Japan: The Economic Consequences of Disaster

The human misery wrought by the tsunami and earthquakes in Japan tests the imagination of economists — but the effects on Japan’s economy and wealth are a different matter.

GDP, which measures goods and services produced, will immediately dive in Japan and stay lower through the second quarter and into the third quarter of 2011. It will then surge as the country rebuilds and increases spending on construction and capital equipment.

Overall, however, Japan will be poorer as a result of this disaster. Lost infrastructure, factories and the like will be replaced. However, wealth is the sum of what citizens and governments own. This includes physical assets, like those just noted, and financial wealth, namely securities and cash. Rebuilding will run down Japan’s financial wealth as the country replaces lost physical assets.

As estimates of the damage emerge, those totals are real deadweight losses to wealth. To the extent Japan must run down financial assets and bring home foreign investment to rebuild, the country’s net wealth is permanently reduced.

Generally, after three years or so, the impact on GDP is small — production is lost in the first two quarters, but more goods and services are produced in later quarters to rebuild. Often the net loss in GDP, from even the largest natural disasters, comes to no more than 1% of GDP in large advanced industrialized countries.

Replacing lost production and rebuilding lifts output in a nation’s geographic areas less affected by the disaster as they provide the resources to rebuild and compensate for lost output in the most-affected regions.

However, this time could be different. Japan has encountered three disasters — the tsunami and earthquake, plus the ongoing problems at some of the country’s nuclear power plants — and globalization may make Japan more vulnerable than in the past.

The triple whammy has the potential to keep the Japanese economy shut down longer, and globalization offers Japan’s export customers alternatives they might not have enjoyed a decade or two ago. For example, Hyundai and Ford now are good substitutes for Toyota’s cars, and even more so, Caterpillar tractors made in China can replace Komatsu’s land movers.

Because they will delay Japan’s return to full capacity, the power shortages stemming from the nuclear meltdowns will cause production to rev up outside the country.

In the longer term, the nuclear disaster will accelerate the implosion of Japan’s economy caused by an aging population, just as Hurricane Katrina caused people and activities to permanently leave more economically depressed areas of the Gulf region for faster-growing places in the United States.

Some of Louisiana’s and Mississippi’s lost capital will never be restored — it went elsewhere in the United States. For Japan’s disaster-stricken economy, that “elsewhere” may be other places around the world.

For the global economy, the nuclear disaster in Japan will cause more delay in reducing dependence on oil from the politically volatile Middle East. Wind, solar and other alternatives hold great promise, but nuclear still offers the safest large-scale option around.

This time, the path to recovery will be tougher for Japan — and for the global economy, ripped by the Great Recession and expensive oil, the path to recovery will be inexorably altered.