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Special Report: Advanced economies cope better with disasters
BEIJING (Reuters) - The earthquake that devastated northeast Japan displaced the country's main island by 2.4 meters and even tilted the axis of the Earth by nearly 10 centimeters. The shock sounds awesome but it was imperceptible. History suggests the same will be true of the economic impact.
The instinctive reaction when viewing the extensive damage and frantic efforts to secure damaged nuclear reactors is to assume economic havoc will follow.
But researchers who have studied similar disasters in rich countries reach a reassuring conclusion: human resilience and resourcefulness, allied to an ability to draw down accumulated wealth, enable economies to rebound quickly from what seem at first to be unbearable inflictions - be it the September 11, 2001, attacks on New York or Friday's 8.9-magnitude earthquake, the worst in Japan's history.
Japan itself provides Exhibit No. 1 in foretelling the arc of recovery. A 6.8-magnitude temblor struck the western city of Kobe on January 17, 1995, killing 6,400 people and causing damage estimated at 10 trillion yen, or 2 percent of Japan's gross domestic product.
The importance of Kobe's container port, then the world's sixth-largest, and the city's location between Osaka and western Japan made it more significant for the economy than the more sparsely populated region where the latest quake and tsunami struck. Extensive disruption ensued, yet Japan's industrial production, after falling 2.6 percent in January 1995, rose 2.2 percent that February and another 1.0 percent in March. GDP for the whole of the first quarter of 1995 rose at an annualized rate of 3.4 percent.
"Despite the scale of the disaster, it is hard to find much evidence in the macroeconomic data of the effects of the Kobe earthquake," said Richard Jerram, chief Asian economist at Macquarie in Singapore and a veteran Japan-watcher.
Indeed, Takuji Okubo, chief Japan economist at Societe Generale in Tokyo, noted that Japan's economy grew by 1.9 percent in 1995 and 2.6 percent in 1996, above the country's trend growth rate at the time of 1.5 percent. Private consumption, government spending and, especially, public fixed investment all grew above average in 1995 and 1996, Okubo said in a report. By analogy, the medium-term impact on growth from the latest quake was also likely to be positive, he said.
Today's circumstances are, of course, different. Japan's economy has floundered in the intervening 16 years and its public finances have deteriorated. On paper, the country, is perhaps less well prepared at this stage of the economic cycle to pick itself up off its feet.
But Mark Skidmore, an economics professor at Michigan State University, attaches greater importance to a rich society's capacity to constantly adapt to the risks it faces. In the case of Japan, prone to regular earthquakes, this means improving its disaster response systems and adopting the latest techniques to help buildings withstand shocks.
Most of the damage wrought in Japan was by the ensuing tsunami, for which there was no time to prepare, and not by collapsing buildings - even though the quake was 1,000 times more powerful than the Kobe one.
"We don't know yet how devastating this is going to be economically, or even in terms of human casualties, but Kobe was able to rebound very quickly and I think there is the same potential here," Skidmore said in a telephone interview.
Skidmore and Hideki Toya from Nagoya City University in Japan have examined data for 151 countries over the period 1960-2003 and found that countries with higher levels of income, education and financial development suffer fewer losses from a natural disaster. Other researchers have reached similar conclusions.
"As incomes rise in a society, you can devote more resources to safety. So economies that have relatively high exposure to earthquakes or hurricanes start taking the precautions they need. Japan is among the best prepared in the world because they have high exposure and high income," Skidmore said.
OPENNESS TO TRADE
Countries with an openness to trade are also better able to cope with disasters because they create supply chains as well as commercial and diplomatic relationships that prove to be important. A well-oiled, well-financed government that can spring into action and limit the spillovers of the disaster is also crucial. This bodes well for Japan.
"They have the resources. They have the social and economic and government infrastructure to effectively utilize the resources that may come in from outside as well as internally. They can focus not just insurance but also government assistance to respond effectively," Skidmore said.
Another U.S. academic who has studied the lessons from Kobe, the late George Horwich of Purdue University, noted that media reports said it could take the city as long as a decade to recover. In the event, within 15 months manufacturing in Kobe was at 98 percent of its pre-disaster trend; imports had fully recovered within a year and exports were back at 85 percent capacity; and 79 percent of shops had reopened by July 1996.
"Natural disasters in large advanced economies tend not to significantly reduce current aggregate output or induce an associated rise in the general price level. In geographically dispersed economies, disasters are almost always localized events. But in any economy, it is the capital stock, not output, that is directly reduced by the disaster," he wrote in a paper published in 2000.
Horwich concluded that physical capital is the most visible contributor to economic recovery but human capital is the dominant economic resource. And Japan has that in spades.
"Destroy any amount of physical capital, but leave behind a critical number of knowledgeable human beings whose brains still house the culture and technology of a dynamic economy, and the physical capital will tend to reemerge almost spontaneously," he said.
The 2008 earthquake in the western Chinese province of Sichuan, which killed nearly 90,000 people, is in line with the academic finding that strong institutions and human capital are central to the process of recovery.
As a developing country, China had not made enough buildings earthquake-resistant. Many schools crumbled. Yet the ruling Communist Party mobilized vast resources for rescue, relief and reconstruction. As a result, according to a government think tank, the disaster actually added an estimated 0.3 percentage point to China's GDP growth in 2008. Less than three years on, the office charged with reconstruction has been disbanded, its work complete, an official said on Sunday.
Compare and contrast with Haiti, the most impoverished country in the Western Hemisphere. The 7.0 magnitude quake that struck on January 12, 2010, was much less powerful than that in Japan, but it killed at least 250,000 people, injured 300,000, left 1.5 million homeless and wrecked large parts of the capital, Port-au-Prince.
With weak finances and no emergency fund to tap, Haiti's economy slumped at least 5 percent last year, and the release of billions of dollars in international aid has been too slow to settle the homeless and get basic services running again, let alone spur an economic recovery. A cholera epidemic and political instability over contested elections reflect the failures of reconstruction efforts and in turn have made recovery even more difficult.
Haiti's woes confirm the findings of numerous researchers that poverty, high unemployment, limited access for the poor to basic services and a lack of strong national and local institutions amplify the economic blow of natural disasters.
"The impacts of natural disasters on society and the environment are substantially greater in less developed countries," according to a paper by Reinhard Mechler, who heads the research group on disasters and development at the International Institute for Applied Systems Analysis near Vienna.
INDIAN OCEAN TSUNAMI
Another case in point is Aceh, at the northern tip of the Indonesian island of Sumatra, which bore the brunt of the Indian Ocean tsunami of December 26, 2004.
Of the 230,000 people killed by the speeding, towering waves, 167,000 were from Aceh, which suffered total damage of about $4.5 billion. A big relief effort was launched, but more than two years later a report from the Asian Development Bank Institute said key reconstruction targets had not been met and coordination among the many government agencies and international donors was poor.
With Aceh accounting for just 2 percent of Indonesia's economy, the catastrophe was not enough to move the needle of the country's GDP. But, as with Haiti, the shortcomings of the region's recovery stood In stark contrast to the experience in Kobe.
After the initial loss of output, disasters in advanced economies do not invariably result in a boost to economic activity.
Gus Faucher, director of macroeconomics at Moody's Economy.com, a consultancy, has cited the aftermath of Hurricane Katrina, which devastated New Orleans in 2005: the city did not experience an economic bounce because so many residents left, government aid was slow to arrive and insurance payments were low.
But, as a rule of thumb, reconstruction jobs and the influx of emergency assistance apply balm to an economy's wounds. Take the 6.7 magnitude Northridge quake near Los Angeles in 1994 that killed 57 people, injured 9,000 and resulted in about $40 billion in property damage.
Daniel Blake, an economics professor at California State University Northridge, found a year later that the $18 billion in aid and insurance payments made by the federal government actually jump-started the area's fragile economy after four years of recession.
And after the 1989 Loma Prieta earthquake, which severely damaged major roads around the San Francisco Bay, an official estimate put the Bay Area's lost economic output at between $181 million and $725 million, a fraction of its 1989 gross regional product of $174 billion. Indeed, the California Trade and Commerce Agency later found that the Bay Area even managed to do better than many parts of the state in weathering the early 1990s recession.
A more recent example is that of Chile, where 500 people died in an 8.8 magnitude quake in February 2010 that caused an estimated $30 billion hit to the economy due to damaged infrastructure and property and lost productivity.
Both the government and central bank trimmed their growth outlooks after the quake, estimating it could shave around 0.25 to 0.5 percentage point off annual growth. But the economy grew about 5.2 percent in 2010, within the original range of projections. With the state only halfway through its rebuilding programme, GDP growth this quarter is likely to accelerate to around 8 percent.
"The impact of reconstruction on growth is becoming stronger as time goes on," said Finance Minister Felipe Larrain, who financed an $8.4 billion recovery package with a mix of bond issues, higher royalties levied on mining companies and savings from a boom in copper, Chile's principal export.
So what does all this mean for Japan?
Pete Wilson, California's governor at the time of the Northridge quake in 1994, says it was important to cut through red tape. By waiving the requirement for environmental impact hearings and setting incentives for building contractors, Wilson told Reuters he managed to reopen Interstate 10, then the world's busiest road, in just over two months. Some had feared it would take two years.
Chile's experience shows that a government is perfectly justified in resorting to deficit spending to cushion a natural disaster because of the shot in the arm it delivers to the economy, said Alfredo Coutino, Latin America director for Moody's Analytics.
"If one lesson can be learned from Chile's case, it is that Japan's government has to make a quick move in terms of implementing the reconstruction with a variety of funding sources: issue debt, reallocation of public resources, and international aid," he said.
Japan's problem is that its gross public debt, equal to about twice GDP, is already the heaviest in the world. With an aging population posing an ever-growing burden on Japan's public finances, rating agencies have sounded the alarm and warned of possible downgrades unless politicians bury the hatchet and come up with a plan to reduce the debt over the medium term.
"The earthquake should lead to somewhat expansionary fiscal policy. However, due to its already large deficit, it is unlikely that the Japanese government would plan a large scale fiscal stimulus," said Okubo, the Societe Generale economist.
YEN WILD CARD
The reaction of the yen in coming weeks is another wild card in assessing the impact on Japan's economy. The Bank of Japan, which meets on Monday, is widely expected to pledge as much money as needed to prevent the repercussions of the quake from destabilizing financial markets and the banking system.
Economists also expect the central bank will signal its readiness to ease monetary policy further -- even though its policy rate is already near zero -- if the damage from the quake threatens Japan's fragile economic recovery.
That prospect would normally weaken the yen, but economists are keenly aware that the Japanese currency gained sharply in the weeks after the Kobe catastrophe. It rose from 96 per dollar in late February and briefly punched through 80 to an all-time high on April 19, 1995, before reversing course after the BOJ cut interest rates.
Trade tensions with the United States were a driving force in 1995 and are absent today. A rush to bring capital back to Japan, especially by insurers anticipating large claims, was also a factor post-Kobe and could be again. But Jerram, the Macquarie economist, doubted that history would repeat itself.
"Significant yen repatriation that could push the currency higher and, at an extreme, disrupt global markets, looks unlikely," he said.
Another "known unknown" is whether serious damage to the Fukushima Daiichi nuclear plant will cause countries including Britain, China and Italy to reappraise plans to boost investment in nuclear power. If they do, it would be logical to expect higher oil, natural gas and coal prices.
"A serious accident like that will have repercussions in all countries with nuclear," Bertrand Barre, scientific adviser to French nuclear reactor maker Areva, told Reuters.
If there are clear lessons, we will apply them. We need to take time to work out the consequences and act.
Japan's earthquake is just the latest in a series of unwanted shocks for the world economy, which is still far from having shaken off the fallout of the 2008 global financial crisis. Political turmoil in North Africa has reduced oil supplies from Libya and raised the specter of wider disruptions to deliveries from the Middle East.
Food prices have climbed to record highs. The euro zone debt crisis is far from over, with bond yields for Greece, Ireland and Portugal at seemingly unsustainable levels. Policy makers in the main economies who have slashed interest rates close to zero and run up huge budget deficits would appear to have little ammunition left to fire if consumer, business and investor confidence takes a dive because of Japanese quake.
But economists at J.P. Morgan said it was important to bear in mind that most, if not all of these shocks will prove to be temporary and are unfolding against a backdrop of very strong fundamental supports for growth, including booming industrial production, improving labor markets and a 17 percent rise in global share prices since September.
The bank has recently trimmed its forecasts for the United States and the euro zone but its projection for global growth in the first half of 2011 remains at a rate of 3.7 percent, which is 1 percentage point above trend.
"Put differently, the shocks to date would have to magnify considerably to push global growth below this trendline." the J.P. Morgan economists said in their latest Global Data Watch publication.
(Additional reporting by Braden Reddall in San Francisco, Simon Gardner in Santiago and Kieron Murray in Mexico City)
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