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A big goods and services deficit

August 31st, 2004

The seasonally adjusted balance of trade in goods and services came in a deficit of $2.7 billion. If continued at an annual rate, this would amount to about 4 per cent of GDP, implying a current account deficit in excess of 67 per cent.

There’s plenty of debate about whether large current account deficits can be sustained indefinitely. But there isn’t (or shouldn’t be) any such debate about large deficits in the goods and services balance. A large and stable deficit on goods and services necessarily leads to an explosion in net debt and in the current account deficit[1]. This can’t be sustained, and therefore won’t be, but the process of adjustment may not be pleasant.

As various people have pointed out, one contributory factor is the poor performance of the “elaborately transformed manufactures” sector, on which high hopes were set in the early 1990s. More generally, it’s difficult to square this outcome with claims of a miraculous productivity performance in Australia.

I don’t suppose that this will have much impact on the election campaign. But it helps to point up the fact that the government’s reputation as good economic managers is as much the product of good luck as of good judgement. Running sustained large current account deficits is a gamble that world capital markets will continue to take the relaxed view of such deficits that they have in the last decade as regards OECD countries, rather than suddenly changing their minds as they have done in relation to Mexico, Asian countries. Argentina etc.

fn1. If the rate of growth of nominal GDP is higher than the rate of return received by foreign lenders and investors, a small deficit on goods and services can be consistent with a stable ratio of debt to GDP. But that isn’t the case for Australia. The ten-year government bond rate is 6.25 per cent, which is about equal to nominal growth, and private borrowers would mostly be paying rates higher than this.

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  1. Ric Simes
    August 31st, 2004 at 17:39 | #1

    John

    You appear to be a bit light on with your numbers. In the June qtr, we already had a CAD of $12.1 bil (trend) which was the equivalent of over 6% of GDP (trend GDP around $190bil) and with the mthly trade deficit of around $2 bil. A continuation of $2.7 bil trade deficit would have the ratio up to around 7.5%.

    The last time I did the calculations, I estimated that we needed a CAD/GDP of 3.5% to see the net external liab’s to GDP ratio stabilise at current levels. Just what this translates into in terms of a trade balance depends on the interest rate, as you note, but it was not far off zero.

  2. John Quiggin
    August 31st, 2004 at 17:44 | #2

    Thanks for this, Ric. I didn’t have all the numbers to hand, and wanted to stay on the low side. I’ve amended the post.

  3. Dave Ricardo
    August 31st, 2004 at 18:12 | #3

    I suppose it just wouldn’t be cricket for Labor to bring out the foreign debt truck as Peter Costello did when he was in opposition.

    Except now the truck has become a bloody great road train.

  4. September 1st, 2004 at 01:33 | #4

    Then he would have to explain what he was going to do. And I presume that is not going to be much fun.

  5. still working it out
    September 1st, 2004 at 09:51 | #5

    Just wondering if anyone can point me to any fairly comprehensive articles in written about our Current Account Deficity in non-economist terms (not simple, just avoiding jargon that only an economist would understand).

    Ideally I’d like them to explain in detail what Australia’s CAD position is, what the long term implications are, how and if it needs to be fixed, and what any fix might entail.

    I’ve found some great articles on the US position, but I’m not even sure where to start looking for something like this on for Australia.

  6. September 1st, 2004 at 11:18 | #6

    Personally, I support increased levels of net foreign investment. NFI = KAS = CAD

  7. James Farrell
    September 1st, 2004 at 12:17 | #7

    John H,

    Investment in this context means nothing more than the accumulation of assets. This may include investment in plant and equipment or the financing thereof, but it can just as easily mean lending to support unsustainable houshold consumption. But you are perfectly aware of this, so what gives?

  8. September 1st, 2004 at 14:39 | #8

    In addition to JohnH’s point about NFI, take a look at the continued improvement in the terms of trade in the Q2 national accounts released today: 11.2% y/y, with real gross national income at 6.7% y/y. I won’t be losing any sleep over the trade balance with numbers like these.

  9. Ric Simes
    September 1st, 2004 at 15:29 | #9

    Stephen

    A large trade deficit despite the favourable terms of trade and despite the economy growing at around trend (less than trend for the last 6 months) is hardly comforting. That is, unless you expect the terms of trade to continue to improve at this pace for ever more.

    Also, a large NFI number of itself is not a great sign. The welfare of future Australians will depend on the pace of growth (which NFI may help to lift) and who owns the proceeds of that growth (which NFI hurts). And as James infers, the high NFI number is not being accompanied by a large share of national income going into productive investment.

  10. September 1st, 2004 at 16:56 | #10

    I do not believe there is a correct level of domestic savings that is known by government. I do not know exactly the intertemporal trade-offs going on in the minds of all australians, and I think each person is in the best position to make that decision for themselves.

    So I have no automatic concern that our national savings rate is low. And I have no concern when it goes up or down, so long as this is being caused by changes in individual preferences.

    I agree with what I take to be Ric’s point — that a higher savings rate would result in a higher growth rates and more material prosperity in the future. However, I don’t believe that future material prosperity is the only goal in life and I certainly wouldn’t force people to be richer if that’s not what they want.

    Currently I personally have savings > investment and a trade surplus (I’m selling more than I’m buying). Next year I will travel the world and I will have a significant trade deficit. It is true that I could be richer if I continued by trade surplus for another several years… but damn it — I want to travel while I’m still under 30! I hope the government deems this acceptable.

  11. James Farrell
    September 1st, 2004 at 21:49 | #11

    Do travel, John, but buy your travellers cheques now before the dollar dives.

  12. September 2nd, 2004 at 10:34 | #12

    travellers cheques? nah… I was just going to live off what I could earn busking :)

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