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Keith Rankin, a political economist and economic historian. |
Submitted to: The N Z Herald.
On 6 October, a record annual deficit of $NZ 6 billion on the
balance of payments current account was announced.
Such deficits are not new. 1973 was the last year in which export
and foreign investment earnings exceeded import and foreign investment
payments. New Zealand's foreign debt problem today is the equivalent
of the accumulated current account deficits since 1973.
The balance of payments, defined strictly, is always zero. Everything
that New Zealanders buy from nonNew Zealanders is paid for
in some way, whether from current earnings (ie exports), from
foreign currency reserves, from asset sales, from foreign borrowing,
or from any other form of foreign investment. With a floating
exchange rate, reserves are irrelevant; payments can be summarised
as being either from foreign earnings or from foreign capital.
It is the two subcomponents of the balance of payments that
matter: the current account and its complement, the capital account.
The current account balance, through the laws of arithmetic, is
always the negative of the capital account balance. The former
(current account) is the balance on earnings. The latter (capital
account) is the balance on foreign investment.
Since 1974 the current account balance has always been less than
zero (ie negative, in deficit). Therefore the capital account
balance has always been greater than zero (ie positive, in surplus).
A surplus on capital account is generally considered to be bad
news; it represents an increase in a nation's liabilities to foreign
interests. The exception - when it is not bad news - is when foreign
investments generate domestic incomes in excess of the costs of
servicing the investments.
Orthodox interpretation of economic theory suggests that a capital
account surplus is the result of the current account deficit,
and not the reverse. Under such a presumption, the current account
deficit has some independent cause, such as excessive domestic
demand, a lack of domestic savings, or an overvalued exchange
rate.
In the days of fixed exchange rates, the problem could arise from
the exchange rate being set too high by the government of the
day. New Zealanders would buy imports even though some New Zealand
workers were unemployed, because imports were artificially cheap.
In this situation, the problem had nothing to do with the rate
of domestic savings.
Under a system of floating exchange rates, the picture is subtly
different. The problem lies in the reason why the exchange rate
is too high. The Government does not set the exchange rate. Instead,
the exchange rate is too high because of a capital account surplus.
Rather than the capital account surplus being the result of
the current account deficit, the current account deficit becomes
the result of the capital account surplus.
The basic economic theory of international trade claims that it
is impossible for a nation with a floating currency to have a
balance of payments deficit (or surplus) on current account. The
market for a country's tradeable products always sets the price
of that country's currency. This simplistic theory was used to
justify New Zealand's decision in 1985 to float the dollar. The
basic theory simply assumes there is no foreign investment,
hence there is no capital account, hence the current account balance
is always zero.
In the era of high oil prices, from 1974 to 1985, it was sound
policy for New Zealand to run a current account deficit. The alternative
would have been a massive devaluation of the New Zealand dollar.
In those days, it was appropriate for oilpoor countries
to borrow from oilrich countries, at least until the international
economy settled at a new equilibrium, which it did in the late
1980s.
After 1985, international conditions were ideal for New Zealand
to have its current account in balance if not in surplus. What
happened instead was that the capital account went into an increased
surplus following the exchange rate float, causing renewed growth
of the current account deficit.
Why has New Zealand had a capital account surplus since 1985?
Not because of an overheated domestic economy; nor because of
an inability of New Zealanders to save; nor because of free trade.
Rather, it is because a central feature of public policy in
New Zealand has been to generate a net inflow of foreign capital.
This policy was pursued despite the fact that the rationale for
floating the exchange rate depends crucially on the absence of
foreign capital flows.
New Zealand governments have conducted this policy in two ways.
First, they have used high interest rates as a tool to reduce
inflation, in the belief that fixing inflation will in turn fix
other ills. This monetarist approach is simply incompatible with
any commitment to balancing the current account. We might note
that Reserve Bank Governor Donald Brash is reported to be unconcerned
about the balance of payments current account deficit (Brian Fallow,
"Between the Lines", the Business Herald, 7 October).
The antiinflation policy works only to the extent that a
net inflow of foreign capital causes the exchange rate to be overvalued,
and import prices to fall. This policy is now entrenched as the
1989 Reserve Bank Act.
From mid-1994 to early 1997, the Reserve Bank quite explicitly
pursued a high interest rate policy, with the full intention of
a capital account surplus pushing up the exchange rate. Not surprisingly,
the current account deficit has steadily increased since 1993;
a faithful mirror image of a policydriven capital account
surplus.
The second way in which New Zealand has conducted the policy of
having a net inflow of foreign investment is through the process
of sending Finance Ministers overseas. Rather than beg for privileged
export access to Britain as they once did, they sought to sell
New Zealand as an attractive destination for foreign capital;
indeed as a nation with public and private assets for sale at
bargain prices, with inexpensive labour for hire, and with competitive
corporate tax rates.
Why does the government choose to have a surplus on the capital
account of the balance of payments? That choice amounts to the
creation of a means for New Zealanders (or at least some New Zealanders)
to consume at a level that cannot be sustained by New Zealand's
earnings.
I cannot know for sure why any government would choose a policy
that obliges New Zealanders to consume foreign resources while
not fully employing our own. I do not believe that this choice
is made simply to keep inflation low. It may be that the whole
reform process was intended to benefit only one section of the
population.
A small but increasingly conspicuous section of the New Zealand
population is able to live a lifestyle of high consumption; a
lifestyle being bankrolled by cumulative increases in New Zealand's
foreign liabilities. On the other side of the coin, each year
more New Zealanders are having to work less for themselves and
their families, and more for their creditors; for New Zealand's
creditors.
Why have we had current account deficits after 1973?
© 1997 Keith Rankin
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