What is Mercantilism

Mercantilism was the main economic system of trade utilized from the 16th to 18th century. Mercantilist theorists believed that the amount of wealth in the world was static. Thus, European nations took several strides to ensure their nations accumulated as much of this wealth as possible. The goal was to increase a nation's wealth by imposing government regulation that oversaw all of the nation's commercial interests. It was believed national strength could be maximized by limiting imports via tariffs and maximizing exports.



BREAKING DOWN Mercantilism

Mercantilism was popularized in Europe during the 1500s. The system was based on the understanding that a nation's wealth and power were best served by increasing exports and collecting precious metals, such as gold and silver. Mercantilism replaced the older, feudal economic system in Western Europe, leading to one of the first occurrences of political oversight and control over an economy. At the time, England, the center of the British Empire, was small and contained relatively few natural resources. Thus, to grow its wealth, England introduced fiscal policies, including the Sugar Act and Navigation Acts, to move colonists away from foreign products and create another incentive for buying British goods.The resulting favorable balance of trade was thought to increase national wealth. 

The Sugar Act of 1764 introduced high customs for sugar and molasses imported from outside of England and the British colonies. Similarly, the Navigation Act of 1651 was implemented to ensure foreign vessels would not be able to engage in trade along its coast, and also required colonial exports to first pass through British control before being redistributed throughout Europe. Great Britain was not alone in this line of thinking. The French, Spanish and Portuguese competed with the British for wealth and colonies; it was thought no great nation could exist and be self-sufficient without colonial resources.

The Underlying Principles of Mercantilism

Mercantilism is based on the idea that strong nation-states had the opportunity to create a world economy by using a state's military power to ensure local markets and supply sources were protected. Advocates of mercantilism believed the prosperity of a nation was reliant on its supply of capital, and global volume of trade was static. The result was a system of economics that required a positive balance of trade, with surplus exports. However, since it is impossible for every country or nation-state to have a surplus of exports, with many needing increased imports to fuel growth, the basis of mercantilism ensured it was doomed for eventual failure.

One notion behind mercantilism is the economic health of a nation could be assessed by the amount of precious metal, gold or silver it owned. The system advocated for each nation to strive to be economically self-sufficient, which meant the nation would have to increase domestic production and build new homes and industries.

Advocates of mercantilism also saw that agriculture was important and should be promoted so a nation could reduce the need to import foods. They suggested a strong nation-state needed colonies and a merchant fleet, both of which could provide additional markets for goods and raw materials. Mercantilists also believed a large population was integral to the domestic labor force of a nation.

How Were the British Colonies Affected by Mercantilism?

  • Controlled production and trade: Mercantilism led to the adoption of enormous trade restrictions, though, which stunted the growth and freedom of colonial business.
  • The expansion of the slave trade: Trade became triangulated between the British Empire, its colonies and foreign markets. This fostered the development of the slave trade in many colonies, including America. The colonies provided rum, cotton and other products heavily demanded by imperialists in Africa. In turn, slaves were returned to America or the West Indies and traded for sugar and molasses.
  • Inflation and taxation: The British government demanded trades were conducted using gold and silver bullion, ever seeking a positive balance of trade. The colonies often had insufficient bullion left over to circulate in their markets, so they took to issuing paper currency instead. Mismanagement of printed currency resulted in periods of inflation. Additionally, Great Britain was in a near-constant state of war. Taxation was needed to prop up the army and navy. The combination of taxes and inflation caused great colonial discontent.

    What Is the Difference Between Mercantilism and Imperialism?

    Whereas mercantilism is an economic system in which a country's government manipulates the economy to create a favorable trade balance, imperialism is both a political and economic system in which one country asserts its power over another, typically to meet the objectives of mercantilism. Through the use of force or mass immigration or both, imperialistic nations establish control over potentially less-developed regions and force inhabitants to follow the dominant country's laws. Because mercantilism was prevalent in Europe during the imperialistic era of the 16th to 18th centuries, it is often seen as the economic system that drives imperialism.

    One of the most powerful examples of the relationship between mercantilism and imperialism is Britain's establishment of the American colonies. 

    How Did Corporations Act Under Mercantilism?

    By the beginning of the 16th century, European financial theorists had begun to understand the importance of the merchant class in generating wealth. Cities and countries with goods to sell thrived in the late middle ages. It was argued that the state should franchise out the leading merchants in promising industries to create exclusive monopolies and cartels. These monopolistic corporations were to be controlled by the government and act as an arm of government interests. In return, the government would use regulations, subsidies and, if needed, military force to protect the corporation from domestic and foreign competition.

    Citizens could invest money in mercantilist corporations in exchange for ownership and limited liability in their royal charters. They were granted "shares" of the company profit—the first traded corporate stocks. The most famous and powerful mercantilist corporations were the British and Dutch East India companies. The British East India Company had the exclusive, royally granted right to conduct trade between Britain, India and China for more than 250 years. Its trade routes were protected by the Royal Navy and its high-ranking members became very influential in determining British foreign policy.

    Jean-Baptiste Colbert: The Champion of Mercantilism 

    Arguably one of the most influential proponents of mercantilism was French Controller General of Finance Jean-Baptiste Colbert (1619-1683). Colbert had studied the previous theorists of a foreign-trade-driven economy and was in a unique position of authority to execute their ideas. He was also a devout monarchist and wanted an economic strategy to protect the French crown from a rising Dutch mercantile class.

    Colbert increased the size of the French navy on the premise that his country would have to take control of trade routes to increase its wealth. Even though his practices were ultimately unsuccessful, his ideas became hugely popular until the theory of free market economics was popularized. 

    How Did Mercantilism Contribute to the American Revolution?

    When Britain introduced the Sugar Act and Navigation Acts to force colonists away from foreign products, the plan backfired by angering the colonies and promoting dissatisfaction with British rule. The imposition of heavy taxes and restrictions frustrated American colonists and eventually contributed to the American Revolution.

    Defenders of mercantilism argued that the economic system creates stronger economies by bringing colonies and founding countries together. Colonies, creating their own products and obtaining others in trade from the founder, are independent of influence from hostile nations that may manipulate the colonies using trade restrictions. Mercantilist countries use state authority to increase state wealth. As taxes and restrictions are placed on trade, a beneficial balance of trade is sought that promotes wealth from shipping products and acquiring gold. Colonies would benefit founding countries by supplying the large amounts of raw material necessary for a productive manufacturing sector. Founding nations would export the products of their manufacturing to the colonies. This system made the colony and founding nation more independent and served to enrich the state.

    Critics of the economic philosophy noted the increased expense created by the restriction on international trade. Foreign imports were more expensive because all imports had to be shipped by British ships from Great Britain regardless of product origin. Exports from the colonies had to be shipped by the British through Great Britain, forcing the costs of American products higher. These disadvantages were, in the eyes of the colonists, outweighed by the benefits of affiliation with Great Britain. The decision to raise tax rates on the colonies changed how many colonists viewed the Empire. At this point, the benefits of independence became more attractive.

    An expensive war with France left the British Empire eager for revenue and interested in raising taxes. Colonists paid a lower tax rate than citizens in Great Britain, so raising colonial taxes made sense to the British Parliament. The increases caused growing frustration among colonists and led to open rebellion. A boycott of British products began that dropped imports by a full one-third. The Boston Tea Party added to the fierce resistance aimed at British policies. The lack of representation available to colonists led many to become hostile. The British government had an unrestrained right to impose new taxes on the colonists without providing the colonies with any say or recourse against unwanted policies. In order to protect the mercantilist system, Great Britain pushed harder against the colonies, and the Revolutionary War eventually resulted from the mounting disagreements between the British Empire and American colonies.

    How Did Mercantilism Impede Global Economic Growth?

    Mercantilism impeded global economic growth by leading producers to specialize in goods and services that do not take account of comparative advantage. From an economic perspective, mercantilism promotes the overproduction of goods that carry a high opportunity cost. For example, if trade restrictions prevent a country with a highly skilled labor force from importing clothing, businesses might divert resources to its production. That clothing is relatively expensive to produce because of the high wages that a skilled labor force demands. The returns to the high-cost apparel will be lower than the returns from a more appropriate set of activities. Economic growth is dampened for the country with the trade restrictions, and another country with a low-skilled labor force loses an important potential market for its products, leading to lower growth there as well.

    What Are the Advantages of Free Trade Over Mercantilism?

    Free trade provides several advantages over mercantilism for individuals, businesses and nations.

    In a free trade system, individuals benefit from a greater choice of goods for purchase at affordable prices. Mercantilism restricts imports, which reduces the choices available to consumers in the marketplace. Fewer imports mean less competition, and therefore, higher prices.

    Further, under a system of free trade, nations are more prosperous because they are not engaged in a zero-sum game. During the years when mercantilism was the primary economic system, countries were engaged in almost constant warfare. Mercantilism encouraged nations to fight over scarce resources rather than find ways to engage in mutually beneficial trade relations.

    Economist Adam Smith, who is widely considered the father of modern economics, argued in his seminal book "The Wealth of Nations" that free trade enables businesses to specialize in the production of the goods that they manufacture most efficiently. Specialized production leads to economies of scale which, in turn, lead to higher productivity and economic growth. In a free trade system, businesses have incentives to be innovative. By creating more useful products, better production and distribution systems, and more efficient operations, businesses can grow and prosper.

    Today, mercantilism is considered an outdated philosophy. However, barriers to trade still exist to protect locally entrenched industries. For example, the United States adopted a protectionist trade policy toward Japan in the post-war period and negotiated voluntary export restrictions with the Japanese government, which limited the quantity of Japanese exports to the United States.