You may have seen the word "mercantilism" floating around in the Trump-era news. The Washington Post has brought it up, so did the Toronto Sun. But what is mercantilism, exactly, and why has it suddenly become relevant?
The answer is trade wars. Here's how:
What Is Mercantilism?
Mercantilism is an economic philosophy built around exports and trade.
A mercantilist economy tries to increase its wealth by maximizing exports and minimizing imports. This school of thought teaches that there is a limited amount of wealth in the world for which all nations compete against each other. Exports make an economy richer because they bring money into the economy. Imports enrich competitors at the economy's expense.
The logic of mercantilism makes trade a zero-sum transaction in which exporters have an advantage over importers. To increase their wealth and power mercantile nations rely on tariffs, trade leverage and military power to maximize their trade balance. They want to ensure that the nation remained a net-exporter.
As a school of thought mercantilism is highly associated with specie (gold and silver) currency. This is because specie, or "hard money," economies have a fixed amount of currency in circulation. Unlike fiat currencies the more gold an economy spends the less it has. This aligns with mercantilism's belief that trade and wealth are fixed resources for which nations compete.
This belief is one of the theory's greatest weaknesses. It is by definition impossible for both parties in a trade agreement to be net exporters. As a result, mercantilism depends on a relationship in which one nation wins and the other loses. This relationship lends itself either to an involuntary trade relationship or to trade wars in which both nations mutually ratchet up tariffs.
Mercantilism dominated economic thought in Europe from the 16th through the 18th centuries. During this era, European nations often used military power to ensure markets for their exports, as a mercantile trade relationship is almost always a net-negative for at least one trading partner and because mercantilist nations often saw military and economic power as inextricably linked. It entered its decline as a dominant philosophy in the 19th century.
Why Is Mercantilism Relevant in 2018?
Mercantilism has returned to the news because it is the school of thought upon which President Donald Trump has conducted U.S. trade negotiations.
Trump has argued that the U.S. "loses" the money that it spends importing foreign goods and materials. It is his position that a strong economy must run a trade surplus. Further, the language of the president often suggests that any money spent on imports enriches foreign competitors at the expense of American businesses and workers. He has expressed this through rounds of tariffs designed to slow down U.S. purchases of foreign products and advantage domestic production.
This is mercantilism, and it is a change from America's historic approach to global trade.
What Is Capitalism?
Capitalism is an economic philosophy built around competition and productivity.
In capitalism, most property and tools of production are held in private hands. While the government can, and typically does, produce a range of goods and services for general consumption, this role is typically limited. The default position for a capitalist economy is that, unless otherwise specified, a given product or service will be produced and marketed by private individuals using privately-held wealth.
Under capitalism, prices are set by competition in the free market. The most important factor is supply and demand. As consumer demand grows against limited supplies, producers will either create more or raise prices. When demand falls, the market will respond in kind.
The logic of capitalism is built around productivity and the idea that wealth can increase over time. This was the idea that Adam Smith introduced. Modern capitalism descends from Smith's theory that a nation's wealth does not come from its holdings of currency but from the sum of goods and services that it produces. What's more, this pool of wealth can grow over time. By increasing productivity a nation can produce more goods and services and increase its total sum of wealth.
What Is Comparative Advantage?
Comparative advantage is in many ways capitalism's answer to mercantilism.
This is a theory of international trade which teaches that trade and wealth are not zero-sum competitions. Rather, comparative advantage holds that trade partners can both increase their net wealth even though one will necessarily run a trade deficit against the other.
Under comparative advantage, each nation specializes in what it can produce better or more cheaply than its trading partners. This increases the net amount of goods and services produced within the trading bloc, increasing the overall wealth among those nations.
Comparative advantage holds that the lessons of a free market apply on a global scale. Among individuals within a free market economy, competition will generally drive them to work in fields at which they're best. The same holds true of nations. Without artificial barriers to trade, each nation will produce more of what it's best at, enriching everyone.
Example of Mercantilism
Let's say 'Empire' takes a classic mercantile trading posture toward 'Nation.' Under this philosophy, Empire will try to maximize the amount of money it collects and retains from foreign trade. It will view every dollar spent on a Nation product as lost because that dollar went out to another country.
As a result, Empire will erect trade barriers such as tariffs, regulatory hurdles and outright embargoes designed to reduce imports from Nation as much as possible. At the same time, it will try to export as much as possible to Nation, often by subsidizing export firms and clearing regulatory hurdles. Empire doesn't want Nation to erect the same kind of tariffs and obstacles that it erected because it wants trade to flow only one way.
Since this is an inherently unfair trading relationship, Empire will typically have to use political, military or outsize market pressure to ensure that Nation's markets stay open while Empire keeps its markets closed.
Example of Traditional Capitalism
Nation has a capitalist economy. This economy will look much like the one readers are familiar with in most western states.
Most goods and services in the marketplace of Nation will be produced by private citizens. Those citizens will own their own capital, the money and resources used to produce goods and services on the market. They will decide what to produce and how much of it based on perceived needs in the marketplace and will set prices based on supply and demand.
The government of Nation will have some role as a market actor. Since this is a market of individuals incentivized by profit, the government will typically have to exercise significant oversight to prevent abuses. This will involve regulation to prevent predictable or repeat problems. The government will also typically provide desirable goods and services that the free market doesn't tend to efficiently provide on its own. This will classically include education, police and fire protection, and possibly health care.
Example of Comparative Advantage
America trades with Vietnam in a hypothetical relationship.
As a high-skill economy, American companies are excellent at producing valuable products and services, but not cheaply. Even a minimum wage worker in the U.S. is expensive by some global standards. Most workers in the country, given the nation's education and business infrastructure, are extremely expensive.
As a developing economy, Vietnamese firms are not as good at producing high-skill products but can produce large volumes of work quite cheaply. Most workers in Vietnam can work for a small fraction of the cost of a U.S. employee due to a combination of skill, availability and currency.
In a clothing-related trade deal, American companies could import shirts from Vietnam. This trade deal would allow U.S. firms to design patterns and the technology for printing them, to take advantage of the U.S.' skill advantage. It would allow Vietnamese firms to mass-produce the physical garments, to take advantage of Vietnam's inexpensive labor pool. The result is that both markets increase their total wealth: Vietnam gets a net trade surplus and American consumers get more shirts for less money.
Is Capitalism Better Than Mercantilism?
Capitalism and capitalist trade theory is generally considered both more accurate and more stable than mercantilism. Mercantilism has two core problems that have made it an unreliable form of economic theory.
First, as noted above, mercantilism relies on inherently unfair trade balances and trade practices. Mercantile nations depend on being able to erect barriers in their own economies without their trading partners doing the same. In the long run this is an unstable situation, because peer nations rarely willingly concede to economic subservience. For this reason mercantilism has historically been intertwined with trade wars and military adventurism.
Second, also as noted above, mercantilism relies on an archaic and inaccurate view of wealth. This is a school of thought wedded to gold standard philosophy, one in which wealth is measured by currency and is a zero-sum quantity.
Modern economics considers currency a measure of wealth rather than a form of it. It is how nations interact with and trade their productivity, but the real wealth of nations is measured by the goods and services that currency gives access to. This is a fluid sum. As an economy grows through population and technology, it can produce more for all of its participants. This positive-sum reality of wealth undermines the core tenet of mercantilism.