I reworked this former post of mine for the Age Business section which published it today. As you will see it has gone through substantial revision of tone. It’s still the case that no-one’s discussing the idea. Sad really.
Warren Buffett is the billionaire from a Norman Rockwell painting who got rich by building a financial counter culture within his investment company Berkshire Hathaway in which managers loved their businesses so much they treated them like owners.
But hes a worried man. Populist Republican presidents like Ronald Reagan and George W. Bush cut taxes without the hard work of cutting expenditure. The resulting government deficits along with falling saving by American households, have seen America go from trade surpluses to large trade deficits as far into the future as the eye can see.
And whos funding Americas profligacy? The Asian countries particularly China who, being huge savers have the funds to invest in America and the interest in continually lifting Americas credit card limit so it can buy Asian goods.
But credit card limits cant rise faster than income forever, and as Buffet reminds us quoting Herb Stein “If something cannot go on forever, it will stop.”
Under current arrangements that adjustment would happen via a drying up of Asian finance, a depreciating American dollar and a resulting slowdown restraining Americas rampant consumption and shifting the competitive balance towards American industry.
Buffetts concern with this solution is reminiscent of Keynes. Keynes thought competitive markets were admirably flexible and efficient. But he also believed that certain macro-markets – he was thinking of labour markets, but one could make similar arguments about asset and currency markets could defy the fundamentals for a long time.
Buffet makes his point with some storytelling economists would call it a model. He invites his audience on a wildly fanciful trip to two isolated, side-by-side islands of equal size, Squanderville and Thriftville.
Squandervillians live it up by borrowing from Thriftville something they can keep doing until theyve mortgaged all their assets, including their land. This process could go on a long time before the market forces an adjustment. And by then what damage might have been done to Squandervilles economic future not to mention its strategic position with its financier Thriftville (Sorry I nearly said China) ?
Buffett proposes a remedy so simple its odd that, given his profile, its received so little attention. Under his system you couldnt import into America without holding permits to do so. And the only way to get a million dollars worth of import permits would be to achieve exports of a million dollars from America or buy them from someone who had.
The system balances trade. And because it uses freely tradeable permits to do so requiring no other restrictions on trade its an extremely efficient way to balance trade.
But why would you want to balance trade? Just as a company can borrow to build a factory, nations can run trade deficits to build their productive capacity. Buffetts concern is that America is not investing its increased borrowing that its just living it up on the credit card.
Even so, its still not clear that what hes suggesting offers any big improvements on the way the adjustment would otherwise occur. I suspect he fears that Americans dont have the ticker to reduce their consumption to balance trade. But if thats the case theyre unlikely to stick with his solution either.
Under his system, as with a more textbook adjustment involving a declining US dollar, imports would become more expensive funding increased exports and real consumption would fall.
Intriguingly, having been introduced in Asia in the 1960s and 70s, these ideas were further developed in Australia in the 1980s though they were applied to a specific industry (rather than the whole economy) in the context of reducing protection. Export Facilitation provided automotive exporters with permits to import duty free into an otherwise outrageously protected market. That helped move automotive production from local assembly of Ford Lasers (though Japan was doing it much more efficiently) to exporting Holdens and Toyotas, which required much lower assistance.
In the 1980s an Australian association the Society for Balanced Trade was actively promoting for Australia the very idea Buffett is now promoting for America. But, sad to say, its motives were simple protectionism the usual mix of special pleading for manufactures and wilful ignorance of basic economics.
I doubt Buffetts idea makes sense for us now.
First, these mechanisms create explicit export subsidies which are illegal under the WTO. And whereas the Americans might be able to secure a change in WTO rules, wed have no chance of achieving this on our own.
Second, though I think our trade deficit is too high, much of its recent rise has been driven by surging investment. If we tried to balance our trade, investment would almost certainly suffer. If we have a problem which I think we do its ultimately driven by inadequate savings. So we should tackle that more directly with surplus budgets, Future Funds and/or expanded super contributions.
Still, three big things can be said for Buffetts re-invention of this Australian idea.
First it avoids picking winners either between industries, or between import substitution and exports. That makes it more efficient and dynamic but minimises political favouritism and the attendant rent-seeking.
Second, in a mercantilist world in which so many developing countries have succeeded with lavish export subsidies Buffetts system might get them importing more to secure their export access to the American market! That not only assists America make the adjustment it should make, it induces the adjustment that the mercantilist developing states should make for their own and others benefit.
Third, whether or not theres a role for such policies in developed countries, they offer a vastly superior mechanism for using trade policy to respond to balance of payments crises than is currently provided for within current WTO rules which continue to permit the application of temporary, selective tariffs.
Sadly Buffetts intervention has sparked almost no serious interest from economists. I wonder why? Maybe economists cant figure out where to place it on that spectrum between free trade and protection that helps them work out where they stand. Is it protectionist? Kind of. But implemented cleanly it would also produce freer trade than almost any country actually has.
Back in the 1970s and 1980s economists spilled oceans of ink exploring the costs of new forms of protection, such as voluntary export restraints, though the bottom line was pretty clear from the outset avoid where possible. They spent far less time exploring new mechanisms, like export processing zones and export facilitation, that were increasingly important in Asias trade liberalisation and development but ambiguously placed on the free trade versus protection spectrum. Partly because of that, Australian economists took too long to understand (and so revise, their previous hostility towards) export facilitation in the car industry.
And so it has been so far today.
The more things change . . .