Eco Dixon 2024
Eco Dixon 2024
AUSTRALIA IN THE
GLOBAL ECONOMY
2024
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Welcome
We live in an extraordinary time in world history. The
era of globalisation has seen a transformation in the size
and power of the world’s major economies. It has also
seen a transformation in the way that people live, work
and communicate all across the world. But the first two
decades of the 21st century showed that globalisation has
not brought about stability. Instead, it has contributed to
rising uncertainty. By the end of the first decade, we had The textbook team (L–R): Tim Dixon, Toby Suckling,
Michelle Mountford, Ben Lorschy, Michael Pahos,
witnessed a global financial crisis and the worst economic Luke Goldman, Gavin Brennan, John O’Mahony.
downturn in 75 years. By the end of the second decade, the Not pictured: Zain Ahmed, Natalie Baker, Joel Bank,
Vanessa Li, Ben Robinson.
architecture for managing the global economy had begun
disintegrating, with the United States – once the anchor of
the global economy – abandoning many of the principles
and institutions that had shaped American leadership of policy, a business sector that responds quickly to changing
the global economy for almost a century. The third decade conditions, and good luck from developments like the
began with two global shocks: the COVID-19 global global resources boom.
pandemic, and then Russia’s invasion of Ukraine, which
The Year 12 Economics Course gives you the opportunity
together drove inflation to 50-year highs. The accelerating
to grapple with many of these issues. It blends theory with
application of artificial intelligence in many sectors also
current developments, a global perspective, a sensitivity
highlighted new systemic shocks to the global economy
to the factors that determine economic performance and
from technological change.
government policies and a focus on the impacts of those
With the acceleration of technology, global supply chains policies. Quite apart from keeping you busy during Year
and cross-border investment, governments have found that 12, it introduces a smorgasbord of issues that you may
their power to implement domestic economic policies is choose to pursue in greater detail in further study or in
becoming limited in the face of powerful global forces. your working life.
It is made more challenging when many multinational
The first topic of this book examines the global economy.
corporations have a larger annual turnover than most
The second examines Australia’s relationship to the global
national economies.
economy and trade performance. After these topics establish
Globalisation is probably the most important force at work where Australia fits into the world economy, the third
at this time in history. It is changing what products are topic reviews the major problems and issues in the
bought, where people travel, what is studied, what careers Australian economy, such as the goals of economic growth,
are chosen, how people entertain themselves and what low unemployment, low inflation, external balance and
people believe in. It has increased living standards around environmental sustainability. The final topic examines
the world, but its downsides have also created a backlash the macroeconomic and microeconomic policies used by
against globalisation that continues to gather momentum. governments to meet these challenges.
Despite the growth of the global economy and spread of This textbook is a collaborative effort of a team of economic
new technology, significant gaps remain both between researchers. Each year, the book is comprehensively revised
rich and poor countries and between the rich and poor and refined to reflect feedback from students and teachers
people within countries, with just under half of the world’s as well as changes in global and domestic economic
population living in poverty. Incomes have stagnated in conditions and developments in the economic policy
many wealthier nations, jobs have become more insecure environment. The 2024 update reflects changes and
and there is heightened anxiety about the future. developments right up to the day of going to press,
including a major international war, high inflation, rising
Since the 1980s, Australia has embraced globalisation,
interest rates and political instability in many countries.
placing a high priority on integrating its economy with
Our thanks to all of the team involved in the production
other economies in its region and throughout the world.
of this textbook both for this year and previous years. We
As a small economy in a world dominated by much larger
hope that this text helps you make sense of the complex
economic powers, Australia cannot escape the impact
topic of Australia and the global economy and that we can
of global economic developments. However, we’ve seen
pass on to you some of our passion for it.
in the past three decades that Australia can prosper in
this new era, owing to a combination of good economic Tim Dixon and John O’Mahony
Table of contents
TOPIC 1 THE GLOBAL ECONOMY
Chapter 1 Introduction to the Global Economy
1.1 The global economy 3
1.2 Globalisation 4
1.3 The international and regional business cycles 16
Case Studies
Economic collapse in Sri Lanka 74
Brazil 76
Indonesia 89
Chapter 8 Unemployment
8.1 Introduction 182
8.2 Measuring the level of unemployment 182
8.3 Recent unemployment trends 185
8.4 The main types of unemployment 186
8.5 The non-accelerating inflation rate of unemployment 189
8.6 The causes of unemployment 190
8.7 The impacts of unemployment 195
8.8 Policies to reduce unemployment 198
Chapter 9 Inflation
9.1 Introduction 203
9.2 Measuring the rate of inflation 203
9.3 Recent trends in inflation 205
9.4 The main causes of inflation 206
9.5 The effects of inflation 209
9.6 Policies to sustain low inflation 211
APPENDICES
Appendix A Key Economic Skills
A.1 Introduction 375
A.2 Drawing and interpreting economics diagrams 377
A.3 Equations and calculations in economics 382
A.4 Interpreting economic data and information 384
Glossary 398
Index 412
How to use this book
Congratulations on choosing Pearson Economics 12: Australia in the
Global Economy as your Year 12 Economics text. Before you use Australia
in the Global Economy, we’d like to highlight some of its key features.
2 Trade in
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Australia
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2024
7.8 Policies
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*
The accompanying workbook Australia in the Global Economy Workbook
Eleventh Edition is a great resource to further help you in your study of
Year 12 Economics.
Included are enhanced answers to the workbook answers, including
2
Trade in the
worked solutions for answers that require calculations and additional Global Econ
om y
explanations for answers that require you to demonstrate a deeper Multiple Cho
You can download the answers to all multiple choice questions and
producers supply (see answer to
units of imports 400 units. However 800 units question 5). At
the higher price
(800 − 400 =
9 400). Each import are demanded. The shortfall of $24 local
A Free trade takes has a $12 tariff. is made up of
So 400 × $12 400
Countries will advantage of = $4800.
specialise in the the compara
tive advanta
resources into area ges different
this area, meaning of their greatest compara economies have.
main advanta the production tive advantage
ge of and allocate more
simple steps:
the governm In this case the
multiplied by ent, the cost the subsidy
the quantity supplied per unit of the is $6 per unit.
15 (400). In this subsidy ($6) To
C AANZFTA – The case $6 × 400 must be
ASEAN-Australia = $2400.
agreement between -New Zealand
Australia, New Free Trade Agreeme
comprise ASEAN. Zealand and nt –
Answer D is a Answer A is
a bilateral trade the 10 South-E is a multilateral trade
defence treaty. agreement. Answer ast Asian nations that
B is an econom
© Pearson Australia ic forum.
| www.pearsonplac
1. Go to www.pearsonplaces.com.au
es.com.au 9780655
702979
*
We really hope that this text makes your study of economics more enjoyable and
rewarding. The book is revised and updated each year to ensure it stays sharp
and up to the minute – and to save you from having to spend time chasing down
information when you should be focusing on understanding the content and
developing your skills as an economist.
THE GLOBAL
TOPIC 1
ECONOMY
Focus
The focus of this study is the
operation of the global economy
and the impact of globalisation
on individual economies.
Skills
Issues Topic 1 skills questions can ask
you to:
Topic 1 economic issues questions
■ Analyse statistics on trade and financial
can ask you to: flows to determine the nature and extent
■ Examine the effects of globalisation on of global interdependence
economic growth and the quality of life,
■ Assess the impact on the global economy
levels of unemployment, rates of inflation
of international organisations and
and external stability
contemporary trading bloc agreements
■ Assess the potential impact on the
■ Evaluate the impact of development
environment of continuing world economic
strategies used in a range of
development
contemporary and hypothetical situations
■ Investigate the global distribution of
income and wealth
■ Assess the consequences of an unequal
distribution of global income and wealth
■ Discuss the effects of protectionist policies
on the global economy
Economics Stage 6 Syllabus 2009 extracts © NSW Education Standards Authority for and on behalf of the Crown in right
of the State of New South Wales, 2009; reproduced by permission. 1
Australia in the Global Economy 2024
Topic 1
Introduction
This section (chapters 1 to 3) covers Year 12 Topic 1 The Global Economy and focuses on the structure
of the global economy and the key features of globalisation. To understand the Australian economy
we need to start with a global perspective. Topic 1 is critical to the rest of the course because it
provides the overall perspective for when we later examine other topics such as Australian economic
issues and policy.
Chapter 1 provides an overview of the global economy. It discusses the main components of the
global economy – international trade, international flows of finance and investment, and
the role of technology and people movements in strengthening links between individual
economies. These links are highlighted with a review of international and regional
business cycles.
Chapter 2 examines the main economic theory that underpins globalisation – the concept of free
trade and the economic benefits that trade brings. Chapter 2 then examines the reasons for
countries restricting trade and protecting their own industries, and how recent years have
seen many international agreements to reduce barriers to trade. This chapter concludes
with a look at the role of international organisations and government economic forums in
managing the global economy.
Chapter 3 examines the divisions within the global economy. Understanding the gaps in the
living standards between rich and poor nations is essential to an analysis of the global
economy. This chapter looks at the distinction between economic growth and economic
development. It discusses the main categories into which different economies are grouped
and examines the global and domestic factors that contribute to inequality. Chapter 3
also discusses the impacts of globalisation on economic development.
Topic 1 concludes with case studies of Brazil and Indonesia. Understanding the impacts of
globalisation on individual economies is an important complement to any analysis of globalisation
at the global level and is a requirement of the Year 12 Economics Course.
Brazil is one of the four largest emerging economies in the world. Like Australia,
Brazil is a major commodity exporter, but unlike Australia it has not opened up its
economy fully to global forces, and it has had significant economic problems in the
past decade. As a case study, Brazil highlights the opportunities and challenges of
increased economic integration.
Indonesia is the largest emerging economy of South-East Asia – a region that experienced
rapid industrialisation and improvements in economic development in recent decades.
The increasing linkages between Indonesia and Australia make understanding the
Indonesian economy especially valuable for future Australian economists.
The case studies may complement another country that you choose to study. You may decide to
compare the impacts of globalisation on these two economies or you may choose to make either Brazil
or Indonesia your case study in 2024.
2
Introduction to the
Global Economy
1.1 The global economy
1
1.2 Globalisation
1.3 The international and regional business cycles
3
Australia in the Global Economy 2024
travel between countries accelerated the spread of the coronavirus, and countries ran short
of medical supplies because of their reliance on global supply chains. Some economists
describe the past decade as “slowbalisation” because of low growth in trade volumes,
increased restrictions on trade, and rising geopolitical tensions.
From an economic point of view, the major indicators of integration between economies
include:
• international trade in goods and services
• international financial flows
• international investment flows and transnational corporations
• technology, transport and communication
• the movement of workers between countries.
There are many dimensions to globalisation and there are many statistics that can be used
as measures of globalisation. For example, some indication of the extent of globalisation
can be gained from examining the proportion of programming on television networks
and streaming services that is made in Australia versus made overseas; or similarly, the
proportion of music downloads that are local versus overseas artists. These would be
classified as social or cultural indicators of globalisation. Each of these indicators provides
an insight into the way in which economies are now linked to each other and re-shaping
the global economy.
“Even in the face of substantial shocks over the last few years, international
flows have shown great resilience. By 2021, global flows of trade, capital, and
information had surpassed their pre-pandemic levels. And while people flows
were stagnant in 2021, they made progress towards recovery in 2022. To be
sure, today’s geopolitical tensions are reshaping some types of flows, and the
war in Ukraine and worsening macroeconomic conditions have caused the
growth of international flows to slow. But international activity shows no sign
of a retreat.
…
As leaders have confronted the possibility of deglobalization, some have begun
to call instead for reglobalization. This does not refer to a mere reversion to
earlier growth trends, or even a return to prior policy approaches. Instead, the
focus is on reforming globalization to make it work better, expanding its pool
of beneficiaries and better managing its challenges.
…
As policymakers continue to confront major global and national challenges,
one of the clear lessons from the Covid-19 pandemic is that international
connections dramatically expand our capacity to solve problems.”
– Steven A. Altman and Caroline R. Bastian
DHL Global Connectedness Index 2022
15 March 2023
1.2 Globalisation
Trade in goods and services
International trade in goods and services is an important indicator of globalisation because
it is a measure of how goods and services produced in an economy are consumed in other
Gross World Product economies around the world. The value of exports of goods and services has grown rapidly
(GWP) refers to the sum of in recent decades, increasing from US$4.3 trillion (19 per cent of global output) in 1990 to
total output of goods and over US$27.9 trillion (29 per cent of global output) in 2022. The size of the Gross World
services by all economies Product (GWP) – the aggregate value of all goods and services produced worldwide each
in the world over a period
of time.
year in the global economy – is now 9 times its nominal level in 1980, but the volume
of world trade has grown to over 12 times its 1980 level.
4
Chapter 1: Introduction to the Global Economy
% increase
Growth of world trade
15 Growth of world real GDP
12
–3
–6
–9
–12
2023*
2024*
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
Source: IMF World Economic Outlook database April 2023 *projections Year
Annual growth in the value of trade has generally been around the same level as world
economic growth since the global financial crisis. During economic downturns, such as
in the early and late 2000s and in 2020, the growth of global trade has contracted faster
than world economic output, highlighting the greater volatility of trade compared
with the GWP. The impact of the COVID-19 pandemic on supply chains, tourism and
international education led to a contraction in global trade of 7.8 per cent, followed by
a strong rebound in 2021.
The high volume of global trade reflects the fact that economies do not produce all the
items they need, or they do not produce them as efficiently as other economies, and
have to import goods and services. Global trade grew strongly for decades because of
new technology in transport and communications, which reduced the cost of moving
goods between economies and providing services to customers in distant markets. Over
the same period, governments have encouraged trade by removing barriers and joining
international and regional trade groups such as the World Trade Organization (WTO), World Trade
European Union (EU), and the Association of South-East Asian Nations (ASEAN). These Organization (WTO) is
developments have been a major force behind increasing global trade. an organisation of 164
member countries that
implements and advances
1995 2022 global trade agreements
and resolves trade
disputes between nations.
Commercial
Commercial
services 19%
Other services 22%
goods
7% Manufacturing Other Manufacturing
61% goods 55%
Fuels and
9%
minerals 5%
Food and
Source: World Development Indicators 2022 agriculture 6%
Notes: Figures are for exports
5
Australia in the Global Economy 2024
The mix of what goods and services are traded, known as the composition of trade, can
have an impact on individual economies. Figure 1.2 shows that global trade is dominated
by manufactured goods, such as vehicles, clothing and electronic goods. Trade in services,
such as finance and communication, is the fastest-growing category of trade and makes
up two-thirds of global output, but it currently makes up less than one-quarter of global
exports. In particular, digital service exports are likely to be strong future drivers of global
trade growth, already tripling in value since 2005 according to the WTO. Countries
such as Australia should continue to benefit from the growth in services trade because
countries with highly educated workforces are best positioned to compete in growing
global markets for services. Nevertheless, the COVID-19 pandemic resulted in a change
in the composition of world trade, at least in the short term, with services sectors such as
tourism and international education severely affected by travel restrictions.
The direction of trade flows has changed in recent decades, reflecting the changing
importance of different economic regions. Between 1995 and 2020, high-income
economies (concentrated in North America and Western Europe) saw their overall share of
global trade fall from 85 per cent of exports to 64 per cent, as shown in figure 1.3. Over
the same period, the fast-growing economies of East Asia and the Pacific region (which
includes China, Indonesia and Vietnam) experienced the most rapid increase in trade, with
their share of global trade surging from 6 per cent to 20 per cent.
1995 2021
South Asia 1% South Asia 2%
Sub-Saharan Africa 1% Sub-Saharan Africa 2%
Middle East and
North Africa 1% Middle East and
North Africa 2%
Latin America and
High income Latin America and High income
the Caribbean 3%
85% the Caribbean 6% 64%
Europe and Central Asia 3%
Europe and
East Asia and Pacific 6% Central Asia 5%
Trends in the direction of trade can also have an impact on individual economies. For
example, recent decades have witnessed strong growth in the Chinese economy, resulting
in stronger trade relationships and inter-linkages in global supply chains. Countries such
as Australia have prepared for stronger economic relations with China by encouraging
students to learn Mandarin at school. At the same time, concerns about Australia being
too reliant on exports to China are a factor in Australia’s growing emphasis on expanding
trade with India and other growing economies in the region.
reviewquestions
1 E
xplain TWO reasons for the increase in trade in goods and services in the
global economy.
2 Describe trends in the composition and direction of trade flows in the
global economy.
3 Discuss the impacts of changes in global trade flows on economies.
6
Chapter 1: Introduction to the Global Economy
Financial flows
International finance now plays a leading role in the global economy. Because finance
is crucial to so many aspects of how modern economies work, the globalisation of finance
has had a major impact in terms of linking economies around the world. Finance is the
most globalised sector of the world economy because money moves between countries
more quickly than goods and services or people.
International financial flows expanded substantially following financial deregulation
around the world, which in most countries occurred in the 1970s and 1980s. Controls
on foreign currency markets, flows of foreign capital, banking interest rates and overseas
investments in share markets were lifted. Technological change also played an important
role. New technologies and global communications networks linked financial markets
throughout the world, allowing events in major international markets such as New York,
Tokyo, London and Hong Kong to produce immediate results.
While there is no single measure of international financial flows, all have shown a dramatic
increase during the globalisation era. Figure 1.4 shows the growth of exchange-traded
derivatives, which are a major instrument in global financial markets. The volume of
financial flows fluctuates in response to global conditions. Sharp falls in financial flows
have been followed by strong recoveries in 2008 (with the global financial crisis), 2013
(with the Eurozone crisis) and 2020 (with the COVID-19 pandemic).
US$ trillion
110
100
90
80
70
60
50
40
30
20
10
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
7
Australia in the Global Economy 2024
Speculators are
The main drivers of global financial flows are speculators and currency traders who
investors who buy or shift billions of dollars in and out of financial markets worldwide to undertake short-term
sell financial assets investments in financial assets. Based on data from the Bank for International Settlements’
with the aim of making (BIS) Triennial Survey of foreign exchange transactions, only a small share is for “real”
profits from short-term economic purposes such as trade and investment. The vast majority is for speculative
price movements. They
purposes – to derive short-term profits from currency and asset price movements – or for
are often criticised for
creating excessive technical purposes, such as hedging against future exchange rate movements and swapping
volatility in financial funds between currencies. International investment banks and hedge funds, often based
markets. in the United States, are generally responsible for most of these transactions. The aim of
these transactions is either to gain from short-term movements in asset prices – namely
currency and share price fluctuations – and to generate profits, or to hedge against future
movements and minimise the risk of losses.
US$73
TRILLION
75
GLOBAL
%
FINANCE
GLOBAL ECONOMY
US$97 TRILLION
GROSS WORLD PRODUCT
US$55
TRILLION
57
GLOBAL
%
TRADE
SOURCES: World Bank, Bank for International Settlements, International Telecommunications Union, United Nations Conference on Trade and Development, International Organization for Migration.
Excludes migrants who have taken citizenship in their new country.
8
Chapter 1: Introduction to the Global Economy
The main benefit of greater global financial flows is that they enable countries to obtain
funds that are used to finance their domestic investment. In particular, investors in countries
with low national savings levels would not otherwise be able to obtain the necessary finance
to undertake large-scale business and investment projects if their economies were closed
off to global financial flows. In this regard, global financial flows may enable a country to
achieve higher levels of investment (and therefore economic growth) than would otherwise
have been possible if finance from overseas were not available.
However, changes in global financial flows can also have significant negative economic
impacts. Speculative behaviour can create significant volatility in foreign exchange markets
and domestic financial markets. This is because speculators are often accused of acting
with a herd mentality, meaning that once an upward or downward trend in asset prices
is established it tends to continue. Speculative activity has been blamed for large currency
falls and financial crises in several countries over the past decade, including Britain in
2016, Türkiye in 2021 and repeatedly in Argentina. As discussed further in chapter 2,
the International Monetary Fund (IMF) is responsible for the overall stability of the International Monetary
global financial system. One of its roles is to stabilise individual economies experiencing Fund (IMF) is an
currency crises or financial turmoil, in order to prevent flow-on effects to other economies. international agency
that consists of 190
reviewquestions
members and oversees
the stability of the global
financial system. The
major functions of the
1 Account for the trends in international financial flows during the globalisation era. IMF are to ensure stability
2 Examine the role of speculators and currency traders in global financial markets. of exchange rates,
exchange rate adjustment
3 Discuss the impact of global financial flows on economies.
and convertibility.
9
Australia in the Global Economy 2024
Asia ($307 billion to China and Hong Kong, $141 billion to Singapore and $49 billion to
India). The increase in FDI inflows to developing countries since 2020 reflected stronger
returns on FDI, relative to the returns on investment in developed countries.
Developing economies have also become a major source of investment funds in the global
economy. In 2021 these economies contributed 31 per cent of global FDI funds, compared
to around 15 per cent in the mid-2000s.
US$ billion
2100
Developed economies
1900
Developing economies
1700
1500
1300
1100
900
700
500
300
100
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Transnational corporations (TNCs) play a vital role in global investment flows and
account for roughly one-half of global trade. Often, they will have production facilities
in countries around the world, sourcing inputs from some countries, doing most of the
manufacturing in another country, and doing other packaging and marketing tasks in
another country. Around 80 per cent of trade occurs in global value chains, according to
UNCTAD analysis.
As TNCs such as Apple, Amazon and Tesla establish or expand production facilities in a
country, they bring foreign investment, new technologies, skills and knowledge. Because
of the capital and job opportunities they bring, governments often encourage TNCs to set
up in their country through supportive policies like subsidies or tax concessions. Since the
early 1990s, the number of TNCs has grown from 37,000 to 104,000, and the number of
affiliates to TNCs has grown from 170,000 to over 1,116,000. Foreign affiliates of TNCs
employ over 83 million people globally.
TNCs in digital industries have experienced particularly rapid growth due to increased
adoption of digital solutions during the pandemic. Total sales for the top 100 digital
TNCs grew 159 per cent over the five years to 2021, four times faster than the top 100
traditional TNCs. As TNCs continue to increase in both volume and significance, there
has been an associated increase in cross-border cartels between large corporations, which
reduces competition in economies and disadvantages local consumers. Global fines for
cartels were $4.6 billion in 2021. However, many cartel arrangements are never uncovered
by regulators, and fines are unlikely to fully capture the true cost of harm caused by cartels.
A significant cause of the growth of international investment is the increased level
of international mergers and takeovers. During recent decades, there has been a spate
of mergers between some of the world’s largest corporations – most recently between
technology companies Salesforce and Slack, pharmaceutical companies AstraZeneca and
Alexion Pharmaceuticals, and media companies Walt Disney Company and 21st Century
10
Chapter 1: Introduction to the Global Economy
Fox. These mergers have seen the formation of companies worth hundreds of billions of
dollars and reduced the number of truly global companies in different product markets.
The peak year for cross-border mergers and acquisitions (M&As) was 2007, when
US$1 trillion of mergers took place, as shown in figure 1.6. International M&As typically
move in line with changes in global economic conditions – investment falls when economic
growth is lower. In 2022, M&As stood at US$706 billion.
In overall terms, most investment in economies around the world still comes from
domestic sources. FDI typically accounts for less than 20 per cent of total investment,
meaning that over 80 per cent of investment still comes from within national economies.
reviewquestions
1 Distinguish between global financial flows and global investment flows.
2 Outline trends in the growth and direction of FDI flows.
3 Explain the role that TNCs play in global investment flows.
11
Australia in the Global Economy 2024
80
60
40
20
0
Australia
Netherlands
United States
Germany
Russian
Federation
Japan
Brazil
Vietnam
China
World
India
Bangladesh
Zambia
Pakistan
13
Australia in the Global Economy 2024
Figure 1.8 – Net migration by region and country (over past five years)
The movement of labour between economies appears to be concentrated at the top and
bottom ends of the labour market. At the top end, highly skilled workers are attracted
to larger, higher-income economies, such as Europe and the United States, because of the
higher pay and better job opportunities available in these countries. The ILO estimates
that two-thirds of international migrant workers have moved to high-income economies.
Smaller advanced economies, such as Australia and New Zealand, suffer from a “brain
drain” of some of their most talented and skilled workers, who are attracted to other
countries by greater rewards. In effect, there is a global market for the most highly skilled
labour.
At the bottom end of the labour market, low-skilled labour is also in demand in
advanced economies where it may be difficult to attract sufficient people born locally to
do certain types of work. Jobs that only require basic skills (and perhaps do not require
advanced language skills) are often filled by migrants. In the United States migrants
are predominantly from Latin America; in European countries migrants are mainly
from Eastern Europe and Africa; in richer Asian countries migrants are mainly from
lower-income economies in the region. Low-skilled labour migrants often remit their
earnings from countries with higher wages back to their families at home. Economies
received remittances from overseas of US$614 billion in 2021, with India, Mexico and
the Phillipines the main destinations.
International division These trends in migration reflect an international division of labour whereby people
of labour is how the move to the jobs where their skills are needed while the globalisation of the labour market
tasks in the production is increasing but there are still significant barriers to working in other countries. These
process are allocated to
barriers include immigration restrictions, language, cultural factors and incompatible
different people in different
countries around the
educational and professional qualifications. Most people would prefer to stay in the country
world. of their birth, where their family and friends live, and where they are most familiar with
the language and culture. Against this preference, domestic instability and geopolitical
turmoil may force people to flee their countries, with the UNHCR estimating that
103 million people were forcibly displaced by mid-2022, the highest figure on record.
The international division of labour is also evident from another aspect of the world
economy – the shift of businesses between economies, rather than the shift of people. Just
as people may move countries in search of the best job opportunities, corporations shift
production between economies in search of the most efficient and cost-effective labour.
In a globalised business environment, many producers operate what is called a global
supply chain (or global value chain), with production facilities in several countries. The
process called “offshoring” allows companies to shift production between countries to
reduce costs. In 2022, research by the IMF found evidence that global supply chains had
14
Chapter 1: Introduction to the Global Economy
Around 169 million people worldwide have migrated systems in developing countries can suffer when
because of work. The proportion of these “economic qualified doctors and nurses move to high-income
migrants” who are highly skilled heavily outnumbers economies where they are in demand.
those who are low-skilled in almost all countries. In On the other hand, economies experiencing
some countries, like Haiti and Jamaica, more than outwards migration can benefit from remittance
80 per cent of the skilled labour force has moved inflows, interconnected business networks and
overseas. Not even high-income countries are increased sharing of technological developments.
immune to the brain-drain problem, with Hong Kong The World Health Organisation (WHO) and the
and Ireland losing between one-third to one-half of EU recently launched a project focused on the
their college graduates. migration of health workers: From Brain Drain
Brain drains have traditionally been perceived to Brain Gain. The program aims to manage
as a negative outcome for an economy in and improve the flow of health workers from
terms of both development and welfare. High developing economies in Sub-Saharan Africa
levels of skilled labour emigration increase and Asia to maintain health standards and ensure
the technological gap between developed and that source countries retain some ability to deal
developing countries as human capital flows with potential medical crises.
towards more advanced economies and the Sources: IZA World of Labor; WHO Health
source country may experience shortages Workforce Alliance and the Health Workforce
of skilled workers. For example, health Department
operated successfully during the COVID-19 pandemic, with less-affected countries able
to supply goods when other countries were harder hit. Nevertheless, in many countries
governments have taken steps since the COVID-19 pandemic to reduce their reliance on
global supply chains and promote “on-shoring” of essential industries. While offshoring
has been occurring for decades, particularly for labour-intensive manufacturing processes,
recent years have also seen services functions such as IT support, data management and
accounting move to more competitive locations to reduce costs.
The international division of labour reflects the economic concept of “comparative
advantage” that is discussed in chapter 2. This theory states that economies should
specialise in the production of the goods or services that they can produce at the lowest
opportunity cost. Developing economies have a large population of workers with only
basic labour skills and education levels, giving them a comparative advantage in labour-
intensive manufacturing. Advanced economies have generally shifted away from labour-
intensive manufacturing to focus on specialised service aspects of the economy that use
more highly skilled workers who are in greater supply in advanced economies.
reviewquestions
1 Explain the role of innovations in technology communications and transport in
driving the process of globalisation.
2 Outline key trends in migration in recent years.
3 Explain how migration and offshoring reflect an international division of labour
between different economies.
15
Australia in the Global Economy 2024
16
Chapter 1: Introduction to the Global Economy
The world economy rebounded strongly from the pandemic in 2021 with 6.2 per cent
growth in output, before growth rates stabilised at around pre-pandemic levels from 2022.
Emerging and developing economies outperformed the advanced economies, with 6.9 per
cent and 5.4 per cent growth in GDP, respectively.
As a small open economy, the Australian economy is particularly affected by economic
growth rates overseas. Research by the Reserve Bank of Australia (RBA) has found that
63 per cent of changes in the level of output in Australia can be explained by the changes
in interest rates, growth levels and inflation rates in the Group of Seven (G7) largest
industrialised countries. This means that for Australia, domestic factors have half as much
influence as international factors on economic growth in any given year.
The transmission of economic conditions from one country to another is made more
immediate by the increased integration of economies during the globalisation era:
• Trade flows: If there is a boom or recession in one country, this will affect its
demand for goods and services from other nations. The level of growth in an economy
will have significant flow-on effects on the economic activity of its trading partners.
• Investment flows: Economic conditions in one country will affect whether
businesses in that country will invest in new operations in other countries, affecting
their economic growth. For example, Brazil’s weak economic performance in the
past decade has meant that it has invested less in other economies. On four occasions
since 2015, its annual FDI outflows have been negative.
• Transnational corporations: TNCs are an increasingly important means by which
global upturns and downturns are spread throughout the global economy. For
example, following reductions in the headcounts of major US technology companies
Microsoft, Amazon, Google and Meta, in 2023 Australian technology company
Atlassian also reduced its total staff by around 5 per cent.
• Financial flows: Short-term financial flows also play an important role in
transmitting the international business cycle. A 2019 Reserve Bank Bulletin
identified that Australia has benefited from being open to global capital markets,
but that the financial integration of advanced economies exposes the Australian
economy to shifts in their financial conditions.
• Financial market and confidence: Consumer confidence and the “animal spirits”
of investors are constantly influenced by conditions in other countries. This is
highlighted by the strong correlation between movements in share prices of the
world’s major stock exchanges – that is, they tend to go up and down at the
same time. Events that threaten global stability – such as an increased risk of war,
sovereign debt default or the collapse of a major business – can spark an immediate
downturn in share values. This effect was seen in 2023 when the collapse of Silicon
Valley Bank in the US and Credit Suisse in Switzerland sparked fears of another
banking sector crisis, and prompted debate about regulation adequacy.
• Global interest-rate levels: Monetary policy conditions in individual economies
are strongly influenced by interest-rate changes in other countries. If higher
economic growth makes it necessary for the central bank to increase interest rates
in the United States, this places pressure on central banks in other economies to
follow suit. Inflationary pressures across the world in 2022 saw central banks raising
interest rates. The Reserve Bank of Australia followed suit, with interest rate rises
in 2022 and 2023.
• Commodity prices: The prices of key commodities such as energy, minerals and
agricultural products are set by global markets. Their prices, in turn, influence
the levels of inflation, investment, employment, growth and other features of
the international business cycle. Historically, changes in oil prices have had major
impacts on international growth (with lower prices boosting growth overall). In
2022, global sanctions against Russia, the world’s second largest supplier of oil,
17
Australia in the Global Economy 2024
resulted in the largest global energy price increases in half a century, following
contractions to worldwide supply. As a result, the World Bank reduced its growth
forecast for 2022 by one percentage point.
• International organisations: International forums such as the Group of Twenty
(G20) or Group of Seven (G7) economies can play an important role in influencing
global economic activity. Discussions of global economic conditions at summit
meetings mean that the G20 or G7 can act as the unofficial forum for coordinating
global macroeconomic policy, especially during periods of economic uncertainty.
These meetings can also resolve tensions between countries that threaten the
economic outlook.
FACTORS THAT
Nevertheless, it is important to note that despite these linkages between economies, the
pattern and the pace of economic growth differ between countries. Even countries that
STRENGTHEN THE
are at similar stages of economic development, such as the United States and European
INTERNATIONAL
economies, experience differing levels of economic growth. Despite the global linkages
BUSINESS CYCLE
described above, many of the factors that influence the business cycle reflect distinctive
• Trade flows national conditions:
• Investment flows and
• Interest rates have a significant impact on the level of economic activity, and
investor sentiment
interest rates differ between countries (or regions, in the case of European countries
• Transnational
that share a common interest-rate policy). Higher interest rates will dampen
corporations
• Financial flows
economic activity while lower interest rates will stimulate economic activity.
• Technology • A government’s economic policy decisions can influence their economic growth
• Global interest rates rate. For example, the UK’s decision to leave the EU in 2016 reduced the rate of
• Commodity prices economic growth as investor confidence in Britain’s economy fell. Fiscal policies
• International also have a significant effect upon the level of economic growth in the short to
organisations medium term. If a government in one country raises taxes while the government
in another country cuts its taxes, economic growth is likely to move in opposite
FACTORS THAT directions in those two countries.
WEAKEN THE
• Exchange rates differ between countries and impact on the level of trade
INTERNATIONAL
competitiveness and confidence within economies. In turn, these factors will
BUSINESS CYCLE
influence the level of economic growth. The BIS has noted that exchange rates are
• Domestic interest having an increased impact on domestic economies, particularly in the past decade
rates as government policy has less ability to target economic shocks.
• Government fiscal
• Structural factors differ between economies. For example, countries have different
policies
• Other domestic
levels of resilience in their financial systems; different levels of innovation and
economic policies takeup of new technologies; different attitudes towards consumption and savings;
• Exchange rates different population growth rates and age distribution; different methods of
• Structural factors regulating labour markets, educating and training employees and regulating
• Regional factors businesses. These structural factors influence the competitiveness of economies and
their level of growth.
• Regional factors between economies differ. Some economies are closely integrated
with their neighbours and are therefore very influenced by the economic
performance of their major trading partners. Research by Colombian academics
found that regional business cycles in emerging markets experience different
levels of synchronisation depending on factors such as the productive structure
and trade integration of the country. For example, whilst Mexico has a high level
of synchronisation with North America, economic conditions from nearby Latin
American countries have a lower impact on Mexico’s activity due to less trade
integration.
In summary, there is an international business cycle and when there is a substantial economic
downturn, such as in the mid-1970s, the early 1990s, the late 2000s and early 2020s,
this downturn is shared across almost all countries. However, the factors influencing individual
economies differ and the level of world economic growth is one of several factors that
influence economic conditions.
18
Chapter 1: Introduction to the Global Economy
reviewquestions
1 Define the terms international business cycle and regional business cycle.
2 U
sing the example of a specific economy, discuss the extent to which this
economy’s performance has reflected economic growth trends globally and
in its region.
3 O
utline the factors that strengthen and weaken the relationship between the
economic cycles of individual economies.
19
Australia in the Global Economy 2024
chapter summary
1 lobalisation refers to the integration between different countries and
G
economies, leading to the increased impact of international influences on all
aspects of life and economic activity.
2 The global economy is a way of describing the activities of all the economies
of the world as a whole, reflecting the fact that they are now increasingly linked
together into one larger economic system.
3 The gross world product is the sum of the total output of goods and services
produced by all economies in the world over a given period of time.
5 The pattern and direction of world trade has changed to reflect the increasing
importance of advanced technology and services and the growth of the Asia
Pacific region.
6 The process of globalisation has occurred most rapidly in global finance which
faces few barriers and is driven mostly by speculative activity (that is, investors
seeking to make short-term profits out of fluctuations in exchange rates, interest
rates and other financial indicators).
20
Chapter 1: Introduction to the Global Economy
chapter review
1
Explain what is meant by globalisation, using recent trends to illustrate your answer.
2
“Just as the COVID-19 pandemic spread fast because of the contagious nature of
the coronavirus, the COVID-19 recession spread fast because of the connected
nature of the global economy.” Discuss what this statement is saying about the
global economy in the 2020s.
5 Explain how technology drives growth in the trade of goods and services.
10 xplain how changes in the level of economic growth in one economy can impact
E
on economic growth in other economies.
21
2 Trade in the
Global Economy
2.1 Advantages and disadvantages of free trade
2.2 Reasons for protection
2.3 Methods of protection
2.4 Trade agreements
2.5 International organisations
2.6 Government economic forums
Trade has played a critical role in the expansion of the global economy. The periods of
the fastest growth in the global economy have also been periods of rapid growth in trade.
In the 21st century the world’s fastest-growing economies are typically economies with
rising levels of trade. Trade has brought countries together, created wealth and re-shaped
the structure of many economies.
This chapter examines the economic theory behind trade relationships, government
policies that have restricted and facilitated trade, and the role played by international
institutions in trade flows, financial flows and foreign investment.
22
Chapter 2: Trade in the Global Economy
• An increase in unemployment may occur as some domestic businesses may find it hard
to compete with imports. The short-term rise in unemployment should correct itself in
the long term as the domestic economy redirects resources to areas of production in
which it has a comparative advantage. Nevertheless, some specific industries, workers
and regions may lose out in the longer term as a result of free trade.
• It may be more difficult for less advanced economies to establish new industries if
they are not protected from larger foreign competitors.
• Production surpluses from some countries may be dumped (that is, sold at unrealistically
low prices) on the domestic market, which may hurt efficient domestic industries.
• Free trade may encourage environmentally irresponsible production methods
because producers in some nations may win markets by undercutting competitors’
prices – only because they also undercut environmental standards. For example, they
may use production methods which add to pollution in the air and in river systems.
• National security may be undermined if an economy is dependent on trade in a time
of emergency, such as war or pandemic. If supply chains are disrupted, it may not be
possible to source essential items such as defence equipment and vaccines.
reviewquestions Appendix B:
For more information on
1 Explain the principle of comparative advantage. the economic theory of
comparative advantage
2 Describe how the idea of comparative advantage supports the arguments in
and gains from trade,
favour of free trade. go to section B.1 in the
3 Define free trade. Advanced Economic
Analysis appendix at the
4 Examine the costs and benefits of free trade.
back of the textbook.
23
Australia in the Global Economy 2024
Infant industries
New industries generally face many difficulties and risks in their early years. They usually
start out on a small scale with costs that are relatively higher than those of established
competitors in other countries. These “infant industries” may need to be shielded from
competitors in the short run to enable them to build capacity, establish markets and
achieve economies of scale so that they can compete in the global economy. This approach
to the development of new industries has been used by many emerging economies in
recent decades.
The key test for economic credibility of the infant industry argument is whether industry
protection is removed over time. If protectionist policies are not removed, there will be no
real incentive for the industry to reach a level of efficiency that would enable it to compete
without protection. This means that governments should provide temporary assistance
only to industries that have a good chance of achieving some comparative advantage in
the long run so they can compete in the global economy.
Historically, many industries that have received assistance as infant industries have
continued to rely on this assistance for many years (for example, national airlines in
the global aviation industry). The infant industry argument has been used to support
many industries that would never have survived otherwise. For this reason, economists
are generally reluctant to accept businesses seeking protection based on the infant
industry argument. Today, when governments provide help to new industries (such as
manufacturing batteries for electric vehicles), this tends to involve direct assistance and
lasts for a limited period of time.
Prevention of dumping
Dumping occurs when foreign firms attempt to sell their goods in another country’s
Dumping is the practice
of exporting goods to a
market at unrealistically low prices (that is, below the price charged in the home country’s
country at a price lower market). The practice of dumping may be used to dispose of large production surpluses
than their selling price in or to establish a market position in another country. These low prices are usually only of
their country of origin. a temporary nature but can harm domestic producers. Local firms that could normally
compete with such foreign producers may be forced out of business, causing a loss in a
country’s productive capacity and higher unemployment.
The only gain from dumping is that it results in lower prices for consumers in the short
term, but this does not last as foreign producers will put up their prices once the local
competition is eliminated. Under such circumstances it is generally in the economy’s
best interest to impose restrictions on such imports. Using protectionist methods to
prevent dumping is the only reason for protection that is widely accepted by economists.
However, in recent years the World Trade Organization has questioned whether countries
might be unfairly accusing efficient low-cost foreign producers of dumping and abusing
“anti-dumping” processes in order to protect their domestic industries.
24
Chapter 2: Trade in the Global Economy
More than 6500 anti-dumping complaints have been lodged by WTO members since the Top five economies
WTO was formed in 1995, with India and the United States responsible for the highest initiating anti-dumping
number. By 2023, there were around 4500 anti-dumping measures (such as duties) legally measures
in force. The sectors where anti-dumping measures are most common are base metals, India 1130
chemicals, plastics, resin and rubber. Australia has lodged a relatively high number of United States 860
complaints – sixth in the world (with over 375 complaints initiated). Figure 2.1 identifies
the countries that have initiated the largest number of anti-dumping actions and the European Union 547
countries which have had the most dumping claims made against them. Brazil 438
Argentina 418
Protection of domestic employment Top five exporting
economies affected
One of the most popular arguments in favour of protection is that it saves local jobs. If local
producers are protected from competition with cheaper foreign imports, the demand for China 1565
local goods will be greater and this will create more domestic employment. This argument South Korea 487
tends to gain strongest public support during times of recession when unemployment is Taiwan 335
rising, even though technology and automation often play a more significant role in job
losses than trade. United States 318
India 270
However, there is little support among economists for this argument. Protection will
tend to distort the allocation of resources in an economy away from areas of more efficient Source: WTO Dec. 2022
production towards areas of less efficient production. In the long run this is likely to Figure 2.1 – Anti-dumping
lead to higher levels of unemployment and lower growth rates. On the other hand, by actions in force under WTO
system
phasing out protection it is hoped that better and more lasting jobs will be created in
other sectors within the economy that are internationally competitive. Furthermore, if a
country protects its industries it is possible that other countries will retaliate and adopt
similar protectionist policies. The net result could be that the economy might have higher
employment in less efficient protected industries but lower employment in more efficient
export industries.
25
Australia in the Global Economy 2024
The past decade has brought an end to a long period of giving greater priority to security interests over comparative
expanding free trade stretching all the way back to the advantage. Beyond protectionist policies, the trend
post-Second World War era. Many countries have been towards “deglobalisation” may also be reflected in greater
experiencing a backlash against globalisation for decades, restrictions on migration and foreign direct investment, and
but the new era of “deglobalisation” and rising protectionism a weaker commitment to international cooperation.
has come about in response to the vulnerabilities in supply
chains that were exposed during the COVID-19 pandemic At the heart of the trend towards deglobalisation is the
and the war in Ukraine. An IMF report in 2023 suggested “decoupling” between the economies of the United States
that this trend towards deglobalisation and increasing and China. In 2023, President Biden introduced export
fragmentation in world trade could ultimately cost the restrictions to limit China’s access to semiconductor
global economy 7 per cent of its output. chips and technology, while also announcing US$11
billion in grants and subsidies to support the transition
While the basic principles of free trade are still widely
embraced and global tariff levels remain low, governments to green technologies and industries across rural areas.
have become more concerned about the way in which open These measures were introduced to strengthen national
trade makes them more dependent on other economies, security and reduce risks arising from the interdependent
and more vulnerable to overseas developments. relationship between the US and Chinese economies. The
Governments are focusing on improving the resilience of Boston Consulting Group has estimated that with these
their supply chains by increasing inventories, expanding measures in place, trade between the US and China will
local production capacity through increased subsidies, and decrease by US$63 billion in the years to 2031.
reviewquestions
1 Outline the major reasons why nations may argue in favour of introducing
protectionist policies.
2 Identify which argument in favour of protection is most accepted by
economists and explain why.
26
Chapter 2: Trade in the Global Economy
Tariffs
A tariff is a government-imposed tax on
D S Tariffs are taxes on
imports. It has the effect of raising the price Price
imported goods imposed
of the imported goods, making the domestic for the purpose of
producer more competitive. The effects of a protecting Australian
tariff are shown in figure 2.2. industries.
P1 A B
Figure 2.2 reveals the following:
• The curves SS and DD represent P
D C
domestic supply and demand.
S D
• 0P is the price of imported goods if 0 Q Q2 Q3 Q1 Quantity
there was no tariff applied (that is, in Imports after tariff
a situation of free trade). At this price Imports before tariff
consumers demand 0Q1, domestic
producers supply 0Q and the quantity Figure 2.2 – The effect of a tariff
imported would be QQ1.
• If a tariff of PP1 is imposed, all of which is passed on to the consumer, demand will
contract to 0Q3, domestic supply will expand to 0Q2 and imports will fall to Q2Q3.
• Following the imposition of the tariff, the government will raise revenue of ABCD.
• Domestic producers supply a greater quantity of the good. Therefore, the tariff
stimulates domestic production and employment.
• More domestic resources are attracted to the protected industry. This leads to a
reallocation of resources towards less efficient producers (that is, those who are
unable to compete on an equal footing with foreign producers), causing world GDP to
decline. A 2019 IMF study estimated that if tariff rates of 15 per cent were imposed on
$300 billion of Chinese goods and China imposed similar measures on imports, it would
cause world GDP to decrease 0.8 per cent, equivalent to $700 billion.
• C
onsumers pay a higher price and receive fewer goods. This redistributes income
away from consumers to domestic producers. Economic modelling published by the
Productivity Commission suggested that for every $1.00 increase in Australian tariff
revenue, economic activity in Australia would fall by $0.64. GDP would be lower by
over 1 per cent each year, equating to a loss of around 100,000 jobs, and the average
household would face a drop in income by around $1500 per year.
• The tariff raises revenue for the government but that is not the primary objective. In
fact, the more successful the tariff as a protectionist policy (that is, the more imports it
restricts), the less revenue it will raise. In 2023–24, the Australian Government expected
to collect $1.5 billion in tariff revenue, which is roughly 0.3 per cent of its total revenue.
• A tariff can provoke a retaliation effect, where a trading partner imposes some
kind of trade barrier against a country imposing a tariff on its exports. For example,
after Australia imposed a 144 per cent tariff on Chinese steel imports in 2014 (as an
anti-dumping measure), China imposed tariffs on several Australian exports, including
barley in 2018 (at a rate of 74 per cent) and wine in 2020 (at a rate of more than
200 per cent).
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Australia in the Global Economy 2024
Quotas
An import quota controls the volume of a good that is allowed to be imported over a given
Quotas refer to
restrictions on the
period of time, normally for the purpose of protecting domestic production. It may also be
amounts or values of used to reduce the quantity of undesired goods entering a country. For example, in 2018
various kinds of goods Australia implemented a quota system for the importation of hydrofluorocarbons (HFCs),
that may be imported. commonly used in refrigeration, in response to environmental concerns. Quotas guarantee
domestic producers a share of the market. The effects of a quota are shown in figure 2.3.
Figure 2.3 reveals the following:
• The curves SS and DD represent Price D S
domestic supply and demand.
• 0P is the price at which the imported
goods would sell if there was no
quota imposed. At this price, P1
consumers demand 0Q1, domestic
P
producers supply 0Q and the
quantity imported would be QQ1. S D
• If the government imposed a quota 0 Q Q2 Q3 Q1 Quantity
restricting imports to Q2Q3, this Imports after quota
would have the effect of raising the Imports before quota
price of imported goods to 0P1. This
price would allow domestic supply Figure 2.3 – The effect of an import quota
to expand to 0Q2.
Countries sometimes use a system of tariff quotas. Under this system, goods imported up
to the quota pay the standard tariff rate, whereas goods imported above the quota pay a
higher rate. In the past many of Australia’s most highly protected industries (for example,
textiles, clothing, footwear and motor vehicles) were shielded from foreign competition
in this way.
• Domestic producers supply a greater quantity of the good. Therefore, the quota
stimulates domestic production and employment in the protected industry.
• More resources in that economy are attracted to the protected industry, leading to
reallocation of resources from other sectors of the economy (where production and
employment will fall). For example, the European Union (EU) imposes an import quota
allowing no more than 7150 tonnes of high-quality beef imports. This provides certainty
for producers in European countries because they can supply any demand in excess
of the 7150 tonnes of imports, even if their costs are higher than those of overseas
producers.
• Consumers pay a higher price and receive fewer goods. This redistributes income
away from consumers to domestic producers in the protected industry and results in
lower overall levels of economic growth.
• Unlike tariffs, quotas do not directly generate revenue for the government. However,
governments can sometimes raise a small amount of revenue from quotas by
administering the quota through selling import licences allowing firms to import a limited
number of goods.
• As with tariffs, the imposition of a quota on imports can invite retaliation from the
country whose exports may be reduced because of the quota. This can result in lower
exports for the country that initiated the import quota.
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Chapter 2: Trade in the Global Economy
Subsidies Price
D S
Subsidies involve financial assistance to S1
Subsidies are cash
domestic producers, which enables them to payments from the
reduce their selling price and compete more government to businesses
easily with overseas producers. In figure P to encourage production
2.4 this is shown by a rightward shift of of a good or service and
P1 influence the allocation of
the domestic industry’s supply curve from resources in an economy.
SS to S1S1, which results in a lower market Subsidies are often
price. Businesses will be able to sell a higher S granted to businesses
D
quantity of their product on both domestic S1 to help them compete
and global markets. The quantity produced Q Q1 with goods and services
Quantity produced overseas.
increases from Q to Q1. The size of the
subsidy in per unit terms is the vertical Figure 2.4 – The effect of a subsidy
distance between S and S1.
• Domestic producers supply a greater quantity of the good. Therefore, the subsidy
stimulates domestic production and employment in the protected industry.
• More resources in that economy are attracted to the protected industry, leading to
reallocation of resources from other sectors of the economy (where production and
employment will fall).
• Consumers pay a lower price and receive more goods because the subsidy shifts
the supply curve for the sector to the right. However, consumers still pay indirectly for
subsidies through higher taxes.
• Subsidies impose direct costs on government budgets because they involve
payments from the government to the producers of goods and services. This means
that governments have fewer resources to allocate to other priorities such as education
and health care. For example, in the 2023–24 Budget, the Government increased the
Fuel Tax Credits Scheme (Australia’s biggest fossil fuel subsidy) by $2.1 billion to
$9.6 billion, which is expected to cost $41.1 billion over the next four years.
• While economists are opposed to protectionist policies, they often prefer a subsidy to
a tariff because subsidies tend to be abolished more quickly – since they impose costs
on the budget rather than generating revenue.
Export incentives
Export incentive programs give domestic producers assistance such as grants, loans or
technical advice (such as marketing or legal information) and encourage businesses to
penetrate global markets or expand their market share. The popularity of such programs
has grown considerably in recent years as nations have moved to a greater focus on capturing
foreign markets rather than protecting import-competing businesses as a strategy to
achieve higher rates of economic growth and employment. For instance, Australia has
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Australia in the Global Economy 2024
a program known as the Export Market Development Grant (EMDG) that has assisted
over 51,000 businesses in promoting and marketing their exports. Technically, export
incentives do not protect businesses from foreign competition in the domestic market, but
they are nevertheless regarded as a barrier to free trade. World Trade Organization rules
restrict the use of export incentives but countries can still provide some forms of export
assistance to local producers.
In addition to the effects that protectionist policies have which can worsen the balance of trade. It also concluded
on domestic economies outlined previously, they can also that an average tariff increase (of 3.6 per cent) contributed
have overall impacts on the global economy. to an average 0.4 per cent reduction in GDP over five
years, with a larger fall of 1 per cent in GDP in advanced
Protectionist policies reduce the overall level of trade economies.
between nations. For an individual economy, protectionism
Protectionist policies make it more difficult for individual
means that exports and imports will be a smaller share of
economies to specialise in production in which they
the national economy. A Boston Consulting Group report
are most efficient. Businesses are less able to achieve
for the B20 group of business leaders, which provides input economies of scale and therefore have lower profits
to the G20, estimated that the cost of major economies and lower dividends. With fewer competitive pressures,
imposing protectionist policies following the COVID-19 prices for goods and services in individual economies are
pandemic could reduce global economic output by as much higher. This leads to slower economic growth in individual
as $10 trillion by 2025 on the level it would otherwise reach. countries.
Overall, protectionist policies reduce living standards The negative economic impact of the protectionist policies
and reduce global economic growth by shielding of trading blocs tends to be larger (relative to the size of
inefficient producers. A major study released in 2019 by those economies) for developing economies that are
often excluded from access to the markets of advanced
the International Monetary Fund, The Macroeconomic
economies. In making its case against protectionism,
Consequences of Tariffs, concluded that over the medium
the World Bank has highlighted that increased trade
term, countries that raise tariffs experience lower output,
helps reduce global poverty. Between 1990 and 2017,
weaker productivity, increased unemployment and developing economies increased their share of global
increased inequality. The study examined the tariff policies exports from 16 per cent to 30 per cent, while the number
of 151 countries over 50 years and noted that tariff of people in extreme poverty globally fell from 36 per cent
increases tend to lead to an exchange rate appreciation, to 9 per cent.
reviewquestions
1 Describe how subsidies affect the price and quantity of goods sold in a
market.
2 Discuss the impact of tariffs, quotas and subsidies on firms, individuals and
the government in the domestic economy.
3 Discuss the impact of increased protectionism on the global economy.
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Chapter 2: Trade in the Global Economy
preferential trade agreements because, in effect, they give more favourable access to
goods and services from one nation or a group of nations compared to another. Sometimes
they can even make it harder for nations outside the preferential trade agreement, especially
developing economies, to trade. In this respect they may not create better conditions
for free trade at all, particularly for developing economies that struggle to access global
markets. Australia’s bilateral and multilateral trade agreements are discussed further
in chapter 6. In contrast, global free trade agreements conducted through the World
Trade Organization (WTO) are designed to remove barriers to trade uniformly across
all economies.
A trade bloc occurs when a number of countries join together in a formal preferential A trade bloc occurs
trading arrangement, to the exclusion of other countries, such as the European Union (EU) when a number of
countries join together
and the United States-Mexico-Canada Agreement (USMCA).
in a formal preferential
trading agreement, to
T R A D E A G R E E M E N T S the exclusion of other
countries.
Regional trade agreements have multiplied in recent decades, with the number of
agreements registered with the WTO jumping from 27 in 1990 to 585 in 2023. More than
half of international trade is now covered by regional trade agreements. The proliferation of
these agreements has led to some economists arguing that regionalisation is as important
as globalisation in understanding current developments in global trade relations. While
trade usually increases faster between countries that have trade agreements, there are
concerns that this can result in trade diversion, where a country’s imports of a good or Trade diversion is where
service switch from the most efficient producer to a less efficient producer with whom a a country’s imports of a
regional trade agreement exists. good or service switch
from coming from the
The extent to which countries trade with other economies within their regional trade most efficient producer to
another country because
blocs varies between regions. Around 60 per cent of the exports of European Union
of the impacts of a trade
economies go to other members of the EU. On the other hand, for ASEAN economies agreement’s provisions,
around three-quarters of trade occurs with countries outside their region, reflecting that such as tariff levels, import
they are smaller emerging economies and their economic growth strategies have focused quotas or other rules.
on exports to industrialised economies. The economies of the United States-Mexico-Canada
Agreement and ASEAN Free Trade Area in recent years have substantially increased the
level of trade among themselves compared to trade with countries outside their trade area
(although both continued to grow). While there are economic efficiencies in trading with
neighbouring countries (due to lower transport costs), there are also risks that regional
trade blocs could result in global trade fragmenting into self-contained regions, hindering
the spread of global free trade.
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Australia in the Global Economy 2024
No. of agreements
600
500
400
300
200
100
0
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2023
Year
Source: WTO Secretariat
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Chapter 2: Trade in the Global Economy
Economists disagree on the extent to which regional The greater benefits of multilateral
and bilateral trade agreements assist or obstruct agreements
progress towards global free trade. Some say that
“RTAs can complement multilateral efforts, and their
regional and bilateral trade agreements slice the world
success in tackling new and traditional issues provides
into separate trading areas, hindering progress towards
lessons that WTO members can apply in the multilateral
global free trade. Others argue that the regional trade
context. But despite their benefits, RTAs cannot be a
agreements act as a stepping stone towards free trade,
perfect substitute for the multilateral trading system. In a
initially convincing economies to reduce their protection
multipolar world economy, with multiple problems of the
barriers against a small group of economies but
global commons, such as we’ve seen with the pandemic,
eventually encouraging them to remove those barriers
we need effective multilateral governance. Attempting to
for the whole world. Meanwhile, in the post-COVID era
solely rely on trade agreements with selected partners is
the momentum for trade liberalisation has weakened,
a recipe for sub-optimal outcomes.”
with governments focusing on ways to make their
supply chains more secure, including by increasing – Ngozi Okonjo-Iweala,
local production. Director-General, World Trade Organization
100th session of the Committee on Regional Trade
The practical benefits of FTAs Agreements, 22 June 2021
“The Australia–United Kingdom Free Trade Agreement
(A–UKFTA) ... [is a] gold-standard trade agreement Second thoughts on trade liberalisation
[that] will deliver unprecedented benefits to Australian “We’ve been doing FTAs for almost 40 years now. And
businesses and create new well-paying jobs … there while some sectors of the economy have benefited, many
will be no tariffs on over 99 per cent of Australian goods know that the traditional approach to trade — marked
exports to the UK, opening up new export opportunities by aggressive liberalisation and tariff elimination — also
… Savings of approximately $200 million a year will be had significant costs: concentration of wealth; fragile
made as tariffs on imports from the UK are eliminated. supply chains; de-industrialisation; offshoring; and the
After five years, all UK imports will enter Australia decimation of manufacturing communities.
duty free, helping ease cost-of-living pressures for Heightened economic insecurity, the pandemic, and
households and input costs for Australian business.” Russia’s invasion of Ukraine have pushed us to
Don Farrell, Minister for Trade and Tourism re-examine our approach to trade. To get this right,
Media release: “Historic trade deal with the United trade has got to be about more than just unfettered
Kingdom”, 4 May 2023 liberalisation, cheap goods, and maximizing efficiencies.”
– Katherine Tai, United States Trade Representative
speech to the Roosevelt Institute’s Progressive Industrial
Policy Conference, October 2022
The CP-TPP was designed as one of the world’s most ambitious trade agreements, but
its significance was reduced after the withdrawal of the United States in 2017, shortly
before it came into effect. The TPP-11 nevertheless went ahead with the agreement, with
the ambition of lowering 18,000 tariffs, representing over 98 per cent of all tariffs within
the free trade area. However, the TPP-11 lacks a clear implementation timeline and some
members have up to 10 years to implement their commitments. The TPP-11 agreement
also includes controversial provisions that give corporations the right to sue governments
for policy decisions that might harm their investments.
To add to the complex web of regional agreements, in 2022 President Biden announced
the formation of a new economic pact, the Indo-Pacific Economic Framework (IPEF),
comprising mostly the same members as the TPP. The IPEF is intended to focus less on
tariffs and market access (which would require approval from Congress), and more on
strengthening supply chains, promoting infrastructure investment, cooperating on tax
rules and fighting corruption.
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Australia in the Global Economy 2024
The ASEAN Free Trade Area (AFTA) comprises Indonesia, Thailand, Malaysia, Singapore,
Philippines, Vietnam, Brunei, Burma, Cambodia and Laos. The ASEAN-Australia-New
Zealand Free Trade Area (AANZFTA) agreement came into effect in 2010 with ASEAN
nations committing to lowering and eliminating tariffs on 96 per cent of Australian
exports to the region (compared to 67 per cent prior to the agreement). Until the signing
of the RCEP in 2020, this group of nations was collectively Australia’s second-largest
trading partner. Collectively the ASEAN region has a population of 690 million across
12 countries and a combined GDP of $4.5 trillion, equivalent to almost 5 per cent of the
global economy. In 2021, ASEAN nations represented 11 per cent of Australia’s two-way
trade volumes.
EU Members Finland
2004 Entrants
Sweden Estonia
Entrants since 2007 Denmark
Latvia
Ireland
Netherlands
Lithuania
Poland
Germany Czech Rep.
Belgium Slovakia
Portugal Luxembourg
Austria
Hungary
France
Romania
Slovenia
Italy
Spain Bulgaria
Croatia
Greece
Malta Cyprus
35
Australia in the Global Economy 2024
17 per cent of global GDP, in recent years it has been weakened by the departure of one
of its largest members, the United Kingdom.
The formation of the EU (formerly the European Economic Community (EEC)) in the late
1950s helped to dismantle trade barriers within Europe. A single market for European
goods and services was established in 1992, and this has helped drive strong trade growth
within the EU. However, the EU has frequently used tariff barriers against non-member
countries, resulting in accusations that the EU is a closed trading bloc. In particular, the
EU has applied high rates of protection to agricultural products, with direct subsidies and
rural support under the EU’s Common Agricultural Policy absorbing around one-third
of the EU’s total budget at a total cost of US$436 billion between 2021 and 2027. The
United States has justified its continuation of farm subsidies on the EU’s Common
Agricultural Policy, which has for decades been criticised by smaller agricultural trading
countries around the world, including Australia.
Within the EU, 20 member countries also participate in a voluntary monetary union
that is commonly known as the eurozone. The monetary union involves the adoption of
a common currency (the euro) and common interest rates, and it has played a major role
in economic integration among the eurozone economies. While successful in promoting
trade and economic integration among member countries, slower growth rates in EU
economies (averaging just 1.1 per cent per year in the decade to 2022) have meant that
its share of world output, while large, has almost halved since 1980.
36
Chapter 2: Trade in the Global Economy
Bilateral trade agreements have experienced a resurgence in recent years. This reflects a
number of factors, including the loss of momentum around multilateral agreements and
the United States’ increased use of its economic power to negotiate more favourable trade
relationships on a country-by-country basis. These agreements are often as much concerned
with shoring up open trading arrangements against a backdrop of rising protectionism
as they are a means of unlocking new trading opportunities. In the past decade, Australia
has concluded nine new bilateral agreements with Malaysia (2013), South Korea (2014),
Japan and China (2015), Peru, Hong Kong and Indonesia (2020), India (2022) and the
United Kingdom (2023).
Like regional trade agreements, economists are divided over the extent to which bilateral
trade agreements assist or obstruct progress towards global free trade. A Productivity
Commission study in 2017, Rising protectionism: challenges, threats and opportunities for
Australia, noted that although governments often claim that bilateral trade agreements
will deliver large increases in trade, in fact their impact is often much smaller because
benefits are often exaggerated and the costs of establishing and implementing the
agreements are underestimated. The report also noted that bilateral agreements can
contribute to greater “trade diversion” – not adding to overall world trade, but simply
diverting it to nations that are party to an agreement.
Nevertheless, pursuing further bilateral trade agreements remains a key component of
Australia’s trade policy. Against the backdrop of a weakened WTO in recent years,
Australia has given priority to negotiations on bilateral agreements, most recently with
the Australia-UK Free Trade Agreement that came into effect in 2023, with 99 per cent
of tariffs on Australian exports to the UK eliminated. The economic impact of the UK
agreement is likely to be relatively small, with the UK estimating it would add just
0.08 per cent a year to GDP by 2035. One of the advantages of negotiating bilateral
agreements is that they are generally much faster to conclude than multilateral agreements
(although the 10 years of negotiations preceding the China-Australia FTA shows this is
not always the case). Australia’s experience with China has also highlighted that bilateral
agreements do not guarantee a harmonious relationship. Nothing in its bilateral agreement
was able to prevent a series of punitive tariffs and trade barriers imposed by China in
recent years on Australian exports of barley, wine, coal, timber and lobster.
reviewquestions
1 Assess the impact of regional and bilateral trade agreements on the global
economy.
2 Account for the growth of bilateral trade agreements in recent years.
3 Describe the recent developments in trade negotiations in Australia’s region.
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Australia in the Global Economy 2024
38
Chapter 2: Trade in the Global Economy
Nevertheless, the Doha negotiations produced some results, such as the Nairobi Package,
a voluntary agreement in 2015 to reduce export subsidies for farm exports.
A quarter of a century after its establishment, the WTO’s role has been weakened by a
rise in protectionist sentiment globally. Historically, the United States was the leading
advocate for freer trade and the WTO, but this has changed in recent years. Successive
US governments have been critical of the WTO’s use of its enforcement powers, in
particular accusing the WTO of failing to stand up to China’s breaches of trade rules.
Since 2019, the US (under both the Trump and Biden Administrations) has refused to
approve any replacement judges on the WTO’s appeals body, with the US wanting the
WTO’s enforcement powers weakened. As a result, the appeals body cannot enforce WTO
rules, and instead nations can only resolve their disputes through informal arbitration.
Nevertheless, the WTO has still made progress on specific issues, such as with agreements
at its ministerial council meeting in 2022 to override patent rights for COVID-19 vaccines
and to reduce fishing subsidies.
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Australia in the Global Economy 2024
also altered its governance structure to give developing and emerging economies (many
of whom receive IMF assistance) a greater say over IMF policies.
Another criticism of IMF interventions – highlighted in the 2010s sovereign debt crisis
in Europe – is that the IMF’s demands harm the most vulnerable groups in society, while
protecting financial institutions. An IMF audit report in 2016 acknowledged that the
measures demanded by the IMF upon Greece during the crisis disproportionately affected
the most vulnerable groups and intensified a recession. However, a broader IMF evaluation
of its 133 lending programs in operation between 2011 and 2017 was more positive in
concluding that three-quarters of IMF programs were successful or partially successful in
achieving their objectives. The IMF has also been criticised for moving too slowly and
cautiously, such as in the COVID-19 pandemic, resulting in proposals for reforms to the
IMF’s lending practices so it can move faster to provide low-interest loans to economies
in crisis situations.
World Bank
The World Bank’s primary role in the global economy is to help poorer countries with their
economic development. The official title of its main organisation, the International Bank
for Reconstruction and Development, gives an indication of its focus: to fund investment
in infrastructure, to reduce poverty and to help countries adjust their economies to the
demands of globalisation. The World Bank also has a number of organisations that provide
specific assistance to lower-income countries including:
• the International Development Association, which provides “soft loans” (that is,
loans at little or no interest to developing countries)
• the International Finance Corporation, whose role is to attract private sector
investment to the Bank’s projects
• the Multilateral Insurance Guarantee Agency, which provides risk insurance to
private investors
• the International Centre for Settlement of Investment Disputes, which provides
conciliation and arbitration of investment disputes between states, and between
states and corporations.
The World Bank’s two major goals are:
• reducing the rate of extreme poverty to less than 3 per cent of the world’s population
by 2030 (in contrast to current forecasts of 6 to 9 per cent of the world’s population
living on less than $1.90 per day by 2030). At the 3 per cent level those in
poverty will mostly be experiencing “frictional poverty”, that is, poverty related to
short-term disasters such as extreme weather events rather than being in long-term
poverty. This goal supports the United Nations Global Goals, although it is more
narrowly focused.
• reducing inequality by fostering income growth for the world’s bottom 40 per cent.
The World Bank is funded by contributions from member countries and from its own
borrowings in global financial markets. It makes loans to developing nations, at rates
that are below standard commercial rates, to fund infrastructure projects such as power
plants, roads and dams. For example, in response to the COVID-19 recession, the World
Bank committed $157 billion for over 100 lower-income countries that accounted for
70 per cent of the world’s population. This funding helped countries to obtain vaccines,
and strengthen health systems and reduce economic damage from the pandemic. The value
of the World Bank’s active portfolio of investments exceeds US$300 billion, with record
lending commitments of US$105 billion in 2022.
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Chapter 2: Trade in the Global Economy
In overall terms, the World Bank’s global importance as a lender to developing countries
has declined as private lending markets have expanded in recent decades. However, it
played an important role in partnering with the International Finance Corporation to
provide US$47 billion for credit support after the onset of the COVID-19 pandemic in
2020, when private credit markets seized up.
One of the most important actions of the World Bank in the past two decades has been its
support of the Heavily Indebted Poor Countries Initiative, in which it aims to reduce debt
by two-thirds in the world’s poorest countries in Africa, South Asia and Latin America,
whose debt levels are considered unsustainable. By 2023, 37 countries had received debt
relief estimated to have saved them over US$100 billion. The World Bank also plays a
role in the global transition away from fossil fuels, with 35 per cent of its investments
designed to help reduce carbon emissions.
Surprisingly, the world’s largest lender of international Developing countries have reaped significant benefits from
development finance is not one of the international China’s BRI lending. Statistical analysis published in 2022
organisations established to support countries with their indicates that an average BRI project increases economic
economic development or financial stability. growth in a host country by 0.95 percentage points after two
years. The analysis also found that BRI infrastructure projects
“In the past decade, China has become the world’s
can reduce economic inequality, with a 10 percentage point
biggest overseas development lender, way bigger
reduction in the concentration of economic activity within a
than the International Monetary Fund … It’s bigger
district in a low- or middle-income country.
than the World Bank, the IMF and all 22 members of
the Paris Club put together.” Despite these benefits, BRI projects also involve risks for
developing countries. With expedited approvals processes
– Marc Filippino and James Kynge, Financial Times, and high-speed construction, BRI projects have been linked
August 2022 to environmental degradation, inflated costs, social issues
Since launching its Belt and Road Initiative (BRI) in and corruption. The BRI has also created a large-scale debt
2013, China has provided US$1 trillion in support to 147 burden, with China now the world’s largest bilateral lender.
countries through construction contracts and non-financial A growing number of countries are also facing debt distress,
investments. In an average year, China lends around US$85 as rising interest rates and slower growth make it difficult to
billion for overseas development projects – more than service their debts.
double the lending of the US (US$37 billion). BRI support The World Bank has warned that the debt burden from BRI
focuses on building infrastructure in the developing world, projects could trigger a series of international debt defaults
leveraging China’s $3 trillion in foreign exchange reserves. on a scale not seen since the 1980s.
United Nations
The United Nations (UN) is a global organisation whose membership includes more
nations than any other political or economic organisation. The UN was established in
1945 and has grown to cover 193 member states. Its agenda is broader than any other
organisation, covering the global economy, international security, the environment, poverty
and development, international law and global health issues. However, its decision-making
powers are limited (because it relies on the support of its member states) and the budgets
for the different arms of the United Nations are small compared to national governments
in many advanced economies.
The UN has historically played an important role in supporting greater linkages between
economies and promoting globalisation. A range of different UN agencies have developed
international standards that make it easier for trade and investment flows to occur
between nations, such as standards for food safety and rules on copyright and intellectual
property. Key UN agencies include the World Health Organization, the UN Development
Programme, the UN Children’s Fund (UNICEF), the UN Refugee Agency (also known
41
Australia in the Global Economy 2024
as the UN High Commissioner for Refugees or UNHCR), the World Food Programme,
the UN Conference on Trade and Development (UNCTAD) and the UN Environment
Programme (UNEP).
The UN also has overseen the development of a large number of international agreements
to enforce human rights and political freedoms. Research by the World Bank has
consistently shown individual freedoms strengthen a country’s prospects for economic
growth and development. Several of these conventions were also developed with the
intention of addressing the underlying causes of poverty in developing nations.
One of the most important roles played by the United Nations in recent years is
establishing a set of Global Goals (or Sustainable Development Goals), which aim to
reduce global poverty and inequality between 2015 and 2030. These goals build on the
Millennium Development Goals, which oversaw a reduction in the proportion of people
living on less than $1 a day between 1990 and 2015 – from 29 per cent to 14.5 per cent
of all people in low- and middle-income economies (chiefly as a result of rapid economic
growth in China lifting 600 million people out of poverty). The Sustainable Development
Goals comprise 17 goals covering global poverty, hunger, wellbeing, education, gender
equality, clean water and sanitation, clean energy, economic growth, sustainable cities,
climate action and sustainable use of land and oceans. They incorporate 169 targets that
UN member states have pledged to take action towards during the period 2015 to 2030.
At the halfway point in 2023, a progress update on the Sustainable Development Goals
found that only about 12 per cent of measurable targets were on track, close to half were
moderately to severely off track, and 30 per cent had seen no improvement or some
regression below the 2015 baseline.
42
Chapter 2: Trade in the Global Economy
reviewquestions
1 Outline recent developments in global trade negotiations.
2 Identify and discuss the role of the international organisation responsible for
maintaining international financial stability.
3 Explain why the IMF has been described as the world’s financial firefighter.
4 Explain why in recent years the WTO has found it difficult to negotiate further
cuts in protection.
43
Australia in the Global Economy 2024
G20 Members
reviewquestions
1 Explain the role of government economic forums in the global economy.
2 Discuss the role of the G7 in the global economy in recent years.
44
Chapter 2: Trade in the Global Economy
chapter summary
1 Free trade is a situation where there are no artificial barriers to trade
imposed by governments that restrict the free exchange of goods and services
between economies.
2 Protection can be defined as any type of government action that has the effect
of giving domestic producers an artificial advantage over foreign competitors.
9 The World Bank is a global organisation whose main role is to assist poorer
nations with economic development through loans, development assistance and
technical advice with the goal of reducing extreme poverty to 3 per cent of the
global population by 2030 and raising income levels for the lowest 40 per cent of
income earners.
10 The G7 and the G20 are the two most important forums for global economic
policy coordination through annual meetings of national leaders. The G7 includes
the major advanced economies, while the G20 includes the large emerging
economies that have recently been driving global economic growth.
45
Australia in the Global Economy 2024
chapter review
1 Define free trade.
3 Use the following terms to briefly outline the main methods of protection that can
restrict free trade:
• tariffs • local content rules • export incentives • subsidies
• “We
should protect our infant industries so that they have a chance to establish
themselves and become competitive in world markets.”
• “We
should have the capacity to produce mRNA vaccines, so that in a future
global pandemic Australia is not forced to go begging to other countries for
critical supplies.”
6 Examine the role that bilateral and regional trade agreements play in contributing
to free trade between economies.
7 Analyse the impact of the increase in preferential trade agreements and trading
blocs on the global economy.
8 Explain how regional trade agreements in the Asia Pacific might affect Australia’s
economic future.
9 Compare and contrast the role of the following institutions in the global economy:
• World Trade Organization
• International Monetary Fund
• World Bank
10 xplain which international organisation would be most likely to play the major
E
role in the following situations:
•a
dispute between Australia and China about anti-dumping measures on bottled
wine imports from Australia
• construction of a major dam and irrigation project in India
•a
crisis in Latin American financial markets that poses a risk to the global
economy.
46
Globalisation
and Economic
Development
3
3.1 Introduction
3.2 Differences in income and economic growth
3.3 Differences in economic development
3.4 Categories of development in the global economy
3.5 Causes of inequality in the global economy
3.6 The impact of globalisation
3.1 Introduction
The most disturbing feature of the global economy is the very large difference in the
living standards of people around the world. People born into families with high living
standards in wealthy countries have very different prospects in life than those born in
families with lower living standards and in low-income countries. Their opportunities in
life vary significantly in terms of health, education, income and life expectancy. Despite
the extraordinary technological change and progress of the past, stark inequalities persist
between wealthy and poor countries, and between wealthy and poor people within
countries.
While there is a large gap between rich and poor countries, it is also true that in overall
terms living standards are improving in most countries, rich and poor. Evidence of progress
towards overcoming global inequalities is highlighted by the following facts:
• The percentage of people now living in extreme poverty has declined significantly,
with around 9 per cent of the population living below US$2.15 per day in 2019
(2017 PPP), compared to 43.6 per cent in 1981.
• The under-five mortality rate has been reduced by close to 55 per cent between
1990 and 2020.
• The global primary school net enrolment rate increased from 81 to 89 per cent
between 1996 and 2018.
• Life expectancy for those born in countries with low human development
increased from 50 to 61 years between 1990 and 2021.
Sources: World Bank 2023, Human Development Report 2021–22
47
Australia in the Global Economy 2024
On the other hand, evidence also demonstrates the major gaps between the 6.6 billion
people in the developing world and the 1.4 billion people in developed countries who
enjoy a high level of human development.
1995
2005
2015
1980
1990
2000
2010
2020*
Source: World Bank Poverty and Inequality Platform 2023 *estimate Year
48
Chapter 3: Globalisation and Economic Development
Figure 3.1 shows that the United States economy is by far the largest in the GNI 2021
Country Ranking
world. It is around one-third larger than the next largest economy, China, and (US$ bn)
almost five times the size of the third largest, Japan. United States 23,617 1
One of the limitations in comparing the size of economies is the exchange rate China 17,572 2
used. By using the United States dollar, we can make inaccurate comparisons Japan 5129 3
about the living standards of developing countries. For example, if the prices
Germany 4411 4
of goods and services in developing countries are low relative to prices in the
United States, then measuring GNI in terms of the United States dollar will United Kingdom 3127 5
underestimate the true income of people in these developing countries. For this France 3118 6
reason, economists usually make an adjustment using purchasing power parity India 3045 7
(PPP) before comparing GNI levels between countries. Measuring purchasing
Italy 2145 8
power parity adjusts measurements of the size of an economy to reflect the
purchasing power of currencies within a national economy. PPP-adjusted figures Korea, Rep. 1974 9
provide a standard comparison of real income levels between countries. Canada 1831 10
Figure 3.2 groups the global economy into low-, middle- and high-income World total 96,433
economies, a distinction made by the World Bank. It shows raw GNI and
Source: World Bank 2023
then the figures adjusted for purchasing power parity between these countries.
Making these adjustments results in substantially higher comparative figures for Figure 3.1 – The world’s 10 largest
developing countries, whose exchange rates tend to be undervalued. economies by GNI (current US$), 2021
standards in Sub-Saharan Africa and South Asia, where almost Figure 3.3 – Global comparison of living standards
40 per cent of the world’s population lives, are exceptionally low. measured by GNI per capita
49
Australia in the Global Economy 2024
Almost all nations have experienced some economic growth in recent decades, enjoying
higher incomes as a result of an increase in their Gross Domestic Product (GDP). While
the gap in income between the richer and poorer countries appears to be lessening, the
reduction of income inequality in the global economy is occurring very slowly.
Another dimension to global inequality is the unequal distribution of global wealth.
Wealth is an important safety net for people when they do not have income and can be
used to improve a person’s education or find other ways to generate income. According
to a 2022 report by Credit Suisse, the top 1 per cent alone owned 46 per cent of global
wealth, while in contrast, the bottom 50 per cent
Latin owned less than 1 per cent. Most of this wealth is
India 3% America 3%
concentrated in households across Europe, North
Africa 1%
America and in Asia-Pacific countries such as Japan,
China and Australia. People in Latin America, India
Asia-Pacific North America
18% 34%
and Africa, by contrast, hold only a small percentage
of global wealth. Wealth is distributed even more
unevenly than income throughout the global
China
economy. While aggregate household wealth grew
18% during the COVID-19 pandemic, a 2023 Oxfam
Europe
23%
report, Survival of the Richest, found the richest 1 per
cent gained double that of the other 99 per cent
combined. In the past decade, the number of
Source: Credit Suisse Global Wealth Report 2022 billionaires worldwide has doubled and half of them
reside in countries without inheritance taxes,
Figure 3.4 – Global distribution of wealth allowing the concentration of wealth to persist
across generations.
reviewquestions
1 Explain why real GNI per capita (PPP) is used to measure income levels in the
global economy.
2 Identify THREE economic regions that have low-income or middle-income
levels, and state their level of GNI per capita (PPP).
3 Discuss what statistics on income levels in economies reveal about the level
of inequality in the global economy.
Economic development
is a broad measure of
welfare in a nation that
includes indicators of
health, education and 3.3 Differences in economic development
environmental quality,
as well as material living It is important to look beyond simple measures of income and economic growth to assess
standards. the differences in living standards in the global economy. Economic development
is a broader concept than economic growth. It attempts to measure improvements in
Human Development wellbeing or welfare, rather than simply how much extra money people have. Higher
Index (HDI) is a measure incomes play a crucial role in improving wellbeing, especially for those living in poverty.
of economic development However, development also takes into account other quality-of-life indicators, such as
devised by the United
health standards, education levels, domestic work that is not given a financial value, the
Nations Development
Programme. It takes into
level of damage to the environment and inequalities in income distribution.
account life expectancy at
birth, levels of educational Human Development Index
attainment and material
living standards (as A number of indicators have been developed to compensate for the limitations of
measured by Gross economic growth measurements. The main alternative measure to GNI is the Human
National Income per
Development Index (HDI), devised by the United Nations Development Programme
capita).
(UNDP) to measure economic development. It takes into account:
50
Chapter 3: Globalisation and Economic Development
• Life expectancy at birth. This is indicative of the health and nutrition standards
in a country. High levels of longevity are critical for a country’s economic and
social wellbeing.
• Levels of educational attainment. Education is important for the development
of the skills of the workforce and the future development potential of an economy.
The HDI measures the average number of years for which adults aged 25 attended
school and the expected years of total school attendance for school-age children.
• Gross National Income per capita. This measures the sum of gross value added
by all resident producers in the economy, plus income from foreign sources on
a purchasing power parity basis. This is used as a measure of a decent standard
of living and is an essential determinant of the access that people have to goods
and services.
The HDI is a score between 0 for nations with no human development and 1 for maximum
human development. The 2021–22 Human Development Report gave Switzerland the
highest HDI at 0.962 and South Sudan the lowest at 0.385. Australia ranked fifth after
Switzerland, Norway, Iceland and Hong Kong with an HDI of 0.951. In both 2020 and
2021, the global HDI declined - the only recorded declines since records began, reflecting
a reduction in life expectancy due to COVID-19. Two consecutive years of HDI decline
in 2020 and 2021 erased the gains of the preceding five years.
Comparing HDI and GDP statistics reveals the differences between growth and
development across the globe. The comparisons highlight the importance of a broader
measure of welfare than just GDP figures.
In making these comparisons, it is important to emphasise that economic growth is still
crucial for high levels of development – as illustrated by countries such as Norway, which
have very high rates of both per capita income and human development.
GNI per Human GNI per Human
HDI HDI
Country capita (2017 Development Country capita (2017 Development
ranking ranking
PPP, US$) Index value PPP, US$) Index value
Very high human Medium human
development development
Switzerland 66,933 0.962 1 Morocco 7303 0.683 123
Norway 64,660 0.961 2 India 6590 0.633 132
Australia 49,238 0.951 5 Kenya 4474 0.575 152
United Arab Emirates 62,574 0.911 26 Solomon Islands 2482 0.564 155
Malaysia 26,658 0.803 62 Papua New Guinea 4009 0.558 156
High human development Low human development
China 17,504 0.768 79 Nigeria 4790 0.535 163
Cuba 7879 0.764 83 Ethiopia 2361 0.498 175
Mexico 17,896 0.758 86 Afghanistan 1824 0.478 180
Brazil 14,370 0.754 87 Yemen 1314 0.455 183
Indonesia 11,466 0.705 114 Chad 1364 0.394 190
Source: UNDP Human Development Report 2021–22, World Bank Data 2023
Figure 3.5 – Comparison of GNI per capita and the Human Development Index
In some cases, countries had similar HDI levels but very different income levels. This
suggests that in some countries the benefits of income are not well distributed as a result of
their high levels of inequality. For example, the United Arab Emirates has a much higher
income level than Australia but ranks lower in its HDI value. Australia has a GNI per
capita of US$49,238, while the United Arab Emirates has a GNI per capita of US$62,574.
Similarly, Cuba and Morocco have income levels around US$8,000, yet Cuba has a HDI
rank of 83, while Morocco is 40 places lower at 123.
51
Australia in the Global Economy 2024
The SDGs were developed based on the previous Millennium Development Goals (MDGs) that were in place between
1990 and 2015. At the end of that period, some goals were achieved such as reducing extreme poverty, but progress was
stronger in some Asian regions, particularly China, and weaker in others, such as Sub-Saharan Africa. Progress was also
made in other areas, such as child mortality and improving access to safe water. However, many other targets were not met,
including achieving universal primary education, eliminating gender disparity in education, and reducing maternal mortality
by three-quarters.
At the halfway point to 2030, the UN Independent Group of Scientists reported that the world was not on track to meet the
SDGs. While UNCTAD dedicated funds to achieve the SDGs, other factors worked against achieving the goals. COVID-19
saw a further 80 million people live in extreme poverty and 100 million children fall below minimum reading proficiency levels.
Violent conflicts – the greatest number since 1945 – caused food and refugee crises. Rising interest rates further reduced the
capacity of many highly indebted developing nations to spend on programs that might address the SDGs.
reviewquestions
1 Explain the difference between economic growth and economic development
and discuss their relationship in the global economy.
2 Outline how the Human Development Index is calculated and assess its
adequacy as a measure of economic development.
52
Chapter 3: Globalisation and Economic Development
3.4 C
ategories of development in the
global economy
In examining economic data on living standards and development, we have referred
to descriptions of high-income, middle-income and lower-income economies. In this
section, we examine these distinctions in greater detail, and consider the use of other
categorisations such as advanced, developing and emerging economies.
Countries are generally categorised into groups because they tend to confront similar issues
according to their stage of economic development. The main categories that economists
use are:
• Advanced economies: These countries have high levels of economic development,
close economic ties with each other and liberal-democratic political/economic
institutions. The 41 advanced economies identified by the International Monetary
Fund (IMF) make up most of the high-income economies in the world (the others
are very small nations) and comprise most of the members of the Organisation
for Economic Co-operation and Development (OECD). High-income countries
have Gross National Income per capita levels (PPP) above US$13,205 and are
mostly found in North America and Western Europe, with a smaller number in
the Asia-Pacific (such as Australia and New Zealand) and in the Latin American
and Caribbean regions.
• Developing economies: These countries generally have low income levels, human Developing economies
resources with poorer education and health outcomes, and have only experienced experience low living
industrialisation to a limited extent. The major consequence is that developing standards, low education
levels and generally
nations have large numbers of people living in absolute poverty (defined as less have agriculture-based
than $2.15 per day in 2017 US dollars PPP), as shown in figure 3.6. Developing economies with poor
countries are often divided into the two groups of low-income and middle-income infrastructure and
countries. economic and political
institutions.
% Poverty headcount ratio at US$2.15 a day (2017 PPP) (% of population)
70
1990 2013 2015 2019
60
50
40
30
20
10
0
East Asia Europe Latin Middle East South Asia Sub-Saharan Total
& Pacific & America & & Africa
Central Asia Caribbean North Africa
Source: World Bank 2023
Figure 3.6 – Proportion of people in absolute poverty throughout the global economy
While there are significant differences between developing countries, some common
characteristics may include:
• high levels of income inequality within their economies
• dependence on agricultural production for income, employment and trade
opportunities
53
Australia in the Global Economy 2024
Type of
Income levels Economic growth Structure of economy Examples
economy
Advanced High income levels with GNI Slower growth in Large service industries Singapore
per capita above US$13,205 recent decades and advanced Portugal
manufacturing Czech Republic
Developing Low income levels with around Moderate growth Heavily reliant on Madagascar
half of population in absolute rates but population agriculture and (in more Yemen
poverty growth also high extreme cases) foreign aid Myanmar
Emerging Income levels vary, but what Strongest growth Industrialising usually with China
these economies have in rates in the world substantial manufacturing Brazil
common is fast growth in (5–10 per cent) and sectors Indonesia
income levels favourable prospects
reviewquestions
1 Summarise the main categories of development and the typical features for
each classification.
2 List FOUR economies that have the characteristics of each of the main
categories of development.
54
Chapter 3: Globalisation and Economic Development
Global factors
Many features of the global economy and the process of globalisation contribute to the
inequalities between countries. Although globalisation also creates opportunities for
economic growth and development, some aspects of the global economy appear to entrench
rather than reduce global inequalities.
55
Australia in the Global Economy 2024
limited reforms to expand tariff-free access for exports from the least-developed
countries, leaving more ambitious reforms to future negotiations.
• The benefits of free trade agreements are often not accessible to developing
nations because of the substantial cost in implementing international agreements
and lodging appeals against other countries’ protectionist measures. Economists
at the World Bank have concluded that a 1 per cent increase in administrative
costs associated with trade would decrease gross world product by US$75 billion.
The complexity of many trade agreements further tilts the benefits of the global
trade system towards richer countries and can entrench rather than reduce global
inequalities.
of income or wealth to those who already hold substantial wealth. According to the
OECD, corporate tax avoidance cost countries up to US$240 billion in corporate
tax revenue each year, with developing countries suffering disproportionately. In
2023, over 135 countries and jurisdictions were implementing a global plan to
reduce tax avoidance by transnational corporations.
• The role of the IMF, the international organisation that oversees the global
financial system, has been under greater scrutiny in recent years, in particular
because of its impact on developing countries. The major criticism of the IMF
is that the “structural adjustment” policies it advocates serve the interests of
rich countries and may not be appropriate to the conditions of many developing
countries. Acknowledging this concern, the IMF includes sustainable development
prominently in its mandate. Since 2001, an Independent Evaluation Office (IEO)
has undertaken reviews of the IMF’s activities, at arm’s length from management
and the board. A 2023 review of the IMF’s response to the COVID-19 pandemic
found that it “deserves great credit for its effective and agile response to provide
early financial support to a broad range of members at a time of urgent need and
high uncertainty.” Nevertheless, the same review found the IMF’s guidance to
countries on fiscal policy may have encouraged too much spending. Some countries
such as Belarus, Iran, Zambia and Nicaragua did not receive funding or it was
delayed because of concerns about health or economic policies, giving rise to a
perception that the IMF did not treat all countries equally.
• Many developing countries have large foreign debt burdens. Total external debt
for low- and middle-income economies was estimated at US$9.3 trillion in 2021, an
increase of 8 per cent since 2020, according to the World Bank’s International Debt
Statistics. Interest repayments on these past loans reduce the income available for
governments to promote growth and development through spending on education,
health care and infrastructure. As a result, many developing countries spend more
on debt servicing than public health. Prior to the onset of the COVID-19 pandemic,
rising public debt levels and heightened debt vulnerabilities were already a cause
for concern. This prompted the launch of debt relief initiatives for developing
countries, most notably the Debt Service Suspension Initiative (DSSI).
them all the way to countries in Africa, at a far greater expense than buying those
crops in the local region. A 2021 study by the European Network on Debt and
Development found that the OECD Development Assistance Committee reported
one in every five dollars of bilateral and EU aid was tied aid.
• Another limitation of foreign aid is that if it is granted without appropriate
governance mechanisms, or not targeted to developing domestic industries, it may
be wasted or have perverse impacts. For example, a former World Bank consultant,
Dambia Moyo, argued that a significant amount of aid to African countries
historically was misused and contributed to violent conflicts, while poverty levels
increased.
• The distribution of aid by high-income countries often reflects strategic and
military considerations rather than the needs of the world’s poorest countries. The
Quality of Official Development Assistance report, published by the Center for Global
Development in Washington D.C., assesses the quality of aid on 10 criteria. It has
consistently found that multilateral aid agencies are more effective than individual
countries who provide bilateral aid. Australia ranked 21st out of 49 in the 2021
QuODA table.
• While multilateral development aid (distributed by the World Bank, IMF and
United Nations) is better targeted at the world’s poorest countries, it is less than
one-third of the value of total development assistance from the Development
Assistance Committee members. One recent initiative is the Aid for Trade
program, established by the WTO to assist developing countries in overcoming
the structural difficulties that limit their ability to successfully trade out of low
economic development.
World Trade Organization (WTO) arguing that the intellectual property underpinning
COVID-19 vaccines be released for free. This case was opposed by the governments of
several high-income nations with large pharmaceutical industries.
Domestic factors
Economic resources
The simplest explanations for contrasts in levels of development focus on the difficulties
most economies face in acquiring and maintaining sufficient resources for the production
process – namely natural resources, labour, capital and entrepreneurship.
• Natural resources: Natural resources are important inputs for production, such Natural resources
as non-renewable or renewable energy supplies, fertile agricultural land, water include all the resources
supplies and minerals. Economies that have an abundant and reliable supply of provided by nature that
are used in the production
cheap natural resources clearly have better opportunities for economic development process. These are often
than those that do not, even if some have been spectacularly unsuccessful in using simply referred to as
these opportunities. Oil-rich countries in the Middle East, Africa and Latin America “land”. The reward (return)
have achieved higher growth rates than their neighbours largely as a result of their to the owners of natural
exploitation of natural resources. But an abundance of natural resources can also resources is called “rent”.
hamper a country’s economic development if it leads to an overvalued exchange
rate, a narrow export base and an over-reliance on a small number of industries
to drive economic growth. Countries that rely on natural resource exports are also
exposed to downturns in commodity prices, which can result in sudden falls in
national income.
• Labour supply and quality: Labour is an input to the production process for
many sectors of the economy and therefore influences development levels. Whereas
high-income countries tend to have highly educated and skilled labour resources,
low-income nations are characterised by high population growth, lower levels of
educational attainment and low health standards that result in lower productivity
levels. In Singapore, for example, a strong commitment to creating a highly
educated workforce has played a central role in the development of a sophisticated
service-based economy. In South Africa, by contrast, the quality of the labour supply
is diminished by inadequate education facilities and high rates of HIV/AIDS,
which affects nearly one in five South Africans aged 15 to 49 years and reduces
workforce participation and productivity. Barriers to girls’ access to education in
many developing countries also contribute to lower productivity and workforce
participation.
• Access to capital and technology: Difficulty in gaining access to capital for
investment and development contributes to lower rates of economic growth and
lower living standards. Low income levels provide little opportunity for savings that
can be used for investment. Poorly developed financial systems make it difficult for
businesses to gain easy access to loans for investment purposes. To improve access
to finance, microfinance organisations in many developing economies provide
small loans to help the poorest people in the world manage their farms or start
a business. Additionally, with small research organisations and limited funds for
business innovation, developing countries have fewer opportunities to develop
new technologies or to pay for the patents to use technologies developed in other
countries.
• Entrepreneurial culture: While it is difficult to quantify differences in culture
between economies and how this can impact upon economic performance, evidence
suggests that a country’s history and social institutions can impact on its economic
success. In particular, strong civil society institutions, cultural disapproval of
corruption, respect for the rule of law and aspirations towards work, enterprise and
personal responsibility can support economic growth and development.
59
Australia in the Global Economy 2024
• High levels of inequality: Large gaps in the distribution of income and wealth
are a common characteristic of developing countries, and especially of countries
with high concentrations of poverty. Oxford University’s Poverty and Human
Development Initiative has found that two-thirds of the world’s poorest billion
people live not in the poorest countries, but in middle-income countries. High
levels of wealth concentration tend to lead to lower rates of economic growth and
development. We need to examine both differences in living standards within
countries and between countries if we are to understand the overall differences in
living standards across the global economy.
Institutional factors
Institutional factors – ranging from political stability, legal structures, central bank
independence, extent of corruption, strength of social institutions and the government’s
domestic and external economic policies – can affect the ability of a nation to achieve
economic development.
View on globalisation
VIEWPOINT
GLOBALISATION
34 % $ 15
US ION
8,1
99
23% $ 10
US LION
6,3
30
18% $8
5,1
US LION
07
L
BIL BIL BIL
CHINA
NORTH EUROPE
AMERICA 3% $1
US LION
4,2
25
18%
BI L
19
1,3
1.3% $5
80
US LION
8
INDIA S $8 N
U LIO
BIL BIL
3% 2,5
79
B I L
$1
US LION
AFRICA ASIA-PACIFIC
LATIN
AMERICA
SOURCE Credit Suisse Global Wealth Report 2022
61
Australia in the Global Economy 2024
reviewquestions
1 Assess the extent to which global and domestic factors cause inequality in the
global economy.
2 Discuss the extent to which globalisation may increase or reduce the extent of
inequality in the global economy.
62
Chapter 3: Globalisation and Economic Development
Saudi Arabia (3.6 per cent). Higher growth in the Middle East and North Africa
compared with the 1980s (0.1 per cent) was underpinned by higher prices for energy
resources during the globalisation era, although it did not resolve the very high
levels of inequality in many economies in the region. However, political instability
and a decline in oil prices has seen growth averaging only 2 per cent since 2011.
• Sub-Saharan Africa recorded an average growth rate of 4 per cent from 2000 to
2021, with strong growth in Ethiopia (8.7 per cent), Mozambique (6 per cent) and
Nigeria (5.2 per cent). However, other African countries have been less successful,
including Sudan and the Central African Republic, having growth rates so low that
they are experiencing very little improvement in living standards.
• Latin American economies experienced strong annual growth in the first decade of
the 2000s (3.1 per cent), improving from the 2.4 per cent average of the 1980s and
1990s. However, growth fell back to 1 per cent annually in the 2010s, reflecting
weaker commodity prices and political instability in some countries in the region.
Latin American economies experienced the greatest COVID-19 shock of any region
in 2020, contracting by 6.5 per cent.
• High-income economies (or advanced economies) grew by just 2.1 per cent on
average in the 1991–2021 period, slower than the 3.3 per cent recorded during
the 1980s. Over this period, average annual growth rates were 2.4 per cent in the
United States, 1.6 per cent in the European Union and only 0.8 per cent in Japan.
The implications of these trends are mixed. On the one hand, the remarkable growth
experienced by emerging and developing economies that have embraced international
trade, foreign investment and the participation of transnational corporations may indicate
that globalisation facilitates higher rates of economic growth. For example, sustained
economic growth in China and India is linked to policies in both countries that have
encouraged increased trade and foreign investment.
On the other hand, the most globally integrated economies are the advanced economies,
and they have experienced comparatively weak growth over the past two decades,
especially since the global recession of the late 2000s. The 2010s saw a long period of
lacklustre growth, despite record low interest rates and very low inflation. High levels
of indebtedness constrained governments from using fiscal policy to stimulate growth.
Growth rates also weakened in African and Latin American economies. The global
Russia’s invasion of Ukraine in February 2022 fundamentally Many western European nations rely on gas from Russia.
changed the global security environment. According to Russia reduced its supply of gas in the lead up to the war
United Nations figures, in 2023 more than 8 million and along with economic sanctions against Russia, the
Ukrainians became refugees due to the conflict. But the global economy experienced a shock of soaring energy
consequences of the war in Ukraine go well beyond the prices and inflation, reaching levels unseen in more than
security and humanitarian impacts. The war brought about a generation. Food prices also rose sharply, due to the
an inflation shock to the global economy, causing a decline direct effect of disruptions to grain exports from Ukraine
in real incomes for 60 per cent of workers across the world. and Russia, and the indirect effect of increased cost-push
World output grew 3.4 per cent in 2022, a full percentage inflation from higher costs of energy, fertilisers and
point lower than the IMF’s pre-war growth forecast. Even shipping. By the second half of 2022, 323 million people
before the war, the global economy was struggling with were experiencing severe food insecurity.
post-COVID-19 supply chain disruptions and inflationary The inflation surge also caused central banks across the
pressures. The war in Ukraine substantially worsened both, world to quickly unwind the low interest rate policies
creating widespread impacts through soaring commodity implemented during the pandemic. Higher interest rates,
prices. The cost of energy rose more sharply than at any in turn, added to the cost of borrowing, with 60 per cent
time in half a century, with crude oil prices soaring 10 times of the poorest countries facing debt distress.
higher than 2020 levels.
64
Chapter 3: Globalisation and Economic Development
economic contraction resulting from the COVID-19 pandemic and further impacts from
the Ukraine war highlighted how more integrated economies are more exposed to the
transmission of economic shocks.
While globalisation also has impacts on economic development or the wellbeing
of individuals and societies, this influence occurs mainly because of the link between
globalisation and economic growth. If globalisation lifts economic growth rates in
individual economies, it also raises income levels, and provides more resources for education
and health care, and for programs to clean up the natural environment. Globalisation can
also have negative consequences for development if, while contributing to growth in
individual countries, it also caused income inequality to increase and accelerated climate
change and environmental damage. The slow global response to climate change is likely
to widen the gap between growth and development indicators in coming decades, as
countries will need to allocate more resources to addressing accelerating climate change
impacts, such as extreme weather events.
Any statistical analysis of the impacts of globalisation during recent decades is inevitably
dominated by the rising economic power of China. The rise of China is a major structural
change in the global economy that is occurring in parallel to the process of globalisation.
Globalisation has also contributed to the extraordinary speed of China’s economic
development. Trade has been central to China’s rapid industrialisation since China’s
growth has been led by export-oriented manufacturing industries. China’s growth is also
accelerating the process of globalisation, by deepening trade and financial links among
economies. The speed and scale of China’s economic expansion dwarfs any other emerging
economy.
Trends in the Human Development Index (which measures a combination of material
living standards, education and health outcomes) show that, since the 1980s, almost
all countries have experienced major improvements in economic development. There
is little evidence that globalisation, on balance, contributed negatively to economic
development. Declines in economic development are restricted to a handful of countries
that have experienced upheaval in transition from planned systems (Russia, Moldova and
Tajikistan) or serious political turmoil (Zimbabwe, Democratic Republic of Congo and
Afghanistan). Figure 3.8 shows the changes in HDI levels for selected countries over the
past three decades.
HDI
1.0
Australia
0.9
Korea
0.8
Venezuela
0.7 Ukraine
0.6 Zimbabwe
0.5
0.4
1990 1995 2000 2005 2010 2015 2021
Source: Human Development Report 2021–2022 Year
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Australia in the Global Economy 2024
Income inequality
Globalisation also has impacts on income inequalities within countries because, as trade and
financial flows grow, it changes the structure of economies:
• Increased openness to trade provides more export opportunities, which can raise the
incomes of “trade-exposed” or agricultural workers in developing countries. Lower
tariffs on imports improve standards of living for the poor by reducing the prices
of goods. In advanced economies, higher levels of trade may shift employment
towards higher-paid services industries, but it may also depress the incomes of
workers in import-competing sectors (for example, employees in the American
motor vehicle industry have seen their incomes decline as US car producers have
sought to compete against cheaper imports from Asia).
• Increased financial flows provide greater employment opportunities and fuel
economic growth, but FDI flows also tend to be concentrated in higher skill and
higher technology sectors, favouring those who are already better off. IMF research
has found that financial globalisation increases income inequality within countries.
• Income inequality has increased in many emerging economies because the global
mobility of skilled labour means that highly skilled workers may emigrate to more
advanced economies with higher-paying jobs unless they receive higher pay. This
contributes to large increases in pay for highly skilled workers, while incomes for
other workers grow at a much slower rate.
According to the IMF, income inequality rose by almost
0.45 per cent per year during the three decades up until
Gini index
60
the mid-2000s, as measured by the Gini index (a common
Indonesia China
measure of inequality where a higher number indicates a
Brazil United States higher level of inequality). IMF studies have also found that
increased inequality reduces economic development. Increases
50 in the share of income for the top 20 per cent of households
are associated with a corresponding 8 per cent fall in average
growth rates over the following five years. In contrast, an
increase in incomes for the lowest 20 per cent of household
40 income leads to a 38 per cent increase in average growth rates
over the same medium-term period.
The general trend of rising inequality is evident in figure
30 3.9. According to the IMF, about one-fifth of the increase
2017
2001
2003
2005
2007
2009
2011
2013
2015
2019
2021
1991
1993
1995
1997
1999
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Chapter 3: Globalisation and Economic Development
We saw in chapter 1 that international trade in goods and services continues to grow at
least at the same rate as the global economy’s growth in most years, and is now equal
to over half of global output. All regions in the world have experienced this trend, as
changes in technology and government policy have fostered trade growth. An important
feature of trade growth during the globalisation era is that goods are produced through
multiple stages in different economies through global value chains (or supply chains)
where countries engage in “vertical specialisation”, focusing on just one or two parts of
the production process.
The different stages of production for consumer goods such as iPhones might see the
manufacturing of computer chips, logic boards, camera parts, screen casings and the final
assembly occurring in different countries. Figure 3.10 demonstrates how the globalisation
of production processes means there could be many international trade transactions rather
than just the export of a finished iPhone from one country to another. Apple’s organisation
and operation of the value chain allows it to capture the largest proportion of the added
value (59 per cent for the iPhone X). For the first time in history, intellectual property
and commercial know-how are constantly being traded across economies, while investment
is expanding beyond physical capital into productivity training for labour and long-term
business relationships. Since the early 1990s, trade through global value chains (as opposed
to traditional trade of finished goods from one country to another) has increased from less
than half to about 80 per cent of total trade.
The COVID-19 pandemic caused the most significant disruption to international supply
chains of the globalisation era. Prior to March 2020, there was an assumption that supply
chains would continue to become ever more interconnected. But the COVID-19 pandemic
highlighted the vulnerability of countries to global chains – when every country needed
respirators and personal protective equipment, they could not obtain enough supplies
from China, and many economies did not have the capacity to manufacture those goods
themselves. A 2022 survey by Infosys revealed 85 per cent of supply chains were impacted
by the pandemic. In addition, the pandemic resulted in huge disruptions to air travel and
major delays in a range of agricultural, mining and pharmaceutical supply chains. Finding
alternative options for sourcing materials (or at least improving the reliability of supply
chains) became a priority for both TNCs and governments since the COVID-19 pandemic.
iPHONE DISTRIBUTED
IN USA
iPHONE ASSEMBLED DISPLAY SCREEN
IN CHINA MADE IN KOREA INTELLECTUAL PROPERTY
LICENCE FOR CHIP
PRODUCTION
CHIPS MADE
IN CHINA
CASING MADE
IN TAIWAN
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Australia in the Global Economy 2024
The globalisation of financial markets has seen an increased reliance on foreign sources
of finance for investment. From another perspective, more countries now have greater
access to overseas funds for investment than ever before. Either way, FDI is now playing
a greater role in generating economic activity in every region around the world. In 2021,
FDI was over nine times higher than it was in 1990 (but only 69 per cent its peak level
recorded in 2007). Very large increases were recorded for high-growth emerging economies
that have relaxed barriers to foreign investment. However, as discussed in Section 3.5,
the benefits of increased FDI flows have mostly been enjoyed by economies with already
favourable economic prospects, and there has only been a trickle of FDI flowing to the
LDCs. In addition, the growth of short-term financial flows has had a destabilising impact
on many economies.
For a critical view of the
practices of transnational The removal of restrictions on foreign ownership and the development of global capital
corporations (TNCs) in markets have spurred the growth of transnational corporations (TNCs), of which
developing countries visit the there are now more than 104,000. Foreign affiliates of TNCs employ over 83 million
website of CorpWatch
www.corpwatch.org
people globally. They dominate the world’s major industries such as motor vehicles,
telecommunications and pharmaceuticals, and merger activity continues to concentrate
Explain concerns regarding
the conduct of transnational
the number of these companies.
corporations held by this TNCs generally perform better than domestic firms on a range of indicators including
organisation. Outline
productivity, quantity sold, production size and export market share. However, World
one proposal to improve
TNC practices. Bank research has found that, on average, benefits to the local community were lower as
foreign firms tend to use less domestic capital and labour. The full advantages of FDI inflow
can only be realised if TNCs are connected to local suppliers. Another concern relating
to TNCs is that they do not operate under the laws of any one country and so can move
their production facilities to countries with the weakest laws, and artificially structure their
financial flows to avoid paying taxes. According to the OECD, developing economies are
disproportionately affected by tactics TNCs use to avoid US$240 billion in corporate taxes
each year. Lower labour standards and environmental protection laws in developing nations
can also lead to the exploitation of workers and environmental degradation.
Environmental sustainability
The relationship between globalisation and environmental factors is complex. Globalisation
can have negative environmental consequences for several reasons. Low-income countries
that are desperate to attract foreign investment and earn higher export revenue may engage
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Chapter 3: Globalisation and Economic Development
in economic behaviour that harms the environment. Examples of how this may occur
include deforestation for paper or woodchip industries; depletion of marine life through
unsustainable fishing practices or poisoning of water supplies by mining operations;
pollution caused by manufacturing industries; and carbon dioxide emissions from power
plants, contributing to climate change. Additionally, the growth in global trade itself
is increasing consumption of non-renewable fuels for transport by air, road, rail and sea.
The most significant environmental threat in the early twenty-first century is climate
change because the warming of the atmosphere has potentially irreversible and catastrophic
impacts on all aspects of the natural environment including oceans, marine life, the weather,
wildlife, air quality and water supplies. While the carbon emissions that contribute to
climate change come from individual countries, the impacts of climate change affect the
whole world. The impacts are also disproportionate, with a World Bank report finding that
the 74 lowest-income countries are the most affected by climate change despite accounting
for less than one-tenth of global emissions. This means that nations need to work together
to address climate change. A 2022 study by Standard Chartered estimated that globally,
in addition to what is already planned, an investment of US$95 trillion will be needed to
achieve net-zero targets. Developing economies with large debt obligations have limited
capacity to make the investments required. The 2022 Climate Conference in Sharm,
Egypt, called for developed economy parties to replenish the Green Climate Fund to assist
developing economies. Although the original goal of mobilising US$100 billion per year
by 2020 had not been met, some progress was made in establishing a loss and damage fund
for low- and middle-income economies facing climate disasters.
Global efforts to reach agreements between economies on reducing carbon emissions
are coordinated by the United Nations Framework Convention on Climate Change
(UNFCCC). In 1997, the UNFCCC summit of world leaders produced the Kyoto Protocol
on Climate Change, which set carbon emission reduction targets for industrialised
countries. The Kyoto Protocol entered into force in 2005 and expired in 2020. The Kyoto
Protocol was followed by the Paris Agreement, to keep “the increase in global average
temperature to well below 2 degrees Celsius above pre-industrial levels” – the benchmark
scientists believe is necessary to prevent the most dangerous impacts of climate change.
The Paris Agreement was significant because, for the first time, it included developing
nations such as China and India alongside the United States, which had refused to ratify the
Kyoto Protocol. In contrast to the Kyoto Protocol, the Paris Agreement included several
inbuilt mechanisms for transparency and review process, with the intention of increased
global scrutiny to further encourage countries to meet their respective contribution
to global emissions reduction. Nevertheless, countries set their own targets to reduce
emissions, which has meant that the world is still not on target to achieve the extent of
reductions in carbon emissions required to achieve the agreed target. The 2021 Climate
Conference in Glasgow (COP26) produced the Glasgow Climate Pact, ratified by 197
countries, which made progress in several areas and was the first climate deal to commit
to reducing the use of coal. In 2023, members of the United Nations signed the historic
“High Seas Treaty” which agreed to protect the ocean outside national borders (99 per
cent of which was unprotected by any protocol beforehand).
Globalisation also offers opportunities to protect the world’s environment from harm
by forcing individual nations to address their global responsibility for environmental
preservation. It makes it possible for the costs of preservation to be shared and to increase
scrutiny of the environmental practices of transnational corporations. Globalisation has
also facilitated the transfer of new technologies to improve energy efficiency and reduce
environmental pollution. Over time, globalisation may create international mechanisms
to enforce agreements on preventing environmental damage. In recent years, however,
problems that have involved global environmental resources, such as fish stocks or climate,
have proved difficult to tackle and progress in making agreements to combat global
environmental problems has been slow.
69
Australia in the Global Economy 2024
European euro
Japanese yen
British pound
Chinese renminbi
Canadian dollars
Australian dollars
Swiss francs
Other curencies
0 5 10 15 20 25 30 35 40 45 50 55 60
Source: IMF Macroeconomics and Financial data 2022
% of total reserves
70
Chapter 3: Globalisation and Economic Development
tightening. The IMF warned in 2023 that uncertainty surrounding these events could lead
to large capital outflows from emerging and developing economies, potentially reducing
per capita incomes by around 15 per cent.
Despite several decades of globalisation, the US dollar remains the dominant reserve
currency in global financial markets. Figure 3.10 shows that nearly 60 per cent of global
reserves are in US dollars, and 20 per cent are held in euro. Reserves are held for various
reasons, including exchange rate management, debt servicing and to address economic
shocks. Holding reserves in US dollars has been standard practice for many nations since
World War II due to its widespread use and stability. US financial markets are still the
largest and most liquid, giving confidence to central banks that they will be able to access
their US dollar reserves when they need it. Further, it is the most widely used currency
in trade, which gives governments with US dollar reserves confidence that they will be
able to use them to import necessary goods.
reviewquestions
1 Analyse the impact of globalisation on economic growth and development in
the global economy.
2 Explain the impact of globalisation on environmental sustainability in the
global economy.
3 Describe the role of financial markets and the international business cycle
in globalisation.
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Australia in the Global Economy 2024
chapter summary
1 The global economy is characterised by stark inequalities. Out of a world
population of almost 8 billion, just over 1.2 billion live in high-income countries
with high standards of living, while around 685 million people live on less than
US$2.15 per day. While inequality between economies globally has fallen,
inequality within economies has increased.
8 Opinion about the impacts of globalisation is divided. While globalisation does not
appear to have accelerated economic growth overall, many emerging economies
have experienced rapid economic growth and development through global trade
and investment.
10 Globalisation has increased the need for national governments to coordinate their
economic policy with other nations, but recent years have seen significant failures
in policy coordination, both on shorter-term issues such as tariff disputes and the
longer-term threats from climate change.
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Chapter 3: Globalisation and Economic Development
chapter review
1 Explain the difference between the concepts of economic growth and
economic development.
3 Discuss the distribution of income and wealth in the global economy. Assess
whether inequality is increasing or decreasing.
4 Identify what categories are used to group economies. Discuss the key features of
these groupings.
6 Explain how globalisation has changed the role of trade investment and
transnational corporations in economies.
7 Discuss how globalisation has impacted on the distribution of income and wealth
within countries.
8 Analyse the positive and negative impacts that globalisation might have on the
natural environment.
9 Explain how globalisation has increased the need for national governments to
coordinate economic policy with other nations.
10 Critically analyse the argument that the negative impacts of globalisation have
been greater than its positive impacts.
73
Australia in the Global Economy 2024
Case Study:
Economic
collapse in
Sri Lanka
For a brief few days in July 2022, the island nation of Sri Lanka near the southern tip of India was in
the global headlines. Its economy had collapsed, the government had defaulted on debt for the first
time in history, the country was declared bankrupt, and its currency had lost half of its value. With
shortages of fuel and food, prices soaring and constant power disruptions, protestors hit the streets,
burning cars and prompting the president to flee the country. Across the world, platforms like Tik Tok
and Instagram swelled with videos of Sri Lankans breaking into the presidential palace and lapping it
up in the president’s pool.
Sri Lanka’s economic crisis – the worst in the nation’s 74-year history – offers insights into the way that
global economic forces, combined with policy mistakes, can be combustive forces. In recent decades, Sri
Lanka has been one of South Asia’s more successful economies. But several misfortunes hit Sri Lanka,
including the collapse in tourism following terrorist attacks in 2019, the COVID-19 pandemic and
then the surge in commodity prices that began in 2021. Policy decisions then turned these challenges
into a full-blown crisis, after the election of President Rajapaksa in 2019.
President Rajapaksa rejected conventional strategies for integrating with the global economy, instead
adopting protectionist policies. To save foreign currency, Sri Lanka banned imports of fertilisers
overnight (describing this as a national shift to organic farming), resulting in sharp declines in
agricultural output, an urgent need for more food imports, and a worsening currency crisis. In a failed
effort to boost growth, he announced huge tax cuts that emptied the treasury of revenues just as the
COVID-19 pandemic struck.
Soaring global inflation along with a falling currency led to shortages in food, fuel and medicine, and
record price increases. Use of a ‘soft peg’ approach to manage foreign exchange enabled currency outflows
to exceed inflows, contributing to foreign exchange shortages. Sri Lanka’s store of foreign currency
reserves, worth almost $8 billion in 2019, were exhausted as the government struggled to defend its
currency and service rising foreign debt. By the end of 2022, Sri Lanka’s economy had contracted by
7.8 per cent, the currency had depreciated by 81 per cent and inflation was running at 57 per cent. Input
shortages were most severe in the manufacturing and construction sectors, leading to half a million job
losses and a doubling in the national poverty rate.
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Case Study: Economic collapse in Sri Lanka
Sri Lanka’s economic collapse prompted support and rescue packages from neighbours and
international institutions. The World Bank lent Sri Lanka US$600 million, India offered
more than US$4 billion of support through loans, and the IMF approved a US$2.9 billion
debt relief program that was later extended to 2027, providing more time for the
government to restructure its external debt (which by 2023 had risen to 75 per cent of
GDP). The G7 group of economies also committed to helping Sri Lanka in securing debt
relief, and the Export-Import Bank of China announced a two-year moratorium on its
debt. The Sri Lankan Government lifted interest rates by 10 percentage points to combat
inflation, increasing value-added tax to 15 per cent to lift government revenues, and
cutting back on spending to lower the budget deficit. Reform of state-owned enterprises
began, partly to satisfy conditions for IMF support. Meanwhile, around 300,000 Sri
Lankans emigrated in 2022 in search of jobs in other countries.
Recovery has been slow, with the IMF forecasting that a further contraction of 3 per cent
in 2023 would be followed by snail-pace growth of just 1.5 per cent in 2024. The rupee
remained around 40 per cent below its pre-crisis level in 2023, while inflation remained
high at almost 30 per cent. The IMF urged further reforms (to increase revenue, reduce
corruption and improve governance) on President Ranil Wickremesinghe ahead of
elections in September 2024.
The crisis in Sri Lanka shows that in the age of globalisation, simplistic policies that
ignore basic principles of economics are likely to fail. The cost can be high, and for Sri
Lanka, it will be a long road ahead to restore stability, confidence and living standards.
5000 200
4000 150
3000
Total reserves (US$ millions) 100
2000
Sri Lankan rupees (per US$)
1000 50
0 0
2018 2019 2020 2021 2022 2023
Source: Central Bank of Sri Lanka 2023 Year
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Australia in the Global Economy 2024
Case Study:
Brazil
Brazil is a valuable case study in the variations between different
countries’ economic policies and performance. In the 2000s, Brazil was
one of the fastest-growing economies, and widely seen as a success story
of global economic integration. But since 2015 it has been one of the
worst-performing economies in the G20.
Like other Latin American economies, Brazil has embraced globalisation
more slowly than emerging economies in East Asia and elsewhere. A
global commodity boom, combined with the discovery of large new
resource deposits, contributed to years of strong growth and rising
incomes. But this collapsed suddenly in 2014, with a deep recession
as commodity prices slumped and a corruption crisis engulfed the
government. Years of weak growth were followed by catastrophic
mismanagement of the COVID-19 pandemic, which left Brazil among
the worst-affected countries in the world.
Brazil is the world’s ninth-largest economy and is the third-largest of the “BRIC” emerging economies
(behind China and India but ahead of Russia). It is the world’s sixth-largest country by population – and
it is the world’s fifth-largest country in land area. Brazil has a highly diverse population with many waves
of immigration since Portuguese colonisation in the 1500s adding to over 2000 Indigenous groups.
FIGURE 1 – DEVELOPMENT INDICATORS: SELECTED COUNTRIES
Mean years of schooling (2021) 8.1 8.6 7.6 13.7 13.2 9.6 12.7
Life expectancy at birth (1990, 2021) 65.3 72.8 63.3 67.6 69.3 78.2 75.2 77.2 70.9 76.5 64.6 70.2 76.9 84.5
Human Development Index (rank) (2021–22) 0.754 (87) 0.705 (114) 0.768 (79) 0.921 (21) 0.876 (34) 0.731 (97) 0.951 (5)
Sources: IMF 2023, World Bank 2021; Human Development Report 2021–22, accessed July 2023
76
Global Case Study: Brazil
1. Economic performance
In the 2000s decade, Brazil emerged as a rising power in the global economy. It made significant progress
in economic development, with reductions in poverty and improvements in health. Its reputation as one
of the world’s most unequal societies changed as innovative policies saw 40 million Brazilians climb
out of poverty. It also became more open to the global economy, although trade remained a relatively
small part of its economy.
However, Brazil experienced a major reversal in fortunes during the 2010s. It experienced its worst
recession on record, a series of corruption crises, political instability and the mismanagement of the
COVID-19 pandemic that resulted in over 700,000 deaths. This case study examines these developments
as well as the reasons for Brazil’s past successes, which have been partially undone in recent years. One
of the challenges in understanding Brazil as a case study of globalisation is that it comprises both major
successes and major failures – and it is not yet clear whether its future will see leadership of the Latin
American region and an increasing role in the global economy, or a return to economic stagnation as
in the 1980s and 1990s.
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Australia in the Global Economy 2024
% %
20 20
Unemployment rate Real GDP growth
Inflation rate (CPI) Fiscal/budget balance (% of GDP)
15 15
10 10
5 5
0 0
–5 –5
–10 –10
–15 –15
2024*
2023*
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
Sources: IMF World Economic Outlook various years and Banco Central Do Brasil, accessed July 2023 *Forecasts Year
In response to rising inflation in 2016, Brazil’s main interest rate was raised to 14.25 per cent, giving
Brazil the highest interest rates of any comparable economy in the mid-2010s. Sharp falls in tax revenues
also created a vicious cycle of further cuts in spending by state and local governments – even to the
point that many of Brazil’s famous annual Carnival parade celebrations were cancelled in 2016.
Between 2017 and the onset of the COVID-19 recession in 2020, Brazil’s economic recovery was weak.
Economic growth averaged only 1 per cent with foreign investors concerned by sluggish reforms to the
pension and business tax systems. While economies across the globe fell into recession in 2020 due to
the COVID-19 pandemic, Brazil’s recession was worsened by mismanagement of the national response,
which saw the health system overwhelmed by multiple waves of infections. The economy contracted
4.1 per cent in 2020, raising unemployment to a record high and pushing 18 million into poverty.
Brazil recovered slowly from the COVID-19 recession, as the 14 per cent official interest rate raised the
cost of household borrowings and the war in Ukraine disrupted Brazil’s trade relationships. However,
inflation rapidly fell to just 3 per cent in 2023, and forecasts for economic growth rebounded to 4 per
cent on the back of strong commodity exports.
Although Brazil has now experienced two severe recessions in less than a decade, one positive feature
of its performance has been the stable operation of financial markets. This was surprising to some
observers, given Brazil’s history of financial crises. The floating exchange rate (which fell by 50 per cent
in the four years to 2016 and another third during COVID-19) helped improve the competitiveness
of exports, while stronger banking regulations helped maintain confidence in the financial sector. In
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Global Case Study: Brazil
How did a country that had been held up as a Latin American tiger economy, and which was the first
South American country to host the Olympic Games, suddenly become the G20’s worst-performing
economy?
Seven key factors explain the deep recession that Brazil experienced between 2014 and 2016:
1. Brazil is a major commodity exporter, so the sharp fall in the prices for oil, iron ore and agricultural
output resulted in lower export revenues and a fall in national income. Eight of Brazil’s top ten
exports in 2015 were commodities. Brazil’s downturn was significantly worse than other commodity
exporting economies.
2. Brazil was unprepared for a fall in commodity prices: other sectors in the economy could not fill
the gap left by the collapse in export revenue.
3. From 2014 a major corruption scandal engulfed Brazil’s business and political elites, halting
economic reforms. The investigation revealed massive bribery and corruption involving Petrobras,
Brazil’s large state-controlled oil company, and leading political figures. The scandal engulfed so many
major businesses and politicians that Congress could not advance the government’s proposals for
economic reform.
4. Investors were losing confidence in Brazil’s ability to address its budget problems. Public
spending had grown at an annual average of 6 per cent per year for two decades, well above the
rate of economic growth. With interest payments of almost 8 per cent of GDP, Brazil was running a
massive budget deficit of 11 per cent of GDP by 2016.
5. That loss of confidence led to the downgrading of Brazil’s sovereign debt by ratings agencies
to below “investment class”, making it more difficult (and more expensive) for the government to
obtain loans. Public debt rose from 52 to 68 per cent of GDP between 2013 and 2016.
6. Many of the policies implemented by the Brazilian government had failed to overcome
economic problems, including price controls that failed to rein in inflation, aggressive lending by
state banks that failed to stimulate new investment and infrastructure project plans that failed to
attract private investors.
7. Brazil had made little progress on a series of deep-seated structural problems affecting its
labour productivity, transport infrastructure, education levels and reputation as a difficult place to
do business. This left Brazil exposed when the favourable environment of high commodity prices
disappeared.
addition, despite the recession of the 2010s, longer-term foreign investment inflows continued. Brazil’s
share market also rebounded strongly after the first recession, with over a 100 per cent increase in its
index between 2016 and 2019. Likewise, after a sharp slump at the onset of COVID-19 in March 2020,
the stockmarket index recovered and by June 2021 had reached a record high, following a 61 per cent
increase in Brazil’s international commodity price index.
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Australia in the Global Economy 2024
of deforestation since 2006, and for the first time on record, in 2021 the Amazon emitted a greater
volume of carbon dioxide than it absorbed. As president, Bolsonaro also threatened to withdraw from
the 2015 Paris Climate Agreement and even sacked the head of the government agency that published
deforestation data.
While environmental mismanagement worsened during President Bolsonaro’s term from 2019 to 2022,
it has been a long-term issue in Brazil, with forest coverage declining from 72 per cent to 60 per cent
between 1990 and 2020. Brazil’s management of the Amazon is a major concern internationally because
it is the world’s largest tropical rainforest, sometimes described as the “lungs of the planet” because it
produces an estimated 20 per cent of the world’s oxygen supply and soaks up vast amounts of carbon
dioxide (while destruction of the forest releases large quantities of carbon dioxide). On his return to
power in 2023, President Lula took action to reduce land clearing, achieving a reduction of 34 per cent
during his first six months in office.
In contrast to its record on deforestation, Brazil has been a world leader in the development of sustainable
biofuels (ethanol and biodiesel), which assist in transitioning from fossil fuels and emit less carbon.
Brazil is the world’s second-largest ethanol producer (after the United States) and ethanol, which is
mostly made from sugar cane, accounts for around 45 per cent of fuel usage in Brazil.
2. Influence of globalisation
2.1 Influence of trade
Despite maintaining some protectionist trade policies, Brazil has benefited from the rapid growth in
international trade brought about by globalisation. Brazil supplies large quantities of commodities,
which have sustained historically high prices over the last two decades. However, commodity prices are
more volatile than most goods and services, and more than one-third of Brazil’s export revenues come
from just three commodities: iron ore, soybeans and oil. Oil exports have grown rapidly in the past
two decades, following the discovery of large reserves in the “pre-salt” fields three kilometres below the
ocean’s surface in the 2000s. Brazil is also the world’s largest exporter of beef and chicken, with five
billion chickens sold annually by its largest agribusiness company, JBS (which is now also the largest
meat producer in Australia).
Brazil’s export revenues reflect the cycles of global commodity prices. The total value exports soared
from US$55 billion in 2000 to over US$250 billion at the height of the global resources boom in 2011.
After a decade of weaker growth throughout the 2010s, the surge in commodity prices in the early
2020s saw export revenues rise by more than 50 per cent over their pre-pandemic levels to a record
US$335 billion in 2022.
Globalisation has increased Brazil’s exposure to both the ups and downs of commodity prices and the
international business cycle. Lower global commodity prices led to weaker exports and in 2014, a record
trade deficit and a high current account deficit. While the trade deficit improved in subsequent years,
this was achieved only through a sharp depreciation in the real and a severe recession that reduced
demand for imports. Brazil also experienced a series of major disruptions to international confidence in
its economy. In addition to political scandals, the “Weak Flesh” scandal in 2017 damaged confidence in
meat exports, after revelations that producers were using red dye to mask putrefying meat. The collapse
of the Brumadinho dam in 2017 revealed poor safety practices and caused major disruptions to Brazil’s
largest mining company, Vale.
2.2 Influence of external accounts
One of the few benefits of its past decade of weak economic growth is an improvement in Brazil’s
external accounts. While historically Brazil has struggled with external imbalances, the IMF has said
that a current account deficit averaging between 1.2 and 2.0 per cent of GDP is compatible with
long-term economic stability for Brazil, and in the five years to 2023, it has averaged 2.5 per cent of
GDP – slightly above that range but a better outcome than many other economic indicators over the
same period.
Historically, the most significant problem underlying Brazil’s external vulnerability has been its high
level of foreign debt, which was once among the highest in the developing world. Brazil’s debt fell
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Global Case Study: Brazil
during the 2000s due to trade surpluses and greater fiscal discipline, before stabilising from the early
2010s. While a large debt problem may not necessarily cause economic instability, specific characteristics
of the debt have made Brazil’s debt a matter for concern:
• As shown in figure 3, prior to the global resources boom, the cost of servicing Brazil’s foreign
debt reached 89 per cent of the value of exports by 2000. After falling to 29 per cent in 2010,
and rising to 66 per cent during the 2016 recession, the debt servicing ratio returned to 29 per
cent in 2023.
• The IMF calculates Brazil’s total public sector debt at up to 91 per cent of GDP, with persistent
concerns for the sustainability of public spending.
• Servicing the foreign debt cost approximately 9 per cent of GDP in 2023, a level reflecting
vulnerabilty to increases in international interest rates, particularly in the US, which is the source
of a majority of Brazil’s foreign borrowings.
Year Current account (% of GDP) External debt to GDP ratio (%) Debt servicing ratio (% of exports)
Sources: Banco Central do Brasil (Time Series 11404, 11407) and IMF World Economic Outlook various years,
accessed July 2023 *Forecast
Nevertheless, Brazil has made significant progress in managing its external debt. Better current account
outcomes and contractionary fiscal policy have helped stabilise foreign debt levels, and Brazil entered the
2020s with its lowest external debt levels since the mid-2000s. An important factor in this improvement
was a dramatic shift from borrowings in foreign currency to borrowings in Brazilian real (down from
70 per cent in the early 2010s to 3 per cent in 2020, according to the Bank of International Settlements).
Brazil also substantially increased its foreign currency reserves (to US$325 billion in 2023), which in
the event of a sudden depreciation in the exchange rate can be used to buy up Brazilian currency and
stabilise its value. This stock of foreign currency proved useful during a sharp depreciation in the first
half of 2020 when Brazil intervened in the foreign exchange market to the tune of US$40 billion.
2.3 Influence of financial markets
Many Brazilians view the influence of globalisation through the lens of the financial shocks that have
been a regular feature of recent Brazilian economic history. Some of these crises had dramatic effects,
such as the early 1990s collapse of the exchange rate that saw inflation reach over 4000 per cent. The
last time that a major financial crisis in the region spilled over to Brazil was in 2002, when Brazil’s GDP
shrunk by 40 per cent in US dollar terms, interest rates soared to 23 per cent and both unemployment
and inflation rose sharply. The IMF provided an emergency loan of US$30 billion to Brazil, in return
for which the Brazilian government agreed to adopt a range of economic reforms. Those reforms helped
make Brazil more resilient during subsequent crises in 2008, 2014 and 2020. The IMF’s intervention
was successful in restoring investor confidence, and by 2005 Brazil had repaid its entire borrowings
from the IMF, eight months ahead of schedule.
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1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
Note: Net FDI flows are FDI inflows minus FDI outflows Year
Sources: World Investment Report 2022 and World Bank data
82
Global Case Study: Brazil
3.3 Brazil’s economic model has been less export-focused, but it is changing
Despite Brazil’s embrace of financial and investment flows, it has been relatively slow in liberalising
trade flows. Up until the 1990s, Brazil implemented tariffs and subsidies to develop domestic industries
that could substitute locally made goods for imports. While this approach helped to keep import levels
down, it also made Brazilian industry less internationally competitive and less successful in developing
export markets.
“With exports and imports below 30 per cent of GDP, the economy is significantly less integrated into
international trade than other emerging market economies of similar size … External competition is
hampered by trade barriers of various forms. Average tariff levels weighted by imports are almost twice
as high as in neighbouring Colombia and more than 8 times higher than in Mexico or Chile. Brazil’s most
frequently applied tariff rate is 14 per cent, while around 450 tariff lines are at the maximum of 35 per
cent, including textiles, apparel and leather and motor vehicles. Brazil is the country with the highest
number of tariff lines above 10 per cent. The high trade barriers preclude Brazil from many of the benefits
of an increasingly integrated global economy.”
– OECD 2020 Economic Survey of Brazil,
Chapter 2, “Raising Productivity through Structural Reforms”
Although Brazil remains more closed than many comparable economies, it has become more outward-
oriented since the 1990s, substantially reducing industry protection. Between 1990 and 2020, the
average level of tariffs fell from 32.2 to 8 per cent and most import quotas were abolished. Following
these reforms, Brazil’s economic integration increased significantly, with foreign trade increasing from
just 15 per cent of GDP in 1990 to 39 per cent by 2022. This is nevertheless low by international
standards, making Brazil one of the least open economies of the G20 group and the OECD.
While Brazil is under pressure to further reduce protection, and President Lula has expressed support
for trade liberalisation, there are a number of issues to overcome. President Bolsonaro suspended the
planned removal of trade barriers unless other countries (many of which already had fewer protection
policies) did likewise. In December 2020, Brazil even imposed a 20 per cent tariff on all imports of US
ethanol into Brazil. However, to combat high inflation in 2022–23, Brazil made 10 per cent tariff cuts
to 87 per cent of Brazil’s goods subject to tariffs, including 6000 Australian products.
Brazil’s gradual integration into the global economy has contributed to modest changes in industry
structure, as shown in figure 5. The manufacturing sector has become smaller as a share of the
economy and there are concerns about deindustrialisation in some sectors, such as with the closure
of manufacturing operations in Brazil by Ford, Mercedes-Benz, Sony and Canon. Manufactures still
make up the largest share of merchandise exports, although in the two decades to 2020, their share of
exports fell from 58 to 33 per cent. Other parts included in the industry category, such as mining and
construction, have grown, offsetting the decline of manufacturing. Brazil’s services sector makes up the
largest share of its economy, but its services are domestic-oriented, generating very little export income.
1996 2022
e
5%
ur
re 8%
ult
u
ult
ric
c
gri
Ag
A
Services Services
69% Industry 68% Industry
26% 24%
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Foreign currency
reserves (US$ bn)
400
350
300
250
200
150
100
50
0
2001
2011
2021
2023
2002
2012
2022
2003
2005
2007
2009
2013
2015
2017
2019
2000
2004
2010
2020
2008
2014
2018
2006
2016
84
Global Case Study: Brazil
reserves of foreign currency in the world – from just US$54 billion in 2005, these reserves in 2023
were US$343 billion. The OECD has criticised the size of the international reserves held by Brazil,
noting the high cost in interest payments by the central bank, but for Brazil the reserves have provided
a safeguard against instability in global financial markets.
85
Australia in the Global Economy 2024
After rebounding from the COVID-19 recession, the primary macroeconomic challenge for Brazil is
moving beyond the sluggish growth of the 2010s through implementing overdue structural reforms.
The key issue with Brazil’s budget is that less than 15 per cent of expenditure can be changed or
removed from one year to the next (that is, is discretionary funding), while the remaining 85 per cent
is fixed expenditure.
Fiscal policy is caught between the economy’s need for support and the need to address a blowout in
public debt levels in recent years, which has been driven by the rising cost of pensions. There are two
key structural measures that address Brazil’s fiscal problems. The first is the Fiscal Responsibility Law,
which requires reductions in public debt and a medium-term target for the “primary fiscal surplus”
(the fiscal surplus before payments on government debt). The second is a constitutional amendment
passed in 2016, which imposes a spending cap that effectively freezes the national budget in real terms
for 20 years. This was introduced after Brazil’s credit rating was downgraded to BBB− in 2014 and
slid further to BB− in 2023.
To stabilise public debt at current levels, an overall public-sector surplus of 1.1 per cent is required.
Prior to the COVID-19 recession, budget forecasts pointed to a gradual decline in the deficit with
continued increases in public debt. However, like other countries, COVID-19 led to emergency fiscal
measures that, while accepted as appropriate by the IMF, resulted in a sharp increase in public debt
of 15 per cent of GDP. The government invoked the “escape clause” of the constitutional expenditure
ceiling to accommodate this exceptional spending, effectively suspending the Fiscal Responsibility Law.
The fiscal measures included temporary income support to vulnerable households (bringing forward
pension payments, expanding the Família program to another million households and providing cash
transfers to unemployed workers), employment support (compensation to workers and incentives for
firms to keep employees) and lower import levies on essential medical supplies. However, President
Bolsonaro continued spending above the cap after the pandemic, which made Brazil’s high inflation
in 2022 even worse. The government then provided cost of living relief that also exceeded the cap.
The new fiscal framework announced by President Lula in 2023 aims to balance fiscal objectives and
social responsibility. The framework limits government spending, with the goal of achieving a primary
budget surplus of 1 per cent by 2026. Given President Lula’s commitment to tackling inequality
through increased social spending, the fiscal framework relies on revenue increases to achieve its target.
One significant reform where progress has been achieved in recent years is the structural reform of the
pension system, which was approved by Brazil’s parliament just before the COVID-19 pandemic. Age
pension payments are an example of fixed spending because they are paid at similar rates each year.
Brazil’s pension system was one of the world’s most generous, accounting for 56 per cent of the national
budget. It became available from 54 years of age, compared to the average OECD retirement age of
66. The pension reforms increased the retirement age to 65 for males and 62 for females and require
individuals to work for 40 years. It also reduces entitlements for those under 70 to encourage longer
workforce participation. The reform was forecast to save US$230 billion over 10 years, although this
will only stabilise spending at current levels.
During periods of high inflation, monetary policy plays a central role in Brazil’s economic policy
mix. This has again become necessary in the 2020s as Brazil has faced another bout of high inflation,
chiefly due to global price increases. After inflation exceeded 12 per cent in 2022, interest rates rose to
13.75 per cent by August 2022, a sharp increase from the low of 2 per cent in early 2021. This proved
successful with inflation forecast to be 5.6 per cent in 2023, down from 9.3 per cent the previous year.
These outcomes represent significant progress given Brazil’s history of high inflation, which reached
a record 4500 per cent in 1994. Brazil’s reliance on high interest rates risks causing a downturn in
economic activity, but the sharp interest rate increases only mildly affected economic growth in 2023.
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Global Case Study: Brazil
“Economic activity is slowing due to weaker private consumption and exports. Real GDP is projected
to grow by 1.7 per cent in 2023 and 1.2 per cent in 2024. Lower employment growth, still high inflation
and tighter credit conditions will limit household spending capacity despite higher social transfers …
Monetary policy is expected to stay restrictive … Fiscal policy remains expansionary for now, but gradual
consolidation should start in 2024. Implementing a credible medium-term fiscal framework will help to
restore confidence and achieve a more consistent macro-economic policy mix … Reducing the complex
system of taxing goods and services would drastically reduce the current high administrative burdens
on firms and has strong long-term potential to boost productivity and growth … Further progress on
addressing large infrastructure gaps in transport, water and sanitation would reinforce those effects.
These reforms would also boost the competitiveness of Brazilians firms, allowing them to reap greater
benefits from international trade.”
– OECD, Brazil Economic Forecast Update, June 2023
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Australia in the Global Economy 2024
finding a way around a law or a rule, sometimes illegally. For example, Brazil’s complex system of
environmental licences for developments is often criticised by foreign investors, and often evaded
by local developers. In other areas, Brazil’s problem has been a failure to enforce regulations. In
2018, the European Union announced a ban on imports from seven of Brazil’s meat processing
factories because of food safety concerns.
Brazil has nevertheless created some successful and innovative social policies, such as the Bolsa Família
(Family Fund) policy, introduced in 2004 to assist poor households. The success of the Bolsa Família
policy (now known as the Auxilio Brasil policy) has led to an expanded education, elderly care,
health and micro-lending package called Brasil Sem Miséria (Brazil Without Misery). This program
incorporated one of the previous government’s cornerstone projects – the Fome Zero (Zero Hunger)
program – providing monthly support to around 14 million of Brazil’s poorest families. By merging
a range of income distribution payments, the government aimed to target inequality more effectively,
and its cost – just 0.6 per cent of GDP – is very small compared to the 14 per cent of GDP spent on
pension benefits that mostly go to Brazil’s less needy middle class.
5. Conclusion
“We’re an increasingly unequal world, and wealth is increasingly concentrated in the hands of fewer people,
and poverty concentrated in the hands of more people … we have to address the issue of world inequality.
It’s unacceptable that – in a meeting between presidents of important countries – the word inequality does
not appear. Wage inequality, race inequality, gender inequality, education inequality, health inequality …
And we need to be clear about the following: what was created after the Second World War, the Bretton
Woods institutions no longer work, and no longer serve society’s aspirations or interests. Let’s be clear
that the World Bank leaves much to be desired in terms of what the world wants from the World Bank.
Let’s be clear that the IMF leaves a lot to be desired in what people expect from the IMF …
And then we need to deal with international agreements, trade agreements. Trade agreements must be
fairer … we need to take a leap in quality, and invest in structural things that change the lives of countries.”
– President Luiz Inácio Lula da Silva, speech at the Summit for a New Global Financial Pact,
Paris, June 23 2023
Brazil is still in the process of rebuilding from a once-in-100-years pandemic that eroded the health system
and left an already weak economy with political instabilty in a deep recession that was followed by high
inflation and high interest rates. Nevertheless, President Lula has ambitions for Brazil to be the leading
advocate for developing countries in the global economy, with an agenda to reform trade, finance, climate
and globalisation itself.
First, however, President Lula must reckon with significant challenges at home, after a decade characterised
by a long recession, corruption scandals and the catastrophic mismanagement of the COVID-19 pandemic.
Brazil is also far more politically divided than it was when he was first in office in the 2000s. Nevertheless,
for a country that only became a democracy in 1988, Brazil’s institutions have endured a difficult period
and proved to be strong, stable and mostly independent (with some exceptions) – all important elements
of a positive environment for long-term investment and growth.
Brazil has the potential to play an important role in the future of the global economy both because of
the size of its population and economy, and because of its proven potential in a diverse range of export
markets including minerals, fuels, food and manufactures. If strong commodity prices are sustained, Brazil’s
prospects for recovery will be strengthened. But it will take time for Brazil to rebuild confidence in its
economic future. To maintain investor confidence and strengthen Brazil’s place in the global economy,
Brazil will need to improve its educational, regulatory and fiscal performance. The events of recent years
also underscore the importance of political stability, anti-corruption measures and the rule of law in
providing foundations for confidence and growth.
88
Case Study:
Indonesia
The East Asian economic region has been strongly influenced by globalisation over recent decades,
through increased international trade, foreign investment and rapid industrialisation. East Asian
economies have become more closely integrated both at a regional level, and with economies around the
world. With strong economic growth and development over recent decades, East Asia is fast becoming
an economic centre of gravity to rival North America or Europe. Although North Asia has the largest
regional economies – China and Japan – economies in the South-East Asian region are sustaining high
rates of growth. They demonstrate the growth opportunities that come from more open markets, but
also highlight the challenges of managing rapid economic change.
Indonesia is the largest economy of the South-East Asian economic region, with the world’s
fourth-largest population and sixteenth-largest economy. As it has opened its economy to global forces
since the mid-1980s, Indonesia has experienced the growth of trade and investment and the increased
participation of transnational corporations (TNCs) in the economy. Across a range of quality-of-life
indicators, economic development has improved. However, Indonesia has also been exposed to major
international economic disturbances, including a regional financial crisis in the late 1990s and ongoing
volatility in global commodity markets. The severe impacts of the COVID-19 pandemic highlighted
the fragility of the country’s economic and social progress. Indonesia faces major policy challenges to
build more competitive industries, improve its regulatory environment, and make government revenue
and services more sustainable.
Indonesia is an excellent case study of globalisation because of the mixed influences of globalisation on
its economy and the challenges it faces in sustaining economic development. Indonesia also has enormous
long-term importance to Australia’s economy and security – reflected in the fact that new Australian
prime ministers usually visit Indonesia soon after assuming the role (such as Anthony Albanese did in
2022). With trade and financial linkages between the two countries growing stronger, understanding
the Indonesian economy is especially valuable for Australia’s economic future.
FIGURE 1 – DEVELOPMENT INDICATORS: SELECTED COUNTRIES
89
Australia in the Global Economy 2024
2013
1. Economic performance
1.1 Indonesia’s economy and development
With a Gross Domestic Product (GDP) of almost $US1.4 trillion, Indonesia is the world’s sixteenth-largest
economy. Indonesia is much smaller than the world’s largest economies, such as China, which is close to
15 times as big, or the United States, which is nearly 20 times bigger. However, Indonesia is larger than
other economies in its region, such as Thailand and Malaysia, whose economies are around half its size.
As well as a large economy, Indonesia has a very large population of over 270 million. Living standards
in Indonesia remain low despite significant improvements. In 2022 output per capita was US$4788
(without adjusting for purchasing power, as done in figure 1. This is more than five times larger than
the level recorded in 2000 (US$780)). Living standards are similar to those of some nearby economies
such as the Philippines and Vietnam, but around half those of other South-East Asian neighbours such as
Thailand and Malaysia. The World Bank downgraded Indonesia from an upper-middle-income country
to a lower-middle-income country in mid-2021 following the impact of the pandemic.
Indonesia’s low income levels mean that it suffers from a relatively high incidence of poverty. Absolute
poverty rates are relatively low compared to the world’s poorest countries, such as in Sub-Saharan Africa
and South Asia, but with 2 per cent of the population living on less than US$2.15 per day, poverty rates
in Indonesia are around double the average for the East Asia and Pacific regions.
Indonesia also suffers from a relatively low level of economic development. According to the United
Nations, Indonesia’s Human Development Index of 0.705 is below 113 other economies. Mostly this
reflects Indonesia’s low standard of living, as measured by its per capita income. Indonesia also has a
relatively poor performance for other key indicators like adult literacy and life expectancy at birth. Health
outcomes in Indonesia are especially low. Fourteen per cent of the population does not have access to basic
sanitation facilities, and around one in ten Indonesians do not have access to basic drinking-water services.
Expenditure on health, at around US$120 per person each year, is significantly lower than comparable
countries in the region.
Indonesia’s development indicators have nevertheless improved substantially in recent decades. Life
expectancy has improved by six years since 1990. Over the same period, the under-five child mortality
rate has decreased by nearly 75 per cent, from 84 deaths per 1000 births to 22 deaths.
Income inequality in Indonesia, as measured by its Gini index of 38, is similar to other economies in the
region such as Malaysia and Vietnam. The distribution of income is more equal than in many countries
beyond the region such as the United States and Brazil.
90
Chapter 1: Introduction to theStudy:
Global Case Global Indonesia
Economy
spread across East Asia after the end of the Cold War. However, this growth came to an abrupt end in
1997 with the Asian financial crisis, which saw the Indonesian economy contract by 13 per cent in the
following year, with devastating consequences.
FIGURE 2 – ECONOMIC GROWTH IN INDONESIA
%
12
–3
–6
–9
–12
–15
2023*
2024*
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
Source: International Monetary Fund, World Economic Outlook Database (April 2023) *IMF Forecasts
In 2020, the Indonesian economy contracted by 2.1 per cent – the first fall in annual GDP since the
Asian financial crisis. The unemployment rate rose by 1.8 percentage points to be 7.1 per cent in 2020.
The COVID-19 pandemic resulted in reduced consumer spending, business investment and exports.
However, by the end of 2021, output had returned to pre-COVID-19 levels. Economic growth was
forecast to be 5 per cent in 2023 and 2024, supported by export growth and investment. The labour
market recovered rapidly, with unemployment falling to 5.9 per cent in 2022. In 2024, unemployment
is expected to return to the pre-COVID-19 rate of 5.2 per cent.
One characteristic of Indonesia that is typical of an emerging economy is the transformation of its
industry structure in recent decades. Like many other economies in East Asia, Indonesia has seen
the economic importance of the agricultural sector fall, while manufacturing industries and services
have become more important. As shown in figure 3, the past four decades have witnessed substantial
structural change in the Indonesian economy.
1980 2021
Agriculture Agriculture
24% 13%
Industry Industry
42% 40%
Services Services
34% 43%
Indonesia’s primary industries nevertheless remain important. Outside the formal economy, the majority
of Indonesia’s rural population still survives on subsistence agriculture, with wages in the form of crop
shares. The main agricultural product is rice, and other crops include rubber, coffee, cocoa and spices.
Unlike other economies in the region, Indonesia also has a large oil and gas industry. Until 2016,
Indonesia was Asia’s only member of the Organisation of the Petroleum Exporting Countries (OPEC),
the international oil cartel. Palm oil, coal, petroleum oil and gas made up a quarter of total exports
from 2000–2020. Indonesia’s dependence on resource-intensive exports exposes it to currency volatility.
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The Asian financial crisis of 1997 and 1998 was an early rupiah had lost 85 per cent of its value against the US
example of some of the possible negative impacts of dollar (to be worth as little as Rp 16,000 to the US dollar)
globalisation. As the economy most severely affected and the managed float was abandoned.
by the crisis, Indonesia’s experience highlights how The Asian financial crisis had devastating economic
volatile global financial markets, combined with economic consequences for Indonesia. The economy shrank by over
mismanagement, can have devastating consequences for 13 per cent. Unemployment increased and the Indonesian
economic growth and development. Government’s official estimate of the number of people in
The rapid growth of South-East Asian economies for poverty almost doubled from 11 per cent to 19 per cent as
much of the 1990s (as shown in figure 4) had led to a a result. As the exchange rate depreciated and the price of
flood of short-term financial inflows that were increasingly imported goods soared, inflation was recorded at over 75
flooding into stock markets, consumer finance and real per cent. Foreign debt increased to US$148 billion. In May
estate. Inadequate banking regulations saw finance flow 1998, Indonesian President Suharto was forced to step
to customers that did not meet normal creditworthiness down after over 30 years in office. It took six years before
standards. living standards returned to pre-crisis levels.
In July 1997, sentiment changed as foreign investors Aside from the mishandling of the crisis by the IMF and
reassessed the value of their assets and loans and the Indonesian Government, economists often cite two
suddenly withdrew their funds – known as “capital flight”. causes of Indonesia’s problems during the crisis. The first
Beginning with the Thai baht, the currencies of South-East was the combination of open financial markets with a
Asian economies depreciated rapidly as financial outflows fixed exchange rate. The rupiah became overvalued, and
mounted. The financial “contagion” of the crisis also because it was fixed, there was no mechanism for it to
spread to other economies, including Indonesia, South adjust to its market value. A second cause of the crisis was
Korea and Malaysia. excessive financial speculation and the poor regulation of
To obtain an emergency US$18 billion financial assistance the financial sector during a period of rapid globalisation.
loan from the IMF, the Indonesian Government was The Asian financial crisis in Indonesia highlights how,
required to undertake policy measures including spending without an appropriate policy framework, global economic
cuts, budget surpluses, dramatically raising interest rates forces can destabilise an economy and cause extensive
(to 80 per cent), closing some banks, cutting fuel subsidies, economic and social harm.
and undertaking long-term structural reforms. Although The Asian financial crisis led to major economic reforms,
designed to strengthen the Indonesian economy in the including the establishment of an independent central bank
long term, these policies had the immediate effect of (Bank Indonesia), a new bankruptcy law, and measures to
further undermining confidence and choking off economic promote competition and improve the social safety net. The
activity. By mid-1998, as panic spread to Indonesia’s Indonesian Bank Restructuring Agency (IBRA) oversaw the
businesses, households and other deposit holders, the reforms to the financial sector.
FIGURE 4 – EAST ASIAN GROWTH RATES The Asian financial crisis also
forced a change in the way that
GDP growth Indonesia Philippines the IMF responds to financial
(annual %) Thailand Malaysia crises. In contrast to its policy
15 prescriptions for Indonesia
12 in the late 1990s, during the
9 global financial crisis and
6 the COVID-19 recession in the
3 following two decades, the IMF
0 recommended that economies
actively stimulate growth through
−3
increased spending, lower
−6
interest rates, and boosting the
−9
liquidity of credit markets. As
−12
one of the first major crises of
−15
the modern era of globalisation,
2024*
2023*
2001
2004
2007
2010
2013
2016
2019
2022
1980
1983
1986
1989
1992
1995
1998
92
Chapter 1: Introduction to theStudy:
Global Case Global Indonesia
Economy
Indonesia’s manufacturing sector includes a large textile and garment industry and some other labour-
intensive manufacturing. The sector has fallen from 31 per cent of GDP in 2002 to 19 per cent in 2021.
Usually this happens when countries achieve higher income levels, according to the World Bank, but
in Indonesia’s case it reflects a lower level of competitiveness than in similar economies. Manufacturers
confront poor infrastructure, limited access to finance, complex regulations and increased barriers to
imports (which raise the cost of capital goods). Nevertheless, Indonesia has two key advantages that
create the potential for growth in manufacturing: a large, low-cost labour force and a huge domestic
market.
Indonesia’s fastest-growing sector is its services sector. In 2021, the services sector made up 43
per cent of GDP, employing 49 per cent of the workforce. Indonesia’s main services are tourism and
retail. In the future, information and communications technology is expected to be a primary driver of
growth in the services sector. Indonesia’s services sector is enjoying increasing foreign direct investment
(FDI) flows, with services accounting for over a third of Indonesia’s investment inflow. The growth
in information and communications services is evidence of the positive role of investment by foreign
technology companies in helping to lift the skills of the Indonesian workforce. Nevertheless, the services
sector is still held back by poor infrastructure and technology and by inadequate workforce skills, and
it has trade barriers for services that are some of the highest in the world.
Indonesia did not meet all of the Millennium Development Goals (MDGs) by the target year of 2015,
but made significant progress in many areas. The Indonesian Government is committed to delivering
progress in the Sustainable Development Goals (or SDGs, also known as Global Goals), building on the
progress achieved with the MDGs, such as reducing poverty (goal 1), promoting gender equality (goal 3),
and dealing with the long-term impacts of climate change (goal 7).
Goal Performance
Poverty headcount (proportion of people living below US$2.15 a day at 2017 PPP) has fallen
1 from 69 per cent (1998) to 2.5 per cent (2022). The proportion of underweight children under five
decreased from 31 per cent (1989) to 18 per cent (2018).
The net enrolment rate for primary children is 93 per cent, and primary school completion improved
2 from 62 per cent (1990) to 100 per cent by 2010. The literacy rate of the population is 96 per cent
(2020).
The proportion of males aged above 25 who have completed at least primary school is 85 per cent
3
(2020). For females, it is 74 per cent (2015).
The mortality rate of children under five years has decreased from 97 (1991) to 22 (2021) per 1000
4
live births.
The maternal mortality rate has fallen from 390 (1991) to 173 (2020) per 100,000 live births. Issues
5
with access to contraception remain.
The prevalence of tuberculosis decreased from 449 (2000) to 354 (2021) cases per 100,000 people,
6
and the proportion of people with HIV/AIDS has decreased.
Carbon emissions are high. Eight per cent of Indonesians do not have access to safely managed
7 drinking water, and 14 per cent do not have access to basic sanitation. The proportion of the urban
population living in a slum has decreased from 51 per cent (1990) to 19 per cent (2020).
Foreign debt (as a per cent of gross national income) has been reduced from 69 per cent (1990) to
8 36 per cent (2021). The total debt servicing ratio (per cent of exports, goods, services and primary
income) has been reduced from 40 per cent (1988) to 29 per cent (2021).
93
Australia in the Global Economy 2024
2013
and population expansion. The Indonesian Government has a moratorium on new clearing for around
66 million hectares of primary forest and peatland. Retention of Indonesia’s rainforests is important for
a number of reasons, including the role they play in absorbing carbon. The forest clearing saved under
the moratorium contributed 86.9 million tons of emissions reductions between 2011–2018. This is
despite retaining only an average of 0.65 per cent more forest coverage than non-moratorium areas.
Other key environmental concerns include loss of species and water pollution:
• Economic activity has affected natural habitats and regeneration, with 265 critically endangered
animal and plant species as of 2019.
• Protection of the marine environment is a major challenge because of Indonesia’s vast coastline,
pollution from industry and over-exploitation of fishing stocks.
Tonnes
2.5
2.0
1.5
1.0
0.5
0.0
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2019
Sources: World Bank data and European Commission’s Emissions Database for Global Atmospheric Research
Indonesia’s rapid economic and population growth is placing pressure on its ability to reduce emissions.
Although emissions of carbon dioxide are low in per capita terms (2.3 tonnes per year), Indonesia is the
world’s eighth-largest contributor to global carbon dioxide emissions (including emissions caused by
deforestation). This is concerning because Indonesia is especially vulnerable to the future impact of climate
change due to its high coastal population density. The World Risk Index ranks Indonesia’s exposure to
natural hazard-related risk as fifth-highest in the world, and climate risks have accelerated plans to move
the capital from Jakarta on the island of Java to the new forest city of Nusantra on Borneo, some 1000 km
away. Indonesia has already seen a sharp increase in the number of climate-related adverse weather events.
The number of adverse events has risen from 82 in 2000 to 3058 in 2022, with recent examples including
the 2019 land and forest fires in which 600,000 hectares were burned and 900,000 contracted respiratory
illnesses, and the 2022 West Java earthquake that killed at least 335 people.
Reducing carbon dioxide emissions while maintaining economic growth will be a key environmental
management challenge in the future. Indonesia has a Nationally Determined Contribution (NDC)
to reduce emissions by 32 per cent by 2030 and reach net zero emissions by 2060 or sooner. These
commitments will require significant policy and investment.
Indonesia is focusing on reducing its electricity sector emissions by 49 million tonnes by 2028, with a shift
towards renewable sources. In 2021, Indonesia’s government utility company Perusahaan Listrik Negara
(PLN) committed to building no new coal-fired plants after 2022 and a phase out of all coal plants by
2056. The Indonesian Government has also committed to a 23 per cent renewable energy target by 2030.
However, despite large sources and investment in geothermal and hydropower, it is unlikely to meet this
target. Government efforts in renewable energy have been focused on small-scale projects, such as installing
solar panels in villages. Large public investment is needed, particularly in distribution infrastructure, to
ensure renewable energy can be added to the system.
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Indonesia is also confronting a number of other environmental issues, particularly in relation to resource
management. For example, Indonesia has the second-highest plastic waste among the world’s 146 coastal
countries. The Government has a policy to slash marine litter by 70 per cent by 2025 (and by 2020 had
achieved a 15 per cent reduction). In 2016, the Government introduced a charge on plastic bags. Within
three months, this step had reduced plastic bag use across Indonesia by 25 per cent.
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Round of trade negotiations, hoping for reductions in agricultural protection by advanced economies.
However, Indonesia also argued that “special and differential treatment” provisions must be at the heart
of a negotiated agreement. This refers to provisions in WTO agreements that give developing countries
special rights, such as a slower tariff reduction schedule.
The process of regional integration has seen the Association of South-East Asian Nations (ASEAN)
emerge as the most important regional organisation. Formed in 1967 by Indonesia, Malaysia, the
Philippines, Singapore and Thailand, ASEAN has since expanded membership to include Brunei, Burma,
Cambodia, Laos and Vietnam. The ASEAN Free Trade Area (AFTA) agreement, signed in 1992, aims
to reduce tariff and non-tariff barriers within the region. It uses a Common Effective Preferential Tariff
scheme, where tariffs are less than 5 per cent for goods originating among member economies. In 2007,
ASEAN leaders adopted a blueprint for the creation of the ASEAN Economic Community (AEC), intended
to create a single market of around 600 million people, allowing the free flow of goods, services, capital and
labour. The vision for the AEC is to enhance the attractiveness of South-East Asia as a foreign investment
destination and improve the level of regional integration. While the initial plan was to establish the AEC
by 2015, this was revised under the AEC Blueprint 2025, which gave members another decade to pursue
the reforms and initiatives needed to achieve the vision of a highly integrated, cohesive and competitive
economic region.
Indonesia is also a party to a number of other trade agreements through the ASEAN Plus Three
framework. ASEAN has concluded free trade agreements with China, South Korea, Japan, India, Australia
and New Zealand. Indonesia is also a member of the Asia-Pacific Economic Cooperation (APEC) forum,
which has aimed to advance regional and global trade and investment liberalisation. Indonesia is also a
member of the Regional Comprehensive Economic Partnership (RCEP), the world’s largest trade bloc,
which came into force in 2022.
The Indonesia-Australia Comprehensive Economic Partnership Agreement was signed in March
2019, reflecting the growing significance of economic relations between the two countries. Under
this agreement, almost all import tariffs in both countries were reduced or eliminated, effective from
2020. Australian primary industry exports such as frozen beef and sheep meat are now being processed
more quickly at the border, reducing barriers to trade. Total trade between Australia and Indonesia was
A$18 billion in 2021–22, making Indonesia Australia’s 14th most significant trading partner.
Indonesia also has a comprehensive bilateral trade agreement with Japan that took effect in 2008. Japan
accounts for 8 per cent of Indonesia’s exports and is its third-largest export destination after China (23 per
cent) and the United States (11 per cent). Indonesia has agreements with South Korea, Chile, Mozambique,
Pakistan and the European Free Trade Association (which itself is comprised of Norway, Switzerland,
Iceland and Liechtenstein). Indonesia has also signed, or is negotiating, agreements with the EU, India,
Tunisia and TÜrkiye, but these are not yet in force. Figure 7 outlines Indonesia’s trade agreements.
FIGURE 7 – INDONESIA’S TRADE AGREEMENTS
Global Regional Bilateral
Founding member o f the ASEAN Free Trade Agreement (1992) Japan (2008)
World Trade O
rganization Asia-Pacific Economic Cooperation Pakistan (2012)
(1995) forum Australia (2019)
Regional Comprehensive Economic Chile (2019)
Partnership (2020)
European Free Trade Association (2021)
Mozambique (2022)
South Korea (2023)
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Chapter 1: Introduction to theStudy:
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Economy
contribution of trade to Indonesia’s economy (as measured by percentage of GDP) has fallen over the past
two decades. Trade in goods and services was equal to around 33 per cent of Indonesia’s GDP in 2020,
down from 72 per cent in 2000. A major reason for the declining contribution of trade is that Indonesia
still relies on a relatively narrow base of commodity exports.
The contribution of trade to the Indonesian economy is lower than the regional average for East Asian
and Pacific economies (56 per cent), highlighting the potential for Indonesia to expand further into
international markets. Indeed, while being the 16th-largest economy with the 4th-largest population,
Indonesia is only the 25th largest in exports. It also means that, through trade linkages at least, Indonesia
is less exposed to the international business cycle than some other economies. Also, with nearly three-
quarters of its trade being with other Asian economies, Indonesia is most closely integrated at a regional
level with economies such as Japan, China, Singapore, Malaysia and South Korea.
FIGURE 8 – INDONESIAN EXPORTS
Exports (% of GDP)
45
40
35
30
25
20
15
10
0
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2021
Since the mid-1990s, Indonesia’s export base has shifted back towards food and fuels, with manufactured
exports falling as a share of trade. High-technology exports contribute less than 3 per cent of Indonesia’s
total export revenues. Unlike many other economies in the region, Indonesia has not emerged as a major
low-cost manufacturer for global markets, relying instead on its commodity exports. In part, this reflects
the fact that some commodity prices have remained strong. However, it also highlights Indonesia’s need to
do more in coming years to develop sustainable exporting industries. Service exports, particularly tourism,
represent an area of potential growth for Indonesia. The Indonesian Government has also promoted the idea
of “resource down-streaming” or value-adding to existing commodity exports, pointing to the success of
a government ban on the export of unrefined nickel ore in 2020 that substantially increased nickel-based
steel exports by 2022. Nickel is also an important component in electric vehicle batteries, and Indonesia is
hoping to become by 2027 one of the world’s three largest manufacturing hubs for EV batteries. Despite
the economic reforms of recent decades, Indonesia’s main exports are oil and gas, coal, palm oil, steel and
electrical machinery/equipment.
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decision to ban raw nickel ore exports (noted above), Chinese and US companies invested in local
processing facilities to shore-up supplies of nickel, a critical input to the electric vehicle production.
Encouraging FDI, along with continuing to reduce trade barriers, is important to securing export-led
development. Figure 9 sets out some key features of foreign investment and integration of Indonesia
with the global economy. The largest sources of foreign investment in 2022 were Singapore, China,
Hong Kong, Japan and Malaysia.
FIGURE 9 – FOREIGN DIRECT INVESTMENT IN INDONESIA
Trends FDI inflows reached a record level of US$45.6 billion in 2022 (excluding banking, oil and
gas sectors), reflecting recent policies for the base metals sector.
Investment source Singapore (29%); China (18%); Hong Kong (12%); Japan (8%); Malaysia (7%);
country (2022) others (26%)
Destination region Java (42%); Sulawesi (20%); Sumatra (15%); Maluku (10%); Kalimantan (7%); Bali and
within Indonesia
Nusa Tenggara (3%); Papua (3%)
(2022)
Destination sector Agriculture and mining (15%); metal goods (24%); other manufacturing (30%);
(2021) services (31%)
Financial markets have also been liberalised in recent decades to encourage economic growth,
beginning with the shift in Indonesia from a fixed exchange rate to a managed float in 1978. The
currency, the Indonesian rupiah, was devalued during the 1980s as a deliberate strategy to improve
the competitiveness of exports. The managed float was abandoned during the Asian financial crisis in
August 1997, and the rupiah was allowed to float freely after the central bank’s attempts to stabilise
the currency were unsuccessful. The rupiah suffered a massive depreciation, causing major turmoil in
financial markets and the economy.
Currency volatility is a continuing problem in Indonesia, with major shifts in the rupiah caused more
by global factors than domestic factors. To reduce instability (and encourage longer-term foreign
investment), the Indonesian Central Bank has strengthened capital controls in financial markets – with
investors in government bonds required to hold them for a minimum of six months, slowing the pace of
any “capital flight”. IMF research has found currency volatility reduces private sector investment – for
every 1 per cent increase in volatility, there is reduction in investment of almost 0.2 per cent.
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As Indonesia emerged from the COVID-19 pandemic, its government began the task of fiscal repair,
with fiscal policy becoming contractionary. Indonesia’s budget deficit fell to expected 2.8 per cent of
GDP in 2023, below the legally mandated ceiling of 3 per cent. The fiscal repair task has been aided
by windfall revenues from record commodity prices. However, overall spending still increased in 2022
due to subsidies for high fuel prices and the increasing interest burden from government debt.
A key constraint on the sustainability of Indonesia’s fiscal policy is the narrowness of its tax base.
Indonesia’s ratio of tax revenues to GDP has been the lowest in the ASEAN-5 (Singapore, Malaysia,
Phillipines, Indonesia and Thailand) and had been declining since 2013 up until the pandemic. This
reflects factors relating to both the economy and the fact that Indonesia’s tax revenues are heavily linked
to the cyclical commodities sector. There are many gaps in the tax collection system, and a large number
of exemptions in the tax system. Some improvements have been achieved under President Widodo
reflecting tax reforms (particularly relating to tobacco) and increased compliance, as well as higher
commodity prices. In 2022, the value-added tax rate (a tax on the delivery of goods and services) was
increased, contributing to a 14 per cent increase in tax revenues. Measures to improve tax compliance
include a tax amnesty (which allows the declaration of previously untaxed assets), the simplification of
compliance processes for taxpayers, and more effective use of banking data. However, over-reliance on
commodity prices to drive revenue remains a critical problem. Indonesia collected more tax in 2022
than it had for some years, partly repairing the tax-to-GDP ratio.
One of the weaknesses of current policy settings is that the tax and transfer payment system makes no
overall difference to the level of inequality. Fiscal policy’s failure to promote inclusive growth reflects
low-quality spending in infrastructure, education and health, particularly evident in East Indonesia. For
example, 60 to 70 per cent of people in East Indonesia lack adequate internet access. The Indonesian
Government has identified the need to substantially increase spending across these areas.
The Indonesian Government has also recognised the need to increase its investment in infrastructure.
Between 2014 and 2018, infrastructure spending grew 22 per cent a year on average. The Government
has an ambitious plan to spend around US$430 billion on infrastructure in the five years to 2024.
In 2019, the government announced a US$32 billion project to move its capital city from Jakarta to
Borneo, officially changing over in 2024. The government hopes 60,000 people will move between
the two cities by 2025, and that this will encourage foreign investment into a less-developed region
of the country. However, Indonesia still has a large infrastructure deficit. Private investment will need
to play a role too, but it has been hampered by regulatory issues, inadequate planning and issues in
securing finance. The Government has established a Public Private Partnership Unit within the Ministry
of Finance to facilitate faster project approval and delivery, and has made steps to reduce regulatory
burdens. International assistance can also help address infrastructure needs, such as through a recent
US$210 million project funded by the World Bank to improve protection of Indonesia’s marine areas
and coral fisheries.
Indonesia’s expenditure on education and health care is inadequate for population needs. Education
spending is 3.5 per cent of GDP, despite a commitment that 20 per cent of government expenditure
should be spent on education. Inadequate investment in education contributes to Indonesia’s high
rate of youth unemployment, which is usually around four times higher than for other age groups.
Educational outcomes are also relatively low, with around 55 per cent of Indonesians completing
education functionally illiterate. The Government has expanded its Program Indonesia Pintar (PIP)
policy, which provides a cash subsidy for school-age children in poor households, with a budget for
17.9 million students in 2023. Further, the “Merdeka Belajar” consists of 22 programs in place since
2019 to improve Indonesia’s human capital, including a revision of the national exam to better align
with international standards.
Public spending on healthcare is below 1.5 per cent of GDP, lower than in most South-East Asian
economies, such as the Philippines or Cambodia. Improved health outcomes have been achieved since
the introduction of a universal health insurance program in 2014, the Jaminan Kesehatan Nasional (JKN).
The universal healthcare program has nearly reached 90 per cent coverage, assisted by a program in
2022 that provided 97 million low-income households extra assistance in accessing the program. The
cost of JKN for individuals depends on their ability to contribute, with the poorest households having
100
Chapter 1: Introduction to theStudy:
Global Case Global Indonesia
Economy
no requirement to contribute. Around 240 million Indonesians participate in the scheme, although
in 2021 only 60 per cent were in the lowest income categories. The government has made steps to
improve the scheme, including the introduction of the “Standard Inpatient Class” system in 2022. This
reformed the existing tiered framework, which offered hospital wards of varying quality based on the
premiums individuals paid. However, while this addresses inequalities for in-patients, attention has
been drawn to JKN’s inability to address high out-of-pocket expenses, which make up a third of total
health expenditures (above the WHO recommendation of 20 per cent).
The most audacious attempt at structural reform in Indonesia in recent years has been the Job Creation
Act of 2020, also known as the “Omnibus Law” because of its wide-reaching impacts on so many
aspects of the economy. The legislation amended 77 other laws relating to environmental protection,
spatial planning, special economic zones, small and medium enterprises, land rights, transport, energy,
agriculture, fisheries and taxation, with the aim of encouraging business investment and economic
growth. Labour market changes mostly reduced protections for employees. Foreign investment
restrictions were reduced for hundreds of industries, including information and communications
technology (ICT), energy and tourism. However, the Omnibus Law was highly contentious, prompting
criticism from environmental and labour groups and even street protests. In 2021, the Constitutional
Court declared the law unconstitutional. In 2023, an amended law removed three key restrictions on
foreign investment and established the Indonesian Investment Authority with US$5 billion to create
long-term investment opportunities in the country.
A consistent hurdle for reforming the Indonesian economy is resistance from established interest groups
whose economic interests have been threatened by the removal of regulations that advantaged them.
Historically, Indonesia has been associated with “crony capitalism”, where economic policies were set
up for the benefit of corrupt officials and relatives of senior officals and political leaders. Indonesia was
ranked 110th in the world in 2022 on the Corruption Perception Index. In 2023, a US$20 billion tax
scandal forced President Widodo to pledge further efforts to fight corruption. One part of his strategy
over the past decade has been to shift towards a more decentralised state, with large areas of public
expenditure and services being transferred from the central government to the nation’s 440 local
governments. However, significant reforms are still required for the legal system to improve corporate
practices, with the World Bank ranking Indonesia 73 out of 190 countries for ease of doing business
in 2019.
The potential dividend from economic reform and policy intervention is significant. According to the
Ministry of National Development Planning (Bappenas), by 2030, policy interventions could lift fourth
grade reading proficiency to 68 per cent, reduce women in child marriages from 10 per cent to 7 per
cent, increase annual real GDP per capita growth to 5.4 per cent and lower the Gini index from 37 to
36. However, achieving these economic and social gains will require major investment, almost US$700
billion in annual spending on Sustainable Development Goals by 2030.
4. C
onclusion: Is Indonesia a globalisation
success story?
Indonesia provides a complex picture of globalisation. Since the 1980s, Indonesia has liberalised trade,
investment and financial flows. Global and regional integration have delivered Indonesia substantial
benefits and have allowed for progress towards reducing poverty. The severity of the Asian financial
crisis in the late 1990s resulted in lasting reforms and improved governance. While growth has been
strong, Indonesia has fallen short of its ambitious growth target, and reforms have been hindered
by difficulties in managing the economy, with its huge population, diverse range of cultures and a
population scattered across 6000 inhabited islands. Indonesia’s experience highlights that globalisation
is not an economic “silver bullet”. To sustain growth over the long term, countries need to establish
strong governance systems, build competitive industries, reform their economies and undertake major
investment in education, health and infrastructure to achieve economic development.
Despite sustaining growth rates above 5 per cent in recent decades, Indonesia is faced with numerous
challenges. In the short term, it must sustain economic growth that has been fuelled by higher
101
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commodity prices and a recovery in tourism, and which could be jeopardised by inflationary pressures,
higher interest rates or weaker international conditions. Securing foreign investment will be critical to
strengthening the economy and sustaining strong growth through the 2020s. While the government
cannot ensure the stability of the currency, it can contribute to investor confidence. In the long term,
key economic challenges will include strengthening the financial sector, reorienting government
spending towards more efficient spending on education and infrastructure, improving coordination
between the national and local governments and attracting more foreign investment that can diversify
the Indonesian economic base.
Stronger economic growth is needed to reduce the incidence of poverty and improve quality of life.
Indonesia hopes to mark its 100-year anniversary of independence in 2045 by achieving high-income
status and reducing poverty to zero. This is an ambitious goal, and will require the Government to
continue to provide a strong policy framework and support the development of human capital. With
Joko Widodo completing his maximum two terms in office in 2024, the new president will play a
central role in determining Indonesia’s progress towards its economic ambitions.
102
AUSTRALIA’S
TOPIC
2
PLACE IN THE
GLOBAL ECONOMY
Focus
The focus of this topic is an examination
of Australia’s place in the global economy
and the effect of changes in the global
economy on Australia.
Issues
By the end of Topic 2, you will
be able to examine the following Skills
economic issues: Topic 2 skills questions can ask
■
Assess the impact of recent changes in the you to:
global economy on Australia’s trade and
■ alculate the main components of Australia’s
C
financial flows
balance of payments
■ xamine the effects of changes in trade
E
■ nalyse the relationship between the balance
A
and financial flows on Australia’s economic
of the capital and financial account and the
performance
net income balance
■ Analyse the effects of changes in the value
■
Explain the relationship between the current
of the Australian dollar on the Australian
account balance and the balance of the
economy
capital and financial account
■ iscuss the impact of free trade and
D
■ se supply and demand diagrams to explain
U
protection policies on the quality of life in
how the value of a currency is determined
Australia
under different exchange rate systems
■ ropose likely changes to the structure
P
■
Analyse the impact of changes in the
of industry within Australia as a result of
components of the balance of payments on
current trends in the global economy
the value of the Australian dollar
Economics Stage 6 Syllabus 2009 extracts © NSW Education Standards Authority for and on behalf of the Crown in right
of the State of New South Wales, 2009; reproduced by permission. 103
Australia in the Global Economy 2024
Topic 2
Introduction
Australia is a big country in terms of its physical size, yet its economy is relatively small compared
to the rest of the world. As economies throughout the world become more integrated, Australia’s
economy is increasingly affected by developments in the global economy. Global economic forces
have changed the Australian economy and the lives of Australians dramatically in recent years, and
these changes will accelerate as globalisation continues.
Chapters 1 to 3 covered Year 12 Topic 1 – The Global Economy and reviewed some of the main
features of the global economy. It was noted that economies have become far more integrated in
recent years because of flows of trade, finance, investment, technology and labour. International
institutions have become more important as economies have become more closely linked to each
other. There has been significant progress in recent years to remove trade barriers between nations.
Yet with the increasing integration of the global economy, there remains an extraordinary gap in
wealth between rich and poor nations.
This topic – Australia’s Place in the Global Economy – will focus on examining where Australia fits
into the global economy and the impact of changes in the global economy on Australia’s internal
and external stability.
Chapter 4 outlines Australia’s trade and financial flows. It looks at how Australia’s trade patterns
have changed over time, and how Australia’s trading partners have also changed.
Chapter 4 also examines the key topic of the balance of payments. The balance of
payments tracks Australia’s trade and financial relationships with the global economy.
Chapter 4 sets out the structure of the current account and the capital and financial
account, along with links between key balance of payments categories. This chapter also
analyses recent trends in the size and composition of Australia’s balance of payments.
Chapter 5 explains the role that Australia’s exchange rate system plays in Australia’s relationship
with the global economy. It gives an overview of how exchange rates are determined,
and looks at the influences on the demand for and supply of Australian dollars. This
chapter also examines the role of government policy in influencing the exchange rate,
and the effects that exchange rates can have on other economic outcomes.
Chapter 6 examines free trade and protection with a particular focus on Australia’s trade and
protection policies, which have changed significantly in the past three decades. These
changes have had impacts for many participants in the economy. The chapter concludes
with a look at the implications for Australia of the free trade and protectionist policies
of other countries and international organisations and the future of Australian industry
in the global economy.
104
Topic 2: Australia’s Place in the Global Economy
AUSTRALIA’S PLACE
IN THE GLOBAL ECONOMY
IMPORTS
EXPORTS $547 BILLION
$686 BILLION
PROTECTIONIST
BARRIERS
DISMANTLED
AVERAGE TARIFF 0.5%
IN 2023 (WAS 25%
IN 1983)
FINANCIAL FLOWS
FOREIGN INVESTMENT IN AUSTRALIA $4.6 TRILLION
AUSTRALIAN INVESTMENT OVERSEAS $3.8 TRILLION
NET FOREIGN DEBT $1.2 TRILLION
SOURCE ABS Balance of Payments and International Investment Position, Australia (Cat. no. 5302.0, Table 10, 11, 16, 29, 30)
105
4 Australia’s Trade
and Financial Flows
4.1 Understanding Australia’s place in the global economy
4.2 Trends in Australia’s trade patterns
4.3 Trends in Australia’s financial flows
4.4 The balance of payments
4.5 Trends in Australia’s balance of payments
4.6 The consequences of a high CAD
106
Chapter 4: Australia’s Trade and Financial Flows
and agricultural products, and because Australia’s level of development has made it an
exporter of services such as tourism and education. It is also partly because Australia has
needed to trade in order to obtain new technology and goods that are not produced in
Australia because of its relatively small population.
In the context of the global economy, Australia is sometimes referred to as a small,
open economy. The Australian economy makes up only a small proportion of the global
economy, producing less than 2 per cent of the Gross World Product. However, trade is
central to the Australian economy. Australia exports more than one-quarter of what is
produced and imports the equivalent of almost one-quarter of Gross Domestic Product
(GDP). As a result, although the Australian economy does not have much influence on
developments in the global economy, world economic developments can have a very
significant impact on Australia.
China/Hong Kong
Imports 23.7%
Exports 31.8% Japan
Imports 5.3%
Exports 15.6%
EU
Imports 15.3% South Korea
USA Exports 4.5% Imports 4.4%
Imports 10.8% Exports 8.2%
Exports 4.5% India
Imports 2.9%
Exports 5.6%
Other countries New Zealand
Imports 18.8% Imports 2.1%
Exports 14.8% ASEAN economies
Exports 2.6%
Imports 16.7%
Exports 12.4%
Source: Department of Foreign Affairs and Trade,
Australia’s direction of goods and services trade, 2021–22
107
Australia in the Global Economy 2024
for trade opportunities. In the 1960s, the Japanese economy was growing strongly and its
demand for minerals and energy increasing rapidly. Australia responded to this opportunity
and Japan became our largest export market. Japan’s share of Australia’s trade began
declining around 1990 and has continued to shrink since then, reflecting both Japan’s
weak growth and Australia’s increased focus on other markets in the region.
In the early 2000s exports to China began a sustained period of rapid growth, which
since 2007, has made China Australia’s largest trading partner (calculated by adding
imports and exports together). This reflects both China’s increasing significance in the
global economy and Australia’s role as a major commodity supplier. China is Australia’s
dominant export market, overshadowing all other countries and has a share of exports
more than twice as large as Australia’s second-largest export market, Japan. In 2022–23,
China accounted for more than one-third of Australia’s export earnings from merchandise
trade, and as figure 4.2 shows, the growth in exports to China since 2000 has been
extraordinary, with annual exports to China expected to soon exceed $200 billion. The
2020s are seeing ongoing shifts in the direction of Australian trade towards other rapidly
growing economies, including India and those of South-East Asia.
Figure 4.2 shows that the trends in the direction of Australia’s exports and imports
differ. Although Australia does not sell a high proportion of its output to other advanced
economies, it still buys a substantial amount from these economies, in particular Europe
and the United States. This reflects the importance of imports from these countries, both
for capital equipment and for many consumer items. China and ASEAN economies are
also large sources of imports, reflecting Australia’s demand for manufactured imports that
these economies specialise in producing. China’s share of Australian imports has grown
dramatically in the past three decades and, since 2016, China has been our largest source
of imports.
China/Hong Kong 2.4 4.4 20.4 35.3 38.8 31.8 2.0 5.7 14.0 21.0 24.0 23.7
Japan 23.9 17.3 15.1 11.8 10.0 15.6 16.2 11.3 7.4 5.7 5.7 5.3
ASEAN 10.6 13.6 11.1 11.1 11.6 12.4 6.9 14.0 19.0 15.3 15.0 16.7
European Union 10.9 8.4 5.4 3.9 3.8 4.5 17.0 15.1 16.0 15.2 16.3 15.3
South Korea 4.6 6.5 7.2 5.8 6.2 8.2 2.0 3.2 2.8 2.8 3.0 4.4
United States 11.6 10.9 5.8 5.8 5.3 4.5 23.7 20.8 12.8 13.4 11.7 10.8
New Zealand 6.2 7.0 4.4 3.3 3.1 2.6 4.4 4.2 3.8 3.2 2.5 2.1
Other countries 29.7 32.0 30.5 23.0 21.2 14.8 28.0 25.7 24.2 23.4 21.7 18.8
Source: Department of Foreign Affairs and Trade, Australia’s direction of goods and services trade 2021–22
Australia has experienced significant changes in the composition of its export base. In
2022–23, Australia’s total exports were worth $686 billion, up from $595 billion in
2021–22. This increase reflected strong metal ores and minerals exports (from $180 billion
in 2021–22 to $189 billion in 2022–23), and an increase in services exports (which rose
from $61 billion in 2021–22 to $94 billion in 2022–23).
Several factors have contributed to the decline of agricultural exports as a proportion of
Australia’s trade over recent decades. Large fluctuations in world prices as well as the
trade protection policies of other countries have influenced the export revenue from
agricultural commodities. In addition, most agricultural trade involves commodity items
to which little extra value is added in processing, unlike other areas of world trade, such
as elaborately transformed manufactures, which are high in added value. In recent years,
natural disasters such as floods and bushfires caused by extreme weather patterns have
also become more frequent and more severe, reducing the output and productivity of the
agricultural sector.
1989–90 2022–23
Rural
11%
Rural
23%
Services
Minerals Minerals
16%
and metals and metals
39% 61% Man
ufac
Services turin
13%turing
g
20% 7%
O
th
Man 5%
er
ufac
5%
r
he
Ot
Source: ABS International Trade in Goods and Services, Australia (Cat. no. 5368.0)
Manufactured goods make up only a small share of exports. While Australia does
not compete well in the manufacture of high-volume, low-cost products, its sales of
sophisticated, niche-market-manufactured goods picked up in the 1990s. But since the
mining boom increased the value of the Australian dollar in the mid-2000s, Australian
manufacturing exporters have encountered more difficult conditions, alongside increased
competition from goods manufactured in China and other low-cost economies in Asia.
“Sure, our economy makes a motza selling fossil fuels to the world today, and ... it will
continue to be a lucrative trade for a while yet. But it looks inevitable that overseas
demand for fossil fuels will decline in the decades ahead as the world attempts to limit
the effects of climate change ...
Clearly we should find other exports to fill the gap, whether that’s from minerals to power
electrification boom such as lithium; or hydrogen; or even green electricity through
undersea cables ... we need to ... stimulate heavy investments in sectors such as critical
minerals and renewable energy to make sure we are competitive in the future.”
– Clancy Yeates, Deputy Business Editor, Sydney Morning Herald, 30 August 2023
The global resources boom stirred debate about whether Australia can continue to rely
so heavily on exports of commodity items. Some economists argue that the prospects
for high commodity prices are positive in the medium to longer term because of the
rapid growth of China, India and other developing economies. However, others point
to the risks of Australia being too reliant on commodity exports and one major export
market (China), especially given China’s recent history of imposing trade barriers against
Australian exports. Australia’s resource exporters have experienced considerable volatility
in the past two decades, although commodity prices have since the early 2000s remained
well above historic averages. There are specific risks in Australia’s reliance on global
demand for coal and gas exports. Although there has been strong demand for these exports
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Australia in the Global Economy 2024
recently, particularly following Russia’s invasion of Ukraine, in the medium term demand
is expected to fall as economies transition to energy sources with lower carbon emissions.
Over-reliance on fossil fuel exports could also mean that Australia is harder hit if carbon
tariffs are adopted around the world as part of the global response to climate change.
Australia’s best long-term alternative to its dependence on traditional mineral and energy
exports is to diversify exports towards new mineral and energy exports, and services
demanded by the growing population of middle-class consumers across Asia. Australia
has large reserves of “critical minerals” used in clean energy technologies such as lithium,
cobalt and “rare earths”. Australia also has the potential to export clean energy sources
such as hydrogen. In addition, Australia has sophisticated service industries and a highly
skilled workforce, nearly three-quarters of which is employed in service industries. In
recent decades, Australia has grown substantial export markets for education services,
financial services, insurance and tourism, as well as smaller markets for transport, health
and communications services. However, the COVID-19 pandemic had a devastating
impact on service exports (in particular, tourism and education). As these sectors recovered
after the pandemic, Australia continued to rely heavily on its resource exports (notably
iron ore) whose prices proved resilient during the pandemic.
Figure 4.4 illustrates trends in the composition of Australia’s imports as a percentage of total
import expenditure. During this time, the composition of Australia’s imports has changed
moderately. The share of capital goods has remained largely unchanged at around one-fifth
of imports. Part-finished intermediate goods and services imports have both fallen slightly.
Consumer goods as a proportion of imports have increased. These changes can be explained
by the shift away from large-scale manufacturing in Australia, especially with the gradual
reduction of tariffs and local content rules. In 2022–23, Australia’s total imports were valued
at $547 billion. Intermediate goods accounted for $190 billion, followed by consumption
goods ($138 billion) and capital goods ($105 billion).
reviewquestions
1 Identify the key changes in the direction and composition of Australia’s trade
over recent decades.
2 Discuss whether Australia’s reliance on commodity exports is beneficial or
harmful for the Australian economy.
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Chapter 4: Australia’s Trade and Financial Flows
Figure 4.5 shows a change in the composition of financial flows between direct
investment and portfolio investment. Direct investment includes the establishment
of a new company, or the purchase of a substantial proportion of shares in an existing
company (10 per cent or more). When a business undertakes direct investment, it is
generally considered to be a longer-term investment and the investor normally intends to
play a role in the management of the business. This is different from portfolio investment,
which includes loans, other forms of securities and smaller shareholdings in companies.
Businesses and individuals that undertake portfolio investment generally do not intend
to play a role in the running of the business.
Prior to the deregulation of the financial sector, most financial flows came into Australia
in the form of direct investment. Governments preferred direct investment, because it
brought the benefits of job creation and technology transfer. Portfolio investment was not
as important, as overseas purchase of shares was relatively small and, in an environment
where financial markets were regulated, overseas loans were not common. The removal
of restrictions on financial flows changed this situation, as Australia saw the benefit of
attracting the growing flows of finance into the economy, injecting money into Australian
companies through loans and share purchases.
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Australia in the Global Economy 2024
Following the deregulation of the financial sector and the floating of the Australian
dollar in the 1980s, foreign investment inflows began to grow rapidly, a trend that has
been sustained for the past four decades. The rate of growth of portfolio investment into
Australia – the shorter-term and more speculative inflow – has been significantly faster
than the growth in longer-term foreign direct investment. Similarly, Australian investment
overseas is seven times what it was in 2000, and the level of portfolio investment is
significantly higher than the level of direct investment. Financial flows have grown at a
faster rate than the growth in trade.
Another significant feature of the financial flows between Australia and the global
economy is the imbalance between investment in Australia and Australian investment
overseas. Australia has always been a net capital importer, with the level of foreign
investment in Australia consistently remaining well above the level of Australian
investment abroad. In part, this reflects the historically low level of domestic savings
within Australia. For many years, Australia has relied on financial flows from overseas to
make up for the shortfall between savings and investment in Australia, and this remains
a feature of financial flows between Australia and the global economy today. However, it
is important to note that these flows are not all one-way – even though there is a much
higher level of foreign investment in Australia, with around $4.6 trillion invested in the
Australian economy in 2022–23, Australia had also invested more than three-quarters as
much overseas ($3.8 trillion). Australian businesses have substantial overseas assets, and
Australia also has significant shorter-term overseas investments such as overseas loans and
shares on overseas stock markets. One reason for this is that as overseas capital markets
have become more open to international investors, Australia’s large superannuation funds
have increasingly pursued investment opportunities overseas.
reviewquestions
1 Explain the difference between direct and portfolio investment flows.
2 Identify TWO factors that have influenced financial flows into and out of
Australia in recent years.
3 Discuss the extent to which Australia’s financial flows have been influenced
by globalisation.
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Chapter 4: Australia’s Trade and Financial Flows
The balance on goods and services (BOGS) is the amount that is derived Credits 79.2 92.0
by adding net goods and net services together. Figure 4.6 shows a surplus Debits −167.8 −200.7
of $138.8 billion in 2022–23. Net primary income −88.6 −108.7
Secondary income
Net primary income
Credits 10.6 12.5
This refers to earnings on investments, that is, income that is earned
Debits −13.3 −13.7
as a return from a factor of production. It covers interest payments on
borrowings and returns on other foreign investments, such as foreign- Net secondary income −2.7 −1.2
owned companies in Australia or foreign land ownership. When Balance on current
43.8 28.9
foreigners invest in Australia, income in the form of rent, profits, interest account
and dividends flows overseas. When Australians invest overseas, there is Source: ABS Balance of Payments and International
Investment Position, Australia (Cat. no. 5302.0)
a flow of income back to Australia. Figure 4.6 shows a deficit in the net
primary income account of $108.7 billion in 2022–23. Figure 4.6 – Structure of the current account
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Chapter 4: Australia’s Trade and Financial Flows
The final part of the balance of payments is the category of net errors and omissions.
This refers to statistical discrepancies. It is included because under a floating exchange
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Australia in the Global Economy 2024
rate system, the balance of payments would always balance to zero (that is, a deficit of
$12 billion on the current account would be offset by a surplus of $12 billion on the
capital and financial account). For convenience, the balancing item is often added on to
the capital and financial account figure to ensure the balance of payments sums to zero.
It is therefore often reported with the capital and financial account. In 2022–23 the net
errors and omissions item was $1.5 billion.
Over a period of time, a high level of capital and financial account surpluses will result in
a widening current account deficit because of the servicing costs associated with increased
foreign liabilities (that is, higher foreign debt and foreign equity). In extreme cases this
may lead to a “debt trap” scenario, in which an economy borrows from overseas merely to
pay the interest-servicing costs on its existing foreign debt.
Another perspective on the links between the two sides of the balance of payments
can be seen by examining savings and investment. Australia’s historically low savings
level (relative to investment demand) makes it necessary to attract a large inflow on the
financial account. This perspective suggests that Australia’s history of running current
account deficits is not simply the result of a trade imbalance. Between the mid-1980s
and mid-1990s, economists generally associated Australia’s balance of payments’
problems on Australia’s lack of international competitiveness (that is, on the BOGS on
the current account). This encouraged successive governments to introduce a series of
microeconomic reforms in trade, financial and labour markets with the aim of achieving
greater competition and growth in productivity. More recently, there has been a focus
on the gap between savings and investment as the cause of Australia’s long-running
external imbalances, because low savings result in a need for foreign capital inflow to
fund investment within Australia (that is, making the current account deficit a capital
and financial account problem).
reviewquestions
1 Identify the main components of the balance of payments.
2 Explain the main components of the capital and financial account.
3 Explain the relationship between the TWO sides of the balance of payments.
4.5 T
rends in Australia’s balance
of payments
The balance of payments is an important indicator of the health of the economy and the
ability for Australia to make good on its obligations to the rest of the world. It reflects
key features of the structure of the economy, and it highlights any imbalances in the
relationship between Australia and the global economy.
The main focus of analysis of trends in the balance of payments is the current account
deficit, and in particular its main components, the BOGS and net primary income.
Figures 4.8 and 4.9 highlight the trends in Australia’s balance of payments. In the decades
prior to the 2010s, calculated as a percentage of GDP (which provides the most accurate
comparison across time and between countries), the current account was consistently in
deficit, at a level averaging around 4 per cent of GDP. After reaching a record level of 6.6
per cent of GDP in 2007–08, the current account has shown a sustained improvement.
In 2022–23, the current account recorded its fourth consecutive financial year surplus –
after recording no surpluses between 1973 and 2019–20. The improvement in Australia’s
current account during the COVID-19 recession was driven by strong commodity prices,
low global interest rates and a larger contraction in imports than exports. It was sustained
by a further surge in commodity prices that ended in 2023. The short-term nature of
some of these factors is reflected in the Treasury forecast for a return to a current account
deficit of 2.5 per cent of GDP in 2023–24, with weaker commodity prices and higher
debt servicing costs due to rising interest rates.
Australia’s current account balance moves in cycles, reflecting a mix of short- and
longer-term domestic and external influences. The size and movements on the BOGS and
primary income account are influenced, to varying degrees, by both cyclical and structural
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Australia in the Global Economy 2024
factors. Cyclical factors are those that vary with the level of economic activity – such as
changes in global demand for commodities, Australia’s terms of trade and the value of
the exchange rate. On the other hand, structural factors are those that are underlying or
persistent influences on the balance of payments – such as the structure of Australia’s
export base, the international competitiveness of Australia’s exports, and the level of
national savings.
1996–97
1997–98
1998–99
1999–00
2000–01
2001–02
2002–03
2003–04
2004–05
2005–06
2006–07
2007–08
2008–09
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
2016–17
2017–18
2018–19
2019–20
2020–21
2021–22
2022–23
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
−1 −1
−2 −2
−3 −3
−4 −4
−5 −5
−6 −6
% of GDP Current Account Balance Balance on Goods and Services % of GDP
Net Primary Income Balance
Source: ABS Balance of Payments and International Investment Position, Australia (Cat. no. 5302.0)
Cyclical factors
The BOGS is affected by a range of cyclical factors, including the exchange rate, the terms of
trade, and the rate of economic growth in the Australian economy and the global economy.
• Exchange rate: Movements in the exchange rate affect the international
competitiveness of Australia’s exports and the relative price of the goods and
services that Australia imports. A depreciation decreases the foreign currency price
of Australia’s exports, increasing the international competitiveness of Australian
exports on world markets. At the same time, a depreciation increases the Australian
dollar price of imports and discourages consumers from purchasing imports, also
improving the BOGS account.
• Terms of trade: The greatest influence on Australia’s balance of payments in Terms of trade measures
recent years has been changes in Australia’s terms of trade. The terms of trade the relative movements
in the prices of an
shows the relationship between the prices Australia receives for its exports and the
economy’s imports and
prices it pays for its imports. An improvement in the terms of trade means that exports over a period of
the same volume of exports can buy more imports. Unless there is a significant time. The terms of trade
decrease in export volumes compared to import volumes, then this would lead to index is calculated as
an improvement on the BOGS (either a larger surplus or a smaller deficit), and a export price index divided
decrease in the current account deficit. A more detailed explanation of the terms by import price index
multiplied by 100.
of trade index is shown in the following box.
The terms of trade is expressed as a number known The following example, based on the information in figure 4.11,
as the terms of trade index. It shows the ratio of the demonstrates how to calculate the terms of trade.
export price index to the import price index. The
export price index shows the proportional change in Export price Import price Terms of trade
Year index index index
the level of export prices, while the import price index
shows the proportional change in the level of import 1 100 100 100
prices. If export prices are increasing relative to 2 115 105 109.5
import prices, Australia’s terms of trade will improve. 3 120 130 92.3
On the other hand, if import prices are increasing
relative to export prices, then the terms of trade will Figure 4.11 – Hypothetical terms of trade index figures
deteriorate. It should be noted that, as with all index
numbers, the proportional change is relative to a In this example, the terms of trade have improved in Year 2 and
base year, or starting point, which is given an index deteriorated in Year 3 (shown by the falling index number), with
number of 100. (Note: You are not required to make import prices rising faster than export prices.
calculations of the terms of trade index for the NSW
Year 12 syllabus but understanding the terms of trade 120 100
Year 3 terms of trade index = x = 92.3
is important for analysis of recent trends in Australia’s 130 1
balance of payments.)
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Australia in the Global Economy 2024
For the two decades since 2003, Australia has experienced The strength of the global recovery from the COVID-19
the largest sustained terms of trade boom in its history. pandemic increased demand for Australia’s commodity
This reflects the impact of a long boom in the prices exports, and the volatility caused by Russia’s invasion of
for global commodities. As most of Australia’s exports Ukraine and its threat to cut off gas supplies to Europe,
are commodities, Australian exporters received higher resulted in soaring prices for resource and energy exports.
prices for their exports, increasing the value of Australian Slower growth China in 2023 prompted a fall in commodity
export revenues. At the same time, the rise of China and prices.
other low-cost emerging economies also flooded world The terms of trade affects both the BOGS and the
markets with low-cost manufactured goods, reducing exchange rate. Ordinarily, a higher terms of trade means
import prices. Both of these factors helped to improve that exports receive higher prices for the same level of
the BOGS. output, which increases export revenue and improves the
After the beginning of the boom in global commodity BOGS. However, because a higher terms of trade reflects
prices in 2003, Australia experienced a doubling of its an increase in demand for Australian exports, the demand
terms of trade. Even when there have been temporary for Australian dollars rises, causing an appreciation of the
declines during the global recession in 2009 and in the exchange rate. The higher Australian dollar weakens the
early 2010s, Australia’s terms of trade has remained well international competitiveness of Australia’s non-commodity
above historic averages. By 2023, the terms of trade was exports. As a result, a lower level of non-commodity exports
almost double its level in 2003 but had begun to fall sharply. partially offsets the benefits of the rising terms of trade.
Source: ABS Australian National Accounts: National Income, Expenditure and Product Year
(Cat. no. 5206.0) *2023–2024 Budget forecast
• Economic growth rates: The level of domestic economic growth influences the
BOGS balance by affecting demand for imports. An upturn in the domestic business
cycle results in increased business investment and higher disposable income, which
leads to higher consumption. Higher levels of business investment and household
consumption spill over into higher imports (especially since imports constitute a
large proportion of both capital and consumer spending), worsening the BOGS. If
economic growth is driven by investment in productive capacity that will expand
exports, this worsening of the BOGS will be reversed in the medium term and
exports grow. This helps explain why, after the onset of the mining boom in 2003,
the BOGS worsened for several years before its turnaround in the 2010s.
Changes in the international business cycle impact the BOGS by affecting the
demand for Australia’s exports. A slowdown in global economic growth and weaker
growth in Australia’s key regional trading partners both reduce growth in demand
for Australia’s exports, worsening the BOGS. A key feature of Australia’s economic
successes in recent decades is that our economy has been more closely integrated
with faster-growing economies than many other developed countries.
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Chapter 4: Australia’s Trade and Financial Flows
Structural factors
Over the long term, Australia’s BOGS has tended to remain in deficit. This reflects two key
structural factors on the BOGS: Australia’s narrow export base and a lack of international
competitiveness.
• Narrow export base: Australia’s export base is narrow, in the sense that Australia’s
exports are heavily weighted towards a small number of commodities. Australia’s
comparative advantage lies in products that do not involve a large value-added
component, such as minerals and agriculture, which together account for around
two-thirds of Australia’s export earnings. Australia is highly exposed to movements
in prices and demand in these markets. This volatility contributes to large
fluctuations in the BOGS from year to year.
Until the early 2000s, many economists thought that the long-term downward
trend in commodity prices over the second half of the 20th century would continue
to worsen Australia’s external position. However, the increased global demand for
commodities made commodity exports far more valuable in the first decades of the
21st century. Although there was volatility in the terms of trade, it remained well
above longer-term averages. This led to a sustained improvement in Australia’s
trade performance.
In recent decades there has also been an upturn in the prices for many agricultural
exports, although the increase has been smaller than for the mining sector. The
Reserve Bank’s index of rural commodity prices rose by almost one-third in US
dollar terms between the 2000s and 2010s, from 46.7 to 70.6, and in the 2020s
has risen further to an average of 84.8 up to mid-2023. The increase in agricultural
prices reflects growing global food demand, rising incomes in the developing world,
rising prices for agricultural inputs such as oil and fertilisers, the effect of the war
in Ukraine and the impact of climate change in reducing agricultural productivity,
such as through natural disasters.
While the boom in commodity prices has benefited Australia during the first quarter
of the 21st century, economists agree on Australia’s need to reduce its dependence on
fossil fuel exports. As economies across the world accelerate their shift away from
carbon-intensive fossil fuels, Australia will not be able to rely on carbon-intensive
exports such as coal and gas. In addition, agricultural practices will need to change
as output is affected by changing weather patterns and natural disasters.
• Lack of international competitiveness: Australia lacks international
competitiveness in manufacturing and relies heavily on imports of value-added
products such as consumer goods and capital goods, while relying on the export
of bulk commodities that are usually exported without value-adding. As a result,
BOGS has historically tended to be in deficit rather than surplus because import
payments very often outstrip export revenues.
Many economists argue that in the long run Australia must diversify its exports
towards high-growth, high value-added sectors of global trade, including technology
and elaborately transformed manufactures (ETMs) – that is, technologically
advanced goods and services, as opposed to simply transformed manufactured goods
or commodity exports. Services exports provide many of the strongest growth
opportunities, given Australia’s close proximity to emerging economies in Asia.
Continued growth in services exports is essential to diversifying Australia’s export
base since Australia is chiefly a service-based economy. Prior to the impact of
COVID-19, Australia’s services exports reached a peak of $96.6 billion in 2018–19,
after a sustained period of double-digit annual growth for most of the 2010s.
Australia’s services exports fell to $61.1 billion in 2021–22 before rebounding to
$93.5 billion in 2022–23.
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Australia in the Global Economy 2024
Cyclical factors
The net primary income deficit reflects Australia’s net servicing costs for its foreign
liabilities. These can take the form of interest repayments on foreign debt or dividend
payments and profits on foreign equity. The three main factors that drive these servicing
costs are domestic economic growth, the exchange rate and interest rates.
• Domestic economic growth: When the domestic economy experiences strong
growth, company profits rise, and these profits are redistributed to shareholders as
dividends. In Australia, approximately 40 per cent of the Australian public share
market is foreign-owned. As a result, a large proportion of dividends flow out of
Australia as payments to overseas shareholders. This means that higher domestic
profits tend to increase equity servicing costs in the form of dividend outflows,
which then increase the net primary income deficit. Since Australia’s mining sector
is mostly owned by foreign companies, a high level of profits in the mining sector
results in a significant dividend outflow from Australia. This has a major influence
on the size of the net primary income deficit.
• Exchange rate: Movements in the exchange rate alter the Australian dollar value of
debt denominated in foreign currencies. This is known as the “valuation effect”. An
appreciation decreases the Australian dollar value of debt denominated in foreign
currencies, decreasing Australia’s debt servicing costs (in Australian dollar terms),
reducing the value of net primary income outflows and reducing the net primary
income deficit. On the other hand, a depreciation of the Australian dollar results
in the opposite impact.
However, the valuation effect on the net primary income account is limited,
particularly in the short term. A large amount of Australia’s foreign debt is
“hedged” in some way (meaning that the lender and borrower will agree to fix
the exchange rate over the course of the loan to reduce the risk of large exchange
rate fluctuations). In addition, a significant part of Australia’s foreign debt is
denominated in Australian dollars, which means it is not affected by exchange
rate movements.
• Changes in interest rates: Australia’s overseas loans can be taken out with overseas
interest rates (when borrowed in foreign currencies) or an Australian interest rate
(when borrowed in Australian dollars). When interest rates change, the cost of
servicing foreign debt also changes. Australia’s sensitivity to global interest rates
was reflected in the cost of debt servicing, almost doubling in 2022–23 from
$18 billion to $33 billion in net terms, as interest rates on debt in both Australian
dollars and foreign currency rose sharply.
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Chapter 4: Australia’s Trade and Financial Flows
Structural factors
The main reason for Australia’s long-term net primary income deficit is an underlying
structural feature of the Australian economy: a gap between savings and investment.
Australia is a relatively small economy with a historically low level of national savings.
At the same time, the Australian economy requires high levels of capital investment
for its economic growth. In particular, Australia’s major export industry, minerals and
resources, requires substantial investment in exploration, capital equipment for extraction
and transport infrastructure from remote locations.
Since Australia is an open economy, firms are able to look to foreign sources of finance to
fund their investment. This means that Australia tends to fund a large part of its investment
through overseas borrowing (which increases foreign debt) or selling ownership stakes in
Australian businesses (which increases foreign equity). This increases Australia’s foreign
liabilities and creates future servicing obligations in the form of interest repayments (on
debt) and dividends (on equity). These servicing costs are recorded as outflows on the net
primary income account and are the major reason why the current account remained in
deficit until recent years even as Australia sustained trade surpluses.
On the other hand, the growth in Australia’s overseas investments (which has been led by
Australia’s large volume of superannuation funds) results in inflows of earnings on those
investments, which improve the net primary income balance. Two factors that contributed
to the trend towards a lower primary income deficit in the 2010s are increased returns on
overseas equity held by Australian investors and a lower exchange rate.
Historically, Australians have had low levels of household and public savings. Australian
households are highly leveraged compared to other countries, with twice as much debt (as
a proportion of their household income) as two decades ago. Household savings increased
dramatically during the COVID-19 recession in 2019–20, as households had fewer
opportunities to spend and many also benefited from COVID-19 economic government
support payments. However, the increase in savings was not sustained. Households began
spending these savings when the economy rebounded. Likewise, when interest rates rose to
combat higher inflation, many people had to save less to cover the increased cost of living.
At the same time, Australian governments have substantially increased their borrowings
during the past decade, detracting from the overall level of national savings.
% %
24 24
22 22
20 20
18 18
16 16
14 14
12 12
10 10
8 8
6 6
4 4
2 2
0 0
−2 −2
−4 −4
2001–02
2003–04
2005–06
2007–08
2009–10
2011–12
2013–14
2015–16
2017–18
2019–20
2021–22
2022–23
1981–82
1983–84
1985–86
1987–88
1989–90
1991–92
1993–94
1995–96
1997–98
1999–00
Year
Source: ABS Australian National Accounts: National Income, Expenditure and Product (Cat. no. 5206.0)
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Australia in the Global Economy 2024
Governments can increase Australia’s national savings through policies to increase the level
of personal savings (such as increasing the rate of compulsory superannuation, removing
incentives in the tax system that encourage increased debt and encouraging increased
savings through tax incentives). Governments can also increase public savings by reducing
budget deficits and moving the public sector into surplus through fiscal consolidation.
A budget deficit is a form of negative public savings, whereas a budget surplus makes a
positive contribution to the level of national savings. While the COVID-19 pandemic
required historically unprecedented levels of government spending to prevent a major
economic downturn, a key issue for economic debate in the 2020s will be the speed of
deficit reduction, which will have a long-term influence on the savings/investment gap
and therefore on the balance of payments.
reviewquestions
1 Discuss THREE trends in Australia’s balance of payments performance in
recent years.
2 Explain how changes in commodity prices have influenced Australia’s terms of
trade and the current account in recent years.
3 Analyse the relationship between the level of national savings and imbalances
on the current account.
4 Evaluate recent influences on the current account.
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Chapter 4: Australia’s Trade and Financial Flows
• Constraint on future economic growth – in the longer term, a high CAD may
become a speed limit on economic growth. Higher levels of economic growth
generally involve an increase in imports and a deterioration in the CAD. Economies
with a CAD problem are therefore forced to limit growth to the level at which
the CAD is sustainable. This is known as the balance of payments constraint.
• More contractionary economic policy – if they find it necessary to reduce a high
CAD in the short term, governments may use tighter macroeconomic policies and
accelerate the implementation of microeconomic reform. In the short run, tighter
fiscal and monetary policies will reduce economic growth and contribute to a
lower CAD.
• A sudden loss of international investor confidence – economic crises can
sometimes be triggered by a sudden shift in the attitude of global markets towards a
country whose external imbalance appears unsustainable. In recent years such crises
have been seen in Sri Lanka and Argentina, reflecting a loss of investor confidence in
response to its unsustainable debt levels. Investor confidence can change suddenly,
and countries with high CADs and foreign debt are more vulnerable to shifts in
investor sentiment.
Although Australia sustained high current account deficits for several decades, concerns
about Australia’s external balance have decreased in recent years. This was especially the
case as the scale and persistence of the mining boom became clearer during the past two
decades. During the era of globalisation, financial markets have become more willing
to accept external imbalances, and have been confident that Australia’s natural resource
wealth will underpin continued strong export growth in the future, allowing Australia to
service its foreign liabilities. A report on Australia’s current account performance by the
International Monetary Fund in 2018 concluded that for the foreseeable future, Australia’s
current account is likely to remain below its pre-2008 levels. It calculated that if Australia
can keep the current account in an average range of 2.5 to 3 per cent of GDP, net foreign
liabilities can be sustained at around 55 per cent of GDP, giving an external position that
the IMF judged to be “broadly consistent with medium-term fundamentals and desirable
policies”. Since then, a series of current account surpluses during recent years have helped
to reduce Australia’s net foreign liabilities.
Some economists warn, nevertheless, that the current account may still re-emerge as a
long-term risk for Australia. Changes in economic conditions, such as a loss of Chinese
export markets or a rise in global interest rates, could see a return of high current account
deficits (as the Treasury forecasts indicate). Sustained current account deficits make
Australia dependent on continuing financial inflows in order to fund the servicing costs
of its high foreign liabilities. They argue that while Australia’s current account has not
been a problem in recent years, this is due to favourable external conditions that could
change in the future – after all, until the sudden onset of the global financial crisis in
2008, investors were willing to lend freely to many economies that then experienced very
deep economic crises. A more diversified export base, and lower net foreign liabilities, could
make the Australian economy more resilient.
reviewquestions
1 Describe THREE consequences of a persistently high current account deficit.
2 Explain how a high current account deficit might affect the exchange rate.
3 Discuss why Australia’s current account has not caused significant problems
for Australia in recent years. Explain whether you think this might change in
the future.
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Australia in the Global Economy 2024
chapter summary
1
The direction of Australia’s exports has shifted considerably in recent years from
the United States, Japan and Europe towards China, Hong Kong, South Korea,
India and the ASEAN countries.
2
Historically, agricultural products such as wheat, wool and beef comprised a large
share of the composition of Australia’s exports. These have declined in relative
importance, while mineral and energy exports, and to a much lesser degree
services, have increased in relative importance.
3
The balance of payments summarises all transactions between Australia
and the rest of the world over a given period of time. The balance of payments
consists of the current account and the capital and financial account.
4
The current account shows the money flowing from all of Australia’s exports
and imports of goods and services, income and transfer payments for a period
of one year. The main feature of current account transactions is that they are not
reversible.
5
The capital account consists of Australia’s capital transfers, such as those from
conditional foreign aid and the purchase and sale of intellectual property rights.
The financial account shows Australia’s transactions in financial assets and
liabilities. The main feature of capital and financial account transactions is that
they are reversible.
The current account and the capital and financial account are closely linked.
6
A deficit on the current account corresponds to a surplus on the capital and
financial account. These surpluses, which cause rising foreign debt or the
sale of Australian assets, result in longer term outflows on the primary income
component of the current account.
The long-term effect of running a current account deficit (CAD) is the growth of
7
foreign liabilities. This may occur in the form of foreign debt or foreign equity
(the sale of Australians’ assets such as land, companies and shares).
10 A persistently high current account deficit may increase foreign liabilities, debt
servicing costs, exchange rate volatility and interest rates, resulting in slower
economic growth. However, financial markets have tolerated deficits for several
decades and, more recently, Australia has seen a series of current account
surpluses.
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Chapter 4: Australia’s Trade and Financial Flows
chapter review
Outline recent changes in the direction and composition of Australia’s trade flows.
1
3 Briefly explain what is meant by the balance of payments. Outline the structure
of the two main accounts of the balance of payments.
4 Explain the relationship between the current account and the capital and
financial account.
Discuss the impact of movements in the exchange rate on the current account.
6
Discuss the role of cyclical and structural factors in influencing the net primary
7
income account.
8 Explain how movements in the terms of trade impact on the current account,
with reference to recent Australian experience.
10 Discuss the possible problems associated with a high current account deficit.
127
5 Exchange Rates
5.1
5.2
5.3
Introduction
Australia’s floating exchange rate system
Reserve Bank intervention in the foreign exchange market
5.4 Fixed exchange rate systems
5.5 Exchange rates and the balance of payments
5.1 Introduction
Exchange rates play a central role in the relationships between individual economies and
the global economy. All trade and financial relationships between countries are mediated
through the exchange of currencies. For this reason, exchange rate movements have a
significant impact on international competitiveness, trade flows, investment decisions,
inflation and many other factors in the economy. Chapter 2 examined how global foreign
exchange markets operate. This chapter will examine more closely where Australia fits into
global foreign exchange markets, and the influences on the value of the Australian dollar.
The exchange rate is the price of Australia’s currency in terms of another country’s
currency. It is the price at which traders and investors can swap Australia’s currency for
another currency. Exchange rates are necessary because exporting firms want to be paid in
their own currency, which means importers need a mechanism to convert their domestic
currency into a foreign currency so they can make payments. For example, a South Korean
firm exporting to Australia wants to be paid in South Korean won (the local currency).
The Australian importer must convert Australian dollars into won in order to make
the payment. To do so, they must know how many won they can buy with their dollars.
This currency conversion occurs in the foreign exchange market (also referred to as the
forex market) where the forces of supply and demand or, in the case of a fixed exchange
rate, the government or its representatives, determine the price of one country’s currency
in terms of another (that is, the exchange rate).
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Chapter 5: Exchange Rates
Countries can use different systems for determining the exchange rate of their currency.
These include a floating system (clean or dirty float), a fixed-rate system and a flexible
peg. Another option for countries with similar regional interests is a currency union with
major trading partners, such as the euro, which is the currency of 20 European Union
members, known as the eurozone, as well as four non-EU countries.
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Australia in the Global Economy 2024
markets and Australia’s inflation rate is relatively low, Australia’s exports will
generally be relatively cheaper and more attractive to foreign buyers.
– Changes in global economic conditions will also influence the overseas demand
for exports. The demand for Australia’s commodity exports is highly dependent
on the growth rates of Australia’s trading partners – when the world economy
is in recession, demand and prices for Australia’s exports fall, and vice versa.
– Tastes and preferences of overseas consumers will also affect the demand for
Australia’s exports.
Supply of Australian dollars is represented by all those people who wish to sell the
currency. The supply of Australian dollars is determined by a number of factors:
• The level of financial flows out of Australia by Australian investors who wish to
invest overseas and who will need to sell A$ and purchase foreign currency.
– The level of Australian interest rates relative to overseas interest rates
influences financial flows out of Australia and the supply of A$. Relatively lower
Australian interest rates will make investing savings overseas more attractive and
hence increase the supply of A$.
– The availability of investment opportunities overseas influences financial flows
out of Australia. Greater opportunities to start businesses overseas or to purchase
shares in overseas companies will increase financial flows out of Australia and
increase the supply of A$.
• Speculators in the foreign exchange market who expect the value of the A$ to
go down will sell A$, increasing the supply of A$ and thus contributing to the
anticipated depreciation.
• The exchange rate will be affected by the domestic demand for imports since
Australian importers who buy from overseas need to sell A$ in order to obtain
foreign currencies to make import payments.
– Demand for imports will be determined by a range of factors within Australia.
One of the most important is the level of domestic income. Strong economic
growth and rising incomes and employment will result in the demand for
imports also rising, increasing the supply of A$.
– The domestic inflation rate and the competitiveness of domestic firms
that compete with imports will also influence import levels. If Australia’s
domestic inflation rate is higher and its import-competing firms are relatively
uncompetitive, imports will be relatively cheaper than domestic products and
demand for imports will be higher.
– Tastes and preferences of domestic consumers change over time and an
increasing preference for goods and services from overseas will raise the supply
of A$ on the foreign exchange market.
In section 5.3, we discuss how governments may intervene in foreign exchange markets
to affect demand and supply and the value of the dollar. In addition, government policy
measures may also indirectly affect the value of the currency. For example, in 2020 when
the Reserve Bank of Australia (RBA) purchased bonds in the bond market (to increase
liquidity and put downward pressure on interest rates), it also had the effect of increasing
the supply of Australian dollars, which the RBA estimated resulted in a 1 to 2 per cent
depreciation of the exchange rate in November 2020. In February 2022, the Reserve
Bank ended its bond purchase program, with the intention of reducing its bond holdings
over time.
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Chapter 5: Exchange Rates
Figures 5.2 and 5.3 show how the exchange rate of the A$ against the US$ can appreciate
(increase) or depreciate (decrease) due to changes in supply and demand.
Figure 5.2 reveals that any increase in the demand for A$ (shift in the demand curve to
the right, from D1 to D2) will increase the price of A$ in terms of US$ (that is, cause an
appreciation of the A$).
D1 D2 D
S S2 S1
0.80 0.80
0.70 0.70
S2
D2
D
S D1 S1
0 0
Quantity A$ Quantity A$
Likewise, any decrease in supply of A$ (a shift in the supply curve to the left, from S1 to
S2) would also cause an appreciation. The appreciation shown in both cases is an increase
in the value of the A$ from US70 cents to US80 cents.
D1 D
S S1
D2
S2
0.70 0.70
0.60 0.60
S D2 D1 D
S1 S2
0 0
Quantity A$ Quantity A$
Figure 5.3 reveals that any decrease in the demand for A$ (shift in the demand curve to
the left, from D1 to D2) will decrease the price of A$ in terms of US$ (that is, cause a
depreciation of the A$).
Likewise, any increase in supply of A$ (shift in the supply curve to the right, from S1
to S2) would also cause a depreciation. The depreciation shown in both cases is a decrease
in the value of the A$ from US70 cents to US60 cents.
A floating exchange rate does not just allow market forces determine the value of a
currency. It also acts as an “automatic stabiliser” to help protect the economy from external
booms or busts. A prime example of this took place during the mining boom in Australia
from the mid-2000s to the early 2010s. The increase in demand for Australian resources
pushed commodity prices up, which subsequently caused the dollar to appreciate. As
a result, industries that did not directly benefit from the mining boom saw their costs
increase and demand for output fall. The appreciation of the dollar helped the economy to
re-allocate labour and capital to the booming mining sector, therefore reducing inflationary
pressures and maintaining a stable employment level within the economy.
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Australia in the Global Economy 2024
APPRECIATION ▲ DEPRECIATION ▼
• an increase in Australian interest rates or decrease in • a decrease in Australian interest rates or increase in
overseas interest rates overseas interest rates
• improved investment opportunities in Australia or • deterioration in investment opportunities in Australia
deterioration in foreign investment opportunities or improvement in foreign investment opportunities
• a rise in commodity prices and an improvement in • a fall in commodity prices and a deterioration in
Australia’s terms of trade Australia’s terms of trade
• an improvement in Australia’s international • a deterioration in Australia’s international
competitiveness competitiveness
• lower inflation in Australia • higher inflation in Australia
• increased demand for Australia’s exported goods and • increased demand for imported goods and services
services • expectations of a currency depreciation based on
• expectations of a currency appreciation based on forecasts of one of the above factors
forecasts of one of the above factors
Figure 5.4 – Main factors causing an appreciation or depreciation of the Australian dollar
Australia has many exchange rates – one for each of the currencies of the countries for
which foreign exchange transactions are required. Thus, it is possible that at any given time
Australia’s exchange rate may be appreciating against some currencies and depreciating
against others. For example, in April 2023, the Australian dollar appreciated against the
Japanese yen but depreciated against the British pound.
A comparison of the value of the dollar against a single currency, such as the US dollar, can
create a misleading impression of trends in the Australian dollar’s value. This is because
just as there are unique factors influencing the Australian dollar, there are also unique
factors influencing the value of the US dollar. For example, the US dollar depreciated
significantly against most currencies during the 2000s. If we only examined the exchange
rate between the Australian and US dollars, and did not make other comparisons, we
Trade Weighted Index
would think that the Australian dollar had appreciated on its own by over 100 per cent
(TWI) is a measure of the of its value during the decade to 2011. In fact, the Australian dollar was rising while
value of the Australian the US dollar was falling, creating an exaggerated impression of the rise in the A$. The
dollar against a basket of Australian dollar rose by a smaller amount against other currencies.
foreign currencies of major
trading partners. These The Trade Weighted Index (TWI) gives an indication of how the value of the A$ is
currencies are weighted moving against all currencies in general. The TWI is calculated by measuring the value
according to their of the A$ against the currencies of Australia’s major trading partners compared with a
significance to Australia’s base year. The currencies of the countries that are more prominent in Australia’s trade are
trade flows.
given a higher weighting so that they have a greater influence on the TWI.
Figure 5.5 – Trade Weighted Index: the currency weightings of Australia’s top 10 trading partners
Figure 5.5 indicates how the TWI is calculated. Each year, the Reserve Bank amends the
measurement of the TWI based on the volumes of trade for the previous financial year.
The total number of countries included in the TWI must cover at least 90 per cent of
Australian trade (in 2023, 17 countries were included in the TWI calculations). During
the last two decades, the relative significance of the exchange rates with the Japanese yen
and the US dollars have declined, while the exchange rate with the Chinese renminbi has
become more important.
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Chapter 5: Exchange Rates
An important limitation of the TWI exchange rate measurement is that the weighting is
only based on volumes of trade regardless of the currency in which exports and imports
are invoiced. In fact, Australia often sells its commodities in US dollars even when trading
with another country such as Japan or South Korea. In fact, almost 90 per cent of For the latest statistics
and analysis of exchange
Australia’s merchandise exports and more than half of imports are priced in US dollars.
rate movements, visit the
As a result, the A$/US$ exchange rate is far more important than the weight it receives website of the Reserve Bank
in the TWI calculation. This is important when analysing the impact of movements in of Australia: www.rba.gov.au
the A$ against the US$ and TWI on Australia’s trade and financial flows.
70 0.85
60 0.70
50 0.55
40 0.40
1981–82
1983–84
1985–86
1987–88
1989–90
1991–92
1993–94
1995–96
1997–98
1999–00
2001–02
2003–04
2005–06
2007–08
2009–10
2011–12
2013–14
2015–16
2017–18
2019–20
2021–22
2022–23
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Australia in the Global Economy 2024
Figure 5.7 shows exchange rate movements since 2000–01 for the currencies of some of
Australia’s major trading partners as well as the TWI. It shows that while there are often
sustained trends, such as the overall depreciation of the Australian dollar over the period
2022–23, there are also years that break the trend, such as the appreciations experienced
in 2016–17 and again in 2020–21.
The Chinese yuan is the Year US dollar Euro Japanese yen Pound sterling Chinese yuan TWI
basic unit of the Chinese 2000–01 0.54 0.60 61.5 0.37 4.40 50.3
currency, the renminbi.
The yuan and renminbi 2010–11 1.03 0.72 82.1 0.62 6.60 74.0
are referred to in a similar 2011–12 1.01 0.80 81.9 0.65 6.58 76.0
way that economists refer
to the British currency as 2012–13 0.92 0.68 95.0 0.55 6.39 73.5
sterling and its unit as the
2013–14 0.91 0.69 94.2 0.56 5.62 70.7
British pound.
2014–15 0.79 0.68 93.7 0.51 5.13 64.7
Sources: ABS Australian Economic Indicators (Cat. no. 1350), Balance of Payments and International Investment
Position (Cat. no. 5302) and Reserve Bank of Australia.
reviewquestions
1 Define the term exchange rate.
2 Describe how the Trade Weighted Index (TWI) is calculated and explain why
it is a better measure of the value of the Australian dollar than the US$/A$
exchange rate.
3 Account for recent movements in the A$.
4 Outline the possible impact of the following scenarios on the Australian dollar:
a) an increase in commodity prices and Australia’s terms of trade
b) overseas consumers switching to Australian exports
c) speculators believing that the Australian dollar will soon appreciate
d) an increase in Australia’s economic growth rate
e) an increase in interest rates overseas.
5.3 R
eserve Bank intervention in the
foreign exchange market
Although Australia relies primarily on market forces to determine the exchange rate, the
Reserve Bank of Australia (RBA) sometimes plays a role in influencing the value of the
currency. While the RBA cannot change the value of the Australian dollar in the long
term, it is able to smooth out swings in the dollar relating to short-term factors. It can
do so by dirtying the float and through monetary policy intervention.
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Chapter 5: Exchange Rates
reviewquestions
1 Explain how the Reserve Bank of Australia could directly intervene in the
foreign exchange market to prevent a rapid depreciation of the Australian
dollar. Discuss the limitations of this method of intervention.
2 Explain the impact of a decrease in Australian interest rates on the
Australian dollar.
3 Explain what is meant by a dirty float of a currency.
4000
3500
3000
2500
2000
1500
1000
500
0
2002
2004
2023
2020
2022
1990
1992
1994
1996
1998
2000
2006
2008
2010
2012
2014
2016
2018
Source: State Administration of Foreign Exchange of the People’s Republic of China March figure Year
reviewquestions
1 Explain, using graphs, how the Reserve Bank of Australia can influence the
exchange rate by buying and selling Australian dollars.
2 Outline the risks of operating a fixed exchange rate system.
3 Distinguish between a fixed exchange rate and a managed flexible peg.
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Australia in the Global Economy 2024
The following example demonstrates how a change in the current account can influence
the exchange rate and the capital and financial account. If the value of imports increased,
while exports remained unchanged, this would result in a deterioration in the current
account. It would also cause an increase in the supply of A$ (importers will be selling more
A$ in order to buy foreign currency), resulting in a depreciation of the currency. Also,
because of the depreciation, a given level of financial inflows would be able to buy more
A$. Therefore, the positive balance on the capital and financial account would increase in
A$ terms to match 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) would most likely lead to a
depreciation of the A$ and an increase in the surplus on the capital and financial account.
On the other hand, an improvement in the current account would result in an appreciation
of the A$ and a decrease in the surplus on the capital and financial account.
The effect of the balance of payments on the exchange rate also depends on the perceptions
of financial markets. If financial markets are concerned that a current account deficit 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, the dollar
may appreciate despite increases in a current account deficit if financial markets believe
the external position is sustainable and they have confidence in Australia’s future economic
prospects. For example, the Australian dollar appreciated to over US95 cents in mid-2008,
a time when the current account deficit was large, but investors believed that Australia’s
current account problems did not pose a short-term economic risk, and they expected that
Valuation effect is the current account would improve as a result of high commodity prices. The COVID-19
where an appreciation recession likewise showed that an improvement in the balance of payments may not be
(or depreciation) of the the largest influence on the exchange rate in any one year. After 2019, despite the current
currency causes an
account moving into surplus (after almost half a century in deficit), the exchange rate
immediate change in the
depreciated (because of other factors).
Australian-dollar
value of foreign debt Recent years indicate the most significant influence on exchange rate movements is how
that is borrowed in financial markets choose to react to developments in economic indicators (such as the
foreign currencies or balance of payments) and sometimes those reactions are difficult to predict. This results
foreign assets held by in greater instability in foreign exchange markets because market sentiment can change
Australians.
quickly.
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Chapter 5: Exchange Rates
An appreciation
NEGATIVE EFFECTS
• B
y increasing the value of the A$ in terms of other currencies, Australia’s exports
become more expensive on world markets and therefore more difficult to sell, leading to
a decrease in export income and a deterioration in Australia’s CAD in the medium term.
• Imports will be less expensive, encouraging import spending and worsening Australia’s
CAD. Domestic production of import substitutes is likely to fall.
• Higher import spending and reduced export revenue will reduce Australia’s economic
growth rate.
• Foreign investors will find it more expensive to invest in Australia, generally leading to
lower financial inflows. However, financial inflows may continue if foreign investors expect
the currency to continue rising.
• An appreciation reduces the A$ value of foreign income earned on Australia’s investments
abroad and would cause a deterioration in the net primary income component of the CAD.
• An appreciation will also reduce the value of foreign assets in Australian dollar terms – a
phenomenon known as the valuation effect.
POSITIVE EFFECTS
• Australian consumers enjoy increased purchasing power – they can buy more overseas
produced goods with the same quantity of A$.
• A
n appreciation decreases the interest servicing cost on foreign debt because Australians
can buy more foreign currency with Australian dollars. This would reduce outflow on the
net primary income component of the current account in future years and help reduce
Australia’s CAD.
• An appreciation will also reduce the A$ value of foreign debt that has been borrowed in
foreign currency – a phenomenon known as the valuation effect.
• For Australian investors looking to purchase overseas assets, an appreciation will reduce
the price of those assets.
• Inflationary pressures in Australia will be reduced as imports become cheaper. This is
likely to reduce pressure on the RBA to raise interest rates to defend its inflation target.
A depreciation
NEGATIVE EFFECTS
• Australian consumers suffer reduced purchasing power – they can buy fewer overseas
produced goods with the same quantity of A$.
• A depreciation increases the interest servicing cost on Australia’s foreign debt because
Australia can buy less foreign currency with its domestic currency with which to pay
interest. This increases income outflow on the net income component on the current
account and thus increases Australia’s CAD.
• A depreciation will also raise the A$ level of foreign debt that has been borrowed in
foreign currency as expressed in Australian dollar terms – a phenomenon known as the
valuation effect.
• A depreciation will raise the price of overseas assets that are being purchased by Australian
investors.
• Inflationary pressures in Australia will increase as imports would now be more expensive.
This may increase pressure on the RBA to raise interest rates to defend its inflation target.
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Australia in the Global Economy 2024
POSITIVE EFFECTS
• By decreasing the value of the A$ in terms of other currencies, Australia’s exports
become cheaper on world markets and therefore easier to sell, leading to an increase
in export income and an improvement in Australia’s CAD in the medium term. A
weaker A$ following the end of the commodities boom is largely credited with helping
the Australian economy adjust to reduced income from mining by increasing the
international competitiveness of other sectors.
• Imports will be more expensive, discouraging import spending and potentially improving
Australia’s CAD. Domestic production of import substitutes should also rise.
• Lower import spending and greater export revenue will increase Australia’s growth rate,
but this may not happen if Australia is unable to replace its imports with domestically
produced goods.
• A depreciation increases the A$ value of foreign income earned on Australia’s
investments abroad and would cause an improvement in the net primary income
component of the CAD.
• A depreciation will also increase the value of foreign assets in Australian dollar terms – a
phenomenon known as the valuation effect.
• Foreign investors will find it less expensive to invest in Australia, generally leading to
greater financial inflows. However, financial inflows may dry up if foreign investors
expect the currency to continue falling.
The impact of exchange rate movements on the value of Australia’s foreign assets
and liabilities (and consequently, the balance of payments) ultimately depends on the
currencies in which they are denominated. An analysis of Australia’s liabilities reported
in the RBA Bulletin in 2023 made the surprising conclusion that a depreciation of the
Australian dollar may reduce rather than increase Australia’s net foreign liabilities because
of the composition of those liabilities. Australia’s liabilities are largely denominated in
Australian dollars while our assets are largely denominated in foreign currencies. The
article concluded therefore that “the Australian economy overall is well protected from
vulnerabilities associated with a depreciation of the exchange rate, despite its net foreign
liability position.”
Given the positive and negative effects of both depreciations and appreciations, we might
ask the question: do economists and policy makers favour a higher or lower exchange rate?
The answer is that economists mostly favour an exchange rate values that reflects the true
forces of supply and demand. These “true” supply and demand forces would result from
the exchanges of goods, services and finance between Australia and the rest of the world,
but would not include exchange rate changes due to speculation. Speculators who buy or
sell A$ in anticipation of a change in the currency distort exchange rate movements and
they increase exchange rate volatility by exaggerating upwards and downwards cycles.
One of Australia’s problems is that it is a small economy that relies on substantial financial
inflows to deal with its large external imbalances. This has traditionally made the A$ a
“hot money” currency, which makes it more vulnerable to speculators than many other
advanced economies. Excessive speculation and volatile currencies have become major
global economic issues during the globalisation era, with many countries experiencing
large swings in their currencies.
reviewquestions
1 Critically evaluate whether the value of the A$ is likely to be higher or lower
against the US$ by the end of this year. Justify your forecast. (Hint: check the
currency forecasts on the websites of any of the major Australian banks.)
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Chapter 5: Exchange Rates
chapter summary
1 The exchange rate is the price of Australia’s currency in terms of another
country’s currency.
2 nder Australia’s floating exchange rate system, the value of the currency
U
is determined by the interaction of the forces of demand and supply in the
marketplace, which determine an equilibrium value for the currency. This
equilibrium changes regularly (the levels of minute by minute) as supply and
demand change.
5 he two main exchange rates are the Australian dollar against the United
T
States dollar, the world’s leading currency, and the Trade Weighted Index,
which is a basket of currencies weighted according to their significance to
Australia’s trade patterns.
6 The Reserve Bank of Australia (RBA) can influence the value of the dollar by
intervening directly in foreign exchange markets through buying or selling the
dollar with the aim of influencing its value, which is known as dirtying the float.
7 The RBA can also influence the currency’s value through monetary policy
decisions. For example, an increase in the level of interest rates will tend to attract
financial flows into Australia and raise the value of the currency.
8 Under a fixed exchange rate system the value of the currency is normally
determined by the central bank, either for the longer term or on a day-to-day
basis through a flexible peg system.
10 Movements in the value of the exchange rate can have an impact on the level of
inflation, international competitiveness, the level of exports and imports, foreign
debt servicing costs, the current account and the rate of economic growth.
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Australia in the Global Economy 2024
chapter review
1 Describe what is meant by the exchange rate.
2 Outline the factors that affect the demand for Australian dollars.
4 With the aid of a diagram, explain what is meant by a fixed exchange rate system.
Outline the problems that the RBA could experience when maintaining a fixed
exchange rate.
5 Explain what is meant by a depreciation of the dollar. With the aid of a diagram,
describe how a depreciation may occur.
6 Outline what is meant by the Trade Weighted Index. Identify why it is useful for
analysing movements in the value of the Australian dollar.
7 Explain how, under our present floating exchange rate system, the Reserve Bank
can influence the exchange rate:
8 Examine how the exchange rate will be influenced by a deterioration in the current
account.
10 Discuss how speculation can influence the value of the Australian dollar.
142
Protection
in Australia 6
6.1 Introduction
6.2 Government initiatives to reduce protection
6.3 Australia’s free trade agreements
6.4 Implications of a reduction in protection levels for the Australian economy
6.5 The impact of international protection levels on Australia
6.6 The future of Australian industry in the global economy
6.1 Introduction
Trading relationships have long been important to the Australian economy. Australia’s
distance from the rest of the world, and the relatively high proportion of output that is
traded, mean that barriers to trade have a significant effect on the economy, whether these
For further information
barriers are within Australia or in overseas markets. Over the past 50 years, the Australian
on Australian trade rules
economy has benefited from the gradual removal of trade barriers. Although the momentum and agreements, visit the
towards freer trade has faltered in recent years, Australia remains a vocal advocate for further Department of Foreign
trade liberalisation. Protectionist sentiments around the world have gathered strength over Affairs and Trade (DFAT)
the past decade, and the COVID-19 crisis alongside rising geopolitical tensions have added website dfat.gov.au, the
Productivity Commission
to this trend. In addition to its immediate impacts on trade in goods and services, the
pc.gov.au and the Bureau
pandemic and the war in Ukraine have sparked a broader debate about whether globalisation of Agricultural and Resource
has left economies too dependent on vulnerable global supply chains that might fail in a Economics and Sciences:
time of crisis. agriculture.gov.au/abares
Historically, Australia was one of the most highly protectionist countries in the world. Using the DFAT website,
identify current negotiations
Governments felt it was necessary to protect Australian manufacturers, who for many being undertaken by the
years found it difficult to compete because of the relatively small population and low Australian Government
production levels in Australia. However, beginning in 1973, Australia began to shift for future bilateral and
away from protectionism, and throughout the 1990s and 2000s, Australia phased out regional trade agreements.
almost all tariffs. Australian leaders often describe our economy as one of the most open
economies in the world.
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Australia in the Global Economy 2024
144
Chapter 6: Protection in Australia
When other protectionist methods, such as subsidies to domestic producers, are taken into
account, Australia is one of the least protectionist economies in the world. Australia
provides far fewer subsidies for domestic producers compared with North America, Western
Europe and East Asia, where they play a significant role in boosting the competitiveness
of these countries’ agricultural sectors. In 2021, Australia had among the lowest levels of
agricultural protection in the OECD, with subsidies accounting
for less than 3 per cent of farm income. By comparison, subsidies WHY DID CHINA SLAP TARIFFS
accounted for 11 per cent of farm income in the US, 18 per cent ON AUSTRALIA IN 2020?
in the EU and 49 per cent in South Korea.
While protection and direct assistance for producers has been In 2020, the Chinese Government imposed tariffs of
80 to 200 per cent on Australian exports of wine, and
substantially reduced during recent years, some export assistance
on exports of barley, a type of grain used to make
programs still exist. These programs are administered through
beer and to feed livestock. Officially, the Chinese
Austrade (the Australian Trade and Investment Commission). government described the tariffs as “anti-dumping”
Austrade’s assistance for exporters includes financial assistance, and “anti-subsidy” penalties. However, no evidence
information on potential export markets and marketing advice. of dumping was provided. China also restricted other
The main program that Austrade administers is the Export Australian exports – such as cotton, coal, lobsters and
Market Development Grants (EMDG) scheme, which since timber – through unofficial channels, by instructing
1974, has supported more than 51,000 small- and medium-sized importers not to buy from Australia, or by imposing
exporters in promoting their exports in over 180 countries. A overly strict customs and regulatory barriers targeted
2023 operational review found that the EMDG program had at Australian products.
achieved its goals of simplifying and streamlining assistance Most economists saw the tariffs as retaliation
for promotional activities, developing marketing skills, and against Australia for policy decisions perceived to
delivering improvements to program design and access to be anti-Chinese. These included restricting some
information for exporters. major Chinese investments in Australia (such as the
construction of Australia’s 5G mobile network) and
Australia’s reductions in protection levels have typically gone advocating an international inquiry into the origins of
well beyond those required by international trade agreements COVID-19, which was seen by Chinese officials as an
such as the World Trade Organization (WTO) agreement. While effort to blame China for the pandemic. The measures
some other countries have only reduced protection levels to the could also have been partly motivated by Australia’s
extent required by their trade agreements, Australia has pursued own anti-dumping measures on Chinese steel and
a general strategy of phasing out protection. A Trade Policy aluminium products. As a result of the trade bans,
Review of Australia by the WTO in 2020 commended exporters sought to grow sales in other markets,
Australia’s trade policies and highlighted only a few examples including India, Japan and South Korea. Improving
where policy changes could further liberalise trade. These Australia’s relationship with China has been a priority
included Australia’s tax on luxury cars (which hurts exports from of the Albanese Government, and during 2023, China
removed restrictions on Australian coal, timber and
particular countries), certain foreign investment restrictions, and
barley, with the prospect that it may also reduce other
Australia’s prolific use of anti-dumping measures. (The WTO
barriers to Australian exports.
report implied that Australia may have been overzealous with
these measures, implementing some when they may not have
been justified.) Australia’s use of anti-dumping measures has also been criticised within
Australia, with the Productivity Commission arguing in a 2016 report that often there is
insufficient economic justification for these measures, and they generally have negative
overall impacts. Nevertheless, changes to Australian laws in 2017 made it even easier for
governments to keep enforcing anti-dumping measures after the related dumping activity
has stopped. In addition, despite the closure of Australia’s car manufacturing industry, the
Australian Government still imposes tariffs on new cars and heavily restricts the importation
of second-hand cars.
reviewquestions
1 Outline trends in Australia’s protection levels over recent decades.
2 Explain the government’s main objectives in reducing protection levels.
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The Australia–United States Free Trade Agreement (AUSFTA), in operation since 2005, provides
significant tariff reductions on a number of goods, especially in agriculture and manufacturing. In particular,
automotive tariffs were eliminated immediately, and tariffs on all goods were eliminated from 2015.
Between 2005 and 2020, two-way trade between Australia and the US nearly doubled, while two-way
investment flows have nearly tripled since the agreement has been active. The US is currently Australia’s
second-largest trading partner.
The Korea–Australia Free Trade Agreement (KAFTA), in operation since late 2014, improves access for
Australian exporters to the US$1.5 trillion South Korean economy, with tariff-free exports rising from 84 per
cent to 99 per cent of exports over the next 20 years. The agreement also facilitates more services trade
in legal, accounting, financial, engineering, telecommunications and education services. The agreement
seeks to improve opportunities for Australian investors and investments in South Korea, and will help
attract direct investment from South Korea into Australia. Two-way trade between the countries increased
by over 40 per cent between 2015 and 2019.
The Australia–United Kingdom Free Trade Agreement (A–UKFTA) came into force in May 2023, resulting
in no tariffs on over 99 per cent of Australian exports. Over the first 10 years of the agreement, tariff quota
volumes on agricultural products including beef, sheep meat, dairy and sugar will be eliminated completely.
The agreement is expected to avoid $200 million per year in tariffs and result in cheaper imports for
consumers and lower input costs for Australian businesses. The deal also supports Australians applying
for working holidays in the United Kingdom by raising the age cut-off for applications (from 30 to 35) and
extending the maximum stay.
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Chapter 6: Protection in Australia
in a time of rising protection. Nevertheless, they are widely used, with a 2018 study of
Free Trade Agreement Utilisation by PwC finding that 62 per cent of Australian businesses
used at least one FTA in exporting products, and 78 per cent use them in importing.
One of the challenges of having so many bilateral trade agreements around the world is
that they create a complex web of overlapping and inconsistent trade rules for exporters
and importers. For instance, an exporter may have to comply with very different rules in
order to sell the same product in different foreign markets. These complex rules can create
inefficiency. In 2022, the Productivity Commission estimated that the cost of collecting
tariffs under the current tariff system was between 59 cents and $1.57 per dollar of tariff
revenue raised.
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Australia in the Global Economy 2024
Administration in 2017). In 2021, the UK formally requested to join the agreement, with
negotiations for its inclusion substantially completed in early 2023.
During the 1990s, Australia’s multilateral trade negotiations focused on the Asia-Pacific
Economic Cooperation (APEC) forum. In 1994, the APEC forum set a target of free
trade by 2020. This goal was never formalised in a trade agreement, and for most of its
history the annual meeting of APEC forum leaders each November has focused on other
priorities such as terrorism and climate change. APEC has therefore receded over the years
from the centre of Australia’s trade policy. A 2020 analysis by the APEC Policy Support
Unit nevertheless argued that, even without binding commitments, the forum has
indirectly supported trade liberalisation among its members. Since 1994, average tariff
levels have fallen from 17 per cent to around 5 per cent, the proportion of tariff-free goods
has increased to over 60 per cent, and over 150 free trade agreements have been
implemented involving APEC members.
reviewquestions
1 Distinguish between a bilateral trade agreement and a multilateral
trade agreement.
2 Explain the key features of TWO of Australia’s bilateral trade agreements.
3 Compare and contrast TWO of Australia’s multilateral trade agreements.
Effects on firms
While the long-run effect of reduced protection on businesses may be beneficial, as shown in
figure 6.3, there is no doubt that reducing protection creates winners and losers, particularly
in the short run. Individual firms that operate in marginal, import-competing industries
will shrink unless they are able to improve their competitiveness. In some cases, production
in some sectors of the economy ceases altogether – for example, the manufacturing of
• Import-competing industries go out • Structural unemployment increases as • Cutting tariffs will reduce government revenue
Short of business
• Lower tariffs provide lower input
inefficient firms close
• Consumers gain access to wider
• Reducing protection may have adverse political
consequences
run costs for firms variety of goods at lower prices • Government spending on structural adjustment
programs may increase
Long • Efficient firms restructure operations • Job opportunities increase in • Sustainable economic growth should
run
to compete on global stage internationally competitive sectors raise revenue
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Chapter 6: Protection in Australia
consumer electronics products such as televisions, sound systems and microwave ovens in
advanced economies such as Australia has almost entirely ceased (with car manufacturing
in Australia ceasing in 2017). This is because manufacturing of these products generally
requires high production volumes and a large workforce, and advanced economies cannot
compete with the lower-wage costs of emerging economies such as China and Vietnam.
Some businesses will respond to a phasing out of protection by restructuring their operations
with the aim of staying in business or perhaps putting their focus on specialising in one
aspect of production. This restructuring may involve measures such as consolidating their
manufacturing processes down to a single plant, eliminating less profitable product lines,
finding opportunities for exporting in response to the decline in their share of the domestic
market, adopting new production technologies in order to reduce production costs, or
reducing staffing levels.
The aim of removing protection for local industries is to force them to develop
the innovation and efficiency that is necessary to compete on the world stage. By 1989–90
Total exports = $61 billion
operating in a competitive domestic market, Australian firms should be better able Exports % of GDP = 14%
to compete in global markets. This should also result in higher levels of investment
for those firms that survive, as Australian businesses invest in improving their Other
technology or expanding their business. Productivity Commission research shows 11%
M
an
that reducing tariffs spurs innovation and productivity growth through increased Rural 23%
uf
ac
competitive pressure. 13%
tu
rin
g
Lower tariffs can also generate benefits for firms by reducing the price of imports
that they use as inputs in their production processes. For example, mining companies Services
Minerals and 20%
in Australia rely on machinery produced overseas to extract commodities such as metals
33%
coal and gas. Eliminating tariffs that reduce businesses’ inputs costs lowers their
production costs and makes them more internationally competitive when selling
final goods to consumers. For example, the removal of tariffs on inputs such as farm
machinery has improved the competitiveness of Australia’s agricultural industries. 2022–23
Total exports = $694 billion
Indeed, this is why the agricultural industry’s lobby group, the National Farmer’s Exports % of GDP = 32%
Federation, has supported reducing levels of industry protection for many years. The
Productivity Commission estimated that the cost imposed by tariffs in Australia Other Rural
Ma
By creating winner firms and loser firms, changes to trade protection have affected Services
tur
ing
the overall composition of Australia’s exports. During the 1990s, the reduction in 12%
expected to remain in place for at least the medium term, with natural gas and
lithium expected to be strong drivers of export growth in the coming years.
Source: ABS International Trade in Goods and
In addition to the changing composition of exports during this period, there has Services, Australia (Cat. no. 5368.0)
Numbers may not add to 100 per cent due to
also been substantial overall growth in export volumes, suggesting that Australia rounding
is becoming more integrated with the world economy. A higher proportion of
Australia’s production is being exported, and equally, a higher proportion of the Figure 6.4 – Changes in Australia’s
goods and services that Australians consume are imported. export profile in the past decades
Effects on individuals
Individuals can experience substantial dislocation as a result of reduced protection levels,
in particular through the increase in unemployment associated with the restructuring of
industries, and cuts in local production. The impact of these job losses can be particularly
harsh on individuals who have worked in these industries for a long time and have limited
alternative job opportunities.
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Australia in the Global Economy 2024
• T
he import-competing industries that were most affected by reductions
LESSONS FROM COVID-19: in protection have been concentrated in particular regions, such as the
DOES AUSTRALIA NEED manufacturing areas of Victoria and South Australia, where there are
INDUSTRY PROTECTION fewer alternative sources of employment. With reductions in protection,
TO MAKE ITS SUPPLY unemployment rates in these areas climbed dramatically and it was
CHAINS MORE RESILIENT? difficult for people who lost jobs in these areas to find alternative
employment.
Australia grappled with supply shortages
for essential medical and other items • M
any of the jobs lost in the manufacturing sector because of lower
during the COVID-19 pandemic, protection are relatively low-skilled, production-line jobs. The limited
including vaccines, face masks, cars skills that workers develop in these jobs are not easily transferred to
and smart televisions. The shortages of other workplaces, especially at a time when the overall number of people
goods occurred when transport networks employed in many of the manufacturing industries has been declining.
and overseas producers were disrupted
People who lose jobs as a result of tariff cuts
or could not expand production to
often join the ranks of the structurally CLOTHING TARIFF CUTS
meet demand during the pandemic.
These shortages stoked debate about
unemployed, because they often find that
their skills do not match the job vacancies in The reductions in tariffs on clothing
whether the phasing out of protection
the economy. It may then become necessary goods from 17.5 per cent to
left Australia vulnerable to global supply
10 per cent in 2010 were strongly
chains that fail in times of greatest need. for these workers to retrain to develop work
opposed by manufacturing industry
The Productivity Commission (PC)
skills that are relevant to the current needs
employees. In the lead up to the
evaluated these issues in its 2021 report of the economy. Australian governments cuts, some workers took their
Vulnerable Supply Chains and concluded have funded many adjustment programs, campaign to the Parliament House,
that free trade policies actually make such as the $155 million Growth Fund arguing that the decision would
supply chains more resilient. The report to support the transition away from the create unemployment. A report
argued that with fewer barriers to trade, automotive industry after it was announced by the Productivity Commission
there are more suppliers. In other words, that domestic car production would end in estimated that the lower clothing
diversification of suppliers, rather than 2017. tariffs would reduce industry
“onshoring” production, is the best way employment by over 5 per cent –
to make supply chains more resilient.
However, the effects of reduced protection
the equivalent of over 1500 jobs.
Overall, the PC estimated that only on employment patterns are not entirely However, the government decided
around 5 per cent of goods imported negative. While unemployment is likely to proceed with the cuts because
by Australia come from vulnerable to increase in the short term due to cuts in there would be overall economic
supply chains. Roughly two-thirds of protection, in the longer term employment benefits, including lower prices
these imports come from China. The PC levels may increase. Provided the process of for consumers, a view strongly
rejected the case for increased industry structural change promotes internationally supported by the Productivity
protection. competitive firms in the future, the lost Commission. A further reduction to
In 2023, with the United States and employment opportunities should be more 5 per cent was implemented in 2015.
other economies increasing production than recouped by the growth experienced
subsidies and local content rules, the by those sectors in the economy that are efficient and internationally
Productivity Commission’s Advancing competitive. For example, while manufacturing industries declined in recent
Prosperity report recommended that decades, new export industries such as liquefied natural gas (LNG) have
government intervention should be a grown. Before 1989, Australia did not export any LNG at all. Australia is
last resort, and should only support
now one of the world’s largest LNG exporters. The problem with reducing
high-risk and critical supply chains. It
protection in overall terms may not be that it raises the total level of
also recommended that any supply chain
assistance should be subject to an
unemployment, but that the gains and losses from protection cuts are
assessment by the Office of Supply distributed unevenly throughout the population, with some communities
Chain Resilience, with public reporting and individuals winning while others lose out.
on the justification, benefits and costs of One way in which all individuals can benefit from lower levels of protection
any intervention. is in their capacity as consumers. Lower trade barriers have resulted in
consumers being able to buy a wider variety of goods at lower prices. For
example, research by the Centre for International Economics found that the national price
level in Australia was 3.4 per cent lower in 2016 because of reductions in trade protection
that have been implemented since 1986 (see the box below for more details of the research).
The increased level of competition has also contributed to improved customer service from
firms in some sectors. Figure 6.5 shows how the removal of tariff protection lowers the
domestic price of products (from PT to PW), and increases the amount of foreign products
available (from Q2Q3 to QQ1).
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Chapter 6: Protection in Australia
The phasing out of trade barriers and the opening up of the Australian economy
Price
to global markets is intended to improve living standards for individuals. D (domestic) S (domestic)
The quality of goods and services is higher because globally competitive
businesses enter Australian domestic markets, forcing domestic firms to
lift their game. Highly competitive markets also tend to encourage greater
innovation as firms seek to differentiate themselves from competitors. The
PT
domestic presence of many firms that operate in global markets also ensures
that innovations in other markets are brought into Australia more quickly.
PW
Effects on governments D
S
Cutting tariffs will lead to a reduction in government revenue, since 0 Q Q2 Q3 Q1
Quantity
tariffs provide indirect tax revenue to the government. In the early years of
Australia’s nationhood at the beginning of the 20th century, tariffs provided Figure 6.5 – The effect of tariff reductions
the largest source of revenue to the Commonwealth Government. Indeed,
the two largest political parties were the Protectionist and Free Trade parties. In contrast,
there is general agreement about free trade among Australia’s major political parties, and
tariff revenue is now only a minor source of revenue. The approximately $1.9 billion in
tariff revenue collected by the government in 2023–24 accounted for about 0.3 per cent
of its total revenue.
A program of reducing protection levels may also have effects on the levels of
government spending. Governments may be required to assist the structural ECONOMIC BENEFITS
adjustment process through increased expenditure on unemployment benefits OF TRADE
and retraining programs to aid individuals who lose their job. For example, for Australia’s trade liberalisation policy
workers who lose their jobs because of restructuring, motor vehicle industry between 1986 and 2016 increased
policy includes specialised assistance such as job search assistance, relocation GDP by 5.4 per cent and increased
assistance and industry-specific training. average family income by up to
Governments can also be affected by the political consequences of tariff $2670, according to modelling by the
reductions. Despite the general consensus among economists that cutting Centre for International Economics.
protection will benefit the economy, this policy is generally unpopular with the Overall benefits included:
wider community. The costs of lower protection are highly visible: structural Gross Domestic Product + 5.4 %
unemployment, the closure of factories and well-known businesses, and the National income + 5.1 %
damage to the economy of regional Australia. The benefits are less visible, Exports + 28.5 %
because they are spread out across the economy, and they may take a long time Imports + 28.6 %
to arrive. In the meantime, governments can lose votes by pursuing policies Prices − 3.4 %
to reduce protection. This explains why governments in many countries are Real wages + 7.4 %
reluctant to reduce protection levels, and why some, including the United Source: Centre for International Economics
States, have moved recently to increase them. The Productivity Commission (2017), “Australian Trade Liberalisation”,
has called for the Australian Government to better engage with the community prepared for the Department of Foreign
Affairs
and make the case for why free trade benefits ordinary Australians, and why
increasing protectionism would be bad for Australia.
account over the longer term as exports grow. In fact, government reports have argued that
Australia’s failure to reduce tariffs until the late 1980s contributed to a less competitive
export sector and higher current account deficits.
The benefits of reduced protection grow over time, and this influenced Australia’s
decision to adopt a process of phasing tariffs out over a 30-year period rather than with
a small number of large cuts. Many trade liberalising measures implemented through
free trade agreements are also phased in gradually over a period of time instead of being
activated immediately. Implementing these changes gradually can help industries adjust
better to changing business conditions. Most economists would agree that the short-
to-medium-term problems of reducing protection are far outweighed by the long-term
benefits, but a gradual phasing out makes it easier to manage the structural changes that
occur as a result.
reviewquestions
1 Outline the impacts of reduced protection on economic growth, unemployment,
and external stability in the Australian economy.
2 Explain the effects of a reduction in protection on domestic firms and
individuals. Outline how reducing protection creates winners and losers in the
Australian economy.
3 Examine the short-term effect of reducing tariffs on government revenue and
expenditure.
6.5 T
he impact of international
protection levels on Australia
Just as domestic policies to protect Australian industries have an impact on the Australian
economy, so do the policies of other nations to protect their industries. When other
countries put tariffs on Australian goods and services, Australian exports become less
competitive in those overseas markets. When other countries subsidise their exports, they
raise the supply and reduce the price of those goods on global markets. The result is that
countries like Australia that compete to sell similar products on global markets experience
a reduction in their income. Overall, international protectionism reduces the output of
the Australian economy. Equally, a reduction in global protection levels should increase
Australia’s national income. A 2018 report by the Centre for International Economics
estimated that a global reduction in tariffs that reduces import prices by 10 per cent
would increase Australia’s real GDP by 0.6 per cent a year.
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2021
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Chapter 6: Protection in Australia
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Australia in the Global Economy 2024
Most trade restrictions are imposed on imports, but sometimes governments impose
restrictions on exports when they conclude that markets are not operating in the national
interest. Natural gas is one such market. Most gas exporting countries apply some form
of gas reservation policy, or other policy mechanism, to protect their national interest in
supplying their domestic energy market. Although Australia is the world’s largest supplier
of liquefied natural gas (LNG), until recently it had no national policy to guarantee its own
domestic supplies – there was only a state-based law in Western Australia requiring that
15 per cent of the state’s natural gas production be made available for domestic use.
In 2017, the Federal Government answered the concerns of energy retailers and
manufacturers, who claimed that Australia’s LNG industry had tied itself up with long-term
deals to sell all of its output to overseas buyers, and had failed to sell to the domestic energy
market at a fair price. The Government introduced the Australian Domestic Gas Security
Mechanism (ADGSM) to restrict exports of LNG in situations of gas supply shortages
on the east coast of Australia. In 2023, reforms were introduced to increase flexibility in
responding to domestic gas supply shortfalls. These reforms included the ability to activate
the AGDSM quarterly, ahead of peak seasonal demand, the introduction of new protections
for long-term gas contracts, and shared responsibility for LNG exporters in preventing
shortfalls. The ADGSM was also extended to 2030.
some of the best food in the world, but the market for restaurant customers is limited
to people either living in or visiting Australia. This makes it difficult for Australian
restaurateurs to export their services (other than to tourists, who make up a very small
proportion of the global consumer market for food).
However, protectionism also plays a role in reducing services trade in the global economy.
Unlike goods, the main barriers to services trade are not tariffs, but a range of government
regulations and practices that have the effect of restricting services trade. Many countries’
banking sectors are protected from foreign competition by restrictions on granting licences
for overseas-owned banks. This restricts the growth of Australia’s financial services industry
in overseas markets. Similarly, competitive Australian firms in the electricity, recycling and
communications industries face many overseas markets that are dominated by monopoly
government providers or procurement arrangements that favour local providers. Figure 6.7
lists some common barriers that Australian service businesses face in overseas markets.
The impact of restrictions to trade in services is significant for service-based economies
such as Australia. A Productivity Commission report in 2015 noted that international
barriers to Australian services trade remain costly – particularly restrictions on establishing
commercial operations in key Asian markets (especially for Australian financial services).
One of the main goals of Australia’s trade agreements with Japan and South Korea, for
instance, is to reduce some of these trade barriers.
Service industry Potential trade barriers
Financial services Restrictions on foreign ownership of banks and other financial institutions
Figure 6.7 – Trade barriers that often affect Australian services exporters
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Chapter 6: Protection in Australia
reviewquestions
1 Discuss the impact of subsidies in overseas economies on Australia’s trade
performance.
2 Compare and contrast recent trends in global protection levels across different
industries in the global economy.
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Australia in the Global Economy 2024
there are no substitute products available. In addition, natural gas is playing a role as a
“transition” source of energy that countries can use to gradually reduce emissions (since
gas has fewer emissions than coal). This should support the demand for Australian LNG
exports over the short-to-medium term. The soaring global demand for electric vehicles is
also increasing demand for lithium for battery production, with Australia well positioned
as the world’s largest lithium exporter.
Australian agricultural industries face a more mixed outlook. Global food prices have
increased significantly in recent years. This has lifted farm incomes. The return of the
Australian dollar closer to historic averages has also made farming exports more competitive.
However, Australian agriculture faces major long-term challenges: more extreme weather
patterns resulting from climate change, including increased drought, bushfires, floods and
threats to livestock. Access to overseas markets may also be affected by trade barriers and
increasing levels of agricultural efficiency among competitors. Processed food industries that
add value to traditional agriculture (such as wine and dairy industries) are playing a larger
role in exports, particularly as they have been afforded greater market access under Australia’s
more recent trade agreements than traditional areas of agriculture. The global market for
high-quality processed foods is expected to continue growing strongly in coming years,
fuelled by the growth of the middle class in China and India, and Australia’s high-quality
food industries are well positioned for export growth.
Although Australia has seen a gradual reduction in its older, import-competing manufacturing
sector, at the same time, smaller, export-oriented manufacturing has continued to grow.
Overall, manufactured exports grew from less than $10 billion to around $40 billion in the
three decades to 2023. This growth is expected to continue at a slower pace, as specialised
manufacturers expand their markets by producing high-quality goods aimed at specific
market niches. For example, an Australian lithium-ion battery manufacturing industry is
developing (in addition to lithium mining) to meet global demand which is expected to grow
forty-fold by 2050. A new “gigafactory” opened in the Hunter Valley in 2023, and work is
underway on another gigafactory in Geelong. Future shifts in the exchange rate will also be
important for the competitiveness of Australian manufacturers.
Services exports fell sharply following the onset of the COVID-19 pandemic, but by
2023 (other than for travel) had recovered to pre-COVID levels. Prior to the COVID-19
pandemic, tourism had been Australia’s largest service export, driven by increased travel
across the world and the attractiveness of Australia as a safe location with excellent weather
and exceptional flora and fauna. As tourism export earnings fell in 2020, the industry
repositioned itself to serve Australian domestic tourists, who were largely prevented from
travelling overseas. Australia’s other major services export (worth $30 billion a year before
the pandemic) is international education, with Australian schools and universities benefiting
from a large intake of overseas students, especially from China and India. Other growing
areas of services exports include:
• Digital services: information and communications technology (or digital goods
and services) have become Australia’s fourth-largest export, expected to be worth
$19 billion by 2030, according to a report by the Export Council of Australia.
• Environmental services: these have longer-term growth potential, such as in
the renewable energy sector, where historically Australia has been an innovator.
According to the International Renewable Energy Agency, annual global investment
in energy transition reached a record high of almost $2 trillion in 2022.
Other services sector exports for Australia that may grow in the future include professional
services, financial services and services related to infrastructure.
reviewquestions
1 List THREE industries that you think will play a greater role in Australia’s export
mix in the future. Justify your answer.
2 Outline the likely future trends in the direction of Australia’s exports.
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Chapter 6: Protection in Australia
chapter summary
The aim of reductions in protection over recent decades has been to make
1
Australian industry more internationally competitive and to reallocate resources to
the most efficient sectors of the economy.
2 In the past, the Australian economy had relatively high levels of protection.
However, tariff reductions began in 1973, and during the 1990s and 2000s
Australia phased out most of its tariffs barriers. Tariff levels in Australia are
low with an average tariff rate of 0.5 per cent. Almost 90 per cent of imported
goods and services are tariff free, and the general tariff rate is 5 per cent or
less. Non-tariff barriers in Australia are low compared with other industrialised
countries.
4
The effects of reducing protection levels on firms vary across different industries,
with traditional import-competing manufacturers losing out due to cheaper
imports, while export-oriented industries benefit from lower input costs.
6 While lower levels of protection may benefit the economy generally, in the short
to medium term, governments may lose out from reduced revenue, increased
expenditure (such as for higher unemployment benefits and structural adjustment
packages) and a loss of public support. The economy may also experience a
higher current account deficit (CAD) in the short to medium term.
8 Risks to Australia’s trade outlook include trade tensions with China, rising trade
barriers, and the impacts of climate change on exports, both through extreme
weather events and potential carbon border taxes.
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chapter review
1 Describe the factors that have influenced government policies to reduce
protection in Australia during recent decades.
3 Discuss recent changes in Australia’s protection levels and the outlook for
protection levels in the future.
4 Describe the main features of TWO of Australia’s bilateral and TWO of Australia’s
multilateral free trade agreements.
158
ECONOMIC
TOPIC 3
ISSUES
Focus
This topic focuses on the nature,
Issues causes and consequences of the
economic issues and problems that
By the end of Topic 3, you will be can confront contemporary economies.
able to examine the following
economic issues:
■
Examine the arguments for and against
Skills
increasing economic growth rates Topic 3 skills questions can ask
you to:
■
Investigate the economic and social
problems created by unemployment ■ Identify
and analyse problems facing
contemporary and hypothetical economies
■
Analyse the effects of inflation on an
economy ■
Calculate an equilibrium position for an
economy using leakages and injections
■
Discuss the effect of a continued current
account deficit on an economy ■
Determine the impact of the (simple)
multiplier effect on national income
■
Investigate recent trends in the distribution
of income in Australia and identify the ■
Explain the implications of the multiplier for
impact of specific economic policies on this fluctuations in the level of economic activity
distribution in an economy
■
Analyse the economic and social costs of ■
Calculate the unemployment rate and the
inequality in the distribution of income participation rate using labour force statistics
■
Examine the economic issues associated ■
Interpret a Lorenz curve and a Gini
with the goal of ecologically sustainable coefficient for the distribution of income in an
development economy
■
Use economic concepts to analyse a
contemporary environmental issue
■
Assess the key problems and issues facing
the Australian economy
Economics Stage 6 Syllabus 2009 extracts © NSW Education Standards Authority for and on behalf of the Crown in right
of the State of New South Wales, 2009; reproduced by permission. 159
Australia in the Global Economy 2024
Topic 3
Introduction
This section (chapters 7–12) covers Year 12 Topic 3, Economic Issues, and focuses on the nature, causes
and consequences of the economic issues and problems that confront contemporary economies such
as Australia.
Chapter 7 examines the issue of economic growth in the Australian economy. It provides a
foundation of economic theory with which to examine Australia’s recent growth
performance. Concepts examined include aggregate demand and supply, injections and
withdrawals, the simple multiplier and the measurement of growth through changes
in real Gross Domestic Product (GDP). The chapter looks at the sources and effects of
economic growth in Australia, recent trends in the business cycle and the impacts of
economic growth.
Chapter 8
examines the issue of unemployment in the Australian economy. The chapter
covers measurement of unemployment, trends in unemployment, types and causes of
unemployment, the concept of a non-accelerating inflation rate of unemployment and
examines which groups in the community are most affected by high unemployment
levels. The chapter finishes with a review of the economic and social consequences of
unemployment.
Chapter 9 examines the issue of inflation in the Australian economy. Australia has been successful
in achieving low inflation outcomes since the early 1990s, but has faced a global surge
in inflation in the early 2020s. The chapter looks at the measurement of inflation and
its trends in recent years. It then examines the main causes of inflation and the effects of
inflation on the Australian economy.
Chapter 10 examines the issue of external stability in the Australian economy. Many dimensions of
Australia’s relationship with the global economy are reflected in our external accounts.
The chapter addresses how we measure external stability in terms of the relative size of
the current account deficit, net foreign debt and net foreign liabilities. The trends in
Australia’s external accounts are briefly reviewed, with reference to Topic 2. Chapter
10 also examines the causes and effects of external imbalance in Australia.
Chapter 11 examines the issue of distribution of income and wealth in the Australian economy.
The chapter looks at how we measure inequality, and we examine some of the factors
that influence inequality by looking at the sources of income and wealth. It examines
the relationship between inequality and a range of social dimensions, such as gender,
age, occupation, ethnic background and family structure. It also examines the economic
and social costs and benefits of inequality in the context of the Australian economy.
Chapter 12 examines the issue of environmental sustainability in the Australian economy. This
is a priority because of the long-term economic impacts of climate change and water
shortages. The chapter covers the issues of ecologically sustainable development, private
and social costs and benefits of growth, and public and private goods. A number of
issues, such as preservation of natural environments, pollution control, climate change
and depletion of renewable and non-renewable resources, are also examined in the
context of the Australian economy.
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Economic Growth
7.1
7.2
7.3
Introduction
Economic growth and aggregate demand and supply
The components of aggregate demand
7
7.4 Changing levels of growth: the multiplier process
7.5 The role of aggregate supply
7.6 The effects of economic growth
7.7 Recent trends in economic growth
7.8 Policies to sustain economic growth
7.1 Introduction
Economic growth creates jobs, allows individuals to increase their consumption, and
raises living standards. Accordingly, economic growth is generally considered the most
important measure of an economy’s performance, and is therefore a key government policy
objective.
Economic growth can be defined as an increase in the volume of goods and services that
an economy produces over a period of time. It is measured by the annual rate of change
in real Gross Domestic Product (GDP), that is, the percentage increase in the value
of goods and services produced in an economy over a period of time, usually one year,
adjusted for the rate of inflation. This is more accurate than nominal GDP, which is not
adjusted for price changes.
The Australian Bureau of Statistics (ABS) estimates the level of GDP in Australia every
three months (that is, for every quarter of the year) in the publication called Australian
National Accounts: National Income, Expenditure and Product. To measure GDP, the ABS uses
information about household and business incomes, expenditure on goods and services, and
production by firms. You might recall from the Circular Flow model in the Preliminary
Economics Course the three separate sources of economic growth – income, expenditure
and production – which can be used to calculate GDP. There are also three different time
periods used to measure Australia’s rate of economic growth:
• Quarterly economic growth: calculated every three months by the ABS. For
example, quarterly growth in the March quarter of 2024 is the percentage increase in
GDP since the previous December quarter (that is, the final three months of 2023).
So if quarterly GDP was $564 billion in the December quarter of 2023 and $570
billion in the subsequent March quarter of 2024, the quarterly rate of economic
growth would be around 1 per cent.
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Chapter 7: Economic Growth
Aggregate demand – represented by the symbol AD – is the total level of expenditure in Aggregate demand
an economy over a given period of time. It includes consumption, investment, government refers to the total demand
spending and net export spending (export spending minus import spending). for goods and services
within the economy.
Aggregate supply – represented by the symbol Y – is the total level of income in Components of aggregate
an economy over a given period of time. Part of national income is collected by the demand are: consumption
government through taxation, and the rest is either spent on consumption or is saved. (C), investment (I),
government spending (G)
and net exports (X – M).
AD = C + I + G + (X – M) Y=C+S+T
WHERE: WHERE:
Aggregate supply refers
AD = aggregate demand Y = aggregate supply or national
to the total productive
C = consumer spending by households income
capacity of an economy,
I = investment spending by businesses C = consumer spending by that is, the potential
G = government spending households output when all factors
X = export revenue S = saving by households of production are fully
M = spending on imports T = taxation by the government utilised.
The economy is in equilibrium, that is, it will tend to be stable, when the level of
aggregate demand is equal to aggregate supply (national income). By substituting the
components of aggregate demand and supply into the equilibrium equation, we find
an alternative condition for equilibrium in the economy – that the leakages of savings,
taxation and imports will be equal to the injections of investment, government spending
and exports. (This is the way we looked at economic growth in the Preliminary Course,
with the Circular Flow of Income model). Changes in leakages and injections influence
the level of economic activity. If injections are greater than leakages, economic growth
will increase – but if leakages are greater than injections, economic growth will decrease.
reviewquestions
1 Define the term economic equilibrium.
2 Assume an economy is in equilibrium and investment increases by $10 billion.
Describe the economic effect in terms of leakages, injections and economic
growth.
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Influences on consumption
Examining the influences on leakages and injections allows us to see what factors influence
the level of economic growth.
Influences on consumption and saving
Consumption is an important determinant of the level of economic
Public investment 5%
Household Government spending
growth because consumption by households typically forms at least
consumption (total general government) half of expenditure (or aggregate demand) in the economy (see
55% 20%
figure 7.1). Anything that boosts consumption is also likely to boost
expenditure (demand) and hence economic activity (that is, income
or supply).
Business
investment Obviously, the most important factor influencing the level of
13%
consumption is income itself. People with higher incomes tend to
Housing consume more. If a person’s income rises over time, their consumption
(dwelling construction)
6% tends to rise too. Economies with higher income levels tend to
Source: ABS Australian National Accounts (Cat. no. 5206.0, Table 3, September 2023) consume more. However, because we want to know how consumption
Note that aggregate demand is calculated by adding net exports (exports minus
imports); figures may not add to 100 because of rounding can influence economic activity (including income), we must look at
the factors that influence consumption for a given level of income – that
Figure 7.1 – The components of domestic demand
is, all the factors other than income. Put another way, our concern
Average propensity
is with the proportion of total income that is spent on consumption, called the average
to consume (APC) is propensity to consume (APC), and the proportion of total income that is saved, called the
the proportion of total average propensity to save (APS). The three greatest influences on the APC are consumer
income that is spent expectations, the level of interest rates and the distribution of income.
on consumption.
Consumer expectations
Expectations about future price rises and the general availability of goods will influence
Average propensity consumers’ decisions to spend or save their income. If consumers expect a rise in their
to save (APS) is the incomes or in inflation, or if they anticipate future shortages of goods, then they tend to
proportion of total spend more and save less in the short term. On the other hand, if consumers expect that
income that is not spent, their incomes might fall, that prices might fall or that goods and services might become
but is saved for future
more available in the future, then they are inclined to spend less and save more.
consumption.
The level of interest rates
An increase in the general level of interest rates would discourage individuals from
spending their money (as the cost of borrowing money is now higher) and therefore
encourage them to save, while a decrease in interest rates would encourage spending and
discourage saving. For example, global inflationary pressures in 2022–23 led to higher
interest rates, prompting households to be more conservative in their discretionary
spending as they budgeted for increased mortgage repayments.
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Chapter 7: Economic Growth
Influences on investment
Business investment is one of the most volatile components of demand or aggregate
expenditure, historically contributing between 10 and 15 per cent. The main factors
influencing business investment are the cost of capital equipment and business expectations.
Business expectations
Business expectations about future prospects, a factor sometimes described as entrepreneurial
or as “animal spirits”, influence the level of investment. The factors that affect expectations are:
• Any change in expected demand for their products. If entrepreneurs expected
a future increase in demand, they would be more inclined to purchase new capital
equipment to boost production and satisfy that demand.
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reviewquestions
1 Explain how expectations can affect both consumption and investment.
2 Describe the impact of lower taxation on demand.
3 Discuss the influence of net exports on the level of aggregate demand.
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that aggregate demand will now exceed output in the economy. This excess in aggregate
demand will manifest itself in an unplanned rundown of stocks. Producers will respond
by increasing output and national income will initially increase by $10,000 (since the
initial increase in aggregate demand was $10,000).
However, the multiplier process ensures that national income will ultimately rise by much
more than $10,000. It works like this:
• National income will increase by the initial $10,000.
• Of that $10,000, $8000 will be spent (since the MPC = 0.8) while $2000 will be
saved (MPS = 0.2).
• The $8000 that is spent will be income to those who receive it as payment for goods
and services.
• Of that $8000, $6400 will be spent (0.8 × $8000), while $1600 will be saved.
• The $6400 that is spent will be income to those who receive it. They in turn spend
80 per cent of it and save 20 per cent – and so on.
This process will continue, but the amount of additional consumption spending each time
will decline until it eventually becomes insignificant.
The following points should be noted before the total increase in income generated by
this multiplier process is calculated. First, it is the MPS that causes the amount of income
generated by each successive wave of spending to decrease. Second, the sum of each
successive wave of income generated will add up to the total amount by which national
income increases. The final increase in national income is equal to the initial increase in
aggregate demand multiplied by “the multiplier”.
1
The size of the multiplier is k = (k being the symbol for the multiplier)
MPS
determined by the MPS and or
can be expressed as: 1
k = (since MPC + MPS = 1)
1 − MPC
Under the assumptions in our 1 1
example (that is, MPS = 0.2): k = = = 5
MPS 0.2
The total increase in income
generated by the $10,000 Y = k× AD = 5 × $10,000 = $50,000
increase in aggregate demand is:
Clearly, the larger the MPS, the smaller the value of the multiplier. If individuals save
proportionately more of their extra income, they will spend less and therefore generate
less additional income. It follows that the factor by which we must multiply our initial
increase in aggregate demand must also be less. The reverse will also be true – the smaller
the MPS, the larger the value of the multiplier.
The multiplier process also works for decreases in aggregate demand. For example, if we
had a decrease in investment spending of $10,000, the multiplier effect would work in
reverse, leading to a decrease in national income of $50,000.
Thus, any change in the level of planned expenditure (whether due to changes in
investment, government spending, consumer spending or net export spending) will
have a multiplied effect on the level of national income. Governments use the multiplier
process because an initial increase in government spending can result in a much larger
increase in economic activity as money circulates through the circular flow of income.
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Chapter 7: Economic Growth
For example, if the government builds new roads, construction firms receive funding to
purchase inventory for the new roads and road construction workers receive wages which
they consume and save.
Note that in the analysis above we have only used what is called the “simple multiplier”,
Appendix B: Advanced
as required by the Year 12 Economics Syllabus. The simple multiplier is calculated by Economic Analysis at
only considering savings as a leakage from the circular flow. If we were to also include the the back of this textbook
government and international sectors of the circular flow, we would also need to know looks at the income-
what proportion of income is “leaked” into taxation and import spending. For example, expenditure diagram –
if in addition to 20 per cent of income being saved, a further 10 per cent of income an extension of the
economic growth theory
was paid in tax and a further 10 per cent was spent on imports, total leakages would be
covered in this chapter.
40 per cent of income, and the value of the multiplier would fall to 1 divided by 0.4,
that is, 2.5. However, the Year 12 Economics Syllabus only requires you to calculate the
multiplied impacts of changes in leakages and injections on national income using the
simple multiplier.
reviewquestions
1 The following numbers apply to a hypothetical economy:
($m) G = 30, C = 40, I = 15, X = 10, M = 10, MPC = 0.6
(a) Calculate the level of aggregate demand in the above economy.
(b) Calculate the value of the MPS.
(c) If the government wanted to increase national income by $100m, by how
much would it have to increase its own spending levels?
2 In a hypothetical economy, a $30m increase in consumption leads to a $150m
increase in national income. Calculate the value of this economy’s marginal
propensity to save.
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Aggregate supply can be increased when a higher level of output can be produced for the
same cost, that is, when there is an increase in quantity or improvement in the quality of
the factors of production. This can be achieved through the changes set out in the table
below.
Population growth Labour is the main input into the production process, so an
increase in the population (through higher migration or birth rates)
means more workers are available and the economy will be able to
produce more goods and services. For several decades, Australia’s
relatively high migration intake has been a major contributor to
growth rates above most advanced economies.
Discovery of new New mineral and metal deposits discovered in Australia can be
resources exploited to increase exports and increase economic growth.
Workers acquiring More highly trained doctors and health professionals may be able
new skills to diagnose illnesses more quickly and treat them more effectively.
If policymakers focus only on increasing aggregate demand, at some point they are likely
to run into constraints with the economy’s aggregate supply. When aggregate demand
outstrips supply, economies experience capacity constraints, causing inflation to rise
(discussed further in chapter 9). Skills shortages – when employers are unable to fill
specific roles – emerged as a major constraint to Australia’s recovery from COVID-19
due to the rapid fall in immigration during the pandemic. In the year to February 2023,
ABS data showed an average of 457,000 job vacancies – a historic level almost double
pre-pandemic levels. Labour shortages discourage businesses from investing (other than in
labour-saving technology) and expanding production. Similarly, failing to plan adequately
for future expansion can result in infrastructure bottlenecks, such as congested roads
and ports. For this reason, microeconomic policies to increase aggregate supply are an
important part of the economic policy mix.
reviewquestions
1 Outline the impact of an increase in aggregate supply on economic growth.
Use a diagram to support your answer.
2 Explain TWO policies or changes that might increase aggregate supply in an
economy.
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Chapter 7: Economic Growth
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growth. For example, the transition to net zero carbon emissions could boost Australia’s GDP
by $75 billion each year through to 2035 according to a 2023 report from the McKinsey
consulting group.
reviewquestions
1 Contrast TWO positive and TWO negative impacts of economic growth.
2 Explain how higher rates of economic growth can affect living standards and
income distribution in an economy.
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Chapter 7: Economic Growth
• Over the last three decades, Australia’s macroeconomic policy has largely maintained
a sustainable rate of economic growth – a level that generates employment growth
and maintains external balance without pushing inflation above its target range of
2–3 per cent. The Australian Treasury estimates that Australia’s long-term sustainable
rate of economic growth is around 2.5 per cent of GDP. In the three decades to 2020,
growth was 2–4 per cent for 22 out of 30 years.
• During economic downturns, the Reserve Bank of Australia (RBA) has acted quickly
to reduce interest rates to support aggregate demand. For example, in response to
weakening economic growth in 2019 (before the COVID-19 pandemic), the RBA
reduced the cash rate three times, to 0.75 per cent. In response to the pandemic,
the RBA then reduced the cash rate to a record low 0.10 per cent. When interest
rates are adjusted in anticipation of a change in growth and inflation, it is known as
pre-emptive monetary policy.
The Reserve Bank aims to use pre-emptive monetary policy to maintain low inflation
and a sustainable rate of growth. This is not an easy balancing act, and its conduct
of monetary policy is sometimes criticised. In 2022 and 2023 it faced criticism both
for being too slow to raise interest rates as inflationary pressures grew, and going too
far in raising interest rates to counter inflation, contributing to a sharper slowdown
in growth.
• During periods of economic downturn, the Government has successfully used
fiscal policy to stabilise economic growth. In response to COVID-19 in 2020, the
Government initiated the largest fiscal policy intervention in Australian economic
history, helping to ensure a smaller downturn than other countries and a quick
recovery.
• Australia has one of the highest sustained population growth rates among advanced
economies, resulting from high immigration levels since the mid-20th century.
However, due to COVID-19 the international border was closed for the first time
since World War II, and net overseas migration was negative in 2020–21. This
contributed to labour shortages that constrained growth throughout 2022 and
2023, prompting a temporary lift in the annual migration cap to 200,000 and a
comprehensive review into Australia’s migration program.
5
“The recession we had to have”
4
Global financial crisis
3
COVID-19 pandemic
Asian financial crisis
“dotcom” crash
2
Mining boom
0
1991
1997
2001
2006
2009
2020
2021
−1
−2
2023*
2024*
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
Figure 7.4 – Australia’s economic growth performance (annual real GDP growth)
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Australia in the Global Economy 2024
80 80
60 60
40 40
20 20
1995 1999 2005 2011 2017 2023
Source: RBA Commodity Prices I2, 2023
The increase in commodity prices sparked the largest sustained improvement in Australia’s
terms of trade on record. Although the terms of trade slipped during the global financial
crisis in 2009, it quickly rebounded to reach a 140-year high in 2011. This provided a
very large stimulus to the economy. The Reserve Bank noted in 2011 that the terms of
trade boom had added 15 per cent to Australia’s nominal GDP, equivalent to over $190
billion per year. This meant that the resources boom had a larger impact on national
income in Australia than the revolution in information and communication technologies.
Although foreign-owned mining companies sent a share of their increased profits
overseas, Australian taxpayers also benefited as higher company tax receipts allowed the
Government to reduce personal income taxes.
A decade and a half after the beginning of the terms of trade boom, income per person
in Australia was around 20 per cent higher than it was in the mid-2000s, and average real
wealth per person had risen by 40 per cent. The prices for Australia’s commodity exports
have remained resilient even though many economists counted 2012 as the end of the
resources boom, as shown in figure 7.5.
Global recessions, such as that triggered by COVID-19, usually result in a downturn in
commodity prices, but prices for iron ore, copper, nickel, lithium and coal began to surge
shortly after the height of the pandemic in 2020 partially due to disruptions in supply
chains. In 2021–22, both iron ore and coal prices went beyond the record set during the
mining boom in 2011, once again driving Australia’s economic growth. In many respects,
the mining boom that began in 2003 is still continuing in the 2020s.
While demand for fossil fuels will decline in coming decades as economies transition to
net zero emissions, resources including lithium and cobalt – important inputs to clean
energy technologies – are likely to continue contributing to Australia’s economic growth.
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Chapter 7: Economic Growth
• Large increases in asset prices such as real estate and shares since the early 2000s have
Growth GDP
increased the wealth of households, encouraging greater borrowing and consumption. Year
(%) ($bn)
This is known as the “wealth effect”. Of course, higher housing prices also constrain
2010–11 2.5 1606
the spending power of homebuyers, but overall, the wealth effect tends to increase
economic growth. 2011–12 3.9 1669
2012–13 2.6 1712
• A slowdown in productivity growth has contributed to lower rates of growth in
2013–14 2.6 1756
recent years, following a period of record growth in the 1990s. The Productivity
Commission’s 5-year Productivity Inquiry reported in 2022 that labour productivity 2014–15 2.2 1794
growth averaged 1.1 per cent per year in the 2010s, compared with 1.3 per cent in 2015–16 2.7 1843
the 2000s and over 2 per cent in the 1990s. Other advanced economies have also 2016–17 2.3 1886
experienced slower productivity growth in recent years. 2017–18 2.9 1940
Australia has been relatively successful in navigating changing economic conditions and 2018–19 2.1 1981
external developments – including the Asian financial crisis of 1997–98, the collapse of 2019–20 0.0 1981
the “dotcom” boom of 2001, the deep global recession triggered by the global financial 2020–21 1.6 2012
crisis in 2008, the global COVID-19 recession in 2020 and the surge in inflation following 2021–22 3.9 2090
the war in Ukraine. In part, this has reflected good luck – the specific impacts of each of 2022–23 2.1 –
those events on Australia was milder than for most advanced economies, and Australia has 2023–24* 1.7 –
had the benefit of a sustained boom in resources exports, offsetting downward pressures on Source: ABS Australian National
growth. Yet with less skilful macroeconomic policy, and without the economic flexibility Accounts (Cat. no. 5206.0),
created by past microeconomic reforms, Australia would have had much less success in Table 34, GDP chain value (real)
*Forecast
responding to those events.
Figure7.6 – Australia’s GDP
According to the Australian Treasury, “the three Ps” – productivity, participation and
population – are the key to Australia’s long-term economic growth. Sustaining long-term
productivity growth, high levels of workforce participation and continued population
growth from natural growth and immigration will help Australia to achieve the highest
possible rate of sustainable economic growth.
However, Australia’s 2023 Intergenerational Report highlighted ongoing concerns for
each of these indicators. It projected a fall in average annual growth from 3.1 per cent
per year in the past four decades to 2.2 per cent in real GDP for the next four decades.
Low growth in labour productivity is a long-term concern due to slowing growth in
educational attainment. Workforce participation is expected to decline as Australia’s
population continues to age. Population growth rates have also been reduced by the
slowdown in migration during the COVID-19 pandemic as well as lower fertility rates
in the population overall.
reviewquestions
1 Outline the recent economic growth performance of the Australian economy.
2 Discuss the effect of productivity, participation and population on Australia’s
economic growth.
3 Compare the recent economic growth performance of the Australian economy
to ONE other high-income economy.
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7.8
Policies to sustain economic
For further information
growth
on the recent economic A major aim of economic management is to sustain a high rate of economic growth to
growth performance of
allow national wealth to grow and individuals to experience a higher standard of living.
the Australian economy,
visit the recent speeches
The government uses macroeconomic policies (fiscal and monetary policy) to influence
and publications sections economic growth in the short term with the goal of smoothing fluctuations in the business
on the websites of the cycle. These policies will have only a limited impact on the level of long-run growth rate.
Australian Treasury, (Macroeconomic policies are discussed in chapters 14 and 15).
Reserve Bank of Australia
or Australian Bureau Fiscal policy involves the use of the Commonwealth Government’s Budget to influence
of Statistics, or the the level of aggregate demand and therefore the level of economic growth. Government
economics section of expenditure in the Budget represents an injection into the economy, whereas government
the websites of major revenue (taxation) is a leakage. If the Government wants to increase the level of economic
Australian banks. growth, it can reduce taxation, increase expenditure or do both. This would increase the
level of injections relative to leakages and cause an upturn in the level of economic growth.
Alternatively, economic growth would be constrained if taxation receipts were increased
or government expenditure was reduced. Generally, fiscal policy is more effective in
stimulating growth during a downturn than slowing down an economy that is growing
fast. The JobKeeper wage subsidy and increased JobSeeker welfare payments were central
to the Australian Government’s response to the COVID-19 recession in 2020–21 and are
good examples of fiscal policy in action.
The Government is also able to use monetary policy to influence economic growth.
Monetary policy involves the Reserve Bank of Australia influencing the level of interest
rates in the economy, which in turn influences the level of aggregate demand and the
rate of economic growth. If the RBA wants to stimulate growth, interest rates can be
reduced to encourage consumer and business spending. Conversely, to decrease growth,
interest rates can be raised. Monetary policy has been the main macroeconomic policy tool
for influencing the level of economic growth in recent years, although its effectiveness
has been questioned. Prior to the pandemic, economic growth remained weak for several
years despite a period of very low interest rates. The effectiveness of monetary policy was
also questioned as the RBA sharply increased interest rates in 2022 and 2023, with 12
rises in 14 months.
$
% Economic growth Inflation Unemployment Current Account
12.0
10.0
8.0
6.0
4.0
2.0
0.0
2023*
2001
1983
1986
1989
1992
1995
1998
2004
2007
2010
2013
2016
2019
2022
–2.0
–4.0
–6.0
Sources: ABS Australian National Accounts (Cat. no. 5206.0), Consumer Price Index (Cat. no. 6401.0),
Labour Force (Cat. no. 6202.0), Balance of Payments and International Investment (Cat. no. 5302.0), June 2023 *Estimate
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Chapter 7: Economic Growth
reviewquestions
1 Discuss the use of macroeconomic and microeconomic policies to support
economic growth.
2 Discuss the policies a government might use to slow economic growth.
3 Analyse the role of government policies in increasing aggregate supply.
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Australia in the Global Economy 2024
chapter summary
1 conomic growth is measured as the percentage increase in the value of goods
E
and services produced in an economy over a period of time, usually one year.
3 The Circular Flow of Income model shows that certain economic factors
can be identified as either injections or leakages in the overall level of economic
activity. Investment, government spending and exports are injections because
they add to the circular flow of income. Savings, taxation and spending on
imports are leakages because they take money out of the circular flow of income.
10 Australia’s most recent economic growth cycle was the longest on record,
lasting from 1991 to onset of the COVID-19 pandemic in 2020. The growth
cycle was sustained by an enduring major terms-of-trade boom, demand for
Australian resource exports from China, the success of macroeconomic policies
in sustaining low inflation, and the legacy of substantial microeconomic reform in
past decades.
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Chapter 7: Economic Growth
chapter review
1 Explain why economic growth is important to an economy.
3 Outline the main factors that influence the levels of consumption and investment
in an economy.
5 Define the multiplier. Explain how the concept of the multiplier is related to an
understanding of economic growth.
6 Consider why economist John Maynard Keynes advocated an active role for
the government in influencing the level of economic activity. Discuss how the
government might influence the level of aggregate demand.
7 Contrast the positive and negative impacts of a higher level of economic growth
for an economy.
8 Explain the importance of aggregate supply and how a government may be able
to achieve sustainable economic growth in the long term.
9 Examine the factors that have contributed to the recent growth performance of
the Australian economy.
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180
COVID-19 The Impacts on the Australian Economy
2019
2020
2021
2022
2023
“COVID-19 caused significant disruption to historic
patterns of growth in the Australian economy. With
most COVID-19 related restrictions and health Source: ABS, Australian National Accounts: National Income,
measures lifted, economic growth has begun to Expenditure and Product (Cat. no. 5206.0)
return to longer term patterns
…
Figure7.8 – Real GDP – Australia
While growth is returning closer to pre-pandemic
rates, the level of GDP is estimated to have suffered
a cumulative loss of $158 billion compared to its
pre-pandemic trajectory” …
– Australian Bureau of Statistics Economics gains
and losses over the COVID-19 pandemic
7 September 2022
181
8 Unemployment
8.1
8.2
8.3
Introduction
Measuring the level of unemployment
Recent unemployment trends
8.4 The main types of unemployment
8.5 The non-accelerating inflation rate of unemployment
8.6 The causes of unemployment
8.7 The impacts of unemployment
8.8 Policies to reduce unemployment
8.1 Introduction
One of the most important measures of an economy’s health is the state of the labour market,
and in particular the proportion of people engaged in productive work. High levels of
unemployment are a major problem, because the opportunity cost of higher unemployment
includes less production, slower economic growth, lower taxation revenue and higher
social welfare payments. In addition, unemployment leads to major long-term social costs,
including increased inequality, poverty, family problems, crime and social division.
In recent decades, the labour market has changed in many significant ways. Some of the
most significant changes have been in the age and gender profile of the workforce; the
expansion of highly skilled jobs and decline of unskilled work; and the move away from
secure, full-time employment. The level of unemployment is regarded as our key indicator
of the state of the labour market, but economists also pay attention to other measures as
well, such as underemployment and the underutilisation of labour.
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Chapter 8: Unemployment
• self-employed persons working for at least one hour per week in their own business
or a family business
• unemployed persons aged 15 and over, who are currently available for work and are
actively seeking work.
Those persons not included in the labour force are:
• children under 15 years of age
• full-time, non-working students above 15 years of age
• people who perform full-time domestic duties
• unemployed persons who are not willing to actively apply for jobs and attend job
interviews or who are not available to start work
• people who have retired from the labour force.
The size of the labour force in Australia was approximately 14.5 million in 2023.
The participation rate in Australia was 67 per cent in mid-2023, a recovery of around
4 percentage points from the depths of the COVID-19 lockdown in mid-2020, when
many people stopped actively seeking work.
Unemployment
Unemployment statistics reflect the number of people who are out of work but are Unemployment refers
actively seeking work. To be classified as actively seeking work, a person without a job to a situation where
must satisfy any one of a number of criteria, such as: individuals want to
work but are unable
• regularly checking advertisements from different sources for available jobs to find a job, and as a
• being willing to respond to job advertisements, apply for jobs with employers and result labour resources
attend interviews in an economy are not
utilised.
• registering with an employment agency linked to Workforce Australia.
To determine the rate of unemployment, the Australian Bureau of Statistics (ABS) undertakes
a monthly survey of the labour force. Through this survey of around 26,000 dwellings, the
ABS calculates both the total number of unemployed people and the rate of unemployment.
Number of persons unemployed 100
Unemployment rate (%) = ×
Total labour force 1
Australia’s unemployment rate was 3.5 per cent in June 2023, just above its lowest
level in almost 50 years.
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There is some debate amongst economists about the accuracy 750,000 were “employed” but did not work a single hour
of the calculations that are currently used in the official (although this was temporary, as the number of people working
measure of unemployment. As a result of structural changes zero hours fell from 767,000 in April 2020 to just 57,000
that have occurred in Australia’s labour market in recent a year later).
years, the classification of all people into three categories of Taking into account the combination of unemployment and
employed, unemployed and not in the labour force does not underemployment, the ABS publishes additional measures of
provide a complete picture of the actual utilisation of labour the underutilisation of labour. The first of these is the labour
(or spare capacity), and may disguise the extent of Australia’s force underutilisation rate, which measures the number of
labour market problems. There are two main problems people unemployed plus the number who want to work more
associated with current labour force statistics: hours. In mid-2023, the labour force underutilisation rate was
1 By classifying people as either employed or unemployed, 10 per cent, down from a peak of 20.1 per cent during the
official statistics do not take into account the number of COVID-19 recession in May 2020, and below its levels before
hours people work. Some employed people with a limited the pandemic.
amount of work want to work more hours – known as The ABS also publishes an extended labour force
underemployed people. If a 40-hour per week job were underutilisation rate, which adds two additional groups of
converted into four 10-hour per week jobs, this would create people, who are marginally attached to the labour market,
three new jobs and reduce the official unemployment rate, to the utilisation rate: persons actively looking for work and
without increasing real economic activity or the demand for able to start within four weeks but not within one week, and
labour. Much of the impact of the COVID-19 lockdowns in discouraged jobseekers. It shows that official unemployment
2020 was reflected in increased underemployment rather statistics measure less than half of the number of people who
than unemployment. are short of work.
2 By classifying people as either in the labour force or not The problem with merely adding the percentage of unemployed
in the labour force, official unemployment statistics do not and underemployed workers together is that it does not give
include people who have not been able to find work and us an accurate view of the spare capacity in the labour market,
have left the labour force – known as “hidden unemployed”. because unemployed people typically want to work three
Also known as “discouraged jobseekers”, this group may times as many additional hours as underemployed people. In
order to better measure the amount of spare capacity in the
include family members undertaking home duties, students
labour market during the COVID-19 pandemic, the Reserve
that would rather work, and people with disabilities who
Bank calculated an hours-based labour underutilisation rate.
would take up suitable employment if it were available.
This measure adds to the unemployment rate the extra hours
These shortcomings were highlighted in the labour market that underemployed part-time workers are seeking, effectively
statistics at the beginning of the COVID-19 pandemic, when converting those hours to the equivalent of full-time jobs.
the official number of unemployed people initially increased by In June 2020, underutilised hours across Australia totaled
just 105,000, even though 1.3 million people had lost their jobs. 57 million hours per week. This represented an hours-based
Around 500,000 left the labour force, because they saw no point underutilisation rate of 6.3 per cent, much lower than other
in seeking work when so many businesses were closed. Another measures of underutillisation.
reviewquestions
1 Outline how the unemployment rate is calculated and explain what it
measures.
2 Explain why the official unemployment rate may not be the best measure of
the number of Australians out of work.
3 Discuss whether an increase in the participation rate is likely to increase or
reduce unemployment.
4 Identify THREE reasons why a person may not be counted within estimates of
the size of the labour force.
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2023–24*
2024–25*
1969–70
1971–72
1973–74
1975–76
1977–78
1979–80
1981–82
1983–84
1985–86
1987–88
1989–90
1991–92
1993–94
1995–96
1997–98
1999–00
2001–02
2003–04
2005–06
2007–08
2009–10
2011–12
2013–14
2015–16
2017–18
2019–20
2021–22
Australia’s unemployment
problem became one of the
major structural issues facing Source: ABS Labour Force, Australia (Cat. no. 6202.0) *Treasury Forecast Year
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increased during the COVID-19 pandemic, reaching a record high 13.7 per cent in 2020
(or 1.8 million people), before falling back to lower levels (in mid-2023 it was 6.4 per
cent). Some 30 per cent of employed Australians were in part-time jobs, averaging 17
hours per worker each week. In 2023, around one in five part-time workers wanted to
work longer hours.
Australia needs economic growth rates above 3 per cent in order to make progress on
reducing unemployment (assuming no changes in medium-term trends in immigration,
family sizes, productivity and participation). The relationship between economic
Okun’s Law explains growth and unemployment is explained by Okun’s Law, which says that to reduce
the relationship between unemployment, the annual rate of economic growth must exceed the sum of percentage
unemployment and growth in productivity plus the increase in the size of the labour force in any one year.
economic growth,
showing that to reduce
Analysis by the Reserve Bank in 2015 (“Okun’s Law and Potential Output”) concluded
unemployment, the that the rate of GDP growth consistent with stable unemployment had fallen from around
annual rate of economic 5 per cent in the 1970s to 2.9 per cent by 2015.
growth must exceed
the sum of percentage
One implication of Okun’s Law is that in the short term, higher rates of productivity
growth in productivity growth actually make it more difficult to reduce the rate of unemployment (as Australia
plus the increase in the experienced in the 1990s when it was enjoying higher productivity growth rates).
size of the labour force in Conversely, one of the short-term impacts of lower productivity growth will often be
any one year. a lower rate of unemployment (as Australia experienced in the 2000s). However, this
trade-off between faster productivity growth and faster employment growth only applies
in the short term. In the long run, a higher level of productivity growth should lead to
stronger economic growth and more job creation, but in the shorter term more jobs are
likely to be created during a period of lower productivity growth because employers will
be forced to hire more workers if they want to increase production.
Australia’s labour force participation rate is expected to decline gradually over coming
decades, falling from a peak of 66.9 per cent in May 2023 to 63.8 per cent by 2062–63
(according to the Treasury’s 2023 Intergenerational Report). Structurally, Australia’s
population is ageing because of longer life expectancy and lower fertility rates. In 2021,
17.2 per cent of Australia’s population was aged over 65 years, compared to 12.2 per cent
before the turn of the century. The ABS forecasts that by 2030 this will grow to 18.1 per
cent of the population (or over 5.4 million Australians). At the same time, the expected fall
in the participation rate caused by the growth in the over-65 population will be partially
offset by continued increases in the participation rates of women of all ages. Other factors
that may influence the participation rate in coming decades include technological change
(for example, allowing more remote working), the continued shift towards a service-based
economy, and changes to the occupational structure of the Australian workforce.
reviewquestions
1 Outline the recent trends in Australia’s unemployment rate.
2 Explain the relationship between productivity and unemployment.
Cyclical unemployment
Cyclical unemployment occurs because of a downturn in the level of economic activity and
falls during times of strong economic growth. Falling demand means fewer employment
opportunities. Cyclical unemployment was the major contributor to a rise in unemployment
in 2020, as the COVID-19 pandemic led to a short recession.
Frictional unemployment
Frictional unemployment represents the people who are temporarily unemployed as they
change jobs – they have finished one job but have not started a new one. It generally takes
time to move from one job to another, as workers invest time and effort into finding a
suitable job, and as employers invest time and effort in the search for suitable candidates.
Frictional unemployment is inevitable, although it is increased by delays in matching
unemployed people to available jobs. Improving the efficiency of job matching services
through job and skills databases can help to reduce frictional unemployment. In an average
year in Australia, around 1 in 10 workers change jobs. This fell to a record low of 1 in 12
workers during the COVID-19 pandemic in 2021. In the wake of the pandemic, the US
economy experienced a surge in workers changing jobs, called “the Great Resignation”,
and there was some evidence of this also occurring in Australia.
Seasonal unemployment
Seasonal unemployment occurs at predictable and regular times throughout the year
because of the seasonal nature of some kinds of work (for example, selling gelato on the
beach in summer or being a shopping centre Santa Claus). It also accounts for the influx
of students finishing school, university and technical and further education (TAFE) courses
between December and March each year. The Australian Bureau of Statistics publishes
seasonally adjusted unemployment statistics, which take these fluctuations into account.
Hidden unemployment
Hidden unemployment includes those people who can be considered unemployed but Hidden unemployment
do not fit the Australian Bureau of Statistics, definition of unemployment and are thus refers to those people
not reflected in the unemployment statistics. This includes those individuals who have who can be considered
unemployed but do not
been discouraged from seeking employment and are no longer actively looking for a job. fit the official definition of
Because they are not actively seeking work, such people are not officially classified as unemployment and are
unemployed; they simply are not participating in the labour force. These people are known thus not reflected in the
as the hidden unemployed, or discouraged jobseekers. For example, someone who worked unemployment statistics.
as a tour guide and lost their job in 2020 during the COVID-19 pandemic might have
decided not to seek alternate employment until restrictions on visiting Australia were
removed and tourist visits got underway again.
The presence of hidden unemployment shows up in the statistics as a decline in the labour
force participation rate when these individuals give up looking for work, but they are not
shown in the unemployment statistics. While it is difficult to measure this figure, the
Australian Council of Social Service has estimated that there are as many as 1.3 million
hidden unemployed people in Australia. The Australian Bureau of Statistics has reported
a sustained increase in recent years in the number of people who want to work and are
able to work, but are not actively seeking work for reasons such as family responsibilities,
short-term illness and study. The ABS calculated in 2023 that 1.3 million Australians
were in the category of wanting to work but not actively seeking work (and not officially
in the labour market).
Underemployment
Underemployment refers to people who work for less than full-time (35 hours per week)
but would like to work longer hours. These people are not classified as unemployed,
but they represent a significant growing part of Australia’s unemployment problem.
Since 2014, the Australian Bureau of Statistics has published estimates of the level of
underemployment on a monthly basis.
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In June 2023, 935,000 Australians were underemployed, representing 6.4 per cent of the
workforce. This means that Australia has a larger number of people who are underemployed
than who are unemployed. The long-term trend of rising underemployment reflects the
fact that there has been faster growth in part-time and casual work than full-time jobs in
recent years. Underemployment is a particular challenge for young workers. In 2022–23,
the underemployment rate for people aged between 15 and 24 averaged 14.3 per cent,
significantly higher than for any other age group.
Long-term unemployment
Another important measure of unemployment is the number of long-term unemployed –
referring to those people who have been out of work for 12 months or longer, usually as
a result of structural unemployment.
If a large pool of long-term unemployed people exists, it can be very difficult to reduce it.
High economic growth can help because it stops the pool growing, but on its own it is
not enough to solve the problem. Long-term unemployment often turns into permanent
unemployment. This is because people who are out of work for long periods of time find it
much harder to find a job, even when the economy picks up. Some reasons for this include:
• New arrivals into the unemployment pool are re-absorbed into the workforce more
quickly, especially if they have skills that are more up to date and attractive for
employers, compared to the longer-term unemployed.
• The long-term unemployed usually suffer from structural unemployment and do not
possess the skills demanded in the labour market.
• Unemployed people lose their confidence that they will find work
Average Median Long-term
Year (weeks) (weeks) unemployed when they are persistently unsuccessful in applying for jobs.
(%) • Unemployed people also lose contact with the world of paid work
1970 7.3 n/a n/a and do not learn about the new skills and developments in the labour
1975 12.7 n/a n/a market, which further reduces their employment opportunities.
1980 32.0 n/a n/a • Potential employers tend to look less favourably towards people who
1985 49.5 n/a n/a
have been out of work for a long period of time.
1990 39.4 14 21.0 Figure 8.2 shows that a sharp increase in the proportion of the jobless who
1995–96 50.5 19 28.1
are classified as long-term unemployed occurred during the recession of
the early 1990s. Although there was a significant decline in long-term
2000–01 47.5 16 22.5
unemployment as a proportion of total unemployment until 2008–09,
2005–06 39.6 13 18.2 since then there has been an increase in the proportion of long-term
2010–11 36.7 14 19.3 unemployed. This is in addition to the discouraged jobseekers (not actively
2015–16 45.4 16 22.9 seeking work) who are not counted in the pool of long-term unemployed
2020–21 55.0 19 33.4
persons. Australia’s large-scale policy response to the COVID-19 recession
proved effective in preventing labour market “scarring”, that is, long-term
2021–22 51.8 14 26.8
unemployment. Long-term unemployment initially doubled as a result
2022–23 47.7 12 21.3 of the COVID-19 recession, from a low of 134,000 in April 2020 to
Source: ABS Labour Force, Australia, Detailed a 26-year high of 259,000 in March 2021. However, by mid-2023
(Cat. no. 6291.0.55.001, Table 14a)
long-term unemployment had fallen to 100,000, below its pre-pandemic
Figure 8.2 – Duration of unemployment level – reflecting the success of Australia’s policy response.
Hard-core unemployment
Economists sometimes also speak of hard-core unemployment, which refers to people
who are out of work for so long that employers consider them unemployable because
of their personal circumstances. Circumstances that might result in a person not being
employable include mental illness, physical disability, drug abuse and anti-social behaviour.
When someone is assessed as being unable to undertake work, even on a part-time basis,
they are placed on a disability support pension. People on the disability support pension
are not counted in the official unemployment statistics.
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Chapter 8: Unemployment
reviewquestions
1 Define cyclical and structural unemployment.
2 Explain the difference between underemployment and hidden unemployment.
3 Discuss why it may be more difficult for a long-term unemployed person to
find work compared to other unemployed persons.
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Declining inflationary and wage pressures in recent years have suggested that the NAIRU
is lower than previously thought. While the NAIRU has previously been estimated at
around 5 per cent, in 2021 the Treasury estimated that the NAIRU was within the range
of 4.5 to 5 per cent in the five years before COVID-19. In the 2023–24 Budget, the
Treasury noted that the volatility in the labour market and inflation had made it harder
to calculate the NAIRU, but concluded that its best estimate is 4.25 per cent.
reviewquestions
1 Explain why economists are interested in estimating the non-accelerating
inflation rate of unemployment.
2 Outline how an economy might reach its non-accelerating inflation rate
of unemployment.
3 Discuss the implications of an economy’s unemployment rate falling below its
non-accelerating inflation rate of unemployment.
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cent. On the other hand, when growth is above 3 per cent, the level of unemployment
is likely to fall. This was seen in the period from 2003 to 2008, when faster growth saw
unemployment fall from around 7 to 4 per cent. When economic growth is in the 2 to
3 per cent range, as it was for most of the 2010s, unemployment tends to remain relatively
stable. Reserve Bank research in 2023 estimated that the peak impact of a change in
economic activity on the unemployment rate occurs after around two years. Changes in
the level of economic growth mainly affect cyclical unemployment.
The trends in the measures of unemployment and underutilisation in recent years confirm
how strongly economic growth affects unemployment. Just as the sharp contraction in
economic activity that began in the March quarter of 2020 resulted in an immediate surge
in unemployment, so too economic recovery saw unemployment fall. The 2023–24 Budget
estimated that a growth rate of 3.25 per cent over 2022–23 led to employment growth
of 2.5 per cent, which helped keep unemployment below 4 per cent.
1992–1994 Australia emerged from recession with expansionary policies that saw
unemployment fall from 11 per cent to 8.5 per cent.
1996–1997 A shift towards tighter monetary policy and fiscal consolidation contributed
to slower growth and a slight increase in unemployment to 9 per cent.
1997–1999 Interest rate reductions helped accelerate growth, encouraging spending,
business investment and job creation.
1999–2001 The cycle of interest rate increases slowed down growth in 2000 and 2001
and resulted in an increase in unemployment levels.
2003–2008 The mildly expansionary stance of monetary and fiscal policy alongside a
major resources boom helped sustain reductions in unemployment to around
4 per cent.
2008–2009 Unemployment increased to around 6 per cent as the global financial
crisis impacted on the Australian economy, prompting highly expansionary
macroeconomic policies that softened the downturn.
2009–2011 Unemployment fell as the global economy recovered and macroeconomic
policy settings promoted economic growth.
2011–2020 With economic growth below its long-term average and inflation low,
monetary policy became increasingly expansionary, in part to offset
contractionary fiscal policy, which was focused on gradually reducing the
budget deficit.
2020–2021 The COVID-19 pandemic required a shutdown of many parts of the
economy, causing a brief recession. Fiscal policy became strongly
expansionary, and interest rates fell to record lows. These settings
remained in place in 2021 as the economy recovered, to support a return
to full employment and inflation within its target band.
2022–2023 The economy recovered quickly and unemployment fell to a 50-year low.
A global surge in inflation, resulting from supply shortages and disruptions
to energy markets as a result of Russia’s invasion of Ukraine, saw a mild
tightening of fiscal policy, and a steep increase in interest rates.
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cost of lower growth and higher unemployment in the short term, such as through the
tightening of monetary policy that began in May 2022.
Constraints on economic growth
Over the longer term, unemployment is influenced by the level of sustained economic
growth achieved in an economy. If there are significant constraints on economic growth,
the economy will struggle to create enough jobs to reduce unemployment. In recent
years, concerns about the historic constraints on growth – inflation and external balance –
have been low. Nevertheless, a surge in inflationary pressures prompted a series of 11
consecutive interest rate rises beginning in May 2022. Economists differed in their views
of whether this surge in inflation was likely to be sustained.
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of output. However, in the long term, higher productivity growth contributes to higher
economic growth and therefore lower rates of unemployment. Conversely, a slowdown in
productivity growth will tend to result in lower unemployment in the short term but
higher unemployment in the longer term, since an economy with lower productivity
growth will be less competitive and slower growing (and employers may substitute greater
use of capital for a reduced use of labour).
Inadequate levels of training and investment
Structural unemployment is related to the mismatch between the skills of the unemployed
and the skills demanded by employers for job vacancies. During the 2000s, significant
skills shortages emerged in many areas of the economy for occupational groups such as
tradespeople, health professionals and construction workers. In 2023, 19 occupations were
included on Australia’s skill shortage list (whereas at the peak of the economic boom before
the global financial crisis in 2007–08, 85 per cent of all occupations were experiencing
skill shortages). Persistent skill shortages continue to be experienced for a wide range of
technicians and trade workers, including arborists, carpenters, stonemasons, bakers, pastry
cooks, plumbers and air conditioning mechanics. Where significant skills shortages persist
alongside significant numbers of people being out of work, this suggests that there are
gaps in Australia’s education and training system. Inadequate levels of training make
Australia more reliant on skilled migration to fill job vacancies.
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Globalisation has accelerated the process of economic change, and electricity, gas, water and waste services (although
resulting in changes to the structure of Australian industries and there are services jobs even within these industries).
to the labour market. A study of structural change in Australia, Much of the growth in the services sector has been
published by the Reserve Bank in 2018, highlighted two of the driven by health care and social assistance. This industry
largest changes to the labour market in the past 50 years: has had strong employment growth, and the needs of
• the growth of more highly skilled, non-routine jobs in Australia’s ageing population will result in continued
the business services sector (such as financial services, growth in jobs in this sector, especially as few of these
consulting, technology, communications, recruitment, jobs can be automated. Professional, scientific and
design and legal jobs), which has doubled from around technical services has also recorded strong employment
10 per cent to 20 per cent of total employment growth, more than doubling its share of employment in
the three decades to 2023.
• the decline of lower skilled, routine jobs in the goods
production sector (manufacturing, mining, construction, Job growth in recent years has been driven by five key
utilities and agriculture). industries: health care (which now employs around 2.1 million
Australians), and professional services, construction, education
Structural change in the three decades to 2023 has also
and hospitality, which employ around 1 million each.
changed the Australian job market in profound ways:
This process of change in the structure of the labour market
• Manufacturing accounted for more jobs than any other
is expected to continue in the decades ahead. Artificial
industry in 1991, with 13.8 per cent of overall employment.
intelligence and automation will change the skills required
Since then, its share of jobs has halved (falling to 6.5 per
from workers in coming years. The World Economic Forum’s
cent in 2023), with manufacturing now the eighth-largest
2023 Future of Jobs report predicts that the fastest-growing
employer of Australian workers.
jobs are technology related roles, like AI and machine learning
• Employment in agriculture, forestry and fishing shrunk specialists, and sustainability related roles, like renewable
from 6 per cent to 2.2 per cent of total employment in the energy engineers. The majority of the fastest-declining roles
same time period. are clerical or administrative roles, such as bank tellers and
• The services sector now employs more than three-quarters postal service clerks. The COVID-19 pandemic may also have
of Australian workers. The services sector is generally accelerated technological disruption across the economy,
defined as all industries other than manufacturing; through a greater shift to delivering services and engaging
construction; agriculture, forestry and fishing; mining; customers and clients online.
105th out of 140 nations in the world for inflexibility in wage determination, and 110th
for the flexibility of hiring and firing rules. However, OECD studies of the Australian
labour market usually point to the relative flexibility of the Australian labour market, and
highlight the need for improvement in skills and training to reduce underemployment
rather than focusing on labour market rules. (These issues are further discussed in
chapter 17.)
reviewquestions
1 Examine how the stance of macroeconomic policies can influence the level of
unemployment.
2 Discuss the positive and negative impacts of technological and structural
change on the labour market.
3 Describe how a lower rate of productivity growth might impact the rate of
unemployment in the short term and long term.
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Social costs
Increased inequality
Unemployment tends to occur more frequently among lower-income earners in the
economy, such as the young and unskilled. Because unemployment means a loss of
income for these people, they become relatively worse off compared to higher-income
earners, contributing to poverty and overall inequality in income distribution. In June
2022, just below one in five families in Australia was a “jobless family”, where no-one
in the family aged over 15 years had a job. Recent research by the Smith Family (see
chapter 11) has highlighted the “intergenerational” dimension of inequality and poverty,
where disadvantage is passed from one generation to the next, often described as the
“poverty trap”.
Rate (%)
Unemployment for particular groups
35 The problem of unemployment is far more severe for some groups in society than
Underutilisation rate
Unemployment rate
others. One example is the youngest group – those aged 15–19 – who can have
30
difficulties entering the workforce. Unemployment in this age group is up to three
25 times the rate of the general population, as shown in figure 8.4. Young workers
were particularly affected by the COVID-19 recession because of their above-
20 average levels of employment in casual and part-time positions, and a heavier
concentration of young workers in sectors such as hospitality and accommodation,
15
which were among the hardest-hit industries. An Australia Institute report in
10 2022 found that while individuals aged 15–24 make up just 14 per cent of the
workforce, they experienced 55 per cent of job losses during the COVID-19
5 lockdowns. A longer-term cause of higher unemployment rates among groups
such as younger people is educational experiences that do not provide them
0
with the skills needed in the workplace. For example, remote learning during
55 +
15–19
20–24
25–34
35–44
45–54
the COVID-19 pandemic proved more difficult for disadvantaged students and
Age group those whose home environments made online learning harder.
Source: ABS Labour Force, Australia
(Table 22, May 2023) High youth unemployment rates come about because employers are often
Figure 8.4 – Unemployment and seeking workers who have education, training and experience. This helps to
underutilisation among different age explain why four in five Australian students now complete high school, compared
groups, 2023
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Chapter 8: Unemployment
to just one in three in the 1980s. With most jobs now requiring post-secondary school
skills, the challenge for Australia’s education and training system is to better manage the
transition from school into further education, training or apprenticeships.
Other factors also contribute to higher levels of unemployment among specific groups:
• Indigenous Australians have relatively high unemployment rates, especially in
regional and remote areas. The Australian Government’s “Closing the Gap” report
in 2020 noted that employment among Aboriginal and Torres Strait Islanders is
approximately two-thirds the level of non-Indigenous Australians, with 49.1 per cent
of Indigenous Australians employed compared to around 75 per cent for the rest of
the community. However, there is almost no difference in employment rates among
Indigenous Australians with higher levels of education, suggesting that education
and skills are critical to closing the gap.
• Age-related unemployment. Unemployment rates are highest among young
Australians. Among those aged 15–19 who are in the labour force, the labour force
underutilisation rate was 33.8 per cent in June 2023, compared to a national average
of around 10 per cent. Older workers also have greater difficulty in finding work once
they have lost a job. Analysis by the Reserve Bank in 2020 found that older workers
are most likely to be out of work for an extended period of time, while younger
workers are least likely to experience long-term employment. An Australian Human
Rights Commission report in 2021 found evidence of significant age discrimination
towards older workers, with almost half of the human resources and business leaders
surveyed saying that their organisation would be reluctant to hire workers over a
particular age.
• Specific regions suffer from higher unemployment rates than others, although in
recent years the gap between city and regional unemployment has diminished. In
2022–23 the average unemployment rate in Greater Sydney (with a labour force of
3 million) was 3.4 per cent, while it was 3 per cent for the rest of the state (with
a labour force of 1.5 million). Within Greater Sydney, unemployment rates varied
from 2.1 per cent in Sutherland to 5.2 per cent in Sydney’s South-West. In the rest
of NSW, unemployment rates varied from 1.8 per cent in the Riverina to 4.3 per
cent on the mid North Coast.
• People born outside of Australia. Unemployment rates can differ for people
born outside of Australia, with a higher rate for newcomers’ first years in the
country as they integrate and adjust to language and other differences. In 2023, the
unemployment rate for people who had migrated to Australia in the past five years
was 6 per cent for those from the main English-speaking countries, and 5.9 per cent
for those from other countries (compared to 3.4 per cent for those born in Australia).
However, once migrants have been in Australia for more than 10 years they have lower
unemployment rates than the locally born population, and there is no significant
difference between those from English-speaking and non-English-speaking countries.
CEDA analysis in 2021 found that nearly a quarter of permanent skilled migrants
were over-qualified for their current job but had not found a better job because they
did not have enough work experience and lacked access to local networks.
In addition to these factors, higher unemployment rates for some groups in society may
indicate the persistence of discrimination and unequal employment opportunities in the
labour market. For example, prejudicial attitudes to Indigenous Australians in parts of
regional Australia are often cited as a factor in their higher unemployment rates.
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reviewquestions
1 Outline TWO economic and TWO social costs of unemployment.
2 Explain why youth unemployment is higher than the level of unemployment for
the general population.
3 Identify one part of the Australian labour force that experiences above-
average levels of unemployment and account for this higher level of
unemployment.
4 Australia is currently experiencing an ageing of its population, with the
proportion of Australians aged over 65 expected to grow from 16 per cent of
the population in 2019 to 23 per cent by 2055. Discuss the possible effects of
this longer-term trend on Australia’s labour market.
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The severity of the COVID-19 recession prompted the largest-scale government economic
support program in Australian economic history. The Australian Treasury has estimated
that unemployment would have peaked at 5 percentage points higher (over 12 per cent)
without the economic support program. Its centrepiece was the JobKeeper wage subsidy
program, which aimed to prevent employers laying off staff. The subsidy program
provided a $1500 per fortnight payment to an estimated 3.5 million workers. Other
measures included support for businesses, free child care and increased unemployment
benefits. The policy strategy was similar to that adopted in 2008, when a major fiscal
stimulus successfully prevented the global financial crisis tipping Australia into recession.
The $90 billion JobKeeper program supported almost one in three Australian workers
through the COVID-19 recession and was successful in avoiding a sustained jump in
unemployment.
In addition to addressing cyclical unemployment through macroeconomic policies,
governments also use a range of measures to address structural unemployment. By lifting
the economy’s efficiency, competitiveness and productivity, microeconomic reform
aims to increase economic growth and job creation over the long term. Australia’s
microeconomic reform policies have included tariff reduction, deregulation, national
competition policy, privatisation and tax reform. In particular, policies relating to the
labour market – such as industrial relations, education and training, and welfare-to-work
initiatives – are intended to foster a higher level of employment growth over time.
Labour market policies play an important role in reducing many types of unemployment.
The range of labour market policies available to governments extends from education and
training programs for people who are out of work or at risk of unemployment, measures
to improve the matching of unemployed people to job vacancies, and policies to increase
demand for labour by making it more attractive for employers to hire workers, such
as through wage subsidies. One of the first acts of the Albanese Government was to
convene a Jobs and Skills Summit in Canberra in September 2022, which included policy
commitments involving an additional $1 billion for TAFE funding and accelerating the
delivery of 465,000 fee-free TAFE places, and increasing Australia’s Migration Program
ceiling to 195,000 in 2022–23 to ease labour shortages. Australia’s investment in labour
market programs is the fourth-largest in the OECD, including expenditure on training,
public employment services, direct job creation and unemployment benefits.
Government policies relating to the wage determination system have an influence on how
the forces of demand and supply interact in the labour market. Since the 1990s, changes
to labour market regulations such as enterprise bargaining have given employers more
flexibility in determining employment conditions. These changes have aimed to increase
productivity and give employers greater incentives to hire workers. There is an ongoing
debate over how Australia can best strike a balance between policies that give flexibility
to employers, and policies that provide fair pay and conditions to employees. Changes
to the Fair Work Act introduced by the Albanese Government aim to reduce gender
discrimination, protect casual employees and allow for more flexible working arrangements
to increase workforce participation.
Successive governments have implemented labour market policies aimed at moving
individuals off welfare and into paid employment. These measures include making
it harder to access welfare payments such as through longer waiting periods, tougher
eligibility rules, requirements to keep applying for jobs and requirements to undertake
training. These changes have been designed to encourage unemployed individuals to
actively seek work or additional education and training. In July 2022, a Points Based
Activation System was brought in for individuals receiving the Jobseeker payment. It
replaced previous rules requiring jobseekers to make at least 20 job applications per month.
Instead, jobseekers must attain a minimum of 100 points per month to continue receiving
benefits. The more flexible points-based system gives individuals points for a wider range
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of activities such as attaining new skills (25); attending a job interview (25); relocating
for a job (100); and participating in the Defence Force Reserves, self-help support groups
and drug and alcohol rehabilitation.
State governments can also play a role in tackling unemployment, such as the NSW
Government’s Fee Free Vocational Education and Training program, introduced in
2019–20 and subsequently expanded and extended. Under this policy, vocational
education programs were placed within a new “Smart and Skilled” system, reducing fees
with the goal of improving access to training. Traineeships were made fee-free from 2020
to 2024.
Governments can influence the labour market through their immigration policies, which
are especially important to Australia’s economy, given our high immigration intake and
skills-based immigration policy. As part of the re-opening of Australia’s borders during
the recovery from the COVID-19 pandemic, the Government appointed a Global Business
and Talent Attraction Taskforce to address skills shortages and find ways to attract more
skilled employees from overseas. Australia’s permanent migration program for 2023–24
was set at 190,000 places, with 72 per cent of visas allocated for skilled workers who will
fill skill shortages.
Another area of policy changes aimed at the supply side of the labour market involves
lifting workforce participation by reforming the way that the tax and welfare systems
interact. Often, unemployed persons and low-income earners face very high “effective
marginal tax rates”, meaning that for every extra dollar they earn from work, they have
to pay tax as well as lose a portion of their welfare benefit. Reducing effective marginal
tax rates can therefore provide incentives to lift workforce participation and increase
employment.
Changes to parental leave programs have also aimed to increase supply in the labour
market by making it easier for parents to stay in paid employment over the longer term.
Paid parental leave, combined with policies to make child care accessible and affordable,
makes it easier for both parents in a family to maintain paid employment and take care of
their children. The 2023–24 Federal Budget allocated $12.7 billion in childcare subsidies,
increasing the amount most families received from July 2023.
Government policies can reduce frictional unemployment by helping to match jobseekers
with job vacancies. In July 2022, Workforce Australia Online, an employment services
platform with a strong focus on online job searching, was introduced. It focuses funding
towards the most disadvantaged jobseekers and the long-term unemployed. One of the
criticisms of Australia’s past job placement policies has been their underinvestment in
helping those most in need, reflected in the fact that Australia spends less than half the
OECD average on employment services, which may contribute to people who need more
intensive assistance dropping out of the labour market altogether.
reviewquestions
1 Outline the role of macroeconomic policy in reducing unemployment.
2 Identify TWO recent labour market policies and discuss how they assist in
reducing unemployment in the economy.
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Chapter 8: Unemployment
chapter summary
1 The labour force is the number of people 15 years of age and above who are
either working or actively seeking work.
4 Underemployment refers to people who work for less than full-time hours per
week but would like to work longer hours. Although not officially unemployed,
they represent a significant part of Australia’s unemployment problem.
•
cyclical unemployment, which occurs because of a downturn in the level of
economic activity
•
frictional unemployment, which occurs when people are temporarily
unemployed as they change jobs
9 Unemployment has many economic and social costs. Economic costs include
the opportunity cost of lost production, a decline in workforce skills, and the
cost of income support for the unemployed. Social costs include increased
inequality, poverty, family breakdown and crime.
10 In recent years, Australia has seen a greater emphasis on policies to improve
vocational training and workforce participation in order to address structural
unemployment.
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chapter review
1 Define unemployment and explain how it is measured.
7 Explain the effect of an increase in economic growth on the participation rate and
the level of unemployment.
8 Outline the economic and social costs for Australia of a sustained high rate
of unemployment.
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Inflation
9.1
9.2
9.3
Introduction
Measuring the rate of inflation
Recent trends in inflation
9
9.4 The main causes of inflation
9.5 The effects of inflation
9.6 Policies to sustain low inflation
9.1 Introduction
Inflation is an economic problem that can have negative impacts on many economic
outcomes, including economic growth, international competitiveness, exports and income
inequality. Maintaining low inflation is a major objective of economic policy because of
the benefits that lower inflation provides to the economy in the long run.
For over thirty years from the early 1990s, Australia sustained relatively low levels of
inflation, a significant achievement after persistently high inflation in the 1970s and
1980s. However, Australia's low inflation performance came to an abrupt end in 2022,
when disruptions to labour markets, global supply chains, energy markets and commodity
prices combined to produce a worldwide surge in inflation. In this chapter, we examine
these trends in inflation, unpack the different causes, and look at how inflation impacts on
different parts of the economy and how policymakers try to address inflation.
The basket of goods and services used to calculate the CPI does not include all goods
and services available in the economy, but covers a wide selection that reflects average
household spending patterns. As such, the CPI gives a good indication of the overall
movement in the prices of consumer goods, and reflects general changes in the cost of
living (how much consumers have to pay for the goods and services they buy). The CPI is
compiled by the Australian Bureau of Statistics (ABS) and is published every three months.
The weights given to the expenditure groups in the basket are based on the ABS
Household Expenditure Survey and are shown in figure 9.1. The ABS regularly updates the
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There is no single measure of underlying inflation in that is, the trimmed mean and weighted median added
Australia, and both the Treasury and the RBA have their together and then divided by two.
own way of calculating the underlying inflation rate. Most
The ABS reports seasonally adjusted and underlying
economists focus on two measures of the underlying inflation
measures of inflation to help make CPI adjustments more
rate – the trimmed mean and the weighted median –
comprehensive and reliable.
which were originally developed by the RBA but are now
published quarterly by the ABS. These measures adjust Prior to the higher levels of inflation seen in 2022 and
the official CPI figures to give less weight to goods and 2023, both headline and underlying inflation were at
services that experienced very large rises or falls in price. relatively low levels for three decades. During certain
Although the calculation of these measures is a highly periods they can move in different directions, such as
technical exercise, the logic behind each measure is quite during COVID-19. Headline inflation fell from 2.2 per cent
straightforward. at the end of March 2020 to −0.3 per cent three months
• T
rimmed mean inflation is determined by calculating later, only to climb back up to 3.7 per cent by June 2021.
the average inflation rate after excluding the 15 per cent At the same time, underlying inflation remained relatively
of items with the largest price increases and the 15 per steady, just below 1.5 per cent. Headline inflation alone
cent of items with the smallest price increases (or largest can give the impression that inflation is volatile, but
price falls) from the CPI. underlying inflation points to ongoing price pressures.
• Weighted median inflation is calculated by comparing It is important to note that underlying inflation can be
the inflation rate of every item in the CPI and identifying either below or above the headline inflation rate. For
the middle observation. The inflation rate of half of the example, the headline inflation fell below underlying
items in the CPI will be greater than the weighted median inflation in 2020 because a temporary government subsidy
inflation rate, and the inflation rate of the other half will during the COVID-19 pandemic sharply reduced childcare
be less than it. costs. After the subsidy ended, the headline inflation rate
When the RBA refers to its estimate of underlying inflation, went up steeply. Meanwhile, underlying inflation was
it is referring to the average of its two measures – unaffected.
reviewquestions
1 Define the term inflation.
2 Distinguish between headline and underlying inflation.
3 Analyse the limitations of the CPI as a measure of inflation in the economy.
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Chapter 9: Inflation
0
−1
1982–83
1984–85
1988–89
1990–91
1992–93
1994–95
1996–97
1998–99
2000–01
2002–03
2004–05
2006–07
2008–09
2010–11
2012–13
2014–15
2016–17
1986–87
2018–19
2020–21
2022–23
Sources: ABS Consumer Price Index, Australia; Reserve Bank of Australia, 2023
One of the most significant macroeconomic achievements of the past generation is that
Australia has generally sustained low levels of inflation after experiencing relatively high
inflation in the 1970s and 1980s (see figure 9.2). Between 1996 and 2023, both headline
and underlying inflation averaged 2.6 per cent. A key factor behind this success was the
introduction of inflation targeting. In 1993, the RBA began to target an inflation rate
averaging 2–3 per cent over the course of the economic cycle as a guide in determining
interest rate decisions. The inflation target was formalised in 1996 by an agreement
between the Treasurer and the RBA Governor. Inflation generally remained around this
target band until 2022, when inflation began to overshoot the RBA’s target.
The key event that brought the high-inflation era of the 1970s and 1980s to an end was
the recession of the early 1990s. Australia emerged from this recession with low inflation
Structural change refers
levels. The RBA’s inflation target then locked in this lower inflation rate. This has meant to the process by which
that whenever inflationary pressures have emerged – such as in 1994, 1999, 2007, 2010 the pattern of production
and 2022 – the RBA has increased interest rates to slow down the growth in demand and in an economy is altered
curb inflation rate rises. On the other hand, headline inflation rates persistently below the over time, and certain
RBA’s inflation target played a role in the RBA decreasing interest rates to a record low products, processes of
production, and even
prior to the COVID-19 pandemic in 2020.
industries disappear,
During Australia’s unbroken run of economic growth between 1991 and 2019, inflation while others emerge.
pressures remained constrained. Monetary policy was relatively successful in addressing
inflation pressures when they emerged. Many economists attributed these lower inflation Productivity refers to the
rates to the impact of structural changes during the 1980s and 1990s. Microeconomic quantity of goods and
reform increased the intensity of competition within Australia and from overseas, while services the economy
productivity growth also improved in the 1990s, all contributing to sustained low can produce with a given
amount of inputs such as
inflation. This made it possible for Australia to achieve low inflation whilst simultaneously
capital and labour.
enjoying strong economic growth and falling cyclical unemployment.
There was nevertheless a period of stronger inflationary pressures between 2005 and 2008.
Underlying inflation peaked at 5.1 per cent in September 2008 as a result of higher global
prices and the strength of economic activity. This period of strong inflationary pressures
ended with the global downturn in 2008, which reduced consumer confidence, investment
spending, demand for labour, and wage growth. Australia’s inflation rate remained at or
below the RBA’s target band during the 2010s decade.
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The COVID-19 recession in 2020 led to the largest quarterly fall in the CPI since 1931,
and the first annual decline in inflation since the 1960s. This reflected very weak levels of
economic activity across the economy, with prices for fuel and many services falling during
the period. In addition, several government emergency pandemic policies put downward
pressure on inflation. As the economy recovered from COVID-19, global inflation rates
surged. This reflected disruptions to global supply chains, high commodity prices, low
unemployment, wage growth and rising rental costs. The war in Ukraine also caused the
largest surge in energy prices in half a century. These factors pushed global inflation to its
highest levels in several decades. In Australia, headline and underlying inflation peaked
at 7.8 per cent and 6.3 per cent in December 2022. Inflation was expected to fall from
3.3 per cent in 2023–24 to 2.7 per cent in 2024–25, according to the Reserve Bank’s
survey of market economists in June 2023.
reviewquestions
1 Outline TWO factors that have affected Australia’s inflation rate in the past year.
2 E
xplain the factors behind Australia’s success in sustaining low inflation levels
during recent decades.
3 Discuss the impact of globalisation on Australia’s level of inflation.
growth, the cost of labour for each unit of output increases. Since
General price level
wages typically make up around 60 per cent of a firm’s costs, firms
AD AS2 AS1
will attempt to pass on the wage increase to consumers in order to
maintain their profitability. Similarly, an increase in the price of oil
or other raw materials will generally lead to an increase in the price
of the final product, as firms pass on the increase in prices in order to
P2
maintain their profit margins.
P1
Inflationary expectations
If individuals in the economy expect higher inflation in the future, AS2 AS1
they may act in a way that causes an increase in inflation. There are AD
two ways in which high inflationary expectations can bring about 0
Total output
higher inflation:
1. If the prices of goods and services are expected to increase in the Figure 9.4 – Cost-push inflation
economy, consumers will attempt to purchase products before
prices increase. As consumers bring forward their planned purchases, this will cause
an increase in consumption, resulting in higher demand-pull inflation. Similarly,
if a firm expects that demand for their product will increase, the firm may raise
prices in order to maximise profits, causing an increase in inflation.
2. If employees expect inflation to increase, they will take this into account when
negotiating their wage increases. Workplace contracts are typically negotiated
in advance for the next two or three years, so an employee who expects higher
inflationary pressures over the next few years will ask for a higher wage rise to
preserve the purchasing power of their wage. Higher wage increases may be passed
on by firms, leading to cost-push inflation.
Managing inflationary expectations is a major challenge for policymakers. Once
individuals in the economy expect higher inflation, they will act in a way which accelerates
higher inflation – in effect, they fulfil their own prophecy. To help manage the public’s
inflationary expectations, the RBA in 2023 announced it would increase the frequency
and clarity of its communications with the public.
Imported inflation
Imported inflation is transferred to Australia through international transactions. The
most obvious cause of this type of inflation is rising import prices. An increase in the price
of imported goods will increase the inflation rate in exactly the same way as an increase in
the price of domestically produced goods. A depreciation of the Australian dollar will also
increase the domestic price of imports and will lead to inflation. The extent to which an
increase in import prices or a fall in the Australian dollar will lead to consumers paying
higher prices for imports depends on market conditions. If imports face competition
from locally made products, importers may reduce their profit margins and not pass on
to consumers the full effect of the overseas price rise or depreciation. An RBA research
paper in 2015 noted that imported inflation now accounts for a much larger share of the
variability in the headline inflation rate than in the past, reflecting the extent of Australia’s
integration with the global economy. Imported inflation was a key driver of the surge in
inflation in 2022 and 2023, as soaring prices for fuel imports and other goods and services
impacted households and raised production costs.
Other causes
The four types of inflation listed above are the most common causes of inflation within
the Australian economy. However, there are two other possible causes of inflation:
• Government policies may directly influence the level of inflation in several
ways. By increasing indirect taxes, the government can influence the general level
of prices. For example, in 2020, the Government’s decision to make child care
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free for parents during the COVID-19 lockdown was a factor in reducing the
headline rate of inflation to below zero. Other measures that may influence prices
include competition and other regulatory reforms, changing tariff rates, imposing
price controls or price monitoring, and Fair Work Commission decisions on the
minimum wage.
• Excessive increases in the money supply can also lead to an increase in inflation.
When the increase in the money supply outstrips the growth rate of the economy,
an increased volume of money chases the same amount of goods and services, and
prices are likely to rise. Therefore, increasing the money supply without an increase
in real production effectively leads to an increase in aggregate demand relative to
supply that causes inflation (sometimes called “monetary inflation”). For example,
research published by the Bank for International Settlements in 2023 found that
countries with high money supply growth during the COVID-19 pandemic had
experienced significantly higher inflation. From November 2020 to February 2022,
the Reserve Bank of Australia’s “quantitative easing” program involved purchasing
almost $300 billion of government bonds, which had the effect of dramatically
reducing interest rates. While the action supported the economy during the
COVID-19 recession, by early 2022 it had contributed to economic recovery and
rising inflation. From then, the Reserve Bank started “quantitative tightening”.
These actions are explained in more detail in chapter 15.
It is possible to have all of the above types or causes of inflation operating at the same time,
but usually one or two types of inflation are more prominent than others. For example,
during the mid-1970s and early 1980s, inflationary expectations and cost-push inflation
tended to be more prominent; whereas the late 1980s saw demand-pull inflation as the
predominant contributor to inflationary pressure. The introduction of the GST in 2000
was an example of a federal government policy that raised inflation sharply, to a headline
rate of 6.1 per cent in 2001. The commodities boom in the 2000s significantly increased
business investment and consumer confidence, increasing aggregate demand, and thus
demand-pull inflation. Persistently low wage growth contributed to subdued inflation
expectations during the 2010s, and slower economic growth weakened demand-pull
pressures.
The COVID-19 recession meant that Australia entered the 2020s with inflation at very low
levels, but the global recovery from the pandemic witnessed an acceleration of inflationary
pressures as supply chains struggled to keep up with demand. Global inflation increased
further as a result of the war in Ukraine, with energy prices rising at their fastest rate in half
a century. The RBA noted in 2023 that short-term inflation was high but declining, and
long-term expectations remain consistent with the RBA’s inflation target. This indicates
that the market expects inflationary pressures to ease over time.
“As in all the rich economies, many industries are now dominated by just a few huge
companies. In our case, we’re down to just four big banks, three big power companies,
three big phone companies, two airlines and two supermarket chains ... markets have
increasingly become dominated by just a few huge firms, which has given them the power
to keep prices higher than they should be, and wages lower than they should be.”
reviewquestions
1 Outline recent trends in TWO types of inflation over the past decade.
2 Distinguish between demand-pull and cost-push inflation.
3 Discuss the effect of the COVID-19 pandemic on inflation.
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Chapter 9: Inflation
“High inflation hurts all Australians and damages the functioning of the economy. It
erodes the value of savings, makes it harder for businesses to plan and invest, and
worsens income inequality. And if high inflation were to become entrenched in people’s
expectations, it would be very costly to reduce later, involving even higher interest rates
and a larger rise in unemployment. It is for these reasons that the Board is resolute in its
determination to return inflation to target within a reasonable timeframe and will do what
is necessary to achieve that.”
Wages
The level of inflation is a major influence on nominal wage demands. During periods Nominal wage is the pay
of higher inflation, employees will seek larger wage increases in order to be compensated received by employees
in dollar terms for their
for the erosion in the purchasing power of their nominal wages. This can lead to the
contribution to the
emergence of a wage-price inflationary spiral that becomes difficult to break, where production process, not
wage increases lead to higher prices, which lead to higher wage demands and so on. The adjusted for inflation.
surge in inflation in recent years prompted higher wage demands in Australia and around
the world. In June 2023, the Fair Work Commission announced a 5.75 per cent increase
to award rates of pay, the largest in 16 years.
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Income distribution
High inflation rates tend to have a negative impact on the distribution of income because
lower-income earners often find that their incomes do not rise as quickly as prices. In
addition, lower-income earners may face higher interest rates on their borrowings if inflation
rises. In general, high rates of inflation hurt those individuals who are on fixed incomes or
whose incomes are not indexed to (or rise as fast as) the rate of inflation. Higher inflation
rates can also erode the value of existing savings so that individuals who do not have a means
of protecting their savings from the impact of inflation will see their net wealth decline.
Unemployment
The levels of unemployment and inflation are often closely related, especially in the
short term. Higher levels of inflation will usually result in more contractionary fiscal
and monetary policies, resulting in slower economic growth and higher unemployment
in the short to medium term. More generally, periods characterised by high levels of
unemployment often also have low inflation rates, while low levels of unemployment
are often associated with rising inflation – a relationship demonstrated by the Phillips
curve. Previously, governments generally chose between the priority of low inflation
(and slower growth) or lower unemployment (at the risk of rising inflation). However,
over the long term this inverse relationship breaks down. For example, in the mid-1970s
Australia experienced simultaneous increases in inflation and unemployment (a problem
Stagflation occurs when known as stagflation). For most of the 1990s and 2000s, Australia experienced the
the rate of inflation and opposite – a combination of low inflation and falling unemployment. Incoming Reserve
the rate of unemployment Bank Governor Michele Bullock argued in 2023 that to return inflation to the RBA’s
rise simultaneously.
target range of 2 to 3 per cent, unemployment would need to rise to a more sustainable
level of around 4.5 per cent by late 2024 (from around 3.5 per cent in 2023).
The economic theory of purchasing power parity says the price of its bikes will rise. Australian bikes will become
that exchange rates in the long run will change to reflect more internationally competitive and there will be an
the real purchasing power of currencies. This means increase in exports to NZ. NZ consumers will prefer to
that goods that are traded globally (such as processed switch to the cheaper Australian substitutes. The increased
food, clothes and electronic goods) should cost roughly demand for Australian bikes will increase demand for the
similar amounts in different countries once money
Australian dollar, causing an appreciation. As a result, the
is converted into the local currency. The theory suggests
Australian bikes will become less competitive, restoring
that there is a strong link between inflation and exchange
the purchasing power parity between the two economies.
rate movements. Economies with high inflation should
experience a depreciation relative to those economies Of course, this theory does not work perfectly because
with lower inflation rates. of a range of local factors like transport costs, taxes and
The theory relies on an assumption of free trade and floating the shorter-term influences of global financial flows on
exchange rates. Suppose that the price of an electric currencies. Purchasing power parity is nevertheless a
bike is the same in Australia and New Zealand, and the long-term anchor for the exchange rate between different
exchange rate is equal. If NZ experiences higher inflation, countries.
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Chapter 9: Inflation
Interest rates
Lower inflation normally brings about reductions in nominal interest rates, since nominal
interest rates are based on a real rate of return (or real interest rate) plus inflation. The
reduction in inflation in advanced economies following the COVID-19 recession in 2020
contributed to record low interest rates. The surge in global inflation from 2022 prompted
central banks to raise interest rates to reduce demand pressures in the economy and avoid
the negative consequences of high inflation. By mid-2023, the RBA had responded to
increasing inflation with 12 increases to interest rates, taking the cash rate to 4.1 per cent.
Benefits of inflation
The benefits of inflation are generally considered to be limited. A small amount of inflation
can be beneficial because it allows for adjustments in relative prices in an economy without
requiring reductions in normal prices, which can often be “sticky” (especially for wages).
The greater benefit of a low positive level of inflation is that it reduces the likelihood
of the economy experiencing falling prices, or deflation, which can also have negative
consequences. Deflation gives consumers an incentive to delay purchases, which can cause a
fall in consumer spending and an economic downturn. Deflation can also make borrowing
money less attractive because the amount to be repaid is rising in real terms, not falling.
In addition, deflation can make hiring more workers less attractive if nominal wage rates
stay the same and real wages rise.
For these reasons, central banks like the RBA tend to target low inflation levels that avoid
the negative consequences of inflation. They also do not strive for zero inflation, which
can increase the risk of deflation and other economic problems.
reviewquestions
1 Describe THREE consequences of high inflation.
2 Explain the relationship between the level of inflation and economic growth.
3 D
iscuss the impact of high inflation on international competitiveness and the
exchange rate.
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Australia in the Global Economy 2024
the economy by tightening monetary policy. This has the effect of dampening consumer
and investment spending, resulting in a lower level of economic activity and therefore
lower inflation.
The RBA has generally used pre-emptive monetary policy to tackle inflation before it
emerges as a problem. However, in early 2022, the RBA delayed increasing interest rates,
despite emerging inflationary pressures, because it was unsure whether those pressures
were transitory due to COVID-19’s effects on global supply chains. Once it was clear the
inflation was sustained, the RBA responded with an aggressive tightening of monetary
policy – the fastest rise in interest rates since the 2–3 per cent target range was adopted.
The RBA has attempted to make its use of monetary policy predictable by consistently
emphasising its intention to use monetary policy primarily to ensure that inflation remains
within its target band. This has had the effect of lowering inflationary expectations and
thus further reducing inflation as a problem in the economy. Underlying inflation in
Australia was consistently below the RBA’s target of 2–3 per cent for much of the period
between 2014 and 2020. This was a catalyst for the Australian Government commissioning
a review into the RBA in 2022, which recommended more frequent communication with
the public to help anchor inflationary expectations.
Fiscal policy can also play a support role in maintaining low inflation. In a period of rising
inflationary pressures, a government might increase revenue and reduce spending in order
to minimise demand pressures in the economy and therefore reduce demand-pull inflation.
Fiscal policy settings that support the low-inflation objective may also reduce the need
for higher interest rates to combat an inflation challenge. However, with low inflation in
recent years, fiscal policy has not been influenced by concerns about inflationary pressures.
Microeconomic policies The Australian Government’s use of microeconomic policies has contributed to the
are policies that are aimed economy’s long-term record of low inflation. Reduced protection has lowered the prices
at individual industries, of imports and increased the competition faced by domestic producers from both overseas
seeking to improve the
efficiency and productivity
competitors and from new entrants to domestic markets. This makes it more difficult for
of producers – also domestic producers to raise their prices. In addition, reforms to the labour market attempt
referred to as supply-side to ensure that wage increases are linked to productivity improvements. If productivity
policies. rises, the economy will be able to afford real wage increases without inflationary pressures.
During the mining boom in the 2000s and 2010s, Australia’s deregulated labour market
Labour market policies allowed for wage increases for workers whose skills were in high demand, without leading
are microeconomic
to large wage rises in other sectors of the economy. This helped to restrain inflationary
policies that are aimed at
influencing the operation
pressures. Finally, greater investment in economic infrastructure such as roads, railways
and outcomes in the and ports can help avoid transport and other bottlenecks that can increase production
labour market, including costs and add to inflationary pressures.
industrial relations policies
that regulate the process The RBA’s commitment to maintaining low inflation and the heightened level of
of wage determination as competition in the economy make it less likely that the high levels of inflation experienced
well as training, education in the 1970s and 1980s will return. However, a combination of global and domestic factors
and job-placement has brought inflation back into the centrestage of economic policy debate in recent years,
programs to assist underscoring how strongly Australian economic conditions are tied to global economic
the unemployed.
developments.
reviewquestions
1 Identify the types of inflation directly influenced by monetary policy.
2 Explain why the RBA implements monetary policy pre-emptively.
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Chapter 9: Inflation
chapter summary
1 Inflation is a sustained increase in the general level of prices in an economy.
4 Since the early 1990s, the Reserve Bank has targeted an inflation rate of
2–3 per cent on average over the course of the economic cycle. This is known
as inflation targeting.
Australia’s inflation rate generally stayed within the 2–3 per cent target range for
5
three decades from the early 1990s. Inflation increased in 2022 and 2023 due to
global and domestic factors, including supply chain disruptions due to COVID-19,
low unemployment and wage growth, and the effects of the war in Ukraine on
food and fuel prices.
6 The two main causes of inflation are demand-pull inflation and cost-push
inflation. Demand-pull inflation occurs when excessive aggregate demand
results in upward pressure on the prices of a limited supply of goods and
services. Cost-push inflation occurs when rising costs of production are passed
on to consumers. Wage rises are the main source of cost-push inflation.
7 The other main causes of inflation are inflationary expectations, imported inflation,
specific government policy decisions and excessive increases in the money supply.
9 Inflation is a major constraint on the rate of economic growth, since high levels
of inflation tend to discourage investment and may also prompt the RBA to
increase nominal interest rates, both of which will lower growth. Lower rates of
inflation are often associated with higher levels of unemployment, lower nominal
wage growth, a more equitable distribution of income, and increased international
competitiveness.
10 The main policies to sustain low inflation are monetary policy, which can
respond quickly to rising inflation, and microeconomic policies, which can
increase competitive pressures, making it harder for firms to raise prices.
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chapter review
1 Define the term inflation.
214
External Stability
10.1
10.2
Introduction
Australia’s current account deficit
10
10.3 Australia’s foreign liabilities
10.4 Australia’s exchange rate
10.5 Policies to achieve external stability
10.1 Introduction
Achieving external stability is an important objective of economic policy. External External stability is an
stability ensures that imbalances in Australia’s relationship with the global economy aim of government policy
do not hinder achieving domestic economic policy goals such as higher growth, lower that seeks to promote
sustainability on the
unemployment or lower inflation. Achieving these goals can be affected by external
external accounts so that
imbalances, such as an unsustainable increase in the current account deficit (CAD) or Australia can service its
foreign liabilities, or by large movements of the exchange rate. If overseas investors decide foreign liabilities in the
that Australia’s external position is not sustainable, this can have serious effects on the medium to long run and
Australian economy, including a depreciation of the currency, a withdrawal of investment avoid currency volatility.
funds, difficulties for firms in accessing overseas financial markets, higher interest rates
and slower economic growth.
The key concern behind the issues of external stability is that, for Australia to sustain
economic prosperity, it must manage its relationship to the global economy. Australia
needs to “pay its way” in the world and avoid imbalances that could threaten long-term
prosperity. The main external stability issues for the Australian economy in recent decades
have been:
• A persistent current account deficit. Until recent years, Australia has averaged
relatively large deficits on its current account since the 1980s, driven by a deficit
on the net primary income account. For most of the period since then, the deficit
on the current account has moved between 3 and 6 per cent of GDP, until a more
lasting improvement took place in the 2010s. Although a series of current account
surpluses began in 2019–20, the 2023–24 Budget forecast a return to deficit, with
the CAD rising to 3.5 per cent in 2024–25.
• Volatile terms of trade. In recent years Australia’s terms of trade have fluctuated
significantly as a result of the largest commodity price boom in Australian history,
which began in 2003. After falling from 2011, beginning to improve again from
2016 and rising sharply during the COVID-19 pandemic, the war in Ukraine
prompted further changes in the global economy that took the terms of trade to
record levels in 2022. A combination of strong demand from China and supply
constraints resulted in a surge in commodity prices, especially for Australia’s single
largest export, iron ore. Australia’s terms of trade rose by around 60 per cent in the
six years to 2021–22, before the terms of trade began a sharp fall in 2023.
• Australia’s lack of international competitiveness. Throughout its economic
history, Australia has struggled with its remoteness from the centres of the global
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economy and its small population base, which have made it harder to be competitive
in many markets for tradeable goods and services, such as manufactured goods
and the technology sector. Factors that contribute to our lack of international
competitiveness in these markets include the cost of transporting goods to overseas
markets, the lack of economies of scale in domestic production, the high cost base
for labour, and a lack of financial backing for innovative business start-ups.
• The growth of foreign debt. Globalisation has seen a sustained long-term increase
in Australia’s net foreign debt to around 52 per cent of GDP. Although it has
continued to grow, the past two decades of low global interest rates have meant that
foreign debt servicing costs are still lower than in the 1990s.
• Rising foreign ownership in Australia. High levels of foreign ownership result
in a large share of profits going offshore. Those outflows on the net primary income
account are offset by inflows of profits from Australian investments overseas. Many
sectors of the Australian economy have high levels of foreign ownership, with a total
of $4.6 trillion of foreign investment in Australia in 2022–23.
• The volatility of the Australian dollar. Because commodities make up a large share
of Australia’s exports, the value of the Australian dollar often reflects fluctuations
in commodity prices. Exchange rate volatility occurred during the onset of the
COVID-19 pandemic in 2020, at one stage driving the dollar below US60 cents. A
strong economic recovery and demand for commodity exports drove the exchange
rate back to US80 cents in early 2021, before global instability and rising interest
rates contributed to a depreciation to under US65 cents in 2023.
Although economists have expressed concern about Australia’s external imbalances from
time to time, these concerns have receded in recent years because of an improvement on
the current account and the fact that external imbalances have not had negative effects
on Australia’s economic performance. In fact, Australia has maintained the confidence of
foreign investors even while experiencing larger external imbalances than most advanced
economies. Increased commodity export revenues have played an especially important role
in strengthening confidence in the sustainability of Australia’s external imbalances.
Many of the general issues relating to Australia’s balance of payments were previously
addressed in chapter 4. This chapter focuses specifically on the sustainability of Australia’s
external imbalances and the relationship between external outcomes and other economic
issues in Australia.
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Chapter 10: External Stability
Over time there have been different explanations for Australia’s persistent current account
deficit. Section 4.5 discussed the cyclical and structural causes affecting the components
of Australia’s balance of payments. The extent to which the current account is perceived
as a problem, as well as the policy response required, depends on what factors are seen to
be the causes of the deficit. In this section we examine three explanations of Australia’s
persistent CAD.
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of Australia’s export base is reflected in the fact that two-thirds of export revenue in
2022–23 came from minerals and energy and more than two in five export dollars came
from Chinese markets.
% of GDP
Business investment Net saving
20
Current account balance
15
10
−5
−10
2000–01
2002–03
2004–05
2006–07
2008–09
2010–11
2012–13
2014–15
2016–17
2018–19
2020–21
2022–23
1980–81
1982–83
1984–85
1986–87
1988–89
1990–91
1992–93
1994–95
1996–97
1998–99
Sources: ABS Australian National Accounts (Cat. no. 5206.0), Australian System of
National Accounts (Cat. no. 5204.0), Balance of Payments (Cat. no. 5302.0) Years
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Chapter 10: External Stability
reviewquestions
1 Give TWO economic reasons why Australia’s current account has been in
deficit throughout most of Australia’s economic history.
2 Discuss the arguments in favour of and against the view that Australia’s
current account and foreign liabilities should not concern the Government.
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Chapter 10: External Stability
debt to GDP ratio since the beginning of the globalisation era in the 1980s. Fluctuations
can occur in the shorter term, in response to movements in the Australian dollar and
trends in foreign investment inflows and outflows (for example, exchange rate movements
contributed to an increase in net foreign debt in 2018–19, and a fall in 2019–20).
Australia’s net foreign debt was around $1.2 trillion in 2022–23, or 52.5 per cent of GDP.
% of GDP
70
Net foreign liabilities
60
50
40
Net foreign debt
30
20
10
0
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
Sources: ABS Australian National Accounts (Cat. no. 5206.0), Year
Balance of Payments and International Investment (Cat. no. 5302.0)
Figure 10.3 – Net foreign liabilities and net foreign debt in Australia (% of GDP)
In the long term, a resumption of growth in Australia’s foreign debt could lead to a debt
sustainability problem. If the size of the debt is rising faster than the increase in GDP,
the interest payments on the debt will progressively take up a greater proportion of our
GDP. Over time, higher debt servicing costs will reduce both Australia’s overall standard
of living and its economic growth potential. High foreign debt can also create a vicious
cycle, sometimes known as the debt trap scenario. This starts with a high CAD, which
requires an inflow of foreign funds that may come in the form of either foreign debt or
selling Australian assets to foreigners. With a larger foreign debt, Australia’s interest
payments on that debt increase, which are recorded as primary income debits that flow
out on the current account.
Thus, today’s foreign debt adds to future deficits on the current account. If international
financial markets suspect that Australia’s debt may become unsustainable, they may
reduce Australia’s international credit rating (which reflects the confidence that financial
markets have in Australia). A downgrading in Australia’s credit rating would make it
more difficult to borrow funds internationally and would increase the interest rate on
borrowing. However, Australia has avoided a debt sustainability problem. A sustained
period of low global interest rates and rising export revenue have ensured that Australia
has been able to service its foreign liabilities.
One of the most reliable economic measures of a country’s capacity to service its foreign
debt is the debt servicing ratio. This figure indicates the proportion of export revenue
that must be spent on interest payments on foreign debt. A country is better able to
service its foreign debt when it has a high volume of exports and is therefore earning a
substantial amount of foreign currency. The debt servicing ratio in Australia peaked at
just over 20 per cent in 1990. The debt servicing ratio rose to 4.8 per cent in 2022–23,
from a low of 2.9 per cent the previous year, reflecting the rising level of global interest
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rates. The effect of rising interest rates on the debt servicing ratio has been offset by very
strong growth in exports during recent years, improving Australia’s capacity to service
its foreign debt.
Historically, most foreign investment flows into Australia (both debt and equity)
have been into the private sector. Part of this represented an inflow from the offshore
funding of the banking sector. In other words, Australian banks borrowed on overseas
financial markets in order to make loans to Australian households and businesses.
However, in the years following the global financial crisis, banks reduced their reliance on
offshore funding because of increased domestic savings. Meanwhile, a larger share of capital
flows into Australia has gone into government securities, as foreign investors purchase
Australian Government debt. The Australian Government is one of a small number of
national governments that still holds a AAA credit rating, which is attractive to overseas
lenders because it represents a very low risk level. Foreign investors held 45 per cent of
the stock of Commonwealth Government Securities on issue in 2022.
Net foreign equity is the smaller component of Australia’s foreign liabilities. When
foreign investors buy assets in Australia, this is recorded as an increase in foreign equity.
When Australians buy overseas assets, this is recorded as a decrease in net foreign equity.
Since 2013, the value of Australia’s foreign assets has been greater than the value of foreign
ownership of Australian assets (so that net foreign equity became negative), reflecting a
trend increase in Australian ownership of foreign assets. Net foreign equity as a percentage
of GDP peaked in the 1990s, as foreign investment in Australia increasingly involved asset
sales rather than foreign borrowing. Net foreign equity tends to be more volatile than net
foreign debt, reflecting exchange rate movements and shifts in the market valuation of
companies and assets, which in turn are affected by changes in investor sentiment.
Foreign equity attracts servicing costs in the form of profits and dividends that are returned
to overseas investors. This can create an ongoing strain on Australia’s external accounts
by worsening the net primary income account (although it is offset by earnings from
Australia’s overseas investments). Equity servicing costs account for around half of total
primary income outflows. While there are some disadvantages with high levels of foreign
ownership, the sustainability of the servicing costs for foreign equity is of less concern
than for foreign debt because dividends are only sent overseas when an Australian asset
or business is generating a profitable return – while interest payments on debt must be
paid regardless of whether there is a profit.
While there has been a rise in Australia’s net foreign liabilities, this masks the large rise
in the value of Australian investments overseas, as well as the overall growth of other
countries’ liabilities to Australia. This is reflected in figure 10.4. Between 2000–01 and
2022–23, Australian ownership of equity overseas rose from $0.3 trillion to $2.1 trillion,
while Australian loans overseas grew from $0.2 trillion to $1.7 trillion. However,
Australia’s gross foreign liabilities are still much larger: over the same period, foreign-
owned equity in Australia increased from $0.4 trillion to $1.8 trillion, while gross foreign
debt increased from $0.5 trillion to $2.8 trillion. While Australia’s gross foreign debt is
significantly greater than the level of Australian lending to overseas, as previously noted,
the gap between foreign equity inflows and outflows is much smaller. In overall terms,
as Australia has become increasingly integrated into the global economy, foreigners have
been lending and investing in Australia more than Australia has been lending or investing
overseas.
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Chapter 10: External Stability
$ billion
10000
6000
Gross foreign liabilities
4000
2000
Gross foreign assets
0
2000–01
2002–03
2004–05
2006–07
2008–09
2010–11
2012–13
2014–15
2016–17
2018–19
2020–21
2022–23
1988–89
1990–91
1992–93
1994–95
1996–97
1998–99
Australia’s external imbalance has the potential to cause problems for Australia in the longer
term, although it has only occasionally been a concern in recent decades. Among advanced
economies, Australia has relatively high foreign liabilities, and external developments will
determine whether the improvement in the current account balance in recent years proves
sustainable. If global economic conditions became less favourable to Australia than they
have been in the past two decades, this could make Australia vulnerable. For example, the
reliance of the Australian financial system on an ongoing inflow of foreign capital was a
major reason why the Government considered it necessary to provide a temporary guarantee
for all overseas loans of banks and financial institutions after the global financial crisis in
2008. The Government argued that without the government guarantee, banks would not
have been able to obtain overseas loans and the financial system would have faced a major
crisis. This demonstrates the extent to which a country with higher external imbalances is
more vulnerable to adverse economic developments overseas.
reviewquestions
1 Explain the link between the current account deficit and foreign debt in
Australia.
2 Explain how a high level of foreign debt might affect an economy.
3 Discuss whether Australia’s foreign liabilities pose a threat to Australia’s economy.
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70 0.85
60 0.70
50 0.55
40 0.40
1981–82
1983–84
1985–86
1987–88
1989–90
1991–92
1993–94
1995–96
1997–98
1999–00
2001–02
2003–04
2005–06
2007–08
2009–10
2011–12
2013–14
2015–16
2017–18
2019–20
2021–22
2022–23
Although the exchange rate itself has experienced periods of volatility, it has operated
as a powerful stabilising mechanism that has helped the Australian economy adjust to
changing conditions in the global economy. During periods of weaker growth in Australia
or in the global economy, exchange rate depreciations have helped make Australia more
internationally competitive and helped stimulate export growth. The depreciation of the
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Chapter 10: External Stability
Australian dollar that followed the fall in the terms of trade after 2011 made exporters and
import-competing sectors more competitive. Many non-mining firms in those sectors were
adversely affected by the high value of the dollar during the mining boom. In recent years,
the lower dollar has helped support international competitiveness in export industries.
Although the floating exchange rate is one of the most important mechanisms that helps
Australia adjust to changing global economic conditions, it can have a significant impact
upon Australia’s external stability. A change in the exchange rate influences the balance of
payments by affecting Australia’s international competitiveness and the size and servicing
costs of our foreign debt (that is borrowed in foreign currency). Therefore, if the value of
the dollar moves sharply, two of the major indicators of Australia’s external stability will
also be volatile. Large swings in the value of the dollar can create policy challenges and
economic instability.
In particular, a sudden or large depreciation in the Australian dollar due to a fall in
the confidence of foreign investors can create a vicious cycle. Investors may fear further
volatility in the dollar, and investment decisions can be discouraged if the dollar is falling
sharply, often because it has become a target of financial speculators (who make money
from short-term financial market changes). Once a downward trend sets in, it can continue
until enough investors begin to think that the currency is undervalued and start buying
it again.
During the past two decades, the global economy went through an extended period of
historically low interest rates on global financial markets that came about after the global
financial crisis of 2008 and went even further after the onset of the COVID-19 pandemic.
This period of low interest rates ended as the global economy recovered from the pandemic
and experienced a surge in inflationary pressures.
An environment of falling global interest rates has indirect flow-on effects on the Australian
economy by pushing down the so-called “equilibrium interest rate” (the interest rate
consistent with a neutral stance) for Australia. As other countries loosen monetary policy,
their currencies weaken and in relative terms the Australian dollar strengthens. This reduces
the competitiveness of exports, and places downward pressure on inflation in the short to
medium term.
Through the decade to 2020 with low global interest rates, the Reserve Bank reduced
domestic interest rates from 4.75 per cent to just 0.1 per cent in November 2020. One
benefit for Australia’s external accounts was that this helped to reduce debt servicing costs
and slow the growth of net foreign debt. Given that Australia’s net foreign debt exceeds
$1 trillion, every percentage point decrease in benchmark interest rates significantly reduces
the servicing cost of foreign liabilities.
Global interest rates began rising from 2022, reversing the pattern of the previous decade.
As economies across the world faced the highest inflation rates in almost half a century,
central banks increased interest rates from near-zero levels that were in place during the
COVID-19 pandemic. In Australia, the Reserve Bank began raising interest rates in May 2022,
and continued increasing them to their highest level in over a decade by mid-2023. However,
as overseas interest rates rose more quickly than in Australia, funds moved offshore and
the Australian dollar depreciated. The higher global interest rates and lower dollar almost
doubled debt servicing costs in 2022–23, from $18 billion the previous year to $33 billion.
reviewquestions
1 Explain how external imbalances may affect the value of the exchange rate.
2 Discuss the impacts of exchange rate volatility on the Australian economy.
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Chapter 10: External Stability
One of the best measures of external stability is the extent to which Australia maintains the
confidence of international investors. Governments aim to sustain international confidence
in Australia’s economy with consistent, medium-term policy settings such as Australia’s
inflation targeting regime, the goal of budget surpluses and a continued commitment
to microeconomic reform. This approach has been largely successful in maintaining
international confidence in Australia’s economy in recent decades.
Nevertheless, the global financial crisis also provided an important lesson about the
connection between private and public sector borrowings. Even if a high level of foreign
debt is the result of private sector borrowings, governments can be forced to take
responsibility for those borrowings, in order to prevent a meltdown of their entire financial
system and a potential economic depression. Even in Australia, the Government felt it
necessary to provide a guarantee for all of the private borrowings of Australian banks in
2008. In effect, the Australian Government guaranteed the nation’s private sector foreign
debt. This, to some extent, undermines the argument that private sector borrowings from
overseas do not matter because it shows that in times of extreme financial instability, an
external imbalance – whatever its origins – can make an economy more vulnerable to
external shocks. Even so, the effects of economic shocks can be both positive and negative,
as Australia’s external accounts have shown in recent years.
“Australia’s balance of payments and external position provide a useful lens through
which to view changes in the domestic and global economy. As savings have
exceeded investment over the past few years, the current account shifted from a
deficit to a surplus. This followed the end of the investment phase of the mining boom
as production came on line. Higher domestic savings throughout the pandemic have
also contributed to this shift. Australia is now a net exporter of capital, as excess
savings led to portfolio equity outflows and banks reduced their offshore borrowing,
and the capital and financial account has shifted from a surplus to a deficit.”
– Nicole Adams and Tim Atkin, “The Significant Shift in Australia’s
Balance of Payments”, RBA Bulletin, March 2022
reviewquestions
1 Account for the declining importance of external stability as a specific
objective of economic policy.
2 Discuss how policy approaches can be used to address the current account
deficit in Australia, with specific reference to the different accounts on the
balance of payments.
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chapter summary
External stability is a broad term that describes a situation in which external
1
indicators such as the current account balance, foreign liabilities and the
exchange rate are at a sustainable level, that is, a level in which they can remain
in the longer term without negative economic consequences.
The main factor that influences a country’s external stability is its current
2
account balance. A current account deficit (CAD) is generally regarded as being
at a sustainable level in the long term if it averages less than 3 per cent of GDP
and in the short term if it is less than 6 per cent of GDP.
4 ome economists argue that Australia’s current account balance and foreign
S
liabilities do not constitute a major economic problem because foreign capital
adds to investment and productive capacity in Australia and because Australia’s
external imbalances are chiefly due to decisions of private investors for which the
government is not responsible.
Australia has a relatively high level of net foreign liabilities because of the growth
7
in net foreign debt since the 1980s. Rapid growth in foreign liabilities is regarded
as an indicator that a country’s external position is not sustainable, but the growth
in Australia’s liabilities has proved sustainable during recent decades.
Movements in the value of the exchange rate are an indicator of the degree
9
of international confidence in the economy, among other factors. If international
investors form the view that the economy’s external position is not sustainable,
the value of the dollar is likely to fall.
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Chapter 10: External Stability
chapter review
1 Define what is meant by external stability.
5 Explain the relationship between net foreign liabilities and the current account.
6 Examine the difference in the economic effects of a rising level of foreign debt
compared with rising foreign equity.
8
Critically evaluate the argument that the current account and foreign liabilities are
not significant economic problems in Australia.
9 Discuss the extent to which the historic pattern of current account deficits in
Australia reflects a shortfall of savings, and to what extent it reflects weaknesses
in Australia’s international competitiveness and trade performance.
229
11 Distribution of
Income and Wealth
11.1 Introduction
11.2 Measuring the distribution of income and wealth
11.3 Sources of income and wealth
11.4 Trends in the distribution of income and wealth
11.5 The costs and benefits of inequality
11.6 Government policies and inequality
11.1 Introduction
One of the most difficult challenges in economic management is ensuring fairness in the
spread of wealth and economic opportunity throughout society. While all societies have some
higher income and some lower income groups, research has shown that economies with a
smaller gap in incomes between high and low income earners tend to have greater happiness,
better health outcomes and higher levels of social mobility. In recent years there has been a
growing consensus among economists that globalisation has increased inequality in many
countries. One of the greatest challenges of adjusting to structural change in an economy is
ensuring that one part of society does not shoulder an unfair share of the burden of change,
and that benefits do not just flow to those who are already financially well off.
Australia has traditionally considered itself to be a country offering people a “fair go”, with
less inequality than other nations. Economic evidence suggests, however, that on most
measures, Australia is around the OECD average. Even if inequality is worse in countries
to which Australia often compares itself, such as the United Kingdom or the United
States, there are a number of countries from which Australia could model improvement.
Australia’s income inequality has increased in recent decades, but economic growth,
universal access to public education and health care, and a well-targeted social security
safety net have prevented a greater widening of inequality.
Many of the factors that contribute to an increase in inequality are side effects of the
policies that encourage market forces and improve competitiveness. While some level
of inequality is present in all economies, levels of inequality can increase when nations
implement economic policies such as reducing marginal income tax rates, restricting
welfare, reducing spending on public services and deregulating labour markets. However,
this does not mean that there is always a trade-off between increased growth and reduced
inequality. High levels of inequality can in fact reduce economic growth. In the past
decade, the OECD and IMF have emphasised the benefits of economic reforms that lessen
inequality.
To understand the nature of inequality we first need to understand how wealth and income
are distributed. As we look at factors such as occupation, age, gender, ethnic background
and geography, we can piece together the influences on the distribution of income and
wealth in Australia. This can then help us understand the role that government policies
can play in redistributing income and wealth and reducing inequality.
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Chapter 11: Distribution of Income and Wealth
Lowest quintile 8.1 7.7 7.5 7.9 7.9 8.2 8.3 8.1
Third quintile 17.7 17.6 17.5 16.7 16.4 16.6 16.6 16.6
Fourth quintile 23.9 23.6 22.8 23.2 21.9 21.7 21.7 21.8
Highest quintile 37.3 38.5 39.7 40.1 41.6 40.9 40.6 40.9
Gini coefficient 0.296 0.311 0.314 0.329 0.323 0.324 0.318 0.318
Sources: ABS Household Income and Wealth, Australia, Table 1.1 (Cat. no. 6523.0), Australian National Accounts: Distribution of Household Income,
Consumption and Wealth (Cat. no. 5204.055.011). Note that statistics are not released for every financial year and statistics since 2005–06 are not
directly comparable to earlier statistics.
Figure 11.2 illustrates the difference in average incomes (before tax and welfare payments)
among different groups in the Australian economy. The average annual pre-tax income
for households in the highest quintile is $365,133, 12 times the average for the lowest
quintile of $29,936.
Mean income per week $576 $1316 $2306 $3416 $7022 $2895
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The following concepts will also be useful when we are interpreting statistics relating to
the distribution of income and wealth later in the chapter:
• Mean income – the average level of income. It is calculated by dividing the total
income of a group by the number of income recipients in that group.
• Median income – that level of income that divides the income recipients in a
group into two halves, one half having incomes above the median and the other
half having incomes below the median (it is the “middle” income).
The share of income data in figure 11.1 can be used to produce two other measures of
income inequality used by economists – the Lorenz curve and the Gini coefficient.
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Chapter 11: Distribution of Income and Wealth
every few years. Nevertheless, there are clear conclusions from this data, including that the
distribution of wealth is far more unequal than the distribution of income, and this level of
inequality has existed for a long time.
Figure 11.4 depicts Australia’s level of inequality in the distribution of wealth. While we
found in figure 11.1 that the top quintile earns 40.9 per cent of total income, figure 11.4
shows that the top quintile owns 62.8 per cent of total wealth. Similarly, while those in the
bottom quintile earn 8.1 per cent of total income, they own less than 1 per cent of total
wealth. Around 70 per cent of households have less than the average level of household
wealth, which was $1,057,000 in 2022, not including liabilities.
Second quintile 2.0 3.0 6.2 5.4 5.2 5.1 5.1 4.5 4.8
Third quintile 12.0 10.0 12.0 11.9 12.0 11.4 11.4 11.1 11.3
Fourth quintile 23.0 22.0 20.2 20.0 21.0 20.5 20.4 20.4 20.5
Highest quintile 63.0 65.0 60.3 61.8 60.8 62.1 62.5 63.4 62.8
Gini coefficient 0.64 0.64 0.581 0.602 0.593 0.605 0.605 0.621 0.611
Source: ABS Household Income and Wealth, Australia, Table 2.1 (Cat. no. 6523.0), April 2022
Although wealth inequality has remained relatively stable over time (and is below its
level in the 1980s and 1990s), this reflects forces at work in opposite directions. The
Gini coefficient has been reduced by the growth of superannuation accounts since the
1990s, which have helped to build a store of wealth for people in lower income quintiles
with jobs. On the other hand, the value of many wealth assets has risen strongly in recent
decades, benefiting those who own those assets.
The increase in inequality in recent years reflects how wealth accrues to owners of capital
during periods of both growth and decline. Australia’s house prices have risen dramatically
in the past two decades, increasing the wealth of asset owners but making it harder for
low- and middle-income households to buy a home. A 2020 RBA Research Discussion
Paper on The Distributional Effects of Monetary Policy found that real-estate prices in more
expensive areas are more responsive to interest rate changes. This means that periods of
low interest rates in recent decades have increased wealth inequality, as owners of expensive
properties see the value of their assets increase more than those with less valuable real
estate. Similarly, the study found that higher interest rates have a larger downward impact
on the prices of more expensive properties. This suggests that recent increases in interest
rates may decrease wealth inequality.
The 2022 report The wealth inequality pandemic by the Australian Council of Social Service
and UNSW, found that the COVID-19 pandemic had a mixed impact on wealth distribution
in Australia. The strongest influence came from the rapid rise in house prices, which
soared by 22 per cent in 2021, the highest in 35 years. Overall wealth levels increased
rapidly and wealth inequality was reduced (because housing is distributed more evenly
across the population than other kinds of wealth). However, many younger people found
it more difficult to buy a home. Australia’s 131 billionaires, who hold 3 per cent of all
wealth, increased their wealth by an average of $395 million each (or 12 per cent) during
the pandemic, with those with interests in the mining and property development sectors
enjoying the greatest increase.
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reviewquestions
1 Outline the TWO methods used to measure income inequality.
2 Explain the difference between Australia’s income inequality and wealth
inequality.
3 Analyse how the share of income received by the highest income earners in
Australia has changed in recent years.
Other 11%
Wages and
Transfer payments 12% salary
58%
Rent from
ownership of housing 10%
Source: ABS Australian National Accounts: National Income, Expenditure and Product (Cat. no. 5206)
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Chapter 11: Distribution of Income and Wealth
Shares 2%
Trusts 3%
Vehicles 2%
Own business 5%
Contents of house 6%
Owner-occupied
property 40%
Savings in financial
institutions 7%
Investment property
16%
Superannuation 19%
Source: ABS Household Income and Income Distribution (Cat. no. 6523.0) 2019–20, April 2022
The relative importance of the two largest components of household wealth, housing
and superannuation, have increased in recent years, while savings and ownership of
business assets have declined. Figure 11.6 highlights how more value is held in owner-
occupied properties than any other asset, accounting for 40 per cent of total assets with
an average value of $502,500. Combined with investment properties, real estate assets
comprise 56 per cent of household wealth in Australia. Around two-thirds of Australian
households own their primary place of residence, and 24 per cent own other property.
Superannuation funds are the second largest household asset and the largest financial asset,
averaging $229,900 per household across all households. Superannuation funds accounted
for 19 per cent of household assets.
reviewquestions
1 Explain how households derive income from the ownership of capital.
2 Discuss the importance of transfer payments.
3 Outline the THREE main sources of household income in Australia.
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Australia in the Global Economy 2024
0
0
250
500
750
1000
1250
1500
1750
2000
$
Source: ABS Household Income and Wealth Distribution, Table 1.3 (Cat. no. 6523.0) 2019–20 data, April 2022
Note: These figures are different to figure 11.2 because these are equivalised disposable numbers
(which remove income tax and adjust for household size).
Figure 11.7 highlights the extent of income inequality in Australia, with weekly
disposable incomes below $900 for the majority of households. Over half of the population
earn less than the mean income of $1062 per week, indicating that income distribution is
asymmetric – a relatively small number of households have relatively high incomes, and
a large number of households have relatively low incomes.
Figure 11.8 highlights the extent of wealth inequality in Australia, and that wealth is more
unequally distributed than income. More than 80 per cent of households have a net worth
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Chapter 11: Distribution of Income and Wealth
that is below the average because wealth is so highly concentrated. The lowest 20 per cent
of households have a mean net worth of $35,100. In comparison, the mean net worth of
the wealthiest 20 per cent of households is around 94 times that of the lowest 20 per cent
of households, at $3.3 million. This indicates a highly unequal distribution of wealth and
an even greater concentration of wealth at the “top end” compared with the distribution
of income. To be in the wealthiest 1 per cent, a household must have net assets exceeding
$6 million.
15–19 20–24 25–34 35–44 45–54 55–59 60–64 65 and over Median all ages
All persons ($) 756 1100 1450 1730 1741 1700 1507 1543 1516
Source: ABS Employee Earnings, August 2022, Table 2.1 (Cat no. 6337.0)
Figure 11.9 – Median weekly income by age for full-time workers, August 2022
Income varies over the course of a person’s life, although it tends to remain highest between
the ages of 35 and 54 – the main years of a person’s working life. Figure 11.9 indicates that
the 45– 54 age bracket earns the highest median weekly earnings ($1741). while those aged
15–19 earn the lowest ($756), followed by those aged 20–24 ($1100). The table shows that
income levels are lower in the earlier years of working life (since people have less education
and experience and hold lower-paying jobs). While figure 11.9 focuses on full-time work,
workers in younger age brackets may also be employed in casual or part-time jobs, which
are typically lower-paying, even when number of hours is taken into account.
Figure 11.10 highlights the influence of educational qualifications on a person’s income.
Not surprisingly, those with higher qualifications such as tertiary degrees and diplomas
enjoy income levels much higher than those with vocational training or no qualifications
beyond high school. Earnings are highest for those with a postgraduate degree ($1750),
and lowest for those without a post-school qualification ($934). On average, employees
who had a post-school qualification had median weekly earnings of $1424, $490 higher
than employees without a post-school qualification.
0 200 400 600 800 1000 1200 1400 1600 1800 2000
$
Source: ABS Employee Earnings, August 2022, Table 6.1
Figure 11.10 – Median weekly earnings in main job, by level of educational qualification
The rapid increase in housing prices in the 2000s has significantly widened inequality
in the distribution of wealth by age. A 2019 Grattan Institute paper, The Generation
Gap, found that older households are now on average four times as wealthy as younger
households. Those over 65 had experienced a real increase in median net wealth of almost
70 per cent since 2002, compared to an increase of just 3 per cent among people aged
25–34. Increases in housing prices since 2019 have further widened this generation gap.
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Average weekly
earnings ($)
2500
Males Female
2000
1500
1000
500
0
Health and Financial Media and Construction Administrative Education Manufacturing Retail Hospitality Average
social services services telecommunications services (all jobs)
Source: ABS Average Weekly Earnings, Australia, Table 10A, 10D (Cat. no. 6302.0)
Another factor that contributes to inequality in wealth distribution between men and
women is that women generally accumulate lower superannuation balances during their
working lives. A Treasury report on retirement savings in 2020 found that superannuation
balances for women who have worked full-time through their careers are 17 per cent lower,
on average, than those of men. Including casual and part-time employees, the gender gap
is 33 per cent (reflecting the higher proportion of women working casual or part-time
roles). This reflects several factors, including that women are paid lower wages, they often
take longer career breaks for caring responsibilities, and when they take parental leave,
employers are not required to make superannuation payments.
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Chapter 11: Distribution of Income and Wealth
An estimated 250,000 Australians work in the “gig economy”, by performing tasks for
others on digital platforms, facilitating food delivery, ride-sharing, household chores
and even building websites. Gig economy jobs provide flexibility, but a 2023 survey
conducted by the McKell Institute found that 45 per cent of gig economy workers are
paid at a rate below the hourly minimum wage.
The gig economy also appears to reward women less generously than men. A 2021
Queensland University of Technology report on gig economy jobs, Gendered Dimensions
of Digital Platform Work, found that women earn approximately 30 per cent less than men
on a weekly basis, and $2.67 less than men per hour.
The report provides several reasons for this gap, many of which mirror the reasons that
exist in the broader economy. A key factor relates to the higher concentration of women
in certain jobs such as care work, which are paid less well than such tasks as software
development whose workers are more often male. Another factor is that women’s home
caring responsibilities reduce the time they have available for platform work, which affects
their weekly wages relative to men. The report also concludes that algorithms can directly
and indirectly discriminate against female workers. If, for example, an algorithm is set up
to preference workers who work more frequently, then female workers are disadvantaged.
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This suggests that there are barriers to employment in higher-paid jobs for non-English-
speaking migrants, perhaps due to differences in English proficiency. Nevertheless,
Australia ranks well compared to other countries for its integration of migrants (for
example, ranking 8th in a group of 38 economies in the Migrant Integration Policy Index).
Main English-speaking countries 11.6 7.5 6.6 5.5 7.7 3.9 3.3 5.8
Other than main English-speaking countries 24.1 13.3 10.0 12.0 12.3 7.1 5.9 6.3
Main English-speaking countries 8.5 5.2 4.9 5.1 6.0 4.0 2.4 3.1
Other than main English-speaking countries 16.4 10.9 7.0 7.1 8.1 6.1 3.6 4.1
Main English-speaking countries 7.7 4.9 3.5 3.9 5.2 3.7 3.0 2.5
Other than main English-speaking countries 8.8 5.1 4.2 4.5 5.6 5.1 3.2 2.9
Born in Australia 9.0 6.2 5.1 6.0 6.2 5.1 3.8 3.8
Source: ABS Labour Force, Australia, Detailed, LM7. ‘Main English-speaking countries’ does not include India, Pakistan or other countries where
English is an official language but not the main language spoken.
INDIGENOUS AUSTRALIANS
Indigenous Australians (Aboriginal and Torres Strait Islanders) comprise around 3.2 per cent
of the Australian population, or around 812,000 people. Around one-third of Indigenous
Australians live in major cities, while two-thirds live in remote or regional communities.
A majority of Indigenous Australians live in either NSW (34 per cent) or Queensland (29
per cent). The regions in NSW with the largest Indigenous population are North-Western
NSW (18.6 per cent), Dubbo (15.7 per cent) and North-Eastern NSW (11.5 per cent). In
contrast, there are several regions in the Northern Territory, Queensland, Western Australia
and South Australia where Indigenous Australians comprise the majority of the population.
The Indigenous population is significantly younger on average than other Australians, with
an average age of 23 compared to 38 for the general population. This reflects population
growth and the fact that life expectancy for Indigenous Australians is around eight years
below that of non-Indigenous Australians (at 71.6 for Indigenous males and 75.6 for
Indigenous females).
• Indigenous Australians have much lower levels of income and wealth than the population
average for Australia, alongside many indicators of disadvantage in health, education,
housing and criminal justice. For this reason, since 2008, Australian governments have
been committed to strategies aimed at closing the gap between Indigenous Australians
and the wider population.
• The Australian Census in 2021 found that, compared to $1200 for the population overall,
Indigenous households had equivalised median weekly income of $830.
• One in five Australians experiencing homelessness in 2021 were Indigenous (a total
of 24,930).
• Nationally, the employment rate for Indigenous Australians increased from 47 per cent
to 52 per cent between 2016 and 2021. Over the same period, the non-Indigenous
employment rate was stable at 76 per cent.
• The average school attendance rate for Indigenous students between Years 1 and 10
was 79.4 per cent in 2022, compared to 91.6 per cent for non-Indigenous students.
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Chapter 11: Distribution of Income and Wealth
• During the COVID-19 pandemic, Indigenous Australians were almost twice as likely
to be on income support (57 per cent compared with 27 per cent for the rest of the
population). Further, more than half of Indigenous Australians aged 15 and over For more information
reported living in a household considered to be in financial stress. on the economic
The policy solutions to address Indigenous disadvantage are complex. Nonetheless, characteristics of
there has been progress, according to the Overcoming Indigenous Disadvantage report Indigenous Australians,
released by the Productivity Commission in 2020. Life expectancy for boys and girls born see ABS National
Aboriginal and Torres
between 2015 and 2017 is 71.6 and 75.6 years respectively, an improvement of 4.1 and
Strait Islander Health
2.5 years respectively on 10 years before. Infant mortality for under one-year-olds fell
Survey and the
from 13 to 5 deaths per 1000.
Productivity Commission’s
latest Overcoming
Indigenous Disadvantage
Family structure report.
Family structure (or household structure) is another important factor influencing trends in
income inequality, particularly because of recent demographic changes in Australia, such
as the growth of female participation in the workforce, decreasing family sizes as people
raise fewer children on average, and the increasing proportion of people living alone.
Figure 11.14 reveals a large disparity in household income and wealth levels. One-person
households and single-parent households received weekly income levels significantly
below the median of $958 per week. Single-parent households, which have a weekly
income around one-third below the average for all family structures, were the worst off.
This is partly explained by the fact that only 14 per cent of single parents of children
aged less than 4 years are employed full-time. Although single parents work longer hours
as their children grow older, they still work fewer hours than couples and therefore have
lower incomes. Forty per cent of single-person households are in the bottom income
quintile. This is likely to reflect lower rates of full-time employment, driven by caring
responsibilities. Couples without dependent children were the highest income family
structure and received $1148 per person per week.
It is important to note the influence of age in interpreting these findings because of the
relationship between an individual’s age and the family structure to which an individual
belongs. Couples with dependent children have a much lower proportion of household
members in paid work, and we might expect them to have lower average incomes than
couples without dependents. A study in 2020 by the Australian Institute of Health
and Welfare titled Australia’s Children found that one in four low-income households in
Australia had children under 14 years of age. However, couples with children are also more
likely to be older, so the adults in the household are more likely to have higher individual
incomes, even if they do have to share it among more household members. Additionally,
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Australia in the Global Economy 2024
the major reason for the low income levels of single-person households is because of the
large number of aged people who are no longer in the workforce and who may rely on
government benefits as their primary source of income.
The distribution of wealth by household type shows a similar pattern to income
distribution, with couple-households enjoying significantly higher wealth levels compared
with single-parent and single-person households. The main difference is that single-person
households have much more wealth than single-parent households despite their similar
weekly incomes. This primarily reflects the influence of “income-poor and asset-rich”
elderly people in the single-person category who have paid off their mortgages and now
live off modest government pensions or other retirement incomes.
Geography
Another important dimension of Australia’s distribution of income and wealth is the
inequality between different regions of the country. Wealth tends to be concentrated in
major cities, where property prices are highest and there is a wide range of higher-paid
jobs. Governments develop policies to increase economic growth in areas outside of major
cities, to help address this gap. While there are differences between states in their average
income levels, perhaps more significant is the pattern of inequality that is found within
each of the states, between people in major cities and regional areas, and between better-off
suburbs in major cities and the suburban fringes.
Figure 11.15 highlights the inequality in household income distribution between
Australia’s states and territories, with the Australian Capital Territory and Northern
Territory enjoying the highest household incomes of $1406 and $1185, while Tasmania
has the lowest income of $961 per week. Western Australia and the Northern Territory –
the regions with the largest shares of economic activity in mining – have experienced a
lasting benefit from the mining boom and now have incomes above most of the eastern
states. Age also plays a role in interstate inequality, with areas with younger populations
such as the Australian Capital Territory and New South Wales having higher incomes than
states with older populations like Tasmania. An important limitation of this data is that it
does not take into account differences in the cost of living. For example, Sydneysiders are
paying the highest weekly rents in the country, with the average price of renting a property
NT
$1185
QLD
$1087
WA
$1146
SA
$1038
NSW
$1150
VIC ACT
$1129 $1406
Australia
$1124
Source: ABS Household Income and Income TAS
Distribution, Table 14 (Cat. no. 6523.0) 2019–20 data, $961
April 2022
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Chapter 11: Distribution of Income and Wealth
in Sydney in 2023 at $711 per week. In contrast, the weekly median rent for an Adelaide
property is $534. So, although incomes might be similar in both cities, actual living costs
might be lower in a smaller city such as Adelaide, resulting in higher living standards.
Inequality also exists within states, in particular between the major cities and the rest
of the state. A study released by the Committee for Economic Development of Australia
in 2018, called How Unequal? Insights on Inequality, found that half of NSW’s most
disadvantaged regions were concentrated in just 6 per cent of the state (or 37 postcodes),
and that this geographical inequality had barely changed since 2007. Figure 11.16 shows
that in New South Wales, the population living in the capital city area earned 24 per cent
more than those in the rest of the state. Even larger differences can exist for net wealth,
reflecting the big differences between property values in cities compared to regional areas.
The higher net worth for Sydney households is explained by their property assets, which,
at an average of $1.2 million per home, are worth almost double the $695,000 in average
home values for households in the rest of NSW. In interpreting these statistics, however,
it is important to remember that, as with interstate comparisons, cost-of-living differences
mean that raw income levels can exaggerate the true extent of income inequality between
geographic areas.
Average net worth 1,187,100 1,199,400 790,300 917,800 868,100 779,000 1,042,000
Source: ABS Household Income and Wealth, Australia, Table 13.3, 13.5, 13.7, 13.9 (Cat. no. 6523.0)
2019–20 data, April 2022
Australians like to think of our country as a land of opportunity, but economic analysis
suggests that there is much less social mobility than we like to think. One of the most
important factors determining your future qualifications, job and income is what your
parents do. This means that just as richer families pass down wealth from one generation
to the next, it is also true that education levels and income levels tend to be handed down
the generations as well.
Two studies of inequality in Australia highlight the nature of the debate about inequality
and its causes.
A report, Understanding Inequality in Australia, published by the Institute of Public Affairs in
2017, argued that problems with rising inequality in Australia were often exaggerated, and
that different data sources reach different conclusions. It argued that Australia is around
average for its levels of inequality, if not better than average; that, if anything, inequality is
in decline; and that there was greater inequality in the pre-1950 period than today.
The IPA report also placed emphasis on the role of family and local community in influencing
the values of individuals around work and study, which, in turn, have significant impacts
upon educational outcomes. As the graph highlights, earnings for individuals whose father
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Australia in the Global Economy 2024
completed a university degree are around one-third higher than for those with a father who
only completed Year 10 or below. The report also argued that to understand inequality
we need to look beyond measures of income and take account of the fact that some
individuals are happier with a lower income but greater leisure time, or the opportunity to
do the work that they most enjoy.
The IPA report noted the importance of housing prices to inequality, noting that while
98 per cent of Australians want to own their own home, housing has never been more
unaffordable than it is today. The report also noted concerns that, against international
benchmarks, student results at Australia’s schools have declined in recent years. This
decline has taken place across mathematics, science and reading literacy.
In 2023 the Australia Institute published a report on similar issues, Inequality on Steroids,
and came to different conclusions to the IPA. Its analysis identified a trend towards
increasing concentration of wealth, with the top 10 per cent of income earners in Australia
securing 93 per cent of the growth in income that occurred in Australia in the decade to
2019. This contrasted with all previous time periods since the Second World War, which
saw the majority of income growth going to the bottom 90 per cent of income earners.
The report advocated for a more inclusive post-pandemic economic growth to avoid
worsening inequality.
Using the international benchmark of the gini coefficient, Australia is ranked 21st out of
the OECD’s 38 countries, meaning that it has slightly more inequality than the majority of
OECD economies.
Although the distribution of wealth in Australia is far more an increase in income inequality can result in a widening of
unequal than the distribution of income, wealth and income wealth inequality, and an increase in wealth inequality can
are closely related. Individuals with high incomes tend to result in an increase in income inequality. This helps explain
also enjoy greater levels of wealth compared to low income why the gap between the incomes of Australia’s youngest
earners. and oldest age groups has grown since 2008.
Household income can be used to purchase goods and
A Productivity Commission research paper in July 2020
services, service debts and acquire assets. The more
income a household has left after covering living expenses, found a trend towards above-average income growth
the greater its capacity to build wealth. Also, the more among over 65s in the years that followed the global
wealth a household has, the greater its capacity to generate financial crisis, and below-average income growth among
income. A household can generate higher income in the under 35s. The largest contributing factor was that over
form of rent from a property investment, or dividends from 65s enjoyed their fastest income growth not from work or
a share portfolio. But these assets may not be affordable government transfers, but from their wealth assets (such
until income levels reach a certain threshold. In this way, as rent and dividends).
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Chapter 11: Distribution of Income and Wealth
reviewquestions
1 Describe the recent trends of income inequality within Australia, with reference
to specific demographic groups.
2 Outline the effect that geographic location may have on income and wealth
inequality in Australia.
3 Analyse possible reasons behind the disparity in average earnings between men
and women.
4 Discuss the accuracy of using the average weekly income measurement as a
measure of income distribution in Australia.
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Australia in the Global Economy 2024
decades from 1990 to 2010. One of the main reasons for this negative economic impact
is that as inequality increases poverty, particularly in the bottom decile, tends to become
entrenched. This was also highlighted in Treasury research in Australia published in 2022.
“The empirical evidence amply supports the negative effect of poverty on economic
growth. However, the impact of inequality on growth is less straightforward. A case can
be made that inequality can serve as an incentive for effort and investment. However,
other theoretical arguments and empirical evidence point to a negative effect of
inequality on growth through a variety of channels ...
[I]f the opportunity to save, invest, acquire skills, innovate, and take risks are thwarted
by barriers (such as fixed costs) that depend on an individual’s initial income, wealth,
place of birth, race, ethnicity, sexual orientation or disabilities, inequality can prevent
many poor and marginalized people from contributing to growth.”
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Chapter 11: Distribution of Income and Wealth
4.6 per cent of working age males and 6.4 per cent of females are persistently in poverty.
The 2023 ACOSS/UNSW report Poverty in Australia found that during the COVID-19
pandemic, temporary increases in income support payments helped to reduce the percentage
of Australians in poverty from 14.6 per cent of the population in March 2020 to 12 per cent
of the population in June 2020. Poverty tends to trap families into a vicious cycle of low
incomes and limited economic opportunities. High poverty levels also tend to be associated
with increased levels of crime, poor physical and mental health and reduced life expectancy.
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Australia in the Global Economy 2024
a “larger pie” from which all members of society could benefit. Additionally, one might
argue that there are social benefits from an economic system that encourages hard work,
risk-taking and social mobility. However, income inequality has few overall social benefits,
since the economic system that determines the distribution of income and wealth does not
give everyone the same level of opportunity to pursue their income and wealth goals.
Inequality of opportunity exists in Australia due to several factors:
• Existing inequality in the distribution of income and wealth tends to perpetuate
inequality of opportunity. For instance, higher income earners have better access to
educational opportunities, making it more likely that they will gain admission
to university courses, allowing them to take up higher paid occupations.
• Not everyone has the same mental and physical attributes and the same potential
with regard to the acquisition of income and wealth. For example, some people are
more talented at manual work, which tends to lead to lower paying jobs than jobs
that require analytical skills.
• People who acquire wealth through inheritance have a much greater opportunity
to build up their wealth through investments, as opposed to those that start with
no wealth.
• People may not have access to the same networks of people that may lead to new
opportunities. For example, new migrants are likely to find it difficult to access
social and business networks. Often this inequality is difficult to overcome because
many of the barriers to opportunities are informal barriers (for example, business
people may prefer to do business with people who went to their school, or have a
similar social background, because they feel more comfortable with such people –
this will informally exclude other people).
Given the problem of inequality of opportunity, it is generally felt that the social benefits
associated with inequality are very limited.
reviewquestions
1 Explain how reducing inequality might increase economic growth. Use a
numerical example to support your answer. (Hint: the marginal propensity to
consume at different levels of income).
2 Outline the major social and economic costs and benefits of inequality.
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Chapter 11: Distribution of Income and Wealth
in Australia in the past have contributed significantly to an increased gap between high
and low income earners. Unemployed people must rely on government benefits, which
are significantly below the average incomes earned by people in employment. Thus, lower
unemployment rates tend to reduce the gap between the rich and the poor. One of the
main purposes of the Australian Government’s JobKeeper package introduced during the
COVID-19 recession in 2020 was to maintain the employer/employee relationship, and
minimise job losses during the periods when business activity was most disrupted by
COVID-19. By reducing job losses during the worst period of the recession, the Government
was able to limit “labour market scarring” in the form of long-term unemployment, and
the long-lasting rise in inequality that has historically followed recessions.
Changes in the labour market
Changes in the pattern of employment have meant that many of the jobs that have been
created in recent years have been casual or part-time rather than full-time jobs – in fact,
data released by the Australian Bureau of Statistics in 2023 showed that 6.8 per cent
of all jobs (or 1,061,100) are “secondary” jobs, that is, not the worker’s main source of
income. The decline of full-time work contributes to underemployment – people in Underemployment refers
part-time or casual jobs wanting to work longer hours but being unable to find more work. to those persons who
Underemployed people often hold casual or temporary jobs in the so-called “gig economy”, are working less than full
time (and therefore not
with work hours changing from week to week. Thus, they tend to have lower incomes unemployed) but would
and suffer greater fluctuations in their income levels because when an economy goes into like to work more hours.
a downturn, the first measure businesses often take is to reduce casual and overtime hours.
The decentralisation of the labour market has widened inequality between wage
earners. Under enterprise agreements, workers with greater skills and bargaining power
have achieved higher average wage increases than less skilled workers who rely on
industrial awards for wage rises. In addition, as jobs have become more highly skilled and
highly specialised, the gap between pay for high skilled and unskilled work has widened.
The problem of increased wage dispersion was recognised in the Fair Work Act 2009,
which includes special provisions to help low paid workers engage in enterprise bargaining.
Australia’s national industrial relations regulator, the Fair Work Commission, also has an
influence on inequality through its annual decision on adjustments to minimum wages
in Australia. This decision establishes minimum wage levels for millions of employees
who are covered by awards and agreements based on awards, and also indirectly influences
other wage outcomes throughout the economy. Since its first minimum wage decision in
2010, the Fair Work Commission has indicated a willingness to raise minimum wages to
assist low-paid workers where it has been confident that such increases would be affordable
for businesses.
In June 2023, the Fair Work Commission announced an increase to the national minimum
wage of 8.65 per cent, from $21.38 per hour to $23.23 per hour. It also increased award
pay rates by 5.75 per cent. These represented the largest increases awarded under the
current pay system, and came in response to a surge in inflation following the war in
Ukraine and the recovery from the COVID-19 pandemic. A key parameter for decisions
of the Fair Work Commission’s Minimum Wage Panel is keeping minimum wages at
around 55 per cent of median full-time earnings for Australians.
Government policies to reduce inequality
Changes in government taxation, transfer payments and other assistance have the
most direct impact on inequality in Australia. Overall, government intervention tends to
reduce income inequality by taxing the wealthiest groups more heavily and redistributing
income to lower socio-economic groups. The 2023–24 Budget allocated $250 billion for
social security and welfare payments. The largest transfer payments are the age pension
($59 billion), the disability support pension ($21 billion) and the JobSeeker payment for
the unemployed ($13 billion).
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Figure 11.17 shows that income inequality is significantly reduced through government
intervention. The final income of households (bottom row) is more evenly distributed
than income from private sources (the top row). Without any taxes or government
benefits, income for the highest quintile is over 12 times the average for the lowest
quintile (most of whom are age pensioners or people on disability support). As
a result of government policies, the average annual disposable income received
by the lowest quintile of income earners is almost doubled, so that the highest
income earners take home incomes around five times those of the lowest quantile.
Source: ABS Australian National Accounts: Distribution of Household Income, Consumption and
Wealth, Table 11.11, December 2022
Figure 11.17 – Distribution of annual household income, taxes and benefits, 2021–22
As income rises, so too does the level of taxation (the difference between gross income and
disposable income). This occurs because Australia has a progressive income tax system,
with higher marginal tax rates for higher income levels. Nevertheless, the Australian
Bureau of Statistics’ data on the distribution of government taxes and benefits (ABS cat. no.
6537) showed that in 2018, the lowest 40 per cent of income earners had a proportionately
larger tax burden, earning only 12 per cent of total private income but paying 15 per
cent of total taxes. This occurs because of the impact of indirect consumption taxes that
are not related to household incomes, such as the Goods and Services Tax. This is offset
by government benefits that primarily assist those in the lowest three income quintiles.
Government transfers and the provision of government services such as health, education
and housing, are the primary mechanism for reducing disadvantage in Australia. The
combined effect of taxes and transfers, according to a 2018–19 Productivity Commission
study, is the reduction of income inequality by about one-third.
Recent budgets have contained several policy measures with significant consequences
for inequality. Major changes to Australia’s personal income system were introduced in
three phases from 2017–18 to 2024–25. The first stage of the cuts was targeted at lower
income earners, but the largest tax reductions are the stage-three tax cuts, taking effect
from 1 July 2024 and abolishing the 37 per cent tax bracket. By reducing the number of
tax brackets from four to three, income earners pay the same rate for all earnings between
$45,000 (which is slightly above the minimum wage) and $200,000 (which is two and
a half times the average wage). Although a Treasury Working Paper in 2019 found that
Australia’s personal income tax became more progressive between 1994 and 2016, the
changes taking effect from 2024–25 make Australia’s tax system less progressive.
Compulsory superannuation has influenced the distribution of wealth in Australia
since its introduction in 1992. Employers in Australia are required to contribute a
minimum of 11 per cent (rising to 11.5 from 1 July 2024) of an employee’s wages to a
superannuation fund that they cannot access until their retirement. Since the mid-1980s,
the proportion of employees covered by superannuation has risen from 42 to 94 per cent.
While superannuation assets boost the wealth of all wealth quintiles, they are particularly
important for low- to middle-income earners, for whom superannuation may be one
of few significant financial assets. The beneficial effects of compulsory superannuation
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Chapter 11: Distribution of Income and Wealth
reviewquestions
1 Outline how THREE government policies may indirectly affect the distribution
of income and wealth.
2 E
xamine how labour market policies might be used to address income
inequality.
3 Explain how a government might implement policies to reduce the inequality
in income and wealth distribution.
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Australia in the Global Economy 2024
chapter summary
1 Income inequality refers to the degree to which income is unevenly distributed
in an economy.
5 Wages and salaries are the largest source of income, constituting over half of total
income to individuals, followed by business profits, rental property income and
returns from enterprise.
8 The costs of inequality are that it diminishes total utility in society, reduces
social mobility, lowers consumption and economic growth, encourages
conspicuous consumption, reduces work efficiency, and contributes to worse
wellbeing and health outcomes. It can also create an “underclass” of people who
are stuck in poverty.
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Chapter 11: Distribution of Income and Wealth
chapter review
1 Distinguish between income and wealth.
2 Explain how the following can be used to measure the degree of inequality
in the distribution of income:
5 Discuss the general trends in the distribution of income and wealth in Australia
in recent years.
6 Outline the economic costs and benefits associated with income inequality.
7 Outline the social costs and benefits associated with income inequality.
8 Discuss the relationship between increasing level of inequality and the level of
economic growth in an economy.
10 Analyse the impact of the government’s policy mix on income inequality in Australia.
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12 12.1
Environmental
Sustainability
Introduction
12.2 Ecologically sustainable development
12.3 Market failure: private benefits and social costs
12.4 Public and private goods
12.5 Major environmental issues
12.6 Government policies and environmental sustainability
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While prioritising environmental concerns may involve economic costs in the short term,
sustainable economic growth in the longer term depends on a healthy environment. Action
to protect the environment can therefore support economic growth in the medium to long
term. For example, a 2020 Deloitte Access Economics report, A New Choice: Australia’s
Climate for Growth, estimated that the cost to the Australian economy of not acting on
climate change will by 2070 amount to $3.4 trillion and 880,000 jobs. On the other hand,
the benefit from shifting Australia’s economy to net zero carbon emissions could increase
GDP by 2.6 per cent by 2070, adding $680 billion and creating over 250,000 jobs.
In recent decades, environmental factors have been incorporated into economic theory
through the emergence of environmental economics. This chapter begins with an
explanation of how economic theory deals with environmental issues. Concepts such as
market failure, public goods and externalities are useful in understanding the contemporary
environmental challenges and policies addressed in sections 12.5 and 12.6.
12.2 E
cologically sustainable
development
Environmental economics emphasises the need to pursue a sustainable level of growth, taking
into account the effects that economic activity has on the environment. Unless the hidden
costs of economic growth are taken into account, fast growth may lead to a rapid depletion
of resources, a polluted environment and a reduction in quality of life.
Primary
In chapter 7 we looked at the concept of sustainable economic growth. goods
This is the idea that growth should be maintained at a level that
is not so low that unemployment increases, and not so high that
Now
it causes excessive inflation or external imbalance. Environmental
concerns provide an additional longer-term dimension to the concept
of sustainable economic growth. Overuse or exploitation of natural
resources to achieve short-term growth can deplete these resources
and permanently damage the environment, reducing the productivity
of affected sectors of the economy. Consumption that depletes an Future
economy’s natural resources will reduce the future potential output in
the longer term, especially in primary industries that rely on natural 0 Manufactured
resources as inputs in the production process. This is represented by goods
a decrease in the economy’s production possibility curve, as shown in
Figure 12.1 – The long-term impact of resource
figure 12.1. overuse on the production possibilities curve
Some historians argue that the severe depletion of natural resources played a major role in
the collapse of past civilisations and empires, when deforestation and soil erosion made it
impossible to sustain a food supply for local populations. This explanation for the decline of
past empires (including the Roman Empire, the Mayan civilisation and smaller communities
such as Easter Island) is the most extreme example of the impact of ecologically unsustainable
development.
Ecologically sustainable development involves conserving and enhancing the community’s Ecologically sustainable
resources so that ecological processes and quality of life are maintained. It is a level of development involves
economic activity that is compatible with the long-term preservation of the environment, conserving and enhancing
the community’s resources
rather than the maximum level of growth possible in the short term. so that ecological
The long-term purpose of achieving both economic growth and environmental protection processes and quality of
life are maintained.
is to improve people’s quality of life. The benefit of satisfying a greater number of material
wants is diminished if it comes at the expense of damage to the natural environment,
the depletion of natural resources or harmful effects on human health. Further, harm to
the environment reduces the quality of life for future populations by depleting natural
resources – and therefore the future growth – of the economy. One of the major principles
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Australia’s National Strategy for Ecologically Sustainable Development (NSESD) was first
developed in 1992. The core objectives of the strategy are:
• to enhance individual and community wellbeing and welfare by following a
path of economic development that safeguards the welfare of future generations
• to provide for equity within and between generations
• to protect biological diversity and maintain essential ecological processes
and life-support systems.
The pursuit of ecologically sustainable development has been incorporated into the policies
and programs of Australian governments as a significant policy objective. For example,
government departments are required to report on environmental matters in their annual
reports. The principles and objectives under the strategy remain relevant today, and continue
to guide government initiatives, such as the Nature Positive Plan to reform national
environmental regulation.
The Australian Government has endorsed the United Nations’ 2030 Agenda for Sustainable
Development, which aims to integrate the social, environmental and economic dimensions
of sustainable development. The Department of Climate Change, Energy, the Environment
and Water is responsible for leading progress towards the Sustainable Development Goals
related to clean water, energy, responsible production and consumption, climate action, life
below water and life on land.
reviewquestions
1 D
escribe what is meant by ecologically sustainable development, and explain
how it fits within the study of economics.
2 O
utline the concept of intergenerational equity and discuss the impact of
policies to encourage intergenerational equity on economic growth.
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consumers demand goods, producers will make them available, so long as they can receive
a price that at least covers their costs. This means that as demand increases, production
will increase.
However, the price mechanism does not effectively take into account the long-term effect
of economic activity on the environment. Stocks of fish, for example, may continue to be
farmed until they run out, forests may be logged until there are none left, and rivers and
the atmosphere may be polluted. This is because producers enjoy a private benefit from
the activity that depletes resources or pollutes the environment, but they do not directly
face the social costs that their economic activity creates. Similarly, the market price that
is paid by consumers does not reflect these social costs.
Market failure occurs because the price mechanism only takes account of private benefits
and costs of production to consumers and producers – it does not take account of wider
social costs and benefits borne by all of society. These other costs and benefits that are
passed on to other members of society are known as externalities. Negative externalities
are a cost to society and positive externalities are a benefit to society.
The concept of negative externalities generally refers to the adverse spillover effects on A negative externality is
the environment from economic activity. Goods and services that have negative externalities a negative outcome of an
economic activity whose
are known as demerit goods.
cost is not reflected in
In an economic system based on private property ownership, there are no general property the operation of the price
rights associated with environmental resources such as oceans and the atmosphere. This is mechanism.
one of the main economic problems that lie behind the market’s
failure to account for the environmental impacts of production. SINGLE-USE PLASTIC: CAUSING
The price mechanism does not determine a price or value for these A NEGATIVE EXTERNALITY
resources, and they are freely depleted. Therefore, the environment
and other common resources can be destroyed through overuse
(such as overfishing the seas or rivers, or polluting the atmosphere
and waterways). This market failure is referred to as the tragedy
of the commons. In OECD countries, each person produces an
average of 238 kilograms of plastic waste each
Nevertheless, the price mechanism plays a limited role in
year. Single-use plastic packaging has been
protecting the environment by limiting the sales of depleted
strongly favoured by businesses and consumers
resources that do have a price. When environmental resources because of its convenience, flexibility and its low
become scarce, the cost of natural resources increases, reducing cost to produce. But after a consumer is finished
the number of resources consumed. Therefore, if a large number with the plastic, it can pollute the environment
of trees are cut down to be sold on the market, eventually it will as litter or end up in landfill, where it can take up
become more expensive to supply them. The remaining supply to 500 years to decompose. It also ends up in
will be in a remote location, and of a lower quantity, so prices waterways, where it can be ingested by marine
will rise and reduce the number of people who can afford them. life and transferred up the food chain to humans,
In addition, the high price will also induce producers and buyers with adverse health consequences. None of these
to look for and develop alternative inputs to production. events impose direct costs to the businesses that
supply the packaging or to individual consumers.
However, this approach can only protect resources that are sold In this situation, single-use plastic causes a
in markets, such as fish and timber. The price mechanism plays negative externality, because society bears the
no part in allocating environmental resources that can be used cost of the environmental damage and pollution.
for free, such as the use of the atmosphere to dispose of gases
generated during the production process. Further, remaining
resources may not be protected if the price increases too late and
by too little.
Not all externalities are negative. Positive externalities are the beneficial spillover A positive externality is
effects from economic activity. Although production does not usually generate positive a positive outcome of an
environmental outcomes, it can generate other beneficial spillover effects for society. economic activity whose
value is not reflected in
For example, use of public transport can reduce commuting costs for consumers but the operation of the price
also generate positive externalities such as reduced road congestion and reduced carbon mechanism.
emissions. Goods and services that have positive externalities are known as merit goods.
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The role of externalities in the marketplace can be demonstrated with the use of a demand
and supply diagram. In figure 12.2, the costs of production are borne by the producer,
and are represented by the producer’s supply curve. Negative externalities that are borne
by the whole society, however, are an additional cost on top of the producer’s costs. If we
add the producer costs and social costs together for each level of output, we can plot the
supply curve for the whole society – S (social cost), which lies above the normal supply
curve. The vertical distance between the two supply curves is the size of the externality.
S (private cost)
S (private cost)
ps
ps
pm pm D (social benefit)
D
D (private benefit)
qs qm Quantity qm qs Quantity
Where: pm = market price Where: pm = market price
ps = socially optimum price ps = socially optimum price
qm = market quantity qm = market quantity
qs = socially optimum quantity qs = socially optimum quantity
The market will only take into account private costs and benefits of production, resulting
in a price of pm and an output level of qm. If the negative externality were borne by either
the producer or consumer, however, the price would rise to ps, reflecting the higher cost of
production. Output would fall to qs, highlighting that goods and services with negative
externalities tend to be overproduced.
Positive externalities are the opposite – they are benefits of production that are not enjoyed
by the individual consumer. For example, replacing an inefficient old refrigerator with a
new energy-efficient refrigerator will not only reduce an individual household’s energy bill
but also reduce its energy consumption and the emissions of carbon dioxide – a benefit for
the whole society. In figure 12.3, the consumers’ demand curve is based on the individual
benefits of consumption. If we add the social benefits, we can plot the demand curve for
the whole of society – D (social benefit), which lies above the normal demand curve. The
vertical distance between the two demand curves is the size of the positive externality.
The market will only take into account private costs and benefits of production, resulting
in a price of pm and an output level of qm. However, if the positive externality were enjoyed
by the producer or consumer, the price would rise to ps, reflecting the higher value of the
good’s production. Output would rise to qs, showing that goods and services with positive
externalities tend to be under-produced.
reviewquestions
1 Explain why individuals and businesses may not pay for the environmental
costs of their economic activities.
2 Identify THREE examples of negative externalities and positive externalities
resulting from economic activity.
3 Suppose a particular good has a high social cost that is not accounted for
by the price mechanism. With the use of a diagram, contrast the socially
optimum equilibrium with the market equilibrium outcomes.
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1. Public goods are non-excludable – once 2. Public goods are non-rival – consumption
public goods are provided, the producer of the good by one individual consumer
cannot exclude consumers from enjoying does not reduce the quantity of the good
the benefit of that good even if they are available for other consumers.
not prepared to pay. For example, one person’s “consumption”
Once national defence, street lights or of the benefits of public order does not
a clean environment is provided, even reduce the ability of others to also enjoy
non-paying consumers cannot be this public good.
excluded from enjoying the benefits of
these goods.
These characteristics of public goods create the opportunity for “free rider” behaviour. This Free rider refers to groups
occurs when consumers or businesses benefit from a good or service without having to pay for or individuals who benefit
its production or maintenance. A fishing company that benefits from clean oceans without from a good or service
without contributing to the
paying the cost of cleaning up ocean pollution is an example of free-riding behaviour.
cost of supplying the good
The potential for free rider behaviour means that private markets either do not provide or service.
or under-provide public goods, since private-sector firms would not be able to charge
consumers for enjoying the benefit of that good. Therefore, the price mechanism cannot
produce an equilibrium outcome that properly reflects the forces of supply and demand,
and setting a price does not limit the consumption of public goods. The incentive for free
riders would therefore tend to undermine any attempt by the private sector to clean up the
environment or protect it from overuse and depletion. For this reason, public goods tend
to be provided by the government.
It is important to distinguish between public goods and public-sector goods, that is, Public-sector goods
goods and services that are provided by the government or its agencies. Not all public- are goods and services
sector goods are public goods. Train services, for example, are usually provided by the provided by the
government, such as train
government, but they are not public goods because they are excludable, since train services and hospitals.
guards can prevent you from riding for free. Likewise, not all public goods are provided
by the government.
reviewquestions
1 Identify a public good that is provided in your local area. Outline how
the problems of public goods apply in this situation. What role does the
government play in providing the good?
2 Using examples, describe the characteristics of a public good. Explain how
these characteristics lead to the free rider problem.
3 Distinguish between public goods and public-sector goods.
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Climate change
The most profound threats to the global environment come from climate change. Climate
change, also known as global warming, is related to the emission of greenhouse gases,
including carbon dioxide (CO2), nitrous oxide (N2O) and methane (CH4).
Agriculture 2% The world’s most authoritative source of information on climate science
Construction 1% is the Intergovernmental Panel on Climate Change (IPCC), involving
Water and waste 0.3%
hundreds of the world’s leading scientists. In its sixth global assessment
Other 1%
report released in 2022–23, the IPCC observed that changes in the Earth’s
climate, across every region, were unprecedented across thousands, if not
Electricity hundreds of thousands, of years. The report found that average emissions
25% in the last decade were higher than in any previous decade. The updated
modelling indicates that the environmental, health and economic impacts of
Com
5%
merc
ial Transport additional degrees of warming are more significant than previous estimates.
25%
Residential The IPCC estimated that over the next 20 years, global temperatures will
8% reach or exceed 1.5 degrees Celsius of warming. The report found that
Mining global temperatures are expected to increase until 2050 under all scenarios,
Manufacturing
15%
18% with warming exceeding 1.5 degrees Celsius unless large reductions in
greenhouse gas emissions are made. At 1.5 degrees Celsius of global
warming, there will be increasing heat waves, longer warm seasons and
shorter cold seasons. At 2 degrees Celsius of global warming, heat extremes
Source: Department of Climate Change, Energy,
the Environment and Water, 2023 would more often reach critical tolerance thresholds for agriculture and
Numbers may not add to 100% due to rounding health. An important implication of the IPCC climate modelling is that
Figure 12.4 – Australia’s energy consumption
achieving net zero CO2 emissions caused by human activity will be required
by sector to stabilise global temperatures at any level.
Because of the worldwide reliance on fossil fuels, there is a close link between increased
economic growth and the growth in carbon emissions in most economies around the world.
As standards of living improve, greater demands are being placed on limited natural
resources to satisfy the world’s energy and food supply needs. The average estimated
increase in carbon dioxide emissions from 2001 to 2025 is 1.9 per cent per year. As
highlighted in the latest IPCC report, uneven economic development across countries has
meant that vulnerable communities that have historically contributed the least to climate
change are disproportionately affected by it.
Climate change is expected to have major consequences around the world and in Australia,
as outlined in figure 12.5. Australia is particularly vulnerable to the effects of climate
change because it is already a hot, dry country. Australia is also vulnerable because of the
importance of fossil fuels to energy production and exports, and its proximity to other
countries that will be affected by increased temperatures and rising sea levels, such as
Indonesia and Bangladesh. The Productivity Commission noted in its report 5 Year
For more information about Productivity Inquiry in 2023 that the Australian economy is highly exposed to the threat
climate change and
of climate change, more than any other OECD country other than Norway. However,
government policies,
visit the websites of the Australia is behind the majority of OECD countries in transitioning to lower carbon
United Nations Framework emissions, and slow responses are contributing to lower productivity.
Convention on Climate
Change, the Department of
While there is a scientific basis for targeting reductions in carbon dioxide emissions, many
Climate Change, Energy, the nations, including Australia, been slow to reduce their emissions. This is partly because
Environment and Water and individual countries cannot, by themselves, slow the pace of climate change, and some of
the IPCC Sixth Report. the measures to address climate change can involve short-term costs. In chapter 16, when we
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• Increase in sea levels by 0.4 to 0.8 metres • Reducing Australia’s GDP by 4.8 per cent by 2100,
by 2100 consumption by 5.4 per cent and real wages by
• Weather conditions becoming more extreme 7.8 per cent
and unpredictable • Causing permanent damage to environmentally
• 3.3 to 3.6 billion people living in areas highly sensitive regions in Australia, such as the bleaching
vulnerable to climate change of coral in the Great Barrier Reef due to rising ocean
• More intense and more frequent droughts, temperatures, and the loss of up to 80 per cent of
floods, fires and cyclones Kakadu wetlands by the end of this century, also
• 3–14 per cent of land species will be harming the Australian tourism industry
critically endangered with 1.5°C warming • Increased incidence of heat-related health
and nearly half of species with 5°C warming conditions, such as malaria, heat stroke and
• Malnutrition and micronutrient deficiency skin cancer
due to food security risks • Increased frequency of drought in southern parts
• Average global temperatures rising between of Australia, leading to a reduction in agricultural
1.0°C and 5.7°C production
• Increased risk of natural disasters, the economic
costs of which are forecast to triple by 2061
Figure 12.5 – Global and Australian impacts of climate change, 21st century
examine policies for improved environmental management, we take a closer look at policies
to address climate change.
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For non-renewable resources, calculating an optimal rate of use involves determining a rate
of decline that is acceptable for both the present generation and future generations. This
starts with eliminating overuse and waste, but ultimately may result in taking action to
recycle or curb consumption of these resources.
Economists face two main challenges in calculating the optimal rate of resource use for a
non-renewable resource. First, it can be hard for present generations to predict the needs
of future generations. Second, it is often hard to assess the existing stock of a resource.
There may be limited or conflicting evidence about the quantity of that resource that
remains available. It was often argued in the 1970s, for example, that the world’s supply
of oil would be exhausted by the end of the twentieth century.
Throughout Australian history, the economy has relied need to diversify its production so it can achieve greater
heavily on the exploitation of natural resources. For many economic and environmental sustainability.
years, abundant natural resources have underpinned our Australia is well placed to shift to using renewable energy,
success as a primary commodity producer. In the nineteenth given favourable conditions for solar and wind energy. The
and twentieth centuries, Australia was considered the share of Australia’s electricity generated from renewable
“bread-basket” of the British Empire because of its wheat sources increased from 8 per cent in 2001 to 29 per cent
exports, and the economy was able to “ride on the sheep’s in 2021, including wind (12 per cent), solar (10 per cent)
back” because of the strong demand for our wool exports. and hydro (6 per cent). Australian Government projections
Since the gold rushes of the mid-nineteenth century, indicate that up to 48 per cent of Australia’s electricity could
successive waves of commodity booms have played an be generated from renewable energy sources by 2030. The
important role in Australia’s economic development, in closure of Hunter Valley’s Liddell coal-fired power station
driving population growth and in forming Australia’s national in 2023 – which previously provided up to 10 per cent
character. of NSW’s electricity – is one example of the major shift
In more recent decades, Australia has relied on its unusually occurring in Australia’s electricity sector.
large concentrations of non-renewable mineral and energy For many years, energy and climate policies have been at
resources. This includes major deposits of gold, coal, iron the centre of Australian political debate. The public has
ore, copper, gas and oil, as well as the world’s largest toggled between concerns about the impact of climate
reserves of zinc, lead, bauxite, nickel and uranium. The policies on Australia’s economy (and its energy and
global resources boom of the 2000s made the mining resources sector in particular) and concerns about the
industry more central to Australia’s economic prosperity, impacts of climate change. Policymakers, economists
with mineral and metal exports surging from less than a and politicians have wrestled with complex challenges
third to well over half of Australia’s total export revenue. relating to the security and reliability of Australia’s energy
Australia’s economic reliance on primary commodity supply, short-term shortages, rising prices and the carbon
exports, especially non-renewable energy resources, is emissions intensity of Australian electricity generation.
unlikely to be sustainable in the longer term. In 2022, the These debates have played a role in the downfall of the
value of Australia’s mining and energy exports soared to past six Australian Prime Ministers dating back to 2007.
over $300 billion, as the war in Ukraine prompted a spike Debate over energy and climate policies played a key role
in the price of fossil fuels. But globally, economies are in the 2022 election, which saw the Albanese Government
increasingly focusing on renewable energy sources and elected with a commitment to accelerating Australia’s
technologies. While exporting non-renewable resources transition to net-zero emissions, and rapidly expanding
plays a central role in Australia’s export mix, Australia will renewable energy.
reviewquestions
1 Outline TWO difficulties facing governments that seek to implement policies to
preserve natural environments.
2 U
sing the example of climate change, explain the concepts of market failure,
externalities, public goods and free riding.
3 Examine the importance of renewable and non-renewable resources for the
Australian economy and the environment.
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“Overall, the state and trend of the environment of Australia are poor and deteriorating as a
result of increasing pressures from climate change, habitat loss, invasive species, pollution
and resource extraction. Changing environmental conditions mean that many species and
ecosystems are increasingly threatened. Multiple pressures create cumulative impacts that
amplify threats to our environment, and abrupt changes in ecological systems have been
recorded in the past 5 years.”
– Australia State of the Environment Report 2021
reviewquestions
1 Summarise government policy options to achieve environmental objectives
and explain how they influence the behaviour of individuals and businesses.
2 Explain how a tax on the consumption of certain goods and services can be
used to address negative externalities.
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chapter summary
1 The natural environment represents the totality of the physical environment in
which human society lives, and includes the land, water, climate and plant and
animal life.
3 The private interests of business, consumers and government often conflict with
environmental objectives. Market failure occurs because the price mechanism
only takes into account the private benefits and costs of production to consumers
and producers, but does not take into account social costs (such as damage to
the environment), also known as externalities.
6 Pollution occurs where the natural environment is degraded in some way, such
as by harmful chemical substances, noise or unattractive development. Pollution
affects the atmosphere, water resources and land. Virtually all areas of economic
activity, including manufacturing, agriculture and household consumption,
contribute to the pollution of our environment.
8 Non-renewable resources are those natural resources such as oil, coal and
gas that are finite in supply and cannot be re-created in a short time frame.
Renewable resources, by contrast, naturally regenerate themselves in a time
frame that makes their use sustainable.
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chapter review
1 Describe what is meant by the term natural environment.
4 Outline how market failure occurs in the management of the natural environment.
7 Identify what methods a government might use to control the level of pollution.
8 Discuss why climate change is widely regarded as the greatest long-term threat to
the natural environment.
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ECONOMIC POLICIES
TOPIC 4
AND MANAGEMENT
Focus
This topic focuses on the aims and
operation of economic policies in the
Australian economy and hypothetical
situations.
Issues
By the end of Topic 4, you will
be able to examine the following
economic issues:
Analyse
■ the opportunity cost of government
Skills
decisions in addressing specific economic Topic 4 skills questions can ask
problems or issues you to:
Investigate
■ structural changes in the Explain
■ how governments are restricted
Australian economy resulting from in their ability to simultaneously achieve
microeconomic reforms economic objectives
Apply
■ economic theory to explain how a Use
■ (simple) multiplier analysis to explain how
government could address an economic governments can solve economic problems
problem or issue in hypothetical situations
Identify
■ limitations on the effectiveness of
Analyse
■ alternative ways to finance a economic policies
budget deficit
Explain
■ the impact of key economic policies
on an economy
Propose
■ and evaluate alternative policies to
address an economic problem in hypothetical
and the contemporary Australian contexts
Explain,
■ using economic theory, the
general effects of macroeconomic and
microeconomic policies on an economy
Select
■ an appropriate policy mix to address a
specific economic problem
Economics Stage 6 Syllabus 2009 extracts © NSW Education Standards Authority for and on behalf of the Crown in right
of the State of New South Wales, 2009; reproduced by permission. 269
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Topic 4
Introduction
The first three topics of this book examined how Australia fits into the global economy and the
kinds of economic issues that confront the Australian economy. This final topic examines Economic
Policies and Management – looking in particular at the policies that can be used to address Australia’s
economic problems.
In this section we examine both the theory and practice of economic management. Each chapter
examines the theory behind the policy, reviewing how economic policies can operate in hypothetical
situations. We then examine the current policy environment in Australia, including recent
Australian policies and alternative approaches.
Chapter 13 In studying economic policy, it is important to remember that there is always a reason
why a government implements or changes a policy. In other words, all economic policies
are related to policy objectives. Chapter 13 examines policy objectives in Australia and
the potential conflicts in objectives that a government may face in implementing the
economic policy mix.
In deciding which policies to implement, governments choose between a range of policy
alternatives. In general terms, a distinction can be made between the government’s use
of macroeconomic policies, which are the broad policies that have overall impacts on
the economy, and microeconomic policies, which are the policies designed to improve
the operation of individual sectors and industries. The following chapters are divided
between a discussion of macroeconomic and microeconomic policy instruments.
Chapters These two chapters examine macroeconomic policy in Australia – fiscal policy and
14 and 15 monetary policy – and how they can be used by the government to achieve its economic
objectives.
Chapters These two chapters look at microeconomic policies, with a focus on labour market
16 and 17 policies in chapter 17.
Chapter 18 The book concludes with an evaluation of how well these policies achieve their objectives.
Like all kinds of economic decisions, economic management involves making difficult
choices between competing aims. Because of the difficulty in achieving all policy
objectives, governments must prioritise their goals and respond to changing conditions
in the global economic environment. Australia has achieved many of its economic policy
objectives during the past 50 years. However, Australia still faces a range of longer term,
structural problems and may face difficulty in sustaining its recent successes over time.
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The Objectives of
Economic Policy
13.1
13.2
Introduction
The objectives of economic management
13
13.3 The goals of government policy in 2024
13.4 Conflicts in government policy objectives
13.5 The economic policy mix
13.1 Introduction
In managing an economy, the first priority for a government is to determine what it will
pursue as its economic objectives. Governments can choose to pursue a range of policy
goals, and often the priorities of government policy shift over time.
Economists have traditionally described the major objectives of economic management
in the following three ways:
• Economic growth: An increase in the level of goods and services produced in an
economy, which increases the number of material wants satisfied and raises the
living standards of individuals in the economy.
• Internal balance: Pursuing the goals of price stability (low inflation) and full
employment.
• External balance: Keeping the current account deficit, foreign liabilities and
exchange rate at stable and sustainable levels.
In the following pages we review the main objectives of government policy generally, and
then discuss the current objectives of economic management in Australia.
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Full employment
The objective of full employment involves the full use of all resources (land, labour, capital and
enterprise), but economists generally focus on the full employment of labour. This is because
when labour resources are not fully utilised, some people will be unemployed – resulting in
significant social and economic problems.
Full employment does not mean that there is no unemployment. Rather, it means that the
The non-accelerating economy is at its non-accelerating inflation rate of unemployment (NAIRU), otherwise
inflation rate of known as the natural rate of unemployment. The concept of the NAIRU reflects the fact
unemployment (NAIRU) that there is always going to be a certain level of frictional, seasonal, structural and hard-core
refers to the level of
unemployment at which
unemployment in the economy. The natural rate of unemployment is therefore the level
there is no cyclical of unemployment that remains after the elimination of cyclical unemployment – the
unemployment, that is, unemployment caused by the upturns and downturns of the economic cycle. This means
where the economy is at that the NAIRU is caused by supply side factors rather than deficiency in demand.
full employment.
The government can reduce unemployment to its non-accelerating inflation rate through
successful implementation of macroeconomic policies. It may also use microeconomic
policies to reduce the NAIRU over the longer term. (The different types of unemployment were
discussed in more detail in chapter 8).
The benefits of achieving full employment, or minimising unemployment, can be
summarised as follows:
• fully utilising the economy’s current capacity to produce, and therefore increasing
living standards
• minimising the adverse economic and social problems associated with unemployment
(for example, personal and family problems, loss of workforce skills and greater
inequality).
Price stability
Price stability refers to keeping inflation, or the sustained increase in the general price
level, at an acceptable level. This does not mean that the government aims to eliminate
inflation altogether; instead, it aims to sustain inflation at a level that will cause minimal
distortion to the economy.
High inflation was a significant problem for advanced economies in the 1970s and
1980s. Until 2022, recent decades had seen inflation remain at low levels. In Australia,
the Government and the Reserve Bank are committed to sustaining the average rate of
inflation at 2–3 per cent over the course of the business cycle. (This objective, as well as the
causes of inflation, were discussed in more detail in chapter 9).
Inflation is seen as a problem because of its economic consequences. A high level of
inflation may:
• reduce the real value of income and wealth
• reduce our international competitiveness, due to rising costs of production
• cause a depreciation in the exchange rate
• create uncertainty about future costs and distort economic decision making
• distort the pattern of resource allocation by encouraging speculation in relatively
unproductive activities and discouraging savings and investment in productive
activities that contribute to higher output.
External stability
Achieving external stability involves a country meeting its long-term financial obligations
to the rest of the world so that its external accounts do not hinder internal economic goals
such as higher growth and lower inflation. As discussed in chapter 10, this is also known
as achieving “external balance”. Commonly used measures of external stability include:
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• Achieving a sustainable position on the current account of the balance of Current account is the
payments. This means, over the long term, balancing our payments for imports of part of the balance of
goods and services, as well as other income payments, with our receipts for exports payments that shows the
receipts and payments
of goods and services, as well as other income receipts. for trade in goods and
• Net foreign debt as a percentage of GDP. Foreign debt should be kept at a level services, as well as both
where an economy can afford to make interest payments on its debt, most often primary and secondary
measured via the debt-servicing ratio – the percentage of export revenue that is income flows between
Australia and the rest
spent on making interest payments on foreign debt. of the world in a given
• Terms of trade. This reflects the relative prices of Australia’s exports and imports. time period. These
An increase in the terms of trade improves external stability because it indicates are non-reversible
that Australia is able to buy more imports with a given quantity of exports. transactions.
• Exchange rate. In the short term, the exchange rate is a measure of international
confidence in the Australian economy. High volatility in the exchange rate may Balance of payments
indicate a lack of external stability. is the record of the
transactions between
• International competitiveness. Improving Australia’s international competitiveness Australia and the rest
is the best way to maintain external stability over time. of the world during a
Although Australia has had large external imbalances, during recent decades this has given period, consisting
of the current account
not been a major concern for the Australian economy. Nevertheless, improving external and the capital and
imbalances is a policy goal as lower external imbalance will mean reduced vulnerability financial account.
to adverse developments in the global economy.
Environmental sustainability
In the process of achieving a society’s economic objectives, economic activity may create
side effects such as pollution and the depletion of natural resources. In order to address
these problems, governments may sometimes establish specific environmental objectives,
such as a reduction in greenhouse gas emissions, an improvement in energy efficiency, a
reduction in the use of old-growth forests for the timber industry, or a reduction in waste
and pollution.
Environmental objectives are part of the government’s overall framework of economic Ecologically sustainable
management, and a substantial amount of money is spent by Commonwealth and State development involves
governments on environmental programs. Traditionally, governments have been willing to conserving and enhancing
trade off some longer-term environmental objectives in favour of the benefits of increased the community’s resources
economic activity in the short term. However, with growing recognition of the serious so that ecological
processes and quality of
impacts of economic activity on climate change, ecologically sustainable development
life are maintained.
has become an increasingly important economic objective.
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reviewquestions
1 Describe the Government’s economic objectives of internal stability and
economic growth.
2 Discuss how effective you believe the Australian Government has been in
achieving external stability in recent years. Has this goal conflicted with other
economic objectives?
Fiscal consolidation
In response to the COVID-19 pandemic, the Government undertook unprecedented
spending to ensure minimal disruption to the economy, while protecting the public
health. At the time of the 2021 Intergenerational Report, the Budget was forecast to
stay in deficit until 2060. However, this outlook has since improved, with a surge in
commodity prices leading to a one-off budget surplus for 2022–23, the first surplus in
15 years. With the budget returning to deficit in 2023–24, fiscal consolidation remains a
major medium-term priority for the Albanese Government. Measures to increase revenue
include increasing tax on multinational companies and funding an Australian Tax Office
taskforce to crack down on tax avoidance.
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the years ahead will involve changes in every aspect of the economy, including industry
structure, skills training, exports and regional development policy. Although in the past
the transition to net zero was seen as involving a trade-off between environmental and
economic policy goals, this is much less true now. With an emerging consensus among
economists, business, and other interest groups, there is agreement that this transition is
necessary and provides many opportunities for new industries to emerge.
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reviewquestions
1 Outline the long-term objectives of government policy.
2 Briefly outline how successful Australia has been in recent years in achieving
each of the economic goals listed above.
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additional costs to the government. Governments may often be more focused on short-term
objectives because of political considerations such as avoiding unpopular policies, rather than
long-term objectives that may not deliver benefits for some time.
reviewquestions
1 Briefly outline which economic objectives can be achieved simultaneously,
that is, where the government does not face a conflict.
2 Describe TWO possible conflicts between the economic objectives of the
government.
3 Using a diagram, explain the conflict between the government’s internal
stability objectives.
Macroeconomic
Government macroeconomic management is designed to minimise these fluctuations so
management refers to that economies experience low rates of inflation and unemployment, and relatively stable
the use of government economic growth. Macroeconomic management can be defined as the use of government
policies to influence the policies to influence the economy with the aims of reducing large fluctuations in the level
economy with the aims of of economic activity and achieving certain economic goals.
reducing large fluctuations
in the level of economic Government policies can help to stabilise the level of economic growth by smoothing
activity and achieving the peaks and troughs of the economic cycle. This is why macroeconomic policies are
certain economic goals. also referred to as counter-cyclical policies. During periods of fast economic growth, it
may be necessary to reduce the level of economic activity to avoid excessive inflation or a
blowout in the current account deficit. Governments can increase the level of tax, reduce
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spending or the Reserve Bank of Australia can raise interest rates in order to reduce the
level of economic activity:
• Higher tax rates will reduce consumers’ disposable income and reduce the level
of spending and aggregate demand, also reducing pressures on inflation and
the current account deficit.
• Reduced government spending will also lower the level of aggregate demand by
lowering the level of aggregate expenditure in the economy.
• Higher interest rates make borrowing money less attractive and will discourage
borrowing and spending by both consumers and businesses.
On the other hand, when the economy experiences a downturn in economic growth, such as
during the COVID-19 recession, a government may use macroeconomic policy to stimulate
economic activity and raise the level of aggregate demand. This may be done through
increased government spending, tax cuts and reductions in the level of interest rates.
One of the major lessons of Australia’s economic performance over recent decades is that
macroeconomic policy is not enough to achieve complex policy goals. Macroeconomic policy
works effectively in either stimulating or dampening the economy in the short term, but it
is much less effective in dealing with longer term problems such as low productivity growth,
entrenched underemployment, inequality, weak international competitiveness, a low level
of national savings or the need to reduce carbon emissions. However, macroeconomic and
microeconomic policies can be effective when used together.
Microeconomic policy
Microeconomic policy is action taken by government to improve resource allocation Microeconomic policy
between firms and industries, in order to maximise output from scarce resources. refers to policies that
are aimed at individual
Microeconomic policies are central to the government’s long-term aim of addressing
industries, seeking to
potential constraints on growth such as inflation and external imbalance. increase aggregate
Microeconomic policy over recent decades has reflected a change in the focus of economic supply by increasing the
management from influencing demand towards measures to influence supply. This efficiency and productivity
of producers.
economic strategy is known as supply-side economics. As governments have wrestled
with the limited effectiveness of macroeconomic policies that mainly influenced the level
of demand, they have turned to policies that focus on increasing the aggregate supply level
by improving the competitiveness, productivity and efficiency of Australian industries,
and raising workforce participation.
Microeconomic policy involves a range of specific policies varying from practices in
individual government departments to policies for entire industries. The overall aim of
microeconomic reforms is to encourage the efficient operation of markets and increase
aggregate supply – by raising productivity, making the economy more adaptable to change
and encouraging Australian producers to take on “world best” practices. The role of these
policies is discussed in chapter 16.
reviewquestions
1 Distinguish between the roles of macroeconomic and microeconomic policies
in the government’s policy mix.
2 Discuss how macroeconomic policy responds to changes in the business cycle.
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chapter summary
1 The main objectives of economic management are economic growth, low
inflation, full employment, external balance, an equitable distribution of income
and wealth, and environmental sustainability.
4
Price stability refers to keeping inflation, or the increase in the general price
level, at a reasonable level. This is currently reflected in the Reserve Bank’s target
of an average of 2–3 per cent inflation over the course of the economic cycle.
5
External stability refers to a situation where Australia is meeting its financial
obligations to the rest of the world and its external accounts – its current account
outcomes and foreign liabilities do not hinder it from achieving other economic
objectives.
7 The main long-term aims of economic policy are to increase productivity growth
to improve international competitiveness and the long-term sustainable growth
rate of the economy, sustain high levels of workforce participation and accelerate
Australia’s transition to a less carbon intensive economy.
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Chapter 13: The Objectives of Economic Policy
chapter review
1 Explain why economic growth plays a central role in a government’s policy
objectives.
4 Identify how the Reserve Bank of Australia attempts to achieve price stability.
5 Explain why Australia’s economic policy objectives have changed in recent years.
8 Explain why the goals of low inflation and low unemployment are considered to
be conflicting aims of economic management.
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14 14.1
Fiscal Policy
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Chapter 14: Fiscal Policy
When governments make smaller changes to fiscal policy throughout the course of the
year, the full costings of these decisions are set out afterwards, either in the next Budget,
or in a statement released around December each year, known as the Mid-Year Economic
and Fiscal Outlook statement (or MYEFO). This statement also provides updates to the
Treasury’s forecasts for the Budget and future economic conditions. Changes in economic
conditions can significantly affect planned revenues and expenditures.
Budget outcome
(deficit/surplus)
General economic concept
Underlying cash balance Headline cash balance Fiscal balance Net operating balance
The most commonly used budget The underlying cash balance plus A more reliable measure of the The best measure of the
measure, shows the budget’s net cash flows from investments in budget but doesn’t distinguish sustainability of the budget
short term impact on the country. financial assets for policy purposes between capital and and whether revenue is
and net earnings from the Future Fund. day-to-day spending. meeting recurrent spending.
The Commonwealth Government’s Budget includes four main measures of the budget
outcome, which are the result of different accounting methods:
• The underlying cash balance (cash deficit or cash surplus) is the Government’s
preferred measure of the budget outcome because it gives an indication of the short-
to medium-term impact of fiscal policy on the level of economic activity and the
budget’s call on cash resources from other sectors of the economy. It is calculated
using the cash accounting method (which records revenues and expenditures when
the money is collected or spent). However, it does not distinguish between the type
of spending (for capital or recurrent purposes) and does not reflect international
standards of accrual accounting. In figure 14.1, the underlying cash balance may
vary from the difference between receipt and payments because net Future Fund
earnings are removed until the Australian Government’s superannuation liability
is expected to be met.
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Receipts Payments Underlying cash balance Fiscal balance Net operating balance
Year
$bn $bn $bn % GDP $bn % GDP $bn % GDP
• The headline cash balance reflects the underlying cash balance plus the
government’s purchase or sale of assets. It is often billions of dollars higher or lower
than the underlying cash balance, either because government assets have been sold
or because new assets have been acquired. For example, the $6 billion privatisaion of
Medibank in 2014 had a positive impact on the headline cash balance, but because
such transactions are one-off (so could not be counted on to cover expenses in future
years) they are not included in the underlying cash balance. Asset sales reduce the
government’s borrowing requirement to finance the deficit, but they also mean the
government forgoes any dividends it might earn from the asset.
• The fiscal balance (fiscal deficit or fiscal surplus) calculates revenue minus expenses
less net capital investment, based on accrual accounting. Accrual accounting measures
expenditures and revenues when they are incurred or earned, rather than when a
cash transaction actually occurs. For example, if the government’s superannuation
obligations to public servants increased by $5 billion in one year, this would increase
a fiscal deficit by $5 billion for that year, even if the money is not paid out until years
later. This is regarded as more accurate than cash accounting. However, the fiscal
balance does not distinguish between spending for capital or recurrent purposes.
• The net operating balance (operating deficit or operating surplus) is regarded
as the best measure of the sustainability of the budget because it shows whether a
government is meeting its recurrent (day-to-day) obligations from existing revenue.
The net operating balance distinguishes between spending for capital or recurrent
purposes, and it removes spending on capital from the balance (that is, resulting in a
smaller deficit or increased surplus), although it includes the cost of depreciation (the
run-down in the value of existing assets). The rationale for separating the two types
of expenses is that capital spending is different from other spending because it adds
to productive capacity and to the government’s assets. Like the fiscal balance, the net
operating balance is based on accrual rather than cash accounting.
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reviewquestions
1 Explain the difference between a budget surplus and a budget deficit.
2 What is the difference between an underlying cash surplus and a net operating
surplus?
3 Identify TWO key trends in recent budget outcomes and discuss the
relationship between these trends and economic conditions.
Nevertheless, it is important to realise that automatic stabilisers, on their own, are rarely
strong enough to counter the effects of the economic cycle. Automatic stabilisers are not
powerful enough by themselves to bring an economy out of a severe recession, or to curb
an economic boom – they merely reduce the severity of the problem. Governments still
rely upon discretionary policy measures to smooth the economic cycle as the Morrison
Government did with the unprecedented measures to support economic activity in 2020,
following the onset of the COVID-19 pandemic.
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reviewquestions
1 Explain the role of cyclical and structural factors in influencing the budget
outcome from year to year.
2 If the government wished to slow the pace of economic activity, explain what
changes it would make to revenue and expenditure and the impact on the
size of: a) a budget deficit b) a budget surplus.
3 Outline how fiscal policy might affect the distribution of income.
from 76 per cent in 2012 to around 45 per cent in 2022, as Australia’s interest rates
compared to other countries made Australia’s securities less attractive to overseas investors.
Selling assets
An alternative to funding a deficit by borrowing is to sell government assets. Selling assets,
such as Commonwealth land or the Commonwealth’s share in businesses such as Medibank
Private or Australia Post, does not reduce the level of such underlying cash deficit or the
net operating deficit because these are adjusted to reflect one-off transactions like asset
sales. However, in cash terms, from year to year, a government can create a headline budget
surplus by selling assets. For example, if the Government raises $10 billion through asset
sales, it simply means that it needs to issue $10 billion less in Treasury Bonds to finance
its deficit. However, the demand for funds from Australia’s pool of domestic savings
remains essentially the same. This is because the buyers of the government asset will either
reduce their savings by $10 billion, or borrow $10 billion, instead of the Government
borrowing that money. The overall effect on the pool of domestic savings is the same,
but the financing burden is simply shifted from the public sector to the private sector.
Also, while reducing government borrowing reduces interest payments in the future, by
selling assets, the government also forgoes any dividends it may have earned on the assets.
For several years during the late 1990s and early 2000s, the Government used surplus
funds to pay off public sector debt. This reduces the size of public debt and frees up funds
on financial markets for other purposes. For example, the increase in funds available for
private sector investment may lead to economic activity that offsets the contractionary
effect of the fiscal surplus.
During that period of budget surpluses, the Government established the Future Fund as a
dedicated investment fund to store surpluses to meet the future cost of the Government’s
superannuation liabilities. Its assets were valued at $251 billion in 2023.
Commonwealth
State Consolidated
Year cash balance
cash balance cash balance^
(% GDP)
The public sector cash outcome was in surplus from the late 1990s until 2008–09. The
reversal of the Commonwealth Government’s Budget position from surpluses throughout
the 2000s decade to a deficit in 2008–09 was the main cause of the public sector cash
outcome moving into deficit. The net operating deficit shows that in most years, the
public sector’s revenue has not met its recurrent spending.
Over a period of time, running a public sector deficit results in an accumulation of public
sector debt. Public sector debt consists of the accumulated debt of the government
sector, which is owed both domestically and overseas. This includes debt accumulated by
the Commonwealth Government, state and local governments and government-owned
businesses. As figure 14.3 shows, public sector debt in Australia rose during three periods:
after the early 1990s recession, after the global financial crisis in 2008 and after the
290 COVID-19 pandemic in 2020.
Chapter 14: Fiscal Policy
$bn % of GDP
1000 50
900
Net debt ($bn) [LHS]
800 40
Net debt (% of GDP) [RHS]
700
600 30
500
400 20
300
200 10
100
0 0
−100
−200 −10
2022–23*
2024–25*
2026–27*
2001–02
2003–04
2005–06
2007–08
2009–10
2011–12
2013–14
2015–16
2017–18
2019–20
2021–22
1995–96
1989–90
1991–92
1993–94
1997–98
1999–00
It is important to distinguish the public sector debt from the foreign debt, which is
the amount owed by both the public and private sectors to overseas lenders. Australia’s
foreign debt is much higher than our public debt, and it mostly consists of private
sector borrowings. When undertaking borrowings, governments generally source their
borrowings from within Australia, although some of the participants in Australian
financial markets are overseas-based institutions. By borrowing on domestic markets in
Australian dollar securities, governments avoid being exposed to exchange rate movements
that may increase their debt and interest servicing costs.
reviewquestions
1 Describe THREE ways in which a government might finance a budget deficit.
2 Explain the factors that could influence a government’s decision about how to
finance a budget deficit.
3 Outline which budget measure best reflects the overall impact of the public
sector on the Australian economy.
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In the years prior to COVID-19, Australia’s fiscal strategy was centred on a medium-term
objective of returning the Budget to a surplus of one per cent of GDP. Fiscal policy played
only a minor role in influencing the level of economic activity during this period. The
Coalition Government had been elected in 2013 with a commitment to achieving budget
surpluses, but only achieved a balanced budget once (in 2018–19) in its nine years in
government. While in office, the Coalition Government also made a commitment not to
allow tax receipts to rise above 23.9 per cent of GDP.
As figure 14.4 shows, during the 2010s the budget outcome gradually improved, but at
a slower rate than had occurred during previous recoveries such as in the 1980s and the
1990s. The main reason for the slow progress was that despite a commitment to offset any
new spending with other spending cuts, government expenditure continued to increase
as a percentage of GDP during this period. At the same time, the recovery in tax receipts
was slow, which explains why, after the global financial crisis had plunged the Budget into
deficit in 2008, it was another 10 years until the Budget was again balanced.
% of GDP
3
2
1
0
–1
–2
–3
–4
–5
–6
–7
–8
2022–23*
2024–25*
2026–27*
2000–01
2002–03
2004–05
2006–07
2008–09
2010–11
2012–13
2014–15
2016–17
2018–19
2020–21
1970–71
1972–73
1974–75
1976–77
1978–79
1980–81
1982–83
1984–85
1986–87
1988–89
1990–91
1992–93
1994–95
1996–97
1998–99
The COVID-19 pandemic prompted a dramatic change in the fiscal strategy, with
long-lasting effects. The Morrison Government used fiscal policy to cushion the economic
effects of the pandemic and the lockdown that resulted in many businesses being forced to
close temporarily. The Government introduced a comprehensive suite of policies, including
JobKeeper – a program that at one stage in 2020 was subsidising the wages of around
one-third of the workforce. The Government also implemented policies such as direct cash
support payments to households and investment allowances for businesses.
This aggressive expansionary fiscal policy stance resulted in a significant deterioration in
the budget outcome. After being in balance in 2018–19, the Budget recorded a deficit
of $134 billion (6.5 per cent of GDP) in 2020–21. In just two years from 2018–19
to 2020–21, Australia’s net public sector debt increased by nearly 50 per cent, from
19.2 per cent of GDP to 28.6 per cent of GDP. This was the result of a combination of
discretionary policy measures (such as the introduction of the JobKeeper wage subsidy
program) and the operation of automatic stabilisers, such as lower taxation receipts and
increased welfare benefits. The combined impact of discretionary policy and automatic
stabilisers was unprecedented.
As economic recovery led to a rapid fall in unemployment, from 2021–22 the fiscal stance
became mildly contractionary, with a medium-term fiscal strategy of sustaining economic
growth and stabilising and reducing debt, while also advancing longer-term government
priorities.
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Chapter 14: Fiscal Policy
We can better understand the recent stance of fiscal policy by identifying the impact of
cyclical and structural factors. The four key cyclical factors influencing the stance of
fiscal policy in recent years are as follows:
• In the years prior to the COVID-19 pandemic, Australia saw a slower recovery in the
budget deficit than usual, which showed that the economy was growing below its
medium-term growth rate, and wages were consistently growing at below-forecast
rates. This resulted in slower growth in tax receipts.
• The COVID-19 pandemic brought about the fastest cyclical downturn in the
economy since the Great Depression of the 1930s. Record falls in business
investment, household consumption, the labour market and trade activity triggered
the automatic stabilisers in the Budget, through decreased taxation receipts (as
incomes fell) and increased payments (as unemployment increased). In mid-2020,
the Treasury estimated cyclical factors had resulted in a deterioration of the budget
outcome of $105 billion over 2019–20 and 2020–21.
• Australia’s terms of trade have been a positive cyclical influence on the budget
outcome for several years. The Budget temporarily returned to surplus in 2022–23
due to revenues from the large surge in commodity prices (especially liquefied
national gas) that followed Russia’s invasion of Ukraine, but the trend towards
high prices for major commodity exports (especially iron ore) that increased mining
company profits and taxation revenues has been strong since 2016. Treasury
estimated in the 2022–23 Budget that while it was assuming global prices for iron
ore and coal would fall, a slower fall would result in Australia’s nominal GDP being
$123.7 billion larger, and the budget deficit being $17.7 billion lower in 2022–23.
• Australia’s faster-than-expected economic recovery after COVID-19 has improved
the outlook for the Budget. This reflects a combination of persistently high iron
ore prices on company tax revenues, increased income tax receipts and lower
unemployment benefit payments due to a rebound in the labour market, and lower
than expected costs for emergency COVID-19 policies. The 2023–24 Budget saw a
$67 billion increase in forecast tax receipts over the two years to 2023–24.
The three key structural factors (that is, discretionary government policy decisions)
influencing the stance of fiscal policy in recent years are as follows:
• Prior to the onset of the COVID-19 pandemic, a structural reason for the slow
progress in reducing the deficit was a trend increase in government spending. Federal
government spending rose from 22.5 per cent of GDP in 2013–14 to 24.9 per cent
of GDP in 2018–19. This reflected sustained, real increases in spending across
several areas of government policy, such as for defence and the National Disability
Insurance Scheme. Pressures to increase spending continue in a number of policy
areas including unemployment benefits, education, health care and aged care.
• During the peak of the mining boom in the mid-2000s, governments implemented
large reductions in personal income taxes that reduced revenue growth in the years
after the global financial crisis. Earlier policy decisions to introduce new taxes on
mining profits and carbon emissions were reversed or abandoned. The 2018–19
Budget also introduced a program of reductions in personal income tax phased in
by 2024–25, which are expected to reduce revenue by more than $30 billion per
year once fully implemented.
• Finally, a key longer-term structural influence on fiscal policy is the ageing of the
population, which is contributing to slower growth in the revenue base (with more
people in retirement), and increased spending pressures (on health and aged care).
The Parliamentary Budget Office has estimated that by the end of the 2020s,
aged care needs will add $36 billion per year to government spending, more than
the current total annual expenditure on Medicare. The 2021–22 Budget set out a
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$17.7 billion increase in aged care funding over five years, and the 2023–24 Budget
committed a further $11 billion to pay for higher wages for aged care workers, to
help overcome staffing shortages.
“From energy bill relief to national defence, manufacturing to Medicare, investments in this
Budget aim to make Australia more resilient and more secure in uncertain times. Fundamental
to this is our responsible economic management and our efforts to put the Budget on a
stronger foundation. This Budget, we’ve returned 82 per cent of the extra revenue windfall
that’s largely come from lower unemployment, stronger jobs and wages growth, and higher
prices for key exports. We’ve now returned 87 per cent over this Budget and the last. We’ve
also ... limited annual real spending growth to just 0.6 per cent over 5 years. Because our
first 2 budgets made such a firm commitment to responsibility and restraint, we are now
forecasting a small surplus in 2022–23 – which would be the first in 15 years ... because
we are returning most of the welcome improvement in revenue to the budget, debt will be
almost $300 billion lower by the end of the medium term, saving $83 billion in interest costs
over the next 12 years.”
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Figure 14.5 – The outlook for Australia’s budget deficit through to 2063
reviewquestions
1 Describe trends in Australia’s budget outcome in recent years.
2 Evaluate the stance of fiscal policy in the current federal budget.
3 Explain the difficulties in reducing the budget deficit in recent years.
Economic growth
Since the 1990s, fiscal policy has only played an active role in managing the economic
cycle during major downturns – in the early 1990s, following the global financial crisis
in 2008 and the COVID-19 pandemic in 2020. Outside of those periods, fiscal policy
played a much smaller role in influencing the level of economic growth. The introduction
of inflation targeting, independently implemented by the Reserve Bank of Australia,
meant that monetary policy became the main macroeconomic policy instrument for
influencing the level of economic growth. The 2023 Review of the RBA concluded that
this macroeconomic strategy had been effective, and Australia should continue using
monetary policy as the primary demand management tool.
The limited role for fiscal policy in the period before 2020 is reflected in the Budgets of
the late 2010s. As the Budget gradually moved towards balance, the Morrison Government
legislated long-term plans to reduce taxation rates for businesses and individuals, as part
of its policy commitment to keep tax revenues below 23.9 per cent of GDP (in fact, tax
revenues peaked at 23.4 per cent of GDP in 2018–19). Its objective in reducing tax rates
was to provide more incentives for work, investment, job creation and economic growth
by allowing individuals to retain more of their income, and companies to retain more of
their profits.
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The 2019–20 Budget announced three stages of reductions in personal income tax,
with the first stage focused on a tax rebate for low- and middle-income earners between
2018–19 and 2020–21. The second stage, implemented from 2020–21 to 2023–24, raised
the tax brackets, so that higher tax rates cut in at higher-income levels. The third stage,
from 2024–25, involves abolishing the second-highest tax rate (of 37c in the dollar),
benefiting middle- and upper-income earners. Fully implemented, the three stages of tax
cuts contained in the 2019–20 Budget were expected to reduce revenue by $158 billion
between 2019–20 and 2029–30, in addition to $144 billion in tax cuts announced in the
2018–19 Budget. During this period, the Government also reduced company tax rates for
entities with a turnover below $50 million from 30 per cent to 25 per cent.
The role of fiscal policy changed dramatically from March 2020 as governments around
the world focused on preventing the spread of the coronavirus. This approach is based
on Keynesian economic theory, which dominated policymaking between the 1940s and
1970s, and which argued that an expansionary budget involving increased spending or
tax cuts would accelerate economic growth. To offset the economic impact of lockdowns
and disruptions to economic activity, the Australian Government announced a series
of policies including cash payments to households, wage subsidies for businesses,
investment allowances, industry support measures and increased expenditure on health and
infrastructure. At the time, the Treasury estimated that the Government’s budget policy
measures (up to and including announcements in July 2020) would result in economic
activity being 4.5 per cent higher in 2021–22 than it would otherwise have been.
A key feature of Australia’s policy response to COVID-19 was to sustain business
investment. The 2021–22 Budget introduced a policy of “immediate expensing”, which
allows business to make investments of any size and write off the full cost immediately,
in contrast to normal practice, which only allows businesses to claim a tax reduction
equal to the depreciation in the value of an asset (usually between five and ten years). The
Budget also allowed businesses to claim a “loss carry-back” – allowing them to claim tax
losses from the past. Businesses could undertake investment during 2021–22, claim the
full deduction immediately, and then incur a tax loss. They would then become eligible
to claim a refund against tax that they paid in past years, before the pandemic. The
Government argued these measures would support investment and economic growth, and
help reduce unemployment.
In the circumstances of 2020, there was a widespread consensus that the fiscal policy
measures were necessary even though they resulted in the Budget moving from balance in
2018–19 to a deficit of 6.5 per cent in 2020–21, and net public sector debt rising from
$374 billion or 19.2 per cent in 2018–19 to $592 billion or 28.6 per cent in 2020–21.
In the longer term, the effectiveness of fiscal policy in influencing economic growth may
diminish if the accumulation of past budget deficits has created a high level of public
debt. The Albanese Government’s fiscal strategy is focused on reducing debt as a share
of the economy. Unlike previous fiscal strategies, it does not explicitly target a return to
surplus. Rather, it makes a commitment to improve the budget balance over time.
In evaluating the impact of fiscal policy on economic growth, it can also be important to
take into account any impact that fiscal policy changes might have on monetary policy.
Economists have differing views about the relationship between fiscal and monetary
policies, but under an inflation-targeting regime, changes in fiscal policy can clearly affect
monetary policy decisions – and possibly reduce any impact that fiscal policy might have.
To the extent that changes in fiscal policy impact on inflationary pressures, fiscal policy
can affect the Reserve Bank’s monetary policy decisions. The 2023–24 Budget sought
to manage the conflicting objectives of reducing inflationary pressures and supporting
households struggling with cost-of-living pressures due to high inflation. The cost-of-
living measures were designed to support households and reduce inflation, through
subsidies on electricity bills and caps on wholesale energy costs. Treasury estimated
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Allocation of resources
Governments use expenditure and revenue measures to influence resource allocation in the
economy less actively than in the past. Other than where there are market failures that need
to be corrected, governments generally rely on market forces to achieve the most efficient
allocation of resources. With the shift away from governments directly influencing resource
allocation, the factors that shape market forces – such as changing consumer preferences,
changing business practices, new technologies and the forces of globalisation – generally
have the greatest influence on resource use.
Governments were once much more involved in the provision of services in Australia –
they owned airlines, airports, banks, electricity utilities, insurance companies, phone
companies, pharmaceutical businesses, printers, agricultural marketing businesses and
gambling businesses. During the 1990s and the years that followed, most of these public
trading enterprises were privatised and “user pays” systems have been introduced. Direct
subsidies to industries have declined to less than $4 billion per year, and governments have
even been willing to allow industries to shut down altogether, as the Abbott Government
did with the closure of Australia’s car manufacturing sector in 2013. Nevertheless, some
areas of government expenditure still have a significant effect on resource allocation. The
2023–24 Budget set out an additional $4 billion of funding for Australia’s transition to
cleaner energy sources, bringing to $40 billion its total funding commitment to accelerate
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Figure 14.6 – The budget outcome and the current account deficit since 1979
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Distribution of income
Fiscal policy decisions have significant impacts on the distribution of income, and the
distributional effects of policy changes are often a major feature of debates about budget
policies. The Budget can impact income distribution through specific tax and revenue
measures, as well as through its broader impact on economic conditions.
A key goal of the Australian Government’s response to the COVID-19 pandemic was
to prevent the large-scale job losses that could lead to a widening of inequality in the
distribution of income. In addition to the JobKeeper Payment that subsidised the wages
of around 3.5 million Australians (at a cost of $90 billion), the Government temporarily
relaxed access to unemployment benefits, while also increasing payments through the
Coronavirus Supplement of $550 per fortnight, at a cost of $16.8 billion. It also provided
a direct cash support payment of $1500 to pensioners, income support recipients, carers
and student payment recipients, costing $9.4 billion. These measures provided assistance
to lower-income earners.
The 2023–24 Budget contained a range of measures to assist groups most affected by
inflationary cost-of-living factors. These measures included $3 billion in subsidies for
electricity bills for five million Australian households, a $20 per week increase in the
JobSeeker payment and a 15 per cent increase in rent assistance payments.
In contrast to the positive effect of measures during the pandemic, the income tax
reductions phased in from the late 2010s through to 2024–25 were widely criticised for
making the tax system less progressive by reducing the number of tax thresholds from four
to three. Other measures included a reduction in tax rates and a lifting of tax brackets. An
analysis of the tax package by the Grattan Institute in 2019 concluded that it would make
Australia’s tax system less progressive than at any time since the 1950s. Its modelling
showed that while someone in the middle of the income distribution would have an
increase in their tax rate of 3.7 per cent by 2030 under the package, the average tax rate
for the top 15 per cent of income earners would fall by 1 per cent. Overall, the share of
income tax paid by middle-income earners will rise from 32 per cent in 2017–18 to 35
per cent by 2029–30. On a standard measure of progressivity of tax systems (comparing
tax paid on incomes 0.5 versus 2.5 times average earnings), Australia would fall from 12th
in the OECD in 2017–18 to 19th by 2024–25.
reviewquestions
1 Outline the main impacts of fiscal policy in recent years.
2 Identify TWO ways in which the recent Budget might impact the level of
economic growth.
3 With reference to recent economic examples in Australia, identify TWO ways
in which a fiscal policy change might affect the distribution of income.
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chapter summary
1 Fiscal policy involves the use of the Commonwealth Government’s Budget to
achieve the Government’s objectives by influencing economic activity, resource
allocation and income distribution.
2 The main tools of fiscal policy are government spending, revenue collection
and the budget outcome. These are usually changed once each year in the
Commonwealth Government Budget, which is usually released in May.
3 The budget outcome can be a surplus, deficit or balanced. The budget stance
gives an indication of the overall impact of fiscal policy on the state of the
economy and can be described as expansionary, contractionary or neutral.
4 The two main measures of the budget outcome are the underlying cash
outcome, which is calculated through an accounting method known as cash
accounting and which includes capital spending, and the net operating
balance, which is calculated using a different accounting method as revenue
minus expenses, with capital expenditure removed.
5 The net operating balance is the best indicator of the sustainability of the
fiscal strategy because it shows the gap between recurrent expenses and revenue
(that is, it distinguishes between capital spending and day-to-day spending).
The underlying cash outcome is the best indicator of the short-term impact
of fiscal policy on the level of economic activity because it shows actual cash
revenue and spending in a year.
8 A budget deficit is usually financed through borrowing from the private sector,
which reduces national saving and may put upward pressure on interest rates.
It can also be financed by borrowing from overseas or from the Reserve Bank
(printing money), or by selling government assets.
10 In contrast to its generally neutral or mildly contractionary stance during the
2010s, in 2020 the Government shifted fiscal policy to a very expansionary
stance, helping to accelerate Australia’s recovery from the COVID-19 pandemic.
More recently, fiscal policy has been returning to a mildly contractionary stance.
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chapter review
1 Explain what is meant by fiscal policy.
4 Distinguish between the underlying cash balance and the net operating balance.
Explain what each indicates about the budget stance.
9 Discuss the impact of recent changes in fiscal policy on the Australian economy.
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15 15.1
15.2
Monetary Policy
Introduction
The objectives of monetary policy
15.3 The implementation of monetary policy
15.4 The impact of changes in interest rates
15.5 The stance of monetary policy in Australia
15.1 Introduction
Monetary policy refers to actions by the Reserve Bank of Australia (RBA), Australia’s
central bank, to influence the cost and availability of credit in the Australian economy.
Monetary policy is a macroeconomic policy that, like fiscal policy, can smooth fluctuations
in the business cycle and influence the level of economic activity, employment and prices.
Monetary policy is generally the primary macroeconomic policy used for this purpose
over the short to medium term in Australia and other advanced economies. This chapter
outlines the objectives of monetary policy and how it is implemented to influence
economic outcomes.
The formal objectives of monetary policy and the powers of the RBA are set out in
federal legislation in the Reserve Bank Act (1959), along with the broader powers and
responsibilities of the RBA. There is also a complementary agreement between the
Commonwealth Government and the RBA Governor called the Statement on the Conduct
of Monetary Policy. The agreement expresses a shared understanding of how the formal
objectives can be met by the RBA and how monetary policy should be conducted in more
detail. Within the scope set out by these documents, the RBA is authorised to make
monetary policy decisions independent of the Federal Government.
One of the RBA’s key roles is to hold and manage deposits owned by commercial banks
in Australia that they use to settle transactions between each other. This gives the RBA
the ability to influence the supply of money in the economy and therefore interest rates.
The RBA sets a desired target for the cash rate (which is the interest rate on loans in the
overnight money market), and uses open market operations (OMOs) to help achieve it.
The cash rate influences other interest rates in the economy.
Contractionary monetary policy is when the RBA increases interest rates in the economy,
which reduces the amount that households with mortgages have available for consumption
and makes business investment more expensive. This lowers economic activity, reduces
employment growth and reduces inflationary pressure. Expansionary monetary policy
is when the RBA lowers interest rates, resulting in higher consumption and investment,
economic activity, employment growth and inflation. Since the early 1990s, monetary
policy has been guided by an inflation-targeting framework, which seeks to keep inflation
between 2 and 3 per cent.
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Inflation targeting
Since the 1990s, Australia has followed the example of several other countries, including
Canada and New Zealand, where the central bank operates independently of the
government to try to keep inflation within a predetermined target range (the target is
normally jointly agreed upon by the central bank and the government). In doing so, the
RBA prioritises maintaining low and stable inflation over all else. This reflects several
important characteristics of monetary policy:
• Monetary policy is effective at fighting high levels of inflation.
• When assigned multiple goals, monetary policy often struggles to achieve them
simultaneously. Listing one objective as the main one to achieve makes monetary
policy more certain, consistent and predictable.
• When governments control monetary policy directly, their policy decisions can be
distorted by political pressures, particularly at times of elections, when politicians
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may want to keep interest rates low even if that might be suboptimal for the
economy. Giving independence to a central bank in its conduct of monetary policy
helps to reduce the risk of political factors distorting interest rate decisions.
• Inflation targeting has generally been successful at keeping inflation low and stable
without central banks having to resort to high interest rates, which lower growth
and increase unemployment. In other words, keeping inflation low and stable over
the medium to long run helps the RBA achieve its other objectives as well. This
largely explains why price stability is the primary objective for the RBA and other
central banks. To sustain low and stable inflation, inflation targets need to entrench
expectations in the economy that inflation will be low and stable over time. This
is because expectations are a significant factor influencing the level of inflation.
The RBA’s specific inflation target is to keep inflation between two and three per cent.
It is important that the target is flexible and presented as a range. This reflects that
inflation can be affected by shocks and events outside of the RBA’s control, such as the
COVID-19 pandemic and the war in Ukraine, and that the RBA must use its judgment
to quickly return inflation to near the midpoint of its target. The target was previously
expressed as between “two and three per cent, on average, over time”, but the review of the
RBA recommended removing the qualifying words “on average, over time” because they
weakened the RBA’s accountability for inflation outcomes.
Price stability is desirable because it allows households and businesses to prosper, and
improves overall welfare in the economy. This prosperity is the overarching goal of monetary
policy in Australia, so it is pursued by the RBA even if it means short-term inflation
numbers are inconsistent with the target.
Successive governments have supported the RBA’s flexible inflation target consistently
since it was first introduced. Governments since the 1990s have broadly endorsed this
approach in written agreements between the Governor of the RBA and the Australian
Government (these agreements can be thought of as agreements on how the RBA should go
about pursuing the legislative objectives described previously). The most recent agreement
is the 2023 Statement on the Conduct of Monetary Policy following the review of the
RBA. The 2023 Statement reaffirms the Government’s commitment to the independence
of the RBA and its support for the inflation-targeting framework.
The inflation-targeting regime clearly places the goal of price stability at the centre of
monetary policy. However, reducing unemployment and promoting prosperity are still
important goals of monetary policy. The flexibility of the regime supports the RBA in
its exercise of monetary policy.
“Just because our inflation objective has been in focus recently, it does not mean that the
other part of our mandate – maintaining full employment – has become any less important.
Full employment is, and has always been, one of our two main objectives …
We think of full employment as the point at which there is a balance between demand and
supply in the labour market (and in the markets for goods and services) with inflation at the
inflation target; this is the level of employment that is sustainable with our price stability
mandate in the longer term.”
– Michele Bullock, (then) RBA Deputy Governor,
Achieving Full Employment (speech), 20 June 2023
The RBA’s inflation-targeting regime has been in place for about three decades. The
review of the RBA recognised that this regime “remains the best operational framework
for monetary policy”. Since the regime was introduced, inflation has averaged around
2.6 per cent. Expansionary monetary policy also supported economic activity during the
Asian financial crisis in the late 1990s, the global financial crisis in 2007–08 and the
COVID-19 pandemic.
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Despite success in maintaining economic stability and low inflation during the inflation-
targeting era, monetary policy in Australia has attracted criticism in recent years. In the
years leading up to the pandemic, critics argued that the RBA’s monetary policy stance
was not expansionary enough, especially when inflation was below the target band. When
inflation increased sharply in 2022, critics said the RBA’s response to COVID-19 was too
expansionary. These views were part of the impetus for an independent review of the RBA
which was completed in 2023.
The Treasurer appoints the Governor of the Reserve Bank for a term of seven years,
with the possibility of extending that term. As his predecessors (Glenn Stevens and Ian
Macfarlane) had their appointments extended by three years each, there was speculation
in 2023 as to whether the same would occur for Lowe.
The end of Philip Lowe’s term was unusual because of the lack of support and confidence
he faced as Governor steering the economy through the COVID-19 pandemic and its
aftermath. Despite interest rates being raised by central banks all over the world following
the pandemic, public sentiment turned against Lowe. “He did no worse than any other
central bank, and some got it worse,” noted Warwick McKibbin, a former member of
the Reserve Bank Board. While the British Government defended the Bank of England
Governor for raising interest rates, Lowe was exposed to public and political anger during
the interest rate tightening cycle.
Much of this criticism stemmed from a statement that Governor Lowe had made in
2021 when the cash rate was at a historic low of 0.1 per cent, saying it was “very likely
to remain at [that level] until at least 2024”. People who borrowed funds based on that
advice faced rising repayments and cost-of-living pressures as interest rates increased.
The purpose of the 2023 review of the RBA was to identify improvements to the RBA’s
operations, in the context of significant changes in the policymaking environment in recent
decades. The review also aimed to assess external criticisms that the RBA’s culture was
too insular and hierarchical.
MAIN ECONOMIC
Part of the Government’s rationale in appointing a new governor was to install someone INDICATORS
new to drive institutional reform of the RBA through implementing the review’s TAKEN INTO
recommendations. While domestic and international candidates were considered,
ACCOUNT BY
Bullock’s appointment follows a trend since the mid-1990s of Deputy Governors
succeeding Governors in the role. THE RBA
• Inflation
reviewquestions • Expectations of
future inflation
• Wages growth
1 Outline the broad objectives of monetary policy.
• The unemployment
2 Define inflation targeting and discuss why it is used in Australia. rate
3 Briefly explain how the following events would impact on the RBA’s decision- • Economic growth
making process when it influences interest rates: • Interest rates
a) wage growth of 6 per cent • The exchange rate
b) a sustained fall in consumer spending • Commodity prices
c) a sudden fall in the value of the Australian dollar • Terms of trade
d) predictions of a sharp fall in inflation in 2024–25. • Global economic
conditions
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rate target. This management of supply is what reinforces the convention mentioned above,
so it is important for ensuring the actual cash rate stays in line with the target. Without
the prospects of these interventions, the cash rate would bounce around inside the policy
rate corridor whenever demand fluctuates.
Domestic market The RBA manages the supply of ES funds by conducting domestic market operations
operations are actions (DMO). DMO refers to the purchase and sale of financial securities by the RBA in
by the Reserve Bank exchange for ES balances. These purchases and sales affect the supply of ES funds because
in the short-term
ES funds are used to complete these transactions. If the demand for ES funds increases,
money market to buy
and sell second-hand the RBA would need to increase the supply of ES funds to keep the cash rate stable, all
Commonwealth else being equal. To do this, the RBA would buy financial securities held by banks, and
Government Securities pay for this by depositing funds in their exchange settlement accounts. This increases the
to influence the supply supply of ES funds so that it meets the additional demand. If the RBA needed to decrease
of exchange settlement
the supply of ES funds to keep the cash rate at target (because of a decrease in demand),
balances in order to keep
the actual cash rate at the
the RBA would sell financial securities to banks, and withdraw funds that were sitting
policy target. in their exchange settlement accounts. This would decrease the supply of ES funds down
to the lower level of demand.
DMO usually involves the use of repurchase agreements (also called repos), where the
“seller” of a bond or other financial security effectively agrees to buy the bond or security
back from the “buyer” at a later date. The RBA prefers using repos to conduct DMO
because they are highly flexible instruments and can be used to manage ES supply much
more precisely than outright purchases or sales of financial securities.
In summary, the RBA uses the cash rate policy corridor to implement changes to the cash
rate target, and can use DMOs to ensure that the cash rate stays consistent with the target
every day when the demand for ES funds changes. The RBA expects that ES balances
will decline over the next few years as funding provided to banks unwinds and the RBA’s
holdings of government bonds mature.
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Influenced by RBA to
Tightening Increases Shifts upward ensure cash rate is Rises Rise
consistent with target
Influenced by RBA to
Shifts
Loosening Decreases ensure cash rate is Falls Fall
downward
consistent with target
While announcements of changes in the cash rate are the most important statements by
the RBA, other releases such as board minutes and speeches by key RBA officials are also
scrutinised closely by markets. Financial markets often interpret small changes in the
RBA’s description of economic conditions as a signal of future interest rate movements.
Markets can “price in” a future interest rate increase or decrease even before it has
happened. This can result in interest rates in financial markets changing before the RBA
changes the cash rate target.
Unconventional monetary policy
In recent years, central banks have gone beyond the traditional usage of interest rates
to implement monetary policy, and have experimented with additional measures. This
became necessary because, with interest rates already close to zero, further stimulus to the
economy required other policy instruments. While other central banks had adopted several
of these measures in response to the global financial crisis of 2007–2009, it was in response
to the COVID-19 recession that the RBA implemented these measures in Australia:
• Asset purchases: purchasing government securities in the secondary market from
financial institutions and paying for them by depositing newly created ES balances
in their accounts
• Forward guidance: using official communications about the future stance of
monetary policy to influence current interest rates on longer-term assets
• More liquidity: the RBA increased the size of its DMO compared to normal,
and created the Term Funding Facility which provided cheap additional loans to
commercial banks to support them lending more to households and businesses
• Changing the size of the corridor: by setting the corridor floor to 0.1 percentage
points below the cash rate target (instead of 0.25 percentage points), the RBA was
able to lower the cash rate to 0.1 per cent without the risks of negative interest rates.
These measures were largely unwound in the second half of 2021 as Australia’s recovery
from the pandemic took hold.
The use of tools other than a central bank’s main policy interest rate (the cash rate in
Australia) is often called unconventional monetary policy. In this instance, the term
“unconventional” refers to the fact that central banks in advanced countries have only
begun using these tools in the past two decades, and mostly in response to extreme
economic events. This is in contrast to conventional monetary policy, when central banks
use interest rates as their main tool.
Negative interest rates are another form of unconventional monetary policy, and they have
been implemented in Japan, the European Union and Sweden. However, the RBA has Appendix B: In 2020, a
consistently stated that it is very unlikely to introduce negative interest rates. controversial theory on
inflation and monetary
One way to think about the influence of unconventional monetary policy is through the policy called modern
yield curve. This curve shows how, in general, loans of longer maturity tend to have higher monetary theory (MMT)
interest rates because lenders expect higher returns to compensate for the greater risks gained prominence. For an
explanation, see Appendix
involved with lending out money for a longer period of time. Unconventional monetary
B (section B.4).
policy measures generally work by reducing interest rates specifically on longer term loans.
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While conventional monetary policy usually lowers the entire yield curve – reducing
interest rates across the board – unconventional measures typically flatten the curve, as
shown in figure 15.4. This flattening represents the additional stimulus provided by
unconventional monetary policies.
cash cash
rate rate
Figure 15.4 – Impact of conventional and unconventional monetary policy on the yield curve
reviewquestions
1 Explain how interest rates are determined in Australia with reference to
domestic market operations, exchange settlement accounts and the cash rate.
2 Identify the impact of the following transactions on the supply of funds in the
short-term money market and their impact on the cash rate.
a) The Reserve Bank buys Commonwealth Government Securities from a bank.
b) The Reserve Bank sells Commonwealth Government Securities to a financial
institution.
3 Explain the difference between conventional and unconventional monetary
policy.
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• Reduced interest rates also have an effect on businesses and consumers that already
have loans since the cost of servicing existing loans becomes cheaper. This means that
existing borrowers can use more of their income on additional spending rather than
servicing their loans. This is often called the cash flow channel of monetary policy.
• A fall in the level of interest rates also discourages financial inflows into Australia,
which, as discussed in chapter 5, leads to a depreciation of the currency. A
depreciation of the Australian dollar makes Australian goods relatively more
competitive in both domestic markets (since imports are more expensive) and
overseas markets. This consequence of a fall in the level of interest rates also
stimulates aggregate demand and could add to inflation.
• Lower interest rates also can cause asset prices to increase for a range of assets
including houses and shares in public companies. Higher asset prices provide asset
holders (such as home owners) with more wealth, which they often use to consume
and invest more than they otherwise would. This is frequently called the wealth
channel of the transmission mechanism.
All of the channels described above cause aggregate demand to increase when interest rates
are lower. This typically generates higher economic activity and employment (particularly if
the economy was previously in recession), but could spill over into higher prices and wages
if the economy was already close to full employment. The transmission mechanism would
work in the opposite direction if the RBA put upward pressure on interest rates through
contractionary monetary policy.
Overall, a tightening of monetary policy puts upward pressure on interest rates, which
has the effect of dampening consumer and investment spending, resulting in a lower level
of economic activity, with lower inflation and the possibility of higher unemployment.
On the other hand, a loosening of monetary policy puts downward pressure on interest
rates, boosting consumer and investment spending, resulting in a higher level of economic
activity, with falling unemployment, and often an increase in inflationary pressures.
Debate about the impacts of interest rate movements was sparked recently by a research
paper arguing that the most effective channel through which monetary policy affects
inflation is actually via the exchange rate. The paper, published in 2022 by economists
Isaac Gross and Andrew Leigh (also an Assistant Minister in the Federal Government),
concluded that if interest rates increase relative to interest rates overseas, this makes holding
cash in AUD-denominated assets more attractive and the exchange rate appreciates. This
lowers some prices directly (such as prices for imports), reduces input costs, increases
competition and reduces aggregate demand (because exports become more expensive).
The challenge for policymakers is that the effectiveness of the exchange rate channel in
Australia depends on monetary policy decisions made in other countries – that is, if other
countries also increase interest rates, Australia’s exchange rate may not appreciate, and the
change in monetary policy will have limited impact.
While a change in monetary policy can be implemented almost immediately (that is, it
does not require legislation or parliamentary approval), it can take considerably longer
for that change to bring about the desired impact on economic growth, inflation and
unemployment. Monetary policy can have a time lag of around 12 to 24 months before the
full impact of interest rate changes are felt in the economy. This time lag can sometimes
pose problems for policymakers. Economic circumstances can change substantially
during the relatively long lag period and make current monetary policy inappropriate.
For example, a series of interest rate increases which lower consumption and investment
may still be constraining economic activity at a time when a recession occurs and looser
monetary policy is needed to restore price stability. This is why the RBA usually focuses
on the likely economic conditions in 12 to 24 months’ time when it sets monetary policy.
For this reason, the RBA invests considerable resources into forecasting future values of
macroeconomic variables, including GDP, inflation and unemployment.
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reviewquestions
1 Explain what is meant by the monetary policy transmission mechanism.
2 For each of the following scenarios, explain how DMO might be used to
influence the economy and what impact these changes would have.
a) A shortage of skilled workers is putting upward pressure on wages growth
and creating inflationary pressures.
Appendix B: “Advanced
b) Global economic growth is raising demand and prices for raw materials
Economic Analysis”
and commodities that are used as inputs to production.
at the back of this
textbook looks at the c) A fall in consumer and business confidence causes reductions in
implementation and consumption and employment growth.
limitations of monetary 3 Describe the role of time lags in the conduct of monetary policy in Australia.
policy in more detail.
MONETARY POLICY
HOW A POLICY TIGHTENING WORKS
(policy loosening involves the opposite impacts)
Economic Growth
4.1%
Unemployment RBA
Exchange Rate
Inflation Forecasts
From 2024 onwards: RBA's Monetary The RBA announces its decision of The Reserve Bank moves the cash rate
Policy Board meets 8 times per year to whether to raise, lower or maintain corridor up, to raise the actual cash rate
decide the stance of monetary policy. interest rates at 2.30pm after and implements the DMO to maintain the
its meetings. cash rate at the new target.
Spending Investment
Mortgage
2–3%
Interest Rates
Personal
Inflation Interest Rates
Business
Consumers Business Interest Rates
Downward pressure on Economic activity falls. There is also Consumers and businesses reduce To maintain margins
inflation after a time lag of increased demand for the AUD. spending and investment because interest rates go up.
around 12 to 18 months. borrowing is more expensive.
AUSTRALIAN
INFLATION ECONOMY CONSUMERS AND BUSINESS FINANCIAL MARKETS
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The stance of monetary policy is further reflected by broader interest rate changes in the
economy. Interest rates in Australia have varied considerably over time as monetary policy
has been altered to respond to varying economic conditions (see figure 15.5). As the graph
shows, there have been periods of both rapid interest rate reductions (in the early 1990s
and late 2000s) and periods of rapid increases (in the mid-1990s and early 2020s). There
have also been periods of slow increases (in the 2000s) and slow decreases (in the 2010s).
Cash rate
target (%)
18
17
16
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
1995
2005
2015
2023
1990
2000
2010
2020
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Monetary policy was made very expansionary in response to COVID-19. Even before the
onset of the pandemic, the cash rate target had reached historically low levels in response
to a period of weak growth and low inflation. Since the pandemic placed substantial
downward pressure on economic growth, inflation and employment, the cash rate target
was lowered further to 0.10 per cent, its lowest level ever. In addition, the RBA introduced
several unconventional monetary policy measures that further eased the stance of monetary
policy. All of this monetary support helped the Australian economy successfully recover
from the worst of the pandemic in 2020 and 2021. However, significant inflation pressures
emerged in Australia in 2022 and 2023 due to global supply chain issues arising from
the pandemic, the war in Ukraine, high levels of inflation overseas, labour shortages,
and strong aggregate demand – partly reflecting the extent of stimulus provided by
governments. The RBA responded to rising inflation with a series of rate increases, lifting
the cash rate above 4 per cent.
Overall, the RBA has generally been successful in controlling the level of inflation.
However, prior to the COVID-19 pandemic, the RBA was criticised for inflation being
too low and for making economic forecasting and policy errors. In the years leading up to
the pandemic, inflation remained below the RBA’s target, averaging around 1.6 per cent
from 2016 to 2019. Some commentators blamed this on the stance of monetary policy
not being expansionary enough at the time. Others argued that the RBA’s policy stance
during COVID-19 was too expansionary and its “forward guidance” that the cash rate was
very unlikely to be raised until 2024 reflected bad economic judgment. These concerns
helped prompt the independent review of the RBA released in 2023.
Concern about the potential impacts of the global financial crisis on Australia sees
2008–2009
the RBA slash the cash rate to 50-year lows of just 3 per cent.
Monetary policy returns to a more neutral position as the crisis eases, with the
2009–2011 cash rate rising to 4.75 per cent by late 2010. The domestic recovery and strong
mining sector growth sees the RBA refocus on containing inflationary pressures.
Monetary policy remains expansionary for a long time period, against the backdrop
2011–2018 of low inflation and below-average economic growth. The cash rate target reached
a historic low of 1.5 per cent in 2016, where it remained until 2019.
The RBA responded to rising inflation by sharply increasing interest rates, earlier
2022– than it had expected, with 12 interest rate increases between mid-2022 and
mid-2023, leading to a cash rate of above 4 per cent.
There are five main factors that help to explain the stance of monetary policy:
1. The low inflation objective: Both the government and the Reserve Bank are
committed to maintaining the RBA’s inflation target – an average rate of inflation
between 2 to 3 per cent. Monetary policy is the major tool used to achieve this
outcome.
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reviewquestions
1 Examine recent changes in the stance of monetary policy in Australia.
2 For each of the following scenarios, propose an appropriate monetary policy
response (and justify your decision).
a) A
rise in petrol and natural gas prices increases inflation but lowers
consumer spending.
b) A
recession overseas causes the Australian dollar to depreciate and
increases domestic unemployment.
3 Explain how wages growth may impact monetary policy decisions.
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chapter summary
1 Monetary policy involves actions by the Reserve Bank of Australia to
influence the cost and supply of money and credit in the economy, in order to
achieve the government’s policy objectives.
3 The objectives of monetary policy are low inflation and maintaining full
employment – with an overarching purpose of promoting economic prosperity for
Australians. Its primary goal is to contain inflation within a target range of 2–3 per
cent on average, over the course of the economic cycle.
5 The objectives of monetary policy are often in conflict, since faster economic
growth and job creation tend to be associated with higher levels of inflation.
7 When the RBA sells government securities in the short-term money market, it
reduces the supply of funds, and this results in higher interest rates. The RBA
implements this policy when it wants to slow down the level of economic growth
and reduce inflationary pressures. Alternatively, if it wants to accelerate growth,
the RBA buys government securities, increasing the supply of funds and reducing
interest rates.
8 In recent years the Reserve Bank has deployed several unconventional
monetary policy measures to support growth, stabilise financial markets,
encourage lending and influence market expectations. These measures have been
used when conventional monetary policy measures (interest rates) have reached
the limits of their effectiveness.
9 Interest rate changes affect the economy through the monetary policy
transmission mechanism, in which lower interest rates encourage increased
consumer spending and business investment, raising the level of aggregate
demand. Higher interest rates dampen aggregate demand by discouraging
consumer spending and business investment.
10 In making monetary policy decisions, the RBA’s Monetary Policy Board
considers a number of economic indicators that are likely to affect its policy goals
over the coming year, including inflation, inflationary expectations, wages growth,
the rate of economic growth, the unemployment rate, interest rates overseas, the
exchange rate and the balance of payments.
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chapter review
1 Define monetary policy.
3 Identify what is meant by inflation targeting and why it has been implemented
in Australia.
5 Identify the economic indicators monitored by the government and the Reserve
Bank to determine whether a change in monetary policy is necessary.
7 Outline what action the Reserve Bank would take if it wanted to:
8 Discuss how changes in interest rates influence the level of economic activity.
9 Discuss how Australia’s growth and inflation levels have influenced the conduct of
monetary policy in recent years.
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16 Microeconomic
and Environmental
Policies
16.1 Microeconomic policies and aggregate supply
16.2 Microeconomic policies and individual industries
16.3 Environmental management policies
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Policy
Microeconomic policies are closely associated with structural change. Structural change Structural change
refers to shifts in the pattern of production that reflect changes in technology, consumer involves shifts in the
preferences, policy, global competitiveness and various other factors. It results in the pattern of production
decline of products, processes, and even industries, while facilitating the emergence that reflect changes in
of others. Microeconomic policies promote structural changes and help the Australian technology, consumer
preferences, global
economy respond more effectively to changing economic conditions by making product
competitiveness and other
and factor markets work more efficiently. Product markets include the market for goods, factors. It results in some
such as motor vehicles, and services, such as transport. Factor markets are markets for products, processes and
the inputs to production, such as the labour market and financial markets. Markets work even entire industries
efficiently when goods are produced at the lowest cost, and resources flow to areas where disappearing, while
others emerge and
they have the highest value.
become more prominent.
The structure of the Australian economy has changed in recent decades because of
improvements in technology, increased trade, changes in patterns of consumer preferences
and the implementation of wide-ranging microeconomic policies between the early 1980s
and the beginning of the 21st century. For example, figure 16.2 shows a significant shift in
the allocation of resources in Australia away from manufacturing and towards the mining
sector since the 1980s. As we will see in the next section, long-term trends can be at least
partly explained by the impact of microeconomic policies.
Manufacturing 15%
Manufacturing 6%
Source: ABS National Account: National Income, Expenditure and Product, Australia (Cat. no. 5206.0)
Note: Figures do not necessarily add up to 100 per cent because of rounding.
Microeconomic theory says product and factor markets will generally be more efficient if
there is greater competition between private businesses, and the market forces of supply
and demand are able to operate with fewer distortions, either from government policies or
anti-competitive market conduct. For example, electricity is a major input to production
and a necessity for households. The price of electricity is highly regulated. This may lead to
lower prices for households in the short term but lower investment in new energy generation
facilities in the long term, if investors expect that price regulation will lead to lower profits.
Underinvestment in energy generation infrastructure could lead to less reliable energy
supply, lower productivity and higher energy prices. Some advocates of microeconomic
reform regard price regulation in the electricity sector as a distortion of market forces that
should be removed. Others, however, regard such regulation as necessary to prevent large
energy firms from exploiting their market power and extracting excessive profits.
Microeconomic policies can operate on different levels, from decisions by an individual
government official about a single company to sweeping policies for entire industries.
The overriding goal of microeconomic reforms is to encourage the efficient operation
of markets – to lift productivity, improve flexibility and responsiveness to change,
and encourage Australian firms to take on “world best” practices in order to increase
aggregate supply.
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There are three dimensions to improving the efficiency of markets: allocative, technical and
dynamic efficiency. However, many microeconomic policies will have impacts on all three
aspects of efficiency simultaneously, potentially blurring the distinctions between the concepts.
For example, past reforms to Australia’s telecommunications industry have increased
competition, forcing companies to become more technically efficient to maintain and
improve market share. The forces of competition have also encouraged innovation and
dynamic efficiency, attracting more investment to the telecommunications industry (a sign
of allocative efficiency). Nevertheless, it is useful to identify the specific ways in which
ALLOCATIVE EFFICIENCY
Allocative efficiency By minimising the distortions to the market economy (such as the impact of government
refers to the economy’s regulations, tax loopholes, subsidies and anti-competitive behaviour), the operation of
ability to shift resources market forces should bring about a more efficient allocation of resources. In a free market
to where they are most economy, resources should shift to those producers who have the greatest capacity to
valued and can be used pay, and that capacity to pay will reflect relative efficiency and value to the economy (more
most efficiently.
efficient producers stand to make greater profits from production and so are willing to pay
more for resources). Achieving allocative efficiency promotes beneficial structural change
by allowing resources to flow to those areas where they are used most efficiently. For
example, economists argue that the removal of tariff protection has led to a reallocation
of resources away from inefficient producers who could only survive behind tariff barriers
towards the more efficient producers who are competitive without protection.
TECHNICAL EFFICIENCY
Technical efficiency Technical efficiency is the ability of
$ $
refers to the economy’s an economy to achieve the maximum
ability to produce the
$
level of output from a given quantity
maximum level of output of inputs. Technical efficiency is The finance and insurance industry achieved
from a given quantity of higher multifactor productivity growth (measured
measured by the productivity of a
inputs. across both labour and capital inputs) than most
business or an economy: that is, how
other sectors in Australia during the period from
much output can be produced from
1997 to 2022, recording average annual productivity
a given quantity of inputs. Greater increases of around 1.5 per cent. In contrast,
productivity means that businesses average annual productivity growth in Australia’s
can produce output more cheaply, manufacturing sector was around 0.4 per cent over
which makes them more competitive in the same period. Industry changes that contributed
domestic and global product markets. to increased productivity in the finance sector
include online banking, the automation of information
Businesses operating in a competitive
processing, closures of local bank branches and
market therefore have very powerful
reduced staffing, offshoring of some processing
financial incentives to maximise functions and organisational restructuring. Policy
technical efficiency. They will be more decisions and structural changes in past decades
inclined to adopt the latest production contributed to these changes, including deregulation,
technology and use the least-cost privatisation and increased competition for traditional
combination of resources to produce. financial institutions.
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reviewquestions
1 Define microeconomic policy.
2 Describe the THREE different types of efficiency that microeconomic policies
aim to improve.
3 Explain how microeconomic policies promote or respond to structural change
and increase aggregate supply.
Financial sector
The financial sector plays an important role in ensuring that businesses can access funds
for investment and growth, and investors can easily and confidently invest their savings in
various ways. Microeconomic policies in the financial sector in the 1980s aimed to make
the sector’s provision of these services more efficient and competitive. The first step in
financial deregulation was the floating of the Australian dollar, and the removal of the
Reserve Bank’s direct monetary controls over banks, which gave them more autonomy
to set interest rates on their deposit accounts and loans consistent with market forces.
The second was the removal of barriers to foreign banks entering the Australian market.
Financial deregulation has resulted in a more competitive environment for many financial
services. The benefits of a more competitive financial sector are spread across the entire
economy, as consumers and businesses pay lower prices to access finance that is better
geared to their needs. Better access to finance can facilitate more consumption by
individuals and more investment by businesses.
The global financial crisis of the late 2000s resulted in some businesses in the financial
sector collapsing or being acquired by other businesses, reducing competition in the
financial sector. In many countries, the financial crisis was also blamed on governments
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having gone too far in deregulating the financial sector, allowing banks to take too many
risks with depositors’ money. This highlights the need for a balance between the goals of
efficiency and competition (which generally favour deregulation) and the goals of consumer
protection and financial system stability (which generally favour regulation).
Finding this balance was the overarching aim of the Financial System Inquiry (also known
as the Murray Review), a policy review of Australia’s financial sector conducted in 2014.
It led to an increase in the minimum capital requirements for banks to make them more
resilient to future financial crises. It also resulted in the removal of rules imposing tougher
capital requirements on smaller banks compared with larger banks. The increased capital
that was built up in Australian banks as a result proved useful during the COVID-19
crisis, as banks were well-positioned to support lending to businesses during the economic
downturn. In that sense, the finance sector was part of the solution to the economic crisis in
2020, whereas it was part of the problem during the economic crisis of 2008. Consumers
have also benefited from laws banning excessive credit card surcharges since 2016 (another
recommendation from the inquiry).
Tensions between consumer protection and efficiency were highlighted in the Royal
Commission into Misconduct in the Banking, Superannuation and Financial Services
Industry in 2019. The Royal Commission uncovered a range of dishonest practices,
including breaches of industry codes of practice, failings on contracts, and widespread
mistreatment of customers. It also found widespread governance problems at senior
levels in financial institutions, and major flaws in how the industry was regulated by the
Australian Securities and Investment Commission (ASIC).
The Royal Commission concluded that the current laws and regulations remain largely
appropriate, but that these rules require stricter enforcement and harsher penalties.
Regulatory agencies subsequently adopted a tougher approach to litigation-enforcing
regulations, reflected in several high-profile court cases against banks and other finance
companies, including allegations that Westpac Banking Corporation breached responsible
lending laws when extending housing loans to some customers, and that the National
Australia Bank had charged superannuation customers fees without providing any financial
services. The Commission did not recommend major legislative changes, despite the
problems it uncovered, because of concerns that introducing more regulations might make
it harder to obtain credit in Australia, especially for small businesses.
Agricultural industries
Deregulation in the agricultural sector has created more competition in markets for farm
produce. In the past, single government-owned businesses or industry cooperatives had
a monopoly on buying farmers’ produce in areas such as dairy, wheat and wool. With
deregulation those monopolies ended, and farmers were given new incentives to innovate
and diversify their outputs. Combined with tariff reductions, these changes transformed
Australia’s agricultural sector from a highly regulated industry to one of the least regulated
agricultural industries in the world. Australia’s agricultural output expanded significantly
in the years after deregulation. Nevertheless, over the past two decades, growth in
agricultural productivity has slowed considerably. Average annual productivity growth in
the broadacre agricultural industry (all agriculture production except for dairy products)
has been sluggish since the start of the 21st century. In contrast, annual average growth in
agricultural productivity was around 2 per cent over the second half of the 20th century.
Evidence from the Australian Bureau of Agricultural and Resource Economics and Sciences
suggests that this decline can partly be attributed to deteriorating climate conditions.
Recent productivity estimates that attempt to account for climate conditions (both short
term and long term) are higher than the unadjusted estimates that do not account for
changes in climate, although the difference is relatively small.
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Transport industries
Transport industries are crucial to Australia’s economy because of the large distances within
Australia, and between Australia and other nations. Two key examples of deregulation in
Australia’s transport industries are:
1 Australia’s domestic aviation industry is dominated by two airline groups: Qantas/
Jetstar and Virgin Australia. In some respects, its structure is similar to when the
sector was deregulated in 1990, abolishing the official Two Airline Policy in place
since 1952. Several airline businesses have entered the Australian aviation market
since 1990, but have struggled to compete against the major carriers. Two smaller
airlines, Rex and Bonza (which commenced operations in 2023), mainly compete on
regional routes. According to a 2023 report from the Australian Competition and
Consumer Commission, a lack of competition helps explain why Australia’s aviation
industry has underperformed for domestic travellers in recent decades (in terms of
prices and service quality). The Government’s Aviation White Paper, expected in
2024, aims to strengthen competition and improve outcomes for consumers.
2 Rail: The efficiency of the rail freight industry has undergone significant reforms
over recent decades. In 1997, the Commonwealth and state governments established
the Australian Rail Track Corporation (ARTC) to manage the 10,000- kilometre
national interstate rail network. The ARTC sells access to privately owned freight
businesses such as Pacific National and oversees maintenance of the network and
new capital works. Establishing corporations at arms-length from government,
however, does not guarantee efficient operations, however. A 2023 review of
Inland Rail by Dr Kerry Schott, found the 1,700 kilometre infrastructure project
that runs through the eastern states had been poorly managed and experienced an
“astonishing” cost-blowout. Part of the reason was a government failure to appoint
people to the board with the necessary freight rail or infrastructure skills.
Telecommunications industry
Telecommunications is an important contributor to productivity, and as a sector contributes
around 2 per cent of economic output. The dominant role in the industry is still held
by Telstra (formerly a government-owned monopoly called Telecom Australia), but the
industry has been transformed by competition since it was deregulated in the 1990s. A
combination of new technologies and competition lowered telecommunications costs
dramatically. New market entrants successfully competed in different product and service
markets, including internet service providers, mobile carriers and providers of business
services. Nevertheless, Telstra still retained its role as the largest firm in the industry.
For many years Telstra was accused of making it difficult for competitors to gain access
to its local monopoly over residential phone connections. For this reason, the decision
was made during the rollout of the National Broadband Network (NBN) in the 2010s
to separate the wholesale business of providing access to the infrastructure from the retail
businesses that offer telecommunications services to households and businesses. The goal
of these changes was to improve access in order to increase competition among retailers
while also making high-speed internet access more widely accessible.
Effective regulation
Effective deregulation involves striking a balance between competing policy goals. Excessive
regulation can increase costs, reduce investment, discourage new market entrants and
ultimately lower economic growth. On the other hand, excessive deregulation (or to put it
another way, inadequate regulation) can lead to market failure (such as a lack of competition)
and economic instability. This tension is especially apparent in the finance industry because
financial crises have flow-on effects across the whole economy.
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Australia has repealed many regulations that reduced competition, and most
MAKING DIGITAL comparative studies conclude that Australia has a less regulated economy
GIANTS PAY FOR NEWS than most other advanced economies. Even so, many aspects of business
activity are regulated. Environmental regulations play a significant role in
CONTENT
the agricultural and mining industries. Construction, energy and transport
One example of new regulation in
have comprehensive safety regimes. Pricing and investment decisions are
response to technology change is the overseen by regulators in industries such as electricity, gas, water, postal
News Media and Digital Platforms services and telecommunications – as these industries are dominated by
Mandatory Bargaining Code, very large players that would otherwise have the ability to charge much
introduced in 2021. The code came higher prices because of the lack of outside competition. Professional services
about in response to the 2019 ACCC industries, such as law and accounting, exist in part to help businesses
Digital Platforms Inquiry, which found comply with and navigate regulation. When new areas of commerce emerge,
that tech giants had substantial such as ridesharing services offered by Uber, homesharing through Airbnb,
market power in the supply of internet
online services through Google, Facebook and Amazon, and buy-now-pay-
search advertising services (Google)
later credit products provided by Afterpay and others, governments have
and supply of display advertising
services in Australia (Facebook). These responded with new transport, safety, planning, privacy, tax, consumer
businesses make significant profits protection and other laws.
from users consuming content on their Although Australia has undergone extensive deregulation, changes in
platforms, while the cost of creating
technology and business models require ongoing changes to industry
this content is being borne by media
regulation. The coming years are likely to see new regulations for
companies. Their substantial market
power has created an imbalance in cryptocurrencies such as Bitcoin, and generative artificial intelligence
bargaining power between the tech products such as Open AI’s ChatGPT. These products and services could
giants and news media businesses in bring harmful economic and social consequences without adequate market
Australia, and has made it difficult for regulation. Two large sectors in the Australian economy that are already
media companies to sustain investment regulated but likely to undergo further significant reforms are the national
in quality journalism, which is essential market for disability services (facilitated by the National Disability Insurance
for a healthy democracy. Facebook Scheme or NDIS), and the national market for aged-care services. Demand
fought against the regulation, initially for disability and aged-care services has grown rapidly, and determining
blocking publishers and people in
the best model for service provision and regulation has proved difficult for
Australia from sharing local news
content on its platforms. After a public
successive governments.
backlash and last-minute changes
to the regulations, agreements were Reforms to public trading enterprises
reached for the digital platforms to pay Microeconomic policies have promoted efficiency in public trading
more for the content that they were enterprises (PTEs) – also known as government business enterprises –
using on their sites to generate internet
through two main approaches: corporatisation of PTEs and privatisation
traffic and advertising revenue.
of PTEs.
Corporatisation of PTEs
Corporatisation aims to encourage PTEs to operate independently from the government, as
if they are private business enterprises. This involves eliminating political and bureaucratic
supervision and making public enterprise managers accountable for enterprise performance.
Corporatised public enterprises attempt to achieve a rate of return on assets comparable
to private sector companies, and they often operate in competitive markets (although in
some cases they continue to operate as regulated monopolies). In doing so, they must
still comply with competitive neutrality laws that try to ensure that PTEs do not receive
artificial competitive advantages over private businesses just because they are publicly
Examples of privatised
owned. Examples of PTEs that have been subject to corporatisation are Australia Post,
public trading Energy Australia and the Sydney Water Corporation.
enterprises are:
Privatisation of PTEs
Telstra, Qantas, GIO,
Commonwealth Bank, Privatisation takes corporatisation a step further by selling off PTEs so that they do in fact
NSW Ports, Queensland become private enterprises, either in whole or in part. Australia has undertaken extensive
Rail, Victorian electricity, privatisation in recent decades, and the total value of privatised businesses is among the
state banks and airports.
highest in the world. The most recent major privatisation by the Federal Government
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was health insurer Medibank Private, which after 38 years in government ownership
was sold for $5.6 billion in 2014. In recent years, state governments have also privatised
assets to free up capital for other purposes, such as transport projects. For example, the
NSW Government’s $20 billion privatisation of its electricity “poles and wires” business
in the 2010s helped to fund several transport infrastructure projects, including a second
harbour rail crossing, a light rail project and extension of Sydney’s North West Rail Link.
Governments have implemented privatisation with the aim of raising one-off revenues,
increasing competition, encouraging more rational management and pricing behaviour,
and forcing businesses to become more efficient.
In a departure from the trend of privatisation, in 2009 the Federal Government established
a new public trading enterprise to build and operate an optical fibre telecommunications National Competition
system, the National Broadband Network (NBN). The final cost of building the network Policy is an agreement
was $51 billion. The NBN company is one of the largest in the Australian economy. It is between Australia’s
Commonwealth and State
expected to be privatised at some point in the future. Another example against the trend
governments signed
of privatisation came in 2023 when the new Minns Labor Government in NSW enacted in 1995 to encourage
legislation to prevent the future privatisation of two state-owned corporations, Sydney microeconomic reform
Water and Hunter Water. throughout the
Australian economy.
National Competition Policy
Competition policy aims to promote competition in markets so that firms increase
efficiency and lower prices for consumers. Australia’s laws regulating market BUSINESS PRACTICES
behaviour went through a major shake-up after 1995 when the Commonwealth OUTLAWED BY THE
and state governments agreed to implement the National Competition Policy. COMPETITION AND
Under these reforms, governments agreed to implement reforms that would
increase competition in the sectors where they operated monopolies, such as CONSUMER ACT
electricity, gas, water, and rail and road transport. Governments also agreed to INCLUDE:
remove special provisions that gave publicly owned enterprises an advantage
over private sector competitors (what is known as the “competitive neutrality” • M
onopolisation: when a firm
principle). The national competition watchdog, the Australian Competition uses its dominant market position
and Consumer Commission (ACCC), was also established. The ACCC actively to eliminate competition, such as
enforces Australia’s competition laws, and, in 2022, its investigations of breaches through temporary price cutting.
of competition and consumer protection laws led to $230 million in penalties • Price discrimination: when a
against offending businesses. firm sells the same type of good
or service in different markets at
An important aspect of the reforms was the establishment of a national regime to different prices (for reasons not
regulate the cost of access to infrastructure. This meant that where businesses related to different costs, such as
owned a monopoly infrastructure asset (such as owning an airport, rail line or for transport).
telecommunications network), they were required to give competitors access to • E
xclusive dealing: when a firm
that network at a reasonable price. sets conditions for supply that
A key principle of competition policy in Australia is workable competition. exclude retailers from dealing
While governments generally aim to maximise competitive forces, workable with other competitors.
competition may sometimes mean that in order to achieve international • C
ollusion and market sharing:
competitiveness, it may be necessary to reduce the number of firms in an industry. when firms get together to fix
Those remaining firms can then operate on a larger scale and achieve the lowest prices or agree on a market
sharing arrangement that reduces
possible long-run average costs of production.
effective competition between
A review of competition policy led by Professor Ian Harper (the Harper Review) firms.
in 2015 recommended that competition principles should be incorporated into
a wider range of government regulations, procurement and service delivery
systems, and extended to human services such as health and aged care. A Productivity
Commission report concluded that with the public sector spending around $200 billion
per year on human services, significant improvements in economic outcomes could be
achieved by extending competition laws to social housing, public hospitals, services in
remote Indigenous communities, and family and community services. The Harper Review
concluded that implementing its reform could boost economic growth as much as the first
round of competition policy reforms in the 1990s.
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While many of the Harper Report recommendations were not implemented, several
changes were made to Australia’s competition policy regime in 2017, principally by
expanding the laws on misuse of market power. Businesses must not misuse their market
power to reduce competition in the market by lowering prices, refusing to supply goods
or services or other behaviours. Previously, regulators had to prove that a business actually
intended to harm competitors in order to convict it of misusing market powers; under
the new law, regulators now only have to establish that the business practice in question
had the effect of harming competition. “Concerted practices” were also banned; they
include actions such as sending price information to competitors, even if there is no formal
agreement to collude to raise prices.
Future of microeconomic policy
The period from the mid-1980s to the early 2000s witnessed extensive microeconomic
For more information reforms that saw industries change dramatically in Australia. Fewer reforms have
on microeconomic been achieved in the past two decades, as the policy focus has shifted more towards
policies, visit the following macroeconomic concerns such as managing the mining boom, the global financial crisis,
websites: www.pc.gov.au consolidating government debt and navigating the COVID-19 pandemic. In addition,
(Productivity Commission),
www.accc.gov.au
implementing microeconomic reforms has become a much more difficult proposition for
(Australian Competition and governments.
Consumer Commission).
A key focus of the reform agenda in more recent years has been better coordination between
the Commonwealth and state governments in areas where Australia’s Constitution gives
Outline some areas the the states regulatory powers. Achieving agreement across all levels of government in
Productivity Commission
Australia often proves difficult. For example, only limited progress was made with a set
has investigated
for possible future of “seamless national economy” reforms to simplify business regulations under the Rudd
microeconomic policies. and Gillard Governments between 2007 and 2013.
Many other major recommendations made by policy reviews over the past decade have
not been implemented. In 2020, the Morrison Government announced it would use
the recovery phase following the COVID-19 pandemic as an opportunity to revisit
long-standing economic reform opportunities, such as for taxation, industrial relations
and business regulation. This included replacing the long-standing Council of Australian
Governments (COAG) with a National Federation Reform Council (NFRC) that would
be based on the success of the “National Cabinet” that brought the federal and state
governments together in their response to COVID-19. This was celebrated at the time
as a reform that would streamline and improve government decision-making. While
some changes were achieved (for example, reforms to Australia’s business insolvency laws
introduced in 2021), little progress took place in difficult areas of recommended reform
including in health care, schools, pharmacies and stamp duty on residential property.
In 2016, the Australian Government commissioned the Productivity Commission to
publish a report every five years that assesses Australia’s productivity performance and
recommends productivity-enhancing microeconomic reforms. The first report, Shifting the
Dial, was published in 2017. In 2023, the Productivity Commission published the second
report in the series, Advancing Prosperity. It concluded that efforts to increase productivity
should focus on Australia’s services industries. Among its 71 specific recommendations
are microeconomic reform initiatives in the following areas:
• harnessing data and digital technologies, such as providing better access to digital
infrastructure (fast internet) in regional areas, and promoting the diffusion of new
knowledge and data by, for example, making it easier to use intellectual property
that provides significant value to society.
• education reforms, such as improving schools’ capacity to provide foundational
skills for Australia’s future workforce (including digital skills), increasing access
to and quality of tertiary education (university and TAFE) via regulation and price
incentives, and supporting lifelong learning by workers to improve the adaptability
of the workforce
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reviewquestions
1 Using ONE industry as an example, explain how microeconomic policies
deliver better outcomes for consumers. Identify why businesses in this
industry might resist microeconomic reform.
2 Summarise the microeconomic policies that have been implemented in
individual sectors of the Australian economy.
3 Explain how microeconomic policies can lead to improved economic
performance in the long term. Identify any costs of microeconomic policies.
4 Outline THREE areas for future microeconomic policies in Australia and
explain how they might boost economic growth and productivity.
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based policies to influence behaviour and reduce environmental impacts. Like other areas
of economic policy, environmental management is guided by research bodies and by targets
set by governments, and is influenced by international agreements between governments.
Targets
The Australian Government uses many targets to guide its environmental policies.
Australia’s most important long-term policy target relates to the reduction of Australia’s
carbon emissions. This has proved to be the most difficult area of policymaking in the past
two decades in Australia, with several Prime Ministers losing office after a backlash over
their policies relating to energy prices and emission reductions. In 2022, the Albanese
Government legislated two emissions targets: a 43 per cent reduction on 2005 levels by
2030, and a reduction to net zero emissions by 2050.
Regulations
Environmental regulations are the traditional policy tool for achieving environmental
sustainability goals. Regulations are laws or rules that govern economic behaviour.
Regulations may prohibit a person from doing something that causes
environmental damage, such as illegally dumping waste or producing
polluting chemicals. Alternatively, regulations may specify how a good or
service is produced or consumed, as with rules relating to agricultural or
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Market-based policies
Policies that create market-based incentives for environmental protection have been
increasingly used in Australia and other economies during recent decades. Market-based
policies involve financial incentives and disincentives (such as subsidies and taxes) to
influence the behaviour of households and businesses.
As we saw in chapter 12, many environmental problems arise because of market failure.
Environmental costs (or benefits), known as externalities, are borne by all of society and
are not taken into account by producers and consumers in the marketplace. In the case of
negative externalities, this results in the equilibrium price being too low and production
being too high. Figure 16.3 shows the demand and supply for goods with negative
environmental externalities.
Price ($) S2
S (social cost) Price ($)
S1
S (private cost) p
3
ps
p
2 Size of tax
pm
p
1
D
D
qs qm Quantity qs qm Quantity
Where: pm = market price
ps = socially optimum price Where: p1p3 = amount of tax
qm = market quantity qm = market quantity
qs = socially optimum quantity qs = socially optimum quantity
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Chapter 15: MonetaryPolicies
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criticised for relying too heavily on future technologies credit scheme is a market mechanism but not an emissions
and for expensive one-off measures such as through the trading scheme. In 2023, the Albanese Government
Emissions Reduction Fund. Other policy measures include reformed the safeguard mechanism, with the goal of
the Renewable Energy Target, investments in low emissions improving its effectiveness. From July 2023, top polluters
technologies through the Australian Renewable Energy across mining, manufacturing, transport, oil, gas and waste
Agency (ARENA) and the Clean Energy Finance Corporation are required to gradually reduce emissions in line with
and the National Energy Productivity Plan. Australia’s emissions reduction targets. Firms must reduce
their absolute emissions in line with a maximum annual cap
Market-based policies
that will decline over time.
Individual governments have implemented a range of
“In Australia we have put in place a number of
market-based policies to meet emissions reductions targets.
arrangements to reduce emissions, including:
The most well-known example in Australia was the Gillard
regulation, subsidies, emissions trading schemes
Government’s carbon pricing scheme in 2012. It put a price
and baseline and credit schemes. The one thing they
on each tonne of carbon dioxide emitted as part of energy or
all have in common is that they all aim to provide an
industrial production processes. Adding a price factored the
incentive to reduce emissions by changing relative
cost of carbon pollution into the cost of production, giving
prices …
Australia’s 500 largest polluters a financial incentive to switch
to comparatively cheaper, lower-emissions processes. The Policy making is difficult. Climate change is perhaps
carbon price was initially fixed and was due to be replaced Australia’s best recent example of how difficult it
by a “cap and trade” emissions trading scheme (ETS). can be. It is especially difficult when many forces
In 2014, the Abbott Government abolished this scheme, are arranged against the best outcome for the
arguing it was adding to business and household costs and community …
damaging economic growth. The more recent change of heart among business
groups is because the world has moved in such a way
Emissions trading is used across the world, including in the
that it is now in the financial interests of their members
EU, China and New Zealand. Under an ETS, businesses are
to no longer resist. Markets have begun to price in
issued permits, or need to buy permits, for the emissions of
diminishing use of fossil fuels, banks and investors
greenhouse gases. Such a scheme can be “internationally
are baulking at, or charging a premium for, new fossil
linked”, meaning that businesses with excess emissions may
fuel investments, and most fundamentally renewable
buy permits internationally from businesses that produce
energy sources are now plainly cheaper than using
fewer emissions and hold spare permits. This system of
coal or gas.”
trading permits effectively puts a price on the emission of
greenhouse gases and incorporates the real cost of carbon – Dr Steven Kennedy, Secretary to the Treasury,
emissions into the price mechanism. It is a market-based 20 July 2022, Speech to the University of Sydney –
mechanism to create incentives for businesses to develop Celebrating 100 years of Economics
new technologies and processes to reduce emissions. Regulations
However, critics argue that acting ahead of other economies
creates the risk of “carbon leakage” – where emissions- Regulations also act to ensure that newly produced goods
intensive industries simply move to countries with no meet environmental standards that are consistent with
emissions target, increasing domestic unemployment, but Australia’s aim to reduce greenhouse gas emissions. For
with no overall reduction in emissions. example, in 2007 Australia banned older-style incandescent
light bulbs, replacing them with more energy-efficient options
The centrepiece of Australia’s emissions reduction policy such as fluorescent and LED bulbs. In 2010, planning laws
under the previous Coalition Government was the Emissions in several states were changed to require newly constructed
Reduction Fund, which replaced carbon pricing. Firms homes to comply with six-star energy ratings involving
were paid out of this fund to reduce emissions from their improved insulation, water recycling and other features.
production processes, at the lowest cost of abatement, Government policy decisions around agriculture, mining
a process overseen by the government’s Clean Energy and transport also have major effects on carbon emissions.
Regulator. The lowest-price emissions were purchased As part of a broader package of climate change policies,
by the government via an auction where firms bid to sell the Albanese Government has committed to applying new
their projects to reduce emissions at the lowest price. After standardised reporting requirements for climate risks and
15 rounds of auctions, the Emissions Reduction Fund had opportunities for large businesses.
purchased 217 million tonnes of CO2 abatement. Uptake of
State Governments are also acting to address climate
the policy declined over time as low-cost opportunities for
change through regulatory measures. For example, the NSW
abatement were exhausted.
Environmental Protection Agency released its first climate
A second element of the scheme was the “safeguard change policy and action plan, which signals stronger
mechanism” – a baseline level of emissions top polluters regulatory action to facilitate the state government’s 2050
could not exceed or had to account for. This baseline and net zero commitment.
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MURRAY-DARLING BASIN
Australia’s Murray-Darling Basin is one of the world’s largest river systems. It covers
14 per cent of the country, spanning from Queensland through NSW and Victoria to
South Australia, and provides water for two million residents, industry and agriculture.
But for decades, the government has faced challenges in managing the basin because of
competing economic, social and environmental interests, and recurring water shortages.
By the beginning of the 21st century, conflicts between water users were taking a toll on
the basin’s health, and not enough water was reaching downstream users. The Murray-
Darling Basin Authority was formed in 2007 to take responsibility for the basin. In 2010 it
released the Murray-Darling Basin Plan, aiming to return up to 4000 gigalitres of water to
the basin to improve the health of the river system. The plan was controversial, with claims
that the plan could reduce agricultural production, increase unemployment, and threaten the
viability of towns. Over the following decade, the implementation of the plan was plagued
by controversy, including allegations of poor enforcement and corruption.
In August 2023, the Australian Government announced a new plan to balance the needs
of the environment with the interests of different water users. It proposed to resume
buying back water licences, a market scheme where water users such as farmers can
voluntarily sell their licences to the government. Instead of drawing the water from the
basin, the government ‘uses’ these licences to ‘return’ water to the environment, effectively
reducing the amount of water that can be drawn from the basin to a more sustainable
level. Queensland, NSW and South Australia signed on for the new plan but Victoria held
off signing, due to concerns about the social and economic impacts of reduced water in
agricultural communities.
International agreements
For environmental management policies to be successful they often require international
cooperation. Collective action is often necessary because individual nations cannot
successfully address global environmental problems on their own. Additionally, when
addressing environmental issues, individual nations are often reluctant to impose strict
environmental management policies on their own economy if other nations are not willing
to do the same.
One example of global pollution problems is the depletion of the ozone layer (the
atmospheric layer that filters out dangerous ultraviolet radiation). This is related to the
emission of chlorofluorocarbons into the atmosphere from industry refrigeration units
and aerosols. To reduce this problem, an international agreement known as the Montreal
Protocol committed members to phasing out the production of ozone-depleting products
by 2000. According to the United Nations Development Programme, over 98 per cent of
ozone-depleting substances were eliminated between 1987 and 2014. As a result, scientists
predict that the ozone layer should recover to pre-1980 levels between 2050 and 2065.
A number of other international environmental agreements are also in force. In many cases,
international agreements are required to prevent the overuse of common international
resources. This is an issue known as the tragedy of the commons. For example, the
United Nations Fish Stocks Agreement, to which Australia is a signatory, was developed
to ensure the long-term conservation and sustainable use of highly migratory fish stocks.
In 2023, an international agreement was reached for a new treaty to protect the seas and
oceans outside country boundaries, which cover 60 per cent of the earth’s surface. This
agreement was supported by Australia and will establish Marine Protected Areas (MPAs)
and processes for environmental impact assessments.
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The Vienna Convention for the Protection of the Ozone Layer 1987
reviewquestions
1 Outline the impact of international agreements on Australia’s environmental
management policies.
2 Explain the tools available to policymakers to achieve environmental
sustainability.
3 Analyse the role of market-based environmental management policies in
improving the economy’s environmental sustainability.
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chapter summary
Microeconomic policy is action taken by government to improve resource
1
allocation between firms and industries, in order to maximise output from scarce
resources and promote structural change. Microeconomic policy can help to
accelerate the process of structural change by making the economy able to move
factors of production from one area to another more quickly.
2 By reducing costs and increasing efficiency, microeconomic policies should have
the effect of shifting the aggregate supply curve to the right so that more goods
and services are produced at lower prices.
3 Since the 1980s, microeconomic policy has played an important role in the
economic strategy of successive governments. Microeconomic policy is more
effective than macroeconomic policy in addressing longer-term structural
problems in the economy.
5 Deregulation involves the removal of legislation and other rules that constrain
the operation of market forces, and it aims to improve the efficiency of industries.
In the past three decades, Australia has deregulated its financial services,
telecommunications, electricity, gas, aviation and agricultural industries. This has
had both positive and negative consequences.
7
National Competition Policy reforms introduced since 1995 have increased
the level of competition across many sectors of the economy. The rules for
business practices and prohibitions on anti-competitive behaviour are set out in
the Competition and Consumer Act 2010, which is enforced by the Australian
Competition and Consumer Commission.
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Chapter 16: Microeconomic and Environmental Policies
chapter review
1 Explain how microeconomic policies aim to increase economic growth.
5 Outline how and why the government regulates specific sectors of the economy.
6 Explain what is meant by deregulation. Using two specific examples, discuss the
benefits of deregulating major industries.
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17 Labour Market
Policies
17.1 Introduction
17.2 The role of national and state workplace systems
17.3 Australia’s wage determination system
17.4 Dispute resolution
17.5 Decentralisation of the labour market
17.6 Education, training and employment programs
17.7 Evaluating labour market outcomes in Australia
17.1 Introduction
Labour market policies Labour market policy involves governments influencing the process or outcomes of wage
are microeconomic determination. Governments intervene in labour markets for several reasons, including:
policies that are aimed at
influencing the operation
• achieving macroeconomic objectives such as low inflation and macroeconomic
and outcomes in the stability (since wages growth is a major influence on inflation)
labour market, including • achieving microeconomic objectives such as productivity growth and
industrial relations policies
improved competitiveness for Australian businesses, and resolving disputes that
that regulate the process
of wage determination as
arise in the workplace
well as training, education • achieving objectives relating to the distribution of income and wealth, such as
and job-placement ensuring that fair minimum standards apply to all employees (since wages are the
programs to assist the
main source of income for most households).
unemployed.
In Australia, the Government has historically played an important role in wage
determination, either directly or through independent industrial courts and tribunals.
The extent of government regulation of the labour market has been a matter of ongoing
debate since Federation in 1901.
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Over time, Australia developed separate industrial relations systems – six different
state systems, plus the federal system. These systems established minimum wages
and conditions for employees through a system of industrial awards for employees,
based on their industry or occupation. Awards for some employees were made by the
Commonwealth, while others were made at a state level. This meant that employers whose
workforces spanned multiple states needed to comply with different state systems as well
as the federal system.
The inefficiency of separate state and federal systems created pressure to adopt a national
workplace relations system, resulting in the Fair Work Act (2009), which covers around
70 per cent of Australian workers. Figure 17.1 shows that the Federal Government’s
constitutional power extends to all employees of incorporated businesses and its own
employees. State governments have also “referred” (that is, handed over) some of their
powers to the Federal Government, including for employees of sole traders, local
government and the state public sector. Western Australia is the only state that has not
referred any powers to the Federal Government.
NSW ✔ ✔ ✘ ✘ ✔
QLD ✔ ✔ ✘ ✘ ✔
SA ✔ ✔ ✘ ✘ ✔
VIC ✔ ✔ ✔ ✔ ✔
ACT ✔ ✔ ✔ ✔ ✔
NT ✔ ✔ ✔ ✔ ✔
TAS ✔ ✔ ✔ ✘ ✔
WA ✔ ✘ ✘ ✘ ✔
Figure 17.1 – Coverage of employees under the national workplace relations system
During this period, the Commonwealth also replaced most state-based awards with simpler
federal awards, established a national system of occupational health and safety legislation,
and set up the national workplace relations system. State and territory regulation of the
labour market is now limited mostly to state government employees and to a smaller
range of specific issues such as workers’ compensation and public holidays. The national
system is overseen by the Fair Work Commission (FWC).
reviewquestions
1 Explain the role that national and state systems have traditionally played
in the regulation of the Australian labour market.
2 Outline the benefits of shifting towards a national workplace relations system.
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Source: ABS Employee Earnings and Hours, Australia (Cat. no. 6306.0), accessed June 2023
Note: Percentages indicate the proportion of the workforce covered by each type of agreement.
Note that individual contracts cannot be made within the formal system. Note also that high-income earners
(more than $167,500) on common law contracts are not covered by award provisions.
Around 30 per cent of Australian workers are outside the national wage determination
For a detailed overview
of Australia's wage system, in two main groups:
determination system, • individuals whose conditions are unregulated (17 per cent of Australian workers),
visit the Productivity divided evenly between independent contractors and other business operators
Commission’s website and
download the Workplace • individuals regulated by a state workplace relations system (12 per cent), almost
Relations Framework report all of whom are state public sector employees.
from 2015:
www.pc.gov.au/
Below, some key features of the national workplace relations system are examined.
inquiries/completed/
workplace-relations/ Minimum employment standards
report
Australian employees are protected by a set of legally guaranteed employment conditions, known
as the National Employment Standards (NES). These provisions include:
• Maximum weekly hours of work. A full-time employee’s hours of work must not exceed
38 ordinary hours per week, plus reasonable additional hours of work.
• Right to request flexible working arrangements. Parents or carers and people over 55 years
of age or living with a disability may request a change in working arrangements,
such as changes to hours, job sharing and working from home. Employers can only
refuse on “reasonable business grounds”.
• Leave. Employees have the right to paid annual, sick and compassionate leave as
well as public holidays. They further have the right to unpaid parental, community
service and long service leave.
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Chapter 17: Labour Market Policies
• Casual conversion. Casual employees who have worked for their employer (excluding
small business) for more than 12 months must be offered the option to convert to
full-time or part-time employment.
In 2023, the Albanese Government introduced legislation to expand the NES to include
provisions relating to superannuation (the Superannuation Guarantee and protection from
underpayments) and up to 10 days’ paid leave for victims of domestic violence. These
were described as the most significant changes to the NES since the Fair Work Act came
into operation.
Minimum wages
The national minimum wage provides a safety net for any employee not covered by
an award. The Fair Work Commission Expert Panel conducts an Annual Wage Review
to set minimum wages (and award wages), which take effect from 1 July each year. The
Fair Work Act requires the panel to consider both economic and social objectives when
determining the minimum wage. This includes the performance of the national economy,
the macroeconomic impact of its decision, the impacts on businesses (who might be
discouraged from hiring additional employees) and the cost of living for households.
“Inflation is reducing the real value of these employees’ incomes and causing households
financial stress. We have also taken into account the recent robustness of the labour
market, and the fact that increases to modern award minimum wage rates will provide a
disproportionate benefit to female workers and may contribute to narrowing the aggregate
gender pay gap across the entire employee workforce.”
– Fair Work Commission Annual Wage Review Decision 2023
2 June 2023
In June 2023, the Fair Work Commission announced a two-tiered increase to wages in
Australia. The national minimum wage was increased by 8.6 per cent, from $21.38 per
hour to $23.23 per hour, or $882.80 per week. Other award pay rates were increased
by a slightly lower amount of 5.75 per cent, with a guaranteed minimum increase of
$40 per week.
This decision delivered the highest minimum wage increase since Australia’s centralised
wage system was established in the early 1980s. This was a response to inflation rising to
7.8 per cent in the March quarter of 2023.
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Awards
Awards establish the Awards are a set of pay and conditions that are specific to an employee’s work or industry
minimum wage and sector (such as the Airport Employees Award or the Gas Industry Award). Awards provide a
working conditions for safety net of minimum wages and conditions. Many employers pay above award wage rates,
employees based on
their industry.
but awards set the minimum rates of pay and entitlements. The Fair Work Commission
sets these minimum award wage rates.
In the past, awards were complex and comprehensive, sometimes relating to specific firms.
Under the Fair Work Act, Australia’s award system was restructured and streamlined from
around 4300 awards to 123 awards (although some state awards continue to operate). These
consolidated awards are sometimes known as modern awards. In the retail sector, one
of Australia’s largest industries, the Fair Work Act replaced 41 federal and state awards
totalling 2082 pages with just two awards totalling 76 pages.
Figure 17.3 shows that awards are an important part of the workplace relations system. The
number of employees covered by awards has grown in the past decade, reflecting the fact
that modern awards are often simpler for employers to use than negotiating enterprise or
individual agreements. One study estimated that a further one in five non-award employees
are employed on “over-award” arrangements – where awards form the basis of individual
or collective agreements, but those agreements add to the award conditions. This suggests
that in total, around 40 per cent of employees are on “award-based” arrangements.
2012 2021
Awards Awards
Working 16% Working 23%
business business
owners 3.3% owners 4.1%
Source: ABS Employee Earnings and Hours, Australia (Cat. no. 6306.0), accessed June 2023
Figure 17.3 – The national wage determination system, by types of employment contract
Modern awards extend the protections of the National Employment Standards, with provisions
tailored to the needs of a specific industry, occupation or enterprise. These may include types
of employment, arrangements for when work is performed, overtime and penalty rates,
annualised wage or salary arrangements, allowances, leave-related matters, superannuation
and procedures for consultation, representation and dispute settlement.
Further, modern awards (as well as enterprise agreements) must now include a clause that
allows for an individual flexibility agreement (IFA). This clause enables an individual
employee and employer to vary the effect of an award to meet their needs without negotiating
a separate agreement. The flexibility clause can only vary specific terms, such as when work is
performed, overtime rates, penalty rates and leave loading. The IFA must leave the employee
better off overall. Flexibility clauses can only be made after the employee has commenced
employment and cannot be offered as a condition of employment. Flexibility clauses allow
work arrangements to reflect the particular needs of firms and individuals, while preventing
employers from using flexibility arrangements to reduce pay and conditions. Research by the
Fair Work Commission in 2021 found that IFA usage is very low, but temporarily increased
during the pandemic.
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Enterprise agreements
The most common method of wage determination in the formal system is a workplace
agreement negotiated collectively between an employer (or employers) and employees,
usually represented by unions. These are known as enterprise agreements (known Enterprise agreement
elsewhere as collective agreements). The Fair Work Act introduced a right for employees is a collective workplace
to engage in enterprise bargaining with employers. Employers can be required to engage agreement that is
negotiated between an
in bargaining discussions if a majority of employees vote in favour of seeking a collective employer and a group
agreement. As figure 17.3 shows, 35 per cent of employees in the national system are of employees, usually
covered by enterprise agreements (down from 42 per cent in 2012), which is above the through a union.
average of 32 per cent coverage across OECD economies.
As a minimum, all agreements must comply with the National Employment Standards
and cannot offer pay rates below the equivalent award. Enterprise agreements must also
pass the “better off overall test” (BOOT), requiring employees be made better off overall
under the agreement compared to the applicable award. The BOOT also applies to any
individual flexibility agreement, a clause that can be negotiated as part of an enterprise
agreement. The Fair Work Commission administers the test.
Enterprise agreements usually cover all workers up to management level in a workplace.
Unions usually negotiate these agreements on behalf of all employees in a workplace, even
though only 12.5 per cent of Australian workers are union members. Collective agreements
normally cover issues such as wage increases, loadings for additional work hours, and
other changes that are intended to increase productivity. Wage increases under collective
agreements declined from an average of around 4 per cent (from 1991 to 2015) to 2.7 per
cent between 2015 and 2022. Changes that came into effect from 2023 have made it easier
for employees to negotiate multi-employer enterprise agreements, especially in sectors
that have had low levels of collective agreements. These changes also gave the Fair Work
Commission greater powers to determine outcomes (known as arbitration) where disputes
have become “intractable” (that is, there is no prospect of reaching an agreement).
Figure 17.4 – How the FWC distinguishes employees from independent contractors
reviewquestions
1 Identify the THREE main ways in which the wages and conditions of
Australia’s employees are determined.
2 Describe how minimum wages and conditions are determined.
3 Explain the difference between an enterprise agreement and an
individual agreement.
4 Explain how an employer can make an individual agreement with an employee.
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Chapter 17: Labour Market Policies
2002
2012
2022
1990
1994
2000
2020
1998
2004
2010
2008
2014
2018
1996
2006
2016
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Chapter 17: Labour Market Policies
reviewquestions
1 Describe TWO ways in which disputes between employers and employees
might be solved.
2 Explain how the role of industrial tribunals in dispute resolution has changed
in recent years.
Centralisation Decentralisation
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Chapter 17: Labour Market Policies
• Centralised wage determination can provide an additional policy tool for the
government to influence labour market outcomes and achieve economic policy goals
such as lowering inflation. For example, it could restrain wages growth to avoid
cost-push inflation, or trade-off a tax cut in exchange for lower wage increases.
While economists generally favour more flexible and decentralised wage
determination systems, as the OECD Employment Outlook highlighted in 2019, some
degree of centralisation allows governments to target labour market policies more
effectively, including retraining, improving skills, adopting new technology and
protecting employee rights.
reviewquestions
1 Explain the difference between a centralised and decentralised industrial
relations system.
2 Discuss the advantages and disadvantages of centralised and decentralised
wage determination systems.
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Several recent education and training programs and reforms have aimed to improve
workforce skills, increase job growth and raise productivity:
• The National Cabinet (which brings together Federal, State and Territory
governments) agreed on a National Skills Agreement in 2022, which included
funding for 300,000 additional fee-free TAFE and vocational education places.
• In 2023, the Government announced a partnership with universities to offer
28 “micro-credential” short courses to fill key skills gaps in the Australian labour
market. The courses include teaching, nursing, engineering and cyber security. To
encourage uptake of these courses, individuals can access the same scheme to defer
payment for their course as standard university degrees.
• Early childhood education standards have been increased and places have been
expanded to provide access for all children before starting school.
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Chapter 17: Labour Market Policies
• The 2023–24 Budget announced plans to increase paid parental leave from 18 to
20 weeks from 2023, rising to 26 weeks’ leave by 2026. This aims to sustain higher
levels of participation in the workforce, especially among women.
• Australian governments have substantially increased funding for childcare, both to
expand eligibility for subsidised care and to address shortages of skilled workers in
this sector. Increased availability of childcare makes it easier for parents to combine
work and caring responsibilities for young children.
• Reforms to the interaction of the tax and welfare systems, to reduce high “effective
marginal tax rates” (EMTRs). High EMTRs mean that for every extra dollar that
welfare recipients earn, they have to pay tax as well as lose a portion of their welfare
benefit, and this can undermine incentives to find paid work.
reviewquestions
1 Discuss the impact of increasing the quality of education on the labour market.
2 Identify TWO labour market policies that aim to reduce unemployment.
3 Explain why increased workforce participation is a priority for labour market
policy.
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eliminated old, outdated work practices. However, these were one-off gains from
reforms, and productivity growth has averaged just 0.6 per cent since the 2010s,
according to the ABS. Many other advanced economies have been experiencing
low productivity, and economists have differing views about the role of skills,
technology, research and development, and regulation in influencing productivity
outcomes. To the extent that workplace arrangements can influence future
productivity growth, in its recent 5-Year Productivity Inquiry, the Productivity
Commission questioned the effectiveness of the enterprise bargaining system.The
report cited evidence that bargaining objectives were mostly about wages growth
and minimising the risk of industrial action, not driving productivity growth. It
recommended that agreements ban the inclusion of clauses that limit productivity-
enhancing changes to technology, and that the Better Off Overall Test should be
made more flexible so that agreements could be made even if some workers were
worse off, provided “the benefits to winners are larger than the losses to losers”.
• Unemployment. Reforms to the wage determination system have provided
Australian workplaces with greater flexibility to adjust to fluctuations in the
business cycle. In overall terms, Australia has been successful in combining lower
unemployment with rising wages and productivity since the 1990s. In mid-2023,
One of the most surprising features of wage outcomes during the 2010s was that despite
low unemployment levels and persistent skills shortages, wage growth remained weak
throughout the decade. Figure 17.7 shows that throughout the 2010s, the Treasury
forecast an upturn in wages growth in Australia, but it never materialised. The average
national pay increase was just 2 per cent for the five years between 2015 and 2020, and
annual real wage growth fell to just 0.5 per cent.
In 2022–23, nominal wages grew substantially for the first time since the global financial
crisis, increasing 3.7 per cent in the year to March 2023. However, inflation outpaced
income growth, rising to a 30-year high of 7.8 per cent over the same period. This means
real wages fell 4.1 per cent. Economists debated whether wages growth should be kept
below inflation, to prevent locking in a higher inflation rate, or whether they should keep
pace with inflation, to preserve living standards for low- and middle-income earners.
Wage growth %
4.0
3.5
3.0
2.5
2.0
0.0
2024–25
2025–26
2011–12
2012–13
2013–14
2015–16
2016–17
2017–18
2018–19
2019–20
2020–21
2021–22
2022–23
2023–24
2014–15
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Chapter 17: Labour Market Policies
reviewquestions
1 Explain the relationship between the industrial relations system and
productivity outcomes.
2 Discuss the advantages and disadvantages of Australia’s shift to a
decentralised system of wage determination.
3 Analyse the impacts of industrial relations changes on employers and employees.
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chapter summary
1 While the Australian labour market has traditionally been governed by a combined
system of federal and state laws, since 2009 Australia has had a unified national
system for the private sector under the Fair Work Act, which directly determines
wage outcomes for around 7 in 10 Australian workers.
3 The National Employment Standards set out in law the minimum employment
entitlements of all Australian employees. They include maximum weekly hours of
work, annual leave, personal leave (including sick leave), parental leave, a right to
request flexible working arrangements if caring for a child, a requirement of notice
before termination and a right to redundancy pay.
4 Modern awards are a set of pay and conditions that are specific to an
employee’s work or industry sector, that provide a safety net of minimum wages
and conditions. They include flexibility clauses so that employers and employees
can vary the effect of an award.
6 Common law contracts are individual employment contracts that play a role
outside of the formal industrial relations system. They apply automatically and to
employees who have informal employment contracts that may provide above-
award conditions.
7 In recent decades, Australia has shifted from a system in which industrial tribunals
played the main role in dispute resolution to a system in which employers and
employees are largely responsible for resolving their own disputes.
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Chapter 17: Labour Market Policies
chapter review
1 Outline the main features of Australia’s national workplace relations framework.
4 Explain the role of the workplace relations system in influencing the level of
inflation in the economy.
5 Discuss how wage earners who do not have a workplace agreement can achieve
wage rises.
6 Describe how disputes between employers and employees are resolved under
Australia’s workplace relations system.
9 Discuss the arguments for and against increasing the use of individual contracts
within the labour market.
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18 Effectiveness
and Limitations
of Economic Policy
18.1 An overview of the effectiveness of economic management
18.2 Limitations of economic policy
18.3 Evaluating the effectiveness of economic policies
This chapter concludes our study of the Australian economy with a discussion of the
effectiveness and limitations of economic policies. This ties together some of the themes
of topic 3 and topic 4, as well as reviewing some aspects of the global economy from the
first half of the book that impact the effectiveness of economic policies.
As a starting point, we can evaluate the effectiveness of government policies against the
six objectives that were discussed in chapter 13:
1 economic growth and wellbeing
2 full employment
3 low inflation
4 external balance
5 an equitable distribution of income and wealth
6 environmental sustainability.
It is also important to consider the limitations of economic policy, including time lags,
political constraints and global influences. We conclude by outlining how to evaluate
specific policies, with reference to their objectives, implementation, and outcomes, and
provide a general overview of the effectiveness of macroeconomic and microeconomic
policies in Australia in recent decades.
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However, when there is spare capacity in the economy, the economy can sustain a higher
growth rate in the short to medium term (especially during recovery from a recession,
as was the case in 2021–22). Achieving this goal has required balancing the objectives
of stronger growth and lower unemployment against the objectives of keeping inflation
within the 2 to 3 per cent target range and maintaining external stability. The goal of
microeconomic policies has been to improve productivity and competitiveness, with
the outcome of achieving a higher level of economic growth over the longer term (that
is, lifting the sustainable rate of economic growth).
Australia’s most distinctive economic achievement in recent decades is that it sustained
the longest unbroken run of economic growth on record anywhere in the world, between
1991 and 2019, and that it recovered quickly from the COVID-19 recession. Australia’s
economic growth rate averaged 2.9 per cent during the growth cycle from 1991 to 2019,
significantly stronger than the average 2.1 per cent growth rate among OECD economies
during the same period. However in the second half of the 2010s it fell to just 2 per cent,
only fractionally above the OECD average, and Australia’s slowest growth rate for 60 years
on a per capita basis.
Australia ranks well on comparative measures for living conditions and economic
development. For example, Australia ranks fifth in the world on the Human Development
Index. Global investment bank Credit Suisse in its 2022 Global Wealth Report ranked
Australians first in the world by median adult wealth, with US$273,900. On the other
hand, while it is still among the top 20 countries, Australia’s ranking on the global
Prosperity Index fell in the decade to 2023 by three places to 15th. The Prosperity Index,
which is published annually by the Legatum Institute, ranks countries on the basis of a
range of statistical factors, including economic growth, education, health, governance,
human rights and environmental standards.
Australia’s economic outcomes indicate the improved effectiveness of economic policies
since the 1990s. Governments have managed the conflicts between economic policies
better, and have generally not been forced to sacrifice one macroeconomic objective for
another. This has been helped by reduced volatility in the economy, and governments have
been able to strike a balance between their goals for growth, inflation, unemployment and
external balance. In contrast, economic management in the 1970s and 1980s had been
characterised by constant tensions over whether priority should be given to maintaining
low inflation or reducing the level of unemployment, both of which remained high during
those two decades.
In part, Australia’s economic performance reflects more favourable external conditions than
those of most other economies. Australia has benefited from its rich endowment of natural
resources, which allowed it to take advantage of a historic rise in global commodity prices
and the rapid industrialisation of China. Australia’s terms of trade rose in the 2000s to
almost double their average during the last quarter of the century, and again surged as
the global economy emerged from the COVID-19 pandemic and as energy prices soared
after Russia’s invasion of Ukraine. Australia also benefits from strong population growth
(one of the highest rates in the OECD) with a migration program that focuses on skilled
migrants who increase the economy’s productive capacity.
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Australia in the Global Economy 2024
0.93 6
Denmark 0.948
Iceland 0.959
Ireland 0.945
5
0.92 United
4
Japan +
States + Indonesia + Brazil
3 + + + Canada
0.91
2 South
Korea
0.90 1 China
0 0 +
0 1 2 3 4 5 6 7 8 9 10 11 12
Source: hdr.undp.org Sources: OECD and IMF Unemployment (%)
growth (%)
8
5.3
7
Qatar
4.1
6
3.6
3.5
5 31.7
3.0
Kuwait
2.9
United States
2.8
Australia
2.2
4
2.1
Canada
World average
21.2 Germany
2
China
14.8
1
13.6 13.0
0 7.8
7.3
New Zealand
Brazil
United
Kingdom
United States
Advanced
economies
China
Euro area
Australia
Indonesia
India
4.3
of trade that underpinned export revenue, and high levels of workforce participation. On
the other hand, Australia’s growth rate has slowed in recent years (notwithstanding the
volatility caused by the COVID-19 pandemic). Governments aimed for a sustainable
growth rate of 3 to 4 per cent through the 1990s and into the 2000s, and more recently
have aimed for growth above 3 per cent. Australia’s slower growth (of 2.4 per cent) in the
2010s was below its long-term potential. After COVID-19, the long-term sustainable
growth rate had fallen to 2.5 per cent, reflecting Australia’s long-term trend of weak
productivity growth, and the absence of major new sources of growth or investment.
Australia’s inflation record since the early 1990s has been outstanding, notwithstanding
the global surge in inflation in 2022. After averaging 10 per cent during the 1970s
and 8 per cent during the 1980s, inflation has averaged around 2.5 per cent since
the introduction of inflation targeting in the early 1990s. This was a result of several
factors, including a clear and transparent framework for monetary policy, lower tariff
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Chapter 18: Effectiveness and Limitations of Economic Policy
barriers, increased competition across many industry sectors, price reductions resulting
from new technologies and cheaper imports, moderate wage outcomes and a period of
strong productivity growth in the 1990s. Even during the mining boom, which brought
about cost pressures and capacity constraints, Australia was successful in controlling
inflationary pressures, and inflation has fallen more quickly than in other countries after its
post-COVID-19 surge. Figure 18.1 shows Australia’s economic performance since 1990.
% %
12 12
Unemployment
Inflation
9 9
GDP (growth)
Current account
6 6
3 3
0 0
–3 –3
–6 –6
*Forecast
–9 –9
2022–23*
2023–24*
2024–25*
2000–01
2001–02
2002–03
2003–04
2004–05
2005–06
2006–07
2007–08
2008–09
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
2016–17
2017–18
2018–19
2019–20
2020–21
2021–22
1989–90
1990–91
1991–92
1992–93
1993–94
1994–95
1995–96
1996–97
1997–98
1998–99
1999–00
Year
Sources: ABS Australian Economic Indicators (Cat. no. 1350), Australian National Accounts (Cat. no. 5206), Balance of Payments
and International Investment Position (Cat. no. 5302), 2023–24 Budget *Forecasts
Australia’s labour market is generally regarded as having attained full employment during
recent years. The unemployment rate was around 3.5 per cent in 2023, its lowest level in
50 years. While Treasury forecasts pointed to unemployment rising to 4.5 per cent, this
was still lower than pre-pandemic levels of above 5 per cent. The strength of the labour
market is also reflected in lower levels of underemployment. After growing to above 9 per
cent in the 2010s, in 2023 it had fallen to just above 6 per cent.
Favourable external conditions have helped Australia to reduce its large external
imbalances. The structural improvement in the current account and net foreign liabilities
came about as a result of three major developments: China’s emergence as Australia’s
largest export market, a remarkable turnaround in Australia’s terms of trade and a long
period of record-low global interest rates. In the decade to 2020, the current account
deficit averaged around 2.3 per cent of GDP, compared with an average of 4 per cent in
the previous three decades. Official forecasts indicated that Australia would return to a
current account deficit in 2023–24, after four years of being in surplus. These surpluses
reflected a combination of strong export prices, a fall in overseas travel during COVID-19,
lower global interest rates during COVID-19 and a surge in energy prices following
Russia’s invasion of Ukraine. Despite an improvement in its external stability, Australia
still has a high level of foreign liabilities and remains vulnerable to adverse external
shocks, especially given its reliance on commodity exports and on China as its dominant
export market. Australia’s external imbalances nevertheless cause less concern now than
in previous decades, and the fact that most external debt is denominated in Australian
dollars reduces the economy’s risk exposure.
While Australia has managed shorter and medium-term risks, its greatest long-term
vulnerability may come from the impacts of climate change. Australia’s ecological
vulnerability has been demonstrated by natural disasters in recent years, including the
2022 floods in Queensland and northern NSW and the “Black Summer” bushfires that
burned 186,000 km2 of bushland across Australia in 2019–20. Agriculture, tourism and
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Australia in the Global Economy 2024
For many decades, the economic reform debate in advanced economies has been
dominated by the “Washington consensus” policies: reduced government intervention
in markets, deregulation, trade liberalisation and privatisation of public assets. Those
policies have been advocated by think tanks, business lobby groups and international
bodies such as the IMF and World Bank. No other organisation has championed those
policies more than the Organisation for Economic Cooperation and Development (OECD)
– an organisation that brings together many of the world’s leading economists to advise
on economic policy for advanced economies, and which has been a major influence on
Australian economic policy. Although the OECD never advocated a complete “laissez-
faire” approach of governments not intervening in free markets, it paid limited attention to
questions of inequality and focused strongly on increasing economic growth.
In the past decade, this has changed dramatically. The OECD now argues that its past
approach failed. The world has seen weak growth and increasing inequality in the decade
since the global financial crisis. In addition, there is a widespread backlash against
globalisation and growing resistance to open trade in many countries.
In recent years, the OECD has called for a major paradigm shift in economic policy around
the world. It is urging member countries such as Australia to focus on an agenda of
inclusive growth. This approach emphasises issues of income and wealth distribution and
economic opportunity, alongside growth. The inclusive growth agenda does not abandon
the OECD’s historic commitment to market-based mechanisms. But it requires a more
active long-term role for government in addressing the inequalities that now pose a growing
threat to the stability and social cohesion of many countries. Among other policies, the
OECD’s Inclusive Growth Initiative urges governments to:
• remove distortions in tax systems that are contributing to inequality (such as capital gains
tax concessions, loopholes exploited by multinational companies and the exclusion of
housing and inherited wealth from tax systems)
• invest in early childhood development programs (currently, a child born to parents who
did not complete high school has a 15 per cent chance of going to university, while there
is a 60 per cent chance for a child born with at least one parent who has a university
degree)
• support young firms and small and medium-sized enterprises by reducing the barriers
to entry to markets, encouraging research and development, and making it easier to
obtain finance.
regional economies are especially vulnerable to these impacts. Australia has a poor record
in preserving its biodiversity, protecting natural environments, managing scarce water
resources and overusing agricultural land. Australia has also made slower progress than
other economies in reducing its carbon emissions as one of the world’s highest emitters
of greenhouse gases per capita, with a heavy reliance on carbon-intensive fossil fuels for
both energy generation and export income. Political disagreements over the economic
policy response to climate change and frequent policy changes have also resulted in policy
uncertainty for the past 15 years, further complicating Australia’s pathway to reducing
emissions. Despite commitments to achieving net zero emissions by 2050, Australia
will face ongoing challenges in the decarbonisation process, such as shifting Australia’s
coal-dominated electricity market to renewable energy sources.
Another longer-term concern is that despite an unprecedented period of sustained
economic growth and falling unemployment, Australia has experienced an increase in
inequality in its distribution of income and wealth. Like other advanced economies,
Australia has experienced a shrinkage of middle-level jobs alongside growth in earnings at
the top end and an expansion of lower-paid service industry jobs. Rising property prices
have contributed to a widening gap in wealth inequality. A Productivity Commission
report in 2018 found that, while the evidence is mixed, in overall terms inequality has
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Chapter 18: Effectiveness and Limitations of Economic Policy
increased in the past three decades, with the fastest growth in income and wealth occurring
among the highest earners. A 2021 Productivity Commission report also highlighted
disparities between young and older people, which are exacerbated by the high cost of
housing in Australia.
The impact of rising inequality has been intensified by a decline in wage growth during
recent years. Since 2015, wage growth in Australia has been below the average for OECD
economies, following a long period in which Australians became accustomed to some of
the highest levels of real wage growth in the world. Together, slow wage growth and rising
inequality are contributing to some Australians feeling left behind by globalisation and
technological change. In addition, specific groups of Australians are disproportionately
affected by entrenched social disadvantage, including Indigenous Australians and people
who are excluded from the labour market.
reviewquestions
1 Discuss the extent to which the goals of economic management have been
achieved in Australia in recent years.
2 Assess the role of macroeconomic policies, microeconomic policies and
international factors in influencing Australia’s economic performance in recent
years.
Time lags
There are two types of time lags that can limit the effectiveness of economic policies.
Implementation time lags exist when it takes time for the government to make changes
to or introduce new economic policies. Impact time lags exist when it takes time for
a new policy or a policy change to have an impact on the economy. Both of these time
lags are summarised for different policies in figure 18.2. A change in monetary policy
can be implemented very quickly. Under changes effective from 2024, the Reserve Bank
holds eight scheduled meetings per year, usually towards the start of the month. The
outcome of the meeting is announced to financial markets at 2.30pm on the second day
of the meeting. In some extreme situations, however, the RBA Governor may be given the
discretion to change interest rates if conditions change during the period of time between
RBA meetings. Once the decision is announced, it has an immediate effect on the cash rate.
On the other hand, the implementation of fiscal policy can take a substantial amount of
time. Major changes to fiscal policy usually occur annually with the Budget. Substantial
changes to spending or revenue collection are mostly made at the time of the Budget,
although a government can also announce fiscal policy changes between budgets (in fact,
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the largest fiscal policy changes ever made, in response to the COVID-19 pandemic, were
announced outside of the normal budget cycle as emergency measures). Most spending and
revenue changes need to go through a complex process of budget committee meetings and
will be scrutinised by several government departments before being approved. The process
of developing each year’s Budget starts early in the year and runs for several months until
the Budget is finalised in May. It can then take several months for budget legislation to
pass through Parliament, and as discussed in more detail below, political constraints can
sometimes stop governments from implementing their budget proposals.
Similarly, changes to microeconomic policies can take a long period of time. This is
because of the planning and complex policymaking involved in microeconomic policies.
Microeconomic policy can also take a lot of time to implement if it is necessary to secure
the support of state governments as well as the Commonwealth. For example, introducing
a national energy policy, reforming Australia’s system for schools funding, implementing
uniform consumer protection laws and introducing a national disability insurance scheme
all required the support of the six states and two territory governments. The process of
negotiating these changes often takes a considerable time because of the different interests
of each state.
Policies can also take time to achieve their aims due to the differing time lags in their
impacts. Some policies will take effect in a relatively short time period – for example,
while it takes a long time to implement changes in fiscal policy, these changes can have
a quick effect on economic activity. A tax reduction can immediately affect income levels
or prices, and an increase in government spending can quickly affect economic conditions.
The impacts of shorter-term changes in the stance of fiscal policy can generally be seen
within a year. Fiscal policy therefore becomes more important during a downturn, as fiscal
policy’s shorter time lag in impacting the economy makes it the most effective policy to
achieve an immediate boost in aggregate demand. This was evident in the Government’s
rapid expansionary fiscal policy response to shocks such as the global pandemic in 2020
and the global financial crisis in 2008–09.
On the other hand, there is a time lag of up to 24 months for monetary policy changes
to have an impact on the economy. This is because it takes some time for changes in the
level of interest rates to feed through to changes in the borrowing and savings behaviour of
consumers and businesses. Part of the challenge for the Reserve Bank is to adjust monetary
policy pre-emptively, based on the future level of inflation and other economic conditions
that it expects in a year to 18 months’ time, to address this impact lag. The monetary
policy time lag has more recently lengthened from 18 months to as long as 24 months
because of the higher share of households on fixed-interest rate mortgages (which shot up
from around 20 per cent to around 40 per cent during the COVID-19 pandemic). This
means that for some households, interest rate increases in 2023 may not be felt until 2025.
The impacts of microeconomic policies can probably only be assessed after a period of
several years, and perhaps decades, if we are to get a fuller picture of the effectiveness of
these policies. The benefits of structural change can take several years to become apparent
as resources are reallocated from one sector to another, and the full effects of those changes
flow through to costs, business profits, export growth and productivity. In addition, it
can be difficult to accurately measure the impact of microeconomic policies since several
microeconomic policies might be implemented at the same time and it may be hard to
distinguish the impacts of one reform from another.
Political constraints
Economic policy decisions are made in a democratic context. Governments in Australia
are elected to represent the public, and often have specific election commitments that
they are responsible to deliver. Once elected, governments can face difficult trade-offs
in making decisions that are consistent with their commitments and compatible with
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Chapter 18: Effectiveness and Limitations of Economic Policy
economic conditions, and that will be passed through the Parliament. For example, the
Morrison Government was elected in 2019 with a commitment to sustain budget surpluses
but instead, due to the COVID-19 pandemic, delivered the largest budget deficits in
Australian history.
Governments must be sensitive to public opinion in developing and implementing
economic policies. Governments also consider whether a policy will be supported by
members of their own political party, and by other stakeholders, and whether that policy
might also be opposed by specific groups. Typically, governments implement longer-term
(and less popular) policies in the first year of the three-year term. In the year before an
election, governments can be reluctant to make unpopular decisions and are often under
pressure to implement policies that are popular with the electorate but may not have
long-term economic benefits.
The constraints on implementing unpopular policies are a major consideration for
economic management. Unpopularity has become the largest barrier to economic reform
in Australia in the past decade, according to a report in 2021 from the Grattan Institute
at Melbourne University. It has become less common for governments to implement
unpopular reforms to achieve long-term economic goals, as happened in 2012 with
the Gillard Government’s introduction of a carbon tax and in 2000 with the Howard
Government’s introduction of the Goods and Services Tax.
Governments can delegate authority for some decisions to independent government
agencies to minimise these political constraints. For example, the Reserve Bank makes
interest rate decisions and the Fair Work Commission decides on increases to the national
minimum wage and award wages. In addition, independent authorities approve pricing
decisions in regulated sectors like postal services and electricity prices. A government
responsible for making these decisions would be under political pressure to make
short-term, popular decisions, which might not be consistent with long-term economic
objectives.
Another aspect of the political constraints on government is the role of the Australian
Parliament, and especially the Senate. Many economic policies can only be implemented
through legislation, including budget measures, changes to the industrial relations system,
and changes to business laws. Under the Australian parliamentary system, legislation must
receive a majority of votes in both the House of Representatives (the Lower House) and the
Senate (the Upper House). Historically, it has been uncommon for a government to have a
majority in the Senate, and as a consequence governments have to make compromises to
win the support of other senators, from either the Opposition or minor parties, to pass the
proposed legislation. Elections in recent years have mostly led to very small majorities in
the House of Representatives, and neither party winning a majority in the Senate, which
has made it harder to implement changes.
In the May 2022 election, the Albanese Labor Government was elected with 77 out of
151 seats in the House of Representatives (a majority of just one), and only 26 of the 76
seats in the Senate. This means that to pass legislation, the Government has two options:
either secure support from the Opposition (the Liberal/National Coalition), which holds
32 seats, or from the Greens (who hold 12 votes) plus one of the six other Senators
(2 Lambie Network, 2 One Nation, 1 United Australia Party and 1 Independent). While
the Government was successful in having most of its election commitments approved in
the Senate, it was unable to secure a majority of votes for its plan to increase social housing,
involving the creation of the Housing Australia Future Fund. Some senators opposed
it for going too far, and another group of senators opposed it for not going far enough.
Combined, the two groups of senators were able to block the legislation.
Australia’s system of federalism can act as another political constraint on the Commonwealth
Government. The Commonwealth and state governments share responsibility for major
parts of the economy, including energy policy, the education system, health care, aged
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Australia in the Global Economy 2024
care, business regulation, and infrastructure such as roads. This means that to implement
major changes, the Commonwealth often must win the cooperation and agreement of
some or all of the states. The Commonwealth’s greater capacity to raise revenue means it
can offer financial incentives to achieve reform progress. For example, in August 2023,
the Albanese Government provided $3 billion to states and territories and $500 million
to local governments in return for planning reforms that would help achieve an increased
target of 1.2 million new homes built over the following five years.
When the Commonwealth and the states are unable to agree on a policy compromise,
the Commonwealth might try to impose changes on the states, a step that can lead
to lengthy constitutional challenges in the High Court. In 2006, for example, the
Commonwealth won a major constitutional case in which the states challenged its takeover
of their industrial relations powers. The High Court has generally favoured an expansive
interpretation of the power of the Commonwealth over the states in recent decades, but
the states still retain significant powers under the Australian Constitution.
Special
Voters interest groups
Federal
government State
The Senate governments
Special interest groups can also play an important role in government policymaking.
Often, political parties have strong relationships with supporters – business groups tend
to have significant influence on the policies of both major political parties, especially
the Coalition parties, while unions have a close relationship with the Labor Party. Large
businesses often employ lobbyists to influence government policies because of the potential
financial impacts of policy decisions on their activities. Interest groups are especially active
on the numerous policy debates relating to climate and energy policies, where coal, gas
and other fossil fuel interests are frequently in dispute with environmental and climate
organisations. Examples of recent policy debates include proposals to introduce a windfall
profits tax on the oil and gas industry, increase the royalties tax on Queensland’s resources
sector, lift Australia’s carbon emissions reduction targets, and allow for the building of
new coal mines.
Global influences
As the Australian economy has become more integrated with the global economy, global
factors have become a greater constraint on economic policy. The constraints imposed
by globalisation work at many levels. Conditions in the global economy have a more
immediate impact on Australia. Economies often face immediate consequences for economic
mismanagement, mainly through the reaction of financial markets. Governments also
voluntarily accept constraints on their own economic policy in order to win concessions from
other nations, such as through trade agreements.
In a global environment in which exchange rates and economies are vulnerable to sudden
shifts in financial flows, governments place a high priority on maintaining the confidence
of international investors and global financial markets. This has become particularly
important in recent years with global financial markets experiencing enormous volatility
following the global financial crisis and the pandemic. As we saw in chapter 5, foreign
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Chapter 18: Effectiveness and Limitations of Economic Policy
exchange markets tend to support policies that promote stronger trade and financial
linkages to the global economy, and support economic and financial stability. These
policies include:
• reduced government spending and reduced budget deficits Appendix B: Advanced
• low rates of corporate and capital gains taxes Economic Analysis at
• reduced trade barriers and openness to foreign investment the back of this textbook
looks at “crowding
• deregulation of the financial sector, including the removal of restrictions on out”, the twin deficits
international financial flows hypothesis and the
• deregulation across most areas of the economy, with the aim of increasing competition quantity theory of
• privatisation of government-owned businesses money – theories that
explain the limitations of
• deregulation of labour markets and better targeting of social welfare macroeconomic policies.
• trade agreements that give overseas businesses the power to take legal action
against national governments if policy changes undermine the profitability of their
investments.
Governments face constraints if they wish to adopt policies that differ from the generally
accepted formula for good economic management. Most advanced economies have adopted
a similar policy mix in recent years. Critics argue that global financial markets effectively
restrict the policy options available to governments, while others argue that financial
markets are effective in disciplining governments that might otherwise make bad policy
decisions. A government that adopts alternative policies may face a loss of foreign investor
confidence and a fall in their currency. For example, ratings agency Fitch took away the US
Government’s triple A credit rating in 2023, citing its political instability and the way that
political disputes in Congress had almost led to a default on the US Government’s debt.
Global financial flows and overseas interest rates can also directly influence the conduct
of monetary policy. If interest rates are rising in other countries, a country’s rate of return
will be relatively less attractive for overseas investors. This might result in an outflow of
funds and a depreciation in the currency, which in turn may add to inflation and undermine
confidence. In order to prevent this, governments will often adjust interest rates in response
to changes in other economies. For example in 2022, increases in Australian interest rates
mirrored rising global interest rates, as inflationary pressures rose across the world. Market
interest rates in Australia can also be directly affected by changes in overseas interest rates,
because Australian banks rely on borrowing from overseas to fund their loan portfolios.
The international business cycle can also restrict the scope of policymaking within
individual countries. It is difficult for a country to significantly increase its level of economic
growth if the global economy is in an economic downturn. Faster domestic growth will
cause an increase in imports while export growth weakens, resulting in a substantial increase
in the current account deficit. This can force the government to slow down the economy
through tighter fiscal and monetary policy, risking a more severe recession. This is one reason
why industrialised countries generally keep their economic growth in step with both the
international and regional business cycle.
Finally, international organisations can have a direct influence on domestic macroeconomic
and microeconomic policies. The World Trade Organization (WTO) can influence
individual trade policies because of its enforcement powers. On occasion, the WTO has
forced the Australian Government to change export assistance policies or Australia’s strict
quarantine regulations – such as when Australia was forced to abandon its ban on fresh
salmon imports from Canada. Other international forums can also influence economic
policymaking, such as the international pressure placed on Australia to step up its climate
change commitments ahead of the UN Climate Change Conference in Glasgow in 2021.
Decisions of the Group of Seven (G7) nations and the G20 group (see chapter 2) can
have a significant influence over the global economy and the domestic macroeconomic
policies of small countries such as Australia. The growing integration of economies through
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Australia in the Global Economy 2024
globalisation leaves limited scope for small countries to adopt a different macroeconomic
policy stance to that adopted by the major industrialised economies.
reviewquestions
1 Explain how time lags limit the effectiveness of economic policies.
2 Outline two major economic policy initiatives undertaken by the Government
during the past year, and for each:
•S
ummarise arguments for and against the initiative as raised by any special
interest group or the media.
•D
iscuss how the initiative may have been influenced by political factors.
3 Discuss how the separation of monetary policy decisions from the control
of the Commonwealth Government to the Reserve Bank might influence the
effectiveness of the policy mix in Australia.
4 Briefly discuss how global economic conditions have constrained or assisted
Australia’s economic performance in the past year.
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Chapter 18: Effectiveness and Limitations of Economic Policy
The next step to is ask whether other factors significantly affected the economic
outcome. Government economic policy is always at the mercy of other developments,
and economic policy is often just one of many factors that determines economic outcomes.
Economists often speak of policies being effective in terms of the Latin phrase “ceteris
paribus” – meaning “with everything else being the same” or effectively, “if nothing else
changes”. The problem in measuring the effectiveness of policies is that other things do
change. For example, per capita growth in greenhouse gas emissions fell in the years after
Australia abandoned the carbon tax in 2014. However, this was not because of the policy
change. Other factors had a larger effect, including reduced fossil fuel emissions given
the closure of large-scale manufacturing, oil refineries and aluminium smelters, reduced
household demand due to higher energy prices, and the rapid take-up of residential
solar power.
Some of the factors that might affect economic outcomes include:
• changes in global economic conditions or the economy of a major trading partner
• overseas interest rate movements
• a sharp movement in the value of the currency
• developments that might affect future expectations, such as a crisis in a particular
industry or region of the world
• changes in commodity prices and Australia’s terms of trade, such as a fall in oil
prices or a rise in iron ore prices
• developments in our natural environment, including droughts, floods, natural
disasters and pandemics
• industrial unrest, such as a dispute between a union and a major company
• new technologies or shifts in consumer preferences
• a shift in investor and consumer confidence relating to the economy, for example,
as a result of a downward adjustment in credit ratings.
The final question to be considered is whether a policy had any other consequences
or side effects. This is especially important to ask if there are signs that the policy was
reasonably effective in achieving its main aim. At this point, we might ask: at what price
was this achieved? Was another part of the economy badly affected by this policy? This
highlights the trade-off between policy objectives because of the conflicting objectives
of economic management. For example:
• There is a short-term trade-off between reducing inflation and reducing
unemployment. When inflation exceeds the Reserve Bank’s two to three per cent
target band, it may be necessary to raise interest rates to reduce inflation, typically
resulting in a short-term contraction in economic activity and increased cyclical
unemployment. It could be tempting for the Government to avoid taking action
against inflation using contractionary macroeconomic policy, particularly during
an election year. This is why the Reserve Bank operates independently from the
Government, to prevent political considerations from constraining the conduct of
monetary policy in achieving price stability. This trade-off came into focus in 2023,
with the new RBA Governor Michele Bullock saying unemployment has to rise to
return inflation back to target.
“The unemployment rate is expected to rise to 4.5 per cent by late 2024. While 4.5 per
cent is higher than the current rate, this outcome would still leave us below where it was
pre-pandemic and not far off some estimates of where the NAIRU might currently be …
Our goal is to return the labour market (and the market for goods and services) back to a
level more consistent with full employment – something like the endpoint in our forecasts.
We think this can be achieved if employment and the economy more generally grow at a
below-trend pace for a while. This would help to bring demand and supply into better balance
and give us the greatest chance of securing sustainable full employment into the future.”
– Michele Bullock, (then) Deputy RBA Governor, Speech to Ai Group, 20 June 2023
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Chapter 18: Effectiveness and Limitations of Economic Policy
Monetary policy has worked well since the early 1990s in managing the growth cycle and
achieving price stability. The inflation target has largely been achieved (notwithstanding
occasional periods of inflation outside the target, as has recently occurred) and Australia
has maintained stable economic growth.
Early 1990s: Expansionary fiscal and monetary policies were needed to bring about a
Expansionary gradual economic recovery.
Mid-1990s: Monetary and fiscal policy were both successfully tightened, addressing
Contractionary growing pressures on inflation and the current account by 1996.
Late-1990s: The macroeconomic policy mix changed as tighter fiscal policy was offset
Expansionary by looser monetary policy between 1996 and 1998, and interest rates
then began increasing to head off rising inflation rates with the introduction of
contractionary GST in 2000.
Early 2000s: As the global economy dipped into recession in 2001, Australia shifted to
Expansionary expansionary fiscal and monetary policies – with interest rates falling to their
lowest levels in 30 years – and avoided recession.
Mid-2000s: As the Australian economy returned to normal growth rates, both fiscal and
Contractionary monetary policy became less expansionary to avoid excessive growth and
increasing inflationary pressures from the boom in commodity prices. By
2007, monetary policy was contractionary.
2008–2009: With the onset of the global financial crisis in late 2008, policy settings
Strongly were reversed to provide a large expansionary stimulus for a weakening
expansionary economy. Interest rates were reduced to their lowest level in 50 years, and
the Government embarked on a massive fiscal stimulus to cushion Australia
from the full force of the recession.
2010–2019: As growth recovered, interest rates were returned to more neutral levels,
Neutral stance while fiscal policy became mildly contractionary. From 2012, mildly
contractionary fiscal policy was offset with expansionary monetary policy
where interest rates were reduced to record lows.
2020–2021: The COVID-19 recession prompted the most aggressively expansionary
Strongly macroeconomic policy settings in Australian history, with a record-level
expansionary deficit in 2020–21 and interest rates falling to their lowest on record.
2022–2023: With the economy in recovery, the task of fiscal consolidation and stabilising
Mildly debt re-emerged as a priority. Interest rates rose sharply as inflation surged
contractionary in Australia and globally.
The effectiveness of monetary policy relies on the overall policy mix. The main limitation
of monetary policy is that it is rarely effective when it is used on its own – it needs to be
supported by similar fiscal policy settings. It is not effective when it is working in the
opposite direction to fiscal policy, such as in 2008 when inflation had risen to 5 per cent, and
interest rates had to be increased further to counter the inflationary effect of income tax cuts.
The past three decades have also shown that monetary policy is more effective in
implementing contractionary macroeconomic policy than expansionary policy. During
periods of major economic downturn or an extended period of sub-par growth, low interest
rates are generally not enough to stimulate economic activity and lower unemployment.
In an effort to support economic growth after they had already reduced interest rates to
just above zero in response to the COVID-19 recession in 2020, central banks engaged
in more unconventional monetary policy measures such as purchasing government debt
(“asset purchase programs”) from the private sector, providing low-cost credit to the
banking sector and introducing a yield target for government bonds. The use of these
approaches demonstrates that conventional monetary policy can be ineffective in an
already low interest rate and inflation environment. Nevertheless, low interest rates can
play a supporting role to expansionary fiscal policy in boosting economic growth. This
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Australia in the Global Economy 2024
is because fiscal policy has a direct impact on aggregate demand, while monetary policy
relies on households and businesses responding to interest rate incentives.
“Flexible inflation targeting, and the RBA’s actions within this framework, have been
successful overall. The RBA has played a particularly critical role during crises, where it has
acted decisively and effectively to support the economy and protect against severe outcomes
… Flexible inflation targeting remains the best operational framework for monetary policy to
pursue the dual mandate of price stability and full employment.”
– Commonwealth of Australia (2023), An RBA Fit for the Future: Review of the Reserve
Bank of Australia, March 2023
The other main limitation of monetary policy is that it is a demand management policy –
that is, it can influence aggregate demand but not the structural (or supply-side) causes
of certain problems. During the inflation surge of 2022, the Reserve Bank highlighted
the fact that inflationary pressures were being driven by supply-side and overseas factors
– with the economy’s fast recovery from the pandemic contributing to choke points in
supply chains and labour shortages, while Russia’s invasion of Ukraine resulted in sharp
increases in food and energy prices. While higher interest rates can reduce demand pressures,
they do not deal with supply-side problems, and for that reason some economists saw the
steep increase in interest rates during 2022 and 2023 as excessive. Monetary policy can
also struggle with conflicting goals, especially in its impact on demand and asset prices.
Prior to the pandemic, the Reserve Bank noted the tension between raising interest rates
in order to curb a potentially dangerous housing price bubble and wanting to encourage
stronger economic growth. Monetary policy is a blunt policy instrument, and has limited
effectiveness if policymakers want to support growth in one sector or region of the economy
while restraining growth in another.
Monetary policy also cannot successfully address structural problems such as low productivity
growth, the transition to a less carbon-intensive economy or improving external balance.
In fact, even though monetary policy is intended to achieve low inflation, it can do little
to address inflationary pressures other than those driven by demand from consumers and
businesses. Raising interest rates to address other sources of inflation, such as a falling
currency, would be attempting to solve the inflation problem by attacking something other
than its real cause.
Monetary policy can also face an additional strain during periods of sustained economic
growth, because it is also the tool of last resort if wages are growing too quickly. In the
absence of an incomes policy that can control wage increases directly, the most effective tool
to limit inflation and wage rises is tighter monetary policy. In recent times, the RBA has
warned that wages growth must be accompanied by productivity improvements to ensure
that wages do not contribute to inflation.
Fiscal policy is the most effective policy to stimulate the economy and job creation during
a downturn, but it is less effective in slowing it down when the economy is overheating.
Australia’s fiscal responses to the COVID-19 recession in 2020 and the global financial
crisis in 2008 both proved successful in immediately strengthening aggregate demand
before the economy had slumped into recession. In 2009, Australia avoided recession
altogether, while in 2021, although Australia could not avoid recession, it staged a quick
recovery from the downturn. Fiscal policy was effective in strengthening growth on
both occasions with policy packages centred on supporting household incomes but also
including investment incentives, wage subsidies (in 2020), industry rescue packages, and
infrastructure investment.
Like monetary policy, fiscal policy also has its limitations. Expansionary fiscal policy
leads to increased budget deficits and higher public debt levels. In an environment where
an economy is growing, it can draw savings away from private investment. Economists
generally agree that sustained higher budget deficits over the longer term can contribute
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Chapter 18: Effectiveness and Limitations of Economic Policy
to higher long-term interest rates, lower national savings and an increased current account
deficit. One of the longer-term concerns about the increases in public debt resulting from
the COVID-19 recession is that it could take decades to pay off the debt, and higher
interest rates in the future could make these debt levels a heavier burden on budgets.
“Australia’s economic recovery from the pandemic has been world leading, however to
ensure Australians continue to enjoy higher living standards, we need to continue to focus
on the task of lifting productivity …
Given the scale and nature of the economic shock caused by the COVID-19 pandemic, it is
expected to have an enduring impact on Australia’s productivity challenge. The acceleration
in the uptake of technology by business and individuals has stimulated growth in remote
work, online commerce, businesses’ digital presence and innovative delivery of public
services like health and education. The pandemic has affected business models in some key
sectors and underscored the need for labour mobility across the economy.
In this environment, Australia needs policy settings that foster a flexible and dynamic
economy, that is able to adapt in the face of economic challenges and opportunities. Policy
settings should encourage the economy to adapt to the growing importance of digital
technologies, including through developing a skilled labour force. They must also be forward
looking and support an environment that promotes economic dynamism, entrepreneurship
and appropriate risk-taking, and innovation and technological adoption.”
– Productivity Commission, 5-year Productivity Inquiry: Advancing Prosperity, 2023
In the broadest sense, the Government’s macroeconomic policy mix was successful
in sustaining 28 years of economic growth in which Australia progressively reduced
unemployment, kept inflation low and enjoyed rising living standards. There was no
realistic way that the policy mix could have saved the economy from recession in 2020,
given the severe economic effect of lockdowns that imposed a shutdown on several sectors
of economic activity. Australia recovered relatively quickly from the pandemic recession
although, like other economies, macroeconomic policy then confronted a surge in inflation.
The deeper problems of low productivity growth and the need to reduce the carbon
intensity of the Australian economy point to the greatest limitation of macroeconomic
policies – addressing structural problems.
Microeconomic management
Australia’s extensive microeconomic reforms since the 1980s are generally regarded
as a success. Microeconomic policy has made it possible for the economy to avoid the
boom/bust cycle and sustain growth, with improved living standards and reduced
unemployment. The Australian economy has become more internationally competitive,
and inflationary pressures have been contained. Australia’s economy is generally regarded
as one of the world’s more open and successful economies, despite our geographic isolation
from the major centres of the global economy.
Some economists have criticised the lack of ongoing microeconomic reform in the past
two decades. Compared with the rapid pace of micro reform in the 1990s – when
governments implemented national competition policy, enterprise bargaining, major
industry deregulation, accelerated tariff cuts and the introduction of the GST – For discussion of the recent
conduct of monetary policy,
microeconomic reform has moved slowly in recent decades. To some extent, this is
visit the Reserve Bank website
inevitable since many of the reforms of the 1990s involved once-off structural changes www.rba.gov.au and view
that could not be repeated. Nevertheless, the OECD and economic agencies, such as the the speeches section. In
Treasury and the Productivity Commission, have argued that more needs to be done to particular, look at the Hansard
accelerate microeconomic reform. For example, in its 5-Year Productivity Inquiry in 2023, transcript of the Governor’s
parliamentary testimony given
the Productivity Commission outlined 71 specific recommendations for policy change,
every six months (around
many of which were microeconomic reforms. The reforms included increasing flexibility February and August).
in workplace agreement making, streamlining planning and zoning laws, charging vehicles
for road use, removing anti-competitive regulations on the ownership and location of
pharmacies, and reforming the tax system.
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Australia in the Global Economy 2024
Critics argue that despite Australia’s relatively successful economic performance, the
economy has structural weaknesses. They make the case that Australia has become too
reliant on its resources exports to China and other developing economies. Productivity
Commission analysis found that in the decade to 2020, Australia’s labour productivity
growth had slowed to the lowest rate in over 60 years. Despite improving labour market
conditions, a significant number of working-age Australians remain either unemployed,
underemployed or outside the labour force. Australia has lacked a clear, consistent
economic policy response to climate change and has adopted expensive and often ineffective
policies. Australia’s ranking on competitiveness has also slipped (for example, falling
from 4th in 2004 to 19th in the 2023 World Competitiveness Yearbook). Australia also faces
significant looming challenges, including climate change, an ageing population, declining
workforce participation and the risk of a sustained slowdown in China. All these factors
underline the need for continued microeconomic reform, diversification of the economy
and investments in education, early childhood programs and infrastructure to underpin
future productivity growth.
In the longer term, the success or failure of Australia’s policy mix will be measured by
our capacity to restore and sustain growth, employment and living standards, while
preparing for the far-reaching disruptive effects of climate change and water shortages,
distributing the rewards of economic growth more equitably and achieving a sustainable
position on the external accounts. The Government acknowledged the need for broader
measures of the effectiveness of policy in 2023, with its “Measuring What Matters”
statement. It adopted 50 indicators to measure progress across the themes of a healthy,
secure, sustainable, cohesive and prosperous Australia.
The effectiveness of economic policies cannot ultimately be judged by reference to economic
outcomes alone. Economic policies affect the kind of society we live in and how we lead our
lives. Critical questions confront economic policymakers in the 2020s. Does an increase in
GDP result in an increase in people’s wellbeing and happiness? Should measures of wellbeing
play a greater role in policymaking? Do we have a responsibility to future generations to act
with more urgency in reducing our carbon emissions and slowing down our consumption
of non-renewable resources? Is it fair that one person who grows up in a poor family has
far fewer opportunities than someone who grows up in a prosperous family? Is it fair that
Australians enjoy such good living standards compared to other nations when so many
people are dying of easily preventable diseases in developing countries? These are more than
just technical economic issues. They are choices that go to our values as a nation, and what
we think is important in life – and answering these questions requires us to go beyond an
economics textbook.
reviewquestions
1 Identify TWO major global events in recent years and explain how they have
influenced Australian economic policy.
2 Describe an example of a recent government policy that illustrates the
conflicts in economic policy objectives.
3 Critically analyse which economic policy instruments have been most effective
in recent years in achieving their goals.
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Chapter 18: Effectiveness and Limitations of Economic Policy
chapter summary
1 Since the early 1990s, the main goal of the economic policy mix has been to
achieve the maximum sustainable economic growth rate in the short to
medium term (through macroeconomic policies), while implementing policies that
will raise the long-term sustainable growth rate (through microeconomic policies).
In overall terms, this policy mix has been reasonably successful.
3 Economic policies can differ in the time lag involved before they impact the
economy. While fiscal policy changes such as tax cuts can have an immediate
impact on the economy, monetary policy changes take up to 24 months to have
their full impact and the impacts of microeconomic reforms can take many years.
4 In the short term, the main global influences on the Australian economy are the
international business cycle, overseas interest rates, financial market conditions
and commodity prices.
5 In the long term, the Australian economy is influenced by global trends in
economic management. Examples include the shift away from government
intervention to deregulation and privatisation in the 1980s, the adoption of
inflation targeting in the 1990s, and policies to reduce carbon emissions.
10 Governments often face a trade-off between the goals of equity and efficiency
in economic management. Inclusive growth policies aim to overcome this trade-off
by simultaneously supporting growth and reducing economic inequality.
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Australia in the Global Economy 2024
chapter review
1 Identify which economic objectives have had the highest priority in recent years.
2 Explain to what extent time lags affect the operation of monetary, fiscal and
microeconomic policies.
3 Explain two ways in which global influences affect the conduct of economic
management in Australia.
4 Discuss how a major downturn in the global economy might affect the key
economic indicators in Australia.
7 Identify a policy objective that has been achieved during recent years and explain
the factors contributing to that success.
8 Discuss the relationship between economic growth and increased inequality in the
distribution of income and wealth.
10 Critically evaluate the extent to which equity and environmental outcomes have
been sacrificed to achieve other economic objectives in recent years.
374
appendix A
Key Economic
Skills
A.1 Introduction
A.2 Drawing and interpreting economics diagrams
A.3 Equations and calculations in economics
A.4 Interpreting economic data and information
A.1 Introduction
Economics is a subject that requires you to understand the relationships between different
economic indicators, such as trade flows, exchange rates, unemployment and interest
rates, and the role of different actors in the economy such as transnational corporations,
international organisations, and government agencies. It is a mix of social science, with an
emphasis on human activities, and scientific analysis, where we can test our theories of how
economies operate by analysing the relationships between different economic indicators.
Throughout the 18 chapters of this textbook, you’ve probably found that one of the most
challenging aspects of economics is that it is neither a “writing” subject nor a “numbers”
subject, but a unique blend of both qualitative and quantitative analysis. In the Year 12
exam, the expected length for each extended response is 800 words, although you will
not be penalised for writing more. This is the same as for other courses such as Business
Studies and Geography.
For further Studying economics is not simply about memorising a lot of information. You must
information on skills also learn a range of skills to understand how modern economies function, and predict
and assessment how changes in one part of the economy can affect other parts. For this reason, applying
in Economics or economic skills is central to the Year 12 Economics Course. Each topic of the course
a full copy of the contains between 3 and 8 skills, and there are 23 skills in total for the whole course.
Economics Syllabus,
visit the website of It is best to learn economic skills as you learn the content of the course. For this reason,
the NSW Education
each of the economic skills is listed at the beginning of each topic area in this textbook,
Standards Authority
and the skills are incorporated into the chapter material. The aim of this section is to
reinforce your grasp of economic skills because of the crucial role that these skills play
in economic analysis for the Year 12 Course.
375
appendix A Australia in the Global Economy 2024
YEAR 12
COURSE
TOPIC SYLLABUS SKILLS
Economic • identify and analyse problems facing contemporary and hypothetical economies
Issues • calculate an equilibrium position for an economy using leakages and injections
• determine the impact of the (simple) multiplier effect on national income
• explain the implications of the multiplier for fluctuations in the level of economic
activity in an economy
• calculate the unemployment rate and the participation rate using labour force
statistics
• interpret a Lorenz curve and a Gini coefficient for the distribution of income in
an economy
• use economic concepts to analyse a contemporary environmental issue
• assess the key problems and issues facing the Australian economy
Economics Stage 6 Syllabus 2009 extracts © NSW Education Standards Authority for and on behalf of the Crown in right
of the State of New South Wales, 2009.
376
appendix A
Appendix A: Key Economic Skills
Knowledge and understanding of course content is worth 40 per cent of Year 12 assessment. The other 60
per cent is divided equally between three other components – each of which you can strengthen with the
material in this chapter: stimulus-based skills (20 per cent); inquiry and research (20 per cent); and communication
of economic information, ideas and issues in appropriate forms (20 per cent).
The course skills can be divided into three main areas:
• drawing and interpreting economics diagrams
• equations and calculations in economics
• interpreting economic data and information.
377
appendix A Australia in the Global Economy 2024
Exchange rate:
Price of A$ in terms of US$
D S
S D
0 Q1 Q2
Quantity A$
378
appendix A
Appendix A: Key Economic Skills
Analyse the impact of changes in the Interpret a Lorenz curve and a Gini
components of the balance of payments on coefficient for the distribution of income in
the value of the Australian dollar an economy
The balance of payments comprises the current The Lorenz curve shows us the cumulative
account, and the capital and financial account. proportion of income that is received (vertical axis)
Any credit on the balance of payments, such by the cumulative proportion of income recipients
as an increase in exports, increase in primary (horizontal axis). If income were distributed evenly
or secondary income received, or an increase in across the whole population, the Lorenz curve
capital or financial inflow, will increase demand would be the diagonal line through the origin of
for the Australian dollar, causing an appreciation. the graph. The further the Lorenz curve is away
Alternatively, any debit on the balance of payments, from this line, the greater the degree of income
such as an increase in imports, increase in primary inequality in society.
or secondary income payments, or an increase in
capital or financial outflow, will increase the supply 100 Y
D2
The Gini coefficient is a single statistic that
summarises the distribution of income across
S D1 the population, calculated as the ratio of the area
0
Quantity A$
between the actual Lorenz curve and the line
of equality (area A in figure A.9) and the total
area under the line of equality (A+B). The Gini
Figure A.7 – An increase in demand and appreciation
of the Australian dollar
coefficient ranges between zero when all incomes
are equal, and one when a single individual receives
all the income. The smaller the Gini coefficient,
Exchange rate:
Price of A$ in terms of US$ the more even is the distribution of income.
D
S1 A
Gini coefficient =
A+B
S2
80c
379
appendix A Australia in the Global Economy 2024
The society’s supply curve is above the producer’s The government may also face a trade-off in its
supply curve. The socially optimum price is above goals of full employment and a fair distribution
the market price and the socially optimum quantity of income. If the government imposes a minimum
is below the market quantity. wage rate above the market clearing wage level,
such as W1 in figure A.12, it may reduce the
Price ($) S (social cost)
level of income inequality between workers, but
S (private cost)
may also see some workers remain unemployed
ps (LS – LD) if the real wage rate is too high to achieve
pm equilibrium in the labour market.
D Wage level
D S
qs qm Quantity unemployment
Where: pm = market price W1
ps = socially optimum price
qm = market quantity We E
qs = socially optimum quantity
Governments face many trade-offs when trying Figure A.12 – High minimum wages may cause
to simultaneously achieve their economic and unemployment
other policy objectives, not all of which can be
demonstrated by the use of diagrams. The best The government may also face a trade-off between
known diagram that shows these conflicts is the its short-term objective of economic growth and
Phillips curve diagram, which demonstrates, in its longer-term objective of ecologically sustainable
the short term at least, that governments face development. If economic growth is unsustainable
a choice between achieving their goal of price because of poor production techniques or the rapid
stability (low inflation) or full employment (low depletion of natural resources, it may over time
unemployment) (see figure A.11). Implementing reduce the productive capacity of the economy.
expansionary macroeconomic policy is likely to see This can be shown by a production possibilities
the economy move up the curve to the left (with curve moving towards the origin because fewer
lower unemployment but higher inflation), while goods and services can be produced.
contractionary macroeconomic policy settings may
see the economy move down the curve to the right Primary
(with lower inflation but higher unemployment). goods
Now
Inflation (%)
Future
0 Manufactured
goods
380
appendix A
Appendix A: Key Economic Skills
Explain the impact of key economic policies Expansionary macroeconomic policy (such as a
on an economy reduction in interest rates, a reduction in taxation
No single diagram will show all of the economic or an increase in government spending) increases
effects of any single policy. Here are some suggestions aggregate demand, shifting the AD curve to the
of how diagrams explained in this section could be right (see figure A.14). At the new equilibrium,
used to illustrate the impacts of key economic total output and income have increased, so
policies on particular economic indicators: unemployment will fall, and there is a rise in the
general price level (higher inflation).
• The general impacts on output and price
levels of macroeconomic and microeconomic General price level
policies can be demonstrated using the AD AD1 AS
P1
Explain using economic theory the
general effects of macroeconomic and AS
microeconomic policies on an economy
AD1 AD
The aggregate supply and aggregate demand
0 Y1 Y
diagram (known as the AS-AD diagram) can Total output
be used to show the impacts of changes in
macroeconomic policy, also known as demand- Figure A.15 – Contractionary macroeconomic policy
management policy, and microeconomic policy, also shifts AD to the left, causing a fall in output and
inflation
know as supply-side policy. The AS-AD diagram
graphs the impacts of changes in aggregate demand
and supply on the general price level and the total
output (or income) of the economy.
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appendix A Australia in the Global Economy 2024
AS
AS1 AD
0 Y Y1
Total output
382
appendix A
Appendix A: Key Economic Skills
Note: If you are given a question and you are It is a good idea to become very familiar with the
provided with or need to calculate the level of various combinations of these equations that can be
consumption (C), aggregate demand (AD), or used to calculate the values of economic indicators.
income (Y, also known as aggregate supply), the
leakage/injection equation will not help because C, etermine the impact of the (simple) multiplier
D
effect on national income
AD and Y are not in that equation. In this case you
need two other equations – those for aggregate Explain the implications of the multiplier for
fluctuations in the level of economic activity in
demand and aggregate supply. The equation for an economy
aggregate demand is consumption plus investment
se (simple) multiplier analysis to explain how
U
plus government spending plus “net exports”. The governments can solve economic problems
equation for aggregate supply (income) is
consumption plus savings plus taxation. Both the The multiplier shows that if equilibrium in the
AD and AS equations are identities, in that they circular flow is disrupted by an injection or leakage,
are always true regardless of whether the economy it will have a more than proportional impact on
is in equilibrium or disequilibrium. If you set AD national income. An injection of export revenue
and AS equal to each other, that is, for equilibrium, to businesses, for example, initially results in a
a simple substitution and rearrangement of the proportional increase in income for individuals. When
equation gives the leakage and injection equation. individuals spend this income on consumption, it
further boosts firm revenue and individual income
AD = C + I + G + (X – M) – multiplying the effect of the export injection.
Where: However, the increase in individual income will also
increase individuals’ savings, taxation payments and
AD = aggregate demand spending on imports (which are all leakages). These
C = consumer spending by households all reduce the “speed” of the multiplier.
I = investment spending by businesses
For the Year 12 Course, we limit our concern to the
G = government spending “simple” multiplier, which only takes into account
X = export revenue the savings leakage. The multiplier is calculated
M = spending on imports
as 1 divided by the “speed limit” – the marginal
propensity to save. To calculate the total impact on
national income of an injection or leakage, multiply
Y = C + S +T the initial change in the injection or leakage (the
Where:
change in aggregate demand) by the multiplier.
Y = aggregate supply or national income
C = consumer spending by households
S = saving by households
T = taxation by the government
383
appendix A Australia in the Global Economy 2024
384
appendix A
Appendix A: Key Economic Skills
financial flows, and identifying who and what are Evaluate the impact of development
the most important drivers of global economic strategies used in a range of
flows. Most major international organisations have contemporary and hypothetical situations
their own statistical databases and key economic One of the most complex tasks faced by economists
publications. is assessing whether or not development strategies in
Useful research terms: individual economics have been successful. A central
requirement in the Year 12 Course is that you must
• Trends in global interdependence
undertake a case study of an economy other than
• Drivers of trade and financial flows Australia.
• Changing pace of globalisation
Useful research terms:
Key data sources:
• Economic development strategies
• World Bank – World Development Indicators
• Economic performance
• World Trade Organization – World Trade Report
• Issues with economic development
• United Nations Conference on Trade and
Key data sources:
Development – Trade and Development Report
and World Investment Report • The Economist
• International Monetary Fund – World Economic • United Nations Development Programme
Outlook • United Nations Conference on Trade and
Development
Assess the impact on the global economy • OECD
of international organisations and
contemporary trading bloc agreements • Centre for Global Development
385
appendix A Australia in the Global Economy 2024
Identify and analyse problems facing • Private sector organisations such as commer
contemporary and hypothetical cial banks and financial services companies are
economies good sources for up-to-date and market-oriented
Assess the key problems and issues commentary about Australia’s economic policy
facing the Australian economy and performance.
Identify limitations of the effectiveness of • Economic media sources such as the Australian
economic policies Financial Review and Analysis and Policy
Propose and evaluate alternative policies Observatory have some of the most concise
to address an economic problem in and up-to-date commentary on Australian
hypothetical and the contemporary economic issues and policies.
Australian contexts
• Think tanks, industry associations, trade
Select an appropriate policy mix to unions and community organisations often
address a specific economic problem focus on a small number of economic issues,
These final five economic skills are of a general and can have highly relevant commentary for
nature, covering the second half of the Course – some parts of the Course. Examples include
Topic 3 Economic Issues and Topic 4 Economic The Australia Institute, the Australian Industry
Policies and Management. Interpreting economic Group, the Business Council of Australia, the
data and information for these skills is a potentially Committee for the Economic Develop ment
endless job. So instead of limiting you to a few of Australia, the Australian Council of Trade
websites, we would recommend you consult widely Unions and the Australian Council of Social
from a range of sources. In visiting some of the Service.
following websites, you should be able to explain,
If you still haven’t had enough of economics, check
using statistics and other evidence, the key features
out some of the following:
of economic problems and how government policies
are (or could) addressing these problems. • Weekly economic analysis by Ross Gittins
• Government agencies like the Australian • Pannell Discussions – Professor David Pannell’s
Bureau of Statistics, the Reserve Bank, the blog on economics, environment and policy
Productivity Commission and the Australian • Paul Krugman’s New York Times blog – blog of
Competition and Consumer Commission, and one of the world’s leading economic
Government departments like Treasury and commentators
Foreign Affairs and Trade all publish statistics
and analysis of Australian economic problems
and policies.
• Research bodies like the National Centre
for Social and Economic Modelling and the
Melbourne Institute (attached to universities),
the Grattan Institute (independent), and the
Economic Society of Australia and Australian
Business Economists (professional associations)
publish more specialised (and more difficult to
understand) economic papers.
386
appendix B
Appendix B: Advanced Economic Analysis
Advanced Economic
Analysis ... for students who want
to take their understanding
The analysis in this to the next level.
section is not specifically
required by the Year 12
B.1 Comparative advantage and gains from trade Economics syllabus and
is intended as an
B.2 Income-expenditure diagram extension ...
B.3 Long-run Phillips curve
B.4 Limitations of macroeconomic policy
387
appendix B Australia in the Global Economy 2024
However, the theory of absolute advantage is not within each economy. We first determine which
a sufficient basis for global free trade. It suggests economy has a comparative advantage in grapes.
that countries that are unable to produce any To do so, we must calculate the opportunity cost
product with an absolute advantage (perhaps due of growing grapes in Australia and then in France.
to a lower skilled labour force or poor production
In Australia:
techniques) have no basis for trade.
Opportunity Cheese
Comparative advantage =
cost of grapes Grapes
The theory that best illustrates the benefits of 100
=
free trade is comparative advantage, which was 300
developed by another British economist, David = 1
tonnes of cheese
3
Ricardo, writing almost half a century after
Adam Smith.
In France:
Comparative advantage states that an economy Cheese
Opportunity =
should specialise in the production of goods and cost of grapes Grapes
services that it can produce at a lower opportunity
300
cost, even if it cannot produce a greater quantity =
400
than another economy. Comparative advantage is 3
focused on the relative efficiencies of production. = 4 tonnes of cheese
When an economy specialises in production of a
good in which it has a comparative advantage, it For Australia to produce an additional tonne of
can trade with other economies using the income grapes it must give up production of one-third of
from its exports to pay for imports of products in a tonne of cheese, whereas France must give up
which it does not have a comparative advantage. three-quarters of a tonne of cheese. Since Australia
had to give up fewer resources to produce grapes,
The theory of comparative advantage can be Australia has a comparative advantage in grapes.
illustrated using a simple model with a few
assumptions. There are two economies, Australia We will now determine which economy has a
and France, which produce two products, grapes comparative advantage in cheese. As we did before,
and cheese, of identical quality and each economy we calculate the opportunity costs of making
has the same resource endowment. Each economy cheese in Australia and then in France.
has a different set of production techniques, which In Australia:
leads to different output quantities. In the example
in figure B.1, Australia can produce a maximum of Opportunity Grapes
=
cost of cheese Cheese
300 tonnes of grapes or a maximum of 100 tonnes
of cheese. France can produce a maximum of 400 300
=
tonnes of grapes or 300 tonnes of cheese. 100
= 3 tonnes of grapes
Grapes Cheese
(tonnes) (tonnes) In France:
Australia 300 100
Opportunity Grapes
=
France 400 300 cost of cheese Cheese
400
Figure B.1 – A simple two-good two-economy model
=
300
= 113 tonnes of grapes
In the example above, France has the absolute
advantage in the production of both grapes and
cheese since with the same level of inputs it can For Australia to produce one additional tonne of
produce a greater quantity of each compared with cheese it must give up producing three tonnes
Australia. Under the theory of absolute advantage of grapes, whereas France must give up only one
there is no basis for trade between the countries. and a third tonnes. Since France had to give up
fewer resources to produce cheese, France has a
To determine which economy has a comparative comparative advantage in cheese.
advantage we must calculate the opportunity costs
388
appendix B
Appendix B: Advanced Economic Analysis
You will notice from the previous example or 100 tonnes of cheese and France could produce
that it is impossible for one economy to have 400 tonnes of grapes or 300 tonnes of cheese. These
a comparative advantage in both products. If production possibilities are shown in the production
one economy is relatively better at producing possibility curves (unbroken lines) in figure B.2.
one product, then it must be relatively worse at
producing the other. To calculate gains from trade we must now also
consider the prices of the two products. Let
Following the theory of comparative advantage, us suppose that cheese is twice as expensive as
Australia ought to specialise in the production grapes – that is, one tonne of cheese will purchase
of grapes and import cheese from France. France two tonnes of grapes or one tonne of grapes will
ought to specialise in the production of cheese and buy half a tonne of cheese.
import grapes from Australia.
Australia begins by producing 300 tonnes of
Ordinarily, the level of consumption within an grapes. It exports some of its produce. For each
economy is limited by its production possibilities tonne of grapes that Australia exports it is able to
curve. In a closed economy (one which does not import half a tonne of cheese. If Australia exports
trade), the economy will consume all that it all of its grapes, it will be able to import a total of
produces. In the Preliminary Economics Course 150 tonnes of cheese. This is illustrated graphically
we saw that if an economy is at full employment in Australia’s consumption possibilities curve
of resources, it cannot produce on a point outside (the broken line in figure B.2). The consumption
the production possibilities curve. The only way to possibilities curve begins at the country’s point of
increase production levels is to improve production specialisation (in this case, 300 tonnes of grapes) and
methods or discover new resources. extends out to the maximum number of imports the
country can afford (150 tonnes of cheese).
However, an economy is able to consume at
a point above its production possibility curve Similarly, imagine France begins by producing 300
through international trade. By specialising in tonnes of cheese. It exports some of its produce.
the production of goods and services in which the For each tonne of cheese it exports, it is able to
economy has a comparative advantage and trading import two tonnes of grapes. If France wants to
with another economy, there will be a greater purchase all of Australia’s grapes, it only has to sell
amount of goods and services available in the 150 tonnes of cheese. This is illustrated in France’s
global economy, allowing for higher consumption consumption possibilities curve.
in each economy.
Notice that in figure B.2 for each economy the
Gains from trade consumption possibilities curve is higher than
To examine the gains from trade we return to our the production possibilities curve, allowing each
example where Australia was specialising in grapes economy to consume a greater quantity than it
and France was specialising in cheese. Remember could without trade.
that Australia could produce 300 tonnes of grapes
France’s production
Production possibilities curve
300 for France
50 Australia’s
production
0
0 50 100 150 200 250 300 350 400
Grapes (tonnes)
389
appendix B Australia in the Global Economy 2024
The actual consumption combination will be possibilities curve, and so France will continue
determined by consumer demand within each to trade with Australia so long as the gains from
economy. Suppose, for example, that given the trade exist.
price of cheese, Australia sells 150 tonnes of grapes
to buy 75 tonnes of cheese. Australia will consume The theory of comparative advantage provides a
at point A on its consumption possibilities curve, powerful argument in favour of free trade. Not
and is able to consume 25 more tonnes of cheese only will firms benefit from increased levels of
than it could produce itself. France sells 75 tonnes output, but overall levels of consumption can rise
of cheese and purchases 150 tonnes of grapes, throughout the world, improving the standards of
consuming at point F, also above what it could living for millions of people in absolute poverty,
have produced itself. and overcoming some of the limits imposed by
the natural scarcities within individual countries.
Terms of trade
This does not mean, however, that the arguments
The consumption possibilities curve is determined supporting protection (examined in section 2.2) are
by the terms of trade, which measures the price all invalid or that continued use of protectionist
level of an economy’s exports relative to the price policies in the global economy is surprising. In the
of its imports. If the terms of trade improve, an simple model above, for example, we assumed the
economy is able to purchase more imports with free movement of labour and capital between the
a given quantity of exports. If the terms of trade grape and cheese industries in Australia, depending
deteriorate, the economy can purchase fewer imports on changes in consumer tastes and price levels.
with the same level of exports.
The real world is very different: if cheese production
A movement in the terms of trade will alter the were to grind to a halt overnight, dairy industry
consumption possibilities curve. Suppose now workers would not simply leave their Victorian
that Australia’s terms of trade improves, and cheese factory to take up a job on a South
when Australia sells 150 tonnes of grapes it Australian vineyard. It might be too far away. They
can purchase 100 tonnes of cheese. Australia’s may not have the right skills. The former dairy
consumption possibilities curve will shift upward – worker might be unemployed for a long period of
the improvement in the terms of trade means that time. The grape and cheese example also does not
for every tonne of grapes Australia exports it can consider the impact of a shrinking grape industry
now import a higher quantity of cheese. on French culture and farm life, for example, or
However, since France exports cheese, which how a surge in imported grapes will affect the
has fallen in price, its terms of trade will have French economy’s trade balance or exchange rate.
deteriorated. Its consumption possibilities curve While it is one of the most powerful theories in
will fall since every tonne of grapes that France economics, comparative advantage has clearly not
wishes to import must be paid for with a higher ended all disagreements about trade policy in the
quantity of cheese. However, France’s consumption global economy.
possibilities curve is still higher than the production
50 Australia’s
production
0
0 50 100 150 200 250 300 350 400
Grapes (tonnes)
391
appendix B Australia in the Global Economy 2024
Figure B.5 shows that a rise in aggregate demand In this economy, the government may want to
(such as from a rise in investment caused by an increase government spending, G, to increase
increase in business confidence) shifts the AD line aggregate demand and raise income to its full
upwards from AD1 to AD2. Equilibrium will be employment level. Figure B.6 shows that the
achieved when income increases from Y1 to Y2. government, by increasing government spending
Note that income has increased by more than the from G1 to G2, can increase aggregate demand
initial change in aggregate demand because changes from AD1 to AD2 and boost income from its initial
in AD have a multiplied impact on national equilibrium level Ye to the full employment level
income. If you were to calculate Y2 – Y1 divided of income, Yf .
by AD2 – AD1, this would give you the size of the
multiplier in the economy. Expenditure
Y=E
AD2 = C + I + G2 + (X – M)
deflationary gap
Expenditure
Y=E } AD1 = C + I + G1 + (X – M)
AD2
AD1
AD
} Income
Ye Yf
Figure B.6 – F
ull employment equilibrium and the
Income deflationary gap
Y1 Y2
Y2 – Y1 = change in income Alternatively, if the full employment level of
income was below the current equilibrium level
AD2 – AD2 = change in demand
Y = multiplier
(that is, Yf was to the left of Ye), there would be
AD an inflationary gap. The government may want
to decrease government spending, G, to reduce
Figure B.5 – A
n increase in aggregate demand and
aggregate demand and income to contain inflationary
national income pressures in the economy. Therefore, macroeconomic
policies are important to achieve the government’s
With the orderly adjustment process outlined above, objective of reducing unemployment and inflation.
it is not immediately obvious why governments The relationship between the output of the economy,
decide to intervene in the operation of the economy. unemployment and inflation is discussed in further
Each time there is a shock, the multiplier process detail in chapters 8, 9 and 13.
does its magic, and the economy adjusts to its new
level of equilibrium income and expenditure. Why
should governments use macroeconomic policies
to increase or decrease aggregate demand if the
multiplier process can already do the job?
The answer, as outlined by British economist John
Maynard Keynes, is that there may be a difference
between the equilibrium level of income determined
by the forces of demand and supply, and the level
of income consistent with full employment. Put
another way, it is possible for the economy to reach
an equilibrium, that is, for there to be no tendency
to change, and for the unemployment rate to still be
high. In figure B.6, the current equilibrium level
of income, Ye is below the full employment level
of income Yf . The difference between AD1 and the
45 degree line at Yf is called the deflationary gap.
392
appendix B
Appendix B: Advanced Economic Analysis
The Phillips curve shows the trade-off governments has cost-push causes, such as the world oil price
face in trying to simultaneously achieve the economic spikes of the time, as well as demand-pull causes,
objectives of low inflation and low unemployment. such as faster economic growth. However, the
While higher economic growth creates jobs and high rates of inflation and unemployment were
reduces unemployment, it can also lead to excessive such an intractable problem for governments that
demand in the goods market, pushing up prices. It it prompted an entire rethink of the relationship
can also create extra demand in the labour market, between unemployment and inflation.
causing an increase in wages, which will add to
inflation as businesses raise prices to protect profit The outcome of this rethink was the Long-run
margins. The principle of a trade-off between Phillips curve (also called the Friedman-Phelps
low inflation and low unemployment was an Expectations Augmented Phillips curve). This new
important part of macroeconomic policy setting curve was based on the inclusion of two long-term
in the decades following the Second World War. economic principles in the explanation of the
In the economy shown in figure B.7, for example, relationship between inflation and unemployment:
expansionary government policies could reduce the natural rate of unemployment and inflationary
the unemployment rate from 6 per cent to 3 expectations. The natural rate theory says that
per cent, but only at the cost of increasing the rate there will always be some level of frictional,
of inflation from 2 per cent to 4 per cent (that structural, seasonal, and hard-core unemployment,
is, moving from point A to point B). Un, that cannot be addressed through demand-
management or macroeconomic policies. If a
Inflation (%)
government uses expansionary macroeconomic
policies to lift demand and reduce unemployment,
it will result in an increase in wage levels and
inflation. As workers become used to the higher
level of inflation, they will begin to demand
even higher wages, which, if granted, will see the
unemployment rate return to its natural level.
4% B Their inflationary expectations, however, will
remain high. As a result, in the “long-term”
A
(defined here as the time it takes for workers’
2% expectations of inflation to catch up to the
new level), expansionary macroeconomic policy is
not effective in reducing unemployment because
3% 6%
Unemployment (%) unemployment is locked-in at the natural rate. The
only long-term impact of expansionary policy is a
Figure B.7 – Phillips curve permanently higher level of inflation.
In the 1970s, however, this relationship between Figure B.8 shows the Friedman-Phelps Expectations
unemployment and inflation broke down. (In reality, Augmented Phillips curve. The Long-Run Phillips
it never existed as neatly as the theory suggested). curve is a vertical line at the natural rate of
In Australia, as in many other industrialised unemployment, Un, which is equal to 5 per cent
nations, inflation levels increased and remained in this hypothetical economy. The economy starts
high even when the economy was stagnating on Short-Run Phillips curve P1, at point A, with
and unemployment was high – a situation called an unemployment rate of 5 per cent and 0 per cent
stagflation. It was not clear whether governments inflation. If the government operates expansionary
should be loosening macroeconomic policies to macroeconomic policy, such as through an increase
reduce unemployment or tightening macroeconomic in government spending, the economy will move
policies to combat rising inflation. At one level, to point B, with a lower rate of unemployment at 3
the new crisis simply demonstrated that inflation per cent, but higher rate of inflation at 2 per cent.
393
appendix B Australia in the Global Economy 2024
394
appendix B
Appendix B: Advanced Economic Analysis
The hypothesis is derived from the equilibrium Australia’s current account deficit grew larger.
condition that injections equal leakages. By The government no longer uses fiscal policy to
rearranging the injections and leakages equations, target a reduction in the current account deficit.
we see that the trade balance (X– M) must be
Quantity theory of money
equal to the savings-investment imbalance plus
the budget balance. If one assumes that the Efforts to use expansionary monetary policy to
savings-investment imbalance is not affected by increase the level of aggregate demand and reduce
the government’s spending and revenue decisions unemployment also face limitations. According
(that is, is constant), then it can be shown that an to the quantity theory of money, expansionary
increase in the budget deficit causes an increase in monetary policy has no long-run impact on the
the trade deficit. (Although the theory is usually level of economic activity and unemployment
quoted as saying it will cause a current account and instead only has the impact of increasing the
deficit). level of inflation. Put another way, changes in the
“money” side of the economy (the money supply
Injections = Leakages and interest rates) do not have impacts on the “real”
side of the economy (output and employment).
I+G+X=S+T+M
Under this theory, revived in the 1970s by Milton
(X – M) = (S – I) + (T – G) Friedman (the same economist who developed the
Holding S – I constant, Friedman-Phelps Expectations Augmented Phillips
curve), unemployment in the long term is fixed at
(T – G) = (X – M)
the natural rate, with an associated fixed level of
national output and income.
Increase in budget deficit causes
increase in current account deficit
The quantity theory of money, much like the twin
deficits hypothesis, relies on applying a range
“The fiscal balance measures the Australian of principles and assumptions to an equation.
Government’s investment-saving balance. It
measures in accrual terms the gap between
The equation of exchange says that the money
government savings plus net capital transfers, supply multiplied by the velocity of circulation
and investment in non-financial assets. As such, (the volume of times of the money supply is
it approximates the contribution of the Australian used) must equal the total volume of goods and
Government General Government Sector to the
balance on the current account in the balance services purchased, multiplied by the price level.
of payments.” For example, if the money supply in Australia was
$200 billion and it was used five times in a year,
– 2023–24 Budget Paper 1, Appendix A
total transactions would equal $1 trillion, and this
would be equal to the sum of the prices of all the
There are, however, limitations of this theory. goods and services produced in the economy over
First, it is based on an equilibrium economy. If the same period (that is, GDP).
the economy is not in equilibrium, the budget
deficit and trade deficit do not have to be equal. MV = PT
Second, the savings-investment imbalance is not Where:
M = money supply P = price level
constant or unaffected by the budget balance. If V = velocity of circulation T = volume of transactions
the crowding out theory is true, an increase in
the budget deficit will actually cause investment
to fall relative to savings, potentially leaving the The quantity theory then makes two assumptions:
trade balance unchanged. Alternatively, if the that velocity of circulation is fixed and that the
government achieved a surplus, the resulting lower volume of transactions (that is, the output of goods
interest rates may simply increase the savings- and services) is fixed. If these assumptions are
investment imbalance and leave the trade balance accurate, then any increase in the money supply
unchanged. Evidence from the Australian economy (through a reduction in interest rates) will simply
over the past decade supports the view that the twin cause an increase in the price level.
deficits hypothesis is not a very useful theory. In the The quantity theory of money was used by
late 1990s, the government argued that the primary monetarist economists in the 1970s to argue
reason for shifting the budget balance from deficit that central banks should target the growth rate of
to surplus was to reduce the current account deficit. the money supply to contain the level of inflation.
Yet even when modest surpluses were achieved, After a brief use of monetary targeting in the
396
appendix B
Appendix B: Advanced Economic Analysis
late 1970s and early 1980s, it was abandoned in as they like, funding it by “printing money” –
Australia in 1985 because the targets were not that is, issuing bonds and paying for them by
achieved and inflation was not contained. “creating reserve assets”. While this approach has
The main problem with the quantity theory is that been associated with economic instability in past
the assumptions do not hold – that is, the velocity eras, the advocates of MMT argue that in recent
of circulation could be influenced by behavioural years the private sector has demonstrated little
changes in consumers or businesses and not be reluctance about buying such bonds.
constant, and factors that expand the productive MMT argues that the one major limiting factor
capacity of the economy will increase the amount on government spending is the rate of inflation,
of output and transactions. Since the adoption of which can rise with excessive creation of money.
interest-rate setting monetary policy in Australia, It advocates large-scale spending during severe
the Reserve Bank does not even have direct control downturns (such as in 2020) because in such
of a money supply measure that could be used to situations, inflation is rarely a significant problem.
influence the level of inflation, making the theory In addition to increased spending on cash transfers
even less useful. and public services, MMT proposes a universal job
The one lesson of the quantity theory of money that guarantee that gives every person a government-
maintains relevance today is that it is not possible funded job at the minimum wage.
to use consistently expansionary monetary policy Monetary policy would not be used to control levels
to achieve increases in output and employment. of economic activity under an MMT framework,
To the extent that the economy has a speed and interest rates would be set to zero. While taxes
limit determined by structural factors such could be raised if fiscal policy needed to become
as technology levels, education levels, market contractionary, its advocates argue that taxes are
flexibility, international competitiveness and not needed to balance government budgets. In
efficiency, macroeconomic policy cannot keep the fact, they say taxes are a tool to encourage citizens
economy above this speed limit without adding to earn income and conduct exchanges in the
to inflationary pressure. Long-term economic
local currency. MMT economists argue that the
challenges require the government to implement
solution to inflation in product or labour markets
successful microeconomic policies and invest in the
is measures such as competition policy, regulation
long-term drivers of economic growth.
or incomes policies, but not higher interest rates.
Modern Monetary Theory
The limitation of MMT is that it has been developed
Modern Monetary Theory (MMT) is a “heterodox” in response to a specific and relatively short-term set
(unconventional) economic theory focused on of economic conditions. Its arguments are in many
the relationship between the money supply ways a more extreme version of a conventional view,
and economic activity, but with very different that debt is affordable in a time of low inflation,
conclusions. Its focus is explaining the financial low interest rates and weak demand. Its focus is
conditions that have prevailed since the global what governments can do when economic activity
financial crisis that began in 2008. While it is and inflation levels are very low, and it does not
generally rejected by mainstream economists, its propose new solutions to the historic problem that
ideas have sparked debate about current economic expanding the money supply creates inflation and
conditions. The naming of MMT is credited to economic instability. Its approach could also make
Australian economist Bill Mitchell (from the labour markets more inefficient and currencies
University of Newcastle), who gained increased more unstable, and its relevance may be limited to
public attention during the COVID-19 recession. the relatively unusual period of economic history
MMT asserts that because governments issue their of the early 21st century. But it has contributed
own currency, they can never run out of money – to the economic debate, and shone a light on the
after all, they can always just create more money. way that conventional approaches failed to restore
It argues that governments can spend as much robust growth after the global financial crisis.
397
Glossary
A
Absolute poverty refers to the condition of people with Australia-United States Free Trade Agreement
the lowest living standards in the global economy, and (AUSFTA) is a bilateral free trade agreement between
is measured by an income level of less than US$1.90 per Australia and the United States, which came into force
day. See also, relative poverty. in 2005.
Advanced economies refer to high-income, Australian Competition and Consumer Commission
industrialised or developed economies. The group of (ACCC) is Australia’s competition watchdog whose role
advanced economies includes 39 economies across North is to enforce the Competition and Consumer Act 2010 and
America, Europe and the Asia-Pacific. ensure that businesses do not engage in anti-competitive
Aggregate demand refers to the total demand for behaviour.
goods and services within the economy. Components of Australian Council of Trade Unions (ACTU) is
aggregate demand are: consumption (C); investment (I); the peak trade union body in Australia, covering most
government spending (G); and net exports (X-M). trade unions.
Aggregate supply refers to the total productive capacity Australian Prudential Regulation Authority (APRA)
of an economy, that is, the potential output when all is the government body established to regulate all
factors of production are fully utilised. deposit-taking institutions, life and general insurance
Allocative efficiency refers to the economy’s ability to organisations and superannuation funds.
shift resources to where they are most valued and can Australian Securities and Investments Commission
be used most efficiently. See also, dynamic efficiency and (ASIC) is the government body with responsibility
technical efficiency. for corporate regulation, consumer protection and the
Appreciation is an increase in the value of an economy’s oversight of financial service products.
currency in terms of another currency. See also, Australian Trade and Investment Commission
depreciation. (Austrade) is a government organisation that assists
Arbitration is a dispute resolution process in which an Australian exporters to succeed in developing overseas
industrial tribunal hands down a legally binding ruling markets.
to firms and employees. See also, conciliation. Automatic stabilisers are instruments inherent in the
ASEAN-Australia-New Zealand Free Trade Area government’s budget that counterbalance economic
(AANZFTA) is a regional trade agreement in effect activity. In a boom period, they decrease economic activity
from 2010. and, in a recession, they increase economic activity. The
most common examples are transfer payments and a
ASEAN Free Trade Area (AFTA) is a regional free
progressive tax system.
trade agreement signed in 1992 which covers the 10
ASEAN members. See also, ASEAN. Average propensity to consume (APC) is the
proportion of total income that is spent on consumption.
Asia Pacific Economic Cooperation (APEC) forum is
See also, marginal propensity to consume.
a group of 21 Asia-Pacific economies including Australia
that promotes free trade and economic integration. Average propensity to save (APS) is the proportion
of total income that is not spent, but is saved for future
Association of South-East Asian Nations (ASEAN)
consumption. See also, marginal propensity to save.
was established in 1967 to reduce regional tensions
and to develop cooperative approaches in dealing with Average rate of tax is the proportion of total income
outside countries. Its members are: Brunei, Cambodia, earned that is paid in the form of a tax. See also, marginal
Indonesia, Laos, Malaysia, Myanmar, Philippines, rate of tax.
Singapore, Thailand and Vietnam. Awards establish the minimum wage and working
Australia-India Economic Cooperation and Trade conditions for employees depending on their industry,
Agreement (Australia-India ECTA) is a regional free occupation or workplace. Restructured and streamlined
trade agreement signed in 2022. awards are known as modern awards.
B
Australia-New Zealand Closer Economic Relations Balance of payments is the record of the transactions
Trade Agreement (ANZCERTA) is a bilateral free between Australia and the rest of the world during a
trade agreement between Australia and New Zealand, given period, consisting of the current account and the
which came into effect in 1983. capital and financial account.
Australia-United Kingdom Free Trade Agreement Balanced budget is the budget outcome in which
(A-UK FTA) is a free trade agreement which entered the level of taxation revenue is equal to government
into force in 2023. spending.
398
Glossary
Better off overall test (BOOT) is a test that enterprise Cash rate is the interest rate paid on overnight loans
agreements must pass in order to be approved under in the short-term money market. See also, interest rates.
the Fair Work Act. It examines whether an employee Casualisation of work refers to the growth of casual
is better off than they would be under the applicable employment (and the relative decline of full-time
industrial award. permanent jobs) as a proportion of the total workforce.
Bilateral free trade agreement is an agreement See also, underemployment.
between two economies to lower tariff levels and other Centralised incomes policy is a system in which a
trade barriers in order to encourage increased trade flows. government or industrial tribunal determines wages
See also, multilateral free trade agreement and regional free and working conditions for all employees, regardless
trade agreement. of which firm they work for. See also, decentralised
Broad money is a measure of the money supply that incomes policy.
consists of currency in circulation; all bank deposits, Centrally planned economy is an economic system
and deposits in non-bank financial intermediaries minus whereby government planners make economic decisions
their holdings of bank deposits. and there is little scope for individual choice to
Budget is the tool of the government for the exercise influence economic outcome. See also, market economy
of fiscal policy. It shows the government’s planned and mixed economy.
expenditure and revenue for the next financial year. Ceteris paribus is the concept in economics that in
Budget deficit is a budget outcome in which order to understand the relationship between two
government spending is greater than revenue. factors, we need to analyse the impact of one factor on
Budget surplus is a budget outcome in which another factor while assuming nothing else changes. It is
government spending is less than revenue. a Latin phrase that means “other things being equal” or
assuming that everything else is held constant.
Business cycle refers to fluctuations in the level of
economic growth due to either domestic or international Circular flow of income is a model that describes how
factors. economic activity occurs between the different groups in
an economy. Saving, taxation and spending on imports
Business firm is an organisation involved in using represent leakages from the circular flow, that is, they
entrepreneurial skills to combine factors of production decrease the level of economic activity. Investment,
to produce a good or service for sale. government spending and export revenue represent
C
Capital is the manufactured products used to produce injections into the circular flow, that is, they increase
goods and services, commonly described as “the the level of economic activity.
produced means of production”. See also, labour, land, China-Australia Free Trade Agreement (ChAFTA) is
natural resources and enterprise. a bilateral free trade agreement that entered into force
Capital and financial account records the borrowing, in 2015.
lending, sales and purchases of assets between Australia Clean float is an exchange rate system in which the
and the rest of the world. Financial inflow has the Reserve Bank does not intervene in foreign exchange
immediate effect of increasing the supply of foreign markets to influence the value of the Australian dollar.
exchange to Australia whereas financial outflow See also, dirty float and dirtying the float.
reduces it. Collective agreement is a workplace agreement that
Capital gains are the profits made by investors who sell is negotiated between an employer and a group of
their shares or assets at a price above the level that they employees, usually through a union. See also, enterprise
originally paid for them. bargaining.
Capital goods are items that have not been produced Collective bargaining (see enterprise bargaining)
for immediate consumption but will be used for the Collective wants are wants of the whole community.
production of other goods. See also, consumer goods. This will depend on the preferences of the community
Carbon border adjustments are import taxes on as a whole and not individuals. In Australia, collective
emission-intensive goods from countries that do not wants such as parks and libraries are most commonly
adequately charge producers for carbon emissions. These provided by the government. See also, public good.
operate in a similar way to tariffs. Collusion occurs when firms agree on a pricing or
Carbon tax is an environmental management policy market sharing arrangement that reduces effective
in which businesses must pay a price for each tonne of competition between them, and tends to inhibit the
carbon dioxide emitted through energy or industrial entry of competitors into the market.
production process. It is designed to discourage activities Common Agricultural Policy is a scheme used
that contribute to climate change. by economies in the European Union to promote
Cartel describes a situation in which individual European farm production through export subsidies and
firms have implicitly or explicitly agreed to restrict restrictions on imports from economies outside the EU.
competition, such as through agreements to fix Common law contract is an individual agreement
prices, segregate the market, or limit the quantity of between an employer and employee that sets out pay
goods produced. and conditions for work. These are commonly used by
399
Australia in the Global Economy 2024
small businesses and high-income earners not covered Council of Financial Regulators is a coordinating
by awards. See also, individual agreement. body for financial market regulation that provides for
Comparative advantage is the economic principle that cooperation and collaboration among its four members –
nations should specialise in the areas of production in the Reserve Bank of Australia, the Australian Prudential
which they have the lowest opportunity cost and trade Regulation Authority, the Australian Securities and
with other nations, so as to maximise both nations’ Investments Commission, and the Australian Treasury.
standards of living. Counter-cyclical policies are economic policies
Competition is the pressure on business firms in a designed to smooth fluctuations in the business cycle.
market economy to lower prices or improve the quality Macroeconomic policies such as fiscal policy and
of output to increase their sales of goods and services to monetary policy are usually used as counter-cyclical
consumers. See also, pure competition. policies.
Competitiveness (see international competitiveness) Credit is loans to individuals, businesses and
Complement is a good that is used in conjunction governments for spending on consumption and
with another good. For example, chargers would be a investment.
complement of laptops. Crowding out effect occurs where government
Conciliation is a dispute resolution process in which spending is financed through borrowing from the private
firms and employees meet to discuss their differences in sector, which puts upward pressure on interest rates and
the presence of a third party (such as from an industrial “crowds out” private sector investors that cannot borrow
tribunal) who attempt to bring the parties to an at the higher rates of interest.
agreement. See also, arbitration. Current account is the part of the balance of payments
Constitution (Australian) is the document that provides that shows the receipts and payments for trade in goods
the overall framework for Australia’s system of and services, as well as both primary and secondary
democratic government and the relationship between income flows between Australia and the rest of the
the Commonwealth (or federal) and state governments. world in a given time period. These are non-reversible
transactions.
Consumer goods and services are items produced for
the immediate satisfaction of individual and community Current account deficit (CAD) is recorded when
needs and wants. See also, capital goods. the debits in the current account (imports and income
Consumer Price Index (CPI) is a measure of the payments to overseas) are greater than the credits
movement in the prices of a basket of goods and services (exports and income payments from overseas).
weighted according to their significance for the average Cyclical unemployment refers to those persons that
Australian household. It is used to measure inflation in have become unemployed due to a downturn in the
Australia. See also, inflation. business cycle.
D
Consumer sovereignty refers to the manner in which
Debt servicing ratio is the proportion of export revenue
consumers, collectively through market demand,
that is used to make repayments on foreign debt, and is
determine what is produced and the quantity of
a common measure of the sustainability of Australia’s
production.
foreign debt level.
Consumption function is a graphical representation
of the relationship between income and consumption Decentralised incomes policy is a system in which
for an individual or an economy. It is usually upward wages and working conditions are determined through
sloping with a gradient less than one, and with a positive negotiations between individual firms and their
y-intercept. employees. See also, centralised incomes policy.
Contracting out (see outsourcing) Demand is the quantity of a particular good or service
that consumers are willing and able to purchase at
Contractionary policies are government policies that
various price levels, at a given point in time.
attempt to reduce economic activity. Contractionary fiscal
policy would involve decreasing government spending Demand-pull inflation occurs when aggregate demand
or increasing taxation. Contractionary monetary policy or spending is growing while the economy is nearing its
would involve an increase in interest rates. supply capacity, so that higher demand leads to higher
prices rather than more output.
Convergence (see international convergence)
Corporatisation occurs when the government changes Depreciation (of capital) refers to the “wear and tear”
the rules around how government-owned businesses are that all capital goods experience, which causes their
operated so that they behave more like private sector value to fall over time.
businesses, independent from the government. See also, Depreciation is a decrease in the value of an economy’s
privatisation. currency in terms of another currency. See also,
Cost-push inflation occurs when there is an increase appreciation.
in production costs (such as oil price increases or wage Deregulation is the removal of government controls
increases) that producers pass on in the form of higher over an industry that is intended to make business more
prices thus raising the rate of inflation. responsive to market forces.
400
Glossary
Devaluation occurs when the government (or central Economic cost (see opportunity cost)
bank) lowers the value of a currency that operates with a Economic development is a broad measure of welfare
fixed exchange rate. See also, revaluation. in a nation that includes indicators of health, education
Developing economies are economies with a low level and environmental quality as well as material living
of material well-being and economic development, standards.
and which tend to have poor health and education Economic growth occurs when there is a sustained
standards, weak infrastructure and agriculture-based increase in a country’s productive capacity over time.
economies. This is commonly measured by the percentage increase
Diminishing marginal returns occur when a firm in real Gross Domestic Product. See also, Gross Domestic
experiences a decline in additional output as it increases Product.
a factor of production (such as labour) while holding the Economic policy mix refers to the combination of
amount of other factors of production constant. macro economic (fiscal and monetary) and micro
Direct tax is a tax where the person upon whom a tax economic policies used by the government to achieve
is levied must pay the tax because it cannot be passed its economic objectives.
onto someone else. For example, income tax. See also, Economic problem involves the question of how to
indirect tax. satisfy unlimited wants with limited resources.
Dirty float is an exchange rate system in which the Economies of scale (see internal economies of scale and
value of the currency is mainly determined by demand external economies of scale)
and supply in foreign exchange markets, but the Reserve Efficiency (see allocative efficiency, technical efficiency and
Bank occasionally intervenes to stabilise the value of the dynamic efficiency)
Australian dollar during periods of excessive volatility.
Elaborately transformed manufactures (ETMs)
See also, clean float and dirtying the float.
are technologically advanced and high value-added
Dirtying the float is where the Reserve Bank buys and manufacturing products, such as motor cars, that
sells Australian dollars in foreign exchange markets generally command high prices on international
to influence the value of the exchange rate. See also, markets. See also, simply transformed manufactures.
clean float and dirtying the float.
Elasticity (see price elasticity of demand, price elasticity
Diseconomies of scale (see internal diseconomies of scale of supply)
and external diseconomies of scale)
Elasticity of demand (see price elasticity of demand)
Distribution of income (see income distribution) Elasticity of supply (see price elasticity of supply)
Diversification occurs when a firm enters a new Emerging economies are economies experiencing the
industry that is not directly related to its existing fastest rates of growth in the global economy with many
business operations. undergoing rapid industrialisation. The group includes
Dividends are the profit returns received by the share China, India, Brazil, Mexico, Egypt and Poland and
holders (owners) of a business. See also, profit. many other economies across Asia, Latin America,
Division of labour (see specialisation of labour) Central and Eastern Europe, the Middle East and
North Africa.
Domestic Market Operations are actions by the
Reserve Bank in the short-term money market to buy Emissions trading scheme is an environmental
and sell second hand Commonwealth Government management policy where the government sets a cap
Securities in order to influence the cash rate and the on the amount of greenhouse gas emissions, requires
general level of interest rates. See also, monetary policy. companies to have a permit to emit gases, and allows
permits to be traded between companies, providing an
Dumping is the practice of exporting goods to a country incentive to reduce emissions.
at a price lower than their selling price in their country
of origin. Employer associations are organisations that are
formed to represent the interests of businesses, especially
Dutch disease is a term that refers to high commodity in industrial relations and in lobbying the government.
export prices driving up the value of the currency,
Enterprise involves the organisation of the other
making other parts of the economy less competitive,
factors of production to produce goods and services. The
leading to a higher current account deficit and a greater
entrepreneur makes the decisions and bares the risk of
dependence on commodities. The term was coined in
the business. The return for enterprise is profit. See also,
1977 by The Economist magazine to describe the impact
land, natural resources, capital and labour.
of gas discoveries on the economy of the Netherlands.
Enterprise agreement is a collective workplace
Dynamic efficiency refers to the economy’s ability
agreement that sets out pay and conditions for
to shift resources between industries in response to
employees. EAs are negotiated between an employer and
changing patterns of consumer demand. See also,
a group of employees, usually through a union. See also,
allocative efficiency, technical efficiency.
collective agreement and enterprise bargaining.
E
Ecologically sustainable development involves Enterprise bargaining refers to negotiations between
conserving and enhancing the community’s resources employers and employees (or their representatives) about
so that ecological processes and quality of life are pay and work conditions at the level of the individual
maintained. firm.
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Environment is the surroundings or conditions in of a firm changing its own scale of operations. See also,
which human society lives, and includes the land, water, internal diseconomies of scale.
climate and plant and animal life. External economies of scale are the advantages that
Environmental management refers to actions to accrue to a firm because of the growth of the industry
protect and enhance the natural environment, including in which the firm is operating, and are not the result of
protecting the quality of air, water and soil, preserving the firm changing its own scale of operations. See also,
natural environments and biodiversity, ensuring internal economies of scale.
the sustainable use of renewable and non-renewable External stability is an aim of government policy that
resources, and minimising the negative environmental seeks to promote sustainability on the external accounts
consequences of economic activity. so that Australia can service its foreign liabilities in the
Equilibrium is achieved in an individual market when medium to long run and avoid currency volatility.
any consumer who is willing to pay the market price Externalities are external costs and benefits that private
for a good or service is satisfied, and any producer agents in a market do not consider in their decision
who offers their goods or services at the market price making process. For example, airlines and passengers do
is able to sell their produce. It occurs when quantity not consider aircraft noise when negotiating airfares. See
demanded is equal to quantity supplied, that is, when also, market failure, positive externality, negative externality.
the market clears.
F
Factors of production are any resources that can be
Equilibrium level of income refers to the level of
used in the production of goods and services. The four
income, output and employment at which the spending
main types are natural resources (or land), capital, labour
plans of the various sectors of the economy are identical
and enterprise.
to the aggregate production plans of the economy, that
is, aggregate demand is identical to aggregate supply. Factor market is a market for any input into the
Alternatively, it may be thought of as the level of production process, including land, labour, capital and
aggregate income where total leakages from the economy enterprise. See also, labour market and product market.
are identical to the total injections into the economy. Fair Work Commission is the government agency
Ethical decision-making is when business decisions that regulates industrial relations in Australia. It
about production methods, employment and other combines the functions of an industrial tribunal (such
matters are made to improve outcomes for the broader as the Industrial Relations Commission) with a role of
society and the environment, and not simply to education and promotion of enterprise bargaining.
maximise profits for the firm. Fair Work Ombudsman is the government agency
Euro area (also known as the eurozone) refers to the that investigates complaints and enforces compliance
monetary union of 20 countries of the European Union. with Australia’s workplace laws.
Financial aggregates are the Reserve Bank of Australia’s
European Union (EU) is an economic and political
three main indicators of the money supply – money
association of 27 European nations that has a single
base, M3 and broad money.
market for goods, services, finance and labour.
Fiscal policy is a macroeconomic policy that can
Excess capacity refers to the situation where a firm or
influence resource allocation, redistribute income
economy is operating below maximum potential output.
and reduce the fluctuations of the business cycle. Its
This is due to unemployed or under-utilised resources,
instruments include government spending and taxation
that is, the economy is producing inside its production
and the budget outcome.
possibility curve.
Fixed exchange rate is when the value of the economy’s
Exchange rates are the price of one currency in terms of currency is officially set by the government or the
another economy’s currency. central bank.
Exchange settlement accounts are the funds held by Flexible peg is an exchange rate system in which the
banks with the Reserve Bank of Australia (RBA) in currency’s value is fixed at a pre-announced level, but
order to settle payments with other banks and the RBA. it can be changed by the central bank in response to the
Expansionary policies are policies that attempt forces of supply and demand in foreign exchange markets.
to increase aggregate economic activity in the Floating exchange rate is when the value of a economy’s
economy. Expansionary fiscal policy would involve currency is determined by the forces of demand and
increasing government spending or reducing taxation. supply in foreign exchange markets.
Expansionary monetary policy would involve a reduction
Foreign debt refers to the total level of outstanding
in the interest rates.
loans owed by Australian residents to overseas residents.
Exports are goods or services that are produced See also, foreign equity, foreign liabilities, net foreign debt.
domestically and purchased by overseas consumers. See Foreign direct investment (FDI) refers to the
also, imports. movement of funds between economies for the purpose
External diseconomies of scale are the disadvantages of establishing a new company or buying a substantial
faced by a firm because of the growth of the industry proportion of shares in an existing company (10 per cent
in which the firm is operating, and are not the result or more). FDI is generally considered to be a long-term
402
Glossary
investment and the investor normally intends to play a government spends to provide services such as health
role in the management of the business. and education.
Foreign equity is the total value of Australian assets Government procurement refers to the policies and
such as land, shares and companies in foreign ownership. procedures for purchasing goods and services for the use
See also, foreign debt, foreign liabilities, net foreign equity. of the government and public trading enterprises.
Foreign exchange market (or forex market) refers to Gross Domestic Product (GDP) is the total
the market in which currencies are traded. market value of all final goods and services produced
Foreign liabilities are Australia’s total financial in an economy over a period of time. See also,
obligations (foreign debt plus foreign equity) to the rest economic growth.
of the world. See also, net foreign liabilities. Gross National Income (GNI) is the total income
Free riders refers to when groups or individuals benefit earned by domestically owned factors of production over
from a good or service without contributing to the cost a period of time. See also, gross domestic product.
of supplying the good or service. As a consequence, the Gross World Product (GWP) refers to the sum of
good or service is likely to be under-supplied in relation total output of goods and services by all economies in
to the total demand. the world over a period of time.
Free trade is a situation where there are no artificial Group of Seven (G7) refers to the seven largest
barriers to trade imposed by governments for the industrialised nations who meet annually to discuss
purpose of shielding domestic producers from foreign economic and political issues and wield tremendous
competitors. influence over the global economy. Its members are the
Frictional unemployment are those who are US, UK, France, Germany, Italy, Canada, and Japan.
unemployed due to time lags involved in the transition Growth (see economic growth)
between jobs. G20 is the group of the world’s 20 largest economies.
Full employment occurs when it is no longer possible It was formed in 1999 and has played an increasingly
to achieve a sustained reduction in unemployment important role in addressing the reform of the global
through stronger economic growth. See also, natural rate financial system and macroeconomic coordination.
of unemployment. It incorporates the G7 economies, plus the European
Future Fund is a Commonwealth Government Union, Argentina, Australia, Brazil, China, India,
investment account that receives the proceeds of Indonesia, Mexico, Russia, Saudi Arabia, South Africa,
budget surpluses and asset sales and invests them in South Korea and Turkey.
H
order to generate returns to meet the Commonwealth
Government’s future superannuation liabilities. Hard-core unemployment refers to long-term
unemployed people who may be considered unemployable
G
Geographical mobility refers to the ability of labour to by employers because of personal circumstances such as
move between different locations to gain higher wages drug use or mental or physical disabilities.
or improved employment opportunities. Heavily Indebted Poor Countries (HIPCs) are a
Gini coefficient is a number between zero and one that group of developing countries, mostly in Africa, that
measures the extent of income inequality in an economy. suffer extreme external debt sustainability problems.
It is calculated by measuring the degree to which the Hidden unemployment refers to those people who can
Lorenz curve deviates from the line of equality. See also, be considered unemployed but do not fit the official
Lorenz curve. definition of unemployment and are thus not reflected
Global economy refers to the sum of the interactions in the unemployment statistics.
between the economies of individual countries that Horizontal integration occurs when a firm takes
are now increasingly linked together into one larger over another business involved in the same kind of
economic system. production, that is, one of its competitors.
Global financial crisis describes the period of extreme House of Representatives is the main chamber of
volatility on world financial markets in 2008 and 2009 the Australian Parliament. When a party coalition has
that caused the deepest recession in the world economy a majority of votes in the House of Representatives it
since the Great Depression of the 1930s. forms a government under a Prime Minister who is also
Globalisation refers to the integration between different one of the 151 members of the House of Representatives.
countries and economies and the increased impact Household savings is the proportion of total household
of international influences on all aspects of life and disposable income not spent on consumption.
economic activity.
Human capital is the economic concept that the supply
Goods and Services Tax (GST) is a 10 per cent sales of labour cannot be simply measured by the size of
tax imposed on most goods and services in Australia. the labour force, but also by its quality, which can be
Government Business Enterprises (GBEs) (see public increased through education and training.
trading enterprises) Human Development Index (HDI) is a measure of
Government expenditure is an injection in the economic development devised by the United Nations
circular flow of income. It includes all money that the Development Program. It takes into account life
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Australia in the Global Economy 2024
expectancy at birth, levels of educational attainment other, such as the financial services industry or the
and material living standards (as measured by Gross car industry.
National Income per capita). Industry policy involves measures to support the
Hysteresis is the process whereby unemployment development of key industries and increase the com-
in the current period results in the persistence of petitiveness of domestic industries against foreign
unemployment in future periods as unemployed people competitors.
can lose their skills, job contacts and motivation Inelastic demand (see price elasticity of demand)
to work.
Inelastic supply (see price elasticity of supply)
I
Imperfect competition is any market structure that Infant industry argument refers to the argument that
is not a perfectly competitive market, which gives newly established or “infant” industries during the early
individual firms the ability to influence price levels. years are not competitive with established industries in
Imported inflation occurs when there is an increase other countries and may need protection from overseas
in the price of imports, either due to inflation in the competition in order to survive.
economies of our trading partners or because of a Inflation is the sustained increase in the general level
depreciation of the A$, which results in higher prices of of prices over a period of time, usually one year. This is
consumer imports and imported inputs. commonly measured by the percentage change in the
Imports are goods and services that are produced Consumer Price Index (CPI).
overseas and purchased by domestic consumers. See also, Inflation targeting occurs when a central bank
exports. implements monetary policy with the aim of achieving
Income is the amount of money, or other benefits a particular level of inflation. In Australia, the Reserve
measured in money terms, which flow to individuals Bank has an inflation target of 2-3 per cent, on average,
or households, usually for their contribution to the over the course of the economic cycle.
production process or as a direct payment from the Inflationary expectations is where inflation may be
government over a period of time. perpetuated by the expectations of workers and firms
Income distribution refers to the way in which an that it will occur.
economy’s income is spread among the members of Injections into the circular flow model of income are
different social and socio-economic groups. those flows of money that increase aggregate income
Indirect tax is a tax that is levied on an aspect of and the general level of economic activity. The three
economic activity other than a person or an organisation’s injections are investment, government spending and
income, such as sales tax. See also, direct tax. exports. See also, leakages.
Individual agreement is an agreement between an Interest is the reward to the factor of production capital
employer and individual employee that sets out pay for its use in the production of goods and services.
and conditions for work. These are commonly used by See also, wages, profit and rent.
small businesses and high-income earners not covered Interest rate differential is the difference between two
by awards. See also, common law contract. interest rates, either between two economies’ interest
Industrial dispute occurs when employers or employees rates or between a financial institution’s borrowing and
take action to disrupt the production process in order lending interest rates.
to highlight a disagreement between employers and Interest rates are the cost of borrowing money expressed
employees. as a percentage of the total amount borrowed.
Industrial relations refers to the relationship between Intermediate goods are semi-finished goods that
employers, employees, and their representatives. See are transformed into higher-value goods before sale to
also, industrial relations system. Also known as workplace consumers (for example, steel is an intermediate good in
relations. the production of motor vehicles). See also, capital goods
Industrial relations system involves the laws, and consumer goods and services.
institutions and processes established to manage relations Internal diseconomies of scale are the cost
between employers and employees. The structure of disadvantages (specifically, the increase in marginal costs
the industrial relations system determines the process per unit) faced by a firm as a result of the firm expanding
of wage determination and conflict resolution in the its scale of operations beyond a certain point. They
Australian labour market. Also known as workplace occur when a firm’s output level is above the technical
relations system. optimum. See also, external diseconomies of scale.
Industrial tribunals are government agencies that Internal economies of scale are the cost saving
oversee the industrial relations system and attempt to advantages that result from a firm expanding its scale
prevent or resolve workplace conflict between employees of operations. They occur when a firm’s output level is
(usually represented by unions) and employers (some- below the technical optimum. See also, external economies
times represented by employer associations). Fair Work of scale.
Commission is the main industrial tribunal in Australia International business cycle refers to fluctuations in
Industry is the collection of firms involved in making the level of economic activity in the global economy
a similar range of items that usually compete with each over time.
404
Glossary
International competitiveness refers to the ability Land is the natural resources used to produce goods and
of an economy’s exports to compete on global markets. services. The return for land is rent. See also, capital, land
An economy may be competitive by selling products of and enterprise.
a higher quality or a lower price than its competitors. Leakages are the items that remove money from the
International convergence refers to the increasing circular flow of income, decreasing aggregate income
similarity of economic conditions in different economies and the general level of economic activity. The three
during the globalisation era, in terms of economic leakages are savings, taxation and imports. See also,
systems, performance and structure, and living standards. injections.
International division of labour is how the tasks in Least Developed Countries (LDCs) are those
the production process are allocated to different people economies that suffer from low living standards (as
in different countries around the world. measured by GDP per capita levels less than around
International Monetary Fund (IMF) is an interna US$900 per year) and longer term impediments to
tional agency that consists of 190 members and oversees economic development.
the stability of the global financial system. The major Liquidity is the ease with which a financial asset can
functions of the IMF are to ensure stability of exchange be transformed into cash so it can be used as a medium
rates, exchange rate adjustment and convertibility. of exchange.
Investment is any current expenditure where the Local content rules specify that goods must contain a
benefits will be obtained in the future. Most typically, minimum percentage of locally made parts to qualify for
this injection will involve the purchase of capital goods trade protection assistance.
or the build up of stock or inventory.
Long-term unemployment refers to a person being
J
J-curve effect is an economic concept that suggests that unemployed for a period of one year or longer.
a depreciation of a currency will lead to a short-term Lorenz curve is a graphical representation of income
deterioration of Australia’s trade balance (as exporters distribution, plotting the cumulative increase in
receive lower revenue for a given quantity of exports and population against the cumulative increase in income.
import spending rises for a given quantity of imports) See also, Gini coefficient.
and a long- term improvement in the trade balance
M
as exports become more competitive and imports less M3 is a measure of the money supply that consists of all
competitive, so that export volumes rise and import currency in circulation, bank deposits with the Reserve
volumes fall. Bank and private sector deposits in banks.
K
Macroeconomic policies are policies that affect
Korea-Australia Free Trade Agreement (KAFTA) is the economy as a whole with the aim of minimising
a bilateral free trade agreement between Australia and fluctuations in the business cycle. Also referred to as
Korea signed in 2014. demand management or counter-cyclical policies.
Kyoto Protocol is an agreement ratified by 191 countries
Malaysia-Australia Free Trade Agreement (MAFTA)
since 1997 designed to lower emissions of carbon dioxide
is a bilateral free trade agreement between Australia and
and other greenhouse gas emissions in order to combat
Malaysia signed in 2012.
climate change.
Managed exchange rate is an exchange rate system
L
Labour is human effort, both physical and mental, used where the value of the currency is determined or
to produce goods and services. The return for labour is substantially influenced by central bank intervention
wages. See also, land, capital and enterprise. in the foreign exchange market, but where the level of
Labour force consists of all the employed and exchange is not held at a permanently fixed level.
unemployed persons in the country at any given time. Marginal propensity to consume (MPC) is the
Also known as the workforce. proportion of each extra dollar of earned income that
Labour force participation rate (LFPR) (see is spent on consumption. See also, average propensity
participation rate) to consume.
Labour on-costs (see on-costs) Marginal propensity to save (MPS) is the proportion
Labour market is where individuals seeking of each extra dollar of earned income that is not spent,
employment interact with employers who want to but saved for future consumption. See also, average
obtain the most appropriate labour skills for their propensity to save.
production process. Marginal rate of tax is the proportion of each extra
Labour market policies are microeconomic policies dollar earned that must be paid in tax. See also, average
that are aimed at influencing the operation and rate of tax.
outcomes in the labour market, including industrial Market clearing occurs when there is equilibrium in
relations policies that regulate the process of wage the market, that is, when the demand and supply curves
determination as well as training, education and job- intersect, when quantity demanded equals quantity
placement programs to assist the unemployed. supplied and there is no tendency for change.
Labour productivity refers to the quantity of output Market economy is an economic system whereby all
produced in a production process per unit of labour per major economic decisions are made by individuals and
unit of time. See also, multifactor productivity. private firms, which are both motivated by self-interest,
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Australia in the Global Economy 2024
without government intervention. See also, centrally Monopolistic competition is a market structure in
planned economy and mixed economy. which there are many sellers producing differentiated
Market equilibrium (see equilibrium) products, and there are no significant barriers to entry.
This is not the same as monopoly.
Market failure occurs when the price mechanism
takes into account private benefits and costs of Monopoly describes an industry where there is only
production to consumers and producers, but it fails to one seller producing a unique product. There are high
take into account indirect costs such as damage to the barriers to entry, so the monopolist has market power
environment. and can determine price or output (but not both). See
Market learning (also known as learning by doing) is also, natural monopoly.
where a business becomes more efficient at producing Multifactor productivity refers to the quantity of
a particular good or service as it gains more experience output produced in a production process per combined
producing that good or service. This will shift the input of labour and capital per unit of time. See also,
business’s average cost curve downwards and shift its labour productivity.
supply curve to the right. Multilateral free trade agreement is an agreement
Merit goods are goods that are not produced in between a number of countries, usually in a region, to
sufficient quantity by the private sector because private lower tariff levels and other forms of protection in order
individuals do not place sufficient value on those goods, to encourage increased trade flows. See also, bilateral free
that is, they involve positive externalities that are not trade agreement and regional free trade agreement.
fully enjoyed by the individual consumer. Merit goods Multinational corporations are firms that sell and
include education and health care. produce goods or services in more than one country. See
Microeconomic policies are policies that are aimed also, transnational corporations.
at individual industries, seeking to increase aggregate Multiplier is the greater than proportional increase in
supply by improving the efficiency and productivity of national income resulting from an increase in aggregate
producers. demand.
Migration is the movement of people between
N
countries on a permanent or long-term basis, usually for National competition policy is an agreement between
12 months or longer. Australia’s Commonwealth and state governments
Microeconomics is concerned with the study of signed in 1995 to encourage microeconomic reform
economics at the level of individual economic actors or throughout the Australian economy.
sectors of industry. National Federation Reform Council (NFRC) is a
Mixed economy is an economic system where the forum including the Prime Minister, Premiers, Chief
decisions concerning production and distribution Ministers, and Treasurers, which meets to focus on
are made by a combination of market forces and priority national federation issues. The NFRC replaced
government decisions. See also, market economy and the Council of Australian Governments in 2020.
centrally planned economy. National saving is the proportion of national income
Mobility of labour (see geographical mobility, occupational not spent by consumers, firms or the government.
mobility) Natural monopoly is a market situation in which
Monetary aggregates (see financial aggregates) only one operator can operate efficiently in an industry,
Monetary policy is a macroeconomic policy that usually because of extremely high barriers to entry, for
aims to influence the cost and supply of money in the example, the capital cost of a railway network.
economy in order to influence economic outcomes such Natural rate of unemployment refers to the level
as economic growth and inflation. The Reserve Bank of unemployment at which there is no cyclical
of Australia (RBA) administers monetary policy by unemployment, that is, where the economy is at full
influencing the level of interest rates. employment. See also, full employment, non-accelerating
Monetary union is where two or more countries share inflation rate of unemployment (NAIRU).
a common currency. Natural resources include all the resources provided by
Money is the medium of exchange in most modern nature that are used in the production process. These are
economies. often simply referred to as “land”. The reward (return)
to the owners of natural resources is called rent. See also,
Money base is a measure of the money supply that
land, capital, labour, enterprise.
consists of all currency in circulation and all bank
deposits with the Reserve Bank. Necessities (see needs)
Money wage (see nominal wage) Needs are individual desires for the basic necessities of
Money supply is the total amount of funds in an life, such as food and shelter.
economy that can be used as a medium of exchange, Negative externality is an unintended negative
a measure of value, a store of value and a method of outcome of an economic activity whose cost is not
deferred payment. The Reserve Bank’s measure of the reflected in the operation of the price mechanism. See
money supply is M3. also, positive externality.
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Glossary
Net errors and omissions is the entry on the balance Non-rival goods are goods and services whose
of payments that ensures that the sum of the current consumption by one individual does not reduce the
account and the capital and financial account equals zero. ability of other individuals to also consume the good or
service. See also, public good.
Net foreign debt refers to the level of outstanding loans
owed by Australian residents to overseas residents minus North American Free Trade Agreement (NAFTA)
the level of outstanding loans owed by overseas residents was a free trade agreement between the United States,
to Australian residents. See also, foreign debt. Canada and Mexico in effect from 1994 to 2020. It has
been replaced by the United States-Mexico-Canada
Net foreign equity is the value of Australian assets Agreement. See also, United States-Mexico-Canada
such as land, shares and companies in foreign ownership Agreement (USMCA)
minus the value of foreign assets in Australian owner
ship. See also, foreign equity. Non-wage outcomes are the benefits that many
employees receive in addition to their ordinary and
Net foreign liabilities are equal to Australia’s financial overtime payments, such as sick leave, superannuation, a
obligations (foreign debt plus foreign equity) to the company car, study leave or arrangements for employees
rest of the world minus the rest of the world’s financial to work from home for part of the week.
obligations to Australia. See also, net foreign debt and net
O
foreign equity. Occupational mobility refers to the ability of labour
to move between different occupations to gain higher
Net primary income is a component on the current
wages or improved employment opportunities.
account of the balance of payments calculated by
subtracting primary income debits from income credits. Okun’s Law explains the relationship between
Primary income debits include interest payments, unemployment and economic growth, showing that
dividends and rent paid by Australians on foreign to reduce unemployment, the annual rate of economic
liabilities, while income credits consist of similar growth must exceed the sum of percentage growth in
payments by foreigners to Australians. productivity plus increase in the size of the labour force
in any one year.
Net secondary transfers is a component of the current
account that includes all transactions in which products Oligopoly describes a market structure consisting
or financial services are provided without a specific good of a few large firms producing slightly differentiated
or service being provided in return. This includes items products. There are significant barriers to entry and each
such as aid to developing nations. firm engages in non-price competition.
On-costs are the additional costs to business of
Net zero emissions are achieved when anthropogenic employing labour (beyond their wage rates) such as sick
emissions of greenhouse gases to the atmosphere are leave and workers’ compensation.
balanced globally by anthropogenic removals over
a specified period – in other words, the amount of Open Market Operations (see Domestic Market
greenhouse gases that an economy produces is the same Operations)
or less than the amount it removes. Opportunity cost represents the alternative use of
resources. Often referred to as the “real” cost, it represents
Newly industrialised countries (NICs) refers to
the cost of satisfying one want over an alternative want.
economies that experience rapid economic growth in
This is also known as economic cost.
national output over an extended period, some of which
now have living standards that are similar to advanced Organisation for Economic Cooperation and
industrialised countries. Development (OECD) is an organisation of 38
developed countries that seeks to promote economic
Nominal wage is the pay received by employees in growth and free markets amongst its members.
dollar terms for their contribution to the production
Outsourcing occurs when an organisation pays another
process, not adjusted for inflation. See also, real wage.
business to perform a function that it does not regard
Non-accelerating inflation rate of unemployment as a core part of its business focus. Also known as
(NAIRU) refers to the level of unemployment at which sub-contracting or contracting out.
there is no cyclical unemployment, that is, where the Outlay method (see total outlay method)
economy is at full employment. See also, natural rate of
P
unemployment. Participation rate refers to the percentage of the
Non-excludable goods are goods or services whose population, aged 15 and over, in the labour force, that is
consumption cannot be restricted to those willing to either employed or unemployed.
pay for them, such as clean air and national defence. The Perfect competition (see pure competition)
private sector is generally unwilling to provide non- Perfectly elastic demand is where consumers demand an
excludable goods because individuals may not pay for infinite quantity of a good or service at a particular price
using them. See also, free riders, public good. but nothing at all at a price above this. This situation can
Non-renewable resources are inputs to production be represented by a horizontal demand curve.
where the stock of the resource is reduced in the process Perfectly elastic supply is where producers are willing
of production and consumption, for example, petroleum to supply an infinite quantity of a good or service at
and coal. See also, renewable resources. a particular price but nothing at all at a price below
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Australia in the Global Economy 2024
this. This situation can be represented by a horizontal Primary financial markets are markets in which firms
supply curve. raise funds by selling financial assets, such as shares or
Perfectly inelastic demand is where consumers are debentures, to investors.
willing to pay any price in order to obtain a given Private good is a good that is temporarily or
quantity of a good or service. This situation can be permanently used up when someone consumes it and
represented by a vertical demand curve. is easy to exclude people who are unwilling to pay for
Perfectly inelastic supply is where producers are its benefits. See also, public good.
willing to supply a given quantity of a good or service Private sector refers to those sectors of the economy
regardless of price. This situation can be represented by that concern private individuals, that is, the household,
a vertical supply curve. the firm and the financial sector.
Phillips curve is a graphical representation of the Privatisation occurs when the government sells public
theory that the economy faces a trade-off between low trading enterprises to the private sector. See also,
levels of inflation and low levels of unemployment. corporatisation.
Policy mix (see economic policy mix) Product differentiation is when firms try to make their
good or service look different from competitors (such
Portfolio investment refers to the short-term
as through packaging or product image) to increase
movement of funds between economies for loans or the
brand loyalty and give the firm some degree of price
purchase of small share holdings (less than 10 per cent
setting power.
of the total value of a company).
Product market is the interaction of demand for and
Positive externality is an unintended positive outcome
supply of the outputs of production, that is, goods
of an economic activity whose value is not reflected in
and services.
the operation of the price mechanism. See also, negative
externality. Production possibility frontier is a graphical
representation of all the possible combinations of the
Poverty (see absolute poverty, relative poverty) production of two goods and services (or two types of
Precautionary motive is the demand for money for the goods and services) that the economy can produce at any
purposes of unpredictable circumstances and emergencies given time.
for which people need to have liquid assets such as cash. Productivity refers to the quantity of goods and services
Price ceiling is a maximum price set by the government the economy can produce with a given amount of inputs
for which a good, service or factor of production can such as capital and labour. See also, labour productivity
be sold, usually resulting in market disequilibrium as and multifactor productivity.
market demand will be greater than market supply. Profit is the return to the factor of production enterprise
Price discrimination is when a firm sells the same good for its role in the production of goods and services. See
or service in different markets (or to different consumers) also, interest, rent and wages.
at different price levels. Profit motive refers to the process by which a business
Price floor is a minimum price set by the government seeks to maximise profit by using the lowest cost
for which a good, service or factor of production can combination of resources and charging the highest
be sold, usually resulting in market disequilibrium as possible price.
market supply will be greater than market demand. Progressive tax system is a tax system in which higher
Price elasticity of demand measures the responsiveness income earners pay proportionally more tax. As income
of quantity demanded to a change in price. It is calculated increases, the average rate of tax increases.
as the percentage change in quantity demanded divided Proportional tax system is a tax system in which all
by the percentage change in price. income earners pay proportionally the same amount
Price elasticity of supply measures the responsiveness of tax. The average rate of tax remains constant as
of quantity supplied to a change in price. It is calculated income rises.
as the percentage change in quantity supplied divided Protection refers to government policies that give
by the percentage change in price. domestic producers an artificial advantage over foreign
Price mechanism is the process by which the forces of competitors, such as tariffs on imported goods.
supply and demand interact to determine the market Public company is an entity whose shares are traded
price at which goods and services are sold and the freely on the share market, and are not subject to any
quantity produced. restrictions on being transferred to other parties.
Price stability is a goal of government economic policy Public good is an item that private firms are unwilling
seeking to restrain the growth rate of the general price to supply as they are not available to restrict usage and
level, essentially meaning low inflation. benefits to those willing to pay for the good. Because of
Prices and incomes policy is a government macro this, governments should provide these goods. See also,
economic policy that seeks to control the growth rate private good.
of prices and/or wages and expand employment by Public sector refers to the parts of the economy that are
imposing restraints on wages growth. owned or controlled by the government. It includes all
408
Glossary
tiers of the government as well as government business Relative poverty refers to those whose standards of
enterprises. living are substantially lower than the average for the
Public sector goods are goods and services provided by economy as a whole, and is often defined as a level of
the government such as train services and hospitals. See income below 30 per cent of average earnings. See also,
also, public good. absolute poverty.
Public Trading Enterprises (PTEs) are businesses Renewable Energy Target (RET) is the policy to
owned and managed by a government at either the increase Australia’s production of electricity from
Commonwealth or state level. renewable energy such as solar, wind, and geothermal
Purchasing power parity (PPP) states that exchange energy to 33,000 gigawatt hours per year by 2020.
rates should adjust to equalise the price of identical goods The target stays the same from 2020 to 2030, with
and services in different economies throughout the world. new renewable energy power stations still able to be
accredited after 2020.
Pure competition describes the theoretical market
structure where there are many buyers and sellers. Renewable resources are inputs into the production
They each sell a homogeneous product and there are no process that reproduce themselves, ensuring that present
barriers to entry into the industry. They are price takers, consumption of these resources does not necessarily
as individually they have no power to influence price. reduce the ability of future generations to consume these
resources in the future, for example, timber. See also,
Q
Quality of life refers to the overall well-being of non-renewable resources.
individuals within a country according to their material Rent is the return to the factor of production natural
living standards and a range of other indicators such resources (land) for its use in the production of goods
as education levels, environmental quality and health and services. It does not just include rent from property
standards. See also, standards of living. but all income rewards derived from the productive use
Quantitative easing involves a central bank creating of natural resources. See also, wages, interest and profit.
new money electronically, and then injecting it into Reserve assets refer to holdings of foreign currency
the money supply through buying assets, usually
and gold held by the Reserve Bank to use in foreign
government bonds, from investors such as fund managers
exchange markets in order to influence the value of the
and banks. By increasing liquidity and lowering interest
Australian dollar.
rates, quantitative easing aims to increase borrowing and
stimulate economic activity in the private sector. Reserve Bank of Australia (RBA) is Australia’s central
bank. Its main roles are to conduct monetary policy and
Quotas refer to restrictions on the amounts or values of
oversee the stability of the financial system.
various kinds of goods that may be imported.
Returns to production are the payments made to
R
Real Gross Domestic Product is the total value of all factors of production to compensate for their use. The
final goods and services produced in an economy over a returns to production include: wages to labour, rent on
period of time, adjusted for changes in the general price land, interest on capital and profit on enterprise.
level. Revaluation occurs when the government, or central
Real cost (see opportunity cost) bank, increases the value of a currency that operates with
Real wage is a measure of the actual purchasing power a fixed exchange rate. See also, devaluation.
S
of money wages (that is, adjusting nominal wages for the
effects of inflation). See also, nominal wage. Salary (see wages)
Recession is the stage of the business cycle in which Satisficing behaviour is the idea that firms will
there is decreasing economic activity, defined as two attempt to pursue a satisfactory level in all goals (profit
consecutive quarters (six months) of negative economic maximisation, sales maximisation etc.) rather than
growth, that is, a fall in GDP. maximising any single goal.
Regional business cycles are fluctuations in the level Savings represent the amount of disposable income that
of economic activity in a geographical region of the is not spent on consumption. Savings is a leakage from
global economy over time. the circular flow of income, which is necessary to fund
investment. The reward for savings is interest.
Regional free trade agreement is a multilateral
agreement between three or more economies within a Seasonal unemployment affects those persons
geographic region to lower tariff levels and other forms unemployed due to the seasonal nature of their work.
of protection in order to encourage increased trade flows. Their jobs are only available at certain times of the
See also, bilateral free trade agreement and multilateral free year such as fruit picking or being a shopping centre
trade agreement. Santa Claus.
Regressive tax system is a tax system in which lower Secondary financial markets are markets in which
income earners pay proportionally more tax. As income investors trade financial assets, such as shares or
increases, the average rate of tax falls. debentures, with other investors.
Regulation is the collection of government rules and Share is a type of financial asset that provides an
institutions that influence the operation of markets and individual with ownership over part of a business or
the participants in markets. company.
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Australia in the Global Economy 2024
Share market is a market for the sale of equity interests Supply is the quantity of a good or service that all firms
in companies. in a particular industry are willing and able to offer for
Simply transformed manufactures (STMs) are sale at different price levels, at a given point in time.
low-value added manufacturing goods that generally
T
command low prices on international markets, such Tariffs are taxes on imported goods imposed for the
as socks and singlets. See also, elaborately transformed purpose of protecting Australian industries.
manufactures. Tax (see taxation)
Singapore-Australia Free Trade Agreement Tax base is the items that are taxed by the government,
(SAFTA) is a bilateral free trade agreement between such as income, wealth or consumption.
Australia and Singapore that was signed in 2003. Tax-free threshold refers to the level of income below
Social welfare payments are payments from the which income tax is not payable.
government to assist people with basic costs of living.
Taxation is a leakage from the circular flow model
A number of terms are commonly used for transfer
of income. It refers to the amount of revenue that the
payments including: transfer payments, government
government obtains from different sectors and activities
benefits, social security, income support and Centrelink
in the economy.
payments.
Technical efficiency is the ability of an economy
Specialisation occurs when an economy concentrates on
to achieve the maximum level of output for a given
producing a particular set of goods or services in which
quantity of inputs. See also, allocative efficiency and
it has a comparative advantage.
dynamic efficiency.
Specialisation of labour occurs when the volume of
Technical optimum is the most efficient level of
production is large enough for workers to concentrate on
a particular stage of the production process. production for a firm. At this point, average costs
of production are at their lowest possible level.
Speculators are investors who buy or sell financial
assets with the aim of making profits from short-term Technology transfer occurs when falling global barriers
price movements. They are often criticised for creating to trade and financial flows allow developing economies
excessive volatility in financial markets. to access more advanced technology from overseas.
Stagflation occurs when the rate of inflation and the Terms of trade measures the relative movements in the
rate of unemployment rise simultaneously. prices of a economy’s imports and exports over a period
of time. The terms of trade index is calculated as export
Standards of living refers to the material wellbeing
price index divided by import price index multiplied
of individuals within a country, usually measured by
by 100.
Gross National Income (GNI) per capita. See also,
quality of life. Thailand-Australia Free Trade Agreement (TAFTA)
is a bilateral free trade agreement between Australia and
Structural change involves changes in the patterns of
Thailand signed in 2003.
production that reflect changes in technology, consumer
demand, global competitiveness and other factors. It Total outlay method is a way to calculate the price
results in some products, processes and even industries elasticity of demand by looking at the effect of changes in
disappearing, while others emerge. price on the revenue earned by the producer. If price and
Structural unemployment describes those persons revenue move in the same direction, demand is inelastic;
unemployed because of a mismatch between their skills if price and revenue move in the opposite direction,
and those skills demanded by employers. This occurs demand is elastic; and if revenue remains unchanged in
due to factors such as technological change and rapid response to a price change, demand is unit elastic.
changes in consumer demand, where labour skills cannot Trade bloc occurs when a number of countries join
adapt quickly enough to such changes. together in a formal preferential trading agreement to
Stock exchange is an organisation that provides the exclusion of other countries.
facilities for investors to trade shares and other financial Trade liberalisation is the process of reducing tariffs,
assets. See also, share market. subsidies and other barriers to trade in order to encourage
Sub-contracting (see outsourcing) increased linkages between economies.
Subsidies are cash payments from the government to Trade union is an organisation that represents the
businesses to encourage production of a good or service interests of workers, primarily by seeking to improve
and influence the allocation of resources in an economy. their wages and working conditions.
Subsidies are often granted to businesses to help them Trade Weighted Index (TWI) is a measure of the
compete with overseas produced goods and services. value of the Australian dollar against a basket of foreign
Substitute is a good that consumers may choose to buy currencies of major trading partners. These currencies are
in place of another good, such as butter and margarine weighted according to their significance to Australia’s
or tea and coffee. trade flows.
Superannuation is a form of saving that individuals Tragedy of the commons refers to a situation where
cannot access until they reach retirement age. the failure of the market to assign costs to individuals
410
Glossary
V
leads to an overuse of resources such as the natural Valuation effect is where an appreciation (or
environment, which have no single owner. depreciation) of the currency causes an immediate
Transactions motive is the demand for money for day- decrease (or increase) in the Australian dollar value of
to-day purchases for which people need to use money. foreign debt.
Transfer payments (see social welfare payments). Voluntary export restraints are agreements to restrict
Transition economies are former socialist economies the number of exports to another country in exchange
that are now becoming market economies, and are for a similar concession from the other nation.
W
concentrated in Central and Eastern Europe and Asia.
Wages are the return to the factor of production labour
Transmission mechanism explains how changes in for its use in the production of goods and services. These
the stance of monetary policy pass through the economy not only include wages but also salaries, fees, commissions
to influence economic objectives such as inflation and and other earnings. See also, interest, profit, rent.
economic growth. Wants are material desires of individuals that provide
Transnational Corporations (TNCs) are global some pleasure when they are satisfied. This will depend
companies that dominate global product and factor on personal preferences. Wants are said to be unlimited.
markets. TNCs have production facilities in at least See also, collective wants.
two countries and are owned by residents of at least two Wage Price Index is a measure of growth in hourly
countries. rates of pay that is released quarterly by the Australian
Treasury is the Australian Government department Bureau of Statistics. It is regarded as the most reliable
responsible for developing fiscal policy through the indicator of underlying wage growth as the index is not
Federal Budget, and advising the government on affected by changes in bonuses or the quality or quantity
financial stability issues. of work.
Wealth is the value of the stock of assets held by
U
Underemployment refers to those persons who individuals at a point in time.
are working less than full time (and therefore not
Wealth effect occurs when an increase in the price of
unemployed) but would like to work more hours.
assets such as property and shares leads to an increase
Underlying inflation is a measure of the increase in the in consumption. This occurs because rising asset prices
general price level that removes the effect of one-off or make the owners of these assets feel wealthier and so more
volatile price movements. willing to spend a greater a proportion of their income.
Unemployment refers to a situation where individuals Welfare (see utility, social welfare payments)
want to work but are unable to find a job, and as a result
Workable competition is the government’s objective
labour resources in an economy are not utilised.
to achieve the maximum level of competition within an
Unemployment rate is the number of people officially industry that is compatible with the market structure
unemployed as a percentage of the labour force. and specific conditions of the industry, that is, a situation
Union (see trade union) where all markets are contestable.
Unit elasticity of demand is where a change in price Workforce (see labour force).
causes a proportional change in quantity demanded such Workforce Australia is a federal government service
that total spending by consumers on a good remains that enables people to search for jobs and information
unchanged. related to employment.
United Nations is a global organisation of 193 Workforce participation rate (see participation rate)
member states established in 1945 with a broad agenda
Workplace relations system is the laws, institutions
covering the global economy, international security, the
and processes established to determine wage outcomes
environment, poverty and development, international
and manage interactions between employees and
law, and global health issues.
employers. Also known as industrial relations system.
United States-Mexico-Canada Agreement (USMCA)
World Bank is a financial institution owned by 189
came into effect on 1 July 2020. It is an updated version
member countries that assists poorer nations with
and replacement of the NAFTA. See also, North American
economic development through loans (often at little or
Free Trade Agreement (NAFTA).
no interest rates) to fund investment and reduce poverty.
Utility is the satisfaction or pleasure that individuals See also, Heavily Indebted Poor Countries (HIPCs).
derive from the consumption of goods and services.
World Trade Organization (WTO) is an organisation
of 164 member countries that implements and advances
global trade agreements and resolves trade disputes
between nations.
411
Index
Entries that are bolded are glossary protection in 143–58 C
entries. stance of monetary policy 312–15 capital
tariffs in 144–5 access to 59
A terms of trade 119–20, 172, 215, account 114
absolute advantage 387–8 217–18, 273, 293 capital and financial account 112,
advanced economies 30, 53, 54, 63, trade 34, 35, 36, 37 114–15
64, 66, 360 trade, changing composition 108–10 balance on 115
African conflicts 58 trade, changing direction 107–8 calculated 115
age 237, 242, 293 trade, comparative advantage 22 defined 114
aggregate demand 162–3, 164–6 trade agreements 146–8 capital markets
aggregate supply 163, 169–70 trade and financial flows 106–58 global 68
Agreement on Traded Related Aspects
trade patterns, trends 106–10 carbon
of Intellectual Property Rights
wealth distribution 232–3 emissions 153, 329, 332
(TRIPS) 58–9
Australia-New Zealand Closer leakage 153
agricultural sector 55, 66, 109, 121,
Economic Relations Trade tariffs 26, 110
145, 149, 152–3, 155, 156, 322
Agreement (ANZCERTA) 36, 146 carbon border adjustments 153
Aid for Trade program 58
Australia-United Kingdom Free Trade carbon tax 153
appreciation
Agreement (A-UK FTA) 37, 146 cash rate 302, 308–9
of the Australian dollar 132, 133, 139
Australia-United States Free Trade Central Asia 19, 63
ASEAN-Australia-New Zealand Free
Agreement (AUSFTA) 146 central bank digital currency
Trade Area (AANZFTA) 35, 146,
awards 342 (CBDC) 138
147
China 19, 22, 25, 26, 32, 37, 41, 49,
ASEAN Free Trade Area (AFTA) 31, B 51, 54, 56, 61, 63, 64, 65, 67, 69, 71,
35 balance of payments 112–16 107, 108, 109, 125, 136, 145, 153,
Asia-Pacific Economic Cooperation
balance/equilibrium 116 155, 156, 174, 215, 217–18, 224
(APEC) forum 34, 148
calculated 115 China-Australia Free Trade
Association of South-East Asian
constraint 124, 277 Agreement (ChAFTA) 37
Nations (ASEAN) 31, 34–5, 107,
defined 112 climate change/mitigation 43, 65, 69,
108
exchange rates and the 137–40 110, 121, 155, 254, 255, 262–3, 331,
Austrade (Australian Trade and
links between key categories 332–3
Investment Commission) 145
116–17 Climate Conference in Sharm (2022) 69
Australia
trends in Australia’s 117–24 coal exports 109–10, 121, 155, 174,
balance of payments, trends 117–24
balance on capital and financial 293
biodiversity 260, 261
account 115 commercial know-how 67
changing industrial structure 319
balance on current account 114 commodity markets
and corruption perception 61
balance on goods and services (BOGS) and globalisation 68
current account balance 122–4
(or trade balance) 113 commodity prices 17–18, 109, 117,
dumping complaints lodged 25
cyclical factors 119–20 119, 174
economic influences on 17
economy, COVID impacts on 180–1 structural factors 121–2 common law contract 343
(see also COVID-19) banking sector 56, 154 communication
effects of overseas protection Belt and Road Initiative (BRI) 41 transport and technology 11–13
on 152–4 bilateral trade agreements 30, 31, 33, comparative advantage 22, 388–9,
export assistance program 29–30 36–7, 146–7 390
external stability 215–29 biodiversity 260, 261 consumer confidence 17
financial flows, trends 111–12 brain drain 15 consumer expectations 164
floating dollar 116, 128, 132, 133, Brazil 19, 51, 54, 56, 61 Consumer Price Index (CPI) 203–4,
216 (case study) 76–88 205
floating exchange rate system Budget 277, 282–3 consumers
129–34, 210–11, 224–5 2063, looking ahead to 294–5 benefits from lower protection
foreign liabilities 220–3 financing a deficit 288–91 150–1
gap between savings and outcomes 283–4, 285–7 consumption
investment 123–4 business influences 164–5
in the global economy 103–58 expectations 165–6 contractor 344
and the HDI 51, 65 innovation 59 corporate tax avoidance 57
highly protected industries 28 business cycles corruption 61
industry future 155–6 defined 16 Corruption Perception Index 61
labour market outcomes 351–3 international 16–18, 71 cost-push inflation 206–7
lack of international regional 19 countries with violent conflict 61
competitiveness 121–2, 215–16, business firms COVID-19
217, 273 protection reduction effects and the “digital divide” 12, 58
narrow export base 121 on 148–9 impact 15, 33, 39, 48, 66, 150, 173,
412
Index
180–1, 191, 194, 249, 293, and development 63–5 ethnic background 239–41
296–7, 299, 309, 314, 341, 350, domestic 122 Europe 19
363, 368–9, 371 effects of 171–2 eastern 63
and internet usage 13 and environmental sustainability 276 European Union (EU) 19, 28, 31, 34,
and the labour market 341 equation 161 35–6, 44, 64, 107, 108, 152, 153
lessons from 150 and external balance 277 Eurozone crisis, recovery 7
recovery 200, 326, 357 inclusive 360, 368 exchange rates 7, 18, 119, 122, 124,
CP-TPP see Trans-Pacific Partnership and income differences 48–50 128–42, 210–11, 224–5
credit 112 level 190–1 and the balance of payments 137–40
cultural background 239–41 policies to sustain 176–7 and external stability 273
cultural factors 61–2 rates 120 fixed systems 135–7
culture and recent fiscal policy 295–7 introduction 128–9
entrepreneurial 59 recent trends in 172–5 and market forces 136
current account 112, 113–14, 273 and “the three Ps” 175 exchange settlement accounts 306
balance 122–4, 298 and uncertainty 209 Export Market and Development Grants
calculated 115 and wellbeing 271 (EMDG) 145
defined 113 economic institutions 61 exports 121–2, 125, 149, 155, 156
and reducing protection 151 economic issues 159–268 incentives/assistance 29–30, 145
current account deficit (CAD) 117, 215, economic management influences 166
216–19 and economic policies 269–374 external stability 215–29
consequences of a high 124–5 effectiveness, overview 356–61 and economic growth 171, 272–3
cyclical factors 119–20, 122 economic policies externalities 257–8
cyclical unemployment 187 limitations 361–6
and management 269–374 F
D economic resources 59–60 family structure 241–2
debit 112 financial account 114
economic skills, key 375–86
debt servicing ratio 221 financial crises 7, 13, 56, 128, 175, 293,
economic volatility 56
debt trap scenario 221 295, 309
economics, equations and calculations
decarbonising economies 332 financial derivatives 115
in 382–4
defence 25 financial flows 7–9, 17, 56–7
economics diagrams
deflation 211 financial markets
drawing and interpreting 377–82
deglobalisation trend 26 globalisation of 68
income-expenditure 391–2
demand-pull inflation 206
education 110, 156, 237, 349–51 movements 17, 56
depreciation
girls’ access to 59 role 70–1
of the Australian dollar 132, 133,
inadequate levels of training 193 financial sector 321–2
139–40, 210
educational attainment, levels 50, 51 financial services 156
deregulation 321–4
efficiencies 320 finished goods 67
developed economies 61
elaborately transformed fiscal policies 18, 173, 176, 282–301
developing economies/countries 30,
manufactures (ETMs) 121 and external stability 226
53–4, 56, 57, 58, 59, 61, 63, 66, 68,
emerging economies 54, 56, 60, 61, impact on economic activity 286
69, 153
65, 66, 121 impact on external balance 287
development
employee 344 impact on resource use 286
and economic growth 63–5
employment and inflation 212
economics 55
domestic, protection of 25 meaning 282–3
digital platforms 238–9, 324
and economic growth 171 recent, impact of 295–9
digital services 156
full 272 and unemployment 191–2
dirtying the float 135
enterprise agreements 343 floating exchange rate system 115–
Doha Round 38
entrepreneurial culture 59 116, 129–34, 210–11, 224–5
domestic factors 59–62
environmental damage/degradation 65, food security 25
domestic market operations (DMO)
68, 69, 261 forced labour 26
307–8
environmental economics 255 foreign aid 57–8
dumping, prevention 24
environmental factors 26, 50 foreign debt (or international
E environmental impacts 171–2 borrowing)
East Asia and Pacific region 63 environmental issues, major 260–4 57, 116, 117, 124, 216, 273
East Asian region 19 environmental management policies foreign direct investment (FDI) 9, 56,
ecologically sustainable development 328–35 60, 68, 111
255–6, 273 environmental preservation 69 foreign equity (or foreign investment)/
economic analysis, advanced 387–97 environmental protection foreign ownership 116–17, 124,
economic data and information, international agreements 332, 334, 216, 222
interpreting 384–6 335 foreign exchange market (or forex
economic development laws, lower 68 market) 7, 128
defined 50 market-based incentives for 330–1 equilibrium 116
differences 50–2 market-based policies for 333 RBA intervention in 134–5
and globalisation 47–73 environmental services 156 foreign liabilities 125, 220–3 see also
and living standards 47–8 environmental sustainability 254–68, foreign debt; foreign equity
economic growth 161–79 273, 276 free rider behaviour 259
constraint 124, 192 equilibrium 163 free-to-air television 29
413
Australia in the Global Economy 2024
free trade see trade, free and higher incomes 50 and inflation 211
free trade agreements (FTAs) see trade, real 161, 171, 175 negative 309
agreements, free Gross National Income (GNI) 48–9, 51 intergenerational equity 256
Gross World Product (GWP) 4 international borrowing (or foreign debt)
G Group of Seven (G7) 17, 43 57, 116, 117
G20 (Group of Twenty Nations) 44 international business cycles 16–18,
gas exports 109–10, 121, 156, 174, 293 H 71
gender 238–9 high-income economies 64 defined 16
inequality 61–2 “High Seas Treaty” (2023) 69 factors that strengthen 18
pay gap 346 households 241–2 factors that weaken 18
General Agreement on Tariffs and Trade Human Development Index (HDI) international competitiveness 121–2,
(GATT) 38 50–1, 65, 106 129–30, 151–2, 210, 215–16, 217,
Gini index 66 273
girls’ access to education 59 I international finance 7
Glasgow Climate Pact (2021) 69 imported inflation 207
international financial rules 56–7
global aid and assistance 57–8 imports 166
International Monetary Fund (IMF) 9,
income
global economy 1–103 37, 44, 58
differences and economic growth
development categories 53–4 role 39–40, 57
48–50
explained 3 international organisations 18, 37–43
distribution 50, 171, 210, 231–2,
future of Australian industry in the internet 58
236–44, 273, 275, 287, 299
155–6 investment see also foreign direct
and global wealth distribution 50, 61
inequality, causes 55–62 investment (FDI)
inequality 66, 232
introduction 2 direct 111, 114–15
sources 234–5
and trade 22–46 flows 17, 61
and wealth relationship 244
global factors 55–9, 364–6 foreign 116–17, 123
India 19, 25, 49, 51, 56, 61, 63, 64, 107,
global financial architecture 56–7 inadequate levels 193
108, 156
global financial crisis 13 and inflation 209
Indigenous Australians 240–1, 361
recovery 7 influences 165–6
individuals
global free trade agreements 31 other 115
protection reduction effects on
global goals 52 portfolio 111, 112, 115
149–51
global interest-rate levels 17 and transnational corporations 9–11
Indo-Pacific Economic Framework
global technology flows 58–9 investor confidence 17, 227
(IPEF) 33
global trade system 55–6 loss of international 125
Indonesia 51, 54
global wealth distribution 50, 61 iron ore 155, 174, 215, 293
(case study) 89–102
globalisation 4–15
industrial relations systems (state) J
commodity markets 68 338–9
and economic development 47–73 Japan 19, 49, 64, 107, 108, 152
inequality 230, 236–7 jobs
effects 17–18 costs and benefits 245–8
explained 3 face-to-face 66
gender 61–2 shifting 194
future 60 and geography 242–3
government responses to 62 “just in time” global supply chains 25
in the global economy, causes
impact 63–73 55–62 K
and social media 12 and government policies 248–51 Korea-Australia Free Trade
government economic forums 43–4 high levels 60 Agreement (KAFTA) 146
government expenditure/spending horizontal 62 Kyoto Protocol (2005-20) 69
and cutting tariffs 151 income 66, 232
influences 166 women 62 L
government policy 62, 207–8, 215 infant industries 24 labour
contractionary 125 inflation 203–14 costs 193
decisions 18 benefits 211 demand for 190
effectiveness, evaluating 366–72 causes, main 206–8 dispute resolution 345–6
and environmental sustainability and economic growth 171 forced 26
265–6 effects 209–11 and income inequality 66, 232
goals in 2024 274–5 policies to sustain low 211–12 lower standards 68
and inequality 248–51 rate, measuring 203–4 and migration, international division
objectives 271–81 targeting 205, 303–5 13–15
objectives, conflicts 276–8 trends, recent 205–6 productivity 192–3
government procurement 154 underlying 204 supply and quality 59
government revenue inflationary expectations 207 labour, international division of 14
and cutting tariffs 151 infrastructure services 156 labour force 182–3
governments institutional factors 60–2 labour force participation rate (LFPR)
protection reduction effects on 151 institutional fragility 61 183
Great Barrier Reef 329 intellectual property 58–9, 67 labour market policies 177, 249,
Green Climate Fund 69 interest rates 18 338–55
Gross Domestic Product (GDP) and the cash rate 308–9 labour markets 13
benefits of trade on 151 changes 122, 310–11 decentralisation of 347–9
defined 16 global 17, 117, 225 inflexibility 193
414
Index
outcomes, evaluating 351–3 natural barriers 153–4 overall impacts on global economy
Latin America 19, 64 natural disasters 109, 121, 260, 262–3 30
law enforcement, lack 61 natural environments, preserving 260–1 public good 259, 286
least developed countries (LDCs) 54, natural resources 59, 263–4 public trading enterprises (PTEs)
56, 68 net errors and omissions 115 reforms 324–5
life expectancy 51 net goods 113 pull factors 13
lithium 156, 174 net primary income 113 purchasing power parity (PPP) 49
living standards 60, 65, 151, 327 net secondary income 113 push factors 13
and economic development 47–8 net services 113
and economic growth 171 net zero emissions Q
local content rules 29 by 2050 332, 368 quality of life 271
transition towards 266, 274–5 indicators 50
M New Zealand 36, 107, 108, 112, 210, quotas
macroeconomic management 278, 260 defined 28
368–71 non-accelerating inflation rate of
macroeconomic policies 176, 278–9 unemployment (NAIRU) 189–90, R
limitations 395–7 272 regional business cycles 19
and unemployment 191 North Africa 63–4 Regional Comprehensive Economic
manufacturing sector 109, 121, 144, North American Free Trade Partnership (RCEP) 34, 146, 147
153, 156 Agreement (NAFTA) 34, 36 regional factors 18
market failure 256–8 regional trade agreements (RTAs) 31,
microeconomic management 371–2 O 33, 36
microeconomic policies 177, 279 occupation 238–9 regional trading blocs 55
and aggregate supply 318–21 offshoring 15 regulations
future 326–7 Okun’s Law 186 effective 323–4
and individual industries 321–8 on-shoring 15 environmental 329–30, 333
and inflation 212 opportunity cost 22 research 59
overall impacts 327–8 Organisation for Economic reserve assets 115
microeconomic reform 226, 251, Cooperation and Development Reserve Bank of Australia (RBA) 17,
321–8, 371–2 (OECD) 42, 57–8, 145, 152, 244, 173, 302, 303, 306–9, 312–15
microfinance 59 327, 360 appointment of a new Governor 305
Middle East 63–4 and CBDC 138
migration P and inflation 212, 367
and labour, international division Pacific Agreement on Closer Economic and inflation targeting 205, 303–5
13–15 Relations Plus (PACER Plus) 35, intervention in the foreign exchange
Millennium Development Goals (MDGs) 146, 147 market 134–5
52 Paris Agreement 69, 335 main economic indicators used 305
mining phantom aid 57 monetary financing 289
boom 109, 174, 293 Phillips curve 210, 276 resources
sector 109–10, 121, 153, 155–6 long-run 393–4 allocation 297–8
modern monetary theory (MMT) 397 Pitchford thesis 219 sector 153, 155, 174
monetary policy policy rate corridor 306–7 retaliation effect 27
contractionary 302, 369–70 political consequences, tariff reduction Russia 56, 61, 64, 65, 71, 110, 172, 293
conventional 310 151
decisions by RBA 135 political constraints 362–4 S
and the distribution of income and political instability 61 savings 287
wealth 251 political institutions 61 domestic, low 112, 117, 123–4
expansionary 302, 314 pollution 261–2 and inflation 209
and external stability 226 poorest people 59, 60, 61 national 298
implementation 306–10 population growth rates 175 national, low 226
and inflation 211–12 poverty 61, 62, 246–7 savings-investment gap 218
influences 17, 176 preferential trade agreements 31 services sector 109, 110, 121, 153,
loosening 311 price stability 272 154, 156, 194
objectives 302, 303–5 primary income account 122–4 slavery, modern 26
pre-emptive 173, 212 cyclical factors 122 social media
stance in Australia 312–15 structural factors 123–4 and globalisation 12
tightening 311 private good 259 social security transfers 66
unconventional 309–10 professional services 156 South Asia 19, 49, 54, 63
and unemployment 191–2 protection speculators 8, 56
money supply, excessive increases 208 implications of reducing 148–52 Sri Lanka (case study) 74–5
multilateral development aid 58 initiatives to reduce 144–5 stagflation 210
multilateral trade agreements 30, 31, introduction to 143 structural factors 18, 121–2, 123–4
32, 33, 34, 35, 146, 147–8 main aims in reducing 143 structural unemployment 151, 186
multiplier 167–9 methods of 27–30 structurally unemployed 150
overseas, effects of 152–4 Sub-Saharan Africa 19, 49, 55, 64
N reasons for 24–26 subsidies
national competition policy 325–6 protectionism economic effects of 29
national security 25, 26 in the agricultural sector 55 explained 29
415
Australia in the Global Economy 2024
superannuation 235, 239, 250–1 in goods and services 4–6 United States 24, 25, 26, 32, 37, 49, 57,
guarantee 226 liberalisation 33, 151, 152 64, 71, 107, 108
supply chains 25, 67, 143, 150 reforms 55–6 United States-Mexico-Canada
Sustainable Development Goals (SDGs) through global value chains 67 Agreement (USMCA) 31, 36
52 trade balance see balance of goods and
services (BOGS) V
T Trade Weighted Index (TWI) 132–3, vaccines 25, 34, 59, 144
tariff quotas system 28 135 valuation effect 138
tariffs 36, 144–5, 149, 150, 151, 152–3 training 349–51 value chains
carbon 26, 110 inadequate levels 193 trade through global 67
defined 27 Trans-Pacific Partnership (CP-TPP or vertical specialisation 67
economic effects of 27 TPP-11) 32–3, 34, 146, 147
taxation 249–50, 274, 293, 331, 351 transfer payments 235, 249–50 W
influences 166 transnational corporations (TNCs) 10 wage determination system 340–4
technical cooperation 57 digital 12 wage level, differentials 26
technology and global upturns and downturns wages
access to 59 17 growth, weak 352
change 192, 361 and investment 9–11 and inflation 209–10
change, impact 66 and trade investment 66–8 minimum 341
flows, global 58–9 transport wealth
transport and communication 11–13 communication and technology distribution 232–3, 236–44, 273, 275
telecommunications industry 323 11–13 and income relationship 244
terms of trade 390 industries 323 sources 235
Australia’s 119–120, 172, 215, wealth effect 175
217–18, 273, 293 U wellbeing 50, 65, 256, 271
calculating 119 Ukraine 13, 19, 25, 26, 43, 57, 64, 65,
Budget 277
defined 119 70, 71, 110, 121, 143, 155, 172, 206,
women
tied aid 57–8 215, 293
and domestic violence 62
time lags 361–2 unemployment 182–202
economic inequality 62
tourism 110, 119, 154, 156 causes 190–4
rights 62
TPP-11 see Trans-Pacific Partnership impacts 195–7
trade workforce participation 175
and inflation 210
agreements 30–7, 145 and recent fiscal policy 297
level, measuring 182–4
agreements, free 30, 31, 33 non-accelerating inflation rate of workplace relations systems (national)
barriers 37 189–90 338–9
bloc 31, 34, 36, 55 policies to reduce 198–200 World Bank 13, 37, 44, 56, 58
composition of 6 and recent fiscal policy 297 role, funding and goals 40–1
diversion 31, 37 trends, recent 185–6 World Trade Organization (WTO) 37
economic benefits 151 types, main 186–8 anti-dumping complaints and
flows 17 unemployment rate 183 measures 25, 145
flows, direction 6 equation 183 defined 5
free, advantages of 22, 23 United Kingdom (UK) 18, 37, 49, 107, history and role 38–9, 155
free, disadvantages of 23 260 restriction on use of export
free, explained 22, 23 United Nations 58, 69 incentives 30
gains from 389–90 role 41–2 trade agreements 31, 145
gap, CAD as a 217–18 United Nations Conference on Trade trade initiatives 58
in the global economy 22–46 and Development (UNCTAD) 34 trade reforms 55–6
416
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417