THEORY OF MERCANTILISM

Mercantilism the first theory of international Trade, is an economic concept for

the purpose of building a wealthy and powerful state, Which believes that the
wealth of a nation Could only be achieved through government Controls and
regulation of trade, commerce And economic activities. It involves
wealtwealth=umulation, establishment of favorable Trade with other countries, and
development Of internal resources in the manufacturing and agriculture sectors.
The economic policies That pursued by the Mercantilists, such as Governmental
control of the use and Exchange of precious metals, which is often Referred to as
Bullionism. ADAM SMITH coined the term “mercantile system” to describe the
system of political economy that sought to enrich the country by restraining
imports and encouraging exports. This system dominated Western European
economic thought and policies, including Portugal, France, Spain, and Great Britain
from the sixteenth to the late eighteenth centuries. Its use was favored by writers
such as Jean-Baptiste Colbert, who at a time served as the French Finance Minister.

Mercantilism involves

 Restrictions on imports – tariff barriers, quotas or non-tariff barriers.

 Accumulation of foreign currency reserves, plus gold and silver reserves. (also
known as bullionism) In the sixteenth/seventeenth century, it was believed
that the accumulation of gold reserves (at the expense of other countries)
was the best way to increase the prosperity of a country.

 Granting of state monopolies to particular firms especially those associated

with trade and shipping.

 Subsidies of export industries to give a competitive advantage in global

markets.

 Government investment in research and development to maximise the

efficiency and capacity of the domestic industry.

 Allowing copyright/intellectual theft from foreign companies.

 Limiting wages and consumption of the working classes to enable greater

profits to stay with the merchant class.

 Control of colonies, e.g. making colonies buy from Empire country and taking
control of colonies we

The basic concepts of mercantilism in terms of trading are:

 • This approach assumes the wealth of a nation depends primarily on the
possession of precious metals such as gold and silver.

• During 16th to 18th century, gold and silver were the currency of trade
between countries.

• By exporting goods, countries could earn and therefore maximize the amount
of gold and silver. Conversely, importing goods from other countries resulted
in an outflow of gold and silver to those countries

• The basic concept of mercantilism in terms of trading is to make sure that

the country’s own resources are exported to other countries in higher volumes
or amounts compared to the goods imported, which are kept to a minimum
level. Trading is said to be “balanced” if a country exports more than it
imports. Through this system, resources will increase and there will be a
surplus on gold and silver reserves.

• In the words of the English mercantilist writer Thomas Mun, “The ordinary
means therefore to increase our wealth and treasure is by foreign trade,
wherein we must ever observe this rule” to sell more to strangers yearly than
we consume of theirs in value”.

• This theory suggests that the government should play an active role in the
economy by encouraging exports and discouraging imports, especially through
the use of tariffs.

Criticism of Mercantilism

Adam Smith and David Hume were the founding fathers of antimercantilist
thought; This practice was strongly attacked by Adam Smith in his 1776 work “The
Wealth of Nations”. The criticisms of mercantilism are given elaborately-

• Mercantilists viewed the economic system as a “zero-sum game”, in which a

gain by one country results in a loss by other. Adam Smith & David Ricardo argued
that, trade should be a positive-sum game, or a situation in which all countries can
benefit.

• Mercantilism unduly emphasized the importance of money and over-emphasized

the importance of gold and silver. So Mercantilist ideas about wealth were
nonsensical and untenable.

Conclusion:

Mercantilist regulations were steadily removed over the course of The Eighteenth
Century in Britain, and during the 19th century the British government fully
embraced free trade and Smith’s laissez-Faire economics. In France, economic
control remained in the hands of the royal family and mercantilism continued until
the French Revolution. The continued pressure resulted in the implementation Of
laissez faire economics in the nineteenth century.

THEORY OF ADAM SMITH

Adam Smith was among the first philosophers of his time to declare that wealth
is created through productive labor, and that self-interest motivates people to put
their resources to the best use. He argued that profits flowed from capital
investments, and that capital gets directed to where the most profit can be made.
These ideas — That wealth follows capital, and that individuals own capital — are
core to capitalism as we know it today. But at the time, Smith’s ideas were
revolutionary.

Adam Smith was an 18th-century Scottish economist, philosopher, and author

who is considered the father of modern economics. Smith argued against
mercantilism and was a major proponent of laissez-faire economic policies. In his
first book, The Theory of Moral Sentiments, Smith proposed the idea of an invisible
hand—the tendency of free markets to regulate themselves using competition,
supply and demand, and self-interest

Smith is also known for creating the concept of gross domestic product (GDP)
and for his theory of compensating wage differentials. According to this theory,
dangerous or undesirable jobs tend to pay higher wages to attract workers to these
pposition. Smith's most notable contribution to the field of economics was his 1776
book, An Inquiry into the Nature and Causes of the Wealth of Nations.

Laissez Faire:

Adam Smith’s theory is based on the principle of ‘Laissez-Faire’ which requires that
state should not impose any restriction on freedom of an individual. The theory of
economic development rests on the pillars of saving, division of labour and wide
extent of market. Saving or capital accumulation is the starting point of this theory.
He believed that “there is a set of rules or rights of justice and perhaps even of
morality in general which are, or may be known by all men by hello either or reason or
of a moral sense, and which possesses an authority superior to that of such
commands of human sovereigns and such customary legal and moral regulations as
may contravene them”.

The policy of laissez-faire allows the producers to produce as much they like,
earn as much income as they can and save as much they like. Adam Smith believed
that it is safe to leave the economy to be propelled, regulated and controlled by
invisible hand i.e. the forces of competition motivated by self interest be allowed to
play their part in minimizing the volume of savings for development

Production Function:

Adam Smith recognized three factors of production namely labour, capital and land.

Y = f (K, L, N)

K = Stock of Capital

L = Labour force

N = Land

He emphasized labour as an important factor of production along with other factors

and observed, “The annual labour of nation is the fund which originally supplies it
with all necessaries and conveniences of life which it annually consumes and which
consists always either in immediate produce from other nations”. Since the growth
is a function of capital, labour, land and technology and land being passive element is
least important. Prof. Adam Smith regarded labour as father and land as mother. He
wrote, “To him (farmer) land is the only instrument which enables him to earn the
wages of his labour and to make profits of this stock. "

Division of Labour:

The rate of economic growth is determined by the size of productive labour and
productivity of labour. The productivity of labour depends upon technological
progress of a country and which, in turn, depends upon the division of labour. This
division of labour becomes the true dynamic force in Adam Smith’s theory of growth.
The only remarkable feature of Smith’s account of division of labour is pointed by
Prof.

Schumpeter as “nobody, either before or after Adam Smith ever thought of putting
such a burden upon division of labour. With Adam Smith it is practically the only
factor in economic progress”.

Division of labour increases the productivity of labour through specialization of

tasks. When a work is sub-divided into various parts and the worker is asked to
perform small parts of whole job, his efficiency increases as now he can focus his
attention more carefully. Thus, the concept of division of labour means the
transference of a complex production process into number of simpler process in
order to facilitate the introduction of various methods of production.

Adam Smith concentrated upon the social division of labour which emphasized the co
-operation of all for satisfaction of the desires of each. It is the process by which
different types of labour which produce goods to satisfy the individual needs of
their producers are transformed into social labour which produces goods for
exchanging them for other goods.

Capital Accumulation:

It is the pivot around which the theory of economic development revolves. The
growth is functionally related to rate of investment. According to Smith, “any
increase in capital stock in a country generally leads to more than proportionate
increase in output on account of continually growing division of labour”.

Capital stock consists of:

(а) Goods for the maintenance of productive workers.

(b) Goods for helping the workers in their productive activities.

Agents of Growth:

Smith has observed that farmers, producers and businessmen are the important
agents of economic growth. It was the free trade, enterprise and competition that
led farmers, producers and businessmen to expand the market and which, in turn,
made the economic development inter-related. The development of agriculture leads
to increase in construction works and commerce. When agricultural surplus arises as
a result of economic development, the demand for commercial services and
manufactured articles arises.

Process of Growth:

“Taking institutional, political and natural factors for granted, Smith starts from
the assumption that a social group may call it a ‘nation’ will experience a certain
rate of economic growth that is accounted for by increase in numbers and by savings.
This induces a widening of market which, in turn, increases division of labour and
thus, increases productivity. In this theory, the economy grows like a tree. This
process is no doubt exposed to disturbances by external factors that are not
economic… but in itself, it proceeds continuously and steadily.

Conclusion:

It can be concluded that Prof. Adam Smith did not propound any specific growth
theory. His views relating to economic development are part of general economic
principle propounded by him. R. Lekachaman says, “A good deal of Smith’s analysis
reads as though written with todays UDC’s in mind”. In a very important aspect then
this book (Wealth of Nations) was the theory of economic development.
THEORY OF KARL MARX

Marxism, Ideology and socioeconomic theory developed by Karl Marx and

Friedrich Engels. The fundamental ideology of communism, it holds that all people
are entitled to enjoy the fruits of their labour but are prevented from doing so in a
capitalist economic system, which divides society into two classes: nonowning
workers and nonworking owners. Marx called the resulting situation “alienation,”
and he said that when the workers repossessed the fruits of their labour, alienation
would be overcome and class divisions would cease. The Marxist theory of history
posits class struggle as history’s driving force, and it sees capitalism as the most
recent and most critical historical stage—most critical because at this stage the
proletariat will at last arise united. The failure of the European Revolutions of 1848
and an increasing need to elaborate on Marxist theory, whose orientation is more
analytical than practical, led to adaptations such as Leninism and Maoism. In the
late 20th century the collapse of the Soviet Union and its Eastern bloc allies seemed
to mark the end of Soviet Marxism as a practical political or economic model.
Meanwhile, China adopted many elements of a free-market economy in what it called
a development rather than a repudiation of Marxist theory. In the West, Marxism
continues to be appreciated as a critique of market capitalism and a theory of
historical change. See also Communist Manifesto; dialectical materialism; socialism;
Stalinism; Trotskyism.

THEORY OF THE PRESENT

Schumpeter’s theory of development assigns paramount role to the

entrepreneur and innovations introduced by him in the process of economic
development. According to Schumpeter, the process of production is marked by a
combination of material and immaterial productive forces. The material productive
forces arise from the original factors of production, viz., land and labour, etc., while
the immaterial set of productive forces are conditioned by the ‘technical facts’ and
‘facts of social organization’. The Schumpeterian production function can, therefore,
be written as –Q = ƒ [k, r, I, u, ν) …(1)

Where, Q stands for the output, k for the Schumpeterian concept of “produced
means of production”, r for natural resources, l for the employed labour force. The
symbol u represents the society’s fund of technical knowledge and ν represents the
facts of social organization, i.e., the socio-cultural milieu within which the economy
operates.

The above function shows that the rate of growth of the output depends upon
the rate of growth of productive factors, the rate of growth of technology and the
rate of growth of investment friendly socio-cultural environment. Schempeter held
that the alterations in the supply of productive factors can only bring about gradual,
continuous and slow evolution of the economic system.

On the other hand, the impact of technological and social change calls for
spontaneous, discontinuous change in the channels of output flow. Thus taking into
account these two types of distinct influences Schumpeter distinguished two
components in the dynamic evolution of the economy – (a) the “growth component”
which brings about gradual, continuous and slow evolution due to the changes in the
factor availability, (b) the “development component” which brings about
spontaneous and discontinuous change in the channels of output flow due to changes
in the technical and social environments.

Schumpeter regarded land to be constant. The growth component will, therefore,

include only the effects of changes in population and of increase in the producer
goods. But Schumpeter further maintains that there does not exist any a priori
relationship between the changes in population and the changes in the flow of goods
and services. In other words, Schumpeter considers the population growth to be
exogenously determined. Now, the increase in producer goods results from a positive
rate of net savings.

The major part of savings and accumulations are attributed by Schumpeter to

profits. But, according to him, the profits can arise if innovations such as new
techniques of production are employed or if new product is introduced. Hence
ultimately it is the change in the technical knowledge (i.e., variable u) which is
responsible for any change in the stock of producer goods, i.e., the rate of capital
accumulation directly depends on the rate of technical change.

Role of Entrepreneur as an Innovator:

In economic development as outlined by Schumpeter, the entrepreneur plays a key

role. The credit for innovations and the outburst of economic activity goes entirely
to the entrepreneur.

Innovation consists in:

(i) Introduction of anew good,

(ii) Introduction of a new method of production,

(iii) The opening of a new market,

(iv) The discovery of a new source of supply of raw materials or semi-manufactured

goods, and

(v) Introduction of a new organisation in an industry

Capitalism- Its Potentialities and its Degeneration:

The classical economists were depressed by the inexorable law of diminishing

returns and the irresistible growth of population. Schumpeter does not share their
pessimism. He also does not believe in the inherent tendency towards a
maldistribution of incomes resulting in ever-recurring severe crises as Marx did. Nor
does he agree with the stagnationists that there is persistent lack of investment
opportunities together with institutional rigidities making for an equilibrium at less
than full employment. Schumpeter, on the other hand, has faith in the capacity of
the capitalist system in attaining ever increasing levels of national output and
income. He is prepared to admit, however, that there might be temporary setbacks.

According to Schumpeter, the economic and social foundations of capitalism will

crumble on account of:

(a) The decay of the entrepreneurial function,

(b) The destruction of the institutional framework, and

(c) The disintegration of the protecting political framework.

Apart from differences in emphasis, three major differences may be noted between
the Classical School of Marx and the Schumpeterian analysis:

(a) Schumpeter introduces interest rate as a determinant of savings which is an

important factor in economic development’,

(b) He separates the autonomous investment from the induced investment and
emphasises innovations as the factor affecting autonomous investment; and

(c) He regards entrepreneurship as the vital force which shapes an economy.

Evaluation of Schumpeter’s Theory of Development:

Schumpeter has been a great ‘theorist’ whose writings contain brilliant thoughts
and a deep insight into the working of an economy. However, his analysis of the
entrepreneurial innovations is not applicable to modern conditions in which the act
of invention and innovation is carried on not by individual entrepreneurs but by large
corporations as a routine affair. It is not possible to identify entrepreneurs who
introduced many actual innovations. He himself recognises the tendency towards
obsolescence of the entrepreneur.

It has been pointed out by critics that what Schumpeter gives is the theory of
business cycles and not an analysis of economic development. Even Schumpeter’s
analysis of business cycles can be accepted only with some modifications to suit
modern economic conditions. According to Shumpeter, crisis in capitalism is brought
about by maladjustment caused by waves of innovations. But big businesses in
modern times can absorb these waves and produce steadier and larger expansion of
the total output. Further, the main cause of business cycles is fluctuations in
aggregate demand as pointed out by J.M. Keynes.

The assumption that innovations are financed by borrowing from credit creation
by the banks is also not very realistic. It is a well-known fact that most of the bank
loans are short-term loans whereas the implementation of innovations requires long-
term finances. The long-term projects are financed by retained profits or by the
issue of shares and debentures by the companies concerned.

DISCUSSIONS AND HIGHLIGHTS OF THERE DIFFERENCES :

The mercantilist nations believed that the more gold and silver they acquired, the
more wealth they possessed. Smith believed that this economic policy was foolish
and actually limited the potential for "real wealth," which he defined as "the annual
produce of the land and labor of the society."Mercantilism was a form of economic
nationalism that sought to increase the prosperity and power of a nation through
restrictive trade practices.In the Theory of Adam Smith wealth is created through
productive labor, and that self-interest motivates people to put their resources to
the best use. While, Marxism is a social, political, and economic theory originated by
Karl Marx that focuses on the struggle between capitalists and the working class.
Schumpeter’s theory of development assigns paramount role to the entrepreneur
and innovations introduced by him in the process of economic development. According
to Schumpeter, the process of production is marked by a combination of material
and immaterial productive forces. The material productive forces arise from the
original factors of production, viz., land and labour, etc., while the immaterial set of
productive forces are conditioned by the ‘technical facts’ and ‘facts of social
organization’.

REFERENCES