MERCANTILISM

Mercantilism is a national economic policy that is designed to maximize the exports of a nation.
Mercantilism was dominant in modernized parts of Europe from the 16th to the 18th centuries[1] before
falling into decline, although some commentators argue[2] that it is still practiced in the economies of
industrializing countries in the form of economic interventionism.[3]

It promotes Government regulation of a nation's economy for the purpose of augmenting state power at
the expense of rival national powers. Mercantilism includes a national economic policy aimed at
accumulating monetary reserves through a positive balance of trade, especially of finished goods.
Historically, such policies frequently led to war and also motivated colonial expansion.[4]

ORIGIN OF MERCANTILISM
The term "mercantile system" was used by its foremost critic, Adam Smith,[31] but Mirabeau (1715–1789)
had used "mercantilism" earlier.

Mercantilism functioned as the economic counterpart of the older version of political power: divine right
of kings and absolute monarchy.[32]

Scholars debate over why mercantilism dominated economic ideology for 250 years.[33] One group,
represented by Jacob Viner, sees mercantilism as simply a straightforward, common-sense system whose
logical fallacies remained opaque to people at the time, as they simply lacked the required analytical tools.

The second school, supported by scholars such as Robert B. Ekelund, portrays mercantilism not as a
mistake, but rather as the best possible system for those who developed it. This school argues that rent-
seeking merchants and governments developed and enforced mercantilist policies. Merchants benefited
greatly from the enforced monopolies, bans on foreign competition, and poverty of the workers.
Governments benefited from the high tariffs and payments from the merchants. Whereas later economic
ideas were often developed by academics and philosophers, almost all mercantilist writers were
merchants or government officials.[34]

Monetarism offers a third explanation for mercantilism. European trade exported bullion to pay for goods
from Asia, thus reducing the money supply and putting downward pressure on prices and economic
activity. The evidence for this hypothesis is the lack of inflation in the British economy until the
Revolutionary and Napoleonic Wars, when paper money came into vogue.

A fourth explanation lies in the increasing professionalisation and technification of the wars of the era,
which turned the maintenance of adequate reserve funds (in the prospect of war) into a more and more
expensive and eventually competitive business.
Mercantilism developed at a time of transition for the European economy. Isolated feudal estates were
being replaced by centralized nation-states as the focus of power. Technological changes in shipping and
the growth of urban centres led to a rapid increase in international trade.[35] Mercantilism focused on
how this trade could best aid the states. Another important change was the introduction of double-entry
bookkeeping and modern accounting. This accounting made extremely clear the inflow and outflow of
trade, contributing to the close scrutiny given to the balance of trade.[36] Of course, the impact of the
discovery of America cannot be ignored.[citation needed] New markets and new mines propelled foreign
trade to previously inconceivable volumes, resulting in "the great upward movement in prices" and an
increase in "the volume of merchant activity itself".[37]

Prior to mercantilism, the most important economic work done in Europe was by the medieval scholastic
theorists. The goal of these thinkers was to find an economic system compatible with Christian doctrines
of piety and justice. They focused mainly on microeconomics and on local exchanges between individuals.
Mercantilism was closely aligned with the other theories and ideas that began to replace the medieval
worldview. This period saw the adoption of the very Machiavellian realpolitik and the primacy of the
raison d'état in international relations. The mercantilist idea of all trade as a zero-sum game, in which
each side was trying to best the other in a ruthless competition, was integrated into the works of Thomas
Hobbes. This dark view of human nature also fit well with the Puritan view of the world, and some of the
most stridently mercantilist legislation, such as the Navigation Ordinance of 1651, was enacted by the
government of Oliver Cromwell.[38]

Jean-Baptiste Colbert's work in 17th-century France came to exemplify classical mercantilism. In the
English-speaking world its ideas were criticized by Adam Smith with the publication of The Wealth of
Nations in 1776 and later by David Ricardo with his explanation of comparative advantage. Mercantilism
was rejected by Britain and France by the mid-19th century. The British Empire embraced free trade and
used its power as the financial centre of the world to promote the same. The Guyanese historian Walter
Rodney describes mercantilism as the period of the worldwide development of European commerce,
which began in the 15th century with the voyages of Portuguese and Spanish explorers to Africa, Asia, and
the New World.

NEOMERCANTILISM
Neomercantilism is a policy regime that encourages exports, discourages imports, controls capital
movement, and centralizes currency decisions in the hands of a central government. The objective of neo-
mercantilist policies is to increase the level of foreign reserves held by the government, allowing more
effective monetary policy and fiscal policy.

ORIGIN OF NEOMERCANTILISM
Neomercantilism is founded on the use of control of capital movement and discouraging of domestic
consumption as a means of increasing foreign reserves and promoting capital development. This involves
protectionism on a host of levels: both protection of domestic producers, discouraging of consumer
imports, structural barriers to prevent entry of foreign companies into domestic markets, manipulation
of the currency value against foreign currencies and limitations on foreign ownership of domestic
corporations. While all nations engage in these activities to one degree or another, neo-mercantilism
makes them the focus of economic policy. The purpose is to develop export markets to developed
countries, and selectively acquire strategic capital, while keeping ownership of the asset base in domestic
hands.

This use of protectionism is criticized on grounds that go back to Adam Smith's The Wealth of Nations,
which was aimed directly at classical mercantilist policies, and whose arguments are applied to neo-
mercantilism. Namely that protectionism is effective as a means of fostering economic independence and
national stability; and questioning the conclusion that it allows for sustainable development of the
nation's industrial base in the most efficient manner. Instead market economics has for over two centuries
argued that increasing competition within the nation which will more effectively promote capital
development and efficient allocation of resources. "Free traders" argue that by closing an economy,
resources will be spent duplicating products that could more effectively be bought from abroad, and that
there will be less development of exports which offer a comparative advantage. Market economists also
argue that protection denies a nation's own consumers the opportunity to buy at cheaper market prices
when quotas or tariffs are imposed on imports.

The subsidy of goods has also been advocated under neomercantilism. The fair trade movement claims
that the protection of stability in emerging economies by guaranteeing a minimum purchase of goods at
prices above those available in the current world markets, can contribute to restoring economic and social
balance as well as promote social justice. Proponents of the movement argue that this may help to avoid
the instability generated by the influence of global corporations on developed and developing nations.

Neomercantilists claim that "free trade" results in a negative philosophy that a nation that is not
competitive deserves to decline and perish, just like an under-performing corporation should. They argue
that "free trade" does not work well whenever dumping is practiced or the international rules do not take
into account the differences between wages, costs environmental regulations, and benets from nation to
nation. For instance, there is a major difference in the cost of labour between a "First World" and "Third
World" country for two equally skilled (or unskilled) sets of workers. When this economic reality is
exploited by "First World" manufacturers, the benefits accrue to "First World" shareholders and
consumers (and slightly improved work condition of exploited Third World workers) at the expense of
privileged "First World" workers and their status in the "middle class".

An unquestioningly open policy in such circumstances may effectively devalue "first world" human capital
investments in favor of financial capital investments. Consider for example, a person deciding whether to
invest in training as an engineer or in a portfolio of financial assets. Offshoring dramatically increases the
effective supply of engineers, and as a result, their price will tend to decline (or grow at a slower rate).
This decline will be increased by the lower cost of living in non-first world countries that would allow an
engineer there to live much better on a lower nominal salary than their first world counterpart (see
purchasing power parity). This obviously is resulting in a huge immigration of skilled professionals from
first world countries to the third world, seeking a better quality of life.
Faced with such prospects, rational economic agents will tend to avoid investing in human capital in areas
that are vulnerable to such government-induced devaluation. Instead, they will shift training toward areas
that are "protected by regulation" (for example: careers in law, medicine, government) or social tradition
(tenured academia), or socio-cultural factors (sales) or local physical requirements (nursing, medicine,
construction). Alternatively, rational economic agents in "first world" economies may choose to invest in
financial assets instead of human capital—further eroding the long term ability of the "first world" country
to produce and grow. As predicted by Adam Smith, this effect would reduce the inequality between First
World and Third World countries, increasing overall fairness.

Additionally, since cost of goods sold tends to be a larger component of total revenue than profits for
most industries, production within a country may keep a larger portion of the total wealth within the local
economy in comparison to dividends of profits and reduced prices on consumer goods. Furthermore,
infrastructure investments may be reduced when production is shifted offshore. Over the longer term,
such reduced local investments may reduce longer term productivity and economic growth.
Neomercantilist economies on the other hand are often characterised by "higher long term growth rates"
(that tend to flatten when neomercantilist policies are halted). This claim unfortunately is not verified
among developed nations, where Australia is both the main proponent of international free trade and
among the first world countries, the one with the higher sustained growth during the last fifteen years.
Anecdotally, as of February 2009 Australia was the only developed country who was not officially in
recession.

The language of neomercantilist policies repeats the claims of earlier centuries that protective measures
benefit the nation as a whole and that governmental intervention secures the "wealth of the nation" for
future generations. In doing so, neomercantilist admit that the interests of large corporations might as
often be represented and protected as pushed aside for the national interest.

As a neomercantilist nation's industrial production capacity and improving research and development
grow as a threat to the hegemon's (who usually unilaterally practices free-trade as Britain in the 19th
century and the US in the late 20th century) domestic markets, so protectionism is the usual response,
initially through political and, when necessary, military means (see World War I).

Examples of Neomercantilism
United States and Germany in 19th century

By 1880 the United States passed the British Empire in economic strength—ahead of Germany, second in
strength, due to Bismarck's adherence to similar neomercantilist policies.

After 1900, Britain was unable to remain an effective hegemon, having followed its "free trade"
philosophy since the 1840s, but the United States was still pursuing policies of its American School rooted
in Hamilton's three reports, that it had embraced in the 1860s under Abraham Lincoln. Germany followed
Otto von Bismarck's policies based on Friedrich List's "National System", and American economic
practices—allowing both powers to continue their dominance in world economics and power. Germany
chose to use its strength to pursue a 'balance of power' with the British Empire leading indirectly to World
War I, whereas the United States refrained from European power struggles through its foreign policy of
'isolationism' or non-interventionism in foreign conflicts.

ABSOLUTE ADVANTAGE
In economics, the principle of absolute advantage refers to the ability of a party (an individual, or firm, or
country) to produce a greater quantity of a good, product, or service than competitors, using the same
amount of resources. Adam Smith first described the principle of absolute advantage in the context of
international trade, using labor as the only input. Since absolute advantage is determined by a simple
comparison of labor productiveness, it is possible for a party to have no absolute advantage in anything[1].

ORIGIN OF ABSOLUTE ADVANTAGE

[2]The main concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication
The Wealth of Nations in which he countered mercantilist ideas.[1][3] Smith argued that it was impossible
for all nations to become rich simultaneously by following mercantilism because the export of one nation
is another nation’s import and instead stated that all nations would gain simultaneously if they practiced
free trade and specialized in accordance with their absolute advantage.[1] Smith also stated that the
wealth of nations depends upon the goods and services available to their citizens, rather than their gold
reserves.[4]

Because Smith only focused on comparing labor productivities to determine absolute advantage, he did
not develop the concept of comparative advantage.[1] While there are possible gains from trade with
absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the
range of possible mutually beneficial exchanges.

COMPARATIVE ADVANTAGE
The law or principle of comparative advantage holds that under free trade, an agent will produce more of
and consume less of a good for which they have a comparative advantage.[1] Comparative advantage is
the economic reality describing the work gains from trade for individuals, firms, or nations, which arise
from differences in their factor endowments or technological progress.[2] In an economic model, agents
have a comparative advantage over others in producing a particular good if they can produce that good
at a lower relative opportunity cost or autarky price, i.e. at a lower relative marginal cost prior to trade.[3]
One does not compare the monetary costs of production or even the resource costs (labor needed per
unit of output) of production. Instead, one must compare the opportunity costs of producing goods across
countries.[4]

ORIGIN OF COMPARATIVE ADVANTAGE

Adam Smith first alluded to the concept of absolute advantage as the basis for international trade in The
Wealth of Nations:

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it
of them with some part of the produce of our own industry employed in a way in which we have some
advantage. The general industry of the country, being always in proportion to the capital which employs
it, will not thereby be diminished [...] but only left to find out the way in which it can be employed with
the greatest advantage.[9]

Writing several decades after Smith in 1808, Robert Torrens articulated a preliminary definition of
comparative advantage as the loss from the closing of trade:

[I]f I wish to know the extent of the advantage, which arises to England, from her giving France a hundred
pounds of broad cloth, in exchange for a hundred pounds of lace, I take the quantity of lace which she has
acquired by this transaction, and compare it with the quantity which she might, at the same expense of
labour and capital, have acquired by manufacturing it at home. The lace that remains, beyond what the
labour and capital employed on the cloth, might have fabricated at home, is the amount of the advantage
which England derives from the exchange.[10]

COUNTRY SIZE THEORY

Variety of Resources The theory of country size holds that because countries with large land areas are
more apt to have varied climates and natural resources, they are generally more nearly self-sufficient than
smaller countries.

ORIGIN OF COUNTRY SIZE THEORY

FACTOR PROPORTION THEORY

The Heckscher-Ohlin model is a theory in economics explaining that countries export what they can most
efficiently and plentifully produce. This model is used to evaluate trade and, more specifically, the
equilibrium of trade between two countries that have varying specialties and natural resources. The
model places emphasis on the exportation of goods requiring factors of production that a country has in
abundance and the importation of goods that a nation cannot produce as efficiently.

ORIGIN OF FACTOR PROPORTION THEORY

Bertil Ohlin first explained the theory in a book published in 1933. Ohlin wrote the book alone, but he
credited Heckscher as co-developer of the model because of his earlier work on the problem, and because
many of the ideas in the final model came from Ohlin's doctoral thesis, supervised by Heckscher.

Interregional and International Trade itself was verbose, rather than being pared down to the
mathematical, and appealed because of its new insights.

2×2×2 model
The original H–O model assumed that the only difference between countries was the relative abundances
of labour and capital. The original Heckscher–Ohlin model contained two countries, and had two
commodities that could be produced. Since there are two (homogeneous) factors of production this
model is sometimes called the "2×2×2 model".

The model has "variable factor proportions" between countries—highly developed countries have a
comparatively high capital-to-labor ratio compared to developing countries. This makes the developed
country capital-abundant relative to the developing country, and the developing nation labor-abundant
in relation to the developed country.

With this single difference, Ohlin was able to discuss the new mechanism of comparative advantage, using
just two goods and two technologies to produce them. One technology would be a capital-intensive
industry, the other a labor-intensive business—see "assumptions" below.

Extensions
The model has been extended since the 1930s by many economists. These developments did not change
the fundamental role of variable factor proportions in driving international trade, but added to the model
various real-world considerations (such as tariffs) in the hopes of increasing the model's predictive power,
or as a mathematical way of discussing macroeconomic policy options.

Notable contributions came from Paul Samuelson, Ronald Jones, and Jaroslav Vanek, so that variations of
the model are sometimes called the Heckscher-Ohlin-Samuelson model or the Heckscher-Ohlin-Vanek
model in the neo-classical economics.

COUNTRY SIMILARITY
The idea that countries with similar qualities are most likely to trade with each other. These qualities may
include level of development, savings rates, and natural resources, among others. The country similarity
theory is based on the idea that economic actors with similar qualities are going to want many of the same
things.

ORIGIN OF COUNTRY SIMILARITY

The country similarity theory was proposed by economist Staffan Burenstam Linder in 1961[1] as a
possible resolution to the Leontief paradox, which questioned the empirical validity of the Heckscher-
Ohlin theory (H-O). H-O predicts that patterns of international trade will be determined by the relative
factor-endowments of different nations. Those with relatively high levels of capital in relation to labor
would be expected to produce capital-intensive goods while those with an abundance of labor relative to
(immobile) capital would be expected to produce labor-intensive goods. H-O and other theories of factor-
endowment based trade had dominated the field of international economics until Leontief performed a
study empirically rejecting H-O. In fact, Leontief found that the United States (then the most capital
abundant nation) exported primarily labor-intensive goods. Linder proposed an alternative theory of trade
that was consistent with Leontief's findings. The Linder hypothesis presents a demand based theory of
trade in contrast to the usual supply based theories involving factor endowments. Linder hypothesized
that nations with similar demands would develop similar industries. These nations would then trade with
each other in similar, but differentiated goods.

PRODUCT LIFE CYCLE TRADE THEORY

The Product Life Cycle Theory is an economic theory that was developed by Raymond Vernon in response
to the failure of the Heckscher-Ohlin model to explain the observed pattern of international trade. The
theory suggests that early in a product's life-cycle all the parts and labor associated with that product
come from the area where it was invented. After the product becomes adopted and used in the world
markets, production gradually moves away from the point of origin. In some situations, the product
becomes an item that is imported by its original country of invention.[1] A commonly used example of
this is the invention, growth and production of the personal computer with respect to the United States.

ORIGIN OF PRODUCT LIFE CYCLE THEORY

Introduction

INTERNATIONAL product life cycle (IPLC)

theory, developed by Vernon (1966, 1971, 1976)

and his associates-particularly Wells (1968,

1969)-has become one of the leading explanations

of international trade patterns in the marketing

literature (e.g., Keegan 1980, pp. 266-68; Robock,

Simmonds, and Zwick 1977, pp. 41-3, 267-8; Terpstra

1978, pp. 28-9). The theory postulates a fourphase

international trade cycle for most products.

PORTER DEMAND THEORY

The Porter Diamond, properly referred to as the Porter Diamond Theory of National Advantage, is a model
that is designed to help understand the competitive advantage nations or groups possess due to certain
factors available to them, and to explain how governments can act as catalysts to improve a country's
position in a globally competitive economic environment. The model was created by Michael Porter, a
recognized authority on corporate strategy and economic competition, and founder of The Institute for
Strategy and Competitiveness at the Harvard Business School. It is a proactive economic theory, rather
than one that simply quantifies comparative advantages that a country or region may have.