Date created: 12/4/07 Last modified:12/4/07 Maintained by: John Quiggin John Quiggin
23 June 2005
After a long period of benign neglect, Australia’s current account deficit is once again the subject of public debate. The first-quarter deficit of 7.2 per cent of GDP focused attention, though this was offset by a smaller trade deficit for April, reflecting higher prices for coal and iron ore exports.
Whenever the current account goes into deficit, it's important to begin with the observation that a deficit on the current account is necessarily matched by a surplus on the capital account, that is, by borrowing or investment from overseas. In trying to explain a deficit, we can look either at factors leading us to import more than we export or at factors leading overseas owners of capital to be more willing to supply debt and equity capital to Australia.
Both factors are relevant in the current case. There's plenty of evidence that low rates of interest, arising in the first instance from expansionary monetary policy, have encouraged high levels of consumption and borrowing. On the other hand, incoming Chairman of the US Council of Economic Advisors Ben Bernanke has argued that the US current account deficit reflects a 'global savings glut' resulting from the desire of Asian countries to build up their net overseas position in the wake of the Asian financial crisis. This argument is equally relevant to Australia.
An even more important question is: what are we doing with the money we borrow? The ideal case for a current account deficit is one where we are attracting foreign debt or equity capital for new direct investments in the tradeable goods sector, which will generate exports that will permit repayment of the capital invested.
The least appealing case is one where borrowings are used to finance current consumption, implying the need to reduce consumption in the future. An intermediate case is that where borrowing finances new investment, but is allocated to the non-traded sector, for example, residential housing.
Unfortunately, for any story you might want to tell about the current account, there’s a plausible set of statistics.
The pessimists can point to the statistics on household savings, which have been negative for several years, as households consume some of the increases in wealth generated by the boom in house prices. Although real for the households that experience it, this increase in wealth is spurious for Australia as a whole, unless foreign investors are willing to buy Australian houses at inflated prices.
The optimists have numbers on their side too. The volume measures in the national accounts suggest that investment is booming, and that the biggest growth area is that of machinery and equipment.
However, looking at actual expenditures, we find that machinery and equipment investment is flat or declining as a share of GDP, and that the big growth area is construction, particularly housing. The latter view is obviously more consistent with casual observation.
If volumes and values are moving in opposite directions, the prices of investment goods in the construction and equipment sectors must be diverging. Since 2001, the price index for machinery and equipment has fallen by 20 per cent. Price indexes for construction have risen by 20 per cent.
The declining price of equipment reflects the steady improvement in the power and speed of computers, which is recorded as a reduction in price in the hedonic adjustment method used by the Australian Bureau of Statistics. The price index for computers is falling by about 20 per cent a year. Since the amount spent on computers has been rising over time, it seems likely that the price of other machinery and equipment is rising and that the volume of investment in equipment and machinery, other than computers, is static or falling.
If the decline in computer prices translated directly into increased productivity, there wouldn't be much of a problem here. But even on optimistic views about the role of computers, the implied productivity gains are overoptimistic.
In any case, the decline in computer prices is a worldwide phenomenon. The fact that we, and everyone else, can buy computers more cheaply does not mean that it makes sense for us to go into debt to do so.
A more plausible explanation of our deficit starts with the fact that most other English-speaking countries are showing a similar pattern, with big deficits, weak exports and a boom (or bubble) in housing prices. These similar patterns may be due to similarities in macroeconomic policies or to the effects of financial liberalisation. Either way, it would appear that the resulting levels of consumption are unsustainable.
John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.
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