Economist Ed Huang looks at this question on the balance of
payments:
"Evaluate the
causes of persistent current account deficits for developed or developing
countries”.
A
current account deficit happens when there is a net outflow of currency from a
country on the trade, investment income and transfer account. It is an almost
inevitable consequence of trade that there will be imbalances in doing so, thus
some countries are left in surplus, others in deficit – and many stay in one of
these two camps for extended periods of time. It is not difficult to observe
that the UK has been subject to one such persistent current account deficit.
Having not experienced current account trade surplus for 30 years now, the
evidence is clear – despite the best claims the current Conservative party are
making about the future. Of course, the UK is far from the only country with a
current account deficit, but there are clearly different causes for different
nations that lead to an imbalance in trade.
One potential cause of a persistent current account deficit
is that of sustained economic growth. Growth in an economy is indicated by a
sustained rise in its real GDP, which in turn must mean that the total income
of the nation has increased. If the incomes of at least some of the individuals
within the economy are rising, then almost certainly a proportion of this
increase will be spent on imported goods and services. In developing economies,
this may be especially true as economic growth may coincide with changes in
tastes towards luxury and higher-tech goods, which are often imported from
developed nations.
Thus economic growth has a direct link to an increase in the
value of imports which, ceteris paribus, will lead to an increase in the
current account deficit. This is evident in economies such as Ethiopia and
Rwanda, who both have current account deficits in excess of 10% of GDP, but are
two of the fastest growing nations globally (10.3% and 7.7% respectively).
However, this much depends on the marginal propensity to
import of the nation. This concept can be defined as the proportion of an
additional unit of income that will be spent on imported goods. If the marginal
propensity to import is high, then a rise in income (characterised by economic
growth) will have a larger effect on the current account deficit than if it is
low, since it implies that the level of imports will vary closely with changes
in income.
The UK population has a characteristically high MPM, so the
current account deficit is far more sensitive to growth rates than other
countries – particularly those with high import tariffs (Djibouti has an
average 18% tariff compared to the US’ 1.5%). Furthermore, the marginal
propensity to import also varies between individuals in a nation. Some classes
(especially those reliant on commodity imports, such as the steel processing or
energy generation industries) are more likely to spend a greater proportion of
additional income on imported goods than others. Thus if the economic growth is
concentrated in sectors with high MPMs, then the changes in the current account
deficit will be magnified compared to if the rise in output and income is
located in sectors with low MPMs.
Furthermore, it could be argued that high current account
deficits caused by high growth rates are unsustainable, and therefore perhaps
not persistent (depending on one’s interpretation of the word). In the case of
Rwanda and Ethiopia, such a large deficit will drain foreign reserves and –
given that at least part of the deficit is caused by an inflow of borrowed
money used to close the savings gap between investment and savings – accumulate
debt. Extended periods of high current account deficits are therefore
unsustainable in the long term, although if the deficit is used to build
critical infrastructure that can later serve a self-sustaining economy, then
there need not be one indefinitely.
Extended periods of high inflation can also lead to
persistent deficits in the current account. High inflation indicates that the
prices of domestic goods and services are rising rapidly, and this can mean
that domestic production becomes less competitive compared to imported goods
and services, since it is becoming comparatively more expensive relative to
abroad. One such example would be Turkey, where inflation was 9% in 2013 and
the current account deficit was a sizeable 5% of GDP.
However, this can be entirely offset if inflation is
similarly high – or even higher – in the countries where the imported goods
originate from. If prices are rising not just domestically, but also abroad,
then there is no change in competitiveness and thus no effect on the balance of
payments. In the case of Turkey, were inflation to be equally high within the
EU (where over 50% of its imported goods originate from), then this would offset
its high inflation as there would be no significant change in price
competitiveness between foreign and domestic goods, ceteris paribus.
Finally, economies can also be subject to persistent current
account deficits if their levels of investment are too low to allow for exports
of high (or even moderate) value items. For instance, economies with low levels
of investment may have to rely on exports of raw, unprocessed commodities that
have the potential to be greatly increased in value if they were processed on
site. Examples would include oil exports in Angola (where 80% is exported as
unrefined crude oil), and coffee plantations in Ethiopia (where many of the
beans are left unprocessed on site, to be roasted once they are exported). This
results in price-uncompetitive exports, lowering the country’s export
capabilities and thus worsening the balance of payments. This may also include
too little investment in human capital (i.e. insufficient spending on
education), which translates into low productivity (so high unit labour costs
and therefore uncompetitive goods and services), as well as a lack of the
skills necessary for higher skill jobs.
Countries
such as Romania (where there has been a sharp growth in the IT sector in the
last couple of decades) can benefit from higher-value goods and services being
exported per worker compared to other economies where human capital levels are
lower, and thus where the value of goods produced per worker is also less.
Insufficient levels of investment will therefore lead to the inability to
export high-value goods and services, and thus may mean a diminished total
value of exports and thus a worse current account deficit.
