Why does New Zealand almost always have an international balance of payments (BoP) deficit?
Some argue that a persistent BoP deficit reflects a poor national savings rate. It is true that the BoP deficit is equal to the difference between national saving and investment. But this is just an accounting identity it says nothing about the direction of causation. Claiming that one causes the other has about as much validity as looking at someone with low saving and blaming it on too much expenditure when low current income might be the main determinant, or not considering that they might have access to the wealth of rich relatives.
Proponents of inadequate saving theory argue that if we lift our national saving rate we would reduce our imports. It might, simply because if we are saving more we must be consuming less, and hence import demand would also fall. However, if more saving is matched by a rise in investment there would be no change in the savings-investment balance and so no change in the BoP deficit either.
New Zealanders have a high propensity to consume imports as income rises. We like to buy cars (and oil to run them), electronic goods, different foods, overseas trips and so on. This has some interesting policy implications:
Import protection such as tariffs and import licences will not lower the BoP deficit. They just mean that we would import more of the unprotected goods and services, and that the export sector would lose competitiveness because of a higher cost structure. Competition in the domestic market would decline, resulting in higher prices to consumers. Remember the price of televisions when they were manufactured in New Zealand with protection from imports. Or pantyhose; in 1981 standard popular pantyhose cost $2.70 per pair, which in current prices is about $10.00. A supermarket now sells them for considerably less. Ultimately under import protection we all become poorer as resources are allocated to activities in which we're not competitive.
By the same logic, a Buy New Zealand campaign, unless it helps educate consumers about product quality so that they can make more informed choices, just robs resources from efficient exporters to the benefit of those who compete with imports. Again resources flow to the wrong industries.
Running an undervalued exchange rate (a common call of late) also does not help, at least not in the long run. Any extra revenue from exports is immediately used to buy imports, albeit that the latter are relatively more expensive. Furthermore, higher export volumes in that context often mean lower export prices. We cannot push evermore dairy products into premium foreign markets. Just as a business aims for higher profits, not higher sales, exporting more low profit products does not make us richer. Producing and exporting more tonnes of milk solids to import a car just exhausts us.
Ultimately the size of our BoP deficit is determined by how much the rest of the world is happy to lend to us and the price, that is the interest rate, it demands for doing so. That interest rate could be relatively high if there is a perceived risk of currency devaluation.
The risk of a fall in the exchange rate can be reduced by government maintaining a stable policy environment that underpins growth and low inflation. And although we have no control over unfavourable external events such as global financial crises, such events do change our sense of what is prudent just as when those rich relatives suddenly go broke.
Might the causation be the other way around high domestic interest rates attracting foreign capital, driving up the exchange rate to artificially high levels and thereby lowering the price of imports and reducing export competitiveness? Some of the time this happens and the accompanying changes in the exchange rates can be dramatic, but as an explanation of our persistent BoP deficit it doesn't wash. The theory implies that over the long run the New Zealand dollar is over-valued. However, as most of us know when we travel overseas, a comparison between what a dollar buys in New Zealand and what a dollar converted into foreign currencies buys in other countries, does not make us feel like we have a strong currency. Empirical analysis supports this impression.
In the long run then, our persistent BoP deficit is caused by our love affair with imports. And why shouldn't we listen to iPod, watch Hollywood movies and drive Japanese cars like everyone else? In a small country we cannot efficient producers of everything we want to consume. Coupled with our relative isolation and the associated desire by most of us to see and experience the rest of the world, there is little prospect of a reduction in the nation's propensity to import any time soon. Nothing wrong with that, as long we're willing to wear the interest rates and accommodate the occasional currency slump.
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