Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative.
Statistics Canada's estimates for the current account balance for the third quarter of 2010 - a deficit of $17.5-billion - have generated any number of stories trying to put this in context. But all you really need to know to understand this number is the fact that all investment must come from savings.
The current account represents the net change in Canada's international investment position. A negative current account means that Canadian asset holdings abroad fell, foreign holdings in Canada increased, or some combination of the two. Another interpretation is as the net international transfer of savings: a negative current account occurs when foreigners shift more of their savings to Canada than Canadians send abroad.
Domestic savings take two forms. If taxes are less than government spending, then the resulting deficit reduces domestic savings; if the government balance is positive, then public savings is a net contributor to domestic savings. Private savings are after-tax income that is not spent on current consumption. Put together, private savings and the government balance add up to domestic savings.
The following accounting identity must always hold:
Investment = Domestic savings + Foreign savings
So another way of interpreting a current account deficit is that investment expenditures in Canada is higher than it would have been if they had to be financed out of domestic savings. Is this a bad thing? And if it isn't, why have so many people been worrying about the large and persistent U.S. current account deficit?
The answer depends on what sort of investment is being made. For example, foreign savings helped fuel a housing bubble in the U.S. and contributed to the financial crisis there. In other countries, sudden and large inflows of 'hot money' have often been destabilizing. But if foreign savings are financing the purchase of new equipment and the creation of new productive capacity, then that's good news for output, productivity and wages.
Happily, that latter scenario seems to be what is happening in Canada. Even though GDP growth was weak in the second and third quarters of 2010, spending on machinery and equipment - the form of investment spending most closely related to improvements in productivity - increased at an annual rate of 30 per cent.
Current account deficits and surpluses cannot and will not persist forever. But in the short term, they are nothing to worry about. Indeed, they are generally beneficial. Increasing domestic savings to finance higher levels of investment would involve cutting back consumer spending and the government budget balance. These adjustments will have to be done eventually, but not right away: austerity makes little sense at this point of a fragile recovery. Running a current account deficit allows us to build medium and long-term productive capacity without putting the short term in danger.
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