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Economic Nationalism: From Mercantilism to World War II

Mises Daily: Tuesday, July 13, 2010 by

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[Excerpted from chapter 3 of Studies in Economic Nationalism.]

We now move to a period that, from the point of view of the present inquiry, is of particularly great importance. It extends over roughly 300 years — the 16th, 17th, and 18th centuries — and involves the birth and consolidation of the modern concept of the national state. The economics of that period, in particular the regulation by the state of external trade on behalf of national power, are known as "the 'mercantile' system" or "mercantilism."

Countries that adopted the economic policies of mercantilism had, at least to begin with, authoritarian and powerful governments, absolute monarchies having developed upon the disintegration of the decentralized feudal systems. The rulers of that period had far-reaching powers over the activities of their subjects, while individual liberties were largely submerged.

The eventual revolt against mercantilism was associated with the promotion of democratic principles. In England the democratic revolution started in the last quarter of the 17th century; in France a hundred years later. The internal policies of mercantilism varied greatly, therefore, as between France (and other continental countries), on the one hand, and England, on the other. There was more similarity in respect of foreign economic policies, i.e., the impact of the state upon the conduct of foreign trade and finance.

Mercantilism evolved for the first time in history a more or less consistent body of doctrines explaining and justifying state action to regulate, control, and restrict various elements of international economic relations.[1] These doctrines are inspired by a primary concern for national power and a secondary concern for national well-being. In the 19th century, the world having moved very far in the direction of free trade and of economic internationalism, the mercantilist tradition seemed to be relegated to the historians' domain, while the economic doctrines of mercantilism were looked upon as discredited and discarded curiosities from the past.

Since then, instead of moving further ahead in the direction of world order, we have made, through a maze of detours, a turn around ourselves and we seem to be right back where we were 250 years ago! Thus Professor Philip W. Buck, a careful student of mercantilism, could write in November 1941 in the preface to his Politics of Mercantilism that "modern totalitarianism — an awkward word used in this book to include the Soviet, Fascist, and Nazi states and their policies — is in many ways a revival of the ideas and practices of the mercantile system."

Actually, the new economic nationalism of the mid-20th century stems from two different sources, not from one source alone: one of these is, obviously, mercantilism; the other is the doctrine of "national insulation" which, leaving aside the ancient claims of Aristotle, goes back to Johann Gottlieb Fichte. Of these two sources, the latter, though the less acknowledged and the less known, is certainly the more important.

The mercantilist tradition included certain elements that are not found again in the contemporary world, such as colonialism; and other elements which are very prominent in present-day society, such as concern for balances of payments and for full employment. What is, therefore, particularly important to us today is not so much the entire mercantilist tradition as some special parts of it. These can be described as our mercantilist heritage.


The end of mercantilism was due to many causes. Because mercantilism was so intimately related with the state, with state structure and powers, its practical manifestations varied from country to country — as did its eventual contradictions and difficulties. French mercantilism disintegrated with the disintegration of the absolute monarchy. British mercantilism, closely linked with Britain's "old colonial system" (as distinct from the 19th century "new" colonial empire, which was to evolve eventually into the British Commonwealth of Nations), was brought to an end largely by the American Revolution. The Industrial Revolution of the end of the 18th century and early 19th was another factor instrumental in the liquidation of controls and restrictions characteristic of the mercantilist system. Free trade, heralded by Adam Smith in the year of American Independence, became a reality of British politics about 70 years later, in the age of Richard Cobden and Sir Robert Peel.

When Great Britain decided to give up its agriculture in favor of its industry, it also decided to accept international economic interdependence as a basic fact of life. Such an acceptance could only be made on the assumption of durable peace, an assumption that seemed reasonable during the century when "Britannia ruled the waves" (instead, as a recent wit remarked, of "waiving the rules"). International insecurity produces, of course, economic nationalism.

This was undoubtedly a factor in the mercantilist period, as it is again a factor in our own day. Cobden — whose overriding passion was the establishment of durable peace in the world — believed that free trade could make peace secure. We may be somewhat skeptical about this today, but even our own experience tells us that the fear of war or the preparation for war tends to stimulate economic nationalism, while political security is a prerequisite (or at least a concomitant) of economic internationalism. It may also be said that economic nationalism tends to make peace more precarious and conflict more likely.

Upon the ruins of mercantilism, and notwithstanding the increasing prestige of Adam Smith, new forms of economic nationalism soon began to grow. These took, however, all through the 19th century, the form of "liberal protectionism" and not of what we defined as "economic nationalism" in the restricted sense of the term. Although, in one of its aspects at least, the American Revolution was a reaction against mercantilism, as early a builder of the republic as Alexander Hamilton laid the intellectual and practical foundations for a new cause of economic nationalism in his Report on the Subject of Manufactures, published in 1791.[2]

This report represents one of the most important early reactions against the free trade doctrines of Adam Smith's Wealth of Nations. Also — and therein lies its importance — it is the cornerstone of American protectionism. Alexander Hamilton was as fascinated in his day as statesmen from the so-called underdeveloped countries are today by the sight of a wealthy industrial nation. In Hamilton's time that nation was England and its industrial advance was an attractive and stimulating model for the young republic to follow.

In 1791, it will be recalled, mercantilism was breaking down but free trade existed only on paper. State interference in foreign trade was still the rule even in England. Hamilton advocated the adoption of governmental measures for the encouragement of domestic industries, not because of any concern for foreign trade and balances of payments (he does not seem to have been influenced by mercantilist considerations) but because of his interest in the development of the domestic economy of the United States. This is made quite clear in the following observations in his report:

It is now proper … to enumerate the principal circumstances from which it may be inferred that manufacturing establishments not only occasion a positive augmentation of the produce and revenue of the society, but that they contribute essentially to rendering them greater than they could possibly be without such establishments. These circumstances are:

  1. The division of labour;
  2. An extension of the use of machinery;
  3. Additional employment to classes of the community not ordinarily engaged in the business;
  4. The promoting of emigration from foreign countries;
  5. The furnishing greater scope for the diversity of talents and dispositions, which discriminate men from each other;
  6. The affording a more ample and various field for enterprise;
  7. The creating, in some instances, a new, and securing, in all, a more certain and steady demand for the surplus produce of the soil.[3]

It might be noted, by the way, that Hamilton proposed to use government subsidies or bounties to stimulate the development of domestic manufacturers quite as much as — and even in preference to — tariffs to reduce the competition of foreign-made goods. Concerning the latter, he had the following comments to make:

It shall be taken for granted … that manufacturing pursuits are susceptible, in a greater degree, of the application of machinery, than those of agriculture. If so, all the difference is lost to a community which, instead of manufacturing for itself, procures the fabrics requisite to its supply from other countries. The substitution of foreign for domestic manufactures is a transfer to foreign nations of the advantages accruing from the employment of machinery, in the modes in which it is capable of being employed with most utility and to the greatest extent.[4]

Although Hamilton had textile industries in mind, his proposition is susceptible of broader application.

There comes a time when the question must be asked whether a fully developed new domestic industry can produce goods as cheaply as they can be imported from abroad and in as good a quality, and the issue between protection and free trade was ultimately argued on that basis. Hamilton's concern was, however, most of all for the creation of new industries on the assumption that they would be entirely viable when they reached their full bloom. His argument, further developed by later economists, especially by Friedrich List, has come to be known as the "infant industries" argument for protection. To apply it to fully developed industries is actually an abuse of the argument.

Although Alexander Hamilton can be considered the father of American protectionism during the first half or two thirds of the 19th century, he surely must not be burdened with that responsibility for the protectionism of the late 19th and the 20th centuries. His arguments (but not his name) are today widely used by spokesmen of the so-called underdeveloped countries, in combination with other much less defensible arguments and policies.

"Alexander Hamilton was as fascinated in his day as statesmen from the so-called underdeveloped countries are today by the sight of a wealthy industrial nation. In Hamilton's time that nation was England and its industrial advance was an attractive and stimulating model for the young republic to follow."

The artificial stimulation of new industries can be defended on economic grounds only if these industries are to receive no further state support once they are fully grown. The argument for increasing the diversity of occupations and skills within the nation can, of course, be defended with the greatest of ease on grounds other than economic. On economic grounds, one must inquire into the consequences of such diversification in terms of the higher prices the man in the street has to pay for what he buys; this is the sole basis on which an economically valid decision can be made.[5]

Although his primary interest was directed towards the development of new industries, Alexander Hamilton regarded his proposals as very advantageous to agriculture as well. He drew attention to the consequences for American agricultural producers of the uncertainties resulting from fluctuations in foreign demand, and he noted that a growth of industry combined with immigration would increase the domestic market for agricultural products. It was Hamilton's opinion that "a domestic market is greatly to be preferred to a foreign one, because it is, in the nature of things, far more to be relied upon." Reverting to that subject on a later page of his report,

there appear strong reasons to regard the foreign demand for that surplus [products of the soil] as too uncertain a reliance, and to desire a substitute for it in an extensive domestic market. To secure such a market there is no other expedient than to promote manufacturing establishments.[6] (my italics)

The "infant industries" argument was further developed, indeed brought to its most perfect formulation by the German economist Friedrich List, whose major work, The National System of Political Economy, appeared in 1840. Note the title of that work and compare it with Adam Smith's An Inquiry Into the Nature and Causes of the Wealth of Nations: the contrast is most illuminating!

Actually, it would be very misleading to place Hamilton and List into one and the same doctrinal "compartment"; the differences between them exceed the similarities. There was nothing aggressive towards the outside world in Alexander Hamilton's protectionism. List, however, is very much concerned with considerations of power. Economic policy in his eyes is for the state a means of achieving its full bloom. He envisages the acquisition of a "well-rounded" territory,[7] a large population, and a well-balanced economic structure. He also emphasizes that a nation must possess adequate military power to protect its political independence and its trade routes. Unlike Hamilton, List is interested in outlets for surplus population and emphasizes the need for colonies.

The next observation, which shows the contrast between the philosophy of List and that of Alexander Hamilton, has been brought out by William E. Rappard in his essay The Common Menace of Economic and Military Armaments.[8] Rappard notes that according to List, industrial protection

is not the artificial product of political speculation, as the school erroneously teaches. History shows that trade restrictions are born either of the natural efforts of the nation to attain well-being, independence, and power, or of wars and hostile commercial measures on the part of the dominating manufacturing nations.

Wars, then, are regarded by List as a frequent source of protectionist policies, and Rappard draws attention to List's conclusions that

a war which promotes the transition from the purely agricultural to the mixed agricultural-manufacturing State is therefore a blessing for a nation … whereas a peace which throws back into a purely agricultural condition a State destined to become industrialised, is a course incomparably more harmful than a war.[9]

Here economic nationalism rears its very ugly (and often hidden) head: far from being a mere adjunct of political nationalism, it appears as a policy which even welcomes war as a means of attaining certain economic ends.


Once American industry came of age and once German industry became powerful, the arguments of Hamilton and List ought no longer to have been invoked in their countries (although they still were available for the new underdeveloped areas and indeed were to be frequently used by their statesmen). But the protected industrial "infants" continued to cling to the state's apron strings — or purse strings — and would insist that protection of infant industries should become the protection of increasingly powerful vested interests. It is these interests that are largely responsible for the upsurge of protectionism in Western Europe in the last quarter of the 19th century and the early part of the 20th, and for the persistence of protectionism in the United States.

However motivated, 19th century protectionism was a considerably milder instrument of state interference with economic life than were the quantitative trade restrictions (coupled with tariffs) practiced in the preceding centuries. Tariffs did not stultify the price mechanism, nor did they disrupt the intricate interrelationships of world markets. They affected the distribution of resources and of industries throughout the world; the "liberal" mechanism of markets and prices continued to function undisturbed.

The protectionism of the 19th century operated in the environment of a liberal society and at a time when the economic powers of the state were, throughout the Western world, at a low ebb. There was in those days a good deal of interest everywhere in an expanding world economy. The growth of trade, the smooth functioning of the gold standard, and the sustained flow of capital from country to country, not to forget the easy migrations, all were expressions of the same favorable attitude towards the world economy.

"However motivated, 19th century protectionism was a considerably milder instrument of state interference with economic life than were the quantitative trade restrictions (coupled with tariffs) practiced in the preceding centuries."

Political nationalism, to be sure, was unabated, but liberal democracy was making increasing inroads on authoritarianism, such as the liberalization of the czarist regime in Russia after 1905. The world economy was in a state of continuous growth and expansion. The clash of powerful nationalisms culminating in World War I took place in what was, for all the growth of protectionism, a reasonably close approximation to a well-integrated world economy.

To say this is not in the least to deny that the widely spread protectionist miasma had very dangerous implications for the future of international relations. World War I disrupted world economic processes and, in conformity with List's prevision, considerably stepped up economic nationalism. It is interesting to speculate on the possible course of events if there had been no war. Would American, German, and Russian protectionism have continued to grow, and would Great Britain have succumbed to the blandishments of the followers of Joseph Chamberlain and given up free trade?

No one can tell, of course, but there is no doubt that even in the absence of World War I, free trade would have needed new enthusiastic, forceful, and persuasive champions in the 20th century in order to continue its course towards complete world economic integration, rather than be eroded by a rising tide of protectionism.


Trade and war do not mix well. A war on a world scale, a war taxing all the resources of the belligerents, could not but disrupt international economic relations. The international gold standard broke down under the strain, trade and payment controls were widely adopted, trade routes were disrupted, and war needs acquired a veto power over the decisions of the price mechanism. Economic nationalism was the real victor of World War I, just as collectivism was to be the real victor of World War II.

We now come to events that are familiar to the older readers of this book, although they are already remote to the younger. The reconstruction that took place after 1918, largely under League of Nations auspices, proved very precarious, owing to the contradictory tendencies prevailing in the world of the twenties. Monetary reconstruction was carried out as the first item on the postwar international agenda, there was a large expansion of international capital movements, especially out of the United States, and trade routes were reestablished fairly rapidly.

Nevertheless, the foundation of that reconstruction was very tenuous. The monetary reconstruction was superficial and proved to be largely spurious.[10] The revived capital movements were more the product of the bond salesmen's zeal than of the banks' shrewd appraisal of the economic outlook in borrowing countries. Many of these investments carried with them the seeds of default. The combination of erratic foreign investments with the technical faults of the "new gold standard" promoted an inflationary wave, worldwide in scope, with the most devastating depression of modern times following in its wake.

The financial internationalism of the twenties, such as it was, stood in contrast to the increasingly protectionist commercial policies of the period and to the spread of monetary nationalism (of mild expression). True, exchange controls and quantitative import restrictions which sprang up during World War I disappeared again a few years later, but economic nationalism was very strong and growing, both in the old, established countries and in those that either regained their independence or were newly formed at the Paris Peace Conference of 1919. The "new" countries were largely inspired by the "infant industries" argument, the older countries by the protection of vested interests. In Great Britain the increase of protectionist tendencies was a symptom of economic decline.

In the United States it was consequence of the failure of Congress, government, and the public to understand the effects of the country's drastically changed position in world affairs. From a fast-growing adolescent, the United States became the new leader of the world economy. It inherited from its elders responsibilities that they, crippled by war, were no longer able to discharge. These were, however, responsibilities that the United States was not yet mature enough to carry out wisely. Hence the twenties, with their orgy of indiscriminate foreign lending and simultaneously rising tariffs. Hence, also, the failure to realize that a creditor country must move towards free trade and not away from it, if it is not to suffer great losses itself while upsetting the international economic balance.

The "decade of unreason" (as it might well be called) culminated in the most spectacular economic crisis of modern times and socially the most upsetting. It ushered in the destructive depression of the thirties — a complex economic process with internationally interlocking causal connections that still awaits careful, complete, and penetrating study. It has led to a great expansion of collectivist creeds and collectivist practices throughout the world, including the West, and to at least a temporary decline of economic liberalism and internationalism.

Economic nationalism reappeared after over a century of decline, first in the form of neomercantilism, later in the more extreme forms advocated in 1800 by Johann Gottlieb Fichte. The views of Fichte on national self-sufficiency were rediscovered, or rather reinvented, by John Maynard Keynes in 1933. Easily the most influential economic thinker of this century, Keynes at this crucial time placed his immense gifts, intellectual as well as literary, and his great powers of persuasion at the service of economic nationalism.

It was, however, not a thinker but a man of action who was to apply the Fichtean blueprint in practice: Dr. Hjalmar Schacht of Germany, the architect of the Nazi economic policies. In the mid-30s "Schachtian" policies were instrumental in promoting Germany's self-sufficiency, or autarky, through totalitarian trade methods, which included "peaceful conquests" of several neighbors of Germany in the Danubian basin, a necessary prelude to her military march into Austria (in 1938) and Prague (Spring 1939) and to the wars of aggression started on September 1, 1939. Thus Fichte's blueprint was put into effect 130-odd years after its publication!

The "Schachtian" concept of economic nationalism was also instrumental, at least implicitly so, in shaping the foreign economic policies of the Soviet Union, today the greatest outpost in the world of ruthless economic nationalism.

After the end of World War II economic nationalism remained the prevalent tendency of most countries of the world. Although its most extreme forms, those which hark back to Fichte, were limited to the Soviet bloc, many other countries continued to practice strict trade and payment controls in order to insulate from outside influences their national plans for economic development or full employment or, in the mercantilist tradition, to "protect" their balances of payments and monetary reserves.

What must be noted in conclusion of the present account of "Economic Nationalism through the Ages" is that there has developed, especially from the end of the forties onward, a growing revulsion against economic nationalism. Limited at present to the Western world, this revulsion, if it lasts, may start a new era in the economic history of the world.[11] It may well be that future historians will find that the mounting tide of economic nationalism, having reached its peak in the latter thirties, has been decisively reversed in the 1950s.

Notes

[1] Although there is no such thing as a single mercantilist doctrine.

[2] See The Works of Alexander Hamilton, vol. 1 (New York: Williams & Whiting, 1810).

[3] Quoted from Louis M. Hacker, The Shaping of the American Tradition (New York: Columbia Univ. Press, 1947): p. 301. See, however, Alexander Hamilton, Papers on the Public Credit, Commerce and Finance, ed. Samuel McKee, Jr. (New York: Liberal Arts Press, 1957); and Richard B. Morris, ed., Alexander Hamilton and the Founding of the Nation (New York: Dial Press, 1957).

[4] Hacker, Alexander Hamilton, p. 302.

[5] Alexander Hamilton enjoys great favor today with the American protectionists and many a labor leader. They will (or should) be interested in point 4 of the statement quoted above in which he expresses himself in favor of increased "emigration" from foreign countries to the United States, an objective not very popular with Hamilton's modern admirers. On the other hand, those members of the labor movement who favor economic development through protectionist measures or the maintenance of employment through such measures, may be interested, in the following observations, also quoted from Hamilton's report (where he appears to be partial to one, at least, of the mercantilist predilections):

It is worthy of particular remark that, in general, women and children are rendered more useful, and the latter more early useful, by manufacturing establishments, than they would otherwise be. Of the number of persons employed in the cotton manufactories of Great Britain, it is computed that four-sevenths nearly are women and children, of whom the greatest proportion are children, and many of them of a tender age.

[6] A point of view shared by the contemporary advocates of national economics planning and of "insulation."

[7] Which is highly reminiscent of Fichte (whom List does not quote).

[8] Originally given as "The Eighth Richard Cobden Lecture" (Dunford House Association, London, May 25, 1936), later published as The Common Menace of Economic and Military Armaments (London: Cobden-Sanderson, 1936): pp. 21–22.

[9] Ibid., p. 22.

[10] Through the substitution of the gold exchange standard for the gold standard, with the "rules of the game" of the former largely ignored and with the price of gold at an unreasonably low level. Cf. Michael A. Heilperin, International Monetary Economics (London: Longman, Greens & Co., 1939): ch. 9.

[11] Reference should be made to the establishment of the Organization for European Economic Cooperation (O.E.E.C.), its Liberalization Code, the adoption of the "Common Market" by France, Germany, Italy and the three Benelux countries, the negotiation of a wider free trade area among all members of the O.E.E.C., and the growth of freer-trade sentiments in. the United States, often associated nowadays with concrete and drastic practical policy proposals. Reference should also made to the return to principles of monetary internationalism associated with national monetary discipline in a growing number of countries, and the partial removal of exchange restrictions by many countries of western Europe.