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Significance of the Current Account Deficit

Economics (Year 12) - Balance of Payments

Christian Bien

A Positive View of the Current Account Deficit

Positive View #1: The Current Account Deficit Allows Australia to Achieve a Higher Rate of Investment

Australia has a savings and investment gap, requiring foreign investment to supplement the gap. Foreign investment allows Australia to achieve a higher rate of investment and hence, a higher rate of economic growth. The investment will also be used to expand Australia's production capacity. As foreign investment increases, the current account deficit will naturally increase.

Positive View #2: Foreign Investment is a Positive Indicator of the Economy

Continually flows of foreign investment into Australia means that overseas investors are still confident in the Australian economy and that their investment will seek safe and profitable returns.

Positive View #3: A Portion of Income Generated from Foreign Investment is Reinvested into the Economy

While most foreign investment will result in an outflow of income debits, a portion of gains from foreign investment will be reinvested into the economy, creating new economic growth and employment.

A Negative View of the Current Account Deficit

Negative View #1: Overspending on Imports

A current account deficit that is fuelled by a trade deficit could be an indicator of an economy that is living beyond its means and that money spent on imports would be better off spent on domestic production. However, this view states that producers are more important than consumers, which is wrong.

Negative View #2: Future Generations Could be Punished

An economy's current reliance on foreign investment could result in a growth of an unsustainable foreign debt that punishes future generations with high-interest repayments. High levels of foreign equity could also result in future generations being punished by high levels of foreign ownership of domestic assets.

Negative View #3: Credit Rating Risk

Too much sovereign debt could result in a credit rating risk as the risk of government default on overseas loans increases. However, most foreign debt is in the form of private debt, which is done by 'consenting adults' that states that the private sector always makes decisions based on a profitable outcome.

Negative View #4: Australia has a Limited Stock of Assets to Sell

Foreign ownership could reach the point where it is no longer sustainable. There are concerns over future supplies, to which foreign-owned companies could divert all their production to export markets. Evidence of this can be seen in the gas price market where domestic gas prices are often two times higher than export prices. According to ABC News "The exporters, struggling to fulfil contracted orders written years ago when the plants were in planning stage, have begun raiding gas from the domestic market to meet their contracts." As a result, a supply shock has occurred in the domestic market has seen gas prices increase. Some domestic producers that use gas have seen their costs of production increase, creating a competitive disadvantage.

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