Creative Destruction in Japan

Some may recall the teachings of Joseph Schumpeter, the Austrian economist (1883-1950) who advocated the concept of creative destruction.  Schumpeter argued that old economic models or investments had to be destroyed in order to liberate the financial and human capital to undertake new, innovative and more profitable ventures.  For the first time since the end of WWII, a major developed economy has suffered an economic calamity of the scale deserving an analysis under Schumpeter’s model.  The question is whether Japan, as an economic and social society, is prepared to seize this moment to radically change its economic model, or if it will miss the moment and re-create what has not served it well over the past 20 years.

First, a bit of historical review is in order.  The German and Japanese economies lay in ruins after WWII.  In the decades that followed, these nations embraced a high quality, high productivity export- oriented goods manufacturing strategy that served them very well.  Both had strong currencies that did not detract from their competitiveness; continued investment in productivity enhancing technologies kept them strong and allowed them to consistently reduce the costs of production.

Japan also exported production to lower cost nations, to Singapore, Malaysia, Vietnam and later, China.  Germany took advantage of the fall of the Eastern Bloc to invest heavily in these formerly communist nations and profited from modernizing their production base.

Japan fell off the rails when their real estate bubble burst at the end of the 1980s and the government was unwilling to force the banks to restructure and cleanse themselves of their excess debt.  The deflationary spiral that resulted increased the debt burden on both the private and public sectors to the point where the current Japanese debt level is over 200 percent of GDP.  Japan was granted an exemption on debt to GDP targets set by the G20 last year because everyone recognized that there was no way that Japan could comply without causing their domestic consumption to implode.

Japan is the poster child for the non-renewable-based economy.  The means of production runs on fossil fuels or nuclear; green, renewable energy is a small percentage of their energy pie.  Oil still accounts for just under half of all energy consumed, according to the 2010 Energy in Japan report.  A review of the graphic indicates that renewable energy is not going to displace fossil fuels anytime soon for energy production.  Even hydroelectric power has seen its share cut in half over the past 60 years, below 10%.

The earthquake, tsunami and meltdown at the Fukushima plant are a disaster of epic proportions for the nation as a whole, but the highest level of economic catastrophe is reserved for the power industry.  Nuclear power was perceived by the general public as safe and clean, since it had no emissions and the plants ran well.  The dirty little secret was that coal and natural gas, non-renewable and polluting sources of energy, were growing in importance as the country tried to get away from imported oil.  If nothing changes, Japan will be forced to bring oil plants back online, expand existing coal and gas facilities, and bring older hydro plants into service as well.  In fact, Tokyo Electric Power has already put seven mothballed hydro plants back into service to try to fill the output gap created by the Fukushima shut-down.

The coastal areas laid waste by the tsunami, including the port city of Sendai and the whole Miyagi Prefecture are the largest area destroyed in a developed nation since the WWII.  Looking beyond the human misery and economic cost of rebuilding estimated at $300 billion, the debate must now become what energy and economic models will be used to reconstruct this area.

Schumpeter would probably look at the poor economic performance of Japan over the last 20 years and determine that the lack of political appetite for reform among the political class would not give him hope that the bureaucratic planners are willing to embrace radical change.  Most international observers would agree – but the reality is that the leadership may have no choice.  The Fukushima plant will never again produce electricity to supply the Miyagi Prefecture, so any building codes for replacement housing will have to embrace low energy consumption principles as simple as outlawing wasteful incandescent light bulbs.  Flat roof buildings will need to be equipped with green design features such as rainwater collection for irrigation or toilet flushing, even going so far as to having grass or gardens for self sufficiency.

Efficient community heating from central steam boiler plants would come into vogue; some cities in the world, notably Moscow, never abandoned this arrangement and the Chinese city of Shangri-La is currently installing 200 megawatts of electrode boilers for just such a system.    Old and new ideas about efficient energy consumption will have to come together to make this work.

Solar and wind power can be experimented with on a grand scale for dedicated regional use.  If the new energy sources and policies are applied to Miyagi, then it will create a “green” economy contained within a fossil fuel economy that will finally demonstrate whether all these revolutionary technologies and practices can support a first world multi-industry economic base.

Car ownership will likely face severe restrictions with one gasoline powered vehicle permitted per household in order avoid rebuilding the same fuel distribution infrastructure that existed before the disaster.  Workers will be encouraged to live near their place of business, and we may even see self-contained commercial villages run by a single employer, similar to what exists in rural China.  The Japanese possess the cultural values necessary to sacrifice personal choice and flexibility for the greater good of the collective; just witness the calm, orderly behavior of those citizens affected by the crisis.  How many of us would have lined up so patiently to be tested for radiation levels by government officials, ironically from the same department that oversees nuclear safety?

It will take several months to finally contain the radiation at the Fukushima site.  It may not be safe to repopulate the area immediately surrounding the plant, but the debate over how to rebuild the coastline and what will power it should begin in earnest.  The Japanese embraced the concept that “quality is free” and demonstrated that they could undercut North American production on price and surpass it in quality.  The challenge has been placed before them to show us that “green is free” – let’s hope that they pursue it wholeheartedly and show us a better economic model for the next industrial revolution.