- Economic Theory
ByKimberly Amadeo
Updated on September 9, 2022
Reviewed by
Robert C. Kelly
:max_bytes(150000):strip_icc()/ScreenShot2020-03-23at2.04.43PM-59de96b153e540c498f1f1da8ce5c965.png "What Is Mercantilism? (1)")
Reviewed byRobert C. Kelly
Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital.
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In This Article
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In This Article
- How Mercantilism Worked
- Mercantilism Today: Neomercantilism
- Frequently Asked Questions (FAQs)
Mercantilism is an economic theory that advocates government regulation of internationaltradeto generate wealth and strengthen national power. Merchants and the government work together to reduce the trade deficitand create a trade surplus.
How Mercantilism Worked
Mercantilism—a form ofeconomic nationalism—funds corporate, military, and national growth. It advocatestrade policies that protect domestic industries.
In mercantilism, the government strengthens the private owners of thefactors of production. These four factors of production are:
- Entrepreneurship
- Capital goods
- Natural resources
- Labor
Mercantilism establishes monopolies, grants tax-free status, and grants pensions to favored industries. It imposes tariffs on imports. It also prohibits the emigration of skilled labor, capital, and tools. It doesn't allow anything that could help foreign companies.
Note
In return for the protection provided by national government, businesses funnel the riches from foreign expansion back to their governments via taxes. Those taxes taxes pay for increasing national growth and international political power.
Example of Mercantilism
Mercantilism was the dominant economic system in Europe between 1500 and 1800. Countries all wanted to export more than they imported. In return, they received gold. It powered the evolution of nation-states out of feudalism. Holland, France, Spain, and England competed on the economic and military fronts. These countries created skilled labor forces and armed forces to defend them.
Merchants supported national governments to help them beat foreign competitors. An example was The British East India Company which defeated the princes of India with 260,000 mercenaries. It then plundered their riches as the British government protected the company's interests. Many members of Parliament owned stock in the company. As a result, the company's victories lined lawmakers' pockets.
Mercantilism depended upon colonialism, as the government would use military power to subdue foreign lands. Businesses then exploited natural and human resources found there. The profits fueled further expansion, benefiting both the merchants and the nation.
Mercantilism also worked hand-in-hand with theinternational gold standard. Countries paid each other in gold for exports. The nations with the most gold were therefore the richest. They could hire mercenaries and explorers to expand their empires. As a result, nations sought trade surpluses with which to amass gold, rather than a deficit.
Note
Success within mercantilism depended on reliable shipping and transportation. Control of the world's waterways was vital to national interests.
Successful mercantilist nations developed strong merchant marines and imposed high port taxes and regulations on foreign ships arriving with goods to sell. England, for example, required all imports from Europe to come in its own vessels, or in a vessel registered in the country where the goods originated.
Mercantilism vs Capitalism
| Mercantilism | Capitalism |
|---|---|
| Focused on building a nation's strength | Focused on earning profits |
| Government-controlled trade | Free trade |
| Aims to increase net exports to create wealth, often through colonization | Aims to increase productivity to create wealth |
Democracy and free trade ended mercantilism's dominance in the late 1700s.American and French revolutions formalized large nations ruledby democracy. They endorsed capitalism rather than mercantilism.
Adam Smith argued against mercantilism with his 1776 publication of The Wealth of Nations. He argued that foreign trade strengthens the economies of both countries involved, as long as each trading partner specializes in what it produces best, giving it a comparative advantage. He also explained that a government that put business ahead of its people would not last. Smith's economic theories coincided with the rise of democracy in North America and Europe.
In 1791, mercantilism was breaking down, but free trade hadn't yet developed. Most countries still regulated trade to enhance domestic growth. Then-U.S. Treasury Secretary Alexander Hamilton was a proponent of mercantilism. He advocated government subsidies to protect infant industries necessary to the national interest. The industries needed government support until they were strong enough to compete with established foreign industries and producers. Hamilton also proposed tariffs to reduce competition in those areas.
Fascism and totalitarianism adopted mercantilism in the 1930s and 1940s. After the stock market crash of 1929, many nations turned toward trade protectionism to save industry and jobs.They responded to theGreat Depressionwith tariffs and trade restrictions.
Note
In the U.S., the 1930Smoot-Hawley Actraised tariffs on more than 20,000 items. When other countries retaliated, global trade fell 66% by 1933, prolonging thedepression.
Mercantilism Today: Neomercantilism
World War II's devastation forced Allied nations into desiring global cooperation. They created theWorld Bank, theUnited Nations, and theWorld Trade Organization. They saw mercantilism as dangerous and globalization as the alternative.
But not all nations agree that trade liberalization is in their interests.
Both Russia and Chinacontinue to promotea form of mercantilism. In fact, neomercantilism fit with those nations' formerly communist governments. They relied on centrally planned command economies that allowed them to regulate foreign trade. They also controlled their balance of payments and foreign reserves. Their leaders selected which industries to promote. They engaged in currency wars to give their exports lower pricing power. For example, China bought U.S. Treasurys to fuel its trade with the U.S. As a result, China became one of the largest foreign owners of U.S. debt.
Significance of Mercantilism Today
Mercantilism laid the foundation for today's nationalist and protectionist economic policies. Nations felt they lost power as a result of globalism and the interdependence fostered by free trade.
Note
The Great Recession, like the Great Depression, aggravated a tendency toward mercantilism in capitalist countries. For example, in 2014,Indiaelected Hindu nationalist Narendra Modi. In 2016, the United States choseDonald Trumpfor the presidency. Some observers considered Trump's policies a form of neomercantilism.
In response, leaders like U.S. President Donald Trump advocated expansionaryfiscal policies, such astax cuts,to help businesses. He also argued forbilateral trade agreementsbetween two countries, rather thanmultilateral agreementsbetween many countries.Mercantilism opposesimmigrationbecause it takes jobs away from domestic workers.Trump's immigration policiesfollowed this mindset.
In 2018, Trump's mercantilist mindset contributed to his launch of a trade war against China. Trump imposed tariffson Chineseimports, and China responded with its own policies that hurt U.S. exports. Despite announcing a "Phase 1" deal to end the trade war in 2020, President Trump left office without ending the trade war. In fact, with roughly a week left as president, the Trump administration imposed a new round of trade restrictions covering tomato and cotton products from China, citing concerns over slave labor in China.
Key Takeaways
- With mercantilism as their economic system, nations focus on building their strength and dominance through regulating trade and increasing net exports.
- Mercantilism uses taxation, tariffs, and other regulations to limit the outward flow of anything that would help other countries.
- The foremost economic system of Europe from about 1500 to 1800, mercantilism relied heavily on colonization to maximize exports.
- Capitalism and globalization rose during the 20th century, mostly replacing mercantilism (except in the case of fascist countries with protectionist agendas).
- Some countries, such as Russia and China, still lean toward a neo-mercantilist approach in place of trade liberalization.
Frequently Asked Questions (FAQs)
What is mercantilism?
Mercantilism is an economic system that seeks to promote the development of national business and industry over foreign business and industry. Mercantilists promote policies that seek to create trade surpluses for their own nations and use the resulting wealth to further promote national economic goals and national businesses.
How did mercantilism work?
Mercantilism was a cooperative relationship between a nation's business and trading classes and its government. Domestically, mercantilist governments support local industries with investment, favorable taxes, and other benefits while protecting it from foreign competition with tariffs and other trade restrictions. Internationally, mercantilist governments support local business expansion with strong armed forces and large navies and merchant shipping to protect access to raw materials and markets.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
The Library of Economics and Liberty. "Mercantilism."
Jeffrey Freiden. "The Modern Capitalist World Economy: A Historical Overview," Download PDF: Page 19. Oxford Handbook of Capitalism.
New Statesman. "East India Company: The Original Corporate Raiders."
Wilson Center. "Chapter 3: Trade Agreements and Economic Theory."
Mises Institute. "Economic Nationalism: From Mercantilism to World War II."
The Herbert Hoover Library and Museum. "The Smoot-Hawley Tariff of 1930."
World Trade Organization. "Trade in War’s Darkest Hour."
Margherita Zanasi. "Saving the Nation: Economic Modernity in Republican China," Page 237. University of Chicago Press, 2010.
U.S. Treasury Department. "Major Foreign Holders of Treasury Securities."
Carnegie Endowment for International Peace. "Trump’s National Security Strategy: A New Brand of Mercantilism?"
Brookings Institution. "What Will Trump's Embrace of Bilateralism Mean for America's Trade Partners?"
Cato Institute. "The U.S.-China Trade War: Is There an End in Sight?"
Peterson Institute for International Economics. "US-China Phase One Tracker: China's Purchases of US Goods."
Customs and Border Protection. "CBP Issues Region-Wide Withhold Release Order on Products Made by Slave Labor in Xinjiang."
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