Reconstruction after the March 2011 Disaster in Japan: issues, policy options and prospects Presentation at the XVI conference on Dynamics, Economic Growth, and International Trade (DEGIT-XVI) at the Saint-Petersburg University 8-9 September 2011. Sisira Jayasuriya and Nobu Yamashita School of Economics and Finance La Trobe University
A 9.0 magnitude earthquake on at 14.46, 11 March 2011, hitting the northeast coast of Honshu, Japan. The worst affected area was the east coast of Tohoku region. Then, the earthquake triggered a devastating Tsunami wiping away houses, buildings, cars along the widespread areas of the northeast coast. Estimated deaths (including missing people) over 25,000 (compared with less than 7,000 in Kobe earthquake in 1995) and displaced (evacuees) close to half million people The Tsunami damaged the emergency generators and the cooling systems at the Fukushima Dai-ichi Nuclear Power Generators resulting in spread of radiation and fears of a catastrophic nuclear disaster 2
Japanese community response to the disaster Japanese people faced the crisis with remarkable discipline, courage and social cohesion Contrast with breakdown of social order after Hurricane Katrina in USA Immediate measures taken to attend to affected communities and to restore vital infrastructure Some criticism of government for not acting fast enough, particularly regarding the nuclear plant 3
Impact on World and Regional Economies Impact on currency and stock markets: Stock markets fell Yen appreciated very strongly immediately after but fell back after G-7 intervention Impact on international trade: Japanese exports affected (food, manufactured goods) Disruption to supply networks due to impact on parts and components - felt globally, very strongly in East Asia (motor vehicles, electronics). Note: China is Japan s largest export market Impact on commodity prices mixed: expectations of higher Japanese demand for oil and construction related resources Impact on insurance sector, including reinsurers: estimates of some $35 billion to private insurers (compared with less than one billion in 1995 -Kobe) Confidence in (already fragile) global recovery further shaken but resource exporters expect to gain once reconstruction starts 4
Economic Cost to Japan: worst ever natural disaster Total damage excluding radiation-related damages and longer term disruptions to power supplies - could be as much as much as 6% of GDP (> US$300 billion). - compared with around 2% of GDP damage from 1994 Kobe earthquake - almost four times the cost of Hurricane Katrina in USA - Fatalities much smaller than in the 2004 Asian Tsunami: 227,000 deaths vs <30,000 but economic cost much higher: US$ 10 billion vs US$300 billion 5
Economics of Reconstruction 6
Destruction of Assets Destruction of STOCK of productive assets (capital, infrastructure, labour etc)- app 1% of capital stock: economy poorer Immediate impact on GDP flow relatively minor and as reconstruction begins, GDP growth picks up Estimated impact 0.25%-1.5% during 2011-2012 and 0.5%-1.25% in 2013 7
Economic activity at various stages following a disaster Economic Activity Relief Rehabilitation Reconstruction Time Source: Adapted from Jayasuriya and McCawley (2010) 8
Challenges for Japan The nuclear energy issue Financing reconstruction 9
Nuclear Power is a major component of Japanese power industry: Share of total energy supply before march 2011: around 30% 10
In June 2010, the official government Strategic Energy Plan of Japan stated that one of the main targets will be: Promoting nuclear power generation, aiming to build 9 new or additional nuclear plants by 2020 and more than 14 by 2030 11
Nuclear Crisis: continuing impact The nuclear power issue has become very controversial and has both local and global implications Generally reconstruction can begin after the natural disaster The nuclear crisis has an ongoing impact, so total impact difficult to assess and also complicates recovery/reconstruction efforts 12
The Fukushima Dai-ichi nuclear power plant crisis (and how it was handled) has led to a breakdown of public confidence in both the nuclear industry and in governments and politicians Safety measures inadequate: June 2011 IAEA report Attempts at cover up and corrupt practices Regulatory failure Government-business relations: very cosy, too cosy 13
Financing Reconstruction Many disaster affected countries face financing problems in undertaking reconstruction and require international assistance or large borrowings 14
Japan: can it finance reconstruction? The Economist, July 21, 2011 Japan's debt - The long-term prognosis for the debt-ridden economy is not good Fact: Japan is NOT a poor, indebted country: despite 20 years of economic stagnation it is a rich and affluent country with huge national savings 15
Source: IMF, 2010 16
Government has a large debt, but to its own citizens foreigners own only 5% of Japanese government bonds. 17
Japanese Government Debt Source: Financial Times, Feb7, 2010 18
Capacity to fund reconstruction is not the issue in Japan What are the best options for financing reconstruction? 19
In principle, government can finance reconstruction in four ways (or varying combinations of them): 1. Cut current expenditure and divert funds to reconstruction 2. Introduce a new tax to raise revenues 3. Borrow from the public ( selling bonds to the public ) 4. Monetize the debt by selling government bonds to the Bank of Japan (BOJ) 20
Context Twenty years of stagnation, near zero interest rates, deflationary pressures, large government debt Global developments reducing global demand, appreciating Yen: negative impact on exports and lower chances of overall recovery 21
Reconstruction offers opportunity for a large stimulus to the economy, through spending on productive investments 22
Reconstruction: a construction boom Reconstruction is initially concentrated in construction sector in affected areas construction sector boom in disaster area A construction boom raises economic activity overall, initial impact on construction then spreads through to other parts of economy 23
Construction Boom and Prices Construction boom raises demand for construction inputs (materials and labour) tends to increase prices Relatively elastic supply of easily imported (tradable) inputs but less elastic supply of domestically sourced (non-tradable) inputs construction materials prices and skilled construction wages some appreciation of the real exchange rate (relative price of non-tradables to tradables) Real exchange rate appreciates (non-tradeables/tradeables relative price increases) Construction boom can have negative impact on net exports Magnitude of price increases depends on size of demand increase and on supply elasticities 24
International Experience: 2004 Asian Tsunami reconstruction In Aceh, Indonesia and Sri Lanka, skilled construction labour wages increased by 50-60% and in some cases doubled and overall construction costs increased by 80-100% (Note: Aceh is remote from major population centres such as Java) Funding gaps emerged due to underestimation of cost increases In Thailand, magnitude of reconstruction effort was smaller relative to GDP and construction sector was large and had been depressed, wage increases were very small and overall construction cost escalation minor 25
Impact of Reconstruction Policies on Critical Economic Variables Borrow sell bonds to public or to central bank: Bank of Japan and fiscal conservatives oppose government borrowings Opposition demands cuts in social programmes Some rating agencies have warned more government borrowing will precipitate a bond market crisis driving up interest rates If BOJ buys government bonds, exchange rate - tend to depreciate inflation - tend to increase But bond markets MAY react by driving up interest rates.. 26
Collapse of confidence in Japanese government bonds? 27
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Bond yields after March 9 March 10: 1.2 % Ten-year yields July 25: 1.11 % Sept 7 (yesterday): 1.01 % Source: Bloomberg 29
Inflation in Japan? March 11 - a negative demand shock and milder supply shock consumer spending down due to restraint and deepening pessimism about future worsens deflationary pressure Some positive inflation to be welcomed! 30
Source: IMF, 2010 31
Impact on: Policy Govt debt Exchange rate Prices Economic activity Cut current spending No increase None or minor (+ or -) depending on extent of diversion of spending to non-tradables Minor (+ or -) depending on extent of diversion of spending to non-tradables Minor (+ or -) Increase taxes No increase Might appreciate: private sector savings go down, Current Acct surplus down, may generate inflows Minor (+ or -) Minor (+ or -) Sell bonds to public Increase: higher debt to public Might destabilise bond markets, appreciate Minor (+ or -) Minor (+ or -) Monetize debt Increase: higher debt to BOJ Depreciate Inflationary Significant + 32
Long term recovery: Confidence and Spending Japan has had twenty years of stagnation : the two lost decades : economy needs a boost to demand through more spending But: Consumer confidence further shaken spending down Concerns about government debt in absence of a medium term plan for debt reduction, higher government spending may generate a Ricardian response Broader economic recovery may be further delayed with social and political repercussions 33
Best Option? A combination of money finance and a temporary reconstruction tax, with a clear medium term strategy for debt reduction (higher consumption tax in future ) But most likely: reconstruction with no major stimulus, continuing economic stagnation 34