The importance of an open capital account

Does a current account deficit matter? Well the UK is in the red £8.4 billion (net visible and invisibles), which in basic terms means that more is leaving the country in import spending than is being generated in export revenues. If we include the other components of the current account; net income flows from assets held overseas where there’s a surplus of £4.6 billion and the deficit on current transfers of £5.5 billion (This last part of the current account is also where remittances, the money sent home by migrants, are recorded – nice interactive tracking these flows found here) there’s an overall deficit of £9.3 billion. The UK’s not alone in having such a taste for foreign imports – The US has a trade deficit on goods and services of $43.6 billion.

Now, these deficits must be financed by surplus’ on the capital account in order for the Balance of Payments to “balance”. If an economy can do this then what’s the problem? Well anyone who watched the BBC’s Made in Britain will have discovered the importance of high value manufacturing as an export earner so therefore running such large deficits suggests perhaps that whatever it is you make, you’re not as good at it as your competitors. This has big implications for the government and its supply side policy to improve British competitiveness but in the meantime the capital account needs to attract funds in order to balance out the deficit. The UK is a highly open and dynamic economy which has no problem in attracting the necessary investment. Here’s an example of Why Chinese companies want to buy British businesses (HT #ecbusteach). With regards the US, foreign investment rose 49% in 2010 from 2009 “making the US the number 1 destination for foreign investments in the world” according to this WSJ article. Obama puts this success down to the US having the “world’s most productive workforce, a culture of innovation, remarkable colleges, and a business environment marked by transparency and the rule of law.”

FDI in 2010 amounted to $228 billion and according to the article these investments support 5.7 million workers in the U.S. There’s no shortage of examples of the high tech high skilled industries that now exist in the US (What America makes, Exports good, imports bad?) so as long as America can attract overseas investment and the trade deficit is financed by a healthy capital account surplus, US citizens benefit from consumption of cheap goods made overseas - where’s the problem?