PEARSON ECONOMICS 12

AUSTRALIA IN THE
GLOBAL ECONOMY
2024

Tim Dixon • John O’Mahony

PEARSON ECONOMICS 12
AUSTRALIA IN THE
GLOBAL ECONOMY
2024

Tim Dixon • John O’Mahony

Pearson Australia
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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

Chapter 2 Trade in the Global Economy

2.1 Advantages and disadvantages of free trade 22
2.2 Reasons for protection 24
2.3 Methods of protection 27
2.4 Trade agreements 30
2.5 International organisations 37
2.6 Government economic forums 43

Chapter 3 Globalisation and Economic Development

3.1 Introduction 47
3.2 Differences in income and economic growth 48
3.3 Differences in economic development 50
3.4 Categories of development in the global economy 53
3.5 Causes of inequality in the global economy 55
3.6 The impact of globalisation 63

Case Studies
Economic collapse in Sri Lanka 74
Brazil 76
Indonesia 89

TOPIC 2 AUSTRALIA’S PLACE IN THE GLOBAL ECONOMY

Chapter 4 Australia’s Trade and Financial Flows
4.1 Understanding Australia’s place in the global economy 106
4.2 Trends in Australia’s trade patterns 106
4.3 Trends in Australia’s financial flows 111
4.4 The balance of payments 112
4.5 Trends in Australia’s balance of payments 117
4.6 The consequences of a high CAD 124

Chapter 5 Exchange Rates

5.1 Introduction 128
5.2 Australia’s floating exchange rate system 129
5.3 Reserve Bank intervention in the foreign exchange market 134
5.4 Fixed exchange rate systems 135
5.5 Exchange rates and the balance of payments 137

Chapter 6 Protection in Australia

6.1 Introduction 143
6.2 Government initiatives to reduce protection 144
6.3 Australia’s free trade agreements 146
6.4 Implications of a reduction in protection levels for the Australian economy 148
6.5 The impact of international protection levels on Australia 152
6.6 The future of Australian industry in the global economy 155
TOPIC 3 ECONOMIC ISSUES
Chapter 7 Economic Growth
7.1 Introduction 161
7.2 Economic growth and aggregate demand and supply 162
7.3 The components of aggregate demand 164
7.4 Changing levels of growth: the multiplier process 167
7.5 The role of aggregate supply 169
7.6 The effects of economic growth 171
7.7 Recent trends in economic growth 172
7.8 Policies to sustain economic growth 176
COVID-19: The impacts on the Australian economy 180

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

Chapter 10 External Stability

10.1 Introduction 215
10.2 Australia’s current account deficit 216
10.3 Australia’s foreign liabilities 220
10.4 Australia’s exchange rate 224
10.5 Policies to achieve external stability 226

Chapter 11 Distribution of Income and Wealth

11.1 Introduction 230
11.2 Measuring the distribution of income and wealth 231
11.3 Sources of income and wealth 234
11.4 Trends in the distribution of income and wealth 236
11.5 The costs and benefits of inequality 245
11.6 Government policies and inequality 248

Chapter 12 Environmental Sustainability

12.1 Introduction 254
12.2 Ecologically sustainable development 255
12.3 Market failure: private benefits and social costs 256
12.4 Public and private goods 259
12.5 Major environmental issues 260
12.6 Government policies and environmental sustainability 265
TOPIC 4 ECONOMIC POLICIES AND MANAGEMENT
Chapter 13 The Objectives of Economic Policy
13.1 Introduction 271
13.2 The objectives of economic management 271
13.3 The goals of government policy in 2024 274
13.4 Conflicts in government policy objectives 276
13.5 The economic policy mix 278

Chapter 14 Fiscal Policy

14.1 The meaning of fiscal policy 282
14.2 Budget outcomes 283
14.3 Changes in budget outcomes 285
14.4 Methods of financing a deficit 288
14.5 The current stance of fiscal policy 291
14.6 The impact of recent fiscal policy 295

Chapter 15 Monetary Policy

15.1 Introduction 302
15.2 The objectives of monetary policy 303
15.3 The implementation of monetary policy 306
15.4 The impact of changes in interest rates 310
15.5 The stance of monetary policy in Australia 312

Chapter 16 Microeconomic and Environmental Policies

16.1 Microeconomic policies and aggregate supply 318
16.2 Microeconomic policies and individual industries 321
16.3 Environmental management policies 328

Chapter 17 Labour Market Policies

17.1 Introduction 338
17.2 The role of national and state workplace systems 338
17.3 Australia’s wage determination system 340
17.4 Dispute resolution 345
17.5 Decentralisation of the labour market 347
17.6 Education, training and employment programs 349
17.7 Evaluating labour market outcomes in Australia 351

Chapter 18 Effectiveness and Limitations of Economic Policy

18.1 An overview of the effectiveness of economic management 356
18.2 Limitations of economic policy 361
18.3 Evaluating the effectiveness of specific policies 366

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

Appendix B Advanced Economic Analysis

B.1 Comparative advantage and gains from trade 387
B.2 Income-expenditure diagram 391
B.3 Long-run Phillips curve 393
B.4 Limitations of macroeconomic policy 395

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
Global Ec
the
onomy
The text is divided into four Topics, following the structure of the

*
2.1 Advantage
s and disad
2.2 vantages
Reasons of free trade
for protection
2.3 Methods
of protection
2.4

Year 12 Economics syllabus. Each Topic is introduced by a page

Trade agree
ments
2.5 Internation
al organisatio
2.6 Governme ns
nt economic
forums

that includes the relevant Focus, Issues and Skills for that Topic, Trade has playe
the fastest growtd a critical role in
In the 21st
rising levels
h in the the expansion
century the global economy have
world’s fastes
of the globa
also been periodl economy. The period

reflecting the syllabus objectives. This is followed by a clear

the structure of trade. Trade has broug t-growing economies s of rapid s of
of many econo ht countries are typically growth in trade.
mies. together, create econo
This chapt
er examines d wealth and mies with
policies that the re-shaped
have restricted economic theory behin
institution
s in trade flows and facilitated trade, d trade relationshi
ps, governmen

introduction to each chapter within the Topic.

, financial flows and the role
and foreign playe d by intern t
2.1 Advantag
investment
. ational

es
of free tra and disadvantag
Comparativ
is the econo
e advantage Among econo de es
mic princip mists, there
that nation le achieve highe is widespread
s should r
specialise
in the areas remain signif levels of growth in a agreement
on the princ
icant (even free iple that econo
of production trend towar rising in recen trade environment.
they have
in which ds greater free t years), the Although barrie mies will
the lowest trade in the world has rs to trade
opportunity
cost, and Free trade global econo experienced
can my. a long-term
trade with
other to trade that be defined as a situat
so as to maxim nations restrict the ion
nations’ standa ise both
aim of shield free exchange where governments
Policy ing domestic of impo
r 14:
Fiscal of living. rds producers from goods and services betwese no artificial barriers
Chapte The argum
ent foreig n comp etitors.
en countries
with the
The principle for free trade is based
on the econo
Opportunity goods more of comparative advan mic concept

w
cost efficiently than tage states of comparativ

er revie
represents that even if
the
use of resour alternative
specialises
in the produ another count
ry, trade one country e advantage.
ces. Often comparativ ction of the can produce
good in which will still benefit both

chapt
referred to e efficiency all
as the “real” within that is measured it countries if
cost, it repres
ents the cost country. Thus, by the oppo is comparatively more each
of satisfying lower than rtunity cost efficie
one
over an alterna want
in China (that if the opportunity of producing nt. This
up producing is, in order cost of producing each good
tive want. a to produce
This is also
known as have a comp smaller quantity of smart an extra tonne iron ore in Australia
economic arative advan phones than of iron ore, is
cost. cost of produ tage in iron does China Australia gives
cing smart ore
have a comp phones in China production. At the same), then Australia is said
arative advan time, if the to
tage in smart is lower than in Austr oppor
22 phones. alia, then China tunity
icit and Economy 2024 is said to
cy. lus, def in the Global
by fisc
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chapter summar
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uish bet balance
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cy. rating
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maj or inst
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e the erlying get stan budget
3 Describ the und the bud in the
ween about al role ent’s Budget to
uish bet h indicates -cyclic wealth Governm

*
Disting a counter the use of the Common g economic activity, resource
4 what eac rs play Fiscal policy involves
Explain stab ilise g: 1 ent’s objectives
by influencin
matic the follo
win
achieve the Governm
how auto acts on distribution.

Each Chapter concludes with a 10-point

Explain cy imp allocation and income n
5 g, revenue collectio
fiscal poli government spendin
Out line how tools of fiscal policy are changed once each year in the
2 The main are usually
6 growth outcome. These released in May.
nomic and the budget which is usually
(a) eco Government Budget,
Commonwealth budget stance
urce use or balanced. The
(b) reso get def icit. can be a surplus, deficit on the state of the
The budget outcome

Chapter Summary and 10 Chapter Review

ribution a bud 3 of fiscal policy
me dist finance of the overall impact contractionary
or neutral.
(c) inco ment can
y. gives an indication expansionary,
govern debt. econom be described as
foreign tralian economy and can
how the debt and the Aus are the underly
ing cash
Explain public cy on of the budget outcome known as cash
7 ween fiscal poli The two main measures an accounting method
uish bet nges in years. 4
is calculated through net operating
Disting nt cha recent outcome, which spending, and the
8 of rece during
impact which includes capital accounting method
as revenue

questions. The Chapter Summary is a good

cuss the deficits accounting and d using a different
Dis ds in budget , which is calculate .
9 balance ure removed
the tren , with capital expendit
ount for minus expenses of the
10 Acc the sustainability
best indicator of
g balance is the expenses and revenue
The net operatin between recurrent
5 it shows the gap ay spending).
fiscal strategy because spending and day-to-d
hes between capital impact

starting point for your notes on each Chapter,

(that is, it distinguis of the short-term
is the best indicator
cash outcome it shows actual cash
The underlying activity because
fiscal policy on the level of economic
of
in a year.
revenue and spending discretionary
s are affected by
and budget outcome the government,
and
6 Spending, revenue policy changes by of changing

and the review questions are a great way to

factors, involving to the impact
or structural which relate
ry or cyclical factors, collection.
non-discretiona spending and revenue
s on the levels of
economic condition as automatic
income tax are known nt of the
and progressive compone
7 Unemployment benefits are a built-in counter-cyclical
they
stabilisers because

test your understanding of the Chapter.

Budget. private sector,
through borrowing from the
is usually financed on interest rates.
A budget deficit put upward pressure
8
national saving and may or from the Reserve Bank
which reduces overseas
by borrowing from
It can also be financed ent assets.
or by selling governm
(printing money), policy. Monetary
plays a limited role in macroeconomic ns in growth and
policy fluctuatio
9 Generally, fiscal to control short-term play an
the primary tool fiscal policy can
policy is usually of economic crisis,
, during periods
inflation. However 301 e
demand.
supporting aggregat
important role in onary stance during
the
or mildly contracti
to its generally neutral very expansionary
10 In contrast fiscal policy to a 9 pandemic.
Government shifted from the COVID-1 Australia in the Global
2010s, in 2020 the e Australia’s recovery onary stance. Economy 2024
to accelerat contracti
stance, helping returning to a mildly
policy has been
More recently, fiscal

1 Describe the Governm

reviewquestions
economic growth. ent’s economic objective
s of internal stability
and
2 Discuss how effective
achieving external you believe the Australian
stability in recent Government has
economic objective years. Has this goal been in
s? conflicted with other
300

*
13.3 The goal
s of governme
in 2024 nt policy

This year’s edition also includes:

Although the broad
objectives of economic
to the next, over time policy remain largely
some the same from one
less important. Changing objectives become higher priorities year
economic condition while other goals become
priority at different s influence which goals
times.
in 2022, can sometime The election of a new government or Prime receive the highest
s lead to significan
examines the current t changes in economic Minister, as occurred
objectives of economic priorities. This section

• analysis of changes in economic policy

policy in Australia.
Containing inflation
ary pressures
After three decades
of low inflation, price
recovered from the pressures re-emerge
COVID-19 recession. d as the
short-term priority This makes containin Australian economy
of economic policy. g inflation the highest
the Reserve Bank As inflation surged

under the Albanese Government,

implemen to 6 per cent in 2022–23
Bank was granted formal ted the most aggressive tightenin ,
independence. While g cycle since the Reserve
achieving the goal monetary policy plays
of low inflation, fiscal the central role in
included measures to policy also plays a Chapter
contribute to lower 3. Achi role. The 2023–24 13: The Objec
although some economis inflation by reducing eving econ Budget tives of Econo
of the cost-of-living
ts argued that this
positive effectThewould
energy costs foromic grow
household s, th and exter mic Policy
goverbe

including reforms to the RBA, the labour

measures, including nmen outweigh
t also faces
ed bythe nal balan
domestic demand. an increase inand external balan
JobSeeker some
challenge of ce
account on paymentsce. Stron
, adding managing
g econotomic
the growth often conflicts between econo
Fiscal consolidation increased consu balance of payments. results in a mic growth
High deterioratio
In response to the This is know mption and investment er economic growt n in the curren The balanc
COVID-19 pandemic n as the balan , which will h is usually t e of payme
spending to ensure , the Governm the rate of ce of paym cause the volum associated with constraint nts
minimal disruptio growth becau
ent undertook ents const reflects the

market and climate policy

n to the economy, unpreced
se ented raint, which e of impo extent to
health. At the time
of the 2021 Intergene while protecting the of the impact of high refers to the rts to rise. which
current accou a high
stay in deficit until rational Report, public growth on limitation
2060. However, this AUSthe TRA Budget
LIA’was forecast to
the current
account defici
on limits the
nt deficit
commodity prices
leading to a one-off
outlook has since improved S FIRS T WELLBE t. the econo
speed at which
15 years. With the budget surplus for , with a surge in ING BUD my can grow.

major medium-term
budget returning to
deficit
2022–23
Treasu rer Jim, the
Chalm first surplus in GET
priority for the Albanese in 2023–24 long-t
, fiscal
erm consolida
ers annou
economiction remains nced a signifi
include increasing Governm ent.
introd Measures policy a
goals in cant shift
tax on uced a new in
taskforce to crack down multinational companies and social to frame
increase revenue July 2023 Zealand and

• the impact of rising interest rates and the

funding work for meas when Germany.
on tax avoidance.
reporting
an Australia
wellbe ing. Tradit Tax Office uring economic he
n ionally policy outco
mes by
These frame
works can
on the econo , the Austra and the intera guiding policy influence
Transition towards such as my has lian Treasu ction betwe makers to
“net zero” emissio growth, inflatio focused ry’s measures en econo consider
One of the major ns framework, n and unem on meas of prosperity mic goals
economic challenge set out in ures and susta and broad
ployment. inability. er
transition away from s confronting allidenti fies 50sindica
economie
the Meas
uring What The new The Gover
nment plans
relying on fossil fuels, prosperity.
is to tors
accelerate
that provid
their Matters paper dashboard to update
change. Australia is
a large emitter of greenhouwhich are chiefly , the frame

cost-of-living crisis
responsible for climatee a broader meas to be made
of indicators
annually, work’s online
settings relating to se gases ure of though a
emission reduction Ofon a per-capita
these on how often decision is
the past two decades. s have been uncertain 50 indica basis, and policy released. a reporting yet
and tors: While some statem
Concern about climate • constantly changing ent will be
of the Labor Governm change was a 20 show
significantrend improveme over
reporting
framework
economists
questioned
ent expec tancy,t factor would lead whether the
a commitment to reduce in 2022. After it came to office, the experience
nt over time,
in the election
including
it reflects
the way in to actual policy
carbon emissions by peopl and Government legislated of discriminat life our traditi which gover changes,
achieve “net zero” emissions 43 per cent one,2005 waste gener ion,
ated per perso trust in other
onal econo
mic objec
nments increa
singly see
by 2050. The process • 12 show levels by 2030 and and not just tives as a
of transform a trend n. as ends in means to
ing Australia
diversity, ’sdeteri oration, themselves. an end,

• the global shift towards increased support

productivity economy in including
national gover , homelessne biological “The measu
274 nment. ss and res are in
trust in more traditio addition
• The remai nal ways to, not instea
ning 18 show employment we measu
unchanged, mixed outco , inflation re our econo d of, the
mes or are The Gover and wages my like GDP,
such as nment’s primar .
of people life satisfa largely and laying
experiencin ction, the the found y focus is
psychologic g high or proportion important ations for addressing
future growth inflation

for domestic industries

al distre very high that we simult
ss, and levels of our econo
inequality. income mic and social aneously work on but it
and wealt is part of goals … Measu better aligninis
The devel h a delibe rate effort ring g
opment of fairness and to put people What Matters
a wellbeing about our opportunity and progre
follows in at the very ss,
the footst framework economy
and our societ core of our
eps of Scotla in Austra future.”
nd, Wales lia y, now and thinking
, Canada, – Dr Jim Chalm into the
New
Other conf ers, Treasu
rer, July 21
licts in obje 2023 (media
ctives

• a detailed analysis of the 2024 Budget.

The pursuit release)
of
income distri economic growth can
bution. Econo sometimes
on road tolls mic reform come at the
and other s cost of
distributional user-pays charg may have negative social greater inequality
consequenc es for publi effects, such in
of the labou es
r market may for people on lower incomc services, which can as relying
but also increa have positive es. Decentralisa have negat
se impacts on ive
are often viewe wage dispersion and labour produ tion and dereg
ctivity and ulatio
d as conflicting contribute economic growt n
have recent objectives to inequality.
ly developed While growt h,
gains more “inclusive growt that governments must h and inequ
ality
evenly actual choos
educational ly helps the h” principles, which sugge e between, economists
opportuniti
the future. es has positi economy grow. Givin st that sharin
g economic
Increasing ve social outco g childr
with highe femal mes and impro en in poverty greate
r levels of firm e representation in r
and wealth productivit business leader ves the labour marke
is a long-term y. Achieving ship positions t in
challenge for gover a more equitable distri is associated
The governmen nment policy bution of incom
longer-term t also experiences a range . e
objectives.
the fact that The conflicts of other policy conflicts

Glossary
the policies between short- between short
aimed at long- er-term and
term goals oftenand long-term object
involve signif ives result from
icant struct
ural change

*
Agreement
Free Trade between
nited States agreement
Australia-U bilateral free trade force
of people with is a came into 277
the condition (AUSFTA) States, which
ty refers to economy, and the United
Absolute pover standards in the global US$1.90 per Australia and

A
ission
living than in 2005. mer Comm
the lowest e level of less and Consu role
by an incom
Australian
Comp etition watchdog whose and
is measured .
incom e, competition er Act 2010
relative poverty to high- (ACCC) is
Australia’s and Consum
day. See also, refer of Compet ition anti-co mpetit ive
econo mies ies. The group e the in
Adva nced or developed econom is to enforc do not engage
ies across North businesses
industrialise
d 39 econom ensure that is
ies includes behaviour. s (ACTU)
advanced econome and the Asia-Pacific. Trade Union

The comprehensive Glossary at the back of

d for Council of g most
ca, Europ total deman alian in Austra lia, coverin
Ameri to the of Austr union body
demand refers economy. Components the peak trade
Aggregate s within the
investm ent (I); . rity (APRA)
service ption (C); trade unions Autho
goods and Regulation to regulate
all
d are: consum s (X-M). Prudential
aggregate deman ng (G); and net export ty Australian body established l insura nce
spendi capaci ment genera
government productive is the govern institutions, life and
to the total when all g
supply refers ial output deposit-takin on funds.

the text provides a ready reference for more

Aggregate
y, that is,
the potent and superannuati ments Comm
ission
of an econom tion are fully utilise
d. organisations and Invest sibility
ability to Securities with respon
factors of produc economy’s Australian ment body and the
refers to the valued and
can the govern er protection
efficiency (ASIC) is tion, consum ts.
Allocative to where they are most ic efficiency and ate regula
shift resour
ces
See also, dynam for corpor produc
efficiently. financial service Commission
be used most oversight of Investment assists
y’s Trade and sation that

than 350 key economics terms and concepts.

cy. of an econom
technical efficien e in the value cy. See also, Australian a government organi overseas
is an increas is developing
Appreciation another curren (Austrade) succeed in
terms of exporters to
currency in Australian
an nt in the
process in which markets. ents inhere
depreciation. resolution are instrum ic
is a dispute binding ruling Automatic
stabilisers rbalance econom
Arbitration down a legally budge t that counte economic activity
al hands tion. ment’s se
industrial tribun yees. See also, concilia govern , they decrea activity. The
Trade Area a boom period e economic
to firms and
emplo activity. In on, they increas and a
Zealand Free ent in effect r payments
stralia-New and, in a recessi examples are transfe
ASEAN-Au is a regional trade agreem most comm system.
on
ZFTA ) ) is the
(AAN tax me (APC
a regional
free progressive to consu ption.
from 2010. (AFTA) is 10 prope nsity that is spent on consum
Trade Area covers the Avera ge e
ASEAN Free signed in 1992 which proportion
of total incom to consume.
ent
trade agreem ers. See also, ASEAN. al propensity proportion
(APEC) forum lia
is See also, margin (APS) is the for future
ASEAN memb Cooperation nsity to save is saved
c Economic ies including
Austra Average propethat is not spent, but save.
Asia Pacifi econom of total incom
e al propens ity to
Asia-Pacific economic integration. See also, margin e
a group of 21 and consumption. of total incom
tes free trade ns (ASEAN) proportion al
that promo Asian Natio ns of tax is the of a tax. See also, margin
of South-East reduce regional tensio Average rate form
Association to g with is paid in the
ished in 1967 approaches in dealin dia, earned that ng
was establ and worki
p cooperative i, Cambo rate of tax. um wage ry,
and to develo ers are: Brune ish the minim on their indust
ies. Its memb Myanmar, Philippines, Awards establemployees depending
outside countr sia, streamlined
Laos, Malay conditions
for ctured and
Indonesia, and Vietna m. or workp lace. Restru .
Thailand Trade occupation
ration and n awards

B
Singapore, mic Coope free known as moder
dia Econo is a regional awards are of the transac
tions
Australia-In dia ECTA) is the record during a
(Australia-In payments the world
Agreement signed in 2022. ons Balance of and the rest of t and the
ent mic Relati lia t accoun
trade agreem d Closer Econoa bilateral free between Austra of the curren
ew Zealan , consisting
Australia-N CERTA) is d, given period t.
ment (ANZ and New Zealan financial accoun t outcome
in which
Trade Agree between Australia capital and the budge
ent budget is to government
trade agreem in 1983. Balanced e is equal
which came
into effect Agreement taxation revenu
om Free Trade d the level of
nited Kingd which entere
Australia-U agreement spending.
is a free trade
(A-UK FTA)
in 2023.
into force

398
Australia
in the Globa
l Economy
2024

7.8 Policies
to susta

*
For furthe
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growth perfor
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mance of A major aim
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visit the recent my, allow natio manageme
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policies will the goal of .
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or Australian
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ions relative se expenditur to increa nment
Alternatively, to leakages
and e or do both. se the level of economic
or governmen economic growth would cause an upturn in the This would increase
the
stimulating t expenditure was reduc be constrained if taxati level of economic grow
grow ed. Generally, on receipts th.
fast. The JobK th during a down fiscal policy were increa
turn is more effect sed
to the Austr eeper wage subsidy and than slowing down ive
alian Governme increased JobSe an econo in
good exam
ples of fiscal nt’s response eker welfare my that is growing
policy in action to the COVID-19 payments were
centr
The Governme recession in
. 2020–21 and al
Monetary policynt is also able to use are
involves the monetary
rates in the polic
economy, which Reserve Bank of Austr y to influence econo
rate of econo in turn influe alia influencing mic growth.
mic growth. nces the level the level of
reduced to If the RBA

Throughout the text, you will find references to

encourage of intere
interest rates consumer and wants to stimulate aggregate demand and st
can business spend growth, intere the
for influencing be raised. Monetary st
policy has been ing. Conversely, to decrerates can be
has been quest the level of economic the main macro ase grow
years despi ioned. Prior
to the pande
growth in
recent years, economic policy th,
te a tool
also questionedperiod of very low intere mic, economic grow although its effectivene

organisations whose websites are relevant to that

as the RBA st rates. The th remai ss
rises in 14
months. sharply increa effectiveness ned weak for several
sed interest of monetary
rates in 2022 policy was
and 2023,
with 12
%
$

area of study.
12.0 Economic
growth
10.0 Inflation
Unemployme
8.0 nt
Current Accou
6.0 nt
4.0
2.0
0.0

1983
–2.0

1986

1989

1992

1995
*
–4.0

1998

2001

2004

2007
–6.0

2010

2013

2016

2019

2023*
2022
Sources:
ABS
Labour Force Australian Nationa
(Cat. no. l Accoun
6202.0), Balance ts (Cat. no.
of Paymen 5206.0), Consum

A unique feature of Australia in

Figure 7.7 ts and Internat er Price
– Australia’s ional Investm Index (Cat. no. 6401.0)
ent (Cat.
growth and no. 5302.0) ,
economic , June 2023 *Estima
outcomes te
since 1983

176
2024
A

l Economy to explain

the Global Economy is its two

in the Globa nd diagrams
Australia
y and dema ncy is determined
Use suppl curre
value of a nge rate
systems
how the
ent excha used to show
under differ ms can be In
S demand diagra cy is determined.
appendix

Price S1 Supply and of a curren

D mechanism,
how the value exchange rate demand for

appendices, located at the back

a floating
the case of supply and l
affecting the st rates, internationa
the factors
such as intererates, economic condi-
P
a currency,
appendix B

ess, inflation market

competitiven of foreign exchange
P1
sentiment the currency.
tions and the determine the value of Appendix B: Advanced Economic Analysis
will by shifts to
speculators, can be shown

of the book.
D d
these factors the supply or deman
S
Changes in of either iation or
S1
Quantity or left apprec
Q Q1
the right B.2 Income-expenditure diagram
will cause
either an
curves, which the currency.
of
es depreciation
increase subsidi
blocs may
– Trading
Figure A.3 global price levels In ge
Exchan
rate: 7.2 and
sections 7.3, we examined the conditions
of US$
s in terms
and depres the Price of A$ C = C0 + mpcY
between for equilibrium in the economy, the components of
S
relationship financial
Analyse the l and aggregate demand and supply, and the multiplier Therefore,
the capita ce

Appendix A: Key Economic Skills gives you the

balance of the net income balan process through which changes in aggregate AD = C0 + mpcY + I + G + (X – M)
and t deficit
account a current accoun financial
demand cause the economy to grow. In this section
experiences a capital and we examine these economic principles through the
If a nation be offset by a floating 90c
income-expenditure diagram.
Putting these three factors together, the aggregate
(CAD), it must ) surplus if it has demand line is upward sloping (because higher
supply and
account (KAFAsystem (because the equal). In The income-expenditure diagram is shown in income means higher expenditure), flatter than 45
exchange rate always be D

opportunity to master the 23 skills outlined in the Year

currency must on the KAFA figure B.4. It has income (Y) on the x-axis and degrees (because of the savings leakage) and cuts
demand for the financial inflow which expenditure Qe y-axis.
(E) on the Quanti
And ty of A$
on the income- the y-axis above the origin (because investment,
simple terms, overse as borrowing, 0
come from the sale of expenditure diagram there are two lines – the line government spending, net exports and autonomous
must either or through under ademand.
foreign debt, to foreign of equilibrium and rate
the determ
line ofination
aggregate consumption are independent of income). Figure
adds to the as investors, which adds – Exchan
ge
B.4 shows the income-expenditure diagram. Where
and equity Figure A.5 system
assets to overseway, a build up of debt must be First, exchan
floating
ge rate
the line of equilibrium. Whenexplaiexpenditure
ned the aggregate demand line cuts the 45 degree line,
liabilities) be
canincome
equity. Either as foreign (aggregate demand)
ge rate issystem
equal to (aggregate

12 Economics syllabus. The appendix covers three main

ents or For this the economy is in equilibrium, at Y1.
(together knownh either interest repaym A fixed
supply),exchan
the economy mis(see figure A.6). This means
in equilibrium.
e account similar diagra rate is drawn
serviced througnts on the primary incomthis path, thata whenever
using thenism,
mecha economythe fixed
is on a pointwould on the Expenditure
rate that that
dividend paymea nation continues down which can Y = Egeline,
exchan is the
exchan ge rate diagonal
45-degree line,
the Y=E
If
trap” cycle,
the
or belowinjections known as
system, leakages,
of the CAD. is above
the economy’s a floating equal itsor and the
in the “debt- borrowing central bank
it can result break because further prevai l under
economy is in equilibrium.
govern ment
to The ) if the fixed AD = C + I + G + (X – M)
be difficult borrowings. “market rate”. excess currency (Q1Q2

areas: drawing and interpreting economic diagrams,

ed just to service past to buyrelationship
Another the between
or sell curren
income cy if the
and
requir need marketinrate,
rate is above the
expenditure is shown the aggregate
the market
rate. demand
line. When
rate is below
there is a change in income, there is
fixed
a change in expenditure by individuals across the
rate:
economy.Exchange of US$
Price of A$ in terms 45

equations and calculations, and interpreting economic data

Income
In section 7.2, we looked at a simple version
S of the Y1
aggregate demandD equation:
fixed rate
Figure B.4 – Income-expenditure diagram
AD
80c = C + I + G + (X market
– M) rate
75c If there is a change in any of the components of
So, what is the relationship between aggregate aggregate demand (for a reason other than a change

and information. By working through this material you will

demand and income? In our most simple D
model, in income), the AD line will move upwards or
investment, government S spending, and net exports A$
downwards.
Q2 Quantity
Q1 of income (that
are considered independent
0 is, they
do not rise or fall when income changes). Therefore, • A rise in consumption, investment, government
it is via consumption that income and expenditure
ination
spending, exports (or a fall in imports) will shift
ge rate determ the AD line upwards.
are related.
Figure A.6 – Exchan
When incomege increases
rate systemso too does

develop and reinforce the key economic skills.

fixed exchan
under aand
consumption, hence, overall expenditure in the • A fall in consumption, investment, government
rap” cycle economy. However, not all additional income is spent spending, exports (or a rise in imports) will shift
– The “debt-t on consumption; some is leaked into savings. And
Figure A.4 the AD line downwards.
even when income is very low, individuals will still
Also note that the AD line will become steeper
378 spend a small amount on necessities, paid for out of
if there is a rise in the marginal propensity to
their savings, or by borrowing money. Consumption
consume and flatter if there is a decrease in the
is equal to this “autonomous consumption”, C0, plus
marginal propensity to consume.
the proportion of income that is spent on “induced

Appendix B: Advanced Economic Analysis provides

consumption”, calculated as the marginal propensity
to consume multiplied by income.

extension material beyond the Year 12 Economics Syllabus

391

for students seeking an extra challenge.

Pearson Economics 12: Australia in the Global Economy Workbook

Eleventh Edition

*
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

understanding of key concepts and knowledge. These will allow you to

ice
1 D
6 D*
2 D* 11
7 C*
3 B* 16 B*
B 12 B

not only confirm whether you arrived at the right or wrong

8 B 17
4 C 13 D
9 B
5 A* 18 B*
B* 14 D
10 A* 19
15 A*
*Indicates that C*
an enhanced 20
answer has been A
provided in the
Enhanc section below.

answer, but to understand why.

ed Answers
2 DBilateral trade
agreements,
trade from other instead of increasin
countries to g overall trade,
new non-tarif the members can lead to the
f barriers and of
with econom preferential arrangemthe agreement. These agreeme diversion of
ies that are not
the most efficient ents that result in econom nts can create
5 B
Free trade world producers of ies increasing
price for the good a good. trade
the tariff is $12,
being the differenc is $12. After the tariff the
world price of e between the price increase

How to access answers to the Workbook

$12. new increase s to $24. Therefor
6 d price of $24 e,
D Before the tariff and the original
the free trade
(intersection of price was $12.
demand curve
at this price and price of $12). At this price, 1000 units
(intersection Two hundred were
demand of 1000 of the supply
curve and price units were supplied demanded
units and domesti of $200). The domestically
which is equal c supply difference between
to 800 units (1000 of 200 units must
7 − 200). be made up of
B The tariff is $12 imported goods,
on imported goods

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

example responses to short answer questions by following these

the efficient allocatiofree trade is the ability for of these goods
economies to becomes more
n of scare resource specialis efficient. The
10 A s. e, which best
Equilibrium price promotes
before subsidy
11 is $10. Equilibri
C The size of a um price after
subsidy is the subsidy is $7.
distance between vertical distance $10 − $7 = $3.
S ($13) and between the
calculate the S1 ($7). $13 two supply curves.
total cost to − $7 = $6. So,

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

2. Activate your code to access Australia in the Global Economy eBook

3. Click on the ‘Explore resources’ tab in your eBook.

*
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

1.1 The global economy

The study of economics has traditionally focused on how individual economies operate.
While countries have always traded with each other, economic theories have generally
assumed that economies operate separately from each other and that the structure and
performance of economies is mainly the result of local developments and influences.
This way of looking at economics no longer describes the real world. Today we live in a
global economy – where the economies of individual countries are linked to each other
and changes in a single economy can have ripple effects on others. For many advanced and
developing countries, the value of what they buy and sell from overseas is often greater
than half of the value of the economy’s annual output. When conditions in the global
economy change, these changes can have an impact on the economies of far-flung countries
almost immediately. The importance of global factors in driving economies has been starkly
illustrated in the 2020s by the COVID-19 pandemic and the war in Ukraine. Both of
these events resulted in global economic impacts on supply chains, production and prices.
In many respects there is nothing new in the fact that major economic developments can
have impacts across the world. For example, the Great Depression of the late 1920s and
1930s had a global impact with many countries experiencing a severe economic downturn.
On the other hand, economies are more closely integrated now than at any previous time.
The linkages between economies are deeper and more far-reaching than ever before. There
are few aspects of life that have not been affected by the waves of global influences washing
across the world. This is especially the case in a smaller economy such as Australia, which
has embraced the global economy and pursued policies to integrate its economy with those
of its region and around the world.
In the past three decades, globalisation has become a dominant economic, political and Globalisation refers
social theme. Globalisation is the integration between different countries and economies to the integration between
and the increased impact of international influences on all aspects of life and economic different countries and
economies and the
activity. Unlike many previous times in world history when one major empire often increased impact of
dominated the relationships between economies, globalisation in recent decades has international influences
involved layers of influences in all directions. The United States is still the leading world on all aspects of life and
economy, but its power is increasingly constrained by China and other major economies. economic activity.

Globalisation is also a phenomenon with increasing impacts on national politics. Recent

years have seen a backlash against globalisation in many countries. Numerous leaders
(such as Donald Trump, who was President of the United States from 2017 to 2021) have
come to power promising to strengthen their country against global economic forces.
The COVID-19 pandemic added to public concerns about the impact of globalisation, as

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

Figure 1.1 – Gross World Product and world trade

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 Fuels and

agriculture 8% minerals 8%

Food and
Source: World Development Indicators 2022 agriculture 6%
Notes: Figures are for exports

Figure 1.2 – Composition of global trade, 1995 and 2022

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%

East Asia and Pacific 20%

Source: World Bank 2021. 2021 figures do not add up to 100% because of rounding.

Figure 1.3 – Share of world’s exports by region, 1995 and 2021

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

Source: Bank for International Settlements 2022 Year

Figure 1.4 – The growth of global financial flows: exchange-traded derivatives

An important feature of international finance is foreign exchange markets (or forex

markets), which are networks of buyers and sellers exchanging one currency for another
in order to facilitate flows of finance between countries. Foreign exchange markets have
experienced extraordinary growth in recent years, with average daily turnover reaching
over US$7.5 trillion by 2022, up from US$4 trillion in 2010. The value of a currency is
expressed in terms of another currency and is known as the exchange rate between two
currencies. As will be discussed in chapter 5, most countries determine the value of their
currency through the interaction of the forces of supply and demand in foreign exchange
markets.

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.

GLOBAL INVESTMENT GLOBAL COMPANIES

US$1.58 TRILLION 104 THOUSAND

FOREIGN DIRECT INVESTMENT TRANSNATIONAL CORPORATIONS

US$73
TRILLION
75
GLOBAL
%

FINANCE
GLOBAL ECONOMY
US$97 TRILLION
GROSS WORLD PRODUCT

US$55
TRILLION
57
GLOBAL
%

TRADE

GLOBAL LABOUR GLOBAL COMMUNICATIONS

164 MILLION 5.3 BILLION

MIGRANT WORKERS INTERNET USERS

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.

Investment and transnational corporations

Another indicator of globalisation is the rapid growth of investment between countries
over the past two decades. Since the 1980s, the global economy has witnessed rapid
growth in movements of capital. While there are similarities in the growth of global
finance and global investment, the two concepts can be distinguished by describing the
shorter-term, speculative shifts of money as finance, and the longer-term flows of money
to buy or establish businesses as investments.
One measure of the globalisation of investment is the expansion of foreign direct Foreign direct
investment (FDI), which involves the movements of funds that are directly invested in investment (FDI) refers
economic activity or in the purchase of companies. Reforms in developed and developing to the movement of funds
between economies
countries led to a surge in FDI flows from the 1980s onwards. Figure 1.5 demonstrates for the purpose of
the dramatic increase in FDI flows over the past three decades. FDI flows are strongly establishing a new
influenced by the level of economic activity. The global recession in the late 2000s reduced company or buying a
FDI flows sharply, but they gradually recovered and the 2010s decade saw sustained high substantial proportion
levels of FDI. The COVID-19 pandemic caused another sharp downturn in FDI flows of shares in an existing
company (10 per cent or
in 2020, with UNCTAD recording a fall to under US$1 trillion for the first time in
more). FDI is generally
almost two decades, but this was a brief downturn, with FDI flows recovering quickly considered to be a
the following year. long-term investment
and the investor normally
FDI flows have traditionally favoured developed nations. With greater industrial capacity
intends to play a role
and larger consumer markets, economies in Europe, North America and Japan were the in the management of
natural destination for foreign investment during the globalisation decades of the 1990s the business.
and most of the 2000s. But this dominance has changed, with the share of FDI destined
for developing and other economies significantly exceeding the developed world’s share
since 2020. The majority of FDI inflows to developing countries flow to economies in Asia.
Of the US$916 billion inflows to developing countries in 2021, US$662 billion went to

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

Source: UNCTAD World Investment Report 2023 Year

Figure 1.5 – Total world FDI inflows

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.

Value (US$ billion)

1200
Value of cross-border
1100 mergers and acquisitions
1000
900
800
700
600
500
400
300
200
100
0
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
Source: UNCTAD World Investment Report 2023 Year

Figure 1.6 – Cross-border mergers and acquisitions

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.

Technology, transport and communication

Technology plays a central role in globalisation. In part, this is because technological
developments facilitate the integration of economies. Consider the following examples:
• Developments in freight technology, such as the use of micro warehouses nearer
customers to improve “last mile” logistics and increased use of blockchain
technology to simplify tracking and facilitate greater trade in goods. The WTO
has estimated that the digitisation of trade has the potential to cut trade costs by
6 per cent.
• Cheaper and more reliable international communication through high-speed
broadband allows for the provision of commercial services to customers around the
world. A 2023 OECD study estimated that digital connectivity is having a three
times larger impact on reducing trade costs today than in 1995. The proportion
of the global population using the internet increased from 7 per cent in 2000 to
67 per cent in 2022.

11
Australia in the Global Economy 2024

• In finance and investment, technology plays a key role in facilitating globalisation

through secure, high-speed networks that allow money to move around the world
in a fraction of a second.
• Smartphones and mobile internet access are fundamentally changing the structure
of many industries, from retail and transport sectors to education, leisure and
professional services. Technology is causing disruptive change to the structures of
many of these industries as huge populations embrace online technologies. The
number of mobile phone subscriptions is now over 8 billion, which is roughly equal
to the number of people in the world.
• Advances in transportation, such as longer non-stop flights and high-speed
rail networks, allow greater labour mobility between economies and increased
accessibility to tourism and travel for consumers.
Technology is one of the strongest drivers of globalisation because it allows integration at
a depth unthinkable in previous decades and centuries. OECD research in 2023 found that
a 1 per cent increase in bilateral digital connectivity increases both domestic trade (2.1 per
cent) and international trade (1.5 per cent). Economies that adapt to new technologies
rapidly also tend to be the economies that are most closely integrated with other economies
in their region or around the world. The COVID-19 pandemic also highlighted the
disparity in access to technologies between countries, a phenomenon known as the “digital
divide”. Countries where digital technology use was high (such as Israel, the Netherlands
and Australia) were better able to cope with the physical lockdowns necessary to prevent
the spread of the virus by continuing normal activities through digital marketplaces,
virtual meetings and online learning.
Another way that technology influences globalisation is as
SOCIAL MEDIA AND GLOBALISATION a driver of growth in trade and investment. For the leading
technology innovators and exporters, technology represents a
Social media platforms have accelerated globalisation at major trade opportunity. The United States earns substantial
many levels. By creating new online communities, social export revenues from its global leadership in many areas of
media platforms such as Facebook, Instagram, TikTok,
new technologies. This reflects the geographical distribution
YouTube and X (formerly Twitter) connect individuals
of the top 100 digital TNCs’ headquarters, with 59 per cent
on an unprecedented scale. Of all internet users, over
90 per cent are active on social media. Facebook, for
in the United States. Other countries rely on importing
example, claims 2.9 billion members. technology from a small group of developed economies with
the hope that, over time, as they adopt new technologies,
As well as accelerating the globalisation of cultures,
they can become innovators and develop their own technology
social media platforms have major economic impacts.
exports as countries such as India, South Korea and Israel
Social media is central to marketing consumer products
and services. Firms may use professional networks
have done in recent years. Trade, therefore, spreads new
such as LinkedIn to source the best talent from global technologies. Because innovation is an ongoing process, the
labour markets. Google Chief Economist Hal Varian has leading country can often retain its technological superiority
even suggested that word-search data for terms like for a long period of time.
unemployment benefits and holidays could be used to
Business corporations that play a leading role in developing
predict trends in consumer confidence and economic
new technologies will often move directly into overseas
conditions.
markets in order to sell their products and services direct
Social media platforms are also worth vast sums. Elon to local buyers. For example, leading information and
Musk bought Twitter for US$44 billion in 2022. Google
communications technology corporations such as Google,
earned over US$280 billion in 2023, mostly from
Salesforce and IBM all have extensive global operations. These
advertising revenue. Apple Inc. became the world’s first
trillion-dollar company by selling the phones, tablets
corporations bring extensive know-how into a new market
and laptops through which people access social media. and will often invest substantially in the new countries that
Social media platforms can rise and fall quickly (TikTok, they enter, particularly in education and training. In this
for example, launched globally in 2017 and had over way technology drives increased foreign investment. This
3 billion downloads by 2023), but they are reshaping is particularly apparent for digital TNCs, which have less
the economics of many sectors beyond media and reliance on physical assets. E-commerce TNCs increased their
telecommunications. greenfield investments (a type of FDI that involves building
a foreign subsidiary from the ground up) by 120 per cent in
2020 and a further 10 per cent in 2021.
12
Chapter 1: Introduction to the Global Economy

The internet provides a communications backbone that links businesses, individuals

and nations in the global economy. This not only allows greater communication within
and between firms but also reduces business costs that have in the past been a barrier to
integration between economies. The World Information Technology and Services Alliance
(WITSA) has estimated that the global marketplace for information and communications
technology is worth almost US$5 trillion. The surge in worldwide internet usage to five
billion users highlights the rapid spread of technologies across countries in recent years
and the increasingly interconnected nature of the global economy. COVID-19 accelerated
this trend, with international internet traffic roughly doubling in 2020. At the same time,
as online information flows have become more globalised, regulations have been required
to mitigate cybersecurity attacks, which, around the world, increased by almost 40 per
cent in 2022. Figure 1.7 shows the number of internet users in selected countries.

Internet use (per 100 people)

100

80

60

40

20

0
Australia

Netherlands

United States

Germany

Russian
Federation

Japan

Brazil

Vietnam

China

World

India

Bangladesh

Zambia

Pakistan

Source: International Telecommunication Union Database 2021

Figure 1.7 – Internet users in selected countries

International division of labour and migration

Labour markets differ from markets for goods and services, finance and investment,
in that they are far less internationalised. While money can move around the world in
fractions of a second, goods and services can move in days and investments can be made in
weeks, people do not move jobs quite as freely. In fact, in recent years, the industrialised
world has become more restrictive about immigration of people from poorer countries.
Nevertheless, more people than ever before are moving to different countries to take
advantage of the better work opportunities that other countries offer. The World Bank
estimates that 184 million people are living outside their country of nationality, with
around half coming from low- and middle-income countries. The International Labour
Organisation (ILO) estimates that around 164 million people (around 2 per cent of the
world’s population) are migrant workers. Labour migration into Organisation for Economic
Co-operation and Development (OECD) member countries fell because of reduced job
opportunities following the global financial crisis, gradually recovering during the 2010s.
The number of migrants has continued to grow despite the impacts of COVID-19,
reflecting both ‘push’ factors (such as people leaving their country because of conflict and
violence) and ‘pull’ factors (the demand for workers in many countries). The net migration
statistics in figure 1.8 show that with rare exceptions, the number of people on the move
across the world remains low relative to country population sizes. In 2023, over 8 million
Ukrainians were displaced because of war.

13
Australia in the Global Economy 2024

Net migration 2018–2022

United States 5.0 million
Germany 1.8 million
Canada 1.6 million
United Kingdom 1.1 million
Australia 0.9 million
Türkiye –0.9 million
China –1.0 million
Bangladesh –1.1 million
India –1.7 million
Venezuela –4.2 million

Source: United Nations Population Division 2022

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

BRAIN DRAIN OR BRAIN GAIN?

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

Business cycle refers to 1.3 The international and regional

fluctuations in the level
of economic growth due business cycles
to either domestic or
international factors. The level of economic activity in individual economies is never constant (that is, never in a
state of equilibrium). Economic growth usually moves in cycles – in other words, instead of
sustaining a steady rate of growth from year to year, most economies go through periods of
Gross Domestic Product
(GDP) is the total market
above-average growth that then lead into periods of below-average growth. These ups and
value of all final goods and downs of the business cycle (that is, the general level of economic activity) are caused
services produced in an by changes in the level of aggregate supply and demand. This is shown in figure 1.9,
economy over a period of which also shows that economies usually experience an overall trend of growth in output
time. (measured by increases in Gross Domestic Product).
Just as individual economies experience stronger and weaker periods of
Output economic growth, so too does the global economy. This ebb and flow
of world economic growth is known as the international business
cycle, which refers to the changes in the level of economic activity
in the global economy over time. Although the levels of economic
growth each year often differ greatly between countries, for most
Boom Recession
countries economic growth is stronger when the rest of the world is
growing strongly, and weaker when other countries are experiencing
a downturn. The extent of synchronisation of economic growth levels
Economic growth trend
across individual economies is highlighted by the global recession
resulting from the COVID-19 pandemic. Even countries where the
pandemic was less severe still suffered immense economic damage, in
Time
part because of the flow-on effects of the recession in other countries.
Figure 1.9 – The business cycle Figure 1.10 highlights the strong relationship between the
economic growth performances of the world’s major economies.
International business
The United States, the Euro Area economies, Japan and Australia all experienced a
cycle refers to fluctuations long period of moderate growth during the 2000s, followed by a sharp collapse in
in the level of economic growth after 2008. Each of these advanced economies experienced slower rates of
activity in the global growth during the 2010s before the severe impact of the COVID-19 recession in 2020.
economy over time.
%
8
7
6
5
4
3
2
1
0
–1 World
–2 Australia
–3 United States
–4 Japan
–5 Euro area
–6
–7
2023*
2024*
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 (April 2023) *projections Year

Figure 1.10 – Economic growth performance of major economies

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

Regional business cycles

Similar to the international business cycle, the term regional business cycle refers to Regional business
the changes in economic activity in a particular region. In the same way that countries’ cycles are the fluctuations
activity can be affected by global changes, they can also be affected by regional changes. in the level of economic
activity in a geographical
While changes in the US economy will have ripple effects around the world, they can region of the global
have more pronounced impacts on the nearby economies of Canada and Mexico, which are economy over time.
most closely integrated with the US economy. Likewise, many of the 27 economies of the
EU are influenced by activity levels in Europe’s largest economies, Germany and France.
In the East Asian region, economic conditions are dominated by the influences of China
and Japan – the world’s second- and third-largest economies. While the regional business
cycle in Asia has been weaker than in other regions, it has strengthened in recent years
because of increased integration between Asian economies. On the other hand, as growth
rates in China and Japan slowed down in recent years, the region continued to experience
stable growth due to moderate upswings elsewhere in the region.
Other regions around the world have a higher proportion of developing or low-income
countries, and they tend to be less regionally integrated. In Sub-Saharan Africa, for
example, many economies such as Chad, Uganda and Sierra Leone are dependent on high-
income economies for more than 80 per cent of their exports, and are therefore as likely
to be influenced by conditions in the world economy as they are by neighbouring African
economies. In the South Asia and Latin American regions, regionally dominant
economies such as India and Brazil respectively play a key role alongside influences from
outside the immediate region.
While regional business cycles tend to be dominated by the largest and most globalised
economies, it is also important to recognise the complexity of conditions at the regional
level. In the early 2010s, economic conditions in European economies were weakened by
financial turmoil in the relatively small economy of Greece. A financial crisis in Argentina
and the severe impact of COVID-19 in Brazil weakened economies in Latin America in
2020. The war in Ukraine in 2022 reduced growth, trade and economic policy across
Europe and Central Asia. In this way, smaller economies can affect the performance of
regional economies even if they are not dominant economies or strongly integrated.
Clearly, regional business cycles can be quite different from patterns in global economic
activity, with some regions performing more strongly than others and fluctuating
more independently from other regions. However, regional cycles are also part of the
phenomenon of globalisation because they result from increased cross-border integration.
These business cycles of different regions interact in complex ways to influence the level
of economic activity around the world.

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.

The growth of world trade is an important indicator of the extent of globalisation.

4
During the period of rapid globalisation in the decades to 2010, trade grew at a
much faster rate than world economic growth. In the 2010s, trade grew at close to
the same level as overall economic growth.

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).

Foreign direct investment (FDI) is the injection of funds into an economy to

7
establish a new business or purchase an existing business. FDI flows are driven
by transnational corporations (TNCs) and often involve the transfer of
technological innovations between economies.

Technology, transport and communication have driven increased economic

8
integration by facilitating linkages between businesses individuals and nations in
the global economy.

9 Globalisation has also contributed to the international division of labour in

part because of the migration of workers to countries where jobs are plentiful
or better paid, and also because of the shift of business between economies
in search of the most efficient and cost-effective labour.

10 The concept of international and regional business cycles refers to

the extent to which economies tend to experience a similar pattern of boom,
downturn and recovery at similar times. Although the shape and the length of
the business cycle differs from one economy to the next, the level of economic
growth between different economies is closely related, and recessions and booms
tend to occur around similar times.

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.

3 Describe the role of trade flows in globalisation.

4 Summarise recent changes in the direction and composition of international trade

in goods and services.

5 Explain how technology drives growth in the trade of goods and services.

6 Explain the difference between investment flows and financial flows.

7 Outline the role of foreign-exchange markets in international financial flows.

8 Discuss the role played by transnational corporations (TNCs) in globalisation.

9 Discuss the impact of globalisation on the international division of labour.

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.

2.1 dvantages and disadvantages

A
of free trade
Among economists, there is widespread agreement on the principle that economies will
Comparative advantage
is the economic principle
achieve higher levels of growth in a free trade environment. Although barriers to trade
that nations should remain significant (even rising in recent years), the world has experienced a long-term
specialise in the areas trend towards greater free trade in the global economy.
of production in which
they have the lowest Free trade can be defined as a situation where governments impose no artificial barriers
opportunity cost, and to trade that restrict the free exchange of goods and services between countries with the
trade with other nations aim of shielding domestic producers from foreign competitors.
so as to maximise both
nations’ standards The argument for free trade is based on the economic concept of comparative advantage.
of living.
The principle of comparative advantage states that even if one country can produce all
goods more efficiently than another country, trade will still benefit both countries if each
Opportunity cost specialises in the production of the good in which it is comparatively more efficient. This
represents the alternative comparative efficiency is measured by the opportunity cost of producing each good
use of resources. Often
referred to as the “real”
within that country. Thus, if the opportunity cost of producing iron ore in Australia is
cost, it represents the cost lower than in China (that is, in order to produce an extra tonne of iron ore, Australia gives
of satisfying one want up producing a smaller quantity of smartphones than does China), then Australia is said to
over an alternative want. have a comparative advantage in iron ore production. At the same time, if the opportunity
This is also known as cost of producing smartphones in China is lower than in Australia, then China is said to
economic cost.
have a comparative advantage in smartphones.

22
Chapter 2: Trade in the Global Economy

ADVANTAGES OF FREE TRADE Free trade is a situation

where there are no artificial
barriers to trade imposed
• Trade allows countries to obtain goods and services that they cannot produce by governments for the
themselves or in sufficient quantities to satisfy domestic demand. This would generally purpose of shielding
occur because of a lack of adequate resources. For example, a country may lack the domestic producers from
necessary technology to produce certain manufactured goods. foreign competitors.
• Free trade allows countries to specialise in the production of the goods and services
in which they are most efficient. This leads to better resource allocation and increased
production within countries and throughout the world.
• Free trade encourages the efficient allocation of resources. Resources will be used
more efficiently because countries are producing the goods in which they have a
comparative advantage.
• A greater tendency for specialisation leads to economies of scale, which will lower
average costs of production while increasing efficiency and productivity.
• International competitiveness will improve as domestic businesses face greater
competitive pressures from foreign producers, and governments will encourage
domestic industrial efficiency.
• Free trade encourages innovation and the adoption of new technology and production
processes throughout the world.
• Free trade leads to higher living standards as a result of lower prices, increased
production of goods and services and increased consumer choice, as countries have
access to goods that a lack of natural resources may otherwise prevent. The opening up
of global markets leads to higher rates of economic growth and increased real incomes.

DISADVANTAGES OF FREE TRADE

• 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

2.2 Reasons for protection

Protection can be defined as any type of government action that has the effect of
Protection refers to
government policies that
giving domestic producers an artificial advantage over foreign competitors. The main
give domestic producers protectionist measures include tariffs, import quotas and subsidies.
an artificial advantage
Despite the economic benefits of free trade and the costs associated with protecting
over foreign competitors,
such as tariffs on imported domestic industries, historically, most countries have tended to use at least some forms
goods. of protection to assist local producers in the face of foreign competition. A number of
arguments have been put forward to justify why countries impose protectionist barriers
to trade, including the need to assist infant industries, protecting industries from overseas
firms dumping goods, reducing unemployment and arguments for self-sufficiency for some
essential areas of production.

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.

Defence and national security

Countries sometimes have non-economic reasons for wanting to retain certain industries.
For example, major powers generally want to retain their own defence industries so that
they can be confident that in a time of conflict they would still be able to produce the
equipment needed for their national security.
In recent years concerns about threats to national security from China have prompted
Australia and other countries to restrict Chinese telecommunications giant Huawei’s
involvement in building 5G mobile telecommunications networks. This is despite
Huawei’s technology being regarded as cheaper and more advanced than that of its
competitors.
The argument for self-sufficiency of medical supplies as well as energy, food and essential
manufactured goods has become much stronger in recent years in the wake of recent global
crises such as the war in Ukraine and the COVID-19 pandemic. Concerns about food
security following Russia’s invasion of Ukraine led to restrictions on agricultural exports
in several countries, with 101 export restrictions still in force in 2023, representing over
11 per cent of food trade.
In the wake of the COVID-19 pandemic, governments changed policies to build greater
domestic capacity to produce vaccines and supply essential medical needs (including
Australia, which announced plans to establish a local mRNA vaccine production facility).
The disruptions to “just in time” global supply chains caused by the pandemic led to a
re-think of how both governments and suppliers need to be better prepared for future
disruptions. This is challenging for the Australian economy because of its integration with
global supply chains, reliance on imports and limited domestic manufacturing capacity.

25
Australia in the Global Economy 2024

RISING BARRIERS TO TRADE

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.

Other arguments in favour of protection

Several other arguments are also used in favour of protecting local industries. For example:
• Because of the differentials in wage levels between higher- and lower-income
economies, some economists argue that producers should be protected from
competition with countries that produce goods with low-cost labour. They argue
that labour costs are artificially low in many developing economies because of weak
labour standards (such as restrictions on the rights of workers to form unions and
low safety standards).
• A growing awareness of the existence of modern slavery in global supply chains
in recent years has led governments to prohibit the trade of goods produced
using forced labour such as prison workers and child labour. These restrictions
are generally accepted as a legitimate regulation on trade that can prevent human
rights abuses, even though it can have protectionist consequences. For example,
in 2021 Australia restricted certain imports from China because of concerns about
the use of forced labour in Xinjiang.
• Countries sometimes block trade in goods because of environmental factors, such
as the environmental harm involved in the production of certain goods. Overseas
producers may be able to produce some items cheaply because the producers are
environmentally irresponsible and do not have to comply with the tougher
environmental standards that apply in advanced economies. In recent years some
countries have proposed introducing “carbon tariffs” on goods produced in countries
that are making slower progress on reducing carbon emissions.

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

2.3 Methods of protection

Although we live in an era of relatively free trade globally, most countries use at least some
measures to shield their domestic producers from foreign competition with protectionist
policies. There has been a shift from traditional protectionist measures, such as tariffs
and subsidies, towards less visible measures, such as administrative barriers and industry
assistance plans.

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.

ECONOMIC EFFECTS OF A TARIFF

• 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).

27
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.

ECONOMIC EFFECTS OF A QUOTA

• 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.

ECONOMIC EFFECTS OF A SUBSIDY

• 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.

Local content rules

Local content rules specify that goods must contain a minimum percentage of locally
made parts. In return for guaranteeing that a certain percentage of a good will be locally
made, the imported components may not attract a tariff. Australia has a longstanding
requirement that a majority of free-to-air television content broadcast from 6:00 am
to midnight is locally produced (a minimum of 55 per cent of content under current
rules). In 2023, the Australian Government announced plans to introduce local content
requirements for streaming services such as Netflix, Stan and Binge as part of its Revive
National Cultural Policy.

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.

OVERALL ECONOMIC EFFECTS OF PROTECTIONISM

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.

2.4 Trade agreements

As trade has grown and economies have become more integrated, countries have in recent
years forged agreements and trading alliances to expand their trade opportunities and avoid
being excluded from emerging trading blocs.
Free trade agreements (or trade agreements) are formal agreements between countries
designed to break down barriers to trade between those nations. When the agreement
is between two countries it is said to be bilateral, and when the agreement is between
three or more economies, it is said to be multilateral or regional. While these agreements
are generally described as “free” trade agreements, it is often more accurate to call them

30
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.

Global Multilateral or regional Bilateral

agreement agreements agreements
World Trade Organization EU Most economies have a
USMCA (previously NAFTA) number of bilateral
agreements and
APEC forum
overall several hundred are
ASEAN
in place around the world.
AANZFTA (ASEAN–Australia–
Australia has 14 bilateral
New Zealand)
trade agreements – see
CPTPP
chapter 6.3 and figure 6.2.
IPEF
PACER Plus
RCEP

Figure 2.5 – Types of trade agreements

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

STRAINS IN THE CHINA–US RELATIONSHIP

“The US–China economic and trade relationship is one of profound consequence. As

the two largest economies in the world, the bilateral relationship affects not just the
two participants, but the entire globe. The Biden Administration acknowledges that this
relationship is complex and competitive.”
– United States 2023 Trade Policy Agenda, March 2023
As China’s economic power has grown in recent decades, it has come into increasing
conflict with the US, which argues that China engages in unfair and illegal trading practices.
China and the US are the world’s two largest trading nations, but a large trade imbalance
exists between the two economies, with the US buying US$537 billion of Chinese exports
in 2022, while China bought just US$154 billion of American exports.
Under President Trump, the US and China imposed hefty sanctions on each other’s trade,
at one stage threatening an all-out trade war. By the time the Trump Administration left
office at the end of 2020, America’s average tariffs on Chinese products had risen from
around 3 per cent to 20 per cent, according to calculations by the Peterson Institute of
International Economics. China has meanwhile imposed tariffs on more than half of imports
from the US.
While the US has adopted a more open approach to trade under President Biden, tariffs
on billions of dollars of Chinese imports have been retained. The Biden Administration
is seeking to reduce its reliance on Chinese imports in key areas of technology and
manufacturing, including advanced computer chips and clean energy.

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

Figure 2.6 – The growth of bilateral and multilateral trade agreements

Trans-Pacific Partnership (CP-TPP or TPP-11)

The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (commonly
known as both the CP-TPP and the TPP-11) is a multilateral trade agreement among 11
Pacific Rim countries that was formally signed and ratified in March 2018. Its 11 members
(Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore
and Vietnam) represent 14 per cent of global economic output and around 15 per cent
of global trade, with a market of over 500 million people. Even though the 11 TPP-11
economies only make up around 6 per cent of the global population, their contribution
to global trade is significant, especially for Australia’s economy, representing 22 per cent
of all Australian trade.

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Chapter 2: Trade in the Global Economy

REGIONAL AND BILATERAL TRADE AGREEMENTS:

STEPPING STONES OR STUMBLING BLOCKS?

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

Regional Comprehensive Economic Partnership

The Regional Comprehensive Economic Partnership is the world’s largest multilateral
trade agreement, with its economies representing a larger share of the global economy
than the TPP-11, the EU or USMCA. The RCEP commenced in 2022, and was in effect
for all of its 15 members by June 2023, after almost a decade of negotiations. Estimates
by the World Economic Forum suggest that the RCEP will remove 91 per cent of tariffs
on goods traded in the region, while UNCTAD has estimated that it will boost intra-
regional trade by 2 per cent as a result of both creating new trade worth US$17 billion,
and diverting existing trade worth US$25 billion.
The membership of the RCEP comprises 15 economies, including China (which led its
formation), all ASEAN nations, Japan, South Korea, Australia and New Zealand. India
was also engaged in many of the negotiations but withdrew in 2019. RCEP economies
account for one-quarter of global trade and 30 per cent of both the world’s population and
GWP. Ten out of Australia’s top 15 trading partners are members of the trade agreement,
and together with the other six participating countries, they account for 59 per cent of
Australia’s two-way trade, 17 per cent of two-way investment and 73 per cent of Australia’s
goods and services exports.

Asia-Pacific Economic Cooperation (APEC) forum

In the early 1990s countries in Australia’s region established the Asia-Pacific Economic
Cooperation (APEC) forum in response to the formation of trading blocs in other areas
of the world such as the EU and NAFTA. The 21 member economies of the forum are:
Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Malaysia, Mexico,
New Zealand, Papua New Guinea, Peru, the Philippines, Russia, Singapore, South Korea,
Taiwan, Thailand, the United States and Vietnam. Although the APEC forum has only
21 member economies, it accounts for almost 40 per cent of the world’s population (2.9
billion people), over 60 per cent of world GDP and makes up around three-quarters of
Australia’s total trade in goods and services.
The APEC forum’s original vision of establishing free trade among member countries
by 2020 was not achieved. Its relatively minor role in advancing free trade during the
past three decades is exemplified by a 2019 report by PricewaterhouseCoopers that noted
almost $800 billion of non-tariff trade barriers remain in place across APEC nations.
Nevertheless, APEC has contributed to progress on trade liberalisation. UNCTAD (the
United Nations Conference on Trade and Development) has estimated that average tariff
rates of APEC member states had been reduced from 10.2 per cent in 1999 to 5.2 per cent
in 2020. Total merchandise trade for APEC nations increased sevenfold during this period,
with two-thirds taking place between member countries. Although APEC meetings have
never resulted in a regional trade agreement, they have created a forum for annual meetings
of the leaders of member countries to discuss geopolitical priorities and have helped
develop other trade agreements such as the CP-TPP. During the COVID-19 pandemic,
APEC focused on improving the distribution of vaccines and essential medicines. The
APEC forum has operated differently to other trade groupings in adopting the principle
of non-discriminatory arrangements, which means that nations will trade with countries
outside of the grouping on the same basis as members of the forum if they are prepared to
give equal access to their markets. This contrasts with trade blocs such as the EU, which
increase trade barriers for external countries.

Association of South-East Asian Nations (ASEAN)

Established in 1967, the ASEAN group covers emerging and developing economies in
South-East Asia. ASEAN has acted as a counterweight to the APEC forum, which tends
to be dominated by the large economies such as the United States, China, Japan and
South Korea. ASEAN has become the most effective force for trade negotiations within
the Asia Pacific region.
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Chapter 2: Trade in the Global Economy

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.

Pacific Agreement on Closer Economic Relations Plus

(PACER Plus)
The Pacific Agreement on Closer Economic Relations Plus is a multilateral trade
agreement comprised of 11 Pacific Island Forum members: Australia, Cook Islands,
Kiribati, Nauru, New Zealand, Niue, Samoa, Solomon Islands, Tonga, Tuvalu and
Vanuatu. Unlike most other trade agreements, PACER Plus places a specific emphasis
on economic development, integrating foreign aid programs from Australia and New
Zealand to assist with agricultural development, financial stability, trade infrastructure and
implementation of the agreement itself. Although the member economies only account
for 32 million people, at the time of ratification it represented $2.1 trillion in GDP and
$30 billion of Australia’s two-way trade.

The European Union

The European Union (EU) is the most important trade bloc in the world economy. Its 27
member countries span across the European continent, with a population of 450 million
that account for around 15 per cent of world trade in goods, a market similar in size to the
United States. At present there are eight additional candidate countries that have begun
negotiating potential membership of the EU: Albania, Bosnia and Herzegovina, Moldova,
Montenegro, North Macedonia, Serbia, Türkiye and Ukraine. Although the EU represents

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

Figure 2.7 – European Union member states 2023

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.

Other regional agreements

In addition to the EU, two other regional agreements play key roles on other continents:
• The US-Mexico-Canada Agreement (USMCA) is a three-country trade deal
previously known as the North American Free Trade Agreement or NAFTA.
NAFTA contributed to the value of trade more than tripling between the three
economies in the 25 years after its introduction. The NAFTA agreement was
renegotiated and re-branded as the USMCA, coming into effect from 2020 with
minor revisions addressing issues such as digital trade, corruption and intellectual
property.
• The African Continental Free-Trade Area (AfCFTA) has the largest number
of member economies of any regional trading agreement, bringing together
55 countries and 1.3 billion people with a combined GDP of US$3.4 trillion.
AfCFTA came into force in 2021, with the goal of eliminating 90 per cent of tariffs
between member economies. The World Bank estimates that the agreement will
boost the regional economy by 7 per cent by 2035, lifting GDP by $450 billion and
bringing 30 million people out of extreme poverty. However, its impact depends
on successful implementation in each country.

Bilateral trade agreements

In addition to global and regional agreements, economies also enter into bilateral
agreements. Australia’s most far-reaching bilateral agreement is the Closer Economic
Relations Trade Agreement (CERTA) with New Zealand, which began in 1983 and
is one of the most comprehensive free trade agreements in the world. CERTA prohibits
all tariffs and export restrictions, and has gradually been extended in recent years to
include the harmonisation of business regulations and tax laws between New Zealand and
Australia. Since 1983 it has contributed to an average annual increase in trade between
Australia and New Zealand of around 7 per cent and is widely regarded as being successful
in both countries.

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.

2.5 International organisations

The major institutions of the global economy are the World Trade Organization, the
International Monetary Fund and the World Bank. Both the IMF and the World
Bank were established at the Bretton Woods conference in 1944, which designed the
postwar global economic system. However, the enormous changes in the global economy
since World War II have forced these institutions to adapt to new circumstances without
necessarily being equipped to deal with the more complex flow of capital and goods across
borders that has characterised the globalisation era.
In addition, there are several other organisations with substantial influence in the global
economy, such as the Organisation for Economic Cooperation and Development and
the United Nations.

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Australia in the Global Economy 2024

World Trade Organization

The role of the WTO is to implement and advance global trade agreements and to
For further information on resolve trade disputes between economies. The WTO was formed in 1995 and is the first
international organisations
visit the websites of the
international organisation with powers to enforce trade agreements across the world.
WTO, World Bank, IMF, Prior to the formation of the World Trade Organization, the responsibility for developing
UN, OECD and The
trade agreements was borne by the General Agreement on Tariffs and Trade (GATT)
Global Goals.
process that began in 1947. The GATT process involved regular rounds of trade
negotiations but lacked an enforcement mechanism. This meant that many countries only
implemented parts of the GATT agreements. In 1993, GATT was replaced with a new
global trade organisation with enforcement powers.
The formation of the World Trade Organization was significant not only because it had
power to resolve trade disputes but also because its reach extended beyond trade in goods
to include trade in services (such as insurance and banking) and intellectual property (such
as patents, copyright, electronic circuits and trademarks).
One of the most important features of the WTO is its role in settling disputes between
countries. A country that believes that it is suffering harm as a result of another country’s
failure to comply with its WTO obligations can lodge a complaint with the WTO. A
process of dispute resolution is then commenced and if no agreement can be reached
directly a WTO panel will hear the complaint and then issue a decision. If the country
involved does not comply with the WTO’s directive, the other country or countries may
then impose trade sanctions that may include high tariffs on goods imported from the
offending nation. Since 1995, 617 disputes have been brought to the WTO and over 350
rulings have been issued.
The WTO has proved effective in resolving disputes between smaller countries, although
it has been less effective in resolving disputes between the two largest forces in the global
economy – the United States and the European Union. Although the US and the EU
have not formally refused to comply with WTO determinations, they have delayed and
continued to lodge appeals rather than accept WTO decisions.
The WTO’s membership includes 164 member countries and 25 further “observer”
countries negotiating to join the WTO. Since its formation in 1995, the WTO has
overseen a halving in average tariff rates among member economies and has had some
success in negotiating further agreements to free up world trade. For example, in 2014
the WTO formally agreed on a binding Trade Facilitation Agreement, which aimed at
reducing the cost of trade by 10 to 15 per cent by making customs procedures simpler and
more efficient. In a 25-year anniversary media publication in 2020, the Director-General
of the WTO identified this as one of the WTO’s most important achievements. Some
WTO members have also signed voluntary agreements to reduce trade barriers in financial
services, information technology, telecommunications and shipping.
While the WTO has been effective in resolving disputes and making progress on a series
of voluntary agreements, its efforts to conclude a comprehensive global trade agreement
since 2001 have been unsuccessful. The Doha Round of trade liberalisation talks – named
after the city in the Middle Eastern nation of Qatar in which they were launched – began
with ambitious goals to reduce agricultural protection, lower tariffs on manufactured
goods and reduce restrictions on trade in services. It was claimed that trade liberalisation
could create annual welfare gains of US$90 to US$200 billion per year and lift over 140
million people out of poverty in the developing world.
The Doha Round failed due to disagreements on access to agricultural markets, restrictions
on the production of pharmaceutical medicines, disputes between developed and
developing nations, and arguments relating to manufacturing protection. More generally,
the past two decades have seen declining public support for free trade in many countries.

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.

International Monetary Fund

The International Monetary Fund (IMF) is one of the most important institutions in the
global economy. It has 190 members, covering almost all nations. Its role is to maintain
international financial stability, particularly in relation to foreign exchange markets.
In earlier times the role of the IMF was to oversee a system of fixed exchange rates that
would stabilise economic relationships between economies. When the system of fixed
exchange rates collapsed in the 1970s, the IMF’s role widened to ensuring global financial
stability. In situations where a financial crisis occurs in an economy, region or even across
the world, the IMF plays a critical role in minimising the crisis.
The IMF’s role in ensuring stability in global financial markets was highlighted by its
interventions following the COVID-19 pandemic in 2020. In response to the initial onset,
the IMF established a new Short-term Liquidity Line aimed at providing one-off payments
and interest-free loans to assist developing and emerging economies in designing policy
responses to COVID-19, following requests from over 100 countries by May 2020. In July
2021, the IMF approved its largest-ever relief package, a $650 billion emergency aid fund,
to assist developing economies in buying and rolling out vaccines and paying down debt
accrued during the pandemic. After Russia’s invasion of Ukraine in February 2022, the
IMF approved a four-year Extended Fund Facility of US$15.6 billion as part of a US$115
billion total support package to help Ukraine manage the economic impacts of the war.
In the longer term, the IMF aims to support the free trade of goods and services and the
free movement of finance and capital throughout world markets. The IMF often requires
countries to change their economic policies and open up their markets before they receive
financial assistance. These structural adjustment policies include reducing the size of
government, privatising government businesses, deregulating markets and balancing
government budgets. The impact of the IMF’s policy approach is increased by the fact
that many international banks and other private lenders require that countries adopt
IMF-supported policies before they are willing to lend to those countries. Additionally,
the IMF often tailors these policies to wider economic priorities, with a growing focus
on climate risk given the harsher impact of climate change on many of the world’s most
financially vulnerable countries.
The IMF plays a central role in addressing financial crises in individual countries. However,
the IMF has often attracted criticism during financial crises where its policies appeared to
make conditions worse for the economies affected. After widespread criticism about the
negative impact of some of the reforms demanded by the IMF after a financial crisis in Asia
in the late 1990s, the IMF adopted a different approach during the global financial crisis
of the late 2000s, supporting expansionary macroeconomic policies and giving borrowing
countries more freedom to increase their spending to avoid recession. In 2010 the IMF

39
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.

40
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.

CHINA: FROM NET RECIPIENT OF INTERNATIONAL DEVELOPMENT FINANCE TO

THE WORLD’S LARGEST OVERSEAS DEVELOPMENT LENDER

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.

Organisation for Economic Cooperation and Development

The Organisation for Economic Cooperation and Development (OECD) is an international
economic organisation of 38 mostly advanced economies committed to democracy and
open markets. The primary goal of the OECD is to promote policies “to achieve the highest
sustainable economic growth and employment and a rising standard of living in member
countries while maintaining fiscal stability and thus contribute to the development of
the world economy”. In practice, the main role played by the OECD is to conduct and
publish research on a wide range of economic policy issues and to coordinate economic
cooperation among member nations, such as towards the development of common policy
agendas. For example, the OECD provided a forum for member countries to share research
and coordinate policy responses to the COVID-19 pandemic.
Alongside research conducted by the IMF and the World Bank, OECD economic research
is regarded as the most reliable source of comparative economic data. The OECD publishes
in-depth research and analysis of a wider range of domestic policy issues relating to
advanced economies, including competition, education, employment, health, industry,
innovation, migration, regulation and tax. The OECD has also influenced the global
economic policy agenda in recent years. Its advocacy for “inclusive growth” strategies in the
past decade has challenged traditional assumptions that policymakers must always trade
off equity and efficiency (that is, inequality versus economic growth), reflecting concerns
that the level of inequality in many economies has become a constraint on economic
growth. The OECD also played a key role in an international agreement in 2021 to reform
corporate taxation rules. This agreement involves a global minimum corporate tax rate
of 15 per cent and measures to ensure companies pay tax in the places where economic
activity occurs, rather than using tax havens to avoid paying tax.

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.

2.6 Government economic forums

Organisations that exist as forums for world leaders play an important role in coordinating
policies between major economies especially during times of economic or financial crisis.
The aim of these forums is to enable heads of state along with their treasurers and central
bank governors to discuss global economic issues with particular attention to economic
stability and growth. In the early 2020s they have played a role in fostering greater
cooperation among advanced economies on major economic issues, including recovery from
the COVID-19 pandemic, addressing the fallout from the war in Ukraine and cooperating
on measures to address climate change.

Group of Seven Nations (G7)

In recent decades, the most important government economic forum has been the group
of the seven largest industrialised nations, including the United States, UK, France,
Germany, Canada, Japan and Italy. The G7 has effectively operated as the economic council
of the world’s wealthiest nations, meeting annually to discuss conditions in the global
economy since its formation in 1976. The G7 has been the unofficial forum coordinating
global macroeconomic policy because of its influence over the fiscal and monetary policies
of the world’s largest advanced economies. Because of the G7’s status as the forum for the
world’s most powerful economies, its agenda has often included general political issues
and current priorities such as climate change, global poverty and security.
Critics in recent years have argued that the membership of the G7 is no longer
representative of the most important forces in the global economy (China and India are
more important to the global economy than Canada and Italy, but they are not included
in the G7). The G7’s share of global GDP shrunk from 68 per cent in 1992 to 43 per cent
in 2023, and the G7 nations cover only 10 per cent of the world’s population. When the
global economy faced the sudden onset of the COVID-19 pandemic, and the dislocation
of trade, travel and economic activity, the G7 did not provide a major leadership role. In
response to the war in Ukraine, the 2023 G7 summit in Hiroshima, Japan, provided a
forum for coordinating responses, including issues relating to defence, energy prices and
global food security, as well as securing fresh diplomatic aid for Ukraine through military
assistance packages.
Proposals in recent years have addressed the possible expansion of the G7 to include
observer nations (including Australia). In 2023, leaders from eight economies joined by
special invitation: Australia, Brazil, Comoros, the Cook Islands, India, Indonesia, South
Korea and Vietnam. Ukraine was also invited as a guest. The hosts of the upcoming G7
summits are Italy in 2024 and Canada in 2025.

43
Australia in the Global Economy 2024

G20 Members

Figure 2.8 – Members of the G20

Group of Twenty Nations (G20)

The G20 includes 19 of the world’s largest national economies plus the EU, covering
around 85 per cent of world GDP and 65 per cent of the world’s population. The G20
membership includes several emerging economies that have been a driving force behind
world economic growth since 2008.
The G20 played a key role in the global response to the financial crisis in 2009 and had
an important but less central role following the COVID-19 pandemic. During the global
financial crisis, the G20 helped coordinate fiscal stimulus and improve supervision of the
global financial system and international financial institutions. However, international
economic cooperation has weakened in more recent years, with countries mostly
determining their economic policy responses to the COVID-19 pandemic at a national
level. In 2021 the G20 agreed on a global tax reform plan in partnership with the OECD,
resulting in a minimum global corporate tax rate and measures to reduce tax avoidance.
The G20 also agreed on measures to coordinate large-scale debt relief for developing
countries in conjunction with the World Bank and IMF.
The extent to which the G20 group becomes the forum for international economic
cooperation in future years is unclear, but at the moment the G20’s main activity is its
annual summit, and it does not have any permanent leadership or headquarters. The annual
summit generally deals with a wide range of current issues, and does not advance specific
economic goals. It therefore relies on individual heads of state to provide momentum and
leadership to work together on specific global challenges. Following Brazil’s hosting of
the G20 in Rio de Janeiro in November 2024, South Africa will host the 2025
G20 summit.

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.

3 The arguments in favour of protection include helping “infant industries” to

establish themselves, protecting local jobs being lost because of cheaper imports,
strengthening defence and national security and preventing foreign companies
dumping goods on domestic markets at unrealistically low prices.

4 The arguments against protection are that it results in a distortion in resource

allocation towards less efficient sectors of the economy and in the longer term
can lead to a less internationally competitive economy, higher unemployment
and a lower standard of living.

5 The main methods of protection are: tariffs (a tax on imports), subsidies

(a payment to local producers), local content rules (a requirement that a
proportion of goods are made locally), quotas (a limit on the quantity of goods
imported) and export incentives (other means to encourage local production).

6 rade agreements are a way of reducing barriers to trade between nations.

T
Recent years have seen a proliferation of multilateral and bilateral trade
agreements, and while they have removed some trade barriers they have also
made the global trading system increasingly complicated.

7 The World Trade Organization is a global organisation that enforces the

existing WTO agreement, resolves trade disputes and is the major forum for
global trade negotiations pursuing the goal of global free trade.

8 The International Monetary Fund is a global organisation whose main role

is to maintain international financial stability. The IMF plays a key role in
monitoring the international financial system and assisting economies who
face major economic crises.

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.

2 Explain what is meant by comparative advantage.

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

4 Outline the arguments supporting the following statements on protecting

local industries:

• “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.”

Discuss the economic arguments in response to the following justifications for

5
protection:
• “ It’s time we made Australia great again, and stopped sending jobs offshore to
China.”
• “ We need to protect our essential domestic industries just in case there’s a war
or another global pandemic.”

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.

• An estimated 685 million people live in “extreme poverty”, subsisting on less

than US$2.15 per day in 2022, with around 80 million people in poverty because
of the impact of the COVID-19 crisis. Around two-thirds of this population lives
in Sub-Saharan Africa (which has seen an increase in the number of people living
in extreme poverty compared to 1990).
• Over 1.7 billion people live without access to basic sanitation and around 750
million have no access to electricity.
• It is estimated that 5 million children under the age of five died in 2021.
More than 80 per cent of these deaths occurred in Sub-Saharan Africa or
South Asia. An Oxfam report in 2022, Inequality Kills: The unparalleled action
to combat unprecedented inequality in the wake of COVID-19, estimated that
inequality contributes to the death of at least one person every four seconds.
• Across the world are an estimated 89 million refugees and forcibly displaced people,
who fled their homes because of violence or persecution.
• In April 2023, over 13 billion COVID-19 vaccine doses had been administered
globally. Low-income countries account for 9 per cent of the world population, but
secured just 3 per cent of the total vaccination doses.
Sources: World Health Organization 2021, UNHCR, World Bank 2022, World Data Lab 2023,
Oxfam 2022

In this chapter we look at how to measure and understand differences in economic

development in the context of globalisation.

Number in extreme poverty (millions) World population (billions)

2500 9
8
2000 7
6
1500
5
4
1000
Incomes under US$2.15 a day (2017 PPP) 3
World population
500 2
1
0 0
1985

1995

2005

2015
1980

1990

2000

2010

2020*

Source: World Bank Poverty and Inequality Platform 2023 *estimate Year

3.2 Differences in income and

economic growth
The most popular method for comparing living standards between different economies
is income. It measures the ability of a nation’s citizens to satisfy their material wants.
Gross National Income (GNI) is the sum of value added by all resident producers in
an economy, plus receipts of primary income from foreign sources. Real GNI figures are
obtained by discounting GNI growth for the effects of inflation.

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

Population GNI GNI measured at PPP

Grouping Purchasing power parity
(million) (US$ billion) ($ Int’l billion)
(PPP) is a theory that
Low income 718 541 1468 states that exchange rates
should adjust to equalise
Lower middle income 3398 8607 26,605
the price of identical
Upper middle income 2503 26,671 49,005 goods and services in
different economies
High income 1240 60,295 68,492 throughout the world.
Global economy 7888 96,432 146,002

Source: World Bank 2023

Figure 3.2 – Adjusted GNI for major country groups, 2021

Figure 3.2 shows that high-income economies (also known as GNI

GNI per
advanced economies or industrialised economies) receive around Population capita,
measured
at PPP per
two-thirds of the world’s income as measured in raw GNI and Region (million) Atlas
capita
nearly half of the world’s income using PPP-adjusted GNI figures. 2021 Method
($ current
(US$) 2021
A high level of inequality clearly exists in the global economy, given Int’l) 2021
that high-income economies make up just 1.2 billion of the world High income 1240 9291 55,208
population of around 8 billion. The population of low-income Low and 6620 5262 11,642
economies makes up 9 per cent of the global population but less middle income
than 1 per cent of the size of the global economy. Latin America &
593 7579 15,879
Caribbean
Population size and growth rates differ among economies, and
Europe &
play an important role in comparing one economy to another. To Central Asia
402 8384 24,328
compare living standards between economies, we divide the real
East Asia &
GNI of each country by its population, generating a GNI per 2124 9291 16,676
Pacific
capita figure. Middle East &
418 3409 11,298
North Africa
As figure 3.3 shows, people in high-income regions (around one
in six people in the world) enjoy income levels that are nearly Sub-Saharan
1118 1561 3927
Africa
five times those in low- and middle-income countries, even after
South Asia 1902 2076 6855
adjusting for purchasing power parity. The table also details
information about the regions where income is the lowest. Living Source: World Bank 2023

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

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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.

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Australia in the Global Economy 2024

THE GLOBAL GOALS

In September 2015 in New York, world leaders agreed to 17 new Global Goals, or Sustainable Development Goals (SDGs).
The SDGs promote 15-year targets aimed at tackling poverty with a renewed focus on sustainability issues such as climate
change, ecology and biodiversity, consumption and production, food security, energy provision and infrastructure. The goals
listed below are supported by nearly 170 individual targets, to be achieved by 2030.

17 Sustainable Development Goals

Goal 1 End poverty in all its forms everywhere
Goal 2 End hunger, achieve food security and improved nutrition and promote sustainable agriculture
Goal 3 Ensure healthy lives and promote wellbeing for all at all ages
Goal 4 Ensure inclusive and equitable-quality education, and promote lifelong learning opportunities for all
Goal 5 Achieve gender equality and empower all women and girls
Goal 6 Ensure availability and sustainable management of water and sanitation for all
Goal 7 Ensure access to affordable, reliable, sustainable and modern energy for all
Goal 8 Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work
for all
Goal 9 Build resilient infrastructure, promote inclusive and sustainable industrialisation and foster innovation
Goal 10 Reduce inequality within and among countries
Goal 11 Make cities and human settlements inclusive, safe, resilient and sustainable
Goal 12 Ensure sustainable consumption and production patterns
Goal 13 Take urgent action to combat climate change and its impacts
Goal 14 Conserve and sustainably use the oceans, seas and marine resources
Goal 15 Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat
desertification, halt and reverse land degradation, and halt biodiversity loss
Goal 16 Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build
effective, accountable and inclusive institutions at all levels
Goal 17 Strengthen the means of implementation and revitalise the global partnership for sustainable development
Source: United Nations Sustainable Development Goals Report 2017

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

• reliance on foreign aid and development assistance as a major source of income

• low levels of labour productivity, industrialisation, technological innovation and
infrastructure development
• weak political and economic institutions and a high prevalence of corruption.
The United Nations Conference on Trade and Development (UNCTAD) has also identified
a subgroup of the 46 least developed countries (LDCs), with the lowest GNI per capita
levels in the world (less than US$1081 per year); weak human assets (based on health and
education indicators); and high economic vulnerability (based on economic structure, size
and exposure to shocks). Thirty-three of the 46 LDCs are located in Sub-Saharan Africa,
highlighting what is sometimes called the “Africanisation” of poverty. As figure 3.6 shows,
rapid and significant reductions in poverty have occurred in all regions (particularly in
East and South Asia) except Africa.
Emerging economies Another classification for economies is emerging economies. These economies are in the
are in the process of process of industrialisation or modernisation and are experiencing sustained high levels
industrialisation and of economic growth. This classification includes a range of economies that are neither
experiencing sustained
high levels of economic
high income, nor share the traditional characteristics of developing economies. They
growth. include the economies previously known as newly industrialised economies (such as
Malaysia and the Philippines), economies previously known as transition economies, which
were making the transition from socialist economies (such as China and Hungary), and
developing economies with improved prospects (such as India and Indonesia).

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

It is important to acknowledge the limitations of classifications systems. Classifications are

very broad and can group dissimilar economies together. For example, Brazil and Indonesia
might both be considered emerging economies, but they have very different living standards.
Likewise, some economies do not fit neatly into one of these three categories. Bulgaria is
much better off than a developing economy, yet it is not quite an advanced economy or an
emerging economy. Despite these limitations, classifying economies is still an important
step towards understanding the reasons for economic inequalities between nations.

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.

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Chapter 3: Globalisation and Economic Development

3.5 Causes of inequality in the

global economy
Understanding the reasons for differences in levels of development between nations has
been a central issue of economic debate for over half a century. During the globalisation
era, differences in living standards between rich and poor countries have come into sharper
focus because of the increased interaction between the more prosperous and less prosperous
regions of the world.
The severe and widening extent of inequalities between economies raises fundamental
questions. Why have some economies succeeded in achieving rapid industrialisation
and economic development while others have achieved little or no progress in reducing
poverty? What factors explain this growing divergence of income, health and education
outcomes between and across economies?
Such issues are the domain of development economics, which attempts to identify and
enable the conditions required for sustainable economic growth and development. By
comparing the characteristics of high-income and developing economies, development
economics highlights the specific problems faced by poor countries, such as high rates of
population growth, low levels of skills development, weak legal and financial institutions,
and endemic corruption.
In an era of increased integration between economies, it is important to also understand
how the relationships between nations, the overall structure of the global economy and the
roles of international organisations influence global inequalities. These global factors are
set out below, alongside the domestic factors that contribute to low levels of 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.

Global trade system

Several features of the global trade system work to reinforce rather than reduce global
inequalities:
• Wealthy countries protect their domestic agricultural sector because it is not For further information
competitive with agricultural producers in many developing nations. Developing on global aid issues,
countries that export commodities are severely affected by high levels of global visit the website of
non-government aid
protectionism in the agricultural sector. While total agricultural support to
and advocacy organisation
producers in OECD has fallen by almost half since the mid-1980s, it remained high at Oxfam International
US$245 billion in 2021, providing 18 per cent of income for farmers in rich economies www.oxfam.org
in the European Union and double that in economies such as Japan and Korea.
Using this website, outline
• Regional trading blocs such as the European Union and United States–Mexico– some of the recent policy
Canada Agreement (USMCA) can exclude poorer nations from gaining access to proposals of Oxfam
lucrative global consumer markets. Exclusion from trade opportunities has an to address global poverty.
enormous impact on poor countries because bilateral agreements are rarely as
comprehensive as regional trading blocs.
• The World Trade Organization’s Doha Round of trade negotiations in the early
2000s was promoted as the “development round” because of its focus on trade reforms
to benefit poorer nations. A major reason for its failure was that high-income nations
resisted making concessions on the issues that would provide the greatest benefit
to developing countries. Recent WTO negotiations have focused on much more

55
Australia in the Global Economy 2024

Causes of global inequalities

Global factors Domestic factors

Global trade system Economic resources

Global financial architecture • Natural resources
Global aid and assistance • Labour supply and quality
Global technology flows • Access to capital and indebtedness
• Entrepreneurial culture
Institutional factors
• Political and economic institutions
• Economic policies
• Government responses to globalisation

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.

Global financial architecture

Although deregulated global financial markets and the global financial system are
intended to create development opportunities by enabling the free flow of funds around
the world, the global financial system can also entrench global inequalities:
• Historically, long-term international flows of investment heavily favoured
developed countries. This has changed since the 2000s, with developing economies
receiving around half of global foreign direct investment (FDI) flows. However,
faster-growing emerging economies and developing economies – such as China,
Brazil, India and Russia – have benefited the most. In contrast, the world’s 46 least
developed countries held just 1.2 per cent of the global stock of inward FDI in 2021.
• Short-term financial inflows heavily favour the more prosperous emerging
economies, which offer better financial returns for currency and stock market
speculators. However, as a result, these regions are exposed to economic volatility
as witnessed by the dramatic financial crises of East Asia in the late 1990s and of
Latin America in the early 2000s. When those kind of crises occur, they can set back
economic development for years while global financial market speculators simply
move on to invest in other countries. On the other hand, financial liberalisation
can be an important corollary of trade liberalisation. A 2019 IMF research report
found that low-income countries that had stronger banking sectors were better
able to manage when sudden changes in their terms of trade caused volatility in
their export earnings.
• International financial rules have not kept pace with the globalisation of the
economy and in some areas have tolerated loopholes that contribute to large flows
56
Chapter 3: Globalisation and Economic Development

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).

Global aid and assistance

The relatively small-scale efforts made by developed countries to address the problem of global
inequalities are insufficient to overcome the large differences in living standards:
• The total level of development aid provided by high-income economies reached an
all-time high of US$204 billion, or 0.36 per cent of Gross National Income, in 2022.
However, this was still only half the level promised by high-income economies since
the 1970s (0.7 per cent of GNI). The OECD Development Assistance Committee
found that only five of its member countries met or exceeded the 0.7 per cent UN
target in 2021. The recent boost to aid gave priority to settling refugees in new
countries (14 per cent) and supporting Ukraine during the war (8 per cent).
• Critics of the aid policies of developed countries argue that a significant proportion
of official development assistance is “phantom aid” – that is, aid funds that do not
improve the lives of the poor. According to the OECD, almost one in every six
dollars of foreign aid is “technical cooperation”, which is often paid to consultants
in donor countries. Another 11 per cent of aid is debt-related, such as for relieving
or refinancing past loans, which does not contribute to new development. A further
5 per cent of the foreign aid budget is spent on administration. These disbursements
reduce the amount available for development projects and humanitarian relief.
Additionally, these figures do not reveal the proportion of aid that is “tied aid” –
that is, aid that must be spent on overpriced or unnecessary goods and services that
are produced by the donor country. For example, when the United States provides
food support to very poor countries, it sometimes buys American crops and ships
57
Australia in the Global Economy 2024

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.

Global technology flows

Technology has the capacity to contribute to closing the gaps in living standards, but
it can also entrench inequalities. New technologies can be adopted much more quickly
in economies that have better infrastructure, higher levels of education and that already
have high penetration rates of related technologies such as broadband infrastructure. In
2022, the International Telecommunications Union estimated that around one-third of
the world’s population did not use the internet, and 95 per cent of those without it lived
in developing economies. This means that these businesses and consumers have limited
access to online opportunities to sell and purchase goods and services, which is a rapidly
expanding market, and reinforcing economic isolation from the digitally connected and
developed world. As the world became increasingly reliant on digital technology during
the COVID-19 pandemic, the gaps in developing countries’ access to these technologies
(termed the “digital divide”) became even more important.
New technologies are also largely geared to the needs of high-income countries because
they choose the priority areas of scientific research. Much of this technology – like labour-
saving devices and pharmaceuticals that deal with the health problems of ageing people
in advanced economies – is of little benefit to poorer nations that have abundant labour
supplies, a young population whose main health risks are common infectious diseases,
and limited capital resources. For example, around 10 per cent of the global population
(approximately 750 million people) did not have access to electricity in 2020, according
to the World Bank.
Developing nations also find it difficult to gain access to new technologies. Intellectual
property rights restrict the benefits of technological transfer to poorer countries because
they cannot pay developed country prices for those technologies. The Agreement on Traded
Related Aspects of Intellectual Property Rights (TRIPS), for example, has been criticised
for requiring all countries to implement complex intellectual property regimes that are
difficult to implement for developing economies. This issue came to light during the
COVID-19 pandemic when, in early 2021, developing economies brought a case to the
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Chapter 3: Globalisation and 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.

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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

Globalisation – Where to from here?

“Globalization was meant to bring the world closer together, enmeshing advanced and
developing economies in a web of mutually beneficial economic and financial linkages.
From about the mid-1980s, trade and financial flows between countries expanded rapidly
as governments dismantled barriers to these flows.
Not everything went according to plan. Tensions rose as the benefits were not equally
shared within or among countries. Widening economic inequality, often attributed to free
trade, roiled many advanced economies and has had far-reaching political consequences.
While they benefited from access to foreign markets for their exports, many emerging
market countries were ravaged by volatile capital flows and the fickleness of international
investors. Still, there was a broad consensus that shared economic interests would
ultimately triumph and even help smooth over geopolitical frictions.
…
Foreign direct investment (FDI) flows have tended to follow trade, with corporations
setting up operations abroad and investing in manufacturers as well as suppliers of
various kinds of inputs, including raw materials and intermediate goods.
…
Emerging market countries benefited from globalization in multiple ways. They were able
to expand markets for their products beyond their national borders, allowing them to
build strong manufacturing sectors and robust middle classes
…
Globalization is not dead, but it has clearly taken a turn toward fragmentation along
geopolitical lines, which could have important economic consequences for all countries.
…
For emerging market economies not politically aligned with advanced economies, lower
trade and financial flows will mean fewer technology and knowledge transfers, hindering
their path to development.”
– Eswar Prasad
Professor of Trade Policy, Cornell University
“The World Will Regret Its Retreat From Globalization”
The Economist, 24 March 2023
60
Chapter 3: Globalisation and Economic Development

• Political and economic institutions: Institutional factors in individual countries can

have a dramatic influence on the economic environment for businesses, investors and
consumers, and thus have implications for a nation’s level of economic development.
Countries with high levels of institutional fragility or violent Corruption
Country
conflict will usually have lower levels of economic development. rank
Country Perception
Index (0–100)
For example, it has been forecast that by 2030, 85 per cent of
1 Denmark 90
those in extreme poverty will live in countries with“fragile and
conflict-affected situations”. Today, there are 2 billion people, or 2 Finland, New Zealand 87

roughly a quarter of humanity, living in conflict-affected areas. 4 Norway 84

Political instability, corruption and a lack of law enforcement 7 Switzerland 82
by government agencies can also undermine the confidence of 13 Australia 75
investors, who will be reluctant to take risks if their business 24 United States of America 69
interests are threatened by an inadequate structure for resolving 65 China 44
legal disputes, corruption or other institutional problems. 85 India 40
The impacts of weak political institutions on economic 94 Brazil 38
development are difficult to quantify. One attempt to do so
137 Russia 28
is the Corruption Perception Index, compiled each year by
171 Korea (North) 17
Transparency International. The Corruption Perception Index
180 Somalia 12
is a score between 0 for countries with a relatively high level
of corruption and 100 for countries with a relatively low level Source: Corruption Perception Index 2022
of corruption. Figure 3.7 shows that developed economies Figure 3.7 – Corruption Perception Index,
have, in general, lower levels of corruption than developing selected countries 2022
and emerging economies.
• Cultural factors: are often reflected in legal structures and institutions, and can
influence a country’s economic development. For example, gender inequality can

DISTRIBUTION OF THE WORLD’S WEALTH

Over 90 per cent of the world’s US$463 trillion in wealth is held by individuals in Europe,
North America and in Asia-Pacific countries like China, Japan and Australia. By contrast,
people in Latin America, India and Africa hold only small shares of global wealth. Wealth is
distributed more unevenly than income throughout the global economy.

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

contribute to lower employment levels, lower productivity and weaker social

development. Cultural factors can also lead to ‘horizontal inequalities’ that hinder
development within a nation. Gender inequality is one of the most widespread
horizontal inequalities, with discriminatory laws leading to lower employment,
economic productivity and social development. World Bank research published in
2022 found that the mortality ratio of women to men is 2.3 per cent lower in
countries with legislation outlawing domestic violence. This has significant
economic impacts. In Tanzania, those who are subjected to abuse experience 60 per
cent lower lifetime earnings. The Women, Business and the Law 2023 report concluded
that, globally, women still have only three-quarters of the economic rights that
men have. Further, only 34 reforms relating to women’s rights were passed in 2022,
the lowest in 20 years. This makes women more vulnerable to impacts of crises
such as the COVID-19 pandemic, which increased the number of women in extreme
poverty by 47 million.
• Economic policies: Government economic policies can have a substantial impact
on development, in particular how governments balance the roles of market forces
and government intervention in the economy. If all major decisions are left to
market forces, a country may achieve a high level of economic growth, but it may
not improve education, health care and quality of life. On the other hand, excessive
government control over economic decision making can constrain entrepreneurship
and innovation, reducing economic growth. Countries with the highest levels of
human development, such as Switzerland and Australia, typically have both a strong
market economy and significant government investment in human development.
By contrast, when they were under communist rule between the Second World War
and 1989, with a command economy rather than a market economy, Latvia and
Poland experienced slower growth in development. A widely cited IMF paper,
Income Inequality and Fiscal Policy, found that a major reason for higher inequality
in Latin America compared with European economies was that developing economy
governments are less able to reduce inequality because they have less comprehensive
tax systems and public services. A 2022 paper from the Bank for International
Settlements found that inequality increases faster and more persistently following
recessions. A boom/bust cycle can impede long-term economic growth and increase
inequality. On average, inequality is still higher five years after a recession when
compared to pre-recession levels.
• Government responses to globalisation: Government responses to globalisation
can have a substantial influence on a nation’s ability to achieve economic
development. Policies relating to trade, financial flows, investment flows,
transnational corporations and the country’s participation in regional and global
economic organisations will influence an economy’s ability to take advantage of the
benefits of integration, such as economic restructuring, efficiency, access to foreign
capital and technology and access to overseas goods markets. For example, East
Asian economies that have been most open to trade and foreign investment have
experienced the strongest rates of economic growth in recent decades. The role of
government policy via responses to globalisation in influencing economic
performance is discussed in both case studies after this chapter.

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.

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Chapter 3: Globalisation and Economic Development

3.6 The impact of globalisation

In this section, we address one of the most important questions of modern economics:
what is the impact of globalisation on individual economies and the world as a
whole? We look at how the forces of globalisation have affected economic growth and
development, changed production processes, influenced the gap between rich and poor,
and impacted on the natural environment. While the overall impact of globalisation is
to foster improved economic outcomes, we also note some of the downsides to greater
economic integration.

Economic growth and development

Globalisation has affected countries in different ways. Developing economies have greater
opportunities to grow by producing goods for global consumer markets and can also
benefit from greater access to new technologies and foreign investment. High-income
economies, especially through transnational corporations, have found growth opportunities
in global supply chains and new global service markets. Nevertheless many economies
have not gained as much as might be expected from globalisation, and greater economic
integration has caused disruptive structural changes in some regions. Moreover, the
relatively free movement of people, goods and data across national borders also increases
risks – from cybercrime and the hacking of computer networks to disinformation on social
media and the spread of pandemics such as COVID-19.
Overall, there is evidence that globalisation has produced an acceleration of economic
growth, though the effect has been distributed unevenly across geographical regions. As
the world economy has become more integrated over recent decades, global real GDP
growth has increased from 3.1 per cent per year during the 1980s and 1990s to 3.8 per
cent from 2000 until the onset of the COVID-19 pandemic in 2020.
In recent decades, the fastest-growing economies have been emerging economies such as
China and India, while the slowest-growing economies have been the advanced economies.
Since 1990, a group of emerging and developing economies have been “catching up” to
advanced economies, although this is not the case for many, especially when we assess per
capita incomes.
• The East Asia and Pacific region (excluding high-income countries) has been the
fastest-growing region in the world (8.7 per cent per year on average across the
1990s and 2000s, though it fell to 7.3 per cent during the 2010s). In particular,
strong growth in China during this period (10.4 per cent in the 2000s, falling
to 7.7 per cent in the 2010s) demonstrates the role of industrialisation and
globalisation in economic growth. The region grew by 7.2 per cent overall in 2021,
but this reflected much stronger growth of 8.1 per cent in China, while the rest of
the region averaged growth of only 2.6 per cent. Growth was forecast to be around
4.6 per cent in 2022.
• Economies in South Asia also experienced successful growth, averaging 5.7 per cent
since 2000, particularly with India sustaining growth after its steps towards greater
integration with the global economy (6 per cent) and Bangladesh (6 per cent).
South Asia contracted by 5 per cent in 2020 and rebounded by 8 per cent in 2021.
• The former socialist economies of eastern Europe and Central Asia, which grew by
5.1 per cent in the 2000s, and 3.1 per cent in the 2010s, made a generally successful
transition to becoming market economies after experiencing a severe contraction in
their economies during the 1990s (−0.9 per cent) because of the difficult process
of transition. Output in the region grew by less than 1 per cent in 2022 because
of the impact of the war in Ukraine.
• The Middle East and North Africa experienced strong economic growth (4.4 per
cent) throughout the 1990s and 2000s, including in Egypt (4.7 per cent) and
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Australia in the Global Economy 2024

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

WAR IN UKRAINE – A TRILLION-DOLLAR INFLATIONARY SHOCK

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.

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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

Figure 3.8 – HDI performance of various countries

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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

in income inequality globally is as a result of globalisation.

Source: Solt, Frederick. 2020. “The Standardized World Income
A major part of this increasing inequality is the impact of
Inequality Database.” SWIID Version 9.4, November 2022 technological change which shifts production processes away
from low-skilled labour towards higher-skilled jobs. This
benefits people with higher levels of education but increases
Figure 3.9 – Income inequality in selected countries
unemployment for less skilled workers.
While COVID-19 impacted advanced economies first, the greatest effects were in
emerging economies, whose GDP per capita declined by more than double, 6.7 per cent,
in 2020. A 2023 IMF report found that emerging economies suffered the worst impacts
due to high employment in face-to-face jobs and low social security transfers.

Trade investment and transnational corporations

Globalisation has resulted in substantial increases in the size of trade flows and foreign
investment, reaching a record US$32 trillion in 2022. Because of the key role played
by transnational corporations (TNCs) in both trade and investment flows, TNCs are
increasingly dominating business activity around the world.

66
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

Figure 3.10 – The global supply chain for Apple iPhones

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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.

FOUR WAYS GLOBALISATION HAS IMPACTED COMMODITY MARKETS

IN THE LAST 100 YEARS
“Commodity demand (and production) has increased discovery and development of new reserves and new
enormously over the past century. The largest increases commodities …
have been for energy and metals as population and per
Third, innovation in commodity markets has often occurred
capita income have grown and technological change has
in response to periods of high prices. For example, in the
encouraged the use of industrial commodities … There
case of metals, technological improvements in aluminum
has also been significant substitution across groups of
and policy interventions in the tin market made aluminum
commodities. For example: in ocean shipping, oil replaced
the dominant commodity in packaging …
coal; in the package and container industry, aluminum and
plastics replaced tin; more recently, biofuels (an agricultural Fourth, a variety of interventions have been used to
product) have been used as a substitute for fossil fuel in mitigate commodity market volatility. Interventions have
gasoline … taken different forms, including subsidies, production
quotas, trade measures, and internationally coordinated
Secondly, technological advances have encouraged
supply management schemes.”
consumption by creating new products and new uses
for commodities. They have also reduced the use of – “Commodity Markets: Evolution, Challenges and
raw materials by improving efficiency in consumption Policies.” World Bank, 2022
and production. In addition, they have facilitated the Edited by John Baffes and Peter Nagle

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
68
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.

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The role of financial markets

The influence of global financial markets on economies has increased substantially during
the globalisation era. Driven by global information and communications networks,
global financial markets dominate financial flows around the world. Governments have
encouraged the development of global financial markets by removing “capital controls”
on the flow of finance, floating their exchange rates and deregulating their domestic
banking sectors.
Global financial markets can have positive impacts on economies. Countries would be
unable to conduct international transactions without foreign exchange markets. Businesses
would find it more difficult to access loans or attract investors if they were confined to
domestic financial markets. Efficient international financial markets should encourage
greater transparency of the actions of businesses and governments and should foster
economic development.
However, global financial markets have also produced negative results during the
globalisation era. Financial markets shift massive volumes of money around the world
every day. If investor sentiment turns against a particular economy, it can result in a
collapse in exchange rates, a shock to the economy and a recession accompanied by rising
unemployment.
In the late 2000s global financial markets played a part in producing the worst economic
crisis since the Great Depression of the 1930s. With its origins in the United States
housing market, the global financial crisis of 2008 saw a collapse in worldwide investor
confidence and the seizure of the global financial system. Central banks subsequently
flooded financial markets with liquidity, governments guaranteed banking deposits to
improve confidence and many governments provided “bail-outs” to prevent troubled banks
and financial institutions from collapsing. Although these emergency measures helped
avoid global economic depression, the world economy still contracted by 2 per cent.
The onset of the COVID-19 pandemic in 2020 and the invasion of Ukraine in 2022
showed how global financial markets can exacerbate volatility in economies. During the
height of the pandemic, a loss of investor confidence saw US$100 billion in investment
outflows from emerging economies, twice as big as outflows during the global financial
crisis. As many economies cut interest rates to record lows, some economists raised
concerns that government and corporate borrowers might take on more risk and create
over-indebtedness problems in the future. The subsequent rise in interest rates since 2022
has placed pressure on nations that accumulated large debt stocks over the pandemic, as
well as financial and non-financial institutions that failed to anticipate the rapid financial

Allocated global reserves by currency

United States dollars

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

Figure 3.11 – Allocated global reserves by currency

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.

The international business cycle

The linkages between economies hold benefits and risks for countries in the global
economy. The benefit of integration is that it allows countries to achieve faster rates of
economic growth by specialising in certain types of production and by engaging in trade.
Countries that have a higher level of trade also experience faster economic growth. In
particular, during times when world economic growth is higher, individual economies
are likely to benefit from the upturn in growth.
However, closer economic integration also makes economies more exposed to downturns in
the international business cycle and to developments in their regions. One of the reasons for
the strength of global economic growth in the mid-2000s was the simultaneous upswings
in the United States and China that propelled the global economy to its fastest growth
rates in 30 years. Equally, the closer links between economies resulted in the downturn in
the US economy in the late 2000s and the economic fallout from COVID-19, spreading
more quickly to other developed and developing economies. As the extent of trade and
financial integration continues to increase, there is likely to be greater synchronisation
of the international business cycle, intensifying both the downturns and the upswings in
the global economy.
Greater synchronisation of business cycles between different countries has also increased
the need for macroeconomic policies to be coordinated. Following the late 2000s recession,
for example, the IMF recommended that countries use their combined budgets to stimulate
the world economy by 2 per cent of global GDP in response to the global economic
recession. However, economies generally do not coordinate their macroeconomic policies
unless they are in a global crisis, as seen during the COVID-19 pandemic. A series of
macroeconomic policies were announced by governments around the world to combat
stalling economic activity as a result of the measures to curb the spread of COVID-19,
with many governments copying each other’s policy approaches. The COVID-19 pandemic
struck at a time when global growth was already weak, making it certain that the first
half of the 2020s will be a period of slower growth. Russia’s invasion of Ukraine in 2022,
which destabilised commodity markets and contributed to a global inflation shock, added
further to the uncertainty around the economic outlook for the 2020s.

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.

Standards of living are most commonly measured by Gross National Income

2
(GNI) per capita adjusted for exchange rate impacts or purchasing power parity
(PPP). However, economists recognise that this measure has limitations.

3 Economic growth is an increase in the real Gross Domestic Product over

a specific time period. Per capita GDP growth is the most common traditional
measure used to compare the performance of economies.

4 Economic development is concerned with economic growth alongside other

quality-of-life factors such as income distribution in a population, education
levels, health standards and quality of environment. The most common measure
of economic development is the United Nations Human Development Index
(HDI), which is based on a combination of GNI per capita, life expectancy at birth
and levels of educational attainment.

5 The main two categories of economies are developing economies and

advanced economies. Advanced economies are also sometimes known as
high-income, industrialised, western and first-world economies.

6 Emerging economies are in the process of industrialisation or modernisation

and experiencing sustained high levels of economic growth. This classification
includes a range of economies that are neither high income nor share the
traditional characteristics of developing economies.

While many features of individual economies can contribute to a lack of economic

7
development, such as a lack of quality inputs to production and the nature of
economic and political institutions, the globalisation era has highlighted how certain
features of the global economy – trade, finance, foreign aid and technology –
may work to entrench rather than alleviate inequalities between nations.

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.

9 Globalisation has contributed to a greater synchronisation of economic growth

rates through the international business cycle, reflecting the increased
integration of economies through trade and financial flows.

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.

72
Chapter 3: Globalisation and Economic Development

chapter review
1 Explain the difference between the concepts of economic growth and
economic development.

2 List examples of indicators that measure economic growth and economic

development and outline what factors they include.

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.

5 nalyse the reasons for differences in levels of development between

A
economies.

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.

74
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.

Sri Lankan foreign exchange reserves and exchange rate

Total reserves Sri Lankan rupees
(US$ millions) (per US$)
10,000 400
9000 350
8000
300
7000
6000 250

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

Brazil Indonesia China USA Poland Egypt Australia

Population (millions, 2023) 216 277 1410 335 37 104 26

Gross Domestic Product

2080 1390 19370 26850 748 404 1071
(current US$ billion, 2023)
Share of Gross World Product
2.3 2.5 18.9 15.4 0.9 1.1 1.0
(percent, PPP 2023)
GNI per Capita (%)
17260 14250 21250 77530 41310 14590 60350
(current international dollar, PPP, 2022)
Gini index (2022, 2021*, 2020**, 2019^) 52.9* 37.9 38.2^ 39.7** 28.8^ 31.9^ 34.3^

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

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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.

1.1 Social and economic progress

Brazil is a large economy with many billionaires and a substantial middle class. Its gross national
income per capita of US$17,260 in 2022 puts Brazil in the category of upper-middle-income economies.
However, as one of the world’s most unequal societies, it has always ranked poorly for its levels of
economic development. Brazil has made major progress in recent decades, but from a low starting point.
The 2021–22 Human Development Report ranked Brazil well down the global league table at 87th
in the world for its Human Development Index of 0.754 (up from 0.68 in 2000). This put it slightly
ahead of the average levels of development for the Latin American region, reflecting improvements in
health, education and income during recent years:
• Brazil’s life expectancy increased from 63 years in 1980 to 76 years in 2019, before falling to 72
and a rank of 94th in the world in 2021–22 following the severe COVID-19 pandemic.
• In 2021, 94 per cent of Brazil’s adult population had basic literacy skills, up from 82 per cent
in 1990 (even though the average period of formal education is relatively low).
• Brazil’s infant mortality rate has fallen significantly, from 53 per thousand live births in 1990
to 13 in 2021 – marginally higher than Mexico, El Salvador and Colombia due to recent slow
progress compared to other emerging economies.
One of Brazil’s most significant achievements is progress in poverty reduction. Historically, Brazilian
society has been characterised by very high levels of inequality. Wealth inequality remains particularly
high – according to 2023 Oxfam statistics, Brazil’s six richest men have as much wealth as the 100
million Brazilians who make up the poorest 50 per cent of the population. Nevertheless, Brazil has
made some progress: the Gini index (a measure of income inequality) fell from around 60 in 2000 to
49 in 2020, before sharply rising to 53 during the COVID-19 recession. OECD research has estimated
that of the reduction in inequality in recent decades, around half was the result of economic growth,
and the other half came from government policies to redistribute income in the 2000s during the first
term in office of President Luiz Inácio Lula da Silva (often known simply as “Lula”) from 2003 to 2010.
As president, Lula prioritised policies to reduce inequality.
The flagship policy introduced in 2004 by the Lula administration was the Bolsa Família (Family
Fund) program. Low-income households received small cash transfers in return for them keeping their
children in school and attending preventive health care visits. These programs, known as conditional
cash transfer policies, are regarded as one of the most effective economic strategies to combat poverty.
Between 2002 and 2019, the percentage of Brazilians living on less than US$2.15 per day fell from
23.2 per cent to 5 per cent – the best improvement in Latin America. An IMF paper in 2020 also found
that the program helped more people gain stable employment. While progress was reversed during
the COVID-19 recession, which saw unemployment rise to over 14 per cent, in 2023, the new Lula
administration began laying the groundwork for an expanded Bolsa Família along with tax exemptions
for low-income workers. However, some economists raised questions about whether Brazil can afford
the cost of this expanded program, forecast to exceed US$28 billion per year.

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Australia in the Global Economy 2024

1.2 Economic recessions

In the 2000s decade, Brazil’s economy grew by an average of 3.7 per cent annually and living standards
rose. But the 2010s were dismal, averaging growth only fractionally above zero. The recession of 2015
and 2016 was so severe that it came close to a depression (a deep and sustained recession). Per capita
incomes in 2020 had still not recovered to 2014 pre-recession levels, leading to a rise in the number
of Brazilians living in poverty to 55 million by 2020, or around one in four people.
The 2010s witnessed the unusual crisis of inflation and unemployment surging at the same time (the
textbook definition of “stagflation” – rarely seen in the world economy since the 1970s). Unemployment
reached 13.7 per cent in 2017, leaving close to 14 million Brazilians out of work, while inflation rose
to 9 per cent. Similar conditions recurred during the COVID-19 recession when unemployment surged
to 14.7 per cent in 2021, while inflation jumped over 10 per cent (before falling sharply).
FIGURE 2 – ECONOMIC INDICATORS

% %
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

THE REASONS FOR RECESSION

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.

1.3 Brazil’s environmental challenges

Between 2019 and 2022, President Bolsonaro’s environmental and climate change policies received
major international criticism, as Western governments urged Brazil to act on deforestation in the
Amazon rainforest. Brazil has faced significant challenges in managing its natural environment, which
remains central to the Brazilian economy. Like many developing economies, Brazil also suffers from a
high level of water and environmental pollution. Only 37 per cent of waste water is treated, and almost
half of the country’s garbage and other solid waste is not collected. Around one-third of housing is not
connected to sewerage, and poor sanitation also leads to worse public health outcomes.
Brazil’s economic development has come at the cost of large-scale forestry clearing. Eighty per cent
of Amazon deforestation has been for cattle farming, with other uses including soybean farming and
mining – some of Brazil’s biggest industries. Management of the Amazon has also been a polarising
political issue in recent years. Former President Bolsonaro made land clearing a priority, and even
promised to build a motorway through the Amazon to make logging operations easier. The fires
used for land-clearing purposes under the Bolsonaro Administration contributed to the fastest rate

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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

80
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.

FIGURE 3 – BRAZIL’S EXTERNAL INDICATORS

Year Current account (% of GDP) External debt to GDP ratio (%) Debt servicing ratio (% of exports)

1980 −5.4 27.0 70.9

1990 −1.0 26.3 65.1

2000 −3.8 36.6 88.6

2005 1.6 19.2 55.8

2010 −3.6 12.0 29.4

2015 −3.5 18.6 55.7

2016 −1.4 18.2 65.6

2018 −2.7 16.0 50.3

2020 −1.7 18.6 42.5

2022 2.9 19.3 27.1

2023* −2.7 16.3 29.6

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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3. Brazil’s response to globalisation

3.1 Brazil’s approach is different from the Asian tiger economies
Like most Latin American nations, Brazil has been more cautious in embracing globalisation than
many East Asian economies. Successive governments throughout the 20th century sought to create a
large industrial base and minimise Brazil’s dependency on imported manufactured goods in the hope of
developing greater self-sufficiency. Nevertheless, Brazil relied largely on foreign borrowing to fund its
industrialisation, which focused less on developing exports markets and more on substituting imports
with production for the domestic market.
The higher growth rates of more open East Asian economies in the 1980s and 1990s led many observers
to question the more protectionist Latin American approach. Brazil, like many of its neighbours,
gradually opened its economy in the 1990s, attracting foreign investment and pursuing export
opportunities. Brazil benefited from several developments in the global economy, including China’s
rapid growth and hunger for resources as well as growth in Latin American economies.
FIGURE 4 – BRAZIL’S NET FDI FLOWS Brazil’s model of globalisation is less
reliant on export demand. Brazil values
FDI (US$ billions) control over its natural resources, such
100 as oil and gas, where until recently,
90 there was a requirement that Brazil’s
80 state-owned business Petrobras must
70 own at least 30 per cent of new projects.
60 Brazil remains cautious about the
50 adverse impacts of globalisation, such
40 as unrestrained financial flows, and
30
previously restricted short-term financial
speculation by foreign investors. Brazil’s
20
political environment has also resulted in
10
slower progress on changes recommended
0 by international investors.
1990

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

3.2 Brazil’s increased openness to foreign investment

Since the 1990s, Brazil has attracted foreign investment, rather than merely borrowing funds from
overseas to provide the capital for economic development. To increase its attractiveness to foreign
investors, Brazil has undertaken extensive reforms, including deregulation and the privatisation of
state-owned monopolies like Vale (mining) and Embraer (aircraft manufacturing). It also gave priority
to low inflation as a major goal of macroeconomic policy.
These measures dramatically increased foreign investment in Brazil. Transnational corporations (TNCs)
play an important role in industries such as telecommunications, pharmaceutical, and manufacturing.
Brazil receives the largest share of foreign direct investment (FDI) in Latin America, with a focus on
the resources, finance and construction sectors. While international confidence and FDI in Brazil fell
under the Bolsonaro Administration, they recovered strongly in 2022.
Another important aspect of Brazil’s response to globalisation is an increasing level of investment
by Brazilian companies in other countries. Brazil’s stock of foreign direct investment assets more than
doubled in the decade between 2010 and 2020 from $173 billion to $392 billion. Brazil’s TNCs are
making large offshore acquisitions in the steel production, cattle, banking and construction sectors.
Brazilian FDI outflows have a substantial focus on developing and emerging countries, reflecting a
historic shift because FDI typically flowed from developed to developing economies.

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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.

FIGURE 5 – STRUCTURE OF THE BRAZILIAN ECONOMY

1996 2022
e

5%
ur

re 8%
ult

u
ult
ric

c
gri
Ag

A
Services Services
69% Industry 68% Industry
26% 24%

Source: System of Quarterly National Accounts, Current values table,

Instituto Brasileiro de Geografia e Estatística

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3.4 Brazil’s role in the global economy

President Lula is currently seeking to renew Brazil’s role of leadership in the global economy, which
diminished during the decade before he came back to office. Its poor economic performance since 2014,
combined with corruption crises and political instability, have reduced its capacity for global, and even
Latin American, leadership. This stands in sharp contrast to the 2000s, when Brazil and India led a bloc
of developing economies pushing for a new World Trade Organization agreement (the Doha Round
– which ultimately failed, but Brazil helped to advance reforms of intellectual property rules to make
medicines cheaper in poorer countries).
One aspect of Brazil’s role in the global economy that has been more consistent in recent decades is its
support for greater regional economic integration, especially through preferential trade agreements.
Within the South American continent, Brazil was a driving force for the formation of the Mercado
Común del Sur (Mercosur), a customs union between Brazil and four other Latin American nations
(Argentina, Paraguay, Uruguay and Venezuela), which came into effect in 1995. Trade within the
Mercosur bloc is mostly tariff free. The Mercosur bloc concluded a trade agreement with the European
Union in 2019 after nine years of negotiations that is gradually removing tariffs on 92 per cent of goods
traded between the two blocs, many of which previously attracted tariffs of up to 35 per cent. Brazil also
wants to negotiate a trade agreement with the US, but this would not be possible without changing the
rules of Mercosur, which prevents member countries from signing bilateral trade agreements.

3.5 Brazil’s currency reserves have helped stabilise financial markets

Financial instability is one of the most undesirable impacts of globalisation for developing economies.
Brazil has experienced numerous exchange rate crises caused by sudden shifts of sentiment on financial
markets. Those crises pointed to Brazil’s high foreign debt and its exposure to changing foreign investor
sentiment.
Brazil responded to its history of financial instability by floating its exchange rate in 1988 and building
up its currency reserves. Floating exchange rates are generally less vulnerable to excessive speculation
on foreign exchange markets than fixed exchange rates. While Brazil has continued to experience
volatility in its currency during economic and political crises, these currency movements have assisted
the economy in adjusting to changed economic conditions.
Since the global financial crisis of 2008, Brazil has also used foreign reserves to cushion itself from
financial speculation and from the risk of further financial volatility. Brazil has built the tenth-largest

FIGURE 6 – BRAZIL’S CURRENCY RESERVES

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

Source: Banco Central do Brasil 2023, Table IE-13 Year

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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.

BRAZIL’S POLITICAL CRISES: FROM IMPEACHMENT TO

COVID-19
In modern economies, governments play an important role in responding to changing economic
conditions and establishing policy priorities. But it is rare for political crises to have such economic
impact as Brazil has seen in the past decade.
Brazil’s recent political crises have seen corruption charges made against the last three presidents, with
Lula da Silva serving time in prison, Dilma Rousseff losing office before her presidential term ended and
Jair Bolsonaro facing several trials for his conduct as president.
Brazil’s political crises began in 2014 with one of the biggest corruption scandals in modern history,
involving billions of dollars in contracts from the state-owned energy company Petrobras. The scandal
saw 352 of the 594 members of Congress facing criminal accusations, alongside 27 of Brazil’s largest
construction companies. Inevitably, the blame rested with President Rousseff, even though there was
no evidence she was directly involved.
The Petrobras scandal and the extensive criminal investigation that followed brought the economy to a
halt at the same time as falling commodity prices were undermining Brazil’s export revenues. President
Rousseff lost popular support amidst public anger over corruption, the weak economy, poor government
services and rising prices. In 2016, Brazil’s congress voted President Rousseff out of office. The
official reason for her impeachment was that she had used accounting tricks to make the fiscal deficit
look smaller than it really was, so that she could increase public spending before the 2014 election.
Instead of restoring stability, President Rousseff’s removal worsened Brazil’s political crisis. Within months
of taking office, the new president, Michel Temer, was caught up in corruption allegations as part of the “Weak
Flesh” scandal, in which meat packers had bribed politicians and officials to turn a blind eye to breaches of
food safety laws. The scandal resulted in a ban on Brazilian meat exports to the US and European Union.
The popular former president Lula da Silva had been expected to win the 2018 presidential election, but
was prevented from standing because of a corruption charge that was later nullified by the Supreme
Court. With Lula out of the race, the 2018 presidential election was won by a populist anti-establishment
candidate, Jair Bolsonaro. He was nicknamed “Trump of the Tropics”.
Brazilian society has become increasingly polarised in recent years. Its political crises continued under
President Bolsonaro, with a series of new scandals involving members of his family and successive
resignations by senior officials and cabinet ministers. He downplayed the COVID-19 pandemic, which
he described as “just a little flu” while Brazil suffered the world’s fifth-highest number of deaths per
capita, with over 700,000 lives lost. International confidence in Brazil was weakened when President
Bolsonaro threatened to disregard the results of the October 2022 election, which former president Lula
won in a run-off. Confidence was also weakened when the finance minister, Paulo Guedes, shut the
IMF’s representative office, saying that the IMF was not needed in Brazil and “stayed only because they
like feijoada [a popular Brazilian black bean and meat stew], football, good conversation and, from time
to time, to criticise and make wrong predictions”.

4. Brazil’s recent policy developments

4.1 Macroeconomic policy
The key themes concerning economic management emerging from Brazil’s recent economic history are:
• investor concerns about corruption and political incompetence
• poor management of fiscal policy due to structural problems in public finances
• better management of monetary policy to reduce inflation
• despite political instability, Brazil has made progress on the management of financial instability
and trade liberalisation.

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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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“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

4.2 Microeconomic policy

Comprehensive reviews of the Brazilian economy undertaken by the IMF and OECD in recent years have
set out a detailed agenda for microeconomic reform in Brazil. They highlight a set of policy challenges
that Brazil needs to address to ensure the economy is on a path towards long-term, sustainable growth:
• The pension reforms mentioned above are regarded as a key microeconomic reform because of
their potential to improve workforce participation and increase Brazil’s low savings rate.
• Brazil remains, in the words of the IMF, “one of the most closed major economies in the world”.
Although Brazil is the world’s ninth-largest economy, it represented just 1 per cent of the value
of global trade in 2022 and, as a proportion of GDP, trade is lower in only seven other countries
in the world at 39 per cent, according to the World Bank. Brazil has also been the world’s
third-most active user of anti-dumping actions in the WTO.
• Brazil needs to increase labour productivity, which is low by international standards and around
one-third the level of its main regional competitor Argentina. Productivity growth will be the
main engine of growth in the longer term. Strengthening it will require more competition in
many sectors to allow labour and capital to move to activities with strong potential.
• Brazil has a young population but has had poor education outcomes in the past. The quality of
education (measured by the international standard of PISA tests) is below the OECD average and
is expected to deteriorate due to high drop-out rates curing COVID-19. Vocational education is
especially weak, with fewer students enrolled in vocational programs than in all but three OECD
economies. The share of young adults who have completed tertiary education is 23 percentage
points below the OECD average (2021 data).
• More rapid progress is needed on infrastructure development. Transport infrastructure is
important in a country as large and heavily populated as Brazil. Its road, rail and port quality
ranks poorly according to international studies. A major 2019 IMF report noted that over the
past two decades, Brazil invested an average of just 2 per cent of GDP in public infrastructure –
around one-third the average level of other emerging economies.
• Reforms are needed in government itself. Political crises have revealed corruption throughout
government, which has stifled economic growth. In 2022, Brazil was ranked 94th among 180
countries on Transparency International’s annual corruption index.
• An overhaul of the tax system is needed to reduce the notorious cost of compliance with Brazil’s
tax system. The IMF has recommended that Brazil replace its complex indirect taxes with a
single broad-based value-added tax and remove complexities in the tax system that make tax
compliance expensive. The World Bank’s 2020 “Ease of Doing Business” report ranked Brazil
124th out of 190 countries, noting for example that on average it takes almost 2000 hours for
a business to prepare its tax returns in Brazil, more than any other country (and compared to an
average of around 200 hours for most economies).
• Regulation more generally needs to be simplified and enforced. The OECD’s Product Market
Regulation Indicators report measures a nation’s regulatory barriers to entrepreneurship and has
found Brazil highly restrictive. Excessive regulations have encouraged a culture of “jeitinho”, or

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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.

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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

Indonesia Brazil China USA Poland Egypt Australia

Population (millions, 2023) 277 216 1410 335 37 104 26
Gross Domestic Product
1390 2080 19370 26850 748 404 1071
(current US$ billion, 2023)
Share of Gross World Product
2.5 2.3 18.9 15.4 0.9 1.1 1.0
(percent, PPP 2023)
GNI per Capita (%)
14250 17260 21250 77530 41310 14590 60350
(current international dollar, PPP, 2022)
Gini index (2022, 2021*, 2020**, 2019^) 37.9 52.9* 38.2^ 39.7** 28.8^ 31.9^ 34.3^
Mean years of schooling (2021) 8.6 8.1 7.6 13.7 13.2 9.6 12.7
Life expectancy at birth (1990, 2021) 63.3 67.6 65.3 72.8 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) 0.705 (114) 0.754 (87) 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

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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.

1.2 Indonesia is an emerging economy

In previous decades, Indonesia was considered a developing economy, and later, a newly industrialised
economy. Indonesia is now considered an emerging economy because of its strong growth performance
and prospects. This classification recognises Indonesia’s success in transforming its industry structure to
lift economic performance and development. In the four decades to 2023, Indonesia grew at an average
annual rate of over 5 per cent. Although not as fast as some neighbouring economies in East Asia,
this growth rate puts Indonesia well ahead of most economies around the world, including advanced
economies in Europe and North America, and emerging and developing economies in Latin America,
Central and Eastern Europe, and Africa. With a large population and continued economic growth,
Indonesia is expected to join the world’s largest emerging economies, the so-called BRIC economies
(Brazil, Russia, India and China), in coming decades. According to projections by consulting firm
PwC, Indonesia will surpass Germany and Japan to become the world’s fourth-largest economy by the
middle of this century.
The international business cycle and regional business cycle have also had significant impacts on
the economic performance of the Indonesian economy in the past half century. While most economies
experienced a downturn in growth during the 1970s because of rapid increases in global oil prices,
Indonesia, as a major oil exporter, experienced an acceleration of economic growth. During the 1980s,
the opposite occurred, as the glut of oil supply pushed prices down, and with them the growth rates
of the Indonesian economy. During the 1990s, Indonesia was part of an economic growth boom that

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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.

FIGURE 3 – STRUCTURE OF ECONOMY

1980 2021
Agriculture Agriculture
24% 13%

Industry Industry
42% 40%
Services Services
34% 43%

Source: World Development Indicators 2023

Note: These statistics do not add to 100

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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ASIAN FINANCIAL CRISIS

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

the Asian financial crisis helped

Source: International Monetary Fund, World Economic Outlook (April 2023) *IMF Forecasts shape future economic policy.
**Note Malaysia and Thailand 2022 figures are estimates.

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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).

FIGURE 5 – INDONESIA’S PERFORMANCE ON THE MILLENNIUM DEVELOPMENT GOALS

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).

Source: World Bank World Development Indicators 2023

1.3 Indonesia’s growth has had negative environmental impacts

Degradation of the natural environment has been a significant cost of the industrialisation and
globalisation of the Indonesian economy. Indonesia has the third-largest rainforest in the world, yet is
also home to one of the world’s highest rates of deforestation. A 2019 study by Greenpeace showed that
more than 74 million hectares of rainforest – an area twice the size of Japan – was cleared in the last half
century. This is the result of commercial logging, land clearing for agriculture, mining developments

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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.

FIGURE 6 – INDONESIA’S CO2 EMISSIONS PER CAPITA

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.

2. Indonesia’s path to globalisation

Since it opened up to global forces in the 1980s, globalisation has reshaped the Indonesian economy.
Reforming the economy has been necessary so that Indonesia can keep pace with other economies in
the South-East Asian region and avoid relying too heavily on commodity exports, whose value on
global markets tends to be volatile. As the oil boom of the 1970s subsided, Indonesia needed to find
more sustainable foundations for long-term economic growth, and exporting manufacturing goods was
central to this strategy.
Since the mid-1980s, Indonesia has lowered protectionist barriers to trade, resulting in greater competitive
pressures and making businesses more export-focused. Indonesia has taken opportunities to participate in
multilateral efforts to reduce protectionism. Greater foreign investment has provided a source of capital,
while also creating financial market and economic volatility. Transnational corporations have played a
greater role in the economy for both traditional commodity sectors and other exports.

2.1 Indonesia has reduced protectionist barriers since the 1980s

Trade liberalisation has been a crucial component of Indonesia’s integration with South-East Asia and
the global economy. In the mid-1980s, Indonesia shifted away from a policy of import substitution
towards export-led development. In 2020, the simple mean tariff rate applied to imported goods
was 6 per cent, down from 17 per cent in the early 2000s, and similar to the 5 per cent average for the
East Asia and Pacific region.
Prior to the mid-1980s, Indonesia was a highly protected economy. Indonesia’s oil boom in the 1970s saw
the imposition of strict trade barriers to protect government-sponsored and government-owned business
enterprises. The methods of protection included tariffs, licensing requirements, local content rules and
import monopolies. One area that historically has faced high non-tariff barriers has been agriculture. In
the mid-1980s, under the control of Indonesia’s sole approved rice importer, Bulog, the country was able
to achieve self-sufficiency in rice production and phase out all rice imports. The effective rate of protection
for agriculture between 2011–2020 averaged 27 per cent of total consumption, which is much higher
than regional peers and contributes to higher domestic prices. Many farmers are also disadvantaged by
protectionism, as two-thirds buy more food than they sell (making them “net food buyers”).
Indonesia’s shift towards trade liberalisation began in the mid-1980s. The average level of tariffs was
reduced by almost one-third. Between 1987 and 1995 the effective rate of tariff protection for the
manufacturing sector fell from 86 per cent to 24 per cent. For agriculture over the same period it halved,
from 24 per cent to 12 per cent. The Government has also relaxed the complicated network of import
licensing restrictions. Annual deregulation and liberalisation packages aimed to reduce barriers to foreign
trade and investment.
After the Asian financial crisis in 1998, Indonesia continued to pursue trade liberalisation under the
auspices of an IMF program. Tariff and non-tariff barriers were reduced, together with an easing of the
restrictions on foreign investment. However, in the decade to 2020, the average tariff level increased
marginally.

2.2 Indonesia has joined regional trade agreements

At the same time as it has been (mostly) reducing protectionist barriers, Indonesia has become increasingly
integrated with the global economy through participation in global, regional and bilateral trade
agreements. Indonesia has also become more prominent on the global stage, in particular through its
membership in the Group of 20 (G20) major economies.
Indonesia has been an active member of the World Trade Organization (WTO) since 1995. With
almost a third of the population employed in the agricultural sector, Indonesia supported the failed Doha

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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)

2.3 Changes in trade in goods and services

Trade liberalisation has improved Indonesia’s access to overseas export markets and led to stronger economic
growth. Exports of goods and services have grown at an average annual real rate of 4.9 per cent globally
in the period between 1980–2020. Meanwhile, Indonesia’s trade expanded by 5.2 per cent. While giving
the country access to wider markets and improving export industry revenues and employment, this trade
growth was low when compared with Malaysia, Thailand and the Phillipines, which grew 12-fold. The

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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

Source: World Bank data 2023 Year

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.

2.4 Barriers to finance and investment have also been liberalised

Indonesia has reduced barriers to financial and investment flows during the globalisation era to
encourage economic growth and development. From the mid-1980s, Indonesia pursued tax reforms,
deregulation of industry sectors, and the removal of restrictions on foreign ownership. While previous
decades saw FDI flow mainly to the oil and mining sectors, in the 1990s Indonesia saw an increased
flow of investment into manufacturing.
While FDI reached a record level in 2022, overall FDI inflows to Indonesia remain lower than in
comparable countries, owing to uncertainty about government policy settings and lower levels of
international competitiveness. However, there have been occasional successes. Following the government

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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%)

TNCs in Indonesia • About 220 pharmaceutical companies operate in Indonesia

• Commodity sector attracts TNCs like ExxonMobil
• L’Oréal and Toyota have manufacturing facilities in Indonesia

Benefits of FDI • More investment when domestic savings are low

• Employment in production and management
• New technologies and business processes
• Links to export markets and international supply chains

Risks of FDI • Exchange rate and financial market volatility

• Structure of FDI may limit technology and training benefits for local economy
• Environmental sustainability of FDI in natural resource sector

Drivers of FDI • Large endowment of natural resources

• Large consumer market
• Relatively low labour costs

Constraints on FDI • Inadequate transport and energy infrastructure

• Inadequately trained staff
• Complicated regulations
• Exchange rate volatility undermines investor confidence
• Economically disconnected regions

Source: BKPM – Indonesia Investment Coordinating Board

Note: Numbers do not add to 100 due to rounding.

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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2.5 Foreign aid and assistance have supported economic development

Economic development in Indonesia has been supported by foreign aid and assistance. In addition, the
World Bank funds many active projects in Indonesia with a cumulative lending value of US$19.6 billion.
These programs have targeted community empowerment, government administration, energy and
infrastructure development. Australia was expected to provide Indonesia with $286 million in official
development assistance in 2023–24, and also donated 8 million doses of COVID-19 vaccines during
the pandemic.

3. Recent developments in economic policy

Indonesian economic policy has evolved gradually in recent years, with governments aiming to achieve
macroeconomic stability, promote economic development, attract foreign capital and increase social
expenditure. At one point, Indonesia set a goal of being a top 10 and middle-income economy
by 2025, but a combination of disappointing
economic growth rates and the recession caused by FUEL SUBSIDIES
the COVID-19 pandemic made that goal impossible.
A continuing drain on Indonesia’s public
The central element of Indonesia’s current economic resources for many years has been the
policy framework is the 20-year development plan large government expenditure on fuel
known as RPJMN (Rencana Pembangunan Jangka subsidies, which have been larger than
Menengah Nasional). The plan, which began in all central government social and capital spending
2005, is in its final phase. This last phase aims to combined. At their peak, fuel subsidies accounted
focus on improving human capital and Indonesia’s for 20 per cent of government spending. Petrol
international competitiveness. prices have previously caused political turmoil,
The conduct of monetary policy is led by Indonesia’s forcing a reversal of subsidy cuts in 2008,
Central Bank, Bank Indonesia, which has been 2011 and 2018. The Government announced
independent from the Government since 1999, and an intention to further lower subsidies to reduce
has had a medium-term inflation target of 4 to 6 per spending on fuel subsidies to US$14 billion in
cent since 2005. During the 2010s, the main central 2023. Fuel subsidies mainly benefit the middle
bank interest rate moved within a band between 4 and class, with the poorest 10 per cent of households
8 per cent. Monetary policy was loosened throughout receiving just 2 per cent of fuel spending.
2016 and 2017, and after increasing rates in 2018,
Bank Indonesia reduced interest rates to 3.5 per cent in 2020. Rates rose sharply in late 2022, stabilising
at 5.75 per cent for the first half of 2023.
Fiscal policy has focused on maintaining the confidence of international investors and in providing
macroeconomic stability. During the 1990s, the Government achieved budget surpluses, using those
surpluses to retire government debt. Spending was restrained while tax revenues increased (by around
15 per cent). In the two decades to 2019, government debt fell from 87 per cent to 30 per cent. As a
result of COVID-19 stimulus spending, government debt rose to 40 per cent of GDP in 2020.
The Indonesian Government implemented a major fiscal policy response to COVID-19. The
Government relaxed its self-imposed budget deficit ceiling of 3 per cent. The Indonesian Government
budgeted around US$50 billion – more than 4.5 per cent of GDP – on its national economic recovery
program (PEN). The PEN was split into the following areas:
• Healthcare spending (US$7 billion), including purchase of medical equipment, funds for mass
vaccination and incentives for medical workers.
• Social protection (US$16 billion), including food support programs for up to 20 million families,
extending the pre-employment card program for around 5.6 million impacted workers, free
electricity for around 30 million customers, supporting low-cost housing and providing other
support needs.
• Tax incentives and credit for business (US$8 billion), including income tax exemptions, deferring
import tax and debt payments, and reducing the corporate tax rate from 25 per cent to 22 per cent.
• Economic recovery program (US$12 billion), focused on providing credit restructuring and
financing for small and medium businesses.

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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
Australia in the Global Economy 2024
2013

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.

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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)

NET FOREIGN DEBT

SERVICING $33 BILLION
NET RETURNS TO FOREIGN
INVESTORS $65 BILLION

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

4.1 Understanding Australia’s place in

the global economy
In the first section of this book we examined the key features of the global economy,
including the trends towards greater integration among countries, trade and financial
linkages, trade policies, important global institutions, and the income gap between
advanced and developing economies. In this section, the focus is on where the Australian
economy fits into the global economy and in particular the nature of Australia’s trade and
financial links with the rest of the world.
By global standards, Australia is large in some respects and small in others. On size
alone, the Australian economy ranks 12th in the world – placing it in the middle rank
of advanced economies, between Brazil and South Korea. This means that the Australian
economy is larger than almost 200 other countries, but if it is compared to the giants of
the world economy, such as the United States, China, the EU or Japan, then it is relatively
small. Another way to compare Australia with other countries is to look at standards of
living. Australia was ranked fifth in the world in terms of quality of life, according to
the United Nations’ 2021–22 Human Development Index. This demonstrates that
Australia has a very high level of economic development.
Measures of the size of the economy and living standards only provide a snapshot comparison
between economies. To really understand the impacts of changes in the global economy
on the Australian economy, we must understand the linkages between Australia and the
global economy. This requires an analysis of Australia’s trade patterns and trade policies,
Australia’s financial relationships with overseas countries, and the influence of the exchange
rate on the structure and performance of the Australian economy.

4.2 Trends in Australia’s trade

patterns
Despite Australia’s geographic isolation from the rest of the world, trade has always
represented a high proportion of Australia’s economic activity. In part, this is because there
have always been overseas markets for Australia’s primary commodities, such as minerals

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.

The changing direction of trade

The direction of Australia’s trade has changed considerably over recent decades. China has
become Australia’s dominant trading partner in the past decade, while India and ASEAN
countries have also become more important. Meanwhile, the key export markets for
Australia in previous decades – Japan, the United Kingdom and Europe – have declined
in importance. Figure 4.1 illustrates the importance of each of these regions to Australia’s
merchandise trade (which includes trade in physical goods but not trade in services).
There was a historic shift in the direction of Australian trade after the United Kingdom
joined the European Economic Community (EEC) trading bloc, now known as the European
Union (EU), in 1973. The United Kingdom had been Australia’s major trading partner
prior to this period, reflecting the historic ties going back to when Australia was a colony
of Britain. Once the United Kingdom joined the European trading bloc, it was required to
impose the same barriers to trade with Australia as with other countries, in effect giving a
preference to trade from European countries. Australia soon lost many of its traditional export
markets for agricultural products in the United Kingdom. Although since 2023 Australia
and the UK have had tariff-free trade (following the signing of a trade agreement after the
UK’s departure from the European Union), the UK remains a much less significant market
than the faster-growing economies in closer proximity to Australia.
When Australian exporters found it more difficult to gain access to European markets,
their focus shifted to other areas, particularly the North-East Asian and ASEAN countries,

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

Figure 4.1 – Australia’s major trading partners

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.

Annual exports (%) Annual imports (%)

Country/region
1990 2000 2010 2020 2021 2022 1990 2000 2010 2020 2021 2022

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

India - - - - - 5.6 - - - - - 2.9

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

Figure 4.2 – Australia’s direction of merchandise trade by country and region

The changing composition of Australia’s trade

Primary industries have always been the main focus of Australian exports, as Australia
has a comparative advantage in commodities due to its vast natural resources. Australia
has exported high volumes of agricultural products such as wheat, wool and beef, and
minerals such as coal, iron ore, gold and lithium. Together, agricultural and mineral
exports account for more than two-thirds of Australia’s export earnings. Australia has been
less competitive in manufacturing. While other advanced economies generally developed
substantial manufacturing industries in the second half of the 20th century, Australia has
continued to rely on its primary exports, while importing large quantities of capital goods
and manufactured consumer goods.
108
Chapter 4: Australia’s Trade and Financial Flows

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)

Figure 4.3 – Australia’s composition of exports

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

109
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.

Capital Consumer Intermediate Services

Year
goods (%) goods (%) goods (%) (%)

1989–90 19.0 17.7 37.2 25.7

1999–00 18.1 20.6 36.0 24.1

2009–10 18.2 24.6 32.7 22.0

2014–15 18.3 24.8 32.7 23.1

2019–20 18.4 26.0 31.6 21.8

2020–21 21.5 30.9 32.1 13.2

2021–22 19.5 26.0 37.2 15.8

2022–23 20.1 25.8 33.7 19.4

Source: ABS International Trade in Goods and Services, Australia (Cat. no. 5368.0, Table 1)

Figure 4.4 – Australia’s composition of imports

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

4.3 Trends in Australia’s financial flows

While Australia’s trade flows have increased substantially over recent years, the rate of
growth in financial flows has been much greater, as international businesses have bought
Australian assets and invested in Australian businesses, and as Australian companies have
increased their overseas investments.
International financial flows were less important in the postwar economic boom of the
1950s to the early 1970s, while exchange rates remained fixed and international capital
markets remained largely closed. However, during the early 1970s the international system
of fixed exchange rates (known as the Bretton Woods system) came to an end. Exchange
rates around the world were floated and restrictions on the movement of capital across
national borders were removed. Financial flows began growing rapidly as international
capital markets opened up, exchange rates were floated, and technological changes made
it easier to shift finance between countries. The level of foreign investment in Australia
and investment overseas by Australians has more than doubled in the past decade, and
has been rising rapidly since the 1980s.

Foreign investment in Australia ($m) Australian investment abroad ($m)

Year
Direct Portfolio Total Direct Portfolio Total
1990–91 106,636 145,942 309,330 44,715 22,702 115,583

1995–96 156,172 256,288 482,952 84,786 49,964 204,281

2000–01 253,467 475,407 888,811 218,371 150,145 516,419

2005–06 386,425 831,380 1,456,020 352,019 314,393 918,882

2010–11 557,154 1,192,146 2,116,789 458,567 496,556 1,338,477

2015–16 877,179 1,642,290 3,304,726 624,395 865,905 2,255,207

2020–21 1,085,456 2,077,915 4,080,127 897,603 1,439,679 3,167,305

2021–22 1,184,941 2,086,691 4,496,592 984,583 1,443,017 3,592,164

2022–23 1,213,605 2,181,931 4,639,643 1,042,016 1,594,931 3,817,403

Source: ABS Balance of Payments and International Investment Position, Australia (Cat. no. 5302.0)
Note that direct and portfolio investment differ from calculations of foreign debt and equity

Figure 4.5 – The changing pattern of Australia’s 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.

4.4 The balance of payments

Balance of payments The balance of payments is the single most important economic indicator of the
is the record of the relationship between Australia and the global economy. The balance of payments
transactions between
summarises all transactions that Australia has with the rest of the world over a given period
Australia and the rest
of the world during a of time. It shows the trade and financial flows in and out of the Australian economy. All
given period, consisting of money that flows in is referred to as a credit, and all money that flows out is referred to
the current account and as a debit. For example, if Australia exports goods to New Zealand, the money we receive
the capital and financial for these exports is an inflow, and thus a credit on the balance of payments. On the other
account.
hand, if Australia imports goods from New Zealand, the money paid out for these imports
is a debit. In these accounts, credit entries are considered positive transactions, while debit
entries are negative (denoted with a minus sign).
The balance of payments figures are presented in two accounts – the current account
and the capital and financial account. These accounts are compiled according to a
set of international accounting standards, which make it easier to compare Australia’s
balance of payments with other countries.

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Chapter 4: Australia’s Trade and Financial Flows

The current account

The current account shows the money flow from all exports and imports of goods and Current account is the
services, income flows and non-market transfers for a period of one year. In effect, the part of the balance of
payments that shows the
current account covers external transactions that are not reversible in the sense that once
receipts and payments
commenced, these transactions cannot be undone. Figure 4.6 shows a simplified current for trade in goods
account for the Australian economy. and services, transfer
payments and income
In order to analyse the information in this table, one must understand the meaning of the flows between Australia
items that appear on the current account: and the rest of the world
in a given time period.
Net goods These are non-reversible
transactions.
This refers to the difference between what Australia receives for its exports and what it
pays out for its imports of goods. There are three possible outcomes: Australia could be in
balance (where export receipts equal import payments), Australia could
have a surplus (where receipts exceed payments), or Australia could have 2021–21 2022–23
Component
($bn) ($bn)
a deficit (where payments exceed receipts). Figure 4.6 shows that net
Goods
goods recorded a surplus of $152.4 billion in 2022–23.
Exports 534.0 592.4
Net services Imports −388.1 −440.0
This refers to services that are bought and sold without people receiving Net goods 145.9 152.4
a “good” – for example, transport, travel, insurance charges, telephone Services
calls or tourist accommodation. Services that Australia sells are an inflow
Service credits 61.1 93.5
of money and are shown as credits. Services that Australia buys are an
Service debits −71.9 −107.1
outflow of money and are shown as debits. The net services deficit of
$13.6 billion in figure 4.6 shows that the value of Australia’s services Net services −10.8 −13.6
imports is greater than the value of its services exports. Balance on goods
135.1 138.8
and services

Balance on goods and services Primary income

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

Net secondary income

This refers to non-market transfers, that is, income that is not earned through a factor
of production. These occur when products or financial resources are provided without a
specific good or service being provided in return. This is a small and relatively technical
account, which has little importance in the scope of the overall balance of payments. Net
secondary income includes payouts on insurance claims, workers’ remittances (for example,
foreigners working in Australia and sending money overseas) and funds taken out of
Australia in the form of unconditional aid to developing nations (such as funds given as a
gift to a foreign government without a specified purpose). Pensions received by residents
from foreign governments (which would be a credit on net secondary income) are also
included. Figure 4.6 shows a deficit in the net secondary income account of $1.2 billion
in 2022–23.
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Australia in the Global Economy 2024

Balance on current account

This refers to the addition of the BOGS, net primary income and net secondary income.
Figure 4.6 shows that in 2022–23 the balance on the current account was a surplus of
$28.9 billion.

The capital and financial account

Capital and financial The other side of the balance of payments is the capital and financial account. This
account records the is concerned with financial assets and liabilities – the money flows that result from
borrowing, lending, sales
international borrowing, lending and purchases of assets such as shares and real estate
and purchases of assets
between Australia and the
for a period of one year. The major feature of the capital and financial account is that
rest of the world. these transactions are reversible, in the sense that after the transactions occur, they can
be undone in the future. For example, borrowings can be paid back, and assets that are
bought can be sold again.
Figure 4.7 shows a simplified capital and financial account for the Australian economy.
The main features of the capital and financial account are as follows:

2020–21 2021–22 Capital account

Component
($bn) ($bn)
The capital account consists of two main components. The first
Capital account item is capital transfers, mainly in the form of “conditional” foreign
Capital transfers −0.8 −0.8 aid grants (which are linked to specific capital projects) and debt
Net acquisition/disposal forgiveness. This may be in the form of assistance to other countries
of non-produced, to build up their infrastructure or capital stock (such as an Australian
non-financial assets 0.2 −0.1
donation to build a bridge in the Solomon Islands). The second item
Total capital account −0.6 −0.9
is entries for the purchase and sale of non-produced, non-financial
Financial account assets – mainly intellectual property rights such as patents, copyrights,
Direct investment −50.2 −14.3 trademarks and franchises (such as an Australian company buying the
Abroad −152.4 −54.8 rights from an American company to operate a Subway outlet in
in Australia 102.1 40.5 Australia). Figure 4.7 shows a capital account deficit of $0.9 billion.
Portfolio investment 54.5 6.9
Financial account
Abroad −128.6 −39.9
The financial account shows Australia’s transactions in foreign financial
in Australia 183.1 46.8
assets and liabilities. It is categorised by the type of investment, with
Financial derivatives −9.2 −14.0 five main categories: direct investment, portfolio investment, financial
Other investment −18.6 −2.7 derivatives, reserve assets and other investment. The size of the financial
Reserve assets −20.2 −5.4 account can change substantially from one time period to the next.
Total financial account −43.7 −29.5 This is a result of the large money flows that underlie the balance on
the financial account.
Balance on capital and
financial account −44.3 −30.4 Credit entries in the financial account represent net inflows. These
Net errors and omissions 0.5 1.5 come about because of either an increase in foreign investment in
Source: ABS Balance of Payments and International
Investment Position, Australia (Cat. no. 5302.0)
Australia or a reduction in Australian investment overseas. Debit
entries represent net outflows. Until recent years, Australia has
Figure 4.7 – Structure of the capital and financial account consistently recorded a positive financial account balance, showing
that the rise in Australia’s liabilities to the rest of the world is higher
than the increase in the liabilities of the rest of the world to Australia. When that happens,
Australia has effectively drawn on the savings of the rest of the world to finance a deficit
on its current account.
The five main financial account components are:
• Direct investment: Direct investment covers foreign financial transactions to fund
new investment in Australia or overseas or to buy more than 10 per cent of shares
in an existing company. This might include a South Korean company bringing in

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Chapter 4: Australia’s Trade and Financial Flows

funds to build a motorway in Sydney or BHP Billiton sending funds to Indonesia

to fund the construction of a copper mine. Figure 4.7 shows a direct investment
deficit of $14.3 billion.
• Portfolio investment: Portfolio investment refers to the buying of land, shares
and other marketable securities (that is, securities that can be easily sold) in
existing companies. This is also where most foreign debt is recorded. Portfolio
investment usually involves the largest volume of transactions on the capital and
financial account. Figure 4.7 shows a $6.9 billion surplus in portfolio investment
in 2022–23, down from $54.5 billion in 2021–22 (in other words, the value of
Australian portfolio investment overseas exceeded the value of overseas portfolio
investment in Australia).
• Financial derivatives: Financial derivatives are a category of complex financial
assets that have become increasingly significant in recent years. The value of these
investments is normally derived from the performance of specific assets, interest
rates, exchange rates or indices. Financial derivatives are an important part of global
financial markets. Figure 4.7 shows a $14 billion deficit in financial derivatives.
• Reserve assets: Reserve assets refer to those foreign financial assets that are
available to and controlled by the central authorities for financing or regulating
payment imbalances. Reserve assets include monetary gold (gold held by the
Reserve Bank), Special Drawing Rights, reserve positions in the International
Monetary Fund and foreign exchange held by the Reserve Bank of Australia. Figure
4.7 shows a deficit of $5.4 billion in reserve assets.
• Other investment: Other investment is a residual category that captures
transactions not classified as direct investment, portfolio investment, financial
derivatives or reserve assets. Other investment covers trade credits, loans including
financial leases, currency and deposits, and other accounts payable and receivable
that do not meet the classification requirements of the above categories. Figure
4.7 shows a $2.7 billion deficit for this category.

Balance on capital and financial account

The overall balance of the capital and financial account is determined by adding the
categories together. The outcome should be approximately equal to the deficit on the
current account. Figure 4.7 shows a $30.4 billion deficit in 2022–23.
Australia’s balance of payments figures are derived in the following way:

The current account is calculated as:

net goods + net services
(the balance on goods and services)
+
net primary income + net secondary income

The capital and financial account is calculated as:

capital account + direct investment + portfolio investment
+
other investment + reserve assets + financial derivatives

The balance of payments is calculated as:

current account + capital and financial account
+
net errors and omissions = 0

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.

Links between key balance of payments categories

An important relationship exists between the current account and the capital and financial
account on the balance of payments. Firstly, the two accounts add up to zero – together,
they represent a “balance of payments”. The deficit on the current account is equal to the
surplus on the capital and financial account (allowing for the small category of net errors
and omissions). An increase in a current account surplus will result in a rise in the capital
and financial account deficit.
In theory, the floating Australian dollar plays the key role of ensuring that there is a
balance in the balance of payments. Under a freely floating exchange rate, equilibrium
occurs where:

Supply of A$ Demand for A$

The supply of A$ is represented by: The demand for A$ is represented by:
• Payments for imports of goods and • Receipts for exports of goods and
services (M)
• Primary & secondary income/transfers
= services (X)
• Primary & secondary income/transfers
overseas (Y debits) from overseas (Y credits)
• Capital and financial outflow (K outflow) • Capital and financial inflow (K inflow)

Therefore, for equilibrium in the foreign exchange market:

Supply of A$ = Demand for A$
Which in turn implies:
M + Y debits + K outflow = X + Y credits + K inflow
Rearranging the equation:
M – X + Y debits – Y credits = K inflow – K outflow
OR
Deficit (or surplus) on the current account = Surplus (or deficit) on the capital
and financial account
The strongest link between the current account and the capital and financial account can
be seen on the net primary income part of the current account. In the longer term, a capital
and financial account surplus will result in a larger deficit on the net primary income
account. This is because any foreign financial flow that comes to Australia must earn some
kind of return for its owner, and these earnings are a debit (or an outflow) recorded on
the primary income account. Financial inflows can create debits on the primary income
category of the current account in two ways:
• International borrowing (that is, foreign debt) will require regular interest
repayments. These interest payments, or servicing costs, are not recorded on the
capital and financial account; they are recorded as debits on the net primary income
part of the current account. Only the repayment of the principal (the original
amount borrowed) is recorded on the financial account. Australia’s high level of
borrowing from overseas has contributed significantly to the net primary income
deficit due to the servicing costs of foreign debt.
• Foreign investment (that is, foreign equity) will require returns on the equity
investment. Equity financial inflows are related to the foreign purchase of Australian
assets such as land, shares or companies. Foreign owners of Australian land will
receive rent, owners of shares will receive dividends, and owners of companies will
receive profits. These returns on investment are also recorded as debits on the net
primary income part of the current account.
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Chapter 4: Australia’s Trade and Financial Flows

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)

Figure 4.8 – The current account balance

Balance Balance Capital and

Net
on goods Net primary on current CAD as % financial
Year secondary
& services income ($bn) account of GDP account
income ($bn)
($bn) ($bn) ($bn)
1990–91 –0.6 –16.8 0.6 –16.7 –4.0 16.0
1995–96 –2.4 –18.7 0.4 –20.7 –3.9 19.1
2000–01 0.6 –19.8 –0.4 –19.6 –2.8 16.9
2005–06 –18.5 –38.8 –1.0 –58.4 –5.8 55.7
2010–11 14.6 –56.9 –3.0 –45.2 –3.2 45.8
2011–12 –2.5 –45.6 –3.0 –51.1 –3.4 55.6
2012–13 –20.0 –38.2 –3.3 –61.5 –4.0 61.0
2013–14 –4.5 –41.7 –3.2 –49.4 –3.1 54.7
2014–15 –24.1 –33.0 –2.8 –60.0 –3.7 66.7
2015–16 –37.8 –39.0 –0.6 –77.4 –4.7 85.8
2016–17 9.0 –47.7 –1.4 –40.1 –2.3 40.0
2017–18 6.6 –57.7 –0.8 –51.9 –2.8 60.1
2018–19 48.2 –65.0 –0.7 –17.6 –0.9 15.6
2019–20 74.9 –44.3 –1.2 29.4 1.6 –29.4
2020–21 89.0 –22.6 –3.0 63.4 3.1 –63.4
2021–22 135.1 –88.6 –2.7 43.8 2.3 –44.3
2022–23 138.8 –108.7 –1.2 28.9 1.3 –30.4
Sources: ABS Balance of Payments and International Investment Position, Australia (Cat. no. 5302.0),
Australian National Accounts: National Income, Expenditure and Product (Cat. no. 5206.0)

Figure 4.9 – Australia’s balance of payments performance

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Chapter 4: Australia’s Trade and Financial Flows

The balance on goods and services

The balance on goods and services (BOGS), also sometimes referred to as the trade balance,
has recorded an improving trend in recent years. It has been consistently in surplus since
2016–17, averaging at 3.4 per cent of GDP. This reflects the strong growth in income
from Australia’s resources and energy exports. The BOGS surplus of $138.8 billion
recorded in 2022–23 was the highest on record, reflecting elevated commodity prices,
strong activity in the travel and tourism sectors, and the return of international students
to Australian cities.

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.

CALCULATING THE TERMS OF TRADE

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.)

Export price index 100

Terms of trade index = ×
Import price index 1

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Australia in the Global Economy 2024

THE LUCKY COUNTRY: AUSTRALIA’S RECORD TERMS OF TRADE

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.

Index (2020–21 = 100)

150
140
130
120
110
100
90
80
70
60
50
40 2023–24*
2024–25*
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

Source: ABS Australian National Accounts: National Income, Expenditure and Product Year
(Cat. no. 5206.0) *2023–2024 Budget forecast

Figure 4.10 – Terms of trade

• 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’s international competitiveness is also affected by infrastructure for

transport and information, such as the capacity at the nation’s ports, road and rail
networks, and broadband networks. Substantial increases in public and private sector
investment in infrastructure during recent years have helped alleviate infrastructure
capacity constraints and facilitated export growth.

The primary income account

The primary income account plays a central role in the trends in Australia’s current account
balance. It is composed mainly of payments of interest and dividends on Australia’s net
foreign debt and equity. Between 2004–05 and 2019–20, the net primary income account
typically recorded a deficit between 2 and 3 per cent of GDP. In 2022–23, the net primary
income deficit rose sharply to 4.9 per cent of GDP.

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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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)

Figure 4.12 – Household savings ratio

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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.

4.6 The consequences of a high CAD

Economists differ over their level of concern about Australia’s historic pattern of high
deficits on the current account and foreign liabilities, with some arguing that if the
government is not borrowing money, any external imbalances are simply the result of
normal market transactions in a global economy. Some also argue that a current account
deficit and foreign debt can be beneficial because borrowing from overseas can increase
investment and help the economy to grow faster. The International Monetary Fund
generally considers a current account deficit to be too high if it averages over 4 per cent
in the medium to long term or if it is above 6 per cent in the short term.
There are several risks associated with a sustained high current account deficit. These include:
• The growth of foreign liabilities – over a period of time, a high CAD will
contribute to an increased level of foreign liabilities. A deficit on the current account
presupposes financial inflow on the capital and financial account, either in the form
of borrowings from overseas (foreign debt) or through selling equity in items such as
property and companies (foreign equity). This will mean that lenders may become
more reluctant to lend to Australia or to invest in Australia.
• Increased servicing costs associated with high levels of foreign liabilities lead to
larger outflows on the net primary income account, worsening the CAD. Foreign
debt must be serviced through interest payments that vary according to the level
of interest rates in Australia and overseas, and profits must be returned on foreign
equity investment. Higher levels of foreign debt can result in foreign lenders
demanding a “risk premium” on loans, forcing up interest rates.
• Increased volatility for exchange rates – high CADs may undermine the confidence
of overseas investors in the Australian economy and, by reducing demand for
Australia’s currency, may result in a depreciation of the Australian dollar.

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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).

The terms of trade is an index showing changes in the prices of Australian

8
exports relative to changes in the price of imports. Australia has experienced
the strongest terms of trade surge in its history since 2003, with far-reaching
consequences for the balance of payments and the economy.

The current account is influenced by a combination of cyclical and structural

9
factors. The BOGS is the major cyclical component and is influenced by the
exchange rate, terms of trade and the international and domestic business cycles.
The net primary income deficit is the main structural cause of Australia’s pattern
of current account deficits and is the result of a savings-investment gap.

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

2 Explain why foreign direct investment might be preferable to portfolio investment.

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.

5 xamine Australia’s recent balance of payments performance, distinguishing

E
between short-term and long-term factors influencing the current 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.

9 Examine the role of savings in Australia’s balance of payments problems.

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).

THE AUSTRALIAN DOLLAR IN THE GLOBAL ECONOMY

• The Australian dollar is the world’s sixth-most traded currency after the US dollar,
European euro, Japanese yen, British pound and Chinese renminbi.
• The Australian dollar is used in 6.4 per cent of all daily currency trades in foreign
exchange markets.
• 92 per cent of all Australian dollars sold in the Australian foreign exchange market are
used to buy US dollars.
• A
ctivity in Australia’s forex market has fallen since 2010 but the value of the currency
can still go through large upswings and downswings in any given year.
• T
urnover from foreign exchange transactions averaged US$150 billion per day in
Australia in April 2022.
Sources: Triennial Survey of Foreign Exchange and Derivative Markets, Bank for International Settlements
2022 and the Reserve Bank of Australia 2023

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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.

5.2 Australia’s floating exchange

rate system
In December 1983 Australia switched from a managed flexible peg to
Exchange rate:
a floating exchange rate system. This is regarded as one of the most Price of A$ in terms of US$
important structural changes in Australia’s economic history because it D S
opened up the economy to global financial flows. Under a floating system,
the exchange rate is determined by free market forces and not government
intervention. Supply and demand establish an equilibrium price for the
Australian dollar (A$) in terms of another country’s currency. This is 0.70
demonstrated in figure 5.1, which shows how the exchange rate for A$
in terms of US dollars (US$) is determined.
Just as market forces establish the equilibrium price for a good, they
S D
can also determine the equilibrium price of the A$ in terms of another 0 Qe Quantity of A$
country’s currency. Figure 5.1 reveals that market forces have determined
the value of the A$ in terms of US$ at US$0.70 (that is, A$1 will buy Figure 5.1 – Exchange rate determination under a
US70 cents or alternatively US$1 buys A$1.43). This equilibrium will floating exchange rate system
change regularly (hour by hour, or even minute by minute) as supply and
demand in the foreign exchange market change. Floating exchange rate
is when the value of an
Demand for Australian dollars is represented by all those people who wish to buy that
economy’s currency is
currency. Demand for Australian dollars is affected by: determined by the forces
• The size of financial flows into Australia from foreign investors who of demand and supply in
foreign exchange markets.
wish to invest in Australia and need to convert their currency into A$.
– The level of Australian interest rates relative to overseas interest rates.
Relatively higher Australian interest rates make Australia a more attractive
location for foreign savings and thus increase the demand for A$.
– The availability of investment opportunities in Australia. If there are more
opportunities for investors overseas to start new businesses or buy into existing
businesses via the share market, the demand for A$ will increase.
• Expectations of future movements of the A$. For instance, expectations of a future
appreciation of the A$ will increase current demand for A$ by speculators, thus
contributing to the expected appreciation.
• The demand for Australian exports, since the foreigners who buy Australia’s
exports need to convert their currency into A$ to pay Australian exporters.
– Changes in commodity prices and in the terms of trade have tended to have an
immediate effect on the dollar. A rise in commodity prices and an improvement
in the terms of trade are generally associated with an increase in the value of
Australian exports. Financial markets will often respond to these changes by International
increasing the value of the dollar with an expectation that the value of exports competitiveness is a
will increase over the short to medium term. measure of the ability of
Australian producers to
– The demand for Australian exports will be influenced by the degree of compete with overseas
international competitiveness of domestic exporters and Australia’s inflation producers in both local
and world markets.
rate relative to overseas countries. If domestic firms are competitive in world

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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$).

Exchange rate: Exchange rate:

Price of A$ in terms of US$ Price of A$ in terms of US$

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$

Figure 5.2 – An appreciation of the Australian dollar

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.

Exchange rate: Exchange rate:

Price of A$ in terms of US$ Price of A$ in terms of US$

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 – A depreciation of the Australian dollar

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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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.

Trade weights (%) Trade weights (%)

Currency Currency
2022–23 2022–23
Chinese renminbi 30.7 United Kingdom pound sterling 5.1
United States dollar 12.5 Singapore dollar 5.1
Japanese yen 9.2 New Zealand dollar 3.7
European euro 8.2 Indian rupee 2.9
South Korean won 7.3 Thai baht 2.7
Source: Reserve Bank of Australia 2023

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.

AUSTRALIAN DOLLAR: RECENT MOVEMENTS AND OUTLOOK

The Australian dollar experienced a sustained appreciation commodity exports, such as coal, gas and iron ore, which
during the first decade of the twenty-first century and then contributed to a 7.5 per cent appreciation of the Australian
a trend depreciation in the second decade. After hitting a dollar from January to March 2022. The significance of
low in 2001 (of US47 cents), from 2003 it began appreciating commodity prices is further highlighted by the fact that
strongly as commodity prices increased. The dollar fell the Australian dollar’s depreciation over the first half
sharply in 2009 as the global financial crisis destabilised of 2023 coincided with lower iron ore and coal prices.
international currency markets, losing one-third of its value The Reserve Bank has identified other causes for the
against the US dollar. But it swiftly recovered, peaking at dollar’s recent volatility. When Australia’s cash rate is
US$1.10 in 2011. The dollar then began to depreciate, falling greater than that of other advanced economies, foreign
during the mid-2010s into a range between US70–80 cents. investors (particularly from high-savings nations such
The COVID-19 pandemic saw the dollar briefly depreciate as Japan) become more likely to invest their savings in
even further to just US55 cents in March 2020. It recovered Australia. This is known as “carry trade” and has provided
by early 2021 to almost US80 cents, before depreciating strong support for the Australian dollar for the last two
again to around US65 cents by mid-2023. decades. Despite a sharp increase in interest rates,
Commodity prices have played a critical role in the Australian interest rates were below the levels of most other
volatility of the exchange rate. As a significant commodity advanced economies and so put downward pressure on
exporter, with mineral and metal resources comprising the Australian dollar.
half of all exports, Australia’s terms of trade and long-term
Long-term economic factors such as economic growth,
export performance are strongly influenced by the prices
commodity prices and returns on investment have
of those commodities. During the resources boom,
significant impacts on the value of the exchange rate.
commodity prices soared to over three times their pre-2003
But the past decade has shown that the main way those
value, fuelling demand from trade as well as speculative
long-term factors have an effect is through their impact
investment in the Australian dollar. More recently, in
on global financial markets, in which speculators are
response to the war in Ukraine (beginning in 2022), many
generally more influenced by short-term factors rather than
countries imposed sanctions on Russia, a large commodity
long-term economic trends.
exporter. This caused an increase in demand for Australia’s

Trade Weighted Index

(May 1970 = 100) A$/US$
100 1.30
United States dollar (RHS)
90 1.15
Trade Weighted Index (LHS)
80 1.00

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

Source: Reserve Bank of Australia Year

Figure 5.6 – Recent movements in the Australian dollar

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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

2015–16 0.74 0.67 82.2 0.54 4.70 62.4

2016–17 0.77 0.68 84.8 0.59 5.14 65.5

2017–18 0.76 0.64 84.0 0.57 5.03 63.5

2018–19 0.71 0.62 78.5 0.55 4.80 60.9

2019–20 0.67 0.61 73.5 0.53 4.73 58.0

2020–21 0.77 0.63 84.7 0.54 4.92 63.5

2021–22 0.73 0.64 84.6 0.54 4.69 61.7

2022–23 0.67 0.64 92.3 0.56 4.68 61.6

Sources: ABS Australian Economic Indicators (Cat. no. 1350), Balance of Payments and International Investment
Position (Cat. no. 5302) and Reserve Bank of Australia.

Figure 5.7 – Exchange rate movements 2000–23

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

Dirtying the float

When the Reserve Bank feels that a large short-term change in the exchange rate (possibly
due to excessive speculation) will be harmful to the domestic economy, it may decide to step
into the foreign exchange market, either as a buyer or a seller, in order to stabilise the A$.
In order to curb a rapid depreciation of the currency, the RBA will buy A$, putting upward
pressure on the exchange rate. On the other hand, by selling A$ the RBA may prevent a
rapid appreciation. The RBA last intervened in the foreign exchange market in 2007–08
during the global financial crisis. When the A$ lost one-third of its value against the US$,
the RBA bought $3.3 billion of A$ to stabilise its depreciation. The RBA was able to sell
$3.4 billion of A$ in 2009 as the currency recovered in value. In addition to stabilising
the currency, the forex interventions also generated profits that contributed to the RBA’s
dividend payment to the government.
Nevertheless, the RBA’s ability to intervene through buying A$ is limited by the size of its
foreign currency holdings (that is, its reserves of foreign currency and gold that can be used
to fund such purchases). In reality, the sum total of the RBA’s foreign currency reserves
is relatively small – it is not even equal to one day’s total transactions in the currency.

Monetary policy decisions

Monetary policy initiatives are an indirect way of influencing the exchange rate and are
rarely used for this purpose. If the RBA wants to curb a rapid depreciation, it may increase
the demand for A$ by raising interest rates. Higher interest rates relative to overseas
countries will attract more foreign savings, which must be converted into A$. This will
increase the demand for A$ and put upward pressure on the exchange rate. However, this
policy will generally only be effective for a limited time.
It is unusual for the RBA to change interest rates in response to currency movements as
the primary focus of monetary policy is to influence the domestic economy – particularly
the inflation rate. However, exchange rate movements can at times be so large that they
may affect the stability of the economy or the level of inflation. Reserve Bank research in
2014 estimated that a 10 per cent depreciation leads to a 0.25 to 0.5 per cent increase in
inflation for two years. In 2023, a factor behind the RBA’s decision to continuing raising
interest rates was that interest rates overseas were generally higher, causing the Australian
dollar to depreciate. When the exchange rate is lower, this makes imported goods more
expensive and contributes to inflationary pressures.

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.

5.4 Fixed exchange rate systems

Since December 1983, Australia has had a floating exchange rate system. In previous
decades, however, it operated on a range of fixed exchange rate systems. Prior to November
1976, Australia had a fixed exchange rate system in which the A$ was pegged, at different
times, to the UK pound sterling, US dollar and the Trade Weighted Index. From
November 1976 to December 1983, Australia had a variation of the fixed exchange rate
known as the managed flexible peg.
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GOVERNMENT PARTICIPANTS IN GLOBAL FOREIGN EXCHANGE MARKETS

In recent decades, governments and their central banks trading band was gradually widened, reaching its current
have played a much smaller role in global foreign exchange rate of 2 per cent in 2014. By mid-2023, the yuan was
markets. The power of governments to influence the valued at around 7.0 to the US dollar. To maintain the
exchange rates of currencies has been reduced as private exchange rate around this level, Chinese authorities must
sector participants in forex markets, especially currency be willing to purchase a US dollar for 7.0 RMB and be willing
speculators with very large funds under management, have to purchase 7.0 RMB for a US dollar. If there is too much
become more dominant. Governments, through countries’ demand for renminbi at this “price” in US dollar terms,
central banks, rarely play more than a residual role as a the Chinese central bank will accumulate increasingly
buyer or seller of a country’s currency, mainly to stabilise more US dollar “reserves” as it sells more renminbi. In
its value. fact, the past decade has seen China’s foreign exchange
Instead, exchange rate values are mostly determined by reserves soar from US$150 billion to over US$3.2 trillion –
market forces – that is, the bargaining process between a twenty-fold increase. It was estimated that the Chinese
private sector buyers and sellers of different currencies. The renminbi was 10 per cent lower in late-2022 than
values of currencies such as the Australian dollar, Japanese it would have been without government intervention.
yen and British pound are all determined this way. Some While this makes China’s central bank the world’s
countries, however, attempt to influence the value of their most active public sector forex market participant,
currency against another currency and therefore play a the Chinese Government is gradually moving towards
much larger role in that foreign exchange market. the internationalisation of the renminbi. This gradual
The value of the Chinese yuan, also known as the renminbi, relaxation of government influence over the day to day
is largely set by the People’s Bank of China (PBC). Between currency value can be seen in the moderate fall of China’s
1994 and 2005, the PBC fixed the exchange rate at 8.27 foreign reserves since 2014 (see figure 5.8). This move
RMB to the US dollar. After 2005, it adopted a crawling towards a more flexible exchange rate will contribute
peg exchange rate system, intervening to prevent the value to the diminishing role of central banks in global foreign
of the yuan from deviating more than 0.5 per cent (in either exchange markets.
direction) against the US dollars on any given day. This daily

Foreign reserves minus

gold (US$ billion)

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

Figure 5.8 – China’s foreign exchange reserves since 1990

Fixed exchange rates

Under a fixed exchange rate system, the government, or the RBA, officially sets the
exchange rate (that is, it would not be left up to the forces of supply and demand). A
fixed exchange rate regime is depicted in figure 5.9. In this case, the official rate has been
set at A$1=US80 cents (above the US70 cents rate that would apply if it was left up to
market forces).
The government can attempt to maintain a fixed exchange rate by either buying or selling
foreign currency in exchange for A$. In this case it would be buying the excess supply of
A$ (that is, Q1Q2) at a price of US80 cents.
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Chapter 5: Exchange Rates

Thus, in order to intervene in the foreign exchange market under a fixed

exchange rate system, the government would need foreign reserves of Exchange rate:
Price of A$ in terms of US$
foreign currency and/or gold.
When Australia operated under a fixed exchange rate system, the RBA D S

obtained the necessary foreign reserves by insisting that all foreign

0.80 fixed rate
exchange holdings be lodged with them. Even so, the risk with this
0.70 market rate
system is that in order to prop up the value of the A$, the RBA could
exhaust its foreign reserves by continually exchanging them for the
excess supply of A$, which could lead to a complete collapse of trade in
the currency. S D
0 Q1 Q2 Quantity A$
The other avenue open to the government would be to change the exchange
rate “officially”, so that it was closer to the real market value. It would
Figure 5.9 – A fixed exchange rate system
devalue the A$ when it officially lowered the exchange rate and revalue
the A$ when it increased the exchange rate. Another problem of fixed
exchange rates is it limits the ability of the central bank to influence interest rates, which
are used for monetary policy, and discussed further in chapter 15.

The managed flexible peg

A variation of the fixed exchange rate is the managed flexible peg. This system operated
in Australia from November 1976 to December 1983. Under this system, the Reserve
Bank would “peg” the value of the A$ at 9:00 am each day and that price would operate
throughout that day. A flexible peg system provides more flexibility than the fully fixed
rate, but it can still allow the official rate to drift away from that which would exist
under pure market forces. For example, many economists have argued that Australia had
an overvalued exchange rate under the managed flexible peg system in the early 1980s.

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.

5.5 Exchange rates and the balance

of payments
In an open economy such as Australia’s, the value of the exchange rate can change
substantially in response to economic developments. One of the most important influences
on the exchange rate is the performance of the balance of payments. But just as the balance
of payments influences the value of the dollar, the value of the dollar can also influence
the balance of payments – as well as several other areas of the economy.

How the balance of payments influences the exchange rate

Under a floating exchange rate, the quantity of Australian dollars supplied must always
equal the quantity of dollars demanded. In other words, the net outflow of funds on the
current account (supply of A$) equals the net inflow of funds on the capital and financial
account (demand for A$). (Note, however, that in reality, allowance has to be made for
statistical mistakes through the net errors and omissions item on the balance of payments).
If there is any disequilibrium on the balance of payments, it is only temporary and is
automatically corrected by a movement in the exchange rate.

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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.

CENTRAL BANK DIGITAL CURRENCY

The Reserve Bank of Australia issues the Australian and financial institutions, and a wholesale CBDC limited
dollar in two forms: physical money in the form of to financial institutions.
banknotes and digital money in the form of balances The Reserve Bank is one of many central banks worldwide
held by commercial banks and other financial considering CBDCs. The IMF reported that by mid-2022
institutions. Only 4.5 per cent of Australia’s money there were two fully-launched CBDCs (the eNaira in
takes the form of banknotes or coins. Nigeria and the Bahamian sand dollar) and almost 100
The Reserve Bank has been exploring a third other CBDCs being researched or developed.
option of issuing the dollar as a central bank digital There are several reasons why central banks are
currency (CBDC), and in March 2023 it announced interested in CBDCs. First, a CBDC could make
a small-scale pilot to test use-cases of CBDCs, payment systems more efficient, particularly for sending
in partnership with a group of Australian financial money overseas. For example, it still costs around 5 per
institutions. A CBDC is digital money, denominated in cent of the payment and takes over one day to send
the national unit of account and issued by a central money internationally from an Australian bank. Second,
bank. The difference between a CBDC and existing CBDCs can improve access to digital payment services,
forms of digital money is that a CBDC represents particularly in emerging market economies, which tend
a claim on a central bank, rather than a claim on to be more reliant on physical money.
a private financial institution. There are two types Sources: Reserve Bank of Australia; BIS Innovation Hub and Central
of CBDC: a retail CBDC for use by both the public Banks of Australia, Malaysia, Singapore and South Africa; IMF 2023.

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Chapter 5: Exchange Rates

The effects of a change in the exchange rate

Changes in the exchange rate can also bring about changes in the balance of payments.
The effects of appreciations and depreciations can be both good and bad for the economy.

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.

3 Demand for the Australian dollar is determined by the perceptions of speculators

about future movements in the dollar, changes in interest rates and the demand
for Australian exports, which are in turn influenced by the level of economic
growth in Australia’s trading partners and commodity prices.

4 Supply of the Australian dollar is determined by the perceptions of speculators

about future movements in the dollar, changes in interest rates and the demand
for imports, which are in turn influenced by the level of economic growth and
consumer spending within Australia.

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.

Changes in the balance of payments can influence the currency’s value,

9
although the extent to which the balance of payments impacts on the currency
depends on the response of foreign investors. In general, a deterioration in
the current account is likely to result in a depreciation, and an improvement in
the current account is likely to result in an appreciation.

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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chapter review
1 Describe what is meant by the exchange rate.

2 Outline the factors that affect the demand for Australian dollars.

3 Outline the factors that affect the supply of 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:

a) by dirtying the float

b) through changes in monetary policy.

8 Examine how the exchange rate will be influenced by a deterioration in the current
account.

9 Discuss the positive and negative impacts of an appreciation of the Australian

dollar.

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.

THE GOVERNMENT’S MAIN AIMS IN REDUCING PROTECTION

• Make domestic industries more internationally competitive by exposing them to

competition from imported goods.
• Encourage resources to move away from industries and firms that cannot improve
their competitiveness to those that can become more competitive – in other words,
to concentrate the economy on areas where Australia has a comparative advantage.
• Allow Australia to benefit from greater integration with the global economy by giving
consumers and businesses access to goods and services available on global markets
at the lowest possible prices.
• Promote structural change in the economy, with the long-term aim of encouraging
efficient firms to produce what the global economy demands.

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Australia in the Global Economy 2024

6.2 Government initiatives to reduce

protection
Australia’s transition from a highly protected economy to an economy with relatively low
trade barriers has occurred over a number of decades. As shown in figure 6.1, the average
tariff level in Australia has gradually declined since the late 1960s. Over the same time
period, Australia has also seen the gradual phasing out of other “non-tariff barriers” to
trade, such as quotas and subsidies.
1968–9 1977–8 1982–3 1986–7 1994–5 2002 2013 2023
THE BIRTH OF mRNA
MANUFACTURING IN AUSTRALIA 36% 23% 25% 19% 9% 3.7% 1.8% 0.5%

Sources: Productivity Commission, World Development Indicators, Budget 2023–24

In 2022, the Australian Government and Moderna,
Figure 6.1 – Average tariff rates in Australia
a pharmaceutical and biotech company, finalised
a deal to establish an mRNA research and vaccine
Protectionist policies came under sustained attack from the early
manufacturing facility in Australia – one of the first
1970s. Organisations such as the Productivity Commission (then
ever to be built in the Southern Hemisphere. The
10-year arrangement is worth billions of dollars,
called the Industries Assistance Commission), the Commonwealth
expected to create hundreds of jobs and see Treasury and the National Farmers’ Federation argued that
Australia produce up to 100 million mRNA vaccine protection fostered inefficiency, increased prices, misallocated
doses a year from 2024. The exact terms of the resources, made Australia less internationally competitive,
deal remained confidential, but a substantial damaged our trading performance and reduced living standards
government investment was needed to persuade in the long run.
Moderna to make the investment.
The first significant push to reduce protection was made by
Such government intervention could be the Whitlam Government, which in 1973 announced a 25 per
characterised as a form of trade protection. cent across-the-board tariff cut. However, it was not until 1988
Australia has sourced mRNA vaccines from other that Australia commenced a comprehensive program of trade
countries since 2021 to protect its citizens from
liberalisation. Over the subsequent decade, Australia reduced its
COVID-19. There is no independent evidence that
tariffs faster than any other advanced economy (other than New
Australia has a comparative advantage in making
them locally.
Zealand).
Despite that, the deal was not controversial Today, almost 90 per cent of all imported goods are tariff free,
and not considered to be a harmful example of with the remainder, mostly manufactured goods, subject to
protectionism. This reflects a shift in policymakers’ a general tariff rate of 5 per cent or less. Historically, some
thinking about the limits of free trade in the era manufacturing industries, such as motor vehicles and the clothing
of globalisation. During the pandemic, other and textiles industry, were protected by higher tariff levels.
countries prioritised their own needs which meant However, these arrangements have been significantly reduced
that countries who were relying on vaccine imports over time, with the most recent cuts occurring in 2015. Most
were forced to wait in line for vaccines to arrive. remaining tariffs do not apply to imports from countries with
Establishing an mRNA manufacturing facility in which Australia has a free trade agreement (FTA), such as South
Australia improves health security and should
Korea, Japan and India.
mean that, in the event of future pandemics,
Australia will be better placed to access new Australia’s average tariff level (weighted according to what goods
vaccines and treatments. and services are traded the most) was most recently calculated as
just 0.5 per cent. The Productivity Commission estimates that
the dollar value of tariff assistance to domestic production was $2.1 billion in 2020–21.
Australia’s average tariff level is lower than many other advanced economies such as the
United States (1.5 per cent). Moreover, less than 0.5 per cent of the few tariffs Australia
does apply are considered to be large by the World Trade Organization (tariffs rates are
considered to be large when they exceed 15 per cent). For comparison, around 10 per cent
of all tariffs applied in the world are large based on the WTO’s definition.

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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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Australia in the Global Economy 2024

6.3 Australia’s free trade

agreements
Trade agreements
In addition to reducing their own levels of protection, governments pursue free
Bilateral agreements trade by accessing overseas markets through trade agreements. Over the past
ANZCERTA (New Zealand–Australia) decade, Australia has actively secured free trade agreements with China, Japan
SAFTA (Singapore–Australia) and South Korea, adding to existing agreements with the US, Chile and other
TAFTA (Thailand–Australia) regional economies (see figure 6.2). Australia’s involvement in trade negotiations
AUSFTA (Australia–United States) includes both multilateral agreements and bilateral agreements.
ACI–FTA (Australia–Chile)
IA–CEPA (Indonesia–Australia) Bilateral trade agreements
A–HKFTA (Australia–Hong Kong)
MAFTA (Malaysia–Australia)
Bilateral agreements involve just two nations. They are the easiest trade
KAFTA (Korea–Australia) agreements to negotiate because they only need to factor in the interests of the
JAEPA (Japan–Australia) two participants. The most comprehensive bilateral agreement for Australia is
ChAFTA (China–Australia) the 1983 Australia–New Zealand Closer Economic Relations Trade Agreement
PAFTA (Peru–Australia) (ANZCERTA). This agreement has led to free trade between the two countries, and
ECTA (India–Australia) increased standardisation of laws, business practices and commercial structures.
A–UKFTA (United Kingdom–Australia)
Bilateral trade deals are an important focus of trade policy in Australia. Since 2020,
Multilateral agreements Australia has entered into bilateral agreements with Hong Kong, Peru, Indonesia,
APEC forum (Asia-Pacific Economic India, and most recently, with the United Kingdom in 2023. In addition, the
Cooperation forum) Australian Government is negotiating for separate agreements with the European
AANZFTA (ASEAN–Australia–New Zealand) Union and the Gulf Cooperation Council (covering the economies of Bahrain,
CPTPP (Australia and 10 other Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates). Negotiations
regional countries)
PACER Plus (Australia and 9 other
are also still underway to conclude a more complete agreement with India.
Pacific countries)
RCEP (Australia and 14 other
While bilateral trade agreements reduce protection for Australian industries,
Indo-Pacific countries) they only do so on a country-by-country basis. As a result, they generate fewer
economy-wide benefits than broad trade liberalisation involving multiple countries.
Figure 6.2 – Trade agreements that Increasingly, bilateral deals operate less as a means of unlocking new trading
affect the Australian economy
opportunities and more as a means of shoring up existing rules around free trade

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.

Multilateral trade agreements

Multilateral trade agreements are those that provide for free or preferential trade between
many countries, usually on a regional basis. This category of agreements sometimes refers
to those administered by the WTO, which are global in nature. At other times, this
category can refer to regional trade agreements that involve a select group of countries,
such as the European Union and the United States–Mexico–Canada Agreement (USMCA).
Australia has several key multilateral trade agreements. The first one enacted was the
ASEAN–Australia–New Zealand Free Trade Agreement (AANZFTA) with New
Zealand and the Association of South-East Asian Nations (ASEAN), which came into
effect in 2010. This agreement covers around 15 per cent of Australia’s trade in goods
and services, and effectively creates a free trade area of over 692 million people with a
combined gross domestic product (GDP) of around US$4.6 trillion. ASEAN economies
are also growing rapidly; by 2050 the entire group is projected to be the fourth-largest
economy in the world. Australia and the ASEAN economies are complementary economies.
This means that the type of goods that Australia can export – namely commodities,
particularly in resource-based industries – are in heavy demand in the industrialising
nations of South-East Asia. Conversely, South-East Asia can export to Australia those
goods that we cannot produce competitively, such as simply transformed manufactures
produced in labour-intensive industries. In November 2022, negotiations to deepen the
AANZFTA were concluded, with new provisions covering areas including e-commerce,
trade facilitation, and co-operation on the environment and climate change.
Australia and New Zealand are just two of the six countries that have multilateral trade
agreements with ASEAN (the others being China, India, South Korea and Japan). In
late 2020, after eight years of negotiations, ASEAN and all of these countries (except
India) signed the Regional Comprehensive Economic Partnership (RCEP), a China-led
trade grouping that brings all of these countries together with a single multilateral trade
agreement (but excludes the United States). RCEP covers around 30 per cent of global
GDP and population, making it the world’s largest free trade agreement. By mid-2023, the
agreement had successfully entered into force in all RCEP countries. Under the agreement,
exporters and importers only need to use a single set of rules and regulations to access
preferential trade treatment in any of the 15 RCEP countries. The agreement also provides
greater investment certainty and a common set of rules on intellectual property.
The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) is
a separate multilateral agreement currently in force for Australia, Canada, Japan, Mexico,
New Zealand, Singapore, Vietnam, Peru, Malaysia and Chile, with Brunei Darussalam
also planning to join. The agreement increases market access across borders for businesses
by lowering tariff barriers, simplifying compliance requirements in order for businesses to
access preferential trade treatment, reducing foreign investment restrictions and imposing
rules around the conduct of state-owned enterprises. While a significant free trade area, the
CPTPP is less ambitious than the original plan for a Trans-Pacific Partnership Agreement
(TPPA), which had also included the United States (before its withdrawal under the Trump

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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.

6.4 Implications of a reduction

in protection levels for the
Australian economy
Australia’s decision to phase out protectionism has been one of the most significant
structural changes in the country’s economic history. It has significantly increased Australia’s
integration with the global economy. It has also had far-reaching effects in its impact on
the structure of the economy and the nature of Australia’s trading relationships.

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

Impact of reduced protection on Australian economy

Firms Individuals Governments

• 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

Figure 6.3 – The impact of reduced protection on the Australian economy

148
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

through higher input prices amounted to $1.7 billion in 2020–21. 7% 11%

6%
nu
fac

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%

protection, along with other microeconomic policies, contributed to changes in

Australia’s export base, including a significant growth in manufacturing exports. Minerals and
However, the global resources boom of the 2000s saw Australia shift back to a metals
heavily commodity-focused export base, as shown in figure 6.4. This pattern is 64%

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.

Other economic effects

Phasing out protection also has an impact on Australia’s economic growth and standards
of living. In the short term, lower levels of protection may lead to increased levels of
imports. Because imports are produced overseas and do not create jobs or income in
Australia, reducing protection can be negative for living standards in the short term. In
the long term, however, as resources such as labour and capital move to more productive
areas of the economy – with higher rates of return – economic growth and living standards
should improve. While many other factors have also been important, lower protection
levels in recent decades have generally been seen by economists as being one of the critical
factors causing Australia’s stronger economic performance.
In the short term, the phasing out of protection can have significant effects on Australia’s
trade performance and current account. The current account balance is likely to worsen as
imports rise, because some imports will be cheaper due to lower tariffs and less restrictive
quotas, or if the imports are of a higher quality than locally made products. However,
lower protection should improve international competitiveness and improve the current
151
Australia in the Global Economy 2024

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.

OECD average agricultural subsidies

As a small economy with a high level of agricultural
as a % of farming income trade, Australia suffers particular disadvantages as a
35 result of the protectionist policies of other nations
30 and trading blocs. The EU has, for several decades,
25
heavily subsidised agricultural production through
the Common Agricultural Policy, which absorbs over
20
one-third of the European Union’s budget, and supplies
15 around a fifth of European farmers’ incomes. Farmers also
10 receive significant subsidies in the United States, Japan,
5 South Korea and Switzerland. Australian farmers are
0 therefore competing in global markets at a significant
2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020
2021

disadvantage to their counterparts in the rest of the

Source: OECD 2023 Year
industrialised world. Figure 6.6 shows that agricultural
protection still makes a significant contribution to farm
Figure 6.6 – Subsidies as a percentage of farm incomes for OECD income in the countries of the OECD.
countries

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Chapter 6: Protection in Australia

While Australia’s agricultural sector is mostly affected by protection levels

in developed countries, the policies of other major export markets such as AGRICULTURAL
China also have a significant domestic impact in Australia. For example, PROTECTION AND
China’s punitive tariffs in late 2020 resulted in Australian wine exports to CARBON EMISSIONS
China falling from $1.3 billion prior to the COVID-19 pandemic to just
As governments step up their efforts
$12.4 million in 2023, forcing domestic producers to divert exports to other
to reduce carbon emissions, a key
markets. challenge is to prevent “carbon leakage”,
Global progress towards reducing agricultural protection has been slow in where domestic producers who are
recent years. Partly this reflects a trend towards increased tariffs and other paying higher costs to reduce emissions
protectionist measures around the world. However, agricultural trade has are undercut by overseas producers
who are not taking action. The European
remained more protected than other industries throughout several decades
Union (EU) from 2026 is introducing an
of trade liberalisation. Many of the most protectionist agricultural trading
import tax on emission-intensive goods
nations have taken advantage of complex loopholes in the WTO regulations that come to the EU from countries that
to avoid genuinely freeing up agricultural trade. According to the Australian do not adequately charge their producers
Bureau of Agricultural and Resource Economics and Sciences (ABARES) in for carbon emissions (via a domestic
2020, global agricultural subsidies and trade barriers are currently reducing carbon tax or emissions trading scheme,
Australian agricultural exports by between $8 billion and $10 billion per year. for instance). These taxes are called
carbon border adjustments (CBAs,
Australian firms exporting non-agricultural goods generally face fewer
sometimes also called carbon border
barriers to trade compared with the agricultural sector. The mining and
taxes) and they work in a similar way to
resources sector, whose exports contribute the largest share of Australia’s regular tariffs. Because the EU imposes
exports, faces very few barriers to trade. The products from this sector, such a carbon price on domestic production,
as coal, natural gas, oil and iron ore, are in high demand worldwide. As a its businesses may be at a competitive
result, mining companies and gas producers may be more likely to face export disadvantage compared with firms in
restrictions from an Australian Government trying to secure energy supplies other countries that do not have to
for the domestic economy than from a foreign government trying to protect pay as much for their emissions. CBAs
its minerals and resources industries. From another perspective, the countries can help create incentives for firms in
importing Australian energy and mineral resources often simply do not have countries without carbon prices (such
their own resources to produce domestic alternatives. If a foreign government as Australia) to reduce their emissions.
In contrast, the Australian Bureau of
was to impose tariffs on Australian resource exports, it would simply raise costs
Agricultural and Resource Economics
for its own consumers and businesses, but would not encourage the discovery
and Sciences (ABARES) has highlighted
or exploration of energy resources that the foreign country does not have. In the importance of global agricultural
other words, many countries simply do not have a domestic resource sector support reform in reducing emissions. In
to protect from trade. 2023, ABARES said that removing global
Likewise, Australia’s manufacturing industries generally face few barriers agricultural subsidies would reduce
to trade because of the substantial reduction in industrial tariffs in recent distortions, resulting in a fall in inefficient
production, improved productivity, and
decades that have been negotiated through multilateral and bilateral trade
reduced waste and emissions, while
agreements. Like Australia, most industrialised economies in the world have
maintaining global food security.
low manufacturing tariffs. Within the Asia-Pacific region, which includes
many industrialising and developing countries, average manufacturing tariffs
are also low, although there are exceptions, such as for motor vehicles, which incur tariffs of
around 15 per cent in China. Additionally, some Australian exporters argue that non-tariff
barriers to trade, such as technical restrictions and licensing rules, play a greater role
in creating barriers to trade. For example, inconsistent or varying health regulations for
processed food products in different areas of a country can make it difficult for Australian
exporters to penetrate foreign markets (at times, other countries have made the same claims
about Australia’s strict quarantine rules). For this reason, technical barriers to trade are now
formally part of trade negotiations at the WTO and in bilateral trade agreements.
Australia’s service industries, which account for around 70 per cent of the Australian
economy but less than one-fifth of our exports, arguably face the most prohibitive barriers
to international trade. In many situations, trade in services is simply not feasible. This
is because of natural barriers caused by geography and transport costs, language and
cultural differences, and local tastes and preferences, rather than the result of protectionist
trade policies in other countries. For example, Australian restaurants might be producing

153
Australia in the Global Economy 2024

THE AUSTRALIAN DOMESTIC GAS SECURITY MECHANISM

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

Transport services Restrictions on the number of flight routes in another country

Government Licensing laws that only recognise own country's educational

Professional services
procurement refers to the qualifications
policies and procedures Construction services Government procurement rules that mandate use of local suppliers
for purchasing goods and
services for the use Utility services Government monopoly provision of electricity, gas and water
of the government Environmental services Government preferences for local suppliers of waste or recycling services
and public trading
enterprises. Media and entertainment Minimum local content requirements to preserve country's culture

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.

6.6 The future of Australian industry

in the global economy
The outlook for the global trading environment in the 2020s is more uncertain than it
has been for several decades. Increasing tensions between the United States and China over
trade has destabilised the global trading system, with knock-on effects for small, open
economies like Australia. The WTO’s role in the global trading system has been weakened.
The COVID-19 pandemic and the war in Ukraine have strengthened protectionist
sentiments around the world. The pandemic has also Trends affecting the Australian economy
likely triggered structural changes in the economy,
which are still playing out. Finally, the increased focus Slowing pace of
globalisation
Population growth in
cities and regions
on climate mitigation overseas and in Australia is also
important given the current structure of Australia’s Ageing of the
Policies to reduce emissions
economy and trade. All of these factors are likely to and address climate change population

significantly affect Australia’s trade patterns in the

coming years. Growing middle-
class of China
and India
Predicting future trade patterns and their effects on Elevated geopolitical tensions
in the Indo-Pacific region
the structure of industry is always difficult. During
Shortages of skilled
the 1980s and 1990s, there was an assumption that workers

globalisation would result in a shift towards value-

added manufacturing and services industries, and away Falling prices of Automation and
manufactured goods digital economy
from primary industries and basic manufacturing.
With the rapid industrialisation of China and other
emerging economies generating substantially higher prices for commodities, something
very different happened. Globalisation made resources even more central to the Australian
economy. Likewise, the unprecedented imposition of international border restrictions
following the COVID-19 pandemic in 2020 had a smaller than expected effect on
many of Australia’s goods exports (mainly agriculture and mining) and imports (mainly
manufactured goods), despite some delays in processing by customs at the border.
Mining will likely remain Australia’s most important export industry for the foreseeable
future. The share of Australia’s total export revenue earned by minerals and metals industries
has almost doubled in the past three decades. Resources and energy exports are expected to
earn more than $2 trillion for Australia over the six years from 2022–23. These industries
which, at the dawn of the 21st century, were being ridiculed as “old economy” industries
amidst the “dotcom” boom in electronic commerce, experienced a dramatic resurgence
during the resources boom of the 2000s, underpinned by the rapid industrialisation of East
Asian economies. Australia’s mining output and exports will continue to be our major export
industry for the foreseeable future. Nevertheless, elevated trade tensions with China pose
some risk to mining exports, although China has a limited number of alternative reliable
sources elsewhere in the world. Production capacity has continued to increase as large-scale
mining construction projects have been completed in recent years. A completed pipeline of
LNG projects has very quickly made LNG one of Australia’s major export industries. LNG
exports earned over $90 billion in 2022–23, compared to less than $10 billion a decade
before. The global shift away from coal is likely to reduce Australia’s coal exports rapidly
in the coming years, but other commodities such as iron ore will remain strong because

155
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.

156
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.

3 ustralia’s free trade agreements include bilateral agreements with Chile,

A
China, India, Japan, Malaysia, New Zealand, Singapore, Indonesia, Peru, South
Korea, Thailand, the United Kingdom and the United States; and multilateral
agreements with ASEAN and New Zealand, the Asia-Pacific Economic
Cooperation forum, Pacific nations and the CP–TPP.

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.

5 The impact of lower protection levels on individuals varies. Most individuals

benefit as consumers from goods and services becoming cheaper, and from a
wider product choice and a higher quality of service. However, with the decline
of older import-competing industries, employees with less flexible skills may
experience long-term unemployment.

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.

The use of protectionist policies in other countries has resulted in

7
significant economic costs, in particular the loss of potential export revenue as a
result of lower export prices and reduced access to overseas markets.

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.

Australia’s approach of phasing out protection is likely to lead to an economy that

9
is more integrated with the global economy, with a higher proportion of
production and consumption going to exports and imports.

The resources boom of the 2000s resulted in a large expansion in Australia’s

10
mining and energy exports, underpinned also by higher commodity prices.
Although resources are expected to remain Australia’s largest source of exports,
future export growth is also expected to come from services and a more
diversified export base.

157
Australia in the Global Economy 2024

chapter review
1 Describe the factors that have influenced government policies to reduce
protection in Australia during recent decades.

2 Explain how the short-term problems associated with a reduction in protection

might be outweighed by the long-term benefits.

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.

5 Account for the varying impacts of lower levels of protection on different

industry sectors.

6 Examine how changes to protection levels in Australia have impacted Australia’s

trade performance and economic growth.

7 Discuss the impact of reduced protection levels on individuals.

8 Outline the impacts of lower tariffs on the Australian Government.

9 Discuss the impacts of global protectionist policies on the Australian economy.

10 Outline possible future changes in the structure of industry within Australia as a

result of current trends in the global economy.

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.

160
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.

real GDP (current year) − real GDP (previous year) 100

Economic growth (%) = ×
real GDP (previous year) 1

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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• Year-on-year growth: a less volatile measure of economic growth, which measures

the percentage change in GDP between one quarter and the corresponding quarter
of the previous year. For example, if quarterly GDP was $557 billion in the March
quarter of 2023 and was $570 billion in the March quarter of 2024, the year-on-year
rate of growth would be 2.3 per cent.
• Annual economic growth: calculated using GDP statistics for the whole
financial year, which runs from 1 July to 30 June. When the June quarter national
accounts are released, usually in early September, annual growth is calculated as
the percentage increase in GDP since the last financial year. For example, if GDP
grew from $2222 billion in 2022–23 to $2289 billion in 2023–24, the annual rate
of economic growth would be 3 per cent.
There are a variety of measures of economic growth because each measure is useful for
different purposes. The Reserve Bank, for example, analyses current quarterly levels
of economic growth to forecast growth and inflation trends over the upcoming 12–18
months to inform interest rate decisions. The Productivity Commission, by contrast, is
more interested in long-term growth trends across the business cycle, and would therefore
focus on annual rather than quarterly numbers.

7.2 Economic growth and aggregate

demand and supply
To understand more about economic growth we must first look at the factors that
To access articles and influence the level of economic activity. An understanding of how growth occurs can guide
statistics about Australia’s governments in deciding how to achieve higher rates of economic growth. This has been
GDP growth rate, search an issue of long-running debate among economists.
for Australian National
Accounts: National Income, Traditionally, most economists believed that the most important factor determining
Expenditure and Product economic growth was the ability of firms to produce goods and services – that is, the
on the Australian Bureau of level of total output or supply. Classical and neoclassical economists in the 18th and 19th
Statistics website. centuries believed that market economies would naturally achieve optimum economic
growth without any government intervention. However, opinions changed after the Great
Depression of the 1930s, a period of very low economic growth that left many people
out of work. The experience of the Great Depression caused policymakers to question the
assumptions underpinning economic policy.
As economists looked for new ways to achieve economic growth, John Maynard Keynes
developed a theory stating that the most important influence on economic growth was
the total level of expenditure in an economy – that is, the level of aggregate demand.
Keynesian economics became the most important economic theory of the 20th century,
shaping economic policymaking across the world between World War II and the 1970s.
Keynesian economic theory suggested that people would not necessarily spend their
income just because goods were produced and businesses paid their workers for production.
If households and businesses were generally pessimistic about the future economic outlook,
households would tend to spend less on consumer goods and save more, while firms would
be reluctant to invest in capital goods. This would result in an overall decline in aggregate
demand, with falling production and rising unemployment.

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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.

Equilibrium occurs when:

Aggregate supply = Aggregate demand
Y = AD
Substituting for aggregate demand gives:
Y = C + I + G + (X − M)
Substituting for aggregate supply gives:
C + S + T = C + I + G + (X − M)
By rearranging the equation:
S+T+M = I+G+X
Leakages = Injections

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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7.3 The components of aggregate

demand
Changes in the level of economic growth in the short to medium term are driven largely
by changes in the level of aggregate demand. To better understand what drives economic
growth, we need to examine the individual components of aggregate demand. By analysing
the factors that influence these individual components, we can see what factors will cause
the economy to expand and contract over time – and therefore better understand what
policies may be used to increase the level of economic growth.

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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The distribution of income

Generally speaking, the more equitable (even) the distribution of income, the higher the
rate of overall spending, and vice versa for a more inequitable (uneven) distribution of
income. This is because people on lower incomes tend to spend proportionately more of
their income than those on higher incomes. This reflects a key insight of the Keynesian
consumption function: the more income that an individual receives, the higher proportion
they save and the lower proportion they spend. For example, a person with a net income
of $400 per week might have to spend it all on basic costs of living, whereas someone
receiving a net income of $4000 per week might comfortably save half of that level of
income. As a result, policy changes that redistribute income from higher- to lower-income
earners (such as increasing the rate of JobSeeker payments) are more likely to increase
consumer spending than policies that increase the income of high-income earners (such
as a reduction in the top marginal income tax rate).

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.

The cost of capital equipment

The cost, or relative cost, of capital equipment is influenced by the following factors:
• Changes in interest rates. A fall in interest rates would make it cheaper to borrow
funds for the purchase of capital equipment, and a rise in interest rates would raise
borrowing costs, as well as making it more attractive to save. Interest rates also
represent an opportunity cost for firms who own their capital. Firms with available
cash reserves will compare the returns from either saving money (for example,
lending it to others, such as by buying bonds) or using it to fund the acquisition of
capital or other businesses (alternatively, they may return cash to investors through
increased dividends).
• A change in government policies relating to investment allowances and tax
concessions on capital goods. For example, if the government allowed businesses to
claim the full cost of capital equipment immediately, instead of claiming depreciation
over several years, this would reduce their tax liability and make capital cheaper
than it otherwise would have been. During the COVID-19 recession, the Australian
Government allowed firms with turnover of up to $5 billion to immediately deduct
the full cost of all asset purchases until July 2023. This incentive led to a jump in the
contribution of business investment to aggregate demand between 2021 and 2023.
• Any change in the price or productivity of labour (labour being a substitute
for capital in the production process) or technological innovations will affect the
relative cost of capital compared with labour. For example, if either the cost of labour
increased or more advanced labour-saving technologies became available at the same
cost, then the relative cost of capital compared with labour would have decreased,
making its use more attractive.

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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• Any change in the general economic outlook. If economic growth is expected to

increase, entrepreneurs will be more inclined to invest in capital equipment because
a higher level of economic activity should improve the returns on investment.
• Inflation leads to uncertainty about future prices and future costs of production,
and this is likely to lead to reduced investment in productive capital equipment.

Influences on government spending and taxation

Levels of government spending and taxation can also have a significant influence on
the level of economic activity. Federal government spending usually makes up around
20–25 per cent of aggregate demand or expenditure, while taxation is around 20–25 per
cent of aggregate supply or income.
As we will discuss in chapter 14, when we look at fiscal policy, one of the main goals
of government spending and taxation policies is to maintain a sustainable rate of
economic growth, and help achieve the goals of low unemployment and inflation. This
means that governments may increase their level of spending and/or reduce the level of
taxation to increase aggregate demand and growth. Alternatively, governments may reduce
their level of spending and/or increase the level of taxation to reduce aggregate demand
and growth.
Influences on exports and imports
Changes in export sales and demand for imports can have an impact on the level of
aggregate demand and economic activity. Exports and imports are each equal to between
one-fifth and one-quarter of aggregate demand. If export revenue is equal to import
spending, net exports (export revenue minus import spending, that is, the trade balance)
neither adds nor subtracts from aggregate demand. Australia’s recent sustained trade
surpluses have made a positive contribution to aggregate demand.
Australia’s volumes of exports and imports are influenced by the levels of overseas and
domestic income. When overseas income levels rise, Australia’s exports tend to rise. When
Australian income levels rise, Australia’s imports tend to rise. Australia’s net exports
are also influenced by exchange rates, inflation, levels of international competitiveness,
protectionist trade policies, and consumer tastes and preferences:
• When Australia has a weaker exchange rate, domestic industries are more competitive
as the relative cost to foreign purchasers decreases, often resulting in increased sales.
This means that net exports will be higher, adding to aggregate demand and boosting
economic activity.
• When Australia has a stronger exchange rate, domestic industries are less competitive
and their products become more expensive for foreign consumers. As a result, net
exports will be lower, detracting from aggregate demand and reducing economic
growth.
As detailed in chapter 6, improving Australia’s trade performance is a key policy objective
due to its impact on aggregate demand and economic growth.

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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7.4 Changing levels of growth:

the multiplier process
We now turn to how changes in the level of aggregate demand influence the level of
economic activity. This section simplifies the economy to the three-sector Circular Flow
model of individuals, firms and financial institutions, but excludes the government and
international sectors.
As we saw in the previous section, income (Y) that is not spent on consumption (C) must
be saved (S). Likewise, expenditure in the economy (AD) is made up of consumption (C)
and investment (I).
The consumption that comes from income is obviously equal to the consumption part
of expenditure. However, there is no reason why savings (S) and investment (I) have to
be equal all the time (see the factors influencing savings versus the factors that influence
investment in the previous section as evidence of this).
Whenever S is not equal to I, the economy will be disrupted from its state of equilibrium.
The Circular Flow model suggests the economy will move towards a state of equilibrium –
at a higher level of economic activity when the injection of I is greater than the leakage
of S, and at a lower level of economic activity when the injection of I is less than the
leakage of S.
How does this adjustment take place? Through the multiplier process, an economic
concept developed by John Maynard Keynes.
When there is a shock to the economy, such as a change in consumer or business
expectations, a change in interest rates, or a change in government policies, there will be a
change in injections or leakages. For example, improved business expectations for economic
recovery will increase business investment and expenditure (demand). This expenditure
will provide increased income for individuals, who then consume more, which will further
increase expenditure and income and so on. Therefore, the initial increase in investment
will have a multiplied impact on national income.
However, the increase in investment will not continue to increase income forever. Each
time the injection moves around the economy, its impact on expenditure gets smaller
because some of the income is not consumed but saved. This savings component is a
leakage that reduces the effect of the higher investment on national income. The number The multiplier is the
of times the final increase in national income exceeds the initial increase in expenditure greater-than-proportional
that caused it is the multiplier. The mechanism by which changes in aggregate demand increase in national
result in changes in GDP is known as the multiplier effect. income resulting from
an increase in aggregate
To calculate how a change in injections or leakages has a multiplied impact on income demand.
we need to consider two more concepts:
• the marginal propensity to consume (MPC), that is, the proportion of each extra
Δ in consumption
dollar of income that is spent on consumer products MPC =
Δ in income
• the marginal propensity to save (MPS), that is, the proportion of each extra dollar Δ in savings
MPS =
of income that is saved. Δ in income
In any economy, the sum MPC + MPS = 1 always holds, since each extra dollar of income
must be either consumed (spent) or saved.
This can be explained using the following example: Assume that for each extra dollar of
income, consumers spend 80 per cent (80 cents) and save 20 per cent (20 cents).
In this case MPC = 0.8 and MPS = 0.2
Assume also that investment in the economy has increased by $10,000. This represents
an injection into the circular flow of $10,000, or put another way, an initial increase in
aggregate demand of $10,000. If the economy was previously at equilibrium, this means

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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:

In other words, five times the initial increase in aggregate demand.

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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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.

7.5 The role of aggregate supply

While shifts in aggregate demand play the main role in determining the level of economic
growth in the shorter term, aggregate supply also plays an important long-term role. An
economy’s aggregate supply is determined by the quantity and quality of the factors of
production – natural resources, labour, capital and the ability of entrepreneurs to combine
them efficiently to produce goods and services. Economies with more or better-quality
factors of production produce more goods and services.
Economists sometimes refer to aggregate
AD AS
supply as an economy’s “potential”.
This means that when aggregate supply AS1
General price level

increases, an economy can grow faster. As

figure 7.2 shows, an increase in aggregate
P
supply can lead to an increase in total
P1
output (economic growth) and a reduction
in the general price level (inflation).
An economy can grow faster and more AS

sustainably when aggregate supply is AS1 AD

increased – leading to higher GDP growth 0 Y Y1
alongside price stability through lower Total output
inflation.
Figure 7.2 – The impact of increased aggregate
supply on economic growth

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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.

Economic change Example

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.

Increased capital Investment in capital equipment, such as machinery, that efficiently

replaces labour will, in the long term, increase the capacity of the
business to produce goods.

Adoption of new Businesses investing in artificial intelligence chatbots to respond to

technology frequently answered questions from consumers reduces the cost of
providing customer service.

Measures to By establishing automated package processing centres in

improve efficiency metropolitan Sydney, Amazon has enabled same-day delivery
across the city for items purchased online.

Government Changes to increase competition or reform regulation in an

policies industry, such as the creation of Australia’s national electricity grid.

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

7.6 The effects of economic growth

Traditionally, economic growth has been regarded as the most important economic policy
objective. This is because economic growth makes it possible to achieve other economic
and social objectives. However, too much growth can sometimes create problems.
Living standards
Faster economic growth results in an increase in real GDP per capita. Real wages can
rise and households can enjoy a higher disposable income and therefore higher material
living standards. This is the main reason why countries pursue higher levels of economic
growth. In recent years, the Australian economy has experienced a slower rate of growth
in real GDP per capita, meaning Australians’ living standards have improved more slowly
(annual real GDP averaged 1.1 per cent in the five years prior to the pandemic, compared
to 2.1 per cent in the 1990s).
Employment
Economic growth creates jobs. In an economy that sustains strong economic growth,
everyone who is willing and able to work should be able to find employment. As economies
develop, economic growth also changes the nature of the jobs that are available, creating
jobs that are more highly skilled and contribute to increased productivity, and in turn,
higher incomes. Following the COVID-19 recession, a strong rebound in Australia’s
economic growth helped drive unemployment below 4 per cent for the first time since
the 1970s.
Inflation
Higher levels of economic growth can result in price increases and larger wage claims,
contributing to higher inflation. This is particularly the case when the economy is close to
its full capacity and the growth in aggregate supply cannot keep pace with the growth in
aggregate demand. Inflation is therefore often a side effect of economic growth. A major
aim of macroeconomic policy is to sustain growth without increasing inflation – this is
known as the “sustainable rate of economic growth”.
External stability
Economic growth is often accompanied by higher disposable incomes, which leads to
increased consumption of imported goods. Unless exports keep pace with growth in
imports, the balance of goods and services can worsen and the current account deficit
can increase. Because excessive current account deficits can undermine confidence in an
economy, the balance of payments can sometimes become a “speed limit” on growth. This
can lead to the “balance of payments constraint” where policymakers may deliberately
slow economic growth to improve external stability.
Income distribution
Economists generally assume that economic growth leads to higher living standards and
therefore better outcomes for everyone. However, the benefits of economic growth often
flow disproportionately to higher-income earners, highly skilled workers, or owners of
capital, rather than spreading more universally through wage increases for low-skilled
workers or lower prices for low-income earners. If the benefits of economic growth are not
widely shared, inequality will rise. Absolute poverty should fall as the economy grows,
but relative poverty may increase if income distribution becomes more unequal.
Environmental impacts
If economic growth is pursued with little regard for the environment, it can contribute
to pollution, depletion of non-renewable resources and the catastrophic effects of climate
change. In recent decades there has been a stronger focus on “ecologically sustainable
development” – that is, protecting the environment while also maintaining economic
growth. In many instances, environmental protection can add to long-term economic

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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.

7.7 Recent trends in economic growth

The level of economic activity is never entirely stable. A market economy
Output such as Australia’s is subject to the ups and downs of the business cycle
(that is, the general level of economic activity) caused by changes in
the level of aggregate supply and demand. Figure 7.3 depicts a typical
pattern of growth in real GDP for a market economy. Although showing
an upward trend in real GDP, the pattern of growth is uneven, and
Boom
periods of stronger economic growth are often followed by recession.
Recession
Australia’s economic growth in recent decades has been relatively stable
Economic growth trend compared to previous business cycles and other economies. Australia
enjoyed a record-breaking 28 years of economic growth from 1991–92
to 2019–20, averaging 2.9 per cent annual GDP growth throughout
Time the period. Although this was one of the highest average GDP rates
among OECD countries over this time, real GDP per capita averaged
Figure­7.3 – The business cycle only 1.6 per cent for the same period, which was close to the OECD
average. (This is explained by the fact that Australia’s high population
Recession is the stage
growth makes it possible to have both a high rate of real GDP growth as an economy and
of the business cycle in an average rate of real GDP growth per capita). In 2020, Australia experienced its first
which there is a decline in recession since 1991 with contractions in the March and June quarters of 0.2 per cent
economic activity, defined and 6.7 per cent respectively as a result of the COVID-19 pandemic. The economy then
as two consecutive staged an equally sharp recovery, with the growth then levelling out to levels similar to
quarters (six months)
before the pandemic.
of negative economic
growth, that is, a fall in Below are eight factors that influenced Australia’s business cycle in recent years. Australia
GDP. has mostly benefited from global economic trends, but also from successful policy
management:
• Global economic conditions have been mostly favourable for Australia in recent
decades. Strong demand for Australia’s resource exports underpinned a boom in
mining investment and a subsequent surge in export revenues. This has increased
Australia’s national income and helped the economy to rebound quickly from
external shocks such as COVID-19 in 2020 and the global financial crisis in 2008.
Rising inflation due to supply chain disruptions and a global surge in inflation have
impacted Australia’s growth since recovery from COVID-19 and Russia’s invasion
of Ukraine in 2022.
• Australia experienced terms of trade booms from 2005–2011 and from 2017 to
2022, driven by very large increases in the prices of Australia’s commodity exports
(specifically iron ore, coal and natural gas). As a result, export revenues have grown
substantially, improving Australia’s balance on goods and services, leading to
consecutive current account surpluses that have set aside longstanding concerns about
the balance of payments constraint (see chapter 4).

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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.

% Annual real GDP growth (%)

6

5
“The recession we had to have”

COVID-19 recession rebound

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

Source: International Monetary Fund, July 2023 *Forecast

Figure 7.4 – Australia’s economic growth performance (annual real GDP growth)

173
Australia in the Global Economy 2024

THE UNENDING RESOURCES BOOM

The most significant economic development during Australia’s recent long growth cycle
was the mining boom. At the time, the Reserve Bank Governor, Glenn Stevens, described
it as the greatest expansionary shock to the Australian economy in more than 50 years.
Strong growth in China and other emerging economies resulted in soaring demand
for natural resources, such as coal, gas and iron ore, leading to a sharp increase in
prices and the largest increase in Australia’s terms of trade for 150 years. The spike in
global resource prices in the 2000s was especially large because of a long period of
low investment in mining operations around the world, meaning that global supply was
price inelastic: mining companies were unable to increase output quickly in response
to the increased demand, and so prices soared. This meant that average prices for
Australia’s commodity exports tripled between 2003 and the peak of the cycle – as
shown in figure 7.5.

RBA Index of Commodity Prices

SDR, 2021–22 average = 100
Index Index
120 120
100 100

80 80

60 60

40 40

20 20
1995 1999 2005 2011 2017 2023
Source: RBA Commodity Prices I2, 2023

Figure 7.5 – Reserve Bank of Australia Index of Commodity Prices

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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Australia in the Global Economy 2024

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

Figure­7.7 – Australia’s growth and economic outcomes since 1983

176
Chapter 7: Economic Growth

Microeconomic policies aim to increase the economy’s sustainable growth rate by

increasing aggregate supply. Microeconomic policy also reduces the extent to which
higher growth becomes constrained by inflationary and current account problems. The
Productivity Commission has argued that Australia’s strong rates of growth in the 1990s
and 2000s came about because of the far-reaching microeconomic policies undertaken
during the 1980s and 1990s. However, Australia’s record of microeconomic reform has
deterioriated in more recent years. The Productivity Commission’s 5-year Productivity
Inquiry concluded in 2022 that none of its microeconomic policy recommendations from
five years earlier had been implemented in full. Nevertheless, state governments have made
substantial investments in physical infrastructure. helping to relieve transport and supply
chain bottlenecks for roads and ports. (Microeconomic policy is discussed in chapter 16).
Similar to microeconomic policy, labour market policies encourage economic growth
through increasing aggregate supply, but specifically through improving labour
productivity. Labour market policies aim to help workers produce more through higher
education attainment and upskilling. The Albanese Government’s 2022 Jobs Summit
identified the risk to economic growth from Australia’s skills shortages in information
technology and the care economy (nurses and aged care workers), making a commitment
to release a major Employment White Paper by the end of 2023. (Labour market policies
are discussed further in chapter 17).

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.

177
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.

2 The economy is in equilibrium when the level of aggregate demand (total

demand for goods and services within the economy) is equal to the level of
aggregate supply (total productive capacity of the economy).

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.

4 Consumption is influenced by consumer expectations of future economic

developments, the level of interest rates, income distribution and consumer
preferences between consumption and savings.

5 Investment is influenced by the level of interest rates, government policies,

labour costs, productivity levels and business expectations.

6 Net exports are influenced by income levels in Australia and overseas,

movements in the exchange rate and the international competitiveness of
Australia’s industries.

7 The multiplier process explains how an increase in aggregate demand

will increase the overall level of national income by much more than the initial
increase. This amount is known as the multiplier. The size of the multiplier is
determined by the marginal propensity to save and can be expressed as:
1 1 ∆ in savings
k= OR k= where MPS =
MPS 1 − MPC ∆ in income

8 Aggregate supply resulting from improvements in efficiency and technology

can lift productivity and can accelerate economic growth.

9 Economic growth results in higher living standards and increased employment,

but can also contribute to increased inflation, external instability, greater income
inequality and damage to the natural environment.

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.

178
Chapter 7: Economic Growth

chapter review
1 Explain why economic growth is important to an economy.

2 Consider an economy where: S = 40, T = 20, M = 10, G = 35, X = 5, C = 25,

MPC = 0.6.

a) Determine the level of investment; and

b) Calculate the level of aggregate demand.

3 Outline the main factors that influence the levels of consumption and investment
in an economy.

4 State the leakages and injections equation for an economy to be in equilibrium

and explain the effect on the level of economic activity when:

a) total leakages exceed total injections; and

b) total injections exceed total leakages.

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.

10 Evaluate the policies available to governments to achieve economic recovery after

a recession.

179
Australia in the Global Economy 2024

COVID-19 The impacts on the

Australian economy
COVID-19 represented the most powerful external The effects of the COVID-19 recession were far-reaching:
shock to the Australian economy since the Great
• Economic growth – GDP fell in two successive
Depression in the 1930s. It ended Australia’s record-
quarters of 2020, by 0.2 per cent in March
breaking 28-year economic growth cycle in ways that
and a record 6.7 per cent fall in June. By the
nobody could have imagined: a shutdown of state and
September quarter, the economy had begun
national borders, enforced lockdowns across Australia
to recover, recording an increase in GDP of
that confined people to their houses, and a temporary
3.8 per cent, followed by another 3.3 per cent
prohibition on whole sectors of economic activity. The
increase in December 2020. The economy then
economic impact was far-reaching. Consumer spending
continued on a recovery path, with 3.9 per cent
shifted dramatically: travel, leisure and entertainment
growth in 2021–22.
spending were curtailed, while households stockpiled
emergency supplies from supermarkets and spent more • Labour market – Unemployment
on home entertainment. Within a month the share peaked at 7.5 per cent in July 2020, the
market had fallen 37 per cent, and the dollar had highest rate in over 20 years, with large job
depreciated to US55 cents, its lowest level in almost losses for retail and hospitality workers, along
two decades – although both recovered quickly. with sports and personal services workers. The
labour market rebounded remarkably quickly,
COVID-19 prompted the largest-scale macroeconomic with unemployment falling below 4 per cent
policy intervention in Australian economic history, in 2021 for the first time since the early 1970s.
costing the Budget $291 billion in economic support
by mid-2021, and leading to the largest-ever Budget • Businesses – COVID-19 had vastly different
deficit of $132 billion in 2020–21. Its centrepiece impacts across different industries, with
was JobKeeper, an $89 billion program that initially both winners (such as those in food delivery)
subsidised wages to the tune of $1500 per fortnight and losers (such as restaurants, tourism
per employee for businesses whose turnover had fallen and accommodation). Business relying on
by 30 per cent or more due to COVID-19, with the international tourism suffered severe impacts.
subsidy gradually reduced and phased out by March • Inflation – Some unusually large but temporary
2021. price movements (in particular because of the
Government’s decision to make child care
Other fiscal policy measures introduced during the
free for several months) resulted in the first
pandemic included increased unemployment benefits,
decline in year-ended CPI inflation since the
with fortnightly payments temporarily doubled, as well
early 1960s and the largest quarterly decline
as providing free child care, tax-free cash payments of
since 1931. In 2022, cost pressures soared
between $20,000 and $100,000 to eligible small and
well beyond the RBA’s target band as a result
medium businesses, and one-off COVID-19 business
of demand pressures and Russia’s invasion of
grants.
Ukraine, which sharply increased energy prices.
The Government’s fiscal policy measures were • Distribution of income and wealth – While
complemented by decisive monetary policy action the lasting effects of the pandemic on the
from the Reserve Bank. The RBA cut its cash rate distribution of wealth will take many years to
three times in 2020, down to a record low of 0.1 per emerge, cross-country IMF research into the
cent in November 2020. The RBA also supported five major pandemics of this century (SARS,
the supply of credit to keep the economy afloat, and swine flu, MERS, Ebola and Zika virus) found
undertook asset purchases, involving the outright that income inequality worsened after each
purchase of assets by the Reserve Bank from the private pandemic.
sector.

180
COVID-19 The Impacts on the Australian Economy

While there was a huge cost to Australia’s policy

response to COVID-19, economists agreed that the $b Australia’s recent growth performance
longer-term economic costs would have been even 580
greater without intervention. The cumulative cost
to the economy of $158 billion is much lower than 560
it might have otherwise been. The economic damage
would have been larger and more permanent, as 540

bankruptcies and unemployment would have risen 520

more sharply, and household consumption and business
investment would have fallen much further. Figure 500
7.8 shows the sharp downturn and quick recovery in
economic growth Australia experienced at the onset 480
of the pandemic as well as the RBA’s forecasts for a
460
stabilisation in economic growth. The success of the
vaccination rollout in Australia and globally was a key 440
factor in achieving this recovery.
420
2018

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.

8.2 Measuring the level of unemployment

While economists generally agree on what unemployment is, there are different ways to
calculate the level of unemployment. A considerable amount of economic debate about labour
market conditions is related to the different ways in which we measure unemployment.

The labour force

Labour force consists The labour force (or workforce) can be defined as that section of the population 15 years
of all the employed and of age and above who are either working or actively seeking work. Therefore, the labour
unemployed persons in
force consists of:
the country at any given
time. • persons aged 15 and over who are currently employed for at least one hour per week
of paid work, and also includes those on paid leave, as well as those on leave or stood
down without pay for less than four weeks, on strike, on workers’ compensation, or
receiving payment whilst undertaking full-time study

182
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 labour force participation rate

In Australia, anyone over the age of 15 can participate in the labour force and is therefore Labour force
considered to be a member of the working-age population. Determining the actual size participation rate refers
to the percentage of the
of the labour force requires taking into account people’s willingness and preparedness to
population, aged 15 and
participate in the labour force, either by working, or for those without a job, by looking over, in the labour force,
for work. People may decide not to participate in the labour force for many reasons, such that is either employed
as studying, undertaking carer’s responsibilities, volunteering full-time, or because they or unemployed.
have other income sources or feel they are unlikely to find work.
The labour force participation rate can be defined as the percentage of the working-age
population – those aged 15 years and over – who are in the labour force, that is, either
working or actively seeking work.
Labour force 100
Labour force participation rate (%) = ×
Working-age population (15+) 1

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.

183
Australia in the Global Economy 2024

PROBLEMS WITH THE METHOD USED TO MEASURE UNEMPLOYMENT

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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8.3 Recent unemployment trends

Australia’s labour market has experienced unusual volatility in recent years due to
the COVID-19 pandemic, which led to a surge in unemployment followed by the
lowest unemployment rates in almost 50 years. While in some economies the rate of
unemployment soared (in the United States, it soared from 4 per cent to 16 per cent),
Australia’s quick and large-scale policy response meant that the pandemic’s impact on
unemployment in Australia was much smaller.
As shown in figure 8.1, Australia began experiencing higher unemployment rates in the
mid-1970s, after recording very low unemployment rates in the 1960s and early 1970s.
The level of unemployment peaked in the early 1990s – the 10.7 per cent unemployment
rate recorded in 1992–93 was its highest level since the Great Depression of the 1930s.
The main reason for this increase was a severe recession in Australia and the global
economy. Falling aggregate demand saw cutbacks in production and the closure of many
firms, which led to the shedding of labour and an increase in unemployment.
The unemployment problem Unemployment
during this period was worsened rate (%)
11
by extensive structural
10
change and microeconomic
9
reform. Many people who had
8
lost their jobs in declining
7
industries during the recession
6
were unable to obtain new jobs
5
created in growing industries
4
because the job vacancies often
3
required higher or different
2
skills. As new technologies and
1
production techniques changed
0
the structure of businesses,

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

the Australian economy. There

Figure 8.1 – Unemployment in Australia
was a gradual downward trend
in unemployment for the 15 years from 1993 to 2008. In 2008, the global financial crisis
triggered a worldwide recession, but in Australia the increase in unemployment was much
milder than in most advanced economies. Unemployment rose by almost 2 per cent during
2008–09, but a recovery in growth the following year meant that unemployment was
again close to 5 per cent by 2010.
During the 2010s, Australia’s unemployment rate stayed mostly in the range of 5 to
6 per cent, which was just below the average for advanced economies. As a result of the
COVID-19 pandemic and associated lockdowns, the unemployment rate peaked at 7.4 per
cent in July 2020. This was the highest rate of unemployment seen in over 20 years but
was still lower than the peaks seen in the 1990s, and better than most other advanced
economies. The employment rate recovered to its pre-pandemic level in the first half of
2021, more than 18 months ahead of the OECD average. In mid-2023 the unemployment
rate was 3.5 per cent, around its lowest since 1974. However, a Reserve Bank forecast
pointed towards a mild upward trend in unemployment during 2024.
Australia’s labour market has also sustained faster growth in part-time than full-time
jobs during recent decades. The official unemployment statistics do not fully capture the
problem of underemployment, in which individuals are in employment but they want to
work more than their current hours. While Australia has lower unemployment than most
similar OECD economies, it has a higher rate of underemployment. Underemployment

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Australia in the Global Economy 2024

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.

8.4 The main types of unemployment

In order to understand how the government’s economic strategies can reduce unemployment,
it is helpful to distinguish between the different types of unemployment.
Structural unemployment
Structural unemployment occurs because of structural changes within the economy caused
by changes in technology or the pattern of demand for goods and services. Workers find
that the skills previously useful in declining industries do not match the job opportunities
opening up in newly emerging industries. Most of Australia’s long-term unemployment
is attributed to structural unemployment.
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Chapter 8: 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.

8.5 The non-accelerating inflation

rate of unemployment
The non-accelerating inflation rate of unemployment (NAIRU) is another important
concept in understanding unemployment. The theory behind the NAIRU is that some
The non-accelerating
level of unemployment is inevitable in an economy, and efforts to reduce unemployment inflation rate of
below this “natural” level will be counterproductive. This natural rate of unemployment, unemployment (NAIRU)
commonly called the NAIRU, is comprised of frictional, seasonal, structural and hard-core refers to the level of
unemployment. unemployment at which
there is no cyclical
When unemployment is above the NAIRU, there is spare capacity in the labour market, unemployment, that is,
which suggests that policymakers should stimulate economic growth with the aim of where the economy is at
reducing unemployment. When unemployment is already at or below the NAIRU, an full employment.
increase in economic growth will increase wage pressures because there are insufficient
numbers of unemployed people to fill those job vacancies (given that they need to have the
right skills and be available to work). In other words, efforts to reduce unemployment below
the NAIRU will result in higher inflation. The conflict between inflation and unemployment
can be shown on the Phillips Curve diagram, which is discussed further in chapter 13.
The concept of the NAIRU has important implications for economic policy. It suggests that
policies to encourage economic growth and reduce unemployment will be worthwhile up to
a point, but beyond that, these policies will only create inflation. A lower NAIRU increases
the economy’s capacity to grow without increasing inflation and can be achieved over the
long term through policies that reduce structural, seasonal and frictional unemployment.
For instance, the NAIRU might be
reduced through increasing retraining % %
12 12
and re-skilling programs to aid the Unemployment rate
structurally unemployed, or by making 11 11
NAIRU (Treasury calculation)
it easier for workers to change jobs 10 10
or move interstate, or by removing
hurdles for people with a disability to 9 9
access a workplace. 8 8
Estimating the NAIRU is very 7 7
complex because there is no simple way
to measure it, and because calculations 6 6
of the NAIRU aim to remove cyclical 5 5
influences, even though the levels
4 4
of unemployment and inflation are
highly influenced by cyclical factors. 3 3
It is also difficult to pinpoint as it ~ ~
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023

can shift up and down with changes

in the structure of the labour market. Source: ABS Labour Force, Australia (Cat. nos. 6202.0, 6204.0), 2022–23 Budget Paper No.1,
Figure 8.3 shows that estimates of the Statement 2: RBA Bulletin (2017) Estimating the NAIRU and Unemployment Gap,
and RBA (2019), Assistant Governor Luci Ellis speech
NAIRU have trended downwards in
recent decades. Figure 8.3 – Unemployment and the NAIRU since 1979

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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.

8.6 The causes of unemployment

Economists disagree over the causes of unemployment and what policies governments
should use to reduce unemployment. There are many explanations for unemployment
offered by economists, including that:
• Economic growth has been too low to generate adequate employment growth.
• Jobseekers do not have the right skills to fill job vacancies.
• Jobseekers do not have adequate opportunities for education and training.
• Structural change is creating a larger pool of workers whose skills are no longer in
demand.
• Wage rates are too high, especially for low-skilled workers.
• There are too many regulations surrounding employment, discouraging employers
from hiring new employees.
• Some people choose to remain unemployed, because they can receive government
welfare benefits instead.
• Workers in high-income economies whose jobs can be performed overseas cannot
compete with workers who are paid low wages in developing economies.
• Not enough is done to help people with mental illness or with a disability to find
suitable work.
The causes of unemployment are considered in detail on the following pages.

The level of economic growth

The demand for labour is a derived demand – it is derived from the demand for the goods
and services that labour helps to produce. If there is a downturn in the level of aggregate
demand in the economy, this may be reflected in a downturn in the demand for labour and
an increase in the level of unemployment. The decline in aggregate demand could be due to:
• an economic downturn with lower domestic consumption and investment spending
• government policies (such as contractionary monetary or fiscal policy) designed to
dampen demand
• a decrease in the demand for Australia’s exports due to a global recession, slower
growth in the economies of our major trading partners, or because of less competitive
Australian goods and services in world markets.
Unemployment is correlated with the overall level of economic growth. It is generally
felt that unemployment is likely to start rising when growth falls below around 2 per

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Chapter 8: Unemployment

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.

The stance of macroeconomic policies

Macroeconomic policy settings can influence the level of cyclical unemployment in the
short to medium term, through their influence on the business cycle.
Fiscal and monetary policy both influence the level of aggregate demand through their
influence on the business cycle, and this in turn influences the level of unemployment
in the short to medium term. An expansionary stance aims to increase economic growth
and job creation. A contractionary stance aims to reduce inflation, even if this is at the

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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.

Rising participation rates

An increase in the labour force participation rate will tend to cause an increase in the
rate of unemployment in the short term. This is because more people who previously
were not looking for work (and were not classified as unemployed) start actively seeking
employment. This situation usually occurs in times of economic recovery when many
discouraged jobseekers, observing that employment opportunities are improving, start
looking for work. For this reason, they re-enter the labour market, and unless they obtain
a job immediately, they join the ranks of the unemployed. This means that the level of
unemployment may only be reduced slowly during an economic recovery, even when
economic growth and employment growth are strong, because more people are looking
for jobs.
Structural change
The process of structural change in the economy often involves significant short-term
costs. One of the most significant costs in the short term is a loss of jobs in less efficient
industries and in areas undergoing major structural change. Globalisation has contributed
to changes in labour markets around the world, with domestic businesses becoming more
integrated into global supply chains leading to the offshoring of some jobs. Nevertheless,
an analysis of job losses in OECD countries during recent decades found that trade and
globalisation accounted for only half as many job losses as automation. One longer-term
shift that emerged in recent years has been the increase in remote working and a reduction
in jobs involving face-to-face contact.
Technological change
Rapid technological change can cause unemployment, at least in the short term. The
pace of change in the labour market is expected to accelerate in the 2020s as automation
driven by artificial intelligence (AI) applications, including large language models such
as ChatGPT, transform jobs. In its 2023 Productivity Inquiry report, the Productivity
Commission noted the potential for artificial intelligence to drive future productivity
growth in Australia. Research firm Forrester has estimated that Australia could see as
many as 1.5 million overall job losses in Australia by 2030. However, these job losses
are likely to be offset by the creation of new jobs that utilise AI. The World Economic
Forum’s 2023 Future of Jobs report predicted a 35 per cent rise in demand for data analysts
and information security analysts by 2027, generating a combined 2.6 million jobs to the
world economy. It noted that 60 per cent of today’s professions did not even exist in 1940,
and that artificial intelligence is likely to have an even greater effect in contributing to
the creation of whole new jobs.
Productivity
The productivity of labour is a significant factor affecting the decision of employers
to increase or reduce employment. Low productivity growth has different short- and
long-term impacts. Higher productivity growth will tend to slow employment growth (or
increase unemployment) in the short term, because fewer employees are required per unit

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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.

Increased labour costs

Unemployment may rise because of a sustained increase in labour costs (wages), although
recently economists have been concerned by the low level of wage growth rather than the
excessive wage growth that contributed to inflation in the 1970s and early 1980s. The
circumstances in which increased labour costs could contribute to higher unemployment
include:
• A shortage of skilled labour may result in employers competing with each other for
a limited pool of labour, thus forcing up labour costs more generally and possibly
creating wage inflation and overheating the economy.
• A wages breakout caused by excessive wage demands. When nominal wages are rising
too fast, outstripping inflation and productivity increases, they can reduce business
profits. Businesses may choose to substitute capital for labour, or reduce output, to
improve profits. In these circumstances labour would be effectively pricing itself
out of a job.
• A decision by the Fair Work Commission to increase award wages substantially Fair Work Commission
in its National Minimum Wage Order (to improve the living standards of lower is the government agency
paid workers) could make it too expensive for some employers to keep all of their that regulates Australian
workplaces, with functions
workers employed. that include the setting
• A substantial rise in labour on-costs. These are the additional costs of employing of minimum wages, the
labour, and include payroll tax, superannuation, sick leave, holiday pay and workers’ approval of workplace
compensation. These are affected mainly by government policy decisions. If these agreements and in some
instances, the resolution
on-costs are too high, they can cause a decline in the demand for labour.
of industrial disputes.
Inflexibility in the labour market
One of the reasons for higher labour costs may be inflexibility in the labour market.
Some economists argue that Australia’s relatively high minimum wages rates make it
less attractive for employers to hire less-skilled workers, contributing to a higher level of
unemployment, and that deregulation of the labour market might lead to lower minimum
wages and a lower level of unemployment. For example, a study released in 2019 by the
Institute of Public Affairs titled “Expanding Economic Opportunity: An International
Comparison of Australia’s Labour Market Regulation” attributed Australia’s high level of
underemployment to regulation of the labour market. The IPA’s analysis ranked Australia

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SHIFTING INDUSTRIES AND SHIFTING JOBS

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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Chapter 8: Unemployment

8.7 The impacts of unemployment

A high level of unemployment has serious negative effects on the economy, on individuals
and on society. For this reason, lowering unemployment is an important goal of economic
management.
Economic costs
Opportunity cost
Unemployment means that the economy’s resources are not being used to their full
capacity – the economy is thus operating below its production possibility frontier.
Therefore, total output is below what it could potentially be, since unemployed people are
not contributing to the production process. Lower total output also means lower household
incomes and expenditure, which may lower sales and profits. Higher unemployment levels
may therefore lead to reduced business investment, production and economic growth.

Lower living standards

Those who are out of work will have lower incomes (relying on welfare payments) and
therefore lower living standards. In addition, those who are in employment will need to
contribute higher taxes to cover the cost of income support to the unemployed. With
high rates of unemployment, the production of both consumer goods and capital goods
is lower, resulting in lower living standards.

Decline in labour market skills for the long-term unemployed

Unemployment leads to a loss of skills among existing workers who find themselves
without work for extended periods of time. Persistently high unemployment will mean
that those who are unemployed will lose their labour market skills, confidence and
experience, and will become less employable or even unemployable. In this way, cyclical
or short-term unemployment can turn into long-term structural unemployment, a process
known as hysteresis. In addition, new members of the labour force (such as young school Hysteresis is the process
leavers and new university graduates) will find it more difficult to develop skills if they whereby unemployment
in the current period
are unable to obtain jobs soon after finishing their education.
results in the persistence
of unemployment in future
Costs to the government
periods as unemployed
High levels of unemployment can have a significant influence on the government’s people can lose their
revenue and expenditure (and therefore on the federal Budget). Higher unemployment skills, job contacts and
leads to lower household incomes and therefore less tax revenue, while at the same time motivation to work.
the government is burdened with increased transfer payments (unemployment benefits) to
the unemployed, as well as the cost of training and labour market programs. This decrease
in revenue and increase in expenditure will cause a deterioration in the budget outcome.

Lower wage growth

High levels of unemployment mean that there is an excess of labour supply in the
economy, which should lead to a fall in the equilibrium level of wages. However, there
is a “downward stickiness” for wages – that is, wages do not often get reduced (because,
for example, they are set through formal enterprise agreements or industrial awards).
Instead, higher unemployment is more likely to lead to slower wage growth over time
rather than actual reductions in wages. Similarly, the laws of supply and demand suggest
that low unemployment should lead to higher wage growth. Australia has been through
a long period in which wage growth has been below expectations, despite relatively low
unemployment. This lower wage growth is attributed to other factors that are discussed
in chapter 17.

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Australia in the Global Economy 2024

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”.

Other social costs

Unemployment is associated with many of the most serious personal and social problems
in Australia. Among families and individuals, especially those who suffer from long-term
unemployment, there is an increased incidence of social problems, including:
• severe financial hardship and poverty
• increased levels of debt
• homelessness and housing problems
• family tensions and breakdown
• loss of work skills
• increased social isolation
• increased levels of crime
• erosion of confidence and self-esteem
• poor health, mental health conditions and a higher risk of suicide.
These social problems have an economic cost for the community as a whole since more
resources must be directed towards dealing with them. For example, more public
funds must be spent on health, welfare services, social workers, the police service and
correctional centres, rather than being used to satisfy other community wants. In addition,
increased unemployment and inequality can create social tensions and a backlash against
globalisation more generally, as was seen in many countries after the global financial crisis
of 2008.

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.

8.8 Policies to reduce unemployment

Reducing unemployment is one of the most difficult tasks of economic management.
Lasting reductions in unemployment take time to achieve and are dependent upon
sustaining economic growth over a long time period. In periods of rising unemployment,
the challenge for governments is to minimise the short-term increase in joblessness in
order to achieve the fastest possible return to low unemployment. The broader challenge
for governments is to reduce long-term structural unemployment through a combination
of labour market policies, investment in training and other wider economic reforms.
Governments choose policies to reduce unemployment based on what they see as the
main causes of unemployment. If, for example, a government believes that the main
cause of unemployment is structural unemployment, in which the skills of jobseekers
are not suitable for the jobs that are available, it would implement policies that aim
to train workers with new skills. On the other hand, if the government believes that
cyclical unemployment is a main reason for people being out of work (due to an economic
downturn), it might implement policies to encourage stronger economic growth. The
changing priorities of government policies to reduce unemployment often reflect changing
views on the causes of unemployment.
Macroeconomic policies are the main instruments used to reduce cyclical unemployment,
sustain economic growth and minimise sharp downturns in the business cycle. Economists
describe employment as a derived demand of production, meaning that reductions in
unemployment require increases in output. Expansionary fiscal policy, involving either
lower taxes or increased government spending, can stimulate economic activity and
cause an increase in output through the multiplier effect. For example, as governments
increase expenditure on infrastructure, businesses will increase investment and employ
more people. Expansionary monetary policy, involving lower interest rates, can stimulate
consumer spending and business investment and similarly cause an increase in output.
In Topic Four, we examine in detail the role of fiscal, monetary and other policies in
influencing the level of output and therefore job growth.
Australia’s economic history over the past half century has shown that unemployment
rises quickly during a recession, but it can take many years of economic recovery for
unemployment to return to its pre-recession levels. Avoiding sharp downturns in the
economy can therefore minimise any increase in cyclical unemployment. The goals of
achieving an economic growth rate of 3 per cent or more, and keeping inflation within the
2 to 3 per cent target band, have been central to macroeconomic policy since the 1990s.
The main reason why Australia succeeded in sustaining lower rates of unemployment since
the 1990s is that it sustained growth and avoided recession (a feat which has broken world
records) for 28 years up until the COVID-19 pandemic in 2020.

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Chapter 8: Unemployment

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.

2 The labour force participation rate is the percentage of the working-age

population who are either working or actively seeking work.

3 Unemployment refers to the proportion of people in the labour force actively

seeking work but unable to find it. It is measured by the unemployment rate.
The unemployment rate is calculated by:

Number of persons unemployed 100

Unemployment rate (%) = ×
Total labour force 1

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.

5 Australia experienced a trend increase in unemployment from the mid-1970s.

After falling slowly from the early 1990s to 2008, it then stabilised in the range
of 5 to 6 per cent during the 2010s. The unemployment rate rose to above
7 per cent during the COVID-19 recession, but recovered quickly to below
4 per cent by 2022, where it remained in 2023.

6 The main types of unemployment include:

•
cyclical unemployment, which occurs because of a downturn in the level of
economic activity

• structural unemployment, which occurs because of a mismatch between

the skills of the unemployed and the skills required by job vacancies

•
frictional unemployment, which occurs when people are temporarily
unemployed as they change jobs

• seasonal unemployment, which occurs at predictable and regular times

throughout the year because of the seasonal nature of some kinds of work.

7 The main causes of unemployment include low levels of economic growth,

contractionary macroeconomic policies, rising participation rates, structural
and technological change, changes in productivity, inadequate training and
investment, rapid increases in labour costs and inflexibility in the labour market.

8 The non-accelerating rate of unemployment (NAIRU) is a concept used by

economists to refer to the minimum rate of unemployment that can be sustained
without inflationary pressure – thought to be around 4.25 per cent in Australia.

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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Australia in the Global Economy 2024

chapter review
1 Define unemployment and explain how it is measured.

2 Discuss recent trends in the level of unemployment in Australia.

3 Explain the difference between unemployment, underemployment and the

underutilisation rate.

4 Identify the main types of unemployment that might exist in an economy.

5 Explain the role of technological change in influencing the level of unemployment.

6 Explain what is meant by the non-accelerating inflation rate of unemployment.

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.

9 Identify which groups in Australian society tend to experience higher levels

of unemployment.

10 Outline THREE recent policies to reduce unemployment in Australia.

202
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.

9.2 Measuring the rate of inflation

Inflation is a sustained increase in the general level of prices in an economy. The
best-known and most widely used measure of inflation in Australia is the percentage
change in the Consumer Price Index (CPI). The CPI summarises the movement in the Consumer Price Index
prices of a basket of goods and services, weighted according to their significance for the (CPI) summarises
average Australian household. The annual inflation rate is calculated by the percentage the movement in the
prices of a basket of
change in the CPI over the year. goods and services,
weighted according to
Inflation rate (%) = CPICY – CPIPY 100 their significance for
×
CPIPY 1 the average Australian
household. It is used
Where CPICY = the value of the CPI in the current year
to measure inflation
Where CPIPY = the value of the CPI in the previous year
in Australia.

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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Australia in the Global Economy 2024

Weighting weighting for each expenditure group to more accurately reflect

Expenditure group
factor % average consumer purchasing patterns. The CPI excludes some
Food and non-alcoholic beverages 17 items of household spending such as changes in mortgage interest
Alcohol and tobacco 8 rates and consumer credit charges. In addition, the CPI does not
Clothing and footwear 3 include prices of property or land, so the changes in residential
Housing 22 property prices in recent years are not reflected directly in the CPI.
Furnishings, household equipment and
9 The official or “headline” rate of inflation, calculated using the
services
Health 6 CPI, can be a misleading indicator of ongoing price pressures in
Transport 11 the economy because it includes some goods and services whose
Communication 2 prices may be highly volatile or affected by one-off factors.
Recreation and culture 11 Economists, including those at the Reserve Bank of Australia
Education 4 (RBA or Reserve Bank), therefore prefer to look at the level of
Insurance and financial services 6 underlying inflation (also known as “core” inflation). Underlying
All groups 100 100 inflation removes the effects of one-off or volatile price movements
Source: ABS Annual weight update of the CPI and Living Cost Indexes, 2022 (see the box below on how underlying inflation is calculated). As
a result, measures of underlying inflation tend to be less variable
Figure 9.1 – Weighting of main expenditure groups in the
CPI basket
than headline inflation.

MEASURES OF UNDERLYING INFLATION

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

9.3 Recent trends in inflation

Inflation (%)
12
Headline inflation (CPI)
Underlying inflation
10

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

Figure 9.2 – Inflation in Australia 1982–2023

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.

9.4 The main causes of inflation

Economists generally recognise four main causes of inflation: demand-pull, cost-push,
inflationary expectations and imported inflation. We consider these causes below, along
with two other possible causes of inflation – government policies and excessive increases
in the money supply.

Demand-pull inflation Demand-pull inflation

General price level
occurs when aggregate In a market economy, prices are
demand or spending AD1 AD2
determined by the interaction of AS
is growing while the
economy is nearing its
demand and supply in the marketplace.
supply capacity, so that When aggregate demand (or spending)
higher demand leads to exceeds the productive capacity of the P2

higher prices rather than economy, prices rise as output cannot

more output. P1
expand any further in the short term.
Consumers force prices up by bidding
against each other for the limited AS
goods and services available. This is AD1 AD2

reflected in figure 9.3, as aggregate 0

Total output
demand increases from AD1 to AD2.
Consumers are willing to pay a higher Figure 9.3 – Demand-pull inflation
price for any given level of supply.
Prices will therefore increase from P1 to P2 (causing an expansion in supply). The price
increase that results from higher aggregate demand is known as demand-pull inflation.
Cost-push inflation
occurs when there is an Cost-push inflation
increase in production Cost-push inflation is caused by an increase in the costs of the factors of production.
costs (such as oil price
When production costs rise, firms attempt to pass them on to consumers by raising the
increases or wage
increases) that producers
prices of their products. This is reflected in figure 9.4, as aggregate supply shifts from AS1
pass on in the form of to AS2. Producers face higher costs so they now supply less quantity for any given price
higher prices, thus raising level. Prices therefore increase from P1 to P2 (causing a contraction in demand).
the rate of inflation.
Major sources of cost-push inflationary pressures in the Australian economy include wages
and the prices of raw materials such as fuel. When wages increase faster than productivity
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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.”

– Ross Gittins, Less competition reduces the power

of interest rates to cut inflation, July 2023

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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9.5 The effects of inflation

Inflation has significant effects on the economy in both the short and long term. In
general, the higher the level of inflation, the more negative the consequences. As a result,
governments around the world give priority to sustaining low inflation in order to avoid
the negative consequences that high inflation brings.

“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.”

– Philip Lowe, Governor of the Reserve Bank of Australia

Economics Society of Australia address, 12 July 2023

Economic growth and uncertainty

In ordinary economic circumstances, inflation is regarded as one of the major constraints on
economic growth. Excessive economic growth tends to raise inflationary pressures through
increased wage demands and through strong consumer demand bidding up price levels.
On the other hand, a sustained lower inflation rate allows moderate economic growth to
be maintained without it becoming necessary to curtail growth through higher interest
rates. Sustained low inflation for three decades from the early 1990s allowed for a long
period of relatively high economic growth.
In overall terms, higher inflation distorts economic decision making since producers and
consumers change their spending and investment decisions in order to minimise the
effect of inflation on themselves, such as through buying assets rather than investing in
income-producing activities.
Low inflation has a beneficial effect on the level of economic growth because it removes
the distortion to investment and savings decisions that is caused by higher inflation.
High inflation discourages business investment because it makes producers uncertain
about future prices and costs, and therefore future profit levels. Low inflation has a positive
impact on business investment, restoring the incentive to invest in long-term productive
assets rather than short-term speculative investments, which a high-inflation environment
encourages.
Higher inflation will also distort consumers’ decisions to spend or save disposable income.
Sustained high inflation reduces the purchasing power of money and can contribute to
cost-of-living pressures. Sustained low inflation is likely to encourage consumers to save
a higher proportion of their disposable income. However, Australia’s recent experiences
suggest that other factors, such as house prices, superannuation and the broader economic
outlook, can be more important in influencing the overall level of savings in the economy.
When the economy is performing strongly and people’s assets are rising in value,
consumption rises and the savings rate falls, even when inflation rates are low.

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).

International International competitiveness

competitiveness High inflation results in increased prices for Australia’s exports, reducing international
refers to the ability of
an economy’s exports
competitiveness, leading to a lower quantity of exports. As the price of domestic goods
to compete on global increases, consumers will likely switch to import substitutes, worsening the trade deficit.
markets. An economy may By contrast, low inflation should improve Australia’s international competitiveness,
be competitive by selling making the price of Australian goods and services more attractive to other countries and
products of a higher making local products more competitive with imports. This should lead to an expansion
quality or a lower price
of exports and the replacement of imports by domestic substitutes, thus improving the
than its competitors.
trade balance.

HOW INFLATION CAUSES AN EXCHANGE RATE DEPRECIATION

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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Exchange rate impacts

In the short term, higher inflation may result in an appreciation of the exchange rate,
as speculators anticipate the RBA raising interest rates in response, attracting greater
financial flows. However, high inflation generally causes the currency to depreciate over
time. Australian experience offers some evidence of the relationship between inflation and
a depreciation (although the stronger relationship is where a depreciation causes higher
inflation). Over the long term, sustained low inflation may foster greater international
confidence in the Australian economy, strengthening the value of the dollar.

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.

9.6 Policies to sustain low inflation

Since the large fall in inflation during the recession of the early 1990s, the Government
and the RBA have sought to maintain a low level of inflation in the Australian economy.
Monetary policy has been the main tool used to achieve the policy goal of low inflation,
but occasionally other parts of the policy mix have also been used to address price pressures.
Monetary policy has played the primary role in Australia’s low inflation record since
the early 1990s. In the short to medium term, monetary policy is the major tool used
to reduce inflation. Monetary policy attempts to sustain economic growth at a level that
does not create inflationary pressures, trying to hold inflation between the RBA’s 2–3 per
cent target. If inflation starts rising, the RBA is able to increase interest rates throughout

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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 summary
1 Inflation is a sustained increase in the general level of prices in an economy.

2 The inflation rate measures the percentage change in prices of consumer

goods (as measured by the Consumer Price Index) and therefore reflects any
change in the cost of living. The CPI is compiled from calculations of the change
in the prices of a basket of goods and services, weighted according to the
purchasing patterns of Australian households.

3 Measures of underlying inflation exclude one-off and volatile changes in prices

and provide a measure of ongoing price pressures in the economy. The Reserve
Bank’s calculation of underlying inflation is based on an average of two measures
of ongoing inflationary pressures (the trimmed mean and weighted median).

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.

8 Inflationary expectations can lead to inflation if individuals and businesses

within the economy expect an increase in the rate of inflation and attempt to
protect themselves from it by raising prices and wages.

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.

2 Explain how the inflation rate is calculated.

3 Distinguish between headline and underlying inflation.

4 Outline recent trends in Australia’s inflation performance.

5 Describe the main causes of inflation.

6 Explain how an increase in inflationary expectations can cause an increase

in inflation.

7 Discuss the benefits of low inflation.

8 Explain TWO consequences of high inflation.

9 Examine the relationship between the levels of inflation and unemployment in

an economy.

10 Explain how changes in economic policy have influenced Australia’s inflation

performance in recent years.

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.

10.2 Australia’s current account deficit

A key measure of an economy’s external stability is the current account deficit as a
percentage of GDP. Except for the series of current account surpluses in the years since
2019–20, Australia has a long history of large CADs since the 1980s. Australia has paid
out considerably more for goods, services and income than it has received from overseas.
The current account balance as a percentage of GDP is the best measure of trends in
the current account over time, rather than the current account’s dollar value. Using this
measure allows an accurate comparison across time and between countries.
In chapter 4 we saw that, until recently, the CAD had generally remained in a range
of around 3 to 6 per cent of GDP (see figure 4.8). As a percentage of GDP, the CAD
averaged 1.1 per cent in the 1970s, then 4.1 per cent in both the 1980s and 1990s,
4.9 per cent in the 2000s and then fell to 2.5 per cent in the 2010s. The large increase
in the CAD in the 1980s caused alarm and prompted major structural reforms to restore
the competitiveness of the Australian economy. While the current account is expected to
return to deficit in 2024–25, its recent trend improvement is expected to be sustained
in the foreseeable future.

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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.

The CAD as a trade deficit

When the current account first emerged as a major problem in the 1980s, economists
mainly explained it as a product of Australia’s trade problems. In other words, the CAD
was blamed on persistent deficits on the balance on goods and services, caused by a
combination of slow export growth and expanding demand for imports. While the balance
on goods and services is not the main reason for the persistence of Australia’s CAD, it
is still a critical part of Australia’s balance of payments performance. There are two key
dimensions to the argument that the CAD is the result of a trade gap.
Firstly, Australia lacks international competitiveness in many of the higher value-
added areas of global trade, such as elaborately transformed manufactures (ETMs). Many
of Australia’s traditional manufacturing industries have lost their markets at home and
overseas, because they have not been able to compete with overseas competitors who
specialise in large-scale, low-cost manufacturing, such as China. For example, many
areas of manufacturing have largely moved offshore, such as footwear, clothes, textiles,
electronics, whitegoods, motor vehicles, tyres, machinery, oil refining and even some
areas of food processing. Australia’s manufacturing sector has declined as a share of total
output, increasing our reliance on imports. Since the 2000s, a sustained period of high
commodity prices has led to higher values for the Australian dollar, making Australia’s
non-commodity resources less competitive. Economists use the term “Dutch disease” to
describe how demand for one type of exports may drive up the value of the exchange rate,
making other exports less competitive (leading to a contraction in production of those
exports).
Australia’s lack of international competitiveness can be seen as the result of both cost
factors (being able to sell goods and services at attractive prices on global markets,
influenced by exchange rates, labour costs and productivity levels) and non-cost factors
(such as the quality of production, reliability of supply, marketing efforts and customer
services). In the 2023 IMD World Competitiveness Yearbook, Australia was ranked as the
19th-most competitive economy in the world. The Yearbook noted Australia’s need to
return productivity growth to long-term averages, manage its clean energy transition
more efficiently and grow and deepen its export base.
Secondly, Australia’s terms of trade (discussed in chapter 4) have a major effect on changes
in the CAD. Since 2003, the terms of trade has increased dramatically, so that by their
peak in 2022, the terms of trade was around double its level in 2003. Large investments
were made in the mining sector to take advantage of higher prices for resource exports,
and by the 2010s there was a sustained fall in the CAD, eventually leading to the first
current account surpluses in almost half a century.
The relationship between movements in the terms of trade and Australia’s trade balance
(and therefore current account) has strengthened in recent years. A 64 per cent increase in
the terms of trade during the six years to 2022 helped the trade surplus to reach a record
6.0 per cent of GDP. Overall, the trade balance improved from an average deficit of 1.5
per cent of GDP in the 2000s to an average surplus of 0.2 per cent in the 2010s. Between
2019–20 and 2021–22, it averaged 4.7 per cent of GDP. While Australia has profited
from a period of high commodity prices, the risk of its heavy reliance on minerals and
energy exports is that a sharp fall in prices for those commodities, or a major disruption
to Australia’s exports to China, could trigger a large increase in the CAD. The narrowness

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Australia in the Global Economy 2024

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.

The CAD as a savings-investment gap

Another explanation of Australia’s history of current account deficits is that it is the result of
an excess of domestic investment over domestic savings – the savings-investment gap. If
domestic spending exceeds domestic output, resulting in a deficit on the current account, we
are forced to make up for this by bringing in financial inflows from overseas – in other words,
Australia borrows from overseas or sells domestic assets to overseas residents. As such, foreign
savings instead of domestic savings are used to finance domestic investment. Similarly, if the
Government runs a budget deficit, this will reduce the level of national savings and widen
the savings-investment gap. The relationship between business investment, net saving and
the current account can be seen in figure 10.1. Recently record-low global interest rates
and a fall in investment have helped to narrow the savings-investments gap and improve
the current account balance.

% 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

Figure 10.1 – Australia’s savings–investment gap

From the perspective of the savings-investment gap, Australia’s persistent CAD and need
for capital inflow is partly explained as a natural consequence of specific features of the
economy. As a country with a small population, a large land mass and extensive natural
resources, to develop its economy Australia has historically relied on overseas capital to fill
the gap between domestic savings and investment. Foreign investment and borrowings have
made it possible for Australia to develop more rapidly than if it had relied only on domestic
sources of capital. In this context, so long as foreign investors and foreign loans are increasing
Australia’s productive capacity (and not just funding the purchase of existing assets such
as housing), they will add to Australia’s capacity to service its foreign liabilities – and
deficits on the current account will therefore be sustainable in the longer term.

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Chapter 10: External Stability

The “consenting adults” thesis (the Pitchford thesis)

The argument that the CAD and foreign liabilities are not a major concern was popularised
by Australian National University Professor John Pitchford in the 1990s and was known
as the Pitchford thesis. It is now commonly known as the “consenting adults” thesis. The Pitchford thesis
Pitchford noted that Australia’s CAD and foreign liabilities were almost entirely generated states that as long as a
by the private sector (despite the Government running large budget deficits in recent current account deficit is
the result of savings and
years, the private sector still accounts for around 80 per cent of Australia’s net foreign investment decisions
debt). He argued that Australia’s current account problem was different from that of other by the private sector
countries with large external imbalances who had experienced financial crises arising that are not the result
from large foreign debt burdens, because their foreign debt was the result of government of distortions to normal
borrowings. In Australia’s case, Pitchford’s argument was that foreign liabilities helped market mechanisms,
then there is no cause
to fund private investment projects, or were direct investments in firms and ventures by
for concern about an
foreign residents. So long as private-sector decision making is not distorted by other factors economy’s external
(such as government policy), individuals and firms make proper calculations of the risks stability.
and costs of borrowing from overseas, and borrowers and lenders are responsible for their
own decisions – in other words, they are “consenting adults”.
Provided that Australia’s foreign liabilities are largely accumulated by the private
sector, the argument goes that there is no need for the Australian Government to be too
concerned about the level of foreign liabilities any more than with the level of domestic
liabilities. However, the “consenting adults” view has attracted some criticism since the
global financial crisis. The major point of debate has been whether one of the assumptions
underpinning the Pitchford thesis – that private-sector decision making involves a
proper calculation of risks – always holds true. Critics point to the role of the collapse
of the subprime mortgage market in the United States in 2008. In this instance, large
financial institutions were not able to accurately calculate the risks of borrowing and
lending associated with complex financial products called mortgage-backed securities.
The Pitchford thesis also assumes that private-sector debt is entirely separate from public-
sector debt. However, the global financial crisis demonstrated that national governments
are often forced to assume the liabilities of their country’s private-sector banks in order to
avert a more serious financial collapse. Nevertheless, while the Pitchford thesis remains
a matter of debate, a downward trend in Australia’s net foreign liabilities has, in recent
years, supported the view that, at least in an environment of strong commodity prices,
Australia’s external imbalances are sustainable.

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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10.3 Australia’s foreign liabilities

Net foreign liabilities One of the long-term impacts of current account deficits is the growth of net foreign
are equal to Australia’s liabilities (or net external liabilities). Net foreign liabilities reflect Australia’s total financial
financial obligations obligations to foreigners, minus the total financial obligations of foreigners to Australia.
(foreign debt plus foreign The two components of net foreign liabilities are:
equity) to the rest of the
world minus the rest • net foreign debt (or net external debt), which is the total stock of loans owed
of the world’s financial by Australians to foreigners, minus the total stock of loans owed by foreigners to
obligations to Australia. Australians
• net foreign equity, which is the total value of assets in Australia, such as land,
shares and companies in foreign ownership, minus the total value of assets overseas
that are owned by Australians.
Overseas borrowing adds directly to Australia’s foreign debt. The
Net foreign liabilities
initial borrowed sum eventually has to be repaid and the debt must be
serviced with regular interest payments. The servicing of Australia’s
debt constitutes an outflow of funds on the current account, and thus
increases our CAD. By contrast, selling assets to foreigners does not add
Net foreign
debt + Net foreign
equity
directly to Australia’s foreign debt. Australia does not have to repay the
price of purchasing equity unless the company or assets are sold back to
Australians. However, Australia does have to send overseas returns on
equity investment, such as company profits, rent on land and dividends on shares. In
recent years, equity servicing costs on the primary income account have exceeded interest
repayments on debt. The returns on equity that Australia pays to overseas investors are
partly offset by returns received by Australians from investments overseas.
Figures 10.2 and 10.3 show the growth in Australia’s net foreign liabilities as a
percentage of GDP. This reflects the growth in net foreign debt and changes in net
foreign equity. The figures reveal a trend of ongoing growth in Australia’s net foreign

Net foreign % of Net foreign % of Net foreign % of

Year GDP ($b)
debt ($bn) GDP equity ($bn) GDP liabilities ($bn) GDP
1980–81 637.9 9.4 1.5 24.0 16.0 33.4 22.3
1985–86 737.8 78.4 10.6 21.1 8.3 99.5 39.0
1990–91 857.6 142.8 16.7 50.9 12.3 193.7 46.7
1995–96 1005.4 191.0 19.0 87.7 16.6 278.7 52.7
2000–01 1216.2 295.5 24.3 76.5 10.8 372.4 52.7
2005–06 1440.4 489.4 34.0 47.8 3.3 537.1 53.8
2010–11 1650.5 0.0 0.0 100.5 6.1 778.3 47.2
2011–12 1714.9 0.0 0.0 64.9 3.8 819.6 47.8
2012–13 1759.1 821.8 46.7 −4.7 −0.3 817.0 46.4
2013–14 1804.4 898.3 49.8 −24.7 −1.4 873.5 48.4
2014–15 1843.3 988.7 53.6 −96.0 −5.2 892.7 48.4
2015–16 1893.6 1082.9 57.2 −33.4 −1.8 1049.5 55.4
2016–17 1936.8 1046.4 54.0 −38.4 −2.0 1008.0 52.0
2017–18 1992.7 1136.6 57.0 −80.5 −4.0 1056.1 53.0
2018–19 2036.0 1227.6 60.3 −143.3 −7.0 1084.3 53.3
2019–20 2034.9 1194.9 58.7 −136.4 −6.7 1058.5 52.0
2020–21 2080.4 1233.5 59.3 −320.6 −15.4 912.8 43.9
2021–22 2157.1 1167.6 54.1 −263.1 −12.2 904.4 41.9
2022–23 2227.6 1169.5 52.5 −347.3 −15.6 822.2 36.9
Sources: ABS Australian National Accounts (Cat. no. 5206.0), Balance of Payments and International Investment
(Cat. no. 5302.0)

Figure 10.2 – Australia’s net foreign liabilities

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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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Australia in the Global Economy 2024

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

8000 Net foreign liabilities

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

Sources: ABS Australian National Accounts (Cat. no. 5206.0), Year

Balance of Payments and International Investment (Cat. no. 5302.0)

Figure 10.4 – Australia’s international investment position

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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10.4 Australia’s exchange rate

The exchange rate provides a direct link between Australia and the rest of the world.
All trade and financial relationships between Australia and other countries are mediated
through the exchange rate. Therefore, the exchange rate has a significant impact on
Australia’s international competitiveness and external stability.
As chapter 5 noted, Australia’s reliance on commodity exports has resulted in greater
volatility in our exchange rate. The larger fluctuations in commodity-based currencies
can often attract speculators, and despite making up just 1 per cent of global trade, the
Australian dollar is the world’s fifth-most traded currency (after the US dollar, the euro,
the yen and the pound sterling). Recent years have seen very large movements in the
dollar, from its peak of US$1.10 in 2011, falling to a low of US56 cents in March 2020,
before appreciating to US80 cents in February 2021, falling again to a low of US62
cents in October 2022, rising to 71 cents in February 2023, and falling to US64 cents
in September 2023.
The volatility in the Australian dollar that can be seen in figure 10.5 is more the result of
increased global economic instability than domestic economic instability. At the turn of
the century, commodity prices were very low and the dawn of the internet era resulted in
countries with “low tech” economies, such as Australia, being shunned by global markets.
This changed after 2003, when commodity prices started rising sharply on the back of the
surging Chinese demand for natural resources. The trend increase in the Australian dollar
continued until 2011, as Australia’s terms of trade reached record levels, underpinned
by rising exports, sustained economic growth and the interest rate differential between
Australia and other economies. The Australian dollar depreciated during the 2010s, as the
terms of trade fell from its historic peak, and the Australian economy grew at a slower rate
than previous decades. Depreciating after the onset of the COVID-19 pandemic, the dollar
recovered as demand for commodity exports rose and the Australian economy recovered.
The dollar’s weakness during 2022 and 2023 was driven by global interest rates rising
more quickly than domestic interest rates in Australia.

Trade Weighted Index

(May 1970 = 100) A$/US$
100 1.30
United States Dollar (RHS)
90 1.15
Trade Weighted Index (LHS)
80 1.00

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

Source: Reserve Bank of Australia Year

Figure 10.5 – Changes in the value of the Australian dollar

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.

THE IMPACT OF GLOBAL INTEREST RATE MOVEMENTS

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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10.5 Policies to achieve external stability

Achieving external stability has, at certain points in Australia’s history, been a major
economic policy concern. However, in more recent years, improving external stability
has not been a major objective of macroeconomic policy. In part, this change reflects
a widespread acceptance of the “consenting adults” view of the current account among
economists and policymakers, that CADs and foreign debt reflect the decisions of the
private sector and do not require policy change by government. The reduced concern
around external stability is also related to Australia’s improved medium-term export
prospects (and several current account surpluses) and increased household savings.
This change does not mean that external stability is unimportant or of no interest to
economic policymakers. What it has meant is that achieving sustainable outcomes on
the current account and foreign liabilities and a stable value of the currency are now
treated more as long-term objectives of economic policy. External stability issues are now
addressed through Australia’s longer-term policy settings, which aim to reduce the risk of
external shocks that could adversely affect Australia’s access to global financial markets:
• Monetary policy is not being used to address Australia’s external imbalances. In
the past, contractionary monetary policy was used to reduce consumer spending on
imports in order to create a short-term improvement in the balance on goods and
services. However, this approach is now considered ineffective, since its impact is
only temporary, and it results in a slowdown across the whole economy. In addition,
higher interest rates can also increase capital inflows, generating higher net primary
income outflows and worsening the current account. Monetary policy is also unable
to target the long-term structural causes of Australia’s external imbalances.
• Fiscal policy has had some role in addressing Australia’s historically low level of
national savings. By adopting the policy of fiscal consolidation (running balanced
or surplus budgets over the course of the economic cycle), governments since the
late 1990s have sought to reduce their call on private savings over the medium
term. While COVID-19 resulted in a significant increase in government borrowing,
Australia’s fiscal strategy has more recently returned to fiscal consolidation. While
rising public debt levels have had a negative effect on national savings, public debt
is projected to fall as a share of GDP from 39.5 per cent in 2020–21 to 32.3 per
cent in 2033–34. This should limit any upward pressure on interest rates and the
“crowding out” of private borrowers.
• Australia’s superannuation guarantee (or compulsory superannuation) requires
employers to contribute a minimum percentage of employee wages to their
superannuation, and since the 1990s this has substantially expanded the pool of
national savings. In turn, it has also increased Australia’s overseas investments,
which help to create financial inflows on the net primary income account. The
superannuation guarantee increased to 11 per cent of wages in July 2023, rising
further to 11.5 per cent from July 2024 and 12 per cent from July 2025.
• Microeconomic reform can be used to address the structural problems causing
Australia’s external imbalances. The international competitiveness of Australian
goods and services should be improved by measures that lift the efficiency and
productivity of Australian producers. These policies have included measures to reduce
capacity constraints in the economy by improving infrastructure and alleviating
skills shortages, removing protectionist barriers that shielded inefficient producers
from foreign competition, and labour market reforms to increase productivity and
workforce participation.

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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.

Australia’s current account balance improved during the 2010s. A series of

3
current account surpluses beginning in 2019–20 contributed to a fall in net foreign
liabilities, and increased confidence in Australia’s role in the global economy.

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.

A CAD can be viewed as a consequence of an imbalance between savings

5
and investment – that is, a consequence of a shortfall in domestic savings.
Historically, Australia’s relatively low level of household savings has contributed
significantly to the CAD. The CAD is also influenced by Australia’s international
competitiveness and the terms of trade.

Another indicator of sustainability is the level of net foreign liabilities as a

6
percentage of GDP. This includes net foreign debt and net foreign equity.
A high level of net foreign liabilities poses risks for external stability because it
involves large servicing costs in the long term.

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.

Another indicator of the sustainability of foreign debt is the debt servicing

8
ratio, which measures the percentage of export revenues spent in servicing the
foreign debt. Despite Australia’s rising foreign debt levels, the debt servicing ratio
has fallen during recent years because of lower global interest rates.

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.

Governments have limited policy instruments available to address problems

10
of external imbalance. Governments mainly rely on market mechanisms (such
as an exchange rate depreciation) and long-term policy settings to address
external imbalances.

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Chapter 10: External Stability

chapter review
1 Define what is meant by external stability.

2 Describe an example of external instability.

3 Briefly discuss what factors influenced Australia’s external balances during

recent years.

4 Discuss the recent trends in the current account.

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.

7 Explain why exchange rate movements are an important indicator of external

stability in Australia.

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.

10 Outline what policies may be used to improve external stability.

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

11.2 Measuring the distribution of

income and wealth
Income distribution
Personal income is the amount of money, or other benefits measured in money terms, that
flows to individuals or households from the sale of factors of production over a period of
time. Forms of income include wages from labour, rent from land, interest from capital,
and profit from enterprise. Income can be regarded as the benefit that flows to the owners
of the factors of production for owning, maintaining and managing productive resources.
Individuals can also receive income such as pensions and benefits from the government.
Income inequality refers to the degree to which income is unevenly distributed among
people in the economy. The degree of unevenness can range from a high level of equality,
where people receive a similar share of income, to a high level of inequality, where there
is a large gap between high- and low-income earners.
Income inequality can be measured by the share of total income received by different
groups. For example, figure 11.1 looks at what proportion of disposable income (after tax)
is received by each quintile, with a quintile being a 20 per cent grouping ranked from
lowest to highest income earners. The table shows that in 2021–22, the lowest 20 per cent
of Australians received just 8.1 per cent of income, while the highest 20 per cent received
40.9 per cent of income. In the past 25 years, the share of income has only risen for the
highest income quintile, whose share is now more than 3 percentage points higher than
two decades ago.

Share of disposable income (%)

Quintile
1995–96 1999–00 2005–06 2009–10 2015–16 2019–20 2020–21 2021–22

Lowest quintile 8.1 7.7 7.5 7.9 7.9 8.2 8.3 8.1

Second quintile 13 12.6 12.5 12.2 12.2 12.6 12.7 12.6

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 11.1 – Share of disposable income by households in Australia

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.

Lowest Second Third Fourth Highest Average all

quintile quintile quintile quintile quintile households

Mean income per week $576 $1316 $2306 $3416 $7022 $2895

Annual $29,936 $68,433 $119,926 $177,650 $365,133 $150,547

Source: Australian National Accounts: Distribution of Household Income, Consumption and Wealth (Cat. no. 5204.055.011)

Figure 11.2 – Average gross household incomes in Australia, 2021–22

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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.

Measuring income inequality – the Lorenz curve

Lorenz curve is a We construct the Lorenz curve by plotting Y
100

Cumulative proportion of total income (%)

graphical representation the cumulative percentage of total income
of income distribution, received (vertical axis) against the cumulative 80
plotting the cumulative Line of equality
increase in population
percentage of income recipients (horizontal
against the cumulative axis). Using information showing the 60

increase in income. distribution of income across different income A B

40
groups (such as in figure 11.1), a Lorenz curve
can be constructed for Australian households. 20
Lorenz curve
If income were distributed evenly across the
0 X
whole population, the Lorenz curve would 0 20 40 60 80 100
be the diagonal line through the origin of Cumulative proportion of persons ranked by income (%)
the graph – the line of equality. The further
Figure 11.3 – Lorenz curve
the Lorenz curve is away from this line, the
greater the degree of income inequality in a
society.

Measuring income inequality – the Gini coefficient

Gini coefficient is a The Gini coefficient is a single statistic that summarises the distribution of income across
number between zero the population. It is calculated as the ratio of the area between the actual Lorenz curve and
and one that measures
the line of equality (area A in figure 11.3) and the total area under the line of equality (A+B).
the extent of income
inequality in an economy.
It is calculated by A
Gini coefficient =
measuring the degree to A+B
which the Lorenz curve
deviates from the line of
equality.
The Gini coefficient ranges between zero, when all incomes are equal, and one, when
a single household receives all the income. Therefore, the smaller the Gini coefficient,
the more even the distribution of income. Figure 11.1 shows that the degree of income
inequality in Australia has increased since the mid-1990s. The OECD, which releases
its own Gini coefficient measurements, found that Australia’s Gini coefficient was 0.318
in 2020, a decrease from 0.325 in 2018. This places Australia 21st out of 38 OECD
countries, and slightly less equal than the OECD average, which is 0.315. Meanwhile,
the Australian Bureau of Statistics measured Australia’s most recent Gini coefficient to
be 0.318 in 2020–21, which is around the Australian average since 1994 of 0.315, and
below its peak of 0.336 in 2007–08. In 2022, Reserve Bank research found that the Gini
coefficient was higher in mining areas (because mining industry jobs pay substantially
more than regional industries) and in major cities (where there is a very wide range of
occupations).

Measuring the distribution of wealth in Australia

The process of measuring household wealth is more complex than measuring income levels.
The ABS only began releasing official measures in 2006, and the ABS only releases new data

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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.

Share of aggregate wealth (%)

Quintile
1986–87 1998–99 2005–06 2009–10 2011–12 2013–14 2015–16 2017–18 2019–20

Lowest quintile 0 0 1.3 0.9 0.9 0.9 0.8 0.7 0.7

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

Figure 11.4 – Distribution of wealth in Australia, selected years

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.

11.3 Sources of income and wealth

We can gain a better insight into the factors influencing the distribution of income and
wealth by looking at their sources and how each factor of production contributes to income
or wealth levels. For household income, these are:
• Wages from the sale of labour: This is the main source of income for consumers. It
comes in the form of wage or salary payments for labour when consumers participate
in the labour market. It also includes non-wage income such as bonuses, fringe
benefits and employer contributions to superannuation. The Australian Bureau of
Statistics categorises this as “Compensation of employees”, and it is also sometimes
described as “Returns to labour”.
• Rent from land: Many consumers own land that becomes a source of income
when it is rented. For example, consumers may own an investment property that
generates rental income.
• Earnings from capital: Returns from the ownership of capital are a significant
source of household income. These returns might include earnings from financial
assets such as investment funds, superannuation accounts and bank deposits, or the
ownership of shares (or whole companies). Because ownership of capital is highly
concentrated among the most wealthy households in Australia, a large share of
this type of earnings goes to the wealthiest households. This is the main way in
which inequality in the distribution of wealth contributes to inequality in the
distribution of income.
• Profit from entrepreneurship: A substantial number of Australians are involved in
operating businesses, especially small businesses. If the business makes a profit this
income is considered a return for their use of entrepreneurial skill. The calculation
for returns to enterprise is especially complicated, but the best estimate comes from
the Australian Bureau of Statistics’ calculation of mixed income from unincorporated
enterprises, which is used in figure 11.5.

Other 11%

Wages and
Transfer payments 12% salary
58%

Rent from
ownership of housing 10%

Business profits and

capital investments 9%

Source: ABS Australian National Accounts: National Income, Expenditure and Product (Cat. no. 5206)

Figure 11.5 – Sources of household income in Australia

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Chapter 11: Distribution of Income and Wealth

• Transfer payments: A significant proportion of household income in Australia is Transfer payments

received by way of social security or social welfare, also known as transfer payments or are payments from the
government to assist
government benefits, as figure 11.5 indicates. Australian statistics measure two types
people with basic costs
of social benefits: social assistance benefits (welfare payments) and social insurance of living. A number of
benefits (such as workers compensation). This is income collected through taxation terms are commonly used
and then transferred from governments to households. Over a third of the total income for transfer payments
tax that is collected is used to pay unemployment and sickness benefits, age and including: social welfare
disability pensions, family allowances and similar social security payments. The effects payments, government
benefits, social security,
of taxation, transfer payments and other assistance on the distribution of income are
income support and
examined in more detail in Section 11.6. Centrelink payments.

Sources of wealth in Australia

Household net worth is used by the Australian Bureau of Statistics to measure private sector
wealth in Australia. Net worth is the extent to which the value of household assets such as
houses and savings (that is, the things they own) exceeds the value of their liabilities such
as loans (that is, the things they owe).
In 2021–22, the average value of household assets was $1.7 million, while the average level
of household liabilities (debts) was $276,462. This gives an average net worth for Australian
households of approximately $1.4 million. Figure 11.6 shows the composition of household
assets in 2019–20.

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

Figure 11.6 – The composition of household wealth

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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11.4 Trends in the distribution of

income and wealth
In recent decades, Australia has experienced a modest increase in overall levels of inequality.
In this section we find that some groups in society are more affected by inequality than
others, depending on their age, qualifications, gender, occupation, ethnic background,
family type and where they live in Australia.

% Distribution of equivalised disposable household income

5
Median
income Mean
4 ($959) income
($1124)

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).

11.7 – Distribution of household income

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.

% Distribution of household net worth

20
18
Median Mean net
16 net worth worth
($579,200) ($1,042,000)
14
12
10
8
6
4
2
0
100
200
300
400
500
600
700
800
900
1000
1200
1200
1400
1600
1800
2000
2200
2400
2600
3000
4000
5000
7000
10,000
>10,000
0

$100,000 increments $’000

Source: ABS Household Income and Income Distribution, Table 5.2 (Cat. no. 6523.0) 2019–20 data, April 2022

Figure 11.8 – Distribution of household net worth

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

236
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.

Age and education

Age groups

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.

Without any post-school qualification

Other
Certificate III/IV
Diploma/Advanced diploma
Bachelor degree
Graduate diploma/Graduate certificate
Postgraduate degree

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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Gender and occupation

Males Females Gender is another important influence on the distribution of income and wealth. Figure
Year
($) ($) 11.11 shows that full-time female workers earn less than males. Progress has been made
1985 400 328 in reducing the gender gap since the ABS began tracking wage relativities four decades
ago, but it has been slow. In 1985, women in full-time jobs were earning 82 per cent of
1990 567 470
male earnings, and in 2022 this had risen to 87 per cent. Even after taking into account
1995 689 576 differences in jobs and working hours, the average weekly earnings of females are still lower
2000 829 695 than those of males. The current state of the gender pay gap is influenced by a variety of
2005 1050 892 factors, including that occupations with a high proportion of female employees are generally
2010 1334 1105
paid lower wages, women still have greater home caring responsibilities than men in many
families, and there are fewer senior roles for employees who choose to work part-time (as
2015 1592 1307
a higher proportion of women do). In addition to these economic factors, women still
2019 1750 1508 experience different forms of direct and indirect discrimination.
2020 1804 1562
This presence of discrimination is confirmed by observing the average earnings of males and
2021 1847 1591 females working full-time in the same industries, presented in figure 11.12. Even after we
2022 1907 1654 have taken occupations into account, on average, female employees earn less than their male
Source: ABS Average Weekly counterparts, even when they have the same qualifications and experience. Women earn on
Earnings, Australia, Table 3A, 3D average $256 per week less than men.
(Cat. no. 6302.0), November 2022

Figure 11.11 – Average

Figure 11.12 shows that the gender pay gap is not exclusive to male-dominated industries.
weekly ordinary time earnings Some of the greatest income discrepancies between males and females occur in industries
(full-time) in which females account for a greater proportion of the workforce, including health and
social services.

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)

Figure 11.12 – Average weekly earnings by gender for a range of industries

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

COULD DIGITAL PLATFORMS EXACERBATE THE GENDER

PAY GAP?

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.

‘‘Digital platform work in Australia and internationally, as demonstrated by empirical

research reported in this review, can both reproduce and exacerbate existing gender
inequalities in work, just as it can create new modes of gender inequality”.

– Queensland University of Technology Centre for Decent Work and Industry,

Gendered Dimensions of Digital Platform Work, September 2021

Ethnic and cultural background

Another factor that plays a role in the distribution of income in a society is the ethnic and
cultural backgrounds of different households. Almost half of the Australian population
has a direct connection to immigration: 30 per cent were born overseas and are therefore
first-generation Australians, and another 19 per cent have at least one parent born overseas,
making them second-generation Australians. Almost 60 per cent of migrant Australians
come from countries that are not mainly English-speaking nations.
Figure 11.13 shows that in the short term, migrants – particularly those from non-English-
speaking countries – tend to have slightly higher rates of unemployment. However, in
the long term, unemployment is around the same level for people born in Australia and
those born overseas. Migrants from English-speaking countries are more likely to be highly
skilled and professionally qualified, which explains their lower rate of unemployment
compared to other recent migrants. Participation rates are higher for skilled migrants.
According to the Australian Government’s 2023 Labour Market for Migrants report, the
labour force participation rate of migrants that have been in Australia for 10–14 years is
approximately 80 per cent – substantially higher than Australia’s population average of
67 per cent.
The Australian Bureau of Statistics first released data on the income status of migrants in
2022. The median annual personal income for migrants in 2019–20 was $45,351, slightly
below the median income of $52,338 for the population as a whole. The Melbourne
Institute’s 2015 HILDA survey found that, on average, English-speaking migrants earned
between $1193 (for males) and $3979 (for females) more than Australian workers, whereas
those from non-English-speaking countries generally earned around $8000 less per year,
and also had significantly less wealth. They also have higher underemployment (around
20 per cent, compared to 12 per cent for migrants from English-speaking backgrounds).

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Australia in the Global Economy 2024

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).

Unemployment rate (%)

1991 2000 2010 2015 2020 2021 2022 2023

Arrived within last 5 years

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

Arrived 5–9 years ago

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

Arrived 20 or more years ago

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.

Figure 11.13 – Unemployment rates by migrant status

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.

COUPLE COUPLE SINGLE SINGLE ALL

FAMILY (no dependent (Dependent PARENT PERSON HOUSEHOLDS
TRUCTURE
children) children)
MEDIAN INCOME
PER WEEK $1148 $1007 $686 $718 $958
MEDIAN $1 150 300
NET WORTH
$699 000 $151 000 $389 100 $579 200

Figure 11.14 – Median income and net worth by family type

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

Figure 11.15 – Mean disposable income per week, Australian states

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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.

NSW Vic Qld SA WA Tas Australia

($) ($) ($) ($) ($) ($) ($)

Mean weekly disposable

1231 1174 1132 1068 1158 1096 1179
income c
apital city area

Mean weekly income

990 979 1036 918 1094 847 1001
outside capital city

Average net worth

1,363,800 1,246,700 833,500 875,500 860,000 982,300 1,124,900
capital city area

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

Figure 11.16 – Income and wealth by state and region

AUSTRALIA: THE LAND OF UNEQUAL OPPORTUNITIES?

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.

Median hourly rate $

32
30
28
26
24
22
20
18
16
14 $29.98 $28.80 $24.93 $23.03
12
10
8
6
4
2
0
University Year 11 or Vocational Year 10 or
Year 12 below
Father’s highest educational qualification

THE RELATIONSHIP BETWEEN INCOME AND WEALTH

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.

11.5 The costs and benefits of

inequality
Inequality has some limited economic benefits but significant social and economic costs.
Some economists argue that inequality is a natural consequence of the free market
functioning effectively, since each individual receives a share of income according to their
marginal productivity. In addition, they contend that inequality has the advantage of
creating and strengthening individuals’ incentives and increasing their share of output.
In other words, people will be encouraged to work harder to gain a larger share in the
distribution of income.
Other economists emphasise the social costs associated with inequality. They argue
that free market capitalism divides society into different classes (for example, working
class, middle class and upper class) and that the system tends to entrench high levels of
inequality and poverty.

Economic costs of inequality

Inequality reduces overall utility
Inequality in the distribution of income reduces the total utility, or satisfaction, in society.
This is because people on higher incomes gain less utility from an increase in income
than people on lower incomes. This is explained by the principle of diminishing marginal
utility: as more of a good is consumed it will provide progressively less utility to the
consumer. This means that an extra $1 of income is worth more to a lower income earner
than to a higher income earner. A more equitable distribution of income would therefore
increase total utility (in other words, create a greater overall level of satisfaction in
society). However, although the concept of utility (similar to the concept of happiness)
is important, it is difficult to measure accurately and consistently.
Inequality can reduce economic growth
Low income earners spend a higher proportion of their income than higher income earners,
since the cost of essentials such as housing and food take a higher proportion of their income.
In economic terms, lower income earners have a higher marginal propensity to consume
(MPC) because they spend more of each additional dollar they earn than higher income
earners. That means that in an economy with a high level of income inequality, there will
be a relatively lower level of consumption and higher level of savings. This in turn would
lead to lower economic activity, employment, investment and living standards.
Research into the consequences of rising inequality in recent decades is providing evidence
that higher levels of inequality tend to lead to lower levels of economic growth. One
study by the OECD estimated that the rise in income inequality in OECD economies
between 1985 and 2005 reduced cumulative growth by 4.7 per cent during the two

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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.”

– International Monetary Fund (2021), IMF Working Paper:

Links Between Growth, Inequality and Poverty: A Survey

Inequality creates conspicuous consumption

Some economists argue that inequality in the distribution of income creates a “leisure
class” consisting of the higher income earners in society. The leisure class puts a large
proportion of their money towards “conspicuous consumption”, which is the consumption
of expensive goods and services, such as yachts, private jets and expensive jewellery. This
can contribute towards a culture where individuals’ sense of their own worth depends on
their access to a particular lifestyle.
Inequality creates poverty and social problems
Inequality in income distribution causes relative poverty. Poverty contributes to the
development of an underclass of low-income earners, which has limited access to
educational opportunities and can suffer health and other disadvantages that may reduce
labour force participation and create a self-perpetuating cycle of disadvantage.
Inequality increases the cost of welfare support
Governments provide safety net income support for people out of work, the aged and
people with disabilities. Higher levels of inequality require increased levels of government
assistance. In addition, economic research suggests that entrenched disadvantage imposes
For more details on research proportionately greater costs on governments as workforce participation declines and
into the economic and social households rely more heavily on government services.
costs of inequality, visit the
website of the Equality Trust,
which collects the leading Social costs of inequality
research on these issues:
www.equalitytrust.co.uk
The two major social costs of inequality are those associated with social-class divisions
and poverty.
Social-class divisions
The distribution of income and wealth creates class distinctions in modern economies, such
as between groups broadly described as upper class, middle class and working class. Class
divisions can result in tensions between people and between different regions, as well as
higher levels of crime and social disorder. Wage disputes between workers and employers,
in which workers try to improve their income level, are a common cause of dispute. These
divisions can sometimes lead to social and economic instability, especially in developing
economies where the gains of rising prosperity are often unequally distributed.
Poverty
Australia does not have high levels of absolute poverty, but it does experience significant
levels of relative poverty. Approximately one in ten Australians are living in poverty at any
one point in time, although for most of them, this experience only lasts for one or two years,
according to the 2022 Household Income and Labour Dynamics (HILDA) survey. Around

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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.

Economic benefits of inequality

Income inequality can create economic incentives which lead to an increase in the
productive capacity of resources and thus an increase in real GDP per capita.
Inequality encourages the labour force to increase education and skill levels
If those with higher qualifications and skills reap higher income rewards, new entrants
and existing participants in the labour force will be encouraged to improve their education
and skill levels. Some level of income inequality may therefore encourage an increase in
the quality of the labour force. However, this assumes that children growing up in poor
households still have the opportunity to access a good education, perform well at school and
afford higher education. If not, an economy is likely to suffer in the longer term from lower
levels of productivity growth.
Inequality encourages the labour force to work longer and harder
The potential to earn higher incomes produces an incentive for workers to work longer
hours or to work overtime, which may enhance economic growth. However, workers will
only be willing to give up leisure in order to work longer hours when they feel the extra
income is more valuable than their leisure time. In addition, if workers are rewarded for
being more productive, this should increase their incentives to build on skills and therefore
improve labour productivity.
Inequality makes the labour force more mobile
Higher incomes can act as an incentive to encourage labour to move to where it is most
needed. A more mobile labour force will lead to a more efficient allocation of resources and
a higher rate of economic growth. This has been an important factor in the past decade as
high earnings in mining jobs attracted workers to remote parts of Australia, such as the
Northern Territory and mining communities on Australia’s north-west coast.
Inequality encourages entrepreneurs to accept risks more readily
The prospect of income rewards accruing to entrepreneurs encourages them to take the
risks associated with new investment and innovation. If entrepreneurs received no extra
reward for risk-taking, there would be fewer entrepreneurs and businesses, a lower rate of
economic growth, weaker investment, less innovation, fewer jobs and a reduced productive
capacity in the economy.
Inequality creates the potential for higher savings and capital formation
There is a strong relationship between income and saving levels. The higher the income an
individual earns, the greater the proportion of income that will be saved; and likewise, the
lower the income, the lower the proportion of savings. In theory, greater income inequality
should encourage increased savings in the economy because of the greater number of higher
income earners. Increased savings should reduce Australia’s reliance upon foreign capital
by providing domestic funds for investment.

Social benefits of inequality

It is difficult to identify significant social benefits of inequality. The potential economic
benefits of inequality – such as higher levels of saving or productivity – could produce

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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.

11.6 Government policies and inequality

Government policies can influence inequality in society in direct and indirect ways. Fiscal
and labour market policies generally have the most direct impact through changing the
levels of government benefits, taxation, and wages and salaries. However, the side effects of
policies pursued for other purposes, such as microeconomic policy, can also affect inequality.
In recent decades governments have adopted a strategy of reducing government intervention
in markets generally, but also taking additional targeted policy steps to reduce economic
and social disadvantage such as through personalised assistance with training and finding
work. During periods of heightened instability, such as the COVID-19 pandemic and the
global financial crisis, major policy interventions have been used to prevent a severe economic
downturn that could sharply increase inequality.
Macroeconomic management and job growth
Since employment is the main source of income for households, unemployment is the main
reason for low incomes and poverty. Periods of unemployment (and underemployment)

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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.

Average annual income ($)

Lowest Second Third Fourth Highest All
Disposable income quintile quintile quintile quintile quintile households
($) ($) ($) ($) ($) ($)
Before tax and social
29,936 68,433 119,926 177,650 365,133 150,547
assistance benefits

After tax and before

28,084 61,036 103,523 147,476 284,761 123,661
social assistance benefits

After tax and social

54,134 86,689 117,495 154,434 288,311 139,064
assistance benefits

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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for reducing inequality are expected to grow further as compulsory superannuation

contributions rise to 12 per cent of employee incomes from 2025–26 onwards.
The Albanese Government has announced several measures to improve the affordability
of housing, which is a key driver of the wealth inequality gap. Housing ownership skews
heavily towards the wealthy, with 80 per cent of investment properties owned by the
top 20 per cent of wealth holders, according to an ACOSS/UNSW 2020 report. The
Government plans to establish a $10 billion Housing Australia Future Fund to build
30,000 social and affordable homes over five years. It also plans to establish a shared-
equity scheme to allow first home buyers to purchase partial ownership of properties, with
a Commonwealth authority buying and owning up to 40 per cent of the home’s equity.
When they sell the property, homeowners will be required to repay the initial investment
as well as sharing any capital gains. The shared equity policy is modelled on schemes in
the UK and Western Australia.
The indirect impact of government policies
The impact of government policies aimed at creating a more equitable distribution of
income can be outweighed by the consequences of other government policies that tend
to widen the gap between higher and lower income earners.
The use of monetary policy to slow the rate of economic growth can influence the
distribution of income and wealth. When interest rates increase, disposable incomes
will be lower for households with large mortgages (because repayments will be higher)
and higher for those whose main source of income is from interest-bearing assets such as
superannuation funds. Sharp increases in interest rates, like those experienced in 2022
and 2023, may also reduce house prices and slightly improve wealth inequality because
wealthier households have more housing assets. These outcomes for inequality are side
effects of a policy that is used for other purposes such as maintaining a low rate of inflation.
Microeconomic reform initiatives sometimes require economic restructuring that can
create unemployment in the short term, or may result in the closure of some industries.
Privatisation of formerly government owned businesses, for example, is often followed by
price increases and “downsizing” of the workforce to improve profitability for shareholders.
In general, microeconomic reform is intended to improve efficiency and increase the
returns on investments to owners of assets. This means that its benefits can tend to flow
to wealthier asset owners, while its costs tend to be felt most by lower income earners.
One of the challenges for governments is to implement microeconomic policies in such a
way that they do not increase inequality. Microeconomic policies are often accompanied
by substantial adjustment packages to compensate for the hardship that lower income
groups may experience as a result of the reforms. For example, when a proposal to
increase Australia’s Goods and Services Tax from 10 to 15 per cent was raised in 2015, its
advocates highlighted the need to provide compensation to ensure that low income earners
would not be disadvantaged. Targeted transitional support to groups directly affected by
microeconomic reforms have proved effective in building greater public support for reform
and minimising the hardships associated with structural change.

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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chapter summary
1 Income inequality refers to the degree to which income is unevenly distributed
in an economy.

2 The Lorenz curve is a graphical representation of the degree of income

inequality in an economy. It plots the cumulative increase in income against the
cumulative increase in population when the population is ranked by income level.

3 The Gini coefficient measures the degree of income inequality in an economy,

by calculating the degree to which the distribution of income deviates from
perfect equality. It is represented by a number between 0 and 1, with a number
closer to 0 representing greater equality and a number closer to 1 representing
a higher level of inequality. Inequality as measured by the Gini coefficient has
increased since the mid-1990s.

4 Like income, wealth is unevenly distributed in the economy. Individuals in the

top quintile own around 60 per cent of the total wealth in the economy while the
bottom quintile has almost no wealth at all.

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.

6 Household wealth is mostly held in either owned occupied or investment property.

Other sources of wealth include superannuation, business ownership, shares,
savings accounts and shares.

7 Inequality for individuals is influenced by a range of factors. An individual’s social

background is a major influence – those who are born in rich families are likely
to stay rich, and those born in poor families are likely to stay poor. Age is a
significant factor because lower incomes are seen among young people and old
people, but incomes are higher in middle age. Other influences include cultural
background, family structures and where someone lives.

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.

9 The benefits of inequality in a society are that inequality creates an incentive

for people to work harder, to acquire new skills, to undertake entrepreneurial risks
and innovate, and to save more in order to be able to start a business. If more
productive workers receive higher incomes, this might increase inequality but
might also increase national wealth.

Government policies have had a mixed impact on the distribution of income

10
and wealth. Progressive income taxation, social welfare payments, government
services and compulsory superannuation have reduced inequality, while
microeconomic and labour market reforms have contributed to rising inequality.

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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:

a) The Lorenz curve (explain using diagrams)

b) The Gini coefficient (explain using numerical examples)

3 Explain the relationship between income inequality and wealth inequality.

4 Examine which groups tend to be adversely affected by inequality according

to occupation, education and ethnic background in Australia.

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.

9 Discuss government policy options to improve the distribution of income

and wealth in Australia.

10 Analyse the impact of the government’s policy mix on income inequality in Australia.

253
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

Australia’s key environmental statistics 12.1 Introduction

Forest area
(thousand sq. km) 1341
Economists have traditionally assumed that there is an almost endless
supply of natural resources to meet demands for production. If demand
Freshwater resources
(per capita cu. m) 19,177 for a good increased, it was assumed that the supply of that good
Critically endangered animals
would also expand. However, in recent decades, economists have
and plants (no. of species) 244 shifted away from this traditional model that ignored environmental
Fossil fuels constraints. As environmental factors such as pollution, rising fuel
(% of total energy use) 92 costs and climate change have increasingly affected people’s lives,
Carbon dioxide emissions
economists have been working to include environmental factors in
(per capita metric tons) 17.8 their economic analysis.
Sources: World Bank 2023; Department of Climate Environmental sustainability is about protecting and enhancing the
Change, Energy, the Environment and Water 2023
natural environment: the totality of the physical environment we live
in, including the land, water, climate and plant and animal life. This
“Climate change, biodiversity loss, worsening includes protecting the quality of air, water and soil, preserving
resource bottlenecks, and life-shortening air
pollution continue to pose great systemic risks
natural environments and biodiversity, ensuring the sustainable use of
to the wellbeing of current and future generations. renewable and non-renewable resources, and minimising the negative
Without stronger action to improve the environmental consequences of economic activity. Some of the key
environmental performance of our economies, environmental sustainability challenges facing Australia include:
the impacts of environmental degradation will
undermine development prospects and the • reducing the emission of greenhouse gases, which contribute
progress in well-being achieved in the past to climate change
50 years.” • ensuring adequate supplies of water for use by households,
– OECD (2023) “What is green growth farmers and businesses
and why do we need it?”
• preserving the health of forests, waterways and ecosystems.
Historically, many aspects of economic activity in Australia have caused environmental
harm. Economic activities – including farming, mining and industry – have resulted in
land degradation, depletion of non-renewable resources, the extinction of many plant
and animal species, and the pollution of water systems. Government policies now seek
to address the impact of economic activity on the environment to improve quality of life
and preserve the natural environment for future generations.

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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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of ecologically sustainable development is the principle of fairness between generations, or

intergenerational equity. This describes the concept that resources should not be used
in a way that will limit the quality of life of future generations.

KEY PRINCIPLES OF ECOLOGICALLY SUSTAINABLE

DEVELOPMENT

• Integrating economic and environmental • Ensuring fairness in the allocating

goals in policies and activities of costs and assets within and
• Ensuring that environmental assets are between generations
appropriately valued • Taking into account the global
• Managing environmental risks with effects of environmental issues
caution

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.

12.3 Market failure: private benefits

and social costs
In a modern market economy, the price mechanism is the key determinant in decisions
about what goods will be produced, in what quantity, and the price at which they will
be sold. The price mechanism involves the interaction of the market forces of supply and
demand to reach an equilibrium price and quantity of production. Thus market outcomes
reflect a balance between consumer preferences (as represented by consumer demand)
and the costs of producing output (as represented by the firms’ supply schedule). When

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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.

Price ($) S (social cost) Price ($)

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

Figure 12.2 – Negative externalities Figure 12.3 – Positive externalities

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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Chapter 12: Environmental Sustainability

12.4 Public and private goods

Having a clean and unpolluted environment is valued by individuals and society and
considered a “good”. Yet private markets do not provide environmental “goods” like other
goods and services. If all of us value a cleaner environment, why aren’t our environmental
problems solved by businesses offering environmental goods and services, and the public
paying for them?
In order to answer this question, we must appreciate the difference between public and
private goods. A clean environment, just like national defence and the maintenance of
public law and order, has the characteristics of a public good.

THE TWO CHARACTERISTICS OF PUBLIC GOODS

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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12.5 Major environmental issues

The task of environmental sustainability appears simple while we discuss it in general
terms. Surely it is just a matter of measuring the social costs of economic activity, then
introducing laws and establishing authorities so that these costs are borne by the producer
or consumer? In reality it is not so simple. Experts often disagree sharply on how to
calculate the environmental costs of economic activity, and on which policies are most
effective in solving environmental problems. Industries resist pressure to change their
practices or to pay the full costs of their environmental impact. Governments must then
decide whose evidence is most convincing and how environmental and economic goals
should be balanced.
Below, we examine four major environmental issues with economic consequences that
governments must confront in economic policy-making.
Preserving natural environments
In the long run, the economy cannot keep growing if the environment is degraded.
Environmental damage also affects human health through higher levels of air and water
pollution, and restricts the availability of resources. Measures to preserve the environment
aim to avoid the social and economic problems that arise when the environment is not
actively preserved.
Preservation of the environment may include measures such as:
THE 2019–20 BUSHFIRES:
• restricting development in environmentally sensitive
BURNING THROUGH AUSTRALIA’S
areas, such as mining in national parks
BIODIVERSITY
• protecting native plant and animal species from extinction
Australia experienced an unprecedented bushfire • controlling the emissions of waste products
season in the summer of 2019–20, with devastating • requiring new plantation in areas where logging has
effects on the environment, as well as communities’
occurred.
economic and social wellbeing. Multiple uncontrolled
fires burnt through over 18 million hectares of land, Awareness of the importance of environmental issues has been
with the loss of many homes and buildings. The slow to develop in Australia and throughout the industrialised
fires also devastated natural habitats and assets. world. Australia protects 20 per cent of its total land area,
This resulted in significant damage to many forest compared with 33 per cent in New Zealand and 28 per cent in the
areas with high biodiversity and threatened species, United Kingdom. Australia also has a poor record of preserving
with the loss of an estimated billion birds, mammals biodiversity despite being one of the six most biodiverse nations
and reptiles due to lost habitats and food sources. on the planet. Australia has identified and named only 30 per
Recovery of these areas will take many years and cent of its estimated 600,000 species. In 2023, 244 flora and
may result in the permanent extinction of species. 107 fauna were considered critically endangered under the 1999
In addition to the effects on biodiversity, the Environment Protection and Biodiversity Conservation Act, a number
fires also generated significant smoke and ash, that increased, partly as a result of the Australian bushfire season
which created hazardous air quality, polluted in 2019–20. Despite government efforts (including a new five-year
environments and affected water quality. These Threatened Species Action Plan), governments have failed to
effects could be seen from outer space, and reverse the growing number of threatened species – primarily due
hazardous air quality occurred in areas as far away
to invasive species and habitat loss from urban development and
as South America. The smoke pollution resulted in
agriculture. The most recent State of the Environment Report
negative health consequences, including increased
respiratory illnesses and it exacerbated existing
assessed Australia’s biodiversity as in a state of decline. While
health conditions. conservation policies have reduced the rate of decline in some
species, there has been insufficient investment to reverse the overall
The loss of natural habitats also affected Australia’s
trend, and further extinctions are expected in coming decades
economic activity, given the destruction of much
agricultural land area and the effects of the bushfires on
without further investment.
Australia’s tourism industry. The World Wildlife Fund
estimated that the bushfires resulted in economic
losses to Australia’s food system of $4–5 billion.

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Governments often face significant problems in trying to preserve

the natural environment: “UNSUSTAINABLE”:
BIODIVERSITY UNDER THREAT
• In the short term, environmental policies may result in a
reduction in economic growth through interventions in The Commonwealth Government manages
the price mechanism that cause higher prices or reduced how industry and governments act to protect
supply. For example, water allocations for irrigation may be Australia’s environment through the Environment
critically important for environmental reasons, but result in Protection and Biodiversity Conservation (EPBC)
lower agricultural output in the short term. Act. This Act aims to conserve biodiversity,
provide environmental protection particularly
• Industries will face higher costs if they have to comply with on matters of national significance, streamline
rigorous environmental standards. Australia may miss out on environmental assessments and approval
opportunities that would lift economic growth and exports if processes, promote ecologically sustainable
our environmental safeguards result in additional production development through sustainable use of natural
costs compared with other countries, although exports may resources, as well as recognise and promote
sometimes become less competitive if Australia’s weaker Indigenous peoples’ knowledge of biodiversity.
environmental standards result in tariffs on our exports, such In 2021, an independent review of the EPBC Act
as with carbon border taxes. Groups that represent affected called for major reforms of Australia’s national
industries, such as farming, mining and construction, may environmental protection legislation.
try to lobby governments to prevent strict environmental The review found that the Act does not clearly
protection policies. define the intended environmental outcomes
• The cost of repairing damage to the environment is often and should instead provide a basis to actively
plan for environmental outcomes and restore
borne by taxpayers rather than by those who have caused
the environment, in line with Australia’s future
the economic damage, such as with the Commonwealth development needs. Despite its intentions to
Government’s $200 million Environment Restoration Fund support how the Commonwealth Government
to manage erosion around waterways, clean up waste and works with State and Territory governments
protect the habitat of threatened species. In some situations, on environmental policy, the Act was found to
the government may try to pass costs on to industry. For be too complex and a barrier to coordinated
example, the NSW Government introduced a Container management of the environment.
Deposit Scheme in 2017, where beverage containers can be The Government accepted the need for
deposited at recycling facilities in exchange for a 10-cent reforms, and affirmed that State governments
refund. This reform aims to reduce littering and increase have primary responsibility in assessing the
recycling in order to protect the natural environment, with environmental impacts of major projects,
the associated scheme costs borne by beverage producers. under new National Environmental Standards.
Although not explicitly recommended in the
Pollution Review, the Government also committed
to establishing a national Environmental
Pollution occurs where the natural environment is degraded in some Protection Agency to support the monitoring
way, such as by harmful chemical substances, noise and untreated and enforcement of environmental standards.
rubbish. Pollution affects the atmosphere, water resources and land.
All sectors of the economy, including manufacturing, agriculture
and households, contribute to the pollution of our environment.
Pollution has been an environmental problem ever since large numbers of people began
living in close proximity in towns and cities. The Industrial Revolution in the 18th
century made pollution into a major health and economic concern through the waste and
pollution generated by production, population growth and the high concentrations of
people in cities. Mining and manufacturing processes create toxic waste and pollution,
and the worst polluted areas in the world are in industrial cities in developing countries,
such as Delhi in India or Baoding in China.
The impact of pollution is often felt far away from its original source – and can therefore
often be characterised as a negative externality. Pollution can therefore be a problem for
the global economy and for international institutions, as well as for national governments.
For example, high levels of industrial pollutants such as toxic metals and plastics are
now found in aquatic life throughout all the world’s oceans, even in places thousands of
kilometres from any land mass.

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Within individual countries, governments can implement policies to reduce pollution.

The range of options available to the government includes laws banning environmentally
damaging production techniques, quotas to restrict the emission of harmful pollutants,
subsidies to encourage environmentally friendly practices and taxes to discourage some
forms of economic activity.

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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Chapter 12: Environmental Sustainability

Global impact Domestic impact

• 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

Sources: IPCC and the Garnaut Climate Change Review

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.

The depletion of natural resources

The depletion of natural resources is both an environmental and an economic problem.
On their own, market mechanisms do not prevent the overuse of resources. The impact of
the depletion of natural resources is greatest on future generations. Sustainable resource
management aims to ensure that the present generation does not overconsume the
stocks of renewable resources and minimises depletion of non-renewable resources. New
technology may also make alternative resource uses possible. In order to determine what
level of resource use is sustainable, economists can estimate the optimal rate for the use of
resources over time. An optimal rate of resource use may be calculated for both renewable
and non-renewable resources.
For renewable resources, establishing an optimal rate of use means arriving at a threshold
exploitation level that allows the resources to regenerate so that there is no long-term decline
in these resources. For example, over-fishing, over-grazing, excessive farming of agricultural
land and the over-exploitation of timber resources must be prevented if these resources are
to be available in sufficient quantities for future generations. The critical water shortages
experienced in many parts of Australia, in particular in areas relying on the Murray–Darling
River System, reflect the long-term overuse of the renewable resource of fresh water.

• Renewable resources: Renewable resources can naturally regenerate or replace

themselves in a relatively short period of time. However, these resources may
be depleted to the point where they become non-renewable (that is, they cannot
regenerate) and they are lost forever. For example, overfishing of a species of fish
may cause the numbers to fall to a level at which the species cannot reproduce and
may become extinct.
• Non-renewable resources: Non-renewable resources are those natural resources
that are in limited supply because they can only be replenished over a long period
of time, or cannot be replenished at all. Non-renewable resources include fossil fuels
such as petroleum and coal, and minerals such as copper and iron ore.

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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.

AUSTRALIA’S RESOURCES: PAST, PRESENT AND FUTURE

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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Chapter 12: Environmental Sustainability

12.6 Government policies and

environmental sustainability
In recent decades, environmental sustainability has emerged as an increasingly important
issue for policymakers worldwide. The increasing impact of climate change has made
policymakers more aware that environmental protection, instead of being in competition
Details of Commonwealth
with economic growth, is in fact critical for sustaining growth in the longer term. This environmental policies
section outlines some key policies for environmental management, which are examined relating to climate change,
in more detail in chapter 16. conservation, water quality
and land management are
Government policies can influence environmental management by discouraging available from the website
environmentally harmful activities and providing incentives for firms and individuals to of the Department of
act in an environmentally responsible manner. Climate Change, Energy,
the Environment and Water.
A ban on the production or sale of a particular good or service is the most extreme action Policies specific to NSW and
a government can take to achieve improved environmental management. For example, Sydney are available from
since 2021 it has been illegal to sell or use agricultural chemicals containing mercury in the websites of the NSW
Australia. Until 2021, sugar cane and other farmers were permitted to use a fungicide Department of Planning and
called shirtan, despite its ban in many other countries. The ban on shirtan prevents the Environment and the NSW
Environment Protection
release of over 5000 kg of mercury (a harmful poison) into the environment annually.
Authority.
Banning a product eliminates the externalities associated with its production and use, to
the extent that its use can be stopped. Government bans can also impose severe costs on
firms and individuals, particularly those whose employment depends on the production of
the product. Consequently, governments generally only consider this option if a particular
product is causing severe environmental or social damage, or where a suitable substitute
product exists. For example, in 2021, the NSW Government introduced legislation to
ban plastic bags, straws, cotton buds and polystyrene cups – which all have substitute
products and are particularly harmful where they end up as litter in the ocean, harming sea
life. In 2023, progress was made on the UN Treaty on Plastic Pollution. The agreement,
expected by 2024, aims to reduce plastic pollution by addressing the production, design
and disposal of plastic.
Bans may also be used to prevent consumption or other activities that may harm the
environment. For example, the Chinese Government recently banned imports of mixed
recycled materials from other countries, to protect China’s environment and improve
public health. This ban had major flow-on effects for the Australian recycling industry,
as around 30 per cent of Australia’s recyclable waste was exported to China. The ban
has caused an oversupply of recyclable waste that has led to the dumping of recyclable
materials in landfill.
Another measure governments can take to cover the economic costs associated with the
consumption of a good is to impose a tax on its production or use. For example, the
Commonwealth Government imposes a tax or excise on fuels such as petrol. These taxes
aim to internalise the externalities associated with a particular economic activity. That is,
they require the firm or individual that causes the externality to pay for some, or all, of
its costs. For example, the tax on petrol forces the owners of motor vehicles to pay some
of the costs associated with building and maintaining roads and managing traffic.
Governments can also introduce policies to encourage firms and individuals to use more
environmentally-friendly goods and services. All Australian cities have subsidised public
transport services such as buses, trains and ferries to offer individuals an alternative to
motor vehicles. Government funding is also used to accelerate the introduction of new
technologies that have environmental benefits but high establishment costs. For example,
the Australian Government invested $500 million in the Powering Australia Technology
Fund to help businesses develop innovative projects and technologies to reduce emissions.

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In the case of public goods, however, even government subsidies may

TOWARDS NET ZERO lead to an under-provision of resources. In this case, the government
may have to provide these services itself. For example, the
Market-based mechanisms are one tool being Australian Government operated a Threatened Species Recovery
used by the government to help Australia
Hub during the 2010s to support research on threatened species in
achieve its commitment to net-zero emissions
Australia and help fight the extinction of at-risk plants and animals
by 2050.
– which might not be viable as a privately funded venture.
A key strategy for achieving emissions
reductions is the Safeguard Mechanism which Governments also seek to monitor and measure changes in the
was reformed in July 2023. While the environment over time. For example, the Commonwealth Government
mechanism has been in place since 2016, publishes the State of the Environment report, which documents changes
the 2023 reforms include stricter limits in key areas of Australia’s environment over a five-year period,
on emissions and stronger incentives for including the atmosphere, biodiversity, coasts, marine environment,
businesses to reduce emissions. inland water, land, heritage, Antarctic environment and built
Each year until 2030, around 215 of Australia’s environment. The 2021 report found that each of these aspects of
largest industrial emitters will need to cut Australia’s environment are under increasing pressure or deteriorating,
emissions by an average of 4.9 per cent a and that government action has been insufficient to reverse these
year. If a business exceeds its emissions cap, trends. The Australian Bureau of Statistics has also started recording
it can purchase carbon credits to reduce its the Australian Environmental–Economic Accounts, which measures
net emissions. Australia’s stock of environmental assets as an addition to the typical
Government-held carbon credits will be made measures of assets within the economy. This will be built upon in
available at a capped price of $75 per tonne of future, with the 2023–24 Budget including over $50 million to
emissions, with the capped price increasing by establish Environment Information Australia, an independent office
inflation plus 2 per cent each year. This carbon to provide a central authoritative source of environmental information.
price is a market-based mechanism which The availability of better quality data provides governments with
creates an incentive for businesses to innovate
better information about the trade-offs involved in decision making
and develop lower-cost ways to reduce their
to support and manage economic and environmental outcomes,
emissions.
particularly where there may be adverse economic or environmental
consequences.
Overall, governments have shifted away from outright bans and directly providing public
goods to using market mechanisms such as taxes and subsidies. However, there are
exceptions, such as the expansion of Australia’s renewable energy Snowy Hydro Scheme,
which is jointly owned by the Commonwealth, NSW and Victorian Governments. When
it comes into operation, expected in 2028, it will expand its generation capacity by 50 per
cent, providing power for an additional 500,000 homes.
Just as most environmental problems take years or even decades to emerge, most solutions
to those problems also take many years to have their impact. This is a reason why
governments often delay acting on environmental problems: they are often less urgent
than other issues, and the results of policy actions are often less immediate.

“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 12: Environmental Sustainability

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.

2 cologically sustainable development (ESD) is the concept of maintaining a

E
level and quality of economic growth that does not result in long-term damage to
the environment or depletion of limited resources.

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.

4 The two characteristics of public goods are non-excludability and

non-rivalry. A good is non-excludable where it is not possible to exclude
individuals from enjoying the benefits of these goods once they are provided,
even if they have not paid for them. A good is non-rival where an individual’s
enjoyment of a good does not reduce the ability of others to enjoy that good.

5 A major goal of environmental protection is to preserve the natural

environment, by controlling development, limiting pollution, restraining the
use of non-renewable resources and minimising any other negative effects of
economic activity.

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.

Climate change is the increase in global temperatures and impacts on sea

7
levels and weather patterns, believed to be caused by the emission of greenhouse
gases such as carbon dioxide. Its long-term consequences are the most serious
environmental threat to the global economy.

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.

9 The sustainable use of resources is particularly important in Australia because of

the significance of agriculture and mining to Australia’s export base.

10 Government policies to address environmental problems include bans or taxes on

environmentally-damaging goods and services, and subsidies for, or provision of,
environmentally-friendly goods and services.

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Australia in the Global Economy 2024

chapter review
1 Describe what is meant by the term natural environment.

2 Discuss why environmental sustainability is often in conflict with other

economic objectives.

3 Explain what is meant by the term ecologically sustainable development.

4 Outline how market failure occurs in the management of the natural environment.

5 Explain what is meant by an externality. Give an example of an externality.

6 Describe what is meant by a public good.

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.

9 Distinguish between renewable and non-renewable resources.

10 Examine what initiatives the government can undertake to preserve the

natural environment.

268
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
Australia in the Global Economy 2024

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.

13.2 The objectives of economic

management
Economic growth and wellbeing
Economic growth involves an increase in the volume of goods and services that an
economy produces. It is measured by the annual rate of change in real GDP, that is,
the percentage increase in the value of goods and services produced in an economy over a
period of one year, adjusted for the rate of inflation. Quality of life refers to
Economic growth offers substantial benefits to a nation, including: the overall wellbeing
of individuals within
• an increased standard of living for the population
a country according
• improved job prospects for the labour force to their material living
• the opportunity for increased public investment in infrastructure and services standards and a range
such as education funded through higher government tax revenues. of other indicators, such
as education levels,
Economic growth also contributes to the general wellbeing of households, or quality of environmental quality and
life, because it means there are more resources available for important contributors to quality health standards.
of life, such as health care, education and programs to support the natural environment.

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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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Chapter 13: The Objectives of Economic Policy

• 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.

An equitable distribution of income and wealth

An overall objective of government policy is to create a fairer distribution of income
and wealth in the economy. Governments generally accept that when free markets
operate without government intervention, they will produce unfair outcomes because some
individuals and some groups in society have fewer opportunities than others.
While governments do not aim to remove all of the inequalities between individuals, it is
widely agreed that societies should make provision for the needs of people who are not able
to provide for themselves – such as aged persons, people with disabilities or illnesses, and
people who are unable to find work. Government policies also generally aim to reduce some
of the gap between higher and lower income earners through redistribution policies – such
as higher tax rates for high income earners, and social security payments for lower income
earners, especially those with families to look after. To address the problem of poverty
or social disadvantage passing from one generation to the next, government policies also
aim to improve opportunities for all Australians to achieve their potential through access
to education and other opportunities. Specific policies such as these are often needed to
address specific areas of inequality, alongside macroeconomic policies to increase economic
growth, keep inflation low and reduce unemployment.

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?

13.3 The goals of government policy

in 2024
Although the broad objectives of economic policy remain largely the same from one year
to the next, over time some objectives become higher priorities while other goals become
less important. Changing economic conditions influence which goals receive the highest
priority at different times. The election of a new government or Prime Minister, as occurred
in 2022, can sometimes lead to significant changes in economic priorities. This section
examines the current objectives of economic policy in Australia.

Containing inflationary pressures

After three decades of low inflation, price pressures re-emerged as the Australian economy
recovered from the COVID-19 recession. This makes containing inflation the highest
short-term priority of economic policy. As inflation surged to 6 per cent in 2022–23,
the Reserve Bank implemented the most aggressive tightening cycle since the Reserve
Bank was granted formal independence. While monetary policy plays the central role in
achieving the goal of low inflation, fiscal policy also plays a role. The 2023–24 Budget
included measures to contribute to lower inflation by reducing energy costs for households,
although some economists argued that this positive effect would be outweighed by some
of the cost-of-living measures, including an increase in JobSeeker payments, adding to
domestic demand.

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.

Transition towards “net zero” emissions

One of the major economic challenges confronting all economies is to accelerate their
transition away from relying on fossil fuels, which are chiefly responsible for climate
change. Australia is a large emitter of greenhouse gases on a per-capita basis, and policy
settings relating to emission reductions have been uncertain and constantly changing over
the past two decades. Concern about climate change was a significant factor in the election
of the Labor Government in 2022. After it came to office, the Government legislated
a commitment to reduce carbon emissions by 43 per cent on 2005 levels by 2030 and
achieve “net zero” emissions by 2050. The process of transforming Australia’s economy in

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Chapter 13: The Objectives of Economic Policy

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.

Maintaining low unemployment

Australia has sustained low rates of unemployment in recent years. Unemployment fell to
a low of 3.4 per cent in October 2022, its lowest level in almost 50 years, reflecting both
the strength of Australia’s post-COVID recovery and ongoing restrictions to migration
which, in the short term, led to shortages of workers becoming a larger challenge than
shortages of jobs. Governments implement a wide range of policies to improve skills,
increase workforce participation and ensure that the labour market operates efficiently.
Government policy in 2024 is focused on preventing high levels of inflation becoming
entrenched, which in the longer term would threaten the goal of sustainable economic
growth and low unemployment.

Increasing Australia’s productivity and sustainable rate of long-term growth

A major focus of the policy mix over the past four decades has been to implement
structural changes that will support a higher rate of long-term economic growth (which
has fallen since the 1990s). This requires measures to improve productivity growth,
increase workforce participation and address capacity constraints in the economy (related
to inadequate infrastructure and shortages of skilled workers). Higher productivity
growth has become a high priority because Australia’s ageing population is likely to
reduce Australia’s labour force participation rate in coming years, threatening to reduce
Australia’s sustainable rate of economic growth. The Productivity Commission’s 2023
Advancing Prosperity report identified that productivity in the services sector, which makes
up 80 per cent of the economy and 90 per cent of the workforce, has lagged behind
global counterparts. The Productivity Commission identified the need for policy changes
to support education, skilled migration and the labour market to boost productivity.
Improved productivity is also a key objective for state and federal government investment
in physical infrastructure projects including roads, public transport, water and ports.
Some of the Government’s policies aimed at boosting the country’s productive capacity
include fee-free TAFE courses, cheaper and more accessible child care, and investing in
infrastructure such as the National Broadband Network and the digital economy.
Improving distribution of income and wealth
Improving the distribution of income and wealth has been a long-term objective of policy
that influenced several policy changes in the past decade. These include education funding
reforms (to assist disadvantaged schools), welfare changes (such as increases in the age
pension) and the National Disability Insurance Scheme, which reduces out-of-pocket
expenses for people with significant disabilities.
Protecting vulnerable groups was a major consideration in the design of policies responding
to the economic downturn caused by COVID-19. Besides the JobKeeper wage subsidy
program, the Government also temporarily doubled the unemployment benefit and made
it easier to access. More recent policy measures by the Government to reduce inequality
included increasing wages for low-income earners (through an increase in the minimum
wage), extending Parenting Payment (Single) to parents with children up to 14 years
(previously 8 years), increasing investment in social housing and introducing new health,
education and employment programs to assist with the goal of Closing the Gap between
Indigenous and non-Indigenous Australians.

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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.

13.4 Conflicts in government policy

objectives
Governments face significant conflicts in seeking to achieve the goals of economic growth,
low inflation, low unemployment, environmental sustainability and external balance
simultaneously. In attempting to achieve one goal, the government may limit its ability
of achieving another. There are three major conflicts between the government’s economic
objectives:

1. Achieving a simultaneous reduction in unemployment and inflation

It is often argued that the government faces a trade-off between lower unemployment
and inflation in the short to medium term. Stronger aggregate demand creates jobs
and reduces unemployment, but is also likely to put upward pressure on prices.
Weaker aggregate demand forces businesses to restrain price rises, but also tends to
increase unemployment. The Phillips curve, shown in figure 13.1, shows this inverse
relationship between inflation and unem­ ploy­
ment, highlighting the
Inflation (%) trade-off that governments face when making policy decisions. However,
this relationship is not necessarily symmetrical. A 2021 Reserve Bank
research paper found strong evidence that the Phillips curve was actually
flatter at higher levels of unemployment. That is, when unemployment
is high, wages growth (and therefore prices) is largely unresponsive to
changes in unemployment. However, wages growth becomes increasingly
responsive to unemployment when it is at lower levels.
Australia’s economic policymakers faced a Phillips curve trade-off between
inflation and unemployment objectives in 2023. In a speech in June 2023,
Michele Bullock, the (then) Deputy Governor of the RBA, said that the
0
Unemployment (%) unemployment rate would need to rise from 3.6 per cent to 4.5 per cent
to help bring inflation down to the bank’s target range of 2 to 3 per cent.
Figure 13.1 – The Phillips curve
2. Achieving economic growth and environmental sustainability
Appendix B: Advanced
Economic Analysis at The pursuit of greater economic growth can come at the cost of environmental damage.
the back of this textbook Approving new developments or land clearing in environmentally sensitive areas for
looks at the Long Run housing or agriculture can reduce forestation, disrupt habitats and endanger species of
Phillips Curve – a more
floral and fauna. Land and water resources can be degraded by excessive or inappropriate
sophisticated analysis of
the relationship between farming practices. Greater economic activity can cause pollution and an increase in waste.
unemployment and The goal of reducing carbon emissions has become more central to policy making all
inflation. across the world in recent years, because of the importance of reducing carbon emissions
to long-term economic growth. While Australia continues to face many conflicts between
economic and environmental objectives, in the longer term, achieving economic and
environment objectives can (and must) be done simultaneously. For example, recent
economic research has found that acting on climate change early has the potential to lift
GDP growth and create new jobs in clean energy industries.

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Chapter 13: The Objectives of Economic Policy

3. Achieving economic growth and external balance

The government also faces the challenge of managing conflicts between economic growth The balance of payments
and external balance. Strong economic growth often results in a deterioration in the current constraint reflects the
account on the balance of payments. Higher economic growth is usually associated with extent to which a high
increased consumption and investment, which will cause the volume of imports to rise. current account deficit
This is known as the balance of payments constraint, which refers to the limitation on limits the speed at which
the economy can grow.
the rate of growth because of the impact of high growth on the current account deficit.

AUSTRALIA’S FIRST WELLBEING BUDGET

Treasurer Jim Chalmers announced a significant expansion policy outcomes by guiding policymakers to consider
of economic policy goals in July 2023 when he introduced the interaction between economic goals and broader
a new framework for measuring economic and social measures of prosperity and sustainability.
wellbeing. Traditionally, the Australian Treasury’s reporting
The Government plans to update the framework’s online
on the economy has focused on measures such as growth,
dashboard of indicators annually, though a decision is yet
inflation and unemployment. The new framework, set out in
to be made on how often a reporting statement will be
the Measuring What Matters paper, identifies 50 indicators
released. While some economists questioned whether the
that provide a broader measure of prosperity.
reporting framework would lead to actual policy changes,
Of these 50 indicators: it reflects the way in which governments increasingly see
• 20 show trend improvement over time, including life traditional economic objectives as a means to an end, and
expectancy, experience of discrimination, trust in other not just as ends in themselves.
people, and waste generated per person.
“The measures are in addition to, not instead of, the
• 12 show a trend deterioration, including biological more traditional ways we measure our economy like GDP,
diversity, productivity growth, homelessness and trust employment, inflation and wages.
in national government. The Government’s primary focus is addressing inflation
• The remaining 18 show mixed outcomes or are largely and laying the foundations for future growth but it is
important that we simultaneously work on better aligning
unchanged, such as life satisfaction, the proportion
our economic and social goals … Measuring What Matters
of people experiencing high or very high levels of is part of a deliberate effort to put people and progress,
psychological distress, and income and wealth inequality. fairness and opportunity at the very core of our thinking
about our economy and our society, now and into the
The development of a wellbeing framework in Australia future.”
follows in the footsteps of Scotland, Wales, Canada, New
– Dr Jim Chalmers, Treasurer, July 21 2023 (media release)
Zealand and Germany. These frameworks can influence

Other conflicts in objectives

The pursuit of economic growth can sometimes come at the cost of greater inequality in
income distribution. Economic reforms may have negative social effects, such as relying
on road tolls and other user-pays charges for public services, which can have negative
distributional consequences for people on lower incomes. Decentralisation and deregulation
of the labour market may have positive impacts on labour productivity and economic growth,
but also increase wage dispersion and contribute to inequality. While growth and inequality
are often viewed as conflicting objectives that governments must choose between, economists
have recently developed “inclusive growth” principles, which suggest that sharing economic
gains more evenly actually helps the economy grow. Giving children in poverty greater
educational opportunities has positive social outcomes and improves the labour market in
the future. Increasing female representation in business leadership positions is associated
with higher levels of firm productivity. Achieving a more equitable distribution of income
and wealth is a long-term challenge for government policy.
The government also experiences a range of other policy conflicts between shorter-term and
longer-term objectives. The conflicts between short- and long-term objectives result from
the fact that the policies aimed at long-term goals often involve significant structural change
and substantial costs in the shorter term, such as an increased level of unemployment or

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Australia in the Global Economy 2024

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.

13.5 The economic policy mix

Economic policy mix Governments have a variety of policy instruments that can be used to achieve their
refers to the combination objectives. In a general sense, the instruments of economic policy are divided between
of macroeconomic (fiscal macroeconomic and microeconomic policies.
and monetary) and
microeconomic policies • Macroeconomic policies, such as government budgets and changes in the level
used by the government of interest rates, have an impact on the overall level of economic activity. These
to achieve its economic policies tend to influence the level of aggregate demand in the economy.
objectives.
• Microeconomic policies involve specific measures to improve the operation
of firms, industries and markets, by achieving change at the level of individual
firms and industries. These policies tend to influence the aggregate supply of the
economy – that is, improving productivity and efficiency so that the overall level
of supply may be increased.
Governments normally use a combination of macro and micro policies
Output
in order to best achieve their economic objectives. This combination of
policies is called the economic policy mix, a term which is intended
to capture the overall impact of the range of macro and micro policy
measures implemented. The 2023 review of the Reserve Bank of Australia
recommended that the RBA and Treasury establish a research program to
Boom Recession investigate the optimal policy mix between monetary and fiscal instruments.

Economic growth trend Macroeconomic policy

The main role of macroeconomic policy is to manage the business cycle
(changes in the level of economic activity). The level of economic activity is
Time never constant. Economies are subject to the ups and downs of the business
cycle, caused by changes in the level of aggregate supply and demand. This
Figure 13.2 – The business cycle
is shown in figure 13.2.

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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Chapter 13: The Objectives of Economic Policy

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.

2 Economic growth involves an increase in the volume of goods and services

produced in an economy over a given time period, measured by the rate of
change in real GDP. Growth is generally considered to be the highest priority of
economic management because of its relationship to improved living standards.

3 An economy is considered to be at full employment (or the non-accelerating

inflation rate of unemployment) when cyclical unemployment is eliminated.

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.

6 The Government’s shorter-term economic priorities in 2024 are to contain

inflationary pressures while keeping unemployment low and foster sustainable
economic growth.

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.

Conflicts exist among the objectives of economic management, such as

8
between keeping inflation low and achieving full employment, and between
achieving faster economic growth and promoting environmental sustainability.

Macroeconomic policies, such as fiscal and monetary policies, attempt to

9
reduce fluctuations in the business cycle by influencing the level of aggregate
demand.

10 Microeconomic policies are aimed at promoting structural change by

influencing the supply side of the economy. By improving productivity and
workforce participation, microeconomic policies aim to raise Australia’s
sustainable rate of growth over time.

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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.

2 Discuss how the Australian Government’s economic growth objectives have

changed in recent years.

3 Distinguish between internal balance and external balance.

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.

6 Examine how the objectives of reducing inequality in the distribution of income

and wealth and improving environmental sustainability objectives are related to
the objective of increasing economic growth.

7 Discuss the current priorities of economic management.

8 Explain why the goals of low inflation and low unemployment are considered to
be conflicting aims of economic management.

9 Distinguish between macroeconomic and microeconomic policy, with reference to

the concepts of aggregate demand and aggregate supply.

10 Explain how the concept of sustainable economic growth represents a balance

between the government’s conflicting policy goals.

281
14 14.1
Fiscal Policy

The meaning of fiscal policy

14.2 Budget outcomes
14.3 Changes in budget outcomes
14.4 Methods of financing a deficit
14.5 The current stance of fiscal policy
14.6 The impact of recent fiscal policy

14.1 The meaning of fiscal policy

Fiscal policy is a Fiscal policy is at the heart of the management of the economy. Although it generally
macroeconomic policy plays a less important role than monetary policy in influencing economic growth, fiscal
that can influence policy can influence the overall level of economic activity and have a targeted impact on
resource allocation,
redistribute income and
specific sectors of the economy such as individual industries or parts of society.
reduce the fluctuations Fiscal policy involves the use of the Commonwealth Government’s Budget in order to
of the business cycle.
achieve the government’s economic objectives. By varying the amount of government
Its instruments include
government spending and
spending and revenue, the government can alter the level of economic activity, which in
taxation and the budget turn will influence economic growth, inflation, unemployment and the external indicators
outcome. in the economy.
Further, changes in government spending and revenue collection can also lead to a
reallocation of resources, which changes the pattern of production in the economy, as
well as redistributing income within the community.
The Budget is the tool of The Budget is the annual statement from the Australian Government of its income and
the government for expenditure plans for the next financial year. It is normally released in May. The Budget
the exercise of fiscal includes all forms of revenue received by the Government, including both taxation and
policy. It shows the
government’s planned
other revenue:
expenditure and revenue • direct tax (personal income tax and company tax)
for the next financial year.
• indirect tax (such as customs and excise duties and the Goods and Services Tax)
• other revenues (such as dividends from public trading enterprises).
The other side of the Budget is government expenditure. The major items of expenditure
in the Budget are social welfare, health, education, general public services and defence.
In some years, governments make major policy changes in response to changing
economic or political conditions. Although most policy changes are announced in the
Budget, governments also usually make a series of smaller policy changes at other times.
Governments attract more public attention (and therefore political advantages) when the
spread out “good news” announcements such as new spending programs over a period of
weeks or months before the Budget. On the other hand, “bad news” announcements such
as tax increases or spending cuts will often be bunched together in the Budget.

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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.

14.2 Budget outcomes

Besides the individual instruments of spending and revenue collection, the overall outcome
of the Budget – known as the budget outcome – is itself an important feature of fiscal
policy. The budget outcome gives an indication of the overall impact of fiscal policy on
the economy.
There are three possible budget outcomes: a surplus, a deficit, or a balanced budget.
• Budget surplus – A positive balance that occurs when the Commonwealth
Government anticipates that total government revenue (T) will exceed total
expenditure (G) – that is, T > G.
• Budget deficit – A negative balance that occurs when total government expenditure
exceeds total revenue – that is, G > T.
• Balanced budget – A zero balance that occurs when total government expenditure
is equal to total revenue – that is, G = T.
The Government’s main fiscal policy aim is to achieve budget surpluses, on average, over
the course of the economic cycle. The Government’s progress towards that goal is reflected
in the four-year projections for budget outcomes that are provided in the Budget and other
fiscal documents. In addition, since 2013–14 the Treasury has published a 10-year
medium-term budget projection.

MEASURING THE BUDGET OUTCOME

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

1989–90 98.6 92.7 5.9 1.5 n.a. n.a. n.a. n.a.

1994–95 113.5 127.6 −14.2 −2.9 n.a. n.a. n.a. n.a.
1999–00 166.2 153.2 13.0 2.0 11.7 1.8 11.6 1.7
2004–05 236.0 222.4 13.6 1.5 12.2 1.3 13.3 1.4
2009–10 284.7 336.9 −54.5 −4.2 −53.9 −4.1 −47.4 −3.7
2014–15 378.3 412.1 −37.9 −2.3 −40.8 −2.5 −38.1 −2.3
2015–16 386.9 423.3 −39.6 −2.4 −37.5 −2.3 −33.6 −2.0
2016–17 409.9 439.4 −33.2 −1.9 −35.0 −2.0 −32.1 −1.8
2017–18 446.9 452.7 −10.1 −0.6 −6.5 −0.4 −5.2 −0.3
2018–19 485.3 478.1 −0.7 0 1.4 0.1 7.5 0.4
2019–20 469.4 549.6 −85.3 −4.3 −95.8 −4.8 −91.8 −4.6
2020–21 519.9 654.1 −134.2 −6.5 −136.1 −6.6 −128.9 −6.2
2021–22 584.4 616.3 −32.0 −1.4 −35.1 −1.5 −26.6 −1.2
2022–23* 635.6 631.4 4.2 0.2 −1.5 −0.1 9.0 0.4
2023–24* 668.1 682.1 −13.9 −0.5 −14.1 −0.5 −3.7 −0.1
2024–25* 671.2 706.3 −35.1 −1.3 −45.3 −1.7 −38.0 −1.4
2025–26* 700.9 737.5 −36.6 −1.3 −35.0 −1.3 −29.6 −1.1
2026–27* 735.1 763.6 −28.5 −1.0 −32.8 −1.1 −23.5 −0.8
Source: 2023–24 Budget Paper 1, Statement 11, Tables 1 and 6; *Estimate

Figure 14.1 – Recent Commonwealth Budget outcomes

• 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.

14.3 Changes in budget outcomes

Each year, the levels of government spending and revenue collection, and thus the
budget outcome, change. This reflects the impact of two key factors: changing economic
conditions (known as cyclical or non-discretionary changes) and changes in government
policy (known as structural or discretionary factors).
• Discretionary changes in fiscal policy. Discretionary changes involve deliberate
changes to fiscal policy, such as reduced spending or changing taxation rates. If the
government deliberately increased expenditure in order to stimulate demand, this
would be an example of discretionary fiscal policy. Discretionary changes influence
the structural component of the budget outcome.
• Non-discretionary changes in fiscal policy. The final budget outcome can be
influenced by factors other than planned (discretionary) changes to government
revenue and expenditure. These non-discretionary changes are caused by changes
in the level of economic activity. When an economy is in recession, the budget
deficit will increase, whereas during a period of strong economic growth the deficit
will contract or the budget will shift into surplus. Non-discretionary changes
influence the cyclical component of the budget outcome.
Budgetary changes that are influenced by the level of economic growth are also known
as automatic stabilisers. Automatic stabilisers can be defined as those changes in the Automatic stabilisers are
level of government revenue and expenditure that occur as a result of changes in the level policy instruments in the
of economic activity. They are referred to as “automatic” because they are built into the government’s budget that
counterbalance economic
Budget, and they are activated by a change in the level of economic activity, not by a activity. In a boom period,
deliberate change in government policy relating to either revenue or expenditure. they decrease economic
There are two main automatic stabilisers: activity, and, in a
recession, they increase
• Unemployment benefits. When the economy moves into recession, the level economic activity. The
of economic activity falls, causing a rise in unemployment. An increase in most common examples
unemployment leads to greater government expenditure on unemployment are transfer payments and
a progressive tax system.
benefits. Thus, a decline in the level of economic activity automatically leads to
an increase in government expenditure. On the other hand, an increase in the
level of economic activity would have the opposite effect – causing a decrease in
unemployment and less government expenditure on unemployment benefits.
• The progressive income tax system. Progressive income tax means that people
on higher incomes pay proportionately more tax than those on lower incomes.
During an economic boom, employment opportunities are increasing and incomes Counter-cyclical policies
are rising. Rising incomes move workers into higher income tax brackets, and are economic policies
previously unemployed persons start paying income tax. Both situations lead to an designed to smooth
increase in government taxation revenue. On the other hand, a decrease in the level fluctuations in the business
cycle. Macroeconomic
of economic activity would lead to a decrease in taxation revenue.
policies such as fiscal
Automatic stabilisers are built into the Budget with a counter-cyclical role. When policy and monetary
economic growth is high, demand is automatically slowed through higher tax revenues policy are usually used as
and reduced government expenditure. On the other hand, when the economy moves into counter-cyclical policies.

recession, it is given a boost by increased government expenditure through unemployment

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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.

Impact on economic activity

The most significant short-term impact of fiscal policy is how it affects economic activity.
The budget stance (not to be confused with the budget outcome) refers to the impact
of fiscal policy on economic growth and can be described as expansionary, contractionary
or neutral:
• An expansionary stance is one in which the government is planning to increase the
level of economic activity in an economy. This can occur through either a reduction
in taxation revenue and/or an increase in government expenditure, creating either
a smaller surplus, or a larger deficit than in the previous year. Expansionary fiscal
policy leads to a multiplied increase in consumption and investment and stimulates
aggregate demand, which will increase the level of economic activity.
• A contractionary stance is one in which the government is planning to decrease the
level of economic activity in an economy. This can occur through either an increase
in taxation revenue and/or a decrease in government expenditure, creating either a
smaller deficit or a bigger surplus than in the previous year. Contractionary fiscal
policy leads to a multiplied decrease in consumption and investment, dampening
aggregate demand, which will decrease economic activity.
• A neutral fiscal policy stance occurs when the government plans to maintain the
gap between revenue and spending at around the same level as the previous year. A
neutral fiscal policy should have no effect on the overall level of economic activity.

Impact on resource use

Fiscal policy changes can influence the allocation of resources in the economy directly or
indirectly. Fiscal policy may directly affect resource use through government spending in
a particular area of the economy, such as transport infrastructure (for example, the Western
Sydney Airport construction) to help boost tourism growth. The indirect influence of fiscal
policy covers tax and spending decisions that make it more or less attractive for resources to
be used in a particular way – for example, removing taxes from ethanol production might
encourage farmers to use more of their wheat, sugar and other crops to produce ethanol.
Governments are more likely to use direct measures to provide goods or services if they
expect that markets will not provide the resources quickly enough without government
intervention. For example, in an emergency situation such as a natural disaster or a
pandemic, governments will usually step in and direct relief operations so that emergency
resources are made available to the people most directly affected. Similarly, the government
A public good is an might pay directly to provide public goods, because it is unlikely that the private sector
item that private firms will produce such goods, and it is difficult to prevent anyone else from enjoying the benefit
are unwilling to provide of those goods. Examples of public goods include lighthouses, street lighting, national
as they are not able to
restrict usage and benefits
defence and environmental protection agencies that enforce clean air standards.
to those willing to pay for Governments use specific taxing and spending policies that lead to changes in resource use
the good. Because of this,
that meet the government’s objectives. For example, if the government wants to discourage
governments generally
provide these goods. the consumption of products without banning them, it might apply high tax rates, as it
does with tobacco products (which generate the negative externality of increased health
care costs through tobacco-related diseases). This helps to discourage tobacco consumption,
which in the longer term may reduce the costs to the health care system.
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Impact on income distribution

From year to year, changes in fiscal policy play the most important role of any government
policy in influencing the distribution of income in the economy. Australia has a progressive
income tax system designed to create a more equal distribution of income. People on
higher incomes pay higher rates of income tax, allowing the government to use this money
for transfer payments, community services and other types of social expenditure, which in
particular assist people on lower incomes.
Changes to taxation arrangements can affect income distribution significantly. For
example, a reduction in tax rates at the upper end of the income scale would make the
tax system less progressive and may create a less equal distribution of income. Likewise,
introducing tax concessions (that is, exemptions from tax for certain types of income such
as earnings from superannuation) might affect the distribution of income without actually
changing the tax rates. Similarly, if the government were to increase the rate of the Goods
and Services Tax (a regressive tax), this would make the tax system less progressive and
would result in lower-income earners paying a relatively higher proportion of their incomes
in tax, increasing income inequality.
Budgetary changes involving government spending can also influence income distribution
significantly. Increases in spending on community services such as health and aged care
and labour market programs, or increases in welfare payments such as the age pension,
will tend to reduce income inequality because they have a greater proportional benefit
for low-income earners. On the other hand, Government spending cuts often increase
income inequality because low-income earners tend to be more reliant on income support
payments and government services than higher-income earners.

Impact on savings and external balance

A long-term relationship exists between the budget outcome and the size of the current Appendix B: Advanced
account deficit and foreign debt. There has been debate over the extent of this relationship Economic Analysis at
for many years (see also chapter 10.5). Over the long term, a budget deficit decreases the back of this textbook
looks at the relationship
national savings because governments finance budget deficits by borrowing from private between the budget and
sector savings. A budget deficit (or more accurately, an overall public sector deficit) is a the current account in
form of negative savings, or dissavings, that will reduce the level of national savings, more detail.
which is composed of public savings plus private savings.
With a depleted national savings pool, the competition for a limited amount of savings
to finance domestic consumption and investment will make it more difficult to access
funds and place upward pressure on interest rates, making private sector investment more
expensive. This is known as the crowding out effect. In a closed economy, this will lead
to a decrease in private investment. However, in an open economy such as Australia, the
crowding out effect is less pronounced as private sector borrowers may simply turn to
overseas sources of funds to finance domestic investment and consumption. This will show
up as an inflow on the capital and financial account and will increase the size of Australia’s
foreign debt. Alternatively, if the Government borrows from overseas, the inflow of funds
will directly lead to an increase in Australia’s foreign liabilities. This will raise the net
primary income deficit as the higher level of foreign liabilities is serviced with higher
interest repayments. Thus when the Government consistently runs large fiscal deficits
over several years, the current account deficit will tend to be higher. However, there is
very little evidence of any short-term relationship between budget deficits and the current
account balance.
Australia’s history of current account deficits reflects imbalances between private savings
and private investment, rather than public sector borrowing. Nevertheless, one of the
reasons for the objective of sustaining fiscal balance is to ensure that fiscal policy is not
contributing to higher current account deficits in the longer term.

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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.

14.4 Methods of financing a deficit

In this section, we look at where and how the government obtains the extra money it needs
when it budgets to spend more money than it receives, as well as what the government
does with surplus funds when revenue exceeds expenditure.
When the government budgets for a deficit, it is planning to spend more than it receives
in revenue over the current financial year. In short, this deficit is financed through
borrowing from the domestic private sector, from overseas investors or from the
Reserve Bank (by printing money, known as monetary financing). Alternatively, the
government can also sell government assets. In recent times, when it has run a deficit,
the Australian Government has relied almost exclusively on borrowing from the domestic
private sector.

Borrowing from the private sector

The main form of deficit financing is through borrowing from the private sector by selling
Treasury Bonds domestically under a tender system. Under this system, the government
sets the value of bonds to be sold (determined by the size of the deficit to be financed),
and the prospective purchasers tender to buy a certain quantity at a particular rate of
interest. The government then accepts the tenders, starting with those offering to buy at
the lowest rate of interest, through to the highest, until all bonds are sold. The advantages
of this system are twofold: the government can always be certain that it will fully finance
its deficit, and the market will set the interest rate on these newly issued bonds.
However, it is also worth considering the effect of a deficit financed by domestic borrowing
from the private sector on private sector spending, and in particular on private investment.
Crowding out effect The crowding out effect describes how a budget deficit will soak up funds in Australia’s
occurs where government domestic savings pool, putting upward pressure on interest rates and leading to a reduction
spending is financed in private sector spending and investment (as discussed in the previous section). The
through borrowing from
private sector is “crowded out” of the domestic market by government borrowing, since
the private sector, which
puts upward pressure on lenders will prefer to lend money to the government. Under these circumstances, the
interest rates and “crowds private sector would have less access to domestic savings and may be forced to borrow
out” private sector overseas instead.
investors who cannot
borrow at the higher rates The strength of the crowding out effect depends on economic conditions. If the government
of interest. increases the fiscal deficit when the economy is in recession, it is less likely to crowd
out the private sector, since investment spending would be low at this time. But if the
government continued to run a deficit during periods of strong economic growth, when
Appendix B: Advanced substantial private sector activity is already occurring, it would be more likely to lead to
Economic Analysis at
a significant crowding out effect. However, in an era of globalised financial markets, the
the back of this textbook
looks at the theory of crowding out effect is now much weaker since many of the financial institutions that buy
“crowding out” in more bonds on domestic financial markets are from overseas. Overseas investors are attracted by
detail. Australia’s low risk profile (reflected in the Australian Government’s AAA credit rating)
and the interest rate differential between Australia and other advanced economies. The
estimated proportion of Australian government securities held by overseas investors fell
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Chapter 14: Fiscal Policy

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.

Other methods of financing a deficit

While Australian governments have relied on financing deficits mainly through borrowing
from the private sector, other methods are also available. These include borrowing from
overseas, borrowing from the Reserve Bank and selling assets.
Borrowing from overseas
Governments may borrow from overseas financial markets in order to minimise the
crowding out effect, while still stimulating growth. In an era of global financial markets,
it is less likely to be necessary to raise funds on overseas markets since old distinctions
between domestic and overseas borrowing are now less relevant, as there are now many
overseas institutions that participate in Australia’s domestic financial markets. However,
if the Budget was in deficit, the Government could, at any time, borrow directly on
overseas markets and in overseas currencies should this become a less expensive option
than domestic borrowing. When the Government borrows from overseas it directly adds
to Australia’s foreign debt, with interest repayments recorded as debits on the net primary
income account of the balance of payments.
Borrowing from the Reserve Bank (monetary financing)
The Government may simply borrow from the Reserve Bank to finance the deficit – this
is sometimes referred to as “monetary financing” or “monetising the deficit”. In effect, this
amounts to the Government printing money in order to finance its expenditures. Since
1982, with the deregulation of the financial sector, the Government has not engaged in
this kind of deficit financing. The Government has avoided monetary financing to ensure
that it does not increase the money supply and add to inflation. This also means that there
is no longer any direct connection between the implementation of monetary policy and
fiscal policy (that is, they now operate independently of one another). However, as we
will discuss in chapter 18, the policy settings of fiscal and monetary policy are indirectly
related.

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.

Using budget surpluses

The alternative outcome to a deficit is a surplus. When the Government budgets for a
surplus, it is planning to receive more revenue than it spends in the current financial year.
The Government can use the surplus in three ways:
• depositing it with the Reserve Bank
• using it to pay off public sector debt
• placing the money in a specially established, government-owned investment fund.
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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.

Public sector borrowing and debt

Although changes in the budget outcome provide an important measure of the underlying
stance of fiscal policy, they do not represent the full impact of the public sector on the
economy. To get the full picture relating to the public sector’s revenue raising and
expenditure activities, we must also consider the activities of the rest of the public sector
in Australia – the state and local levels of government, as well as public trading enterprises
(also known as government business enterprises) such as Australia Post, Sydney Water
and Sydney Trains.
The overall impact of the public sector on the economy is reflected in the public sector
cash outcome. The deficit or surplus shows the borrowing needs or surplus funds from
all levels of government, as well as government authorities and public trading enterprises.
It gives the most comprehensive indication of the current impact of the public sector on
the Australian economy. Figure 14.2 shows the public sector net operating balance as a
percentage of GDP. A negative outcome means that there is an overall public sector deficit.

Commonwealth
State Consolidated
Year cash balance
cash balance cash balance^
(% GDP)

2012–13 −1.2 −1.4 −2.9

2013–14 −3.0 −0.6 −4.2
2014–15 −2.3 −0.3 −2.8
2015–16 −2.6 −0.4 −3.1
2016–17 −2.1 −0.4 −2.5
2017–18 −0.8 −0.8 −1.7
2018–19 −0.1 −1.1 −1.3
2019–20 −4.5 −2.5 −7.7
2020–21 −6.7 −2.8 −9.2
2021–22 −1.6 −2.3 −4.4
2022–23* −0.1 −1.8 −2.4
2023–24* −0.8 −2.0 −3.3
Source: 2023–24 Budget Paper No. 3 Appendix C, Table C7 *Estimate
^For technical reasons Commonwealth and State do not add up

Figure 14.2 – Non-financial public sector cash balance

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

Source: 2023–24 Budget Paper 1, Statement 11, Table 4; *Estimate

Year

Figure 14.3 – Australia’s net public sector debt

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.

14.5 The current stance of fiscal policy

For most years in the business cycle, fiscal policy plays a supporting role in the policy
mix, with monetary policy used as the primary tool for macroeconomic management. So
long as the economy is growing, governments tend to give priority to medium-term fiscal
policy goals rather than using fiscal policy to influence the state of economic activity in
the shorter term. However, when the economy experiences a major downturn, an event
which tends to happen on average once per decade, governments use fiscal policy very
actively to return the economy to growth. The most recent example of this active use of
fiscal policy is in response to the COVID-19 pandemic and, before that, in response to
the global financial crisis in 2008. In this section, we discuss the stance of fiscal policy
since the pandemic struck in 2020 and identify key cyclical and structural influences on
fiscal policy.

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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

Source: 2022–23 Budget Paper 1, Statement 11, Table 1 *Estimate

Figure 14.4 – Commonwealth underlying cash budget outcomes since 1970

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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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.”

– Jim Chalmers, Treasurer of Australia, Budget Speech, 9 May 2023

BUDGET POLICY: LOOKING AHEAD TO 2063

One of Australia’s instruments for long-term economic policy planning is the
Intergenerational Report (IGR), which is updated approximately every five years. The
IGR provides economic and fiscal projections for the next 40 years. The most recent
report, released in 2023, provides projections for the Australian economy out to 2062–63.
The 2023 IGR projected that real GNI per person will grow at an annual rate of 1.0 per
cent over the next 40 years, compared to 2.1 per cent in the preceding 40 years. So while
living standards will be 50 per cent higher by 2063, annual growth will be half what it has
been. One factor behind slower growth is that the improvements in terms of trade which
lifted GNI significantly in the past 40 years but are not expected to be repeated over
the next 40. That leaves the Australian economy reliant on the “three ps” of productivity,
participation and population for economic growth.
1 Productivity. The report assumes that productivity will continue to grow at 1.2 per cent
annually, on average, similar to the level over the past 20 years (but notably well below
the 1.5 per cent average of the past 30 years and the assumption in the previous IGR).
Productivity is a key driver of income and economic growth.
2 Participation. Workforce participation is projected to decline from 66.8 per cent in 2023
to 63.8 per cent by 2062–63. This is primarily driven by the ageing of the population,
which is partially offset by a continued increase in women’s participation in the
workforce. The projected decline in participation is far milder than originally anticipated.
When the first IGR was released in 2002 it projected workforce participation would
sink below 60 per cent by 2023 and keep falling, which would have had significant
consequences for the Commonwealth budget.
3 Population. Australia’s population is projected to reach 40.5 million in 2062–63. The
projected 1.1 per cent annual growth rate is below the historical average because
of lower fertility rates and a migration level that, while high, falls as a proportion of
population over time.
The 2023 IGR projected the Budget to remain in deficit every year until 2062–63. As
shown in figure 14.5, budget outcomes were expected to improve during the 2020s
but then worsen from the 2030s as pressures on spending rise due to health and aged
care, the National Disability Insurance Scheme (NDIS), defence and interest payments
on Government debt, while the Government’s ceiling on tax revenues prevents revenue
from keeping up with expenditure growth.

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Underlying cash balance

2
1
0
−1
−2
−3
−4
−5
−6
−7
−8
2000–01
2002–03
2004–05
2006–07
2008–09
2010–11
2012–13
2014–15
2016–17
2018–19
2020–21
2022–23
2024–25
2026–27
2028–29
2030–31
2032–33
2034–35
2036–37
2038–39
2040–41
2042–43
2044–45
2046–47
2048–49
2050–51
2052–53
2054–55
2056–57
2058–59
2060–61
2062–63
Source: 2023 Intergenerational Report

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.

14.6 The impact of recent fiscal policy

Recent years provide a case study of the impact of fiscal policy on the economy, with the
COVID-19 pandemic prompting the largest-ever fiscal policy interventions in Australian
economic history. In contrast, during the decade before the pandemic, fiscal policy was
playing a relatively minor role in Australia’s economic policy mix. While monetary policy
played the critical shorter-term role of influencing the level of economic activity and
keeping inflation within its target range, the goal of fiscal policy was to gradually return
to surplus, and from time to time to achieve specific policy goals relating to the allocation
of resources in the economy.

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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headline inflation will be reduced by three-quarters of a percentage point in 2023–24

as a result of these measures, with the goal of reducing the need for further interest rate
increases to address inflation.

Unemployment and workforce participation

The short-term impact of fiscal policy on unemployment is closely related to the impact
of fiscal policy on economic growth. In stimulating aggregate demand, expansionary fiscal
policy can help to reduce unemployment or, during an economic downturn, reduce the
rate at which cyclical unemployment increases. The priority of Australia’s fiscal policy
measures in response to the COVID-19 pandemic was to prevent a much larger surge in
unemployment. The JobKeeper Payment played the central role in this strategy. Under
this policy, the Australian Government was in effect paying the wages of workers at a
time when many employers could not afford to pay them because of the suspension of
normal economic activity. The Treasury estimated that this wage subsidy prevented a 5
percentage point rise in the unemployment rate. Without action to prevent those job
losses in the short term, the Treasury argued that the recession would be much longer
and more severe, given the time required for employers to recruit and for workers to find
jobs in the months and years that followed.
With the unemployment rate rapidly falling after the pandemic, the role of fiscal policy
in the labour market returned to its pre-pandemic focus. Measures were introduced to
target priorities such as addressing skills shortages in specific trades or industry sectors,
fostering career transitions and retraining older workers. The 2022–23 Budget included
a $2.8 billion Australian Apprenticeships Incentive System, which aimed to streamline
apprenticeships and create more places in priority areas, and a $550 million Skills and
Training Boost, which provided a 20 per cent bonus tax deduction for small businesses
to upskill their employees through external training providers.
Childcare policies have a major influence on how quickly parents are able to return to the
workforce after a new birth. In 2022–23, the Albanese Government allocated $4.7 billion
to increase the Child Care Subsidy to 90 per cent for eligible families. The plan’s economic
policy objective was increased workforce participation, by improving work incentives for
second-income earners (most often women), by slowing down the rate at which rising
family incomes result in lower childcare subsidies. The Government also announced
$532 million to expand Paid Parental Leave to up to 26 weeks starting from 2026.

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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the growth of renewable energy industries. In addition, Australia is committed to spending

tens of billions of dollars on building submarines in Australia as part of its commitment
to the local defence industry and the AUKUS alliance.
Governments can also have a significant influence on resource allocation through their
general policy settings, especially through regulations, tax concessions and exemptions.
An example of regulation that influences resource use is the Renewable Energy Target that
successfully required by 2020 that around 23 per cent of energy generation came from
renewable sources (through a system of renewable energy certificates).

National savings and the current account balance

Fiscal policy can influence an economy’s level of national savings, either by increasing
savings (through surpluses) or detracting from savings (through deficits). Rather than
using the Budget directly to address Australia’s large current account deficit, in recent
decades the Government has pursued a goal of budget surpluses over the medium term so
that the Government is not directly adding to Australia’s savings imbalance. Over time,
this should help contribute to improving Australia’s external balance.
The extent to which a budget deficit leads to a current account deficit (a relationship
sometimes known as the “twin deficits” hypothesis) has been a matter of economic debate
in Australia since the 1980s. In reality, the current account is influenced by many factors,
and the level of budget deficits is just one of many. As figure 14.6 shows, there is no
direct linkage between Australia’s budget outcome and the current account deficit. In
some periods, such as the mid-2000s, the current account deficit may increase even when
Australia is recording sustained budget surpluses. At other times, such as in recent years,
the current account may move into surplus while the budget moves sharply into deficit.
This reflects the fact that, although budget outcomes influence national savings, and
national savings influences external balance, at any moment in time many other factors
are also influencing those economic outcomes. Nevertheless, this does not mean that the
level of public savings has no effect on the current account over the longer term. A higher
level of public savings (and therefore national savings) is likely to result in a lower current
account deficit than if the Government has a budget deficit, and vice versa – but the
relationship is long-term not short-term, and influenced by many other factors.

% of GDP Current account balance Underlying cash balance

4
3
2
1
0
−1
−2
−3
−4
−5
−6
−7
−8
2023–24*
2021–22*
2022–23*
2019–20
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
2017–10

Source: 2022–23 Budget Paper 1, Statement 11, Table 1 *Estimate

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.

6 Spending, revenue and budget outcomes are affected by discretionary

or structural factors, involving policy changes by the government, and
non-discretionary or cyclical factors, which relate to the impact of changing
economic conditions on the levels of spending and revenue collection.

7 Unemployment benefits and progressive income tax are known as automatic

stabilisers because they are a built-in counter-cyclical component of the
Budget.

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.

9 Generally, fiscal policy plays a limited role in macroeconomic policy. Monetary

policy is usually the primary tool to control short-term fluctuations in growth and
inflation. However, during periods of economic crisis, fiscal policy can play an
important role in supporting aggregate demand.

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.

2 Distinguish between the possible budget outcomes of surplus, deficit and

balance.

3 Describe the major instruments of fiscal policy.

4 Distinguish between the underlying cash balance and the net operating balance.
Explain what each indicates about the budget stance.

5 Explain how automatic stabilisers play a counter-cyclical role in the budget.

6 Outline how fiscal policy impacts on the following:

(a) economic growth

(b) resource use

(c) income distribution

7 Explain how the government can finance a budget deficit.

8 Distinguish between public debt and foreign debt.

9 Discuss the impact of recent changes in fiscal policy on the Australian economy.

10 Account for the trends in budget deficits during recent years.

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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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AN INDEPENDENT REVIEW OF THE RBA

In 2022, the Albanese Government initiated the first • Increased information sharing between the RBA and
independent review of the RBA since inflation targeting was Treasury, through performing joint scenario analysis
introduced in the early 1990s. The purpose of the review • Reducing the number of Board meetings each year
was to reassess the RBA’s objectives and performance. from 11 to 8 and increasing the time spent on monetary
The review’s 51 recommendations were released in March policy and strategy
2023. The Government agreed in principle with all of the • Creating two separate boards for the governance of the
recommendations, including: RBA and for the conduct of monetary policy
• Clearly defining the objectives for monetary policy as • Improving transparency through Board members
a dual mandate to contribute to price stability and full speaking publicly about the Board’s decisions
employment, with an overarching purpose to promote • Implementing 5-yearly reviews of the monetary policy
economic prosperity frameworks and tools.

15.2 The objectives of monetary policy

The objectives of monetary policy are laid out formally in the Reserve Bank Act of 1959,
which states that in its implementation of monetary policy the RBA should aim for:
• The stability of Australia’s currency – which now means maintaining low and stable
inflation and preserving the purchasing power of the Australian dollar.
• The maintenance of full employment in Australia – which means sustaining a low
level of unemployment.
• The promotion of the economic prosperity and welfare of the people of Australia –
which primarily means maintaining a stable and sustainable economic and financial
environment.
The 2023 review of the RBA recommended that the objectives should be clarified as a dual
mandate for price stability and full employment only, with the promotion of economic
prosperity not being a separate third objective but, instead, an overarching purpose for
the RBA. This recommendation is intended to reduce the discretion of the RBA in its
application of monetary policy and support it in focusing on two objectives. At times,
it can be difficult for the RBA to achieve all three objectives simultaneously. Since the
early 1990s, the RBA has generally prioritised the first objective: the maintenance of low
and stable inflation via its inflation-targeting regime. Executing monetary policy in this
manner can come at the expense of the RBA’s employment objective. For instance, when
inflation is high, the RBA will increase interest rates which can restrict economic activity
and lead to a rise in unemployment.

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.

APPOINTING A NEW GOVERNOR OF THE RBA

Michele Bullock’s term as Governor of the Reserve Bank began in September 2023,
replacing Philip Lowe who had been Governor since 2016.

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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15.3 The implementation of monetary

policy
Cash rate is the interest The cash rate is the main tool that the RBA uses to implement monetary policy. The
rate paid on overnight cash rate is the interest rate in a financial market called the overnight money market –
loans in the short-term the market for very short-term loans between banks, where loans are literally made for
money market.
overnight use in many cases. The cash rate influences many other interest rates in the
economy (such as rates on mortgages and business loans), and the general level of interest
rates influences inflation and the overall level of economic activity. The RBA can therefore
achieve its economic objectives through its capacity to change the cash rate.

Whenever the RBA announces

Until the end of 2023, the RBA Board met 11 times a year to set a target for the cash
the cash rate, the Reserve rate. In line with the recommendations of the RBA review, this was changed from 2024
Bank Governor releases a onwards, with the establishment of a separate Monetary Policy Board meeting eight times
statement to explain the per year (on the first Monday and Tuesday of relevant months), with its policy decision
RBA’s decision, and the announced at the end of the meeting. The RBA is responsible for ensuring that the actual
minutes from the meeting
cash rate is consistent with the target announced by the board.
are released two weeks later.
These documents, along To fully understand monetary policy, it is important to understand more about what the
with a range of other useful cash rate is and the mechanics of how it is determined. The mechanics of the cash rate and
information, are available on
the RBA’s website.
the overnight money market can jointly involve three key elements: exchange settlement
accounts, the policy interest rate corridor and domestic market operations.
Using the RBA’s statistics
page, identify the most recent
statistics for inflation, growth,
Exchange settlement accounts
unemployment and wages. Commercial banks need to hold a certain proportion of their funds with the Reserve Bank
Explain how these indicators in exchange settlement accounts (ES accounts) to settle payments with other banks and
justify the current level of
the Reserve Bank. For example, when a customer of the Commonwealth Bank of Australia
interest rates in the Australian
economy. (CBA) uses a debit card to buy a good or service from a business that has a bank account
at National Australia Bank (NAB), funds need to flow from CBA to NAB to complete
the transaction. Many interbank payments like this need to happen every day. These
payments are made by transferring funds between banks’ ES accounts. At the end of every
trading day, some banks may not have enough funds in their ES accounts to satisfy all of
their interbank payment obligations for that day, while other banks may have a surplus
of ES funds. These other banks can hold excess ES balances in accounts at the RBA as a
way of storing value.
The overnight money market (also known as the short-term money market) is the market
where banks that have a shortage of ES funds can borrow money from banks that have an
excess of ES funds beyond what they need in their accounts. The market therefore enables
banks to always settle their interbank payment obligations with each other. As with any
other financial market, demand by borrowers and supply from lenders interact to set the
market price (interest rate). But unlike other financial markets, the RBA can influence
the overnight money market to ensure that the actual cash rate lines up with the target
that the RBA board sets for it. The RBA does this using the policy rate corridor and open
market operations.

The policy rate corridor

The RBA does not directly set the actual cash rate at the target that it announces. But
the RBA ensures that the actual cash rate can never stray far from the target because of
how the RBA deals with the funds in commercial banks’ ES accounts.

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Firstly, the RBA normally pays an interest rate to Price

banks on funds held in ES accounts that is 0.25
percentage points below the cash rate target (for
RBA lending rate Supply
example, if the cash rate target is 1 per cent, the
+0.25ppt
RBA’s deposit rate is usually set to 0.75 per cent).
Policy
This means that banks with excess ES balances are
Cash rate interest
not given an incentive to lend funds to other banks target rate
if the actual cash rate is less than 0.25 percentage
corridor
points below the target; these banks could earn RBA deposit rate
greater returns by simply leaving their extra funds in −0.25ppt Demand
their ES account and ignoring the overnight money
market. The RBA’s deposit rate therefore creates a
floor or minimum value for the cash rate. Quantity
Secondly, the RBA is always willing to lend ES balances Figure 15.1 – The Australian cash market
directly to banks outside of the overnight market. The RBA always sets an interest rate on
these loans equal to 0.25 percentage points above the cash rate target (for example, if the cash
rate target is 1 per cent, the interest rate on these loans is set to 1.25 per cent). Banks that need
to borrow ES balances are not incentivised to pay a rate higher than the RBA’s lending rate in
the overnight money market. If the cash rate were higher than the RBA’s lending rate,
banks would simply borrow ES funds directly from the RBA. The RBA’s lending rate
therefore creates a ceiling or maximum value for the cash rate.
The floor created by the RBA’s deposit rate and the ceiling created by the RBA’s lending
rate together form the policy rate corridor for the cash rate. No banks, whether they have
a surplus or a shortage of ES funds, have an incentive to complete transactions in the
overnight money market outside of this corridor. The RBA’s policy target for the cash
rate is normally exactly in the middle of the corridor. This helps ensure that the actual
cash rate always closely follows the RBA’s target cash rate.
The policy rate corridor is responsible for implementing changes to the RBA’s cash rate
target. If the RBA were to decrease the target, the floor and ceiling of the corridor would
shift downwards immediately, and banks would be incentivised to borrow and lend from
each other within a new range that is consistent with the new cash rate target (see figure
15.2).
Rate
In reality, there is no mechanism that
forces the actual cash rate to be exactly
RBA lending rate
the same as the cash rate target (that is, in
+0.25ppt
the middle of the band). However, there
is a well-established convention that the Banks want
Cash rate target to borrow at Policy
actual cash rate should be the same as lowest rate interest
the target. Borrowers and lenders in the
Banks want rate
overnight money market generally follow RBA deposit rate to deposit at
−0.25ppt highest rate corridor
this convention. Because of this, changes
to the cash rate happen as soon as the RBA
announces a change to its target – the Day 1 Day 2 Time
RBA does not have to do anything besides
make the announcement. Figure 15.2 – Policy interest rate corridor

Domestic market operations

Demand for ES balances by banks fluctuates on a daily basis. This is especially the case
on days where there are large transactions or payments in the economy, such as when the
Government pays social security benefits. The actual cash rate is the price at which this
demand intersects with the supply of ES funds that are available. The RBA can manage
the level of supply of ES funds so that it meets demand at a price closer to the RBA’s cash

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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.

The transmission of the cash rate to other interest rates

The cash rate is often called the foundation or the anchor of the interest rate structure in the
Australian economy. This simply means that the cash rate has a major influence on many
other interest rates in Australia. It has this influence because it affects how much it costs
financial institutions such as banks to fund themselves. An increase in the cash rate means
that it becomes more expensive for financial institutions to obtain funds in the short-term
money market (and generally other funding markets too). To maintain their profit margins
financial institutions generally respond by increasing the interest rates that they charge to
borrowers, such as on household mortgages used to buy houses. Similarly, a reduction in the
cash rate lowers the funding costs for banks and other financial institutions (that is, it costs
them less to borrow money), and competition between financial institutions causes them
to pass this cost saving on to their customers in the form of lower lending interest rates.
However, factors other than the cash rate also influence the main interest rates in the
economy (home loans, credit cards, personal loans and commercial loans). These include
competition in the banking sector, regulations, conditions in global and domestic financial
markets and risk assessments relating to economic conditions. This means that the margin
or difference between the cash rate and those other interest rates can change over time in
response to these other factors.
The Reserve Bank can either tighten monetary policy by raising the cash rate target,
or loosen monetary policy by lowering the target. The impacts of the Reserve Bank’s
implementation of monetary policy are summarised in figure 15.3.

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Monetary policy Cash rate Policy rate Cash Market interest

Overnight money market
stance target corridor rate rates

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

Figure 15.3 – The conduct of monetary policy

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.

Conventional monetary policy Unconventional monetary policy

interest interest
rates rates

yield curve yield curve

cash cash
rate rate

overnight length of loan 10-year overnight length of loan 10-year

loan government bond loan government bond

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.

15.4 The impact of changes in

interest rates
Economists often describe the process through which monetary policy affects the economy
Transmission mechanism as the transmission mechanism of monetary policy. The transmission mechanism works
explains how changes in through a number of different channels:
the stance of monetary
policy pass through the • Downward pressure on interest rates through expansionary monetary policy makes
economy to influence borrowing cheaper for consumers and businesses. Consumers often need to borrow to
economic objectives such make major purchases such as housing and consumer durables. Similarly, businesses
as inflation and economic borrow for the purposes of investment in capital, plant upgrades and expansions. In
growth.
addition, the interest rate they can obtain by investing in financial assets represents
an opportunity cost of investing funds in the business for business owners. Thus, a
fall in the level of interest rates should encourage borrowing by both businesses
and consumers, leading to rising consumption and investment demand in the
economy. This raises the overall level of economic activity.

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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.

15.5 The stance of monetary policy in

Australia
The RBA communicates the stance of monetary policy in its cash rate target announcement
following each Board meeting, and publishes official minutes from the meeting two weeks
later.
After the recommendations from the review of the RBA are implemented, the RBA will
communicate the stance of monetary policy by making a cash rate target announcement
after each meeting of the Monetary Policy Board. Immediately after the announcement,
the Governor will give a press conference and the Board will release a public statement
outlining the discussion and votes at the meeting.

MONETARY POLICY
HOW A POLICY TIGHTENING WORKS
(policy loosening involves the opposite impacts)

Wages Growth INTEREST RATES UP! CASH RATE

Economic Growth

4.1%
Unemployment RBA
Exchange Rate

Inflation Forecasts

Tighten monetary policy RBA Domestic Markets Financial

Department Institutions

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.

ECONOMIC DATA RBA BOARD RBA ANNOUNCEMENTS OVERNIGHT MONEY MARKET

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).

HOW FAST IS TOO FAST?

By late July 2023, the Reserve Bank had increased the sending many households into mortgage stress. Other
cash rate 12 times (including 10 consecutive increases) arguments suggested that the pace of increases did
from its pandemic low of 0.1 per cent as it sought to keep not allow time for the changes to take effect, due to the
rising inflation under control. long and variable monetary policy lags. Economist Ross
The increases in interest rates were a necessary response Garnaut noted in May 2023 that “the responsible thing is to
to the high inflation and low unemployment being pause until we see those effects [of lifting interest rates]”.
experienced in the Australian economy. However, some Overall, Australia’s experience of rising interest rates has
economists argued that the increases were too fast. In been moderate, with interest rates below those in the UK,
July 2023, AMP chief economist Shane Oliver noted “the Europe and North America. Perhaps the most extreme
more you raise rates the more you could tip [the economy] example elsewhere is in Türkiye, where the central bank
over the edge”. is not independent from the government. To avoid an
In response to the interest rate increase in June 2023, increase in interest rates or a downturn during the election
Treasurer Jim Chalmers warned “there will be a lot of campaign, Türkish President Recep Tayyip Erdogan sacked
Australians who will find this decision difficult to understand three central bank governors in quick succession. Once
and difficult to cop”, urging the Reserve Bank to defend re-elected, and with official inflation rising above 40 per
its decision. For mortgage holders, monthly repayments cent, Erdogan appointed a central banker who, in one
on an average $600,000 mortgage increased by almost move, raised interest rates from 8.5 per cent to 15 per cent,
two-thirds (from $2,185 to $3,559 over the 12 increases), sending the economy into a sharp downturn.

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

Source: Reserve Bank of Australia

Figure 15.5 – Australian cash rate

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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.

Monetary policy is tightened to deal with the inflationary consequences of the

Early 2000s depreciation of the exchange rate and the introduction of the Goods and Services
Tax.

Expansionary monetary policy to support growth during a mild downturn, followed

Mid-2000s by gradually increasing interest rates as inflationary pressures emerge during the
boom in commodity prices.

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.

Subdued economic conditions, modest employment growth and low inflation

motivated the RBA to ease monetary policy further. In 2019 the cash rate target
2019–2021 was gradually lowered to 0.75 per cent. Following the outbreak of COVID-19,
the RBA slashed the cash rate target to 0.1 per cent and introduced a range of
unconventional measures to strengthen the financial system and support growth.

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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2. Inflationary expectations: One key element in the government’s strategy of

achieving low inflation is reinforcing expectations of sustained low inflation. If
inflationary expectations remain low, businesses will plan lower price increases and
unions will seek lower wage rises. The RBA will raise and maintain high interest
rates if necessary to reduce inflationary expectations.
3. Labour costs: Future interest rate movements are dependent upon movements in
the level of inflation, and one of the most significant determinants of inflation is the
cost of labour trends in productivity growth. The best indicator of wages growth is
the Wage Price Index released by the Australian Bureau of Statistics (ABS).
4. The RBA remains committed to achieving low unemployment and promoting
economic prosperity. The level of growth and unemployment are also important
indicators of whether the economy is close to its supply constraint. If the economy
is operating at a point that is close to capacity (that is, close to full employment
of labour and other resources), continued growth in spending and demand will
not lead to higher output and employment, and will instead spill over into higher
prices.
5. External factors: Australia’s integration with the global economy means that
international conditions consistently influence RBA monetary policy settings. For
example, if global conditions deteriorate, Australia is more likely to face slower
economic growth and higher unemployment, and the RBA may move to reduce
interest rates to prevent a downturn. More broadly, the RBA monitors conditions
in global financial markets for any early warning signs of inflationary pressure or
economic volatility so that it can move pre-emptively to change monetary policy
settings. The RBA also assesses external factors because the exchange rate channel is
an important component of the transmission mechanism of monetary policy.

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.

2 Monetary policy is the main macroeconomic policy instrument used to

influence the level of economic activity in the short to medium term.

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.

4 Like many other industrialised nations, Australia adopted an inflation-targeting

monetary policy regime in the early to mid-1990s that has generally proved
successful in sustaining low inflation and relatively stable economic growth.

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.

6 Monetary policy is implemented through domestic market operations –

the purchase and sale of second-hand government securities by the Reserve
Bank in the short-term money market for the purpose of influencing interest rates.

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 15: Monetary Policy

chapter review
1 Define monetary policy.

2 Outline the broad objectives and overarching purpose of monetary policy.

3 Identify what is meant by inflation targeting and why it has been implemented
in Australia.

4 xplain what is meant when we describe Australia’s inflation target as a

E
flexible target.

5 Identify the economic indicators monitored by the government and the Reserve
Bank to determine whether a change in monetary policy is necessary.

6 Explain how the RBA conducts domestic market operations.

7 Outline what action the Reserve Bank would take if it wanted to:

a) tighten monetary policy

b) loosen monetary policy

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.

10 Outline how time lags influence the implementation of monetary policy.

317
16 Microeconomic
and Environmental
Policies
16.1 Microeconomic policies and aggregate supply
16.2 Microeconomic policies and individual industries
16.3 Environmental management policies

16.1 Microeconomic policies and

aggregate supply
Microeconomic Microeconomic policies are actions taken by governments to improve the efficiency of
policies are firms and industries in order to maximise the amount of output that can be produced
government actions from the scarce resources available in an economy. Microeconomic policies are central to
that aim to increase the government’s long-term aim of increasing the level of sustainable growth in Australia
aggregate supply and reducing the extent to which inflation and external imbalances constrain economic
by improving the growth.
efficiency and
productivity of Microeconomic policies are also important because many of Australia’s economic problems
producers and are caused by structural factors. Macroeconomic policies can only manage the level of
industries. economic activity in the short term. Interest rate changes and automatic stabilisers cannot
readily address structural issues in Australia such as labour market skill shortages or
decarbonising our energy and transport systems. Lifting Australia’s longer term growth
requires structural changes to increase productivity in existing industries and help Australia
transition successfully to new industries, such as fast-growing knowledge-based services and
green energy. Microeconomic reforms include tax reform, improving the education system
and supporting investment in technology infrastructure.
Microeconomic policy is different
from macroeconomic policy because General price level
AD AS
microeconomic policies influence supply
rather than demand. It is therefore AS1

sometimes called supply-side economics.

The ultimate focus of supply-side P
economics is to increase aggregate supply, P1
which shifts the aggregate supply curve
to the right – the result is that more AS
goods and services are provided at lower
AS1 AD
prices. This is shown in figure 16.1.
0
Policies that focus on increasing the level Y Y1
Total output
of aggregate supply do so by improving
the competitiveness, productivity and Figure 16.1 – Increasing supply as a result of
efficiency of Australian industries. microeconomic reform

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Chapter 16: Microeconomic and Environmental
Chapter 15: MonetaryPolicies
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.

Gross value added by industry

1980 2022
Government administration, Government administration,
education & health 19% education & health 17%

Agriculture, forestry Agriculture, forestry

& fishing 3% & fishing 4%

Services 58% Mining 6% Services 58%

Mining 15%

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.

Figure 16.2 – The changing industrial structure of Australia’s economy

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.

DYNAMIC EFFICIENCY AND INNOVATION

Dynamic efficiency Dynamic efficiency means that producers are able to respond quickly to changing patterns of
refers to the economy’s demand in both the domestic and global economy. For example, a dynamically efficient car
ability to shift resources manufacturer would be able to shift relatively quickly from producing petrol cars to producing
between industries in electric vehicles as consumers become more concerned about fuel emissions. In addition,
response to changing producers who are dynamically efficient are able to adopt new technologies and innovative
patterns of consumer
business practices. One of the major ways in which microeconomic reforms can increase
preferences.
dynamic efficiency is by increasing the level of competition in industries, which will tend to
force producers to be more responsive to changes in demand and supply.

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Policy

individual microeconomic reforms have affected the allocative, technical and

MICROECONOMIC REFORM
dynamic efficiency of specific sectors in the Australian economy.
POLICIES
In the following section we look at industries and how they have been affected
Deregulation
by a range of microeconomic policies, including deregulation, reforms to
public trading enterprises and competition policy. In section 16.3 we look at Reforms to public trading enterprises
the national and global context for environmental management. Although the Competition policy
ultimate objectives of environmental policies are different to microeconomic Environmental management
policies, they are included in this chapter because of the similar way in which
they affect households, businesses, industries and the economy. Moreover, Reducing protection – see chapter 6
climate change, and policies introduced in response, will likely cause the most Tax reforms – see chapter 14
influential structural changes to the economy over the coming decades. It Labour market reforms – see chapter 17
is also important to note that as well as the policies covered in this chapter,
examples of other microeconomic policies are provided in several other chapters
in topics 3 and 4.

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.

16.2 Microeconomic policies and

individual industries
Deregulation
Deregulation involves the simplification or removal of rules that constrain the operation
of market forces, and it aims to improve the efficiency of industries. The process of
deregulation has driven extensive structural change in many industries.

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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• economic dynamism reforms, including encouraging entrepreneurship, promoting

investment in key areas by making land zoning more flexible, appropriately
charging motorists for using roads, improving competitive pressures in highly
regulated sectors (especially health services), and restructuring the tax system to
make it productivity-enhancing.
• various climate change mitigation and adaptation reforms to improve Australia’s
future productivity performance
• non-market reforms such as making health services more integrated, patient-centred
and data-driven, and increasing the allocative efficiency of public infrastructure
funding.
The latest report also emphasised that the recommendations made by the first report,
which focused primarily on health policies, how cities operate, and how state and federal
governments work together, remain relevant and important.
Overall impacts
Microeconomic policies have generally been championed by Australian governments
because of their potential to lift economic growth and living standards. However,
microeconomic reform has always been associated with shorter-term costs, such as
job losses, business closures and damage to regional economies. As a result, many
microeconomic reforms were met with strong opposition, especially from those sectors
that stood to lose out from the changes. Microeconomic policies nevertheless have achieved
extensive long-term benefits, which have become clearer over time.
Higher productivity growth from microeconomic policies has contributed to an
increase in economic output and lower unemployment. According to the Productivity
Commission, Australia’s GDP was around 2.5 per cent, or $25 billion
higher in 2005–06 as a result of Australia’s extensive national competition “Although the past five years have been
an eventful period for the Australian
policy reforms of the 1990s. This translated into higher living standards
economy, the themes from Shifting the
of around $1200 per person. These improved outcomes were the result
Dial, and the 28 recommendations from
of increased productivity growth as sectors of the economy became more that report are, if anything, increasingly
competitive, innovative and flexible. The Productivity Commission has relevant following the significant
cited as evidence the pattern of higher productivity growth in sectors most COVID-19 disruptions of the past
affected by microeconomic reform in the years following implementation, 2 years. However, overall, the dial has yet
such as telecommunications and financial services in the 1990s. More to be shifted by government. As noted by
recently, the Productivity Commission has argued that Australia’s poor a number of submissions to this inquiry,
productivity performance over the past decade highlights the need for more although some progress has been made
meaningful economic reforms. The Productivity Commission estimated in in terms of implementation, many
2021 that, if productivity growth in the decade to 2020 had kept pace with recommendations, including those with
the 60-year average (1.7 per cent compared to 1.1 per cent), gross national potentially large economic implications,
are yet to be implemented, and none
income per person would have been 6 per cent ($4600) higher in 2020.
have been fully implemented.”
Australia has achieved weaker productivity growth since the mid-2000s,
– Productivity Commission 5-year
with especially weak growth in labour productivity (as distinct from the Productivity Inquiry: The Key to
productivity of all combined factors of production). In the years leading up Prosperity – Interim report no. 1
to the COVID-19 pandemic, productivity growth in Australia fell sharply July 2022
to below the average rate in OECD countries. In a 2021 report, the IMF
attributed this to a decline in productivity-enhancing investments (in areas such as R&D
and information and communication technologies) and inadequate market competition
in key industries. The Productivity Commission, IMF and OECD have all recommended
that further reforms are needed if Australia is to return to the higher productivity growth
required to generate higher living standards. In a 2021 review, the OECD recommended
measures to strengthen competition and improve the operating environment for
businesses, reduce Australia’s reliance on tax revenue from income taxes towards more
use of consumption taxes, and take steps to reduce inequality in educational attainment.

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A major benefit of microeconomic reform is lower inflation, resulting from greater

competitive pressures and increased supply (both of which lower cost-push inflation) in
sectors affected by microeconomic reforms. The Productivity Commission has estimated
that since the early 1990s, rail freight rates have fallen by as much as 42 per cent, while
both port and telecommunications charges have dropped by up to 50 per cent. Other
Commission research has concluded that because of lower prices and higher wages, the
benefits of microeconomic policies have been relatively evenly shared between individuals
and businesses.
Microeconomic policies are not without critics. Some argue that poorly designed reforms
BENEFITS have simply replaced one problem with another. For example, the former chairperson
Greater efficiency and of the ACCC, Rod Sims, in 2017 argued that privatisation was “severely damaging”
productivity growth the Australian economy because governments were selling vital assets such as ports and
New business and job airports to private-sector monopolies, resulting in higher one-off revenues for governments
opportunities but then large increases in prices to consumers. Another common criticism is that
Higher economic growth reforms have often benefited wealthy investors while costs have been borne unevenly
and living standards by lower-income earners. Indeed, this is often cited as a criticism of policies introduced
Lower inflation to encourage globalisation, such as reduced trade protection and barriers to foreign
investment. Critics also question whether the productivity statistics exaggerate the benefit
COSTS of microeconomic policies. For example, research has demonstrated that many workers
Higher unemployment are experiencing an increase in work intensity – that is, people working longer hours
in the short term without extra pay. This means that some of the claimed increase in labour productivity
Closure of inefficient may disguise the fact that people are now working longer hours than in previous decades
businesses but these extra work hours are not recorded. While microeconomic reforms are vital
Greater work intensity for generating increased productivity, growth and living standards, each reform needs
Less equal distribution to be evaluated on its own merits since not all reforms are effective. Designing and
of income implementing microeconomic reforms is one of the greatest challenges for governments.

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.

16.3 Environmental management

policies
Environmental management policies are designed to address issues of environmental
sustainability. These include the preservation of natural environments, pollution and
climate change, and managing the use of renewable and non-renewable resources.
While environmental management policies often address different objectives than
microeconomic policies, they are included in this chapter because, in many ways, they have
a similar role in the economic policy mix. Like microeconomic policies, environmental
policies aim to influence the long-term behaviour of households, businesses and industries.
The two main policy tools for environmental management are regulations and market-

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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

THE GREAT BARRIER REEF

The Great Barrier Reef is the largest living structure in the community benefits, economic benefits and governance. Key
world, covering 344,400 km2 in area, with 3000 coral reefs, elements include:
1625 types of fish, 133 types of sharks and rays, over • establishing the $40 million Great Barrier Reef Trust
200 types of birds and 600 types of coral. As the world’s
• banning the disposal of material from capital dredging
largest coral reef ecosystem, the Great Barrier Reef became
projects within the Great Barrier Reef Marine Park, as
a UNESCO World Heritage site in 1981 and is the most
well as restricting these activities to limited surrounding
biodiverse heritage site, indicating its significant scientific
areas
and intrinsic importance. The Great Barrier Reef is also a
major tourist destination, with over 2 million visitors each • banning the disposal of material from capital dredging
year, which contributes approximately $6.4 billion to the projects within the Great Barrier Reef Marine Park, as
economy each year. well as restricting these activities to limited surrounding
areas
The Great Barrier Reef is suffering from the effects of
• providing additional protections for turtles and dugongs
climate change. Changes in ocean temperatures threaten the
through anti-poaching laws, improved sustainability
reef’s delicate ecosystem. The latest five-yearly Great Barrier
agreements and funding to reduce marine debris
Reef Outlook Report downgraded the condition of the reef
from “poor” to “very poor”. In the previous five years, the • reversing the decline in water quality associated with
reef experienced multiple episodes of coral bleaching as a agriculture, through $35 million in ongoing funding
result of marine heat waves, as well as cyclones and crown- and an additional $100 million over five years to
of-thorns starfish. A recent aerial survey of the reef indicates supportwater quality initiatives and scientific
that around two-thirds of the reef has now suffered from research and to transition current business practices
coral bleaching (around 1500 km of the total 2300 km length), • reducing the presence of the crown-of-thorns starfish to
and it would take many years to recover from the death of support coral populations.
the coral, even without further water temperature rises.
In 2022, the Albanese Government increased funding for the
In response to the recommendations for management Reef 2050 Plan which supports marine ecosystem research
and protection made in a monitoring report from the and crown-of-thorns starfish culling programs, more
World Heritage Centre, the Queensland and Commonwealth sustainable farming and fishing practices, and protection
Governments committed to a 2050 Long-Term Sustainability efforts for turtles, dugongs and dolphins. Overall, the federal
Plan, based on a two-year strategic assessment of the and Queensland Governments are jointly investing a total of
reef, and provided $140 million in funding. Its priorities $2 billion to protect the reef.
include ecosystem health, biodiversity, heritage, water quality,

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mining techniques. In Australia, environmental regulations can be made by local, state

or federal governments, or by their agencies.
Some regulations impose requirements that the quality of goods meet environmental
standards. For example, the Fuel Quality Standards Act 2000 regulates the quality of fuel
for Australia. The aim of the legislation is to reduce the levels of pollutants and emissions
from fuels that may cause environmental and health problems.
Regulation can require firms and individuals to follow certain environmental procedures. For
example, the Environment Protection and Biodiversity Conservation (EPBC) Act provides
a framework for the protection and management of matters of national environmental
significance. This includes the protection of World and National Heritage sites,
Commonwealth marine areas, nationally threatened species and ecological communities
and migratory species. States and territories have responsibility for all other matters of
state and local significance. In response to the 2021 five-yearly State of the Environment
Report, which found a significant deterioration in many aspects of Australia’s flora and
fauna, the Australian Government is establishing a new national Environmental Protection
Agency to strengthen monitoring and compliance with environmental regulations.
Broader regulatory frameworks can also relate to environmental issues. For example,
investigations undertaken by the Australian Competition and Consumer Commission
in 2023 published a report, Greenwashing by Businesses in Australia, that raised serious
concerns about claims that businesses make about the environmental impact of their
products and services. Of the 247 business examined, 57 per cent made claims that “raised
concerns”, including vague statements that lacked evidence or using third-party symbols
or certifications in a confusing way.

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

Figure 16.3 – Negative externalities Figure 16.4 – Taxing the externality

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A market-based response to this scenario would be to levy a tax or fee on production

that is approximately the same as the environmental costs associated with this economic
activity. This should move the supply curve to the left, increasing the market price and
reducing the amount consumed in the economy.
Figure 16.4 shows how a tax equal to the vertical distance between the curves shifts the
supply curve from S1 to S2 and influences the market. This is sometimes called “internalising
the externality” because it makes consumers and producers pay for environmental costs.
Likewise, governments can provide subsidies to consumers or producers to encourage
production of environmentally beneficial goods and services.
Governments generally prefer taxes over subsidies when they want to influence economic
behaviour. Although it is difficult to calculate the full cost of an externality, and therefore
to calculate the optimum tax rate to implement, there are other benefits to taxes
over subsidies. Taxes discourage environmentally damaging activities. They also raise
government revenue that can be used for other environmental programs. For example,
through the Product Stewardship for Oil Program, the Government imposes a 8.5 cent per
litre levy on the purchase of oil to help fund the recycling of old oil. Environmental tax
revenues constitute a varying proportion of government tax revenues in OECD countries,
ranging from less than 3 per cent in the United States to more than 11 per cent in India.
Australia’s revenues from environmental taxes are around 5 per cent of the total tax base.
Subsidies are grants provided by the government to producers with the aim of reducing
costs of production and promoting environmentally beneficial activities. For example, the
federal Government’s Australian Renewable Energy Agency (ARENA) provides funding
for research and development, as well as large-scale renewable energy projects.
Over time, there has been a shift towards policies to facilitate market development
and support private sector investment, rather than more direct forms of government
intervention. In 2023, the Australian Government introduced the Nature Repair Market
Bill to Parliament. The Bill sets out a framework for a voluntary national nature repair
market, which would issue tradeable certificates for projects that restore and protect
nature. This rewards landowners for supporting biodiversity, and enables businesses to
invest in nature repair.
Water management is another contested area of environmental policy that has adopted
market-based reforms. A recent Productivity Commission review found that governments’
water management efforts – which created clear property rights for water, established
water markets and improved water planning – had been successful in lowering household
water use, increasing water allocations to the environment, and making industry water
use more efficient. However, the review also found that existing efforts were not sufficient
to meet future water policy challenges associated with growth in city populations and
the impact of climate change. It recommended changes to water management in urban
areas, including water recycling and the use of stormwater. Water policy issues are also
increasingly linked to an international climate change agenda. In 2023, the UN held
its first international water conference in 46 years to grow commitments to improve
management of water resources globally.

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CLIMATE CHANGE POLICIES

“Decarbonising” economies – that is, reducing the carbon to achieving specific targets. Australia has in the past
emissions from economic activity that contribute to climate negotiated lower targets for emission reductions than most
change – is widely regarded by economists as the greatest other advanced economies, arguing that our reliance on
economic reform challenge of the 2020s. Climate change emissions-intensive industry and fossil fuels for energy has
poses a profound threat to the global economy, the made it more expensive to achieve ‘emissions abatement’.
stability of international relations and the environment. This is because the cost of reducing each unit of emissions
As the Reserve Bank noted in 2019, climate change in Australia is higher than in many other countries. Over time,
threatens disruption to economic output through extreme this has resulted in growing global criticism of Australia’s
weather events as well as higher insurance costs, legal efforts to address climate change – particularly due to
risks and falling asset values. A 2023 IMF analysis of the Australia’s opposition to stronger action in international
effects of climate shocks on inflation and growth found negotiations.
that climate-induced natural disasters increase volatility,
Australia’s emission reduction targets have centred on three
in particular inflation shocks, that can harm all sectors of
key dates:
the economy. Scientists are recording growing evidence
of rising sea levels, more intense droughts and floods, • 2020 target: In the lead up to 2020, Australia adopted
and more extreme and unpredictable weather events. a target of reducing carbon emissions by 5 per cent on
Despite widespread agreement on the seriousness of the 2000 levels. This target was criticised for being too low
threats from climate change, it has been very difficult for and while Australia met the target, it was only made
governments around the world to agree on how to respond possible due to a number of technical and temporary
and who should bear the costs of structural changes. factors. These factors included a slower rate of growth
than anticipated, the way that emissions relating to
International agreements
land usage were calculated and the success of the
The global threat of climate change was recognised in Renewable Energy Target which expired in 2020.
December 1997 when 160 nations reached an agreement
• 2030 target: Australia’s 2030 target was a major issue in
in Kyoto, Japan. The agreement limited emissions of carbon
the 2022 Federal election, with the Coalition parties (in
dioxide and other greenhouse gases. The Kyoto Protocol is an
government) committing to a 26–28 per cent reduction by
international agreement that required industrialised countries
2030 on 2005 levels, while the Labor Party (in opposition)
to set internationally binding emission reduction targets. promised to increase this target to 43 per cent. Labor
At the 2015 UNFCCC Conference in Paris, representatives won the election, and along with a large number of
from nearly 200 countries made a commitment to keep Independent candidates (the “teal Independents”) and
“the increase in global average temperature to well below Greens, advocated for a higher target. As a result, the
2 degrees Celsius above pre-industrial levels”. This is the 43 per cent target was subsequently passed into law
benchmark scientists believe is necessary to prevent the in the Climate Change Act 2022. The Independents
most dangerous impacts of climate change. This agreement also successfully amended the law so that the 43 per
reflected the difficulty in climate change negotiations cent target is a minimum, that climate policies benefit
of achieving a compromise between the interests of regional communities, and that advice is sought from the
high-income and developing countries. High-income Climate Change Authority before setting future targets.
countries have large per capita greenhouse gas emissions, The Climate Change Authority (CCA), an independent
whereas developing countries have lower but rising levels government agency, had in 2015 recommended a 40–60
of emissions and rely on using cheap fossil fuels to expand per cent reduction by 2030.
their output and improve living standards. The Paris
Agreement, effective since 2020, is significant because, for • 2050 target: Australia has committed to achieving
the first time, it included developing nations such as China “net zero” emissions by 2050. This requires a reduction
of greenhouse gas emissions so that the amount
and India, alongside the United States (which withdrew
of greenhouse gases that the Australian economy
under President Trump, and then rejoined under President
produces is the same as the amount we remove. In
Biden). The Agreement has mechanisms for transparency
2023, the Government also announced a new national
and monitoring progress, but its weakness is that individual
government agency, known as the “Net Zero Authority”,
countries set their own targets for emissions reduction. The
to support the energy transition required to achieve
Paris Agreement came into force in November 2016, and
Australia’s net zero target and manage the ongoing
has 193 signatories. Its implementation received a setback
economic transformation.
with the COVID-19 pandemic, with countries delaying
negotiations for the “rulebook” to guide individual country Domestically, Australia’s climate change policies have also
actions. faced criticisms from economists and business leaders
about the absence of an overall policy framework to
Setting targets for emission reductions
sustain long-term emission reductions since the abolition
A key part of international policymaking to reduce global of the carbon tax in 2013. Since then, Australia’s efforts
carbon emissions is that individual countries commit have depended on piecemeal measures that have been

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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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Chapter 16: Microeconomic and Environmental
Chapter 15: MonetaryPolicies
Policy

Australia’s participation in international treaties

Treaty Year signed

The CITIES Convention on International Trade in Endangered Species of

1976
Wild Fauna and Flora

The Vienna Convention for the Protection of the Ozone Layer 1987

The Montreal Protocol for Chlorofluorocarbon Control 1989

The Convention on Biological Diversity 1993

The Convention to Combat Desertification, to address land degradation

2000
in the world’s drylands
The Stockholm Convention for the protection of human health and the
2004
environment from organic pollutants

The Kyoto Protocol on climate change 2008

The Paris Agreement on climate change 2016

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.

4 Microeconomic reform improves the efficiency of the operation of markets on

the supply side of the economy. This results in an improvement in allocative
efficiency, technical efficiency and dynamic efficiency.

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.

6 Reforms to public trading enterprises have included corporatisation,

putting the organisations at arm’s length from government so they run like private
sector businesses, and privatisation, which involves selling the business to the
private sector.

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.

8 Most economists agree that microeconomic policies have contributed to

Australia’s improved economic performance since the 1980s, with higher levels of
productivity and economic growth and lower inflation and unemployment.

9 Environmental sustainability has been increasingly recognised as an important

policy objective in the context of managing the economy. Environmental
management policies such as targets, market-based policies and regulations
aim to improve the environmental sustainability of the Australian economy.

10 The highest priority environmental issue is climate change, with economies

across the world transitioning towards a “net zero” carbon emissions goal.

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Chapter 16: Microeconomic and Environmental Policies

chapter review
1 Explain how microeconomic policies aim to increase economic growth.

2 Discuss how microeconomic policies contribute to greater efficiency in

the economy.

3 With the aid of a diagram, explain how microeconomic policy influences

aggregate supply in the economy.

4 Outline the main areas in which the government has implemented

microeconomic policies.

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.

7 Examine the benefits and costs of microeconomic policies.

8 Describe THREE environmental management policies that have been implemented

in Australia.

9 Evaluate the effectiveness of regulations compared with market-based policies in

achieving environmental sustainability.

10 Outline the influence of targets and international agreements on environmental

management in Australia.

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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.

17.2 The role of national and state

workplace systems
Australia has traditionally regulated its labour market through a mix of federal and
state laws, with significant overlaps between the different systems. This is because the
Australian Constitution does not give the Commonwealth Government the power to
directly legislate over the labour market – instead, it only gives the Commonwealth
the power to resolve industrial disputes that cross state boundaries. Nevertheless, the
Commonwealth has gradually expanded its role in labour market policies over the past
century through other constitutional powers. These policies have centred on what have
historically been called “industrial relations” or, more recently, “workplace relations”.

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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.

Partnerships State Federal

Local
Corporations and sole Government Government
Government
traders Public Sector Public Sector

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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17.3 Australia’s wage determination

system
Australia’s national wage determination system is set out in the Fair Work Act (2009), and
it covers around 70 per cent of working Australians. There are four means for determining
pay and conditions for employees within this national system:
• Awards and collective agreements (or enterprise agreements) make up the formal
system.
• Individual contracts (sometimes called common law contracts) and working
business owners form the informal system.

Formal system Informal system

Awards Collective Common law contracts Working

only agreements (individual arrangements) business owners
23.0% 35.1% 37.8% 4.1%

Trade-offs of award conditions,

subject to “better off overall” test

Modern Awards (10 matters)

National Employment Standards (guaranteed employment conditions)

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.

Figure 17.2 – The workplace relations framework

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.

COVID-19 AND THE LABOUR MARKET

Australia’s wage determination system was designed to changes to the Fair Work Act. Rules relating to workers’
provide flexibility in response to the ups and downs of the hours, duties, days and location were suspended for a
economic cycle. However, the labour market impacts of the period of six months, giving employers powers to change
COVID-19 pandemic in 2020 were so unprecedented that existing arrangements quickly and to require employees
temporary changes to the system were taken to minimise to use up their annual leave. This was significant as it
job losses during the national lockdown, which closed not only made the workforce vastly more flexible during
many places of work – with the support of governments, lockdowns, but also because it remains one of very few
businesses and unions. instances in which unions and business groups have
A lesson from past recessions is the long period of time found consensus on wage determination.
it takes to reduce sudden increases in unemployment. While there was agreement between the Government,
To prevent employers laying off workers, the Government employers and unions on these emergency measures,
introduced JobKeeper, a payment to businesses initially set there was no consensus on longer-term reform. The
at $1500 per fortnight to subsidise employee wages. Morrison Government nevertheless tried to make several
In addition to the JobKeeper program, agreement was changes to the Fair Work Act, but only secured enough
reached between governments, employer groups and the votes in the Senate for some small changes to improve
Australian Council of Trade Unions (ACTU) to allow temporary protections for casual employees.

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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

Individual Collective Individual Collective

arrangements agreements arrangements agreements
38.7% 42% 37.8% 35.1%

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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Chapter 17: Labour Market Policies

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).

Common law contracts and employment contracts for

high-income earners
Individual arrangements cover almost 40 per cent of workers in the federal system. The
most common individual arrangement is a common law contract, which are especially Common law contract is
widespread in small businesses. These often set out terms of employment in just one or an individual agreement
two pages. These arrangements are enforced through ordinary law courts rather than between an employer
and individual employee
through workplace tribunals, as they are not considered to be part of the formal industrial that sets out pay and
relations system. conditions for work.
These are commonly
There are two key differences between common law contracts and enterprise agreements.
used by small businesses
The first is that they are negotiated individually, not collectively. The second is that and high-income earners
they cannot trade off or lower any award entitlements inlcuding pay. The one exception not covered by awards.
to this rule is employment contracts for high-income earners. Under the Fair Work
Act, modern awards do not apply where an employee is earning in excess of a threshold
(salary of $167,500 in 2023–24). High-income earners are only covered by the National
Employment Standards rather than entitlements in awards as the award system was
designed to provide a safety net for lower-income workers with less protections.
Except for high-income earners, individual contracts cannot bypass the award system and
industrial regulations. Previously, a system of individual contracts known as Australian
Workplace Agreements (AWAs) were allowed from 1997 to 2009. They were abolished by
the Fair Work Act, following criticism that they were unfair because employers have much
greater bargaining power than individual employees, so AWAs were often imposed on
employees with no genuine negotiation process. In some cases, employers used Australian
Workplace Agreements to remove entitlements that employees had previously enjoyed
under collective (or enterprise) agreements and awards, such as penalty and overtime rates.
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EMPLOYEES OR INDEPENDENT CONTRACTORS?

THE DILEMMA OF WORK IN THE “GIG ECONOMY”
One of the greatest challenges to Australia’s labour market Commission followed the High Court’s ruling and found
policies today is the transformation of work arising from that a Deliveroo driver was not protected from unfair
the “sharing economy” or the “gig economy”. Sharing dismissal, because he was not an employee under
economy businesses provide a platform for customers the terms of his contract. As a contractor, he had no
to interact directly with individual workers who provide protections when he lost his job with Deliveroo in 2020
services such as fast-food delivery, transport and general after its algorithm determined he was too slow in his
household assistance. A report commissioned by the deliveries. In contrast in 2022, a NSW court ruled that a
Victorian Government estimated in 2020 that more than Hungry Panda delivery rider who died in a road accident
one million Australians had gig economy jobs, with over 100 while making a delivery was in fact an employee. His
digital platforms. family was therefore entitled to an $830,000 workers’
Gig economy businesses usually classify their workers as compensation payout.
individual contractors rather than as employees, excluding To resolve this confusion, the Albanese Government
them from the Fair Work Act’s coverage. However, gig set out plans to give the Fair Work Commission (FWC)
economy businesses often treat workers like employees, formal powers to establish minimum standards for
providing the materials needed for the job and setting a gig workers, while aiming to preserve the flexibility of
fixed rate of pay per item contractors produce or service digital platforms. The Fair Work Legislation Amendment
they perform (such as delivery of fast food). This lowers (Closing Loopholes) Bill, introduced to parliament in
business costs compared to hiring employees, because September 2023, also addresses loopholes relating to
those businesses are able to avoid normal employee “permanent casuals” and labour hire arrangements.
entitlements and award wages. The FWC is given powers to create minimum standards
During the 2010s, the FWC made several major rulings for gig workers who are not employees where three
about whether a gig worker is an employee using what is conditions are met: individuals are on low pay compared
known as the “multi factor test” (see figure 17.4), which to employees, have low bargaining power, and have
considers the key factors of an individual’s day-to-day limited control over their work. In introducing the Bill,
work. However, a landmark High Court decision in 2022 Workplace Relations Minister Tony Burke argued that,
ruled that a written contract ultimately determines whether “it’s got to be possible to have 21st-century technology
an individual is an employee or contractor. The Fair Work without having 19th-century working conditions”.

EMPLOYEE INDIVIDUAL CONTRACTOR

Control over how work is performed Less control More control
Hours of work Standard or set hours Controls hours of work
Bears financial risk No risk Bears the risk of making a financial loss on each task
Superannuation Employers pay Pays themself
Entitled to receive paid leave Yes No
Expectation of work Ongoing expectation Engaged only for specific tasks
Tools and equipment Provided by employer Uses their own
Source: Fair Work Ombudsman

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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17.4 Dispute resolution

One of the most important roles of an industrial relations system – alongside determining An industrial dispute
wages and work practices – is to resolve disputes that arise between employers and occurs when employers
employees (commonly described as the “parties” to an agreement). Disputes can arise or employees take
action to disrupt the
because of disagreements over many issues, including changes to wages, work conditions, production process
business restructuring and specific actions of employers that employees consider wrong in order to highlight a
or unfair, such as a decision to sack an employee or some employees. Disputes can lead to disagreement between
different forms of industrial action that interrupt work, including: employers and
employees.
• strikes, in which employees withdraw their labour and refuse to work
• work bans, in which employees refuse to undertake a certain aspect of their work
• lockouts, in which employers refuse to give employees access to their workplace.
One of the aims of an industrial relations system is to solve these disputes quickly,
efficiently and fairly, because industrial action can result in reduced productivity, lower
output, lower profits and damage to a business’s customer relationships.
The processes for resolving industrial disputes in Australia have undergone major change
in recent decades. Since the early 20th century, Australia has mostly relied on a unique
system of specialist industrial tribunals to administer dispute resolution processes. The
specialist tribunals aim to avoid drawn-out disputes that occur in other countries and allow
for an independent umpire to make a judgment based on fairness and business conditions.
The two main forms of dispute resolution that have been practiced in Australia are:
• Conciliation – a process whereby an industrial tribunal tries to help the parties Conciliation is a dispute
reach a mutual agreement. The tribunal does not impose a resolution on the parties, resolution process
in which firms and
but once the parties reach an agreement, they might undertake proceedings with
employees meet to
the tribunal to formally implement their respective sides of the agreement. discuss their differences
• Arbitration – when an industrial tribunal makes a legally binding ruling that in the presence of a third
resolves a dispute. This occurs after the tribunal has given both parties the party (such as from an
opportunity to put forward their arguments. Where conciliation is unsuccessful, industrial tribunal) who
attempts to bring the
arbitration can resolve the dispute and require employees to return to work. parties to an agreement.
Australia has shifted from resolving industrial disputes mainly through compulsory
arbitration to a system where arbitration is only used in rare circumstances. In most Arbitration is a dispute
instances, employers and employees take responsibility for resolving their disputes. Under resolution process in
the Fair Work Act, the Fair Work Commission has limited powers to intervene: which an industrial tribunal
• Compulsory dispute settlement terms: The Fair Work Act requires that all hands down a legally
binding ruling to firms and
awards and enterprise agreements explain the process that the parties will adopt if
employees.
they have a dispute relating to their agreement. A common feature of such a term
is that if parties cannot resolve a dispute between themselves, they must refer it
to a third party organisation that can assist. This third party might be the Fair
Work Commission or a non-government organisation that offers dispute resolution
services.
• Bargaining in good faith: To make the bargaining process fair and orderly, both
employers and employees must comply with six good faith obligations, including
participating in all meetings, disclosing relevant information, giving genuine
consideration to all proposals and refraining from conduct that would undermine
collective bargaining. Although it rarely uses these powers, the Fair Work
Commission can make legally binding orders if either side breaches their obligation
to bargain in good faith. The aim of the bargaining rules is to put pressure on both
parties in a negotiation to be constructive and reach agreement.
• Intractable bargaining declarations: Under changes in effect from 2023, the
Fair Work Commission can make a declaration where negotations have become
“intractable”, and after an optional period of time for parties to finalise negotiations,
the Commission can decide the outcome of the negotiations, through a workplace
determination.
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Australia in the Global Economy 2024

• Resolving industrial action: Industrial action is permitted during the process

of enterprise bargaining. The Fair Work Commission is only able to step in to
suspend or terminate such industrial action if special circumstances exist, including
where there is threat of significant harm to the economy or the population, or the
industrial action has been going on for a long period of time and is damaging the
bargaining parties.
One measure of the effectiveness of an industrial relations system and its dispute resolution
processes is the level of disputes and strikes. As figure 17.5 shows, Australia has experienced
a low level of days lost in industrial disputes in recent years (in contrast, more than 4
million days’ work were lost due to disputes in 1981). The low level of industrial disputes
reflects the way in which employer/employee relations changed in recent decades, with
increased competitive pressures, changes in industry structures and lower levels of union
membership. There is now
Working days lost (’000) less conflict and a stronger
1800 focus on employers and
employees cooperating to
1600 resolve disputes themselves.
1400 In addition, since the 1990s
the right to strike has been
1200
curtailed by laws that only
1000 allow industrial action
during a formal bargaining
800
process and only in very
600 limited circumstances when
400
an enterprise agreement is
in force. Nevertheless, the
200 Productivity Commission
0 has previously noted that
2023
1992

2002

2012

2022
1990

1994

2000

2020
1998

2004

2010
2008

2014

2018
1996

2006

2016

industrial disputes play a

positive role in reducing
Source: ABS Industrial Disputes, Australia (Cat. no. 6321.0.55.001), March 2023 Year
workplace power imbalances
and can improve efficiency
Figure 17.5 – Number of working days lost due to industrial disputes in Australia, 1990–2023 in the long term.

WHERE DOES THE GENDER PAY GAP COME FROM?

One aspect of Australia’s industrial relations system (16.1 per cent) than the public sector (11.2 per cent),
that has recently been tested through industrial and higher for those on individual agreements
action is the pay gap between men and women. (16.1 per cent) compared to collective agreements
This is known as the gender pay gap. The pay gap is (12.8 per cent).
monitored by the Workplace Gender Equality Agency. Not every comparative measure shows women
The national gender pay gap fell to a record low being paid less than men. Among employees who
of 13.3 per cent in 2023. It has fallen significantly are directly covered by awards, pay for women is
since 2014, when women earned, on average, 18.5 3.8 per cent higher than for men. Award-only pay
per cent less than men. One reason for this gap is is more common in industries with higher female
that male-dominated industries, such as mining and employment, reflected in the fact that women are
financial services, tend to pay more than industries the majority of the 23 per cent of employees who
with higher proportions of female workers, such as are on award-only pay arrangements (comprised of
health and education (the gender pay gap is 22.1 13.6 per cent women, 9.4 per cent men). But since
per cent in Western Australia, which has a higher award-only employees are typically paid less than
proportion of mining and construction industry those on enterprise agreements or common law
jobs, whereas it is only 7.8 per cent in South contracts, in overall terms the gender pay gap is not
Australia). The gap is also higher in the private sector bridged by the award system.

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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.

17.5 Decentralisation of the

labour market
Australia’s industrial relations system has undergone a historic shift in recent decades
from a highly centralised wage determination system for most of the 20th century, to a
system where wages are mostly determined through enterprise bargaining at the level of
individual businesses or workplaces. This reflects a shift from using non-market forces
to a greater reliance on market forces to determine wage outcomes.
A centralised labour market is one in which wages and other labour market outcomes are
primarily determined by a government, or a government-appointed tribunal such as the
Fair Work Commission. A decentralised labour market determines wage outcomes at a
workplace level, with a lesser role for industrial tribunals. This means that market forces
of supply and demand for labour, as well as the individual firm’s capacity to pay, play a
greater role in determining wage increases. This ensures that there is more flexibility, and
wage levels change between different firms and industries.
Early in the 20th century, Australia developed a centralised system of wage determination
that reflected a national culture of fairness and a belief that workers should be paid the
same wage for doing the same work. It also reflected the influence of the union movement,
with most Australian workers belonging to a union. The national industrial tribunal was
known from 1904 to 1956 as the Commonwealth Court of Conciliation and Arbitration
(now the Fair Work Commission), and similar tribunals also existed at a state level.
Governments believed that allowing the market to set wage levels would result in some
workers being underpaid and exploited. Instead, a system of tribunals could deliver
fairer and more consistent outcomes, using a formal process in which representatives of
employers and unions presented their arguments for or against a wage increase or a change
in working conditions.
In the early 1990s, economists argued that greater flexibility was needed so that wages
could increase faster in more efficient sectors (to attract more labour), and wage increases
needed to be more closely tied to productivity growth so that employees had the incentive
to improve their skills and work practices. As a result, from 1991 Australia began shifting
to a labour market where wages were mostly set through enterprise bargaining, while
the highly centralised award system would only provide a safety net of minimum wages
and conditions.

Centralisation Decentralisation

Single national Awards with wages Enterprise Individual

wage case for all set on an industry or bargaining contracts
employees occupation basis

Figure 17.6 – Centralised and decentralised wage determination systems

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Australia in the Global Economy 2024

Arguments in favour of decentralisation

• A decentralised system can lead to a more efficient allocation of resources and
structural change. Firms that are more efficient can afford to pay more and therefore
attract higher-skilled employees. In contrast, centralisation can slow down the
pace of structural change. If the same wage increases occur across all industries, it
becomes difficult for more profitable and growing industries to attract more highly
skilled labour from less profitable and declining industries – therefore slowing
down the process of structural change in the economy. The decentralised labour
market made it easier for Australia’s mining industry to attract skilled labour from
other sectors of the economy by offering higher pay. Between 2005 and 2015, the
Wage Price Index for mining industry workers grew by 53 per cent, compared to
an average of 40 per cent for workers generally.
• A decentralised system can promote productivity. It gives employees the incentive
to work more efficiently, because they can be rewarded directly for their productivity
improvements through arrangements at the workplace level. Conversely, under a
centralised wage determination system, employees in individual workplaces may
not have enough incentive to implement productivity improvements if they are
already guaranteed a uniform wage increase, regardless of whether or not they
improve their skills or adopt more efficient work practices. Higher productivity
also helps to reduce inflationary pressures in the economy.
• Wage flexibility can help the labour market adjust when the economy is affected
by negative shocks, which helps keep unemployment at a lower rate. If a recession
causes a reduction in the aggregate demand for goods and services, therefore
decreasing the demand for labour, a flexible labour market can allow wages to fall
while keeping people in jobs. This might help to minimise job losses or reductions
in corporate profits during a downturn. For example, during the COVID-19
pandemic, some firms initially reduced the working hours of full-time employees
as a trade off for eliminating fewer jobs. As the economy recovered, staff returned
to full-time roles.

Arguments against decentralisation

• Decentralisation tends to lead to greater inequality through increased “wage
dispersion”. Workers doing the same job in different industries or firms may receive
different pay and working conditions. This is particularly the case for low-skilled
workers, who are easier to replace, might be less familiar with their workplace
entitlements and are less able to demand pay rises from their employers.
• A decentralised labour market can produce outcomes that reflect imbalances
in bargaining power between employers and employees. Those employees who
are in an industry or firm where unions have little power are less likely to achieve
wage increases, regardless of their productivity, because they lack bargaining power
with employers. In practice, wage increases can often reflect the bargaining power
of employees more than improvements in productivity. In 2023, the Government
enacted “multi-employer” bargaining to give employees more bargaining power.
• Enforcement of wage entitlements becomes more difficult under a decentralised
system. In recent years, widespread problems with the underpayment of workers
have emerged across many Australian industries. In 2023, Fair Work Australia
secured undertakings to redress underpayments from a wide range of small to large
businesses, including $32 million from Suncorp and $4 million from the University
of Technology, Sydney. Even the Reserve Bank owned up in 2023 to over $1 million
of underpayments. In 2023, the Government announced plans to strengthen
enforcement for wage entitlements through introducing criminal penalties and
requiring employers to pay superannuation at the same time as ordinary wages to
prevent long-term underpayments of superannuation.

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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.

17.6 Education, training and

employment programs
In addition to regulating the industrial relations system, governments also influence
labour market outcomes through their policies relating to education and training,
apprenticeships, social security (welfare benefits) and employment services. These policies
aim to increase participation in the workforce, improve the productivity of the workforce
and prepare workers for future changes in the labour market. Labour market policies can
use a wide range of policy instruments to achieve these outcomes.

Education and training

Governments play a central role in shaping the education system, ranging from pre-school
to tertiary education. From an economic perspective the most successful education system
is one that provides students with a broad range of skills that will help make them more
productive and able to adjust to changing economic conditions. Overall, the economy
will be more productive and grow faster if it has a higher quality and more responsive
education and training system.
To improve Australia’s capacity to train workers for the skills demanded by a fast-changing
job market, in 2022 the Albanese Government established Jobs and Skills Australia. Its
role is to improve Australia’s long-term planning of skills training, addressing significant
national skill shortages and helping workers re-train for jobs in growing sectors. According
to the Labour Market Update in May 2023, 92 per cent of new jobs in Australia require
post-secondary school qualifications. Increased use of artificial intelligence is accelerating
change in the labour market, underscoring the need for ongoing training for workers to
have the skills required by the labour market.
To encourage school leavers to study in areas where there are shortages of workers, in
2022 the Morrison Government significantly changed the prices of university degrees.
Fees decreased up to 60 per cent for health, maths, agriculture and teaching degrees
to encourage high school leavers to study (and ultimately work) in these areas facing
shortages. In contrast, in other areas such as humanities and communications, fees
increased by 113 per cent. However, data from NSW universities showed that despite
the higher fees, there was a 9 per cent increase in enrolments for humanities degrees in
2022. This reflects the fact that fees are only one of several factors, along with interests,
abilities and earning potential, that shape student choices.

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Australia in the Global Economy 2024

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.

Labour market programs

Governments deliver a range of labour market assistance programs that aim to improve
people’s readiness for the labour market and increase participation and productivity. Many
of these programs address the individual circumstances that might make it harder for a
person to find suitable work – including a disability, mental illness, language barriers
or having been out of the paid workforce for a long period of time. These programs are
integrated with income support (or welfare) payments, so that the ability of individuals
to receive continued income support is often tied to them making genuine efforts to find
paid work. In Australia, a national agency called Centrelink oversees individuals’ access
to income support and their interaction with labour market programs.
Employment services – matching people to jobs and giving them adequate training – are
contracted through a network of government-funded employment services agencies. This
$1.3 billion network, called the New Employment Services Model, provides funding for
employment agencies to prepare unemployed people for work and place them into available
jobs. Employment agencies are provided with higher payments for successfully helping
the long-term unemployed find work.
A major long-term goal of labour market policies is to increase and sustain participation
in the workforce. The Australian Treasury’s Intergenerational Report predicts a long-term
decline in workforce participation, driven by the ageing of the population. Maintaining
high workforce participation, including keeping older people in the workforce, will be
needed to generate tax revenue that can offset the growing costs of the ageing population.
Measures taken to increase workforce participation include:
• During the COVID-19 pandemic in 2020 and 2021, the Government established
a JobMaker Hiring Credit aimed to prevent a rise in long-term unemployment
among younger people. JobMaker allowed businesses to claim $200 per week for
new employees aged 16 to 29 and $100 per week for those aged 30 to 35.
• In 2023, the Albanese Government announced a major overhaul of Australia’s
immigration system. The reform plan creates a three-tier system: a lower-wage
segment in specific sectors with labour shortages, such as aged care; a mid-level
segment for jobs paid above a new temporary skilled migration threshold of
$70,000; and a lighter-touch approach for highly paid, high-skilled migrants.
• Another feature of the reform plan is making it easier for temporary skilled
migrants, who are typically younger workers, to become permanent residents. This
helps to reduce the average age of the working population and increase participation
rates over the longer term.
• Among its smaller-scale labour market policies, the Government funds job fairs
and provides payments of up to $6,000 for workers moving to rural areas to work
in agriculture (known as AgMove).

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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.

17.7 Evaluating labour market

outcomes in Australia
Australia’s labour market has a hybrid system of wage determination that emphasises
market forces through enterprise bargaining, while retaining some non-market forces
such as labour market institutions like the Fair Work Commission. In concluding this
chapter we review some of the evidence about the performance of the system in recent
years, noting that many factors other than labour market policies can shape outcomes in
the labour market.
In overall terms, under enterprise bargaining Australia has sustained moderate wage
increases, low inflation and relatively strong employment growth. The shift to a
decentralised industrial relations system appears to have contributed to Australia’s recent
economic outcomes in several ways:
• Wages growth and inflation. A key macroeconomic goal for the wage
determination system is to sustain a level of wage growth that strikes a balance
between stable, low inflation outcomes and real income growth for wage earners.
Wage outcomes during recent decades have been consistent with sustained low
inflation, but have delivered low increases in real wages. The flexibility of the
decentralised system has allowed larger wage rises in specific areas where strong
wage pressures exist, without this spilling over to wage increases across the board.
The low overall wage outcomes of the late 2010s even prompted the former Reserve
Bank Governor, Philip Lowe, to advocate an increase in wage growth in order to
increase spending and strengthen economic growth. However, concerns about
inflation returned in 2022 following a sharp spike in inflation across the world.
Policymakers wanted to prevent the inflation surge from increasing inflationary
expectations and creating an inflationary wage spiral. As noted in figure 17.7,
wages growth accelerated in 2022–23 but remained well below the rate of inflation.
• Work practices and productivity. The deregulation of the labour market since
the 1990s has helped to bring about major changes in Australian work practices.
Australia experienced its best sustained productivity growth performance on
record during the 1990s, averaging 2.1 per cent per year as enterprise agreements

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Australia in the Global Economy 2024

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,

THE MYSTERY OF AUSTRALIA’S WAGE GROWTH

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

1.5 Actual wage growth

Budget forecasts
1.0 2015–16 2018–19 2021–22
2016–17 2019–20 2022–23
0.5 2017–18 2020–21 2023–24

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

Sources: ABS (Cat. no. 6345.0) and various budget papers

Budget year

Figure 17.7 – Forecast and actual wages growth

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Chapter 17: Labour Market Policies

Australia’s unemployment was 12th lowest among the OECD’s 38 economies,

despite the fact that Australia has the highest minimum wage levels in the OECD.
The labour market’s record of responding flexibly to changing circumstances was
shown following COVID-19, with unemployment falling below 4 per cent for the
first time since the 1970s.
• Income inequality. One of the negative effects of decentralised wage determination
is a widening of the gap between higher- and lower-income earners. Workers
with greater skills and who belong to stronger unions tend to receive larger wage
increases under enterprise agreements, whereas those with lesser skills and in
weaker bargaining positions do not. Although the past three decades of enterprise
bargaining have resulted in a widening of income inequality, the safety net of awards
and minimum wage increases has modestly increased real wages for the lowest-
income earners. In the decade to 2020, while consumer prices rose 22 per cent,
the national minimum wage rose 32 per cent – slightly faster than the increase in
the overall wage price index of 29 per cent. On the other hand, employees at the
top of the earning scale have enjoyed the fastest income growth – for example, in
2022–23 the average income growth of CEOs of large Australian companies was
15 per cent, more than four times that of the average worker.
For well over a century, Australians have been debating how the economy should set wages
and conditions for workers. This is unsurprising given that labour is the largest cost item
for most businesses (on average, labour is around 60 per cent of business costs). Policies
that influence labour costs therefore have a major impact on individual businesses and the
economy overall. At the heart of this debate are different views of the role of market forces
and non-market forces in Australia’s wage determination system. Historically, Australian
governments have believed that because employers possess unequal bargaining power over
individual employees, non-market institutions such as industrial tribunals are needed to
ensure outcomes that are fair to employees. In fact, Australia was among the first nations
in the world to recognise minimum entitlements for employees, such as the eight-hour day
and the right to a minimum wage that was high enough to support a decent standard of
living for a family. In its first term in office, the Albanese Government has given priority to
reforms to the Fair Work Act, to strengthen both the role of the Fair Work Commission and
the bargaining power of workers – reflecting the fact that long-running debate is ongoing.
The continued debate over workplace relations demonstrates that workplace issues remain
as much a part of Australian economic policy debate now as they have been since Australia’s
Federation more than 120 years ago. The processes for determining wages, work conditions
and work practices are among the most important aspects of economic policy because they
have such wide impacts on the economy and on people’s lives. For this reason, the debate
over labour market policies and their impacts is likely to continue for many years to come.

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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Australia in the Global Economy 2024

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.

2 Australia’s workplace relations system consists of three main streams – awards,

collective agreements and individual contracts (common law contracts).

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.

5 Enterprise bargaining is a method of wage determination in which a workplace

agreement is negotiated collectively between an employer and employees, often
represented by unions.

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.

8 Decentralisation refers to a situation in which instead of decisions about wages

being made by a government or a central industrial tribunal, they are made in
individual workplaces such as through enterprise bargaining.

9 Decentralisation of wage determination can increase productivity and help prevent

a flow-on of wage rises from one sector of the economy to another, but as a
result can also contribute to greater inequality in the distribution of income.

10 Labour market programs are implemented to address unemployment that

is related to supply-side factors such as frictional, structural and long-term
unemployment. These programs attempt to reduce the non-accelerating inflation
rate of unemployment by improving the skills, job-readiness and employment
opportunities of people who are currently out of work.

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Chapter 17: Labour Market Policies

chapter review
1 Outline the main features of Australia’s national workplace relations framework.

2 Outline how the minimum entitlements of employees are determined.

3 Define enterprise bargaining. Explain the role of enterprise bargaining in Australia’s

labour market.

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.

7 Explain the difference between a centralised and decentralised system of wage

determination.

8 Describe the relationship between wage outcomes and productivity.

9 Discuss the arguments for and against increasing the use of individual contracts
within the labour market.

10 Analyse the effectiveness of labour market policies in achieving government

economic objectives in recent years.

355
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.

18.1 An overview of the effectiveness

of economic management
Assessing the effectiveness of economic policies involves evaluating their outcomes against
the objectives that they were implemented to achieve. Policy objectives change over time,
Macroeconomic and governments have changed how they prioritise different objectives over recent decades.
policies are policies that Policymakers often need to choose between conflicting objectives (as discussed in chapter
affect the economy as 13). It is also important to consider the wider context for economic management to assess
a whole with the aim of the effectiveness of policy in addressing specific economic issues.
minimising fluctuations in
the business cycle. Also Since the early 1990s, the roles of different economic policies have been defined in
referred to as demand fairly clear terms. Overall, macroeconomic policy has aimed to achieve the maximum
management or counter- sustainable rate of economic growth. Australia’s long-term potential growth rate has in
cyclical policies.
recent years been revised down to 2.5 per cent, according to Treasury calculations in 2023.

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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.

Outcomes for growth, inflation, unemployment and

external balance
One way to assess the effectiveness of economic policies is to examine specific economic
outcomes. The sustained economic growth in the period from 1991 to 2019 was
achieved because the economy avoided major fluctuations in the business cycle, such as
where a boom in growth triggers a surge in inflation, which then needs to be curbed by
contractionary policies such as high interest rates that might trigger recession. Stable
economic growth was underpinned by relatively high population growth, resilient terms

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Australia in the Global Economy 2024

HOW AUSTRALIA STACKS UP

OVERALL, AUSTRALIA IS AMONG THE BEST LOW UNEMPLOYMENT AND AFFECTED BY SURGING
PLACES TO LIVE IN THE WORLD – WITH A VERY INFLATION, LIKE OTHER COUNTRIES
HIGH HUMAN DEVELOPMENT INDEX.
Inflation (%)
HDI (1.00) 12
0.96 11
10
0.95 9 United
8 Kingdom
0.94 +
7 Euro Area
+
Switzerland 0.962

Hong Kong, China

(SAR) 0.952

New Zealand ++ Australia

Australia 0.951

0.93 6
Denmark 0.948

Germany 0.942 + India

Sweden 0.947
Norway 0.961

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 (%)

AUSTRALIA’S GROWTH IS ABOVE OTHER AS OTHERS REDUCE THEIR EMISSIONS, AUSTRALIA

ADVANCED ECONOMIES. FACES BIG ADJUSTMENTS AS ONE OF THE LARGEST
Economic PER CAPITA EMITTERS OF GREENHOUSE GASES.
7.0

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

Carbon dioxide emissions per capita (metric tonnes)

Annual economic growth (2022)
Source: World Bank, accessed 2023
Source: World Bank, accessed 2023

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

Figure 18.1 – Australia’s economic performance since 1990

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

TIME FOR A PARADIGM SHIFT IN ECONOMICS?

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.

18.2 Limitations of economic policy

Several factors can constrain the effectiveness of economic policies and affect whether or
not the policies achieve their goals. Below we note three key factors that can influence the
effectiveness of policies: time lags, political constraints and global influences.

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.

Policy Implementation time lag Impact time lag

Fiscal Medium term (annual Budget) Short term (a few months)
Short term
Monetary Medium term (6–18 months)
(monthly RBA meeting)
Microeconomic reform Long term (a few years) Long term (up to 20 years)

Figure 18.2 – Policy time lags

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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Australia in the Global Economy 2024

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

Figure 18.3 – Political constraints on economic policy

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.

18.3 Evaluating the effectiveness of

specific policies
To examine the effectiveness of economic policies we must look at individual policies and
determine whether or not they have been effective in achieving their goals in comparison
with other policies. This can be a challenge because it is often difficult to isolate the specific
effects of one policy compared with another. However, we can assess the effectiveness of
policies by analysing:
• the specific objectives of a policy
• whether the policy was implemented effectively
• the relevant economic outcomes, and how they compare with the objectives
• time lags
• other factors that may have affected outcomes during that period, including external
factors
• whether there were any side effects associated with policy implementation.
In evaluating whether a policy has been effective, we need to identify the policy’s original
objective. For example, in evaluating the effectiveness of monetary policy we first identify
that the Reserve Bank’s goal is to keep inflation within a target range of 2 to 3 per cent
over the medium term. With this objective, monetary policy over the past two decades
at the very least would appear to have been successful. If its target was to achieve zero
inflation, then we would conclude that it has failed to achieve its objective.
The next question to ask is whether the government actually implemented the policy
that it had originally set out to implement. Policies might be changed before they are
fully implemented, for example, if a government is voted out of office or has changed its
priorities. In addition, sometimes governments have economic policies that they are not
able to implement because of political constraints.
The next step in evaluating policies is to review the economic outcomes, and how closely
they relate to the policy objectives. Sometimes it is difficult to determine whether a policy
has been successful, because governments do not always set themselves specific targets or
For further information
objectives when they implement a policy. For example, governments have set targets for
on Australia’s economic
performance and policies, economic growth and inflation during recent years, but not for unemployment, other than
visit the OECD website, a general aim of reducing the rate. Without specific goals, it is more difficult to measure
and the Treasury website. the effectiveness of policies.

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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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Australia in the Global Economy 2024

• The COVID-19 pandemic forced governments at a state and federal level in

Australia to make difficult trade-offs between maintaining economic activity and
the public health risks associated with travel and interaction. Lockdowns and
closures of Australia’s international and state borders cost the economy tens of
billions of dollars, but governments assessed that the consequences of not taking
those measures would have been even worse.
• In recent years economists have raised concerns about excessive growth in housing
prices in Sydney and other cities, and whether Australia’s household debt levels are
sustainable. Some economists have argued that greater controls should be imposed
on lending for housing. However, such measures would also result in lower levels
of economic activity and household incomes.
• When economies have high public debt levels, governments must make difficult
trade-offs between reducing their budget deficit (to address financial market
concerns about public debt levels) and the risk that contractionary fiscal policy
could put their economy back in recession. Australia has not faced this difficult
trade-off in recent years, because it has had much lower deficits and debt levels than
other advanced economies, but several Europeans economies face this constraint.
• Economists have historically accepted that there is a trade-off between achieving higher
levels of economic growth and increased inequality in the distribution of income and
wealth. In particular, “boom” periods (such as the resources boom in Australia, or
the rapid growth in the Chinese economy in the past three decades) often generate
income and wealth that is distributed very unevenly. Traditionally, it was thought
that countries must accept higher levels of inequality if they wish to achieve faster
growth. However, organisations such as the OECD and IMF now emphasise the need
for a more inclusive approach to economic growth, because of the negative economic
and social effects of increasing inequality. Advocates of inclusive growth argue that
policies to promote greater income equality will boost economic growth (because
measures to increase the incomes of lower-income earners will boost consumption,
and therefore growth). This suggests that there is no longer a clear trade-off between
increased equality and increased growth.
• In 2022, Australia legislated its commitment to reduce its carbon emissions to “net
zero” by 2050. However delivering on this commitment will require structural
changes to the Australian economy over the next quarter century, which in turn will
require greater certainty and stability in policy settings. For the past two decades
Australian governments have regularly changed their climate and energy policies
or have had their proposals rejected in Parliament. There has been extensive debate
about how policies that put a price on carbon emissions might affect different parts
of the economy, especially carbon-intensive industries in regions like Wollongong,
Newcastle and the Hunter Valley. Governments have been forced to make trade-offs
between the long-term goal of reducing greenhouse gas emissions and the short-term
impact of a carbon price, including higher energy prices, slower economic growth and
potential job losses.
Examining the side effects of economic policies, such as those discussed above, can help
us to reach a more balanced assessment of the effectiveness of the policy mix.

Economic management in Australia: Past, present and future

Macroeconomic management
Macroeconomic management has mostly proved effective in achieving its short- to
medium-term goals since the early 1990s. Economic growth has been sustained alongside
low inflation and relatively low rates of unemployment. When the global COVID-19
pandemic forced the economy into recession in 2020, Australia was in its 29th consecutive
year of economic growth: a world record. Australia recovered quickly from the COVID-19
recession, with unemployment falling to its lowest level in almost half a century.

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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.

2 Economic policies differ in their implementation time. While monetary policy

decisions can be implemented immediately, major changes to fiscal policy
generally take several months to plan and implement, and microeconomic policies
can often take several years to implement.

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.

Political constraints can have a significant impact on economic management,

6
including the three-year political cycle, the unpopularity of some policies and the
difficulty governments often experience in getting legislation through Parliament.

7 Effective economic management often requires governments to trade off some

objectives against others and to balance conflicting goals such as achieving
both low inflation and low unemployment.

8 The goal of achieving a sustainable rate of economic growth in the short

term balances the objectives of inflation, growth, unemployment and external
balance. The longer-term goal of raising the sustainable growth rate involves
improving international competitiveness, workforce participation and productivity,
and ensuring that Australia’s economic growth is compatible with a fair
distribution of income and wealth, and environmental outcomes.

Microeconomic policy is generally regarded as having succeeded in boosting

9
productivity, economic growth and living standards over recent decades.
However, some economists argue that Australia has not undertaken enough
microeconomic reform in recent years.

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.

5 Explain how political constraints can influence economic policymaking.

6 Evaluate the effectiveness of Australia’s economic policy mix in sustaining

economic growth and low inflation during the past decade.

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.

9 Evaluate the extent to which economic management in Australia has been

successful in recent years compared with preceding decades. Analyse the extent
to which this is the result of global or domestic factors.

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.

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appendix A Australia in the Global Economy 2024

YEAR 12
COURSE
TOPIC SYLLABUS SKILLS

The Global • analyse statistics on trade and financial flows to determine

Economy the nature and extent of global interdependence
• assess the impact on the global economy of international
Skills are an
organisations and contemporary trading bloc agreements important
addition
• evaluate the impact of development strategies used in a to any
range of contemporary and hypothetical situations economist’s
toolkit.

Australia’s • calculate the main components of Australia’s balance of payments

Place in • analyse the relationship between the balance of the capital and financial account and
the Global the net income balance
Economy
• explain the relationship between the current account balance and the balance of the
capital and financial account
• use supply and demand diagrams to explain how the value of a currency is
determined under different exchange rate systems
• analyse the impact of changes in the components of the balance of payments on the
value of the Australian dollar

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

Economic • explain how governments are restricted in their ability to simultaneously

Policies and achieve economic objectives
Management • use (simple) multiplier analysis to explain how governments can solve
economic problems
• identify limitations of the effectiveness of economic policies
• 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

Source: NSW Board of Studies, Offical Notice BOS 47/09, 2009

Figure A.1 – Economic skills in the Year 12 Economics Course

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.

A.2 Drawing and interpreting economics diagrams

Being able to draw and interpret diagrams is an
essential skill in the Year 12 Economics course. Price
D S
Some diagrams, like supply and demand in the
foreign exchange market, are explicitly referred
to in the Syllabus. Other diagrams, such as those
representing the labour market and market failure,
are not explicitly referred to in the Syllabus PT
but are nevertheless useful for deepening your
understanding of how economies operate. Some PW
diagrams are useful for representing the macro-
S D
economy at the “big picture” level, while others are
useful for analysing the microeconomic impacts of 0 Q Q2 Q3 Q1
Quantity
changes in specific parts of the economy.
Figure A.2 – International organisations and trade
In this section, we review the skills of the Course
agreements may result in lower tariff levels
where diagrams can be used to help explain how
economies operate. The impact of contemporary trading bloc
agreements is more complex. They may work to
Assess the impact on the global economy
of international organisations and
reduce tariff levels for all their trading partners (as
contemporary trading bloc agreements is the goal of the APEC forum), or they may only
reduce tariff levels for members of the trading bloc
Global protection levels have been significantly (as is the case in USMCA). In some cases, such
affected by international organisations and trade as the European Union, however, trading blocs
agreements. The World Trade Organization may not only maintain high tariff levels to shield
(supported by the International Monetary Fund and producers from outside competition, but may also
World Bank) has tried to achieve reductions in trade increase production subsidies, the effects of which
protection levels, such as tariffs, by facilitating trade can be shown in a diagram (see figure A.3). The
negotiations. The impact of these organisations production subsidies reduce the cost of production,
on tariff levels can be shown in a simple supply shifting the industry’s supply curve to the right,
and demand diagram (see figure A.2). For an causing an oversupply of products and depressing
individual economy, the removal of a tariff lowers global price levels, which will have adverse impacts
the domestic price of products (from PT to PW), and on exporters outside the trading bloc that do not
increases the amount of foreign products available receive government subsidies.
(from Q2Q3 to QQ1). The contraction in domestic
supply from import-competing firms (from 0Q2
to 0Q) may cause a (short-term) rise in domestic
unemployment.

377
appendix A Australia in the Global Economy 2024

Use supply and demand diagrams to explain

Price how the value of a currency is determined
S
D under different exchange rate systems
S1
Supply and demand diagrams can be used to show
how the value of a currency is determined. In
P the case of a floating exchange rate mechanism,
P1
the factors affecting the supply and demand for
a currency, such as interest rates, international
competitiveness, inflation rates, economic condi-
S
D tions and the sentiment of foreign exchange market
S1 speculators, will determine the value of the currency.
Q Q1
Quantity Changes in these factors can be shown by shifts to
the right or left of either the supply or demand
curves, which will cause either an appreciation or
Figure A.3 – Trading blocs may increase subsidies
and depress global price levels depreciation of the currency.

Analyse the relationship between the Exchange rate:

balance of the capital and financial Price of A$ in terms of US$
account and the net income balance
S
If a nation experiences a current account deficit
(CAD), it must be offset by a capital and financial
account (KAFA) surplus if it has a floating
90c
exchange rate system (because the supply and
demand for currency must always be equal). In
simple terms, the financial inflow on the KAFA
must either come from overseas borrowing, which D
adds to the foreign debt, or through the sale of 0 Qe Quantity of A$
assets to overseas investors, which adds to foreign
equity. Either way, a build up of debt and equity
(together known as foreign liabilities) must be Figure A.5 – Exchange rate determination under a
floating exchange rate system
serviced through either interest repayments or
dividend payments on the primary income account A fixed exchange rate system can be explained
of the CAD. If a nation continues down this path, using a similar diagram (see figure A.6). For this
it can result in the “debt-trap” cycle, which can exchange rate mechanism, the fixed rate is drawn
be difficult to break because further borrowing is above or below the exchange rate that would
required just to service past borrowings. prevail under a floating system, known as the
“market rate”. The government or central bank
need to buy the excess currency (Q1Q2) if the fixed
rate is above the market rate, or sell currency if the
fixed rate is below the market rate.

Exchange rate:
Price of A$ in terms of US$

D S

80c fixed rate

75c market rate

S D
0 Q1 Q2
Quantity A$

Figure A.6 – Exchange rate determination

Figure A.4 – The “debt-trap” cycle under a fixed exchange rate system

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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

Cumulative proportion of total income (%)

of the Australian dollar, causing a depreciation.
80
Figure A.7 shows that an increase in demand Line of equality
leads to an appreciation of the exchange rate. 60

Figure A.8 shows that an increase in supply leads A B

40
to a depreciation of the exchange rate.
Lorenz curve
20
Exchange rate:
Price of A$ in terms of US$
0 X
0 20 40 60 80 100
D1 D2
S Cumulative proportion of persons
ranked by income (%)
90c
Figure A.9 – A hypothetical Lorenz curve
80c

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

70c Use economic concepts to analyse a

contemporary environmental issue
D
S1 S2 A key concept in explaining contemporary environ­
0 mental issues such as pollution, climate change and
Quantity A$
preserving natural environments is externalities.
Externalities occur because the price mechanism
Figure A.8 – An increase in supply and depreciation
of the Australian dollar takes account of private benefits and costs of
production to consumers and producers but does
not take account of wider social costs and benefits
borne by all of society. Negative externalities are a
cost to society and can be shown as in figure A.10.

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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

Figure A.10 – Negative externalities

S D
Explain how governments are restricted in
their ability to simultaneously achieve LD Le LS Quantity
economic objectives of labour

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

Figure A.13 – Unsustainable economic growth may

0 reduce productive capacity in the long term
Unemployment (%)

Figure A.11 – The Phillips curve

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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

aggregate supply and aggregate demand

diagram. P1

• The expansionary and contractionary P

impacts of macroeconomic policies on
inflation and unemployment can be shown
using the Phillips curve. AS

• The impacts of reducing protection levels AD AD1

on prices, imports, and production levels of 0 Y Y1
import-competing firms can be shown using Total output

the tariff diagram.

Figure A.14 – Expansionary macroeconomic
• The impact of central bank intervention policy shifts AD to the right, causing a rise in output
in foreign exchange markets, or of and inflation
abandoning a fixed exchange rate system,
could be illustrated using the exchange Contractionary macroeconomic policy (such as an
rate diagram. increase in interest rates, an increase in taxation
or a decrease in government spending) reduces
• The impact of labour market reforms or aggregate demand, shifting the AD curve to the
income policy changes, such as a rise or fall left (see figure A.15). At the new equilibrium,
in the minimum wage rate and fall or rise in total output and income have decreased, so
unemployment, could be illustrated using unemployment will rise, and there is a fall in the
the labour market diagram. general price level (lower inflation).
• The impact of policies on income inequality
could be illustrated using a Lorenz curve. General price level
AD1 AD AS
• The impact of environmental policies to
conserve or better use natural resources
could be illustrated using a production
possibility curve. P

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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Microeconomic policies, such as reducing protection,

deregulating markets or increasing competition, General price level
AS
should in the long term increase aggregate supply, AD

shifting the AS curve to the right (see figure A.16). AS1

At the new equilibrium, total output and income

have increased, so unemployment will fall, and there P
is a fall in the general price level (lower inflation). P1

AS

AS1 AD

0 Y Y1
Total output

Figure A.16 – Microeconomic reform shifts AS to the

right, causing a rise in output and a fall in inflation

A.3 Equations and calculations in economics

Mathematical skills play a small but important role
The current account is calculated as:
in the Year 12 Economics course. Compared with
net goods + net services
natural sciences, the “mathematical” component of (the balance on goods and services)
economics is relatively straightforward, involving +
net primary income + net secondary income
only a handful of calculations and equations. But
compared with other humanities (essay writing) The capital and financial account is calculated as:
capital account + direct investment + portfolio investment
subjects, like History and English, studying +
economics does require a greater understanding other investment + reserve assets + financial derivatives
of how numbers operate, or more technically, how The balance of payments is calculated as:
quantitative information can be used to understand current account + capital and financial account
how economies operate. Equations and calculations +
net errors and omissions = 0
can be used to examine the economy as a whole, such
as through the injections and leakages equations, or
Figure A.17 – Calculating the balance of payments
to quantify specific economic outcomes, such as the
terms of trade index and the level of unemployment. If you are provided a limited number of components
In this section, we review the skills that require of the balance of payments you can use the formulas
equations and calculations. shown in figure A.17 to calculate unknown
components. For example, if you are provided
Calculate the main components of
Australia’s balance of payments
with values of the capital and financial account
surplus, and the net primary income deficit and
Explain the relationship between the net secondary income deficit, you can calculate the
current account balance and the balance of
balance on goods and services.
the capital and financial account
The current account and the capital and financial Calculate an equilibrium position for an
account are the two main components making economy using leakages and injections
up the balance of payments, and the sum of these An economy is in equilibrium if savings, taxation
two accounts adds up to zero under a floating and import leakages are equal to investment,
exchange rate system. The numerical value of the government spending and export injections. If you
current account is equal to the capital and financial are provided with the values of all six leakages and
account, but one account will have a positive value injections, you can test to see whether the economy
(in surplus) and the other will be negative (in is in equilibrium or not. If you are told that the
deficit). If there is an increase in the value of the economy is in equilibrium and you are provided
current account deficit there would be an equal with the values of five items, you can calculate
increase in the value of the capital and financial the sixth item. If you know the economy is in
account surplus. equilibrium and you are provided with the value
of three of these items and either the trade deficit

382
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Appendix A: Key Economic Skills

(X-M), the budget deficit (G-T) or the savings-

investment imbalance (S-I), you can also calculate Equilibrium occurs when:
the remaining item. Remember – the leakage and Aggregate Supply = Aggregate Demand
injection equation is only true when the economy
is in equilibrium. Therefore, it is sometimes called Y = AD
an equilibrium condition. Substituting for aggregate demand gives:
Y = C + I + G + (X – M)
S+T+M = I+G+X
Leakages = Injections Substituting for aggregate supply gives:
C + S + T = C + I + G + (X – M)
S = saving by households
T = taxation by the government By rearranging the equation:
M = spending on imports
I = investment spending by businesses S+T+M=I+G+X
G = government spending
Leakages = Injections
X = export revenue

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

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appendix A Australia in the Global Economy 2024

yet the economy with the higher multiplier will

1 also be more responsive to policy instruments,
k = (k being the symbol for the multiplier)
MPS making “fine-tuning” more difficult. When the
or
1 multiplier is lower, fiscal policy adjustments
k = (since MPC + MPS = 1) (government spending and taxation) and monetary
1 – MPC
policy adjustments (interest rates, which mainly
Y = kx AD affect investment and consumption flows) are less
necessary and have a smaller impact.
The size of the multiplier is an indication of how
Calculate the unemployment rate and the
much economic activity will fluctuate in the
participation rate using labour force statistics
event of an economic shock. A lower marginal
propensity to save increases the multiplier and Two important labour market outcomes require
makes economic fluctuations larger. Conversely, a a calculation. The first is the labour force
higher marginal propensity to save decreases the participation rate, which is the total number
multiplier and reduces economic fluctuations. of people employed or unemployed, divided by
the working-age population. The second is the
unemployment rate, which is the total number
1
k= unemployed, divided by the labour force.
MPS
Lower savings leakage increases the multiplier
and economic fluctuations Labour force Labour force 100
= ×
participation rate Working-age 1
(%) population (15+)
A higher multiplier generally makes life more
difficult for governments. The economy will Number of
experience greater fluctuations when there are Unemployment persons unemployed 100
= ×
economic shocks of increased injections or leakages, rate (%) Total labour force 1
suggesting the economy will need more active
macroeconomic (counter-cyclical) policies. And

A.4 Interpreting economic data and information

Our study of economics would be incomplete (and There are six broad categories of websites that we
fairly boring) if we only ever looked at diagrams, discuss – latest news, Australian Government
equations and economic theories without reference to sites, financial institutions, community sector
how economies operate in the real world. Analysing organisations, international organisations, and
the nature of economic relationships and the educational bodies. Artificial intelligence tools
performance and structure of economies in the real are also becoming increasingly useful for research.
world is central to the Year 12 Course. In broad terms, These tools can develop responses to queries that
the Syllabus highlights the importance of researching draw from several different sources, but responses
information from a variety of sources; analysing, should always be checked against other sources for
synthesizing and evaluating that information; and accuracy and completeness.
being able to communicate economic information,
Analyse statistics on trade and financial
ideas and issues. In the final section of this chapter,
flows to determine the nature and extent of
we look at the key skills in the Year 12 Syllabus global interdependence
that require individual research and how you can
find, interpret and explain economic data and Global interdependence is a complex phenomenon
information. that can not be adequately described by a couple
of statistics showing that trade flows and financial
In what follows, we focus on the use of the flows have increased in recent decades. Appreciating
internet and websites, highlighting the role of the more subtle features of global interdependence
online resources on economic research methods and requires an understanding of specific trends in trade
techniques. For each of the key skills highlighted and financial flows, such as the pace and volatility of
in the Syllabus, we have identified useful research trade growth, the level of interdependence between
terms and websites which provide data and analysis. regions and countries, the extent of changes to

384
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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

Globalisation has increased the importance and role

Use economic concepts to analyse a
of organisations that operate across the borders of contemporary environmental issue
different economies. Most of these bodies are trade-
related – from the global influence of the World At a general level, some of the environmental issues
Trade Organization to the regional influence of the facing the Australian economy include climate
Association of South-East Asian Nations, to the change and controlling pollution of land, water and
local influence of bilateral trade deals. the air. More specific problems include preserving
native habitats and the sustainable use of water for
Useful research terms: agricultural, household and business use.
• Function and influence of the World Trade
Useful research terms:
Organization
• Australian Government environmental policies
• Criticisms of the current structure of world trade
• Climate change policy
• Australia’s free trade agreements
• Ecologically sustainable development
• Global trade statistics
• Environmental externalities
Key data sources:
Key data sources:
• APEC Forum
• Australian Government Department of Climate
• Association of South-East Asian Nations
Change, Energy, the Environment and Water
• Department of Foreign Affairs and Trade – Free
• Office of Environment and Heritage
trade agreements
• United Nations Climate Change Conference
• Oxfam
(COP 28)

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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

B.1 Comparative advantage

and gains from trade
In sections 2.1 and 2.2 of chapter 2 we examined exports and minimise their imports, thus achieving
the advantages and disadvantages of free trade and a trade surplus and an inflow of wealth in the form
the reasons for protection. In this section we take of gold and silver (used for international transactions
our analysis further, looking at how countries can at the time). Adam Smith, by contrast, argued that
achieve gains from trade when they specialise in this strategy would produce inflation because the
the production of goods and services in which they inflow of gold and silver might not be matched by
have a comparative advantage. an increase in the production of goods and services.
Smith argued that it was better for a country to
Absolute advantage
specialise in the production of goods it could produce
In economics, few topics have generated quite efficiently, and import goods from other countries if
as much debate as the issue of free trade. they could produce them more efficiently.
The COVID-19 pandemic resulted in a wave
of protectionism as countries looked towards Adam Smith’s argument for free trade is known
self-sufficiency amid global trade controls. Among as absolute advantage. This theory states that
economists, debates over trade policy are mainly achieving an increase in a nation’s wealth requires
concerned with a range of more subtle issues, the removal of protection and encouraging
such as whether protection is justified for certain specialisation in those products in which the
industries or during certain circumstances; which economy has an absolute advantage. An economy
methods of protection are better and worse for the has an absolute advantage if it can produce a greater
economy; and whether bilateral and regional trade quantity of a product with a given level of resources
agreements play a constructive role in achieving than another economy is able to. Smith argued that
global free trade. Most fierce, however, are the by reducing protection, consumers would gain
debates inside the World Trade Organization access to more goods and services at lower prices,
negotiations in recent years about the process by which would improve standards of living.
which freer global trade should be achieved.
“If a foreign country can supply us with a commodity
Trade theory traces its origins back to the writings cheaper than we ourselves can make it, better buy
of Scottish economist Adam Smith, a man generally it of [sic] them with some part of the produce of our
regarded as the founder of modern economics. In own industry, employed in a way in which we have
some advantage.”
his 1776 book, The Wealth of Nations, Smith argued
– Adam Smith, An Inquiry Into the Nature and
against the prevailing wisdom of the time, known as
Causes of the Wealth of Nations, Book IV
mercantilism, which stated that countries should
use heavy protectionist methods to maximise their

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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

250 Consumption possibilities curve

F for France
Cheese (tonnes)

200 Production possibilities curve

for Australia
150
Consumption possibilities curve
100 for Australia
A

50 Australia’s
production
0
0 50 100 150 200 250 300 350 400
Grapes (tonnes)

Figure B.2 – Gains from trade

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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

France’s production Production possibilities curve

300 for France

250 Consumption possibilities curve

for France
Cheese (tonnes)

200 Production possibilities curve

for Australia
150
Consumption possibilities curve
100 for Australia

50 Australia’s
production

0
0 50 100 150 200 250 300 350 400
Grapes (tonnes)

Figure B.3 – Effect of terms of trade

390
appendix B
Appendix B: Advanced Economic Analysis

B.2 Income-expenditure diagram

In sections 7.2 and 7.3, we examined the conditions

for equilibrium in the economy, the components of C = C0 + mpcY
aggregate demand and supply, and the multiplier Therefore,
process through which changes in aggregate AD = C0 + mpcY + I + G + (X – M)
demand cause the economy to grow. In this section
we examine these economic principles through the
Putting these three factors together, the aggregate
income-expenditure diagram.
demand line is upward sloping (because higher
The income-expenditure diagram is shown in income means higher expenditure), flatter than 45
figure B.4. It has income (Y) on the x-axis and degrees (because of the savings leakage) and cuts
expenditure (E) on the y-axis. And on the income- the y-axis above the origin (because investment,
expenditure diagram there are two lines – the line government spending, net exports and autonomous
of equilibrium and the line of aggregate demand. consumption are independent of income). Figure
B.4 shows the income-expenditure diagram. Where
First, the line of equilibrium. When expenditure the aggregate demand line cuts the 45 degree line,
(aggregate demand) is equal to income (aggregate the economy is in equilibrium, at Y1.
supply), the economy is in equilibrium. This means
that whenever the economy is on a point on the Expenditure
Y = E line, that is the 45-degree diagonal line, Y=E

the economy’s injections equal its leakages, and the

economy is in equilibrium. AD = C + I + G + (X – M)

Another relationship between income and

expenditure is shown in the aggregate demand
line. When there is a change in income, there is
a change in expenditure by individuals across the
economy. 45
Income
In section 7.2, we looked at a simple version of the Y1
aggregate demand equation:
Figure B.4 – Income-expenditure diagram
AD = C + I + G + (X – M)
If there is a change in any of the components of
So, what is the relationship between aggregate aggregate demand (for a reason other than a change
demand and income? In our most simple model, in income), the AD line will move upwards or
investment, government spending, and net exports downwards.
are considered independent of income (that is, they
do not rise or fall when income changes). Therefore, • A rise in consumption, investment, government
it is via consumption that income and expenditure spending, exports (or a fall in imports) will shift
are related. When income increases so too does the AD line upwards.
consumption, and hence, overall expenditure in the • A fall in consumption, investment, government
economy. However, not all additional income is spent spending, exports (or a rise in imports) will shift
on consumption; some is leaked into savings. And the AD line downwards.
even when income is very low, individuals will still
Also note that the AD line will become steeper
spend a small amount on necessities, paid for out of
if there is a rise in the marginal propensity to
their savings, or by borrowing money. Consumption
consume and flatter if there is a decrease in the
is equal to this “autonomous consumption”, C0, plus
marginal propensity to consume.
the proportion of income that is spent on “induced
consumption”, calculated as the marginal propensity
to consume multiplied by income.

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

B.3 Long-run Phillips curve

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

the cyclically unemployed lose their skills, job

Inflation (%) contacts and motivation while unemployed, and
Long-run Phillips curve
P1 P2 subsequently find it difficult to get a job even
when economic conditions pick up (that is, they
become structurally unemployed). In figure B.8,
hysteresis would be shown by a rightward shift of
the Long-run Phillips curve when unemployment
is higher than the natural rate.
2% C
B The analysis of the Friedman-Phelps Expectations
Augmented Phillips curve has profound
P2
A
implications for macroeconomic policy:
3% 5%
Unemployment
P1 (%)
1. Expansionary macroeconomic policy
Natural rate of unemployment Un cannot reduce the level of unemployment
in the long run.
Figure B.8 – F
riedman-Phelps Expectations Augmented
2. Expansionary macroeconomic policy will
Phillips curve
only increase the level of inflation in the
However, when workers realise inflation is now long run.
2 per cent, they will demand higher wages to 3. Contractionary macroeconomic policy
offset the increase in the cost of living. Businesses, may increase the level of unemployment
realising that the prices of other goods have also in the long run through hysteresis.
risen by 2 per cent, and facing higher wage costs,
4. The only way to reduce unemployment
are likely to cut back production and reduce their
in the long run is through supply-side
workforce. Unemployment will slowly creep back
or microeconomic policies.
up to the natural rate, but inflationary expectations
will remain high. The economy jumps from one 5. It is important to contain inflationary
Short-run Phillips curve to another – from P1 to expectations.
P2. In the long term, the expansionary policies have This analysis led policymakers to give priority to
simply raised inflation to 2 per cent with the same reducing inflation, putting a higher priority on
level of unemployment – that is, the economy will long-term measures to reduce unemployment.
be at point C.
Australia’s policy mix reflects some of the lessons
In theory, the processes outlined above can be of the Friedman-Phelps Augmented Phillips
reversed through the adoption of contractionary curve. The most important macroeconomic policy,
macroeconomic policies. Tight macroeconomic monetary policy (the setting of interest rates),
policies will move the economy downwards to the is generally focused on fighting inflation first,
right along a Short-run Phillips curve. Inflation and has an inflation target band to guide its
will fall and unemployment will rise. When policy decisions and which acts as an anchor for
the inflationary expectations of businesses and inflationary expectations. While it does not produce
workers fall, the economy will gradually return an estimate of the non-accelerating inflation rate of
to the natural level of unemployment, but with unemployment (NAIRU), the Reserve Bank watches
a lower level of inflation. The economy will have very closely for any signs of excessive demand in
shifted onto a lower Short-run Phillips curve the labour market when setting interest rates. The
and move back to where it started. This would other macroeconomic policy, fiscal policy, plays a
suggest that any damage done (to inflation) by support role in managing aggregate demand during
short-term policies to expand the economy and periods of slower economic growth such as in 2009
reduce unemployment can be easily reversed. and 2020. Expansionary fiscal policy was also being
However, macroeconomic policy experience has used to create jobs and stop unemployment rising
found that this is not the case. Contractionary during the COVID-19 pandemic, but generally, low
economic policies, which raise the level of unemployment is pursued through microeconomic
unemployment in the short term, also tend policies such as training policies, reform of the tax
to increase the natural rate of unemployment. and welfare systems, and promoting market forces
This phenomenon, called hysteresis, is where in the economy.

394
appendix B
Appendix B: Advanced Economic Analysis

B.4 Limitations of macroeconomic policy

In this section we look at three examples of the renovating their houses, it will increase prices for
limitations of macroeconomic policy: how the building materials and wages for construction
success of expansionary fiscal policy may be limited workers. If these pressures feed through into a higher
by its impact on interest rates (the crowding overall inflation rate, the Reserve Bank may raise
out effect) and the current account deficit (the interest rates to defend its 2–3 per cent inflation
twin deficits hypothesis) and how the success target band. As interest rates rise, private sector
of expansionary monetary policy may be limited business activity will contract as it is crowded out.
by its impact on inflation (the quantity theory Some economists also point out that if government
of money). spending fuels inflation and interest rate rises, it
Crowding out effect will also attract foreign financial inflows. As the
exchange rate appreciates, and the international
Expansionary fiscal policy occurs where the competitiveness of exporters falls, the government
government increases spending or reduces taxation may be crowding out private sector export activity.
to boost aggregate demand and promote growth in
the economy. The objective of this policy stance Indirectly, therefore, fiscal policy and monetary
is to raise living standards and create jobs. Some policy are related. To the extent that there is a
economists, however, argue that increased public speed-limit on how fast the economy can grow
sector economic activity simply “crowds out” the each year, governments face a trade-off: increased
private sector and cannot achieve its intended public sector activity or a shift to expansionary
objectives. fiscal policy may simply crowd out private sector
activity. Note: if the government shifted fiscal
In its most simple form, the “crowding out” policy to contractionary settings, it would put
theory says that if a government moves from a downward pressure on interest rates and encourage
balanced budget to a deficit budget position, it private sector activity (known as the “reverse
will have to borrow money from the private sector. crowding out effect”).
If there is a limited supply of borrowable funds,
In recent decades in Australia, the potential for a
that is, savings, in the economy, then government
“crowding out effect” has been limited because the
borrowing will raise the demand for money and put
shifts in the stance of fiscal policy (measured by
upward pressure on interest rates. As interest rates
changes in the budget balance, as a percentage of
rise, some businesses will not be able to borrow to
GDP) were small. Where government spending has
fund their investment and expansion plans – that
increased more rapidly, such as in response to the
is, they will be crowded out. As a result, the move
COVID-19 pandemic, it has occurred when private
by the government to boost growth simply shifts
sector activity has been weak and unemployment
activity from the private sector to the public sector,
has been rising. Additionally, some government
and leaves the economy with higher interest rates.
borrowings, such as for railway infrastructure,
In modern, open economies like Australia, this may encourage private sector activity, such as
version of the crowding out theory does not describe construction of homes near train stations. This
how the economy really works. Interest rates in is known as the “crowding in effect”. And while
Australia are indirectly set by the Reserve Bank potentially adding to activity and inflation in
independently of the level of government borrowing, the short term, government investments in
and access to global capital markets generally means education, research and development and physical
there is no shortage of borrowable funds. infrastructure also add to the economy’s growth
potential in the long term.
However, this does not mean that government
borrowing (fiscal policy) and interest rates (monetary Twin deficits hypothesis
policy) are unrelated. If a government was to shift Another potential limitation on the effectiveness of
from a contractionary fiscal stance to an expansionary expansionary fiscal policy in promoting economic
fiscal stance at a time when economic growth was growth and reducing unemployment is the twin
already high, it will add to demand pressure in deficits hypothesis. The twin deficits hypothesis
markets for labour, for raw materials, and final says that budget deficits, used to stimulate the
goods and services. For example, if the government economy, cause current account deficit, and
announces large tax cuts that people spend on therefore should be minimised.
395
appendix B Australia in the Global Economy 2024

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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Australia in the Global Economy 2024

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

403
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.

406
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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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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