MERCANTILISM

Mercantilism is a political and economic system that arose in the 17th and 18th centuries. It purports that a country's economic strength is directly related to the maintenance of a positive balance of trade. That is, in order to remain economically and politically viable a country must export more than it imports. Such a positive balance of trade, according to mercantilist thought, results in a surplus of gold in the practicing country's treasury.

Although not a proponent of mercantilism, noted 18th century Scottish economist Adam Smith (1723-1790) was responsible for coining the term "mercantile system." Mercantilism was in opposition to Smith's concepts of free trade, free enterprise, and the free movement of people and goods. In other words, it went against the precepts of a laissez-faire economy. One of the key assertions of mercantilism is that national wealth will come through the import and accumulation of gold or other precious metals such as silver. Smith was highly critical of this theory of wealth and he clearly understood the class bias in the merchant system that supported it. In fact, Smith expressed great concern about colonialism and the monopoly trade routes instituted by the merchant class, which often worked against the economic interests of the citizenry.

Mercantilism as an economic system is generally held in low regard today. Japan, however, with its structural barriers to foreign competition and its discouragement of foreign direct investment has been accused of practicing a late 20th century form of mercantilism.

Mercantilism as a historical period has been associated with the rise of a particular form of European capitalism often referred to as merchant capitalism. Mercantilism was also a doctrine advanced by various economic writers of the period, who tended to call for a powerful alliance between merchants and the monarchial system, which was then in decline. The term mercantilism is often used today to describe protectionist trade policies which, when coupled with other government policies, directly or indirectly subsidize particular industries in order to gain national or regional trade advantage. Japan, as stated above, is a late 20th century example of such policies. Mercantilism has thus come to be associated with nationalistic economic policies and is shunned by free trade advocates who argue for minimal state interference in the domestic and international marketplace.

The mercantile system advocated various nationalistic trade policies thought to enhance the wealth of the respective nation. This wealth was to be achieved via mercantilism's five essential elements, as noted in the work of writer David L. Sills:

• Nationalism and policy go hand in hand, with all policy being directed towards nationalism.
• Foreign trade should always be thought of in terms of its effect on the country's stock of precious metals.
• Lacking domestic gold or silver mines, these precious metals must be accumulated by an excess of exports over imports.
• Government trade authorities, through policy, should strive to restrict imports and encourage exports.
• Economic foreign policy and political foreign policy should be coordinated toward the achievement of these ends.

While most closely associated with 18th century Europe, the term mercantilism has also been used to refer to the general principle of the aggrandizement of state power for the economic gain of its capitalist class by manipulating and controlling trade. During colonial times, for example, this took the form of military control over trade routes, large tariffs on imported goods (especially manufactured products), and outright plundering of colonies in pursuit of gold and raw materials.

The rationale for mercantilist practices, aside from the imperatives of empire and colonial conquest, was reflected in 18th century notions of the origin of profit and the nature of exchange. From a merchant's perspective, profit originated from "buying cheap and selling dear." While this is the goal of any for-profit entity, mercantilists applied this view to the nation as a whole. This is in contrast to the sacred belief of marketplace ideology held by classical economists—that exchange should be made on the basis of equivalents. Mercantilists believed, moreover, that the seller gains via the buyer's loss. Therefore, a nation will only become richer if it exports or sells more than it imports or buys. Gold or other "money commodities" will thus be amassed to the benefit of the state. The view that profit or surplus originates in the unequal exchange of commodities was therefore perfectly consistent with the mercantilist policy of controlling the terms of trade.

Mercantilism played an important but not necessarily dominant role in the transition from feudalism to industrial capitalism. Mercantilism, however, did greatly benefit large merchant enterprises such as the British East India Company, which shipped home goods over trade routes protected and maintained by the state. Foreign trade was thought to be necessary for the accumulation of gold because domestic trade could not generate a net surplus or profit. Armed with this view of the origin of profits, merchants promoted exports as a necessary means of gaining surplus profits. Like all good policy makers, the merchants argued that this policy would in turn benefit the state as a whole.

Policies to these ends involved state subsidies of export industries; high tariff walls to encourage home production; a prohibition on the sale of gold to foreigners; subsidization of key industries when necessary; control over certain types of capital; and the relentless import of gold and raw materials from colonies. Most of these policies involved strict control over trade routes and the stabilization of prices by state fiat.

During the mercantilist period, merchants controlled the trading system but not the production of goods and services. Before the advent of industrial capitalism, production was along the line of a crafts system, which embodied remnants of the old feudal order. As industrial capitalism emerged the power of the merchant class declined. Merchants would eventually come to see that taking over or being more involved in the means of production would enhance their profits by giving them control over the productivity of labor. For the most part, however, merchants did not control the means of production, as their primary concern was buying and selling. Mercantilist policies encouraged the importation of raw materials, which in turn could be manufactured into various products. Now carrying an added value, these finished goods could subsequently be exported and sold for a high price relative to their original cost. Thus would gold ultimately find its way to the nation's treasury.

The rise of the mercantile system coincided with the beginnings of capitalism in 16th and 17th century Europe. By this time Spain, France, and the low countries of Belgium and Holland had been transformed into merchant-dominated economies. Concurrently, modern nation-states were emerging as a political complement of the merchant economy. It was this coalition of merchants and monarchs that eventually led to the dissolution of the old feudal order. A system evolved that was instead regulated by a competitive labor market. This led to the eventual formation of a class of people who found themselves free from feudal ties to the land only to be forced to sell their labor in order to ensure subsistence. Also emerging was a class of industrial and manufacturing entrepreneurs who were "recruited" from the now declining merchant class.

The merchant class eventually gave way and lost control of the new economic order to the emerging forces of capitalist competition where price and profits were regulated by the production and accumulation of capital. While trading was essential to the emerging industrial capitalist system, transactions were seen as merely a sharing out of the total selling price among the buyers and purchasers, including the merchant. The mercantile idea that trade led to profits for the system as a whole gave way to the classical economist's view that production and the reinvestment of profit was the true source of a nation's wealth.

In addition to the shift in focus from trading to production, the new social and economic dynamic of capital accumulation, in turn, led to devastating critiques of the mercantilist doctrine by English classical economists, such as Adam Smith, and the French Physiocrats. Mercantilist doctrine was pushed aside by the doctrine of comparative advantage which enshrined the idea that free and open trade would be the most beneficial system for all who participate.

While the general perception of mercantilism is one of a long cohesive chapter in the history of economic thought, mercantilist authors were typically business and professional people who haphazardly wrote and made known their thoughts—long before economics came to be an academic discipline. To paraphrase one writer of the time, merchants were proselytizing and pamphleteering men of affairs, rather than philosophers, and had no pretensions to science. This is in contrast to their antecedents, such as Italian religious and philosopher Thomas Aquinas (1225-1274), who sought to understand a just or fair price.

Most representative of mercantilist writings were the French and English writers of the 17th century. These eminently practical thinkers sought the order, protection, and stability that was essential for the expansion of their activities, which in turn would benefit the state. In exchange for military protection of their trading routes, they often succeeded in gaining monopolistic subsidization from the crown while the state expanded its material means for colonization. Wealth accrued to both the state and the merchant elite in the form of gold and various raw materials to which value could be added and then exported in the form of finished goods. Mercantilists viewed production as being important only in so far as it led to an export surplus.

While the merchant class was far from cohesive, disagreements about policy within the merchant class were subservient to the aims of the common goal of expanding the trade surplus. Mercantilists vigorously encouraged exports, except machinery and plant and equipment that might aid foreign competitors. They also discouraged imports, except raw materials and of course precious metals. The colonies, including the Americas, served as a prime export market and a source of tax revenue, military bases, and of course a source of gold, silver, and raw materials. A strong navy and a military war machine was vital to the implementation and maintenance of these policies.

As production became relatively more important, capitalists realized that by controlling production, it would be possible to cut costs, raise productivity, and undercut competitors by lowering prices. This line of reasoning led economists such as Adam Smith to reject the idea that gold (i.e., money) constituted wealth. In a powerful critique of mercantilists, Smith pointed out that money merely reflected the wealth produced by production while expressing the value of commodities and services offered in the marketplace. Furthermore, struggles between merchants over trade monopolies and prices fostered conflict to the detriment of all concerned. Merchants as a class were thus compelled to become full-fledged capitalists or fade into the newly emerging working class. The many criticisms of mercantilism culminated in a devastating critique known as the specie-flow mechanism. Scottish philosopher and political economist David Hume (1711-1776) pointed out that the very success of a nation's mercantilist policies—a trade surplus—would set in motion forces that would tend to reverse the trade surplus, all through the normal operation of markets. Allowing for the free flow of money, at this time mostly gold, it was argued, would tend to result in a balance of trade equilibrium.

While Hume's specie-flow mechanism is the most well known critique of mercantilist thought, opposition to mercantilist thinking began as early as the late 17th century. The main idea here was that the very success of mercantilist policies would trigger unintended consequences. As argued by Hume and others, a positive trade balance implies a positive net flow of money, because more money is coming in than going out. A situation would soon evolve where too much money is chasing too few goods, as the system is operating at full capacity and money is not generally hoarded but kept in circulation. The only logical effect of this is a rise in prices. In deficit countries, as opposed to the mercantilist surplus countries, money is flowing out, which results in falling prices. The deficit countries will thus become more competitive over time and trade will shift their way resulting in a trade equilibrium. This doctrine later became known as the quantity theory of money.

In terms of its historical influence, mercantilist policy accelerated the breakup of the feudal economy and the guild crafts system of production. State policy and the merchant system complemented one another. The main objective was to foster growth of foreign trade (along with shipping and export industries such as textiles) while encouraging the inflow of precious metals and raw materials to which value could be added for export. Mercantilism thus served to accelerate the transition of Europe from a land-based economy to a monetary economy. Although pure mercantilism is a dead economic issue today, vestiges of it remain. As author and historian Paul Johnson wrote in Commentary, "To trade freely is not a human natural propensity."