What the earthquake and tsunami might mean for Japan's economy.

Commentary about business and finance.
March 11 2011 5:23 PM

Economic Devastation?

What the earthquake and tsunami might mean for Japan's economy.

A factory building has collapsed after an earthquake shakes Japan. Click image to expand.
Earthquake damage in Fukushima prefecture

Nobody knows just how bad the damage is from the earthquake in Japan, and the current focus remains on preserving human life. Still, some investors and analysts are already starting to question how it will affect Japan's economy.

One concern voiced in investor notes and wire stories is that the earthquake will nudge the country closer to a debt crisis. Japan is deep in the red—much deeper in the red than the United States or, really, any other developed country. Its 20-year bout of recessions has given it a massive national debt. And last quarter, despite a global return to growth, its economy actually shrank. If the Japanese government needs to issue new bonds to rebuild, the concern goes, that might further imperil its fiscal situation, raising its borrowing costs and even sparking default.

The question is whether the disaster could "push Japan over the edge" financially, Brendan Brown of Mitsubishi UFJ Securities told Bloomberg. Another analyst told CNN Money that "Japan's economic recovery has lost momentum and a large part of the reconstruction costs will add to the government's significant debt burden." But it's too early to say whether an economic crisis will follow the humanitarian one. And concerns about Japan's ability to repay its debt due to the earthquake seem overblown.

As a general rule, earthquakes are less harmful—in terms of human life and economic damage—in rich, stable countries. Consider the case of two major earthquakes that hit in 2010: the 7.0 magnitude earthquake near Port-au-Prince, Haiti, and the 8.8 magnitude earthquake that hit Chile. In many ways the two quakes are not comparable: Haiti's earthquake, though smaller, hit very close to a densely populated region; Chile's, though much stronger, hit offshore and affected a less populated area. Nevertheless, the former killed 316,000. The latter killed about 500 people. Chalk that up to Chile's wealth and stability: stricter building codes, better emergency preparedness, excellent hospitals, and functional government.

Thus, Japan should be able to recover from this earthquake as quickly as any nation could. It has the strictest building codes in the world, and its economy is huge—and the bigger the country, the smaller the proportion of GDP impacted by any one event. Most important, the country is wealthy. On the one hand, that means there are a lot of businesses, homes, and infrastructure to damage. (Say an earthquake hit your yard. If it damaged your vegetable garden, it might cost $20. If it damaged the garage housing your Ferrari, it might cost $200,000.) On the other, it means the country has ample resources to draw on to rebuild.

But analysts are worried about the earthquake's impact on the country's fiscal situation specifically. It is a fair concern: Japan's books do not look very good. Its public debt is 228 percent of GDP, compared with 144 percent for Greece and 77 percent for the United Kingdom. Moreover, the country's politicians have failed to tackle the debt crisis, given that borrowing costs remain so low, despite warnings from ratings agencies. In January, Standard and Poor's cut Japan's long-term sovereign debt rating, saying politicians had no real plan to bring the country back into the black and worrying debt levels "will continue to rise further than we envisaged before the global economic recession hit the country and will peak only in the mid-2020s."

The question at hand is whether and how the cost of rebuilding might add so much to that debt as to worry investors and raise borrowing costs, precipitating some kind of debt crisis. In the short term, rebuilding might actually benefit Japan's economy, as former Treasury Secretary Larry Summers pointed out on Friday. In the long term, it is hard to believe the earthquake will be the straw that breaks the fiscal camel's back. In fiscal year 2011, the country plans to issue about $2 trillion in new debt. Its outstanding long-term government debt is about $10 trillion. If rebuilding costs reach $10 billion, which some analysts on CNBC estimated, or even $100 billion, it would be but a drop in a very big bucket.

Japan's debt problem is very serious—but it's a long-term problem. The earthquake and its associated rebuilding costs might have left Japan more vulnerable to a fiscal crisis. But it is the government's unwillingness to pay the debt down, the country's significant demographic challenges, Japan's sluggish and often nonexistent economic growth, and its massive existing fiscal burden that remain the real looming threats.

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