The visible hand in economics

Current account deficit is not a big deal: Discuss

Posted on: August 9, 2008

So, New Zealand has a stock of debt that is equivalent to 86% of annual GDP and ran a 7.8% current account deficit over the year to March 2008.

My article in the Dom today states that “this isn’t a big deal”.  Discuss :)

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19 Responses to "Current account deficit is not a big deal: Discuss"

Matt – we’re leeching capital overseas at a great rate of nots, which is part of the reason why our capital markets are shallow, our productivity growth is low, and our wage growth is low. The same thing is happening in the US (the median household income has decreased there in the last 20 years, as it did here during the 1990s (it has grown as small amount in the last 9 years).

Sorry, should have been:

The same thing is happening in the US (the median household income has decreased there in the last 10 years.

none of the Austalian Banks are foreign owned and they still have high protections on their manufacturing industry, so they have a positive balance sheet – and therefore better productivity growth than us.

He may not be very popular at the moment, but Winston Peters has a much more convincing economic vision than I see coming from trendy right-wing economists like yourslef.

http://www.supload.com/music/The-Revolution-Will-Not-Be-Televised-Winston-Peters-Interview-download-AQ45DXNK8Z16.html

Hi Roger,

Before I answer you I must be clear here, my article described what a current account deficit actually is – it was fully descriptive. After describing it, it appeared self-evident that a current account deficit is not a big problem – in the absense of information asymmetries and when the government isn’t running up a big debt.

Now it’s not clear how you’re disagreeing with me, so in turn I will answer your points.

“Matt – we’re leeching capital overseas at a great rate of nots, which is part of the reason why our capital markets are shallow, our productivity growth is low, and our wage growth is low”

That is not consistent with the data. 20% of our goods imports are capital and plant. Treasury estimated that the impact of open capital markets added at least $2,600 per person to our countries productive income between 1996-2006 – that sounds like higher productivity to me.

Our current account deficit over time has been the result of importing capital – as long as this capital, on average, makes a fair rate of return then running a deficit in this sense is a good thing.

If we closed off our capital markets we would have HIGHER interest rates – I can’t see that leading to more capital investment and productivity, can you?

“but Winston Peters has a much more convincing economic vision than I see coming from trendy right-wing economists like yourslef”

Ok
A) I’m definitely not trendy :)
B) When has “right-wing economics” ever been “trendy”
C) You actually sound like the “growth focused” person to me.
D) You are listening to a xenophobe like Winston Peters when it comes to policy that involves other countries, hmmmm

Let me explain C)

I don’t mind a current account deficit because my focus is on maximising the lifetime happiness of people in New Zealand.

Now if we could stop people buying consumption things and forced them to put that money into investment, we would increase growth in New Zealand and have a lower current account deficit.

However, in order to get this growth, we would have to force people to sacrifice consumption they want now – this could only be justifiable on welfare terms if you believe that the government knows what an individual better than the individual does.

Therefore, by complaining about the CA deficit so much you are either saying that you care more about growth than peoples happiness, or that you and the government know what is better for people than the people do.

Overall, I don’t agree. I think people are the best judges of what is in their best interest, and I think the purpose of government is to promote the highest level of happiness in society.

As a result, I’m confused. Why do you keep calling me a “right-wing economist” who “only cares about growth”?

“Our current account deficit over time has been the result of importing capital – as long as this capital, on average, makes a fair rate of return then running a deficit in this sense is a good thing.”

A tricky little argument Matt. I would be fine with having open capital markets. Your argument only accounts for 20% of import costs however. Why not bolster NZ’s productivity through having export focused policy like the scandanavian countries do? Why not aim for a high value-added, high productivity economy rather than trying to compete with the likes of thailand and china?

“However, in order to get this growth, we would have to force people to sacrifice consumption they want now”

Not true – you make too many assumptions. i.e. doesn’t kiwisaver provide people wit ha “choice”, while encouraging deeper capital markets?

As long as government is not involved, markets do not care about current account deficits. The New Zealand government has no net debt. The foreign currency debt was paid off by Bill Birch many years back. The New Zealand debt is private, it is totally being funded by the private sector. It is being funded by banks, either offshore or onshore. Since banks only lend over assets of greater value than the debt, it is fair to argue that the debt has a greater total of assets supporting it.

So who cares? I agree with you Matt, the current account deficit is irrelevant, a fact that has been obvious to NZD traders for years.

Markets only get worried when governments are involved as soveriegn debt requires no assets to support it, just the power to tax.

The markets have not had a problem with New Zealands current account deficit for some years now.

And before anyone comments on the falling NZD and blaming that on the CA deficit …it is only happening because the USD is finally strengthening. Just look at the down moves in the euro, British pound, Japanese yen, Swiss franc and Australian dollar etc etc for proof of that.

“Your argument only accounts for 20% of import costs however”

20% of imports is a LOT LOT LOT more than our entire deficit.

“Why not aim for a high value-added, high productivity economy rather than trying to compete with the likes of thailand and china?”

We don’t produce the same things as Thailand and China.

Ultimately, we have a low population density, which is going to make it difficult for us to make highly value added products. As long as the right incentives are there businesses will add value – hell its in their interest to. Closing off the economy will not do this – it will make it harder for domestic businesses to get capital and expand, thereby preventing any value being added.

Remember, if we wanted to remove our current account deficit, we would have HIGHER INTEREST RATES.

“As long as government is not involved, markets do not care about current account deficits”

Indeed – that is very true.

I think you are trendy.

“I think you are trendy.”

We must have very different definitions ;)

“Therefore, by complaining about the CA deficit so much you are saying … that you and the government know what is better for people than the people do.”

Hit the nail on the head right there.

It is good to know that Nome has solved all our problems and discovered a way for us to save without reducing consumption.

“It is good to know that Nome has solved all our problems and discovered a way for us to save without reducing consumption.”

It suspect it stems from his dislike of any mathematics – on that note.

“doesn’t kiwisaver provide people wit ha “choice”, while encouraging deeper capital markets?”

Firstly, people can already save without Kiwisaver. It is not that difficult to get a savings account at a bank.

Secondly, the “deepening of capital markets” depends on whether we really believe Kiwisaver will increase national savings – a fuller discussion of this can be found on the, as yet unfinished, productivity series on this blog (which is related to the also still unfinished inflation series ;) ):

http://tvhe.wordpress.com/category/productivity-series/

As it is unlikely anyone will read it, my conclusion is that Kiwisaver won’t increase national savings (in a full sense), but it may change where savings goes – which could be quite useful for the domestic economy given current issues in the capital market. However, this is probably a second best solution at best compared to education and information.

“Firstly, people can already save without Kiwisaver. It is not that difficult to get a savings account at a bank.”

Sure they can. So? The question is not can they save already: then question is do they to the same levels.

There is substantial evidence from the US and UK and opt-out retirement savings schemes get substantially higher rates of participation than opt-in schemes. (eg, http://www.nber.org/papers/w12009 but google can easily find you a bunch of other papers on the effect)

This obviously wouldn’t happen if we were all purely rational self-maximizers. But we aren’t. It’s one of those effects where you can postulate theories about human behaviour all you want, but we’ve got real empirical data and it says that (irrational though it seems) whether the default is participation or non-participation really matters.

One *could* still argue that this doesn’t matter because participation in retirement savings schemes will reduce other savings to match. But if someone were to make such a bold empirical claim then I would hope they would provide some empirical data to back it up, and not mere arm-chair theorizing.

Icehawk, check your tone. This isn’t The Standard, and the host bloggers always respond intelligently and with respect to posters.

Simply stating what the empirical data shows is only half the job, you need to explain why you think it is so.

Personally, I think the incentives for individuals to stay in Kiwisaver are going to increase overall savings as time goes on, and people come to realise the “free money” that is sloshing around.

But at the moment I dont think most people treat Kiwisaver as savings, I reckon they treat it more like a levy or a tax. That is, it leaves their pay without them seeing it go, it isnt large enough to make an obvious difference, and they budget based on net income.

As with most things, the explanation will probably come down to informational asymmetry or deficiency.

“This obviously wouldn’t happen if we were all purely rational self-maximizers. But we aren’t”

Huh? Opting into or out of a scheme has a cost. When I wanted to change my default Kiwisaver provider I had to fill out a bunch of paper work and keep in touch with IRD – if it was an Opt out scheme then I would expect to have to do the same just to get into the scheme.

As a result of this transaction cost, it makes sense that their is a difference between the degree of saving in that scheme in the “opting in” vs “opting out” cases.

Furthermore, the choice is not between saving and not saving – the choice is between the type of saving vehicle. If the scheme we are automatically put into offers the same return as other savings types, then an incredibly small transaction cost would be enough to see us reducing other savings types as a result.

This implies that total national savings may not increase – and households will continue their choice of consumption.

“but we’ve got real empirical data and it says that (irrational though it seems) whether the default is participation or non-participation really matters”

We do not have sufficient empirical evidence to state this – even Treasury said that, and they’ve gold plated this scheme for the government!

That was going to be one of the pluses of the original Kiwisaver scheme – it would tell us how opting in made a difference, and then we could look at the numbers from there. However, then all sorts of subsidies were added – which implies that we now can’t use it to check what happens in the case of voluntary opt in.

“But if someone were to make such a bold empirical claim then I would hope they would provide some empirical data to back it up”

Once the data is out we will look at it – it is still a bit soon, I need 30 data points :P

When there is no data, theorizing is better than just stating whatever the hell my opinion is – as it is transparent, so people know where the points of difference are and we can discuss them.

Note that I haven’t even been criticising Kiwisaver, I was just stating that saving more now implies that we consume less now as well – and I’m not a fan of telling people what to do with their income, because I don’t believe I know better than them.

Educate people, give people choices, and try to reduce the transaction costs associated with these choices are the things I would do – and I’m glad that Kimble agrees ;)

Now, this isn’t even a post on Kiwisaver, it is on the CA deficit. Ultimately, none of this discussion on Kiwisaver has stated why the CA deficit in its current form can be a bad thing.

If people want to discuss Kiwisaver, please go to the Kiwisaver posts here:

http://tvhe.wordpress.com/category/productivity-series/

However, if people would like to tie this back into a discussion on the CA deficit, then lets do that here. If we are going to do that though, I would like a clear description of what is being criticised – not a random comment taking one of my sentences and criticising that (not saying that anyone has been doing this – it does happen over time though) :)

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