Nikkei Veritas – Market Eye column, 16th May 2011
The catastrophe of the earthquake and tsunami is a great human tragedy. Its impact on the economy will be much less than the suffering that it causes to individuals. Governor Shirakawa initially expected the loss of output to be restored within six months and the IMF forecast that growth would amount to 1.4% in 2011 compared to 3.9% estimated for 2010. Economic forecasts are of course unreliable and particularly so in Japan’s current circumstances. Although early forecasts are being revised down, they are nonetheless reasonably encouraging.
Much, of course, needs to be done. Decisions are needed about how and where to rebuild Tohoku’s stricken economy and how to aid those who have suffered emotionally and financially. Probably around half of the total cost will fall on the government and I think that the funds should be borrowed rather than raised in taxes, so that the economy does not have a fall in demand to add to the loss of output. It is also clear that the electric utility industry needs reform. Its regulatory structure needs toughening and difficult decisions are needed over the future of those who have been displaced by the radiation. The extent to which Japan should rely on nuclear power must also be decided. The present government is clearly in a weak position to push through the measures needed, but unfortunately its plans also appear to be indecisive and public expectations seem low. I expect that Japan will muddle through and the economy will recover, but that the Japanese people will continue to feel disillusioned and let down by their politicians and bureaucrats.
As I have pointed out in previous articles, Japanese companies need to invest less at home and more abroad. In the short-term, the impact of the tsunami will be to increase investment within Japan to replace capital that has been destroyed, but the longer term impact will be to encourage foreign investment by showing the disruption that can result from relying on supplies of parts from Japan. Customers for these parts will want to be less dependent on Japanese sources in the future and Japanese companies will not wish to lose market share by having these supplied by competitors. This will encourage Japanese companies to increase their overseas production, so that they can retain their customers’ loyalty while reducing the risk of breakdowns in supply.
Looking beyond the next year or so, Japan will be faced with the same issues as before. The budget deficit will have to be brought down and it seems to be increasingly recognised that a serious start must be made on this programme once the economy has recovered. What does not seem to be understood is that this will almost certainly require Japan to continue to run a large trade surplus. Because of the steady fall in Japan’s population the country cannot expand at other than a slow pace. Excluding the temporary extra investment which the rebuilding will require, the current level of capital expenditure is too great for a slow growing economy with the result that the return on new capital is absurdly depressed. Domestic investment should therefore fall rather than rise. However, national savings will naturally rise as the government’s budget deficit declines. This must be balanced by a rise in investment, which can only sensibly occur overseas.
It has been surprising and disappointing that Japanese companies have been so slow to increase the rate at which they invest abroad. They need to do so and this should be encouraged by the benefits in the future of being able to supply customers from outside Japan as well as from domestic sources.
Japan’s trade balance will probably move over the rest of this year into deficit, as imports will be needed for reconstruction and exports will be prevented by the disruption of output. For a strong and vigorous recovery export growth will then have to be strong. This will be only be possible if world demand is growing strongly and the yen does not strengthen. There was a risk when the earthquake hit, that the yen would strengthen. Happily prompt action both by the Bank of Japan and by international agreement prevented this. It will be very important that such action is repeated if the threat of a stronger yen recurs.
The Bank of Japan can of course do nothing about world demand and we must hope that by the time the economy has recovered from the catastrophe it will not be hit by international troubles.