The Impact of the Great Eastern Japan Earthquake on International Trade

TANAKA Ayumu
Fellow, RIETI

Introduction

How will the huge earthquake that struck eastern Japan on March 11 and the subsequent tsunami and radiation leaks at the Fukushima power plant affect international trade? For Japanese companies, which overcame the "Great Recession" of 2008-2009 and withstood shocks in 2010 (last year) such as the sharp rise in the yen and the block on exports of rare earths by China, this disaster presents a new test. With the full extent of the damage still unknown and the problems at the nuclear power plant still unresolved, it is difficult to make predictions. Nevertheless, I would like use the insights provided by previous research to consider the likely impact of the disaster on international trade.

The difference between the Great Recession and this disaster

A comparison of this disaster with the Great Recession of 2008-2009 will be our starting point for considering its impact on trade. A great deal of research has been conducted worldwide on the reasons that trade declined during the Great Recession, and much insight has been gained.

The Great Recession began with a financial crisis, and reduced demand worldwide. The Great Eastern Japan Earthquake, on the other hand, caused human casualties and physical damage, and has reduced the ability of companies to supply goods. Unlike the Great Recession, the disaster has inflicted direct damage on the real economy. The government estimates the direct damage to production facilities, roads, etc. at 16-25 trillion yen and the impact on the economy, due to factors such as reduced output, at 1.25-2.75 trillion yen in FY 2011 alone. During the Great Recession companies had spare capacity. The problem was a lack of demand. With this disaster, however, companies have a reduced ability to supply goods, even if there is demand for them, because of the human casualties, the shortage of power and fuel, and the destruction of production facilities, roads, and ports.

Unlike the Great Recession, therefore, this disaster will probably not lead to a sharp decline in total exports due to a lack of demand. One of the characteristics of the Great Recession of 2008-2009 was that exports dropped by more than the decline in GDP. Trade is vulnerable to shocks. Demand for traded goods like automobiles falls steeply during recessions. Amiti and Weinstein (2009) found that while GDP dropped by only 5% during the 2008 financial crisis, global exports fell by 17%. An influential study by Eaton et al. (2010), meanwhile, argued that the main reason trade fell during the Great Recession was not the increase in trade friction due to factors such as protectionist trade policies, but rather the decline in demand. They claim that 80% of the drop in trade can be explained by a decline in demand. This disaster will not cause worldwide demand to fall, so a sharp drop in Japan's total exports resulting from a drop in demand cannot be envisaged. However, a fall in demand for goods at risk of radioactive contamination may lead to a sharp drop in exports.

Power shortages

Limiting factors on the supply side, however, are expected to have a severe impact on companies. The shortage of power, loss of people, and destruction of production facilities, roads, and ports is making life difficult for firms in the disaster zone and the region supplied with power by Tokyo Electric Power (TEPCO). If the power shortage is alleviated by raising electricity charges, prices across the economy will increase, making it more difficult for Japanese companies to compete with foreign firms.

The disaster and ongoing energy restrictions will lower Japanese exports in two ways, by reducing the number of exporting companies (extensive margin of trade) and reducing the average value of exports per firm (intensive margin of trade).

The damage from the disaster and the energy restrictions may make it difficult for some companies to continue operating in Japan or exporting from here. In theoretical terms, this is because the threshold level of productivity required to operate in both the domestic market and export market will rise. Companies that use a lot of energy will find it especially hard to keep producing in Japan.

Trade finance

The trade structures of countries such as Japan and China are known to be different from those of other nations. Eaton et al. (2010) suggest that the sudden decline in trade by Japan and China during the Great Recession had a lot to do with factors other than the drop in demand. According to them, only 8%-23% of it can be explained by the fall in demand.

According to Amiti and Weinstein (2009), a decline in the availability of trade finance may have contributed to the sharp drop in Japan's trade during the Great Recession. Using data on individual Japanese companies, they showed that the health of a company's bank had a large impact on the company's exports. They indicate that the reasons for this are that the shipping times and risks involved in trade are more important factors than producing domestically. If a company's bank is healthy and able to provide trade credit, the company's exports will rise. If insufficient trade credit is supplied, however, the company's exports will struggle to grow. According to them, the Great Recession of 2008-2009 began with the financial crisis that followed the collapse of Lehman Brothers in September 2008. This crisis, they say, had an immediate impact on Japanese banks, which in turn affected exporting companies.

The direct impact on the real economy, particularly the human casualties and physical damage, has led, even though it may be temporary, to a plunge in stock prices and a rising yen (see Note 1). As a result, the government and the Bank of Japan have moved to intervene in the foreign exchange market and loosen monetary policy. To ensure that financial instability does not restrict exporting by companies by reducing their access to trade credit, these policies from the government and the Bank of Japan must also be accompanied by the stable provision of trade credit by Nippon Export and Investment Insurance (NEXI).

Trade policy

One of the main reasons for the shrinkage in trade during the Great Depression of 1929 until around 1935 was protectionism. GATT, and later the World Trade organization (WTO), have established a framework of free trade based on the lessons of that experience, so there is now little room for employing protectionist policies to restrict trade. Even if trade restrictions are imposed, they will only pertain to certain goods and are therefore unlikely to affect trade as a whole.

Nevertheless, it has been reported that concerns about radioactive contamination have already caused several countries to impose trade restrictive measures on exports from Japan (see the table below). Other countries also look likely to follow suit. For example, the U.S. Federal Drug Administration (FDA) has basically prohibited the import of certain food products from Fukushima and three other prefectures (Import Alert #99-33). It has also been reported that some shipments of cargo from Japan to countries such as the U.S. and China have been delayed due to radiation testing. In addition, some foreign transport companies have ceased using ports such as Tokyo and Yokohama due to worries about the safety of their crews (The New York Times, March 26, 2011).

Main trade restrictive measures
U.S., South Korea, etc.Suspension of imports of dairy products, vegetables, and fruit from four prefectures: Fukushima, Ibaraki, Miyagi, and Gunma
ChinaRadiation testing of food products from Japan
TaiwanTesting of 658 manufactured products including processed food products and household appliances
Singapore, Malaysia, Thailand, and VietnamTougher testing of products from Japan

(Source)Compiled by the author

The Japanese government needs to work with relevant international bodies such as the World Health Organization (WHO) and the International Commission on Radiological Protection (ICRP) to provide information to national governments and transport companies to alleviate concerns about radioactive contamination and put a stop to trade restrictive measures that have no scientific foundation.

Increasing economic welfare through freer trade will also be important for recovering from the disaster. Even if it is postponed, the policy of moving forward with the Trans-Pacific Partnership (TPP) does not in itself need to be changed.

Trade structure

It has been said that this disaster has highlighted weaknesses in the global supply chain (i.e. the procurement of components at a worldwide level) and the "just-in-time" production system, which seeks to keep levels of inventory as low as possible. If water, fuel, power and critical components cannot be procured, companies are forced to suspend production. Media reports in both Japan and overseas have shown numerous real instances of this problem. Toyota Motor, for example, has announced that its suspension of vehicle assembly due to a shortage of some electronic components will be extended until March 26. In addition, fears about being unable to procure adequate supplies of components from Japan have resulted in the suspension of night-time and Saturday operations at 14 plants in the U.S., Canada, and Mexico as of March 24.

Companies from other countries such as the U.S. and Sweden are also being hit by the halt in supplies of components from Japan. General Motors (GM) of the U.S. has suspended operations at its auto plants in the U.S. since March 21. According to The New York Times (March 16, electronic edition), Apple may also be affected. This is because Japan's Shin-Etsu Chemical accounts for at least 15 % of global output of the integrated circuit boards used in smart phones.

Despite these problems, global supply chains will remain a fact of life, and some companies may use the disaster as an opportunity to switch their procurement of components hitherto sourced from Japan to other countries.

All Japanese companies can do is employ R&D to keep manufacturing superior products. The Great Kanto Earthquake destroyed railways and made automobiles more popular. Seeing what was happening, Toyota Motor founder Kiichiro Toyoda resolved to start producing automobiles. Over the medium to long term, an entrepreneurial spirit focused on taking advantage of the limitations imposed by this disaster to create new industries and products will be important.

Lessons from the Great Kanto Earthquake and the Great Hanshin Earthquake

Lessons can also be learned from the Great Kanto Earthquake of 1923 and the Great Hanshin Earthquake of 1995. In the year of the Great Kanto Earthquake, Japan's exports dropped by 8.9% compared with the previous year (see the table below). In the year of the Great Hanshin Earthquake, however, they increased by 3.0%. Although this disaster has led to more loss of life than the Great Hanshin Earthquake, exports are unlikely to decline as much as they did following the Great Kanto Earthquake. Moreover, the impact of the Great Hanshin Earthquake on trade was less than that of the Great Recession.

Table 2
(Note)Compiled by the author. Data for the Great Kanto Earthquake is from Kokumin shotoku (chouki keizai toukei) [National Income (Long-Term Economic Statistics)] by Kazushi Okawa et al., with the real value of imports and exports calculated using the ratio of nominal gross national expenditure to real gross national expenditure. The data for the Great Hanshin Earthquake and the Great Recession was based on monthly data from the Bank of Japan, with monthly figures for the real value of exports and imports totaled to give annual figures. Data on the values of imports and exports through the Port of Kobe was obtained from the Kobe Customs' website, and converted into real values using indexes of import and export prices from monthly data from the Bank of Japan. All units are percentages.

Domestic supply may not be enough to meet the rise in demand resulting from the disaster, so there is a possibility that imports will increase. Panasonic is already flying in batteries from plants around the world. Reconstruction-driven demand following the Great Kanto Earthquake led to big trade deficits during the 1920s (Miwa, 2002), and after the Great Hanshin Earthquake imports climbed at a faster rate than exports. During the Great Recession both imports and exports fell, but following earthquakes it is imports that tend to increase.

If the wrong policies are implemented following a disaster, there can be an impact on trade. In 1927, a few years after the Great Kanto Earthquake, the "Showa Financial Panic" occurred. This panic was sparked by the disposal of "earthquake notes" (i.e. promissory notes issued by companies that had been affected by the earthquake and for which their obligations had been temporarily waived). Following the earthquake, venerable Japanese trading houses such as Takada Shokai and Suzuki Shoten failed (Nakamura, 1994). In the case of the Great Eastern Japan Earthquake, the Financial Services Agency has already called on financial institutions to keep supplies of credit smooth, including by providing extensions on the payment of promissory notes. In addition, the Small and Medium Enterprise Agency is offering financial support to small and medium-sized enterprises that have suffered due to the disaster. However, in light of the lessons learned from the earthquake note debacle after the Great Kanto Earthquake, care will need to be taken to ensure that bad debts do not become a problem again.

The disaster is expected to have a serious impact on trade in the areas affected. Certain areas, particularly the disaster zone in Tohoku, may see a sudden drop in the value of trade. This is because the destruction of transport infrastructure there means that it will take some time to restore distribution functions. Airports and harbors in Tohoku such as Sendai airport and Sendai-Shiogama port were damaged by the tsunami. However, Sendai airport's share of the nation's air cargo exports is only 0.1%, putting it in ninth place, while Sendai-Shiogama port's share of sea cargo exports puts it outside the nation's top 10 (according to a 2008 survey on distribution trends from the Ministry of Finance). With such small shares, there is unlikely to be much impact on Japan as a whole. However, the destruction of transport infrastructure will probably have a big impact on the regional economy.

After the Great Hanshin Earthquake in 1995, the total value of Japan's imports and exports increased year on year. However, in 1995 the value of imports and exports handled by the Port of Kobe, which was damaged in the earthquake, plunged by 40.3% and 36.8%, respectively, compared with the previous year. Even now, the Port of Kobe has still not recaptured its pre-earthquake share.

Conclusion

This paper has considered the impact of the Great Eastern Japan Earthquake on international trade. This disaster has dealt a big blow to the supply side, and there are fears that companies may shift production out of Japan to other countries. In terms of the Japanese economy as a whole, though, industries and production processes in which Japan possesses a solid comparative advantage will probably remain in Japan. However, the new constraints imposed by the disaster may make it necessary to perform a long-term and difficult adjustment of the structure of industry, one which will entail corporate failures and job losses. Japan's comparative advantage will therefore need to be reexamined.

Acknowledgements

I wish to express my gratitude to Ryuhei Wakasugi, Professor at Kyoto University and Research Counselor and Faculty Fellow at the Research Institute of Economy, Trade and Industry (RIETI) for his advice. And with regard to the impact on ports, I also referred to the views of Masahisa Fujita, President of RIETI.

March 29, 2011
Footnote(s)
  1. At one point the exchange rate reached 79 yen to the dollar, an appreciation of 3 yen compared with before the earthquake (real-time trading data from the Bank of Japan on central rates for the Tokyo foreign exchange market.
Reference(s)
  • Amiti, Mary and David E. Weinstein. 2009. "Exports and Financial Shocks," NBER Working Paper, No. 15556.
  • Eaton, Jonathan, Sam Kortum, Brent Neiman, and John Romalis. 2010 "Trade and the Global Recession," NBER Working Paper, No. 16666.
  • Nakamura, Takafusa. 1994. Nihon keizai: sono seichou to kouzou [The Japanese economy: its growth and structure], 3rd edition, University of Tokyo Press.
  • Miwa, Ryoichi. 2002. Gaisetsu Nihon keizaishi: kingendai [Outline of Japanese economic history: the modern era], 2nd edition, University of Tokyo Press.

March 29, 2011

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