Possible Economic Effects of Japanese Disasters

Some information is starting to develop about the economic impacts of the events in Japan.  A week ago, just after the triple disasters of earthquake, tsunami, and nuclear plant partial meltdown, it was much too difficult to foresee the probable impacts of the crisis. Now it’s starting to show and the news is not encouraging for a world that was only engaged in a weak precarious “recovery” from the Global Recession/Global Financial Crisis.

This crisis is really going to be a “stress-test” of modern globalized supply-chains.  The growth of world trade, particularly trade with and within Asia in the last 2 decades has been less about traditional trade, the buying and selling of finished goods between independent agents in different countries.  Instead, “globalization” is increasingly about extended specialization that stretches production processes around the globe. In traditional trade, a disruption of supply from one region is quickly substituted by other products from other regions. Thus traditionally, a natural disaster in one area tended to harm the economy of that region but not have ripple effects elsewhere.  Now, with globalized supply chains for complex designed products like consumer electronics, automobiles, industrial equipment, and computers, a simple disruption in one region might require the shutdown of production in far distant regions as parts become scarce.  Parts of sub-assemblies are usually design-specific and cannot be easily replaced by other sources.

We’re seeing the early signs of such problems.  Last week GM announced the temporary shutdown of an assembly plant in Shreveport, LA due to a lack of parts from Japan.  The NYTimes and WSJ report, via Calculated Risk, that in Japan itself, while Nissan has announced the first re-start of an entire auto assembly plant, resumption of full production at Japanese automakes remains uncertain.  Honda has warned that full production may not restart until May.  They also report that GM has had to curtail production at at least 2 plants in Europe in Spain and Germany. Now today, USA Today reports that the GM shutdown in Shreveport has rippled back to Tonawonda, NY, where GM makes engines for the pickups that are hung up pending Japanese parts.  More on the Japanese struggles to recover at the NYTimes.

Right now, many economists, particularly investment bank economists are saying the risks to global growth are minimal.  But much of their argument is based on the past and the experience with the Kobe earthquake in Japan in 1994.  I’m not so sure.  For one thing, the global supply chains are much more complex and tightly integrated now than they were after Kobe.  It’s not just autos. It’s also a lot of other industries and production spread throughout east Asia such as Hong Kong, Taiwan, Thailand, and Korea.

Another very serious factor is how fast electrical power generation can be restored.  The Economist quotes Richard Koo:

the country as a whole might have suffered about a 12% decline in its capacity to supply electricity. Since the elasticity of electricy usage to GDP is about 2, this means that Japan’s GDP might have shrunk by as much as 6% in the wake of this disaster. Although efforts to improve electricity supply are on the way, even a momentary GDP decline of 6% is a huge shock to the economy.

I’m inclined to agree.  Electricity capacity is not quickly restored if the entire plants are scrapped as is happening with Fukashima, the site of the destroyed nuclear reactors.  This could mean a very deep contraction for Japan with a slow recovery. A 6% decline in the third largest GDP in the world and one of the most active trading partners would be a very serious dent in the world economy.  Especially at a time when Europe is struggling to grow because of it’s Euro-strait jacket monetary system and growth-reducing austerity policies.

Here in the U.S., we are facing our own threats to this very anemic “recovery” in the form of deeper state and local government spending and employment cuts.  We are also facing the prospect of higher gas prices for a protracted period which will also slow the economy.  I had hopes that the Japanese disasters, by slowing the Japanese economy, might at least weaken global demand for oil and possibly temper the recent rises in prices. But, alas, with the weekend decision to bomb Libya, oil prices have once again begun to rise.