Policy Article

The Importance of Investment Income and Transfers in the Current Account: A New Look on Imbalances

Kiel Policy Briefs, 48

Imbalances in the current account and their changes over time are usually portrayed by imbalances in the trade balance. For a long time, this was adequate given that the two other components of the current account, net income from investment abroad and transfers were unimportant relative to trade of goods and services. However, this has changed in the course of increasing internationalization of production and the rising importance of remittances following rising flows of migrants. Both components have become more important. The author Rolf J. Langhammer shows how much the three components of the current account vary over countries. It can be expected that ageing economies like Japan will become increasingly dependent on investment inflows to balance a deteriorating trade account and that economies with a high supply of migrants like India will balance trade deficits basically by inflows of remittances from their guest workers abroad. He also shows that concerns about the sustainability of current account deficits of countries like Spain and Italy are well-based, because these countries do not only suffer from trade balance deterioration but also from rising outflows of investment income.