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International trade and comparative advantage, a story of Japan

August 9, 2017

Photo of Mt. Fuji in Japan at Business Insider http://www.businessinsider.com/sc/guide-to-the-japanese-economy-2016-11

 

 

If you read my story about the two ship-wrecked castaways and how they used their comparative advantages, traded with each other and came out with more fish and bread than when they were at odds and kept to themselves. If you haven't read the story, or you want to refresh your understanding of the theory of comparative advantage and the gains from trade, click go to this link http://bit.ly/2vrYopE

 

 

You may be asking, well it's a nice story but can you give me any evidence that any country that was once closed off from the rest of the world and engaged in almost no trade with other countries, finally opened up and began trading with other countries and their total output went up as a result?

 

Well as a matter of fact, there is such a case that has been documented. Japan, after a relatively open period to other countries and regions, was closed off by its shogun leaders to foreigners during the years 1633 - 1853.  Foreign influences and trade with foreigners were strictly limited and severely controlled. In the years preceding 1633 Japan was a country largely of free and open markets and engaged in trade with other countries, and regions; and after the closed period ended, Japan again became a country with free competitive markets open to international trade. How and why the period of seclusion ended is another story, but there was some force involved from western nations, including from American war ships.

But the long period of isolation followed by a dramatic opening to international trade in the 19th century gave rise to what economist call a natural experiment. A country closed for 200 years to international trade, suddenly becomes reintroduced to it. What happened to Japan's domestic income and product, to its national income as a result?

 

Two economists, Daniel M. Bernhofen and John C. Brown published a paper in the American Economic Review in 2005 that took advantage of this natural experiment to quantify the gains from trade as a result of comparative advantage. To measure the effect of comparative advantage separately from other effects that Japan enjoyed from the opening up of their country to foreign technology and ideas Bernhofen and Brown (B&B) analyzed a brief period, the late 1860s through the mid 1870s. They did this because their goal was to measure the effect of comparative advantage alone and not combine and confuse it with other benefits that international openness and trade conferred on the Japanese economy.

 

The late 1860s to mid 1870s was a period when Japan's trade barriers came down, but before the enthusiastic adoption of new Western technologies and the adaption of Western methods of administration and management that the newly opened economy became exposed to; and that caused an explosion of industrial productivity and diversification - another benefit from trade.

 

So by restricting their data and analysis to that brief period just after the removal of tariffs and quotas and other restrictions on trade and before the introduction of foreign technologies, B&B were able to isolate the gains from trade to Japan's income and production that resulted from comparative advantage alone. For technical and data availability reasons, B&B had to estimate what Japan's national income would have been in the period 1851-1853, the years just before the opening to trade, as if the opening had occurred earlier and had been in effect in 1851 - 1853.  They estimate that for that brief period the gain in Japan's national income would have been from 8-9 percent per year higher if international trade had been allowed during that period, but there was no use of learned foreign technologies and methods of management and administration. They take this as an estimate of the gains from international trade to Japan during that period resulting from comparative advantage. Of course in subsequent years Japan's growth in national income took off, but not all of that was from comparative advantage effects of trade. It was wound up with and compounded by new technologies that came their way as a result of exposure to, and relationships with, foreigners.

 

Supporting the notion that the closed Japanese economy between 1633 and 1853 was far from dynamic comes from this quote from a A History of Japan, 1582–1941 by L. M. Cullen. After studying whatever accounts were available during these years, Cullen writes that during 1709–1783, nearly in the middle of the closed economy years, "The outlook of officials and samurai writers at large was profoundly coloured by a crisis in income more than by one in the economy. This was all the more serious for samurai and government alike as inelastic incomes did not compensate for high urban living costs. Harvest failures created immediate problems: while prices rose, output was down, and abatements to peasants on the rice levy were usually necessary."

 

On the period 1919-1941 solidly after the closed economy period, Cullen writes, "Japan’s economic diversification gathered pace. Urban population grew rapidly, and its cities acquired a recognizably western style infrastructure."

 

So there you have it. A natural experiment that verifies the positive gains from international trade. It is one way economists try to use data to verify conclusions drawn from purely theoretical models. Remember my blog post "Economists do it with models?" It is important that economists attempt to verify conclusions drawn from their models. Natural experiments are one way they try to do this, but it is not the only way. Using statistical analysis of large and small data sets is yet another way. Natural experiments are relatively rare, but when an economist finds one, it can be a gem.

 

References: 

 

 DANIEL M. BERNHOFEN AND JOHN C. BROWN, "An Empirical Assessment of the Comparative Advantage Gains from Trade: Evidence from Japan, American Economic Review, March 2005

 

L.M. Cullen A History of Japan, 1582–1941 Cambridge University Press 2003

 

 

 

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