Hamish McRae: This tragedy will have an impact far beyond Japan

Economic Studies

The economic costs of a catastrophe such as that which has struck Japan should always rank second to the human costs. Economic losses can be recouped; human losses cannot, and it seems almost improper to be trying to make a tally of the economic and financial consequences of what has happened as the terrible story continues to unfold. But such is the harsh reality of our ever more global economy, that these calculations are indeed being made – even if the answers may turn out to be wildly wrong.

So what can sensibly be said? Some thoughts first about Japan itself; then about its influence on the world economy and financial markets; and then finally about one industry that will be most radically changed by these events: nuclear power.

There is for Japan a template of sorts: the Kobe earthquake of 1995. Kobe is the port of Osaka (Japan's second city) and the earthquake there, while smaller in magnitude, struck a more densely populated area and resulted in 6,500 deaths. The size of the local economy directly affected is broadly similar, some 7 per cent of Japan's GDP, though the balance then was more skewed towards trade and services while now it is manufacturing. The overall cost in 1995 worked out at about 2.5 per cent of GDP and that was a real loss of wealth carried by the country. But in terms of GDP there was little overall impact: some lost in the early months offset, maybe more than offset, by reconstruction-spurred growth thereafter. How can you have a real cost to wealth but no negative impact on GDP? Because resources used to rebuild are resources not available to be consumed. Debt is higher and living standards are further depressed.

If Kobe is the template, then this event feels somewhat more serious, sadly in human terms but also in economic. That is because the damage to the country's power infrastructure may have further-reaching consequences than the considerable physical damage in Kobe. But barring some further disaster it is hard to see the losses being more than, perhaps, 5 per cent of GDP.

That is huge of course, for this is the world's third largest economy, but it is not unmanageable. Japan does in any case face great challenges: its ageing population, its national debt, its anaemic growth, its social and economic rigidities and so on. This is an additional blow and one coming at a particularly difficult time, for the economy was already shrinking. But countries do recover remarkably swiftly from physical destruction and Japan has the social cohesion to speed it on its way.

The rest of the world? Well, we have seen the impact on the financial markets. It would have been astounding had they responded to the news, with all its uncertainties, in any other way. There may, as a result of the financial disruption, be some further and unforeseeable consequences: companies that might go under as a result, or financial institutions that would collapse if they are not rescued.

The Bank of Japan has made the right response by pumping money into the system and it is quite possible that the increases in interest rates that would shortly have occurred in Europe and the UK will now have to be delayed. On the other hand, this blow comes at a time when demand in the emerging world seemed to be slackening, reducing pressure on commodity and energy prices, so an improvement in inflation prospects might quite separately justify holding off a while yet before the inevitable tightening of monetary policy kicks in. Unless something unspeakable happens in the next few days, the markets should be able to look through the disruption and focus on the still-evident global recovery.

One thing however will be changed for a generation, maybe for ever. That will be the developed world's attitude to nuclear power. Power plants in most other countries are not built in earthquake zones but in Europe at least they are arguably more exposed to terrorist attack than those in Japan. This, mercifully, does not seem to be as dreadful in technical terms as the Chernobyl disaster, but in political terms its effect will be at least as big. This is not an inherently unsafe design in what was then part of the Soviet Union. It is a supposedly safe one in a technically competent, advanced economy.

We have already seen the reaction in Germany: it is taking seven of its 17 plants off-line for three months as it assesses the plans to extend their life. Whatever the balance of scientific argument, it will become very difficult to win authority to build new plants in the developed world. It may be that China can race on with its nuclear programme, and it has nearly half of all nuclear power currently being built. Maybe other emerging economies will be able to build new plants too, but to put the point at its weakest, nuclear power will not be a significant element in the global shift to a low-carbon economy.

This changes things. What is the point of switching to electric cars, with all the rare elements needed for their batteries, if the power to drive them is going to be produced by thermal power stations? We become a world even more dependent on the Middle East, and/or on oil and gas from difficult and dangerous ocean and Arctic locations. Maybe, just maybe, the developed world will use the price mechanism more aggressively to make people conserve energy. If that were so it would be a silver lining indeed.

We need to learn from this. There are many lessons – economic, commercial and social – that we can take from Japan. Anyone who visits the country will be aware of that, just as there are things that Japan can learn from the UK and Europe. What Japan does matters to us directly: it has, after all, played a huge role in rescuing the British motor industry. But it also affects us indirectly in that Japanese manufacturing technology has been one of the forces that have over the past generation reshaped the daily lives of everyone in the world. And now, as this dreadful story unfolds, the world economy will be reshaped again.