Warren Buffett’s Interesting Solution for the Trade Deficit

Note that I call it an ‘interesting’ solution, rather than ‘sensible’ or ‘good’. I like Buffett – he seems like a decent guy (for a billionaire) and his priorities are basically in the right place, in my opinion. But this idea has some serious problems.

In an article in Fortune magazine (subscription required), Buffett says that he is extremely worried about the US trade deficit. In particular, he is worried about the fact that by running trade deficits, and thus effectively trading US assets for foreign goods and services, the US is becoming too deeply indebted to the rest of the world. Here’s his solution:

The time to halt this trading of assets for consumables is now, and I have a plan to suggest for getting it done. My remedy may sound gimmicky, and in truth it is a tariff called by another name. But this is a tariff that retains most free-market virtues, neither protecting specific industries nor punishing specific countries nor encouraging trade wars. This plan would increase our exports and might well lead to increased overall world trade. And it would balance our books without there being a significant decline in the value of the dollar, which I believe is otherwise almost certain to occur.

We would achieve this balance by issuing what I will call Import Certificates (ICs) to all U.S. exporters in an amount equal to the dollar value of their exports. Each exporter would, in turn, sell the ICs to parties—either exporters abroad or importers here—wanting to get goods into the U.S. To import $1 million of goods, for example, an importer would need ICs that were the byproduct of $1 million of exports. The inevitable result: trade balance.

To his substantial credit, by the way, Buffett began his piece with a disclaimer, acknowledging that he is not an economist and does not have a good record of macroeconomic forecasting.

But what about the substance of his suggestion? I find it fascinating to consider.

He’s basically completely right in everything he says. The US is indeed becoming more indebted to the rest of the world with every passing day. He’s also right that his plan would very quickly eliminate the US’s trade deficit. And he’s right when he says that his proposed solution functions essentially like an across-the-board tariff, though he doesn’t mention that it’s a peculiar type of tariff with the revenues being transferred directly into across-the-board export subsidies. It’s actually an extremely elegant way to simultaneously and uniformly tax imports and subsidize exports.

Now what about the question of whether it’s a good idea? Put aside the fact that it would be grossly illegal under WTO rules, and would therefore probably require the US to exit the WTO altogether. The problem is while he’s right that the trade gap is problematic in the long run, in the short run its a good thing. In this, it’s very much like the paradox of thrift.

In other words, there are substantial benefits to the US trade deficit in the short run. In particular, the trade deficit allows the US to have higher business investment (in addition to consumption) than it would otherwise. Without it, therefore, US firms would be investing in less productive capacity, making the US economy grow more slowly, be less productive, and therefore have lower wages over time.

Another problem is that without a trade deficit, the US would (by definition) no longer be attracting net capital flows. All of the money that is currently flowing into the US to purchase US assets would go elsewhere. This would probably lead to a substantial drop in asset prices. The stock market would fall, interest rates would have to rise sharply, and real estate prices would tumble.

His plan would also probably create all sorts of temporarily perverse incentives during its implementation, would wreak havoc on international financial markets, would lead to a sharp bout of inflation for the US, and probably cause a few other problems as well.

And yet, I completely agree with Buffett’s worries about the long-run implications of the US trade deficit. So while I can’t endorse Buffett’s solution, I’m sympathetic to his goals. As an alternative, I can repeat the tired old prescription of “higher savings, lower consumption” in the US – but that’s not really something that a policy-maker can do much about. So I have to admit that I don’t have a good solution of my own to offer. I wish I did.