The Lessons of the Great Tohoku Earthquake and Its Effects on Japan’s Economy (Part 1)

The Effects of the Great Earthquake on Japan’s Macro Economy

Hidetaka Yoneyama
Senior Research Fellow

April 8, 2011 (Friday)

We at the Fujitsu Research Institute extend our deepest condolences to those people of the Tohoku area who were affected by the Great Tohoku Earthquake of March 11, and we pray for the speedy recovery of the affected area. We also wish for a speedy resolution to the incident at the Fukushima nuclear reactor, which weighs heavily upon the victims of the disaster, aggravates their anxieties, and makes recovery even more difficult. There is no doubt that the earthquake and tsunamis, and moreover the nuclear reactor incident, will have long-term, wide-ranging, and profound effects on Japan’s economy. What these effects are specifically will likely be debated much in the coming days, but currently we would like to offer proposals for evaluating the effects and speeding recovery as much as possible. The analyses and opinions contained herein are those of the individual researchers and may change based on future research. However, we would like to publish our thoughts as soon as possible and thereby awaken wide-ranging discussion, learn as many lessons as possible from this severe disaster, and lend whatever aid we can to speed the affected area’s recovery. The posting of articles is planned as below but may vary due to changes in the situation.

The structure of this series is as below.

(1) The Effects of the Great Earthquake on Japan’s Macro Economy

(2) Making Use of Juki-net to Provide Safety Information Rapidly

(3) Japan’s Energy Policy and its Impact on Global Warming Countermeasures

(4) The Effects of Power Shortage on Japan’s Economy

(5) Japanese Industry After the Great Tohoku Earthquake

(6) Thoughts on Planned Blackouts: Redesigning the Power System

(7) Disaster Prevention and Regional Development in an Aging Society

(8) Toward Rebuilding the Japan of Tomorrow

(1) The Effects of the Great Earthquake on Japan’s Macro Economy

We are still unable to grasp the full scope of the damage wreaked by the Great Tohoku Earthquake of March 11, but it is certainly causing enormous damage to Japan’s economic activity. Below, we look at the effects of the earthquake on Japan’s macro economy.

1. Direct Damage from the Earthquake

First, when calculating the economic damage due to an earthquake or any natural disaster, we normally divide it into direct and indirect damages. Direct damage is damage to stock such as houses and buildings, roads and harbors. In the case of the Great Hanshin Earthquake, direct damages were calculated at ¥9.9 trillion (estimated by Hyogo prefecture). The method of calculating damages is to multiply each stock’s valuation amount (fixed asset valuation amount, etc.) by the percent of damage, and then sum these together cumulatively.

However, at this point in time we are yet unable to grasp the full picture of the damage, and it is impossible to perform such calculations; this type of calculation can only be done after the damage has been sorted out. At present, a number of private institutions are estimating damages of around ¥10-15 trillion, 1.5 times the damage of the Great Hanshin Earthquake. These calculations are based on the idea of using the direct damage of the Great Hanshin Earthquake as a baseline and taking into account the differences in stock scale and economic scale of the areas affected by the respective earthquakes.

Such preliminary calculations are the best that can be done at this point, but let us check the validity of these numbers from a different angle. EQECAT, a catastrophe risk evaluation company based in California, has preliminarily calculated the damages due to the earthquake that are covered by earthquake insurance at around $8-15 billion (¥640 billion-1.2 trillion; exchange rate $1 = ¥80 on March 16, 2011). In contrast, the full amount of earthquake insurance paid at the time of the Great Hanshin Earthquake was ¥78.3 billion (according to the General Insurance Association of Japan). When calculating direct damage, in addition to using the ratable value or carrying value, the insurance money estimate may be used as well. Because insurance requires prompt payment, companies which evaluate the risk of such payment have the know-how to calculate damages by comparison with past disasters.

If we use this insurance payment amount together with the percentage of earthquake insurance enrollment in Hyogo prefecture before the Great Hanshin Earthquake (4.8%) and the average enrollment across Iwate, Miyagi, and Fukushima Prefectures before the Great Tohoku Earthquake (19.6% in 2009), and further, if all houses damaged in each earthquake had earthquake insurance coverage (the percentage of earthquake insurance enrollment of damaged houses is assumed to be the same as the overall percentage of home insurance enrollment), we are then able to calculate how much the total insurance payment would be. This works out to ¥1.6 trillion for the Great Hanshin Earthquake and ¥3.3-6.1 trillion for the Great Tohoku Earthquake. The latter’s direct damage to houses was 2 to 4 times greater than the former’s.

This point requires caution, however, because earthquake insurance coverage extends to include not only the house itself but household articles as well, and the past and present cover ratios are likely different. It is important to note that after the Great Hanshin Earthquake, from 1996 onwards, the payment limit on earthquake insurance was increased fourfold. However, because there was no significant difference between the per-household insurance payouts of the Great Hanshin Earthquake and the Chuetsu Earthquake (the earthquake with the greatest per-household payout to occur after the Great Hanshin Earthquake), the effects of increased payment limits on insurance payout amounts was not taken into account in this calculation.

Direct damage also includes stock other than houses, but in highly populated urban areas, houses increase proportionately to the population while other facilities and roads do not. Therefore, the magnitude of the direct damage to houses at the time of the Great Hanshin Earthquake would be less than that of the direct damage to stock other than houses. However, even taking this point into consideration, the above numbers show that the scale of the direct damage done to all stock by the recent earthquake is possibly several times greater than that of the Great Hanshin Earthquake. These numbers exceed any other direct damage numbers that are currently being released.

2. Indirect Damage from the Earthquake

Indirect damage involves economic stagnation, loss of opportunity and the like. Destruction of production plants and blockages in their logistics networks make companies unable to produce or transport products compared to if the earthquake hadn’t happened, and this difference is the amount of loss they suffer. In this case, the earthquake caused a nuclear power plant to stop functioning, which led to power shortages and planned blackouts, which consequently caused cessation of production. This is an example of indirect damage.

Within the stagnant production of the Tohoku area, production of electronics parts and information-related intermediary goods have been particularly hard-hit. In recent years, the Tohoku region has increased its production share in these industries by actively inviting factories. The six prefectures of the Tohoku region comprise a 12.3% share of shipping in electronic parts, circuitry, and devices and a 14.4% share of information communications equipment. Of the six prefectures, Iwate, Miyagi, and Fukushima took enormous damage and all production has stopped. As a result, factories in other regions which rely on the supply of parts from the factories in these prefectures have also had to stop production. Companies in South Korea and China which import parts from these factories are also worried about the supply of parts being cut off.

Table 1: Shares of manufactured goods shipping comprised by Tohoku region (2009)

This situation is likely to continue for the foreseeable future, but there is a trend which is gradually spreading among manufacturers towards transferring production of parts from Tohoku factories to other regions. If this transfer continues to progress, there is a real possibility that the supply of parts will start up again. Such a framework will likely be prepared within a few months’ time.

On the other hand, the planned blackouts due to power shortages have affected production; depending on the product, even a short stoppage of power can stop production completely, and manufacturers are racking their brains to deal with this problem. If one considers that TEPCO has lost 25% of the power production necessary for this time of year, then by corollary the various activities for which people rely on electricity must be curtailed by the same amount. However, if the power outages end at the end of April as planned, thanks to the operation of thermal power plants while the Fukushima nuclear plant is offline, there should be no lasting adverse effects. On the other hand, the question of whether or not TEPCO will be able to supply enough power during the summer is yet uncertain, and the situation remains unpredictable. For products which cannot have production stopped mid-flow, manufacturers may start transferring production to factories in areas that are not affected by blackouts.

This is not limited, however, to manufactured goods, as supply of foodstuffs to the Tohoku region has also been severed and there are shortages of certain items. However, switchovers to supply from other regions have increased, and shortages are expected to be resolved before long.

This production-related, indirect damage can be overcome to a certain extent by switching over to supply from other areas and is not expected to have long-lasting effects on Japan’s economy. In terms of GDP statistics, reduction of production from January to March had a negative effect, while adverse effects are likely to gradually disperse from April to June. Conversely, if stoppages in production draw on, the incomes of people working in those plants will decline, and the consumption slump will remain in its rut. If, however, decreased production is nipped in the bud, the adverse effects on Japan’s economy can be minimized.

Among the various indirect damages, one that is likely to grow more severe in the future is the expected drastic drop in the number of visitors from abroad. At present, cancellations by tours and individual tourists are coming one after another. Hardest hit by this trend are tourist attractions that have grown in popularity in recent years, such as Akihabara. This will likely appear as a deficit in travel within Japan’s current-account balance.

3. Contriving to Raise Reconstruction Funds and Reconstruction Plans

Now that the earthquakes have settled down, and once the nuclear power plant’s radiation leaks have been sealed successfully, the stage will be set at last for rebuilding in earnest. If things proceed well, real reconstruction demand will emerge in the second half of 2011. At the time of the Great Hanshin Earthquake, three supplementary budgets were drafted—the second budget in 1994 and the first and second budgets in 1995—with a total of ¥3.2 trillion in expenditures. According to Hyogo Prefecture, ¥16 trillion in reconstruction funds was invested over a ten-year period. Since the direct damages resulting from the recent earthquake amount to twice as much as those of the Great Hanshin Earthquake, reconstruction will require twice the amount of funding. It would be nice if supplementary budgets were twice what they were in the past as well. For quite some time, reconstruction demand will have a beneficial effect on Japan’s economy, especially in terms of GDP growth rate.

The problem is sources of funding. For example, even if increases in child assistance amounts were frozen, this would amount to nothing more than a small and temporary source of funds which would not be able to supply the necessary funds over a long period of time. Other than issuing national bonds, which has been done up until now, some ideas for securing funding sources which have been proposed are: issuing interest-free national bonds, issuing disaster reconstruction national bonds, temporarily raising consumption tax, or imposing an environmental tax.

For the time being, if even trimming down unnecessary annual spending does not result in obtaining the necessary funds, there will be no choice but to increase the issuance of national bonds. In the case of interest-free national bonds, the government would have to provide some alternative benefit in order to offset the lack of interest, such as exemption on inheritance tax, which raises the question of whether there is on balance any merit for the government to issue these bonds. At the time of the Great Hanshin Earthquake it was proposed that disaster reconstruction national bonds be exempt from tax on interest receipts, but there is the concern that if this type of national bond were sold, no one would buy other types of national bonds.

Over the mid- to long-term, increased issuing of national bonds could lead to long-term increase in interest rates. The only way to sweep away the concerns about financial reconstruction is to advance the discussion of drastic reforms of the tax system. Increased consumption tax rates and the introduction of environmental tax, which should be realized through the drastic reform of the tax system, would provide a realistic means of funding rebuilding efforts. At the same time, reform of annual spending and the reduction of public servant salaries should be brought about as well.

Japan’s reconstruction plan is something that the public and private sectors should hammer out together as a plan that will lead Japan’s revitalization in the future. Some examples of future projects are: reconstruction of agriculture and fisheries by making full use of high-tech; implementing a new type of urban development (compact cities, development of tourism resources that are attractive to foreign countries); and ensuring far greater safety at nuclear power plants and promoting the movement towards new energies.