Mercantilism, physiocracy and classical political economy

Detail

The common thread: "market or state?"

• Every school of economics gives its own answer to one question: should the market decide, or the state?
• Each answer came from a crisis of its own time:
• Bullion wars (16th–18th c.) → mercantilism (the state leads)
• Industrialisation (late 18th–19th c.) → classical school (the market leads)
• 1930s depression → Keynes (1936) (the state steps in again)

• 1970s stagflation, the 2008 crash, and behaviour that did not look rational → later schools

• Indian policy has borrowed from almost all of these schools.

• This section covers the first three steps: mercantilism → physiocracy → classical political economy.

1. Mercantilism (16th–18th century)

Core idea

• Mercantilism held that a nation's wealth is its stock of gold and silver (bullion).
• To get more bullion, a nation should:
• run an export surplus (sell more abroad than it buys), and

• protect home industry with tariffs and colonies.

• Britannica puts the contrast plainly. For mercantilists, coin and bullion were the essence of wealth. The physiocrats later said wealth was only the products of the soil [4].

Worked example: how a trade surplus becomes bullion

• Say England exports goods worth ₹120 crore and imports goods worth ₹100 crore.
• Balance of trade = Exports − Imports = 120 − 100 = +₹20 crore (a surplus).
• Foreigners pay the ₹20 crore gap in gold or silver.
• So England's bullion stock rises by ₹20 crore. To a mercantilist, the nation is now "richer".

Key names

• Thomas Mun (England), England's Treasure by Forraign Trade. He wrote it in the 1620s, and it was published in 1664. Mun was a director of the East India Company. He argued that the overall balance of trade matters, not each single deal.
• Jean-Baptiste Colbert (France, 1660s–80s), finance minister to Louis XIV. His state-led form of mercantilism is often called Colbertism.

Tools of mercantilist policy

• Tariffs (taxes on imports) to keep foreign goods out
• Bans on exporting raw materials, so home factories get them cheap
• Colonies, used both as captive markets and as sources of raw materials
• Chartered monopoly companies: firms given sole trading rights by the Crown. The East India Company (1600) was mercantilism in action.

Zero-sum view

• Zero-sum trade: world wealth is a fixed cake, so one nation gains only if another loses.
• This view made trade look like war, and the "bullion wars" followed.
• Adam Smith (1776) later attacked it. He argued that trade makes both sides better off (positive-sum).

Bullionism

• Bullionism was the crudest form of mercantilism.
• It said wealth is precious metal, so the state should ban the export of gold and silver outright.
• Mun's generation softened this. Some bullion could leave the country, as long as the overall trade balance stayed in surplus.

Colonial India as a mercantilist case (NCERT link, Class 11)

• Under British rule, India exported raw materials and imported finished British goods.
• India ran an export surplus. But that surplus did not bring gold into India.
• Instead, it paid for the colonial government's office in Britain, Britain's wars, and "invisible" imports. Economists call this outflow of wealth the drain of wealth.
• This is the colonial side of mercantilism: the mother country gains and the colony loses.

Neo-mercantilism today

• Neo-mercantilism is the modern version. It shows up as:
• export-led surpluses (large, lasting trade surpluses)
• hoarding of foreign exchange (forex) reserves. A country's forex reserves are the foreign currency and gold held by its central bank.

• tariff wars (countries raising import taxes against each other)

• India's scale: India's forex reserves stood at US$ 698,192 million (about US$ 698.2 billion) on 25 July 2025. Of this, foreign currency assets were US$ 588,926 million and gold was US$ 85,704 million [2].

• Note the difference. Mercantilists stored gold as wealth. The RBI holds reserves as insurance: to calm sharp swings in the rupee and to cover imports during a crisis.

2. Physiocracy (France, 1750s–70s)

Core idea

• Physiocracy means "rule of nature" (Greek physis = nature, kratos = rule).
• It held that only land and agriculture produce a net surplus, called the produit net. This is what the land yields over and above the cost of producing it.
• Manufacturing and trade are "sterile": they only change the form of what land yields. A carpenter turns wood into a table, but he adds no new wealth.
• Quesnay compared a workshop with a farm and argued that the farm alone adds to a nation's wealth [4].

Worked example: produit net

• A farmer sows seed and pays for labour worth ₹100 and harvests grain worth ₹150.
• Produit net = 150 − 100 = ₹50. This is new wealth from nature.
• A weaver buys yarn worth ₹50, works on it, and sells cloth for ₹50 plus the cost of his own upkeep. On the physiocrats' view, no surplus is added.

Tableau Économique (1758)

• François Quesnay was physician at the court of Louis XV and the founder of the school.
• His Tableau Économique (1758) was the first circular-flow model of an economy. A circular-flow model shows money and goods moving in a loop between groups in the economy.
• It was a diagram of payments flowing between three classes [3]:
• the productive class (farmers)
• the proprietors (landlords)

• the sterile class (artisans and merchants)

• In the Tableau, Quesnay developed the idea of economic equilibrium: a state where the flows balance and the economy can repeat itself year after year. Later economists often start from this idea [3].

• Today's circular flow of income in NCERT Class 12 macroeconomics comes from this.
• Turgot (A.R.J. Turgot, French finance minister 1774–76) was the other leading physiocrat.

Policy

• Single tax on land (impôt unique): since only land yields a surplus, only landowners' net income should be taxed.
• "Laissez faire, laissez passer": let things be made, let goods pass. In other words, free trade and deregulation.
• Quesnay wanted free trade and lower taxes [4].
• Faith in mercantilism faded in the 18th century, first because of the physiocrats. They wanted trade and industry left to follow their natural course [5].

NCERT line (Class 12, Introduction)

• "The Physiocrats of France were prominent thinkers of political economy before Smith."
• Smith met Quesnay and Turgot in France in 1764–66, while he was preparing Wealth of Nations. He took the free-trade idea from them but rejected the claim that industry is "sterile".

3. Classical school (1776 to the mid-19th century)

What "classical" means

• Classical economics is the pre-Keynesian school. Its thinkers were mostly British.
• NCERT (Class 12, Introduction) sums up its belief: "all the labourers who are ready to work will find employment and all the factories will be working at their full capacity."
• In short, a free market settles by itself at full employment. There is no lasting unemployment, so there is no need for the state to step in.
• Keynes (1936) challenged exactly this belief after the Great Depression.

3a. Adam Smith (1723–1790)

• Smith was a Scot, a professor at Glasgow, and a moral philosopher by training.
• His two books:
• Theory of Moral Sentiments (1759), on ethics and sympathy

• An Inquiry into the Nature and Causes of the Wealth of Nations (1776)

• NCERT calls him the "founding father of modern economics". The subject was then called "political economy".

Self-interest (the butcher-brewer-baker line)

• "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest."
• The point: each person acts out of self-interest, and yet society still gets fed. People often quote this line in support of free markets.
• Caution: Moral Sentiments shows that Smith did not praise greed. He assumed people also feel sympathy and follow moral rules.

Division of labour

• Division of labour means splitting production into small, specialised tasks. For Smith it was the main source of productivity growth.
• Worked example (the pin factory):
• 10 workers, each doing one step, made about 48,000 pins a day.
• That is 48,000 ÷ 10 = 4,800 pins per worker per day.

• Smith said one untrained worker doing every step alone could make hardly 20 pins a day. Specialisation raised output by more than 200 times.

• Why it works:

• workers become more skilled at one task
• no time is lost switching between tasks

• simple, repeated tasks invite machines

• It is "limited by the extent of the market". A small village cannot support a specialist pin-maker. Bigger markets allow finer specialisation. This is one reason trade matters.

Invisible hand

• Smith uses the phrase only once in Wealth of Nations.
• NCERT (Class 12, Market Equilibrium) reads it as the force that adjusts prices by itself until the market clears:
• excess demand (buyers want more than sellers offer) → price rises
• excess supply (sellers offer more than buyers want) → price falls

• this goes on until demand = supply (market equilibrium)

• Detail is in market-equilibrium-price-controls.

Laissez-faire and the three duties of the state

• Laissez-faire means the state interferes in the economy as little as possible.

• Smith gave the state only three duties: 1. Defence, to protect society from foreign attack 2. Justice, to protect each member from injustice by others 3. Public works and institutions that no private person would find profitable to provide (roads, bridges, basic education)

• Critics later mocked this as the night-watchman state: a state limited to police, courts and defence. The phrase is linked to the German socialist Ferdinand Lassalle.

3b. Labour theory of value (Smith, Ricardo)

• Labour theory of value: a good's value depends on the labour time needed to make it.
• Worked example:
• A chair takes 4 hours of labour and a stool takes 2 hours.

• So 1 chair = 2 stools in value.

• Karl Marx later built his theory of exploitation on this idea. The marginal revolution of the 1870s replaced it with value based on utility, the satisfaction a buyer gets from a good.

3c. Say's law (J.B. Say, Treatise on Political Economy, 1803)

• Say's law: supply creates its own demand.
• Logic: producing goods worth ₹100 creates incomes of ₹100 (wages, rent, interest, profit). Those incomes are spent on other goods, so all output finds buyers.
• So there can be no general glut, meaning no economy-wide overproduction. Some goods may pile up for a while, but not all goods at once.
• This is why the classical school expected full employment.
• Keynes (1936) turned it around: demand creates supply. If people hoard their savings, demand falls short and workers lose jobs.

3d. David Ricardo (1772–1823), Principles of Political Economy and Taxation (1817)

• Ricardo studied how total output is divided among three classes: landlords (rent), workers (wages) and capitalists (profit) [7].
• At the heart of his system: growth must sooner or later stop, because growing food on a limited area of land keeps getting costlier [7].
• Comparative advantage (cross-ref the trade topic):
• A country should export what it makes at a lower opportunity cost, meaning it gives up less of other goods to make it. This holds even if it is worse at making everything.

• Ricardo's example, in labour-years needed to make one unit:

  	Wine	Cloth
  Portugal	80	90
  England	120	100

• Portugal is better at both goods (it has an absolute advantage in both).

• But in Portugal, 1 wine costs 80/90 = 0.89 cloth. In England, 1 wine costs 120/100 = 1.2 cloth.
• So Portugal has the comparative advantage in wine and England in cloth. If each specialises and they trade, both gain.

• This destroys the mercantilist zero-sum view.

• Differential rent:

• Rent arises from differences in land fertility.

• Worked example: three plots get the same labour and capital (cost = 60 quintals of grain each).

  Land	Output	Rent (Output − 60)
  A (most fertile)	100	40
  B	80	20
  C (marginal, i.e. the worst land in use)	60	0

• As population grows, poorer land comes into use. Rent on better land then rises, while the landlord does nothing.

• This is why Ricardo attacked the Corn Laws (British import duties on grain, repealed in 1846).

3e. Thomas Malthus (1766–1834), Essay on the Principle of Population (1798)

• The full title of the 1798 book was An Essay on the Principle of Population as It Affects the Future Improvement of Society, with Remarks on the Speculations of Mr. Godwin, M. Condorcet, and Other Writers [6][9].
• Malthus met Ricardo in 1811, and they became close friends [6].
• Malthusian theory of population:
• Unchecked, population grows geometrically (1, 2, 4, 8…). Food grows only arithmetically (1, 2, 3, 4…).

• So population always tends to outrun the food supply [6].

• Worked example (Malthus assumed population doubles every 25 years):

Year	0	25	50	75	100
Population	1	2	4	8	16
Food	1	2	3	4	5

• After 100 years, food per head = 5/16 ≈ 0.31, less than a third of the start.

• Two kinds of check keep population and food in balance:

• Positive checks raise the death rate: famine, disease, war.

• Preventive checks lower the birth rate: late marriage, moral restraint.

• Malthusian trap:

• output rises → more children survive → population rises → food per head falls back → living standards stay near subsistence (the bare minimum needed to stay alive)

• The world escaped this trap only through:

  • the Industrial Revolution, which made output grow faster than population
  • the demographic transition: first death rates fall, then birth rates fall

• Neo-Malthusianism: the Club of Rome's Limits to Growth (1972) revived these fears for resources and the environment.

3f. Iron law of wages (Ricardo; named by Lassalle)

• Iron law of wages: in the long run, population pressure pushes real wages down to subsistence.
• wages rise above subsistence → families grow → more workers → wages fall back

• wages fall below subsistence → starvation and fewer births → fewer workers → wages rise back

• Ricardo's view fits Malthus's population theory, which held that population adjusts to the means of supporting it [8].

• Real wages are money wages adjusted for prices, i.e. what the wage can actually buy.

3g. Utilitarianism (Jeremy Bentham, J.S. Mill)

• Utilitarianism: the right action is the one that gives "the greatest happiness to the greatest number".
• It underpins early welfare economics, the study of how policy changes total well-being.
• J.S. Mill (Principles of Political Economy, 1848) was the last great classical economist. He separated:
• the laws of production (fixed by nature), from

• the laws of distribution (which society can change, e.g. through taxes)

• This opened the door to reform, and to a bigger role for the state.

Prelims Hooks

• First circular-flow model: Quesnay's Tableau Économique (1758), a physiocrat work, not classical and not Keynesian [3].
• Physiocrats: only agriculture yields a net surplus (produit net). Manufacturing and trade are "sterile". Their tax policy: a single tax on land.
• "Laissez faire, laissez passer" is a physiocratic slogan. Smith popularised the idea, but the phrase did not start with him.
• Wealth of Nations was published in 1776 and Theory of Moral Sentiments in 1759. The phrase "invisible hand" appears only once in Wealth of Nations.
• Division of labour is limited by the extent of the market (Smith). Pin factory: 10 workers made about 48,000 pins a day.
• Say's law (1803): "supply creates its own demand", so there is no general glut. Keynes rejected it.
• Match the book to its author and year:
• England's Treasure by Forraign Trade: Mun (published 1664)
• Essay on Population: Malthus (1798)

• Principles of Political Economy and Taxation: Ricardo (1817)

• Malthus: population grows geometrically, food arithmetically. Positive checks raise the death rate. Preventive checks lower the birth rate. Trap: late marriage is a preventive check, not a positive one.

• Differential rent and comparative advantage come from Ricardo, not Smith. Smith's trade idea was absolute advantage.
• Bullionism (a ban on exporting gold and silver) is the crudest form of mercantilism, which treats trade as zero-sum.

Mains Points

• Neo-mercantilism versus free trade (GS-III):
• Today's tariff wars and export-led surplus strategies bring back the zero-sum mercantilist logic.
• Ricardo's comparative advantage and the WTO system rest on trade as positive-sum.

• India holds forex reserves of about US$ 698 billion (25 July 2025) [2]. It does so for safety (to steady the rupee and cover imports), not to hoard bullion as wealth. This is a useful point when you judge "reserve hoarding" critiques.

• State versus market in Indian planning (GS-III):

• The Mahalanobis model and import substitution (1950–90, NCERT Class 11) protected infant industries. Critics compare this with mercantilist tariff protection.
• The 1991 reforms moved India closer to Smith's laissez-faire.

• But India kept Smith's three duties, and added a bigger welfare role for the state, which comes from utilitarian welfare economics.

• Colonial drain as mercantilism in practice (GS-I/GS-III):

• The East India Company was a chartered monopoly. India was made an exporter of raw materials and a market for British goods.
• India's export surplus did not bring wealth home. It paid for British expenses (the drain).

• This shows that mercantilism's zero-sum outcome fell hardest on colonies.

• The Malthusian debate and India's demography (GS-I/GS-III):

• The Green Revolution and falling fertility show that technology and the demographic transition broke the Malthusian trap.
• Neo-Malthusian worries (Limits to Growth, 1972) still matter for water, land and climate stress.
• Ricardo's point about "limited land" returns in debates on farm productivity and land fragmentation.