Approaches to IPE: Mercantilism vs. Liberalism

Introduction to Mercantilism and Liberalism

Mercantilism and liberalism represent two major, and at times competing, schools of thought in international political economy. Mercantilism emerged in the seventeenth and eighteenth centuries, developing theories linking economic activity and state power. Core mercantilist ideas emphasize the interconnection between national power and economic strength, see trade as a means for states to acquire wealth, and prioritize certain economic sectors deemed most valuable.

In contrast, liberalism arose in the eighteenth century as an intellectual challenge to mercantilism. Led by thinkers like Adam Smith and David Ricardo, liberalism distinguishes between economics and politics, argues that trade benefits countries regardless of surpluses or deficits, and contends that wealth derives from efficiently producing goods and engaging in trade, not just manufacturing. Liberalism advocates market-based allocation of resources to maximize individual welfare.

While differing substantially, mercantilism and liberalism have both significantly shaped modern perspectives on the relationship between states, markets, and economic policy. Their contrasting theories continue to inform debates around international political economy.

Core Principles of Mercantilism

Mercantilism is rooted in theories from the 17th and 18th centuries that link economic activity and state power. At its core, mercantilism holds three central propositions:

• National power and wealth are intricately connected. Mercantilists argue that a country’s economic and military power are directly tied together. They believe that a strong economy is necessary to support military strength and national security.

• Trade is a means for countries to acquire wealth from abroad. Mercantilists view trade as a zero-sum game where countries compete to amass wealth at the expense of their trading partners. The goal is to maximize exports while minimizing imports to achieve a trade surplus and accumulate gold reserves.

• Certain economic activities hold more value. Mercantilists place greater importance on economic activities like manufacturing, mining, fisheries, and agriculture since they produce tangible goods for trade. Less value is placed on services or retail since they don’t directly contribute to exports.

The mercantilist argument asserts that national power and wealth are inextricably linked. Economic activities that strengthen exports are prioritized as key to state power in this worldview.

Mercantilist Trade Policy

One of the key principles of mercantilism was that trade should be used as a means for a country to acquire wealth from abroad. This led to policies that favored maximizing exports while minimizing imports.

Mercantilists believed that a country could amass wealth by encouraging production of goods at home, then exporting those goods to other countries. The funds from selling exports would result in an inflow of treasure and wealth. At the same time, mercantilist policies aimed to discourage importing goods from other countries, as this was seen as a drain of a nation’s wealth to foreign lands.

Some common mercantilist trade policies included:

• High tariffs on imported manufactured goods to discourage imports and protect domestic industries. This allowed local producers to charge higher prices.

• Low or no tariffs on imported raw materials to support local manufacturing.

• Subsidies, state aid, and protection for industries considered important for a nation’s economic and military power. This included manufacturing, shipping, and high-tech industries of the time.

• Promoting the colonies as a captive market for exports from the home country. The colonies were also a source of cheap raw materials.

• Monopoly trading companies and trade routes to control trade and amass maximum benefit.

Through this intentional steering of trade flows to create net export surpluses, mercantilists believed a nation could continually build its stock of treasure and wealth at the expense of its trading partners. This view of trade as a zero-sum game, where one side benefits at the other’s expense, was core to mercantilist trade theories. It stood in sharp contrast to the liberal perspective that would emerge later.

Mercantilist Economic Priorities

Mercantilism places significant value on certain economic activities over others, specifically high-technology manufacturing. In the mercantilist view, manufacturing activities hold inherent economic value, driving innovation and providing skilled employment. Manufactured goods were prioritized for export while raw materials were deemphasized as mere inputs into production.

The mercantilist emphasis on manufacturing stemmed from its central role in wealth generation during the emergence of capitalism and early industrialization. New manufacturing technologies and production techniques allowed for increased efficiency, scale, and productivity. Mercantilists linked manufacturing prowess to national power, believing states with the most advanced and innovative manufacturing sectors held economic and geopolitical advantages.

With manufacturing elevated as a source of economic strength, mercantilists advocated policies promoting domestic manufacturing. These included subsidies, tax incentives, and other measures to stimulate growth of high-value manufacturing industries. Mercantilists justified such policies as enhancing national power and believed market forces alone were insufficient to develop strategic manufacturing capabilities. This manufacturing-focused economic approach remains influential today, with many viewing manufacturing as vital for innovation, jobs, and global competitiveness.

Role of the State in Mercantilism

The core mercantilist argument asserts a significant role for the state in resource allocation decisions, believing economic activity is too vital to be left to uncoordinated market processes. Mercantilism holds that the state should actively manage economic policies and intervene in the economy to promote national power and wealth. This includes using tariffs, quotas, subsidies, and other measures to encourage exports, restrict imports, and favor certain domestic industries over others.

Mercantilists contend that the free market alone cannot properly allocate resources in a way that maximizes national power. They argue that economic activities are intricately tied to state power, so the state must coordinate production, trade, and economic development. Without strong state oversight and intervention, mercantilists believe the economy would operate inefficiently and fail to strengthen the nation. Therefore, under mercantilism, the state plays a central, coordinating role in all aspects of the economy to harness economic activity for national objectives. This represents a significant difference from later schools like liberalism that advocate limiting the economic role of the state in favor of free markets.

Emergence of Liberalism

Liberalism emerged in the 18th century as a challenge to mercantilism, led by prominent British thinkers such as Adam Smith and David Ricardo.

Smith, often considered the father of modern economics, published his seminal work The Wealth of Nations in 1776. This text formed a foundation for classical liberal economics by arguing that nations prosper not from stockpiling gold and erecting trade barriers, but by allowing individuals the freedom to pursue their own self-interest within a competitive market system.

Smith contended that trade imbalances are self-correcting and mutually beneficial for countries. His theory of absolute advantage demonstrated how countries can benefit by specializing in goods they can produce most efficiently and trading with partners, rather than trying to be self-sufficient. Smith also diverged from mercantilism by claiming that a nation’s wealth lies not just in physical goods like gold and silver, but in the productive capabilities and labor of its citizens.

Building on Smith’s ideas, David Ricardo formalized the theory of comparative advantage in his 1817 book On the Principles of Political Economy and Taxation. Ricardo argued that even if a country is more efficient at producing every good than its trading partners, it still benefits from specializing in products where it has the greatest advantage and importing other goods. This novel perspective further shifted economics away from mercantilist zero-sum attitudes about trade.

Together, Smith and Ricardo systematically dismantled major tenets of mercantilism and developed foundational concepts that still underpin free market economics today. Their work spearheaded the transition from policies aimed at amassing bullion and running trade surpluses to a new liberal focus on deregulation, efficiency, and mutual gains from trade.

Liberalism Distinguished Economics and Politics

Emerging in eighteenth-century Britain, liberalism made a key distinction between economics and politics that differentiated it from mercantilism. Adam Smith, David Ricardo, and other early liberal thinkers argued that economic activities should aim to enrich individuals, not enhance state power.

Liberals contended that individuals should be free to make economic decisions in their own self-interest through voluntary transactions in markets. Rather than the state controlling economic matters, liberals believed that the invisible hand of market forces would allocate resources efficiently. They saw the role of the state as creating the conditions for open and fair competition, not intervening to achieve preferred economic outcomes.

In the liberal view, individuals undertaking economic activities to improve their own welfare would collectively produce broader social benefits. This stood in contrast to mercantilists who saw economic policy primarily as a tool to strengthen the nation-state. By decoupling economics from state power, early liberals developed theories that provided the intellectual foundation for free market capitalism.

Liberalism on Trade

Liberalism challenged the prevailing mercantilist belief that countries only benefit from trade when maintaining a surplus in the trade balance. The liberal economic thinkers of the 18th century argued that both the exporting and importing country benefit from trade, regardless of which country has a trade surplus or deficit.

According to liberalism, the purpose of trade is not accumulating wealth for the state, but rather increasing the welfare and consumption choices of a country’s citizens. As such, liberal thinkers contended that countries are better off trading goods that they can efficiently produce at home in exchange for goods that are expensive to produce domestically. This allows all trading partners to enjoy access to a wider variety of goods than they could produce efficiently on their own.

Liberalism holds that voluntary trade is mutually beneficial, as long as it is based on comparative advantage rather than achieving surpluses. Since different countries have varying resources and capabilities, they can maximize wealth creation by specializing in goods they can produce most efficiently and trading for whatever else they require. This interdependence can make all trading partners better off. As the economist David Ricardo demonstrated, two countries can gain from trade even if one country has an absolute advantage in producing all goods.

By shifting the focus from trade surpluses to mutual gains, liberalism laid a strong intellectual foundation for the expansion of free trade. It established trade as a positive-sum game with widespread benefits, challenging the view that one country’s gain necessarily comes from another country’s loss. This liberal trade theory became highly influential in subsequent centuries.

Liberalism on Wealth Creation

Liberalism challenged the mercantilist belief that national wealth derived primarily from manufacturing and trade surpluses. Instead, classical liberal theorists like Adam Smith argued that a nation’s wealth stemmed from efficient production and mutually beneficial trade.

According to liberalism, countries prosper not by hoarding gold and silver, maintaining trade surpluses, or focusing narrowly on manufacturing. Rather, nations grow wealthier by developing their productive capacities across all sectors of the economy. Using scarce resources efficiently to meet market demands allows countries to specialize based on their competitive advantage.

Liberalism contends that through open markets and international trade, countries can benefit by exporting goods produced efficiently at home and importing products made more efficiently abroad. The resultant improvements in living standards, productivity, and innovative capacities, fuel broader economic growth and development. Thus, liberalism links national wealth, not to specific activities like manufacturing, but to the productivity and efficiency gains delivered by market allocation and international trade.

Liberalism Resource Allocation

Liberalism advances a market-based system for resource allocation, asserting that the highest societal welfare emerges when individuals freely make decisions about resource use through voluntary transactions in the marketplace. This contrasts with the mercantilist view that economic activities are too important to be left to unregulated market forces.

According to liberalism, the market efficiently coordinates decentralized information and allows individuals to freely pursue their self-interest. This builds individual and aggregate welfare. Liberal thinkers like Adam Smith contended that an “invisible hand” guides market participants, as if through an invisible hand, to promote ends that benefit society, even if that was not their original intent.

Liberalism prioritizes individual freedom and welfare in economic decision making rather than subordinating individual interests to state power and wealth accumulation. The liberal perspective holds that unconstrained market transactions create greater prosperity. Individuals allocating resources according to personal utility maximizes social welfare since participants directly feel the benefits and consequences of their economic choices.

Conclusion

Source: Oatley, T. H. (2012). International political economy (5th ed). Longman.