Is a current account surplus a good thing?

Let’s start with my point: the current account balance is neither ‘good’ nor’ bad’. 

(Okay, I’ll clarify. The current account deficit can be considered too large, if it hits around 6 plus per cent of GDP.) 

But, in general, the government doesn’t label the current account balance as ‘good’ or ‘bad’. The Australian government doesn’t try to achieve a particular current account balance. You won’t see ScoMo on the news talking about how only his government can achieve a current account surplus (CAS).

This is because the government has limited control over the factors that drive the current account balance. The government can’t change the amount of exports or imports companies and people buy (trade balance). The government can control how much it borrows from overseas, but it cannot control how much private companies borrow from overseas (this affects the size of capital inflows and then the net primary income balance as a result).

I recently had some students comment on my YouTube channel about the advantages and disadvantages of a current account surplus. I wouldn’t think of it as having specific pros and cons. 

I also wouldn’t talk about the government “should” reduce the current account deficit (CAD) or “should” achieve a CAS.

Instead, I would focus on the consequences of the current account balance. It’s a different perspective.

I would divide my thinking up between the consequences of a current account surplus (CAS) and deficit (CAD). If you’re writing about this in 2021, the focus is on the CAS.

Consequences of a CAS

In Australia we’re now talking about current account surpluses. What are the consequences of this?

Let’s think about this from the trade balance and then net primary income (NPY). This is because net exports and NPY are the key drivers of Australia’s current account balance.

Trade balance

• If the trade balance is improving, Australia is selling more exports which is increasing GDP and the government’s revenue. This revenue can then be used on a range of functions across society to improve people’s standard of living.

• If the trade balance is improving, Australians may be purchasing fewer imports. This could lead to greater purchases of domestically produced goods (maybe) which could boost GDP. The issue I have with this: Australia doesn’t produce the same goods as we import.

NPY

• If NPY is shrinking, Australia has a greater stock of domestic funds (as these funds are not needed to service foreign debt). This could boost domestic savings and allow more projects to be funded domestically WITHOUT the need for foreign borrowing. Essentially Australia could shrink its savings-investment gap.

Consequences of a CAD

Your textbook will have a whole list of these. You can also see my video for help.

One thing to note: in the past, the world hasn’t seemed too concerned about the level of our CAD. As recently as 2015, Australia’s CAD was around 5.4 per cent of GDP. This did not spark a mass selling off of the $A!

In terms of positive consequences of a CAD? We could think about points such as:

• If the trade balance worsens, maybe Australians have greater access to imports and this improves their standard of living

• If the trade balance worsens, maybe Australian businesses have had a greater opportunity to purchase capital equipment for their operations and this could boost productivity and output for the economy

• If the net primary income deficit increases, this means Australian individuals and businesses have been able to borrow more funds which could be used for productive purposes across the economy.

Here and here are some extra resources you can check out.

Solving external stability

External stability is all about ensuring Australia can manage its financial relationships with other nations.

In practice, external stability is all about three questions:

1. Is the CAD too large?

2. Is the level of foreign debt too large?

3. Is the $A at an acceptable level?

Great. So how do we solve external stability?

“To improve external stability, the government could use fiscal policy to reduce the need for foreign debt by the public and private sectors.”

For all three questions, monetary policy (the Reserve Bank of Australia’s use of the cash rate to affect the level of economic activity) isn’t really useful. It’s too much of a blunt tool.

For example, using contractionary monetary policy to improve external stability will seriously slow the whole economy. Not a great outcome. (Ask me more about this in the comments.)

Let’s look at fiscal policy instead. This is the use of the federal budget to achieve economic objectives.

To improve external stability, the government could use fiscal policy to reduce the need for foreign debt by the public and private sectors.

For the public sector, the federal government could run budget surpluses (where taxation revenue exceeds government spending), create a nice pool of domestic savings for itself, which it can then use to fund investment — without having to call on (bring in) foreign capital.

So that will reduce the public sector part of foreign debt, and hopefully improve the CAD (less need for capital outflows, less primary income outflows). External stability improves!

For the private sector, the government could use fiscal policy to boost domestic savings by increasing the rate of compulsory superannuation.

Compulsory super is the Australian retirement scheme where employers are forced to put a portion of an employee’s wages into a retirement fund. The money cannot be touched until retirement. BUT! The superannuation funds, who hold the money, can invest it to earn a nice return for their members.

So a higher rate of compulsory super will increase the domestic pool of savings and again reduce the need for capital inflows to fund investment. Thus, external stability improves.

One more option. The federal government can try and make exports more competitive so Australia can sell more exports, put BoGS into surplus more often, and improve the CAD. The government can do this through microeconomic reform, supply-side policies that will allow firms to produce more at lower prices (represented by an increase in aggregate supply).

Or the government could do nothing. Capital inflows and a CAD are funding vital investment in Australia, that we could not otherwise fund. Why stop the party?