RDP 9003: The Balance of Payments in the 1980s VIII. Conclusion

Two of the economic events that distinguished the 1980s from earlier decades were the apparent structural increase in the current account deficit and the rapid accumulation of foreign debt. Over the three decades from 1950 to 1980, the current account deficit averaged 2–1/2 per cent of GDP. Generally, the deficits experienced during the 1980s were double this earlier figure.

The paper argued that the major influences on the current account shifted over the course of the decade. The low level of national saving (which was largely due to the decline in public saving) underpinned the deficit in the first half of the decade. This was exacerbated at the beginning of the decade by a sharp rise in private investment. Even though investment subsequently fell to historically low levels, the current account failed to narrow markedly as fiscal policy became expansionary and private saving fell during the 1982/83 recession. Each of these factors contributed to an appreciation of the real exchange rate during this period and left the real exchange rate above its earlier level for a considerable time. This reduction in competitiveness, coupled with the rise in expenditure, resulted in a sharp widening of the current account deficit. In hindsight, the response of the current account to these shocks was not surprising. This cannot be said for the behaviour of the current account in the second half of the decade.

Despite a large depreciation of the nominal and real exchange rate between early 1985 and mid-1986, a substantial contraction of fiscal policy and subsequently a large rise in the terms of trade, the current account showed little sustained narrowing and continued to fluctuate around 5 per cent of GDP. This can largely be explained by a large rise in private investment (due to increased profitability resulting from sustained real wage reductions). The rise in the terms of trade was not reflected in increased saving and therefore a reduction in the current account deficit. These shocks placed upward pressure on income, expenditure and the real exchange rate. The tightening of monetary policy beginning in 1988 may have exacerbated this exchange rate rise and contributed to the widening of the deficit but domestic anti-inflationary objectives dictated that monetary policy should resist the surge in domestic expenditure. The earlier depreciation was partly reversed and the current account response to the reduction in the Public Sector Borrowing Requirement (PSBR) was therefore inhibited,

While the shocks mentioned above contributed to this, the deregulation of the financial markets, the abolition of exchange controls and the development of offshore markets in $A denominated securities, facilitated the increased foreign borrowing. These factors increased the mobility of capital and gave domestic agents (the government at the beginning of the decade and the private sector at the end) greater recourse to foreign savings to finance their expenditures. Also, the abolition of exchange controls led to a switch to debt rather than equity finance. The deregulation of the financial markets, coupled with relatively high domestic inflation and distortions in the tax system, may have also contributed directly to the rise in the current account deficit by altering savings and investment decisions.

Can Australia's current account deficit be classified as good or bad? A case can be made that the deficits experienced between the mid-1970s and the mid-1980s were generally bad. They reflected a rapid rise in public sector spending not funded by current taxation. For most of this period (excluding the resource boom) private investment expenditure was subdued. (As a proportion of GDP it was well below its levels of the 1960s). Thus the increase in foreign borrowing in this period did not finance a large increase in the capital stock: rather it financed increased public consumption.^[58] On the other hand, it can be argued that the most recent deficits can be classified as good. The public sector accounts have moved into surplus and public expenditure and private consumption have declined relative to GDP. The deficits have financed a substantial rise in private investment expenditure. To the extent that this investment is profitable, it will finance the servicing costs without requiring lower consumption in the future. Some of the recent deficit reflects cyclical excess demand in 1988 and 1989 which has since been eliminated.

Footnote

This conclusion must be qualified because public consumption expenditure may be welfare enhancing. [58]