Economic aftershocks

The apocalyptic images of the destruction wrought in Japan by Friday's massive earthquake and the resulting tsunami will live long in the memory. On the whole you would have to say that Japan's extensive earthquake preparedness served the country well. Reports on Saturday suggest that life in Tokyo is returning to some semblance of normality, though in the worst-affected areas around Sendai the extent of the devastation is still unclear, and of course there's still the Fukushima nuclear plant to worry about, though fears of "another Chernobyl" seem to be overblown. (Update, March 15: Bloomberg has a good explanation of the physics here).

Even before the cleanup gets under way, people are starting to make assessments of the likely economic impact, on Japan itself and on the global economy. Some of these have been frankly quite peculiar. Let's take a look.

The standard text on the subject is "Sixty seconds that will change the world", by Peter Hadfield. Published in 1992, it's now out of print, though you can still pick up a copy on Amazon (perhaps at a higher price than was the case a few days ago). Hadfield attempted to predict the consequences of a repeat of the Great Kanto Plain Earthquake of 1923, which killed 140,000 people and left much of Tokyo in ruins. His belief was that the death toll in any repeat occurrence would be much higher, because of the rise in population, and the damage would be much more severe -- there weren't any three-storey expressways in the middle of Tokyo back in 1923. He predicted that the entire world economy would be plunged into depression as Japan turned its attention to rebuilding, sold its foreign financial assets and withdrew temporarily from trading with the rest of the world.

This week's event wasn't on the Kanto Plain, but even allowing for that, much of Hadfield's analysis seems dated. Japan has continued to make progress in earthquake-proofing its buildings and infrastructure. The relative lack of damage suffered in the Tokyo area suggests that a Kanto-style event (i.e. a tremor on land rather than at sea) would be less damaging than the 1923 disaster was, as the Japanese have always claimed. There's not much you can do about a tsunami, but the area worst affected by flooding is relatively less populous and less pivotal to the Japanese economy than Kanto was in 1923, or is now. Lastly, Japan is much less important to the global economy now than it was when Padfield wrote his book, so the impact on the rest of the world should be correspondingly smaller.

Despite these differences, much of the early analysis seems to be heavily influenced by Padfield's doom-and-gloom approach. There are fears that the economy will be plunged into recession and that the government's dismal fiscal position will be pushed over the edge by the costs of reconstruction. This piece on Slate by Annie Lowrey is fairly typical. Even the Tokyo stock market seems to think the same, selling off as news of the disaster came in.

There's no doubt that the economy has slowed to a crawl for the last day or two, but there's no reason to think that will last very long. The rebuilding process that will soon get underway is a Keynesian public works project writ very large. What's more, it won't all have to be paid for by the government. The Japanese are the best-insured people in the world. Householders will now claim on their insurance to rebuild homes, replace furniture and cars, and so on. This will give economic activity a strong boost in the very near future, and to the extent that this private sector spending generates tax revenues for the government, even the needed infrastructure rebuilding may not place an undue burden on the public purse.

The bill to be met by the insurers does raise one interesting possibility that was discussed in the Hadfield book. Japanese insurers have always been big buyers of foreign financial assets, including US Treasuries, because of the need to ensure liquidity in the event of a major earthquake. They have also ceded a great deal of coverage to the major international reinsurers. To the extent that the Japanese companies themselves, or the reinsurance giants, now have to liquidate assets in order to meet claims, the effect of the earthquake could well be felt in global financial markets. But it's highly unlikely that the quake and the tsunami will trigger an economic slowdown, either in Japan itself or anywhere else.

Addendum, 14 March. Bloomberg has a well thought-out piece on Japan here.