Think Big and the balance of payments
Posted August 25, 2008on:
When I was listening to Radio NZ on Sunday I heard some people discussing why they thought “Think Big” was a good idea.
Although I agree with some of the points they raised, if those points are actually true (namely that they felt, given forecasts at the time, these projects would have been viable – and that there were substantial barriers to private entry) I also disagreed with large amounts of it.
One of the main things I disagreed with was the call that increased “self-sufficiency” in terms of steel and fuel improved our “balance of payments”. Now this is a claim I’ve heard from a number of “Think Big” supporters – and as a result it is a claim I plan to discuss here.
The Balance of Payments?
Ok, I’m sick of people calling the current account deficit the balance of payments deficit – as fundamentally, this is what people are trying to say. The Balance of Payments is the current account balance + the capital accounts balance + the financial accounts balance + “technical adjustment” = 0. It is an identity that always equals zero – so lets stop misusing it for a bit.
So given this, we have people telling us that we have a lower current account deficit because we are “self-sufficient” – fundamentally, as we make it here instead of importing it. This is incredibly wrong-headed.
We have discussed this before (see claim one when we took up the frogs challenge). It is unclear whether forced “self-sufficiency” will improve or worsen our current account position.
Current account position
Now our current account balance is the balance of trade + balance on foreign factor income + net transfer income (thank you wikipedia). Putting transfers to the side this tells us that we can be pushed into a deficit if we import more than we export, or if we have a poor investment position with the rest of the world (which leads to dividend and interest rate payments overseas).
The thinking that our friends on Radio NZ had was that if you increase the domestic production of things we import, we don’t have to import it anymore and woohoo our trade balance improves – and so does our current account balance.
However, there are a couple of problems when looking at the argument this way:
- There is an opportunity cost from producing steel etc here. Those resources could be allocated to making other things. If the things that are prevented are exports then we may not get that improvement in the balance of trade.
- If we do not have a comparative advantage at making these imports, the price will be higher – which implies that people will substitute to other goods. We may import these other goods – leading to a smaller improvement in the trade deficit then we expected.
- There is a capital cost associated with setting up the industries. If we borrow this capital from overseas (as Muldoon did) then we keep have to make interest payments from this borrowing overseas. If the interest payment exceeds any improvement in the trade balance, then our current account deficit will be worse.
As a result, even if we do have the unusual policy goal of “improving the current account deficit” (something I have said appears to be a sort of silly goal), Think Big type projects in no way ensure that we will actually reach this goal!