The various ideas about 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 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.
- that European countries are in direct competition,
- that whichever country has the most wealth wins that competition, and
- that gold and silver bullion are synonymous with wealth.
A key tenet of mercantilism was that exporting raw or unfinished materials disadvantaged a nation, as greater wealth would result by performing manufacturing work within that nation. Thus for instance England banned the export of unfinished cloth to the Netherlands.
Reliance on foreign trade also appeared harmful. To deal with this England passed the Navigation Acts which forbade any ship that was not English, or carrying goods produced in its own nation, from entering English ports. The effect was to restrict the ability of English colonies to trade with nations other than England.
Mercantilism also fueled the intense violence of the seventeenth and eighteenth 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, it won't do for one's colonies to give gold to others for those others' goods. Thus, trade restrictions limited commerce with outside powerss, 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. Its governor decided to salute the SS Andrea Doria, a ship under the flag of the Continental Congress.
Adam Smith's Invisible Hand and liberal theory of economics gradually put an end to the dominance of mercantilism. Liberalism and mercantilism were fundamentally at odds on one key issue. Mercantilism stated 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 that because needs are different, 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 really nothing more than yellow rock that was valuable only because there wasn't much of it. Most economists now agree with Smith.
Elements of mercantilist theory have still remained in economic discourse throughout the years. One still cannot dispute that 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 such as minerals, timber, oil 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 product, for example, is in its own way a sort of a finished good.)
The economist John Maynard Keynes also saw a great deal of good in mercantilism. While Adam Smith rejected the idea of bullion being more than just another commodity, Keynes saw an inflow of gold and silver as being beneficial. He argued that greater gold reserves would lead to increased borrowing and lower rates of interest that would both stimulate growth and aid government borrowing. Keynes also adopted the essential idea of mercantilism that government intervention in the economy was 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.
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.