Perspective 4: What’s wrong with a Current Account deficit?
In Perspective 3 we examined the concepts of the current and capital account as well as the balance of payments. Recall that a country’s balance of payments is a record of all transactions between a country and the rest of the world. It consists of the current account and the capital account. The current account measures trade in goods and services (mainly) and the capital account measures borrowing and lending.
Psychologically a deficit sounds self-evidently bad! Perhaps it is the parallel with having an overdraft at the bank.
Should countries then aim for a current account surplus? A country running a current account deficit means that it is becoming more indebted to foreigners. Many people would instinctively regard this as bad! However, because we don’t yet trade with Mars, the current and capital accounts for the world as a whole must be in balance. Therefore if some countries are in surplus some others must be in deficit.
In a closed economy total saving will equal total investment. However in an open economy such as ours investment may exceed saving i.e. we can borrow from overseas. In this case we would run a current account deficit. Should we do so?
The answer is that it depends on why we are borrowing. If the borrowing is used for productive purposes, as opposed to consumption, then it may well be a good thing. For example poorer countries are likely to have accumulated less capital than richer ones and hence it may make sense for them to borrow from richer countries. Indeed, for much of the 19th century, the USA borrowed from the rest of the world and hence ran a current account deficit. It was not until 1900 that it managed to notch up a current account surplus. Australia and Canada have remained net debtors throughout their history. During part of the periods 1870-1889 and 1890-1913 Argentina was one of the richest countries in the world while running a deficit of 17% and 6.2% of GDP respectively!
Therefore, provided a country can service its debts, there is not necessarily a problem. The ability to service debts implies that such borrowing be used for productive purposes. Another good reason for running a (sizeable) current account deficit is to respond to a temporary shock. For example a temporary drop in the price of a country’s main exports. Note that if the drop is permanent a country needs to reduce its consumption because it is now permanently poorer.
Note that a current account deficit may be caused by either government or private borrowing. Many people think that a current account deficit driven by private borrowing is nothing to worry about. However there are at least two good reasons for worrying in this case. Firstly, some private borrowers (especially banks) may borrow more than is prudent because they think that governments will bail them out if they strike trouble (Moral Hazard!). Secondly, the supply of funding from abroad may suddenly dry up if markets think that a country has become too risky.
Regarding the current situation in New Zealand with respect to the supposed lack of savings and hence balance of payments worries I leave the last word to Gareth Morgan:
"In theory if Balance of Payments rise to ‘critical’ levels then one would expect interest rates to rise – to reflect risk. Currently long term interest rates are falling (including in New Zealand) so is there seems to be a surplus of savings looking for a dearth of investment opportunities."
In other words the world, which is saving ‘too much’, is eager to lend us money. We are indeed borrowing from the rest of the world and with interest rates so low why wouldn’t we? Strangely the Minister of Finance is suggesting we should be saving more!
In summary, there are no simple answers. What is clear is that, contrary to what is often supposed, current account deficits are not always bad.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
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