CHAPTER 2: Theories of international trade

Intended Learning Outcomes:

By the end of this topic, you will be able to:

​ ●Identify and explain the major theories of international trade.

​ ●Analyze the strengths and weaknesses of each theory.

​ ●Apply these theories to real-world trade scenarios.

​ ●Understand the implications of different trade theories for businesses and

policymakers.

A theory is a well-substantiated explanation of some aspect of the natural world,

supported by a body of facts that have been repeatedly confirmed through observation and
experimentation. In the context of economics, a theory provides a framework for understanding
and explaining economic phenomena, such as international trade.

Theories of international trade are models that attempt to explain the patterns and
benefits of trade between countries. These theories analyze factors like resource availability,
production efficiency, and market structures to explain why countries trade and how they benefit
from it.

These theories provide different perspectives on the drivers of international trade, helping
us understand the complex factors that influence global trade patterns.
 LESSON 1: Mercantilism

Key Principles of Mercantilism:

1. Bullionism: The belief that a

nation's wealth was directly
proportional to its holdings of gold
and silver.

2. Favorable Balance of Trade: A

favorable balance of trade occurs
when a nation exports more goods than it imports. This led
to an inflow of gold and silver, which was seen as a
measure of national wealth and power.

3. Government Intervention: Governments played a

significant role in regulating trade, promoting exports, and
restricting imports.

4. Colonialism: Mercantilism encouraged the establishment of colonies to provide raw

materials and markets for the mother country

Key Characteristics of Mercantilism:

●Wealth as a measure of power: Mercantilists believed a nation's wealth, particularly in the form
of gold and silver, directly determined its power and influence.

●Favorable balance of trade: The goal was to export more goods than imported, leading to a
surplus of gold and silver. This was achieved through protectionist policies like tariffs and
subsidies.

●Government intervention: Mercantilism advocated for strong government involvement in the

economy, regulating trade, promoting domestic industries, and controlling colonies.

●Population growth: A large population was seen as a source of cheap labor and a strong
military, contributing to national wealth and power.

●Importance of colonies: Colonies were viewed as sources of raw materials and markets for
manufactured goods, bolstering the mother country's economy.

●Protectionism: Mercantilists believed in protecting domestic industries from foreign competition

through tariffs, quotas, and other trade barriers.
●Emphasis on manufacturing: Mercantilists encouraged the development of manufacturing
industries to produce goods for export, generating wealth and employment.

Origins of Mercantilism

The origins of Mercantilism can be traced

back to a confluence of factors in 16th-century
Europe, a period marked by significant political,
economic, and social changes:

1.​ The Rise of Nation-States:

• Centralized Power: The emergence of

powerful nation-states, such as England,
France, Spain, and Portugal, led to a shift in
focus from local interests to national interests.

• National Wealth: These states sought to

consolidate their power and wealth through
economic policies that benefited the nation as a
whole.

2. The Age of Exploration and Colonialism:

• Discovery of New Lands: The exploration of new lands, particularly in the Americas, brought
vast wealth in the form of gold, silver, and other resources to European powers.

• Colonial Expansion: European countries established colonies to control these resources and
ensure a steady supply of raw materials and markets for manufactured goods.

3. The Decline of Feudalism and the Rise of Capitalism:

• Shifting Economic Order: The feudal system, based on land ownership and agricultural
production, was gradually replaced by a more commercial and capitalist economy.

• Merchant Class: A powerful merchant class emerged, driving trade and seeking government
support for their activities.

4. The Influence of Bullionism:

• Precious Metals: The discovery of gold and silver in the Americas fueled the belief that these
precious metals were the ultimate measure of wealth and power.
• Bullionism: This theory, which emphasized the accumulation of gold and silver, became a
cornerstone of Mercantilist thought.

5. Early Economic Writers:

• Jean-Baptiste Colbert (France): Colbert, the finance minister of Louis XIV, implemented
policies that favored French industry and exports, promoting a favorable balance of trade.

• Thomas Mun (England): Mun, a merchant and writer, argued in his book "England's Treasure
by Foreign Trade" that a nation should strive to export more than it imports to accumulate gold
and silver.

Mercantilism was a dominant economic theory in Europe from the 16th to 18th centuries. It
emphasized national wealth and power through a favorable balance of trade, where a nation
exported more goods than it imported. This accumulation of gold and silver was seen as a
measure of a nation's strength and prosperity.

Colonies were seen as sources of raw materials and markets for the mother country's
manufactured goods. They were expected to contribute to the mother country's wealth and
power.

Mercantilism, while it fueled economic growth for the mother country, had a negative
impact on colonies. It created a system of economic dependence, social injustice, and political
unrest that ultimately led to the decline of colonial empires.

Mercantilism had a significant and often detrimental impact on European colonies,

particularly those of Great Britain.

Economic Dependence:

• Raw Material Suppliers: Colonies were primarily viewed as sources of raw materials for the
mother country, such as timber, cotton, sugar, and tobacco. They were discouraged from
developing their own manufacturing industries.

• Limited Trade: Colonies were restricted in their trade, often forced to sell their goods only to
the mother country and buy manufactured goods back from them. This created a system of
economic dependence.

• Taxation: Colonies were heavily taxed, often without representation in the mother country's
government. These taxes were used to fund the mother country's military and administration,
further draining colonial wealth.

Social and Political Tensions:

• Slavery: Mercantilism fueled the transatlantic slave trade, as colonies were forced to provide
labor for plantations that produced raw materials for the mother country. This created a brutal
and exploitative system.

• Inflation: Colonies often experienced inflation due to the mismanagement of paper currency
issued to make up for insufficient gold and silver.

• Unrest and Rebellion: The combination of economic exploitation, limited political rights, and
heavy taxation led to growing discontent among colonists. This eventually culminated in
revolutions, such as the American Revolution, where colonists sought independence from the
mother country.

Examples:

• British Colonies in America: The Navigation Acts, a series of laws passed in the 1660s,
restricted colonial trade to British ships and markets. This led to increased prices for colonists
and limited their economic opportunities. The colonists also faced heavy taxes, such as the
Stamp Act and the Tea Act, which sparked widespread protests and ultimately led to the
American Revolution.

Tariffs are taxes placed on imported goods. Mercantilist governments used tariffs to
discourage imports and protect domestic industries.

Examples of Mercantilist policies include:

​ ●Navigation Acts: Laws that restricted colonial trade to the mother country.

​ ●Subsidies for Exports: Government assistance to encourage domestic industries to

produce goods for export.

​ ●Restrictions on Imports: Tariffs and quotas to limit the flow of foreign goods into the
country.

Examples of Mercantilism:

​ ●16th-18th Century European Empires: European nations like Britain, France, Spain,
and Portugal actively pursued mercantilist policies. They sought to amass gold and silver by
exporting manufactured goods and raw materials while restricting imports. This led to the
establishment of vast colonial empires to control resources and trade routes.

​ ●Modern China: While not strictly mercantilist, China's economic strategy has elements
of mercantilism. It encourages exports and promotes domestic industries while maintaining
some control over imports, particularly in strategic sectors.
Criticisms about Mercantilism:

• Hindered economic growth: By limiting imports, it restricted access to cheaper goods and
innovation.

• Created tensions between nations: The pursuit of a favorable balance of trade led to
competition and conflict.

• Exploited colonies: Colonies were often treated as sources of wealth for the mother country,
with little regard for their own development.

Conclusion:
The origins of Mercantilism can be traced to the rise of powerful nation-states, the Age
of Exploration and Colonialism, the decline of feudalism, the influence of bullionism, and the
works of early economic writers. These factors combined to create an intellectual and economic
environment that fostered the development of Mercantilist ideas.

Mercantilism was a significant economic theory that shaped European economic policies
for centuries. While it contributed to the rise of powerful nation-states, it also had its drawbacks.
The transition to free trade and more open markets in the 19th century marked a departure from
Mercantilist principles. However, some elements of Mercantilist thinking, such as the importance
of national competitiveness, continue to influence economic policy today.

Review Questions and Answers:

1.​ What is Mercantilism?
2.​ What is the role of colonies in Mercantilism?
3.​ What are tariffs, and how did they relate to Mercantilism?
4.​ What is a favorable balance of trade, and why was it important in Mercantilism?
5.​ What are some examples of Mercantilist policies?
6.​ What were some of the criticisms of Mercantilism?
7.​ What are the key principles of mercantilism?
8.​ Discuss briefly the origin of mercantilism.
9.​ What are the characteristics of mercantilism?

References:
Ridley, M., “Humans: Why They Triumphed,” Wall Street Journal, May 22, 2010, accessed December 20,
2010, http://online.wsj.com/article/SB10001424052748703691804575254533386933138.html.

Smith, A., An Inquiry into the Nature and Causes of the Wealth of Nations (London: W. Strahan and T.
Cadell, 1776). Recent versions have been edited by scholars and economists.

https://open.lib.umn.edu/internationalbusiness/?s