18 April 2008

Stop worrying, and learn to love trade deficits

This article is excerpted from the 18 April 2008 edition of “globeandmail.com”.

Back in the 1980s, an Australian economist named John Pitchford made the counterintuitive case - now known as the "Pitchford thesis" - that market-driven countries should learn to love current account deficits. He was persuasive, especially at home, sending Australia in precisely the opposite direction to Canada. Australia had run current account deficits for years. Now it ran larger deficits. In the past few years, it has enthusiastically run one of the largest deficits in the world, on occasion exceeding the infamous U.S. current account deficits.

Professor Pitchford, now retired from Australian National University in Canberra, remains remarkably relaxed about Australia's current account deficits. In interviews last year, he insisted that these deficits have given Australia a competitive advantage that still holds - notwithstanding progressive increases in the size of them. …

"No, I am not particularly concerned," Prof. Pitchford said. "This is a good thing… because, in fact, it means that we're able to have much more investment than we would have if the current account were balanced. [The deficit] means not only that we import more than we export, it means that we invest more than we save."

Current account statistics broadly measure a country's international trade -- and include, among other things, goods, services, investment income and tourist travel. Current account surpluses mean that a country has sold more goods and services to the rest of the world than it has bought - which is precisely the status Canada has impeccably maintained since 1999.

In accounting practice, though, every current account surplus must balance against a capital account deficit. Every current account deficit must balance against a capital account surplus. And a capital account surplus means that a country has "imported" more foreign money - principally in the form of direct foreign investment - than it has "exported." The policy options are apparent.

Welcome imports (all else equal) and you necessarily welcome foreign investment. Discourage imports (all else equal) and you necessarily discourage foreign investment - and economic growth.

Since 1980, Australia has recorded a real, average annual increase in per capita GDP of 1.96. In these same years, alternating between current account surpluses and current account deficits, Canada recorded an averag