ATAR Notes HSC Year 12 Economics Complete Course Notes (2022) [2022-2024 ed.] 1922394807, 9781922394804

Citation preview

Year 12 Economics Complete Course Notes 2022–2024 Giuliana De Bellis

Published by InStudent Publishing Pty Ltd 91a Orrong Cres Caulfield North, Victoria, 3161 Phone (03) 9916 7760 www.atarnotes.com As and when required, content updates and amendments will be published at: atarnotes.com/product-updates Copyright © InStudent Publishing Pty Ltd 2022 ABN: 75 624 188 101 All rights reserved. These notes are protected by copyright owned by InStudent Publishing Pty Ltd and you may not reproduce, disseminate, or communicate to the public the whole or a substantial part thereof except as permitted at law or with the prior written consent of InStudent Publishing Pty Ltd. Title: Year 12 Economics Complete Course Notes ISBN: 978-1-922394-80-4 Disclaimer No reliance on warranty. These ATAR Notes materials are intended to supplement but are not intended to replace or to be any substitute for your regular school attendance, for referring to prescribed texts or for your own note taking. You are responsible for following the appropriate syllabus, attending school classes and maintaining good study practices. It is your responsibility to evaluate the accuracy of any information, opinions and advice in these materials. Under no circumstance will InStudent Publishing Pty Ltd (“InStudent Publishing”), its officers, agents and employees be liable for any loss or damage caused by your reliance on these materials, including any adverse impact upon your performance or result in any academic subject as a result of your use or reliance on the materials. You accept that all information provided or made available by InStudent Publishing is in the nature of general information and does not constitute advice. It is not guaranteed to be error-free and you should always independently verify any information, including through use of a professional teacher and other reliable resources. To the extent permissible at law InStudent Publishing expressly disclaims all warranties or guarantees of any kind, whether express or implied, including without limitation any warranties concerning the accuracy or content of information provided in these materials or other fitness for purpose. InStudent Publishing shall not be liable for any direct, indirect, special, incidental, consequential or punitive damages of any kind. You agree to indemnify InStudent Publishing, its officers, agents and employees against any loss whatsoever by using these materials. Trademarks "ATAR" is a registered trademark of the Victorian Tertiary Admissions Centre (“VTAC”); "HSC" is a registered trademark of the Board of Studies Teaching and Educational Standards (“BOSTES”). VTAC and BOSTES have no involvement in or responsibility for any material appearing in these guides. Nor does BOSTES endorse or make any warranties regarding the material in these books or sold by InStudent Media Pty Ltd. HSC syllabuses and related content can be accessed from the BOSTES website. HSC examination questions and syllabus extracts are reproduced by permission, from NESA (http://educationstandards.nsw.edu.au).

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Preface Hi, I am Giuliana, and congratulations on picking up this book! I am a 2019 graduate who received 97 for Economics. I have a passion for teaching and have a wide variety of tutoring experience, from teaching coding, to dancing, and of course, HSC Economics! My goal with these Notes is to provide personal insights, concise content, and skill development to help you smash your studies. What you can expect to gain from these Notes is a perfectly condensed summary of the syllabus, allowing you to focus on what you need to know for exams, and ace the HSC! There’s also plenty of exam and study tips and tricks throughout to help you on your journey towards becoming a Band 6 student. Everything is written in an easy to understand, succinct way. Before jumping into content, here are a couple of tips on how I recommend using these notes and learning class content in general. Understanding > Memorisation Let’s face it, the Economics syllabus can feel dense sometimes. There are a lot of dot points to cover and remembering content can feel like a chore. This is why I made a conscious effort to understand every new concept before moving onto the next when I was learning. Ensuring you understand concepts, links between concepts, and core issues will make studying for exams much easier. A good starting point is ensuring you stay on top of your class notes, compile your own notes weekly, read over and revise those notes, ask any questions you may have, and regularly complete practice questions to test your knowledge. Use these notes as a resource to supplement your own notes, not as a replacement for them. This will ensure you truly understand the syllabus, and will be more effective when it comes to revision. Contemporary Economic Issues A common question I am asked by students is “how many statistics do I need to know?” As I said above, Economics is less about memorisation and more about understanding. This also goes for contemporary economic issues and statistics. It is less important that you have a list of numbers and trends memorised for an exam, and more important that you understand the context of those statistics. This includes identifying reasons for trends or changes in these figures, analysing the implications of these trends, and identifying a clear link between the trends and the theoretical content in your response. You can think of the use of ‘contemporary economic issues’ as similar to analysis of quotes you give in English essays to explain your judgement on a certain theme, or the use of case studies in Business Studies to support a theoretical point in an essay. The use of contemporary economic knowledge, such as that of economic booms, recessions, and trade wars are all necessary to include in your response, but must be done so with purpose, analysis, and explanation.

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Don’t just pay attention in class, engage in discussion You have probably been told to pay attention in class by countless adults in your life, but this is for good reason. If you are a student who doesn’t enjoy spending all their free time at home struggling to understand concepts, it is very important that you focus in class, and take summary notes. I preferred to handwrite summarised notes in class and type these up at home as revision, as I found I understood content better when I handwrote my notes. As an extension to paying attention in class, I found I remembered content the best when I engaged in class discussion, gave my own opinions and judgement, and remembered anecdotes about the content we covered. I understand it takes a degree of confidence to speak up and question content, or offer your own opinion, but it is a highly effective method of learning and is a skill you can build up over time. A good starting point is to read the news once a week or think of a relevant question about a current issue that you could bring up in class. Go beyond the syllabus; be inquisitive Reading the news and being an informed Economics student is essential to achieve high marks in this course. But how does one go about studying content alongside keeping up with the plethora of economics news released daily? Personally, I read the news once every few days, for about 15 minutes. I used sources such as the Sydney Morning Herald, ABC News, the RBA website and SBS. For variety, I used the Apple News app which allows you to select your interests and compiles a personalised feed of articles. I’d read articles I found interesting, ones that had headlines relevant to syllabus dot points, and opinion pieces on the Australian economy. I found a balance that kept me interested in reading and allowed me to develop my own voice as an Economics student. This should be your main goal after reading the news; don’t just collect statistics you think would be useful in exams. Rather, find articles that resonate with your interpretation of the Economics syllabus and use these to deepen your ability to write analytically. Form your own judgement Following on from becoming an informed Economics student is understanding that the content you learn in Economics is not all considered to be ‘fact.’ What you learn is theoretical data, which has been gathered from information about past economic events, and this is used to forecast future economic trends. Therefore, it is important to be conscious of your writing style when giving answers, and your ability to incorporate your own informed judgement. When writing, use low modal words like ‘may,’ ‘might,’ ‘could,’ ‘can,’ or ‘theoretically’ rather than high modal words like ‘will,’ ‘must,’ ‘always,’ or ‘has to’ when describing economic theory. These theories are models for what can happen in an economy when certain events occur. No theory you learn is guaranteed to occur, and many economic events happening at this very moment continue to baffle economists. That being said, try not to directly critique economic theory; it is a complex and well-researched field that shouldn’t be dismissed because of ambiguities or unpredictability. What you should aim for is a balanced consideration of a variety of economic facts, where you effectively explain links and potential issues in the interaction of economic theories. Good luck with your studies! — Giuliana De Bellis

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Contents I

The Global Economy

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International economic integration 1.1 The global economy and Gross World Product . . 1.2 Globalisation . . . . . . . . . . . . . . . . . . . . 1.2.1 Trade in goods and services . . . . . . . 1.2.2 Financial flows . . . . . . . . . . . . . . . 1.2.3 Investment and transnational corporations 1.2.4 Technology, transport, and communication 1.2.5 International division of labour, migration . 1.2.6 International and regional business cycle .

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Trade, financial flows, and foreign investment 2.1 The basis of free trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Role of international organisations . . . . . . . . . . . . . . . . . . . . . . 2.2.1 World Trade Organisation (WTO) . . . . . . . . . . . . . . . . . . . 2.2.2 International Monetary Fund (IMF) . . . . . . . . . . . . . . . . . . 2.2.3 World Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2.4 United Nations (UN) . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2.5 Organisation of Economic and Cooperation of Development (OECD) 2.3 Influence of government economic forums . . . . . . . . . . . . . . . . . . 2.3.1 G20 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3.2 G7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 Trading blocs, monetary unions, and free trade agreements . . . . . . . . . 2.4.1 Evaluating multilateral and bilateral trade agreements . . . . . . . . 2.4.2 European Union (EU) . . . . . . . . . . . . . . . . . . . . . . . . . 2.4.3 Asia Pacific Economic Cooperation (APEC) . . . . . . . . . . . . . 2.4.4 North American Free Trade Agreement (NAFTA) . . . . . . . . . . . 2.4.5 Association of South-East Asian Nations (ASEAN) . . . . . . . . . . 2.4.6 Bilateral trade agreements . . . . . . . . . . . . . . . . . . . . . . Protection 3.1 Reasons for protection . . . . . 3.2 Methods of protection . . . . . 3.2.1 Tariffs . . . . . . . . . 3.2.2 Quotas . . . . . . . . 3.2.3 Subsidies . . . . . . . 3.2.4 Local content rules . . 3.2.5 Export incentives . . . 3.3 Effects of protectionist policies

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Globalisation and economic development 4.1 Differences between economic growth and development 4.2 Distribution of wealth and income . . . . . . . . . . . . 4.3 Income and quality of life indicators . . . . . . . . . . . 4.4 Reasons for differences between nations . . . . . . . . 4.4.1 Global factors . . . . . . . . . . . . . . . . . . 4.4.2 Domestic factors . . . . . . . . . . . . . . . . 4.5 Effects of globalisation . . . . . . . . . . . . . . . . . . 4.6 Trade, investment, and transnational corporations . . . 4.7 Environmental sustainability . . . . . . . . . . . . . . . 4.8 International business cycle . . . . . . . . . . . . . . .

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Case study: China . . . . . . . . . . . . 4.9.1 China’s economic reform policy . 4.9.2 Size of the Chinese Economy . . 4.9.3 China’s Economic Development 4.9.4 China’s International Trade . . . 4.9.5 China and the Environment . . .

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II

Australia’s Place in the Global Economy

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Australia’s trade and financial flows 1.1 Value, composition, and direction of Australia’s trade and financial flows . . . . 1.1.1 Trends in Australia’s trade pattern . . . . . . . . . . . . . . . . . . . . 1.1.2 Trends in financial flows – debt and equity . . . . . . . . . . . . . . . 1.2 Australia’s Balance of Payments . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.1 Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.2 Links between key balance of payments categories . . . . . . . . . . 1.2.3 Trends in the size and composition of Australia’s Balance of Payments 1.2.4 Terms of trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.5 International borrowing . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.6 Foreign investment . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Exchange rates 2.1 Measurement of relative exchange rates . . . . . . . . . . . . . . . . 2.2 Factors affecting the demand for and supply of AUD . . . . . . . . . . 2.3 Changes in exchange rates – appreciation/depreciation . . . . . . . . 2.4 Determination of exchange rates including fixed, flexible, and managed 2.5 Influence of the Reserve Bank of Australia on exchange rates . . . . . 2.6 Effects of fluctuations in exchange rates on the economy . . . . . . . . Free trade and protection 3.1 Australia’s policies regarding free trade and protection . . 3.2 Australia’s multilateral and bilateral free trade agreements 3.2.1 Bilateral Agreements . . . . . . . . . . . . . . . 3.2.2 Multilateral Agreements . . . . . . . . . . . . . . 3.3 Implications of Australia’s policies . . . . . . . . . . . . . 3.4 Implications of other countries and trading blocs . . . . .

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Economic Issues in the Australian Economy

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Economic growth 1.1 Aggregate demand and its components . . . . . . . . . . . . . . . . . . . 1.2 Injections and withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3 The simple multiplier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 Measurement of growth through changes in real GDP . . . . . . . . . . . 1.5 Sources of economic growth in Australia . . . . . . . . . . . . . . . . . . 1.6 Effects of Economic Growth in Australia . . . . . . . . . . . . . . . . . . . 1.7 Increase in aggregate supply – improvements in efficiency and technology 1.8 Trends in the business cycle . . . . . . . . . . . . . . . . . . . . . . . . .

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Unemployment 2.1 Measurement of unemployment . . . . . . . . . . . . . . 2.2 Trends in unemployment . . . . . . . . . . . . . . . . . . 2.3 Types of unemployment . . . . . . . . . . . . . . . . . . 2.4 Causes of unemployment . . . . . . . . . . . . . . . . . 2.5 Non-accelerating inflation rate of unemployment (NAIRU) 2.6 Main groups affected by unemployment . . . . . . . . . . 2.7 Effects of unemployment . . . . . . . . . . . . . . . . .

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Inflation 3.1 Measurement of inflation . . . . . . . . . . . . . . . 3.2 Trends in inflation . . . . . . . . . . . . . . . . . . . 3.3 Causes of inflation . . . . . . . . . . . . . . . . . . . 3.3.1 Demand-pull inflation . . . . . . . . . . . . . 3.3.2 Cost-push inflation . . . . . . . . . . . . . . 3.3.3 Imported inflation and inflationary expectations 3.4 Positive and negative effects of inflation . . . . . . . .

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External stability 4.1 Measurement and causes of external stability . . . . . . . . . 4.1.1 Current Account Deficit (CAD) as a percentage of GDP 4.1.2 Net foreign debt as a percentage of GDP . . . . . . . . 4.1.3 Net foreign liabilities as a percentage of GDP . . . . . 4.1.4 Terms of trade . . . . . . . . . . . . . . . . . . . . . . 4.1.5 Exchange rate . . . . . . . . . . . . . . . . . . . . . . 4.1.6 International competitiveness . . . . . . . . . . . . . . 4.2 Trends and effects of external instability . . . . . . . . . . . . .

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Distribution of income and wealth 5.1 Measurement of distribution of income and wealth . . . . 5.2 Sources of income as a percentage of household income 5.3 Taxation, transfer payments, and other assistance . . . . 5.4 Sources of wealth . . . . . . . . . . . . . . . . . . . . . 5.5 Dimensions and trends . . . . . . . . . . . . . . . . . . 5.6 Benefits and costs of inequality . . . . . . . . . . . . . .

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Environmental sustainability 6.1 Ecologically sustainable development . . . . . . . . . . . . . 6.2 Private and social costs and benefits . . . . . . . . . . . . . 6.3 Public and private goods . . . . . . . . . . . . . . . . . . . 6.4 Environmental issues . . . . . . . . . . . . . . . . . . . . . 6.4.1 Preservation of the natural environment . . . . . . . 6.4.2 Pollution . . . . . . . . . . . . . . . . . . . . . . . . 6.4.3 Climate change . . . . . . . . . . . . . . . . . . . . 6.4.4 Depletion of renewable and non-renewable resources

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Economic policies and management Economic objectives 1.1 Objective areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.1 Economic growth and quality of life . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.2 Full employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.3 Price stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.4 External stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.5 Environmental sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1.6 Distribution of income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Potential conflict among objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.1 Price stability vs. full employment . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.2 Economic growth vs. stability, sustainability, employment, and income distribution

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Macroeconomic policies 2.1 Fiscal policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1.1 Federal Government Budgets and budget outcomes . . . 2.1.2 Effects of budgeting changes . . . . . . . . . . . . . . . 2.1.3 Methods of financing deficits . . . . . . . . . . . . . . . 2.1.4 Use of a surplus . . . . . . . . . . . . . . . . . . . . . . 2.2 Monetary policy . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2.1 Purpose of monetary policy . . . . . . . . . . . . . . . . 2.2.2 Implementation of monetary policy by the RBA . . . . . . 2.2.3 Impact of changes in interest rates on economic activity . 2.2.4 Impact of changes in interest rates on the exchange rate

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Microeconomic policies 3.1 Rationale for microeconomic policies . . . . . . . . . . . . . . . . . . . . . . . . 3.1.1 Shifts in AS and efficiency . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Effects of microeconomic policies . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.1 Product and factor markets . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Regulation and deregulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.1 Competition policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Labour market policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4.1 Role of national and state systems . . . . . . . . . . . . . . . . . . . . . 3.4.2 Dispute resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4.3 Arguments for and against the use of centralised and decentralised wages 3.4.4 Education, training, and employment programs . . . . . . . . . . . . . . . 3.5 National and global context for environmental management . . . . . . . . . . . . 3.5.1 Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5.2 Market-based policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5.3 Targets set by international agreements . . . . . . . . . . . . . . . . . . 3.6 Limitations on economic policies . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6.1 Time lags . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6.2 Global influences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6.3 Political constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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65 65 65 66 66 66 67 67 67 68 68 69 69 70 70 70 70 70 71 71

Policy responses and their effects in dealing with economic objectives 4.1 Economic growth and quality of life . . . . . . . . . . . . . . . . . . . 4.2 Full employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Price stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 External stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5 Distribution of income . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6 Environmental sustainability . . . . . . . . . . . . . . . . . . . . . . .

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72 72 72 72 72 73 73

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V

General Statistics

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VI

Exam Skills and Tips

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Topic I

The Global Economy

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International economic integration

Section 1

International economic integration K EY P OINT :

This topic explores globalisation, and the impact of increased global integration on individual economies and the global economy at large. It explores the causes and effects of globalisation, both positive and negative. It is often considered the ‘easiest’ topic, but one many students forget as they learn it first and rarely revise it. You can earn some easy marks if you are able to recall this theory.

1.1

The global economy and Gross World Product

The global economy refers to the integration between economies of the world. It considers the sum of all economic activity of individual countries, and the interactions between them. This integration has increased in recent years, along with the process of globalisation. Section 1 – International economic integration

Economic integration refers to the liberalisation of trade between two or more countries. This means goods and services, labour, and other resources can move more freely between economies. We live in a global economy whereby economies of the world take advantage of increased economic integration to maximise output and efficiency. However, with increased integration comes increased risk, such as financial contagion. Financial contagion is where news of an economic disaster results in financial traders moving money out of affected or nearby areas/economies. For example, the financial crisis in Greece had many flow-on effects for European countries. Gross World Product (GWP) is the total value of goods/services that are produced worldwide (income) over a period of time (e.g. a year) measured in $USD for consistency. This is used to measure the overall trend of growth or decline for the global economy. GDP at Purchasing Power Parity (PPP) is the total value of Gross World Product in a given time period, adjusted for national variations in price and different exchange rates. Purchasing power parity is where currencies are converted to be in equilibrium, or ‘on-par,’ so prices can be compared accurately. This is used to compare GDP levels across different economies more accurately.

C ASE S PACE :

According to the IMF’s world economic outlook from 2019, advanced economies represent 40% of the world’s GDP at PPP, but only contain 14% of world population. Emerging and developing economies account for 60% of world GDP at PPP but contain 86% of population. In this case GDP at PPP allows a more accurate comparison of the economic performance of different economies, revealing the displacement of income across the world. This is because a relatively smaller number of advanced economies dominate global production, compared to the larger number of emerging and developing economies.

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1.2 Globalisation

1.2

Globalisation

Globalisation refers to the integration and removal of barriers between countries/economies. The forces driving globalisation, according to the World Bank, include:

1.2.1

Trade in goods and services

Trade in goods/services has increased dramatically in the last few decades, from 38% of global output in 1990 to 50% of global output in 2018 (World Bank). This has been caused by the factors promoting globalisation detailed above, but perhaps most influenced by the increase in trade agreements between countries, and the overall trend of decreased domestic protection. For example, Australia reduced tariffs to a record low of 2.23%, in 2018. Australia has promoted free trade through bilateral agreements such as AUSFTA (Australia and the US), and multilateral agreements such as APEC (Australia and the Asia-Pacific region). The composition of global trade is continually changing due to changing trends in demand for different goods and services. Changes in demand are also affected by the general rise in affluence, new technologies, and innovation. The direction of trade flows has also changed, along with the importance of regions. Trade flows have increased significantly for emerging economies, growing from 7% to 19% of global trade over the past decade. For example, Australia has seen an increase in trade with China (now our largest trading partner), after China experienced a series of economic reforms and rapid economic growth.

1.2.2

Financial flows

Finance is the most globalised feature of the world economy because everything revolves around money, and recent technologies allows money to move instantly between countries. This facilitates an efficient movement of international finance, contributing to globalisation. The main drivers of global financial flows include: • Financial deregulation: beginning on a global scale in the 1970s and 1980s. For example, Australia floated the dollar in 1983, lifting many restrictions on the flow of the Australian currency globally. • Speculators: investors that buy/sell financial assets with the aim of making profits from short-term price movements. This has increased the amount of global financial transactions, but this has also increased volatility in prices worldwide. This can be seen in forex (foreign exchange) daily turnover increasing from $4 trillion in 2010 to $6.6 trillion in 2020, causing a 40% increase in trading volume over the past decade.

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Section 1 – International economic integration

• New markets: growth of global markets in services, such as finance and international transportation, motivates deregulation of financial markets and antitrust laws. This ensures such markets continue to grow rapidly and expand internationally, facing increased competition, innovation, and opportunity. • New actors: the growth of multinational corporations (MNCs) has caused reformations to global supply chains, where supplies are commonly sourced internationally to take advantage of cheaper inputs. This has increased supply chain links and global integration. The WTO has also been an instrumental actor in facilitating globalisation, as they govern free and fair trade internationally. Nongovernment organisations which provide foreign aid, trading blocs and organisations like the EU, and government economic forums like the G7 also facilitate global policy coordination and communication. • New rules and norms: with the increased spread of democracy, human rights awareness, action agendas for developing countries, and market-based economic policies (like those of Australia and the US), governments of the world have sought greater global communication and integration. For example, the creation of multilateral and bilateral agreements has facilitated greater global trade links. • New tools of communication: the internet, and the increase in use of electronic communication and international transportation has facilitated an increase in efficiency of global communication.

1.2 Globalisation

The main benefit of foreign exchange is it enables countries to obtain greater investment finance to expand operations and output. However, increased global financial flows increases the risk of financial contagion. C ASE S PACE :

During the GFC, there was a fall in activity in financial markets due to the increased risk aversion of lenders, higher cost of credit and increased volatility. This led to total activity on global capital markets falling by approximately US$1,000 billion from 2008 to 2009.

1.2.3

Investment and transnational corporations

Investment made by Transnational Corporations (TNCs) involves the expansion of businesses globally in hopes of reaching a larger market and making greater profits. Investment can also be made by third parties into TNCs through foreign direct investment. The aim of this investment is to receive a share of the company’s profits, without getting involved with operations. Foreign direct investment (FDI) is the purchase of a controlling interest in a foreign subsidiary (over 10%). Easing capital controls and financial deregulation has caused FDIs to increase to over six times their level a decade ago.

Section 1 – International economic integration

The global expansion of TNCs has especially been prevalent in manufacturing industries, where countries can take advantage of cheap resources from around the world, and low labour costs to maximise the efficiency of their supply chains. The main drivers of FDI increases include government policies of deregulation that attempt to encourage FDIs, and reformed migration laws that encourage an increase in international labour mobility.

1.2.4

Technology, transport, and communication

Due to the rapid development of new technologies, especially in areas of communication and transport, the global economy has seen an increase in integration. Consumers are now global, accessing e-commerce and travel from other economies, and developing new tastes and preferences adopted from other cultures due to this increase in global exposure and choice. Firms are also global, reforming their supply chains to take advantage of cheaper and more efficient resources, inventory management, and labour. Due to the increased access to global markets, there has also been an increase in competition and efficiency of firms, as innovation is necessary to compete on a global scale. Technology has also facilitated improved transportation. Improvements to infrastructure such as roads, railways, and airports facilitate the movement of all resources (including labour), increasing efficiency for all industries. Communication improvements, such as the continual and rapid development of telecommunication technologies has resulted in rapid spread of information, and has facilitated greater links between consumers, firms, governments, and economies of the world. C ASE S PACE :

The introduction of 5G networks is set to increase global GDP as it facilitates faster mobile connectivity and continues to drive gains in productivity and efficiency. In 2016, mobile technologies generated 4.4% of GDP globally, growing to 4.9% in 2020.

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1.2 Globalisation

1.2.5

International division of labour, migration

The international division of labour refers to the allocation of tasks to different people in different countries, in order to maximise specialisation and efficiency. It includes activities such as TNCs establishing manufacturing plants in emerging economies to utilise cheaper labour, outsourcing services and elements of a supply chain internationally. It also includes geographical mobility and migration of workers to developed economies that are seeking skilled labour. Immigration laws around the world generally restrict lower-skilled workers from moving to other countries. However, higher-skilled workers, and those with skills that advanced economies are lacking are commonly allowed to migrate. This increases the technological gap between developed and developing economies further, as skilled labour is attracted to greater opportunity in the most advanced economies, leaving developing economies behind. Australia’s major intake of migration is in the category of ‘skilled migration.’ According to the World Bank, 3% of the world’s population has migrated to work in different countries.

1.2.6

International and regional business cycle

The international business cycle refers to the changes in world output/economic activity across time. Changes in the international business cycle have varying effects on domestic business cycles, depending on the level of a country’s internationalisation and integration.

Both the international and regional business cycles can be different to domestic economic activity but are often very impactful on domestic economic activity. Research by the RBA shows that 63% of changes in output in Australia have been due to changes in interest rate growth levels and inflation from the G7.

Factors that strengthen the international business cycle

Factors that weaken the international business cycle

Trade flows: reduced trade barriers between economies increases overall volume of trade

Trade flows: restrictions such as protection decrease overall trade volumes

Financial flows: trends of deregulation, forex trading and speculation increases financial integration

Financial flows: fluctuations in exchange rates and forex markets can cause volatility to domestic currencies as well as contagion

Investment flows: increased TNCs, global supply chains, and FDI

Investment flows: exploitation of workers in developing countries can weaken international support of globalisation

Technology: improves transport and communication, contributing to an overall efficient usage of resources

Government fiscal policies: taxes decrease spending, including spending on imports

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Section 1 – International economic integration

The regional business cycle refers to the fluctuations in the level of economic activity in a geographical region of the global economy over time (e.g. the EU). Regional business cycles can be different to international business cycles.

Trade, financial flows, and foreign investment

Section 2

Trade, financial flows, and foreign investment 2.1

The basis of free trade

Free trade: occurs when there are limited artificial barriers imposed by the government upon the flow of goods/services across international borders. Each country has resources it is naturally abundant in, and skills which are (by comparison) of superior quality to other economies. This theory is referred to as having an advantage over another economy. The two types of advantage discussed in HSC Economics include:

Section 2 – Trade, financial flows, and foreign investment

• Absolute advantage: when a country can produce more output with the same resources as another country. For example, country A can produce 3 coats with a given amount of wool, and country B can produce 5 coats with a given amount of wool. Here country B has absolute advantage. • Comparative advantage: is when a country has a lower opportunity cost when producing a good, meaning they make most efficient use of resources in production. This is based on the David Ricardo’s theory of comparative advantage (tip: mention this in your essays!).

S AMPLE :

Consider the following data about commodity production in Australia and New Zealand. Wool

Beef

Australia

150

100

New Zealand

200

60

Which country has an absolute advantage in the production of each commodity? Australia has an absolute advantage in beef, as they can produce more than New Zealand (100 vs 60), whereas New Zealand has absolute advantage over wool, as they can produce more than Australia (200 vs 150). For Australia, what is the opportunity cost of producing 1 unit of wool? 100 units of beef ÷ 150 units of wool = 0.67 New Zealand, what is the opportunity cost of producing 1 unit of wool? 60 units of beef ÷ 200 units of wool = 0.3 Which country should specialise in wool? Why? New Zealand should specialise in wool, as their opportunity cost is lower. The theory of comparative advantage forms the basis for the reason why free trade is so effective in supporting global economic growth. Producing and exporting goods/services which an economy has comparative advantage in allows the economy to take advantage of economies of scale and high efficiency levels, meaning more goods can be produced at a lower price. When economies are able to specialise in a product, they hold comparative advantage in, and trade with the rest of the world to acquire products they are inefficient at producing, global output increases overall, boosting global economic growth.

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2.2 Role of international organisations

Disadvantages

+ Consumers and firms have greater variety of goods/services. This increases variety and choice, and may allow consumers to purchase more products with their income, increasing living standards. For firms, this increased variety is an opportunity to source cheaper input costs, to lower prices and become more competitive, or source unique resources to differentiate from competitors. + Allows countries to specialise, the process of specialisation and achieving economies of scale in production ensures resources are allocated efficiently and output is maximised. + Improved international competitiveness as firms are able to adopt foreign production methods, new technologies and engage in processes of innovation. + Increased GDP as output increases across a domestic economy. In the long-term, free trade and specialisation allows firms to produce more with their given resources, supporting output and economic growth.

– When a country adopts policies of free trade, there may be an increase in unemployment, and closure of inefficient domestic firms which find it difficult to compete with importing industries. This is a short-term effect of the redistribution of resources, where inefficient firms close and production is shifted elsewhere. – It may be difficult to establish new businesses if they are not protected in the establishment phase. This is because competition is tight among domestic and international firms, leaving little room for new businesses to establish their own competitive edge on such a large scale, across a mass market. – International firms may dump surplus production on a single, domestic market. Domestic firms may be unable to compete with these very low prices, and may be forced to close. – Negative externalities may occur, including environmental degradation and exploitation of a labour force, especially in developing countries. – Adopting a narrow export base may increase dependence on other nations and pose potential security and defence issues. – Possible CAD issues, if there is a large BOGs deficit.

As you may observe above, many of the disadvantages of free trade are reasons for protection (covered later in this section). This is because protection is a mechanism used to hinder free trade, and therefore protect against the potential negative effects of free trade.

2.2

Role of international organisations

Global organisations promote international policy coordination, as a forum for global issues and disputes.

2.2.1

World Trade Organisation (WTO)

The WTO is a multilateral trade organisation and agreement, binding governments to keep trade policies. This is the largest multilateral trade agreement, and the organisation monitors developments in world trade to provide basic principles, including trade liberalisation, with the aim to eliminate trade barriers through multilateral negotiation, and stability of trade relations, acting as a mediator to solve disputes A recent WTO policy that will benefit the global economy is the Trade Facilitation Agreement (TFA), implemented in 2017 with the aim of improving the efficiency, effectiveness and fairness of agencies that oversee trade, especially in developing countries. Estimates of the economic benefits of this new agreement vary from $68 billion to $1 trillion per year.

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Section 2 – Trade, financial flows, and foreign investment

Advantages

2.2 Role of international organisations

C ASE S PACE :

The latest round of WTO trade negotiations was the Doha Round (2001–present). The main aim of these negotiations was to reduce agricultural subsidies employed by advanced economies, and to grant developing countries greater market access globally. Progress was hindered by disagreements on access to agricultural markets, and arguments surrounding manufacturing protection. Disagreements led to slow progress, and the shift towards bilateral and regional agreements.

2.2.2

International Monetary Fund (IMF)

The IMF is an international agency that oversees the stability of the global financial system. They aim to: • Promote international monetary cooperation and exchange rate stability • Facilitate the expansion of international trade and multilateral payments system • Give resources and funds to members experiencing balance of payments difficulties

Section 2 – Trade, financial flows, and foreign investment

The IMF is an important organisation for the global economy as a country in severe financial trouble poses potential problems for the stability of the international financial system, which the IMF was created to protect. It sources funds from a pool of advanced economies’ contributions. These funds are then used to support countries experiencing short-term financial problems. All of these loans need to be paid back to the IMF with low rates of interest. After the GFC, the IMF injected US$250 billion into the economy to promote liquidity and suspended interest payments on loans to help developing countries. C ASE S PACE :

At the start of 2020, the IMF forecasted that 160 nations would enjoy positive income growth on a per capita basis. By March, the expectation was that over 170 nations will have negative per capita income growth due to the COVID-19 pandemic. “With weak health systems to begin with, many face the dreadful challenge of fighting the virus in densely populated cities and poverty-stricken slums, where social distancing is hardly an option,” the IMF chief (Georgieva) announced. The IMF therefore agreed to double loan levels from its emergency facilities, allowing the IMF to provide over US$100 billion in financing to low-income countries. An unprecedented 102 of the IMF’s 189 member countries sought financial assistance.

2.2.3

World Bank

The World Bank aims to promote economic development in developing countries through influencing macro and micro economic policy. The world bank aims to assist developing economies through providing: • Development assistance (foreign aid) and loans • Support for long-term investment projects to encourage economic development • Dispute settlements in investment projects (e.g. disputes hindering progress between governments and firms) However, the World Bank and IMF usually require governments to implement specific structural reforms in their economies to receive assistance. This is called the conditionality principle. This principle can be seen as undermining a nation’s sovereignty and autonomy, and therefore may restrict the ability for these organisations to assist nations who disagree with their terms. The World bank’s two major goals, to be achieved by 2030, include: • Reducing the rate of extreme poverty to less than 3% • Reducing inequality by fostering income growth for the world’s bottom 40%

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2.3 Influence of government economic forums

2.2.4

United Nations (UN)

The UN’s primary aims involve peacekeeping, conflict prevention, humanitarian assistance, and human rights on a global scale. The UN covers a wide range of issues from sustainable environmental management to economic development. They also provide the global standard for development to ensure no country is left behind, known as the 2030 Agenda for Sustainable Development. This features 17 goals, aiming to end all forms of poverty. These goals officially came into effect in 2016, covering the next 15 years. Examples of these goals include: • Eradicate poverty and hunger everywhere by halving the number of people living in extreme poverty • Achieve gender equality and empower all women and girls The UN has overseen a reduction on the amount of people living off less than US$1 a day from 29–15%, from 1990 – 2015.

2.2.5

Organisation of Economic and Cooperation of Development (OECD)

• Promote sustainable economic growth and development, and maintain financial stability • Contribute to global economic development through providing specialised advice to member nations. It publishes regular reports such as the OECD Economic Outlook on each member’s economic performance and prospects. It also makes policy recommendations to improve the economic performance of its member nations. For example, in 2018, they released an OECD Pensions Outlook, which examines how pension systems are adapting to improve retirement outcomes.

2.3

Influence of government economic forums

Government economic forums are global forums that influence and coordinate world trade and economic policies across the global economy. Discussions include those around global economic governance, environmental and ethical issues, and international security.

2.3.1

G20

The G20 was established after the 2008 GFC to coordinate a global response to avert a depression. G20 members account for 85% of the world economy, 75% of global trade, and approximately 66% of the world’s population (DFAT). It came about because the G7 wasn’t truly global. G20 leaders meet annually at the G20 Summit. Australia hosted the G20 Summit in Brisbane in 2014, which agreed to lift growth by 2%. The G20 aims to: • Coordinate fiscal stimulus around the world • Improve supervision of global financial system • Discuss key issues in the global economy

2.3.2

G7

The G7 has been the unofficial forum for coordinating global macroeconomic policy due to its influence over the fiscal and monetary policies of the world’s largest economies. Lately, the significance of G7 has declined. This is because there has been a shift from the global balance of power towards emerging economies, in particular China. The G7’s share of global GDP has shrunk from 68% in 1992 to 46% in 2018. In 2008 they met in Washington DC to coordinate macroeconomic policies to overcome the GFC, pledging over US$1 trillion in loans and guarantees for the IMF.

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Section 2 – Trade, financial flows, and foreign investment

The OECD engages in research, consultation, and coordination of economic issues. With only 34 member countries, they are the smallest of the international organisations, however this allows the organisation to promote coordination of macroeconomic policy among members to support economic growth. The organisation aims to:

2.4 Trading blocs, monetary unions, and free trade agreements

2.4

Trading blocs, monetary unions, and free trade agreements

A trading bloc is where countries enter preferential trade agreements, establishing free trade between themselves and external tariffs on imports for the rest of the world. This is beneficial if there is trade creation and not trade diversion (i.e. increased trade volumes overall), as countries are able to utilise comparative advantage. Trade diversion is where trade with non-member countries decreases. Monetary unions are formed when groups of countries share a common currency and monetary policy. This creates an increasingly integrated regional market, boosting financial efficiencies. An example of a monetary union (and trading bloc) is the Eurozone, consisting of all the European Union (EU) countries that adopted the Euro as their national currency. Free trade agreements are formal agreements between countries to reduce trade barriers such as tariffs. Free trade doesn’t necessarily mean no barriers at all; it refers to the reduction of barriers (some forms of protection may remain). Free trade agreements can be multilateral (e.g. WTO agreements), regional (e.g. the EU), or bilateral, (e.g. AUSFTA, the Australia-United States Free Trade Agreement).

2.4.1 Section 2 – Trade, financial flows, and foreign investment

2.4.2

Evaluating multilateral and bilateral trade agreements Advantages

Disadvantages

+ FTAs allow countries to sell more exports and engage in greater trade at reduced costs. This can lead to increased output and economic growth. + FTAs promote closer political relationships between countries as countries work towards building mutually beneficial agreements.

– Trade diversion may occur, where trade with non-members may decrease. – The global economy may become divided along regional lines, as trading blocs give preferential access to markets within areas.

European Union (EU)

The EU is a customs and monetary union (for countries in the Eurozone), trading bloc, and multilateral agreement consisting of most European countries. The creation of a single European market through common trade and migration policies has allowed for increased efficiency in the allocation of resources in this region. The single currency of the Euro ( C) managed by the European central bank, reducing transaction costs in an increasingly integrated regional market. The EU accounts for 17% of the world market for exports – larger than China or US. The implications of this preferential region for non-members include high rates of protection for agricultural goods. For example, the EU’s Common Agricultural Policy subsidies absorbed 38% of its budget in 2016.

2.4.3

Asia Pacific Economic Cooperation (APEC)

APEC is a multilateral trade agreement and regional economic forum created to promote free trade within the Asia-Pacific region. The aims of APEC include to: • Implement common trade policies with member nations • Develop mechanisms for closer trade and investment links in Asia Pacific (e.g. dispute settlement procedures) APEC is non-discriminatory, as it agreed not to become a protectionist trading bloc, but also aims to reduce barriers to non-member countries as well. However, in recent years the significance of APEC has declined due to the forum’s large size and subsequent inefficiency. Even though APEC members account for approximately 40% of the world population, they account for 60% of world GDP and 47% of world trade. APEC had a target of ‘free trade’ by 2020 under the Bogor Declaration. Tariff levels within countries dropped from 20% to 13% between 1994–2018.

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2.4 Trading blocs, monetary unions, and free trade agreements

2.4.4

North American Free Trade Agreement (NAFTA)

NAFTA: multilateral free trade agreement consisting of Canada, Mexico, and the US mainly based on eliminating agricultural protection and tariffs. The benefits to the US and Canada include the opportunity to increase international competitiveness by exploiting lower production costs by shifting production to Mexico. The advantages for Mexico include greater access for firms to the large markets of the US and Canada. However, trade diversion may have been created due to this agreement, as there is an incentive for American and Canadian firms to relocate production to Mexico and close manufacturing in Canada and the US. Despite this, consumers have benefited from lower prices, and US corporations from the lower costs. NAFTA accounts for 13% of global merchandise trade. C ASE S PACE :

This new agreement focuses largely on automobile and agricultural exports, increases environmental and working regulation and incentivises more domestic production of automobiles. Analysis of the new agreement reveals mixed effects on the economic growth of member nations, but the International Trade Commission found the agreement will increase GDP by 0.35% and jobs by 176,000 in the next 6 years.

2.4.5

Association of South-East Asian Nations (ASEAN)

ASEAN is a free trade area covering emerging and developing economies in South-East Asia. The aim of ASEAN is to promote economic development, social progress, and cultural development within this region. It has acted as a counterweight to the APEC forum, which tends to be dominated by the large economies like US and China. Australia and New Zealand created a multilateral agreement with ASEAN in 2010 called the ASEAN Australia New Zealand Free Trade Area (AANZFTA). ASEAN nations committed to eliminating tariffs on 96% of Australian exports to the region. This is the largest preferential trade agreement that Australia has reached, representing 20% of Australia’s trade in goods and services.

2.4.6

Bilateral trade agreements

The slow progress in WTO negotiations (such as the Doha Round) led to the rapid growth in bilateral FTAs in recent years. C ASE S PACE :

One of Australia’s most significant bilateral trade agreements is the Australia New Zealand Closer Economic Relations Trade Agreement (ANZCERTA). This led to the elimination of all tariffs and trade restrictions on goods and services between the two nations. It also involved the harmonisation of business regulations and tax laws. It is the first bilateral trade agreement to include free trade of services. The agreement aims to strengthen the economic relationship between Australia and New Zealand, and promote fair trade and competition.

Advantages + Reduce trade barriers more quickly than waiting for WTO, as multilateral negotiations are often a very lengthy process due to disputes. + More flexibility in conditions of agreement, as agreements are tailored to suit only two nations.

Disadvantages – Trade diversion may occur, causing inefficient allocation of resources as trade with non-member countries decreases. – Bilateral trade agreements may undermine the WTO’s most favoured nations principle, which specifies that countries should not give preferential trade policies to certain countries.

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Section 2 – Trade, financial flows, and foreign investment

Following Donald Trump’s presidential election, the future of NAFTA became uncertain. Renegotiation took place between 2017–2018, with the top priority being to reduce the US’ trade deficit. The renegotiations were successful, and a preliminary deal was reached, preserving the trilateral pact. The new name for the agreement is the United States-Mexico-Canada Agreement (USMCA), ratified in March 2020, replacing the goals of NAFTA.

Protection

Section 3

Protection Protection refers to the use of artificial barriers which restrict the free flow of goods and services in international trade, to give domestic producers an artificial advantage.

3.1

Reasons for protection

K EY P OINT :

The main reasons for protection include the infant industry argument, domestic employment, dumping, and defence. These often come up in short-answer questions and can be used in essays to strengthen analysis, so this theory is very important to remember!

Section 3 – Protection

Infant industry argument: allowing newly established industries sufficient time to achieve economies of scale to compete in global markets and become efficient. When companies engage in open trade policies, competition between firms becomes high and those that are able to achieve economies of scale and hold a competitive edge over others find the most success and profits. This makes it difficult for new firms to establish a place in the market, as they are unable to achieve the same level of production and scale as well-established firms with high rates of investment. However, if protection is implemented for new firms, it should be temporary, until they are internationally competitive. Otherwise, this may result in inefficient resource allocation if firms become reliant on protection and don’t innovate. Domestic employment: if overseas countries offer cheaper production, then domestic jobs are put at risk as firms shift production elsewhere to decrease costs. Imposing tariffs or barriers can prevent job losses which have the potential to cause economic contractions and recessions. However, this may be at the expense of efficient export industries, as higher trade barriers may affect export competitiveness and terms of trade. C ASE S PACE :

A major motivator of Donald Trump’s shift towards protectionism of the US economy was to protect domestic jobs and lower their structurally large trade deficit. However, with the protection of domestic industries comes higher prices for consumers and firms which rely on imports in their supply chain. @realDonaldTrump tweeted in 2018: “When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win.” However, the idea of trade wars (when countries attack each other’s trade with high protection), can hurt other nations’ economies equally and lead to rising political and global tensions. Dumping: if a country has an oversupply of goods it may dump excess products on another economy at a very low price, damaging local businesses as they are unable to compete. This may be due to excess supply and stock levels. This especially hurts developing economies as they drive down world prices of key commodities and create unfair trade. A country may impose a quota on imports to restrict dumping from occurring. For example, Oxfam has called for the EU to review its Common Agricultural Policy, which heavily subsidises agricultural production and causes excess production, which Oxfam claim is destroying livelihoods of farmers in developing countries. Defence: involves defence of the nation in the event of war, or defence of a cultural preservation. It is a form of national security for countries to have their own goods, including weapons and essential goods such as food production, rather than solely rely on imports.

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3.2 Methods of protection

3.2

Methods of protection

K EY P OINT :

The methods of protection are commonly tested as harder multiple-choice and short-answer questions, so practise drawing, interpreting, and analysing the following diagrams.

3.2.1

Tariffs

3.2.2

Tariffs are taxes on imported goods imposed for the purpose of protection.

Quotas are quantitative restriction on certain categories of imported goods.

Fig 2: The effect of an import quota (from world price P to P1 ).

K EY P OINT :

The advantages and disadvantages of quotas are similar to tariffs, except no government revenue is generated. Shorten your notes by ensuring this theory doesn’t double up!

Advantages

Disadvantages

+ Redistribution effect: tariffs stimulate domestic production and employment, which may increase domestic incomes (redistributing income). + Revenue effect: the government gains revenue from tariffs collected on imports (illustrated by the rectangle ABCD in Fig 1). + Consumption and protection effect: imports may decrease overall, which may improve terms of trade, balance of payments, and lower the CAD.

– Price effect: tariffs may lead to imported inflation, as the equilibrium price of a product increases. This may result in a loss in consumer’s real income, due to higher prices, lowering living standards. – Reciprocity argument: retaliatory tariffs on domestic exports may be implemented by other nations, nullifying the positive effect of the initial protection, as export revenue is lost, decreasing overall trade volumes.

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Section 3 – Protection

Fig 1: The effect of a tariff (from world price P to P1 ).

Quotas

3.2 Methods of protection

3.2.3

Subsidies

Subsidies are forms of financial assistance paid to domestic producers such as farmers to allow them to increase supply and compete internationally.

Fig 3: The effect of a subsidy.

Section 3 – Protection

Advantages

Disadvantages

+ A subsidy has all the advantages of a tariff, minus government revenue. + Subsidies offer a price advantage for local consumers as there is less inflationary pressure (as prices are kept at the competitive, world price level). + They are easier to remove than a tariff. Subsidies cost the government tax revenue and are therefore subject to regular reviews.

– Subsidies distort resource allocation as they support industries that may be inefficient compared with international standards. – They may increase the tax burden on the government, contributing to high expenses and inefficiencies. – They have direct costs on government budgets, rather than income (such as the income brought in by tariff revenue).

3.2.4

Local content rules

These specify that goods must contain a minimum percentage of locally produced parts, or a proportion of goods in the market must be locally made. An example of an Australian local content rule is that all commercial, free-to-air television licensees broadcast an annual minimum transmission quota of 55% Australian programming between 6:00 a.m. and midnight. This protects Australia’s dramatic and informative entertainment and culture.

3.2.5

Export incentives

These give domestic producers assistance (e.g. grants, loans or technical advice) to encourage businesses to penetrate global markets and expand market share. For example, Austrade is a government body that helps businesses in importing and exporting. It provides advice and guidance on overseas investment opportunities. Austrade’s Export Market Development Grands (EMGDs) reimburse exporters for costs relating to the promotion of exports into new markets. Each dollar spent generates $13.50 for $27 worth of exports.

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3.3 Effects of protectionist policies

3.3

Effects of protectionist policies Effect on Global Economy

– Distorts resource allocation and income distribution: local industries gain in the short-term, however in the long-term the economy experiences a shift from efficient to less efficient industries, as resources are consumed by industries with a higher opportunity cost. – Inflation: may increase as a result of the tariff on imported goods (as this raises prices). If inflation increases, this may increase wage pressures and lead to an increased cost of production. – Economic growth may be slower: as resources are not used efficiently. When an economy does not achieve allocative efficiency of resources, economic growth is limited. Output may remain in the domestic market and firms may find it difficult to benefit from economies of scale. – Exports may be lower: because the protected industries tend not to seek overseas markets, due to the high profit returns locally.

– Reduce access to markets: developing economies are often excluded from access to the markets of advanced economies and trade policies and agreements are often more favourable for advanced economies. International organisations such as the WTO aim to promote fair trade globally, especially supporting the interests of developing economies. – International trade barriers: tend to harm developing economies who are exporting their agricultural products and some of their manufactured goods causing an increase in income inequality between nations. – Global political tensions: and retaliatory effects may increase due to a lack of harmonious trade and economic relationships globally. International organisations attempt to resolve these disputes by acting as a mediator and forum for negotiation. – Reduced trade and economic growth: due to shielding inefficient producers, lower trade volumes, higher overall prices, less variety and lower living standards.

Section 3 – Protection

Effect on Domestic Economy

C ASE S PACE :

US-China Trade War US President Donald Trump has long accused China of unfair trading practices and intellectual property theft and China has long viewed America as attempting to curb its rise as a global economic power. This resulted in a trade war between the two nations, with negotiations proving very difficult. At the height of the trade war, Trump threatened a 45% tariff on all Chinese imports. About 20% of China’s exports end up in the USA, so this would have severely impacted China’s export revenue. At the height of the trade war in 2018–2019, the US implemented a tariff of 10% on US$200 billion of Chinese imports, and China retaliated with a tariff of 10% on US$60 billion on American imports. Preliminary negotiations occurred in January 2020, around phase 1 of the US-China agreement. In this agreement China pledged to boost US imports by US$200 billion and strengthen intellectual property rules, and the US has agreed to half some of the new tariffs it has imposed on China. However, the COVID-19 pandemic put a halt to the implementation of these policies as the pandemic has caused renewed tensions between the two nations.

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Globalisation and economic development

Section 4

Globalisation and economic development K EY P OINT :

This theory forms the basis for the case study. Often, students are lost on what content should be included in notes for their case study. Use the syllabus terms from this section as a guide for what content is frequently examined for your prescribed economy.

4.1

Differences between economic growth and development

Economic growth is the increase in GDP over time, adjusted for inflation (real GDP). Economic growth is a quantitative measure of the performance of an economy. In Australia, the average growth rate in recent years has been approximately 3%. In 2019, the annual economic growth rate was 2.2%.

Section 4 – Globalisation and economic development

Economic development is the structural changes needed for growth to occur in an economy and to sustain increases in living standards. Economic development is a qualitative measure of the performance of an economy. Economic development can be measured by the Human Development Index (HDI), a metric devised by the UN. HDI is measured on a scale of 0 to 1; the higher the score, the more economically developed a nation is. In 2019, Norway had the highest HDI at 0.95, and Niger the lowest at 0.38. Australia was ranked sixth with 0.94. HDI takes into account: • Life expectancy: indicative of the health and nutrition standards in a country, which are critical for a country’s economic and social wellbeing. If health levels are low, the quality of labour resources are also lower and hence less productive. • Education levels: refer to the development of the skills of the workforce, which determine the future development potential, innovation, and productive capacity of an economy. • GNI per capita: shows citizens’ access to goods and services, and the extent of potential demand in an economy. It also offers insight into living standards in an economy, as higher incomes generally support higher living standards.

4.2

Distribution of wealth and income

The rewards of globalisation are not shared equally between and within countries. The distribution of income refers to the comparison of annual incomes, which are direct returns from factors of production (land, labour, capital and enterprise investment) of citizens. The distribution of wealth refers to the comparison of asset ownership of citizens. While over 1 billion people have moved out of extreme poverty since 1990, there is great inequality of income and wealth across the global economy. Over 50% of those living in extreme poverty live in Sub-Saharan Africa, where the vast majority live in rural areas and are poorly educated. 50% of those living in extreme poverty are under 18 years of age Comparison of wealth ownership highlights global inequality most; in 2019 the Credit Suisse Global Wealth Report found that the richest 1% of the world owned 44% of the world’s wealth. According to Oxfam, the wealth divide between the global billionaires and the bottom half of humanity is steadily growing. The number of billionaires it took to equal the wealth of the world’s poorest 50% fell from 380 to 26 between 2009 and 2019.

4.3

Income and quality of life indicators

Gross national income (GNI) measures the sum of value added by all resident producers in the economy, plus primary income from foreign sources, on a purchasing parity basis (US$). The UN in the Human Development Report in 2016 stated that “inequalities in income influence inequalities in other dimensions of wellbeing.” This highlights the importance of considering income when measuring quality of life, as it represents an individual’s ability to access goods and services and perform autonomous consumption (consumption which is necessary to survive). HDI can measure quality of life as it is a broader, more comprehensive measure that takes income into consideration with a range of other factors. 16

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4.4 Reasons for differences between nations

Developing, emerging, and advanced economies

4.4.1

Income levels

Economic growth

Structure of economy

Examples

Advanced

High-income levels, average per capita income over US30,000 p.a.

Slower growth in recent decades

Market based economies, services

USA Australia

Emerging

Income levels vary but fast growth in income levels

Strongest growth rates in the world (5-1-0%) and favourable prospects

Industrialising, manufacturing

China India

Developing

Low-income levels, around half of population in absolute poverty

Moderate growth rates but population growth also high

Heavily reliant on agriculture and (in more extreme cases) foreign aid

Egypt Cambodia

Reasons for differences between nations Global factors

The main global factors that contribute to inequality between nations include: • Global trade system • Global financial architecture • Global technology flows Global trade system High global protectionism in the agricultural sector has caused high inequality globally, as developing economies aren’t exporting to developed economies due to the restricted market access. The failure of the Doha Round is an example of the inequality caused by the global trade system, as high-income nations resisted making concessions on the issues that would provide the greatest benefit to developing countries. Global financial architecture Many advanced economies will engage in short-term financial investment in emerging economies, as they offer high returns due to the high risk involved. This creates economic volatility, as money is moved in and out of the financial market quickly, which can have flow-on effects for investor confidence, market stability, terms of trade and exchange rates. Furthermore, due to the high rates of foreign borrowing and low incomes of developing nations, massive foreign debt burdens occur for those nations who are already experiencing balance of payment difficulties. Interest repayments on these loans grows exponentially as the nation accumulates more debt to pay off previous loans, resulting in a debt-trap cycle. This further reduces income available for economic growth and development and causes inequality between nations. Global technology flows Technology flow between advanced and emerging economies entrench rather than alleviate inequalities between nations, as advanced economies have access to greater amounts of capital, boosting productivity.

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Section 4 – Globalisation and economic development

4.4

Type of economy

4.4 Reasons for differences between nations

4.4.2

Domestic factors

Domestically, a variety of factors can contribute to a nation’s inability to accumulate wealth. These can be separated into two core reasons: economic resources and institutional factors. Economic resources

Section 4 – Globalisation and economic development

• Natural resources: a lack of natural resources results in a lack of resources for production, creating higher opportunity costs across an entire economy. Resource-rich nations tend to have higher amounts of wealth. Also, countries that heavily rely on natural resource exports are exposed to downturns in commodity prices which can result in sudden falls in a nation’s income. • Labour supply and quality: high population growth, poor education levels, and low health standards reduce the quality of a nation’s labour supply. Reduced labour quality decreases a nation’s productivity levels and output, hence limiting economic growth and income levels. • Lack of both infrastructure and capital formation: slow economic growth contributes to an inefficient use of both labour and capital. • Low per capita incomes: reduce the overall spending and investment rate of a nation. This results in the poverty cycle, illustrated in figure 4. This illustrates how low per-capita incomes results in low levels of saving and investment, which causes low rates of productivity and output. This limits overall economic growth.

Fig 4: The poverty cycle Institutional factors • Political and economic institutions: political instability and corruption means investors may not have confidence in an economy and are reluctant to take risks in investment. • Economic policies: governments that collect less tax revenue due to the low incomes of citizens cannot provide the same level of public services and social welfare as advanced economies. This limits the government’s capacity to support economic growth and development within the economy, increasing inequality between nations. • High levels of foreign debt: leads to higher debt-servicing costs, which diverts money away from other essential services and limits economic growth and development.

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4.5 Effects of globalisation

4.5

Effects of globalisation

There are mixed effects of globalisation on the different economies of the world. Globalisation has mostly benefited emerging economies, as the reformation of trade and financial flows has allowed these economies to experience rapid economic growth and development. Overall, there has been an international convergence of economies due to the increased integration of market economies. The economies of the world have built stronger relationships and implemented international organisations, forums and treaties to stabilise these relationships and manage any tensions and disputes. In terms of economic growth, globalisation has caused:

In terms of economic development, globalisation has caused: • Increased income inequality, as global mobility of labour results in the emigration of skilled labour from developing economies to advanced economies (often called the “brain drain”) – According to the IMF, income inequality has increased by 0.45% per year over the past 3 decades. However, the easing of trade restrictions has allowed for increased market access for exporters, lower overall prices, and greater variety, which can improve living standards. • Increased negative externalities such as environmental degradation and exploitation of the labour forces of developing nations

4.6

Trade, investment, and transnational corporations

There have been rapid increases in trade, investment, and TNCs as a result of globalisation. This has created a global web of production facilities and supply chains which connects economies. TNCs are often criticised for taking advantage of poorer countries by exploiting lower labour costs and natural resources. They are also criticised for exploiting global tax laws. C ASE S PACE :

In 2019, Apple was accused of labour violations in China in a report released by China Labour Watch. Apple denies most allegations but acknowledged they did exceed the number of contract workers allowed by Chinese law and agreed to compensate workers. In 2017, Apple was accused of exploiting Irish tax laws, whereby they would pay tax in Ireland on some of their profits. Ireland has a 12.5% corporate tax rate compared to the OECD average tax rate of 21%. Tax strategies like the ones used by Apple and other major corporations cost governments around the world as much as $240 billion a year in lost revenue, according to an OECD estimate.

4.7

Environmental sustainability

Environmental sustainability involves sustaining the increasing living standards as a result of globalisation. This is a global issue of increasing importance, as economies of the world must work together to implement policies which preserve the natural environment. Advanced economies have created many of the global environmental problems that exist through high pollution and energy use, due to high rates of production and consumption. Emerging economies deplete the environment in the pursuit of higher economic growth. An OECD report predicts in 2050 the world economy will be about four times bigger than it is today, using approximately 80% more energy. Copyright © 2022 InStudent Publishing Pty. Ltd.

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Section 4 – Globalisation and economic development

• Increased opportunity for firms to achieve economies of scale, specialise, and take advantage of lower input costs • Increased technological innovation due to increased competition internationally, which has stimulated productivity levels, especially in developed nations with access to high levels of FDIs • Financial contagion whereby financial crises can be transmitted quickly – this has highlighted the need for coordination of macroeconomic policy (e.g. the establishment of the G20 due to the events of the GFC)

4.8 International business cycle

K EY P OINT :

Use notes from Topic 3: Environmental Sustainability and Topic 4: National and Global Context for Environmental Management if examined on the above theory. This is because both Topic 3 and 4 explore environmental sustainability comprehensively. It is also worth noting that due to the repetitive nature of theory involving the environment in the Economics syllabus, it is of great importance and will be examined often!

4.8

International business cycle

K EY P OINT :

To efficiently prioritise your study, use notes from the regional and international business cycle introduced earlier on in this topic, and focus on a small case study here to support your theory. This can be used in essays to extend your explanations and engage in deeper analysis.

Section 4 – Globalisation and economic development

C ASE S PACE :

The Global Financial Crisis (GFC) The Global Financial Crisis (GFC) of 2008/2009 exposed the problem of financial contagion, as the onset of the crisis is thought to be (in part) due to a catalyst financial crisis in the US, where US house prices were falling, borrowers were unable to repay their loans, and a bank (Lehman Brothers) declared bankruptcy. Due to the globalised nature of the US financial system, foreign banks and investors experienced spill-over effects and there was worldwide panic in financial markets. Global confidence tumbled, and prices fell as investors pulled out of ventures, businesses became unwilling to invest, and households less willing to spend. During the GFC, advanced economies contracted by 3.4% and the world economy experienced a recession, which led to a contraction in world trade and investment. The world economy experienced its sharpest slowdown since the Great depression, however global macroeconomic responses prevented a global depression. (Source: RBA – The Global Financial Crisis Explainer).

4.9

Case study: China

K EY P OINT :

The case study component of Topic One can be a time burner for many students, who put many hours into research and compilation of notes for a certain country. It is important to study efficiently for this section of the syllabus, treating it like other sub-topics both in terms of length of notes and the time taken to study for it. You should focus on: • The country’s involvement with the global economy, and policies and global organisation involvement used to promote globalisation • Effects of any of the following which are relevant to the economy: trade, financial flows, investment, technology, migration and the international business cycle (components of globalisation) • Economic reforms made to the economy that have affecting economic growth and development • Current economic policies used to manage key issues in the economy

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4.9 Case study: China

4.9.1

China’s economic reform policy

When Deng Xiaoping came into power in 1978, he implemented many economic reforms to alleviate poverty in China. The focus was on reforming the economy to become more globalised and market driven. The reform was based on policies of industrialisation, with the aim to increase living standards and reduce poverty overall and support economic development. Influence

Agriculture: farmers could sell their surplus output after meeting the minimum state quote for production (called de-collectivisation).

This led to increases in food production, and surplus income was re-invested into towns and manufacturing.

Open door policy: was adopted in regards to trade in 1980, with low tax rates and protection.

Exports grew, technology improved and increased FDI in manufacturing supported employment.

Special Economic Zones (SEZ): areas in which foreign and domestic companies can trade and invest with less regulations. Trade increased from10% to 36% between 1978–1996, supported by the creation of SEZ.

This led to increased trade, exports, FDI and employment. Chinese industries were exposed to overseas competition, increasing efficiency due to economies of scale in manufacturing.

Cut tariffs: in the mid 1990s, Beijing took control of taxes away from provinces and cut tariffs

This encouraged efficiency in domestic industries and led to China becoming internationally competitive.

Taxation reforms: in 1994, there was a shift in power to collect taxes to the central government.

This improved the efficiency of tax collection and increased funds to finance public infrastructure spending and increased welfare support.

Banking laws: relaxation of restrictions on foreign banks offering retail banking services (e.g. in 2012, ANZ was granted a license to offer finance products to Chinese citizens).

This made the Chinese banking industry more efficient and competitive, due to exposure to international financial markets, and led to better facilitate saving and investment in China.

Section 4 – Globalisation and economic development

4.9.2

Strategy

Size of the Chinese Economy

China became the largest economy in 2014, producing 17.1% of global GDP, according to the IMF. It has the world’s largest population of 1.3 billion, which is about 20% of the global population. China’s Economic Growth Rates China’s growth rate was about 10% per year from the late 1990s to 2008. From 2016 onward, it slowed to about 6.5% due to less reliance on export growth. Strategy

Influence

When the GFC slowed the Chinese economy, the Chinese Government used a fiscal stimulus of US$586 billion, to build infrastructure and encourage export growth.

China’s exports grew by an average of 20% between 2005 and 2010 but have slowed down post -GFC.

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4.9 Case study: China

4.9.3

China’s Economic Development

China’s living standards Real income per capita, literary rates, life expectancy, and the HDI index have all increased substantially since China’s economic reform. China’s HDI value rose from 0.52 to 0.74 between 1995 to 2015. Distribution of income Per capita incomes in large cities are much higher than rural areas, causing an increase in regional income inequality. Urban areas have experienced the fastest economic and employment growth due to their proximity to the Special Economic Zones. For example, Shanghai and Beijing have income levels 150% higher than the national average.

4.9.4

China’s International Trade

China’s Currency – The Yuan

Section 4 – Globalisation and economic development

China’s central bank pegs the Yuan to the $US and sets the value of the Yuan daily. The US has argued that China needs to integrate more with the global financial system and therefore should allow the Yuan to trade more freely. The volume of China’s exports grew annually by 8.8% between 2005–2015. Over 90% of their exports are manufactured goods. Strategy

Influence

In August 2019 China relaxed some of this pegging, lowering the value of the Yuan below its 7 to 1 peg against the dollar in response to increasing US tariffs.

This made exports less competitive, and relieved tensions between the US and China. However, an overvalued currency makes imports cheaper.

China’s membership of the WTO China was admitted as a member of the WTO at the Doha Round in 2001. Greater access to world exports through WTO membership allows for future growth and development of China by achieving the following three goals: • Diversification of its export base due to greater market access • Attracting more foreign investment due to lessened trading restrictions • Encouraging innovation and the use of technology in the domestic economy due to increased competition Investment and Financial flows There has been an increase in imports into China due to an increase in domestic demand from household consumption and business investment. This has financed the growth in China’s rate of urbanisation. Additionally, companies have established production facilities in major Chinese cities to take advantage of cheap labour and power, resulting in large increases in FDIs. China is currently the world’s largest recipient of foreign direct investment. China, the US, and Australia China and the US combined account for a quarter of global trade. The US is China’s biggest export market, with 17% of exports going to the US. In 2015 China invested just over $15 billion in Australia; an increase of 60% from 2014, illustrating China’s increasing bilateral integration with Australia. Australia was the second largest recipient of Chinese investment behind the USA for the period of 2005–2017. This bilateral relationship is further supported by the China-Australia Free Trade Agreement which allows for 93% of Australian exports to enter China with no protection as of 2019.

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4.9 Case study: China

4.9.5

China and the Environment

The high level of economic growth in China has led to high levels of environmental degradation and resource depletion, due to the rapid development of the economy. China is the world’s largest emitter of greenhouse gases in 2019, with approximately 27% of global emissions. China also has red alerts for severe pollution due to their status as the largest producers of coal in the world. Influence (environmental impacts)

To achieve clean air targets by the end of 2017 China implemented a series of policies to minimise emissions including: • Coal banned in China’s coal capital • Factories closed down for failing pollution inspections • Investment in renewables infrastructure However, since 2018 China has lifted the coal ban and emissions have begun to increase again (4% growth in the first half of 2019).

China has increased energy demands to power manufacturing and the growing urban areas. Industries have polluted water supplies as negative social externalities have not been considered in production, leading to water depletion. Poor farming practices, overgrazing, the effects of climate change, and the water crisis has turned much of China’s fertile land into desert (desertification).

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Section 4 – Globalisation and economic development

Strategy

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Topic II

Australia’s Place in the Global Economy

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Australia’s trade and financial flows

Section 1

Australia’s trade and financial flows K EY P OINT :

The focus of this topic is to examine Australia’s involvement with the global economy, and the effect of changes in the global economy on Australia. You will also examine tools to measure this relationship. Despite being one of the shortest topics, the theory can get tricky and hence will require attention to detail and may take a little longer for students to wrap their heads around it. Don’t lose confidence if you struggle with some of these concepts at first! Spending time revising this content repeatedly will help – try a variety of the study techniques noted at the back of this book to help your understanding.

1.1

Value, composition, and direction of Australia’s trade and financial flows

1.1.1

Trends in Australia’s trade pattern

Australia’s trade balance is the difference between exports and imports is currently positive. As of March 2020, the trade balance hit a record high of about $10.6 billion. The following statistics are all sourced from DFAT in 2019. 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) Australia also manufactures some niche, sophisticated products including: • Medical equipment • Pharmaceuticals • Processed food Australia imports the most from the US (12.5% of imports), including: • Overseas travel (top import, representing 11% of Australian imports) • Cars and petroleum Australia is sometimes criticised for having a narrow export base, but the economy is reasonably resilient. 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.

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Section 1 – Australia’s trade and financial flows

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.

1.2 Australia’s Balance of Payments

1.1.2

Trends in financial flows – debt and equity

The financial system was reformed in 1983, with the floating of the exchange rate. This allowed for greater accessibility of Australian firms to world capital markets, and foreign investment into Australia. The Australian financial market become increasingly globally integrated. FDI into Australia, and investment overseas by Australians has doubled in the past decade. The top international investors from Australia has shifted, from commodity companies in 1990s, to service-sector business in 2010s (e.g. banks). This represents the changing pattern of Australian production and subsequent movement of financial flows. 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

Section 1 – Australia’s trade and financial flows

• 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. • Debt: loans/money borrowed by an individual, firm, or government. • 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.

1.2

Australia’s Balance of Payments

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 attraction for foreigners to invest in Australia is that they can own a business in a country that has a stable economy and a functioning legal system, meaning investments are less risky and volatile. The attraction for Australia to welcome foreign investment is to stimulate economic growth. This is because foreign firms provide employment, pay local taxes (increasing government revenue), and buy from local suppliers and firms, hence injecting money into the economy.

1.2.1

Structure Balance of Payment

26

Current Account

Capital and Financial Account

• Net Goods and Services (X – M) • Net Primary Income (NPY) • Net Secondary Income

• Financial • Investments: direct or portfolio • Loans • Capital • Capital transfers • Net acquisition, disposal of assets

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1.2 Australia’s Balance of Payments

K EY P OINT :

The Balance of Payments is separated into the Current Account (CA), and the Capital and Financial Account (KAFA). The HSC Economic syllabus and past exams heavily focuses on the CA, much more so than the KAFA. This means your notes for the KAFA can be minimal, as it is rarely examined and is of less importance when compared to the CA. The Current Account + Capital and Financial Account = 0 must always be true. This is a key fact commonly examined in multiple-choice questions. If both accounts do not balance, it is forced to equal 0 through the introduction of net errors or omissions, which represents the unbalanced sum. 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 Current Account reflects current transactions, which are transfer of payment. The CA represents income (a return on a factor of production e.g, land, labour, capital enterprise), which is a non-reversible transaction. The CA consists of: 1: BOGS (X-M)

2: Net Primary Income (NPY) • Earnings on investments, which is income earned as a return from a factor of production (i.e. income, dividends (profits), rent etc.) • When foreign companies invest in Australia and profits flow back overseas • When Australian businesses invest overseas profits flow back to Australia 3: Net Secondary Income • Non-market transfers → income not earned through a factor of production • Small part of the Current Account (e.g. remittances to relatives) The CA is measured as a percentage of GDP. In the long-term, a CAD of 3% or less, and in the short-term a CAD of 5% or less is considered sustainable. Australia’s average CAD is approximately 3.2%. S AMPLE :

Calculating Current Account Example 1: BOGS (X - M) • Exports of Goods = 350 • Imports of Goods = 250 – Balance of goods = 100 (350 – 250) • Exports of Services = 150 • Imports of Services = 200 – Balance of services = –50 (150 – 200) • Balance of Goods/Services (BOGS) = 50 (100 + (–50)) 2: Net Primary Income • NPY = –250 3: Net Secondary Income • NPS = 50 Current Account Balance = –150(50 + (–250) + 50). A CAD of $150 million means there will be a capital account surplus of $150.

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Section 1 – Australia’s trade and financial flows

• Difference between the number of goods and services exported and imported • Called net goods and services or the Balance of Goods and Services (BOGS)

1.2 Australia’s Balance of Payments

C ASE S PACE :

In 2019, Australia experienced its first Current Account Surplus of 0.2% of GDP (US$6 billion), since 1975. This surplus has been motivated mainly be an improvement in the BOGS. Increased commodity prices, booming exports of iron ore and coal, and decreasing demand for imports has improved the trade balance (BOGS). While an increase in exports contributes to GDP growth, the decrease in imports also highlights the underlying weakness in domestic demand. The Current Account Surplus is expected to be a short-term trend, as commodity prices are cyclical components of the economy, meaning they are likely to fall in the near future. 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.

Section 1 – Australia’s trade and financial flows

• 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).

1.2.2

Links between key balance of payments categories

Australia’s persistent CAD generally reflects a high rate of international investment. 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. As the KAFA represents a net movement of financial flows and investment into Australia, this increases foreign liabilities, causing an increase in outflows of investment income and servicing costs, which are debits on the NPY component of the CA. 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. Another example of the links between the KAFA and CA is when foreign firms invest in Australia. The opening of foreign firms domestically requires international investment, which is recorded on the KAFA as a surplus. Money then flows back overseas if the company makes a profit and sends this money back to headquarters overseas. This profit outflow is recorded on the CA as a deficit.

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1.2 Australia’s Balance of Payments

1.2.3

Trends in the size and composition of Australia’s Balance of Payments

The factors that contribute to CAD are either cyclical or structural. Cyclical factors are those that vary with economic activity (the business cycle). The volatility of these factors can cause fluctuations in the BOP, and can create unstable, short-term trends. These include: • Exchange rate: the volatility of the exchange rates impacts domestic and international demand levels, affecting both trade and investment (BOGS and NPY). • Terms of trade (TOT): the terms of trade directly affects the BOGS. For example, an improved TOT may improve the trade balance and CA. • Domestic economic growth: favourable economic conditions domestically attracts foreign investment (KAFA surplus) and may cause an increase in foreign liabilities (CA deficit). The opposite is true for economic downturns. • International business cycle: favourable global conditions and confidence will generally be reflected by an increase in export volumes and foreign investment into Australia, which may cause an increased CAD, due to increased credits in the KAFA. The opposite is true for a downturn in the international business cycle. For example, this was seen in early 2020 where the international business cycle was negatively affected by the COVID-19 pandemic, and foreign liabilities in Australia decreased.

• Australia is an attractive, open and safe economy: this is a major factor that affects the general trend of Australia’s persistent CADs, as Australia is a recipient of high volumes of FDI, which is recorded as a credit on the KAFA, and debit on the CA. • Dependence on low-value exports: such as mining products (e.g. iron ore). This impacts the BOGS, as exports are subject to changes in commodity prices, which can cause volatility in Australia’s trade balance, and the BOGS. • Dependence on high-value imports: this also impacts the BOGS, as high-value imports (e.g. electrical goods, technology) are subject to changes in domestic consumer confidence. Hence, in times of strong domestic growth, these imports may increase in volume and worsen the trade balance, and BOGS. The opposite is true for economic downturns domestically. • Cuts in protection: (such as tariffs) for local industries over the last 30 years have allowed for greater volumes of trade and has increased the size of BOP. • Low rate of domestic savings: savings are sourced from overseas to fund the level of investment (savings–investment gap). This is recorded as a credit on the KAFA, and a debit on the CA (outflow from NPY, in the form of interest repayments). The household savings ratio in Australia averages about 3–4%. However, in early 2020 this ratio increased to 5.5% due to anticipated contractions in the economy and decreased consumer confidence. Savings–investment gap 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. International competitiveness International competitiveness refers to a the ability of an economy’s exports to compete with global production. Australia has been criticised that it needs to broaden its export base, due to its high dependence on low-value exports, such as coal and iron ore to a single, main buyer: China. The reasoning is because demand for these exports are subject to high volatility, due to frequent changes in commodity prices. Additionally, changes in Chinese demand may lower export volumes and worsen the BOGs.

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Section 1 – Australia’s trade and financial flows

On the other hand, structural factors are the long-term factors that belong to the economy. These are often difficult to change and are much more stable factors that affect the BOP. These include:

1.2 Australia’s Balance of Payments

C ASE S PACE :

The Mining Boom (2003–2012) During the mining boom, Australia benefited from its high supply of natural resources as the prices of for commodities began rising. This was stimulated by increased demand from emerging Asian economies, including China. While the mining boom boosted exports and the BOGS, the CAD remained at 3% of GDP. This is because of the high increase in overseas investment in the mining sector, which provided the means for Australia to meet the rapid increases in demand for these exports. For the 50 years leading up to the resources boom, mining investment averaged just over 1.5% of GDP. In 2012, mining investment has increased five times its level in 2004, peaking at 9% of GDP (RBA). This investment resulted in the increase in profit repayments overseas, recorded as a debit on the NPY and contributing to the CAD.

Section 1 – Australia’s trade and financial flows

After the mining boom, the Australian economy has transitioned to what is known as a ‘post-mining boom economy’. This includes an increased focus on services as an export to diversify the Australian export base. The economy is still experiencing economic growth, despite the decline in commodity prices and the slowing down of China’s economic growth. Therefore, the Australian economy is resilient, and not solely dependent on mining as a key source of economic growth. The economy can maintain international competitiveness through structural and long-term changes, called microeconomic reform.

1.2.4

Terms of trade

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 DFAT, during Australia’s mining boom period, the terms of trade reached their highest levels in 140 years. Movements in TOT can have a significant influence on the Balance of Payments and the living standards of a nation, as the terms of trade affects both the BOGS and NPY (see mining boom case space above) and can support increased economic growth overall. Terms of trade index = Export price index ÷ Import price index × 100

K EY P OINT :

This formula is often tested in multiple-choice questions. A common mistake students make is the confusion of whether to divide the export price index by the import price index or vice versa. A tip to remember which comes first is to remember that ‘E’ comes before ‘I’ in the alphabet, hence it is first in the equation. Read multiple-choice questions carefully, as examiners will often put the import column first to throw off students in their calculations. Below is an example of TOT calculations: Year 1

Year 2

Year 3

Year 4

Export Price Index

100

105

112

108

Import Price Index

100

110

115

106

Terms of Trade Index

100

95.5

97.4

101.9

If asked to describe the trends in a trade index, use words like ‘favourable’ (Y3–Y4), or ‘unfavourable’ (Y1–Y2).

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1.2 Australia’s Balance of Payments

1.2.5

International borrowing

Foreign borrowing offers a wide source of money to Australian based firms, which can be invested to expand and improve their businesses. However, it is important to note that all debt must be paid back with interest. This highlights the importance of ensuring the CAD is sustainable, as interest accumulates and can cause a debt-trap cycle.

1.2.6

Foreign investment

Foreign investment is when investors from overseas purchase assets and firms in Australia. Australia is an attractive economy for foreign investment and has always been a net importer of foreign capital because of this. This investment is encouraged as it supports domestic employment, tax payments, and overall demand in the economy. FDIs also increase capital inflows, which may support the introduction of new technologies, innovation, and competition. It can also support living standards due to the increase in variety and quality of products. 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, limiting the size of the CAD through managing the debits in the NPY component of the CA.

The CAD is a concern for external stability if it gets out of hand. Concerns regarding foreign investment, international borrowing: 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. Having a high level of foreign debt increases risk in the economy, especially if these risks have not been hedged. For example, if interest rates, exchange rates, or income levels worsen, debt servicing costs may become more expensive and cause repayment issues. This 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. Concerns regarding terms of trade and international competitiveness: a higher TOT can be reflected by an increased demand for exports, and the AUD (as domestic exporters are paid in AUD). This can cause an appreciation of the AUD (see the next section for a detailed explanation of this process). An appreciation of the AUD means that it is more expensive for overseas consumers and investors to purchase from Australia, which can decrease international competitiveness of other industries in Australia. This process is known as Dutch disease. For instance, during the mining boom, the AUD appreciated due to increased demand for mining exports, decreasing the international competitiveness of other industries such as agriculture, and negatively affecting their export volumes.

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Section 1 – Australia’s trade and financial flows

Effects of these trends on Australia’s Balance of Payments

Exchange rates

Section 2

Exchange rates 2.1

Measurement of relative exchange rates

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). Exchange rates provide the basis for the conversion of currencies of nations, necessary to engage in international trade, investment and finance. Trade Weighted Index (TWI) The TWI is the average value of the AUD compared to Australia’s major trading partners currencies, weighted according to their significance. It can be thought of like comparing the Australian currency to a basket of the most significant nations, regarding trade relationships. This gives an indication of how the AUD is moving against these other currencies. 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.

Section 2 – Exchange rates

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. For example, approximately two thirds of export trade and half of import trade in Australia are priced in USD. Hence, the AUD/USD is more significant than its TWI weighting.

2.2

Factors affecting the demand for and supply of AUD

Financial Flows • Level of Australian interest rates relative to overseas interest rates: high domestic rates attract foreign investment, as Australian banks may offer greater returns than overseas banks. This creates a higher demand for AUD. By contrast, low domestic rates incentivise saving funds in overseas banks, which may offer greater interest returns. This creates a high supply of AUD. • Investment opportunities: high opportunities domestically support a high demand for AUD, whereas high foreign opportunities may create high supply of AUD. For example, during the mining boom, there was abundant investment opportunity in Australia, causing an increase in demand for AUD. • Speculation: if there is an expectation of a future appreciation, there may be high demand for AUD, as investors aim to make short-term profit on currency fluctuations. By contrast, if there is an expectation of a future depreciation, investors may aim to sell the AUD to avoid the price decrease, creating a high supply of AUD. Trade Flows • Exports: if there is high demand for domestic exports (e.g. due to competitiveness and low inflation causing comparative advantage), there will be high demand for AUD, as Australian exporters are paid in AUD. • Imports: if there is high demand for imports (e.g. due to low competitiveness and high inflation making it more expensive to purchase domestically), there will be a high supply of AUD, as consumers and firms shift demand to overseas producers. • Commodity prices and terms of trade: improvements in commodity prices and terms of trade increase the value of exports, causing high demand for AUD. A decrease in commodity prices and terms of trade decreases the value of exports, causing high supply of AUD. For example, when commodity prices rose in 2011 (during the mining boom), so too did the AUD, peaking at US$1.10.

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2.3 Changes in exchange rates – appreciation/depreciation

Economic conditions • Expansionary period: an upturn in the domestic and/or international business cycle may increase demand for Australia’s exports, creating high demand of AUD. • Contractionary period: a downturn in the domestic and/or international business cycle may decrease demand for Australia’s exports, creating high supply of AUD. • Tastes and preferences: affect demand of Australian exports and imports, and therefore the demand and supply of the AUD.

2.3

Changes in exchange rates – appreciation/depreciation

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.

Fig 6: Appreciation of $AUD caused by decreased supply

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.

Fig 7: Depreciation of $AUD caused by decreased demand

Fig 8: Depreciation of $AUD caused by increased supply

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Section 2 – Exchange rates

Fig 5: Appreciation of $AUD caused by increased demand

2.4 Determination of exchange rates including fixed, flexible, and managed

2.4

Determination of exchange rates including fixed, flexible, and managed

Fixed exchange rates 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 (pegged) to the TWI, after an analysis of the market by the RBA and the government on a daily basis. 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. Advantages

Section 2 – Exchange rates

+ Flexible EXR more accurately reflects international competitiveness, which encourage free trade as relative prices aren’t distorted by a manipulated currency. + Dutch-disease: a boom in one export industry (such as mining) causes an appreciation in exchange rates making other industries less competitive.

2.5

Disadvantages – Volatile or sudden changes cause future transactions to become uncertain. This heavily influences speculative investment; a sharp depreciation of the exchange rate can cause an even further depreciation as investors seek to sell the currency before further price drops. – Depreciations may cause inflation, as imports are more expensive and this price increase can be reflected in the domestic inflation rate.

Influence of the Reserve Bank of Australia on exchange rates

Direct Intervention The RBA buys/sells foreign exchange when the AUD goes either too high or too low. This is because volatile changes in the currency may hinder the economic objectives of the government by altering confidence, availability of funds, demand, and output. • 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. Indirect Intervention Monetary policy: the RBA sets interest rates to manage the economy, with a secondary function of changing the interest rate difference between Australia and overseas (called the interest rate differential). This is because a higher interest rate domestically, when compared to overseas will offer foreign investors greater returns on their savings. To save in Australian accounts, investors must convert their currency to AUD, increasing demand and appreciating the dollar. A lower interest rate domestically when compared to overseas may encourage domestic investors to shift money overseas, where greater returns are offered, causing an increase in the supply of the AUD. Thus, the setting of interest rates can appreciate or depreciate the dollar indirectly. Indirect intervention can be summarised as follows: • 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 34

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2.6 Effects of fluctuations in exchange rates on the economy

2.6

Effects of fluctuations in exchange rates on the economy

Impacts of Appreciation Negative

+ Cheaper imports may cause lower import inflation as prices are lower. This may minimise domestic inflation and lower interest rates (as higher interest rates control high rates of inflation by decreasing spending). + Cheaper imports encourage allocative efficiency of resources, resulting in a long-term shift to more competitive industries. + Cheaper imports mean consumers and firms can buy a greater quantity of products due to the increased purchasing power, therefore improving living standards and lowering input costs. + Valuation effect on debt decreases interest servicing costs on foreign debt and the overall AUD value of foreign debt, due to the increased value of the AUD. This may improve the CAD by minimising NPY outflows.

– Exports are more expensive. At this higher price, we expect a fall in the quantity demanded. While in the short-term, demand may be inelastic and income may increase, in the long-term there will be a loss of investors, causing slower economic growth. – Cheaper imports may cause domestic firms to lose competitiveness, which may cause increased unemployment. Higher import spending may also worsen the BOGS in the long- term, and the CAD. – Valuation effect on assets: reduce AUD value of foreign income earned, and the overall AUD value of foreign assets decreasing NPY inflows and potentially worsening the CAD. Section 2 – Exchange rates

Positive

Impacts of Depreciation Positive

Negative

+ Exports are cheaper. At this lower price, we expect an increase in the quantity demanded. While in the short-term, demand may be inelastic and income may decrease (T1), in the long-term there will be an increase in investment, supporting an improved trade balance (T2) and economic growth (see figure 9: J-curve effect of depreciation). + More expensive imports may cause domestic firms to improve competitiveness, which may cause increased employment. Lower import spending may also improve the BOGS in the long-term, and the CAD. + Valuation effect on assets: increase AUD value of foreign income earned, and the overall AUD value of foreign assets increasing NPY inflows, and potentially improving the CAD.

– Imports are more expensive, which may cause higher import inflation as prices are higher. This may increase domestic inflation and cause an increase in interest rates (as higher interest rates control high rates of inflation by decreasing spending). – More expensive imports mean consumers and firms can buy a lower quantity of products due to the decreased purchasing power, which may decrease living standards and increasing input costs. – Valuation effect on debt: increase interest servicing costs on foreign debt and the overall AUD value of foreign debt, due to the decreased value of the AUD. This may worsen the CAD by increasing NPY outflows.

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2.6 Effects of fluctuations in exchange rates on the economy

Fig 9: J-Curve for a Depreciation

C ASE S PACE :

Section 2 – Exchange rates

The impact of COVID-19 and the Australian recession on the Australian dollar From its lowest level in nearly two decades of 55 US cents in mid-March in 2020, the Australian dollar has seen an increase to 70 US cents as of 2022. This means in less than a quarter of economic activity, the dollar has seen a 24% increase in value against the US dollar – at the height of a global economic downturn. Why is this the case? The appreciation of the dollar can be attributed to a variety of factors, the main reasons being an increase in demand for exports and optimism in the Australian economy. China’s economy began economic recovery, and its demand for Australia’s minerals, especially iron ore, increased. This caused a boom in iron ore prices, and with this export accounting for around 16% of Australia’s exports, demand for the dollar increased. Furthermore, the decreased demand for outbound tourism (Australians travelling overseas) has decreased the supply of the dollar. Australians spent over $52 billion overseas in 2019 on tourism, which drastically decreased in 2020–2021. Optimism in the Australian economy has been supported by the positive interest rate differential Australia holds with other advanced economies. While interest rates are at a record low for Australia, they are relatively high for the developed world. The EU and Japan have rates below zero, and the US around 0–0.25%. Hence, investment in Australia is seen as relatively attractive. These recent trends in the value of the Australian dollar suggest that Australia will emerge from the COVID-19 pandemic in a better position than many other advanced economies of the world – creating further optimism in the economy and supporting demand for the dollar.

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Free trade and protection

Section 3

Free trade and protection 3.1

Australia’s policies regarding free trade and protection

Protection refers to any type of government action that has the effect of giving domestic producers an artificial advantage over foreign competitors. Over the past 30 years, the Australian Government years has removed many protective barriers on various Australian industries, such as manufacturing. In 1973, there was a 25% unilateral reduction of protectionist policies by the Whitlam Government. This aimed to promote structural change to increase efficiency, productivity, and competition in the Australian economy. From 1995–2018, there has been a decrease In the average tariff level in Australia from 9% to 0.8%. The volume of exports has increased by 8.6%, and has increased Australia’s GDP by approximately $4 billion, according to the Productivity Commission in 2015. Some subsidies still remain. For example, the Australian Government subsidies farmers to increase international competitiveness as food prices can be volatile, especially after natural disasters. C ASE S PACE :

3.2 3.2.1

Australia’s multilateral and bilateral free trade agreements Bilateral Agreements

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. The China-Australia Free Trade Agreement (ChAFTA) is expected to further promote trade with China. China is Australia’s largest trading partner. 86% of Australian exports to China are tariff free – this will increase to 98% upon full implementation of the agreement. This improves the international competitiveness of Australian markets in agriculture and granted Australia greater market access for services (e.g. financial and educational). However, the agreement includes investment facilitation arrangements that allow Chinese migrant workers to work on major projects for Chinese companies at the cost of Australian workers. This could negatively affect the Australian construction industry.

3.2.2

Multilateral Agreements

The ASEAN-Australia-New Zealand Free Trade Agreement (AANZFTA) comprises Australia, New Zealand, and ASEAN member states from South-East Asia. It strengthens Australia’s economic and strategic engagement with the South-East Asia region and helps to develop Australia’s trade/investment relationships through reduction of tariffs. Australia hosted the Australia-ASEAN Summit in March 2018 and released the Sydney Declaration after the summit, supporting security and economic prosperity within the region. APEC is a cooperative effort of 21 countries with common goals of improving free trade in this region. First established in 1989, APEC has facilitated and improved trade among its member countries, with over 50% of the GWP comes from member nations of APEC (see page 10 for aditional goals of APEC). Copyright © 2022 InStudent Publishing Pty. Ltd.

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Section 3 – Free trade and protection

During the Australian bushfires of early 2020, over 820,000 hectares of agricultural land was affected by the severe natural disaster (over 14% of the entire country). The Australian Government committed $100 million in emergency grants to support primary producers through the extreme interruption and devastation of production. Austrade provides financial assistance, technical and marketing advice, and Export Market Development Grants (EMDGs) which reimburse exporters for costs relating the promotion of exports into new markets. Each dollar spend generates $13.50 for $27 worth of exports.

3.4 Implications of other countries and trading blocs

K EY P OINT :

It is recommended that you choose a bilateral agreement that involves both Australia and your case study economy from Topic 1 (if possible), to maximise the efficiency of your study. Also, picking multilateral agreements that double as international organisations were taught in Topic 1 will also minimise the content you need to focus on.

Government

Section 3 – Free trade and protection

Firms

Individuals

3.3

3.4

Implications of Australia’s policies Short-term

Long-term

– Structural and regional unemployment in import-competing industries may increase. – Less protection means some industries may need to restructure and cut local production (e.g. the car industry and the closure of the Holden factory in 2017 that left 2,500 people unemployed).

– Erosion of skills principle: the long-term unemployed may experience a decrease in their skills as they aren’t routinely practising them. – Job opportunities increase in more efficient, exporting industries as allocative efficiency of resources improves. – Wider variety of goods: accessed at lower prices, improving living standards.

– Firms are forced to innovate, invest, and increase competitiveness to avoid closure. – Some inefficient import competing industries may close as they cannot compete internationally. – Loss of profits in the short-term, while the restructuring process is necessary.

– Higher overall competition, which contributes to higher productivity as resources are reallocated to efficient industries. – May lower input costs for other firms that use imported goods.

– Reduced government revenue due to decreased tariffs and tax collection from protection. – Government spending may increase in subsidies to retrenched workers and provide welfare payments to the structurally unemployed. – Governments may lose votes for reducing protection, as domestic effects are unfavourable in the short-term.

– The restructuring of industries and reallocation of resources should raise revenue in the future, as the economy can become more efficient and utilise comparative advantage, creating sustainable economic growth.

Implications of other countries and trading blocs

High domestic protection can result in retaliatory effects from international economies. An example of this can be seen in the two-way trade war between China and the US, whereby one country’s increase in protectionist policies causes the other to enact a similar policy. Australia has played an active role in the WTO to achieve reductions in agricultural subsidies which distort agricultural prices. For example, EU farmers are able to produce at a cheaper price than much of the world, due to the Common Agricultural Policy providing high subsidies to farmers. This denies market access to efficient exporters, like Australia. Protectionist policies such as tariffs on Australia’s exports will result in an overall reduction of exports and less GDP for the Australian economy. Hence, it is important Australia works with the global economy to minimise both domestic and international protectionist policies. This will ensure export growth can continue, and economic growth will be supported.

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Topic III

Economic Issues in the Australian Economy

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39

Economic growth

Section 1

Economic growth K EY P OINT :

This topic is about economic issues that face an economy, including their causes and consequences. This topic also requires trend analysis of these issues in the contemporary Australian economy. This topic is sometimes taught alongside Topic 4, which covers theories about the government response to these issues. I think it is important to understand Topic 3 before study of Topic 4, where you should be extending your knowledge of this theory to analyse these issues in the domestic and global economy. Economic growth is the increase in a country’s productive capacity over time (real GDP). Australia experienced 28 consecutive years without a recession (as of mid 2020), and is one of the few economies in the post-WWII period to achieve this. A recession is defined as two quarters (i.e six months) of negative economic growth.

K EY P OINT :

Section 1 – Economic growth

One can argue that the overall objective of an economy is to achieve economic growth, while balancing the other outcomes of economic production. Due to this, economic growth and the theory surrounding it can be applied to many different scenarios. This means the content below is of high importance to understand and remember as it can be included in many exam responses due to its significance.

1.1

Aggregate demand and its components

Aggregate Demand (AD) is the total demand (level of expenditure) over a period of time. It is defined by the equation below:

AD = C + I + G + (X – M) Aggregate demand = Consumption + Investment + Government expenditure + (Exports – Imports) • Consumption is defined as spending by households. This can be autonomous, which is consumption that occurs autonomous/independent of income (spending needed to survive, such as things like rent and groceries), or induced/dependent consumption, which changes depending on disposable income levels. Consumption represents approximately 60% of AD in Australia. Consumption levels can be influenced by a variety of factors including interest rate levels, a person’s income levels, their Average Propensity to Consume (APC) or what percentage of their income they spend, and the distribution of income across an economy. • Investment is spending by firms to increase productive capacity. It represents approximately 15% of AD. Investment levels are influenced by factors including the cost of inputs, interest rates, profit levels, business expectations, tax rates and government policy. • Government expenditure by local, state and federal governments also contributes to AD. It comprises of approximately 20% of AD. It is influenced by the policy objectives of the government (such as lower inflation and unemployment) and the general state of the economy. • Net foreign demand/exports – imports is expenditure by foreigners on domestically produced goods/services (exports), minus expenditure on foreign goods/services (imports). This comprises approximately 20% of AD. The trade balance is influenced by factors such as the global business cycle, exchange rate and commodity prices. Keynesian economic thought refers to the theory that output (and therefore growth) is determined by expenditure of consumers, firms, the government and exports, totalling to aggregate demand. During an economic downturn, overall spending decreases and demand contracts. Keynesian economic thought suggests that governments should intervene to stimulate demand and support economic growth. 40

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1.2 Injections and withdrawals

1.2

Injections and withdrawals

Aggregate Supply (AS) is the total productive capacity (income) when all factors of production are fully utilised over a period of time. It is defined by the equation below. Consumption is included in AS as it comes from personal income earned and is therefore a result of production and supply. AS = C + S + T Aggregate supply = Consumption + Savings + Taxation Equilibrium is when AD = AS. This is where the quantity of real GDP demanded equals the quantity supplied. Balancing the equations for AD and AS, consumption cancels out and we have: I + G + X = S + T + M injections = leakages An injection is any money inputted into the economy, whereas a leakage is money that flows out from the economy (from the theory of the circular flow of income model in Year 11). If injections are greater than leakages in an economy, then economic growth occurs as income is greater than outflows.

1.3

The simple multiplier

Change in consumption ÷ Change in income The Marginal Propensity to Save (MPS) is the proportion of the extra dollar earned that is saved. The formula to calculate MPS is: Change in savings ÷ Change in income The MPS + MPC = 1. This is because every extra dollar earned is either spent or saved, therefore the sum will be 1. The multiplier is defined as the proportional increase in national income, due to an increase in AD. This increase in income is greater than the initial injection. This is because re-spending increases income, production, employment, and economic confidence, boosting income further in the future. For example, an initial injection of $50 million into the economy by the government to increase the NSW road networks should result in an even greater boost to AD over time. Some of the funds spend on construction will go to labourers, who will use this money to purchase other goods and services. An employee may spend this income on a new haircut, which then becomes income for the hairdresser. This income can be re-spent in an infinite chain. Therefore, the initial injection of $50 million has caused a ripple effect on AD, as it has increased spending in a vast range of industries. Hence, an initial injection into an economy will lead to money being continually re-spent. The formula for the multiplier is as follows K =

1 1 – MPC

or

1 MPS

K × change of income = new income

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Section 1 – Economic growth

The Marginal Propensity to Consume (MPC) is the proportion of the any extra dollar earned that is consumed. In the case of the multiplier, this ‘extra income’ is an additional injection into an economy. The formula to calculate MPC is:

1.4 Measurement of growth through changes in real GDP

K EY P OINT :

The above two formulas are often examined in multiple-choice questions. You should be comfortable applying these formulas to a variety of questions. It is also a good idea to become familiar with the below table of common multipliers which frequently come up in multiple-choice questions. Table of common multipliers

1.4

MPC

K (multiplier)

0.6

2.5

0.8

5

0.9

10

Measurement of growth through changes in real GDP

Australia’s GDP is US$1.5 trillion (2019). Real GDP is the increase in value of goods/services compared to the previous year adjusted for inflation. Australia’s real GDP growth rate for 2019 was 2.2%. Real GDP per capita (per person) = Real GDP ÷ population. This is used to compare standards of living between countries. A per capita recession occurs when the population increases faster than real output. Section 1 – Economic growth

1.5

Sources of economic growth in Australia

Anything that encourages growth in AD (C + I + G + (X–M)) will be a source of growth. Factors of Production as a Source of Growth • Natural resources (land): an increase in the quantity of resources or the discovery of new resources causes an increase in supply. This decreases the costs of production and stimulates AD. However, these resources must be developed within the parameters of the environment to ensure sustainability of economic growth. For example, the Australian economy has a natural endowment of minerals and energy, contributing to a competitive advantage in mining and agricultural industries. This is a major source of has economic growth in Australia, and its strong impact can be seen through the growth experienced during the mining boom. • Labour: if the size of the labour force or participation rate increases, or there is an increase in the quality of the labour force then there will an increased supply/quality of labour. This decreases the costs of firms and increases opportunities for productivity, maximising output and hence supporting economic growth. Australia has a highly skilled workforce and well-supported education system that supports overall productivity in the economy. • Capital: if there is an increase in capital stock, quality, technology, or capital deepening (faster growth in capital technologies than there is growth in the labour force), then there will be an improvement in production methods. Through the capacity for increased efficiency of production, output will increase, and economic growth supported. The high rates of investment into Australia supports the use of innovative technologies, allowing efficient production. • Enterprise (entrepreneurial ability): refers to people with ideas who are willing to take calculated risks and spend money to start and develop a business. In Australia, there is high rates of investment both domestically and by foreign investors. This supports investment into Australian firms, increasing output and contributing to economic growth. Government Policies as a Source of Growth Effective government policies and political stability create a favourable climate for economic growth, as it forms the basis of investor confidence in an economy. Also, macroeconomic policies including fiscal and monetary policy seek to stabilise and support economic growth, as these policies are a tool used to support the economic objectives. Topic 4 explores the influence of the government on economic growth in greater detail. 42

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1.6 Effects of Economic Growth in Australia

1.6

Positive

Negative

+ Higher GDP per capita improves living standards and economic development. + Increased employment opportunities as economic growth stimulates production and job creation. This contributes to lower unemployment, and can potentially lower income inequality as jobs may be higher paid due to the increased demand for labour. + Increased confidence due to high growth rates may cause an ‘accelerator effect.’ This is when investment increases due to the higher attraction caused by economic growth.

– Investment into new capital may cause a short-term increase in structural unemployment. However, in the long run economic growth will increase employment opportunities in other industries. – As higher AD increases prices, this may lead to higher inflation. Unsustainable rates of economic growth can also cause ‘bubble growth,’ whereby prices in a single industry increase rapidly, and then crash. – A potential increase in imports as consumers have greater disposable incomes may cause a worsened BOGS and increased CAD. – Increased negative externalities and social costs, due to increased production (e.g. increased environmental degradation).

Increase in aggregate supply – improvements in efficiency and technology

AS can increase through increased productivity, which is dependent on the sources of economic growth as contributors to increased overall productivity and efficiency. The capacity constraint refers to the point at which the economy approaches full employment and cannot grow any further. When an economy approaches full employment in the short-term, resources become scarce and the capacity to grow decreases. This causes a sharp increase in prices. This is a common phenomenon in the labour market. When unemployment nears 0, inflation grows exponentially as labour becomes scarce and firms must offer higher wages to attract staff. The AS curve becomes steeper and inelastic towards the full employment level of income, illustrated below in the Phillips curve. In the long run, AS must increase to match AD, because if it doesn’t then further AD (economic growth) will simply cause inflation.

Fig 10: Phillips Curve

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Section 1 – Economic growth

1.7

Effects of Economic Growth in Australia

1.8 Trends in the business cycle

1.8

Trends in the business cycle

Australia’s last recession was in the early 1990s and ever since then there has been an average of 3.5% of growth per annum. This can partially be attributed to the global resource boom, and high TOT. Australia has been successful in maintaining sustainable rates of economic growth that does not push inflation above its target range of an average 2–3%. Australia has higher than average economic growth compared to other OECD countries (2.3% per annum, 2019). Australia experienced below average growth of 1.3% in 2008–2009 due to the global recession caused by the GFC. However, Australia avoided a recession during this period due to the resources boom, and according to the Australian Treasury, the large fiscal stimulus the government provided to citizens which supported AD. Australia is forecast to reach an average annual GDP growth of 2.7% between 2019 to 2023, the highest among major advanced economies. This is largely due to the diverse services and technology sectors, strong export market and low government debt levels.

C ASE S PACE :

Impacts of COVID-19 on Australia’s economic growth

Section 1 – Economic growth

The Australian economy contracted by 0.3% in the March quarter of 2020, and continued to contract as the full effects of the pandemic and government-enforced lockdown becomes apparent. We can use these contractionary GDP figures and the breakdown of AD components to help us understand why the Australian economy has headed toward a recession. • Consumption (C) comprises over 60% of AD, and hence it is not surprising to see that the fall in consumer spending of 1.1% contributed 0.6 percentage points to the contraction of the economy. Some of this was inevitable, as the lockdowns forced the closure of many businesses and prevented households from shopping physically. However, some of this was deliberate as households increasing savings in anticipation of an economic downturn. • Investment (I) spending in property fell by 1.7%, and spending in businesses also fell, by 0.8%. The private sector therefore also contributed to the contraction in economic activity, contributing 0.8 percentage points. This was due to both government restrictions and decreased investor confidence and certainty. • Government expenditure (G) contributed positively to economic activity, growing by 1.8%. This added growth to infrastructure investment, supporting economic growth by 0.3 percentage points. • Net exports (X – M) also contributed positively to economic growth, contributing 0.5%. The overall volume of exports did fall, but imports fell at a greater rate, keeping the trade balance positive for the March quarter. A major impact on trade was the travel bans, which hit inbound and outbound tourism as well as international study in Australia.

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Unemployment

Section 2

Unemployment The unemployed refers to people willing and able to work, actively seeking work, but unable to find employment (in the previous week at a minimum) according to the ABS. This occurs when total demand for labour (available jobs) is less than the total supply of labour (available workers).

2.1

Measurement of unemployment

• Labour force: employed + unemployed people • Working age population: labour force + people in the working age bracket (15–64) that aren’t actively seeking work • Participation rate: labour force ÷ working age population • Unemployment rate: unemployed ÷ labour force × 100 S AMPLE :

Calculate the unemployment rate and the participation rate using the above statistics. Category

11,000

Unemployed

700

Labour force

11,700

Working age population

19,000

Unemployment rate:

700 11700

× 100 = 6%

Participation rate:

11700 19000

Section 2 – Unemployment

Employed

Amount of people (000s)

× 100 = 62%

K EY P OINT :

It is important to remember the above formulas, as these are often examined in multiple choice and short answer questions. This is an expected skill in economics, and students can easily become confused between definitions – spend some time revising these.

2.2

Trends in unemployment

In Australia, the participation rate averaged 66% in 2019 but fell to a 15-year low of 63.5% in April 2020 amid business closures and lockdowns due to the COVID-19 crisis. Higher unemployment was experienced from mid 1970s onward due to high microeconomic reforms and structural change within the Australian economy. This involved the restructuring and closure of many industries as Australia become more efficient and focused on industries with comparative advantage. Peak unemployment was reached in 1992, of 11%. This was during Australia’s last recession. This fell steadily, reading 4% by 2008 due to high sustainable economic growth. Unemployment averaged 5–5.3% from 2019 to early 2020, however in April 2020 the unemployment figure rose to 6.2%. This is the highest rate since 2015, due to social distancing and other business-related restrictions implemented to slow the spread of COVID-19. Since 1986 total employment has grown by approximately 5 million jobs (70% increase), according to the RBA. Additionally, the proportion of routine manual jobs fell from 40% to 30%, and professional occupations rose from 27% to 36%. Copyright © 2022 InStudent Publishing Pty. Ltd.

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2.3 Types of unemployment

The casualisation of the workforce refers to the trend of decreased full-time work and increased parttime and casual work. This has been mostly due to the flexibility casual workers offer firms. However, this has caused an increase in underemployment in recent years. In 1966, part time workers represented about 10% of the total workforce, by 2018 this had increased to about 31% of total workforce. In 2019, underemployment was approximately 8%, though has been increasing since. The labour underutilisation rate refers to the sum of the unemployment and underemployment.

2.3

Types of unemployment

• Cyclical: unemployment caused by a contraction in economic activity and AD. This generally occurs in the short-term during periods of economic downturn. • Structural: structural (long-term) changes causing workers to become redundant or displace (e.g. new technology may make some skills redundant). • Frictional: people who are temporarily unemployed as they move between jobs. • Seasonal: certain work at certain times of the year can create unemployment that changes with seasons (e.g. winter/ski jobs or Christmas jobs). • Hidden: those who are unemployed and who have given up actively seeking work. • Long-term: unemployed for more than 12 months. This can be linked to structural unemployment if a reskilling process is not undertaken. • Underemployed: part-time or casual workers who would like to work more hours than they are currently offered.

2.4

Causes of unemployment

Section 2 – Unemployment

Economic growth levels influence unemployment, especially cyclical unemployment. The demand for labour is derived demand i.e. it is derived from aggregate demand. This is because the demand for goods/services stimulates production, which increases the demand for labour. If AD is deficient, then unemployment may increase. Hence, in times of economic downturns, unemployment will theoretically increase, and in times of economic expansion, unemployment will decrease. For example, during the mining boom there was strong demand for labour in the resources industries and professional services. This caused unemployment to decrease from 7% to 4%. • Okun’s law: to reduce unemployment, the annual rate of economic growth must exceed the sum of the rate of productivity growth and labour force increases. This is because an increase in productivity decreases the demand for labour, and an increase in the labour force increases supply of labour, both causing an increase in unemployment. In Australia, this is estimated to be 3%. • Fiscal policy and monetary policy: influence the economic cycle and aim to always minimise the unemployment rate while balancing the other economic objectives. • Rising participation rates: when people who were not looking for work start looking for work again (for example, in better economic times), then they are counted in the labour force, and the unemployment rate may rise in the short-term. • Structural change: (microeconomic reform) will have longer term impacts on the patterns of employment, and in the process will cause structural unemployment. This may increase unemployment in the short-term; but in the long-term, job opportunities should increase in more efficient industries. • Wage-induced unemployment: where the price of labour exceeds the price of capital machinery or the price of overseas labour. This may displace jobs if firms decrease employment.

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2.5 Non-accelerating inflation rate of unemployment (NAIRU)

2.5

Non-accelerating inflation rate of unemployment (NAIRU)

The natural rate of unemployment refers to the level of unemployment at which there is no cyclical unemployment. This is where the economy has reached full employment, and where the supply of labour equals the demand of labour. When an demand begins to exceed full employment, cost-push inflation occurs. This is because labour becomes scarce and wages must increase to attract workers away from their current positions, to other firms. These increased costs will be passed on by firms to consumers and cause inflation across the economy. This can be illustrated with the Phillips curve on page 43. The NAIRU represents the lowest unemployment rate which can be sustained without an increase in inflation. Recently, Australia lowered the NAIRU estimate from 5% to 4.5%. This revision was made mainly due to low wage growth and inflation, despite low rates of unemployment nearing 5%. Hence, the RBA recognised the Australian economy still had spare capacity in the labour market.

2.6

Main groups affected by unemployment

2.7

Effects of unemployment

Economic costs of unemployment • Opportunity cost: the economy is losing the opportunity of working to full capacity when labour is not fully employed. For example, the production of goods and services will be lower, and income and GDP growth will be limited. • Lower living standards: lower income leads to lower purchasing power, disposable incomes and living standards. • Loss of skills: the erosion of skills principle states that when a person is unemployed for a significant amount of time, they lose some of the skills they had in their previous job. This may result in a rise in structural unemployment. • Government costs: increase social welfare and the collection of less tax as lower income earners pay less tax. • Lower wage growth: a greater supply of workers means firms can offer lower wages. This can also contribute to increased inequality of incomes as lower skilled workers may find it harder to negotiate higher wages. Social costs of unemployment • Increased inequality: unemployment tends to occur among low income earners, who may experience relative poverty. This can contribute to a range of social issues including increased mental health issues, crime rates, alcohol abuse and family tensions. • Loss of self-esteem and dignity: people may experience reduced motivation to search for work or reskill. This may also increase hidden unemployment.

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Section 2 – Unemployment

• Young people: face high rates of unemployment due to the lack of experience and/or skills, and/or education. The unemployment rate for those aged 15–19 is currently 7% higher than the national unemployment rate (RBA, 2019). • Aboriginal and Torres Strait Islanders: also have high rates of unemployment at around 3 to 4 times the national average. • Specific regions: such as country areas in Australia, where there are limited jobs available, experience higher than average unemployment levels. • Migrants: often have limited English skills, may find it harder to obtain work, and hence experience higher unemployment.

Inflation

Section 3

Inflation 3.1

Measurement of inflation

Inflation: percentage change in the general level of prices, measured by the Consumer Price Index (CPI). Inflation must be maintained to achieve the objective of price stability. CPI is the average level of prices of the goods/services that a ‘typical household’ buys. It measures changes in the prices of selected household items, weighted according to significance, monitored by the ABS. The CPI figure for inflation is released every 3 months. The inflation rate for 2019 was 1.9%. Inflation rate =

Current CPI – Previous CPI Previous CPI

× 100

Headline inflation is the actual inflation rate, but it may include one-off events that distort the figures (e.g. GST in the year 2000). Underlying inflation is a more accurate measure of inflation because it removes the effects of one-off events that distorts the figures. The RBA has a target framework for the inflation rate, of between 2–3% since 1993. This rate maintains economic growth and price stability within an economy. As a nation we are required to hit our target ‘on average over the economic cycle’. C ASE S PACE :

Section 3 – Inflation

The introduction of the GST in 2000 resulted in Australia’s highest rate of inflation (4.5%) since the introduction of the 2–3% inflation targeting.

3.2

Trends in inflation

The highest inflation rate was over 11%, in the early 1980s. This was before Australia experienced microeconomic reform across many industries, increasing overall productivity and efficiency and lowering price levels. Since the early 1990s, Australia has had relatively low inflation, below 3%. The current levels of low inflation can be attributed to: • The success of the RBA targeting inflation of between 2–3% • Cuts in protection and the encouragement of free trade • Growth of enterprise bargaining in the labour market containing wage pressures The inflation rate reached 4.5% in 2007–2008 because of the resources boom, and unemployment nearing the NAIRU, increasing wage pressures. In recent years, inflation has maintained low rates of around 1–2% due to record low wage growth in Australia. However, the beginning of 2020 saw inflation rise above 2% to 2.2% in the first quarter of 2020. This reflects the impact of the Australian bushfire crisis and the early effects of COVID-19, which increased prices across the economy.

3.3

Causes of inflation

3.3.1

Demand-pull inflation

When demand exceeds the available supply, resources become scarce and prices rise in the short-term. This is illustrated by the demand curve shifting to the right. Demand-pull inflation is caused by any increase in AD. This can include higher levels of consumer spending and investment. This could be due to to higher confidence, income increases, tax cuts, or falling interest rates. 48

Fig 11: Demand-pull inflation

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3.4 Positive and negative effects of inflation

3.3.2

Cost-push inflation

When production costs increase, firms must also raise prices to cover these costs. This is illustrated by the supply curve shifting to the left. Cost-push inflation can be caused by an increase in the price of wages, rent, supplies or other business inputs. If these increase, the costs are generally passed onto consumers in the form of higher prices. A common cause of cost-push inflation is increased wage pressures. This can cause a cycle whereby firms raise prices to cover wage increases, and consumers (who also form the labour market) demand even higher wages to pay for the increased cost of living.

3.3.3

Fig 12: Cost-push inflation

Imported inflation and inflationary expectations

If import prices increase (perhaps caused by a depreciation of the AUD), then Australia pays higher prices for goods and services imported. This flows through to the official (domestic) inflation rate. If consumers expect prices to rise, they may increase spending while the price is lower in order to beat the price rise. This causes demand pull inflation. This can also occur with cost push inflation. For example, if consumers expect prices to rise, they may start demanding higher wages. This will increase the cost for employers and cause cost push inflation.

3.4

Positive and negative effects of inflation

There is a major difference between questions which ask for the effects of high levels of inflation vs low levels of inflation. Low inflation is necessary to ensure demand and price stability, and is explored further in Topic 4 as an economic objective. • Reduces deflation: deflation is when prices fall. An economy should avoid deflation as price falls encourage consumers to wait for further price drops, resulting in an overall decrease in demand and spending, which can spiral into an economic downturn. • Loss in purchasing power: if inflation rises at an unsustainable rate, wages will be unable to keep pace with price increases and hence real income (adjusted for inflation) will decrease. This will lower disposable income levels and decrease living standards. • Higher unemployment: price rises also affect firms as input costs may become more expensive. This may force producers to reduce their workforce to cut costs and afford the increase in wages being demanded. Furthermore, consumers may be discouraged from spending if prices rise significantly. Since labour is a derived demand of products, workers may be cut as demand decreases. • Lower exports: as domestic prices increase, Australia experiences reduced international competitiveness, when prices are compared to other nations. This may result in a decrease in demand for exports, which can potentially worsen the BOGS, CAD and economic growth. • Value of savings decreases: if interest rates do not keep pace with inflation, then inflation may erode the value of savings. • Increased inequality: inflation impacts most on lower income earners who have less bargaining power to keep their wage growth in pace with inflation. • Wage-price inflationary spiral: employees seek higher wages to ensure their income keeps pace with inflation. However, these wage increases lead to higher prices, which causes cost-push inflation. This can create an inflation spiral, as employees seek further wage increases to cover increased prices and the deterioration of their income’s real value. • Constrain economic growth: high inflation may cause the government to implement contractionary policy, which constrains economic growth. • Resource misallocation: investment in speculative (short-term) assets may increase due to higher returns in the short-term. This may be incentivised if the returns on savings accounts becomes significantly lower than inflation rates. This diverts investment and causes misallocation of resources. Copyright © 2022 InStudent Publishing Pty. Ltd.

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Section 3 – Inflation

K EY P OINT :

External stability

Section 4

External stability K EY P OINT :

For this economic objective, use your knowledge from Topic 2 to expand upon the theory below. This will deepen your analysis and minimise study time! External stability refers to the Australian economy’s financial relationship with the world. The main aspects of external stability include: • The current account • Net foreign liabilities • Exchange rate

4.1 4.1.1

Measurement and causes of external stability Current Account Deficit (CAD) as a percentage of GDP

Section 4 – External stability

The CAD as a percentage of GDP is better than the size of the CAD in dollar terms, as this measure allows for an accurate comparison across time and between countries. The CAD can cause external instability if it exceeds the growth rate of an economy, as the servicing cost of external liabilities is equivalent to the growth in income and output. This would mean that an economy’s debt levels are rising faster than the growth in income, causing debt sustainability issues. Since the GFC in 2008, Australia’s CAD has been reduced. From 5% of GDP, it has averaged 3% in recent years. This indicates a more sustainable financial position, and external stability. From the 1990s onwards, the CAD has been partly caused by a lack of the savings-investment gap. The household savings ratio has averaged about 2.5% in recent years, highlighting the need for investment to finance production. Recently, Australia has experienced its first CA surplus – see the case space on page 28 for further details.

4.1.2

Net foreign debt as a percentage of GDP

If the size of the debt is rising faster than the increase in GDP, the interest payments on the debt will take up a greater proportion of GDP. This may pose debt sustainability problems in the future, as the size of debt exceeds the level of income growth. This can also impact on our credit rating (debt repayment reputation) as a nation. As of 2020, Australia has a AAA credit rating from all three world credit rating agencies. If the credit rating falls, this may decrease investor confidence and cause a contraction in AD, lowering economic growth. Recently, Australia’s net foreign debt as a percentage of GDP has averaged 56%. This is considerably lower than many other advanced economies and is a contributing factor to Australia’s high credit rating. This is because Australia’s current level of debt is comparatively low, and considerably sustainable. For example, the US external debt accounts for about 95% of the country’s GDP levels.

4.1.3

Net foreign liabilities as a percentage of GDP

This provides an indication of Australia’s total debt and equity servicing costs of accumulated CADs. It represents how much of Australia’s economic activity can be attributed to international markets. It is also considered in the determination of Australia’s credit rating, affecting investor confidence. Net foreign liabilities reached 52% of GDP in 2019. The government’s approach to foreign investment policy is to encourage foreign investment consistent with Australian interests. The government encourages this investment as long as it cannot potentially harm the Australian economy, or Australia’s relationships with other nations. For example, the government can choose to block foreign takeover bids. 50

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4.2 Trends and effects of external instability

C ASE S PACE :

The Morrison’s government decided to block Hong Kong’s largest infrastructure company from buying an Australian gas pipeline operator company for AUD$13 billion in 2018. The Australian company, APA Group owns about half the gas used in Australia. The Australian Foreign Investment Review Board act as an advisory body for the government, and disproved the takeover. The final decision rested with the Federal Treasurer, Josh Frydenberg, who blocked the bid. He knocked back the deal as it would result in “a single foreign company group having sole ownership and control over Australia’s most significant gas transmission business.” This is not in the best interest of Australia’s national security. However, he did emphasise the government remained committed to welcoming foreign investment as “it helps support jobs and rising living standards.”

4.1.4

Terms of trade

The terms of trade (TOT) are a measure of external stability as an improvement in the TOT leads to an improvement in the BOGS. This improves the Balance of Payments (BOP) and Australia’s external stability. This is because an improvement in the TOT means a greater volume of imports can be financed with a given volume of exports. On the other hand, a deterioration of the TOT means less imports can be financed with a given volume of exports. This could be due to high domestic inflation, commodity prices or changes in the international business cycle. This worsens the BOP. Australia’s TOT has generally improved in the last two decades due to the mining industry, which still accounts for about 7% of Australia’s GDP. Despite iron ore and coal prices falling, they are still Australia’s top exports. Australia’s top three exports include iron ore (16%), coal (15%), education related travel services (8%) (DFAT, 2019).

Exchange rate

A change in the exchange rate influences the BOP by affecting international competitiveness, and the size and servicing costs of our foreign debt. If the exchange rate is volatile, this has a flow-on effect on all three indicators of external stability, causing instability. For example, a sharp depreciation may cause reduced consumer confidence, whereas slight depreciation may improve international competitiveness, the TOT, and the BOP. For example, when the dollar depreciated rapidly in 2009, it caused a decrease in investor confidence. Therefore, it is most beneficial to external stability when the exchange rate isn’t volatile.

4.1.6

International competitiveness

As a country becomes more competitive, exports, TOT, and BOP increase. International competitiveness has been contributed to by structural change over the last 30 years (microeconomic reform) and a competitive currency which has made the economy more efficient, though Australia’s overall competitiveness has fallen in recent years.

4.2 Trends and effects of external instability A persistent CAD leads to: • High NPY outflows: this may cause difficulty in debt repayments, which can lead to a debt-trap cycle if income doesn’t exceed debt repayments. This could result in a loss of confidence in the economy, higher foreign interest rates, and a worsened credit rating. • Depreciating/volatile exchange rate: this may cause imported inflation and the valuation effect on debt (increased overall value of debt denominated in $AUD). • Increase in interest rates: high instability may cause the government to implement contractionary policy to encourage saving and debt repayments. This results in a fall in consumption, production and investment, which will constrain economic growth However, it must be remembered that interacting with international markets allows domestic firms to fund investment, which creates employment and development within the economy. Hence, overseas liabilities are acceptable if they are used to fund investment into industries that create money to pay back the loans. This is referred to as the Pitchford thesis.

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Section 4 – External stability

4.1.5

Distribution of income and wealth

Section 5

Distribution of income and wealth 5.1

Measurement of distribution of income and wealth

Section 5 – Distribution of income and wealth

Income inequality refers to the differences in income and wealth that people experience in the same society. This can be measured by: • Lorenz Curve: graphical representation of income distribution (figure 13). The 45 degree, upward sloping line indicates the line of perfect equality of income. The greater the sag or dip of a curve, the lower the equality of income. • Gini coefficient: measure of income distribution calculated using the Lorenz curve: A ÷ (A + B). A coefficient of 0 represents perfect equality of income, and 1 would represent a perfect inequality of income (i.e. a single household receives all the national income. A coefficient of 0.4 or higher starts to indicate a polarisation between rich and poor. Australia’s Gini coefficient is currently about 0.34 (last measured in 2018). The top quintile of the population holds approximately 63% of wealth, with the lowest quintile holding approximately 1% (ABS).

5.2

Fig 13: Lorenz Curve

Sources of income as a percentage of household income

Income refers to money and other benefits received by individuals in return for the factors of production such as land, labour, capital, and enterprise It also includes social welfare or transfer payments. The main sources of income according to the ABS include: • • • •

5.3

Wages and salary: 54% Business profits and capital investments: 19% Property income: 12% Transfer payments: 9%

Taxation, transfer payments, and other assistance

• Progressive tax: reduces inequality, as the more you earn the more you pay • Proportional tax: (e.g. 10% for all) this doesn’t reduce equality as it takes a standard proportion of income from all • Regressive tax: impacts lower income earners more than higher income earners (e.g. GST, which doesn’t vary depending on income) C ASE S PACE :

Australia’s progressive tax system redistributes income. Under this system, the tax-free threshold of $18,200 ensures lower income earners aren’t required to pay tax. Rates range from 21% to 47% as income increases, ensuring higher income earners pay a higher proportion of tax. Over a third of revenue raised from tax income collected is spent on transfer payments. This resulted in income inequality falling by 5% from 2008 onwards, due to increased welfare payments. Transfer payments: (social welfare payments) such as age pensions, unemployment benefits and more, exist to protect those who cannot earn a sufficient amount of income themselves. 52

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5.6 Benefits and costs of inequality

5.4

Sources of wealth

Wealth refers to the value of assets owned by individuals, including property, consumer durables (e.g. home contents), and financial assets (e.g. super, shares). The negative wealth effect is when the price of housing falls it can make people feel poorer (as their assets are worth less, and they have less wealth). This may cause households to cut back on their spending. Community wealth includes publicly owned infrastructures such as roads, railways, and bridges. These are often referred to as public goods. The main sources of wealth in Australia (according to the ABS) include: owner occupied property (42%), superannuation (17%), investment properties (16%), and owned businesses (6%). Others include, in order of significance: home contents, savings in financial institutions, vehicles, and shares.

5.5

Dimensions and trends

Social

Economic

5.6

Benefits and costs of inequality Benefits

Costs

+ Incentive effect: people will seek to increase skills, education, productivity, and geographical mobility if they are motivated to earn more. + Encourage entrepreneurialism: people are willing to accept investment, risk, and innovation for higher profits. + Higher savings: higher incomes lead to more savings, which may result in less reliance on overseas borrowing, which may improve the CAD.

– Overall utility is not increased: due to the law of diminishing marginal utility, when higher income earners earn more, they find less utility (satisfaction) from this increase in income. – Consumption and economic growth decreases: higher income earners have a lower MPC compared to lower income earners, hence adding less to AD. – Government welfare: increases with increased income inequality.

+ Incentivises community values: including hard work, the importance of skills and education and dedication

– Class division: increased income inequality can cause tension and conflict, and a possible poverty cycle and discrimination – Decreased wellbeing: less economic development for lower income earners can affect health outcomes or crime rates.

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Section 5 – Distribution of income and wealth

• Gender: men and women do not always receive equal pay in management jobs, which are not covered by awards or enterprise agreements. In Australia there is a 14% wage difference between men and women (ABS). • Age: income varies over the course of a person’s life due to experience and skills. Younger people typically earn lower incomes due to less experience. People aged 20 and under receive lowest weekly earnings of all age groups. People over 60 find it more difficult to gain employment as they near retirement age and may receive lower pay. • Occupation: managers and professionals with a degree, higher qualifications, and owners of successful businesses earn the most. This is usually due to the greater time and monetary investment needed for higher qualification, and the enterprise risk involved in business ownership. For example, postgraduate degree holders receive the highest weekly earnings, according to qualification type. • Ethnic background: those with limited English skills often have difficulty obtaining skilled work, where proficient English is a requirement. On average, English speaking migrants earned between $1,000 and $3,000 more than non-English speaking migrants • Family structure: this refers to the composition of a family; for example two income families, or single parent families. Single parent households have a weekly income around one third below the average for all family structures, whereas couples without dependent children have the highest income of all family structures.

Environmental sustainability

Section 6

Environmental sustainability Economic management and environmental management are often seen as conflicting. The global economy exists within and depends on the natural environment. Economic growth, rising affluence, and a growing world population are the major contributors to environmental degradation. According to the OECD, if Australia follows environmentally sustainable practices in the short-term, it will increase economic growth by 1% per annum.

6.1

Ecologically sustainable development

Ecologically sustainable development involves conserving and enhancing of resources so that ecological processes and quality of life are maintained. Any development must be balanced against its impact on the environment. A short-term exploitation of natural resources can deplete and permanently damage the environment. This reduces productivity in the long run and can be described as anthropocentric (human-centred) behaviour.

Section 6 – Environmental sustainability

Fig 14: Impact of resource depletion on the production possibilities curve

6.2

Private and social costs and benefits

The price mechanism is the interaction between demand and supply, and the relationship between them to establish a price equilibrium. However, it deals with private benefits (those for consumers and producers), including profit and satisfaction levels. Market failure describes how the price mechanism fails to consider social costs, called externalities. There can be both positive and negative externalities to production. For example, education has positive externalities for society as it produces skilled citizens and an improved labour market. However, negative externalities refer to the adverse effects of production, for example the degradation of the environment due to economic activity. The below diagram illustrates how the social cost of production may be higher than the private cost (the ordinary supply curve).

Fig 15: Price mechanism considering social costs of production 54

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6.3 Public and private goods

6.3

Public and private goods

A private good is owned and used by individual consumers (for example this book is a private good, as you purchased it for your own consumption!). A public good has two qualities: non-excludability (or non-rivalry) and non-diminishability. • Non-excludability: it is impossible to exclude anyone from consuming the good • Non-diminishability: one person’s consumption does not diminish or lower another person’s ability to consume the same good Free riders are people who use a good without contributing to the cost of supplying it. For example, free riders may use a park not in their local area as parks are open to the general public, not just residents who pay council taxes. Therefore, people are able to use the park without directly contributing to its cost through paying taxes to the local council. The possibility of free riders consuming goods and services often excludes the private sector from producing certain items. As such, most public goods which are exposed to free riders are provided by the government sector.

6.4 6.4.1

Environmental issues Preservation of the natural environment

Additionally, environmental damage affects human health through higher levels of air and water pollution and restricts the availability of resources for future production. For example, the quality of the labour force may be lower due to worsened health conditions, restricting productivity. An example of a method of preservation includes restrictions on development (e.g. the protection of national parks). Australia protects 17% of total land area. Even if preservation results in slower growth and higher costs in the short-term, it is beneficial in the longterm as it ensures higher productive capacity can be maintained.

6.4.2

Pollution

Pollution occurs when the natural environment is degraded (e.g. by harmful chemical substances, noise, rubbish etc.). Pollution can also affect human health levels and restrict labour force productivity. Governments can implement policies to reduce pollution, including: • Laws banning environmentally damaging production methods • Quotas to restrict the emission of harmful pollutants • Subsidies to encourage environmentally friendly practices

6.4.3

Climate change

Climate change is caused by the overuse of fossil fuels and land degradation (e.g. deforestation). The UN’s IPCC (Intergovernmental Panel on Climate Change) reported that half of cumulative carbon dioxide emissions from human activity have occurred in the past 40 years. Addressing climate change by reducing emissions reduces economic growth in the short-term. This has resulted in nations being reluctant to change policies, as it could adversely affect their economic potential, especially if they are unsure other nations will do the same.

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Section 6 – Environmental sustainability

To ensure economic growth can continue in the future, the environment must be preserved. This ensures intergenerational equity of production, as resource usage now has the ability to limit or expand future generation’s resources and production possibility.

6.4 Environmental issues

The international community is trying to limit greenhouse gas emissions and through initiatives such as the Kyoto Protocol and Paris Climate Accord (Dec 2015). For example, the Paris Climate Accord brings nations into a common cause to undertake efforts to combat climate change, with a measurable aim to keep global temperature only increasing between 1.5 and 2 degrees. A rise greater than this may lead to extinction of over 15% of biodiversity and 30% of the world’s land mass in drought by 2100 (Stern report, UK government). C ASE S PACE :

The Kyoto Emissions target isn’t a legislative requirement; however, it is used as a guideline for the implementation of environmental policies in Australia. The Climate Solutions Package of 2020 ($3.5 billion) builds on the Emissions Reduction Fund, which subsidises efficient energies. It aims to meet Australia’s Kyoto commitments. This method of market regulation is preferred over the carbon tax, which increases energy prices. Hence, the climate solutions package aims to price in the social cost of emissions.

6.4.4

Depletion of renewable and non-renewable resources

Non-renewable resources such as oil, are considered to be finite. An optimal rate of use is acceptable for both present and future generations. Section 6 – Environmental sustainability

Renewable resources can be replenished to some degree but must be used sustainably. An optimal rate of use is allowing resources to regenerate so that there is no long-term decline in these resources. C ASE S PACE :

In 1973 the world experienced an oil crisis as Middle Eastern countries decided they wanted greater control over their own oil. This resulted in the price of oil rising dramatically. The world then became much more aware of oil as a precious and finite resource.

K EY P OINT :

For policies that Australia and the global economy have used to manage environmental degradation, see Topic 4 (page 69). Using knowledge across topics to support theory here will deepen your analysis and make your study more efficient.

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Topic IV

Economic policies and management

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Economic objectives

Section 1

Economic objectives K EY P OINT :

Topic 4 focuses on the functions of economic policies in the Australian economy. The economic issues studied in Topic 3 are all related to the economic objectives in Topic 4. The only difference is Topic 4 focuses on balancing and achieving the optimal standards for each of the economic issues. Hence, it is possible to use your notes from Topic 3 to address economic objectives theory in Topic 4. It is also a common trend for examiners to create essay questions linking economic issues to economic management (hence linking Topic 3 and 4 in essays). Keep this in mind as you study this Topic! The government tries to achieve a range of economic objectives, through a balanced consideration of tools. Not all economic objectives can be achieved at once.

1.1 1.1.1

Objective areas Economic growth and quality of life

Section 1 – Economic objectives

Sustainable growth is an economic objective, as unrestrained growth compromises other economic objectives. A consistent rate of economic growth increases quality of life through increasing GNI per capita (used to measure economic development). This means economic growth increases people’s access to goods and services, raising living standards. Higher incomes also create higher taxation revenue which can be used to fund public goods and support the general welfare of an economy.

1.1.2

Full employment

The government aims to achieve full employment, in line with the estimated NAIRU. This is the rate at which there is no cyclical unemployment in the economy. The government can also aim to lower the NAIRU through microeconomic reform, which over the long-term minimises the structurally unemployed and increasing the supply of the labour force. When the economy is at fully employment, production is maximised and prices are minimised, which supports economic growth and prevents the negative effects involved with unemployment.

1.1.3

Price stability

Price stability involved the close monitoring of inflation to ensure the general level of prices are at an acceptable level that causes minimal disruption to the economy. The Australian Government uses monetary policy as the primary tool to control inflation, with the RBA setting the inflation target at 2–3% over the business cycle. This avoids the negative effects of high inflation, and ensures consumers maintain purchasing power, supporting AD and economic growth.

1.1.4

External stability

External instability is often a constraint on internal government objectives; hence an economy must ensure it can meet its long-term financial obligations to the rest of the world so internal goals are not jeopardised. For example, a high CAD may cause decreased foreign investment and overall consumer confidence in an economy, constraining economic growth and other internal objectives.

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1.2 Potential conflict among objectives

1.1.5

Environmental sustainability

The government aims to implement environmentally responsible policies to ensure intergenerational equity and consider the social costs of production alongside private costs. Under most market-based economies, environmentally responsible production is not incentive by the price mechanism only. Hence the government has a responsibility to regulate markets and ensure negative externalities are accounted for.

1.1.6

Distribution of income

The government aims to create a more equitable distribution of income, mainly through taxation and redistribution of income, which are features of fiscal policy. Market-based economies can disadvantage lowincome earners, and hence the government has a responsibility to ensure poverty-traps do not occur, and there is equitable opportunity in the economy. This avoids the range of social and economic disadvantages of high levels of inequality.

1.2 1.2.1

Potential conflict among objectives Price stability vs. full employment

1.2.2

Economic growth vs. distribution

stability, sustainability, employment, and income

Economic growth causes an increase in consumption. This may increase import volumes, worsening the BOGS and CAD. A worsened CAD has the potential to cause external instability if this trend continues in the long-term. Economic growth is restricted by the parameters of the environment. Furthermore, increased expenditure on environmental policies may limit short-term economic growth but maximise long-term growth. Economic growth through microeconomic reform has the potential to raise unemployment in the shortterm, as industries restructure and may make some workers redundant. The benefits of economic growth are often skewed towards entrepreneurs and owners of capital. Hence, those with high incomes may find increased opportunity to further increase their incomes, causing increased inequality of the distribution of income.

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Section 1 – Economic objectives

This conflict can be summarised as the government’s aim to simultaneously decrease unemployment while maintaining price stability. This is illustrated by the Phillips curve (see page 43). When unemployment is deceased, labour becomes scarcer, causing firms to offer higher wages to attract labour. This increases the cost of production, causing cost-push inflation. Furthermore, this can cause a wage-price spiral, where because of the increased prices of goods and services, the labour force (who are also consumers) will demand higher wages to afford the price increases, causing demand-pull inflation, forming an inflation cycle of wages and prices.

Macroeconomic policies

Section 2

Macroeconomic policies Macroeconomic policy is the use of government policies to reduce large fluctuations and stabilise economic activity, in order to achieve economic goals. Due to the nature of macroeconomic policy minimising fluctuations, it often has short-term effects (rather than long-term impacts) on the economy, supporting AD and economic growth by stabilising the business cycle. Hence, the effectiveness of macroeconomic policy benefits from the multiplier effect of spending on the economy. Rationale for macroeconomic policies The rationale for economic stabilisation policies is to achieve both internal and external balance across the whole economy, while sustaining economic growth. Macroeconomic policies change AD as they affect spending in the short-term, whereas microeconomic policies change AS as they affect production in the long-term.

Section 2 – Macroeconomic policies

Internal balance refers to economic issues affecting the internals of an economy, including low unemployment, low inflation and stable economic growth, whereas external balance concerns an economy’s objective in relation to the world, including financing import and export expenditure, stability of exchange rate, level of net foreign liabilities, and debt as percentages of GDP. The policy mix refers to the combination of macroeconomic and microeconomic policies used in an economy.

2.1

Fiscal policy

Fiscal policy involves the government using spending, taxation and the budget outcome to influence resource allocation, redistribute income and reduce fluctuations in economic activity.

2.1.1

Federal Government Budgets and budget outcomes

The Budget is a tool which plans government expenditure and revenue for the next financial year, in an economy. Budget outcomes refer to the overall outcome of the Budget (different to the budget stance!). The budget outcomes include: • Deficit: expenditure greater than revenue • Surplus: revenue greater than expenditure • Balanced: revenue equal to expenditure Over the economic cycle, Australia aims to achieve ‘balanced budgets’ where surpluses outweigh deficits to ensure debt is sustainable. Australia’s Fiscal Framework (IMF, 2017) stated “Australia has a well-established record of responsible fiscal policies.” Budget stances refer to the spending pattern of the government, and includes: • Expansionary budget: a net increase in government spending (increase in government expenditure or decrease in revenue collected). This is often used in downturns or recessions, as it increases AD, supporting economic growth. • Contractionary budget: a net decrease in government spending (increase in revenue collected or decrease in government spending). This is often used in periods of economic growth to contain AD and promote sustainable economic growth and price stability.

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2.1 Fiscal policy

C ASE S PACE :

The 2020–2021 Federal Budget was delayed by the Federal Government due to the COVID-19 pandemic. This had already impacted the 2019–2020 budget through the range of government stimulus packages. According to the Treasury, “the government’s economic support package of $259 billion represents fiscal and balance sheet support across the forward estimates of 13.3% of annual GDP. Direct fiscal measures are equivalent to around 6.9% of GDP.” The 2019-2020 Federal Budget promised the first surplus in over a decade. Some main specific policies that featured in the 2019 budget included: • Personal Income Tax plan: tax relief to low-income and middle-income earners. Around 4.5 million middle income earners will receive the full benefits, supporting more equitable distribution of income in Australia, and boosting consumption and AD. • Backing small businesses: company tax rate for small-to-mid-sized enterprises (SMEs) with an annual turnover of less than $50 million has been lowered to 27.5%. This will decrease the costs on firms and increase profits, which may support increased business investment. • Making multinationals pay their fair share: the government is providing more than $1 billion to extend the ATO’s Tax Avoidance Taskforce to hold multinational companies accountable for the tax they owe the Australian Government.

Automatic stabilisers are instruments inherent in the government budget that counterbalance economic activity (e.g. progressive tax system and transfer payments). For example, when an economy improves, tax revenue increases. This is because people’s income increase, into higher tax brackets (called bracket creeping), causing higher tax collection and a lower demand for welfare. This occurs in times of economic growth, to help contain inflation and excessive growth. Conversely, as tax revenue falls and welfare increases in contractionary periods, AD is supported to maintain spending. This offsets higher unemployment, and lower economic activity. The cyclical component (non-discretionary changes) of fiscal policy are caused by changes in the level of economic activity (e.g. automatic stabilisers in the budget). On the other hand, the structural component (discretionary changes) of fiscal policy are the deliberate changes to the budget (e.g. the 2019 tax cuts to lower-income and middle-income earners).

2.1.2

Effects of budgeting changes

Resource use The government reallocates resources through taxes collected from different sectors and industries and reallocates to others e.g. income tax reallocates income levels. This ensures efficient allocation of resources across the economy, while allowing for the government to account for the negative externalities of production. A book called Fair Share (2018) argued that economic growth depends on the mix of different taxes; for example, spending on infrastructure, education, and training (longer-term priorities) would increase productivity and give the economy impetus going forward. Income distribution The government can increase marginal tax rates or decrease taxes for lower income earners and redistribute these through welfare payments. The government can also increase inequality through decreasing taxes for higher income earners. For example, research from ANU on the 2019 Budget stated that new tax policies may “make the tax system marginally more regressive, favouring high income earners over lower income earners.” However, Australia’s progressive tax system aims to create a more equal distribution of income.

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Section 2 – Macroeconomic policies

Changes in budget outcomes

2.1 Fiscal policy

Economic activity The budget stance highlights the impact of fiscal policy on economic growth through changes in the budget outcome (either expansionary, contractionary or neutral outcomes). When the government increases spending, it causes a multiplier effect on this initial income, supporting AD. Governments can also give fiscal stimuli in times of crisis. For example, the one-off financial payments of $900 made in 2009–2010 during the GFC, combined with other discretionary fiscal stimulus measures, was estimated to boost Australia’s real GDP by 2.75%.

2.1.3

Methods of financing deficits

The government could utilise automatic stabilisers to finance deficits, however this may not be sufficient. The government could also raise taxes but are often reluctant to do this because it would make them politically unpopular. Borrow from the private sector

Section 2 – Macroeconomic policies

Debt financing is the selling of Treasury bonds to raise funds. It is the main form of deficit financing where investors lend money through bond purchasing and the government pays back the money, with interest. This is advantageous as there is no change in the money supply, since the government is borrowing within the domestic economy, so there is no increase in net foreign debt. This is injected through spending, returning to private sector. However, this can also lead to a crowding out effect that puts upward pressure on interest rates as less money is invested in banks (lower money supply). The government may need to offer higher interest rates, and the private sector (banks) may then need to borrow from overseas, which would add to CAD. Borrow from the RBA Quantitative easing/monetary financing increases supply through the government’s selling of securities to the RBA, which increases their cash flow. This method increases the quantity (supply) of money in the economy and is usually used only when the cash rate is nearing 0, as interest rate cuts become ineffective. The advantages to this are that there is no change to the interest rate, no accumulation of public debt, and no increase in net foreign debt. On the other hand though, this can devalue the currenct as there is an increase in the supply of money. Prices may increase as overall purchasing power increases, causing demand-pull inflation. This is rarely used by governments, though was seen in the US during the GFC, which devalued their currency. Borrow from overseas The RBA sells government securities to foreign investors, then the RBA credits the Australian dollar equivalent of the loan to the government’s account. If the government budget is ‘irreparable’ it could borrow from the IMF, but currently Australia is not in such a position. This means there is no interest in domestic interest rates, and minimal impact on the domestic economy as there is no increase in supply (less inflation, interest rates etc.). It may also be less expensive than domestic borrowing, as funds aren’t as limited. However, this accumulation of foreign dept adds to CAD as interest repayments increase NPY outflow. Exchange rate fluctuations can also be volatile and may affect the servicing costs of the debt (valuation effect).

2.1.4

Use of a surplus

• Pay off retiring public debt: will reduce future debt obligations, as interest repayments become lower, minimising future expenditure • Reduced foreign debt: will reduce interest payable and the size of NPY deficit, hence reducing the CAD and overall foreign debt levels • Government owned investment funds: surplus government revenue can be invested into government funds used for future expenditure (e.g. the Future Fund helps cover superannuation liabilities)

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2.2 Monetary policy

2.2

Monetary policy

Monetary policy involves the setting of interest rates administered by the RBA, on behalf of the government. The aim is to smooth the effects of economic fluctuations and maintain low inflation.

2.2.1

Purpose of monetary policy

Price stability, full employment, and economic growth RBA’s inflation target framework aims to keep inflation between 2% and 3%. If inflation or the CAD rises, the RBA may tighten monetary policy to reduce spending as this may threaten the stability of growth. In 2010, monetary policy returned to a more neutral position as the GFC impacts eased, with the cash rate rising to 4.75%. This was due to domestic economic recovery and strong mining sector growth, which saw the RBA refocus on containing inflationary pressures. Conversely, monetary policy may be eased if growth is below target, and unemployment is rising.

C ASE S PACE :

Currently the RBA is maintaining low interest rates to encourage spending. In June 2020, the cash rate was 0.25%, which is the lowest rate Australia has ever had. The RBA governor Phillip Lowe has said 0.25% is the “effective lower bound” for the cash rate, meaning further reductions wouldn’t have any added benefit for the economy.

2.2.2

Implementation of monetary policy by the RBA

Monetary policy is implemented by the RBA through open/domestic market operations (DMOs). The cash rate is the interest rate paid on overnight loans in the short-term money market. An Exchange Settlement Account (ESA) is the account used to settle payments (clearing) with other banks, and the RBA. When an ESA is negative, the cash rate is charged as interest on the balance. The RBA can buy and sell Commonwealth Government Securities (CGS) to increase or decrease the supply of money in ESAs. If the RBA increases cash rate, banks pay more to maintain their ESA. This incurred extra cost (interest) puts upward pressure on interest rates. This is then passed onto consumers in the form of higher interest rates. However, cash rate changes are not always passed on by banks, hence their effects can be limited. For example, cash rate cuts may not be passed on in the form of lower interest rates for consumers.

2.2.3

Impact of changes in interest rates on economic activity

If AD is growing too fast and consumer confidence is too high, the RBA may increase the cash rate. This is because an increased cash rate causes interest rates to increase, incentivising spending and raising the costs of borrowing. If AD is slowing down and consumer confidence is low, the RBA may decrease the cash rate. This is because a lower cash rate causes interest rates to decrease, incentivising spending.

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Section 2 – Macroeconomic policies

In the media release by the RBA in May 2020, it was specified that “the Board is committed to do what it can to support jobs, incomes and businesses during this difficult period and to make sure that Australia is well placed for the expected recovery. The Board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3% target band,” revealing the motives behind the record low cash rate.

2.2 Monetary policy

The transmission mechanism refers to how changes in the stance of monetary policy influence economic objectives, such as inflation and economic growth. The intertemporal substitution channel of monetary policy refers to the phenomena where interest rates are low and savings are discouraged, causing consumption and other forms of investment to increase, until rates increase again. The wealth effect refers to when lower interest rates makes borrowing cheaper, which encouraging spending and increasing demand e.g. housing, making homeowners feel wealthier and more likely to spend. The opposite is true for a higher interest rate making consumers feel wealthier due to increased asset prices. According to the RBA, for every 1% decrease in interest rates, household spending would increase between 0.1% and 0.2%. The impacts of changes in the cash rate can be illustrated in the diagram below.

Section 2 – Macroeconomic policies

2.2.4

Impact of changes in interest rates on the exchange rate

High domestic interest rates increase demand for the AUD, as savings rates are more attractive for investors. This can cause an appreciation of the dollar, whereas low domestic interest rates may increase supply for the AUD, as savings rates are less attractive for investors, and money may be invested internationally. This interest rate differential determines whether investment, and hence demand for the dollar, increases or decreases. However, the impact on the exchange rate is a secondary function of monetary policy, with the RBA focusing on stabilising inflation as a priority.

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Microeconomic policies

Section 3

Microeconomic policies Microeconomic policies aim to increase Aggregate Supply (AS) by improving the efficiency and productivity of producers. These policies are aimed at individual industries or markets, for example the labour market. Microeconomic policy may involve deregulation, privatisation (selling of government enterprises), or reformation of the competition policy. During the 1980s and 1990s, Australia experienced transformative microeconomic reform which largely increased the efficiency of the economy. This has supported strong economic growth levels across the past 28 years. A famous quote (that can be used in microeconomic policy essays), and describes Australia’s need for this reform is “I had to make sure this slothful, locked up place finally became an open, competitive economy” (Paul Keating, former Treasurer from 1983–1991 and Prime Minister of Australia from 1991–1996).

Microeconomic policy is continuous (often over 10-20+ years!) and complements macroeconomic policy with the aim to stabilise the economy and achieve objectives in the long-term.

3.1 3.1.1

Rationale for microeconomic policies Shifts in AS and efficiency

Microeconomic reform may have high costs and can restrict short-term economic growth; however, the benefits of higher long-term productivity and international competitiveness increase economic growth in the long-term. Microeconomic reform can be illustrated by an increase in the supply curve (i.e. a shift to the right). Firms can be ‘forced’ to improve their own performance by exposing them to greater competition from foreign firms, for example through the removal of protectionist policies. Competitive pressures encourage efficient operation of markets, for example an increased investment in new technology. This increases productivity, and improve flexibility and responsiveness to change. The Australian economy has experienced major reforms to overall economic output since the 1980s. The economy experienced a shift from manufacturing production to focus on primary commodity markets (highlighted by the significance of the mining boom), to an increased focus on services. This has been due to a variety of reasons, including: • New technology has reshaped jobs and increased the efficiency of industries • Government policies to support free market operations (e.g. the floating of the exchange rate in 1983) • Increased globalisation, and the lowering of barriers to international markets e.g. lower protection and increased competition • Increased specialisation in industries with comparative advantage e.g. mining There are three types of efficiency gains from successful microeconomic policies, including: • Technical/productive efficiency: where firms are able to produce more output with lower opportunity cost. This is represented by the point of technical optimum for firms. • Allocative efficiency: where the prices charged reflect the marginal cost of production. Hence, resources are allocated to reflect consumer preferences • Dynamic efficiency: where firms are increasingly able to adapt to changing circumstances (e.g. the use of new technologies and consumer preferences) Copyright © 2022 InStudent Publishing Pty. Ltd.

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Section 3 – Microeconomic policies

Since the early 1980s, microeconomic reform has been a major long-term economic objective of the government. Australia experienced the ‘J-curve effect’ due to microeconomic reform, as the implementation of these policies often involve increased unemployment and the closure of inefficient firms and industries. However, in the long-term job opportunities increase and other benefits such as increased allocative efficiency of resources are achieved.

3.2 Effects of microeconomic policies

3.2

Effects of microeconomic policies Benefits

Costs

+ Greater efficiency and productivity growth in long-term due to increased AS, which can also increase comparative advantage of exports and increase GDP and economic growth overall + New business and job opportunities + Higher economic growth leads to lower prices (inflation) and higher living standards + Helps to overcome structural problems of an economy (e.g. low rate of savings)

3.2.1

– Higher unemployment in the short-term – Closure of inefficient business and industries – Greater work intensity due to the greater demands of increased competition and innovation – Less equal distribution of income, as higher income earners tend to benefit most – Increased government cost to retrain redundant workers

Product and factor markets

Section 3 – Microeconomic policies

A product reform occurs in a specific industry. A factor reform involves the form of a factor of production. For example, reforms made to the labour market are factor reforms. Because labour is utilised in every industry, an increase in productivity in the labour market will increase overall productivity and benefit overall economic output. Capital deepening refers to the use of more machines per worker. This improves productivity; for instance, from 2001 to 2018, capital deepening productivity grew 1%.

3.3

Regulation and deregulation

Deregulation refers to the removal of rules that constrain the operation of market forces in the aim to improve the efficiency of industries. The government, firms and industries are all responsible for implementing change. The current rationale for deregulation is largely based on the US economist George Stigler’s critique of regulation. It was argued that protection: • Increases government’s bureaucratic costs • Leads to the ‘theory of capture and rent seeking’ whereby the protected industries always expect favourable treatment • Causes high opportunity cost by an inefficient use of resources C ASE S PACE :

Financial sector deregulation (example of reform of a product market) The deregulation of the financial sector ensured an increase in the efficient allocation of capital resources, and minimisation of costs. It created a more competitive environment, where consumers and businesses pay lower prices for their access to finance. Notable financial reforms include: • The floating of AUD in 1983, which caused an increase long-term competitiveness as it reflected the true value of the currency • The RBA using DMOs to conduct monetary policy and implemented inflation targeting • The removal of barriers for foreign banks entering Australia in 1985, which allowed 16 foreign banks to provide competition for local banks (e.g. ING) • The selling of government assets and enterprises in 1996 (e.g. CBA) to raise money and improve efficiency in those utilities • Non-Bank Financial Institutions (NBFI) allowed to compete with the banks in providing a range of services (e.g. Qantas Credit Card)

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3.4 Labour market policies

C ASE S PACE :

Telecommunications deregulation (example of reform of a product market) The telecommunications industry was deregulated in 1992, to provide competition for Telecom Australia (now called Telstra). The industry was partially deregulated in 1992, when Optus was granted a fiveyear licence to operate in Australia. Full deregulation of the industry occurred in 1997, where a range of providers such as Vodafone, TPG, etc. were allowed into the market, providing greater competition and increasing the efficiency of this industry.

3.3.1

Competition policy

The National Competition Policy is an agreement between Australia’s Federal and State Governments, made in 1995 to encourage microeconomic reform throughout the economy. Competition policy is monitored by the ACCC under the Competition and Consumer Act 2010, which promotes competition, fair trading and consumer protection, as well as monitors unfair market practices (such as collusion and price-discrimination). The penalties that can be applied for breaches of the Competition and Consumer Act are up to $10 million for companies and $500,000 for individuals.

3.4 Labour market policies

The government determines legislation that underpins the industrial relations system, aiming to control: • Wage demands and inflation outcomes to contain the cost of labour and promote efficiency and competitiveness • Wage justice setting national standards to protect incomes and conditions of all employees • A mechanism for solving industrial disputes (e.g. mediation, conciliation and arbitration through the Fair Work Commission) • Promotion of labour market reform through different contract types (e.g. enterprise bargaining to promote flexibility and productivity)

C ASE S PACE :

Wage indexation (matching) for inflation was abandoned in 1987. This was followed by the Workplace Relations Act of 1996, which caused a 2.2% productivity growth in this period. This was mainly due to the implementation of: • Award Safety Net: official industrial award system • Certified Agreements: a form of enterprise bargaining • Australian Workplace Agreements: facilitation of individual negotiation

3.4.1

Role of national and state systems

Inefficiency of separate state and federal systems created growing pressure to move towards a national industrial relations system. In 1990 more than 80% of workers were covered by an award, but this has declined to less than 20% today. The Fair Work Act of 2009, administered by the Fair Work Commission, allowed for the centralisation of the industrial relations system (where state control was shifted to the federal level). It also allowed for increased efficiency in the provision of labour wages conditions. The current industrial relations system comprises of a formal and informal system. The formal system includes collective agreements (36.4%) and awards (23.9%). The informal system includes common law contracts (36.2%) and returns on profits from an incorporated business (3.5%) (RBA).

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Section 3 – Microeconomic policies

The industrial relations system is used to determine wages and conditions in Australia. This system was centralised (i.e. controlled by government) in the 1990s, but is now decentralised, whereby the free market determines wage prices with the government only setting floor prices and conditions.

3.4 Labour market policies

The National System (Fair Work Act 2009) The National (minimum) Employment Standards are ten minimum employment standards and are often called the ‘safety net’ to which all employees are entitled. For example, standard 1 specifies a maximum of 38 hours of work per week. Minimum wage rates are the base rate of pay. This applies to all employees and awards. It is reviewed annually by the Fair Work Commission, who considers performance and competitiveness of the economy, along with labour productivity levels. As of June 2020, the national minimum wage is $753.80 per week, or $19.49 per hour. This was a 3% increase from the previous year, designed to support wage growth. Awards are a legal document that outlines the minimum wages and working conditions for all employees in a particular business or industry. Awards can be inflexible and therefore may not suit all employees or businesses. Under awards, all employees are guaranteed the minimum pay and conditions, regardless of productivity. Enterprise agreements are where pay, and conditions are negotiated and voted on between an employer and a union or group of employees. This is then approved and registered by the Fair Work Commission, to ensure it is in the employee’s interest and does not violate the better off overall test (BOOT). This test ensures award entitlements aren’t omitted. The agreements are consultative, involving employees campaigning for improved conditions, supporting increased productivity. Enterprise agreements can be:

Section 3 – Microeconomic policies

• Single-enterprise agreements: between a single employer and a group of employees • Multi-enterprise agreements: between two or more employers and employees • Greenfields: enterprise agreements made relating to a newly established business Employment contracts for high-income earners are private agreements (individual contracts) between an employer and employee and comprise the informal part of the industrial relations system. However, they must still comply with industrial law. The main benefit is flexibility for both the employer and employee.

3.4.2

Dispute resolution

An industrial dispute occurs when employers or employees take action to disrupt the production process, in order to highlight a disagreement e.g. unfair dismissal. Unfair dismissal refers to a harsh, unjust or unreasonable dismissal of a worker. The industrial relations system aims to solve disputes efficiently to minimise the impact on productivity, output, and profits. Dispute resolution may involve: • Collective bargaining: a form of negotiation between employers and groups of employees or unions • Conciliation: where Fair Work Australia or a third-party act as a mediator and suggest solutions to resolve a dispute • Arbitration: where an industrial tribunal sets a legally binding decision on the dispute – this is usually a last resort and can involve further court judgements if escalated The Fair Work Ombudsman provide advice, assistance and education to employers and employees. They ensure compliance with Fair Work Act 2009 by investigating possible breaches and appointing inspectors to monitor this. They may also take court action for serious contraventions of the act and have the authority to regularly audit workplaces.

3.4.3

Arguments for and against the use of centralised and decentralised wages

A centralised wage system is where there is a single national wage case for all employees, or multiple award wages set on an industry or occupation basis. A decentralised wage system involves individual contracts or enterprise bargaining, with less involvement from the government.

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3.5 National and global context for environmental management

Arguments in favour of decentralisation include the fact that it promotes an efficient allocation of resources, as efficient firms can pay more for labour and attract higher skilled workers. There is also an incentive to increase work efficiency, as labour is rewarded directly. This reduce inflationary pressures as wage increases come with productivity increases. Furthermore, wage price flexibility helps the labour market adjust to fluctuations in the economy. This is because firms can limit wage growth in times of economic hardship, reducing the need for employees to be laid off. Arguments against decentralisation often revolve around greater inequality, as lower income earners may experience a lack of bargaining power, due to lower skill and experience levels. This may increase wage disparity. Wage (cost) push inflation may also occur if unemployment dips below the NAIRU. Another argument is that it can be difficult to enforce wage entitlements and conditions, as individuals negotiate conditions and may be treated unfairly or be wrongly classified by firms (e.g. classified as a contractor not an employee).

3.4.4

Education, training, and employment programs

The National Plan for School Improvement in 2013 increased government spending in schools by $15 billion. A higher school retention rate generally leads to increased skills of the labour force, and an overall increase in productivity in the economy. Job Active is the Government’s national employment services system, providing training, skills development, work experience and other tailored assistance to Australians, especially the unemployed.

The Fair Work Act improved equity in the distribution of income, as it created a stronger safety net and assistance for lower paid employees in enterprise bargaining. It provided a simplified system with three main agreements (single-enterprise, multi-enterprise, and greenfield), creating greater clarity in wage decision process. This simplified negotiation process for wages aimed to emphasise collective bargaining to increase the incentive for productivity increases, supporting economic growth and containing inflation. Current industrial relations system Overall, there is an increase in the competitiveness, flexibility, and skills of the labour force. Annual labour productivity growth in the past decade has risen to 1.5%. The economy has experienced lower overall inflation and unemployment, and high rates of economic growth. However, labour market segmentation has risen, which has caused increased inequality. This is because highly skilled works aligns with enterprise and individual arrangements, which are generally higher paid than low skilled workers, which align with awards and the minimum wage.

3.5

National and global context for environmental management

K EY P OINT :

For definitions and explanations of environmental issues facing the nation and the globe, see page 56. Use notes from both this section and Topic 3 when responding to environmental exam questions to deepen your analysis. The national context for environmental management refers to the Australian Government implementing policies to protect Australian biodiversity. The global context refers to the Australian Government implementing policies that work with international standards to combat global environmental issues.

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Section 3 – Microeconomic policies

Trade schools offer school-based apprenticeships and traineeships, specialising in an area of local skill shortages (e.g. construction). This increases productivity and dynamic efficiency of the labour force. Traineeships offer training opportunities for young people in the services sector that last for a year or less. They are common in retail, hospitality, childcare, and aged care, and also increases productivity levels.

3.6 Limitations on economic policies

3.5.1

Regulations

Regulation is required to enforce environmental protection on firms, due to market failure of the price mechanism (see topic 3 for extended explanation). Regulations are complex on a global scale due to differing consumption and exploitation levels of economies. The Environment Protection and Biodiversity Conservation Act of 1999 is an Australian Government policy to combat environmental issues through establishing a regulatory framework. For example, it mandates licensing requirements for commercial development. The government aims to achieve a balance between international competitiveness, as we are a primary industry exporter, relying heavily on natural resources, and environmental regulation.

3.5.2

Market-based policies

Market based policies involve financial incentives and disincentives (such as subsidies and taxes) to address market failure and negative externalities. These policies utilise demand and supply to change market economic behaviour to encourage environmentally sustainable development. Examples of marketbased policies include pollution charges, licenses, and taxes on production.

Section 3 – Microeconomic policies

Emissions trading encourages the buying and selling of emission permits for reducing emissions of pollutants. This limits the amount of pollution in an economy by setting a ceiling on production. However, it also allows the most productive firms to produce the most pollution as they are able to purchase more permits from other firms. This is cost effective and increases efficiency as the market determines the lowest cost of pollution abatement. An example of a market-based environmental policy in Australia is the Product Stewardship for Oil Program. This imposes an 8.5 cent per litre levy on the purchase of oil, to help fund and encourage the recycling of old oil.

3.5.3

Targets set by international agreements

For environmental management policies to be successful they often require international cooperation. Global agreements are not legally binding, and hence global economies are not obligated to agree or enforce internationally recognised environmental policies. Often nations are reluctant to impose strict policies if other nations are not willing to do the same, as this limits their short-term economic growth. The Kyoto Protocol and Paris Accord promote environmental sustainability within the global community. To deliver on Australia’s 2030 (Kyoto agreement) target to reduce emissions by 26–28% below 2005 levels, the government is investing $3.5 billion in a Climate Solutions package. The aim of this package is to reduce emissions while lowering energy prices for Australians, through the use of subsidisation rather than taxation, as taxation often increases the cost of production and price levels.

3.6 3.6.1

Limitations on economic policies Time lags

Policy lag refers to the length of time that elapses between a change in the stance of economic policy and its effects on real economic activity and behaviour. Implementation lag refers to the time it takes for the government to make, change, or introduce new economic policies. Impact lag refers to the time it takes time for a new policy or policy change to have an impact on the economy (e.g. for prices or consumption to adjust accordingly).

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3.6 Limitations on economic policies

Fiscal policy has a medium-term implementation lag, as the budget is decided annually, and has a shortterm impact lag, as spending multiplies AD at a fast rate. Major changes to spending or revenue collection occur on an annual basis, and it can take several months for budget legislation to pass through Parliament. For example, tax reduction immediately affects income, prices, and economic conditions. Hence there is a shorter impact lag for fiscal policy, making it the most effective policy to achieve an immediate boost in aggregate demand (e.g. expansionary fiscal policy during the GFC). Monetary policy has a short-term implementation lag, as the cash rate is reviewed monthly; however, it has a medium-term impact lag as spending adjusts to the changing price of borrowing. Change can be implemented quickly, as it has immediate effect on the cash rate. It takes time for changes in the level of interest rates to feed through to changes in the borrowing and savings behaviour of consumers and businesses. Hence, it can be difficult for the RBA to make the right adjustments. This means they need to consider the anticipated level of inflation, confidence and economic conditions in the future. Microeconomic reform as a long-term implementation lag, as policies are often researched and reviewed in depth before they are implemented due to their potential for large impacts. The impact lag for microeconomic policy is long-term, as it can take up to 20 years for structural reforms to take place in an economy.

3.6.2

Global influences

Globalisation and the international business cycle has increased the risks of financial contagion. This can negate the benefits of domestic economic policies and will influence the policy mix. For example, during the GFC, domestic economic objectives were affected by global factors, resulting in the need for easing of fiscal and monetary policy to prevent a recession. In a global environment in which exchange rates and economies are vulnerable, governments place a high priority on maintaining the confidence of international investors and global financial markets. Financial deregulation, along with inflation targeting and a floating exchange rate has allowed for effective monetary policy. This is because monetary policy affects the flow of capital, the size of the CAD, and foreign debt levels. The government aims for fiscal balance over the economic cycle, and hence can utilise monetary policy as a tool to ensure Australia’s financial relationship with the world remains prudent. World economic policy such as that set by the WTO and APEC may set boundaries for domestic policies (e.g. protection). For example, the WTO forced Australia to abandon its ban on fresh salmon imports from Canada in order to benefit the world economy. If interest rates are rising in other countries, and Australia does not raise its interest rates, its rate of return will be relatively less attractive for overseas investors. Hence, the interest rate differential, determined by monetary policy, can influence foreign investment into Australia.

3.6.3

Political constraints

In a parliamentary democracy like Australia, a party must win public support for its policy platform in an election every three years to form a federal government. Hence to continue microeconomic reform, an Australian government must be re-elected. Additionally, a bill must be passed by both houses of parliament to become law. A government may not have a majority in both houses, which may delay negotiations and policies. Often, when election times near, governments will try to implement ‘vote-buying’ policies such as tax cuts to encourage re-election. However, the government needs to balance vote-buying policies with suitable economic policies.

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Section 3 – Microeconomic policies

Change takes a long period of time as it involves extensive planning and detail. It may take longer if it is necessary to secure the support of state governments and the Commonwealth. The full effect of these changes occurs in terms of aggregate supply, costs, profits, export growth, and productivity, which are all measured in the long-term.

Policy responses and their effects in dealing with economic objectives

Section 4

Policy responses and their effects in dealing with economic objectives 4.1

Economic growth and quality of life

Globalisation is seen as the way forward towards greater growth for all economies, therefore the government helps firms access these world markets through trade agreements. Section 4 – Policy responses and their effects in dealing with economic objectives

Expansionary macroeconomic policy will boost AD due to the multiplier effect of additional expenditure. Microeconomic policy causes increases in AS, which require reform to increase productivity, economic output and growth. Australia has continued to sustain moderate growth mainly due to a combination of successful macroeconomic policy stimulus and microeconomic reform. For example, during the GFC Australia maintained economic growth of 1.3%, compared to the OECD nation’s average of –3% during 2008–2009 due to: • The RBA cutting the cash rate from 7.25% to 4% within seven months • The Rudd Government’s fiscal stimulus package of $900 per household • Tight regulation of the Australian banks, where the government guaranteed all bank deposits to encourage consumer confidence in the financial sector

4.2

Full employment

Expansionary macroeconomic policies lower cyclical unemployment, which occurs due to a downturn in the business cycle, since labour is derived demand. Microeconomic policies have the potential to lower the NAIRU through labour market reforms. For example, greater investment in skills and training can lower the structurally unemployed. The ineffective expansionary macroeconomic policy of the 1990s caused high unemployment rates in Australia. This increased the need for microeconomic reform of the labour markets, which when combined with the global resources boom, decreased unemployment in Australia. In 1991, there was a high unemployment rate of 10.7%. In 2007, this reached a historic low of 4.2%, below the OECD average 5.5%.

4.3

Price stability

Contractionary macroeconomic policy is used to lower inflation, as it limits AD and spending. Microeconomic reforms that that cause productivity to be greater and goods/services to be cheaper in the longer term will also assist with price stability. The RBA has a framework of 2–3% inflation. When this target was introduced, inflation fell from 8% in the 1980s to a stable 2.5% average since the introduction of inflation targeting. Sustained low inflation has also been due to the successful: • Target framework for monetary policy • Lower protective barriers supporting increased competition across industry sectors • Labour market reforms regarding enterprise bargaining and competition policy, containing wage pressures

4.4

External stability

Contractionary macroeconomic policy will decrease spending, including spending on imports, improving the BOGS and lowering the CAD. Furthermore, a fiscal policy surplus can lower public foreign debt. Microeconomic policy causes increased competitiveness, for example protection reforms, which will increase exports, improving the BOGS and lowering the CAD. 72

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4.5 Distribution of income

Australia’s external balances improved during the 2010s as a result of: • China’s emergence as Australia’s largest export market • A long period of low global interest rates encouraging foreign investment • An IMF report in 2018 which concluded that these factors should put Australia on a pathway towards keeping the CAD within a long-term average of 2.5–3%. Monetary policy also has the secondary function of affecting the exchange rate, controlling volatility and contributing to external stability. During the mining boom, there was a rising households saving ratio due to contractionary policies and increased incomes. This raised domestic funds and improved trade performance, reducing the CAD to –2.6% of GDP in 2010–2011.

4.5

Distribution of income

Macroeconomic policies such as discretionary changes to the budget, including the progressive income tax which details a tax-free threshold of $18,200, with high income earners paying up to 47% of income, and automatic stabilisers, exist to protect lower income earners in economic downturns. Microeconomic policies regarding labour market reforms, for example the introduction of 10 minimum standards, protect lower wage recipients and can minimise income inequality. However, the decentralisation of wage determination in the 1990s, while causing an overall growth in incomes, also contributed to inequality in the distribution of income. This increased the need for Fair Work Act, which aims to provide a simplified system and stronger protective barrier for lower income earners.

4.6

Environmental sustainability

K EY P OINT :

See page 69 for information on the national and global context for environmental management for policies regarding environmental sustainability. Additionally, international agreements such as the Paris Climate Accord (covered on page 56) give the government a framework to work within and manage their domestic environment policies. In terms of macroeconomic policies, fiscal policy can implement policies to regulate environmental degradation that occurs due to the free market. For example, to deliver on Australia’s 2030 (Kyoto agreement) target to reduce emissions by 26–28% below 2005 levels, the government is investing $3.5 billion in a Climate Solutions package. This aims to reduce emissions while lowering energy prices for Australians. Microeconomic reform can increase the use of sustainable behaviours, for example the implementation of new technologies. For example, the Federal Government’s Australian Renewable Energy Agency (ARENA) provides funding for research and development and large-scale renewable energy projects. The Environment Protection and Biodiversity Conservation Act 1999 is an Australian government policy to combat environmental issues, through establishing a regulatory framework. For example, it specifies licensing requirements for commercial development. K EY P OINT :

Overall, the environmental policies must balance: • Economic growth vs. the environment • Domestic policy balanced vs. international efforts • Short-term vs. long-term goals in terms of intergenerational equity

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Section 4 – Policy responses and their effects in dealing with economic objectives

Australia is experiencing rising inequality in its distribution of income; however it is still the lowest of all major OECD countries (the G7 countries). Since 2015, wage growth has been below the average for OECD economies, which has contributed to the rising gap between the rich and poor, as lower income earners have not been effectively supported.

Topic V

General Statistics

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K EY P OINT :

Below is a table that has statistics of key economic indicators from the syllabus for important economic events in Australia’s history. Often if an exam question specifies a point in time to provide evidence from, it is one of the three scenarios below. Hence, I recommend knowing at least some of these statistics. Additionally, if you know the information about these events from the case spaces throughout these Notes, you can use these statistics as evidence for that theory. I do not recommend remembering only this table; without understanding the theory behind these events, you won’t be able to explain why the figure was at that level, which is also highly important in the exam.

2008-9: GFC

2010-12: Mining Boom

2019/2020*

International growth

–1.5%

3.1%

3%

Australia’s economic growth

1.3%

3.6%

2.3%

Unemployment

6%

6%

5.3%

Inflation

1%

2%

1.6%

54% USD

79% USD

60% USD

China’s economic growth

9%

8%

6.3%

CA

–4%

–3%

0.2%

Net foreign debt as a % of GDP

53%

55%

62%

Gini coefficient

0.34

0.32

0.34

Cash Rate

3%

3%

0.25%

TWI

*These figures are mostly annual 2019 data, as subsequent data was greatly impacted by COVID-19. These statistics have been taken from various sources, including the RBA, IMF, World Bank and OECD, so you should check these for the most up-to-date information. Some statistics have been rounded for simplicity of memorisation (this is okay to do in exams!).

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Topic VI

Exam Skills and Tips

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Essay Writing Guide for Economics Writing Style Don’t stress about making your essays sound sophisticated! Economics is not the same as subjects like English in the sense that markers will not award you for complex sentences. What they will focus on is your ability to convey your argument with clarity. This means answering the question directly and using graphs to support your explanations. Your writing style should be succinct, but not lacking in detail or containing slang. Use economic descriptors when analysing to achieve this balance (e.g. words like ‘depreciate’ instead of ‘decrease in value’). You must also consider the differences between economic theories and realities. Most of what we learn in HSC Economics provides a model for what may happen in the economy if a certain event occurs. We gain insight into this theory through case studies from real economic events (hence the need for statistics and reading the news). This means that economic theory may not always be true. Because of this we cannot use high modality when providing economic theory in response to a question. This means using words like ‘may,’ ‘might,’ ‘should,’ ‘could,’ ‘can,’ or ‘theoretically’ instead of ‘will,’ ‘must,’ ‘always,’ or ‘has to.’ Another point to consider when refining your economics writing style is your analytical abilities. What I mean by this is ensuring every point or argument you make has an insightful counterargument. If you imagined a spectrum like the one below, you want to try to be firmly on one side of an argument, but not completely agreeing or disagreeing.

This means you need to have insightful ‘however’ statements throughout your essay to shows you understand the flexible and complex nature of economic theory. You can do this while explaning content; for example: ‘while a rapid depreciation may be detrimental to an economy, the J-curve effect proves in the long run, economic growth will occur due to increased competitiveness.’ You can also introduce these challenges when mentioning case studies; for example: ‘while the mining boom caused a rapid increase in Australia’s economic growth, it also caused the economic phenomena of Dutch disease due to the rapid appreciation of the currency.’

Know Your NESA Verbs Common verbs used in HSC Economics that you need to understand the differences between include: • Explain: use cause-and-effect language with emphasis on links! Detail each step in the economic process of the situation, assuming the marker knows nothing. • Analyse: draw out and relate implications. This is commonly asked in questions with multiple topics or syllabus points, asking you to see how they affect each other, and the economy. • Assess/Evaluate: make a judgement based on specified criteria. Here you must provide a judgement about the effectiveness of economic theory (e.g. policies in achieving their goals, and critically analyse a topic). Use words like ‘strong impact’ or ‘highly effective’ in your response. • Discuss: provide points for and against. This is similar to ‘assess’ but doesn’t require a specific judgement. However, you need a balanced approach to the question.

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Statistics Statistics are crucial to support your economic theory, as the theory is derived from real economic events. This can consist of actual figures (e.g. GDP), trends (e.g. GDP across time), economic policies (e.g. the 2009 tax cuts), or specifics of economic policies (e.g. a tax cut of $900 per family in 2009). You must select the most appropriate form for your argument. It should be integrated, meaningful, and most importantly, analytical. This means you cannot just add the statistic to the end of a sentence and move on. You must add a couple sentences analysing the statistic and what it meant for the economy. Think of it like giving quote evidence in English – you need to analyse each quote, and in Economics, you must analyse your statistical evidence. Below is an example of the start of a statistical analysis – extend this with an evaluation of the effectiveness of the policy by detailing its effects on the economy. S AMPLE :

During the GFC the Rudd government provided a fiscal stimulus of $900 per family with the aim of improving consumer spending. However, following the principle of fiscal implementation lag, the stimulus had a limited effect on the economy. . . In my HSC, I tried to be smart with this. I preferred to memorise fewer statistics and just make sure that the ones I did remember were like case studies where I understood the economic climate around the statistics and the implications it had on the economy as a whole. You can see examples of statistics I studies in these notes in the case space sections! Keep in mind that if your essay includes a stimulus source, analyse it to the best of your abilities! Many of these stimuli are sourced from key contemporary economic events. This is another reason why it is important to understand the economic climate of Australia during major key events, including (but not limited to) the mining boom, the GFC, and the current economy.

Structuring Your Essay Planning I never recommend memorising essays for Economics. The stimuli you are given is unseen, and questions vary in in both content and analysis required across most HSC papers. Hence, taking a couple minutes to flesh out a short essay plan before beginning your essay will help you get a better idea of where you are going to take your essay analytically, and the evidence you will use to support your arguments. It will also help you manage your time better as you don’t risk putting the most effort into your first arguments, with the essay trailing off as you get to the conclusion. Try organise your plan as a series of dot points for each paragraph you want to include, and brain dump any quote, statistics, or graphs you don’t want to forget to include underneath. The plan shouldn’t be longer than half a page. Another important tip is to ensure you include the plan inside the exam response booklet! HSC markers will read your plan before the essay and have a clearer idea – almost like a summary – of what you are going to include in the essay. I would draw a line underneath my plan to indicate where my actual response began. Introduction Every Economics essay I wrote began with a definition of one or two key terms in the question. This is incredibly important to establish your knowledge of the core theory you will discuss in your essay. It can also help guide you in the right direction towards writing a succinct, relevant thesis statement as you remind yourself of the relevance of the theory, in relation to the question provided. Its also your marker’s first impression of your essay, and first impressions matter! How do you pick which terms to define? Generally, they will be terms taken directly from the syllabus! Your next sentence should address the question directly, becoming your thesis. This should outline the argument you want to make, and your judgement if required in the question. Thesis statements can often seem hard to write, but if you imagine the essay question was a short-answer question, you’d have to answer the question within a couple of sentences – this should resemble what your thesis will look like. 78

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Your next sentence or two should summarise the arguments contained in your body paragraphs. Be careful not to waffle here! Markers want a summary, not a long list of arguments! Sometimes this was only a short, single sentence in my essays if I was able to summarise my arguments well in my thesis. Remember, markers are looking for succinct introductions, which should never be longer than a few sentences. I would also recommend adding a final link to the question before you jump into the essay. This might also reinforce your judgement after you have introduced the arguments included in your essay. Body Paragraphs Paragraphs in Economics should have their basis in content from the syllabus, and be accompanied by examples, evidence, and trend analysis. However, other students may be skilled at writing with a focus on evidence, accompanying this with theory. You can experiment with both methods – ultimately you want to write in a style that allows you to conduct the most sophisticated analysis. (When I mention analysis, I am referring to your ability to synthesise, communicate, and provide a strong judgement on Economic theory!) Your body paragraphs should always begin with a topic statement, and explanation of economic theory, similar to that of the start of your introduction. Include a definition where relevant, and an explanation of how the concept works. This is where I recommend including diagrams to help with the explanation of your theory. Make sure to label these diagrams (e.g. Fig 1) and refer to your model in your response. This is critical, as an inclusion of a diagram in an essay is worthless without explanation of what it represents. Your next few sentences might include cause and effect language, advantages and disadvantages, or an evaluation of something. This will depend on the NESA verb you are given. Here is where you want to include your trend analysis and case studies. See my above tips on statistic inclusion for tips on how to analyse your economic evidence, rather than include it like a shopping list of economic events. Here is where many markers differentiate between higher band essays, and this is a main reason why I don’t recommend memorising statistics without any content, as the explanation of a trend is more important than the statistic itself. You can compare the inclusion of trends to the inclusion and analysis of quotes in English. Whenever you introduce a new argument, you should have a form of evidence to support this. You should also end your paragraphs with a question summarising your argument and linking it back to the question. Conclusion This should be the shortest paragraph in your essay; it should not exceed three or four sentences. The focus should be on summarising your stance on the question. You can structure this similar to your introduction, minus the definitions included at the start. You can also include a summary of your body paragraphs in a couple sentences here. Your final sentence should focus on an overall impact or synthesis of your argument. For example, in many of my final sentences I would reference the overall domestic or global economic effect of the theory included in my essay, as this was relevant to many questions. The most important thing to keep in mind here is you want to summarise your response to the question.

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Example Essay K EY P OINT :

The following essay is a high band 6 level response, written in 40 minutes under exam conditions. This should give you an idea of the required balance between detail and succinctness in Economics essays. I have chosen an ‘assess’ question to give an example of the high degree of analysis required in these essays, common in exams. Note: This essay was written before the expansion of fiscal stimulus in response to the Australian bushfire crisis and COVID-19 pandemic. This, along with the extension of the budget announcement to October should be included in a more recent response to this essay question.

S AMPLE :

Question: Assess the success of Fiscal policy and the recent Australian Budget in managing full employment and the distribution of income in the Australian economy. Plan • • • • • •

Budget outcomes & stances (theory from fiscal policy) 2019/20 Budget overview, employment and income trends Unemployment + underutilisation of labour + budget specifics Distribution of income and the budgetary effects + Lorenz curve Overall analysis of success of budget Quotes from: ANU, AFR, IMF, SMH [Note: I ticked these off as I included them in the essay, as I would tend to forget these!]

Essay Fiscal policy is the government’s control of the yearly budget to stabilise fluctuations in economic activity and redistribute resources including income. Through the collection of tax and spending of government revenue the government has the ability to influence the economic objectives of full employment and equal distribution of income. Therefore, an effective fiscal policy stance may be able to achieve these objectives, along with the overall maintenance and growth of the economy. The budget may have a contractionary or expansionary outcome. An expansionary outcome is either an increased deficit (increase of government spending) or a decreased surplus (net decrease of government spending), which increases aggregate demand (AD), increasing economic output and growth. A contractionary outcome is either a decreased budget deficit (net decrease of government spending) or an increased government surplus (net increase of government spending), decreasing AD and contracting economic growth and output (as AD = C + I + G + (X – M), where G is net government spending. Therefore, the fiscal policy, through its discretionary control of the budget (planned government expenditure and revenue), provides the government with control over their output and demand of the economy. Following Keynes’ economic thought, where an increase of government expenditure leads to a greater increase in income and demand (the multiplier effect), the budget has the ability encourage household consumption. Due to labour being a derived demand of consumption, the fiscal policy can therefore encourage full employment, and control the distribution of income. The fiscal policy also contains a cyclical, non-discretionary component of automatic stabilisers. These are in-built functions of fiscal policy to offset large fluctuations in economic activity. In regard to employment, the automatic stabiliser of the progressive tax system maintains unemployment levels, as during times of economic downturn, households fall into lower categories of tax brackets, and government welfare increases. This ensures consumption does not contract excessively and cause increased unemployment and unequal distribution of income. Therefore, through both the discretionary and non-discretionary components of fiscal policy, the government can effectively deal with full employment and the distribution of income.

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The 2019 budget described as a “vote-buying budget” by the Australian Financial Review, was in an election year, meaning the objectives and forecasted figures may seem optimistic. The budget is mildly contractionary, whereby it aims to return to the first surplus since the GFC, of around $7 million. This increase is forecasted to be driven by increased consumption, investment and economic growth of about 0.5-1% between the next 2 financial years. A major driver of this growth is planned to be increased consumption, whereby 94% of taxpayers are projected to face a marginal tax rate of 32.5% or less, costing the budget over $4.5 million (Australian Government Budget). This spending has the aim of increasing AD, as consumption makes up 60% of AD, boosting recently low wage growth and employment through increased production by firms, to meet the increased consumption levels. The budget is providing further support to businesses, to encourage investment and employment through reforms of regulations and taxes, such as the tax rate for SMEs being cut to 27.5%. This is expected to increase business investment by 4% also boosting employment. Overall the 2019 budget aims to achieve the economic objectives of a deceased unemployment rate and increased equality of income, despite its contractionary nature, through expected increases in consumption, and consumer confidence, encouraging Australians to take on extra work. Unemployment refers to those who seek work and are actively able to work but are unable to find employment. Currently in Australia, we are experiencing 5.2% unemployment by many economists until the RBA released a new NAIRU (Non-Accelerating Inflation Rate of Unemployment). The NAIRU indicates the level of full employment for an economy, which maintains price stability, and is optimal for economic growth. The NAIRU has decreased from 5% to 4.5%, indicating a 0.7% spare capacity in the Australian economy. Therefore, the government has aimed in their fiscal policy and budgetary outcomes to decrease unemployment, as this spare capacity presents opportunity cost for economic growth in the Australian economy. Furthermore, Australia’s labour underutilisation rate, which includes those who are underemployed (desire to work longer hours than they currently do) is increasing, at 13% of the population, in 2018. This indicates the trend of the casualisation of the workforce, as 30% of the Australian labour force is part-time, compared to the 10% of part-time workers recorded in the 1960s. This further highlights the need for government stimuli of employment. The importance of decreasing this labour underutilisation includes to ensure consumption of households doesn’t decrease and cause a contractionary effect on economic growth, as unemployment causes a decrease in real incomes and wages (due to spare capacity of the labour force) and little wage pressures), causing overall decreased household consumption. Therefore, to maintain economic growth, the 2019 budgets’ goal of maintaining “certainty to taxpayers that they will face the same marginal tax rate” (Australian Government Budget) with a potential decrease in the future, encourages consumption, while the budget’s investment into firms may increase demand for labour and decrease the unemployment rate. The distribution of income refers to the degree of equality of returns from factors of production. This can be measured by the Lorenz curve and the Gini coefficient.

Fig 1: The Lorenz curve

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Figure 1 above illustrates a sag of the line in income, representing inequal distribution. In Australia, our Gini coefficient, determined by the figures of the Lorenz curve, is 0.34. This indicates a moderate polarisation of income between the population, where 0 is perfect equality and 1 is perfect inequality. Distribution of income is affected by employment, as high unemployment, especially the structurally longterm and hidden unemployed will cause an increase in low-income earners, affecting the distribution of income, as it widens the gap between the earnings of full time employed workers and the lack of income earnt by the unemployed. Therefore, when fiscal policy aims to decrease unemployment, it is generally alongside minimising the unequal distribution of income. While tax cuts may encourage employment, economists at the ANU have determined “the 2019 budget will favour high income earners over low income earners.” Through research of the impacts of the tax cuts across the economy. Therefore, while the 2019 budget may improve employment, it may not cause increased equality of income, due to the lack of additional transfer payments and support for low income earners. Therefore, in 2019, low income earners may be relying on the non-discretionary automatic stabiliser of transfer payments as the primary government form of support. Overall, the 2019 budget has taken measures to decrease the labour underutilisation rate, in the pursuit of full employment, but its ambitious foals of a surplus have limited its impact on increasing the equality of the distribution of income. Through the study of the current employment and income climate of Australia, it is clear, however, fiscal policy has the potential to be successful in achieving full employment and an equal distribution of income.

Study Techniques Learning content and making notes Your approach to content in Economics will depend on how you learn best. Personally, I handwrote notes in class based on my teacher’s presentations. I would then type up my notes into a document. Once a week I would read through these notes and cut out any unnecessary information. Closer to exams, I would read through my notes side by side with the textbook and ATAR Notes book, ensuring I wasn’t missing any information or had unnecessary detail. I would also add in extra notes I had collected from the news and other relevant sources. Personally, I used the previous edition of these notes to solidify my knowledge in Economics. I highlighted my hardcopy and handwrote extra notes from the book. For students who note-take in class, I would recommend using this book as a supplement. For students who prefer making notes before content is covered at school, or don’t take notes in class this book contains enough notes to cover the syllabus comprehensively. You may find supplementing this book with a textbook may enhance your understanding of Economics. This method of note taking allowed me to revise content at the same time. When I typed my notes, I would revise content from that day, then compiling my notes allowed me to revise every week-month. Alongside my extended readings from the news and other resources, this allowed for a holistic study of Economics, where I had a deep understanding of the course. Like I mentioned at the beginning of this book, understanding the content is much more important than (and actually helps with) memorisation! Now, I learn easily from reading and writing so this method worked for me, however, it won’t work for all students! So, here are a list of techniques you could try out to learn content and make notes for Economics: • • • • • •

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Make mind maps on topics, including mini diagrams to help you remember links Watch YouTube videos explaining concepts (even if they aren’t HSC-focused!) Watch the ATAR Notes lectures or revision videos for Economics Make flashcards with definitions, key concepts and formulas Record yourself speaking your notes, and play it back on repeat Attempt practice questions and past exam papers

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Revising content To revise content before exams, I would print my final notes, highlight key components, and handwrite a condensed cheat-sheet version. In this process, I would also read my notes out loud, have someone test me on the content, or better still, have group study sessions where I could revise the content and discuss the theory with friends. Group study sessions are a highly effective form of revision! Often, our memory associates content with events, funny moments, quirks, or anything of interest – so group study sessions can often assist you with understanding and remembering difficult concepts.

Essay plans When it came to prepare for Trials and HSC, my preferred method of practising applications of my knowledge was the creation of essay plans. By the HSC, I aimed to have essay prepared for each sub-topic (e.g. for each economic issue in Topic 3). I found essay plans were the most efficient way of preparing for these larger exams, as they wouldn’t take longer than 20 minutes to create (shorter than writing an entire essay), but allowed me to organise theory and create links in my mind – effectively applying my understanding of the content. It also allowed me to recall case studies and statistics, and practice analysis – which are trickier components of economics study. I would set out these essay plans in dot-point form. My introduction would be two or three dot points. Paragraphs would have a topic sentence-like title, with theory, links, and examples below. My conclusions would also be around two dot points. All up, an essay plan might be around one to two pages, though I preferred writing these on A3 paper so I could visually see the progression of my essay on a single page. Studying with essay plans effectively allows you to practice for short answer questions too (as these are often in a similar format to body paragraphs) and recall information tested in multiple choice questions, effectively minimising the time you need to study, and maximising the development of your Economics skills.

Practice papers Many students attempt practice papers before they understand content. In my opinion, this can be bad for motivation and confidence levels. If you are nearing an exam, I think it is more important to take a step back, ensure you understand all the theory being tested, and then focus on practising and applying your knowledge. Doing practice questions will certainly give you exposure to typical exam-style questions and will build up your analytical skills, but without a foundational knowledge of the content first, your efforts will not be as effective. Furthermore, you may identify topics of weakness you should prioritise practising over others, saving you time. I also recommend trying to get all of your practice work marked, so you may wish to start practising essays sooner so you can have enough time to apply the feedback you get from your teacher. Multiple-choice questions can be left until later as they’re easier to self-mark. Truthfully, I spent much more time understanding content and writing essay plans than doing practice papers. But again, this was what worked for me – you may find you learn best through practical tasks, and practice papers may help you more. In the lead up to the HSC, I found my weakness lied in multiple-choice questions, so I spent most of my ‘practice time’ grinding past HSC and Trial multiple-choice questions, rather than essays or short-answer questions. The main piece of advice I can give is to focus on which skill (i.e. multiple-choice, short-answer or essay questions) and topic (e.g. inflation) you are the least confident in. Start there, and gradually work up to the topics you are more confident in. Although this may feel uncomfortable when studying, it will maximise the efficiency of your study and result in the greatest boost of marks possible, as you are improving upon your weakest areas.

Approaching the Trial and HSC Papers I preferred to have about 45–50 minutes per essay in these exams. This was to ensure I had enough time to plan properly and included deep enough analysis to reach what was required for a Band 6. NESA will recommend 35–40 minutes per essay. If you are able to, don’t spend the recommended 30–35 minutes on the multiple-choice questions; instead aim for 25. Also, reduce the 1 hour and 15 minutes recommended for short-answer questions to about 1 hour and 10 minutes. This will give you an extra 15 minutes to work on both essays, which I found to be extremely valuable. Copyright © 2022 InStudent Publishing Pty. Ltd.

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I will remind you though that this is the method that worked for me personally. Some people may find they can write much more succinct essays than my lengthy responses and will find a better use of their time to be focusing on the trickier multiple-choice questions. Doing a couple of papers under timed conditions, with varying time breakdowns for each section will help you figure out which will maximise your marks.

Multiple-choice questions Multiple choice questions are often overlooked as the easiest component of an exam, but in Economics they are often the source of curveball questions. Here are a couple things to keep in mind when answering multiple choice questions: • Language: be extremely careful when reading these questions. Examiners are often tricky and change questions slightly with words like long-term impact and short-term impact, high and low, hypothetical economy and a specific economy, what would happen and what is currently happening in the economy, expenditure and revenue, etc. A good tip is to highlight or underline these words before deciding on an answer. • Common skills: questions students are often tripped up on involve what can be considered to be commonly tested economics skills (e.g. calculating a CAD based on a given table of values, calculating a multiplier value, recognising the size of a tariff and subsidy). On a first approach, these questions are tricky. But with practice, they can become easy marks! I recommend frequent practising of these skills to ensure this question type won’t throw you in the exam. • Question 17–20: as most students know, the Economics multiple-choice questions are (mostly) ordered in terms of difficulty. This can result in students become less confident as they approach those final questions. Staying calm and certain in your knowledge is incredibly important in exams. Don’t view these questions differently from the others, know you have the knowledge to find an answer and take your time to think through a method to the solution. Practising more of these questions will definitely help build your confidence here.

Short-answer questions Markers aren’t looking for essays here, but they also are looking for some degree of analytical skill. So, where does the balance lie? A general tip is at least one to two sentences per mark (depending on the NESA verb used). But I never counted my sentences in an exam – that would be a silly waste of time! A general layout you could remember for higher-order short answer questions (perhaps those asking you to analyse, discuss, or even just explain) is to firstly define the key economic term in the question. The take a moment to draw connections in your mind between your knowledge and formulate an argument that directly answers the question. Too often students will repeat memorised notes here, which is where they may lose marks. This is why it is much more important to understand theory rather than memorise it, because in the end examiners will ask you to apply economic theory, not relay it. Another tip when answering short answer questions is to consider impacts on individuals, businesses and the government in ‘impact’ style questions. For example, tariffs may benefit firms and the government, but disadvantage consumers – hence tariffs impact these sectors of the economy differently. Furthermore, a question may specify you to analyse the impact on the domestic and/or global economy which cannot be overlooked. Often, impacts for these can also be different. For example, tariffs may benefit the domestic economy, but disadvantage the global economy as it creates barriers to free trade. Also, students often don’t realise they are able to include diagrams and graphs in short answer responses to assist your explanations. These are usually more useful in longer short answer questions (e.g. 6 marks). Try not to force these in; only include a diagram if you think it allows for a clearer explanation of a concept.

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Acknowledgments I would like to give a special mention to Edwina Adisusila, my best friend, who was by my side throughout my entire HSC journey, and who I can count on to this day. I would also like to thank my Economics teachers Ms Zaccagnini and Mr Russo for their continual support through my HSC. Mr Russo, your stories kept a smile on my face every day. Lastly, I’d like to thank my parents, and my sister Sofia for constantly supporting me throughout my HSC, through the good times and the bad.

Final Note Thank you for trusting me with part of your Economics journey. I hope this book has given the extra confidence you needed in your study of Economics. Remember, your marks are a reflection of your study, and not you. Good luck with your HSC! Giuliana

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