Mercantilism Theory

The classical economist inaugurated as a revolution against an ordinary group of economists known as mercantilism. The main concern of the classical economists was about a surplus of the economy regarding to its formation, its distribution among different classes in the economy and its utilization (either luxury or for investment). The classical focus is more in favouring investment as the best way for surplus utilization since in the long run it can facilitate expansion in capital formation, hence ‘wealth of a nation’ (Felderer and Homburg 1992: 15). The classical theory begins with the theory of absolute advantage which was advanced by Adam Smith. Smith advocates for a free market in the absence of the government regulations for the perfect

For instance, in a hypothetical world of only two countries involved in trade i.e. A and B and only two goods traded eg. wheat and coffee. If country A could produce wheat by using real cheaper factors than in its production with coffee, then it should specialise in production and export of wheat and traded for coffee with country B and vice versa is true (Smith 1776: 98). For the case of trade between Tanzania and Germany, Tanzania exports raw materials such as coffee, tobacco, and minerals to Germany, while Germany exports industrial machines, vehicles and commodity goods. With absolute advantage theory Tanzania needs to specialise and export raw materials in exchange for manufactured goods from Germany. Through this, both countries gain because each specialises on the production and exports of goods which it has absolute advantage and import goods in which it has the absolute

From his book, he advances a theory of comparative advantage in 1820’s which is still very famous among the economist. The theory states that the country needs to put emphasis to production and export of goods in which it results to cost advantage compared with other countries, and import goods that its production has relative cost disadvantages (Ricardo 1817: 13; Samuelson and Nordhaus 2010: 341). In this theory, Ricardo explains that even if a country has a low ability to produce in both goods, should concentrate on the production of good which it has a less disadvantage and trade with the other country to import goods which it has high disadvantages (Ricardo 1817). Ricardo uses the hypothetical ideas of two countries A and B and two products involved in trade i.e. coffee and tea. If country A has an absolute advantage in the production of both commodities, does it mean country B should not trade because of its inefficiency? No, according to Ricardian theory country A will produce and export a commodity that it has higher comparative advantage i.e. coffee and trade for good that it has less comparative advantage i.e. tea. For the case of country B, it should produce a product that it has a less comparative disadvantage