Economics notes

NOTE: these notes generally follow the syllabus however where applicable syllabus areas or information is
condensed or rearranged for succinctness
Source: Tim Riley Economics textbook, Australia In The Global Economy textbook
10.1 THE GLOBAL ECONOMY
FEATURES OF THE GLOBAL ECONOMY

Economic integration and International convergence
Globalisation refers to the increasing level of economic integration between countries.
Leading to the emergence of a global market place or single world market.
Economic integration refers to when trade barriers are reduced or removed between
countries to facilitate growth in international trade and investment.
Global economic integration has raised living standards by allowing countries to focus on the
export of G&S in which they have a comparative advantage in exchange for G&S in which
other countries have a comparative advantage.
The integration of regional groupings of countries has resulted in large amounts of inter-
regional trade and intra-industry trade
More policy coordination groups e.g. G7, G8, G20, OECD
WTO is the first multilateral organisation with the authority to enforce nationals
governments compliance with rules on free and fair trade
o Leading to integration and standardisation of rules and norms to operate in the
global economy.
Trading bloc such as EU are only beneficial if they create rather than trade from other
regions
Main forms of economic integration:
o Free trade area: where a group of member countries abolish trade restrictions
between themselves
o Customs union: member countries not only abolish trade restrictions but adopt
common external restrictions
o Common market: a customs union that allows free mobility of labour and capital
within common market countries
o Monetary union: a common market with a single currency and a single central bank
A majority of nations have adopted a market economic system or are in transition from
socialist to capitalist
Other forces promoting convergence of economic systems include:
o Spread of similar technology and economies of scale in production
o Growth of international trade and consumerism
o Increased levels of migration and labour mobility
o Political cooperation between governments to embrace benefits of globalisation
Contemporary Trading Blocs and Agreements and International organisations
A trading bloc in a strict economic sense if when a group of countries join together in a
formal preferential economic relationship to the exclusion of other economies.
Multilateral trade agreements are considered the most effective way of achieving trade
liberalisation on a global basis because they are non-exclusive and create rather than divert
trade.

EU (European Union), formed in 1959:
o A single European market with no trade barriers and free mobility of G&S, people,
labour and capital.
o Is a full monetary union with most states adopting: a single currency, the euro, in
replace of national currencies, a single interest rate, and single foreign exchange and
monetary policies conducted by the European central bank.
o Main benefits of the EU monetary union: a reduction in transaction costs by using a
single currency, greater economic stability and improved economic performance
through coordinated monetary, exchange rate and other economic and social
policies.
o Recent sovereign debt crisis in southern Europe has revealed a number of problems
with the union: states that were granted membership under the condition that
certain economic improvements were made (such as Greece) have not made those
improvements, and many EU policies are ignored such as the policy that debt must
not exceed 3 per cent of GDP (currently no EU member has a debt to GDP ratio of
less than 3 per cent)
NAFTA (North American Free Trade Agreement) signed in 1992:
o For the USA and Canada it increased their international competiveness by allowing
domestic companies to exploit lower production costs in Mexico.
o For Mexico it gave greater access for it exports to the large and high income markets
of USA and Canada.
o Opponents argue that NAFTA diverts trade, as firms would relocate to the cheaper
Mexico, rather than create trade. Also non member country companies may
relocate to Mexico to access US and Canadian markets whilst avoiding those
countries strict tariffs. In response rules of origin were established which are used
to determine if goods are wholly produced in the North American region.
APEC (Asia Pacific Economic Cooperation) formed in 1989:
Types of
International
Agreements
Multilateral:
WTO
Regional:
EU, APEC, ASEAN,
NAFTA
Bilateral:
ANZCERTA,
Austraia-US FTA
o Multilateral regional trade forum which pursues common trade policy issues and
developed mechanisms for closer trade and investment links in the Asia Pacific
region
o Major achievements:
1994 Bogor Declaration with dismantling of trade barriers by developed
economies by 2010 and for developing economies by 2020. Involved
Individual Action Plans for trade liberalisation and Collective Action Plans for
the regional facilitation of common standards, rules and procedures.
Establishment of electronic tariff database for the region
A review of regional customs procedures and a review of existing market
access arrangements in the region.
ASEAN (Association of South East Asian Nations) formed in 1967:
o Initiatives: fostering commerce and industry links between member economies,
consultation on banking and finance, and dialogues with other regional groupings
such as NAFTA and the EU
o 1992 agreement on the formation of the ASEAN Free Trade Area which would allow
greater regional specialisation and economies of scale and attract more foreign
investment into the region.
o In 2009 ASEAN, Australia and NZ signed the ASEAN-Australia-NZ Free Trade Area
(AANZFTA) agreement.
ANZCERTA (Australia New Zealand Closer Economic Relations Trade Agreement) signed in
1965:
o In Response to Britain joining the EU ANZCERTA was signed with the objectives to:
Strengthen the broader economic relationship between AUS and NZ
Develop closer economic relations through mutual free trade
Eliminate barriers to trade with minimal level of disruption
Develop trade between AUS and NZ under conditions of fair competition
o Agreement has led to free flow of labour and capital resources between the two
countries improving efficiency of resource allocation.
WTO
o GATT was signed in 1947 and became WTO in 1995. Basic guiding principle of GATT
and WTO are:
Non discrimination, which means that trade concessions granted to one
member nation must be extended to all member nations
Trade liberalisation which involves the WTO working towards the
elimination of all tariff and non-tariff barriers through a process of
multilateral negotiations between member countries
Stability of trading relations, where WTO mechanisms are set up to discuss
and solve trade disputes between countries
Transparency of trade agreements, where trade preferences between
countries are open to scrutiny and discussion in the WTO forum
o Since 1947 there have been nine rounds of trade negotiations mainly resulting in
cuts to tariffs. The eighth round was held in Uruguay and the ninth was principally
held in Doha
o Uruguay round focused on areas were GATT rules did not previously exist, such as:
Trade in agriculture
Trade in services
Trade related intellectual property rights
Trade related investment measures
o Major outcome of Uruguay round was agreement by EU and US to cut agricultural
subsidies
An average cut in all agricultural tariffs of 36 per cent
Domestic support measures to be cut by 20 per cent
Export subsidies to be cut by 36 per cent in budgetary terms.
o Doha round had intention of reducing protection and achieving free and fair trade.
Main agenda items:
Further reduction on agriculture subsidies, building on those in Doha round
Trade concessions from developed countries to developing countries to give
them more manufacturing and agricultural export market access
Measures to allow environmental and labour standards to be imposed on
trade related activities
o Doha round collapsed as EU, US and developing countries failed to reach agreement
on reform to agricultural trade.
IMF
o Established under Bretton Woods Agreement in 1944 with a role to assist countries
in the post World War Two period.
o IMF was established with pool of central bank reserves and national currencies
which could be made available to countries with short term balance of payments
issues.
o A new form of IMF reserve asset, Special Drawing Rights (SDR), was introduced in
the 1970s as many countries floated their exchange rates. This allowed countries to
obtain foreign exchange by drawing on their own currency balances held by other
IMF countries
o The IMFs five main responsibilities in the global economy are:
Promoting international monetary cooperation
Facilitating the expansion of international trade
Promoting exchange rate stability
Supporting the multilateral payments system
Making resources available to members experiencing balance of payments
difficulties.
World Bank
o Also set up under the 1944 Bretton Woods Agreement
o It focus on long-term development projects in developing or emerging economies.
It attempts to influence the design of macroeconomic and microeconomic policies in
developing countries.
o The world bank has a number of organisations that provide specific assistance to
lower income countries:
International Development Association provides soft loans (loans at little
or no interest).
International Finance Corporation role is to attract private investment to
the Banks projects
Multilateral Insurance Guarantee Agency provides risk insurance to private
investors investing in developing economies.
o In recent years the World Banks major aim as set out in the Millennium
Development Goal to reduce the proportion of people living of less than US$1 a
day to 14.5 per cent of all people by 2015.
o At the end of 2008 the WB tripled its lending in response to the GFC to US$35 Billion
World Economic Growth
IMF estimate for gross world product in 2008 was about US$69 trillion
Overall, globalisation era has only produced a small increase in the level of economic growth
globally
o Average world growth in output between 1997-2007 was 3.9 per cent
High income and newly industrialised economies have mostly emerged as winner in
globalisation, with faster economic growth built on increased trade and investment flows.
o The advanced industrialised economies accounted for 55.3 per cent of world GDP in
2008 with 15.3 per cent of the worlds population in 2007.
o Developing economies accounted for 36.6 per cent of world GDP in 2008 yet had a
majority 77.9 per cent of the worlds population in 2007.
Globalisation was expected to bring about greater similarities in growth level of economies
o Wider gap in long-term growth rates between faster and slower growing economies
has emerged
o Sometimes referred to as convergence in economic growth rates
Trade
Rapid liberalisation of global trading environment
o Through trade agreements and micro-economic reform (removing protection)
o High growth in world trade and investment between 1970s and 1990s due to
financial deregulation, globalisation, and improvements in technology and
communications
Trade has rapidly increased in response a range of major trading agreements, as mentioned
earlier (WTO, NAFTA, etc.)
Direction of trade flows has shifted
o High income countries accounted for 82 per cent of global merchandise exports in
1995 and 71 per cent in 2007. Every other region saw an increase in their share of
world exports.
o East Asia and pacific region saw largest increase in global merchandise exports rising
from 7 per cent in 1995 to 13 per cent in 2007.
Compositional shifts in world trade
o Parts and components, services (financial, business, accounting, insurance
telecommunications, entertainment), ETMs, technology goods
Trade between the three major economic groupings (Europe, North America, and East Asia;
known as the global trade and investment triad) has become increasingly intra-regional
overtime.
o East Asias intra-regional trade rose from around 35 per cent of those total countries
trade in 1980 to 55 per cent in 2004
o EUs intra-regional trade in 2004 was 65 per cent
o This trend has been accelerated by preferential liberalism (liberalising trade, as
described in the first dot point through trade agreements etc., but with a preference
for countries in that region)
MNCs/TNCs (multi/transnational corporations) have emerged as one of the main drivers of
global trade
o A global wed of production facilities has emerged to facilitate the distribution and
production of parts and components
o Since the 1990s the number of TNCs has grown from 37,000 to 79,000.
Changes in the international business cycle have magnified effect on the level of world trade
- greater volatility in trade
o In the downturns in the mid-1970s, early 1980s, in 2001 and in the GFC growth in
world trade has contracted faster than the contraction in world economic output.
Statistics on global trade (NOTE: take your pick different statistics suit different essays or
essay questions better):
o Word exports of G&S has increased threefold since 1980s
o Average growth in world trade in 1990s was 6.6 per cent; in 2000s it is 4.8 per cent
o Trade has been heavily geared towards highest income countries
Advanced industrialised economies as a group accounted for 65.1 per cent
of world exports of G&S in 2008.
However Share of world trade by LDCs has increased from 23 per cent to 29
o Trade in G&S has increased from US$8.7 trillion (38 per cent of global output) in
1990 to $US31.2 trillion (63 per cent of global output) in 2007
o World trade in G&S grew from 12 per cent of world GDP in the 1960s to 25 per cent
of world GDP in the 2000s
Impacts in global trade flows:
o Shifts in trade affect the structure of an economy over time if an economy is
experiencing increased demand for particular exports, resources in that economy
will shift towards increasing the production of that G or S.
o Example: global resources boom and demand for Australian mineral has led to an
expansion in mining investment and operations in Australia and our economy is now
dominated/driven by mineral exports.
Investment
Growth in FDI and portfolio investment is mainly due to easing of capital controls between
countries as financial deregulation spreads to global financial markets.
Central banks also removed direct lending controls, allowing a greater role for market forces
to allocate financial and investment resources.
Also increased turnovers in world stock markets through new technologies allowing greater
access for individuals, companies and governments to raise funds or engage in merger and
acquisition activity.
International trade increasingly linked with investment as companies use FDI to gain access
to foreign markets
Since the 1980s portfolio investment has increased investment sevenfold
FDI flows were valued at around US$ 80 billion in 1980, US$201 billion in 1990, and peaked
at US$1.8 trillion in 2007

Much of increased Investment flows has been directed to emerging economies in need of
large capital injections to assist industrialisation, modernisation, urbanisation, and eco
development
Major structural change in the direction of world FDI occurred between 1990 and 1997, with
increasing shares of FDI going to emerging economies in Asia
The supply of capital will continue to grow from pension and mutual funds and MNCs
Australia has benefited largely from Chinese investment
NOTE: global investment falls under global finance (below). However they can often be distinguished
by describing the shorter term, speculative shifts of money as finance and the longer term flows of
money to buy or establish businesses as investments. (This is not a strict definition)
Finance
Integration of national financial systems to create a world financial market. This has been
the result of financial deregulation in most countries
Financial deregulation and floating exchange rates leading to increased capital mobility
Controls on foreign exchange currency markets, flows of foreign capital, banking interest
rates and overseas investments in share markets were lifted.
Collapse of communism and NIEs has increased demand for capital, as transition countries
have sought more integration with the global economy.
Main types of global forex transactions are spot transactions, outright spot transactions and
swaps
Stats:
o Foreign exchange turnover increased dramatically - Forex turnovers increased from
$US 15 billion in 1970s to around $US 2 trillion in 2000s
o Financial flows have increased from US$ 2.3 trillion in 1990 to $US 31.9 trillion in
2000s
o Global capital market turnover grew from US$2.8 trillion in 1995 to US$7.6 trillion in
2008
o Exchange derivatives where worth about US$ 1 trillion in 1988 and reached about
US$56 trillion in 2007.
The main institution participating in forex include MNCs, banks, super funds, and central
banks
95 per cent of forex turnovers are due to the actions of speculators seeking short gains from
currency movements.
Main participants in forex markets in 2007:
o Commercial and investments banks acting on behalf of clients. They accounted for
43 per cent of total turnover in 2007
o Financial institution that buy and sell currencies on behalf of clients to make a profit.
Accounted for 40 per cent of total turnover
o Non-financial institutions such as government, MNCs, IMF, World Bank. They
accounted for 17 per cent of total turn over
Types of forex traders:
o Exporters want to be paid in their own currency, which mean importers need to
convert the currency they operate in to make the payment for G&S
o Foreign investors who are purchasing assets such as property or shares
o Speculators who make short-term currency trades
Impact of global financial flows:
o Changes in financial flows have an effect on confidence within a country and in that
economy.
o To an extent the value of the currency is seen as an indication of overseas
confidence in the economys future therefore when money is flowing out of an
economy and the exchange rate is falling it can weaken confidence in the economy
therefore slowing domestic growth.
Technology Revolution and Electronic Commerce
The ICT revolution has led to new types of products and employment in businesses servicing
the global market through the internet.
o New products, services and processes increase the range of choice for consumers
while greater international competition leads to lower prices
Firms can use IT systems to reduce costs and increase efficiency
o Ordering of stock and inputs can be done instantaneously, allowing firms to respond
to changes in demand quickly and to reduce the wastage of resources
o Time savings through use of internet and electronic commerce allow firms to reduce
labour costs in marketing and final distribution
o The role of wholesaler or middlemen in the distribution chain is reduced, reducing
costs
Rapid technological change allows for faster rate of innovation
World Information Technology and Services Alliance estimates that the global marketplace
for information and communications technology will reach US$4 trillion by 2011
In late 2008 worldwide internet usage surpassed 1 billion users
Labour
Labour markets have also liberalised, however tight restrictions remain (due to border
security and terrorism)
A vigorous international labour market has emerged due to labour strategies in particular
industries
International market for labour appears to be concentrated at top and bottom ends:
o High skilled labour travels the global village to where the returns are highest.
o Low-skilled labour is also in demand in advanced economies where it may be
difficult to attract significant people born locally to do certain types of work.
Guest workers from mainly developing countries gain temporary employment in developed
economies or NIEs in response to labour shortages in particular industries in those countries.
Workers frequently make a substantial contribution to the balance of payments in their
home countries by remitting savings from their salaries
o Workers remittances reached US$371 billion in 2007
A international labour organisation publication identified key issues in international labour
markets
o Workers from developing economies were often exploited
o Emerging black market in migrant workers being smuggled to work in illegal
industries
o Developed countries need, to increase labour supply due to ageing population, often
led to illegal migrant labour
Another problem is brain drain from developing economies
o Highly skilled workers seek employment and higher incomes in other rich industrial
countries
o Reduced availability of highly skilled labour in those economies
Governments that have embraced a globalisation strategy have generally pursued policies to
raise labour productivity as a way of increasing competiveness
o Example: successive Australian governments deregulated and decentralised wage
determination and instituted policies to increase the flexibility of the labour market
Short-term structural unemployment as domestic economies open up to international
competition and jobs move offshore.
International Business Cycle
Greater synchronisation of short-term economic growth, reflecting the increased
importance of the international business cycle.
Globalisation and economic integration have meant that the economic performance of
individual economies is more closely linked to changes in international business and
commodity cycles.
Financial or global contagion can occur where a crisis in one financial market or economy is
spread to others, causing regional or global instability
o Increased integration between countries and regions led to the rapid spread of the
GFC in 2007-08 causing a global recession.
Change in international business cycle will have varying effects on the domestic economy
cycle. The main transmissions for these changes are :
o Trade flows: boom or recession will directly affect demand for imports from other
economies
o Investment flows: one of the main causes of weak FDI inflows to developing
countries in the late 2000s was the weaker economic performance in the US.
o TNCs: improved economic conditions in developed countries will lead to increased
investment in other economies as TNCs seek to increase their productive capacity.
o Financial flows: a 2009 IMF paper, How Linkages Fuel the Fire, showed that bank
lending and financial flow linkages transmit financial conditions from advanced to
developing economies and was the main reason the GFC spread so quickly from the
US to other economies
o Financial and market confidence: strong correlation of the movements in share
prices among the worlds major stock exchanges.
o Global interest rate levels: supply of foreign credit for domestic investment.
o International organisations: Research by the RBA has found that 63 per cent of
changes in output levels in Australia can be explained by changes in interest rates,
growth levels and inflation in the G7. Therefore domestic Australian factors have
less influence on economic growth than international factors in any given year.
There are two types of external shocks that can be transmitted from the global economy to
a domestic economy:
o Real shocks: changes in variable such as world output, commodity prices or
technological change which can cause structural changes to occur in the real
economy. Negative and positive real shocks.
Positive real shock: the global resources boom in 2004-07 caused by strong
demand for commodities from developing economies, particularly China. It
caused global output to reach 5 per cent in this period above the 3.7 per
cent trend for the decade. It led to higher export incomes, higher rates of
capacity utilisation leading to increased investment in new plants/projects
and equipment, and falling unemployment.
o Financial or monetary shocks: changes in financial variables such as changes in
international share prices, global interest rates or inflation rates.

FREE TRADE AND PROTECTION

The basis of free trade advantages and disadvantages
Free trade is imposing no artificial barriers to trade. The argument for free trade is based on the
economies concept of comparative advantage:
Comparative advantage nations should specialise in the areas of production in which they
have the lowest opportunity cost and trade with other nations so as to maximise both
nations standard of living.
Opportunity cost represents the alternate use of resources. That is, the costs of satisfying
one want over the costs of an alternate want.
Since countries have different factor endowments specialisation of production will take
place, and expected economic gains (such as cost reductions through economies of scale)
will result if countries engage in free trade.
A reason for a country specialising in the production of goods in which it has a comparative
advantage is that it may be able to generate economies of scale in production

Advantages of free trade Disadvantages of free trade
Increased specialisation - leads to
economies of scale, resulting in greater
levels of output and employment
Greater range of output due to
specialisation, increasing quality and
quantity of goods available to consumers
Increased productivity of resources -
leading to greater allocative efficiency
Increased competition between firms -
leading to lower consumer prices and
higher real incomes
Encourages innovation and spread of new
technology and production processes
More efficient allocation resources due to
comparative adv.

Overall:
Higher national income and living standards
as a result of lower prices, higher eco.
growth, increased production of G&S and
increased consumer choice

Newly established firms in infant industries
will find it difficult to compete against
established foreign firms - Infant industries
will take longer to generate the necessary
economies of scale to compete.
The most efficient and competitive
producers will attract resources away from
less efficient and less competitive
industries, causing some regions to lose key
industries and experience unemployment.
Can lead to negative externalities because
some nations may produce goods at a
lower cost because of weaker
environmental protections or exploitation
of labour in LDCs which reduce compliance
costs.
Inability of country to diversify their
economic base because they specialise in
production according to comparative
advantage.
Production surplus may be dumped (sold
at unrealistically low prices that domestic
business cannot compete) which may hurt
efficient domestic industries.
Country pursuing free trade can often
experience sustained or ongoing CAD. This
can lead to a shortfall in export income to
finance import income

Reasons for protection
Infant industries: these businesses usually start out on a small scale, with costs that are relatively
higher than those of more established firms because of these firms larger scales of production
which reduce costs. It is argued infant industries need protection in short run to enable them to
expand their scale and reduce their costs of production so that they can compete with the rest of
the world. If this argument is valid protection should only be temporary, otherwise there would be
no real incentive for the industry to reach a level of efficiency that would enable it to compete
without protection.
Prevention of Dumping: is the practice of exporting goods to a country at a price lower than their
selling price in their country of origin. It may be used to dispose of large production surpluses or to
establish a market position in another country. The only gain from dumping is a reduction in price
for consumers, which will be short-term as foreign producers put up prices once competition is
eliminated. Economists consider this the only valid argument for imposing protection.
Protection of domestic employment: the argument is that if local producers are protected from
competition with cheaper foreign imports, the demand for local goods will be greater and this will
create more domestic employment. However protection will tend to distort the allocation of
resources away from areas of more efficient production towards areas of less efficient production. In
the long term this lead to lower growth rates and higher unemployment
Defence and Self-sufficiency: major powers generally want to retain their own defence industries so
that they can be confident that in a time of war they would still be able to produce defence
equipment. A similar argument can be made for self-sufficiency of food supplies.
Methods of protection and the effect of protectionist policies on the domestic
and global economy
Artificial barriers placed on imports
Tariffs: a tax on imported goods imposed for the purpose of protecting domestic industries. The
effects of a tariff are:
Stimulates domestic production and employment as domestic firms are artificially more
competitive than foreign firms.
Reallocation of resources towards less efficient industries
Consumers pay higher price and receive fewer G&S.
Raises revenue for government
Retaliation effect can be experienced in response to tariff other countries may impose
protection which may offset gains in employment and production by reducing them in
export competing industries.
Quotas: are restrictions on the amounts or values of various kinds of goods that may be imported.
The effects of a quota are largely the same as a tariff, except there is no government revenue.
However some revenue may be obtained through selling import licenses.
Local content rules: these specify that goods must contain a minimum percentage of locally made
parts. In return for guaranteeing that a certain percentage of good will be locally made, the
imported components may not attract a tariff.
Artificial competitive advantage for Exports
Subsidies: cash payments from government to business to encourage the production of a good or
service and influence the allocation of resources in an economy. Subsidies are often granted to
business to help them compete with overseas produced G&S. Subsidies tend to reduce prices, thus
lowering inflation and benefiting consumers.
Export incentives: these are programs that give domestic assistance such as grants, loans or
technical advice (such as marketing or legal information), and encourage business to penetrate
global markets or expand their market share.
Effects of protectionist policies
Local industries and firm receiving protection gain in the short term because they are able to
raise prices, increase output and raise market share.
Major macroeconomic effects of protection on domestic economy are negative:
Resources are misallocated: resources are directed away from efficient and competitive
industries to industries that rely on protection
Inflation: distorting effects of tariffs on import prices, which can be pasted into the domestic
cost and price structure
Negative protection: efficient export industries are penalised by paying higher prices for capital
equipment, and because they cannot easily pass on these cost in world markets, their
competitiveness is reduced.
Economic growth: is retarded because capital and labour may not be used intensively if output is
geared towards small domestic markets where it if difficult to reap economies of scale.
Export earnings: are lower because protect domestic industries tend not to seek overseas
market because the domestic industry lacks competitiveness.
Microeconomic effects:
Rent seeking: protected industries devote resources to the unproductive activity of political
lobbying for maintenance or increases in levels of protection
Generally in Australia the management and labour forces in protected industries used outdated
work practices and had low levels of productivity
Non-exposure to international competition leads to minimal adoption of innovation and the
latest cost-saving technology
Statistics and facts:
Non tariff barriers in the EU, USA, S. Korea and Japan reduce Australias net farm export income
by depressing world agricultural prices.
US Department of Agriculture estimates that trade policies like those of the EU, USA, S. Korea
and Japan reduce agricultural prices by 12 per cent
OECD estimates that agricultural policies in OECD countries cost consumers and taxpayers
US$300b every year.
Australian policies regarding free trade and protection
Governments MAIN AIMS in reducing protection are to:
Force domestic industries to become internationally competitive by exposing them to
competition from imported goods
Encourage resources to move away from industries that cannot improve their competitiveness
to those that can focus on areas of the economy where Australia has a comparative advantage
Allow Australia to benefit from greater integration with the global economy by giving business
and consumers access to G&S available in global markets at lowest prices
Promote structural change (microeconomic reform) in the economy with the long term aim of
encouraging efficient firms to produce what the global economy demands

Process towards complete free trade:
1970s Whitlam govt. introduces 25 per cent across the board cut to protection to stimulate
greater industry efficiency and lower the price of imported consumer, intermediate and capital
goods.
1970s-80s protection increased in industries such as passenger motor vehicles (PMV), textiles,
clothing and footwear (TCF) and steel industries which experienced intensified export
competition.
1980s Hawke government implements policy of large scale dismantling of industry protection
with 1988 industry statement:
o This statement phased in cuts to protection over 4 years
o PMV, TCF and steel industry exempted from cuts. They were put on separate industry
plan allowing for much longer phase down of protection period
1986 Australia joins Cairns Group of agriculture free trading countries
1989 Australia helped to form APEC forum in response to EU and NAFTA
1990s 1991 Industry Statement introduced to accelerate the pace of reform. It announcing
following measures:
o Reduction of majority of tariffs to 5 per cent by 1996
o Abolition of import quotas for PMV and a reduction in tariffs for PMV to 15 per cent by
2000
o Abolition of import quotas on TCF and reduction in maximum tariff to 25 per cent by
2000
o Exemption of sales taxes on export industries to improve their internationally
competiveness.
1994 Australia became member of WTO (was member of GATT in 1944)
1994 Australia signs Bogor Declaration committing APEC nations to eliminate all trade barriers
by 2020.
2000s Automotive Competiveness and Industry Investment Scheme introduced by Howard in
2001 to provide transitional assistance to PMV. Continued tariff reduction throughout 2000s
2007 Productivity Commission (PC) estimates tariff assistance to domestic producers is valued
at $9.2b
2010 Around half of imports are tariff free with the remainder subject to tariff of 5 per cent or
less. Only TCF had tariff above 5 per cent at 10 per cent which also falls to 5 per cent in 2015.
1968-69 1977-78 1982-83 1986-87 1994-95 2003-04 2005 2007
36% 23% 25% 19% 9% 4.5% 3% 1.8%
Average tariff levels in AU, source: Productivity Commission

Implications of Australian policies for individuals firms and governments
Individuals
As employees
o Increased structural unemployment as industry restructure to gain efficiencies
o Increased use of capital equipment in favour of labour increased unemployment
o Increased future employment opportunities as efficient domestic industries expand
into international markets.
o Higher wages Centre for International Economics (CIE) produced modelling in 2009
that calculated real wages have increased by 2 per cent due to Australias trade
liberalisation policy.
As consumers
o Decrease in prices of g&s due to increased competition
o Increase range of g&s available
o Improved living standards CIE modelling calculated the average family income has
increased by $3,900 per year
Firms
Short term
o Firms operating in marginal, import-competing industries may shrink or cease
operations as they not cannot compete in global marketplace.
o Increased investment in order to implement necessary changes to sustain
profits/market share
o Increased payments for redundancy
o Increased need for workplaces training and capital expenditure to accommodate
changes in productivity
o Lower input costs as imported capital equipment may be cheaper. The PC estimates
that reduced tariffs will reduce input costs for services by $4.8b; for mining by
$298m; and for primary producers by $56m
Long term
o Decrease in cost of production as methods become more efficient and productivity
increases therefore increased profits
o Increased potential market globally competitive
Government
Short term
o Increase welfare and industry payments increased structural unemployment and
transitional assistance to business
In 2004 the government announced $50m in labour market assistance to
workers made redundant by the closure of an engine plant in South
Australia
o Decrease in tax revenue due to decrease in tariffs
Long term
o The benefits of reduced protection was estimated by the PC as a gain of $4b to GDP
through additional export income and higher rates of economic growth
o Increased eco growth
o Increased access to overseas markets increase in trade agreements as economy in
competitive in global market.
Implications for Australia of protectionist policies of other countries and
organisations
Australian agricultural producers face significant barriers to trade:
The EU operates the Common Agricultural Policy which subsidies EU farmers by 25 per cent.
Farmers in US, Japan and S. Korea also receive similar subsidies, putting Australian
agricultural producers at a significant disadvantage.
Australian Bureau of Agricultural and regional Economic estimates that a reduction in global
agricultural protection could boost Australian agricultural exports by US$9b by 2020.
Australian firms exporting non-agricultural goods generally face fewer barriers to trade.
The mining and resources sector is more likely to face export barriers from the Australian
government trying to secure energy supplies. If a foreign government were to impose tariffs
on Australian resource exports it would raise costs for business and consumers but would
not encourage resources exploration.
Manufactured goods face few barriers to trade as most economies have low tariffs or have
bilateral of multilateral agreements with Australia.
Australia service industry encounter no artificial barriers to trade, however, though they
account for three quarters of GDP they account for less than a quarter of exports. This is
because services face a number of barriers to trade including natural barriers such as
geography, transport costs, language and cultural differences, and local tastes and
preferences. The Australia Services Roundtable estimates that liberalisation of global trade
in services could increase exports by up to $5b a year for Australia. Examples of service
export barriers:

Service industry Potential trade barriers
Financial services Restrictions on foreign ownership of banks and other financial institutions
Transport services Restrictions on airlines providing services in another country
Professional services Licensing laws that only recognise own countries educational qualifications
Construction services Government procurement rules that mandate use of local suppliers
Utility services Government monopoly provision of electricity, gas and water
Environment services Government preference for local suppliers of waste or recycling
Media & Entertainment Minimum local content requirements to preserve countrys culture

IMPACT OF GLOBALISATION ON THE STANDARD OF LIVING IN THE GLOBAL ECONOMY

Variation in the standard of living in the global economy
Contrasts in level of development
Impact of globalisation
Fuck it, its not real economics

10.2 AUSTRALIAS PLACE IN THE
GLOBAL ECONOMY
AUSTRALIAS TRADE AND FINANCIAL FLOWS

Value, composition and direction of Australias trade and financial flows
The Australian economy ranks 14
th
in GDP size in the world
Large growth in services exports between 2002 to 2010 - A surplus occurred in net services
between 2002-07.
The value of exported services grew by 60 per cent between 2002 to 2009 while the value of
import services grew 71 per cent in the same period.
Exports and imports in goods as a percentage of GDP rose from 12 per cent in the mid-1980s
to 23 per cent in the 2000s
Australia recorded a surplus in the G&S balance of $5 billion in 2008-09
The changing direction of trade
In 1950s Australian mainly traded with the US, UK and other European Countries
In following decades Australias trade shifted towards Japan.
In the past two decades China, South Korea, and the ASEAN countries have come to
dominant out export markets.
Reasons for this:
o The UK joined the EU in 1973 and was required to impose the same barriers with
Australia as with other countries and give preference to trade with EU members.
o By the 1960s the Japanese economy was sustaining rapid economic growth and its
demand for product inputs such as minerals was increasing rapidly
o During the 1980s Japanese growth rates began to slow down and the direction of
Australias trade shifted more towards other economies in Asia
Asia accounted for 59 per cent of exports in 2008.
In 2007 China became Australias largest trading partner.
The EU (particularly Germany) and the US remain important but primarily as a source for
imports.
Changing composition of Australias trade
Primary industries has always been the main focus of Australias exports as it is in
commodity goods that Australia has the greatest comparative advantage
The composition of Australias imports Since the 1980s:
o The share of capital goods has remained unchanged
o Part-finished intermediate g&s have declined
o Consumer goods have steadily increased
While imports have remained relatively unchanged Australias exports have significantly
changed
The agricultural sector has declined: large fluctuations in world prices and trade
protectionist policies have influenced export revenue making it unattractive export to focus
on. It also has little extra value added in processing.
Minerals have rapidly increased: world economy and resources boom has ensured demand
however prices and volumes fluctuate significantly
Australia does not compete in the manufacturing sector, however sales of sophisticated
niche market manufactured goods picked up in the 1990s.
Trends in Australias financial flows
Year Total Foreign investment into Australia Total Australian investment abroad
1980-81 $46.8 billion $13.4 billion
1995-96 $461.3 billion $185.9 billion
2008-09 $1735.1 billion $1009.2 billion

Financial flows grew most rapidly in the 1980s, when the Australian dollar was
floated and financial markets were opened up.
Level of portfolio investment in 1980s was lower than direct investment. Portfolio is
now higher than direct investment
Australia has always been a net capital importer, with the level of foreign
investment in Australia consistently remaining close to twice the level of Australian
investment abroad.
Australian businesses have substantial overseas assets, and Australia also has
significant short-term overseas investments such as shares.
Main sources of foreign investment into Australia are the USA, Britain, Japan, Hong
Kong, China, Singapore and New Zealand.
The balance of payments
Current account non reversible transactions
Goods
Services
Net primary income
Net secondary income
Capital and Financial account reversible transactions. Also financial inflow has the immediate
effect of increasing the supply of foreign exchange to Australia while financial outflow reduces it
Capital account
o Capital transfers credit
o Capital transfers debits
o Net acquisition/disposal of non-produced, non-financial assets
Financial account
o Direct investment
o Portfolio investment
o Financial derivatives
o Other investment
o Reserve assets
The current account is calculated as:
net goods + net services
(the balance on goods and services)
+
Net income + net current transfers
The capital and financial account is calculated as:
Capital account + direct investment +portfolio investment
+
Other/financial investments + reserve assets
The balance of payments is calculated as:
Current account + capital and financial account
+
Net errors and omissions = 0

Links between key balance of payments categories
In theory the floating Australia dollar plays the key role of ensuring that there is a balance in the
balance of payments. Under a freely floating exchange rate, equilibrium occurs where:


Following with the idea that theoretically the floating Australia dollar ensures the balance in the
balance of payments, then for equilibrium in forex markets:
Supply of $A = Demand for $A
Which in turn implies:
M + Y debits + K outflow = X +Y credits +K inflow
Rearranging the equation:
M X + Y debits Y credits = K inflow K outflow
OR
Deficit on the current account = Surplus on the capital and financial account
Australias balance of payments performance
Supply of $A
The supply of $A is represented by:
-Payments for imports of goods and
services (M)
-Income/transfers overseas (Y debits)
-capital and financial outflow (K outflow)

Demand for $A
The demand for $A is represented by:
-Receipts for exports of goods and
services (X)
-Income/transfers overseas (Y credits)
-Capital and financial inflow (K inflow)

Australia has experienced persistently large current account deficits since the mid 1980s:
o Net goods balance is usually in deficit
o Net services is usually in surplus
o Net incomes has always been in deficit since 1980
o Net current transfers regularly records very small deficits or very small surpluses
In 2000-01 the CAD reached its lowest level in two decades at 2.4 per cent
CAD was 4.8 per cent of GDP in 1999-2000 compared 3.2 per cent of GDP in 2008-09
CAD has averaged over 4 per cent of GDP, giving Australia one of the highest CAD outcomes
amongst advanced economies


Year:
Balance
on G&S
Net
income
Net current
transfers
Balance on
current account
Capital
account
Financial
account
CAD as %
of GDP
1980-81 -2.9 -2.4 -0.4 -5.8 0.2 4.7 -3.9
1990-91 -0.7 -17.2 0.5 -17.5 2.1 15.9 -4.3
2000-01 1.8 -18.7 0.0 -16.9 1.1 16.3 -2.4
2008-09 5.8 -43.6 -0.6 -38.4 2.3 37.2 -3.2

Australias current account deficit moves in cycles reflecting short and longer term, domestic
and external influences. Generally the deficit increases when domestic growth is stronger
than world growth:
o Balance of goods and services (BOGS) is influenced by short term cyclical factors
such as changes in global demand for commodities, Australias terms of trade and
the demand for imports from Australian consumers and business
o High economic growth within Australia generally contributes to a higher CAD. An
economic downturn has the opposite effect as it did in 2000-01, 2008-09 and in the
early 1990s.
o The net incomes are more stable than the BOGS and remain high regardless of
cyclical swings in the CAD. This is because the main factors that determine income
credits and debits the size of foreign liabilities, and the servicing costs associated
with those liabilities are structural factors that do not change substantially from
year to year.
Trends in 2000s:
o RBA raised interest rates in 2000 to reduce import spending. In 2001 stronger
growth in exports cut the trade deficit and the CAD.
o Drought in 2002-03 reduced export income and a weak global economic recovery
softened demand for Australian exports. Import spending also increased due to
strong domestic growth.
o In 2003-04 the drought persisted while Australian economic growth continued to
exceed world growth reducing export income and increasing import spending
o In 2004-05 a global recovery in growth and softening drought conditions led to a rise
in exports, but imports also rose due to strong domestic growth.
o In 2005-06 the global resources boom boosted exports.
o In 2006-07 the CAD rose due to higher net income deficit as investors sought a
return on investment from the mining boom.
o 2007-08 the G&S deficit rose due to stronger import spending
o 2008-09 saw an improvement in the CAD due to the effects of the GFC.
Foreign liabilities and the balance of payments
Net foreign liabilities reflect Australias total financial obligations to foreigners, minus the total
financial obligations of foreigners to Australia. There are two components:
Net foreign debt: total stocks of loans owed by Australians to foreigners, minus the total
stock of loans owed by foreigners to Australians.
+
Net foreign equity: is the total value of assets in Australia such as land, shares and
companies in foreign ownership, minus the total value of assets overseas that are owned by
Australians
Overseas investment in Australian equity does not add directly to Australias foreign debt. However,
we do have to send overseas some returns on equity investments, such as profits on companies or
rent on land.
On the other hand borrowing does add directly to Australias foreign debt. Initial borrowed sum
eventually has to be repaid and the debt must be serviced (regular interest payments = debt
servicing)
Australias net foreign debt to GDP ratio has grown dramatically during the period of
globalisation
Issues in the balance of payments
The main issues associated with the trends in the balance of payments:
The terms of trade:
Terms of trade measures the relative movements in the prices of an economys imports and
exports over a period of time.
Essentially it measures how much export income can be used to buy imports.
Export income is increased by increasing the quantity of G&S sold or by increasing the price
of G&S sold.
Therefore the terms of trade has a very significant impact on Australias balance of
payments:
o If the terms of trade deteriorates as it did between 1989 and 1994 it means that the
same volume of exports can buy less imports. This would then lead to a larger deficit
in the G&S balance and therefore an increase in CAD.
o The prices of primary exports on global markets tend to change rapidly. Therefore
Australia can experience large shifts in its terms of trade. One of the benefits of
diversifying Australias export base is that it will create a more stable terms of trade,
reflecting the fact that prices of manufacturing and service exports tend to be more
stable...
The structure of Australias export base (Australias narrow export base)
Almost 60 per cent of Australias export earnings come from Australias mineral and
agricultural commodity exports. In comparison to other advanced economies this indicates
an unusually heavy reliance on the exports of primary industries
In the long term Australias narrow export base contributes to the volatility in the CAD
because Australia is exposed to large fluctuations in the commodity prices from year to year.
Concerns over reliance on primary industry exports have lessened in recent years as
Australia has benefited from the medium-term trend increase in resource prices that was
only partly reversed during the GFC.
International competiveness
Australias competiveness depends on cost issues (price) and non-cost issues (quality)
Cost competiveness is influenced by labour costs and productivity levels, infrastructure
costs, the cost of basic services such as electricity and water, access to raw resources,
transport costs, the tax system, and the value of the currency.
Benchmarked against productivity of the average American employee, the productivity of
the average Australian employee went from 79 per cent of the American equivalent in 1990
to 86 per cent in 1999, before dropping to 83 per cent in 2008.
Non-cost issues include quality of G&S produced, reliability of supply, the effectiveness of
marketing efforts, and the quality of customer service.
Structural change
In order to diversify Australias narrow export base and improve international
competitiveness Australian governments must implemented a range of micro-economic
reforms. Reforms attempt to address structural factors that affect international
competiveness such as inflation, productivity levels, wages growth, and the improved
efficiency of the public sector.
If Australia has an inflation rate higher than countries it competes with, Australia
exporters are put at a competitive disadvantage, because their costs of production are
increased. This was problem throughout the 1980s, but since the 1990s Australia has
maintained relatively low inflation.
For Australia to develop a high-value-added export sector it needs education for a
highly skilled workforce, investment into research and development, and adequate tax
and other incentives for venture capital. These three factors have been highlighted
repeatedly as critical factors in research on export success in advanced economies
To compete internationally Australian firms must sustain productivity growth.
Competitive labour costs are important for business as labour is the largest component
of business costs.
To improve international competiveness Australia needs to embrace the changing role
of government, emphasising a smaller and more efficient public sector. There is a view
amongst international investors that greater competiveness will be achieved in
countries with a smaller public sector, lower taxes and in particular with minimal levels
of government ownership of business.
As a result of the sustained increases in resource prices, the Australian economy has
undergone structural change since the early 2000s towards emphasis on resources
industries.
Cost of servicing foreign liabilities
Major effects of ongoing CAD is that is must be financed by a surplus in the capital and
financial account through debt and equity borrowings (foreign liabilities)
A higher level of foreign liabilities then contributes to an outflow of funds in net incomes
due to interest costs on foreign debt and returning profits on foreign investment.
If the foreign liabilities rise, the deficit on the net income component of the current account
will grow. The main issue in the balance of payments has nearly always been the net
incomes deficit from 1999 to 2009 the net income deficit accounted for 50 per cent or
more of the CAD
One of the best economic measures of a countrys capacity to service its foreign debt is the
debt servicing ratio, which measures the proportion of export revenues used to make
repayments on foreign debt.
When interest rates overseas are low, as they were during the past decade, the servicing
costs of foreign debt are lower.
Exchange rates also affect the size of the net income. Investors demand a set percentage
return on investment, therefore if the exchange rate is low it costs more Australian dollars
to meet that set return on investment than if the exchange rate was high.
o More recently, more loans have been taken out in Australian dollar terms, and
favourable exchange rate movements and lower global interest rates have reduced the
proportionate size of foreign liabilities and their servicing costs.
National savings
Australia has one of the lowest levels of household savings in the developed world.
Over time, a lower national savings rate contributes to a higher level of foreign liabilities,
because Australia has to rely more on the savings of foreigners to fund local investment.
Government can address the savings problem by implementing policies to increase the level
of personal savings (such as compulsory superannuation), and through measures to
eliminate the budget deficit and move the public sector into surplus, so not to crowd out
(crowding out effect) the domestic credit market.
The consequences of a high CAD
Economists differ over the extent to which we should be concerned about Australias CAD and
foreign liabilities. Some economists argue that any external imbalances are simply the result of
normal market transactions in a globalised economy, and that the CAD and foreign liabilities are
beneficial because borrowing from overseas can increase investment and help the economy grow
faster. There are however clear risks to a sustained high CAD:
Growth of foreign liabilities. This will mean that lenders may become reluctant to lend to or
invest in Australia and decisions affecting the Australian economy will increasingly be made
by international business
Increased servicing costs associated with foreign liabilities. This can contribute to the
problem of the debt trap, in which Australia is borrowing money simply to service its existing
foreign liabilities.
Increased volatility for exchange rates high CAD may undermine confidence of investors
in the economy reducing demand for Australias currency. This can cause a depreciation in
the $A and worsen the CAD problem in the short term as cost of imports increase.
Constraint on future economic growth in the longer term, the CAD acts as a speed limit on
economic growth. Higher levels on economic growth generally involve increased imports
and deterioration in the CAD. Economies with a CAD problem are therefore forced to limit
growth to the level at which the CAD is sustainable. This is known as the balance of
payments constraint.
More contractionary economic policy if they find it necessary to reduce a high CAD in the
short term, governments will use tighter macroeconomic policies and an acceleration of
microeconomic reform leading to short term unemployment and a slowdown in economic
growth.
Sudden loss of international investor confidence leadings to economic crisis. Countries
with a high CAD are more vulnerable to shifts in investor sentiment, and investor confidence
can change suddenly. As investors withdraw money from an economy, it can often have a
dramatic effect, sometimes triggering a major crisis.

EXCHANGE RATES

Measurement of Relative Exchange Rates
To other individual currencies
Measures 1 unit of $A relative to 1 unit of a foreign currency, usually that of a major trading
partner.
Trade Weighted Index
TWI is a measure of the value of the $A against a basket of foreign currencies of major
trading partners. These currencies are weighted according to their significance to Australias
trade flows.
Fixed exchange rate systems
Fixed exchange rate either through foreign reserves of currency and/or gold or officially value the
exchange rate
Governments can attempt to maintain a fixed exchange rate by either buying or selling
foreign currency in exchange for $A.
Alternately a government would devalue the $A when it officially lowered the
exchange rate and revalued the $A when it increased the exchange rate
Managed flexible peg This system operated in Australia between 1976 and 1983.
Under this system the RBA would peg the value of the $A at 9am each day and that price
would operate throughout that day.
This system provides more flexibility than the fully fixed rate, but it can still prevent the
rate from drifting away from that which would exist under pure market forces.
Australias floating exchange rate system
The Australian dollar ($A) was floated in 1983. Under a floating system, the exchange rate is
determined by the free play of market forces and not government intervention.
Demands for $A will be affected by:
Size of financial flows into Australia from foreign investors
o The level of Australian interest rates relative to overseas rates relatively higher
Australian interest rates makes Australia a more attractive location for foreign savings.
o Investment opportunities in Australia will also strongly influence demand for $A
Expectations of future appreciation of the $A
Demand for Australia for Australian exports
o Changes in commodity priced and in the terms of trade have tended to have an
immediate effect on the dollar. A rise in commodity prices and an improvement in the
terms of trade are generally associated with an increase in Australian exports.
o Demand for Australia exports will be influenced by the degree of international
competiveness of domestic exporters and Australias inflation rate relative to overseas
countries.
o Changes in global economic conditions will also influence the overseas demand for
exports
o Tastes and preferences of overseas consumers will affect demand for Australians
exports

Supply of $A is represented by all those people that wish to sell $A:
The level of financial flows out of Australia by Australian investors
o Level of Australian interest rates relative to overseas rates
o Availability of investment opportunities overseas
Speculators in the foreign exchange market who expect the value of the $A to go down
Domestic demand for imports
o Level of domestic income when the domestic economy is growing output,
employment and incomes are rising and the demand for imports will also rise.
o Domestic inflation and the rate and the competitiveness of domestic firms that
compete with imports will also influence import levels
o Tastes and preference of domestic consumers


Main factors causing an appreciation or depreciation of the Australian dollar
Appreciation Depreciation
Increase in Australian interest rates or
decrease in overseas rates
Improved investment opportunities or
deterioration in foreign investment
opportunities
Rise in commodity prices
Improvement in Australias international
competiveness
Lower inflation in Australia
Increased demand for Australias exported
G&S
Expectations of a currency appreciation
Decrease in Australian interest rates or
increase in overseas rates
Deterioration in Australian investment
opportunities or improvement in foreign
investment opportunities
Fall in commodity prices
Deterioration in Australias international
competiveness
Higher inflation in Australia
Increased demand from Australians for
imported G&S
Expectation of currency depreciation

Reserve Bank intervention in the foreign exchange market
When the RBA feels that a large short term change in the exchange rate will be harmful to the
domestic economy (due to one of three reasons: exchange rate deviation from long-run equilibrium,
excessive speculation in forex markets, excessive depreciation or appreciation), it may decide to step
into the foreign exchange market.
Dirtying the float (direct intervention) by selling $A the RBA may prevent a rapid appreciation.
RBA may also buy $A (by selling its foreign currency reserves in exchange for $A only) to prevent
a rapid depreciation

Cash rate (indirect intervention) if the RBA wants to curb a rapid depreciation, it may increase
the demand for $A by raising interest rates. To decrease demand for $A it may lower the cash
rate.
There is a third type of intervention which is performed by the government and not the RBA. It is
where the government changes its stance of macroeconomic policy to increase or decrease
domestic growth.
It should be noted that direct intervention by the RBA in the forex market may have implications for
domestic liquidity and the stance of monetary policy. If the RBA sells foreign currency it takes
Australian dollars out of domestic circulation thereby restricting liquidity and pressuring the RBA to
ease liquidity through use of monetary policy.
To offset this, the RBAs intervention may be sterilised: this is where the RBA offsets its
transactions by buying or selling the equivalent amount of government securities in the
domestic financial market, leaving the monetary responsibilities of the RBA unchanged.
The effects of a change in the exchange rate
An appreciation
Negative effects Positive effects
Australias exports become more expensive on world
markets and therefore more difficult to sell, leading
to a decrease in export income and a deterioration in
Australias CAD
Imports will be less expensive, encouraging import
spending and worsening Australias CAD
Higher import spending and reduced export income
will reduce economic growth
Foreign investors will find it more expensive to invest
in Australia generally leading to lower financial
inflows
$A value of foreign income earned on Australias
investments abroad and would cause a deterioration
in the net income component of the CAD
The value of Foreign assets in Australian dollar terms
will decrease known as the valuation effect
Australian consumers enjoy
increased purchasing power
they can buy more overseas
produced goods with the same
quantity of $A
Appreciation decreases the
interest servicing costs on
Australias foreign debt
Reduce the $A value of foreign
debt that has been borrowed in
foreign currency a phenomenon
known as the valuation effect.
Inflationary pressures in Australia
will be reduced as imports
become cheaper. Reduces
pressure on RBA to raise rate.

A depreciation
Negative effects Positive effects
Australian consumers suffer
reduced purchasing power
Increased interest servicing
cost on Australias foreign
debt
Raises the $A level of foreign
debt that has been borrowed
due to valuation effect
Inflationary pressures in
Australia will increase as
imports are now more
expensive. Increases pressure
on RBA to raise rates.
Australias exports become cheaper on world markets
and therefore easier to sell, leading to an increase in
export income and an improvement in Australias CAD.
Imports will be more expensive discouraging import
spending and potentially improving Australias CAD.
Domestic production of import substitutes should also
rise
Lower import spending and greater export revenue will
increase Australias growth rate
Depreciation will also increase the value of Foreign assets
in Australian dollar terms, due to valuation effect
Foreign investors will find it less expensive to invest
Australia.

Recent Movements in the Australian dollar
2000s saw one of the most volatile period in the $A since it was floated.
In just over 18 months the $A surged from US80 cents to almost achieve parity in mid-2008
before losing almost a third of its value dropping to US63 cents in early 2009.
The dollar surged to a 25 year high of 74 on the TWI in 2008 before falling back to around 63
in 2009.
In late 2010 the $A achieved parity with the US briefly and continues to hover around US97-
100 cents
Year $US TWI
1990-91 0.79 58.91
1995-96 0.76 54.83
2000-01 0.54 50.33
2003-04 0.71 61.49
2006-07 0.79 64.82
Year-average exchange rate movements
10.3 ECONOMIC ISSUES
ECONOMIC GROWTH

Economic growth improves livelihoods, allows individuals to increase consumption, creates job
opportunities, and raises household and government incomes. Higher household incomes directly
reduce poverty and help people afford the basic necessities of life. Growth also increases
government revenues that can be invested into schools, roads, and hospitals (Source: AusAID)
Economic growth is the increase in the volume of G&S that an economy produces over time. It is
measured by the percentage increase in the value of G&S produced in an economy over a period of
time. The ABS uses three separate sources of data to calculate GDP:
The quarterly rate of economic growth: the percentage increase in GDP from one quarter of
a year to the next quarter of that year.
Year-on-year growth: the percentage increase in GDP from a quarter of a year to the same
quarter of the previous year.
Annual economic growth rate: percentage increase in GDP since the last financial year.
Components of aggregate demand
Aggregate demand: refers to the total demand for G&S within the economy.
Aggregate supply: refers to the total productive capacity of an economy, i.e. the potential output
when all factors of production are fully employed.
AD = C + I+G + (X-M) Y = C + S + T
Where:
AD = aggregate demand
C = consumer spending by households
I = investment spending by business
G = government spending
X = export revenue
M = spending on imports
Where:
Y = aggregate supply or national income
C = consumer spending by households
S = savings by households
T = taxation by the government

The economy is in equilibrium, that is, will tend to be stable, when the level of aggregate demand
and aggregate supply are equal:
Equilibrium occurs when:
Aggregate supply = Aggregate demand
Y = AD

Substituting for Aggregate demand and supply gives:
C+S+T = C+I+G+(X-M)

By rearranging the equation we get the leakages and injection in the circular flow of income:
S+T+M = I+G+X
Leakages = Injections

By analysing the influences on leakages and injections we can see what factors will cause the
economy to expand or contract over time:
S - Influences on consumption (whether to spend or save):
Influences on consumption and saving
o People and economies with higher incomes tend to consume more.
o Average propensity to consume: the proportion of total income spent on
consumption
o Consumption function: C = Co + cY: total consumption expenditure = autonomous
consumption + that income spent and not saved (determined by the MPC).
Consumer expectations
The level of interest rates
The distribution of income
Stat: Household consumption represented 56 per cent of expenditure on GDP in 2007-08
I Influences on investment
The cost of capital equipment
o Changes in interest rates: cost of borrowing to purchase capital equipment.
o Government policies: changes in government policies relating to investment
allowances and tax concessions on capital goods
o Price or productivity of labour: labour is a substitute for capital
Business expectations
o Expected demand for their products
o General economic outlook
o New resources and/or increase in technology
o Inflation: leads to uncertainty on future prices and future costs
Private investment by firms accounted for 24.4 per cent of GDP in 2007-08
T&G Influences on government spending and taxation
One of main goals of government is to maintain a strong and stable rate of economic
growth.
Government spending usually makes up between one-fifth and one-quarter of aggregate
supply or income. It accounted for 22.2 per cent of GDP in 2007-08
X&M Influences on exports and imports
Overseas and domestic income
International competitiveness of Australian exports
Overseas and domestic consumer tastes and preferences
Exchange rates: e.g. when exchange rates are weaker domestic industries are more
competitive and their products have greater appeal to foreign consumers.
If export revenue was equal to import spending, net exports would add no value to GDP.
Because of Australias trade deficit net exports detracted 3.1 per cent from GDP
Multiplier process
The MPS causes the amount of income generated by each successive wave of spending to
decrease
The sum of each successive wave of income generated will add up to the total amount by
which national income increases
The final increase in national income if equal to the initial increase in aggregate demand
multiplied by the multiplier.
Effects of Economic Growth
Higher economic growth can lead to a number of favourable outcomes in an economy:
Living standards: real wages can rise and household enjoy a higher disposable income and
therefore higher material living standards
Levels of savings: the private and public sector can increase saving through increased
incomes. This can lead to an increase in the household savings ratio, with households able to
reduce debt and save for retirement. Business also has greater capacity to utilise savings to
invest and expand as profits are higher. Government has increased revenue through higher
taxation and less spending on welfare as more individuals are employed. This revenue is
usually saved in high growth scenarios to stabilise growth.
Productivity and technological progress: producers are able to reduce production costs and
innovated in keeping pace with rising demand for G&S. Also increased profits giver business
greater freedom to invest in research and development.
Employment: creates jobs and countries with higher levels of economic growth tend to
create more highly paid and highly skilled jobs.
External stability: economic growth leads to higher output some of which may be exported
to other countries.
Higher economic growth can also cause a number of problems:
Inflation: higher economic growth results demand-pull inflation as consumers demand
more, and also cost-push inflation as prices go up and wage claims rise in level with inflation
Income distribution: sometimes the benefits of economic growth flow mainly to a particular
group such as shareholders of executives, rather than flowing more broadly.
External stability: increased consumer and business spending often results in higher level of
imports
Environmental impact: if growth is pursued with little or no regard for the environment, it
can result in pollution and depletion of non-renewable resources.
Recent Economic Growth Trends
Year Growth % GDP ($b) Year Growth % GDP ($b)
1990-91 -0.6 577 2002-03 3.2 878.3
1993-94 4.1 623.2 2005-06 3.0 967.5
1996-97 3.9 704.4 2007-08 3.7 1037
1999-2000 4.0 804.4 2008-09 1.0 1095.4

In the early 1990s Australia experienced a recession
Between 1991 and 2008 Australia experienced it longest period of sustained growth ever
averaging 3.6 per cent per annum.
Australia experienced a quarter of marginal negative economic growth in 2009 but managed
to retain an annualised growth rate of 1 per cent.
Australias robust economic performance reflects a combination of domestic and external factors:
Global economic conditions: apart from a major slowdown in world activity around the
2000s, from the 1990s to 2008 global economic conditions favoured Australia with low
inflation, lower interest rates, lower unemployment rates and greater macroeconomic
stability.
Resources boom coupled with emergence of China: Australias growth through the 2000s
has been underpinned by Chinese demand for commodities. Chinas continued economic
growth despite the 2008-09 downturns tremendously assisted Australia in avoiding a
recession. The development of the resources boom is described below:
o Rapid growth in emerging economies largely driven by China and India has sharply
increased demand for natural resources.
o At the same time major commodity exporters have been slow to increase supply of
resources, reflecting a long period of relatively low investment in mining.
o This combination of rising demand and limited supply has pushed up commodity
prices at the same time that export volumes have increased.
o The Australia treasury estimated that the terms of trade boom as a result of this has
increased national income by 13 per cent between 2002 and 2008. Treasury also
estimates that GDP has been boosted by $260b since 2003 through terms of trade
increases alone.
o Directly, the resources boom has increased employment, resulted in higher incomes
for mining industry employees and businesses and for investors in shares.
o Indirectly, the boom has increased government revenue from company tax allowing
Government to reduce personal income tax across the economy.
Fiscal policy: fiscal policy has been accurately and successfully used to make economic
growth sustainable and to boost aggregate demand during periods of low growth. In
particular the Australian government announced stimulus adding up to $77b to boost the
economy during the GFC.
Low domestic inflation: The RBA has continuously taken quick action to prevent inflation
above its target band, sustaining economic growth, providing a lower base to act from
during the GFC and encouraging business investment.
Productivity growth and long-term benefits of microeconomic reform: productivity growth
reached 2.6 per cent per year in the 1990s dur to microeconomic reforms in the previous
decades. Though this fell back in the 2000s the take of new technologies has continued well
into the 2000s.
Treasury has described the three Ps productivity, participation and population as the major
future challenges in achieving the highest rate of economic growth. In 2002 released the
Intergenerational Report which treasury would continue to release every 5 years. It noted the
future challenges for Australia growth prospects, the main one being the ageing population and
declining participation rate.
The 2007 intergenerational report estimates that living standards will improve by 1.6 per cent in the
next four decades, down from 2.1 per cent in the previous three decades. It estimates average
growth of real GDP to fall from 3 per cent in the 2000s to 2.3 per cent by 2020 and to 2 per cent by
2040.
UNEMPLOYMENT

Measuring the Level of Unemployment
Labour force (also known as the workforce): consists of all employed and unemployed persons in the
country at any given time. The ABS uses the following definition to determine those persons who are
counted as part of the Australian labour force or workforce:
Persons aged 15 years and over who are engaged in at least one hour of paid work a week. It
also includes those on paid leave, those stood down without pay for less than four weeks,
those on strike, etc.
Self employed persons working in family business or their own business.
Unemployed persons available for work and seeking work.
Labour force participation rate: refers to the percentage of the population aged 15 or over, in the
labour force, that are either employed or unemployed. The average participation rate in 2008-09
was 65 per cent. The participation rate is determined by four specific factors:
The size of the population
The level of net migration adds to skills base and size of labour force
The age distribution of the population the more people in the 15 years to 64 years age
group the larger the pool of potential workers
The participation rate of the working age population an economy might have a large
working age population but a very small labour force if the majority of the population isnt
working
Unemployment: refers to a situation where individuals want to work but are unable to find a job,
and as a result labour resources in an economy are not utilised. To be classified as unemployed a
person must satisfy a number of criteria:
Regularly checking advertisements from different sources for available jobs.
Being willing to respond to job advertisements, apply for jobs with employees and attend
interviews
Register with an employment agency linked to job services Australia.
Natural rate of unemployment
Natural rate of unemployment: refers to the level of unemployment at which there is no cyclical
unemployment.
The natural rate of unemployment in effect represents the supply constraint of an economy.
This is because once the natural rate of unemployment is reached, any stimulus to aggregate
demand will not lead to permanent reduction in unemployment.
This is why the natural rate of unemployment is referred to as the Non-Accelerating Inflation
Rate of Unemployment (NAIRU) stimulus to aggregate demand will not reduce
unemployment, but it will cause inflation.
A lower NAIRUA increases an economies capacity to grow without fuelling inflation.
The only way to further reduce unemployment once the NAIRU is reached is through
education and training programs.
Treasury calculated that the NAIRU for Australia in 2009 was 5.0 per cent, however
Australias rate of unemployment has fallen below this in the 2000s (it reached 3.9 per cent
in 2008) while inflation was adequately managed, suggesting the NAIRU is lower than 5.0
per cent.
The Main Types of Unemployment
Structural unemployment results from a mismatch of labour skills and qualifications of employees
with the available employment opportunities.
Cyclical unemployment occurs because of a downfall in the level of economic activity, and falls
during times of strong economic performance
Frictional unemployment is caused by people moving between jobs or experiencing changing
economic circumstances
Seasonal unemployment occurs at predictable and regular times throughout the year because of
the seasonal nature of some kinds of work
Regional unemployment occurs when one or two major industries in a particular region reduce
their demand for labour causing widespread unemployment.
Hidden unemployment refers to those people who can be considered unemployed but do not fit
the official definition of unemployment. They are also known as discouraged job-seekers because
they believe they cannot find a job and therefore do not seek employment.
Underemployment refers to those who work for less than full time hours per week but would like
to work longer.
Long term unemployment those people that have been out of work for 12 months or longer
The Causes of Unemployment
Level of Economic Growth
Derived demand demand for labour is derived from the demand for G&S which labour
helps produce. Therefore a downturn will increase the level of unemployment and an upturn
will decrease it.
Constraints on economic growth if there are continued constraints on economic growth
the economy will struggle to create enough jobs to reduce unemployment
Government Policy
Stance of macroeconomic policy:
1992-94 Expansionary policy, with large deficits and low interest rates, saw
unemployment fall from 11 per cent to 8.5 per cent
1996-97 A shift towards tighter monetary policy and fiscal consolidation contributed to
slower growth and a slight increase in unemployment to 9 per cent
1997-99 Interest rates reductions helped accelerate growth, encouraging spending,
business investment and job creation
1999-01 The cycle of interest rate increases in this year slowed down growth in 2000
and 2001 and resulted in an increase in unemployment
2003-04 The mildly expansionary stance of monetary policy supported growth and led
to a fall in unemployment levels
2005-08 Mildly expansionary fiscal policy alongside a major resources boom helped
sustain further reductions in unemployment to around 4 per cent
2008-09 A shift to highly expansionary macroeconomic policy helped abate a sudden
spike in unemployment caused by the GFC

Inadequate levels of training, education and investment a mismatch of skills to growth
industries which are demanding employment prevents unemployment from falling.
Furthermore unskilled labour is less likely to be employed in a highly skilled digital
advanced economy.
Rising Participation Rates
An increase in the labour force participation rate will tend to cause in increase in
unemployment in the short term.
Structural Change
Microeconomic reform will open industries to increased competition potentially causing
some businesses to cease operation or move offshore, making much of their current
workforce redundant.
Productivity higher productivity will tend to increase unemployment in the short term, but
increase employment in the long term as the economy is internationally competitive and
grows at a faster rate. Lower productivity will decrease unemployment in the short term, but
increase unemployment in the long term as the economy grows slower and firms may
replace workers with more productive capital.
Technological change new and improved production methods often result in the
substitution of capital for labour.
Inflexibility in the Labour Market and Labour costs
Regulation too many regulations surrounding employment may discourage employers
from hiring new employees
Minimum wage rates high minimum wages rates make it less attractive for employers to
hire less skilled workers
Wage expectations an important factor that can cause unemployment is the role of wage
expectations in pushing up the price of labour relative to capital. For example if employees
expect a rise in the minimum wage it may become cheaper to substitute labour for capital.
The role of wage expectations is linked to:
Rapid increase in labour costs this can be caused by a shortage of skilled labour, excessive
wage demands or industrial action.
The Impacts of Unemployment
Economic costs
Opportunity cost
o Unemployment means an economys resources are not being used to its full
capacity. Therefore unemployment is the opportunity cost of lost output and
income
Lower standard of living
o With high unemployment the production of both consumer and capital goods is
lower leading to a reduced rate of economic growth and therefore living standards.
Decline in labour market skills for long term unemployed
o Known as hysteresis: this is the process whereby unemployment in the current
period results in the persistence of unemployment in future periods as unemployed
people can lose their skills, job contacts and motivation to work.
Costs to the government
o Falling incomes associated with unemployment generate less tax revenue
o Government is forced to pay out more transfer payments as well as funding training
and labour market programs.
Lower wage growth
o Higher levels of unemployment mean there is an excess supply of labour forcing
down wages of restricting wage growth.
Social costs
Increased inequality
o Unemployment tends to occurs among lower income earners in the economy,
leading to loss of income which means this group earns even less.
Other social costs:
o Severe financial hardship and poverty
o Increased levels of dept
o Increased levels of crime
o Bunch of other unimportant non-economic stuff
Particular unemployment issues unemployment by group and hidden unemployment
o Youth - Persons aged 15-19 experience levels of unemployment up to three times
the rate of the general population. There is also a pattern where youth
unemployment increases about twice as much as the increase in general
unemployment, as observed during the GFC.
o Indigenous Australians a PC study in 2007 found that the unemployment among
Indigenous Australians was 13 per cent compared to 4 per cent for non-indigenous
people. Also:
Indigenous Australians have a much lower participation rate
Research shows that Indigenous workers are three to four more times likely
to be discouraged job seekers compared to non-indigenous workers (Hunter
and Gray 2009)
o Women job loss during recessions have a disproportionate effect on hidden
unemployment; research by The Australian Institute suggests women are more likely
to exit the labour market and take up domestic work immediately following job loss
rather than follow the unemployment path during recessions.
o Age related unemployment many older Australians fall into hidden unemployment
as the leave the workforce because of few job opportunity and fewer opportunities
to re-skill.
The take up of Pensions conceal older workers who would otherwise be
classified as unemployed (OBrien 2001). Currently 400,000 people aged
over fifty but younger than the retirement age receive the disability support
pension.
o People born outside of Australia unemployment rates are slightly higher for people
born outside of Australia, which might be caused by language and cultural barriers.
Also, Australian firms may not recognise overseas qualifications leading to systemic
underemployment of highly skilled people born outside of Australia.
Policies to reduce unemployment
Australia needs economic growth rates of around 3.5 per cent or higher to reduce unemployment.
The relationship between economic growth and unemployment is explained by Okuns Law to
reduce unemployment the annual rate of economic growth must exceed the sum of percentage
growth in productivity plus an increase in the size of labour force in any one year.
Government can use policies to increase economic growth to reduce unemployment in this way, or
it can specifically target problems that cause unemployment in the first instance:
Macroeconomic policies
Fiscal and monetary policy is very efficient in reducing cyclical unemployment.
o Nation Building Economic Stimulus Plan funded labour intensive infrastructure
projects for reducing cyclical unemployment during the GFC
Experience in economies such as Australia over the past few decades have shown that
monetary and fiscal policies are relatively ineffective in reducing structural unemployment.
Government policy
The government can utilise regulation outside of microeconomic reform: decreasing or
increasing the number of work visas offered to overseas workers, and increasing or
decreasing the immigration rate and skilled migration quota.
The government can utilise fiscal policy specifically targeted at unemployment:
o Job Services Australia established in 2009, which replaced the Job Network
reduces frictional unemployment be improving the flow of information between job
seekers and potential employers. Also reduces structural unemployment by
assessing the skills of job seekers and recommending training or education.
o The 2009-10 Jobs and Training Compact
o The Education Investment Fund and the Education Revolution
Microeconomic reform
Labour market reforms designed to make labour markets more flexible, encourage
competitive work practices and higher levels of labour productivity.
o Decentralised wage determination linking wage rises to gains in productivity
Tax and welfare reforms strengthen incentives and obligation of welfare recipient to work
o The Work for the Dole programme (1997)
Recent unemployment trends and an analysis.
The unemployment rate peaked in 1992-93 at 10.7 per cent largely due to a severe
Australian and global recession combined with structural change caused by the
microeconomic reforms of the previous decade.
Following the early 1990s there has been a steady decrease in the unemployment rate
largely due to sustainable economic growth rate which averaged 3 per cent per annum over
the mid 1990s late 2000s period.
o In early 2008 unemployment reached a 34 year low of 3.9 per cent.
o Unemployment was lowest in Western Australia and Queensland which most
benefited from the commodities boom.
ADVANCED ECONOMIC ANALYSIS: Economists suggest that the average unemployment rate
of between 4-5 per cent during Australias 17 years of consecutive economic growth hides
the real story in the Australian labour market:
o The ABS calculates the number of underemployed people as the labour force
utilisation rate. If this rate is added to the unemployment rate we arrive at a figure
of 13.8 per cent of the labour force in 2010. It is difficult to measure hidden
unemployment but conservative estimates put total figure of official unemployed,
underemployed and hidden unemployed at around 15 per cent of the labour force in
2010. Though the year 2010 is coming out of a small downturn this would still
suggest that they real level of unemployment during the 17 years of consecutive
growth was significantly higher than official estimates.
The GFC caused unemployment to rise however unemployment only rose to a peak of 5.8
per cent in 2009, much lower than forecast and much lower than the OECD average of 8.8
per cent.
o A corresponding spike in underemployment emerged, suggesting the reason for this
relatively low unemployment rate was a reduction in hours rather than jobs by
employers. The ABS estimates the underemployment increased by nearly 50 per
cent since mid-2008 to over 900,000 people by early 2010
o Youth unemployment rose from 8.1 per cent in early 2008 to 12.2 per cent in min-
2009
o Unemployment during the GFC was spread disproportionally by region areas in the
north shore had unemployment rates of less than 3 per cent in 2008 while areas in
western Sydney had unemployment rates well above 10 per cent.
o The ABS calculated that the number of discouraged job-seekers grew by nearly
40,000 in 2008.
INFLATION

Measuring Inflation
Inflation is the sustained increase in the general price level over time. In Australia the most widely
used measure of inflation is the Consumer Price Index (CPI) calculated by the ABS. The RBA also
calculated the underlying inflation rate as it is seen as a more accurate measure as it is not affected
by one-off volatile price movements.
CPI or the headline inflation rate summarises the movement in the price of a basket of
G&S weighted according to their significance for the average Australian household.
The underlying inflation rate is the average of these two inflationary calculations added
together:
o Trimmed mean inflation is determined by calculating the average rate after
excluding the top 15 per cent of items with the largest price increases and the
bottom 15 per cent of items with the smallest price increases.
o Weighted median takes the middle/median inflation rate of the list of every item
on the CPI.
Main Causes of Inflation
Demand-pull inflation occurs when aggregate demand or spending is growing while the economy is
nearing its supply capacity, so that higher demand leads to higher prices rather than more output.
It can occur through excessive growth in any component of aggregate demand, such as an
increase in consumption spending, an increase in business investment spending or an
increase in net government expenditure.
Another major source of demand-push inflation is an excessive increase in the money
supply, where an increased volume of chases the same amount of G&S.
Cost-push inflation occurs when there is an increase in production costs that producers pass on in
the form of higher prices.
Common causes of cost-push inflation are a rise in government charges and taxes or across
the board wages increases that do not reflect productivity growth.
Import inflation is a particular kind if cost-push inflation: imported inflation is transferred to
Australia through an international transactions, e.g. a rise in the price of imported goods or a
depreciation of the $A.
Inflationary expectations this can occur regardless of a real change in the level inflation, but often
is the cause of a real change in the level of inflation:
If the price of G&S is expected to increase in the future consumers may attempt to purchase
products before such increases. This caused an increase in consumption as future
consumption is added to current consumption, causing demand-pull inflation
If employees expect inflation to increase, they will take this into account when negotiating
their wage increases. In this way employees will seek higher wages to offset the expected
increase in prices, causing cost-push inflation as firms accommodate increased wage costs
by waging prices. This is often referred to as the wage-price spiral.
Effects of Inflation
Economic growth: inflation is the main constraint on economic growth as policies to reduce
inflation retard economic growth.
Wages (effects consumers and workers): higher cost of living and a fall in real wages unless
wage growth is the same as inflation growth. Leads to a reduction in living standards for
consumers and wager-earners
Unemployment (effects producers, government, and workers): higher levels of inflation will
usually result in more contractionary fiscal and monetary policy resulting in slower economic
growth and higher unemployment. Business may also choose to reduce their labour force to
decrease cost pressures. This is known as stagflation where the rate of inflation and the rate
of unemployment rise simultaneously.
International Competiveness (effects exporters): as supply costs increases Australian
exporters will either have to let profit margins fall due to a lower price-cost differential or
increase prices on international markets making their product less price competitive.
Consumers will also be more likely to switch to cheaper imported substitutes than buy
domestic G&S.
Government: the cost of providing G&S will rise and welfare payments due to increased
unemployed may rise causing an expansion in government expenditure. However, taxation
will also rise as taxpayers are forced to pay more tax on consumer goods and wage earners
are pushed into higher wage brackets.
Investment: high inflation distorts the incentive to invest as it makes producers uncertain
about future profits and encourages short term speculative investments.
Saving: Savers will find the real value of their savings will decline if nominal interest rates do
not keep up pace with inflation.
Policies to Reduce Inflation
Monetary policy
Fiscal policy
Micro-economic policy
Recent Trends
Inflation averaged 6-10 per cent since the mid-1970s to early 1990.
Inflation has stayed well below 3 per cent in both underlying and CPI terms for most of the
1990s and 2000s.
o Adoption by the RBA of inflationary band targeting in 1993 for the conduct of
monetary policy.
o Structural changes during the 1980s and 1990s to increase competition in product
and factor markets.
o Adoption of a national competition policy in 1995 put downward pressure on price
levels in factor markets.
o Linking wage growth to productivity increases.
o The impact of technological change and globalisation helped reduce production
costs and increase competitive pressure to contain price growth.
In 2006-2008 there was an upswing in inflation to around 4.5 per cent in CPI and underlying
terms. This reflects:
o Resources boom and associated increased wage rise claims.
o Economy nearing full capacity i.e. demand was exceeding supply.
With the onset of the GFC inflation dropped with CPI rising 1.5 per cent in 2008-09. This
reflects:
o Demand pressures easing globally and domestically due to slower economic activity
o Australian economy was operating with spare capacity i.e. supply exceeded demand.
o Lower world commodity prices, lower housing costs and slower growth in labour
costs.
EXTERNAL STABILITY

The debt-trap cycle:

DISTRIBUTION OF INCOME AND WEALTH
ENVIRONMENTAL MANAGEMENT

increase in
foreign
liabilities
increase in income
outflows to foreign
investors
worsening of net
income component
of current account
increase in CAD
foreign borrinings or
foreing investment
required to fund CAD
Australias Key Environmental Statistics
Forest Area (thousand sq. Km, 2005) 1,637
Freshwater resources (per capita cubic metres, 2007) 23,412
Threatened animals and plants (no. of species, 2008) 623
Fossil fuels (% total of energy use, 2006) 94.7
Carbon dioxide emissions (per capita metric tonne, 2005) 18.1

Ecologically Sustainable Development
Ecological sustainable development: involves conserving and enhancing the communitys
resources so that ecological processes and quality of life are maintained. The keys principles
are:
o Integrating economic and environmental goals in policies and activities
o Ensuring the environmental assets are appropriately valued
o Ensuring fairness in the shifting of costs and assets within and between generations
o Managing environmental risks with caution
o Taking into account the global effects of environmental issues
Australias National strategy on Ecological Sustainable Development (NSED) was first
developed in 1992 with three core objectives:
o Enhance Individual and community well-being and welfare
o Provide for equity within and between generations
o Protect biological diversity and maintain essential ecological processes
Market Failure: private benefits and social costs
Market failure: occurs when the price mechanism takes account of private benefits and costs of
production to consumers and producers, bit it fails to take into account indirect costs such as
damage to the environment.
The price mechanism ignores costs benefits associated with production in two main ways:
The costs of additional production do not take account of any additional social or
environmental costs
The price mechanism does not take account of future demand for G&S that may not be
satisfied or how the economys ability to grow in the future may be affected because a
resource has been used up or destroyed.
Tragedy of commons: refers to a situation where the failure of the market to assign costs to
individuals leads to damaging overuse of resources such as the natural environment.
Public and Private Goods
Public goods: non-excludable and non-rival
Private goods: excludable and rival
Free riders: refers to groups or individuals who benefit from a good or service without contributing
to the cost of supplying the G&S as a consequence, the good or service is likely to be under-supplied
in relation to total demand.
Major Environmental Issues
Preserving natural environments
Preservation of natural environments may include:
Restrictions on developments in environmental sensitive areas, such as mining in national
parks
Controls over emissions of waste products
Requiring new plantation in areas where logging has occurred
Controls over emissions of waste products
Actively protecting the natural environment from threats such as non-native plants and
animals
Government often face significant problems in trying to preserve the natural environment:
Short term: intervention is likely to result in a reduction in economy growth and an
intervention in the price mechanism may cause higher prices or reduce supply
Industries will face higher costs if they have to comply with rigorous environmental
standards. In a highly competitive global market place our environmental standards make us
less competitive.
Cost of repairing damage to the environment is often borne by taxpayers.
Controlling pollution
Pollution occurs when the natural environment is degraded in some way, such as by harmful
chemical substances, noise, or untreated rubbish.
Pollution is often observed far away from its original source making it problems for the
global economy and global institutions.
One of the best known problems pollution causes is climate change.
o The Intergovernmental Panel on Climate Change (IPCC) estimates that emissions as a
result of human activity have increased by about 70 per cent between 1970 and
2004.
o Several economists have linked the growth in emissions to increasing per capita
incomes, and growth in the worlds population over time.
o In the long run the IPCC estimates the increased emissions to lead to average global
temperatures rising by between 1.1 and 6.4 degrees.
o This would threaten economic growth as agricultural activity and human health are
put at risk from:
An increase in sea levels of between 18 and 59 cm coastal flooding that
may affect 20 million people and place an additional 30 million at risk of
hunger
More intense droughts and floods
Extreme and unpredictable weather conditions
Skin cancer rates increasing by as much as 140 per cent
Number of environmental refugees increasing by up to 200 million
o The most comprehensive report on the effects of unmanaged climate change on the
Australian economy (Garnaut Report) found that:
GDP could be reduced by 4.8 per cent by 2100, consumption by 5.4 per cent
and real wages by 7.8 per cent
Permanent environmental damage such as bleaching of the Great Barrier
Reef and the loss of up to 80 per cent of Kakadu wetlands.
Increased incidence of heat related health conditions in Australia, such as
malaria and skin cancer
Increased frequency of droughts in southern parts of Australia, decreasing
agricultural production
Climate change also provides a case study of how policy can be used to address
environmental issues:
o 1997 Kyoto protocol which requires industrialised countries to reduce greenhouse
gas emissions by 5 per cent on 1990 levels by 2012. Australia ratified this agreement
in 2007.
o When the Kyoto protocol expires in 2012 it is expected to be replaced by a new
international agreement in 2013 negotiated through UN Framework Convention on
Climate Change.
o Australia has also expressed interest (as have other countries already done) in
putting a cap on the level of emissions that can be produced in any year.
The proposed Carbon Pollution Reduction Scheme would include 6
greenhouse gases, 1000 large firms with mandatory obligations and covered
three-quarters of total emissions
Externalities
Negative externality: is an unintended negative outcome of an economic activity whose cost
is not reflected in the operation of the price mechanism
Positive externality: is an unintended positive outcome of an economic activity whose value
is not reflected in the operation of the price mechanism
The depletion of natural resource
Renewable resource: renewable resources can natural regenerate of replace themselves in a
short period of time. The resources can, however, be depleted to point where they become
non-renewable e.g. fishing is renewable however overfishing causes the resource to be
depleted faster than fish can reproduce, reducing fishing stocks.
Non-renewable resources: are those natural resources that are limited in supply because
they can only be replenished over a long period of time or cannot be replenished
THE OBJECTIVE OF ECONOMIC POLICY
FISCAL POLICY

Fiscal policy refers to the use of the Commonwealth Governments Budget to affect:
o Economic activity (economic growth, employment, inflation), resource
allocation, income distribution
Budget is the annual statement by Government of its income and expenditure:
o Direct tax, indirect tax, other revenue
o Expenditure: social welfare, health, education

Budget outcomes:
o Deficit
o Surplus
o Balance
Changes in budget outcomes:
o Discretionary (influence structural)
o Non-discretionary (causes by cyclical activity)
o Also automatic stabilisers: policy instrument that counterbalances economic
activity
Unemployment benefits
Progressive income tax system

Impact on economic activity:
o Contractionary: multiplied decrease in consumption and investment that
dampens AD
o Expansionary: multiplied increase in consumption and investment that
stimulates AD
o Neutral: no overall effect
o Keynesian principles vindicated by recent use of budget to stimulate economy
out of recession
o Evidence BY IMF research papers that contractionary fiscal policy that reduces
debt can in medium-long term increase economic growth because of the
reversal of the crowding out effect.
Impact on resource use:
o Directly affect resource use such through government spending on particular
area of economy
o Indirectly affects resource use through tax or spending decisions that make it
more or less attractive for resources to be used in a certain way e.g. Taxes on
tobacco
o Also through provision of public goods
Impact on income distribution
o Taxation and transfer payments
o Effects on inequalities
Impact on savings and CAD: public sector deficit and crowding out effect making the
pool of domestic funds smaller.

Methods of financing deficit: borrowing from private sector, overseas, selling assets, or RBA
(monetary financing)
Using budget surplus: pay of public debt or placing money in specially established
government-owned investment fund (future fund, Building Australia fund, education
endowment fund)
Current/recent stance:
o Cyclical factors: 2009-10 budget deficit of $56bn, forecast taxation to decline by
up to $210bn by 2012-13
o Structural factors: stimulus; $10.4bn economic security strategy, $42bn national
building and jobs plan
MONETARY POLICY

Influence cost and availability of money and credit in economy.
Objectives: maintain low inflation (inflation band targeting formalised by statement of conduct
on monetary policy in 1996 however original wording of RBA Charter has not changed meaning
the RBA must still pursue the following goals), reducing levels of unemployment, and sustained
level of economic growth
Domestic markets operations are the main instrument of RBA that influence interest rates in
economy
Cash rate is set by forces of demand and supply in the short term money market
(market for short-term loans between financial institution)
RBA influences this through DMO
o Banks are required to hold a certain proportion of funds in exchange
settlement (ES) accounts, which the banks hold with the RBA
o Supply of funds in ES accounts is affected by day-to-day banking transaction
between banks and through taxation and transfers as the RBA is the bank to
the government
o RBA exercise direct control of supply of funds through the forced buying and
selling of CGS to financial institutes. These may be outright or may take the
form of repurchase agreements
o This buying and selling of CGS increases or decreases supply of funds in ES
accounts thus decreasing or increasing cash rate
Impact of cash/interest rate through 6 channels of transmission mechanism:
Investment, savings, and consumption decisions are made on rate of interest
Alters cash flow between borrowers and lenders: high interest rate decreases cash
flow as more cash has to paid to servicing debt
Cost of credit
Affect on asset prices: may alter distribution of wealth. By discouraging spending
leading to less demand and fall in asset price
Exchange rate: high interest rate encourage capital inflow
Inflationary expectations
MICROECONOMIC POLICY

Microeconomic policy overall aim: encourage efficient operation of markets
o Allocative efficiency: economies ability to shift resources to where they are used
most efficiently
o Technical efficiency: ability of economy to achieve maximum level of output per
given level of input
o Dynamic efficiency and innovation: economies ability to shift resources between
industries in response to changing patterns in economy.
Microeconomic theory states the product and factor markets will work more efficiently if there is
more competition between private business and the market forces operate without government
interference. Hence micro-reform focuses on removing distortions
Main reforms
o Deregulation: removal of simplification of rules that constrain efficient market
operation
Financial sector: 3 steps; floating of Australia dollar, removal of RBAs direct
monetary controls over banks, and removal of barriers to foreign banks
entering Australia
Telecommunications: dominated by Telstra, but was opened up to Optus
and Vodafone in the early 1990s. Full competition in 1997. In 2009 the
government announced it would undertake reforms to remove the virtual
monopoly Telstra has including separating Telstra into its wholesale and
retail business
o Reforms to public trading enterprises:
Corporatisation of PTEs: aims to encourage PTEs to operate independently
from government as if it were a private business. Involves eliminating
political and bureaucratic supervision.
Privatisation of PTEs: completely government free
o National competition policy reforms:
National Competition Policy agreement in 1995 between states to engage in
micro-reform
As part of reforms Australian Competition and Consumer Watchdog was set
up
National regime to regulate costs of access to infrastructure
o Also tax reform, labour market policy, and reducing protection
o Overall impact of micro-reform:
Benefits: greater efficiency and productivity growth, new business and job
opportunities, higher economic growth and living standards, lower inflation
Costs: short term unemployment, closure of inefficient industries, greater
work intensity, higher inequality
EFFECTIVENESS AND LIMITATIONS OF ECONOMY POLICY

Limitations on policy implementation
Time lags:
Significant time lags can exist in implementing economic policy and waiting for those
changes to have an impact on the economy.
Policy Implementation time lag Impact time lag
Fiscal Medium term major changes to the
budget occur on an annual basis and
need to go through a complex process
of budget committee meetings and
department scrutiny. However, the
government can announce major fiscal
policy changes between budgets
Short term (a few months)
Monetary Short term the board of the RBA
meets to discuss changing the cash rate
every month and announce any change
to financial markets at 2.30pm on the
same day. However the RBA governor
does have the discretion to changes
interest rates if conditions change
significantly during the period of time
between RBA meetings
Medium term (6-18 months)
Microeconomic
reform
Long term (a few years)
microeconomic reform often involves
extensive planning, detail and
consultation. It often occurs in
response to or after a major
government study has been
commissioned. They can also take a lot
of time to implement if it is necessary
to secure the support of the state
governments.
Long term (up to 20 years)

Political constraints:
The three year political cycle is often regarded as a constraint on long-term economic policy
decision making typically government undertake long term reforms in the first year of
tenure and around halfway through their three year term the begin preparing for the next
election, reluctant to make policy that could be perceived as unpopular
The issue of unpopular policies often leads governments to delegate unpopular decisions to
government organisations. For example if the government was in control of interest rates
rather than the independent RBA they would be under political pressure to keep interest
low.
System of federalism can also act as a constraint as responsibility is shared across
jurisdictions making national coordination difficult. The Council of Australian Governments
(COAG) was created in the 1990s to facilitate agreements between the commonwealth
government and the states on policy issues such as microeconomic reform.
Theories that explain the limitations of macroeconomic policies:
Crowding out effect
Twin deficits hypothesis
Quantity theory of money