Global Letter On Japan

Here's an interesting note from Nomura International's Global Chief Economist, Paul Sheard, who lived in Japan for many years and is a fluent Japanese speaker.

'Tragic as it is, this natural disaster may serve as a catalyst for Japan to forge a brighter future.

Prime Minister Naoto Kan this week described Japan’s earthquake and tsunami as presenting the country with its biggest crisis and challenge since World War II. For a country that rose from the nuclear ashes of horrendous defeat to become (and remain for four decades) the second largest economy in the world this is no small claim. It may be true or at least close to the truth.

In economic terms, natural disasters such as this one represent (in the broad) a combination of an immediate negative shock to supply, as human life, infrastructure and wealth are lost and economic activity is disrupted, and a positive shock to demand, which starts to emerge with a lag and can last for several years. In judging the impact on GDP, levels and rates of growth need to be distinguished. Typically, potential output falls, as does the current or next quarter’s growth rate relative to what it would otherwise have been, but higher growth rates are recorded later on. Our Japan team expects the disaster to shave 0.4pp off 2011 real GDP growth (we now expect 0.9%) but add 0.3pp to 2012 growth (2.5%) (see Japan Roundup in this issue for details).

But as Mr Kan’s assessment suggests, this disaster has implications far beyond a narrow GDP accounting exercise. There is the added short-term uncertainty associated with the damaged nuclear reactors, meaning that the ultimate scale of the disaster remains unknown. But an event like this – reminding people of their vulnerability in the face of Mother Nature and of the limits of their technology – can also be a shock to confidence and alter the way an individual, and a society, thinks and behaves. Ramifications can be long-lasting and difficult to divine in advance.

Will the shock further reinforce the sense of economic, social and political malaise that has developed in Japan in the past two decades, making it more difficult for the economy to escape its deflation trap and get off its worrying fiscal trajectory? Or will it galvanise the resolve of the Japanese people and serve as a catalyst for changes that one day, in retrospect, may be seen as marking a positive turning point in the economy ? It is far too early to say, but we see some positive signs already and some room to be cautiously optimistic on that score.

First, the disaster has significantly altered the political landscape, at least in the short term. Before last Friday, it looked like the prime minister whom just last month the Economist magazine described as “proposing the boldest reforms to Japan in decades” was on his way out and the country was headed for a possible early election over a budget impasse. Japanese politicians are now rallying around the flag, and the Kan administration has a chance to lead.

Second, a more expansionary fiscal and monetary policy mix is on its way. This is exactly what deflation-ridden Japan needs. Japan’s GDP deflator has fallen by 15% since its peak in Q2 1994 while the US GDP deflator is up 40% in that period (the UK’s is up 47%, Korea’s by 63%). The government says it “[places] top priority on casting off deflation”. Many, particularly in Japan, worry that Japan’s parlous fiscal situation does not give it the leeway to expand fiscal policy. But there is a world of difference between “Japan” and “the government of Japan”: the latter has a debt problem, the former does not – it is a large net creditor to the rest of the world, a status that is bolstered each year it continues to run a big current account surplus. And the Bank of Japan, which until Monday had hardly expanded its balance sheet since the 2008 crisis, has unlimited capacity to do so by buying JGBs and other assets, financed by creating excess reserves.

Third, Japan has suffered from a “brand image” problem in recent years and has been subject to what Japanese call “Japan passing (ignoring)” (as opposed to earlier “Japan bashing”). Now it is in the world’s limelight, and has its abundant sympathy. Last week’s unexpected decision by the G7 to engage in coordinated foreign exchange intervention with Japan may reflect elements of both. Japan has an opportunity to press the reset button on its image and even its place in the world.

Fourth, in the future Japan will need to engage in a lot of reconstruction and new construction as it strives to make its vulnerable archipelago safer for its people, and do so at a time when its population will be rapidly ageing and its construction workforce has been depleted and is ageing too. The associated need for construction workers, not to mention nursing and personal care workers, may serve as a catalyst for Japan to revisit its immigration and guest-worker policies.

Japan has the resources to overcome this challenge and to emerge even stronger and in better economic health; it just needs the resourcefulness. Through history, it has always displayed that'.

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