Mercantilism and Early Classical Thought

c. 1500 - c. 1790

Mercantilism

• The Term “Mercantilism” was coined by Adam Smith

• It was a system prevalent in:– France– Spain– England– Holland

Main Policies of Mercantilism

• A country’s wealth is measured by its holdings of precious metals (specie)

• International trade is a zero sum game• A country should maintain a positive trade

balance (that is, export more than it imports)

9 points by Phillip Wilhelm von Hornick (1864)

• 1 That every inch of a country’s soil be utilized for agriculture, mining, or manufacturing

• 2 That all raw materials found in a country be used for domestic manufacturing, since finished goods have a higher value than raw materials

Von Hornick’s blueprint

• 3 That a large, working population be encouraged

• 4 That all exports of gold and silver be prohibited and all domestic money be kept in circulation

• 5 That all imports of foreign goods be discouraged as much as possible

Von Hornick’s blueprint

• 6 That were certain imports are indispensable they be obtained at first hand, in exchange for other domestic goods instead of gold and silver

• 7 That as much as possible, imports be confined to raw materials that can be finished at home

Von Hornick’s blueprint

• 8 That opportunities be constantly sought for selling a country’s surplus manufactures to foreigners, so far as necessary, for gold and silver

• 9 That no importation be allowed if such goods are sufficiently and suitably supplied at home

Main Policies of Mercantilism

• A country’s wealth is measured by its holdings of precious metals (specie)

• International trade is a zero sum game• A country should maintain a positive trade

balance (that is, export more than it imports)

Colonies

• Are important because:– provide raw materials– are forbidden from

purchasing manufactured goods unless they come from the “mother” country

– can provide workers

The Seas

• NEED to be protected since they are the lifeline to commerce– In England: Sir Walter

Raleigh– In Spain the Pirate

Raleigh

The Paradox of Mercantilism

To be “rich” a country needed to have a lot of poor people!

Hume’s Challenge: the Price-Specie Flow Mechanism

• Hume (mid-18th century): maintaining a trade surplus forever is impossible

• Trade surplus inflow of specie • inflow of specie increased Ms • increased Ms higher wages • higher wages lower exports and higher

imports

Smith’s Challenge: The Principle of Absolute Advantage

• Smith believed trade to be a positive-sum game

• Countries should export those goods which they can produce efficiently, and import those which they cannot

• If countries trade according to this principle, all will gain from trade (trade will be mutually beneficial)

Absolute Advantage: An Example

Corn Blankets

U.S. 1 hour/bu 6 hrs/bl

Mexico 3 hrs/bu 5 hrs/bl

Autarky PriceRatios (APRs)

1B = 6C,1C = 1/6B

1B = 5/3C,1C = 3/5B

Limits to Smith’s Thinking

• If one country has an absolute advantage in the production of both (or all) goods, Smith would say that that country cannot gain from trade.

Absolute Advantage: The Limits to Smith’s Thinking

Corn Blankets

U.S. 1 hour/bu 5 hrs/bl

Mexico 3 hrs/bu 6 hrs/bl

Autarky PriceRatios (APRs)

1B = 5C,1C = 1/5B

1B = 2C,1C = 1/2B

Limits to Smith’s Thinking

• If one country has an absolute advantage in the production of both (or all) goods, Smith would say that that country cannot gain from trade.

• But David Ricardo’s Principle of Comparative Advantage (1817) took Smith’s work farther: even in the above example, trade can be mutually beneficial!