Mercantilism and the Physiocracy
Early economic thought (pre-classical economics) (8th century BC – 1776)
1. early pre-classical economics (Greeks, Scholasticism) (800 BC – 1500)
2. late pre-classical economics (1500-1776)
· Mercantilism, 16th - 18th centuries;
· Physiocracy, France, 1750 -1789
Late pre-classical economics spans from circa the year of 1500 to 1776. We can distinguish two main currents of economic thought in this period: Mercantilism, active in the whole Europe from 13th to 16th century and Physiocracy, a French school of economic thought, active from about 1750 to 1789. We discuss them in turn.
Important writers of this period (late pre-classical economics)
Thomas Mun, England’s Treasure by Foreign Trade, 1664
William Petty, Political Arithmetic, 1690
Bernard Madeville, The Fable of the Bees, 1714
David Hume, Political Discourses, 1752
Richard Cantillon, Essay on the Nature of Commerce in General, 1755
Francois Quesney, Tableu Economique, 1758
The period between 1500 and 1750 was characterized by an increase in economic activity. Feudalism was giving way to increasing trade. Individual economic activity was less controlled by the custom and tradition of the feudal society and the authority of the church. Production of goods for market became more important and land, labor and capital began to be bought and sold in markets.
This laid the groundwork for the Industrial Revolution in the second part in the 18th century. However, we have to remember, that still we are talking about pre-industrial world, where agriculture is the most important sector of the economy.
During this period from 16th to the half of 18th century, economic thinking developed from simple applications of ideas about individuals, households and producers to a more complicated view of the economy as a system with laws and interrelationships of its own.
Mercantilism.
Mercantilism is the name given to the economic literature and practice in Europe of the period between 1500 and 1750. Although mercantilist literature was produced in all the developing economies of Western Europe (and I should add some Eastern European, for example in Poland, economies too), the most significant contributions were made by the English and the French.
Whereas the economic literature of scholasticism was written by medieval churchmen, the economic theory of mercantilism was the work of secular people, mostly merchant businessmen, who were privately engaged in selling and buying goods. The literature they produced focused on questions of economic policy and was usually related to a particular interest the merchant and writer (in one person) was trying to promote.
For this reason, there was often considerable skepticism regarding the analytical merits of particular arguments and the validity of their conclusions. Few authors could claim to be sufficiently detached from their private issues and offer objective economic analysis. However, throughout the mercantilism, both the quantity (there were over 2000 economic works published in 16th and 17th century) and quality of economic literature grew. The mercantilist literature from 1650 to 1750 was of distinctly higher quality, these writers created or touched on nearly all analytical concept on which Adam Smith based his Wealth of Nations, which was published in 1776.
The age of mercantilism has been characterized as one in which every person was his own economist. Since the various writers between 1500 and 1750 held very diverse views, it is difficult to generalize about the resulting literature. Furthermore, each writer tended to concentrate on one topic, and no single writer was able to synthesize these contributions impressively enough to influence the subsequent development of economic theory.
Secondly, mercantilism can best be understood as an intellectual reaction to the problems of the times. In this period of the decline of feudalism and the rise of the nation-states, the mercantilists tried to determine the best policies for promoting the power and wealth of the nation, the policies that would best consolidate and increase the power and prosperity of the developing economies.
What is especially important here is the mercantilistic assumption that the total wealth of the world was fixed and constant. These writers applied the assumption to trade between nations, concluding that any increase in the wealth and economic power of one nation occurred at the expense of other nations (the rest of the world). Thus, the mercantilists emphasized international trade as a mean of increasing the wealth and power of a nation.
Using some modern game-theoretic language, we may say, that they perceived economic activity and international trade in particular as a zero-sum game, that is a game, where it is impossible for both players to win (In a two-person zero-sum game, the payoff to one player is the negative of that going to the other player). So according to mercantilists, it is impossible to increase a global wealth of the world in effect of international trade. It is a very sad assumption, and modern economists do not share it.
The goal of economic activity, according to most mercantilists, was production, not consumption, as classical economists would later have it.
They advocated increasing the nation’s wealth by simultaneously encouraging production, increasing exports and holding down domestic consumption. Thus, in practice, the wealth of nation rested on the poverty of the many members of society. One again, they advocated high level of production, high level of export and low domestic consumption.
In addition, they proposed low wages in order to give the domestic economy competitive advantages in international trade. Most of the mercantilists held that wages (of the workers) should be set on the subsistence level, allowing workers to preserve their lives, but not to consume more than it is required to continue their lives. Higher wages would cause laborers to limit their work supply and national output; national wealth would fall, according to mercantilists.
Thus, when the goal of economic activity is defined in terms of national output and not in terms of national consumption, poverty for the masses benefits the nation. This is another sad consequence of mercantilist economic theory.
Third general point about mercantilism is their insistence on the notion of balance of trade.
Balance of trade figures, also called net exports, are the sum of the money gained by a given economy selling exports, minus the cost of buying imports.
A positive balance of trade is known as a trade surplus and consists of exporting more (in financial terms) than one imports. A negative balance of trade is known as a trade deficit and consists of importing more than one exports.
As we know today, neither positive nor negative balance of trade is necessarily dangerous in modern economies, although large trade surpluses or trade deficits may sometimes be a sign of other economic problems.
According to mercantilists a country should increase exports and discourage imports by means of tariffs, quotas, subsidies, taxes and the like in order to achieve a so-called favorable or positive balance of trade.
Production should be stimulated by government interference in the domestic economy and by the regulations of foreign trade.
Protective duties should be placed on manufactured goods from abroad; and the state should encourage the import of cheap raw materials to be used in manufacturing goods for export.
Why did the mercantilists argued for a positive balance of trade?
It is not an easy question to answer.
Many early mercantilists defined the wealth of nation not in terms of nation’s production or consumption, but in terms of its holdings of precious metals such as gold or silver. They argued for positive balance of trade because it would lead to a flow of precious metals into the domestic economy to settle the trade balance. Remember here that later or most eminent mercantilists equated the wealth of nation with the overall production of the nation. While for early mercantilists the wealth of nation consisted of the precious metals accumulated in the domestic economy.
The first mercantilists argued that a positive balance of trade should be struck with each nation. A number of subsequent writers however argued that only the overall balance of trade with all nations was significant. Thus, England might have a trade deficit with India, but because it could import from India cheap raw materials that could be used to manufacture goods in England for export, it might well have a positive overall trade balance with all nations.
A related issue concerned the exports of precious metals or bullion (that is gold or silver in bars).
Early mercantilists recommended that the export of bullion be strictly prohibited. Later writers suggested that exporting bullion might lead to an improvement in overall trade balances if the bullion were used to purchase raw materials for export goods.
So much on the mercantilist concept of positive trade balance.
One more point about mercantilist theory concerns money.
The early mercantilists equated the wealth of nations with the stock of precious metals internally held in the country. They were very impressed with the significance of the tremendous flow of precious metals into Europe, particularly into Spain, from the New World, from America. It is therefore not surprising that they became to identify the wealth of nations with gold and silver.
However later mercantilists subscribed to a more sophisticated view and identified the wealth of nation with the nation’s overall production. They were able to develop useful analytical insights into the role of money in an economy.
A central feature of this late mercantilist literature is the conviction that monetary factors, money supply, rather then real factors (such as quantity of labor, capital goods and the like), are the chief determinants of economic activity.
They maintained that an adequate supply of money is particularly essential to the growth of trade, both domestic and international. Changes in the quantity of money, they believed, generate changes in the level of real output. Therefore, in this view a positive balance of trade, which would effect in a flow of money into the domestic economy, would increase the production, the real output and therefore contribute to the increasing wealth of nation.
Classical economists and Adam Smith radically rejected this view, that monetary factors are main determinants of economic activity and economic growth in the second halt of 18th century.
Classical economists held that the level of economic activity and the rate of growth depend upon a number of real factors: the quantity of labor, natural resources, capital goods and the institutional structure of the society. Any changes in the quantity of money according to classical economists would not influence the level of neither output nor growth, but only the general level of prices.
Mercantilists held that money supply (not any non-monetary, real factor) was the main factor contributing to the wealth of nation.
So much on the assumptions of the mercantilistic economic doctrine, and we can move to the discussion of its contribution to the economic theory – theoretical contributions of mercantilists.
Probably the most significant accomplishment of the later mercantilists was the explicit recognition of the possibility of analyzing the economy. As we remember, the ancient and medieval thinkers were mostly engaged in moral, ethical analysis of the economy. It is just in mercantilistic writings, that economy becomes an object of a purely scientific, not moral analysis. They started to think about an economy as a subject of science, they realized that the laws of economy could be discovered by the same methods that revealed the laws of physics and other sciences. This was extremely important step toward subsequent developments in economic theory.
Many mercantilists saw an economy as a mechanical system and believed that if one understood the economic laws governing the economy, one could control the economy. Wisely proposed legislation could, in this view, positively influence the course of economic events and economic analysis would indicate what forms of government intervention would help the economy.
They however realized that government intervention must not be in contradiction with some basic economic truths such as the law of supply and demand.
Some of them correctly deduced, for example, that price ceilings set below the equilibrium prices lead to excess demand and shortages.
In addition, the later mercantilists frequently applied the concepts of economic man and the profit motive in stimulating economic activity – they said, that government cannot change the basic nature of human beings, and especially their egoistic drives. Therefore, politicians have to take these factors as given (that humans are egoistic and driven by profit motive) and try to create a set of laws and institutions that will channel these drives to increase the power and prosperity of the nation.
Many of the later mercantilists became aware of the serious analytical errors of their predecessors (that is early mercantilists). They recognized, for example, that stock of gold and silver is not a measure of the wealth of a nation, that it was not possible for all nations to have a positive balance of trade, and also that no one country could maintain a positive balance of trade over the long run.
What’s more, some of them realized that trade can be mutually beneficial to nations and that advantages will occur in those countries that practice the division of labor in production.
An increasing number of writers recommended a reduction in the amount of government intervention, anticipating the prescriptions of Adam Smith and other classical economists.
We have to remember however, that none of these writers was able to present an integrated view of the operation of a market economy – the manner in which prices are formed and scarce resources are allocated. This was eventually achieved by Adam Smith and classical economists in the second half of 18th century and in 19th century.
The popular explanation of this failure of mercantilists to produce a systematic account of a market economy is that the mercantilists believed that there was a basic conflict between private and public interests or between private and public welfare.
Therefore, they considered it necessary for government to channel private self-interest into public benefits. Classical economists, on the other had, found a basic harmony in society between private, egoistic drives of individuals and social welfare. Even the later mercantilists who advocated market policies lacked sufficient insights into the operation of market to make an adequate argument linking private self-interest and social welfare.
Still, the writings of the later mercantilists were used by Smith to develop his analysis, and this is another significant contribution of the mercantilists.
So much on the analytical contributions of mercantilists to the economic theory.
The thought of some influential mercantilist writers.
Thomas Mun (1571-1641), director in one of the most important English trading companies, his most important book was England’s Treasure by Foreign Trade, published after his death in 1664.
Mun was a typical mercantilist, he was a proponent of governmental policies that benefited a particular business interest. It is often said that his book is the classic example of English mercantilist literature.
Mun asserted in the tile of the book that England’s treasure (the wealth of England) was gained by foreign trade. His thinking was typically mercantilistic in that he confused the wealth of nation with its stock of precious metals and therefore argued for a positive balance of trade and inflow of gold and silver to England.
He believed that government should regulate foreign trade to achieve a positive balance, encourage importation of cheap raw materials, encourage exportation of manufactured goods, use protective tariffs on imported manufactured goods and take other actions to increase population and keep wages low and competitive.
These are all classic mercantilistic policies.
But Mun also has refuted some of the cruder mercantilistic notions, such as a view that England should have a positive balance of trade with each country; he argued that the really important thing is to have a positive balance of trade with all countries.
So much on Mun’s book.
Another mercantilist thinker, William Petty (1623-1687), was a sailor, physician, inventor, and what is most important for us, the first economic writer to advocate the measurement of economic phenomena.
His economic writings were not general treatises; they were the result of his practical interests in matters such as taxation, politics, money, and measurement.
His most important economic work, Political Arithmetic, was published after the death of the author in 1690.
Petty was apparently the first to explicitly advocate the use of what we would call statistical techniques to measure social and economic phenomena. He tried to measure population, national income, exports, imports, and the capital stock of England. His methods were very crude or simple indeed, but the tried to express economic events in terms of numbers, weight, and measure, which is a characteristic feature of modern economics. So we could say, that Petty is a precursor of contemporary methodological position of mainstream economics, which aims at statistical and econometric testing of theoretical propositions.
Later Adam Smith rejected Petty’s political arithmetic because of the simplicity of Petty’s methods and the problems of obtaining reasonably accurate data, and the process of quantification of economic analysis has stopped for nearly 100 years until the second half of 19th century.
Another mercantilistic thinker Bernard Mandeville (c. 1670-1733) wrote a satirical poem entitled Fable of the Bees, or Private vices, Public Benefits (1714), which drew interest not only from economists but also from philosophers, psychologists, and other scientists.
In the poem, Mandeville argued against some widely shared at the time views about morality. According to these views, good society and accordingly good economy requires that people behave virtuously, that is altruistically for example. In other words, the popular opinion at the time was that people should care not only for their own good, but also for the good of other members of society, if you want to have a prosperous society with high standard of social welfare.
Mandeville argued that egoism and selfishness is a moral vice, but that social good, public benefit could result from selfish acts if these actions were properly channeled by government. On the other hand, if you would try to change people by moral persuasion, and try to build a society where people are driven by private virtues (not private vices as in the real societies) you would end up with much lower level of economic output, unemployment and economic depression. So private vices produce public benefits.
So, according to Mandeville, one should accept men and women as they are and not try to moralize about what they should be. It is the role of government to take imperfect humankind, full of vice, and by rules and regulations channel its activities toward the social good.
As a mercantilist, Mandeville had no concept of natural harmony, where the so-called “invisible hand” of the market, within appropriate institutional setting and without the need of government intervention, makes individual, egoistic actions also profitable for the whole society. Such a concept was later developed by Adam Smith.
He still insisted that government should regulate much of the economic activity, for example, regulate the foreign trade in order to create employment and to undertake various projects to provide employment for the poor. In Mandeville thought mercantilist ideas thus coexisted with his recognition of the importance of the beneficial effects of the markets.
David Hume (1711-1776).
He is now best known for his philosophical writing, but he also contributed to economics. He was a close friend to Adam Smith; his economic views are contained in nine essays published in 1852 as a part of a volume of Political Discourses.
Like many of his contemporaries Hume could be called a liberal mercantilist, he had one foot in mercantilism, but with the other stepped forward into classical political economy.
His most important contribution is known in international trade theory as the ...
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