RDP 9003: The Balance of Payments in the 1980s III. The Chronology of the Current Account

(i) The longer-term trends

The fact that Australia experienced a current account deficit during the 1980s was not unusual. It has done so for most of the post-war period. What was unusual was the size of the deficit and the prolonged period in which the large deficit persisted. The deficit widened in the early 1980s for reasons that were considered temporary at the time (i.e. the investment phase of the “resources boom”), It reached 5–3/4 per cent of GDP in 1981/82; a large, but not unprecedented figure (Figure 1). There has been little sustained narrowing since that time. Indeed, the deficit failed to fall much below 4 per cent of GDP in any of the years of the 1980s. This behaviour is atypical. In earlier periods (in the 1950s and 1960s for example) rises in the deficit tended to be quickly reversed. The current account deficit averaged 4–1/2 per cent of GDP in the 1980s. This compares with averages of 1–3/4 per cent and 3 per cent of GDP in the 1970s and 1960s respectively.

The rise in the current account deficit largely reflected movements in the merchandise trade balance which widened from a surplus averaging 1–3/4 per cent of GDP in the 1970s to average a deficit of 3/4 of one per cent of GDP in the 1980s. The net income and transfers balance also widened from around 2 per cent of GDP in the 1960s and 1970s to around 3–1/2 per cent of GDP in 1988/89 because of higher interest payments on foreign debt.

The increase in the current account deficit since the late 1970s has been associated with a sharp rise in imports. Figure 2 plots import and export values relative to GDP, During the 1960s the import to GDP ratio was largely flat before falling sharply in the early 1970s.^[13] The import share of GDP then rose quickly in the second half of that decade. During the 1980s, it continued to trend upwards. The import share averaged just under 18 per cent of GDP in 1980s. This is substantially higher than the 15–3/4 per cent and 14–3/4 per cent of GDP recorded in the 1960s and 1970s respectively. The value of exports as a proportion of GDP has only risen from around 15 per cent in the 1960s and 1970s to 16 per cent in the 1980s. However, there was a pick-up in export performance in the second half of the decade with exports being about one half of one per cent of GDP higher than in the first half.

Export prices have fallen substantially relative to domestic prices over the past 30 years. These relative price falls have been offset by growth in export volumes (Figure 3). Exports, in volume terms, have grown by around 1–1/2 per cent of GDP per decade and have grown much faster than GDP since 1982/83. Import volumes grew quickly during the early 1980s and remained high relative to GDP for most of the decade. In the last two years of the decade the ratio of import volumes to GDP has risen substantially.

Rural exports were the predominant source of export income until the beginning of the 1980s. They have now been surpassed by exports of non-rural commodities (notably, mineral fuels) which account for almost 40 per cent of total exports. (Figure 4 plots export values as a proportion of nominal GDP.)

The export-import version of the current account identity was plotted in Figure 2. How have the savings-investment and output-absorption versions of the identity behaved?

Figure 5 plots five year average growth rates of real GDP and GNE. Output and absorption were very subdued, on average, in the period 1975 to 1985 after a period of rapid expansion in the previous fifteen years.

Growth in both output and absorption recovered in the second half of the 1980s but still remained below the rates of the first half of the sample. This suggests that the widening of the current account deficit has not been due to excessive expenditure growth per se. A sharp slowing in output growth meant that the economy had to sustain slower expenditure growth just to maintain a given current account deficit. This situation has eased a little because of the recovery in output.

In terms of the saving-investment identity, the rise in the current account deficit has been associated with a decline in national saving rates. (See Figure 6^[14]). There was a major fall in total saving during the second half of the 1970s.

In recent years there has been a recovery in the level of saving. However, it is still below the levels achieved in the 1960s and early 1970s. In contrast, there has not been a significant change in the rate of investment. Although, in the short-term, the investment rate has been more volatile than the saving rate (e.g. the sharp rises in investment at the beginning and end of the 1980s) it has not experienced a marked secular change. Thus, for most of the period since the mid-1970s, the widening of the current account deficit has been associated with subdued saving for a given level of investment.

(ii) The 1980s

We now examine, in an episodic fashion, the progress of the current account through the 1980s. This is done in terms of proximate causes, not going beyond the uncontroversial observation that the current account reflects an excess of demand over production, and the price effects of the terms of trade.

After narrowing in 1979/80, the current account deficit widened sharply until 1981/82. This was driven by increased expenditure, particularly investment expenditure on mineral processing and electricity generation associated with the “resources boom” following OPEC II.^[15] Toward the end of this period, the economy was reaching capacity constraints. This constraint was exacerbated by large real wage increases which slowed domestic production. Rural exports also fell as a result of the drought. Even though the deficit was very high in this period, it was not seen as alarming because it was explainable in terms of an increase in the rate of return to capital in Australia. The imbalance was seen as the first stage of a process which would produce an increase in exports.^[16]

The very sharp slowing of the economy in 1982 brought the current account deficit back from about 6 per cent of GDP to around 4 per cent. Despite this, the current account had not returned to its traditional level. Also, at this time the budget deficit increased sharply, mainly for counter-cyclical demand management reasons. The economy recovered rapidly from the 1982 recession; at first expansion of domestic production was able to meet a large part of the increase in expenditure. This was aided by the recovery in the rural sector. However, as the recovery continued, the speed of growth and relative price pressures were boosting import volumes and the current account deficit began to widen. This was exacerbated by the sharp decline in the terms of trade in 1985. The terms of trade fell by 14 per cent between March 1985 and March 1987. By this time the current account was again around 6 per cent of GDP.

In response, principally to the overheated domestic economy, but also later to the subsequent fall in the exchange rate, monetary policy was tightened. A sharp contraction of fiscal policy was also commenced – a move seen as important by those who viewed the current account deficit as the “twin” of the budget deficit (see page 5 above). The Treasurer's “Banana Republic” comment belongs to this period – an acknowledgment that policy adjustment was needed. The resulting slowing of the economy offset the continuing deterioration of the terms of trade but the results, in terms of a narrowing of the current account deficit, were slow in coming. The fall in the exchange rate was, through valuation effects, increasing the current account deficit (as recorded in $A): hence the debate on the “J curve”. (See Office of EPAC (1986).)

In 1987, the terms of trade began to improve; the economy was not, at that stage, growing quickly and the real exchange rate was very low. So in the two years up to 1987/88, there was a narrowing in the current account of over 2 per cent of GDP. As the economy picked up pace (largely through private investment), and as the improvement in the terms of trade (combined with a tightening of monetary policy) pushed up the exchange rate and shifted relative prices to encourage imports, the current account deficit widened sharply, to reach about 6 per cent of GDP in 1988/89. The continuing substantial current account deficit could be associated, proximately, with the large increase in private sector investment. By the end of the decade, the economy had begun to slow and, while imports were not yet falling, they had at least levelled out and the current account as a proportion of GDP was edging downwards.

Footnotes

Macfarlane(1979) examines factors behind this decline. [13]

The saving and investment measures are based on ABS national accounts estimates. The difference between saving and investment is equal to net lending to overseas plus the statistical discrepancy. [14]

For example, business fixed investment rose by 17 per cent in 1980/81 and 12 per cent in 1981/82, rates not seen for twenty years. [15]

Derrick, McDonald and Kosendale(1981), contains a profile of export earnings that were expected from these resource developments. [16]