Age of European Exploration

While European powers were exploring the globe, they usually set up trading outposts that would become colonies.

Colonies were administrated as to benefit the interest of home country, we now call this system of economic policies Mercantilism.

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Power of the state is a function of its wealth Gold and silver are the only real measure of wealth

Prohibit export of gold and silver Control foreign trade to obtain a “favorable balance of trade”

Discourage imports Import only cheap raw materials Encourage domestic production Export expensive manufactured products

Economic nationalism Large military is required to build and defend a strong state Enforce trade restrictions Obtain concessions in trade treaties

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Mercantilism in Theory

Classic “Zero-Sum” game Only a finite amount of resources and wealth in the system Each nation should become self-sufficient by accumulating as many resources as possible Whatever one country gains, another must lose

Export > Imports Trade isn’t valuable, merely the profits from trade

Trade is generates monetary flows

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Mercantilism in Theory

As Europe explored more of the world, it became imperative to be the first to lay claim to whatever lands were encountered. The more land that was claimed, the more resources that country would control.

Colonies served as: Suppliers of raw materials to the home country Consumers of manufactured goods from the home country

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Mercantilism in Practice

There is only a finite amount of trade every year. Therefore trade must be restricted and regulated to ensure that it brings in the maximum amount of wealth for the country.

Although the policies and laws were different across Europe, all the countries that practiced mercantilism had 5 major things in common.

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Mercantilism in Practice

1 Bullionism Accumulating gold and silver within a country Forbidding its export abroad

2 Promote domestic industries Economic self-sufficiency Restricting the consumption of foreign goods

3 Restricted international trade Tax imports Subsidize exports

4 Utility of Poverty Support low wages Promote large working population

5 Navigation Acts All trade must go through the mother country first All trade is handle by the mother country’s merchant marines

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Shortcomings of Mercantilism

Mercantilism began to decline by the late 17th century because it was a self-defeating system.

Colonies had insufficient income to support sustained trade imbalances

Sold raw materials (low prices) Purchased manufactured goods (high prices)

Bullionism backfired All countries are stockpiling precious metals Lack of scarcity, SGold ↑ ⇒ PGold ↓ Inflation

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Shortcomings of Mercantilism

Market regulations lead to an explosion of the blackmarket Blackmarket isn’t taxed Undermines legitimate demand Major items smuggled: sugar, molasses, and tea

Empire-builders colonized all available foreign lands Mercantilism requires an every increasing market Large military and naval to enforce policies Majors wars are inevitable Limited invest in infrastructure

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Effects of Mercantilism

It is fair to say that the European colonization of Asia, Africa, and the lower Americas weakened the economies in these areas to reduce them to a condition of dependency.

Colonial economic policies were actively designed to maintain the low cost of production of the goods imported to Europe. Most of the colonial economies were restricted to single industries with suppressed wages.

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Reaction to Mercantilism

Adam Smith- An Inquiry into the Nature and Causes of the Wealth of Nations (1776)

Only source of wealth for a country was its land and labor. Markets self regulate through the “invisible hand” of individual self-interest. Therefore trade itself, not the actually goods being traded matter.

Theory of Value (1) Value of a good doesn’t come from its ability to be

exchanged for gold and silver (2) All goods have some basic intrinsic value (3) Market value for a good is the intrinsic value plus the labor,

talent, technology, and resources used

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Effects of Mercantilism (Smith’s view)

Domestic merchants and traders benefited from mercantilist policies, at the expense of everyone else Monarchs had little, if any, understanding of economic principles

Relied on self-interested ministers to run the economy Cronyism

Mercantilism often undermined national wellbeing in the long run Potential for positive effects in the short run

Misallocation of resources and investment Prohibitions on specialization limits benefits from comparative advantage and trade

Numerous costly wars in Europe and in the colonies

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Mercantilism vs. Neoclassical Economics

Neoclassical Economics strongly disagrees on the fundamental assumptions of Mercantilism:

Country’s wealth is measured by it’s real output Real goods/services matter, not the money supply Actual commodities generating the GDP is irrelevant

Trading is a voluntary, mutually beneficial act Both parties gain from trade Trade generally lowers cost Increases product diversity

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Political Influences on Economic Growth

The major colonist powers of Europe were Spain, Portugal, France, Netherlands, and England.

One of the most important difference between the countries that led to different status of powers heading into the 20th century was how concentrated the power was in a central authority.

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Political Influences on Economic Growth

Spain, Portugal, and France were absolute monarchies with the king having unlimited authority to tax and borrow.

England and the Netherlands had strong representative legislatures that limited the authority of the monarch.

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  • Mercantilism