Opening Remarks

Japan: Economic Aftershocks


Humanity's powers of recovery are remarkable. The Japanese, who have already reconstructed some roads that were ripped apart by the Mar. 11 earthquake, are only the latest to demonstrate this. "What has so often excited wonder [is] the great rapidity with which countries recover from a state of devastation," the English philosopher and economist John Stuart Mill wrote in the 19th century. In the spirit of Mill, forecasters today are predicting that the Japanese economy will suffer just one, or at most two, quarters of declining output, followed by a boom as rebuilding kicks into high gear. The rest of the world, they say, will scarcely sense a tremor. "We are not changing our growth forecast for the U.S.," says Augustine Faucher, director of macroeconomics at Moody's Analytics (MCO), an economic consulting firm in West Chester, Pa.

History is on the optimists' side. Southern California rebounded rapidly after the Northridge earthquake in 1994, as did China after the Sichuan earthquake in 2008 and Japan itself after the Kobe earthquake in 1995.

Still, there are two scary differences between this disaster and previous ones. One is the release of ionizing atomic radiation, which by endangering the health of rescue workers and ordinary civilians is likely to deepen the downturn and slow the recovery. The other is the vulnerability of global manufacturers to disruptions in supply from Japanese factories, including those far from the devastation that are nonetheless affected by rolling blackouts and aftershock tremors.

The truth is, no one yet knows how much of a problem the radiation and supply-chain disruptions will prove to be. That uncertainty is itself cause for concern. "It's very Rumsfeldian. It's the unknowns that are unknown we're dealing with," says Michael Robinet, director of global production forecasts at IHS Automotive (IHS) in Northville, Mich.

Stephen S. Roach is more worried than most of his economist confreres. "There's a predisposition to ignore anything until it's too late," says Roach, the supervisory board chairman of Morgan Stanley (MS), who is now teaching at Yale University. The advanced economies remain weak after the financial crisis. Oil prices have shot up on unrest in the Middle East and North Africa. The European sovereign debt crisis won't end. "None of those in isolation would qualify as a tipping point," Roach says, "but I worry about the combination. I just think it's important to be cautious in this climate."

The prudent course is to prepare for a worse-than-expected outcome. For business, that means putting people and money to work on contingency plans that with any luck will prove unnecessary. Automakers are already doing that to some extent—analyzing whether scarce parts can be sourced elsewhere or designed around. For governments outside of Japan, scenario planning means readying emergency fiscal and monetary interventions just in case the disaster refuses to stay contained to the island nation.

When John Stuart Mill marveled at the "disappearance, in a short time, of all traces of the mischiefs done by earthquakes, floods, hurricanes, and the ravages of war," he did not have millisieverts in mind. Today that measure of dosage of radiation is a constant presence on Google (GOOG) News. France's Institut de Radioprotection et de Sûreté Nucléaire estimated on Mar. 22 that the Fukushima Dai-Ichi nuclear power plant had already released 90 quadrillion becquerels' worth of radioactive iodine-131. If so, that is more than 100,000 times as much as was released in the partial meltdown at Three Mile Island in 1979, according to the Institute for Energy and Environmental Research, a nonprofit based in Takoma Park, Md.

Radiation is paralyzing both physically and psychologically. Even factories and offices that were not damaged by the earthquake or tsunami have been rendered off-limits by radiation risk. And the situation hasn't stabilized. On Mar. 29 regulators detected record-high radioactivity in seawater near the crippled plant. Meanwhile, the aftershocks are unnerving. According to a Bloomberg Businessweek calculation from U.S. Geological Survey data, there were 397 tremors of 5.0 or higher on the Richter scale off or near the east coast of Japan's main island from Mar. 11 through Mar. 23. That's nearly one-third as many as occur worldwide in a typical year.

Conventional economic analysis assumes that Japan's problems will remain localized. The country hasn't been an engine of growth for other nations since the 1980s, anyway. For the U.S., exports to Japan accounted for only 0.4 percent of gross domestic product, says Moody's Faucher. Economists assume that the interruption won't be severe enough to cause layoffs and destroy consumer demand, so sales missed now will be made up in the future.

But that lofty perspective misses what happens on the ground if the world runs out of critical components that are made in Japan. A Mar. 30 study by the U.S. Business and Industry Council found that imports from Japan accounted for 33 percent of all capacitors sold in the U.S., 26 percent of magnetic and optical recording media, and 21 percent of metal-cutting machine tools as of 2009.

A modern automobile has about 15,000 parts, counting every last screw. If even one part is missing, the car can't be completed. In Europe, General Motors (GM) temporarily stopped some work at plants in Zaragoza, Spain, and Eisenach, Germany, that build the Corsa small car. Ford Motor (F) told dealers to stop ordering vehicles in tuxedo black and is limiting production of three shades of red because of the loss of a pigment called Xirallic from a plant in the Fukushima exclusion zone. IHS Automotive predicts that global auto production will be down 15 percent to 30 percent two months after the quake.

This is the biggest earthquake ever to strike an important exporting zone. Who knew before Mar. 11 that a Japanese company called Kureha had 70 percent of the global market for polyvinylidene fluoride, or that PVDF is necessary as a binder in lithium ion batteries? The only Kureha factory to make the resin is in Fukushima Prefecture and has stopped production because it suffered damage and can't get raw materials, says spokesman Akio Kazui. Bad news for Apple (AAPL), which uses the pliable batteries in products like the iPod. Apple declined to comment.

In many cases companies aren't even aware of their exposure, says Kevin Tynan, an automotive analyst for Bloomberg Industries in New York. They know their suppliers, but not their suppliers' suppliers, or the suppliers of those suppliers. "I keep telling people, anybody who can figure out the global automotive supply chain will get a Nobel prize," Tynan says.

In the long run, the healing that amazed Mill will occur. Companies will improvise and work around obstacles. In 2002, Honda Motor (HMC) airlifted carbon sheet steel from Japan to the U.S. at a cost of $3,000 a ton after tariff-related supply disruptions. In this crisis, "You're going to try to keep assembly lines running as best you can," says Dave Andrea, senior vice-president for industry analysis and economics at the Original Equipment Suppliers Assn., an auto-parts trade group based in Troy, Mich. But getting back to normal will take foresight, creativity, and determination. The best way to achieve a rapid recovery from the Japanese disaster is to prepare for a slow one.

Coy_190
Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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