The Story of Mercantilism

Mercantilism gained tract in the late 16th century. We follow the story of how it came to be and its fall from grace as the main economic policy of that age. We end by asking whether mercantilism still exists in this modern world.

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Photo by Dmitry Demidko on Unsplash

Mercantilism in Europe began in late 16th to early 17th century with the Dutch puzzle: how is it that a newborn nation with little to no natural resource managed to become one of the richest and most powerful state in Europe in a span of just a couple of decade? The United Provinces of the Netherlands or most commonly known as the Dutch Republic (an area we know today as the Netherlands and some parts of Belgium) was the first independent Dutch Nation state. It gained independence from the Kingdom of Spain which was ruled by the Hapsburgs. The signing of the Union of Utrecht in 1579 marked the beginning of the Dutch Nation state. In a couple of decades, that new independent Republic had transformed into the richest and most powerful nation in Europe. While the rest of Europe was having trouble financially (mainly caused by the excessive lives of its royals), the Dutch had no trouble amassing great armies and mobilizing its armada of ships quickly.

The rest of Europe (especially Britain, France, and Germany) quickly began to wonder how the Dutch managed to achieve that feat. Thinkers and statesmen began to throw out ideas as to how the Dutch’s achievement came to be. They found that the Dutch generally had positive trade balances with all its trading partners. The general conclusion was that the Dutch’s massive increase in wealth is a consequence of its positive trade balance. They managed to maximize the export of high value goods while only importing raw materials with low value. The net export position, at the end of the day, brought gold and silver to the Dutch Republic. The backing and settlement of foreign currencies between banks at the time is in gold and silver. To an extreme view, the Dutch had stolen gold an silver from its trading partners through trade.

Finding out how the Dutch managed to achieve the miraculous feat, other countries in Europe wanted to emulate or even compete. These nations started to implement policies that would encourage the country’s own positive balance of trade. The British, for example, enacted the Navigations Act. This Act bans British colonies from trading with other nations except through Britain and/or British ports. Also, imports from British colony to Britain was tightened, and exports to British colony from Britain is promoted. These protectionism policies are even supported by the might of the state military.

Bullionism

At an early stage of mercantilism, bullionism took hold. After finding out that the Dutch had amassed great wealth from its favorable trading positions, early commentators concluded that the wealth of a nation is indicated by the amount of gold and silver a nation has in its holdings. Because a favorable trading position (net export) causes the inflow of gold and silver, the notion of wealth coming from holdings of precious metals seems to hold. Bullionists believe that wealth is defined by the amount of gold and silver owned, as money in those days are gold and silver.

Bullionists pushed for policies that restrict the flow of gold and silver. At the extreme, bullionists wanted the bureaucrats to ensure (by every means possible, right or wrong) the restriction of money from leaving the country and encourage money to enter the country. A literal ban on taking money out of the country should be placed. Bullionsists believe that increasing the supply of money in the country would result in rising prices (inflation). This is desirable as rising prices was thought to increase profits and lower interest rates (easy credit). Modern economic theory, however, proved the fallacy of that notion.

Traditional Mercantilism

Bullionist’s theory and proposed policy was heavily criticized by others. Opponents to bullionism believe that a literal ban on flows of money would hinder trade and economic activities. The majority of the opponents of bullionism and the ban on the export of gold and silver comes from those involved in the charter companies and British East India Company. A charter company is a company that is given exclusive rights by the crown to trade, explore, and/or colonize. Overseas trade by these charter companies would rely on the bullions to be taken and exchanged abroad.

To these men, gold and silver were a means of exchange. Like the Bullionists, these men do believe that inflows of precious metals are good for the nation’s economy. However, restricting money itself from exchanging hands (and exported abroad) is not the way. They propose that, as money is a medium of trade, the one that should be regulated is trade itself. Policies should be implemented to encourage trade that is beneficial for the country: exports. Naturally, when exports are larger than imports, money will flow inward.

The Downfall of Mercantilism

The downfall of mercantilism was brought by the economic thinking of the late 18th century men. Works by David Hume and Adam Smith heavily criticized mercantilism and its policies. Contrary to Mercantilists, the wealth of a nation, according to these men, is ought to be measured by the amount of commodities (goods) produced by the nation and not by the amount of money (stock of gold and silver) it holds. Money only functions as the lubricant of the economy and is supposed to be neutral in a transaction.

The most significant blow to mercantilism is the criticism on international trade. International trade is not a zero-sum game, which was in accordance with mercantilists thinking, where one party wins and the other loses. Contrary to that, international trade would be beneficial to the parties involved. Also, positive balance of trade is impossible to maintain in the long run. Inflow of money would inflate prices domestically making goods in the country relatively more expensive than its international counterpart. This would swing back the balance of trade in favor of the trade partner.

These works and economic thinking would then influence the policy making of later governments (even through to modern age). Export subsidies, import tariffs, and monopolies would then be uprooted to encourage the natural flow of international trade.

Modern Day Mercantilism?

Mercantilism in the 16th to 18th century is basically a nationalist idea of an economy. To encourage the inflow of money, a country has to run trade surpluses. Trade surplus can only be achieved if a nation can produce and sell in bigger quantity and/or higher value than that it consumes. The answer to that is to grow the domestic industry and be self-sufficient. To be self-sufficient and grow the domestic industry, one can impose tariffs on foreign goods and provide subsidies to domestic goods sold abroad. Protectionism policy is abundant, and the state is expected to enforce it even with military might.

That same nationalist view of economy — being elf-sufficient — is a main theme in politics and economic debates these days. Right wing politicians, with the promise of bringing prosperity to its own citizens, are grabbing offices left and right. India, Brazil, Turkey, and even the US, to name a significant few. The latter, though, is having trouble getting rid of its own right-wing leader even after having lost the election fair and square.

Nowadays, tariffs on import still persist, the reason being to protect domestic industry from ‘unfair prices’ (sounds familiar?). Subsidies on exported goods also exists though not as ‘headline grabbing’ as tariffs on imported goods. Other ways of making domestic goods cheaper abroad is to undervalue the country’s own currency. Something that is known to be practiced by China.

It is fair to say that modern-day mercantilism is most identifiable to nationalist’s view of economic policy.

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I write for fun! I write about my field of work (tax, accounting, and economics) and hobby (programming, javascript, react). Sometimes in Indo, usually in Eng

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