Our hearts go out to the Japanese people and wish them all the luck in the coming weeks and months in dealing with the loss of loved ones, and in putting their lives and homes back together. Beyond the unimaginable human toll, the disaster in Japan has exposed serious longer term risks that have been aggravated by this catastrophe .The earthquake and tsunami did not create these risks; but they are certainly being made more serious in its aftermath.

There have been many media commentaries since the Sendai disaster on the risks posed to the global supply chains in electronics and auto as a result of halted production in Japan. In fact, the best and the most competitive of Japan’s companies have been investing heavily for a long time in building production facilities outside of Japan.  It has been estimated that in 2009 Japan’s GNP (counting all economic outputs produced worldwide by Japanese entities regardless of their geographical locations) is around 4% bigger than Japan’s GDP (counting only all economic outputs that take place within Japan’s national boundary) (estimate by Yasuhiro Maehara, School of International and Public Policy, Hitotsubashi University, Japan). The motivation for relocating production facilities overseas has been driven by need to be closer to markets with strong growth in demand and lower production costs, which is not in Japan. The Sendai disaster will, however, accelerate this trend, to the detriment of domestic employment and government tax revenue.

According to CEIC data, while the market for Japanese government bonds has been able to take comfort from the fact that the financial assets of the household sector is about 300% of GDP , making the financing of the government’s deficit non-problematic. It also supports the conventional wisdom that it will be at least another decade before the government needs to worry about financing new borrowing. But things are beginning to look a bit different after Sendai. Instead of the public sector debt-to-GDP ratio, the same level of public sector debt can be compared to the government’s tax revenue.  This shows that public sector debt-to-tax revenue in Japan now approaches an astonishing 1,900%, up from 1,100% in 2000.  For the Japanese economy to have a chance to climb out of its two decades of stagnation, this ratio has to be reduced. After Sendai, a convergence of the factors examined above may make this impossible.

Government spending is now set to rise. The new spending is unlikely to lift economic growth sustainably. The only lasting impact is a net increase in public sector debt.  Households will likely run down their savings faster too.  Not all of the damage to homes and properties will be covered by insurance.  Households will need to fund a great deal of repair and rebuilding out of their savings.  There is then a net reduction in the total household financial asset that has been such a comforting factor to the bond market.  Finally, with the trend of businesses relocating overseas accelerating, the government’s tax base will shrink further, rendering the public sector debt-to-tax revenue ratio even more difficult to bring down.

After Sendai, the government bond market may not have the ten years of safety margin that it once thought it had.

Also appears on The Heart of Commerce Blog.

Topics: Economic Outlook