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Theory of Mercantilism


The theory of mercantilism is the first theory of international business which

emerged in England in the mid-sixteenth century. The main proposition of

this theory is that gold and silvers are the backbone of the economy and

are essential for business. During the 16th century, gold and silvers are

used as the currency and the trade between countries was carried as the

transaction of goods and services in return for gold and silver. The

countries used to earn gold and silver by exporting goods. In the same

way, import of goods results in an outflow of gold and silvers. Earning of

gold and silvers was the main motive of countries during that century. The

main theme of this theory is that the country should maintain its trade

surplus by increasing the export as compared to import. In other words, the

best interest of the country would be accumulating more wealth i.e. gold

and silvers.

Based on aforementioned beliefs, the mercantilism advocates that

intervention of national government in order to achieve trade surplus. To

achieve trade surplus, the government should discourage imports by

levying tariffs and subsidizing export.

The main source of mercantilism was colonizing the resource-rich less

developed countries. The developed countries used to colonize the less

developed countries and take advantage of its resources. Essential raw

materials like tea, coffee, cotton, tobacco, and rubber were shipped into the

mercantilist nation and they were processed to finished goods. These

finished goods were later exported to colonies. The mercantilist nation

earned huge profit by buying raw materials at cheap price and selling the

finished goods at higher price. Thus, the mercantilist nations managed

trade surplus by itself. One of the examples of this practice was

colonization of east India Company in India in the name of trade.

The mercantilism theory is criticized bitterly by the economists. Subsidizing

export and putting restrictions on import hits citizen in both ways. Export

subsidies are passed on to taxpayers. Similarly, import restriction also hit

consumers in the form of higher prices. International trade expert also

criticizes this theory because it is based on zero-sum game. The zero-sum

game is the condition in which the gain by one country results in loss to

another country. However, exporters praise this theory because of the

incentives and subsidies they receive from the government. Similarly, the

domestic manufacturers also are in support of mercantilism as it protects

them from the competition of importers.

Similarly, mercantilist also ignored other sources where the country would

accumulate wealth. Factors like skilled labor force, natural resources, the

quantity of capital, the strength of resources were completely overlooked.

Theories like absolute advantage theory and comparative advantage theory

cover these limitations of mercantilism theory.

Despite being highly criticized, the theory is still practiced in the world in

different ways. Governments in all countries today also intervene in their

international trade by imposing barriers on import and offering incentives to


1. Mercantilism (William Petty, Thomas Mun and Antoine de Montchrtien model)

Mercantilism is a philosophy from about 300 years ago. The base of this theory was the
commercial revolution, the transition from local economies to national economies, from
feudalism to capitalism, from a rudimentary trade to a larger international trade.
Mercantilism was the economic system of the major trading nations during the 16th, 17th,
and 18th century, based on the premise that national wealth and power were best served by
increasing exports and collecting precious metals in return. It superseded the medieval
feudal organization in Western Europe, especially in Holland, France, United Kingdom,
Belgium, Portugal and Spain. The monarch controlled everything. Their policy was to export
in the countries that they controlled and not to import (to have a positive Balance of Trade).
Geographical discoveries not only stimulated the international trade, but also produced an
affluent flow of gold and silver, which could be used to encourage the economy based on
money and prices. The state exercised much control over economic life, chiefly through
corporations and trading companies. Production was carefully regulated with the object of
securing goods of high quality and low cost, thus enabling the nation to hold its place in
foreign markets. The theory states that the world only contained a fixed amount of wealth
and that to increase a country wealth; one country had to take some wealth from another,
either through having a higher import/export ratio. So, this tendency, to export more and
import less and to receive in exchange gold (the deficit is paid in gold) is called
MERCANTILISM. The theory was criticized by the newly appeared class. More money was
associated with less products and inflation. The standard of living is weaker. Mercantilist
ideas did not decline until the coming of the Industrial Revolution and of laissez-faire.
International economics,

What is 'Mercantilism'
Mercantilism was the primary economic system of trade used from
the 16th to 18th century. Mercantilist theorists believed that the amount of wealth in
the world was static. Thus, European nations took several strides to ensure their
nations accumulated as much of this wealth as possible. The goal was to increase a
nation's wealth by imposing government regulation that oversaw all of the nation's
commercial interests. It was believed national strength could be maximized by
limiting imports via tariffs and maximizing exports.

BREAKING DOWN 'Mercantilism'

Mercantilism was popularized in Europe during the 1500s. The system was based on
the understanding that a nation's wealth and power were best served by increasing
exports and collecting precious metals, such as gold and silver. Mercantilism
replaced the older, feudal economic system in Western Europe, leading to one of the
first occurrences of political oversight and control over an economy.At the time,
England, the center of the British Empire, was small and contained relatively few
natural resources. Thus, to grow Englands wealth, England introduced fiscal
policies, including the Sugar Act and Navigation Acts, to move colonists away from
foreign products and create another incentive for buying British goods.The resulting
favorable balance of trade was thought to increase national wealth.

The Sugar Act of 1764 introduced high customs for sugar and molasses imported
from outside of England and the British colonies. Similarly, the Navigations Act of
1651 was implemented to ensure foreign vessels would not be able to engage in
trade along its coast, and also required colonial exports to first pass through British
control before being redistributed throughout Europe.Great Britain was not alone in
this line of thinking. The French, Spanish and Portuguese competed with the British
for wealth and colonies; it was thought, no great nation could exist and be self-
sufficient without colonial resources.
The Underlying Principles of Mercantilism
Mercantilism is based on the idea that strong nation-states had the opportunity to
create a world economy by using a state's military power to ensure local markets and
supply sources were protected. Advocates of mercantilism believed the prosperity of
a nation was reliant on its supply of capital, and global volume of trade was static.
The result was a system of economics that required a positive balance of trade, with
surplus exports. However, since it is impossible for every country or nation-state to
have a surplus of exports, with many needing increased imports to fuel growth, the
basis of mercantilism ensured it was doomed for eventual failure.

One notion behind mercantilism is the economic health of a nation could be

assessed by the amount of precious metal, gold or silver it owned. The system
advocated for each nation to strive to be economically self-sufficient, which meant
the nation would have to increase domestic production and build new homes and

Advocates of mercantilism also saw that agriculture was important and should be
promoted so a nation could reduce the need to import foods. They suggested a
strong nation-state needed colonies and a merchant fleet, both of which could
provide additional markets for goods and raw materials. Mercantilists also believed a
large population was integral to the domestic labor force of a nation.

How Were the British Colonies Affected by Mercantilism?

Controlled production and trade: Mercantilism led to the adoption of enormous trade
restrictions, though, which stunted the growth and freedom of colonial business.
The expansion of the slave trade: Trade became triangulated between the British
Empire, its colonies, and foreign markets. This fostered the development of the slave
trade in many colonies, including America. The colonies provided rum, cotton and
other products heavily demanded by imperialists in Africa. In turn, slaves were
returned to America or the West Indies and traded for sugar and molasses.
Inflation and taxation: The British government demanded trades were conducted
using gold and silver bullion, ever seeking a positive balance of trade. The colonies
often had insufficient bullion left over to circulate in their markets, so they took to
issuing paper currency instead. Mismanagement of printed currency resulted in
periods of inflation. Additionally, Great Britain was in a near-constant state of war.
Taxation was needed to prop up the army and navy. The combination of taxes and
inflation caused great colonial discontent.

What Is the Difference Between Mercantilism and

Whereas mercantilism is an economic system in which a country's government
manipulates the economy to create a favorable trade balance, imperialism is both a
political and economic system, in which a country asserts its power over another,
typically to meet the objectives of mercantilism. Through the use of force or mass
immigration or both, imperialistic nations establish control over potentially less-
developed regions and force inhabitants to follow the dominant country's laws.
Because mercantilism was prevalent in Europe during the imperialistic era of
the 16th to 18th centuries, it is often seen as the economic system that drives

One of the most powerful examples of the relationship between mercantilism and
imperialism is Britain's establishment of the American colonies.

more: Mercantilism
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2.1 MERCANTILISM It was only after the publication of The Wealth of Nations by Adam Smith in
1776, the subject of economics emerged in an organized scientific form. Prior to that 28 during the
17th & 18th centuries in Europe a group of men like merchants, bankers, traders, government
officials and philosophers, wrote essays and pamphlets on international trade that advocated an
economic philosophy known as mercantilism. The term mercantilism first acquired significance at
the hands of Adam Smith. Mercantilism, as the term implies is closely associated with trade and
commercial activities of an economy. Mercantilist theory was highly nationalistic in its outlook and
favoured state regulation and centralization of economic activities including foreign trade. The
mercantilists believed that a nations wealth and prosperity is reflected in its stock of precious
metals (also known as specie), namely, gold and silver. At that time, as gold and silver were the
currency of trade between nations, a country could accumulate gold and silver by exporting more
and importing less. The more gold and silver a nation had, the richer and more powerful it was. They
argued that government should do everything possible to maximize exports and minimize imports.
However, since all nations could not simultaneously have an export surplus and the amount of gold
and silver was limited at any particular point of time, one nation could gain only at the expense of
other nations. In other words, mercantilists believed that trade was a zero sum game (i.e. ones gain
is the loss of another). For mercantilists, the objective of foreign trade was considered to be
achievement of surplus in the balance of payments. Hence, they advocated achieving as high trade
surplus as possible. In this context, Blaug (1978) points out that The core of mercantilism, of
course, is the doctrine that a favourable balance of trade is desirable because it is somehow
productive of national prosperity. When mercantilist authors speak of the surplus in the balance of
trade, they mean an excess of exports, both visible and invisible, over imports, calling either for an
inflow of gold or for granting of credit to foreign countries, that is 29 capital exports. In other words,
they were roughly thinking of what we would now call the current account as distinct from the
capital account in the balance of payments. 1 The mercantilist ideas were strongly criticized in the
18th century by economists like David Hume, Adam Smith and David Ricardo. For instance, Adam
Smith criticized mercantilists on the ground that the mercantilists falsely equated money with
capital, and the favourable balance of trade with the annual balance of income over consumption.
Thus, Blaug (1978) critically points out that - The idea that an export surplus is the index of
economic welfare may be described as the basic fallacy that runs through the whole of the
mercantilist literature. 2 Another flaw of mercantilism is that it they viewed trade as a zero sum
game. This view was challenged by Adam Smith and David Ricardo who demonstrated that trade was
a positive sum game in which all trading nations can gain even if some benefit more than others.
From the above analysis it is seen that the concept of balance of payments or balance of trade was
evolved for the first time in the writings of mercantilists. As pointed out earlier, at that time
economics was not yet developed in an organized form, so the concept of balance of payments /
balance of trade was evolved in a vague form. In spite of various flaws in the ideology, due credit
may be given to the mercantilist writers in the development of the concept of balance of payments /
balance of trade.


This theory was developed in the sixteenth century and is considered to be the oldest
theory of International Trade. According to this theory, a countrys wealth could be
determined by the amount of its gold and silver holdings. This group of theorists believed
that every country should increase its gold and silver holdings by increasing its exports and
reducing imports. During that point of time, gold and silver had the status of currency. The
countries should focus on having a trade surplus i.e. value of exports should be greater than
the value of imports. Trade deficit is to be avoided.

It was Adam Smith who coined the term Mercantile System. Under such a system, the
economies try to enrich the wealth of the nation by restraining imports and encouraging
exports. Adam Smith was also the one who heavily criticized this theory. He argued that free
trade benefits both the parties i.e. the exporter and the importer. He also argued that Mercantile
System proved harmful to the population in general as the consumers received the goods at a
higher price.

This theory flourished during the 17th and the 18th century as imperialism was being promoted
by colonial empires. The countries used raw materials to manufacture goods and sell them,
thereby promoting exports. However, advocates of free trade believe that mercantilism
promoted protectionism. Import restrictions were imposed by countries that ultimately led to
higher prices and severely affected the consumers. The biggest promoters of this theory
were British, Dutch and Spanish Empires.

Even today this theory is being followed to some extent by export economies like Germany,
Japan, and Singapore etc. Some have dubbed the policy of these countries to be a kind of neo-