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Current Account Deficit, Global Imbalance, and Policy
Implications
Late developing countries in Southeast Asia, including
Cambodia, Laos and Vietnam have been trapped in persistent
current account deficits for Quiet a few years. The largest
deficit for Vietnam appeared in the year of 2008, the year of
a global financial crisis, with its merchandised trade
deficits reaches 20 billion USD. The deficit for Laos ranges
from 10% to 20% of GDP since1980. Cambodia’s current account
deficit moves around 1 to 2 billion USD in the last decade,
with the highest appeared in 2008. This essay claims that the
causes of persistent current account deficit are caused by
structural weakness, competition for foreign direct investment
and import substitution policy. It indicates that the global
imbalance is cause by globalization and different macro
1
economical policies of every country. It analyzes the
circumstances in which devaluation and liberalization would
not be effective to cure the deficit, and suggests that
focusing on long term strategy for improving competitiveness
is more crucial that pursuing rapid policy change.
I. The Causes of Persistent Current Account Deficits in
Southeast Asian Late Developing Countries
Generally speaking, there are four sets of factors causing
current account deficit, namely excess of imports over
exports, excess of investment over savings, low savings rather
than high investment, and intertemporal trade (Ghosh &
Ramakrishnan, 2012). These causes of current account deficit
are generalized from a broad view of global economy, however,
there are similarities and differences for the causes of
2
deficits in late developing countries in Southeast Asia, i.e.
Vietnam, Laos and Cambodia. The causes of current account
deficits in these countries can be summarized as structural
weakness, competition for foreign direct investment and import
substitution policy.
1. Structural Weakness
The Common problem of these countries is that they all have
a structure problem in their export sector, which is
undiversified. These countries either rely on limited numbers
of manufacture sector or concentrated mainly on primary
products. The structural weakness in these countries is the
main cause of current account deficits, either because it is
vulnerable to external shocks or unsustainable in the long
run. Both Cambodia and Vietnam have limited sources for
export, while Laos depends too much on primary products.
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Cambodia’s biggest industry is the garment manufacturing
sector which is also the main source of trade revenue for the
country. The garment industry in Cambodia has been expanding
rapidly and as a result textiles account for more than 70% of
total exports in 2004 (Hatsukano 2010: p. 39), and expands to
over 80% in 2013 (Styllis, 2014). However, the growth in
exports could be dampened by the disruptions to garment
production while domestic demand will ensure a growth in
imports because the rest of the industry cannot meet the need
of its daily consumption.
About 40% of Vietnam’s export still concentrated on crude
oil, agriculture (including rice), and garment and foot-wear
manufactures, although the diversification of exports had been
improved over the last decade (Vietnam Trade Promotion Agency,
2011). The inelasticity of most of the export products of
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Vietnam would make it subject to price volatility. Price
changes in these products would not likely to contribute to
growth of export revenue while cost of imports may rise.
Laos' main exports products are minerals, electricity
(hydroelectricity based on water resources) and wood. The
natural resources based export accounts for three quarters of
its export revenue (World Band Lao PDR Country Office, 2011).
As one of the most resource rich countries in Asia, Laos can
mine and export primary products to gain revenue, which do not
need too much sophisticated technology and capital. However,
in the long term, this pattern of development will present
constraints to growth and undermine its ability to cure
deficits because there is one day that the mineral resources
will be exhausted and water resources depends too much on
climate. Moreover, it also has disputes with its neighboring
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countries for exploiting water resources of Mekong River.
In addition, lack of trading partners is also counted as a
structural weakness causing persistent deficits. This is
especially the case of Laos and Cambodia. As a landlocked
state, Laos has only a handful of trading partners such as
Thailand, China and Vietnam. Cambodia export mainly depends on
the European Union and the United States, with more than 60%
of the export flow to the two markets. Depending on limited
destinations of export deprives Cambodia and Laos of the
flexibility of trade strategy and makes their export
performance vulnerable to the decline of the demand by these
countries.
2. Competition for Foreign Direct Investment
Competition for foreign direct investment (FDI) is an
important cause for current account deficit in Southeast Asian
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Countries. A country with a low level of national saving
against a high level of investment tends to have current
account deficit because of a large capital inflows from
abroad. Since Cambodia, Laos and Vietnam had adopted an open
economic policy in late 1980s, they have experience a rapid
growth in foreign direct investment. For example, Cambodia had
achieved a 12-fold increase in FDI from 2004 to 2007; Laos FDI
in percentage to GDP had increased from 1% to 8% during the
period between 2005 and 2007; the FDI in percentage to GDP has
maintained at the range of 6% to 9% for Vietnam (The Global
Economy, 2014). However, foreign capital inflows and foreign
debt may become complementary. In order to attract foreign
investment, a country might have to develop appropriate
infrastructure (roads, ports, power plants, etc.) which
require external borrowing. If the debt is larger than the
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invested, the country will have to earn surplus in current
account to equal the debit amount. Where this is not feasible,
the country would run current account deficits (Lim, 2009).
3. Import Substitution Policy
Persistent current account deficits were also generated by
import substitution policy. A country implementing import
substitution policy is aiming at replacing import with
domestic production in order to achieve industrialization, but
often resulting to the rise of domestic prices and fall of
export competitiveness. If factories in poor developing
countries, e.g. Cambodia, Laos, and Vietnam, are to produce
goods, they need to import machine. After the machines are in
place, factories again need to import intermediate inputs that
could not be produced domestically. Import substitution policy
would lead to the rise of the prices of machines and
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intermediate inputs as their demand go up. The more these
countries want to produce, the larger import they need. In
this situation, the cost of producing goods in these countries
will rise with the growth of the economy. Consequently,
countries with import substitution would gradually find out
that they are unable to export enough to buy the imports they
need (Oatley, 2008: p. 141).
II. Global Imbalance
In recent years, IMF has consistently released reports
pointing out that we are experiencing the global imbalances.
It considers that the global imbalances are the fault of China
and other emerging economies. However, it is irrational to
blame every single country for the global imbalances. To some
extent, it is not the fault of China. Originally, we should
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explore the deep reasons of global imbalance and eventually
find who should be blamed.
1. The definition of global imbalances.
Global imbalance is actually global current account
imbalance. The current account is the inflows and outflows of
capital in a country. More precisely, it means exports and
imports. If the inflows and outflows in a country couldn’t be
cancelled by each other to zero value, then there would be a
global imbalance, i.e. trade surplus or trade deficit.
The national saving is equal to the GDP minus the household
and government consumption. If the country’s output is not all
consumed by the household and government, then what is saved
would be used for the investment and exports. So, basically,
saving minus investment should be equal to exports minus
imports. If there is a current account surplus, it also means
10
that the saving is too high and the investment is too low, and
vice versa.
So when we are analysing the global imbalance, we should
focus on these four elements: saving, investment, exports and
imports.
2. The performance of global imbalance.
The dominant expression is that the United States and other
developed countries have run long term current account
deficits. On the other hand, the corresponding surpluses has
happened in the rest countries of the world, especially Asia,
Mid-East countries and Russia (Charles&Donghyun 2009).
There are some significant features about the performance
of global imbalance. Firstly, before the 1997 crisis, the
United States had run a small current account deficit. After
1997 and 1998, this current account deficits began to enlarge
11
with their imports grew rapidly. In the year of 2006, the
United States current account deficit peaked at the point of
1.5% of the world GDP, which is by far the largest current
account deficit percentage in the world (Gang, n.d.).
Secondly, the total increase of the U.S. current account
deficits is to some extent equal to the increase of the
current account surpluses in other countries, such as
developing Asia, Mid-East countries and Russia. It is
obviously that the global imbalances occurred mainly in small
countries. Thirdly, the whole region of developing Asia was in
the current account deficits before 1997 and only began to
indicate the current account surpluses after the 1997 crisis,
which illustrates that the current account surpluses were a
brand new phenomenon rather than a serial one.
3. The reason of global imbalance.
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Basically, the global imbalance is the results of
globalisation which brings the imbalance of economical
structures. Besides, it is also because every nation
implements different macro economical policies.
Essentially, it is the monetary globalisation, i.e, the
global opening market allowing the capital flows from
countries to countries.
Besides, some small and developing countries have huge
amount of banking saving, in particular the developing Asia.
This leads to a phenomenon called the Saving Glut.
In regard to the Saving Glut, there could be some reasons
to explain it. First, after the 1997 crisis, Asian countries
realised that they could not trust the international financial
institutions led by the United States any more. They began to
increase their exchange reserves in case of the future’s
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financial crisis. Second, the low level of social security of
some Asian countries is also a crucial element. The majority
of people in these countries prefer to save their money in
banks to secure their normal life. Third, in some developed
countries such as Germany and Japan, the ageing issue is
becoming more significant. In order to enjoy a good later
life, people also save a huge amount of money in banks leading
to the saving glut as well. The reasons above, I reckon, could
be summarised as the high saving rates low investment rates in
these countries.
4. China is not the main reason for the global imbalance.
When talking about the United States current account
deficits, the Americans always blame China. There is indeed a
trade deficit in United States with China. Because of the
merchandise trade deficits in United States with China, U.S.
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often has a current account deficit. The Americans consider
that China has an unfair trade with the United States, because
China exports much more than imports. There are some counter –
arguments for this phenomenon.
First, the United States trade deficits above are in term
of merchandise trade. The current account includes both
visibles and invisibles. Although the United States have a
high level trade deficit, it is only in term of those
visibles. If we take the invisibles into account, we could
conclude that the United States trade has been surplus. The
United States exported a great amount of financial and
insurance services to other countries. If we take both the
goods trade and service trade into consideration at the same
time, the United States is still in a position of surplus in
the global trade.
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There has been a huge trade surplus of private services in
United States with China. Since 2004 the United States have
expanded the surpluses of private services trade with China.
The United States private service exports to China have surged
from 5.7 billion dollars in 2003 to 20.1 billion dollars in
2010. However, the United States imports of private services
from China have peaked at 10.6 billion dollars in the year of
2007, and then fell to 8.3 billion dollars in 2009. Although
the tendency was still rising, the United States imports
relatively little private services from China. Besides, the
United States private services surpluses with China has surged
from 1.9 billion dollars in 2003 to 10.4 billion dollars in
2010 (David&Fenwick, n.d.). Second, China do not only export
so much, it also import a lot. The contributions to China’s
rapid GDP growth include both exports and imports. In past
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years, China’s trade was almost balanced. In 2004, for
instant, China’s surpluses took account for only 2 per cent of
GDP. The Americans only see the trade imbalance between U.S.
and China, they do not realise that China actually have a
trade deficits with the neighbouring Asian countries. China
imported a lot from the developing Asia. Asia is emerging a
new phenomenon called “Made in Asia”. It is actually a
production - supply chain, with China as a centre of assembly
and manufacturing. Many productions labeled “Made in China”
are actually “Made in Asia”. Asian countries export semi -
finished product to China. These products then are reprocessed
and manufactured by the cheap labor forces in China. In fact,
China could generate only 10 - 20 per cent of the total
benefits (Gang, n.d.).
Third, the global imbalance is often accounted the outcome
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of Chinese over—saving and American overspending. There is the
case that the United States spends a lot.
However, there would be no case for the Chinese over—
saving. National saving includes household, business and
government saving. First of all, in terms of household saving,
the saving rate of Chinese people is actually very low. Both
rural and urban Chinese people could not save much money at
all (Mike 2013).
As for business and government savings, they saved indeed a
lot. However, they also invested a lot as well. China is now
encouraging consumption, so there emerges a great amount of
constructions. Recently, China’s leaders visit other countries
frequently. In every visit, Chinese government will purchase a
huge amount of foreign products and technology. The entire
country invests 40 per cent of its GDP in industrial
18
capacities, housing and public infrastructure (Gang, n.d.).
Besides, in terms of global balance of payments, it refers
to the foreign assets savings in a country which is precisely
the net national savings. Nevertheless, China did not have a
salient net national savings. It only accounted for 30 billion
dollars per annum. However, the United States current account
deficits are over 600 billion dollars per annum (Gang, n.d.).
It is irrational to blame China as the main culprit for global
imbalances.
5. The United States is the reason of global imbalance.
In terms of American’s overspending, it is very important
to focus on four significant periods: 1951- 1980, 1981- 1992,
1993 – 2000 and 2001 – 2004. In these four periods, the
proportion of household, business and government saving
indicated a salient change. American’s household saving was
19
becoming much less. Since the United States government carried
out a deficit fiscal policy and loose monetary policy, the
government saving is becoming extremely less.
In the 1990s, because of the wealth effect led by stock
price, the majority of American people invested a lot in the
stock market. In 2001, the stock market bubbles collapsed.
Then the real estate market emerged, which developed rapidly.
The Americans then further expanded their saving to pursue the
benefits generated by real estate. Furthermore, owing to the
rise of labour productivity and the financial innovation, the
average saving rate of Americans is relatively low.
Since Americans over consumed and the spending is much more
than saving, it stimulates the huge amounts of imports. The
oil import is one of the examples. The United States need a
great deal of oil import from the mid—east countries. Due to
20
the high price of oil, the mid—east countries has been a trade
surplus with U.S. and obtained a huge windfall.
From 1950s, the United States began to update the industry
system. The manufacturing industry was moved to Asia. Because
of the low cost of labour and the huge amount of raw
materials, most of Asian countries manufacture lots of
products. The excess products which are not consumed in the
country are exported to the states, where the demand for these
products is extremely huge, in particular the United States.
To sum up, because of the globalisation and the different
strategies in every country, there could be a global
imbalance. It is irrational to blame every single country for
this imbalance. However, the United States should take
measures to change the over saving situation. Mid—East
countries should fix the oil price based on the market. The
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developing countries should improve the level of social
security and encourage consumption. Changing the global
imbalance needs all countries’ effort.
III. The Limitation of Devaluation and Liberalization on
Curing Current Account Deficits
According to the IMF a country with a persistent and large
current account deficit should devalue and liberalize.
Theoretically speaking, devaluation of a country’s currency
will achieve a fall in the foreign price of its exports,
making its goods and services more competitive and therefore
there will be an increase of export. Similarly, devaluation
will reduce the demand of import by increasing the prices of
imports. Current account deficit would be improved by both
ways. It also suggests that trade policies do not affect the
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trade balance because they do not alter national saving or
domestic investment. So removal of trade barriers will help
each economy to specialize in areas where it has comparative
advantage and balance of payment will be balanced over time.
However, this essay suggests that they should not be
implemented indiscriminately because there are limitations on
these set of tools.
1. Limitations on Devaluation
Devaluation may has an effect on the improvement of current
account deficit, however, its implementation implies a
political-economic risk that the reputation of the country
will be damaged and future trading relations will be damaged.
Even if the country has decided to devalue its currency
regardless of the risk, there are some technical constraints
on the effect of devaluation. Elasticity of demand, inflation
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and external demand are three factors that should be
considered if devaluation is implemented to improve current
account deficit.
If a country export mainly inelastic goods, devaluation
will not improve current account deficits. Inelastic goods are
products where demand changes slightly with the changes in
price. These kind of goods are those consumers need in their
daily life, e.g. agricultural products and clothing. The
exports of industrialized countries are mostly manufactured
products with high elasticity. Generally speaking, devaluation
would therefore have a positive effect on the balance of
current account. However, the exports of developing countries,
especially late developing countries, are relatively inelastic
products. Vietnam mainly exports crude oil and agricultural
products; Laos’ minerals are the lion’s share of its export
24
products; and Cambodia mainly rely on garment industry to earn
trade revenue. A large portion of their exports are inelastic
good. Therefore, devaluation of their currencies would not
improve their current account deficits.
Domestic inflation can dampen the effect of devaluation on
the improvement of current account deficit if the inflation
rate is larger than the exchange rate devalued. It will
stipulate import spending because the increase of import price
caused by devaluation cannot offset the decrease of real value
of imported goods caused by inflation. Even if a country wants
to pursuit a large scale devaluation to offset the effect of
inflation, it may not work because devaluation per se would
probable cause inflation. In the first place, devaluation will
make import more expensive. In a country where a large part of
CPI goods are imported and the demand is inelastic, the
25
increase in the prices of imported goods will be passed on to
consumers. This is especially true in the three late
developing countries since a large part of their CPI products
are imported from industrialized countries. In addition, if
devaluation make export easier, domestics firm would have less
incentive to control their cost. At the end of the day,
inflation will be triggered by high cost in production.
External Market is also a determinant for devaluation to
take effect. Other things being equal, an external market with
a high demand will increase import from a devaluing country,
while an external market with a lower demand will not
necessarily increase its import. In the global recession in
2008 for example, Vietnam did not improve its current account
deficit by devaluation of Vietnamese Dong, because its export
partners could not buy its products even though they were
26
cheaper than before. External market factor has a special
implication for Cambodia and Laos, because they have only a
few export partners. Thus the reliance on their partners is
more profound.
2. Limitations on Liberalization
According to comparative advantage theory, countries will
specialize in areas where they have comparative advantage in a
free trade environment. However, due to the difference in the
stages of development, many developing countries will suffer
from free trade if a rapid liberalization is implemented.
Liberalization will enlarge the gap between developed and
developing countries. Many developing countries, including the
three late developing countries shown above, have comparative
advantage in producing primary products because of the lack of
technology and skilled workers. Depending on primary products
27
for export will make the current account vulnerable because of
the volatility of their prices and inelasticity of their
supply and demand. Moreover, under a free trade environment,
they have incentives to concentrate their efforts on the
primary sector and do not have incentives to promoted
education and technological advancement. Thus the economic
status of developing countries, as well as their ability to
correct the existing current account deficits, would not
improve.
Liberalization will hinder the diversification of economies
in developing countries. To diversify the economy, a country
would have to establish new industries. However, the newly
established industry is not likely to win in the competition
with its foreign counterparts in developed countries. In
addition, most economies have experienced a period of
28
protectionism at the beginning. So it is argued that
developing countries can place some degree of protection
measures in the first place, and remove the measure after it
has achieved an economy of scale (Miller, 2008: p. 117).
IV. Policy Implication for Late Developing Countries
The persistent current account deficits in late developing
countries are caused by the structure weakness of their
economies, as well as some policies employed during the
development of economy. This essay holds that the fundamental
cause of the problem is the lack of competitiveness in their
economies, thus short term policies, especially devaluation
should not be taken as panacea for curing current account
deficit. Long term strategies, including the increase of
government spending on education, are favorable measures to
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diversify the economy of developing countries and improve
their competitiveness. Along the way to pursue the
diversification of economy, some degree of protectionism
should be implemented until they achieve an economy of scale.
At the same time, some pragmatic measures such as
strengthening relations with their limited number of export
partners are also helpful. Besides, changing the global
imbalance needs all countries’ effort. The United States
should take measures to change the over saving situation. Mid—
East countries should fix the oil price based on the market.
The developing countries should improve the level of social
security and encourage consumption.
30
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