The History of Mercantilism

The History of Mercantilism

We will have two simple rules when it comes to this country: Buy American and Hire American… We will defeat the enemy on jobs and we have to look at it almost as a war.

President Elect Donald Trump (1946- ) at a North Carolina rally. December 6, 2016

Economic warfare is not a new concept. Mercantilism has its roots in Renaissance Europe and while it ultimately proved disastrous, vestiges have continued, even into the 21st century.

Let’s begin with Jean-Baptiste Colbert (1619–1683), Minister of Finances for King Louis XIV (1638–1715). It was his guidance that led France from the brink of bankruptcy to that of an economic powerhouse — at least temporarily. He rooted out and eliminated corruption and inefficiency in the tax collection process, and by closing loopholes was effective in taxing the rich. He also encouraged manufacturing, demanded high quality from producers, and implemented important economic reforms. But, from a historical perspective, his real significance was being the most dominant practitioner of economic warfare or mercantilism.

The philosophical underpinnings for this system consist of five basic assumptions: First, there is only a fixed and limited amount of wealth in the world. If this is true then every international transaction is a Zero-sum Gain (or “Game”). (a Zero-sum Gain is when one person’s gain is equivalent to another person’s loss so the net change in wealth is zero.) For example, if France wanted to become wealthier, then it needed to find a country with wealth and take it from them. Now this could be accomplished by military conquest, or it could be accomplished by international trade, which brings us back to our topic at hand: economic warfare. Second, true wealth consists primarily of gold, silver or land. Third, self-interest is anti-social. Therefore, the interests of the crown (or state) should always be placed ahead of our own selfish personal interests. Fourth, business should be conducted by government-granted monopolies, also called Grants of Exclusive Privilege or in French, De jure Monopoly. Under these arrangements, highly lucrative and well connected oligarchical companies operate completely unfettered by competition, as mandated by law.

Jean-Baptiste Colbert was an adherent to a new breed of economic thinkers who were influenced by Isaac Newton and the Age of Enlightenment. If, they believed, the entire universe could be explained through scientific principles, then why not use scientific methods to control society? Louis the XIV was the epitome of an absolute monarch and as such was obsessed with amassing great amounts of wealth and power. So, control was exactly what he wanted and his method was through the use of government regulations. If a nation could manage and control a nation’s resources and people during times of war, then why not use similar methods to also manage and control the nation during times of peace, and of course, control it all from France’s center of power: his majesty, King Louis XIV? Then, blend a combination of government regulations, military and economic warfare to simultaneously weaken your international rivals and take their money to enrich yourself. Voila, mercantilism!

International Trade

To explain this requires a brief lesson in 17th century international trade. If, for example, you were an English wine merchant who periodically traveled across the English Channel to re-stock your shelves, you had a problem with your English money, Pounds Sterling, which the French exporter could not spend in France because the French had their own currency, Francs. To solve this problem, the French and English, along with other countries, allowed their banks to accept the other nation’s currency and exchange it for an equivalent amount of gold or silver. So, the English merchant got his wine and the French exporter got his French Francs and everyone was happy. However, to take the example further, we need to look at the French bank in possession of English Pound Sterling Notes. The bank, in conjunction with all of the French banks holding English currency, would periodically total up all of their Pound Sterling Notes, take them to England, and redeem them for actual sterling silver or an equivalent amount of gold. A Pound Sterling Note would be exchanged for a pound of actual sterling silver. This process would likewise be reversed in France. If, in a given year and by coincidence you had an exact balance of trade, then each country would have transferred to the other exactly the same value of gold and/or silver.

The French believed that if they could export far more goods than they imported, then they would consequently increase their gold reserves at the expense of their rivals, which meant that France would have more money to pay her military and her impoverished rivals would have less, making them easy targets for conquest and plunder. It would also provide France with the money to finance the exploration and conquest of India, Africa, the Pacific islands and the Americas; then to colonize them in the name of France. This meant fighting not only indigenous populations, but also rival colonizers, like England, the Netherlands and Spain. Secondly, King Louis didn’t want his people buying the produce and products of other countries. Instead, he wanted to protect the French farmers and craftsmen by forcing French consumers to buy only French stuff. Why should Frenchmen enrich the farmers and manufacturers of some other country, sending their hard-earned money into the hands of the enemy? At the same time, he wanted to encourage exports to his rival trading partners. To accomplish these goals, King Louis reduced taxes on major exports and in some cases provided government subsidies; all designed to make his country’s products and produce artificially cheap on the international markets. Next, he erected trade barriers, such as tariffs, to restrict imports of products into his country. And if these measures weren’t harsh enough, he would ban the imports of certain products altogether. These policies were directed primarily against English and Dutch products, with the ultimate goal of making these countries economically dependent on France.

An important element of mercantilism was to exert absolute control over your colonies. If, France and England were at war in Europe; then your colonies would be forced to fight in America, Africa, and India as well. Also, force them to purchase products manufactured only in the mother country, then ship colonial produce only in boats manufactured in the mother country, and only to ports within the mother country (and of course force them to pay taxes to the mother country). In other words, don’t treat your colonies as independent entities; but instead make them work for you.

Keep in mind that the colonies were subject to the absolute will of the Crown (and in the case of England, Parliament). The purpose of colonial imperialism was to extract slave labor, and raw materials like gold, silver, lumber, and useful minerals, as well as agricultural products like sugar, tobacco and cotton from militarily weak, underdeveloped lands. The next step was to ship the mother country’s dregs of society to the colonies and let them fend for themselves or work as indentured servants, without the crown having to bear the social costs of welfare, crime or imprisonment.

It took England some time to figure out these new rules of international economics. In the mid-1600’s they were consumed with civil war, which resulted in the beheading of their king, Charles I (1600–1649). By this time, France had bounced back from its own devastating religious war in the 1590’s. By the late 1690’s, England had stabilized and was fully engaged in both military and mercantilist warfare.

Meanwhile in Spain, the King and Queen were spending money faster than it was coming in from the New World and were becoming quite annoyed by, and a little jealous of, the Conquistadors who had not only become fabulously wealthy but had the audacity to act as if they too were royalty. The Conquistadors had gone into partnership with the Crown and as such were able to keep for themselves a pretty big share of all the New World plunder. So, taking a page out of the mercantilist playbook, Spain simply annexed their portion of the Americas, nationalized all the assets and installed the Crown’s own colonial administrators.

The economic warfare between the countries of Europe ignited trade wars, military confrontations, and the exploration of uncharted territories with the goal of exploiting their natural resources. This led to the imperialistic colonizing of Africa, India, North and South America, Australia and islands around the globe. Indigenous populations were killed, enslaved, or in other ways subjugated to the will of the conquering Europeans.

In case you’re wondering how all this turned out, I can tell you in one word: Badly! Only 78 years after the death of King Louis XIV, his great, great grandson, King Louis XVI, along with his family and political supporters were executed. The king was only 38. The French Revolution ended the House of Bourbon, brought forth civil war and the Jacobin’s Reign of Terror, which culminated in the military dictatorship of Napoleon Bonaparte (1769–1821). England gave up its thirteen colonies of North America after losing the Revolutionary War, and by the mid 1800’s had largely abandoned mercantilism as an economic system. It continued, however, to gobble up cheap natural resources from its remaining colonies.

Even though Spain took from the Aztecs and Incas about $500 billion in today’s currency, it still went bankrupt in 1575, having squandered its New World wealth on fruitless wars, and by the early 1800’s was ruled by Napoleon. Spain subsequently lost control of its South and Central American colonies through a series of wars for independence; instigated by descendants of the original Conquistadors who wanted to regain complete political and economic control of their former territories. Spain’s final defeat came at the hands of the United States, after losing the Spanish-American War, which ended in 1898 with the signing of the Treaty of Paris. Even though Spain suffered a resounding defeat, the U.S. agreed to pay them $20,000,000 for the Philippines. They were forced, however, to give up Cuba, Puerto Rico and Guam. With the signing of this agreement the United States became a colonial power. Filipino nationalists, however, sought independence from their new colonial rulers, so fighting broke out two days before the U.S. Senate ratified the Treaty. The Philippine-American War lasted three years and caused the deaths of about 4,200 U.S. soldiers and 20,000 Filipino combatants. Worse yet were civilian casualties: some 200,000-people died from violence, famine and disease. The United States allowed the Philippines to become a commonwealth in 1935 and in 1945 recognized it as an independent state. Even afterwards the United States maintained its military bases on the island, and throughout the 20th century meddled in its internal politics. For example, the U.S. propped up the Ferdinand Marcos (1917–1989) regime throughout his 20-year reign as President of the Philippines, providing over $1 billion in military aid and hundreds of millions in economic aid, during which time Marcos siphoned off billions from the Philippine Treasury into his personal off-shore accounts. Even though he was ousted from office in 1986, the U.S. allowed him safe haven in Hawaii. Our government later charged him with racketeering, but to no avail, he died in 1989.

Vestiges of Mercantilism in the United States

The entire westward expansion of the United States was a process of colonization and military conquest, including Hawaii.

Today our government places import restrictions and tariffs on many imported products. In addition, subsidies and grants are commonly given to American manufacturers and growers of certain crops. And if our government doesn’t like the actions of a rival nation, economic sanctions are a convenient substitute for military confrontation.

The world we live in today is largely the result of mercantilism and European Colonial expansion. The influx of cheap raw materials fueled the Industrial Revolution, which led to technological advancements and the modern economy.

While the standards of living for industrialized nations have benefited, the poorest nations of the world continue in poverty. As the economist, David Landis has written:

…the difference in income per head between the richest industrial nation, say Switzerland, and the poorest nonindustrial country, Mozambique, is about 400 to 1. Two hundred and fifty years ago, this gap between richest and poorest was perhaps 5 to 1.

It’s safe to say that without the exploration and eventual European habitation of previously unknown lands, the world would look much different than it does today — both for good and bad.

Adam Smith vs. the Mercantilists

So, let’s analyze the main ideas behind mercantilism and compare them to the views of Adam Smith.

1. The world’s wealth is fixed.

Smith believed that wealth increases every time there is a mutually advantageous transaction, which is enhanced by the division of labor and continuously improving production techniques.

2. Economic Nationalism

Smith believed in economic internationalism. If every mutually advantageous transaction (whether domestic or international) increases wealth, then it stands to reason that in aggregate, the sum of all mutually beneficial transactions must also increase a nation’s wealth.

3. Gold and silver constitute a nation’s wealth.

Smith believed that gold and silver have value, but only to the extent that they are useful or desirable as commodities, and as money, in which case they hold a commonly accepted value that can be used as collateral in international transactions. Smith believed that true wealth is constituted by goods and services and that money is nothing more than a means to an end, not true wealth. In other words, money is like a claim-ticket to what we want — goods and services. If you couldn’t exchange money for goods and services, then it would be worthless. The paper Fiat Money that is issued by nations today has no intrinsic value. It, in essence, is nothing more than an IOU. Its value is only relative to the financial strength of the issuing government; in other words, the country’s ability to manage its finances, primarily its debt.

It should be noted that the gold in the King’s treasury did not belong to the Crown. It was held in the vaults to back the currency of France and actually belonged to all the holders of French money. The portion of gold that represented tax revenue is all that belonged to King Louis IV. It was this tax revenue that paid for government services and the French military. Smith was advocating that if you increase mutually beneficial trade, then economic activity is increased. By increasing economic activity, you also increase the taxes collected by the Crown. Therefore, economic activity is the key to increasing a nation’s wealth, and to a financially successful government.

4. Government created monopolies.

Until Adam Smith, governments thought that monopolized market segments were the most efficient and desirable way to manage an economy. Smith acknowledged that although these “Grants of Exclusive Privilege” were beneficial to the politically connected business owners, they were a terrible idea. By reducing or eliminating competition, they increased costs to consumers, made the industries less competitive in international markets, and hurt the total potential employment of the industries affected. This, in turn, reduced the potential tax revenues going to the Crown.

5. Self-interest is anti-social. The interests of the Crown should be placed ahead of our own selfish personal interests.

Smith believed that it is human nature to want to better ourselves, to get ahead in life, and to leave our children and grandchildren in a better, more prosperous state. All of these aspirations are related to the profit motive and self-interest. When we do this in a peaceful, mutually beneficial way through trade, then it is a good thing.

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