Is it harmful to a country's economy if it runs a current account deficit?
The current account balance is determined by the sum of following four components: the exports of goods and services, the imports of goods and services, the net income abroad and the net current transfers.
When a country has a current account deficit it is essential to analyse the reasons behind the deficit. Only when this is done would it be possible to say if the current account deficit is harmful or not.
The current account can show a deficit when the country is building up on its capacity to produce goods and services in the future. To do this, if it does not have enough resources, it would have to import them from other nations. The imports can be in the form of external investments, resources for boosting its production capacity and the import of finished goods as the present capacity is not being used to manufacture what it requires. This creates a current account deficit but ensures that in the future the country would have the ability to convert it into a surplus.
A deficit can also be created if large amounts of funds are being invested in sources of income abroad and in the future the returns from these would eliminate the deficit.
If a country has a deficit but none of what has been mentioned above is being accomplished a current account deficit is a matter of concern as it continually increases the debt on the country. This may lead to a situation where the country can no longer afford to pay for imports or pay the interest on the funds that it has borrowed.
It is not necessarily harmful to a country's economy if the country has a current account deficit. This is especially true if the deficit is not too large. For example, the United States has had a current account deficit since the mid-1970s and has not been affected too badly by that.
The reason for this is that most of the current account deficit comes from trade. In other words, a country that imports more than it exports (as the US does) will usually have a current accounts deficit. However, it is not all bad to have a trade deficit. Importing more than you export can simply mean that your economy is much richer than other economies. In such circumstances, a country often imports many products made by low-skilled foreign labor. The country's own workers are then freed up to do things that require more skill and are more lucrative.
Because of this, economists say that it is not necessarily bad to have a current accounts deficit.