The English disease

One of the striking features of world trade is the fact that nearly all the English-speaking countries run big current account deficits. The United States, formerly a big net exporter, has been in deficit for twenty years or so. The deficit has now reached 5 per cent of GDP despite a continuing recession/slow recovery. The UK has mostly run deficits for the past twenty years or so, though it still has strongly positive net investment income, reflecting its century or more as the main source of world investment. Australia and New Zealand are consistent deficit countries. Although they occasionally reach balance on the goods and services account, they are large net debtors, and therefore have consistent deficits on the income account. The only exception (and a relatively recent one) is Canada. Conversely of course, the rest of the developed world, that is, in essence, the EU and Japan run fairly consistent surpluses.

Why is this? I’m not attracted to cultural explanations for a couple of reasons. First, both the UK and US were, for a very long time, the major surplus countries. Second, if you go back only 25 years, the “English disease” referred to rampant union demands, class conflict and rigidities that hampered productivity. At least in the sphere of popular factoid, all these disabilities are now presented as characterising the EU and Japan rather than the English-speakers.

Of course, the change in stereotypes about laziness etc reflects the greater impact of neoliberal policy reforms in the English-speaking countries. So my question is: does neoliberalism cause current account deficits? And if so, is this a good thing reflecting the greater attractiveness of investment in these countries (the ‘consenting adults’ view, put forward prominently, though in a slightly different context by John Pitchford). Or is it a bad thing, reflecting debts incurred because of excessive borrowing by households and debts pumped up in speculative investment booms. Readers won’t be surprised to learn that I hold the latter view.

At the moment the’consenting adults’ view is dominant, particularly among supporters of neoliberalism. But looking at the way this group changed their tune after the Asian and Argentine crises, it’s not hard to predict that, in the event that things go sour, they will switch to the latter view very quickly and, as far as they can manage it, retrospectively (search on ‘crony capitalism’ for examples).

Via Jack Strocchi, update billmon at Whiskey Bar has more detail on the US case, including a neat way of presenting the data I haven’t seen before. In recent years, imports have grown by 40 cents for every dollar of GDP growth. I need to think a bit more about this.

A number of commentators have defended the ‘consenting adults’ view and have asked for a ‘market failure’ reason why it isn’t right. The obvious candidate is the moral hazard produced when financial markets are deregulated but the central bank continues to act as a lender of last resort. Exhibit A is Australia in the 1980s, which is when we ran our foreign debt up to its current levels. I don’t suppose anyone is going to claim that the investments of Bond, Skase, Elliott and others were good ones. Most of the debt in this period was borrowed through the Big Four banks. In a regulated system, they would have been stopped. In a fully deregulated system they would have failed. As it was they were rescued (Westpac being the most notable case). The story of state-regulated institutions (building societies and State Banks) is more complex, but basically the same. I put this argument forward in a piece in 1992, Partial financial deregulation and the current account?, Economic Papers 11(1), 53?56, which I notice is not up on my website. Another job waiting to be done!

18 thoughts on “The English disease

  1. I recall that when Pitchford was defying the conventional wisdom, at the time of the peak current account hysteria in the late 80s/early 90s, there were plenty of people saying that the coming decade would be economically disastrous because of the current account deficit.

    The 90s turned out to be pretty good, especially in comparison with 70s and the 80s. On some views, all that investment in the 90s we made in ICT has led to a big productivity boom, with more to come. Even if that story is oversold, you couldn’t say that the current account deficit has led to disaster, and we’ve had long enough (about 14 years) to test that hypothesis.

    Some time in the future we’ll have another recession, because shit happens. That doesn’t mean the current account will be to blame.

  2. These countries run large current account deficits because their growth and investment opportunities exceeds domestic saving. By the same token, Japan runs large current account surpluses.

    The idea that this can be attributed to a short-term investment boom does not explain why the US and Australia, for example, were essentially built on massive current account deficits for most of the late 19th and 20th centuries.

    But maybe John is on to something. “Neo-liberalism” creates the growth opportunities that are reflected in current account deficits.

  3. There is a lot of confusion about the significance of ICT and other “productivity booms”. Look at the figures in this week’s Australian Financial Review, for instance, and work out what they mean.

    It is NOT a good thing when you get around 30% productivity increases flowing through to around 25% of the increases in growth (and it hasn’t even been established to my satisfaction that the link is that solid). I don’t have the precise figures to hand, but the key point is that the second figure is smaller, and we don’t have any figures for how big the actual growth is – the base.

    Let’s see what these figures really mean. If growth went from something small to something slightly bigger, the game wasn’t worth the candle – there were costs to achieving it. But even if there was a material increase in growth, productivity increases exceeded it! The excess must mean a decrease in inputs – which includes employment. So it’s a mixed bag.

    Productivity increases are only ever good in a derivative way by enabling something else, and if productivity does not form a constraint or bottleneck to production and thence to consumption you don’t get a full answer if you just stop with looking at them. And right now, productivity does not form a constraint or bottleneck.

  4. What they said. John, give us a ‘micro foundations’ story of why you think CADs are a problem. At least the crony capitalism argument had a micro story. And even if you do have a micro story behind your concern, it may show that the policy variable of interest isn’t the CAD

  5. Steve Kircner says:

    These countries run large current account deficits because their growth and investment opportunities exceeds domestic saving.

    Then how come Australian had a higher rate of growth/employment in the 40, 50 & 60s yet had a lower CAD? Ditto NZ, US & UK?
    True, during the take off to sustained growth, non-finanicialist countries did run trade deficits. But these were one-off affairs.
    The big CADs started to come to mature economies when increases in “life cycle” consumer spending started to take a bigger bite of income and drove down savings, leading to increased borrowing.
    This may have been because:
    propensity to consume rose (consumerism)
    rate of income growth fell (terms of trade)
    In any case, there was a shift in class power to the Big End of Town following the 80s liberalisation of factor markets:
    capital (financial deregulation)
    labour (enterprise bargaining)
    THis power shift increased the pressure on labour to produce more (hence longer hours).
    It made non-labour assets work harder by “financialising” everything that could get a security title.
    This has given the income distribution advantage to those gifted at figuring or finagling.
    Buffett, the best businessman in the US, and no fan of the stock market, defended higher taxes on dividends thusly:

    I was luckier in that I came wired at birth with a talent for capital allocation — a valuable ability to have had in this country during the past half-century. Credit America for most of this value, not me.

    Finance (& lawyering) are all about distribution,
    not production.
    Thus when former producers became financiers (Bond et al) they tended to turn into crooks.
    The same thing happened in the US during the recent boom, when CEOs spent more time “managing” earnings than making them, leading to Enron-syle crashes when the investor mugs tumbled to the fact.
    NO body much likes paper shufflers, either statist bludgers or finacialist parasites.

  6. The “better investment opportunities line” makes sense, but IMO part of that is not policy but demographics. Low population growth means, ceteris paribus, low returns on investment over time – Europe and Japan are OLD (the Japanese labour force is already shrinking).

    As I’ve said elsewhere, many people seem to consistently underestimate the effects of demography on macroeconomic performance – which is surprising because the relevant theory is very well developed and tested.

  7. I wouldn’t know, but I doubt it because those advisers were mostly self taught converted engineers or accountants and the like, based in Queensland. This one is down as being of the School of Economics at the University of Sydney (as a glance at the newspaper would have told you). Their internet site does show someone of that name of long standing and with a publication history.

  8. John, on a completely unrelated issue, I’d be interested to hear your thoughts on the relation between the opinion columns in broadsheets (to the extent that Australia has these) and blogs.

    The opinion columns are usually situated next to editorial insight. With blogs, the capture of attention is less direct, but more compelling, in a market way. So (acknowledgeing your FIN article of some weeks ago)are blogs editorial or opinion? What is their active policy status? In this open market for ideas, do existence conditions apply?

    Curious, and yellow.

  9. Evan Jones is of the ‘political economics’ school at Sydney University thus I wouldn’t normally take notice of him but very unusally for him he has a history of being a strong econometrician.
    I am unsure whether that is a good or bad thing.

    Like all of that lot They put too much emphasis on Manufacturing as being bulwark of the economy.
    Perhaps one day they will discover it isn’t.

  10. Milton, although most people judged Pitchford to have won the debate in retrospect, he didn’t win in practice on the main point, the undesirability of inducing a recession to bring down the CAD. As well as killing off inflation, the recession did bring the CAD down to levels at which debt/GPD ratios stabilized (a CAD of about 4 per cent of GDP) for quite a while.

  11. “the recession did bring the CAD down to levels at which debt/GPD ratios stabilized (a CAD of about 4 per cent of GDP) for quite a while.”

    The CAD hit 6% of GDP in 1994, which was actually quite soon after the recession. It hit this level again in 1998 (due to the Asian crisis) and 2002 (due to the tech wreck/S11 world slowdown), and 2% of GDP in between times.

    Pitchford came too late to stop the recession of the early 90s. But nobody since then has suggested that a recession is a good way to bring down the CAD. Instead, the exchange rate has been allowed to fall and the CAD has fixed itself.

  12. The last time I looked at the CAD it was improving slightly but it had not “fixed itself”. It is still quite high compared to the 1960s and 1970s and seems to have been fluctuating in a 2-5.5% band ever since the early 1980s. But no-one seems to worry about it any more, so as John says, Pitchford did win the debate in retrospect.

  13. John, you are placing an awfully big burden on Pitchford to suggest that he should single-handedly swing the view of the entire official policy community at the time he was writing (although he did have some allies, such as Max Corden, who was also writing on this at the time).

    Interestingly enough, this was a time when “economic rationalism” was thought to be at a high point, but macro policy was being determined by an entirely mercantilist view of the current account deficit at foreign debt.

  14. Much of Aust foreign debt accumulated from the mid-eighties until the nineties recession was the result of Big End of Town entrepreneurs sucking in cheaper foreign capital to finance equity market bubbles, share market takeovers & speculative investments.
    The asset prices for which were liquidated in the share market crash.

    A similar thing has happened in property markets since the the mid nineties. Most of the increase in Australia’s cumulative foreign debt since interest rates have fallen is the result of Back Yard entrepreneurs sucking in foreign capital to finance the bubble in metropolitan housing prices.

    Colebatch sums it up:

    Around 1980, treasurer John Howard took the first steps to deregulate Australia’s financial markets. We discovered that you could borrow money from foreigners. In 1980 Australia’s net foreign debt was just $8 billion, or about $500 per head. By 2001 net foreign debt was $326 billion, or more than $16,000 per head.

    Does this imply we are heading for a property market crash in the early ’00’s comparable to the equity market crash that occurred in the late ’80’s?
    Colebatch sums up the shaky economics of the nineties property price bubble:

    Australia has enjoyed two decades of strong growth, financed largely by borrowing and asset sales. Since the Coalition took office in 1996, the nation’s net debt has soared from $193 billion to $353 billion: not for business investment, but for banks to lend to households to drive up home prices.
    There are many good reasons why countries borrow overseas. But one of the dopiest is to finance a housing-price boom. It produces nothing that can generate foreign income to pay off the debt. And it creates a false sense of prosperity, when asset values, in fact, depend on unsustainable foreign borrowing.
    The authorities skite about Australia’s high growth, attributing it to economic reforms. But any country that borrows $350 billion from the rest of the world can finance above-average growth, until the lenders ask for it back. Then things will get sticky, particularly if all we have to show for it is overpriced housing.

    Again Colebatch has the goods on the recent Reserve Bank warnings of over-heated inner city property market prices:

    The housing market continues to defy everyone’s forecasts. Housing finance keeps soaring to record levels: in April alone, the total stock of home lending shot up 2.2 per cent or almost $8 billion. Increasingly, people are using home loans for other consumer spending, keeping domestic demand strong even with exports in free fall.
    But most of that record lending still goes into housing, and mostly to drive up prices. In the past year the growth in borrowing has come from housing investors, defying warnings from the Reserve Bank of rising vacancy levels, especially for inner-city apartments. Making losses on rental housing need not worry investors when they can write off the losses against tax and calculate their future gain from rising property prices. But when prices start falling – as they will – investors will worry.
    Reserve governor Ian Macfarlane fears that when investors with loss-making properties see the market falling, they will head for the exit doors and try to sell. The ensuing glut would further depress prices, hurting the entire housing market. The International Monetary Fund warns that almost half of housing booms end in a bust, with huge consequences: on average, output losses equivalent to $60 billion in an economy our size

    The huge output losses mentioned (about 10% of GDP) sound a bit far fetched, after all, liquidation of paper losses in housing will not cause loss of production or unemployment, just wealth losses to financial insititutions and over-geared property investors.
    (unless interest rates are cranked up as a property-risk premium to Australian debtors).

    So Pr Q – the $64000 question: are we headed for a property price crash (and recession we had to have?)

    PS shouldn’t you credit me for sending you that billmon link?

  15. Slack of me, Jack. I remembered as soon as I posted it that I should have given a credit, but what with the computer upgrade and all, I slacked off. Fixed now!

    As regards the main question, I have become the butt of many jokes in my household for saying, repeatedly, “it will all end in tears”. I now do it as an acronym IWAEIT, or in charade mode (is there an XML schema for this, I wonder).

  16. Despite the fact that The World Is Going To Hell In A Hand Basket (TWIGTHIAHB) and IWAEIT, as a an Ozblogospheric Alpha-male you must always spare the time to toss crumbs of intellectual credit to politically-allied Ozblogoshpheric Beta-males.
    Lest these status-ambitious apes conspire behind your back to topple you from your lofty perch.

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