TOKYO: The scale of the earthquake and tsunami that struck Japan in March was far greater than even the authorities' worst scenarios foresaw. Nearly six months later, the total damage remains difficult to estimate. Social unrest and confusion, as well as radiation leaks from the Fukushima nuclear power plant, continue. And now the country has absorbed another huge blow: another downgrade of its bond ratings. Both Moody's and Standard & Poor's now rate Japanese bonds at only their fourth-highest level. So what policies should be implemented in response to these economic blows? Last year, Japan's economy grew at a relatively healthy 3 percent annual rate, higher than in the United States or the European Union, owing mainly to the fiscal expansion undertaken after the collapse of Lehman Brothers in 2008. But growth in 2011 had been predicted to slow even before the earthquake. Indeed, the economy shrank by 3.5 percet year on year in the first quarter. Now, with so much fixed capital and infrastructure destroyed by the earthquake and tsunami, the economy's productive capacity has fallen by an estimated 2 percent of GDP. But that may not be a bad thing: Prior to the earthquake, Japan had a demand-supply gap of approximately 5 percent of GDP. While reducing this gap to 3 percent of GDP has led to higher prices, this is exactly what Japan needs after years of persistent deflation. Meanwhile, higher public spending on capital investment and other special procurements will boost domestic demand. The Hanshin earthquake in 1995 destroyed capital stock worth 2 percent of GDP. This time, the loss is estimated at 3.4 percent of GDP, implying a larger increase in domestic demand if the right public policies are pursued. On the downside, confidence among consumers and investors alike has taken a hit, mainly owing to fears about radiation leakages and power shortages. According to the Japan Center for Economic Research, power-supply disruptions could negatively affect the Japanese economy for the next three years. If the Tokyo metropolitan area's power supply were to decrease by 10 percent this year, for example, Japan's GDP would fall by 2 percent. Soon after the disaster, the government announced that reconstruction demand and higher prices would bring about relatively rapid economic recovery. I think this view is too optimistic, because I suspect that the government wants to finance its new expenditure with a tax hike. Moreover, the extremely sharp contraction in first-quarter GDP may indicate that the disaster's negative impact on the economy was more significant than expected. Indeed, the economy is expected to have shrunk by another 2.6 percent year on year in the second quarter, with growth set to resume only in July-September. And, contrary to the government's outlook, the start of economic recovery could be delayed until the end of this year, with medium-term annual growth reaching 1.5- 2 percent. A key question has been the disaster's impact on global supply chains. According to Japan's Ministry of Economy, Trade, and Industry, which surveyed firms roughly a month after the earthquake, more than 60 percent of production sites in affected areas had already recovered as of April 15. Almost 30 percent expected to recover by the summer, and the remaining 10 percent foresaw normal operations after the autumn. But the impact of even a small number of disruptions to supply chains can be highly significant, particularly for the Asia-Pacific region. Consider Renesas Electronics, a medium-size company, with ¥150 billion ($1.9 billion) in annual sales, which accounts for more than half of worldwide production of essential micro-computing components for automobiles. Partly as a result of the damage at Renesas, Toyota's capacity-utilization rate dropped to 50 percent at the beginning of May. Likewise, the chemical manufacturer Kureha (¥130 billion in annual sales) has a 70 percent share of the global market for adhesive materials for lithium-ion batteries — a small but essential component of cell phones. Nokia in Finland, for example, imports 12 percent of its cell-phone components from Japan, and thus could be indirectly affected by the disaster. As a result, more companies are likely to create and implement business continuity plans. Indeed, “BCP” is set to become a key term in the region's economic discourse. Using BCPs to determine alternative producers means that regional economies will be integrated in a new form, with companies establishing cooperative relationships even with their competitors. Unfortunately, Japan's public officials appear incapable of similar flexibility. The disaster confirmed the traditional view of Japan as a country that combines a dynamic private sector with an anemic public sector and central administration. The government's mistakes in so-called “risk communication” regarding the Fukushima nuclear plant, and its slowness in getting necessary aid to people displaced by the disaster, have once again put the stereotype on full display. In terms of international relations, however, the disaster could improve Japan's bilateral ties with influential countries. For example, Chinese Premier Wen Jiabao and South Korean President Lee Myung-bak met with outgoing Japanese Prime Minister Naoto Kan in Fukushima, near the damaged plant — helping to ease neighboring countries' concerns about radiation leakage. Moreover, Japan's relations with the US, which had suffered since the Democratic Party of Japan came to power two years ago, appear to have emerged from the disaster stronger than ever. Japan's Self-Defense Forces played an important role in rescue and restoration activities, with about half of its 200,000 personnel dispatched to the damaged area. While this severely weakened Japan's defenses, the US ensured East Asia's security by deploying an aircraft carrier and cruisers, and American forces also searched for missing victims together with the JSDF. But Japan's neighbors expect rapid reconstruction and normalization, and for that, stronger political leadership is needed. The earthquake and tsunami have confronted Japan with a profound crisis — but also with a rare opportunity to undertake the comprehensive reforms that the country has postponed for far too long. Heizo Takenaka was Minister of Economics, Minister of Financial Reform, and Minister of Internal Affairs and Communications under Prime Minister Junichiro Koizumi. He is currently Director of the Global Security Research Institute at Keio University, Tokyo. This commentary is published by Daily News Egypt in collaboration with Project Syndicate, www.project-syndicate.org.
