Mercantilism theory of trade

History of Mercantilism theory of trade

Adam Smith is widely regarded as the father of economics.  However, prior to his time, history was filled with many economic thinkers and practices. Among those, mercantilism economic ideas dominated Europe until Adam Smith‘s publication of “Wealth of Nation” in 1776.

What is Mercantilism?

From the 16th through the 18th centuries, mercantilism was a popular economic philosophy and practice in Europe. This theory arose from the works of many philosophers, politicians, merchants, and policymakers who expressed their opinions on economics. They were passionate about the importance of the government’s involvement to preserve the nation’s economic strength from its neighbors.

According to current understanding, the views of mercantilists are not considered economic theory. They have, however, written on current national economic issues such as increasing tax revenues, the mobility of gold, and how nations compete for international commerce. Between the 16th and 17th centuries, these ideas influenced European policies to a greater extent.

What are the main ideas of mercantilism?

  • A nation’s wealth and power were mainly depend on precious metals, such as gold and silver
  • Foreign trade is the mean of accumulating treasure, export more, import less and keep a positive balance of trade, which would lead to a flow of precious metals
  • Trade is a Zero-sum game – exporters always win, importers always lose
  • Government military power to promote trade and hamper the trade of foreign competitors, colonization
  • Concept of nationalism and colonization

Main idea of mercantilism

The main principle of mercantilism was the belief that the nation’s wealth depends on the gold and silver stock they have. And for that, they had to export more and import less. This idea was built based on a case called Dutch puzzle.

Dutch Puzzle

There is a small country in Europe called the Netherlands, Dutch, or Holland. And that country was founded in the 1580s. They did, however, become wealthy and more powerful in a short amount of time. They were also able to establish an empire in Asia and Africa.

People in other areas of Europe, particularly Britain, were astonished by the Dutch’s success because they had a relatively small population and fewer natural resources than the rest of Europe. So they looked into the secret and discovered that the success element was a favorable trade balance. The Dutch exported high-value manufacturing products (finished fabric, tools, and weapons) while imported low-value manufacturing goods (raw wool, shoes, and clothing).

Mercantilism theory of International Trade

Mercantilists built their theory of international trade based on these and other examples. According to mercantilism, a country’s wealth and power are determined by precious metals such as gold and silver. A country’s gold and silver production should be increased by maintaining a trade surplus or a favorable trade balance; exporting more and importing less. This can then be converted into gold and silver.

As a result, mercantilists favor protectionism. They urged governments to limit imports through tariffs and promote exporters through subsidies. As a result, trade has devolved into a zero-sum game. Only exporters benefit, while importers suffer.

This notion was embraced by the majority of European nations, resulting in a trade war and even colonialism. Because every country was at war, establishing new colonies to grow their markets and maintain a positive trade balance was essential.

What are the disadvantages of Mercantilism?

  • Mercantilism believes that free trade is a zero-sum game in which exporters gain and importers lose, although trading is a positive-sum activity.
  • Beggar thy Neighbor Policy – A policy that seeks to improve a country’s trade balance by hurting the interests of its trading partners.
  • Putting more emphasis on gold and silver, this may eventually lead to domestic inflation – According to David Hume, the more gold and silver there is, the larger the domestic money supply, which leads to domestic inflation. Higher domestic prices lead to low exports and more imports (because of lower import prices). Finally, Trade surplus gradually turns into a trade deficit.
  • Trade surplus gradually turns into a trade deficit.
  • Mercantilists justified the establishment of colonies.

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