Articles by Infometrics
Is New Zealand bankrupt?
8 August 2008
New Zealand is an
indebted nation that persistently runs current account deficits. This raises
the questions, what is a current account deficit and should we be concerned
The best way to think of the current
account deficit is to relate it to your own spending as a household. When the
country is running a current account deficit it is borrowing to fund current
spending – just like if you were spending more than you earned then you would
have to borrow.
Just like an individual, a nation may spend
more than it earns because (as a whole) it wants to consume more now, or
because it wants to invest for the future. It appears that the recent increase
in our current account deficit is the result of both rising consumption and
On the investment side, the idea of
borrowing now to fund capital expenditure is a fairly mundane concept. The
benefit of an investment project will materialise over time, while a
disproportionate portion of the cost is incurred straight away. As long as the
benefit of the investment exceeds the cost over the investments lifetime, and
the risks are known, then there is no reason to be concerned about this form of
An example of how this works for a household
is as follows. If you wish to buy an expensive asset (eg a car or, house) you
can either save up the funds or you can borrow and pay back the funds over
time. The risk from borrowing is that you have made a commitment to repay the
loan, which might become difficult if, say, you lose your job. On the other
hand, if you pay for everything out of savings you miss out on all the
opportunities – say from having a car today instead of waiting several years.
Over the past five years, the New Zealand dollar has been especially strong, and the world price of capital equipment has
been surprisingly low. In this type of situation it makes sense that New Zealand businesses have invested in assets by borrowing – thereby taking advantage of
this opportunity while it was available.
Unless we believe that businesses are
incapable of making sensible decision regarding their own investment, then
there really is no problem with having a current account deficit that funds
private investment activity.
On the consumption side, a nation may spend
more than it earns because it either anticipates that it will grow in the
future or it may substantially favour spending now ahead of spending in the
future. As the goal of policy should be to maximise society’s lifetime
happiness, if individuals want to consume more now (to the detriment of future
consumption opportunities) they should be allowed to.
For a household, this type of borrowing is
equivalent to “smoothing” the amount you consume over time. When you are
young, you expect your lifetime earnings to increase in the future – as a
result it is in your interest to borrow now. As a nation, we expect our
lifetime earnings to increase in the future – and as a result, if we are
offered credit at attractive rates we will be willing to borrow now.
There is an issue of fairness associated
with borrowing to consume; economists term this “intergenerational equity”. If
you and I borrow now to consume and don’t pay it back in our lifetime, this
will create a debt that future generations are burdened with.
But if we expect the economy to continue
growing over time and if we value the lifetime happiness of our children as
much as ourselves, it may still make sense for households to redistribute
income over time in this way – because growth will increase future incomes. As
long as we believe that households can borrow sustainably, then there is no
problem with a current account deficit stemming from individuals choice of
The decision to borrow in order to fund
consumption and investment has built up a stock of debt in New Zealand that is equivalent to 86% of the countries income (gross domestic product). As
a result, a major determinant of our current account deficit each year is the
interest payments that head overseas. However, this stock of debt is the
result of consumption and investment choices in the past. In a household
sense, this is equivalent to paying off the interest on your mortgage or a hire
The current account deficit is merely the
result of the borrowing, consumption, and investment decisions of every
household and firm in the economy. As long as these households and firms are
fully informed of the risk and return associated with their borrowing
decisions, is there really any reason to fear the spectre of a current account
deficit? To answer my own rhetorical question – it appears not.