Chapter 4 Outline

Mercantilism

The first theory of international trade emerged in England in the mid-16th century. Referred to as mercantilism, its principle assertion was that gold and silver were the mainstays of national wealth and essential to vigorous commerce. At that time, gold and silver were the currency of trade between countries; a country could earn gold and silver by exporting goods. By the same token, importing goods from other countries would result in an outflow of gold and silver to those countries. The main tenent of mercantilism was that it was in a country's best interests to maintain a trade surplus, to export more than it imported. By doing so, a country would accumulate gold and silver and increase its national wealth and prestige. As the English mercantilist writer Thomas Mun put it in 1630:

The ordinary means therefore to increase our wealth and treasure is by foreign trade, wherein we must ever observe this rule: to sell more to strangers yearly than we consume of theirs in value.¹

Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade. The mercantilists saw no virtue in a large volume of trade. Rather, they recommended policies to maximize exports and minimize imports. To achieve this, imports were limited by tariffs and quotas, and exports were subsidized.

An inherent inconsistency in the mercantilist doctrine was pointed out by the classical economist David Hume in 1752. According to Hume, if England had a balance-of-trade surplus with France (it exported more than it imported) the resulting inflow of gold and silver would swell the domestic money supply and generate inflation in England. In France, however, the outflow of gold and silver would have the opposite effect. France's money supply would contract, and its prices would fall. This change in relative prices between France and England would encourage the French to buy fewer English goods (because they were becoming more expensive) and the English to buy more French goods (because they were becoming cheaper). The result would be a deterioration in the English balance of trade and an improvement in France's trade balance, until the English surplus was eliminated. Hence, according to Hume, in the long run, no country could sustain a surplus on the balance of trade and so accumulate gold and silver as the mercantilists had envisaged.

The flaw with mercantilism was that it viewed trade as a zero-sum game. (A zero-sum game is one in which a gain by one country results in a loss by another.) It was left to Adam Smith and David Ricardo to show the shortsightedness of this approach and to demonstrate that trade is a positive-sum game, in which all countries can benefit. The mercantilist doctrine is by no means dead.² For example, Jarl Hagel-stam, a director at the Finnish Ministry of Finance, has observed that in most trade negotiations:

The approach of individual negotiating countries, both industrialized and developing, has been to press for trade liberalization in areas where their own comparative competitive advantages are the strongest, and to resist liberalization in areas where they are less competitive and fear that imports would replace domestic production.³

Hagelstam attributes this strategy by negotiating countries to a neomercantilist belief held by the politicians of many nations. This belief equates political power with economic power and economic power with a balance-of-trade surplus. Thus, the trade strategy of many nations is designed to simultaneously boost exports and limit imports. For example, many American politicians claim that Japan is a neomercantilist nation because its government, while publicly supporting free trade, simultaneously seeks to protect certain segments of its economy from more efficient foreign competition (see the next Country Focus feature for further details).