A Model for Indirect Losses of Negatives Shocks in Production and Finance

Abstract

The Japanese economy has been frequently affected by natural disasters and domestic and overseas financial crises. These events cause production disruption and several other economic losses including the negative impacts on the banking system. The understanding of the transmission mechanism that causes various negative second-order effects post-catastrophe is crucial for policymakers in order to define more efficient strategies for recovery. We introduce in this work the credit-based adaptive regional input-output (ARIO) model to analyze the effects of disaster and crisis on the supply chain and the bank-firm credit networks. Using the exogenous shocks of the 2008 Lehman Brothers bankruptcy and the Great East Japan Earthquake (March 11, 2011), this paper has three research objectives. First, investigate how Japanese listed firms' strategies differ between financial crisis and natural disaster. Second, show how exogenous shocks related to those catastrophic events are transferred to the Japanese banks through the bank-firm network. Third, investigate the most vulnerable Japanese industrial sectors and Japanese geographic locations when hit by a financial crisis and natural disaster, respectively. The model is initialized based on the real supplier-customer network of Japanese listed firms, the real borrowing-lending network of Japanese banks and Japanese listed firms, and the financial statements of these firms. The credit-based ARIO model is calibrated using the Latin hypercube sampling and the design of experiments to reproduce the short-term (one year) dynamics of the index of industrial production of Japan post the 2008 Lehman Brothers bankruptcy and the 2011 Great earthquake in Japan. We reproduced by simulation the Japanese economic dynamics post these two disastrous events. We show how the disruption of production caused by financial crisis or natural disaster is transferred to the banking system by generating additional non-performing loans and liquidity pressure. Then, by simulation experiments we identify the most vulnerable Japanese industrial sectors as the chemical and petroleum manufacturing, and the transport, since those sectors are damaged by a crisis similar to the 2008 financial crisis. The impact on the global economy is measured and the systemic risk of industrial sectors is explained by their position in the supply chain network. Finally, the scenario of the 2011 Great earthquake is simulated on Japanese prefectures to understand differences between regions in terms of global engendered indirect economic losses. Tokyo and Osaka prefectures are the vulnerable geographic locations because of the higher concentration of those vulnerable industrial sectors.