roubini, lecture 1

...On average, about 60-70 percent of gross output goes to labor, the rest to capital (including corporate profits, rents, net interest and proprietor's income). The point is that GDP measures both production of goods and services and income to workers and owners: by the logic of double entry bookkeeping, the two are inseparable.
(...) It is very important to understand that if a country runs a current account deficit (CA<0),> (...)The recent experience in Asia shows that large current account deficits led to an accumulation of foreign debt that eventualy became unsustainable and led to a currency crisis. This leads to the following question: is it a bad idea to run a current account deficit? The answer is actually quite complex because running a current account deficit may me a good or bad, sustainable or not sustainable, depending on the cause of the current account deficit. (...)A current account deficit may be caused by: (1) An increase in national investment OR 2. A fall in national savings; specifically: 2a. A fall in private savings and/or 2b. An increase in budget deficits (a fall in public savings)

(...) FIRST, So, in general a persistent current account deficit and foreign debt accumulation generated by a boom in investment should not be considered with too much concern and it might actually increase the rate of growth of an economy where domestic savings are not sufficient to finance all profitable investment projects. There are however several caveats to be made to this argument.

1. Borrowing form the rest of the world to finance investment that produces new goods is especially good if the new investments are in the traded sector of the economy (i.e. the sectors of the economy that produce goods that can be sold in foreign markets). In fact, at some point in time the foreign debt has to be repaid back and, for a country, the only way to pay back foreign debt it to run at some point trade and current account surpluses. If the new investments are instead in the non-traded sector of the economy (such as commercial and residential investment), they create goods (housing services) that cannot be sold abroad. So, in this case the long run ability of the country to repay its debts through trade surpluses may be limited and this can create a problem. For example, many Asian countries in the 1990s were running large and increasing current account deficits that were financing new and excessive investments in the non-traded real estate sector (residential and commercial building). Such investments went bust in 1996-97 because of a glut of real estate and the collapse of the real estate asset price bubble that lead to a rapid fall in the price of land and real estate values...
2. The second caveat is relevant both for traded sector firms and non-traded sector firms. Every firm knows that it is optimal to borrow funds to finance investments only as long as the return on these investments are at least as high as the cost of the borrowed funds; otherwise, a firm that borrowed too much and invested in bad projects will eventually experience losses, a financial crisis and potentially go bankrupt if most investments turn out to be bad. The story of the Asian crisis is in part one of a current account deficit and foreign debt accumulation caused by a boom of investment that turned out to be excessive. In Asia, there were too many investments (both in traded and non-traded sectors) that turned out to be not very profitable.

(...) SECOND, A fall in national savings caused by lower public savings (higher budget deficit) is potentially more dangerous than a fall in private savings. The reason for this is that a fall in private savings is more likely to be a transitory phenomenon while structural public sector deficits are often hard to get rid of. The private savings rate will recover when future income increases occur. On the other hand, large and persistent structural budget deficits may result in an unsustainable build-up of foreign debt. For example, in the late 1970s many developing countries were running very large budget deficits to finance large and growing government spending; to finance these deficits, the governments borrowed heavily in the world capital markets (either directly from international banks or indirectly by issuing bonds purchased by foreign investors). In this case, the large and growing budget deficits led to large current account deficits and the accumulation of a very large stock of foreign debt. By 1982, the size of this public foreign debt was so large (often close to or above 100% of GDP) that many governments began having difficulties in repaying interest and/or principal on their foreign liabilities; therefore, a severe Debt Crisis emerged in the 1980s with many countries risking default on their foreign debt and having to negotiate a rescheduling of their foreign liabilities. So the lesson is that running current account deficits and borrowing from abroad to finance budget deficits is a dangerous game that will eventually lead to a debt crisis. Unlike firms that borrow to finance investment projects that will be eventually self-financing (as they generate trade surpluses that will be used to repay the original foreign debt), fiscal deficits are rarely self-financing, especially if such deficits are chronic, the result of excessive spending and structural lack of tax revenues.

(...) Needless to say, many episodes of unsustainable current account deficits do not fit the patterns described. For example, the deterioration of the current account balance in the years preceding the 1994 Mexican peso crisis was largely due to a fall in private savings. In the Mexican episode, the boom in private consumption and the sharp fall in private savings rates was fueled by the combined forces of overly optimistic expectations about future growth and permanent income increase together with the loosening of liquidity constraints on consumption deriving from the liberalization of domestic capital markets. Under such conditions, the fall in private savings rates led to a rapid and eventually unsustainable current account deterioration... This suggests that current account deficits that are driven by structurally low and falling private sector saving rates may be a matter of concern even if they are the results of the "optimal" consumption and savings decisions of private agents. This is especially the case when the private consumption boom, like in Asia in the 1990s, is in part the consequence of an excessively rapid liberalization of domestic financial markets that gives access to credit to households that were previously borrowing-constrained.
(...) Whether a large current account deficit is sustainable or not also depends on a number of other macroeconomic factors: 1. the country's growth rate; 2. the composition of the current account deficit; 3. the degree of openess of the economy (as measured by the ratio of exports to GDP); 4. the size of the current account deficit (relative to GDP).

1. Large current account deficits may be more sustainable if economic growth is higher. High GDP growth tends to lead to higher investment rates as expected profitability increases.


2. The composition of the current account balance which is approximately equal to the sum of the trade balance and the net factor income from abroad will affect the sustainability of any given imbalance. A current account imbalance may be less sustainable if it is derived from a large trade deficit rather than a large negative net factor income from abroad component. In fact, for a given current account deficit, large and persistent trade deficits may indicate structural competitiveness problems while large and negative net foreign factor incomes may be the historical remnant of foreign debt incurred in the past.


3. Since a country's ability to service its external debt in the future depends on its ability to generate foreign currency receipts, the size of its exports as a share of GDP (the country's openness) is another important indicator of sustainability.


4. Most episodes of unsustainable current account imbalances that have led to a crisis have occurred when the current account deficit was large relative to GDP.