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The New Future of Japan?

Apr 05 , 2011

As the dust settles from Japan’s devastating triple tragedy — the earthquake and
tsunami of March 11, plus the ongoing nuclear power crisis — the country will have
to face new future scenarios.

Japan’s Nikkei average has already suffered its worst two-day fall in quarter of a
century, while fires at the Fukushima Daiichi nuclear plant, quakes in and around
Tokyo, and potentially very high radiation contribute to uncertainty among investors. On Monday, Japan’s central bank injected $183 billion to stabilize financial markets – far too little to contain volatility in Japanese, European and U.S. stock markets.

The tragedy of March 11 has the potential to keep Japan mired in its lost years —
but it could also contribute to a new future for the country.

Slowing recovery

During the past ten to 15 years, Tokyo has exhausted traditional monetary and fiscal policy instruments, while lingering deflation and a high public debt ratio constrain the nation’s ability to rebound.

Gross public debt is now over 210% of GDP. Since much of this debt is owned by the government and backed by real assets, net debt may be more relevant in this case.

Currently, it is 110% of GDP, which slows growth but is significantly lower than the
gross public debt. Moreover, the debt is in yens — it is not owned by foreign investors who are less committed to Japan’s national fortunes. As a result, sovereign default risk in Japan looks much lower than in Greece in the short term. In the longer term, fundamental risks will increase.

Over time, however, larger fiscal deficits and a decreasing household saving rate
could move Japan toward a savings crisis, with adverse impacts on both the Japanese and world economies.

Even before the earthquake, the turmoil in North Africa and the Middle East caused
increasing anxiety in Japan, which receives more than 5% of its imports from Saudi
Arabia and over 4% from the United Arab Emirates. The unrest has highlighted oil- dependence throughout energy-thirsty Asia, but especially in resource-poor Japan, which buys 90% of its crude from the Middle East. In mid-February, the Economy, Trade and Industry Minister Banri Kaieda warned that rising oil prices were the biggest risk to the nation's economic recovery.

Before the country’s current crisis, Japan hoped to revise its economic fortunes by maintaining its competitive edge as an exporter of high-quality consumer and high-technology capital goods, especially through greater trade liberalization.

Amidst the crisis, dozens of Japanese firms, from component makers to electronics firms and automakers, are keeping their plants shuttered. Meanwhile, damage to infrastructure will take months to repair. Concurrently, major vehicle manufactures — including Toyota and Honda — halted production for several days across Japan. Several other highprofile companies — Toshiba, Sony and Nippon Paper Group, for example — closed plants due to outages and the need for check-ups.

As damage at Japanese plants and infrastructure threatens to disrupt the global manufacturing chain longer than many had expected, it will not only extend the price increases for key technology components. It will also result in a search for alternatives to Japan’s producers.

Extensive immediate impact

Only a month before the earthquake, IMF warned that Japanese banks may need to raise their capital base to cope with various risks, including a potential global slowdown induced by Europe’s debt crisis and an increase in bad loans to smaller companies. In the aftermath of the nuclear crisis, these risks will increase.

For now, the Japanese devastation has hit hardest three prefectures – Fukushima, Miyagi, and Iwate – which together account for 4% of Japan’s GDP. However, production and distribution have come to a standstill also in Tohoku and Hokkaido. If these are included in the affected areas, the GDP share soars to almost 12%.

Even then, damage estimates remain difficult because today global value chain networks dominate across many regions and industries.

In Japan, power shortages led Tepco – Tokyo Electric Power Company, the largest electric utility in Japan, and the 4th largest worldwide – to launch rolling blackouts, which constrain economic activities in the nine prefectures affected (Tokyo and its eight neighbors), which account for some 40% of Japanese GDP.

The power shortfall amounts to 25% of total. Currently, rationing is expected to last until late April, affecting millions of people from the northeast coast down to Shizuoka, the center of the most recent earthquake, 200km south of Tokyo.

However, reconstruction will also trigger colossal increases in construction investment. After the Kobe earthquake in 1995, the subsequent reconstruction provided a substantial boost to the economy. If the Bank of Japan seizes the opportunity to conduct more expansionary monetary policy, acceleration of policy easing efforts could reduce deflation in Japan.

Indeed, a bold reconstruction effort could actually increase Japan’s growth rate.

Japan’s secular transition

In mid-February, Japan officially lost its position as the world's second-biggest economy to China. Still, the nation continues to account for 8.7% of world GDP (at nominal prices). Consequently, Japan’s growth trajectories — further deterioration, or substantial reconstruction demand, or both — will have a substantial impact on both the global economy and commodity prices.

Since the 1980s and 1990s, large emerging economies have begun to play an increasing role in the world economy and global growth. At the same time, the proportionate role of the advanced economies is declining. In 2010, Japan accounted for 9% of world GDP. By 2030, the figure will be 3%.

These projections, however, use the rearview mirror to anticipate the future.

In any nation, crisis is a crossroads of both threat and opportunity. In this regard, Japan is no exception. In the aftermath of the current crisis, it could respond to the
shock by implementing reforms needed to reverse its impending decline.

Internationally, Japan is known for its highly regarded, capital-intensive and very innovative global corporations. In Japan, however, some 75% of employees continue to produce goods and services for the domestic economy. In the longer run, Japan needs to rebalance its economy and create new business opportunities in the international economy.

Despite the great aura of “Made in Japan” today, population aging has failed to trigger the creation of vibrant new domestic and export markets for medical equipment, services for the elderly and related needs. As old industries are now declining and new rivals — from South Korea and Taiwan to China and India — populate emerging industries, the risk is increasing that Japan’s growth prospects could stagnate even further in the absence of significant, even radical, reforms.

Reinvigorating the economy will require a pro-growth economy — and that requires able and bold leadership. In the past few years, sluggish growth has gone hand-inhand with indecisive political leaders. If the Democratic Party of Japan (DPJ), led by Prime Minister Naoto Kan, can cope with the crisis, it will become a credible alternative to the Liberal Democratic Party (LDP), which ruled the nation for over half a century. If it fails to seize this opportunity, it will open still another window of opportunity to the LDP.

Tokyo is at a tipping point. It can be swept by forces it cannot control — or it can
reverse their direction to its benefit.

Dr Steinbock is Research Director of International Business at India, China and
America Institute (USA) and Visiting Fellow at Shanghai Institutes for International
Studies. He also serves as the chief contributor of The Globalist on issues of
G-20 economies and global corporations.

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