Despite world-wide bloc economies after the Depression, Japan had a tight relationship with the British Commonwealth and created tight connections with the Sterling and the Gold blocs in the late 1930s. The world-wide bloc economies did not isolate Japan.International Economics; Exchange Rates; Trade; Whatever Related

Toshihiro Okubo

English

Research Papers in Economics

 
 
 
 
HEI Working Paper No: 05/2006 
 
Shake Hands or Shake Apart?    
Pre-war Global Trade and Currency 
Blocs: 
 the Role of the Japanese Empire 
 
 
Toshihiro Okubo 
Graduate Institute of International Studies 
 
Abstract 
Despite world-wide bloc economies after the 
Depression, Japan had a tight relationship with the 
British Commonwealth and created tight 
connections with the Sterling and the Gold blocs in 
the late 1930s. The world-wide bloc economies did 
not isolate Japan.  
 
 
© Toshihiro Okubo. 
All rights reserved. No part of this 
paper may be reproduced without 
the permission of the authors. Shake Hands or Shake Apart?    
Pre-war Global Trade and Currency Blocs: 
 the Role of the Japanese Empire 
Toshihiro Okubo
1 
Graduate Institute of International Studies, Geneva 
March 2006 
 
ABSTRACT  
Despite world-wide bloc economies after the Depression, Japan had a tight 
relationship with the British Commonwealth and created tight connections with the 
Sterling and the Gold blocs in the late 1930s. The world-wide bloc economies did not 
isolate Japan.  
JEL Classification: F10, F15, N70.  
Keywords: Trade/ Currency Blocs; Trade Diversion and Creation. 
 
 
 
                                                 
1 I would like to thank Professor Richard E. Baldwin for his comments.  Correspondence: okubo3@hei.unige.ch   
Tel +41-22-908-5918, Fax: +41-22-733-3049, 11a Ave de la Paix, Geneve 1201, Switzerland 
 The Japanese Empire and Blocs  2
1 INTRODUCTION 
With the onset of the Great Depression, world trade contracted steadily. Countries formed bloc 
economies worldwide, and protectionism and regionalism became widespread. This paper 
investigates the position of the Japanese Empire’s trade bloc in the evolving world pattern of 
trade. Eichengreen and Irwin (1995) estimated trade diversion and creation in the pre-war blocs: 
the British Commonwealth and the Reichsmark as trade bloc, the Sterling area, the Gold bloc, 
and the exchange control countries as currency bloc. They found significant trade-creating effects 
in the British Commonwealth and the Reichsmark bloc, reflecting increased protectionism. 
However, their observed trade-diversion effects were not significant. On the other hand, with 
regard to currency blocs, the Sterling area and exchange control members did not have 
significantly large trade-creating effects. Exchange control members had a significant trade-
diversion effect, while the Gold bloc slightly increased trade with non-bloc members due to their 
indiscriminate use of trade restriction. Overall, substantially significant trade-creating effects 
were found in trade blocs and no substantial trade-diversion and creation was observed in 
currency blocs except trade diversion in Exchange control members.
2 
Eichengreen and Irwin did not analyze the Japanese Empire due to data restriction. Okubo 
(2006) estimated the bloc border effect and found a sizeable and increased border effect. In other 
words, the Japanese empire had substantial trade creation effect within the empire, but that paper 
did not look at the relationship with any other blocs in the 1930s.  
This short paper focuses on the trade diversion effect in the Japanese Empire in relationship 
with other blocs using Okubo (2006)’s data resources. Using a gravity-model we investigate: 1) 
                                                 
2 Interestingly, this non-substantial trade creation by a currency bloc stands in contrast with the current currency 
union (Rose, 2000). 
 The Japanese Empire and Blocs  3
whether a substantial trade diversion can be observed in the Japanese trade in the 1930s, 2) 
whether the Japanese foreign trade with any other major blocs declined or increased, and 3) 
whether Eichengreen and Irwin’s findings are robust. The paper also adds to the current 
“Multilateralism versus Regionalism” debate on economic integration with econometric evidence 
on interwar trade blocs (Bairoch and Kozul-Wright, 1996). The remainder of this paper is 
structured as follows: stylised facts are presented in Section 2, econometric methodology and the 
estimation results in Section 3, and conclusions in Section 4.  
2 STYLISED FACTS 
Japan acquired its first colony, Formosa (Taiwan), in 1895 as a result of the Sino-Japanese 
war. Korea was annexed in 1910 as a consequence of the Russo-Japanese War. When the Great 
Depression and the financial crises of 1929-1930 struck, mainland Japan had developed a tight 
relationship with Korea and Formosa. The reaction in Japan, as in the rest of the world, was to 
increase protection between the Japanese Empire and the rest of the world, but not within the 
Empire itself. As shown in Yamazawa and Yamamoto (1974), Japanese protectionism increased 
in tariff and quota over time. Likewise, in the British Commonwealth, the Imperial Economic 
Conference at Ottawa was held in 1932 and the United Kingdom, its dominions, and India 
ratified reciprocal trade agreements and some agreements on tariffs (Macdougall and Hutt, 1954).  
Also, in several European countries import quotas were imposed. On the other hand, in the 
United States, the Smoot-Hawley Tariff Act was passed in 1930, and the Reciprocal Trade 
Agreements Act was passed in 1934, which promoted the bilateral trade agreements with specific 
countries (Irwin, 1998). We can say that series of these incidents more or less affected the The Japanese Empire and Blocs  4
Japanese bloc’s trading relationship with other blocs. This qualitative analysis suggests a number 
of testable hypotheses. 
3 ECONOMETRIC ANALYSIS 
We employ gravity model analysis to study trade creation/diversion in the internal and 
external trade of the Japanese Empire. Our econometric strategy is to adopt an empirical 
specification based on Eichengreen and Irwin (1995). We have data for the trade of three parts of 
the Japanese Empire (mainland Japan, Korea and Formosa) with 24 non-Empire countries, which 
were major trading partners of the Japanese Empire.
3 We do not include trade among the 24 non-
Empire nations due to lack of the data for each country in each period. We have data for 1915, 
1920, 1925, 1930, 1935 and 1938.  
3.1 Estimation  Strategy 
Following Eichengreen and Irwin (1995), we focus on the sign and significance of dummies 
between the Japanese Empire and the members of the other blocs. We singled out blocs which 
included many major trading partners of the Japanese Empire: the British Commonwealth (a 
trade bloc), as well as the Sterling area, the Gold bloc and Exchange control countries (currency 
blocs). Pooling all of the 6 years, we estimate yearly bloc dummies with feasible generalised 
least-squares (FGLS) panel estimation where we allow heteroskedastic variances across panels 
but no cross-sectional correlation in the error structure: 
  TRADEijt = α0+α1GDPit +α2GDPjt +α3DISij+α4CAPit +α5CAP jt+∑
=
38
15 τ
α6τBLOCijτ 
+∑
=
38
15 τ
α7τJPNDUMijτ+∑
=
38
20 τ
α8τYEARDUMτ+εijt 
                                                 
3 See Data Appendix about the components of 24 non-Empire countries and the member countries in each bloc. The Japanese Empire and Blocs  5
where BLOC∈(British, Sterling, Gold, Exchange)  
The dependent variable (TRADEijt) is year t’s logarithm of nominal trade in Japanese yen 
from country or region i to country or region j. In other words, it denotes exports or imports of 
mainland Japan, Korea and Formosa with each trading partner as well as the six intra-Empire 
trade flows (imports and exports between the three nations). The first five right-hand side 
variables are the classic control variables for the gravity equation. GDP denotes the logarithm of 
the GDP (in Japanese yen,1935), DIS indicates the logarithm of bilateral distance (in km) 
between the capitals or the seats of government, and CAP indicates the logarithm of GDP per 
capita for the exporting ‘i’ and the importing ‘j’ countries.
4   
JPNDUM takes on a value of unity for intra-empire trade (trade among Mainland Japan, 
Formosa and Korea) and zero for non-Empire trade flows and other border effect analyses. This 
can test trade-creating effect within the Japanese Empire in the sense that trade within the 
Japanese bloc is higher than would be expected, controlling for standard gravity equation factors.  
The variable of interest in this regression equation is each BLOC dummy, i.e. British, Sterling, 
Gold and Exchange dummies, which takes the value one for the Japanese trade with its bloc 
members. If the coefficients of the bloc dummies decline over time and become negative, this 
indicates a trade-diversion effect. On the other hand, if the coefficients are significant and 
increase over time, this represents a trade-creation effect. We also allow for year-specific fixed-
effects to control for unobservable factors that are common across all pairs by including year 
dummies (YEARDUM).  
Our sample includes 75 trade pairs compromised of 72 trade pairs between the 3 Empire 
countries and 24 non-Empire nations plus the 3 intra-Empire trade flows. Since we have import 
                                                 
4 Seoul (Taipei) is regarded as the capital of Korea (Formosa). The Japanese Empire and Blocs  6
and export data separately for each pair, there are 150 ‘columns’ in the panel. There are six years 
in our data so the total number of observations is 900 (i.e. 150 times 6). 
3.2 Estimation  Results 
As seen in the Table, British dummies are all significantly positive and increase over time. In 
particular, the late 1930s saw high values. Sterling dummies are significant in the 1930s. Gold 
dummies, not so robust, are also significantly positive in the 1930s, while Exchange dummies are 
unclear. Overall, despite the increased protectionism and regionalism in the world, a trade-
diversion effect by bloc formation cannot be clearly observed. Rather, the Japanese Empire had 
gradually established tight relations with the British Commonwealth over time in the interwar 
period. Concerning the two currency blocs, the Sterling area and the Gold bloc, we find 
significant and positive values in the late 1930s. In particular, the Japanese Empire had 
established a solid economic relationship with the Sterling area. The closer relationship with the 
Gold bloc might reflect the fact that the Gold bloc members did not implement so many 
discriminatory trade policies.  
These results contrast those in Eichengreen and Irwin (1995), which suggested no significant 
influence of currency bloc formation on the pattern of trade: no remarkable trade diversion or 
trade creation effects. In the current context, our results are somewhat similar to NAFTA’s 
experience, in which the trade diversion effect is weak, regardless of a trade-creation being 
observed (Krueger 1999; 2000; Soloagta and Winters, 2002). However, our results are also 
different from Rose (2000): the pre-war currency blocs never excluded Japan but strengthened  
the connection with the Japanese Empire. Also, our result contrasts with the features of the 
current Japanese economy, though the prewar bloc was of course very different from the current 
level of economic integration. Wall (2002) found that Japan in the 1980s and 1990s was isolated The Japanese Empire and Blocs  7
from world trade in the sense that economic integration has significantly reduced Japan’s trade 
with the member countries of trading blocs.   
4   CONCLUSION 
While the Japanese Bloc, which represented trade between Japan and its colonies, had a 
substantial trade-creating effect, it had gradually created tight connections with other blocs in the 
worldwide bloc economy period in the 1930s. In particular, the Japanese Empire had a tight 
relationship with the British Commonwealth over a long period, as well as with the Sterling area 
and the Gold bloc in the 1930’s, although the relationship with the other blocs was not so clear.  
The Japanese relationship with them intensified overtime. We can conclude that inter-war Japan 
was not isolated from other world-wide trade and currency blocs and rather sought to build 
tighter relationships with them. 
DATA APPENDIX    
The data set of all variables is taken from Okubo (2006). 24 non-bloc countries are India, the 
Netherlands Indies, China, Russia, the United Kingdom, Canada, Australia, New Zealand, 
Norway, Denmark, Sweden, Switzerland, Italy, Germany, France, Belgium, the Netherlands, 
Spain, Argentina, Mexico, Brazil, the United States, Chile, and Peru.  
 
Components of the Countries in Each Bloc 
The British Commonwealth: the United Kingdom, Australia, New Zealand, India, Canada 
The Sterling Area: the United Kingdom, Australia, New Zealand, India, Norway, Denmark, 
Sweden, Argentina    The Japanese Empire and Blocs  8
The Gold Bloc: Belgium, France, Italy, the Netherlands, Switzerland, the Netherlands Indies 
Exchange Control Members: Denmark, Italy, the Netherlands, the Netherlands Indies, 
Spain, Sweden, Germany  
 
REFERENCES 
Bairoch,P. and R.Kozul-Wright (1996) “Globalisation myths: Some historical reflections on integration, 
industrialization and growth in the world economy”, UNCTAD DP No.113. 
Eichengreen.B, and D.A.Irwin (1995) `Trade blocs, currency blocs and the reorientation of world trade in the 1930s’ 
Journal of International Economics 38: pp1-24. 
Irwin,D.A. (1998) “The Smoot-Hawley Tariff: A Quantitative Assessment,” Review of Economics and Statistics 80, 
pp.326-334.  
Krueger,A.O. (1999) “Trade creation and trade diversion under NAFTA”, NBER WP 7429. 
Krueger,A.O. (2000) “NAFTA’s effects: A preliminary assessment ”, World Economy, 23: pp761-775. 
Okubo,T (2006) `Trade Bloc Formation in Inter-war Japan -A gravity model analysis', Journal of the Japanese and 
International Economies. 
Rose,A (2000) “One Money, One Market: Estimating the Effect of Common Currencies on Trade”, Economic Policy 
30, 9-45. 
Macdougall,D. and R.Hutt (1954) “Imperial Preference: A Qualitative Analysis”, Economic Journal, 64: pp233-257. 
Soloaga,I. and L.A.Winters (2001) “Regionalism in the nineties: What effect on trade?”, North American Journal of 
Economics and Finance, 12 (1): pp1-29.   
Yamazawa,I and Yamamoto.Y. (1974), Chouki-Toukei-Keizai 14 Boueki-to-Kokusai-Shuushi, .Toyo-Keizai 
Shinpousha 
Wall,H.J. (2002) ‘Has Japan been left out in the cold by regional integration?’ Federal Reserve Bank of St. Louis 
Review, 84, pp25-36.                  Estimation Results 
123456
GDPI 2.358 2.377 2.300 2.297 2.385 2.318
[51.40]** [44.08]** [43.88]** [44.74]** [45.45]** [46.07]**
GDPE 2.786 2.795 2.695 2.702 2.814 2.781
[55.56]** [46.58]** [45.81]** [45.29]** [48.05]** [54.51]**
GDPCAPI 0.779 0.880 1.105 1.145 0.718 0.553
[7.80]** [6.59]** [8.31]** [9.58]** [5.43]** [4.90]**
GDPCAPE 1.818 1.999 2.235 2.261 1.923 1.690
[15.29]** [14.14]** [15.57]** [15.32]** [13.14]** [13.74]**
DIS -2.259 -2.402 -2.621 -2.692 -2.339 -2.112
[-23.23]** [-19.99]** [-21.30]** [-20.84]** [-20.45]** [-19.23]**
JPNDUM-1915 4.708 4.401 3.888 3.626 4.454 5.120
[3.96]** [3.59]* [3.16]** [2.93]** [3.63]** [4.33]**
JPNDUM-1920 5.448 5.232 4.737 4.480 5.387 6.146
[4.58]** [4.27]** [3.85]** [3.62]** [4.39]** [5.19]**
JPNDUM-1925 6.186 5.773 5.367 5.144 5.843 6.878
[5.18]** [4.70]** [4.35]** [4.14]** [4.74]** [5.79]**
JPNDUM-1930 7.245 6.943 6.446 6.378 7.217 8.174
[6.09]** [5.67]** [5.24]** [5.15]** [5.88]** [6.91]**
JPNDUM-1935 6.831 6.475 5.954 5.688 6.930 7.783
[5.74]** [5.29]** [4.84]** [4.60]** [5.64]** [6.58]**
JPNDUM-1938 7.100 6.749 6.044 5.676 6.792 7.587
[5.97]** [5.51]** [4.92]** [4.59]** [5.52]** [6.41]**
British-1915 1.436 1.639
[4.72]** [4.39]**
British-1920 1.970 2.379
[6.46]** [6.38]**
British-1925 2.148 2.762
[7.04]** [7.41]**
British-1930 2.117 2.857
[6.94]** [7.67]**
British-1935 2.885 3.627
[9.42]** [9.74]**
British-1938 2.925 3.264
[9.54]** [8.76]**
Sterling-1915 0.585 0.754
[1.48] [1.74]*
Sterling-1920 0.947 1.191
[2.41]** [2.75]**
Sterling-1925 0.380 0.614
[0.97] [1.42]
Sterling-1930 0.890 1.108
[2.26]** [2.56]**
Sterling-1935 1.249 1.726
[3.17]** [3.99]**
Sterling-1938 1.326 1.650
[3.37]** [3.81]**
Gold-1915 -0.133 0.302 0.376
[-0.38] [0.81] [0.92]
Gold-1920 0.222 0.574 0.898
[0.65] [1.54] [2.21]**
Gold-1925 0.081 0.428 0.872
[0.24] [1.14] [2.14]**
Gold-1930 -0.075 0.359 0.571
[-0.22] [0.96] [1.40]
Gold-1935 0.376 1.022 1.382
[1.09] [2.73]** [3.39]**
Gold-1938 -0.101 0.782 0.785
[-0.29] [2.08]** [1.93]*
Exchange-1915 -0.391 -0.284 0.187
[-1.27] [-0.82] [0.52]
Exchange-1920 -0.170 -0.191 0.611
[-0.55] [-0.55] [1.69]*
Exchange-1925 -0.196 -0.253 0.624
[-0.64] [-0.73] [1.72]*
Exchange-1930 0.163 0.136 1.187
[0.53] [0.39] [3.27]**
Exchange-1935 -0.016 -0.100 1.139
[-0.05] [-0.29] [3.14]**
Exchange-1938 -0.643 -0.860 0.590
[-2.09]** [-2.48]** [1.63]
Observations 900 900 900 900 900 900
Groups of Sample 150 150 150 150 150 150
Chi-squared 13278.19 10578.17 10236.63 9858.93 10099.2 13391.63
Loglikelihood -2250.151 -2250.151 -2253.555 -2254.816 -2249.503 -2211.613
1. **/* significance at the 5/10% level.
2. z-statistics in brackets. 
3. YEARDUMs and CONST are omitted.

[1.63] Observations 900 900 900 900 900 900

Globalisation myths: Some historical reflections on integration, industrialization and growth in the world economy”, UNCTAD DP No.113. Eichengreen.B, and D.A.Irwin

Shake Hands or Shake Apart? Pre-war Global Trade and Currency Blocs--the role of the Japanese Empire

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Shake Hands or Shake Apart? Pre-war Global Trade and Currency Blocs--the role of the Japanese Empire

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