Option 1: Analyse the influence of different factors on Australia’s trade and financial flows.
Australia’s international trade is the exchange of goods and services between Australia and
another country, whereas international financial flows include debt and equity borrowings,
foreign exchange and derivatives trading across national boundaries. Both flows of trade and
finance between Australia and other nations are influenced to varying degrees by factors both
cyclical and structural, with cyclical factors generally being more significant. Cyclical factors
such as the global business cycle, particularly prices of commodities, and the exchange rate, as
well as structural factors including Australia’s narrow export base, proximity to the growing
economies of China and Asia, and policies such as protectionism all have both positive and
negative influences on Australia’s flow of trade and finance.
The global business cycle has the largest impact on Australia’s flow of trade than any other
factor. An expansion in the global business cycle will generally result in an increase in demand
for Australian exports. This is as growing economies have increased income to spend on
imports, as well as the fact that economic growth requires energy and infrastructure. As
Australia is the world’s largest exporter of both coal and iron ore, growth in the global economy
leads to a large increase in demand for Australian exports. However, Australia is extremely
dependent on commodity exports, making up 66% of the export base. As such, much of
Australia’s trade is dictated greatly by the global business cycle and the world price of
commodities. This can act as both a large positive and negative, depending on the economic
outlook of the global economy. In times of extreme economic growth and increased commodity
price, such as the mining boom of the early 2000s, the demand for commodities greatly
increased, and as such, so did both the value and volume of Australian exports. However, in
times of global economic downturn such as the COVID-19 pandemic in 2020, the demand for
commodities decreases, which is detrimental to Australia’s trade balance.
I do not know how to fit imports into this without writing too much. Should I write a
couple paragraphs on the domestic business cycle?
Furthermore, the business cycle also has a large influence on investment flows into and out of
Australia. In periods where Australia’s economy is growing faster than the global economy,
foreign investors will choose to invest in Australia instead of other nations. As such, this attracts
large amounts of foreign investment into the economy in periods where Australia is rapidly
growing. For example, the mining boom saw mining investment grow from 2% in 2002 of GDP
to 8% in 2012. Conversely, when the global economy is growing faster than the Australian
economy, Australian firms and individuals will invest more overseas to capitalise on the
increased rate of growth. Australia is often viewed by investors as one of the most stable and
reliable economies for investments. Until the COVID-19 pandemic which completely disrupted
trade, Australia had experienced 27 concurrent years of economic growth which is
demonstrated by the net foreign liabilities deficit of over A$850b, representing the large amount
of investment flows into Australia.
Australia’s exchange rate both largely influences, and is influenced by the flow of trade. The
value of the Australian dollar impacts both the prices of imports and exports for Australian firms
and households. An appreciating dollar will increase the price of exports and reduce the costs of
imports, an improvement in terms of trade, whereas a depreciating dollar decreases export
costs and increases import costs, a deterioration of terms of trade. Whilst a weak dollar will
initially reduce the price of exports, in the long term, as demonstrated by the J-curve theory, it
will increase the international competitiveness of the exports in the long term, increasing the
value of Australian exports as a whole. The opposite is also true with a strong dollar. However,
Australia is reliant on its narrow export base, and as such, the exchange rate is greatly impacted
by the demand for commodities. This means the economy is vulnerable to a phenomenon called
Dutch disease. Dutch disease in Australia occurs as demand for commodities leads to a highly
valued currency, making other exporting sectors, such as manufacturing, much less
internationally competitive.
I am writing way too much and I do not know what to do about it.
Flows of finance between Australia and other nations are greatly impacted by the value of the
AUD as it dictates the cost of foreign and domestic assets. An appreciating Australian dollar
makes it cheaper for Australian investors to purchase foreign assets as they can acquire more
foreign currency for the same amount of the Australian dollar. Conversely, a weak dollar means
foreign investors can purchase more Australian assets for a lower cost. Furthermore, interest
rate differentials between Australia and the global economy influence the flows of savings, as
households will choose to save in countries with the highest interest rates.
I do not know how to do examples for this. It is all theory based
Australia’s proximity to China and other growing Asian economies has been a large driver in the
direction and volume of Australia’s trade. China’s rapid economic growth at over 10% annually
from 2000 to 2012 was a large driver of Australia trade, both exports and imports. China’s
extreme growth required large amounts of commodity inputs, and as such, there was a large
increase in demand for Australian commodity exports. This is represented in the fact that 35 to
40% of all Australian exports go to China. Furthermore, proximity to China is beneficial for
Australia’s importing as China produces relatively cheap consumer goods. 20% of all Australian
imports come from China as a result of this. However, this large reliance on trade with China
can carry large disadvantages if the relationship between the nations were to deteriorate. This
occured in 2020, where China prohibited the importation of Australian coal, and imposed large
tariffs on agricultural products, greatly decreasing the value of Australian exports.
This is not a great essay
Australia’s relationship with and proximity to China has a large impact on the flow of finance
between the nations as each nation has comparative advantage in different aspects. Much of
the financial flows between Australia and China involve direct investment as Chinese firms
purchase mines in Australia, and Australian firms establish factories in China. In 2022, the
mining industry equated for over 70% of the total Chinese investment flows. The overall flow of
investment between these nations is less significant than many other nations, as China is only
the 5th largest investor into Australia, and China is only the 8th largest recipient of Australian
investment.
Policy implementation, particularly protectionism and free trade agreements has a large impact
on Australian flows of trade as it impacts the international competitiveness of exports and
relations between nations. Protectionism in the global economy makes Australian exports less
competitive due to the implementation of tariffs, quotas and subsidies. This reduces Australia’s
trade value as demand is greatly reduced. Furthermore, protectionism in Australia generally
makes imports more expensive for consumers, reducing the volume of imports in the nation.
Trade agreements between Australia and other nations greatly influence the direction of trade.
Bilateral agreements such as the China Australia Free Trade Agreement are the most common
form of free trade agreements that Australia makes. Whilst free trade agreements greatly reduce
protectionism between countries, making trade volumes much higher, bilateral agreements can
lead to trade diversion. Trade diversion can occur when bilateral agreements lead to nations
favouring their established trading partners over the most efficient option. This can lead to
Australia losing some efficiency within trade through the prioritisation of other trading partners.
The deregulation of the financial market is the most substantial factor in the flow of finance
between Australia and other nations as it allows for the interactions between financial
institutions to a much higher degree. The deregulation of the financial market in 1983 led to
much greater accessibility of Australian firms to world capital markets. Following the derivation
of the financial sector, foreign investment inflows began to grow rapidly, with the growth of
portfolio investment being much higher than long term direct investment. Similarly, Australian
investment overseas is six times what it was in 2000 and the level of portfolio investment is
significantly higher than the level of direct investment. Financial flows have grown at a faster
rate than the growth in trade. This growth in investment has been largely positive for Australia
providing large capital inflows. However, this also greatly increased Australia’s vulnerability to
global volatility, as seen in the COVID-19 pandemic.
Overall, Australia's trade and financial flows are greatly impacted by many factors, but cyclical
factors are those with the highest influence. Both positively and negatively, Australia’s
interactions with the global economy in the form of trade and financial flows is impacted greatly
by the global business cycle, influencing the demand for exports and levels of investment which
is furthered by fluctuations in the exchange rate. To a great extent, Australia’s direction and
volume of trade has been impacted by the proximity of China and its extreme growth, providing
high demand for Australian exports, and the flow of finance to a lesser degree. Finally, policies
such as protectionism and the deregulation of the financial markets has had a large influence on
the volume of trade through competitiveness, and has largely facilitated flows of investment
between nations.
Option 2:Assess the importance of factors that determine the size and composition of
Australia’s current account.
Australia’s balance of payments (BOP) summarises all transactions that Australia has with the
world over a given period of time and is the single most important economic indicator of
Australia's relationship with the global economy. The BOP is presented in two accounts, the
current account and the capital and financial account. The Current account of the BOP shows
the flow of transactions that are not reversible. A majority of the current account is made up of
the first two components as the balance of goods and services (BOGS) and net primary income
(NPY), where secondary income is a small portion of the current account. The size and
composition of the current account is impacted by factors both cyclical and structural. In
general, the cyclical factors are more important than structural factors in the composition of the
current account as the credits and debits within the current account are dictated by levels of
economic activity.
Australia’s balance of goods and services, being Australian exports less than Australian imports,
is affected to the largest extent by the cyclical factors of exchange rates, terms of trade, and
economic growth rates. This is as cyclical factors impact both the levels and price of imports
and exports to an extreme degree. Movements in the exchange rate affect the international
competitiveness of Australia’s exports as well as the relative price of imports. A depreciation
decreases the foreign currency prices of Australian exports which, as demonstrated by the
J-curve theory, will lead to an increase in trade value and volume in the long term due to more
competitive exports, meaning more credits in the current account. At the same time, a
depreciation increase the Australian dollar price of imports which discourages the purchasing of
imports, improving the BOGS account. The opposite is also true with an appreciating dollar,
demonstrating the large impact of the exchange rate on the current account. Australia’s terms of
trade has been the greatest influence on Australia’s BOP in recent years. An improvement in the
terms of trade means the same volume of exports can buy more imports, meaning that unless
there is a significant decrease in trade volumes, it would lead to an improvement on the BOGS
as credits exceed debits. After the beginning of the global commodity boom in 2003, Australia
experienced a doubling of its terms of trade to 2022 due to exceeding demand for Australian
exports, increasing export revenues and improving the BOGS. However, this increased demand
for Australian exports leads to an appreciation of the Australian dollar, which greatly harms the
international competitiveness of Australia’s non-commodity exports. Due to the fact that a vast
majority of Australian exports are commodities Australia has still continued to experience
improvements in the BOGS, leading to the current account surplus in 2019. The level of
domestic economic growth influences the demand for imports, influencing the BOGS. An upturn
in the domestic business cycle will result in increased consumption, worsening the BOGS. This
explains why despite the large increase in exports during the mining boom, the BOGS worsened
until the 2010s. Changes in the international business cycle greatly impact the BOGS by
affecting demand for Australian exports. A key feature of Australia’s recent increase on the
BOGS is due to the integration with fast growing economies such as China which demand high
volumes of Australian commodities. The cyclical impacts on the BOGS is the most significant
and important factor on the size and composition of Australia’s current account as cyclical
factors determine Australia's export competitiveness, volumes of exports and level of imports to
the highest degree.
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I think this one is good, just extremely long.
The largest component of the current account is BOGS, meaning any influence on Australia’s
trade balance has a large impact on the current account as a whole. Australia’s BOGS has
historically tended to remain in deficit due to two very important structural factors; being a
narrow export base and a lack of international competitiveness in other industries. Australia’s
export base is extremely narrow as it is heavily reliant on a small number of commodities.
Australia’s comparative advantage relies on primary sector goods, such as minerals and
agricultural products, which account for over 66% of Australian export earnings. This means that
Australia’s export revenue is highly exposed to the volatile markets of commodities, as
demonstrated by the large fluctuations in the BOGS from year to year. While the boom in
commodity prices and global demand has greatly benefited Australia’s trade during the first
quarter of the 21st century, as represented by consistent BOGs surplus since 2016-17, Australia
will not be able to rely on carbon-intensive exports such as coal and gas as economies
accelerate their shift away from fossil fuels. This high dependence on commodity exports leaves
Australia’s BOGS, and in turn, current account, extremely vulnerable to any global shift in
demand for commodities.
On the other side of Australia’s BOGS, Australia is heavily reliant on imports of value-added
products such as consumer and capital goods due to a lack of competitiveness in
manufacturing. As a result, BOGS has tended to be in deficit as import payments very often
outstrip export revenues, leading to more debits. Overall, the structural elements of Australia’s
BOGS have one of the largest impacts on the current account as the narrow export base and
lack of competitiveness in industries outside of commodities make the BOGS vulnerable to
movements of global demand and import prices.
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I do not know what else to write about international competitiveness
The three main factors that drive Australia’s net servicing costs for its foreign liabilities are
domestic economic growth, the exchange rate and interest rates, which have a large impact on
Australia’s current account size and composition. In Australia, almost 40% of the Australian
public share market is foreign-owned, and as such, when company profits rise during economic
growth, a large proportion of dividends flow out of Australia as payments to foreign
shareholders. This means that higher domestic growth and profits tend to increase the cost of
servicing equity investments. Furthermore, as most of Australia’ mining sector is owned by
foreign firms, a high level of profits in the mining sector result in significant dividend outflow from
Australia. This has a major influence on the size of the current account as growth that leads to
credits in the other areas of the current account has significant debits in the form of servicing
costs. An appreciation of the Australian dollar decreases the AUD value of debt denominated in
foreign currencies, meaning debt servicing costs are decreased in Australian dollar terms. This
is known as the valuation effect, and the opposite is also true for a depreciation of the Australian
dollar. However, the valuation effect on the net primary income is limited as a majority of
Australia’s foreign debt is denominated in Australian dollars, meaning it is not affected by
exchange rate movements. When interest rates change, the cost of servicing foreign debt also
changes. The decline in Australian and global interest rates to low levels in recent years
reduced the cost of debt servicing considerably to onl $17 billion in 2021-22. Low interest rates
have contributed to the narrowing of the net primary income deficit over this period. However,
rising domestic and global interest rates are expected to drive an increase in the NPY deficit in
the medium. The cyclical factors of the NPY component of the current account have one of the
largest impacts on the composition of the current account as they determine the servicing costs
of Australia’s high level of foreign liabilities.
The current account and its size is impacted to a great extent by the net primary income
component as the NPY deficit is a large impact on the current account. Australia has historically
had a net primary income deficit. This is due to the underlying structural feature of a gap
between savings and investment. Australia is a small economy with a low level of national
savings (6.9% in 2022), which requires a high level of capital investment for economic growth.
Australia’s major export industries of mineral and resources, making up 10% of domestic GDP,
requires substantial investment in capital goods and transport infrastructure. Australia tends to
fund a large part of its investment through overseas borrowing or selling ownership stakes in
Australian businesses. This greatly increased Australia’s foreign liabilities and created future
servicing obligations in the form of interest repayments and dividends. These servicing costs are
recorded as debits on the net primary account and are the major reason why the current
account has historically remained in a deficit even with sustained trade surpluses in the 2010s.
On the other side of income, a majority of Australia’s investment overseas is led by Australia’s
volume of superannuation funds, resulting in credits on the NPY balance. The trend toward a
lower NPY deficit in the 2010s were the increased returns on overseas equity held by
Australians and lower rates of interest, increasing credits on the current account. The savings
investment gap is a key structural factor that has largely contributed to Australia’s historical
current account deficit as the costs of servicing these investments leads to an income deficit on
the current account as capital flows into Australia are much greater than investment flows into
other nations.
Australia’s current account balance, composition and size is determined by many factors of
varying importance. The cyclical nature of the BOP means that cyclical factors on both the
BOGS and NPY have the largest impact on the current account balance. In particular, global
demand dictated by various cyclical factors for Australian exports on the BOGS has the largest
impact on the current account, greatly dictating the balance and size. Furthermore, the level of
servicing costs is also largely dictated by cyclical movements, having a large impact on the
balance of the current account. The structural components of a narrow export base, the savings
investment gap and international competitiveness increase the current account’s susceptibility to
cyclical fluctuations, as well as have a large impact on the composition of Australia’s current
account.
Option 3: Explain how movements in the Australian dollar can affect the performance of the
Australian economy.