TRADE LIBERALISATION

↓ = undermine, slows, limits, decreases, restricts

↑ = increases, improves, expands, supports,

 = contributes to, leads to, tends to, results in

DEFINE:
- Trade liberalisation is gov policy of the removal of protectionist measures of local industry by governments to increase the free movement and
exchange of G/S around the world
 ↓ quotas, tariffs, subsidies

 ↑ increasing free trade agreements, reduction in industry assistance.

 MOST RECENT: Indonesia-Australia Comprehensive Economic Partnership Agreement (IA-CEPA) 5 th July 2020 –
involved removal/reduction of tariffs on Australian exports to Indonesia and Indonesian imports to Australia.
- With freer trade, nations are forced to allocate resources into areas of production where they have a comparative cost advantage
 The Australian government has gradually adopted this policy since 1972, but especially in the period 1990 to 2020

 world trade – the total value of exports plus imports of goods and services – as a percentage of GDP exploded by 43% over a recent
15-year period.

DEFINE FREE TRADE (Different from Liberalisation): Free trade means no protection of local industry at all – opposite of trade
protectionism

WHAT IS TRADE:

EXPORTS
- Are those G/S which AUS sells to buyers in other countries (AUS – iron ores, coal, education)

IMPORTS
- Are those G/S which AUS buys from sellers in other countries

AUSTRALIAN POLICIES

POLICIES DEFINE/EFFECT (BARRIER/ENABLING) TRADE LIBERALISATION

SUBSIDIES - Government cash payments made to local producers/industries  - ↓ subsidies paid to local firms  allow imports to compete on same
domestic G/S dearer basis as locally manufactured products
- designed to help cover COP – incentivise production of a G/S +
keep prices low
 Tax Incentive Scheme: R&D in smaller companies
 Farm Household Allowance: concessional loans –
support financial hardship
 Tasmanian Freight Equalisation: reduce transport cost
disadvantages
TARIFFS - Indirect tax levied on the price of selected imported goods → make - ↓ tariffs  encourage firms to be internationally competitive  make
them dearer/less attractive to local consumers foreign goods cheaper
 ↓ foreign competition/the supply of goods in local markets.  ↑ productive capacity/living standards
 resources allocated inefficiently (industries without  (Implemented in AUS in past 50 years)
comparative cost advantage)
 local firms can remain uncompetitive and still survive
 while local households and businesses must pay high  (General Tariff Rate - ↓36% (1968–69) to around 5% (1995–
prices for these items  ↓ living standards. 96 onwards)

IMPORT QUOTAS - quantitative government restrictions to restrict supply of - import quotas  expand volume of foreign goods entering the country
specific imports allowed in the country (issue of licences to -
importers
- 1970s-1980s: cars, textiles, footwear and clothing
FREE TRADE - Treaties between two or more countries designed to reduce or - signing up to more bilateral/multilateral free trade agreements (FTAs)
AGREEMENTS eliminate barriers to trade and investment with other countries
(FTA)
- progress has been slow due to significant opposition from interest
groups (America, Trump dropped out of Trans-Pacific Partnership +
others)

- 14 in operation by late 2020

 Closer Economic Relation 1983: Australia – NZ

 Trans-Pacific Partnership 30 Dec 2018: eliminate 98% tariffs
on agricultural exports:

Australia – Singapore, Thailand, China, Korea, Japan,

Indonesia
 (MOST RECENT) Indonesia-Australia
 Comprehensive Economic Partnership Agreement
(IA-CEPA): 5th July 2020 – involved
removal/reduction of tariffs on Australian exports to
Indonesia and Indonesian imports to Australia.

PROTECTIONISM V TRADE LIBERALISATION

PROTECTIONISM/BARRIERS TO TRADE TRADE LIBERALISATION

DEFINE - tools/means by which countries protect local industries/jobs - Trade liberalisation is gov policy of the removal of protectionist
measures of local industry by governments to increase the free
movement and exchange of G/S around the world

DIFFERENCES - Protect Australian jobs/incomes International Competitiveness

- Prevent the erosion of local culture and identity
- Satisfies the Infant Industry Argument
 new industries that are just being established will have
higher production costs than well established
competitors
- Encourages firms to specialise their production in areas of comparative
cost advantage, minimising opportunity costs
- Economies of large-scale production: larger production runs, by selling
in massive export markets
- Forces firms to restructure their operations, adopt latest technology,
seek lowest cost of production (dynamically and technically efficient)
- Encourage firms to think creatively, provide better service & meet
customers’ changing needs (dynamic efficiency)

 (Global competition – dumping, attacking)

 justifies helping them get started through form of trade

protection measures

EFFECT OF TRADE LIBERALISATION ON AUSTRALIA’S INTERNATIONAL COMPETITIVENESS

- Forces businesses/firms to:
 use resources most efficiently in areas of comparative cost advantage.
 restructure and cut production costs through more imports
 gain better economies of large-scale production by selling/accessing niche/bigger markets.

BENEFITS/EFFECT OF TRADE ON MLS/NMLS

(Seeing the benefits and costs of the growth in world trade due to trade liberalisation)

DEFINE LIVING STANDARDS:

- Material living standards:
 ‘quantity’ of G/S households can afford/access to consume – measurable
 Given level of wellbeing/purchasing power
 (National production, distribution of g/s, inflation, unemployment)

- Non-material living standards

 'quality' of life unconnected to material possession/purchasing power
 more difficult to measure – subjective
 (happiness, physical and mental health, crime rates, life expectancy, literacy rates)

POSITIVE IMPACT OF FREER TRADE ON LIVING STANDARDS

International specialisation – EVALUATE IMPACT ON MLS

- trade liberalisation has exposed Australian producers to increased competition from cheaper imports  Australian producers need to improve
production processes and efficiency to survive in the new more competitive marketplace.
- Meaning countries will produce/export only a limited range of G/S
 Through a reallocation of resources away from industries/sectors where AUS is a relatively inefficient producer (certain fields of
manufacturing)
 focusing on those areas where they have the greatest cost advantage over their international rivals – tourism, education, mining
 income gained used to pay for imports too expensive to produce locally
 (Each country have different combinations of resources  some more efficient in certain forms of production)
 By allocating resources to their most productive or efficient use  nation can generate more output (GDP) from the same inputs
(resources)  ↑ Efficiency
- Evaluate effect on MLS:
 SHORT TERM (BAD): exposed to more intense international competition  many industries forced to restructure
 cause a temporary fall in general living standards.
 uncompetitive firms/industries close down (clothing/vehicle)
 relocate to low-wage countries
 restructure their production by substituting machines for workers.
 Leads to significant job losses  ↓ MLS
 LONG TERM (GOOD): restructuring economy towards industries w comparative advantages  allocating resources to their most
productive/efficient use  nations generate more output (GDP) from the same inputs ↓ COP  ↑ employment  ↑incomes 
Since the full-time minimum wage is greater than welfare payments, more G&S can be bought  ↑ MLS.
  Additionally, AUS able to access cheaper imports (w/o needing to pay tariffs that add to import prices)  ↑ PP of
household incomes  ↑ household access to G/S  ↑MLS
 CONCLUSION: short term adjustments outweighed by long term benefits of ↑ efficiency/output
 in recognition of the negative impact of the restructuring  governments provided assistance and support to those
industries subjected to costs of adjusting to trade liberalisation.

What is International specialisation based on?

- International specialisation based on:
 Absolute cost advantage: occurs if a nation is the cheapest/most efficient producer of a single G/D in the world
 Means that the country would benefit from international trade as their exports will sell well
 Korea – cars, Australia – iron ore (Korea or other keen to buy from Aus)
 Comparative cost advantage: occurs if a nation specialises in a few key areas of production
 where its cost advantages are greatest or its disadvantages are lowest  opportunity cost minimised and output
maximised
 even though a nation might not have absolute cost advantage, international trade is still beneficial for a nation in terms of cost
advantage

Economies of large-scale production – MLS

- International trade allows firms to sell to a larger markets  economies of large-scale production
 Are reductions in a firm’s average costs per unit, associated with an increase in its annual production level
- Producing large volume of G/S  firms spread fixed costs (remain same irrespective of volume – salaries, taxes, utilities) more thinly over a
large volume of output (↓cost per unit)
 As international trade gives opportunity for Robots, product design, purchase of raw materials
- In the removal of protectionist measures → bus access larger global market (up to 7.4 bill > 25.7 mill Aus)  firms produce on a larger scale
→ greater sales volumes  such that larger production volumes ↓ avg COP
 Firm’s can ↓ prices, whilst maintaining profit margins  ↑ consumer purchasing power  ↑ MLS
 Through an expanded market demographic  derived demand for labour  ↓ unemployment  ↑ NMLS - ↓ crime and stress

Lower prices for consumers - MLS

- Trade  ↓ COP  ↓ inflation ↓ prices for consumers  ↑ consumer’s purchasing power  ↑MLS
- Studies (Melitz/Schwerhoff/Sy) in 2003/2013: ↓ tariffs  ↓ average annual inflation rate over 120 countries (26% to 4%)
- Due to:
 Access to the cheapest suppliers
 ↑ competition with local suppliers/markets  ↑ international specialisation (countries specialise in production they specialise in)
 Reduced domestic market power - ↑ imports = firms are forced to become internationally competitive  innovate so ↑quality ↓prices
 ↑ wage competition
 ↑ the level of competition from low-wage countries  slow the growth of wage costs  firms sell their product more
cheaply
 Economies of large-scale production

Countries access more resources – MLS

- Australia has plentiful iron ore and coal deposits, but does not have many oil deposits
 export iron ore/coal, imported petroleum dominated by Singapore
- Natural: Australia & African countries
- Labour: China, India & Indonesia
- Capital: Japan & Singapore

Reduce Unemployment – MLS + NMLS

- increased international trade  ↑ need for labour resources to produce exports  creates jobs
 thus lowering unemployment (in the long term) – purchasing power, ↓ crime/stress
 ↓ global poverty rate by over 56% from 1990

Greater consumer choice – MLS + NMLS

- they can access a more diverse range of G&S
 particularly those not available domestically
- wants can be satisfied to a greater degree  ↑ access to G/S
- celebrates/enriches the culture of nations  more vibrant and interesting societies.

Promote peace – NMLS

- need for good relationship/inter-dependence  nation maintain cordial relationships to promote exports/imports
 ↓ likelihood for war/conflict.
 ADVERSE IMPACT OF FREER TRADE ON LIVING STANDARDS
REASONS
CAUSE A RISE IN STRUCTURAL UNEMPLOYMENT IN
THE SHORT TERM
EFFECTS ON INCOME DISTRIBUTION
WEAKEN ECONOMIC STABILITY
ADVERSE EFFECTS ON THE NATURAL/URBAN
ENVIRONMENT
DISCOURAGE/PREVENT DEVELOPMENT OF INFANT
INDUSTRIES
IMPACT ON MACROECONOMIC GOALS/IC
GOAL
LOW INFLATION (2-3%)
FULL EMPLOYMENT (4.5-5%)
STRONG/SUSTAINABLE ECO GROWTH (3%)
WHY
- exposed to more intense international competition  many industries forced to restructure
- cause a temporary fall in general living standards.
 uncompetitive firms/industries close down (clothing/vehicle)
 relocate to low-wage countries
 restructure their production by substituting machines for workers.
- Leads to significant job losses  ↓ MLS
- There is a rise in income inequality observed with accelerated growth in international trade (not proven)
 Trade in China since 1990  reduce global poverty rates by over 56% (MOSTLY in East Asia)
 Strong competition from imports  producers are encouraged to sell overseas where they can get
better prices  higher local prices of basic food  depresses wages + business closure
- Dependence on international trade means that
 if a major nation were to fall into a recession/slowdown
 this reduces economic stability as others are likely to follow
 global financial crisis (2008-10)
 slowdown in major economy (CHINA)
 COVID-19 (2019-2021)
- global output increase at faster rate – depletion of natural resources (Indo, Brazil)
- higher carbon and other emissions – transportation of G/S  global warming/pollution
- accelerated urban problems – trade encourages growth of cities  overcrowding/transport congestion
- new industries that are just being established will have higher production costs than well established
competitors
- Trade exposes domestic industries to stronger competition from often cheaper imports.
- higher costs & limited cash flow  less competitive  ↓ growth in capacity/job creation  ↓ MLS
IMPACT
When tariffs are reduced/removed, price of imported goods is reduced
 helps to keep the inflation rate low  likely be exceeded by growth in nominal incomes  ↑
real incomes  ↑purchasing power  ↑ G&S can be bought  ↑ MLS.
This exposes Australian businesses to more intense price competition from foreign goods → forces firms to
improve productivity (more output from inputs) to lower average costs of production to be able to compete on
price → international competitive
Allowed cheaper access to imported capital equipment, which reduces costs of production and bears down on
cost inflationary pressure – as resources are re-allocated to areas where Australia has a comparative cost
advantage, increasing allocative efficiency.
SHORT-TERM
As local businesses are exposed to competition with imports – uncompetitive firms will be forced to shut down
or restructure (e.g., replace labour with capital)  structural unemployment
Also, the removal of subsidies such as those made to Australian car manufacturers meant that producing
Australian cars was no longer viable => Increase in structural unemployment
LONG TERM
A low inflation climate will be conducive to business investment and expansion as businesses are able to
budget for profit with greater certainty → more employment opportunities
local businesses become more internationally competitive with more opportunities for sales in export markets
→ increase derived demand for labour resources  ↑AD  ↑EG
SHORT TERM
Imports will penetrate the local market as they have ↓ protectionist measures 
→ ↓ domestic sales  local firms close down when they are unable to compete with reduced price imports 
↑ imports  ↓ AD/GDP/Economic growth
↓ tariffs on inputs in production (e.g. capital equipment) lead to lower costs of production → increase
international competitiveness → increase economic growth
LONG TERM
Local firms restructure operations to compete with imports and resources reallocated from less efficient
industries to most efficient industries → Australia has a comparative cost advantage → ↑ efficiency  ↓ COP
 per unit for firms  allow them to offer ↓ prices  ↑ internationally competitive in terms of price  ↑ exports/↓
imports  ↑AD/Economic growth

INTERNATIONAL COMPETITIVENESS SHORT TERM

imports will penetrate the local market as they have ↓ protectionist measures  ↑ relative price
of AUS G&S compared to imports  ↓AUS IC in terms of price  ↑ import purchases instead of
domestic substitutes.

LONG TERM

↑ efficiency  ↓ COP per unit  ↓ prices  will strengthen Australia’s IC in terms of price  ↑
export sales/↓ import purchases

BALANCE OF PAYMENTS

BALANCE OF PAYMENTS ACCOUNTS

TYPES OF INTERNATIONAL TRANSACTIONS: trade of g/s, financial capital flows, shares, international transfers, foreign aids, human
capital flows

DEFINE:
- Balance of payments account (BOP): annual statistical record of the money value of different types of financial transactions between Australia
and the rest of the world – monitor economic performance
 money Australia receives by residents from overseas – regarded as a CREDIT
 money Australia pays to overseas – classified as a DEBIT

ENTRIES:
- Credits – a transaction that results in an inflow of money into AUS (positive entry)
- Debits – a transaction that results in an outflow of money from AUS (negative entry

BALANCE OF PAYMENTS ON CURRENT ACCOUNT

THE CURRENT ACCOUNT records individual consumption with net flow of money resulting from international trade/income related to G/S that (are one-off) do not result in future obligations

SUB ACCOUNT WHATS RECORDED CREDITS (IN) DEBITS (OUT)

(DIFF IN VALUE OF)
NET Total credits received from the: Exports: iron ores, beef, natural gas Imports: oil, electronic equipment and machinery
GOODS/BALANCE Export credits for goods sold overseas
OF MERCHANDISE Less
TRADE (BOMT) Import debits for goods purchased from abroad
(sometimes in surplus)
NET SERVICES Total credits received from the: Exports: tourism, education, Imports: tourism, education, transportation,
(largest component) Exported service credits received by Australia
transportation, construction, financial, construction, financial, royalties, licence
LESS royalties, licence fees and insurance, CALL CENTRES
Imported Service debits paid from abroad fees and insurance, BANKING
TRADE BALANCE = NET GOODS + NET SERVICES (FORMS PART OF GDP – USED FOR ECONOMIC ANALYSIS
NET PRIMARY Total credits received from the: Wages, salaries, interest, profits Wages, salaries, interest paid on debt, profits earned
INCOMES income credits received from overseas earned by Australian companies by foreign companies operating in AUS, DIVIDENTS
LESS overseas, DIVIDENDS ON FOREIGN ON AUS SHARES
income debits paid out abroad SHARES

FROM WORKING (WAGES) OR FINANCIAL

INVESTMENTS (DIVIDENDS)
NET SECONDARY Total credits received from the: Gifts from overseas, non-life Gifts, taxes, foreign food aid indebted/donated by
INCOMES secondary income credits received by AUS residents insurance transfers (e.g., pensions) AUS residents
(insignificant) LESS
the value of secondary income debits paid abroad

Secondary incomes diff from other transactions

(One-way transaction with nothing exchanged in
return)
+
Income that AUS residents earn from
LESS
Income that they pay to

the rest of the world from the government (e.g. tax

payments and refunds).

THE BALANCE OF PAYMENTS/CAB = NET GOODS + NET SERVICES + NET PRIMARY INCOMES + NET SECONDARY INCOMES
 BALANCE OF PAYMENTS ON CAPITAL AND FINANCIAL ACCOUNT

CAPITAL AND FINANCIAL ACCOUNT records net changes/transactions in ownership of assets/liabilities that creates future obligations to send or receive money
SUB ACCOUNT WHATS RECORDED CREDITS (IN) DEBITS (OUT)
(DIFF IN VALUE OF)
BALANCE ON CAPITAL ACCOUNT: insignificant, records capital transactions/transfer of assets – net capital transfers/the net acquisition of non-produced/non-financial assets
= CAPITAL TRANSFERS + NET ACQUISITION/DISPOSAL OF PRODUCED, NONFINANCIAL ASSETS
CAPITAL capital transfer credits received Net inflow of funds into Australia by permanent Net outflow of funds out of Australia to permanent
TRANSFERS LESS migrants migrants
capital transfer debits paid - forgiveness of debt (borrower no longer - forgiveness of debt (borrower no longer needs
needs to repay what they borrowed) to repay what they borrowed)
- conditional grants for capital projects - conditional grants for capital projects (foreign
(foreign aid to build schools/dam) aid to build schools/dams)
- transfer of assets between - transfer of assets between residents/non-
residents/non-residents residents
NET ACQUISITION / Inflow/outflow of assets that covers the excess - Australia sells a license to the US - ???
DISPOSAL OF NON- of credits over debits for the sale of: - overseas franchises (KFC, MCDONALDS)
PRODUCED,  copyright
NONFINANCIAL  patents
ASSETS
 overseas franchises (KFC,
MCDONALDS)
 trademarks of a tangible nature
BALANCE ON FINANCIAL ACCOUNT: shows how Australia funds its CAD, record the total credits for investment/ borrowing LESS total debits for investments and lending
 concerning foreign financial assets/liabilities that impact official and non-official flows
 Each official and non-official flows will be recorded in one of the five subaccounts within the Financial Account
= NET INVESTMENT (INVESTMENT CREDITS – INVESTMENT DEBITS) + NET RESERVE ASSETS BY THE RBA (CREDITS RECEIVED – DEBITS PAID)
NET DIRECT Purchase, setting up or expansion of - Uniqlo opening a new store in - Australian mining company opening a new oil
INVESTMENT companies/assets through capital investment Chadstone field in PNG
into AUS by foreigners where investor has
voting power
(>10% or >ownership of shares)
LESS
similar investments overseas by Australian
residents
NET PORTFOLIO transactions (<10% investment in a company) - Foreign household buys Qantas shares - Australian household buys Apple shares
INVESTMENT by foreign individuals purchasing Australian
shares, equities, debt and securities
LESS
the value of similar assets purchased by
our residents.
OTHER INVESTMENT Other investment inflow credits - Inflow of funds/assets - ANZ deposits in Swiss bank accounts
LESS - Australian government issues/sells - Loan, deposits and trade credits
Other investment outflow debits bonds (Importer purchases goods from overseas and
- Loan, deposits and trade credits does not pay for the goods until they are
(importer purchases goods from received (e.g. Australian travellers pay for
overseas and does not pay for the goods accommodation in Bali)
until they are received (e.g. Australian
travellers pay for accommodation in Bali)
NET INVESTMENT = NET DIRECT + NET PORTFOLIO + OTHER INVESTMENT
NET RESERVE RBA and government transactions involving - Money received from overseas - Payments made overseas
ASSETS foreign currency and contributions to the IMF - (RBA purchases AUD to smooth out - (Australian government sends money to the
and UN volatility) UN)
NET ERRORS AND net errors and omissions this reflects -
OMISSIONS inaccuracies in the above calculations and
estimations.
(its impossible to get billions of dollars to
balance perfectly to zero – ABS adds/minus
small value in this section to represent these
mistakes so BOP is perfectly balanced
NET RESERVE ASSETS = NET RESERVE ASSETS – NET ERRORS AND OMISSIONS
RELATIONSHIP BETWEEN THE CURRENT ACCOUNT AND THE CAPITAL AND FINANCIAL ACCOUNTS

RELATIONSHIP (ZERO BALANCE):

- Items on the BOP are grouped into current account transactions or capital and
financial account transactions
 With the overall BOP – the CA and CAFA add together to equal zero as a
negative balance in one of the accounts must be exactly offset by a
positive balance of the same size in the other account(credit: money
inflow = debit: money outflow)
 With credits balanced against debits.
 (While this is true in theory, statistical manipulations are
made to ensure that this occurs in practice)
- This logic is represented in the double-entry accounting framework where the
value of whatever is traded (CA) is offset by a movement of some form of asset to
pay for it (CAFA)
 Consequentially, the balance of one account is in surplus (+, credit) and the
other must be in deficit (-, debit)
- Where the CAFA is how Australia finances its CAD  When Australia
experiences a CAD, the shortfall is financed by loans from overseas (debt) or the sale
of Australian assets to overseas holders (equity)
 Means that AUS CAD (debit) is offset/matched by a credit in the BOP
associated with a capital and financial account surplus  ↑ NFD
 As Part of the reason for AUS CAD is the interest Australia pays to the rest
of the world on its international borrowing

IMPACT ON MOVEMENT ON CA ON CAFA:

- ↑ CA balance contributes to a smaller surplus in the CAFA
- Any improvement in the CA balance over the period represents a ↓ in the net outflow of funds/debits
 Thus with less spending on imports/debits (e.g., from COVID-19)  ↓ debits/CAD to offset/finance  ↓ amount of inflows/credits
needed via the CAFA
 such that the balance of payments for the period will add up to zero.

CURRENT AUS BALANCE OF CAPITAL AND FINANCIAL:

- overall, Australia’s balance on capital and financial accounts is generally positive.

- This means there has often been a net financial inflow – a rise in the nation’s liabilities overseas

 will exactly offset the usual deficit recorded on the current account, allowing the overall BOP account to be in balance

CURRENT ACCOUNT DEFICIT (CAD)/CURRENT ACCOUNT SURPLUS (CAS)

- in Australia's case, the overall balance involves a large current account deficit (CAD)
wherein CA is negative and total value of debits exceeds the total value of credits.
 Usually NPI is the primary reason for persistent, large CADs
 Also from foreign ownership of many Australian companies and
the large foreign debt involving the annual payment of incomes
overseas.
- means that there has to be an offsetting rise in the nation's net external liabilities
 where savings from the rest of the world are used to finance Australia’s high
levels of investment and consumption
 through overseas borrowing (debt) and/or the sale of Australian assets (equities)
 facilitating the two-way relationship that makes up overall BOP
- However, on occasions, AUS run a current account surplus (CAS) as seen in 2019–20

CAUSES OF CAD

HOW AND WHY IS CAD RECORDED

- AUS has persistent CAD – illustrated in either billions of dollars/CAD to GDP ratio percentage
 3-4% indicative of AUS not paying its way in its international financial transactions
 CAD evident as most of the components are negative
- Important to account for huge deficit recorded every year for net primary income
  Where this means that AUS is very dependent on heavy overseas borrowing and a reliance on capital inflow
 thereby necessitating high levels of income debits

DIFFERENCES BETWEEN CYCLICAL AND STRUCTURAL CAD DETERIORATION :

- A cyclical deterioration of the CAD occurs as a result of an increase in national spending (e.g. final demand or GNE)
  impacts spending on imports  ↑ Balance on Merchandise Trade and Net Services deficits
 Furthermore, if this increases spending relative to income  ↑ foreign borrowing to support the strong growth in domestic spending
 Accordingly, the CAD increases in line with an increase in the economic cycle
(e.g. during spending booms the CAD is high).
- In contrast, a structural deterioration of the CAD occurs as a result of other factors that are unrelated to changes in the economic cycle

AGGREGATE DEMAND FACTORS AFFECTING AUSTRALIA’S CYCLICAL CAD

HOW CAD INCREASES/DECREASES IN RESPONSE TO AD:

- ↓ AUS CYCLICAL CAD or may turn to a surplus – favourable domestic AD factors  ↓ AUS spending on imports, ↑ overseas spending on
AUS exports
- ↑ AUS CYCLICAL CAD – unfavourable domestic AD factors  ↑ AUS spending on imports, ↓ overseas spending on AUS exports

AD FACTORS
Overall Demand
- High overall demand  ↑ demand for imports  ↑ debts in BOGS  ↑ CAD

Peak/Period of economic growth in business cycle

-  ↑ consumer confidence and AD  people save less and invest more  ↑ borrowing from overseas  ↑ NFL  ↑ debits in net primary
incomes  ↑ CAD

Strong Economic Activity/↑ GDP Overseas

- ↑ economic growth overseas (such as China – major trading partner)  ↑ demand for Australian exports  ↑ inflows or credits on the current
account as ↓ net G/S debits  ↓ CAD.
 ALSO ↑ TOT (due to ↑ demand/↓ supply of AUS exports)  the average price of exports has risen relative to the average price paid for
imports  ↑ value of export sales relative to the value of purchases of imports over the same period  ↑ level of credits relative to
debits for BOGS  as BOGS is a significant subaccount of the CA  ↓ Australia’s cyclical CAD
 strong economic growth overseas has also helped in lifting Australia's terms of trade recently until COVID-19 Recession March 2020
 overseas economic activity among major trading partners has helped grow the level of overseas spending on Australian exports by
around 3-4% a year.

Terms of Trade
↑ TOT (due to ↑ demand/↓ supply of AUS exports)  the average price of exports has risen relative to the average price paid for imports  ↑
value of export sales relative to the value of purchases of imports over the same period  ↑ level of credits relative to debits for BOGS  as
BOGS is a significant subaccount of the CA  ↓ Australia’s cyclical CAD

Decrease in Economic growth overseas (opposite)

- ↓economic growth overseas (such as China – major trading partner)  ↓demand for Australian exports  ↓inflows or credits on the current
account as ↑ net G/S debits  ↑ CAD.
 ALSO ↓Australia’s TOT  greater quantity of exports are needed to purchase the same quantity of imports  ↓ level of credits relative
to debits for net goods  ↑Australia’s cyclical CAD.
Weaker exchange rate for the Australian Dollar
- AD factor that affects spending on AUS-made G/S, and hence size of cyclical CAD
- Recently relatively weaker AUD  ↓ cyclical CAD/↑CAS – ↓ prices for exports  ↑ sales/credits, while imports are dearer (↑ prices)  ↓ debits
 ↓ cyclical CAD

Fairly flat consumer confidence and slowing business confidence

- Recently, flat domestic consumer confidence and falling levels of business confidence about future economic prospects  slow the growth in
the spending on imports of goods (e.g. cars/electrical appliances/machinery) and services (e.g. travel)
- As weaker domestic AD factors have tended to () ↓ Australia’s cyclical CAD or cause a CAS.

Slow rise in real disposable income per head

- The relatively slow rise in Australia’s real household disposable incomes in 2018–19–20  ↓ spending on imports  ↓ debits for goods and
services  ↓ cyclical CAD/↑ CAS.

Low interest rates

- Record low interest rates recently have had mixed effects on Australia’s CAD.
 ↓ interest rates  ↓ cost of borrowing of credit to help finance household consumption/business investment spending  ↑ spending on
imports of G/S  ↑ Cyclical CAD
 However, ↓ interest rates relative to those abroad in say the United States  ↓ exchange rate  make our exports more attractive
abroad, relative to imports  ↓cyclical CAD/↑ CAS.
Higher Interest Rates
- the higher interest rates help to restrain growth in spending  ↓ gap between spending and income that is the primary cause of the CAD
- However, Stronger domestic spending  RBA ↑ interest rates to control inflation  makes Australia relatively more appealing to investors 
attracting additional capital inflow  ↑ demand for AUD  ↑ exchange rate  ↓This is turn makes Australia comparatively less internationally
competitive  ↓ net exports relative AUS spending on imports  net outflow on the current account  ↑ cyclical CAD.

Reductions in the size of the government’s budget deficit

- Over the last few years until 2020, the Australian government ↓ budget deficit through ↑ budget tax/other receipts relative to government
spending and other outlays  ↓ growth in AD  ↓ spending on import and other debits (e.g. reduced outlays on foreign aid)  ↓ Cyclical CAD,
- the recent rise in the budget deficit due to the COVID-19 recession  ↑ CAD.

HOW CAD INCREASES/DECREASES IN RESPONSE TO AS:

- ↑ Structural CAD in the long term - unfavourable AS factors  ↓ efficiency  ↑ costs  ↓ international competitiveness of locally-made
Australian exports/businesses against imports
- ↓ Structural CAD or ↑ CAS in the long term – Favourable aggregate supply factors  ↑ efficiency  ↓ costs  ↑international competitiveness
of locally made Australian exports/businesses against imports.

AS FACTORS

Reduction in real unit labour costs (RULCS)

- wages are a major production cost, accounting for around 60-70% of the overall COP
- therefore, recent ↓ Australia's level of real wage costs per unit of output as a favourable AS factor
  ↓ production costs  ↓cost prices  locally-made goods and services more internationally competitive price wise
  ↑ ability of local firms to sell domestically against imports and to export abroad  ↓ structural CAD/↑ CAS
 still a problem prone to fluctuation as Australia is still a high-wage country

The Relatively Low Cost of Oil

- oil is an important cost of producing/distributing/delivering G/S
- recently, oil prices have been relatively low  ↓ cost of imports, keeping debits and the CAD low
 ↑ value of export credits against import debits – the overseas sector is more likely to consume exports.

Reduced Rates of Company Tax And Improvements In Infrastructure

- the Australian government recently cut the rate of tax for small and medium sized companies from 30% to 27.5% to 26% (2020-21) and to
25% (2021-22).
- by ↑ after-tax profits of local firms, this policy allow Australian companies to sell at cheaper prices
  be more internationally competitive both domestically and abroad  ↑ export credits relative to import debits  ↓ structural CAD
low.
- there have also been an increase in government budget outlays to ↑ efficiency/adequacy of national infrastructure (in areas – roads/rails) +
utilities (electricity/gas) ↓ production costs – bus use infrastructure  ↑ international competitiveness of local firms

A Lack of National Savings and A Dependence on Overseas Borrowing (Savings-Investment Gap)

- a deficiency of national/domestic savings by households, bus, gov to finance high levels of national investment
 as a problem that stems from the fact that capital investment is sought within Australia needed to grow the economy's productive
capacity and maintain high living standards.
 of which is worth more than the total savings available in the country that can be borrowed.
- means that they must borrow or sell equity to overseas  credit is recorded in the CAFA.
- However, this imbalance must be financed by foreign funds  ↑ NFLs/the interest repayments/debt which must be repaid
 That are recorded as debits in net primary incomes  ongoing structural CAD contributes to CAD

Weaker Growth in Productivity

- productivity indicates efficiency – important for international competitiveness.
 measured as either labour productivity or multifactor productivity.
 labour productivity reflects the total number of hours worked against GDP
 multifactor productivity where the total value of labour, capital and other inputs are measured against GDP
- recently, productivity growth has been very weak  ↓ Australia's international competitiveness  ↓ export sales  ↑ imports  ↑ structural
CAD.

Climate Change and Severe Weather Conditions

- over the last two years, Australia has experienced more severe weather events  damages infrastructure and businesses  ↓ Australia's
productive and export capacities  ↑ production costs  ↓ profits  make local firms less internationally competitive  ↑ Structural CAD

The Effects of our Ageing Population and Immigration

- Australia has an ageing population  ↓ growth in the supply/availability of labour resources  unfavourable – ↑ wage costs  ↓ international
competitiveness  shortages in terms of labour supply/skills  ↓ growth of export  ↑ Structural CAD

Poor International Competitiveness

 - Australia has poor international competitiveness in terms of price due to high-cost structures/low levels of efficiency compared to many
other countries (through high costs of labour, value of AUD)  This results in fewer export sales (i.e. fewer G&S credits) and more import
purchases (i.e. G&S debits)
 This means that the value of the BOGS is often in deficit  ↑ structural CAD

Outline why the CAFA surplus in the balance of payments will increase in response to a CAD and explain the implications for
Australia's level of NFD (3 marks)
- A CAD indicates that for a particular period, Australia spends more than it receives and this shortfall needs to be funded by overseas
borrowing or selling of assets which is reflected in the CAFA surplus.
- To the extent that the funding comes in the form of debt rather than equity...
- this increases the NFD

Outline how a subsidy for exporters can have a positive impact on the Balance on Merchandise Trade (4 marks)
- A subsidy (direct cash payment or tax concession) for exports  ↓ COP  suppliers more willing/able to supply  ↑ supply
- Competitive businesses may choose to pass on this cost in the form of a discounted price  ↓ prices of Australian exports relative to
international rivals  ↑ Australia's international competitiveness.
- As foreign consumers now need to convert less of their own money to purchase Australian goods  ↑ exports (credits) relative to imports
(debits).
- Thus, the Balance on Merchandise Trade may increase.

NET FOREIGN LIABILITIES – 1st INFLUENCE

DEFINE NET FOREIGN LIABILITIES (NFL): an accumulation of all the past credits-debits in the financial account as a representation of Australia’s
net financial obligations to the rest of the world and can be calculated using:

NFL = NET FOREIGN DEBT + NET FOREIGN EQUITY

DEFINE EQUITIES – ownership of assets such as companies, shares and property

DEFINE DEBT – obligation to pay interest and, at some time in the future, to repay the original capital borrowed.

DISTINGUISH BETWEEN NFD AND NFE:

- Net foreign debt (positive, used as indicator of AUS external position):

 total stock of loans and liabilities owed/borrowed by Australians to foreigners less Australia’s Assets, or what has been lent/invested
overseas that is owed by foreigners to Australia
 includes borrowing through the issue of bonds, loans, advances and overdrafts
 POSITIVE – if AUS owes more to other economies than they do to the AUSTRALIAN economy
 NEGATIVE – if AUS owes less to other economies than they do to the AUSTRALIAN economy
 NFD has increased – 46% of GDP (2002–03)  a record high almost 60% (2019–20)
NFD = LIABILITIES (OWES/ BORROWED) – ASSENTS (LENT)
- Net foreign equities (currently negative, reduce NFL position)
 Total excess value of foreign-owned Australian assets less the total value of assets overseas that are owned by Australians
 Is the ownership of companies, shares and property in ne country by an entity in another country
 POSITIVE if foreigners own more AUS assets than AUS own of foreign assets.
 NEGATIVE if AUS own more foreign assets than foreign countries own of AUS assets (AUS recent NFE has been negative)
NFE = OWED ASSETS (AUS owned foreign assets) – OWNED ASSETS (foreign owned AUS assets)

NET FOREIGN DEBT

COMPOSITION OF AND TRENDS IN AUSTRALIA’S NFD

PUBLIC SECTOR (OFFICIAL DEBT) PRIVATE SECTOR (NON-OFFICIAL DEBT)

Over $1 trillion AUD = 60% of GDP (measure overall size of economy)
PURPOSE Finance government budget deficits (generally by issuing Are large companies that need to raise capital
bonds)

Why: for financing business expansion and takeovers

Why: value of tax and other receipts not enough to pay for
government spending and other budget outlays.
CAUSES/EXAMPLES - Global financial crisis (2008-09) + (2019-2020)
 governments relied heavily on this option to help
finance large budget deficits.
 AUS gov is $360 billion in debt
 result of running 11 budget deficits
(between 2008-09 and 2018-19)
- Net foreign equities
- Banks source money from overseas
 Large proportion of money they use to lend to
households/firms
- High domestic interest rates & lack of national savings
(exacerbates this problem)

PROPORTION/ACCOUNTS FOR: The extent gov sourced credit from overseas: The extent private sector borrow credit from overseas:
(BY 2019-20) Public sector’s share of NFD: 24% or ¼ Private sector’s share of NFD: 76% or ¾

PERCEPTION “BAD” “GOOD”

- mostly used for political purposes - business borrow with an expectation of profit and hence, can
- may not add to productive capacity and ability to repay repay the debt

CAUSES OF AUSTRALIAN NFD

 REASONS DESCRIPTION
(LARGELY CUS OF) - a deficiency of national/domestic savings by households, bus, gov to finance high levels of national investment
SAVINGS-INVESTMENT GAP - contributed to high interest rates → encourage banks/bus/gov to borrow & source credit from overseas
- result: NFD has increased – 46% of GDP (2002–03)  a record high almost 60% (2019–20)

MANY BUDGET DEFICITS
OPPORTUNITIES FOR FOREIGN
INVESTORS
SOUND ECONOMIC, POLITICAL AND
SOCIAL CLIMATE
LOWER VALUE FOR AUS DOLLAR
FINANCIAL SECTOR DEREGULATION
AND GLOBALISATION
- Economic slowdown since GFC  11 expansionary government budget deficits  financed by borrowing abroad (selling
government bonds)
- Due to Australia’s vast resources  opportunities for foreign investors to make high returns  inflow of investment capacity
- ↑ productive capacity BUT ↑ external liabilities
- Australia offers foreign investors a relatively stable economic/political environment
 sound infrastructure
 efficient institutions
 educated labour force
 regarded as a good place to live
- adds to external liabilities as there has been
 massive foreign investment in residential property.
 rural investment to enhance their food and resource security domestically (CHINA)
- adds to Australia’s external liabilities
 A lower Australian dollar (e.g., 2014-20)  make purchase of assets (bus, shares, property) by non-residents
cheaper and hence more attractive.
- Financial deregulation + trade liberalisation
 increased overseas capital inflow and foreign ownership of assets (businesses, shares, property)
 despite supervision of large projects by the Foreign Investment Review Board (FIRB).
EFFECTS OF NFD

- can be good provided its used to finance expenditure NOT consumption spending (satisfy immediate wants)

POSITIVE NEGATIVE
FINANCE FOR FUTURE EXPANSION CREATION OF ECONOMIC HARDSHIP
- foreign debt makes up for deficiency in local savings - Excessive government debt
- borrowing help finance private/public sector   repaying interest & principal  governments lift taxes, cut
 ↑ productive capacity, GDP, employment spending & contracting economic activity  economic activity shrink
- Helps fund investment projects that may not otherwise happen & unemployment to rise (GREECE)

PROVIDE ACCESS TO CHEAPER CREDIT. BURDEN OF DEBT REPAYMENT:

- Australian interest rates often higher than some rates overseas
- ↓production costs for businesses/acts as a favourable aggregate supply factor
 business expansion.
- As with any debt, the major problem is interest. – more borrowed = higher
these payments become  higher these payments are the less likely it will be
paid off
- If debt is expressed in another currency + AUD value falls against that
currency → ↓ in credit rating → ↑ interest rate

ADDS TO THE CURRENT ACCOUNT DEFICIT (CAD)

- NFD contributes to AUS’ large deficit in NPI/CAD
- foreign debt requires the payment of interest to overseas lenders
 meaning Australian dollars sold in the foreign exchange market
 ↑ supply of Australian dollars relative to demand  weakens the
currency  diminishes its purchasing power
NET FOREIGN EQUITIES
Cause: large pool of superannuation fund (> $3 trillion) which needs to be invested once it matures.
 Investors diversify their portfolio by investing in a range of geographical locations (overseas)

LINKS BETWEEN THE CAD, NFD AND AUD

- When ↑ CAD  the shortfall/deficiency between revenue and expenditure (savings-investment gap)  ↑ NFD  interest repayments  ↑ the net
incomes deficit  CAD increases.
- When ↑ AUD  ↓ prices for imports  ↓ overseas demand for exports  ↑ CAD
- ↑NFD  ↑ interest repayments to overseas  ↑ supply of AUD in the Foreign exchange market  depreciation of the AUD  becomes harder to
repay debt denominated in foreign exchange.

LINKS BETWEEN THE CAD, NFD AND NFE:

- (define NFD, NFE and CAD + how its financed/offset)
- If the money is borrowed from overseas, then the value of net foreign debt will increase.
- If the current account deficit is financed by selling assets overseas, then the value of net foreign equity will increase as Australian assets are sold to
foreigners.

TERMS OF TRADE (TOT) – 2ND INFLUENCE

DEFINE TERMS OF TRADE (TOT)
- an index measuring the ratio for the average price the world is prepared to pay for Australia’s exports
 relative to the average price it pays for imports
- TOT indicates the quantity of M (imported goods) that can be purchased for/with a given unit of X (exported goods).
 If it improves, we can buy more M with the same quantity of X.
- In long term, TOT will decline for countries that depend on/overspecialise in exports of natural resource/primary commodities (Prebisch- Singer
Hypothesis)

PREBISCH SINGER HYPOTHESIS:

- Issue of long-term decline of TOT for countries that depend on/overspecialise in exports of natural resource/primary commodities
  Exports of natural resources as necessity goods are income inelastic (rise in income doesn’t necessarily lead to large rise in demand for
coals)
 imports of manufactured goods are income elastic (rise in average income leads to rise in demand for white goods/capital imports)
- drives demand for manufactured products  ↑ price of manufactured products relative to prices of primary products (stays low/stable)
  long term: import prices likely to increase faster relative to export prices export prices for developing countries  TOT declines
 For the developing country to import the same amount, they need to export more to gain revenue to fund higher prices of imported
goods
 Bad for wellbeing/quality of life, inhibits development, becomes WORSE-OFF
- Advise: TOT may improve in the short term (↑ prices of natural resources)
 Developing countries need to act on and be aware of these short term swings in providing a temporary equilibrium
 Must utilise greater export revenues (through greater TOT), not for the purchase of imports, but rather the diversification of the economy
 Separate themselves from undue dependence on primary products  prevent long term decline

HOW IS TOT MEASURED:

- The TOT is measured by means of an index that uses a base year (where the index equals 100 points) to compare following years.
- export price index measures change in the average prices of AUS exported goods, with items weighted according to their relative importance in
trade.
- import price index measures changes in the average prices of imported goods, with items weighted according to their relative importance in trade

- when TOT is greater than 100%, the country is accumulating more capital from exports than it is spending on imports.
 more favourable
 export prices received rise faster, or fall less, than import prices
 this allows for a nation to purchase more imports with a unit of exports
- when TOT is less than 100%, more capital is leaving the country than it is entering
 less favourable
 export prices rise more slowly, or fall more quickly, than import prices
 a nation can purchase fewer imports with a given unit of its exports

TOT AS AN AD FACTOR:
- The TOT is primarily regarded as an aggregate demand factor affecting spending levels.
 because the prices received or paid in international transactions affect the value of AUS exports and the value paid for import
- weaker global demand  world chooses to pay lower prices for AUS exports (2013-16 and 2019-20)  ↓ value of exports (lower injections)
sold relative to value of imports (higher leakages)  slow AD and economic activity.
- ↑ shortages or stronger global demand  world pays higher prices for AUS exports relative to imports (2016-19)  ↑ value of exports
(higher injections) relative to imports (lower leakages)  strengthens AD and economic activity

TERMS OF TRADE TRENDS AUS

- Australia's TOT deteriorated up to 2015-16 (export fell to import)
- 2016-17-18-19 better export which resulted in stronger terms of trade
- Australia’s TOT strengthened up until 2018–19 as export prices rose relative to import prices.
- More recently in 2019–20, generally, lower export prices saw weaker terms of trade

FACTORS THAT AFFECT AUS TOT

HOW DOES DEMAND/SUPPLY AFFECT TOT

- Where exports are volatile due to agriculture and mining, and imports are stable because of manufactured intermediate and capital goods
 changes in TOT are usually caused by changes in prices of exports
- Assuming global competition is reasonable + countries are price takers – the price of each good is largely determined by its level of demand
and supply at market equilibrium
- Upturn in the Chinese construction industry – Construction is steel intensive, and coal and iron ore are needed to produce steel
 means there is an ↑ demand for commodities globally  ↑ commodity prices globally  ↑ AUS exports more commodities  ↑
export price index  ↑ TOT

SPECIAL OIL PRICE EFFECT ON AUSTRALIAN TOT

- Even though oil is a commodity that Australia exports, ↓ price will improve TOT
 Because Australians consume more oil than that being exported and the fall in price is a supply side benefit to the economy

CHANGES IN GLOBAL CONDITIONS OF DEMAND

- the level of world demand for Australian exports influences prices paid to Australians.
 DECREASE IN GLOBAL DEMAND FOR AUSTRALIAN EXPORTS
- ↓global demand for AUS exports  ↓ prices received for AUS exports  depresses TOT
 ↓ due to;
 ↓ rates of economic growth among major trading partners
 ↓ levels of consumer and business confidence abroad reducing the demand for exports
 ↓ growth rates in global disposable income or population
 ↓ exchange rate  ↓ price of exports, ↑ price of imports (AUD worth less)  ↓ TOT

INCREASE IN GLOBAL DEMAND FOR AUSTRALIAN EXPORTS

- ↑ global demand for AUS exports  ↑ prices received for AUS exports  ↑ TOT
 ↑ due to;
 ↑ rates of economic activity among major trading partners
 Overseas (China) economic growth leading to the mining boom (2005-2011)
 ↑ levels of consumer and business optimism overseas
 ↑ growth rates in global disposable income or population
 Appreciation of exchange rate  ↑ price of exports, ↓ price of imports (AUD worth more)  ↑ TOT

CHANGES IN GLOBAL CONDITIONS OF SUPPLY

INCREASE IN THE GLOBAL SUPPLY

- ↑ global supply ↓ prices received for AUS exports  ↓ depresses TOT
 ↑ due to;
 new discoveries of minerals or the opening of new mines
 the effect of new technology on productivity and hence production
 ideal domestic and international growing conditions for crops

DECREASE IN THE GLOBAL SUPPLY

- ↑ export prices  ↑ TOT
- ↓global supply  ↑ prices received for AUS exports  ↑TOT
 ↓ due to;
 resource depletion and exhaustion
 declining productivity
 severe climatic conditions here or overseas
 Supply shock (event suddenly ↑/↓ supply of G/S)
 Vale’s dam tragedy (2019) and closure due to COVID-19 restrictions (2020)

EFFECTS OF MOVEMENTS IN AUSTRALIA’S TOT

EFFECT ON HOW
INFLATION Higher prices for X  ↑ national income  triggers demand inflationary pressures  ↑ purchasing power  shortages  firms ↑ prices

Hight X quantity  adds to capacity constraints for local production (no capacity left) /↑ COP (coal and gas price)  ↑ supply inflation

Lower prices paid for imports  ↓ inflationary pressures

BALANCE OF ↑ TOT  ↑ X prices (OR ↓ M prices) and volumes stay the same  ↑ credits relative to debits on Net G/S  ↑ CA surplus/↓CA deficit
PAYMENT ↓ TOT  ↓ X prices (OR ↑ M prices) and volumes stay the same  ↓ credits relative to debits on Net G/S  ↓ CA surplus/ ↑CA deficit
CAD
EXCHANGE ↓ TOT (due to export prices) = those buying AUS X now need less AUD to buy a given quantity of X (as the price has fallen)  decrease
RATE demand for AUD  AUD depreciates

↓ TOT (due to import prices) = more supply of AUD needed to purchase the same imports  AUD depreciates (as its now worth less)
MACRO GOALS ↑ TOT = ↑ Export prices relative to prices paid for imports (AD factor)  ↑ value of net exports (higher injections relative to leakages)
 ↑ profits that are distributed as higher dividends, higher incomes/wages to employee  ↑ consumption and private investments  ↑ AD
 Firms try to lift production in response to ↑ demand/↓ levels of unsold stocks  ↑GDP  ↑ cyclical rate of economic growth
 Thus more derived demand for labour  ↓ cyclical rate of unemployment
 ↓ stocks of goods  No unused productive capacity  widespread shortages  ↑ prices  ↑ demand inflation

↓ TOT = ↓ Export prices relative to prices paid for imports (AD factor)  ↓ value of net exports (lower injections relative to leakages)
 ↓ profits that are distributed as higher dividends, higher incomes/wages to employee  ↓ consumption and private investments  ↓ AD
 ↓ New orders  firms cut their production to avoid unplanned ↑ in stocks of goods  ↓ cyclical rate of economic growth
 Cut production  Thus less derived demand for labour  ↑ cyclical rate of unemployment
 ↑ unsold stocks of goods  many sellers discount their prices  ↓ demand inflation competitiveness
LIVING ↓ TOT  ↓ X prices relative to M  ↓ value of export sales (lower injections) relative to the value of M (higher leakages)  ↓ AD  ↓
STANDARDS
economic growth  ↑ cyclical unemployment  ↓ average incomes  ↓ purchasing power/consumption/MLS + ↑ unhappiness/stress/↑
physical and mental health outcomes

↑TOT  ↑ prices received for AUS exports relative to those paid for imports  ↑ value of export sales (higher injections) relative to the
 value of M (lower leakages)  ↑ AD  ↑ economic growth  ↓ cyclical unemployment  ↑ average income  ↑ purchasing
power/consumption/MLS + ↓ unhappiness/stress/↓ physical and mental health outcomes

INEFFECTIVENESS OF TOT:
- TOT is useful to some extent, but in failing to account for certain information and factors, improvements may not always be beneficial for a given
nation
- This is based on the assumption/theory that:
 When ↑ price of exports (perhaps through ↑ demand for exports)  ↑ TOT  quantity remains exactly the same
 That through this countries through the increased prices for a given basket of exported G/S  can buy in more imports than they
could before
- That theory is only supported and beneficial where an ↑ TOT translates to ↑ export revenues  allowing a nation to buy in more imports  ↑
nation’s purchasing power
 ↑ Export demand (change in fashions/taste that favours exports of a given nation)  ↑ export prices (p1  p2)  ↑ Demand  ↑ Quantity
 ↑ TOT  ↑ Export Revenue  BENEFICIAL

FACTORS TO CONSIDER
- An improvement in the Terms of Trade is not always good because revenue (to purchase more imports) from exports is price x qty
 International competitiveness: if the increase in cost of production (e.g. falling labour productivity) is reflected in a higher selling price 
cost inflation  ↑ TOT  HOWEVER ↓ quantity of exports  ↓ export revenue  not beneficial
 Quantities of X & M
 Price elasticity of X & M: if XD is price inelastic (high inflation  ↑ export prices)  ↑ export revenue, if XD is demand elastic  ↑ prices
 ↓ revenue generated

DETERIORATION ISNT ALWAYS BAD

- ↑ productivity/ tech available in a country  ↓ COP  ↓ prices  nation more internationally competitive  leads to lower export prices  but
greater exports being sold  higher overall export revenue  ↑ economic situation

EXCHANGE RATE – 3RD INFLUENCE

DEFINE
- Measures the price/value of AUD when it is swapped for other currencies – relative to the purchasing power it has over another country’s currency –
serves as both an AD/AS factor
- Exchanging currencies is necessary because people normally want to be paid in their nation’s appropriate currency.
- An appreciation of the AUD means that 1 AUD can now purchase more foreign currency and vice versa
 The AUD will appreciate (increase) if ↑ demand for AUD/↓ supply of AUD
 The AUD will depreciate (decrease) if ↓ demand for AUD/↑ supply of AUD
 Affected by these transactions: purchase of g/s, investment, flow of income and loans

HOW IS IT MEASURED

FLOATING EXCHANGE RATE

- Since 1983 Australia has had a flexible floating exchange rate, with an equilibrium price for AUD determined by currency demand and currency
supply in the foreign exchange market (FOREX) by currency buyers and sellers
 Thus (like G/S), the value of the exchange rate changes in accordance with forces of supply and demand of AUD on the FOREX
 AUD is demanded when foreign currency is converted to AUD (sell something/EXPORTS)
 AUD is supplied when AUD is converted to foreign currency (buy/demand something/IMPORTS)
 Hence - rate will rise when less selling(supply)/more buying (demand) of the currency, rate will fall when more selling (supply) /less buying
(demand) of the currency
 The floating exchange rate can create instability and unpredictability.
- Supply/Demand for AUD affected by financial flows in/out of the economy – affected as investors confer their dollars into AUD from foreign
currencies, or from AUD to foreign currencies

MEASURING METHODS
- Usually measured through
 Individual exchange rates: The Australian dollar has a separate exchange rate for every currency in the world. These express how
many units of currency one Australian dollar can buy in each country. (AUD usually expressed in USD)

 Trade Weighted Index: The TWI represents the average exchange rate for a basket of foreign currencies weighted according to their
relative importance for Australia
 Base year: 1970

CAUSES OF CHANGES IN THE EXCHANGE RATE:

FLOATING EXCHANGE RATE (SAME THING)

 HOW SUPPLY AFFECTS AUD

- supply is affected by the purchasing of imports conducted by Australian residents or investments overseas (domestic residents exchange AUD)
 if sales of AUD rise, this will exceed the demand for the currency at the original price resulting in a depreciation of the exchange rate.
 if sales of AUD fall, this will lower the demand for the currency at the original price resulting in an appreciation of AUD
- The need to sell/supply AUD comes from:
 Australians investing overseas
 those paying dividends/interest overseas
 those buying imports.

SUPPLY FACTORS AFFECTING THE SALE/SUPPLY OF AUD

- factors that can affect the number of dollars sold or supplied;

LOCAL CONSUMER/BUSINESS CONFIDENCE

- local consumer (↑ buying of imports ↑ supply  ↓ ER) or business confidence (↑ selling of exports  ↑ demand  ↑ER)

RELATIVE INTEREST RATE (DIFFERENTIAL)

Interest rate – cost of borrowing or the reward of saving (focus on the reward of saving aspect)

Interest Rate Differential – SUPPLY

- Australia’s interest rate differential measures the difference between interest rates in Australia and those in other economies
 key driver of the D/S of AUD
 important driver of capital flows - measures the money that flows into, and out of, Australia for investment purposes
- Ceteris Paribus, ↑ in AUS interest rates relative to interest rates in (US, EUROPE, JAPAN)  AUS assets become more attractive for foreign/AUS
investors for higher interest rate returns on offer in AUS
  ↑demand for AUS assets/currency  AUS/foreign investors prefer to hold more Australian assets than rather than investing
in/purchasing overseas assets
  ↓ AUS capital/money outflow out of AUS  ↓ supply of AUD  appreciation of the exchange rate
- In contrast, ↓ AUS interest rates relative to interest rates in (US, EUROPE, JAPAN)  AUS assets become less attractive for foreign/AUS investors
for lower interest rate returns on offer in AUS
  ↓ demand for AUS assets/currency  AUS/foreign investors prefer to hold more overseas assets rather than investing in/purchasing
AUS assets
  ↑ AUS capital/money outflow out of AUS – funds exiting AUS in search of higher offshores returns  ↓ supply of AUD  depreciation of
the exchange rate

Explain the impact of an increase in US interest rates on the Australian dollar following an increase in US inflation
- If ↑ inflation rates in the US  likely ↑ US interest rates to depress inflationary pressure  US assets become more attractive for foreign/US
investors for higher interest rate returns on offer in US
- Since AUS interest rates have fallen relative to the US, ceteris paribus  ↓ capital inflow/↑ AUS capital outflow out of AUS – funds exit AUS in
search of higher offshore returns  ↓ supply of AUD  depreciation of the exchange rate

RBA Monetary Policies

Because the interest rate differential is a key driver of exchange rates, the RBA’s monetary policy decisions play a key role in influencing the
exchange rate – important influence on economic activity/inflation in AUS
 If the Reserve Bank ↓ cash rate  (this means ceteris paribus,) AUS interest rates ↓compared w interest rates in the rest of the world
  ↓ returns investors earn from assets in AUS relative to other countries  ↓ demand for assets in AUS as well as for AUD  investors
shifting their funds to foreign assets/currencies instead.
 Thus ↓ interest rates compared with the rest of the world  ↓ exchange rate – G/S more expensive compared with those produced in
Australia  ↑ exports/domestic activity + inflation – imports more expensive in AUD.
 CAPITAL IN-/OUTFLOWS FROM AUS
- Affects by the relative interest rates (above) and the risk/return trade off in investing in AUS relative to other economies indicated by Australia’s debt
level
- If it seems profitable for foreigners to purchase AUS equity (e.g., shares) they will need to sell their own currency to do so  Australians
- In late 2016, credit ratings agencies were on the verge of downgrading Australia’s credit rating following news of a further blow out in the budget
deficit (and net government debt) over the next few years.
  ↓ AUD – currency speculators invested in other currencies to avoid losses that could materialise if Australia was considered a riskier
investment option.

TERMS OF TRADE

DEMAND/PRICES OF IMPORTS
- AUD are bought sold to facilitate the international trade of goods and services
 Where the value of AUD is influenced by the level of demand for exports/imports
- ↑ domestic demand for imports will affect supply of AUD – AUS consumers importing from an
overseas seller needs to sell AUD by obtaining/converting it into foreign currencies to purchase
imports  ↑supply of AUD in the foreign exchange market/equilibrium price increases?
/decreases?  depreciation of exchange rate
- Conversely if ↓ domestic demand for imports  ↓ supply of AUD

Explain How the Dumping of Steel and Aluminium Into Australian Markets Can Cause A
Depreciation Of Australia's Exchange Rate

- The dumping of steel into AUS markets is likely to ↑ demand for imported steel given that the
relative price of foreign steel will fall compared to domestic steel
- To the extent that the volume of imported steel demanded is significant enough to outweigh the
fall in price  ↑the value of steel imports + the demand for foreign currency  AUS consumers
importing from an overseas seller needs to sell AUD by obtaining/converting it into foreign
currencies to purchase imports  ↑supply of AUD in the foreign exchange market/equilibrium
price increases? /decreases?  depreciation of exchange rate

RELATIVE LEVELS OF INFLATION/PRODUCTION COSTS/COMPETITIVENESS

- Higher relative inflation rate in Australia compared to the world → ↑ the prices of exports which are denominated in AUD
- If:
 demand is inelastic  export values ↑  ↑ AUS international competitiveness  positive impact on net export demand  ↑ demand/↓
supply on FOREX  Appreciation of exchange rate
 demand is inelastic  export values ↓  ↓ AUS international competitiveness  negative impact on net export demand  ↓ demand/↑
supply on FOREX  Depreciation of exchange rate

Purchasing Power Parity

- Inflation ↑ prices of exports that are denominated in AUD
- With AUS’ Floating exchange rate incorporated in 1983, these rates should adjust to reflect the theory of Purchasing Power Parity (PPP) - connects
the level of exchange rates to the level of prices between economies
 suggesting that, over time, exchange rates adjust so that the cost of an identical basket of G/S is the same when converted to another
currency in another country
 So the same amount is able to buy the exact same level of foreign G/S
- If G/S are expensive in AUS due to inflation relative to the same goods in other economies  ↓ demand/↑ supply for AUS G/S over time given
natural consumer behaviour  ↓ exports/net export demand  ↓demand/↑supply of AUD on FOREX  depreciation of AUD
- A lower value of AUD  ↓ price of AUD G/S for foreigners, who now require less of their own currency to purchase AUD G/S
  PPP states that this process of adjustment should occur until AUS G/S are no longer expensive relative to those in other economies.

POPULATION GROWTH:

HOUSEHOLD SAVINGS RATIO:

BUDGET RECEIPTS, GOVERNMENT SPENDING OUTLAYS:

HOUSEHOLD SAVINGS RATIO:

CHANGES IN TAX RATES AND DISPOSABLE INCOME:

HOW DEMAND AFFECTS AUD

- demand is affected by the purchasing of exports and investment in Australian assets (nations abroad purchase AUD)
 if the demand for currency rises relative to its supply, the exchange rate will appreciate
 if demand for the currency lessens relative to its supply, the exchange rate will depreciate

DEMAND FACTORS AFFECTING THE PURCHASE/DEMAND OF AUD

- factors that can affect the number of dollars purchased or demanded;

RELATIVE LEVELS OF INFLATION/PRODUCTION COSTS/COMPETITIVENESS (same)

INTEREST RATE DIFFERENTIAL – DEMAND:

- Australia’s interest rate differential measures the difference between interest rates in Australia and those in other economies
 key driver of the D/S of AUD
 important driver of capital flows - measures the money that flows into, and out of, Australia for investment purposes
- Ceteris Paribus, ↑ in AUS interest rates relative to interest rates in (US, EUROPE, HAPAN)  AUS assets are now paying a higher interest rate
  AUS assets that pay interest (gov bonds) become more attractive to foreign/AUS investors (that invest overseas) – becomes more
profitable to invest money in an AUS bank/assets as the return received for their investment each year will be high
  if investors purchase more AUS assets for higher interest rate returns on offer in AUS  ↑ foreign capital/money inflow into AUS  ↑
demand for AUD  appreciation of the exchange rate
- In contrast, ↓ AUS interest rates relative to interest rates in (US, EUROPE, JAPAN)  AUS assets are now paying a lower interest rate
  AUS assets that pay interest (gov bonds) become less attractive to foreign/AUS investors (that invest overseas) – becomes less
profitable to invest money in an AUS bank/assets as the return received for their investment each year will be low
  if investors purchase less AUS assets for lower interest rate returns on offer in AUS  ↓ foreign capital/money inflow into AUS –
funds going elsewhere in search of higher returns  ↓ demand for AUD  depreciation of the exchange rate

MOVEMENTS IN THE TERMS OF TRADE AND THE PRICES OF COMMODITIES – DEMAND

- ↑ TOT = any given value of AUS exports earning more export revenue to a given volume of imports  ↑ values of net exports  ↓ net demand for
AUD  appreciation of the exchange rate
- ↓ TOT = any given value of AUS exports earning less export revenue to a given volume of imports  ↓ value of net exports  ↓ net demand for
AUD  depreciation of the exchange rate
- Influenced by commodity prices (goods – iron ore, natural gas and agricultural products)
 Because they account for a large share of Australia’s exports and so movements in commodity prices result in movements in export prices.
 ↑ commodity export prices = ↑ AUD required to purchase the same amount of Australia’s commodity exports  ↑ demand for AUD
 appreciation of exchange rate
 E.g., ↑ price of iron ore  ↑ export prices/TOT
 through increased investment so when ↑ commodity prices  exporters may decide to invest in expanding their production capacity to
take advantage of higher export prices
 where investment has typically been funded from money/capital inflow into Australia from overseas  ↑ demand for AUD 
appreciation of the exchange rate.
 E.g., During the mining investment boom – very large ↑ in commodity prices during mid-2000s through to 2013  large inflows of
foreign investments to help expand production capacity in AUS resource sector  AUD appreciated - reaching a record high of
A$1.10 against the US dollar in 2011  reflects ↑ demand for AUD and more positive economic outlook for AUS relative to other
countries. (can use for capital inflows as an example as well!!)

DEMAND/PRICES OF EXPORTS
- AUD are bought sold to facilitate the international trade of goods and services
 Where the value of AUD is influenced by the level of demand for exports/imports
- ↑ demand for AUS exports (such as primary commodities which form a large part of AUS’s export base) will affect demand of AUD – AUS exporting
to overseas buyers  foreigners convert their currency into/purchase AUD to pay for the items  ↑ demand of AUD in the foreign exchange market
equilibrium price decreases  appreciation of the exchange rate
- Oppositely if ↓ decreased demand for exports  ↓ demand for AUD used to purchase them  demand shifts to the left and the equilibrium value of
the dollar decreases
  the level of economic activity overseas

 consumer confidence in our major trading partners and globally

THE LEVEL OF ECONOMIC ACTIVITY OVERSEAS

CONSUMER CONFIDENCE IN OUR MAJOR TRADING PARTNERS AND GLOBALLY

EFFECTS OF MOVEMENTS IN AUS EXCHANGE RATE

EFFECTS AGGREGATE DEMAND AGGREGATE SUPPLY

LOW INFLATION (2-3%)
MACROECONOMIC GOALS
DEMAND SIDE BENEFITS > SUPPLY SIDE COSTS  ↓ AUD  ↑ ECONOMIC/ECO GROWTH
Depreciation → ↑ X (o/s sales), ↓ M (domestic g/s)  ↑ AD = Depreciation → ↑ X (decrease selling price o/s), ↓ M
(increase cost of imports) = mixed effects
↑ Demand pull inflation: stimulates exports  excessive and ↑ Cost inflation: ↑ COP for firms which import capital  eroding
strongly rising spending in an economy that has little or no business profits /are passed on as higher costs to consumers to
unused productive capacity  shortages maintain profit margins

Inflation may exceed the growth in nominal income  ↓ real
income  ↓ PP  ↓ G/S can be bought  ↓ MLS
STRONG/SUSTAINABLE If the AUD depreciates, the tradeable sector becomes more IC in
ECONOMIC GROWTH (3%) terms of price  ↑ Demand for exports – now relatively cheaper
in foreign currency + ↓ demand for imports – now relatively
expensive in AUD.
 For markets with elastic demand this may mean an
increase in total incomes  ↑ AD --> by extension
lifting production. (assuming there is some unused
capacity available)
 Thus, the short-term cyclical rate of EG increases
Stimulates investment by enhancing demand in both
domestic/export markets
 HOWEVER, can also ↓ investments – the ↑ cost of
imported intermediate goods (product used to produce
a final good or finished product) and the user cost of
capital through lower value of AUD
Inflation may exceed the growth in nominal income  ↓ real
income  ↓ PP  ↓ G/S can be bought  ↓ MLS
If the AUD depreciates, imported capital is now more expensive
for Australian firms in AUD/on international level profits are
converted into a smaller amount of foreign currency
  ↑ Costs for producers buying imported capital 
become less W/A to produce due to reduced
profitability
  ↓ AS/productive capacity – meaning ↓ levels of
production are possible before there is a build up of
inflationary pressure
  ↓ long term sustainable non-inflationary rate of EG

FULL EMPLOYMENT (4.5-5%)
↓ AUD  ↑ AD  ↑ economic growth  ↓ long term cyclical Mixed effects on structural unemployment  lesser profit returns
unemployment through new jobs/overseas demand and consequentially business closures.
 ↓ COP and costs of imported capital  allowing bus
to ↑productivity/production capacity  ↑ derived lesser profit returns and consequentially business closures.
demand for labor  ↓ long term cyclical
unemployment ↓ Employment growth and may now be lower than the growth in
 Since the full-time minimum wage is greater than the size of the LF  ↑ unemployment greater than 5%
welfare payments, more G&S can be bought,
increasing MLS

CURRENT ACCOUNT – EXPORTS/IMPORTS

CURRENT ACCOUNT BALANCE
Depreciation  exports are less expensive  ↑ value of overseas spending on AUS exports relative to AUS
spending on imports  ↑ inflows/credits on CA as ↓ net G/S import debits  ↑ Balance of Goods/Services ↓
CAD/↑ CAS
 Makes purchase of AUS assets less attractive  ↓overseas investment in AUS assets  ↓ inflow of capital
to AUS  ↓ CAD
 HOWEVER, → more expensive to service debts denominated in foreign currencies → ↑ debits for Net
Primary Income → ↑ CAD/ ↓ CAS
Appreciation  exports become more expensive overseas  ↓ value of overseas spending on AUS exports relative
to AUS spending on imports  ↑ outflows/debits as ↓ G/S export credits ↓ Balance of Goods/Services  ↑CAD

INTERNATIONAL COMPETITIVENESS

DEFINE
- Australian businesses can profitably produce and sell their G/S at a price/quality level equal or lower than that provided by foreign rivals –
determinant of how well their exports compete in international markets
 ↓ price/↑ quality compared to foreign firms = ↑ IC
  ↑global sales/incomes  accelerate economic stability/low inflation/full employment – overall holistically ↑ AUS living standards
- Considerations to be IC:
 Competitive/final selling price – consumers compare domestic prices against similar items abroad  firms need to maximise efficiency in
their use of resources to ↓ COP
 Non-price factors
 quality better than items abroad
  satisfy changing needs of consumers better than rivals,
 innovating/thinking of new products + ideas to better satisfy people’s wants
 superior customer service – prompt delivery
 Ability to attract factors of production

RECENT TREND
- Australia’s IC position is relatively poor – 19-20 Australia ranked 18th out of 63 nations
 Strength: education, health and environment, social framework and finance
 Weakness: business productivity, labour market (aging population), tech, government red tape/competence

FACTORS THAT INFLUENCE AUSTRALIA’S IC

FACTOR DETAILS
DIRECTLY IMPACTED BY TRADE LIBERALISATION (HOW FREE TRADE  ↑ IC)
PRODUCTION If the CoP fall, firms are able to ↓ prices and maintain their profit margins  AUS firms more IC in terms of price
COSTS  Wages and labour on-costs (superannuation, leave entitlements, workers compensation) – Impacted by recent slow wage growth
 Capital costs (machinery, technology) – impacted by recent rising electricity prices
 Cost of borrowing on credit (rate of interest on business overdrafts)
 Raw materials (utilities)

PRODUCTIVITY Measures ratio of output obtained from a given quantity of inputs/resources used in production
 Labour productivity: level of GDP/total output divided per hour worked
 Multifactor productivity: efficiency of combined inputs (natural, capital, labour)
 (labour + multifactor → capital productivity)
 labour and multifactor productivity plunged dramatically between 2011–12 and 2017–18 (and 2018–19 for labour
productivity).
Growth in productivity means a greater volume of G&S can be produced from existing inputs  ↓ amount of input needed
for each final product
 ↓ cost per unit/COP  allows firms to reduce prices and maintain their profit margins
  favourable AS factor - more attractive to overseas buyers  making Australian firms more IC in terms of price
 ↓ structural CAD
Reasons for Australia’s weak productivity growth
 Productivity often moves in cycles → hard to determine exact origin of change
 Changes in productivity over time occur at irregular intervals across different areas (technology, agriculture)

RELATIVE ongoing low rate of inflation in AUS, relative to inflation rates in other countries = AUS average prices are rising more slowly in comparison
INFLATION to price growth in competitor’s economies
RATE   exports will be relatively cheaper in global markets, and import prices will be relatively higher in the Australian market
  ↑ net export demand  ↑ AD/eco growth/standard of living  make AUS products more IC in terms of price

GENERAL
AVAILABILITY The availability of natural resources determines where a country has comparative advantage.
OF NATURAL  AUS’s access to unique natural resources of mineral deposits and arable land give them a comparative advantage in mining and
RESOURCES agriculture (main seller of opal)  ↑ IC
If natural resources are plentiful allowing minimal costs for Australia using these resources to produce mining/agricultural goods at a
relatively low price compared to other countries  AUS firms are more IC in terms of price
Will erode in the long term as resources are depleted
 Climate change increase incidents of natural disasters

EXCHANGE “Buffer” effect

RATES Lower growth in productivity → ↑ costs → ↑ inflation/↓ IC → ↓ demand for Xs/higher demand for Ms → depreciation of AUD
 makes the tradeable sector (i.e. export and import-competing firms) more IC in terms of price – exports become less expensive in
foreign currency/imports more expensive in AUD
 China manipulates exchange rates in order to keep the currency undervalued in order to promote growth in production,
employment and incomes

EFFECTS OF AUSTRALIA’S IC ON MACRO GOALS

ECONOMIC GROWTH:

↑IC = Means products are sold at competitive prices in global markets, where if demand is elastic (often is as in international markets, there are
many substitutes)
  lower prices result in a proportionally bigger increase in quantity demanded
  ↑ export sales/↓ import purchased domestically  ↑AD  firms become more W/A to produce
  ↑ AUS productive capacity as firms increase production  ↑ short-term cyclical rate of EG.
 FULL EMPLOYMENT:
- To be IC firms may implement new technology/capital or new business techniques  changes to industries operating on an international scale –
resources are reallocated to countries with the comparative advantage  may initially cause some structural unemployment.
 however as time passes the higher demand for finished products will lead to higher production/derived demand for labour and
unemployment will decrease.
 Since the full-time minimum wage is greater than welfare payments, more G&S can be bought, increasing MLS.
 Low IC = High structural unemployment – firms relocate overseas to seek for lower production costs

LOW INFLATION:
- Increased IC stems from lower prices – if firms pass on lower production costs in the form of reduced selling prices  AUS prices fall/rise at a
slower rate  ↓ inflationary pressures  low inflation
 As prices are rising at a slower rate, inflation is likely to be exceeded by growth in nominal incomes.
 means ↑ real incomes  ↑PP and consumers will be able to purchase more G&S  ↑ MLS

REMINDER OF THE MACRO GOALS:

- The goal of strong and sustainable economic growth is defined as the fastest rate of growth in national production, averaging perhaps 3 per
cent per year, that is consistent with achieving other economic and environmental goals.
- The Australian government’s goal for full employment is to:
 eliminate cyclical unemployment caused by weak AD
 achieve the lowest rate of unemployment rate at around 4.5-5% of the labour force
 consistent with achieving low inflation and other government economic goals, as determined by the RBA
 as close as possible to the Non-Accelerating Inflation Rate of Unemployment (NAIRU)

- Reserve Bank of Australia (RBA) has set a goal of low inflation

 achieved when general consumer prices for goods and services are increasing fairly slowly

 within the current target range of 2-3% a year average

 over the duration of an economic cycle

 as measured by the Consumer Price Index (CPI)

 at a rate that is consistent with achieving other government macroeconomic goals.