Mercantilism: China and Beyond

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The self-liquidating nature of the mercantilist model cannot be reversed, it can only be managed as stagnation.

Everyone is an expert now on China. Which to say, everyone has an opinion about China, and the majority of those opinions fall into simplistic Bull or Bear camps.

As someone who has been a student of China for over 50 years, my sense is every claim of expertise has its limits. The more substantial the expertise, the greater the willingness of the expert to confirm the limits of their expertise. The more you know, the sharper your awareness of what you don’t know.

Being embedded in a culture makes it difficult to be objective. As an American, I don’t claim to be an expert on America; we only learn about being American by going elsewhere and observing, listening and learning from those raised in other cultures.

So rather than discuss China per se, let’s discuss the dynamics of mercantilism that play out not just in China but beyond, as they play out in every nation with mercantilist policies.

Mercantilism is rooted in a basic question facing every society: what is the primary source of our prosperity? For nations rich in natural resources, the answer is extracting and exporting these resources to those who lack them. For nations with fertile land, it’s growing and exporting grains and other foodstuffs. For nations poor in natural resources, value-adding manufacturing/crafts are an answer.

Every nation manages the balance between investing and consuming the surplus generated by the economy. Every dollar of surplus that’s funneled into investing in expanding production of exports is a dollar that isn’t spent in the domestic economy. It’s a tradeoff: we accept being poor now in order to become rich as exports expand.

Mercantilism is the political-economic-social policy that seeks to increase prosperity by focusing on optimizing profitable exports at the expense of domestic consumption. Rather than consume the surplus, the surplus is invested to increase exports. Wages are kept low to subsidize capital investment.

Mercantilism relies on manipulation of market forces. Mercantilist policy recognizes that the way to reap the biggest gains is to corner the market for whatever is being exported. The ideal way to accomplish this is to sell your exported goods at a loss, making them so cheap that the importer’s domestic producers cannot compete on price, so they close down.

Once the domestic producers have been wiped out or marginalized, the mercantilist nation’s producers can jack up prices because the importing nation is now dependent on the mercantilist nation’s exports. At the same time, the mercantilist nation establishes trade barriers to imports, making them so expensive that they cannot compete with domestic producers.

Mercantilism rigs trade on both sides of the coin to benefit the mercantilist nation at the expense of other nations. The mercantilist nation protects its domestic producers from overseas competition while flooding the targeted importing nations markets with cheap goods, driving their domestic production out of business.

Japan demonstrated how to optimize mercantilist policies in the period 1949 to 1989. Domestic consumption was limited as the necessary tradeoff to invest heavily in production of exports. This required tight coordination of the government and private industry, who worked hand in hand to finance and favor export production.

Currency, labor costs and state subsidies are all core to optimizing exports. The weak yen and initially lower labor costs meant that Japanese goods were cheap in the US. So mercantilism favors weak currencies, ample government subsidies of favored export industries and policies that cap or suppress labor costs.

The problem with mercantilist optimization is the targeted importing nations eventually wake up to the dire consequences of their dependence on mercantilist exporters. The downstream costs of losing domestic production and jobs become apparent, and the power that was transferred to the mercantilist nation without anyone noticing is now a visible threat.

This threat becomes even more apparent when the mercantilist nation deploys its vast trade surpluses to buy up companies, farmland and other assets in the importing nations. Alarm bells go off as the importing nation awakens to their future as a dependent peasantry working for industries owned by the mercantilist nations.

In other words, mercantilism is self-liquidating, because it’s fundamentally a one-sided manipulation of markets that impoverishes the importing nations. Self-preservation forces the importing nations to finally push back against the mercantilist manipulations by protecting what’s left of domestic production, limiting imports and demanding equal trade access to the mercantilist’s domestic market.

The unrecognized problem is the very success of the mercantilist model leads to the mercantilist nation becoming dependent on that model, which is inherently centralized and tightly controlled–the opposite of a free market. Since decentralized, open-market forces have been limited to low-level consumption, the mercantilist economy has lost the capacity to adapt as an emergent system, i.e. self-organizing based on a churn of low-level, localized experiments and enterprises.

The limits of the centralized, tightly controlled mercantilist model only become apparent when it starts failing, at which point the model becomes a trap. Since the state-corporate partnership limits localized, uncontrolled open-market forces, this capacity is too constrained to replace mercantilism. In the the mercantilist model, the “solution” is always centralized: increase subsidies for export industries, strip-mining the economy and society to benefit whatever export industries the leadership has chosen to favor.

Since domestic consumption has been limited to boost investment in export capacity, the domestic economy cannot replace faltering export growth. What the mercantilist model optimized was investment, and as centralized control has throttled adaptive forces, the investments in more export capacity are now mal-investments, as the world has changed. Dumping the economy’s surplus into expanding export capacity is no longer a golden road to wealth, it’s a catastrophic mis-use of capital.

The grand irony in becoming dependent on the mercantilist model is that there is no way out of its self-liquidating limits. The centralized planners–so accustomed to the successes of manipulating trade and currency markets to their exclusive advantage–have no adaptive means left, as that would require dismantling the centralized control that is the heart of the mercantilist model.

So they do more of what’s failing: weakening their currency, over-investing in export capacity, and maintaining a tight grip on the levers of control, as if doing more of what cannot possibly work like it did in the past will magically work because it was so successful in the past.

The story of China is the leadership has chosen export industries to conquer the world, but the world has changed. Importers have awakened to the consequence of becoming dependent on mercantilist nation’s exports: national impoverishment and the loss of control of the nation’s future.

Japan has managed a controlled stagnation of the mercantilist model in these ways:

1. Japan adapted the mercantilist model by moving auto production to the importing nation’s domestic economy. Profits still flow back to Japan but the jobs and parts now benefit the importing nations’ domestic economies.

2. Japan bought up enormous quantities of overseas assets in the go-go bubble decade of the 1980s, assets that generate income denominated in other currencies, enabling currency arbitrage, a.k.a. the yen carry trade.

3. Japan benefited from the deflationary boom generated by China: Japan moved a substantial portion of its production to China, along with other developed nations.

4. Japan has managed the debts left by the collapse of its gigantic asset bubbles in 1990 by keeping the non-performing loans on the books. Rather than writing off all the bad debt, Japan has chosen to bleed it off over decades of stagnation.

5. Japan’s cultural unity and stability enabled the continuation of the mechanisms of the mercantilist model even as the model generated stagnation. The workforce continues to accept long work hours and other sacrifices jettisoned by other developed nations, centralized planning from the 1960s that forces needless domestic consumption, and the general stagnation of the purchasing power of wages evident in many nations: the number of young people who cannot afford to buy a home or start a family is now a consequential demographic factor.

To summarize: the self-liquidating nature of the mercantilist model cannot be reversed, it can only be managed as stagnation—and only if specific conditions apply. Absent those conditions, stagnation is not stable, it generates instability.

What’s playing out in China is mercantilism with Chinese characteristics, just as mercantilism with Japanese characteristics has been playing out in Japan over the past 36 years. If the income generated by overseas assets replaces the stagnating income from exports, the decay of living standards can be masked by the continuation of a stable social order: the trains still run on time, everyone can get by on their salaries, etc.

But to say this is the same as the go-go euphoria of mercantilism’s glory days–no. The self-liquidation can be slowed, not reversed, for the world has changed. This is not isolated to any one nation, it’s inherent to mercantilism.

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Source: http://charleshughsmith.blogspot.com/2026/04/mercantilism-china-and-beyond.html