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ECONOMICS
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Noah Gong

HSC 2020 - Notes

Topic 1 - The Global Economy

1 - Introduction to the Global Economy
2 - Trade in the Global Economy
3 - Globalisation a1nd Economic Development
Case Study: China

Topic 2 - Australia’s Place in the Global Economy

4 - Australia’s Trade and Financial Flows
5 - Exchange Rates
6 - Protection in Australia

Topic 3 - Economic Issues

7 - Economic Growth
8 - Unemployment
9 - Inflation
10 - External Stability
11 - Distribution of Income and Wealth
12 - Environmental Sustainability

Topic 4 - Economic Policies and Management

13 - The Objectives of Economic Policy
14 - Fiscal Policy
15 - Monetary Policy
16 - Microeconomic and Environmental Policies
17 - Labour Market Policies
18 - Effectiveness and Limitations of Economic Policy

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 Topic 1 - The Global Economy

Chapter 1 - Introduction to the Global Economy

1.1 - The Global Economy

● Globalisation: The integration between different countries and economies and the
increased impact of international influences on all aspects of life and economic activity
● Today we live in a global economy where the economies of individual countries are linked
to each other and changes in a single economy can have ripple effects on others
● Globalisation has become a dominant economic, political and social theme
● The major indicators of integration between economies include:
○ International trade in goods and services
○ International financial flows
○ International investment flows and transnational corporations
○ Technology, transport and communications
○ The movement of workers between countries
○ International and regional business cycles

1.2 - Globalisation

Trade in Goods and Services

● Important indicator of globalisation as it is a measure of how G/S produced in an economy
are consumed in other economies around the world
● Value of G/S X has grown from US$4.3 tn in 1990 to US$25.1 tn in 2018
○ From 19% to 30% of global output
● Gross World Product (GWP) is now over 50 times its nominal level in 1960, but world trade
volumes have grown over 125 times in the same time period
● Annual growth in world trade has been around the same as GWP growth since the GFC
○ Grew at around double the global rate of growth from the 1980s-2000s
● Trade has a greater volatility than GWP
● WTO forecast global trade growth of 3% for 2020
● The high volume of global trade reflects the fact that economies do not produce all the
items they need, or do not produce them as efficiently as other economies
● New technology in transport and communications have reduced the cost of moving goodsw
● Governments have encouraged trade by removing barriers and joining trade groups
● Composition of global trade:
Category 1995 2017

Manufactures 62% 55%

Food and agriculture 10% 8%

Fuels and minerals 7% 12%

Other goods 2% 2%

Commercial services 19% 23%

● Trade in services will be the fastest growing category of trade
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 ○ Services make up 2/3 of global output but only 1/4 of global X
● The direction of trade flows has changed to reflect the shifting importance of different
economic regions

Region 1995 2017

High Incomes 82% 68%

East Asia and Pacific 7% 15%

Eastern Europe and Central Asia 4% 5%

Latin America and the Caribbean 4% 5%

Middle East and North Africa 1% 2%

Sub Saharan Africa 1% 2%

South Asia 1% 3%
● Trade directions can impact individual economies
● Due to China’s rising influence, other economies eg Australia have place an increased
priority on their trade relationships with China, increased investment in domestic
industries whose G/S are in greatest demand from China

Financial Flows
● International finance plays a leading role in the global economy
● Most globalised sector of the world economy as money moves faster than G/S or people
● International financial flows expanded substantially following financial deregulation,
mostly in the 1970s and 80s
○ Eg lifting of controls on foreign currency markets, flows of foreign capital, banking
interest rates and overseas investments
● New technologies and global communications networks linked financial markets
throughout the world
● All measures of financial flows have shown dramatic increases during the globalisation era
○ Exchange traded derivatives have grown from US$1 trillion to US$98 trillion
annually from 1988 to 2018
■ Now larger than the size of the GWP (US$88 trillion)
■ Fell significantly following the GFC and the Eurozone crisis
● Foreign exchange markets are an important feature of international finance
○ Daily forex market turnover increased from US$4 tn to US$5.1 tn from 2010-16
● Main drivers of global financial flows are speculators and currency traders who undertake
short term investments in financial assets
● Vast majority of forex transactions are for speculative or technical purposes (hedging and
swapping) by international investment banks and hedge funds
● Greater global financial flows enables countries to obtain funds that are used to finance
their domestic investment - in particular in countries with low national savings
○ May facilitate higher levels of investment and therefore economic growth
● Speculative behaviour can create significant volatility in forex and domestic financial
markets due to their herd mentality
○ Eg Asian Financial Crisis of 1997, British Pound falls in 2016 post Brexit referendum
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 ○ The IMF is responsible for the overall stability of the global financial system

Investment and Transnational Corporations

● Global finance - shorter term, speculative shifts of money
● Global investment - longer term flows of money to buy/establish businesses as investments
● Foreign direct investment (FDI) involves the movement of funds that are directly invested
in economic activity or in the purchase of companies
○ Surged since the 1980s due to reforms
○ Strongly influenced by the level of economic activity
● GFC reduced FDI flows but they recovered throughout the 2010s, fell again recently
○ Underlying trend growth fell to below 1% after GFC
○ FDI fell from US$2 trillion in 2015 to US$1.3 trillion in 2018 due to geopolitical
uncertainty and US tax policy decisions
● FDI traditionally favours developed nations with greater industrial capacity and larger
consumer markets - changed in recent years
● Share of FDI destined for developing economies has increased from 1/4 of total to 1/2 in
recent years (mostly to Asia)
○ US$706 billion inflows to developing countries in 2018: US$512 to Asia, US$255 to
China and Hong Kong, US$77 to Singapore and US$42 to India
● The slower increase in FDI inflows to developing countries in the 2010s reflects a decline
in returns on FDI
○ Average return on FDI in developing countries fell from 11% in 2010 to 7.8% in 2018
○ Average return on FDI in developed economies fell from 6.4% to 6%
● Developing and transitional economies have significantly increased their share of FDI
outflows - 42% in 2018 compared to 15% in the mid 2000s
○ Three largest investors were Japan, China and France

● Transnational corporations (TNCs) are global companies that dominate global product and
factor markets
○ Have production facilities in at least two countries and are owned by residents of
at least two countries
○ Play a vital role in global investment flows
● They bring foreign investment, new technologies, skills and knowledge as they establish or
expand production facilities in a country
○ Governments often encourage TNCs to set up in their country due to the capital
and job opportunities they provide
○ Since the early 1990s, the number of TNCs has grown from 37,000 to 104,000
○ Number of affiliates to TNCs has grown from 170,000 to over 1,116,000
● 240 cross border cartels were penalised between 1990 and the mid 2010s with a financial
impact of US$7.5 trillion
● A significant cause of the growth of international investment is the increased level of
international mergers and takeovers eg Walt Disney - 21st Century Fox (March 2019)
● Mergers and acquisitions (M&As) peaked in 2007 when over US$1 trillion took place
○ Typically moves in line with changes in global economic conditions
○ Rose 18% in 2018 to US$816 billion
● Most investment still comes from domestic sources - FDI typically accounts for less than
20% of total investment

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Technology, Transport and Communication
● Technology is the ultimate driver for globalisation as it allows integration at a depth
unthinkable in previous decades and centuries
● Containerisation, cargo tracking and more efficient logistics systems facilitate greater
trade in goods
● Cheaper and more reliable international communication through broadband allows for the
provision of commercial services to customers around the world
○ 49% of the globe now used the internet in 2017 compared to 7% in 2000
● Technology enables money to move around the world in a fraction of a second
● Smartphones and mobile internet access are causing structural change in industries such as
retail, transport, education and leisure
○ Number of mobile phone subscriptions was 8.3 billion in 2019
● Transportation advances eg aircraft and high speed rail allow greater labour mobility and
increased accessibility to tourism and travel for consumers

● Technology also directly drives growth in trade and investment

○ The US receives half of the royalties and licence fees from the world’s technology
transfers as other countries rely on importing technology from leading countries
● The internet provides a communications backbone that links businesses, individuals and
nations in the global economy
○ Global marketplace for ICT is worth almost US$5 trillion
● Social media contributes to cultural globalisation and is central to marketing consumer
products and services
○ Google earned almost US$100 billion in 2017, mostly from advertising revenue

International Division of Labour and Migration

● Labour markets are far less international than G/S, finance and investment
● More people than ever before are moving to different countries for better work
opportunities - 164 million migrants workers (2% of world population)
○ Rising labour supply pressures and income inequality could increase this level
● Political unrest and conflict drive migration along with economic and financial motivations
○ 71 million people were forcibly displaced during 2018, the most since WWII
● Highly skilled workers are attracted to higher income economies due to higher wages and
better job opportunities
○ Two thirds of international migrant workers have moved to high income economies
○ Smaller economies suffer from a brain drain
■ In Haiti and Jamaica, over 80% of the skilled labour force have emigrated
● Low skilled labour is also in demand where it may be difficult to attract sufficient people
born locally to do certain types of work
● Net migration by country (last five years):
Country Net emigration Country Net immigration

Syria 4.2 million USA 4.5 million

India 2.6 million Germany 1.8 million

Bangladesh 2.5 million Turkey 1.6 million

China 1.7 million Saudi Arabia 1.6 million

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Pakistan 1.2 million Lebanon 1.3 million

● International division of labour: How the tasks in the production process are allocated to
different people in different countries around the world
● Corporations shift production between economies in search of the most efficient and cost
effective labour
● Many producers operate a global supply chain (or global value chain) with production
facilities in several countries
○ This is called offshoring and allows companies to shift production between
countries to reduce costs
○ Reflects the concept of comparative advantage
● Recent years have seen the offshoring of service functions eg IT support, data
management and accounting
○ Most elaborate in the electric and machinery manufacturing sector

1.3 - The International and Regional Business Cycles

● Economic growth (measured in GDP) moves in cycles called business cycles
● The ebb and flow of world economic growth is known as the international business cycle
● The extent of synchronisation of economic growth levels across individual countries is
highlighted by the GFC
● 63% of changes in the level of output in Australia can be explained by the changes in
interest rates, growth levels and inflation rates in the G7

Transmission of Economic Conditions

● The transmission of economic conditions from country to country is made more immediate
by the increased integration of economies during the globalisation era
● Trade flows: Booms or recessions in one country will affect its demand for G/S from other
nations, having flow on effects on the economic activity of trading partners
○ World economic growth forecasts scaled down due to China US trade war
● Investment flows: Economic conditions in one country will affect whether business in that
country will invest in new operations in other countries
○ Brazilian recession resulted in US$13 billion of negative outflows to other Latin
American economies
● TNCs: Can spread economic upturns and downturns throughout the global economy
○ Deutsche Bank announced 18,000 job losses including selling off some divisions in
2019 as a long term fallout from the GFC
● Financial flows: Countries with strong financial integration will experience an increase in
financial flows between themselves in response to external shocks
○ Eg in response to the Brexit referendum in 2016
● Financial market and confidence: Consumer confidence and the “animal spirits” of
investors are constantly influenced by conditions in other countries
○ Strong correlation between movements in share prices around the world
○ Global corporate debt has increased by 16% since the late 2000s to 130% of GWP -
risk of financial stability
● Global interest rate levels: monetary policy conditions in individual economies are strongly
influenced by interest rate changes in other countries
○ Higher interest rates in a major economy makes borrowing more expensive for
developing economies
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 ○ When the Fed raised interest rates in 2018, investment into emerging economies
was predicted to reduce by up to 1.1% of GDP
● Commodity prices: Prices of key commodities eg energy, minerals and agricultural products
influence inflation, investment and employment
○ Historically low oil prices have boosted global growth, however increased
diversification of energy sources has made them less important
○ Higher iron ore prices benefited the Australian economy in 2019
● International organisations: Forums such as the G20 or G7 can influence global economic
decisions through coordinating macroeconomic policy

Factors That Influence Individual Business Cycles

● Interest rates: Higher rates dampen economic activity while lower rates stimulate growth
● Policy decisions: A government’s economic policy decisions can influence growth rates
○ UK’s growth fell after its decision to leave the EU in 2016 due to lower confidence
○ Fiscal policies also have impacts in the short and medium terms
● Exchange rates: Impact trade competitiveness and confidence within economies
○ Exchange rates are having an increased impact on domestic economy as
government policy has less ability to target economic shocks
● Structural factors: Influence the level of competitiveness and their level of growth
○ Eg levels of resilience in their financial systems, levels of innovation, savings and
consumption habits, population growth rates, age distribution, labour market
regulations, education and training, business regulations
● Regional factors: Some economies are closely integrated with their neighbours
○ Geopolitical instability in countries like Egypt, Turkey and Yemen has held back
economic growth in other Middle Eastern economies

Regional Business Cycles

● Countries’ economic activity can be affected by global changes and regional changes
● While changes in the US will have ripple effects around the world, they can have more
pronounced impacts in North America due to increased integration eg NAFTA
● The EU’s 27 economies are influenced by activity levels in Germany and France
● East Asia is influenced by China and Japan, although this regional business cycle is not as
strong as some other regions
● Developing economies tend to be less regionally integrated eg in Sub Saharan Africa
○ Chad, Uganda and Sierra Leone depend on high income economies for more than
80% of their X rather than neighbouring African economies
● In South Asia and Latin America, regionally dominant economies India and Brazil play a key
role alongside outside influences
● Regional business cycles tend to be dominated by the largest economies, although can
sometimes be much more complex
○ France and Italy weakened by the Greek debt crisis
○ East Asian financial crisis triggered by the depreciation of the Thai baht

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Chapter 2 - Trade in the Global Economy

2.1 - Advantages and Disadvanta2ges of Free Trade

● Economies will achieve higher levels of growth in a free trade environment
● Free trade: A situation where governments impose no artificial barriers to trade that can
restrict the free exchange of G/S between countries with the aim of shielding domestic
products from foreign competitors
● Comparative advantage: The economic principle that nations should specialise in the areas
of production in which they have the lowest opportunity cost and trade with other nations
so as to maximise both nations’ standards of living
● Comparative efficiency is measured by the opportunity cost of producing each G/S within
that country

Advantages of Free Trade

● Allows countries to obtain certain G/S that they cannot produce themselves
○ Generally occurs due to a lack of resources eg technology
● Allows countries to specialise in the production of G/S in which they are the most efficient
○ Leads to better resource allocation and increased production
● Encourages the efficient allocation of resources - countries are producing G/S in which
they have a comparative advantage
● Greater tendency for specialisation leads to economies of scale - lowers average costs
while increasing efficiency and productivity
● International competitiveness will improve as domestic businesses face greater
competitive pressures from foreign producers
● Encourages innovation and the spread of new technologies and production processes
● Higher standards of living as a result of lower prices, increased production and increased
consumer choice - higher rates of economic growth and increased real incomes

Disadvantages of Free Trade

● Potential increase in unemployment as domestic businesses struggle to compete with M
○ Should correct itself in the long term as the domestic economy redirects resources
to areas of production with a comparative advantage
● May be more difficult for less advanced economies to establish new businesses and new
industries if they are not protected from larger foreign competitors
● Production surpluses may be dumped on the domestic market which may hurt efficient
domestic industries
● May encourage environmentally irresponsible production methods - producers in some
nations may win markets by undercutting competitors' prices

2.2 - Reasons for Protection

● Protection: Any type of government action that has the effect of giving domestic
producers an artificial advantage over foreign competitors
○ Main measures include tariffs, import quotas and subsidies
● Most countries have tended to impose at least some forms or protection
● Reasons for protection: assisting infant industries, prevention of dumping, reducing
unemployment, self-sufficiency

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 ● Infant industries: New industries face risks in their early years due to higher costs - may
need to be shielded from competitors in the short run to build capacity, establish markets
and achieve economies of scale
○ Infant industry protection must be removed over time if the argument is to have
any economic credibility
○ Many industries have continued to rely on this support for many years and would
not have survived otherwise
● Prevention of dumping: Occurs when foreign firms attempt to sell their goods in another
country’s market at unrealistically low prices
○ May be used to dispose of large production surpluses or to establish a market
position in another country - can harm domestic producers - loss in productive
capacity and higher unemployment
○ It is generally in the economy’s best interest to impose restrictions on such imports
- only reason for protection that is widely accepted by economists
○ Almost 6000 anti-dumping complaints have been lodged by the WTO members since
it was formed in 1995 - over 3500 anti-dumping measures legally in force
○ China imposed an 80% tariff on Australian barley in May 2020, supposedly due to
dumping - actually used as a political tool amidst the COVID-19 pandemic
● Protection of domestic employment: If local producers are protected from competition the
demand for local goods will expand, creating more domestic employment
○ Little support for this argument - protection will distort the allocation of resources
○ In the long run - likely to lead to higher levels of unemployment and lower growth
○ Other countries will retaliate and adopt similar protectionist policies
● Defence and self-sufficiency: Non-economic reasons for wanting to retain certain
industries eg defence, food supplies
○ Japan has high rice tariffs despite inefficient production - wartime famine
○ This approach may result in lower living standards
● Diversify an economy’s base: It may be in a country’s interest to diversify its economic
base in industries such as manufacturing
● Other arguments: Protecting producers from competition in countries with low wages,
weak environmental standards
○ Sometimes countries restrict their own production for non-economic reasons eg
Australia restricting uranium, live sheep X

2.3 - Methods of Protection

● The use of protectionist barriers has declined in recent years - shifted from traditional
measures to less visible measures eg administrative barriers and industry assistance plans

Tariffs
● A government imposed tax on imports - raises prices of imported goods

● Protective effect: Domestic producers supply a greater quantity of G/S - stimulates

domestic production and employment
● More domestic resources are attracted to the protected industry - reallocation of
resources towards less efficient producers
● Inflationary effect: Consumers pay a higher price and receive fewer goods - redistributes Y
away from consumers to domestic producers
● Changes consumer / producer surplus - leads to deadweight welfare loss

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 ● Raises revenue for the government, but not the primary objective - the more successful
the tariff, the less revenue it will raise
○ The Aus government provided around $675 million in tariff assistance in 2017
● A retaliation effect can sometimes occur - other countries may impose their own tariffs

Quotas
● An import quota controls the volume of a good that is allowed to be imported over a
period of time, guaranteeing domestic producers a share of the market
● Tariff quota: Goods imported up to the quota pay the standard tariff rate whereas goods
imported above the quota pay a higher rate

● Domestic producers supply a greater quantity of the good

● Reallocation of resources to the protected industry
● Consumers pay a higher price and receive fewer goods
● Do not directly generate revenue for the government - however a small amount can be
raised by the sales of import licences to administrate the quota
● Can invite retaliation

Subsidies
● Financial assistance to domestic producers allowing them to reduce their selling price

● Domestic producers supply a greater quantity of the good

● Reallocation of resources to the protected industry
● Consumers pay a lower price and receive more goods
● Direct costs on government budgets - fewer resources to allocate to other priorities

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 ○ Tend to be abolished more quickly than tariffs as they impose costs rather then
generating revenue - economists prefer over tariffs

Other
● Local content rules: Specify that goods must contain a minimum percentage of locally
made parts - in return the imported parts may not attract a tariff
○ Eg DCNS French defence contractor won $50 billion submarine building contract in
2016 due to promising to undertake some manufacturing and servicing in Australia
● Export incentives: Gives domestic producers assistance such as grants, loans or technical
advice to encourage them to expand global market share
○ Aus has the Export Market Development Grant (EMDG) - provides funding and
assistance to local manufacturers looking to break into international markets
■ Funding is provided to compensate eligible export businesses up to 50% of
their promotional expenses above $5000 (grants of $5k-$150k)
○ Do not protect businesses from foreign competition in the domestic market, but
are still an artificial barrier to free trade
● Outright bans / embargos, quarantine, licensing

Overall Economic Effects of Protectionism

● Global protectionist policies reduce trade between nations - X and M will be a smaller
share of the national economy
● 2019 IMF study: Protectionist policies reduce living standards and reduce global economic
growth by shielding inefficient producers
○ Over the medium term countries experience lower output, weaker productivity,
increased unemployment and increased inequality
○ Tariffs lead to exchange rate appreciation and thus weakens balance of trade
○ Average tariff increase (3.6%) reduced GDP by 0.4% after 5 years (1% for advanced
economies)
○ A 10% increase in tariffs would reduce global trade by 16%, shrink the global
economy by 2% and reduce investment across the world by an average of 3.5%
● Make it more difficult for individual economies to specialise in production in which they
are the most efficient - businesses are less likely to achieve economies of scale
○ Lower profits and dividends
● Less competitive pressures - prices for G/S are higher - slower economic growth
● 2019 KPMG report - Trump tariffs will reduce Australia’s projected GDP by 0.3% by 2022
($36 billion in overall economic activity)

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 ● 2017 Productivity Commission model - A return to 1930’s style protectionism worldwide
could result in more than 100,000 job losses and reduce median weekly Y for Aus
households by $1500
● Negative impacts are strongest for developing economies - 2/3 of the USD$90-200 billion
annual welfare gains from trade liberalisation flow to developing countries
○ Lifts 140 million people out of poverty

2.4 - Trade Agreements

● Can be bilateral, multilateral or global
● A trading bloc occurs when multiple countries join together in a formal preferential
trading agreements to the exclusion of other countries eg EU, NAFTA
● Free trade agreements are formal agreements between countries designed to break down
barriers to trade between those nations
○ Can sometimes make it harder for nations outside the preferential trade agreement
to trade - may not create better conditions for free trade at all
● Global free trade agreements conducted through the World Trade Organisation (WTO) are
designed to remove barriers to trade across all economies
● Regional trade agreements have increased from 27 in 1990 to 467 in 2019
○ Emergence of regionalisation, not globalisation
● While trade has increased between countries that have trade agreements, not necessarily
trade creation but trade diversion
○ Trade diversion: Where a country’s M of a G/S switch from the most efficient
producer to another county because of the impacts of a trade agreement
● Around 2/3 of European trade occurs within the EU - more closed trade bloc due to
protectionist policies
● ASEAN economies primarily trade outside their region as they are smaller economies
centred on X to industrialised economies
● Economies of NAFTA and ASEAN have substantially increased trade amongst themselves
compared to countries outside their trade area (although both are still increasing)
○ Risk that regional trade blocs could result in global trade fragmenting into
self-contained regions, hindering global free trade
● Trump began implementing a protectionist agenda in 2018, applying tariffs to Chinese G/S
○ Prompted retaliation from China and other trading partners - could trigger a
recession in the world economy
● 2018 study found that 78% of Australian businesses used at least one FTA to source
products from overseas, while 62% of exporting businesses used at least one to sell
products to foreign markets

Examples of Trading Bloc Agreements

● Asia-Pacific Economic Cooperation (APEC) Forum: Founded 1989, 21 members, 40% of
world pop, 60% of world GDP, 47% of world trade, over 70% of Australia’ total trade
○ Relatively minor role in advancing free trade in the past 3 decades - never created
its own regional trade agreement
○ Non-discriminatory grouping - trade with members outside bloc on the same basis
as members (unlike EU)
● Association of South-East Asian Nations (ASEAN): AFTA signed 1992, 10 members
○ AANZFTA came into effect 2010, with ASEAN nations lowering / eliminating 96% of
tariffs on Aus X (compared to 67% before the agreement)

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 ○ Largest preferential trade agreement that Aus has concluded (by pop) - represents
20% of Australia’s trade in G/S
○ Proposed Regional Comprehensive Economic Partnership (RCEP) covering 16
countries including 10 of Australia’s top 15 trading partners, over 60% of two-way
traded, over 65% of G/S X
● European Union (EU): Founded 1993, 28 members, world’s most important trading bloc
○ Predecessor formed in late 1950’s, helping dismantle trade barriers within Europe
○ EU has frequently used tariff barriers against non-members - accusations of being a
closed trading bloc
○ High rates of agricultural protection (direct subsidies and rural support) absorb
almost 40% of the annual EU budget (167 billion euros in 2020)
■ Generated an oversupply of agricultural commodities - contributed to the
continuation of farm subsidies in the US - ongoing conflict
○ 19 members are part of the Eurozone with common currency and interest rates
■ Under pressures since GFC due to failure to enforce common fiscal policies
and failure to account for differing economic conditions across the region
● US-Mexico-Canada Agreement (USMCA / NAFTA): Founded 1994, value of trade tripled
between members in the 25 years since its introduction
○ Significant increases in US X to Canada, Mexico
○ Trump threatened to withdraw - renegotiated terms, tightening requirements
around “rules of origin” or local content rules for car manufactures etc

Bilateral Trade Agreements

● Eg the Closer Economic Relations Trade Agreement (CERTA) between Australia and New
Zealand - founded 1983
○ Has contributed to an average annual increase in trade between Australia and New
Zealand of 8% - successful in both countries
● Have experienced a resurgence in recent years due to slower progress of WTO
negotiations, US using economic power to negotiate deals on a country by country basis
● Arguable whether these agreements assist or obstruct progress towards global free trade
● Bilateral negotiations are generally faster than multilateral agreements
○ Although Australia-China FTA negotiations took 10 years

2.5 - International Organisations

● Major institutions of the global economy include WTO, International Monetary Fund (IMF)
and the World Bank
○ IMF and World Bank established at the Bretton Woods conference of 1944

World Trade Organisation (WTO)

● Formed in 1995 as the first international organisation with powers to enforce trade
agreements across the world - 164 members, 23 observer countries
● Role is to implement and advance global trade agreements and resolve trade disputes
● Successor to the General Agreement on Tariffs and Trade (GATT) (1947)
● Reach extends beyond trade in goods to trade in services eg insurance, banking,
intellectual property (patents, trademarks, copyrights)
● WTO is involved in dispute resolution when a country fails to comply with their obligations
○ Other countries may then impose trade sanctions against the offending nations
○ Over 500 disputes have been brought to the WTO since 1995

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 ○ Effective in resolving disputes between smaller countries
● In 2014 the WTO agreed on a binding Trade Facilitation Agreements aiming to reduce the
cost of trade by 10-15% by making customs procedures simpler and more efficient
● The WTO has been unsuccessful in its efforts for a comprehensive global trade agreement
● Uruguay Round (1993) - last major agreement; included reduced protection for
agriculture, services and intellectual property rights
○ Reduced tariffs by 40% for developed countries on $787 billion of industrial goods
● Doha Round of trade liberalisation talks failed due to disagreements on agricultural
markets, pharmaceutical production, disputes between developing and developed
countries
○ Each WTO member has signed on average 13 PTAs
● The past decade has seen a decline in public support for free trade with a shift towards
bilateral and regional trade agreements
● Currently facing a serious threat to its relevance with the ongoing trade war between
Trump and China - US threatening to withdraw from the WTO altogether

International Monetary Fund (IMF)

● 189 members - role of maintaining international financial stability, particularly in relation
to foreign exchange markets
● Used to oversee a system of fixed exchange rates - collapsed in the 1970’s
● When a crisis occurs in an economy, the IMF will often develop a rescue package to help
stabilise the economy
● $57 billion loan package to Argentina in 2018 after a currency crisis in which the Argentine
peso lost half its value, contributing to 55% inflation by mid 2019 and raising concerns that
Argentina would default on its external debt
● In response to the initial GFC, the IMF injected USD$250 billion into the global economy to
promote liquidity
○ Lending commitments reached a record level of USD$157 billion in 2009
○ Suspended interest payments on some loans to help developing countries cope
● Large scale loans and relief programs for 11 European countries to address the ongoing
sovereign debt crisis
● In the longer term, the IMF’s policies are to support free trade
● Often require countries to adopt structural adjustment policies (Washington Consensus)
that open up their markets
○ Many banks require countries adopt IMF policies before they are willing to lend
● IMF supported expansionary macro policy during the GFC
● Has undertaken steps to make its governance structure more representative so emerging
economies have a greater say over policies
● IMF’s handling of the Euro debt crisis reignited criticisms that the IMF was demanding loan
recipients to implement policies that harmed the most vulnerable groups while protecting
banks and the monetary union
○ A 2016 IMF report acknowledged some criticisms, with Greece’s nominal GDP falling
26% lower than IMF projections
● A broader IMF evaluation of 133 lending programs between 2011 and 2017 found that three
quarters were at least partially successful

World Bank
● Primarily concerned with helping poorer countries with their economic development

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 ● Main organisation - the International Bank for Reconstruction and Development: Aims to
fund investment in infrastructure, reduce poverty, help countries adjust their economy to
the demands of globalisation
● International Development Association: Provides soft loans (low / no interest)
● International Finance Corporation: Attracts private sector investment to projects
● Multilateral Insurance Guarantee Agency: Provides risk insurance to private investors
● International Centre for Settlement of Investment Disputes: Provides conciliation and
arbitration of investment disputes between states and corporations
● Funded by contributions from member countries and from its own borrowings on global
financial markets
● Provided USD$67 billion in loans, grants etc in 2018
● Value of active investments is USD$200 billion
● Two major goals: Reducing the rate of extreme poverty to less than 3% by 2030 (currently
6-9%) - mainly frictional poverty
○ Reducing inequality by fostering income growth for the world’s bottom 40%
● Global importance as a lender has declined as private lending markets have expanded
○ $35 billion in short term trade finance for low income economies in the GFC
● Supports the Heavily Indebted Poor Countries Initiative which aims to reduce debt by
two-thirds in the world’s poorest countries
○ By 2018, 36 countries had received debt relief estimated at USD$99 billion

United Nations (UN)

● Established in 1945 with 193 member states
● Decision-making powers are limited as it relies on the support of members
● Set up the Sustainable Development Goals aiming to reduce global poverty and inequality
between 2015 and 2030
○ 17 goals with 169 individual targets

Organisation for Economic Cooperation and Development (OECD)

● 36 countries committed to democracy and the market economy
● Promotes policies to achieve the highest sustainable economic growth and employment
and a rising standard of living while maintaining fiscal stability
● Conducts and publishes research on a wide range of economic policy issues

2.6 - Government Economic Forums

● Enables heads of states, treasurers, central bank governors to discuss global economic
issues with particular attention to economic stability and growth

Group of Seven Nations (G7)

● USA, UK, France, Germany, Canada, Japan, Italy
● Largest industrialised economies - unofficial forum coordinating global macro policy
● Significance of G7 is in decline due to shift in global balance of power, nationalistic
posture of the US

Group of Twenty Nations (G20)

● 19 of the world’s largest economies plus EU - 80% of world GDP, 2/3 of world pop
● Played a key role in coordinating global response to the GFC - fiscal stimulus, supervision
of the global financial system and financial institutions

14
● Economic cooperation has weakened in recent years

15
Chapter 3 - Globalisation and Economic Development

3.1 - Introduction
● While there is a large gap between rich and poor countries, in overall terms, living
standards are improving in most countries
● Less than 10% of people lived in extreme poverty in 2015 (under US$1.90 a day) compared
to 40% in 1981
● The infant mortality rate has been reduced by more than half between 1990 and 2016
● The global primary school net enrolment rate increased from 81% to 89% from 1996-2016
● Life expectancy for those born in low HDI countries increased from 49.6 to 60.8 between
1980 and 2017
● Of the 731 million people living in extreme poverty, half live in Sub Saharan Africa, which
has seen an increase in the number of people living in poverty compared to 1990
● 2.3 billion people live without basic sanitation, and 1 billion without electricity
● 5.4 million children under five died in 2017, mostly in Sub Saharan Africa or Southern Asia
● 68.5 million refugees and forcibly displaced people have had to abandon their homes to
seek protection due to conflict or persecution

3.2 - Difference in Income and Economic Growth

● Gross National Income (GNI) is the sum of value added by all resident producers in an
economy plus receipts of primary income from foreign sources
● A limitation of this measure is the exchange rate, which makes inaccurate comparisons
between living standards
○ Economists usually make an adjustment using purchasing power parity (PPP)
○ These adjustments result in substantially higher comparative figures for developing
countries whose exchange rates tend to be undervalued
● High income countries receive 64% of the world’s income as measured in raw GNI
○ 47% using PPP adjusted figure
○ Only make up 17% of the world population
○ Low income countries make up 10% of world population but only 0.7% of GNI
● By taking population into account, we can generate a GNI per capita figure
Grouping Population GNI per capita GNI PPP adjusted
(million) (US$) per capita ($Int’l)

High Income 1225 40630 48075

Low and Middle Income 6277 4376 10693

Latin America and the Caribbean 569 6917 13340

Eastern Europe & Central Asia 415 7375 20323

East Asia & Pacific 2068 6973 14848

Middle East & North Africa 380 3671 12873

Sub Saharan Africa 1049 1485 3704

South Asia 1788 1724 6465

16
 ● Almost all nations have experienced some economic growth in recent decades, resulting in
higher incomes as a result of higher GDP
○ The reduction in income inequality is occurring very slowly across the world
● Global wealth is distributed even more unequally than income
○ Top 1% own almost half of the world’s US$317 trillion in wealth in 2018
○ Africa owns 1% of global wealth compared to 34% in North America

3.3 - Differences in Economic Development

● Economic development: A broad measure of welfare in a nation that includes indicators of
health, education and environmental quality as well as material living standards
○ Takes into account income and quality of life indicators
● Main measure is the Human Development Index (HDI), consisting of:
○ Life expectancy at birth
○ Levels of educational attainment - average and expected years of schooling
○ Gross National Income per capita PPP adjusted
○ Scored between 0 and 1
■ Norway rank 1 (0.953), Australia rank 3 (0.939), Niger last (0.352)
● Some countries have similar HDI levels but very different income levels, a result of high
income inequality, or vice versa
○ Indonesia and Vietnam have the same HDI of 0.694 but Indonesia has a GNI per
capita of US$10846 compared to US$5859 in Vietnam
○ Cuba has a GNI per capita of US$7524 and Eswatini US$7620 but Cuba ranks 73rd in
HDI compared to Eswatini which ranks 144th

3.4 - Categories of Development in the Global Economy

Less Developed Economies

● Common characteristics of developing economies include:
○ High levels of income inequality within their economies
○ Dependence on agricultural production for income, employment and trade
opportunities
○ Reliance on foreign aid and development assistance as a major source of income
17
 ○ Low levels of labour productivity, industrialisation, technological innovation and
industrial development
○ Weak political and economic institutions and a high prevalence of corruption
● Sub group of 47 least developed countries with GNI per capitas of less than US$1035 per
year, weak human assets (health and education) and high economic vulnerability
○ 33 are in Sub Saharan Africa - Africanisation of poverty
● Classifications are very broad and can group dissimilar economies together

3.5 - Causes of Inequality in the Global Economy

● Inequality issues are the domain of development economics, which attempts to identify
and enable the conditions required for sustainable economic growth
● There are many causes of global inequality split into global and domestic factors
○ Global: trade system, financial architecture, aid and assistance, technology flows
○ Domestic economic resources: natural resources, labour supply and quality, access
to capital and indebtedness, entrepreneurial culture
○ Domestic institutional factors: political and economic institutions, economic
policies, government response to globalisation

Global Factors - Global Trade System

● Developing countries that export commodities are severely affected by high levels of
global protectionism in the agricultural sector
○ Total agricultural support to producers in OECD was US$287 billion in 2016,
providing 26% of income for farmers
● Regional trading blocs eg EU, NAFTA can exclude poorer nations from gaining access to
lucrative global consumer markets
○ Bilateral agreements are rarely as comprehensive as regional trading blocs
● WTO’s Doha Round was promoted as the development round but failed due to high income
nations resisting concessions on issues that would benefit developing countries
● Benefits of free trade agreements are often not accessible to developing nations because
of the substantial cost in implementing international agreements
○ A 1% increase in administrative costs associated with trade would decreased GWP
by US$75 billion

Global Factors - Global Financial Architecture

● Long term international flows of investment heavily favoured developed countries
○ Changed in the last decade, with developing economies receiving half of global FDI
funds, although most of the benefit has gone to fast growing emerging economies
○ The world’s 47 least developed countries held just 1.1% of the global stock of FDI
inflows in 2018
● Short term financial inflows heavily favour the more prosperous emerging economies
○ Offer better returns for currency and stock market speculators
○ Exposed to the most economies volatility as a result eg 1997 Asian Financial Crisis
○ Financial liberalisation can be an important corollary of trade liberalisation
● International financial rules have not kept pace with globalisation and in some areas
loopholes can contribute to large flows of income or wealth
○ US$600 billion of profits are held in tax havens
■ Represents 40% of multinational profits
■ Fostered by a lack of country by country reporting

18
 ● The IMF’s structural adjustment policies serve the interests of rich countries and may not
be appropriate to many developing countries
● Many developing countries have large foreign debt burdens
○ Total external debt for low and middle income economies was estimated at US$7.1
trillion in 2018, a 10% increase since 2017
○ Interest repayments on these loans reduces the income available for governments
to promote growth and development through spending
○ Major efforts in recent years by the World Bank and IMF to provide debt relief

Global Factors - Global Aid and Assistance

● Total level of development aid provided by high income economies was US$149 billion or
0.3% of GDP in 2018
○ Promised 0.7% of GDP since the 1970s - only 5 OECD countries over 0.7%
● A significant proportion of official development assistance is ‘phantom aid’ that does not
improve the lives of the poor
○ Almost 1/6 of foreign aid is ‘technical cooperation’ often paid to consultants in
donor countries
○ 11% is debt related, not contributing to new development
○ 5% is spent on administration
○ Large proportion is ‘tied aid’ that must be spent on overpriced or unnecessary G/S
● Distribution of aid by high income countries often reflects strategic and military
considerations rather than the needs of the poorest countries
○ Since 2002 almost half of the US$178 billion increase in global aid from wealthy
countries wrht to Iraq and Afghanistan
● Multilateral development aid is less than 1/s of the value of total development assistance
● Better targeted at assisting world’s poorest countries

Global Factors - Global Technology Flows

● New technologies can be adopted much quicker in economies with better infrastructure,
higher levels of education and higher penetration rates of related technologies
● The internet remained unavailable to 3.4 billion people in 2017
○ Reinforces economic isolation from the digitally connected and developed world
○ Known as the ‘digital divide’
● New technologies are also geared to the needs of high income countries as they choose the
priority areas of scientific research
○ Eg pharmaceuticals for the elderly, labour saving devices
○ 17% of the world population doesn’t even have access to electricity
● Intellectual property rights restrict the benefits of technological transfer to poorer
countries as poorer nations cannot afford to pay for these rights

Domestic Factors - Economic Resources

● Natural resources: Economies with abundant supplies of cheap natural resources eg energy
supplies, fertile land, water, minerals have better opportunities for economic growth
○ Oil rich Middle East, African and Latin American countries have achieved higher
growth rates as a result of their exploitation of natural resources
○ Also can hamper development by leading to an overvalued exchange rate, narrow X
base and an over reliance on a small number of industries
■ Can become over reliant on commodity prices

19
 ● Labour supply and quality: Low income nations are characterised by high population
growth, lower levels of education and low health standards
○ Results in lower productivity levels
○ Singapore’s commitment to education has led to the development of a
sophisticated service based economy
○ South Africa’s labour supply is diminished by inadequate education, high rates of
HIV/AIDS and barriers to girls’ access to education
● Access to capital and technology: Difficulty in gaining access to capital contributes to
lower rates of economic growth
○ Low incomes provide little opportunity for savings that can be used for investment
○ Poorly developed financial systems make it difficult for businesses to gain easy
access to loans for investment purposes
■ Microfinance organisations have been established in many developing
economies to provide loans to the poorest people
● Entrepreneurial culture: A country’s history and social institutions can impact its economic
success, although it can be hard to quantify differences
○ Strong civil society institutions, cultural disapproval of corruption, respect for the
law and aspirations towards work, enterprise and personal responsibility can
support economic growth and development
● High levels of inequality: 70% of the world’s poorest billion live in highly middle income
countries, not the poorest countries
○ High levels of wealth concentration tend to lead to lower rates of economic growth

Domestic Factors - Institutional Factors

● Political and economic institutions: Can have a dramatic impact on the economic
environment for businesses, investors and consumers
○ Political instability, corruption and a lack of law enforcement tend to undermine
the confidence of investors
○ The Corruption Perception Index scores countries from 0 to 100
■ Denmark rank 1 (88), Australia rank 13 (77), USA rank 22 (71), China rank 87
(39), Somalia rank 180 (10)
● Economic policies: Government policies impact how governments balance the roles of
market forces and government intervention in the economy
○ Countries with the highest levels of development tend to have both a strong
market economy and significant government investment
○ Developing economy governments are less able to implement policies that can ease
inequality as they collect less tax revenue
● Government responses to globalisation: policies relating to trade, financial flows,
investment flows, TNCs and the country’s participation in regional and global organisations
influence an economy’s ability to take advantage of integration
○ Benefits include economic restructuring, efficiency, access to foregin capital and
technology and access to overseas goods markets
○ East Asian economies have been the most open to trade and foreign investment and
have experienced the strongest rates of economic growth in the last decade

3.6 - The Impact of Globalisation

20
Economic Growth and Development
● Developing economies have greater opportunities to grow by producing goods for global
consumer markets
○ Can also benefit from greater access to new technologies and foreign investment
● Developed economies have found growth opportunities in global supply chains and new
global service markets, especially through TNCs
● Real GWP growth has fallen marginally from 2.9% per year in the 1980s and 90s to 2.8% per
year from 2000 to 2018
● Globalisation appears to be contributing to the convergence in living standards in the
global economy
○ East Asia and Pacific: Fastest growing region in the world
■ 9% p.a across the 1990s and 2000s, 6.9% p.a between 2011 and 2018
■ 10.4% growth p.a from China in the 2000s, 7.4% p.a between 2011 and 2018
○ South Asia: Strong growth since 2000 - 6.7% p.a
■ 7.2% p.a in India, 6.2% p.a in Bangladesh
○ Eastern Europe and Central Asia: Strong rebound in growth following the difficult
process of transitioning to a market based economy
■ 5% p.a in the 2000s, 3% p.a between 2011 and 2018, -0.9% in the 1990s
○ Middle East: High growth underpinned by higher energy resource prices, dampened
by political instability and a fall in oil prices post 2011
■ 5.1% throughout the 1990s and 2000s, 3.3% since 2011
■ Many economies are characterised by high levels of inequality
○ Sub Saharan Africa: Growth of 4.8%% p.a from 2000 to 2018
■ 9.1% p.a in Ethiopia, very little growth in Sudan and C.A.R
○ Latin America: 3.1% p.a in the 2000s, 2.1% p.a since 2010
■ Weaker commodity prices and political instability have limited growth
○ Advanced economies: 2.2% p.a from 1991-2018, 2.5% p.a for the US
■ Just 1% p.a in Japan, 1.8% p.a in the EU
● The high growth experienced by emerging economies that have embraced international
trade, foreign investment and TNCs may indicate that globalisation facilitates higher rates
of economic growth eg in China and India
● The most globally integrated economies have experienced weak growth since 2000
○ The 2010s saw lacklustre growth despite record low interest rates and low inflation
○ High levels of debt constrained governments from fiscal stimulus
● Globalisation lifts economic development through raising incomes
○ Can have negative impacts on inequality as well as environmental damage
● Globalisation has contributed to China’s economic development, the main structural
change in the global economy
○ Trade has been central to their export oriented manufacturing industries
○ In turn accelerates globalisation through deepening trade and financial links
● Almost all countries have experienced major improvements in the HDI

Income Inequality
● Increased openness to trade provides more X opportunites, raising incomes for agricultural
workers in developing countries
○ Lower tariffs reduce prices for M, improving living standards
○ May shift employment towards higher paid service industries and away from import
competing sectors eg PMV industry
● Increased financial flows provide employment opportunities and fuel economic growth
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 ○ Tend to be concentrated in higher skill sectors, favouring those who are better off
● Global mobility of skilled labour means that highly skilled workers may emigrate to more
advanced economies with higher paying jobs, increasing inequality in emerging economies

● The top 0.1% has garnered the same economic benefits as the bottom 50% since 1980
● Income inequality rose by almost 0.45% per year during the three decades up to the mid
2000s - rising inequality reduces economic development
○ About 20% of the increase in income inequality is a result of globalisation
■ Technological change shifts production to higher skilled jobs

Trade Investment and Transnational Corporations

● International trade in G/S now accounts for 2/3 of global output
● Goods are produced in different stages in different economies through global supply chains
○ Countries engage in vertical specialisation, focusing on just one or two parts of the
production process
● Intellectual property and commercial know how is being mass traded across economies
● Investment is expanding beyond physical capital into productivity training for labour and
long term business relationships
● Trade through global value chains as opposed to finished goods has increased from less
than 50% to over 60% of total trade
● More countries now have greater access to overseas funds for investment
○ Between 1990 and 2018, FDI increased by sixfold
■ The benefits of FDI has mostly flowed to MEDCs
■ The growth of short term financial flows has had a destabilising impact on
many economies
● The foreign affiliates of the 104,000 TNCs accounted for 1/3 of total world X and
employed over 73 million people
● The combined value added by TNCs accounted for over 1/4 of GWP in 2017
○ Foreign affiliates contributed 10%
● While TNCs generally perform better than domestic firms, they benefit the community less
and they tend to use less domestic capital and labour
● TNCs do not operate under the laws of any one country and move operations to countries
with the weakest laws
○ Developing countries lose around US$200 billion in corporate taxes each year

Environmental Sustainability
● Low income countries that are desperate to attract foreign investment may engage in
behaviour harmful to the environment eg deforestation, water poisoning, emissions
● The growth in global trade increases consumption of non renewable fuels for transport
● 1997 Kyoto Protocol on Climate Change set carbon emission reduction targets
○ 2015 Paris Agreement included developing countries - 188 states ratified

● Globalisation also offers opportunities to protect the world’s environment by forcing

nations to address their global responsibility for environmental preservation
○ Cans share costs and increase scrutiny of environmental practices
● Facilitated the transfer of new technologies that improve energy efficiency
● May create international mechanisms to enforce agreements preventing environmental
damage, however progress is slow

22
The Role of Financial Markets
● Global financial markets have developed through the removing of capital controls on the
flow of finance, floating exchange rates and deregulating banking sectors
● Countries would be unable to conduct international business without forex markets
○ Businesses would find it more difficult to access loans or attract investors
● Efficient international financial markets should encourage greater transparency of the
actions of businesses and governments
● If investor sentiment turns, it can result in a collapse in exchange rates
○ GFC saw a GWP contraction of 2% despite many government bailouts

The International Business Cycle

● Allows countries to achieve faster rates of growth by specialising in certain types of
production and by engaging in trade
● Can expose economies to downturns internationally and in their region
● The world experienced strong growth in the 2000s due to upswings in the US and China
○ Closer links resulted in a world downturn during the GFC
● Increases the need for macroeconomic policy to be coordinated
● Rising economic nationalism and protectionism have weakened global confidence

23
Case Study: China

Strategies Essay
Analyse the strategies used by the Chinese government to promote economic growth and
development
____________________________________________________________________________________

Economic growth refers to an increase in the total amount of goods and services produced by an
economy over time, usually measured by the change in real GDP. Economic development is a
broader measure of a nation’s wellbeing, encompassing indicators measuring income, health and
education. In order to promote progress in both these areas, the Chinese government has
undertaken a period of rapid decollectivisation and modernisation enabled by extensive
microeconomic reforms. Since 1978, the government has fostered globalisation (the breaking
down of national borders to enable greater integration of the world economy), shifting away from
a centrally planned system towards a freer market and facilitating a rapid increase in investment,
trade and financial flows. This has sparked unprecedented growth and development, with China
now the world’s second largest economy (GDP of US$14.1 trillion in 2019). However, these
industrialisation strategies have also given rise to issues including increased inequality, financial
instability and environmental degradation.

Under China’s ‘Open Door Policy’, five special economic zones (SEZs) were established in 1979-85
that permitted Foreign Direct Investment (FDI) under the Equity Joint Venture Law of 1979. FDI
and technology inflows overcame domestic capital constraints to enable the creation of global
supply chains through vertical specialisation. Tax incentives (15% Y tax instead of 33%) were
offered to foreign firms to encourage the use of Chinese facilities and labour. By 2005, 210
national development areas were in place, increasing FDI inflows from $0.25bn in 1979 to $137bn
in 2019. The abundance of cheap labour led to China specialising in manufacturing in accordance
with Ricardo’s principle of comparative advantage. China is now home to the 2nd most TNCs
(including domestic firms like Huawei) in the world as these SEZs have created over 30 million
jobs, contributing to 45% of FDI and 60% of exports.

Trade liberalisation has been another major strategy to promote economic growth and
development. China’s import substitution industrialisation development strategy was phased out
from 1978, with protectionist measures loosened. The average tariff rate was reduced from 43.1%
to 23% from 1992-96, and further cut to 3.39% following World Trade Organisation (WTO)
accession in 2001. China has signed 16 Free Trade Agreements, becoming the world’s largest
trader in 2013 and trading $4.6 trillion worth of goods in 2018 (12.4% of world’s total). Trade
continues to increase despite tensions with the US, accounting for 38.25% of GDP in 2018, up from
8.4% in 1977.

The Chinese government has also undertaken currency manipulation and financial deregulation.
The RMB was pegged to the USD at a rate of 8.27:1 from 1995-2005 as a way of ensuring certainty
for firms, with the artificially low exchange rate helping China’s international competitiveness.
Though the system was abandoned in 2005 in favour of a ‘crawling peg’ due to concerns around
external stability, China has continued to make currency devaluations when appropriate to boost
exports, most recently in mid-2019. Financial flows into China were enabled by the
re-establishment of the Shanghai Stock Exchange in 1990 along with a secondary SE in Shenzhen.
Moreover, post WTO accession deregulation of the banking sector included lifting bans on foreign

24
institutions and the introduction of private neobanks in 2015 to improve ease of access to
liquidity and curb China’s $8.4 trillion shadow banking industry.

Macro policy has also played a role in China’s economic growth. Monetary policy has been used as
a countercyclical tool to combat China’s volatile inflation rates, as low inflation is a prerequisite
for sustainable economic growth. Inflation has largely stayed in the 1-3% range since 2012,
indicating apparent success in management. The benchmark interest rate was lowered to 3.85% in
April 2020 due to the COVID-19 crisis to stimulate growth, working in conjunction with $2.8
trillion RMB of fiscal stimulus. Fiscal policy has been used throughout the last decade to ‘pump
prime’ the economy, with 13 consecutive deficits peaking at -4.2% of GDP in 2018, including $4
trillion RMB worth of tax cuts and infrastructure spending during the GFC.

Numerous other micro reforms and projects have taken place throughout the last few decades.
The number of state owned enterprises has been reduced from 150 to 97 since 2008 to encourage
competitiveness, while the ‘Made in China 2025’ plan aims to move production up the global
value chain. A focus on increasing technological inflows, productivity and innovation has been
emphasised in recent Five-Year Plans in order to avoid a possible middle income trap. Having
reached the Lewis Turning Point of the labour market, China is losing its competitive advantage in
low-cost manufacturing and is now undergoing structural change to further increase growth and
development.

The Chinese government’s policies have had significant implications on economic growth,
resulting in an average GDP growth rate of 10% over three decades and a 94 fold increase in
productive output since 1978. A consistent trade surplus since 1994 has increased the net exports
component of AD, with net trade contributing 0.8% to GDP in 2019. SEZs account for 22% of GDP
through the multiplier effect of FDI, as investment is the driving engine of economic growth. This
growth has however largely been ‘catch up growth’ in line with the Solow model as China
converges in output with more advanced economies. The economy has been experiencing a
slowdown of late, with just 6.1% growth in 2019 and a 9.8% contraction in the first quarter of
2020 due to COVID-19. As the country transitions towards becoming a developed economy, efforts
to promote consumerism have been implemented in order to continue growth. Household
consumption driven by China’s 400 million middle class citizens accounted for 39.1% of GDP in
2017, and this figure will only continue to rise as incomes increase.

China’s vast improvements in economic development are closely linked to its growth, as higher
incomes allow for more to be spent on health, education and other services. GNI per capita has
increased 47 fold since 1978, lifting 850 million people out of poverty. China’s HDI has also
increased from 0.502 in 1990 to 0.758 in 2018, with life expectancy up 11.5 years since 1978 and
adult literacy rates 31.5%. This signifies a transition from a primarily agrarian based economy
towards a developed economy, with their Engel Coefficient (% of income spent on food) falling
from 0.575 to 0.284 in four decades, below the 0.3 threshold signifying a wealthy country. Thus
the success of China’s strategies in promoting growth and development can be seen.

Despite the gains China has experienced in economic growth and development, the strategies
used by the Chinese government have also had some negative consequences. Inequality has
increased as growth strategies have targeted the coastal areas, particularly in the eastern and
southern provinces. China’s Gini coefficient has spiked to 0.465 in 2019, up from 0.30 in 1980 and
household incomes in urban areas are now 2.72 times that of rural areas. The main drivers of this
25
high inequality are the absence of a fully functioning land market and the hukou system, which is
a major obstacle to migrant workers. Steps have been taken to address this, with the introduction
of a ‘35-Point Plan’ in 2013, a loosening of hukou restrictions and a 165% increase in social
security expenditure between 2011-19.

China’s strategies in pursuing globalisation have exposed the economy to a multitude of

exogenous shocks. Shanghai’s stock index fell almost 70% during the GFC, mirroring the fall in
GDP growth from 14.2% in 2007 to 9.4% in 2009, while the pre COVID slowdown was due in part to
the secular stagnation of the international business cycle. China’s debt to GDP ratio of 304% raises
the possibility of a Minsky Moment, with a major collapse in asset values a likelihood due to
unsustainable speculative borrowing. To insulate the economy from external shocks, China has
accumulated $3.4 trillion in foreign reserves in addition to embarking on externally focused
growth projects like the Belt and Road Initiative (BRI). The BRI is a 36-year program valued at
over $900 billion and covering 152 countries, and has accounted for 27.4% of China’s overall trade
since 2013, thus increasing stability.

Another major negative implication of China’s economic growth strategies is environmental

degradation. Following the environmental Kuznets Curve, sustained periods of high growth have
led to unsustainable levels of resource use, with Chinese emissions up 270.3% since 1992. Poor air
quality causes an estimated annual US$38 billion economic loss in the form of premature deaths
and lost food production. Through government policy responses, China has since become the
world’s largest investor in renewable energy, accounting for 23% of global investment, with
renewable and nuclear energy production increasing over 7x since 2000. China also signed the
Paris Agreement in 2015, agreeing to peak emissions by 2030. While the negative externalities of
growth and development strategies can be seen, China has taken steps towards addressing these
issues.

Since 1978, the Chinese government has pursued numerous strategies in order to promote
economic growth and development. The creation of SEZs along with trade and financial
liberalisation have led to tremendous growth in FDI and trade flows, while macro policy and micro
reforms have also been employed to drive economic growth and development. While these
policies have been successful at their aims, they have come at the cost of increased inequality,
financial instability and environmental degradation.

26
 Topic 2 - Australia’s Place in the Global Economy

Chapter 4 - Australia’s Trade and Financial Flows

4.1 - Understanding Australia’s Place in the Global Economy

● 2% of world GDP (rank 13 - US$1.45 trillion)
● 3rd highest on the HDI
● Australia has needed trade to export our primary commodities and import new
technologies and items not produced in Australia
● Australia is referred to as a small, open economy
○ We trade heavily - export 25% of GDP, import similar amount
● Export (X) = money coming into the country
● Import (M) = money leaving the country

4.2 - Trends in Australia’s Trade Direction

● Since 1973 (when UK joined the EEC), Australia has looked to Asia for X markets
● China has been our main trading partner (X+M) since 2007
● As Australian exporters found it increasingly difficult to access European markets, there
was a shift to Asia for trade opportunities
● By the 1960s, Japan’s economy was sustaining rapid growth and its demand for minerals
and energy products was increasing
○ Became our largest X market - share began declining in the 1990s
● Future shifts of Australian trade will most likely be to other fast growing Asian economies
in South and South East Asia eg India
Annual Exports (%) Annual Imports (%)
Country / region
1990 2018 1990 2018

China 5.8 37.4 4.4 23.0

Japan 26.5 15.6 15.6 7.4

ASEAN 12.6 10.5 7.0 15.7

EU 16.9 5.8 26.1 17.9

USA 13.1 3.9 23.4 10.5

Changing Trade Composition - Exports

● For 2018/19, Australia’s total X increased from $403 to $470 billion
● Iron ore $109 b, coal $70 b, tourism $66.1 b, LNG $50 b (doubled in two years)
○ Australia is forecast to be the world’s largest LNG exporter by the early 2020s
● Minerals and agricultural products are simply transformed manufactures (STMs) with low
value added
○ Commodity prices tend to fluctuate
○ Agricultural products can be protected and depend on weather patterns
● Australia produces few elaborately transformed manufactures (ETMs) with high value
added - share decreased in the mining boom due
27
 ○ We do have some sophisticated, niche market manufactured goods eg biotech

Export category 1999/00 2018/19

Minerals and metals 35% 58%

Services 24% 21%

Manufacturing 18% 11%

Rural 18% 10%

Other 5%

Changing Trade Composition - Imports

● Total M valued at $420 billion
● Small changes can be explained by a shift away from large-scale manufacturing in
Australia - a reduction of tariffs and local content rules
● 2011/12 - 20.8% capital goods (mining I boom)

Import Category 2001/02 2018/19

Capital goods 17.4% 18.6%

Consumer goods 24.1% 24.8%

Intermediate goods 35.0% 31.5%

Services 22.1% 23.8%

4.3 - Trends in Australia’s Financial Flows

● Direct investment: Buying more than 10% of a firm’s shares or establishing a new firm
○ Longer term investment where the investor plays a role in management
● Portfolio investment: Buying less than 10% of a firm’s shares, loans, securities and bonds
○ Marketable securities - securities that can be easily sold
○ Short term speculative form of investment with no management role
○ 36% of portfolio investment is in the form of bonds
Foreign I in Australia ($b) Australian I Abroad ($b)
Year
Direct Portfolio Total Direct Portfolio Total

1980/81 24.9 7.8 47.0 4.6 0.1 13.4

2000/01 253.5 475.4 888.8 218.4 150.1 516.4

2018/19 1060.0 1947.3 3826.0 816.6 1232.4 2824.4

● The rate of growth in financial flows has been greater than trade flows
● During the early 1970s the international system of fixed exchange rates came to an end

28
 ○ Restrictions on the movement of capital across borders were removed
○ Technological changes made it easier to shift finance between countries
● Prior to the deregulation of the financial sector, most financial flows came in the form of
direct investment
○ Governments preferred this as it brought job creation and technology transfer
● Foreign I inflows began to grow rapidly in the 1980s after the floating of the AUD
○ The growth in portfolio I has been faster than the growth in direct I
● Australia has always been a net capital importer
○ Foreign investment > Australian investment abroad
○ Reflects the low level of domestic savings within Australia
● We own more overseas shares than foreigners own Australian shares
○ Negative net foreign equity
○ Due to large superannuation funds increasingly pursuing opportunities overseas

4.4 - Balance of Payments

● The record of the transactions between Australia and the rest of the world
● Published according to international standards so we can make comparisons
● Categorises all transactions into two accounts and many sub accounts
○ Current account (CA)
○ Capital and financial account (KAFA)
● Money coming in = credit / export
● Money going out = debit / import

Current Account (CA)

● Covers the receipts and payments of non reversible transactions
● Net goods
○ 2018/19: X = $373bn, M = $319bn, net goods = $54bn
● Net services
○ 2018/19: X = $97bn, M = $101bn, net services = $-4bn
● Balance on goods and services (BoGS): Net goods + net services
○ 2018/19: BoGS = $50bn
● Net Primary Income (NPY): Payments to the four factors of production (rent, wages,
interest, profit)
○ 2018/19: X = $70bn, M = $131bn, NPY = $-61bn
● Net Secondary Income (NSY): Non-market transfers - income earned not related to the
factors of production
○ Eg insurance payouts, worker’s remittances, unconditional aid, pensions
○ 2018/19: X = $9bn, M = $11bn, NSY = $-1bn
● Balance on current account: BoGS + NPY + NSY
○ 2018/19: CA = $-12bn (0.6% of GDP)

Capital and Financial Account (KAFA)

● Records the borrowing, lending, sales and purchases of assets between Australia and the
rest of the world - reversible transactions
● Capital account: Capital transfers
○ Eg conditional foreign aid, debt forgiveness
○ 2018/19: $-0.8bn
● Capital account: Non-produced, non-financial assets

29
 ○ Eg intellectual property rights - patents, copyrights, trademarks, franchises
○ 2018/19: $0bn
● Financial account: Direct investment
○ 2018/19: $69bn
● Financial account: Portfolio investment
○ 2018/19: $-82bn
● Financial account: Financial derivatives (futures)l
○ 2018/19: $-8bn
● Financial account: Reserve assets
○ Eg monetary gold, Special Drawing Rights (IMF), IMF reserves, foreign exchange
○ 2018/19: $4bn
● Financial account: Other investment - transactions not classified in the other sections
○ Eg trade credits, financial leases, currency and deposits
○ 2018/19: $42bn

Links Between the CA and KAFA

● The two accounts add up to zero - together they are in a balance
● In reality it doesn’t so a net errors and omissions term is added as a balancing item
○ 2018/19: $-12bn
● CA shows net spending (credits - debits)
○ In Australia we have few savings to fund this if debits > credits
○ We must borrow funds or sell equity, which are recorded in the KAFA
○ When purchased, shares, loans and bonds appear on the KAFA
○ Any corresponding servicing costs appear in the CA under NPY
● Australia has been a destination of foreign investment (due to high IRs) in the past and the
CA shows what we’ve done with this net inflow
● In theory BoP = 0 due to the floating exchange rate system as demand = supply
○ At any one point the AUD is always in equilibrium
○ Supply of AUD: Payments for imports of G/S (M) + primary and secondary income
outflows (Y debits) + capital and financial outflow (K outflow)
○ Demand of AUD: Receipts for exports of G/S (X) + primary and secondary income
inflows (Y credits) + capital and financial inflow (K inflow)
○ So M + Y debits + K outflow = X + Y credits + K inflow
○ Rearranging: M - X + Y debits - Y credits = K inflow - K outflow
■ Or: -CA = KAFA
● Also = 0 due to accounting framework - double entry

4.5 - Trends in Australia’s Balance of Payments

● The BoP is an important indicator of the health of the economy and reflects key features
of the structure of the economy

2020 Current Account Surplus

● 4th CAS in succession: Rose $6.7bn to $8.4bn in the March quarter of 2020
○ BoGS rose $5.6bn to $19.2bn, NPY deficit fell $0.8bn to $10.6bn

2019 Current Account Surplus

● Year to September 2019: X = $388bn, M = $321bn, net services = $-4bn, net Y = $-59bn
○ BoGS = $63.1bn, CA = $3.861bn, or 0.2% of GDP

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 ● Reasons: China doing well - record high % of X to China
● Higher X volumes of resources and services, even manufacturing
○ Volume and price of iron ore increasing
■ Due to dam collapses in Brazil in Jan 2019 which restricted world supply
○ ToT near historical highs
○ Services up, especially tourism from China
● M down - mainly capital investment
● Depreciating AUD assisted in improving trade accounts

Past Current Account Deficit Trends

● CAD peaked 2007/08 at -6.6% of GDP ($78.0bn CAD, BoGS $-30.0bn)
● CAD usually between 3-6% of GDP, NPY usually 3-4%
● Average CAD: 1990s 4.1%, 2000s 4.9%, 2010s 3.1%
● First quarterly surplus in the CA in June 2019 for 44 years

The Balance on Goods and Services - Cyclical Factors

● Australia’s growth - influences demand for M
○ 2007/08 $-30bn: Pre-GFC high demand for M - high incomes and capital expenditure
(capex) due to mining investment
○ 2018/19 $50.2bn: Decreased demand for M - low wage growth and capex
● International growth - influences demand for our X
○ China number 1
● AUD - Increasing AUD leads to higher X prices and lower M prices
○ Decreases international competitiveness - volume effect
● Terms of Trade - Xp Index / Mp Index
○ High ToT deemed as favourable as we can buy more M for a given amount of X
○ Between 2000-2010, ToT doubled due to the global commodity boom
○ In March 2016, ToT reached a low point of 89 (2016/17 base year)
■ Iron ore price $38.5 / tonne in December 2015
○ Since then ToT have increased over 100 as commodity prices increased
■ Iron ore price $121 / tonne in July 2019
○ China’s emergence as a low cost manufacturer has also kept Mp low, increasing ToT
○ However the effect of a high ToT on BoGS is somewhat mitigated by its effect on
the AUD - appreciation leads to lower international competitiveness

The Balance on Goods and Services - Structural Factors

● Narrow X base - heavily weighted towards primary commodities (rocks and crops)
○ Minerals and agriculture account for 2/3 of our X earnings
■ Commodity prices are more volatile than manufacturing or services
○ Aus needs to import capital equipment to expand its mining capacity
■ Lags between increased commodity prices and increased X volumes
■ During the 2000s, Aus only increased X by 3% pa while M increased by 8% pa
○ Increasing agricultural prices due to growing global food demand
■ Prices 36% higher in the 2010s than in the two previous decades
■ Rising Y in the developing world, rising prices for agricultural inputs, impact
of climate change in reducing productivity
○ Aus could benefit by diversifying x base towards high growth sectors eg high tech
and elaborately transformed manufactures (ETMs)

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 ■ Greater role for services given close proximity to emerging Asian economies
■ Aus X $97bn or services in 2018/19 - mainly tourism and education
○ Due to the growing impact of climate change, Aus needs to address structural
dependence on carbon-intensive X
● International competitiveness - Aus lacks this in the manufacturing sector
○ Added pressure due to (previously) high AUD, low cost Asian manufacturers
○ Closure of major industries eg PMV puts Aus manufacturing at risk of losing the
base level of skills and capacity required to compete
○ High labour costs lack of economies of scale due to small population

The Primary Income Account - Structural Factors

● Savings and Investment Gap - lack of national savings is the main reason for Australia’s
ongoing NPY deficit
● We are a small, open economy and we don’t save enough to fund domestic I
○ We must borrow from overseas or sell shares - liabilities
○ Servicing costs - interest and dividends - are recorded in NPY
● Good news is that foreigners have always been willing to lend / buy shares
○ AAA credit rating
● Bad news is the possibility of the debt trap scenario
○ Large CAD - borrowing from overseas - servicing costs - higher NPY deficit - CAD
● Aus household savings rate: 1983/84 14%, 2002/02 -1%, 2008/09 10%, Dec 2019 3.6%
● Current average household debt is 190% of income
● Government also has a role to play - a larger deficit leads to more borrowing
○ Can increase public savings through moving the budget from a deficit into surplus -
fiscal consolidation
○ Can address low savings through microeconomic reform eg compulsory super,
encouraging savings through tax incentives
○ However public sector debt is only 20% of Y - very low compared to other countries
● Since 2014, NPY has been helped by a depreciating AUD and the growth in super funds

The Primary Income Account - Cyclical Factors

● Interest rate differentials - if global IRs are low, lower debt servicing costs
○ 2018/19: $24.9bn in interest repayments
● AUD - When the AUD depreciates, negative valuation effect on debts in forex
○ Hedging and swapping limits this
○ However there is a positive effect on our dividends and assets owned overseas
● Domestic business cycle - when we boom, higher dividend outflows
○ 40% of ASX is foreign owned, 80% of mining stocks
○ 2018/19: $60.3bn outflows on foreign direct I

4.6 - The Consequences of a High CAD

● Net foregin liabilities (NFL) - cumulation of all our past CADs
○ Australia’s financial obligations to the rest of the world - world’s obligations to us
■ 2018/19: $1tn in debt, or 51.5% of GDP
● NFL = Net foreign debt (NFD) + net foregin equity (NFE)
○ 2018/19: NFD = $1.15 trillion, 59% of GDP
○ 2018/19: NFE = -$0.15 trillion, 7% of GDP
■ We own more overseas assets than overseas own ours - due to super

32
 ○ March 2020: NFD up $3.8bn to $1.146tn. -NFE up $105bn to $338bn

What is Wrong With a CAD?

● Continuous CADs lead to increased NFL as we need to borrow from overseas or sell shares
● Higher NFL leads to increased servicing costs - debt trap
● Increased AUD volatility - may result in a depreciation
● Loss of investor confidence due to the above and a consequent loss of AAA credit rating
○ Lenders may increase IRs, charging a risk premium - compounds debt trap
○ The 1997 Asian financial crisis was triggered by concerns over Thailand’s high CAD
● Need contractionary policy to reduce a CAD in the short term
○ Will reduce economic growth
● Constraint on future economic growth - the balance of payments constraint

Concerns With the CAD

● Concerns over Australia’s CAD have decreased in recent years
● In the era of globalisation, financial markets have become more willing to accept external
imbalances as it has not stopped countries from sustaining strong economic growth
● Financial markets have also been confident that Australia’s resources will underpin
continued X growth in the future
● However the high CAD makes Australia dependent on continuing financial inflows
● The IMF suggests that a CAD of 6% of GDP is sustainable only in the short run
● Over the long run, 4% is probably the maximum sustainable

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Chapter 5 - Exchange Rates

5.1 - Introduction
● The exchange rate is the price of one currency in terms of another
○ Can be bilateral or multilateral quotes
● Necessary because exporting firms want to be paid in their own currency
● Currency conversion occurs in the foreign exchange market (forex)
● AUD is the world’s 5th most traded currency after the USD, Euro, Yen and Pound
○ AUD used in 6.9% of all currency trades
○ 89% of all AUD sold are used to but USD
● US$135 billion of forex transactions in the Australian market in 2016 - 3% global total
● Daily global forex trade is worth US$6.6 trillion (including derivatives, April 2019)
● Countries can use different systems to determine their exchange rate eg floating (clean or
dirty), fixed rate and flexible peg
○ Currency unions eg Euro with 19 EU members and 4 non members

5.2 - Australia’s Floating Exchange Rate System

● AUD switched from a managed flexible peg to a floating exchange rate in December 1983
● One of the most important structural changes in Australia’s economic history
○ Opened up the economy to global financial flows
● The value of the currency is determined by the forces of supply and demand in the forex
markets as they establish an equilibrium

Demanders of AUD
● Our X buyers
● Foreigners investing in Australia
● Aussies earning interest / dividends from loans / shares overseas
● Speculators expecting the AUD to go up (97% of all trades) - known as hot money

Suppliers of AUD
● Our M buyers
● Aussies buying investments overseas
● Foreigners earning interest / dividends in Australia
○ Almost 50% of the ASX is foreign owned (~80% of mining stocks)
● Speculators expecting the AUD to fall

Influences on Supply and Demand

● World growth determines the demand for our X
● Our growth determines demand for M
● Relative interest rates - if ours are greater, there will be higher demand for the AUD
● Availability of investment opportunities
● Inflation - if ours is greater than overseas, we have lower international competitiveness
thus decreased demand for our X and increased demand for M
● Terms of trade - if ToT increases, demand for AUD to buy X will increase
○ Often depends on commodity prices
● Expectations of changes in the AUD - speculators

34
Factors Causing an Appreciation / Depreciation of the AUD
● An increase in Australian interest rates or decrease on overseas interest rates
● Improved investment opportunities in Australia or deterioration in foregin investment
opportunities
● A rise in commodity prices and improvement in Australia’s terms of trade
● An improvement in Australia’s international competitiveness
● Lower inflation in Australia
● Increased demand for Australia’s exported goods and services
● Expectations of a currency appreciation based on forecasts of one of the above factors
● The opposite of these would cause a depreciation in the AUD

The Trade Weighted Index (TWI)

● A comparison of the value of the AUD against a single currency can create a misleading
impression of trends in the value of the AUD
● The TWI gives an indication of how the value of the AUD is moving against all currencies
○ Calculated by measuring the value if the AUD against the currencies of 19 major
trading partners compared with a base year
○ Currencies more prominent in our trade are given a higher weighting - amended
each financial year by the RBA
■ RMB 27.7%, Yen 10.9%, USD 9.7%, Euro 9.7%, SK Won 6.5%
○ The total number of countries included in the TWI must cover 90+% of Australian
trade (usually around 20 countries)
● The USD is underweighted - 2/3 of our X and half our M are priced in USD

History of the Australian Dollar - Trends

● Low of 0.477 USD in April 2001 (dot com bubble)
● Began appreciating strongly as commodity prices increased from 2003
● 2008-09: Fell sharply in GFC from 0.985 to 0.60 in a matter of weeks
○ People flocked to the USD as a safe haven currency
● 2009-11: Swiftly recovered post GFC - from 0.60 to 1.10 in 2011
○ People backed out of USD after GFC
○ China boom, increasing demand for our resources (Mining Investment phase)
○ Rise in terms of trade (106.4 in 2011)
○ Became new safehaven as Australia continued to grow
■ AAA credit rating, US and EU floundering
○ Cash rate up (max 4.75%), encouraging foreign investment
■ Carry trade (moving money around to find better interest rates)
○ Effects: decreased imported inflation, increased overseas tourism, increased CAD,
structural change towards mining - caused manufacturing crash (Dutch Disease)
● 2012-15: AUD began to depreciate, falling to around 0.70 by 2015
○ China’s growth slowed to 6.9%
○ ToT fell back below 100, commodity prices fell
○ US started to recover, people returned there as a safe haven
○ US and other economies started quantitative easing
○ Australia’s growth slowed, cash rate dropped to 2% in 2015
● 2016-18: Hovered between 0.70-0.80
○ China slowdown continued
○ US recovery continued

35
 ○ Commodity prices had small increase
○ Political uncertainty (multiple PMs)
○ Cash rate down to 1.5% in 2016, US Fed starting increasing rates in 2016 (peaked
2.5% in late 2018 - early 2019)
■ I.R differential continued to narrow
○ QE wound back, global growth slowing
● 2019-2020: Dropped to post GFC low of 0.65 (Feb 29, 2020)
○ No carry trade - cash rate down to 0.5%
○ Now threat of further IR cuts due to increase in unemployment (5.3%)
○ Growth slowing, bushfires, droughts, coronavirus
○ Poor Chinese manufacturing data, continued trade war effects
● COVID-19 crisis: Low of 0.55 (March 2020)
○ Sold off the AUD for USD as a safe haven during the COVID-19 crisis
○ Recovered to 0.70 in June as iron ore prices rose ($103.59 June 12)
■ Brazil supply shock

5.3 - Reserve Bank Intervention in the Foreign Exchange Market

● Although primarily relying on market forces to determine the exchange rate, the RBA
sometimes influences the value of the currency both directly and indirectly

Direct Intervention - ‘Dirtying the Float’

● When the RBA feels that a large short term change in the exchange rate will be harmful, it
can buy / sell in order to stabilise the AUD
● To appreciate AUD, the RBA will buy AUD to increase demand (sell forex reserves)
● To depreciate AUD, the RBA will sell AUD to increase supply (buy forex)
● Ability to intervene is limited due to small size of foreign currency holdings - less than one
day’s total transactions
● Has been used at various times since 08/1986
● RBA purchase $3.3 billion of AUD to moderate its depreciation in late 2008 when the AUD
lost one third of its value against the USD
○ Was able to sell $3.4 billion in 2009 as the currency recovered in value - generated
profits that contributed to the RBA’s dividend payment to the government

Indirect Intervention
● Monetary policy initiatives can be used to influence the exchange rate, although rarely are
○ To appreciate AUD, increase the cash rate to attract foreign savings
○ However the RBA generall only uses the cash rate to control inflation
● Jawboning - talking up the AUD by making positive statements about Australia’s economic
prospects or the reverse
○ In 2015/16 Glenn Stevens said “AUD is overvalued” to try and get the AUD down to
increase international competitiveness
● A 10% depreciation in the AUD leads to a 0.25-0.5% increase in inflation for 2 years
● A 10% appreciation corresponds with a 0.3% annual decline in inflation

5.4 - Fixed Exchange Rate Systems

● Australia had a fixed exchange rate system prior to November 1976
○ Pegged at different times to the USD, Pound, TWI
● The government or RBA officially sets the exchange rate

36
 ● The government can attempt to maintain the fixed rate by either buying or selling foreign
currency for AUD
○ Requires large foreign reserves of foregin currency and gold
● Risk with the system is that the RBA could exhaust its reserves by continually exchanging
them for the excess supply of AUD - could lead to a total collapse of trade in the currency
● The government can change the exchange rate officially so it gets closer to the market
value - devalue and revalue

The Managed Flexible Peg

● Operated in Australia from November 1976 to December 1983
● The RBA would peg the value of the AUD at 9am each day and that price would operate
throughout the day
● Provides more flexibility than the fully fixed rate but can still allow the official rate to
drift away from that which would exist under pure market forces

Chinese Yuan
● Currently uses a ‘Crawling Peg’ system
● Between 1994-2005, used a fixed exchange rate at 8.27 RMB to 1 USD
● After 2005, could deviate 0.5% per day
● The daily trading band was gradually widened, reaching the current 2% in 2014
● If there is too much demand for the RMB, the Chinese central bank will accumulate
increasingly more USD
● In the past 20 years, China’s forex reserves have increased 20 fold from US$150 billion to
over US$3 trillion in 2014
○ This makes China’s central bank the world’s most active public sector forex market
participant
● Gradual relaxation of government influence over the currency value can be seen in the
moderate fall of China’s foreign reserves since 2014

5.5 - Exchange Rates and the Balance of Payments

● The balance of payments influences the dollar and vice versa
● Under a floating exchange rate, quantity supplied must equal quantity demanded
○ The net outflow of funds on the current account equals the net inflow of funds on
the capital and financial account
● If the CAD deteriorates, it would increase the supply of AUD, resulting in a depreciation
○ Because of the depreciation, the financial inflows would be able to buy more AUD
● The effect of the balance of payments on the exchange rate also depends on the
perceptions of financial markets
○ Can depreciate with a current account surplus (2019)
○ Can appreciate with a large CAD (2008)

Effects of a Change in the Exchange Rate - Appreciation

Positive Negative

- Consumers have increased purchasing power - Exports become more expensive - leads to a
decrease in X income, increasing CAD

37
- Decreases the interest servicing cost on - Imports become cheaper, encouraging M
foreign debt - will reduce outflow on the net spending. Domestic production of import
primary income component of current account substitutes will fall

- Reduce the value of foreign debt borrowed in - Worse (X-M) component will reduce
foreign currency (valuation effect) economic growth rate

- Reduced inflationary pressures as imports - Foreign investors will find it more expensive
become cheaper to invest in Australia - financial inflows may
continue if the AUD is expected to keep rising

- Reduces the value of foreign income earned

on investments abroad

- Reduce the value of foreign assets (valuation

effect)

● A depreciation would have the opposite effects - positives become negatives

Volume Effect
● When AUD depreciates, X prices decrease, leading to greater demand
○ M prices increase, leading to less demand
● Overall impact depends on size of changes - price elasticity of demand (elastic = good)
● Marshall-Lerner Condition states that for a devaluation in a currency to improve the
current account, PED of X + PED of M must be greater than 1
○ Leads to a J-curve phenomenon - inelastic in the short run
○ RBA says that a 10% depreciation in the AUD will lead to a 4% increase in X and 3.5%
decrease in M (combined PED of 0.75)
● Overall, an appreciation in the AUD is said to be positive for the volume effect

Valuation Effect
● If the AUD depreciates, it means the AUD value of our foreign assets and interest dividends
will increase
○ But the AUD value of loans taken out in forex and any interest will increase
● Overall valuation effect in the past was highly negative as we took out a lot of forex loans
● Now the loan component is thought be 0:
○ Interest rates have decreased
○ We own a lot of overseas assets through super
○ We have limited forex loans as they are hedged (buying foreign currency at the
time to pay) or swapped into AUD as soon as borrowed
● Overall, an appreciation in the AUD is said to be negative for the valuation effect

38
Chapter 6 - Protection in Australia

6.1 - Introduction
● Australia’s isolation and high proportion of output that is traded means that trade barriers
would have a significant impact on the economy
● Australia’s economy has benefited from the removal of trade barriers globally
● Australia remains committed to trade liberalisation despite Trump’s election
● Historically, Australia was one of the most protectionist countries in the world
○ Government protected manufacturers who found it difficult to compete due to low
populations and production levels in Australia
● Australia began to phase out almost all tariffs from the late 1980’s - now one of the most
open economies in the world
● The government’s main aims in reducing protection:
○ Force domestic industries to become internationally competitive by exposing them
to competition from imported goods
○ Encourage resources to move away from industries and firms that cannot improve
their competitiveness - focus on areas of comparative advantage
○ Allow Australia to benefit from greater integration with the global economy by
giving consumers access to G/S available on global markets
○ Promote structural change in the economy with the long-term aim of encouraging
efficient firms to produce what the global economy demands

6.2 - Government Initiatives to Reduce Protection

● Gradual decline in the average tariff level in Australia

● Protectionist policies came under attack from the 1970’s

● Organisation argued that they fostered inefficiency, increased prices, misallocated
resources, made Australia less internationally competitive, damages our trading
performance and reduced living standards in the long run
● Whitlam government announces a 25% tariff cut across the board in 1973 (unilateral)
● In 1988 Australia commenced a comprehensive program of trade liberalisation
○ Reduced tariffs faster than any advanced economy in the next decade (except NZ)
● Around half of imported goods are tariff free - the remainder subject to a general tariff
rate of 5% or less (mainly manufactured goods)
● Arrangements protecting manufacturing industries eg PMV, TCF were protected by higher
tariff rates - phased out in 2015
● Has imposed other forms of trade protectionism - $50 billion submarine contract to be
manufactured in SA in 2016, 2018 ban of Huawei and ZTE from involvement in rolling out
the new 5G networks for fears of national security
● Estimated value of tariff assistance to domestic production was $6.8 billion in 2016-17
● Australia’s average tariff rate is lower than the US (1.7%) and the EU (1.8%)
● In 2017 Australia had the 2nd lowest level of agricultural protection in the OECD, with
subsidies accounting for less than 2% of farm income (only NZ lower)
○ 10% in the US, 18% in the EU, 49% in Japan
● Export assistance programs still exist, administered through Austrade
● Main program in the Export Market Development Grants (EMDG) scheme

39
 ○ Provides around $140 million in grants to around 4000 businesses to help them find
export markets and enhance export promotion
○ A 2015 review found that each dollar spent generates net gains of $1.55 to $7.03
● Australia’s reductions in protection levels typically go beyond those required by
international trade agreements such as the WTO agreement
○ Australia often criticised for relying on anti-dumping rules (eg new law in 2017)
○ Still tariffs on new cars and a ban on second-hand car importation despite the lack
of a domestic car manufacturing industry to protect

6.3 - Australia’s Free Trade Agreements

● Governments pursue free trade by accessing overseas markets through trade agreements
● Australia has secured trade deals with China, Japan and South Korea in the last decade
● 12 bilateral agreements, 2 multilateral, 5 more under negotiation

Bilateral Trade Agreements

● Easiest trade agreements to negotiate because they only need to factor in the interest of
the two participating economies
● Most comprehensive bilateral agreement for Australia is the 1983 Australia - New Zealand
Closer Economic Relations Trade Agreement (ANZCERTA)
● ChAFTA (2015) - tariff free goods will rise from 86% to 98% - directly improves
competitiveness of key agricultural industries eg beef, dairy, wine, fruit, seafood
○ Largest trading partner worth over $150 billion
○ Greater market access for certain services eg financial, professional, educational
● JAEPA (2015) - ending of PMV and household electronics tariffs, 19% decrease in beef
tariffs to 19.5%
○ Our second largest trading partner (17.7% of X)
● AUSFTA (2005) - automotive tariffs eliminated immediately, all tariffs since 2015
○ The US is Australia’s third largest trading partner - 9% of two way trade
○ 97% of non agricultural tariffs abolished
○ Aus firms have access to US government procurement, a market worth $415-535 bn
● KAFTA (2014) - tariff free X rising from 84% to 99% of X over the next 20 years - facilitates
more services trade in legal, accounting, financial, engineering, telecommunications and
education services
○ Trade between the countries increased by around 50% between 2014 and 2017
○ 4th largest trading partner with 7.5% of X and 4.3% of M
● Preferential trade agreements add to the complexity and cost of international trade
● Generate fewer economy wide benefits than broad trade liberalisation

Multilateral Trade Agreements

● ASEAN-Aus-NZ FTA (AANZFTA) since 2010 - covers 20% of Australia’s trade in G/S and
creates a free trade area of 650 million people
○ ASEAN and Australia are complementary economies - the goods we X eg
commodities are in heavy demand in industrialising nations while the goods they X
eg manufactured products cannot be produced domestically
○ 96% of goods will be tariff free (up from 67% pre agreement)
○ Agreement was forecast to boost Australia’s economy by USD$19 billion during the
decade following its implementation

40
 ● Since 2012, ASEAN and Aus, NZ, India, China, S Korea and Japan have been negotiating the
Regional Comprehensive Economic Partnership (RCEP) that would bring all these countries
into a single multilateral trade agreement
○ Would cover 40% of the global economy and almost 50% of global pop
● Trans-Pacific Partnership (CP-TPP / TPP-11): Signed March 2018, 11 members, 6.8% of
world pop, 13% of world GDP, 15% of world trade, $164 billion Aus X (22% of all Aus trade)
○ Trump withdrew in 2017
○ 30 chapters and provisions to lower 18,000 tariffs (over 98% of tariffs in trading
area) came into effect when ratified in 2018
○ The World Bank estimated that the TPP-11 (with US) could increase trade among
members by 11% by 2030, increase GDP in member countries by an avg of 1.1%
● During the 1990’s, Australia’s regional trade negotiations focused on the Asia-Pacific
Economic Cooperation (APEC) forum
○ No binding commitments have been finalised in this time
○ Since 1994, average tariff levels have fallen from 17% to under 6%, goods without
tariffs risen to 60% and 150 FTA have been implemented involving APEC members

6.4 - Implications of a Reduction in Protection Levels for the Australian Economy

● One of the most significant structural changes in the economy in recent economic history
○ Significantly increased integration with the global economy

Effects on Firms
● Reducing protection creates winners and losers, particularly in the short run
● Individual firms that operate in marginal, import competing industries will shrink unless
they are able to improve their competitiveness
● Production in some sectors may cease altogether eg consumer electronic manufacturing,
PMV manufacturing - now import from lower-wage economies of Asia
● Some businesses will restructure their operations - putting their focus on specialising in
one aspect of production
○ Eg consolidating manufacturing processes, eliminating less profitable product lines,
finding X opportunities, adopting new technologies, reducing staffing levels

41
 ● By operating in a competitive domestic market, Australian firms should be able to better
compete in global markets
○ Should result in higher levels of investment - spurs innovation and productivity
growth through increased competitive pressure
● Lower tariffs mean lower input costs for firms that import capital goods eg machinery
● Abolishing tariffs on intermediate production inputs would reduce input costs by $6 billion
per year - makes firms more internationally competitive
● Curing the 1990’s, the reduction in protection along with other microeconomic policies
contributed to changes in Australia’s X base - growth in manufacturing
○ The resource boom of the 2000’s saw Australia shift back to a heavily commodity
dominated X base eg gold, natural gas
○ Has been substantial growth in X volumes in this period
○ A higher proportion of Australia’s production is being exported, and a higher
proportion of G/S consumed are imported

Effects on Individuals
● Increase in unemployment associated with restructuring of industries and cuts in
production - can lead to severe long term structural unemployment
○ Reduction in clothing tariffs from 17.5% to 10% in 2012 lead to 5% employment drop
in the industry (1500 jobs) but lowered prices for consumers - further reduction to
5% was implemented in 2015
● The import competing industries most affected have been concentrated in particular
regions eg manufacturing in Victoria and SA
○ Unemployment rates have climbed dramatically with little alternative employment
○ Many of the jobs lost are low skilled - skills are not easily transferable
● The structurally unemployed may need to retrain
○ Government established a $155 million Growth Fund to support the transition away
from the PMV industry after the domestic car industry closed 2017
● In the longer term, employment may increase - the lost employment should be recouped
by the growth experienced by those sectors in the economy that are efficient
○ Eg while manufacturing has declined, services eg tourism, education have grown
○ In 2018, education represented just under 40% of Australia’s service X compared to
11% in 1999
○ Received 9.1 million visitor arrivals in 2018
● The gains and losses from protection reductions are unevenly distributed throughout the
population, with some communities winning while others lose out
● Lower trade barriers results in consumers being able to buy G/S at lower prices
○ Wider variety of G/S available
○ Lower protection and other factors resulted in real price falls of up to 54% between
1985 and 2011 for a range of manufactured goods eg footwear, electronics
● Increased competition has also contributed to improved customer service

42
 ● Removal of trade barriers also improves living standards for individuals - higher quality G/S

Effects on Governments
● Cutting tariffs will lead to a reduction in government revenue
○ Used to be the largest source of revenue for the Commonwealth government -
importance has declined throughout the 20th century
○ The $2 billion in tariff revenue collected by the government in 2018-19 accounts
for less than 1% of total revenue
● Governments may be required to assist the structural adjustment process through
increased expenditure on unemployment benefits and retraining programs
○ Specialised financial support to certain industries eg job search assistance,
relocation assistance and industry-specific training
● May be political consequences of tariff reduction - generally unpopular with the wider
community - costs are highly visible while the benefits are wider spread and longer term
○ Governments can lose votes by pursuing policies to reduce protection

Other Economic Effects

● In the short term, can reduce standards of living due to increased M
● In the long term, as resources move to more productive areas of the economy with higher
rates of return, growth and living standards should improve
● Can have significant effects on trade performance and the current account deficit (CAD)
○ CAD likely to worsen as imports rise - should be reduced in the longer term as
exports grow
○ Australia’s failure to reduce tariffs until the late 1980’s contributed to a less
competitive X sector and higher CADs
● Trade liberalisation between 1986 and 2016 increased GDP by 5.4% and increased average
family Y by $2670 according to economic modelling
○ +28.5% X, 28.6% M, -3.4% prices, +7.4% real wages
○ Trade has meant that real Y for the avg Aus family is higher by an estimated $8,448
(Simon Birmingham, 2019)
● Australia adopted a decision to phase out tariffs over a 30 year period to help industries
adjust better to changing business conditions

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6.5 - The Impact of International Protection Levels on Australia
● International protectionism reduces the output of the Australian economy
● Tariffs make Australian X less competitive while subsidies make overseas X cheaper and
increase supply - both lead to a reduction in Y
● A global reduction in tariffs that reduces M prices by 10% would increase Australia’s real
GDP by 0.6% a year
● If tariffs globally rose by 15%, Australia’s GDP would be reduced by 1% every year, cost
100,000 jobs and reduce median household Y by $1500 a year
○ 5% of capital stock would be lost
○ Global trade would be 22% lower and global output would be 3% lower
● 1671 new measures to restrict trade have been implemented by WTO members since 2016

Agriculture
● Australia suffers particularly as a result of protectionist policies from other nations and
trading blocs eg EU Common Agricultural Policy
○ Absorbs one third of EU budget and supplies one fifth of EU farmers’ Y
○ OECD average agricultural subsidies as a % of farming Y was about 18% in 2017
● The reduction of Chinese tariffs on Australian wine helped Australia’s wine X to China to
double by 2018 to more than $2 billion every year
● Slow global progress to reduce agricultural protection in recent years, reflecting a
protectionist trend worldwide since the election of the Trump administration
● Many protectionist agricultural nations have taken advantage of loopholes in WTO
regulations to avoid freeing up agricultural trade
● Reductions in agricultural protection have been modest despite significant FTAs
● If the Doha Round talks had been realised, Australia’s agricultural X could have been
boosted by USD$9 billion by 2020

Mining and Resources

● These X contribute the largest share to Australia’s total X - very few barriers
● Products from this sector eg coal, iron ore are in very high demand worldwide - companies
are more likely to face X restrictions from the government trying to secure domestic
energy supplies than from a foreign government
○ WA domestic gas reservation policy requires that 15% of the state’s natural gas
production is reserved for domestic use
○ LNG X have grown rapidly since the commodity price boom started around 2004
■ Australia overtook Qatar in 2018 to become the world’s largest supplier
○ In 2017 Turnbull announced a law to restrict LNG X in order to ease domestic supply
constraints on the east coast
■ Aims to limit wholesale and retail prices which have increased sharply
■ Restrictions would only be used if there is a gas shortage in a given year -
has not been used yet and appears unlikely to be used anytime soon
● Importing countries often don’t have their own resources - no domestic resource sector to
protect from trade

Manufacturing
● Few barriers due to substantial reductions in industrial tariffs in recent decades
● There are exceptions to the generally low tariffs eg PMV in China have a 20% tariff
● Non-tariff barriers eg technical restrictions and licensing rules exist

44
 ○ Eg varying health regulations for processed foods both X and M
○ Technical barriers to trade are now formally a part of trade negotiations at the
WTO and in bilateral trade agreements

Services
● Account for 70% of GDP but less than a quarter of X
● In many situations trade is simply not feasible due to geography, transport costs, language
/ cultural differences, local tastes / preferences
● Protectionism also plays a role in reducing services trade through government regulations
● Many countries’ banking sectors are protected by restrictions on granting licences for
overseas owned banks
● Firms in the electricity, recycling and communications industries face overseas markets
dominated by monopoly government providers or arrangements that favour local providers
● The impact of service trade restrictions is significant for service based economies
○ Liberalisation of trade in services could increase Australian service X by $11 billion
per year by 2025
○ Restrictions on establishing commercial operations in key Asian markets especially
for financial services remains costly
○ One of the main goals of FTAs with Japan and China is to reduce these barriers

Service Industry Potential Trade Barriers

Financial Restrictions on foreign ownership of banks and other DTIs

Transport Restrictions on the number of flight routes in another country

Professional Licensing laws that only recognise local education qualifications

Construction Government procurement rules that mandate use of local suppliers

Utility Government monopoly provision of electricity, gas, water

Environmental Government preferences for local suppliers

Media and Entertainment Minimum local content requirements to preserve culture

6.6 - The Future of Australian Industry in the Global Economy

● Currently uncertainty surrounding the future of trade relationships due to US - China
● There has always been uncertainty about how the structure of industry will change in
response to globalisation and trade
○ There was an assumption in the 80’s and 90’s that Australia would shift to
value-added manufacturing and services - instead now relies on resources
● Mining and energy industries will likely remain Australia’s most important X
○ Since the early 2000’s, total X revenue earned by minerals and metals industries
has risen from under one third to over 50%
○ Mining and resources X exceeded $200 billion in 2018-19
○ These “old economy” industries experienced a dramatic resurgence during the
resources boom of the early 2000’s due to rapid industrialisation of Asia
○ Production capacity has continued to increase as large scale projects come online

45
 ○ Multiple LNG projects are expanding supply - LNG X estimated at $51 billion for
2019-20 compared to less than $10 billion a decade ago
● Agricultural industries face a mixed outlook
○ Global food prices have increased
○ Decreased AUD has improved international competitiveness
○ Lack of reduction in global protectionist barriers
○ Impact of climate change on weather patterns and output - water shortages
○ Increasing levels of agricultural efficiency in other countries
● Processed foods are likely to play a bigger role in X - greater market access from recent
FTAs eg wine and dairy
○ Global market for high-quality processed foods is expected to continue growing
fuelled by the expanding middle-classes of China and India
● X oriented manufacturing has continued to grow - from $5 billion to $30 billion in the
three decades to 2019
○ Growth expected to continue as specialised manufacturers expand their markets by
produced high quality niche goods
○ Trends in the exchange rate will be important for future competitiveness
● Services expected to continue to grow as a proportion of X
○ Tourism is the main service X with annual earnings over $60 billion
○ International education worth over $30 billion in X earnings - overseas students
○ Digital services - ICT have become Australia’s 4th largest X at $5 billion for 2018
○ Environmental services have long term potential eg renewables
○ Annual global investment in clean energy is now almost USD$280 billion

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 Topic 3 - Economic Issues

Chapter 7 - Economic Growth

7.1 - Introduction
● Economic growth is defined as an increase in the volume of goods and services that an
economy produces over a period of time
● Measured by the annual rate of change in real Gross Domestic Product (GDP)
● Calculated by the ABS using income, expenditure and production
○ Equal in the circular flow model
● Calculated quarterly to produce three figures
○ Quarterly rate of economic growth
○ Year on year growth figure (previous four quarters)
○ Annual economic growth rate (over the course of the financial year)

7.2 - Economic Growth and Aggregate Demand and Supply

● Traditionally, most economists believed that the most important factor determining
growth was the level of total output (supply)
○ Opinions changed after the Great Depression of the 1930s
● John Maynard Keynes theorised that the most important influence on growth was the total
level of expenditure in the economy - the level of aggregate demand
○ Keynesianism shaped economic policy in developed nations after WWII
● AD: the total level of expenditure in an economy or demand for G/S
○ Consumption, investment, government spending, net export spending
● AS (Y): the total level of Y or productive capacity in an economy
○ Collected through taxation, spent or saved
● Economy is in equilibrium when AD = AS
○ Leakages = injections (Circular Flow of Income model)

7.3 - The Components of Aggregate Demand

● Changes in the level of economic growth in the short and medium term are largely driven
by changes in the level of AD
● Domestic demand components (March 2019)
○ Household consumption: 59%
○ Government spending (total general government): 17%
○ Business investment: 15%
○ Public investment: 5%
○ Housing (dwelling construction): 4%

Influences on Consumption
● Typically makes up 50-60% of AD
● Influences on saving:
○ People with higher incomes tend to consume more, but people with lower incomes
consume more in proportion to their incomes
○ Relates to the average and marginal propensities to consume and save
● Consumer expectations:

47
 ○ Expectations about future price rises and the general availability of G/S will
influence consumers’ decisions
● The level of interest rates:
○ Higher interest rates discourage spending and encourage saving
● The distribution of income:
○ The more equitable the distribution of income, the higher the rate of overall
spending - relates to the higher APC of lower income earners

Influences on Investment
● Keynes: ‘Investment is the engine of economic growth’
● Business investment tends to be the most volatile component of AD, usually around 15%
● Cost of capital equipment:
○ Influenced by changes in interest rates and global credit conditions
○ Changes in government policy relating to investment allowances and tax
concessions eg claiming depreciations, instant asset write off
○ Changes in the price of productivity of labour - labour being a substitute for capital
in the production process
● Business expectations:
○ ‘Animal spirits’ - Keynes, entrepreneurial spirits
○ Changes u expected demand for their products - demand encourages investment
○ Change in general economic outlook
○ Inflationary expectations - high inflation leads to low investment

Influences on Government Spending and Taxation

● Federal G usually makes up 20-25% of AD and taxation around 20-25% of AS
● Goal is to maintain a sustainable rate of economic growth
● Also influenced by objectives of external stability and sustainability of debt

Influences on Exports and Imports

● Each equal to 20-25% of AD
● Influenced by the levels of overseas and domestic income
● Also influenced by: exchange rates, international competitiveness, protectionist policies,
consumer tastes and preferences

7.4 - Changing Levels of Growth: The Multiplier Process

● How changes in the level of AD influence the level of economic activity
● In the three sector model, Y must be either saved (S) or spent (C)
● The Circular Flow model suggest that the economy will move towards s state of
equilibrium through the multiplier process - developed by Keynes
● Changes in expenditure will provide increased income for individuals who consume more,
which will further increase expenditure and income
○ Initial increase in investment will have a multiple impact on national income
● The number of times the final increase in national income exceed the initial increase in
expenditure is called the multiplier
○ The mechanism is known as the multiplier effect
● Marginal propensity to consume (MPC): proportion of each extra dollar of income that is
spent on consumer products
● Marginal propensity to save (MPS): proportion of each extra dollar of income that is saved

48
 ● MPC + MPS = 1
● Multiplier k = 1/MPS or 1/1-MPC
● Multiplier process also works for decreases in AD
● The three sector multiplier is called the ‘simple multiplier’
○ Five sector multiplier = 1/leakages

7.5 - The Role of Aggregate Supply

● AS plays an important long term role in influencing levels of economic growth
● AS is determined by the quantity and quality if the factors of production
● An economy can grow faster and more sustainably when AS is increasing
○ Result in GDP growth and price stability through lower inflation
● AS is increased when there is an increase in quantity or improvement in the quality of the
factors of production, achieved through changes such as:
○ Population
■ Discovery of new resources
○ Participation
○ Productivity
■ Workers acquiring new skills
■ Increased capital
■ The adoption of new technology
■ Measures to improve efficiency
○ Policy
■ Eg reforms to rules and regulations
● Over time an economy will begin to run out of spare capacity and reach capacity
constraints is successfully in managing AD
○ Only result after that without a corresponding increase in AS is inflation
○ Micro policies are aimed at increasing AS

7.6 - The Effects of Economic Growth

● Growth is essential to achieve many economic and social objectives, but can also
sometimes create problems
● Living standards:
○ Results in an increase in real GDP per capita
○ Real wages can rise leading to higher disposable income and living standards
○ Australia had per capita real income growth of 2.3% in the 2000s
○ In 2019, the average Australian household had less disposable income in real terms
than five years before due to below average wage growth
● Employment:
○ Growth creates jobs and the development of new and more advanced industries
○ More highly paid and skilled jobs
● Inflation:
○ Result in price increases and larger wage claims
○ Growth in AS cannot keep up with growth in AD
○ Major aim of macro policy to obtain sustainable rate of economic growth
● External stability:
○ Higher incomes lead to increased consumer and business pending and higher levels
of imports

49
 ○ When an economy grows faster than its trading partners, the BoGS can worsen the
CAD - BoP constraints as a speed limit for growth
○ Can undermine confidence in the economy
● Income distribution:
○ The benefits of growth flow disproportionately to higher income earners or owners
of capital
○ Can lead to increased inequality in income distribution
○ Absolute poverty falls but relative poverty rises
● Environmental impacts:
○ Can result in pollution, depletion of nonrenewable energy sources and damage to
the local environment
○ Increasing impacts of climate change
○ Economies must now pursue ecologically sustainable development
○ Transition to renewable energies can create new jobs and industries
○ Higher growth may lead to a greater capacity to invest in environmentally friendly
technologies and stronger environmental protection

7.7 - Recent Economic Growth Trends (Includes U/E + Infl)

● A market economy is subject to the ups and downs of the business cycle caused by changes
in the level of AS and AD
● Market economies usually experience an overall trend of growth in real GDP
● Australia had the record for the longest consecutive period of growth from 1991-2020
○ Avoided recession: two consecutive quarters of negative GDP growth
● Averaged 3.3% growth in the 1990s and 3.1% in the 2000s, above the average for the OECD
● Slowed to an average of 2.6% in the 2010s, and down to 1.4% in the year to June 2019, the
slowest since 2000
● Recent growth reflected a mix of domestic and external factors:
○ Global economic conditions: strong growth in the US, then China in the 2000s
■ Surging demand for resource X, helping avoid a recession during the GFC
■ More recent concerns about the US - China trade war
○ Major structural improvement in the terms of trade
■ Enjoyed the benefit of rising X prices and volumes
■ Mining investment boom increased output capacity
■ ToT reached highest levels in 140 years in 09/11, adding 15% to national Y
■ Declined slightly, but recovered in 2016/17 and 2018/19
○ Macro management has been successful at curbing inflation to 2-3%
■ Has experienced within 1% of the sustainable growth rate of 3-3.25% for 21
of the 28 years since 1991/92
○ RBA’s preemptive use of monetary policy and its focus on maintaining low inflation
■ Quick to cut the cash rate to support AD
○ Successful use of active fiscal policy during periods of economic downturn
■ Avoided recession during the GFC due to stimulus
○ High population growth - net migration of around 1% of population
○ Large increases in asset prices such as real estate and shares - wealth effect
○ Productivity growth reached record levels in the 1990s (2.1% p.a vs 1.3% during the
80s), reflectiving the beneficial impact of extensive micro reforms
■ Only averaged 1.2% in the 2000s and 1% in the 2010s
● Australia has successfully navigated the events of the long economic growth cycle -
avoided recessions during the Asian Financial Crisis, the dotcom bubble and the GFC
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 ● The three P’s - productivity, participation and population will help achieve long term
economic growth
○ Participation expected to fall due to the ageing population
○ For every additional 0.1% increase in annual productivity growth over the next 40
years, Australians will enjoy an average increase in living standards of $4500 a year

Mining Boom Mark I (Demand / Price Phase): 2003-07

● Very strong growth - peak of 4.9% in June 2007
● Demand for minerals was very high (China), global supply inelastic due to low investment
○ Prices increased, boosting X-M

GFC: 2008-09
● Growth fell to 1.4%
● Rudd delivered 2x massive budget deficits with $70bn of G
○ GDP increased by 2%, helped avoid recession but increased debt
○ ‘Pump Prime’ - Keynes

Mining Boom Mark II (Investment Phase): 2010-13

● Growth peaked at 4.5% in 2012 due to:
○ Strong China recovery (12.2% growth in 2010)
○ Increasing iron ore prices: US$90 / tonne in 2009, US$187 / tonne in 2011
■ Low supply as mine were still being built
○ Terms of trade doubled (highest in 140 years)
■ ToT boom added 15% to nominal GDP (over $190bn a year), more than all
reforms of the 1980s and 90s and the information revolution
● Unemployment down to 4.9% due to Okun’s Law, less than 5% NAIRU?
● Inflation rose to 3.6% (2011) due to increasing wages and natural disasters eg Cyclone Yasi

Mining Boom Mark III (Quantity Phase): 2013-15

● Growth decreased to 1.9% in 2013, hovered around 2.5% until 2015 due to:
○ China slowdown (down to 8% in 2013)
○ Slow US and Japan recovery post GFC
○ Euro debt crisis
○ Decreased mining investment and slow take up of other investment
○ Iron ore prices decreased to US$130/tonne
○ Terms of trade decreased 20% in 2013
● Unemployment increased to 6.1%
● Inflation decreased below 2%, 1.3% in 2015

Stagnant: 2016-2018
● 2016-2018 growth averaged 2.6%, although increased to 3.1% in the last half of 2018
● Mainly due to:
○ C maintained as S dropped to 1%
○ Increased X of liquid gas by 72%
○ ToT increased from 70 to 92 index points
○ Lower AUD increased international competitiveness
● Fiscal stimulus with I projects worth $75bn eg start of Sydney 2nd airport
● Unemployment rose to 5.8% (2015-17)

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 ● Inflation low at 1.9% due to:
○ Low wage growth (2.3%)
○ Negative wealth effect as house prices fell
■ Leads to lower confidence and consumption
○ Drought impacting agricultural products

2019:
● GDP growth 1.4% to June 2019 - per capita recession of -0.2%
● Record low IRs, Investment decreased 1.6% to June 2019
○ Further declines in capex in mining (peaked June 2012)
○ May have bottomed out - highest level of mining I since 09/18
● Dwelling I decreased by 9.1% to June 2019 (peaked 09/2018)
● Higher X levels due to previous investment:
○ X volumes increased 2.9% to June 2019, resource X up 2%
○ Rural X down 6.5% due to drought
○ ToT at 101.1, first time over 100 since 2011
○ Commodity prices up by 1/3 in the two years to June 2019
■ Falling AUD, Brazil supply constraints
● M down 2.8% to June 2019 due to lower business I
○ Capital M down 2.1%
○ Also due to weak consumer spending and lower AUD
● Real public spending up 5.2% to June 2019 - increased public sector employment, NDIS
○ Despite political aims of seeking a budget surplus
● H/H consumption largest component of demand, down from recent years
○ Growth at 1.4% to June 2019, below 2.9% of previous years, averaged 3.2% in the
past 2 decades
● Disposable Y saved down to 2.3% from 3.2%, 4.3% in 2018 and 2017

Bushfires and COVID-19 Pandemic: 2020

●

7.8 - Policies to Sustain Economic Growth

● Macroeconomic policies smooth volatile fluctuations in the business cycle
○ Influence AD in the short and medium term
○ Limited impact on the level of long run growth rate
● Fiscal policy involves the use of the Commonwealth Government's Budget in order to
achieve economic objectives
○ G represent an injection, T leakage
● Monetary policy involves the RBA changing the level of interest rates which in turn
influence AD
○ Main macroeconomic tool in recent years
○ Effectiveness limited by the 0 lower bound
● Microeconomic policies aim to increase AS and reduce the extent of inflationary and
current account problems
○ Strong growth in the 1990s came about due to microeconomic policies
○ Increased investment in workforce skills and physical infrastructure in recent
budgets aims to increase AS alongside reforms to increase competitive pressures
and reduce unnecessary regulation

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53
Chapter 8 - Unemployment

8.1 - Introduction
● One of the most important measures for an economy’s health is the level of employment
○ High unemployment suggests economic failure, slower growth, lower taxation
revenue and high social welfare payments
○ Long term social costs eg increased inequality, poverty, crime
● Australia has had relatively low unemployment since 2002, reflecting sustained growth
○ Struggled to reduce it post GFC

8.2 - Measuring the Level of Unemployment

The Labour Force and Participation

● The labour force consists of all employed and officially unemployed persons in the country
○ Persons aged 15 and over who are currently employed for at least one hour a week
of paid work
■ Includes paid leave, worker’s compensation, stood down / on leave for less
than four weeks without pay, on strike
○ Self employed persons working at least one hour a week in their own business or a
family business
○ Unemployed persons aged 15 and over who are currently available for work and are
actively seeking work
○ Labour force in Australia is around 13.5 million people
● Those no included in the labour force are:
○ Children under the age of 15
○ Full time, non working students above the age of 15
○ People who perform full time domestic duties
○ Unemployed persons who are not willing to actively apply for jobs and attend job
interviews or who are not available to start work
○ People who have retired from the labour force
● Those over the age of 15 are considered members of the working age population
● Labour force participation rate = percentage of the working age population who are in the
labour force

Unemployment and Underemployment

● Unemployment: those who are out of work but are actively seeking work
○ Number of unemployed / total labour force
○ Must satisfy any one of a number of criteria:
■ Regularly checking advertisements from different sources for available jobs
■ Willing to respond to job advertisement, apply for jobs with employers and
attend interviews
■ Registering with an unemployment agency linked to Job Services Australia
● ABS undertakes a monthly survey of the labour force
○ Around 52,000 individuals
○ Doesn't take into account underemployment, hidden unemployment, volunteers
● Underemployment: Those who are employed but want to work more hours
● Labour force underutilisation rate: unemployment rate + underemployment rate

54
 ● Extended labour force underutilisation rate: Adds in two additional groups who are
marginally attached to the labour market
○ Actively looking for work and able to start within four weeks but not one week
○ Discouraged job seekers
● RBA calculated an hours based labour underutilisation rate
○ Adds the extra hours that underemployed part time workers are seeking,
converting those hours to the equivalent full time jobs
○ Better measure of the amount of spare capacity in the labour market

8.3 - Recent Unemployment Trends

● Peaked at 10.7% in 1992/93 - highest level since the Great Depression
○ Severe recession saw falling AD and cutbacks in production
○ Worsened by extensive structural change and microeconomic reform
○ Workforce of declining industries were unable to find employment in growing
industries due to a mismatch in skills
● Gradual fall in unemployment for 15 years from 1993 to 2008 (4%) - lowest since 1974
● GFC caused unemployment to rise to 5.8% in 2008/09
○ Fell quickly back to 5% by 2010 due to a quick recovery
● Mostly stayed in the 5-6% range since 2010, rising marginally higher in 2015
○ Just below advanced economies average
○ Growth has been sufficient to sustain mild job growth
● Dropped to 4.9% in 01/19 following 3+% growth in 2018
● Currently 7.4% (07/2020) following sharp rise due to COVID

Underemployment and the Labour Force

● Faster growth in part time employment than in full time
● 2019: Australia has the 3rd highest level of underemployment in the OECD (8.2%)
○ Over 30% of workers on part time, employed for an average of 17 hours a week
○ 1 in 4 wanted more hours - average of 14 additional hours per week
● Close to historically high participation rates, will likely decline over the coming decades
○ Will fall from 66% in 2019 to 62.4% by 2054-55
○ Proportion of Australia’s population aged over 65 rose from 12.2% to 15.7% from
1998 to 2018
■ Will continue to rise 2% every decade through to the 2050s
■ Will be partially offset by the increase in over 65s working, retirement age
will be lifted to 67
○ Rose 1.6% from 09/16 to 07/2019 - increased confidence of jobseekers, particularly
women (participation reached record high 61%)
● Labour force increased due to the following factors:
○ Population growth of 1.6%
○ Increasing female participation
○ Increasing need for dual incomes
○ Older people retiring later than expected
○ Increase in part time jobs - now 30% of total
● This is despite low economic growth which usually decreases participation

Okun’s Law
● Need economic growth to be greater than 3% to stop unemployment increasing

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 ● To reduce unemployment, economic growth must exceed the sum of growth in productivity
plus the increase in the size of the labour force
○ 2015 RBA analysis concluded this rate was 2.9%, down from 5% in the 1970s
● Higher rates of productivity growth makes it more difficult to reduce the rate of
unemployment in the short term

8.4 - The Main Types of Unemployment

● Structural: Workers do not have the required skills for jobs in newly emerging industries
due to structural changes in the economy eg technological change, preferences for G/S
● Cyclical: Downturn in economic growth leads to falling demand and thus fewer
employment opportunities
● Frictional: Temporarily unemployed as they change jobs - inevitable
○ 1 in 12 Australian workers (around 1 million) change jobs each year
● Seasonal: Occurs at regular times throughout the year due to the seasonal nature of some
kinds of work
○ Official figures are usually seasonally adjusted to take into account fluctuations
● Hidden: Those unemployed that do not fit the ABS definition of unemployment
○ Discouraged job seekers - shows as a decline in participation
○ 1.1 million Australians in 2019 (ABS)
● Underemployment: people who work less than 35 hours a week but would like more
○ Higher for women and young workers
○ Reflects shift away from full time towards casual and part time work
● Long-term: those out of work for 12 months or longer
○ Newly unemployed workers are reabsorbed into the workforce faster - more up to
date and attractive skills
○ Long term unemployed usually suffer from structural unemployment
○ Loss of enthusiasm to find work
○ Loss of contact with the work world - do not learn about new skills and
developments in the labour market
○ Potential employers look less favourably towards long term unemployed persons
○ Amount of weeks unemployed (ABS):
Year Average (wks) Median (wks) Long-term (%)

1970 7.3 n/a n/a

2005/06 39.6 13 18.2

2019/20 48.9 15 24.1

● Hard-core: Considered unemployable due to personal circumstances
○ Disabilities, drug abuse, anti social behaviour

8.5 - The Non-Accelerating Inflation Rate of Unemployment (NAIRU)

● The level of unemployment at which there is no cyclical unemployment
○ Comprised of frictional, seasonal, structural, hard-core
○ Economy is at full employment
● When unemployment > NAIRU, there is spare capacity in the labour market
○ Policy makers should stimulate economic growth
● When unemployment </= NAIRU, further economic growth will cause inflationary pressures

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 ○ Relationship is highlighted in the Phillips Curve
○ Friedman-Phelps Expectations Augmented (Long Run) Phillips Curve
● A lower NAIRU increase the economy’s capacity to grow without increasing inflation
● Currently estimated to be around 4.5% (Phil Lowe June 2019)
○ Fell from 7% to 5% in the two decades to 2015

8.6 - The Causes of Unemployment

● Many explanations for unemployment:
● Lack of economic growth:
○ Cyclical unemployment: demand for labour is derived demand
○ Decline in AD could be due to: an economic downturn, government policies (stance
of macro policy) or a decrease in demand for X
○ Generally felt that unemployment rises when growth is below 2.5% and falls when
it is above 3% - time lag of about six months
○ Constraints on economic growth eg inflation, CAD
● Rising participation rates:
○ Increase in short term rate of unemployment as more people actively seeking work
○ The level of unemployment may only be reduced slightly during an economic
recovery due to discouraged job seekers reentering the workforce
● Structural / technological change:
○ Significant short term costs - loss of inefficient industries and jobs
○ 2017 OECD analysis concluded that the shift from manufacturing to service
industries is responsible for 1/3 of job losses, automation 2/3
○ 2019 OECD report - 36% of jobs at a high risk of automation, 46% overall in OECD
○ Leads to sunrise and sunset industries (boom vs bust)
■ Biotech, services (education, tourism) booming
■ Manufacturing eg PMVs, TCFs bust
● Productivity:
○ Higher productivity growth will slow employment growth in the short term as fewer
employees are required per unit of output
○ Will increase employment in the long run as higher productivity increases growth
● Labour market: Inadequate levels of training and investment:
○ If workers are not retrained, long term unemployment will rise - skills mismatch
○ 38 occupations on Australia’s skills shortage list (2019) eg arborists and
panelbeaters, wide range of tradespeople, health professionals and construction
■ 85% of jobs had skills shortages before the GFC in 2007-08
○ Number of people in traineeships or apprenticeships in 2017 was halved over the
previous five years to just 268,000
○ Main training program announced in the 2018 budget: Prepare, Trial, Hire (PATH)
● Labour market: Increased labour costs
○ May rise because of a sustained increase in labour costs
○ Concerns over low wages growth in recent years
○ Shortage of skilled labour may result in wage inflation
○ Wages breakout caused by excessive wage demands could reduce profits and cause
firms to substitute capital for labour or reduce output
○ The Fair Work Commission’s decision to increase the National Minimum Wage Order
■ Eg 2020 increased to $19.84/hr
○ Rise in labour on-costs eg payroll tax, super, sick leave, holiday pay, workers’
compensation - affected by government policy
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 ● Labour market: Inflexibility in the labour market:
○ ‘Wages are sticky in a downward direction’ - Keynes
○ High minimum wages makes Australia unattractive for low skilled jobs
○ 2019 study attributed high underemployment to labour regulations - ranked
Australia 105th out of 140 countries for inflexibility of wage determination
○ 1996 Workplace Relations Act decentralised the labour market, decreasing trade
union power and increasing flexibility
○ 2009 Fair Work Act - slightly more intervention (10 National Employment Standards)

Shifting Industries and Shifting Jobs

● Globalisation has accelerated the process of economic change (structural change)
● 2018 RBA study highlighted the two changes to the labour market in the past 50 years:
○ Growth in highly skilled, non-routine jobs in the business services sector
■ Eg financial services, consulting, technology, communications etc
■ Doubled from 10% to 20% of total employment
○ Decline in lower skilled, routine jobs in the goods production sector
■ Eg manufacturing, mining, construction, utilities, agriculture
● Industry specific analysis ‘Australian Jobs 2018’ found the following changes:
○ Manufacturing went from the largest employing industry to the 7th largest from
1987 to 2017 (15% of workforce to 7%)
○ Employment in Agriculture, Forestry and Fishing halved from 6% to 3%
○ Service sector now employs 3/4 of the workforce
■ Driven by Health Care and Social Assistance (ageing population, NDIS etc)
and professional, scientific and technical services
● Job growth in recent years has been driven by five key industries:
○ Health Care (1.7 million)
○ Professional services, construction, education, hospitality (1 million each)
● Structural change is expected to continue into the future with artificial intelligence and
automation rendering a substantial number of jobs obsolete
● 2018 studies found that 14-20% of all jobs will be lost to new technologies by 2038
○ Will expand employment in some sectors eg health care, software, programmers,
teachers, chefs, plumbers

8.7 - The Impacts of Unemployment

Economic Costs
● Opportunity cost of lost production - lower total output, incomes and expenditure
○ Unemployed resources
○ Lower living standards
● Decline in labour market skills for the long term unemployed
○ Can turn into long term structural unemployment through hysteresis
● Cost to the government as taxation decreases and transfer payments increase
● Lower wage growth which leads to decreased consumption and inflation

Social Costs
● Increased inequality: unemployment tends to occur in lower income earners eg young and
unskilled - will contribute to poverty and inequality
○ 1 in 8 children grow up in a family where no one is working - ‘jobless family’

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 ○ Intergenerational dimension of poverty - poverty trap
● Other social issues: homelessness, family tensions, increased social isolation, crime,
erosion of confidence, poor physical and mental health, higher risk of suicide
● Impact on certain groups:
○ Youth: 18.1% unemployment (15-19) , 28.4% underutilisation (15-24)
■ High school retention rates increased from 1/3 to over 80% from 1980 to
2013, also an increase in tertiary education
■ 50,500 of the 267,000 Australian 15-24 year olds had spent over 12 months
looking for work without success
○ Indigenous Australians: 21.3% unemployment, 47% total employment (72% for the
general population)
○ Age: average job seeking time of 68 weeks for 55+, 49 weeks for 25-54 and 30
weeks for 15-24. 27% of over 50s had experienced age discrimination
○ Regional: 4.4% in Sydney, 4.9% in NSW, 10.6% in Southern Highlands and Shoalhaven,
2.4% in Baulkham Hills and Hawkesbury, North Sydney and Hornsby, Inner West (May
2019)
○ Migrants: 7.4% among migrants in the last decade
■ Higher participation (70% vs 66%)

8.8 - Policies to Reduce Unemployment

● Macro policy are the main instruments used to reduce cyclical unemployment
○ Expansionary fiscal and monetary policy
○ GFC stimulus dragged unemployment down 1.5%
● Micro reform is used to address structural unemployment
○ Make the economy more efficient
○ Shifts AS to the right and NAIRU to the left
○ Eg tariff reduction, deregulation, national competition policy, privatisation, tax
reform, labour market
● Labour market: an increase in G on active labour market programs of 1% of GDP will
reduce unemployment by 2% compared to 0.5% of spent on other budget priorities
○ Changes to workplace regulation eg 1996 Workplace Relations Act, 2009 Fair Work
Act which introduced National Employment Standards
■ Aims to make the labour market more flexible
○ Increase in skills and training eg $752 m PaTH program (2016)
■ Compulsory skills training, voluntary internship placement, wage subsidies
○ State government programs eg NSW Government’s Youth Employment Program
($65m)
● Other policies eg immigration, parental leave programs
● Frictional: network of 62 employment service providers known as jobactive ($1.3bn in
2018/19), Morrison announced digital jobactive program
○ Helps workers find jobs, transition between jobs
○ Australia spends less than half the OECD average on employment services

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Chapter 9 - Inflation

*9.1 - Introduction
● Inflation can have negative impacts on many outcomes including growth, international
competitiveness, exports and income inequality
● Maintaining low inflation is a major economic objective of economic policy

9.2 - Measuring the Rate of Inflation

● Inflation is a sustained increase in the general level of prices in an economy
● Most widely used measure is the percentage change in the Consumer Price Index (CPI)
○ Summarises the movement in the prices of a basket of G/S weighted according to
their significance for the average Australian household
■ Housing 23%, food 16%, recreation 13%, transportation 10% etc
○ Gives a good indication of the overall movement in the prices of consumer goods
and reflects general changes in the cost of living
○ Published every three months
● The official (headline) rate of inflation is calculated using the CPI
○ Can be misleading as it includes goods of high volatility
● Underlying inflation (core inflation) removes the effects of one off or volatile price
movements - tend to be less variable
○ Trimmed mean: Average inflation rate excluding the top and bottom 15% of price
changes
○ Weighted median: the middle inflation rate of every CPI item
○ The RBA’s underlying inflation is an average of these two measures

9.3 - Recent Trends in Inflation

● Experienced relatively high inflation in the 1970s and 1980s
● RBA introduced inflation targeting of 2-3% over time in 1993
○ Between 1996-2019, headline inflation average 2.4% and underlying 2.6%
● Introduction of the GST in 2000 caused a one off increase in headline inflation to 6%
● Most recently peaked at 5.1% in September 2008 as a result of high global prices
○ Ended with the GFC
● Since the mid 2010s, inflation has stayed low due to low wage growth and weak growth in
parts of the economy as well as globally
○ Intense retail competition has led to price discounting
○ Softening demand for market services eg hairdressing, financial services
○ Rent eased due to new apartments increasing supply
■ Low non tradable and administered inflation - housing, utilities
● Monetary policy has been relatively successful in addressing inflationary pressures
● Lower inflation rates can also be attributed to the impact of structural change and
productivity growth in the 1980s and 1990s

9.4 - The Main Causes of Inflation

● Four main causes of inflation: demand-pull, cost-push, inflationary expectations and
imported inflation
● Two other possible causes: government policies and excessive increases in money supply

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 ● Demand-pull: When AD exceeds productive capacity, prices rise as output cannot expand
any further in the short run
○ Consumers are willing to pay a higher price for any given level of supply
● Cost-push: When there is an increase in the costs of factors of production eg oil, wages
○ Firms pass on cost increases to the consumer by raising prices
○ When wages increase faster than productivity growth, the cost of labour per unit of
output increases
■ Wages make up 60% of firms costs
● Inflationary expectations: If individuals expect higher inflation in the future, they may act
in a way that causes an increase in inflation
○ Attempt to purchase products before prices increase - demand-pull inflation
○ Employees will try to negotiate wage increases with costs passed onto consumers
● Imported inflation: Transferred to Australia through international transactions
○ Increase in the price of imported goods
○ Depreciation of the AUD
○ If imports face local competition, importers may absorb costs and not pass on
increases to consumers
○ Now accounts for a larger share of variability in the headline inflation rate than in
the past, reflecting the impact of trade liberalisation
● Government policies: Increasing indirect taxes, deregulating an industry, changing tariff
rates, imposing price controls, changing prices of goods made by PTEs
○ Tobacco excise increases of 12.5% a year from 2013-2020 made tobacco the largest
single contributor to headline inflation in this period
● Excessive increases in the money supply: When the increase in the money supply outstrips
the growth rate of the economy, prices for G/S are likely to rise
○ Effectively leads to an increase in AD relative to AS
○ Also called monetary inflation

9.5 - The Effects of Inflation

● High inflation leads to negative short and long term impacts of the economy
● Economic growth and uncertainty:
○ Acts as a constraint on growth and increases uncertainty
○ Distorts economic decision making as producers and consumers change their
spending and investment decisions in order to minimise the effect of inflation on
themselves eg by buying assets rather than investing in Y producing activities
● Nominal wage demands:
○ Employees will seek larger wage increases in order to be compensated for the
erosion in the purchasing power of their nominal wages
○ Emergence of a wage price inflationary spiral that is difficult to break
● Income distribution:
○ Low incomes don’t rise as quickly as prices, especially for those on fixed incomes
○ Borrowers may face higher interest rates
○ Can also erode savings, causing net wealth decline
● Unemployment:
○ Results in contractionary macro policy, slowing growth and increasing
unemployment in the short to medium term
○ Phillips Curve shows an inverse relationship between unemployment and inflation
in the long run

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 ○ Relationship has broke down eg 1970s stagflation, recent low unemployment and
inflation since the mid 2010s
● International competitiveness:
○ Increased prices for Australia’s exports, reducing international competitiveness
○ Consumers may switch to import substitutes, worsening the trade deficit
● Exchange rate impacts:
○ High inflation can lead to short term appreciation in the exchange rate as
speculators anticipate the RBA raising interest rates
○ Generally causes depreciation over time
○ Loss of confidence in the Australian economy, weakening the value of the AUD
○ The economic theory of purchasing power parity says that exchange rates in the
long run will change to reflect the real purchasing power of currencies
■ Strong link between inflation and exchange rates
■ Relies on the assumption of free trade and floating exchange rates
■ Does not work due to local factors eg transport costs, taxes, shorter term
global financial flows
● Interest rates:
○ Results in higher interest rates as central banks try to reduce demand pressures in
the economy and avoid the negative consequences of high inflation
● Benefits of inflation:
○ Generally considered to be limited
○ A small amount of inflation can be beneficial as it allows for adjustments in
relative prices in an economy without requiring reductions in normal prices
■ Prices tend to be sticky, especially for wages
○ Deflation gives consumers an incentive to delay purchases, which can cause a fall
in consumption and an economic downturn
■ Can make borrowing and hiring workers less attractive

9.6 - Policies to Sustain Low Inflation

● Monetary policy has been the main tool used to achieve low inflation since the 1990s
○ Other parts of the policy mix have also been used
● Monetary policy:
○ Attempts to sustain growth at a level that does not create inflationary pressures
■ Inflationary target of 2-3% over time
○ Increased interest rates used to target inflation - will dampen consumer and
investment spending, lowering economic activity and inflation
○ Pre-emptive monetary policy taken before inflation emerges as a problem
■ To account for policy lag between implementation and effect
■ 7x interest rate increases in 2009/10 post GFC
○ Target band also lowers inflationary expectations
● Fiscal policy:
○ Can also play a supporting role
○ Can increase T and decrease G to reduce demand pressures
○ Has not been used to target inflation in recent years
● Microeconomic policies:
○ Contribute to long term low inflation environment
○ Reduced protection lowers the price of imports and increases competition for
domestic producers

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 ○ Labour market reforms ensure wage increases are linked to productivity
improvements, meaning real wage increases will not create inflationary pressures
○ Greater infrastructure investment can help avoid bottlenecks that can increase
production costs and cost push inflation
● In the long run, inflation is likely to be increasingly influenced by global factor rather than
government policies
○ Rise of China as a low cost producer has reduced global inflationary pressures
●

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Chapter 10 - External Stability

10.1 - Introduction
● External stability is an aim of government policy that seeks to promote sustainability on
the external accounts so that Australia can service its foreign liabilities in the medium to
long run and avoid currency volatility
● Achieving external stability is an important objective of economic policy
○ It ensures that imbalances in Australia’s relationship with the global economy do
not hinder achieving domestic policy goals eg higher growth
● 3 external imbalances: CAD, foreign liabilities, exchange rate
● If foreign investors decide that Australia’s external position is unsustainable, this can have
serious effects on the economy
○ Depreciation of the AUD
○ Withdrawal of investment funds
○ Difficulties for firms in accessing overseas financial markets
○ Higher interest rates
○ Slower economic growth
● Concerns over Australia’s external imbalances have receded in recent years due to a lower
CAD and the lack of impact of these issues on our economic performance
● Australia has maintained sustainable economic growth, low inflation and low
unemployment, maintaining confidence from foreign investors
○ Confidence has been strengthened by increased commodity X revenue
● As such achieving improvements in external stability has diminished in priority

The Main External Stability Issues for Australia

● A persistent CAD: Australia has run high deficits on its current account since the 1980s,
driven by a large deficit on net primary income
○ Averaged 5.1% of GDP in the 2000s decade
○ Averaged 3.1% during the 2010s
● Volatile terms of trade: Australia’s ToT have fluctuated wildly due to the commodity price
boom from 2003-2011
○ Underpinned by rapid industrialisation in emerging economies eg China and India
○ ToT peaked in 2011 at their highest level in 140 years - 85% above the 20th century
average
○ Fell 36% from 2011-2016, but increased again to only 16% below 2011 peak by mid
2019
○ This boosted Australian X and national income but had negative impacts on other
sectors due to the high AUD
● Lack of international competitiveness: Due to our remoteness and small population base,
Australia struggles to compete in markets such as manufacturing and the technology sector
○ Due to high transportation costs, lack of economies of scale, high labour costs and
a lack of financial backing for startups
● The growth of foreign debt: Grew rapidly during the 1980s from 6% to 35% of GDP
○ Around 55% now, although servicing costs are still lower than in the 1990s due to
low global interest rate
● Rising foreign ownership in Australia: A large share of profits go offshore - NPY
○ The minerals and resources sector has particularly high levels of foreign ownership
■ $366 billion in foreign investment in 2018

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 ■ 80% foreign owned at the height of the mining boom in 2011
● The volatility of the AUD: As commodities make up a large share of Australian X, the value
of the AUD oftens reflects fluctuations in commodity prices
○ Underwent a strong rise in the 2001-2011 decade (60+% on TWI, 130+% against USD)
○ Lost ground since its highs in early 2012 - down 1/3 against USD by mid 2019

10.2 - Australia’s Current Account Deficit

● A key measure of external stability is the CAD as a percentage of GDP
● The large increase in the CAD in the 1980s prompted a range of major structural reforms
to restore the competitiveness of the Australian economy
● The CAD is explained as the result of a savings and investment gap rather than a trade gap
○ Structural issue related to net primary income
● The CAD may be sustainable since it is the result of high levels of direct investment in
Australia that have helped generate higher economic growth and X in the long term
● A high CAD may put Australia at risk of not being able to finance its external liabilities

The CAD as a Trade Deficit

● In the 1980s, the CAD was blamed on persistent deficits on the BoGS, caused by slow X
growth and expanding demand for M
● While the BoGS is not the main contributor to the CAD, it still plays a critical part in
Australia’s balance of payments performance
● Australia lacks international competitiveness in many higher value added areas of global
trade eg ETMs
○ Much of Australia’s traditional manufacturing industries have not been able to
compete with large scale, low cost overseas competitors eg China
■ TCF, PMV, oil refining etc have all moved offshore
○ Our exports of finished goods have decreased, increasing our reliance on imports
○ A sustained period of high commodity prices in the 2000s has led to a higher AUD,
making non mining sectors less competitive - Dutch Disease
○ Result of both cost factors (exchange rate, labour costs, productivity) and non-cost
factors (quality, reliability of supply, marketing, customer services)
■ Australia was ranked 18th in 2018 for innovation and sophistication
○ Australia has developed new X markets in business and financial services to growing
Asian markets due to out proximity
■ Australia was ranked the 14th most competitive economy in 2018
● Australia’s ToT has major effects of the changes in the CAD
○ Falling commodity prices in the last quarter of the 20th century increased the CAD
○ The trend changed in 2003, and the 2011 peak in the ToT was more than double the
1980-90s average
■ High ToT contributed to an increase in the CAD due to a surge in capital M
(high capex) and consumer M (high Y and AUD)
■ Fell after a historic CAD of 6.7% of GDP in 2007
○ A 23% increase in ToT in the three years to 2018/19 helped deliver Australia’s
largest trade surplus on record
○ The trade balance has improved from an average deficit of 1.5% of GDP in the
2000s to 0.1% in the 2010s
○ The risk of the heavily reliance on minerals and energy X is that a fall in commodity
prices can trigger a large increase in the CAD

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 ■ Coal and iron ore provide more than 1/3 of our X revenue

The CAD as a Savings - Investment Gap

● The savings - investment gap is another explanation for the CAD
● If domestic spending exceeds domestic output, we are forced to bring in financial inflow
to make up the difference ie borrowing or selling assets
○ If the government runs a budget deficit, this will also reduce savings
○ A recent fall in investment has helped narrow the gap
● Australia has historically relied on overseas capital to fill in the gap, making it possible to
develop more rapidly
● So long as foreign investors are increasing Australia’s productive capacity, they will add to
Australia’s capacity to service its foreign liabilities and the CAD will thus be sustainable
● This relates to the costs and benefits of foreign investment:
Benefits Costs

- Boosts domestic employment, economic - Dividend repatriation and debt servicing can
development and growth and capital stock adversely affect balance of payments

- Boosts technological innovation and research - Leads to domestic industry employment

capacity rationalisation

- Creates new industry (including M - Creates social instability by selling off

replacement) and employment opportunities domestic assets

- Raises living standards - Overseas control over Australian assets

- Creates better products and services - Excessive investment can result in negative
investor sentiment and a lower AUD

- Finances a deficiency in national savings over

national investment

The Pitchford Thesis (“Consenting Adults”)

● States that as long as a CAD is the result of savings and investment decisions by the private
sector that are not the result of distortions to normal market mechanisms, then there is
no cause for concern about an economy’s external stability
○ Popularised by ANU professor Jon Pitchford in the 1990s
● Despite budget deficits, the private sector still accounted for around 80% of Australia’s net
foreign debt in the late 2010s
● CAD was different to other countries as their debt was the result of government borrowing
● Foreign liabilities help fund private investment projects - borrowers and lenders are
responsible for their own decisions, hence “consenting adults”
● There is no need for the government to be concerned about the level of foreign liabilities
any more than the level of domestic liabilities
● This view has attracted criticism since the GFC - large financial institutions were not able
to accurately calculate the risks of lending, leading to a crisis
○ Also assumes that private sector debt is separate to public debt - however the
government was forced to bail out private firms

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 ● However our strong economic performance during the GFC supported the view that in the
climate of strong commodity prices, Australia’s external imbalances are sustainable

10.3 - Australia’s Foreign Liabilities

● A long term impact of a high CAD is the growth of net foreign liabilities (NFL)
● NFL: Australia’s financial obligations to the rest of the world minus their obligations to us
○ Consists of net foreign debt (NFD) and net foreign equity (NFE)
○ As of March 2019: NFD: $1.1 tn, NFE: $-133 bn, NFL: $966bn
○ NFD accounts for 114% of total NFL
● NFD: The total stock of loans owed by Australians to foreigners minus their total stock of
loans owed to us
● NFE: The total value of assets owned in Australia by foreigners minus the total value of our
assets overseas
● NFE has been negative since 2013 due to growth in Australian super funds which buy many
foreign assets seeking higher returns
○ Grown from $-5.4bn in 2012/13 to $-141.9bn in 2018/19 (0.4% to 7.3% of GDP)
● NFD is positive as Australia need to borrow foreign funds to finance our savings -
investment gap
○ Grown from $809.2bn in 2012/13 to $1143.5bn in 2018/19 (52.7% to 58.8% of GDP)
● NFL has been fairly steady as a % of GDP since the start of the century as the growth in
NFD has been offset by the increasingly negative NFE
○ Grown from $372.4bn in 2000/01 to $1001.6bn in 2018/19 (52.8% to 51.5% of GDP)
● Borrowing adds directly to Australia’s foreign debt, while selling assets does not
● Debt and equity servicing represent outflows on Australia’s CA
○ Equity servicing costs have exceeded interest repayments on debt in recent years

Net Foreign Debt

● NFL and NFD as a % of GDP have been growing consistently since the 1980s
○ NFD high of 61.7% in June 2016, 57.3% of annual GDP in March 2019 ($1.1 tn)
● Excessive growth in Australia’s NFD could lead to a debt sustainability problem
○ If the size of the debt is rising faster than GDP, interest repayments will
progressively take up a greater proportion of our GDP
○ Could create a debt trap scenario
○ Today’s foreign debt adds to future CADs
● If debt becomes unsustainable, Australia’s credit rating may be reduced, affecting
international confidence - could lead to interest rate premiums
● A sustained period of low global interest rates since the 1990s and rising X revenue after
2003 have ensured that Australia has been able to service its foreign debt
● Debt Servicing Ratio: The proportion of X revenue that must be spent on interest
repayments on foreign debt
○ Peaked at over 20% in 1990, just 5.6% in 2019
● Historically, most foreign investment flows into Australia have been into the private sector
○ An inflow of offshore funds into the banking sector
● Since the GFC, banks have reduced their reliance on offshore funding due to increased
domestic savings
● A larger share of capital inflows have gone into commonwealth government securities
(CGS) as the Australian government still holds a AAA credit rating
○ 55% of CGSs are foreign owned in 2019

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 ○ Public sector debt represents less than 20% of NFD

Net Foreign Equity

● NFE is the smaller component of Australia’s NFL
● Since 2013, the value of Australia’s foreign assets has been greater than the value of
foreign ownership of Australian assets - negative NFE
● NFE as a % of GDP peaked in the 1990s - 16.6% of GDP in 1995/96
● Tends to be more volatile than NFD, reflecting exchange rate movements and shifts in the
market valuation of companies and assets - investor sentiment
● Equity servicing costs (profits, dividends) account for around half of all NPY outflows
○ The sustainability of these servicing costs is of less concern than interest
repayments as dividends are only sent overseas when an asset is generating a profit
● Between 2000/01 and 2018/19, Australian ownership of equity overseas rose from $306 bn
to $1554 bn while loans grew from $211 bn to $1200 bn
○ Foreign owned equity rose from $382 bn to $1271 bn while debt increased from
$506 bn to $2414 bn

Issues With High Foreign Liabilities

● Among advanced economies, Australia consistently has among the highest CAD and NFL
● This makes Australia vulnerable when global economic conditions become unstable
● Australia’s financial system relies heavily on an ongoing inflow of foreign capital
● The government considered it necessary to provide a temporary guarantee for all overseas
loans of financial institutions after the GFC
○ Without this, banks may not have been able to obtain overseas loans and the
financial system would have faced a major crisis

Benefits of Low Global Interest Rates For Australia

● Post GFC, monetary policy has been aggressively loosened with cash rates being pushed
towards zero as central banks are faced with low economic growth and inflation
○ Negative rates in japan and some European countries
● Has had flow on effects for Australia - pushed down the equilibrium interest rate (neutral
stance rate)
○ As other countries lower IRs, the AUD appreciates, placing downward pressure on
inflation and curbing international competitiveness
● The RBA cut domestic rates 17 times between 2011 to March 2020 (4.75% to 0.25%)
○ This helped stabilise the level of foreign liabilities - decreases servicing costs
● Rates rose in mid 2019 (US Fed rate at 2.5%), increasing Australian servicing costs
● S&P has had Australia’s credit rating on a negative outlook since 2016, citing the slow path
to fiscal consolidation and Australia’s large external imbalances, namely its reliance on
foreign borrowing
○ Should Australia lost its AAA rating, investors will demand higher risk premiums

10.4 - Australia’s Exchange Rate

● All trade and financial relationships between Australia and other countries are mediated
through the exchange rate
● The exchange rate therefore has a significant impact on international competitiveness and
external stability

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 ● The high level of volatility in the AUD is the result of Australia’s heavy reliance on
commodity X
○ The larger fluctuations in commodity based currencies can attract speculators
○ AUD makes up only 1% of global trade, but is the world’s 5th most traded currency
● In the past two decades, low of US$0.47 in 2001 to a high of US$1.10 in 2011
● This volatility is more the result of increased global economic instability than domestic
economic instability
○ Low commodity prices and ‘dot com’ boom at turn of the century - low AUD
○ Huge ToT boom from 2003 - 2011 barring GFC underpinned by China - soaring AUD
■ Sustained economic growth in Australia, high interest rate differentials
○ Falling ToT after 2011 - fall in AUD
○ Another fall in the late 2010s - weakness in the Australian economy, low interest
rates and stronger growth in other countries eg USA
■ Depreciated despite a growth in commodity prices

Positive and Negative Outcomes of Volatility

● Despite periods of volatility, the exchange rate has operated as a powerful stabilising
mechanism that has helped the Australian economy adjust to changing conditions
● During periods of weaker growth, exchange rate depreciations help make Australia more
internationally competitive and stimulate X growth
○ The depreciation post 2011 helped many non mining sectors adversely affected by
the high AUD during the mining boom
● The floating exchange rate can have significant impacts on Australia’s external stability
○ A change in exchange rate influences our international competitiveness and the
size and servicing costs of our foreign debt
○ A continually changing AUD can create policy challenges and economic instability
● A sudden or large depreciation in the AUD due to a fall in confidence can create a vicious
cycle due to becoming a target for financial speculators

10.5 - Policies to Achieve External Stability

● In more recent years, external stability has not been a major objective of macroeconomic
policy - acceptance of Pitchford’s view of the CAD
○ Australia also has improved medium term X prospects (higher volumes of resources
X) and increased household savings
● Achieving sustainable outcomes on the current account and foreign liabilities and a stable
AUD are now treated more as long term objectives of economic policy
● Monetary policy: Not being used to address external imbalances
○ Contractionary policy was used in the past to reduce consumer spending on M in
order to improve the BoGS
○ Ineffective as it is only temporary and results in a slowdown of the whole economy
○ Also attracts higher capital inflows generating higher NPY outflows
○ Unable to target long term structural causes of Australia’s external imbalances
● Fiscal policy: Has had some role in addressing Australia’s low level of national savings
○ By adopting fiscal consolidation, governments since the late 1990s have sought to
reduce their call on private savings over the medium term
○ Reducing the public sector deficit can lessen upward pressure on interest rates or
the crowding out of private borrowers

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 ● Compulsory superannuation: 9.5% of wages set aside - has lifted national savings since the
early 1990s
○ A major contribution to Australia’s increased foreign investment, which create
financial inflows on the NPY account
○ Plan to lift super to 12% by 2025 will further increase savings, reducing long term
pressures on Australia’s external accounts
● Microeconomic reform: Can address structural problems causing external imbalances
○ Improves international competitiveness through measures that lift efficiency and
productivity of Australian producers
○ Reduce capacity constraints by improving infrastructure, alleviate skills shortages,
remove protectionist barriers and reform labour markets to increase workforce
participation and productivity

Maintaining International Investor Confidence

● The best measure of external stability is the extent to which Australia maintains the
confidence of international investors
○ Governments aim to sustain this through medium term policy settings eg inflation
targeting, goal of budget surpluses and continued microeconomic reform
○ This has been largely successful in recent decades
● The GFC proved that even if a high level of foreign debt is from the private sector,
governments can be forced to take responsibility for those borrowings in order to prevent
a meltdown of the whole financial system
○ Undermines Pitchford’s argument as it shows that in times of extreme financial
instability, an external imbalance, no matter its origin, can make an economy more
vulnerable to external shocks

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Chapter 11 - Distribution of Income and Wealth

11.1 - Introduction
● A major challenge of government policy is to ensure fairness in the spread of wealth and
economic opportunity throughout society
● More equal economies tend to achieve higher levels of happiness, stronger economic
growth, better health outcomes and more social mobility
● Australia has traditionally considered itself to be a country offering people a ‘fair go’
○ Has been protected from a sharp rise in inequality due to sustained economic
growth, progressive Y taxation, universal education and health care and a social
security safety net
● Many factors that contribute to an increase in inequality are side effects of policies that
aim to create a more internationally competitive economy
● Governments have a responsibility to ensure certain equity in terms of income and wealth
○ How much fairness is the right amount? Will it compromise efficiency?

11.2 - Measuring the Distribution of Income and Wealth

Income Distribution
● Personal income is the amount of money or other benefits that flow to individuals or
households from the factors of production over a period of time
● Income inequality refers to the degree to which income in unevenly distributed among
people in the economy
● Can be measured by the share of total income received by different groups
○ Since 1995/96, the income share of every quintile has decreased except the top
quintile although this has stabilised since the GFC
● The average annual pre tax income for households in the highest quintile is more than 8x
higher than the lowest quintile ($261,196 vs $31,616)
○ Average all households $116,584
● Share of income:
Quintile 1995/96 2007/08 2017/18

Lowest 8.1% 7.3% 7.5%

Highest 37.3% 41.0% 40.4%

Gini 0.296 0.336 0.328

● The Lorenz curve is a graphical representation of income distribution, plotting the
cumulative increase in population against the cumulative increase in income
○ The Lorenz curve would be a diagonal line if income were distributed evenly
■ The line of equality
● The Gini coefficient is a number between zero and one that measures the extent of
income inequality in an economy
○ Calculated by measuring the degree to which the Lorenz curve deviates from the
line of equality: A/A+B
○ The smaller the Gini, the more equal
○ 2017 OECD ranked Australia 22nd out of 34 for its Gini of 0.323 (OECD avg 0.317)
■ Ranked 17th in 2004, suggesting Australia has become more unequal
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Wealth Distribution
● Much more unequal than the distribution of income
● 70% of households have less than the average level of household wealth ($1,022,200)
● Between 1915 and 1967, wealth inequality in Australia improved dramatically as a result of
urbanisation, industrialisation and the declining significance of rural landholders
● Worsened between 1967 and 1986 but has since remained relatively stable
○ Inequality grown across many types of wealth assets eg property, land, shares,
financial investments, business ownership, interest bearing deposits
○ Superannuation has played a role in lessening inequality
● Share of wealth:
Quintile 1915 1967 2016

Lowest 0% 1% 1%

Highest 90% 54% 63%

Gini 0.86 0.52 0.62

● Growing inequality between generations
○ Couples over 65 experienced a real increase in median net wealth of almost 70%
between 2002-2017
○ 25-34 year olds had an increase of just 3.2%

2018 Productivity Commission Study Conclusions

● Increase in income inequality over the past three decades
○ No strong trends, some improvement since 2010
● Sustained economic growth has improved living standards in every income decile
● During periods of rapid growth, wealthy individuals who own capital tend to benefit more
○ Income inequality has fallen since the GFC due to lower returns on capital and
continued growth in income from labour
● Progressive taxation and targeted transfer payments are effective in reducing income
inequality, lowering the Gini by 30%
○ Private income vs equivalised disposable income
● Distribution of income fails to capture in-kind transfers from governments eg health,
education and childcare subsidies, government housing
○ The distribution of final consumption lowers Gini by a further 30%
■ Shows greater increase in inequality in recent decades
● Income inequality ranks around average for the OECD
○ 8th most equal in wealth distribution among the OECD’s 28 members
● Inter generational mobility in Australia is similar to other OECD economies
○ A man is 4x more likely to be in the top decile for lifetime earnings if his father
was in the 95th percentile compared to the 5th percentile
● Most Australians move across the income distribution over time due to changing life
circumstances eg study, employment, family duties, marital status, retirement
○ The average Australian moves across five income deciles during a 15 year period
○ Income mobility ranks 10th in the OECD, just above average
● Experience of significant economic disadvantage is temporary for most Australians
○ 79% of poverty spells last less than three years, just 6% last more than six years

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 ● Persistent and recurrent poverty is concentrated among the 3% of households (700,000
people) who have remained stuck in the bottom quintile over the past three decades
○ Multiple deprivation is most common for single parent or Indigenous families, the
unemployed and the disabled

11.3 - Sources of Income and Wealth

● Household income comes from five main sources:
○ Wages from the sale of labour: includes wages, bonuses, fringe benefits, employer
contributions to super (aka returns to labour, compensation of employees)
■ Wages and salary (56%)
○ Rent from land: rent from ownership of housing (9%)
○ Earnings from capital: earnings from financial assets, ownership of shares
■ Business profits and capital investments (11%)
○ Returns to enterprise: profits from operating businesses (10%)
○ Transfer payments: social assistance benefits eg welfare, social insurance benefits
eg workers compensation (9%)
○ Other: 5%
● Net worth (private sector wealth) measures the value of household assets minus the value
of their liabilities (90% of liabilities are mortgages)
● Average value of household assets was $1.2m, average level of liabilities was $183,900
giving average net worth of $1.02m (2017/18)
○ 42% owner occupied property (average $500,600, owned by 2/3 of households)
○ 18% superannuation (average $213,700)
○ 15% investment property (owned by 24% of households)
○ 7% contents of house
○ 6% own business
○ 5% savings in financial institutions
○ 3% vehicles
○ 3% trusts
○ 2% shares

Causes of Inequality
● Distribution of resources - those who acquire / inherit the best resources make the most Y
● Self reinforcing cycle of wealth - more Y leads to greater wealth, leading to more Y
● Self perpetuating cycle of poverty
○ Secondary labour market >> low Y >> low education >> low skills >> secondary
labour market
● Cyclical levels of economic growth
○ Booms lower unemployment, increasing equality as unemployment is a key driver
of inequality
● Structural changes eg globalisation and technology - jobs disappear, increasing inequality
● Institutional and social factors - discrimination eg female glass ceiling, Trade Union power

11.4 - Trends in the Distribution of Income and Wealth

● Some groups are more affected by inequality than others
● Income distribution is asymmetric - mean Y $1062, median $889 (equivalised household
income per week 2017/18)
● Over 80% of households have a net worth below the average

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 ○ Mean $1,022,200, median $558,900 (households 2017/18)
○ Lowest quintile average $25,200, highest quintile average $3.2m (93x more)
○ Household must have over $6m to be in the top 1%

Age and Education

● Income varies over the course of a person’s life - highest between 25-54
○ 45-54 earn the highest mean weekly full time earnings ($1823) - average is $1666
○ 20 and under earn the lowest ($966), 21-34 earn $1360
○ Younger people have less experience and education, work more casual jobs
● Distribution of wealth follows a similar pattern according to age
● Higher qualifications led to higher incomes
○ Average weekly earnings in main job for postgraduates is $1500
○ $844 for those without any post school qualifications
○ Employees with a non school qualification had median weekly earnings $356 higher
than those without one

Gender and Occupation

● Full time female workers earn less than males
● Women have greater domestic responsibilities, fewer senior roles, work more part time
○ Lack human capital factors - education, skills, qualifications
● In 1985, women earned 82% of men’s salary, 86% in 2019
○ 1985: $400 vs $328 a week, 2019: $1728 vs $1486
● Jobs requiring higher levels of education, training and experience offer higher Y
○ General managers (both genders) earn over $2500 a week
○ Fast food cook earn less than $500

Ethnic and Cultural Background / Indigenous Australians

● 29% of Australians were born oversea, 49% have at least one parent who was born overseas
● 55% of migrants come from countries that are not majority English speaking (NESB)
● 8.8% of recent migrants were unemployed compared to 4.6% for those born in Australia
● Recent migrants and temporary residents had a higher participation rate
○ 70% vs 66% overall (2016)
● Migrants who have become Australian citizens have a higher labour force participation rate
○ 80% vs 70% for workers born in Australia
● 78% of skilled migrants participate vs 59% of those under the family migration program
● Migrant income and wealth vs Australian born (aged 35-54, 2015):
Migrant background Males Females

NESB migrants from Europe, annual income -$8535 -$4989

NESB migrants from other regions, annual income -$7822 -$8594

ESB migrants +$1193 +$3979

NESB migrants from Europe, household wealth -$382,512 -$327661

● Underemployment is 17% for NESB migrants vs 11% for ESB migrants
● Migrants find work and integrate into the economy more quickly when they move to
suburbs with a high concentration of people from the same background as them
● Indigenous Australians comprise 3% of the population
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 ○ Average age of 23 vs 38 for the general population
○ Median weekly disposable Y was $441vs $661 for the general population for
individuals and $1203 vs $1438 for households (2016)
○ Employment rate of 47% vs 72% (2016)
○ Queensland remote unemployment rate of 33.3% in 2016, 13x higher
○ Life expectancy for those born between 2010-12 was 10 years lower than non
Indigenous Australians (10.6 yrs for men, 9.4 yrs for women)
○ Attendance rates of 82% vs 93% (2018)
○ Proportion of 20-24 yr olds who completed year 12 increased from 47.4% in 2006 to
65.3% in 2016 (78% in 2010 for general population)

Family Structure
● Single parent households are the worst off
○ Only 14% of single parent of children under four are employed full time
○ 40% of single parent households are in the bottom quintile
● Couples without dependent children were the best off
● Family structure is also influenced by age
● Median income and net worth by family type (2017/18):
Family Couple (no Couple (dependent Single Single All
Structure dependent children) children) parent person households

Median Y per $1151 $924 $633 $662 $899

week

Median net $1,094,000 $659,000 $98,500 $358,400 $558,900

worth

Geography
● Inequality between different states and between rural and urban areas
● NT and WA have high incomes due to mining
● ACT and NSW have high incomes due to a younger average age
● Living costs differ between cities which will affect standards of living
○ Median rent in Sydney in 2019 was $582 a week vs $385 for Perth
● Mean disposable income per week (2017/18):
State / ACT NT NSW WA VIC QLD SA TAS AUS
territory

Mean weekly $1256 $1243 $1118 $1105 $1041 $997 $989 $922 $1062
disposable Y
● In NSW, those living in the Sydney area earned 32% more than those in rural areas, 54%
higher wealth due to property prices
○ $806,000 in Sydney vs $369,000 in the rest of NSW
● Mean weekly disposable income and average net worth by state and region (2017/18):
NSW VIC QLD SA WA TAS AUS

Weekly Y - CCA 1218 1095 1040 1035 1142 1002 1130

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 Weekly Y - non 925 864 956 822 946 858 918
CCA

Net worth - CCA 1,512,000 1,121,000 774,200 818,900 962,600 782,100 1,144,200

Net worth - non 1,261,000 1,046,200 741,600 786,200 955,200 708,800 1,022,200
CCA

11.5 - The Costs and Benefits of Inequality

● Inequality is a natural consequence of the free market functioning effectively as each
individual receives a share of income according to their marginal productivity
● Free market capitalism divides society into different classes and entrenches high levels of
inequality and poverty

Economic and Social Costs of Inequality

Economic:
● Reduces overall utility - low Y earners value an extra dollar more than high Y earners
(marginal utility)
● Can reduce economic growth
○ MPC of higher Y earners is lower, restricting consumption and growth
○ Lower Y households are less able to invest in education, leading to a lower skilled
workforce and higher unemployment
○ The rise in inequality in OECD economies between 1985-2005 reduced cumulative
growth by 4.7% from 1990-2010
○ ‘If you feed the horse enough oats, some will pass through to the road for the
sparrows’ - trickle down economics: (J.K.Galbraith)
● Creates conspicuous consumption
○ A leisure class consuming expensive G/S purely to display wealth
● Increases the cost of welfare support
○ More individuals rely on government support and contribute less tax revenue

Social:
● Social class divisions which could result in higher levels of crime, social disorder and
economic instability
● Poverty - absolute and relative
○ 13% of Australia lives in poverty, 3% of whom are persistently in poverty
■ Vicious poverty cycle
○ Also associated with increased crime, suicide, disease and reduce life expectancy

Economic and Social Benefits of Inequality

Economic:
● Can lead to an increase in the productive capacity of resources and thus GDP through the
incentive effects of inequality
○ Encourages the labour force to increase education and skill levels
○ Encourages the labour force to work longer and harder
○ Makes the labour force more mobile

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 ○ Encourages entrepreneurs to accept risks more readily
● Creates the potential for higher savings and capital formation
○ Reduce reliance on foreign capital by providing domestic funds for investment

Social:
● Economic benefits could create a larger pie from which we could all benefit
● Assumes equal opportunity which does not exist due to:
○ Existing inequality perpetuates inequality
○ Differing mental and physical attributes
○ Wealth through inheritance
○ Differing access to networks of people - informal barriers

11.6 - Government Policies and Inequality

● Fiscal and labour market policies generally have the most direct effect through changing
government benefits, taxation and wages
● Side effects of other policies eg micro reforms also affect inequality

Macroeconomic Management and Job Growth

● Unemployment is the main reason for low incomes and wages
● Unemployed people must rely on government benefits, increasing the gap between high
and low income earners
● Fall in proportion of the unemployed that are long term unemployed since the 1990s has
helped reduce income inequality between households

Changes in the Labour Market

● Recent years have seen the creation of more casual and part time jobs in the gig economy
○ Tend to work less hours and have lower wages
● The decentralisation of the labour market has widened inequality between wage earners
○ Workers with greater skills and bargaining power achieve higher wage increases via
enterprise agreements than less skilled workers who rely on industrial awards
○ Jobs have become more highly skilled and specialised, widening the gap
○ Problem recognised in the Fair Work Act of 2009 which includes special provisions
to help low paid workers engage in enterprise bargaining
● The Fair Work Commission (national industrial relations regulator) influences inequality
through its annual decision on adjustments to minimum wages
○ Millions of employees are covered by awards and agreements based on awards
○ Indicated a willingness to raise minimum wages since 2010
○ Increased minimum wage by 3% in June 2019 to $19.49/hr
○ Increased minimum wage by 1.75% in June 2020 to $19.84/hr
○ Federal minimum wage is 55% of median full time earnings, almost the same of the
56% a decade ago (2019)

Government Policies to Reduce Inequality

● Changes in taxation, transfer payments and other assistance influence inequality through
the redistribution of Y to lower socioeconomic groups
● $48.3bn age pension, $17.5bn disability support pension, $18.1bn family tax benefits,
$16.9bn unemployment benefits, $8.7bn carers payments

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 ● Without government intervention, highest quintile households earn 22x the Y of the lowest
quintile ($4987 a week vs $223)
○ Reduced to 6x after T and G ($3690 vs $591)
■ Reduces Gini from 0.52 to 0.34
● Progressive income taxation reduces inequality, although regressive indirect taxes increase
it eg GST
○ The lowest 40% of Y earners earn 12% of private Y but pay 15% of total taxes
● Budget tax cuts of 2017/18 - 2024/25 will benefit high Y earners
○ 54% go to the top 20% and just 3% go to the bottom 20%
● Compulsory super has improved distribution of wealth since 1992
○ Minimum contribution of 9.5% of wages (12% by 2025)
○ The proportion of employees covered by super has risen from 42% to 94% since the
mid 1980s
● Social wages eg access to free health care, education and public housing

Indirect Impact of Government Policies

● Monetary policy: high IRs transfer wealth from low to high Y earners
● Micro reforms tend to increase efficiency but decrease employment, increasing inequality
● Targeted transitional support to groups directly affected by micro reforms have proved
effective in building greater public support for reform

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Chapter 12 - Environmental Sustainability

12.1 - Introduction
● Economists have shifted away from a traditional model that ignored environmental
constraints to production
● The natural environment represents the totality of the physical environment in which
human society lives
● Environmental sustainability is about protecting and enhancing the natural environment
○ Reducing the emission of greenhouse gases
○ Ensuring the adequate supply of water
○ Preserving the health of forests, waterways and ecosystems
● Many aspects of environmental harm eg farming, mining and industry have resulted in land
degradation, depletion of non-renewable resources and the pollution of water systems
● Short term economic costs for sustainable longer term growth
○ 2017 OECD report estimated that policies which support growth and mitigate
climate change could increase the economic output of OECD countries by an
average of up to 2.8% by 2050

12.2 - Ecologically Sustainable Development

● Environmental economic emphasises the need to pursue a sustainable level of growth
○ Fast growth may lead to a rapid depletion of resources and reduced quality of life
○ Could have a long term impact on the production possibility curve
● Ecologically sustainable development involves conserving and enhancing the community’s
resources so that ecological processes and quality of life are maintained
● Involves the key principle of intergenerational equity
● 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
○ Taking into account the global effects of environmental issues
● Australia’s National Strategy for Ecologically Sustainable Development (NSESD) was first
developed in 1992 with the core objectives of:
○ To enhance individual and community wellbeing and welfare by following a path of
economic development that safeguards the welfare of future generations
○ O provide for equity within and between generations
○ To protect biological diversity and maintain essential ecological processes and
life-support systems

12.3 - Market Failure: Private Benefits and Social Costs

● In market economies, the price mechanism is the key determinant in decisions about what
goods will be produced, in what quantity and at what price
● Does not effectively take into account the long term effect of economic activity on the
environment - enjoy private benefits without facing the social costs
● Market failure occurs because the price mechanism only takes into account the private
costs and benefits of production to consumers and produces without the wider social costs
and benefits to all of society
● Negative externalities are a cost to society, positive externalities are a benefit
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 ○ G/S with negative externalities are known as demerit goods
○ G/S with positive externalities are known as merit goods
● Environment and other common resources can be destroyed through overuse, known as the
tragedy of the commons
● The price mechanism can only play a limited role in taking into account environmental
costs as supply lessnes - doesn’t affect free resources
● Negative externalities graph with social costs:

○
● Positive externalities with social benefits:

○
○ Contingent valuation - derives market demand from surveys according to how much
people are willing to pay
○ Opportunity cost - calculate the net benefits of possible alternatives
○ Hedonic pricing - value of the environment found through close market substitutes

12.4 - Public and Private Goods

● Public goods - non-excludable and non-rival
○ Cannot exclude consumers from enjoying the benefit of the good
○ One individual’s use does not affect the quality of the good for another
○ Eg national defence, seawall
● Public goods create the opportunity for ‘free rider’ behaviour
○ Those who benefit from a G/S without contributing to the cost of supplying it
○ Means that private markets either do not provide or underproduce public goods
■ Tend to be provided by the government
● Public goods are different from public sector goods (G/S provided by the government)
○ Eg trains are public sector goods but not public goods

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12.5 - Major Environmental Issues
● Four major environmental issues with economic consequences that governments must
confront in their longer term policy settings:

Preserving Natural Environments

● The economy cannot keep growing if the environment is degraded
● Can also affect human health through higher levels of pollution
● Preservation may include measures such as restrictions on development in environmentally
sensitive areas eg mining in National Parks; protecting native plant and animal species
from extinction; controls over emissions of waste products; requiring new plantations in
areas where logging has occurred
● Australia protects 19% of its total land area vs 33% in NZ and 29% in the UK
○ Also has a poor record of preserving biodiversity despite being one of the six most
biodiverse nations on the planet
○ 181 flora and 78 fauna species critically endangered in 2019
○ Less than 40% of threatened species have recovery plans in place
● Governments face significant problems in trying to preserve the natural environment:
○ May result in a short term reduction in economic growth
○ Industries will face higher costs if they have to comply with rigorous environmental
standards - less competitive
○ Cost of repairing damage to the environment is often borne by taxpayers rather
than those who have caused the damage
■ Eg $100m Environment Restoration Fund (2019) - grants to community
groups for erosion management around waterways and habitat protection
■ Can try to pass on costs to industry eg Container Deposit Scheme

Pollution
● Occurs where the natural environment is degraded in some way eg harmful chemical
substances, noise, untreated rubbish
● Has created serious health risks since the Industrial Revolution - mining and manufacturing
● Impact of pollution is often felt far from its original source
○ 5,000 Australians die from exposure to polluted air each year

Climate Change
● Emissions of greenhouse gases eg carbon dioxide, methane and nitrous oxide
● Half of cumulative CO2 emissions from human activity between 1750 and 2010 have
occurred in the past 40 years
● Driven by two main sources:
○ Burning of fossil fuels
○ Changes in land use eg agriculture, deforestation
● Average estimated increase in CO2 emissions from 2001 to 2025 is 1.9% a year
● Global impacts:
○ Melting polar ice caps will raise sea levels between 18-59cm
○ More extreme and unpredictable weather conditions
○ 200 million extra environmental refugees, 20 million from coastal flooding
● Domestic impacts:
○ Reducing Australia’s GDP by 4.8% by 2100, C by 5.4% and wages by 7.8%

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 ○ Permanent damage to environmentally sensitive areas eg 80% of Kakadu, GBR
bleaching, harming tourist industry
○ Increased drought leading to a reduction in agricultural production
● Struggled to implement effective policy responses

Depletion of Natural Resources

● Establishing an optimal rate of use - threshold exploitation level that allows the resources
to regenerate so there is no long term decline
○ Eg overfishing, overgrazing, excessive farming
○ Murray-Darling water shortages
● Intergenerational equity for nonrenewable resources
● Rocks and crops economy - relies on exporting nonrenewables

12.6 - Government Policies and Environmental Sustainability

SEE 16.3 FOR FURTHER ENVIRONMENTAL POLICIES
● Environmental issues tend to play a secondary role to other objectives
● Policies can discourage harmful activities (ban or tax) and provide incentives for
environmental responsibility (subsidies)
● Ban on the production of a G/S: leaded petrol (2002)
○ Ban on single use plastic bags in some states / territories
○ Chinese government banned M of mixed recycling materials from other countries
■ 30% of Australia’s recyclable water was X to China
● Impose a tax on the production of certain G/S eg 2012 carbon tax
○ Repealed by the Abbott government to years later
○ Fuel excises - internalise the externalities
● Subsidise environmentally friendly G/S eg public transport
○ Government funding of new technologies with environmental benefits but high
establishment costs eg $1bn Clean Energy Innovation Fund
● Government may provide G/S itself eg $30m Threatened Species Recovery research hub to
help fight the extinction of vulnerable animals and plants
● May monitor and measure changes in the environment over time
○ State of the Environment report over five years - atmosphere, biodiversity, coasts,
marine environment, inland water, land, heritage, Antarctic, built environment
○ Also started measuring Australia’s environmental assets
○ Availability of better data informs governments of trade offs involved in
management, particularly where there may be adverse consequences
● Generally shifted against outright bans and directly providing public goods to using market
mechanisms eg taxes and subsidies
○ Exceptions eg expansion of Snowy Hydro Scheme - will increase generation by 50%
(500,000 homes) - federal government committed $1.4bn in 2019
● Most policies take many years to have any impact - can lead to delays in implementation

Murray-Darling Basin Case Study

● Covers 14% of Australia and 2 million people
● Decades of water overuse have depleted the health of the river system
● Murray-Darling Basin Authority established in 2007 to manage the rivers in the basin
○ Plan announced in 2010 to return 3000-4000GL of water to the system, would’ve
led to reduced agricultural production and unemployment

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● Updated Water Recovery Strategy was released in 2014 - annual target of 2750GL with
flexibility through the Sustainable Diversion Limit Adjustment mechanism
○ More on farm efficiency eg storage dam outlets rather than water buybacks
● Highly controversial with allegations of corruption and mismanagement
○ Mass fish kill at Menindee in 2019 - SA Royal Commission
● Difficulties in striking a balance between industry, agriculture, the environment and local
communities - calls for a national Royal Commission inquiry

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 Topic 4 - Economic Policies and Management

Chapter 13 - The Objectives of Economic Policy

13.1 - Introduction
● Governments have three major economic objectives:
○ Sustainable economic growth
○ Internal balance: price stability (low inflation) and full employment
○ External balance: managing the CA, NFL and exchange rate - external stability
● Achieves these through a combination of macro (AD) and micro (AS) policies

13.2 - The Objectives of Economic Management

● Economic growth and quality of life
● Benefits:
○ An increased standard of living for the population
○ Improved job prospects for the labour force
○ The opportunity for increased public investment in infrastructure and services such
as education funded through higher government taxation revenue
● Full employment (NAIRU) - can be reduced through implementing micro policies
● Benefits:
○ Fully utilising the economy’s current capacity to produce, therefore increasing
standards of living
○ Minimising the adverse economic and social problems associated with
unemployment eg family problems, loss of workforce skills (hysteresis), inequality
● Price stability - keeping inflation at an acceptable level (2-3% over time)
● Negatives of inflation:
○ Reduce the real value of income and wealth
○ Reduce our international competitiveness due to rising costs of production
○ Cause a depreciation in the exchange rate as forex markets lose confidence in the
Australian economy
○ Create uncertainty about future costs and distort economic decision making
○ Distort the pattern of resource allocation by encouraging speculation in relatively
unproductive activities eg existing real estate that simply redistribute income
● External stability - achieving external balance
● Six main measures:
○ Achieving a sustainable position on the current account of the balance of payments
○ Net foreign debt as a % of GDP
○ Net foreign liabilities as a % of GDP
○ Terms of trade
○ Exchange rate
○ International competitiveness
● Distribution of income and wealth
○ Reduced through social security payments and taxation
○ Addresses the problem of poverty and social disadvantage
● Environmental sustainability
○ May be a side effect of achieving economic objects eg pollution, depletion of
natural resources

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 ○ Ecologically sustainable development has become an increasingly important
economic objective
● Can have other objectives eg productivity growth, political aims (budget surplus)

13.3 - The Goals of Government Policy in 2020

● Maintaining sustainable economic growth (2.75-3%)
● Supporting a sustained reduction in unemployment
● Reducing the budget deficit and maintaining investor confidence
● Keeping inflation stable, within the range of 2-3%
● Increasing productivity and the sustainable rate of growth in the longer term
● Improving distribution of income and wealth
● Promoting environmental sustainability

13.4 - Conflicts in Government Policy Objectives

● There are two major conflicts between the government’s economic objectives:
○ Achieving a simultaneous reduction in unemployment and inflation
■ Phillips Curve relationship
○ Achieving economic growth and external balance
■ Balance of payments constraint
● Other conflicts:
○ Growth and environmental sustainability
○ Growth and decreased inequality
○ Shorter term and longer term objectives
■ Policies aimed at long term goals often involve significant structural change
and substantial costs to the government

13.5 - The Economic Policy Mix

● Economic policy mix refers to the combination of macro and micro policies used by the
government to achieve its economic objectives
● The instruments of economic policy are divided between macroeconomic and
microeconomic policies

Macroeconomic Policy
● Macro policies impact on the overall level of economic activity (AD)
○ Monetary and fiscal policy
● Macroeconomic management is designed to minimise the fluctuations in the business cycle
○ Stabilise the level of economic growth by smoothing the peaks and troughs
■ Counter cyclical policies
● Macro policy is not enough to achieve complex policy goals
○ Not effective in dealing with longer term problems eg lack of international
competitiveness, low productivity growth, low national savings

Microeconomic Policy
● Micro policies involve specific measures to improve the operation of firms, industries and
markets by achieving change at an individual level (AS)
○ Improve resource allocation between firms and industries to maximise output from
scarce resources
■ Supply side economics

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○ Encourage the efficient operation of markets and increase AS

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Chapter 14 - Fiscal Policy

14.1 - The Meaning of Fiscal Policy

● Fiscal policy involves the use of the Commonwealth Government’s Budget in order to
achieve economic objectives
○ Instruments include government spending (G) and taxation (T)
● Macro policy that can influence resource allocation, redistribute income and reduce the
fluctuations of the business cycle
● Plans for the forthcoming financial year (1/7 - 6/30) are announced the annual Budget
○ Usually on the second Tuesday of May
○ Mid-Year Economic and Fiscal Outlook (MYEFO) usually released in December
● Includes all forms of revenue and expenditure
○ Direct taxes (eg Y tax), indirect taxes (eg GST), other revenues (eg PTE dividends)
○ Welfare, health, education, public services, defence etc

14.2 - Budget Outcomes

● The budget outcomes gives an indication of the overall impact of fiscal policy on the
economy - three possible outcomes:
○ Budget surplus: T > G
○ Budget deficit: G > T
○ Balanced budget: G = T
● Prior to COVID-19, both parties accepted a path of fiscal consolidation i.e reducing the
budget deficit over time
○ Labour aimed for a balanced budget over the business cycle
○ Liberal aims for a budget surplus over the business cycle

Measuring the Budget Outcome

● There are four measures of the budget outcome, results of differing accounting methods:
● Underlying cash balance (cash accounting) - the government’s preferred measure
○ Excludes one-offs, only counts G and T for the budget year
○ Best short term indicator of the impact of fiscal policy
● Headline cash balance
○ Includes all G and T including one off asset sales
● Fiscal balance (accrual accounting)
○ Excludes one-offs, counts G and T when they are incurred i.e counts spending even
if not occurring in that year
○ Regarded as more accurate than cash accounting for the longer term
● Net operating balance
○ Removes spending on capital from the balance (recurrent expenses only)
○ Considers whether the government can meet its daily cash needs
○ Best measure of the sustainability of the budget

14.3 - Changes in Budget Outcomes

● The budget outcome changes annually due to two factors - changing economic conditions
and changes in government policy
○ Structural component: discretionary changes in G and T
■ Truest indicator of the budget stance
■ Eg increased G due to increased value of Newstart from $280 to $550/week
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 ○ Cyclical component: non-discretionary adjustments to G and T due to fluctuations
in the business cycle - automatic stabilisers
■ Eg increased G due to higher unemployment and more people on newstart
■ Two main automatic stabilisers are transfer payments and progressive Y tax
● Progressive taxation - bracket creep leading to fiscal drag
● The economy cyclically influences the budget, which structurally influences the economy

Impact on Economic Activity - Budget Stances

● Can be described as expansionary, contractionary or neutral
○ Expansionary: Increase in G relative to T
○ Contractionary: Increase in T relative to G
○ Neutral: No change in G relative to T

Impact of Resource Use

● Can be direct eg spending on a particular areas of the economy
○ Transport infrastructure eg Western Sydney Airport
● Can be indirect eg changes in taxation and spending policy that make it more or less
attractive for resources to be used in a particular way
○ Eg removing taxes from ethanol production may encourage farmers to grow more
wheat / sugar for ethanol production
● Governments are more likely to use direct measures to provide G/S if they expect markets
will not provide the resources quickly enough
○ Eg during a natural disaster
○ Eg the provision of public goods (non rival and non excludable)

Impact on Income Distribution

● Progressive income tax system allows money to be spent on transfer payments, community
services and other types of social expenditure
● Regressive taxes eg GST increase income inequality
● Changes in taxation arrangements (rates / concessions) can affect income distribution
● Changes in G can also influence inequality eg by increasing welfare payments

Impact on Savings and the Current Account

● Over the long term, a budget deficit decreases national savings because governments
finance budget deficits by borrowing from private sector savings
● A public sector deficit is a form of negative savings (dissavings)
○ Makes private sector investment more expensive - crowding out effect
■ Less pronounced in an open economy like Australia as private sector
borrowers can turn to overseas sources of funds
○ Could lead to larger CAD under the twin deficits hypothesis
■ Larger CAD leads to more inflows and higher NPY deficit from servicing costs

14.4 - Methods of Financing a Deficit

● A deficit can be financed from the domestic private sector, from overseas investors or
from the RBA (printing money - monetary financing)
● Can also sell government assets

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Borrowing From the Private Sector
● Can be domestic or from overseas
● Selling Treasury Bonds by tender (secret bids)
○ Ensures that the government gets the best prices i.e pays the least
● May lead to an issue known as crowding out
○ Government spending is financed through borrowing from the private sector, which
puts upward pressure on interest rates and ‘crowds out’ private sector investors
who cannot borrow at the higher interest rates
○ Not an issue now as interest rates are low globally, huge global financial market to
access funds, only 40% of bonds are bought domestically

Other Methods of Financing a Deficit

● Monetary financing: ‘borrowing’ from the RBA
○ Printing money in order to finance expenditure
○ Has not been done since financial deregulation in 1982
○ Will increase money supply and inflation
● Selling assets: land, businesses etc
○ Only a one-off solution included in the headline budget figure only

Using Budget Surpluses

● The government can use a surplus in three ways:
○ Depositing it with the RBA
○ Using it to pay off public sector debt
○ Placing the money in a specially established government owned investment fund
■ Largest if the Future Fund intended to help cover the government’s super
liabilities - valued at $154bn in 2019

Public Sector Borrowing and Debt

● To get the full picture relating to the public sector’s revenue raising and expenditure
activities, one must also consider the rest of the public sector - state and local levels of
government, public trading enterprises (PTEs)
● Overall impact of the public sector is reflected in the public sector underlying cash
outcome - most comprehensive indication of the fiscal impact of the public sector
● Was in surplus from the late 1990s until 2008-09
○ Net operating balance was in deficit until 2017-18
● Public sector deficits result in an accumulation of public sector debt
○ Was around 19% of GDP pre COVID-19

14.5 - The Current Stance of Fiscal Policy

● Fiscal policy has generally played a supporting role to monetary policy in the government’s
macro policy mix over the last two decades
● Apart from the GFC, it has mainly been used to influence resource allocation rather than
increasing or decreasing economic growth

2005-07
● Howard ran successive budget surpluses leading to the paying off of public sector debt and
the creation of special funds eg Future Fund and Education Fund
○ Had savings of around 2% of GDP

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 ● Took advantage of big increased in company tax receipts associated with the mining boom
mark 1 (price phase)
● Even with tax cuts, was able to maintain a mildly contractionary stance

2008-10: GFC
● Under Rudd, the budget had extremely expansionary stances
● Fiscal balance decreased by $75bn (6% of GDP) over two budgets as he embarked on huge
spending programs
● Fiscal policy was the main policy tool, monetary policy supporting at an ‘emergency
setting’ of 3%
● Kept Australia out of a recession - growth was 1.4% in 2009
○ Would’ve been -0.7% if not for the boost - Rudd added 2% to GDP

2010-16
● Stance has been mildly contractionary or neutral as successive governments have tried to
decrease budget deficits and return to surplus
○ Pursuing a fiscal strategy of consolidation
● Labour aimed for a balanced budget, liberal for a surplus over the business cycle
● 2009-10: 4.3% deficit, 2010-11: 3.4% deficit, 2011-12: 3% deficit
● Successive treasurers have forecasted surpluses mainly at the end of the relevant 4 year
mandatory projection period, but all have failed
● 2014-16 budgets all failed to decrease the deficit significantly - cyclical and structural
reasons:
○ Cyclical: growth below medium run economic growth rate for a number of years
■ Company tax receipts slow to recover post GFC
● Profits used to pay off previous losses - untaxed
■ Nominal wage growth low, unemployment and underemployment high
■ Global recovery weaker than expected, external conditions not as
favourable as pre GFC
○ Structural: G decreased from 25.9% of GDP in 2009/10 to 24.6% in 2019/20
■ Ageing population increases cost of health, welfare and other services
● Additional $36bn per year by the end of the decade
■ NDIS rose from $8bn to $18bn from 2017-18 to 2019/20
■ Defence budget rose $8.5bn in the five years to 2019/20 to $32bn
■ Structural reductions in personal Y tax during boom years
● 2018/19 and 2019/20 Y tax reductions of $30bn a year

2016-19
● Liberal government managed to decrease deficit
○ 2016/17: -1.9%, 2017/18: -0.5%, 2018/19: -0.2%, (2019/20: 0.4% surplus)
○ Three previous budgets were all better than forecast
○ Helped by automatic stabilisers: increased Y and company tax from higher iron ore
prices
● Mildly contractionary stance due to political aim of decreasing deficit despite RBA’s
expansionary stance (cash rate decreases down to low of 0.25%)
○ Led to criticism of government
■ Phil Lowe said the government needs to take a more active role in
stimulating the economy

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2019-20 (Pre COVID-19)
● Cuts to personal Y tax rates, LMITO of $1080
● Taxpayers earning $45-$200k would see tax drop to 30% by 2024
● Instant asset write off lifted to $30,000 for businesses with revenue of up to $50 million
● Corporate tax for small / medium businesses lowered to 25% by 2020-21
● 10 year infrastructure plan increased from $75bn to $100bn
● $3bn Urban Congestion Infrastructure Fund

COVID-19 Unforeseen Events and Stimulus Packages

● $4bn impact on the budget due to the bushfires
● COVID-19 packages total to $259bn (13.3% of GDP)
○ Direct fiscal measures are equivalent to $134bn (6.9% of GDP)
○ Debt will roughly double to $800bn
● Stimulus Package 1 - $17.6bn (2nd March 2020)
○ Payments of $750 to pensioners, social security recipients, veterans and other Y
support groups
■ Cost $4.8bn to 6 million recipients
○ $1bn to support tourism, agriculture and education
○ $6.7bn to support business cash flow
○ $1.3bn to support 120,000 apprentices and trainees (50% wage subsidy)
○ $700m to increase instant asset write off thresholds
○ $3.2bn to accelerate business depreciation deductions
● Stimulus Package 2 - $66bn (22nd March 2020)
○ Extra $550 per fortnight for 6 months for welfare recipients under the Job Safe
program - renamed newstart to JobSeeker
○ Further $750 payment to the 1st group
○ Up to $100,000 loans to small and medium businesses to help meet operating costs
○ $715m to assist airlines and airports
○ $2.4bn for health including advertising, clinics and supplies
○ RBA announced a $90bn funding facility to support bank lending
● Stimulus Package 3 - $70bn ($130bn before fuckup) (31st March 2020)
○ $1500 per fortnight JobKeeper wage subsidy for business who suffered 30% turnover
losses
○ Funding for childcare and kindergartens
○ Extra funding for aged service providers and the health sector
● JobMaker Scheme (26th May 2020, further details announced 14th June)
○ Wide ranging industrial relations reform
○ Move to simplify the vocational education system
○ Does not include any new funding for skills and training beyond the current $1.5bn
○ Fast tracked 15 major infrastructure projects
■ Eg $10bn Melbourne to Brisbane inland rail, $4.5bn Marinus Link between
Tasmania and Victoria (underwater cable), expansion of Olympic Dam
■ Could support ‘over 66,000 direct and indirect jobs’ - Morrison
○ Target a 50% reduction in Commonwealth assessment and approval times for major
projects from an average of 3.5 years to 21 months
○ Also includes an extra $1.5bn towards smaller infrastructure projects
○ June 4th - $25,000 HomeBuilder grant for eligible new homes or the substantial
renovation of existing homes

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Overall Fiscal Support:
● Support for individuals and households (cost from 19/20 to 23/24 in brackets):
○ Income support for individuals (JobSeeker) of $550 a fortnight ($14.1bn)
○ Payments to support households - two rounds of $750 ($8.8bn)
○ Temporary early release of super of $10,000 in 2019/20 and another $10,000 in
2020/21 ($1.15bn)
○ Lower the social security deeming rates to 0.25-2.25% ($876m)
● Support for business (cost from 19/20 to 23/24 in brackets):
○ JobKeeper Payment of $1500 a fortnight for 26 weeks ($70bn)
○ Boosting cash flow for employers - small and medium business entities with
aggregated annual turnover under $50m can receive $20,000 to $100,000 ($31.9bn)
○ Temporary relief for financially distressed businesses - includes lessening the threat
of insolvency, temporary flexibility in the Corporations Act 2001, payment
reductions or deferrals etc ($0)
○ Increasing the instant asset write off threshold to $150,000 from $30,000 and
broadening the base to include businesses with a turnover of up to $500m ($700m)
■ Will cost $2.5bn in 2020-22, will make $1.8bn in 2022-24
■ Will support 3.5m businesses (99%) employing 9.7m employees
○ Backing business investment - 15 month investment incentive, accelerating
depreciation deductions - businesses can deduct 50% of the cost of eligible assets
on installation ($3.2bn)
■ Will cost $6.7bn in 2020-22, will make $3.5bn in 2022-24
○ Supporting apprentices and trainees - 50% wage subsidy to a maximum of $21,000,
supporting 70,000 businesses and 117,000 apprentices ($1.3bn)
○ Support for Coronavirus affected regions and communities ($1bn)
○ Support for Australian airlines and airports ($715m)
● Supporting the flow of credit (maximum cost in brackets)
○ Government support for immediate cash flows needs of small and medium sized
enterprises - 50% loan guarantee arrangement ($20bn)
○ Australian Office of Financial Management Support investing in structured finance
markets used by small lenders ($15bn)
○ RBA Support - 0.25% loans to banks ($90bn)
○ Changes to bank capital ratio expectations by APRA ($0)
● https://treasury.gov.au/sites/default/files/2020-05/Overview-Economic_Response_to_the
_Coronavirus_3.pdf
● UPDATED STATS: https://budget.gov.au/2020-efu/downloads/fact_sheet_overview.pdf

14.6 - The Impact of Recent Fiscal Policy

Economic Growth
● Fiscal policy’s most important impact from the 1940s to 70s was on economic growth in
accordance with Keynesian economic theory
● Since the 1990s, monetary policy has acted as the main instrument in influencing growth,
with fiscal policy being reduced to an occasional counterbalancing role
● Large fiscal stimulus during the GFC played a central role in managing growth
○ Spending increased by almost 1/4 in the 2008-09 and 2009-10 budgets
○ Regarded as one of the most successful examples of expansionary fiscal policy in
recent history

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 ○ Cash payments to households in December 2008 helped sustain consumption
○ Added 2% to growth in 2009, leading to 1.4% growth instead of a 0.7% contraction
● The effectiveness of fiscal stimulus may diminish if the accumulation of past budget
deficits has created large public debt
○ Seen in Europe after the GFC - led to a crisis of confidence
○ In these cases, contractionary policy may be more useful as it boosts confidence - a
reversal of the crowding out effect
● The main goal of fiscal policy in the 2010s has been to return the budget to surplus
gradually and sustain low interest rates to create greater scope for investment and growth
● Another goal has been to sustain Australia’s relatively low public debt levels
○ 19% of GDP in 2018-19, 1/7 the average for advanced economies
● Budget policies have also shifted towards supply side policies eg boosting small business
investment, increasing workforce participation and investing in infrastructure
● The government has also advanced two long term planes to reduce taxation for individuals
and businesses in order to provide more incentive to work
○ Committed to limiting taxation receipts to under 23.9% of GDP
● 2019-20 budget announced three stages of reductions in personal Y tax
○ First was the ‘Low and Middle Income Tax Offset’ for the four years from 2018-19
to 2021-22
■ Tax offset for taxpayers earning up to $126,000 of up to $1080
○ Three stages are expected to reduce revenue by $158 billion between 2019-20 and
2029-30, in addition to $144 billion in tax cuts announced in 2018-19
● 2016-17 budget contained a decade long plan to reduce company tax from 30% to 25%, but
the government was only able to reduce taxes for small businesses with a turnover of less
than $50 million
● While some tax changes have assisted short term growth, the fact that tax cuts have been
legislated as many as five years ahead of time reflects their main goal of keeping tax low
● Changes in fiscal policy affect monetary policy decisions
○ The mildly contractionary stance of fiscal policy has allowed the RBA to keep
interest rates at record lows
○ Phillip Lowe publicly advocated for expansionary fiscal policy, noting the limits of
the effectiveness of monetary policy

Unemployment and Workforce Participation

● Expansionary fiscal policy can help reduce unemployment by stimulating AD
● Specific measures have been introduced to address some of Australia’s longer term labour
market challenges
○ Ageing population, the need to increase participation, reducing structural
unemployment - aimed at reducing NAIRU
● The 2019-20 budget included a $525 million Skills Package to address skills shortages and
boost apprenticeships
○ Up to $8000 for businesses to hire apprentices in areas of skills shortages, $2000 to
the individual for taking up the apprenticeship
○ Planned to create 80,000 apprenticeships over five years
● The 2018-19 budget introduced ‘More Choices for a Longer Life’, a package designed to
assists older Australians
○ Incorporated a number of jobs and skills initiatives to allow Asutralisns to remain in
the workforce for longer

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 ● The 2017-18 budget announced a levy for employers who bring in overseas workers on
temporary visas - the ‘Skilling Australians Fund’
○ Used to fund skills training and apprenticeships - estimated to provide $1.5 billion
over four years to support 300,000 apprentices and trainees
● The 2016-17 budget provided $37.3 billion in funding for the ‘Jobs for Families’ childcare
package which simplified the childcare subsidy, hoping to put downward pressure on
childcare costs, allowing more parents to return to work

Resource Allocation
● Governments have sought to give market forces the main influences in the way that
resources are used rather than government policy
○ Market forces: changing consumer preferences, changing business practices, new
technologies and the forces of globalisation
● Direct subsidies to industry have declined to less than $4 billion per year
● The Abbott government declined to prevent the closure of Australia’s PMV industry in 2013
● In the 2014-15 budget, the government announced an end to subsidies for locally produced
ethanol fuel
● There has been a decline in the government’s direct provision of economic services eg
road, rail and aviation, banking and electricity supply
○ Public trading enterprises have increasingly been privatised
● The 2016-17 budget included a $30 billion increase in defence spending over 10 years, in
part to pay for a new submarine building program based in Adelaide
● The 2019-20 budget contained a plan for $100 billion in transport infrastructure over the
next decade including the construction of the Western Sydney Airport, Melbourne’s Airport
rail link and an inland rail route between Melbourne and Brisbane
● Governments still have significant influence on resource allocation through ongoing policy
settings eg regulations, tax concessions and exemptions
○ Renewable Energy Target aims to ensure 23% of energy generation comes from
renewable sources
○ Government’s tax concession for the cost of fuel for the agricultural and mining
sectors worth around $7.5 billion annually
○ Private Health Insurance rebate - costs the budget around $6 billion per year since
1999 for buying private health insurance

National Savings and External Stability

● Surpluses increase national savings while deficits detract from them
● The government is pursuing the goal of a budget surplus over the medium term to not
directly add to Australia's savings imbalance
● The ‘twin deficits’ hypothesis has been a matter of economic debate since the 1980s
● There is no obvious linkage between Australia’s budget outcome and the CAD
● Even though budget surpluses may contribute to higher national savings, increased private
investment can have a much larger effect of increasing Australia’s savings and investment
gap eg pre GFC
● Even during periods of budget deficits, the government can create assets and funds to
increase the level of net national savings
○ The $61 billion Future Fund was created in 2006 in order to help pay for public
sector super liabilities
■ Earned an average of 10% p.a to 2019, when it was worth $154 billion

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Distribution of Income
● The budget can impact Y distribution through specific tax and revenue measures as well as
through its broader impact on economic conditions
● After trying for three years to pass a series of spending cuts worth $13.5 billion including
$7 doctor copayments, the Coalition abandoned those planned changes in 2017
● More recently, budgets have contained fewer proposed spending cuts that could negatively
impact lower income earners
● The 2016-17 budget reduced superannuation tax concession for higher income earners
● The 2015-16 budget tightened the assets test for age pensioners (max $823,000)
● Debate has been focused on the government’s planned changes to personal Y tax
○ Will make the tax system less progressive by eliminating a tax bracket by 2024-25
○ The LMITO will make the system more progressive for the four years in which it
applies - $1080 to low and middle income earners of $45000-$90000
○ The second and third stages involve a reduction in tax rates and a lifting of tax
brackets - elimination of the 37% bracket and decreasing the 32.5% bracket to 30%
while increasing the threshold to $200000
● This package will have a regressive effect, making the tax system less progressive than at
any time since the 1950s
○ The share of Y tax paid by middle income earners will rise form 32% in 2017-18 to
35% in 2029-30
○ Australia would fall from 12th in the OECD in 2017-18 to 19th by 2024-25 in terms
of tax progressivity
● Technological change and automation are resulting in structural changes and the erosion of
job security for many Australians
○ May result in ongoing budget pressures if governments are to prioritise avoiding
increases in income inequality

Effectiveness of Fiscal Policy

● Advantages:
○ Short impact lag
○ Can be very specific and targeted
○ Can boost confidence (timely, targeted, temporary)
○ Automatic stabilisers
● Disadvantages:
○ Long implementation lag (normally 1x per year)
○ Political constraints
○ Heavily reliant on accurate forecasts

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Chapter 15 - Monetary Policy

15.1 - Introduction
● Monetary policy involves action by the RBA to influence the cost and availability of credit
in the economy
○ Conducted without the direct control of the government
● The main instrument of monetary policy is the cash rate - the interest rate in the
overnight money market
● The RBA sets a desired cash rate through conducting domestic market operations (DMOs)
● Higher interest rates (tightening of monetary policy) result in a fall in AD
● Lower interest rates (loosening) result in a rise in AD

15.2 - The Objectives of Monetary Policy

● The primary macro policy used to manage the level of economic growth
○ Stances can be described as expansionary or contractionary
● It is not always possible for the RBA to pursue all the goals of economic policy at once
○ Tension between inflation and economic growth / employment
● The three objectives of the RBA laid out in the Reserve Bank Act 1959
○ The stability of Australia's currency
■ Maintaining low and stable inflation
■ Preserving the purchasing power of the AUD
○ The maintenance of full employment in Australia
○ Promoting the economic prosperity and welfare of the people of Australia

Inflation Targeting
● The RBA has targeted an inflation band since the early 1990s
● Reflects several important aspects of monetary policy:
○ Particularly suited to fighting inflation
○ Often unsuccessful in achieving simultaneous goals
○ Giving independence to a central bank in its conduct of monetary policy helps to
reduce the risk of political factors distorting interest rate decisions
○ Countries where central banks were given the responsibility of targeting inflation
have achieved low inflation without increasing unemployment
● Keep inflation between 2-3% on average over time
○ Medium term goal provides a clearly identifiable performance benchmark
● Inflation targeting regime consists of four key elements:
○ Establish a clear and credible medium term nominal anchor for the economy
○ Nested within the broader objective of welfare maximisation
■ Inflation control is not the ultimate objective - means to an end
○ Has a degree of flexibility
○ Accompanied by a high level of accountability and transparency
● The RBA considers many indicators of the financial conditions and economic performance
of the economy as well as forecasts of these indicators
○ Lagging indicators: inflation, wages growth, unemployment, economic growth,
terms of trade, global economic growth
○ Leading indicators: interest rates, exchange rates, commodity prices, new car
registrations, development approvals

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15.3 - The Implementation of Monetary Policy
● There have been two main approaches for implementing monetary policy:
○ Monetary targeting: influencing the size of the money supply (M3)
○ Rate-setting monetary policy: influencing the general level of interest rates in the
economy by setting the cash rate
● Monetary targeting was used from the mid 1970s to early 1980s when the financial sector
was closely regulated by the government and the RBA
○ Abandoned in the mid 1980s in favour of interest rate instruments
● The RBA does not directly control or regulate the market interest rates charged by banks
○ Instead sets a short run interest rate (cash rate)

Domestic Market Operations (DMOs)

● Instrument of monetary policy is the cash rate , the interest rate paid on overnight loans
in the short term money market
○ Cash rate is set by the forces of supply and demand, but the RBA can increase or
decrease the supply of funds throughs DMOs to control the cash rate
● Banks need to hold a certain proportion of their funds with the RBA in Exchange
Settlement Accounts (ESAs) to settle payments with other banks
○ Some banks need to borrow in order to settle their daily transactions
○ Borrowing and lending takes place in the short term overnight money market
● A DMO is where the RBA buys or sells securities (CGSs / repos) to a financial institution
○ Has the effect of increasing or decreasing the supply of loanable funds in the ESAs
○ Pays for securities by depositing money in the seller’s ESA
○ Sells securities by withdrawing money from the buyer’s ESA
● RBA constantly conducts DMOs to maintain the cash rate at its target level as the demand
for ESA funds changes on a daily basis
● The RBA deals with ESAs through the use of a cash rae corridor
○ Pays 0.25% below the cash rate target
○ Charges interest at 0.25% above the cash rate target
○ Two rates form the upper and lower bounds of the cash rate corridor as banks have
no incentive to trade with each other outside of this range
● An increase in the cash rate means that it becomes more expensive to obtain funds,
increasing the overall cost structure of borrowing
○ Interest rates also affected by banking sector competition, regulations, conditions
in global financial markets, risks according to economic conditions

Monetary Policy Stance DMOs Overnight money market Cash rate

Tightening RBA sells CGSs Shortage of available funds Rise

Loosening RBA buys CGSs Excess of available funds Fall

15.4 - The Impact of Changes in Interest Rates

● The main effect of a change in the general level of interest rates is to changes the demand
for credit
● The process through which monetary policy impacts the economy is known as the
transmission mechanism - operates in two stages
○ Stage 1: The cash rate impacts upon other interest rates

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 ○ Stage 2: Interest rates impact upon the general economy and inflation

Channels of the Transmission Mechanism

● Five channels within the second stage
● Savings and investment (intertemporal substitution):
○ Lower interest rates encourage investment and discourage savings
○ Leads to increased Y, employment and output, increasing inflation
● Cash flow:
○ Lower interest rates reduce servicing costs on existing loans
○ Leads to increased disposable Y, C and inflation
● Asset prices and wealth:
○ Lower interest rates increase the demand for assets (real estate)
○ Leads to increased asset prices, wealthier households, increasing C and inflation
● Exchange rates:
○ Lower interest rates discourage financial inflows into, depreciating the AUD
○ Leads to increased international competitiveness, more expensive M, increasing AD
and inflation
● Inflationary expectations (underpins the other channels):
○ Lower interest rates cause people to expect a rise in inflation
○ Leads to increased C, wage demands and inflation
● Monetary policy can have an impact lag of 6-18 months
○ Poses a problem for policymakers

Advantages of Monetary Policy

● Short implementation lag (1x a month)
● Independent of politics
● Very effective in contractionary stance
● Targets demand inflation

Disadvantages of Monetary Policy

● Long impact lag (6-18 months)
● Blunt instrument - doesn’t discriminate sectors, firms or industries
● Not so effective in expansionary stance, especially when rates are low
○ 0 lower bound
● Conflicts between targets eg unemployment and inflation
● DTIs may not pass on changes in cash rate due to funding issues
● Can’t help imported inflation or exogenous shocks

Alternative View on Monetary Policy - Keynes

● Keynes is known for his promotion of fiscal policy as a macro stabilisation tool
● He advocated for budget deficits to get out of the 1930s depression
● He also said monetary policy has a role - interpretation of his ideas as follows:
○ Interest rate decreases lead to greater investment (savings investment channel)
■ Marginal efficiency of capital
■ Change in investment * multiplier (k) = change in income
■ Potential liquidity trap: When interest rates approach 0%, lower rates will
not increase investment
○ Higher investment increases C according to the consumption function

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 ○ Higher Y cause higher inflation and bring down unemployment (Phillips Curve)

15.5 - The Current Stance of Monetary Policy

● RBA meet on the first Tuesday of every month except January
● Inflation has average 2.4% since the adoption of inflation targeting in the early 1990s
● Five main factors explain the stance of monetary policy:
○ The low inflation objective (2-3% over time)
○ Inflationary expectations - the RBA is committed to keeping expectations low
○ Labour costs - future rate movements are dependent on inflation, which is
significantly impacted by labour trends - best indicator is the WPI
○ Committed to the other objectives of economic growth and lower unemployment
■ Low inflation is a prerequisite for economic growth
○ External factors - Australia’s integration with the global economy means
international conditions consistently influence the RBA’s monetary settings

2005-08: Mining Boom Mark 1 (Price Phase)

● Headline inflation increased to 5% (9/08) and unemployment down to 4% (below NAIRU)
○ Skilled labour shortages
● Cash rate increased to 7.25% - contractionary

2008-09: GFC
● Headline inflation decreased to 1.2% (9/09)
● Series of big rate cuts (3x1%) to 3% - emergency expansionary setting
● Monetary policy took a more supporting role to Rudd’s stimulus ($75bn over two years)

2009-11: Mining Boom Mark 2 (Investment Phase)

● Recovery: unemployment down to less than 5% and inflation up to 3.5% (6/11)
● Cash rate up to 4.75% (11/10) - contractionary
● Monetary policy now assuming more dominant role as fiscal policy became dominated by
the political aim of decreasing the deficit from the GFC

2011-2020: Slowdown
● Economy slowing in general
● 17x rate cuts from 11/11 to 3/20 - currently 0.25%
● RBA has run out of cash rate ammunition - effectiveness is reduced at low rates
○ Much easier to stop people from spending than to encourage it
● When the economy shrinks, people’s fear increases which increases savings rates (now
5.5%) rather than consumption
○ Makes economy shrink faster - paradox of thrift
○ Self fulfilling expectations
● 0.25% is the lowest the cash rate can be given the corridor system of +-0.25% before you
get into negative interest rates
○ ‘Extremely unlikely’ in the word of Phil Lowe

March 2020: Unconventional Monetary Policy

● Package in March 19/20 of 2020 - emergency meeting
● Cut cash rate to 0.25% (conventional)
● Adjustment: Deposit rate in ESAs should be 0%, RBA announced that it will pay 0.1%

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● Asset purchases: Announced a target for three year CGSs of 0.25%
○ Ensure no negative interest rates
○ Provide certainty to firms to plan ahead
○ Successful - only bought $50bn so far (May 21)
● Term funding facility - three year fixed borrowing at 0.25%
○ $90bn to DTIs if needed ($15bn used by 7/7/2020)
● Forward guidance: Committed to lower uncertainty and not increase interest rates until
economic conditions improve: 2-3% CPI, 4.5-5% unemployment
● Decided against pursuing quantitative easing for the moment

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Chapter 16 - Microeconomic and Environmental Policies

16.1 - Microeconomic Policies and Aggregate Supply

● Microeconomic policies are policies that aim to increase AS by improving the efficiency
and productivity of producers and industries
○ Krugman: ‘Productivity isn’t everything, but in the long run it is almost everything’
○ AS can be divided between the four P’s
■ Population, participation, productivity, policy
○ Say’s Law (law of markets): ‘Supply creates its own demand’
■ Rejected by most modern economists
■ Krugman wrote: ‘the reverse is largely true - specifically, that inadequate
demand destroys supply’
● Aim to increase the sustainable rate of economic growth and decrease NAIRU
○ Does this by increasing productive capacity
● Micro policy is important as many economic problems are caused by structural factors that
cannot be addressed by managing the level of AD
○ Help Australia transition to new knowledge based industries
● Micro policy influences supply - sometimes called supply side economics
● Micro policies are closely associated with structural change
○ Structural change refers to shifts in the pattern of production that reflect changes
in technology, consumer demand, policy, global competitiveness and other factors
○ Results in the disappearance of some industries and the emergence of others
● Makes product and factor markets work more efficiently
● Gross value added by industry:
○ Services: 1980: 58%, 2018: 63%
○ Mining: 1980: 6%, 2018: 10%
○ Manufacturing: 1980: 15%, 2018: 6%
● Microeconomic theory says that product and factor markets will generally be more
efficient if there is greater competition between private businesses and the market forces
● Micro policies can operate on different levels
○ Can range from single firms to entire industries
● The general aim of all micro reforms is to encourage the efficient operation of markets
○ Lift productivity, improve flexibility and responsiveness to change

Efficiency
● Efficiency can be divided into three parts - allocative, technical and dynamic
○ Many micro policies will impact all three aspects simultaneously
● Allocative efficiency: the economy’s ability to shift resources to where they are most
valued and can be used most efficiently
○ Moving to the edge of the production possibility frontier
● Technical efficiency: the economy’s ability to produce the maximum level of output from
a given quantity of inputs
○ Moving to the technical optimum in the long run average cost curve
● Dynamic efficiency (innovation): the economy’s ability to shift resources between
industries in response to changing patterns of consumer demand

16.2 - Microeconomic Policies and Individual Industries

● Nine areas of microeconomic reform:
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 ○ Labour market (chapter 17)
○ Environmental management (also in chapter 12)
○ Deregulation
○ National competition policy
○ Reform of GBEs/PTEs
○ Taxation reform
○ Trade policy (also in chapters 2 & 6)
○ Industry assistance eg subsidies (also in chapter 2 & 6)
○ Infrastructure reform
○ Education and health sector reforms

National Competition Policy

● Agreement between states and federal government (1995) to encourage competition
between firms which will lead to an increase in efficiency
● Four key objects:
○ Decrease barriers to entry
○ Decrease government regulations
○ Expose GBEs to competition (achieve competitive neutrality)
○ Break down monopolies
● Key is to encourage ‘workable competition’
○ Appropriate number and size of firms
○ Mergers approved / disallowed in terms of public interest
■ Just allowed TPG to merge with Vodafone (Feb 2020)
○ ‘4 Pillars Policy’ (1990) - big four banks are not allowed to merge and monopolise
● Overseen by the national competition watchdog, the Australian Competition and Consumer
Commission (ACCC)
○ Prohibits unfair business practices eg monopolisation, price discrimination,
exclusive dealing, collusion and market sharing
● Turnbull government updated competition policy regime in 2017 by expanding the laws on
misuse of market power
○ $10 million in penalties imposed on Optus in 2019 for misleading customers who
unknowingly purchased /subscribed to content through their direct billing service
● Estimated costs / gains:
○ Increased structural unemployment, decreased subsidies which increased prices,
rural communities suffer losses
○ $25bn (2.5%) increase to GDP by 2005-06, $9bn to households ($1500 each), higher
living standards of $1200 per person, 3% increase in real wages, 30,000 jobs
created, decreased freight charges (-18%) and port charges (-23%)

Reform of GBEs/PTEs
● Three approaches to promote efficiency: privatisation, corporatisation, commercialisation
● Privatisation: selling off PTEs to the private sector
○ Medibank Private sold after 38 years for $5.6bn in 2014
○ Telstra privatised from 1997-2011: 1/3 of the shares sold for $14bn in 1997
○ Opposite: creation of the NBN PTE in 2009 - valued at $8.7bn
■ Network cost $51bn by 2018
● Corporatisation: encouraging PTEs to operate independently from the government
○ Attempt to make profits as if they were private enterprises

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 ○ Eg Australia Post is no longer subsidised (since 1989)- paid over $1.5bn in dividends
to the Australian government
● Commercialisation: recognition that some PTEs will never be profitable, but provide
targets to improve efficiency
○ Eg Sydney Trains - loss of $1.7bn before government support in 2018/19

Tax Reform
● 10% GST introduced in 2000, removal of other taxes which were inefficient
○ Resulted in a one off spike in inflation to 6%
○ Increase in international competitiveness as exports are exempt
● Company tax decreased from 33% to 30%, 27.5% for small businesses
● 2018/19 budget introduced changes in Y tax to increase incentives to work
○ Will also increase inequality: progressivity of tax system will fall from 12th to 19th
in OECD
○ Removal of 37% tax bracket by 2024/25
■ $45-$200k taxed at 30%, over $200k taxed at 45%

Trade and Industry Assistance

● Australia has decreased protection in certain industries
○ Eg tariffs on PMVs, subsidies on agriculture etc
● Joined many trade agreements
○ Multilateral eg WTO
○ Regional eg AANZFTA, CP-TPP
○ Bilateral eg ChAFTA, ANZCERTA
● Subsidies in agriculture are the 2nd lowest in the OECD behind NZ (2% of Y)
● Business welfare system phased out since the 1990s

Infrastructure Reform
● Roads, rail, ports, electricity, gas, water - important factors of production
○ 90% government owned
● Key is to remove capacity constraints and bottlenecks eg at Newcastle coal port
● Main reforms include the application of competitive neutrality and reforms to PTEs
● Spending - $100bn in the decade after 2019/20 budget
○ ‘Planning for Australia’s Future Population’ package - National Infrastructure Plan
○ Contributions to Western Sydney Airport
○ Road projects eg WestConnex, NorthConnex
● Set up ‘Infrastructure Australia’ in 2008
● Gains: multifactor productivity increased by 60% in electricity, gas and water in the 1980s
○ Doubled in transport and communications in the 1990s

Education and Health Industry Reforms

● Reforms in social infrastructure impacting on these sectors:
● Review of funding arrangements for universities
○ Increase in international students
○ Change in fees for courses - STEM down, arts and economics up
● Review of the PBS (prescriptions)
○ 2018 budget: $1.3bn national health and medical industry growth plan
○ 2019 $1.3bn community health and hospitals program

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Deregulation
● The simplification or removal of rules that constrain the operation of market forces
○ Has helped improve efficiency and drive extensive structural change

Financial Industry:
● Floating of the AUD (December 1983)
● Removal of the RBA’s direct monetary controls over banks (from 1973 onwards)
● Removal of barriers to foreign banks entering the Australian market (1984)
○ Further loosened in 1992
● Tenders for Treasury bonds adopted in 1982
● Resulted in more competition for financial services
○ Benefits spread across the entire economy as households and businesses pay lower
prices to access finance
○ Finance and insurance industry higher multifactor productivity growth (measured
across labour and capital inputs) than most other sectors from 1997-2018
■ Average annual productivity increases of 2%
■ Due to online banking, reduction in branch staff, shifting processes online or
overseas, organisational restructuring and low interest rates
● Need for a balance between the goals of efficiency and competition and the goals of
consumer protection and financial system stability
● 2014 Financial System Inquiry (Murray Review) conducted to find a balance between aims
○ Laws banning excessive credit card surcharges enacted in 2016
○ Important recommendations such as giving ASIC more explicit powers have not yet
been implemented
● 2019 Royal Commission revealed significant problems in how the industry was regulated by
ASIC, uncovered a range of dishonest practices
○ Held back from recommending major legislative changes due to concerns about the
ease of access to credit

Agricultural Industries:
● Single PTEs or industry cooperatives used to have monopolies on buying farmers’ produce
eg dairy, wheat, wool
○ Deregulation ended these monopolies
● Growth in agricultural productivity has slowed to 0.9% in the last 20 years from 2% in the
second half of the 20th century
○ Due to deteriorating climate conditions rather than a failure to innovate

Transport Industries:
● The Two Airline Policy of 1952 was ended in 1990 in the domestic aviation industry
○ Consolidation between airline businesses has resulted in two dominant airline
groups: Qantas/Jestar and Virgin Australia/Tigerair
● The Commonwealth and State governments esta;bished the Australian Rail Track
Corporation (ARTC) to manage the 10,000km national rail network
○ Sells access to private freight businesses eg Pacific National

Telecommunications Industry:
● Contributes 3% of economic output as a sector
● Telecom Australia (Telstra) was the monopoly provider of services until the early 1990s
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 ● During the rollout of the NBN, the wholesale business of providing access to the
infrastructure was separated from the retail businesses that offer telecommunications
services to households and businesses
○ Should increase competition among retailers

Continuing Regulation:
● Excessive regulation can impose additional costs, constrain economic growth and
undermine competitiveness
● Excessive deregulation can lead to market failure and economic instability
● Most industries still operate with a significantly regulated framework
○ Environmental regulations in the agricultural and mining industries
○ Safety regimes in construction and transport
○ Pricing and investment decisions are overseen by regulators in electricity, gas,
water, postal services and telecommunications
○ Professional services industries eg law and accounting exist in part to help
businesses comply with and navigate regulation
○ New transport, planning, privacy, tax and other regulations in response to the rise
of gig economy corporations eg Uber, AirBnB, Facebook, Amazon

The Future of Microeconomic Policy

● The period from the mid 1980s to the early 2000s witnesses extensive micro reforms
○ Since then, priorities have shifted to managing the mining booms and GFC
● Criticism of the government for a lack of change
● Rudd and Gillard governments implemented a range of ‘seamless national economy’
reforms from 2008 to make it easier to do business
○ Uptake by states has been poor
● Abbott government commissioned a major audit of the budget in 2013
○ Measures to cut spending did not achieve political support
● Review of the energy sector in 2017, but the subsequent National Energy Guarantee was
scrapped in 2018 by the Turnbull government
● Adoption of a needs based school funding model in 2017
● The ‘Shifting the Dial’ report in 2017 estimated that the increase in productivity resulting
from micro changes could lift GDP by $80bn a year
○ Health reforms eg making regional health funding more flexible, reducing support
for services with little impact, changing the structure of pharmacy, reforming
alcohol tax
○ Education reforms eg extending consumer laws to cover universities, independent
assessment of skills at university, extending access to learning options
○ City reforms eg changing public infrastructure funding, using competition principle
for land use, introducing road charades, improving the assessment of developments
○ Market reforms eg tax reform, better cooperation between levels of government,
public sector reform, energy sector reforms

Overall Impacts of Microeconomic Policy

● Main long term tool to lift economic growth and living standards whilst also addressing
external imbalances and inflation levels
● Many reforms are met with strong opposition due to short term costs eg unemployment
● High productivity growth in sectors affected by micro reform eg telecommunications and
financial services since the 1990s
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 ● Australia experienced weaker productivity growth from the mid 2000s
○ Slowdown in labour productivity has been especially pronounced
● 2018 OECD reform stressed the need for education and training policy reforms so that the
labour force could better adapt to the structural changes of globalisation
○ Recommended the adoption of a more comprehensive framework for facilitating
job transitions for workers displaced by global forces and automation
● Benefit of structural change is lower inflation from greater competitive pressures
○ Since the early 1990s, rail freight charges have dropped by up to 42%, port and
telecommunications by up to 50%
● Many critics of micro reform suggest that one problem is simply replace with another:
○ Privatisation is ‘severely damaging’ the Australian economy as vital assets being
sold off results in private monopolies, increasing consumer prices (Rod Sims 2017,
chairman of the ACCC)
○ Reforms tend to benefit wealthy investors while the costs are borne by lower
income earners
○ Productivity stats exaggerate the benefit of micro policies
■ Has been an increase in work intensity - unpaid hours
● Criticism that micro reform has stalled in the last ten years (except labour market)
○ In the 80’s all the low hanging fruit were picked, leaving the difficult higher fruit

16.3 - Environmental Management Policies

● Environmental issues have risen in significance in recent years
● Aim to influence the behaviour of households, businesses and industries
● Two main policy tools are regulations and market based policies

Targets
● Renewable Energy Target (RET) to source 23.5% of our electricity supply from renewable
energy sources by 2020
○ Places legal obligations on electricity companies to contribute to the target by
producing or paying for renewable energy
○ Is expected to be met
● Most important long term policy target is to reduce the carbon intensity of the economy
and lower Australia’s carbon emissions
○ Abbott government announced an emissions reduction target of 26-28% on 2005
levels by 2030 in the lead up to the 2015 Paris Conference
○ Different policies announced to help achieve this target eg the Emissions Reduction
Fund, the National Energy Productivity Plan

Regulations (Command and Control)

● Regulations are laws or rules that govern economic behaviour
○ Prohibit individuals and companies from causing environmental damage
○ Specify how a G/S is produced or consumed
● Fuel Quality Standards Act 2000 regulates the quality of fuel for Australia
○ Introduced the phasing out of leaded petrol - completed by January 2002
● The Environment Protection and Biodiversity Conservation (EPBC) Act provides a
framework for the protection and management of matters of national environmental
significance eg World and National Heritage Sites, threatened species and communities

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 ○ Developers must provide an environmental impact assessment of a proposal if it has
the potential to harm a matter of national environmental significance

Case Study: Great Barrier Reef

● The Great Barrier Reef became a UNESCO World Heritage Site in 1981
● Over 2 million annual visitors, worth $6.4bn to the economy, supports 69,000 jobs
● Between 2015 and 2018, hard coral cover of the central areas of the GBR fell from 22% to
12% - two thirds of the reef suffered from coral bleaching
● The Queensland government joined the Commonwealth to commit to the Reef 2050 Long
Term Sustainability Plan - provides $140 million in funding
○ Established the $40 million GBR Trust
○ Banning the disposal of material from capital dredging projects within the GBR
Marine Park
○ Providing additional protection for turtles and dugongs through anti poaching laws
○ Funding to reduce marine debris
○ $35 million in ongoing funding to reverse the decline in water quality associated
with agriculture - an additional $100 million over five years to support water
quality initiatives and scientific research
○ Reducing the presence of crown of thorns starfish
● The Federal and Queensland governments are jointly investing $2bn to protect the reef
● The Turnbull government announced a $444 million grant to the GBR Foundation to
improve and monitor the health of the reef

Market Based Policies

● Policies designed to create market based incentives for environmental protection have
been increasingly used in recent years
○ Financial incentives and disincentives eg taxes and subsidies
● Many environmental problems arise because of market failure
○ Externalities are borne by all of society but aren’t taken into account by producers
and consumers in the market
○ Results in the equilibrium price being too low in the case of negative externalities
● Market based response to externalities is to levy a tax on production
○ Referred to as ‘internalising the externality
○ Discourage damaging principles and raise government revenue
● The Product Stewardship for Oil Program imposes an 8.5 cent per litre levy on the
purchase of oil to help fund the recycling of old oil
● Australia’s revenue from environmental taxes constitute 6% of government tax revenue
● The federal government’s Australian Renewable Energy Agency (ARENA) provides funding
for research and development as well as large scale renewable energy projects

International Agreements
● Collective action is often necessary as individual nations cannot successfully address global
environmental problems
● Depletion of the ozone layer:
○ Related to the emission of chlorofluorocarbons into the atmosphere
○ Montreal Protocol (1989) committed members to phasing out the production of
ozone depleting products by 2000
○ Over 98% of such substances were eliminated between 1987 and 2014

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 ○ The ozone layer should recover to pre 1980 levels between 2050 and 2065
● International agreements are required to prevent the overuse of common international
reseources - tragedy of the commons
○ UN Fish Stocks Agreement was developed to ensure the long term conservations
and sustainable use of highly migratory fish stocks
● Australia is a participant in the following international treaties:
○ CITIES Convention (1976) on International Trade in Endangered Species of Wild
Fauna and Flora
○ Vienna Convention (1987) for the Protection of the Ozone Layer
○ Montreal Protocol (1989) for Chlorofluorocarbon Control
○ The convention on Biological Diversity (1993)
○ The Convention to combat Desertification (2000), to address land degradation in
the world’s drylands
○ The Stockholm Convention (2004) for the protection of human health and the
environment from organic pollutants
○ The Kyoto Protocol (2008) on climate change
○ The Paris Agreement (2016) on climate change

Climate Change Policies

International Agreements:
● 160 nations reached an agreement in Kyoto in December 1997 to limit emissions of
greenhouse gases
● UN Framework Convention on Climate Change (UNFCCC)
○ The Protocol required industrialised nations to reduce average national emissions
by 5% below 1990 levels between 2008-2012
○ 37 countries agreed to extend the Protocol to include 2013-2020 - pledged to
reduce average national emissions by at least 18%
■ Those countries only made up 15% of total global emissions due to the lack
of participation of key countries like the US and Canada
● The 2015 Paris UNFCCC Conference agreed to keep ‘the increase in global average
temperature to well below 2 degrees celsius above pre industrial levels’
○ Includes developing countries such as China and India for the first time
○ US withdrew in 2017
○ Has mechanisms for transparency and monitoring progress but allows individual
countries to set their own targets for global emissions reduction
○ Came into force in November 2016 with 185 of 197 parties ratified by mid 2019

Targets:
● Australia’s 26-28% reduction on 2005 levels by 2030 was announced in the lead up to the
2015 Paris Conference
○ 5-25% reduction on 2000 levels by 2020
● Australia has a high cost of emissions abatement due to a heavy reliance on emissions
intensive industry and fossil fuels
● Climate Change Authority, an independent government agency, recommends a 30%
reduction in carbon emissions by 2025 and a 40-60% reduction by 2030

Market-based Policies:

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 ● Gillard government introduced a carbon pricing scheme in 2012 which put a fixed price on
each tonne of carbon dioxide emitted as part of energy or industrial production processes
○ Was due to be replaced by a ‘cap and trade’ emissions trading scheme (ETS)
○ Abolished by the Abbott government in 2014
● ETSs are used across the world including in the EU and NZ
○ Businesses can trade permits creating a market based mechanism to create
incentives for businesses to reduce emissions
○ May create ‘carbon leakage’ where emissions intensive industries move to countries
with no emissions target
● The Emissions Reduction Fund (ERF) was introduced to replace the carbon pricing policy
○ Projects are submitted to the government's Clean Energy Regulator
○ Firms bid to sell their emissions reductions at the lowest price
○ After eight rounds of auctions, the ERF has funded 193 million tonnes of CO2
abatement at an average cost of $13.87 a tonne
○ The Federal government announced its Climate Solutions Fund in 2-19 which
included an additional $2bn to support the continuation of the ERF

Regulations:
● Australia banned older style incandescent light bulbs in 2007, replacing them with more
energy efficient options eg fluorescent and LED bulbs
● Planning laws in several states were changed in 2010 to require newly constructed homes
to comply with six star energy ratings involving improved insulation, water recycling etc
● Policy decisions around agriculture, mining and transport

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Chapter 17 - Labour Market Policies

17.1 - Introduction
● Government intervenes in the labour market for many reasons
○ Micro: productivity growth, aggregate supply, international competitiveness,
dispute resolution
○ Macro: Inflation, unemployment, income and wealth distribution
● Wage determination has historically not been left up to the free market
○ Fair Work Act 2009 replaced the Workplace Relations Act 2006 (decentralised)

17.2 - The Role of National and State Industrial Systems

● Regulated through a mix of federal and state laws
● Industrial awards based upon occupation can be at federal or state level
● Inefficiency has created growing pressure to move towards a national industrial relations
system - Fair Work Act (2009) covered all private employees except WA
○ Estimated to save $4.8bn in compliance costs in the decade to 2020
○ Also replaced most state awards and established national occupational health and
safety legislation
● State regulation is mostly limited to state government employees and a smaller range of
specific issues eg worker’s compensation, public holidays and long service leave
● National system is overseen by the Fair Work Commission

17.3 - Australia’s Wage Determination System

● Directly covers around 70% of workers
● Set out in the Fair Work Act 2009, establishing three main streams that determine
conditions and pay for employees
○ Industrial awards (minimum wages and conditions): 21%
○ Collective (enterprise) agreements: 38%
○ Common law contracts (individual agreement): 37%
○ Working owner of incorporated business - 3.8%
● 29% of Australian workers are outside of the national wage determination system
○ Unregulated conditions (17%) divided between independent contractors (8%) and
other business operators (9%)
○ State regulated conditions (12%) divided between state public sector employees
(11%) and WA employees of unincorporated small businesses (1%)

Minimum Employment Standards

● 10 National Employment Standards, or guaranteed employment conditions eg:
○ Maximum of 38 weekly hours worked, after which it is counted as overtime
○ Right to request flexible working arrangements eg to care for children
○ Right to paid annual leave, public holidays, carers and compassionate leave
○ Right to 1-4 weeks notice for termination and redundancy pay
● Minimum award wage is set annually by the Fair Work Commission for unskilled workers -
$19.84/hr or $753.80/wk (06/2020, up 1.75%)

Streams of Wage Determination

● Awards - minimum pay and conditions specific to an employee’s work or industry
○ Restructured under the Fair Work Act from 4300 awards to 122 modern awards
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 ■ 107 are based on industry classifications and 15 by occupation
○ Modern awards allow for individual flexibility agreements
■ Around 2% of workers have entered into IFAs
○ Additional 20% of employees are on award influenced arrangements
● Collective or enterprise agreements
○ Negotiated on a firm by firm basis between employers and employees
○ Employees are often represented collectively by unions
○ Subject to the ‘better off overall test’ (BOOT) - scrutinised by the FWC to ensure
workers are better off than they would be on the relevant award
○ Often involve enterprise bargaining - wage increases based on productivity
● Individual contracts, usually in small firms with minimal HR or for high income earners
○ Individual contracts (Australian Workplace Agreements) were abolished as part of
the formal industrial relations system by the Fair Work Act
○ Under the Fair Work Act, modern awards fo not apply where an employee is
earning over a threshold - $148,700 in 2019/20

17.4 - Dispute Resolution

● Industrial disputes occur when employers/employees take action to disrupt the production
process in order to highlight a disagreement between employers and employees
○ Can lead to different forms of industrial action eg strikes, work bans, lockouts
● Dispute resolution process has changed over recent decades as the relevant laws
implemented change - mostly relied on a series of specialised industrial tribunals
● Two main forms of dispute resolution:
○ Conciliation: firms and employees meet to discuss their differences in the presence
of a third party (eg industrial tribunal)
■ Tribunal does not impose a resolution
○ Arbitration: an industrial tribunal hands down a legally binding ruling
■ Rare nowadays - less than 100 cases per year
■ Carried out by the FWC
■ Each party is obliged to negotiate in good faith
■ Compulsory dispute settlement terms in all awards and agreements
■ Resolving industrial action
● Australia has experienced a very low level of days lost in industrial disputes since the early
2000s - right to strike has been curtailed by laws limiting it to times of formal bargaining
○ 1981: 4 million, 2000: 400,000, Now: Under 100,000

17.5 - Decentralisation of the Labour Market

● Australia’s industrial relations system has undergone a shift from using non market forces
to a greater reliance on market forces to determine wage outcomes
○ Shift from a centralised system to a decentralised labour market
● Australia’s centralised system reflected cultural values of fairness and egalitarianism
○ Heavily influenced by the union movement
● Prior to 1993, wages were determined by the accord, which was a voluntary agreement
between bosses, firms, workers and the government
○ Had several marks (phases), started out as a very centralised system where the
government decided everything - determined wage increases
● Movement away from this started in 1991, when Keating (treasurer) introduced the system
of enterprise bargaining (wage increases based on productivity) - more flexibility

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 ● Order of centralised to decentralised wage determination systems:
○ Single national wage case for all employees
○ Awards with wages set on a industry or occupation basis
○ Enterprise bargaining
○ Individual contracts

Arguments in Favour of Decentralisation

● Leads to a more efficient allocation of resources and structural change
○ Firms can pay more to attracts higher skilled employees
○ From 2005-2015, WPI for mining grew 53% compared to 40% for workers generally
● Can promote productivity as there is greater incentive to work more efficiently
○ Helps reduce inflationary pressure in the economy
● Flexibility can help the labour market adjust when the economy is affected by negative
shocks, helping keep unemployment at a lower rate
○ Wage falls during recession can minimise job losses or profit reductions

Arguments Against Decentralisation

● Tends to lead to greater inequality through increased wage dispersion
○ Employees in industries with little union power are less likely to achieve wage
increases because they lack bargaining power
● Can produce outcomes that reflect imbalances in bargaining power between employers
and employees - lack of worker bargaining power
○ Historically, concerns about the union’s capacity to cause wage push inflation
● More difficult to enforce wage entitlements
○ 24 of 34 Pizza Hut stores audited were breaking the law (2017 FWO speech)
● Centralised wage determination systems provide an additional tool that the government
can use to achieve its economic objectives eg inflation, unemployment
○ More centralised systems are better able to reach larger numbers of employees
with adapting to change such as through retraining, new technologies, improving
work practices and protecting the rights of all employees

17.6 - Education, Training and Employment Programs

● Governments can influence labour market outcomes through education and training,
apprenticeships, social security and employment services
○ Address participation, productivity and adaptability
○ Can include subsidies, funding etc

Education and Training

● The economy will be more productive if it has a higher quality and more responsive
education and training system
● One of the major challenges is to address the large skills mismatch in the changing job
market - 14% of existing jobs could disappear by 2040, further 32% changing radically
● New education and training programs and reforms include:
○ Early childhood education standards and placements increased
○ Trade training centres built adjacent to high schools and secondary colleges
○ Training places for trades increased
○ Students are more easily available to obtain loans for vocational courses

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 ○ Goals set to halve the number of people who do not have a minimum skill
qualification, increase school retention to 90% by 2020, raise number of 25-34 year
olds with a university degree to 40% by 2025
● Secondary education funding was recommended to be restructured to a needs-based
model by the 2012 Gonski Review
○ Consistent with international evidence that improved educational access is
effective at reducing inequality and increasing social mobility
○ Gonski 2.0 (2017) - planned increase in funding by up to $23.5bn over 10 years
■ Replaces 27 separate funding arrangements with a nationally consistent
system expected to bring an extra $2300 per student
● Deregulation of university fees - decrease for STEM, increase in arts

Labour Market Programs

● These policies are attempts to decrease NAIRU ie structural and frictional
● Aims include increasing participation, productivity, prepare workers for future (AS)
○ Shift the LRPC left and AS right
● Centrelink oversees individuals’ access to income support and their interaction with labour
market programs
● Employment services match unemployed people to jobs and give them adequate training
○ Jobactive - a federally funded network of 42 agencies paid on a basis of getting
unemployed people into jobs - $1.3bn budget in 2019
● A major long term goal of labour market policies is to increase participation in the
workforce, needed due to our ageing population
○ Reducing access to government benefits to give greater incentives to work
■ $2.1bn in savings in 2019/20 budget from changes in the way income is
assessed for social security payments
○ $752m Youth jobs PaTH program (2016) - employability skills training for under 25s,
voluntary internships and wage subsidies
■ Expected to produce 120,000 jobs over four years
■ First 18 months: only 5,619 completed the program, 65% (3,652) found work
○ 2019/20 budget expanded the Harvest Labour Services program to give
horticultural businesses subsidies to hire seasonal Australian workers
○ 2019/20 budget created the Restart program which provides $10,000 for businesses
that hire or retrain a worker above the age of 50
○ JobTrainer and JobMaker schemes including $250m for the creative economy
■ $2bn JobTrainer for retraining and upskilling via training places and wage
subsidies - shared with the states
○ National minimum scheme of paid parental leave in 2011
○ Increased child care subsidies and an expansion in places (free during COVID)
○ Reforms to the interaction of the tax and welfare systems to reduce high effective
marginal tax rates which welfare recipients pay tax as well as lose payments

17.7 - Evaluating Labour Market Outcomes in Australia

● Hybrid system of wage determination with an emphasis on market forces while still
retaining some role for non market forces
● Sustained moderate wage increases, low inflation and relatively strong employment
● Low wages growth and cost push inflation
○ Decentralised system have allowed larger wage increases in specific areas

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 ○ WPI between 2016-2019 was just 2% - not enough to fuel consumption
● Work practice changes and productivity increases
○ Trade off between productivity improvements and wage increases
○ Labour productivity averaged 2.1% in the 1990s compared to 1.2% in the 1980s
○ Averaged just 1.1% in the five years to 2019
● Unemployment has stayed low due greater flexibility
○ Same as the OECD average for advanced economies in 2019 despite having the
highest minimum wage
● Increase in wage dispersion and income inequality from decentralised wage determination
○ Those with greater skills and stronger unions earn larger wage increases
○ Those on awards tend to earn above average wage increases
○ Decade to 2019: CPI 20%, minimum wage 30%, WPI 28%

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Chapter 18 - Effectiveness and Limitations of Economic Policy
● Evaluate the effectiveness against the six objectives from chapter 13:
○ Sustainable rate of economic growth
○ Sustaining a low level of inflation
○ Reducing the level in unemployment
○ Maintaining external balance - keeping the CAD and NFD at sustainable levels
○ Ensuring a fair distribution of income and wealth
○ Preserving the environment for future generations
● Must consider the limitations of policy eg time lags, political constraints, global influences

18.1 - An Overview of the Effectiveness of Economic Management

● Policymakers often need to choose between conflicting objectives
● Overall, macro policy has aimed to achieve maximum sustainable rates of economic
growth around 3% (around 4% in the 1990s)
● Micro policy has aimed to improve productivity and competition
● Sustained the longest period of unbroken economic growth pre COVID
○ 3rd in HDI, 1st in median adult wealth (US$191,451), 13th in global Prosperity Index
(growth, education, health, government, human rights, environment)
○ Indicates effectiveness of policy - reduced volatility, balance between objectives
○ Also due to favourable international conditions eg China growth, iron ore prices
■ ToT added an extra 13% to real per capita household disposable Y and raised
real wages by 6% by 2013
■ Also benefited from strong population growth from skilled migration

Outcomes for Growth, Inflation, Unemployment and External Balance

● Australia has avoided extreme business cycle fluctuations - sustained growth since 1991
○ Average annual growth for OECD countries to 2019 was 1.5%, Australia’s growth was
2.6% for the same period
○ Successful macro policy, resilience of commodity prices, high population growth
○ Stronger productivity and participation growth is needed into the future
● Inflation averaged 10% in the 1970s, 8% in the 1980s and just 2.5% since the introduction of
inflation targeting in the early 1990s
○ Transparent monetary policy, lower tariffs, increased competition, new
technologies, cheaper imports, moderate wage outcomes and productivity growth
○ Successful at controlling inflationary pressures during the GFC
● Unemployment rate is around OECD average at just above 5%
○ Masked by high underemployment - 8.2% in 2019 - high part time and casual levels
○ Increased vocational education and training, funding for disadvantaged schools,
active labour market programs needed to address structural unemployment
● Favourable external conditions have helped Australia manage its external imbalances
○ Improved in the 2010s with a decreased CAD and NFL
■ China’s emergence as a large X market
■ Should keep the CAD in the 2.5-3% range, NFL at 55% of GDP
● Rising inequality in the distribution of income and wealth
○ Shrinkage of middle level jobs alongside growth in the top end
○ Decline in wage growth apart from the highest earners
■ Below average for OECD economies since 2015
■ Specific groups disadvantaged eg Indigenous Australians

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 ● Significant environmental challenges eg biodiversity loss, scarce resources, degradation
○ Climate change increases exposure to natural disasters
○ Political disagreements have hindered progress in this regard

18.2 - Limitations of Economic Policy

Time Lags
● Implementation time lags - the time it takes to introduce new economic policies
● Impact time lags - time for a new policy to have an impact on the economy
● Fiscal: medium implementation lag (annual), short impact lag (a few months)
○ Could have extra lag from political constraints
● Monetary: short implementation lag (monthly), medium impact lag (6-18 months)
● Micro: long implementation lag (a few years), long impact lag (5-20 years)
○ Often considerable lags between different levels of government
○ Long time before the efficiency dividend

Political Constraints
● Election promises and trade offs in decision making
○ Decisions consistent with promises by conflicting with economic conditions
■ Fiscal consolidation of the Liberal government
● Governments must be sensitive to whether or not a policy has public support
○ Slow to implement unpopular policies eg climate strategies
● Governments delegate authority to independent agencies to minimise political constraints
○ RBA, Fair Work Commission, independent pricing authorities
● Australian parliament can constrain legislation measures, mostly the Senate
○ Uncommon to have majorities in the Senate eg 2016, 2019
● System of federalism with a division of power between states and the federal government
○ Lengthy constitutional challenges in the High Court
● Special interest groups play an important role in policymaking
○ Political affiliations eg the unions with the ALP
○ 2019 Adani Coal mine decision in the Galilee Basin

Global Influences
● Governments place a high priority on maintaining the confidence of international investors
and global financial markets
○ Particularly important since the increased volatility post GFC
● Stronger trade and financial linkage policies eg:
○ Reduced government spending and reduced budget deficits
○ Low rates of corporate and capital gains tax
○ Reduced trade barriers and removal of restrictions on foreign investment
○ Deregulation of the financial sector and international financial flows
○ Deregulation across the economy to increase competition
○ Privatisation of GBEs
○ Deregulation of labour markets and better targeting of social welfare
○ Trade agreements that give overseas businesses the power to sue national
governments for policy changes that undermine profitability of investments
● Governments that adopt alternative policies may face a loss of investor confidence
○ 2016 Brexit vote caused the pound to lose 20% of its value

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 ● Global financial flows and overseas interest rates can impact the conduct of monetary
policy - if one country increases rates, others will follow to prevent outflows
● The international business cycle restricts the scope of policy making
○ Industrialised countries try to keep their growth in step with cycles
● International organisations can directly influence domestic macro and micro policies
○ WTO can influence trade policies
○ G7 and G20 reflect growing integration of policy stances

18.3 - Evaluating the Effectiveness of Economic Policies

● Assess the effectiveness by analysing:
○ The specific objectives of a policy
○ Whether the policy as implemented effectively
○ The relevant economic outcomes and how they compare with the objectives
○ Time lags
○ Other factors that may have affected outcomes during that period
○ Whether there were any side effects associated with policy implemented

Macroeconomic Management
● Mostly been effective in achieving its short to medium term goals since the early 1990s
○ Maintained growth despite sometimes difficult global economic conditions
● Monetary policy has managed the growth cycle and achieved price stability
○ Effectiveness relies on the overall policy mix - rarely effective on its own
○ More effective in the contractionary stance than in the expansionary stance
■ Relies on households and businesses responding to incentives
○ The real cash rate was 1/9% lower in the decade 2008-2018 than in the previous
decade but average annual economic growth fell from 3.5% to 2.6%
○ Monetary policy is a demand management policy
■ Can’t influence structural or supply side causes
■ Struggles with conflicting goals eg asset prices - blunt instrument
○ Cannot successfully address the CAD problem
● Fiscal policy is the most effective policy during a downturn
○ Avoided recession in 2009 by adding 2% to growth resulting in a 1.3% GDP growth
○ Macro policy mix has been relatively successful in conjunction
● Has not addressed rising inequality, weak productivity growth, high debt, reliance on
China, significant underemployment and non participation

Microeconomic Management
● Micro reforms since the 1980s have generally been regarded as successful
○ Contained inflationary pressures and improved living standards
● Some have criticised the lack of ongoing reform since the 1990s
○ More than 50 reform options highlighted in 2019’s Priorities for the Next
Commonwealth Government
○ Structural weaknesses - fell from 4th to 18th in the World Competitiveness
Yearbook from 2004 to 2019
○ Leaderships changes, policy backflips, political uncertainty
● Challenges eg ageing population, declining participation, climate change, China slowdown
● Success can be measured by our capacity to sustain growth while achieving a sustainable
position on the external accounts, distribution of income and wealth and the environment

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