Nowadays, in an era of globalisation, 'buy British' campaigns sound rather out of touch. In fact, some economists argue that with the free movement of capital, a current account deficit is no problem because the deficit can easily be easily financed. However, a current account deficit can give insights into the performance of an economy, and in some cases cause economic problems.
Effects of A Trade Deficit
Competitiveness. A deficit may imply a decline in competitiveness; e.g. higher labour costs. The UK's persistant deficit since the early 1980s, is arguably a reflection of the deterioration in the competitiveness of the manufacturing sector.
Depreciation. In the long term, a current account deficit can cause a depreciation of the exchange rate which reduces living standards (imports are more expensive). This is because a deficit means foreign exchange is flowing out of the country. If the deficit is small, it may be easy to finance it through capital flows; but, if the deficit is large like US (6.5% of GDP in 2007, it will almost certainly cause a depreciation in exchange rate.
High Growth. A deficit may simply be because the economy is growing quickly. When the economy is growing people will be buying more imports. Therefore, a current account deficit may be a reflection of high growth and falling unemployment, which is a good thing. Japan has had a current account surplus but very sluggish growth in the 1990s.
- However, a deficit may also indicate the economy is growing too quickly causing domestic inflation and so people buy from abroad to avoid high domestic prices.
- E.g. China has economic growth of 10%, but, has a current account surplus. This reflects its high savings ratio. The US current account was partly due to a very low savings ratio and high level of personal debt, which suggests an unbalanced economy.
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