Japan Might Become the First Economic Casualty of War

J. Sean Curtin (Professor, Japanese Red Cross University)

Economically, the war in Iraq could not have come at a worse time for Japan. The financial uncertainty caused by the military build up in the Gulf and the subsequent U.S.-led invasion has seriously shaken an already ailing economy. Some Japanese analysts predict that if the conflict drags on for just six weeks, it could easily send the fragile financial system over the precipice. This is because the government has no contingency plans for a prolonged war. Unless the fires raging around Baghdad are extinguished soon, they could help create an economic crisis in Japan.

The benchmark Nikkei average has in the past few weeks sunk below the 8,000 points barrier, something last seen twenty years ago. Although it has recovered somewhat since fighting broke out, it is still subject to huge daily swings depending on how the war is progressing. To try to put the present fall in perspective, the current Nikkei average is about 80% below its all-time high of 38,915 points which was recorded on 29 December 1989. If the Nikkei drops below 7,500 points, some Japanese banks will not be able to meet their international capital adequacy requirements. This could cause meltdown for some sectors of the country's financial system.

While stock markets have also tumbled in the United States and Britain, steep rises in real estate prices have cushioned the losses of many investors. Not so in Japan, the Land, Infrastructure and Transport Ministry just released data for 2002 showing that the cost of land fell for the twelfth straight year in a row. Residential land prices plunged an average of 5.8%, representing a larger decline than the abysmal 5.2% drop recorded in 2001. Commercial land prices fell by an average 8% in 2002, although this was actually an improvement on the 8.3% drop recorded in 2001. To put this figure into context, the average price of commercial land is now roughly equivalent to that seen in the late 1970s. The huge uncertainty generated by the war and its still unpredictable consequences is certain to depress land prices further during 2003.

According to a new report by the Ministry of Public Management, Home Affairs, Posts and Telecommunications, the key gauge of consumer prices in Tokyo fell 0.9% in 2002. The index was down for a record fourth consecutive year which indicates that there is increasing deflationary pressure across the country. For Japanese investors, it feels like nowadays there is no safe domestic haven for their money.

Perhaps the greatest potential threat to Japan's economic health might come from a prolonged conflict, even if that does not currently seem likely with U.S. troops fighting in the centre of Baghdad. The Daiwa Institute of Research has produced various scenarios that illustrate the perils of prolonged military action. If the invasion ends in a month, then the economy would probably emerge relatively unscathed from the conflict as the government calculates. However, if the war continues for up to six weeks, there is likely to be a substantial economic impact with Gross Domestic Product only growing by about 0.2%. Should the hostilities rage on for between six to twelve weeks, then Japan's real GDP would probably contract by about 0.5% in fiscal 2003. In the unlikely event that the war continues for more than three months, then GDP could shrink by as much as 1.3%.

Underlining the sense of crisis, the Bank of Japan called its first ever extraordinary Policy Board meeting on 26 March to discuss how the nation will cope with the economic ramifications of the war on Iraq. The BOJ fears that higher oil prices and a slump in the global economy could hamper Japan's meager forecast of 0.5 % economic growth for fiscal 2003. Additionally, as a U.S. ally, financial support for the postwar reconstruction of Iraq could aggravate an already huge mountain of government debt.

The 1991 Gulf War is estimated to have cost Japan about 13 billion U.S. dollars (1.7 trillion yen), but back then the Japanese economy could afford to shoulder the heavy cost thanks to a boom in stock and land prices. Today, the situation is completely different. Japan is in an extremely weak situation in that it is simultaneously facing a price slump in both goods and assets as well as the lingering effect from the collapse of the late 1980s bubble economy. This time around the Japanese government is only expected to provide about one billion U.S. dollars in loans and grants. Even this limited financial support would force the government to issue yet more bonds, putting the nation's coffers in a truly perilous state. Thus, the fate of Japan's economy will be substantially influenced by the course of the battles raging across the fire-red sands of biblical Mesopotamia.