Mercantilist Follies, Then and Now

Reprinted from Law & Liberty

At the 2022 American Economic Forum organized by the Intercollegiate Studies Institute, I had occasion to listen to an after-dinner speech about trade—more precisely, an economic nationalist view of trade—by former US Trade Representative, Robert Lighthizer. Chatting afterwards with students attending the Forum, one of them asked me what I thought of Ambassador Lighthizer’s remarks. My response was: “It was mercantilism, updated for the twenty-first century.” “What’s mercantilism?” she inquired.

What indeed is mercantilism? It’s not a word used commonly today, but mercantilism is shorthand for a set of economic, political, and legal ideas and practices that dominated the European world between 1500 and 1800. “The Mercantile System,” as Adam Smith called it, was also the target of Book IV of his Wealth of Nations. It was, as Smith himself later wrote to a Danish correspondent, “a very violent attack . . . upon the whole commercial system of Great Britain.” Smith’s broadside, however, drew back the curtain to show what mercantilism really entailed. The picture that emerged was not a pretty one, but it illustrates why free trade abroad and free markets at home are far preferable to the neo-mercantilist alternatives on offer today.

A Zero-Sum World

One difficulty with analyzing mercantilism is that its proponents rarely laid out a systematic case for it. In his History of Economic Analysis, the economist Joseph Schumpeter noted that “mercantilist doctrines” emerged in a scattered fashion from the early-fifteenth century onwards. This often took the form of pamphlets defending specific economic endeavors or exploring issues like the balance of trade. The most systematic case for mercantilism (and a moderate version at that) was developed by the Scottish Jacobite, Sir James Steuart, in his Inquiry into the Principles of Political Economy (1767). Widely read throughout the late-eighteenth century, including by Adam Smith, this text was in many American founders’ libraries.

In other settings, mercantilist ideas were formally laid out in state papers authored by government ministers like Louis XIV’s Controller-General of State Finances, Jean-Baptiste Colbert. This indicates the extent to which mercantilist ideas were driven by the desire to achieve political goals rather than an empirical inquiry into how economies function.

What’s clear from the extant literature is that mercantilism’s economic vision did not emphasize economic growth. Rather, economies were considered largely static. Wealth was thus not believed to come through entrepreneurship, competition, and free exchange. For mercantilists, countries prospered by acquiring as much of the world’s existing wealth as they could.

That basic conviction translated into several things. One was an effort by states to snap up as much territory and dominate as many trade routes as they could handle. Practically speaking, this meant European states like Britain encouraging or organizing colonial settlements around the world and barring British goods from being carried on non-British ships. These policies were backed up by a willingness to use force to protect territorial gains and enforce trade prohibitions.

Part of mercantilism’s wealth-acquisition strategy involved governments giving charters to joint-stock companies which conferred upon them a monopoly of a country’s trade in particular parts of the world. This produced outfits like the Hudson Bay Company, the Dutch East India Company, and the French East India Company. The most famous of such enterprises, the British East India Company, was created in 1600. By the mid-eighteenth century, it was exercising powers akin to a sovereign state throughout modern-day India and Bangladesh. The East India Company’s monopoly of British trade in these regions was gradually accorded subtle and, when necessary, unsubtle protection by British soldiers and the Royal Navy. Such were the close links that mercantilism forged between governments and many merchants.

A second byproduct of mercantilism’s static view of wealth was a fixation with balance of trade questions: more specifically, ensuring that you exported more than you imported. Countries went to enormous lengths to try and secure a positive balance of trade. This makes sense if you believe that the sum-total of wealth in the world is finite.

Every time you imported a good from abroad, mercantilist arguments went, you exported wealth in the form of payments of gold and silver. To try and reduce imports, governments sought to create or bolster numerous domestic industries via subsidies and regulation, as well as tariffs on imports to discourage people from buying foreign-made products. In some cases, gold and silver exports were banned. Conversely, exports of goods were encouraged and often subsidized, because this meant that Frenchmen were paying, say, British merchants for British goods, thereby bringing more precious metals into Britain.

False Conceptions of Wealth

This brings us to a central mercantilist proposition: the more gold and silver that a country possessed and acquired, the wealthier it was. That was part of the economic logic that drove the Spanish conquistadors, with the eventual backing of the Spanish Crown, to conquer Central, South, and much of North America in an astonishingly short period of time.

It turned out, however, that acquiring vast sums of gold and silver did not make nations wealthy. After 1521, Spain experienced decades of enormous precious metal influxes from its American possessions. Yet by the mid-seventeenth century, Spain’s economy was stagnating and visibly becoming poorer relative to other European nations. This owed something to Spain being constantly at war with major powers like France, Britain, the Netherlands, and the Ottoman Empire from the mid-1550s until the 1650s. But there is much research illustrating that Spain’s economic decline was also partly driven by growing reliance upon gold and silver imports from the New World and the subsequent crowding-out of wealth-producing industries.

Herein lay yet another problem with mercantilism. The Spanish example shows that the essence of wealth is not, as mercantilists held, how much a country possesses by way of precious metals. Adam Smith demonstrated the falsity of that claim as early as his Lectures on Jurisprudence. Wealth is our capacity to satisfy our economic needs and wants. Among other things, this means being able to offer others something they want and being prepared to exchange it for something that you want. From this, it follows that the more barriers that you erect to obstruct people’s ability to exchange and compete with others (which mercantilism did), the more you inhibit wealth creation.

Indeed, mercantilism discouraged individuals and countries from discovering and then specializing in what they do comparatively better than others. That mattered because the division of labor is key to facilitating the greater efficiencies and productivity that create new wealth. Instead, mercantilism encouraged governments to create and prop up inefficient domestic sectors, and incentivized merchants to curry favor with governments to extract privileges from them: something unconducive to efficient wealth-creation and positively corrosive to good government.

Law-breaking, Inefficiency, and Cronyism

By the mid-1700s, frustration with mercantilist practices was growing throughout the European world. The high customs duties imposed on imports had resulted in widespread smuggling throughout Europe. This bred disrespect for law but also necessitated vast expenditures on a customs apparatus that tried and largely failed to curb smuggling.

That wasn’t the only economic cost related to mercantilism. Mercantilist ideas contributed to the growth of vast European colonial empires. But, as Britain discovered after its comprehensive victory over France in the Seven Years’ War, providing the military forces needed to protect and police its huge global possessions and the trade routes between them was a major drain on the public purse. Attempts to make the American colonies pay for what British parliamentarians viewed as their fair share of the costs of maintaining British military establishments in North America helped sparked insurrection and, eventually, a revolution.

Then there were the political and economic dysfunctionalities associated with mercantilist enterprises like the East India Company. As Edmund Burke noted in his Speech on Fox’s India Bill (1783), the Company’s trade monopoly severely distorted the workings of the price mechanism in India and consequently introduced widespread inefficiencies into British trade throughout the region. Worse, Burke pointed out, the Company’s monopolistic convergence of economic and political power had corrupted many British colonial officials, merchants, and their Indian counterparts. Young British gentlemen of middling prospects, he famously stated, went out to India and were quickly turned into “birds of prey.”

That corruption had a way of spreading. The East India Company spent vast sums maintaining a strong lobby in Britain’s halls of power. It proved exceptionally proficient at nullifying attempts to diminish the Company’s monopoly of British trade in the Far East. The fact that, by this point, the British government (and many MPs) was a major shareholder in the Company made the cronyism and corruption positively incestuous and all the harder to break.

Growing dissatisfaction with this state of affairs was not, however, enough to spark reform. Despite some trade-liberalization measures like the 1766 Free Port Acts, which Burke helped pass in Parliament, mercantilism’s hold on European economies actually strengthened in the late-eighteenth century. Something else was required to start loosening its grip. That something else turned out to be a book.

Enter Adam Smith

To say that Adam Smith’s Wealth of Nations intellectually demolished mercantilism is an understatement. For one thing, Smith showed how mercantilist efforts to protect domestic industries didn’t increase a country’s total output. No regulation, Smith stated, “can increase the quantity of industry in any country beyond what its capital can maintain.” Instead, they divert part of a country’s capital “into a direction into which it might not otherwise have gone.” But, Smith added, “it was by no means certain that this artificial direction is likely to be more advantageous to the society than that into which it would have gone of its own accord.”

Smith’s point was that tariffs don’t bolster production. Output is driven by factors like efficiency, specialization, and the amount of capital invested in an enterprise. Tariffs can only encourage businesses to shift their investments elsewhere, and there is no possibility of knowing ahead of time if this will boost output.

As for mercantilism’s restricting of imports, Smith recognized that this misconceived the purpose of economic production. The goal of production, he stated, was not production itself. Production is a means to an end. And that end is consumption. We don’t consume goods and services to promote production. Production is supposed to satisfy consumers’ needs and wants. It followed, Smith stated, that “the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer.” The problem, Smith stressed, with mercantilism is that “the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.”

Furthermore, unlike millions of dispersed consumers, Smith stressed that producers could exert disproportionate influence over trade policy and thus promote their sectional interests at everyone else’s expense. In a 1783 letter, Smith contended that “every extraordinary, either encouragement or discouragement that is given to the trade of any country more than to that of another may, I think, be demonstrated to be in every case a complete piece of dupery, by which the interest of the state and the nation is constantly sacrificed to that of some particular class of traders.”

Lastly, there was the balance of trade issue. Smith explained how the concept was “absurd.” “When two places trade with one another,” he wrote, “this doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium.” Alas, Smith stated, “Both suppositions are false.” When two people freely exchange goods within or between countries, Smith saw, they both “win,” albeit to varying degrees, insofar as they both get what they want. Otherwise, neither would have assented to the exchange.

Consumers—Not Producers—Should Rule

With this background in mind, we can see how mercantilist notions shape some of our present economic debates. Balance of trade questions, for instance, still preoccupy many economists who are by no means protectionists. In the case of contemporary economic nationalists, they regularly portray trade between nations in mercantilist terms as a win-lose equation. They focus heavily on trade imbalances, and regard trade deficits vis-à-vis other countries as a “loss.” Like the mercantilists of old, they also emphasize building up and protecting specific industries via tariffs, import quotas, and subsidies.

Above all, modern-day economic nationalists follow the mercantilist prioritization of production over consumption. This was one of Lighthizer’s central recommendations in his American Economic Forum address.  We need, he said, to shift the emphasis of American trade policy away from consumption and “move it towards workers, their families, our communities, production, and values.” As these words illustrate, the well-being of American consumers—all 330 million of them—does not rank high on economic nationalism’s priority list. Lighthizer even described contemporary free traders’ focus on consumers and consumption as “the essence of materialism.”

What economic nationalists downplay or ignore is that it is precisely through serving consumers in a competitive market that businesses produce wealth. In these conditions, companies must constantly innovate, find efficiencies, and reduce their margins to outpace their competitors. In the process of doing so, they create new wealth. That same wealth allows businesses to employ millions of people, thereby providing individuals and families with the salaries, wages, and benefits that enable them to pursue numerous non-economic goals. How, I ask, is this materialistic?

But this is not the only reason why “consumer sovereignty,” as the German ordoliberal economist Wilhelm Röpke called it, matters. If the well-being of producers becomes the focus of economic life, it opens the door to the cronyism and often outright corruption that characterized the mercantile system. Certainly, many businesses and their armies of lobbyists insist that they deserve government assistance because they claim to be essential to the well-being of a town, blue-collar men, etc. But as Adam Smith observed of the commercial and political purveyors of mercantilist doctrines of his time, “I have never known much good done by those who affected to trade for the public good.”

The clear analogies between mercantilist practices and present-day economic nationalist impulses remind us that there is little new under the economic sun. As John Maynard Keynes wrote in his General Theory, “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.” In the case of today’s economist nationalists, their scribblers go back over 250 years. And the prescriptions of those scribes are as mistaken now as they were in their own time.