The mercantile system is a system of managing the economy of a country through the regulation of its foreign trade. The goal of this system is to establish a permanent positive balance of trade. This goal can be accomplished by implementing the following trade tactics:
High tariffs on inbound goods. By increasing the prices of inbound goods from other countries, it becomes more likely that purchases of goods from other countries would decrease.
Subsidies on exports. The government pays subsidies to exporters, making it easier for them to lower their prices and sell more goods into other countries.
Low internal labor costs. The cost of labor is kept low, which has the dual effects of leaving little money for individuals to buy expensive imports and making it less expensive to manufacture goods for export.
Colonialism. Countries acquire territories overseas and set them up as colonies that are required to trade exclusively with their parent countries. This practice creates a flow of funds from the colonies to the parent country.
All of these tactics combine to create an environment where a country's inhabitants buy primarily from within its borders, while being as competitive as possible overseas.
Mercantilism was found to be an invalid system of thought for the following reasons:
Not everyone can have a positive balance of trade; the system assumes that trading partners will have correspondingly large negative trade balances on an ongoing basis. This results in a permanent wealth imbalance between countries.
The system encourages countries to produce all of their own goods, when in fact some countries have lower overall costs, and so should distribute their wares throughout the world.
The cost of a country's currency would gradually increase along with its balance of trade, until it would reach the point of being too expensive for trading partners, who would no longer find it cost effective to buy goods from that country.
Subsidies tend to be paid to those companies currently favored by the government, which smacks of favoritism. This action also tends to impede free trade.
The mercantile system was eliminated from use once colonies separated from their "parent" countries, as well as with the advent of a number of regional free trade agreements.