The Rise of Mercantilism as a New Economic System

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Moving into the 15th century, as European nation states grew and became stronger, their bureaucracy and armies expanded. The monarchies had to look for new ways to collect revenues to finance the growing expenditures. Against the background of flourishing international trade, this need for new revenue sources led to emergence of a new economic system, known as mercantilism (重商主义), based on the beliefs that (a) the amount of wealth in the world was relatively static; (b) a country’s wealth could best be judged by the amount of precious metals (gold) it possessed; (c) a country should be self-sufficient (i.e. autarkic自给自足) in producing manufactured goods and should encourage exports over imports in order to obtain a favourable balance of foreign trade that would in turn yield such metals; and (d) the crown or the state should exercise a dominant role in assisting and directing the national and international economies to these ends.[1]

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In other words, mercantilists saw international trade as a zero-sum game in which gain for one country meant loss for another. It was therefore necessary for national governments interventions to determine prices, protect their industries from foreign competition, and avoid the sharing of economic information.

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Moreover, to maximize gains from international trade, many European governments created chartered companies with protected privileges. The British, for example, formed the East India Company in 1600 to trade in the Indian Ocean region, initially with India and the East Indies, and later with Qing China. By the 16th century, a European’s network of monopolies (垄断集团) comprising private companies that lobbied governments for the right to operate exclusive trade routes, or to be the sole importers or exporters of goods had emerged. To justify their position of unfair advantage, the rent-seeking (寻租) merchants presented themselves as public servants to increase the nation’s wealth by maintaining a ‘favourable’ trade balance in order to increase the amount of gold held by the monarchy.

 

From 16th to the 18th centuries, as a result of their monopolistic market power, the merchant elites were able to extract extraordinary profit as economic rent (经济租金) by forcing the masses to accept inflated prices.[2] Even worse, instead of building peaceful bond of ‘union and friendship’ between states, the rent-seeking merchants turned commerce into an instrument of war. They played on nationalistic sentiments and inflamed the domestic populations while also prodding politicians into fighting wars to protect home markets or acquire foreign ones. In the second half of the 17th century, for example, three separate armed conflicts between the English and Dutch ended with the English’s capture of New Amsterdam, a Dutch territory which was renamed New York. Then after the War of Spanish Succession (1701 – 1714), Britain won from France parts of Canada and from Spain its control of the slave trade. This was followed by the Seven Years’ War (1756 -1763) fought in Europe and in North America, from which Britain won the rest of the French holdings in North America.

 

Adam Smith’s Critique of Mercantilism

 

The rent-seeking mercantilist policies served the nation states well by enabling them to maintain very favourable balances of trade which in turn allowed the monarchies accumulate vast amount of gold and silver. By the mid-18th century, however, the oppressive nature of mercantilism was drawing increasing criticism.

 

Small merchants, who were bullied out of business by the large trading companies, wanted their fair share and argued against mercantilism in favour of free trade. A group of theorists, who believed that mercantilism repressed the individual and did not allow for competition, began to suggest major changes in economic policy to supplant the mercantile system. Led by French theorist Francois Quesnay, they proposed the doctrine of laissez-faire (“let it be, leave it alone”) which entailed the abolition of monopolies and special privileges, the replacement of these policies by open competition in an unregulated marketplace, and the substitution of free trade for tariffs. One of the loudest voices in the debate against the rent-seeking mercantilism came from the Scottish professor and philosopher Adam Smith (亚当史密斯1723–1790), the Scottish professor and philosopher typically hailed as the founding father of economics.

 

As aforementioned, Smith's The Wealth of Nations (国富论) published in 1776 is widely regarded as the ground-breaking work that marks the beginning of classical economics (古典经济学), the first modern school of economics. In the book, Smith broached the concept of unearned income and described the rent-seeking mercantilism as oppressive, restrictive, and unfair. He further asserted that the wealth of any nation was determined not by the gold in the monarch's coffers, but by its national income (国民收入) based on the efficient division of labour of its inhabitants and on the effective use of accumulated capital (积累的资本). Moreover, Smith and the other classical economists were strong advocates of free trade. They held that open trading arrangements based on comparative advantage (相对优势) between nations would lead to higher productivity which would in turn allow collective wealth to grow for the benefit of all. They thus called for economic liberalism as opposed to the mercantilist’s protectionism.[3]

 

As for the role of the state, Smith was certainly skeptical of politicians’ ability to do a better job than free market forces in allocating scarce resources. However, he acknowledged that there were areas where the market, when left alone, would not lead to the best of common interests. In those instances, the state had a very important role in supporting and paying for the costs of developing the common good. Beyond that, however, Smith maintained the economy would benefit from individuals being allowed to compete for their own self-interests without the intervention of the government. He thus proposed a laissez faire (自由主义) economic policy approach which would require that the government stayed out of the way to let the economy play out.

 

For his contributions, Smith is usually portrayed as an early champion of the superiority of markets over government planning, a free-market precept famously captured by Smith's metaphor of the invisible hand. The truth, however, is that this single most famous idea of his was originally invoked not to draw attention to the problem of state intervention, but of state capture by the rent-seeking merchant elites, given the context of mercantilism at that time.[4]

 

In other words, when Smith argued that markets were self-correcting and worked remarkably efficiently in allocating resources free from interventions, it was more an appeal to free individuals from the monopolies that the merchants had established, and were using state power to uphold. Smith’s original intention was therefore to advocate for restrictions on the rent-seeking merchants so that the free-market mechanism could be liberated to do the job of efficiently allocating scarce resources.

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REFERENCES

 

[1] See Encyclopedia.com. “Mercantilism”. Extracted 11 June, 2019.

[2] See Nicki Lisa Cole. (2018). “The Three Historic Phases of Capitalism and How They Differ.” ThoughtCo. 8 January, 2018.

[3] See Paul Sagar. (2018). “The Real Adam Smith.” Aeon. 16 January, 2018.

[4] See Paul Sagar. (2018). “The Real Adam Smith.” Aeon. 16 January, 2018.