Mercantilism, Usury Laws, Stamped Money, Under-Consumption Theories

Book 6 Short Notes Suggested by the General Theory

FOR 200 years, people saw a national advantage in a favourable balance of trade, and grave danger in an unfavourable balance, particularly if it results in an efflux of the precious metals.

But this changed in the past 100 years.

Most statesmen, practical men in most countries, and nearly half of them even in Great Britain, the home of the opposite view, have remained faithful to the ancient doctrine.

Whereas almost all economic theorists have held that anxiety concerning such matters is absolutely groundless except on a very short view. This is because the mechanism of foreign trade is self-adjusting.

Attempts to interfere with it are futile and will greatly impoverish those who practise them because they forfeit the advantages of the international division of labour.

The older opinion is Mercantilism. The newer one is Free Trade.

Modern economists believe that:

• the international division of labour produces gains which outweigh the gains claimed by mercantilism
• the mercantilist argument is fully based on an intellectual confusion

Marshall’s [1] references to Mercantilism are not altogether unsympathetic. But he had no regard for their central theory.[2]

In the same way, the theoretical concessions which

have been ready to make in contemporary , relating, for example, to

There are current controversies on whether:

• infant industries should be encouraged
• the terms of trade should be improved

Free-trade economists address these controversies without looking into the theoretica substance of the mercantilist case.

The Mercantilist doctrine has some scientific truth*.

• Its claimed advantages are national advantages and not global ones.

When a country is growing rapidly in wealth, this growth can be interrupted by the insufficiency of the incentives to new investment.

• The well-being of a progressive state essentially depends on such inducements*.

They may be found either in home investment or in foreign investment.

If the level of aggregate investment is determined by the profit motive alone:

• the volume for home investment will be governed in the long run by the domestic interest rate.
• the volume of foreign investment will be determined by the size of the favourable balance of trade.

The interest rate will be governed by the quantity of gold and silver, measured in hourly-common-wage, available to satisfy the love for money if the following are stable:

• the hourly-common-wage
• the state of liquidity-preference
• the banking conventions

The quantity of the precious metals will largely depend on whether the balance of trade is favourable or unfavourable.

Thus, as it happens, a preoccupation on the part of the authorities with a favourable balance of trade served both purposes; and was, furthermore, the only available means of promoting them. At a time when the authorities had no direct control over the domestic rate of interest or the other inducements to home investment, measures to increase the favourable balance of trade were the only direct means at their disposal for increasing foreign investment.

At the same time, the effect of a favourable balance of trade on the influx of the precious metals was their only indirect means of reducing the domestic rate of interest and so increasing the inducement to home investment.

There are 2 limitations on the success of this policy:

1. If the domestic rate of interest falls so low that the volume of investment is sufficiently stimulated to raise employment to a level which breaks through some of the critical points at which the wage-unit rises, the increase in the domestic level of costs will begin to react unfavourably on the balance of foreign trade, so that the effort to increase the latter will have overreached and defeated itself.

2. If the domestic rate of interest falls so low relatively to rates of interest elsewhere as to stimulate a volume of foreign lending which is disproportionate to the favourable balance, there may ensue an efflux of the precious metals sufficient to reverse the advantages previously obtained.

The risk of one or other of these limitations becoming operative is increased in the case of a country which is large and internationally important by the fact that, in conditions where the current output of the precious metals from the mines is on a relatively small scale, an influx of money into one country means an efflux from another; so that the adverse effects of rising costs and falling rates of interest at home may be accentuated (if the mercantilist policy is pushed too far) by falling costs and rising rates of interest abroad.

Spain’s economic history in the latter part of the 15th and 16th centuries provides an example of a country whose foreign trade was destroyed by the effect on the hourly-common-wage of an excessive abundance of the precious metals.

Great Britain in the pre-war years of the 20th century is an example where the excessive facilities for foreign lending and the purchase of properties abroad frequently stood in the way of the decline in the domestic rate of interest which was required to ensure full employment at home.

The long history of India is an example of impoverishment by a preference for liquidity amounting to so strong a passion that even an enormous and chronic influx of the precious metals has been insufficient to bring down the rate of interest to a level which was compatible with the growth of real wealth.

Nevertheless, if we contemplate a society with a somewhat stable wage-unit, with national characteristics which determine the propensity to consume and the preference for liquidity, and with a monetary system which rigidly links the quantity of money to the stock of the precious metals, it will be essential for the maintenance of prosperity that the authorities should pay close attention to the state of the balance of trade.

For a favourable balance, provided it is not too large, will prove extremely stimulating; whilst an unfavourable balance may soon produce a state of persistent depression. It does not follow from this that the maximum degree of restriction of imports will promote the maximum favourable balance of trade.

The earlier mercantilists laid great emphasis on this and were often to be found opposing trade restrictions because on a long view they were liable to operate adversely to a favourable balance. It is, indeed, arguable that in the special circumstances of mid-nineteenth-century Great Britain an almost complete freedom of trade was the policy most conducive to the development of a favourable balance. Contemporary experience of trade restrictions in post-war Europe offers manifold examples of ill-conceived impediments on freedom which, designed to improve the favourable balance, had in fact a contrary tendency.

There are strong presumptions of a general character against trade restrictions unless they can be justified on special grounds.

The advantages of the international division of labour are real and substantial, even though the classical school greatly overstressed them. The fact that the advantage which our own country gains from a favourable balance is liable to involve an equal disadvantage to some other country (a point to which the mercantilists were fully alive) means not only that great moderation is necessary, so that a country secures for itself no larger a share of the stock of the precious metals than is fair and reasonable, but also that an immoderate policy may lead to a senseless international competition for a favourable balance which injures all alike.[4]

A policy of trade restrictions is a treacherous instrument even for the attainment of its ostensible object. This is because private interest, administrative incompetence and the intrinsic difficulty of the task may divert it into producing results directly opposite to those intended.

Thus, the weight of my criticism is directed against the inadequacy of the theoretical foundations of the laissez-faire doctrine upon which I was brought up and which for many years I taught;— against the notion that the rate of interest and the volume of investment are self-adjusting at the optimum level, so that preoccupation with the balance of trade is a waste of time.

We, the faculty of economists, are guilty of presumptuous error in treating as a puerile obsession what for centuries has been a prime object of practical statecraft.

Under the influence of this faulty theory the City of London gradually devised the most dangerous technique for the maintenance of equilibrium which can possibly be imagined, namely, the technique of bank rate coupled with a rigid parity of the foreign exchanges.

This meant that the objective of maintaining a domestic rate of interest consistent with full employment was wholly ruled out. Since, in practice, it is impossible to neglect the balance of payments, a means of controlling it was evolved which, instead of protecting the domestic rate of interest, sacrificed it to the operation of blind forces.

Recently, practical bankers in London have learnt much, and one can almost hope that in Great Britain the technique of bank rate will never be used again to protect the foreign balance in conditions in which it is likely to cause unemployment at home.

Regarded as the theory of the individual firm and of the distribution of the product resulting from the employment of a given quantity of resources, the classical theory has made a contribution to economic thinking which cannot be impugned.

It is impossible to think clearly on the subject without this theory as a part of one’s apparatus of thought. I must not be supposed to question this in calling attention to their neglect of what was valuable in their predecessors.

Nevertheless, as a contribution to statecraft, which is concerned with the economic system as whole and with securing the optimum employment of the system’s entire resources, the methods of the early pioneers of economic thinking in the sixteenth and seventeenth centuries may have attained to fragments of practical wisdom which the unrealistic abstractions of Ricardo first forgot and then obliterated.

There was wisdom in their intense preoccupation with keeping down the rate of interest by means of usury laws (to which we will return later in this chapter), by maintaining the domestic stock of money and by discouraging rises in the hourly-common-wage. In their readiness in the last resort to restore the stock of money by devaluation, if it had become plainly deficient through an unavoidable foreign drain, a rise in the wage-unit[5], or any other cause.