Ghana’s trade deficit has been identified as a major cause of our underdevelopment. The claim that Ghana imports even toothpicks is usually made in order for us to bow our heads in shame and berate ourselves for our inability to fulfill the industrialization plans of Dr Kwame Nkrumah.
However I feel that the discussions about trade in the public domain have been inadequate. It is mostly made up of patriotic calls for us to buy Made in Ghana goods or the imposition of tariffs on imports that are similar to goods made here. You also hear talk about the need to grow more cocoa or to promote non-traditional exports.
All of these are worthy discussions to have, but often they do not explain the full details of international trade and may lead to a misunderstanding of the situation. In this post I am going to give a simple explanation of a current account, a capital account, balance of payments and what they all mean in the Ghanaian context.
The balance of payments is a summary of the transactions between a country and the rest of the world. Components of the balance of payments include the current account and the capital account. Let’s look at what makes up both accounts.
- The difference between the value of a country’s exports and imports (trade balance). Take note that this trade balance usually makes up most of the current account but it is not the only component.
- Net international transfer payments i.e. the difference between all free fund transfers (such as remittances) going out of and coming into a country.
- Net international factor income i.e. the difference between what a country’s citizens earn abroad and what people from other countries earn in that country.
- The difference between all the investments in assets (such as real estate, bonds, stocks) made by foreigners in a country and the investments made by the country’s citizens in other countries.
- Loans from foreign governments.
The interesting part is that the total of the balance of payments on the current account plus the total of the balance of payments on the capital account must be equal to zero. In other words, a current account deficit must equal a capital account surplus and a current account surplus must equal a capital account deficit. This is an accounting identity, that means, it must be equal and any difference means there has been an error in calculation.
In 2015, Ghana’s current account deficit was US$2.8bn and the capital account surplus was US$2.7bn. As you can see, they are almost the same. But it is very difficult to track all the transactions coming in and going out of the country, hence the small difference. The simplistic interpretation of these figures is that Ghana got goods and services worth $2.8bn from foreigners and paid for it by selling assets (real estate, bonds, stocks) worth the same figure (ignore the error already referred to) to foreigners. If you want to consume more than you produce you have to borrow to finance it. This is essentially what is happening.
China’s huge current account surplus has caused it to make huge investments in other places including the USA and Africa. If it had not done this it could not have kept the value of the yuan low, and the rising yuan would have reduced the demand for Chinese exports. If you run a current account surplus, you must necessarily run a capital account deficit. You cannot have both.
Does this mean that we do not have to worry about the current account deficit because an equal amount of funds must necessarily flow into the country? Not at all. The assets that the foreigners are buying will generate returns, which they will take away. However the inflow of the capital is an investment into the country and depending on how we use it, it can be very helpful.
For example, the capital inflows keep borrowing costs lower than they would have been if we run a current account surplus. That’s because these foreign inflows compete with local money for assets and the prices of those assets are therefore lower than they would be if only local money was in play. We can use these inflows (at least the portion we control) to invest in infrastructure, education, health and agriculture or we can waste it. That choice is ours. Also notice that the assets these foreign inflows are used to buy don’t actually leave the country and the owners stand the risk that Ghana may decide to unilaterally claim these assets at any time.
On the other hand, a trade deficit (which is the major component of a current account deficit) takes away from a country’s GDP. The GDP is calculated as Consumer Spending (C) plus Business Investment (I) plus Government Spending (G) plus Exports (E) minus Imports (I). Imports therefore reduce the size of a country’s GDP. Jobs that Ghanaians could also have been doing are lost because we import some things instead of producing them. Then there is the issue of countries subsidizing their producers to make their exports cheaper. This is a very sore point which strengthens the argument for protectionism and deserves a post of its own. Most conspicuously, a trade deficit weakens the value of a country’s currency. This is because we have to exchange our currency for the currency of the people who we purchase from.
But let’s not forget that we enjoy a whole range of goods and services through trade. That is a contributor to a higher standard of living. We are not worse off because we use laptops from the USA, shoes from Italy, exercise books from China or toothpicks from India. There is no need to be ashamed of that. Also a trade deficit could mean that we are not polluting our environment producing stuff for ourselves or other countries. Take a look at the smog pictures in China to get my point.
In summary, a current account deficit is not necessarily a good thing or a bad thing. Like other often misunderstood concepts like public debt or public sector deficits, it depends on several factors. It would do everyone a lot of good if discussions on our trade deficits go further than the self-criticism over the failure to industrialize and the chanting of patriotic slogans.
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Understanding balance of payments crises in a fiat currency system by Frances Coppola
A Current Account Surplus is Obviously a Good Thing. Isn’t it? by Ari Andricopoulos