Lecture notes from Northwestern U:
Here is a second example where a negative current account might be a bad thing.
Suppose the government of a particular country oﬀers guarantees to foreign lenders who ﬁnance domestic investment projects. This has the eﬀect of reducing the foreigners’ risk exposure, and so
they are less reluctant to get involved with investment projects. This is likely to boost I ,
and produce a large current account deﬁcit. But, this may not be a good thing. Government
involvement in eﬀect makes taxpayers part of the deal. If the investment goes well, the
foreign lenders and the domestic borrower do well. If it goes bad, the foreign lender still
does well, the domestic borrower’s loss is limited, and the taxpayer picks up the real tab.
Now, this may be ﬁne if the government’s decision to commit the taxpayer has carefully
taken into account the interests of the taxpayer. But, if not, then in eﬀect the interests
of an important party to the transaction have not been taken into account.
Interestingly, the ‘taxpayer’ in this example is not necessarily just a domestic citizen. In practice it may
even involve taxpayers in the world as a whole. To the extent that international ﬁnancial
organizations stand ready to bail out governments that get into trouble, those organizations
6in eﬀect place the taxpayers of the countries they represent at risk. So, a current account
deﬁcit may be bad if it is fueled by investments that are implicitly guaranteed by taxpayers,
when the interests of those taxpayers have not been taken into account.
Are these concerns in practice? Many people say they are. A feature of the Asian
economies that experienced ﬁnancial crises in late 1997, is that their governments oﬀered
guarantees to foreign lenders. It is generally thought that when those guarantees were extended, the interests of the taxpayers were not fully taken into account. Asian governments
are often accused of engaging in ‘crony capitalism’, where members of the government extended guarantees on projects run by family members or prospective business associates,
without worrying about the interests of the taxpayers they represent.