History of Economics


2nd Mercantilism and physiocrats





1st Introduction to the problem

2nd Term and dissemination of mercantilism

3rd The most important representatives of mercantilism

4th The philosophy of mercantilism

5th Aim hierarchy

6th The monetary theory foundations

7th The customs policy instruments of mercantilism




1st Introduction to the problem


In the first part of this lecture we will introduce the most important doctrines that have been developed in the course of the history of economics.


We had already mentioned in the introductory chapter 1 that modern economics begins with Adam Smith in the late 18th century. For this reason, one might be inclined to let this teaching history also begin with Adam Smith.


But now we had already mentioned in the first chapter that the teachings of Adam Smith were created as reactions against the mercantilism which was taught and practiced at that time. For these very reasons it might be appropriate to begin this history of teaching with mercantilism, since we can only understand and classify the reactions of the teachings founded by Adam Smith correctly if we also know the main principles and practices of mercantilism, which the liberalism of Adam Smith had opposed. Thus, we begin our doctrinal history overview with the presentation of mercantilism.


However, there is a second reason to begin this teaching history with mercantilism. In the course of this lecture, we will be able to see that at almost all times of the examined epochs, predominantly only two basic tendencies have argued and fought against each other, that one group (the liberalism) was concerned with making visible that a market-economy system was the best of all possible solutions, while the second group (the interventionists) fought for the conviction that an economic system only produces satisfactory results if it is guided and influenced in decisive points by the state.


One of these two directions can be traced back to the liberalism taught by Adam Smith, while the other direction has always drawn on the measures and ideas already practiced by mercantilism. Of course, this permanent debate can only be understood properly if we know the beginnings of both directions. In fact, the ideas of John Maynard Keynes, for example, are sometimes described as neo-mercantilistic. For these reasons, too, we want to begin this history of economic theory with mercantilism.



2nd Term and dissemination of mercantilism


The term 'mercantilism' originally comes from Latin and is derived from the word 'mercari = trading'. Marquis de Mirabeau was probably the first to speak of mercantilism in 1763, thus referring to the prevailing economic theory at that time. Adam Smith, too, had always spoken of mercantilism when he opposed these teachings. Later on, this term was used generally to refer to the then prevailing doctrine; while at first only the critics of this doctrine (Mirabeau and Smith) spoke of mercantilism, the term was later used by the followers of this doctrine.


Mercantilism thus means political influence by the state on trade and production in general and foreign trade in particular. Today, this term is largely equated with interventionism of the state of any kind, which aims to influence private economic entities, but principally enterprises.


Mercantilism in the form in which Adam Smith opposed it was the economic policy doctrine of absolutism. Absolutism was the predominant state system beginning at the end of the 16th until the 18th century and disseminated mainly in France, but also in a somewhat weaker form in England and in several German small states. Here, absolutism initially emerged in France and reached its peak under the Sun King Louis XIV and under King Louis XV. The manner in which Louis XIV ruled and held court in Versailles soon became a model for the other rulers in Europe, especially for the Saxon King August the Strong.


The absolutist king strove for the exclusive rule in his dominion. Louis XIV is supposed to have said once: 'I myself am the nation' (L'État, c'est moi). In the Middle Ages and in the beginning of modern times, the respective ruler had to share his power with the nobility and the clergy, he was controlled by the parliaments of the estates, in which nobility, clergy and citizens were represented.


In this context, the parliaments of the estates had primarily the right to tax approval. In this way, they could significantly curtail the power of the king. At the same time, the king was also dependent on the nobility, as all activities at court and in war were carried out by the nobility. On the one hand, the nobles were obliged to work for the king in this way, namely by providing mercenaries for the war campaigns of the kings, and on the other hand, they had to carry out the most varied tasks at court. On the other hand, however, the king himself depended in this manner on the willingness of the nobility to cooperate.


The absolutist rulers now strove to break this power of the estates. For this purpose, they created a standing army, which meant that warfare and its success no longer depended on how many combat-ready and trained mercenaries were provided by the nobility. At the same time, they established a civil service with the help of which all tasks at court could be carried out, so that the king was no longer dependent on the services of the nobility at court.


In this way, the king was able to use his scarce resources much more efficiently than before. On the one hand, for the individual tasks the most capable officials could be assigned. On the other hand, the fact that now certain people were always available for the same task increased their abilities even more.



3rd The most important representatives of mercantilism


As already outlined, mercantilism originated in France and was also most widespread there. A forerunner of French mercantilism was Jean Bodin, lawyer and natural law philosopher, who lived from 1530 - 1596. He had also recognised already the central importance of an active trade balance for the welfare of a nation, a major concern of French mercantilism.


But the main representative of mercantilism in France was Jean Baptiste Colbert, who lived from 1619 to 1683 and was Louis XIV's finance minister for a longer period. According to his ideas, the aim of an active trade balance was to be achieved by way of a corresponding protectionist customs policy. Thus, Colbert increased import duties, while on the other hand he tried to promote exports by all available means. The development of a French merchant fleet served to strengthen foreign trade. Colbert also emphasised already the importance of the colonies for the French economic system.


But according to Colbert, the aims of mercantilism should not only be achieved by promoting foreign trade. Colbert also pursued the aim of promoting domestic production by granting monopolies, further by quality controls, protective measures and state subsidies. These measures were so typical for French mercantilism that in France it was simply referred to as 'Colbertism' in the subsequent time.


In England the mercantilist ideas were mainly represented by William Petty, a British economist and statistician who lived from 1623 to 1687. From a historical point of view, he carried out one of the first econometrical studies on Ireland. He is also considered a forerunner of classical economics and supported an only moderate mercantilism. With him, also the first approaches to labour value theory were found, which later became the focus of David Ricardo's analyses. It was also Petty who introduced statistical and demographical methods into economic analysis.


Eventually, in Germany a very special variety of mercantilism emerged - mainly due to a political particularism. Here, the focus was less on questions of foreign trade than rather the efficient organisation of state administration, and this political debate brought about a wealth of administrative literature. For example, Joseph Schumpeter had spoken of the fact that in England merchants wrote for merchants, whereas in Germany professors and civil servants wrote for civil servants. Johann Peter Süßmilch, the field preacher of Frederick the Great, was of particular importance among the cameralists with his work on 'the divine order in the conditions of the human race', which marked the beginning of a population theory. Professor Johann Joachim Becher from Mainz also achieved greater importance among the cameralists, as he already distinguished between monopolies (Monopolium) and competition (Polypolium), thus heralding the beginning of the theory of market for structure.


Despite a uniform name, the mercantilistic works differ considerably between the individual countries. True, all mercantilists strive to give their rulers advice on wise economic policy, but it is difficult to find a common denominator for these works. Only on the one issue of the crucial importance of the precious metals gold and silver for the prosperity of the economy all mercantilists did agree. A country should make an effort to keep the precious metals in the country or, if it does not have its own gold and silver mines, to bring them in by foreign trade (by means of an active trade balance).



4th The philosophy of mercantilism


In almost all the treatises of the representatives of mercantilist theses a basic conviction is emerging: The advantage of the one (country) becomes the disadvantage of the other (country). One could initially interpret this relationship from a moral point of view. Accordingly, one is entitled to strive for one's own advantage, even if the other one suffers a disadvantage. According to Christian conviction, this may be considered amoral and therefore undesirable, since Christian morality draws a line for selfish striving where another person suffers harm because of the own actions.


However, the mercantilist philosophy goes a step further and interprets the statement: 'the advantage of one is the disadvantage of the other' not only in a moral sense. It understands this statement as an explicative statement in the sense that no other relationship between two partners is possible. Whenever an activity is to the advantage of the one, the other always suffers disadvantages. Either I harm the other or he harms me. Another alternative is not seen at all. In this world, the natural law of 'eat or be eaten' also applies to interpersonal relationships.


Let's take a closer look at this mercantilistic basic conviction by starting from a matrix that lists all possible alternatives that are available to an acting person. We can - if we take advantage and disadvantage as criteria for classification - distinguish between five possible alternatives.


Alternatives 1 and 2: It is quite conceivable that certain open alternatives do not bring any advantage at all to the respective actor (alternative 1) and in some cases even cause harm (alternative 2). Here, it is irrelevant how the situation of the partners changes: This can remain unaffected, bring advantages, but also harm.


It is clear, a person who is trying to maximise its benefits will not choose such alternatives, nor will anyone who is not characterised by an altruistic attitude give the advice to choose such alternatives.


Alternative 3: Furthermore, alternatives are conceivable which bring advantages to the respective actor (perhaps even merely promise advantages), without affecting the situation of the respective other. There will probably be nobody who advises against such an alternative. Even to those who respect the interests of their fellow human beings, this alternative will generally be considered desirable.


Alternative 4: We now look at the alternatives which promise advantages to the actor just like alternative 3, but at the same time cause harm to fellow human beings. It is clear. This is where the opinions differ: While the mercantilist clearly considers such an alternative to be justified and also desirable, a Christian-based morality comes to a rejection. Of course, either here, it is not rejected that such alternatives exist and that a majority of people regard such alternatives as justified.


Alternative 5: Finally, those alternatives remain in which all involved parties gain advantages. It is clear, in these cases such alternatives are considered highly desirable from all points of view.


Of course, another alternative could also be conceivable, where the advantage of the actor would show different effects on third parties: Some are harmed by the action, others also experience advantages, a third group remains unaffected. However, we can assign such possibilities to alternatives 3, 4 and 5, which have already been discussed. In this case, an action comprises several alternatives - with regard to the effects on others - and thus represents a mix of the other alternatives.


The essential difference between mercantilists and other directions is now that mercantilism differs from other schools of thought not only in how the individual actions are judged morally. Mercantilism also denies, in contrast to other directions, that there are alternatives in the real world that do not belong to category 4. The advantage of the one is (almost) always connected with a disadvantage of another. This means that from a mercantilistic point of view category 4 contains 100% of the alternatives, while all other categories are empty.


We need to ask ourselves now, on the basis of what findings has mercantilism arrived at this pessimistic view, does this conviction not contradict our everyday experiences? Don't we notice in our lives that at least some of the possible alternatives are beneficial to feasibly several people at once?


The answer to this question can be found in the consideration of the trade balance. The trade balance of a country compiles all income and expenditure resulting from trade with other economies. On the left-hand side of the balance sheet we enter all income from trade relations with other countries, while on the right-hand side we enter all expenditure arising from foreign trade relations.


Instead of the trade balance, we could have chosen the current account balance or even the balance of payments. The current account balance is based on the trade balance and furthermore includes revenues and expenditures from the transfer of services and unpaid performances. Finally, the balance of payments includes all payment flows from foreign trade relations, i.e. starting from the current account balance additively short and long-term capital movements including foreign exchange trade, are also taken into account. The fact that mercantilism was generally based on the trade balance rather than the current account was simply due to the fact that trade in services was not yet a major factor in international trade. Finally, the balance of payments is less suitable for our considerations, simply because a balance of payments is by definition always in balance.


In general, imports are paid by foreign exchange revenues which are generated due to the export of goods. If the values of exports and imports were the same, all imports could be paid from the foreign exchange revenues in connection with the exports.


However, foreign trade transactions can always be paid with gold, the official international currency of the time. Importers feel compelled to take this step if the foreign exchange revenues from exports are not sufficient to pay for all intended imports. Basically, the importer can always pay for his imports with both forms of payment. Whether he pays with foreign exchange or with gold depends solely on whether foreign exchange or gold achieves a lower price. Whenever less is exported than is imported, the exchange rates rise with the consequence that at a certain price the purchase of gold becomes cheaper and it pays off for the importer to pay with gold. This price of a currency is therefore also called gold-point.


The import value in this case corresponds by definition to the sum of foreign exchange revenues plus the payment with gold, which must automatically lead to a gold export.


Conversely it applies, of course, that if the export value total exceeds the import value total, then for exports it is no longer exclusively foreign exchange that is received, but that exports partly lead to gold revenues and thus to gold imports. Here too, it applies that in the case of an export surplus, the sum of foreign exchange earnings and gold imports corresponds to the export value total. Both sides of the balance of payments are therefore always - at any given moment - by definition balanced if, in addition to the proceeds from the transfer of goods, the transfer of gold is also included in the analysis.


Let us now consider additionally the balance of trade of the countries which do foreign trade with us. By definition, the import value total of our economy is equal to the export value total of all our trading partners. This relationship results simply from the fact that the same goods leaving our country, i.e. which are exported, are imported by one of our trading partners, so that both values must be the same, since they relate to one and the same goods. The same applies, of course, mutatis mutandis to the export value of our country. For the same reasons, this also corresponds to the import value total of the foreign economies with which we do foreign trade.




From these considerations follows now that an export surplus of the own country is always accompanied by an equally large import surplus of our trading partners. If we now strive for an export surplus, this is tantamount to the fact that if these efforts are successful, foreign countries as a whole must automatically achieve an equally large import surplus with respect to our national economy.


In general, we speak of an active trade balance of an economy if it shows an export surplus; conversely, a country shows a passive trade balance if the import value sum exceeds the export value sum.


If we now assume that the welfare of an economy increases ceteris paribus the higher the export surplus is and decreases accordingly the higher the import surplus is, we can automatically deduce the core theorem of mercantilism: it is desirable to achieve an active trade balance, but this automatically means that foreign countries achieve a passive trade balance with respect to our economy, which according to these conceptions is equivalent to a loss of welfare abroad.


Now we just have to clarify why the mercantilists assumed that an active trade balance is desirable for an economy in any case. Does this idea not contradict the appearance? If we receive more imported goods from abroad than we ourselves export abroad, do we not increase our wealth, and the more goods we receive for a unit of export, the better off we are indeed?


However, this consideration would be too superficial. When abroad provides us with more goods than we supply abroad in exchange, we do not receive this surplus of goods as a gift, we have to pay for it with gold, and thus we lose welfare by exporting gold.


Nevertheless, it can be stated that an active trade balance is highly undesirable for at least some of the domestic entrepreneurs because of its direct consequences. For if exports outweigh imports, then more foreign exchange is received than is needed to pay for imports. This means that in a free foreign exchange market, the supply of foreign exchange exceeds demand, with the result that the exchange rate declines.


This in turn means, ex definitione, that the value of our own currency is increasing. At the same time, domestic entrepreneurs are in increased competition with foreign enterprises, since they can now charge a lower price calculated in the currency of our country in order to obtain the dollar price applicable abroad. In other words, if the balance of trade is active, international competition will intensify, and domestic entrepreneurs now run the risk of being able to export less in total in the future due to increased competition. At the same time, domestic entrepreneurs face increased competition from abroad. Why should this be an advantage from the perspective of the whole economy?


The answer is, of course, that the absolutist ruler can only achieve his aims if the economy thrives. Indeed, as we will show in the next section, the aims of absolutism can only be achieved if the state increases its revenues, that is, if it can raise higher taxes, and of course the prospect of increased tax revenues increases as the economy grows as a whole. According to the mercantilists, however, the growth of the economy itself depends in turn on whether the economy is supplied with sufficient money. We had a gold currency at the time of absolutism, and France was a country that did not own any major gold mines at that time, so that the quantity of gold could mainly be increased only on the basis of an active trade balance. More below we will take a critical look at these monetary theory teachings of mercantilism. At this point it is sufficient to demonstrate why, from a mercantilist perspective, an active trade balance is essential for the well-being of an economy and thus why the advantage of one country is always accompanied by the disadvantage of one or more other countries.


Concluding, mercantilism must be seen as a doctrine that sees the advantage of a nation as the result of conflicts between the national economies. We shall see in a subsequent chapter that liberalism vehemently opposed this idea and defended the opinion that, on the contrary, harmonious relations between nations do exist, provided that one is prepared to abandon the mercantilist regulation of foreign trade by the state and to allow free trade, which is not hindered by customs duties and other measures. However, we will not be able to dedicate ourselves to this comparison until the broad outlines of liberalism have been set out. Then we will also see that the differences between the two worldviews are somewhat more complicated than characterising one worldview only as a conflict model and the other only as a harmony model.



5th Aim hierarchy


The various aims and measures, which are summarised under the heading of mercantilism, can now be listed in a clear and concise hierarchy of aims.


On the first, highest aim level is the aim of the absolutist ruler to become independent (absolute) and to shake off the existing feudal controls by the estates and the parliament of the estates. All other aims and complexes of measures of mercantilism can be subordinated to this aim.


This aim is directly served at the second aim level by the formation of a standing army and the establishment of a civil service. The ruler can dispose of a standing army at any time; then he is no longer dependent on the goodwill and of course not on the ability of his own vassals to recruit an own army. At the same time, the ruler can also directly ensure that this army is up to date with the latest equipment and war technology.


If the absolutist ruler has furthermore an established, permanently working bureaucracy at his disposal, then again he is no longer dependent on the services of the nobility in these matters either; he himself can ensure that his officials are sufficiently trained for their tasks and that for a particular task the respectively most capable officials are selected.


The downside of these advantages, however, is that both the formation of a standing army and the introduction of a permanently active bureaucracy entail high costs for the ruler, which previously he has been able to largely pass on to his subordinate vassals within the framework of the feudal order.


Therefore, there developed on a third aim level the need to levy new taxes. In the previous feudal order there were, with few exceptions, mainly direct taxes, which were levied as duties on land, whereby the ruler had made land available to his subordinates as a fiefdom and gave him the right to demand a part of the yields as periodic duties. However, in a long dispute with the ruler, the parliaments of the estates had fought for the right that direct taxes on land had to be approved by the parliament of the estates.


Thus, it was clear from the outset that the ruler could certainly not achieve his aim by financing armies and civil servants from taxes which had to be approved by the very same estates whose controls were to be shaken off. Thus, it required the introduction of new types of taxes, which did not have to be approved especially by the parliament of the estates. These were all indirect taxes on the turnover of goods or customs duties on imports or exports. Since industrial production and a widespread trade in goods only emerged in modern times, the estates did not yet have the right to decide on indirect taxes.


But the tax revenue depends directly on the fact that also many goods were produced and traded, on which the state could then levy a sales tax or customs duties. Thus, the state could only achieve its aim of increasing the tax revenue to finance the army and civil service if it simultaneously ensured that production and trade were expanded. The state was thus forced to provide incentives to expand production and trade at a fourth aim level.


For this purpose, the ruler granted so-called monopolies to willing merchants, i.e. rights to produce and distribute certain raw materials or goods as the only ones in an area. These enterprises were often also favoured by state subsidies (grants).


Now, the economic growth of an economy depends not only on whether the country has sufficient entrepreneurial personalities who have the technical know-how to produce these goods and who are at the same time willing to bear the risks involved in almost any production. A smooth economic growth can only be guaranteed if an economy is also supplied with sufficient money. This is because the quantity of money determines the price level according to the quantity equation, which was already known to some mercantilists. If the money supply is not sufficient to purchase the goods produced, the prices decline and thus the entrepreneurs would lose the possibility and the incentive to maintain production for the future.


The currency in use during the absolutist era was mainly gold. Thus, in order to maintain economic growth at a fifth aim level, the state had an immediate need to expand the quantity of gold as much as possible, but by all means not to reduce it. This is where the aim of an active trade balance, already discussed in the previous section, comes into play. The state strives for an active trade balance as a way of expanding the circulating money supply and thus maintaining economic growth. Since the French state during the time of Louis XIV did not possess any major gold mines and thus did not have its own national gold production, it was dependent on the trade balance remaining as active as possible and that part of the exported goods were thus paid for with gold.


However, foreign trade was promoted by the mercantilist state not only to guarantee a sufficient supply of money, but also because the state was able to increase its revenues by levying customs duties.


However, the aim of maximising customs revenue is in some contradiction with the aim of achieving an active trade balance. The more exports exceed the import total, and thus the import value total decreases, and the more the trade balance becomes active, the less the state generates additional income from import duties. Now, of course, the state could also levy duties on exports and, as we will see below, the mercantilist state did indeed levy export duties, but - as we will see below - only on very specific exports, which were mainly limited to raw materials.


 With regard to the export of goods, the mercantilist state even tried to grant premiums in order to open up new markets abroad for domestic enterprises. At the same time, the state introduced import duties not only to generate additional income, but also to protect domestic enterprises from foreign competition.


In this way, the state expected to receive additional revenues in case the production of the domestic enterprises would be expanded and due to this production new tax revenues from sales taxes and consumption taxes were generated. The state therefore had to make a certain compromise to ensure that the activation of the trade balance did not increase too much, because otherwise customs revenues would automatically have decreased. The aim of a sufficient supply of money was therefore in a certain conflict with the aim of the highest possible customs revenue from foreign trade.



6th The monetary theory foundations


I had already pointed out that at least some of the mercantilist writers had recognised monetary theory connections, which later found their way into the so-called quantity theory and quantity equation with the classicists.


The quantity equation establishes a correlation between the value of money in circulation and the value of traded goods. Here, the value of money is determined by the quantity of money in circulation (G) multiplied by the velocity of circulation (U), i.e. the quantity that indicates how often one and the same piece of money is used on average to buy goods within a period. The value of traded goods, by contrast, is the product of the real quantity of goods (H also referred to as the trading volume) and the average price level of traded goods (P).


In each period, the value of the trading volume must be equal to the value of the money, since they are simply two sides of the same purchase act. The value of money indicates the amount of money spent to purchase the goods, while the value of goods indicates the amount of revenue that is received by the supplier of those goods. Of course, both values are identical, the exchange act is viewed once from the perspective of the consumer and once from the perspective of the supplier. Therefore, the equation applies:

G * U = P * H


If we now proceed from the assumption that the velocity of circulation of money depends on the payment practices which remain constant, at least in the short term, and is therefore also constant and given, and that, furthermore, the supply of goods can also be regarded as constant and given in the short term, then the price of goods necessarily depends on the quantity of money. If, for example, the available money supply together with its velocity of circulation is not sufficient to buy the supply of goods, the price of the goods will continue to fall until the entire supply can be bought up with the available money supply.


If we now assume that the absolutist ruler wants to have the goods turnover increased because this is the only way for him to obtain the hoped-for additional tax revenue, he must ensure that the money supply is also expanded accordingly. Since obviously only gold is recognised as money and France was only able to increase its gold reserves by means of an active trade balance, the logical consequence of this connection is the demand for an active trade balance.


The question remains, however, why it has to be gold in order to expand the money supply, why at that time the money supply was not simply expanded by the state or a central bank commissioned by the state providing the necessary amount of money in the form of banknotes?


Precisely because we were able to establish that at least some mercantilists knew about the quantity-theoretical relationships, one should actually have expected them to realise that the value of money at a given velocity of circulation of money and given trading volume depends solely on the quantity of money in circulation. This would have led to the conclusion that the value of money is not primarily determined by its precious metal content, but solely by the amount of money in circulation.


Why was this insight obscured for the mercantilists? Obviously, they were based on the idea that the private exchange partners only trusted in the value of money if they could also sell the money as a commodity. The commodity value of money corresponds to the precious metal content and is therefore accepted by the population, according to the mercantilists, whereas the commodity value of a banknote is only a small fraction of the nominal value of money.


But now we know that in general times the population of today accepts banknotes very well and also book money. The reason for this is mainly that the state has declared paper money to be official money and this means that anyone who pays his debts with this state-guaranteed money has finally repaid these debts. No creditor would succeed in court if he refused to accept paper money and insisted that the debt was paid in another, supposedly harder currency. It is therefore sufficient for the state to give this guarantee (that debts are considered to be definitively repaid when they have been paid with this money) to create confidence in this money.



7th The customs policy instruments of mercantilism


Finally, let us take a more detailed look at the customs policy instruments of mercantilism. These instruments are certainly among the best thought-out complex of measures of mercantilism. As already shown, these instruments serve two aims. On the one hand, it is intended to provide the state with additional revenue that cannot be controlled by the parliaments of the estates. On the other hand, the state also wants to establish new markets for domestic enterprises in this way. Here applies that the import duties serve to prevent domestic enterprises from being exposed to foreign competition. At the same time, the state facilitated access to foreign markets for domestic enterprises by granting export subsidies, namely by enabling domestic enterprises to sell their goods abroad even below cost.


In this context, finished products are treated differently from raw materials. While the state endeavoured to curb the import of goods by levying import duties, at the same time the aim was to prevent the export of raw materials as far as possible by imposing export duties. France was one of the countries which had only a small amount of raw materials available domestically and which, even during the high period of mercantilism, did not yet have sufficient colonial states in Africa, America or Asia from which the required raw materials could be obtained. They thus had to rely on the few raw materials available being reserved for domestic enterprises. This policy was supplemented by the fact that premiums were granted by the state for the import of scarce raw materials, just as premiums were paid for the export of goods.


This policy may have been quite successful at the beginning of the mercantilist phase. However, it must be realised that such a protectionist policy can only be successful so long as only a single state pursues this policy. But this cannot be expected in the long run. In the long run, the negatively affected states will react; they must react simply because no state can maintain a passive trade balance in the long run. As long as the balance of trade remains negative, gold or hard currency will flow out and no country has unlimited gold or foreign currency reserves.


Particularly, if no monetary policy measures (devaluations) are possible, most states will react to 'hostile' import duties by levying duties on the imports of those states that have started this customs policy. A tariff war will break out and this reciprocal levying of duties and their increase have two fatal consequences. Firstly, they reverse the initial successes of unilateral tariff collection, and the terms of trade shift back in the direction of the price relations which existed before this customs policy began. In any case, the measures have been to no avail in the long term.


More serious, however, is the fact that each duty levied - whether by the country itself or by foreign governments - leads to a reduction in the absolute volume of trade. However, since the welfare of a country is crucially dependent on the extent to which an international division of labour takes place, this policy harms all nations involved in the customs war in the long run.


Trade agreements between different economies generally aim to stimulate international trade by mutually reducing trade barriers. Precisely the opposite aim can be observed in trade agreements concluded by states influenced by mercantilism. Typical for such treaties that prevented trade was the Methuen Treaty, which England and Portugal concluded in 1703. The main purpose of this treaty was to prevent imports of goods from France as far as possible.