RDP 9003: The Balance of Payments in the 1980s VI. Long-Term Equilibrium

It was noted in the introduction that the 1980s have seen a return to the earlier concerns about overly large current account deficits and a growing concern with the rapid accumulation of foreign debt. Indeed, many commentators, by simply extrapolating the present external position, see Australia inexorably heading towards a “debt trap”. With these concerns in mind, this section addresses issues about long-term equilibrium.

So far our attention has been focused on the equilibrating mechanisms – through relative prices and income – that operate to maintain the two halves of the X-M/S-I identity. This section will consider the equilibrating or stabilising factors which seem to prevent the overall size of the imbalances from getting too large.

Before attempting to identify what these equilibrating forces are, we look at the facts from two viewpoints – from the X-M side of the dichotomy and from the S-I side.

Consider first the behaviour of exports and imports. Table 1 reports the results of cointegration tests on imports and exports, to see whether some (unspecified) forces are tending to make them move together in the long run. The table shows that nominal imports and exports are cointegrated and that real imports are cointegrated with real exports and the terms of trade.^[50] This is consistent with the hypothesis that, in the long run, nominal import growth is constrained by nominal export income and that real import growth is constrained by real exports and the terms of trade. These results suggest, for instance, that a permanent change in the terms of trade may have little long-run effect on the current account. Furthermore, they imply that the opening of new export markets or policies aimed at shifting resources into industries that are likely to experience relative price rises, other things equal, may not significantly alter the current account position in the long run but may increase income growth. They also support Forsyth(1990) who argues that micro-economic reform aimed solely at boosting productivity and income will not, in itself, reduce the current account deficit over time.

Now consider the saving-investment side. By observing that countries tended to have highly correlated savings and investment, Feldstein and Horioka(1980) concluded that capital was not mobile. That is, savings-investment imbalances (and the current account) were prevented from getting too large because of limited capital flows. The results reported earlier for Australia showed that although the correlation declined over time (indicating increased capital mobility) there was a significant correlation between savings and investment.

The standard interpretation of this result is that it indicates less than perfect capital mobility. This is probably not the case. If there are endogenous or policy responses to external imbalances that limit the overall size of the current account deficit then, even with perfect capital mobility, there will be a significant correlation between domestic savings and investment. On this interpretation, the results reported earlier are not inconsistent with both the increase in capital mobility over time and the presence of factors limiting the size of the current account deficits.

What have these factors been in Australia? Was the savings-investment imbalance constrained by limited access to foreign funding, resulting in investment lower and/or saving higher than they would have otherwise been? Was it policy responding to impending current account crises? Or was export income limiting our capacity to import? One factor that probably has not been important to date, but may be in the future, is foreign debt. The recent accumulation of foreign debt has probably not affected private expenditure. One reason for this is that the rise in private sector wealth in the 1980s has probably mitigated the wealth effects of rising external debt. Each of the above factors – limited access to foreign capital markets, policy responses to excessive deficits and expenditure responses to the terms of trade – seem to have played a role in applying some constraint to the current account. It is likely, therefore, that a weakening of some of these factors in the 1980s played a role in the widening of the deficit.^[51]

Footnotes

In the first three equations the augmented Dickey-Fuller statistic is significant at the five per cent level while in the final equation it is significant at the ten per cent level. Thus, in each of the equations there is evidence of a cointegrating relationship. [50]

FitzGerald and Urban(1989) consider some of these longer-term adjustment issues. [51]