Mercantilism is the economic theory that a nation's prosperity depended upon its supply of gold and silver, that the total volume of trade is unchangeable. This theory suggests that the government should play an active role in the economy by encouraging exports and discouraging imports, especially through the use of tariffs. Mercantilism is the economic policy that flourished in the early modern period are often referred to as mercantilism or as the mercantile system. These ideas stemmed from bullionism, a theory that precious metals equal wealth.

The term was coined by the political economist Adam Smith in 1776, from the Latin word mercari, which means "to run a trade", from merx, meaning "commodity". It was initially used solely by critics, such as Smith.

Theory

Mercantilist points:

• Nations are in a direct zero-sum competition with each other for wealth
• Gold and silver bullion are synonymous with wealth

The main objective to these precepts, which would define international relations for centuries, is that a country needs a positive balance of trade to gain more precious resources. Each nation has to export more goods and services than it imports, except for nations that can produce a lot of its own precious metals. From a mercantilist perspective, England established colonies in the western hemisphere to have an independent source of timber, rather than depending on purchases from the Baltic area; this was important in ship-building, and thus in maintaining naval power . Mercantilism fuelled colonialism under the belief that a large empire was the key to wealth.

A key tenet of mercantilism is that exporting raw or unfinished materials disadvantages a nation, as greater wealth results from performing value-added manufacturing work within that nation. Thus, for instance England banned the export of unfinished cloth to the Netherlands.

Reliance on foreign trade is also harmful. Thus England passed the Navigation Acts, requiring that ships entering English ports either be English or be carrying goods from their country of origin. This prevented the Dutch from most trade with England (as they produced few goods of their own).

Mercantilism also fueled the intense violence of the 17th and 18th centuries in Europe. Since the level of world trade was viewed as fixed, it followed that the only way to increase a nation's trade was to take it from another. A number of wars (for example, the Anglo-Dutch Wars and the Franco-Dutch Wars ) can be linked directly to mercantilist theories.

One key complaint of American revolutionaries in the late 18th century related to the British use of tariffs. Mercantilist theory implies that if one wants as much gold as possible in one's empire, one's colonies cannot trade gold for international goods. Thus, trade restrictions limited commerce with outside powers, forcing colonists to buy finished goods only from their ruling power, and keeping prices higher than Adam Smith would have viewed as efficient. The presence of a small Caribbean island (St Eustace) owned by the Dutch, who had supported the idea of free trade since the days of Hugo Grotius (1583 – 1645), played a major role in the revolution that followed. The island was open to all and had no tariffs whatsoever. After the Declaration of Independence, its governor decided to salute the USS Andrea Doria, a warship under the flag of the Continental Congress. This was the first recognition of the United States as an independent country.

Elements of mercantilist theory have remained in economic discourse throughout the years. There is a limited amount of gold in the world and, more importantly today, a limited amount of oil. A key motivator of Japan's World War II expansionism, for example, was the need to acquire control of natural resources, primarily petroleum, as well as others including minerals, timber, and rubber, which the Japanese islands lacked in bulk. Latin America's Cold-War Populism, and import substitution economic schemes, along with past and present Marxist theories, rest on the belief that the colonial economic structures still remain in place, with raw-goods exporters at odds with what equates to finished-goods exporters. (McDonald's products, for example, are in their own way finished goods.)

Mercantilist theory also influences the notion that trade surpluses are automatically good and that trade deficits are automatically bad. Some economists argue that Japanese trade policy in the 1970s and 1980s was in large part based on mercantilist concepts and that these policies form one of the causes of Japanese economic stagnation in the 1990s. Hence, one result of the growing deficit of the USA was that the American financial markets offered good investments and growth, whereas the Japanese market languished and financial returns were meager if not negative. Japanese banks also offered interest to depositors of less than one quarter of one percent. This reality contradicted mercantilist theory that a trade surplus and appreciating currency are automatically good.

Views

Adam Smith's Invisible Hand and liberal theory of economics gradually put an end to the dominance of mercantilism. Liberalism and mercantilism differed on one key issue. Mercantilism states that all the world's people must compete for the world's limited wealth. Adam Smith believed that wealth and trade was a non-zero-sum game, which essentially means two parties involved in a transaction could each actually gain, because the exchanged items were more valuable to their new owners. Bullionism dictated that gold was gold — period. Thus, what one party gained, the other party had to give up (i.e., the zero-sum game assumption). Smith felt that gold was nothing more than a yellow mineral that was valuable only because there wasn't much of it. The majority of economists now agree with Smith.

The economist John Maynard Keynes supported some of the tenets of mercantilism. While Adam Smith rejected the idea of bullion being more important than any other commodity, Keynes saw an inflow of gold and silver as being beneficial. He argued that greater gold reserves leads to lower interest rates, and thus the ability to borrow more money at a lower cost. This would both stimulate growth and aid government borrowing. Keynes also adopted the essential idea of mercantilism that government intervention in the economy is a necessity. A number of political parties embraced Keynes' theories, and they came into force under Franklin Roosevelt's New Deal program in the United States and also under Britain's Labour government after the Second World War. These policies continued under all parties until the end of the "post-war consensus" in the mid 1970s.