annie unsworth - economics topic 2.docx[1]

8/3/2019 Annie Unsworth - Economics Topic 2.Docx[1]

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Topic 2: Australias Place in the global economyAustralias trade and financial flows

Value, composition and direction of Australias trade and financial flows

Composition: refers to what we buy and sell (import and export) i.e. resources,agricultural commodities, manufactured goods and services

Direction: refers to with whom we tradeTrends in Australias trade patternTrade: refers to the exchange of goods and services across national boundariesTrends in CompositionExports

Strong representation of agriculture and commodities

In 1954 minerals and fuels accounted for 7% of export income, now 43%shift in exports due to commodities boom

Fluctuations in agricultural exports due to drought and changes in agriculturalcommodity process

Elaborately Transformed Manufactured goods: small but growing (such as

motor vehicles, telecommunications equipment and medical technology.:grew323% over the nine years to 1994 and now constitutes 25% of all ourexports

Services represent 20% of our exports. E.g. tourism and education Last 5 years increase in primary exports due to recovery from drought and

additional mineral exports to China. Principally export coal to China worth60,000 AUD

Imports Largely ETMs, finished luxury and consumer goods, capital equipment Small market for intermediary goods in manufacturing Great demand fro professional services (finance, law insurance) Composition: Travel 18000 million, Crude petroleum 17900 million,

Transportation 17500 million

Reliance on imports111111111111111 trade deficit since X >MTrends in direction

Exports - lesser focus on Europe from 62% in the 1950s to 20% in 2009. Increase in exports to Japan, China and ASEAN nations. APEC is 68% of two

way tradePush factors

Distance = increased cost and reduced comparative advantage Regionalisation of trade

Low transport costs preserve comparative advantage High regional growth in China and Japan

Cheap labour in Asia

Strategic alliance with the US

Creation of trade barriers by the EU with tariffs and subsidiesPull Factors

Harness comparative advantage enjoyed by Asian countries e.g. cheap labour Creation of free trade agreements, CERTA and Thailand Rapid economic growth in other countries increasing export market

opportunitiesFinancial Flows

High FDI into minerals Growing service sector investing in China and Asian countries


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Net position of $US 629 billion. However this creates a service burden.Australias Balance of Payment

Balance of Payments: records the transactions between Australia and the rest of theworld e.g. exports, imports, interest on debt, dividendsComprised of:

The current Account The Capital and Financial Account

Current Account balance will be equal In size, but opposite, to the balance on capitaland financial account Hence when the current account is in deficit the capital andfinancial account is in surplusThe current account

Records all transactions of a current nature such as exports and imports ofgoods, services, income and transfers

If total debits exceed total credits the current account is in deficit The current account consists of

Goods

Exports are credits (rural and non-rural) Imports are debits (consumption, capital and intermediate goods)

Services

E.g. tourism, education, transport and insurance Net income

Income received from Australian owned assets overseas (credits) minus the paymentof income for foreign owned assets in Australia (debit)

Interest, rent, dividends, profit, royalties Net current Transfers

Involve giving something and not getting anything in return i.e. aid

Foreign pensionsTrends Always in deficit due to net income, which is the structural component and is

always negative it accounts for 70 90 % of the GDP. The goods balance is usually in deficit though a surplus was recorded in 2008

Australia has a persistent deficit of about -5% 2005-2006 reduction in CAD due to the global resources boom 2008-2009 increase in CAD due to increased public sector debt.

Reason for trends Balance on goods and services = cyclical component

Movements of GDP and income elasticity for domestic demand forimports. An increase in income increase in imports

An increase in aggregate demand leads to an increase in national income via themultiplier effect, which leads to an increasing demand for imports

Demand for X is income inelastic

In overseas markets consumers tend to buy better quality food rather than more China demand for exports is income elastic

Price of exports is price inelastic i.e. changes in price do not affect

great changes in demand Rise of imports is price inelastic i.e. changes in price do not attract

great changes in demand.


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Comparative Economic Growth - When a domestic economy grows

faster than the world economy, import demand is greater than exportdemand. This causes BOGS to deteriorate.

International Competitiveness (Australias ability to compete)

Exchange rates a higher $A reduces international competitiveness

Relative inflation rates higher inflation leads to export prices rising faster thanimports.

Changes in productivity increased productivity decreases costs Reliability of supply affected by drought.

Structural component of net income

The level of consumption and investment is greater than the level of

national savings. Since we have insufficient savings we rely on thesavings of others. we live beyond our means.

There is a savings and investment gap in the private sector as in 2007

national savings were 18% of GDP, while investment was 24%. To maintain our standard of living we need constant borrowing and

investment from overseas public and private sector debt This leads to a continual demand for foreign investment and foreign

debt borrowing from overseas Our low interest rates means that non-residants are encouraged to lend or invest in

Australia.

Multiplier effect, increased foreign debt investment and

productive capacity increase O, Y and E good standard of living(also leads to increased imports, which increases CAD)

Relationship between net foreign liabilities and the CAD

Accumulate foreign debt is financed by continual borrowing which

adds to the external debt.Foreign Debt

Repayment of interestIncrease in CAD

Increased net income deficit

Foreign Equity

Increased net income deficitIncrease in CAD

Repayment of Dividends


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Foreign debt/ equity interest/ derivatives are payed back and

increase in net income deficit increase in CAD Net Foreign liabilities = net foreign debt + net foreign equity.

Direct relationship (increase in net foreign liabilities increase inCAD

Issues Associated With a current Account Deficit

Not a problem Large problem

Australia is structurally a poor saver and isa commodity exporter and high valueadded importer. Thus a CAD is a fact oflife.Australia has strong economic growtheven with a CAD

Pitchford ThesisThe CAD doesnt matter if it is driven by

the private sector as it is between twoconsenting adults As long as they areusing the borrowed funds in incomegenerating areas e.g. aggregate supply thenthe private sector borrows in order to makea profitBudget surpluses have repaid our foreigndebtCredit ratings overseas lend to us as they

know we can pay it bac.

Our CAD is 7th highest in the worldWe are to reliant on commodity exportsand are hurt by protectionHas a low level of savingsCommodity exports means that we aretied to world frowth

Dependency - Were relying on thecontinual growth from China and onoverseas funds for growthWe require funds from overseas to repaydebt. Therefore, need to keep our interestrates high

The capital and financial account Records capital transactions which tend to be long term in nature such as

foreign aid, portfolio and direct investment Consists of

Capital Transfers

Official government capital, gold, government assets in foreign currency, net capitaltransfers of foreign aid and net capital brought into Australia by migrants

Financial account: Direct investment

Seek 10% ownership of a firm, purchase shares, merges, takeovers Financial Account: portfolio investment

Foreign debt (where our foreign savings come from - borrowings) Speculative investment in shares

Derivatives and other

TrendsIs always in surplus to finance the persistence current account deficit. Mainlyrepresents debt and equity borrowings by the private and public sectors In Australia tofinance investment

Summary Current Account Balance =


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Goods Balance + Net Services + Net Income + Current Transfers

Capital and Financial Account Balance = Capital Account Balance + Financial Account Balance

Balance of Payments = Current Account Balance + Capital and Financial Account Balance

Issues Associated with trends in the balance of payments

Terms of Trade Refers to the relative prices a country receives for its exports and pays

for its imports It is the ratio of export prices to import prices

Terms of trade index = Export Price Index x 100

Import Price index 1 A favourable movement in the terms of trade occurs when export

prices rise faster than import prices, meaning that a country canfinance a greater volume of imports with an existing volume ofexports.

Australias vulnerability: due to reliance on agricultural and mineral

exports for earning export income. Demand for commodities isinelastic. Therefore, a fall in price = a fall in revenue

Trends experienced improvements in its terms of trade between 2004

and 2008 due to rising commodity export prices.

Size of the current account balance as a percentage of Gross Domestic Product Measurement of the Cad as a % of GDP gives an accurate indication of

its relative size to national output over time

A CAD of 5% of GDP is desirable, anything over is considered to beunsustainable sine it constrains domestic economic growth. Since theeconomy cant grow faster without increasing imports, which increasesthe CAD.

A concern is the increase in the accumulation of external liabilities to

find the increase in the CAD. This increases servicing costs in terms ofinterest payments.

Foreign Debt and Foreign liabilities CAD is financed by a surplus in the capital and financial account

through debt and equity borrowings

Net foreign liabilities = Net equity + Net Debt The growth in net foreign debt increases the amount of debt to be

repaid in the future, plus the cost of servicing the debt in the form ofinterest payments.

International competitiveness Changes in international competiveness will affect the goods balance

and the current account Measure of Australias international competiveness

Real exchange rate Real unit labour costs

Structural Changes in the Australian economy


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Structural changes refer to changes in the economys structure of

production and technological progress. Linked to the allocation of resources between primary, secondary and

tertiary industries. Implications for the Balance of Payments as a more efficient allocation

of domestic resources and technology diversifies Australias exportbase and increases the competitiveness of exports.

Sustainability of Australias external imbalance

Interest, rent and dividend payments on net foreign liabilities as a percentageof exports needs to remain at about 9% to be sustainable

Exchange RatesExchange rates: the value of one currency in terms of another.Measurement of relative exchange rates:

Bilateral: measure the value of a unit of domestic currency relative to another

currency Trade Weighted Index:

measures movements in the Australian dollar against a basket of

currencies of Australian trading partners weighted according to theirimportance and proportion in Australian Trade.

Gives a more accurate measure of Currency movements and there

effects on Australias trade performance e.g. BOGS and CAD Chinese Remninibi is the currency with the highest weight

Trends sharp depreciation in 2008 due to GFC and market volatility,

fell from 63.4 to 54.6 between September and October. Resource boombetween 2000-2008 it appreciated.

Appreciation The value of the Australian dollar increases its purchasing power relative to

another currency Australian exports are more expensive and imports less expensive

Reduces international competitiveness

SD1DQ1Q0.7

0.9569lolololololololol$US/$A

Demand Shifts outwards D-D1 creating a new equilibrium at an inflated price

S1

SD

QQ1


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$US/$A

0.950.7

Figure 2: Supply Contracts S-S1 creating new inflated equilibriumDepreciation

The value of the Australian dollar falls in purchasing power relative to other

countries Leads to exports being less expensive and imports being more expensive

Increases international competitiveness

Demand shifts inwards D-D1 creating a new equilibrium at deflated price

Supply Shifts outwards S-S1 creating new deflated equilibrium

Factors affecting the demand for $A Foreigners purchasing exports goods and services, imports in overseas

countries Foreigners wishing to pay income (interest, rent, dividends) to Australian

residents Foreigners transferring unrequited payments to Australia (e.g. English

pensions) Foreigners investing in Australia

Tourists to Australia

Factors affecting the Supply of $A Australians buying imports of goods and services

Australian paying income to non-residents

Australians making transfer payments to non-residents 9e.g. foreign aid)

Australians investing In other countries

Australian tourists overseas.

Reasons for recent movements in the $A

Appreciation Trend 2007-2008

Depreciation Trend 2008 mid 2009

Appreciation End 2009 -

Commodity based currency positive terms of tradeHeavily speculated uponTaxation reformsFinancial stability

Global downturnT of Trade fellMore conservativementalityFlight from Asia toAustralia

Massive global publicsector stimulusChina corrected its GDPgrowth rateChina and India =increased demand forcommoditiesInterest rate differential

Current Account influences on the demand for Australian exports and imports

include:

Interest rate differentials


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Affect the relative prices of competitiveness of exports and imports

A rise in the relative inflation differential will reduce Australias

export competitiveness and the demand for its exports This causes the exchange rate to depreciate

Terms of Trade Important for commodity currencies like Australias

Falls in the terms of trade results in a decline in export earnings and

decreased demand for the Australian dollar This causes the exchange rate to depreciate

Comparative economic growth Lower rates of world economic growth leads to decreased demand for Australia

exports and $A Stronger Australian economic growth leads to an increase in demand for imports and

an increase in the supply of $A This causes the exchange rte to depreciate

Capital and financial account influences on the demand for Australian and

foreign assets include:

Interest rate differentials A fall in Australian interest rates relative to those overseas may decrease the interest

rate differential causing decreased capital inflow This decreased demand for the Australian dollar may cause it to depreciate

Speculation Exchange rate expectations about the future value of the exchange rate can influence

the demand and supply of Australian dollars If foreign speculators expect the Australian dollar to appreciate in the future, they

may buy $A and sell foreign exchange. Increase demand for $A causes and appreciation

Under a floated exchange the current account balance = capital and financial

account.

Types of Exchange rates

Floated Exchange Rates The exchange rate is determined solely by demand and supply. There

is no government intervention. Advantages

Reflects Australian economy Discourages destabilising speculation Government can pursue effective monetary policy as balance of payment surpluses/

deficits would not impact monetary supply Disadvantages

Volatility may cause uncertainty Subject to sudden shifts

Managed Exchange Rates Some RBA invention

Keeps the exchange within a target band

Fixed Exchange Rate


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Central Bank buys/ sells currency to maintain a predetermined value

against another currency or gold Advantages

Certainty about immediate short term exchange value. Assists importers and exporters Disadvantages

Speculation increases Requires large foreign exchange reserves Balance of payments influences domestic inflation rates. E.g. current account surplus

raises money supply causing inflation

RBA influence on exchange rates

Indirect effect monetary policy seeks to create a low inflationary economy with consistent

economic growth rates

Foreign investors see this as an attraction and move their money into $A appreciation

Statements on monetary policy changes expectations of market participantsby increasing the information available

Direct effect Enter the Foreign exchange market to dirty the float. This involves the

buying and selling of $A to send a signal to the market Buying $A

Takes AUD out of financial system and sterilises by buying government securities.This means no change to money supply and interest rates.

Selling $A

Increases the supply of $A, sterilises this by selling government securities so as not to

affect interest rates Symbolic gesture have insufficient finds and resource of currency to

influence in the long termEffect of Exchange Rate fluctuations

J-curve theory Short Term

A country with existing Cad that has a currency depreciation will

experience a worsening of its trade balance in the short term Due to low price elasticity of demand for imports and exports in the

immediate aftermath of an exchange rate change Hence export revenue falls and import prices rise

Long term The depreciation improves international competitiveness as demand

for exports picks up and domestic consumers switch their spendingaway from imported goods and services

This reduces the size of its trade deficit and its CAD


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Effects of Depreciation

Inflation Cost push inflation

Price inelastic demand for intermediary and finished goods Aggregate supply reduces owing to raised input costs New equilibrium recorded at a higher price

Potential wage-price spiral. Then the cost of production in Australia

will accelerate, eroding any short term improvement of internationalcompetitiveness

Inflation also increases the uncertainty about future returns, and hence

may cause entrepreneurs to lost confidence and reduce investment

Current Account Deficit BOGS

Immediate depreciation with long term gains (J-curve) External Debt

Depreciation increase external debt, as 62% of overseas borrowings are denominatedin foreign currencies

Increase in both the repayment of principal, and also the debt servicing ratio Higher interest payments are likely to lead to a higher net income deficit, and increase

the size of the CAD

Economic Growth and Unemployment Economic growth

The increased profitability of exports would tend to encourage production, raising thequantities of factors of production required, and stimulating a further increase innational income, savings, investment and aggregate demand

Structural adjustment through pressures Depreciation in mid 1980s, assisted growth of

manufacturing and service exports, raising dynamic andallocative efficiency, exports rose 25% (1987-1993)

Unemployment

Derived demand from growth with potential structural change

Environmental Sustainability Derived from growth and resource use

Australias free trade and protection policies

Unilateral policy agreements The active decision to reduce protection on Australian industry Australia has a long history of protection in the manufacturing sector where

tariffs and quotas have been used to shield firms from direct importcompetition

Whitlam Government 1973: Whitlam introduced 25% across the board protection cuts


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1980s: Raised protection as passenger motor vehicles, steel, textiles,

clothing and footwear (65%) subject to intensified competition This led to low levels of efficiency, exports and innovation

Hawke Government 1988 Industry Statement

Dismantled industry protection on a large scale Protection of manufacturing reduced from 15% in 89 to 10% in 94

1991 Industry Statement

Majority of tariffs to 5% by 1996 Abolition of quotas and a reduction in tariffs for PMV to 15% by 2000 TCF maximum tariffs of 25% by 2000

Howard Governments Most tariffs averaged 5%

Bilateral Policy Australia has actively sought to reduce protection on Australian industry

ANZCERTA

USA and Thailand

However not complete e.g. US and agriculture

Multilateral policy WTO Cairns Group

19 agricultural countries

Aim to abolish export subsidies and domestic, trade distorting support

Enhanced free trade (Doha) but limited recent success

Implications of Australian Protectionist policies Nominal Rate of protection

The apparent tariff rate Effective Rate of protection

The nominal rate of protection plus any other levels of protection that

change the final effect of protection e.g. protection can occur on rawmaterials and parts

Passenger motor vehicle industry Tariffs reduced from 40% to 10% from 1990-2005

Niche marketing in larger passenger vehicles

Per employee increases 12-18 from 1990-2005

Exports increased from 10-30% of production from 1990-2005

Faults per vehicle reduced 50%

$A 224 million - $A 372 million profit between 1990 and 2005

Long Run Benefits Competition

Reduction in protection eposes previously protected industries and firms to moreimport competition. This reduces prices and dampens inflation. Lower input costs forefficient industry

Productivity

Forced productivity gains through competition Resource allocation

Releases resources previously locked into inefficient an less competitive industriesand firms become more efficient, productive and growing industries. This process of


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structural change enhances economys productive capacity and increases employmentin the tradable goods sector of the economy

Income redistribution

Redistribute income away from the government an d inefficient industries toconsumers and export firms in the form of lower prices, taxes and costs

Government social responsibilities as $50m education and retraining for MitsubishiAdelaide

Value of reduced protection The productivity commission estimate a permanent gain in Australias

GDP o $4b Export volumes were estimated to rise by 8.6$ Employment growth was estimated to increase by 0.1% CPI to fall by 3.8%

Short Term Costs Structural unemployment

Uncompetitive industries contract and unviable firms go out of business Lower employment levels have occurred in TCF and PMV industries Structural adjustment also leads firms to substitute more capital for less labour to

achieve higher productivity Specific job training programs such as Jobtrain, Skillshare, Jobskiss and Jobstart were

developed by the federal government and targeted at the long term and structurallyunemployed.

Regional Adjustment

Cities dependent upon manufacturing industries i.e. Geelong, Newcastle and PortKembla have high levels of structural unemployment because of structural change

Unemployed workers find it difficult occupationally and geographically to find jobsin growing sectors of the economy such as services, because they lack the skillsdemanded or the willingness to relocate

Import Spending

Will rise, worsening CAD and foreign debt This has happened in the past because of Australias lack of competitiveness and the

reliance on primary export income

Implications of International Policy GATT saw tariff reforms from 40% to 5% between 1947 and 1985

The absence of GATT codes for trade in agricultural commodities left

Australian in a vulnerable position because US wheat subsidiesthrough the Export Enhancement Programme (EEP) and EU wheatsubsidies through the common Agricultural policy (CAP) deniedmarket access for Australian wheat and depressed world wheat prices,cutting export returns to Australian farmers

Non-tariff reforms of protection such as voluntary export restraints

impeded the growth of world trade and penalised efficient commodityproducers like Australia in favour of less efficient producers in NorthAmerica n Europe

WTO Uruguay rounds International Outcomes

36% reduction in agricultural subsidies


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Manufactured goods tariffs cut by 15% Outcomes for Australia

Scaling down of Agricultural subsidies in the EU and USA Governments subsidising agriculture were forced to adhere to WTO rules on

agriculture

Increased market access for trade services was a boost for Australias service exports

annie unsworth - economics topic 2.docx[1]

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