How Mercantilism Works - Coursework Example

Running Head: MERCANTILISM Assignment 2 – Mercantilism Student’s Name Course Tutor’s Name Date: Mercantilism Mercantilism is a trade theory that suggests that nationals “should accumulate financial wealth, usually in the form of gold by encouraging exports and discouraging imports” (Wild & Wild, 2014, p. 161). Mercantilism downplays the importance of measures such as human development or living standards in the wellbeing of a nation. In other words, the theory implies that a nation’s performance should be measured based on the amount of exports it has as opposed to imports and the amount of wealth (measured by gold standards) it accumulates in the ensuing trade. The importance of one-way trade was underscored, and that the benefits accrued by the exporter would be at the expense of the importer (Cairns & Silwa, 2008, p. 21). Mercantilism therefore represented the interests of (mainly) governments, but also merchants, while disadvantaging the laboring and farming countries. Indeed, Cairns and Silwa (2008) note that the economic and social poverty of the importing countries was perceived as desirable, because any increase in social or economic power would have led to a decline in productivity, and as a result, would have denied powerful exporting countries the raw materials they needed to make imports. This paper will discuss how mercantilism worked, identify its essential pillars, identify its strengths and weaknesses and identify the argument that liberals have against it. The paper concludes by noting that the passage of time and the development and acceptance of more efficient trade theories have succeeded in wiping out some components of mercantilism. How Mercantilism Worked The basis of mercantilism was the transition from rudimentary trade to international trade and from feudalism to capitalism (Andrea, 2004, p. 1). It was the economic system adopted by major trading nations in the wake of geographical discoveries. In mercantilism, governments exercised control over trading companies and corporations and would carefully regulate production in order to maximize high quality goods in an effort to enable the country establish or uphold a certain position in foreign markets (Andrea, 2004, p. 1; Musonera, 2008, p. 2). The foregoing assumption is further noted by Lim (2009) who observes that “mercantilism is based on the very simple assumption that the international political economy is governed, first and foremost, by state power” (p. 2). Another assumption by the mercantilist states was that wealth was finite, and as such, the more a state had in its vaults, the more secure it would be in future (Pincus, 2012, p. 5). The latter assumption whetted the mercantilist states’ appetite for hoarding gold and silver. To succeed, mercantilist policies would protect domestic industries using tax breaks, subsidies, quotas, and tariffs among other measures, hence disadvantaging foreign industries (Lim, 2009, p. 2). It was further pegged on the realist perspective that intimated that people live in a ‘man eat man world/society’. In other words, every country was a self-interest actor, and all decisions made were in the pursuit of maximizing benefits accrued by a country while minimizing costs (Lim, 2009, p.5). It also worked on the assumption that states were unitary actors, whose actions were guided by the national interest. On his part, Irwin (1991, p. 1296) points out that mercantilism worked both as a commercial policy and as an economic thought. As a commercial policy, mercantilism was assisted by extensive regulations by government, which ensured that the country benefited from any form of international trade it engaged in. As an economic thought, mercantilism held that the gains that a country got were based on exports alone and that international trade for a country should be equivalent to a “zero-sum game” (Irwin, 1991, p. 1296). In a zero-sum game, what one party gains and the opposing party loses (Harris, 1993, p. 2; Raghavan, 1994, p. 736). In other words, if one trading party earns profits, it would be obvious that the other party in the trade arrangement would lose. The exact manner in which mercantile system worked is explained by TDL (2012, n.pg), where it is indicated that small countries like England, and which championed the mercantile cause, could wage war against other competing countries. Additionally, they would empower local manufacturers to produce goods internally by subsidizing their operations and encouraging the formation of monopolies (Rothbard, 1963, n.pag). Also, they would develop their own shipping system and protect it in order to provide the infrastructure needed to enhance exports, while limiting imports. Finally, they set out to establish colonies, which acted as a source of cheap raw materials, and a market for the value-added and manufactured items. Obviously, the balance of trade favored the countries that were pursuing the mercantile agenda owing to the fact that they would sell the manufactured items at a higher price than they would purchase raw materials from the same trade partners. To take full advantage of the colonies, countries such as Britain would forbid direct importation of raw materials from the colonies to competing economies. TDL (2012, n.pag) for example observes that tobacco produced from Jamestown would be shipped to Britain first where it would be taxed before being sold to other countries. Essential Pillars of Mercantilism Government intervention, trade surpluses and colonialism have been identified as the three main pillars of mercantilism. According to Wild and Wild (2014), trade surplus was the overarching pillar of countries which believed in mercantilism. To such countries, the ultimate goal was to take in more gold thorough more exports than imports. To such countries, trade deficits (i.e. where the imports would be more than exports) were an undesirable state that was to be avoided at all times (Wild & Wild 2014, p. 162). The second pillar is identified by Wild and Wild (2014, p. 162) as government intervention, which was a prerequisite for countries that wanted to maintain a trade surplus. Government policies came in handy especially in the imposition of tariffs and quotas to imports, and the provision of subsidies to local economies. Wild and Wild (2014) further note that governments “outlawed the removal of their gold and silver to other countries” (p. 162). According to McCusker (1996, p. 338), mercantilists believed that only through strong nation-state protection could businesses and workers attain economic satisfaction. Additionally, mercantilism urged governments to develop the economy in a manner that would serve the best interest of the nation-state. It is argued that by emphasizing the interests of nation-states, workers and businesses would benefit as well (McCusker, 1996, p. 338). The third pillar as identified by Wild and Wild (2014, p. 162) is colonialism, which was the act through which mercantilist nations obtained overseas territories. The territories would then act as an invaluable source of raw materials, which would be shipped to beneficiary nations. The cost of acquiring raw materials from the colonies was always low and this meant that mercantilist countries could make huge profits from selling manufactured products obtained from processing the raw materials. The Strengths and Weaknesses of Mercantilism To mercantilist nations, their practices especially in relation to their colonies enabled them to expand their wealth (Wild & Wild, 2014, p. 162). Consequently, they were able to maintain trade surplus, which arguably led to economic stability. According to the mercantilist thought, the structure of the economy determined the growth therein. Furthermore, economics was linked to power and the more wealth a country had (i.e. in the form of gold and silver), the more powerful the country would be (Pincus, 2012, p. 7). However, the disadvantages of mercantilism appear to outweigh its advantages. For example, Wild and Wild (2014, p. 162) observe that mercantilism was inherently flawed, and as a result, it severely restricted trade between countries. Additionally, mercantilism led to the under-development of colonies from where mercantilist countries sourced their raw materials, because fair prices were not paid for the raw materials. Since the colonies did not generate enough money from the raw materials, their ability to purchase the manufactured products which were exported to them by the mercantilist countries was equally limited. In other words, mercantilism was a self-defeatist (at least in some areas) approach to trade. Other critics of the mercantilist doctrine (e.g. Manis, 2012, p. 360 Sumonera, 2008, p. 2), have demonstrated that when freely initiated, trade would be a positive-sum game for both parties involved in the trade arrangement. The foregoing therefore negates the importance of mercantilism. Another disadvantage of mercantilism according to Manis (2012, p. 365) was that the collusive relationship forged by industries and governments in mercantilist countries had negative consequences to the rest of the population. Citing Adam Smith, Cairns and Silwa (2008, p. 20) indicate that while merchants accumulated more wealth based on government restrictions such as restrictive trade treaties and tariffs, the rest of the population did not benefit from government intervention. Ideally, a laisser-faire environment would have enhanced the public well-being especially because more products from the exports market would have been available for purchase. The availability of more products in the local market would have brought in competition and price differentials, which in the long-term would have been beneficial to the public. Hume (cited by Smith, El-Anis and Farrands, 2010) further demonstrated that “a continual inflow of gold would raise domestic prices and cause economic activity to move abroad, therefore reversing the flow of gold” (p. 6). Hume’s argument was reflective of what would happen if any economy had too much money: inflation would rise, and the cost of living would go up as the economy tries to absorb the excess money from the market (Dreger & Wolters, 2013, p. 3). Consequently, even the price of production would go up, effectively making a country a relatively expensive place to run a business. Overall, mercantilism is disadvantageous to countries which pursued it because the risk of governmental failure meant that the entire economy would suffer (Pincus, 2012, p. 4). Additionally, there was the risk that governments and merchants would disguise their narrow interests as a matter of state interest and by doing so, would disadvantage the general population. Finally, it was hard to determine which of the industries that operated in an economy deserved more attention (e.g. through subsidies or tariffs). Arguments that Liberals have against Mercantilism Among the critics of mercantilism were David Hume and Adam smith. David Hume (1711-1776) argued that even if all the gold and silver of the Great Britain was to increase five-fold overnight, the country would not become wealthier; rather, the cost of labor and commodities would rise, and no other country would afford to buy from the country (Rashid, 1984, pp. 157-158). He further argued that the costs in the country would be too high such that even the country’s own populace would look for cheaper alternatives elsewhere. Adam Smith (1723-1790) held liberal trade views, and argued that in free exchange of goods and services, both parties to trade would be better off (Adam Smith Institute, 2014, n.pag.; Wild &Wild, 2014, p. 163). He reasoned that if one party to a trade knows they will lose, the probable thing is that they would not get into a trade arrangement. According to Levy and Thompson (2011, p. 1993), Smith reasoned that there ought to be a natural harmony in trade between and among states. In other words, Smith was discrediting the zero-sum game approach of the mercantilist system. Smith further posited that a “nation’s wealth is not the quantity of gold and silver in its vaults, but the total of its production and commerce” (Adam Smith Institute, 2014, n.pag.). What Smith was referring to at that time is today known as the gross national product. Another point of criticism for mercantilism targeted its colonial policies, protectionism and the formation of economic monopolies (Levy & Thompson, 2011, p. 1993). The foregoing practices, combined with the zero-game assumption of the mercantilist system, made a contribution to the militaristic and expansionist policies of the mercantilist states. Arguably, enhanced military weight and expansion which led to the acquisition of more colonies by the mercantilist states made war a useful instrument of accumulating wealth. It is noted in literature (Brooks, 2005, p. 45; Gartzke, 2007, p. 163) that war was too costly as a way of wealth accumulation, and in fact, it countered the goal of accumulating gold and/or silver since warring nations would be required to dig into their reserves in order to finance their military. Overall, liberals argue that different countries have different resource endowments (Mingst & Arreguin-Toft, 2010, p. 76). Consequently, their respective wealth could be maximized if they trade freely with each other in a manner that enables each one of them to get fair prices for their commodities. David Ricardo (1772-1823) was one such liberal economist who is known as a proponent of the comparative advantage theory. Ricardo argued that if countries would specialize in the production and exportation of products they produce efficiently, gains from trade would be maximized since each country would reduce its opportunity costs (Carbaugh, 2013, p. 31). Conclusion This paper has provided an introduction to mercantilism, explained how the concept worked, identified its strengths and weaknesses and identified the arguments that liberals have against the mercantilist thought. From the points that have been discussed, it would appear that mercantilism was indeed a flawed approach to trade and wealth creation by countries. Arguably, it would be hard to fathom a world where mercantilism was still upheld as the prominent economic theory, especially considering that wealth has already been established not to be a finite resource as mercantilists thought. Additionally, countries that were colonized before have already been emancipated and with their freedom come freer trade choices, which allow them to become willing participants in any trade arrangement. Consequently, and as argued in this paper, it would be hard for any country to enter into a trade arrangement with prior knowledge that it would lose. References Adam Smith Institute. (2014). Introduction: Why Adam Smith is important. Retrieved April 20, 2014, from http://www.adamsmith.org/adam-smith. Andrea, E. A. (2004). Classical theories of international trade. International Economics, Course 2. Retrieved April 19, 2014, from http://cis01.central.ucv.ro/iba/files/int_ec2.pdf Brooks, S. G. (2005). Producing security: Multinational corporations, globalisation, and the changing calculus of conflict. Princeton, NJ: Princeton University Press. Cairns, G., & Sliwa, M. (eds.) (2008). Classical and neo-classical theories of international trade. 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