Classical Theories of International Trade

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Evolution of Trade Theories
Mercantilism
Absolute Advantage
Comparative Advantage
Factor proportion Trade
International Product Cycle
New Trade Theory
National Competitive Advantage

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Outline
Introduction to Mercantilism
Historical Background of Mercantilism
Main Points
Mercantilist Thinkers
Conclusion

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What is Mercantilism?
the theory that a country’s power depended mainly on its wealth to build strong navies and purchase vital trade goods.

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Mercantilism had no systematic, comprehensive, consistent treatise, no leader, common method, or theory.
Each “mercantilist" sought advantage for a specific, trade, merchant, joint-stock company or social group.
"Protectionism" is often seen as a primary characteristic of Mercantilism.

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The primary objective of Mercantilism was to increase the power of the nation state.
One of the important aspects of national power or strength was wealth that was equated with specie.
The states that followed a policy of mercantilism tended to see trade, colonialism and conquest as the primary ways of increasing wealth.

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When?
16th – 18th C
Where?
Western Europe, particularly England and France

Historical Background of Mercantilism
Generally, Mercantilism is associated with the rise of the “Nation state.”
Feudal institutions were weakened by the increasing use of money and a greater reliance on exchange within the economy.
The Protestant Reformation weakened the role of the church and consequently the civil role of the state was expanded
There was a rise of Humanism (the concern for well-being of humans in the short term).
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The decline of feudalism was influenced by changes in technology
“enclosure movement” and the commercialization of agriculture
Increasing use of money in the economy reduced the role of barter and reciprocity, people wanted to sell or work for money
nailed horse shoe, harness, stirrup, horse collar, heavy plough
rise of mechanical power [water, wind] used in textile and mining
urbanization
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rise of markets and fairs
gunpowder
improvements in navigation, shipping, transport
moveable type, (standardization, mass production and marketing of books in a variety of languages),
mechanical clocks, mechanisms, instruments,
Increased skills of craftsmen who made machines

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The Decline of Feudalism and the Plague
The "Black Death" of 1346-61
restricted trade
reduction in population
Increased production of wool; need industry and commerce to process and sell wool and textiles.
strengthening of guilds leads to an emphasis on trade

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Reduction in Population
Population of England fell by about 1.5 million (out of a population of 3.5 to 5 million in 1346).
Result was more money per person but also more animals, land and goods per person, prices fell.
Labour shortage pushed wages and earnings up.

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Less people with increased agricultural production (some problems with harvests and animals dying, but on average diets improved.)
Labour became more mobile, masters on feudal estates had to "hire" labour. This led to the rise of "free" labour.
If you couldn't hire workers, then you rent the land to others. Small farms with limited labour shifted to pasture and sheep rather than tilling the soil.

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Medieval Breakdown
Feudal system imposed many imposts upon merchants/tradesmen/moneylenders; but social change went against feudalism:
Growth of specialist manufactures in towns: the guilds
Growth of specialist traders between nations: the Mercantilists
Revolt against religious strictures against merchants/lending, church hypocrisy
Religious revolts: beginnings of Protestantism bound up with growth of merchants/financiers
A new ideology/analysis struggled for dominance: Mercantilism

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1500s and 1600s
Invention of printing with movable type gave rise to economic literature written by lay people
Thomas Wilson (1525-81) wrote Discourse on Usury (1572)
Charles Dumoulin (Latinized as Molinaeus) wrote Treatise on Contracts and Usury (1546)
Denied that interest was forbidden by divine law
Suggested public regulation of lending and interest
Inflow of gold and silver from the New World

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Main Points of Mercantilism:
Economics as applied statecraft
Promotion of National wealth and power
Importance of trade surpluses
Trade surplus leads to a net gold inflow, and thereby to greater national wealth and power
Encourage domestic production and exports, discourage imports

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Economics as statecraft not analysis
Tendency to see gold and “treasure” as constituting national wealth
Emphasis on balance of trade surpluses
Emphasis on maximizing productivity and output
Role of government in encouraging domestic manufacturing and exports while minimizing imports
Link between money supply and prices

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Two Ways to Increase a Nations Wealth
obtain as much gold and silver as possible
establish a favorable balance of trade, in which it sold more goods than in bought

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Mercantilism = unfair or unbalanced trade
Mercantilism Explained
colonies existed for the benefit of the Mother Country
Source of Raw materials = cheap
shipped to M. C. to be turned into finished goods
Finished good shipped to Colony = expensive
profit goes to M. C.
Pass laws forbidding colonies from producing their own goods

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Triangular Trade
Europeans transported manufactured goods to the west coast of Africa

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Traders then exchanged these goods for captured Africans who were then sold in the Americas

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Merchants then bought sugar, coffee, and tobacco in the West Indies and sailed back to Europe to sell these products.

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Long Term Results
global trade routes shifted over time
the old silk routes declined
West Asia and the Islamic world were displaced as the centralized location of global trade
the Atlantic and Pacific sea routes become the new focus of global trade

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It measures the wealth of nation by the size of its accumulated treasures i. e. gold & silver.
Focus is international trade, rather than internal commerce
Nationalism essential: promote nation by gain from trade
Trade imbalance the object: export more than import

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Wealth (Gold) can be accumulated by encouraging exports and discouraging imports.
This theory aims at creating trade surplus.
Limitations:
Accumulation of wealth takes place at the cost of another trading partner; a win-lose game & a zero-sum game for global wealth (international trade).
Supported only in short run.
Overlooks other resources such as its natural resources, manpower & its skill levels, capital, etc.
Used by colonial powers as a means of exploitation and not development.

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Recap
Feudal ideology significantly anti-capitalist, anti-financier. But
Merchants essential
“Exotic” commodities from other lands
Trade between different fiefs/kingdoms
Finance essential
Merchant activity
Wars
Merchants tolerated (but controlled, taxed)

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Mercantilist Thinkers
Josiah Child
Bernard Mandeville
David Hume
Von Hornick
Thomas Mun

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Niccolo’ Machiavelli (1469-1527)
Author of The Prince, 1512
Machiavelli's work is associated with the rise of nation state
Morality was necessary as guide to private actions
Politics should be free from ethical or theological influence
general postulate about human nature, self- interest

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David Hume
David Hume questioned mercantilist assumptions in his essays.
He denied that money and gold were equivalent to wealth. Instead, they had merely instrumental value.
He thought that accumulating precious metals would result in higher prices.
Hume believed that imports as well as exports were beneficial.
He suggested that trade was not equivalent to warfare, since both to the parties to the transaction benefit.

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He thought that accumulating precious metals would result in higher prices.
Hume believed that imports as well as exports were beneficial.
He suggested that trade was not equivalent to warfare, since both to the parties to the transaction benefit.

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Thomas Mun
England’s Treasure by Foreign Trade (1664)
Mercantilist Programs
- Importance of trade and the social position of the merchant
-Bring all unused land into production
- Fully utilize natural resources including fisheries
- Reduce consumption of imports, particularly luxuries
- Export goods with inelastic demand—can charge higher prices

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- Customs duties on imports to be consumed domestically
-Export in own ships
-Encourage distant trade
- make England a trans-shipment point
- Export of bullion permitted, if for purposes of trade (non-bullionist position)
- “Make the most we can of our own”