Aftershocks: Prepare for the Slowdown

I’m back from the Higher Learning Commission conference in Chicago, which is why postings have been sparse.  I probably won’t get really back up to speed on postings for yet another few days because I’ve teaching, grading, and taxes to do.

In Japan, the aftershocks continue from the massive March 11 earthquake and tsunami.  The global economy is beginning to experience aftershocks from the triple disaster (quake-tsunami-nuclear meltdown) as well.  As readers might remember, I pointed out last month that the disaster would prove to be the first real large scale “stress test” of the concept of globalization in manufacturing.  The initial expectation of economists after the disaster was that it would prove a challenge and shock to the Japanese economy but that there really wouldn’t be much impact outside of Japan.  Now we are starting to see that this initial reaction was wrong.  We are starting to see aftershocks in the global economy.

The news for the last two weeks in the global auto industry has been about supply-chain interruptions and temporary plant closures. For example Forbes reports today on Toyota’s announcement:

Toyota Motor Corp. said today it is going to halt production in Europe for eight days due to parts supply shortages resulting from Marchs earthquake and tsunami.

The shutdowns will take place from April 21 to May 2.

Assembly plants in the U.K., France and Turkey will be impacted as well as engine manufacturing facilities in the U.K. and Poland.

The plants will then run at a limited capacity.

This is on top of earlier announcements of rolling temporary shutdowns at U.S. plants and the continued shutdown or slowed production at it’s Japan plants.  Other news reports today have Toyota advising U.S. dealers that there will likely be shortages of some models at showrooms this summer.  Other reports.

You can’t sell cars you don’t have and haven’t built.  And you can’t build cars without all the parts – less than 100% of the parts is just not enough. Phillipines, Japan, Turkey, France, U.S., Germany, Britain.  This is global. And it’s not just one company. It’s across the industry since most firms had all adopted the same globalized supply chain strategy built around single sources for key parts.

It’s also not just the auto industry. The Wall Street Journal reports how electronics manufacturers are being affected:

Over the weekend, the Nikkei reported that Sharp halted LCD panel production at its Kameyama plant in Mie Prefecture, western Japan, and at its Sakai plant in Osaka until after the Golden Week holiday season in early May. The paper cited disruptions to industrial gas supplies and said the company expects to secure more gas in about a month…

Sony said Friday it is suspending operations at its optical parts and IC cards plant in Miyagi prefecture in northeastern Japan, following a power outage caused by the biggest aftershock to hit the area late Thursday.

A Sony spokeswoman said the plant will resume operations as soon as the power supply has been restored.

“Electronics makers and auto makers are extremely sensitive to further damages as it is becoming increasingly unclear how soon companies can resume full production,” Watanabe said.

I think it’s safe now to say that Japanese earthquake-driven interruptions to supply chains are more than just a “risk” to the global economic performance. We should consider the interruptions and concomitant plant shutdowns as a factor currently slowing economic growth.  At this time, the big question is just how much they will slow growth and even potentially reduce employment.

As I’ve mentioned previously, I have no great (or little) econometric model that I use.  I just go on my intuition.  Right now, I’m thinking the supply chain interruptions reduce GDP growth in the U.S. in second and third quarter 2011 by maybe 0.2-0.3 percentage points.  That’s not much. And in normal times it could be easily absorbed.  But this is not normal times.  We only grew at 2.9% in 4Q 2010.  We won’t know 1Q 2011 growth for another two weeks, but estimates are running lower – in the 1.5 to 2.5% range.  We need growth above 4% if we are to make serious inroads on re-hiring the nearly 20 million unemployed people, so, yes, this hurts.

And, like all aftershocks, this one is not isolated. There’s other aftershocks starting to hit our economy. Aftershocks from misguided budget deals and misguided European monetary policy.  I’ll talk more about those as I get time. Unlike GE, I have to pay my taxes this weekend.

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.

Chile, Haiti, Earthquakes and Economics Tales

The popular story about Chile, as told in the Commanding Heights video and elsewhere, has “The Chicago Boys” helping dictator Pinochet to overthrow Marxism and quickly establishing a growing free-market, small-government paradise.  Even today, the free-market fundamentalists tout here and  here and here that the Chicago Boys and the free-market ideology is responsible for Chile having a lower death toll from their recent earthquake than Haiti experienced.  Balderdash.

First off,   I’m amazed that in the rush to congratulate Milton Friedman for “saving” so many Chileans from dying in the earthquake, that the free-market ideologues don’t consider population density.  Haiti is the world’s 30th most densely populated country. Chile is 192. Any earthquake that hits a densely populated area kills more than one in a less dense area. Duh. see Wikipedia.

Second, Chile’s current wealth/income and strong building codes are not exactly the result of what the Chicago Boys preached.  Things like 20% of Chile’s national income coming from mining, which in turn is dominated by a state-owned enterprise: Codelco.  Or, that Milton actually hated building inspectors and considered building codes as an unnecessary tax on property owners.

Third, Chile did not really grow rich from the Chicago Boys “reforms” in the mid-1970’s.  In fact, Chile’s economy suffered greatly from the shock therapy and privatization program and didn’t recover and then grow until 15 years later. I quote Krugman:

Fantasies of the Chicago Boys

DESCRIPTIONTotal Economy Databse

Ah, Chile. Remember how, during the Social Security debate, Chile’s retirement system was held up as an ideal — except it turned out that it actually yielded very poor results for many people, and the Chileans themselves hated it? Now we have the usual suspects claiming that Chile’s relatively low death toll in the quake proves that — you guessed it — Milton Friedman was right. You see, the Chicago Boys made Chile rich, and that’s what did it.

As a number of people have pointed out, there’s this little matter of building codes. Friedman wasn’t exactly fond of such codes — see this interview in which he calls such codes a form of government spending, because they “impose costs that you might not privately want to engage in”.

But there’s another point: the economics of Chile under Pinochet are a lot more ambiguous than legend has it. The way the story is told now, the free-market guys moved in, liberalized, and then there was a boom.

Actually, as you can see from the chart above, what happened was this: Chile had a huge economic crisis in the early 70s, which was, yes, partly due to Allende and the accompanying turmoil. Then the country experienced a recovery driven in large part by massive capital inflows, which mostly consisted of making up the lost ground. Then there was a huge crisis again in the early 1980s — part of the broader Latin debt crisis, but Chile was hit much worse than other major players. It wasn’t until the late 1980s, by which time the hard-line free-market policies had been considerably softened, that Chile finally moved definitively ahead of where it had been in the early 70s.

So: free-market policies are applied, and presto! prosperity follows — fifteen years later.