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Multinationals and CADs

April 9th, 2005

As current account deficits in the US and other English speaking countries continue to balloon, there’s a big demand for talking points in support of a “Don’t Worry, Be Happy” position. A favourite contender is the idea that the US trade and current account deficits are overstated because about half of all US imports come from overseas subsidiaries of US multinationals. For those who’d like to get straight to the bottom line, this fact makes no difference to the current account deficit or its sustainability.

For those who enjoy somewhat eye-glazing arguments about economic statistics, read on.

The claim gets a (somewhat confused) run, in this generally informative NYT piece by Louis Uchitelle

American companies with operations abroad now account for nearly 48 percent of the nation’s imports, the Commerce Department reports, up from an average of 45 percent in the 1990′s … Indeed, the American-made content of a heart stent, a jet aircraft engine, or any imported item might be 50 percent of its value or more. But in the trade statistics, that distinction is not made; the entire value is listed as an import.

Uichitelle is mixing up two different things here, but neither of them make any difference to the current account deficit in the long run.

Taking the second point first, many imported items incorporate US exports. As he acknowledges, the US contribution gets counted in US export figures, so there’s no net effect on trade and current account balances.

The first point is the one most Pollyannas have focused on. But, if US-owned firms make goods overseas, they earn a return to capital which is ultimately repatriated to the US as dividends or capital gains. This goes into the current account balance, offset by the corresponding payments made by foreign-owned firms in the US. So even if the US had a positive net investment position, this would be fully reflected in the current account deficit.

In fact, taking debt and equity together, the US is now a net debtor[1], and net income payments are just about in balance. Net debt will increase, relative to GDP, as long as substantial trade and current account deficits are allowed to continue so net income payments must become large and negative in the future.

All of this is true in spades for Australia, since we never had any overseas assets to begin with. Unless you believe, with Ben Bernanke, that there is a permanent pool of savers in poor countries, eager to finance our consumption, the present trade and current account deficits are unsustainable, and the process of stabilisation is likely to be painful.

fn1. It’s probably true that the statistics underestimate the value of overseas US equity investments, since they don’t take full account of various forms of capital appreciation. This is partially responsible for the apparent higher rates of return earned by US assets abroad, compared to foreign-owned assets in the US. Similar points apply to the UK, which also has a negative net position on official measures, but manages a substantial income surplus.

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  1. April 9th, 2005 at 21:55 | #1

    Well… there is one complication, from sovereign risk. Given US hegemony, US foreign investments are less risky than other countries’ investments in the USA. This isn’t suggesting anything as crude as repudiation, but rather the sort of thing that wiped out European holdings there in the 19th century.

    I know of no way to put this adjustment into the figures explicitly. It’s just what you have to allow for when you remember that these things are always gross figures and need to be interpreted.

  2. Econowit
    April 11th, 2005 at 22:47 | #2

    The Australian economy is always in deficit and it always probably will be.

    Looking at the CAD on its own does not give a clear picture of what is going on. It is just shows cash flow. The balance sheet has a part to play in this story.

    Australia’s real net worth per capita is growing and the value of assets has stood at around four times the value of liabilities for a while. The real net worth is only calculated on known assets so we might be richer per capita than we think.

    Our debt servicing ratio dropped 10% over the last decade (with the increasing foreign debt).

    In my view if there is a major deterioration in the gearing level and that is primarily caused by short term consumption borrowing, then we should be concerned.

  3. Razor
    April 12th, 2005 at 14:02 | #3

    CAD Chicken-littling fails to put up cogent arguments as to why, if things are so bad (according to the ALP and their supporters – and it is all John Howard’s fault!) don’t the other important economic indicators reflect how bad it is. The beauty of the Australian economy is that if the CAD becomes an issue, then our dollar falls, meaning Australian exports become more competitive, more demand for AUD . . .

  4. Brian Bahnisch
    April 12th, 2005 at 22:16 | #4

    There was an interesting article by Joseph Stiglitz last year (12 August 2004) in the AFR entitled ‘Natural wealth no sure road to national riches’. The first paragraph goes:

    “There is a curious phenomenon that economists call the resource curse – so named because, on average, countries with large endowments of natural resources perform worse than countries that are less well endowed.”

    I keep hearing that our currency is a resource currency, which would interfere with the balancing mechanism Razor mentions. I’ve often thought that our minerals are not the unmitigated blessing they are always assumed to be.

  5. April 13th, 2005 at 13:30 | #5

    That seems to be related to the “Dutch disease”, which afflicted Holland in the ’60s after their gas finds first started coming ashore. Some people worried that the same thing might happen in the UK from North Sea oil: that the funds flows would atrophy the rest of the economic infrastructure, in particular the industrial base.

    When I looked at it, I discovered that oil, in contrast to coal, didn’t have problems with – as it were – liquidity. With coal, the only cheap thing you can do with it is burn it, so in the UK coal spawned value adding industries near the coal fields, and soon got positive network effects to go with them.

    On the other hand I have seen an Iranian’s (I forget just who) summary of a Leontiev analysis of the Iranian oil fields in the ’50s. He concluded that they acted as an offshoot of the British metropolitan economy, with remarkably little interaction with the rest of Iran (and so no material wealth transfer via trickle down).

    So there is something to say for revenue tariffs, if only the outgoings can go to genuine infrastructure/investment; it works as a drip tray, to catch wealth outflows and conserve them for any synergies. But there’s a big “if” hidden in there.

  6. Razor
    April 13th, 2005 at 14:27 | #6

    Brian – interestingly, a few years ago Australia’s currency was the eighth highest traded currency – significantly higher than our global GDP ranking or trade-flows ranking (Ihaven’t checked recently but doubt it would have changed much). This means that it is subject to higher speculative influences than most other currencies and this possibky causes over-shoots relative to theoretcial valuation methods. Still haven’t had any CAD chicken-littlers discuss that as an issue!

    As for the resource endowment issue – I wonder if it took into account the political and economic framework in countries as this generally has some impact on economic performance.

  7. Homer Paxton
    April 13th, 2005 at 15:19 | #7

    Razor it has been as high as fifth traded currency.
    you should also look at the time between the CAD is high and then when the market believes it is a problem.
    There is a lag.

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