Mercantilist trade strategies have been the rage among most countries, save the US, whose trade policies have been oriented towards making the world safe for American multinationals and investment banks. And one can see why. Sustained trade surpluses allow exporters to leech off other nations’ demand, allowing them to enjoy higher employment levels and/or better paid laborers than they’d have otherwise. It also allows exporters to enjoy both high domestic savings rate and budget surpluses. This is important because, it means the government isn’t playing a role that businesses find unappealing to reach full (or closer to full) employment. Michal Kalecki made this point in his seminal essay, “Political Aspects of Full Employment” in 1943:
In should be first stated that, although most economists are now agreed that full employment may be achieved by government spending, this was by no means the case even in the recent past. Among the opposers of this doctrine there were (and still are) prominent so-called ‘economic experts’ closely connected with banking and industry…
In the great depression in the 1930s, big business consistently opposed experiments for increasing employment by government spending in all countries, except Nazi Germany. This was to be clearly seen in the USA (opposition to the New Deal), in France (the Blum experiment), and in Germany before Hitler. The attitude is not easy to explain. Clearly, higher output and employment benefit not only workers but entrepreneurs as well, because the latter’s profits rise. And the policy of full employment outlined above does not encroach upon profits because it does not involve any additional taxation. The entrepreneurs in the slump are longing for a boom; why do they not gladly accept the synthetic boom which the government is able to offer them? It is this difficult and fascinating question with which we intend to deal in this article.
The reasons for the opposition of the ‘industrial leaders’ to full employment achieved by government spending may be subdivided into three categories: (i) dislike of government interference in the problem of employment as such; (ii) dislike of the direction of government spending (public investment and subsidizing consumption); (iii) dislike of the social and political changes resulting from the maintenance of full employment.
Put more simply, running trade deficits finesses the contentious political issues that arise when governments have to step in to provide for an adequate level of demand by running trade deficits. While many instinctively reject the notion that government deficits are desirable except when the economy is at full employment, the reality is that private investors demand a rate of return that would otherwise result in underinvestment (see Andrew Haldane and Richard Davies for one of many confirmations; you can also see it in rampant short-termism among investors). As a result, we’ve been in a protracted period (including before the crisis) where businesses around the world have been underinvesting. The so-called “savings glut” is a misnomer; it’s more accurately called a “corporate savings glut” or better yet, an “investment drought”.
But the general point remains: being an exporter confers a lot of advantages. So most countries jockey to try to attain and maintain that position. And under the gold standard, there was no ready way to discipline countries who’d managed to peg the value of their currency low in gold terms and kept accumulating gold. The difficulty of reining in chronic surplus nations so concerned Keynes that he made solving that problem one of the important features of his proposed but never-adopted post World War II currency system, the bancor.
But when you’ve gotten there, is it all that it’s cracked up to be? If you are a small country, say Nordic-scale, the answer is probably yes. But if you are large, the equation over time becomes more complicated.
One of the issues with being a chronic exporter is that you are effectively funding your sales. You wind up exporting capital. You sell your goods to them and take their currency in return. Now of course, you could just sell those dollars or euros or pesos and convert it into your currency, but that is pretty much never done on a large scale, since selling those currencies will drive the home currency price up relative to them, undermining your position as exporter. Now the exporter can simply hold those foreign currency payments as cash, but that is seen as unimaginative, so most recipients at least put it into something with more yield (government bills or bonds) or more speculative assets (stocks, real estate, re-investment in the country in question).
Now this still sounds ducky on the surface. The exporter can become a stealth colonizer or attain influence over the other country through holding so much in the way of its assets, right? Again, it’s not so simple in practice. For instance, it’s been a staple in certain corners of the financial blogosphere that China can tank the US any time it wants to by dumping Treasuries. But that would send the renminbi to the moon, the last thing the Chinese want. And the Fed could simply soak them up if it wanted to, as some parties argue the Fed did with a recent large sale of Treasuries by Belgium.
Yes, but foreigners can also buy the real wealth of a country, in the form of real estate, mineral resources, and productive businesses. Robert Peston of the BBC argues today that, based on the research of Diana Choyleva of Lombard Street that the Chinese will keep exporting to the West as before, but the capital exports will come less in the form of government bond purchases through official FX reserves, and more from individuals and businesses. And those two types of investors are much more likely to want higher-return assets.
This is where the exporters’ curse comes in.
Readers may recall I worked with the Japanese when they were in the same position the Chinese are in now, that of exporting massive amounts of capital, and at the juncture when private businessmen were eagerly hoovering up foreign investments. In some ways, the Japanese then were better positioned than the Chinese are now due to the strength of the yen in the later 1980s (the result of the Plaza Accord of 1985 which sought to and succeeded in lowering the dollar relative to the yen). Before then, I did some advisory work for a cross-border M&A effort of a McKinsey client, and have been recruited by boutiques that were focused on cross-border investing.
What I have seen directly and second hand: in the overwhelming majority of cases, foreign investors get leftovers. The best deals don’t get shopped broadly, but are snapped up by domestic buyers. The one exception is in very high end residential property in major cities, where the market is thin and the buyers are international top wealthy.
Foreign investors also have trouble on other levels. For instance, they can’t get the best deal lawyers to work for them. If they go to a famous white shoe firm, they’ll get the second team. Even if they are looking at making a significant acquisition, they’ll be seen as at best intermittent clients, and thus vastly less attractive than financial buyers (PE firms) and major domestic corporations who buy all sorts of legal services in addition to M&A. If the foreign investor has really good connection or insight, he might be able to find a small firm with savvy attorneys who’d see them as an important potential client. But the foreign investor isn’t well qualified to judge the caliber of counsel, so even if he is sophisticated enough to try to find that sort of player, it’s an open question as to whether he can vet them successfully.
I saw again and again how the Japanese were treated as marks. For instance, Japanese banks were big takers of leveraged buyout loan syndications. Sumitomo Bank, which was widely regarded as the best managed bank in Japan, had only very aggressive revenue targets for its branches, and no notion of adjusting revenues for capital used or risk assumed. So they were delighted, for instance, to lend $500 million to Campeau, a notorious end-of-cycle deal that went bust. All they could see was the $30 million up front fee, which they booked as profit. That magnitude of fee should have served as a huge warning about the level of risk, but that simply wasn’t a concern. If a big reputable bank like Chase offered it to them, surely it must be OK.
I thought a lot of my job running an M&A business was trying to protect Japanese clients from being exploited without killing a deal. And you can see the evidence in how many bad investments the Japanese made: ridiculously overpriced golf courses and resorts, or even good assets turned into bad investments by paying too much for them (the purchase of Rockefeller Center was a classic example). I was even on transactions where people in the bank who’d managed to invade my deals were working against the client’s interest by pushing him to grossly overpay (one of the rules of M&A is “get the buyer’s price expectations up” because if the buyer is paying a really rich price, everything else becomes surprisingly easy to negotiate). Over time, that client came to realize I was the only person trying to protect him, which given that this was one of the bank’s most important clients, put the Japanese at the bank on tilt.
The same appears to be happening to the Chinese who venture out on the risk curve. Remember how the Chinese were snapping up farms and other agricultural assets in Africa? On paper, that seemed smart. China has lots of mouths to feed; food security is only going to become a bigger issue over time. Mineral deals in Africa might seem a bit safer, since at least you aren’t expropriating, um, buying resources that could increase hunger among the locals. But Africa is a long way away from China and the Chinese ability to enforce their rights in a not exactly stable part of the world seemed to be an open issue. And the security of transportation is another big potential fly in the ointment.
It turns out those deals are now seen as not having been so sound. From the Wall Street Journal last week, in Beijing Shows More Caution on Africa Resource Deals:
China is taking a more cautious approach to Africa after a series of big loans and investments in resource deals over recent years have failed to pan out…
China’s foreign direct investment in Africa is falling. Chinese companies invested $2.5 billion in 2012, the latest official available figures, down from $3.2 billion in 2011 and a peak of $5.5 billion in 2008, according to China’s Ministry of Commerce…
China’s big push into Africa, which began as its economy revved up more than a decade ago, has led to some successes. But it has also caused problems. Some African officials have berated China for acting like a colonial power. Deals have foundered amid claims that Chinese companies breached safety and environmental standards.
Other projects have gotten bogged down in the complexities of doing business in Africa.In some cases, China is trying to renegotiate contracts—many involving loans to build infrastructure in return for resources—that no longer make sense after commodity prices fell sharply from record levels.
“Chinese were out there throwing money at anyone who would take it, and a lot of strange decisions were made,” said Derek Scissors, a resident scholar at the American Enterprise Institute in Washington. Now “they’re not as frantic.”
If you notice, private businesses have pulled back, but the Chinese government, which has more leverage, is trying to find a better way to make these investments. Perhaps they’ll be successful, particularly since they’ve had the opportunity to learn from their mistakes. But this is inherently difficult.
There’s an additional issue, which is that an asset can legitimately be worth less in the hands of foreign owners than domestic ones. When at McKinsey, I was asked to value a privately-held Mexican air conditioning company that a US firm was keen to buy. There was a 10 times difference between what the buyer wanted to pay and what the seller was asking. When you did the valuation from each party’s perspective, allowing for tax issues (the domestic owner could play games to keep revaluing assets and minimize taxes that a big rich US multinational wouldn’t be allowed to do), the extra labor costs (a US buyer would have to be much nicer to the local union), and the very large difference in return requirements, (any US investor at this time assigned a huge risk premium to investing in the peso), plus other adjustments, each party’s valuation was actually pretty much correct. But a foreign buyer will have to pay the domestic price, even when he faces costs or complications that no domestic owner has to contend with.
You can see how the Germans are in a similar fix relative to the rest of Europe, although for the most part, their capital recycling has taken place through loans rather than foreign direct investment. While the Germans as exporters have managed to squeeze the periphery countries harder than I had thought possible, it’s hard to see how they aren’t going to have to acknowledge losses at some point, whether directly, or through the deflation they are imposing on the periphery eventually infecting the core. But the Germans seem determined to delay restructurings as long as possible, which seems likely to increase their eventual cost.
There are no simple answers. But the mercantilist ideal of exporting one’s way to economic power isn’t as simple or risk free as it seems. And as we’ve discusses separately, no country in modern times has made a crisis-free transition from being export-driven to having a large domestic consumer base. Development economists, late to recognize this issue, now recommend a more balanced growth model that places less emphasis on exports and more on building internal markets. But the current export champions seem unwilling or unable to abandon their past successful formula, even when it’s not working as well for them as it once did.