Saturday 30th of September 2023

of debt, of deficit and trade surplus......


In recent years, commencing in the pre-COVID period, Australia’s balance of payments has consistently recorded a surplus on the current account. This has confounded some commentators, especially those who followed the compelling ‘debt and deficit’ (and especially the ‘twin deficits’) narrative that emerged in the mid-1980s. Does it mean that that narrative should no longer haunt Australian policy makers? Or is there something even more concerning at play?


Australia’s remarkable current account surplusBy Ken Henry 

Some important concepts

The current account balance represents the sum of the trade balance (exports minus imports) and net income flows. Traditionally, Australia has recorded deficits in both accounts. But since 2016, the trade balance has been in surplus in every quarter bar one, and in the last few years has averaged about six per cent of GDP. The net income balance has remained in deficit, with a 30-year average of about -three per cent of GDP. Between late 2015 and late 2019, the current account balance improved from a deficit of about five per cent of GDP to a surplus of about three per cent.

A current account deficit implies a capital account surplus, the latter measuring the country’s dependence upon financing flows (debt and equity) from the rest of the world. This historical dependence upon foreign capital is the source of the ‘debt and deficits’ narrative. But Australia has recently become a net capital exporter, recording capital account deficits.

Importantly, the current account balance is identically equal to the difference between national saving and national investment. National saving includes saving by households, businesses, and government. Thus, the existence of a current account surplus, and a capital account deficit, implies that national saving exceeds the flow of capital that is being absorbed by national investment.


The behaviour of national saving and investment

Figure one shows the behaviour of national saving and investment since the December quarter 1993, which coincides approximately with the economy’s emergence from the recession of the early 1990s. The chart presents seasonally adjusted quarterly numbers published in the National Accounts. Also shown are the rolling averages of these quarterly figures through to the June quarter 2008, which is about when the Global Financial Crisis started impacting saving and investment flows.

The other vertical lines in Figure One mark the acceleration in commodity prices and the terms-of-trade from the end of 2003, driven by Asian century growth, and the onset of the COVID pandemic from the end of 2019.

Both quarterly series are quite volatile (the dip in investment associated with the replacement of wholesale sales tax with GST in 2000 stands out starkly). Nevertheless, some trends appeared to have been established pre-GFC. National saving appeared to have settled into an average of about 21 ¼ per cent of GDP, while investment was strengthening off the back of higher commodity prices.

Since the GFC, national saving has been exceptionally volatile. On average, it has been about 2 percentage points of GDP higher (about 23 ¼ per cent, with a standard deviation more than 1 ½ per cent) than in the pre-GFC period. Perhaps the national saving rate has been trending higher post-GFC, but I wouldn’t want to call it.

I am more comfortable describing the behaviour of investment in the post-GFC period. It is a textbook illustration of one of the primary symptoms of Dutch disease, overlaid by the temporary impact of the GFC. With the onset of the GFC, non-mining investment collapsed, and there was a pause in mining investment in line with weakening growth in our major trading partners, especially China. Once Asian growth resumed, commodity prices rose strongly, and mining investment regained strength, for a time. But, because of the mining boom, every other trade-exposed sector of the economy had lost substantial international competitiveness due to the real exchange rate having appreciated by about 70 per cent in less than a decade. So non-mining investment did not recover. As a share of GDP, mining investment peaked about a decade ago, and non-mining investment had been falling for some years before that.

The national investment rate appears to have settled at about 22 ½ per cent of GDP, lower than at any time in history, aside from deep recessions.


So, what explains the current account surplus?

A shorthand explanation for Australia’s transition from current account deficit to current account surplus is that relative to the pre-GFC period, national saving has risen by about 2 percentage points of GDP, and in recent years some three and one-half percentage points, while investment has fallen by about three percentage points of GDP.


How, then, should we interpret the capital account deficit?

Many commentators have opined that Australia’s having become a net capital exporter is a natural consequence of a rapidly growing stock of savings in superannuation funds. And there is no doubt that Australian superannuation funds have grown rapidly and invested a lot offshore. But I don’t see how the development of superannuation can explain the blue line in Figure One. The Australian superannuation story has been playing out since the early 1990s, with no discernible impact on the national saving rate pre-GFC, and I can’t imagine how superannuation could possibly explain what has happened to national saving since then.

In any event, investment is clearly a big part of the story. National investment has collapsed. And Australian superannuation funds could have had something to do with this. It could very well be that those who have had to decide where to allocate capital, including Australian superannuation funds, have found this economy an increasingly unattractive destination. They have simply been doing better elsewhere.


What about debt and deficits now?

The debt and deficits narrative derived from a concern that those who supply external debt financing, especially of short duration, might be fickle. A country reliant upon offshore debt can find itself hostage to the demands of uncompromising creditors, limiting its policy freedom.

Following an unsuccessful attempt in the late 1980s to build sufficient domestic saving capability to avoid the need to rely so heavily upon foreign financing, Australian policy makers in the 1990s accepted that the best ‘defence’ was to showcase world’s-best policy and transparency frameworks. This was tested, successfully, in the GFC.

In the post-GFC period, our defence against the risk of capital flight appears to have been altogether different: to present ourselves as an increasingly unattractive destination for global capital; on several fronts, including taxation policy, foreign investment policy, and in our foreign policy posture. Perhaps our policy makers have been kidding themselves that we don’t have to worry about attracting foreign capital when we have so much accumulating in Australian superannuation funds. But those Australian funds are not hostage to Australia. They, too, have been finding more attractive destinations.


What are the policy lessons?

Australia’s loss of appeal to those who allocate capital has been reflected in its growth performance. The average rate of growth in GDP per capita has been falling for two decades. In the decade immediately prior to the onset of the COVID pandemic, the average rate of GDP per capita growth was as low as in the worst of the five-year periods spanning previous recessions. Falling GDP per capita growth is largely explained by deteriorating productivity growth. And, in my view, this is a consequence of Dutch disease driven by the failure of our political system to deliver policy settings appropriate for rapidly accelerating export prices.

It is ironic that Australia should have become a net capital exporter in the Asian century when it stood to gain more from the region’s growth than any other industrialised economy. In these early years of the Asian century, we should have been viewed as a super-attractive destination for globally mobile capital from all over the world. It turns out that we simply lacked the political maturity.