October, 2018

The Mercantilists’ View on Trade

1. Economics as an organized science can be said to have
originated with the publication in 1776 of the Wealth of
Nations by Adam Smith.

2. However, writings on international trade preceded this date

in such countries as England, Spain, France, Portugal,
and the Netherlands as they developed into modern
national states.

3. Specifically, during the seventeenth and eighteenth

centuries, a group of men (merchants, bankers, government
officials and even philosophers) wrote essays and
pamphlets on international trade that advocated an
economic philosophy known as Mercantilism.

4. Briefly, the Mercantilists maintained that the way for a

nation to become rich and powerful was to export more
that it imported. That is, a favorable balance of trade or
a positive trade balances. The resulting export surplus
would then be settled by an inflow of bullion, or precious
metals, primarily gold and silver.

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 5. Thus, the government had to do all in its power to stimulate
the nation’s exports and discourage and restrict imports
(particularly, the import of luxury consumer goods).

6. However, since all nations could not simultaneously have

an export surplus and the amount of gold and silver was
fixed at any particular point in time, one nation would gain
only at the expense of other nations, that is, trade was a
zero-sum game. In other words, one country’s economic
gain was at the expense of another.

7. The Mercantilists thus preached economic nationalism.

Strong army, strong navy, and merchant marine, and
productive economy were critical to maintain and
increasing the power of a nation state.

8. Note that the Mercantilists measured the wealth of a

nation by the stock of precious metals it possessed. In
other words, wealth was used as synonymous with the
accumulation of precious metals or specie. In contrast,
today we measure wealth of a nation by its stock of human,
man – made, and natural resources available for producing
goods and services.

9. The Mercantilists were writing primarily for the rulers and

to enhance national power. With more gold, rulers could
maintain larger and better armies and consolidate their
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 power at home; improved armies and navies also made it
possible for them to acquire more colonies.

10. Thomas Munn (1571 – 1641) was perhaps the most

influential of the Mercantilist writers.

11. Mercantilism cannot be classified as a formal school

of thought, but rather as a collection of similar attitudes
toward domestic economic activity and the role of
international trade. Indeed, Mercantilism is often referred
to as the political economy of state building.

12. The Mercantilist, as did the classical writers,

employed a labor theory of value. That is, commodities
were valued relatively in terms of their relative labor
content.

The Challenges to Mercantilism by Early Classical

Writers
By the late eighteenth century, ideas concerning
international trade began to change when early Classical
writers such as David Hume and Adam Smith challenged
the basic tenets of Mercantilism.

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 i) David Hume – The Price – specie – Flow
Mechanism:

One of the first attacks on Mercantilist thought was

raised by David Hume (Scottish Philosopher), in his
Political Discourses, 1752, with his development of the
price-specie-flow mechanism. He argued that the
accumulation of gold by means of trade surplus would
lead to an increase in the money supply and therefore
to an increase in prices and wages. The increases
would reduce the competitiveness of the country with a
surplus. At the same time, the loss of gold in the deficit
country would reduce its money supply, prices and
wages, and increase its competitiveness. Thus, it is not
possible for a nation to continue to maintain a positive
balance of trade indefinitely. The formal link between
money and prices is provided by the Quantity Theory
of Money.
This is represented by: Ms V = P Y
Where, Ms = the supply of money
V = the velocity of money or the rate at which money
changes hands
P = the price level
Y = the level of real output

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 We assume that the velocity of money is fixed by
tradition and institutional arrangements, and that Y is
fixed at the level of full employment. Thus, any change
in the supply of money is accompanied by a proportional
change in the level of prices.

ii) Adam Smith and the invisible Hand

A second assault on Mercantilist ideas came in the
writing of Adam smith. Smith perceived that a
nation’s wealth was reflected in its productive
capacity, that is, in its ability to produce final goods
and services, and not in its holding of precious
metals. Smith believed that growth in productive
capacity was fostered best in an environment where
people were free to pursue their own interests. Self –
interest would lead individuals to specialize in and
exchange goods and services based on their own
special abilities. Productivities would be gained
through increased division and specialization of labor.
According to Smith, self – interest was a catalyst and
competition was the automatic regulation mechanism.
Smith saw little need for government control of the
economy. He stressed that a government policy of
laissez faire (allowing individuals to pursue their
activities within the bounds of law and order and
respect for property rights) would best provide the

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 environment for increasing a nation’s wealth. The
proper role of the government was to see that the
market was free to function in an unconstrained
manner by removing the barriers to effective operation
of the “invisible hand” of the market.
iii) The Third Challenge was Mercantilist’s static
view that trade is a zero-sum game. Rather,
trade should be viewed in a dynamic sense as a
positive – sum game.

Contributions of the Mercantilists

i) The concept of trade balance originated with the
Mercantilists
ii) Still, in today’s world, there are governments
whose policies are to promote exports and restrict
imports
iii) The mercantilists laid the foundation for latter
writers such as Adam smith and David Ricardo,
because these writers reacted to the Mercantilists’
views.

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