Understanding Australia’s Place in the Global Economy

Why does Australia’s place in the Global economy matter?

To understand the impacts of changes in the global economy on the Australian economy, you need to consider the linkages between Australia and the global economy, that is:

• Australia’s trade patterns and trade policies• Australia’s financial relationships with o/s

countries• Influence of the exchange rate on the structure

and performance of the Australian economy.

Why does Australia trade?

• Australia has natural resources that are demanded by other countries

• Our small population means we can not produce all our wants and we seek new technology and other items from other countries.

Australia Produces <2% of world economic output

Of this 2% of world production, Australia exports

25% of it’s production

Rest of world Production

Australian

Production Exports

Other

We import 25% of what we buy

Imports

Other

So, although we have little influence on the Global Economy, the Global Economy has a significant influence on us!

Australia’s trade patterns

• 1950s – Aust traded mainly with UK & other European countries

• More recently, Aust has increased its exports to China, South Korea and ASEAN counties

• This trend was a result of the UKs membership of the European Union (EU) which forced the UK to impose trade barriers on Aust

• Aust responded to trade barriers by looking for export markets within the Northern East Asian and ASEAN countries

• By 1960, Japanese economic growth was creating demand for product inputs such as minerals resulting in an increasing demand for Aust’s natural resources

• As growth in Japan slowed, Aust began trading with countries experiencing high levels of growth

• The Asia-Pacific is now the most important export market to Australia – by a significant margin

• Exports to Japan peaked in 1980s

• Trade with South Korea, China and ASEAN countries has grown rapidly

• US & EU remain import sources of imports for business inputs and commodities

• Japanese imports have reduced have the size since 1980s

• Over the same period, imports from other countries in the East Asian region have almost quadrupled

Changing composition of trade

• Aust exports have always been predominantly from primary industries due to our comparative advantage

• Agricultural products eg wheat, wool and beef• Mineral products• Aust is less competitive in manufacturing

markets and has continued its reliance on primary industries

• High income economies have generally developed their manufacturing industries in the latter half of the 20th century

Composition of Imports has changed only moderately

Year K goods (%) Cons goods (%) Int goods (%) Services (%)

1981-82 18.1% 15.5% 43.0 23.5

1986-87 19.1 17.2 39.9 23.8

1991-92 17.2 19.8 37.4 25.6

1996-97 18.2 20.5 37.7 23.6

2001-02 17.5 24.1 37.0 21.4

2002-03 18.8 24.6 36.7 19.9

2004-05 18.9 24.8 35.6 20.7

2005-06 19.0 23.9 37.7 19.5

2006-07 18.1 24.1 38.8 19.5

2007-08 18.0 23.2 39.7 19.0

2008-09 18.4 21.9 39.4 20.0

Sources ABS Catalogue 1350.0

Year K goods (%) Cons goods (%) Int goods (%) Services (%)

1981-82 18.1% 15.5% 43.0 23.5

1986-87 19.1 17.2 39.9 23.8

1991-92 17.2 19.8 37.4 25.6

1996-97 18.2 20.5 37.7 23.6

2001-02 17.5 24.1 37.0 21.4

2002-03 18.8 24.6 36.7 19.9

2004-05 18.9 24.8 35.6 20.7

2005-06 19.0 23.9 37.7 19.5

2006-07 18.1 24.1 38.8 19.5

2007-08 18.0 23.2 39.7 19.0

2008-09 18.4 21.9 39.4 20.0

Sources ABS Catalogue 1350.0

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This all means that…

• Australia’s composition of imports has been relatively stable of the past three decades

But what about exports?

Balance of Payments

• The record of all transactions between Aust and the rest of the world over a given period

• Consists of the current account and the capital and financial account

Current Account

Shows receipts and payments for:

• Goods and services

• Transfer payments

• Income flows between Aust and rest of world over a given period

These transactions are NOT reversible!!!

Balance of Payments: Record of all transactions between Australia and the rest of the world

over a period of time

Current Account:Shows receipts and payments for:

Goods and servicesTransfer payments

Income flows between Aust and rest of world over a given period

These transactions are NOT reversible!

Capital & Financial Account:Shows the:BorrowingLending

Sales and purchasing of assetsBetween Aust and rest of

world over a given period of time

These transaction ARE reversible!

Capital and Financial Account

Shows the:

• Borrowing

• Lending

• Sales and purchasing of assets

Between Aust and rest of world over a given period of time

Aust’s BOP Current AccountType of Transaction Debit (payment

abroad)Credit (payment to Australia)

Exports of goods

Imports of goods

Exports of services

Imports of services

Int & profits payable by o/s residents

Int & profits to o/s residents

Source: Economics HSC. Cambridge, p.125

Aust’s BOP Current AccountType of Transaction Debit Credit

Exporting iron ore

Importing clothing

Donating to o/s charity

Tourists coming to Aust

Int paid on o/s loan

Int paid on

Source: Economics HSC. Cambridge, p.125

Financial Inflow

Supply of foreign

exchange

Reliance on raw materials

• Australia’s exports are very heavily reliant on commodities (raw materials).

• Demand for these products does not grow quickly and are usually highly influenced by fluctuations in the world economy.

• Many of our imports are capital products. • This means that whenever Australia wants

to expand, it will increase imports of capital, thus worsening the trade position.

Demand for AUD

Represents all those people who want to buy AUD, including:

• Investors who wish to invest their money in Australia will need to convert it

• Trading partners who wish to purchase our goods and services need to convert their currency to complete the transaction

Trade Flows

• Money moving into or out of a country as a result of global trading

Australia

Money flows out of Australia as a result of importing

Money flows into Australia as a result of exporting

Importing

• Adds currency of the importing country to the market

• Creates demand for the currency of the exporting country

• Because goods are typically purchased in the currency in which goods are produced, so importer must exchange their currency

Effect of trade

• Countries who rely heavily on imports will see a weakening effect on their currency

• Export oriented countries will have a strengthened currency

How do we value a currency over time?

• Measuring a currency against one other currency is misleading as both currencies will be moving for a number of reasons

Trade Weighted Index (TWI)

• Provides an indication of the value of the $A against the currencies of Australia’s major trading partners

• In Sept each year, the RBA measures the TWO based on the volumes of trade for the previous financial year

• The TWI must cover at least 90% of Australian trade

Limitation of TWI

• Weighted according to volumes of trade irrespective of the currency in which export and import contracts are invoiced

Reserve Bank Intervention

• A dirty float

• Fixed exchange rates

• Managed flexible peg

• Floating exchange

A dirty float

• RBA intervening potential volatile deviations are likely and will have harmful effects pon the domestic economy, it acts as a buyer or seller to stabilise the $A

• If $A is deteriorating rapidly, the govt will buy $A

• If the $A is appreciating rapidly, the govt will sell $A

Reality Check

• In second half of 2008 the $A depreciated by a third of its value to the $US

• The RBA purchased $3.3 billion $A to depreciate the economy

• The RBA sold the currency when the $A recovered in value

• This generated profits for the govt

Flexible Exchange Rates

• Prior to November 1976

• RBA officially sets exchange rate (not the market)

• RBA sets rate by either buying or selling $A in the forex market

• Therefore, the govt requires foreign reserves of foreign currency and/or gold to make the trading possible

Fixed Rate to appreciate the $A

D

S

90c

80c

Q1 Q2

fixed rate

market rate

• Govt buys foreign currency in exchange for the $A

• In this case, the govt is buying the excess supply ie Q2-Q1

• $A increases from 80c to 90c

The managed flexible peg

• Operated in Australia from Nov 1976 to Dec 1983

• RBA ‘pegged’ the value at 9am each day and that price would operate throughout the day

• Provides more flexibility than the fixed rate• Does allow the rate to move away from

what it would have been if determined by market forces

Negative Effects of an appreciation

• X become more expensive resulting in demand, resulting in X income and deterioration of CAD in medium term

• M become more attractive, M spending worsening CAD.

M spending and X rev will ec growth• Foreign investors are deterred from investing,

financial inflows (depending on speculation)value of foreign income earned on o/s

investmentsvalue of foreign investments

The following graph shows a movement in the supply and demand of $A against the $US on the forex market.

Which of the following may have caused a shift in demand for the $A from DD to D1D1?

a) A drop in tourism into Australiab) A drop in interest rate levels in the Australian economyc) An appreciation in Australia’s exchange rated) A significant boost in Australian export sales due to an

Austrade promotion

D1

D

S

Price of $A in $US terms

Quantity of $A

Govt initiatives to reduce protection

• Gradual decline in average tariff levels since late 1960s

• Whiltam announced in 1973 a 25% reduction across the board on tariffs

• 1988 comprehensive program of trade liberalisation

• Aust in the last decade has reduced tariffs faster than any other advanced economy (excl NZ)

Today

• Approx 50% of all imports are tariff free

• Mostly manufactured goods are subject to tariffs of 5% or less

• 2007, average tariff levels across all goods and services was 1.8%

• Equating to $9.2 billion in 2007-08

• Similar to other industrialised economies such as US (1.6%) and EU (1.8%)

Today (cont)

• Aust one of the least protected economies in the World

• Well beyond those required by international trade agreements eg WTO

• Therefore, Aus unlikely to face additional obligations after completion of the next Doha round

• APEC has not had significant impact on Aust protectionist policies as it aims to achieve free trade in developed countries by 2010 but as there is no binding agreement, this has not occurred.

Implications of reduced levels of protection

• Firms