Mercantilism

by Laura LaHaye
About the Author
Mercantilism is economic nationalism for the purpose of building a wealthy and powerful state. Adam Smith coined the term “mercantile system” to describe the system of political economy that sought to enrich the country by restraining imports and encouraging exports. This system dominated Western European economic thought and policies from the sixteenth to the late eighteenth centuries. The goal of these policies was, supposedly, to achieve a “favorable” balance of trade that would bring gold and silver into the country and also to maintain domestic employment. In contrast to the agricultural system of the physiocrats or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state.

The most important economic rationale for mercantilism in the sixteenth century was the consolidation of the regional power centers of the feudal era by large, competitive nation-states. Other contributing factors were the establishment of colonies outside Europe; the growth of European commerce and industry relative to agriculture; the increase in the volume and breadth of trade; and the increase in the use of metallic monetary systems, particularly gold and silver, relative to barter transactions.

During the mercantilist period, military conflict between nation-states was both more frequent and more extensive than at any other time in history. The armies and navies of the main protagonists were no longer temporary forces raised to address a specific threat or objective, but were full-time professional forces. Each government’s primary economic objective was to command a sufficient quantity of hard currency to support a military that would deter attacks by other countries and aid its own territorial expansion.

Most of the mercantilist policies were the outgrowth of the relationship between the governments of the nation-states and their mercantile classes. In exchange for paying levies and taxes to support the armies of the nation-states, the mercantile classes induced governments to enact policies that would protect their business interests against foreign competition.

These policies took many forms. Domestically, governments would provide capital to new industries, exempt new industries from guild rules and taxes, establish monopolies over local and colonial markets, and grant titles and pensions to successful producers. In trade policy the government assisted local industry by imposing tariffs, quotas, and prohibitions on imports of goods that competed with local manufacturers. Governments also prohibited the export of tools and capital equipment and the emigration of skilled labor that would allow foreign countries, and even the colonies of the home country, to compete in the production of manufactured goods. At the same time, diplomats encouraged foreign manufacturers to move to the diplomats’ own countries.

Shipping was particularly important during the mercantile period. With the growth of colonies and the shipment of gold from the New World into Spain and Portugal, control of the oceans was considered vital to national power. Because ships could be used for merchant or military purposes, the governments of the era developed strong merchant marines. In France, Jean-Baptiste Colbert, the minister of finance under Louis XIV from 1661 to 1683, increased port duties on foreign vessels entering French ports and provided bounties to French shipbuilders.

In England, the Navigation Act of 1651 prohibited foreign vessels from engaging in coastal trade in England and required that all goods imported from the continent of Europe be carried on either an English vessel or a vessel registered in the country of origin of the goods. Finally, all trade between England and its colonies had to be carried in either English or colonial vessels. The Staple Act of 1663 extended the Navigation Act by requiring that all colonial exports to Europe be landed through an English port before being re-exported to Europe. Navigation policies by France, England, and other powers were directed primarily against the Dutch, who dominated commercial marine activity in the sixteenth and seventeenth centuries.

During the mercantilist era it was often suggested, if not actually believed, that the principal benefit of foreign trade was the importation of gold and silver. According to this view the benefits to one nation were matched by costs to the other nations that exported gold and silver, and there were no net gains from trade. For nations almost constantly on the verge of war, draining one another of valuable gold and silver was thought to be almost as desirable as the direct benefits of trade. Adam Smith refuted the idea that the wealth of a nation is measured by the size of the treasury in his famous treatise The Wealth of Nations, a book considered to be the foundation of modern economic theory. Smith made a number of important criticisms of mercantilist doctrine. First, he demonstrated that trade, when freely initiated, benefits both parties. Second, he argued that specialization in production allows for economies of scale, which improves efficiency and growth. Finally, Smith argued that the collusive relationship between government and industry was harmful to the general population. While the mercantilist policies were designed to benefit the government and the commercial class, the doctrines of laissez-faire, or free markets, which originated with Smith, interpreted economic welfare in a far wider sense of encompassing the entire population.

While the publication of The Wealth of Nations is generally considered to mark the end of the mercantilist era, the laissez-faire doctrines of free-market economics also reflect a general disenchantment with the imperialist policies of nation-states. The Napoleonic Wars in Europe and the Revolutionary War in the United States heralded the end of the period of military confrontation in Europe and the mercantilist policies that supported it.

Despite these policies and the wars with which they were associated, the mercantilist period was one of generally rapid growth, particularly in England. This is partly because the governments were not very effective at enforcing the policies they espoused. While the government could prohibit imports, for example, it lacked the resources to stop the smuggling that the prohibition would create. In addition, the variety of new products that were created during the industrial revolution made it difficult to enforce the industrial policies that were associated with mercantilist doctrine.

By 1860 England had removed the last vestiges of the mercantile era. Industrial regulations, monopolies, and tariffs were abolished, and emigration and machinery exports were freed. In large part because of its free trade policies, England became the dominant economic power in Europe. England’s success as a manufacturing and financial power, coupled with the United States as an emerging agricultural powerhouse, led to the resumption of protectionist pressures in Europe and the arms race between Germany, France, and England that ultimately resulted in World War I.

Protectionism remained important in the interwar period. World War I had destroyed the international monetary system based on the gold standard. After the war, manipulation of the exchange rate was added to governments’ lists of trade weapons. A country could simultaneously lower the international prices of its exports and increase the local currency price of its imports by devaluing its currency against the currencies of its trading partners. This “competitive devaluation” was practiced by many countries during the Great Depression of the 1930s and led to a sharp reduction in world trade.

A number of factors led to the reemergence of mercantilist policies after World War II. The Great Depression created doubts about the efficacy and stability of free-market economies, and an emerging body of economic thought ranging from Keynesian countercyclical policies to Marxist centrally planned systems created a new role for governments in the control of economic affairs. In addition, the wartime partnership between government and industry in the United States created a relationship—the military-industrial complex, in Dwight D. Eisenhower’s words—that also encouraged activist government policies. In Europe, the shortage of dollars after the war induced governments to restrict imports and negotiate bilateral trading agreements to economize on scarce foreign exchange resources. These policies severely restricted the volume of intra-Europe trade and impeded the recovery process in Europe in the immediate postwar period.

The economic strength of the United States, however, provided the stability that permitted the world to emerge from the postwar chaos into a new era of prosperity and growth. The Marshall Plan provided American resources that overcame the most acute dollar shortages. The Bretton Woods agreement established a new system of relatively stable exchange rates that encouraged the free flow of goods and capital. Finally, the signing of the GATT (General Agreement on Tariffs and Trade) in 1947 marked the official recognition of the need to establish an international order of multilateral free trade.

The mercantilist era has passed. Modern economists accept Adam Smith’s insight that free trade leads to international specialization of labor and, usually, to greater economic well-being for all nations. But some mercantilist policies continue to exist. Indeed, the surge of protectionist sentiment that began with the oil crisis in the mid-1970s and expanded with the global recession of the early 1980s has led some economists to label the modern pro-export, anti-import attitude “neomercantilism.” Since the GATT went into effect in 1948, eight rounds of multilateral trade negotiations have resulted in a significant liberalization of trade in manufactured goods, the signing of the General Agreement on Trade in Services (GATS) in 1994, and the establishment of the World Trade Organization (WTO) to enforce the agreed-on rules of international trade. Yet numerous exceptions exist, giving rise to discriminatory antidumping actions, countervailing duties, and emergency safeguard measures when imports suddenly threaten to disrupt or “unfairly” compete with a domestic industry. Agricultural trade is still heavily protected by quotas, subsidies, and tariffs, and is a key topic on the agenda of the ninth (Doha) round of negotiations. And cabotage laws, such as the U.S. Jones Act, enacted in 1920 and successfully defended against liberalizing reform in the 1990s, are the modern counterpart of England’s Navigation Laws. The Jones Act requires all ships carrying cargo between U.S. ports to be U.S. built, owned, and documented.

Modern mercantilist practices arise from the same source as the mercantilist policies of the sixteenth through eighteenth centuries. Groups with political power use that power to secure government intervention to protect their interests while claiming to seek benefits for the nation as a whole. In their recent interpretation of historical mercantilism, Robert B. Ekelund and Robert D. Tollison (1997) focused on the privilege-seeking activities of monarchs and merchants. The mercantile regulations protected the privileged positions of monopolists and cartels, which in turn provided revenue to the monarch or state. According to this interpretation, the reason England was so prosperous during the mercantilist era was that mercantilism was not well enforced. Parliament and the common-law judges competed with the monarchy and royal courts to share in the monopoly or cartel profits created by mercantilist restrictions on trade. This made it less worthwhile to seek, and to enforce, mercantilist restrictions. Greater monarchical power and uncertain property rights in France and Spain, by contrast, were accompanied by slower growth and even stagnation during this period. And the various cabotage laws can be understood as an efficient tool to police the trading cartels. By this view, the establishment of the WTO will have a liberalizing effect if it succeeds in raising the costs or reducing the benefits of those seeking mercantilist profits through trade restrictions.

Of the false tenets of mercantilism that remain today, the most pernicious is the idea that imports reduce domestic employment. Labor unions have used this argument to justify protection from imports originating in low-wage countries, and there has been much political and media debate about the implications of offshoring of service sector jobs for national employment. Many opponents have claimed that offshoring of services puts U.S. jobs at risk. While it does threaten some U.S. jobs, it puts no jobs at risk in the aggregate, however, but simply causes a reallocation of jobs among industries. Another mercantilist view that persists today is that a current account deficit is bad. When a country runs a current account deficit, it is either borrowing from or selling assets to the rest of the world to finance expenditure on imports in excess of export revenue. However, even when this results in an increase of net foreign indebtedness, and associated future debtservicing requirements, it will promote economic wealth if the spending is for productive purposes that yield a greater return than is forgone on the assets exchanged to finance the spending. Many developing countries with high rates of return on capital have run current account deficits for extremely long periods while enjoying rapid growth and solvency. The United States was one of these for a large part of the nineteenth century, borrowing from English investors to build railroads (see international capital flows). Furthermore, persistent surpluses may primarily reflect a lack of viable investment opportunities at home or a growing demand for money in a rapidly developing country, and not a “mercantile” accumulation of international reserves at the expense of the trading partners.


About the Author

Laura LaHaye is an adjunct professor at the Illinois Institute of Technology. She was a visiting scholar from 2004 to 2005 at the University of Illinois in Chicago and an economics professor there from 1981 to 1990. In 1981, she was a research economist with the General Agreement on Tariffs and Trade.


Further Reading

Allen, William R. “Mercantilism.” In John Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave: A Dictionary of Economics. Vol. 3. London: Macmillan, 1987. Pp. 445–448.
Ekelund, Robert B. Jr., and Robert D. Tollison. Politicized Economies: Monarchy, Monopoly and Mercantilism. College Station: Texas A&M University Press, 1997.
Heckscher, Eli. Mercantilism. 2 vols. London: Allen and Unwin, 1934.
Magnusson, Lars. Mercantilism: The Shaping of an Economic Language. London: Routledge, 1994.
Salvatore, Dominick, ed. The New Protectionist Threat to World Welfare. New York: North-Holland, 1987.
Smith, Adam. The Wealth of Nations. Edwin Cannan edition. 1937. Available online at: http://www.econlib.org/library/Smith/smWN.html
Viner, Jacob. Studies in the Theory of International Trade. New York: Harper and Brothers, 1937.

Return to top