I’m a huge fan of Warren Buffett – the billionaire from a Norman Rockwell painting. He understands the central problem of finance reduced in economists jargon to the principal-agent problem in the context of asymmetric information. Investors need to be able to trust managers, so Buffett only invests in managers he trusts.
One aspect of his style of investing reminds me of a conversation I had with Mr Hideo Tamura, then CEO of Toyota Australia in the mid 1980s. Mr Tamura, it was said had links back to Japanese Samurai and was in the line to become a Kamikaze pilot when the war stopped. I have no idea if that was true, but I could certainly see why such rumours might have started. He looked like a baddie in a James Bond movie complete with liberal doses of gold in his teeth with a gentle but strong Japanese accent. But he wasnt a baddie. He was a goodie. I enjoyed my conversations with him immensely.
When I asked why takeovers were pretty unheard of in Japan he explained that this was because the owner of a business was assumed to love that business and to take away something that they loved was dishonourable. This comment so surprised me that, as is my wont, I filed it away for further reflection.
I get it out every now and again to see if I can make anything of it. It certainly springs to mind when I think about Buffett who runs Berkshire Hathaway, a conglomerate of serious size it must be capitalised at over a hundred billion by now with a staff of less than thirty people when I last looked. And not in flash New York but in Omaha, Nebraska. One of his early rules when he realised he needed more than Ben Grahams the principles of value investing if his investing activities were to continue growing, was to buy businesses that their owners loved. And wanted to go to a good home. As he put it Why not invest your assets in the companies you really like? As Mae West said, Too much of a good thing can be wonderful. His methods for doing so were truly radical.
But I digress. . . . Buffett has just proposed a very interesting response to the massive external deficit the US is running.
Note firstly his jokey self deprecation and modesty. Just as he rehearses his biggest mistakes to his shareholders in his annual presentations, he warns us how wrong hes been in the past.
I’m about to deliver a warning regarding the U.S. trade deficit and also suggest a remedy for the problem. But first I need to mention two reasons you might want to be skeptical about what I say. To begin, my forecasting record with respect to macroeconomics is far from inspiring. For example, over the past two decades I was excessively fearful of inflation. More to the point at hand, I started way back in 1987 to publicly worry about our mounting trade deficits — and, as you know, we’ve not only survived but also thrived. So on the trade front, score at least one “wolf” for me. Nevertheless, I am crying wolf again and this time backing it with Berkshire Hathaway’s money. . . .
Then he gets down to crying wolf. Note firstly how he puts his arguments. I presume hes done economics at uni but lots of people have done some economics and dont get it. I think Buffett gets it. His analogies are very simple but powerful. No mention of misguided clichés like competitiveness or working harder or smarter or any such stuff. Instead Buffett invites his readers to go on a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville.
These are toy models of the world of the same kind as economists models which get to the heart of what happens to a country that doesnt save and that in fact contracts out its saving to another country as the US is contracting out its own saving.
His solution well its very interesting particularly to me and indeed its had a long subterranean life in the history of practical economic thinking not least in this country.
Buffett proposes a new kind of protectionism. This might reasonably be termed macro-protectionism. Buffett proposes that US exports be encouraged and imports to the US be discouraged by a system of tradeable permits in which access to import to the US is available only to those who hold certificates equal to the same dollar value of exports. That is if I want to import $1 mill worth of automobiles to the US I dont have to pay any tariffs, but I have to cough up a certificate showing that this import has been paid for by some correspondingly valued export.
Introduce this system and voila! trade goes from being wildly unbalanced to being balanced. Of course an adjustment like that would hurt and the mechanism that would bring it about is that imports would subsidise exports. Importers would begin paying exporters to export so they can get more certificates from them. That would drive up the price of imports and so reduce the living standards of Americans. Like Buffett says;
There is no free lunch in the IC plan: It would have certain serious negative consequences for U.S. citizens. Prices of most imported products would increase, and so would the prices of certain competitive products manufactured domestically. The cost of the ICs, either in whole or in part, would therefore typically act as a tax on consumers.
And one doesn’t need to think of the mechanism as one that must bring trade balance – it can be tweaked to introduce its effects gradually and/or partially.
I got thinking about these kinds of mechanisms in the mid 1980s because Australia had introduced something like this I called it an import/export link and its official name was Export Facilitation – for the automotive industry. Export facilitation had strong attractions particularly given that when it was initially introduced there were already quantitative restrictions on automotive imports (so the import/export link lowered the cost of those restrictions). As I argued in various forums then, there was also a case for Export Facilitation in the context of continuing reductions in automotive protection.
I also mused on the merit or otherwise of doing this with the entire economy in other words in what Buffett has now proposed for the US. I didnt end up pursuing it for a variety of reasons including these.
- It was GATT illegal now WTO illegal
- It was too easy to pillory as snake oil. Indeed there was a society dedicated to promoting the policy which was run by people like this one whose unreflective protectionism has since demonstrated what looked pretty obvious at the time that they are wilfully ignorant of the basic ideas of economics.
- Given these problems it seemed silly to go out and bat for an approach to a problem that wasnt clearly superior and I expect it is inferior to approaches that focus on savings directly which we were pursuing at the time (see below).
Still Buffett is quite eloquent in his defence of the proposal. Viz.
This plan would not be copied by nations that are net exporters, because their ICs (Import Certificates) would be valueless. Would major exporting countries retaliate in other ways? Would this start another Smoot-Hawley tariff war? Hardly. At the time of Smoot-Hawley we ran an unreasonable trade surplus that we wished to maintain. We now run a damaging deficit that the whole world knows we must correct.
For decades the world has struggled with a shifting maze of punitive tariffs, export subsidies, quotas, dollar-locked currencies, and the like. Many of these import-inhibiting and export-encouraging devices have long been employed by major exporting countries trying to amass ever larger surpluses — yet significant trade wars have not erupted. Surely one will not be precipitated by a proposal that simply aims at balancing the books of the world’s largest trade debtor. Major exporting countries have behaved quite rationally in the past and they will continue to do so — though, as always, it may be in their interest to attempt to convince us that they will behave otherwise.
The likely outcome of an IC plan is that the exporting nations — after some initial posturing — will turn their ingenuity to encouraging imports from us. Take the position of China, which today sells us about $140 billion of goods and services annually while purchasing only $25 billion. Were ICs to exist, one course for China would be simply to fill the gap by buying 115 billion certificates annually. But it could alternatively reduce its need for ICs by cutting its exports to the U.S. or by increasing its purchases from us. This last choice would probably be the most palatable for China, and we should wish it to be so. . . .
Were we to install an IC plan, we might opt for some transition years in which we deliberately ran a relatively small deficit, a step that would enable the world to adjust as we gradually got where we need to be. Carrying this plan out, our government could either auction “bonus” ICs every month or simply give them, say, to less-developed countries needing to increase their exports. The latter course would deliver a form of foreign aid likely to be particularly effective and appreciated.
Like Buffett argues, there are attractive features to this and it fits another idea Ive pondered from time to time that there might be merit not in picking winners but in developing the capacity of the nations economic managers to influence certain of the economys aggregates. In this case the whole point and indeed the place where Buffett doesnt really go is that he wants to sort out the USs trade deficit without a powerful devaluation which he believes would be more damaging to the US than what is entailed in his proposal. He may be right but that was where I lost confidence that this was the right way to go. The problem with balancing trade by fiat is that it cuts off potentially beneficial trades in savings. Thus if there arise a bunch of new and worthwhile investment opportunities, it makes sense to import some savings i.e. to run trade deficits to finance that investment. Buffett doesnt get into this and this is the weakness of his proposal.
In Australia its GATT illegality is a show stopper. In the US that need not be the case.
But I’m glad that Buffett has brought it up. Its a worthwhile thing to ponder and have debated. And it ought to be relatively easy to agree that the instrument is greatly superior in certain circumstances to practices that are still sanctioned within the WTO (well they were in the GATT which was when I last looked). * Thus there is a permission for ‘temporary’ restrictions of imports for countries in situations of economic distress. Now one can argue that this exemption shouldn’t be permitted at all – that such countries should allow their exchange rates to fall – though that will often involve a lot further distress depending on a range of factors. But if this provision for temporary trade measures is used import certificates are vastly superior because industry assistance they provide is non-discriminatory:
- both between industries and
- between import replacement and export.
That’s a huge step forward in terms of efficiency for activist trade policy.
Sadly, but unsurprisingly, at least judging from my own blog surfing, this hasn’t sparked much comment from economists. This was precisely the case a couple of decades ago. Economists spent little time exploring the economics of import/export links and other means of non-traditional trade liberalisation that were widely used by the most successful developing economies from the 1960s on like Japan, Korea, Taiwan, and even Singapore and subsequently their imitators.
Economists spilled vast oceans of ink in formal analyses and wordy discussions of instruments that could be easily characterised on the free trade v protection dichotomy as liberalising or as freeing trade. Thus there were hundreds of papers on voluntary export restraints, and plenty of papers optimal tariff reform (virtually all ignoring these new instruments), but very little on pragmatic moves to open economies like export processing zones and next to nothing on an equally important mode of liberalisation duty remission schemes that go beyond duty drawback on inputs to export.
And so it has been so far today. The more things change . . .
Postscript: I found this quite interesting interview with Buffet on the Wall St Journal’s site. I rather liked the lack of slickness in the occasionally tongue tied reporter who asked him the questions. Then again maybe I just liked the way she looked. Buffett is down to earth and sensible as usual. If the screen doesn’t make it through our software – you can watch the video by clicking here.
* I have now looked and the WTO agreements preserve the inward orientation of the old GATT exemptions for temporary balance of payments crises.