Japan's Black Swan

The earthquake changed everything. What will Tokyo do next?

Observers of world affairs often speak of "unimaginable" events, developments which like the end of the Cold War, the 2008-2009 global financial crisis, or the recent Arab revolutions prove stunning not so much because they are illogical but rather because they fall outside the normal range of experience and prediction. The surprise, in other words, arises from a failure of human imagination. Japan's recent disaster fits this pattern. In hindsight there was only a single "black swan" anomaly: the 9.0 earthquake. That such an event, once it had happened, would trigger an enormous tsunami was surely predictable, as was the impact on nuclear facilities that were designed to withstand only more limited shocks and the sickening human and social devastation that would ensue. The political, economic, and strategic implications of the continuing disaster are likewise more foreseeable than was the disaster itself.

Political Implications

The immediate effect of the Japanese catastrophe has been to give new life to a government that was on the verge of collapse. The ruling Democratic Party of Japan (DPJ) rose to power in the autumn of 2009 with a strong electoral mandate, ousting a Liberal Democratic Party (LDP) that had long maintained a stranglehold on the Japanese political system. Soon, however, the DPJ's mistakes in managing alliance negotiations with the United States, maritime quarrels with China, and feckless economic policies sent the party's approval ratings spiraling downward. After a series of scandals within the upper reaches of the DPJ as well as the government's failure to pass in a timely fashion the enabling legislation necessary to effectuate the budget for fiscal 2011 (which begins in two weeks), Prime Minister Naoto Kan appeared doomed. The situation was so bad that the prestigious Nihon Keizai Shimbun openly queried whether he -- and perhaps even his ruling DPJ -- could survive through the end of March.

The current crisis has given the prime minister a second chance. With thousands of confirmed deaths, some 15,000 persons missing, hundreds of thousands displaced, and several nuclear reactors on the brink of meltdown, this is no time for a change of government. Kan has made reasonably good use of this "rally round the flag" moment, establishing a national crisis management center and dispatching ministers and other staff to deal with various problems. It is still too early to say that he has done enough, but he seems to have improved upon his predecessors' performance after the Kobe Earthquake that took more than 6,000 lives in 1995. Rather than proudly rejecting offers of foreign assistance, for example, Kan quickly accepted all offers of aid, mobilized the military for rescue operations, and appeared frequently on television to calm a nervous public.

Due both to the magnitude of the disaster and to Kan's relatively firm leadership, the opposition has likewise adjusted its position, edging toward a more conciliatory stance on several major issues. Sadakazu Tanigaki, the head of the LDP, and other opposition leaders have thus declared their desire to work together in the formulation and passage of an emergency spending package. The ambit of this new cooperation will probably expand to include the regular budget as well, enabling Kan to obtain Diet approval for the aforementioned enabling legislation. Kan and his party may therefore succeed in gaining several more months of time in which to rebuild their reputation and power -- assuming, naturally, that the trouble at the Fukushima nuclear facility ends without producing yet another catastrophe. But with that caveat, this second opportunity, is for the DPJ, the silver lining on a very dark cloud.

Domestic Economics

The economic effects of the disaster vary depending on one's time horizon. As attested by the sharp falls in Japanese equity prices, the short-term impact is decidedly negative. Not only have extensive tracts of real estate and productive capacity been lost, but much of the transport and energy infrastructure has been destroyed. The major auto manufacturers have already curtailed their production levels, and, at the behest of the government, steel companies and electronics manufacturers have voluntarily reduced their operations in order to conserve energy. Along with officially orchestrated rolling blackouts, these decisions will inevitably engender shortages of various goods and services. Depending on how severe the nuclear problem turns out to be, the rate of gross domestic product (GDP) growth could fall well into negative territory during the second and perhaps third quarters of 2011. Yen appreciation could exacerbate this dynamic as Japanese companies repatriate overseas investment capital in order to support domestic reconstruction, but the central bank has already loosened monetary policy so aggressively as to countervail this danger and could, in conjunction with the Ministry of Finance, intervene massively in the foreign exchange markets if necessary.

Over the longer term, however, the crisis could prove a boon. Recall that Japan has suffered more than two decades of low or no growth due primarily to excess savings and, equivalently, inadequate demand. The only time during this period in which the economy grew reasonably strongly was in the aftermath of the 1995 Kobe Earthquake, when the need to rebuild vast swathes of residential and industrial properties propelled government and corporate spending upward and produced a surge in GDP growth that lasted into early 1997. Assuming again that the nuclear element of the present crisis does not worsen much further, the exigencies of reconstruction should make a similarly big contribution to the economy in late 2011 and 2012.

Looking a bit further into the future, however, the disaster and reconstruction will almost certainly exercise a malign influence over Japan's national finances. With the gross national debt already approaching 200 percent of GDP, ratings agencies concluded that the risk of a financial crisis was increasing substantially and therefore downgraded Japanese government debt. Even before the disaster in Sendai, Tokyo knew it must quickly address this problem by closing the budget deficit and beginning to pay down its obligations. A raise in the consumption tax and other duties was thus under consideration. Now, however, fiscal reform will be impossible. The DPJ and the LDP are discussing the adoption of an emergency tax, but this would only be a temporary expedient and presumably not large enough to offset the greater expenditures on disaster relief and reconstruction. The net effect will be to delay significant progress on fiscal consolidation for at least another couple of years, leaving the country to resolve a bigger debt problem with an older workforce, less surplus capital, and a greater probability of failure. In this sense, this natural disaster could ultimately contribute to a financial debacle comparable in scale to perhaps the 1997-1998 East Asian crisis or the implosion of the technology bubble a decade ago.

Global Economics

If the domestic implications of the disaster are mixed, its international import will be more uniformly negative. In the short run, the interruption of normal commercial activity in Japan will reduce global demand and hence tip the balance away from global price inflation and toward deflation. This effect may well be amplified by capital movements: Upward pressure on U.S. interest rates due to the outflow of Japanese funds could be overwhelmed by inflows of money seeking a safe harbor in the present storms. The cost of capital in American markets could therefore fall rather than rise, effectively perpetuating the abnormal conditions that ensued from the 2008-2009 global financial crisis.

Over time, however, the world will assuredly see greater inflationary momentum in the prices of specific goods and services. The decision by China and other developing countries in late 2008 and 2009 to expand public works spending in reaction to the global slowdown was already driving up the prices of concrete, ferrous metals, rare-earth elements, wood, simple electronics, and the other goods required for infrastructure projects. Canada, Australia, parts of Africa and Latin America, and the oil-producing countries all benefited from these trends. The more forceful entry of Japan into these markets will reinforce this pattern over the medium term, underscoring the inflationary bias that was starting to unsettle central bankers in the months before the Japanese earthquake. 

A more pronounced version of the same pattern will likely unfold in oil markets, where rapid growth in the largest developing markets and continuing instability in the Arab world caused prices to spike upward in late 2010 and early 2011. The trouble at the Fukushima reactors, which has discredited a source of energy to which the whole world was turning, will only accelerate this process. Not only will Japan's much vaunted "nuclear first" energy policy likely now be abandoned, so too will be the global "nuclear renaissance" that even some environmental activists advocated as preferable to the present reliance on heavily-polluting coal and oil. Since the Sendai earthquake France, Germany, and Switzerland have announced their intentions to reconsider their nuclear energy plans; many other nations will likely follow suit. The problem is that at present the only alternatives that are both economically feasible and capable of rapid expansion are hydrocarbons. In this sense, bad news for Japan is also bad news for the global environment.

Geopolitical Ramifications

Geopolitically, the recent events will enhance U.S.-Japan relations in an international environment that is in some ways becoming more inclement. After decades of accepting U.S. supremacy in Asia as the foundation of its foreign and security policies, Japanese strategists had just begun open debate on the consequences of a changing regional power balance. In 2009 and 2010, the DPJ government accordingly considered a tilt toward China, but then the quarrel in the Sea of Japan and Beijing's use of an embargo on rare-earth exports as a diplomatic weapon persuaded Tokyo to pull back to the status quo ante. As one former defense minister subsequently noted: "we learned an important lesson, but the tuition was high." China likewise seems to have learned from the contretemps. Not only did Prime Minister Wen Jiabao express sympathy for the Japanese people following the earthquake, he also promised $4.5 million in aid and appears willing to dispatch personnel to assist in the relief and recovery efforts. Initial signs thus suggest that Beijing has moved beyond what one scholar calls "the harsher jingoistic anti-Japanese reflex in China that has poisoned relations with Japan in recent years." 

Meanwhile, the natural disasters have enhanced the legitimacy of both the Japan Self-Defense Forces (SDF) and the U.S. alliance. In the largest deployment of Japanese military personnel since the Pacific War, 100,000 soldiers have been mobilized to deal with the search, rescue, and eventual reconstruction campaign. All early evidence suggests they have been welcomed in this role, meaning that the nation is growing more comfortable with an army and navy about which it has long felt ambivalent. The same improvement may be seen in the Japanese attitude toward the American troops stationed on their soil. Within hours of learning of the earthquake, President Barack Obama expressed his sadness, promised extensive financial and humanitarian assistance, and declared the alliance "rock solid." At Japan's request, Washington immediately redirected the USS Ronald Reagan and its carrier task force from the waters around South Korea toward the affected Japanese coast. Supported by American personnel and equipment from as far afield as Singapore, those forces are now engaged with the SDF in their first ever full-scale joint rescue and relief operations. The deployment of helicopters from the controversial Futenma Marine air base in Okinawa has also been well received, perhaps marking significant progress towards the end of the bilateral disagreement over that facility. The alliance has never worked so smoothly nor been so widely accepted.

Yet the two countries will need this deeper cooperation to deal with challenges that the disasters have rendered graver. Most obviously, the loss of so much Japanese wealth, productive capacity, financial resilience, and national confidence will over the longer term accelerate China's rise relative to Japan. Beijing's sagacious gestures of goodwill cannot obviate -- and may be intended in part to conceal -- this unnerving reality. Also worrisome is the greater influence that the world's disenchantment with nuclear power will bring to the oil-rich countries. A country so dependent on imported energy as Japan cannot look upon this development with equanimity; and the United States and Europe will surely regret anything that empowers such difficult interlocutors as Iran. Managing these profound changes in the global balance of power will require not just closer bilateral relations but stronger and more strategic leadership than either Washington or Tokyo have manifested in recent years.

Japan is in fact at a turning point. By galvanizing public opinion, the disaster has given the government a chance to act boldly and responsibly. If successful in this regard, the DPJ might develop the internal discipline and leadership habits necessary finally to address the economic and financial problems that bulk so large on the horizon. The incipient tilt toward ever closer cooperation with the United States could play a supportive role in this process. But if Tokyo fails to address the crisis forcefully and effectively -- no small matter, since it is deepening at this writing-- Japan's outlook will grow even darker than it has been. In that event, the country will emerge from this disaster with its international powers curtailed, its confidence impaired, and its finances further damaged. The tendency of the world to view Japan as a spent force would thus be confirmed and the country left to await the eventual onset of a financial crisis that finally resolves its enormous fiscal problems.

Thanks to Robert Madsen & Richard J. Samuels / ForeignPolicy