Japan disaster to have smaller economic impact than the financial crisis

The economic costs of natural disasters are typically much less than those of major financial shocks, according to a research note from Capital Economics. In fact, Japan’s gross domestic product may actually rise higher than it would have as a result of the rebuilding that will occur in the wake of the massive earthquake and tsunami that hit the island nation earlier in March, the firm said. While the economic costs of a natural disaster are dwarfed by the loss of life, typically they cause less disruption to the economy than a major financial shock would, the note said. Estimates of the economic costs of the tragedy in Japan vary widely, and impacted financial firms are now trying to put a price tag on the disaster. “But there is a broad consensus that the adverse impact will be much smaller than that in the wake of the global financial crisis,” Capital Economics analysts said. “We have cut our Japan GDP growth forecast for 2011 from 1% to 0, whereas Japan’s GDP was more than 10% lower in the first quarter of 2009 than a year earlier. Similarly, the economic impact of the Kobe earthquake in 1995 was dwarfed by the fallout from the Asian financial crisis in 1997-98.” Also Wednesday, Munich Re estimated its pretax loss of €1.5 billion ($2.11 billion) on Japan earthquake damages. The insurer said it will take many weeks until claims notifications provide a clearer picture of the actual loss. “Many reinsurance covers do not attach until very high losses have been sustained by individual cedants, it will only become apparent at a later stage whether and to what extent reinsurers are affected by losses under particular treaties,” said Commerzbank analyst Roland Pfaender. “Further uncertainties result from the impact on international flows of goods and supply chains from business interruptions suffered by Japanese industrial producers.” Capital Economics cited four reasons why natural disasters might at least appear to cause less economic damage than financial shocks: 1. Geographical scope. Natural disasters usually only have a direct impact on a small part of a country, whereas financial shocks affect the whole economy. 2. The damage to homes and infrastructure caused by a natural disaster has no direct impact on GDP, which measures economic activity rather than changes in the stock of capital. “Subsequent reconstruction spending will boost activity, producing the perverse result that GDP may eventually be higher than it would otherwise have been,” the report said. Capital Economics notes that this doesn’t mean that the country is any better off. “Lost assets have simply been replaced and productive potential is no higher than before.” But it does mean that the estimated cost to repair the damage, in the hundreds of billions of dollars, should be seen as a potential positive for GDP rather than a negative. Conversely, there is no such “upside” from financial shocks. In addition, speculative pressures during financial crises can drive asset prices well above their sustainable levels. “Asset prices can swing up and down by 50% as a result of developments in the financial sector – very few natural disasters could ever have the same effect.” 3. Financial shocks typically cause greater uncertainty. The impact of natural disasters, however awful to view, is usually fairly transparent and costs are relatively straightforward. “Contrast this with the complexity of the financial instruments involved in the subprime crisis and the prolonged loss of confidence in (and even between) the banks.” 4. Society’s reaction in a natural disaster helps in the recovery, the firm noted. People, both at home and abroad, are much more likely to rally round to help in the wake of a natural disaster than a financial shock. “Contrast this with the public’s reluctance to ‘bail out’ bankers following the subprime crisis and the current regulatory backlash against the financial sector in the U.S. and Europe.” While the firm said there are reasons to be optimistic that the overall economic impact of the earthquake and tsunami will be less than the global financial crisis, it doesn’t diminish “the terrible human costs or the blow to confidence, which will surely hold back any recovery.” Write to Kerry Curry. Follow her on Twitter @communicatorKLC.