Q&A: Why might a country have a sustained surplus on their current account?

Why might a country have a sustained surplus on their current account?

The current account of the balance of payments is the sum of four separate balances: • Net trade in goods • Net trade in services • Net investment income from overseas assets • Net transfers

4/5ths of the trade surpluses in the world economy can be found in China, Japan, Germany and the oil-exporting nations of the gulf. According to Martin Wolf (FT, December 2008) “As a share of gross domestic product, China’s current account surplus is forecast at an astonishing 9.5 per cent, Germany’s at 7.3 per cent and Japan’s at 4 per cent. “

Many countries operate with a current account surplus as indeed they must since there are other countries running current account deficits. There are several causes and each country will have a unique set of circumstances:

1. Export-oriented growth: Some countries have deliberately set out their stall to increase the capacity of their export industries as a growth strategy. Huge investment in new capital provides the means by which economies of scale can be exploited, unit costs driven down and comparative advantage can be developed. Germany, Japan and China are all examples of countries that are strong net exporters of goods – often sufficient to bring about a current account surplus. Keep in mind though that all three are now suffering from the global economic downturn. Strong export growth might also be the result of a high level of foreign direct investment into a country where foreign affiliates establish production plants and then export out of the economy.

2. Undervalued exchange rate: A trade surplus might result from a country attempting to depreciate its exchange rate and therefore make its exports more competitive overseas whilst imports would appear more expensive in home markets. Keeping the exchange rate down might be achieved by enormous levels of currency intervention by a nation’s central bank, i.e. selling their own currency and accumulating reserves of foreign currency.

3. High domestic savings rates: Some economists attribute current account surpluses to high levels of domestic savings and relatively low rates of domestic consumption of goods and services. When consumer spending is subdued, this reduces demand for imported products and it also frees up capacity for exporting. China is an economy with a very high household saving ratio and a huge trade surplus; in contrast the savings ratio in the United States has collapsed (it dipped into negative territory at one point) and at the same time, their external trade deficit has got bigger and bigger. Critics of countries with persistent trade surpluses argue that they should do more to expand domestic demand relative to potential output and therefore provide a boost to world trade.

4. Closed economy – some countries have a low share of national income taken up by imports – perhaps because of a range of tariff and non-tariff barriers or because consumer preferences favour home produced rather than foreign produced goods and services.

5. Strong investment income from overseas investments: A part of the current account that is often overlooked is the return that investors get from purchasing assets overseas – it might be the profits coming home from the foreign subsidiaries of multinational businesses, or the interest from money held on overseas bank accounts, or the dividends from taking equity stakes in foreign companies.

In short – persistent current account surpluses can result from:

A surplus of domestic savings over investment
An undervalued exchange rate
A boom in export revenues due to a sharp rise in the global price of a key export
High returns from overseas investment