The balance-of-trade doctrine and the specie-flow mechanism

Mercantilism

The term ‘mercantilism’ first acquired significance at the hands of Adam Smith. ‘The different progress of opulence in different ages and nations has given occasion to two different systems of political economy, with regard to enriching people ‘,

The balance-of-trade doctrine and the specie-flow mechanism

The leading features of the mercantilist outlook are well known: gold bullion and treasure of every kind as the essence of wealth; regulation of foreign trade to produce an inflow of gold and silver; promotion of industry by encouragement of cheap row-material imports; protective duties on imported manufactured goods; encouragements of exports, particularly finished goods; and an emphasis on population growth, keeping wages low. The core of mercantilism, of course, is the doctrine that a favourable balance of trade is desirable because it is somehow productive of national prosperity. Like an individual, a country must spend less than its income if its wealth is to increase. Money was falsely equated with capital and the favourable balance of trade with the annual balance of income over consumption. The idea that an export surplus is the index of economic welfare may be described as the basic fallacy that runs through the whole of the mercantilist literature. A country earns foreign exchange by either

1. Visible commodity exports,

2. Invisible export of services,

3. Export of precious metals or

4. Imports of capital, either in the form of foreign investment at home, profits on its own foreign investment abroad, or loans granted by foreigners.

A country spends foreign exchange by

1. Visible imports,

2. Invisible imports,

3. Import of precious metals and

4. Exports of capital in general form of acquiring claims on foreigners.

The four items always balance because if the first three do not, the difference appears as a capital export or import. When mercantilist authors speak of a surplus in the balance of trade, however, they mean an excess of exports, both visible and invisible, over imports, calling either for an inflow of gold or for the granting of credit to foreign countries, that is, capital exports. Thomas Mun, writing as early as 1630, had realised that an inflow of bullion raises domestic prices and that ‘selling dear and buying cheap’ tends to turn the balance of trade against a country. Thomas Mun had shown that any net deficit or surplus in the balance on current account, the visible plus invisible items, must be financed by the outflow or inflow of bullion and, hence, that the volume of exports imports depends upon relative price levels in different countries. Writing in the 1690s, John Locke made it perfectly clear that prices vary in a definitive proportion to the quantity of money in circulation. Cantillon and Hume restated this argument in the eighteenth century and for a century or more this ‘specie-flow mechanism’ provided the definitive refutation of mercantilist principles. Purely automatic forces, the argument ran, tend to establish a ‘natural distribution of specie’ between the trading countries of the world and levels of domestic prices in different countries such that each country’s exports come to be equal to its imports. Any additional mining of gold in one country will raise its price level relative to those of other countries; the resulting import surplus must be financed by a specie outflow; this engenders the same reaction in the gold- receiving country; and the process continues until all trading nations have established a new equilibrium between imports and exports corresponding to the higher supply of gold. The preoccupation of the mercantilist with gold inflows was no ‘puerile obsession’, Keynes declared, but an intuitive recognition of the connection between plenty of money and low interest rates. When direct public investment or monetary policy is out of the question, as it was before modern times, the best that can be done is to encourage inflation through a favourable balance of trade: the export surplus serves to keep up prices and the inflow of gold lowers interest rates, thus stimulating investment and employment by boosting the money supply. This, Keynes felt, was ‘the element of scientific truth in mercantilist doctrine’. English economists railed against ‘locking up money’, converting it into ‘dead stock’; they urged spending on luxury goods and proposed public works programmes to relieve ‘supernumeraries’

Date: 2016-01-14; view: 649