Wednesday, November 26, 2014

The New Mercantilist Challenge

CAMBRIDGE – The history of economics is largely a struggle between two opposing schools of thought, “liberalism” and “mercantilism.” Economic liberalism, with its emphasis on private entrepreneurship and free markets, is today’s dominant doctrine. But its intellectual victory has blinded us to the great appeal – and frequent success – of mercantilist practices. In fact, mercantilism remains alive and well, and its continuing conflict with liberalism is likely to be a major force shaping the future of the global economy.

Today, mercantilism is typically dismissed as an archaic and blatantly erroneous set of ideas about economic policy. And, in their heyday, mercantilists certainly did defend some very odd notions, chief among which was the view that national policy ought to be guided by the accumulation of precious metals – gold and silver.

Adam Smith’s 1776 treatise The Wealth of Nations masterfully demolished many of these ideas. Smith showed, in particular, that money should not be confused for wealth. As he put it, “the wealth of a country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds.”

But it is more accurate to think of mercantilism as a different way to organize the relationship between the state and the economy – a vision that holds no less relevance today than it did in the eighteenth century. Mercantilist theorists such as Thomas Mun were in fact strong proponents of capitalism; they just propounded a different model than liberalism.

The liberal model views the state as necessarily predatory and the private sector as inherently rent-seeking. So it advocates a strict separation between the state and private business. Mercantilism, by contrast, offers a corporatist vision in which the state and private business are allies and cooperate in pursuit of common objectives, such as domestic economic growth or national power.

The mercantilist model can be derided as state capitalism or cronyism. But when it works, as it has so often in Asia, the model’s “government-business collaboration” or “pro-business state” quickly garners heavy praise. Lagging economies have not failed to notice that mercantilism can be their friend. Even in Britain, classical liberalism arrived only in the mid-nineteenth century – that is, after the country had become the world’s dominant industrial power.

A second difference between the two models lies in whether consumer or producer interests are privileged. For liberals, consumers are king. The ultimate objective of economic policy is to increase households’ consumption potential, which requires giving them unhindered access to the cheapest-possible goods and services.

Mercantilists, by contrast, emphasize the productive side of the economy. For them, a sound economy requires a sound production structure. And consumption needs to be underpinned by high employment at adequate wages.

These different models have predictable implications for international economic policies. The logic of the liberal approach is that the economic benefits of trade arise from imports: the cheaper the imports, the better, even if the result is a trade deficit. Mercantilists, however, view trade as a means of supporting domestic production and employment, and prefer to spur exports rather than imports.

Today’s China is the leading bearer of the mercantilist torch, though Chinese leaders would never admit it  – too much opprobrium still attaches to the term. Much of China’s economic miracle is the product of an activist government that has supported, stimulated, and openly subsidized industrial producers – both domestic and foreign.

Although China phased out many of its explicit export subsidies as a condition of membership in the World Trade Organization (which it joined in 2001), mercantilism’s support system remains largely in place. In particular, the government has managed the exchange rate to maintain manufacturers’ profitability, resulting in a sizable trade surplus (which has come down recently, but largely as a result of an economic slowdown). Moreover, export-oriented firms continue to benefit from a range of tax incentives.

From the liberal perspective, these export subsidies impoverish Chinese consumers while benefiting consumers in the rest of the world. A recent study by the economists Fabrice Defever and Alejandro Riaño of the University of Nottingham puts the “losses” to China at around 3% of Chinese income, and gains to the rest of the world at around 1% of global income. From the mercantilist perspective, however, these are simply the costs of building a modern economy and setting the stage for long-term prosperity.

As the example of export subsidies shows, the two models can co-exist happily in the world economy. Liberals should be happy to have their consumption subsidized by mercantilists.

Indeed, that, in a nutshell, is the story of the last six decades: a succession of Asian countries managed to grow by leaps and bounds by applying different variants of mercantilism. Governments in rich countries for the most part looked the other way while Japan, South Korea, Taiwan, and China protected their home markets, appropriated “intellectual property,” subsidized their producers, and managed their currencies.

We have now reached the end of this happy coexistence. The liberal model has become severely tarnished, owing to the rise in inequality and the plight of the middle class in the West, together with the financial crisis that deregulation spawned. Medium-term growth prospects for the American and European economies range from moderate to bleak. Unemployment will remain a major headache and preoccupation for policymakers. So mercantilist pressures will likely intensify in the advanced countries.

As a result, the new economic environment will produce more tension than accommodation between countries pursuing liberal and mercantilist paths. It may also reignite long-dormant debates about the type of capitalism that produces the greatest prosperity.

Read more from our "The Clash of the Capitalisms" Focal Point.

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    1. CommentedJose araujo

      First, there is no such thing as "liberalism" in economy, you have the classics and neo-classics. Mercantilism is an 17th-18th century theory and the major opposition came from the Physiocrats - Agrarian vs Trade.

      To major formal errors from a Professor of Social Sciences, but a bigger one on not recognizing that importance of Marxism, Keynesianism and Monetarism, all off them at par with the classics and neo-classics in the economic wall-of-fame.

      Last but not the least, supply-side economics is something you link to the "Neo-Classics", demand is linked to Keynesians, so a major error on the proposition Mercantilism-supply and "liberalism" (whatever that means) - demand.

    2. CommentedSithembiso Malusi Mahlaba

      Both economic concepts are neither bad nor good, but each one will be relevant to peculiar situation for specific objectives indeed. For developmental state mercantilism seems an appropriate approach, from my perspective in Afrika, up until such time, an element of liberalism to some degree can be factored in economic equation. There is nothing cast in stone indeed, as global forces can change directions at anytime, therefore any concept applied must evolve with changing times.

    3. CommentedRitesh Kumar Singh

      Chinese mercantilist policy (a combination of overt-covert subsidies, manupulation of exchange rate and export restriction with respect to industrial raw materials) have resulted in huge trade deficit for the US (of late for India as well). Troubled EU and US means China will have to look towards boosting domestic consumption as exporting to EU or the US will be more difficult going forward. This is perhaps the most serious limitation of mercantilism. Each country will grow if trade is fair...otherwise some countries will grow faster but slow growing countries will finally pull down everyone. The solution is to go for multilateral trade lineralization under WTO framwork...and not EU or the US going the mercantilist way.

    4. CommentedEtienne Schneider

      I do not think that Germany is a mercantilist country in the way the author describes it. Germany does not exercise so much control over companys, and especially not over banks and the financial sector as China does. Due to the centralised monetary policy of the ECB Germany would not even have the power even if it would like to do .

      The fact that Germany is profiting from the weak Euro is more a happy coincidence for Germany that the willingness of german policy makers to work towards a weak euro.

        CommentedAxel Cabrol

        Of course Germany is following a mercantilist model: Schroders and Harz reform was a clear trade off between consumption and productive investment in Germany. ove rthe last 10 yrs German rea wages stagnated: this is not exactly a preference for consumption.
        Moreover the German example shows the political/social control over companies or production is not only channeled through central government control.

    5. CommentedKir Komrik

      Thanks for the mainstream but reasonable perspective,

      imo, both mercantilism and liberalism are failures. It's just that the "liberals" don't realize it yet. It's not durable. It's unjust. It's unsustainable. It's time for fresh, new ideas that are truly original and not a rehash of old ones, imo. It's time for genuine global rule of law with General Federalism and Fiducial Economics, imo ... or a better idea if I hear one.

      - kk

    6. CommentedYoshimichi Moriyama

      Which is right or true, economics of liberalism or that of mercantilism? This questiion is meaningless like that of which is right or true, a microscope or a telescope. Each scope has its due area in which to function.

      Though it is hard for us to understand why people of the eighteenth century upheld mercantilism, there was much "turth" in the belief that hoarding precious metals bred wealth, because it made it possible for an emerigng nation-state, Great Britain or France or whatever, to accumulate capital for industrialization. (There was another important reason which was social and therfore political, namely to protect society from disintegrative economic forces. I do not think this reason is obsolete.)

      It misses the point if we compare the two economic theories on a purely theoretical plane. We must compare them, placing each in its own interacitons with its specific
      social conditions.

    7. CommentedJoshua Ioji Konov

      Great article Mr. Rodrik..
      from the prospective of "liberalism" and "mercantilism", the mostly productivity and big business liberalism's driven economy is less diverse and more globalization inclined, however, with the globalization and rising productivity, and with China's industrialization the reliance of the Transnational corporations to keep the entire world happily employed and fiscal reserves in plenty are just an illusion...., the point that China is subsidizing thus cutting on the consumer actually does not comply with the dataset that shows rapidly rising internal consumption for the last few years accelerated particularly by the new administration in China..., to balance salaries by governmentally run enterprises and projects, however could be partially replaced by a flourishing small and medium business and investors activities in the conditions of more fair competition..., which theory is not neither schools product, because only under most recent global market conditions of improving technologies and rising productivity in such globalization such new industrial capacity is possible that could carryon long term lack of Inflation diverse economic development..., Sincerely.

    8. CommentedPaul Hanly

      Germany can also be viewed as a mercantilist nation, benefiting from the weak Euro caused by the weakness in the periphery to export more than it otherwise could.

    9. Commentedsrinivasan gopalan

      Rodrik's subtle points of how a Marxist model has unobtrusively unleashed and underpinned mercantile forces to subsidize consumption of liberals in the western markets heightens the injustice to the people of the Middle Kingdom who had been the silent and hapless victims of the state-sponsored repressive policies. Cohabitation of mercantilism with market forces and central planning with communist ideologies has come a full circle now that the developed countries too remain the weakest link in global economy while the Asian countries including China and India are contributing to the growth stories in whatever limited way they could. A point to ponder is that in all the debate about capitalism, mercantilism or communism or state-guided public policies to shore up their export industry either through artificial managing of currencies or providing inexpensive infrastructure and liberal fiscal policies, most of the citizens of the world now feel the pinch and paroxysm of pain the resultant inequality has led to. It is time a root-and-branch rethinking emerged that would help identify each country's potentials and frailties so that they could be welded in a cohesive manner to achieve growth with equity to all. G.Srinivasan, Journalist, New Delhi

    10. CommentedMichael Muoio

      We have not managed our trade policy in the national interest, but rather in the interest of global corporatism.

      After essentially 32 years of wrong turns and existential damage, could Rumpelstiltskin be stirring?

      I certainly hope so but I see little evidence of it.

      Obama just did the Korean Free Trade deal and our trade deficit with them shot up 16% almost instantaneously.

      The fix on this one will be more than discussion and debate.

    11. Portrait of Pingfan Hong

      CommentedPingfan Hong

      "Today’s China is the leading bearer of the mercantilist torch":this statement needs some qualification. First of all, if Chinese trade policy in the past 30 years did have a streak of mercantilist, it must be imported from the West, as more than 50 per cent of Chinese exports have been produced by foreign companies in China, and those foreign companies are the teacher of mercantilism for Chinese policymakers. Secondly, in recent years, particularly after the global financial crisis, mercantilist policies have revived significantly in the US and Europe in the form of anti dumping and countervailing measures against China,while China has been calling for free trade in G20 and other international policy forums.

    12. CommentedJan Smith

      It is even worse than Professor Rodrik says. The neoliberals are in denial not only about the worldwide success of mercantilist industrial development. Wedded to the bizarre and extreme views of Say and Walrus, they ignore the Malthusian-Ecclesian-Keynesian tradition and, hence, cannot understand the nature and causes of the ongoing crisis.

      The neoliberals are divided into two camps. One camp says the economy will recover quickly and completely if left alone; the other camp says the economy will recover quickly and completely only if there is a massive and continuing transfer of debt from the private to the public sector.

      Could it be that both camps are wrong? That neoliberalism never will recover?

    13. Commentedaj mendespt

      "It may also reignite long-dormant debates about the type of capitalism that produces the greatest prosperity".

      Yes, but we need to consider more types of capitalism not just two. For instance the problems in Western countries are mostly due to the rise of managerial capitalism and its alliance with state capitalism.
      See these posts on capitalism:

    14. CommentedProcyon Mukherjee

      “Un-hindered access to the cheapest goods”, as Mr. Rodrik points out, could quite be the hallmark of the current mercantilism in vogue, but I am not so sure whether this is fairly ubiquitous across all products in the developed world; to pick a few like credit, higher education, health, welfare goods and public goods in general, could be out of sync with this general notion. State capitalism on the other hand has some brilliant examples as in the state of Gujarat in India, but I am not so sure whether the success rate for the start-up ventures there would eventually hold good for sustainable periods of time, when state subsidies in all forms get eased out and the more fundamental intrinsic factors that lead to success of businesses come to the fore.

      Procyon Mukherjee

    15. CommentedV S

      Ok, everyone knows the problems and the questions. But, where are the answers?! Or, at least a couple of possibilities?

        CommentedMichael Muoio

        Labor equalization tariffs applied directly or via VAT would be a good first step.

        CommentedZsolt Hermann

        I would argue that we still do not know the root of the problems, or more precisely we try very hard to ignore it.
        Instead we philosophize about different systems that all became obsolete.
        The root problem is that humanity is forcing an unnatural and unsustainable socio-economic system within a natural system that is regulated by strict natural laws.
        We are basing our life on the assumption that humans are above the system and can do whatever they like, inventing their subsystems, their own laws.
        Thus we invented and blew out of proportion the present overproduction/over consumption economy and its facilitating governing structures.
        The present system is basically built on implanting unnatural, artificial desires into humans, who otherwise would not have any willingness to consume, by sophisticated marketing and subsequent social pressure.
        This artificial bubble is then inflated continuously driving everybody, individuals and nations alike into debt burdens while piling up things nobody truly needs.
        According to certain estimates over 90% of the production of goods worldwide is simply obsolete, unnecessary for a normal, comfortable, modern human life, moreover is mostly harmful.
        We do not need to go backwards with theories, we need to learn and accept the system we exist in and apply its natural laws to consumption and lifestyle.
        Humans are part of the natural system, for a sustainable future and survival we need to adapt like any other species that want to continue on the evolutionary path.