Download Essay - Globalisation Effects on China

Describe the impact of globalisation on China’s economic growth and development.
1. Explain how China’s government development strategies have responded to the process of globalisation.
Globalisation refers to the process of increased integration between different countries and economies and the increased
impact of international influences on all aspects of life and economic activity. The past 15 years have seen an increase in the four
major indicators of globalisation: international trade flows, international financial flows, international investment flows and
transfers of technology, and the movement of labour. In an effort to capture the benefits of globalisation without relinquishing
Communist control, Mao Tse Tung’s successor, Deng Xiao Ping, implemented a range of radical economic reforms between 1978
and his death in 1997, which began with China’s official move from an economy with a domestic focus to one with a trade
oriented focus. In turn, China has experienced phenomenal economic growth (percentage increase in real GDP over time) and an
improvement in its economic development.
Recent decades have seen mixed fortunes for different regions as a result of globalisation for whilst some have emerged as
winners, such as China and Australia, others have been pushed to the margins, such as Zimbabwe. An international convergence
of economic performance is shown through China’s ‘catch up’ against the GDP of the developing world. That is, China’s
economy, measured on a Purchasing Power Parity (PPP) basis, was close to $9 trillion in 2008, ranking it the 2 nd largest economy
after the US.
From this rapid economic growth stem major improvements in all aspects of economic development. The Human Development
Index (HDI) is a measure of economic development devised by the United Nations Development Program that takes into
account: life expectancy at birth, levels of educational attainment and material living standards. Between 1975 and 2007,
China’s HDI rose from 0.527 to 0.777 while its HDI rank (out of 177 countries) rose from 94 to 81. Also, over the last 25 years,
poverty has been reduced by 400m people in China, all of whom were previously living on US$1 per day, signifying an increase in
the Chinese standard of living.
However, globalisation has also accelerated resource use and environmental degradation, a fact recognised in both the Genuine
Progress Indicator (GPI) and the Happy Planet Index (HPI). In 2007, a China-commissioned environmental study by the
Organisation for Economic Co-operation and Development (OECD) found that pollution was reducing China’s annual GDP by 7%
and causing health problems. Similarly, carbon dioxide emissions were 6.2 billion tonnes in 2006, 8% higher than in the USA,
owing mainly to electricity and cement production.
On the other hand, globalisation ensured the Chinese government’s response to such environmental challenges. Its involvement
in the World Trade Organisation (WTO) and in hosting the 2008 Olympics prompted the setting of targets for future pollution
levels. These rely on shifting from coal-fired power generation to nuclear and hydroelectric power generation, especially the
Three Gorges Dam Project. Overall, expenditure on environmental protection has risen from 0.8% to 1.3% of GDP.
Facilitated by China’s newfound stability and transparency, its accession to the WTO at the Doha Conference in 2001 produced 3
major outcomes relating to future growth and development: the diversification of its export base to incorporate more value
added Elaborately Transformed Manufactures (ETMs) and service exports, greater foreign investment into the tertiary sector of
the Chinese domestic economy and a higher prominence of Information and Communications Technology (ICT). Reduced
protection, such as a fall in the average Chinese tariff rate from 47% to 10% between 1991 and 2004, attracted foreign
competition, resulting in higher efficiency yet also structural unemployment.
Transnational Corporations (TNCs), growing in line with global trade flows and foreign investment, have influenced the direction
and composition of China’s trade flows. Although once reliant primarily on agricultural production, China now accounts for over
5% of world merchandise trade (up from 2% in 1992). From the late 1980s, TNCs were drawn to China’s large unskilled labour
force and factory wages averaging less than 5% of those in the USA. Their arrival prompted further restructuring of the domestic
economy, which in turn facilitated rapid economic growth in a highly populous nation. With this rise of local wealth and of
industry heavily dependent upon resource and energy imports, China now accounts for 10% of world resource consumption.
Using its managed peg system to ensure price competitiveness of its exports, China is currently the 3rd largest goods trading
country in the world, responsible for 17% of global imports and 7% of global exports. Neighbouring Asian countries, such as
Japan, Hong Kong and Korea, and ASEAN, together comprise 53% of China’s exports and 65% of its imports.
FDI drives economic growth as it leads to improvements in infrastructure and business efficiency (a product of new marketing
skills and expertise). The four special economic zones established in southern and some eastern coastal provinces of China in
1980, as part of the government’s ‘open door policy’, attracted FDI rather than portfolio investment through incentives such as
low tax rates, exemption from import duties, cheap labour and power, and less stringent government regulations. In 2008, FDI
into China totalled $92.4b (making it the top recipient of FDI in the world).
While globalisation contributes to China’s economic growth and development, some aspects of China’s dualistic economy, such
as the Household Responsibility System, entrench, rather than alleviate, geographical disparities in income and wealth. Under
this system established in 1978, the Special Economic Zones provide those living in coastal regions with copious employment
and income opportunities whilst those living in China’s north-western regions suffer from low occupational mobility and poor
living standards. For example, between 1978 and 1998, the performance of coastal areas, such as Shanghai and Shenzen, grew
an astonishing 13% pa, which was 5 times the level faced by China’s north-western regions. Political instability stemming from
widespread peasant revolts forced the Chinese government to propose a plan to double, by 2020, the disposable income of the
750m ppl in the Chinese countryside through land reforms.
To ensure the reinjection of China’s large pool of domestic savings (the Chinese Average Propensity to Save is approximately 0.5)
into the circular flow of income, China’s relatively underdeveloped banking system required many reforms. For example,
following the establishment of the People’s Bank of China in 1984, four big specialist banks were used to direct savings into
government chosen sectors and industries, although now they are more market oriented and efficient due to the introduction of
foreign banks. On the other hand, stock exchanges in Shanghai and Shenzen established in 1995 encouraged the growth of new
local businesses and the Chinese economy.
Still, the Chinese government faces major challenges relating to its ‘fragile’ domestic banking and finance system. For instance,
since the majority of investors in China (apart from institutional investors) consist of individuals eager to make capital gains by
investing their life’s savings in high-risk stocks, ‘speculation bubbles’ regularly occur. The resulting need for adequate prudential
standards and an improvement in lending practices is as equally important as a more competent payments system including
foreign exchange, electronic funds transfer and ATM access for consumers in their market dealings.
The international business cycle refers to fluctuations in the level of economic activity in the global economy over time. Limited
foreign connection and a fixed currency once shielded China from global downturns (1997 Asian economic crisis) since it was
less vulnerable to speculation and the state of the international business cycle. However, since China’s exports now account for
35% of its GDP, it has increased its dependency on other countries. The recent credit crisis in America, for instance, caused
China’s economic growth rate to fall from 11% in 2008 to 6.1% in the March quarter of 2009, reflecting the 17% fall in exports in
the year to March.
In response, the Chinese government implemented a 4 trillion yuan infrastructure package – 30% of which will be funded by the
government whilst most of the rest will be financed by bank lending. Already there is evidence of the effectiveness of this
strategy, with China achieving an economic growth rate of 7.9% in the June quarter of 2009 and retail sales up 16%. Yet
economists argue that this is not a long-term solution. Instead, the Chinese government must introduce structural reforms that
improve the consumption mentality of the Chinese population so that in the future China is less exposed to the state of the
global economy.
In moving from a planned to a socialist market economy, China has adopted the ‘Washington Consensus’ of market friendly
policies, including trade liberalisation, privatisation of state enterprises and fiscal discipline. Following its abandonment of
prices-wages policy, the Chinese government currently relies on strong infrastructure spending (particularly towards “image”
and low efficiency structures) underpinned by massive (and probably unsustainable) bond sales to manage aggregate demand.
Although, inflationary pressures resulting from high growth rates and non-performing loans of SOEs call for a more effective
management of macroeconomic policy so as to maintain the price competitiveness of China’s exports. Taxation reforms in 1994
specifically targeted tax evasion and avoidance in order to maximise finance for infrastructure spending and social welfare.
In conclusion, China has relied on its export-oriented strategy and adherence to the ‘Washington Consensus’ in addition to
banking, agricultural and taxation reforms to drive economic growth and development. Still, problems such as the inefficiency of
the financial market, the global slowdown, inequality and environmental degradation are yet to be confronted if China is to
emerge as the new economic world leader in the near future.
Explain the role of microeconomic policies in assisting structural change in the Aus economy.
Directed towards individual firms and industries, microeconomic policies promote the efficient operation of markets by lifting
productivity, improving flexibility and responsiveness to change, and encouraging Australian firms to take on ‘world best’
practices. They accelerate the process of structural change, that is, change in the pattern of production in an economy over
time, by enabling the economy to move factors of production more quickly from one area to another. Although market forces
tend to be more active in assisting structural change, government forces (in the form of microeconomic reform) do play a
substantial role. This rapid structural change produces both short-term costs and longer-term benefits.
Microeconomic reform encourages allocative, technical and dynamic efficiency with the aim of fostering structural change. In a
free market situation, resources tend to move to those producers who have the greatest capacity to pay, which is generally a
function of their relative efficiency and value to the economy. Thus, minimising distortions to the market economy, such as the
impact of government regulation on prices and wages, will improve the economy’s allocative efficiency, that is, its ability to shift
resources to where they are most valued and can be used most efficiently.
In addition, business enterprises operating in a relatively free market situation have very powerful financial incentives to
maximise efficiency and minimise production costs. Consequently, they would be more inclined to adopt the latest production
technology and use the ‘least cost combination of resources’, causing an improvement in the economy’s technical efficiency, or
in other words, the economy’s ability to achieve the maximum level of output for a given quantity of inputs.
Moreover, in a deregulated market with an increased level of competition, the economy is more likely to achieve dynamic
efficiency, whereby producers respond more quickly to changing patterns of consumer demand in both domestic and global
economies.
Since the mid 1980s, Australia has undergone extensive microeconomic reforms involving the deregulation of certain industries,
the reduction in protection levels, the National Competition Policy as well as reforms to public trading enterprises (PTEs) and the
labour market. As a result, Australia has seen three main shifts in the allocation of resources between 1979-80 and today,
including a reduction in the relative size of the public sector (from 17% to 15%), the halving in relative size of the manufacturing
sector (from 20% to 11%) and the strong growth of the services sector (from 57% to 64%).
Deregulation involves the simplification or removal of rules that constrain the operation of market forces, seeking to improve
the efficiency of industries. However, effective deregulation involves striking a balance between excessive regulation, which can
limit growth and undermine competitiveness, and inadequate regulation, which can lead to market failure, inefficiencies and
excessive volatility. Since the 1980s, Australia’s agricultural, specifically dairy, wool and wheat, industries have undergone major
deregulation. In 2008, for example, the Australian Government introduced reforms to wheat export marketing, replacing a
monopoly regime with a competitive system overseen by a new regulator, Wheat Exports Australia. This resulted in the creation
of larger, more efficient farms, causing production to increase by 24% while the number of farms declined by 13%. With these
reforms and advances in farm technology, agricultural productivity has grown faster than the average for the rest of the
economy over the past two decades.
Historically, Australia was a highly protectionist country. However, since the early 1970s, organisations, such as the Productivity
Commission (PC), have argued that protection and industry assistance lead to higher prices, a misallocation of resources, less
internationally competitive firms and a poor trading performance in the long run. For these reasons, the Whitlam Government
announced a 25% across the board tariff cut in 1973, initiating the process of reducing protection throughout the Australian
economy. Following the many gradual and well-planned tariff reductions that took place throughout the 1990s, Australia is
currently considered a low tariff economy, with a general tariff level of 5% applying to imports.
In response to the 1993 Hilmer report, Australia’s Commonwealth and State Governments signed the National Competition
Policy in 1995 to encourage microeconomic reform throughout the Australian economy. The Governments agreed to implement
reforms that would increase competition in the sectors where they operated monopolies, such as electricity and gas. The
Governments also agreed to remove special provisions that gave PTEs an advantage over private sector competitors. As part of
the reform package, the Australian Competition and Consumer Commission (ACCC) was established as the new national
competition watchdog. An important feature of the reforms was the establishment of a national regime to regulate the cost of
access to infrastructure, whereby businesses that owned a monopoly infrastructure asset, such as an airport or a rail line, were
required to give competitors access to that network at a reasonable price.
Microeconomic reforms have promoted structural change in PTEs through two main approaches: the corporatisation and
privatisation of PTEs. By eliminating political and bureaucratic supervision and making public enterprise managers accountable
for enterprise performance, for example in the case of Australia Post, corporatisation compels PTEs to achieve a rate of return
on assets that is comparable to private sector companies. Comparatively, the privatisation of PTEs, for example Qantas, involves
partially or completely selling them off to the private sector with the aim of increasing competition, encouraging more rational
management and pricing behaviour, and forcing businesses to become more efficient.
From a highly centralised system under which most employees had their wage determined by the Government’s prices and
incomes policy in the 1980s, the 1990s saw a shift to a decentralised system where wages are mostly determined through
workplace bargaining. This has encouraged labour resources to move to firms and industries that are more efficient and which
have the capacity to pay more. Nevertheless, most labour market economists argue that the Australian industrial relations
system is still subject to a significant amount of regulation – although the nature of that regulation has changed over time, from
favouring employees in the early 1990s to favouring employers since 2006. Yet, many economists also argue that wage
determination must remain regulated to ensure fair outcomes.
By hastening structural adjustment, microeconomic reform produces numerous benefits, relating to productivity growth,
inflation, economic growth, job opportunities and trade performance. It leads to increase in productivity growth because
employees have a greater financial incentive to work more productively and increased competition puts pressure on firms to
keep their output prices low – although the notion of workable competition balances this need with the need to achieve
economies of scale. For example, the manufacturing sector has experienced productivity growth of 3.4% p.a. between 1989 and
1994.
Much of this productivity gain has been passed on to consumers through lower output prices, which translate to a lower rate of
AS diagram
inflation. Some of the gain has also gone towards increasing the rate of return of the owners, who have often been governments
and by extension, taxpayers.
Moreover, increased efficiency and productivity resulting from microeconomic reform has contributed to greater economic
activity and thus, lower unemployment in the long term. According to the PC, Australia’s GDP was around 2.5% higher in 200506 as a result of Australia’s extensive microeconomic reforms of the 1990s. In turn, Australians have experienced higher living
standards of around $1,200 per person. While significant, this payoff from microeconomic reform is nevertheless short of the
5.5% of GDP dividend estimated when the reforms commenced in 1995.
Finally, structural change boosts Australia’s trade performance as Australian firms produce the most advanced products at the
lowest prices, and change their patterns of production to suit global consumer demand. This leads to an increase in export
revenue and a reduction in the current account deficit.
On the other hand, structural change is not without its disadvantages, and these are typically borne by individuals or
governments, as well as the industries themselves. The primary disadvantage is the temporary increase in structural
unemployment, which stems from the mismatch of skills between those provided by employees and those required by
employers. This represents an opportunity cost because it means that not all resources are being used to their full capacity; the
economy is operating at a point below its production possibility frontier. In turn, the economy experiences slower economic
growth and a lower standard of living in the short term.
Production possibility frontier
Given that the short-term costs, such as closed firms and structural unemployment, are more obvious than the longer-term
benefits, which may take several decades to full flow through the economy, governments are often unpopular when they
impose structural changes. However, to abandon the process would not only deny us the benefits promised by the increased
efficiency, but it would put our economy at serious risk of falling continuously behind other economies in terms of economic
development.
Evaluate the effectiveness of current macroeconomic policy.
Macroeconomic policies affect the economy as a whole, aiming to reduce the severity of fluctuations in the business cycle by
controlling the level of aggregate demand (AD). Thus, they are also known as counter-cyclical policies. There are four types of
macroeconomic management: fiscal, monetary, international, and prices and incomes, although the Australian Government
currently relies only on the first two to achieve its key economic objectives. These range from a sustainable rate of economic
growth, full employment and price stability to external stability, a fairer distribution of income and wealth, and ecologically
sustainable development. Contrary to historical trends, the current Global Financial Crisis (GFC) has seen a rise in the importance
of fiscal policy in macroeconomic management; monetary policy is likely to play a supplementary role.
Fiscal policy can influence resource allocation, redistribute income and reduce the severity of fluctuations in the business cycle
through the manipulation of government spending and taxation, and the budget outcome. In addition to promoting internal
stability, the 2009-10 Budget has also managed to target the other, less prominent, objectives of equitable distribution of
income and wealth and ecologically sustainable growth. In 2002, Howard abandoned the objective of external stability
altogether, yet fiscal policy still affects it indirectly.
The move from a $21.7 billion budget surplus in 2008-09 to a $57.6 billion budget deficit in 2009-10 deems this year’s budget
expansionary, and hence represents a shift towards an overtly Keynesian approach to fiscal policy. The size of the deficit reflects
a combination of discretionary and non-discretionary influences. Typically, as economic growth contracts, automatic stabilizers,
namely, the progressive income tax system and unemployment benefits, work to decrease government revenue and increase
government expenditure. However, this year, the fall in company and capital gains tax collection, coupled with increased
pensions, cash hand-outs and infrastructure development, has increased the size of the deficit to a greater extent.
The Government’s three-tiered stimulus strategy, consisting of a series of one-off cash handouts, shovel-ready minor capital
works and infrastructure projects, is likely to boost economic growth in the short term, with GDP expected to rise by 0.75% in
2009-10 and 0.5% in 2010-11. These measures are likely to be effective in boosting AD because of the timely, targeted and
temporary manner in which they were executed. In fact, their impact may have already been felt in the economy in the form of
the 0.4% growth in GDP in the March quarter of 2009.
However, the 2009-10 Budget “tries to move in both directions simultaneously” (Gittins, R. 2009), with some typically
contractionary measures as well. For example, Treasurer Wayne Swan plans to cut back middle-class welfare by reducing the cap
on concessional superannuation contributions from $50,000 to $25,000, means-testing private health insurance rebates. Still,
the Government has dropped or deferred major spending cuts over the next four years out of concern that severe measures
would undermine the economic recovery, focusing instead on long-term reforms to the structure of Commonwealth outlays.
Although the budget outcome may be justified given the current economic climate and it is in line with Rudd’s aim to “achieve
budget surpluses, on average, over the medium term”, the potential external ramifications cannot be ignored. That is, the twin
deficit would require a greater surplus on the capital and financial account (see figure 1), eventually leading to a higher deficit
on the income component of the current account. With seven years of forecasted deficits, the Government’s net debt level is
expected to rise to 13.1% of GDP in 2014-15, which will be its highest level since 1998-99. Even if this level is encouraging
compared with forecasts of at least 80% for Britain and the USA, it is also necessary to consider that Australia entered the
recession from a much more favourable economic position than those countries. Nevertheless, all three of the ratings agencies –
Moody’s, Standard and Poor’s and Fitch – said the nation’s AAA credit rating remains safe and thus, was not likely to affect
Australia’s external stability.
Twin deficit diagram
Similarly, ongoing budget deficits may have a negative impact on Australia’s economic recovery due to the crowding out effect.
This effect describes the process in which successive budget deficits soak up funds in Australia’s domestic savings pool, putting
upward pressure on interest rates and leading to a reduction in private sector spending and investment. In the current
recession, however, this effect is unlikely to occur because business investment is already set to fall by 18.5% in 2009-10. In fact,
it will have something of a crowding in effect – whereby the government actively stimulates the economy through its own public
investment. It will only become a problem if economic growth reaches its forecasted level of 4.5% by 2011-12 because it would
pose a constraint on economic growth.
Comparatively, the Minister for Employment and Workplace relations, Ms. Gillard, recently emphasised the importance of fiscal
policy measures in managing unemployment. As the demand for labour is a derived demand, the Government’s efforts to
stimulate the economy “are expected to support up to 210,000 jobs and reduce the unemployment rate by 1.5 percentage
points below the double-digit peak it would otherwise have reached” (Swan, W. 2009). This would in turn indirectly improve
income inequality. However, in May alone, the economy lost a net 1700 jobs, and this figure would have been larger had it not
been for the increasing casualisation of labour, with 24,500 part-time jobs created in the month to offset the 26,200 full-time
positions shed.
Furthermore, in order to reduce the extent of hysteresis taking place in the economy, the 2009-10 Budget outlines a $1.5 billion
(over five years) Jobs and Training Compact. It consists of several labour market programmes designed to provide assistance for
training and development and job search facilities. Hysteresis is the process by which an increase in cyclical unemployment
during a recession leads to an increase in the natural rate of unemployment in the long term. It is exacerbated by the slow speed
at which unemployment falls during an economic recovery – explained by Okun’s law, which states that a growth rate of at least
3.5% is necessary to reduce unemployment.
Moreover, the Budget aims to improve the supply capacity of the economy. This will ensure that firstly, inflation remains low
even as the economy recovers and secondly, that potential export volumes increase, causing the goods and services balance on
the current account to improve in the long-term. While increasing the level of infrastructure will help to reduce capacity
constraints in the economy, the paid parental leave scheme, together with the Government’s plan to increase the qualifying age
for the aged pension to 67 years by 2023, should boost the workforce participation rate. Comparatively, increased spending on
education (an extra $5.7 billion for higher education and innovation over the next 4 years) will improve the quality of Australia’s
labour force and thus render Australia’s exports more internationally competitive.
To produce a more equitable distribution of income, this year’s Budget delivers higher pensions for the aged and disabled,
carers, veterans and war widows. Whilst single people will see their pension increase by $32/week, couples will see their
pension increase by $10. This increase in government spending will have a multiplied effect on the level of national income and
the multiplier will be relatively high, reflecting the pensioners’ high Marginal Propensity to Consume (see figure 2). Yet, tax cuts
to higher-income earners will not only offset these measures, but they will also increase expenditure on imports. Thus, the
goods and services balance on the current account will worsen in the short-term, causing the current account deficit to
deteriorate and external stability to falter.
Keynesian cross diagram
Finally, the 2009-10 Budget promotes ecologically sustainable growth by directing $3.5 billion towards the Clean Energy
Initiative over nine years to focus on carbon capture and storage, and solar and other renewable technologies. However, Greens
leader Bob Brown is not impressed: “it is clear the Rudd Government is more interested in propping up the coal industry than
investing in the clean, renewable energy jobs of tomorrow”.
Monetary policy involves action by the Reserve Bank, on behalf of the Commonwealth Government, to influence the cost and
availability of money and credit in the economy. The objectives of monetary policy, which are laid out formally in the Reserve
Bank Act 1959, include: the stability of the Australian currency, the maintenance of full employment in Australia and the
promotion of economic prosperity and welfare among its people. However, in 1996 the RBA limited itself to containing headline
inflation within a medium-term 2-3% target range (on average, over the economic cycle), with the assumption that low inflation
is a precursor of the other two objectives. By contrast, monetary policy cannot be used to pursue ecologically sustainable
growth and is often criticised for being a ‘blunt instrument’ that widens the gap between low and high-income earners within
the economy.
The primary instrument of monetary policy is the overnight cash rate, which the RBA manipulates through domestic market
operations in the Overnight Money Market (OMM). By buying or selling second-hand Commonwealth Government Securities,
the Reserve Bank can increase or decrease the supply of loanable funds in banks’ Exchange Settlement (ES) accounts (in which
they must hold a certain proportion of their funds to settle payments with other banks and the RBA), thus decreasing or
increasing the cash rate of interest. The market interest rates are predominately affected by the cash rate since approximately
90% of a bank’s funds come from the OMM. The fall in the cost of obtaining funds on the OMM is reflected in the fall in the
overall cost structure of borrowing. Thus, banks can afford to lower interest rates whilst still maintaining profit margins. When
market interest rates decrease, consumers and businesses find it cheaper to borrow money, resulting in a higher level of
consumption and investment spending, and a subsequent boost to economic activity. The process by which changes in the
stance of monetary policy impact upon the economy (as above) is referred to as the transmission mechanism.
The Reserve Bank’s decision to release the minutes of Board deliberations for the public record in December 2007 gave way to a
new level of transparency and accountability for changes it makes to the stance of monetary policy. By influencing people’s
expectations of future inflation and economic performance, this measure has improved the effectiveness of monetary policy.
With the first cut to the official cash rate since December 2001, the stance of Australian monetary policy changed dramatically in
September 2008, from contractionary to expansionary. The RBA cut the cash rate six times between September 2008 and April
2009, causing a dramatic fall in the cash rate from 7.25% to just 3%. This has helped to put downward pressure on household
mortgage interest rates as well as interest rates on business loans such as overdrafts and term loans. The frequency and size of
the rate cuts reflect the RBA’s deep concern over the global financial crisis, and its potential to cause a recession in the
Australian economy, deflation and a large rise in the unemployment rate. However, much of this monetary easing took place
before the emergence of clear evidence that inflation was declining.
Over the year to the September quarter of 2009, the CPI increased by only 1.3%, compared with the 5.0% increase over the year
to September 2008. The significant reduction in fuel prices and the prices of deposits and loans were the main contributors to
this recent decline in headline inflation. However, the decline was limited by the higher prices for imported goods resulting from
the sharp depreciation of the exchange rate in November last year.
In October 2009, the RBA increased the cash rate to 3.25% in response to a combination of domestic and global factors.
Economic conditions in Australia have been stronger than expected, with the underlying inflation rate reaching 3.9% in the
September quarter and unemployment falling to 5.7%. Business confidence is at a 6 year high while consumer confidence is at a
2 year high, and the stock market is showing early signs of a recovery (the September quarter was the best since 1987). Housing
credit growth has been solid and dwelling prices have risen appreciably this year. This is in part due to the numerous fiscal and
monetary initiatives implemented earlier this year. In addition, export revenue is likely to increase as the global economy
resumes growth, with the US economy recording an annualised growth rate of 3.5% in the September quarter (after 18 months
of a recession). Although, the recent rise in the currency to over US90c is likely to constrain output in the tradeables sector and
dampen price pressures.
The further 0.25% increase in the cash rate in November 2009 is in line with the RBA’s plan to gradually return rates to their
normal level of 4.5-5%, with the danger of a serious economic contraction no longer in sight; there is no longer a need to keep
interest rates at an emergency low setting.
The effectiveness of policy implementation may be undermined by three key factors: time lags, political constraints and global
factors. First, the use of policy instruments to manage demand in the short term is subject to three different kinds of lags. The
first is the recognition lag – the delay before the economic managers recognise the need to boost or dampen demand. The
length of this lag is the same for fiscal policy as for monetary policy. Second is the implementation lag – the delay between the
managers realising they need to act and actually being able to act. Whereas monetary policy can be implemented almost
immediately as the RBA Board meets on a monthly basis, the implementation of a fiscal response must go through a complex
process of budget committee meetings and will be scrutinised by several government departments before being approved.
Therefore, there is less risk associated with monetary policy as the stance can be adjusted rapidly – even reversed, if necessary.
Third is the transmission lag – the delay between the measure taking effect and it working its way through the economy to cause
the desired response from demand. The transmission lags associated with fiscal policy can be highly uncertain whereas
monetary policy acts with a variable lag as different sectors of the economy will be affected to different degrees, depending on
their interest rate elasticity.
Secondly, policy implementation is limited by political constraints. When governments make fiscal policy decisions, they must
consider how the public will receive them – particularly when preparing for an election. For example, although the recent tax
cuts to higher-income earners are likely to exacerbate income inequality, they are in line with the Rudd Government’s 2007
election promises. Furthermore, the Government must hand down another tough budget next year if it wants to demonstrate
strong economic management credentials. Yet, this will be unlikely considering it is an election year. Conversely, the
independence of the RBA from the government means that it can implement monetary policy irrespective of public support.
Thirdly, the process of globalisation has caused global factors to place a greater constraint on economic policy. This is
particularly true for Australia, with its high level of foreign liabilities totalling 62.5% of GDP in 2007-08. That is, Australia’s
macroeconomic policies should not undermine international confidence in the Australian economy; otherwise international
investors may withdraw funds and cause a destabilisation. Yet, with its strong banking sector, massive resource base and trading
links with emerging China, Australia remains in a good position to benefit from the next global economic expansion despite its
growing debt level. Conversely, many economists doubt China’s ability to drive global growth without a significant improvement
in the economy of the USA. In addition, global financial flows and overseas interest rates have directly influenced the conduct of
monetary policy in Australia.
Overall, macroeconomic management throughout the past decade has been effective in achieving certain economic objectives.
Prior to the current GFC, economic growth had been sustained for 17 years, the longest period of growth on record. Inflation
averaged just above 2.5% since the early 1990s, and in 2008 the unemployment rate fell to 4%, its lowest level in over thirtythree years, and below the average for industrialised nations.
On the other hand, Australia has not recorded an improvement in either the distribution of income and wealth or in
environmental management. Australia still has a high level of inequality compared with many other advanced economies and it
also has a poor record in preserving biodiversity, protecting natural environments, managing scarce water resources and
overusing agricultural land.
Following this trend, the 2009-10 Budget, coupled with recent easing of monetary policy, has directly addressed unemployment,
inflation and economic growth. According to Swan, “in the absence of our efforts, the contraction would be four times bigger”,
with forecasts of a return to 2.25% economic growth by 2010-11. Even the IMF supports the Government’s large and coordinated stimulatory response to global financial crisis.
However, their “efforts” have indirectly worsened Australia’s external stability whilst making little progress towards achieving an
equitable distribution of income and ecologically sustainable growth. Progress is required in these areas so that Australia can
achieve advancements in human development, not just in economic growth. Even then, the Australian economy may take longer
to recover than is currently forecast given the present international outlook; many consider the Treasury’s forecasts to be rather
optimistic. Despite the 0.4% growth in GDP in the March quarter, “we are not out of the woods yet,” according to Kevin Rudd.
“Growth will continue to be slow for some time, unemployment will continue to rise and we cannot rule out the possibility of
further negative economic growth in Australia.” In which case, the Government will face increasing pressure to borrow, increase
tax rates and further reduce expenditure.
In general, macroeconomic policy works effectively in either stimulating or contracting the economy in the short term, but it is
much less effective in dealing with longer-term problems such as our lack of international competitiveness, high foreign debt,
and low level of national savings. Hence, macroeconomic policies must operate in concert with microeconomic policies.
Outline the arguments for ecologically sustainable development, and discuss the likely impacts of an increase in the rate of
Aus’s eco growth on the environment.
In the past, government policies tended to focus on traditional issues such as output, employment and prices. However, in
recent decades, the environmental consequences of economic development have received a greater prominence. The key
environmental management challenges facing Australia in the early twenty-first century range from reducing greenhouse gas
emissions, which contribute to climate change to ensuring adequate water supplies and preserving the health of forests,
waterways and ecosystems. Whilst prioritising environmental concerns can involve economic costs in the short-term, a healthy
environment is crucial to achieve sustainable economic growth in the longer-term. The challenge for policy makers is thus to
achieve a balance between the short and long-term objectives of economic growth and environmental preservation.
Ecologically sustainable development (ESD) conserves and enhances the community’s resources so that ecological processes and
quality of life are maintained. It is a level of economic activity that is consistent with the long-term preservation of the
environment, rather than merely the maximum level of growth possible in the short term. It involves five key principles:
integrating economic and environmental goals in policies and activities, ensuring that environmental assets are appropriately
valued, ensuring fairness in the shifting of costs and assets within and between generations, managing environmental risks with
caution, and taking into account the global effects of environmental issues. First developed in 1992, Australia’s National Strategy
of Ecologically Sustainable Development (NSESD) facilitates a coordinated and co-operative approach to ESD and advocates
long-term benefits for Australia over short-term gains.
Supporters of ecologically sustainable development insist that it protects Australia’s longer-term economic interests. The natural
environment is especially important to Australia because our natural resources account for a large proportion of our export
revenue – around 60% of exports are commodities such as minerals and agricultural produce. By ensuring that these resources
are not overused or exploited to achieve short-term growth, ESD promotes intergenerational equity and an increase in the
sustainable rate of economic growth.
According to numerous indicators of human development, namely the Genuine Progress Indicator and the Happy Planet Index,
preserving the environment through ESD is also necessary to achieve a higher quality of life. This is partly because excessive air
and water pollution tends to reduce the average life expectancy of a country’s population, and the rapid depletion of natural
resources restricts economic growth in the future and results in intergenerational inequity as above.
In a market economy such as Australia, the forces of demand and supply interact to determine the market price at which goods
and services are sold and the quantity produced. However, this price mechanism ignores the costs and benefits associated with
production (that is, the negative and positive externalities) in two main ways: first, it only takes into account the private costs of
additional production, ignoring the additional social and environmental costs, and secondly, it does not account for future
demand of goods and services that may not be satisfied or how the economy’s ability to grow in the future may be affected
because a resource has been used up or destroyed. The primary reason behind the market’s failure to consider the
environmental impacts of production is that in an economic system based on private property ownership, there are no general
property rights associated with environmental resources, such as oceans or the atmosphere, and so they tend to be overused.
Market failure
Although the price mechanism plays no part in allocating environmental resources that can be used for free, such as the use of
the atmosphere to dispose of gases during the production process, it does play a limited role in protecting the environment by
restricting the sales of depleted resources which do have a price, namely timber and minerals. That is, when these resources
become scarce, their prices increase, reducing the number of resources consumed. Hence, producers and buyers are forced to
look for and develop alternative inputs to production. Yet, the prices often increase too late and by too little. For this reason, the
government is forced to intervene in the market to preserve the environment.
The main assumption of economic theory is that economic growth is the key to the well-being of society, and that governments
should pursue policies that maximise the level of growth. Particularly considering the current economic climate, governments
around the world are growing more desperate to restart growth by any means possible. However, it is important to consider
that economic growth is only one strategy to achieve well-being and, in terms of natural resources, a demonstrably inefficient
one. When economic growth is pursued with little regard to its environmental consequences, it inevitably leads to a rapid
depletion of resources and excessive pollution levels. Strong growth, therefore, increases the material standard of living in the
short-term, although it may detriment the quality of life and restrict potential economic output in the longer-term.
When economic growth leads to the rapid depletion of renewable and non-renewable resources, it is a problem particularly for
future generations. Overuse or exploitation of these resources to achieve short-term growth can deplete these resources and
permanently damage the environment. This will lead to a fall in the productivity of primary sectors and in turn, a fall in future
potential output, represented by a movement in Australia’s production possibility frontier to the left. Future generations will
also be forced to bear the costs of finding alternative resources and repairing the environment.
To determine the level of resource use that is sustainable, economists can estimate the optimal rate for the use of resources
over time. For renewable resources, this involves arriving at a threshold exploitation level that allows the resources to
regenerate so that there is no long term decline in these resources, whereas for non-renewable resources, this involves
Production possibility frontier
determining a rate of decline that is acceptable for the present generation and future generations. This calculation involves two
main challenges: first, it is difficult for present generations to predict the need of future generations, and secondly, it is difficult
to assess the existing stock of a mineral or other resources due to conflicting evidence about the quantity of that resource that
remains available.
In the past, Australia has been poor at addressing the issue of resource depletion. For example, the critical water shortage
experienced in many parts of Aus, in particular in areas relying on the Murray Darling River System, reflects the long-term overuse of the renewable resources of fresh water. Furthermore, Australia has a long-standing record of exploiting its unusually large
concentrations of non-renewable mineral and energy resources, such as coal, zinc, lead, bauxite, to achieve economic growth.
However, the 2009-10 Budget directed $3.5 billion towards the Clean Energy Initiative over nine years to focus on carbon
capture and storage, and solar and other renewable technologies.
During periods of economic growth, output increases and all sectors of the economy thus pollute the environment in some way.
Pollution occurs when harmful chemical substances, noise, untreated rubbish or the like degrade the natural environment.
Although it usually stems from populated areas, the impact is often felt far away from its original source. The problem has
become particularly rampant since the industrial revolution. Within individual countries, there is a range of options available to
the government to counter this problem. For instance, governments can introduce laws banning environmentally damaging
production techniques, such as in 2002 when it became illegal to sell leaded petrol in Australia. Alternatively, governments can
introduce quotas to restrict the emission of harmful pollutants, or subsidies to encourage environmentally-friendly practices,
such as is the case with public transport in Australia. Moreover, governments can levy taxes to discourage some forms of
economic activity. For example, in 2008 the Australian Conservation Foundation argued that aviation fuel tax should be
increased from 3c per litre to 38c. This method is particularly favourable because the taxes not only reduce production and
consumption, but also raise government revenue. In recent years, however, governments have shifted towards solutions, such
as the Carbon Pollution Reduction Scheme, that use market mechanisms to internalise negative externalities.
On the other hand, people and governments are more inclined to implement measures to preserve the environment during a
period of economic boom. For example, industries and agricultural producers would be less likely to oppose controls over
emissions of waste products and reductions in water allocations for irrigation respectively. Nevertheless, governments will
always face problems in trying to implement measures, which protect the natural environment, when they come at a cost to
short-term economic prosperity.
Environmental management remains one of the most controversial areas of economic policy, with fierce opposition between
primary industries and environmentalists. Although their interests may vary in the short term, however, ESD will undoubtedly
benefit both parties in the longer-term. Pursuing government policies that encourage Australia’s economic growth without first
considering their impacts on the environment will lead to a rapid depletion of resources and higher pollution levels, thereby
contributing to a lower quality of life and a lower rate of economic growth in the future. Still, some economic growth ensures
that people can afford to act in an environmentally-responsible manner.
Explain how exchange rates are determined and discuss the impacts on the Australian economy of a sustained appreciation of
the Australian currency?
All trade and financial flows between countries require the exchange of currencies. Therefore, exchange rate movements, or
changes to the price of one currency in terms of another, have a significant impact upon a country’s international
competitiveness, trade flows, investment decisions, inflation and many other areas of the domestic economy. Since Australia
converted to a floating exchange rate system in 1983, the forces of supply and demand currently determine the value of its
currency. Nevertheless, the Reserve Bank can intervene directly by dirtying the float or indirectly through monetary policy.
All those who wish to purchase Australian dollars ($A) represent the demand for them whereas all those who wish to sell $A
represent the supply. While a decrease in the value of the currency, or depreciation, results from a decrease in demand or
increase in supply, an increase in value, or appreciation, results from an increase in demand or decrease in supply.
Three factors affect the demand: First, the size of financial flows into Australia from foreign investors. For example, there is a
high demand for $A when Australia’s interest rates are higher than those overseas, or there are more opportunities for foreigner
investors either to start new businesses in Australia or to buy into existing businesses via the share market than overseas.
Secondly, the expectation of a future appreciation of the Australian dollar will cause speculators to raise the demand. Thirdly,
the demand for Australian exports will reflect the demand for Australia’s currency. For instance, a rise in commodity prices and
an improvement in Australia’s terms of trade are generally associated with an increase in Australian exports in the shortmedium term, resulting in an increase in the value of the Australian dollar. Also, a low inflation rate and internationally
competitive domestic exporters will produce a similar effect, as will an upturn in global economic conditions and global tastes
and preferences that favour Australia’s exports.
Comparatively, three factors affect the supply of $A: First, the level of financial flows. For example, when Australia’s interest
rates are lower than those overseas and there are greater opportunities to invest in overseas companies, there will be an
increase in the supply of $A. Secondly, when speculators expect a decrease in the value of Australia’s currency (and choose to
sell), they tend to contribute to the anticipated depreciation by increasing the supply. Thirdly, the domestic demand for
Australia’s imports affects the supply of $A since an exchange of currencies must take place in order to pay for the imports. For
instance, when the output of the domestic economy is growing, and employment and incomes are rising, the demand for
imports will rise, causing the supply of Australian dollars to increase. Similarly, a high domestic inflation rate and uncompetitive
import-competing firms means imports are cheaper than domestic products, creating higher demand for imports and an
increase in the supply of $A. When tastes and preferences favour imports, the supply of Australian dollars also tends to increase.
Disequilibrium in the balance of payments, that is, when the net outflow of funds on the current account (supply for $A) doesn’t
equal the net inflow of funds on the capital and financial account (demand for $A), is only temporary and automatically
corrected by a movement in the exchange rate. For example, if the value of imports increased, while exports remained
unchanged, it would cause a deterioration of the current account deficit (CAD) and therefore, an increase in the supply of $A
(importers will be selling more $A in order to buy foreign currency) followed by a depreciation of the currency. This depreciation
would enable the positive balance on the capital and financial account to increase (the given level of financial inflows would be
able to purchase more $A) to counteract the bigger deficit on the current account. Likewise, any other increased outflow of
funds on the current account, for example, payment of services, income payments or current transfers, will generally lead to a
depreciation of the Australian dollar and an increase in the surplus on the capital and financial account.
The experience of recent years, however, indicates that the most significant influence on the exchange rate is how financial
markets perceive developments in the balance of payments, rather than the actual balance of payments figures themselves. This
results in greater volatility in forex markets because market sentiment can change quickly. For example, if financial markets are
concerned that an increase in the CAD is not sustainable, they may be less willing to buy Australian assets, and so the value of
the dollar is likely to fall further as capital inflow is reduced. On the other hand, if financial markets believe that the rise in the
CAD is justified by some other factors, as in April 2008, there may be no significant effect on the currency.
When the RBA feels that a large short-term change in the exchange rate will be harmful to the domestic economy, it may decide
to intervene in the forex market, either as a buyer or as a seller, in order to stabilize the Australian dollar. For example, the RBA
can buy Australian dollars in exchange for foreign reserves to curb a rapid depreciation. However, the RBA’s ability to intervene
by buying $A is limited by the size of its foreign currency holdings, that is, the reserves of foreign currencies and gold that can be
used to fund such purchases, for it is not even equivalent to one day’s transactions in the currency. Therefore, the RBA can only
enter the market in the short-term, usually to head off severe speculation.
The RBA rarely deliberately employs monetary policy to affect the exchange rate, although the capacity to influence it is always
there. For example, if the RBA wants to curb a rapid depreciation, it may sell Commonwealth Government Securities on the
Overnight Money Market to increase the demand for Australian dollars and thereby increasing the cash rate. The subsequent
increase in commercial interest rates tends to attract more foreign savings, which must be converted into $A, increases the
demand for $A
An appreciation of the Australian currency can produce numerous positive and negative effects relating to Australia’s CAD, the
capital and financial account, inflation and economic growth.
An appreciation can improve Australia’s balance of payments because it reduces the Australian dollar value of foreign debt that
has been borrowed in foreign currency, which is known as the ‘valuation effect’. The decrease in the interest servicing costs on
Australia’s foreign debt, on the other hand, reduces the outflow on the net income component of the current account in future
years and helps to reduce Australia’s CAD.
Furthermore, an appreciation causes Australian consumers to benefit from increased purchasing power, that is, they can buy
more overseas-produced goods with the same quantity of $A. Less inflationary pressures in Australia resulting from imports
becoming cheaper also tends to discourage the RBA from raising interest rates.
By contrast, an appreciation can also worsen Australia’s CAD. By increasing the value of the Australian dollar in terms of other
countries’ currencies, Australia’s exports become more expensive on world markets and therefore, more difficult to sell,
resulting in a decrease in Australia’s export income. At the same time, imports will be less expensive to purchase, which
encourages import spending and generally leads to a fall in the production of import substitutes. An appreciation also reduces
the Australian dollar value of foreign income earned on Aus’s investments abroad, lowering the net income component of CAD.
Together, these factors will cause a deterioration of Australia’s Current Account Deficit (CAD) in the medium term and a
subsequent slowdown in Australia’s economic growth
In addition, an appreciation tends to reduce the surplus on Australia’s capital and financial account. It causes foreign investors to
find it more expensive to invest in Australia, leading to potentially lower financial inflows. Although, if foreign investors expect
the currency to continue rising, financial inflows may continue. Simultaneously, the value of foreign assets in Australian dollar
terms will be reduced.
Overall, primarily the forces of demand and supply influence exchange rates in Australia, although the RBA may decide to
intervene in some cases, either through monetary policy or by dirtying the float. An appreciation in the value of Australia’s
currency tends to benefit consumers and have diverse effects on the balance of payments.
Outline the factors affecting Aus’s economic growth, and analyse the relationship between economic growth and changes in
Aus’s employment rate.
Economic growth refers to the increase in the volume of goods and services that an economy produces over a given period of
time, measured by the annual rate of change in real Gross Domestic Product (GDP). Following the Great Depression, Keynes
realised that the total level of expenditure in the economy, or aggregate demand (AD), is the main driver of economic growth.
The components of AD include: consumption, investment, government spending, and net export spending (export spending
minus import spending). Since the demand for labour is a derived demand, that is, it is derived from the demand for the goods
and services that labour helps to produce, changes in AD are reflected in Australia’s employment rate.
Consumption represents approximately sixty percent of AD in the Australian economy and is the most stable component of AD.
Although the most important factor influencing the level of consumption is income, economists are more concerned with the
Average Propensity to Consume (APC) and Save (APS). Consumer expectations, the level of interest rates and the distribution of
income greatly affect Australia’s APC. For example, if consumers expect a price rise, a rise in their real incomes or a shortage of
goods in the future, consumption will increase in the short term. Alternatively, an increase in interest rates will cause a decrease
in the APC and therefore, an increase in the APS (since income can only be spent or saved). Furthermore, the more equitable the
distribution of income in an economy, the higher the rate of overall spending because people on lower incomes tend to spend
proportionately more of their income than those on higher incomes. An increase in consumption ultimately causes an increase
in aggregate demand (and vice versa). Currently, low interest rates and consumer confidence have caused a slowdown in
economic growth.
As the most volatile component of AD, the level of investment in the Australian economy is influenced by a number of factors.
The level of interest rates, for instance, affects the price of borrowing funds for the purchase of capital equipment. Therefore, a
fall in interest rates may result in an increase in investment, reflected in a subsequent increase in AD. Similarly, government
policies relating to investment allowances and tax concessions on capital goods may also be used to manipulate the level of
investment in the Australian economy. For example, if the Government allowed businesses to claim a higher rate of depreciation
on their capital equipment, this would reduce their tax liability, causing capital to decrease in price. Alternatively, the price or
productivity of labour affects the relative cost of capital compared to the cost of labour so that when the cost of labour
increases while the cost of capital remains the same, capital is more attractive and investment spending increases. Lastly,
business expectations about future prospects play perhaps the most important role in determining the level of investment in the
Australian economy. That is, if firms expect a future increase in the demand for their products, strong economic growth, a
discovery of new resources or new technology, or low inflation rates, they will be more inclined to purchase new capital
equipment.
Although the level of government spending will to a degree depend on the government in power, it tends to represent
approximately one-fifth to one-quarter of AD. One of the main goals of fiscal policy is to maintain a strong and stable rate of
economic growth. For example, the Australian Government may decide to increase the level of spending and/or reduce the level
of taxation in order to boost AD and therefore, economic growth.
Since Australia’s trade balance on the current account is usually in deficit, net exports usually make a small negative contribution
to aggregate demand (where exports and imports are each equal to between one-fifth and one-quarter of AD). Australia’s net
exports are influenced by domestic and overseas incomes, the exchange rate, levels of international competitiveness and
consumer tastes and preferences. For example, a rise in overseas incomes tends to be mirrored by a rise in Australia’s exports
whereas a rise in domestic incomes tends to be reflected in a rise in Australia’s imports. Moreover, when Australia has a weaker
exchange rate, domestic industries appear more competitive and therefore, their products are in greater demand by foreign
consumers. This leads to a higher level of net exports and consequently, greater AD and faster economic growth.
Keynesian cross diagram
Any change in the level of planned expenditure, due to changes in any of the
components of aggregate demand, will have a multiplied effect on the level of
national income. For example, lower interest rates will increase business investment
and therefore, AD. Consequently, individuals will earn higher incomes, prompting
higher consumption levels and further increases in expenditure (AD) and income lead
the cycle to continue. However, the Marginal Propensity to Save (MPS) causes the
amount of income generated from each time the injection flows through the economy
to decrease as savings represents the only leakage in the assumed three-sector
economy.
In the past, high unemployment rates have been consistent with low levels of
economic growth and vice versa. For example, the main reason behind the 10.7% unemployment rate recorded in 1992, which
was Australia’s highest level since the Great Depression of the 1930s, was the severe global recession. By contrast, between
1991 and 2008, Australia’s unemployment rate fell gradually, with fifteen years of sustained economic growth bringing it down
to below 5%. Furthermore, until 2008, the global resources boom spurred increases in national income and business investment,
causing the demand for labour in Australia to increase. This was particularly the case for the resource-rich states of Queensland
and Western Australia as they experienced 4% unemployment in mid-2006 compared to the 5% experienced by NSW and
Victoria. Currently, poor consumer and business confidence have contributed to slowing economic growth, leading to higher
rates of unemployment (5.2% in Feb 2009).
As employment and unemployment are lagging indicators of economic activity, however, they will typically show a change
following a variation in the overall level of economic growth. For example, the significant rise in Australia’s unemployment rate
(from 4.8% in Jan 2009 to 5.2% in Feb 2009) reflects easing demand levels in the economy earlier in 2008.
Based on this relationship, the Australian Government’s most important strategy to reduce (primarily cyclical) unemployment
has been the use of macroeconomic policy to ensure a sustainable rate of economic growth (within 3-4% of GDP). Even the
Minister for Employment and Workplace Relations, Ms. Gillard, recently emphasised the importance of fiscal policy measures in
managing unemployment. It follows that the Rudd Government has decided to implement expansionary macroeconomic
policies in response to the current economic slowdown. For example, it announced five key $950 one-off payments for low and
middle income households and individuals in December 2008 in addition to spending measures that allocated $15.1 billion to
education and health programs and $4.7 billion to road, rail and education infrastructure.
According to Okun’s Law, however, Australia requires economic growth rates, which exceed growth in labour productivity and in
the size of the labour force (around 3.5% or higher) in order to make progress on reducing unemployment. Although this was a
problem during the 1990s, since the early 2000s productivity growth has been much slower, enabling unemployment to
continue falling despite economic growth averaging around 3%. Although in the long term a higher level of productivity growth
should lead to stronger eco growth and more job creation, in the shorter term more jobs are created during a period of low
productivity growth because employers require more workers if they want to increase production.
Interestingly, the relationship between economic growth and employment works both ways – the continued avoidance of high
rates of unemployment will be important in containing the extent of the economic downturn in the current cycle. This is
because increased levels of unemployment can trigger the economy to enter a “vicious cycle”, whereby higher unemployment
leads to lower consumption levels, which lead to further increases in unemployment.
Overall, Australia’s economic growth is affected by the components of aggregate demand. Since the demand for labour is a
derived demand, it will always reflect changes in economic growth. Similarly, low unemployment levels can perpetuate
downturns in economic growth.
Impact of sustained fiscal deficits on resource use and eco activity in Aus economy
1. Intro:
a. Fiscal policy and fiscal deficit. Describe how fiscal deficit is calculated.
2. Opinion about the impact of a fiscal deficit on the economy tends to polarise between the perspectives of the main two
schools of economic thought, Keynesian and neo-classical economics. The debate is often conducted in the framework
of govts choosing either an expansionary or contractionary fiscal policy (define each stance).
a. Keynesians argue that fiscal deficits have the positive effect of stimulating growth in the economy. They favour
an expansionary fiscal policy during eco downturn, claiming that a net injection of funds into the economy will
raise AD (show eqn) and increase the level of eco activity
b. Neoclassical economists more often argue that the govt should maintain a balanced budget. They focus on the
implications of the govt’s call on savings – crowding out effect
3. Over time, budget deficits can have a significant impact on an economy’s external stability.
a. Esp the case for Aus, which has had sig external probs since 1980s
b. Higher deficit reduces level of public savings, which will reduce national savings and subsequently increase
foreign borrowing.
c. In long term, servicing foreign debt creates deficit on net income component of CA, increasing CAD
d. To counter this problem, Rudd Govt aims to “achieve budget surpluses, on average, over the medium term”
4. Specific impact of a budget deficit will also depend on the method used to finance it
a. Domestic borrowing – explain
i. Disadv: Depending on the conditions of the market, a large release of govt bonds will tend to increase
interest rates and possibly crowd out domestic investment. For this reason, Govts tend to look for
alternative methods.
b. Overseas borrowing – explain
i. Adv: Does not reduce money supply and only has an indirect influence on domestic interest rates
ii. Disadv: it exposes the govt to risks bc an exchange rate depreciation will increase the Aus dollar value
of debt denominated in foreign currencies + it will increase national debt, which in long run adds to
servicing costs and increases CAD
c. Monetary financing – explain
i. Disadv: Although it does not increase debt, the inflationary consequences are considered worse. This
method is therefore not used in Aus bc of the govt’s priority of maintaining inflation
5. The impact of the budget deficit is also influenced by the size of existing govt debt
a. If govt debt is already high, further fiscal deficits are likely to have a more severe –ve impact on investor
confidence, interest rates and the CAD
b. Fiscal surpluses since 2001-02 contributed to a fall in Commonwealth Govt debt from 18.5 per cent in 1995-96
to as low as -3.8 per cent of GDP in 2007-08 – this widens the scope for the govt to have lower
surpluses/higher deficits in the future to respond to adverse eco conditions (as is the case today)
6. The impact of a budget deficit in any one year will be shaped by the particular spending and revenue policies that are
associated with the budget deficit (i.e. reasons for it)
a. E.g. if a deficit was related to increased investment in public infrastructure or education, it may produce
benefits over a long period of time
b. By contrast, if it is the result of tax cuts, the benefits may be short-lived
7. Conclusion: the expansionary 2009-10 Budget represents a return to an overtly Keynesian approach to fiscal policy.
Many economists agree that it is appropriate given the severity of the current global economic slowdown, irrespective
of any potential external ramifications.
Analyse the impact of reduced levels of protection on the global and domestic economies.
1. Intro:
a. Protection
b. Economists believe that economies will achieve the fastest levels of growth in a free trade environment 
recent yrs have seen sig progress towards achieving this goal, despite some remaining barriers
c. Benefits have been widespread…
d. Detriments too…
2. E.g.s of global trade agreements i.e. reduced barriers to trade
a. Effect of GFC
3. Various forms of protection
4. Reasons for protection (if q only refers to global economy)
5. Reduced protection promotes world trade and the integration of different economies throughout the world…based on
principle of comparative adv
6. Reduced protection also contributes to a higher global standard of living.
7. However, since the majority of trade liberalization strategies have been limited to within specific trade blocs, they have
not benefited all countries equally. E.g. EU’s Common Agricultural Policy, which absorbs approximately 44% of its
$A200 billion budget.
8. Nevertheless, some economists argue that these trade blocs act as a valuable stepping-stone towards free trade. E.g.
APEC
9. Furthermore, the breakdown of trade barriers can force low-income economies to disregard the environment in policy
setting in order to achieve international competitiveness…TNCs
10. In addition, reduced protection can prevent a country from defending/sustaining itself in wartime.
11. Similarly, reduced protection can hurt the domestic economy by leading to an increase in dumping and structural
unemployment, and the collapse of infant industries. E.g.
a. In 2005, World Trade Organisation members had a total of 1,279 anti-dumping measures in force, with over
20% of these put into place by the USA and 14% by India.
b. The APEC forum’s ‘Bogor goals’ were predicted to cause a boost in Australia’s national output of 6.8% and
create 500,000 jobs by 2010.
12. Conc:
a. Reduced levels of protection have benefited primarily the developed regions of the global economy.
b. Developing nations, on the other hand, have been excluded from most preferential trade agreements,
restricting their ability to participate on overseas markets in order to achieve economic growth and a higher
sol.
c. It has also come at a cost to the environment and the domestic economy in some cases.
Outline the features of globalisation and analyse the impact of globalisation on the sol and eco development in the global
economy.
1. Intro:
a. Globalisation
b. 5 features of globalisation include…
c. Overall sol experienced by the world economy has increased sig during this period, particularly for those
countries able to compete on international markets.
d. Yet globalisation has come at a cost to environment and global equality.
2. Increased trade flows
3. Increased financial flows
4. Increased investment flows and transfers of technology
5. Increased flows of labour
6. International convergence i.e. international business cycle
7. While some of these features clearly facilitate economic growth and therefore an increase in the sol, others tend to
destabilize or constrain it
a. Overall, globalisation era does not appear to have produced an acceleration of world eco growth…
b. Instead, it has resulted in a divergence of growth trends…
c. Whilst high-income and newly industrialised economies have profited from the participation of TNCs and
closer relationships built on increased trade and investment flows, slower growth can be attributed to
problems with transition (in central Asia), political turmoil (in Africa) and a range of other domestic policy
problems (in continental Europe)
d. The changing direction of world trade has particularly influenced the prosperity of different eco regions.
8. From this eco growth, stem major improvements in eco development.
a. HDI
9. However, growth in global trade has also accelerated resource use and environmental degradation due to increased
production and transport use, a fact recognised in both the GPI and the HPI.
a.
b.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
E.g. China stat
TNCs, growing in line with global trade flows and foreign investment, have been criticised for their exploitation
of environmental protection laws and lower labour standards in developing countries.
c. Low-income economies desperate to attract FDI and earn higher export revenue are esp likely to engage in
environmentally-harmful behaviour
On the other hand, globalisation has also driven govts to face up to their global responsibility to carry out
environmental preservation.
a. Costs of preservation can be shared
b. Increase scrutiny of the environmental practices of TNCs
c. Progress in making agreements to combat global environmental problems (e.g. Kyoto protocol) has been slow
While globalisation creates opps for eco growth and development, many aspects of the global economy, such as the
trade system, financial architecture, aid and tech flows, appear to be entrenching, rather than alleviating, geographical
disparities in income and wealth.
a. Currently the world’s richest 5% have 165 times as much money as the poorest 5% and this sig inequality has
come into sharper focus in recent yrs due the increased interaction bw the more prosperous and less
prosperous regions of the world.
Trade system
a. Since 1970, most of the success in export promotion has been enjoyed by a few OPEC countries and the four
Asian Tiger economies (HK, Singapore, S.Korea, Taiwan).
b. So far this century, it has been the emerging economies led by China and India that have made substantial
gains in export markets
c. However, generally speaking, the majority of developing countries have experienced a continuing decline in
their share of world trade.
Financial architecture
Aid
Technology
But not all inequality can be attributed to globalisation; domestic factors are also partially responsible…Institutional
factors
Economic factors
Nevertheless, some progress in overcoming global inequality can be shown through the rise in life expectancy in
developing countries from 55 to 65 between 1970 and 2004, and during the same period, the decline in infant mortality
from 1.07% to 0.59%.
a. Also, evidence suggests that economic inequality within countries is falling in some and rising in others.
Between 1990 and 2001, inequality fell significantly in East Asia and South Asia, and increased in sub-Saharan
Africa.
Conc:
Analyse the impact of changes in the global economy on Australia’s current account and net foreign debt.
1. Intro:
a. Globalisation
b. The evolution of the global economy and Australia’s consequent exposure to the international business cycle
greatly affect Australia’s current account balance and its net foreign debt level.
c. Yet domestic factors play an equally important role.
2. Current account
a. Non-reversible transactions
b. Categories: net goods, net services, net income, net current transfers
c. Derived by adding these four components together, the balance on the current account can either be in
balance, in surplus or in deficit.
d. Since the 1980s, Australia has managed to sustain a high CAD, although it tends to fluctuate between -3 and 6% of GDP. In March 2009, the CAD fell to -1.5% of GDP, yet Treasury suggests that this is only a temporary
fall, with the CAD forecast to rise to -5.25% of GDP in 2009-10.
3. Net foreign debt, together with net foreign equity, makes up Australia’s net foreign liabilities
a. From 2000-01 to 2007-08 alone, Australia’s net foreign debt rose from 44% to 55% of GDP.
4. Servicing costs consistently make up a large proportion of Australia’s CAD, with the income component of the current
account (where these costs are recorded) averaging around 3% of GDP each year.
a. Lower global interest rates + falls in domestic profits have helped to reduce servicing costs during recent years.
b. Yet the problem is primarily structural: Australia’s ongoing CAD results in a greater need for foreign financial
inflow  must be serviced
c. ‘Debt trap scenario’
d. Question of whether Australia’s CAD drives net foreign debt or the other way around
5. In contrast, the balance on goods and services shows a cyclical trend over time, influenced by changes in the level of
growth in Australian and world economies.
Slower eco growth in Aus + strong growth in world economy  improvement E.g. 2000-01
Strong domestic demand + weaker overseas conditions  negative effect E.g. 2008-09. This is due to
increased import spending (on consumer and capital goods) and falling export spending (despite strong growth
in China, the sig contraction in global economic activity is expected to reduce exports by 4% over 2009-10)
6. Quite apart from these cyclical factors, however, the move towards free trade between nations (through reduced
protection and the establishment of free trade agreements) has spurred growth in the volume of global trade flows.
a. GWP/volume of world trade stat
b. This does not necessarily contribute to Australia’s CAD; favourable ToT and/or a sig greater volume of exports
relative to volume of imports  improvement
c. Although, for the five years to 2007-08 the CAD remained above 5% of GDP, despite record high ToT (121.1 in
Sept 08)…the Treasury is predicting a fall of 13.25% during 2009-10
7. In the long term, Australia’s narrow export base (60% of Australia’s export revenue comes from commodity sales alone)
will contribute to higher volatility in the CAD because Australia is exposed to large fluctuations in commodity prices
from year to year.
a. + High dependence on imports  worsens CAD, esp bc Aus’s comparative adv lies in low value-added products
and therefore tends to import high-value added products
b. Economists argue that Aus should expand its export base to include more services and ETMs in line with
changing global demand pressures
c. For this to occur, Aus industries must become more internationally competitive. Hence the Government’s
efforts to maintain a low inflation rate and boost productivity levels through extensive monetary policy and
changes to work practices respectively.
8. The exchange rate influences both the income and goods and services components of the current account bc it affects:
a. The price (and therefore competitiveness) of our M/X
b. The cost of servicing our net foreign debt (because 60% of it was borrowed in foreign currency terms).
c. The value of our foreign debt i.e. ‘valuation effect’ + value of foreign assets i.e. ‘reverse valuation effect’
d. Since $A was floated in 1983, it is now determined by forces of d&s in forex markets  subject to whims of
foreign investors such that a high ongoing CAD may prompt a lack of confidence in the Australian economy and
in turn, lower demand for our products and a further depreciation in the exchange rate  Aus govt is very
conscious of our overseas image, at the risk of injuring our CAD
9. Australia’s low level of national savings entrenches the CAD.
a. With household debt representing 160% of household income in 2008, Australia has one of the lowest levels of
household savings in the developed world.
b. Large gap bw savings and investment  higher level of foreign liabilities  higher def on income component
bc Aus must rely more on savings of foreigners to fund local investment
c. Govt’s recent attempts to increase the levels of private and public savings through compulsory superannuation
and fiscal consolidation (running balanced and surplus budgets) respectively have clearly not been enough
10. Like the CAD, Australia’s net foreign debt is influenced by global and domestic factors.
a. Exchange rate (as above)
b. Internal trends in investment E.g. growth in foreign debt will slow if investors favour equity-financing over
debt-financing (as they did during the 2003-04 commodity boom)
c. Global financial deregulation  increase in foreign debt
11. There are 2 measure of Australia’s debt sustainability: the net foreign liabilities figure + the debt servicing ratio
a. Aus’s level of net foreign liabilities has continued to grow rapidly in recent yrs to an almost record high of
61.2% of GDP by March 2009.
b. Aus’s debt servicing ratio peaked at just under 20% in the late 1980s and has since fallen due to lower global
interest rates and growth in Australia’s exports, although it was back up to 11.5% in 2007-08.
c. Both these statistics indicate that Australia could experience a debt sustainability problem in the future.
12. Conc:
a. The globalisation phenomenon has rendered Aus’s CA and net foreign debt more vulnerable to shifts in global
investor sentiment and consumer demand.
b. To prevent this from posing a threat to Aus’s long-term economic stability, the Aus govt must implement more
micro reforms aimed at addressing the structural problems behind the CAD, namely the low level of national
savings and the narrow export base.
a.
b.
Economic implications for the Aus economy of Aus’s continuing CAD
1. Intro:
a. Current account
b. Averaging 4.5% of GDP over the past two decades, Aus’s CAD – whereby total payments exceed total receipts
– has remained high over the long term.
c. Recent years have shown that there are many complex factors involved in assessing the economic implications
of such a trend for the Australian economy.
2. CA categories
3. Those who support Professor Pitchford’s argument insist that CADs are generally beneficial to the Australian economy.
4. Another argument pt forward by some economists is that Aus’s CADs have been largely a product of high savings rates
in other economies, rather than structural imbalances
a. Aus’s higher interest rates have traditionally attracted excess funds from countries such as Japan, China, other
East Asian countries, and the world’s major oil exporting countries.
5. Others, however, believe that there are clear risks associated with a continuing CAD.
6. Greater need for foreign financial inflow
7. Higher servicing costs… ‘debt trap scenario’
8. Undermine confidence of overseas investors in Aus economy  increased volatility of exchange rates – process sped
up by recent technological advances and the deregulation of financial markets during the 1980s.
9. Constraint on future eco growth  contractionary govt policy
10. Yet in determining the overall effect of an ongoing CAD, it is important to consider precisely the factors that have
contributed to it.
a. E.g. higher CADs that are caused by increased productive investment in the long run are likely to improve
international competitiveness and boost trade performance.
b. By contrast, those that have resulted from increased consumption are more likely to have negative effects.
c. In Australia’s case, the ongoing CAD has largely reflected structural problems in the economy, including an
over-reliance on commodity exports, a lack of competitiveness in manufacturing and services industries, and
the ongoing costs of a high level of foreign liabilities (such as interest payments on foreign debt).
11. The size of the continuing CAD is another major factor shaping its impact on the economy.
a. Since the 1980s, Australia has managed to sustain a high CAD, although it tends to fluctuate between -3 and 6% of GDP.
b. In March 2009, the CAD fell to -1.5% of GDP, yet Treasury suggests that this is only a temporary fall, with the
CAD forecast to rise to -5.25% of GDP in 2009-10.
c. The IMF’s rule of thumb is that CADs are a problem when they exceed 4% of GDP.
d. Even so, it has had fewer negative consequences for the economy than many economists would have
predicted.
12. To prevent the ongoing CAD from posing a threat to Australian prosperity in the future, the Australian Government
must implement microeconomic reforms aimed at improving the level of domestic savings and broadening our export
base…
13. Given that relatively large CAD outcomes have not prevented Australia from achieving 17 years of strong economic
growth and other positive economic fundamentals, many economists no longer regard it as a threat to Australia’s longterm economic stability.
a. Yet there are some who dispute this assertion, particularly those working for the IMF.
b. Economists more widely agree that microeconomic reforms are needed to address the structural problems
behind the ongoing CAD.
Analyse the impact of globalisation on the economic performance of the Australian Economy
Intro:
 In an era of globalisation, with greater linkages b/w economies than at any other time throughout history, the
performance of individual economies such as Aust have become increasingly dependent on the swings of the worlds
major economies
 Globalisation
 Globalisation has provided Aust with a major source of economic growth, funds for domestic investment, demand for
exports and new investment opportunities in other economies with different comparative advantages
 Yet as an economy with a relatively high degree of global integration it is now also much more vulnerable to both
regional and global collapses on the strength on the increasingly synchronised global business cycle
1. Globalisation of trade
 Globalisation has resulted in dramatic increases in trade flows between nations – contributors: global webbing +
reduced protection
 International trade has historically played a very sig role in the development of the Aust economy, despite its
geographic isolation from the rest of the world
 Annual trade with the rest of the world = almost half of Aust’s economic output  world economic developments can
have a very sig impact on Aust
 Reduced protection in agricultural sector has greatly increased Australia’s trade by allowing Aust firms compete in
international markets – although ag protection remains high
 Increased global trade has also led to changes in the composition of Aust’s export base…
 Our dependence on primary exports (narrow export base) make the large fluctuations in world commodity prices
particularly problematic e.g.
o Current global recession, which has ushered in a sig decline in commodity prices due to falling demand, will
lead to a sig decline in Aust’s ToT from a high of around 120 in 2008 to below 90 in 2009-10  this will reduce
real domestic income and the rate of domestic growth as a given volume of exports will finance a lower
volume of imports
2. Finance
 Globalisation and the growth of international financial flows have had both positive and negative effects on the Aust
economy
 Following the deregulation of the financial industry (began 1983), Aust saw a dramatic increase in its level of net foreign
investment
 Aust’s persistent trade deficit (CAD has averaged -4.6% of GDP over the 2000s and over -5% for the last 5 years) + low
level of national savings  high foreign liabilities, leaving the economy vulnerable to changes in global financial market
sentiment
 While this has greatly assisted our investment and eco activity over last 2 decades, it has also left Aust with enormous
net foreign debt
o 2007-08 debt servicing ratio increased to 12.2% due to tight global credit but by March 09 had fallen to 9.8%
due to reductions in global interest rates
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(i) impact on AUD
Globalisation and the growth of international trade and financial flows have led to an increase in the volatility of the
AUD
It is the process of globalisation (resulting from deregulating financial markets and technology) that enables a huge
volume of speculative flows which largely determine the value of AUD and make its value vulnerable to fluctuations)
Since 2007, volatility in the exchange rate, measured by daily fluctuations, has remained well above its long term
average due to strong fluctuations in commodities prices and general uncertainty in markets
After reaching a post-float high of US97.86 cents in July 2008, the AUD depreciated sharply, declining by almost 30% in
2 month period from late August 2008 to a low of US61.22 cents in October 2008
The most important longer term factor which has lead to this depreciation is the terms of trade  collapse in global
demand stemming from the global recession, and the dramatic slowdown in growth in China, has seen prices fall
sharply (deterioration ToT)
This depreciation has increased the price of imported goods
(ii) Inflation
Aust’s inflation rate has been one of the cornerstone’s of our economic success in recent years
With the exception of the one off following the strong upswing in eco growth in 1995, the GST in 2000 and the supply
constraints in 2007-08, Aust has maintained an inflation rate that has on average remained within the RBs inflation
target of 2-3%  this has largely been due to globalisation
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Inflationary targeting (adopted in Aust in 1996) has become part of the generally accepted global framework for eco
policy in recent decades following its success in numerous countries such as Germany
Additionally, the increased competitive pressures that have come from increased global trade have added to pressures
keeping inflation low for the Aust economy
3. Convergence of policies
 Globalisation has had a significant impact on economic management across the globe
 This can be seen in the synchronised response to the GFC:
o In response to the GFC governments through their central banks have eased monetary policy: in major
advanced economies central banks have lowered policy interest rates significantly, with some policy interest
rates even near zero (official cash rate: US = 0.125%, Aust = 3%)
o Also implemented substantial budget stimulus packages designed to support aggregate demand and
production over and above the operation of automatic fiscal stabilisers of govt spending and taxation
 Aust joined rest of world in adopting expansionary macro policy settings in dealing with the GFC
4. Labour markets
 Despite these benefits, several negative impact on Aust’s economic performance have stemmed from globalisation
 Increasing international trade and movements towards international free trade may have long term benefits for the
economy, but they also have short term costs
 In the 90s the beginnings of structural change in Australian economy led to an increase in structural unemployment in
sectors such as agriculture and manufacturing
 E.g. global push to market forces placed downward pressures on wages resulting in lower incomes for many workers 
increased the inequality of wage distribution in Aust and many other countries
5. Responsiveness of global business cycle
 The global business cycle refers to fluctuations in the level of economic activity in the global economy over time
 The global business cycle experienced a prolonged upswing and subsequent boom with growth rates averaging 3.7%
from 1971-2008 reaching 55 between 2003-2008
 The shock of the GFC pushed the cycle into a downswing and trough with growth expected t fall to 0.5% in 2009 (IMF)
 These movements in the global business cycle are reflected in Aust’s economic growth performance
 Over the 90s and early 2000, Aust sustained the second highest growth rate in the second highest growth rate in the
industrialised world (3.5%)
 This was achieved while still maintaining low inflation and falling unemployment
 The current global down turn that has resulted in recession in many industrialised and developing economies is
expected to reduce Aust’s growth to almost zero in 2009 despite low domestic interest rates and the govt’s fiscal
stimulus packages helping to support domestic demand
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Aust has proved more resilient than other industrialised nations to downturns in the international business cycle
Notably, the Asian led crisis of 1996, US led downturn in 2001 and the current GFC
Despite faltering to 1.8% in early 2000-01, the Aust economy did not follow many of the world’s economies into
recession
Economic growth rebounded to 4.1% in 2001-02 due to favourable economic conditions
The Aust economy has been insulated to a large extent from the current global crisis as a result of monetary and fiscal
policies providing substantial stimulus to domestic demand and confidence; the economy being in better economic and
financial shape than many other economies before the onset of the GFC; the depreciation of AUD increasing
competitiveness and the better than expected export sales particularly to China, however these factors have not
prevented a sig downturn