Don’t cry for Japan: Like the Phoenix, it will rise from ashes

A massive earthquake in the magnitude of 9.0 on the Richter scale struck offshore Japan on Friday, 11 March, 2011. It caused tsunami waves to rise, as high as 10 metres at an incredible speed of some 800 kilometres per hour, almost equal to the normal speed of a commercial jetliner.

These waves invaded the North Eastern coastal belt of the country with such ferocity that nobody had time to save his or her valuable mobile property. This was too much for Japan’s inbuilt defence system against tsunami and within hours, the entire coastal belt was reduced to a heap of debris covered by mud and sea water. The disruption to the power supply caused by tsunami waves brought in another unexpected disaster for which the country had not been ready at all. That was the consequential explosions in two nuclear power plants located along the coastal belt due to the failure of the cooling system caused by disconnected power supply. The result was a secondary disaster for which there was no immediate solution. It caused the exploded plants to belch profusely clouds of smoke containing hazardous radioactive materials.  

The initial tsunami drew sympathy of all other nations prompting them to rush assistance to Japan. But the subsequent spread of radioactive materials sent fear waves through both Japan and its neighbouring countries forcing them to take immediate protective measures. It appeared that Japan has been hit by disaster after disaster within such a short period of time making that giant of an economy sick, lame and immobile.

The Popular Opinion: Japan is beaten and down

Naturally, the markets immediately took a negative view of Japan’s disaster. Their reaction caused both the Japanese Yen and its stock index, Nikkei, to fall. At the same time, future prices of many other products which would be in high demand for rebuilding work took a steep rise.

The ground situation was so precarious that it prompted many analysts to lament over the end of an economic giant which had kept its head up for decades above the rest of the crowd.

Simon Winchester, the author of Krakatoa: The Day the World Exploded, writing in the Newsweek of 21 March, 2011, equated the disaster in Japan to a cruel and unannounced withdrawal of the geological consent under which the mankind has come to inhabit this earth.

According to him, this can take place again and again, since Japan is located on the tip of the earthquake producing tectonic belt and earthquakes normally swing from one end of the belt to the other like a pendulum.

It is only a matter of time for Japan and other nations along the belt to experience a similar disaster again.

All in all, the popular opinion is that Japan is badly beaten and down.

Parallels with Central Bank’s bomb explosion of 1996

In my view, there is no ground for being pessimistic and losing hope.

I have the first hand experience of the massive destruction that took place in the Central Bank of Sri Lanka in 1996 in a huge bomb explosion in front of the building. Immediately after the bomb explosion, the scenario around the area was quite similar to what one saw in videos on Japanese tsunami today. It was a scene of debris scattered all around being watched by still smoking and sad looking high rise buildings that had been reduced just to skeletons. When this was shown on television, many, including the terrorists who had perpetrated this horrendous act, believed that it was the end of the Central Bank.

But that was not to be. Governor A.S. Jayawardena who had by then recovered from the initial shock of the attack valiantly announced to the media at a press briefing held the following day that “We’ve been badly beaten, but not down”. He implied at the press briefing and subsequently carried it to the letter too, that like the mythical Phoenix which rose from the ashes after it was completely burned, the Central Bank too would in no time rise from the ashes.

He had good reason to say so with a tone of confidence. The bomb had destroyed the Bank’s physical infrastructure including its computer system, but its human capital base consisting of so many brains had been left practically intact. It is the collective action of humans who build institutions, nations and civilisations and also man made creations.

So, the Central Bank rose from the ashes – rising to greater heights this time which no one had anticipated – by mobilising its top brains.

Japan’s Human Capital Base is intact.   

In the recent tsunami, a significant part of Japan’s physical infrastructure has been destroyed. But, its human capital base which matters for that nation to rebuild itself has largely remained intact.

What is this often talked about human capital base of Japan? It is the unparalleled managerial, engineering, technological and scientific competency of its people which elevated Japan to a nation of significance within decades after it had been destroyed fully in the course of the unfortunate events of the World War II. Since then, Japan has been upgrading its human capital continuously through research and development at home and getting new knowledge developed elsewhere through scientific collaboration. It has helped Japan to do engineering marvels. The introduction of the world’s fastest train system, construction of high rise buildings susceptible to earthquakes, building of off shore airports, long suspension bridges connecting far away islands are some of the recent engineering marvels about which Japan can truly be proud of. It can, therefore, mobilise its competent human capital base at any time for rebuilding the nation.  

Hence, Japan has been beaten, but not down.

Japan’s economy, sick but not dead

Japan attained a high economic growth continuously in 1960s and 1970s thanks to the growing global demand for Japanese industrial products which could successfully compete with the rival products of Western countries on account of their low prices. This growth momentum was fuelled by high investments made by Japan continuously with the support of the traditionally high savings of the Japanese. In some years, savings of the Japanese were as high as a half of their total income. Hence, Japan’s economic prosperity was basically attained by integrating to the international markets rather than satisfying the domestic demand.

Over the years, Japan generated a surplus of savings which was much more than its annual absorption capacity within the economy. At the same time, with growing prosperity, its labour costs started to rise, eroding the cost efficiency it has been maintaining over the rival products of Western countries. Both the high savings and rising labour costs led Japan to transfer its production base to other low cost Asian countries such as Malaysia, Thailand, the Philippines, South Korea and China. Japan, therefore, continued to increase its exports and enjoy surpluses in its trade account which eventually led to surpluses in its overall balance of the balance of payments. The ultimate result of the surpluses in BOP was the accumulation of foreign exchange reserves. But such accumulations threatened to inflate the economy if the Bank of Japan bought such foreign currency for local money to support the international value of the Yen. Considering inflation to be a bigger enemy and under pressure from the US Administration, Japan allowed its currency to appreciate in the market.

In terms of the traditional economic theory, the appreciation of the Yen would have solved the problem by reducing Japan’s exports (because exports are now more expensive) and encouraging imports (because imports become cheaper). This did not happen in Japan’s case because of another development which economists have begun to call the “Bazaar Effect”.

Japan, the bazaar man

Bazaar Effect, first identified by German economist Hans Werner Sinn in the case of the German economy, simply means that a country becomes a bazaar man instead of a producer. A bazaar man just buys goods at a lower price and sells at a higher price and, therefore, an intermediary between a producer and a consumer. His income is the profits from his sales.

There is nothing bad about bazaar men and they too are essential participants of the production – consumption processes of modern economies. But, if a whole country becomes a bazaar man, then, its production base is replaced by just buying and selling and, therefore, it loses a significant part of income which it would have earned as a producer before it became a bazaar man.

This is the sickness from which the Japanese economy is presently suffering. It has a growing export sector, but the export income is earned not in Japan but elsewhere. For instance, Toyotas manufactured in plants in Malaysia are brought to Japan and re-exported to the other destinations with a “Made in Japan” tag attached to them. This bazaar tactic helps Japan to record a high export volume, but its value addition in Japan is only the profit margin earned on the exports.  Therefore, despite the high export growth, its income growth within the country has been minuscule.

What is the ultimate result of these developments? It is the development of a distorted economy with many contradictions: a high export growth accompanied by low economic growth; low inflation accompanied by low domestic consumption; negative real interest rates accompanied by low domestic investments, and finally, all these contradictions leading to a stagnating economy.

Hence, Japan’s economy is sick. But it still produces a marginally growing output and, therefore, it is not dead.

The current situation in Japan has been explained by economists in terms of a popular economic concept known as the liquidity trap. The liquidity trap was a term coined by the famous British economist, John Maynard Keynes, to explain the special situation in which low interest rates prompt people to hoard money instead of using it for consumption or investment. This is because they choose to hold onto money balances hoping that the future interest rates would rise in their favour. In such a situation, however much the central bank or the government produces new money, such new money would not increase expenditure – both investment and consumption – as expected by the authorities.

Japan went into this liquidity trap in early 1990s and has been caught in it now for nearly two decades.

Japanese authorities used various tactics to get the economy out of the liquidity trap but without success. One tactic was for the government to borrow and spend on the domestic economy. This measure has raised Japan’s public debt to an unsustainable level exceeding even two times of its national income. The other was for the Bank of Japan to maintain a low interest rate regime – negative in real terms – so that people would borrow, invest and consume more. This measure has forced the consumption – shy Japanese to invest in other markets in search of high real yields.

Thus, the bazaar man economy has not been responsive to the stimulus measures introduced by authorities to raise the domestic expenditure and take the economy out of the long standing liquidity trap.

Raising the needed financial resources

Wiseman considers every adversity as an opportunity. The recent tsunami disaster should also be considered as an opportunity given to Japan to get out of the long standing economic stagnation.

A major problem which Japan would face in this exercise is how to raise the required financial resources. A country which is faced with this problem could resort to special disaster recovery taxation, borrow from the domestic market through the issue of disaster recovery bonds, raise money from the international financial markets through the issue of sovereign bonds or use the existing savings in the form of accumulated foreign reserves which have now been invested elsewhere.

Japan can resort to any combination or all of these measures to raise the required financial resources for rebuilding the nation. The gravity of the disaster has united the Japanese both physically and emotionally. Hence, it is not difficult for the government to justify the imposition of an additional tax for rebuilding the nation. Japan’s credit standing in the international markets is high and therefore it could easily raise funds through the issue of sovereign bonds. Even if it is interested in borrowing domestically, that too could be done easily given the high saving habit of the Japanese. As for foreign exchange reserves, it is the second largest foreign exchange reserve holder in the world. Hence, mobilising financial resources for nation rebuilding would not be an object for the Japanese government.

Has Nature intervened to do what men have failed in the past?

We noted above that the measures taken by Japanese authorities in the past to take the economy out of the liquidity trap were not successful.

However, it appears that nature has now created an opportunity for Japan to incur a high expenditure programme within the economy and increase the domestic value addition. This is because the tsunami disaster has created the need for Japan to spend heavily on building houses, roads, bridges, ports, airports, power plants and all other capital goods that have been destroyed by the tsunami waves. Japan has both money and men and it will spend that money to mobilise men for the rebuilding programme.

In the case of countries which do not have domestic rebuilding capacity, such expenditure would leak out, creating income elsewhere. This is because the rebuilding task has to be contracted out to foreign companies which would take their income out of the country. But, Japan is different and possesses a marvellous domestic construction and engineering industry which can take over the job of rebuilding the nation as mentioned above. Hence, the natural disaster has created an opportunity for Japan to increase its domestic expenditure, in this case, the domestic capital expenditure, and raise both income and employment.

Hence, what the Japanese government and the Bank of Japan could not do in the past appears to have been accomplished by nature by creating the need for embarking on a massive expenditure programme.

Hence, the adversity is in fact an opportunity in disguise.

Japan’s excellent tack record

Japan has shown on many occasions in the past that it is capable of rebounding quite comfortably after being hit by disasters. At the end of the World War II, Japan had lost everything – its infrastructure, manpower and financial resources. Yet, the indefatigable Japanese made a quick come back astonishing the whole world at the swiftness of the recovery. It made a similar come back when it was hit by the recent disastrous earthquake in Kobe City. Hence, rebounding after disasters is not a challenge for the Japanese at all.

It is true that the recent tsunami disaster has caused immeasurable damage to Japan. But, all disasters force enterprising mankind to do better and rise even to greater heights. In my view, Japan will bounce back pretty soon from this disaster like the mythical bird Phoenix rising from the ashes after it has been fully burnt.

(W.A. Wijewardena can be reached on [email protected] )