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Describe the impact of globalisation on Chinas economic growth and development.

Explain how Chinas government development strategies have responded to the process of globalisation.

Globalisation refers to the process of increased integration between different countries and economies and the
increased impact of international influences on all aspects of life and economic activity. The past 15 years have
seen an increase in the four major indicators of globalisation: international trade flows, international financial
flows, international investment flows and transfers of technology, and the movement of labour. In an effort to
capture the benefits of globalisation without relinquishing Communist control, Mao Tse Tungs successor, Deng
Xiao Ping, implemented a range of radical economic reforms between 1978 and his death in 1997, which began
with Chinas official move from an economy with a domestic focus to one with a trade oriented focus. In turn,
China has experienced phenomenal economic growth (percentage increase in real GDP over time) and an
improvement in its economic development.

Recent decades have seen mixed fortunes for different regions as a result of globalisation for whilst some have
emerged as winners, such as China and Australia, others have been pushed to the margins, such as Zimbabwe. An
international convergence of economic performance is shown through Chinas catch up against the GDP of the
developing world. That is, Chinas economy, measured on a Purchasing Power Parity (PPP) basis, was close to $9
trillion in 2008, ranking it the 2
largest economy after the US.

From this rapid economic growth stem major improvements in all aspects of economic development. The Human
Development Index (HDI) is a measure of economic development devised by the United Nations Development
Program that takes into account: life expectancy at birth, levels of educational attainment and material living
standards. Between 1975 and 2007, Chinas HDI rose from 0.527 to 0.777 while its HDI rank (out of 177 countries)
rose from 94 to 81. Also, over the last 25 years, poverty has been reduced by 400m people in China, all of whom
were previously living on US$1 per day, signifying an increase in the Chinese standard of living.

However, globalisation has also accelerated resource use and environmental degradation, a fact recognised in
both the Genuine Progress Indicator (GPI) and the Happy Planet Index (HPI). In 2007, a China-commissioned
environmental study by the Organisation for Economic Co-operation and Development (OECD) found that
pollution was reducing Chinas annual GDP by 7% and causing health problems. Similarly, carbon dioxide emissions
were 6.2 billion tonnes in 2006, 8% higher than in the USA, owing mainly to electricity and cement production.

On the other hand, globalisation ensured the Chinese governments response to such environmental challenges.
Its involvement in the World Trade Organisation (WTO) and in hosting the 2008 Olympics prompted the setting of
targets for future pollution levels. These rely on shifting from coal-fired power generation to nuclear and
hydroelectric power generation, especially the Three Gorges Dam Project. Overall, expenditure on environmental
protection has risen from 0.8% to 1.3% of GDP.

Facilitated by Chinas newfound stability and transparency, its accession to the WTO at the Doha Conference in
2001 produced 3 major outcomes relating to future growth and development: the diversification of its export base
to incorporate more value added Elaborately Transformed Manufactures (ETMs) and service exports, greater
foreign investment into the tertiary sector of the Chinese domestic economy and a higher prominence of
Information and Communications Technology (ICT). Reduced protection, such as a fall in the average Chinese tariff
rate from 47% to 10% between 1991 and 2004, attracted foreign competition, resulting in higher efficiency yet also
structural unemployment.

Transnational Corporations (TNCs), growing in line with global trade flows and foreign investment, have influenced
the direction and composition of Chinas trade flows. Although once reliant primarily on agricultural production,
China now accounts for over 5% of world merchandise trade (up from 2% in 1992). From the late 1980s, TNCs were
drawn to Chinas large unskilled labour force and factory wages averaging less than 5% of those in the USA. Their
arrival prompted further restructuring of the domestic economy, which in turn facilitated rapid economic growth
in a highly populous nation. With this rise of local wealth and of industry heavily dependent upon resource and
energy imports, China now accounts for 10% of world resource consumption. Using its managed peg system to
ensure price competitiveness of its exports, China is currently the 3
largest goods trading country in the world,
responsible for 17% of global imports and 7% of global exports. Neighbouring Asian countries, such as Japan, Hong
Kong and Korea, and ASEAN, together comprise 53% of Chinas exports and 65% of its imports.

FDI drives economic growth as it leads to improvements in infrastructure and business efficiency (a product of new
marketing skills and expertise). The four special economic zones established in southern and some eastern coastal
provinces of China in 1980, as part of the governments open door policy, attracted FDI rather than portfolio
investment through incentives such as low tax rates, exemption from import duties, cheap labour and power, and
less stringent government regulations. In 2008, FDI into China totalled $92.4b (making it the top recipient of FDI in
the world).

While globalisation contributes to Chinas economic growth and development, some aspects of Chinas dualistic
economy, such as the Household Responsibility System, entrench, rather than alleviate, geographical disparities in
income and wealth. Under this system established in 1978, the Special Economic Zones provide those living in
coastal regions with copious employment and income opportunities whilst those living in Chinas north-western
regions suffer from low occupational mobility and poor living standards. For example, between 1978 and 1998, the
performance of coastal areas, such as Shanghai and Shenzen, grew an astonishing 13% pa, which was 5 times the
level faced by Chinas north-western regions. Political instability stemming from widespread peasant revolts forced
the Chinese government to propose a plan to double, by 2020, the disposable income of the 750m ppl in the
Chinese countryside through land reforms.

To ensure the reinjection of Chinas large pool of domestic savings (the Chinese Average Propensity to Save is
approximately 0.5) into the circular flow of income, Chinas relatively underdeveloped banking system required
many reforms. For example, following the establishment of the Peoples Bank of China in 1984, four big specialist
banks were used to direct savings into government chosen sectors and industries, although now they are more
market oriented and efficient due to the introduction of foreign banks. On the other hand, stock exchanges in
Shanghai and Shenzen established in 1995 encouraged the growth of new local businesses and the Chinese

Still, the Chinese government faces major challenges relating to its fragile domestic banking and finance system.
For instance, since the majority of investors in China (apart from institutional investors) consist of individuals eager
to make capital gains by investing their lifes savings in high-risk stocks, speculation bubbles regularly occur. The
resulting need for adequate prudential standards and an improvement in lending practices is as equally important
as a more competent payments system including foreign exchange, electronic funds transfer and ATM access for
consumers in their market dealings.

The international business cycle refers to fluctuations in the level of economic activity in the global economy over
time. Limited foreign connection and a fixed currency once shielded China from global downturns (1997 Asian
economic crisis) since it was less vulnerable to speculation and the state of the international business cycle.
However, since Chinas exports now account for 35% of its GDP, it has increased its dependency on other
countries. The recent credit crisis in America, for instance, caused Chinas economic growth rate to fall from 11% in
2008 to 6.1% in the March quarter of 2009, reflecting the 17% fall in exports in the year to March.

In response, the Chinese government implemented a 4 trillion yuan infrastructure package 30% of which will be
funded by the government whilst most of the rest will be financed by bank lending. Already there is evidence of
the effectiveness of this strategy, with China achieving an economic growth rate of 7.9% in the June quarter of
2009 and retail sales up 16%. Yet economists argue that this is not a long-term solution. Instead, the Chinese
government must introduce structural reforms that improve the consumption mentality of the Chinese population
so that in the future China is less exposed to the state of the global economy.

In moving from a planned to a socialist market economy, China has adopted the Washington Consensus of market
friendly policies, including trade liberalisation, privatisation of state enterprises and fiscal discipline. Following its
abandonment of prices-wages policy, the Chinese government currently relies on strong infrastructure spending
(particularly towards image and low efficiency structures) underpinned by massive (and probably unsustainable)
bond sales to manage aggregate demand. Although, inflationary pressures resulting from high growth rates and
non-performing loans of SOEs call for a more effective management of macroeconomic policy so as to maintain the
price competitiveness of Chinas exports. Taxation reforms in 1994 specifically targeted tax evasion and avoidance
in order to maximise finance for infrastructure spending and social welfare.

In conclusion, China has relied on its export-oriented strategy and adherence to the Washington Consensus in
addition to banking, agricultural and taxation reforms to drive economic growth and development. Still, problems
such as the inefficiency of the financial market, the global slowdown, inequality and environmental degradation
are yet to be confronted if China is to emerge as the new economic world leader in the near future.

Explain the role of microeconomic policies in assisting structural change in the Aus economy.
Directed towards individual firms and industries, microeconomic policies promote the efficient operation of
markets by lifting productivity, improving flexibility and responsiveness to change, and encouraging Australian
firms to take on world best practices. They accelerate the process of structural change, that is, change in the
pattern of production in an economy over time, by enabling the economy to move factors of production more
quickly from one area to another. Although market forces tend to be more active in assisting structural change,
government forces (in the form of microeconomic reform) do play a substantial role. This rapid structural change
produces both short-term costs and longer-term benefits.
Microeconomic reform encourages allocative, technical and dynamic efficiency with the aim of fostering structural
change. In a free market situation, resources tend to move to those producers who have the greatest capacity to
pay, which is generally a function of their relative efficiency and value to the economy. Thus, minimising
distortions to the market economy, such as the impact of government regulation on prices and wages, will improve
the economys allocative efficiency, that is, its ability to shift resources to where they are most valued and can be
used most efficiently.
In addition, business enterprises operating in a relatively free market situation have very powerful financial
incentives to maximise efficiency and minimise production costs. Consequently, they would be more inclined to
adopt the latest production technology and use the least cost combination of resources, causing an improvement
in the economys technical efficiency, or in other words, the economys ability to achieve the maximum level of
output for a given quantity of inputs.
Moreover, in a deregulated market with an increased level of competition, the economy is more likely to achieve
dynamic efficiency, whereby producers respond more quickly to changing patterns of consumer demand in both
domestic and global economies.
Since the mid 1980s, Australia has undergone extensive microeconomic reforms involving the deregulation of
certain industries, the reduction in protection levels, the National Competition Policy as well as reforms to public
trading enterprises (PTEs) and the labour market. As a result, Australia has seen three main shifts in the allocation
of resources between 1979-80 and today, including a reduction in the relative size of the public sector (from 17%
to 15%), the halving in relative size of the manufacturing sector (from 20% to 11%) and the strong growth of the
services sector (from 57% to 64%).
Deregulation involves the simplification or removal of rules that constrain the operation of market forces, seeking
to improve the efficiency of industries. However, effective deregulation involves striking a balance between
excessive regulation, which can limit growth and undermine competitiveness, and inadequate regulation, which
can lead to market failure, inefficiencies and excessive volatility. Since the 1980s, Australias agricultural,
specifically dairy, wool and wheat, industries have undergone major deregulation. In 2008, for example, the
Australian Government introduced reforms to wheat export marketing, replacing a monopoly regime with a
competitive system overseen by a new regulator, Wheat Exports Australia. This resulted in the creation of larger,
more efficient farms, causing production to increase by 24% while the number of farms declined by 13%. With
these reforms and advances in farm technology, agricultural productivity has grown faster than the average for the
rest of the economy over the past two decades.
Historically, Australia was a highly protectionist country. However, since the early 1970s, organisations, such as the
Productivity Commission (PC), have argued that protection and industry assistance lead to higher prices, a
misallocation of resources, less internationally competitive firms and a poor trading performance in the long run.
For these reasons, the Whitlam Government announced a 25% across the board tariff cut in 1973, initiating the
process of reducing protection throughout the Australian economy. Following the many gradual and well-planned
tariff reductions that took place throughout the 1990s, Australia is currently considered a low tariff economy, with
a general tariff level of 5% applying to imports.

In response to the 1993 Hilmer report, Australias Commonwealth and State Governments signed the National
Competition Policy in 1995 to encourage microeconomic reform throughout the Australian economy. The
Governments agreed to implement reforms that would increase competition in the sectors where they operated
monopolies, such as electricity and gas. The Governments also agreed to remove special provisions that gave PTEs
an advantage over private sector competitors. As part of the reform package, the Australian Competition and
Consumer Commission (ACCC) was established as the new national competition watchdog. An important feature of
the reforms was the establishment of a national regime to regulate the cost of access to infrastructure, whereby
businesses that owned a monopoly infrastructure asset, such as an airport or a rail line, were required to give
competitors access to that network at a reasonable price.
Microeconomic reforms have promoted structural change in PTEs through two main approaches: the
corporatisation and privatisation of PTEs. By eliminating political and bureaucratic supervision and making public
enterprise managers accountable for enterprise performance, for example in the case of Australia Post,
corporatisation compels PTEs to achieve a rate of return on assets that is comparable to private sector companies.
Comparatively, the privatisation of PTEs, for example Qantas, involves partially or completely selling them off to
the private sector with the aim of increasing competition, encouraging more rational management and pricing
behaviour, and forcing businesses to become more efficient.
From a highly centralised system under which most employees had their wage determined by the Governments
prices and incomes policy in the 1980s, the 1990s saw a shift to a decentralised system where wages are mostly
determined through workplace bargaining. This has encouraged labour resources to move to firms and industries
that are more efficient and which have the capacity to pay more. Nevertheless, most labour market economists
argue that the Australian industrial relations system is still subject to a significant amount of regulation although
the nature of that regulation has changed over time, from favouring employees in the early 1990s to favouring
employers since 2006. Yet, many economists also argue that wage determination must remain regulated to ensure
fair outcomes.
AS diagram
By hastening structural adjustment, microeconomic reform produces numerous benefits, relating to productivity
growth, inflation, economic growth, job opportunities and trade performance. It leads to increase in productivity
growth because employees have a greater financial incentive to work more productively and increased
competition puts pressure on firms to keep their output prices low although the notion of workable competition
balances this need with the need to achieve economies of scale. For example, the manufacturing sector has
experienced productivity growth of 3.4% p.a. between 1989 and 1994.

Much of this productivity gain has been passed on to consumers through lower output prices, which translate to a
lower rate of inflation. Some of the gain has also gone towards increasing the rate of return of the owners, who
have often been governments and by extension, taxpayers.
Moreover, increased efficiency and productivity resulting from microeconomic reform has contributed to greater
economic activity and thus, lower unemployment in the long term. According to the PC, Australias GDP was
around 2.5% higher in 2005-06 as a result of Australias extensive microeconomic reforms of the 1990s. In turn,
Australians have experienced higher living standards of around $1,200 per person. While significant, this payoff
from microeconomic reform is nevertheless short of the 5.5% of GDP dividend estimated when the reforms
commenced in 1995.
Finally, structural change boosts Australias trade performance as Australian firms produce the most advanced
products at the lowest prices, and change their patterns of production to suit global consumer demand. This leads
to an increase in export revenue and a reduction in the current account deficit.
On the other hand, structural change is not without its disadvantages, and these are typically borne by individuals
or governments, as well as the industries themselves. The primary disadvantage is the temporary increase in
structural unemployment, which stems from the mismatch of skills between those provided by employees and
those required by employers. This represents an opportunity cost because it means that not all resources are being
used to their full capacity; the economy is operating at a point below its production possibility frontier. In turn, the
economy experiences slower economic growth and a lower standard of living in the short term.

Production possibility frontier
Given that the short-term costs, such as closed firms and structural unemployment, are more obvious than the
longer-term benefits, which may take several decades to full flow through the economy, governments are often
unpopular when they impose structural changes. However, to abandon the process would not only deny us the
benefits promised by the increased efficiency, but it would put our economy at serious risk of falling continuously
behind other economies in terms of economic development.

Evaluate the effectiveness of current macroeconomic policy.
Macroeconomic policies affect the economy as a whole, aiming to reduce the severity of fluctuations in the
business cycle by controlling the level of aggregate demand (AD). Thus, they are also known as counter-cyclical
policies. There are four types of macroeconomic management: fiscal, monetary, international, and prices and
incomes, although the Australian Government currently relies only on the first two to achieve its key economic
objectives. These range from a sustainable rate of economic growth, full employment and price stability to
external stability, a fairer distribution of income and wealth, and ecologically sustainable development. Contrary to
historical trends, the current Global Financial Crisis (GFC) has seen a rise in the importance of fiscal policy in
macroeconomic management; monetary policy is likely to play a supplementary role.
Fiscal policy can influence resource allocation, redistribute income and reduce the severity of fluctuations in the
business cycle through the manipulation of government spending and taxation, and the budget outcome. In
addition to promoting internal stability, the 2009-10 Budget has also managed to target the other, less prominent,
objectives of equitable distribution of income and wealth and ecologically sustainable growth. In 2002, Howard
abandoned the objective of external stability altogether, yet fiscal policy still affects it indirectly.
The move from a $21.7 billion budget surplus in 2008-09 to a $57.6 billion budget deficit in 2009-10 deems this
years budget expansionary, and hence represents a shift towards an overtly Keynesian approach to fiscal policy.
The size of the deficit reflects a combination of discretionary and non-discretionary influences. Typically, as
economic growth contracts, automatic stabilizers, namely, the progressive income tax system and unemployment
benefits, work to decrease government revenue and increase government expenditure. However, this year, the fall
in company and capital gains tax collection, coupled with increased pensions, cash hand-outs and infrastructure
development, has increased the size of the deficit to a greater extent.
The Governments three-tiered stimulus strategy, consisting of a series of one-off cash handouts, shovel-ready
minor capital works and infrastructure projects, is likely to boost economic growth in the short term, with GDP
expected to rise by 0.75% in 2009-10 and 0.5% in 2010-11. These measures are likely to be effective in boosting AD
because of the timely, targeted and temporary manner in which they were executed. In fact, their impact may
have already been felt in the economy in the form of the 0.4% growth in GDP in the March quarter of 2009.
However, the 2009-10 Budget tries to move in both directions simultaneously (Gittins, R. 2009), with some
typically contractionary measures as well. For example, Treasurer Wayne Swan plans to cut back middle-class
welfare by reducing the cap on concessional superannuation contributions from $50,000 to $25,000, means-
testing private health insurance rebates. Still, the Government has dropped or deferred major spending cuts over
the next four years out of concern that severe measures would undermine the economic recovery, focusing
instead on long-term reforms to the structure of Commonwealth outlays.
Although the budget outcome may be justified given the current economic climate and it is in line with Rudds aim
to achieve budget surpluses, on average, over the medium term, the potential external ramifications cannot be
ignored. That is, the twin deficit would require a greater surplus on the capital and financial account (see figure 1),
eventually leading to a higher deficit on the income component of the current account. With seven years of
forecasted deficits, the Governments net debt level is expected to rise to 13.1% of GDP in 2014-15, which will be
its highest level since 1998-99. Even if this level is encouraging compared with forecasts of at least 80% for Britain
and the USA, it is also necessary to consider that Australia entered the recession from a much more favourable
economic position than those countries. Nevertheless, all three of the ratings agencies Moodys, Standard and
Poors and Fitch said the nations AAA credit rating remains safe and thus, was not likely to affect Australias
external stability.
Twin deficit diagram
Similarly, ongoing budget deficits may have a negative impact on Australias economic recovery due to the
crowding out effect. This effect describes the process in which successive budget deficits soak up funds in
Australias domestic savings pool, putting upward pressure on interest rates and leading to a reduction in private
sector spending and investment. In the current recession, however, this effect is unlikely to occur because business
investment is already set to fall by 18.5% in 2009-10. In fact, it will have something of a crowding in effect
whereby the government actively stimulates the economy through its own public investment. It will only become a
problem if economic growth reaches its forecasted level of 4.5% by 2011-12 because it would pose a constraint on
economic growth.
Comparatively, the Minister for Employment and Workplace relations, Ms. Gillard, recently emphasised the
importance of fiscal policy measures in managing unemployment. As the demand for labour is a derived demand,
the Governments efforts to stimulate the economy are expected to support up to 210,000 jobs and reduce the
unemployment rate by 1.5 percentage points below the double-digit peak it would otherwise have reached
(Swan, W. 2009). This would in turn indirectly improve income inequality. However, in May alone, the economy
lost a net 1700 jobs, and this figure would have been larger had it not been for the increasing casualisation of
labour, with 24,500 part-time jobs created in the month to offset the 26,200 full-time positions shed.
Furthermore, in order to reduce the extent of hysteresis taking place in the economy, the 2009-10 Budget outlines
a $1.5 billion (over five years) Jobs and Training Compact. It consists of several labour market programmes
designed to provide assistance for training and development and job search facilities. Hysteresis is the process by
which an increase in cyclical unemployment during a recession leads to an increase in the natural rate of
unemployment in the long term. It is exacerbated by the slow speed at which unemployment falls during an
economic recovery explained by Okuns law, which states that a growth rate of at least 3.5% is necessary to
reduce unemployment.
Moreover, the Budget aims to improve the supply capacity of the economy. This will ensure that firstly, inflation
remains low even as the economy recovers and secondly, that potential export volumes increase, causing the
goods and services balance on the current account to improve in the long-term. While increasing the level of
infrastructure will help to reduce capacity constraints in the economy, the paid parental leave scheme, together
with the Governments plan to increase the qualifying age for the aged pension to 67 years by 2023, should boost
the workforce participation rate. Comparatively, increased spending on education (an extra $5.7 billion for higher
education and innovation over the next 4 years) will improve the quality of Australias labour force and thus render
Australias exports more internationally competitive.
To produce a more equitable distribution of income, this years Budget delivers higher pensions for the aged and
disabled, carers, veterans and war widows. Whilst single people will see their pension increase by $32/week,
couples will see their pension increase by $10. This increase in government spending will have a multiplied effect
on the level of national income and the multiplier will be relatively high, reflecting the pensioners high Marginal
Propensity to Consume (see figure 2). Yet, tax cuts to higher-income earners will not only offset these measures,
but they will also increase expenditure on imports. Thus, the goods and services balance on the current account
will worsen in the short-term, causing the current account deficit to deteriorate and external stability to falter.
Keynesian cross diagram
Finally, the 2009-10 Budget promotes ecologically sustainable growth by directing $3.5 billion towards the Clean
Energy Initiative over nine years to focus on carbon capture and storage, and solar and other renewable
technologies. However, Greens leader Bob Brown is not impressed: it is clear the Rudd Government is more
interested in propping up the coal industry than investing in the clean, renewable energy jobs of tomorrow.
Monetary policy involves action by the Reserve Bank, on behalf of the Commonwealth Government, to influence
the cost and availability of money and credit in the economy. The objectives of monetary policy, which are laid out
formally in the Reserve Bank Act 1959, include: the stability of the Australian currency, the maintenance of full
employment in Australia and the promotion of economic prosperity and welfare among its people. However, in
1996 the RBA limited itself to containing headline inflation within a medium-term 2-3% target range (on average,
over the economic cycle), with the assumption that low inflation is a precursor of the other two objectives. By
contrast, monetary policy cannot be used to pursue ecologically sustainable growth and is often criticised for being
a blunt instrument that widens the gap between low and high-income earners within the economy.
The primary instrument of monetary policy is the overnight cash rate, which the RBA manipulates through
domestic market operations in the Overnight Money Market (OMM). By buying or selling second-hand
Commonwealth Government Securities, the Reserve Bank can increase or decrease the supply of loanable funds in
banks Exchange Settlement (ES) accounts (in which they must hold a certain proportion of their funds to settle
payments with other banks and the RBA), thus decreasing or increasing the cash rate of interest. The market
interest rates are predominately affected by the cash rate since approximately 90% of a banks funds come from
the OMM. The fall in the cost of obtaining funds on the OMM is reflected in the fall in the overall cost structure of
borrowing. Thus, banks can afford to lower interest rates whilst still maintaining profit margins. When market
interest rates decrease, consumers and businesses find it cheaper to borrow money, resulting in a higher level of
consumption and investment spending, and a subsequent boost to economic activity. The process by which
changes in the stance of monetary policy impact upon the economy (as above) is referred to as the transmission
The Reserve Banks decision to release the minutes of Board deliberations for the public record in December 2007
gave way to a new level of transparency and accountability for changes it makes to the stance of monetary policy.
By influencing peoples expectations of future inflation and economic performance, this measure has improved the
effectiveness of monetary policy.
With the first cut to the official cash rate since December 2001, the stance of Australian monetary policy changed
dramatically in September 2008, from contractionary to expansionary. The RBA cut the cash rate six times
between September 2008 and April 2009, causing a dramatic fall in the cash rate from 7.25% to just 3%. This has
helped to put downward pressure on household mortgage interest rates as well as interest rates on business loans
such as overdrafts and term loans. The frequency and size of the rate cuts reflect the RBAs deep concern over the
global financial crisis, and its potential to cause a recession in the Australian economy, deflation and a large rise in
the unemployment rate. However, much of this monetary easing took place before the emergence of clear
evidence that inflation was declining.

Over the year to the September quarter of 2009, the CPI increased by only 1.3%, compared with the 5.0% increase
over the year to September 2008. The significant reduction in fuel prices and the prices of deposits and loans were
the main contributors to this recent decline in headline inflation. However, the decline was limited by the higher
prices for imported goods resulting from the sharp depreciation of the exchange rate in November last year.

In October 2009, the RBA increased the cash rate to 3.25% in response to a combination of domestic and global
factors. Economic conditions in Australia have been stronger than expected, with the underlying inflation rate
reaching 3.9% in the September quarter and unemployment falling to 5.7%. Business confidence is at a 6 year high
while consumer confidence is at a 2 year high, and the stock market is showing early signs of a recovery (the
September quarter was the best since 1987). Housing credit growth has been solid and dwelling prices have risen
appreciably this year. This is in part due to the numerous fiscal and monetary initiatives implemented earlier this
year. In addition, export revenue is likely to increase as the global economy resumes growth, with the US economy
recording an annualised growth rate of 3.5% in the September quarter (after 18 months of a recession). Although,
the recent rise in the currency to over US90c is likely to constrain output in the tradeables sector and dampen
price pressures.

The further 0.25% increase in the cash rate in November 2009 is in line with the RBAs plan to gradually return
rates to their normal level of 4.5-5%, with the danger of a serious economic contraction no longer in sight; there is
no longer a need to keep interest rates at an emergency low setting.

The effectiveness of policy implementation may be undermined by three key factors: time lags, political
constraints and global factors. First, the use of policy instruments to manage demand in the short term is subject
to three different kinds of lags. The first is the recognition lag the delay before the economic managers recognise
the need to boost or dampen demand. The length of this lag is the same for fiscal policy as for monetary policy.
Second is the implementation lag the delay between the managers realising they need to act and actually being
able to act. Whereas monetary policy can be implemented almost immediately as the RBA Board meets on a
monthly basis, the implementation of a fiscal response must go through a complex process of budget committee
meetings and will be scrutinised by several government departments before being approved. Therefore, there is
less risk associated with monetary policy as the stance can be adjusted rapidly even reversed, if necessary. Third
is the transmission lag the delay between the measure taking effect and it working its way through the economy
to cause the desired response from demand. The transmission lags associated with fiscal policy can be highly
uncertain whereas monetary policy acts with a variable lag as different sectors of the economy will be affected to
different degrees, depending on their interest rate elasticity.

Secondly, policy implementation is limited by political constraints. When governments make fiscal policy decisions,
they must consider how the public will receive them particularly when preparing for an election. For example,
although the recent tax cuts to higher-income earners are likely to exacerbate income inequality, they are in line
with the Rudd Governments 2007 election promises. Furthermore, the Government must hand down another
tough budget next year if it wants to demonstrate strong economic management credentials. Yet, this will be
unlikely considering it is an election year. Conversely, the independence of the RBA from the government means
that it can implement monetary policy irrespective of public support.

Thirdly, the process of globalisation has caused global factors to place a greater constraint on economic policy. This
is particularly true for Australia, with its high level of foreign liabilities totalling 62.5% of GDP in 2007-08. That is,
Australias macroeconomic policies should not undermine international confidence in the Australian economy;
otherwise international investors may withdraw funds and cause a destabilisation. Yet, with its strong banking
sector, massive resource base and trading links with emerging China, Australia remains in a good position to
benefit from the next global economic expansion despite its growing debt level. Conversely, many economists
doubt Chinas ability to drive global growth without a significant improvement in the economy of the USA. In
addition, global financial flows and overseas interest rates have directly influenced the conduct of monetary policy
in Australia.

Overall, macroeconomic management throughout the past decade has been effective in achieving certain
economic objectives. Prior to the current GFC, economic growth had been sustained for 17 years, the longest
period of growth on record. Inflation averaged just above 2.5% since the early 1990s, and in 2008 the
unemployment rate fell to 4%, its lowest level in over thirty-three years, and below the average for industrialised

On the other hand, Australia has not recorded an improvement in either the distribution of income and wealth or
in environmental management. Australia still has a high level of inequality compared with many other advanced
economies and it also has a poor record in preserving biodiversity, protecting natural environments, managing
scarce water resources and overusing agricultural land.
Following this trend, the 2009-10 Budget, coupled with recent easing of monetary policy, has directly addressed
unemployment, inflation and economic growth. According to Swan, in the absence of our efforts, the contraction
would be four times bigger, with forecasts of a return to 2.25% economic growth by 2010-11. Even the IMF
supports the Governments large and co-ordinated stimulatory response to global financial crisis.
However, their efforts have indirectly worsened Australias external stability whilst making little progress
towards achieving an equitable distribution of income and ecologically sustainable growth. Progress is required in
these areas so that Australia can achieve advancements in human development, not just in economic growth. Even
then, the Australian economy may take longer to recover than is currently forecast given the present international
outlook; many consider the Treasurys forecasts to be rather optimistic. Despite the 0.4% growth in GDP in the
March quarter, we are not out of the woods yet, according to Kevin Rudd. Growth will continue to be slow for
some time, unemployment will continue to rise and we cannot rule out the possibility of further negative
economic growth in Australia. In which case, the Government will face increasing pressure to borrow, increase tax
rates and further reduce expenditure.
In general, macroeconomic policy works effectively in either stimulating or contracting the economy in the short
term, but it is much less effective in dealing with longer-term problems such as our lack of international
competitiveness, high foreign debt, and low level of national savings. Hence, macroeconomic policies must operate
in concert with microeconomic policies.

Outline the arguments for ecologically sustainable development, and discuss the likely impacts of an increase in
the rate of Auss eco growth on the environment.
In the past, government policies tended to focus on traditional issues such as output, employment and prices.
However, in recent decades, the environmental consequences of economic development have received a greater
prominence. The key environmental management challenges facing Australia in the early twenty-first century
range from reducing greenhouse gas emissions, which contribute to climate change to ensuring adequate water
supplies and preserving the health of forests, waterways and ecosystems. Whilst prioritising environmental
concerns can involve economic costs in the short-term, a healthy environment is crucial to achieve sustainable
economic growth in the longer-term. The challenge for policy makers is thus to achieve a balance between the
short and long-term objectives of economic growth and environmental preservation.
Ecologically sustainable development (ESD) conserves and enhances the communitys resources so that ecological
processes and quality of life are maintained. It is a level of economic activity that is consistent with the long-term
preservation of the environment, rather than merely the maximum level of growth possible in the short term. It
involves five key principles: integrating economic and environmental goals in policies and activities, ensuring that
environmental assets are appropriately valued, ensuring fairness in the shifting of costs and assets within and
between generations, managing environmental risks with caution, and taking into account the global effects of
environmental issues. First developed in 1992, Australias National Strategy of Ecologically Sustainable
Development (NSESD) facilitates a coordinated and co-operative approach to ESD and advocates long-term
benefits for Australia over short-term gains.
Supporters of ecologically sustainable development insist that it protects Australias longer-term economic
interests. The natural environment is especially important to Australia because our natural resources account for a
large proportion of our export revenue around 60% of exports are commodities such as minerals and agricultural
produce. By ensuring that these resources are not overused or exploited to achieve short-term growth, ESD
promotes intergenerational equity and an increase in the sustainable rate of economic growth.
According to numerous indicators of human development, namely the Genuine Progress Indicator and the Happy
Planet Index, preserving the environment through ESD is also necessary to achieve a higher quality of life. This is
partly because excessive air and water pollution tends to reduce the average life expectancy of a countrys
population, and the rapid depletion of natural resources restricts economic growth in the future and results in
intergenerational inequity as above.
In a market economy such as Australia, the forces of demand and supply interact to determine the market price at
which goods and services are sold and the quantity produced. However, this price mechanism ignores the costs
and benefits associated with production (that is, the negative and positive externalities) in two main ways: first, it
only takes into account the private costs of additional production, ignoring the additional social and environmental
costs, and secondly, it does not account for future demand of goods and services that may not be satisfied or how
the economys ability to grow in the future may be affected because a resource has been used up or destroyed.
The primary reason behind the markets failure to consider the environmental impacts of production is that in an
economic system based on private property ownership, there are no general property rights associated with
environmental resources, such as oceans or the atmosphere, and so they tend to be overused.

Market failure
Although the price mechanism plays no part in allocating environmental resources that can be used for free, such
as the use of the atmosphere to dispose of gases during the production process, it does play a limited role in
protecting the environment by restricting the sales of depleted resources which do have a price, namely timber
and minerals. That is, when these resources become scarce, their prices increase, reducing the number of
resources consumed. Hence, producers and buyers are forced to look for and develop alternative inputs to
production. Yet, the prices often increase too late and by too little. For this reason, the government is forced to
intervene in the market to preserve the environment.
The main assumption of economic theory is that economic growth is the key to the well-being of society, and that
governments should pursue policies that maximise the level of growth. Particularly considering the current
economic climate, governments around the world are growing more desperate to restart growth by any means
possible. However, it is important to consider that economic growth is only one strategy to achieve well-being and,
in terms of natural resources, a demonstrably inefficient one. When economic growth is pursued with little regard
to its environmental consequences, it inevitably leads to a rapid depletion of resources and excessive pollution
levels. Strong growth, therefore, increases the material standard of living in the short-term, although it may
detriment the quality of life and restrict potential economic output in the longer-term.
Production possibility frontier
When economic growth leads to the rapid depletion of renewable and non-renewable resources, it is a problem
particularly for future generations. Overuse or exploitation of these resources to achieve short-term growth can
deplete these resources and permanently damage the environment. This will lead to a fall in the productivity of
primary sectors and in turn, a fall in future potential output, represented by a movement in Australias production
possibility frontier to the left. Future generations will also be forced to bear the costs of finding alternative
resources and repairing the environment.

To determine the level of resource use that is sustainable, economists can estimate the optimal rate for the use of
resources over time. For renewable resources, this involves arriving at a threshold exploitation level that allows
the resources to regenerate so that there is no long term decline in these resources, whereas for non-renewable
resources, this involves determining a rate of decline that is acceptable for the present generation and future
generations. This calculation involves two main challenges: first, it is difficult for present generations to predict the
need of future generations, and secondly, it is difficult to assess the existing stock of a mineral or other resources
due to conflicting evidence about the quantity of that resource that remains available.
In the past, Australia has been poor at addressing the issue of resource depletion. For example, the critical water
shortage experienced in many parts of Aus, in particular in areas relying on the Murray Darling River System,
reflects the long-term over-use of the renewable resources of fresh water. Furthermore, Australia has a long-
standing record of exploiting its unusually large concentrations of non-renewable mineral and energy resources,
such as coal, zinc, lead, bauxite, to achieve economic growth. However, the 2009-10 Budget directed $3.5 billion
towards the Clean Energy Initiative over nine years to focus on carbon capture and storage, and solar and other
renewable technologies.
During periods of economic growth, output increases and all sectors of the economy thus pollute the environment
in some way. Pollution occurs when harmful chemical substances, noise, untreated rubbish or the like degrade the
natural environment. Although it usually stems from populated areas, the impact is often felt far away from its
original source. The problem has become particularly rampant since the industrial revolution. Within individual
countries, there is a range of options available to the government to counter this problem. For instance,
governments can introduce laws banning environmentally damaging production techniques, such as in 2002 when
it became illegal to sell leaded petrol in Australia. Alternatively, governments can introduce quotas to restrict the
emission of harmful pollutants, or subsidies to encourage environmentally-friendly practices, such as is the case
with public transport in Australia. Moreover, governments can levy taxes to discourage some forms of economic
activity. For example, in 2008 the Australian Conservation Foundation argued that aviation fuel tax should be
increased from 3c per litre to 38c. This method is particularly favourable because the taxes not only reduce
production and consumption, but also raise government revenue. In recent years, however, governments have
shifted towards solutions, such as the Carbon Pollution Reduction Scheme, that use market mechanisms to
internalise negative externalities.
On the other hand, people and governments are more inclined to implement measures to preserve the
environment during a period of economic boom. For example, industries and agricultural producers would be less
likely to oppose controls over emissions of waste products and reductions in water allocations for irrigation
respectively. Nevertheless, governments will always face problems in trying to implement measures, which protect
the natural environment, when they come at a cost to short-term economic prosperity.
Environmental management remains one of the most controversial areas of economic policy, with fierce
opposition between primary industries and environmentalists. Although their interests may vary in the short term,
however, ESD will undoubtedly benefit both parties in the longer-term. Pursuing government policies that
encourage Australias economic growth without first considering their impacts on the environment will lead to a
rapid depletion of resources and higher pollution levels, thereby contributing to a lower quality of life and a lower
rate of economic growth in the future. Still, some economic growth ensures that people can afford to act in an
environmentally-responsible manner.

Explain how exchange rates are determined and discuss the impacts on the Australian economy of a sustained
appreciation of the Australian currency?
All trade and financial flows between countries require the exchange of currencies. Therefore, exchange rate
movements, or changes to the price of one currency in terms of another, have a significant impact upon a
countrys international competitiveness, trade flows, investment decisions, inflation and many other areas of the
domestic economy. Since Australia converted to a floating exchange rate system in 1983, the forces of supply and
demand currently determine the value of its currency. Nevertheless, the Reserve Bank can intervene directly by
dirtying the float or indirectly through monetary policy.
All those who wish to purchase Australian dollars ($A) represent the demand for them whereas all those who wish
to sell $A represent the supply. While a decrease in the value of the currency, or depreciation, results from a
decrease in demand or increase in supply, an increase in value, or appreciation, results from an increase in demand
or decrease in supply.
Three factors affect the demand: First, the size of financial flows into Australia from foreign investors. For example,
there is a high demand for $A when Australias interest rates are higher than those overseas, or there are more
opportunities for foreigner investors either to start new businesses in Australia or to buy into existing businesses
via the share market than overseas. Secondly, the expectation of a future appreciation of the Australian dollar will
cause speculators to raise the demand. Thirdly, the demand for Australian exports will reflect the demand for
Australias currency. For instance, a rise in commodity prices and an improvement in Australias terms of trade are
generally associated with an increase in Australian exports in the short-medium term, resulting in an increase in
the value of the Australian dollar. Also, a low inflation rate and internationally competitive domestic exporters will
produce a similar effect, as will an upturn in global economic conditions and global tastes and preferences that
favour Australias exports.
Comparatively, three factors affect the supply of $A: First, the level of financial flows. For example, when
Australias interest rates are lower than those overseas and there are greater opportunities to invest in overseas
companies, there will be an increase in the supply of $A. Secondly, when speculators expect a decrease in the
value of Australias currency (and choose to sell), they tend to contribute to the anticipated depreciation by
increasing the supply. Thirdly, the domestic demand for Australias imports affects the supply of $A since an
exchange of currencies must take place in order to pay for the imports. For instance, when the output of the
domestic economy is growing, and employment and incomes are rising, the demand for imports will rise, causing
the supply of Australian dollars to increase. Similarly, a high domestic inflation rate and uncompetitive import-
competing firms means imports are cheaper than domestic products, creating higher demand for imports and an
increase in the supply of $A. When tastes and preferences favour imports, the supply of Australian dollars also
tends to increase.
Disequilibrium in the balance of payments, that is, when the net outflow of funds on the current account (supply
for $A) doesnt equal the net inflow of funds on the capital and financial account (demand for $A), is only
temporary and automatically corrected by a movement in the exchange rate. For example, if the value of imports
increased, while exports remained unchanged, it would cause a deterioration of the current account deficit (CAD)
and therefore, an increase in the supply of $A (importers will be selling more $A in order to buy foreign currency)
followed by a depreciation of the currency. This depreciation would enable the positive balance on the capital and
financial account to increase (the given level of financial inflows would be able to purchase more $A) to counteract
the bigger deficit on the current account. Likewise, any other increased outflow of funds on the current account,
for example, payment of services, income payments or current transfers, will generally lead to a depreciation of
the Australian dollar and an increase in the surplus on the capital and financial account.
The experience of recent years, however, indicates that the most significant influence on the exchange rate is how
financial markets perceive developments in the balance of payments, rather than the actual balance of payments
figures themselves. This results in greater volatility in forex markets because market sentiment can change quickly.
For example, if financial markets are concerned that an increase in the CAD is not sustainable, they may be less
willing to buy Australian assets, and so the value of the dollar is likely to fall further as capital inflow is reduced. On
the other hand, if financial markets believe that the rise in the CAD is justified by some other factors, as in April
2008, there may be no significant effect on the currency.
When the RBA feels that a large short-term change in the exchange rate will be harmful to the domestic economy,
it may decide to intervene in the forex market, either as a buyer or as a seller, in order to stabilize the Australian
dollar. For example, the RBA can buy Australian dollars in exchange for foreign reserves to curb a rapid
depreciation. However, the RBAs ability to intervene by buying $A is limited by the size of its foreign currency
holdings, that is, the reserves of foreign currencies and gold that can be used to fund such purchases, for it is not
even equivalent to one days transactions in the currency. Therefore, the RBA can only enter the market in the
short-term, usually to head off severe speculation.
The RBA rarely deliberately employs monetary policy to affect the exchange rate, although the capacity to
influence it is always there. For example, if the RBA wants to curb a rapid depreciation, it may sell Commonwealth
Government Securities on the Overnight Money Market to increase the demand for Australian dollars and thereby
increasing the cash rate. The subsequent increase in commercial interest rates tends to attract more foreign
savings, which must be converted into $A, increases the demand for $A
An appreciation of the Australian currency can produce numerous positive and negative effects relating to
Australias CAD, the capital and financial account, inflation and economic growth.
An appreciation can improve Australias balance of payments because it reduces the Australian dollar value of
foreign debt that has been borrowed in foreign currency, which is known as the valuation effect. The decrease in
the interest servicing costs on Australias foreign debt, on the other hand, reduces the outflow on the net income
component of the current account in future years and helps to reduce Australias CAD.
Furthermore, an appreciation causes Australian consumers to benefit from increased purchasing power, that is,
they can buy more overseas-produced goods with the same quantity of $A. Less inflationary pressures in Australia
resulting from imports becoming cheaper also tends to discourage the RBA from raising interest rates.
By contrast, an appreciation can also worsen Australias CAD. By increasing the value of the Australian dollar in
terms of other countries currencies, Australias exports become more expensive on world markets and therefore,
more difficult to sell, resulting in a decrease in Australias export income. At the same time, imports will be less
expensive to purchase, which encourages import spending and generally leads to a fall in the production of import
substitutes. An appreciation also reduces the Australian dollar value of foreign income earned on Auss
investments abroad, lowering the net income component of CAD. Together, these factors will cause a
deterioration of Australias Current Account Deficit (CAD) in the medium term and a subsequent slowdown in
Australias economic growth
In addition, an appreciation tends to reduce the surplus on Australias capital and financial account. It causes
foreign investors to find it more expensive to invest in Australia, leading to potentially lower financial inflows.
Although, if foreign investors expect the currency to continue rising, financial inflows may continue.
Simultaneously, the value of foreign assets in Australian dollar terms will be reduced.
Overall, primarily the forces of demand and supply influence exchange rates in Australia, although the RBA may
decide to intervene in some cases, either through monetary policy or by dirtying the float. An appreciation in the
value of Australias currency tends to benefit consumers and have diverse effects on the balance of payments.

Outline the factors affecting Auss economic growth, and analyse the relationship between economic growth
and changes in Auss employment rate.
Economic growth refers to the increase in the volume of goods and services that an economy produces over a
given period of time, measured by the annual rate of change in real Gross Domestic Product (GDP). Following the
Great Depression, Keynes realised that the total level of expenditure in the economy, or aggregate demand (AD), is
the main driver of economic growth. The components of AD include: consumption, investment, government
spending, and net export spending (export spending minus import spending). Since the demand for labour is a
derived demand, that is, it is derived from the demand for the goods and services that labour helps to produce,
changes in AD are reflected in Australias employment rate.
Consumption represents approximately sixty percent of AD in the Australian economy and is the most stable
component of AD. Although the most important factor influencing the level of consumption is income, economists
are more concerned with the Average Propensity to Consume (APC) and Save (APS). Consumer expectations, the
level of interest rates and the distribution of income greatly affect Australias APC. For example, if consumers
expect a price rise, a rise in their real incomes or a shortage of goods in the future, consumption will increase in
the short term. Alternatively, an increase in interest rates will cause a decrease in the APC and therefore, an
increase in the APS (since income can only be spent or saved). Furthermore, the more equitable the distribution of
income in an economy, the higher the rate of overall spending because people on lower incomes tend to spend
proportionately more of their income than those on higher incomes. An increase in consumption ultimately causes
an increase in aggregate demand (and vice versa). Currently, low interest rates and consumer confidence have
caused a slowdown in economic growth.
As the most volatile component of AD, the level of investment in the Australian economy is influenced by a
number of factors. The level of interest rates, for instance, affects the price of borrowing funds for the purchase of
capital equipment. Therefore, a fall in interest rates may result in an increase in investment, reflected in a
subsequent increase in AD. Similarly, government policies relating to investment allowances and tax concessions
on capital goods may also be used to manipulate the level of investment in the Australian economy. For example, if
the Government allowed businesses to claim a higher rate of depreciation on their capital equipment, this would
reduce their tax liability, causing capital to decrease in price. Alternatively, the price or productivity of labour
affects the relative cost of capital compared to the cost of labour so that when the cost of labour increases while
the cost of capital remains the same, capital is more attractive and investment spending increases. Lastly, business
expectations about future prospects play perhaps the most important role in determining the level of investment
in the Australian economy. That is, if firms expect a future increase in the demand for their products, strong
economic growth, a discovery of new resources or new technology, or low inflation rates, they will be more
inclined to purchase new capital equipment.
Although the level of government spending will to a degree depend on the government in power, it tends to
represent approximately one-fifth to one-quarter of AD. One of the main goals of fiscal policy is to maintain a
strong and stable rate of economic growth. For example, the Australian Government may decide to increase the
level of spending and/or reduce the level of taxation in order to boost AD and therefore, economic growth.
Since Australias trade balance on the current account is usually in deficit, net exports usually make a small
negative contribution to aggregate demand (where exports and imports are each equal to between one-fifth and
one-quarter of AD). Australias net exports are influenced by domestic and overseas incomes, the exchange rate,
levels of international competitiveness and consumer tastes and preferences. For example, a rise in overseas
incomes tends to be mirrored by a rise in Australias exports whereas a rise in domestic incomes tends to be
reflected in a rise in Australias imports. Moreover, when Australia has a weaker exchange rate, domestic
industries appear more competitive and therefore, their products are in greater demand by foreign consumers.
This leads to a higher level of net exports and consequently, greater AD and faster economic growth.

Keynesian cross diagram
Any change in the level of planned expenditure, due to changes in any of the components of aggregate demand,
will have a multiplied effect on the level of national income. For example, lower interest rates will increase
business investment and therefore, AD. Consequently, individuals will earn higher incomes, prompting higher
consumption levels and further increases in expenditure (AD) and income lead the cycle to continue. However, the
Marginal Propensity to Save (MPS) causes the amount of income generated from each time the injection flows
through the economy to decrease as savings represents the only leakage in the assumed three-sector economy.
In the past, high unemployment rates have been consistent with low levels of economic growth and vice versa. For
example, the main reason behind the 10.7% unemployment rate recorded in 1992, which was Australias highest
level since the Great Depression of the 1930s, was the severe global recession. By contrast, between 1991 and
2008, Australias unemployment rate fell gradually, with fifteen years of sustained economic growth bringing it
down to below 5%. Furthermore, until 2008, the global resources boom spurred increases in national income and
business investment, causing the demand for labour in Australia to increase. This was particularly the case for the
resource-rich states of Queensland and Western Australia as they experienced 4% unemployment in mid-2006
compared to the 5% experienced by NSW and Victoria. Currently, poor consumer and business confidence have
contributed to slowing economic growth, leading to higher rates of unemployment (5.2% in Feb 2009).
As employment and unemployment are lagging indicators of economic activity, however, they will typically show a
change following a variation in the overall level of economic growth. For example, the significant rise in Australias
unemployment rate (from 4.8% in Jan 2009 to 5.2% in Feb 2009) reflects easing demand levels in the economy
earlier in 2008.
Based on this relationship, the Australian Governments most important strategy to reduce (primarily cyclical)
unemployment has been the use of macroeconomic policy to ensure a sustainable rate of economic growth (within
3-4% of GDP). Even the Minister for Employment and Workplace Relations, Ms. Gillard, recently emphasised the
importance of fiscal policy measures in managing unemployment. It follows that the Rudd Government has
decided to implement expansionary macroeconomic policies in response to the current economic slowdown. For
example, it announced five key $950 one-off payments for low and middle income households and individuals in
December 2008 in addition to spending measures that allocated $15.1 billion to education and health programs
and $4.7 billion to road, rail and education infrastructure.
According to Okuns Law, however, Australia requires economic growth rates, which exceed growth in labour
productivity and in the size of the labour force (around 3.5% or higher) in order to make progress on reducing
unemployment. Although this was a problem during the 1990s, since the early 2000s productivity growth has been
much slower, enabling unemployment to continue falling despite economic growth averaging around 3%. Although
in the long term a higher level of productivity growth should lead to stronger eco growth and more job creation, in
the shorter term more jobs are created during a period of low productivity growth because employers require
more workers if they want to increase production.
Interestingly, the relationship between economic growth and employment works both ways the continued
avoidance of high rates of unemployment will be important in containing the extent of the economic downturn in
the current cycle. This is because increased levels of unemployment can trigger the economy to enter a vicious
cycle, whereby higher unemployment leads to lower consumption levels, which lead to further increases in
Overall, Australias economic growth is affected by the components of aggregate demand. Since the demand for
labour is a derived demand, it will always reflect changes in economic growth. Similarly, low unemployment levels
can perpetuate downturns in economic growth.

Impact of sustained fiscal deficits on resource use and eco activity in Aus economy
Fiscal policy and fiscal deficit. Describe how fiscal deficit is calculated.
Opinion about the impact of a fiscal deficit on the economy tends to polarise between the perspectives of
the main two schools of economic thought, Keynesian and neo-classical economics. The debate is often
conducted in the framework of govts choosing either an expansionary or contractionary fiscal policy
(define each stance).
Keynesians argue that fiscal deficits have the positive effect of stimulating growth in the
economy. They favour an expansionary fiscal policy during eco downturn, claiming that a net
injection of funds into the economy will raise AD (show eqn) and increase the level of eco activity
Neoclassical economists more often argue that the govt should maintain a balanced budget.
They focus on the implications of the govts call on savings crowding out effect
Over time, budget deficits can have a significant impact on an economys external stability.
Esp the case for Aus, which has had sig external probs since 1980s
Higher deficit reduces level of public savings, which will reduce national savings and
subsequently increase foreign borrowing.
In long term, servicing foreign debt creates deficit on net income component of CA, increasing
To counter this problem, Rudd Govt aims to achieve budget surpluses, on average, over the
medium term
Specific impact of a budget deficit will also depend on the method used to finance it
Domestic borrowing explain
Disadv: Depending on the conditions of the market, a large release of govt bonds will
tend to increase interest rates and possibly crowd out domestic investment. For this
reason, Govts tend to look for alternative methods.
Overseas borrowing explain
Adv: Does not reduce money supply and only has an indirect influence on domestic
interest rates
Disadv: it exposes the govt to risks bc an exchange rate depreciation will increase the
Aus dollar value of debt denominated in foreign currencies + it will increase national
debt, which in long run adds to servicing costs and increases CAD
Monetary financing explain
Disadv: Although it does not increase debt, the inflationary consequences are
considered worse. This method is therefore not used in Aus bc of the govts priority of
maintaining inflation
The impact of the budget deficit is also influenced by the size of existing govt debt
If govt debt is already high, further fiscal deficits are likely to have a more severe ve impact on
investor confidence, interest rates and the CAD
Fiscal surpluses since 2001-02 contributed to a fall in Commonwealth Govt debt from 18.5 per
cent in 1995-96 to as low as -3.8 per cent of GDP in 2007-08 this widens the scope for the govt
to have lower surpluses/higher deficits in the future to respond to adverse eco conditions (as is
the case today)
The impact of a budget deficit in any one year will be shaped by the particular spending and revenue
policies that are associated with the budget deficit (i.e. reasons for it)
E.g. if a deficit was related to increased investment in public infrastructure or education, it may
produce benefits over a long period of time
By contrast, if it is the result of tax cuts, the benefits may be short-lived
Conclusion: the expansionary 2009-10 Budget represents a return to an overtly Keynesian approach to
fiscal policy. Many economists agree that it is appropriate given the severity of the current global
economic slowdown, irrespective of any potential external ramifications.

Analyse the impact of reduced levels of protection on the global and domestic economies.
Economists believe that economies will achieve the fastest levels of growth in a free trade
environment recent yrs have seen sig progress towards achieving this goal, despite some
remaining barriers
Benefits have been widespread
Detriments too
E.g.s of global trade agreements i.e. reduced barriers to trade
Effect of GFC
Various forms of protection
Reasons for protection (if q only refers to global economy)
Reduced protection promotes world trade and the integration of different economies throughout the
worldbased on principle of comparative adv
Reduced protection also contributes to a higher global standard of living.
However, since the majority of trade liberalization strategies have been limited to within specific trade
blocs, they have not benefited all countries equally. E.g. EUs Common Agricultural Policy, which absorbs
approximately 44% of its $A200 billion budget.
Nevertheless, some economists argue that these trade blocs act as a valuable stepping-stone towards free
trade. E.g. APEC
Furthermore, the breakdown of trade barriers can force low-income economies to disregard the
environment in policy setting in order to achieve international competitivenessTNCs
In addition, reduced protection can prevent a country from defending/sustaining itself in wartime.
Similarly, reduced protection can hurt the domestic economy by leading to an increase in dumping and
structural unemployment, and the collapse of infant industries. E.g.
In 2005, World Trade Organisation members had a total of 1,279 anti-dumping measures in
force, with over 20% of these put into place by the USA and 14% by India.
The APEC forums Bogor goals were predicted to cause a boost in Australias national output of
6.8% and create 500,000 jobs by 2010.
Reduced levels of protection have benefited primarily the developed regions of the global
Developing nations, on the other hand, have been excluded from most preferential trade
agreements, restricting their ability to participate on overseas markets in order to achieve
economic growth and a higher sol.
It has also come at a cost to the environment and the domestic economy in some cases.
Outline the features of globalisation and analyse the impact of globalisation on the sol and eco development in
the global economy.
5 features of globalisation include
Overall sol experienced by the world economy has increased sig during this period, particularly
for those countries able to compete on international markets.
Yet globalisation has come at a cost to environment and global equality.
Increased trade flows
Increased financial flows
Increased investment flows and transfers of technology
Increased flows of labour
International convergence i.e. international business cycle
While some of these features clearly facilitate economic growth and therefore an increase in the sol,
others tend to destabilize or constrain it
Overall, globalisation era does not appear to have produced an acceleration of world eco
Instead, it has resulted in a divergence of growth trends
Whilst high-income and newly industrialised economies have profited from the participation of
TNCs and closer relationships built on increased trade and investment flows, slower growth can
be attributed to problems with transition (in central Asia), political turmoil (in Africa) and a range
of other domestic policy problems (in continental Europe)
The changing direction of world trade has particularly influenced the prosperity of different eco
From this eco growth, stem major improvements in eco development.
However, growth in global trade has also accelerated resource use and environmental degradation due to
increased production and transport use, a fact recognised in both the GPI and the HPI.
E.g. China stat
TNCs, growing in line with global trade flows and foreign investment, have been criticised for
their exploitation of environmental protection laws and lower labour standards in developing
Low-income economies desperate to attract FDI and earn higher export revenue are esp likely to
engage in environmentally-harmful behaviour
On the other hand, globalisation has also driven govts to face up to their global responsibility to carry out
environmental preservation.
Costs of preservation can be shared
Increase scrutiny of the environmental practices of TNCs
Progress in making agreements to combat global environmental problems (e.g. Kyoto protocol)
has been slow
While globalisation creates opps for eco growth and development, many aspects of the global economy,
such as the trade system, financial architecture, aid and tech flows, appear to be entrenching, rather than
alleviating, geographical disparities in income and wealth.
Currently the worlds richest 5% have 165 times as much money as the poorest 5% and this sig
inequality has come into sharper focus in recent yrs due the increased interaction bw the more
prosperous and less prosperous regions of the world.
Trade system
Since 1970, most of the success in export promotion has been enjoyed by a few OPEC countries
and the four Asian Tiger economies (HK, Singapore, S.Korea, Taiwan).
So far this century, it has been the emerging economies led by China and India that have made
substantial gains in export markets
However, generally speaking, the majority of developing countries have experienced a continuing
decline in their share of world trade.
Financial architecture
But not all inequality can be attributed to globalisation; domestic factors are also partially
responsibleInstitutional factors
Economic factors
Nevertheless, some progress in overcoming global inequality can be shown through the rise in life
expectancy in developing countries from 55 to 65 between 1970 and 2004, and during the same period,
the decline in infant mortality from 1.07% to 0.59%.
Also, evidence suggests that economic inequality within countries is falling in some and rising in
others. Between 1990 and 2001, inequality fell significantly in East Asia and South Asia, and
increased in sub-Saharan Africa.
Analyse the impact of changes in the global economy on Australias current account and net foreign debt.
The evolution of the global economy and Australias consequent exposure to the international
business cycle greatly affect Australias current account balance and its net foreign debt level.
Yet domestic factors play an equally important role.
Current account
Non-reversible transactions
Categories: net goods, net services, net income, net current transfers
Derived by adding these four components together, the balance on the current account can
either be in balance, in surplus or in deficit.
Since the 1980s, Australia has managed to sustain a high CAD, although it tends to fluctuate
between -3 and -6% of GDP. In March 2009, the CAD fell to -1.5% of GDP, yet Treasury suggests
that this is only a temporary fall, with the CAD forecast to rise to -5.25% of GDP in 2009-10.
Net foreign debt, together with net foreign equity, makes up Australias net foreign liabilities
From 2000-01 to 2007-08 alone, Australias net foreign debt rose from 44% to 55% of GDP.
Servicing costs consistently make up a large proportion of Australias CAD, with the income component of
the current account (where these costs are recorded) averaging around 3% of GDP each year.
Lower global interest rates + falls in domestic profits have helped to reduce servicing costs during
recent years.
Yet the problem is primarily structural: Australias ongoing CAD results in a greater need for
foreign financial inflow must be serviced
Debt trap scenario
Question of whether Australias CAD drives net foreign debt or the other way around
In contrast, the balance on goods and services shows a cyclical trend over time, influenced by changes in
the level of growth in Australian and world economies.
Slower eco growth in Aus + strong growth in world economy improvement E.g. 2000-01
Strong domestic demand + weaker overseas conditions negative effect E.g. 2008-09. This is due
to increased import spending (on consumer and capital goods) and falling export spending
(despite strong growth in China, the sig contraction in global economic activity is expected to
reduce exports by 4% over 2009-10)
Quite apart from these cyclical factors, however, the move towards free trade between nations (through
reduced protection and the establishment of free trade agreements) has spurred growth in the volume of
global trade flows.
GWP/volume of world trade stat
This does not necessarily contribute to Australias CAD; favourable ToT and/or a sig greater
volume of exports relative to volume of imports improvement
Although, for the five years to 2007-08 the CAD remained above 5% of GDP, despite record high
ToT (121.1 in Sept 08)the Treasury is predicting a fall of 13.25% during 2009-10
In the long term, Australias narrow export base (60% of Australias export revenue comes from
commodity sales alone) will contribute to higher volatility in the CAD because Australia is exposed to large
fluctuations in commodity prices from year to year.
+ High dependence on imports worsens CAD, esp bc Auss comparative adv lies in low value-
added products and therefore tends to import high-value added products
Economists argue that Aus should expand its export base to include more services and ETMs in
line with changing global demand pressures
For this to occur, Aus industries must become more internationally competitive. Hence the
Governments efforts to maintain a low inflation rate and boost productivity levels through
extensive monetary policy and changes to work practices respectively.
The exchange rate influences both the income and goods and services components of the current account
bc it affects:
The price (and therefore competitiveness) of our M/X
The cost of servicing our net foreign debt (because 60% of it was borrowed in foreign currency
The value of our foreign debt i.e. valuation effect + value of foreign assets i.e. reverse valuation
Since $A was floated in 1983, it is now determined by forces of d&s in forex markets subject to
whims of foreign investors such that a high ongoing CAD may prompt a lack of confidence in the
Australian economy and in turn, lower demand for our products and a further depreciation in the
exchange rate Aus govt is very conscious of our overseas image, at the risk of injuring our CAD
Australias low level of national savings entrenches the CAD.
With household debt representing 160% of household income in 2008, Australia has one of the
lowest levels of household savings in the developed world.
Large gap bw savings and investment higher level of foreign liabilities higher def on income
component bc Aus must rely more on savings of foreigners to fund local investment
Govts recent attempts to increase the levels of private and public savings through compulsory
superannuation and fiscal consolidation (running balanced and surplus budgets) respectively
have clearly not been enough
Like the CAD, Australias net foreign debt is influenced by global and domestic factors.
Exchange rate (as above)
Internal trends in investment E.g. growth in foreign debt will slow if investors favour equity-
financing over debt-financing (as they did during the 2003-04 commodity boom)
Global financial deregulation increase in foreign debt
There are 2 measure of Australias debt sustainability: the net foreign liabilities figure + the debt servicing
Auss level of net foreign liabilities has continued to grow rapidly in recent yrs to an almost
record high of 61.2% of GDP by March 2009.
Auss debt servicing ratio peaked at just under 20% in the late 1980s and has since fallen due to
lower global interest rates and growth in Australias exports, although it was back up to 11.5% in
Both these statistics indicate that Australia could experience a debt sustainability problem in the
The globalisation phenomenon has rendered Auss CA and net foreign debt more vulnerable to
shifts in global investor sentiment and consumer demand.
To prevent this from posing a threat to Auss long-term economic stability, the Aus govt must
implement more micro reforms aimed at addressing the structural problems behind the CAD,
namely the low level of national savings and the narrow export base.

Economic implications for the Aus economy of Auss continuing CAD
Current account
Averaging 4.5% of GDP over the past two decades, Auss CAD whereby total payments exceed
total receipts has remained high over the long term.
Recent years have shown that there are many complex factors involved in assessing the
economic implications of such a trend for the Australian economy.
CA categories
Those who support Professor Pitchfords argument insist that CADs are generally beneficial to the
Australian economy.
Another argument pt forward by some economists is that Auss CADs have been largely a product of high
savings rates in other economies, rather than structural imbalances
Auss higher interest rates have traditionally attracted excess funds from countries such as Japan,
China, other East Asian countries, and the worlds major oil exporting countries.
Others, however, believe that there are clear risks associated with a continuing CAD.
Greater need for foreign financial inflow
Higher servicing costs debt trap scenario
Undermine confidence of overseas investors in Aus economy increased volatility of exchange rates
process sped up by recent technological advances and the deregulation of financial markets during the
Constraint on future eco growth contractionary govt policy
Yet in determining the overall effect of an ongoing CAD, it is important to consider precisely the factors
that have contributed to it.
E.g. higher CADs that are caused by increased productive investment in the long run are likely to
improve international competitiveness and boost trade performance.
By contrast, those that have resulted from increased consumption are more likely to have
negative effects.
In Australias case, the ongoing CAD has largely reflected structural problems in the economy,
including an over-reliance on commodity exports, a lack of competitiveness in manufacturing and
services industries, and the ongoing costs of a high level of foreign liabilities (such as interest
payments on foreign debt).
The size of the continuing CAD is another major factor shaping its impact on the economy.
Since the 1980s, Australia has managed to sustain a high CAD, although it tends to fluctuate
between -3 and -6% of GDP.
In March 2009, the CAD fell to -1.5% of GDP, yet Treasury suggests that this is only a temporary
fall, with the CAD forecast to rise to -5.25% of GDP in 2009-10.
The IMFs rule of thumb is that CADs are a problem when they exceed 4% of GDP.
Even so, it has had fewer negative consequences for the economy than many economists would
have predicted.
To prevent the ongoing CAD from posing a threat to Australian prosperity in the future, the Australian
Government must implement microeconomic reforms aimed at improving the level of domestic savings
and broadening our export base
Given that relatively large CAD outcomes have not prevented Australia from achieving 17 years of strong
economic growth and other positive economic fundamentals, many economists no longer regard it as a
threat to Australias long-term economic stability.
Yet there are some who dispute this assertion, particularly those working for the IMF.
Economists more widely agree that microeconomic reforms are needed to address the structural
problems behind the ongoing CAD.

Analyse the impact of globalisation on the economic performance of the Australian Economy
In an era of globalisation, with greater linkages b/w economies than at any other time throughout history,
the performance of individual economies such as Aust have become increasingly dependent on the swings
of the worlds major economies
Globalisation has provided Aust with a major source of economic growth, funds for domestic investment,
demand for exports and new investment opportunities in other economies with different comparative
Yet as an economy with a relatively high degree of global integration it is now also much more vulnerable
to both regional and global collapses on the strength on the increasingly synchronised global business

1. Globalisation of trade
Globalisation has resulted in dramatic increases in trade flows between nations contributors: global
webbing + reduced protection
International trade has historically played a very sig role in the development of the Aust economy, despite
its geographic isolation from the rest of the world
Annual trade with the rest of the world = almost half of Austs economic output world economic
developments can have a very sig impact on Aust
Reduced protection in agricultural sector has greatly increased Australias trade by allowing Aust firms
compete in international markets although ag protection remains high
Increased global trade has also led to changes in the composition of Austs export base
Our dependence on primary exports (narrow export base) make the large fluctuations in world
commodity prices particularly problematic e.g.
Current global recession, which has ushered in a sig decline in commodity prices due to falling
demand, will lead to a sig decline in Austs ToT from a high of around 120 in 2008 to below 90 in
2009-10 this will reduce real domestic income and the rate of domestic growth as a given
volume of exports will finance a lower volume of imports

2. Finance
Globalisation and the growth of international financial flows have had both positive and negative
effects on the Aust economy
Following the deregulation of the financial industry (began 1983), Aust saw a dramatic increase in its level
of net foreign investment
Austs persistent trade deficit (CAD has averaged -4.6% of GDP over the 2000s and over -5% for the last 5
years) + low level of national savings high foreign liabilities, leaving the economy vulnerable to changes in
global financial market sentiment
While this has greatly assisted our investment and eco activity over last 2 decades, it has also left Aust
with enormous net foreign debt
2007-08 debt servicing ratio increased to 12.2% due to tight global credit but by March 09 had
fallen to 9.8% due to reductions in global interest rates

(i) impact on AUD
Globalisation and the growth of international trade and financial flows have led to an increase in the
volatility of the AUD
It is the process of globalisation (resulting from deregulating financial markets and technology) that
enables a huge volume of speculative flows which largely determine the value of AUD and make its value
vulnerable to fluctuations)
Since 2007, volatility in the exchange rate, measured by daily fluctuations, has remained well above its
long term average due to strong fluctuations in commodities prices and general uncertainty in markets
After reaching a post-float high of US97.86 cents in July 2008, the AUD depreciated sharply, declining by
almost 30% in 2 month period from late August 2008 to a low of US61.22 cents in October 2008
The most important longer term factor which has lead to this depreciation is the terms of trade collapse
in global demand stemming from the global recession, and the dramatic slowdown in growth in China, has
seen prices fall sharply (deterioration ToT)
This depreciation has increased the price of imported goods

(ii) Inflation
Austs inflation rate has been one of the cornerstones of our economic success in recent years
With the exception of the one off following the strong upswing in eco growth in 1995, the GST in 2000
and the supply constraints in 2007-08, Aust has maintained an inflation rate that has on average remained
within the RBs inflation target of 2-3% this has largely been due to globalisation
Inflationary targeting (adopted in Aust in 1996) has become part of the generally accepted global
framework for eco policy in recent decades following its success in numerous countries such as Germany
Additionally, the increased competitive pressures that have come from increased global trade have added
to pressures keeping inflation low for the Aust economy

3. Convergence of policies
Globalisation has had a significant impact on economic management across the globe
This can be seen in the synchronised response to the GFC:
In response to the GFC governments through their central banks have eased monetary policy: in
major advanced economies central banks have lowered policy interest rates significantly, with
some policy interest rates even near zero (official cash rate: US = 0.125%, Aust = 3%)
Also implemented substantial budget stimulus packages designed to support aggregate demand
and production over and above the operation of automatic fiscal stabilisers of govt spending and
Aust joined rest of world in adopting expansionary macro policy settings in dealing with the GFC

4. Labour markets
Despite these benefits, several negative impact on Austs economic performance have stemmed from
Increasing international trade and movements towards international free trade may have long term
benefits for the economy, but they also have short term costs
In the 90s the beginnings of structural change in Australian economy led to an increase in structural
unemployment in sectors such as agriculture and manufacturing
E.g. global push to market forces placed downward pressures on wages resulting in lower incomes for
many workers increased the inequality of wage distribution in Aust and many other countries

5. Responsiveness of global business cycle
The global business cycle refers to fluctuations in the level of economic activity in the global economy
over time
The global business cycle experienced a prolonged upswing and subsequent boom with growth rates
averaging 3.7% from 1971-2008 reaching 55 between 2003-2008
The shock of the GFC pushed the cycle into a downswing and trough with growth expected t fall to 0.5% in
2009 (IMF)
These movements in the global business cycle are reflected in Austs economic growth performance
Over the 90s and early 2000, Aust sustained the second highest growth rate in the second highest growth
rate in the industrialised world (3.5%)
This was achieved while still maintaining low inflation and falling unemployment
The current global down turn that has resulted in recession in many industrialised and developing
economies is expected to reduce Austs growth to almost zero in 2009 despite low domestic interest rates
and the govts fiscal stimulus packages helping to support domestic demand

Aust has proved more resilient than other industrialised nations to downturns in the international
business cycle
Notably, the Asian led crisis of 1996, US led downturn in 2001 and the current GFC
Despite faltering to 1.8% in early 2000-01, the Aust economy did not follow many of the worlds
economies into recession
Economic growth rebounded to 4.1% in 2001-02 due to favourable economic conditions
The Aust economy has been insulated to a large extent from the current global crisis as a result of
monetary and fiscal policies providing substantial stimulus to domestic demand and confidence; the
economy being in better economic and financial shape than many other economies before the onset of
the GFC; the depreciation of AUD increasing competitiveness and the better than expected export sales
particularly to China, however these factors have not prevented a sig downturn