Why does Australia run persistent current account deficits and does it matter?
Explain the causes of Australia's current account deficit using the savings-investment gap, distinguish net foreign debt from net foreign equity, and evaluate whether a current account deficit is a problem
WACE Year 12 Economics Unit 3 on the current account deficit and foreign liabilities: the savings-investment gap, the difference between net foreign debt and equity, the Pitchford consenting-adults view, and whether a deficit is sustainable.
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What this dot point is asking
SCSA wants you to explain the savings-investment cause of the CAD, distinguish the types of foreign liability, and evaluate whether a deficit matters. This is a frequent extended-response topic because it links the balance of payments, foreign investment and national income.
The savings-investment gap
The current account and the capital and financial account are two sides of one coin. A current account deficit is automatically matched by a net capital inflow.
Australia has run a CAD for most of its history because it is a high-investment, relatively low-saving economy: abundant resource and infrastructure projects attract more investment than domestic saving can cover.
Net foreign debt versus net foreign equity
Foreign liabilities are the stock of what Australians owe to and own by foreigners. They divide into two types.
- Net foreign debt is the difference between what Australian residents have borrowed from overseas and what they have lent overseas. It must be serviced with interest payments, regardless of how the economy performs.
- Net foreign equity is the difference between foreign ownership of Australian assets (shares, property, companies) and Australian ownership of foreign assets. It is serviced with dividends and profits, which fall when the economy is weak, making equity a more flexible liability than debt.
Both generate the primary income debits that widen the current account on the income side.
Is a current account deficit a problem?
This is the core evaluation question. Two views frame the debate.
The traditional concern: a large CAD builds up foreign liabilities, raising interest and dividend obligations, exposing Australia to global interest rate rises and currency falls, and risking a loss of investor confidence that could trigger a sudden stop in capital inflow.
Sustainability indicators
To judge whether a CAD is sustainable, economists look at:
- The CAD as a share of GDP (a deficit growing faster than the economy is a warning sign).
- The debt-servicing ratio, the share of export earnings absorbed by net income payments.
- What the borrowing funds: productive investment versus consumption.
- The composition of liabilities: flexible equity and Australian-dollar-denominated debt are safer than foreign-currency short-term debt.
Australia's position is widely judged sustainable because much of its debt is hedged or denominated in Australian dollars, its banks are well regulated, and borrowing has largely funded investment.