The current account balance equals net foreign investment. When net foreign investment is positive, the current account is in deficit. The current account balance is the result of the international trade in savings and the relative rewards and incentives of investing at home or abroad:
- The current account is in surplus when national saving is greater than net domestic investment; and
- The current account is in deficit when national saving is less than net domestic investment.
New Zealand can import more than it exports courtesy of this foreign investment.
- The difference between exports and imports, or net exports, is the trade balance.
- But for net foreign investment, the trade balance would have to always balance.
For most of the last 20-years, exports have been the same as imports, more or less, so the New Zealand current account deficit has little to do with the level of exports or imports.
A current account could be called a capital account surplus, but this label lacks that certain demonic ring the media laps up. Deficits are bad, surpluses are good. How can a surplus be bad? Who wants to cut a surplus?
John Cowperthwaite solved Hong Kong’s current account problems by not collecting trade statistics. His concern was:
If I let them compute those statistics, they’ll want to use them for planning.
Cowperthwaite refused to collect economic statistics
for fear that I might be forced to do something about them
If New Zealand did not collect trade statistics, would anyone be the worse off? How would we notice?
People knew that unemployment and inflation were a problem long before statistics agencies descended upon us.
The better solutions to unemployment and inflation are rules-based and were developed again long before statistics were collected.
Rules based policy regimes that attempt to stabilise unemployment and inflation often reject discretionary responses to the latest statistical releases.
Indeed, the main focus of rules based policy regimes is to prevent monetary and fiscal policy from becoming an independent source of instability. The secret of inflation targeting is to do as little as possible and not make things worse by doing much more that keeping monetary supply growth in check.
What is the welfare cost of a current account deficit and how does it compare?
- Welfare cost of inflation of 10% is maybe 1-2% of national income; and
- The annual welfare cost of the post-war business cycle is about 1% of national income.
People apparently fear the current account because it may lead to recessions and inflation. But the current account must be a small component of the factors contributing to the welfare cost of inflation and the annual welfare cost of the post-war business cycle.
There are a large number of other factors that cause recessions and and one factor that causes inflation. These must get their share of the 1-2% of national income that is the welfare cost of post-war business cycles and inflation of 10%. Adding up constraints mean that the welfare cost of the current account deficit, if there is such a welfare cost, must be small.
Scobie, Zhang and Makin (2008) found average income gains of $2,600 per New Zealand worker on a cumulative basis from capital inflows over the period 1996 – 2006. International capital mobility allows New Zealand to fund additional investment from external sources which raises wages in New Zealand because there is more technology and capital per worker in New Zealand. To the extent that foreign investment occurs, it raises the amount of capital in a country, driving wages up and profits down.
The current account reflects the relative returns of investing at home and abroad and any consumption smoothing. People save and borrow to smooth out consumption during any temporary ups and downs in their annual incomes.
The current-account balance typically gets worse—moves into deficit—in good times. Reason for this is in good times, people anticipate higher permanent incomes in the future and start spending now before the higher income actually arrives.
New Zealand and Australia based their prosperity on borrowing in anticipation of future increases in production based on exploiting the ample land and natural resources in New Zealand and Australia. This increase of wealth could be spread out over many periods including before it actually arrived because of the ability to borrow in the international credit markets in anticipation of permanently higher future incomes.
Utopia, you are standing in it! 
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