Australia and the world economy - John Wiley & … capital ˜ows entail the movement of money...

c03AustraliaAndTheWorldEconomy 146 29 August 2016 1:07 PM

Australia and the world economy

TOPIC 3

There has been a spectacular growth in global trade, from around 2 per cent of the world’s GDP in AD 1500 to around 60 per cent by 2016. Each year international trade in goods alone generates over $40 trillion (US) worth of production globally. This creates jobs, generates incomes, provides access to cheaper goods and improves material living standards for billions of people. However, a downside of this may be accelerated environmental damage and climate change.

Every day, Australians conduct international transactions with people from other countries through trade and capital �ows. International trade involves exporting (selling) and importing (buying) goods and services, while international capital �ows entail the movement of money capital or investments between countries.

Figure 3.1 (part a) shows Australia’s top 10 countries with which we trade, ranked by the total annual value of exports plus imports of goods and services. These include China, Japan, United States, South Korea, Sin-gapore, New Zealand, United Kingdom, Malaysia, Thailand and Germany. The �gure also shows the type or composition of Australia’s exports (part b) and imports (part c) of goods and services, ranked by value and in percentage terms.

ChinaJapanUnited StatesRepublic of KoreaSingaporeNew ZealandUnited KingdomMalaysiaThailandGermany

(a) Australia’s top 10 countries for two-way trade in goods and servicesUNCORRECTED

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UNCORRECTED There has been a spectacular growth in global trade, from around 2 per cent of the world’s GDP in AD 1500 to around

UNCORRECTED There has been a spectacular growth in global trade, from around 2 per cent of the world’s GDP in AD 1500 to around 60 per cent by 2016. Each year international trade in goods alone generates over $40 trillion (US) worth of production

UNCORRECTED 60 per cent by 2016. Each year international trade in goods alone generates over $40 trillion (US) worth of production globally. This creates jobs, generates incomes, provides access to cheaper goods and improves material living standards

UNCORRECTED globally. This creates jobs, generates incomes, provides access to cheaper goods and improves material living standards for billions of people. However, a downside of this may be accelerated environmental damage and climate change.

UNCORRECTED for billions of people. However, a downside of this may be accelerated environmental damage and climate change.

Every day, Australians conduct

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Every day, Australians conduct international transactions

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international transactionscapital �ows. International

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capital �ows. International trade

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trade capital �ows

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capital �ows entail the movement of money capital or investments between countries.

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entail the movement of money capital or investments between countries.Figure 3.1 (part a) shows Australia’s top 10 countries with which we trade, ranked by the total annual value

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Figure 3.1 (part a) shows Australia’s top 10 countries with which we trade, ranked by the total annual value

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of exports plus imports of goods and services. These include China, Japan, United States, South Korea, Sin

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of exports plus imports of goods and services. These include China, Japan, United States, South Korea, Singapore, New Zealand, United Kingdom, Malaysia, Thailand and Germany. The �gure also shows the type or

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gapore, New Zealand, United Kingdom, Malaysia, Thailand and Germany. The �gure also shows the type or composition of Australia’s exports (part b) and imports (part c) of goods and services, ranked by value and in

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composition of Australia’s exports (part b) and imports (part c) of goods and services, ranked by value and in percentage terms.

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percentage terms.

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TOPIC 3 Australia and the world economy 147


AUSTRALIA’S TOP 10 GOODS & SERVICES EXPORTS (a)

(A$ million)

Rank Commodity Value % share

Total (b) 326 862

1 Iron ores & concentrates 66 008 20.2

2 Coal 37 999 11.6

3 Natural gas 17 743 5.4

4 Education-related travel services (c) 17 037 5.2

5 Personal travel (excl education) services 14 227 4.4

6 Gold 13 460 4.1

7 Crude petroleum 10 564 3.2

8 Beef, f.c.f. 7 751 2.4

9 Aluminium ores & conc (incl alumina) 6 336 1.9

10

(a) Goods trade are on a recorded trade basis, Services trade are on a balance of payments basis.(b) Total is balance of payments basis.(c) Includes international student expenditure on tuition fees and living expenses. Based on ABS trade data on DFAT STARSdatabase and ABS catalogue 5368.0.

Wheat 5 920 1.8

Exports Imports

(b) The composition of Australia’s exports

AUSTRALIA’S TOP 10 GOODS & SERVICES IMPORTS (a)

(A$ million)

Rank Commodity Value % share

Total (b) 336 957

1 Personal travel (excl education) services 24 597 7.3

2 Crude petroleum 20 050 6.0

3 Re�ned petroleum 18 579 5.5

4 Passenger motor vehicles 17 566 5.2

5 Telecom equipment & parts 9 845 2.9

6 Freight transport services 9 686 2.9

7 Medicaments (incl veterinary) 7 497 2.2

8 Computers 7 316 2.2

9 Passenger transport services (c) 6 141 1.8

10

(a) Goods trade are on a recorded trade basis, Services trade are on a balance of payments basis.(b) Total is balance of payments basis.(c) Includes Related agency fees & commissions. Based on ABS trade data on DFAT STARS database and ABS catalogue5368.0.

Goods vehicles 6 008 1.8

Exports Imports

(c) The composition of Australia’s imports

FIGURE 3.1 Australia’s top 10 two-way trading partners, and the composition of our exports and imports

Source: Graphs copied directly from DFAT, Australia’s Trade at a Glance 2015.

Note: Data is for 2014.

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Rank Commodity

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Rank Commodity

Total (b)

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Total (b)

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1 Personal travel (excl education) services

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1 Personal travel (excl education) services

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2 Crude petroleum

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2 Crude petroleum

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3 Re�ned petroleum

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3 Re�ned petroleum

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4 Passenger motor vehicles

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4 Passenger motor vehicles

5 Telecom equipment & partsUNCORRECTED

5 Telecom equipment & parts

Exports

UNCORRECTED Exports

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PAGE 6 336

PAGE 6 336

PAGE (a) Goods trade are on a recorded trade basis, Services trade are on a balance of payments basis.

PAGE (a) Goods trade are on a recorded trade basis, Services trade are on a balance of payments basis.(a) Goods trade are on a recorded trade basis, Services trade are on a balance of payments basis.



PAGE (a) Goods trade are on a recorded trade basis, Services trade are on a balance of payments basis.

(c) Includes international student expenditure on tuition fees and living expenses. Based on ABS trade data on DFAT STARS

PAGE (c) Includes international student expenditure on tuition fees and living expenses. Based on ABS trade data on DFAT STARS

5 920

PAGE 5 920

PAGE (c) The composition of Australia’s importsPAGE (c) The composition of Australia’s imports

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PROOFS5.2

PROOFS5.2

PROOFS4.4

PROOFS4.4

PROOFS4.1

PROOFS4.1

PROOFS3.2

PROOFS3.2

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7 751 PROOFS

7 751 PROOFS

148 Economics Down Under 2


3.1 The relationship between trade and living standardsInternational trade occurs because it is bene�cial to nations. It helps them to improve ef�ciency and living standards. Throughout history, there are many examples of how trade has strengthened empires, grown national production and incomes, created jobs, enriched cultures, increased knowledge and raised living standards. By contrast, closed nations that restricted trade ultimately lost their prominence and power.

In order to increase the volume of international trade and raise living standards, governments over the last few decades have adopted the policy of trade liberalisation or freer trade. This has involved reducing the level of trade protection by: • cutting the level of tariffs and thereby making foreign goods cheaper • reducing government cash subsidies paid to local �rms and so allowing imports to compete on the same

basis as locally manufactured products • abolishing import quotas that restrict the volume of foreign goods entering the country • signing up to more bilateral (usually between two nations) and multilateral (between many nations) free

trade agreements (FTAs) with other countries.As a result of trade liberalisation, openness, and a greater recognition of the bene�ts of international trade,

world trade (the total value of exports plus imports of goods and services) as a percentage of GDP grew by 42 per cent over a recent 15-year period. In this section of the course, we examine some of the general bene�ts and costs of this growth in world trade, and its relationships with • material living standards (such as per capita incomes, purchasing power and consumption) • non-material living standards (such as world peace, cultural enrichment and environmental issues).

Trade can encourage international specialisationBecause countries have different combinations of natural, labour and capital resources, they are more ef�-cient at producing some types of goods or services than others. This is re�ected in their level of costs and prices. Especially in recent decades, with reduced government protection of local industry from imports and the growth of freer trade in recent decades, there has been an increase in international specialisation. Here, countries will produce only a limited range of goods and services, focusing on those areas where they have the greatest cost advantage over their international rivals. These goods and services can then be exported, and the income gained used to pay for imports that are too expensive to produce locally. By putting its resources to work in their most productive or ef�cient use, a nation can generate more output (GDP) from the same inputs (resources), and in so doing raise its income and material living standards.

Just by looking at the origin of the goods and services consumed, we can see that many countries specialise in production. For instance, you might wear a watch made in Switzerland, eat lamb grown in Australia, be entertained with movies from the United States or India, drink coffee from Brazil, holiday in Indonesia, wear shoes made in the Philippines and T-shirts sourced from Bangladesh, drive cars made in Germany or South Korea, and use a mobile phone manufactured in China.

Specialisation in production internationally can be based on two types of advantage: absolute cost advantage and comparative cost advantage. • Absolute cost advantage. An absolute cost advantage occurs if a nation is the cheapest or most ef�cient pro-

ducer of a single good or service in the world. For example, if Korea is the cheapest or most ef�cient producer of cars, it is said to have an absolute cost advantage over other countries. It is likely that its car exports will sell very well indeed. Similarly, if Australia is the cheapest producer of iron ore and has an absolute cost advantage, Korean and other manufacturers would be keen to buy from us. Clearly, both countries would bene�t from inter-national trade since each has an absolute cost advantage in different areas of production. However, as we shall see, international trade is still bene�cial even if a country has no absolute cost advantage.

• Comparative cost advantage. A nation has a comparative cost advantage if it specialises in a few key areas of production where its cost advantages are greatest or its disadvantages are lowest. This means that oppor-tunity costs (the value of production forgone or given up, which was illustrated in section 1.3 using a pro-duction possibility diagram) would be minimised and output maximised. Here, resources would be allocated most ef�ciently, and hence production, incomes and material living standards should be most favourable.The famous English economist David Ricardo (1772–1823) outlined the principle of comparative cost

advantage and supported the idea of free trade. He claimed that specialisation in international trade in areas of comparative cost advantage made countries better off economically, generating bene�ts for all. This idea probably makes good sense since, in many ways, nations are like individuals who have greater talent or ef�-ciency in some areas than in others. Logically, we too should specialise in the few things we do best of all and give up other pursuits! To illustrate this concept, Ricardo used the example of two countries, England and Portugal. Each could produce two products, cloth and wine, with the resources available. Table 3.1 summarises the comparative cost advantage of each country producing these products, measured in terms of the number of man-hours that must be worked per unit of output produced.

UNCORRECTED over their international rivals. These goods and services can then be exported, and the

UNCORRECTED over their international rivals. These goods and services can then be exported, and the income gained used to pay for imports that are too expensive to produce locally. By putting its resources to

UNCORRECTED income gained used to pay for imports that are too expensive to produce locally. By putting its resources to work in their most productive or ef�cient use, a nation can generate more output (GDP) from the same inputs

UNCORRECTED work in their most productive or ef�cient use, a nation can generate more output (GDP) from the same inputs (resources), and in so doing raise its income and material living standards.

UNCORRECTED (resources), and in so doing raise its income and material living standards.

Just by looking at the origin of the goods and services consumed, we can see that many countries specialise

UNCORRECTED Just by looking at the origin of the goods and services consumed, we can see that many countries specialise

in production. For instance, you might wear a watch made in Switzerland, eat lamb grown in Australia, be

UNCORRECTED in production. For instance, you might wear a watch made in Switzerland, eat lamb grown in Australia, be entertained with movies from the United States or India, drink coffee from Brazil, holiday in Indonesia, wear

UNCORRECTED entertained with movies from the United States or India, drink coffee from Brazil, holiday in Indonesia, wear shoes made in the Philippines and T-shirts sourced from Bangladesh, drive cars made in Germany or South

UNCORRECTED

shoes made in the Philippines and T-shirts sourced from Bangladesh, drive cars made in Germany or South Korea, and use a mobile phone manufactured in China.

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Korea, and use a mobile phone manufactured in China.Specialisation in production internationally can be based on

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Specialisation in production internationally can be based on and comparative cost advantage.

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and comparative cost advantage.Absolute cost adv

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Absolute cost advantage

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antageducer of a single good or service in the world. For example, if Korea is the cheapest or most ef�cient producer

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ducer of a single good or service in the world. For example, if Korea is the cheapest or most ef�cient producer of cars, it is said to have an absolute cost advantage over other countries. It is likely that its car exports will sell

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of cars, it is said to have an absolute cost advantage over other countries. It is likely that its car exports will sell very well indeed. Similarly, if Australia is the cheapest producer of iron ore and has an absolute cost advantage,

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very well indeed. Similarly, if Australia is the cheapest producer of iron ore and has an absolute cost advantage, Korean and other manufacturers would be keen to buy from us. Clearly, both countries would bene�t from inter

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Korean and other manufacturers would be keen to buy from us. Clearly, both countries would bene�t from international trade since each has an absolute cost advantage

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national trade since each has an absolute cost advantagesee, international trade is still bene�cial even if a country has no absolute cost advantage.

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see, international trade is still bene�cial even if a country has no absolute cost advantage.•UNCORRECTED

• ComparatiUNCORRECTED

Comparatiof production where its cost advantages are greatest or its disadvantages are lowest. This means that opporUNCORRECTED

of production where its cost advantages are greatest or its disadvantages are lowest. This means that oppor

PAGE Trade can encourage international specialisation

PAGE Trade can encourage international specialisationBecause countries have different combinations of natural, labour and capital resources, they are more ef�

PAGE Because countries have different combinations of natural, labour and capital resources, they are more ef�cient at producing some types of goods or services than others. This is re�ected in their level of costs and

PAGE cient at producing some types of goods or services than others. This is re�ected in their level of costs and prices. Especially in recent decades, with reduced government protection of local industry from imports and

PAGE prices. Especially in recent decades, with reduced government protection of local industry from imports and the growth of freer trade in recent decades, there has been an increase in

PAGE the growth of freer trade in recent decades, there has been an increase in countries will produce only a limited range of goods and services, focusing on those areas where they have the PAGE countries will produce only a limited range of goods and services, focusing on those areas where they have the

over their international rivals. These goods and services can then be exported, and the PAGE

over their international rivals. These goods and services can then be exported, and the income gained used to pay for imports that are too expensive to produce locally. By putting its resources to PAGE

income gained used to pay for imports that are too expensive to produce locally. By putting its resources to

PROOFSo nations) and multilateral (between many nations)

PROOFSo nations) and multilateral (between many nations)

As a result of trade liberalisation, openness, and a greater recognition of the bene�ts of international trade,

PROOFSAs a result of trade liberalisation, openness, and a greater recognition of the bene�ts of international trade,

world trade (the total value of exports plus imports of goods and services) as a percentage of GDP grew by

PROOFSworld trade (the total value of exports plus imports of goods and services) as a percentage of GDP grew by 42 per cent over a recent 15-year period. In this section of the course, we examine some of the general bene�ts

PROOFS42 per cent over a recent 15-year period. In this section of the course, we examine some of the general bene�ts

living standards (such as per capita incomes, purchasing power and consumption)

PROOFSliving standards (such as per capita incomes, purchasing power and consumption)

living standards (such as world peace, cultural enrichment and environmental issues).PROOFS

living standards (such as world peace, cultural enrichment and environmental issues).

Trade can encourage international specialisationPROOFS

Trade can encourage international specialisation



TABLE 3.1Ricardo’s example of comparative cost advantage: the number of man-hours that must be worked per unit of output produced in England and Portugal

Country Cloth (hours per unit produced) Wine (hours per unit produced)

Portugal 90 80

England 100 120

In this case, it can be seen that Portugal has lower expenses or an absolute cost advantage in producing both these products. The cost of producing cloth in Portugal is 90 per cent (90/100) of the cost of making it in Britain. By contrast, the cost of producing wine in Portugal is very much lower at only 66.6 per cent (80/120 or 2/3) of the cost in Britain. Some might conclude from this that Britain could not export to Portugal since it is uncompetitive (and to survive, its industries would need government protection). From Portugal’s point of view, it seems that it would not pay to import from England.

However, let’s re-examine the situation. Logically, both countries can bene�t from trade provided that each specialises in its area of relative or comparative cost advantage. What this means is that relatively, Portugal is an even more ef�cient producer of wine than it is of cloth. Because it has a greater comparative advantage in producing wine, it should specialise in wine rather than in cloth if it wants to maximise output and living standards. By contrast, England has a comparative advantage in cloth (where its disadvantage is least) and should allocate its resources accordingly to minimise its opportunity cost and maximise ef�ciency, produc-tion and incomes. Despite the simplistic assumptions in this example (such as the absence of transport costs involved in trade), Ricardo powerfully argues that free trade and specialisation in areas of comparative cost advantage would be bene�cial, increasing the total volume of world output, incomes and living standards.

Trade promotes economies of large-scale productionEconomies of large-scale production are reductions in a �rm’s average �xed costs per unit associated with an increase in its production levels. Fixed costs like equipment, product design, research, advertising and (up to a point) management can be spread more thinly when there are larger production runs. What international trade can do is encourage specialisation and help businesses grow their sales volumes by allowing them to produce on a much larger scale — for a potential global market of up to 7.4 billion people instead of only the local market. In turn this would lower �xed costs, strengthen competitiveness, grow incomes and boost mat-erial living standards.

The spreading of a �rm’s �xed costs over higher annual levels of output to gain economies of large-scale production is illustrated hypothetically in �gure 3.2. Notice that as a �rm’s annual level of production rises from 1000 to 5000 units per year (perhaps enabled by growing its global exports), the average �xed costs of making each unit fall from $3 to just $1. Clearly, trade can boost production and ef�ciency, lower prices, strengthen competitiveness and sales, and thereby improve real incomes and material living standards.

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A firm’s annual level of production/sales (’000)

High perunit cost

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Maximum economies of large scaleFew economies of scale

Fixedcostcurve

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B

Notice that the per unit cost of each extra unit of production by this �rm falls from $3.00 (at point A) to only $1.00 (at point B) as the company raises its annual production and sales from 1000 units to 5000 units. At higher levels of output, �xed costs can be spread more thinly. Exporting can help local �rms justify higher output levels and can enable them to move from point A to point B on the �xed cost curve. This helps increase pro�ts and competitiveness.

FIGURE 3.2 International trade can increase economies of large-scale production for businesses by reducing their �xed costs of production per unit of output.

UNCORRECTED local market. In turn this would lower �xed costs, strengthen competitiveness, grow incomes and boost mat

UNCORRECTED local market. In turn this would lower �xed costs, strengthen competitiveness, grow incomes and boost mat

UNCORRECTED The spreading of a �rm’s �xed costs over higher annual levels of output to gain economies of large-scale

UNCORRECTED The spreading of a �rm’s �xed costs over higher annual levels of output to gain economies of large-scale

production is illustrated hypothetically in �gure 3.2. Notice that as a �rm’s annual level of production rises

UNCORRECTED production is illustrated hypothetically in �gure 3.2. Notice that as a �rm’s annual level of production rises from 1000 to 5000 units per year (perhaps enabled by growing its global exports), the average �xed costs

UNCORRECTED from 1000 to 5000 units per year (perhaps enabled by growing its global exports), the average �xed costs of making each unit fall from $3 to just $1. Clearly, trade can boost production and ef�ciency, lower prices,

UNCORRECTED of making each unit fall from $3 to just $1. Clearly, trade can boost production and ef�ciency, lower prices, strengthen competitiveness and sales, and thereby improve real incomes and material living standards.

UNCORRECTED strengthen competitiveness and sales, and thereby improve real incomes and material living standards.

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Ann

ual �x

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unit

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High perunit cost

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unit cost

PAGE Trade promotes economies of large-scale production

PAGE Trade promotes economies of large-scale productionare reductions in a �rm’s average �xed costs per unit associated with

PAGE are reductions in a �rm’s average �xed costs per unit associated with

an increase in its production levels. Fixed costs like equipment, product design, research, advertising and (up

PAGE an increase in its production levels. Fixed costs like equipment, product design, research, advertising and (up to a point) management can be spread more thinly when there are larger production runs. What international

PAGE to a point) management can be spread more thinly when there are larger production runs. What international trade can do is encourage specialisation and help businesses grow their sales volumes by allowing them to

PAGE trade can do is encourage specialisation and help businesses grow their sales volumes by allowing them to produce on a much larger scale — for a potential global market of up to 7.4 billion people instead of only the PAGE produce on a much larger scale — for a potential global market of up to 7.4 billion people instead of only the local market. In turn this would lower �xed costs, strengthen competitiveness, grow incomes and boost matPAGE

local market. In turn this would lower �xed costs, strengthen competitiveness, grow incomes and boost mat

PROOFSHowever, let’s re-examine the situation. Logically, both countries can bene�t from trade provided that each

PROOFSHowever, let’s re-examine the situation. Logically, both countries can bene�t from trade provided that each , Portugal

PROOFS, Portugal is an even more ef�cient producer of wine than it is of cloth. Because it has a greater comparative advantage

PROOFSis an even more ef�cient producer of wine than it is of cloth. Because it has a greater comparative advantage in producing wine, it should specialise in wine rather than in cloth if it wants to maximise output and living

PROOFSin producing wine, it should specialise in wine rather than in cloth if it wants to maximise output and living standards. By contrast, England has a comparative advantage in cloth (where its disadvantage is least) and

PROOFSstandards. By contrast, England has a comparative advantage in cloth (where its disadvantage is least) and should allocate its resources accordingly to minimise its opportunity cost and maximise ef�ciency, produc

PROOFSshould allocate its resources accordingly to minimise its opportunity cost and maximise ef�ciency, production and incomes. Despite the simplistic assumptions in this example (such as the absence of transport costs

PROOFStion and incomes. Despite the simplistic assumptions in this example (such as the absence of transport costs involved in trade), Ricardo powerfully argues that free trade and specialisation in areas of comparative cost

PROOFSinvolved in trade), Ricardo powerfully argues that free trade and specialisation in areas of comparative cost advantage would be bene�cial, increasing the total volume of world output, incomes and living standards.PROOFS

advantage would be bene�cial, increasing the total volume of world output, incomes and living standards.

Trade promotes economies of large-scale productionPROOFS

Trade promotes economies of large-scale production



Trade helps lower prices for consumersAs a general rule, the rapid growth of international trade (assisted by trade liberalisation or reduced protec-tion of local industry) has slowed in�ation rates. Certainly this has been the experience of most countries, including Australia. For example, studies (such as those by Melitz, Schwerhoff and Sy in 2003 and 2013) showed that when tariffs came down, they caused the volume of global trade (as judged by the total ratio of world exports and imports to international production) to increase from an average of 38 per cent of GDP in 1990 to 54 per cent recently while reducing the average annual in�ation rate for the same period from 26 per cent to just 4 per cent (based on over 120 countries). Indeed, freer and more open international trade has generated windfall gains for people around the world by increasing their purchasing power. Some of this data are shown in �gure 3.3.

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Average global rateof tariffs

Average global rateof in�ation

Average global rate of exportsand imports to world GDP

1990

4

54

2010*

*Note: Data for average global tariffs is for 2005 not 2010.

FIGURE 3.3 Relationships between the average global rate of trade to world GDP, average tariff rates and average global in�ation rates

Source: Data rounded and derived from EconoMonitor.com, How Globalization Helped Decreasing In�ation, 6 August 2013.

There are several reasons why the growth in global trade has generally been associated with lower in�ation: • Access to cheapest suppliers. Freer trade allows domestic households and �rms to purchase imported

goods (mobile phones, cars, appliances, clothes, machinery, steel, coal, meat) and services (education, health, travel, �nance, entertainment) from the cheapest suppliers around the world. This has been boosted by the explosion of online shopping and trading, and much cheaper and faster transportation.

• Increased local competition. Reducing industry protection around the world as a way of growing trade has dra-matically increased competition in local markets, thereby encouraging international specialisation in production and higher productivity. Without protection, resources must be allocated to their relatively most ef�cient use where the cost advantage is greatest and the opportunity cost is least. This should lead to lower in�ation.

• Reduced market power. The growth of trade has helped to reduce the degree of market power that exists in some domestic industries, because �rms face �ercer competition from imports. In their �ght for survival, businesses must now cut their costs, innovate, restructure production and use the latest technology (perhaps purchased more cheaply from overseas due to lower tariffs) in order to keep their prices down and quality up. In short, they are forced to become more internationally competitive.

• Increased wage competition. In domestic labour markets, the growth of trade through liberalisation and reduced protection has increased the level of competition from low-wage countries. This has helped to slow the growth of wage costs around the world, enabling �rms to sell their product more cheaply and competitively.

• Economies of large-scale production. The growth in trade allows competitive �rms to produce and sell on a bigger scale so that their �xed production costs per unit (including advertising, product design, tooling and equipment) can be spread more thinly and the product sold at a lower price both at home and abroad.Ultimately, what lower in�ation means is that the real purchasing power of average incomes is usually

higher (other things being equal). This enables per capita consumption to rise, thereby bolstering material living standards.

Trade boosts GDP and incomesEspecially in the longer-term, nations with open economies who have adopted the principles of trade liberal-isation (combined with certain other policy measures) are far more likely to have higher levels of ef�ciency, national output and hence per capita incomes than those with trade barriers. This can occur for the following reasons: • Greater ef�ciency. Countries will be forced to specialise in the production of commodities where they are

most ef�cient (or least inef�cient) and have a comparative cost advantage (where opportunity costs are

UNCORRECTED There are several reasons why the growth in global trade has generally been associated with

UNCORRECTED There are several reasons why the growth in global trade has generally been associated with Freer trade allows domestic households and �rms to purchase imported

UNCORRECTED Freer trade allows domestic households and �rms to purchase imported goods (mobile phones, cars, appliances, clothes, machinery, steel, coal, meat) and services (education,

UNCORRECTED goods (mobile phones, cars, appliances, clothes, machinery, steel, coal, meat) and services (education, health, travel, �nance, entertainment) from the cheapest suppliers around the world. This has been boosted

UNCORRECTED health, travel, �nance, entertainment) from the cheapest suppliers around the world. This has been boosted by the explosion of online shopping and trading, and much cheaper and faster transportation.

UNCORRECTED by the explosion of online shopping and trading, and much cheaper and faster transportation.

Reducing industry protection around the world as a way of growing trade has dra

UNCORRECTED Reducing industry protection around the world as a way of growing trade has dra

matically increased competition in local markets, thereby encouraging international specialisation in production

UNCORRECTED matically increased competition in local markets, thereby encouraging international specialisation in production

UNCORRECTED

and higher productivity. Without protection, resources must be allocated to their relatively most ef�cient use

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and higher productivity. Without protection, resources must be allocated to their relatively most ef�cient use where the cost advantage is greatest and the opportunity cost is least. This should lead to lower in�ation.

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where the cost advantage is greatest and the opportunity cost is least. This should lead to lower in�ation.et power.

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et power. The growth of trade has helped to reduce the degree of market power that exists

UNCORRECTED

The growth of trade has helped to reduce the degree of market power that exists in some domestic industries, because �rms face �ercer competition from imports. In their �ght for survival,

UNCORRECTED

in some domestic industries, because �rms face �ercer competition from imports. In their �ght for survival, businesses must now cut their costs, innovate, restructure production and use the latest technology (perhaps

UNCORRECTED

businesses must now cut their costs, innovate, restructure production and use the latest technology (perhaps purchased more cheaply from overseas due to lower tariffs) in order to keep their prices down and quality

UNCORRECTED

purchased more cheaply from overseas due to lower tariffs) in order to keep their prices down and quality up. In short, they are forced to become more internationally competitive.

UNCORRECTED

up. In short, they are forced to become more internationally competitive.Incr

UNCORRECTED

Increased wage competition.

UNCORRECTED

eased wage competition. reduced protection has increased the level of competition from low-wage countries. This has helped to slow the

UNCORRECTED

reduced protection has increased the level of competition from low-wage countries. This has helped to slow the growth of wage costs around the world, enabling �rms to sell their product more cheaply and competitively.

UNCORRECTED

growth of wage costs around the world, enabling �rms to sell their product more cheaply and competitively.•UNCORRECTED

• Economies of larUNCORRECTED

Economies of lara bigger scale so that their �xed production costs per unit (including advertising, product design, tooling UNCORRECTED

a bigger scale so that their �xed production costs per unit (including advertising, product design, tooling

PAGE

PAGE Relationships between the average global rate of trade to world GDP, average tariff rates and average

PAGE Relationships between the average global rate of trade to world GDP, average tariff rates and average

Data rounded and derived from EconoMonitor.com, How Globalization Helped Decreasing In�ation, 6 August 2013.PAGE Data rounded and derived from EconoMonitor.com, How Globalization Helped Decreasing In�ation, 6 August 2013.

There are several reasons why the growth in global trade has generally been associated with PAGE

There are several reasons why the growth in global trade has generally been associated with

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

Average global ratePROOFS

Average global rateof in�ationPROOFS

of in�ation

1990

PROOFS1990

PROOFS



relatively lowest). Greater ef�ciency in resource allocation grows their productive capacity and the size of their production possibility frontier, causing real incomes, consumption and living standards to be higher.

• Economies of scale. Nations will gain cost reductions or economies of large-scale production in design, production, marketing, �nance and transport. This advances ef�ciency, pro�tability and the expansion of businesses, leading to higher output, incomes, consumption and material living standards.

• Innovation. Because of stiffer global competition promoted through freer trade, �rms are more likely to innovate and use new technology to lower their costs and grow technical ef�ciency, again boosting the nation’s productive capacity, real GDP, incomes and material living standards.

• Imports of capital. Through imports of machinery, resources, technology and know-how, trade facilitates the growth of a nation’s productive capacity, GDP, real incomes and material living standards.

Trade can create jobsOverall, it seems that increased international trade creates jobs and lowers unemployment, especially in the long term. This is because trade increases ef�ciency in resource allocation, lowers production costs, strengthens business pro�tability and expansion, and boosts economic growth. This should create more jobs, reduce unem-ployment, lift average incomes and improve both material and non-material living standards. In Australia’s case, around one in four jobs are now generated from our exports alone.

However, especially in the short term, it is possible that the growth in trade (facilitated by trade liberalisa-tion measures) might cause a rise in structural unemployment as uncompetitive �rms close down, relocate to low-wage countries or restructure their production by substituting machines for workers. When this occurs, living standards could fall temporarily.

Trade enables access to more resourcesNations have different endowments of natural, labour and capital resources, causing them to specialise in producing particular types of goods and services. Some countries (including Australia) have vast natural resources that allow them to competitively produce more food and minerals than are needed locally. They can export the rest and use the income gained to purchase needed imports. For instance, nations like China, India and Indonesia have plenty of cheap labour available for supporting manufacturing industries, while others (including Japan and Singapore) have good access to inexpensive �nance that makes their purchase of capital equipment more affordable. It is through trade or exchange that a country can access the resources, goods and services that it lacks or cannot produce itself at the lowest possible price.

What international trade does is to grow the quantity and quality of resources available to local businesses, allowing them to boost their production. Similarly, by growing businesses, jobs, incomes and pro�ts, trade allows governments to access and pay for the various types of resources it needs to produce public goods and infrastructure like transport, education, health and defence, thus improving our living standards.

Trade means greater consumer choiceInternational trade has created a shopper’s paradise that should increase the extent to which wants can be sat-is�ed. Consumers now have an exciting smorgasbord of offerings from which to choose when buying clothes, cars, cosmetics, computers, holidays or foods. The range of goods and services is so wide that it would be impossible for any single country’s producers to cater ef�ciently for all tastes. Having freer access to imports solves this problem and helps to raise living standards.

Trade can promote peaceTrade brings people from different countries together and creates dialogue, understanding and cooperation. In addition, it encourages nations to have cordial relationships with each other to promote exports and to maintain the supply of needed imports. Some studies have shown that when there are economic opportuni-ties to improve incomes and living standards, civil war and con�ict are less likely. This especially improves non-material living standards.

Trade enriches the cultureTrade creates a great diversity of goods and services that enriches the culture of nations and leads to more vibrant and interesting societies. This supports non-material living standards.

Trade has mixed effects on income distributionAround the world it has been observed that although real incomes have generally increased, there has been a rise in income inequality coinciding with the accelerated growth in international trade. This has provoked academic debate about whether trade is responsible for this.

UNCORRECTED equipment more affordable. It is through trade or exchange that a country can access the resources, goods and

UNCORRECTED equipment more affordable. It is through trade or exchange that a country can access the resources, goods and services that it lacks or cannot produce itself at the lowest possible price.

UNCORRECTED services that it lacks or cannot produce itself at the lowest possible price.

UNCORRECTED What international trade does is to grow the quantity and quality of resources available to local businesses,

UNCORRECTED What international trade does is to grow the quantity and quality of resources available to local businesses,

allowing them to boost their production. Similarly, by growing businesses, jobs, incomes and pro�ts, trade

UNCORRECTED allowing them to boost their production. Similarly, by growing businesses, jobs, incomes and pro�ts, trade allows governments to access and pay for the various types of resources it needs to produce public goods and

UNCORRECTED allows governments to access and pay for the various types of resources it needs to produce public goods and infrastructure like transport, education, health and defence, thus improving our living standards.

UNCORRECTED infrastructure like transport, education, health and defence, thus improving our living standards.

Trade means greater consumer choice

UNCORRECTED

Trade means greater consumer choiceInternational trade has created a shopper’s paradise that should increase the extent to which wants can be sat

UNCORRECTED

International trade has created a shopper’s paradise that should increase the extent to which wants can be satis�ed. Consumers now have an exciting smorgasbord of offerings from which to choose when buying clothes,

UNCORRECTED

is�ed. Consumers now have an exciting smorgasbord of offerings from which to choose when buying clothes, cars, cosmetics, computers, holidays or foods. The range of goods and services is so wide that it would be

UNCORRECTED

cars, cosmetics, computers, holidays or foods. The range of goods and services is so wide that it would be

UNCORRECTED

impossible for any single country’s producers to cater ef�ciently for all tastes. Having freer access to imports

UNCORRECTED

impossible for any single country’s producers to cater ef�ciently for all tastes. Having freer access to imports solves this problem and helps to raise living standards.

UNCORRECTED

solves this problem and helps to raise living standards.

Trade can promote peace

UNCORRECTED

Trade can promote peaceTrade brings people from different countries together and creates dialogue, understanding and cooperation.

UNCORRECTED

Trade brings people from different countries together and creates dialogue, understanding and cooperation.

UNCORRECTED

In addition, it encourages nations to have cordial relationships with each other to promote exports and to UNCORRECTED

In addition, it encourages nations to have cordial relationships with each other to promote exports and to maintain the supply of needed imports. Some studies have shown that when there are economic opportuniUNCORRECTED

maintain the supply of needed imports. Some studies have shown that when there are economic opportunities to improve incomes and living standards, civil war and con�ict are less likely. This especially improves UNCORRECTED

ties to improve incomes and living standards, civil war and con�ict are less likely. This especially improves

PAGE Nations have different endowments of natural, labour and capital resources, causing them to specialise in

PAGE Nations have different endowments of natural, labour and capital resources, causing them to specialise in producing particular types of goods and services. Some countries (including Australia) have vast natural

PAGE producing particular types of goods and services. Some countries (including Australia) have vast natural resources that allow them to competitively produce more food and minerals than are needed locally. They can

PAGE resources that allow them to competitively produce more food and minerals than are needed locally. They can export the rest and use the income gained to purchase needed imports. For instance, nations like China, India

PAGE export the rest and use the income gained to purchase needed imports. For instance, nations like China, India and Indonesia have plenty of cheap labour available for supporting manufacturing industries, while others

PAGE and Indonesia have plenty of cheap labour available for supporting manufacturing industries, while others (including Japan and Singapore) have good access to inexpensive �nance that makes their purchase of capital PAGE (including Japan and Singapore) have good access to inexpensive �nance that makes their purchase of capital equipment more affordable. It is through trade or exchange that a country can access the resources, goods and PAGE

equipment more affordable. It is through trade or exchange that a country can access the resources, goods and

PROOFSOverall, it seems that increased international trade creates jobs and lowers unemployment, especially in the

PROOFSOverall, it seems that increased international trade creates jobs and lowers unemployment, especially in the long term. This is because trade increases ef�ciency in resource allocation, lowers production costs, strengthens

PROOFSlong term. This is because trade increases ef�ciency in resource allocation, lowers production costs, strengthens business pro�tability and expansion, and boosts economic growth. This should create more jobs, reduce unem

PROOFSbusiness pro�tability and expansion, and boosts economic growth. This should create more jobs, reduce unem-

PROOFS-ployment, lift average incomes and improve both material and non-material living standards. In Australia’s

PROOFSployment, lift average incomes and improve both material and non-material living standards. In Australia’s

However, especially in the short term, it is possible that the growth in trade (facilitated by trade liberalisa

PROOFSHowever, especially in the short term, it is possible that the growth in trade (facilitated by trade liberalisa

as uncompetitive �rms close down, relocate to

PROOFS as uncompetitive �rms close down, relocate to

low-wage countries or restructure their production by substituting machines for workers. When this occurs,

PROOFSlow-wage countries or restructure their production by substituting machines for workers. When this occurs,



On the one hand, by accelerating economic growth, creating jobs and supressing in�ation, global trade is likely to have led to higher real per capita incomes, purchasing power and living standards for many. In addi-tion, trade has increased government revenues, making it more affordable for governments to provide better education, health and economic infrastructure that are required for economic growth.

These positive outcomes seem to especially apply in countries like China, where the rise in interna-tional trade since the early 1990s appears to have been one of the key factors in reducing global poverty rates among people on very low incomes of less than $1.25 a day. Figure 3.4 shows that since 1990, pov-erty reductions have been greatest in East Asia (which includes China) and the Paci�c, South Asia and Sub-Saharan Africa.

Pov

erty

rat

es c

onti

nue

to f

all

People living on less than $1.25 a day (% of population)

Year

60

40

20

01990 1995 2000 2005 2010 2015

Sub-Saharan Africa

South Asia

Middle East &North AfricaLatin America & Caribbean

East Asia & Paci�c

Europe & Central Asia

FIGURE 3.4 Trends in the reduction of extreme poverty by global region

Source: Graph copied directly from World Bank 2014, Development Indicators, p. 2.

On the other hand, experience from particular countries, especially over the shorter term, shows that the rise in global trade (facilitated by trade liberalisation and structural reforms) may have contributed to lower incomes and greater inequality. This could be due to the effect of stronger competition from imports depressing real wages by driving up the local price of basic food. This occurs when domestic producers are encouraged to sell overseas where they can get better prices for their crops than selling locally. In addition, trade has caused some local businesses to close down, possibly leading to structural unemployment and lower incomes.

Trade has mixed effects on economic stability and other aspects affecting living standardsTrade can have mixed effects on a nation’s economic stability and living standards.

Trade can increase economic instabilityWith growing dependence on international trade, momentous economic events like the GFC (2008–10) or a slowdown in a major economy (as happened in China in 2013–16) can spread globally and drag other nations into recession. In turn, this causes rising unemployment, falling incomes and depressed living standards across the world.

Despite this, the opposite is true too. If overseas conditions are strong, these can help offset periods of weak domestic economic activity locally and reduce instability, helping to maintain living standards.

Trade can weaken the environment and living standardsBy growing exports and accelerating production, trade can have adverse direct and indirect effects on the envi-ronment both now and into the future: • Natural and other resources will be depleted and degraded at a faster rate, as is evident in many countries

like Indonesia, Nigeria, Ecuador and Brazil. • Carbon emissions from production and the transportation of goods will increase. This will accelerate climate

change and severe weather events, along with the pollution of rivers and soils as seen in China.

UNCORRECTED

UNCORRECTED

UNCORRECTED Trends in the reduction of extreme poverty by global region

UNCORRECTED Trends in the reduction of extreme poverty by global region

Graph copied directly from World Bank 2014,

UNCORRECTED Graph copied directly from World Bank 2014, Development Indicators

UNCORRECTED Development Indicators

On the other hand, experience from particular countries, especially over the shorter term, shows that

UNCORRECTED On the other hand, experience from particular countries, especially over the shorter term, shows that

the rise in global trade (facilitated by trade liberalisation and structural reforms) may have contributed to

UNCORRECTED the rise in global trade (facilitated by trade liberalisation and structural reforms) may have contributed to lower incomes and greater inequality. This could be due to the effect of stronger competition from imports

UNCORRECTED lower incomes and greater inequality. This could be due to the effect of stronger competition from imports depressing real wages by driving up the local price of basic food. This occurs when domestic producers are

UNCORRECTED

depressing real wages by driving up the local price of basic food. This occurs when domestic producers are encouraged to sell overseas where they can get better prices for their crops than selling locally. In addition,

UNCORRECTED

encouraged to sell overseas where they can get better prices for their crops than selling locally. In addition, trade has caused some local businesses to close down, possibly leading to structural unemployment and

UNCORRECTED

trade has caused some local businesses to close down, possibly leading to structural unemployment and

Trade has mixed effects on economic stability and other aspects

UNCORRECTED

Trade has mixed effects on economic stability and other aspects

UNCORRECTED

affecting living standards

UNCORRECTED

affecting living standardsTrade can have mixed effects on a nation’s economic stability and living standards.

UNCORRECTED

Trade can have mixed effects on a nation’s economic stability and living standards.

Trade can increase economic instability

UNCORRECTED

Trade can increase economic instabilityWith growing dependence on international trade, momentous economic events like the GFC (2008–10) or a UNCORRECTED

With growing dependence on international trade, momentous economic events like the GFC (2008–10) or a slowdown in a major economy (as happened in China in 2013–16) can spread globally and drag other nations UNCORRECTED

slowdown in a major economy (as happened in China in 2013–16) can spread globally and drag other nations

PAGE

PAGE

PAGE

PAGE

PAGE

PAGE

PAGE YearPAGE Year

1990 1995 2000 2005 2010 2015

PAGE 1990 1995 2000 2005 2010 2015

PAGE

Trends in the reduction of extreme poverty by global regionPAGE

Trends in the reduction of extreme poverty by global region

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFSSouth Asia

PROOFSSouth Asia

Middle East &PROOFS

Middle East &



• The growth of cities is likely to quicken, creating a host of urban problems, including overcrowding, waste disposal, transport congestion, injury from disasters and reduced health outcomes.With weaker environmental outcomes, material and especially non-material living standards are likely to

suffer.

Trade can prevent the development of new infant industriesThe liberalisation and growth of trade exposes domestic industries to stronger competition from often cheaper imports. This can discourage the growth of domestic infant industries, which typically have higher production costs and limited cash �ow during their start-up phase than well-established foreign rivals. As a result, growth in capacity and job creation may be limited, with negative consequences for economic activity and therefore living standards.

Weblinks The weblinks in these activities are available in this chapter’s student resources tab.• The big ideas of trade• Why international trade?• Foreign trade — an introduction• How international trade works (1951)• Better understanding global trade �ows• International trade (unit 7, lecture 1)• How bene�cial is world trade?• Comparative advantage and terms of trade,

ACDC Econ 1.3

• The gains from trade• International trade: Absolute and comparative advantage • Comparative advantage and the tragedy of Tasmania • Basic economic principles 3: Specialisation and trade• Another look at comparative advantage• Comparative advantage• Chapter # 2 division of labour specialisation, trade

comparative advantage• Chapter # 2 division of labour and specialisation

CHECK YOUR UNDERSTANDING

1 Identify and explain four important ways whereby the growth of global trade (partly assisted by trade liberalisation policies) might help to increase overall living standards.

2 Identify and explain two important ways whereby the growth of global trade (assisted by trade liberalisation policies) might undermine general living standards.

APPLIED ECONOMIC EXERCISES

Apply your understanding of this subtopic by accessing and completing the Applied economic exercise(s).

• School-assessed coursework > Applied economic exercises > Question 1

3.2 Recording international transactions on the balance of payments accountThe balance of payments account (BOP) is an annual statistical record of the money value of different types of �nancial transactions between Australia and the rest of the world. For accounting purposes, money received by Australian residents is regarded as a credit, while money paid by us to overseas is classi�ed as a debit. Because this is a zero balance account, the overall balance of payments account always balances and the total value of credits is equal to the total value of debits. The items recorded on the BOP are grouped into either current account transactions or capital and �nancial account transactions, before being further subdivided. These transactions are illustrated in �gure 3.5.

Balance on current accountFrom �gure 3.5 you will notice that the balance on current account is broken down into four sub-accounts:1. Net goods. This is the difference in total value between export credits for goods or merchandise sold over-

seas (for example, wool, minerals and manufactured items) minus import debits for goods purchased from abroad (for example, oil, electronic equipment and machinery).

2. Net services. This is the difference between the value of service credits received by Australia (for example from tourism, education, transportation, construction, �nancial, royalties and licence fees) minus service

UNCORRECTED

UNCORRECTED

UNCORRECTED eby the growth of global trade (partly assisted by trade

UNCORRECTED eby the growth of global trade (partly assisted by trade liberalisation policies) might help to increase overall living standards.

UNCORRECTED liberalisation policies) might help to increase overall living standards.eby the growth of global trade (assisted by trade liberalisation

UNCORRECTED eby the growth of global trade (assisted by trade liberalisation policies) might undermine general living standards.

UNCORRECTED policies) might undermine general living standards.

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED ES

UNCORRECTED ES


UNCORRECTED


School-assessed coursework > Applied economic exercises >

UNCORRECTED


3.2 Recording international transactions on the

UNCORRECTED

3.2 Recording international transactions on the balance of payments account

UNCORRECTED

balance of payments accountbalance of payments account (BOP)

UNCORRECTED

balance of payments account (BOP)of �nancial transactions between Australia and the rest of the world. For accounting purposes, money received UNCORRECTED

of �nancial transactions between Australia and the rest of the world. For accounting purposes, money received by Australian residents is regarded as a UNCORRECTED

by Australian residents is regarded as a Because this is a zero balance account, the overall balance of payments account always balances and the total UNCORRECTED

Because this is a zero balance account, the overall balance of payments account always balances and the total

PAGE

PAGE comparative advantage

PAGE comparative advantageChapter # 2 division of labour and specialisation

PAGE Chapter # 2 division of labour and specialisation

PAGE

PAGE

PAGE

eby the growth of global trade (partly assisted by trade PAGE

eby the growth of global trade (partly assisted by trade liberalisation policies) might help to increase overall living standards.PAGE

liberalisation policies) might help to increase overall living standards.

PROOFS

PROOFSInternational trade: Absolute and comparative advantage

PROOFSInternational trade: Absolute and comparative advantage Comparative advantage and the tragedy of Tasmania

PROOFSComparative advantage and the tragedy of Tasmania Basic economic principles 3: Specialisation and trade

PROOFSBasic economic principles 3: Specialisation and tradeAnother look at comparative advantage

PROOFSAnother look at comparative advantage

Chapter # 2 division of labour specialisation, trade PROOFS

Chapter # 2 division of labour specialisation, trade

Chapter # 2 division of labour and specialisationPROOFS

Chapter # 2 division of labour and specialisationPROOFS



debits paid abroad (for example, for transportation, tourism, education, royalties and licence fees, and insurance).

3. Net primary incomes. This is the difference in value between income credits received from overseas (for example, wages, salaries, interest, dividends and pro�ts) minus income debits paid out abroad (for wages, salaries, interest, rent, dividends and pro�t remittances, for example).

4. Net secondary incomes. This is the difference between the value of secondary income credits received by our residents (for example, non-life insurance transfers such as pensions) minus the value of secondary income debits paid abroad (such as gifts, taxes and some foreign food aid donated by our residents). Secondary incomes are dif-ferent from other transactions in that they are a one-way transaction with nothing exchanged in return.

1 — Net goods(credits for goods exported

MINUS debits for goods imported)

Net capitaltransfers(capitaltransfercreditsMINUScapitaltransferdebits)

Netacquisition

of non-produced�nancialassets

(creditsMINUSdebits)

Netinvestment

(equalsnet direct +

net portfolio +net other)= creditsMINUSdebits

Netreserveassets(by theRBA)

= creditsMINUSdebits

1 — Balance oncapital account

2 — Balance on�nancial account

2 — Net services(credits for services exported

MINUS debits for services imported)

3 — Net primary incomes(credits for primary incomes received

MINUS debits for primary incomes paid)

4 — Net secondaryincomes

(credits for secondary incomes receivedMINUS debits for secondary incomes paid)

The balance oncurrent account

The balance on capitaland �nancial accounts

The overall balance of payments account (BOP)

FIGURE 3.5 Structure of Australia’s balance of payments account

To calculate the overall balance on current account, remember the following relationships.

How to calculate the balance of payments on current accountNet goods (credits for goods minus debits for goods)+ Net services (credits for services minus debits for services)+ Net primary incomes (credits for incomes minus debits for incomes)+ Net secondary incomes (credits for secondary incomes minus debits for secondary incomes)= Overall balance on current account

In Australia’s case, the overall balance turns out to be a large current account de�cit (CAD), where the total value of debits exceeds the total value of credits. As we shall see, the existence of the CAD means that there will need to be a rise in the nation’s net external liabilities, which are made up of debt (borrowed money) and equity (ownership).

Balance on capital and �nancial accountsThe balance on capital and �nancial accounts is broken down into two main sub-accounts: the balance on cap-ital account and the balance on �nancial account.1. Balance on capital account. Capital transactions include net capital transfers and the net acquisition of

non-produced, non-�nancial assets. • Capital transfers generally involve the net in�ow of funds into Australia by permanent migrants.

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

Structure of Australia’s balance of payments account

UNCORRECTED

Structure of Australia’s balance of payments account


UNCORRECTED


UNCORRECTED

UNCORRECTED

UNCORRECTED

ow to calculate the balance of payments on current account

UNCORRECTED

ow to calculate the balance of payments on current accountNet goods (credits for goods minus debits for goods)

UNCORRECTED

Net goods (credits for goods minus debits for goods)+

UNCORRECTED

+ Net services (credits for services minus debits for services)

UNCORRECTED

Net services (credits for services minus debits for services)+

UNCORRECTED

+ Net primary incomes (credits for incomes minus debits for incomes)

UNCORRECTED

Net primary incomes (credits for incomes minus debits for incomes)+UNCORRECTED

+ Net secondary incomes (credits for secondary incomes minus debits for secondary incomes)UNCORRECTED

Net secondary incomes (credits for secondary incomes minus debits for secondary incomes)=UNCORRECTED

= Overall balance on current accountUNCORRECTED

Overall balance on current account

PAGE

PAGE MINUS

PAGE MINUScapital

PAGE capitaltransfer

PAGE transferdebits)

PAGE debits)

PAGE

PAGE MINUS debits for secondary incomes paid) PAGE MINUS debits for secondary incomes paid) PAGE

PAGE

PAGE

PAGE PROOFS

PROOFS

PROOFS

PROOFS

credits PROOFS

credits PROOFSNet

PROOFSNet

acquisition

PROOFSacquisition

of non-

PROOFSof non-

produced

PROOFS

produced

PROOFS



• The net acquisition/disposal of non-produced, non-�nancial assets covers the excess of credits over debits for the sale of copyright, patents, overseas franchises (such as KFC and McDonald’s) and trade-marks of a tangible nature.

Of these two items, capital transfers are by far the largest item.2. Balance on �nancial account. The �nancial account shows how Australia funds or pays for its CAD. The bal-

ance on �nancial account records the value of total credits for investments and borrowing received by Australia from abroad (the in�ow of funds) minus total debits for investments and lending by Australians abroad (the out�ow of funds). It records the following transactions involving foreign �nancial assets and liabilities. • Net direct investment involves the purchase, setting up or expansion of companies and assets in Australia

by foreigners classi�ed as credits (the in�ow of funds or assets) minus similar investments overseas by Australian residents classi�ed as debits (the out�ow of funds or liabilities).

• Net portfolio investment is the difference in the value of transactions by foreign individuals purchasing Australian shares, debt and securities minus the value of similar assets purchased by our residents. Port-folio investment �owing in from overseas is recorded as a credit (the in�ow of funds or assets), while this sort of investment abroad by Australian residents is recorded as a debit (the out�ow of funds or liabili-ties) on our �nancial account.

• Other investment includes credits (the in�ow of funds or assets) minus debits (the out�ow of funds or liabilities) for loans, deposits and trade credits.

• Net reserve assets contains both RBA and government transactions involving dealings in reserves of foreign currencies, gold, special drawing rights and required contributions to the International Monetary Fund (IMF). Moneys received from overseas are categorised as credits (the in�ow of funds or assets), while payments overseas are categorised as debits (the out�ow of funds or liabilities) on Australia’s �nancial account.

• Net errors and omissions re�ects inaccuracies in the above calculations and estimations. When this cat-egory is taken into account, the positive balance on Australia’s capital and �nancial account will exactly offset the negative balance on current account (the CAD).

Overall, Australia’s balance on capital and �nancial accounts is positive. This means there has been a net �nancial in�ow seen as a rise in the nation’s liabilities overseas (consisting of either foreign debt or foreign equity in the case of ownership of Australian assets like property or shares). It will exactly offset the de�cit recorded on our current account, allowing the overall BOP account to be in balance.

Relationship between the current account and the capital and �nancial accountsThe overall BOP account should exactly balance or equal zero, at least in theory. That is, Australia’s current account de�cit (where the total value of debits exceeds credits for goods, services, primary incomes and sec-ondary incomes) is exactly equal to or offset by a capital and �nancial account surplus (where the total value of credits exceeds debits for net capital and investments). This directly increases our net foreign debt (NFD).

As shown in �gure 3.6, the existence of ongoing CADs means that there has to be an offsetting rise in the nation’s net external liabilities, consisting of foreign debt (borrowed money) and foreign equity (ownership). Here, we are essentially drawing on savings from the rest of the world to �nance our high levels of investment and consumption, and recording this as a net surplus (in�ow) on our capital and �nancial accounts. Clearly this is a two-way relation-ship between the current account and the capital and �nancial accounts making up the overall BOP.

Australia’s CADs are exactlyoffset by a surplus on thecapital and �nancialaccounts — mostlyinvolving an increase inour foreign liabilities(debt and equity)

Australia generallyruns large CADs

FIGURE 3.6 The relationship between Australia’s current account and the capital and �nancial accounts

As we shall see later, the main problem is that Australia has a national savings-investment gap. Here, there is a low level of savings by households, �rms and governments relative to our high level of investment by households, �rms and governments. This tends to make foreign borrowing and interest rates relatively cheaper

UNCORRECTED Relationship between the current account and the capital and

UNCORRECTED Relationship between the current account and the capital and

UNCORRECTED The overall BOP account should exactly balance or equal zero, at least in theory. That is, Australia’s

UNCORRECTED The overall BOP account should exactly balance or equal zero, at least in theory. That is, Australia’s

(where the total value of debits exceeds credits for goods, services, primary incomes and sec

UNCORRECTED (where the total value of debits exceeds credits for goods, services, primary incomes and sec

ondary incomes) is exactly equal to or offset by a

UNCORRECTED ondary incomes) is exactly equal to or offset by a capital and �nancial account surplus

UNCORRECTED capital and �nancial account surplus

of credits exceeds debits for net capital and investments). This directly increases our net foreign debt (NFD).

UNCORRECTED of credits exceeds debits for net capital and investments). This directly increases our net foreign debt (NFD).

As shown in �gure 3.6, the existence of ongoing CADs means that there has to be an offsetting rise in the nation’s

UNCORRECTED

As shown in �gure 3.6, the existence of ongoing CADs means that there has to be an offsetting rise in the nation’s net external liabilities, consisting of foreign debt (borrowed money) and foreign equity (ownership). Here, we are

UNCORRECTED

net external liabilities, consisting of foreign debt (borrowed money) and foreign equity (ownership). Here, we are essentially drawing on savings from the rest of the world to �nance our high levels of investment and consumption,

UNCORRECTED

essentially drawing on savings from the rest of the world to �nance our high levels of investment and consumption,

UNCORRECTED

and recording this as a net surplus (in�ow) on our capital and �nancial accounts. Clearly this is a two-way relation

UNCORRECTED

and recording this as a net surplus (in�ow) on our capital and �nancial accounts. Clearly this is a two-way relationship between the current account and the capital and �nancial accounts making up the overall BOP.

UNCORRECTED

ship between the current account and the capital and �nancial accounts making up the overall BOP.

PAGE egory is taken into account, the positive balance on Australia’s capital and �nancial account will exactly

PAGE egory is taken into account, the positive balance on Australia’s capital and �nancial account will exactly

is positive. This means there has been a net

PAGE is positive. This means there has been a net

overseas (consisting of either foreign debt or foreign

PAGE overseas (consisting of either foreign debt or foreign

equity in the case of ownership of Australian assets like property or shares). It will exactly offset the de�cit

PAGE equity in the case of ownership of Australian assets like property or shares). It will exactly offset the de�cit recorded on our current account, allowing the overall BOP account to be in balance.

PAGE recorded on our current account, allowing the overall BOP account to be in balance.

Relationship between the current account and the capital and PAGE

Relationship between the current account and the capital and

PROOFS the value of similar assets purchased by our residents. Port

PROOFS the value of similar assets purchased by our residents. Port

folio investment �owing in from overseas is recorded as a credit (the in�ow of funds or assets), while this

PROOFSfolio investment �owing in from overseas is recorded as a credit (the in�ow of funds or assets), while this sort of investment abroad by Australian residents is recorded as a debit (the out�ow of funds or liabili

PROOFSsort of investment abroad by Australian residents is recorded as a debit (the out�ow of funds or liabili-

PROOFS-debits (the out�ow of funds or

PROOFSdebits (the out�ow of funds or

contains both RBA and government transactions involving dealings in reserves of foreign

PROOFScontains both RBA and government transactions involving dealings in reserves of foreign

currencies, gold, special drawing rights and required contributions to the International Monetary Fund (IMF).

PROOFScurrencies, gold, special drawing rights and required contributions to the International Monetary Fund (IMF). Moneys received from overseas are categorised as credits (the in�ow of funds or assets), while payments

PROOFSMoneys received from overseas are categorised as credits (the in�ow of funds or assets), while payments overseas are categorised as debits (the out�ow of funds or liabilities) on Australia’s �nancial account.

PROOFS

overseas are categorised as debits (the out�ow of funds or liabilities) on Australia’s �nancial account.re�ects inaccuracies in the above calculations and estimations. When this catPROOFS

re�ects inaccuracies in the above calculations and estimations. When this category is taken into account, the positive balance on Australia’s capital and �nancial account will exactly PROOFS

egory is taken into account, the positive balance on Australia’s capital and �nancial account will exactly



and, by adding to our NFD, it means there are heavy primary income debits to pay out (interest on borrowed credit, dividends to foreign shareholders, and pro�ts to foreign owned �rms), adding greatly to our CAD.

Weblinks The weblinks in these activities are available in this chapter’s student resources tab.

• Investopedia video: The balance of payments• 11 Understanding the capital account


1 What is the BOP account?2 Draw and label a structural diagram representing the BOP account for Australia, giving two relevant

examples of each speci�c type of transaction.3 What is the CAD and why is this typically large for Australia?4 Explain the relationship between the CAD and balance on capital and �nancial accounts.




3.3 The current account de�cit and its causesEach year Australia records a substantial current account de�cit (CAD) on its balance of payments account (BOP). As shown in �gure 3.7, Australia has a persistent current account de�cit (CAD). This means that the total value of debits for goods, services, primary incomes and secondary incomes is greater than the equivalent value of credits. Commentators often seize on the CAD as a sign of external instability or weakness, especially when its value (expressed as a percentage of GDP — measuring the size of the economy) is high, perhaps at a level above 3–4 per cent. This is sometimes taken as an indication that Australia is not paying its way in its international �nancial transactions.

10

0

20

02

–03

20

04

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05

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11.5

00.5

22.53

43.5

4.5

5.5

6.5

5

6

7

CA

D (

$ b

illio

ns)

Rat

io o

f C

AD

:GD

P (

per

cent

)

Year

CAD ($ billions);see LHS

CAD:GDP ratio forAustralia (annualpercentage, GDPreference year2011–12). A possiblegovernment’s targetmight be around3–4 per cent;see RHS

40.184

47.8

57.252.8

58.4

38.8

53.3

43.7

49.4

58.5

51.956.8

68.2

5.1

5.9

6.7

5.55.6

6.2

3.1

4.1

2.5

3.4

4

3

3.6

FIGURE 3.7 Indicators of Australia’s external imbalance and weakness, 2002–03 to 2014–15

Source: Data derived from ABS 5302.0 (Tables 1 and 35).

Figure 3.8 breaks down Australia’s current account into its four sub-accounts: net goods, net services, net primary incomes and net secondary incomes. As can be seen from the lower part of the graph, overall there is usually a CAD because most of the components are negative. Of special importance, however, is the huge de�cit recorded every year for net primary incomes. This signals that Australia is very dependent on heavy overseas borrowing and relying on capital in�ow, necessitating high levels of income debits.

UNCORRECTED value of credits. Commentators often seize on the CAD as a sign of

UNCORRECTED value of credits. Commentators often seize on the CAD as a sign of when its value (expressed as a percentage of GDP — measuring the size of the economy) is high, perhaps at

UNCORRECTED when its value (expressed as a percentage of GDP — measuring the size of the economy) is high, perhaps at a level above 3–4 per cent. This is sometimes taken as an indication that Australia is not

UNCORRECTED a level above 3–4 per cent. This is sometimes taken as an indication that Australia is not

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

10

UNCORRECTED

10

UNCORRECTED

0UNCORRECTED

0

20

UNCORRECTED

20

UNCORRECTED

UNCORRECTED

UNCORRECTED

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UNCORRECTED

UNCORRECTED

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40.184

UNCORRECTED

40.184

47.8

UNCORRECTED

47.8

57.2

UNCORRECTED

57.252.8

UNCORRECTED

52.858.4

UNCORRECTED

58.4

68.2

UNCORRECTED

68.25.6

UNCORRECTED

5.66.2

UNCORRECTED 6.2

PAGE

PAGE

PAGE 3.3 The current account de�cit and its causes

PAGE 3.3 The current account de�cit and its causes

current account de�cit

PAGE current account de�cit (CAD) on its balance of payments account

PAGE (CAD) on its balance of payments account current account de�cit (CAD) on its balance of payments account current account de�cit

PAGE current account de�cit (CAD) on its balance of payments account current account de�cit

(BOP). As shown in �gure 3.7, Australia has a persistent current account de�cit (CAD). This means that the

PAGE (BOP). As shown in �gure 3.7, Australia has a persistent current account de�cit (CAD). This means that the total value of debits for goods, services, primary incomes and secondary incomes is greater than the equivalent PAGE total value of debits for goods, services, primary incomes and secondary incomes is greater than the equivalent value of credits. Commentators often seize on the CAD as a sign of PAGE

value of credits. Commentators often seize on the CAD as a sign of when its value (expressed as a percentage of GDP — measuring the size of the economy) is high, perhaps at PAGE

when its value (expressed as a percentage of GDP — measuring the size of the economy) is high, perhaps at

PROOFS

PROOFS

PROOFSepresenting the BOP account for Australia, giving two relevant

PROOFSepresenting the BOP account for Australia, giving two relevant

PROOFS

PROOFS

PROOFS


PROOFS


Question 2 PROOFS

Question 2



Net

bal

ance

s m

akin

g up

the

ove

rall

bala

nce

on c

urre

nt a

ccou

nt (

$ b

illio

ns)

Year

Trends in the values of the components making up Australia’s balance of payments oncurrent account, 2003–04 to 2015–16

–80

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–40

–20

0

20

40

4 Net secondaryincomes ($b)

1 Net goods($b)

2 Net services($b)

3 Net primaryincomes ($b)

–0.3

–23.7

–0.3

–0.4

–31.2

–1.9

–15.3 –14

–45.9

–0.3

–0.1

–50.2

–20.8

–3.3 –7.3 –10.7

–45.1–38

–13.6

–4.6

6.4

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–41.9–34

–7.7

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–56.3

–45.4

–0.9–1.5

–47.8

–1.1–2.9

21.9

8.7

–2

–2.3 –2.3 –2.1 –1.9

2.9

10.9

1.8

–37.6

–0.7

0.8

–23.5–23.6

FIGURE 3.8 Changes in the components making up Australia’s balance of payments current account

Source: Data derived from ABS 5302.0 (Tables 1 and 35).

To explain why Australia has a persistent CAD and ongoing external problems, we need to investigate the roles played by both aggregate demand-side factors and aggregate supply-side factors. The in�uence of these two sets of factors on the size of the CAD is illustrated hypothetically in �gure 3.9.

6

CyclicalCAD

Structural CAD

3

0CA

D:G

DP

rat

io (

perc

enta

ge)

Years

1. Aggregate demand-side factors. When stronger aggregatedemand conditions cause Australians to increase theirspending, or when there are weaker demand conditionsabroad, our cyclical CAD:GDP ratio will tend to rise fromaround 3 per cent to 6 per cent. Conversely, weakerspending locally or stronger spending overseas will usuallycause the cyclical CAD:GDP ratio to fall.

2. Aggregate supply-side factors. Ongoing unfavourableaggregate supply-side factors cause Australia’s structuralCAD:GDP ratio to be around 3 per cent. They re�ect ourdependence on overseas borrowing and debt due to thesavings–investment gap, our lower ef�ciency and high costs,and our poor international competitiveness.

FIGURE 3.9 How aggregate demand- and supply-side factors can contribute to Australia’s CAD and external instability

1. Changing aggregate demand-side conditionsAs we shall soon see, generally stronger demand-side conditions originating from within Australia (such as rises in our levels of consumer and business con�dence, disposable incomes and population), and higher levels of activity, tend to cause a rise in the size of our cyclical CAD. This is shown in �gure 3.9 where the CAD:GDP ratio ranges from perhaps 3 to 6 per cent of GDP or even higher. There are several reasons why stronger spending domestically can increase the cyclical CAD: • Strong spending can sometimes cause increased shortages and higher domestic prices for locally produced

goods and services. This makes imports relatively more attractive, increasing the CAD. • Strong domestic spending reduces the potential level of Australia’s exports and makes them less attractive,

increasing the CAD.

UNCORRECTED To explain why Australia has a persistent CAD and ongoing external problems, we need to investigate the

UNCORRECTED To explain why Australia has a persistent CAD and ongoing external problems, we need to investigate the

aggregate demand-side factors

UNCORRECTED aggregate demand-side factors and

UNCORRECTED and

sets of factors on the size of the CAD is illustrated hypothetically in �gure 3.9.

UNCORRECTED sets of factors on the size of the CAD is illustrated hypothetically in �gure 3.9.

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

Structural CAD

UNCORRECTED

Structural CAD

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

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R UNCORRECTED

REUNCORRECTED

E 3.9UNCORRECTED

3.9

PAGE

PAGE 2

01

3–1

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PAGE

PAGE

PAGE

PAGE Changes in the components making up Australia’s balance of payments current accountPAGE Changes in the components making up Australia’s balance of payments current account

PROOFS

20

16

–17PROOFS

20

16

–17

4 Net secondary

PROOFS4 Net secondaryincomes ($b)

PROOFSincomes ($b)

3 Net primary

PROOFS3 Net primaryincomes ($b)

PROOFSincomes ($b)

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS



• Stronger domestic spending can cause the RBA to raise interest rates to control in�ation. This then tends to make Australia relatively more appealing to investors, attracting additional capital in�ow. This drives up our exchange rate, thereby reducing the value of our exports relative to imports and increasing the CAD.In reverse, when aggregate demand-side conditions within Australia are generally weaker and domestic

spending and activity are growing more slowly, the cyclical CAD usually shrinks.One slight complication here is that when economic conditions overseas are stronger and these accelerate

the value of spending on Australian exports (due to higher volumes and/or better commodity prices), our cyclical CAD should fall, whereas a slowdown in external demand can mean a larger CAD.

2. Changing aggregate supply-side conditionsFigure 3.9 also shows that generally less favourable aggregate supply-side conditions — such as the lack of domestic savings, higher costs of production, poor international competitiveness and severe weather events — cause Australia to have an ongoing structural CAD, perhaps equal to at least around 3 per cent of GDP. • The lack of domestic savings causes us to depend on borrowing from overseas, leading to income payments

abroad and a bigger structural CAD. • Higher production costs and poor international competitiveness reduce exports sales while encouraging

imports, thereby adding to our structural CAD.However, if supply-side conditions (including lower labour and other costs, improved productivity, a higher

savings ratio and ideal climatic conditions) generally become more favourable, the structural CAD should fall.Let us now take a closer look at the speci�c aggregate demand-side factors and aggregate supply-side factors

that determine the size of Australia’s CAD.

Aggregate demand-side causes of Australia’s cyclical CADAs already mentioned, changing domestic and international aggregate demand-side conditions can cause cyclical changes (both up and down) in the size of Australia’s CAD. As a general rule, if demand conditions overall cause spending on imports to rise and our exports to fall, the cyclical CAD will increase; while if spending conditions cause imports to fall and our exports to rise, the cyclical CAD will decrease. For various reasons, there was some rise in the CAD:GDP ratio during 2010–11 and 2012–13, followed more recently by generally lower levels during 2013–14 and 2014–15.

Changes in economic activity overseas and our terms of trade indexThe level of overseas economic activity (relating to the strength of GDP and economic growth among our major trading partners like China, Japan, South Korea, Europe and the United States) is an important aggregate demand-side factor that affects spending on Australia’s exports and hence our cyclical CAD. Overseas growth rates also directly affect the favourability of Australia’s terms of trade (the ratio of the prices the world is pre-pared to pay us for our commodity exports against the prices we have to pay for imports). • In general, weaker overseas activity depresses commodity prices and our terms of trade. This tends to reduce

the value of Australia’s exports relative to imports, increasing the size of the cyclical CAD. • By contrast, when economic growth abroad is stronger with higher terms of trade, the value of net exports

tends to rise faster, reducing our cyclical CAD.This relationship is illustrated in �gure 3.10. It shows how changes in the rate of economic growth in China, our

most important customer for exports, has affected our terms of trade and Australia’s CAD. Weaker GDP growth in China in the last few years has tended to depress the terms of trade and cause a rise in our cyclical CAD.

10.7 10.3

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ustr

alia

’s t

erm

s of

tra

de in

dex

and

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D (

$ b

illio

ns)

Year

Chi

na’s

ann

ual r

ate

ofG

DP

gro

wth

(pe

rcen

tage

)

Australia’s CAD($ billions); LHS

Terms of trade index at June(base year 2012–13 = 100index points); LHS

China’s annual rate of GDPgrowth (percentage); RHS

FIGURE 3.10 Relationship between China’s rate of economic growth, and Australia’s terms of trade and CAD

Sources: Data derived from ABS 5206.0 (Table 3); and Trading Economics, http://www.tradingeconomics.com/china/gdp-growth-annual.

UNCORRECTED Changes in economic activity overseas and our terms of trade index

UNCORRECTED Changes in economic activity overseas and our terms of trade index(relating to the strength of GDP and economic growth among our

UNCORRECTED (relating to the strength of GDP and economic growth among our major trading partners like China, Japan, South Korea, Europe and the United States) is an important aggregate

UNCORRECTED major trading partners like China, Japan, South Korea, Europe and the United States) is an important aggregate demand-side factor that affects spending on Australia’s exports and hence our cyclical CAD. Overseas growth

UNCORRECTED demand-side factor that affects spending on Australia’s exports and hence our cyclical CAD. Overseas growth rates also directly affect the favourability of Australia’s

UNCORRECTED rates also directly affect the favourability of Australia’s pared to pay us for our commodity exports against the prices we have to pay for imports).

UNCORRECTED pared to pay us for our commodity exports against the prices we have to pay for imports).

er overseas activity depresses commodity prices and our terms of trade. This tends to reduce

UNCORRECTED er overseas activity depresses commodity prices and our terms of trade. This tends to reduce

the value of Australia’s exports relative to imports, increasing the size of the cyclical CAD.

UNCORRECTED

the value of Australia’s exports relative to imports, increasing the size of the cyclical CAD.By contrast, when economic gro

UNCORRECTED

By contrast, when economic growth abroad is stronger with higher terms of trade, the value of net exports

UNCORRECTED

wth abroad is stronger with higher terms of trade, the value of net exports tends to rise faster, reducing our cyclical CAD.

UNCORRECTED

tends to rise faster, reducing our cyclical CAD.This relationship is illustrated in �gure 3.10. It shows how changes in the rate of economic growth in China, our

UNCORRECTED

This relationship is illustrated in �gure 3.10. It shows how changes in the rate of economic growth in China, our most important customer for exports, has affected our terms of trade and Australia’s CAD. Weaker GDP growth in

UNCORRECTED

most important customer for exports, has affected our terms of trade and Australia’s CAD. Weaker GDP growth in China in the last few years has tended to depress the terms of trade and cause a rise in our cyclical CAD.

UNCORRECTED

China in the last few years has tended to depress the terms of trade and cause a rise in our cyclical CAD.

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

10.7

UNCORRECTED

10.7 10.3

UNCORRECTED

10.3

80

UNCORRECTED

80

100

UNCORRECTED

100

120

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120

Aus

tral

ia’s

ter

ms

of t

rade

inde

x an

d

UNCORRECTED

Aus

tral

ia’s

ter

ms

of t

rade

inde

x an

dC

AD

($

bill

ions

)

UNCORRECTED

CA

D (

$ b

illio

ns)

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED PAGE As already mentioned, changing domestic and international aggregate demand-side conditions can cause

PAGE As already mentioned, changing domestic and international aggregate demand-side conditions can cause changes (both up and down) in the size of Australia’s CAD. As a general rule, if demand conditions

PAGE changes (both up and down) in the size of Australia’s CAD. As a general rule, if demand conditions overall cause spending on imports to rise and our exports to fall, the

PAGE overall cause spending on imports to rise and our exports to fall, the cyclical CAD

PAGE cyclical CAD

spending conditions cause imports to fall and our exports to rise, the cyclical CAD will decrease. For various

PAGE spending conditions cause imports to fall and our exports to rise, the cyclical CAD will decrease. For various reasons, there was some rise in the CAD:GDP ratio during 2010–11 and 2012–13, followed more recently by

PAGE reasons, there was some rise in the CAD:GDP ratio during 2010–11 and 2012–13, followed more recently by

Changes in economic activity overseas and our terms of trade indexPAGE Changes in economic activity overseas and our terms of trade index

(relating to the strength of GDP and economic growth among our PAGE

(relating to the strength of GDP and economic growth among our

PROOFSlack of domestic savings causes us to depend on borrowing from overseas, leading to income payments

PROOFSlack of domestic savings causes us to depend on borrowing from overseas, leading to income payments

veness reduce exports sales while encouraging

PROOFSveness reduce exports sales while encouraging

However, if supply-side conditions (including lower labour and other costs, improved productivity, a higher

PROOFSHowever, if supply-side conditions (including lower labour and other costs, improved productivity, a higher

savings ratio and ideal climatic conditions) generally become more favourable, the structural CAD should fall.

PROOFSsavings ratio and ideal climatic conditions) generally become more favourable, the structural CAD should fall.

Let us now take a closer look at the speci�c aggregate demand-side factors and aggregate supply-side factors

PROOFSLet us now take a closer look at the speci�c aggregate demand-side factors and aggregate supply-side factors

Aggregate demand-side causes of Australia’s cyclical CADPROOFS

Aggregate demand-side causes of Australia’s cyclical CADAs already mentioned, changing domestic and international aggregate demand-side conditions can cause PROOFS

As already mentioned, changing domestic and international aggregate demand-side conditions can cause changes (both up and down) in the size of Australia’s CAD. As a general rule, if demand conditions PROOFS

changes (both up and down) in the size of Australia’s CAD. As a general rule, if demand conditions



Changes in the exchange rate for the Australian dollarThe exchange rate for the Australian dollar can be an aggregate demand-side factor that affects spending and hence the cyclical CAD. • A weaker Australian dollar, as seen between 2013 and 2016, tends to reduce the cyclical CAD. This is

because exports are relatively cheaper and boost the value of sales or credits, while imports are dearer and depress our spending. As a result, the CAD tends to fall.

• A stronger Australian dollar results in lower net exports of goods and services (X – M), and this tends to increase the CAD.

Changes in consumer sentiment, business con�dence and real disposable incomeChanging levels of domestic consumer sentiment and business con�dence about the future are aggregate demand-side factors that greatly affect our spending on imports of both goods and services, thus affecting the size of Australia’s CAD. • When households and businesses are more pessimistic about their future economic circumstances or expe-

rience a fall in real household disposable income as occurred during 2013–15, they tend to save rather than spend, thereby slowing their purchases of imports such as appliances, cars, overseas holidays, machinery and materials. This reduces our cyclical CAD.

• In contrast, greater optimism and faster rises in disposable income tend to cause spending on imports to rise, increasing the cyclical CAD.

Changes in interest ratesAs an aggregate demand-side factor, interest rates have an effect on the levels of both household consumption and business investment spending. At least some of this spending involves imports of goods and services, and hence interest rates will directly affect the CAD. • Lower interest rates and cheaper credit offered to households and �rms during 2011 and 2016 have

encouraged more spending on imports of cars, electronics, clothes, overseas holidays and equipment, thus increasing the CAD.

• However, higher interest rates tend to discourage borrowing and spending on imports because of the increased costs of repaying debt. This should help reduce Australia’s CAD.A slight complication with interest rates is that they also affect the exchange rate and thus the CAD. For

instance, we will soon see that reductions in interest rates by the RBA in 2011–16 relative to those abroad (which would normally increase spending on imports and raise the CAD) have also weakened the Australian dollar. This offsetting factor tends to boost net exports and lower the CAD.

Changes in government defence spending and foreign aidLevels of federal government budget outlays on defence equipment, peacekeeping and foreign aid all affect the CAD. • Imports of defence equipment, including submarines and aircraft, along with foreign aid and spending on

peacekeeping operations in Afghanistan, the Solomon Islands, Iraq and Timor-Leste, have all contributed to Australia’s large CAD.

• However, the recent cuts in foreign aid would tend to reduce the cyclical CAD by decreasing secondary income debits.

Aggregate supply-side causes of Australia’s structural CADAggregate supply-side factors also help to explain Australia’s big and ongoing structural CAD and our net foreign debt (NFD). These factors relate to the way our economy is organised and how production is carried out. Structural problems can re�ect various adverse supply-side conditions such as • poor labour ef�ciency and rising production costs for local �rms that reduce our business competitiveness

against imports • a lack of domestic savings leading to higher interest rates here relative to those overseas • bottlenecks or constraints such as labour shortages • an ageing population • droughts and �oods

all lower our ability to competitively produce exports. These structural problems worsen the structural CAD and erode our living standards.

In recent years, a number of supply-side factors (many of them adverse) have affected Australia’s interna-tional transactions and added to our structural CAD (and NFD). We will now take a closer look at them.

An overall de�ciency of national savings and dependence on overseas borrowingThe level of national savings relative to investment is perhaps the most important aggregate supply-side factor in�uencing the size of a nation’s structural CAD.

UNCORRECTED A slight complication with interest rates is that they also affect the exchange rate and thus the CAD. For

UNCORRECTED A slight complication with interest rates is that they also affect the exchange rate and thus the CAD. For instance, we will soon see that reductions in interest rates by the RBA in 2011–16 relative to those abroad

UNCORRECTED instance, we will soon see that reductions in interest rates by the RBA in 2011–16 relative to those abroad (which would normally increase spending on imports and raise the CAD) have also weakened the Australian

UNCORRECTED (which would normally increase spending on imports and raise the CAD) have also weakened the Australian dollar. This offsetting factor tends to boost net exports and lower the CAD.

UNCORRECTED dollar. This offsetting factor tends to boost net exports and lower the CAD.

UNCORRECTED Changes in government defence spending and foreign aid

UNCORRECTED Changes in government defence spending and foreign aidLevels of federal government budget outlays on defence equipment, peacekeeping and foreign aid all affect

UNCORRECTED Levels of federal government budget outlays on defence equipment, peacekeeping and foreign aid all affect

Imports of defence equipment, including

UNCORRECTED

Imports of defence equipment, including peacekeeping operations in Afghanistan, the Solomon Islands, Iraq and Timor-Leste, have all contributed to

UNCORRECTED

peacekeeping operations in Afghanistan, the Solomon Islands, Iraq and Timor-Leste, have all contributed to

wever, the recent cuts in foreign aid would tend to reduce the cyclical CAD by decreasing secondary

UNCORRECTED

wever, the recent cuts in foreign aid would tend to reduce the cyclical CAD by decreasing secondary

Aggregate supply-side causes of Australia’s structural CAD

UNCORRECTED

Aggregate supply-side causes of Australia’s structural CADAggregate supply-side factors

UNCORRECTED

Aggregate supply-side factors

UNCORRECTED

foreign debt (NFD). These factors relate to the way our economy is organised and how production is carried

UNCORRECTED

foreign debt (NFD). These factors relate to the way our economy is organised and how production is carried out. Structural problems can re�ect various adverse supply-side conditions such asUNCORRECTED

out. Structural problems can re�ect various adverse supply-side conditions such aspoor labour ef�ciencUNCORRECTED

poor labour ef�ciencagainst importsUNCORRECTED

against imports

PAGE and business investment spending. At least some of this spending involves imports of goods and services, and

PAGE and business investment spending. At least some of this spending involves imports of goods and services, and

wer interest rates and cheaper credit offered to households and �rms during 2011 and 2016 have

PAGE wer interest rates and cheaper credit offered to households and �rms during 2011 and 2016 have

encouraged more spending on imports of cars, electronics, clothes, overseas holidays and equipment, thus

PAGE encouraged more spending on imports of cars, electronics, clothes, overseas holidays and equipment, thus

wever, higher interest rates tend to discourage borrowing and spending on imports because of the

PAGE wever, higher interest rates tend to discourage borrowing and spending on imports because of the

increased costs of repaying debt. This should help reduce Australia’s CAD.PAGE increased costs of repaying debt. This should help reduce Australia’s CAD.A slight complication with interest rates is that they also affect the exchange rate and thus the CAD. For PAGE

A slight complication with interest rates is that they also affect the exchange rate and thus the CAD. For instance, we will soon see that reductions in interest rates by the RBA in 2011–16 relative to those abroad PAGE

instance, we will soon see that reductions in interest rates by the RBA in 2011–16 relative to those abroad

PROOFSdemand-side factors that greatly affect our spending on imports of both goods and services, thus affecting the

PROOFSdemand-side factors that greatly affect our spending on imports of both goods and services, thus affecting the

usinesses are more pessimistic about their future economic circumstances or expe

PROOFSusinesses are more pessimistic about their future economic circumstances or expe-

PROOFS-rience a fall in real household disposable income as occurred during 2013–15, they tend to save rather than

PROOFSrience a fall in real household disposable income as occurred during 2013–15, they tend to save rather than spend, thereby slowing their purchases of imports such as appliances, cars, overseas holidays, machinery

PROOFSspend, thereby slowing their purchases of imports such as appliances, cars, overseas holidays, machinery

aster rises in disposable income tend to cause spending on imports to rise,

PROOFSaster rises in disposable income tend to cause spending on imports to rise,

have an effect on the levels of both household consumption PROOFS

have an effect on the levels of both household consumption and business investment spending. At least some of this spending involves imports of goods and services, and PROOFS

and business investment spending. At least some of this spending involves imports of goods and services, and



Unfortunately, Australian households, businesses and governments generally do not save enough to �nance the high level of national investment spending by �rms and governments needed to grow the economy’s pro-ductive capacity and maintain high living standards. This causes Australia to have a large, long-term national savings–investment gap that has become the biggest single reason for our large structural CAD. Figure 3.11 illustrates this diagrammatically. Here, for example, national savings level of say, $200 billion a year, is insuf-�cient to �nance national investment of $300 billion a year. As a result, there has been an increase in foreign borrowing and liabilities of, say, $100 billion a year. This adds to our net foreign debt or NFD (the amount by which Australia’s liabilities abroad exceeds what people abroad owe us).

National savings byhouseholds,

businesses andgovernments

= $200 billion

National investmentby the private and

governmentsectors

= $300 billion

Savings–investment gap(�lled by overseas borrowing)

Valu

e ($

bill

ions

)

300

200

100

0

FIGURE 3.11 Australia’s savings–investment gap shown hypothetically

Australia’s NFD has increased from 46 per cent of GDP in 2002–03 to a record high of 61 per cent by 2014–15. This is largely attributed to rising private sector debt or equity. However, the return of massive government budget de�cits since 2008–09 (possibly to continue beyond 2019–20), partly �nanced by bor-rowing abroad, has pushed up our NFD. Additionally, as shown in �gure 3.12, private borrowing overseas by Australians is encouraged by higher interest rates here against those overseas.

Of�

cial

inte

rest

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e se

t by

the

cen

tral

bank

(pe

rcen

tage

)

Australia Euro area UnitedKingdom

USA Japan0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0.50

0.05 0.13 0.10

2.0

FIGURE 3.12 Differences between of�cial interest rates (percentage in July 2015) in Australia and those overseas contribute to our structural CAD and growing NFD.

Source: Data derived from RBA Statistics, Table F13.

We face high interest rates partly because of the relatively low supply of national savings (as a result of inadequate savings by Australian households, �rms and government) combined with a high demand for credit (by Australian governments, businesses and households). In turn, large interest rate differentials like these not only make Australia look attractive to foreign investors or lenders seeking relatively high returns, they also encourage Australians wanting cheaper credit to borrow overseas. Either way, this causes Australia’s NFD and the structural CAD to remain high, with potentially adverse implications for our living standards.

Additionally, when extra credit is sucked into Australia from overseas following rises in domestic interest rates, this helps to drive up the demand for the Australian dollar and tends to lift the exchange rate. In turn, this makes our exports of goods and services less competitive relative to imports, thereby worsening our long-term structural CAD. By contrast, when the RBA cuts domestic interest rates as a result of weaker economic activity (as happened in between 2011 and 2016), interest rate differentials between Australia and overseas narrow. In itself, this development should help to lower production costs locally, weaken the exchange rate (as a result of the exit of money capital) and stimulate exports relative to imports, perhaps reducing the CAD.

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Source: UNCORRECTED

Source: Data derived from RBA Statistics, Table F13.UNCORRECTED

Data derived from RBA Statistics, Table F13.

We face high interest rates partly because of the relatively low supply of national savings (as a result of UNCORRECTED

We face high interest rates partly because of the relatively low supply of national savings (as a result of

PAGE Australia’s savings–investment gap shown hypothetically

PAGE Australia’s savings–investment gap shown hypothetically

Australia’s NFD has increased from 46 per cent of GDP in 2002–03 to a record high of 61 per cent by

PAGE Australia’s NFD has increased from 46 per cent of GDP in 2002–03 to a record high of 61 per cent by

2014–15. This is largely attributed to rising private sector debt or equity. However, the return of massive

PAGE 2014–15. This is largely attributed to rising private sector debt or equity. However, the return of massive government budget de�cits since 2008–09 (possibly to continue beyond 2019–20), partly �nanced by bor

PAGE government budget de�cits since 2008–09 (possibly to continue beyond 2019–20), partly �nanced by borrowing abroad, has pushed up our NFD. Additionally, as shown in �gure 3.12, private borrowing overseas by

PAGE rowing abroad, has pushed up our NFD. Additionally, as shown in �gure 3.12, private borrowing overseas by Australians is encouraged by higher interest rates here against those overseas.PAGE Australians is encouraged by higher interest rates here against those overseas.

PROOFS

PROOFSNational investment

PROOFSNational investmentby the private and

PROOFSby the private and

government

PROOFSgovernment

sectors

PROOFSsectors

= $300 billion

PROOFS

= $300 billion

PROOFS



In contrast to the situation in Australia, countries that have relatively high levels of national savings often have a current account surplus (CAS) from receiving substantial primary income credits for interest from their loans abroad, and dividends and pro�ts from their ownership of shares and companies overseas.

Weaker growth in productivityProductivity indicates ef�ciency. There are two main measures of productivity. Labour productivity re�ects changes in GDP divided by the total number of hours worked, while multifactor productivity is calculated by dividing GDP by the total value of labour, capital and other inputs used. Ef�ciency levels are seen as an aggregate supply-side factor that can affect our competitiveness and the size of the country’s structural CAD.

Strong rises in labour and multifactor productivity during the 1990s meant more output per unit of labour and capital resources, lowering production costs for local �rms. Unfortunately, productivity has also been rela-tively weaker in recent years. This has adversely affected Australia’s international competitiveness, slowing export sales, lifting imports and adding to the structural CAD. Indeed, current ef�ciency levels in most indus-tries are only around 80 per cent of those in the United States, and even weaker relative to some other countries.

Changes in real unit labour costs (RULCs)Wages are the major production cost in many industries, often accounting for around 60–70 per cent of the overall total. Hence, the level of real wage costs per unit is an important aggregate supply-side factor that can help determine whether or not locally made goods and services can compete with imports. In turn, this affects our structural CAD. • Australia’s real unit labour costs recently recorded a zero increase, on average, during 2011–12 to 2014–15.

This helped to keep a key production cost lower, making our exports more competitive or attractive and tending to lower the structural CAD.

• Yet in absolute terms, Australia’s average hourly pay rates are almost the highest in the world, and we have the highest minimum wage of any country. From an economic perspective, this is a problem. It reduces our international competitiveness and net export sales, pushing up the structural CAD.

Severe climatic conditionsAustralia’s productive and export capacities are increasingly in�uenced by severe climatic conditions that have the ability to affect net exports of goods and services, and hence the structural CAD. • Droughts (to 2010, again in 2012–16), �oods (in 2011 and 2013), �res (in 2011 and 2013) and other extreme

weather events in eastern and northern parts of Australia, have limited our capacity to produce some exports. These include rural production (grains, meat, wool, fruit, vegetables), minerals (due to �ooded mines and destroyed transport infrastructure) and tourism (destroyed by storms and �oods). As a consequence of slowing exports and, in some cases, a greater food dependence on imports, the structural CAD was pushed higher.

• By contrast, ideal climatic events would increase the value of net exports and reduce the CAD.

Changes in oil pricesOil is an important production and distribution cost for many local producers. It is a signi�cant import item that is re�ected in the �nal selling price and hence competitiveness of locally produced goods and services. • High oil prices (over US$100 per barrel in 2008 and 2012) greatly increased the cost and value of Australia’s

oil imports (upon which we rely for around 60 per cent of our needs) and exerted upward pressure on the CAD and a downward force on the exchange rate.

• However, much lower oil prices (under US$50 per barrel in 2014–16) helped to reduce imports and took some pressure off our structural CAD.

Demographic events, including ageingA country’s population growth and age distribution is an aggregate supply factor that can affect our productive capacity, exports and the structural CAD. • Australia’s ageing population and decreasing participation rate slow the growth in labour resources and

increase wages. This reduces the competitiveness of our exports. Additionally, labour and skills shortages act as a bottleneck, limiting the growth of exports and adding to the structural CAD.

• Immigration on the other hand (around 190 000 per year, of whom around 65 per cent are skilled with an average age of around 37) is potentially a more favourable supply-side factor that keeps wage costs lower and eases labour bottlenecks. As a result, exports become more internationally competitive, thus tending to reduce our structural CAD.

Weblinks The weblinks in these activities are available in this chapter’s student resources in tab.• The relationship between the current account balance and exchange rates• Economics 1, Lecture 23: Exchange rates and balance of payments

UNCORRECTED weather events in eastern and northern parts of Australia, have limited our capacity to produce some exports.

UNCORRECTED weather events in eastern and northern parts of Australia, have limited our capacity to produce some exports. These include rural production (grains, meat, wool, fruit, vegetables), minerals (due to �ooded mines and

UNCORRECTED These include rural production (grains, meat, wool, fruit, vegetables), minerals (due to �ooded mines and destroyed transport infrastructure) and tourism (destroyed by storms and �oods). As a consequence of slowing

UNCORRECTED destroyed transport infrastructure) and tourism (destroyed by storms and �oods). As a consequence of slowing exports and, in some cases, a greater food dependence on imports, the structural CAD was pushed higher.

UNCORRECTED exports and, in some cases, a greater food dependence on imports, the structural CAD was pushed higher.

UNCORRECTED contrast, ideal climatic events would increase the value of net exports and reduce the CAD.

UNCORRECTED contrast, ideal climatic events would increase the value of net exports and reduce the CAD.

Oil is an important production and distribution cost for many local producers. It is a signi�cant import

UNCORRECTED

Oil is an important production and distribution cost for many local producers. It is a signi�cant import item that is re�ected in the �nal selling price and hence competitiveness of locally produced goods and services.

UNCORRECTED

item that is re�ected in the �nal selling price and hence competitiveness of locally produced goods and services.ver US$100 per barrel in 2008 and 2012) greatly increased the cost and value of Australia’s

UNCORRECTED

ver US$100 per barrel in 2008 and 2012) greatly increased the cost and value of Australia’s oil imports (upon which we rely for around 60 per cent of our needs) and exerted upward pressure on the

UNCORRECTED

oil imports (upon which we rely for around 60 per cent of our needs) and exerted upward pressure on the CAD and a downward force on the exchange rate.

UNCORRECTED

CAD and a downward force on the exchange rate.wever, much lower oil prices (under US$50 per barrel in 2014–16) helped to reduce imports and took

UNCORRECTED

wever, much lower oil prices (under US$50 per barrel in 2014–16) helped to reduce imports and took some pressure off our structural CAD.

UNCORRECTED

some pressure off our structural CAD.

UNCORRECTED

mographic events, including ageing

UNCORRECTED

mographic events, including ageingA country’s population growth and age distribution is an aggregate supply factor that can affect our productive

UNCORRECTED

A country’s population growth and age distribution is an aggregate supply factor that can affect our productive capacity, exports and the structural CAD.UNCORRECTED

capacity, exports and the structural CAD.Australia’UNCORRECTED

Australia’s ageing population and decreasing participation rate slow the growth in labour resources and UNCORRECTED

s ageing population and decreasing participation rate slow the growth in labour resources and increase wages. This reduces the competitiveness of our exports. Additionally, labour and skills shortages UNCORRECTED

increase wages. This reduces the competitiveness of our exports. Additionally, labour and skills shortages

PAGE the highest minimum wage of any country. From an economic perspective, this is a problem. It reduces our

PAGE the highest minimum wage of any country. From an economic perspective, this is a problem. It reduces our international competitiveness and net export sales, pushing up the structural CAD.

PAGE international competitiveness and net export sales, pushing up the structural CAD.

Australia’s productive and export capacities are increasingly in�uenced by severe climatic conditions that have

PAGE Australia’s productive and export capacities are increasingly in�uenced by severe climatic conditions that have the ability to affect net exports of goods and services, and hence the structural CAD.

PAGE the ability to affect net exports of goods and services, and hence the structural CAD.

ain in 2012–16), �oods (in 2011 and 2013), �res (in 2011 and 2013) and other extreme PAGE ain in 2012–16), �oods (in 2011 and 2013), �res (in 2011 and 2013) and other extreme

weather events in eastern and northern parts of Australia, have limited our capacity to produce some exports. PAGE

weather events in eastern and northern parts of Australia, have limited our capacity to produce some exports.

PROOFStries are only around 80 per cent of those in the United States, and even weaker relative to some other countries.

PROOFStries are only around 80 per cent of those in the United States, and even weaker relative to some other countries.

Wages are the major production cost in many industries, often accounting for around 60–70 per cent of the overall

PROOFSWages are the major production cost in many industries, often accounting for around 60–70 per cent of the overall total. Hence, the level of real wage costs per unit is an important aggregate supply-side factor that can help determine

PROOFStotal. Hence, the level of real wage costs per unit is an important aggregate supply-side factor that can help determine whether or not locally made goods and services can compete with imports. In turn, this affects our structural CAD.

PROOFSwhether or not locally made goods and services can compete with imports. In turn, this affects our structural CAD.

s real unit labour costs recently recorded a zero increase, on average, during 2011–12 to 2014–15.

PROOFSs real unit labour costs recently recorded a zero increase, on average, during 2011–12 to 2014–15.

This helped to keep a key production cost lower, making our exports more competitive or attractive and

PROOFSThis helped to keep a key production cost lower, making our exports more competitive or attractive and

et in absolute terms, Australia’s average hourly pay rates are almost the highest in the world, and we have PROOFS

et in absolute terms, Australia’s average hourly pay rates are almost the highest in the world, and we have the highest minimum wage of any country. From an economic perspective, this is a problem. It reduces our PROOFS

the highest minimum wage of any country. From an economic perspective, this is a problem. It reduces our




1 Identify and explain three important aggregate demand-side factors affecting Australia’s cyclical CAD.2 Identify and explain three important aggregate supply-side factors affecting Australia’s structural CAD.3 Explain the meaning of the savings–investment gap, giving reasons for its existence.




3.4 The net foreign debt (NFD)Foreign debt is often associated with a country not living within its means or paying its way in international �nancial transactions. Here we might think of the problems experienced in recent years by countries like Greece, Spain and Italy, where there has been poor �nancial management over many years. Hence, debt levels often tell us something about the country’s external situation.

De�nition of the NFD and NFENet foreign debt (NFD) is the difference in value between what Australia has borrowed from and owes over-seas (our liabilities) minus what Australia has lent or invested abroad (our assets). It is sometimes used as an indicator of Australia’s external position and includes borrowing through the issue of bonds, loans, advances and overdrafts.

The NFD differs from foreign equity (the ownership of assets like shares and property) because debt implies that there is an obligation to pay interest and, at some time in the future, to repay the original capital borrowed. As previously mentioned, the NFD is largely the consequence of a de�ciency of national savings by the pri-vate sector (households and �rms) and the public sector (various governments) to �nance our high levels of national investment. As mentioned already, this is called the savings–investment gap.

Foreign borrowing through the creation of debt is one type of overseas capital in�ow. The other (and much less signi�cant) type of capital in�ow is foreign equity. Net foreign equity (NFE) represents the excess value of foreign-owned Australian assets (such as property, shares and the retained earnings of overseas-owned com-panies operating here) over overseas assets owned by Australian residents.

Composition of and trends in the NFDAustralia’s NFD has grown quite rapidly over the last decade (see �gure 3.13). It is now almost $980 000 billion, or equal to over 61 per cent of GDP (as a measure of the overall size of the economy). For Australia, there are two main types of overseas borrowers: • of�cial (public or government sector) borrowers, who generate of�cial debt • non-of�cial (private sector) borrowers, who generate non-of�cial debt.

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et e

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Year

Of�cial or publicsector debt

Non-of�cial orprivate sector debt

Total NFD

FIGURE 3.13 The composition of Australia’s net foreign liabilities ($ billions at June)

Source: Data derived from RBA Statistics, International Trade and External Finance, Table I5.

UNCORRECTED vate sector (households and �rms) and the public sector (various governments) to �nance our high levels of

UNCORRECTED vate sector (households and �rms) and the public sector (various governments) to �nance our high levels of national investment. As mentioned already, this is called the savings–investment gap.

UNCORRECTED national investment. As mentioned already, this is called the savings–investment gap.Foreign borrowing through the creation of debt is one type of overseas capital in�ow. The other (and much

UNCORRECTED Foreign borrowing through the creation of debt is one type of overseas capital in�ow. The other (and much

less signi�cant) type of capital in�ow is foreign equity.

UNCORRECTED less signi�cant) type of capital in�ow is foreign equity. of foreign-owned Australian assets (such as property, shares and the retained earnings of overseas-owned com

UNCORRECTED of foreign-owned Australian assets (such as property, shares and the retained earnings of overseas-owned companies operating here) over overseas assets owned by Australian residents.

UNCORRECTED panies operating here) over overseas assets owned by Australian residents.

Composition of and trends in the NFD

UNCORRECTED

Composition of and trends in the NFDAustralia’s NFD has grown quite rapidly over the last decade (see �gure 3.13). It is now almost $980

UNCORRECTED

Australia’s NFD has grown quite rapidly over the last decade (see �gure 3.13). It is now almost $980ver 61 per cent of GDP (as a measure of the overall size of the economy). For Australia, there are

UNCORRECTED

ver 61 per cent of GDP (as a measure of the overall size of the economy). For Australia, there are main types of overseas borrowers:

UNCORRECTED

main types of overseas borrowers: (public or government sector) borrowers, who generate

UNCORRECTED

(public or government sector) borrowers, who generate non-of�cial

UNCORRECTED

non-of�cial (private sector) borrowers, who generate

UNCORRECTED

(private sector) borrowers, who generate

800000UNCORRECTED

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PAGE in value between what Australia has borrowed from and owes over

PAGE in value between what Australia has borrowed from and owes over what Australia has lent or invested abroad (our assets). It is sometimes used as an

PAGE what Australia has lent or invested abroad (our assets). It is sometimes used as an indicator of Australia’s external position and includes borrowing through the issue of bonds, loans, advances

PAGE indicator of Australia’s external position and includes borrowing through the issue of bonds, loans, advances

The NFD differs from foreign equity (the ownership of assets like shares and property) because debt implies

PAGE The NFD differs from foreign equity (the ownership of assets like shares and property) because debt implies

that there is an obligation to pay interest and, at some time in the future, to repay the original capital borrowed.

PAGE that there is an obligation to pay interest and, at some time in the future, to repay the original capital borrowed. As previously mentioned, the NFD is largely the consequence of a de�ciency of national savings by the priPAGE As previously mentioned, the NFD is largely the consequence of a de�ciency of national savings by the private sector (households and �rms) and the public sector (various governments) to �nance our high levels of PAGE

vate sector (households and �rms) and the public sector (various governments) to �nance our high levels of

PROOFS

PROOFS

PROOFSpaying its way

PROOFSpaying its way in international

PROOFS in international

�nancial transactions. Here we might think of the problems experienced in recent years by countries like

PROOFS�nancial transactions. Here we might think of the problems experienced in recent years by countries like Greece, Spain and Italy, where there has been poor �nancial management over many years. Hence, debt levels

PROOFSGreece, Spain and Italy, where there has been poor �nancial management over many years. Hence, debt levels

in value between what Australia has borrowed from and owes overPROOFS

in value between what Australia has borrowed from and owes over



1. Public sector or of�cial government borrowingDuring and following the global �nancial crisis (GFC) of 2008–10, the federal and some state and local governments borrowed money overseas to help �nance their often large budget de�cits (the federal budget de�cits alone total around $325 billion over eight years). To the extent to which governments depended on credit sourced overseas, this added to our NFD. Indeed, in 2014–15 the of�cial or public sector’s foreign debt comprised approximately 25 per cent of our overall NFD.

2. Private sector or non-of�cial borrowingThe main private sector or non-of�cial borrowers are large companies that need to raise capital for �nancing business expansion and takeovers. Part of this represents net foreign equities that arise from the excess value of foreign-owned Australian assets (like companies, shares and property) over overseas assets owned by Australian residents. Additionally, our banks now source from overseas a large proportion of the money they use for lending to households and �rms. Indeed, Australia’s high domestic interest rates and lack of national savings have exacerbated this problem.

Contrary to popular opinion, debt is not always bad. It can be good — provided it is used wisely for sound investment projects that deliver ongoing returns and future bene�ts. Our overseas debt can also make up for the de�ciency in local savings and make access to credit more affordable when domestic interest rates are high. However, as with all debt, the main problem is affording the interest payments. When the Australian dollar depreciates, the debt burden (if denominated in a stronger currency like the US dollar) may become very heavy indeed. Interest and other repayments then require more Australian dollars to be converted into other currencies. Additionally, if our foreign debt rises too quickly and exceeds our capacity to sustain repayments, our credit rating as a nation may be downgraded by rating agencies (Standard & Poors or Moody’s) to re�ect a higher risk. This downgrading translates into even higher domestic interest rates (as found in countries with high levels of sovereign or government debt like Greece).

Causes of the net foreign debtThere are many reasons for the rise in Australia’s NFD, some of which have already been mentioned: • Lack of domestic savings. We have a national savings–investment gap, where current savings by Australian

households, businesses and governments are not suf�cient to �nance our high levels of investment. This has contributed to our interest rates being high relative to those abroad. In turn, high domestic interest rates encourage our banks, businesses and governments to borrow overseas, thereby adding to our NFD.

• Many budget de�cits. The recent slowdown in Australia’s economic activity has led to expansionary government budget de�cits (where the value of the government’s budget outlays is greater than the value of budget receipts) between 2008 and 2016, which were designed to stimulate spending. In part, these de�cits were �nanced by borrowing abroad, usually by selling government bonds.

• Opportunities for foreign investors. Because of Australia’s vast natural resources, there are many oppor-tunities for foreign investors to make high returns. Although this in�ow of investment capital helps grow our economy’s productive capacity, it also adds to our external liabilities.

• Sound economic, political and social climate. Australia offers foreign investors a relatively stable economic and political environment, with sound infrastructure, ef�cient institutions (including the legal and �nancial systems), and an educated and skilled labour force. In addition, Australia is regarded as a good place to live and hence there has been massive foreign investment in residential property. In addition, countries like China are using rural investment here to enhance their food and resource security at home. This adds to our external liabilities.

• A lower value for the Australian dollar. A lower Australian dollar, as seen recently between 2013 and 2016, makes the purchase of our assets (businesses, shares, property) by non-residents relatively cheaper and hence more attractive. This adds to Australia’s external liabilities.

• Financial sector deregulation and globalisation. In recent decades, there has been considerable �nancial sector deregulation. Combined with trade liberalisation, deregulation has increased overseas capital in�ow and foreign ownership of assets like businesses, shares and property, despite supervision of large projects by the Foreign Investment Review Board (FIRB).

The effects of Australia’s foreign debtForeign debt can have both positive and negative effects for a country.

Some bene�ts of foreign debtSustainable levels of debt can be a good thing, providing that it is used wisely to �nance investment expendi-ture rather than consumption spending. Foreign debt provides the following bene�ts: • Finance for expansion. Foreign debt can make up for a de�ciency in local savings, which are needed to

�nance investment and business expansion, expand GDP and create new jobs. • Access to cheaper credit. As Australian interest rates are often higher than rates overseas, foreign debt can

provide access to cheaper credit.

UNCORRECTED has contributed to our interest rates being high relative to those abroad. In turn, high domestic interest rates

UNCORRECTED has contributed to our interest rates being high relative to those abroad. In turn, high domestic interest rates encourage our banks, businesses and governments to borrow overseas, thereby adding to our NFD.

UNCORRECTED encourage our banks, businesses and governments to borrow overseas, thereby adding to our NFD.The recent slowdown in Australia’s economic activity has led to expansionary

UNCORRECTED The recent slowdown in Australia’s economic activity has led to expansionary government budget de�cits (where the value of the government’s budget outlays is greater than the value of

UNCORRECTED government budget de�cits (where the value of the government’s budget outlays is greater than the value of budget receipts) between 2008 and 2016, which were designed to stimulate spending. In part, these de�cits

UNCORRECTED budget receipts) between 2008 and 2016, which were designed to stimulate spending. In part, these de�cits were �nanced by borrowing abroad, usually by selling government bonds.

UNCORRECTED were �nanced by borrowing abroad, usually by selling government bonds.

or foreign investors.

UNCORRECTED or foreign investors. Because of Australia’s vast natural resources, there are many oppor

UNCORRECTED Because of Australia’s vast natural resources, there are many oppor

tunities for foreign investors to make high returns. Although this in�ow of investment capital helps grow our

UNCORRECTED tunities for foreign investors to make high returns. Although this in�ow of investment capital helps grow our economy’s productive capacity, it also adds to our external liabilities.

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economy’s productive capacity, it also adds to our external liabilities.Sound economic, political and social climate.

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Sound economic, political and social climate.political environment, with sound infrastructure, ef�cient institutions (including the legal and �nancial systems),

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political environment, with sound infrastructure, ef�cient institutions (including the legal and �nancial systems), and an educated and skilled labour force. In addition, Australia is regarded as a good place to live and hence there

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and an educated and skilled labour force. In addition, Australia is regarded as a good place to live and hence there has been massive foreign investment in residential property. In addition, countries like China are using rural

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has been massive foreign investment in residential property. In addition, countries like China are using rural investment here to enhance their food and resource security at home. This adds to our external liabilities.

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investment here to enhance their food and resource security at home. This adds to our external liabilities.lower value for the Australian dollar.

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lower value for the Australian dollar. 2016, makes the purchase of our assets (businesses, shares, property) by non-residents relatively cheaper

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2016, makes the purchase of our assets (businesses, shares, property) by non-residents relatively cheaper and hence more attractive. This adds to Australia’s external liabilities.

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and hence more attractive. This adds to Australia’s external liabilities.Financial sector der

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Financial sector der

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sector deregulation. Combined with trade liberalisation, deregulation has increased overseas capital in�ow UNCORRECTED

sector deregulation. Combined with trade liberalisation, deregulation has increased overseas capital in�ow and foreign ownership of assets like businesses, shares and property, despite supervision of large projects by UNCORRECTED

and foreign ownership of assets like businesses, shares and property, despite supervision of large projects by

PAGE There are many reasons for the rise in Australia’s NFD, some of which have already been mentioned:

PAGE There are many reasons for the rise in Australia’s NFD, some of which have already been mentioned:

We have a national savings–investment gap, where current savings by

PAGE We have a national savings–investment gap, where current savings by

usinesses and governments are not suf�cient to �nance our high levels of investment. This PAGE usinesses and governments are not suf�cient to �nance our high levels of investment. This

has contributed to our interest rates being high relative to those abroad. In turn, high domestic interest rates PAGE has contributed to our interest rates being high relative to those abroad. In turn, high domestic interest rates encourage our banks, businesses and governments to borrow overseas, thereby adding to our NFD.PAGE

encourage our banks, businesses and governments to borrow overseas, thereby adding to our NFD.

PROOFSuse for lending to households and �rms. Indeed, Australia’s high domestic interest rates and lack of national

PROOFSuse for lending to households and �rms. Indeed, Australia’s high domestic interest rates and lack of national

Contrary to popular opinion, debt is not always bad. It can be good — provided it is used wisely for sound

PROOFSContrary to popular opinion, debt is not always bad. It can be good — provided it is used wisely for sound investment projects that deliver ongoing returns and future bene�ts. Our overseas debt can also make up for

PROOFSinvestment projects that deliver ongoing returns and future bene�ts. Our overseas debt can also make up for the de�ciency in local savings and make access to credit more affordable when domestic interest rates are

PROOFSthe de�ciency in local savings and make access to credit more affordable when domestic interest rates are high. However, as with all debt, the main problem is affording the interest payments. When the Australian

PROOFShigh. However, as with all debt, the main problem is affording the interest payments. When the Australian dollar depreciates, the debt burden (if denominated in a stronger currency like the US dollar) may become very

PROOFSdollar depreciates, the debt burden (if denominated in a stronger currency like the US dollar) may become very heavy indeed. Interest and other repayments then require more Australian dollars to be converted into other

PROOFSheavy indeed. Interest and other repayments then require more Australian dollars to be converted into other currencies. Additionally, if our foreign debt rises too quickly and exceeds our capacity to sustain repayments,

PROOFScurrencies. Additionally, if our foreign debt rises too quickly and exceeds our capacity to sustain repayments, our credit rating as a nation may be downgraded by rating agencies (Standard & Poors or Moody’s) to re�ect

PROOFS

our credit rating as a nation may be downgraded by rating agencies (Standard & Poors or Moody’s) to re�ect a higher risk. This downgrading translates into even higher domestic interest rates (as found in countries with PROOFS

a higher risk. This downgrading translates into even higher domestic interest rates (as found in countries with



Some costs of foreign debtThere are some downsides to foreign debt: • Creation of economic hardship. As with all debt, the main problem is repaying interest and the principal.

Excessive levels of government or sovereign debt create great hardship, forcing governments to lift taxes and cut spending, contracting economic activity. As seen in some European countries like Greece, this causes economic activity to shrink and unemployment to rise.

• The burden of debt repayment. The burden of debt repayment is especially heavy if the debt is expressed in another currency and the value of the Australian dollar falls against that currency. It can mean a reduction in our credit rating and, ultimately, higher interest rates.

• Adds to the CAD. The NFD is the major reason for Australia’s large de�cit in net primary incomes and our big CAD. This ultimately weakens the currency and diminishes its purchasing power.

Weblinks The weblinks in these activities are available in this chapter’s student resources tab.• Foreign-held public debt and �scal sustainability: Is China owning the US?• Top 10 countries with largest external debt• Foreign debt


1 What is the NFD? How is this different from the NFE?2 Identify and explain three causes of Australia’s NFD.3 Identify and discuss two important costs and two bene�ts of a rise in Australia’s NFD.




3.5 The terms of tradeThe terms of trade (TOT) measures the ratio for the average price the world is prepared to pay Australia for our exports against the average price we pay the world for our imports. Put another way, it is the amount of imported goods that can be purchased with a unit of exported goods. • The TOT is said to rise or become more favourable for a country when the export prices we receive rise faster,

or fall less, than import prices. As a result, a nation can purchase more imports with a unit of its exports. • The TOT is regarded as less favourable for a country when export prices rise more slowly, or fall more

quickly, than import prices. As a result, a nation can purchase fewer imports with a given unit of its exports.

Measurement of the terms of tradeThe TOT is measured by means of an index that uses a base year (where the index equals 100 points) to com-pare following years.

The terms of trade index (TOT) =Export price index

× 100Import price index

Here the export price index is constructed by measuring changes in the average prices of a basket of Australian exported goods, with items weighted according to their relative importance in trade. Similarly, the import price index measures changes in the average prices of our imported goods, with items weighted according to their relative importance.

The TOT is primarily regarded as an aggregate demand factor affecting spending levels. This is because the prices we receive or pay in international transactions affect the value of our exports and the value of our imports. When, for example, the world chooses to pay us lower prices for our exports (as happened with our

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UNCORRECTED Apply your understanding of this subtopic by accessing and completing the Applied economic exercise(s).



UNCORRECTED School-assessed coursework > Applied economic exercises >

3.5 The terms of trade

UNCORRECTED 3.5 The terms of trade

measures the ratio for the average price the world is prepared to pay Australia for

UNCORRECTED measures the ratio for the average price the world is prepared to pay Australia for

our exports against the average price we pay the world for our imports. Put another way, it is the amount of

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our exports against the average price we pay the world for our imports. Put another way, it is the amount of

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imported goods that can be purchased with a unit of exported goods.

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imported goods that can be purchased with a unit of exported goods.TOT is said to rise or become

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TOT is said to rise or become or fall less, than import prices. As a result, a nation can purchase more imports with a unit of its exports.

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or fall less, than import prices. As a result, a nation can purchase more imports with a unit of its exports.TOT is regarded as

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TOT is regarded as quickly, than import prices. As a result, a nation can purchase fewer imports with a given unit of its

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quickly, than import prices. As a result, a nation can purchase fewer imports with a given unit of its exports.

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exports.

Measurement of the terms of trade

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Measurement of the terms of tradeThe TOT is measured by means of an index that uses a base year (where the index equals 100 points) to com

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The TOT is measured by means of an index that uses a base year (where the index equals 100 points) to compare following years.UNCORRECTED

pare following years.

PAGE

PAGE

PAGE Identify and discuss two important costs and two bene�ts of a rise in Australia’

PAGE Identify and discuss two important costs and two bene�ts of a rise in Australia’

PAGE

PAGE

Apply your understanding of this subtopic by accessing and completing the Applied economic exercise(s).PAGE


PROOFS

PROOFS

PROOFS

PROOFS

PROOFS



commodities during 2013–16) because of weaker demand, this normally causes a drop in the value of exports sold. In turn, this tends to slow AD and economic activity. In reverse, if the world pays generally higher prices for our exports because there is a shortage or demand is strong, this normally boosts the value of exports and strengthens our level of AD and economic activity.

Trends in Australia’s terms of trade indexAs can be seen in �gure 3.14, Australia initially enjoyed stronger TOT between 2009–10 and 2011–12, but there was a spectacular deterioration in the subsequent years to 2014–15 as export prices fell relative to import prices.

95.6

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Trends in Australia’s export and import price indexes and the terms of trade index

Year

Export price indexat June

Import price indexat June

Australia’s termsof trade index atJune (base year2012–13 = 100index points)

FIGURE 3.14 How changes in export and import prices affect Australia’s terms of trade index

Sources: Data for the terms of trade index derived from ABS 5206.0 (Table 3); data for the export and import price indexes derived from ABS 6457.0 (Tables 1, 3, 12, 7, 9).

Factors that may in�uence the terms of tradeAustralia’s TOT display the prices received for the basket of our exports and those paid for a basket of imports in world markets. In turn, these re�ect the various conditions of demand for our exports and imports, and the global conditions of supply of exports and imports. Assuming that global competition is reasonable and coun-tries are price takers, the price of each good (Pe) is largely determined by its level of demand (D) and supply (S) at market equilibrium (E). This situation is shown hypothetically in �gure 3.15.

A demand-supply diagram representing the internationalmarket for an exported or imported good

Mar

ket

pric

e ($

)/ u

nit

Glut Supply (S) of a good

Pe

ShortageDemand (D) for a good

Quantity of a good (Q)Qe

Equilibrium (E)

FIGURE 3.15 How demand and supply of each good traded might determine its market price and thus in�uence Australia’s terms of trade.

UNCORRECTED How changes in export and import prices affect Australia’s terms of trade index

UNCORRECTED How changes in export and import prices affect Australia’s terms of trade index

Data for the terms of trade index derived from ABS 5206.0 (Table 3); data for the export and import price indexes derived

UNCORRECTED Data for the terms of trade index derived from ABS 5206.0 (Table 3); data for the export and import price indexes derived

Factors that may in�uence the terms of trade

UNCORRECTED Factors that may in�uence the terms of trade

received for the basket of our exports and those paid for a basket of imports

UNCORRECTED received for the basket of our exports and those paid for a basket of imports

UNCORRECTED

in world markets. In turn, these re�ect the various

UNCORRECTED

in world markets. In turn, these re�ect the various of exports and imports. Assuming that global competition is reasonable and coun

UNCORRECTED

of exports and imports. Assuming that global competition is reasonable and countries are price takers, the price of each good (P

UNCORRECTED

tries are price takers, the price of each good (P(S) at market equilibrium (E). This situation is shown hypothetically in �gure 3.15.

UNCORRECTED

(S) at market equilibrium (E). This situation is shown hypothetically in �gure 3.15.

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How changes in export and import prices affect Australia’s terms of trade indexPAGE

How changes in export and import prices affect Australia’s terms of trade index

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFSExport price index

PROOFSExport price indexat June

PROOFSat June

Import price index

PROOFSImport price index

Australia’s terms

PROOFSAustralia’s termsof trade index at

PROOFSof trade index atJune (base year

PROOFSJune (base year2012–13 = 100

PROOFS2012–13 = 100index points)

PROOFSindex points)

PROOFS



Changes in global conditions of demandThe level of world demand for Australia’s exports has a tremendous in�uence on the prices we are paid and hence our TOT. This is shown in �gure 3.16.

A demand-supply diagram representing the internationalmarket for Australia’s exports given a general decrease

or increase in their demand (relative to supply)

Mar

ket

pric

e ($

)/ u

nit

S1

D1

Pe2

Pe1

Pe0

D0(a decrease)

E2

E1

E0

D2 (an increase)

Qe0 Qe1 Qe2

Quantity of a good (Q)

FIGURE 3.16 How a general increase or decrease in the demand for our exported goods might help to cause their price to rise or fall, thus affecting Australia’s terms of trade.

Hence, when there is an overall decrease in the global demand for Australian exports of commodities (like wheat, beef, wool, coal and iron ore) and manufactured items (relative to their global supply) at a given price (D1 to D0), the prices we receive for exports are lower (P1 to P0), perhaps depressing the TOT. Global demand for our exports may decrease as a result of several factors: • weaker economic growth in our major trading partners like China (as occurred 2013–16), Japan or the United States • depressed consumer and business con�dence abroad reducing the demand for exports of our goods • reduced growth rates in global disposable income or population.

In reverse, when there is an increase in the global demand for our exports (D1 to D2) at a given price (rela-tive to their global supply), this tends to cause a rise in export prices (P1 to P2), perhaps increasing our terms of trade. Global demand for our exports may increase as a result of several factors: • stronger economic activity among our major trading partners • greater consumer and business optimism overseas • faster growth rates in global disposable income or population.

So far we have looked at how a general increase or decrease in world demand for Australian exports affects our export prices and hence the TOT. Let us turn now to consider how the global conditions of supply can affect our terms of trade.

Changes in global conditions of supplyChanges in the global supply of commodities that Australia exports also have a signi�cant in�uence on the prices we are paid and hence our TOT. This is illustrated in �gure 3.17

A demand-supply diagram representing the international market forAustralia’s exports given a general decrease or increase in their

supply (relative to demand)

Mar

ket

pric

e ($

)/ u

nit

S0 (a decrease) S1 S2 (an increase)

E0

E1

E2

D1

P0

Qe0

Quantity of a good (Q)

Qe1 Qe2

Pe1

P2

FIGURE 3.17 How a general increase or decrease in the supply of traded goods might help to cause a rise or fall in export prices, thus affecting Australia’s terms of trade.

UNCORRECTED increase in the global demand

UNCORRECTED increase in the global demandtive to their global supply), this tends to cause a rise in export

UNCORRECTED tive to their global supply), this tends to cause a rise in export of trade. Global demand for our exports may

UNCORRECTED of trade. Global demand for our exports may increase

UNCORRECTED increase

economic activity among our major trading partners

UNCORRECTED economic activity among our major trading partners

consumer and business optimism overseas

UNCORRECTED consumer and business optimism overseas

UNCORRECTED aster growth rates in global disposable income or population.

UNCORRECTED aster growth rates in global disposable income or population.

So far we have looked at how a general increase or decrease in world

UNCORRECTED So far we have looked at how a general increase or decrease in world

our export prices and hence the TOT. Let us turn now to consider how the global conditions of

UNCORRECTED our export prices and hence the TOT. Let us turn now to consider how the global conditions of

Changes in global conditions of supply

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Changes in global conditions of supply

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global supply

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global supplyprices we are paid and hence our TOT. This is illustrated in �gure 3.17

UNCORRECTED

prices we are paid and hence our TOT. This is illustrated in �gure 3.17

PAGE for Australian exports of commodities (like

PAGE for Australian exports of commodities (like wheat, beef, wool, coal and iron ore) and manufactured items (relative to their global supply) at a given price

PAGE wheat, beef, wool, coal and iron ore) and manufactured items (relative to their global supply) at a given price 0

PAGE 0), perhaps depressing the TOT. Global demand

PAGE ), perhaps depressing the TOT. Global demand

er economic growth in our major trading partners like China (as occurred 2013–16), Japan or the United States

PAGE er economic growth in our major trading partners like China (as occurred 2013–16), Japan or the United States

consumer and business con�dence abroad reducing the demand for exports of our goods

PAGE consumer and business con�dence abroad reducing the demand for exports of our goods

growth rates in global disposable income or population.PAGE growth rates in global disposable income or population.

increase in the global demandPAGE

increase in the global demandtive to their global supply), this tends to cause a rise in export PAGE

tive to their global supply), this tends to cause a rise in export

PROOFS

PROOFSHow a general increase or decrease in the demand for our exported goods might help to cause their

PROOFSHow a general increase or decrease in the demand for our exported goods might help to cause their

for Australian exports of commodities (like PROOFS

for Australian exports of commodities (like wheat, beef, wool, coal and iron ore) and manufactured items (relative to their global supply) at a given price PROOFS

wheat, beef, wool, coal and iron ore) and manufactured items (relative to their global supply) at a given price



Hence, when there is an increase in the global supply (S1 to S2) of the commodities Australia exports (like wheat, beef, wool, coal and iron ore) and manufactured items (relative to their global demand) at a given price, the general prices we receive for exports are lower (P1 to P2). This tends to make our TOT less favourable. Global supply of the things we export may increase due to the following: • new discoveries of minerals or the opening of new mines • the effect of new technology on productivity and hence production • domestic and international growing conditions for crops.

By contrast, when there is a decrease in the global supply of the commodities and goods that Australia exports at a given price (S1 to S0), the prices received tend to rise (P1 to P0), and with them, possibly our terms of trade. Supply might fall due to the following: • resource depletion and exhaustion • declining productivity • severe climatic conditions here and overseas.

Effects of movements in the terms of tradeAustralia’s TOT has signi�cant effects, not just on the CAD and exchange rate, but also on AD and the level of domestic economic activity.

Effects of the terms of trade on Australia’s CADWhen the terms of trade rise or fall (due to changes in our export prices relative to import prices), this will affect the values of both exports and imports and hence the size of Australia’s CAD. • A fall in the TOT tends to cause the CAD to rise. This is because when we receive lower prices, for example,

it often means that there is a relatively weaker demand internationally for our exports. In turn, the value of credits for our exports usually decreases, while dearer global prices paid by us for imports tend to increase the value of import debits.

• A rise in the TOT usually results in a decrease in the CAD due to higher prices causing a rise in the value of credits for exports relative to debits for imports.

Effects of the terms of trade on Australia’s exchange rateChanges in the TOT have a powerful effect on the exchange rate for the Australian dollar. Our dollar’s exchange rate or value is what it is worth when swapped for other currencies to help facilitate international transactions between countries. The exchange rate is determined in the foreign exchange market by buyers (D) and sellers (S) of the currency. A rise in the D for our currency relative to its S will push the dollar higher, while a fall in D relative to S will weaken the exchange rate. • A fall in our TOT tends to weaken Australia’s exchange rate. This is because lower export prices often

indicate that there is relatively less international demand for our exports. This tends to reduce the value of exports relative to imports, in turn causing a decrease in the demand for the Australian dollar relative to its supply in the foreign exchange market. This weakens the exchange rate.

• A rise in our TOT often pushes up the value of the Australian dollar. This is because receiving better export prices relative to those paid for imports tends to increase the value of net exports. In turn, this means there is a rise in the demand for the dollar relative to its supply, causing the dollar to strengthen.

Effects of the terms of trade on AD and domestic economic activityThe TOT is an aggregate demand-side factor that can affect the level of spending and economic activity. • A decline in the TOT tends to weaken the value of our export sales relative to import spending, and hence

in itself tends to slow AD and the level of economic activity. • A rise in the TOT, which means receiving better prices for our exports relative to those paid for imports,

tends to boost the value of net exports, AD and domestic economic activity.

Weblinks The weblinks in these activities are available in this chapter’s student resources tab.• Comparative advantage and terms of trade, ACDC Econ 1.3• Why are commodity prices falling?


1 Explain what is meant by the TOT, noting how it is measured.2 What is meant by the phrase less favourable TOT for Australia?3 Identify and explain how both demand and supply factors can affect Australia’s TOT.4 Explain how you would expect a fall in Australia’s TOT to affect each of the following variables:

a the CAD b the exchange rate.

UNCORRECTED rate or value is what it is worth when swapped for other currencies to help facilitate international transactions

UNCORRECTED rate or value is what it is worth when swapped for other currencies to help facilitate international transactions between countries. The exchange rate is determined in the foreign exchange market by buyers (D) and sellers

UNCORRECTED between countries. The exchange rate is determined in the foreign exchange market by buyers (D) and sellers (S) of the currency. A rise in the D for our currency relative to its S will push the dollar higher, while a fall in

UNCORRECTED (S) of the currency. A rise in the D for our currency relative to its S will push the dollar higher, while a fall in

in our TOT tends to weaken Australia’s exchange rate. This is because lower export prices often

UNCORRECTED in our TOT tends to weaken Australia’s exchange rate. This is because lower export prices often

indicate that there is relatively less international demand for our exports. This tends to reduce the value of

UNCORRECTED indicate that there is relatively less international demand for our exports. This tends to reduce the value of exports relative to imports, in turn causing a decrease in the demand for the Australian dollar relative to its

UNCORRECTED exports relative to imports, in turn causing a decrease in the demand for the Australian dollar relative to its supply in the foreign exchange market. This weakens the exchange rate.

UNCORRECTED

supply in the foreign exchange market. This weakens the exchange rate. in our TOT often pushes up the value of the Australian dollar. This is because receiving better export

UNCORRECTED

in our TOT often pushes up the value of the Australian dollar. This is because receiving better export prices relative to those paid for imports tends to increase the value of net exports. In turn, this means there

UNCORRECTED

prices relative to those paid for imports tends to increase the value of net exports. In turn, this means there is a rise in the demand for the dollar relative to its supply, causing the dollar to strengthen.

UNCORRECTED

is a rise in the demand for the dollar relative to its supply, causing the dollar to strengthen.

fects of the terms of trade on

UNCORRECTED

fects of the terms of trade on The TOT is an aggregate demand-side factor that can affect the level of spending and economic activity.

UNCORRECTED

The TOT is an aggregate demand-side factor that can affect the level of spending and economic activity. in the TOT tends to weaken the value of our export sales relative to import spending, and hence

UNCORRECTED

in the TOT tends to weaken the value of our export sales relative to import spending, and hence in itself tends to slow AD and the level of economic activity.

UNCORRECTED

in itself tends to slow AD and the level of economic activity. in the TOT, which means receiving better prices for our exports relative to those paid for imports,

UNCORRECTED

in the TOT, which means receiving better prices for our exports relative to those paid for imports, tends to boost the value of net exports, AD and domestic economic activity.

UNCORRECTED

tends to boost the value of net exports, AD and domestic economic activity.

UNCORRECTED

UNCORRECTED

UNCORRECTED PAGE credits for our exports usually decreases, while dearer global prices paid by us for imports tend to increase

PAGE credits for our exports usually decreases, while dearer global prices paid by us for imports tend to increase

in the TOT usually results in a decrease in the CAD due to higher prices causing a rise in the value

PAGE in the TOT usually results in a decrease in the CAD due to higher prices causing a rise in the value

ustralia’s exchange rate

PAGE ustralia’s exchange rate

Changes in the TOT have a powerful effect on the exchange rate for the Australian dollar. Our dollar’s exchange PAGE Changes in the TOT have a powerful effect on the exchange rate for the Australian dollar. Our dollar’s exchange rate or value is what it is worth when swapped for other currencies to help facilitate international transactions PAGE

rate or value is what it is worth when swapped for other currencies to help facilitate international transactions between countries. The exchange rate is determined in the foreign exchange market by buyers (D) and sellers PAGE

between countries. The exchange rate is determined in the foreign exchange market by buyers (D) and sellers

PROOFSAustralia’s TOT has signi�cant effects, not just on the CAD and exchange rate, but also on AD and the level

PROOFSAustralia’s TOT has signi�cant effects, not just on the CAD and exchange rate, but also on AD and the level

When the terms of trade rise or fall (due to changes in our export prices relative to import prices), this will

PROOFSWhen the terms of trade rise or fall (due to changes in our export prices relative to import prices), this will

in the TOT tends to cause the CAD to rise. This is because when we receive lower prices, for example,

PROOFS

in the TOT tends to cause the CAD to rise. This is because when we receive lower prices, for example, it often means that there is a relatively weaker demand internationally for our exports. In turn, the value of PROOFS

it often means that there is a relatively weaker demand internationally for our exports. In turn, the value of credits for our exports usually decreases, while dearer global prices paid by us for imports tend to increase PROOFS

credits for our exports usually decreases, while dearer global prices paid by us for imports tend to increase






3.6 The exchange rateBecause different countries use different currencies, it is necessary to swap or exchange currencies when con-ducting international trade and other �nancial transactions.

Determination and measurement of the exchange rateThe exchange rate measures the price or value of the Australian dollar when it is swapped for other cur-rencies. Exchanging currencies is necessary because a nation’s residents normally want to be paid in the cur-rency unit appropriate for their country. These days, Australia has a �oating exchange rate. Here, the value or the equilibrium price for the Australian dollar is decided in the foreign exchange market by currency buyers (demanders) and currency sellers (suppliers). This is shown in �gure 3.18.

Equilibrium quantity(Quantity of A$ bought or sold)

Equilibrium

Equ

ilibr

ium

pri

ce o

f A

$or

exc

hang

e ra

teA

ctua

l ER

The exchange rate (ER)or price of the A$

A$depreciates

A$appreciates

Supply/ salesof A$ by sellers

Demandfor A$ by buyers

D = S

Supply > demandfor A$

Shortageof A$

Demand > supplyfor A$

Glutof A$

FIGURE 3.18 How the exchange rate is determined in the foreign exchange market for the Australian dollar (A$)

The exchange rate for the Australian dollar will appreciate (rise) in the foreign exchange market when there is less selling (a decrease in supply) or more buying (an increase in demand) of our currency. This may follow stronger than expected trade �gures, improvements in the terms of trade, strong overseas economic activity, rises in domestic interest rates relative to overseas rates, speculation of a rising dollar, and improved price competitiveness of our economy against prices in economies overseas. However, the exchange rate will depreciate (fall) when there is more selling and less buying of our dollar. This may re�ect rapid dom-estic economic growth, strong consumer and business con�dence locally, cuts in local interest rates, global recession, depressed commodity prices, and the release of worse than expected trade �gures. One conse-quence of a �oating exchange rate like this is that market forces (i.e. the demand and supply for the Aus-tralian dollar) sometimes create instability and unpredictability in the exchange rate for the Australian dollar.

There are two main measures of Australia’s exchange rate — individual exchange rates and the trade weighted index (TWI).1. Individual exchange rates. The Australian dollar has a separate exchange rate for every currency in the

world, including the rate for US dollars, the euro, British pounds sterling, Japanese yen, Chinese renminbi and the Indonesian rupiah. These rates express how many currency units for each country can be purchased with one Australian dollar.

2. Trade weighted index (TWI). The trade weighted index (TWI) represents the average exchange rate for a basket of foreign currencies weighted according to their relative importance for Australia’s trade (for example, the US dollar is weighted more heavily than the Indonesian rupiah). Because the TWI is an index, a base year (May 1970) is used to compare changes in the currency’s value in subsequent years.

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UNCORRECTED Shortage

UNCORRECTED Shortageof A$

UNCORRECTED of A$of A$

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Demand > supply

UNCORRECTED Demand > supplyDemand > supply

UNCORRECTED Demand > supply

for A$

UNCORRECTED for A$

UNCORRECTED

How the exchange rate is determined in the foreign exchange market for the Australian dollar (A$)

UNCORRECTED

How the exchange rate is determined in the foreign exchange market for the Australian dollar (A$)

The exchange rate for the Australian dollar will

UNCORRECTED

The exchange rate for the Australian dollar will there is less selling (a decrease in supply) or more buying (an increase in demand) of our currency. This may

UNCORRECTED

there is less selling (a decrease in supply) or more buying (an increase in demand) of our currency. This may follow stronger than expected trade �gures, improvements in the terms of trade, strong overseas economic

UNCORRECTED

follow stronger than expected trade �gures, improvements in the terms of trade, strong overseas economic activity, rises in domestic interest rates relative to overseas rates, speculation of a rising dollar, and improved

UNCORRECTED

activity, rises in domestic interest rates relative to overseas rates, speculation of a rising dollar, and improved price competitiveness of our economy against prices in economies overseas. However, the exchange rate

UNCORRECTED

price competitiveness of our economy against prices in economies overseas. However, the exchange rate will

UNCORRECTED

will depreciate

UNCORRECTED

depreciate estic economic growth, strong consumer and business con�dence locally, cuts in local interest rates, global UNCORRECTED

estic economic growth, strong consumer and business con�dence locally, cuts in local interest rates, global recession, depressed commodity prices, and the release of worse than expected trade �gures. One conseUNCORRECTED

recession, depressed commodity prices, and the release of worse than expected trade �gures. One conse

PAGE

PAGE

PAGE Equilibrium

PAGE Equilibrium

PAGE

ShortagePAGE

Shortage

PROOFS measures the price or value of the Australian dollar when it is swapped for other cur

PROOFS measures the price or value of the Australian dollar when it is swapped for other currencies. Exchanging currencies is necessary because a nation’s residents normally want to be paid in the cur

PROOFSrencies. Exchanging currencies is necessary because a nation’s residents normally want to be paid in the cur�oating exchange rate

PROOFS�oating exchange rate. Here, the value or

PROOFS. Here, the value or foreign exchange market

PROOFSforeign exchange market by currency buyers

PROOFSby currency buyers

Supply/ sales

PROOFS

Supply/ salesof A$ by sellersPROOFS

of A$ by sellers



Recent trends in Australia’s exchange rateFigure 3.19 shows that over the past decade, the exchange rate for the Australian dollar has moved cyclically. Peaks in 2007–08 and 2011–12 were followed by troughs in 2008–09 and 2014–15.

0.4

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TWI

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ar 1

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0 =

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Year

A$

exc

hang

e ra

te w

ith

US

$

TWI for the exchange rate atJune (1970 = 100 points)59.1; LHS

A$ exchange rate with theUS$ (at June) 0.69; RHS

FIGURE 3.19 Trends in Australia’s exchange rate indicated by the TWI and US dollar

Source: Data derived from RBA Statistics.

Causes of changes in the exchange rateRises and falls in the exchange rate come down to changing aggregate demand- and supply-side conditions here and abroad. These in�uence the level of purchases and sales of the Australian dollar in the foreign exchange market.

Factors affecting the sale or supply (S) of the Australian dollarWhen Australian residents purchase imports of goods or services, make income payments or invest overseas, they must sell their Australian dollars (A$) to buy another currency. Figure 3.20 shows what happens in the foreign exchange market when sales of the A$ rise or fall. If sales of the A$ rise (S1 to S2 in part a ) and exceed the demand for the currency at the original price or exchange rate (ER1), there will be a depreciation of the exchange rate (to ER2). However, in reverse, when sales of the A$ fall (S1 to S2 in part b) relative to the demand for the A$ at the original price or exchange rate (ER1), there will be an appreciation of the currency (to ER2).

Quantity of A$

Pri

ce/e

xcha

nge

rate

(A

$)

Part (a) An increase in selling (S1 to S2) weakensthe Australian dollar (A$).

D1 for the A$

S1 of the A$

S2 of the A$

ER2

ER1

Q1 Q2

Quantity of A$

Part (b) A decrease in selling (S1 to S2) strengthensthe Australian dollar (A$).

D1 for the A$

S2 of the A$

S1 of the A$

Q2 Q1

ER2

Pri

ce/e

xcha

nge

rate

(A

$)

ER1

FIGURE 3.20 How changes in sales of the Australian dollar (A$) affect the exchange rate in the foreign exchange market

The number of dollars sold (S) in the foreign exchange market (for example, to pay for imports of goods and services, and incomes abroad) is affected by the following factors: • local consumer con�dence • local business con�dence

UNCORRECTED S

UNCORRECTED S) o

UNCORRECTED ) of the

UNCORRECTED f the When Australian residents purchase imports of goods or services, make income payments or invest overseas,

UNCORRECTED When Australian residents purchase imports of goods or services, make income payments or invest overseas,

their Australian dollars (A$) to buy another currency. Figure 3.20 shows what happens in the

UNCORRECTED their Australian dollars (A$) to buy another currency. Figure 3.20 shows what happens in the

foreign exchange market when sales of the A$ rise or fall. If sales of the A$

UNCORRECTED foreign exchange market when sales of the A$ rise or fall. If sales of the A$ the demand for the currency at the original price or exchange rate (ER

UNCORRECTED the demand for the currency at the original price or exchange rate (ER

). However, in reverse, when sales of the A$

UNCORRECTED ). However, in reverse, when sales of the A$

for the A$ at the original price or exchange rate (ER

UNCORRECTED

for the A$ at the original price or exchange rate (ER

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Pri

ce/e

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rate

(A

$)

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Pri

ce/e

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rate

(A

$)

Part (a) An increase in selling (S

UNCORRECTED

Part (a) An increase in selling (Sthe Australian dollar (A$).

UNCORRECTED

the Australian dollar (A$).

UNCORRECTED

ERUNCORRECTED

ER2UNCORRECTED

2

ER

UNCORRECTED

ER1

UNCORRECTED

1

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Causes of changes in the exchange rate

PAGE Causes of changes in the exchange rateRises and falls in the exchange rate come down to changing aggregate demand- and supply-side conditions

PAGE Rises and falls in the exchange rate come down to changing aggregate demand- and supply-side conditions here and abroad. These in�uence the level of purchases and sales of the Australian dollar in the foreign

PAGE here and abroad. These in�uence the level of purchases and sales of the Australian dollar in the foreign

PROOFS

PROOFS

Trends in Australia’s exchange rate indicated by the TWI and US dollar PROOFS

Trends in Australia’s exchange rate indicated by the TWI and US dollar



• changes in our tax rates and disposable income • movements in the terms of trade and the prices of imports • levels of in�ation, production costs and competitiveness, relative to those overseas • levels of interest rates on loans and overdrafts, relative to those overseas • changes in budget tax receipts, outlays and the overall outcome (equal to budget receipts minus outlays) • population growth • household savings ratio (the percentage of income not spent) • speculation about future changes in the exchange rate.

Factors affecting the purchase or demand (D) for the Australian dollarWhen people overseas want to purchase our exports, make income payments or invest in our assets, they must sell their currency and buy Australian dollars. Figure 3.21 shows what happens in the foreign exchange market when purchases of the A$ rise or fall.

Pri

ce/e

xcha

nge

rate

(A

$)

ER1

ER2

Quantity of A$

Q1 Q2

Part (a) A rise in buying (D1 to D2) strengthensthe Australian dollar (A$).

D1 for the A$

D2 for the $A

S1 of the A$

Quantity of A$

Q2 Q1

Part (b) A decrease in buying (D1 to D2)weakens the Australian dollar (A$).

D2 for the A$

D1 for the A$

S1 of the A$

Pri

ce/e

xcha

nge

rate

(A

$)

ER2

ER1

FIGURE 3.21 How changes in purchases of the Australian dollar (A$) affect the exchange rate in the foreign exchange market

If the demand for our currency rises relative to its supply of the A$ (the shift from D1 to D2 shown in part a), the price of the dollar or exchange rate will appreciate (ER1 to ER2). If fewer A$ are bought relative to the supply in the foreign exchange market (the shift from D1 to D2 shown in part b), the A$ will depreciate (ER1 to ER2).

The number of dollars bought (D) in the foreign exchange market (for example, when those overseas pay us for our exports and incomes) is affected by the following factors: • the level of economic activity overseas in our major trading partners (e.g. China, Japan and the United

States) and globally • consumer con�dence in our major trading partners and globally • the terms of trade and changes in our export commodity prices • changes in our productivity, international competitiveness and relative in�ation rate • speculation about future changes in the exchange rate • our level of production costs and in�ation rate, relative to other suppliers abroad • the interest rate differential (gap) between Australia and other nations.

Effects of exchange rate movements on domestic macroeconomic goals and the current account balanceChanges in the price of the A$ in the foreign exchange market have powerful effects on our key domestic mac-roeconomic goals (low in�ation, strong and sustainable economic growth, and full employment). In addition, the exchange rate can cause the size of the CAD to rise or fall. This is largely because the exchange rate can act as an aggregate demand-side factor affecting levels of net export spending (X – M) and economic activity, as well as an aggregate supply-side factor affecting our international competitiveness. Now let us look more closely at the effects of a changing exchange rate on the Australian economy.

Effects of the exchange rate on in�ationThe RBA and the government try to pursue the goal of low in�ation — keeping the in�ation rate rising slowly at an average rate of 2–3 per cent annually over the cycle. Rises and falls in the exchange rate for the A$ can affect the rate of demand in�ation and/or cost in�ation.

UNCORRECTED How changes in purchases of the Australian dollar (A$) affect the exchange rate in the foreign

UNCORRECTED How changes in purchases of the Australian dollar (A$) affect the exchange rate in the foreign

relative to its supply of the A$ (the shift from D

UNCORRECTED relative to its supply of the A$ (the shift from D

price of the dollar or exchange rate will

UNCORRECTED price of the dollar or exchange rate will appreciate

UNCORRECTED appreciate

foreign exchange market (the shift from D

UNCORRECTED foreign exchange market (the shift from D1

UNCORRECTED 1 to D

UNCORRECTED to D

The number of dollars bought (D) in the foreign exchange market (for example, when those overseas pay us

UNCORRECTED The number of dollars bought (D) in the foreign exchange market (for example, when those overseas pay us

for our exports and incomes) is affected by the following factors:

UNCORRECTED

for our exports and incomes) is affected by the following factors:vel of economic activity overseas in our major trading partners (e.g. China, Japan and the United

UNCORRECTED

vel of economic activity overseas in our major trading partners (e.g. China, Japan and the United States) and globally

UNCORRECTED

States) and globallycon�dence in our major trading partners and globally

UNCORRECTED

con�dence in our major trading partners and globally

UNCORRECTED

terms of trade and changes in our export commodity prices

UNCORRECTED

terms of trade and changes in our export commodity pricesin our productivity, international competitiveness and relative in�ation rate

UNCORRECTED

in our productivity, international competitiveness and relative in�ation ratespeculation

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speculation about future changes in the exchange rate

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about future changes in the exchange rateour

UNCORRECTED

our level of production costs and in�ation rate, relative to other suppliers abroad

UNCORRECTED

level of production costs and in�ation rate, relative to other suppliers abroadthe

UNCORRECTED

the interest rate differential (gap) between Australia and other nations.

UNCORRECTED

interest rate differential (gap) between Australia and other nations.

Effects of exchange rate movements on domestic UNCORRECTED

Effects of exchange rate movements on domestic macroeconomic goals and the current account balanceUNCORRECTED

macroeconomic goals and the current account balance

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How changes in purchases of the Australian dollar (A$) affect the exchange rate in the foreign PAGE

How changes in purchases of the Australian dollar (A$) affect the exchange rate in the foreign

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFSPart (b) A decrease in buying (D

PROOFSPart (b) A decrease in buying (D1

PROOFS1 to D

PROOFS to D2

PROOFS2)

PROOFS)weakens the Australian dollar (A$).

PROOFSweakens the Australian dollar (A$).

PROOFS

PROOFS

PROOFSS

PROOFSS1

PROOFS1 of the A$

PROOFS of the A$

PROOFS

PROOFS



• Demand in�ation can occur when there is excessive and strongly rising spending in an economy that has little or no unused productive capacity. Here, there will be boom conditions with widespread shortages of goods and services. As an aggregate demand-side factor, a falling A$ can further stimulate exports (because they are more attractive abroad) while depressing imports (because they appear dearer to us). When the value of net exports (X – M) rises, and there is already low unemployment, stocks fall and �rms cannot readily replace them, leading to widespread shortages and hence demand in�ation. In reverse, when the A$ appreciates, demand in�ation slows. The higher dollar tends to reduce net exports, slow AD and cause unplanned rises in stocks, and thus widespread price discounting will slow in�ation.

• Cost in�ation occurs when production costs (such as wages, equipment and materials) rise, eroding busi-ness pro�ts. As a result, �rms are typically forced to pass on higher costs to consumers, so prices rise. As an aggregate supply-side factor, a falling A$ can add to cost in�ation because many local �rms need to purchase imported equipment and materials. In reverse, when the A$ appreciates, costs for some local pro-ducers become cheaper, allowing �rms to cut prices to compete and easing cost in�ation.

Effects of the exchange rate on economic growthThe government generally seeks to promote the macro goal of a strong and sustainable rate of economic growth — keeping the GDP increasing at the fastest rate that is economically and environmentally sustain-able — perhaps at around 3 per cent or a little more. Rises and falls in the exchange rate for the A$ can in�u-ence economic growth by affecting the level of aggregate demand and or aggregate supply. • As an aggregate demand-side factor, changes in A$ can alter AD by affecting net export spending (X – M)

and hence AD and the cyclical level of economic activity. A weaker A$ (as occurred in 2013–16) will tend to boost overseas spending on our exports, while slowing our spending on imports. As AD strengthens and stocks fall, �rms will try to lift production, accelerating the rate of economic growth. In reverse, a stronger A$ will tend to slow net exports and weaken AD, causing stocks to rise and output to be cut.

• As an aggregate supply-side factor, changes in the A$ can make conditions for local businesses either more or less favourable, thereby affecting productive capacity and the potential rate of economic growth. For instance, a lower A$ will be less favourable for those �rms importing materials and equipment since they face higher production costs and lower pro�ts, possibly leading to business closures. Capacity would prob-ably be reduced and the rate of growth slowed. However, these negatives might be partly offset since a weaker exchange rate also makes some businesses more competitive at home and abroad. In reverse, a stronger A$ has mixed effects too. While this is good for �rms importing materials and equipment because it reduces costs and stimulates growth, it also makes other local businesses that do not have to import mate-rials and equipment less competitive, possibly leading to closures and a lower rate of economic growth.

Effects of the exchange rate on employment and unemploymentA third domestic government macroeconomic objective is to promote the goal of full employment or the lowest unemployment rate that doesn’t add to in�ation. Changes in the exchange rate can affect rates of both cyclical and structural unemployment because the A$ can act as an aggregate demand- or an aggregate supply-side factor. • As an aggregate demand factor, the exchange rate can affect net exports (X − M), production, the demand

for resources and unemployment. By boosting exports and slowing import, a weaker A$ helps to accelerate AD (as happened in 2013–16), causes �rms to lift production and employ more labour, thereby decreasing cyclical unemployment. In reverse, a rising A$ slows net exports and aggregate demand, and leads to �rms cutting their output and employment.

• As an aggregate supply factor, the A$ can alter production costs and our international competitiveness. On the one hand, a lower A$ means dearer imports and higher production costs for some (but not all) �rms, reducing their pro�ts and possibly leading to closures and structural unemployment. On the other hand, this problem may be partly offset by improved competitiveness for other local businesses, leading to fewer clo-sures and less unemployment.UNCORRECTED A$ has mixed effects too. While this is good for �rms importing materials and equipment because

UNCORRECTED A$ has mixed effects too. While this is good for �rms importing materials and equipment because it reduces costs and stimulates growth, it also makes other local businesses that do not have to import mate

UNCORRECTED it reduces costs and stimulates growth, it also makes other local businesses that do not have to import materials and equipment less competitive, possibly leading to closures and a lower rate of economic growth.

UNCORRECTED rials and equipment less competitive, possibly leading to closures and a lower rate of economic growth.

fects of the exchange rate on employment and unemployment

UNCORRECTED fects of the exchange rate on employment and unemployment

A third domestic government macroeconomic objective is to promote the goal of full employment or the lowest

UNCORRECTED A third domestic government macroeconomic objective is to promote the goal of full employment or the lowest unemployment rate that doesn’t add to in�ation. Changes in the exchange rate can affect rates of both cyclical

UNCORRECTED unemployment rate that doesn’t add to in�ation. Changes in the exchange rate can affect rates of both cyclical and structural unemployment because the A$ can act as an aggregate demand- or an aggregate supply-side

UNCORRECTED

and structural unemployment because the A$ can act as an aggregate demand- or an aggregate supply-side

gate demand factor, the exchange rate can affect net exports (X − M), production, the demand

UNCORRECTED

gate demand factor, the exchange rate can affect net exports (X − M), production, the demand for resources and unemployment. By boosting exports and slowing import, a

UNCORRECTED

for resources and unemployment. By boosting exports and slowing import, a AD (as happened in 2013–16), causes �rms to lift production and employ more labour, thereby decreasing

UNCORRECTED

AD (as happened in 2013–16), causes �rms to lift production and employ more labour, thereby decreasing cyclical unemployment. In reverse, a

UNCORRECTED

cyclical unemployment. In reverse, a cutting their output and employment.

UNCORRECTED

cutting their output and employment.As an aggre

UNCORRECTED

As an aggregate supply factor, the A$ can alter production costs and our international competitiveness. On

UNCORRECTED

gate supply factor, the A$ can alter production costs and our international competitiveness. On the one hand, a

UNCORRECTED

the one hand, a lower

UNCORRECTED

lowerreducing their pro�ts and possibly leading to closures and structural unemployment. On the other hand, this

UNCORRECTED

reducing their pro�ts and possibly leading to closures and structural unemployment. On the other hand, this

UNCORRECTED

problem may be partly offset by improved competitiveness for other local businesses, leading to fewer clo

UNCORRECTED

problem may be partly offset by improved competitiveness for other local businesses, leading to fewer closures and less unemployment.UNCORRECTED

sures and less unemployment.

PAGE A$ will tend to slow net exports and weaken AD, causing stocks to rise and output to be cut.

PAGE A$ will tend to slow net exports and weaken AD, causing stocks to rise and output to be cut.gate supply-side factor, changes in the A$ can make conditions for local businesses either more

PAGE gate supply-side factor, changes in the A$ can make conditions for local businesses either more or less favourable, thereby affecting productive capacity and the potential rate of economic growth. For

PAGE or less favourable, thereby affecting productive capacity and the potential rate of economic growth. For

A$ will be less favourable for those �rms importing materials and equipment since they

PAGE A$ will be less favourable for those �rms importing materials and equipment since they

face higher production costs and lower pro�ts, possibly leading to business closures. Capacity would prob

PAGE face higher production costs and lower pro�ts, possibly leading to business closures. Capacity would probably be reduced and the rate of growth slowed. However, these negatives might be partly offset since a

PAGE ably be reduced and the rate of growth slowed. However, these negatives might be partly offset since a weaker exchange rate also makes some businesses more competitive at home and abroad. In reverse, a PAGE weaker exchange rate also makes some businesses more competitive at home and abroad. In reverse, a

A$ has mixed effects too. While this is good for �rms importing materials and equipment because PAGE

A$ has mixed effects too. While this is good for �rms importing materials and equipment because it reduces costs and stimulates growth, it also makes other local businesses that do not have to import matePAGE

it reduces costs and stimulates growth, it also makes other local businesses that do not have to import mate

PROOFSgoal of a strong and sustainable rate of economic

PROOFSgoal of a strong and sustainable rate of economic — keeping the GDP increasing at the fastest rate that is economically and environmentally sustain

PROOFS — keeping the GDP increasing at the fastest rate that is economically and environmentally sustain

able — perhaps at around 3 per cent or a little more. Rises and falls in the exchange rate for the A$ can in�u

PROOFSable — perhaps at around 3 per cent or a little more. Rises and falls in the exchange rate for the A$ can in�uence economic growth by affecting the level of aggregate demand and or aggregate supply.

PROOFSence economic growth by affecting the level of aggregate demand and or aggregate supply.

gate demand-side factor, changes in A$ can alter AD by affecting net export spending (X – M)

PROOFSgate demand-side factor, changes in A$ can alter AD by affecting net export spending (X – M)

and hence AD and the cyclical level of economic activity. A weaker A$ (as occurred in 2013–16) will tend

PROOFSand hence AD and the cyclical level of economic activity. A weaker A$ (as occurred in 2013–16) will tend to boost overseas spending on our exports, while slowing our spending on imports. As AD strengthens and

PROOFS

to boost overseas spending on our exports, while slowing our spending on imports. As AD strengthens and stocks fall, �rms will try to lift production, accelerating the rate of economic growth. In reverse, a stronger PROOFS

stocks fall, �rms will try to lift production, accelerating the rate of economic growth. In reverse, a stronger A$ will tend to slow net exports and weaken AD, causing stocks to rise and output to be cut.PROOFS

A$ will tend to slow net exports and weaken AD, causing stocks to rise and output to be cut.gate supply-side factor, changes in the A$ can make conditions for local businesses either more PROOFS

gate supply-side factor, changes in the A$ can make conditions for local businesses either more



Effects of the exchange rate on the current account balance

In international trade, it is essential that we have a system to swap or exchange the currency of one country (like the Japanese yen, the euro or the US dollar) into that of another (like the Australian dollar or the British pound). Currencies are swapped at different exchange rates, and these rates are generally determined by the number of buyers and sellers of each currency in the foreign exchange market. Over time, exchange rates move up and down. Among other things, this affects the prices we pay for imports of foreign goods like electronics and oil, and the prices people overseas pay for Australian goods like iron ore and holidays, and the levels of AD, GDP and employment.

Australia’s current account records transactions between Australia and the rest of the world. These involve credits minus debits for goods and services, along with primary and secondary incomes. Australia typ-ically runs a CAD. A rise or fall in the exchange rate for the A$ can affect the size of our CAD in two main ways: through the value of exports and imports, and through the value of primary income credits and debits.

1. Value of exports and imports of goods and services

Changes in the exchange rate for the A$ affect the price, attractiveness and value of Australia’s exports and imports of goods and services, thereby affecting the balance on current account. • A fall in in the A$ makes Australia’s exports of goods (minerals like coal and iron ore, rural commodities

such as wheat and beef) and services (tourism, education) relatively cheaper to overseas buyers in terms of their currency. As a result, the value of our export sales typically rises, causing the CAD to shrink. In addition, a lower exchange rate often makes imports of goods (oil, cars, electrical appliances) and services (overseas travel) dearer in terms of our currency. This tends to slow purchases of imports, reduce debits and decrease the CAD.

• A stronger A$ often leads to a larger CAD. Our exports of goods and services become dearer, reducing the value of sales, while imports become cheaper, increasing purchases. As a result of decreased debits relative to credits, the CAD tends to increase.

2. Value of primary income credits and debits

Changes in the exchange rate for the A$ alter the cost or attractiveness of overseas capital in�ow and out�ow associated with buying and selling assets internationally. As a consequence, this can indirectly impact on net primary incomes and thus the balance on current account. • A fall in the A$ tends to make the purchase of shares and property, denominated in Australian dollars,

cheaper and more attractive for non-residents. By increasing net capital in�ow and foreign liabilities, this

UNCORRECTED In international trade, it is essential that we have a system to swap or exchange the currency of one country (like the

UNCORRECTED In international trade, it is essential that we have a system to swap or exchange the currency of one country (like the Japanese yen, the euro or the US dollar) into that of another (like the Australian dollar or the British pound). Currencies

UNCORRECTED Japanese yen, the euro or the US dollar) into that of another (like the Australian dollar or the British pound). Currencies are swapped at different exchange rates, and these rates are generally determined by the number of buyers and sellers

UNCORRECTED are swapped at different exchange rates, and these rates are generally determined by the number of buyers and sellers of each currency in the foreign exchange market. Over time, exchange rates move up and down. Among other things,

UNCORRECTED of each currency in the foreign exchange market. Over time, exchange rates move up and down. Among other things, this affects the prices we pay for imports of foreign goods like electronics and oil, and the prices people overseas pay for

UNCORRECTED this affects the prices we pay for imports of foreign goods like electronics and oil, and the prices people overseas pay for Australian goods like iron ore and holidays, and the levels of AD, GDP and employment.

UNCORRECTED Australian goods like iron ore and holidays, and the levels of AD, GDP and employment.

Australia’s current account records transactions between Australia and the rest of the world. These involve

UNCORRECTED

Australia’s current account records transactions between Australia and the rest of the world. These involve credits minus debits for goods and services, along with primary and secondary incomes. Australia typ

UNCORRECTED

credits minus debits for goods and services, along with primary and secondary incomes. Australia typically runs a CAD. A rise or fall in the exchange rate for the A$ can affect the size of our CAD in

UNCORRECTED

ically runs a CAD. A rise or fall in the exchange rate for the A$ can affect the size of our CAD in ain ways: through the value of exports and imports, and through the value of primary income credits

UNCORRECTED

ain ways: through the value of exports and imports, and through the value of primary income credits


UNCORRECTED


Changes in the exchange rate for the A$ affect the price, attractiveness and value of Australia’s exports and

UNCORRECTED

Changes in the exchange rate for the A$ affect the price, attractiveness and value of Australia’s exports and imports of goods and services, thereby affecting the balance on current account.

UNCORRECTED

imports of goods and services, thereby affecting the balance on current account.A

UNCORRECTED

A fall

UNCORRECTED

fall in in the A$ makes Australia’s exports of goods (minerals like coal and iron ore, rural commodities

UNCORRECTED

in in the A$ makes Australia’s exports of goods (minerals like coal and iron ore, rural commodities fall in in the A$ makes Australia’s exports of goods (minerals like coal and iron ore, rural commodities fall

UNCORRECTED

fall in in the A$ makes Australia’s exports of goods (minerals like coal and iron ore, rural commodities fallsuch as wheat and beef) and services (tourism, education) relatively cheaper to overseas buyers in terms UNCORRECTED

such as wheat and beef) and services (tourism, education) relatively cheaper to overseas buyers in terms of their currency. As a result, the value of our export sales typically rises, causing the CAD to shrink. In UNCORRECTED

of their currency. As a result, the value of our export sales typically rises, causing the CAD to shrink. In addition, a lower exchange rate often makes imports of goods (oil, cars, electrical appliances) and services UNCORRECTED

addition, a lower exchange rate often makes imports of goods (oil, cars, electrical appliances) and services

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In international trade, it is essential that we have a system to swap or exchange the currency of one country (like the PAGE

In international trade, it is essential that we have a system to swap or exchange the currency of one country (like the

PROOFS



could ultimately add to primary income debits involving the payment of dividends, rent and pro�ts abroad, and thus the CAD. Additionally, the weaker dollar could make it dearer and less attractive for Australian investors to purchase foreign assets, at least those denominated in foreign currencies. In the longer term, this may indirectly tend to slow our primary income credits and add to our CAD.

• By contrast, a stronger A$ can sometimes encourage capital out�ow associated with the purchase of overseas assets by residents. These assets become relatively cheaper and more attractive if denominated in foreign currencies. In the long term, this could lead to higher primary income credits while discour-aging foreign capital in�ow and primary income debits. As a consequence, there could be a reduction in the CAD.

Weblinks The weblinks in these activities are available in this chapter’s student resources tab.• The relationship between the current account balance and exchange rates • Foreign exchange (FOREX), Macro 5.2• Foreign exchange practice, Macro 5.3• Economics made easy — Lesson 9: Exchange rate policy (devaluation)


1 What is the exchange rate and how is it determined for Australia?2 Explain how Australia’s exchange rate is measured.3 Identify and explain any three domestic and two international factors that are likely to affect Australia’s

exchange rate.4 Explain how you would expect a rise or a fall in the value of the A$ to affect each of the following

economic variables.a The government’s domestic macroeconomic goalsb The balance of payments on current account




3.7 Australia’s international competitivenessAs discussed earlier, Australia gains huge economic bene�ts from international trade. So it is hardly surprising that the federal government uses policies to encourage trade and make local �rms more internationally competitive. This helps Australia to ‘pay its way in international transactions’ and ‘live within its means’, thereby promoting the Australian government’s goal of external stability. In addition, being internationally competitive strengthens the goals associated with domestic economic stability (simultaneously achieving low in�ation, strong and sustainable economic growth and full employment), ultimately promoting Australian living standards.

What is international competitiveness?The Australian government wants local businesses to be internationally competitive. International competitiveness simply means that Australian producers of goods and services can compete, survive, expand and �ourish against foreign rivals, allowing them to capture a growing share of global sales and incomes, and in the process increasing our living standards. Typically, local �rms can get the sales edge over foreign counterparts through several means: • A competitive selling price. The selling price paid for goods and services greatly in�uences the purchasing

decisions of many consumers. Hence, to grow their global market share, local sellers need to be able to trade pro�tably at relatively low prices against similar items made abroad (preferably without government �nancial assistance). This means that �rms need to focus on maximising ef�ciency in their use of resources and keeping production costs down.

• Non-price factors. Consumer decisions are also affected by non-price factors such as:– offering better quality goods or services that match or exceed those available abroad– catering for and satisfying the changing needs of consumers better than rival suppliers overseas– providing superior customer service, including prompt and courteous delivery.

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UNCORRECTED School-assessed coursework > Applied economic exercises >

3.7 Australia’s international competitiveness

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3.7 Australia’s international competitiveness

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As discussed earlier, Australia gains huge economic bene�ts from international trade. So it is hardly surprising that

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As discussed earlier, Australia gains huge economic bene�ts from international trade. So it is hardly surprising that the federal government uses policies to encourage trade and make local �rms more

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the federal government uses policies to encourage trade and make local �rms more This helps Australia to ‘pay its way in international transactions’ and ‘live within its means’, thereby promoting the

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This helps Australia to ‘pay its way in international transactions’ and ‘live within its means’, thereby promoting the Australian government’s

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Australian government’s goal of external stability.

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goal of external stability.goals associated with

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goals associated with domestic economic stability

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domestic economic stabilityeconomic growth and full employment), ultimately promoting Australian living standards.

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economic growth and full employment), ultimately promoting Australian living standards.

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What is international competitiveness?

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What is international competitiveness?The Australian government wants local businesses to be internationally competitive. UNCORRECTED

The Australian government wants local businesses to be internationally competitive. competitiUNCORRECTED

competitivenessUNCORRECTED

veness

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PAGE ee domestic and two international factors that are likely to affect Australia’s

PAGE ee domestic and two international factors that are likely to affect Australia’s

Explain how you would expect a rise or a fall in the value of the A$ to af

PAGE Explain how you would expect a rise or a fall in the value of the A$ to affect each of the following

PAGE fect each of the following Explain how you would expect a rise or a fall in the value of the A$ to affect each of the following Explain how you would expect a rise or a fall in the value of the A$ to af

PAGE Explain how you would expect a rise or a fall in the value of the A$ to affect each of the following Explain how you would expect a rise or a fall in the value of the A$ to af

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PROOFS

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ee domestic and two international factors that are likely to affect Australia’s PROOFS

ee domestic and two international factors that are likely to affect Australia’s



Factors that may in�uence Australia’s international competitivenessMany factors in�uence whether Australian �rms are internationally competitive. They include production costs such as wage rates, productivity, availability of resources, the exchange rate, relative rates of in�ation, inno-vation and R&D, rates of company tax and government subsidies.

Production costs of businesses, including wagesThe price and competitiveness of local �rms is affected by how our costs of production compare with those abroad. Here, production costs for businesses might include • wages and labour on-costs like compulsory superannuation, leave entitlements and workers compensation • the costs of utilities such as power, gas and water, as well as the costs of communications and transport • the costs of �rms borrowing credit or �nance (the rate of interest on business overdrafts) • the costs of purchasing raw materials and equipment.

If these costs overall are higher relative to those overseas, it is likely that local �rms will be uncompetitive. Businesses will have to sell their products at a higher and therefore less attractive price in local and foreign markets, leading to lower exports, higher imports and a bigger CAD.

ProductivityProductivity relates to ef�ciency or the level of output gained from a given quantity of inputs or resources. Labour productivity is commonly measured by the level of GDP per hour worked, while multifactor prod-uctivity measures the ef�ciency with which the combined inputs of labour, capital and natural resources are converted into production. Low productivity translates into higher production costs, and hence act as a less favourable aggregate supply-side factor. It makes locally produced goods less attractive to imports. This weakens our international competitiveness.

Figure 3.22 shows how Australia’s labour and multifactor productivity have changed over the last 18 years, along with the recent changes by industry.

The graph in part (a) of �gure 3.22 shows that, despite some good rises in labour productivity over the period, multifactor productivity overall has been decreasing since 2001–02. Looking at the graph in part (b) of the �gure showing particular industries, multifactor productivity has recently been negative, especially in the mining and utilities sectors. While a few of these industries (especially services) do not directly compete with imports, most do; hence lower productivity is a worry. There are a number of explanations for these changes in ef�ciency that undermine our international competitiveness: • Productivity often moves in cycles and is dif�cult to measure, as it is hard to determine the exact origin of

the change. • Industries where there have been rapid changes in technology record faster improvements. • In the case of agriculture, severe weather events of late would not help, along with the use of more marginal land. • In mining, there has been heavy investment of capital resources, but the full production returns have not yet

been realised. In addition, the remaining natural resources are becoming more costly to extract since the easier ones have already been exploited.

• The rise in labour productivity may have been helped by the general increase in unpaid overtime.

Availability of natural resourcesAustralia is relatively rich in natural resources (coal, bauxite, iron ore, alumina) that are wanted by many nations, and we also have a relatively large area of productive land for grazing and agriculture. This means that mineral and rural commodities can often be produced at lower and more competitive prices, making us more internationally competitive.

The exchange rateAs we know, the exchange rate for the A$ affects the price of exports and imports of goods and services. • A generally lower exchange rate (as occurred between 2013 and 2016) allows Australian-made goods and

services to be sold relatively cheaply. This usually helps to make local industry more competitive at home and abroad.

• In reverse, a higher A$ (as occurred between 2010 and 2013) makes our exports relatively dearer against imports, undermining our international competitiveness.

Relative rates of in�ationAustralia’s in�ation rate compared against rates abroad affects the international attractiveness of locally made goods and services. • A relatively lower in�ation rate here makes our goods and services more attractive to buyers at home and

abroad, making us more internationally competitive. • In reverse, a relatively higher in�ation rate here erodes our international competitiveness and sales.

UNCORRECTED mining and utilities sectors. While a few of these industries (especially services) do not directly compete with

UNCORRECTED mining and utilities sectors. While a few of these industries (especially services) do not directly compete with imports, most do; hence lower productivity is a worry. There are a number of explanations for these changes

UNCORRECTED imports, most do; hence lower productivity is a worry. There are a number of explanations for these changes in ef�ciency that undermine our international competitiveness:

UNCORRECTED in ef�ciency that undermine our international competitiveness:

vity often moves in cycles and is dif�cult to measure, as it is hard to determine the exact origin of

UNCORRECTED vity often moves in cycles and is dif�cult to measure, as it is hard to determine the exact origin of

where there have been rapid changes in technology record faster improvements.

UNCORRECTED where there have been rapid changes in technology record faster improvements.

UNCORRECTED vere weather events of late would not help, along with the use of more marginal land.

UNCORRECTED vere weather events of late would not help, along with the use of more marginal land.

In mining, there has been hea

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In mining, there has been heavy investment of capital resources, but the full production returns have not yet

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vy investment of capital resources, but the full production returns have not yet been realised. In addition, the remaining natural resources are becoming more costly to extract since the

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been realised. In addition, the remaining natural resources are becoming more costly to extract since the easier ones have already been exploited.

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easier ones have already been exploited.rise in labour productivity may have been helped by the general increase in unpaid overtime.

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rise in labour productivity may have been helped by the general increase in unpaid overtime.

ailability of natural resources

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ailability of natural resources

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Australia is relatively rich in natural resources (coal, bauxite, iron ore, alumina) that are wanted by many

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Australia is relatively rich in natural resources (coal, bauxite, iron ore, alumina) that are wanted by many nations, and we also have a relatively large area of productive land for grazing and agriculture. This means that

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nations, and we also have a relatively large area of productive land for grazing and agriculture. This means that mineral and rural commodities can often be produced at lower and more competitive prices, making us more

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mineral and rural commodities can often be produced at lower and more competitive prices, making us more internationally competitive.

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internationally competitive.

The exchange rateUNCORRECTED

The exchange rateAs we know, the exchange rate for the A$ affects the price of exports and imports of goods and services.UNCORRECTED

As we know, the exchange rate for the A$ affects the price of exports and imports of goods and services.

PAGE less favourable aggregate supply-side factor. It makes locally produced goods less attractive to imports. This

PAGE less favourable aggregate supply-side factor. It makes locally produced goods less attractive to imports. This

Figure 3.22 shows how Australia’s labour and multifactor productivity have changed over the last 18 years,

PAGE Figure 3.22 shows how Australia’s labour and multifactor productivity have changed over the last 18 years,

The graph in part (a) of �gure 3.22 shows that, despite some good rises in labour productivity over the

PAGE The graph in part (a) of �gure 3.22 shows that, despite some good rises in labour productivity over the

period, multifactor productivity overall has been decreasing since 2001–02. Looking at the graph in part (b) of

PAGE period, multifactor productivity overall has been decreasing since 2001–02. Looking at the graph in part (b) of the �gure showing particular industries, multifactor productivity has recently been negative, especially in the PAGE the �gure showing particular industries, multifactor productivity has recently been negative, especially in the mining and utilities sectors. While a few of these industries (especially services) do not directly compete with PAGE

mining and utilities sectors. While a few of these industries (especially services) do not directly compete with imports, most do; hence lower productivity is a worry. There are a number of explanations for these changes PAGE

imports, most do; hence lower productivity is a worry. There are a number of explanations for these changes

PROOFSIf these costs overall are higher relative to those overseas, it is likely that local �rms will be uncompetitive.

PROOFSIf these costs overall are higher relative to those overseas, it is likely that local �rms will be uncompetitive. Businesses will have to sell their products at a higher and therefore less attractive price in local and foreign

PROOFSBusinesses will have to sell their products at a higher and therefore less attractive price in local and foreign

relates to ef�ciency or the level of output gained from a given quantity of inputs or resources.

PROOFS relates to ef�ciency or the level of output gained from a given quantity of inputs or resources.

is commonly measured by the level of GDP per hour worked, while

PROOFS is commonly measured by the level of GDP per hour worked, while

measures the ef�ciency with which the combined inputs of labour, capital and natural resources

PROOFS

measures the ef�ciency with which the combined inputs of labour, capital and natural resources are converted into production. Low productivity translates into higher production costs, and hence act as a PROOFS

are converted into production. Low productivity translates into higher production costs, and hence act as a less favourable aggregate supply-side factor. It makes locally produced goods less attractive to imports. This PROOFS

less favourable aggregate supply-side factor. It makes locally produced goods less attractive to imports. This



110Index

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Part (a) Australia: Overall trends in labour and multifactor productivity

90

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70LP

2013–142010–112007–082004–052001–021998–991995–96

MFP

Finance & insurance

Average annual change to 2013–14

Part (b) Australia: Changes in multifactor productivity by industry

Agriculture, forestry & �shing

Retail trade

Construction

Wholesale trade

Accommodation, cafes & restaurants

Arts & recreation

Transport, postal & warehousing

Information media & telecomms

Administration & support

Manufacturing

Professional, scienti�c & technical

Other services

Rental, hiring & real estate

Electricity, gas, water & waste

Mining

Market sector

–6 –4 –2

Change over 5 years

0

Per cent

2 4

Change over 10 years

FIGURE 3.22 Trends in Australia’s labour and multifactor productivity

Sources: Graph (a) copied from ABS 5260.0.55.002, Estimates of Industry Multifactor Productivity, 2013–14 (latest 5/12/14); graph (b) copied from Department of Industry and Science, Competitiveness at a Glance, http://www.industry.gov.au/Of�ce-of-the-Chief-Economist/Publications/IndustryMonitor/section1.html.

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InnovationR&D and innovation (the development of new products and different ways of making things, and adapting to the changing wants of consumers) can all help give a nation a competitive edge and allow it to sell more strongly in both local and international markets. In contrast to some countries, Australian businesses spend less than 1.2 per cent of GDP on R&D (down from around 1.4 per cent over the last �ve years). Government spending on education is also needed to grow our creativity and innovation, but this is also down. We are being overtaken by other countries, and this too helps to explain the fall in our international competitiveness.

Rates of company taxCompany tax rates affect the after-tax pro�ts of �rms and hence the price they must charge to make reasonable returns. With few exceptions, Australia’s corporate tax rates of 30 per cent for large �rms and 28.5 per cent for small �rms (in 2015–16), are generally higher than our competitors in Asia (China, Vietnam, India and Indonesia, where in 2016 the average tax rate was just over 21 per cent) and in Europe (Italy, Germany and Ireland, where it was just 22 per cent). It also means that local �rms cannot afford to purchase more ef�cient technology and equipment needed to improve their productivity. In these ways, higher corporate tax rates help to explain why local businesses need to charge higher prices than some businesses overseas, making them less internationally competitive.

Government subsidiesThe Australian government pays cash subsidies to local producers to help encourage structural change and cover some production costs. This allows businesses to sell their product at a lower price in both local and international markets. Sometimes the decision to pay subsidies is designed to correct market failure, but at other times it could be to help support infant industries and win greater political popularity. Whatever the case, subsidies can make local �rms more internationally competitive.

Weblinks The weblinks in these activities are available in this chapter’s student resources tab.• What is competitiveness?• Global Competitiveness Report 2015–16


1 De�ne the term international competitiveness.2 How internationally competitive is Australian business generally?3 Explain how each of the following might affect Australia’s international competitiveness.

a High production costsb Weaker multifactor productivityc Readily available natural resourcesd Low domestic in�ation ratese A lower exchange ratef High rates of company tax



• School-assessed coursework > Applied economic exercises > Question 7UNCORRECTED

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UNCORRECTED international competitiveness

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nationally competitive is Australian business generally?

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Explain how each of the following might af

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eaker multifactor productivity

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eaker multifactor productivityReadily available natural r

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Readily available natural resources

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esourcesLow domestic in�ation rates

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Low domestic in�ation ratesA lower exchange rate

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A lower exchange rateHigh rates of company tax

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High rates of company tax

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PAGE The weblinks in these activities are available in this chapter’s student resources tab.

PAGE The weblinks in these activities are available in this chapter’s student resources tab.

PAGE PROOFS

Indonesia, where in 2016 the average tax rate was just over 21 per cent) and in Europe (Italy, Germany and

PROOFSIndonesia, where in 2016 the average tax rate was just over 21 per cent) and in Europe (Italy, Germany and Ireland, where it was just 22 per cent). It also means that local �rms cannot afford to purchase more ef�cient

PROOFSIreland, where it was just 22 per cent). It also means that local �rms cannot afford to purchase more ef�cient technology and equipment needed to improve their productivity. In these ways, higher corporate tax rates help

PROOFStechnology and equipment needed to improve their productivity. In these ways, higher corporate tax rates help to explain why local businesses need to charge higher prices than some businesses overseas, making them less

PROOFSto explain why local businesses need to charge higher prices than some businesses overseas, making them less

The Australian government pays cash subsidies to local producers to help encourage structural change and

PROOFSThe Australian government pays cash subsidies to local producers to help encourage structural change and cover some production costs. This allows businesses to sell their product at a lower price in both local and

PROOFScover some production costs. This allows businesses to sell their product at a lower price in both local and international markets. Sometimes the decision to pay subsidies is designed to correct market failure, but at

PROOFS

international markets. Sometimes the decision to pay subsidies is designed to correct market failure, but at other times it could be to help support infant industries and win greater political popularity. Whatever the case, PROOFS

other times it could be to help support infant industries and win greater political popularity. Whatever the case,



3.8 The effect of trade liberalisation on Australia’s international competitiveness, domestic macroeconomic goals and living standards

Most economists believe that free trade, or the absence of government protection of local industry from imports, helps to increase ef�ciency in the use or allocation of resources. In the long term, this should raise national output, employment, incomes and material living standards. Unfortunately, some countries (like Japan, China, United States and certain members of the European Union) still use subsidies and tariffs to protect their farmers and manufacturing industries.

Australia’s policy of trade liberalisationEspecially since the 1990s, the Australian government (like most governments around the world) has gradually adopted the policy of trade liberalisation. Essentially, trade liberalisation involves progressively reducing the various forms of protection of local industry, including the following: • cutting tariffs • reducing subsidies and industry assistance • abolishing import quotas • increasing the number of free trade agreements (FTAs) • scaling back other protective devices.

This approach differs from the policy of free trade, which is the complete removal of all forms of government industry protection. The key policy elements involved in Australia’s policy of trade liberalisation are summar-ised in �gure 3.23.

UNCORRECTED incomes and material living standards. Unfortunately, some countries (like Japan, China, United States and certain

UNCORRECTED incomes and material living standards. Unfortunately, some countries (like Japan, China, United States and certain members of the European Union) still use subsidies and tariffs to protect their farmers and manufacturing industries.

UNCORRECTED members of the European Union) still use subsidies and tariffs to protect their farmers and manufacturing industries.

Australia’s policy of trade liberalisation

UNCORRECTED Australia’s policy of trade liberalisationEspecially since the 1990s, the Australian government (like most governments around the world) has gradually

UNCORRECTED Especially since the 1990s, the Australian government (like most governments around the world) has gradually adopted the policy of trade liberalisation. Essentially,

UNCORRECTED adopted the policy of trade liberalisation. Essentially, various forms of protection of local industry

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various forms of protection of local industry, including the following:

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, including the following:

subsidies and industry assistance

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subsidies and industry assistanceimport quotas

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import quotasthe number of free trade agreements (FTAs)

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the number of free trade agreements (FTAs)

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back other protective devices.

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back other protective devices.This approach differs from the policy of

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This approach differs from the policy of industry protection. The key policy elements involved in Australia’s policy of trade liberalisation are summar

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industry protection. The key policy elements involved in Australia’s policy of trade liberalisation are summarised in �gure 3.23.

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ised in �gure 3.23.

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PAGE Most economists believe that free trade, or the absence of government protection of local industry from imports, helps to

PAGE Most economists believe that free trade, or the absence of government protection of local industry from imports, helps to increase ef�ciency in the use or allocation of resources. In the long term, this should raise national output, employment, PAGE increase ef�ciency in the use or allocation of resources. In the long term, this should raise national output, employment, incomes and material living standards. Unfortunately, some countries (like Japan, China, United States and certain PAGE

incomes and material living standards. Unfortunately, some countries (like Japan, China, United States and certain members of the European Union) still use subsidies and tariffs to protect their farmers and manufacturing industries.PAGE

members of the European Union) still use subsidies and tariffs to protect their farmers and manufacturing industries.

PROOFS

PROOFS



0

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Cumulative number offree trade agreements

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Rate of agriculturaltariffs (percentage)

Estimated value of netsubsidies and industryassistance ($ billions)

Year 1970–71 1980–81 1990–91 2000–01 2010–11 2014–15 2019–20

Cumulative number of free trade agreements 0 0 1 1 7 10

General rate of manufacturing tariffs (percentage) 36 23 16 5 5 5

Rate of agricultural tariffs (percentage) 28 12 13 6 0 0

Estimated value of net subsidies and industry assistance ($billion) 25 20 18 8 11 9

FIGURE 3.23 Indicators of the Australian government’s adoption of trade liberalisation measures, 1970 to 2016

Sources: Data derived from many sources including AGPS; Industry Commission; 2002 Trade Policy Review for Australia; Productivity Commission, Trade and Assistance Review 2015; DFAT; Budget Review 2006–07; and budget papers 2008–09 to 2015–16. Note: Data for 2014–15 represents an estimate only.

Reducing industry protection and liberalising trade allowed Australia to become part of the process of globali-sation in the following ways: • It forced us to specialise and allocate resources more ef�ciently into areas of production where we had a com-

parative cost advantage (or the least cost disadvantage). This meant that more output could be gained from the same inputs of resources, accelerating the sustainable rate of economic and income growth. It also helped to keep in�ation in check, thereby lifting the purchasing power of incomes and material living standards.

• It gave local �rms a clear choice: become internationally competitive by cutting costs and adopting world’s best practice in production, or face extinction. By restructuring their production, some local �rms have become exporters to a huge world market, strengthening our balance of payments current account. Despite the possibility of structural unemployment in some industries, especially in the shorter term, trade liberali-sation has helped to grow employment, real incomes and material living standards.Trade liberalisation also made the government more economically accountable and caused it to focus on

other supply-side ef�ciency measures needed for survival in an open economy. Let us �nd out more about the speci�c policy measures associated with the adoption of trade liberalisation by the Australian government.

Tariff cutsTariffs (also called import duties) represent an indirect tax levied on selected imported goods. In general, tariffs are added onto the price of imports to make them dearer or less attractive to local consumers. They limit foreign competition and restrict the supply of goods in local markets. Because of this, economists agree that high tariffs cause resources to be allocated inef�ciently into industries where we have no comparative cost advantage. This type of protection weakens competition. It means that local �rms can remain inef�cient and uncompetitive and still survive, while local households and businesses must pay higher prices for these items, reducing living standards. These costs offset any gains from a possible increase in incomes and employment arising in the short term from having tariffs. Additionally, when one country raises its tariffs, this becomes a justi�cation for other nations to retaliate and increase their protection. This reduces trade volumes, real incomes, consumption and living standards.

In contrast to high rates of tariff protection, a gradual reduction of protection, as implemented in Australia over the past 50 years, helps to improve allocative, technical and dynamic ef�ciency. Importantly, tariff cuts encourage local �rms to become more internationally competitive by forcing them to cut costs and restructure production operations so as to become internationally competitive. In so doing, this helps to grow Australia’s productive capacity, incomes and living standards. Figure 3.24 shows how tariff protection of Australian industry has been gradually reduced.

UNCORRECTED Reducing industry protection and liberalising trade allowed Australia to become part of the process of globali

UNCORRECTED Reducing industry protection and liberalising trade allowed Australia to become part of the process of globali

It forced us to specialise and allocate resources more ef�ciently into areas of production where we had a

UNCORRECTED It forced us to specialise and allocate resources more ef�ciently into areas of production where we had a

(or the least cost disadvantage). This meant that more output could be gained from the

UNCORRECTED (or the least cost disadvantage). This meant that more output could be gained from the

same inputs of resources, accelerating the sustainable rate of economic and income growth. It also helped to

UNCORRECTED same inputs of resources, accelerating the sustainable rate of economic and income growth. It also helped to

UNCORRECTED keep in�ation in check, thereby lifting the purchasing power of incomes and material living standards.

UNCORRECTED keep in�ation in check, thereby lifting the purchasing power of incomes and material living standards.

ave local �rms a clear choice: become internationally competitive by cutting costs and adopting world’s

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ave local �rms a clear choice: become internationally competitive by cutting costs and adopting world’s best practice in production, or face extinction. By restructuring their production, some local �rms have

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best practice in production, or face extinction. By restructuring their production, some local �rms have become exporters to a huge world market, strengthening our balance of payments current account. Despite

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become exporters to a huge world market, strengthening our balance of payments current account. Despite the possibility of structural unemployment in some industries, especially in the shorter term, trade liberali

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the possibility of structural unemployment in some industries, especially in the shorter term, trade liberalisation has helped to grow employment, real incomes and material living standards.

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sation has helped to grow employment, real incomes and material living standards.Trade liberalisation also made the government more economically accountable and caused it to focus on

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Trade liberalisation also made the government more economically accountable and caused it to focus on other supply-side ef�ciency measures needed for survival in an open economy. Let us �nd out more about the

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other supply-side ef�ciency measures needed for survival in an open economy. Let us �nd out more about the

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speci�c policy measures associated with the adoption of trade liberalisation by the Australian government.

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speci�c policy measures associated with the adoption of trade liberalisation by the Australian government.

Tariff cuts

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Tariff cutsTariffs

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Tariffs (also called

UNCORRECTED

(also called are added onto the price of imports to make them dearer or less attractive to local consumers. They limit foreign UNCORRECTED

are added onto the price of imports to make them dearer or less attractive to local consumers. They limit foreign competition and restrict the supply of goods in local markets. Because of this, economists agree that high tariffs UNCORRECTED

competition and restrict the supply of goods in local markets. Because of this, economists agree that high tariffs

PAGE

PAGE

PAGE

PAGE

PAGE 25 20 18 8 11

PAGE 25 20 18 8 11

Indicators of the Australian government’s adoption of trade liberalisation measures, 1970 to 2016

PAGE Indicators of the Australian government’s adoption of trade liberalisation measures, 1970 to 2016

Data derived from many sources including AGPS; Industry Commission; 2002 Trade Policy Review for Australia; Productivity

PAGE Data derived from many sources including AGPS; Industry Commission; 2002 Trade Policy Review for Australia; Productivity

Commission, Trade and Assistance Review 2015; DFAT; Budget Review 2006–07; and budget papers 2008–09 to 2015–16.

PAGE Commission, Trade and Assistance Review 2015; DFAT; Budget Review 2006–07; and budget papers 2008–09 to 2015–16.

Reducing industry protection and liberalising trade allowed Australia to become part of the process of globaliPAGE

Reducing industry protection and liberalising trade allowed Australia to become part of the process of globali

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS1970–71 1980–81 1990–91 2000–01 2010–11 2014–15 2019–20

PROOFS1970–71 1980–81 1990–91 2000–01 2010–11 2014–15 2019–20

7

PROOFS7

36 23 16 5

PROOFS36 23 16 5 5

PROOFS5

28 12 13 6PROOFS

28 12 13 6

25 20 18 8 11PROOFS

25 20 18 8 11



0

20

40

60

80

100

120

140

160

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19

68

–69

19

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–71

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–16

Eff

ecti

ve r

ate

of t

arif

f pr

otec

tion

(pe

rcen

tage

)Clothing apparel tariffs(percentage)

General manufacturing tariff(percentage)

Passenger motor vehicles tariffs(percentage)

White goods tariffs(percentage)

Agricultural tariffs(percentage)

FIGURE 3.24 Changes in tariff protection of Australian industry, 1968–69 to 2015–16

Sources: Data derived from many sources including AGPS; Industry Commission; 2002 Trade Policy Review for Australia; Productivity Commission, Trade and Assistance Review 2015; DFAT; Budget Review 2006–07; and budget papers 2008–09 to 2016–17.

Notice the following trends in tariff rates shown in �gure 3.24: • General tariff rate. The general tariff rate on most manufactured items was cut from 36 per cent in 1968–69

to only around 5 per cent from 1995–96 onwards (where the tariff level has since remained). • Special tariff rates. Tariffs applied to special industries like agriculture, TC&F (textiles, clothing, and foot-

wear), kitchen whitegoods and passenger cars have all come down at varying rates. These industries initially enjoyed more protection and cutting them too quickly to 5 per cent would have meant certain collapse. From 2010, rates on cars came down to 5 per cent and TC&F to 10 per cent, while in 2015 most tariffs for TC&F were reduced to 5 per cent.

Reduced net subsidies and other assistance to local producersSubsidies are government cash payments made to local producers and industries designed to help them cover some of their production costs. In so doing, they can grow local industry and may help businesses compete internationally. Subsidies or industry assistance can come in many forms but most are normally �nanced through the government’s annual budget outlays. After a peak of $25 billion a year in 1970, overallnet subsidies and budget assistance were generally reduced to roughly $9 billion by 2015. Lower sub-sidies are justi�ed on the grounds that some subsidies damage ef�ciency in resource allocation and create costs that reduce overall living standards. Indeed, in times past, some Australian industries had become dependent on government protective handouts. They had not restructured their production to become inter-nationally competitive.

Nevertheless, today, we still have some industry assistance in cases where there is market failure and various long-term bene�ts can be gained. Here we might think of the following schemes: • Export Development Grants (EMDG) are managed through AUSTRADE. They seek to help �rms cover up

to 50 per cent of the costs involved with the promotion of their goods and services in foreign markets. • There is a Tax Incentive Scheme for investment in R&D by smaller companies involved in innovation and

the commercialisation of ideas for manufacturing and rural industry. It is designed to lift productivity and sales. This accounts for around a third of all budget assistance.

• The Farm Household Allowance provides �nancial assistance to those experiencing �nancial hardship to support measures to improve their long-term situation. This also includes concessional loans.

• The Manufacturing Transition Program provides �nance for individual businesses moving into different areas of production.

• Tasmanian Freight Equalisation Scheme aims to reduce the transport cost disadvantage for businesses oper-ating in that state.

UNCORRECTED The general tariff rate on most manufactured items was cut from 36 per cent in 1968–69

UNCORRECTED The general tariff rate on most manufactured items was cut from 36 per cent in 1968–69 to only around 5 per cent from 1995–96 onwards (where the tariff level has since remained).

UNCORRECTED to only around 5 per cent from 1995–96 onwards (where the tariff level has since remained). Tariffs applied to special industries like agriculture, TC&F (textiles, clothing, and foot

UNCORRECTED Tariffs applied to special industries like agriculture, TC&F (textiles, clothing, and foot

wear), kitchen whitegoods and passenger cars have all come down at varying rates. These industries initially

UNCORRECTED wear), kitchen whitegoods and passenger cars have all come down at varying rates. These industries initially enjoyed more protection and cutting them too quickly to 5 per cent would have meant certain collapse.

UNCORRECTED enjoyed more protection and cutting them too quickly to 5 per cent would have meant certain collapse. From 2010, rates on cars came down to 5 per cent and TC&F to 10 per cent, while in 2015 most tariffs for

UNCORRECTED From 2010, rates on cars came down to 5 per cent and TC&F to 10 per cent, while in 2015 most tariffs for TC&F were reduced to 5 per cent.

UNCORRECTED TC&F were reduced to 5 per cent.

Reduced net subsidies and other assistance to local producers

UNCORRECTED

Reduced net subsidies and other assistance to local producersare government cash payments made to local producers and industries designed to help them

UNCORRECTED

are government cash payments made to local producers and industries designed to help them cover some of their production costs. In so doing, they can grow local industry and may help businesses

UNCORRECTED

cover some of their production costs. In so doing, they can grow local industry and may help businesses compete internationally. Subsidies or industry assistance can come in many forms but most are normally

UNCORRECTED

compete internationally. Subsidies or industry assistance can come in many forms but most are normally

UNCORRECTED

�nanced through the government’s annual budget outlays. After a peak of $25 billion a year in 1970, overall

UNCORRECTED

�nanced through the government’s annual budget outlays. After a peak of $25 billion a year in 1970, overall and budget assistance were generally reduced to roughly $9 billion by 2015. Lower sub

UNCORRECTED

and budget assistance were generally reduced to roughly $9 billion by 2015. Lower subsidies are justi�ed on the grounds that some subsidies damage ef�ciency in resource allocation and create

UNCORRECTED

sidies are justi�ed on the grounds that some subsidies damage ef�ciency in resource allocation and create costs that reduce overall living standards. Indeed, in times past, some Australian industries had become

UNCORRECTED

costs that reduce overall living standards. Indeed, in times past, some Australian industries had become

UNCORRECTED

dependent on government protective handouts. They had not restructured their production to become inter

UNCORRECTED

dependent on government protective handouts. They had not restructured their production to become internationally competitive.UNCORRECTED

nationally competitive.UNCORRECTED

Nevertheless, today, we still have some industry assistance in cases where there is market failure and various UNCORRECTED

Nevertheless, today, we still have some industry assistance in cases where there is market failure and various

PAGE

PAGE Changes in tariff protection of Australian industry, 1968–69 to 2015–16

PAGE Changes in tariff protection of Australian industry, 1968–69 to 2015–16

Data derived from many sources including AGPS; Industry Commission; 2002 Trade Policy Review for Australia; Productivity

PAGE Data derived from many sources including AGPS; Industry Commission; 2002 Trade Policy Review for Australia; Productivity

Commission, Trade and Assistance Review 2015; DFAT; Budget Review 2006–07; and budget papers 2008–09 to 2016–17.

PAGE Commission, Trade and Assistance Review 2015; DFAT; Budget Review 2006–07; and budget papers 2008–09 to 2016–17.

Notice the following trends in tariff rates shown in �gure 3.24:PAGE Notice the following trends in tariff rates shown in �gure 3.24:

The general tariff rate on most manufactured items was cut from 36 per cent in 1968–69 PAGE

The general tariff rate on most manufactured items was cut from 36 per cent in 1968–69

PROOFS



• The Automotive Transformation Scheme provided help that was conditional upon car companies under-taking investment to upgrade plant, equipment and technology. Despite the announced exit of local car makers Toyota, Ford and Holden by 2017, it was announced in 2015 that this scheme will be retained to help �rms in the automotive supply chain diversify and develop new markets.If applied carefully and in moderation, there is sometimes a case for the limited use of subsidies. They can act as a

microeconomic, aggregate supply-side measure that grows productive capacity and our international competitiveness.

Abolition of import quotas and licencesImport quotas are designed to restrict the supply or quantity of speci�c types of imports allowed into the country. They act to protect local businesses and limit foreign competition. In order to achieve a stated volume target, prospective importers must obtain a licence that gives them permission to bring in a certain maximum number of articles of a particular description.

Quotas were commonplace in Australia during the 1970s and early 1980s, especially on cars, textiles, foot-wear and clothing. However, with the adoption of trade liberalisation, these were progressively abolished. The last quotas, applying to cheese, were terminated in 2000–01. Clearly the government believes that, in the long term, their removal will increase ef�ciency in resource allocation, boost productive capacity and sustainable economic growth, slow cost in�ation, improve international competitiveness and, ultimately, strengthen our living standards.

The increased role of free trade agreementsAustralia has membership of various multinational trading groups (involving many countries) like the World Trade Organization (WTO). Through the Doha rounds of trade negotiations with the WTO (so named because negotiations originally took place in Doha, the capital of Qatar), Australia has pushed hard for general reduc-tions in global tariffs and the abolition of subsidies, along with increased access to agricultural, manufacturing and services markets internationally. Indeed, Australia was instrumental in setting up the Cairns group of fair agricultural traders bent on eliminating the agricultural subsidies commonly found in Europe, Japan and the United States. Despite these efforts, progress has been slow due to signi�cant opposition from interest groups.

Given this slow pace of multilateral trade reform, Australia has increasingly negotiated bilateral free trade agreements (FTAs) with two or more individual countries. For example, by early 2016, we had ten FTAs: • Australia–New Zealand FTA (also known as Closer Economic Relations) commenced in 1983 • Australia–Singapore FTA in 2005 • Australia–Thailand FTA in 2005 • Australia–United States FTA in 2005 • Australia–Chile FTA in 2007 • ASEAN–Australia–New Zealand FTA in 2009 • Malaysia–Australia FTA in 2012 • Korea–Australia FTA in 2014 • Australia–Japan FTA in 2014 • China–Australia FTA in 2015.

In addition, negotiations are well underway for striking new bilateral FTAs with India and Indonesia, along with an Australia–Europe FTA. Furthermore, in October 2015, Australia was one of 12 countries (United States, Japan, New Zealand, Canada, Mexico, Brunei, Chile, Malaysia, Peru, Singapore and Vietnam) to sign the massive Trans-Paci�c Partnership Agreement (TPP) covering 40 per cent of the global economy and elim-inating 98 per cent of tariffs on our agricultural exports. However, this agreement still needs to be rati�ed by the Australian Parliament later in 2016 and by those of other signatories.

Essentially, FTAs involve the removal of industry protection. This includes cutting tariff rates applied on trade between member countries, increasing access to services and easing restrictions on foreign investment. In addition to exposing local �rms to more intense foreign competition and forcing them to become more cost ef�cient and improve their international competitiveness, FTAs help Australian producers gain access to potentially huge export markets abroad. They can allow our businesses to expand GDP, gain economies of large scale production, grow Australia’s share of export sales and incomes, improve living standards and reduce our CAD.

Impacts on other government policiesTrade liberalisation is regarded by economists as an important government supply-side microeconomic reform policy designed to improve ef�ciency in the use of resources, and grow Australia’s international competitive-ness and living standards. Additionally, as a direct consequence of adopting trade liberalisation and openness, other productivity-promoting government reform policies have also had to be undertaken. More speci�cally, these included the following: • reform of the labour market • development of a national competition policy • taxation reform, including the lowering of rates and changes to the tax mix.

These measures also sought to strengthen Australia’s international competitiveness, domestic economic stability and general wellbeing. We will see that although trade liberalisation can sometimes have negative effects in some industries, particularly in the short term, the overall bene�ts normally become more apparent in the longer term.

UNCORRECTED in 2009

UNCORRECTED in 2009

UNCORRECTED in 2015.

UNCORRECTED in 2015.

In addition, negotiations are well underway for striking new bilateral FTAs with India and Indonesia, along

UNCORRECTED

In addition, negotiations are well underway for striking new bilateral FTAs with India and Indonesia, along with an Australia–Europe FTA. Furthermore, in October 2015, Australia was one of 12 countries (United

UNCORRECTED

with an Australia–Europe FTA. Furthermore, in October 2015, Australia was one of 12 countries (United States, Japan, New Zealand, Canada, Mexico, Brunei, Chile, Malaysia, Peru, Singapore and Vietnam) to sign

UNCORRECTED

States, Japan, New Zealand, Canada, Mexico, Brunei, Chile, Malaysia, Peru, Singapore and Vietnam) to sign the massive Trans-Paci�c Partnership Agreement (TPP) covering 40 per cent of the global economy and elim

UNCORRECTED

the massive Trans-Paci�c Partnership Agreement (TPP) covering 40 per cent of the global economy and eliminating 98 per cent of tariffs on our agricultural exports. However, this agreement still needs to be rati�ed by

UNCORRECTED

inating 98 per cent of tariffs on our agricultural exports. However, this agreement still needs to be rati�ed by the Australian Parliament later in 2016 and by those of other signatories.

UNCORRECTED

the Australian Parliament later in 2016 and by those of other signatories.Essentially, FTAs involve the removal of industry protection. This includes cutting tariff rates applied on trade

UNCORRECTED

Essentially, FTAs involve the removal of industry protection. This includes cutting tariff rates applied on trade

UNCORRECTED

between member countries, increasing access to services and easing restrictions on foreign investment. In addition

UNCORRECTED

between member countries, increasing access to services and easing restrictions on foreign investment. In addition to exposing local �rms to more intense foreign competition and forcing them to become more cost ef�cient and

UNCORRECTED

to exposing local �rms to more intense foreign competition and forcing them to become more cost ef�cient and improve their international competitiveness, FTAs help Australian producers gain access to potentially huge export

UNCORRECTED

improve their international competitiveness, FTAs help Australian producers gain access to potentially huge export markets abroad. They can allow our businesses to expand GDP, gain economies of large scale production, grow UNCORRECTED

markets abroad. They can allow our businesses to expand GDP, gain economies of large scale production, grow AUNCORRECTED

Australia’s share of export sales and incomes, improve living standards and reduce our CAD.UNCORRECTED

ustralia’s share of export sales and incomes, improve living standards and reduce our CAD.

PAGE agricultural traders bent on eliminating the agricultural subsidies commonly found in Europe, Japan and the

PAGE agricultural traders bent on eliminating the agricultural subsidies commonly found in Europe, Japan and the United States. Despite these efforts, progress has been slow due to signi�cant opposition from interest groups.

PAGE United States. Despite these efforts, progress has been slow due to signi�cant opposition from interest groups.Given this slow pace of multilateral trade reform, Australia has increasingly negotiated

PAGE Given this slow pace of multilateral trade reform, Australia has increasingly negotiated

with two or more individual countries. For example, by early 2016, we had ten FTAs:

PAGE with two or more individual countries. For example, by early 2016, we had ten FTAs:

(also known as Closer Economic Relations) commenced in 1983

PAGE (also known as Closer Economic Relations) commenced in 1983

PROOFSwear and clothing. However, with the adoption of trade liberalisation, these were progressively abolished. The last

PROOFSwear and clothing. However, with the adoption of trade liberalisation, these were progressively abolished. The last quotas, applying to cheese, were terminated in 2000–01. Clearly the government believes that, in the long term,

PROOFSquotas, applying to cheese, were terminated in 2000–01. Clearly the government believes that, in the long term, their removal will increase ef�ciency in resource allocation, boost productive capacity and sustainable economic

PROOFStheir removal will increase ef�ciency in resource allocation, boost productive capacity and sustainable economic growth, slow cost in�ation, improve international competitiveness and, ultimately, strengthen our living standards.

PROOFSgrowth, slow cost in�ation, improve international competitiveness and, ultimately, strengthen our living standards.

(involving many countries) like the World

PROOFS (involving many countries) like the World

of trade negotiations with the WTO (so named because

PROOFS of trade negotiations with the WTO (so named because

negotiations originally took place in Doha, the capital of Qatar), Australia has pushed hard for general reduc

PROOFSnegotiations originally took place in Doha, the capital of Qatar), Australia has pushed hard for general reductions in global tariffs and the abolition of subsidies, along with increased access to agricultural, manufacturing

PROOFS

tions in global tariffs and the abolition of subsidies, along with increased access to agricultural, manufacturing and services markets internationally. Indeed, Australia was instrumental in setting up the Cairns group of fair PROOFS

and services markets internationally. Indeed, Australia was instrumental in setting up the Cairns group of fair agricultural traders bent on eliminating the agricultural subsidies commonly found in Europe, Japan and the PROOFS

agricultural traders bent on eliminating the agricultural subsidies commonly found in Europe, Japan and the



FIGURE 3.25 ‘According to critics of agricultural protectionism, consumers and governments in rich countries have paid $350 billion per year supporting agriculture — enough to �y their 41 million dairy cows �rst class around the world one and a half times.’

Source: WTO.

Effects of trade liberalisation on Australia’s international competitivenessAs a policy, trade liberalisation has been under way for some decades now, and is one of a number of government measures designed to strengthen Australia’s international competitiveness and living standards. Remember that international competitiveness gives �rms the ability to expand their share of global sales and incomes against foreign rivals by selling better quality goods and services at relatively lower prices without government support. Govern-ment measures such as lowering tariffs, reducing subsidies, abolishing import quotas and negotiating FTAs should: • increase competition for local businesses from imports of goods and services, forcing them to lower prices

and improve quality and service • encourage Australian �rms to specialise their production in areas of comparative cost advantage, minimising

opportunity costs and allowing them to sell their products more competitively at a lower price • allow local �rms to gain economies of large-scale production and an ability to sell exports at a lower, more

competitive price through larger production runs made possible by selling in massive export markets • force �rms to restructure their operations, lift ef�ciency and cut their production costs, thereby allowing

them to sell at a lower, more competitive price • allow local �rms to gain access to the latest technology at the lowest cost, increasing technical ef�ciency

and helping them to compete more effectively • encourage �rms to think creatively, provide better service and meet customers changing needs, thus helping

to strengthen our international competitiveness.While it is dif�cult to precisely measure the effects of trade liberalisation and to know what would have

occurred in its absence, we do have some research that compares changes in Australia’s international compet-itiveness. For instance, �gure 3.26 uses data comparing Australia’s rank out of 60 countries (shown in part a), and looks at scores on speci�c aspects of competitiveness that were used to compile this data (in part b).

0

5

18171615

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Aus

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from

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hest

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60

nat

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)

Part (a) Change in Australia’s international competitiveness ranking (out of 60 countries,the lower the better)

Year

FIGURE 3.26 Changes in Australia’s international competitiveness ranking and perceived attractiveness or strengths (continued)

UNCORRECTED competitive price through larger production runs made possible by selling in massive export markets

UNCORRECTED competitive price through larger production runs made possible by selling in massive export marketsforce �rms to restructure their operations, lift ef�cienc

UNCORRECTED force �rms to restructure their operations, lift ef�ciency and cut their production costs, thereby allowing

UNCORRECTED y and cut their production costs, thereby allowing them to sell at a lower, more competitive price

UNCORRECTED them to sell at a lower, more competitive price

w local �rms to gain access to the latest technology at the lowest cost, increasing technical ef�ciency

UNCORRECTED w local �rms to gain access to the latest technology at the lowest cost, increasing technical ef�ciency

and helping them to compete more effectively

UNCORRECTED and helping them to compete more effectively

vely, provide better service and meet customers changing needs, thus helping

UNCORRECTED vely, provide better service and meet customers changing needs, thus helping

to strengthen our international competitiveness.

UNCORRECTED to strengthen our international competitiveness.While it is dif�cult to precisely measure the effects of trade liberalisation and to know what would have

UNCORRECTED

While it is dif�cult to precisely measure the effects of trade liberalisation and to know what would have occurred in its absence, we do have some research that compares changes in Australia’s international compet

UNCORRECTED

occurred in its absence, we do have some research that compares changes in Australia’s international competitiveness. For instance, �gure 3.26 uses data comparing Australia’s rank out of 60 countries (shown in part a),

UNCORRECTED

itiveness. For instance, �gure 3.26 uses data comparing Australia’s rank out of 60 countries (shown in part a), and looks at scores on speci�c aspects of competitiveness that were used to compile this data (in part b).

UNCORRECTED

and looks at scores on speci�c aspects of competitiveness that were used to compile this data (in part b).

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

15UNCORRECTED

15

20

UNCORRECTED

20

UNCORRECTED

com

peti

tive

ness

(fr

om h

ighe

st

UNCORRECTED

com

peti

tive

ness

(fr

om h

ighe

stto

low

est

out

of 6

0 n

atio

ns)

UNCORRECTED

to lo

wes

t ou

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60

nat

ions

)

Part (a) Change in Australia’s international competitiveness ranking (out of 60 countries,

UNCORRECTED

Part (a) Change in Australia’s international competitiveness ranking (out of 60 countries,

PAGE rivals by selling better quality goods and services at relatively lower prices without government support. Govern

PAGE rivals by selling better quality goods and services at relatively lower prices without government support. Government measures such as lowering tariffs, reducing subsidies, abolishing import quotas and negotiating FTAs should:

PAGE ment measures such as lowering tariffs, reducing subsidies, abolishing import quotas and negotiating FTAs should:usinesses from imports of goods and services, forcing them to lower prices

PAGE usinesses from imports of goods and services, forcing them to lower prices

Australian �rms to specialise their production in areas of comparative cost advantage, minimising

PAGE Australian �rms to specialise their production in areas of comparative cost advantage, minimising

opportunity costs and allowing them to sell their products more competitively at a lower price

PAGE opportunity costs and allowing them to sell their products more competitively at a lower price

w local �rms to gain economies of large-scale production and an ability to sell exports at a lower, more PAGE w local �rms to gain economies of large-scale production and an ability to sell exports at a lower, more

competitive price through larger production runs made possible by selling in massive export marketsPAGE

competitive price through larger production runs made possible by selling in massive export markets

PROOFS‘According to critics of agricultural protectionism, consumers and governments in rich countries have

PROOFS‘According to critics of agricultural protectionism, consumers and governments in rich countries have paid $350 billion per year supporting agriculture — enough to �y their 41 million dairy cows �rst class

PROOFSpaid $350 billion per year supporting agriculture — enough to �y their 41 million dairy cows �rst class

Effects of trade liberalisation on Australia’s international

PROOFSEffects of trade liberalisation on Australia’s international

As a policy, trade liberalisation has been under way for some decades now, and is one of a number of government

PROOFSAs a policy, trade liberalisation has been under way for some decades now, and is one of a number of government measures designed to strengthen Australia’s international competitiveness and living standards. Remember that

PROOFS

measures designed to strengthen Australia’s international competitiveness and living standards. Remember that international competitiveness gives �rms the ability to expand their share of global sales and incomes against foreign PROOFS

international competitiveness gives �rms the ability to expand their share of global sales and incomes against foreign rivals by selling better quality goods and services at relatively lower prices without government support. GovernPROOFS

rivals by selling better quality goods and services at relatively lower prices without government support. Govern



FIGURE 3.26 (continued)

Effective legal environment

Reliable infrastructureAccess to �nancing

Open and positive attitudesPolicy stability & predictabilityBusiness-friendly environment

Dynamism of the economyStrong R&D culture

Competency of governmentEffective labor relationsCompetitive tax regime

Cost competitiveness

Quality of corporate governanceSkilled workforce

High educational level

0% 10% 20% 30% 40%

64.9%64.0%

63.1%56.8%

46.8%36.9%

33.3%33.3%

30.6%13.5%

11.7%11.7%

6.3%3.6%3.6%

50% 60% 70%

Part (b) Australia’s international competitiveness: some indicators of attractiveness

Sources: (a) Data was derived from CEDA, competitiveness reports various years, see http://www.ceda.com.au/research-and-policy/explore-all-ceda-research/surveys/world-competitiveness-yearbook; (b) graph copied from CEDA, Competitiveness Trends Overall, p. 2, http://adminpanel.ceda.com.au/FOLDERS/Service/Files/Documents/26525~Australia.pdf.

From the graph in �gure 3.26 (part a), notice that our relative competitiveness has slipped badly, from a high of 5th place in 2009–10, to a recent low of 18th place in 2014–15. This deterioration is shown by the upward trend line. Of the 15 indicators of competitiveness (shown in part b), the business opinion survey felt that Australia’s attractiveness was generally mediocre and outright poor in some key areas such as the R&D culture, company tax regime and cost competitiveness.

Figure 3.27 sheds additional light on some other factors in�uencing Australia’s costs and competitiveness compared with the United States.

0 200 400 600 800

6. Australia’s rate of company taxas a percentage of the US rate

5. Index of Australia’s GDP perhour worked (USA = 100)

4. Australia’s hourly minimum wageas a percentage of the US wage

2. Average number of working days lostper 100000 employees in Australia

as a percentage of the US average

3. Approximate cost of a kilowatt hour of electricity in Australia as a percentage of the US cost

1. Australia’s of�cial interest ratesas a percentage of the US rate

Australian rate as a percentage of the US rate

Indi

cato

r of

com

peti

tive

ness 143

134

132

83

75

700

FIGURE 3.27 Some factors affecting Australia’s international competitiveness compared with the United States

Notes: (a) Cost is a rough guide as special power rates apply in some countries for businesses, and rates also depend on season and quantity purchased. (b) Most data is for 2012 or 2013.

Sources: Data mostly 2013–14 or more recent. Information has been derived from many sources including the following: indicator 1 derived from RBA Statistics; indicator 2 selected from NationMaster, Labour, Strikes, Countries compared, www.nationmaster. com/country-info/stats/Labor/Strikes; indicator 3 derived from Wikipedia, the free encyclopaedia, Electricity Pricing, en.wikipedia.org/wiki/Electricity_pricing; indicator 4 derived from Wikipedia, the free encyclopaedia, countries selected from a table, en.wikipedia.org/wiki/List_of_minimum_ wages_by_country; indicator 5 derived from The Conference Board, Total Economy Database, Summary statistics 1997–2014, Summary tables; indicator 6 derived from KPMG for corporate tax rate comparisons, 2015.

UNCORRECTED Figure 3.27 sheds additional light on some other factors in�uencing Australia’s costs and competitiveness

UNCORRECTED Figure 3.27 sheds additional light on some other factors in�uencing Australia’s costs and competitiveness

UNCORRECTED

UNCORRECTED

5. Index of Australia’s GDP per

UNCORRECTED

5. Index of Australia’s GDP per

4. Australia’s hourly minimum wage

UNCORRECTED

4. Australia’s hourly minimum wageas a percentage of the US wage

UNCORRECTED

as a percentage of the US wage

2. Average number of working days lost

UNCORRECTED 2. Average number of working days lost

per 100000 employees in Australia

UNCORRECTED

per 100000 employees in Australiaas a percentage of the US average

UNCORRECTED

as a percentage of the US average

3. Approximate cost of a kilowatt

UNCORRECTED

3. Approximate cost of a kilowatt hour of electricity in Australia

UNCORRECTED

hour of electricity in Australia as a percentage of the US cost

UNCORRECTED

as a percentage of the US cost

1. Australia’s of�cial interest rates

UNCORRECTED 1. Australia’s of�cial interest rates

as a percentage of the US rate

UNCORRECTED as a percentage of the US rate

Indi

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com

peti

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UNCORRECTED

Indi

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UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED PAGE http://adminpanel.ceda.com.au/FOLDERS/Service/Files/Documents/26525~Australia.pdf.

PAGE http://adminpanel.ceda.com.au/FOLDERS/Service/Files/Documents/26525~Australia.pdf.

From the graph in �gure 3.26 (part a), notice that our relative competitiveness has slipped badly, from a

PAGE From the graph in �gure 3.26 (part a), notice that our relative competitiveness has slipped badly, from a

high of 5th place in 2009–10, to a recent low of 18th place in 2014–15. This deterioration is shown by the

PAGE high of 5th place in 2009–10, to a recent low of 18th place in 2014–15. This deterioration is shown by the upward trend line. Of the 15 indicators of competitiveness (shown in part b), the business opinion survey felt

PAGE upward trend line. Of the 15 indicators of competitiveness (shown in part b), the business opinion survey felt

s attractiveness was generally mediocre and outright poor in some key areas such as the R&D

PAGE s attractiveness was generally mediocre and outright poor in some key areas such as the R&D

culture, company tax regime and cost competitiveness. PAGE culture, company tax regime and cost competitiveness.

Figure 3.27 sheds additional light on some other factors in�uencing Australia’s costs and competitiveness PAGE

Figure 3.27 sheds additional light on some other factors in�uencing Australia’s costs and competitiveness

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS

PROOFS50% 60% 70%

PROOFS50% 60% 70%

(a) Data was derived from CEDA, competitiveness reports various years, see http://www.ceda.com.au/research-and-policy/PROOFS

(a) Data was derived from CEDA, competitiveness reports various years, see http://www.ceda.com.au/research-and-policy/explore-all-ceda-research/surveys/world-competitiveness-yearbook; (b) graph copied from CEDA, Competitiveness Trends Overall, p. 2, PROOFS

explore-all-ceda-research/surveys/world-competitiveness-yearbook; (b) graph copied from CEDA, Competitiveness Trends Overall, p. 2,



With the exception of our lower rate of company tax, the data show that Australia has a competitive dis-advantage with the United States in areas including the cost of borrowing, working days lost through industrial action like strikes, electricity charges, minimum hourly pay rates and labour productivity.

What these data also show is that Australia’s international competitiveness appears to have declined against that of some other countries in recent years. However, it is probably fair to say that without the progress made through liberalising international trade, our situation would almost certainly have been even worse. It is also likely that other countries have been more successful with measures designed to strengthen international competitiveness.

Effects of trade liberalisation on domestic macroeconomic goalsTrade liberalisation (as an important microeconomic reform policy), has helped to lift allocative, technical, dynamic and even intertemporal ef�ciency, grow Australia’s productive capacity and increase AS. As a result, it has impacted on the government’s three key domestic macroeconomic goals of low in�ation, strong and sustainable economic growth, and full employment.

Effect of trade liberalisation on the achievement of low in�ationOne important domestic macroeconomic objective of the RBA and Australian government is the goal of low in�ation (keeping the average rise in price around 2–3 per cent per year over the business cycle). Trade liberalisation has helped to slow Australia’s in�ation rate (especially cost in�ation). This might have happened in several ways: • Trade liberalisation has caused resources to move into their most ef�cient uses and out of areas of inef-

�ciency and high costs. There has been an increase in allocative ef�ciency, slowing in�ation. • Trade liberalisation (especially FTAs) has grown our access to larger markets abroad, allowing local �rms to

gain economies of large-scale production and cutting �xed costs per unit. • Trade liberalisation has allowed local �rms to have cheaper input costs for equipment and raw materials accessed

from overseas. Indeed, the Productivity Commission recently estimated that, despite reductions, tariffs add over $7 billion annually to costs for manufacturing and service businesses. Reducing tariffs should therefore slow in�ation.

• Trade liberalisation has forced local �rms to restructure their operations more ef�ciently, cut production costs and apply world’s best practice. This has increased dynamic ef�ciency and helped to slow in�ationary pressures.Figure 3.28 shows that since signi�cant trade liberalisation from the early 1990s, Australia’s average in�ation

rate has slowed dramatically to just 2.7 per cent over the last 25 years, compared with 9.3 per cent during the previous 20 years. While trade liberalisation is not the only cause (there were also other microeconomic or aggregate supply-side government policies that helped to slow in�ation, such as the deregulation of the labour market), it is likely to have been an important contributing factor. In other words, cutting tariffs, import quotas and subsidies, as well as and signing FTAs, has probably helped to promote the goal of low in�ation. In turn, this has helped to increase the real purchasing power of incomes and raise material living standards.

10 9.3

2.7

12

8

Ann

ual a

vera

ge in

�ati

on r

ate

(per

cent

age)

6

4

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Average annual in�ation rate (%)before signi�cant trade liberalisation

(1970–71/1989–90)

Average annual in�ation rate (%)since signi�cant globalisation

(1990–91/2015–16)

0

Period of time

FIGURE 3.28 The likely link between Australia’s trade liberalisation and our lower in�ation

Sources: Data derived from RBA Statistics, Occasional Paper 8A; ABS 5206.0 (Table 34).

Effect of trade liberalisation on the achievement of strong and sustainable economic growthA second core macroeconomic objective of the federal government is to promote the goal of strong and sus-tainable economic growth. This is de�ned as the fastest average rate of growth in real GDP, around 3 per cent per year or a little more, that is consistent with achieving other economic and environmental goals.

UNCORRECTED rate has slowed dramatically to just 2.7 per cent over the last 25 years, compared with 9.3 per cent during the

UNCORRECTED rate has slowed dramatically to just 2.7 per cent over the last 25 years, compared with 9.3 per cent during the previous 20 years. While trade liberalisation is not the only cause (there were also other microeconomic or

UNCORRECTED previous 20 years. While trade liberalisation is not the only cause (there were also other microeconomic or aggregate supply-side government policies that helped to slow in�ation, such as the deregulation of the labour

UNCORRECTED aggregate supply-side government policies that helped to slow in�ation, such as the deregulation of the labour market), it is likely to have been an important contributing factor. In other words, cutting tariffs, import quotas

UNCORRECTED market), it is likely to have been an important contributing factor. In other words, cutting tariffs, import quotas and subsidies, as well as and signing FTAs, has probably helped to promote the goal of low in�ation. In turn,

UNCORRECTED and subsidies, as well as and signing FTAs, has probably helped to promote the goal of low in�ation. In turn, this has helped to increase the real purchasing power of incomes and raise material living standards.

UNCORRECTED this has helped to increase the real purchasing power of incomes and raise material living standards.

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UNCORRECTED PAGE rade liberalisation has allowed local �rms to have cheaper input costs for equipment and raw materials accessed

PAGE rade liberalisation has allowed local �rms to have cheaper input costs for equipment and raw materials accessed from overseas. Indeed, the Productivity Commission recently estimated that, despite reductions, tariffs add over

PAGE from overseas. Indeed, the Productivity Commission recently estimated that, despite reductions, tariffs add over $7 billion annually to costs for manufacturing and service businesses. Reducing tariffs should therefore slow

PAGE $7 billion annually to costs for manufacturing and service businesses. Reducing tariffs should therefore slow

rade liberalisation has forced local �rms to restructure their operations more ef�ciently, cut production costs

PAGE rade liberalisation has forced local �rms to restructure their operations more ef�ciently, cut production costs

and apply world’s best practice. This has increased dynamic ef�ciency and helped to slow in�ationary pressures.

PAGE and apply world’s best practice. This has increased dynamic ef�ciency and helped to slow in�ationary pressures.Figure 3.28 shows that since signi�cant trade liberalisation from the early 1990s, Australia’s average in�ation PAGE Figure 3.28 shows that since signi�cant trade liberalisation from the early 1990s, Australia’s average in�ation

rate has slowed dramatically to just 2.7 per cent over the last 25 years, compared with 9.3 per cent during the PAGE rate has slowed dramatically to just 2.7 per cent over the last 25 years, compared with 9.3 per cent during the previous 20 years. While trade liberalisation is not the only cause (there were also other microeconomic or PAGE

previous 20 years. While trade liberalisation is not the only cause (there were also other microeconomic or

PROOFSgoal of low

PROOFSgoal of low (keeping the average rise in price around 2–3 per cent per year over the business cycle). Trade liberalisation

PROOFS (keeping the average rise in price around 2–3 per cent per year over the business cycle). Trade liberalisation

has helped to slow Australia’s in�ation rate (especially cost in�ation). This might have happened in several ways:

PROOFShas helped to slow Australia’s in�ation rate (especially cost in�ation). This might have happened in several ways:

rade liberalisation has caused resources to move into their most ef�cient uses and out of areas of inef

PROOFSrade liberalisation has caused resources to move into their most ef�cient uses and out of areas of inef

�ciency and high costs. There has been an increase in allocative ef�ciency, slowing in�ation.

PROOFS�ciency and high costs. There has been an increase in allocative ef�ciency, slowing in�ation.

rade liberalisation (especially FTAs) has grown our access to larger markets abroad, allowing local �rms to

PROOFSrade liberalisation (especially FTAs) has grown our access to larger markets abroad, allowing local �rms to

rade liberalisation has allowed local �rms to have cheaper input costs for equipment and raw materials accessed PROOFS

rade liberalisation has allowed local �rms to have cheaper input costs for equipment and raw materials accessed from overseas. Indeed, the Productivity Commission recently estimated that, despite reductions, tariffs add over PROOFS

from overseas. Indeed, the Productivity Commission recently estimated that, despite reductions, tariffs add over



Trade liberalisation might have helped to strengthen the economically sustainable rate of growth in several ways, particularly in the medium to longer term: • Trade liberalisation leads to a greater specialisation and a more ef�cient allocation of resources involving

lower opportunity costs. This means there is more output gained from the same or fewer inputs, thereby growing Australia’s production possibility frontier and productive capacity. This increases the sustainable rate of GDP growth.

• With trade liberalisation, local businesses need to reorganise their operations ef�ciently to allow them to survive more intensive competition from imports. This allows for an increase in productive capacity and rate of economic growth.

• Trade liberalisation has allowed our local �rms to access equipment, materials and technology at a lower cost, creating the more favourable aggregate supply conditions needed to grow Australia’s GDP at a faster rate.

• Trade liberalisation has grown the size of Australia’s export markets, turbocharging sales and encouraging �rms to boost production levels and GDP.By increasing the growth rate of GDP, trade liberalisation helps to increase national incomes faster.

This helps to lift average real disposable income and consumption per head, and hence material living standards.

A 2009 report concluded that trade liberalisation has delivered a rise in average family incomes over two decades of around $3900 per family per year by adding 1.8 per cent to real GDP (Bene�ts of Trade and Trade Liberalisation by DFAT and Centre for International Economics). Again, in the medium to long term, some of the rise in average real disposable incomes per head might be attributable to the Australian government’s acceleration of trade liberalisation from the early 1990s. Figure 3.29 seems to con�rm that there has been a faster growth in real disposable income of 1.8 per cent per year on average in the 25 years to 2014–15 against 1.4 per cent growth in the 20 years to 1990, prior to signi�cant liberalisation. However, this could be a coinci-dence rather than proof of a causal relationship.

2.5

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Average annual growth rate in realnet national disposable income perhead (%) before signi�cant trade

liberalisation (1970–71/1989–90)

Average annual growth rate in realnet disposable income per head (%)

since signi�cant globalisation(1990–91/2014–15)

Period of time

0

FIGURE 3.29 The possible link between Australia’s trade liberalisation and our faster growth in real net disposable income per head


Despite the bene�ts of economic growth in the medium to longer term, in the short to medium term, trade liberalisation may actually slow economic growth. The main reason is that some local �rms, unable to cut costs quickly enough and restructure, may be forced to close. Here we might think of recent examples in the car industry, TC&F and low end manufacturing. This would mean the loss of productive capacity, slower econ-omic growth and weaker living standards.

Effect of trade liberalisation on the achievement of full employmentThe goal of full employment is a third domestic macroeconomic economic objective of the federal government. This is de�ned as the lowest rate of unemployment, around 5 per cent of the labour force, that does not accel-erate in�ation.

Nearly 25 per cent of all Australian jobs are currently generated through international trade. The effect of trade liberalisation on Australia’s unemployment rate depends partly on whether we consider the short or long term period of time. As a general rule, in the long run, it seems that trade liberalisation has created more jobs and employment, albeit sometimes in different industries, whereas in the shorter term, the effects can be severe for industries that cannot become internationally competitive fast enough.

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED Average annual growth rate in real

UNCORRECTED Average annual growth rate in realnet national disposable income per

UNCORRECTED

net national disposable income perhead (%) before signi�cant trade

UNCORRECTED

head (%) before signi�cant tradeliberalisation (1970–71/1989–90)

UNCORRECTED

liberalisation (1970–71/1989–90)

UNCORRECTED

UNCORRECTED

UNCORRECTED

3.29

UNCORRECTED

3.29 The possible link between Australia’s trade liberalisation and our faster growth in real net disposable

UNCORRECTED

The possible link between Australia’s trade liberalisation and our faster growth in real net disposable income per head

UNCORRECTED

income per head

Sources:

UNCORRECTED


UNCORRECTED

Data derived from RBA Statistics, Occasional Paper 8A; ABS 5206.0 (Table 34).

Despite the bene�ts of economic growth in the medium to longer term, in the

UNCORRECTED

Despite the bene�ts of economic growth in the medium to longer term, in the liberalisation may actually slow economic growth. The main reason is that some local �rms, unable to cut UNCORRECTED

liberalisation may actually slow economic growth. The main reason is that some local �rms, unable to cut UNCORRECTED

costs quickly enough and restructure, may be forced to close. Here we might think of recent examples in the UNCORRECTED

costs quickly enough and restructure, may be forced to close. Here we might think of recent examples in the

PAGE 1.4 per cent growth in the 20 years to 1990, prior to signi�cant liberalisation. However, this could be a coinci

PAGE 1.4 per cent growth in the 20 years to 1990, prior to signi�cant liberalisation. However, this could be a coinci

PAGE

PAGE

PAGE PROOFS

rade liberalisation has grown the size of Australia’s export markets, turbocharging sales and encouraging

PROOFSrade liberalisation has grown the size of Australia’s export markets, turbocharging sales and encouraging

By increasing the growth rate of GDP, trade liberalisation helps to increase national incomes faster.

PROOFSBy increasing the growth rate of GDP, trade liberalisation helps to increase national incomes faster. This helps to lift average real disposable income and consumption per head, and hence material living

PROOFSThis helps to lift average real disposable income and consumption per head, and hence material living

A 2009 report concluded that trade liberalisation has delivered a rise in average family incomes over two

PROOFSA 2009 report concluded that trade liberalisation has delivered a rise in average family incomes over two

decades of around $3900 per family per year by adding 1.8 per cent to real GDP (

PROOFSdecades of around $3900 per family per year by adding 1.8 per cent to real GDP (Bene�ts of Trade and Trade

PROOFSBene�ts of Trade and Trade

by DFAT and Centre for International Economics). Again, in the medium to long term, some

PROOFS by DFAT and Centre for International Economics). Again, in the medium to long term, some

of the rise in average real disposable incomes per head might be attributable to the Australian government’s

PROOFSof the rise in average real disposable incomes per head might be attributable to the Australian government’s acceleration of trade liberalisation from the early 1990s. Figure 3.29 seems to con�rm that there has been a

PROOFS

acceleration of trade liberalisation from the early 1990s. Figure 3.29 seems to con�rm that there has been a faster growth in real disposable income of 1.8 per cent per year on average in the 25 years to 2014–15 against PROOFS

faster growth in real disposable income of 1.8 per cent per year on average in the 25 years to 2014–15 against 1.4 per cent growth in the 20 years to 1990, prior to signi�cant liberalisation. However, this could be a coinciPROOFS

1.4 per cent growth in the 20 years to 1990, prior to signi�cant liberalisation. However, this could be a coinci



Starting with the longer term, trade liberalisation might have helped to create more jobs and better material and non-material living standards in various ways: • By boosting ef�ciency and slowing domestic in�ation, trade liberalisation may make local businesses more

internationally competitive, enabling them to increase their sales in domestic and foreign markets. This can lead to higher production levels and demand for resources including labour, keeping unemployment lower.

• Trade liberalisation, especially FTAs, create bigger markets abroad, allowing for increased sales and busi-ness expansion. This creates job vacancies and helps lower unemployment.

• Trade liberalisation allows local �rms to reduce their costs of equipment and materials. This is a favourable aggregate supply-side factor that enhances business competitiveness and pro�tability, again reducing busi-ness closures and structural unemployment.

By creating more jobs and lowering unemployment, material living standards and consumption should be higher. In addition, lower unemployment can support better non-material living standards including greater happiness, less crime, improved health outcomes and less family con�ict.

However, having suggested that trade liberalisation should help to promote the goal of full employment, evidence of this appears rather thin. Indeed, average unemployment rates in the years since signi�cant trade liberalisation have tended to be signi�cantly higher (see �gure 3.30). Again, this may not entirely be the result of trade liberalisation measures but it is possible that these and related policies have contributed to the problem.

4.2

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Ann

ual u

nem

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tra

te (

perc

enta

ge)

6

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Average unemployment rate (%)before signi�cant trade liberalisation

(1970–71/1989–90)

Average unemployment rate (%)since signi�cant globalisation

(1990–91/2015–16)

Period of time

0

FIGURE 3.30 The possible link between Australia’s trade liberalisation and our unemployment rate

Sources: Data derived from ABS 1350.0, 6202.0; RBA Statistics, Occasional Paper 8A (Table 4.3).

In fact, one of the main criticisms of trade liberalisation in Australia and elsewhere, especially in the shorter term, is that it prevents the growth of infant industries, destroys others that are uncompetitive and causes higher levels of structural unemployment as seen in basic manufacturing during recent decades.

Other evidence of the effects of trade liberalisation on domestic economic goalsWe will conclude this section about the effects of trade liberalisation on the domestic economy in both the short and long terms by looking at some recent research. Economic modelling has recently been concluded showing the possible annual impacts of FTAs for the Australian economy predicted for 2016 to 2035. One report looks at the results of Australia’s three FTAs with Northern Asia (with China in 2015, and with Japan and South Korea in 2014). The results are summarised in table 3.2. Notice the expected signi�cant additions to GDP, consumption and employment.

TABLE 3.2The projected economic effects of Australia’s three FTAs with North Asian Economies (Japan, China and South Korea), 2016–35

GDPReal

consumptionReal consumption

per householda Employment

A$m A$m A$ persons

2016 1 036 2 886 312 7 925

2035 2 260 4 630 370 5 434

Net present value 24 362 46 260 4 348

aPer household �gures use ABS projected number of households (series II) in the relevant year (http://www.abs.gov.au/AUSSTATS/[email protected]/allprimarymainfeatures/0AAC8BFAE9DD3241CA2568A90013942A?opendocument)Note: Present value calculations use a discount rate of 5%

Source: CIE, Economic bene�ts of Australia’s North Asian FTAs, 12 June 2015, p. 30, https://dfat.gov.au/about-us/publications/Documents/economic-modelling-of-australias-north-asia-ftas.pdf.

UNCORRECTED

UNCORRECTED Period of time

UNCORRECTED Period of time

UNCORRECTED The possible link between Australia’s trade liberalisation and our unemployment rate

UNCORRECTED The possible link between Australia’s trade liberalisation and our unemployment rate

Data derived from ABS 1350.0, 6202.0; RBA Statistics, Occasional Paper 8A (Table 4.3).

UNCORRECTED Data derived from ABS 1350.0, 6202.0; RBA Statistics, Occasional Paper 8A (Table 4.3).

In fact, one of the main criticisms of trade liberalisation in Australia and elsewhere, especially in the shorter

UNCORRECTED In fact, one of the main criticisms of trade liberalisation in Australia and elsewhere, especially in the shorter

term, is that it prevents the growth of infant industries, destroys others that are uncompetitive and causes

UNCORRECTED term, is that it prevents the growth of infant industries, destroys others that are uncompetitive and causes higher levels of structural unemployment as seen in basic manufacturing during recent decades.

UNCORRECTED

higher levels of structural unemployment as seen in basic manufacturing during recent decades.

Other evidence of the effects of trade liberalisation on domestic

UNCORRECTED

Other evidence of the effects of trade liberalisation on domestic

We will conclude this section about the effects of trade liberalisation on the domestic economy in both the

UNCORRECTED

We will conclude this section about the effects of trade liberalisation on the domestic economy in both the short and long terms by looking at some recent research. Economic modelling has recently been concluded

UNCORRECTED

short and long terms by looking at some recent research. Economic modelling has recently been concluded showing the possible annual impacts of FTAs for the Australian economy predicted for 2016 to 2035. One

UNCORRECTED

showing the possible annual impacts of FTAs for the Australian economy predicted for 2016 to 2035. One report looks at the results of Australia’s three FTAs with Northern Asia (with China in 2015, and with Japan

UNCORRECTED

report looks at the results of Australia’s three FTAs with Northern Asia (with China in 2015, and with Japan and South Korea in 2014). The results are summarised in table 3.2. Notice the expected signi�cant additions to

UNCORRECTED

and South Korea in 2014). The results are summarised in table 3.2. Notice the expected signi�cant additions to GDP, consumption and employment.

UNCORRECTED

GDP, consumption and employment.

UNCORRECTED

UNCORRECTED

TABLE 3.2UNCORRECTED

TABLE 3.2

PAGE Average unemployment rate (%)

PAGE Average unemployment rate (%)since signi�cant globalisation

PAGE since signi�cant globalisation

(1990–91/2015–16)PAGE (1990–91/2015–16)

Period of timePAGE Period of timePAGE

PAGE

PAGE PROOFS

However, having suggested that trade liberalisation should help to promote the goal of full employment,

PROOFSHowever, having suggested that trade liberalisation should help to promote the goal of full employment,

evidence of this appears rather thin. Indeed, average unemployment rates in the years since signi�cant trade

PROOFSevidence of this appears rather thin. Indeed, average unemployment rates in the years since signi�cant trade liberalisation have tended to be signi�cantly higher (see �gure 3.30). Again, this may not entirely be the

PROOFSliberalisation have tended to be signi�cantly higher (see �gure 3.30). Again, this may not entirely be the result of trade liberalisation measures but it is possible that these and related policies have contributed to the

PROOFSresult of trade liberalisation measures but it is possible that these and related policies have contributed to the

PROOFS

PROOFS

PROOFS



Effects of trade liberalisation on living standardsOverall living standards or wellbeing depend on both material and non-material conditions: • Material living standards re�ect real annual levels of production, income and consumption of goods and

services per person, and the extent to which our wants are actually satis�ed. • Non-material living standards could be affected by many things, from personal happiness and free choice,

to world peace, the existence of democracy, level of cultural enrichment and experiences, the absence of crime, and a clean and sustainable environment.

Positive effectsTrade liberalisation has had mostly positive effects on the welfare of Australians, especially in the long term: • Trade liberalisation should have bolstered our economic wellbeing through:

– greater ef�ciency in resource allocation and the growth of productive capacity – faster economic growth – increased real per capita incomes and purchasing power – lower consumer prices – increased employment in the long term.

• Trade liberalisation can also enhance some aspects of non-economic wellbeing, perhaps through – increasing consumer choice – improving cooperation and world peace – enhancing cultural enrichment, and providing more exciting and diverse experiences.

Negative effectsHowever, trade liberalisation has not been without its problems: • It has led to higher structural unemployment in some uncompetitive industries that have relocated, restructured

or closed down, and it may also have sti�ed the growth of infant industries that would have provided job oppor-tunities had they been able to prosper. In turn, structural unemployment reduces incomes and consumption. It also undermines aspects of non-material living standards including personal happiness, feelings of self-worth, health outcomes and family tensions, and potentially, even increased crime rates.

• It has possibly exposed Australia to greater economic instability like the effects of the GFC. • By increasing production, it has accelerated the depletion of non-renewable natural resources and further

compromised the environment.

Weblinks The weblinks in these activities are available in this chapter’s student resources tab.• A video case study on Aaco Beef• A video case study on AusAb• A video case study on ACPET• A video case study on Burch Family Wines• A video case study on Burra Foods

• AUSTRADE: Bene�ts of trade and FTAs• Export Council of Australia• Potential FTA with India• AUSTRADE: Export Market Development Grants


1 Outline the main policy measures of the Australian government associated with the progressive adoption of trade liberalisation

2 How would you expect trade liberalisation to affect each of the following areas?a Our international competitivenessb Our domestic macroeconomic goals including: i in�ation rate ii rate of economic growth iii unemployment ratec Overall living standards.




UNCORRECTED it has accelerated the depletion of non-renewable natural resources and further

UNCORRECTED it has accelerated the depletion of non-renewable natural resources and further

UNCORRECTED The weblinks in these activities are available in this chapter’s student resources tab.

UNCORRECTED The weblinks in these activities are available in this chapter’s student resources tab.

A video case study on Aaco Beef

UNCORRECTED A video case study on Aaco BeefA video case study on AusAb

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A video case study on ACPETA video case study on Burch Family Wines

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A video case study on Burch Family WinesA video case study on Burra Foods

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A video case study on Burra Foods

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a

PAGE t has led to higher structural unemployment in some uncompetitive industries that have relocated, restructured

PAGE t has led to higher structural unemployment in some uncompetitive industries that have relocated, restructured or closed down, and it may also have sti�ed the growth of infant industries that would have provided job oppor

PAGE or closed down, and it may also have sti�ed the growth of infant industries that would have provided job opportunities had they been able to prosper. In turn, structural unemployment reduces incomes and consumption. It

PAGE tunities had they been able to prosper. In turn, structural unemployment reduces incomes and consumption. It also undermines aspects of non-material living standards including personal happiness, feelings of self-worth,

PAGE also undermines aspects of non-material living standards including personal happiness, feelings of self-worth, health outcomes and family tensions, and potentially, even increased crime rates.

PAGE health outcomes and family tensions, and potentially, even increased crime rates.

has possibly exposed Australia to greater economic instability like the effects of the GFC.PAGE has possibly exposed Australia to greater economic instability like the effects of the GFC.

it has accelerated the depletion of non-renewable natural resources and further PAGE it has accelerated the depletion of non-renewable natural resources and further

PROOFSwellbeing, perhaps through

PROOFSwellbeing, perhaps through

cultural enrichment, and providing more exciting and diverse experiences.

PROOFScultural enrichment, and providing more exciting and diverse experiences.

t has led to higher structural unemployment in some uncompetitive industries that have relocated, restructured PROOFS

t has led to higher structural unemployment in some uncompetitive industries that have relocated, restructured



3.9 School-assessed courseworkThree SACs are to be completed for VCE Economics Unit 3. SAC 3 is worth 30 per cent of the total assess-ment for Unit 3. It assesses the skills and knowledge associated with Outcome 3 that is largely covered in topic 3. The SAC should be part of the regular teaching and learning program, and completed mainly in class and within a limited timeframe. The SAC could involve one or more of the following: • a folio of applied economics exercises • an essay • a report • structured questions • media analysis • case study.

Courses and assessments can change, so teachers are urged to carefully check the latest VCAA assessment guide and various bulletins to ensure that all the assessment requirements are met fully.

Multiple-choice test questionsInstructions: Using the multiple-choice answer grid available in the Resources section, select the letter (A, B, C, D) that represents the most appropriate answer for each question by marking this with a tick (✓).

The answer grid for the multiple-choice questions is available in this topic’s student resources tab. Searchlight ID: doc-19065

Question 1

International relationships exist between countries. Typically, these involve:A exports of goods and services.B imports of goods and services.C exports and imports of goods and services.D exports and imports of goods and services along with movements of money capital and investments.

Question 2

Currently, Australia’s three most important export customers in descending order are:A China, Japan and the US.B the US, China and Japan.C the US, Japan and China.D Japan, China and the US.

Question 3

Freer international trade usually improves living standards by:A increasing ef�ciency in resource use, growing GDP and decreasing in�ation.B allowing countries to specialise in areas of comparative cost advantage.C growing jobs and incomes, especially in the longer term, thereby increasing our purchasing power.D all of the above.

Question 4

Study the hypothetical data below for country A and country B. It shows the total number of hours that must be worked by each employee to produce a unit of wool or a unit of wheat. Each country can produce the same two products, wool and wheat.

Country Wool (hours worked per unit produced) Wheat (hours worked per unit produced)

A 10 50

B 20 200

Based on this data:A country B has an absolute cost advantage in wheat.B country A has a comparative cost advantage in wheat.C country B has no type of cost advantage in either product.D country B has an absolute and comparative cost advantage in both goods.

Question 5

Referring to the data from question 4, which statement is false?A Country A is more ef�cient at producing both wool and wheat than country B.B Country B is less ef�cient at producing both wool and wheat than country A.

UNCORRECTED Currently, Australia’s three most important export customers in

UNCORRECTED Currently, Australia’s three most important export customers in

Freer international trade usually improves living standards by:

UNCORRECTED

Freer international trade usually improves living standards by:increasing ef�ciency in resource use, growing GDP and decreasing in�ation.

UNCORRECTED

increasing ef�ciency in resource use, growing GDP and decreasing in�ation.allowing countries to specialise in areas of comparative cost advantage.

UNCORRECTED

allowing countries to specialise in areas of comparative cost advantage.growing jobs and incomes, especially in the longer term, thereby increasing our purchasing power.

UNCORRECTED

growing jobs and incomes, especially in the longer term, thereby increasing our purchasing power.

Study the hypothetical data below for country A and country B. It shows the total number of hours that must

UNCORRECTED

Study the hypothetical data below for country A and country B. It shows the total number of hours that must be worked by each employee to produce a unit of wool or a unit of wheat. Each country can produce the same

UNCORRECTED

be worked by each employee to produce a unit of wool or a unit of wheat. Each country can produce the same two products, wool and wheat.

UNCORRECTED

two products, wool and wheat.

UNCORRECTED

UNCORRECTED

UNCORRECTED

CountryUNCORRECTED

Country

PAGE International relationships exist between countries. Typically, these involve:

PAGE International relationships exist between countries. Typically, these involve:

exports and imports of goods and services along with movements of money capital and investments.PAGE exports and imports of goods and services along with movements of money capital and investments.

descendingPAGE

descending

PROOFS Using the multiple-choice answer grid available in the Resources section, select the letter (A, B,

PROOFS Using the multiple-choice answer grid available in the Resources section, select the letter (A, B,

C, D) that represents the most appropriate answer for each question by marking this with a tick (

PROOFSC, D) that represents the most appropriate answer for each question by marking this with a tick (✓

PROOFS✓).

PROOFS).

PROOFSThe answer grid for the multiple-choice questions is available in this topic’s student resources tab.

PROOFSThe answer grid for the multiple-choice questions is available in this topic’s student resources tab.

S

PROOFS

Searchlight I

PROOFS

earchlight I

PROOFS



C Country B should specialise in the production of wheat because its comparative advantage is greater than that for wool.

D Country B is relatively more ef�cient at producing wool than wheat.Question 6

Which of the following would not generally explain a country’s comparative cost advantage?A Superior access to natural resourcesB Lower productivity levels for labourC Exploitation of economies of large-scale productionD A rapid rise in the population of working age.Question 7

Examine the following hypothetical data relating to a nation’s balance of payments for 2016–17.

Balance of payments item $ million (+ surplus, − de�cit)

Net goods +100

Net services –50

Net primary incomes –100

Net secondary incomes +25

From these data, the balance of payments on current account would be:A $125 million surplus.B $125 million de�cit.C $175 million de�cit.D none of the above.Question 8

Regarding Australia’s BOP current account and the BOP capital and �nancial accounts, which statement is least correct?A In total, the capital and �nancial accounts are a surplus to offset the CAD .B Australia depends on foreign debt and liabilities to offset the excess of debits on the current account.C A rise in foreign investment in Australia normally reduces our CAD.D The existence of a national savings–investment gap ultimately adds to the CAD while creating a surplus

on the capital and �nancial accounts.Question 9

Which of the following would have the opposite effect on the size of Australia’s CAD to the other three responses? A Severe climatic conditions result in drought and cyclones in Australia.B Australia’s average in�ation rate is consistently below that of our trading competitors.C There is a rise in domestic consumer con�dence and a fall in con�dence in China.D The exchange rate for the Australian dollar rises strongly.Question 10

Which of the following would be likely to have the opposite effect on the size of Australia’s CAD to the other three responses?A Overall stronger domestic aggregate demand-side conditionsB A higher household savings ratio domestically from 3 per cent to 10 per centC Generally less favourable aggregate supply conditions including weaker rises in domestic productivity,

higher RULCs and rises in international oil prices to over US$100 a barrelD Less favourable TOT for Australia and rises in defence spending on equipmentQuestion 11

Concerning Australia’s NFD and liabilities, which statement is false?A The NFD is the excess of what Australia has lent overseas relative to what we have borrowed.B The rise in of�cial debt is partly the result of weaker economic activity and hence larger budget de�cits.C Non-of�cial, private sector debt has risen due to the savings–investment gap and lower interest rates in

some overseas countries.D In part, our abundance of natural resources and favourable economic and social institutions help to explain

the rise in our external liabilities.Question 12

Which statement about Australia’s trade liberalisation is most correct?A A reduction in the protection levels for local industriesB A general reduction of tariffs to 5 per cent or less, and the removal of higher rates of protection for TC&F

(textiles, clothing and footwear) and passenger vehicles during 2015C The abolition of import quotas, an overall reduction in the net value of producer subsidies to local

industries and the signing of additional FTAsD All of the above

UNCORRECTED opposite

UNCORRECTED opposite effect on the size of Australia’s CAD to the other three responses?

UNCORRECTED effect on the size of Australia’s CAD to the other three responses?

Severe climatic conditions result in drought and cyclones in Australia.

UNCORRECTED Severe climatic conditions result in drought and cyclones in Australia.Australia’s average in�ation rate is consistently below that of our trading competitors.

UNCORRECTED Australia’s average in�ation rate is consistently below that of our trading competitors.There is a rise in domestic consumer con�dence and a fall in con�dence in China.

UNCORRECTED There is a rise in domestic consumer con�dence and a fall in con�dence in China.The exchange rate for the Australian dollar rises strongly.

UNCORRECTED The exchange rate for the Australian dollar rises strongly.

Which of the following would be likely to have the

UNCORRECTED

Which of the following would be likely to have the other three responses?

UNCORRECTED

other three responses?Overall stronger domestic aggregate demand-side conditions

UNCORRECTED

Overall stronger domestic aggregate demand-side conditionsA higher household savings ratio domestically from 3 per cent to 10 per cent

UNCORRECTED

A higher household savings ratio domestically from 3 per cent to 10 per centGenerally less favourable aggregate supply conditions including weaker rises in domestic productivity,

UNCORRECTED

Generally less favourable aggregate supply conditions including weaker rises in domestic productivity,

UNCORRECTED

higher RULCs and rises in international oil prices to over US$100 a barrel

UNCORRECTED

higher RULCs and rises in international oil prices to over US$100 a barrelLess favourable TOT for Australia and rises in defence spending on equipment

UNCORRECTED

Less favourable TOT for Australia and rises in defence spending on equipmentQuestion 11

UNCORRECTED

Question 11

Concerning Australia’s NFD and liabilities, which statement is

UNCORRECTED

Concerning Australia’s NFD and liabilities, which statement is A UNCORRECTED

A The NFD is the excess of what Australia has lent overseas relative to what we have borrowed.UNCORRECTED

The NFD is the excess of what Australia has lent overseas relative to what we have borrowed.B UNCORRECTED

B The rise in of�cial debt is partly the result of weaker economic activity and hence larger budget de�cits.UNCORRECTED

The rise in of�cial debt is partly the result of weaker economic activity and hence larger budget de�cits.

PAGE Regarding Australia’s BOP current account and the BOP capital and �nancial accounts, which statement is

PAGE Regarding Australia’s BOP current account and the BOP capital and �nancial accounts, which statement is

In total, the capital and �nancial accounts are a surplus to offset the CAD .

PAGE In total, the capital and �nancial accounts are a surplus to offset the CAD .Australia depends on foreign debt and liabilities to offset the excess of debits on the current account.

PAGE Australia depends on foreign debt and liabilities to offset the excess of debits on the current account.A rise in foreign investment in Australia normally reduces our CAD.

PAGE A rise in foreign investment in Australia normally reduces our CAD.The existence of a national savings–investment gap ultimately adds to the CAD while creating a surplus PAGE The existence of a national savings–investment gap ultimately adds to the CAD while creating a surplus

PROOFS

Regarding Australia’s BOP current account and the BOP capital and �nancial accounts, which statement is PROOFS

Regarding Australia’s BOP current account and the BOP capital and �nancial accounts, which statement is



Question 13

Trade protectionism may involve:A cutting tariffs.B abolishing foreign capital or ownership restrictions.C providing Export Development Grants and other types of �nancial assistance.D removing anti-dumping legislation for foreign goods.

Question 14

Which of the following is not an advantage of free trade?A Resources are diverted to areas where cost disadvantages are relatively lowest and opportunity costs tend

to be minimised.B Local businesses need to restructure their approach to improve ef�ciency in production.C Imports of capital goods incorporating new technology become cheaper for local �rms, helping to boost

their competitiveness.D Employment rates will probably be higher in the short term.

Question 15

The dominant reason for Australia’s CAD in recent years is:A the lack of domestic savings and relatively high local interest rates, which encourage overseas borrowing

and lead to massive income repayments abroad.B too many imports of merchandise and services.C a lack of export competitiveness and sales abroad.D Australia’s secondary income debits are too high.

Question 16

The CAD represents the extent to which:A total debits for merchandise imports exceed total credits for merchandise exports.B total debits for imports of goods and services exceed total credits for exports of goods and services.C total primary and secondary income debits exceed credits.D the total value of debits exceeds credits for merchandise, services, primary incomes and secondary incomes.

Question 17

The aggregate demand-side or aggregate supply-side development most unlikely to cause an appreciation of the Australian dollar is:A a rise in world commodity prices and the terms of trade.B a recession in Japan, China and the United States.C higher domestic interest rates and the relaxation of controls on the level of foreign investment.D huge new discoveries of natural resources.

Question 18

The aggregate demand-side or aggregate supply-side development most unlikely to cause a depreciation of the Australian dollar is:A a rise in the federal government budget surplus where government receipts exceed outlays and there is no

need to borrow credit abroad.B a rise in consumer and business con�dence associated with the onset of a boom in the level of domestic

economic activity.C a drop in worker productivity.D an ongoing reduction in R&D funding by the federal government.

Question 19

Which statement is generally false for Australia?A Very strong levels of domestic economic activity usually cause a cyclical fall in the CAD.B A weaker Australian dollar can actually help improve the balance of net goods.C Very rapid economic growth resulting in higher in�ation can cause a fall in the TWI.D Foreign borrowing can tend to weaken the balance of payments current account by raising the overall

value of primary income debits relative to the overall value of primary income credits.

Question 20

Concerning the balance of payments account, which statement is false?A The sale of Australian wool to Japan would be recorded as a debit on Japan’s balance of net goods.B The payment of share dividends by Telstra Corporation Ltd to overseas shareholders would be recorded as

a debit on Australia’s capital account.C Investment by the Royal Dutch Shell oil company of the Netherlands in expanding its operations would be

initially recorded as an item on the �nancial account.D The staging of the Soccer World Cup would be likely to strengthen Australia’s net services account.

UNCORRECTED The aggregate demand-side or aggregate supply-side development

UNCORRECTED The aggregate demand-side or aggregate supply-side development

a rise in world commodity prices and the terms of trade.

UNCORRECTED a rise in world commodity prices and the terms of trade.a recession in Japan, China and the United States.

UNCORRECTED a recession in Japan, China and the United States.higher domestic interest rates and the relaxation of controls on the level of foreign investment.

UNCORRECTED higher domestic interest rates and the relaxation of controls on the level of foreign investment.huge new discoveries of natural resources.

UNCORRECTED huge new discoveries of natural resources.

The aggregate demand-side or aggregate supply-side development

UNCORRECTED


a rise in the federal government budget surplus where government receipts exceed outlays and there is no

UNCORRECTED

a rise in the federal government budget surplus where government receipts exceed outlays and there is no need to borrow credit abroad.

UNCORRECTED

need to borrow credit abroad.a rise in consumer and business con�dence associated with the onset of a boom in the level of domestic

UNCORRECTED

a rise in consumer and business con�dence associated with the onset of a boom in the level of domestic economic activity.

UNCORRECTED

economic activity.a drop in worker productivity.

UNCORRECTED

a drop in worker productivity.

UNCORRECTED

an ongoing reduction in R&D funding by the federal government.

UNCORRECTED

an ongoing reduction in R&D funding by the federal government.

Question 19

UNCORRECTED

Question 19

Which statement is generally UNCORRECTED

Which statement is generally Very strong levels of domestic economic activity usually cause a cyclical fall in the CAD.UNCORRECTED

Very strong levels of domestic economic activity usually cause a cyclical fall in the CAD.A weaker Australian dollar can actually help improve the balance of net goods.UNCORRECTED

A weaker Australian dollar can actually help improve the balance of net goods.

PAGE total debits for merchandise imports exceed total credits for merchandise exports.

PAGE total debits for merchandise imports exceed total credits for merchandise exports.total debits for imports of goods and services exceed total credits for exports of goods and services.

PAGE total debits for imports of goods and services exceed total credits for exports of goods and services.

the total value of debits exceeds credits for merchandise, services, primary incomes and secondary incomes.

PAGE the total value of debits exceeds credits for merchandise, services, primary incomes and secondary incomes.

The aggregate demand-side or aggregate supply-side development PAGE


PROOFSthe lack of domestic savings and relatively high local interest rates, which encourage overseas borrowing

PROOFSthe lack of domestic savings and relatively high local interest rates, which encourage overseas borrowing



Question 21

An improvement in the terms of trade for Australia would not normally result from:A falling export prices at a rate less than the fall in import prices.B rising export prices at a rate faster than that for import prices.C rapid economic growth in Japan, the United States and Asia generally.D depressed international commodity prices for minerals, wool and cereals.Question 22

Which of the following is not normally regarded as a disadvantage of free trade?A The weakening of national defence and self-suf�ciency in times of war and isolationB A reduction in the opportunities for new industries to get started and create jobsC Greater domestic economic stability in times of global slowdownsD Dangerous or unsafe goods becoming more likely to be sold locallyQuestion 23

Trade liberalisation is likely to slow in�ation because:A resources are reallocated into areas where ef�ciency is highestB local �rms are exposed to stiffer competition from imports, especially of goods.C �rms can spread their �xed costs more thinly over larger production runs.D all of the above may be applicable.Question 24

Which statement about trade liberalisation is incorrect?A For one reason or another, the average unemployment rate appears to now be higher than before

signi�cant trade liberalisation as a policy was widely adopted.B Over a quarter of all jobs in Australia are related to international trade.C Trade liberalisation may destroy jobs in some industries but is likely to create more jobs overall, especially

in the longer term.D Recent FTAs with Northern Asia are expected to decrease GDP and employment.Question 25

A rise in the Australian dollar is most likely to be caused by:A a fall in the TOT and lower rural and mineral commodity prices.B a rise in the supply of the Australian dollar due to weaker con�dence and lower economic activity domestically.C a cut in interest rates locally, relative to those overseas.D stronger levels of global economic activity, especially in China and Japan, and a weaker US dollar.Question 26

A lower Australian dollar is likely to lead to which of the following macroeconomic effects?A Higher cost and demand in�ation, stronger economic growth and lower cyclical unemploymentB Lower in�ation and economic growth, with higher structural unemploymentC Overall reduced competitiveness of domestic manufacturing industries that export and compete with importsD A smaller number of overseas tourists coming to Australia and locals tending to holiday abroad, slowing

down the growth in GDP and employmentQuestion 27

Examine the following data for a hypothetical country’s TOT.

Year Export price index Import price index

2015–16 (base year) 100 100

2016–17 90 90

2017–18 80 70

2018–19 90 80

2019–20 120 70

Which statement is false?A There was no change in the TOT between 2015–16 and 2016–17.B The TOT moved unfavourably in 2017–18 against that for 2016–17.C The TOT moved unfavourably in 2018–19 against that for 2017–18.D The TOT moved favourably in 2019–20 against that for 2018–19.Question 28

Australia’s TOT would tend to fall and be less favourable if:A there was stronger global economic activity.B there was weaker global economic activity.C global disposable income rose.D there were generally less favourable growing conditions for crops worldwide.

UNCORRECTED a rise in the supply of the Australian dollar due to weaker con�dence and lower economic activity domestically.

UNCORRECTED a rise in the supply of the Australian dollar due to weaker con�dence and lower economic activity domestically.a cut in interest rates locally, relative to those overseas.

UNCORRECTED a cut in interest rates locally, relative to those overseas.stronger levels of global economic activity, especially in China and Japan, and a weaker US dollar.

UNCORRECTED stronger levels of global economic activity, especially in China and Japan, and a weaker US dollar.

to lead to which of the following macroeconomic effects?

UNCORRECTED to lead to which of the following macroeconomic effects?

Higher cost and demand in�ation, stronger economic growth and lower cyclical unemployment

UNCORRECTED Higher cost and demand in�ation, stronger economic growth and lower cyclical unemploymentLower in�ation and economic growth, with higher structural unemployment

UNCORRECTED Lower in�ation and economic growth, with higher structural unemploymentOverall reduced competitiveness of domestic manufacturing industries that export and compete with imports

UNCORRECTED

Overall reduced competitiveness of domestic manufacturing industries that export and compete with importsA smaller number of overseas tourists coming to Australia and locals tending to holiday abroad, slowing

UNCORRECTED

A smaller number of overseas tourists coming to Australia and locals tending to holiday abroad, slowing down the growth in GDP and employment

UNCORRECTED

down the growth in GDP and employment


UNCORRECTED


UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

2015–16 (base year)

UNCORRECTED

2015–16 (base year)

2016–17

UNCORRECTED

2016–17

2017–18

UNCORRECTED

2017–18

2018–19UNCORRECTED



2019–20

PAGE Over a quarter of all jobs in Australia are related to international trade.

PAGE Over a quarter of all jobs in Australia are related to international trade.Trade liberalisation may destroy jobs in some industries but is likely to create more jobs overall, especially

PAGE Trade liberalisation may destroy jobs in some industries but is likely to create more jobs overall, especially

Recent FTAs with Northern Asia are expected to decrease GDP and employment.

PAGE Recent FTAs with Northern Asia are expected to decrease GDP and employment.

to be caused by:

PAGE to be caused by:

a fall in the TOT and lower rural and mineral commodity prices.PAGE a fall in the TOT and lower rural and mineral commodity prices.a rise in the supply of the Australian dollar due to weaker con�dence and lower economic activity domestically.PAGE

a rise in the supply of the Australian dollar due to weaker con�dence and lower economic activity domestically.

PROOFS

For one reason or another, the average unemployment rate appears to now be higher than before

PROOFS

For one reason or another, the average unemployment rate appears to now be higher than before

Trade liberalisation may destroy jobs in some industries but is likely to create more jobs overall, especially PROOFS

Trade liberalisation may destroy jobs in some industries but is likely to create more jobs overall, especially



Question 29

Which of the following macroeconomic effects would be unlikely, given a general fall in Australia’s TOT as seen between 2013 and 2016?A Rising demand in�ation and economic growthB Higher cyclical unemploymentC A slowdown in the rate of economic growthD Lower material living standardsQuestion 30

Concerning Australia’s international competitiveness, which statement is false?A Over recent years, our competitiveness has declined.B Multifactor productivity has risen strongly but the fall in labour productivity has weakened our

international competitiveness.C The cut in company tax for small businesses from 2015 (along with the announcement of further

reductions in the 2016–17 budget) should help improve our international competitiveness.D The abundance of many natural resources should enhance our international competitiveness but our

relatively high labour costs undermine it.

Applied economic exercisesInstructions: Complete a selection of the following short-answer questions.Question 1

A Why has world trade grown so quickly in recent decades? (2 marks)B Most believe that the growth in world trade has helped to increase material and non-material living

standards. Explain how each of the following points associated with the growth of international trade (and trade liberalisation) might affect general living standards.

(i) Increased international specialisation in production based on comparative cost advantage (2 marks)(ii) Greater economies of large-scale production (2 marks)

(iii) Better access to resources (1 mark)(iv) Environmental impacts (1 mark)(v) More consumer choice and lower prices (2 marks)

(vi) Higher GDP and average incomes (2 marks)(vii) Job creation (2 marks)

(viii) Promotion of world peace (1 mark)

Question 2

A What is the BOP account and how is it structured? (2 marks)B Copy the following table, then classify each transaction and indicate where and how each

would initially be recorded on Australia’s BOP account. (12 marks)

Transaction

Major section of Australia’s BOP account (e.g. current account, or capital and �nancial accounts)

Minor sub-account making up Australia’s current account, or capital and �nancial accounts

Recorded as a credit (+) or debit (–) on Australia’s BOP

(i) You purchase a laptop computer made in Korea for $2800

(ii) Australia sells lamb to the US and Indonesia worth $750 million

(iii) You donate $50 in food aid to Ethiopia

(iv) BHP-Billiton pays $15 million in dividends to overseas shareholders

(v) The government pays $12 million in interest on its overseas debt

(vi) You make a $10 phone call using an overseas phone company

(vii) An immigrant transfers $45 000 to an Australian bank account

(viii) Qantas sells an old aircraft to Indonesia’s Garuda Airlines for $7 million

(ix) Grand Prix tickets worth $4.5 million are sold to overseas visitors

(x) Chinese investors purchase residential and rural property worth $25 billion

(xi) James Packer buys shares in an overseas media company worth $9 million

(xii) Overseas students from India, China and Thailand purchase $5 billion of education from Australian secondary schools and universities

UNCORRECTED What is the BOP account and how is it structured?

UNCORRECTED What is the BOP account and how is it structured?Copy the following table, then classify each transaction and indicate where and how each

UNCORRECTED Copy the following table, then classify each transaction and indicate where and how each would initially be recorded on Australia’s BOP account.

UNCORRECTED would initially be recorded on Australia’s BOP account.

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED


UNCORRECTED



UNCORRECTED



UNCORRECTED


(iv) BHP-Billiton pays $15 million in dividends to overseas

UNCORRECTED

(iv) BHP-Billiton pays $15 million in dividends to overseas shareholdersUNCORRECTED

shareholders

(v) The government pays $12 million in interest on its overseas debtUNCORRECTED

(v) The government pays $12 million in interest on its overseas debt

PAGE standards. Explain how each of the following points associated with the growth of international trade (and

PAGE standards. Explain how each of the following points associated with the growth of international trade (and

international specialisation in production based on comparative cost advantage

PAGE international specialisation in production based on comparative cost advantage

PROOFSThe abundance of many natural resources should enhance our international competitiveness but our

PROOFSThe abundance of many natural resources should enhance our international competitiveness but our

Most believe that the growth in world trade has helped to increase material and non-material living PROOFS

Most believe that the growth in world trade has helped to increase material and non-material living standards. Explain how each of the following points associated with the growth of international trade (and PROOFS

standards. Explain how each of the following points associated with the growth of international trade (and



C Use table 3.3 to calculate the following balance of payments items for Australia, 2014–15. Show your working. (i) Net goods (ii) Net services (iii) Net primary incomes (iv) Net secondary incomes (v) The overall balance of payments on the current account (vi) The overall balance of payments on the capital and �nancial account (6 × 1 = 6 marks)

TABLE 3.3 Australia’s balance of payments for 2014–15

Item Value (’000 millions) Item Value (’000 millions)

Goods credits 256 Primary income credits 53

Goods debits 269 Primary income debits 87

Services credits 63 Secondary income credits 8

Services debits 71 Secondary income debits 10

Source: ABS 5302.0 (Table 1).

D What is meant by the current account de�cit (CAD)? How big is Australia’s CAD? (2 marks)E Explain the type of relationship that exists between Australia’s balance of payments on current account

and the balance of payments on the capital and �nancial accounts? (2 marks) Question 3

A The size of Australia’s CAD changes over time. Distinguish Australia’s cyclical causes of the CAD from the structural causes of the CAD. (2 marks)

B Examine �gure 3.31 relating to some of the key aggregates making up Australia’s BOP account. (i) Describe the trend in the current account balance over the period. (1 mark) (ii) According to the graph, which area was the main cause of the negative current

account balance? (1 mark) (iii) Suggest two likely reasons for the quarterly surpluses recorded on net goods and services in 2011

and between December 2011 and December 2015. (2 marks)

Dec2011

Dec2012

(a) Seasonally adjusted estimates at current prices.

Dec2013

Dec2014

Dec2015

–25

–20

–15

–10

–5

0

5

10

15$billion

Current account balance

Net goods & services

Net primary income

FIGURE 3.31 Changes in components of Australia’s current account

Source: Graph copied directly from ABS 5302.0 (Summary).

C Australia’s CAD is affected by both aggregate demand-side factors and aggregate supply-side factors. Giving examples, explain the difference between these two types of factors. (4 marks)

D What is meant by Australia’s savings–investment gap and why does it exist? (3 marks)E From the following list, select two aggregate demand-side factors and two aggregate supply-side factors

and explain how they are likely to have affected the size of Australia’s cyclical or structural CAD during the past two years. Where possible, illustrate your answer with reference to some speci�c factors or events to help show the cause–effect relationship.

(i) A drought in the northern and some eastern parts of Australia (ii) Generally slower rates of economic growth in China, Japan and Europe during 2013–16

<Author to update table 3.3.>

UNCORRECTED and between December 2011 and December 2015.

UNCORRECTED and between December 2011 and December 2015.

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED

UNCORRECTED Current account balance

UNCORRECTED Current account balance

UNCORRECTED Net goods & services

UNCORRECTED Net goods & services

Net primary income

UNCORRECTED Net primary income

PAGE The size of Australia’s CAD changes over time. Distinguish Australia’s cyclical causes of the CAD from

PAGE The size of Australia’s CAD changes over time. Distinguish Australia’s cyclical causes of the CAD from

Examine �gure 3.31 relating to some of the key aggregates making up Australia’s BOP account.

PAGE Examine �gure 3.31 relating to some of the key aggregates making up Australia’s BOP account.

the trend in the current account balance over the period.

PAGE the trend in the current account balance over the period.

to the graph, which area was the main cause of the negative current

PAGE to the graph, which area was the main cause of the negative current

two likely reasons for the quarterly surpluses recorded on net goods and services in 2011 PAGE two likely reasons for the quarterly surpluses recorded on net goods and services in 2011

and between December 2011 and December 2015.PAGE

and between December 2011 and December 2015.

PROOFS

PROOFS

PROOFS

PROOFS87

PROOFS87

8

PROOFS810

PROOFS10

What is meant by the current account de�cit (CAD)? How big is Australia’s CAD?

PROOFSWhat is meant by the current account de�cit (CAD)? How big is Australia’s CAD?Explain the type of relationship that exists between Australia’s balance of payments on current account

PROOFSExplain the type of relationship that exists between Australia’s balance of payments on current account

The size of Australia’s CAD changes over time. Distinguish Australia’s cyclical causes of the CAD from PROOFS

The size of Australia’s CAD changes over time. Distinguish Australia’s cyclical causes of the CAD from



(iii) Large budget de�cits totalling over $320 billion in 2008–09 to 2015–16, which the Australian government partly �nanced by overseas borrowing

(iv) The 30+ per cent fall in the exchange rate for the Australian dollar against the US dollar between 2013 and early 2016

(v) A rise in international terrorism(vi) The staging of the Soccer World Cup in Melbourne

(vii) A sustained slowdown in multifactor productivity from 2002–03 to 2015–16(viii) A heavy fall in Australia’s terms of trade index during 2013–16

(ix) A fall in oil prices from over US$100 per barrel to under US$50 per barrel in 2015–16(x) A fall in the annual level of the household savings ratio in Australia from over 10 per cent to around

8 per cent of GDP between 2013 and 2015(xi) A decline in consumer and business con�dence in Japan and China during 2013–16

(xii) A fall in or �at levels of domestic business con�dence during 2011–13(xiii) Lower world commodity prices and terms of trade during 2013–16(xiv) A decrease in the interest rate differential between 2013 and 2016, with rates in Australia falling

closer to those overseas(xv) Speculation that the exchange rate for the Australian dollar will fall even further (2 × 4 = 8 marks)

Question 4

A Australia now has over $1000 billion of NFD. De�ne the term net foreign debt (NFD). (2 marks)B Distinguish Australia’s NFD from NFE. (2 marks)C Distinguish of�cial debt from non-of�cial debt, noting which of the two is higher. (2 marks)D Identify and explain two factors that have led to the rise in of�cial foreign debt in recent times. (2 marks)E Identify and explain two factors that have led to the rise in non-of�cial foreign debt in recent times. (2 marks)F Outline one important cost and one bene�t of Australia’s NFD. (2 marks)

Question 5

A De�ne terms of trade. (2 marks)B Explain how Australia measures the terms of trade. (2 marks)C Examine the hypothetical data relating to a country’s export price index and import price

index shown in the table below. (i) Showing the formula, calculate the TOT index for the four years 2016–17 to 2019–20. (2 marks)

(ii) Describe the trend in this country’s TOT index over the period. (1 mark)

Year Export price index Import price index TOT index

2015–16 (base year) 100 100 100

2016–17 130 120

2017–18 110 110

2018–19 90 100

2019–20 80 90

D What are the general determinants or causes of changes in Australia’s TOT index? (2 marks)E Identify and explain the key factors that caused Australia’s TOT index to fall between 2013 and

2016. As part of your answer, illustrate the impacts of these factors hypothetically on D–S diagrams representing global markets for our exports and imports. (4 marks)

F How would you expect a fall in Australia’s TOT index to affect each of the following variables?(i) The size of our CAD (2 marks)

(ii) The exchange rate for the Australian dollar (2 marks)(iii) The general level of domestic economic activity (2 marks)

Question 6

A How is Australia’s exchange rate determined? Illustrate this diagrammatically for the foreign exchange market (2 + 1 = 3 marks)

B Using D–S diagrams to show the before and after situations in the foreign exchange market, explain what would happen to the exchange rate for the Australian dollar (A$) in each of the following:

(i) there was increased buying of the A$ (1 mark)(ii) there was increased selling of the A$. (1 mark)

C What does the trade weighted index or TWI measure? (2 marks)D Giving clear reasons, explain how each of the following events would be likely to affect the

exchange rate for the Australian dollar:(i) cuts in domestic interest rates, which occurred in 2011–16 (2 marks)

(ii) overall slower economic activity overseas including China and Japan, as happened in 2013–16 (2 marks)

UNCORRECTED wing the formula, calculate the TOT index for the four years 2016–17 to 2019–20.

UNCORRECTED wing the formula, calculate the TOT index for the four years 2016–17 to 2019–20.the trend in this country’s TOT index over the period.

UNCORRECTED the trend in this country’s TOT index over the period.

UNCORRECTED

UNCORRECTED

UNCORRECTED Export price index

UNCORRECTED Export price index

130

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110

UNCORRECTED 110

90

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90

80

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80

What are the general determinants or causes of changes in Australia’s TOT index?

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What are the general determinants or causes of changes in Australia’s TOT index?Identify and explain the key factors that caused Australia’s TOT index to fall between 2013 and

UNCORRECTED

Identify and explain the key factors that caused Australia’s TOT index to fall between 2013 and 2016. As part of your answer, illustrate the impacts of these factors hypothetically on D–S

UNCORRECTED

2016. As part of your answer, illustrate the impacts of these factors hypothetically on D–S diagrams representing global markets for our exports and imports.

UNCORRECTED

diagrams representing global markets for our exports and imports.How would you expect a fall in Australia’s TOT index to affect each of the following variables?

UNCORRECTED

How would you expect a fall in Australia’s TOT index to affect each of the following variables?The

UNCORRECTED

The size of our CAD

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size of our CAD(ii)

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(ii) The

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The exchange rate for the Australian dollar

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exchange rate for the Australian dollar

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(iii) UNCORRECTED

(iii) The UNCORRECTED

The general level of domestic economic activityUNCORRECTED

general level of domestic economic activityuestion 6UNCORRECTED

uestion 6

PAGE foreign debt in recent times.

PAGE foreign debt in recent times.

Examine the hypothetical data relating to a country’s export price index and import price

PAGE Examine the hypothetical data relating to a country’s export price index and import price

wing the formula, calculate the TOT index for the four years 2016–17 to 2019–20.PAGE

wing the formula, calculate the TOT index for the four years 2016–17 to 2019–20.the trend in this country’s TOT index over the period.PAGE

the trend in this country’s TOT index over the period.

PROOFSferential between 2013 and 2016, with rates in Australia falling

PROOFSferential between 2013 and 2016, with rates in Australia falling

4

PROOFS4 =

PROOFS= 8 marks)

PROOFS8 marks)

(2 marks)

PROOFS(2 marks)

, noting which of the two is higher.

PROOFS, noting which of the two is higher.

foreign debt in recent times.PROOFS

foreign debt in recent times. foreign debt in recent times.PROOFS

foreign debt in recent times.



(iii) relatively weak business and consumer optimism in Australia, as occurred (2 marks) (iv) speculation of a future rise in the Australian dollar next week (2 marks) (v) a fall in our terms of trade index, as between 2013–15. (2 marks) (vi) a rise in interest rates in the US relative to those in Australia, as occurred in 2014–15 (2 marks) (vii) a fall in RULCs in Australia, as happened in 2012–14 (2 marks) (viii) reduced foreign aid and a substantial cut in defence spending on new equipment, such

as happened in 2014–15 (2 marks) (ix) a slower rate of in�ation in Australia than in some overseas countries. (2 marks)E Explain how a fall in the exchange rate for the Australian dollar would be likely to affect each variable: (i) size of the CAD (2 marks) (ii) rate of in�ation (2 marks) (iii) rate of economic growth (2 marks) (iv) rate of unemployment. (2 marks)

Question 7

A De�ne what is meant by international competitiveness. (2 marks)B Identify and outline four important factors that have affected Australia’s international

competitiveness over recent years. (4 marks)C Examine �gure 3.32 showing Australia’s international rankings (out of 60 nations; lower scores represent

better competitiveness) on various dimensions of international competitiveness. In which three areas of competitiveness is Australia ranked relatively

(i) highest? (1 mark) (ii) lowest? (1 mark)

Economic performance Government ef�ciency Business ef�ciency Infrastructure

Dom

esti

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1718

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2125

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2628

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16 18 20

9 12

FIGURE 3.32 Australia’s international competitiveness by area

Source: Graph copied directly from the Committee for Economic Development of Australia (CEDA), http://adminpanel.ceda.com.au/FOLDERS/Service/Files/Documents/26525~Australia.pdf.

Question 8

Government trade liberalisation has gained pace in recent decades, especially since the 1990s.A Detail the key policy features of Australia’s trade liberalisation policies. (3 marks)B One aspect of trade liberalisation has been the rapid growth in the number of FTAs. What are bilateral

FTAs and why are they potentially important for Australia? (2 marks)C Explain how you would expect Australia’s trade liberalisation to affect each of the following economic

variables. (i) Australia’s international competitiveness (2 marks) (ii) The in�ation rate (2 marks) (iii) The rate of economic growth (2 marks) (iv) The unemployment rate (2 marks)

(v) Living standards (2 marks)

Author to say when this occurred

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3.32

Source:

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Source: Graph copied directly from the Committee for Economic Development of Australia (CEDA), http://adminpanel.ceda.com.au/

UNCORRECTED

Graph copied directly from the Committee for Economic Development of Australia (CEDA), http://adminpanel.ceda.com.au/FOLDERS/Service/Files/Documents/26525~Australia.pdf.UNCORRECTED

FOLDERS/Service/Files/Documents/26525~Australia.pdf.

PAGE

PAGE Economic performance Government ef�ciency Business ef�ciency

PAGE Economic performance Government ef�ciency Business ef�ciency

Soc

ieta

l fra

mew

ork PAGE

Soc

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mew

ork

Pro

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ivit

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ef�

cien

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PAGE P

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& e

f�ci

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PAGE PROOFS(2 marks)

PROOFS(2 marks)

Examine �gure 3.32 showing Australia’s international rankings (out of 60 nations; lower scores represent

PROOFSExamine �gure 3.32 showing Australia’s international rankings (out of 60 nations; lower scores represent better competitiveness) on various dimensions of international competitiveness. In which three areas of

PROOFSbetter competitiveness) on various dimensions of international competitiveness. In which three areas of



D Most commentators agree that trade liberalisation by Australia has led to faster economic growth, higher disposable incomes, lower in�ation and, possibly in the short term, higher structural unemployment. China is a country of over 1.3 billion people undergoing economic transformation. If it is not already, it will soon be the world’s largest economy. Examine �gure 3.33 showing macroeconomic data, generated through 2008 modelling, of the expected effects of the China–Australia FTA (enacted in 2015) on our economy.

(i) According to this data, by how much is this FTA expected to boost our GDP from the baseline level? (1 mark)

(ii) Explain the various ways whereby this FTA could accelerate Australia’s rate of economic growth (GDP). (4 marks)

(iii) Other things being equal, explain how would you expect this FTA to affect our unemployment rate in:(a) the short term (1 mark)(b) the long term. (1 mark)

(iv) Other things being equal, explain how you would expect this FTA to affect our incomes and material living standards. (2 marks)

(v) Explain why economists generally believe that FTAs will reduce Australia’s in�ation, and thus raise our purchasing power and material living standards. (3 marks)

Real GDP

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FIGURE 3.33 The expected economic effects of the China–Australia FTA

Source: CIE 2008, Estimating the Impact of an Australia–China Trade and Investment Agreement, p. 35 (4.1), http://acbc.com.au/admin/images/uploads/Copy3report_fta_modelling.pdf.

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PROOFSReal consumption

PROOFSReal consumption



(vi) Examine the following table showing China’s estimated tariff rates for selected products. With the China–Australia FTA now in place, these tariffs would be reduced and later abolished. How would this be likely to affect the following?

(a) Australian farmers (2 marks) (b) Australia’s BOP account (2 marks)

ProductEstimated tariff rate (percentage of price) imposed by China before the recent FTA

Wheat, corn and rice 1–10

Vegetable oils 9

Sugar 20

Wool 5.5

Cotton 26.6

Sources: Data derived from various sources including CIE 2008, Estimating the Impact of an Australia–China Trade and Investment, http://acbc.com.au/admin/images/uploads/Copy3report_fta_modelling.pdf

An essayWrite an 800 word essay in answer to one of the following questions.A Has trade liberalisation lowered Australian living standards and so done more harm than good? (20 marks)B How would you expect the recent decrease in Australia’s terms of trade to affect our standard

of living? (20 marks)C The Australian dollar is lower in early 2016 than it was four years earlier. How is this likely

to affect the government’s key domestic macroeconomic goals, the CAD and the standard of living? (20 marks)

A written reportChange to international transactionsWrite a 1000 word report on the following topic. In total, it is worth 20 marks. Ensure you include statistical data, diagrams and graphs where possible.

Recently (to 2016), Australia’s domestic economy has grown more slowly, unemployment has increased and in�ation is very low. How would each of the following events be likely to have contributed to these economic conditions during the last two or so years?A The terms of trade (5 marks)B The change in the A$ (5 marks)C The signing of FTAs (5 marks)D The decline in Australia’s international competitiveness (5 marks)

3.10 ReviewSummaryRelationship between trade and living standards

• Australia’s international relationships include international trade (involving the �ow of exports and imports of goods and services), and capital �ows (movements of money capital and investments between countries).

• Trade volumes have grown rapidly in recent decades due to trade liberalisation (reduced protection of local industry by cutting tariffs, subsidies, import quotas and signing FTAs).

• Trade generally increases material and non-material living standards by: – encouraging production specialisation in areas of comparative cost advantage – the exploitation of economies of scale – lower prices for goods and services – accelerating GDP growth – the creation of jobs, employment and incomes – increasing access to resources – growing consumer choice – reduction of con�ict – cultural enrichment.

• However, trade can bring some problems too: – possibly increased economic instability – cultural tensions – income inequality – prevention of the growth of infant industries.

UNCORRECTED Recently (to 2016), Australia’s domestic economy has grown more slowly, unemployment has increased and

UNCORRECTED Recently (to 2016), Australia’s domestic economy has grown more slowly, unemployment has increased and in�ation is very low. How would each of the following events be likely to have contributed to these economic

UNCORRECTED in�ation is very low. How would each of the following events be likely to have contributed to these economic conditions during the last two or so years?

UNCORRECTED conditions during the last two or so years?

The decline in Australia’s international competitiveness

UNCORRECTED The decline in Australia’s international competitiveness

3.10 Review

UNCORRECTED

3.10 Review

Relationship between trade and living standards

UNCORRECTED

Relationship between trade and living standards

Australia’

UNCORRECTED

Australia’s international relationships include international trade (involving the �ow of exports and imports of

UNCORRECTED

s international relationships include international trade (involving the �ow of exports and imports of goods and services), and capital �ows (movements of money capital and investments between countries).

UNCORRECTED

goods and services), and capital �ows (movements of money capital and investments between countries).rade volumes have grown rapidly in recent decades due to trade liberalisation (reduced protection of local

UNCORRECTED

rade volumes have grown rapidly in recent decades due to trade liberalisation (reduced protection of local industry by cutting tariffs, subsidies, import quotas and signing FTAs).

UNCORRECTED

industry by cutting tariffs, subsidies, import quotas and signing FTAs).•

UNCORRECTED

• T

UNCORRECTED

Trade generally increases material and non-material living standards by:

UNCORRECTED

rade generally increases material and non-material living standards by:Trade generally increases material and non-material living standards by:T

UNCORRECTED

Trade generally increases material and non-material living standards by:T–UNCORRECTED

– encouraging UNCORRECTED

encouraging –UNCORRECTED

–

PAGE to affect the government’s key domestic macroeconomic goals, the CAD and the standard of

PAGE to affect the government’s key domestic macroeconomic goals, the CAD and the standard of

Write a 1000 word report on the following topic. In total, it is worth 20 marks. Ensure you include statistical

PAGE Write a 1000 word report on the following topic. In total, it is worth 20 marks. Ensure you include statistical

Recently (to 2016), Australia’s domestic economy has grown more slowly, unemployment has increased and PAGE

Recently (to 2016), Australia’s domestic economy has grown more slowly, unemployment has increased and

PROOFS

PROOFS

PROOFSEstimating the Impact of an Australia–China Trade and Investment

PROOFSEstimating the Impact of an Australia–China Trade and Investment

Has trade liberalisation lowered Australian living standards and so done more harm than good?

PROOFSHas trade liberalisation lowered Australian living standards and so done more harm than good?How would you expect the recent decrease in Australia’s terms of trade to affect our standard

PROOFSHow would you expect the recent decrease in Australia’s terms of trade to affect our standard

The Australian dollar is lower in early 2016 than it was four years earlier. How is this likely PROOFS

The Australian dollar is lower in early 2016 than it was four years earlier. How is this likely to affect the government’s key domestic macroeconomic goals, the CAD and the standard of PROOFS

to affect the government’s key domestic macroeconomic goals, the CAD and the standard of



Recording international transactions on the BOP account

• De�nition: The BOP account records the various types of transactions between a country and the rest of the world over a period of time.

• Structure: The BOP account is made up of two main types of transactions, each with sub sections. – The current account records credits and debits for goods, services, primary incomes and secondary incomes.

– The capital and �nancial account records credits and debits for capital transactions, especially investments or the movements of money capital.

Relationship between the current account and the capital and �nancial; accounts

• The BOP is a zero balance account where overall, the total value of credits equals the total value of debits. • For Australia, theoretically, our CAD is exactly offset by a capital and �nancial account surplus involving

a rise in our liabilities (debt and equity) abroad.The CAD and its causes

• De�nition: The CAD represents the excess of total debits over total credits on the BOP current account (made up of net goods, net services, net primary income and net secondary income). Australia runs a CAD.

• Causes: The size of Australia’s CAD is determined by both aggregate demand and aggregate supply conditions: – Stronger domestic demand-side conditions (due to locally stronger consumer and business con�dence

and rising disposable incomes), and weaker spending from abroad (due to a slowdown in economic activity or a drop in the TOT), usually lead to increased imports and decreased exports, and hence a bigger cyclical CAD.

– Ongoing aggregate supply-side conditions also add to the structural CAD (a large savings–investment gap, rising oil prices, drought, high production costs and poor international competitiveness).

The composition and cause of the NFD and NFE

• De�nitions: The NFD represents the excess of what Australia owes the rest of the world against what the world owes us. It implies there will be interest payments as well as the repayment of the borrowed capital. Net foreign equity (NFE) is associated with foreign ownership of Australian assets (such as shares and property) minus our ownership of foreign assets.

• Composition: There is both of�cial (government sector) and non-of�cial debt (private sector). • Causes: Various factors account for our large NFD. These include the rise in of�cial debt (due to a large

number of large governments budget de�cits in recent years), the national savings–investment gap and relatively high domestic interest rates, a recent lower A$, plentiful natural resources, a skilled labour force and good economic infrastructure.

• Effects: The NFD brings bene�ts (more �nance for expansion, cheaper costs of borrowing) and costs (the burden of incomes repayments, and a bigger CAD).

The terms of trade

• De�nition and meaning: The TOT relates to the ratio of export prices Australia receives from overseas (we are mostly price takers), relative to the prices we pay for imports. A fall in the TOT means that Australia is trading under relatively less favourable conditions because we are receiving relatively lower prices against those we pay for imports. Here, a given quantity of exports will purchase a smaller quantity of imports, so we are not as well off.

• Measurement: The TOT is measured by means of an index where the base year equals 100 points.

The terms of trade index (TOT) =Export price index

× 100Import price index

• Determinants: For Australia, our TOT is greatly affected by international commodity prices that in turn re�ect the global conditions of demand (such as global economic activity) and supply (such as climatic conditions and new discoveries) for the things we trade.

• Effects: Changes in the TOT affect the balance on current account and the exchange rate. For instance: – The CAD: A fall in the TOT involving the world paying lower export prices tends to cause a drop in the value of exports and/or a rise in the value of imports, leading to a rise in our CAD.

– The A$: A fall in the TOT tends to reduce the demand for the A$ because of the likely decline in the price and value of exports, and/or an increase the supply of the A$ because of the rise in the price and value of imports (less demand for the A$ and/or more supply of the A$ tends to weaken the exchange rate).

The exchange rate

• De�nition: The exchange rate is the price of an A$ when swapped into other currencies in the foreign exchange market.

UNCORRECTED (government sector) and

UNCORRECTED (government sector) and Various factors account for our large NFD. These include the rise in of�cial debt (due to a large

UNCORRECTED Various factors account for our large NFD. These include the rise in of�cial debt (due to a large number of large governments budget de�cits in recent years), the national savings–investment gap and

UNCORRECTED number of large governments budget de�cits in recent years), the national savings–investment gap and relatively high domestic interest rates, a recent lower A$, plentiful natural resources, a skilled labour force

UNCORRECTED relatively high domestic interest rates, a recent lower A$, plentiful natural resources, a skilled labour force

UNCORRECTED The NFD brings bene�ts (more �nance for expansion, cheaper costs of borrowing) and costs (the

UNCORRECTED The NFD brings bene�ts (more �nance for expansion, cheaper costs of borrowing) and costs (the

burden of incomes repayments, and a bigger CAD).

UNCORRECTED burden of incomes repayments, and a bigger CAD).

The TOT relates to the ratio of export prices Australia receives from overseas (we

UNCORRECTED

The TOT relates to the ratio of export prices Australia receives from overseas (we are mostly price takers), relative to the prices we pay for imports. A fall in the TOT means that Australia is

UNCORRECTED

are mostly price takers), relative to the prices we pay for imports. A fall in the TOT means that Australia is trading under relatively less favourable conditions because we are receiving relatively lower prices against

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trading under relatively less favourable conditions because we are receiving relatively lower prices against those we pay for imports. Here, a given quantity of exports will purchase a smaller quantity of imports, so

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those we pay for imports. Here, a given quantity of exports will purchase a smaller quantity of imports, so we are not as well off.

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we are not as well off.

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ement:

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ement: The TOT is measured by means of an index where the base year equals 100 points.

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The TOT is measured by means of an index where the base year equals 100 points.

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UNCORRECTED PAGE CAD (a large savings–investment

PAGE CAD (a large savings–investment gap, rising oil prices, drought, high production costs and poor international competitiveness).

PAGE gap, rising oil prices, drought, high production costs and poor international competitiveness).

NFD represents the excess of what Australia owes the rest of the world against what the

PAGE NFD represents the excess of what Australia owes the rest of the world against what the

world owes us. It implies there will be interest payments as well as the repayment of the borrowed capital.

PAGE world owes us. It implies there will be interest payments as well as the repayment of the borrowed capital. Net foreign equity (NFE) is associated with foreign ownership of Australian assets (such as shares and

PAGE Net foreign equity (NFE) is associated with foreign ownership of Australian assets (such as shares and

(government sector) and PAGE

(government sector) and non-of�cialPAGE

non-of�cial Various factors account for our large NFD. These include the rise in of�cial debt (due to a large PAGE

Various factors account for our large NFD. These include the rise in of�cial debt (due to a large

PROOFS The CAD represents the excess of total debits over total credits on the BOP current account

PROOFS The CAD represents the excess of total debits over total credits on the BOP current account (made up of net goods, net services, net primary income and net secondary income). Australia runs a

PROOFS(made up of net goods, net services, net primary income and net secondary income). Australia runs a

The size of Australia’s CAD is determined by both aggregate demand and aggregate supply

PROOFS The size of Australia’s CAD is determined by both aggregate demand and aggregate supply

domestic demand-side conditions (due to locally stronger consumer and business con�dence

PROOFSdomestic demand-side conditions (due to locally stronger consumer and business con�dence

and rising disposable incomes), and weaker spending from abroad (due to a slowdown in economic

PROOFSand rising disposable incomes), and weaker spending from abroad (due to a slowdown in economic activity or a drop in the TOT), usually lead to increased imports and decreased exports, and hence a

PROOFSactivity or a drop in the TOT), usually lead to increased imports and decreased exports, and hence a

CAD (a large savings–investment PROOFS

CAD (a large savings–investment gap, rising oil prices, drought, high production costs and poor international competitiveness).PROOFS

gap, rising oil prices, drought, high production costs and poor international competitiveness).



• Determinants. Being a �oating exchange rate, the price of the A$ is determined by the forces of demand for the A$ (as affected by international commodity prices and the terms of trade, overseas economic activity, our in�ation rate) and the supply of the A$ (as affected by our levels of imports, local con�dence and economic activity, interest repayments on foreign debt) in the foreign exchange market at equilibrium.

• Measures. The TWI measures the average exchange rate, but there are also separate rates for every currency in the world. As the exchange rate appreciates or depreciates, it can have both good and bad effects on individual companies and the overall economy.

• Effects. Changes in the A$ have both good and bad effects for particular groups in our economy. The exchange rate can affect the cost/price and value of exports, the cost/price and value of imports, and the size of the CAD. It also affects the achievement of the Australian government’s key domestic macroeconomic goals by affecting the levels of AD (via changes in X and M), the in�ation rate, the rate of economic growth (GDP), and employment and unemployment rates.

• An appreciation of the A$ tends to reduce the value of exports/credits relative to imports/debits and increase the CAD. It also slows the growth in AD. This tends to weaken economic activity, reducing in�ation and economic growth, and causing a rise in unemployment.

• A depreciation of the A$ tends to increase the value of exports/credits relative to imports/debits, and decrease the CAD. It also stimulates AD and economic activity, and so tends to accelerate in�ation and economic growth while reducing unemployment.

Factors that may in�uence Australia’s international competitiveness

• International competitiveness refers to the ability of a nation’s businesses to sell goods and services at an attractive price here at home and also abroad, without special government assistance or protection.

• Trends: Recently, Australia’s international competitiveness ranking has decreased against various countries. We have become less internationally competitive according to some measures.

• Determinants: A nation’s competitiveness is affected by many factors including: – the relative production costs (including wages) for businesses – productivity growth – the availability of natural resources – the exchange rate – relative rates of in�ation – innovation and R&D – the relative rate of company tax – government subsidies.

Effects of trade liberalisation on Australia’s international competitiveness, domestic macroeconomic goals and living standards

• De�nition of trade liberalisation: Trade liberalisation involves the government policy of gradually reducing the level of protection of local industries. For Australia, trade liberalisation since the early 1970s, and especially since the early 1990s, has involved: – cutting all tariffs (the general rate is now 5 per cent or less) – reducing the overall value of government subsidies to local �rms – abolishing import quotas – signing more bilateral FTAs (10 by early 2016).

• Free trade means no protection of local industry and is the opposite of protectionism. • Effect of trade liberalisation on Australia’s international competitiveness: Trade liberalisation should help

increase our international competitiveness by forcing businesses to use resources most ef�ciently in areas of comparative cost advantage. It also forces �rms to restructure and cut production costs, and allows them to gain better economies of large-scale production by selling in bigger markets.

• Effect of trade liberalisation on domestic macroeconomic goals: It increases ef�ciency in the use of resources and promotes stiffer competition. As a result: – It can slow cost in�ation pressures by helping to lift ef�ciency and lower production costs – It can strengthen economic growth through greater ef�ciency in the use of resources, restructuring production,

growing access to overseas markets and sales, and increasing economies of large-scale production. – In the long term, it can grow ef�ciency along with markets for goods and services, thereby expanding local businesses and creating more jobs.

• Positive effects of trade liberalisation on the standard of living: Both material and non-material living standards can gain from trade liberalisation: – Material living standards can gain by raising ef�ciency, real per capita GDP, incomes and consumption. – Non-material living standards can gain perhaps by encouraging peace and cooperation through trade relationships, and culturally enriching our lives and experiences.

• Negative effects of trade liberalisation: However, trade liberalisation can present some problems for living standards. It may increase structural unemployment, especially in the short term, increase environmental problems including the depletion of resources, and possibly add to economic instability in countries.

UNCORRECTED Effects of trade liberalisation on Australia’s international competitiveness, domestic macroeconomic

UNCORRECTED Effects of trade liberalisation on Australia’s international competitiveness, domestic macroeconomic

ade liberalisation:

UNCORRECTED ade liberalisation: Trade liberalisation involves the government policy of gradually reducing

UNCORRECTED Trade liberalisation involves the government policy of gradually reducing

the level of protection of local industries. For Australia, trade liberalisation since the early 1970s, and

UNCORRECTED the level of protection of local industries. For Australia, trade liberalisation since the early 1970s, and especially since the early 1990s, has involved:

UNCORRECTED

especially since the early 1990s, has involved:all tariffs (the general rate is now 5 per cent or less)

UNCORRECTED

all tariffs (the general rate is now 5 per cent or less)

UNCORRECTED

the overall value of government subsidies to local �rms

UNCORRECTED

the overall value of government subsidies to local �rmsimport quotas

UNCORRECTED

import quotasmore bilateral FTAs (10 by early 2016).

UNCORRECTED

more bilateral FTAs (10 by early 2016).trade means no protection of local industry and is the opposite of protectionism.

UNCORRECTED

trade means no protection of local industry and is the opposite of protectionism. fect of trade liberalisation on Australia’s international competitiveness:

UNCORRECTED

fect of trade liberalisation on Australia’s international competitiveness:increase our international competitiveness by forcing businesses to use resources most ef�ciently in areas

UNCORRECTED

increase our international competitiveness by forcing businesses to use resources most ef�ciently in areas of comparative cost advantage. It also forces �rms to restructure and cut production costs, and allows them

UNCORRECTED

of comparative cost advantage. It also forces �rms to restructure and cut production costs, and allows them to gain better economies of large-scale production by selling in bigger markets.

UNCORRECTED

to gain better economies of large-scale production by selling in bigger markets.•

UNCORRECTED

• Ef

UNCORRECTED

Effect of trade liberalisation on domestic macroeconomic goals:

UNCORRECTED

fect of trade liberalisation on domestic macroeconomic goals: Effect of trade liberalisation on domestic macroeconomic goals: Ef

UNCORRECTED

Effect of trade liberalisation on domestic macroeconomic goals: Efresources and promotes stiffer competition. As a result:UNCORRECTED

resources and promotes stiffer competition. As a result:–UNCORRECTED

–

PAGE We have become less internationally competitive according to some measures.

PAGE We have become less internationally competitive according to some measures.nation’s competitiveness is affected by many factors including:

PAGE nation’s competitiveness is affected by many factors including:relative production costs (including wages) for businesses

PAGE relative production costs (including wages) for businessesPROOFS

of the A$ tends to reduce the value of exports/credits relative to imports/debits and

PROOFSof the A$ tends to reduce the value of exports/credits relative to imports/debits and

increase the CAD. It also slows the growth in AD. This tends to weaken economic activity, reducing

PROOFSincrease the CAD. It also slows the growth in AD. This tends to weaken economic activity, reducing

of the A$ tends to increase the value of exports/credits relative to imports/debits, and

PROOFSof the A$ tends to increase the value of exports/credits relative to imports/debits, and decrease the CAD. It also stimulates AD and economic activity, and so tends to accelerate in�ation and

PROOFSdecrease the CAD. It also stimulates AD and economic activity, and so tends to accelerate in�ation and

refers to the ability of a nation’s businesses to sell goods and services at an

PROOFS refers to the ability of a nation’s businesses to sell goods and services at an

attractive price here at home and also abroad, without special government assistance or protection.

PROOFSattractive price here at home and also abroad, without special government assistance or protection.

Recently, Australia’s international competitiveness ranking has decreased against various countries. PROOFS

Recently, Australia’s international competitiveness ranking has decreased against various countries. We have become less internationally competitive according to some measures.PROOFS

We have become less internationally competitive according to some measures.nation’s competitiveness is affected by many factors including:PROOFS

nation’s competitiveness is affected by many factors including:



Key termsA depreciation of the exchange rate occurs when the value of a nation’s currency falls against another currency.A subsidy is a cash payment by the government to local producers to help reduce their production costs and

selling price, making them more competitive against imports.A tariff is an indirect tax added onto the price of imports to make them dearer to local consumers and

protect local industries from overseas competition.Absolute cost advantage occurs if a nation is the cheapest or most ef�cient producer of a single good or

service in the world.An appreciation of the exchange rate occurs when the value of a nation’s currency rises against another

currency.An import quota is a government restriction on the quantity of particular goods that can be imported.Balance on current account is equal to the total value of all credits minus the value of all debits for goods,

services, primary incomes and secondary incomes, measured over a period of time.Comparative cost advantage occurs if a nation specialises in a few key areas of production where its cost

advantages are greatest or its disadvantages and opportunity costs are lowest.Current account de�cit (CAD) is when the value of all current account debits exceeds the total value of all current

account credits for goods, services, primary incomes and secondary incomes, measured over a period of time.Current account surplus (CAS) occurs when the total value of all current account credits exceeds the total

value of all current account debits for goods, services, primary incomes and secondary incomes, measured over a period of time.

Cyclical CAD is the rise in the CAD that occurs when there is a rise in AD or spending as a result of strong aggregate demand-side conditions.

Direct investment are capital movements into and out of Australia that involve the establishment, purchase or expansion of companies and other assets.

Dumping refers to the actions of an overseas competitor who sells a good below its cost price, thus damaging local producers.

Economies of large-scale production are reductions in a �rm’s average �xed costs per unit associated with an increase in its production levels, perhaps enabled by trade liberalisation.

Free trade agreements (FTAs) involve two or more nations agreeing to remove various forms of protection of their local industries. They are often seen as bene�cial because countries will be inclined to specialise in areas of comparative cost advantage where opportunity costs are minimised and material living standards maximised.

Free trade involves abolishing protection of local industry by removing tariffs, subsidies and import quotas, thereby forcing local �rms to become more internationally competitive.

International competitiveness means that Australian businesses are relatively ef�cient in their use of resources, and can compete or sell their goods and services both here and in markets around the world without relying on government protection. They can sell goods and services of comparable quality at a lower price than overseas rivals.

International specialisation occurs when countries produce only a limited range of goods and services, focusing on those areas where they have the greatest comparative cost advantage.

Labour productivity is commonly measured by the level of GDP per hour worked.Multifactor productivity measures the ef�ciency with which the combined inputs of labour, capital and

natural resources are converted into production.Net errors and omissions is an item that re�ects the inaccuracies in the recording of international

transactions. Its can be positive or negative.Net foreign debt (NFD) is the difference in value between what Australian households, businesses and

governments have borrowed from and owe overseas, minus what Australia has lent or invested abroad. This debt entails paying interest and repaying the capital borrowed at some time in the future.

Net foreign equity (NFE) is the difference in value between foreign-owned Australian assets (such as property, shares and the retained earnings of overseas-owned companies operating here) and overseas assets owned by Australian residents.

Net goods is a subsection of the BOP current account that records the value of credits for goods exported minus the value of debits for goods imported from overseas, measured over a period of time.

Net primary incomes is a subsection of the BOP current account that records the value of credits for primary income received from overseas minus the value of debits for primary income paid to overseas, measured over a period of time.

Net reserve assets involves both RBA and government transactions, and includes foreign currencies, monetary gold, and required contributions to overseas governments and international agencies.

Net secondary incomes is a subsection of the BOP current account that records the value of credits for secondary income received from overseas minus the value of debits for secondary income paid to overseas, measured over a period of time.

UNCORRECTED of their local industries. They are often seen as bene�cial because countries will be inclined to specialise in

UNCORRECTED of their local industries. They are often seen as bene�cial because countries will be inclined to specialise in areas of comparative cost advantage where opportunity costs are minimised and material living standards

UNCORRECTED areas of comparative cost advantage where opportunity costs are minimised and material living standards

involves abolishing protection of local industry by removing tariffs, subsidies and import quotas,

UNCORRECTED involves abolishing protection of local industry by removing tariffs, subsidies and import quotas,

thereby forcing local �rms to become more internationally competitive.

UNCORRECTED thereby forcing local �rms to become more internationally competitive.

means that Australian businesses are relatively ef�cient in their use of

UNCORRECTED means that Australian businesses are relatively ef�cient in their use of

resources, and can compete or sell their goods and services both here and in markets around the world

UNCORRECTED resources, and can compete or sell their goods and services both here and in markets around the world without relying on government protection. They can sell goods and services of comparable quality at a

UNCORRECTED

without relying on government protection. They can sell goods and services of comparable quality at a lower price than overseas rivals.

UNCORRECTED

lower price than overseas rivals. occurs when countries produce only a limited range of goods and services,

UNCORRECTED

occurs when countries produce only a limited range of goods and services, focusing on those areas where they have the greatest

UNCORRECTED

focusing on those areas where they have the greatest is commonly measured by the level of GDP per hour worked.

UNCORRECTED

is commonly measured by the level of GDP per hour worked.Multifactor productivity

UNCORRECTED

Multifactor productivity measures the ef�ciency with which the combined inputs of labour, capital and

UNCORRECTED

measures the ef�ciency with which the combined inputs of labour, capital and natural resources are converted into production.

UNCORRECTED

natural resources are converted into production.Net errors and omissions

UNCORRECTED

Net errors and omissions transactions. Its can be positive or negative.

UNCORRECTED

transactions. Its can be positive or negative.Net foreign debt (NFD)

UNCORRECTED

Net foreign debt (NFD)governments have borrowed from and owe overseas, minus what Australia has lent or invested abroad.

UNCORRECTED

governments have borrowed from and owe overseas, minus what Australia has lent or invested abroad. This debt entails paying interest and repaying the capital borrowed at some time in the future.UNCORRECTED

This debt entails paying interest and repaying the capital borrowed at some time in the future.Net foreign equity (NFE)UNCORRECTED

Net foreign equity (NFE)

PAGE are capital movements into and out of Australia that involve the establishment, purchase

PAGE are capital movements into and out of Australia that involve the establishment, purchase

refers to the actions of an overseas competitor who sells a good below its cost price, thus

PAGE refers to the actions of an overseas competitor who sells a good below its cost price, thus

are reductions in a �rm’s average �xed costs per unit associated with

PAGE are reductions in a �rm’s average �xed costs per unit associated with

an increase in its production levels, perhaps enabled by trade liberalisation.

PAGE an increase in its production levels, perhaps enabled by trade liberalisation.

involve two or more nations agreeing to remove various forms of protection PAGE involve two or more nations agreeing to remove various forms of protection

of their local industries. They are often seen as bene�cial because countries will be inclined to specialise in PAGE

of their local industries. They are often seen as bene�cial because countries will be inclined to specialise in areas of comparative cost advantage where opportunity costs are minimised and material living standards PAGE

areas of comparative cost advantage where opportunity costs are minimised and material living standards

PROOFS occurs if a nation specialises in a few key areas of production where its cost

PROOFS occurs if a nation specialises in a few key areas of production where its cost

the total value of all current

PROOFSthe total value of all current account credits for goods, services, primary incomes and secondary incomes, measured over a period of time.

PROOFSaccount credits for goods, services, primary incomes and secondary incomes, measured over a period of time.

exceeds

PROOFSexceeds the total

PROOFSthe total

value of all current account debits for goods, services, primary incomes and secondary incomes, measured

PROOFSvalue of all current account debits for goods, services, primary incomes and secondary incomes, measured

is the rise in the CAD that occurs when there is a rise in AD or spending as a result of strong

PROOFS is the rise in the CAD that occurs when there is a rise in AD or spending as a result of strong

are capital movements into and out of Australia that involve the establishment, purchase PROOFS

are capital movements into and out of Australia that involve the establishment, purchase



Net services is a subsection of the BOP current account that records the value of credits for services exported minus the value of debits for services imported from overseas, measured over a period of time.

Non-of�cial debt represents borrowing overseas by Australian businesses to �nance expansion.Of�cial debt represents borrowing by the government, perhaps to �nance budget de�cits.Portfolio investment involves money transactions into and out of Australia involving shares, debt and

securities.Productivity relates to ef�ciency or the level of output gained from a given quantity of inputs or resources. Structural CAD is an ongoing de�cit on the current account resulting from structural or supply-side

problems, including our lack of national savings, high production costs and poor international competitiveness.

The balance of payments account (BOP) is an annual statistical record of Australia’s �nancial transactions with the rest of the world. In turn, these transactions are divided into two main types of transactions — current transactions, and transactions involving the capital and �nancial accounts, each recording credit and debit transactions.

The balance on capital account is a subsection in the BOP capital and �nancial accounts. It records the total value of credits minus the total value of debits for capital transfers and other intangible assets.

The balance on �nancial account is a subsection in the BOP capital and �nancial accounts. It mainly records international transactions involving the movement of money capital or investment, as well as the dealings of the Reserve Bank of Australia (RBA).

The exchange rate is the number of units of another currency that can be purchased with or swapped for one unit of our currency.

The foreign exchange market is where currencies are swapped or converted into other currencies.The national savings–investment gap is the shortfall in value between what Australian households, �rms

and governments save and the level of their investment. This must be covered by overseas borrowing or debt.

The terms of trade (TOT) represents the ratio of the export prices we receive to the import prices we pay.The trade weighted index (TWI) is a general measure of Australia’s exchange rate. It represents the value

of our dollar against a basket of foreign currencies, each weighted according to their relative importance to Australia’s trade.

Trade liberalisation is a government policy that entails reducing protection of local industry by cutting tariffs, subsidies and import quotas, and the signing of FTAs.

Trade protection is a government policy that involves using high tariffs, import quotas and subsidies to local producers to support local industry so that it can compete with imports.

UNCORRECTED tariffs, subsidies and import quotas, and the signing of FTAs.

UNCORRECTED tariffs, subsidies and import quotas, and the signing of FTAs.is a government policy that involves using high tariffs, import quotas and subsidies to local

UNCORRECTED is a government policy that involves using high tariffs, import quotas and subsidies to local producers to support local industry so that it can compete with imports.

UNCORRECTED producers to support local industry so that it can compete with imports.

PAGE and governments save and the level of their investment. This must be covered by overseas borrowing or

PAGE and governments save and the level of their investment. This must be covered by overseas borrowing or

represents the ratio of the export prices we receive to the import prices we pay.

PAGE represents the ratio of the export prices we receive to the import prices we pay.

is a general measure of Australia’s exchange rate. It represents the value

PAGE is a general measure of Australia’s exchange rate. It represents the value

of our dollar against a basket of foreign currencies, each weighted according to their relative importance to

PAGE of our dollar against a basket of foreign currencies, each weighted according to their relative importance to

is a government policy that entails reducing protection of local industry by cutting PAGE is a government policy that entails reducing protection of local industry by cutting

tariffs, subsidies and import quotas, and the signing of FTAs.PAGE

tariffs, subsidies and import quotas, and the signing of FTAs.

PROOFScurrent transactions, and transactions involving the capital and �nancial accounts, each recording credit

PROOFScurrent transactions, and transactions involving the capital and �nancial accounts, each recording credit

is a subsection in the BOP capital and �nancial accounts. It records the total

PROOFSis a subsection in the BOP capital and �nancial accounts. It records the total the total value of debits for capital transfers and other intangible assets.

PROOFSthe total value of debits for capital transfers and other intangible assets.is a subsection in the BOP capital and �nancial accounts. It mainly

PROOFSis a subsection in the BOP capital and �nancial accounts. It mainly

records international transactions involving the movement of money capital or investment, as well as the

PROOFSrecords international transactions involving the movement of money capital or investment, as well as the

is the number of units of another currency that can be purchased with or swapped for one

PROOFSis the number of units of another currency that can be purchased with or swapped for one

is where currencies are swapped or converted into other currencies.

PROOFS

is where currencies are swapped or converted into other currencies.is the shortfall in value between what Australian households, �rms PROOFS

is the shortfall in value between what Australian households, �rms and governments save and the level of their investment. This must be covered by overseas borrowing or PROOFS

and governments save and the level of their investment. This must be covered by overseas borrowing or

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