Mercantilism: Alive and Well in the 21st Century

Japan's recent trade spat with China (Asia Times, June 21, 2001), whilst necessarily raising eyebrows, possibly underlies a more alarming trend: there is a rising, if flawed, sympathy towards mercantilism that is permeating Japan. Indeed, a recent article, Gregory Clark, president of Tama University, reprises the usual protectionist arguments, albeit in a different tenor (Japan Times, June 21, 2001). The comment is distinguished by its source - an academic, and a respectable one at that - and its approach - it is clothed in economic jargon that would presumably lend it credibility. Alas, beyond the rhetoric, there is little new that the author introduces into the age-old debate.

The overarching theme of the essay is that free-trade theory was conceived in "quaint 19th-century paternalism... and assumptions". Fortunately for the cause of free trade, economists have worked diligently over the past fifteen years or so to extend the classical assumptions to include more complex, real-world circumstances[1]. These conclusions, although different in specifics and style, are basically the same in substance: in most practical situations, a free trade policy yields superior outcomes to all others, and in the event that it does not, economic and political realities would render it the best option to pursue regardless.

Before proceeding to outline the case against selective protectionism, it is first necessary to debunk the superfluous conclusions raised in the Clark article. Essentially, it suggests five reasons why protectionism is warranted.

First, protection is necessary for Japan because Chinese workers possess a level of productivity and intellectualism close to that of the Japanese, and since they are willing to work for far less, Japanese workers should be protected in these areas. This interesting variant of the infant-industry argument is defective. For starters, Japan is a mature economy, with established comparative and competitive advantages in a vast number of industries, such as car manufacture, consumer electronics, and video gaming. These exist not only at a regional level, but on a global level. When, then, should there be protection for those areas where Japan does not possess these advantages? In the absence of shelter from competition, economic actors will simply shift resources away from these non-competitive areas to those where they are. The entire economy is made more efficient as a result, and save for the adjustment period, welfare is raised across the board as consumers enjoy the lower prices from imported goods. Surely it is illogical to impose the costs of supporting the towel and clothing industries in Japan on the rest of the populace? Besides, history has shown us that protection often prevents industries from developing into world-class standards - witness the grossly inefficient Japanese agricultural and textile sectors, beneficiaries of government-sponsored shelter from international market forces.

Second, China enjoys increasing returns to scale, due to its large domestic market and tremendous pool of surplus labour. Economic models that employ an increasing returns framework have shown time and again that the remote possibility of an increase in national welfare only occurs when the country is a large player in the international market. In such a case, it can exercise its power as a major buyer or seller to impose a tariff [2] - and if the costs of preserved employment in the protected industry exceeds that of the tariff, then a net welfare improvement is incurred. However, given that Japan is neither a large player in the world textile market (Japan's textile imports and exports in 1998 were US$14.6 and US$5.3 billion, or only 9.7% and 3.5% of world values, respectively), nor is the sector particularly large in Japan, there is little justification for exercising such protection measures.

Third, since a large developing nation is able to exploit the human and physical infrastructure inherent in one industry to gain competitiveness in others, free trade creates major imbalances. Both aspects of this statement are untrue. Examples are rife for cases where countries have tremendous competitive advantages in one particular industry, but this competitiveness has not spilled over into others. Cuba is the world's foremost producer of sugar, but it distinguishes itself in little else (economically, at least). Finland is a world leader in telecommunications products, but we have heard of little else that it produces. Further, to suggest that free trade creates imbalances on the basis of detrimental effects that it has on economic competitiveness - and by extension growth and development - runs against the grain of a multitude of studies on the positive effects of openness on growth[3]. The economies of countries such as Singapore and Taiwan - having pursued export-oriented policies - can hardly be described as "smouldering ruins".

Fourth, the ability of a country's exchange rate to properly adjust to restore trade imbalances is questionable, and even if it managed to do so, currencies are prone to overshoot. Whereas it was true that the 1985 Plaza Accord was effected to correct massive disequilibrium between the major currencies, the conditions that precipitated the situation were due to the structure of the international financial system at the time and are unlikely to be repeated [4]. And whilst it is true that currencies do overshoot, arbitrage in an increasingly efficient foreign exchange market would ensure that such over- or under-valuations do not last long. Besides, the international futures markets provide an outlet for manufacturers to hedge the prices of their goods, and leaving the choice to producers themselves is arguably a far better approach than one of negotiated trade barriers.

Last, only economies with very different endowments can benefit from free trade. This is just plain wrong. The theory of comparative advantage depends not on differences in factor endowments, but on differences in relative productivity. This arises with the slightest perturbation from complete equality - a fact that, undoubtedly, is fulfilled in a world where factors differ not just in quantity but also in quality. Furthermore, the vast volumes of intra-industry trade are a testimony to the fact that even countries with very similar factor endowments might wish to engage in trade. The production networks of East Asia, responsible for much of the world's output of high-technology goods, thrive on this form of trade.

Notwithstanding all the points raised above, there are also very good reasons why selective protectionism will, in the final analysis, fail. Most significant is the potential for retaliation. Countries who suffer the ignominy of blatant enactment of trade barriers are unlikely to sit idly by. The most likely consequence of this will be counter-tariffs raised by the offended country, and in extreme cases, a trade war will ensue. Both countries stand to lose in this case. Already, the ominous rumblings of such an outcome can be felt (South China Morning Post, June 21, 2001).

Another concern is that any form of intervention is likely to be a second-best solution. Poor competitiveness is best resolved by domestic microeconomic restructuring, not across-the-board tariffs. Japan has already shown its mettle by its willingness to bite the bullet with courageous reform plans under Prime Minister Koizumi. Doubtless, there will be teething problems. But to imply that trade barriers are the solution is to substitute short-term palatability for long-term pleasure.

Informational deficiencies might also predicate the need to withhold the heavy hand of government interference in the economy. Existing research show that policy interventions applied for strategic gains can go horribly wrong. Welfare gains are sensitive to different assumptions about the nature of the strategic interactions; and what might have initially been a positive intervention might turn out otherwise due to ambiguities in interpretation or assessment of the current trade situation. 'Strategic' trade barriers are thus little more than a shot in the dark.

The existence of voices opposing free trade warrants the attention of all who believe in the cause for free trade. The Clark article proves that these are not but echoes in the past, but are very real challenges in the present. Almost two centuries after David Ricardo (1817) first argued for unfettered trade between nations, the need to remain vigilant to superfluous contentions remains.


Clark, G. 'The Trouble with Free Trade', Japan Times, June 21, 2001. Online:

Dollar, D. 'Outward-Oriented Developing Economies Really Do Grow More Rapidly: Evidence from 95 LDCs, 1976-1985', Economic Development and Cultural Change (1993): 552-44.

Edwards, S. 'Openness, Productivity and Growth: What Do We Really Know?' Economic Journal 108 (1998): 383-98.

Helpman, E. & P. Krugman. Market Structure and Foreign Trade: Increasing Returns, Imperfect Competition, and the International Economy. Cambridge, MA: MIT Press, 1987.

Ricardo, D. On The Principles of Political Economy and Taxation. London: John Murray, 1817.

Rodriguez, F. & D. Rodrik. 'Trade Policy and Economic Growth: A Skeptic's Guide to the Cross-Country Evidence', Centre for Economic Policy Research Discussion Paper no. 2143.

Sachs, J. & A. Warner. 'Economic Reforms and the Process of Global Integration', Brookings Papers on Economic Activity 1 (1995): 1-118.

Yau, W. 'China Takes Tough Stand with Japan Trade Hit List', South China Morning Post June 21st, 2001. Online:

'That Japan-China Trade Row Nonsense', Asia Times, June 21, 2001. Online:


1. Paul Krugman is the most prominent proponent of this so-called New Trade Theory that integrates oligopolistic market structures into international trade models. Helpman & Krugman (1987) synthesises the literature and remains the seminal work in the field.

2. A large international importer would impose an import tariff, and conversely, a large international exporter can impose either export tariffs or voluntary export restraints.

3. See, for example, Dollar (1992), Edwards (1998) and Sachs & Warner (1995). These, however, have not been exempt from criticism; see Rodriguez & Rodrick (1999).

4. Specifically, the strength of the U.S. dollar was due to the strong demand for U.S. dollars, in part due to the supply-side policies pursued by the Reagan administration, the relatively more attractive real interest rates of U.S. assets, and the poor political climate in Europe and Latin America. These are unlikely to be duplicated. Further, there are those of the view that such concerted intervention in the currency markets was a mistake.

This article first appeared in the Laissez Faire City Times on the 9th July 2001, as Mercantilism in the Land of the Rising Sun.