News & Views item - July 2006

 

 

The Head of Treasury, Ken Henry Opines on the Current Account Deficit and Foreign Debt. (July 12, 2006)

 Dr Ken Henry.
  Photo: Andrew Taylor

    It's one of those matters that seems to be cropping up with increasing frequency -- Australia has one of the largest current account deficits in the developed world, over 6% of its GDP, i.e. US$42 billion.

 

Other western nations, run large current account deficits -- United States, US$805 billion, Spain, US$86 billion, United Kingdom, US$58 billion according to 2004 data -- they lag behind Australia on the basis of percentage of GDP.

 

At a Melbourne Institute Luncheon yesterday The Australian reports differing viewpoints regarding the current account deficit and foreign debt were aired by the head of the Treasury, Dr Ken Henry and the Melbourne Institute's director, Professor John Freebairn.

 

Dr. Henry absolved the government of responsibility telling his audience that meaningful governmental economic policy changes to turn around Australia's deficits were an impossibility.

 

According to The Australian, he claimed that throughout the 1980s, the federal government had sought to use fiscal (budget), monetary (interest rates) and wages (through a centralised wage system) policy to bring down the then very high current account deficit. "From the experiences of the late 1980s, we would have to conclude, that if any of the three levers of macroeconomic policy had any impact on the current account at all ... then they didn't have such an effect until the economy had gone into recession.

 

"I think it's safe to say, in a world of more or less floating exchange rates and international capital mobility, we can't be confident that macroeconomic policy can be used to reduce the current account deficit without it also producing a significant slow-down in the economy, and quite possibly a recession.

    "That provides a reasonably compelling reason for policy makers being a bit wary of targeting the current account."

 

In short one may conclude that his advice to the Treasurer, Peter Costello, was to do nothing and on the basis of Mr Costello's budgets he has taken that advice.

 

While Professor Freebairn said Australia's current account deficit was not as bad as it appeared, foreign debt, as a proportion of the nation's share of wealth, had stayed level in recent years, even though foreign debt was now at $500 billion. But he challenged  Dr Henry's assessment saying he was of the opinion that current account deficits can be a reason for governments to run deficit budgets.

 Professor John Freebairn


Why? Because if exports were being held back because of a lack of investment, in capital or people, then governments should be encouraged to look at spending money. "We're denying ourselves productive capacity."

 

But he cautioned that any investment could only be justified if there had been market failure, and a transparent cost-benefit analysis backed the project.

As object lessons he pointed to the Darwin-Alice Springs railway and Victorian regional very fast trains. "Governments have chipped in hundreds of millions of dollars (into these). Pretty clearly they were dud investments." And he warned that the Federal Government's huge AusLink funding program could also be a waste of hundreds of millions of dollars if there were no transparent cost-benefit analysis of its projects.

 

Following Professor Freebairn's comments you may be excused for forming the view that the director of the Melbourne Institute thinks neither Dr Henry nor the government he advises knows what it's doing when it comes to fiscal policy. Not that the Victorian Government was let off.