Has Foreign Capital Made Us Richer?

Abstract

ustralia’s current account deficit approached seven per cent of GDP in 2004-05, one of its highest ever levels, renewing concerns in financial markets and economic policy circles about the sustainability of the economy’s balance of payments (see Edwards, 2005, Swan, 2005). External deficits of similar magnitude relative to GDP have recently been experienced by the United States, New Zealand and to a lesser extent by the United Kingdom. These deficits have been largely funded by high saving economies in East Asia, especially Japan and China, and oil exporting nations (see MacFarlane, 2005; International Monetary Fund, 2005). Financial market traders and policymakers worry that current account deficits of this size reflect poor international trade performance; that imports are too high and exports are too low. In addition, escalating external debt levels are considered inherently risky because over-reliance on foreign funds exposes an economy to sudden shifts in international investor sentiment and hence to capital flow reversals that could precipitate a currency and financial crisis, spark high inflation and induce a major recession (see, amongst others, Mann, 2002; and Fischer, 2003). The significance of current account deficits has been a long-running theme in Australian economic policy debate. As argued previously (Makin, 1989) at a time when the balance of payments was the central macroeconomic issue, external deficits are often best interpreted as saving-investment imbalances that allow real domestic capital accumulation to proceed more quickly. As a counter to concerns about external imbalances, it can therefore be argued that external deficits and matching capital account surpluses should actually be welcomed since they allow real investment to be higher. Similarly, in stock terms when foreign funds finance expansion of the domestic capital stock, the rise in external liabilities is matched by an increase in the level of productive plant, equipment and buildings. In sum, irrespective of its form net capital inflow allows more domestic capital accumulation which, if used for this purpose, improves the economy’s overall productive capacity. Numerous theoretical approaches have previously been advanced to demonstrate this (see, amongst others, Frenkel and Razin, 1987; McDougall, 1960; Grubel, 1987; Ruffin, 1987; and Makin, 2003). In the resurgent economic policy debate about Australia’s external imbalance, an important question not yet asked nor answered is: By how much has foreign capital raised Australia’s living standards? Or, in other words, how much better off, income-wise, have persistent current account deficits and rising foreign debt levels made us?