Chapter 1 – Mercantilism

Mercantilism was an economic system of trade that spanned from the 16th century to the
18th century. Mercantilism is based on the principle that the world's wealth was static, and
consequently, many European nations attempted to accumulate the largest possible share of that
wealth by maximizing their exports and by limiting their imports via tariffs.

a) Meaning and Definition of Mercantilism.

First popularized in Europe during the 1500s, mercantilism was based on the idea that a nation's
wealth and power were best served by increasing exports, in an effort to collect precious metals
like gold and silver.
Mercantilism replaced the feudal economic system in Western Europe. At the time, England was
the epicenter of the British Empire but had relatively few natural resources. To grow its wealth,
England introduced fiscal policies that discouraged colonists from buying foreign products,
while creating incentives to only buy British goods. For example, the Sugar Act of 1764 raised
duties on foreign refined sugar and molasses imported by the colonies, in an effort to give British
sugar growers in the West Indies a monopoly on the colonial market.
Similarly, the Navigation Act of 1651 forbade foreign vessels from trading along the British
coast and required colonial exports to first pass through British control before being redistributed
throughout Europe. Programs like these resulted in a favorable balance of trade that increased
Great Britain's national wealth.
Under mercantilism, nations frequently engaged their military might to ensure local markets and
supply sources were protected, to support the idea that a nation's economic health heavily relied
on its supply of capital. Mercantilists also believed that a nation's economic health could be
assessed by its levels of ownership of precious metals, like gold or silver, which tended to rise
with increased new home construction, increased agricultural output, and a strong merchant fleet
to provide additional markets with goods and raw materials.

Definition:
“the economic theory that trade generates wealth and is stimulated by the accumulation of
profitable balances, which a government should encourage by means of protectionism.”
“Mercantilism is an economic policy that is designed to maximize the exports and minimize the
imports for an economy. It promotes imperialism, colonialism, tariffs and subsidies on traded
goods to achieve that goal.”

b) Ideas of Mercantilism.
Mercantilism stated that colonies had one main purpose: to enrich the mother country. The idea
was that different regions would trade goods that they had a lot of for goods which were rare in
their own region.

The underlying principles of mercantilism included (1) the belief that the amount of wealth in
the world was relatively static; (2) the belief that a country's wealth could best be judged by the
number of precious metals or bullion it possessed; (3) the need to encourage exports over
imports as a means for obtaining Wealth.

c) Goals and Objectives of Mercantilism.

Mercantilism is an economic practice by which governments used their economies to augment
state power at the expense of other countries. Governments sought to ensure that exports
exceeded imports and to accumulate wealth in the form of bullion (mostly gold and silver).

Mercantilism was built on two understandings within the context that Monarchies or Oligarchs
were the only way to rule a nation.

The State while capable of ruling a country is incapable of controlling each sector or industry so
it must give a franchise (sole right to operate) to a single or a few people who pay a fee (or a tax
that was passed on to the client) in exchange for monopoly control for that industry. Often this
was achieved through the creation of guilds.

The way wealth growth is measured is based on the amount of bullion in a country. By bullion I
mean physical gold. As such imports were looked down upon because gold would flow out and
exports were smiled on because gold would flow in. Although it was acknowledged that
sometimes you needed to import raw resources for cheap and export finished goods for a profit.
Hence the search for colonies to exploit foreign resources.

d) Feature or characteristics of Mercantilism.

Features of mercantilism -

1. Foreign Trade

In the first place the mercantilists laid great emphasis on a favorable balance of trade. They held
that the strength and richness of a country depends on two things-the possession of gold and
silver mines and favorable balance of trade.

As all the countries did not possess mines of gold and silver, they could build up rich stocks of
these metals by exporting maximum of their manufactured articles and importing minimum of
commodities from other countries.
Highlighting the importance of foreign trade Thomas Mun wrote: "The ordinary means....to
increase our wealth and treasure is by Foreign Trade....This ought to be encouraged, for upon it
hangs the great revenue of the king, the honor of the kingdom, the noble profession of the
merchant, the school of our arts, the supply of our poor, the improvement of our lands, the
nursery of our mariners, the walls of the kingdom, the means of our treasures, the sinews of our
wars and the terror of our enemies."

For the maintenance of a favorable balance of trade the mercantilists favored commercial
regulation. They insisted on discouraging the imports through imposition of heavy duties and
prohibitions on foreign goods.

On the other hand, the exports should be encouraged through bounties and other artificial
stimulation of domestic agriculture and industry. For the promotion of the country's trade a
number of Navigation laws were passed to ensure that the country's trade remained in the hands
of the native shippers.

The mercantilism not only laid emphasis on the regulation of foreign trade but also emphasized
the principle of monopoly. In most of the European countries the right to engage in foreign trade
was vested only in a small privileged section of the society.

For example, the British government allowed its subjects to trade freely only with a small area
(viz. France, Spain and Portugal) while the rest of the world was divided for trading purposes
amongst numerous joint stock companies. Each company was allotted a definite trading sphere.

Thus, the East India Company enjoyed monopoly of trade with Asia, Africa Company with
Africa and Levant Company with the Mediterranean. Similarly, the European powers also vested
the right of trade in various joint stock companies. East India Companies were formed in France,
Holland, Sweden and Denmark for carrying on trade with the East.

The mercantilists applied the principle of monopoly with regard to their colonies also. It was
asserted that colonies had no right to regulate their economic independently and must try to meet
the needs of the mother country through supply of raw materials for her manufacturers.

The other foreigners were excluded from the colonial trade. They were not permitted to carry on
trade with the colonies except in some less important articles. Industries were permitted to
develop in the colonies only if they did not compete with the mother country. Obviously, this
policy led to complete neglect of the interests of the colonial people.

2. Importance of Money.

Mercantilism attached great importance of money. It considered the wealth as the source of all
powers and laid great emphasis on the importance of gold, silver etc. It also considered money as
a significant factor for the commercial advancement. Further as the trade in those days was
mostly carried on the basis of barter of goods, the people naturally preferred to keep gold and
silver rather than the commodities.
The importance of money also increased because the state needed more taxes for the
management of its affairs and it naturally preferred those taxes in money rather than in kind. The
enormous amounts required for the conduct of commercial wars with other nations for the
retention of colonies also greatly contributed to the importance of money.

Money was also considered essential for abundance of trade. It was commonly held that "where
money was scarce, trade was sluggish, where it was abundant, trade boomed." In short,
mercantilism emphasized the importance of money on account of numerous reasons.

3. Interest.

The concept of interest formed an important part of mercantilism even though there was no
unanimity among the various mercantilists regarding its use and importance. For example, Mun
justified charging of interest on the money because it could be profitably employed in trade and
enabled the borrower to make hugh profits.

However, by and large the mercantilists favored low rates of interests. They believed that the
high rates of interests made the money scarce. Some of the mercantilist writers who favored low
rates of interests included Thomas Manley, John Locke, Nicholas Barbon etc.

This stand of mercantilist was quite natural in view of the fact that it was an age of great scarcity
of liquid funds, underdeveloped banking facilities and growing antagonism between the
merchant-manufacturers and the goldsmiths and big merchant financiers.

4. Factors of Production.

The mercantilists considered the land and the labor as the sole factors of production. Petty
asserted, "Labor is the father and active principle of wealth, as lands are the mother." Similarly,
Josiah Child held that land and trade went hand in hand.

Most of the mercantilists laid emphasis on the need of increasing production with a view to attain
self-sufficiency in foodstuffs as well as encouragement of exports. Emphasis was laid on the
cultivation of waste lands to increase reduction of agriculture.

5. Large Populations.

Mercantilism emphasized the need of possessing large population for increasing production and
participation in the war. Highlighting the importance of large population Davenant said, "The
people are the real strength of the community; dense population made inventions. It also
developed industries which brought riches to the nation. In view of the importance of the
population Samuel Fortrey plead for freedom of immigration and granting of equal rights to the
immigrants.

He argued the immigrants would bring riches with them and improve the condition of trade and
industry in the country. Large population also made available cheap labor which helped a
country to increase its domestic population and successfully compete with the foreign countries.
In view of this the state encouraged matrimony and parenthood.

6. Commercial Regulations.

Mercantilists accepted the need of commercial regulation for the smooth working of the
economy and promotion of social welfare. Almost all the European countries framed regulations
with a view to restrict the imports of foreign goods and encourage exports.

Generally, the import of raw materials was preferred over import of finished product because it
helped the industrial development of the country. Most of the states imposed artificial restraints
on internal and external trade keeping in view the national interests. As the mercantilists believed
that a country could obtain an advantage at the expenses of another country only, the commercial
regulations were framed keeping in view selfish national interests.

This explains why often the mercantilists did not permit the economic considerations to
outweigh the political considerations and agreed to subserve the economic life to the political
end.

e) Principles of Mercantilism.
Austrian Cameralist, Philip Wilhelm von Hornick (or Hörnigk or Horneck) studied law at
Ingolstadt, receiving his degree in 1661 and setting himself up as a lawyer and civil servant in
Vienna.  He was the brother-in-law of the influential Cameralist theorist, J.J. Becher.

A German nationalist, Hornick was roused to indignation by Louis XIV of France's "chambers of
reunions" policy, aggressively laying claims to German border territories.  Hornick's first
pamphlet (1682) argued for the consolidation of the German states to raise a single army to resist
the French encroachments.

In 1684, Hornick published his principle Cameralist work, Austria above all, where he famously
articulated his 'nine principal rules' of national economy, roughly:

(1) utilize all the soil of a country;

(2) utilize raw materials to build up manufacturing within a country;
(3) encourage a large population
(4) prohibit the export of gold and silver;
(5) discourage importation of foreign consumer goods;
(6) that if you must import, match that with exports rather than cash.
(7) import only raw materials to be finished at home.
(8) try to export as much as possible, in return for gold and silver.
(9) prohibit importation of any good available domestically.

Hornick's nine principles serve as a neat summary of the 17th C. Mercantilism.  Hornick's
pamphlet gained wide circulation and was reprinted numerous times.
Hornick served on occasional embassies, and, from 1690, was appointed Privy Counselor to the
Prince-Bishop of Passau.

f) Way of pricing or value measuring system according to Mercantilism.

The early mercantilists generally abandoned this cost-of-production approach to the

understanding of prices and focused on the point of sale to analyze exchange values. One scholar
of mercantilist ideas has concluded that, despite a wide range of differences on specific issues,
there are three important notions that run through most early mercantilist writings on value
theory. First, the "value" or "natural value" of commodities was simply their actual market price.
Second, the forces of supply and demand determined market value. Third, mercantilist writers
frequently discussed "intrinsic value" or use value as the most important factor determining
demand, and hence as an important causal determinant of market value.

Nicholas Barbon, one of the most important of the mercantilist writers, summed up these three
points in his pamphlet, A Discourse on Trade:

1. The Price of Wares is the present Value. ... The Market is the best Judge of value; for by the
Concourse of Buyers and Sellers, the Quantity of Wares, and the Occasion for them are Best
Known: Things are just worth so much, as they can he sold for, according to the Old Rule, Valet
Quantum Vendi Potest.

2. The Price of Wares is the present Value, and arises by Computing the occasions or use for
them, with the Quantity to serve that Occasion. . .. It is impossible for the Merchant when he has
Bought his Goods, to know what he shall Sell them for: The Value of them, depends upon the
Difference Betwixt the Occasion and the Quantity; tho' that be the Chiefest of the Merchants
Care to observe, yet it Depends upon so many Circumstances, that it's impossible to know it.
Therefore, if the plenty of the Goods, has brought down the Price, the Merchant layeth them up,
til the Quantity is consumed, and the Price riseth.

3. The Value of all Wares arise from their Use; Things of no Use, have no Value, as the English
Phrase is, they are good for nothing. The Use of Things, are to supply the Wants and Necessities
of Man: There are Two General wants that Mankind is born with; the Wants of the Body, and the
Wants of the Mind; To supply these two Necessities, all things under the Sun become useful, and
therefore have a Value. ...The Value of all Wares, arriveth from their Use; and the Dearness and
Cheapness of them, from their Plenty and Scarcity.

Barbon's pamphlet was written at a time during which economic attitudes were beginning to
undergo rapid change. The passages just quoted reflect the attitudes of the earlier mercantilist
who saw profits as originating primarily in the act of exchange.
 g) Limitation or Criticism of Mercantilism.
Criticisms of Mercantilism

 Adam Smith’s “The Wealth of Nations” (1776) – argued for benefits of free trade and
criticized the inefficiency of monopoly.
 Theory of comparative advantage (David Ricardo)
 Mercantilism is a philosophy of a zero-sum game – where people benefit at the expense
of others. It is not a philosophy for increasing global growth and reducing global
problems. Trying to impoverish other countries will harm our own growth and prosperity.
By contrast, if we avoid zero-sum game of mercantilism increasing the wealth of other
countries can lead to selfish benefits, e.g., growth of Japan and Germany led to increased
export markets for UK and US.
 Mercantilism which stresses government regulation and monopoly often lead to
inefficiency and corruption.
 Mercantilism justified Empire building and the poverty of colonies to enrich the Empire
country.
 Mercantilism leads to tit for tat policies – high tariffs on imports leads to retaliation.
 The growth of globalization and free trade during the post-war period showed
possibilities from opening markets and respecting other countries as equal players.
 Economies of scale from specialization possible under free trade.

Justification for neo-mercantilism

Despite many criticisms of mercantilism, there are arguments to support the restriction of free
trade in certain circumstances.

 Tariffs in response to domestic subsidies. Supporters argue that since China’s steel is
effectively subsidized leading to a glut in supply, it is necessary and fair to impose tariffs
on imports of Chinese steel to protect domestic producers from unfair competition. US
tariffs on imports of steel from China 266%. In Europe, tariffs are 13%.
 Protection against dumping. If some countries have an excess supply of goods, they can
sell at a very low price to get rid of the surplus. But this can make domestic firms
unprofitable. Protectionism can be justified to protect against this dumping. Examples,
include EEC dumping excess agricultural production on world agricultural markets and
China’s dumping of steel.
 Infant industry argument. For countries seeking to diversify their economy, tariffs may be
justified to try and develop new industries. When the industries have developed and
benefited from economies of scale, then the tariffs and protectionism can be dropped.