Mercantilism and Some Critics

The Setting

Pre- Mercantilism:

Nation States:  What we saw develop in the fifteenth and sixteenth centuries were powerful “nation states”—partly because of a decline in the power of clerical authorities.

In fact—the setting for large nation-states and mercantilism was readied by two different notions of power:

(1)    Social contract

(2)    Divine right of kings

Emphasis placed on the will as the determinant of human action was found in:

1.                  In Italy we see Florentine Nicolo Machiavelli (1469-1527)

Machiavelli’s philosophy: was based on a speculation theory concerning the rise and decline of states and was designed to teach the appropriate methods of making a ruler powerful and his regime permanent.

The ideal state was a political community independent of any outside authority—especially the church!

Social contract - Also most important was Machiavelli’s reference to a social contract.

Appeal was made to the rules of a natural law, as conceived by reason, in establishing a doctrine which enabled them to derive the hereditary rights of kings and princes from contracts of submission concluded between their ancestors and their subjects—conceived as a collectivity.

The theory of the contract of submission provided arguments against any claims of the church to extend its jurisdiction beyond the religious sphere.

2.                  In France we see:

The theory of the “divine right of kings.”

Second half of the sixteenth century by Frenchman Jean Bodin (1530-1596).

The rights and duties of rulers were prescribed by divine law—and their sovereignty was directly derived from the grace of God.

Was no contract between rulers and subjects—

The divine right was taken to provide the logical and juridical basis of the far-reaching rights claimed by absolute monarchs of the sixteenth and seventeenth centuries.

Nation State (Unified Body of Power):  Both political theories sustained the belief that each of the growing national states constituted a unified body, a whole, engaged in a struggle for power.

The Philosophical Setting

The "pie" was considered "fixed" – the only way to get richer was at the expense of others.  This is still widely accepted today – if Bill Gates gets richer, people believe it is at the expense of someone else.  Is this true?  Does it depend upon how he gets rich?

The idea is that the total volume of power and wealth available for all countries was a more or less fixed magnitude—so that a gain in the struggle for power and wealth of one country could be secured only at the expense of others.

Philosophers of history used this approach to explain the rise and decline of empires!  As one empire flourished, another fell!

This idea most likely shaped policy in the middle of the sixteenth century to the middle of the seventeenth century (and to some degree still does).

When viewed in the light of economic events—this period is commonly called the period of “mercantilism.”

“Merchantilism” applied to almost all authors who dealt with economic problems from mid sixteenth century until about mid eighteenth century.

Following the Psysiocrat Marquis de Mirabeau—The expression “mercantilist” was introduced by Adam Smith—and the “mercantilist system” was what he referred to as the protectionist policies of the eighteenth century.

Ricardo’s followers used the term Mercantilists to denote all authors who defended that policy.

Mercantilism c. 1600 - 1790

No general definition of mercantilism is entirely satisfactory, but it may be thought of as a collection of policies designed to keep the state prosperous by economic regulation. All mercantilist policies may or may not have been applied simultaneously at any given time or place.

Again it was coined by Adam Smith - prevailed in France, England, Spain and Holland

Let’s recognize two approaches to defining Mercantilism (although not a unified body of thought – there are different strands):

Doctrinal approach—

Policy approach—

  Both view mercantilism as a system of power!   Economics should be subordinated to the interests of the state.  References to individual behavior as a relevant economic unit only gradually entered into their considerations.

Perhaps both approaches are correct?

An important part of Mercantilism was:

Government granted monopolies-  "royal letters patent of monopoly"- conferred upon private persons or corporations the exclusive right to produce or sell certain commodities.

Chartered companies especially (A chartered company is an association formed by investors or shareholders for the purpose of trade, exploration and colonization.)—were an important source of royal revenue.  Also used to promote the introduction of new lines of industries such as glass and soap.

Sound familiar today?   (called "infant" industry protection by the state).

But also often used to grant favors for political or personal reasons.

Today we call this Rent Seeking:

So we still see mercantilism in the “rent seeking” activity of business to obtain special government privileges in exchange for financial support of politicians and the government generally speaking.

The following ideas (or rules), then, lumped together, may be called mercantilism.  Quotations are from

Philipp von Hornick (1640 - 1714)—Austrian lawyer and civil servant —published his “Nine principals for national economy”  (1684)

(1) Bullionism was the belief that the economic health of a nation could be measured by the amount of precious metal, gold or silver, which it possessed.

a. The rise of a money economy,

b. the stimulation produced by the influx of bullion from America,

c. the fact that taxes were collected in money,

all seemed to support the view that hard money was the source of prosperity, prestige, and strength.

—“no trouble or expense should be spared to discover gold and silver.” 

Bullionism dictated a favorable balance of trade. That is, for a nation to have gold on hand at the end of the year, it must export more than it imports.

(2) Each nation tried to achieve economic self-sufficiency. Those who founded new industries should be rewarded by the state. All natural resources should be turned into (manufactured) into something to sell.

--- These rules were designed to get a “surplus of gold, silver, and all other things necessary or convenient for its subsistence, derived, so far as possible, from its own resources, without dependence upon other countries…”

(3)   A large population was needed to provide a domestic labor force to people colonies.  And nobody should be idle!

(4)  Gold and silver should always remain in circulation within the country.  This will ensure that the country will always prosper and not "sink into poverty."

(5) Luxury items were to be avoided because they took money out of the economy unnecessarily.  This would also help to ensure a favorable balance of trade.

(6) Items that must be obtained from foreign markets should be bought using domestic wares (not gold and silver) as much as possible.  This also includes transporting the goods - therefore, a powerful merchant fleet would mean that a country would not become dependent on foreign assistance. In addition, a fleet could add to a nation's prestige and military power.  Sea power was necessary to control foreign markets.

(7)  Any imports should be in the "unfinished form" (in order to produce domestically).

---“the payment of manufacturing generally exceeds the value of the raw material…”

(8) Colonies could provide captive markets for manufactured goods and sources of raw material.

---“consumption, so to speak, must be sought in the farthest ends of the earth, and developed in every possible way.”

(9)  Regulated commerce could produce a favorable balance of trade. In general, tariffs should be high on imported manufactured goods and low on imported raw material.  No imports should be allowed if they can be obtained domestically.

 

To add to these nine rules - mercantilism also included:

Thriving agriculture should be carefully encouraged.  Domestic production not only precluded imports of food, but farmers also provided a base for taxation.

State action was needed to regulate and enforce the above policies.   One of the main characters in "administration" of mercantilism was:

Thomas Mun (1571 - 1641)

was a leading mercantilist and a director of the East India Company.  It is for his work England's Treasure by Foreign Trade that he is best remembered.

He thought that government should regulate foreign trade to achieve a favorable balance, encourage importation of cheap raw materials, encourage exportation of manufactured goods, enact protective tariffs on imported manufactured goods, and take other measures to increase population and keep wages low and competitive (in order to stimulate exports).

So very similar to Von Hornick - although Mun was known for being pro international trade (of course, under strict regulation to ensure a favorable balance of trade).

International Trade:

            The Balance of Trade Concept: Acquisition of precious metals (money) through foreign trade represented an advancement in power over other countries which competed for the available supply of metals.

Domestic trade was pretty much irrelevant.

The concept of “cost” was held to be applicable only to the total volume of a country’s trade with other countries, and a gain could result only when this trade showed a surplus expressed by the inflow of precious metals.

Trade and Specie (Gold and Silver) Flow - The Debates

Thomas Mun (from earlier)  took account of the relation which had been established between increases in the volume of money and the movements of prices.

Mun took into account the relation between increases in the volume of money and the increase of prices→ he didn’t like increase in P’s→ so he wanted to counteract this by reinvesting the surplus (from exports) in agriculture and fisheries on one hand and in manufacturers on the other – increase productivity in order to decrease the increase in prices.

He favored the exportation of commodities which were labor intensive….aversion to importation of luxury goods.

This, of course, flies in the face of the idea that the pie is fixed!

A major critic of mercantilism was Adam Smith's friend, David Hume.  One of his most famous theories was his explanation of the relationship between specie flow and prices.  Although Mun understood that there was a relationship between the volume of money and prices -- Hume disagreed with his solution (reinvesting, etc.) and said that it is impossible for a country to continuously maintain a favorable balance of trade ---

   David Hume 1711 - 1776 (Scottish philosopher – not a Mercantilist - a critic)

- Contributed to international trade theory

- Said that it was impossible for an economy to maintain a favorable balance of trade continuously (see below)

- Since you can't sustain high exports and high prices for long

- Said that the growth of economic freedom was correlated with the growth of political freedom

Hume’s Price Specie Flow Mechanism:  David Hume is really credited for explaining what is called the specie flow mechanism more correctly (although he had his predecessors).  Or at least he pointed to a price-specie flow mechanism that linked the quantity of money to prices and alterations in prices to balance-of-trade surplus and deficits.

The process:

(1)   Inflow of gold in England.  Only gold can be used as a medium of exchange.

(2)   The money stock increases in the same proportion (a fiat money fractional reserve system would magnify the increase).

(3)   Price level increases.  (Including export goods)

(4)   Foreign countries’ (with less money) prices decrease, buy less from England.

(5)   British citizens buy more foreign goods, less British goods.

(6)   English trade surplus becomes a deficit.

(7)   Gold flows out, money stock decreases, prices decrease, surplus again!

The cycle continues and the attempt to accumulate gold is self-defeating.

As Hume mentions→ this could be good for industry before prices rise….

            “betwixt the acquisition of money and rise of prices…”

But he argued that money is only a “veil” in the economy—it is not real, it does not contribute to real economic growth or productivity — the stock of money, therefore, is not important—after the price level adjusts (remember, he was friends with Adam Smith).

So here we have the beginnings of  the “quantity theory of money” - still very famous today (via Irving Fisher,  the Monetarists - Milton Friedman, and others.

                        _      _

                      MV=PQ

M =

V =

P =

Q =

            So we have a direct, proportionate relationship between M and P.

                    _  _

Or  P= F(M,   V, Q).

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