Mercantilism and Early Classical Thought

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Mercantilism and Early Classical Thought

• c. 1500 - c. 1790

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Mercantilism

• The Term Mercantilism was coined by Adam Smith
• It was a system prevalent in
• France
• Spain
• England
• Holland

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Main Policies of Mercantilism

• A countrys 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)

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9 points by Phillip Wilhelm von Hornick (1864)

• 1 That every inch of a countrys 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

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Von Hornicks 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

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Von Hornicks Blueprint

• 6 If certain imports are indispensable they
  should be obtained 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

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Von Hornicks Blueprint

• 8 That opportunities be constantly sought for
  selling a countrys 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

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Colonies

• Are important because they
• provide raw materials
• are forbidden from purchasing manufactured goods
  unless they come from the mother country
• can provide workers

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The Seas

• NEED to be protected since they are the lifeline
  to commerce
• In England Sir Walter Raleigh
• In Spain the Pirate Raleigh

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The Paradox of Mercantilism

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

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Humes 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

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Smiths 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)

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Absolute Advantage An Example
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Absolute Advantage An Example
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Absolute Advantage An Example

• Suppose the U.S. and Mexico agree to trade at a
  ratio of 1B 4C (or 1C ¼ B)
• Suppose further that Mexico will specialize in
  blankets and the U.S. in corn.
• From the U.S.s perspective
• Can now buy blankets at a lower price (1B 6C in
  autarky, but 1B 4C in trade)
• Can sell corn at a higher price (1C 1/6 B in
  autarky, but 1C ¼ B in trade)

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Absolute Advantage An Example

• Suppose the U.S. and Mexico agree to trade at a
  ratio of 1B 4C (or 1C ¼ B)
• Suppose further that Mexico will specialize in
  blankets and the U.S. in corn.
• From Mexicos perspective
• Can now sell blankets at a higher price (1B
  5/3C in autarky, but 1B 4C in trade)
• Can buy corn at a lower price (1C 3/5 B in
  autarky, but 1C ¼ B in trade)

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Absolute Advantage An Example

• Bottom line both countries gain from trade, even
  if certain industries (blanket industry in U.S.,
  corn industry in Mexico) stand to lose.

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Limits to Smiths 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.

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Absolute Advantage The Limits to Smiths Thinking
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Limits to Smiths 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 Ricardos Principle of Comparative
  Advantage (1817) took Smiths work farther even
  in the above example, trade can be mutually
  beneficial!