Business

About that record current account (not trade) deficit

What would the NDP have done differently, may I ask?

Here is Tom Mulcair’s first question in Monday’s Question Period:

Mr. Speaker, Canada’s economy is still in difficulty despite the Prime Minister’s boasts. The Conservatives have set a new record with a trade deficit of $50 billion. Hundreds of thousands of manufacturing jobs have vanished—high-quality, high-paying jobs. The artificially high Canadian dollar is hurting export industries. Household debt has never been so high and productivity has never been so low. Does the Prime Minister realize that it is time to change his economic strategy?

As Maclean’s Aaron Wherry notes, the Conservatives are complaining that the NDP got the numbers wrong. It turns out that the $50 billion number is for the annual current account deficit, not the trade balance. As Aaron also notes, the distinction goes like this:

Current account balance = trade balance + net investment income flows

That last item—the difference between the profits Canadians earn on investments abroad and the profits earned on assets located in Canada sent back to foreign owners—is worth about $20 billion these days. Even so, I’m not inclined to score that as a CPC ‘gotcha’. Economists will often use the terms ‘trade deficit’ and ‘current account’ interchangeably in informal discussions. There are times when it’s crucial to make the distinction; this wasn’t one of them. Tom Mulcair made the correction in his speech today, and it didn’t change his point.

The more fundamental problem isn’t the number; it’s the fact that the NDP sees a current account deficit as a problem in the first place.

Aaron reports that the NDP pointed him to this op-ed by Arthur Donner and Doug Peters in the Globe and Mail last April to illustrate their thinking. I remember that op-ed very well, since it motivated me to dash off this rebuttal. Here are the key paragraphs:

The current account represents the net change in Canada’s international investment position. A negative CA means that Canadian asset holdings abroad fell, foreign holdings in Canada increased, or some combination of the two. The CA can also be viewed as the net international transfer of savings, and is negative when foreigners shift more of their savings to Canada than Canadians send abroad.

A national accounting identity states that total investment expenditure must be financed by the sum of domestic and foreign savings. Noting that Canada has a current account deficit is the same thing as noting that investment expenditures are larger than domestic savings – the difference is made up by foreign investors.

The annual current account numbers are available in Table 376-0001 in Statistics Canada’s Cansim database. Here is what they look like:

The last few observations are indeed at record lows. Of course, to provide a proper scale, you should divide by GNP. (Yes, GNP not GDP. GNP is GDP plus the net investment income flow. If we’re going to include investment flows in the numerator, we should include them in the denominator as well.) Expressed as a share of GNP, the recent deficits are still large, but not actually records:

 So what actually happened to the current account, and why would we think that its recent decline is a bad thing? Here’s a variant of the national accounts identity I referred to here:

Current account = Government budget balance + (Savings – Investment)

(Attentive readers will notice that I too played fast and loose with the distinction between the current account and the trade deficit there as well. Another reason why I can’t get too upset when Tom Mulcair does it.)

So why did the current account fall, and what—if anything, should the government have done about it?

  • Government budget balance: The improvements in the governments’ fiscal position in the 1990s contributed to the increase in the current account in the 1990s, and the effect of the recession was the reverse. I don’t think that the NDP is saying that Canadian governments should have responded to the recession by implementing the sort of austerity measures that would have kept government budgets in balance. Nor do I think that they’re calling for a stronger emphasis on austerity in the near future.
  • Savings: Everything else being constant, the loss of income during the recession would reduce savings. I don’t think the NDP would have preferred policies encouraging people to respond to the recession by cutting back on spending. We know from the Paradox of Thrift—one of Keynes’ most important insights—that this would have been a mistake. In addition, interest rates fell, which reduced the return to savings. I don’t think the NDP would have preferred that the Bank of Canada had kept interest rates high in order to discourage spending and to encourage saving.
  • Investment: Investment spending levels have recovered their pre-recession peaks, contributing to a reduction in the last term of the equation on the right-hand side. Again, I don’t think the NDP’s complaint is that there’s been too much investment spending in Canada.

Eventually, the current account will adjust: government budget balances will continue to improve, and savings levels will improve as incomes recover and when interest rates start increasing back to normal levels.

But if the NDP wants to claim that a large current account is a problem, I’d like to know what they would have done  differently during the recession and recovery and how it would have reduced the current account deficit. But more importantly, I’d like to know why they see it as a problem to be solved.