Crossing Borders: The Advantage of Trade

Professor John Brown's research

Would your standard of living be better or worse if you were only able to buy products made in the United States? There would be no access to the latest in Japanese electronics, or French cheese, or Costa Rican coffee. If you were a business owner, how would you feel about having to restrict the sale of your goods and services to the United States? You wouldn't face competition from China or Germany, but you would also lose access to 5.5 billion potential customers.

For almost two centuries, economists and policy makers have argued that a country able to buy from and sell to other countries without restriction will have a higher standard of living than a country that prohibits imports and exports. This perspective, known as the theory of comparative advantage, provides important support for more open trade, including the North American Free Trade Agreement (NAFTA) and the many trade treaties that are enforced by the World Trade Organization (WTO).

The best situation for a direct test of the theory of comparative advantage is one where a country is experiencing no trade at all, a condition known as autarky. It has been difficult to find an example of such a country, particularly for a country that has a market economy. As a result, economists tested this theory using only indirect approaches.

Recently, however, economist John Brown and his collaborator, Research Professor in Economics at Clark Daniel Bernofen,* brought together recent theoretical work and the results of modern Japanese economic history to argue that mid-19th century Japan was a country that came very close to autarky. They have used the economic conditions that existed there—and the "natural experiment" of Japan's sudden opening up to free trade in 1859—to test theory against actual evidence. Their research suggests that a free trade economy does lead to a higher standard of living, even for a country that, by the standards of the day, was very poor and, by every account, technologically backward.

Comparative advantage, free trade, and the standard of living

The concept of comparative advantage includes two predictions:

First, that people will specialize in producing the product or service in which they can make the best (most productive) use of their time. For example, a Wall Street lawyer rarely does all of the typing needed to prepare court briefs, much less grow all of her own food or bake all of her own bread. Even if she types 120 words a minute, it still makes sense for her to hire someone else to do the typing at 60 words a minute, if her comparative advantage is in the preparation and argument of legal cases.

Second, that all those who specialize and then exchange the products of their time and effort will collectively make the best use of their time (and other resources). That results in having more to share among themselves. When people specialize at what they do best, less time is needed in total to get the same amount of goods. Their standards of living rise.

Modern trade economics argues that the principle of comparative advantage applies in general to trade among countries as well. If countries trade according to comparative advantage, they will specialize in the goods that are relatively inexpensive in terms of what else they could produce (what they are "best at"). Likewise, by specializing and then trading according to comparative advantage, they are best able to take advantage of the comparative productivity of others. They should not be made worse off, and they could be made better off with a higher living standard.

When exchange crosses national borders, many argue that the logic of comparative advantage breaks down. The conventional view of critics of globalization is that the rules that govern trading relationships among residents of different countries are fundamentally determined by political and economic power, so that the predictions of mutual gains implied by the idea of comparative advantage no longer hold. The results of the Brown and Bernhofen research challenge this view.

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A test case: 19th century Japan

In the mid-19th century, Japan, isolated in the Pacific Ocean, was essentially self-sufficient. For over 200 years, the government had essentially forbidden the export of products from Japan and the import of products from abroad, including other Asian countries. Only a miniscule amount of trade took place—with Chinese merchants and the Dutch East India Company—at Deshima, a tiny island in Nagasaki harbor. As a result, the Japanese also missed out on the technological improvements associated with the industrial revolution. Their technologies relied almost entirely on hand power and they had very few mechanical devices. Instead of the iron and steel of the advanced economies, they used wood and stone.

Admiral Perry's fleet of "black ships" appeared in Tokyo Bay in 1853 to bring this era of isolation to an end. By 1859, the autarky period was over. Military pressure from the United States and other western powers forced Japan to sign treaties requiring it to adopt a policy very close to free trade. Over the next two decades, Japan went from being a self-sufficient country to one that exported large amounts of unfinished raw materials to Europe and the United States. It acquired a voracious appetite for products of the Industrial Revolution (iron, yarn and cloth) and of its East Asian neighbors, including soybeans, rice and sugar. Thus, within a very short period of time, Japan provides an example of both an autarky and a free trade economy.

Testing the theory of comparative advantage: comparing autarky to free trade

What was the impact on Japanese consumers of this drastic change from a closed to an open economy? The opportunity to import and export affected the prices of goods. Some items became more expensive, while others could be had for much less. New goods such as woolen cloth and inexpensive glass became available to a wider market for the first time. But what was the net impact? Did the average resident of Japan fare better or worse?

To investigate this question, Brown and Bernhofen decided to compare the actual well-being of Japan's 30 million consumers in 1853 (the autarky period) with a careful estimate of how well off they would have been during the same year had Japan been open to free trade. For a non-economist, the instinct might have been to compare the standard of living in 1853 autarky with that in the 1868 free trade period. However, economists know that such a comparison would not be analytically sound. Many changes may have taken place in the Japanese economy between 1853 and 1868 that were not a result of open trade. Instead, the appropriate alternative for comparison, known as the counterfactual, is a Japanese economy that was in every other way identical to the economy that existed when Perry's ships appeared in Tokyo Bay —except that it was open to trade.

As it turns out, historical sources allow a reconstruction of the comparison economy. The main impact of trade during the early period was importing lower-priced products in exchange for silk and tea. Expanded consumption included everyday goods. Indirectly, consumers benefited from the importation of cheaper raw materials, including inexpensive British yarn and iron. Other changes that we associate with open trade had not yet taken place. The technological gap was so large that it took many decades after opening up before Japan could begin to absorb western technologies. There was no notable western investment in Japan. Even the well-known fashion for all things western, including the wearing of bowler hats, took a few decades to take hold.

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Determining cost versus benefit of opening to free trade

To place a value on the net gain to the well-being of the Japanese, the researchers used two pieces of information:

An estimate of how much Japan would have imported and exported in 1853 if it were open to trade.

The actual prices the Japanese paid for these traded goods during autarky.

The benefit for the Japanese was how much they valued the increased consumption from imported goods. Market prices from the autarky economy provide a measure of how much each yard of cloth or bushel of soybeans was worth to the average consumer.

The cost to the Japanese was the value (in autarky) of the products they gave up as exports in exchange.

The gains in well-being were the benefits minus the costs. They compared these gains with reasonable estimates of the Gross Domestic Product (GDP) per person for that year. The GDP is the total value of all goods and services produced by a country in a single year. Economists frequently use GDP per person as an indicator of the standard of living.

To make the autarky/free trade standard of living comparison, the researchers used several kinds of information:

Economies being compared	Type of information needed	Source
Autarky (actual) c. 1853	Gross Domestic Product (GDP) (estimate)	Research carried out by Japanese economic historians using village records from one-region studies of the post-autarky economy. From that Brown and Bernhofen derive a range of plausible estimates of GDP for the country as a whole.
Free trade (estimated) c. 1853	Types and quantities of goods imported and exported (estimate based on projecting back from the free trade period c. 1868). Value of imports and exports from autarky. Types and prices of goods produced in Japan that would be imported and exported under free trade; estimated maximum consumer valuation of goods imported but not produced in Japan, for example, woolens and modern guns	Detailed records kept by Japanese government. Merchant account books compiled by Japanese historians and reports of early foreign visitors. Contemporary guides to Japanese currency, coinage, weights and measures.

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The results: a challenge to the conventional view

If a contemporary observer looked at the position of Japan in the international economy in the mid-1850s, he or she might question whether Japan could possibly benefit from abandoning autarky and opening up to free trade. It was by most measures a backward economy that had missed out on the industrial revolution. The only western language spoken at all was restricted to the few who had learned Dutch. The trade with the outside world was in the hands of foreigners, both westerners and Chinese. Japan lay open to a potential flood of imports from the advanced and wealthy West with very little to offer in exchange. Many critics of globalization argue that when free trade takes place under such conditions, that is, between countries unequal in resources and levels of development, the weaker country inevitably loses out.

Nonetheless, the Clark researchers found that trade according to comparative advantage actually yielded substantial gains to the Japanese. They used several different scenarios to find the most likely range of gains. Expressed as a percentage of GDP, the improvement to well-being was from five to nine percent. The Japanese worked a six-day week back then. An improvement in well-being of five to nine percent of GDP was the equivalent of giving each worker the production of fifteen to twenty-eight days worth of work without requiring him or her to spend another minute in the field or at the loom. By opening itself up to trade, Japan's focus on trading the goods in which it had a comparative advantage for what was available in the world marketplace was almost the equivalent of saving a month of work.

Future research

In the transition to free trade, Japan went through substantial economic change. Silk became an important export and silk producers in the countryside turned from rice and other crops to raising silkworms. Cotton growers gradually turned their fields over to other crops. Cotton yarn, once domestically produced, was imported from countries using mechanized spinning with the result that thousands of Japanese hand spinners were required to seek other kinds of employment. But as a whole, Japan gained. Just who reaped the benefits of these gains—and who lost out—is the subject of a new research project by these Clark professors.

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*Dr. Bernhofen is also Professor of International Economics at the University of Nottingham, England.