Mercantilism

A painting of a French seaport from 1638, at the height of mercantilism.

Mercantilism, an economic system of the major trading nations during the 16th, 17th, and 18th cent., was based on the premise that national wealth and power were best served by increasing exports and collecting precious metals in return. It superseded the medieval feudal organization in Western Europe, especially in Holland, France, and England.

Mercantilism

Definition of mercantilism

As such, mercantilism developed logically from the changes inherent in the decline of feudalism, the rise of strong national states, and the development of a world market economy. The following ideas, and the underlying principles, lumped together,thus may be called mercantilism:

• (1) Bullionism was the belief that the economic health of a nation could be measured by the amount of precious metal, gold, or silver, which it possessed. The rise of a money economy, the stimulation produced by the influx of bullion from America, the fact that taxes were collected in money, all seemed to support the view that hard money was the source of prosperity, prestige, and strength.

• (2) Bullionism dictated a favorable balance of trade. That is, for a nation to have gold on hand at he end oft he year, it must export more than it imports. Exports were later defined to include money spent on freight, or insurance, or travel.

• (3) Each nation tried to achieve economic self-sufficiency. Those who founded new industries should be rewarded by the state.

• (4) Thriving agriculture should be carefully encouraged. Domestic production not only precluded imports of food, but farmers also provided a base for taxation.

• (5) Regulated commerce could produce a favorable balance of trade. In general, tariffs should be high on imported manufactured goods and low on imported raw material.

• (6) Sea power was necessary to control foreign markets. A powerful merchant fleet would obviate the necessity of using the ships of another nation and becoming dependent on foreign assistance. In addition, a fleet in being could add to a nation's prestige and military power.

• (7) Colonies could provide captive markets for manufactured goods and sources of raw material.

• (8) A large population was needed to provide a domestic labor force and to people colonies.

• (9) The belief that the crown or state should exercise a dominant role in assisting and directing the national and international economies to these ends.

Mercantilism: Historical overview

The period 1500–1800 was one of religious and commercial wars, and large revenues were needed to maintain armies and pay the growing costs of civil government. Mercantilist nations were impressed by the fact that the precious metals, especially gold, were in universal demand as the ready means of obtaining other commodities; hence they tended to identify money with wealth. As the best means of acquiring bullion, foreign trade was favored above domestic trade, and manufacturing or processing, which provided the goods for foreign trade, was favored at the expense of the extractive industries (e.g., agriculture). State action, an essential feature of the mercantile system, was used to accomplish its purposes. Under a mercantilist policy a nation sought to sell more than it bought so as to accumulate bullion. Besides bullion, raw materials for domestic manufacturers were also sought, and duties were levied on the importation of such goods in order to provide revenue for the government. The state exercised much control over economic life, chiefly through corporations and trading companies. Production was carefully regulated with the object of securing goods of high quality and low cost, thus enabling the nation to hold its place in foreign markets. Treaties were made to obtain exclusive trading privileges, and the commerce of colonies was exploited for the benefit of the mother country. France displayed perhaps the most thoroughgoing mercantilism. Jean Baptiste Colbert, chief minister of Louis XIV from 1661 to 1683, was a great exponent of economic regulation. As a practical politician intent on the welfare of the middle class to which he belonged, not a doctrinaire theorist; for him mercantilism was the most convenient method of attaining his end. He prohibited the export of money, levied high tariffs on foreign manufactures, and gave liberal bounties to encourage French shipping. He purchased Martinique and Guadeloupe in the West Indies, encouraged settlement in Santo Domingo, Canada, and Louisiana, and established trading "factories" (armed commercial posts) in India and Africa. In England mercantilist policies were effective in creating a skilled industrial population and a large shipping industry. Through a series of Navigation Acts England finally destroyed the commerce of Holland, its chief rival. As the classical economists were later to point out, however, even a successful mercantilist policy was not likely to be beneficial, because it produced an oversupply of money and, with it, serious inflation. Mercantilist ideas did not decline until the coming of the Industrial Revolution and of laissez-faire. Henry VIII, Elizabeth I, and Oliver Cromwell conformed their policies to mercantilism. Belief in mercantilism, however, began to fade in the late 18th century, as the arguments of Adam Smith and the other classical economists won favour in the British Empire (among such advocates as Richard Cobden) and to a lesser degree in the rest of Europe (with the notable exception of Germany where the Historical school of economics was favored throughout the 19th and early 20th century).

Among the former British colonies, the United States of America chose not to adhere to classical economics, preferring a form of neo-mercantilism embodied by the "American School" and reflected in the policies of Hamilton, Clay, Lincoln and later Republican Party economic philosophy, itself mirrored in the theories of the Historicists in Germany by such economists as Friedrich List, until the emergence of the New Deal and the modern era. Today, mercantilism as a whole is rejected by many economists, though elements of it are still accepted by some economists including Ravi Batra, Pat Choate, Eammon Fingleton, and Michael Lind.

By 1860 England had removed the last vestiges of the mercantile era. Industrial regulations, monopolies, and tariffs were abolished, and emigration and machinery exports were freed. In large part because of her free trade policies, England became the dominant economic power in Europe. England's success as a manufacturing and financial power, coupled with the United States as an emerging agricultural powerhouse, led to the resumption of protectionist pressures in Europe and the arms race between Germany, France, and England, which ultimately resulted in World War I. Protectionism remained important in the interwar period. World War I had destroyed the international monetary system based upon the gold standard. After the war manipulation of the exchange rate was added to the government's list of trade weapons. A country could simultaneously lower the international prices of its exports and increase the local currency price of its imports by devaluing its currency against the currencies of its trading partners. This "competitive devaluation" was practiced by many countries during the Great Depression of the thirties and led to a sharp reduction in world trade. A number of factors led to the reemergence of mercantilist policies after World War II. The Great Depression created doubts about the efficacy and stability of free-market economies, and an emerging body of economic thought ranging from Keynesian countercyclical policies to Marxist centrally planned systems created a new role for governments in the control of economic affairs. In addition, the wartime partnership between government and industry in the United States created a relationship—the military-industrial complex, in Eisenhower's words—that also encouraged activist government policies. In Europe the shortage of dollars after the war induced governments to restrict imports and negotiate bilateral trading agreements to economize on scarce foreign exchange resources. These policies severely restricted the volume of intra-Europe trade and impeded the recovery process in Europe in the immediate postwar period. The economic strength of the United States, however, provided the stability that permitted the world to emerge out of the postwar chaos into a new era of prosperity and growth. The Marshall Plan provided American resources that overcame the most acute dollar shortages. The Bretton Woods agreement established a new system of relatively stable exchange rates that encouraged the free flow of goods and capital. Finally, the signing of GATT (General Agreement on Tariffs and Trade) in 1947 marked the official recognition of the need to establish an international order of multilateral free trade.

Mercantilism: theory

Trade policy

Early mercantilist writers embraced bullionism, the belief that that quantities of gold and silver were the measure of a nation's wealth. Later mercantilists developed a somewhat more sophisticated view.

European economists between 1500 and 1750 are today generally considered mercantilists; however, these economists did not see themselves as contributing to a single economic ideology. The term was coined by the Victor de Riqueti, marquis de Mirabeau in 1763, and was popularized by Adam Smith in 1776. In fact, Adam Smith was the first person to organize formally most of the contributions of mercantilists in his book The Wealth of Nations ( Niehaus 1990, p. 6).

Mercantilism was not characterized by the blind adherence to a single, precisely defined economic theorem. Rather, its adherents embraced, in various degrees, parts of a set of commonly held theoretical beliefs or tendencies that were best suited to the needs of a particular time and state. As such, mercantilism developed logically from the changes inherent in the decline of feudalism, the rise of strong national states, and the development of a world market economy.

The shift from payments in kind, characteristic of the feudal period, to a money economy was one key development in this process. By the late fifteenth century, as regional, national, and international trade continued to blossom, European currencies expanded as well; circulation was more common, widespread, and vital. The early mercantilists recognized the seminal fact of this period. Money was wealth sui generis; it gave its holder the power to obtain other commodities and services. Precious metals, especially gold, were in universal demand as the surest means to obtain other goods and services. At the same time the rise of more powerful European states with burgeoning bureaucracies, frequent dynastic wars that required larger and more expensive armies, and more lavish court expenditures exacerbated this fundamental need for money in the form of precious metals. Foreign trade, not domestic trade, was viewed as the preferred method for obtaining bullion, while manufacturing, which provided the goods for such trade, was favored over agriculture. Finally, the discovery of the New World by Columbus in 1492 and the discovery of the sea route to India by Vasco da Gama in 1497–1499 also provided fertile ground for obtaining such wealth while creating an ever greater need for wealth to conquer and protect these colonies and their imperial trade. All of these factors ensured that the rising late medieval and early modern states embraced mercantilism as an economic theory that allowed them to adapt to and seek to exploit these shifting structures.

Of course, the impact of the discovery of America can not be ignored. New markets and new mines propelled foreign trade to previously inconceivable heights. The latter led to “…..the great upward movement in prices…. and an increase in….the volume of merchant activity itself…..” ( Galbraith, 1988, p. 33–34 ).

Mercantilism developed at a time when the European economy was in transition. Isolated feudal estates were being replaced by centralized nation-states as the focus of power. Technological changes in shipping and the growth of urban centers led to a rapid increase in international trade ( Landreth and Colander, 2002, p. 43 ). Mercantilism focused on how this trade could best aid the states. Another important change was the introduction of double-entry bookkeeping and modern accounting. This accounting made extremely clear the inflow and outflow of trade, contributing to the close scrutiny given to the balance of trade ( Wilson , 1966, p. 10 ).

Prior to mercantilism, the most important economic work done in Europe was by the medieval scholastic theorists. The goal of these thinkers was to find an economic system that was compatible with Christian doctrines of piety and justice. They focused mainly on microeconomics and local exchanges between individuals. Mercantilism was closely aligned with the other theories and ideas that were replacing the medieval worldview. This period saw the adoption of Niccolò Machiavelli's realpolitik and the primacy of the raison d'état in international relations. The mercantilist idea that all trade was a zero sum game, in which each side was trying to best the other in a ruthless competition, was integrated into the works of Thomas Hobbes. Note that non-zero sum games such as prisoner's dilemma can also be consistent with a mercantilist view. In prisoner's dilemma, players are rewarded for defecting against their opponents - even though everyone would be better off if everyone could cooperate. More modern views of economic co-operation amidst ruthless competition can be seen in the folk theorem of game theory.

Domestic policy

Mercantilist domestic policy was more fragmented than its trade policy. While Adam Smith portrayed mercantilism as supportive of strict controls over the economy, many mercantilists disagreed. The early modern era was one of letters patent and government-imposed monopolies; some mercantilists supported these, but others acknowledged the corruption and inefficiency of such systems. Many mercantilists also realized the inevitable result of quotas and price ceilings were black markets. One notion mercantilists widely agreed upon was the need for economic oppression of the working population; laborers and farmers were to live at the "margins of subsistence." The goal was to maximize production, with no concern for consumption. Extra money, free time, or education for the "lower classes" was seen to inevitably lead to vice and laziness, and would result in harm to the economy( Ekelund and Hébert , 1997, p. 46 )

Scholars are divided on why mercantilism was the dominant economic ideology for two and a half centuries (Ekelund and Hébert, 1997, p. 61) . One group, represented by Jacob Viner, argues that mercantilism was simply a straightforward, common-sense system whose logical fallacies could not be discovered by the people of the time, as they simply lacked the required analytical tools.

The second school, supported by scholars such as Robert B. Ekelund, contends that mercantilism was not a mistake, but rather the best possible system for those who developed it. This school argues that mercantilist policies were developed and enforced by rent-seeking merchants and governments. Merchants benefited greatly from the enforced monopolies, bans on foreign competition, and poverty of the workers. Governments benefited from the high tariffs and payments from the merchants. Whereas later economic ideas were often developed by academics and philosophers, almost all mercantilist writers were merchants or government officials ( Niehans, 1990, p. 19 ).

Criticisms

Much of Adam Smith's The Wealth of Nations is an attack on mercantilism. Adam Smith --- on the picture --- and David Hume are considered to be the founding fathers of anti-mercantilist thought. A number of scholars found important flaws with mercantilism long before Adam Smith developed an ideology that could fully replace it.

Critics like Dudley North, John Locke, and David Hume undermined much of mercantilism, and it steadily lost favor during the eighteenth century. Mercantilists failed to understand the notions of absolute advantage and comparative advantage (although this idea was only fully fleshed out in 1817 by David Ricardo) and the benefits of trade. For instance, Portugal was a far more efficient producer of wine than England, while in England it was relatively cheaper to produce cloth. Thus if Portugal specialized in wine and England in cloth, both states would end up better off if they traded. This is an example of absolute advantage. In modern economic theory, trade is not a zero-sum game of cutthroat competition, as both sides could benefit, it is an iterated prisoner's dilemma. By imposing mercantilist import restrictions and tariffs instead, both nations ended up poorer.

David Hume famously noted the impossibility of the mercantilists' goal of a constant positive balance of trade. As bullion flowed into one country, the supply would increase and the value of bullion in that state would steadily decline relative to other goods. Conversely, in the state exporting bullion, its value would slowly rise. Eventually it would no longer be cost-effective to export goods from the high-price country to the low-price country, and the balance of trade would reverse itself. Mercantilists fundamentally misunderstood this, long arguing that an increase in the money supply simply meant that everyone gets richer ( Ekelund and Hébert, 1997, p. 43)

The importance placed on bullion was also a central target, even if many mercantilists had themselves begun to de-emphasize the importance of gold and silver. Adam Smith noted that bullion was just the same as any other commodity, and there was no reason to give it special treatment.

The first school to completely reject mercantilism was the physiocrats, who developed their theories in France. Their theories also had several important problems, and the replacement of mercantilism did not come until Adam Smith’s The Wealth of Nations in 1776. This book outlines the basics of what is today known as classical economics. Smith spends a considerable portion of the book rebutting the arguments of the mercantilists, though often these are simplified or exaggerated versions of mercantilist thought ( Niehans, 1990 p. 19 )

Scholars are also divided over the cause of mercantilism's end. Those who believe the theory was simply an error hold that its replacement was inevitable as soon as Smith's more accurate ideas were unveiled. Those who feel that mercantilism was rent seeking hold that it ended only when major power shifts occurred. In Britain, mercantilism faded as the Parliament gained the monarch's power to grant monopolies. While the wealthy capitalists who controlled the House of Commons benefited from these monopolies, Parliament found it difficult to implement them because of the high cost of group decision making (Ekelund and Tollison, 1981 )

Mercantilist regulations were steadily removed over the course of the eighteenth century in Britain, and during the 19th century the British government fully embraced free trade and Smith's laissez-faire economics. On the continent, the process was somewhat different. In France economic control remained in the hands of the royal family and mercantilism continued until the French Revolution. In Germany mercantilism remained an important ideology in the nineteenth and early twentieth centuries, when the historical school of economics was paramount ( Wilson, 1966 p. 6 ).

Legacy

In the 20th century, most economists on both sides of the Atlantic have come to accept that in some areas mercantilism had been correct. Most prominently, the economist John Maynard Keynes explicitly supported some of the tenets of mercantilism. Adam Smith had rejected focusing on the money supply, arguing that goods, population, and institutions were the real causes of prosperity. Keynes argued that the money supply, balance of trade, and interest rates were of great importance to an economy. These views later became the basis of monetarism, whose proponents actually reject much of Keynesian monetary theory, and has developed as one of the most important modern schools of economics.

Keynes and other economists of the period also realized that the balance of payments is an important concern, and since the 1930s, all nations have closely monitored the inflow and outflow of capital, and most economists agree that a favorable balance of trade is desirable. Keynes also adopted the essential idea of mercantilism that government intervention in the economy is a necessity. While Keynes' economic theories have had a major impact, few have accepted his effort to rehabilitate the word mercantilism. Today the word remains a pejorative term, often used to attack various forms of protectionism.

The similarities between Keynesianism, and its successors’ ideas about mercantilism, have sometimes led critics to call them neo-mercantilism. Some other systems that do copy several mercantilist policies, such as Japan's economic system, are also sometimes called neo-mercantilist. In an essay appearing in the May 14, 2007 issue of Newsweek, economist Robert J. Samuelson argued that China was pursuing an essentially mercantilist trade policy that threatened to undermine the post-World War II international economic structure.

In specific instances, protectionist mercantilist policies also had an important and positive impact on the state that enacted them. Adam Smith, himself, for instance praised the Navigation Acts as they greatly expanded the British merchant fleet, and played a central role in turning Britain into the naval and economic superpower that it was for several centuries. Some modern-day economists thus feel that protecting infant industries, while causing short term harm, can be beneficial in the long term.

Bibliography and References

• Salvatore, Dominick, ed. The New Protectionist Threat to World Welfare. 1987.
• Smith, Adam. The Wealth of Nations, Edwin Cannan edition. 1937.
• Horrocks, J. W. , A Short History of Mercantilism (1925)

*Coleman, D. C. ed., Revisions in Mercantilism (1969)
*Miller, J. C. , Way of Death: Merchant Capitalism and the Angolan Slave Trade (1988).

• Galbraith, J.K., Economics in Perspective: A Critical History, Houghton Mifflin Company, 1988
• Ekelund, Robert B. and Robert D. Tollison, Mercantilism as a Rent-Seeking Society: Economic Regulation in Historical Perspective, Texas A&M University Press, College Station, 1981
• Ekelund, Robert B and Robert F. Hébert. A History of Economic Theory and Method. New York: McGraw-Hill, 1997.
• Heckscher, Eli F. Mercantilism. translation by Mendel Shapiro. London: Allen & Unwin. 1935.
• Keynes, John Maynard, General Theory of Employment, Interest and Money, "Notes on Mercantilism, the Usury Laws, Stamped Money and the Theories of Under-Consumption."
• Landreth, Harry and David C. Colander. History of Economic Thought. Boston: Houghton Mifflin, 2002.
• Niehans, Jürg. A History of Economic Theory: Classic Contributions, 1720–1980. Baltimore: Johns Hopkins University Press, 1990.
• Vaggi, Gianni and Peter Groenewegen.. A Concise History of Economic Thought: From Mercantilism to Monetarism. New York: Palgrave Macmillan, 2003.
• Wilson, Charles. Mercantilism. London: Historical Association, 1966

• Rothbard, Murray N. Economic Thought Before Adam Smith. An Austrian Perspective on the History of Economic Thought. Volume I
• Rothbard, Murray N. Classical Economics. An Austrian Perspective on the History of Economic Thought. Volume II

External links

• Thomas Mun's Englands Treasure by Forraign Trade
• Book IV of The Wealth of Nations, Adam Smith's attack on the Mercantile System

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