II.

Early Trade Doctrines

Foreign trade doctrines began to develop during the 1400s. One early form of economic policy, known as mercantilism, dominated Western Europe from about 1500 to about 1800. Supporters of this policy worked to promote national unity and to increase the strength of the nation-state. They considered wealth a necessary condition of power, and the accumulation of gold and silver specie, or coins, a necessary condition of wealth. Countries without gold or silver mines acquired specie by maintaining a surplus of exports over imports through strict governmental control of foreign trade.

A reaction against such control occurred in France in the 1700s. This led to the formulation of the first theory of free trade by a group of economic philosophers known as the physiocrats, who were followers of the French economist François Quesnay. The physiocrats maintained that the free movement of goods was in accordance with the principles of natural liberty. Although their ideas had little effect in France, they influenced the Scottish economist Adam Smith, whose free trade theories contributed to the later development of trade policy in Britain.

Smith refuted the protectionist conclusions of mercantilist thought. He pointed out that wealth consisted not in specie itself but in the material that specie could purchase. Governmental regulation of trade actually reduced the wealth of nations, because it prevented them from purchasing the maximum amount of commodities at the lowest possible price. With free trade, each nation could increase its wealth by exporting the goods it produced most cheaply and importing goods that were produced cheaper elsewhere.

According to Smith, each country would specialize in the production and export of goods in which it had an absolute advantage—that is, it could produce the goods more cheaply than any of its trading partners. Another British economist, David Ricardo, extended that analysis early in the 19th century to encompass the more general case of comparative advantage. Ricardo noted that some nations lack an absolute advantage in the production of any commodity. However, even these nations could gain from free trade if they concentrated on producing commodities in which they had the smallest disadvantage. This enables the nation to trade goods that are easiest to produce for goods that are more difficult to produce. When nations practice the principle of comparative advantage, more goods are produced between the trading countries, and the wealth of both countries increases. The principle of comparative advantage forms the theoretical basis of the argument for free trade.

Ricardo assumed that all nations would share in the gains from free trade. The British philosopher and economist John Stuart Mill later demonstrated that such gains depend on the strength of reciprocal demand for imports and exports. The stronger the demand for the exports of a country relative to its demand for imports, the greater its gain from free trade. The gain would be reflected in an improvement in the international terms of trade for the country, as expressed by the ratio of its export prices to its import prices.