TOPIC 2 - AUSTRALIA'S PLACE IN THE GLOBAL ECONOMY

AUSTRALIA'S TRADE AND FINANCIAL FLOWS:

In the 1950s, Australia mainly traded with the United Kingdom and other European countries
o One of the key factors which somewhat severed Australia's trade ties with the UK was its
decision to join what is now known as the EU in 1973
When the UK joined the EU it was required to impose trade barriers on Australia
and other nations, in effect making trade between countries in the EU preferential

In subsequent decades, Australia's trade patterns shifted, with Japan becoming the major
buyer of Australian exports.
o Japan was sustaining rapid economic growth in the 1960s, and its demand for product
inputs such as minerals was increasing rapidly
More recently, China, South Korean and the ASEAN countries have become increasingly
important as export markets (North-East Asian countries and ASEAN countries)
o During the 1980s when Japan's economic growth rates began to slow, the direction of
Australia's trade shifted to other emerging economies in Asia, where growth rates were
the highest in the world
o In 2007, China became Australia's largest trading partner (addition of imports and
exports together)
o China's share of Australia's imports has increased five-fold over the last 25 years

It is in commodity goods that Australia has the greatest comparative advantage
o Australia exports high volumes of agricultural products such as wheat, wool, beef and
minerals (e.g. coal, iron ore, gold, alumina)
Australia is less competitive in manufacturing
o While other advanced economies have developed substantial manufacturing industries,
Australia has continued to rely on its primary exports while importing large quantities of
capital goods, and manufactured consumer goods
While the composition of trade in imports have been relatively stable over the last 3 decades,
Australia has experienced more changes in its export flows
o 2010-11: Australia's total exports were valued at $298 billion, with iron ore being the
single largest export (valued at $58 billion), followed by coal ($43 billion), and personal
travel services ($32 billion)
o This change is largely due to the resources boom in the 2000s, with minerals and metals
expanding from 33% to 53% of exports from 1989-90 to 2010-11
Reduction in the agricultural exports from 23% to 10%
This is due to:
Large fluctuations in world prices
Trade protection policies of other countries influencing the export revenue
of agricultural commodities
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 value-added
o Manufacturing exports grew substantially during the 1990s (where Australia targeted a
niche market for manufactured goods), but are at a lower level compared to other high-
income countries
The share of exports which is manufacturing has been falling recently
Australia does NOT compete in high-volume, low cost products
Australia faces difficult conditions in the oncoming years because of a high
exchange rate (which makes it substantially more expensive for other countries to
purchase Australian goods), and increasing competition from low-cost economies
in the Asia-Pacific region (notably China)
Global resources boom in the past decade stirred debate about whether Australia can
continue to rely so heavily on exports of commodity items
o Some argue hat the high prices for energy and minerals will last for many years, as China
followed by India will continue to grow within the near future (sustained international
demand)
o However, Australia also has substantial trade in education services (overseas students,
exchange trips) and tourism, as well as smaller trade in transport, insurance, financial
services and communications
o Since near 75% of Australia's workforce is employed in service industries, it has been
predicted/argued that such industries are likely to provide a substantial proportion of
the export growth that may help to improve Australia's trade performance. HOWEVER,
the resources boom has soften this outlook due to its sheer financial gains
The appreciation of the Australian dollar has made Australian services industries
less internationally competitive, leading to a decline in the growth in service
exports
o Whilst the Chinese and Indian economies continue to grow rapidly and resource prices
remain high, Australia can expect that export growth will be dominated by the resources
sector
From 1981 to 2011, the composition of Australia's imports have changed moderately
o Share of capital goods has remained largely unchanged, at nearly 20% of imports
o Intermediate merchandise goods and services imports have declined
o Consumer goods as a proportion of imports have steadily increased

o This change in the composition of imports 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 2010-11, Australia's imports were valued at $276 billion
o Personal travel services (Australians travelling overseas), valued at $26 billion was the
single largest import
o Crude petroleum, valued at $19 billion was second
o Passenger motor vehicles, valued at $14 billion was third

Australian trade flows have increased substantially over recent years
o Rate of growth in financial flows has grown substantially, as international businesses
have bought Australian assets and invested in Australian businesses, and as Australian
companies have increased their overseas investments
During the early 1970s, the international system of fixed exchange rates came to an end,
which had been in place since the end of WWII
o Exchange rates around the world were floated
o Restrictions on the movement of capital across national borders were removed
o Financial flows began growing rapidly as international capital markets opened up,
exchange rates were floated, and technological changes made it easier to move finance
between countries
o The level of foreign investment in Australia and investment overseas by Australians has
more than doubled in the past decade, rising rapidly since the 1980s
Direct investment: the establishment of a new company, or the purchase of a substantial
portion of shares in an existing company (10% or more)
o Considered to be a long term investment
o Investor normally intends to play a role in the management of the business
Portfolio investment: loans, other forms of securities and smaller shareholdings in companies
o Investors 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
o Governments preferred this as it created jobs and the opportunity for technology
transfers
o Portfolio investment was not particularly important, as the level of overseas shares
purchased was relatively small and overseas loans were not common

o With the deregulation, Australia saw growing flows of finance into the economy,
injecting money into Australian companies through loans and share purchases
Financial flows grew most rapidly during the 1980s, when the Australian dollar was
floated
Level of foreign investment grew rapidly and has continued to grow fast
since
Rate of growth of portfolio investment has been significantly faster than the
growth in longer term foreign direct investment
Australian investment overseas is around100 times what it was in 1980
The level of portfolio investment is now higher than the level of direct
investment
The level of growth in financial flows remains higher than growth in trade,
although during recent years the gap between the two has been reduced
Another significant of the financial feature of the financial flows between Australia and the
global economy is the imbalance between investment in Australia and Australian investment
overseas
o Australia has always been a net capital importer (where a country's value of imported
goods is higher than its value of exported goods over a period of time)
o The level of foreign investment in Australia remains consistently close to twice the level
of Australian investment abroad
Somewhat reflects the low level of domestic savings within Australia

BALANCE OF PAYMENTS:
Balance of payments: all transactions Australia has had with the rest of the world over a given
period of time
o Shows the trade and financial flows in and out of the Australian economy
o Credit: money that flows into Australia
o Debit: money that flows out of Australia

o Important indicator of the health of the economy, reflecting key features of the
structure of the economy and highlighting imbalance in the relationship between
Australia and the global economy

Current account: shows the money flow from all exports and imports of goods and services,
income flows and non-market transfers for a period of one year covers external
transactions that are not reversible
Categories under the current account:
o Net goods: difference between Australia's exports and imports (price of exports MINUS
price of imports)
o Net services: services that are bought and sold without people receiving a 'good' (e.g.
transport, travel, insurance charges, telephone calls, tourist accommodation) (service
credit MINUS service DEBIT)
o Balance on goods and services (BOGS): found by adding the net goods and net services
together

o Net primary income: refers to earnings on investments interest payments on
borrowings and returns on other foreign investments (e.g. foreign owned companies in
Australia, foreign land ownership)
Credits MINUS debits
o Net secondary income: refers to non-market transfer when products or financial
resources are provided without a specific good or service being provided in return (e.g.
payouts on insurance claims, workers remittances - e.g. foreign workers employed in
Australia and sending money back overseas, unconditional aid, pensions received by
Australian residents from foreign governments
Credits MINUS debits

Capital and Financial Accounts:
o Concerned with the transfer of financial assets (e.g. shares, real estate), for the period of
one year
o Transactions are REVERSIBLE - assets can be bought again etc.
Capital account:
o First component capital transfers, mainly in the form of conditional aid and debt
forgiveness (e.g. assistance to build up other countries' infrastructure or capital stock -
e.g. Australian donation to build a bridge in the Solomon Islands)
o Second component the purchase and sale of non-produced, non-financial assets,
mainly intellectual property (e.g. patents, copyrights, trademarks, buying of a franchise
the buying of the rights of a foreign company to operate an outlet in Australia - e.g.
McDonalds)

Financial account:
o Shows Australia's transaction in foreign financial assets and liabilities
o Categorised by the type of investment
Direct investment
Portfolio investment
Refers to the buying of land, shares, and other marketable securities
(securities that can be easily sold), that are easily sold in existing companies
Largest item on the capital and financial account largest contributor to
Australia's foreign debt
Financial derivatives
Derived from the performance of specific assets, interest rates, exchange
rates, or indices
Reserve assets
Foreign financial assets that are available to and controlled by the central
authorities for financing or regulating payment imbalances (e.g. monetary
gold (gold held by the RBA), Special Drawing Rights, reserve positions in the
IMF, and the foreign exchange held by the RBA)
Other investment
Covers trade credits, loans (including financial leases, currency and deposits,
and other accounts payable and receivable that do not meet the
classification or requirements of the above categories)
o Increase of foreign investment in Australia or a reduction in Australian investment
overseas credits = net inflows; debits = net outflows

Balance on capital and financial account:
o Overall balance is determined by capital account + financial account
o Outcome should be approximately equal to the deficit on the current account

Net errors and omissions:
o Statistical discrepancies
o Under a floating exchange rate, the balance of payments should ALWAYS balance to zero
(i.e. deficit in the current account should be offset by the surplus in the capital and
financial account)

Links between the balance of payments categories:
o Two accounts should theoretically add up to zero
The floating $A plays a key role in ensuring that there is a balance in the balance of
payments
Under a freely floating exchange rate, equilibrium occurs when deficit in the
current account is offset by the surplus in the capital and financial account
o In the long 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 flows that comes to Australia must earn some
kind of return for its owner, and these earnings are a debit that are recorded on
the net primary income account
Financial inflows can create debits on the primary income category of the current
account in two ways:
International borrowing
Requires regular interest payments
Interest payments or servicing costs are NOT recorded on the capital
and financial account, but as debits on the net primary account
Most significant reason for CAD and the high net primary income
deficit, is the servicing cost of international borrowing which adds to
foreign debt
Foreign investment
Require returns on the equity investment
Equity financial inflow can be related to the foreign purchase of
Australian land (receives rent), shares (receives dividends), or
companies (receives profits)
These returns on investment are recorded on the net primary income
o Over a period of time, a high level of capital and financial account surpluses will result in
a widening CAD, as the servicing costs associated with increased foreign liabilities (i.e.
higher foreign debt - level of outstanding loans owed by Australian residents MINUS the
level of outstanding loans owed by overseas residents to Australian residents - and
foreign equity - value of Australian assets in foreign ownership MINUS the value of
foreign assets in Australian ownership)
o Australia's historically low savings level (relative to investment demand) makes it
necessary to attract a large financial inflow on the capital and financial account low
savings result in a need for foreign capital inflow to fund investment within Australia (i.e.
making the CAD a capital and financial account problem)
Australia's CAD is not simply the result of a trade imbalance

TRENDS IN AUSTRALIA'S BALANCE OF PAYMENTS:
CAD is calculated as a percentage of GDP, which provides the most accurate comparison
across time and countries
o Averaged 1.1% in the 1970s, 4.3% in the 1980s large shift in the CAD caused alarm
and prompted a range of major structural reforms to restore the competiveness of the
Australian economy
o In 2008-09, the CAD was 3.1% of GDP; however, the CAD was reduced to 2.4% in 2010-
11
o Australia's CAD is amongst the highest of all advanced economies
Australia's CAD moves in cycles, reflecting a mix of short and longer term, domestic and
external influences
Size and movements on the balance on goods and services and primary income account are
influenced by cyclical and structural factors
o Cyclical factors: those which vary with the level of economic activity (e.g. changes in
global demand for commodities, Australia's terms of trade, the value of the exchange
rate)
o Structural factors: those which are underlying or persistent influences on the balance of
payments (e.g. structure of the Australian export base, international competiveness of
Australia's exports, level of national savings)

Balance on goods and services varies form occasional small surpluses to deficits of around 2%
of GDP
o BOGS remain in persistent deficit, averaging -2% between 2002-03 and 2007-08
o In 2008-09, a change in the cyclical factors driving the BOGS, saw a reversal in it
performance, reaching a surplus of +0.6% of GDP
o BOGS is the main cyclical component of the CAD, but it is also influenced by structural
factors

o Cyclical factors:
Movements in the exchange rate affect the international competiveness of
Australia's exports and the relative price of the goods and services that Australia
imports
A depreciation decreases the price of Australia's exports, increasing the
international competiveness of Australian exports on world markets
During the deteriorating global economic conditions throughout 2008-
09, the depreciation in the Australian dollar boosted Australia's
international competiveness
Australia experienced a BOGS surpluses on 2000-01 and 2001-02,
when the Australian dollar experienced a sustained depreciation,
reaching an all0time0low of $US0.48 in April 2001
At the same time, a depreciation increases the price of imports for
Australians, discouraging consumers form purchasing imports also
improving the BOGS
Terms of trade: the relationship between the prices Australia receives for its exports
and the prices it pays for its imports
Export price index / import price index
Export price index: the proportional change in the level of import
prices

Export prices increase relative to import prices, Australia's terms of trade
will improve
Improvement in the terms of trade means that the same volume of exports
can buy more imports improvement on the BOGS (either a larger surplus
or a small deficit), and a decrease in the CAD
Terms of trade was a major influence on the BOGS over the 2000s, mainly
due to a boom in global commodity prices, as commodities are Australia's
largest export

However, the rising terms of trade was a major factor behind the
appreciation of the Australian dollar over the 2000s. This is due to the terms
of trade being an indicator of Australia's future economic prospects, it
encouraged positive speculation on the Australian dollar
Higher Australian dollar weakened international competitiveness of
Australia's non-commodity exports (demand for exports was stable
with industrialising Asian countries) commodity export revenue
increased, however non-commodity export revenue decreased
'Dutch Disease': growth in one industry results in a higher exchange
rate, slowing choking off other export industries as they lose their
international competitiveness
o Structural factors:
Structure of Australia's export base has an important influence on the long term
behaviour on the BOGS
Australia has a narrow export base, with Australia's exports being heavily
weighted towards primary commodities.
Australia's comparative advantage lies in low value-added products (e.g.
minerals and agriculture, which together account for two-thirds of
Australia's export earnings)
Australia lacks international competitiveness in manufacturing and tends to
import high-value-added products (e.g. consumer goods and capital goods)

In the long run, the BOGS tends to be in a deficit because import payments
very often outstrip export revenues

Risks associated with a sustained high CAD:
o Over a period of time, a high CAD will contribute to an increased level of foreign
liabilities
o Increased servicing costs associated with high levels of foreign liabilities lead to largest
outflows on the net primary income account, worsening the CAD (interest repayments
must be made to foreign debts and profits must be returned to foreign equity
investment)
o Increased volatility for exchange rates - high current account deficits 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
o In the long term, the CAD acts as a constraint on future economic growth. Higher levels
of economic growth generally involve an increase in imports and a deterioration in the
CAD. Therefore, economies with a CAD problem are forced to limit growth to the level at
which the CAD is sustainable.
o To reduce a high CAD in the short term, governments may use tighter macroeconomic
policies to accelerate the implementation of microeconomic reform. In the short term,
tighter fiscal and monetary policies will reduce economic growth and contribute to a
lower CAD
o A sudden loss in international confidence

EXCHANGE RATES:
Exchange rate movements have a significant impact on international competitiveness, trade
flows, investment decisions, and inflation. This is due to the fact that all trade and financial
relationships between countries are mediated through the exchange of currencies
Exchange rate: the price of Australia's currency in terms of another country's currency
Currency conversion occurs in the foreign exchange market (forex market)

The demand for $A is represented by all the people who wish to buy $A. Demand for $A will
be affected by:
o The size of financial flows from overseas investors wishing to invest in Australia (as they
will need to exchange their native currency for the $A)
The level of Australian interest rates relative to overseas interest rates (higher
interest rates in Australia will make foreign investment more attractive as the
returns are higher increase in demand for $A)
Availability of investment opportunities in Australia (more opportunities
increase in demand for $A)
o Future expectations for the $A (expectations of an appreciation increase of current
demand for the $A, which contributes to the anticipated appreciation)
o Demand for Australian exports (increased demand for Australian exports increased
demand for $A)
Changes in commodity prices and in the terms of trade tend to have an immediate
effect on the $A (rise in commodity prices and an improvement in the terms of
trade increase Australian exports increased demand for $A)
Degree of international competitiveness of domestic exports and Australia's
inflation rate relative to other countries (domestic firms are competitive in world
markets and Australia's inflation rate is relatively low cheaper Australian
exports increase in demand for exports increase in demand for the $A)
Changes in global economic conditions (global economy is on an upturn
demand and prices for Australia's exports will rise increased demand for the $A)
Taste and preferences of overseas consumers
Supply of the $A is represented by those people who wish to sell the $A. The supply of the $A
will be determined by a number of factors:
o The level of financial flows out of Australia by Australian investors wishing to invests
abroad (as the Australian investors will need to convert their $A into foreign currency)
The level of Australian interest rates relative to overseas interest rates (lower
interest rates in Australia will make overseas investment more attractive
decreased supply of $A)
Availability of investment opportunities overseas (greater opportunities to start
businesses overseas or to purchase shares in overseas companies increase
financial flows out of Australia increased supply of the $A)
o Speculators expectations of the value of the $A (expect the value of the $A to depreciate
will sell their supplies of the $A, which then contribute to the anticipated
depreciation)
o Domestic demand for imports (Australian imports will need to exchange the $A to pay
for overseas imports)
Level of domestic income (increase in domestic incomes increase in the
demand for imports increase in the supply of the $A)
Domestic inflation rate and the competitiveness of domestic firms (if Australia's
inflation rate is higher and its import-competing firms are relatively uncompetitive
imports will be relatively cheaper than domestic products increased demand
for imports increase supply of $A)
Taste and preferences of domestic consumers
Appreciation of the $A
o Increase in the demand for the $A
o Decrease in the supply of the $A

o Influences which lead to an appreciation:
Increase in Australian interest rates OR decrease in overseas interest rates
Improved investment opportunities in Australia or deterioration in foreign
investment opportunities
Rise in commodity prices and an improvement in Australia's terms of trade
Improvement in Australia's international competitiveness
Lower inflation in Australia
Increased demand for Australia's exports
Expectation of a currency appreciation
Depreciation of the $A
o Decrease in the demand for the $A
o Increase in the supply of the $A

o Influences which lead to an depreciation:
Decrease in Australian interest rates OR increase in overseas interest rates
Deterioration in investment opportunities in Australia OR improvement in
investment opportunities overseas
Fall in commodity prices and a deterioration in Australia's terms of trade
Deterioration in Australia's international competitiveness
Higher inflation in Australia
Increased demand for imports
Expectations of a currency depreciation

Trade Weighted Index (TWI): gives an indication of how the value of the $A is moving against
all currencies in general
o Calculated by measuring the values of the $A against the currencies of Australia's major
trading partners
Currencies of countries that are more prominent in Australia's trade are given a
higher weighting, so that they have a greater influence on the TWI
o Limitation of the TWI: the TWI is weighted according to the volumes of trade regardless
of the currency in which export and import contracts are invoiced (e.g. as two-thirds of
Australia's and half of Australia's imports are priced in $US, the $A/$US exchange rate is
far more important than the weight it receives in the TWI calculation)

RBA can intervene to smooth out short-term swings in the $A
o Dirtying the float (one-off intervention):
Occurs when the RBA feels that a large short-term change in the exchange rate
will be harmful to the domestic economy
To curb a rapid depreciation of the currency:
The RBA will buy $A
Which reduces the supply of the $A, increasing its value
RBA ability to intervene through the purchasing of the $A is limited by the size of
its foreign currency holdings (i.e. its reserves of foreign currency and gold that can
be used to fund such purchases)
o Monetary policy decisions
If the RBA wants to curb a rapid depreciation:
Raise interest rates, which would make investment in Australia more
attractive to foreign investors as the returns would be higher increased
demand for the $A upward pressure on the $A
Policies are generally only effective for a limited time

Under a fixed exchange rate system, the government - or the RBA - officially sets the exchange
rate
o Government can maintain a fixed exchange rate by either buying or selling foreign
currency in exchange for $A therefore, the government would need a prominent
supply of foreign currency and/or gold, which is exhausted could lead to the complete
collapse of trade in the currency
Under the managed flexible peg system, the RBA would 'peg' the $A at 9am daily and that
price would operate throughout the day.
o Provides more flexibility
o However, it can lead to the overvaluing or undervaluing of the $A

Under a floating exchange rate, the quantity of $A supplied must always equal the quantity of
$A demanded (net outflow of funds on the current account equals the net inflow of funds on
the capital and financial account)
o If there is disequilibrium on the balance of payments, it is automatically corrected by a
movement in the exchange rate
o Example: If the quantity of imports increased, which exports remained unchanged, this
would result in a deterioration in the CAD. It would also cause an increase in the supply
of the $A (as Australians would be selling the $A to convert it into foreign currency),
resulting in a depreciation of the $A. Consequently, a given amount of financial inflows
would be able to buy more $A. Therefore, the positive balance on the capital and
financial account would increase deterioration of the CAD will lead to a depreciation
of the $A and an increase in the surplus on the capital and financial account
Effect of an appreciation on the Australian economy
Negative Effects Positive Effects
Australian exports become more
expensive, leading to a decrease in
export income and a deterioration in
Australia's CAD
Imports will become less expensive,
increasing the demand for imports and
worsening Australia's CAD
Higher import spending and reduced
export revenue will reduce Australia's
economic growth
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)
Reduces the value of foreign income
earned on Australia's investments, in
Australian consumers enjoy increased
'purchasing power' can buy more goods
overseas with the same quantity of $A
Decreases the interest servicing cost (debt
servicing: interest paid on foreign loans taken
out by Australians) on Australia's foreign debt ,
as Australians can by more foreign currency with
the $A (this also reduces outflow on the net
income component reducing the CAD)
Reduce the $A value of foreign debt that has
been borrowed in foreign currency 'valuation
effect'
Inflationary pressures in Australia will be
reduced as imports become cheaper, reducing
pressure on the RBA to raise interest rates to
defend its inflation target


terms of the $A, causing a
deterioration in the net income
component of the CAD
Reduces the value of foreign assets in
terms of the $A 'valuation effect'

Effects of a depreciation on the Australian economy
Negative Effects Positive Effects
Australian consumer suffer due to reduced
'purchasing power' - consumers can buy
fewer goods with the same quantity of $A
Increases the interest servicing cost on
Australia's foreign debt because Australian
can buy less foreign currency with its
domestic currency with which to pay interest.
This increases income outflow on the net
income component, increasing the CAD
Raises the $A value of foreign debt that has
been borrowed in foreign currency -
'valuation effect'
Inflationary pressures in Australia will
increase as imports become more expensive,
which may increase pressure on the RBA to
raise interest rates to defend its inflation
target
Australia's exports become cheaper on
world markets, leading to an increase in
export income and an improvement in
the CAD
Imports will become more expensive,
discouraging import spending, and
potentially improving the CAD
Increase in domestic production of
import substitutes
Lower import spending and greater
export revenue will increase Australia's
growth rate (only possible if Australia
replaces its imports with domestically
produced goods)
Increases the $A value of foreign income
earned on Australia's investments abroad
improvement in the net income
component of the CAD
Increase the value of foreign assets in
terms of the $A - 'valuation effect'
Foreign investors will find it less
expensive to invest in Australia, generally
leading to greater financial inflows (only
if investors expect the currency to
depreciate and then stabilise)

Valuation effect: where an appreciation (depreciation) of the currency causes an immediate
decrease(increase) in the Australian dollar value of foreign debt that is borrowed in foreign
currencies

PROTECTION IN AUSTRALIA:
Australia's policies regarding free trade and protection
o Tariffs: taxes imposed on imports with the intention of raising the prices of foreign
competitive, creating an artificial advantage for domestic producers
o Quotas: controls the volume of goods and services imported into a country, often with a
substantial fee for producers who import over the threshold
o Subsidies: financial assistance given to domestic producers, allowing them to lower costs
and thus be more competitive with foreign producers
o Local content rules
Bilateral free trade agreements:
o 1983 Closer Economic Relations agreement with New Zealand (CERTA), which has led to
free trade between the two countries and increased standardisation of laws, business
practices and commercial structures
o Singapore-Australia Free Trade Agreement (SAFTA)
Covers the elimination of tariffs and improves market access for services exporters
(e.g. telecommunications, financial and professional services)
Provides for cooperation across other areas of policy affecting business (e.g.
professional standards, education, intellectual property protection, competition
policy)
o Australia-United States Free Trade Agreement
Provides significant tariff reductions on a number of goods, especially in
agricultural and manufacturing
Automotive tariffs were eliminated immediately, with tariffs on all goods being
eliminated from 2015
Multilateral free trade agreements:
o ASEAN-Australia-New Zealand Free Trade Agreement (AANZFTA)
Covers 20% of Australia's trade in goods and services, and effectively creates a
free trade area of over 600 million people with an estimated combined GDP of
$US 3.7 trillion in 2011
Australia and the ASEAN economies are complementary economies, meaning that
the type of goods Australia exports is in heavy demand in the industrialising
nations of South East Asia and vice versa
o Asia Pacific Economic Cooperation forum (APEC forum)
In 1994, the APEC forum set a target of free trade by 2020
APEC forum has shifted away from trade liberalisation and now acts as a forum for
discussion on issues such as terrorism and climate change
Since 1994, average tariff levels have fallen from 17% to 6%; proportion of goods
without tariffs has increased to 40%; and 37% of regional free trade agreements
have been agreed between APEC members
Effects of free trade policies on firms
o Individual firms that operate in marginal, import-competing industries will shrink, unless
they are able to improve their competitiveness
o Production in some sectors of the economy may cease altogether manufacturing of
consumer electronics (e.g. microwave ovens, sound systems, televisions), which require
low-skilled labour, has almost entirely ceased in Australia, as advanced economies
cannot compete with the lower wage costs of industrialising economies such as China
o Some businesses will respond by restructuring their operations (by perhaps only
focusing on one particular aspect of production) may involve consolidating their
manufacturing processes to a single plant, eliminating less profitable product lines,
adopting new production technologies, or reducing staff levels
o As Australian firms are forced to compete in global markets, this should result in higher
levels of investment as firms improve their technology or expand their business
o Lower tariffs means lower input costs (lower costs for resources) for many firms - for
example, machinery used by mining companies
Productivity Commission estimated that abolishing tariffs on manufacturing goods
in 2009-10 would reduce input costs for service industries by $4.6 billion and
mining industries by $308 million
Reducing input costs will make exporting firms more internationally competitive
(e.g. removal of tariffs on inputs such as farm machinery has improved the
competitiveness of Australia's agricultural industries
o Reduction in protection contributed in changes in Australia's export base, and also an
overall growth in export volumes
Effects of free trade policies on individuals
o Increase in unemployment associated with the restructuring of industries and cuts in
local production structurally unemployed (when the individual's skills do not match
the job vacancies in the economy)
Import-competing businesses that have been most affected by reductions in
protection have been concentrated in particular regions, where there are often
fewer alternative sources of employment
Many of the jobs lost in the manufacturing sector are relatively low-skilled,
production-line jobs, and hence their limited skills are not easily transferrable to
other workplaces
o However, provided the process of structural chance promotes internationally
competitive firms, the negative effects on sector of the economy should be more than
offset by the growth experienced by sectors that are efficient and internationally
competitive (decline in the manufacturing industries in Australia, however Australia
experienced enormous growth in the service industries - tourism, education)
Thus, the problem with the reduction of unemployment is not that it raises the
unemployment level, but that its effects are not distributed evenly throughout the
population
o Consumers are able to buy more goods at lower prices, with a wider variety of goods
and services being available
o Improves living standards
Quality of goods and services is higher , as domestic firms are competing with the
best international businesses
Encourages innovation as firms seek to differentiate themselves from competitors
With the reduction in protectionist policies, foreign firms are operating in
Australia, ensuring that innovation from foreign countries is brought into
Australia faster
Effects of free trade policies on governments
o Reduction of government revenue, with the removal of tariffs in 2011-12, the
collection of $2.8 billion from tariff collection accounts for less than 1% of the
government's total revenue
o May reallocation government expenditure
Governments may be required to assist the structural adjustment process through
unemployment benefits and retraining programs
Governments may also need to provide financial support to assist certain
industries with the adjustment process (e.g. job search assistance)
o However, in the long run, sustainable economic growth should raise government
revenue
o Political consequences of protection reductions
As the negative impacts of lower protection are highly visible - structural
unemployment - and the benefits are less visible, as they are spread out amongst
the population and may take time to arise, governments may lose support by
pursuing policies which reduce protection
Impact of international protectionist policies on Australia
o Overall, international protectionism reduces the output of the Australian economy
Productivity Commission reported in 2010 that the worldwide abolition of tariff
protection alone, would increase Australia's GDP by almost 1% yearly
When other countries put tariffs on Australian goods and services, Australian
exports become less competitive and struggle to penetrate foreign markets
When other countries subsidies their exports, they raise the supply and reduce the
price of domestic goods on global markets, resulting in Australia's revenue from
exports being reduced
o As a small economy with a high level of agricultural trade. Australia suffers substantial
disadvantage due to the protectionist policies of other nations and trading blocs
The EU's Common Agricultural Policy, absorbs over a third of the EU's budget to
provide almost a quart of European farmers' income
o Australian firms exporting non-agricultural goods generally face fewer barriers to trade
compared with the agricultural sector
The mining and resources sector, which is the largest contributor to Australia's
exports, faces very few barriers to trade as products from this sector (e.g. coal,
natural gas, oil, iron ore) are in very high demand worldwide
Australia's manufacturing industries generally faces few barriers to trade because
of the substantial reduction in industrial tariffs in recent decades that have been
negotiated through multilateral trade agreements
Australia's service industries, which account for three quarters of the Australian
economy but less than a quarter of our exports, arguably faces the most
prohibitive barriers to international trade (natural barriers caused by geography,
transport costs, languages, cultural differences, local tastes and preferences)
e.g. Australian restaurants may be producing the best food in the world, but
the market for restaurants is limited to people living in or visiting Australia
o Protectionism reduces the trade in services in the global economy, as 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
e.g. Australian firms in the electricity, recycling and communications industries
face overseas markets that are dominated by monopoly government providers or
arrangements which favour domestic providers
A report by the Productivity Commission in 2010 states that the liberalisation of
trade in services could be worth $11 billion to Australia by 2025
Service industry Potential trade barriers
Financial services Restrictions on foreign ownership of banks and other
financial institutions
Transport services Restrictions on airlines providing services in another
country
Professional services Licensing laws that only recognise one country's
educational qualifications
Construction services Government rules that mandate the use of local suppliers
Utility services Government monopoly provision of electricity, gas, and
water
Environmental services Government preferences for local suppliers of waster or
recycling services
Media and
entertainment
Minimum local content requirements to preserve a
country's culture