Japan: The Economic Consequences of the Disaster

The toll in human misery wrought by the tsunami and earthquakes in Japan tests the imagination of economists, but the effects on Japan's GDP and wealth are a different matter.

GDP, which measures goods and services produced, will immediately dive in Japan and stay lower through the second and into the third quarters of 2011, but will then surge as construction and spending on capital equipment to rebuild drives up growth.

Overall, however, Japan will be poorer for this disaster. Lost infrastructure, factories and the like will be replaced but wealth is the sum of what citizens and governments own -- those include physical assets like those just noted and financial wealth, namely securities and cash. Rebuilding will run down Japan's financial wealth to replace lost physical assets.

As estimates of the damage emerge, those totals are real, deadweight losses to wealth. To the extent Japan must run down financial assets and bring home foreign investment to rebuild, the net wealth of Japan is permanently reduced.

Generally, after three years or so, the impact on GDP is small; production is lost in the first two quarters but more goods and services are produced in later quarters to rebuild. Often the net loss in GDP, from even the largest natural disasters, comes to no more than one percent of GDP in large advanced industrialized countries.

Replacing lost production and rebuilding lifts output in a nation's geographic areas less affected by the disaster to provide the resources to rebuild and compensate for lost output in the most affected region. However, this time could be different; Japan has encountered two disasters -- the tsunami and earthquake, and the nuclear explosions -- and globalization may make Japan more vulnerable rather than in the past.

The double whammy has the potential to keep the Japanese economy shut down longer and globalization offers Japan's export customers alternatives they might not have enjoyed a decade or two ago. Hyundai and Ford (NYSE:F) are now good substitutes for Toyota's cars, and even more so, Caterpillar (NYSE:CAT) tractors made in China can replace Komatsu's land movers.

The pause and uncertainty effected by the nuclear shutdown will cause production to rev up more outside Japan and take longer to return to full capacity inside the country. Longer term, the nuclear disaster will accelerate the implosion of Japan's economy caused by an aging population, just as Hurricane Katrina caused people and activities to permanently leave more economically depressed areas of the Gulf Region permanently for faster growing places in the United States.

Some of New Orleans' and Mississippi's lost capital will never be restored-it went elsewhere in the United States. For Japan's disaster stricken economy that elsewhere may be other places around the world.

For the global economy, the nuclear disaster in Japan will cause more delay in reducing dependence on oil from the politically volatile Middle East. Wind, solar and other alternatives hold great promise but nuclear still offers the safest, large scale-option around. The problem is the loss of life associated with nuclear failures gets concentrated, even if it is much smaller over time per BTU produced, at events like Fukushima. That latter will increase hesitation around the world about building nuclear plants and keep the global economy in the grip of oil longer.

This time, the path to recovery will be tougher for Japan, and for the global economy, ripped by the Great Recession and high priced oil, the path of recovery will be inexorably altered.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.