Theory of Mercantilism and Theory of Absolute Advantage

Theory of Mercantilism

Mercantilism Theory

The first philosophy of global commerce was mercantilism, which initially appeared in England in the middle of the sixteenth century. The key tenet of this idea is that gold and silver are fundamental to commerce and the foundation of the economy. Gold and silver were utilized as currency during the 16th century, and trade between nations took the form of exchanges of products and services for gold and silver. The nations used to export things in order to gain gold and silver. Similar to exporting products, importing goods causes a flow of gold and silver. During that century, countries were primarily motivated by the desire to earn gold and silver. This theory's central tenet is that the nation should maintain its trade surplus through raising exports relative to imports. In other words, collecting more riches, such as gold and silver, would be in the best interest of the nation.

Based on the aforementioned notions, mercantilism encourages national government action to achieve a trade surplus. By imposing taxes and supporting exports, the government can generate a trade surplus by discouraging imports.

The colonization of resource-rich less developed nations was the main cause of mercantilism. The less developed nations were once colonized by the developed nations who then exploited their resources. The mercantilist nation imported necessary raw commodities including tea, coffee, cotton, tobacco, and rubber, which were then processed into finished goods. Later, colonies received these finished products for export. By purchasing raw materials at a discount and selling the finished products at a higher price, the mercantilist nation made enormous profits. As a result, the mercantilist countries controlled their own trade surplus. One instance of this strategy was the East India Company's colonization of India under the guise of trade.

The economists have harsh words to say about the mercantilism thesis. Both export subsidies and import restrictions negatively impact citizens. Taxpayers ultimately pay for export subsidies. Similar to this, import restrictions also hurt consumers by raising prices. This theory is criticized by experts in international trade as well because it is based on zero-sum games. The scenario where one country gains at the expense of another is known as a zero-sum game. However, because they receive government incentives and subsidies, exporters applaud this approach. Similar to how domestic producers are in favor of mercantilism since it shields them from imports' competition.

Similarly, mercantilists disregarded other opportunities for the nation to amass wealth. A lot of important factors were simply disregarded, including the availability of trained labor, natural resources, capital, and resource strength. These drawbacks of mercantilism theory are addressed by theories like absolute advantage theory and comparative advantage theory.

The theory has received a lot of criticism, but it is nevertheless used in a variety of ways around the globe. Today, governments in every nation take action to influence international trade by placing restrictions on imports and providing incentives for exporters.

Theory of Absolute Advantage

In the 18th century, "Adam Smith," the father of economics, advanced this notion. Smith wrote on the various nations' varying capacities for efficient production of products in his book The Wealth of Nation, which was published in London in 1776. This theory is based on the laissez-faire economy, or freedom of enterprise and commerce, in international trade. According to Smith, all nations would profit from unrestricted free trade, where each nation would focus on the products for which they had the most natural and learned knowledge. According to this notion, a country's imports should be made up of products created more efficiently abroad, while its exports should be made up of products made more efficiently at home.

The English were the world's most effective textile manufacturers during his time, in the 18th century. French were the most effective wine growers because of the good environment and collected knowledge. While the French had an absolute advantage in the wine industry, the English had an absolute advantage in the textile industry. According to the absolute advantage principle, a nation should focus on producing the goods in which it has an absolute advantage before engaging in international trade. Therefore, the French should concentrate on wine production whereas the English should specialize in textile production. By trading textiles for wine, England could buy all the wine it required from France. Selling specialist products allows both countries to benefit in terms of price and quality. Based on this theory Smith criticized the principle of zero-sum game and advocated the principle of the positive game.

There are some elements that give the nation an unquestionable advantage. The availability of natural resources, favorable climate, and skilled workforce increase a nation's capacity to produce specialized goods. These acquired advantages help countries become powerful in the production of specific goods. Tata Steel is currently the sixth largest steel producer in the world, Hero Honda is the largest two-wheeler manufacturer, and Hero Cycle is the top maker of bicycles globally. This is because these businesses have gained a decisive advantage over the rest of the globe.

Three implications flow from the absolute advantage theory:

• There is the possibility to profit from international trade if a nation has a definite advantage in any given good.
• The country produces most effectively and has a greater chance of profiting from international trade the more it specializes in producing goods.
• According to the comparative method, trade profits are not spread equally within a nation.

The absolute advantage argument also emphasizes little to no government intervention in the trade of specialized commodities and services internationally. By itself, the market would be more effective and productive. Government involvement in the economy and in international trade relations (via tariffs and other export/import-discouragement measures) will be counterproductive. The country will profit from free trade because, if it had to make its own goods, imports would be less expensive than domestic items.

This theory's weakness is that it is unable to explain the situation in which a nation has an unbeatable advantage over many goods. Would it still be advantageous for both nations if one produced both goods more effectively than the other? This issue is answered by the theory of comparative advantage.

References

Aswathappa, K. (2010). International Business. New Delhi: Tata McGraw-Hill.

Shenkar, O., Luo, Y., & Chi, T. (2015). International Business. New York: Sage.