FRBSF Economic Letter
2007-08; March 30, 2007
The U.S. Productivity Acceleration and the Current Account Deficit
 On March 14, the Bureau of Economic Analysis reported
that the U.S. current account deficit for 2006 increased
from the previous year to over 6% of GDP. This deficit
reflects the difference between U.S. income and expenditures,
and the additional indebtedness that the country needs
to take on to cover this difference. As Figure 1 illustrates,
the current account consists mainly of the trade balance,
but it also includes the payments on returns from foreign
U.S.-owned assets, net of the payments made to foreigners
for returns on assets they own in the United States.
Though many economists and policymakers agree that a
persistently high current account deficit, or worse, a
growing one,
could prove worrisome, there is much debate about what
the likely path back toward balance will look like. Some
argue that foreign investors' willingness to finance
the deficit may shift abruptly, which would disrupt the
U.S.
economy (Valderrama 2006). Others think that the current
situation is simply a result of market forces and that
the return to balance will be gradual and orderly.
To disentangle the two points of view, it is important
to consider the factors that may explain the current
elevated level of the current account deficit. These include:
the "saving
glut," which characterizes the high saving rates observed
in developing countries (particularly in Asia) that have
pushed international interest rates lower, depressed U.S.
saving, increased expenditures, and fueled borrowing from
abroad; the depressed values of some foreign currencies
relative to the dollar that have made U.S. imports relatively
cheap, encouraged domestic expenditures, and thereby increased
the trade and current account deficits; and the "twin
deficits" story, wherein the current account deficit
is a result of the growing U.S. budget deficit, which has
reduced public saving and increased borrowing from abroad.
There is, however, another factor to consider, which
so far has received relatively little attention in the
press
and in policy circles--the increase in the rate of growth
in U.S. labor productivity since 1996, when the current
account deficit was only about 1% of GDP. This Letter reviews the current facts about the current account deficit
and
its determinants, and describes the channels through
which it is affected by an increase in trend labor productivity
growth.
Decomposing the U.S. current account
 There is more than one way to look at the current account.
For example, using national account identities, the current
account can be viewed as the difference between U.S.
gross saving (public and private) and investment. Figure
2 shows
how these two factors have evolved since 1980 (each as
a fraction of GDP). Between 1991 and 1995 the investment
rate increased faster than the saving rate, causing rising
current account deficits. However, since 1996 most of
the expansion in the deficit can be accounted for by a
large
drop in the gross saving rate.
Another way to look at the U.S. current account deficit
is to examine its counterpart, that is, the current account
surplus of the rest of the world. During the last decade,
investment in Europe, Japan, and many developing countries
in Asia has been low, leading to a greater current account
surplus in the rest of the world and to a higher current
account deficit in the United States.
U.S. labor productivity acceleration and the current
account deficit
After 15 years of tepid performance, U.S. labor productivity
growth began accelerating in 1996 to nearly twice the
earlier pace, and it has averaged 2.7% per year ever since.
The
source of this acceleration has been associated with
improvements in technology occurring as a result of the
IT (information
technology) revolution as well as improvements in business
processes, inventory management, and retailing. It is
also well known that, among the other G-7 industrial countries
(Canada, Japan, France, Germany, Italy, and the United
Kingdom), the United States is the only one to have experienced
this higher trend rate so far.
Some economists have begun to ask whether this productivity
acceleration could have contributed to the burgeoning
current account deficit. Viewing the current account through
the
lens of the saving-investment decomposition is a particularly
useful way to answer this question. Accelerating productivity
growth could affect the current account because it may
both increase the investment rate and lower the saving
rate.
Consider a two-country world where productivity growth
accelerates in the domestic economy but not in the foreign
one. Since domestic workers are expected to be more productive,
each unit of capital they use will also be more productive.
A productivity acceleration thus raises the investment
rate, because investors, both domestic and foreign, want
to take advantage of the higher rate of return to domestic
capital.
When domestic firms increase their investment, they seek
to borrow to finance it. If the increase in desired borrowing
could be supplied from domestic saving, then the current
account would be unchanged. However, domestic saving
itself is likely to be depressed by the labor productivity
acceleration.
An increase in labor productivity growth not only tends
to raise the return on capital, but it also tends to
raise the wages of the more productive workers, thus increasing
income. Because individuals know that their incomes will
be higher and will grow at a faster rate, they will want
to increase their expenditures immediately. Since income
will be higher tomorrow than it is today, desired expenditures
will increase by more than income, depressing the saving
rate, leaving insufficient domestic funds from which
domestic
firms can borrow. Therefore, to increase their investment,
domestic firms will borrow from abroad, and the current
account will move into deficit. When foreign residents
increase their investment in domestic firms, this, too
will move the current account into deficit.
The impact of the increased income growth on lifetime
income and saving itself can be significant. Suppose that
before
the productivity acceleration, income grew at the same
rate as labor productivity, 1.5%; then, it would take
income approximately 45 years to double. Now suppose that
income
growth increased to 3%; that implies that income would
double in approximately 23 years. Even if income were
not to increase at the same rate as labor productivity,
it
is likely that the productivity acceleration would produce
a sizeable increase in lifetime income and that this
increase can account for a large fraction of the saving
rate decline
and the increase in the current account deficit observed
since 1995.
Ferguson (2005), then Vice Chairman of the Federal Reserve
Board, stated that, based on results obtained using an
economic forecasting model of the Board, it was likely
that the increase in U.S. productivity growth was one
of the two most important factors behind the existing current
account deficit. The other factor he cited was the low
level of investment expenditures in foreign countries.
Why has it taken the current account so long to adjust?
Economic theory would suggest that most of the adjustment
of the current account should happen when the acceleration
in productivity growth occurs, particularly because the
saving rate should respond immediately. So, it is natural
to ask why the adjustment is still ongoing, ten years
later.
There are several possible explanations. One is that
savers, or potential savers, did not immediately recognize
the
increase in the trend growth rate of labor productivity.
Edge, Laubach, and Williams (2004) point out that this
trend is hard to measure since yearly changes in productivity
data are very volatile. Therefore, they argue, individuals
incorporate new information slowly as they learn about
changes in the underlying growth rate. If this argument
holds, then it would suggest a muted initial response
to the acceleration of consumption, saving, and investment
and an extension of it for many years. In turn, this
learning
would mute and extend the current account response.
Another explanation for the slow response of the current
account deficit is that there are many barriers and frictions
in the economy that slow the incorporation of new productive
processes into the economy. It takes time to find the
most productive task for workers, to build new plants,
and to
redesign business processes to take advantage of the
increased productivity, so investment cannot quickly adjust
to take
advantage of the higher rate of return. Thus, economic
output will also take time to fully incorporate the new
processes, dampening the response of the saving rate.
Consequently, if saving and investment adjust only gradually,
so will
the current account.
How may the current account return to balance?
Understanding how the current account deficit reached
its current elevated level is useful in understanding how
it
may return to balance. If productivity growth played
a large role in explaining the current deficit, then future
changes in productivity growth will most likely be important
for the evolution of the current account.
If the productivity acceleration is permanent, then,
as income increases, the saving rate will also improve.
This
is because individuals will already have taken advantage
of the increase in their lifetime income by borrowing
early on and will eventually start to pay back their loans.
This
will tend to bring the current account into surplus smoothly.
Similarly, if individuals expect the trend growth rate
of labor productivity to return to its old level slowly,
the saving rate will increase (perhaps somewhat faster
than in the case of a permanent change) and, again, the
current account will smoothly turn to balance.
However, if the trend productivity growth rate unexpectedly
decreases, the adjustment will be much faster, because
individuals will have taken on too much debt. In that
case, consumption may even drop quickly to bring up the
saving
rate and shrink the current account deficit. Such rapid
adjustments in the current account have been associated
with economic slowdowns in many developing and industrialized
countries.
Conclusions
The U.S. current account deficit has grown rapidly, particularly
since 1996. At the same time, the U.S. labor productivity
growth rate has almost doubled. This productivity acceleration
can potentially account for a large fraction of the current
account increase through its impact on saving and investment.
It will be important for economists and policymakers
to study the role of productivity to give them a better
understanding
of the current situation and how the current account
may return to balance.
Diego Valderrama
Economist
References
[URLs accessed March 2007.]
Edge, Rochelle M., Thomas Laubach, and John C.
Williams. 2004. "Learning and Shifts in Long-Run Productivity
Growth." FRBSF Working Paper 2004-04 (March).
Ferguson, Roger W. 2005. "U.S. Current Account Deficit:
Causes and Consequences." Remarks to the Economics
Club of the University of North Carolina at Chapel
Hill, Chapel Hill, North Carolina. April 20, 2005.
Valderrama, Diego. 2006. "What Are the Risks to the
United States of a Current Account Reversal?" FRBSF
Economic Letter 2006-29 (October 27)
Opinions expressed in this newsletter
do not necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco or of the
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