Friday, June 12, 2009

Analysis of current account deficit

One of the problems complicating this recession is that the US and UK ran a huge current account deficit, even before the recession. Current account deficit is roughly the difference between export and import, adjusted to foreign aid, interest payment, dividend payment, etc. So as the country starts spending more money to recover out of the recession, it will get into a fiscal deficit.

The empirical relationship between current account deficit and fiscal deficit is negative for countries that have accumulated huge debt, like the US, under Barro-Ricardo equivalence. So as the fiscal spending increases, it is normal to expect the US to reduce their current account deficit (53% deficit). But then, it would come in terms of reduction in import as more products are made in domestic rather than through export, unless of course as Krugman says the US finds a completely different planet to export its goods to.

I tried to search if there were any country in the past with such a huge current account deficit, accumulated debt, and in recession. It was Germany after the first world war. That is due to the war indemnities imposed on Germany.

So I tried to see how Germany does today (see the graph, above. Courtesy: Robbins Lecture 2009 PDF). WOW!!! More than $250 billion dollars of current account surplus, which is surprising when compared with the others in European union. Germany's surplus is more than 9% of their GDP. Only other country with a similar figure is China. In contrast, the US has a current account deficit that is 53% of their GDP. If some tout China to become epicenter of the world economy at the end of the recession, watch out. Even Germany has a chance. And personally I trust the figures reported by the Federal Republic of Germany over those reported by the People Republic of China.

But for all these Germany has to come out of the recession. German government was smart enough to maintain a good surplus balance of payment. But they don't seem to be doing a good job handle the recession.


  1. Guess all boils down to varavu ettana selavu pathana- the credit mantra that drives most modern economies, esp the US.

    It would be interesting to see the impact of this deficit on countries that depend upon US, UK and the like for their economies. For instance you bring about a good point about US on its way to use more domestic products than imported. Going by what Obama administration's actions are indicating - Protectionism : offered in a different flavor (a truly american way of presenting things) it might also spread its wings to services like IT and ITes. This will impact countries like India & China (for both products & services).However, these countries have a growing local market that can feed their economy - something that Germany does not enjoy. So it would be interesting watch as who emerges successfuly from this wreck - for a change, it would be good to have 3 powers emerging: China, Germany and India - the ecomomical globe will finally have more than two poles!

  2. The sixth pay commission has become another stimulus package which increased the purchase power of govt. staff. Because of this there is a possibility of manufacturing sector improving its activities. The employment in this area will also increase. The ensuing budget will pour a lot of money on infracstructure. Foreign investments will become easier in infrastructure area by making suitable amendments in the rules, which would make govt. approval as not required. IT companies have started showing improvement e.g. satyam has started earning profits; wipro has got orders from ESI corporation for system development. Hope by mid 2010 the recession would end.

  3. @My Thought Cloud
    You have made an excellent point about the lack of local market in Germany. Actually the problem due to the lack of local marked is worse than imagined. Check this out.