Australia’s Place in the Global Economy (Topic 2 Economics)

• Australia is known as a small, open, attractive, and wealthy economy that produces approximately 1.7% of world economic output with only 0.3% of the world’s population.
• Australia’s trade balance is the difference between exports and imports is currently positive. As of October 2023, the trade surplus is 7.13 billion.
• Australia’s major trading partner up until the 1960s was the UK, 50% approx. of exports. Japan was then the biggest export market between 1975–2005 at 25%. China then rose during the mining boom post-2005 to 32.6% of Australian exports.
• Australia has a comparative advantage in: • Commodities (e.g. iron ore, coal, natural gas, and gold, which make up approximately 30% of exports) • Agricultural products (e.g. wheat, beef and wool) • Services (e.g. tertiary education and inbound tourism)
• As of the beginning of 2020, Australia completed 28 years of annual economic growth (before mid-2020), making it one of the few economies in the post-WWII period to achieve this. Australia’s avoidance of recessions can partly be attributed to the reduced levels of protection during the 1980s, encouraging exports and imports. Australia’s trade (as a percent of GDP) increased from 12% in 1980s to 22% in 2018.
• As of 2020, the Australian dollar is the fifth most traded currency
• Equity: refers to the ownership of money or the money of other owners/investors.
• Net foreign equity: is the difference between foreign investment and Australian-owned foreign investment (A – B). Total value of foreign-owned assets (forms, shares, land, property etc.) in Australia minus total value of assets (firms, shares, land etc) owned by Australians overseas
• Direct investment: is when a business purchases a substantial (greater than 10%) share of an existing business or start a brand new business overseas. Portfolio investment is owning a smaller proportion of the business (less than 10%). It can involve owning a small proportion in a range of different assets.
• Net foreign debt: is the difference between loans (A – B). Total value of foreign loans to firms/banks in Australia “borrowing by us” minus The total value of loans made by Australian banks to firms overseas “lending from us” • Net foreign liabilities = net foreign equity + net foreign debt. This represents what foreign investors owe or contribute to an economy.
• The Balance of Payments (BOP) is the record of transactions between Australia and the world, during a given period. A credit is money that flows into Australia (think of it like using a credit card, where you are able to access an increased amount of money; hence it is an inflow). A debit is money that flows out of Australia (think of it like a debit card, which removes money from your savings account; hence it is an outflow).
• The Current Account + Capital and Financial Account = 0 must always be true.
• The Current Account reflects current transactions, which are transfer of payment. The CA represents income which is non-reversible transaction
• Hence, if there is a Current Account Deficit (CAD), then there must be a Capital Account Surplus (as both accounts balance and are hence opposites of each other).
• The Capital and Financial Account (KAFA) records foreign financial and investment transactions, including borrowing, lending, sales and purchases of assets. These are reversible transactions e.g. assets can be resold. A capital inflow (credit) refers to the sale of a domestic asset to foreigners, or the receiving funds borrowed from overseas. A capital outflow (debit) refers to the purchase of a foreign asset, or the repayment of interest to overseas lenders.
• Financial Account: records debt (loans) and equity (investment) transfers. • Capital Account: records non-financial/produced transfers. These include capital transfers (foreign aid), net acquisition, and disposal of assets (such as intellectual property and copyrights).
• The KAFA and CA are inextricably linked. This is because every transaction that is recorded on one account has an opposite transaction in the other account. This is based on the exchange rate mechanism, where the supply of the AUD equals the demand for the AUD.
• Current Account Deficit (CAD) - The amount by which a country's imports exceed its exports.
• Current Account Surplus - A positive current account balance indicates the nation is a net lender to the rest of the world.
• For example, when individuals source funds from banks, a bank may source this money from overseas. Internationally borrowed funds are recorded under the KAFA as a credit (surplus). Money then flows back overseas as a debit when interest is repaid on this loan, to the overseas lender. This is recorded on the CA as a deficit. Hence, international borrowing and lending, which can increase investment in Australia illustrates a key link between the KAFA and CA of the balance of payments
• Surplus = credit, Deficit = debit
• The percentage of income saved in Australia was 2.8% in 2019. Due to this low rate of savings, and high demand in the form of consumption and investment, there was a high savings–investment gap. This gap must be made up by borrowing from overseas. This borrowing requires interest to be paid back overseas, which worsens the CAD.
• A paradox of thrift describes a situation where personal savings improve the CAD in the short-term, due to lower rates of overseas borrowing, however in the long-term, there is lower overall demand, worsening economic growth. Therefore, a CAD should not necessarily be considered as ‘bad’ for the economy, because it allows for increased investment and output, which can support economic growth.
• The terms of trade (TOT) is the relationship between export prices compared to import prices. A better TOT is achieved by an improvement in export values (prices) or quantities, and/or lower import values (prices) or quantities. According to The Department of Foreign Affairs and Trade (DFAT), during Australia’s mining boom period, the terms of trade reached their highest levels in 140 years. Terms of trade index = Export price index ÷ Import price index × 100
• Foreign investment is when investors from overseas purchase assets and firms in Australia. However, Australia must ensure that foreign investment only adds to current competition and doesn’t completely squander domestic production and firms. Therefore, foreign investment must be managed to ensure repatriation of income (profits paid to overseas investors) does not exceed domestic profits.
• A general rule is to ensure the CAD is less than yearly GDP growth – as this growth represents the increase in income in the economy, which can be used to repay foreign liabilities, ensuring the economy doesn’t experience debt sustainability problems. It can result in a decrease in investor confidence. This is referred to as the BOP constraint, whereby a high CAD can undermine the confidence of overseas investors in the Australian economy, which is then a constraint on future economic growth.
• Dutch disease is a concept that describes an economic phenomenon where the rapid development of one sector of the economy (particularly natural resources) precipitates a decline in other sectors. (Mining boom)
• Exchange rates are the value of a currency in comparison to other currency. A base currency refers to the first currency of a compared pair. The quote currency is the second currency of the pair. A floating exchange rate is when the value of a currency is determined by demand and supply (describes Australia’s current exchange rate mechanism, traded on forex markets).
• Trade Weighted Index (TWI) is the average value of the AUD compared to Australia’s major trading partner currencies, weighted according to their significance. Currently, the TWI is 61 (2019). This is not considered as ‘positive’ or ‘negative’ – rather, it illustrates the overall demand for the AUD. The higher the TWI, the higher the demand for the AUD.
• There are some limitations of the TWI. It is weighed according to volumes of trade, regardless of the currency in which the trade is invoiced (paid for) in.
• An appreciation is an increase in the exchange rate of one currency in terms of another. An appreciation of AUD occurs when demand increases and/or supply decreases. A depreciation is a decrease in the exchange rate of one currency in terms of another. A depreciation of $AUD occurs when demand decreases and/or supply increases.
• A fixed exchange rate is when the government or RBA officially sets the exchange rate for an economy. Before the floating of the AUD in 1983, it was fixed to the Trade-Weighted Index (TWI), after an analysis of the market by the RBA and the government daily. This meant the RBA had control over all movements in the dollar and could manipulate its value.
• Flexible Exchange Rates There are two types of flexible exchange rates: • Clean float: pure demand-supply model with no central bank intervention. This only exists in theory, as exchange rates can be very volatile without some intervention. • Dirty float: managed to a certain extent. The AUD is managed through some RBA intervention to modify highs and lows of the AUD (dirtying the float) to mitigate negative effects of high volatility. Managed exchange rate: refers to any official intervention by a government in setting the exchange rate
• • If AUD is too high, the RBA sells AUD reserves to increase supply, and decrease its value. • If AUD is too low, the RBA buys AUD reserves to increase demand, and increase its value
• • Interest rates increase → foreign savings in Australia increase → demand for AUD increases → AUD appreciates • Interest rates decrease → foreign savings in Australia decrease → demand for AUD decrease → AUD depreciates
• The Australia-US Free Trade Agreement (AUSFTA) is a comprehensive agreement that covers investment, government contracts, telecommunications, intellectual property rights, and the environment. In particular, the US wanted to sell more pharmaceuticals into Australia, and Australia wanted better access to their markets for agricultural products such as beef and sugar. The US is Australia’s third largest trading partner. Tariffs on all goods have been eliminated since 2015.