From mercantilism to free trade, a look at global trade
By Dr. Daniel Ostergaard
At times, the only real truth in business is that the world is ever-changing. Globalization is dynamic. Consumer tastes change. New materials and processes emerge. Even entire civilizations rise and fall.
Recognizing this, it is clear that 2019 is seeing more than its share of change. What does this mean for businesses in South Carolina? How can we leverage these trends in our favor while protecting our businesses from the downside risk?
This article starts a three-part series on globalization focusing first on how we arrived at the place we are today. Next month we will examine where we are today, and the following article will focus on what to expect from the near future.
The story of international trade is not new. Traders have plied both seas and land for millennia. And yet, the foundations of today’s international trade are fairly recent in the scope of human history. The first real trade theory, mercantilism, emerged in Europe from the 16th to the 18th centuries. The philosophy behind mercantilism held that governments should encourage trade as a means of gaining access to more power—power that was demonstrated by the possession of precious metals. Colonial holdings would serve as sources of raw materials and as exclusive markets for goods exported from the “home” country.
In this environment, trade was seen as a means to an end in a zero-sum game wherein one nation engages in trade at the expense of others. Mercantilism philosophy dictated that countries should export more and import less to gain a strategic advantage.
In 1776, Scotsman Adam Smith wrote his treatise “The Wealth of Nations” arguing that mercantilism was the wrong trade policy and that freer trade would result in greater societal gains. According to the Adam Smith Institute (ASI), a nation’s wealth was not simply precious metals, it was the “stream of goods and services” being produced. Smith extolled the virtues of reinvesting profits into more efficient systems. Creating a virtuous cycle, ASI explains that the “more we invest, the more efficient our production becomes.” We begin to see a transition away from mercantilist policies.
In 1817, Englishman David Ricardo theorized the benefits of free trade when he explained the societal benefits of markets left to economize both labor and production. Ricardo developed the concept of comparative advantage, meaning that countries should produce those goods that they are relatively better at producing.
Whereas Smith’s absolute advantage held that countries should produce those products that they are best at producing, Ricardo suggests that opportunity costs require countries to produce those products that have a comparative advantage relative to their trading partner. This economic argument led to ever increasing global trade as economies reaped the benefits of the industrial revolution. This trend continued through the 1800s to World War I.
After World War I, international trade began to increase again until it was decimated by the 1929 stock market crash. As a response, protectionist forces in Congress passed the Smoot-Hawley Tariff Act, which increased tariffs on 20,000 imported goods in an attempt to protect U.S. manufacturing interests. Predictably, other countries soon followed suit and a trade war erupted. Over the next decade, international trade decreased to only a third of what it had been, thereby prolonging the economic depression.
Partially in response to this pre-World War II downturn, the 44 Allied powers gathered at Bretton Woods, N.H., in 1944 to discuss post-war efforts both for reconstruction and to ensure stability of global trade. Bretton Woods produced several organizations including the International Monetary Fund and the early stages of what would become the World Bank Group. Bretton Woods also replaced the gold standard with the U.S. dollar as the global currency. This fixed exchange rate system lasted until 1971, when the U.S. responded to increasing inflationary pressures with a number of far-ranging economic policies including cancellation of dollar convertibility into gold. This led to the collapse of the Bretton Woods system of fixed exchange rates and resulted in the floating exchange rate system that we use today.
Soon after Bretton Woods, another agreement was reached in 1947 with the purpose of reducing overall tariffs. The General Agreement on Tariffs and Trade (GATT) initiated a series of trade talks designed to reduce tariffs. Between 1947 and 1994 when the GATT was replaced with the World Trade Organization, tariffs had fallen from an initial high between 22% and 45% to a global average of 5%. Reduction of tariffs was seen as a primary driver of free trade and the economic benefits derived from free trade.
The free trade ideals espoused since Adam Smith continue to govern most trade philosophy pursued by governments today. As the GATT was generally successful in reducing tariffs and thereby ensuring freer trade, the WTO was introduced as a means of continuing the momentum toward freer trade. The WTO provided a robust institution designed to facilitate trade agreements.
And yet, though past may be considered prologue, these free trade institutions are being questioned today both for their value and the role they perform in a global economy. For example, China has pushed to have their yuan replace the dollar as the world’s global currency. Additionally, the U.S. has engaged in a series of trade decisions that may have implications for future trade. At the same time, some international institutions are being seen as “too Western” as emerging economies in Asia—particularly India and China—increase in importance.
What does all of this mean for the South Carolina businesses of today? Join us in our next article when we continue exploring globalization.