Mercantilism

Mercantilism is an economic theory that holds that the prosperity of a nation depends upon its supply of capital, and that the global volume of trade is "unchangable." Economic assets, or Capital, is represented by bullion (gold, silver, and trade value) held by the state, and is best increased through a positive balance of trade with other nations (exports minus imports). Mercantilism suggests that the ruling government should advance these goals by playing a protectionist role in the economy, by encouraging exports and discouraging imports, especially through the use of tariffs. The economic policy based upon these ideas is often called the mercantile system.

Mercantilism was the dominant school of thought throughout the early modern period (from the 16th to the 18th century, which roughly corresponded to the emergence of the nation-state). Domestically, this led to some of the first instances of significant government intervention and control over the economy, and it was during this period that much of the modern capitalist system was established. Internationally, mercantilism encouraged the many European wars of the period, and fueled European imperialism, as the European powers fought over "available markets". Belief in mercantilism 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. Interestingly, the former British colonies, the United States of America did not adhere to classical economics but to what is called the "American School" (a form of neo-mercantilism) in the policies of Hamilton, Clay, Lincoln and later Republican Party economic practices, that were mirrored in the policies 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 some elements are looked upon favorably by some economists including Ravi Batra, Pat Choate, Eammon Fingleton, and Michael Lind.^[1]

Theory

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.^[2] The word comes from the Latin word mercari, which means "to run a trade," from merx, meaning "commodity." It was initially used solely by critics, such as Mirabeau and Smith, but was quickly adopted by historians. Originally, the standard English term was mercantile system. The word mercantilism was introduced into English from German in the early 20th century.

Mercantilism as a whole cannot be considered a unified theory of economics. There were no mercantilist writers presenting an overarching scheme for the ideal economy, as Adam Smith would later do for classical economics. Rather, each mercantilist writer tended to focus on a single area of the economy.^[3] Only later did non-mercantilist scholars integrate these "diverse" ideas into what they called mercantilism. Some scholars thus reject the idea of mercantilism completely, arguing that it gives "a false unity to disparate events".^[4] To a certain extent, mercantilist doctrine itself made a general theory of economics impossible. Mercantilists viewed the economic system as a zero-sum game; where a gain by one party requires a loss by another. Thus, any system of policies that benefited one group would by definition "harm the other", and there was no possibility of economics being used to maximize the commonwealth, or "common good".^[5] Mercantilists' writings were also generally created to 'justify' particular practices, rather than as investigations into the best policies.^[6]

Mercantilist domestic policy was more fragmented than its trade policy. While Adam Smith presented mercantilism as supporting 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 element mercantilists agreed upon was the 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.^[7]

Scholars are divided on why mercantilism was the dominant economic ideology for two and a half centuries.^[8] 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.^[9]

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.^[10] 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.^[11] 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.”^[12] 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 like 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 cooperation amidst ruthless competition can be seen in the Folk theorem (game theory). (See also : http://en.wikipedia.org/wiki/Talk:Folk_theorem_%28game_theory%29)

The dark view of human nature fit well with the Puritan view of the world, and some of the most stridently mercantilist legislation, such as the Navigation Acts, was introduced by the government of Oliver Cromwell.^[13]

Criticisms

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 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. In modern economic theory, trade is not a zero-sum game of cutthroat competition, as both sides could benefit, it is an interated 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.^[14]

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. Gold was nothing more than a yellow metal that was valuable only because there was not much of it.

The first school to completely reject mercantilism were the Physiocrats of France. Their theories also had several important problems, and the replacement of mercantilism did not come until Adam Smith published 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.^[15]

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. ^[16]

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.^[17]

Legacy

In the English-speaking world, Adam Smith's utter repudiation of mercantilism was accepted without question in the British Empire but rejected in the United States by such prominent figures as Alexander Hamilton, Henry Clay, Henry C. Carey, and Abraham Lincoln. 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.

Adam Smith rejected the mercantilist focus on production, arguing that consumption was the only way to grow an economy. Keynes argued that encouraging production was just as important as consumption. Keynes also noted that in the early modern period the focus on the bullion supplies was reasonable. In an era before paper money, an increase for bullion was one of the few ways to increase the money supply. 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.^[18] The similarities between Keynesianism, and its successor ideas, with 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.^[19]

One area Smith was reversed on well before Keynes was that of use of data. Mercantilists, who were generally merchants or government officials, gathered vast amounts of trade data and used it considerably in their research and writing. William Petty, a strong mercantilist, is generally credited with being the first to use empirical analysis to study the economy. Smith rejected this, arguing that deductive reasoning from base principles was the proper method to discover economic truths. Today, many schools of economics accept that both methods are important; the Austrian School being a notable exception.

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.^[20] Some economists thus feel that protecting infant industries, while causing short term harm, can be beneficial in the long term.

Nonetheless,The Wealth of Nations had profound impact on the end of mercantilist era and the later adoption of free market policy. By 1860, England removed the last vestiges of the mercantile era. Industrial regulations, monopolies and tariffs were withdrawn. In pursuing the free trade policy, England became and remained the dominant economic power in Europe for the next many years until World War I.

Notes

References

Further reading

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