HSC ECONOMICS
Topic 1: Global Economy
International Economic integration
Topics to cover:
1.
2.
3.
4.
The Global Economy
Gross World Product
Globalisation
International & Regional Business Cycle
1. The Global Economy
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The level of economic activities and conditions of one economy will have a ripple effect of
many other economies. E.g. Foreign trade, economic impact of COVID
The amount of Trade between different nations have increased dramatically in the last few
decades, especially with the help of technology (e.g. trading online)
Economies have a stronger link ( or integrated) than ever before
Globalisation: Integration between different economies and the increase of impact of
international influences on all aspects of life and economic activity
Major indicators of globalisation or integration between different economies can include
International trade
International financial flows
International investment flows and transitional corporations
Technology, transport and communications
Movement of people
The Global Economy can be classified as:
● Advanced (Develop) Economy: with high level of economic development (GPD per capita
>USD $30K p.a), a market system with limited government intervention. E.g. Australia, US,
UK, France. The growth rate is a lot slower.
● Emerging Economy: Economies with lower GDP per capita and living standards, but they
are experiencing rapid economic growth and development. E.g. BRICS, UAE
● Developing Economy: very low GDP per capita and living standards with limited economic
growth and development. E.g. Nigeria, Ethiopia. Mainly middle east and Africa.
2. Gross World Product
Gross World Product (GWP) is the total monetary value of the output of good and services that all
the economies of the world has produced a given period of time
This has grown substantially since the end of WW2 with contractions during economic downturn.
(E.g. The GFC, COVID)
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3. Globalisation
Globalisation: increased level of economic integration between different countries. It is movement
of people technology, information and financial resources between different economies. i.e. trade.
As economies cannot produce all the goods and services that they need or cannot produce efficiently,
foreign trade is the solution.
Government have encouraged free trade that is removing barriers and joining international trade
groups to increase global trade. E.g. World Trade Organisation (WTO), Australia Pacific Economic
Cooperation (APEC)
There is a trend that trade and GDP growth is rising faster in China and Asians countries than
developed economies.
Characterisation of Globalisation:
● Financial deregulations, increases capital and financial flows, foreign exchange, direct
portfolio investment
● Increases business trade, especially via E-commerce
● Information and technology has led to new types of goods and services produced
● Emerging economies in Asia Pacific region and improved economic development
● Independence of other economies and rapid transmission of financial impact of other
economies. E.g. GFC, COVID
Financial flows:
● Due to deregulations of global financial markets (e.g. floating currency, able to invest in other
countries) and technology, international flows have increase substantially.
● Global financial flows allows investors to access finance and funds for higher level of
investment
● Foreign exchange (FOREX) market (exchange from one country to another) have
experienced extraordinary growth with average daily turnover of USD $6.7 trillion
● Speculators (investors who trade financial instruments of making short term profit) are the
main drivers of global financial flows. However, this has increased the level of volatility.
Foreign Direct Investment (FDI):
● FDI is long term investment to either establish a new company or buying a substantial
portion of shares in an existing company (>10%) of another country. Foreign Portfolio
Investment (FPI) is buying shares (<10%) of another company, short term.
● FDI often favours developed economies and has increased substantially due to economic
reforms and deregulations. It is also strongly affected by the level of economic activity
● Emerging economies (BRICS) have increased the level of FDI substantially since the
1990s, but due to lower commodity prices, global uncertainty & CCOVID, there is a short
term decline.
Transnational corporations:
● TNCs are global companies that operate in more than 2 countries
● They have different operation in different countries to source their inputs, manufacture the
goods, assemble their production line and even package their product. E.g. Apple, Toyota,
Nike. There are > 1m TNCs in the globe.
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Benefits of TNCs
- increase foreign investment
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-New technologies and skills being introduced
-Increase employment opportunities
Governments will often provided subsidies or tax concession to encourage TNCs to set up in
their countries.
Technology transport and communication plays a significant part in globalisation:
● Freight technology have increased trade. E.g. shipping containers, cargo tracking
● High speed technology allows communication and money flows around the globe which
enhances efficiency
● Smartphone have changed retail, transport, leisure, banking and education industry
● High speed transport modes(e.g. airbus, high speed rail) allows greater labour mobility
● Social media has increased connection between people and organisation globally.
Communication and marketing has been introduced to a new platform that is unknown before.
Technology is a key influence of globalisation because it represents a new connection and
integration between different business and countries.
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It enables new technology and innovation, efficiency in the production process, new goods &
services produced (e.g. royalties, uber eats) and can provide training to other countries and businesses.
As technology & innovation is a constant process, businesses or economies that are leaders in this
area can export technology and maintain its leadership over a long period of time. E.g. Google,
Amazon, Oracle
International division of labour and migration:
● People cannot move as swiftly as information, money and products. In some developed
economies, there are strict migration law to prevent people migrate from poor countries.
● The % of migrants leaving from developing to developed countries has increased from 35%
to 50% in the last 20 years.
● As results of migration, some countries have experienced skills shortage. E.g. Australia and
new Zealand
● In advanced countries, low-skilled labour are short in supply because it is difficult to attract
sufficient people locally to do those jobs that require basic skills.
● Factor that motivate people to migrate: better job opportunities (paid), political unrest,
conflicts, civil war, famine, climate.
● Barriers of migration consists of: restrictions, language, cultural factors, incompatible
professional qualifications
● Internal division of labour refers to how the task are allocated to different people around the
globe.
● Some TNCs allows employees to work in different offices around the world which prompts
employees to migrate (working visas) and efficiency can be achieved for the company. (e.g.
IT support, data management)
Problems with migration:
● Workers from developing countries are being exploited (no minimum standards for wages
and working conditions)
● Black market or people smuggling to work in illegal industries (e.g. prostitutions, drug
trafficking)
● Ageing population of developed economies leads to increase in illegal immigrants
● Increase flows of illegal refugees to developed countries (e.g. to Eu, North America)
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4. International and regional business cycle
Business Cycle is the fluctuations in the level of economic growth due to local and/or foreign
factors.
International Business Cycle is the fluctuations in the level of economic activity in the global
economy over a period of time.
Gross Domestic Product (GDP) is the monetary value of the total goods & services that have been
produced in an economy over a period of time.
Economic growth is the increase in the monetary amount of goods and service produced in an
economy of a given time (ie rise in GDP)
Recession: 2 consecutive quarters ( or 6 months) of negative economic growth.
In Australia, we had 29 consecutive years of economic growth. COVID-19 has intervened the
streak.
If the economic activities are improving, it is an expansionary stage or boom
If the economic activities are deteriorating, it is in a contractionary stage or downturn
Impacts of the business cycle
It is the governments responsibilities to smooth the business cycle. Hence, in a period of slow
economic growth or recession. Interventions (e.g. stimulus) are needed.
Scenarios with appropriate Macroeconomic Policies:
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There are several international economic events happened since WW2 which has influenced across
different economies due to the international business cycle. Economic condition of an economy has a
significant influence on other economies. E.g.
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Oil Price shock in the mid 1970s,
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Deregulation of financial markets in the early 1980s,
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Asian Financial Economic Crisis in 1997,
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Dot-Com bubble in 2000
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GFC in 2008
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COVID 2020
On an international basis, there are many factors that can influence International Business Cycle
Factors
Strengthening International
Business Cycle
Weaken International
Business Cycle
Trade Flows
Increase demand of goods &
services of a country will increase
GDP, investment and has a flow
on effect on others. E.g. China.
Decrease in demand of goods
& services can slow down
GDP, investment and growth
of other countries. E.g. GFC.
Investment
Flows
Increase FDI to other developing
countries
Decrease FDI to other
developing countries
Transnational
Corporations
(TNCs)
Increase TNCs offices and
operations around the globe
Fewer TNCs offices and
operations around the globe
Financial Market Higher share price, stronger
(Equity) &
consumer & investment
Confidence
confidence.
Decline share price, lower
consumer & investment
confidence.
Factors
Strengthening International
Business Cycle
Weaken International Business
Cycle
Global
Interest
Rates
Higher interest rates of other
Lower interest rates of other
economies will put pressure on other
economies will put pressure on other
countries to increase their interest rates countries to decrease their interest
rates
Commodity
Prices
High commodity prices can increase
export revenue and hence economic
growth. E.g. Australia’s iron ore
Exchange
Rates
Higher exchange rates will increase
Lower exchange rates will decrease
export revenue in the short term, in the export revenue in the short term, in
Lower commodity prices can decrease
export revenue and hence economic
growth. E.g. Middle East oil exporting
countries
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medium-long term, this will be less
competitive-weaker economic growth.
the medium-long term, this will be
more competitive-stronger economic
growth.
Factors
Strengthening International Business
Cycle
Weaken International Business
Cycle
Structural
Factors
Higher level of innovation, moderate
population growth rates, more educated
and skilful workforce will enhance the
level of competitiveness of the economy
Lack of innovation, illiteracy, more
regulated labour and financial
market will decrease the level of
competitiveness of the economy
Regional
Factors
Stronger ties and relationship with certain
regions or countries may improve the
economic conditions with that region. E.g.
Australia with China in the mid 2000s.
Weaker ties and relationship with
certain regions or countries can
have a negative impact on
economic growth.
2 External Shocks that can be transmitted from the global to local economy:
1. Real Shock: changes in real variables like world output, commodity prices etc. These can
impact on economic growth, unemployment and inflation. E.g. oil crises led to recession, high
unemployment and high inflation
2. Financial Shock: changes in financial variables like share prices, interest rates. These can
be transmitted at a faster rate. E.g. GFC.
These shocks can be positive (beneficial to the economy) or negative (detrimental to the economy).
Trade in the Global Economy
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Topics to cover:
1. Advantages & Disadvantages of Free Trade
2. Reasons for Protection
3. Methods of Protection
4. Trade Agreements
5. International Organisation
6. Government Economic Forum
1. Advantages and disadvantages of free trade
Free Trade is when governments impose no barriers to trade with foreign countries which promotes
free exchange of goods and services.
The main reason to support Free Trade is due to Comparative
Comparative Advantage is when nations should specialise in the production of goods & services
that are the most efficient and hence, with minimum opportunity cost.
If the opportunity cost (amount to give up in order to produce something) is lower for a particular
country, then that country has the comparative advantage.
Absolute Advantage is able to produce more output than another country with the same level of
input.
Advantages for Trade
Disadvantages for Trade
Able to access greater range of products that they
cannot produce, increase quantity & quality of
goods & services which can improve living
standards
Increase in local unemployment as some
industries cannot compete, i.e. structural
unemployment.
Specialise production that are the most efficientbetter allocation of resources
Competitors from developing countries
and newly infant firms/industries are not
protected from larger foreign competitors
Achieving Economies of Scale-lower average
cost of production
Dumping from TNCs (deliberately selling
it at a very low price) can damage
domestic industries, i.e. unfair price
cutting.
Improve international competitiveness
Encourage unethical and environmentally
irresponsible production methods. E.g.
pollution.
Encourages innovation, spread of new technology
and living standards (improve access to goods &
services, more consumer choices and cheaper)
2. Reasons for protection
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Protection refers to government policies which gives domestic producers a favourable advantage
compare to foreign competitors. E.g. tariffs, subsidies, quotas.
Reasons for Trade Protection includes:
1. Infant Industries: New industries and firms often start out with higher costs with intense
foreign competition. This type of assistance should only be temporary such that it should
stop once the ‘infant industries’ has achieved some comparative advantage and economies of
scales. Otherwise, they might be too reliant upon it and lack innovation.
2. Dumping: exporting goods to a country to sell at a deliberate lower price (lower than cost of
production). Businesses practice dumping to dispose large amount of excessive inventory
and/or increase market share in another country. This can force domestic firms out of
business, leading to higher unemployment.
3. Domestic Employment: with cheaper imports, domestic producers are being protected such
that they can compete with foreign competitions which can maintain local employment.
This is essential if during a recession. However, other countries can retaliate.
4. Defence: countries want to retain control in their defence industries such that if there is a
war, they can defend themselves. E.g. defence equipment.
5. Ethical & Environmental factors: governments should discourage firms that are ethically &
environmentally irresponsible (e.g. child labour, pollutants).
3. Methods of protection
There are 5 methods of Protection:
A. Tariffs
B. Subsidies
C. Quotas
D. Local Content Rules
E. Export Incentives
A. Tariffs
Tariffs are taxes on imported goods to protect domestic industries. Often, this is by customs duty.
Foreign competition has to charge a higher selling price such that local producers can compete.
Effects of Tariffs include:
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Local producers can raise prices and compete with imports, hence, stimulate domestic
production & employment
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Reallocate resources to protected firms and industries which are less efficient.
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Consumers have to pay a higher price and receive fewer goods, i.e. inflation.
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Raises Tax Revenue for the government
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Retaliation effect can occur by other countries
Before Tariff, the price is at P1. Hence, Quantity Supply is at Q1, Quantity Demand is at Q4.
The price is now shifted to P2, hence Tariff is P2-P1. Quantity Supply has extended to Q2, Quantity
Demand has contracted to Q3.
Quantity to import with tariff is (Q2Q3) at price P2.
Tariff charged by the government is:
Quantity import * tariff rate = Q2Q3 * (P2-P1)
B. Subsidies
Subsidies are cash payments by the government to local businesses to encourage production.
Domestic businesses can then afford to lower than selling price to compete.
Effects of Subsidies include:
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Local producers can supply a greater quantity, hence, stimulate domestic production &
employment
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Reallocate resources from other sections of the economy to protect firms and industries that
are less efficient.
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Consumers pay a lower price and receive more goods.
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Increase Government Expenditure, less resources to allocate to other areas and increase tax
burden.
Before Subsidy, the price is at 30. Hence, Quantity Supply & Demand is at 100.
With a subsidy of $14 (30-16), Supply has increased from S1 to S2.
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Before reaching the new equilibrium, local firms can charge at $16 at 100 Quantity. To restore
equilibrium, quantity demand has expand to 140.
Hence, Subsidy per unit is the distance of S1S2. Extra quantity produced is the distance of quantity
from the old to the new equilibriums.
Government subsidy amount is $14*140=$1960
C. Quotas
Quotas are restrictions or caps on the amounts or values of goods that can be imported.
The higher the quota, the more it can be imported.
The lower the quota, the less it can be imported.
Effects of Quotas include:
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As domestic producers are protected, this can lead to increase in domestic production &
employment
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Reallocating resources to protect those industries.
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Rise in price and lower quantity demand. This redistribution of income leads to lower
economic growth.
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No revenue can be generated for the government. Except for administration or licenses cost.
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Retaliation effect can occur by other countries
P2 is the price if there is no Quotas. Here, Quantity Demand is Q4, Quantity Supply is Q1. Hence,
have to import Q1Q4.
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When Quotas have been imposed, Domestic Supply has expanded to Q2, but quantity demand has
contracted to Q3 and the price is at P1. Hence, have to import Q2Q3.
Sometimes, there could be a Tariff Quotas.
This is when Quotas are implemented up to a certain quantity and also Tariff is also being charged.
If the import is above a certain quota level, higher tariff rate might apply.
d. Local Content Rules
It is a specification that goods must have a certain % of inputs that are manufactured locally.
Importers must comply with the regulations (including WHS, quality, packaging etc.) before the
goods can be sold to the public.
E.g. in 2016 French Defence Contractor DCNS has a $50b contract that certain parts have to be made
in Australia.
Embargo: complete ban to import/export certain goods for safety and defence reasons. E.g.
firearms, drugs
E. EXPORT INCENTIVES
Export Incentives are assistance given to local producer to encourage them to man their businesses
and increase their market share globally (e.g. Export Market Development Grant) as they can then sell
their goods at a cheaper price.
The overall effects of trade protections:
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Reduce trade with different economies, lower export revenue.
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Lower living standards and global economic growth (every $1 of protection leads to a drop
of 66c in GDP).
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Tariffs can lead to inflations.
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Restrict economies to specialise their production to achieve efficiency and economies of
scale.
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Developing economies will find it much harder to enter into advanced economies.
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4. Trade agreements
Trade Blocs are when a group of economies join together in a formal preferential trading
agreement such that other economies are being excluded.
Free Trade Agreements are formal agreements to remove trade barriers between the economies.
The number of agreements have jumped from 27 in 1980s to 445 in 2017. These can be:
A. Bilateral: between 2 countries.
B. Multilateral: more than 2 countries
C. Global: World Trade Organisations.
A. Bilateral:
Between 2 countries. E.g. Closer Economic Relations Trade Agreement (CERTA) with New
Zealand from 1983. Contributed to 8% of growth in trade.
Often negotiation for Bilateral Agreements are much more efficient and faster than Multilateral
Agreements.
Other E.g.:
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China Australia Free Trade Agreement (CHAFTA)
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Singapore Australia Free Trade Agreement (SAFTA)
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Japan Australia Economic Partnership Agreement (JAEPA)
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Thailand Australia Free Trade Agreement (TAFTA)
B. Multilateral:
Multilateral are often within a specific geographical location. E.g.:
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Asia Pacific Economic Cooperation (APEC): 21 countries including Aus, NZ, USA, Japan,
China, Thailand, Chile, South Korea). Tariffs in this region has dropped from 17% in 1990s
to 5.6%in 2015.
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European Union (EU) with 27 nations in the Europe (but UK has exited).
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North American Free Trade Agreement (NAFTA): US, Canada & Mexico.
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Association of South East Asian Nations (ASEAN): Emerging & developing countries in
South East Asia. 10 countries only.
5. International organisations
A. World Trade Organisation (WTO)
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B. International Monetary Fund (IMF)
C. World Bank
D. United Nations (UN)
E. Organisation for Economic Cooperation & Development (OECD)
A. World Trade Organisation (WTO)
WTO replaced General Agreements on Tariff & Trade (GATT-1947) in 1995. It aims to:
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Promote non-discrimination in trade such that concessions granted to a country must be
extended to all.
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Eliminate all tariff & non-tariff trade barriers by multilateral negotiations or trade rounds.
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Discuss & solve trade disputes to ensure stability in trading relations.
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Promote transparency of trade agreements such that they are open to scrutiny &
discussions.
In 2001, Doha Round
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Further reductions on agricultural products (from the Uruguay Round 1986). E.g. subsidies
had been cut by 30%.
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More trade concessions given to developing countries
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Allow environmental & labour standards on trade related activities.
Although WTO is effective with smaller countries, but with US & the EU, WTO is not effective as
they refuse to comply with WTO decisions. Especially Donald Trump.
Timeline for WTO: http://www.timelinesdb.com/listevents.php?subjid=427&dayinhist=0&date1=99999999999&date2=99999999999&words=&title=WTO&fromrec=0
B. International Monetary Fund (IMF)
IMF’s has a pool of central bank reserves available to use.
Its main responsibilities include:
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Promote international monetary cooperation & financial stability
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Facilitate the expansion of international trade
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Ensure stability in exchange rate
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Support multilateral payment system
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Providing assistance to countries who have problems in debt repayments.
During periods of recessions & economic crisis, it develops rescue packages to help economies to
overcome. E.g. it injected USD $250b during GFC, suspended interest payments on some loans,
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helped negotiation to avoid Greece from default, lent funds to Thailand, Korea & Indonesia during the
1997 Asian Financial Crisis.
IMF also supports reducing the size of governments, privatising government enterprises &
deregulate financial markets.
C. World Bank
The main aim of The World Bank is to help developing countries with their economic development
by funding infrastructure, foreign aid, education, health and reducing poverty.
It is funded by member countries from its borrowings in the global financial market. Then, lend it to
developing economies at a lower rate.
Its goal is to:
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Reduce the extreme poverty rate to <3% of the world’s population.
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Reduce income inequality for the world’s bottom 40% of population.
Other organisations with The World Bank:
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International Bank for Reconstruction & Development (IBRD) provides loans &
development assistance or foreign aid.
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International Development Association (IDA) provides little or interest free loan to
developing countries.
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International Finance Corporation (IFC) encourages private investment projects.
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Multilateral Insurance Guarantee Agency (MIGA) provides risk insurance to private
investors with guarantees to cover economic & political risks.
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International Centre for Settlement of Investment Disputes (ICSID) settles disputes on
governments and businesses.
D. United Nations (UN)
Established in 1945 with more than 193 countries.
It covers a broad range of issues including poverty, human rights, equality, well-being, clean water,
sustainable cities, global economy, environment, international borders etc.
There are 17 Sustainable Development Goals with the UN that it aims to achieve.
E. Organisation for Economic Cooperation & Development (OECD)
OECD has 37 economies committed to democracy & the market economy.
Its ultimate goal is to achieve the highest sustainable economic growth, employment and an
increase in living standards while maintaining financial stability. It conducts and publishes a wide
range of research of various economic policies.
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E.g. in 2008 GFC, it proposes internationally coordinated macroeconomic stimulus.
6. Government economic forum
In terms of influence on Government Economic Forums, it refers to:
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G7: meeting of finance ministers & leaders of the top 7 largest democratic market
economies in the world. US, Japan, Germany, UK, France, Italy & Canada. They discuss
policies to ensure economic sustainability, macroeconomic policies, greenhouse gases,
foreign aid and various security issues (e.g. concerns with China & Russia).
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G8: members are the G7 with Russia, but Russia was expelled in 2014 due to violation of
Ukraine’s sovereignty by invasion. Now replaced by G7.
G20: G8 members plus 12 other advanced, emerging & developing economies.
Its aims are:
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Policy co-ordination to ensure financial stability and sustainable economic growth. E.g.
pledging loans to countries affected by GFC.
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Promote financial regulations that reduce risks and prevent future financial crisis.
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Address environmental issues. E.g. carbon emissions, global warming.
Globalisation and Economic Development
Topics to cover:
1. Differences in Income & Economic Growth
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2.
3.
4.
5.
Differences in Economic Development
Categories of development in the global economy
Causes of inequality in the global economy
Impact of Globalisation
1. Differences in Income and economic Growth
● Economic growth is the increase of GDP, i.e. increase in productive capacity
of an economy. This can increase the level of income, employment and living
standards.
● Purchasing Power Parity (PPP) is a more accurate measurement such that
exchange rates have been adjusted so that the price is more equalised to
compare identical goods and services across the globe.
● PPP will shift to the right if there is economic growth.
● Gross national Income (GNI) is the sum of an economy’s GDP and income receipts
from foreign source.
● GNI is to measure the general level of income in an economy.
● GNI per capita (divided by the total population of the country) is a more accurate
measurement of the living standards.
● Those living in high income regions (1 in 7 people) earn 5 times more than lowmiddle income countries.
● People living in Europe, North America, Japan, Australia & New Zealand are better
off with higher level of income and wealth.
2. Difference in economic development
● Economic Development is a broad measure of welfare and living standards in a
country which includes the indicators of health, education and environmental
quality (more than just income).
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● It refers to the level of living standards & quality of life in the society.
● E.g. constructions of roads, hospitals, schools, dams, power plants.
● Economic Development can be in the form of social structural change: economic
transformation from rural based agricultural society to an industrial and service based
urban society.
● Globalisation can also enhance economic development due to increase in foreign
investment, transfer of technology and management skills.
● The huge gap of rich & poor leads to the problem in the following area:
o Still more than 760m people living in extreme poverty (<$USD 1.90/day).
Half of these live in the Sub-Saharan African countries.
o 2.4b people don’t have access to basic sanitation & 1.1b people don’t have
electricity
o 11m children died before 5 years old each year (majority in Sub-Saharan
African or Southern Asia countries)
o There are 66m refugees in the world to seek protection due to conflicts of
persecution.
● Although there is a huge gap of rich & poor, but there are improvements.
● Examples of improvement in Economic Development:
o % of people living in extreme poverty has declined from 44% in the 1980s to
9.2% in 2020.
o Although extreme poverty has declined, but this is uneven. Majority of the
reduction are from East Asia.
o Under-5 mortality rate has halved since 1990s.
o Global primary school enrolment rate increased from 80-92% since 1990s.
o Life expectancy in poor countries has increased from 49 to 64 from 1980s.
Human Development Index (HDI) is a measure of Economic Development by the United
Nations Development Program (UNDP). It is a score between 0-1.This measure includes the
following factors:
● Life Expectancy at birth: an indication on health & nutrition standards.
● Levels of Educational Attainment (literacy): adults < 25 years old that have
attended school and the expected years of school attendance for children. This is an
indicator of the level of skills in the workforce which is critical for the country’s
future development.
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● GNI per capita: general level of income of its population on a PPP basis.
Often Australia, Canada, New Zealand & Northern Europe (Scandinavia Countries) have the
highest rating (0.95), i.e. Developed or advanced countries.
Central Africa Republic & Niger have the lowest rating (0.35), i.e. Developing countries.
The UN has developed 17 Sustainable Development Goals (aim to achieve by 2030) to
tackle poverty and sustainability issues. This includes: ending poverty, ending hunger,
access to clean water, affordable and clean energy, reduce inequality, ensure sustainable
consumption & production.
Link: https://sdgs.un.org/goals
3. Categories of development in the global economy
Economies can be classified as:
● Advanced/Developed Economies: High levels of economic development with high
incomes, mainly specialising in service and advanced manufacturing industries. The
political system tends to be democratic. E.g. Australia, France, Germany. Low
population growth, low death rates, high life expectancy.
● Emerging Economies: countries in the process of industrialisation with high levels of
economic growth and income. They have substantial manufacturing sectors. E.g.
China, Brazil, Indonesia, India.
● Developing Economies: low living standards due to low income levels. Majority of
people live in absolute poverty (< USD $1.90/day), low education, generally
agricultural based economies with heavy reliance on foreign aid. High population
growth, high fertility rates, low life expectancy, falling death rates. People in these
countries have lower literacy rates and high levels of undernourishment.
Although there is increase in global economic integration (globalisation), this benefit very
little to developing countries.
Type of
Economy
Income
Levels
Economic
Growth
Economy
Structure
Population
Growth
E.g.
Advanced/
Developed
High. GNI
per capita
above
Low
Economic
Growth
Service based,
advanced
manufacturing
Low (some have
negative), high life
expectancy
Australia,
Canada,
Japan
18
USD
$13,000
Emerging
Varies, but
fast
income
growth.
Strong
Economic
Growth
Manufacturing
Growth has
slowed, life
expectancy has
risen, mortality has
fallen.
Brazil,
China,
India,
Indonesia
Developing
Low. Half
of the
population
is below
absolute
poverty.
LowModerate
Economic
Growth
Agricultural
based and
need foreign
aid
High (due to high
fertility), but also
high mortality and
low life expectancy
Yemen,
Niger
Reasons for the differences in the level of Economic Development include:
● Low per capita incomes: this reduces the living standards and increases poverty.
This will also reduce the level of savings as people in developing economies spend
the majority of their income on basic necessities.
● Lack of infrastructure and capital formation: preventing improvement of living
standards, leading to inefficient use of labour & capital resources.
● Low levels of technological progress & labour productivity: which leads to
reduction in economic growth (especially in the long run).
● High population growth rate: if this is higher than Economic Growth rate, there
would be more burden on economic development and hence, reduce living standards.
● High foreign debt and debt servicing costs.
4. Cause of inequality in the Global economy
There are Global Factors & Domestic Factors that causes inequality between different
economies.
Global Factors Consists of:
A. Global Trade System
B. Global Financial Architecture
C. Global Aid & Assistance
D. Global Technology Flows
Domestic Factors Consists of:
A. Economic Resources
B. Institutional Factors
Global Factors:
A. Global Trade System
● Developing economies are vulnerable (not competitive) when advanced economies
protect their domestic agricultural industries.
● Trading Blocs (e.g. EU, APEC) can exclude poor economies to gain access to the
global market, making their exports are less competitive.
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● WTO Doha Round: high income countries are reluctant to pass on concessions to
increase the benefits to developing countries.
● Free Trade Agreements (FTAs) tend to benefit advanced economies more than
developing. The administrative costs can also significantly reduce economic growth
for the developing nations.
B. Global Financial Architecture
● Long term investment funds (e.g. FDI) normally favour developed countries.
However, recently, emerging economies have seen significant increase in FDI
inflows.
● Short term financial inflows can favour emerging economies for better quick
returns (e.g. currency and stock market speculations). However, these countries are
more vulnerable to economic shocks and volatility which can reduce the level of
economic development. (e.g. 1997 Asian Economic Crisis).
● Loop holes in the global financial and tax systems means tax haven countries (e.g.
Cayman Islands) have benefited the rich more due to tax avoidance
● Criticism of IMF’s policies favour the rich and not in the best interest of global
equality and interests of developing countries.
● Many developing countries have massive foreign debt burdens, such that they are
spending more to repay the debt and not on infrastructure, education, health or water.
C. Global Aid & Assistance
● The amount of Economic Assistance and Aid pledged by the advanced economies
(0.3 % of GDP in 2016) compared with the promised amount (0.7%) is less than half.
The difference is more than USD $4t.
● There are arguments that foreign aids do not improve the lives of the poor. E.g.
some are paid to consultants, refinancing loans, administration costs. Hence, not a lot
is actually spent on economic development projects.
● Some aid distributions have political agenda and military considerations, not
necessary the actual need of the countries. E.g. aid to Iraq in terms of weapons.
D. Global Technology Flows
● Technology can reduce the gap of living standards. There are still 3.2b people
without access to the internet and 17% of people without access to electricity in the
developing countries. Hence, they have limited opportunities to increase income and
hence living standards.
● Technology tends to benefit more to developed economies as they prioritise science,
education, research and technology. This can improve the development in these
countries (e.g. medicine, literacy skills, ultimately income and life expectancy.)
● Developing countries cannot afford the price of technology as set by advanced
economies.
Domestic Factors:
A. Economic Resources
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● Natural Resources: those countries who have accessed to cheap natural resources
have better opportunities. E.g. Iron-Ore in Australia, Oil in the Middle East. However,
these economies are vulnerable to the price of the commodities.
● Labour Quality: labour supply that are more educated and skilled tend to earn
higher income. E.g. Singapore, Australia.
● Difficulty to access capital & technology is a structural weakness for developing
nations which can lower the living standards. People in those countries do not have
easy access to loans for investments (small businesses) and lower savings. Hence,
limited chances to develop innovations and technologies.
● Culture: those culture with a high sense of individual responsibilities, commitment,
enterprise, wealth creation and strong work ethic will help the industrialisation
process and enhance economic development.
● Inequality: developing countries often have high level of income & wealth
inequalities.
B. Institutional Factors
● Political: political instability, high levels of corruption and lack of transparency will
reduce consumer and investors confidence, hence, reduction in economic growth
and development. As can be seen on the right, developed economies have less
corruptions.
● Economic: Government policies can affect economic growth & development. It is
not ideal to have a perfect market economy (no improvement in public goods), nor to
have a government with excessive government control (no innovations).
● Government responses to Globalisation: countries with policies that encourage trade,
financial flows, investment flows, TNCs etc. have experienced strong economic
growth rates and improvement in living standards. E.g. East Asian Economies.
5. Impact of globalisation
Impacts on Globalisation can include:
A. Economic Growth & Development
B. Trade Investment & Transnational Corporations (TNCs)
C. Income Inequality
D. Environmental Sustainability
E. Financial Markets
F. International Business Cycle
A. Economic Growth & Development
● Globalisation has encouraged trade with other countries which contributes to
economic growth for the past few decades.
● Emerging Economies benefit the most (especially China & India). Their annual
growth rate > 6% p.a. since the 1990s.
● Developing Economies (Sub-Sahara African Countries) have also recorded some
growth with some countries > 4% p.a. since the 1990s. However, this rate is
insufficient to catch up to developed economies.
● Advanced Economies grew by just 1.9% p.a. since the 1990s
● In terms of Economic Development, as globalisation stimulates economic growth, the
general level of income will increase. This means more resources for education,
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healthcare, infrastructure and hence quality of life which improves the living
standards.
B. Trade Investment & Transnational Corporations (TNCs)
● TNCs are increasingly dominating business activity with over 110,000 TNCs across
the globe employing > 80m people.
● TNCs allow goods can be produced in different stages in different countries which
encourages efficiency and minimise costs. E.g Intellectual design in US, assembly
line in China, packaging in Japan etc.
● Globalisation has also increased the volume of foreign investment (FDI) such that
there is greater access of overseas funds for investment
● An increase trend of more trade in ETM (Elaborate Transformed Manufactures)machinery & technological parts, intellectual property and financial resources.
● Disadvantages can include: TNCs can manipulate laws & regulations in
developing economies where the laws on minimum wage and environmental
protections are weak. Workers & the environment can be exploited.
C. Income Inequality
● Due to globalisation and trade, incomes for households in developing countries have
increased thus improving their living standards. This is especially for primary and
secondary industry. However, employees in these industries in the advanced
economies have seen a decrease in wages because they are not as competitive.
● Globalisation has seen an increase in FDI and financial flows which favours
employment opportunities in industries with higher skill & technology related.
● Highly skilled workers in emerging economies will migrate to advanced economies
for higher paying jobs and better living standards. However, income for other
workers will grow at a slower pace.
● Global Gini Coefficient (measurement of income inequality) has seen a decrease
from 68.7% in mid 2000s to 64.9% in the mid 2010s. Global median income has
also doubled in the same time. There is an improvement in inequality especially in
South East Asia region (especially China).
D. Environmental Sustainability
● Although Economic Growth can be generated due to globalisation, it can also bring
negative environmental consequences. E.g. deforestation (for paper & wood, land
clearing), unsustainable fishing practices, pollutions, increase in carbon emission.
● These environmental problems can lead to climate change which can affect the
natural environment and weather. This can cause greater damage in the long run.
● Agreements to tackle environmental sustainability include: Kyoto Protocol, Paris
Agreement (to confine global rise in temperature to less than 2 degrees).
● Globalisation can stimulate innovation & technology which can improve energy
efficiency, reduce pollution environmental damage, green energy etc.
E. Financial Markets
● With the deregulations of the Australian financial system (1983) which includes
floating of the AUD, Australia can access more funds from overseas and able to
attract more foreign investors as a result of globalisation. A deregulated financial
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market enhances efficiency of financial flows with greater transparency which leads
to higher economic growth.
● The main disadvantage of globalisation on the financial markets is economic shocks
are contagious and can lead to recessions. E.g. GFC, Asian Financial Crisis, COVID.
F. International Business Cycle
● Different stages of international business cycles will affect the level of economic
growth and development.
● Countries with higher level of trade and integration with other economies will
experience faster economic growth (especially if the world is growing rapidly).
● However, they are also more vulnerable if there is a world downturn. E.g. Covid,
GFC.
● Changes in a country’s business cycle can be transmitted to other economies.
Topic Two: Australia In the Global Economy
Balance of Payment
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Balance of Payment
International trade flows refer to the exchange of goods and services with different
countries. This includes:
• Trade in more than 1 currency
• Special set of risks (e.g. fluctuation of currency movements and commodity prices,
interest rates, market demand)
• Dominate by Multinational Corporations (MNC)
• Affected by change in world demand, technology and international business cycle.
Due to the deregulation of the financial market in 1983 and increase in free trade and
globalisation, foreign trades have increased exponentially.
Australia’s exports has risen from 12% of GDP in the1980s to more than 20% in 2017. This
includes: transportation, tourism, education, communications, finance.
Global demand of exports are affected by the international business cycle.
Balance of Payment-Export
Australia has sophisticated service industries with a skilful labour force. E.g. Education
services, tourism, financial services
In the past year due to COVID, services export has dropped by more than 30% to $62b.
The main type of exports are services
Balance of payments- imports
Australia’s main imports include: food, clothing, cars, electronic goods, chemicals etc.
Before the pandemic, Australia’s had 29 consecutive year’s of economic growth, the demand
of imports had increased, and hence there is often a net deficit in the goods and services.
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However, due to the pandemic, Australia’s imports have declined significantly, leading to
trade surplus.
As of 2021, Australia’s total imports are $368b with majority are intermediate goods &
consumer goods.
Balance of payment- trading partners
Our main trading partner is/was China and other Asian countries.
Ever since the mid 1960s, the direction of trade has shifted from European countries to Asian
countries.
More than 70% of exports are to Asian countries with China came first accounting of nearly
40% of our exports.
For imports, China accounts for around 25%, while European Union is around 19% with
other ASEAN countries 17%.
Balance of payment- investment and financial flows
Foreign Investment in Australia refers to foreign liabilities (debt & equity borrowings)
owed by Australian residents to overseas. This is mainly from US, Britain, China, Hong
Kong. It can be:
• Direct Investment: a investor holds > 10% of shares in a company and have a direct
influence on the company.
• Portfolio Investment: investment in equity securities (e.g. shares, options). Other
foreign investment: trade credits, loans, currency
• Financial derivatives: currency swaps, options.
• Due to the deregulation of the Australia Financial Market, Financial Flow has grown
substantially.
• Overseas Foreign Investment in Australia is now 10 times than it was in the 90s,
and Australia Foreign Investment overseas is now 20 times than it was in the 90s.
• Overseas Portfolio Investment in Australia is now 15 times than it was in the 90s,
and Australia Portfolio Investment overseas is now 65 times than it was in the 90s.
• The amount of foreign direct and portfolio investment have increased significantly as
foreign investors believe Australia is a place for higher return.
Advantages for foreign investment:
• Better access on technology
• Management skills
• Increase employment
• Better access to export market
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•
Increase in economic growth
Disadvantages for foreign investment:
• Loss of ownership and control of resources
• Increase debt servicing cost
• Increase impact of the volatility of exchange rate on portfolio investment.
Balance of payments- formula
BOP= Current Account + Capital Account + Net Errors (minimal)=0
Balance of Payment is the summary of all transactions between Australia & the globe of a
given period of time consisting of Current Account & Capital and Financial Account.
Balance of Current Account
• Goods+ Services + Primary Income + Secondary Income (or Transfers)
• It is the total receipts and payments for trade in goods & services, transfer payments
and income flows between Australia & the globe.
• If deficit, it is Current Account Deficit (CAD)
Balance of Capital Account
Capital Account + Financial Account
Due to the Pandemic, the past 2 years, Australia has a Current Account Surplus (whereas
normally, we have Current Account deficit)
Balance of payment- current account
4 Components:
1. Goods
2. Services
3. Primary Income
4. Secondary Income (or Transfers)
1. Goods:
• Net exports of tangible goods
• Payments for exports revenue (X) are called credits (or receipts).
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• Payments for imports expense (M) are called debits (or expenditures).
• X > M = Surplus
• X < M = Deficit
2. Services:
• Net exports of intangible goods or services (transport, tourism, education)
• Payments for exports revenue (X) are called credits (or receipts).
• Payments for imports expense (M) are called debits (or expenditures).
• X > M = Surplus
• X < M = Deficit
• Balance of Goods & Services (BOGS) is the net of Goods & Services.
3. Net Primary Income (NPY):
• Earnings or debt servicing cost of investments.
• This is the return from production & investments.
• E.g. interests, dividends and rent.
• Volatility of exchange rate & global interest rates will affect debt serving cost
• Australia tends to have a low saving ratio which increases the NPY deficit.
4. Net Secondary Income (NSY):
• Secondary Income are non-market transfers
• It is not related to factor of production (i.e. no goods or services have been provided).
• E.g. insurance claim, foreign aids.
• It is often very minimal.
Reasons for Large CAD:
• Narrow Export Base: limited Export revenue
• Fluctuating commodity prices
• High debt servicing cost
• Lack of competitiveness in manufacturing industry
• High labour cost
• High inflation
• High AUD (especially around 2011-2012)
Consequences for Large CAD:
1. Increase in foreign liabilities and debt
2. Increase in debt servicing cost (interest payments), ultimately lead to debt trap (high
CAD needs foreign funds to finance the deficit).
3. Restricts future economic growth and standard of living.
4. Increase foreign exchange volatilities
5. Contractionary Macroeconomic Policies
6. Decrease investors’ confidence
Balance of Payment- Capital and financial account
Capital & Financial account consists of borrowing, sales and purchases of assets between
Australia & the globe.
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Capital Account (credits & debits of movements of non-produced and non-financial
assets):
• Capital transfers (conditional foreign aids)
• Debt forgiveness
• Non-financial assets (include intellectual property rights).
Financial Account:
• Direct Investment
• Portfolio Investment
• Derivatives
• Reserves
Balance of payment- formulas
BOP= Current Account + Capital Account + Net Errors (minimal)=0
Balance of Current Account
• Goods+ Services + Primary Income + Secondary Income (or Transfers)
• If deficit, it is Current Account Deficit (CAD)
Balance of Capital Account
Capital Account + Financial Account
Balance of payment- Australia Trends
Traditionally before the COVID:
• Large CAD since 1980s, high CAD % of GDP (now around 3%).
• Deficit in BOGS (Imports > Exports)
• High Debt Servicing cost
• Narrow export base (heavily rely on agricultural goods and certain services)
• Low level of savings (foreign savings are needed to fund Australian expenditure).
Why do you think there is a CAS since the pandemic?
• High fluctuation on commodity prices can affect export revenue. Due to:
• Large number of sellers
• High trade protection
• Change to demand level
• High import demand for Elaborately Transformed Manufactures (ETMs) i.e.
electronic goods.
• Not competitive as costs are too high in:
• Wages
• Infrastructure
• Electricity & Water
• Tax
Australia needs to improve the level of competitiveness in terms of:
● Quality of goods and services
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●
●
●
●
Reliable suppliers
Cost of production
Skilful labour force
Exchange rates
From the graph previously:
• Size of CAD is influenced by the size of BOGS & Net Primary Income
• In 2008-9 & 2010-11, BOGS were in surplus due to strong mining exports. But due to
GFC it was a deficit in 2009-10 (slow down in global demand).
• NPY has caused the major part of CAD from 2007-2015 due to debt servicing costs.
Cyclical cause:
• If Australia economy is growing faster than the global economy, there will be more
import demand than export, hence higher CAD.
• If the global economy is slowing, export income will decrease, causing higher CAD.
Structural cause:
• This is due to NPY deficit causing high debt servicing cost.
• Narrow Export Base
• Lack of Competitiveness in the manufacturing industry
Balance of payment - foreign debt
Foreign Debt is the amount of borrowings from public & private sectors from overseas
residents.
Gross Foreign Debt includes the total liabilities to the globe.
Net Foreign Debt includes gross foreign debt minus assets held by Australians.
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Balance of payment- terms of trade
Terms of Trade (TOT): relative export price to import price
TOT will increase (improvement) if Export prices rise faster than Import prices, or Import
prices fell faster than Export prices.
TOT will decrease (deterioration) if Import prices rise faster than Export prices, or Export
prices fell faster than Import prices. This indicates that more exports are required to fund the
same amount of imports.
Australia tends to have a deterioration of TOT due to heavy reliance on agricultural and
commodities export (narrow export base). These prices fluctuates in the world market.
But due to the resource or mining boom in the mid 2000s, TOT has improved significantly
TOT fluctuates due to:
• The fluctuation of commodities prices
• Demand & Supply factors
• Protection policies of other nations.
Exchange Rates
Exchange Rate
Exchange rate is the rate of one currency which can be exchanged for another. This reflects
on the relative value or purchasing power of the currency.
Currently, AUD $1= USD $0.74
AUD is the 5th most frequently traded currency in the world.
Exchange rate can be quoted as:
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•
Indirect Method: number of foreign currency need to purchase one domestic
currency. E.g. AUD $1= USD $0.67
• Direct method: number of domestic currency need to purchase one foreign currency.
E.g. AUD $1.49= USD $1
https://www.xe.com/currencyconverter/
Exchange rate movement:
• Appreciation: there is a rise in the value or purchasing power of AUD, i.e. each
AUD can buy more of the other currency. E.g AUD $1= USD $0.67 to AUD $1=
USD $0.76.
• Depreciation: there is a drop in the value or purchasing power of AUD, i.e. each
AUD can buy less of the other currency. E.g AUD $1= USD $0.67 to AUD $1= USD
$0.56.
TWI
Trade Weighted Index (TWI) measures the movement of AUD against a basket of
currencies of Australia’s major trading partners. This is weighted according to the
importance of Australia’s trade in terms of volume.
It moves in line with the fluctuation of Australia’s commodity prices.
Recent trends
In 2009-2011, AUD has appreciated. This is due to:
• Rise of world commodity prices (due to high demand of Australia’s export)
• Higher TOT of commodity export
• Sustained direct & portfolio investment as foreign investors believe Australia is a
better place to invest.
In 2013-2016, AUD has depreciated. This is due to:
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•
•
•
Slow down of global economic growth (including China) which has reduced the
price of commodity
End of mining boom
Reduction of interest rates (as the return of investment is lowered)
Due to the pandemic from 2020, the value of AUD has depreciated initially but then
gradually appreciated due to the strong demand of iron ore.
Type of exchange rates
There are 3 different types of Exchange Rates:
1. Floating/Flexible
2. Fixed
3. Managed
1. Floating exchange rate
Floating or Flexible exchange rate is purely determined by the forces of supply & demand
at the equilibrium point. It can be an automatic stabiliser to protect the economy from
external booms & busts.
On Dec 1983 (before Mr Chow was born), the AUD is floated for 3 main reasons:
1. Efficiency of exchange rate to determine the value of AUD
2. Increase international competitiveness
3. Independent & effective monetary policy
Advantages of Floating Exchange Rate:
• Price is determined by the market which reflects on the status of the economy
including economic growth, unemployment, balance of payment & inflation
• Discourage destabilising speculation
• Independent & effective monetary policy as BOP would not affect money supply
• Consistent with other trading partners (especially developed economies) which will
allow for greater capital market integration and financial flow.
Disadvantages of Floating Exchange Rate:
• Increase volatility which can affect exporters & importers
• Increase foreign speculations on reaction to short term economic & political events.
• Deviate from long run equilibrium path (over appreciate/depreciate)
2. Fixed exchange rate
Fixed exchange rate is set by the central bank by buying or selling foreign currency.
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Advantages of Fixed Exchange Rate:
● Certainty of short term value of the exchange rate.
● Exporters & importers are not subjected to volatile movements such that the cost of
production will not be affected.
Disadvantages of Fixed Exchange Rate:
● Encourage speculation if it is believed to be under/over valued.
● RBA needs to hold large amount of foreign exchange reserves
● It does not react to external structural changes as it cannot respond directly to changes
in the market.
3. Managed Exchange Rate
Managed Flexible Peg: exchange rate means there is central bank intervention to smooth
out the fluctuations in a floating exchange rate system (or dirtying the float). This can
reduce volatility of the currency.
This is neither the extreme of floating nor fixed.
Intervention is due to:
• Exchange is deviated from the long term equilibrium
• Excessive speculation leading to greater volatility.
• Prevent excessive depreciation/appreciation of the currency.
Demand and supply
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The Demand of AUD is represented by those who want to buy AUD. This is affected by:
1. Demand of exports
2. Demand of investment & financial flows
3. Strong Global Economic conditions
4. Increase competitiveness of Australian goods & services
5. Speculation of appreciation in AUD
6. Higher Interest Rate
The Supply of AUD is represented by those who want to sell AUD. This is affected by:
1. Demand of imports
2. Lower Investment opportunities in Australia (or more in overseas)
3. Financial outflows
4. Slow global Economic conditions
5. Reduce Competitiveness of Australian goods & services
6. Speculation of depreciation in AUD
7. Lower Interest Rate
With the use of supply & demand diagram, explain the effect of AUD:
● If there is an increase in demand of AUD
● If there is a decrease in demand of AUD
● If there is an increase in supply of AUD
● If there is a decrease in supply of AUD
Increase in Demand of AUD: Shift of the Demand Curve to the right, causing the
equilibrium price & quantity to rise.
Decrease in Demand of AUD: Shift of the Demand Curve to the left, causing the
equilibrium price & quantity to fall.
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Increase in Supply of AUD: Shift of the Supply Curve to the right, causing the equilibrium
price to fall and the quantity to rise.
Decrease in Supply of AUD: Shift of the Supply Curve to the left, causing the equilibrium
price to rise and the quantity to fall.
Causes
Causes of Appreciation:
• Increase in Australia interest rates
• Improved investment opportunities in Australia
• Improvement in Australia’s competitiveness
• Rise in commodity prices
• Lower Inflation
• Increase demand of exports or decrease demand for imports
• Expecting the domestic currency to appreciate
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Causes of Depreciation:
• Decrease in Australia interest rates
• Less investment opportunities in Australia
• Deterioration in Australia’s competitiveness
• Fall in commodity prices
• Higher Inflation
• Decrease demand of exports or increase demand for imports
• Expecting the domestic currency to appreciate
Depreciation of impacts
Positive Impacts of Depreciation:
• Enhance competitiveness of goods & services because they are cheaper. This can
increase export income and reduce import in the long run and hence improve BOP
& economic growth.
• Discourage import spending
• Higher capital inflow as domestic assets are cheaper to invest (foreign direct &
portfolio investment).
Negative Impacts of Depreciation:
• Australian consumers will have lower Purchasing Power and can buy fewer imports.
• Increase interest servicing costs on foreign debt and the size of the foreign debt.
• There could be inflationary pressure as imports are more expensive.
Appreciation of impacts
Positive Impacts of Appreciation:
• Higher export income and low import expense in the short run which can reduce
the size of CAD.
• As import expense is lowered, domestic inflation will be lowered and raise the real
income of consumers which can improve living standards. However, this can reduce
economic growth.
• Reduce the value of net foreign debt (valuation effect)
• Reduce debt servicing cost
Negative Impacts of Appreciation:
• Reduces competitiveness of export and increase import in the long run which can
worsen CAD and economic growth.
• Due to less competitive, this can create unemployment.
• As domestic assets are more expensive, this can lead to higher amount of capital
outflow, decrease foreign direct & portfolio investment which can slow down
economic growth.
• Reduce foreign income earned on Australia’s investment abroad.
J-Curve
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J-Curve:
J-Curve shows that as a currency depreciates, the economy will experience a worsening effect
on CAD in the short run.
But in the long run, due to more competitive, trading balance should improve.
Trade Protection Policy
Trend and History
•
•
•
Historically, Australia has high level of protection leading to inefficiency and
reduction in competitiveness (especially manufacturing industry).
Since the late 1970s, the amount of trade protection have decreased significantly (e.g.
25% cut in tariffs by the Whitlam Government). This is especially since Australia is
part of APEC and many other bilateral and multilateral free trade agreement.
As of Jan 2022, we are part of the Regional Comprehensive Economic Partnership
(RCEP) with South East Asian countries.
Currently, there are <1% of tariffs.
However, make sure you know that tariffs is not the only method of trade protection.
Gains from free trade
Potential Gains & Aims from Free Trade include:
• Increase economies of scale and specialisation in production which can allow firms to
achieve efficiency.
• Increase quality of goods and services which can improve living standards
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•
•
Increase competition which can reduce prices
Provide incentives for firms to innovate with the use of the latest technology.
Types
4 main types of protection (from Topic 1):
1. Tariffs
2. Quotas
3. Subsidies
4. Embargo
Multilateral
Since 1994, Australia is a member of World Trade Organisation (WTO) where promotes and
reinforce free trade.
Multilateral agreements consist of more than 2 nations (usually at a region). E.g. APEC (Asia
Pacific Economic Co-operation) and EU (European Union), Regional Comprehensive
Economic Partnership
Bilateral
Bilateral agreements consist of Australia and one other nation. E.g. ANCERTA (Australia
New Zealand Closer Economic Relations Trade Agreement), CHAFTA (China-Australia
Free Trade Agreement).
Free Trade agreements can enhance the efficiency in the manufacturing industry, increase
free flow of labour and capital resources between countries.
International Competitiveness
Typically: Australia has a narrow export base and lack of competitiveness. Too much
focus on commodities (e.g. iron ore)
This can lead to a worsening TOT and deteriorating CAD. As CAD deteriorates, debt
servicing cost will increase. Interestingly, since the pandemic, we don’t have a CAD.
Implication of removal of protection
● Long-Run benefits of free trade (removal of protection):
● Increased specialization & achieving economies of scale in production to achieve
efficiency.
● Increase quality & quantity of goods available. Hence improve standards of living
● Increase competition can reduce prices for consumers
● Encourages technological innovation to increase competitiveness.
● Increase economic growth due to better allocation of resources (from government to
consumers and efficient firms).
Costs of free trade (removal of protection):
● There might be a short term rise in structural unemployment where people are
unemployed due to skills mismatch. E.g. people from automobile industry (close
down of Holden).
● Increase Government expenditures for unemployment benefits and training costs.
● Decrease in Government Revenue as Tariffs are reduced.
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Structural Change
Structural change refers to long-term changes which affect the pattern and production
structure of the economy. This can be due to:
• Change to consumption patterns
• Improvement in technology (elimination of certain industries or products)
• Exchange rate fluctuation
• New emerging markets with innovations
• Change to demographic
Structural change polices
The Government can implement a wide range of policies for Structural Change (i.e.
Microeconomic Policies which we will look at it later):
• Decrease protection: this can increase competition from imports
• Microeconomic Reforms (MER) like Competition policies. This can stimulate long
term and sustainable economic growth.
• Deregulation & privatisation of government companies (as resources are redistributed
to ensure companies can operate efficiently).
• Tax Reform: increase Government expenditure to encourage Research &
Development.
Topic 3: Economic Issue
Economic Growth
Measures an increase in the volume of goods and services that an economy can produce in a
given period of time.
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This is expressed by the annual rate of change in Gross Domestic Product (GDP).
GDP is the total value of all goods and services produced within an economy in a given
period of time.
If GDP has not been adjusted for inflation, it is called Nominal GDP. If inflation is removed,
then it is called Real GDP.
Economic growth should increase living standards if the productive capacity growth is
faster than population growth. This means a greater material abundance and a more
satisfying resolution of the economic problem.
GDP doesn’t take into account the following:
• Household work
• Volunteer work
• Second hand sales
• Home grown goods & services (e.g. farm produce)
Recession is declared after two successive quarters of negative economic growth.
Economic Growth (%) =
Real GDP (current year)-Real GDP (previous year)
Real GDP (previous year)
Benefits:
• Improve standard of living with a wide variety of goods & services.
• Increase production level and employment.
• Increase real incomes of the population.
• Increase consumption, saving and investment.
• Growth in tax revenue which can be used to fund infrastructure & public goods and
services.
Costs:
•
•
•
•
•
•
Cost push inflation pressure
Uneven patterns of growth
Widening the gap of rich and poor, inequality income
Short-run structural unemployment
Balance of payment problems and possible foreign debt
Environmental problems
40
Formulae:
Leakages= (S + T + M) Injection= (I + G + X)
Aggregate Demand (AD) = C + I + G + (X-M)
Aggregate Supply (Y) = C + S +T
Marginal Propensity to Consume (MPC) + Marginal Propensity to Save (MPS)=1
Average Propensity to Consume (APC) is the proportion of total income that is consumed.
Average Propensity to Save (APS) is the proportion of total income that is saved.
Marginal Propensity to Consume (MPC) is the proportion of each extra dollar of income
that is consumed.
Marginal Propensity to Save (MPS) is the proportion of each extra dollar of income that is
saved.
41
Multiplier effect (k)
Multiplier (k) = 1 / (1-MPC) = 1 / MPS
Change income = k * Change in Aggregate Demand. ΔY=k* ΔAD
E.g. on Multiplier:
National Income increase by $100,000
If MPC=0.8 (i.e. spend $80,000), then MPS=0.2 (i.e. save $20,000)
The $80,000 spent will become income to someone else who provides the goods & services
This $80,000, $64,000 will be spent (MPC is still 0.8)….. This process will continue.
K=1/(1-0.8)=5. This means there is a 5 times initial increase.
The total increase in income is 5*100K=500K
•
•
•
When there is a shock to the economy, there will be a change in injections or leakages
Eg, lower interest rates will increase investment and spending (demand). This leads to
increased incomes and more spending.
Therefore there is a multiplied effect on the economy
•
•
However, this does not go on forever
Each time the money goes around the economy a portion of it is saved.
Change in MPC
Change in MPS
Change in K Multiplier
Increase
Decrease
Increase
Decrease
Increase
Decrease
Components of Aggregate Demand (AD)
John Keynes developed the famous economy theory that the most significant factor to
stimulate Economic Growth is the level of Consumption (C) expenditure.
If consumers & businesses are pessimistic about the future and reduce consumption &
expenditure, there will be less consumption & investment which will reduce AD.
This concept has shaped economic policies to the industrialised world after WW2.
42
Consumption:
● Consumer expectations: If expecting price to increase, then there will be higher real
incomes, and tend to spend more, save less.
● Interest rates: If interest rates increase, people are discouraged to spend, but to save
instead. If vice versa, then opposite.
● Distribution of income: The more equal this is, the higher the overall rate of
spending as people on low income have to spend a lot on basic needs.
Investment:
• Business expectations, which are influenced by:
• Expected demand-if this increases, businesses will invest more.
• Economic outlook-strong outlook will encourage businesses to increase
investment.
• Inflation-high inflation means higher cost of production which can reduce
investment.
• Investment is influenced by the cost of capital equipment, which is influenced by:
• Interest rates-lower interest rates mean cheaper to borrow, so they can invest
more.
• Government policies-lower tax encourages businesses to invest
• Price or productivity of labour–lower cost will encourages business to
invest.
Government Expenditure (G)-fiscal policy can affect AD. Increase spending will boost
economic growth; whereas reduce government spending will reduce economic growth
Net Exports-Strong AUD means less competitive in the long-run which can detract AD in
the long run. Low AUD means more competitive in the long-run which can increase AD in
the long run
Aggregate Supply
Aggregate supply is the level of total income in an economy at a given time.
Part of the national income is taken by the government (T-tax), the rest is either consumed
(C) or saved (S).
C+S+T=Y (total income). This must also be equal to the total amount of output that was
produced for that level of income – this is aggregate supply
43
An economy can grow faster when aggregate supply is increased.
This is an increase in total output (economic growth) and a reduction in the general price
level (inflation).
Improvement in AS (especially long term structure) will fuel strong sustainable economic
growth.
Aggregate supply can be increased when a higher level of output can be produced for the
same cost (economies of scale). This might be achieved by:
• Population growth (able to produce more goods & services)
• New Resources (increase exports)
• Workers gaining new skills
• New technology
• Improved efficiency (by increase capital investment)
• Government policies addressing skills shortages and regulations
Trends in Economic Growth
Government should maximise growth while maintaining low inflation by using
macroeconomic policies.
Australia has sustained a long period of uninterrupted economic growth from the early 1990s
(nearly 3 decades). Interrupted by COVID.
Australia’s strong economic growth (in the last 2-3 decades) is mainly due to:
• Mining Resource boom
• Strong domestic consumption
• Rapid growth in China-strong demand of export (in the mid 2000s)
• Productivity improvement
• Low Inflation target
• Strong business & consumer confidence
Policies to sustain economic growth
Macroeconomic Policy (aim to influence economic growth in the short term by influencing
aggregate demand, and smooth fluctuations):
• Fiscal Policy (The Budget)
• Monetary Policy (RBA on interest rates)
Microeconomic Policies (investment in workforce skills, infrastructure)
Fiscal policy (the budget)
To increase or stimulate economic growth, Government can increase expenditure and/or
reduce tax income.
Alternatively, to slow down or constrain economic growth, Government can reduce
expenditure and/or increase tax income.
Fiscal policy is more effective to stimulate growth in periods of economic downturn.
44
Monetary policy (RBA interest rates)
To increase or stimulate economic growth, the RBA can lower interest rates which can
encourage consumer and business spending.
Alternatively, to slow down or constrain economic growth, the RBA can increase interest
rates.
If the interest rates are already low, it is difficult for the monetary policy to stimulate
economic growth.
Microeconomic policies
Microeconomic Policies aim to increase sustainable growth rate by increasing aggregate
supply.
Since the early 1990s, the sustainable economic growth is mainly due to strong
microeconomic policies by increase investment in workforce skills, infrastructure and
reforms to increase the level of competitiveness.
45
Unemployment
Achieving full employment is one of the key economic objectives.
Unemployment is when a person who is out of work, actively seeking work and willing and
able to start work immediately.
The current Unemployment Rate is 3.9% from ABS April 2022.
Labour Force includes:
 All people between 15-64 years old who are employed (full time, part time or casual)
for at least one hour a week
 Employers
 Officially classified as unemployed
Those who are not classified as the Labour Force are:
 Those <15 years,
 Those who are >15 but studying full time,
 Out of work but not actively seeking jobs.
Labour Force (LF) = Employed + Unemployed
Participation Rate is the proportion of the labour force population of working age
population.
46
Factors that can affect the size of Labour Force can include:
• The total population size
• The level of net migration
• Age distribution of the population (refer to the Population Pyramid)
• Participation rate of the working age population
Unemployment refers to those who are willing and able to work, actively seeking work but
cannot find work.
Unemployment Rate: is calculated as a % of the total number of unemployed people of the
labour force.
Trends
The overall trend of Australia’s unemployment has decreased from a high of 11% in 1992 to
currently 4%.
The trend of unemployment reflects on the business cycle where it increases when economic
growth slows.
E.g. during the GFC in 2009 (rising from 4.2% to 5.8%). This is explained by increase in
major retrenchments in industries like finance, mining & manufacturing. This is then reduced
to 4.9% in 2011 as economic growth has increased. With the pandemic, it increased to 7.4%
and then dramatically declined.
47
1.
2.
3.
4.
5.
6.
7.
8.
Cyclical
Structural
Frictional
Seasonal
Underemployment
Hidden
Long Term
Regional
Types
1. Cyclical- is caused by slow economic growth. This is also called involuntary
unemployment as people are made redundant. E.g GFC, Pandemic
2. Structural- is caused by mismatch of employees skills and job offer. E.g.
introduction of technology making some jobs obsolete, but new types of jobs have
been created.
3. Frictional- is caused by people switching jobs or moving from education to work.
4. Seasonal- applies to certain industries which are characterised by different times of
the year. E.g. ski instructors, fruit picking, Christmas retailing.
5. Underemployment- is caused by people working part-time or casuals who want to
work longer hours or switching to full time.
6. Hidden is caused by people not in the workforce. E.g. people who gave up looking
for jobs.
7. Long Term refers to people who are unemployed for more than 1 year. This can be
due to lack of skills, education and training to find the suitable jobs. If a person
suffers long term unemployment due to sickness or criminal record, it is called Hard
Core unemployment.
8. Regional refers to major industry in a geographical region reduces its demand for
employees.
48
Causes
Employment & Economic Growth have a positive relationship where periods of strong
growth can lead to more employment (or reduce unemployment). But with inflation, it has a
negative relationship.
Often there is a time lag of 6 months of how changes in economic growth can impact
employment.
1. Major cause of cyclical unemployment is reduction in Aggregate Demand (AD):
C + I + G + (X – M), or slow economic growth.
As economic growth slow, the demand for labour will decrease causing a rise in
unemployment.
Usually when economic growth is below 2.5% p.a., then there will be pressure for
unemployment to increase.
Global economic growth affects the demand for exports, which affects AD.
2. Macroeconomic Policies can influence the level of cyclical unemployment.
Expansionary fiscal and monetary policies can stimulate economic growth, hence
reduce unemployment.
On the other hand, contractionary fiscal and tightening monetary policies can slow
economic growth, hence increase unemployment.
3. Participation Rate. As more people who are actively looking for jobs, the
participation rate will increase and the number of unemployed will rise initially. This
is because they believe it is easier to find a job or they want to work (i.e. more
optimistic).
This will cause a rise of unemployment in the short term, but long term eventually
,they should find a job and reduce unemployment.
4. Structural Changes can cause unemployment. Collapse of certain industries will
increase unemployment (e.g. car industry). People need time to re-train and gain
new skills in order to find another job or profession. Alternatively, some people might
withdraw from the work force.
As the nature of Australian jobs are shifting from secondary industry to tertiary
industry (i.e. service nature) or quaternary, this will cause a rise in structural
unemployment.
5. Technological change-similar to structural change. New methods of production
(often replaced by machinery) means labour capital will be made redundant because
it is cheaper and more competitive to use machinery.
This will cause a rise in unemployment due to new technology.
6. Increase labour costs and excessive employment regulations will discourage
businesses to employ more workers. E.g. higher employee bargain power, increase in
minimum wages by Fair Work Commission, shortage of skilled labour and wage
expectations.
49
NAIRU
Full Employment (or natural rate of employment) is when quantity of labour demand =
supply. The targeted rate in Australia is 5-6%.
This will always fluctuate because of frictional & structural unemployment.
There is a trade-off between inflation and unemployment such that there is a general negative
relationship. This can be shown in the Phillip’s Curve.
Non-Accelerating Inflation Rate of Unemployment (NAIRU) is a rate of unemployment
where there is constant inflation or no change in inflation.
It is also when an economy has no cyclical unemployment or operating at full employment.
In the diagram, the Long Run Phillip’s Curve (LRPC) shows no trade off between
Unemployment & Inflation, i.e. NAIRU.
If NAIRU is decreasing from 6% to 5%, the government needs to implement Microeconomic
Policies to improve productivity & efficiency (e.g. reforms). This long run decrease of
NAIRU will not stimulate inflation.
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Groups Affected
Often, people who are young, less educated or from Non-English Speaking Backgrounds
(NESB) are the most vulnerable to unemployment.
Employers prefer to hire people with more experience, skills and education. Hence, young
people with lack of experience, education training and skills have higher rate of
unemployment. Another term for this is Youth Unemployment.
Different regions unemployment rate will also be different. Urban areas have more jobs
than rural areas as there are more opportunities. In Sydney, the North Shore regions have
higher employment rate compare to South-Western Sydney.
People from non-English speaking backgrounds are disadvantaged of finding employment
due to language difficulties. Employers like to hire people who can communicate in English.
Economic Impacts/Costs
Social Impacts/Costs
Opportunity cost of lost output & income-lead
to lower living standards.
Increase crime rates, drug & alcohol
dependency
Slower wage growth as there is an excess of
labour supply
Family tensions (even possible domestic
violence)
Loss of human capital
Psychological effects like depression
Increase tax burden for those who are
employed
Increase suicide rates
increase government spending on social
welfare payments
Lower self-esteem & personal dignity
Increase debt level
Increase inequality of income (as low income
earners with lower skills and education are
more likely to be unemployed).
Impacts
Okun’s Law states that in order to reduce unemployment, the rate of economic growth
must exceed the growth in labour productivity plus the growth in the labour force through
new entrants.
It is a theory that depicts the relationship between Economic Growth & Employment.
51
Policies
1. Stimulating Monetary Policy by RBA reducing interest rates.
This can offset cyclical economic downturns, hence lower cyclical
unemployment.
As interest rates decrease, the disposable income of consumers and firm’s profit will rise
due to decrease in interest expenses. Hence, consumption & investment will increase
which are the core components of Aggregate Demand (AD). Hence, economic growth
will rise. As firm’s profitability increase, businesses need to hire more people to meet its
demand, hence, reducing unemployment.
2. Expansionary Fiscal Policy by increase Government Expenditure (G) and/or
decrease tax revenue (T). This can stimulate AD as government expenditure
increases, and also by lowering tax, consumers will increase their consumption. This
will lead to rise in the demand of goods & services, so that firms need to hire more
people to meet its demand. Hence, reduce unemployment.
3. Microeconomic Policies:
 Microeconomic reform aims to reallocate resources to ensure efficiency, increase
productivity and competitiveness. This can be used to achieve low unemployment
rate in the long term as the labour force is more efficient, competitive, skilful and
educated, such that firms demand more skilful labour force.
 Increase education & training of workforce. This can ensure that the Australian
workforce is competitive as there is skills shortage in Australia. E.g. New
Apprenticeship Centres, increase funding for vocational and schools, increase funding
for apprenticeships.
 Labour Market Reforms-encourage competitive workforce with higher level of
productivity. This can encourage employers to hire more people to increase
employment. E.g wage rises base on productivity, decentralising wage determination,
and negotiation between employees & employers. Introduction of Fair Work Act
2009, enterprise bargaining and weakening the power of unions and unfair dismissal
laws can help to achieve this.
4. Other Policies:
• Trade protections can ensure domestic industries are protected from
competitive importers. Domestic companies can survive, and hence less
workers become unemployed.
• Immigration policies by attracting skilled workers to address skills shortage.
E.g. 2017 Temporary Skill Shortage VISAs
• Increase child care subsidies can encourage parents to work which increases
the supply side of the labour market.
52
Inflation
Inflation is the increase in the general price level of goods and services over a period of
time.
A deflation is the opposite: decrease in the general price level of goods and services over a
period of time.
Inflation causes the purchasing power to fall.
The RBA has set the inflation target of 2-3% p.a. (since 1993) to achieve the economic
objective of price stability and it will use the Monetary Policy (i.e. Interest Rates) to control
inflation.
Currently, the inflation rate is 3.5% p.a.
The Consumer Price Index (CPI) is used to measure Australia’s inflation rate.
It calculates the change in the price of a basket of goods and services weighted according
to their significance which is a good indicator of the movement in the prices of the goods and
services.
CPI does not include property prices and mortgage interest rates.
Headline Inflation (or Official Rate) is the quarterly rate of change in CPI. This includes
some goods & services which are volatile and can be affected by one off factors (e.g.
drought, implementation of GST, oil prices spike). The reported inflation rate is using the
Headline Rate.
Underlying Inflation (or Core Inflation) is calculation of inflation which does not taken into
consideration of seasonal or volatile factors. Hence a better approach.
Trimmed Mean Inflation: Average rate of inflation excluding 15% of items with the largest
and smallest price increase.
Weighted Median Inflation: Compare inflation rate of all items in CPI and identify the
middle observation.
53
Trends
Actual inflation has mainly stayed around the target of 2-3% since it has been implemented.
As can be seen from the previous graph, traditionally, Australia’s inflation was high (more
than 6% p.a. during the 70s) but has decreased to a sustainable rate since the early 1990s.
54
However, recently after the pandemic 2020, this has increased.
In periods of high inflationary pressure (or expectations of high inflation), RBA has
increased the Interest Rates (Contractionary) to slow down economic growth and curb
inflationary pressure.
Also contractionary Fiscal Policy.
Australia has enjoyed nearly 3 decades of economic growth with sustainable inflation (paused
by the pandemic).
This could be due to structural changes (including technological changes) where resources
have been reallocated to enhance efficiency, achieving economies of scales and
competitiveness.
Events in the past decades which affects inflation include:
• COVID Pandemic 2020-sharp decline
• Stronger exchange rate (reduce import prices, lower inflation) 2009-2012
• GFC (slowing of economic growth, slowing wage growth, reduced investment
spending)
• Increase in global prices of food and commodities 2005-2008.
• Increase competition & reduce foreign protection has put downward inflationary
pressure.
• Structural & technological changes since the late 1980s
• Setting of inflation target by RBA in 1993.
Causes
1.
2.
3.
4.
Demand Pull Inflation
Cost Push Inflation
Imported Inflation
Inflationary Expectations
1. Demand Pull Inflation
Demand Pull Inflation occurs when there is excessive growth in total expenditure or
aggregate demand (C+I+G+X-M).
This is when AD is growing while the economy is close to its supply capacity, such that the
higher level of demand causes higher prices than output.
Prices will be under pressure to rise if this exceeds aggregate output (or GDP) as output
cannot expand any further. AD is the driving force that increase the prices. E.g. in 2007 when
there is full employment and high AD, inflation has increased.
55
From the diagram before, if there is an increase in AD, it will shift to the right AD1.
The price level will rise to P1 (from P) and real GDP is now at GDP2.
Hence, the inflationary gap is cd.
AD rises because:
• Increase in Consumption (C)-this could be higher consumer confidence, taste, rise in
wages, tax cuts etc.
• Increase in Investment (I)-this could be higher profit, higher business confidence and
expectations, tax cuts, lower interest rates.
• Increase in net Government Expenditure (G)-this could be lower tax, infrastructure
projects, larger budget deficit or lower surplus
• Increase in net Export Income (X-M)-this could be higher commodity prices, terms
of trade, increase overseas demand of exports.
2. Cost Push Inflation
Cost Push Inflation is caused by decrease in Aggregate Supply (AS) or substantial
increases in the cost of goods and services.
Firms will pass on the increase of cost of production to final consumers which causes an
increase in inflation.
E.g. rise in wages (more than 50% of firm’s costs), rise in the cost of raw materials (like oil
and energy prices), or other inputs in the production process.
In 2014-16, a drop in oil prices of 20% has reduced inflation by 0.8%.
As AS decreases to AS1 (shift to the left), a new equilibrium point is established at P1
(higher price from P) and reduce in real GDP (GDP2), i.e. lower output.
In this case, the economy experiences both a rise in prices, as well as contraction in output or
reduce economic growth.
Ultimately, this can have the effect of Stagflation (rise in inflation & unemployment). This
occurred in the 1970s in the global economy.
56
Examples of Cost Push Inflation includes:
• General wage increases but not leading to improvement in labour productivity.
• Rise in raw materials (either domestic or imported). E.g. manufacturing components,
oil, energy cost, sugar.
• Rise in Government tax, customs or changes in policies which can increase the cost of
production. E.g. excise duties, freight costs, royalties, tariffs.
• Tightening of monetary policy (increase interest rates) which increases the cost of
borrowing.
3. Imported Inflation
Imported Inflation occurs by international transactions. This is caused by a rise in the
import prices of goods & services. A depreciation of AUD will increase the price of imports,
hence inflations.
In 1973-74 & 1979-80, as OPEC (Organisation of Petroleum Exporting Countries) put
restriction on oil supplies, this has caused energy prices to increase and hence increase cost of
transportation and production.
In the mid 80s, significant depreciation of AUD increased the price of imports which
increased the cost of production. Ultimately, this is passed on to final consumers.
However, if there are more competitions (both domestically or internationally), importers
have to reduce its profit margin and price. Hence, lower inflation.
4. Inflationary Expectations
Inflationary Expectations are people’s perceptions of future inflation given past & present
inflation rates.
2 possible ways:
1. If the prices of goods and services are expected to rise, consumers will buy them
before prices increase, i.e. increase in consumptions, which can lead to demand-pull
inflation. Or if firms expects demand will increase, they will push the prices up to
maximise profit.
2. If prices are expected to rise, employees will negotiate for a rise in wages to protect
their purchasing power. This increase will be passed on to final consumers. It can lead
to further fall in AS and further rises in prices. This is the wage-price inflation spiral.
57
There is a short-run trade-off or inverse relationship between unemployment & inflation. This
is a reduction in unemployment can result in an increase in inflation.
Inflation Effects
Inflation is a major macroeconomic problem. It is important to maintain low, sustainable
inflation.
Inflation can have both positive & negative impacts.
Positive Impacts
• Increase prices on asset prices like shares and property. (note: property or share
market boom can lead to asset price inflation).
• Stronger wage bargaining power for employees.
• Sustainable inflation allows:
• Moderate economic growth.
• Encourages business investments (especially in long term productive assets)
• Improve Australia’s international competitiveness and exports.
• Appreciation of the exchange rate.
Negative Impacts
• Loss in purchasing power and real income. This can increase cost of living, reduce
living standards and economic growth as Consumption will drop.
• Reduce international competitiveness. This is especially when:
• The increase in cost of production cannot pass on to customers who are
overseas.
• Consumers might switch to imports from overseas (as domestic products are
not competitive), which can worsen the trade deficit.
• When nominal wages remain constant but real wages rise, it is not attractive to hire
more workers.
• Firms will pass on the cost to final customers by increasing the prices of goods and
services, and reducing the demand for workers (replace with machinery).
• If savings interest rates cannot keep up with inflation, the real value of savings will
diminish. Hence, consumers are more likely to spend and not save as the purchasing
power of money has reduced.
• Investors can reduce the demand of investment if the cost of borrowing is too high.
• Contractionary fiscal & monetary policy will be used to slow economic growth,
which can increase unemployment in the short run.
• High inflation can lead to a depreciation of currency.
58
Deflation-negative effects
•
•
•
Fall in consumption as consumers expects prices will keep dropping, hence less
incentives to buy now.
Reduce borrowing because the amount of repayment is rising in real terms.
Fall in real wages (W/P): if the rate of increase in wages is not equivalent to prices.
The impact can be severe especially for low-income earners.
Policies to sustain low inflation
•
•
Contractionary Monetary Policy by increase interest rates (limit the amount of
money supply circulating in the economy). This can reduce borrowing and spending
as there is more incentives to save.
Contractionary Fiscal Policy by increase tax and/or reduce government expenditure.
This can lead to a reduction in the net injection of funds into the economy.
Microeconomic Policies are used to induce structural changes to reallocate resources which
can improve efficiency, competitiveness, high level of productivity and hence achieving
economies of scale.
If rise in wages is not based on productivity, microeconomic policies are the most effective.
Or if there is lack of competition or efficiency in the market for raw materials, abolishing
protection can help.
E.g.:
• National competition policy to promote competition
• Tariff reforms and reduce protection can increase foreign competition and lower
prices
• Remove indirect taxes
• Reform of public utilities and privatisation to increase efficiency
• Labour Market Reform (e.g. enterprise agreement): to contain wage rise pressures that
does not reflect on productivity.
• Investment in infrastructure, roads, education
External Stability
59
External Stability is achieved when export income is sufficient to finance import expense.
This is one of the key economic objectives.
It is an aim of government policy to promote sustainability on the external accounts to fund
foreign liabilities in the long run to avoid currency volatility.
External Stability issues (CAD) in the last decade include:
• Persistent CAD (CAS since the pandemic), on average 5% of GDP
• Volatile TOT due to commodity price (rose sharply due to the pandemic by 50%)
• Lack of competitiveness of manufactured goods due to high labour costs
• Growth of foreign debt to around 55% of GDP
• Increase foreign ownership in Australia ($4t) such that more profit will go offshore
(net primary income outflow)
• Volatile AUD due to the fluctuations of commodity prices.
Exports are injections into the circular flow of income. Factors which can affect export
demand:
• Global real GDP growth. The higher it is, the higher export demand.
• International specialisation (e.g. agricultural and mineral commodities)
• Price competitiveness of Australian exports
• The value of AUD: lower AUD means higher demand for Australian exports.
Imports are leakages of circular flow of income. Factors which can affect import demand:
- Australia’s real GDP growth. The higher it ism the higher import demand
- Price competitiveness of foreign goods
- The value of AUD. Higher AUD, higher demand for import.
Measure of external stability
CAD: It is the net outflow of all exports & imports of goods and services, primary income
and secondary income in one financial year.
60
Reasons lead to high CAD (traditionally)
-
Australia’s lack of international competitiveness as we cannot compete with other
countries. Apart from cost, it could also be due to non-cost factor likely quality of
production and reliability of supply
High TOT, although export revenue have increased, import have risen higher. Recent
major disruptions of exports to China is also a concern
1. CAD as % of GDP (i.e. CAD/GDP) . CAD is unsustainable if it exceeds the growth
rate of the economy.
2. Net Foreign Liabilities as % of GDP (Net Foreign Liabilities/GDP). Net Foreign
Liabilities is the difference of the total foreign assets and liabilities (including
interests).
3. Net Foreign Debt as % of GDP (Net Foreign Debt/GDP). Net Foreign Debt is
Foreign Debt Assets less liabilities (excluding interests). If the size of the debt is
rising faster than GDP, interest payments will take a greater % of GDP, leading to
debt-trap scenario.
Terms of Trade (TOT)
Terms of Trade (TOT) measures the relative price of Australia’s exports and imports. If this
rises, great volume of imports can be financed with a given volume of exports. E.g. due to
rise in commodity export prices, TOT has increased between 2004-2009. Also, fall in import
prices due to lower production costs in China can also improve TOT.
As TOT increases, the effects are:
• Increase export income in BOP in the short run.
• Increase in Aggregate Demand (AD) as export income rises and increased investment.
• Long term, lower competitiveness
As TOT decreases, the effects are:
• Decrease export income in BOP in the short run.
• decrease in Aggregate Demand (AD) as export income rises and increased
investment.
• Long term, improve competitiveness
Net Foreign Liabilities
Net Foreign Liabilities are Australia’s financial obligations (consists of foreign debt &
equity) to the world minus the world’s financial obligations to Australia.
61
Net Foreign Debt: total loans owed by Australians to the world less the total loans owed by
the world to Australians.
Net Foreign Equity: total value of foreign owned Australian assets less total value of
Australian owned assets that are overseas.
Servicing cost of Foreign Liabilities will affect NPY. E.g. interests, dividends.
If the growth of Foreign Liabilities increase substantially (i.e. rising faster than the GDP),
debt servicing cost will severely affect NPY which will ultimately affect long term economic
growth, living standards and Australia’s credit rating. Worst case scenario: debt trap.
Competitiveness
By significant reduction in CAD and retirement of foreign debt obligation, then, the net
foreign debt cycle can be corrected.
Exchange Rate
Increase in commodity prices can improve TOT and the demand for AUD.
Also, increase in foreign direct investments will increase the demand for AUD as investors
need to buy AUD to invest in Australia in the hope of better return on investment.
FOREX can affect External Stability (BOP) by:
• Export revenue: due to international competitiveness (affecting export volumes)
• Debt servicing cost: if borrow from other countries, foreign currency fluctuation will
affect interest repayments.
Competitiveness
Overall, the AUD has appreciated significantly until 2012 (due to strong demand of
commodities). This led to a reduction in Australia’s international competitiveness in
manufactured goods, tourism and education exports. The level of export volumes dropped
significantly due to lack of competitiveness.
From 2012 to 2016, TOT has dropped by 35% which has restored competitiveness. However,
since the pandemic, this has increased by 50%
Causes of CAD
•
Growth in Foreign borrowings instead of equity investment as the main source of
capital. This can increase CAD and interest payments
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•
•
•
•
•
•
Higher public sector borrowing requirements which can encourage higher foreign
borrowing.
High inflation & lower international competitiveness
Collapse of TOT can significantly reduce export revenue and increase cost of imports
Reduce protection barriers (e.g. tariffs and quotas) can increase import
Slow global economic growth and demand from other economies
Depreciation of AUD
Caused of Net Foreign Debt
•
•
•
•
•
Persistent increase in CAD lead to high debt servicing cost
Shift from equity financing to debt financing
Depreciate AUD against other OECD currencies
Decline in domestic savings (public & private).
High federal budget deficits
Effect of CAD & Net foreign debt
1. Increase debt servicing costs, deteriorating NPY.
2. Low investor confidence and withdraw Australian Investment (capital outflows).
3. FOREX fluctuations can lead to valuation effect on foreign debt. If AUD depreciates,
the level of debt will increase.
4. Expose Australia to external shocks like trade collapses-reduce export income and
increase interest expenses.
5. Downgrade of credit ratings by international ratings agencies (e.g. Moody’s, S&P).
Policies to reduce CAD
External stability is NOT a major economic objective of macroeconomic policies (but still
a little bit useful)
The argument was: CAD & Net Foreign Debt are mainly reflected on the private sector (e.g.
the amount of net exports & imports, NPY etc.)
Hence, to achieve sustainable External Stability should be a long term goal, i.e.
Microeconomic Policy.
-
-
Monetary policy targets 2-3% to maintain the level of competitiveness of Australia’s
export. Tightening can discourage spending and encourage saving-reducing imports.
However, NPY will be lowered as higher interest rate lead to higher interest expense.
Fiscal policy: budget surpluses can be used to retire public deb and hence reduce net
foreign debt. However, these are high level of budget deficit throughout the last
decade.
Microeconomic policies (reforms): this for long term efficiency of allocating
resources to increase productivity, ie. Competitiveness
o Industrial relations on wages movements to increase productivity
o Increase intake of migrants
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-
o Education and training to address skills shortage
o Remove trade barriers
In the long term, as the economy is more competitive, there should be more export
revenue and NPY which can reduce CAD and hence external stability.
-
Distribution of Income and Wealth
Income inequality is the degree to which income is unevenly distributed among people in
the economy
There are 2 types of measurement:
1. Lorenz Curve
2. Gini coefficient
1. Lorenz Curve
This is a graphical presentation of distribution of income against population
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From the graph, the line of perfect equality is a 45 degree diagonal such that the cumulative
% of families is equivalent to the cumulative % of income or wealth (i.e. 60% of the
population earning 60% of total income)
In reality, it is not possible to operate along the line of perfect equality (i.e. The Lorenz
Curve). It operate just below that line
2. Gini Co-efficient
It is the calculation of the degree of income or wealth inequality. It measures the
degree to which the Lorenz Curve is deviated from the line of perfect equality.
If operating along the line of perfectly equality, Gini co-efficient=0, that is perfectly
equality
The opposite of that is when the Gini co-efficient=1,that is perfect inequality. This one
household earns all the income.
𝟎 ≤ 𝑮𝒊𝒏𝒊 𝑪𝒐 − 𝒆𝒇𝒇𝒊𝒄𝒊𝒆𝒏𝒕 ≤ 𝟏
In Australia, Income inequality is a significant issue. But compare with other developed
economies, Australia’s level of inequality is less severe.
Source of Income
Personal Income is the money and financial benefits received by individuals either in return
of production or by government transfer payments.
ATO income definition: financial benefits received when sale of goods or rendering service
AASB 118 revenue definition: Revenue is the gross inflow of economic benefits during the
period arising in the course of the ordinary activities of an entity when those inflows result in
increases in equity, other than increases relating to contributions from equity participants.
Sources of Income can be:
- Wages when providing labour services, this is the most common source of income
- Rent: earning or returns from land ownerships
- Earning from capital: earning or returns from financial assets. E.g., dividends,
growth. Large proportions of this earning are owned by the wealthiest households.
- Profit from entrepreneurship: this the profit return to business owners.
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-
Transfer payments: this refers to social security payment
In HSC economics, income is divided into:
- Earned personal income: wages & salaries
- Unearned personal income: rent, interest, business profits
Source of income- governments tax- transfer system
1. Progressive tax: as individual earn higher income, there are being taxed at a
higher amount.
2. a significant portion (around a third) from tax revenue is spent on social
security and transfer payments like pensions, allowances, tax benefits etc.
3. other government expenditure: public spending on health, education, childcare
and community services.
Source of wealth
Personal Wealth is the net value of real & financial assets owned by individuals
Real Assets are property and consumer durables (e.g, cars, valuable) (Similar to non-current
assets)
Financial assets are bank deposits, shares, superannuation (similar to current assets)
Net Value of Assets (Net worth) =Total Assets (financial & non-financial)- total liabilities.
Definition of assets according to Australian Accounting Standard Board (AASB)
Assets are future economic benefits controlled by the entity as a result of a past transaction
or other past events
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Assets can be recognised if it is probable that future economic benefits embodied in the
assets will eventuate and the assets possesses a cost or other value that can be measured
reliably.
High income earners generate higher level of wealth as their ability to save is higher. They
can use this saving to generate and accumulate higher level of wealth by various investment
like property, shares, gold etc.
Trends in Distribution of income & wealth
For statistics purposes, Australian population is divided in to quintiles or 20% groupings. Up
to 2020, to share income and wealth of each quintiles can be tabled as the following.
As can be seen, the highest quintile (wealthiest 20% of Australians) earns the most and has a
saving rate of more than 60%. Whereas the lowest quintile saves the least, because they need
to spend most of their income on basic needs for survivals.
In other words:
- a relatively small number oof people have high household income and
- large number of population have relatively low household income
Given the recent budget low middle income tax offset (LMITO), how do you think the
graph might shape for income & wealth?
Do you think it is effective to promote equal distribution of income?
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There is a fair degree of income inequality in Australia. For the past 10 years, the share of
income and wealth has barely changed (0.2% improvement in the lowest quintile)
In 2012, the gini co-efficient has slightly dropped to 0.32 due to increase in minimum wages
and tax free threshold from $6k to $18.2k. however, since then, it has increased to now
around 0.34, i.e. income inequality has widened.
In 2021, it is 0.33, 11th highest out of 33 OECD countries.
The average
household income
per week is around
$2,086.
The median is around
$1,631 per week.
The inequality of distribution of wealth is more significant than income. The lowest 20%
of households has a mean net wealth of $36,500, whereas the top 20% is more than 70 times,
nearly $3m.
Wealth is normally accumulated during ones working life which is utilised when he or she
is retired.
This can be seen in the next graph.
The average
household wealth
now is around
$1,022,200.
The median now is
around $558,900.
The trends can be analysed in terms of:
1. Age
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2.
3.
4.
5.
Gender and types of jobs
Ethnic background
Family structure
Geography location
1. Age
Young people tend to have lower income level as the level of education, skills and
experience is lower
Age groups from 35-55 years old have higher income level as they have the capacity, skills
and experience.
The higher level of qualifications that one has attained, the higher the wages.
Although, older households have accumulated more wealth, but their level of income are
relatively low (as they might have retired)
-
2. Gender & types of jobs:
Male workers tend to earn more than females. This could be explained by the fact that
the society perceives that females have greater household responsibilities, and less full
time high paid job which can balance family needs
Discrimination and glass ceilings in the workplace still exists.
Although there is gap between gender , but the gap has narrowed.
White collar (or management level) jobs tend to have higher income.
It is more common that there is more than one person earning income for a household, and
that people are putting off retirement.
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-
-
-
3. Ethnic Background
People from non English speaking background (NESB) tend to have lower income
and higher level of unemployment.
This could be the fact that people from English speaking background can
communicate better, hence, more easily to be hired.
4. Family structure
Couples with no dependent children earn the most with higher net worth. This is
because there is no financial burden and they have the capacity to work full time
Single parents has the lowest income and wealth as the capacity to work full time is
lowered.
5. Geography Location
In Australia, different states and regions earn differently
Often, highest level of income and wealth can be found around capital cities (Sydney,
Melbourne)
In tern of state and territories, NT and ACT earns the most.
Dimensions in Distribution of Income
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Benefits and costs of inequality
Economic Benefits of income and wealth inequality:
- Employees have the incentive to work harder to earn higher income. This includes
higher productivity, higher level of education and skills
- Higher labour productivity
- More effective labour resource allocation as people tend to move to areas with higher
wages
- Business owners are willing to take more risks to earn higher profits
- Increase national savings and investment which can generate more economic growth
and employment
Economic cost of income & wealth inequality:
- Low consumption level for low income earners. This can reduce economic growth
and living standards.
- Increase government spending on social welfare to support people are unemployed
and low income households. This can lead to higher budget deficit or lower surplus
- High tax burden on taxpayers
- People who have low skills cannot earn higher income and hence, cannot improve
standard of living. They cannot afford to acquire training and education.
Social benefits of income and wealth inequality:
- Improve living standards and increase personal opportunities for people who work
hard and have higher skills level.
- Wealthy households can have better access to education.
Social costs of income and wealth inequality:
- Social division base on different classes of home
- Marginalisation of certain groups of people. They could be alienated from market
opportunities. E.g. changes in the structure of industry
- Social tensions can be raised by those who are low income earners
- Increase level of relative poverty for certain communities
- Increase crime rate
- Reduce of life expectancy and living standards
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Policies to reduce income and wealth inequality
Australian government mainly uses social Fiscal Policy (based on tax-transfer system) to
reduce income & wealth inequality.
Government uses progressive tax system and expenditure on social welfare to low income
earners. This is redistributing income from the rich to the poor.
Components of the Fiscal Policies or The Budget to reduce inequality:
• The Low Middle Income Tax Offset (LMITO) has reduced the tax burden on low
and middle income earners, however, this could stimulate inflation.
• Fringe Benefit Tax (FBT) on items like company car and Capital Gains Tax (CGT)
on gains from shares and real estates. These taxes can redistribute income & wealth
from the rich to the poor.
• Stimulus Package after the GFC, Job Keeper programs can reduce the pressure of
cost of living on low income earners.
• Increase Government Expenditure to reduce unemployment.
• Compulsory Superannuation boosts the wealth of employees.
Monetary Policies: When interest rates increases, inequality increases.
This is because low income earners are borrowers, and have to pay higher interest
expenses (or cost of borrowing).
High income earners have higher savings which their wealth should increase when interest
rates rises.
Microeconomic Policies:
Redistributing of resource to increase efficiency in production and hence achieving
economies of scale can cause short term increase in structural unemployment.
Privatisation will lead to increase in prices and downsizing the workforce to improve
profitability and return to shareholders. Hence more return to owners at the expense of
unemployment which can widen the income & wealth inequality.
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Environmental Sustainability
The natural environment is a source of natural resources and absorb waste from human
activities.
It is crucial to mange the environment in order to ensure the quality of life will not be
reduced and sustainability can be maintained by preventing over exploitation of renewable
and non-renewable resources.
Ecological Sustainable Development
It should be noted that if economic growth is strong, i.e. more goods & services being
produced, more natural resources will be needed.
Hence, this will lead to a depletion of natural resources, wastage, pollution and ultimately
lower quality of life.
In the long term, due to depletion of resources, future potential of output could be dampened,
reducing production and therefore long term economic growth.
This refers to development which meets the present needs without compromising the future
generation of meeting their needs. It involves conserving and enhancing the community’s
resources so that ecological process and quality of life can be maintained.
It should not threaten the globe’s natural and cultural environment for the enjoyment of both
current and future generations. Hence, balancing both economic growth & environmental
sustainability.
Sustainability principles include:
• Integrate both economic & environmental goals
• Valuing biological diversity and environmental assets
• Non-depletion of resources
• Decreasing environmental pollution by managing the environment with caution
• Increasing quality of life
• Raising awareness of the effects of environmental decisions.
In the diagram, the lines A, B & C are Production Possibility Curve. E.g. At line A, Point 1 &
2 are attainable, with point 1 has higher growth but poorer environment quality compare to
point 2.
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The curve will shift outwards if there is an improvement in technology or productivity but
also able to preserve the environment.
If the environment degrades but with less resources used to protect the environment, it will
shift to the left.
Private and Social, cost and benefits
Private Benefits:
• Profits made by firms by selling
Goods and Services (G&S)
• Consumers satisfaction by
consuming the G&S
Private Costs:
• Expenditure by producers on
resources to produce the G&S
• Costs incurred by consumers to
consume the G&S
Social Benefits:
• Positive spillover effect of private
production on the community like
convenience of shopping centres.
Social Costs:
• Costs that are imposed on the
community as a result of private
consumption. E.g. pollution by
industrial output.
Market Failure and Externalities
Market Failure is when the market mechanism doesn’t consider private benefits and
costs.
E.g. a car’s cost does not include pollution which can damage the local environment. This is
an example of spillover or external effect that the market does not take into consideration of a
market transaction.
If the effect is beneficial, it is called: Positive Externality. This goods & services are called
Merit goods.
If the effect is harmful, it is called: Negative externality. This goods & services are called
Demerit goods.
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From the diagram:
• MSC is Marginal Social Cost
• MPB is Marginal Private Benefit
• MPC is Marginal Private Cost.
MSC is like pollution cost not reflected on MPC.
When MPB=MSC, it is at the optimal society welfare, where less quantity is produced with
higher price.
Negative Externalities:
• Intersection of MPC & MPB is without negative externalities.
• If there is negative externality, i.e. extra social costs, the supply curve will shift to the
left MSC.
• New equilibrium is P1, that is due to higher cost of production, and quantity Q1, less
quantity supplied.
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Positive Externalities:
• Intersection of MPC & MPB is without negative externalities.
• If there is positive externality, i.e. extra social benefits, the demand curve will shift to
the right MSB.
• New equilibrium is P1 & Q1, that is due to higher demand. The vertical distance is the
external benefit.
Property Rights gives individuals the exclusive right on certain natural resources (e.g. land,
water). It should have the following 3 factors:
• Excludability: the owner of the property has the right to exclude others from
enjoying the benefits of the property.
• Transferability: property rights are tradable in a market.
• Enforceability: the property rights are legally binding such that compensation
penalties apply to those who violate or damage the property.
However, there are common property (no one owns it) with lack of defined property rights
(i.e. problems of common). Without any restrictions on beaches and national parks, people
may exploit the environment and deplete the resource (e.g. overfishing). Restrictions are also
hard to enforce.
Private and Public Goods
Private goods: those who can pay at the market prices can obtain the goods and service. They
are excludable that those who cannot and unwilling to pay are excluded from enjoying the
benefits.
Private goods are also said to be rival such that once it is consumed, it is not available by
anyone else. E.g bubble tea
Public goods: they are non-excludable and non rival in consumption. Such that no one
excludes others from using the goods and services, and the benefits available to others will
not be reduced no matter how many people have consumed them, E.g. Clean air, beach, street
lights. If many people use these goods, the amenity value will drop.
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It should be noted that not all goods and services provided by the government are public
goods as someone are excludable and rival. E.g. private schools, hospitals, trains. Public
sector goods are just goods and service provided by the government.
Free riders (or non payers): this is mainly for public goods when user do not have to pay to
enjoy the benefit of goods and services. Also, many people do not like to pay or contribute to
the provision of such goods and services as there’s no economic value (expect for marketing)
These can lead to market failure as it can prevent resources from being allocated efficiently
or existence of a market and exploiting the resources and natural environment.
The use of genome editing technology such as CRISPR is able to attempt in the rehabilitation
of Cystic Fibrosis. CRISPR is a short DNA sequence that are palindromic, which means they
can be read both forwards and backwards. They appear in clusters with regular spacing
between them, these spacers contain unique DNA segments.
Environmental Issue- Preserve Natural Environment
There are some unique ecosystems or natural environment which should be preserved for
their intrinsic natural beauty, recreational value and scientific research. E.g. The Great Barrier
Reef, Daintree Forest, National Parks in Tasmania etc.
Without preservation of the environment, there will be nothing left for the future generation.
Methods to preserve the environment can include:
• Restricting access & development near environmentally sensitive areas (e.g.
national parks)
• Protecting flora & fauna
• Controlling emissions of CO2, gas and waste
• New plantation where there is logging of forests.
There are problems which threaten the current and future preservation of natural
environment:
• Land & Soil Degradation near farming areas. The excess usage of irrigation system
can lead to soil erosion, acidity and salinity. E.g. Murray Darling River-where the
water level has dropped significantly and a large number of wildlife has died.
• Land Transformation of coastal areas, forests and wetlands into human
development. E.g. significant high rise development in Olympic Park.
There are problems which threaten the current and future preservation of natural environment
(cont.):
• Over Exploiting of natural resources like logging and over fishing can
damage the biodiversity in the ecosystem and lead to resource depletion
(decline in non-renewable resources).
• Pollution is significant among city areas where population, industrial and
commercial waste are high. This can lead to deterioration of water and air
quality.
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Read Dixon’s textbook P.267-268 & 273 for stats and case studies on the 2019-20 bushfires
& Murray Darling Basin impacts.
Government often faces dilemma when implementing policies to preserve the natural
environment because:
• Environmental policies can restrict economic growth and higher compliance costs,
i.e. industries less competitive.
• Repairing damage costs are often paid by tax payers
Climate change is related to the excess emission of CO2 and greenhouse gas. This is due to:
• Burning of fossil fuels for electricity. Higher standard of living and economic growth
is often linked to higher demand of natural resources and reliance of fossil fuel.
• Changing land use like deforestation, landfill, farming, logging.
Climate Change
The results can be melting of ice caps leading to rise in ocean level and more extreme
weather patterns.
The Intergovernmental Panel on Climate Change (IPCC) has assessed that Climate Change
will have the Global Impacts of:
• Global temperature rises by 1.5 degree
• Rising sea level by 18-60cm due to melting ice caps
• More extreme weather conditions: heatwaves, droughts & floods
• Up to 200m people will become environmental refugee
• 30m could be at risk of coastal flooding
Australia Domestic Impact of Climate Change:
• Australia’s GDP could reduce by 4.8% by 2100
• Reduction in agricultural production
• Permanent damage to The Great Barrier Reef due to coral breaching
• Increase heat related health issues (e.g. heat strokes, skin cancers)
• Increase frequency and damage of droughts and floods
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Depletion of natural resources
Renewable Resources are natural resources which can regenerate by itself. However, if
over exploiting these renewable resources, they might be exhausted and even extinct.
Therefore, these resources should be preserved for sustainability and future use. E.g.
overfishing.
Non-Renewable Resources are natural resources which cannot regenerate it self. E.g. crude
oil, iron ore. The use of green energy (e.g. solar, wind) can reduce the reliance of fossil fuels.
Targets
Targets are used to guide environmental policies. E.g.
• Renewable Energy Target (RET) aims to increase the usage of renewable energy
(wind & solar) to 23.5%. This can be a legal obligation on electricity companies to
contribute to this target by producing renewable energy or paying it.
• Reduce carbon emission by 26-28% on 2005 levels by 2030.
Regulation
Environmental regulations are laws or rules which prohibit an individual from damaging
the environment. E.g. littering, dumping chemicals.
There are other regulations which reflect on immediate needs or to ensure long term
sustainability of the environment. E.g. water restrictions.
Environmental Policies
Government Policies can discourage harmful environment activities.
Banning certain production of goods and services is the most extreme action but it will
eliminate all externalities. E.g. banning of plastic bags in supermarket.
Imposing a tax on the production or usage is a less extreme method. E.g. Carbon tax by the
Gillard Government.
Government can also use subsidies to encourage firms and individuals to use
environmentally-friendly goods and services. E.g. refund of plastic bottles, in 2020, Clean
Energy Finance Corporations pledged $85m for green energy.
Most policies or solutions take many years to see the improved impact, hence government
might delay environmental protection in favour of short term priorities like other economic
objectives.
Market Based Structure
Market-Based Policies involve financial incentives and disincentives to affect individual
behaviour in order to protect the environment.
A tax or levy on production that is about the same as environmental cost can shift the supply
curve to the left (reduce supply in the market mechanism) and hence, increase the market
price and reduce the quantity consumed.
Government prefers tax rather than subsidy (e.g. Australian Renewable Energy Agency
provides funding for research) because aside from protecting the environment, it is also a
type of government revenue.
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International Agreements
Individual countries are reluctant to impose environmental policies without other countries’
commitment. Hence international agreements are needed to prevent the overuse of common
international resources. E.g. Kyoto Protocol, Paris Agreement.
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Topic 4: Economic Policies and Management
Economic Objective
Main Objectives:
1. Economic Growth & Quality of Life
2. Full Employment
3. Price Stability (controllable inflation)
4. External Stability
5. Distribution of Income & Wealth
6. Environmental Sustainability
1. Economic Growth & Quality of Life
Benefits of Economic Growth:
• Improve standard of living, individual well-being and quality of life.
• Increase employment
• Increase public investment and resources in infrastructure & public services (e.g.
education).
• Increase gains from international trade due to specialisation of production (economies
of scale).
2. Full Employment
Full Employment ≠ 0 unemployment.
Natural Rate of Unemployment is Non-Accelerating Inflation Rate of Unemployment
(NAIRU). This is around 4-5%.
This measures the unemployment after adjusting for cyclical unemployment (due to ups and
downs of economic status).
Government can use macroeconomic policies (fiscal & monetary) & microeconomic policies
(reforms like enterprise bargaining) to reduce this rate over time.
Okun’s Law states:
Economic Growth > Labour Productivity Growth + Labour Force Growth.
The level of Economic Growth must exceed the growth of labour productivity and growth in
the Labour Force.
This must be achieved in order to reduce unemployment.
Benefits of Full Employment:
• Economic capacity is fully utilised which can increase standard of living.
• Minimise social problems that are linked with unemployment (e.g. family issues,
crime rate, loss of skills).
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3. Price Stability (Controllable Inflation)
Price Stability is maintaining inflation at a reasonable level (2-3% p.a.).
Negative Consequences of High Inflation Rate:
• Reducing real value of income
• Rising cost of production,
• Not achieving economies of scale and hence less competitive
• Uncertainty in future costs
• Causing the currency to depreciate in the long run.
4. External Stability
External Stability is Australia meeting its short & long term financial obligations with the
world.
Key areas of External Stability:
• Reducing Current Account Deficit
• Ensuring net foreign debt (% of GDP) is low so that interest payment can be repaid
without any risks of financial crisis.
• Higher terms of trade such that it can buy more imports given quantity of exports
• Reduce volatility of exchange rate as it reflects on competitiveness.
• Improving International Competitiveness can minimise leakages, reduce CAD.
5. Distribution of Income and Wealth
In a free market, there is minimum government intervention. However the distribution of
income & wealth will be unequal.
Government should have policies to reduce the gap of high & low income earners by
redistribution resources (e.g. high taxes for high income earners, welfare payments).
6. Environmental Sustainability
Economic activity can have an negative impact on the natural environment. If it becomes
unsustainable, the next generation can suffer (without clean air, clean water and sufficient
food to survive).
E.g. pollution, global warming are significant consequences.
Goals of government polices
•
•
•
•
•
Maintain sustainable economic growth (around 3% of GDP).
Lower Unemployment (e.g. structural changes, skills training).
Stable & reasonable Inflation (2-3%). This can maintain international confidence with
a sustainable economic growth.
Reduce Budget Deficit to reduce reliance on overseas sources to fund expenditure &
investment.
Improve distribution of income & wealth
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•
Promoting Environmental Sustainability.
Conflict in government policy objectives
5. Simultaneous reduction in unemployment & inflation. Often there is a trade
off between unemployment & inflation. Low unemployment and high
inflation, or high unemployment and low inflation. E.g. Low unemployment
and unsustainable economic growth can lead to high inflation.
Low inflation has priority over lower unemployment due to Australia’s history of low
unemployment.
6. Economic growth and inflation (similar to unemployment) will conflict one
another. Often strong economic growth leads to high inflation, and slow
economic growth leads to lower inflation.
7. Achieve Economic Growth & External Balance. Strong economic growth
leads to a deterioration in the current account because of increase consumption
and demand for imports to improve standard of living.
8.
Higher economic growth can have a high cost of environmental damage. If
government imposes laws & regulations to protect the environment, economic
growth will slow (e.g. carbon tax).
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Macroeconomic Policy
Fiscal Policy
It is a macroeconomic policy which can influence resources allocation, redistribute income
and reduce and reduce the fluctuation of business.
Another term for fiscal policy is the Budget
Budget
A budget is a plan of the inflows and outflows of financial resources.
It is an annual statement of the government’s planned Tax Revenue (T) and Government
Expenditure (G) in the next financial year.
Its aim is to plan & direct the economy to a sustainable future.
Types of revenue (T)
- Direct tax (personal income tax and corporate tax)
- Indirect tax (GST, customs, tariffs)
- Other (dividends from public trading enterprise, earning from reserve)
2021-22 Budgeted Government Revenue (T) Breakdown
Types of Government Expenditure (G):
• Social Welfare
• Education
• Infrastructure
• Health
• Defence
• Environment
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2021-2022 Budgeted Government Expenditure (G) breakdown
Strengths
Strengths of a Fiscal Policy:
- It is not blunt instrument such that it can be used to various sections of the economy
- It has control over every aspect of the economy
- It can direct spending to a specific purpose
- Time lag is short
- Taxation can discourage certain behaviour or negative externalities.
Weaknesses
Weaknesses of a Fiscal Policy:
• Tightening fiscal policy to target current account deficit can increase unemployment
and reduce aggregate demand.
• It can become a political tool to win votes for the upcoming election.
• Imports could rise if the stimulus is in the form of tax savings.
• Unsustainable Budget Deficit can result in worsening CAD and debt problems
Purpose
The purpose of the budget is to achieve economic objectives in influencing:
• Stabilise the economy
• Sustain economic growth
• Reduce unemployment
• Control inflation
• Equitable distribution of income
• Efficient allocation of resources
Outcome
The outcomes of a Federal Budget can be:
• Surplus-Tax Revenue (T) is > than Government Expenditure (G).
• Deficit-Tax Revenue (T) is < than Government Expenditure (G).
• Balance-Tax Revenue (T) = Government Expenditure (G).
The main aim over the course of the economic cycle is to achieve budget surpluses.
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Stance
The stance of a Federal Budget (impact of budget) should be compared with the previous
budget:
• Expansionary. It can be a larger budget deficit or smaller surplus. This is to increase
the level of economic activity.
• Contractionary-It can be a lower budget deficit or a larger surplus. This is to reduce
the level of economic activity.
• Neutral-Tax Revenue (T) minus Government Expenditure (G) is same as previous
year. This is rarely the case with no effect on the overall level of economic activity.
Outcome
Underlying Cash Balance: Government’s ‘preferred’ measurement of the budget outcome.
This is using the cash accounting method (only record revenues & expenses when cash is
paid or collected) and not the Accrual Accounting method.
Headline Cash Balance: Underlying Cash Balance plus government’s buy/sale of assets.
Fiscal Balance: measurement of the budget using Accrual Accounting. That is recording
revenue and expenses at the time of incurred no when there is a cash transactions.
Components
The components of the Federal Budget are:
1. Discretionary Changes or Structural
2. Non-Discretionary Changes or Cyclical
1. Discretionary Changes (or structural changes): involves deliberate changes to the fiscal
policy.
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It is when the government makes changes to tax rates, providing tax incentives and/or
changing the level of government expenditure.
E.g. reduce the corporate tax rates, providing one-off tax incentives, expenditure on roads &
infrastructure.
2. Non-Discretionary Changes (or cyclical changes): this reflects on the changing economic
conditions such that an expansionary/contractionary stance can be applied automatically.
In order words, the policy has already been implemented, but the total amount will change
depending on the general economic conditions.
E.g. in periods of recessions, social security payments and unemployment benefits will
increase Government expenditure, leading to budget deficit.
Stabiliser
Cyclical component is the result of automatic stabiliser which reflects on the economic
conditions, ie economic boom or recession
Automatic stabiliser can be used to offset the extremes of business cycle. (e.g.
unemployment benefits and progressive income tax). These are sensitive to changes in the
level if economic activity.
Automatic stabilizer 1:
Unemployment Benefits (as automatic stabilizers) expenditure is expected to increase during
recessions. This is such that people who are unemployed can have an income to survive and
can make a contribution to aggregate demand which can reduce the impact of a recession.
Automatic stabilizer 2:
Progressive Income Tax is expected to increase during economic boom. This is a reflection
on the taxation rate such that as people are earning a higher income, they have to pay higher
taxes. In periods of recession, tax revenue will fall.
Impact
Changes in Budget can have the following impacts:
1. Economic Activity
2. Resource use
3. Income Distribution
4. Savings & Current Account Deficit
Economic Activity Impact
The stance of a Federal Budget (impact of budget) should be compared with the previous
budget:
• Expansionary. It can be a larger budget deficit or smaller surplus. This is to increase
the level of economic activity.
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•
•
Contractionary-It can be a lower budget deficit or a larger surplus. This is to reduce
the level of economic activity.
Neutral-Tax Revenue (T) minus Government Expenditure (G) is same as previous
year. This is rarely the case with no effect on the overall level of economic activity.
Resources Impact
Fiscal policy can affect resource allocation depending on the government expenditure and
revenue source.
E.g.:
• Remove taxes on ethanol production will encourage farmers to use ethanol.
• Increase taxes on tobacco products can discourage people from using these products
and reduce health care costs in the long run.
Income distribution Impact
Australia’s progressive tax system is designed to create a more equal distribution of income.
This is such that higher income earners should pay higher income tax rate. Government
can use the higher tax revenue to assist people on lower income (redistribution of income
from high to low income earners). E.g. social benefits.
A reduction in Government expenditure can increase income inequality because low
income earners often rely on government support to survive.
Saving and current account deficit impact
In the long term, budget deficit (dis-savings) will decrease national savings (public &
private savings) because Government needs to finance the deficit by borrowing from private
sector savings.
A budget deficit can have a crowding out effect where it is harder to access funds with an
upward pressure on interest rates, reduce private sector spending and investment.
Alternatively, Australia can use overseas source of funds to finance the deficit, which might
increase foreign debt.
Impact of fiscal policy
The time lag of Fiscal Policy is often short term 3-6 months to realise the impact.
Impact of recent fiscal policy
The fiscal policy can have an impact on:
- Economic growth (Stimulus package around GFC has improved growth. Since 2010,
the budget is a surplus to sustain the level of debt)
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-
-
-
E.g. 2009 growth rate was 1.4% due to the package; due to 2020 pandemic, the
stimulus (including Job Keeper etc) has propelled a fast recovery from a recession to
4.5%.
Unemployment (during the GFC global downturn, Australia unemployment rate only
increased by 1.8%, whereas US was between 3-6). 2016 Youth Employment
package,2015 childcare subsidies, 2021 increase if tax free threshold, 2011 paid
parental leave, have helped Australia to a sustainable low employment rate.
Since the pandemic, with the help of Job Keeper and Job maker, unemployment rate
has fallen from 7.5% (April 2020) to 4.5% (June 202)
The budget aims to improve the efficiency of resource allocation. Government
expenditure and tax revenue should be effective in directing resources where they are
needed.
Government can reduce subsidies to domestic industries and privation to enhance
efficiency.
National Savings & CAD. Budget Surpluses can increase national savings whereas
deficit can reduce savings. Often a higher level of household savings with reduce
CAD (or improving CAS), however, the impact of the budget on the current account
is not as direct.
Income Distribution. E.g. increase Medicare levy to 2.5% and reduction in
superannuation concessions for high income earners can redistribute income from the
rich to the poor. During the pandemic, increase in COVID payment and pension
support to low income earners.
Cyclical influence on the budget
Cyclical influence reflects on the status of the economy (recession or growth).
In period of recession or slow growth (2008-2010), the budget deficit has increased. During
this period, there was a collapse of tax revenue from 25% to 22% of GDP (2007-2010). The
amount of support payment has increased during that period.
Due to the pandemic, there was a severe cyclical downturn in the economy with record falls
in business investment and household consumption. With the automatic stabilisers, tax
revenue has fallen dramatically and social welfare payment has increased.
Terms of Trade had a strong impact on the fiscal balance.
A 10% drop in the price of Australia’s major exports will increase budget deficit by $5.4b as
company’s profit will decrease in the short run. However, in the long term, export revenue
should increase due to enhance competitiveness.
Structural influence on the budget
Structural influence is about government’s policy decisions.
• General trend of increase in Government Expenditure. This rose from 22% of GDP
to now > 26% of GDP. This includes the large expenditure on Job Keeper during the
pandemic to maintain employment.
• General trend of decrease in Taxation Revenue (leading to deficit). In 2021, tax
revenue has decreased by > $25b.
• Aging Population: this leads to reduction in Tax Revenue (as they are less capable to
work) and increase in Government Expenditure (especially in the provision of Aged
Care).
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Methods of financing budget deficit
1. Borrow funds from the private sector by selling government securities. E.g.
bond/debt financing.
However, there is Crowding Out Effect: By selling government securities, there will be less
money supply which increase pressure on interest rates, hence, reduction in spending &
business investment. This will crowd out the private sector investors who cannot borrow at
higher interest rates.
In recession, this effect is less likely since investment would be low during a recession.
2. Borrow from the RBA (or printing money). This will ultimately increase money
supply in the public.
If this method is used too often, it can reduce business and consumer confidence and also
leading to a depreciation of the currency.
Since the deregulation of the financial market, the Australian Government had not used this
method such that it does not want to increase money supply which stimulates inflation.
3. Sell government assets. E.g. land and shares. Government can create cash surplus by
selling assets.
4. Borrowing from overseas (or sell securities to overseas): which can minimise
crowding out effect and can stimulate economic growth. However, the level of foreign
debt will increase.
The interest payments will become a debit on Net primary income on balance of payment,
which can lead to current account deficit.
Methods of using budget surplus
1. Retiring (or pay off) public debt.
2. Accumulate surplus to finance future expenditure or to fund current tax cuts.
3. Repay accumulated overseas debt. This can reduce the level of government debt
and interest expenses. The net primary income deficit will reduce as well.
4. Deposit with the RBA
Monetary Policy
Monetary Policy is the tool of the Reserve Bank to influence the cash rate or interest rate by
buying or selling of government securities.
This is referred to Domestic Market Operations (DMO).
The Monetary Policy is used to achieve the main economic objectives (especially the big 3).
1. Price Stability:
What is the targeted inflation rate of RBA?
Recall: Underlying inflation rate removes one off seasonal or volatile factors (e.g. high food
prices due to drought, oil prices etc…)
A lot of developed economies have implemented inflation targets to ensure price stability
and stabilise global economic activity.
In Short-Medium term, Monetary policy is the major tool used to reduce inflation, stimulate
employment and to sustain economic growth.
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2. Economic Growth:
RBA’s objective is to achieve sustainable economic growth such that employment
opportunities increase, real wages rise, improvement in standard of living without any
increase in inflationary pressure or deterioration of balance of payment.
Australia has enjoyed nearly 3 decades without hitting recession until the pandemic.
3. Full employment:
RBA’s objective is to have the unemployment rate close to NAIRU (4-5%).
The Australia trend of unemployment has gradually declined since the early 1990s.
It could be argued that the trend is due to effective Monetary Policy to control inflation and
efficient Microeconomic reform.
Implementations
RBA can influence cash rate by buying or selling of Commonwealth Government Securities.
3 possible stance:
• Tighten or Contractionary stance: RBA sells government securities (decrease
money supply) to increase cash rates to slow down economic activity & inflation.
• Loosen or Expansionary stance: RBA buys government securities (increase money
supply) to decrease cash rates to stimulate economic activity & increase employment.
• Neutral: no change.
AS RBA buys/sells securities, the level of Money Supply will be affected.
Money Supply refers to the total amount of funds in an economy (i.e. the level of cash in the
economy).
Everyone should know that RBA’s interest rates ≠ to interest rates charged by the banks (e.g.
NAB, ANZ)
RBA doesn’t directly control the bank’s retail rates (or the market interest rates) charged to
customers. RBA only sets short-run interest rate or Cash Rate (paid on overnight loans).
Any changes in Cash Rate will (and should) influence the general market’s interest rates.
Monetary
Policy Stance
Government
Securities
Money
Supply
Cash Rate
Market
Interest Rates
Tightening
RBA Sells
Decrease ↓
Increase↑
Increase ↑
Loosening
RBA Buys
Increase ↑
Decrease ↓
Decrease ↓
Impact
Fall (↓) in Interest Rates:
• It means it is getting cheaper to borrow for both consumers and businesses. Hence,
this will stimulate Consumption (C) and Investment (I) and discourage savings.
• As Consumption (C) and Investment (I) increase (↑), Aggregate Demand (AD) will ↑.
Businesses will need to hire more people (hence ↑ in employment), and individual
general income will ↑ which can improve living standards.
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•
As AD ↑ due to Consumption (C) and Investment (I), this can lead to Demand Pull
Inflation.
Fall (↓) in Interest Rates:
• Discourage financial inflows from foreigners, ↓ demand for AUD hence AUD
depreciates(less confidence of return from investment). As AUD depreciates, cost of
import will rise, short term revenue of exports will drop. But in the long term, our
exports can become more competitive.
• Asset prices (e.g. property & shares) face upward pressure as borrowing & spending
on acquisition of assets are encouraged.
Rise (↑) in Interest Rates:
• It means it is getting more expensive to borrow for both consumers and businesses.
Hence, this will discourage Consumption (C) and Investment (I) but encourage
savings.
• As Consumption (C) and Investment (I) decrease (↓), Aggregate Demand (AD) will ↓.
Businesses are not motivated to hire more people (hence ↓ in employment), and
individual general income will ↓ which can deteriorate living standards.
Rise (↑) in Interest Rates:
• Encourage financial inflows from foreigners, ↑ demand for AUD hence AUD
appreciates (more confidence of return from investment). As AUD appreciate, cost of
import will drop, short term revenue of exports will increase. But in the long term, our
exports can become less competitive.
• Asset prices (e.g. property & shares) face downward pressure as borrowing &
spending on acquisition of assets are discouraged.
Recent trends
Australia’s interest rates for the past 3 decades has significantly declined from 17.50% to
0.1%.
On 3rd May 2022, it has raised interest rates for the 1st time in more than a decade by 0.25%
to 0.35%.
RBA’s decision has varied in respond to different economic conditions.
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5 factors on the stance of Monetary Policy:
1. Sustainable inflation target (2-3%). If it is higher than this range, RBA might drop
interest rates.
2. Inflationary Expectations. If high inflation expectations, RBA will rise interest
rates.
3. Labour Costs. Changes in labour costs will have a direct impact on inflation, hence,
RBA will intervene when needed.
4. Maintain economic growth & reduce unemployment.
5. External Factors. If global economic conditions deteriorate, Australia’s economic
growth will slow as well.
Effectiveness
•
•
Monetary Policy can have a lagging effect (not as long as Fiscal) of 6-9 months to
impact on economic activity.
Often, tightening monetary policy have a more drastic effect than easing
Unconventional
•
•
•
Unconventional Monetary Policy are other tools that the Reserve Bank used to
stimulate the economy.
This can be when the interest rates are so low (0.1% before), but the Reserve Bank
still has to stimulate the economy due to the pandemic.
The most common tool is Quantitative Easing (QE or Printing Money): Central
Bank creating new money electronically and then injecting into money supply by
buying assets (e.g. Government Bonds) from the fund managers or retail banks. This
aims to increase borrowing, stimulate the economy in the private sector.
Microeconomic Policies
Microeconomic polices are policies aimed at specific industry, or structure of the economy
with the aim to increase aggregate supply by improving efficiency and productivity of
producers
Microeconomic policies are mainly dealing with structural change, especially change in
production change in production that reflects changes in technology, global competitiveness,
and consumer demand. Some industries can collapse as a result of macroeconomic policies.
the main purpose of microeconomic polices (management) is to increase real income and
standard of living by improving market efficiency. This is achieved by redistribute and
reallocate resources effectively and efficiently.
This can improve the level of productivity and enhance international competitiveness.
In a micro-economy:
- Market are interrelated
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-
Some changes can occur instantly, some have time lags
Micro reforms is one of the top priority for the federal government
Microeconomic and macroeconomic policies work hand in hand
Objectives
1. Allocate resource efficiently
2. Achieving technical efficiency
3. Maintaining dynamic efficiency
Allocate resources efficiently
Allocative efficiency is the economy ability to shift resources to where they are most valued
and can be use most efficiently.
If an economy is operating along the production possibility frontier (PPF), then resource are
allocated efficiently.
If the PPF shifts outwards, it means the economy has increased the productivity potentials.
E.g. new resources, capital, skilled labour.
If the PPF shifts inwards, it means the economy has decreased the productivity potentials.
E.g. depletion of resources.
Allocative efficiency is whether an economy can direct resources so that it can be utilised
effectively and efficiently.
In a free market, resources should be allocated to producers who can achieve efficiency in
production
e.g. removal of trade of tariffs has led to a reallocation of resources away from inefficient
producers.
Technical difficulties
Technical efficiency refers to whether an economy can produce the maximum amount of
output with a given quantity of input (e.g. labour, capital).
The aim is to achieve economies of scale. This is such that the unit cost of production can be
minimised and can be more competitive.
E.g. using the latest technology to replace employees).
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Dynamic efficiency
Dynamic efficiency refers to whether an economy can allocate resources between industries
when there is a changing consumer pattern, i.e. the level of adaptation.
E.g. innovation, government regulations, increase competition.
Firms that are dynamic efficient should be able to use new technologies and innovative
practices.
Structural changes
Structural changes can be either:
- Market induced
- Government included
Market induced structural change
Historic market induced structural change include:
- Increase focus of service sector as a contributor to GDP and employment
- Technological changes and the use of ICT can lower cost of production
- Globalisations and increase foreign trade
- Growth of China and other Asian economies which affect Australia’s trade patterns
- Changing nature of jobs
Government induced structural changes
Historic government induced structural changes include:
- Strengthening competition to raise efficiency and reduce consumer prices
- Reduce tariffs to increase competitiveness of Australia’s good and services
- Privatisation and deregulations
- Reforms in capital and labour market
- Simplify tax systems and lower tax rates
Reasons of economic reform
-
Microeconomic management can improve aggregate supply in the long run and hence
improve productivity and lower inflation
It can increase real income which can promote economic growth and improve
standard of living
Preventing a lack of competitions
Discourage underemployment of resources
Reduction of current account deficit (CAD)
Examples of microeconomic policies
-
Increase incentives for investment and innovation
Changes to industrial relations
Reduce the level of government intervention and protection
Improve government enterprise efficiency (e.g. privatisation).
Encourage competition
Reforms
Deregulations
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Effect of microeconomic polices on AS
If microeconomic policies are successful, AS will increase, i.e. shift the curve to the right
Any increase in AD without an increase in AS, will lead to inflation.
Shift in AS to the right will lead to more production and a lower price. This can be higher
productivity or increase resource usage.
Labour productivity
Labour productivity was the highest in the 1960s, gradually decreasing until the 1980s. from
the 1990s to 2008, it has increased faster than the majority of the OECD countries. This
improvement due to:
- Increase capital per worker
- Improvement in the quality of labour (i.e. employees are educated and better trained.)
- Improvement in efficiency
In recent years, it has generally increased which is linked to Australia’s moderate economic
growth. Although the pandemic has led to decline, but this has picked up gradually.
Reforms in product market
-
National competition policy: encourages competition and monopolies are monitored
by ACCC.
Trade and industry policy: removal of tariffs & quotas to promote competition,
improve efficiency and increase exports volume
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-
Tax reforms: a more efficient and equitable tax system which can increase
productivity, savings and investments. GST aims to redistribute resources
effectively. Increase of the tax-free threshold
Labour market reform: Australian workplace agreement (AWA) allows enterprise
bargaining (such that employees who are more productive, skilful and competitive can
bargain for higher wage), ending compulsory unionism, relax the unfair dismissal law.
Reform of Australian financial system: the financial deregulation, floating of
exchange rate, open market operation to conduct monetary policy, allowing entry of
foreign banks. This allows greater access to overseas capital market and attract
foreign investment as the financial markets in more competitive.
Regulation, deregulation & competition policy
Reasons for regulations:
- Income protection (e.g. minimum wages) might be necessary for protection of
Australian families such that they survive. However, this might discourage employee
from being productive.
- Public monopolies are preferable to private monopolies as they are operated by the
government with high level of accountability
- Regulation can prevent high level of foreign ownership & control of Australian
assets.
Reasons for deregulations
-
Deregulation is the removal of restrictions in market operations
Regulatory policies involved large administrative and compliance costs
High opportunity cost due to inefficient use or wasting resources
Examples of deregulations: financial system, airline industry, telecommunication
industry.
Privatisation
Privatisation refers to the sale of government businesses or industries to private ownership
& control. E.g. Telstra, Qantas, Energy Australia, Commonwealth Bank.
Privatisation can improve the efficiency of management.
Benefits of Microeconomic Reform
-
Increase productivity and efficiency
Lower inflation
Increase saving by implementing superannuation
Reduce CAD due to enhanced competitiveness
Sustainable rate of economic growth die to high level of productivity
Reduce unemployment when jobs are create in expanding or new industries
Higher living standards
Costs of microeconomic reform
-
Increase structural unemployment with high level of redundancy
Increase short term unemployment
Closure of insufficient businesses
If reforms are implemented too quickly without adequate planning, it might be hard
for the society to adapt
High retaining costs
Ultimately, it can lead to unequal distribution of income and wealth
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Labour Market Policies
Labour market policies are Microeconomic polices that can affect the quantity of demand,
quantity of supply and labour markets.
This can include industrial relations policies which can regulate wage determination, training
and education to help the unemployed.
Since this is a Micro Policy, the ultimate aim is to redistribute resources to increase
efficiency, economies of scale, productivity and income
Industrial relations (or workplace relations) is the system to determine the working
condition and the appropriate level of remuneration between employers & employees in
Australia,
The Australian Government aims to achieve the following objectives:
- Control wage demands & expectations from unions. This is in order to sustain
inflation (ie prevent cost push inflation)
- Protect income and working conditions of employees (ensure fair distribution of
income)
- Resolve industrial disputes
- Promote reform of labour market by common law contract, enterprise agreement and
modern awards.`
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National & State
Employers have to comply with both the state and federal system of industrial awars to
ensure employees are treated and paid fairly (e.g. min wages). Since employers need to
comply both the state and federal system, this is inefficiency
Fair Work Act (2009) is now covering all private sector employees for most of the state
expect (WA)
Commonwealth level has replaced most state-based awards system with simpler federal
awards (including OHS legislation).
Wage determination system
Australia’s national wage determination system covers around 71% of employees or 9m
employees. The rule for this system are set out in Fair Work Act 2009 include industrial
awards, collective agreements and individual employment contract
The other 29% can still be influenced by the national system. E.g those whose condition are
unregulated, those regulated by the state and WA employees
National Employment Standards (NES)
1. Maximum weekly work hours: 38
2. Parents/carers of children<18 years old can request flexible working arrangements
3. Up to 12 weeks of unpaid leave for parents
4. Minimum 4 weeks (20 working days) of annual leave per year
5. 10 days of paid & 2 days of unpaid Personal Leave per year.
National Employment Standards (NES)
6. Unpaid leave for voluntary community service. 10 days of leave for jury duties.
7. Long Service Leave (usually 3 months after working at the same place for 10 years)
8. Public Holidays are paid
9. 4 weeks notice of termination is needed & 16 weeks of redundancy pay
10. Provide a statement of employees’ rights & responsibilities.
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Minimum wage
The minimum wage panel in the Fair Work Act Commission sets the minimum wage
(reviewing it annually). This is to protect the low-income earners (especially not covered by
an award) to ensure they can survive
The panel considers various economic social factors when setting the minimum wage. E.g.
inflation, level of national competitiveness
This has increased by 2.5% in 2021
What is the impact on real wages??
Awards
Awards are set of minimum pay and working conditions specifically for an employees works
and industry including minimum wage, overtime, penalties, allowance etc. This is determined
by the Fair Work Commission.
There are 121 consolidated awards (or modern awards) for different industries.
Enterprise agreement
Workplace agreement is the negotiated wage and working conditions between employers and
a group of employees (sometimes represented by unions)
Employers can be required to engage in bargaining discussion if most employees agree to
seek a collective agreement. This covers around 35% of Australian employees.
All workplace agreements must comply with the national employment standards (NES) and
must pass the Better Off Overall Test (BOOT) such that employees are better off by the
agreement when compared to an award.
Employment contracts for high income earners
Under the Fair Work Act, employees earning >$158.5K p.a are only covered by the common
law contract (i.e. individual contract with the employer by negotiation & the 10 NES)
Modern awards do not cover high income earners because it is believed
that protection is only needed for low-income earners.
Dispute resolution
Industrial disputes occurs when actions are taken to disrupt production process due to
disagreement between employers and employees. E.g. strikes, lockouts. Since the 2000s, the
amount of days lost due to disputes have significantly declined.
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The aim to resolve these disputes efficiently, quickly and in a fiar manner to prevent loss of
productivity.
Reasons for disputes/disagreements can include: wages, working conditions, business
restructiong, unfair actions etc.
3 main firm of dispute resolution process:
1. collective bargaining: conflicting parties try to reach an agreement by negotiations
2. conciliation: a third party (industrial tribunal) helping both side to reach a mutual
agreement by suggestions
3. arbitration: a third party (industrial tribunal) makes a ruling to resolve the dispute
which both parties must legally comply.
The Fair Work Commission will intervene to solve dispute if:
- awards and enterprise agreement did not explain the process when there is a dispute,
or if both parties cannot resolve the dispute themselves
- if good faith obligation (e.g. participate in meeting, disclose relevant information) are
not followed
- industrial action is causing significant harm to the economy or society.
The gradual decline of disputes could be explained by:
- changes in employer/employee relation
- change in industry structure
- low level of union membership and power
Decentralisation of Labour Market
Nowdays, wages are mainly determined by enterprise bargaining between employees and
employers (i.e using market forces) not government and unions. This method is a
decentralised labour market system.
Centralised labour market is where wages and conditions are conditions are determined by
the government or tribunals.
Argument for decentralised system:
• Allocates resources more efficiently with structural changes as it improves flexibility
of operation.
• Real Wages can rise faster for those who are more skilful and productive.
• Employees are motivated to work harder and more efficient, i.e. increase in
productivity.
• In recessions, decentralised system can allow wages to fall. This can reduce potential
high unemployment in recessions as firms are less motivated to hire new staff.
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Argument against decentralised system:
• Leads to income inequality. Especially when workers doing the same job but in
different industries or firms. In some industries, employees have less bargaining
power.
• Less protection on employees who are disable, have language barriers or with low
skills.
• In period of strong economic growth where employees have higher bargaining power
of wage rise, this can lead to cost push inflation.
• Hard to enforce wage entitlements as some firms might classified their staff as
“contractors”
Education, training and employment programs
Successful education should prepare students with a broad range of skills to ensure they are
ready for employment with skills. This can improve productivity and enhance
competitiveness.
However, there is often a large discrepancy of mismatch in labour skills with education.
Government strategies on education & training include:
• Increase trades training centres or VET for students who want to pursue a career in
trades
• Increase the school retention rates or compulsory years of schooling
• Increase standards for early childhood education
• More general funding for schools (e.g. Gonski 2.0 reforms of funding up to $23.5b).
• Increase placements for apprenticeships
Labour Market Programs aim to increase participation & productivity of labour market.
There are programs which might help people finding suitable work. Especially for people
with disability, mental illness, language problems etc.
JobActive or New Employment Services Model is a network of employment service
agencies. It provides funding to agencies who can place unemployed people with suitable and
sustainable jobs. Agencies are paid based on the number of job placements that can be
matched.
Ultimately, it aims to increase the Labour Force Participation Rate. This can be:
• JobMaker program-businesses can claim credit by hiring young employees
• Increase Apprenticeships
• Subsidies for business to hire those at risk of long-term unemployment
• National minimum scheme for paid parental leave to encourage female workers
Ultimately, it aims to increase the Labour Force Participation rate. This can be (cont.):
• Childcare subsidies to increase female participation.
• Increase restrictions on unemployment benefits
• Training for younger population to improve their skills
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