Japan's earthquake and tsunami: International trade and global supply chain impacts

Hubert Escaith, Robert Teh, Alexander Keck, Coleman Nee

The consequences of the tragic disaster in Japan are many. This column examines the trade effects. It suggests that Japanese exports will fall by 0.5–1.6% and its imports will rise by 0.4–1.3%. Despite the devastation in Japan, the effects on global trade will be relatively small.

The Tohoku earthquake and tsunami that struck the northeast coast of Japan on 11 March has created an enormous human and ecological disaster. In addition to its direct economic cost to Japan, the disaster could potentially have important implications for the rest of the world, not only because of the sheer size of the Japanese economy, but also as a result of the country's pivotal role in the global supply chains that form the back-bone of today's international trade in manufactures (Altomonte and Ottaviano 2009).

What are the foreseeable consequences of the catastrophe for international trade? There are two complementary approaches to tackling this question.

The first uses a gravity approach to determine the macro-level impact on Japan's total merchandise trade flows;

The second employs a measure of the intersectoral connections between Japanese industries and other economies to assess cross-country supply-side effects.

Impact on Japanese trade at the macro level

Research on the economic consequences of natural and man-made disasters mainly focuses on the growth impacts of such events (see for example Cavallo et al. 2010). Only a very small subset of this literature deals specifically with the trade impact of disasters. An example of the latter can be found in a recent paper by Gassebner et al. (2010), which examines data on disasters in 170 countries between 1962 and 2004 using a gravity model.

In this column we use the same methodology to assess the impact of March’s disaster on Japanese and world trade. It is expected that the recent disaster in Japan will:

reduce the volume of Japanese exports by between 0.5% and 1.6%; and

increase the volume of imports by between 0.4% and 1.3%.

These estimates are relative to a baseline in which the disaster did not occur. For example, if we use the OECD's pre-disaster forecast of 6.7% growth in the volume of Japanese exports for 2011 as a starting point, then this study suggests that export growth should fall to between 5.1% and 6.2%.

The reduction in exports can be attributed to a number of factors, including injuries and loss of life (which affect companies’ human resources) as well as the destruction of physical capital related to the export sector. Damage to public infrastructure such as roads, bridges, railways, telecommunications networks and the electricity system may also disrupt supply chains and limit production and exports, as well as hindering production in other countries.

Reasons for the rise in imports may be less obvious. Reconstruction efforts are likely to boost imports since many of the required materials for rebuilding will need to come from abroad. This simulative effect should outweigh any negative impact stemming from of lost output and income. One of the most important findings of our research is that the import increasing effect of a natural disaster is stronger the more democratic a country is.

These are range estimates rather than point estimates due to uncertainty about the way the recent Japanese disaster is to be treated by the World Health Organisation Collaborating Centre for Research on the Epidemiology of Disasters. If it is counted as a single disaster the lower end of the range would be relevant, but if it is counted as three (i.e. an earthquake, a tsunami and a nuclear accident) then the upper range would apply.

The magnitude of the March disaster is unprecedented in the past 50 years, but the earthquake that struck Kobe, Japan in January 1995 provides a model, albeit imperfect, for how the country's trade might respond. Figure 1 shows monthly volume indices for Japanese and world trade before and after Kobe. It is worth noting that the rebound in Japan's imports following the 1995 earthquake was more sustained than the recovery in exports, which accords with our findings. World trade was hardly affected at all by the Kobe disaster.

Figure 1. Japan exports and imports and world trade volume, January 1991 to December 1996 (Indices, 2000=100)

The greater magnitude of the Tohoku earthquake, the spread of global supply chains since 1995, and the Fukushima nuclear incident may exacerbate any short-run declines following this year's earthquake, but the impact over the medium-to-long term (e.g. a year or longer) should still be small.

International supply chains and the supply-side effects

After rising to become the world's second largest manufacturer during the 1960s and 1970s, Japan has developed into a central hub for international supply chains (WTO and IDE-JETRO 2011). Responding to the sharp appreciation of yen after 1985, Japanese manufacturers outsourced a significant portion of their production bases to low-cost neighbouring Asian countries. Offshoring responded also to strategic and commercial objectives.1

Firms engaged in global manufacturing are vulnerable to the disruption of their supply chains. Managers have to balance the costs of keeping high inventories, and the risk of pure "just in time" production. The exceptional nature of the Japanese disaster (a Black Swan, from a probabilistic point of view) by-passes any security procedures embedded in normal supply chain management practices. Additionally, the strategic role played by Japanese firms means that they cannot be easily replaced by foreign suppliers. Indeed, soon after the disaster, production slowdowns and even disruptions began to register in many of the Japanese affiliates abroad and in some foreign industries relying on Japanese inputs. As a French automobile manufacturer realised, the unavailability of only one engine part could shut-down whole assembly lines.

Table 1 uses the model developed by Escaith and Gonguet (2011) to visualise the supply-side transmission channels of a disruptive shock originating in Japan. The model is based on international supply-use tables to measure the intensity of forward linkages of (representative) firms with a Ghosh matrix. The results track the transmission of direct and indirect supply shocks brought about by an exogenous increase in the cost of intermediate supplies. It is particularly well suited to analysing the present situation, as it is generally expected that the struggle for substituting key Japanese inputs will raise the international prices for these parts and components – indeed it is reported that the price of specific types of flash memory or flat panels increased by 20% following the disaster.

Chinese Taipei and Thailand are the economies most exposed to the supply-shock, followed closely by Malaysia. All are relatively small open economies, tightly embedded in regional and global supply chains. Larger developing countries like China and Indonesia are less affected even if some of their industries show high vulnerability. The US is the least affected economy, due to its large size and the predominance of the domestic market as a source of intermediate consumption in industrial inputs. This average picture hides the fact that, at the micro-level, some individual firms are deeply dependent on Asian supply chains, and therefore may be more severely affected.

Table 1. Sectoral transmission of a supply-driven shock emanating from the Japanese industrial sectors (selected countries and sectors, 2008).

Notes: a/ Percentage increase in sectoral domestic production costs resulting from a 30 per cent raise in the price of intermediate inputs imported from Japan. b/ Simple average. Results higher than 2% are highlighted. Source: Adapted from Escaith and Gonguet, (2011), on the basis of IDE-JETRO Asian Input-Output tables.

Conclusions

The Tohoku earthquake and tsunami are expected to have a noticeable impact on both Japan's exports and imports. Even considering the large size of this economy, the world's fourth largest trader in goods and services, the impact on world trade will most probably remain small. Similarly, data available from specialised business organizations tend to indicate that the global supply chains are not expected to be severely affected by the situation in Japan, as long as its economy returns to some normality in the coming weeks. Most disruptions appear to have been domestic, and supply-chain impacts have been relatively controlled. The main effect is anticipated for April-May, while the situation is likely to normalise by the second half of the year.

The opinions expressed in this article and remaining errors are those of the authors. The article is not meant to represent the positions or opinions of the WTO and its Members and is without prejudice to Members’ rights and obligations under the WTO.

References

Altomonte, Carlo and Giancarlo IP Ottaviano (2009), “Resilient to the crisis? Global supply chains and trade flows”, VoxEU.org, 27 November.

Cavallo, E, S Galiani, H Noy and J Pantano (2010), "Catastrophic Natural Disasters and Growth", Inter-American Development Bank Working Paper IDB-WP-183.

Escaith, H and F Gonguet (2011), "International Trade and Real Transmission Channels of Financial Shocks in Global Production Networks: An Asian-USA Perspective", in S Inomata (ed.), Asia Beyond the Global Economic Crisis: The Transmission Mechanism of Financial Shocks, Edward Elgar Publishing Ltd (forthcoming, May). An earlier abridged version is available on VoxEU here.

Gassebner, M, A Keck and R Teh (2010), “Shaken, not Stirred: The Impact of Disasters on International Trade”, Review of International Economics, 18(2):351-368.

WTO and IDE-JETRO (2011), "Trade Patterns and Global Value Chains in East Asia", forthcoming (June), Geneva.