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History Shows Rebuilding Spurs Economy

A few years ago, a senior official at Japan’s finance ministry shocked a foreign guest by making a deliberately provocative statement. “What Japan’s economy needs is a really good earthquake,” he said. Now, tragically, his tongue-in-cheek wish has come true.

Tsunami hits Japan
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Tsunami hits Japan

What the official was trying to say was the following. First, the country was stuck in deflation. Since the mid-late 1990s it had failed to shake off the debilitating drip of gently falling prices. One way of tackling that, the official suggested in remarks that echoed the thinking of Ben Bernanke, now chairman of the US Federal Reserve, was to pump huge amounts of money into the economy.

All the better, said some unorthodox economists, if the Bank of Japan would directly finance all or part of the extra spending, a policy suggestion that is anathema to senior officials at the central bank.

The second point was psychological. Japan had lost its confidence, the official said. A good crisis was all it would take to rekindle the remarkable ability of the Japanese people to pull together in the cause of the nation.

Paradoxically, natural disasters – and the need to rebuild – can prove a catalyst to economic activity.

Naoto Kan, Japan’s prime minister, could capitalize on the crisis to push his regular budget through a parliament that had been blocking its passage. He is also likely to propose a supplementary budget to fund the rebuilding projects that will now be necessary.

One optimist even suggested he might use the disaster to rally support for a rise in consumption tax, now just 5 per cent and seen by some as the key to repairing Japan’s precarious public finances.

No two natural disasters are the same. But in their attempts to forecast the economic effects of Japan’s seismic devastation, analysts have zoomed in on the calamitous 1995 Kobe earthquake. The Kobe quake killed 6,500 people and caused 10,000 billion yen of damage – about 2.5 percent of Japan’s gross domestic product. Over the subsequent six months the country’s stock market plunged 25 percent, even as big global markets moved higher.

But economic activity proved more resilient, as it may do this time. Growth was broadly in line with pre-quake forecasts, partly thanks to an emergency budget put in place immediately after the disaster.

Yet there are big differences between conditions now and 16 years ago. “Japan’s public finances are now in a far more wretched state,” said Chris Scicluna, economist at Daiwa Capital Markets. Japan’s gross government debt now stands at about 200 percent of GDP, twice the level in the mid-1990s. Given this debt burden, some economists reckon the government will be under pressure to spend less than the 3,000 billion yen it dedicated to reconstruction after the Kobe disaster.

Economists at Nomura predict the government will respond to the disaster with a spending package of a similar size to that of 1995. But they warn “the additional fiscal spending would probably involve significantly more borrowing and have an adverse effect on Japan’s fiscal position”.

When financial markets reopen today traders will be watching for announcements from the government and the central bank on the size, timing and nature of their response to the devastation, as well as monitoring Japanese government bond yields and the value of the yen.

In the aftermath of the Kobe quake, the yen appreciated by about 20 percent against the dollar within three months, as domestic investors repatriated overseas funds and insurance companies brought money home to pay claims.

Analysts say the yen will not strengthen as much this time, partly because the finance ministry, already worried about the currency’s strength, will be tempted to intervene. Given the tremendous shock Japan has suffered, other countries may be forgiving of such a move.

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