Current account deficit

MANY COMMENTATORS LAMENT that Britain is running a deficit in the current account of the balance of payments. Some worry particularly about our deficit in goods - what is called the visible balance. The second concern is always misplaced. The first is slightly more complicated. It is therefore better to deal with the simple matter first.

International trade is basically of two types - trade in goods and trade in services. Exports of either generate foreign earnings, so, from that point of view, it does not matter what is exported. Indeed, it is perfectly normal as countries develop for them to produce and trade in services. International trade in services has been in recent years the fastest-growing part of such trade.

Some people worry because manufactured goods have become a smaller part of our output. That is a separate concern. But it is worth remarking that the arguments and evidence do not support the claim that it is intrinsically better to produce manufactured goods rather than services.

Given that the composition of exports does not matter, what about their total? Does it matter if we are exporting fewer goods and services than we are importing?

The best way to answer this question is to start with another How are we paying for these goods and services?

Some of them are paid for by our export earnings. Others are paid for in one of two ways - by running down our savings or by borrowing. Like an individual or a company, more can be spent than is earned, provided savings are reduced or borrowing increased. There are many circumstances where such action is perfectly sensible. There can be favourable investment opportunities, a temporary drop in income, or a chance to buy something more cheaply than usual. There is nothing wrong with borrowing; what matters is what it is for. If spending is wasteful, it is wasteful whether current income or borrowed funds are used.

The same is true for a country. If individual decisions by residents, whether firms or individuals, lead to a current account deficit, then a decision has been taken to spend more than income. If the funds being borrowed to finance that spending are used wisely, there is no problem. If they are not used wisely, then it is foolish spending, not the act of borrowing, that is the problem.

A striking example occurred in the United States. On average, that country ran a deficit on current account from the last quarter of the 19th century into the first decade of the 20th. It did so because there was a tremendous demand for funds to invest. Population, industry, and agriculture were all expanding westwards. The funds were lent from the residents of European countries, where the expected rate of return on investment was on average lower than in the United States. No one - at any rate, no one I know of - has claimed that the decline of the US set in with that foreign borrowing. It was used productively. The balance-of-payments deficit it engendered was in no way symptomatic of a problem.

Sometimes such deficits can be symptoms of problems (though not problems in themselves). For example, the symptom can be of 'excess demand'. Easy monetary policy may have over-stimulated demand, leading not just to rising prices, but also (as goods become harder to obtain or more expensive at home) to more purchases from abroad. If the exchange rate is floating, it will be driven down. And if it is pegged, there will be pressure to devalue.

Before summing up, one point remains. If a country is borrowing abroad, it is not necessarily increasing net overseas indebtedness. That may seem surprising - if a person borrows, his or her debts increase. But even in that case, if he or she has assets, they may be increasing in value more rapidly than the new debts. The same can be true of a country. The value of Britain's overseas assets has in recent years increased more rapidly than her overseas debts; increasing borrowing need not, and in this case did not, bring increased indebtedness.

Now to conclude.

Overseas earnings are overseas earnings; it does not matter whether they come from sale of goods or sale of services. A current account deficit - more goods and services being bought from abroad than are sold here - is not itself a problem. It implies foreign borrowing. What matters is not the borrowing, but what has produced it and what it is being spent on. Current account imbalances are symptoms - but they can be symptoms of sensible decisions or of folly.

So, the current account deficit does not matter - does it?