Challenges for Post-Crisis Japan

Summary

Professor Kiyotaki Presentation Shinji Fujino Presentation Alex Stewart Presentation

The 11 March earthquake and tsunami have produced a human tragedy, to which the Japanese have responded with stoicism. However, this is also an economic crisis, made more complicated by the damage done to the Fukushima nuclear complex and disruption to other east coast facilities, including nuclear and thermal plants. In this seminar, we reflected on the impact of these events on the Japanese and the global economy. Professor Kiyotaki of Princeton University discussed the economic implications of the Tohoku disaster, and raised the prospect of post-crisis planning and rebuilding. Shinji Fujino from the OECD/International Energy Agency discussed current electricity supply problems and the future of Japan’s energy sector. Finally, Alex Stewart, a specialist on the Chuken Kigyo (Japan’s strong, medium-sized companies), looked at how the high-tech corporate sector has been affected by the crisis, asking if these companies can lead Japan’s economic response.

The evening’s first contributor and nuclear expert, Shinji Fujino, speaking in a personal capacity, began by describing the 11 March magnitude 9 earthquake, as the biggest to have hit Japan in centuries. The accompanying tsunami, reaching over 14 metres in height, was unprecedented in scale and swept away almost everything in its wake in the northeast of Japan including houses, buildings, cars and trains.

Given Japan’s reliance on nuclear power, it has built 45 nuclear power units on 17 sites, all located by the sea, in order to prevent overheating. Fujino went on to remark that 14 of these units exist in the northeast of Japan on four nuclear sites. At the time of the earthquake, 11 of the northeastern nuclear units were running while three were not in operation as they had come up for inspection. The 11 operating units all successfully shut down as expected; a cooling down period ensued and nuclear emission into the atmosphere was duly averted.

It was the first time ever that 11 units had automatically switched off as a result of an earthquake. All units cooled down successfully apart from three nuclear reactors at the Fukushima Daiichi Station, which were damaged not by the earthquake but by the tsunami. The Fukushima Daiichi Station is located 10 metres above sea level and normally would not have been affected by a tsunami, said Fujino.  The one in March, however, was extraordinarily high.

The nuclear supply capacity was cut off as a result of the earthquake at which point the reserve batteries or generator should have kicked in to operation. This back-up measure failed in the three aforementioned reactors, however, as a result of the tsunami damage.  Heat continued being emitted. This led to the creation of hydrogen, which resulted in an explosion explained Fujino.

Consequently, 9.720 million watts or 9.7 gigawatts (GW) of electricity supply were lost. Putting this in context, Fujino related that 10 GW is equivalent to New Zealand’s entire electrical capacity while 20 GW is equivalent to Austria’s. As the thermal plants in the northeast of Japan also lost over 9.4 GW, overall about 20 GW was lost. Fujino wondered how Europe would cope if it were to lose such a quantity of electrical capacity.

The Tokyo Electric Power Company (TEPCO) dominates in the Kanto area of Japan, comprising Tokyo, Ibaraki, Chiba, Gunma, Tochigi, Saitama and Kanagawa. It is also dominant in northern Japan along with the Japan Atomic Power Company (JAPC). As a result of the March earthquake and tsunami TEPCO lost 40% of it total capacity, reducing it to 31 GW; the estimated peak demand in the TEPCO region is 55 GW. Thanks to energy-saving activity displayed by the Japanese, TEPCO has not had to implement blackouts since April. However, the Japanese economy faces more economic problems assured Fujino.

The peak of electricity demand in Japan is during the summer rather than the winter as is the case in the UK and Europe. Japanese summers are relentlessly hot. During the record-breaking summer of 2010, the temperature did not dip below 30°C, even at midnight, for days on end.

As the estimated peak demand in the TEPCO region is of 55 GW and its supply capacity is of 45 GW, a saving of 10 GW is necessary. As of 8 April the government announced a power and supply demand plan which Fujino elucidated. 10 GW has to be cut of the peak demand and 25% of large consumers’ energy consumption has to be reduced as well through improved manufacturing efficiency, more energy-efficient machines, shifting and/or shortening working hours and shifting or extending the summer holidays.

The government is also asking smaller businesses to scale down their energy consumption by 20% through implementing voluntary measures including a reduction in cooling, lighting and the quantity of IT equipment used, as well as encouraging the wearing of temperature-appropriate clothing and urging households to decrease their energy consumption by 15-20% through voluntary measures such as cooling and light reduction, the installation of more efficient appliances and dropping the habit of leaving electrical appliances on stand-by power.

The Japanese government’s supply side measures include providing an extra five GW in the TEPCO region by summer 2011. It will continue with its plans to restore damaged thermal capacities and strengthen interregional connections and renewable power capacity from the summer of 2011 onwards.

Fujino finished by referring to Japan’s energy plans. These, which are based on energy security and self-sufficiency, set ambitious targets which may need to be reconsidered in view of the recent earthquake. These targets include doubling its energy self-sufficiency ratio – 18% in 2009 – by 2030, reducing carbon dioxide emissions by 25% and below 1990 levels by 2020 as well as creating nine additional nuclear units by 2020 and 14 by 2030.

Since the talk, these plans have been reviewed.

The second speaker, Professor Kiyotaki, in assessing the macroeconomic implications of the Tohoku earthquake began by looking at its impact on factors of production such as labour, tangible capital, intangibles and social capital.

Taking into account the disaster’s direct impact on the world economy, Kiyotaki allayed concerns, saying its direct impact on supply and demand would be large but limited and that while its impact on energy production is potentially large, this production is substitutable and can be contained through measures such as increasing price and diversifying.

The financial effect has been negligible due to low leverage. As long as the government regains long-term fiscal balance, the impact will be smaller than that of the recent financial crisis (2007 – 2010). The situation is buoyed by the fact that Japan is not borrowing too much money and that its economy is not contracting.

Having said this, Kiyotaki warned against complacency, pointing out that the Japanese government would need to act soon to avert a further economic slump. A potential danger is Japan’s public finance with its large deficit akin to the American situation.  While the UK and the rest of Europe are reducing their deficits quite quickly and the emerging markets are doing rather well, the USA and Japan are, at present, outriders said Kiyotaki.

Kiyotaki went on to talk about the risk of delaying fiscal reform by saying that if the nominal interest rate rose by 1.5% as a result of anticipated inflation or the fiscal balance worsening by 2.4% of GDP (12 trillion ¥) loans and bonds would decrease in value as it only takes a small change in interest rates for a big impact on net worth. If inflation were expected the Bank of Japan would not be able to buy bonds as the result would be counter to its aim of lower interest rates.

Looking into the future, Kiyotaki had some recommendations. The Japanese government, he maintained, must reform social insurance, raise the retirement age and gradually increase consumption tax – at present 5% – as it is, in his view, the most effective tax. The Bank of Japan needs to stop deflation while controlling inflation and firms should invest more in intangible capital including on-the-job training of young workers which is the key to growth. Kiyotaki ended by saying that we all need to contribute more to society and if we do we shall, hopefully, reap rewards.

The third speaker, Alex Stewart, went on to speak about the ‘chuken kigyo’ or ‘mid-sized companies’, which tend to be family-owned – allowing for quick decision-making – often with idiosyncratic founders or philosophy and a ‘number one’ strategy status. Stewart began by wondering if the Japanese economy is resting on these high-tech companies, if they have the vitality to pull Japan around or whether the Japanese economy is flawed and being by-passed by China.

Stewart described Japan as an advanced manufacturing country rather than a ‘post-industrial’ country.  Brand integrators sit at the top of the pyramid; the midsize companies or the chuken kigyo are in the middle providing parts, materials and capital goods while the bottom of the pyramid is comprised of human resources, technologies, knowledge, capital, transport and logistics services.

Even virtually unknown chuken kigyo have a high percentage of the global share said Stewart and referred to the November 2009 edition of the Economist which described the chuken kigyo as being at the core of Japan’s industrial structure, enabling its bigger and better known electronics firms to exist. Providing context, Stewart said that some of the bigger chugen kigyo such as Kyocera, a small components company, have sales reaching £8.3 billion while British Aerospace, one of the UK’s largest companies makes £22 billion annually.

Following the 11 March earthquake, frontline chuken kigyo in Tohoku, including Toshiba, were badly affected by the earthquake. Consequent risks are that Japanese customers may seek alternative suppliers, that foreign companies will reduce their dependency on Japanese midsize companies and that other countries will invigorate their national policies elsewhere. Japanese suppliers will have to pull together and reorganise production. Mitsui Mining and Melting, which owns 90% of the global market share, for example, has responded by permanently shifting part of its production offshore.

Though Japan is facing challenges from Asia as it loses its brand market share to Asian competitors such as Korea’s Samsung and Taiwan’s semiconductor companies and by China’s shift from Original Equipment Manufacturer (OEM) to Original Designed Manufacturer (ODM), Stewart commented that overall, Japan can make the best of its strengths, weaknesses, opportunities and threats.

Japan’s strengths lie in its attention to precise production and logistics, its perfectionism, group orientation, complete manufacturing system and long-term planning system. Its weaknesses on the other hand rest on its weak political system and leadership, its weak decision making processes and mentality, deflation, demographic decline, loss of vision and growing frustration. Opportunities for Japan lie in the size of the Chinese market, the post-oil and carbon economy and the re-thinking of the organisation of supply chains. Threats include competition from other Asian leaders and supply chains, substitution, open innovation and new business models. 

Bearing these factors in mind, Stewart concluded that Japan may not be able to compete with China and that it should not push its weight. Rather, it should focus on what it’s good at, such as the chuken kigyo and its highly cohesive society.

The questions and answers following the talks were varied and lively and covered themes such as the Japanese government’s commitment to carbon reduction and Japan’s potential for renewable energy and technology, the obstacle to Japanese power interconnection with Korea and the Asian continent, the fact that markets are relatively resilient and would be able to deal with serious external shocks such as large increases in the price  of oil as people do conserve in such circumstances, the fact that increasing consumption tax bit by bit would encourage people to spend before each hike, the concern that squeezing the energy sector, raising consumption tax and reconstruction costs is deeply  worrying as costs would soar in the region of $300 – $400 excluding the issues of the power sector – despite reassurances from Kiyotaki that in the long-term he doesn’t expect as big a collapse post the earthquake as occurred after the Lehman crisis; and whether the chuken kigyo will relocate to other parts of Japan outside of Tohoku or overseas spelling the collapse of Tohoku.

 

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