ECO- Growth- Essay - Grade: A PDF

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Economic growth essay...

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Examine the factors affecting Australia’s economic growth and the impacts on the Australian economy Economic growth is considered to be the most important measure of an economy’s performance. Economic growth refers to the increase in total output of an economy over a period of time and it is usually measured by the annual change in real Gross Domestic Product. The factors which affect Australia’s economic growth include: domestic and global income levels, level of investment, government policies and the quality and quantity of Australia’s factors of production (FOP). Changes in economic growth affect living standards, unemployment (u/e) rate, fiscal stance, inflation levels, external stability, the distribution of income and environmental sustainability. After experiencing negative growth in the September quarter, Australia avoided a technical recession (2 quarters of negative growth) with a GDP growth of 1.1% in the last quarter of 2016. This is caused by the resurgence in commodity prices and export values and a record high trade surplus of $3.5 billion in December 2016. Also, strong household consumption contributed 0.3% to quarterly GDP and increased public investment also promoted economic growth. However, some economists believe that slow wage growth would undermine household consumption in the future and can hinder Australia’s economic growth. Yet, other economists believe Australia’s service industry can help sustain Australia’s growth once it Australia’s economy has fully transitioned into a more tertiary based economy. Economic growth occurs duo to increases in both aggregate demand (AD) and aggregate supply (AS). Aggregate demand refers to the total expenditure on goods and services within an economy. The formula for calculating AD is: consumption (C) + investment (I) + government expenditure (G) + exports (X) – imports (M). A change in these components will influence the level of AD. Aggregate supply is the total productive capacity of an economy. It is affected by the quantity and quality (productivity) of the FOP in an economy. The level of consumption in an economy is affected by several factors. The most influential factor of consumption is the level of domestic income of an economy. Generally, people with higher income will consume more and if their incomes continue to rise, their consumption will also increase. This is because higher income earners have the ability to purchase more luxurious goods than low income earners. One factor which influences the level of income is Australia government’s fiscal policy which can manipulate tax rates. Any government policy that reduces taxation could increase household’s disposable income, usually leading to higher consumption. (Example from 2017 budget). Overall, Australian households have relatively high income which correlates to the high level of consumption at 57% of GDP in 2015. Another factor which affects consumption is an economy’s average propensity to consume (APC). APC measures the proportion of total income which is spent on consumption. Economies with a higher APC have a higher percentage of their income spent on consumption. Recently, Australia’s saving ratio, the proportion of disposable income which is saved, has dropped from 8.1% in 2016 to 5.2% in 2017 stemming from low interest rates. Considering that the average saving ratio for OECD countries are above 20%, Australia’s level of saving is significantly lower than other economies meaning the level of consumption is relatively higher than those economies. Changes in the stance of Australia’s monetary policy (MP) also affect the level of consumption. A tight MP (high cash rate leading to high interest rate) will discourage spending and borrowing (cost is higher) and promote saving (returns on savings become higher). Conversely, an loose MP will lead to low interest rate which promotes spending as savings become less attractive and will likely increase APC. During August last

year, the RBA lowered the interest rate to a record low of 1.5%, contributing to increase of household consumption in late 2016. Changes in the levels of investment also affect economic growth. Similar to consumption, low interest rate (from loose MP) promotes investment as it becomes cheaper to borrow funds for the purchase of capital equipment whereas an increase in interest rate would discourage investment as it becomes more expensive. Another influence of the level of investment is business expectation. When firms expect an increase in demand for their products in the future, they may choose to invest into capital in order to increase production to gain more profit in the future. This is seen during the mining boom, where foreign firms had high expectations for the Australian mining industry and led to high level of foreign direct investment into that industry. Also, the general economic outlook affects firms’ decision to invest. During the GFC, global financial uncertainty led to lower overseas business confidence which decreased foreign direct investment (FDI) into Australia by $15 billion during 2008-09. Similarly, weak global economic outlook and the slowdown of mining investment boom led to a minor drop in domestic investment in Australia from 27% to 25% of GDP in 2014 to 2015. Changes in the level of government expenditure influence the level of economic growth. Fiscal policy is a macroeconomic policy which adjusts levels of government expenditure and taxation in order to maintain a strong and stable rate of economic growth. Since government spending accounts for approximately one-fifth of AD, the changes in fiscal policy can have a significant impact on Australia’s economic growth. During the GFC in 2008, there was a loss of consumer and business confidence due to a contraction in the international business cycle which caused a huge decrease in AD in Australia. In response, the government injected two fiscal stimulus packages into the Australian economy in order to increase AD which helped the Australian economy to avoid a recession. (budget) Influences on the trade balance also affect Australia’s economic growth. A factor affecting the level of exports and imports is Australia’s exchange rate. A high exchange rate means Australia’s exports become more expensive relative to the global economy which will decrease exports. Meanwhile, a higher AUD means imports become relatively cheaper for Australia’s households which will increase import value. These changes will lead to a decreased economic growth. Conversely, a low exchange rate means Australia’s exports become relatively cheaper whilst imports become more expensive. Hence, exports will rise whilst imports will fall, leading to an increased economic growth. Since 2012, the depreciation of AUD from $1.1 USD to $0.77 USD (currently) has supported Australia’s exports and reduced imports which have contributed to Australia’s economic growth. On the other hand, the level of AS is determined by the quantity and quality of the factors of production (FOP). Factors of production refer to the input that used in the production of goods and services (land, labour, capital and entrepreneur). The main FOP of an economy is labour as currently most occupations still require high levels of labour involvement. The quantity of labour is usually dependent on the amount of people in the labour force and is measured by the participation rate. A factor which influences the size of the labour force is the population of the country. Australia has a relatively small population meaning the quantity of labour is minimal. The participation rate in Australia is currently 65%, which is relatively high in comparison to other OECD countries. This is because there is high level of government assistance towards promoting employment for the disadvantaged groups (disability and migrants).

The quality of labour, which is also the productivity of labour, is mainly influenced by the level of education and government microeconomic policies. Australia’s governments micro-economic policies such as education reforms and training programs increases the productivity of Australia’s labour workforce and contributes to economic growth. Despite a minor drop in labour productivity growth in 2016, it is recovering and has grown during the start of 2017. Moreover, other government policies and business innovation has improved the productivity of the other FOP. During the mining boom, an increased investment in capital equipment significantly increased the productivity in the mining industry and contributed to the strong growth during the early 2000s. Also, government expenditure into building new roads and infrastructure can improve transportation and communication, leading to an overall higher productivity in the Australian economy. (budget) A major benefit of economic growth is that it leads to an increase in living standards. Faster economic growth results in an increase in real GDP per capita. This may lead to an increase in real wages and households can then purchase more goods and services and enjoy a higher standard of living. Higher living standards will usually incorporate a higher quality of life as households can obtain better education, healthcare and recreation. Australia’s Human Development Index (HDI), a measure of a country’s economic development, has been increasing gradually by 0.24 index points annually over 2010-2015. Overall, households will be better off during fast economic growth. The slow growth in since 2012 correlates to the slow growth in Australia’s household income, where it grew by only $2000 per capita from 2014 to 2016. This leads to a minimal improvement in the standard of living in Australia. Another benefit of economic growth is that it creates jobs and reduces unemployment. Generally during times of economic growth there will be high levels of consumption and AD, meaning firms will want to produce more goods and services to satisfy the demand and make increased profits. Firms will usually hire more workers to increase their production which leads to a decrease in unemployment. The strong growth from 2010-12, contributed to the decreased u/e during that time which fell from 5.5% to under 5% in 2011. Also, high economic growth will lead to high real GDP which will increase government taxation revenue. Fast economic growth means firms will produce more and households have increased incomes, meaning tax revenue will increase. This improves the government’s budget and allows them to spend more money on building infrastructures and roads to further promote economic growth in the long run. (budget) However, a cost major cost of economic growth is increased inflationary pressures. High levels of growth can result in a rise in general price levels. This is particularly negative when AD exceeds AS (spending is growing whilst the economic is at full capacity) and will lead to demand-pull inflation. High inflation may constraint growth in the long run and makes decrease consumers/business confidence which could reduce levels of consumption and investment. However, since Australia has been experiencing slow growth in the recent years, inflation levels have been averaging below the target range of 2% at only 1.3% during 2016. Another disadvantage of high economic growth is the deterioration of Australia’s external stability. High economic growth is usually associated with increased consumer and business spending, which usually results in higher import spending. This will lead to an increased trade deficit and contribute to a higher current account deficit which will worsen Australia’s external stability. Strong economic growth post GFC during 2010-12 increased import spending, from $22 billion to over $26 billion which worsened Australia’s external stability.

In addition, the benefits of economic growth are not spread evenly among the economy and are usually given to high income earners as they use their assets to acquire more income. Income inequality in the long run will lead to a decreased APC which will result in lower consumption and economic growth. It also has social costs including higher crime rates and higher poverty level which can lower the quality of life in Australia’s economy. The Gini coefficient which measures the extent of income inequality in an economy has been increasing over the last three decades due to high economic growth, from 0.28 to a high of 0.34 in 2006. Since then, slower economic growth and government policies aiming to reduce inequality has lowered the Gini coefficient. Another disadvantage of economic growth is that it can damage the environment. Rapid economic growth is usually associated with the production of lots of goods and services which requires energy from fossil fuel. This produces carbon dioxide and other green-house gas which can damage the environment. In 2013, Australia’s emission reached 16 metric tons. Moreover, deforestation may occur if firms require more land to expand their production which will deteriorate the environment further. In conclusion, factors which influence AD and AS will affect the level of economic growth in an economy. High economic growth leads to higher standard of living, lower u/e and an improved fiscal position. However, it can lead to high inflationary pressures, income inequality and damage the environment. Overall, the benefits of economic growth outweigh the disadvantages and the recent increase in economic growth in Australia has benefited the Australian economy. Also, the price and productivity of labour (since labour can be a substitute for capital) can affect the level of investment. Increase labour productivity or a decrease in cost for labour makes labour a more attractive choice for firms, which can decrease capital investment. Conversely, a decrease in labour productivity or increase in labour cost (increased wages) will promote firms to purchase more capitals and increase investment. Despite the general trend of an increase of labour productivity since 1980s, in 2016 labour productivity growth slowed During the early 2000s, despite Australia’s increasing export value (due to high commodity prices), Australia’s trade balance remained in a deficit due to significant rise in household income, increasing from $120bn to over $170bn from 2002 to 2007. This increase income offset the rise in exports with a larger rise in the imports which increased from $12bn to $20bn during that time. A factor which influences the level of Australia’s exports and imports is the level of overseas and domestic income. When overseas income increase, Australia’s exports are also likely to increase as foreigners are able to buy more of Australia’s exports. However, since most of Australia’s exports are commodities and services the main influence on the level of exports would not similarly, if Australia’s domestic income rises, Australia’s imports are likely to increase.

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