Earthquake: Implications for Japan and the World

As most people would now be aware, the earthquake and resulting tsunami which struck Japan’s northern coast line resulted in a truly tragic human and material toll. Indications at this stage point to a loss of life of over 20,000 whilst the infrastructure of whole towns and villages was swept aside. To add to the disorder, the still unfolding disaster at the Fukushima nuclear reactor adds another layer of uncertainty.

As is often the case with a tragedy of this scale the initial reaction of global financial market was very negative, led by a 10% drop in Japan’s Nikkei index but also with sizable falls in the order of 2-4% across Europe and the US. But standing back, how big is the risk to the global recovery from this disaster?

Our assessment is that the external risks are limited. Japan is the world’s third largest economy after recently being surpassed by China. Also, it is a significant link in the global manufacturing supply chain. So undoubtedly, supply shocks will be felt which in an inflationary environment can’t be overlooked.

However, the most important consideration here is Japan’s contribution to global economic growth. Here, we can be more relaxed. While Japan represents just under 6% of global GDP, its expected contribution to global growth in 2011 is minuscule. In basic terms, the absence of Japanese economic growth will not be noticed outside its borders.

Further, rather than focusing on the near term hit to Japanese economic growth we have to consider the boost that will come as the reconstruction effort moves into full gear. In this regard, we can look at the impact of the 1995 Kobe earthquake when Japanese industrial production fell 2.6% during the month of the quake but which completely recovered to pre-quake levels just two months later.

Early estimates of the required reconstruction spend for this disaster range up to $300 billion, a figure that will add to already high demand for many commodities produced by Australia.

In order for the earthquake to have truly serious global implications we would have to in turn see Japan’s financial system sustain serious damage. Although there are areas of concern with Japan’s finances, particularly with government debt to GDP of 200%, we believe the negative financial impact can be contained. Importantly, Japan continues to enjoy near 100% domestic financing of its public debt, another factor which should help confine this disaster to the shores of Japan.

Peter Reed, March 2011