Mercantilism

Adam Smith, an eighteenth-century Scots professor of moral philosophy who influenced the founding fathers of the United States, was a fierce critic of mercantilism and convincing advocate of free trade. He coined the term "invisible hand" to describe how, without any central direction, in a free market economy the butcher, the baker, and the candlestick maker provide what people need. It is, he said, as though there is an invisible hand guiding them to meet people's needs.

In its day, mercantilism was explained by its proponents, says economic historian Gerald Gunderson, as a "a philosophy of nation building, a series of economic controls intended to strengthen a country and its colonies against other antagonistic empires. A major tenant of this view was self-sufficiency: sources of supply--raw materials, agriculture, and industry--should be developed domestically, or in colonies, to prevent interruptions by hostile foreigners. A large merchant marine was also deemed important. Cargo vessels of that era were designed to repel pirates and thus could be easily adapted to military roles during wars. Finally, the mercantilists were preoccupied with specie (gold and silver), then a universal foundation of money. Short of possessing gold mines, as Spain did, specie could be acquired with a 'favorable' balance of trade, that is, through earning foreign exchange by selling exports that brought in more money than was paid out for imports."

Some economic historians, such as Jonathan Hughes, claim that there is nothing extraordinary about mercantilism, as the "use of subsidies, tax rebates, tariffs, and quotas to attempt to protect and encourage American industries at the expense of the rest of the world is standard modern practice. If every member of Congress and every president had the economic background and viewpoints of Adam Smith and David Ricardo (the great theorists of classical economics), we would not pursue such policies. But they do not, and we do pursue them, as do all other governments in the world today and as they did throughout the seventeenth and eighteenth centuries."

Even in medieval times in Europe local governments levied tolls (tariffs) on goods entering and leaving their territory. Local guilds formed by merchants and artisans fixed wages, prices, and other working conditions. Subsequently, these functions were transferred to the government, which sought to use its powers to promote economic growth and enrich the nation. Thus was born mercantilism, which added to existing economic nationalism to the already existing antagonism engendered by religious differences and rivalry among the kings of the various nations.

Mercantilism lasted from the creation of strong central governments in the 15th century until the 19th century, however, mercantilist policies continue to be followed today. Some believe that the American revolution was an outgrowth of conflict between the colonies and England brought about by England's mercantilist policies.

Mercantilism was at its height in the 17th and 18th centuries. Although the economic policies adopted in the nations of Europe were not identical, they shared sufficient common characteristics to consider each country's economic system as being of the same type. The objective of these policies was to maximize the nation's wealth. Wealth was defined in terms of gold; not the way Adam Smith defined it, which is the nation's ability to produce. Gold could be acquired either through a trade surplus or the obtaining of gold-bearing territory. Mercantilism involved the using the power of the state throughout the economy to enrich the state. Therefore, a mercantilist economy is a managed economy.

England, France, Holland, and Spain all restricted their colonies' foreign trade. Subsidies and other assistance was employed to encourage the colonies to produce raw materials; while their right to produce manufactured goods that would compete with those produced by the mother country was restricted. The reason for doing this was to make the nation self-sufficient while enjoying the benefits of specialization. (Most colonial manufacturing took place in the Middle Colonies.)

Colonies, by providing raw materials not found in the mother country and increasing the size of the domestic market made both substantial self sufficiency and specialization possible. Self-sufficiency reduced imports; thus making possible or making larger a trade surplus, which would add to the nation's gold stock. Specialization increased the nation's productivity.

Navigation laws were common in mercantilist nations. These limited to native (citizens of mother country and its colonies) ships the right to bring goods into (imports) or take goods from (exports). This was expected to increase the size of the nation's merchant marine and earn additional specie through the selling of shipping services.

Mercantilist regulation in the thirteen colonies began in the 1620s, when steps were taken to prevent the importation into Britain of tobacco from Spanish and Dutch colonies. In the 1650s and 1660s the British Parliament passes a set of Navigation Acts

In addition to benefiting Great Britain, these Acts were designed to injure the Dutch. In 1651, Holland declared war on Great Britain in order to get a 1651 Navigation Act repealed. It failed. Nonetheless, the Dutch maintained their maritime and commercial supremacy until well into the 18th century.

Although the Navigation Acts did lead to a larger British merchant marine and increased its maritime trade, as Adam Smith pointed out, they imposed a cost on British consumers.

These and other mercantilist policies provided some benefits to the colonies. Protection from foreign competition helped New England's ship building industry. South Carolina benefited from an indigo subsidy. North Carolina benefited from bounties on tar, pitch, turpentine, and lumber. Various colonial exporters benefited when they exported to Britain because competing goods from foreign nations were subject to tariffs theirs were not.

On the other hand, colonists paid more than they otherwise would have for imports from foreign countries because they had to be shipped through Great Britain. (Tariffs levied on foreign goods, but not colonial goods, meant that British citizens paid more for imports than they otherwise would.) They paid more, too, for imported manufactured goods because they had to come through Britain.

Southern planters, particularly rice and tobacco planters, bore much of the burden imposed by the requirement that the colonies' goods be exported to foreign nations via Great Britain, because most Southern exports went there, while smaller shares of the other two regions' exports went there. .New Englanders often evaded this cost through trading with foreign countries illegally.

Enforcement of the Navigation Acts was not very effective until 1763, and it was after enforcement tightened that interest in gaining independence heightened.

Some economic historians do not believe restrictions on colonial manufacturing imposed much of a burden on the colonies because they were in no position to establish much of a manufacturing sector due to the high cost of labor and capital; the small size of the colonial market, which precluded producing on a large enough scale to gain economies of scale; and the lack of necessary knowledge and skills.

Restrictions on trade prevents the reaping of the advantages of comparative advantage.

According to one historian, 1763 marked a turning point in the relationship between Britain and the colonies. Until then, the perceived benefits of Empire membership exceeded perceived costs. After 1763, both the colonists and the English became increasingly dissatisfied with the relationship. England had just emerged victorious in a long war with France. However, the war left Britain with a huge public debt and a growing conviction that the colonies must bear a greater share of the cost of maintaining the Empire. Because effective rates of taxation in England were many times higher than tax rates in the colonies, the English believed it was appropriate to raise revenues via a series of new taxes on the colonies and reformed colonial administrative practices to better enforce new and existing taxes.

There were a series of revenue-raising measures passed by Parliament: the Sugar act of 1764, the Stamp and Quartering Acts of 1765, the Townshend Acts of 1767, the Tea Act of 1773, and others. "Before 1763," says a historian, "only southerners had much reason to chafe under Empire regulations. But enforcement of the Sugar Act restrictions on trade with the West Indies alienated articulate northern merchants, as well, while the highly visible Stamp Act tax on documents irritated just about everyone in business."

Historians disagree as to whether membership in the British Empire was on balance a net benefit or a net loss to the colonies.

The Sugar Act sparked a boycott of imports from Great Britain. A boycott aimed at the Townsend Acts levied import duties on various colonial imports led to imports falling by one-third and Parliament repealing them. Opposition to the Stamp Act led to it be repealed. Therefore, the colonists learned that resistance worked. The British responded by increasing the legal authority of colonial administrators and by sending troops to back that authority.

The objective of Parliament in passing the Sugar Act was to protect West Indian interests by placing taxes on foreign sugar and molasses. The Stamp Act was a way to collect a minor amount of revenue from the issuance of legal documents. The Currency Act (1764) was designed to make self limiting colonial issuance of paper money by establishing reserves for its redemption.

The 1773 Tea Act ran into very strong resistance, including the Boston Tea Party. Outrage was generated in the colonies in 1774 by the passage of the Quebec Act, which limited the expansion of the colonies to the West. Various objectives have been put forth for this Act having been passed, including to stop the colonists from further encroaching on Indian lands and, as a result, initiating hostilities and protecting the trade of Hudson Bay Company. It infuriated colonists wanting to settle in the West and land speculators.

It wasn't paying taxes or the amount they had to pay, which was relatively low, that seems to have angered the colonists most; instead, it was having no say in how much and in what way they would be taxed. Having a say was a right they felt entitled to as Englishmen.

One economic historian (Jonathan Hughes) describes government then and today in this way: "Eighteenth-century government, like most governments now, was one of organized special interests gaining advantages for themselves at the expense of the unorganized. Subsidies here, taxes there, prohibitions, special grants of privilege, year after year, decade after decade, had produced the 'British government'."

Then American Revolution has been labeled as the leading edge of a massive upheaval in the Western world. It was the first of revolutions, large and small, that would transform the world.

In contrast to the colonists, the British had an experienced army and command of the sea. They were led by a government that was not being challenged. It had a larger population and greater total wealth. They could move their troops from place to place by sea, while the colonists had to move via land, which hampered both troop movements and supplying them. The British quickly took seven northern ports. Later some were retaken, but by them some southern ports were taken.

This War did not place anywhere near as heavy a burden on what was to become the U.S. as did the Civil War or World War II. The Continental Army never exceeded 20,000 men. Often General Washington had only one third this many men. Maybe 10,000 men served on navy ships or aboard the larger number of privateers. About 800,000 of the colonies' 2.5 million people were men of fighting age. Many soldiers continued to practice their civilian occupation part time.

Today is believed that only a minority of the colonists' people actively supported the gaining of independence. Arms for the Patriot Cause, as its supporters labeled it, had to be imported. Some Patriot governments would not sent its troops outside the state. Some men refused to serve far from home. Many Patriot officers owed their positions to political pull and had no military training or experience. Fortunately for them, the British sent second rate generals to fight them. Before the conflict ended, the Americans were helped by the fact that the British were also fighting in Europe, the Caribbean, and even in the Orient. Ultimately the British decided winning the war wasn't worth the cost.

The Patriots were led by an articulate middle class composed of lawyers, merchants, and planters. Supporting them were radical farmers and city dwellers opposed to aristocratic privilege. Their domestic opponents were called Loyalists or Tories (after a British political party opposed to the Whig Party the Patriots favored). The Loyalists were led by wealthy landowners in the North, British civil servants, and Anglican clergy.

The War lasted nearly seven years, beginning in 1775 in Lexington, Massachusetts and ending with a skirmish at Combahee, South Carolina in August, 1782. Very little of this time was spent fighting. The British troops spent most of their time occupying a few major (port) cities. General Washing was mostly occupied in keeping an army in the field. In contrast, the war at sea was active.

Some men profited from the War by feeding, clothing, and housing troops. The Middle colonies benefited from the increased demand for food. Money was earned by some, too, by selling to the British and the Patriots' French allies.

Unable to finance the war by taxation, the Patriots' Continental Congress also resorted to printing paper money and confiscating Loyalist property. Some of what the army consumed it simply took. Through the destruction brought about by the war, the tax base shrank. Because the Patriots were fighting over British taxation, it was not politic to press people too hard for the payment of taxes. Loyalists and those not taking sides refused to pay. Taxes could not be collected from Patriots behind British lines. Borrowing was difficult when the army was not doing well, which often happened. State and national borrowing financed about 28 percent of wartime expenditures. Foreign loans accounted for eight percent.

The paper money issued by the Continental Congress combined with the specie spent by the British and the French, and a reduction in the supply of goods and services brought about by the War led to runaway inflation, that is, self generating inflation brought about by the rapidly falling purchasing power of the dollar due to rising prices causing people to spend money ever faster; thereby further raising prices. (Long after the War, Americans described something really worthless as not being worth even a Continental in reference to the Continental Congress' paper money.) Prices peaked at about 135 percent of their prewar level. Soldiers found the purchasing power of their pay shrinking to near nothing, and this caused some to desert. Farmers did not want to accept Continental money in exchange for the food the army needed. This led to the seizures. Washington complained of farmers selling the British, but not to his army.

After 1777, the thirteen colonies' overseas trade rose, but foreign trade was less than it would been if there had been no war. Through British-held areas, smuggling, and purchases of British goods in other nations, some British goods were imported. Privateering brought in goods, and trade with the rest of Europe increased. Domestic manufacturing increased, causing the thirteen colonies to become more self sufficient.

After 1775, because fighting shifted to the South, New England did not experience much fighting. However, British privateers damaged its fishing and whaling fleets, and the British market for whale oil was lost. The South was the only area in which the British employed economic warfare. Besides seizing slaves and luring them into their lines with promises of freedom,, the British destroyed many buildings, crops, and livestock. Because there was no longer a British indigo subsidy, its production fell.

Adam Smith, the first great economist--but not the first economic thinker--had as a chief objective showing that mercantilism is a bad idea. He believed that the real wealth of a nation is its ability to produce goods and services. The experience, he thought, of gold-rich Spain and Great Britain, which came much closer to following laissez-faire, proved his case.

The government, he said, should do only those things the private sector would not, such as national defense and a judicial system. Self-interest, regulated by competition, would assure that people would do their best to meet other people's needs. He advocated free trade, saying it would maximize the world's wealth. He developed the concept of absolute and comparative advantage. He pointed out how productivity is increased by the division of labor. (Productivity per worker can be increased by dividing up the tasks involved in producing an item among several workers, rather than having each worker perform every task.)

In a free market economy individual's preferences govern the making the "how, what, and who" decisions. How many people want and how badly they want the goods and services produced by business firms determines what these firms can afford to pay for the resources necessary to meet the public's demand for goods and services. Producers having the most valuable uses for resources bid them away from producers with less valuable uses for them. For example, in a market economy rising demand for one kind of transportation and falling demand for another kind causes prices and profits to rise in the case of the former and decline in the case of the latter. This leads to the shifting of resources to the former from the latter.

Competition is depended on in the free market system to force producers to do their best to satisfy consumers. If a firm fails to do so, another firm will do so in order to increase its sales by taking away this firm's customers. Unfortunately, Adam Smith said, when businessmen get together they discuss how they can restrain trade (reduce competition).

Although economists assume that people are rational, experiments with college students, mental patients, microscopic animals, birds, and rats have shown that rationality is not necessary for rational behavior to ensue. Therefore, markets do not require rationality in order to be efficient. When microscopic creatures are exposed to different types of food under circumstances in which the effort they have to make in order to consume them differs, they respond like human beings and rats. When their preferred food was very hard to get--the equivalent for humans of being expensive--they made do with second-rate food. Making it easier to get the preferred food--the equivalent of being cheap--caused them them to eat it.) College students, it was learned, who are most interested in learning will pay the most for seats up front in class. Mental patients will take the jobs around the institution that they like the least if the pay is high enough relative to the pay they would get for other jobs.

Obviously, if a country cannot produce something, the only way it can consume it is to trade for it. However, even if a country --or a city or a business an individual for that matter-- can produce something, it may be better to acquire it through trade, rather than producing it.

How a country, business, or individual should decide what to provide themselves with and what obtain by trading is on the basis of comparative advantage. The following example illustrates how everybody can gain by each person producing what they have a comparative advantage in and trading for the other things they need.

Assumed in the following example is that each producer is fully employing all his or her resources and is using them as efficiently as it possible. Therefore, the various possible combinations of output they can produce represent the maximum amounts they can produce. The quantity, quality, and nature of their resources are not the same. As a result, one is the more productive producer of meat, while the other one is the more productive producer of corn.

Suppose a rancher can produce each of the following combinations of meat and corn. (Meat is measured in pounds; corn in bushels.)

The rancher can produce no corn when 40 pounds of meat are produced because producing this much meat requires that all available resources are used to produce meat. When four bushels of corn is produced, no meant can be produced because producing this much corn requires the use of all resources.

Suppose a farmer can produce each of the following combinations of meat and corn.

Based on their liking for corn and meat, the size of their families, etc., suppose the following is how much each decides to produce of each.

If the rancher only produces meat, and the farmer only produces corn, and they trade with one another for the commodity each of them doesn't produce, then both of them can increase their consumption. This is because they can split the 40 pounds of meat and the 40 bushels of corn in the following manner.

The rancher gets to consume more corn, while the farmer gets to consume more meat.

The rancher produces meat because that is the commodity in which he has a comparative advantage. The farmer's comparative advantage is in corn.

The same logic applies to businesses and countries. Oranges can be grown in greenhouses in Canada, but both Canadians and people in Floridians are better off if Canada exports to Florida paper made from its trees, and Florida exports oranges to Canada.

	Meat	Corn

Rancher	30	1
Farmer	1	30