HSC Economics Topic 2 Notes Part 2 PDF

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HSC Economics Topic 2 Notes Part 2...

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Essay points

Anson Tong

o Domestic inflation rates and competitiveness of domestic firms that compete with imports will also effect the e/r o Tastes and preferences Trade Weighted Index (TWI) • Gives an indication of how the value of the AUD is moving against all currencies in general • Calculated by measuring the value of the AUD against the currencies of Aust’s major trading partners over a base year • Currencies that are more prominent in Aust trade are given higher weighting and more influence on the TWI – amended by the RBA every year • TWI must cover at least 90% of Aust trade • Weightings from previous years • Limitations of the TWI could include that the weightings are only based on trade regardless of currency in which the trade is conducted in • Around 2/3 of Aust X and ½ of M are priced in USD • This makes the USD/AUD e/r more important than the weight it receives in the TWI calculations

Reserv Reserve e Ban ankk Interv tervent ent ention ion in the forei foreign gn excha chang nge market ((5.3) 5.3) • • • • • • • • •

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Aust relies primarily on market forces to determine the e/r The RBA sometimes influences the value of the currency While the RBA cannot change the value of the AUD in the long run it is able to smooth out swings in the dollar relating to short term factors This is called dirtying the float and through monetary policy intervention o Possibly from excessive speculation When RBA feels that a large short-term change in the e/r will be harmful to the eco It can decide whether to step into the forex market either as a buyer or seller to stabilize AUD In order to stop the rapid depreciation of the currency the RBA can buy AUD putting an upward pressure on the e/r By selling AUD, the RBA can prevent a rapid appreciation The RBA’s ability to intervene by selling or purchasing $A is restricted by the size of its foreign currency reserves o RBA’s foreign currency reserves is relatively small – less than one day on forex market Monetary Policy initiatives are an indirect way of influencing the e/r and rarely used for that If RBA wants to curb rapid depreciation it may increase demand for AUD by raising i/r Higher i/r will attract foreign investment and savings which have to be converted to AUD This will increase demand for AUD and put an upward pressure on e/r

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Anson Tong

Only effective in the short term Unusual for RBA to do so as MP is used for domestic eco particularly inflation However, e/r fluctuations can be so large that it can affect eco growth and inflation

Fixed excha xchang nge rate syst ystems ems ((5.4) 5.4) • • • • • • • • • •

Prior to 1976, Aust had a fixed e/r system where the AUD was pegged to the UK sterling, USD and even TWI However, from 1976 to 1983, Aust had a variation of a fixed e/r - managed flexible peg Under the fixed rate system, the gov or the RBA can set the official e/r o Official rate was $1 AUD = $0.9 USD The gov can attempt to maintain this rate by buying and selling foreign currency in exchange for AUD. In this case it would be to purchase excess supply of AUD To do this the gov, needs foreign reserves of either foreign currency or gold However, there was potential that RBA could run out of foreign reserve and thus collapse trade in the eco Other ways could be the gov, changing the rate officially – closer to real market value The managed flexible peg would “peg” the value of the AUD every day at 9am And the price would operate throughout that day Allowed more flexibility and allowed it to drift away under pure market forces

Exchang xchange e Rates and th the e Balance of Payments • • • • • • • • • • • • • • •

The value of the e/r can change greatly in response to eco developments One of the most important influences on the e/r is the performance of the BOP The value of the e/r influences BOP and BOP influences e/r Under a floating e/r - quantity of AUD supplied must equal the quantity of AUD demanded Thus, net inflows of funds on KAFA is equal to net outflow of fund on CA Any disequilibrium in the BOP is only temporary and is automatically corrected by the movement in e/r Value of M increases while X doesn’t change this would result in deterioration in the CAD This would also cause an increase in supply of AUD as importers sell their AUD o Resulting in a depreciation of the currency Due to this depreciation the given level of financial inflow would be able to buy more $A Therefore, a positive balance on KAFA would increase $A terms to match deficit on CA The effect of BOP on the e/r also depends on the perceptions of the financial market If financial markets believe that an increase in CAD is unsustainable, they are less likely to buy Aust assets – this causes the AUD to fall as capital inflow is reduced This results in greater instability in forex markets as market sentiment can change quickly Changes in e/r can causes changes to the BOP An appreciation can have both positive and negative effects o Positive  Increased purchasing power – buy more overseas goods for same $A  Decreases the debt servicing costs on foreign debt  Reduce value of foreign debt – valuation effect  Inflationary pressures will be reduced as M is cheaper

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o Negative  Domestic X more expensive  less competitive internationally  worse CAD  Encourage M spending and worsen CAD  Higher M and reduce X will reduce Aust eco growth  Foreign investors will find it more X to invest in Aust  lower financial flows  Reduces $A value of foreign income earned on Aust investments  Reduce the value of foreign assets in Aust dollar terms A depreciation also has its positives and negatives: o Positive  Decrease value of AUD  Aust X cheaper  more competitive  improvement on the CAD  M is more expensive  less M  improve CAD  Domestic production of import substitutes will rise  Increase growth rate due to X > M  Increases $A value of foreign income earned  better NPY  Increase value of foreign assets in Aust dollar terms – valuation effect  Foreign investors - less expensive to invest in Aust  more financial flows o Negative  Aust consumers reduced purchasing power less overseas goods for same $A  Increases debt servicing costs for foreign liabilities  NPY suffers  Raises levels of foreign debt denominated in foreign currencies  Inflationary pressures as M more expensive Speculators buy and sell $A in anticipation of a change in currency This distorts the e/r movements and increase e/r volatility by exaggerating growth and decay One of Aust’s greater problems is that it is small and relies on substantial financial inflows o This causes greater external imbalances This makes the currency more vulnerable to speculators than most advanced ecos Excessive speculation and volatile currency can cause major global eco issues

Free Trade and Protection Introduction (6.1) • • • •

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Aust. has a relatively high output which is traded thus can artificial barriers to trade have a significant effect on the economy. Aust. has benefited greatly from the gradual removal of trade barriers However, since Trump was elected in, there has been a resurgence of protectionism around the world Aust. used to be very protected o Early 1970s – shift away from protection o Late 1980s – began to phase out of almost all tariffs o Currently – one of the most open economies Aims of reducing protection o Force domestic firms to be more competitive by exposing them to imported goods o Encourages more efficient allocation of resources  Focus on sectors of the economy where Aust. has comparative advantage

Essay points

Anson Tong

o Allowing Aust. consumers to benefit from increased g/s from the global market at the most competitive prices o Promote structural change in eco whereby long term goal is to encourage efficient firms to produce what the global eco demands

Gover Government nment initiati initiative ves to reduce trade barriers (6.2) Aust. transitioned from a highly protected eco to an eco with relatively low barriers to trade.

This is seen through the table above which demonstrates the decline of average tariff levels in Aust. Productivity Commission (PC), Commonwealth Treasury and National Farmer’s Association argued that protectionist policies fostered: • Inefficiencies • Increased prices • Misallocates resources • Makes Aust. less int. competitive • Damages trade performance • Reduces living standards in the long run The first significant reduction of protection – “Whitlam Government”. • 1973 – 25% reduction in tariffs • Today around 50% imported goods are tariff free o Remainder – manufactured goods, subject to general tariff of 5% or less • Historically, clothing and textile industries were highly protected • Most tariffs do not apply to M from countries which Australia has free trade agreements with o Korea, Japan and China In 2017 average tariff levels were 0.9 %. PC estimates the dollar value of tariff assistance to domestic production was $6.8 billion 2016-17. Australia’s tariff rates are slightly lower then other industrialized economies like the US (1.7%) and EU (1.8%). When other methods of protection such as subsidies are factored in, Australia is one of the least protectionist economies in the world. Australia provides far fewer subsidies to domestic producers compared with North America, Western Europe and East Asia who all boost the competitiveness of their respective countries agricultural sector. • 2017 – Australia had the second lowest level of agricultural protection in the OECD o Subsidies accounted for less than 2% of farm income Australia o Subsidies account for 10% farm income in US, 18% in EU and 49% in Japan • Although protection and direct assistance programs have been largely reduced, some export assistance programs still exist. o They are administered through Austrade (Australian Trade and Investment Commission)

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o They provide assistance financially, information on potential export markets and marketing advice o Main program is the EMDG scheme (Export Market Development Grants)  Reimburses exporters for advertising their products in new markets  Yearly the scheme aims to provide around $140 million to around 4000 small business o A 2015 study found that the EMDG was effective as each dollar spent generated net economic benefits value from $1.55 - $7.03 Australia’s reductions in protection levels are greater than that required by international trade agreements such as the World Trade Organisation agreement Australia is often criticized for its anti-dumping rules and in 2017 new laws made them easier to enforce Additionally, tariffs on new cars and secondhand cars are still in place even though Australia has no domestic car industry

Australia’s Fre ree e Trade Agreements (6.3) •

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Australia has various free trade agreements with many countries: o China (ChAFTA) o Japan (JAEPA) o Korea (KAFTA) o US (AUSFTA) o Chile (ACI-FTA) Australia negotiates both bilateral and multilateral agreements

Bilateral Trade Agreements • Bilateral agreements involve only two nations • Easiest to negotiate as they only factor in the interest of the two participants • The most comprehensive bilateral agreement for Aust. is the 1983 ANZCERTA (Australia – New Zealand Closer Economic Relations Trade Agreement) • This agreement has led to free trade between the two countries and increased standardization of laws, business practices and commercial structures • Bilateral trade deals are an important focus of trade policy in Aust. • Since 2000, Australia has entered bilateral agreements with Peru, Chile, China, Japan, Korea, Malaysia, Singapore, Thailand and the US.

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Further bilateral agreements were also finalized in 2019 with Hong Kong and Indonesia Aust has entered negotiations for agreements with the Gulf Cooperation Council and India AUSFTA (AUST US), began in 2005 and provided a significant tariff reduction on a number of goods especially in agriculture and manufacturing o Automotive tariffs were eliminated o Tariffs on all goods were eliminated since 2015 o Since 2004 bilateral trade in g/s with the US has increased and the US is now Australia’s third-largest trading partner and 9% of Aust’s two-way trade KAFTA (Korea Aust) in operation since late 2014 and improves access for Aust exporters to the Korean economy o Tariff-free X rising from 84% to 99% over the next 20 years o Agreement also facilitates more services trade in legal, accounting, financial, engineering, telecommunications and education services o Improves opportunities for Aust investors and investments in Korea o Will help attract direct investment from Korea into Australia o Two-way trade between countries has increased by approx. 50% between 2014-17 ChAFTA (China Aust) in operation since 2015, was completed to promote further trade with Australia’s largest trading partner o Currently, around 86% of Aust X to China are tariff free however will increase to 98% upon full implementation of the agreement o This will directly improve the competitiveness of key agricultural industries like beef, dairy, wine, fruit and seafood o China also granted Aust greater market access for certain services than most nations with Chinese agreements – particularly for Aust financial, professional and educational service providers o The agreement also includes a number of controversial items most notably ISDS (Investor-state dispute settlement) provisions which allow foreign investors to directly bring arbitration claims against governments for alleged breaches of FTA’s o The Productivity Commission states that this may “potentially undermine the role of domestic courts and freedom of governments to regulate in the public interest” o Additionally, the agreement includes other investment facilitation arrangements that critics argue would allow Chinese companies to bring in Chinese migrant workers to work on major projects at the cost of Australian workers So, while bilateral trade agreements reduce overall protection for Australian industries, they do so on a country-by-country basis depending on the origin of the imports Thus, they generate fewer economy wide benefits than broad trade liberalisation Many also argue that the significant amount of bilateral trade agreements currently enforced around the world have a created a complex web of overlapping and inconsistent trade rules The Productivity Commission (PC) has concluded that such preferential trade agreements add to the complexity and cost of international trade. The PC, has also found that some businesses find it easier to just pay the general tariff on M than to use the tariff free import provisions which requires more compliance on rules of origin

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Anson Tong

Multilateral Trade Agreements • Multilateral trade agreements are ones that provide for free of preferential trade between many countries, usually on a regional basis • This category of agreements is sometimes referred to as agreements administered by the World Trade Organisation (WTO) • Other times it can also refer to regional trade agreements such as the EU and NAFTA • The main multilateral trade agreement for Aust is the AANZFTA (ASEAN-Australia- New Zealand Free Trade Agreement) where ASEAN (Association of South East Asian Nations) • This multilateral agreement came into effect in 2010 • It covers over 20% of Aust trade in g/s and effectively creates a free trade area of over 650 million people with a combined GDP of over US $4.2 trillion • Aust and the ASEAN countries are complementary economies in that the types of goods Aust X – namely commodities particularly in resource base industries • They are complementary in that they tend to have a high demand due to the recent industrialization • Conversely, ASEAN countries can export to Australia the goods that Aust cannot produce competitively o e.g. simple transformed manufactures that are produced in labour intensive industries • Overall, this agreement is forecasted to boost the Aust eco by US$19 billion during the decade following its implementation in 2010 • Aust and NZ are just 2 of the 6 countries that have multilateral trade agreements with ASEAN • The other 4 countries being China, Japan, India and South Korea • Since 2012, ASEAN and these 6 countries have been negotiating an ambitious Regional Comprehensive Economic Partnership (RCEP) that would bring all countries into one multilateral trade agreement • The RCEP would cover around 40% of the global economy and almost half the world’s population • India and China have played key roles in shaping the proposed RCEP • Australia’s main focus however for multilateral trade agreements have been the TPPA (TransPacific Partnership Agreement) • The coverage of the TPPA was intended to cover 12 countries Australia, Brunei, Chile, Malaysia, New Zealand, Singapore, Peru, US, Vietnam, Canada, Mexico and Japan. • Australia made the TPPA a priority as it consists of around 40% of global GDP, 35% of Aust X and 45% of Aust total outward investment • The US withdrew from the TPPA in 2017 before the agreement was even operative • However, the remaining 11 countries led by Aust and Japan signed a new agreement • This agreement was the CPTPP (Comprehensive and Progressive Agreement for TransPacific Partnership) which was signed in 2018 • Many critics argue that without the US the TPPA has limited value and that the region should finalize the RCEP instead • During the 1990s, Australia’s regional trade focused on the APEC (Asia Pacific Economic Cooperation) forum. • In 1994, the APEC forum set a target of free trade by 2020

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Anson Tong

This goal was never formalized as for most of history the meeting of APEC forum leaders has focused on other priorities such as terrorism and climate change A 2017 analysis by the APEC Policy Support Unit argued that even without the binding commitments, the forum has indirectly supported trade liberalisation Since 1994 average tariff levels have fallen from 17% to just under 6% The proportion of goods without tariffs have risen to 60% and 150 trade agreements have been implemented involving APEC members

Implication Implicationss o off Australia’s Policies for Individual, FFir ir irms ms and Govern overnment ment (6 (6.4) .4) • •

Australia’s decision to abandon a majority of its protectionism has been one of the most significant structural changes in the economy This change has significantly increased Australia’s integration into the global eco

Implications on firms • The long run effects on businesses may appear to be beneficial however, in the short term many businesses appear to be losing out • This is because individual firms that operate in marginal, import competing industries will shrink unless they are able to improve their competitiveness • In some situations, production in some sectors can cease completely o The manufacturing of consumer electronics products has almost entirely ceased o With car manufacturing ceasing in 2017 – Holden being the last to exit • This is because manufacturing of these product require high production volumes and large workforces • Advanced economies cannot compete with lower wage costs of industrializing economies • Some businesses will respond to the phasing out of protection by: o Focusing on specializing on one area of production o Or, by restructuring their operations with the aim to stay in business • This restructuring may involve measures such as

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o Consolidating their manufacturing processes down to a single plant o Eliminating less profitable product lines o Finding opportunities to X in response to decline in share of domestic market o Adopting new production techn...