Brian Gaynor: Quick decisions needed following quakes

The rebuilding after the 1931 Hawkes Bay earthquake was funded mainly through charitable contributions. Photo / Supplied

The latest earthquakes in New Zealand and Japan are an unfortunate reminder that the two countries are particularly vulnerable to major natural disasters.

The Japanese seemed to be well prepared for a major earthquake but last week's tragedy shows that it is difficult to protect modern societies against extreme catastrophes. These disasters have major costs, both human and economic.

Japan has a long history of earthquakes, with the worst in the past 100 years occurring on September 1, 1923. The quake and its ensuing fires wreaked havoc on Tokyo and Yokohama and left an estimated 140,000 dead or missing.

The fires, rather than the quake, caused most of the casualties.

There is no accurate record of its impact on Japan's financial markets because the Tokyo Stock Exchange was not established in its present form until after World War II, and the benchmark Nikkei 225 Index was first compiled in 1949.

But the damage, which was estimated at 5.5 billion or about 42 per cent of the country's gross domestic product, was immense (see table).

The yen depreciated sharply after the earthquake as the Japanese government depleted its international reserves and had to borrow heavily on international markets to finance the reconstruction.

The yen fell 16 per cent against the United States dollar in the two years after the quake before recovering.

In 1927 Japan suffered a serious bank crisis which was a direct result of the huge costs associated with the rebuilding of Tokyo and Yokohama.

September 1 is now marked as Disaster Prevention Day in Japan to commemorate the 1923 quake.

New Zealand's biggest earthquake, in terms of casualties, occurred in Hawkes Bay on February 3, 1931. The estimated cost of the disaster was 6 per cent of GDP, £5 million for Napier and £2 million for Hastings.

It is difficult to measure the economic impact of the Hawkes Bay quake because New Zealand was in the strong grip of the Great Depression. The country's real GDP plunged 8.5 per cent in 1931 and was down a further 2.5 per cent the following year.

In 1931 the Government passed the Hawkes Bay Earthquake Act, which provided loans to individuals and local businesses to rebuild their properties. The funding was inadequate and the rebuild of Napier was paid for mainly through charitable contributions.

The next major Japanese earthquake was at Kobe on January 17, 1995. It resulted in 6400 casualties and caused damage estimated at about 2 per cent of the country's GDP.

The Kobe quake struck at dawn and the benchmark Nikkei 225 Index immediately fell 0.5 per cent from the pre-quake level of 19,331. A week later the index was down 6.1 per cent and on July 3 it hit the year low of 14,296, which was 26.0 per cent below the pre-quake level.

However, the Tokyo market made a dramatic recovery in the second half of the year and it finished 1995 at 19,869, nearly 3 per cent above the pre-Kobe quake level.

One of the differences between then and now is that we didn't have wall-to-wall television channels or mobile-phone video capabilities, which allow us to view the catastrophe on a real-time basis.

Consequently the Kobe tragedy had no impact on world markets, including the NZX, which rose steadily throughout the year.

The yen was on a strong bull run when the Kobe earthquake hit. It had risen from 160 to the US dollar in 1990 to 99 at the time of the quake. It fell briefly after the quake but continued on its upward journey in February 1995.

Another feature of this quake was that only 3 per cent of properties were insured. As a result, the Bank of Japan provided special loans of up to 1 trillion to financial institutions to help fund the reconstruction of the city.

In addition the Japanese government had three extra Budgets: one in the March 1995 year and two in the following year, which contributed 3.4 trillion to disaster relief and the reconstruction of Kobe.

As the accompanying table shows, the Christchurch earthquakes - the disasters in September last year and last month - are extremely costly relative to New Zealand's GDP.

The total cost is estimated to be $20 billion, or just more than 10 per cent of the country's GDP of $191 billion.

Although New Zealanders have much more insurance cover than the Japanese, the Christchurch disaster will still put enormous pressure on the Government's financial position in terms of expenditure to fund the rebuild, reduced taxes and higher social assistance.

The Government's budget deficit will increase and this will have to be funded through overseas borrowings because New Zealand's capital markets aren't deep enough to fund the Crown's full requirements.

The latest Japan earthquake and tsunami are far more devastating than the Christchurch tragedy in human terms but in financial terms, relative to the Japanese economy, it is less costly than the New Zealand calamity.

The area hardest hit accounts for 6 to 7 per cent of the Japanese economy and early estimates are that the quake will cost about US$160 billion ($219 billion) or 3 per cent of the country's GDP.

The most expensive natural disaster before this was Hurricane Katrina, which cost an estimated US$125 billion.

As the current size of the Japanese economy is about US$5.4 trillion then the cost of the disaster would have to reach US$540 billion if it was to equate to 10 per cent of the economy, the same as the Christchurch quake.

This week's reaction to the latest Japanese earthquake and tsunami seemed to be overdone because Japan is now far less important to the world economy than China.

The following figures demonstrate why Japan has become less important as far as the New Zealand economy is concerned:

* Japanese visitor numbers have dropped from 151,373 or 8.5 per cent of New Zealand's total visitors in 2000 to only 87,735 or 3.5 per cent of the overall total last year.

* As far as Auckland International Airport is concerned, Japanese represented 3.9 per cent of total international arrivals last year compared with 6.6 per cent 10 years ago.

* Last year, total exports to Japan were $3.28 billion or 7.5 per cent of the country's total exports compared with $3.95 billion or 13.5 per cent of total exports in 2000.

* Imports from Japan have also decreased and now represent 7.3 per cent of New Zealand's total imports compared with 11.2 per cent 10 years ago.

The major challenge facing the New Zealand economy is the Christchurch earthquake, not the disaster in Japan.

Napier was rebuilt remarkably quickly but the Japanese tend to make quicker decisions because they are more willing to accept Government directives.

The Key Government now faces huge challenges. How does it reconcile the divergent views that Christchurch should be rebuilt with an emphasis on heritage buildings compared with the belief that it should be totally modernised?

The other major issue is how the rebuild will be funded; will the Government defer projects in the rest of the country and focus on Christchurch over the next few years?

It is important to note that all earthquakes are bad for an economy, even though many commentators argue that rebuilds stimulate economic activity.

However, the negative impact of an earthquake can be reduced if a government makes quick and sensible decisions that are widely accepted by the inhabitants of the affected area.

We did that after Napier in 1931 and the Japanese achieved this after Tokyo and Yokohama in 1923, and Kobe in 1995.

* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.