Mercantilism and Early Classical Thought c 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) 1That every inch of a country’s soil be utilized for agriculture, mining, or manufacturing 2That 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 3That a large, working population be encouraged 4That all exports of gold and silver be prohibited and all domestic money be kept in circulation 5That all imports of foreign goods be discouraged as much as possible

Von Hornick’s blueprint 6That were certain imports are indispensable they be obtained at first hand, in exchange for other domestic goods instead of gold and silver 7That as much as possible, imports be confined to raw materials that can be finished at home

Von Hornick’s blueprint 8That opportunities be constantly sought for selling a country’s surplus manufactures to foreigners, so far as necessary, for gold and silver 9That 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-18 th century): maintaining a trade surplus forever is impossible Trade surplus  inflow of specie inflow of specie  increased M s increased M s  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

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

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!