Mercantilism theory and examples

Mercantilism is an economic theory and practise where the government seeks to regulate the economy and trade in order to promote domestic industry – often at the expense of other countries. Mercantilism is associated with policies which restrict imports and foster domestic industries.

Mercantilism stands in contrast to the theory of free trade – which argues countries economic well-being can be best improved through reduction of tariffs and fair free trade.

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Mercantilism involves

  • Restrictions on imports – tariff barriers, quotas or non-tariff barriers.
  • Accumulation of foreign currency reserves and  gold and silver reserves. (known also as bullionism) It was believed in the sixteenth / seventeenth century that the accumulation of gold reserves (at expense of other countries) was the best way to increase the prosperity of a country.
  • Granting of state monopolies to particular firms especially those associated with trade and shipping.
  • Subsidies of export industries to give competitive advantage in global markets.
  • Government investment in research and development to maximise efficiency and capacity of domestic industry.
  • Allowing copyright / intellectual theft from foreign companies.
  • Limiting wages and consumption of the working classes to enable greater profits to stay with the merchant class.
  • Control of colonies, e.g. making colonies buy from Empire country and taking control of colonies wealth.

Examples of mercantilism

  • England Navigation Act of 1651 prohibited foreign vessels engaging in coastal trade.
  • All colonial exports to Europe had to pass through English first and be re-exported to Europe.
  • Under British Empire, India restricted in buying from domestic industries and were forced to import salt from the UK. Protests against this salt tax,  led to ‘Salt tax’ revolt led by Gandhi.
  • In seventeenth Century France, the state promoted a controlled economy, with strict regulations about the economy and labour markets
  • Rise of protectionist policies following the great depression. With countries seeking to reduce imports and also reduce value of currency by leaving gold standard.
  • Some have accused China of mercantilism due to industrial policies which have led to increase in investment and capacity, rise in FDI in China – combined with policy of undervaluation of currency. However, the extent of mercantilist policies are disputed – See Is China Mercantilist? NBER

Modern Mercantilism

In the modern world, mercantilism is sometimes associated with policies, such as.

  • Undervaluation of currency. e.g. government buying foreign currency assets to keep the  exchange rate undervalued and make exports more competitive. A criticism often levelled at China.
  • Government subsidy of industry for unfair advantage. Again China has been accused of offering too much subsidised investment for industry, leading to over supply of industries such as steel – meaning other countries struggle to compete.
  • Surge of protectionist sentiment, e.g. tariffs on Chinese imports.
  • Copyright theft

Criticisms of Mercantilism

  • Adam Smith The Wealth of Nations (1776) – argued for benefits of free trade and criticised 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. Also, increasing other peoples wealth can lead to selfish benefits, e.g. growth of other countries, increases markets for our exports. Trying to impoverish other countries will harm our own growth and prosperity.
  • Mercantilism which stresses government regulation and monopoly tends to 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.
  • Growth of Globalisation and free trade during post-war period show possibilities from opening markets and respecting other countries as equal players.
  • Economies of scale from specialisation 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 subsidised 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 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 benefit from economies of scale, then the tariffs and protectionism can be dropped.

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