RIETI Report May 2011

Beyond Reconstruction and Moving Towards New High Growth

This month's RIETI Report continues to examine issues related to overcoming the Great East Japan Earthquake, which has taken many precious lives and dramatically affected the lives of survivors and the economy at large. TODO Yasuyuki, Faculty Fellow and Professor, Department of International Studies, the University of Tokyo, presents in a positive light how Japan can move forward and turn this tragic event into an opportunity.

Professor Todo believes that not only can Japan return to the level of growth seen before the quake, but can actually record even higher growth going forward if it creates institutions that are superior to the ones previously in place, a concept known as "creative destruction." In this light, Professor Todo discusses FTAs and EPAs, measures for agglomerating cutting-edge industries in the disaster-affected areas, facilitating M&A, and last but not least, today's young people, who have shown great fortitude and tenacity in helping victims of the disaster. It is with their energy that Professor Todo sees opportunities to transform Japan.

This month's featured article

Beyond Reconstruction and Moving Towards New High Growth

TODO YasuyukiFaculty Fellow, RIETI

Introduction

The Great East Japan Earthquake and resulting tsunami have inflicted huge suffering on the Japanese people and caused immense damage to the Japanese economy. It is tragic that all the precious lives that were lost can never be brought back. All we can do for the deceased now is to pray for the repose of their souls. However, in five to ten years, the Japanese economy will definitely rise again from this immense disaster and return to at least the level of slow growth seen before the quake. Indeed, this could turn out to be an opportunity for the Japanese economy to depart from the "lost two decades" of low growth and move into its second high growth era.

War, disaster, and economic growth

In Figure 1, the solid blue line shows Japan's real per-capita GDP (in U.S. dollars) from 1870, just after the Meiji Restoration, to the current period. Since the vertical axis is in logarithmic scale, the slope of the line represents the growth rate. Between 1870 and 1940 the slope is fairly constant, indicating that Japan's per-capita GDP growth rate was stable during that period. Subsequently, the level of per-capita GDP plunged during World War II, but then climbed rapidly during the high-growth era in the 1950s and 1960s. What is interesting is that from the 1960s onward, Japan's per-capita GDP showed far stronger growth than it would have been if the pre-war growth trend (denoted by the black dotted line) had continued. This is probably because the defeat in the war triggered the complete transformation of Japan's institutions, making them more geared to promoting growth.

Figure 1: Japan's real per-capita GDP (in U.S. dollars)Figure 1: Japan's real per-capita GDP (in U.S. dollars)Source: Angus Maddison's website (http://www.ggdc.net/MADDISON/oriindex.htm)

Natural disasters such as earthquakes, tsunamis, and droughts are similar to wars in this regard. Studies on the relationship between economic growth and disasters using cross-country data indicates that when a natural disaster occurs, economic growth slows for a few years but goes back to the pre-disaster level in the long run. Furthermore, some types of disaster are found to raise the long-term growth rate (Sawada et al, 2011, RIETI Discussion Paper, No. 11-E-023). This is because like Japan's defeat in the war, natural disasters promote "creative destruction" by leading to formation of superior institutions.

Therefore, if Japan could turn the tragic disaster into an opportunity to trigger creative destruction and overhaul its institutions and policies, it should be able to catch another wave of high growth (as shown in the red dotted line) instead of simply returning to the pre-disaster, low-growth trend (represented by the purple dotted line in the figure).

A time to open up the country

So what ought to be done to make this happen?

Industrial production in the Tohoku and northern Kanto regions almost ground to a halt following the disaster, but is now slowly restarting thanks to the frantic efforts of the people there. However, some production is being temporarily shifted to other areas or overseas, and these transfers may become permanent, and the industrial clusters in the Tohoku and northern Kanto regions may be lost over the long term.

The area affected by the disaster is a cluster of the automotive and electrical equipment industries, and the products manufactured there are often eventually exported. Therefore, to stimulate demand, which has just begun to recover, and to prevent production from moving overseas, it will be essential to expand free trade agreements (FTAs) and economic partnership agreements (EPAs) with other countries. Although some say that tariffs on exports from Japan are already low enough, this is not necessarily the case. For example, the EU levies a tariff of 14% and China and Malaysia 30% on flat-screen televisions exported from Japan. They also impose tariffs of 3%-25% on automobile components. If these high tariffs can be reduced through FTAs and EPAs, it would be quite possible for Japan to keep industries in the country, including those in the disaster-stricken area, and achieve a level of growth higher than the pre-disaster level.

Before the disaster, the government of Prime Minister Naoto Kan was calling for a "Heisei opening of the country," and seeking to promote EPAs including the Trans-Pacific Strategic Economic Partnership (TPP). Recently, however, the government announced that it was putting off its decision on whether to join the TPP. However, rather than saying that now is not the time for the TPP because of the disaster, we should argue that it is the time to use the TPP as an effective means of recovering from the disaster. By making the country more open, it is more likely to go beyond just reconstruction and get on the path toward high growth.

Agglomerating cutting-edge industries in the disaster-affected areas

However, while EPAs will serve to prevent production from shifting overseas, they will not stop production from moving out of the disaster-affected areas and moving to other parts of Japan. Industrial clusters emerge because of the snowball effect, so it is difficult to restore a cluster that has shrunk (Masahisa Fujita, "Post-Quake Restoration Policy for East Japan from the Viewpoint of Spatial Economics").

If that is the case, rather than reconstructing the industry clusters that already existed in the disaster-affected areas, we should create a new cluster of more cutting-edge industries. For example, special economic zones could be established to give preferential treatment to companies conducting research and development (R&D) in the region and promote university-industry collaboration, and thereby make innovation originating in Tohoku and northern Kanto an axis for driving the clustering of cutting-edge industries. Another idea would be to promote the agglomeration of environmental technology industries by establishing "eco-cities." These special zones and eco-cities should also work actively to attract foreign companies and make themselves international cities that can take advantage of the vitality of overseas economies. Half a century ago in Ishinomaki, one of the worst affected cities, Date Masamune, a famed samurai worrier in the Tohoku region, ordered the construction of a galleon, and upon this ship, his retainer, Hasekura Tsunenaga, took a voyage across the Pacific and to Rome for a trade agreement. So the Tohoku region possesses a historical foundation for the establishment of international cities.

Assisting M&As among small and medium-sized enterprises

One thing that this disaster made me realize is that companies need to be of a certain size to withstand risk events such as earthquakes and tsunamis. Firms that had prepared manuals for dealing with disasters got back on their feet comparatively quickly, but it is difficult for small companies with limited personnel to produce such manuals. In addition, firms with multiple factories and sites have been able to move operations from the disaster-affected areas to other areas, or send people and equipment from other sites to restore operations in the disaster-affected areas. For example, many convenience stores in the disaster-affected areas managed to stay open. This was because each convenience store operator is large, and all their employees were mobilized to keep stores in the affected areas going. Although some companies with only a single site were able to achieve quick recovery by working together with other firms, there were only a few examples of this. Most small companies were unable to deal adequately with the massive damage they suffered in the disaster.

Therefore, M&As among small and medium-sized enterprises (SMEs) should be promoted to ensure that companies are large enough to cope with major risks. Current government policy on SMEs is focused on protecting all such companies. However, SMEs should be defined as a transitional stage of growing into large companies, and government policy should be redirected to helping SMEs that are growing to become even stronger and more resilient through mergers. Of course, I am well aware that the technological prowess of SMEs underpins the Japanese economy, but I feel that making these companies larger is necessary to protect their superb technology from natural disasters and financial crises.

Beyond reconstruction and moving towards new high growth

The points raised above aside, great changes must take place in numerous fields, ranging from the nation's power supply system and primary industries such as agriculture, forestry, and fisheries to Japanese business management institutions. If a wide-reaching transformation encompassing the Japanese society and economy can be engineered, it will definitely be possible to not only get back to the slow growth observed prior to the disaster, but also to use the disaster as an opportunity to achieve high growth. As experiences such as the Meiji Restoration and World War II have shown us, the energy of young people who are flexible and possess innovative ideas is essential. Today's young people have shown fortitude and a tenacity to take action in helping the victims of the disaster, and I truly hope that they use such spirit and action to transform Japan in the future.

>> The original column was published in Japanese on April 8, 2011.

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