International Business and Trade

Module 3

Mercantilism

Mercantilism is a nationalist economic policy that is designed to maximize the exports and
minimize the imports for an economy. In other words, it seeks to maximize the accumulation of
resources within the country and use those resources for one-sided trade.

What is mercantilism in simple terms?

Mercantilism is an economic practice by which governments used their economies to augment

state power at the expense of other countries. Governments sought to ensure that exports
exceeded imports and to accumulate wealth in the form of bullion (mostly gold and silver).Oct
23, 2023

History of Mercantilism

First seen in Europe during the 1500s, mercantilism was based on the idea that a nation's
wealth and power were best served by increasing exports and limiting imports.

Mercantilism replaced the feudal economic system in Western Europe. At the time, England
was the epicenter of the British Empire but had relatively few natural resources.

To grow its wealth, England introduced fiscal policies that discouraged colonists from buying
foreign products and created incentives to buy only British goods. For example, the Sugar Act
of 1764 raised duties on foreign refined sugar and molasses imported by the colonies. This
increased taxation was meant to give British sugar growers in the West Indies a monopoly on
the colonial market.

Merchants and Mercantilism

By the early 16th century, European financial theorists understood the importance of the
merchant class in generating wealth. Cities and countries with goods to sell thrived in the late
middle ages.

Consequently, many believed the state should allow its leading merchants to create exclusive
government-controlled monopolies and cartels. Governments used regulations, subsidies, and
(if needed) military force to protect these monopolistic corporations from domestic and foreign
competition.

Citizens could invest money in mercantilist corporations in exchange for ownership and limited
liability in their royal charters. These citizens were granted shares of the company profit. In
essence, these were the first traded corporate stocks.

Mercantilism vs. Imperialism

Mercantilist governments manipulate a nation's economy to create favorable trade balances.

Imperialism uses a combination of military force and mass immigration to foist mercantilism on
less-developed regions. Military campaigns forced inhabitants to follow the dominant countries'
laws. One of the most powerful examples of the relationship between mercantilism and
imperialism is Britain's establishment of the American colonies.
Mercantilism vs. Capitalism

Capitalism provides several advantages over mercantilism for individuals, businesses, and
nations. With capitalism's free-trade system, individuals benefit from a greater choice of
affordable goods. On the other hand, mercantilism restricts imports and reduces the choices
available to consumers. Fewer imports mean less competition and higher prices.

Mercantilist countries engaged in warfare frequently to control resources. Nations operating

under a free-trade system prospered by engaging in mutually beneficial trade relations.

Mercantilism Today

Today, mercantilism is deemed outdated. The disaster of World War II underscored the
potential danger of nationalistic policies. It also prodded the world toward global trading and
relationships as a way to combat them.

However, it is hard to escape mercantilism. For example, after the war, barriers to trade were
still used to protect locally entrenched industries. The United States adopted a protectionist
trade policy toward Japan and negotiated voluntary export restrictions with the Japanese
government, which limited Japanese exports to the United States.

Today, Russia and China still use a mercantilist system because it partners so well with
their forms of government. They have relied heavily on their ability to control foreign trade, their
balance of payments, and foreign reserves. They have also sought to make their exports
relatively more attractive with lower pricing.

Due to the effects of globalization, many nations and their people suffer from feeling that
they've lost wealth, control, and prestige. This has made the nationalism that is part of
mercantilism more appealing. It helped bring to power the likes of Donald Trump in the U.S.
and Narendra Modi in India.

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What Is Absolute Advantage?

Absolute advantage is the ability of an individual, company, region, or country to produce a

greater quantity of a good or service with the same quantity of inputs per unit of time, or to
produce the same quantity of a good or service per unit of time using a lesser quantity of
inputs, than its competitors.

Absolute advantage can be accomplished by creating the good or service at a lower absolute
cost per unit using a smaller number of inputs, or by a more efficient process.

 Absolute advantage is when a producer can provide a good or service in greater

quantity for the same cost, or the same quantity at a lower cost, than its competitors.
 A concept developed by Adam Smith, absolute advantage can be the basis for large
gains from trade between producers of different goods with different absolute
advantages.1
 By specialization, division of labor, and trade, producers with different absolute
advantages can always gain more than producing and consuming in isolation.
 Absolute advantage can be contrasted with comparative advantage, which is the ability
to produce goods and services at a lower opportunity cost.

Absolute Advantage vs. Comparative Advantage

Absolute advantage can be contrasted with comparative advantage, which is when a producer
has a lower opportunity cost to produce a good or service than another producer. An
opportunity cost is the potential benefits an individual, investor, or business misses out on
when choosing one alternative over another.2

Absolute advantage leads to unambiguous gains from specialization and trade only in cases
where each producer has an absolute advantage in producing some good. If a producer lacks
any absolute advantage, then Adam Smith’s argument would not necessarily apply.

However, the producer and its trading partners might still be able to realize gains from trade if
they can specialize based on their respective comparative advantages instead.3 In his
book On the Principles of Political Economy and Taxation, David Ricardo argued that even if a
country has an absolute advantage over trading many kinds of goods, it can still benefit by
trading with other countries if that have different comparative advantages.

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What Is the Heckscher-Ohlin Model?

The Heckscher-Ohlin model is an economic theory that proposes that countries export what
they can most efficiently and plentifully produce. Also referred to as the H-O model or 2x2x2
model, it's used to evaluate trade and, more specifically, the equilibrium of trade between two
countries that have varying specialties and natural resources.1

The model emphasizes the export of goods requiring factors of production that a country has in
abundance. It also emphasizes the import of goods that a nation cannot produce as efficiently.
It takes the position that countries should ideally export materials and resources of which they
have an excess, while proportionately importing those resources they need.2

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Modern Firm-Based Theories of International Trade

Porter’s National Advantage Theory

Porter's National Competitive Advantage Theory

In the continuing evolution of international trade theories, Michael Porter of Harvard Business
School developed a new model to explain national competitive advantage in 1990. Porter's
theory stated that a nation's competitiveness in an industry depends on the capacity of
the industry to innovate and upgrade. His theory focused on explaining why some nations
are more competitive in certain industries. To explain his theory, Porter identified four
determinants that he linked together. The four determinants are (1) local market resources and
capabilities, (2) local market demand conditions, (3) local suppliers and complementary
industries, and (4) local firm characteristics.

1. Local market resources and capabilities (factor conditions). Porter recognized the
value of the factor proportions theory, which considers a nation's resources (e.g., natural
resources and available labor) as key factors in determining what products a country will
import or export. Porter added to these basic factors a new list of advanced factors,
which he defined as skilled labor, investments in education, technology, and
infrastructure. He perceived these advanced factors as providing a country with a
sustainable competitive advantage.
2. Local market demand conditions. Porter believed that a sophisticated home market is
critical to ensuring ongoing innovation, thereby creating a sustainable competitive
advantage. Companies whose domestic markets are sophisticated, trendsetting, and
demanding forces continuous innovation and the development of new products and
 technologies. Many sources credit the demanding US consumer with forcing US
software companies to continuously innovate, thus creating a sustainable competitive
advantage in software products and services.
3. Local suppliers and complementary industries. To remain competitive, large global
firms benefit from having strong, efficient supporting and related industries to provide the
inputs required by the industry. Certain industries cluster geographically, which provides
efficiencies and productivity.
4. Local firm characteristics. Local firm characteristics include firm strategy, industry
structure, and industry rivalry. Local strategy affects a firm's competitiveness. A healthy
level of rivalry between local firms will spur innovation and competitiveness.

In addition to the four determinants of the diamond, Porter also noted that government and
chance play a part in the national competitiveness of industries. Governments can, by their
actions and policies, increase the competitiveness of firms and occasionally entire industries.

Porter's theory, along with the other modern, firm-based theories, offers an interesting
interpretation of international trade trends. Nevertheless, they remain relatively new and
minimally tested theories. https://learn.saylor.org/