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This leads to differences in cost of production and efficiency Trade allows productive specialization International trade makes it possible to enjoy higher standard of living by world population
Mercantilism Theory of Absolute Advantage (Adam Smith) Theory of Comparative Advantage (David Ricardo) Theory of Reciprocal Demand (John Stuart Mill)
Factor Endowment Theory (Hecksher-Ohlin) Factor Price Equalization Theory (Paul Samuelson) Product Life Cycle Theory (Raymond Vernon) Theory of Competitive Advantage (Michael Porter)
Recent Theories
Mercantilism
The essence of Mercantilism can be summarized in a word.
Power! Mercantilism was about power! All economics and politics is about power.
Is that so unusual?
What is Mercantilism?
It is the economic theory and practice common in Europe from the 16th to the 18th century. It promoted governmental regulation of a nation's economy for the purpose of augmenting state power at the expense of rival national powers.
It was the economic counterpart of political absolutism. It was, in essence, economic absolutism. Its 17th century publicists, most notably Thomas Mun in England, Jean Baptiste Colbert in France, and Antonio Serra in Italy, never used the term Mercantilist to describe themselves. This name was given to them by Adam Smith, the Scottish economist, in his Wealth of Nations (1776).
Mercantilisms Principles
Precious metals, such as gold and silver, were deemed indispensable to a nation's wealth. If a nation did not possess mines or did not have access to them, precious metals should be obtained by trade. It was believed that trade balances must be favourable, meaning an excess of exports over imports. Colonial possessions should serve as markets for exports and as suppliers of raw materials to the mother country. Manufacturing was forbidden in colonies, and all commerce between colony and mother country was held to be a monopoly of the mother country.
Sumptuary laws (affecting food and drugs) were passed to ensure that wants were held low. Thrift, saving, and even parsimony were regarded as virtues. Only by these means could capital be created. In effect, mercantilism provided the favourable climate for the early development of capitalism, with its promises of profit.
Money = Wealth?
There is some controversy over whether Mercantilists equated money with wealth. Some writers such as Thomas Mun and John Lock have maintained that wealth consists of more than gold, i.e., land, houses, etc. But even they slipped away from these ideas. The Mercantilists confused a nation with a family - the old fallacy of composition. For a family to accumulate wealth, it must spend less than its income. It must accumulate a surplus over consumption.
Mercantilism in France
Luxury products like silks and linens tapestries, furniture, wines, etc were of major importance. Close regulation in the production of these goods was essential to maintain high quality. Under Jean Baptiste Colbert, Minister of Finance under Louis XIV, national guilds were set up to regulate major industries. Only craftsmen who were guild members could operate, and they were subject to regulation by the national organization. The royal power, supported by steady revenues from the salt tax, was strong enough to enforce regulation. Guilds remained powerful until the French revolution. In France, mercantilism was referred to as Colbertism.
Mercantilism in England
In England, regulation of domestic industry was not successful because government was always short of money. (The salt tax did not work for Elizabeth as it had for the Louis.) English Mercantilists were devoted primarily to expansion of trade and encouragement of manufacture. Result: medieval guilds disintegrated, especially when cloth production developed in rural areas. Industrial processes were far freer of restrictions than were those of France. When Industrial Revolution began in late 18th century, absence of guilds gave English industry a huge head start over France.
Mercantilism in Germany
German mercantilism resembles in many ways that of the French. Called Cameralism, it was originally concerned with problems of royal finance, taxation, and spending. Very authoritarian political tendencies. Very little development of democratic institutions in countries where it was practiced. Clear relationship between Cameralism of the 16th century and the rejection of classical laissez-faire in the 19th century. Pattern was set for a protectionist and institutional evolution of economic theory and action. We would see this trend if we went into the German Historical School. Von Hornick quoted earlier is one of two writers that illustrate their thinking.
Flaws in Mercantilism
By the 18th century, the economic policies of the mercantilists were under strong attack David Hume (1752) pointed two weaknesses:
It is not the qty. of gold/silver a nation holds that matters; rather it is the qty. of goods and services that these gold/silver can buy. This implied the mercantilist nations would hold all gold & silver, while other nations accumulate worlds output A favourable trade balance is possible only in the short run. In the long, run it (trade surplus) would automatically be eliminated (price-specie-flow mechanism)
World trade in not a zero sum game, as the mercantilists thought of. All nations could simultaneously enjoy benefits of international trade (Adam Smith).