Why does mercantilism work

While the government can, and typically does, produce a range of goods and services for general consumption, this role is typically limited. The default position for a capitalist economy is that, unless otherwise specified, a given product or service will be produced and marketed by private individuals using privately-held wealth. Under capitalism, prices are set by competition in the free market. The most important factor is supply and demand. As consumer demand grows against limited supplies, producers will either create more or raise prices.

When demand falls, the market will respond in kind. The logic of capitalism is built around productivity and the idea that wealth can increase over time. This was the idea that Adam Smith introduced.

Modern capitalism descends from Smith's theory that a nation's wealth does not come from its holdings of currency but from the sum of goods and services that it produces. What's more, this pool of wealth can grow over time. By increasing productivity a nation can produce more goods and services and increase its total sum of wealth. Comparative advantage is in many ways capitalism's answer to mercantilism. This is a theory of international trade which teaches that trade and wealth are not zero-sum competitions.

Rather, comparative advantage holds that trade partners can both increase their net wealth even though one will necessarily run a trade deficit against the other. Under comparative advantage, each nation specializes in what it can produce better or more cheaply than its trading partners. This increases the net amount of goods and services produced within the trading bloc, increasing the overall wealth among those nations.

Comparative advantage holds that the lessons of a free market apply on a global scale. Among individuals within a free market economy, competition will generally drive them to work in fields at which they're best.

The same holds true of nations. Without artificial barriers to trade, each nation will produce more of what it's best at, enriching everyone. Let's say 'Empire' takes a classic mercantile trading posture toward 'Nation. It will view every dollar spent on a Nation product as lost because that dollar went out to another country.

As a result, Empire will erect trade barriers such as tariffs, regulatory hurdles and outright embargoes designed to reduce imports from Nation as much as possible. At the same time, it will try to export as much as possible to Nation, often by subsidizing export firms and clearing regulatory hurdles.

Empire doesn't want Nation to erect the same kind of tariffs and obstacles that it erected because it wants trade to flow only one way. Since this is an inherently unfair trading relationship, Empire will typically have to use political, military or outsize market pressure to ensure that Nation's markets stay open while Empire keeps its markets closed.

Nation has a capitalist economy. This economy will look much like the one readers are familiar with in most western states. Most goods and services in the marketplace of Nation will be produced by private citizens. Those citizens will own their own capital, the money and resources used to produce goods and services on the market.

They will decide what to produce and how much of it based on perceived needs in the marketplace and will set prices based on supply and demand. The government of Nation will have some role as a market actor. Since this is a market of individuals incentivized by profit, the government will typically have to exercise significant oversight to prevent abuses. This will involve regulation to prevent predictable or repeat problems. Your Practice. Popular Courses. Key Takeaways Mercantilism in Great Britain consisted of the economic position that, in order to increase wealth, its colonies would be the supplier of raw materials and exporter of finished products.

Mercantilism brought about many acts against humanity, including slavery and an imbalanced system of trade. During Great Britain's mercantilist period, colonies faced periods of inflation and excessive taxation, which caused great distress. Article Sources.

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Articles. International Markets Hong Kong vs. Mainland China: Understanding the Differences. Partner Links. Related Terms Mercantilism Mercantilism was the primary economic system of trade between the 16th and the 18th centuries with theorists believing that the amount of wealth in the world was static.

Commodity Market A commodity market is a physical or virtual marketplace for buying, selling, and trading commodities. Discover how investors profit from the commodity market. Celtic Tiger Definition Celtic Tiger refers to the country of Ireland during its economic boom years between and around What Is Aggregate Demand? Aggregate demand is the total amount of goods and services demanded in the economy at a given overall price level at a given time. Hamilton also proposed tariffs to reduce competition in those areas.

Fascism and totalitarianism adopted mercantilism in the s and s. After the stock market crash of , countries used protectionism to save jobs. They reacted to the Great Depression with tariffs. In the U. World War II's devastation scared Allied nations into desiring global cooperation.

They saw mercantilism as dangerous and globalization as its salvation. But other nations didn't agree. The Soviet Union and China continued to promote a form of mercantilism.

The main difference was that most of their businesses were state-owned. Over time, they sold many state-owned companies to private owners. This shift made those countries even more mercantilist. Neomercantilism fits in well with their communist governments. They relied on a centrally planned command economy. It allowed them to regulate foreign trade. They also controlled their balance of payments and foreign reserves. Their leaders selected which industries to promote. They engaged in currency wars to give their exports lower pricing power.

For example, China bought U. Treasurys to fuel its trade with the United States. As a result, China became one of the largest foreign owners of U. Mercantilism laid the foundation for today's nationalism and protectionism. Nations felt they lost power as a result of globalism and the interdependence of free trade. The Great Recession aggravated a tendency toward mercantilism in capitalist countries. For example, in , India elected Hindu nationalist Narendra Modi.

In , the United States chose populist Donald Trump for the presidency. Some considered Trump's policies a form of neo-mercantilism. For example, Trump advocated expansionary fiscal policies, such as tax cuts, to help businesses. He argued for bilateral trade agreements that are between the two countries, rather than multilateral agreements between many countries.

These are all signs of economic nationalism and mercantilism. Mercantilism opposes immigration because it takes jobs away from domestic workers. Trump's immigration policies followed this mindset.

In , Trump's mercantilist mindset contributed to his launch of a trade war against China. Trump imposed tariffs on Chinese imports, and China responded with its own policies that hurt U. Despite announcing a "Phase 1" deal to end the trade war in , President Trump left office without ending the trade war. In fact, with roughly a week left as president, the Trump administration imposed a new round of trade restrictions covering tomato and cotton products from China, citing concerns over slave labor in China.

The Library of Economics and Liberty. The University of Minnesota Libraries. Harvard University. Accessed Feb. Saylor Academy. Karen Armstrong. New Statesman. Wilson Center. Mises Institute. The Herbert Hoover Library and Museum. World Trade Organization.