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Introduction

  • Mercantilism is economic nationalism for the purpose of building a wealthy and powerful state. Adam Smith coined the term “mercantile system” to describe the system of political economy that sought to enrich the country by restraining imports and encouraging exports. This system dominated Western European economic thought and policies from the sixteenth to the late eighteenth centuries. The goal of these policies was, supposedly, to achieve a “favorable” balance of trade that would bring gold and silver into the country and also to maintain domestic employment. In contrast to the agricultural system of the physiocrats or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state.
  • The most important economic rationale for mercantilism in the sixteenth century was the consolidation of the regional power centers of the feudal era by large, competitive nation-states. Other contributing factors were the establishment of colonies outside Europe; the growth of European commerce and industry relative to agriculture; the increase in the volume and breadth of trade; and the increase in the use of metallic monetary systems, particularly gold and silver, relative to barter transactions.
  • During the mercantilist period, military conflict between nation-states was both more frequent and more extensive than at any other time in history. The armies and navies of the main protagonists were no longer temporary forces raised to address a specific threat or objective, but were full-time professional forces. Each government’s primary economic objective was to command a sufficient quantity of hard currency to support a military that would deter attacks by other countries and aid its own territorial expansion.
  • Most of the mercantilist policies were the outgrowth of the relationship between the governments of the nation-states and their mercantile classes. In exchange for paying levies and taxes to support the armies of the nation-states, the mercantile classes induced governments to enact policies that would protect their business interests against foreign competition.
  • These policies took many forms. Domestically, governments would provide capital to new industries, exempt new industries from guild rules and taxes, establish monopolies over local and colonial markets, and grant titles and pensions to successful producers. In trade policy the government assisted local industry by imposing tariffs, quotas, and prohibitions on imports of goods that competed with local manufacturers. Governments also prohibited the export of tools and capital equipment and the emigration of skilled labor that would allow foreign countries, and even the colonies of the home country, to compete in the production of manufactured goods. At the same time, diplomats encouraged foreign manufacturers to move to the diplomats’ own countries.

History

  • Originating in 16th-century Europe, mercantilism began with the emergence of the nation-state. The dominant economic theory was that the global supply of wealth was finite, and it was in the nation’s best interest to accumulate as much as possible. During that time, wealth was measured by a country’s quantity of silver and gold. To accumulate more wealth, European countries, such as Britain and France, would focus on maximizing their exports and minimizing imports, which resulted in a favorable balance of trade.
  • For countries with a negative trade balance with a mercantilist country, the difference would be paid back in silver or gold. To maintain a favorable trade balance, the early mercantilist countries would enact imperialist policies by setting up colonies in smaller nations.
  • The aim was to extract raw material to send back to the home country, where it would be refined into manufactured goods. The goods would then be resold to the colonies, allowing early mercantilist nations to accumulate wealth through a positive trade balance.

British Colonial Mercantilism

The British colonies were subject to the direct and indirect effects of mercantilist policy at home. Below are several examples:

  • Controlled production and trade: Mercantilism led to the adoption of enormous trade restrictions, which stunted the growth and freedom of colonial businesses.
  • The expansion of the slave trade: Trade became triangulated between the British Empire, its colonies, and foreign markets, fostering the development of the slave trade in many colonies, including America. The colonies provided rum, cotton, and other products demanded by African imperialists. In turn, slaves were returned to America or the West Indies and traded for sugar and molasses.
  • Inflation and taxation: The British government demanded that trades were conducted using gold and silver bullion, ever seeking a positive balance of trade. The colonies often had insufficient bullion left over to circulate in their markets, so they issued paper currency instead. Mismanagement of printed currency resulted in inflationary periods. Additionally, since Great Britain was in a near-constant state of war, heavy taxation was needed to prop up its army and navy. The combination of taxes and inflation caused great colonial discontent.

The End of Mercantilism

  • Democracy and free trade destroyed mercantilism in the late 1700s. American and French revolutions formalized large nations ruled by democracy. They endorsed capitalism. 
  • Adam Smith argued against mercantilism with his 1776 publication of “The Wealth of Nations.” He argued that foreign trade strengthens the economies of both countries. Each country specializes in what it produces best, giving it a comparative advantage. He also explained that a government that put business ahead of its people would not last. Smith’s laissez-faire capitalism coincided with the rise of democracy in the United States and Europe.
  • In 1791, mercantilism was breaking down, but free trade hadn’t yet developed. Most countries still regulated free trade to enhance domestic growth. U.S. Treasury Secretary Alexander Hamilton was a proponent of mercantilism. He advocated government subsidies to protect infant industries necessary to the national interest. The industries needed government support until they were strong enough to defend themselves. Hamilton also proposed tariffs to reduce competition in those areas.
  • Fascism and totalitarianism adopted mercantilism in the 1930s and 1940s. After the stock market crash of 1929, countries used protectionism to save jobs. They reacted to the Great Depression with tariffs. In the U.S., the 1930 Smoot-Hawley Act raised tariffs on more than 20,000 items. When other countries retaliated, global trade fell 66% by 1933, prolonging the depression.

The Rise of Neomercantilism

  • World War II’s devastation scared Allied nations into desiring global cooperation. They created the World Bank, the United Nations, and the World Trade Organization. They saw mercantilism as dangerous and globalization as its salvation.
  • But other nations didn’t agree. The Soviet Union and China continued to promote a form of mercantilism. The main difference was that most of their businesses were state-owned. Over time, they sold many state-owned companies to private owners. This shift made those countries even more mercantilist.
  • Neomercantilism fits in well with their communist governments.They relied on a centrally planned command economy. It allowed them to regulate foreign trade. They also controlled their balance of payments and foreign reserves. Their leaders selected which industries to promote. They engaged in currency wars to give their exports lower pricing power. For example, China bought U.S. Treasurys to fuel its trade with the United States. As a result, China became one of the largest foreign owners of U.S. debt.

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