The Rankin File: #27

Last month (see The Balance of Payments Deficit; Oct 7), I commented on the large and increasing balance of payments deficit, and its main cause; a net inflow of foreign capital required to push the exchange rate up sufficiently to keep inflation below 2 or 3 percent.

A high inflow of capital creates an ongoing revenue outflow which we call "invisible" payments. The balance on invisibles is the return to international investment. For New Zealand, it is the difference between the earnings of foreign interests in New Zealand and the foreign earnings of New Zealand interests. Basically, a deficit on invisibles represents the flow of "interest" - broadly defined - to foreigners.

A large and growing deficit on invisibles is symptomatic of flows of interest, derived from national "land" (defined very broadly to mean fixed productive assets) and labour, to international capital. International capital represents mobile assets held by parties with no sense of local or national loyalty.

Such a deficit is a problem when the investment that generates the "revenue" stream to international capital is parasitic rather than creative in its nature. A creative investment generates new revenues, and all parties involved can be winners. A parasitic investment however is an appropriation of a resource by an "investor" that does little more than divert an existing revenue stream to that investor. It matters little whether a parasitic investor profiting from New Zealand resources is resident or not.

It is a nation's invisibles - in particular the relationship of invisibles to gross national product (GNP) - that serves as the best available measure of parasitic flows of interest from national resources to international capital. Where foreign investments are on balance creative, rather than parasitic, a nation's GNP rises more than invisible payments.

When there is a deficit on invisibles, GNP, which represents the income of the nation's residents, is less than the gross domestic product (GDP), which represents the product of a nation's resources. Thus, New Zealand's GNP is less than its GDP, by the amount of the invisibles' deficit. Typically, a country receiving inflows of foreign capital will find that its GNP grows less quickly than its GDP. GNP is the more important indicator, inasmuch as either are indicators of national economic well-being.

Brian Gaynor is perhaps the most astute commentator in the New Zealand business press. On 18 October he published the following table (Table 1), detailing the sub­components of New Zealand's invisibles' balance.

Direct investment in New Zealand is the purchase by foreign interests of New Zealand companies or shares in New Zealand companies, or the setting up of new foreign­owned companies.

Portfolio investment by foreign interests is, in essence, the purchase of bonds and other fixed­interest financial assets. Investment in Government bonds is a form of portfolio investment. New Zealand bonds become more attractive to foreign investors either when New Zealand interest rates are high or expected to fall. Foreign purchasers of New Zealand bonds are looking for speculative gains from exchange rate appreciation, for capital gains on bond prices, and for high interest payments. The Reserve Bank manages inflation by acting to increase portfolio investment inflows, thereby pushing up the exchange rate.

The first thing to note from Table 1 is that the deficit on invisibles is larger than the total current account deficit, which means that New Zealand as a nation actually earns a small surplus on commodity trade, despite being well short of paying its collective bills.

The second thing to note is that the majority of foreign profits and interest are repatriated; suggesting parasitic tendencies.

The third thing to note is that New Zealand investments overseas actually aggravate rather than ameliorate the invisibles deficit, thanks to high borrowing from overseas to fund non­performing overseas investments.

Gaynor believes that one of the major problems New Zealand faces is this awful failure of New Zealand investments overseas. I am sure he is right. But few of these investments are made with the national interest in mind, and we should not expect too much from them. They have been a drain on New Zealand's resources; a drain that has caused New Zealand interest rates to be higher than they otherwise would have been. They mainly represent capital outflows similar to those out of Western Ireland described by Richard Douthwaite (on the Instability of the Global Marketplace), and the returns (if any) on those investments tend to be held within the international financial system, and not returned to the local or national economies which made these investments possible.

The invisibles balance of minus $7.5 billion is funded by exports of $1.5 billion and additional foreign capital inflows of $6 billion. Thus, the invisibles deficit will be greater next year, because the additional $6 billion will add something like $500 million of foreign investment income next year's deficit. If the $NZ dollar falls further, then the invisibles deficit will be funded mainly by more exports and fewer imports. But if the $NZ begins a sustained rise - and the coming to power of Jenny Shipley as Prime Minister seems to have caused it to rise - then the 1998 invisibles deficit will be funded, once again, by increased capital inflows which will in turn aggravate the invisibles deficit in 1999.

One way that the future problem might be eased is if foreign investments in New Zealand start to perform as badly as New Zealand investments overseas do. If there is a major sell off of foreign­held assets - eg a sell­off to shore up an overseas sharemarket crash - then the prices of those assets will fall and New Zealand interests may secure windfall gains. It is possible that the problem will eventually resolve itself with most of the losses incurred by foreign rather than national interests. In any process of large scale capital flight from New Zealand, the main losers will prove to be the international interests doing the fleeing. After all, most of their assets in New Zealand are denominated in NZ currency, and capital flight will see a fall in the value of the currency.

New Zealand's present balance of payments problems are not new. They were worse in the 1880s. However, in the 19th century, exchange rates were fixed and British sentiment had moved against New Zealand and in favour of Victoria and Argentina. Thus, there was little that New Zealand politicians could do other than oversee a rapid adjustment from an import surplus to an export surplus. New Zealand had to service its overseas liabilities from export revenue, and not, as it does today, through increasing its overseas liabilities.

One man who understood the situation very well was Frederick Joseph Moss, MP for Parnell in the 1880s and British Resident in the Cook Islands in the 1890s. Table 2 presents his views; views that can be applied with little modification to the understanding of our national plight today.

Table 2:	Frederick Joseph Moss (1829-1904)

One New Zealander who understood the relationship between exports and imports was Frederick Joseph Moss, MP for Parnell (1877­90) and author of Notes on Political Economy by a New Zealand Colonist (1897). Moss would probably have been Minister of Finance in the 1890­93 Liberal Government, had he not decided early in 1890 to retire from Parliament to become British Resident in the Cook Islands. Nevertheless, the reforms of that government followed Moss's economic philosophy, and Moss's book was an attempt to market our reforms to the British. On capital imports (export of debentures) funding an excess of imported goods and services, Moss states (my italics): The foreign trade consists of imports and exports, and in every progressive young country or wealthy old country the imports must exceed the exports. The excess will represent imports to be used as capital, but for which there can be no corresponding export till the fruits of the expenditure are gathered. ... The surplus of imports beyond exports may become excessive, in which case there is ground for careful investigation. The excess may be caused by over­speculation, or it may be from the export of debentures by the Government or other public bodies, an export more or less beneficial or more or less injurious according to the purposes to which the responding imports are to be applied. Moss understood that new countries would incur debt and import more while they were investing in infrastructure. And he understood that mature countries that had invested in foreign infrastructure would gain net inflows of investment income, enabling them to import more goods than they exported. Countries with past debts or with a high level of overseas ownership of their assets would suffer a chronic drain on their living standards, as those debts were serviced or repaid: Whenever in a country, old or new, the exports persistently exceed the imports, the case calls for prompt and searching enquiry. Either the exports are selling at a loss or there is a great drain upon them for the payment of interest on debts, or meeting the expenditure of absentees, or, it may be, for paying debts public or private. Moss recognised that much of the first "Think Big" borrowing (in the 1870s) did not have to come from overseas, and that it fuelled imports of goods that could in many cases have been made in New Zealand. But he also understood that in the following period (the 1880s), when it became difficult to attract further capital imports, New Zealand had to service its debts through its exports. New Zealand was forced to broaden its economic base. In Parliament he stated: We were exporting debentures, and importing not money, but goods, making the fortunes of great companies, sending up shares of every kind, and altogether altering the condition of the country. ... When we come to face the result, we find that, in order to meet the exigencies so created, high duties had to be imposed, and under their operation certain industries were founded. ... So those honourable gentlemen who are now making a great fuss about Free­trade have, by the aid given in heaping debt on this country, so changed its whole commercial, social, industrial and political relations that Protection was inevitable. Moss has a very specific message for us today: do not sell Electricorp/Transpower: Electricity, with its unimaginable possibilities, ought not to be allowed to gorge the few ... every single member of the nation, however small his wants may be, should command this new aid to industry as freely and as cheaply as the richest of his fellow countrymen. The difference between administration in that spirit by the State, and administration in the spirit of personal gain by joint stock companies, needs no demonstration.

{ This document is:                 http://www.oocities.org/Athens/Delphi/3142/krf27-invisibl.html.html
{ the above references are to: http://www.oocities.org/Athens/Delphi/3142/krf12-bop_def.html
{                                     and: http://www.oocities.org/Athens/Delphi/3142/krf21-douthw.html

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