Japans restoration efforts and implications
If the British economist David Ricardo were alive today, he would have been the first to voice strong concern about the potential slowdown in global manufacturing stemming from Japan’s devastating earthquake. At present, global manufacturing relies on the division of labor based on comparative advantage, and Asian economies — particularly Japan — are the key participants in this value chain.
To understand their importance, let’s use Boeing as an example. Seven countries supply parts for Boeing’s B787 Dreamliner, a next-generation passenger jet developed by the aircraft manufacturer. Some of these parts include fuselage doors made in the U.S. and bulk cargo doors from Sweden. But what is interesting here is that aside from the U.S., Japan is the biggest supplier of components used to build it.
The ripple effect from the March 11 earthquake was more pronounced than what we imagined. Global manufacturing firms that used a myriad of intermediate goods from Japan saw their production hit a major snag.
In contrast, there are companies and countries that benefitted from the earthquake, most notably Korea. Thus, we believe it is strategically very important to determine what progress has been made in regard to the post-earthquake restoration as it will have a profound effect on the global manufacturing sector’s pace of recovery and changes in the benefit-sharing mechanism between industries and countries.
The automotive sector was the hardest hit by the disaster in Japan. Auto exports by Japan in May were only half the pre-crisis level in February, whereas overall exports lost a mere 10 percent during the period. But it now appears auto-related sectors are recovering from the shock faster than expected.
According to IHS Global Insight, the disaster’s corrosive impact on global auto production should shrink from minus 13 percent in April and minus 16 percent in May to minus 11 percent in June, minus 7 percent in July and minus 3 percent in August. That is, the production disruption would be the biggest in May but return to normal beyond August.
Of note, the production recovery by auto parts makers has been fast and so have their share prices. Denso, the largest auto parts supplier in Japan, bounced back to roughly 90 percent of the pre-crisis level and others are also outperforming the broader market in Japan.
Power shortages to last longer
The recovery of electric power facilities is slower than the automotive industry. More than three months have passed since the earthquake and tsunami hit Japan but there has been little progress to restore power facilities. The condition of power supply has further worsened as operation was shut down at the Higashidori nuclear power station, operated by Tohoku Electric Power based in Sendai. The suspended capacity at the damaged plants totals 33,000 megavolts at the end of June, up from 32,000 megavolts at the end of April. We can see Japan’s power plants are recovering at a very slow pace. The serious power shortage in Japan will likely remain in place for a lengthy period.
Ironically, catastrophic events such as wars and natural disasters create effective demand. Expectations are great that Japan will prove resilient to the crisis just as it did throughout its turbulent history. But the absence of strong political leadership results in a delayed policymaking process for the national rebuilding effort.
We believe when Japan unveils its monetary and fiscal policy directions in August, the country should provide strong momentum for the global economy.
The combination between voracious China and electricity-strapped Japan should aggravate the power shortage across Asia and drive up regional demand for diesel. As such, we have a positive outlook for refiners although their stocks are retreating due to concern about second-quarter earnings and the possibility of oil price drops.
We believe Korean automakers will see a valuation premium if they can defend market share despite production returning to normal at their Japanese and global rivals. If such is the case, Korean automakers will earn credit for their competitiveness and cast aside their image as an unwitting beneficiary of the Japanese crisis. We expect Korean automakers to throw down the gauntlet to Japanese rivals for a larger piece of the global market.