Japan was able to stabilize the currency markets by buying over 15 trillion yen ($184 billion in U.S. dollars). They were also able to persuade six of the G7 nations, which is comprised of the U.S., France, Germany, Italy, Great Britain, Canada and Japan, to assist by selling their yen holdings. The combination of these efforts stopped the yen from rising and will make Japanese exports more competitive.

Even though the Bank of Japan’s monetary actions quelled market pressure, there are still implications on trade and its impact on U.S. companies. With severe damage to the nuclear reactor complex in northeast Japan, they have imposed rolling blackouts throughout the country to conserve energy. This method is slowing industrial production and is causing difficulty to U.S. and global manufacturing that need those suppliers to meet their manufacturing, electronic, and chemical needs. Depending on its severity and length, the cost of finished goods will continue to rise and that can lead to greater inflation and smaller profit margins. As of right now, it appears that overall production declines will not be severe, though.

There is also concern about radiation and its impact on food supply, but the impact is deemed marginal. The U.S. Food and Drug Administration announced last week that it is temporarily halting food imports from Japan. While this action should place upward pressure on food prices, it is not expected to have much of an effect since they only represent 4% of total U.S. imports.

So far, it appears that the crisis has been quarantined to primarily affect Japan. The cost of reconstruction will be another obstacle for Japan and their attempts to reverse their economic malaise. While some will point to increased economic activity that goes with reconstruction, we must not fall prey to the broken window fallacy. It is true that jobs will be created in rebuilding or replacing nuclear reactors, along with fixing damaged facilities and roads. However, this is simply diverting funding that could have been used in elevating current production, rather than replacing lost production.

On the other hand, relatively successful efforts in containing nuclear waste means that any damage will be moderate and should not be a lag on U.S. or global economic growth. It is true that we might see a temporary rise in auto, electronics, and other durable goods, but it appears that it will not contribute a significant drag on U.S. economic activity. Quick and decisive action led by U.S. intervention in containing the nuclear reactor crisis has helped to moderate the rise in economic cost for the U.S. and the world. Unfortunately, the same cannot be said for Japan.

Aaron Johnson is the assistant Professor of economics at Darton College, where he also serves as director of the small business management program. He publishes a blog at econprofaj.blogspot.com.
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Tom Knighton is the publisher of The Albany Journal. In November, 2011, he became the first blogger to take over a newspaper anywhere in the world. In August of 2012, he made the difficult decision to take the Journal out of print circulation and become an online news agency, a first for the Albany area.

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