Homeland Security Watch

News and analysis of critical issues in homeland security

April 21, 2011

Bank of Japan: “A supply side shock”

Filed under: Catastrophes,Preparedness and Response — by Philip J. Palin on April 21, 2011

Earlier today the Deputy Governor of the Bank of Japan, Kiyohiko Nishimura, gave a speech that provides the most comprehensive overview of post-earthquake-and-tsunami supply chain issues that I have heard or read.  Below are several long excerpts from the speech.  The official translation of the entire address is available from the Bank of Japan.

There is nothing especially new here for readers of HLSWatch, but to have such an authoritative source outlining the issue may help in making the case for those who are not familiar with the key role of supply chains in mitigation, response, and recovery.

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The disaster has caused two types of supply constraints, which I will explain shortly. As a result of these constraints, production in some industries has declined substantially, which has had a severe impact on exports and domestic shipments. Business sentiment has also deteriorated and consumer appetite has waned.

One of these supply constraints is the widespread damage to production facilities and associated malfunctioning of the supply chain networks that deliver parts. The Kobe Earthquake had a devastating impact on city functions in the part of southern Hyogo Prefecture that was directly hit, but the affected areas were not so widespread. In contrast, the March 11 earthquake caused devastating damage over a much wider area, destroying the production facilities of many industries, including the electrical and general machinery industries…

Production of electronic components and devices had been thriving in the affected areas, and there were more than a few parts manufacturers producing unique products with dominant global market share. Damage to the production facilities of these firms has meant that many other firms face difficulties procuring parts — typified by the automobile industry, which relies on computerized and customized parts produced under strict quality control. This is causing constraints on production throughout Japan.

Another supply constraint is the constraints on power supply. More than 20 percent of generating capacity has been lost in the Tokyo Electric Power Company’s service area, due to damage not only to the Fukushima Daiichi nuclear power plant but also to several thermal power plants. The Tohoku Electric Power Company has also lost about 30 percent of its supply capacity. This has resulted in disruption to stable power supply, as rolling blackouts were at one point implemented in the Kanto and Tohoku regions to avoid unexpected large-scale blackouts due to power supply constraints.

There are some industries, such as the food and chemical industries, which need time to start up or shut down production facilities or need continuous power distribution to ensure the quality of their products. It has been pointed out that production levels have declined in these industries because of the absence of stable power supply, even though their production facilities were not significantly damaged by the earthquake.

Meanwhile, on the demand side, while demand for necessities increased temporarily, a deterioration in firms’ appetite for investment and households’ appetite for consumption, due to rising uncertainty about the future, seems to be exerting overall downward pressure on business fixed investment and private consumption. For example, sales at electrical appliance stores and department stores declined significantly after the earthquake, as a result of a deterioration in households’ appetite for consumption coupled with shortened business hours due to power supply restrictions…

Today, I would like to discuss three key aspects to consider in projecting the outlook for economic activity and prices in Japan. The first aspect is when, how, and to what extent the current supply-side constraints that Japan’s economy is facing will be removed.

The sharp downturn in Japan’s economy after the earthquake has been, simply put, triggered by supply-side shock from damage to production facilities, including damage to power supply capacity caused by the earthquake and tsunami.

Therefore, the key for the outlook is when and how the supply-side constraints caused by the disaster will be removed. On this point, I must say that there is a great deal of uncertainty about when they will be removed. This is due to a high degree of uncertainty about the following three problems.

The first problem is that it is very difficult to say with any certainty when the production capacity lost as a result of the disaster will be restored. Firms are making strenuous efforts to, for example, resume operations at affected production facilities and ensure substitute production by factories in non-affected areas. However, progress in these efforts has been slow due to various supply-side constraints including unstable power supply. Another factor that makes it difficult to remove such constraints is that some of the electronic components and high-end materials produced in the affected factories are hard to replace because of quality requirements and high levels of customization.

The second problem, which is also related to the issue of restoring production capacity, is the question of when the disruptions to supply chains will be removed. At present, firms are working to repair or rebuild supply chains by, for example, seeking to secure alternative suppliers, including from overseas, and reviewing product specifications. However, as supply chains are complex and interconnected, if a bottleneck occurs in any one part of the chain, accurately gauging its impact and addressing the problem present various difficulties. Therefore, a considerable amount of time is considered necessary to reconstruct supply chains.

The third problem is uncertainty as to when constraints on electric power supply will be removed. Electric power companies and other related parties are doing all that they can to, for example, resume operations of facilities to restore supply capacity. Firms are also taking various measures to address the situation. One such measure is changing working hours. For example, one firm in Kanagawa Prefecture has changed the working hours of some divisions. These divisions now start work two hours earlier in the morning to reduce the amount of electric power used. Another measure is operating at non-peak times, such as at nights or on holidays. And a third measure is using in-house power generators. Households have also been asked to conserve electricity and voluntary conservation has been ongoing. These efforts have recently eased constraints on economic activity due to power shortages. However, demand for electricity will surge in the summer due to the use of air conditioners, and therefore, the balance between electricity supply and demand will tighten again and a certain degree of supply constraint is likely to emerge.

Taking these points into account, it is unlikely that the supply-side constraints will be removed anytime soon. I must say that Japan’s economy is likely to remain under strong downward pressure, mainly on the production side, for some time to come. However, looking ahead to the autumn and beyond, the supply-side constraints are likely to ease as the tightness in electricity supply and demand balance improves and progress is expected to be made in the reconfiguration of supply chains. If that is the case, as long as the global economy continues to record high growth led by emerging and commodity-exporting economies, which is likely, a recovery in production in Japan and ensuing increase in exports will probably serve as one driving force behind a recovery in Japan’s economy.

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2 Comments »

Comment by William R. Cumming

April 21, 2011 @ 5:14 am

Phil! A really really great post and many thanks. Yes the bane of modern technological society is uncertainty. And it is the destroyer of financial markets since it prevents those algorithims being developed to manipulate the artificial reality called “money”!

But the following sentence is the real killer!

“Meanwhile, on the demand side, while demand for necessities increased temporarily, a deterioration in firms’ appetite for investment and households’ appetite for consumption, due to rising uncertainty about the future, seems to be exerting overall downward pressure on business fixed investment and private consumption.”

I don’t know enough about Japan to understand why it was never quite the “demand” driven economy as was the US. But certainly the die off of domestic demand has got to be worrisome whether for actual or psychological reasons.

All in all it adds up to me that there has been a major disruption in the “force” of the international economy and will not just impact Japan. Will Japan and the world work around some of the problems identified in supply chains–YES! Will a boyuant and vibrant Japanese people and economy rise again–YES! But none of this is going to be easy so the analysis and study of lessons learned from this event over this decade are going to be very important to discern and learn.

KOBE was Japan’s largest port. Largely as most modern ports container shipping was at its core. I estimate that almost $250B was spent directly and indirectly on KOBE restoration and recovery by Japan but other experts seem to doubt my figures. What is true is that the modern economy is ruthless in many ways. KOBE has not regained its lost shipping traffic even now from that 1995 event. This important lesson was lost on all including Japan from that event.

That is why I am predicting a two decade effort needed in Japan to regain what has been lost. Willing as always to hear other arguments.

I also think that it will be important for the Japanese to take looks outside the box as to the future of Japanese life in that highly prone area to the fury of MOTHER NATURE.

I defer to you PHIL and others more familiar with Japan on how this might or will play out. But I think as we cross the six week mark this week end we (the US) and the Japanese are just now coming to grips with the enormity of this event and crisis. And the official evacuation zone now extended. Will access and egress be policed?

Comment by William R. Cumming

April 26, 2011 @ 7:42 am

I notice that the initial BOJ effort is now announced at the 4 Trillion yen level. WOW good first cut.

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