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New Zealand’s unrelenting current account deficits, its trade performance and high external debt level remain central to ongoing economic policy debates. However, what has been overlooked in the discussion of New Zealand’s economic relations with its trading partners is the positive contribution that foreign capital inflow makes to the nation’s economic development. International trade in saving between New Zealand and the rest of the world has potentially contributed more to its economic growth than international trade in goods and services.
This paper views New Zealand’s current account deficits as symptomatic of an economic growth process in which the rate of the economy’s capital accumulation exceeds its domestic saving rate. Expansion of the domestic capital stock attributable to foreign saving leads to higher national output and national income per head, net of the servicing cost of foreign capital.
We first present a framework for understanding how foreign capital inflow generates national income gains, and then provide evidence of the magnitude of these gains. New Zealand’s national income is found to have grown significantly due to the contribution of foreign capital inflow over recent decades. We then construct a stylised national balance sheet that includes New Zealand’s assets and foreign liabilities. This places the stock of foreign debt in proper context and reveals that after accounting for net foreign investment, national wealth gains have also been significant.
A necessary condition for long run sustainability of a country’s external position is that the foreign savings are invested productively and generate a return at least equal to the cost of acquiring those funds. However, fulfilling this necessary condition is not automatically sufficient to ensure sustainability. We recognise there can be legitimate concerns about an “excessive” level of foreign debt. The paper does not address the broader concern over the sustainability of the current account deficit or the management of risk of precipitous adjustment. Its focus is on the necessary condition that New Zealand must have a net increase in its real income after meeting the costs of borrowing for the foreign capital inflows to be justified. Whether those inflows are at a sustainable level in the long run is a separate matter, and a critical concern for economic policy.
The authors are grateful for comments and helpful suggestions on an earlier draft by Bob Buckle, Muge Adelet, David Fielding, Andrew Coleman and participants in a Treasury seminar.
The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author(s).
Working papers are published to contribute to the body of economic knowledge, and to inform and stimulate wider public debate. As such, this Working Paper does not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government, and should not be reported as such. Furthermore, the paper does not constitute government policy or policy advice to government, and should not be considered as such.
The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in this Working Paper.
Table of Contents
- 1 Introduction
- 2 Saving, Investment and the External Imbalance
- 3 Foreign capital and national income: theoretical foundations
- 4 Estimating income gains: A growth accounting approach
- 5 Foreign debt, national assets and national wealth
- 6 Concluding comments