Mercantilism isn't all bad, but Trump's version is worst

Observer

08-05-2025

When economists celebrate the 250th anniversary of the publication of Adam Smith's The Wealth of Nations next year, US President Donald Trump's mercantilism will constitute an incongruous backdrop. After all, Trump's obsession with bilateral trade balances, glorification of import tariffs, and zero-sum approach to international trade has revived – in defiance of Smith's teachings – the worst mercantilist practices.
Economists are right to denigrate Trump's trade policies. Other countries' unfair trade practices are not the main reason for the US trade deficit, and targeting bilateral trade imbalances is downright silly. While the trade deficit has contributed to the decline of US manufacturing, it is hardly the most important factor. And besides, it enables American consumers and investors to borrow cheaply – a privilege most other countries would love to have.
In truth, mercantilism has never been as dead as economists thought, nor is it necessarily as misguided as they insist. Thanks to Smith's followers, laissez-faire and free trade often did find favour in leading countries, but others that were trying to catch up to frontier economies typically adopted mixed strategies.
For example, Alexander Hamilton in the United States and Friedrich List in Germany explicitly rejected Smithian ideas and advocated import protection to grow infant industries. The Argentine economist Raúl Prebisch and others of the 'dependency school' thought that developing countries should shield their manufacturing industries from import competition; and some of the countries that followed their advice, such as Brazil, Mexico and Türkiye, experienced decades of rapid economic growth.
Similarly, East Asian governments pursued a mix of mercantilist and Smithian approaches, leveraging exports and private enterprise, but often behind protectionist walls. The result was what many saw as an economic miracle. While few of these policymakers would explicitly associate themselves with mercantilism, the 'developmentalism' they espoused shared many of its features.
The fundamental difference between the Smithian and mercantilist approaches derives from how consumption and production are treated. Modern economics takes its cue from Smith in focusing on consumption as the ultimate end goal of economic activity. Smith countered mercantilists by arguing that 'consumption is the sole end and purpose of all production,' noting that, 'the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.'
The trade deficit has contributed to the decline of US manufacturing.
Mercantilists, on the other hand, instinctively emphasise production and jobs. What a country produces matters. It is absurd to claim, as one of George H W Bush's advisers once put it, that there is no difference between producing potato chips and producing computer chips. Moreover, once production, especially of manufactured goods, becomes policymakers' top priority, it follows that a trade surplus is preferable to a trade deficit.
It is possible to reconcile these two perspectives by adding various market failures to the conventional mainstream account. Today's Smithians would acknowledge that policymakers should not remain indifferent to the structure of production when certain manufacturers produce technological spillovers or are subject to coordination problems. But one's starting point also matters. Unless there is strong and compelling evidence to the contrary, a mainstream economist will generally oppose 'picking winners.'
Someone with a mercantilist or developmentalist bent, on the other hand, will not hesitate to make choices about what to produce and how. The question is who bears the burden of proof, since this determines whether we treat, say, East Asian-style industrial policies as normal or as an aberration.
Contemporary economists' Smithian focus on consumption also leads them to underestimate the importance of jobs in determining well-being. In the standard 'utility function' that economists use to characterise consumer behaviour, jobs are a necessary evil: they create purchasing power, but otherwise have negative value insofar as they decrease leisure time. But, in truth, jobs are a source of meaning, esteem, and social recognition. Economists' failure to appreciate the personal and social costs of job losses made them insensitive to the consequences of the China trade shock and automation.
Another key difference revolves around the government's relationship with firms. Smith thought one of the defects of mercantilism was that it promoted cosy relationships between policymakers and the private sector, which was a recipe for corruption. Contemporary economics has taken this warning to heart. Models of political economy and rent-seeking emphasise the importance of keeping firms at arm's length from policymakers.
But in many settings – such as frontier innovation, green industrial policies, or regional development – close, iterative relationships between governments and firms have been highly successful. There is a good reason for this. While keeping firms and governments apart may minimise the risk of capture, it also makes it very difficult to learn about constraints and opportunities, and about what is working and what is not. When there is significant uncertainty (whether technological or of some other kind), working closely with firms can be preferable to maintaining strict separation.
Each perspective has its own blind spots. Mercantilists too easily associate producers' interests, especially those well connected to the state, with the national interest. Smith's intellectual children, on the other hand, underplay the importance of production and jobs and overlook the advantages of public-private collaboration. Good policy is often a matter of getting the combination right.
None of this vindicates Trump's approach, of course. His chaotic, indiscriminate trade policies do little to expand critical, strategic investments in the US, and they are riddled with cronyism, exempting politically connected firms and allowing them to game the system. There will be no upside to his mercantilism because it embodies the strategy's worst defects. @Project Syndicate, 2025