Economics hsc topic 2

Economics HSC Topic 2 –Australia’s Place in the Global EconomyAustralia’s trade and financial flowsValue, composition and direction of Australasia’s trade and financial flows Trends in Australia’s trade pattern: -Direction of trade: The direction of Australia’s trade has changed considerably over recent decades. In the 1950s, Australia mainly traded with the United Kingdom and other European countries. In subsequent decades, the direction has shifted and Japan has become the major buyer of exports. More recently China, South Korea and ASEAN countries have become increasingly important. This movement away from United Kingdom was due to their decision to join the EU. Australia then followed the economies in Asia with highest economic growth rates. -Composition of Australia’s Trade: Primary industries always been focus of Australia’s exports as we have a comparative advantage in commodity goods. (Wheat, wool, beef, coal, iron ore and gold). Less competitive in manufacturing, importing large quantities of capital goods, and manufactured consumer goods. Agriculture decreased and minerals increased in importance. Trends in Financial flows: Although trade flows have increased substantially over recent years, the rate of growth in financial flows has been much greater as international businesses have bought Australian assets and invested in Australian businesses, and as Australian companies have increased their overseas investments. When the exchange system of fixed exchange rates came to an end in the 1970s, exchange rates around the world were floated allowing financial flows to grow rapidly. Prior to the deregulation of the finical sector, most financial flows into Australia were direct investment. Following however the benefits of Portfolio investment were seen. Foreign equity and debt has increased dramatically with equity much larger proportion.Australia’s Balance of PaymentsA record of transactions between Australia and the rest of the world, over a period of time.Money flow IN referred to as a CREDIT (+)Money flow OUT referred to as a DEBIT(-) Structure: -Current Account, debits and credits:  Net goods (export goods – import goods)  Net service (export service – import service)  Net income (credit – debit)  Secondary Income -Capital and Financial Account: Capital Account: Transfers in the form of tied aid(for specific purpose), purchase and sale of non-financial assets. Financial Account: Direct Investment, Portfolio Investment, Financial Derivatives, Reserve Assets.

Links between key Balance of Payments categories Current Account Balance + Capital and Financial Account Balance + Net Errors and omissions = 0 The deficit on the current account = Surplus on the capital and financial account. The strongest link between the accounts on the balance of payments can be seen on the net primary income part of the current account. In the long term, a capital and financial account surplus will lead to a larger deficit on the net primary income account. This is because any foreign capital inflow to Australia will have to earn a return for its owner and these earning are a debit on the net primary income account Trends in the size and composition of Australia’s Balance of PaymentsMain focus on the current account deficit, the balance of goods and services and net primaryincome.Australia’s current account deficit moves in cycles due to both domestic and internationalfactors. Influenced by both cyclical and structural factors. Cyclical - those which vary with the level ofeconomic activity. Structural - factors those which have a persistent or underlying influence on theBoP(e.g. export base, international competitiveness ,savings).The balance on goods and services varies from small surpluses to large deficits. Cylical factors thatinfluence BOGs are the exchange rate, terms of trade (export price index/import price index x 100),levels of domestic economic growth, international business cycle. Structural influences includenarrow export bade, lacking international competitiveness in manufacturing and capacityconstraints.The Net Primary Income is the ongoing cause of Australia’s high CAD. Cyclical factors affecting NPIare exchange rates (size of interest payments), changes in domestic and global interest rates(size ofinterest payments made to OS investors), 40% of Australian public share market is foreignowned(when domestic conditions are good, larger proportion of dividends paid to internationalinvestors). Structural factors include very low levels of national savings and high investmenteconomy (major export industries in Aus require enormous amounts of capital investment form OS.Consequences of a high CAD: - Large build up in foreign liabilities - Increasing debt servicing cost - Volatility in exchange rates - Investors reluctant to invest

Exchange ratesAn exchange rate is simply the price of one country’s currency in terms of another country’scurrency. Australia has a floating exchange rate determined bu the marker forces of supply anddemand.Appreciate: increase in valueDepreciate: Decrease in value Measurement of relative exchange ratesComparing Australian currency to other currencies is done by stating what the value of one unit ofAustralian currency ($1) is relative to another currency. E.g. $A1 will buy US90c. The Trade WeightedIndex (TWI) is a measure of the Australian dollar against a basket of foreign currencies of majortrading partners. These currencies are weighted according to their significance to Australia’s tradeflow. In September each year the RBA amends the TWI based on the volumes of trade for theprevious finical year. Factors affecting the demand for and supply of Australian dollarsDEMAND SUPPLY 1. Level of Aus to OS interest rates 1. Level of Aus to OS interest rates 2. Investment opportunities 2. Investment opportunities 3. Expectations 3. Speculators 4. Export levels 4. Import levels 5. Commodity prices 5. Domestic income 6. Terms of Trade 6. Domestic competitiveness 7. International competitiveness Changes in exchange rates – apprectiaton/depreciation APPRECIATION DEPRECIATON 1. ↑ Aust IR, ↓ o/s IR 1. ↓ Aust IR, ↑ o/s IR 2. ↑ inv opportunities in Aust 2. ↓ inv opportunities in Aust 3. ↑ $commodities 3. ↓ $commods 4. ↑ AustToT 4. ↓ AustToT 5. ↑ int comp levels 5. ↓ int comp levels 6. ↓ inflation 6. ↑ inflation 7. ↑ demand for Aust X 7. ↑ demand for M in Aust expect of $ ↑ based on forecasts of expect of $ to ↓ based on forecasts of factors factors Determination of exchange rates including fixed, flexible peg and floating -Fixed: keeping the exchange rate at the same level always -Flexible peg: adjusting the exchange rate value each day and fixing it for 24 hours -Floating: allowing the forces of supply and demand to determine the exchange rate

The influence of the Reserve Bank of Australia on exchange rates Even though Australia’s exchange rate is primarily determined though the forces of demand and supply in the FOREX market, it is sometimes necessary for the RBA to intervene in the marker to prevent large fluctuations in the value of the $AUS which might impact on investor confidence. Can do this by: -Dirtying the Float: e.g. to avoid a rapid depreciation of the currency the RBA can buy $A, putting pressure upward pressure on the exchange rate. -Monetary Policy: rarely used, indirect e.g. to avoid a rapid deprecation, it may increase the demand for $A by raising interest rates, increasing intrust rates will attract more foreign savings which must be converted to $A The effects of fluctuations in exchange rates on the Australian economyChanges in the BoP can influence the exchange rate e.g. If the value of imports incressead, whileexports remained unchanged, this would result in a deterioration in the current account deficit.It would also cause an increase in the supply of $A, resulting in a deprecation of the currency.Also, because of the deprecation, a given level of financial inflows would be able to buy more$A. Therefore, the positive balance on the capital and financial account would increase in $Aterms to match the bigger deficit on the Current Account. POSITIVE APPRECIATION NEG APPRECIATION More purchasing power ↓ of X profits (cost more less buy) ↓ interest on servicing Deteriorating CAD as ↑ M ↓ $A value on o/s debt ↑M sees ↓ eco growth ↓ inflation pressure as imports are Expensive to invest in Aust cheaper ↓ value of foreign income ↓ value of foreign assets to Aust POSITIVE DEPRECIATION NEG DEPRECIATION Cheaper X CAD Less purchasing power Expensive M CAD (buy less) Increased servicing ↑ growth More foreign debt ↑ foreign income earned Increased inflation pressure ↑ $AU value of foreign assets Cheaper to invest in Aust

Free Trade and protection Australia’s policies regarding free trade and protection History: -Australia typically has relied heavily on trade -Historically Aus was one of the most highly protected economies (manufacturing) -In recent decades Aus had attempted to reduce protection levels, now one of the most open economies. Government aims in reducing protection: -Force domestic businesses to become internationally competitive -Encourage allocation of resources away from inefficient industries -Allow Aus to benefit from integration with the global economy, access to more G&S Government initiatives: -Gradual decline in average tariff levels 1969-36% 2008-2.5% -Phasing out of other barriers, such as quotas and subsidies -Whitlam Gov reduced tariffs by 25% across board in 1973 -comprehensive program of trade liberalisation continued into 1990s -Today 50% of all goods are tariff free -Australia’s reduction in protection goes well beyond those recommended by international trade agreements such as WTO Australia’s multilateral and bilateral free trade agreements Australia is very active seeking free trade agreements with other nations. Bilateral: -Closer Economic Relations agreement with New Zealand (CERTA), has led to free trade between the two countries and increased standardisation of laws, business practices and commercial structures. -Singapore-Australia Free Trade Agreement (SAFTA) was Australia’s first free trade agreement with an Asian country. Covers the elimination of tariffs and improves market access for services exporters such as telecommunications, financial and professional services. Multilateral: -ASEAN-Australian-New Zealand Free Trade Agreement (AANZFTA), covers 21% of Australia’s trade in goods and services and effectively creates a free trade area for the included members. Complementary economies. -Asia Pacific Economic Cooperation forum (APEC), aims for free trade between its members but has made little progress as there are no binding agreements.

The implications of Australia’s policies for individuals, firms and governments Implications for Australia of protectionist policies of other countries and trading blocsJust as domestic policies to protect Australian industries have an impact on the Australianeconomyso do the policies of other nations to protect their industries. When other countries puttariffs on Australian goods and services, our exports become less competitive and struggle topenetrate foreign markets. When other countries subsidise their exports, they raise the supply andreduce the price of those goods on global markets. The result is that countries like Australia thatcompete to sell similar products on global markets have their income reduced. Overall protectionismreduces that output of the Australian economy.

Economics hsc topic 2

by Tom Wilkinson on Oct 23, 2011

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