As I noted earlier, Canada is the only G7 country that is running current account and government balance surpluses these days. The story behind the government surplus is of course well-known, and will probably be the subject of another post. But what about that current account surplus?

A cursory look at the data suggests a plausible answer: The current account balance is 2% of GDP, and energy exports have increased by 2% of GDP over the past few years. Conclusion: oil and natural gas exports explain the current account surplus. It turns out that this answer is less than half right – but that the energy sector deserves the extra attention anyway.

First, a bit of review. The current account has two main components: the trade balance (exports minus imports) and the investment balance (profits received by domestic owners of foreign assets minus profits paid to foreign owners of domestic assets).  Since the flows associated with repatriated profits are dwarfed by trade flows, the terms ‘current account balance’ and ‘trade balance’ are sometimes used interchangeably. But the distinction is important for Canada.

Apart from a few recession-related episodes, Canada has had a trade surplus going back to the early 1960s, fluctuating around an average of 2-3% of GDP. Add to that another 2-3% in returns from investments outside Canada. But when you subtract the 5-7% of GDP that has been typically paid to foreign owners of Canadian assets, you get a current account that was in deficit pretty much continually until 1999. (Incidentally, you also get a better understanding of why Canadians are so touchy about foreign ownership.)

The turning point came in 1993, in the aftermath of the 1991-2 recession. In 1993, the current account had a deficit of 3.9% of GDP; in 2004, it had a 2.2% surplus. Where did that 6.1% turnaround come from? The first place to look is of course the trade balance. Total exports went from 30.0% to 38.1% of GDP, while imports rose more slowly, from 30.1% to 33.9%. The resulting swing of 4.3% in the trade balance explains a little over 2/3 of the improvement of the current account.

The remaining 1.8% comes from the investment balance. Most of this (1.1%) came in the form of an increase in income on foreign investment (from 1.9% to 3.0% of GDP), and the remaining 0.7% resulted from reductions in payments to foreign investors (from 5.6% of GDP to 4.9%).

SInce oil and gas accounted for about one-third of export growth between 1993 and 2004, a rough decomposition for the sources of the 6.1% movement in the current account would look something like this:

• 0.7%: Reduced payments to foreign investors
• 1.1%: Increased income of investment outside Canada
• 1.4%: Increased exports of oil and natural gas
• 2.9%: Increases in other exports

That said, it would be a mistake to understate the importance of energy exports. Even though they account for less than one-quarter of the improvement in the current account, their volatility deserves particular attention. If energy prices fall back to mid-1990s levels, the current account would probably go back into deficit.