Unit 2: Why Trade?
Part 2: David Hume’s
Mercantilist Critique
David
Hume developed what became known as the “price-specie-flow”
model of international capital and trade.(“Specie”
in this context refers to any precious metal used as money.)
According to Hume, in a world in which trade was free, nations
that had large export surpluses (beloved of mercantilists)
and that accumulated large reserves of gold as payment for
exports would also see the domestic price of goods rise,
all else being equal. The accumulated precious metal surpluses,
in other words, would drive the value of those monies down.
So the domestic price of goods in gold or silver (or a currency
backed by gold or silver) would rise. This rise in prices
would make the export-surplus nation’s goods more
expensive on the international market and,
Hume thought, cause this same nation to be unable to maintain
an export surplus for very long. In fact, Hume thought that
the adjustment mechanism was efficient enough to ensure
that trading nations wouldn’t really have to worry
about trade or payments imbalances. This would also have
the effect of making the international division of labor
more efficient. The only way that mercantilist nations could
continually run export surpluses, then, was to coerce their
colonial outposts into buying too-expensive goods, and by
doing so to put off a calamitous day of reckoning in the
international payments system.
Animation:
Illustration of
gold flowing from one country to another, prices changing,
and trade patterns reversing.
Prices are essentially determined by a nation’s money
supply (amount of gold) relative to it’s output (stuff
produced) – for example, if a nation had 10 units
of gold and five unist of stuff, then the price of each
unit of stuff, on average, would be 2 units of gold.
As Nation A exports stuff they receive money from Nation
B. As money accumulates in Nation A they experience higher
prices which makes it increasingly difficult for them to
continue exporting their stuff to Nation B.
[Professor says: It would be great if this diagram could
be animated showing stuff going from A to B, gold going
from B to A, and prices rising in A. Webguys, is this possible
to do?
WEBSITE: To learn more about David Hume,
click here:
David Hume
http://www.econlib.org/library/Enc/bios/Hume.html
The relationship between trade accounts and currency
valuation. Hume’s theory is still useful
to us today, as it gives us a fairly accurate way to understand
the relationship between trade accounts and currency valuation.
The United States, for example, has been running enormous
trade deficits for the past 20 years. During the 1990s,
foreign investment was pouring into US financial markets
and keeping the dollar strong, although on account of the
US trade position, the dollar ought to have been weakening
(depreciating in value). Without the huge inflows of investment,
which slowed with the burst of the tech bubble in 2001,
the dollar has lost 40% of its value against the Euro, quite
in keeping with Hume’s theory.
South East Asian financial crisis. Or,
take the example of the Southeast Asian financial crisis
of 1998. In that case, countries like Korea and Thailand,
which depended upon exports for growth, had previously guaranteed
the value of their currencies against the US dollar as a
strategy to attract foreign investment into their nations.
But when the value of the US dollar began to rise due to
the tech boom in the US in the mid-1990s their export growth
strategies became a bust: they had overvalued currencies
and trade deficits (excess imports). So the governments
of South East Asian nations abandoned their currencies’
links to the dollar. At that point, quite in keeping with
Hume’s theory, their currencies’ values fell,
which in turn led a rapid rush for the exits on the part
of investors and the implosion of the regional financial
architecture.
Of course, we no longer live in a world where money is backed
by precious metal. This does change the theory of international
prices and payments substantially, as we learn later in
the course, but it doesn’t change Hume’s basic
insight, which can help us understand international trade
even today.
Indeed, before we move on to the first distortion wrought
by mercantilist theory and practice, it’s worth mentioning
that a critique of mercantilism not unlike Hume’s
still circulates today. The criticism has been leveled against
some Asian economies that have adopted export-led growth
strategies that are focused, as the mercantilists were,
on accumulating currency reserves. Today these reserves
are held (mostly) in dollars rather than gold or silver,
and the point is not just national wealth measured in such
currency. Rather, by buying up dollars (the world’s
benchmark currency) or dollar-denominated bonds, China,
Japan, South Korea and other Asian nations keep their own
currencies from appreciating in value. (Recall that an appreciating
currency makes export-driven growth harder.) This has the
welcome effect of keeping domestic industries employed in
producing low-priced export goods, and makes imports relatively
more expensive. So long as the central banks of these economies
can continue to manage their currencies in this way, their
export-led strategies—and the critiques that have
issued from the US and Europe—will probably continue.
WEBSITE: A detailed analysis of this critique
can be found in the Economist Magazine article, “Oriental
Mercantilists,” September 2003. To access this article,
use the name: STUDENT and the password: ECO300; if that
doesn’t work, try MALS620.
Oriental
Mercantilists
VIDEO: Hume’s Price-Specie-Flow Doctrine clip 1
VIDEO: Hume’s Price-Specie-Flow Doctrine clip 2
