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Chapter 1- Australia’s Trade and Financial Flows:

International trade: The exchange of goods and services across national boundaries

Financial flows across international boundaries including:


-Debt and equity borrowings
-Foreign exchange
-Derivatives: Financial security/asset (a financial asset which gives a return) has its value
in an underlying asset not directly in the derivative itself, eg: value of interest rates,
currency, crops. Example of this is an option
International finance and investment:

-Portfolio: (where an investor has less than 10% share in the company, therefore they do
not have a direct influence on the management of the company). Eg: Shares

-Direct investment: (Where an investor has 10% or greater share in the company and
the investor has a say on the actions of the company). You could buy an existing
company or buy shares in an existing company or even start up a new business. TNC,
open branches/subside in other countries

Features that characterise international trade and financial flows:

1.Trade in more than one national currency: US dollars, Euros or Yen, most global trade
occurs in US dollars, its the world benchmark currency

2.Carries risks such as loss of earning from currency movements, changes in market
demand, interest rates or changes in government policy

3.Usually is dominated by the role of MNC's (global operating countries) which have a
large power and influence which affects global trade and investment patterns

4.Also is affected by the changes in world demand, technology as well as the


international business cycle. Examples of changes include the trade in Elaborately
Transformed Manufactured goods and services, such as the internet boom and spread of
electronic commerce

Factors that have contributed to the increased internationalisation of the Australian


economy:

• A change of government policies, deregulation and foreign exchange controls


were removed
• Deregulation lead to greater accessibility of Australian firms to world capital
markets and reduced the cost of exporting however increased the volatility of
the exchange rate
• Australia began to reduce levels of protection such as cut in tariffs, subsidies,
local content schemes and quotas
• Australia has also participated in much more trade agreements such as WTO,
ASEAN
• E commerce and internet, as well as reduced cost of transports such as planes
and large container shipments
Direction of Australian Trade:
• Has moved away from the UK and European nations to Asian nations such as
China and South Korea
• Trade with UK has decreased since they joined the EU, meaning that they have
trade restrictions on Australia via the EU
• Lower access to EU markets mean Australia now trades with Asia
• Australia’s major export markets is in Japan (22%) followed by China (17%)
• Australia’s major import market is from China (16%)
Changing composition of Australia’s trade:

Exports:

• Main source is commodities, risen in the recent years due to global resources
boom, 2004-2007
• Composed of things such as wheat and beef
• Agricultural exports have declined due to increased protection in foreign nations
and droughts

Imports:

•Capital exports have remained relatively same


•Intermediate goods were in decline but rose in 2009-10 period

Trends in financial flows – debt and equity:


-Investment flows into and out of Australia have increased dramatically since financial
deregulation in 1983

Foreign investment in Australia: Refers to the stock of Australian liabilities (debt and
equity) owned to non residents

Foreign investment Abroad: Refers to the stock of foreign financial assets owned by
Australian residents

International investment involves both foreign investment into Australia and Australian
investment overseas

Foreign investment generally takes for forms:


• Direct investment- The investor in one economy holds a 10% or greater interest
in an enterprise in another country. This type of investment implies a degree of
influence or control over the management of the enterprise. Investment is
usually made by the purchase of ordinary or voting shares

• Portfolio investment- The investor holds less than 10% share of the company. Is
investment in equity (eg shares or options) and debt securities (other than direct
investment). This does not allow for the management of the company

• Other foreign investment includes: trade credits, loans, currency and deposits

• Financial derivatives eg: currency, swaps and options

Main sources of foreign investment into Australia:

USA, Britain, Japan, Hong Kong, China, Singapore and New Zealand

Advantages of foreign investment in Australia:

• Transfers of technology and management skills,


• Access to foreign exchange
• The creation of more employment opportunities and management training and
greater access to export markets

Disadvantages of foreign investment in Australia:

• Loss of ownership and control of resources,


• The cost of servicing overseas debt and equity borrowings
• The volatile nature of speculative portfolio capital flows on the exchange rate

How Australians invest overseas:

-Australian's can invest overseas through: FDI, Portfolio investment, Loans, Credits,
Financial derivatives (currency swaps, options) and Reserve assets

Types of Australian companies that invest overseas:

-The main types of companies are mining companies and manufacturing companies,
however has spread to retailing, banking, media and airlines

What has contributed to the increase in foreign investment:

-The main factor has been Australian businesses securing new export markets in foreign
countries, seeking higher rates of return on their investments and also spreading the
financial risks associated with business activities

The trends in Australian foreign liabilities ie debt and equity:

-Australia has become a net borrower of funds in the international financial market.
Australia imports capital to supplement the domestic savings which are too low to
finance all of the domestic investment. Hence, borrowing money and credit from the
international financial market count as an increase in the foreign liabilities and the total
value of foreign assets is less than the total amount of foreign liabilities, therefore has
contributed to a larger foreign debt.

The costs associated with Australia’s large stock of net external debt and equity:

-Servicing costs of debt such as interest that is paid to foreign companies and loss of
profit and revenue to domestic Australian companies as well as investors in general. The
rent, profits, dividents and income have to be sent overseas if the asset is not owned by
an Australian investor

Australia’s Balance of Payments

Balance of payments: Australia's balance of payments is a record of all the economic


transactions between Australia and the rest of the world in one year

Current Account: Is the part of the balance of payments that show the receipts and
payments for trade in goods and services, transfers payments, income flows between
Australia and the rest of the world in a given time period. These are non- reversible
transactions

Capital and financial account: Records the borrowing, lending, sales and purchases of
assets between Australia and the rest of the world. Financial inflow has the immediate
effect of increasing the supply of foreign exchange to Australia where as outflow reduces
it

It is a double entry system of accounts I.e Uses debits and credits. These are known as
the Current Account and the Capital the Financial Accounts

BOP= the Current account +/- the Capital and Financial Account

Structure

Credits:
•Exports of goods and services
•Income receivable
•Financial transactions involving either a reduction In a country's holding of foreign
assets or an increase in its foreign liabilities
•Activities generating a flow of funds into Australia
Debits:
•Imports of goods and services
•Income payable
•Financial transactions involving either an increase in a countries holding of foreign
assets or a decrease in its foreign liabilities
•Activities associated with an outflow of funds from Australia

Because the BOP is a double entry system every transactions is represented by two
equal and opposite transactions, a debit and a credit. As a result the BOP will always
equal zero

Current account:
•Net goods and services
•Net primary income
•Net secondary income

Capital and Financial Account:


•Capital account
•Financial account

Current Account + Capital and Financial Account = 0

Current Account:
Record all transactions of a current nature between Australia and the rest of the world
over a financial period

Money flows into Australia are credits. Money going out of Australia is debits

Good Balance:
•Is a record of imports and exports of goods (physical), known as the merchandise
account
•Exports are credits
•Imports are debits

Services Balance:

•A record of all service imports and exports


•Eg: transport, education, tourism and spending by government oversees e.g. to
maintain embassies
•Services exported or sold by Australia-credit
•Services imported or sold to Australian by foreign countries-debits

Primary Income Balance:


•A record of earning on investment
•Income earned from Australian owned assets overseas-credits
•Income earned from foreign owned assets in Australia-debits
•Income includes interest payments on borrowings, return on investment eg: rent,
profits, dividends.

Secondary income/ Current Transfers:
•Refers to unearned payments or receipts
•One way traders between Australia and the rest of the world, e.e: no specific goods
or services are exchanged
•Credits include funds brought in by migrants
•Debits include funds taken out of Australia by Australians moving overseas and
foreign aid
•Value of the transaction
•One way transaction, a gift

The balance of current account:


Net goods and services + Net income +Net Secondary income /transfers

The Capital and Financial Account:

Records all financial flows resulting from international borrowing and lending
transactions and the buying and selling of assets. Eg: shares, loans, real assets such as
property

Capital Account:
Records all capital transfers:
•Transfers from people migrating into or out of Australia of a capital nature
•Foreign aid in the form of capital eg: building a bridge
•The purchase and sale of non produced, non financial assets eg: intellectuals
property rights, patents, copyrights, trademarks and franchises

Financial Account:
-Records all transactions in financial assets and liabilities
-Credits entries are net inflows, these come about either because of an increase in
foreign investment in Australia or a reduction in Australian investment overseas
-Debits represent net outflows
•Direct investment: purchase/takeover of companies with greater than 10% holding
•Portfolio investment: records changes in the value of a assets eg: shares and other
tradable assets (This is where most foreign debt is recorded)
•Financial derivatives
•Other investment: Eg: trade credits
•Reserve assets includes:
• RBA holding of foreign currency
• Financial assets controlled by RBA
• Reserves held with the IMF

Net errors and omissions:


•Allows for statistical errors and is used to make the accounts balance
•This represents adjustments made by the ABS to allow a surplus/deficit in the
current account to exactly balance a deficit/surplus in the capital and financial
account
•Australia may borrow capital from overseas to offset the current account deficit

BALANCE OF PAYMENTS EQUALS:

CA + K and FA +/- Net errors and omissions= ZERO

K=capital

Current account balance = Goods balance + Net Services + Net primary income + Net
secondary income
Capital and Financial account = Capital account balance + Financial account balance
Balance of payments = Current account balance + Capital and Financial account balance
+/- Net Errors and Emissions

Links between key balance of payments categories:

• The Current Account and the Capital and Financial account add to zero. Together
they represents the Balance of payments CA + L and Fa = zero

• With a floating exchange rate if there is a Current Account Deficit (CAD) then
there is an equal and offsetting K (capital account) and Fa (financial account)
surplus ei: the BOP is zero

• This is because in the foreign exchange market there can be no surpluses or


shortages of foreign currency

• An increase in the current account deficit (CAD) will result in an increase in the
capital and financial account surplus
Supply of $A (ANYTHING GOING OUT) = Demand of $A (ANYTHING GOING IN)
Payments for imports of goods and Receipts for exports of goods and
services (M) services (X)
Primary and Secondary Primary and Secondary
income/transfers overseas (Y debits) income/transfers from overseas (Y
credits)
Capital and financial outflow (K Capital and financial inflow (K inflow)
outflow)
Supply of $A:

Represented by:

Payments for imports of G & S income transfers overseas, Capital and Financial outflows

=
Demand for $A

Represented by:

Payments for exports of G&S income transfers from overseas Capital and financial
inflows

Exchange rate changes bring about equality between supply and demand of foreign
currency

Deficit in the current account = Surplus on the capital of the capital and financial
account

• -There is a strong link between capital and financial account and the net income
part of the current account. This is because any financial inflow to Australia must
earn return for its owner and is recorded as a debit in the net primary income

• Financial inflows can create a debit in:

• Foreign financial inflows in the form of overseas debt/borrowing will require


interest repayments and servicing costs and are recorded as a debit in the net
income (the original principle stays in the financial account)

• Foreign financial flows in the form of equity will require returns on the equity
investment, foreign equity can be foreign ownership of Australian land,
shares or companies. The rent, dividends and profits flow out of Australia and
will be included as a debit in the net income section

• Australia’s low savings makes it necessary to attract foreign inflows but however
the net primary income deficit that results from this increases the CAD

• There is relationship between the CAD, growth in foreign debt and growth in
foreign liabilities

• Net capital inflow can be Net foreign borrowing or Equity inflow (direct or
portfolio)

• A K and FA surplus means here is a combination of debt inflow and equity


inflow. Debit must be serviced by interest payments will be transferred
overseas and recorded in the income transfers section of the current
account

• If over a period of tie, a high level of capital and financial account surpluses
occurs, it will result in a widening CAD because of the servicing costs associated
with increased foreign liabilities (higher foreign debt and foreign equity) , hence
can lead to the “dept trap” scenario

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

Current Account:

• Usually has a deficit, this is influenced by the size of the deficit in the good and
services balance and the size of net primary income deficit

• Goods and services balance is in deficit, this deficit decreased during the global
resources boom 2005 to 2007. Increased capital imports increased the deficit
until a mining boom meant a surplus is 2008-09 but due to GFC it fell to a deficit
again

• The net primary income deficit represents the large servicing costs of Australia’s
net foreign liabilities

• Net secondary income tends to record a small deficit or a small surplus, it


highlights that Australia spends less income on foreign air, migrant funds and
workers’ remittances

Capital and Financial Account:

• The capital account usually records a small surplus or deficit between $100
million and $600 million

• The financial account balance is always in a surplus and mainly represents debt
and equity borrowings (net direct, net portfolio investment and reserve assets),
this surplus grew during 2001 to 2010
• The balance on the capital and financial account is always a surplus to finance the
deficit in the current account

General trends:

• Because the BOP is always zero is it more appropriate to consider the Current
Account Deficit rather than the overall balance.

• CAD rises when domestic growth is stronger than world growth, this indicates
that Australia are importing more products the import spending increases
relatively to the export income

• The drought in 2002-03 increased the CAD further as farm exports fell by nearly
25% meaning Australia would have to import to compensate other substitutes

• Throughout the 1970's Australia averaged a CAD -2.5% of GDP. During the 1980's
Australia CAD rose to -4.75% making it one of the highest results of the high
income economies.

• 1998/99 the CAD rose to -5.6% due to the impact of the Asian financial crisis
reducing demand for Australian exports together with high domestic growth

• 2009/10 the CAD was -4.4% of GDP

Reasons for these trends in the CAD:

Cyclical factors: Factors those who vary with the level of economic activity

•When the domestic economy grows faster than the world economy, the demand for
imports rise
•The increase in imports means a debit in the current account goods, hence
contributes to a greater CAD

•If the world growth becomes faster than domestic growth such as in 2004 to 2007
(global resources boom), the demand and prices for Australian commodities
would rise

•Export income would increase and in turn reduce the CAD

Structural Factors: Are those such as Australia’s export base, international


competitiveness, exchange rates, and terms of trade

•The issue that most of the CAD is contributed by the servicing costs of Australia’s
debt and equity borrowings through net primary income

•Increased net payments of interest, profits and dividends to foreign lends and
investors can also increase the CAD

• Reporting as a percentage of GDP allows an accurate indication of the size of the


CAD relative to national output over time rather than stating it in absolute terms.

• If the CAD reaches 5% of GDP it is seen as a constraint to domestic economic


growth

• If the CAD is greater than GDP growth in the economy will only occur if imports
are increased. This in turn will lead to an increase in the good balance of the CAD

• When Australia's CAD has exceeded GDP for example rom 2002 to 2006 the RBA
acted on slow economic growth by the use of Monetary Policy to increase
interest rates

Implications of a high CAD:

• Growth in foreign liabilities: A CAD growth results in financial inflow either in the
form of borrowings from overseas (foreign debt) or through selling equity in
items such as property and companies (foreign equity). Lenders may be resultant
to lend to Australia or invest in Australia due to this growth in liabilities

• Increased servicing costs: High levels of foreign liabilities means increased


servicing costs reflected by a large net income deficit in the CAD. A high CAD
means increased interest repayments as well as financial outflows of dividends
and profits for foreign investors. This can lead to Australia borrowing money to
service existing debt

• Increased volatility in exchange rates: High CAD deficit can undermine the
confidence of Australia dollars from foreign investors and reduce demand, this
will lead to a depreciation of the Australian dollar and worsen the debt as
servicing costs would rise due to a low exchange rate

• Constraints on economic growth: GDP would decrease as more money will be


spent trying to reduce the CAD, this will limit economic growth

• Loss of investor confidence, the high CAD may turn off investors as they may see
it as too risky to invest in Australia or lend to Australia. This can result in decrease
in financial inflows, due to low financial inflows the financial account balance can
deteriorate and in turn will become harder to offset the CAD to zero, hence as a
chain reaction the CAD would likely increase
1992-95: The deregulation and cuts in the maximum quotas enabled exports to export
more Australian products to foreign nations, this meant that the exports in the goods
account rose, hence the current account deficit was reduced due to this extra income

1997-98: The current account reached to high levels of deficit at around -6% of GDP, this
was because of the Asian Financial Crisis reducing the number of Australian exports
whilst increasing the demand for foreign imports creating a deficit in goods account
resulting in current account deficit

2001-02: The current account deficit declined due to strong growth in the exports which
was triggered by the depreciation in the exchange rate of the dollar meaning more of
Australian exports could be brought by foreign investors.

2002-03: The severe effects of the drought drastically reduced the amount of Australian
farming exports by around 25%, hence the goods and services deficit rose to $-16.3
billion dollars causing the current account deficit to rise to over -$40,000

2005-06: The global resources boom meant that the commodity prices went up,
therefore the Australian exports increased, hence reducing the CAD to -$51,000 million

2006-07: The current account deficit increased due to a high net primary income deficit
of -$47 billion, therefore the CAD increased to -$58,000 million

2007-08: Due to increased consumer spending, the CAD deficit rose to -$73.9 billion

2008-09: Due to low net primary income deficit and a strong goods and services surplus,
the CAD fell to -$40.5 billion dollars, due to less imports coming in due to the GFC,
consumers were not spending much

2009-10: ?????? GFC?

International competitiveness:
International competitiveness: refers to ability of Australian business to complete with
overseas producer both domestically and overseas. IC will affect the volume of goods
sold domestically by import competing industries. Changes to IC will impact on the
balance of goods and services accounts and in turn the CAD. IC is influenced by price and
non price factors

Price factors:

• Costs are a major contributor to the price of goods and services, when costs fall
due to higher worker efficiency or productivity for example IC will rise. Higher
inflation increases the cost of all factors of production leading to a decrease is IC

• The exchange rate has a significant impact on IC. When g & s are purchases from
overseas they are paid for in that country's currency requiring the domestic
currency to be converted. When the Australian dollar depreciates it makes
Australian exports cheaper, hence increases IC. IF the Australian dollar
appreciates, it will result in an decrease in the international competitiveness

Non-price factors:

• IC will also impacted by the quality of products compared to competitors,


reliability of delivery of the products and government policies such as regulation
and trade agreements

Trends and Effects:

• IC has improved in Aust in 1990's due to structural change leading to improved


productivity. More recently IC has been linked to movements in exchange rates.

• IC has major impacts on the goods & services balances of the Current Account
and the CAD contributing to the consistently high CAD in Australia

Terms of Trade:

Terms of Trade: Is an index that measures the relationship between the relative price of
a country's imports and the relative price of a country's exports. Ie the relative price a
country pays for its imports to exports. (If its over 100 its good, less than 100 is bad)
The terms of trade index is calculated by:

Terms of Trade Index =

• The export price index measure the relative changes in prices received for
exports and the import price index measures the relative changes in the prices
received for imports over a certain period.

• These changes are measured against a base year which always has a value of 100

• If another year has a TOT index of 100, there have been no relative changes in
the prices of exports and imports. IF the TOT index is greater than 100 the price
of exports has increased relative to imports. This indicates favourable or
improving terms of trade and means a country can purchase more imports with
the same quantity of exports. If the TOT is less than 100 the prices of exports has
fallen relative to the price of imports. This indicates unfavourable or
deteriorating TOT. Since the mid 1950's Australia's TOT have been deteriorating
because of the composition of exports and imports.

Trends and Effects:

• Australia's exports are primarily commodities whose prices have generally been
increasing slower than the prices for the manufactured goods Australia imports.
This deterioration in the terms of trade caused problems with the current
account deficit because Australia has constantly been under pressure to produce
more exports just to pay for the same levels of imports.

• Recent years has seen an improvement in the TOT as a result of higher prices for
commodity exports together with slow growth in import prices with 2007 TOT
reaching the highest level since 1950's

• This trend changed with the global financial in 2008/09 with weaker world
growth and lower global commodity prices resulting in an 18% decline in
Australia's TOT. The recovery in 2009/10 has seen n improvement in the TOT led
by strong demand for China for our resources. Declining or worsening TOT
decreases the goods balance in the Current account, contributing to a potentially
higher CAD.

Example:

Year Export Price Index Import Price Index Terms of Trade Index
1 100 100 100
2 115 105 109.5
3 120 130 92.3
Eg: Year 3 was calculated by

Terms of trade index =

International Borrowing:

Foreign Debt and Foreign Liabilities:

Net Foreign Liabilities = Net Foreign Debt + Net Foreign Equity

Gross Foreign debt: total of Australia's liabilities to the rest of the world

Net Foreign Debt: gross foreign debt less the rest of the world's liabilities to Australia's

• Australia's foreign liabilities are made up of debt and equity obligations

• Australia's foreign debt liability has changed significantly over the past 20 years
with an increasing reliance on debt capital. In 1980's debt was less than $10 and
was 6% of GDP. This is increased to $596 in 2007/08 and was 53% of GDP

• From: 1994 to 2006 net foreign debt has averaged 42.5% of GDP. By 2006 91% of
Australia's borrowing was in the form of foreign debt. In 2009/1 foreign debt was
$672 billion or 53% GDP. Foreign debt has averaged 50% of the GDP from 2002 to
2010

• Increased net foreign debt results in an increased amount of debt to be repaid in


the future as well as increased interest repayments to service the debt.

• Remember interest is an income debit in the balance of payments and forms a


structural base for the CAD

Deb Servicing Ratio: DSR is expressed as the percentage of export income that has to be
paid in interest for debt.

• This reached a peak of 20% in the late 1980's but has fallen into an average of
10% in the 1990's and 2000's as a result of slowing debt accumulation and
relatively low world interest rates.

• The debt servicing ratio has risen slightly to 11% in 2006 as a result of higher
world interest rates and increased levels of debt accumulation

Foreign Investment:

• Foreign investment occurs when individuals or businesses from one country


invests in another country. Foreign investment in Australia has been encouraged
by governments by the reduction of trade and investment barriers in order to
promote growth in the domestic economy

• FI has grown due to removal of protective trade barriers (quotas, taxes and
subsidies), increased integration

Foreign investment can be in the form of:

• Portfolio investment: usually shares which provides less than 10% share in a
company

• Direct investment: greater than 10% share giving a controlling interest

Advantages:

• Help to stimulate and expand the economy. FI overcomes the problems


associated with lack of domestic savings and provides the capital needed for
business to expand.
• FI encourages the spread of new technology and ideas
• Greater acess to foreign exchange and foreign capital for Australians
Disadvantages:

• Dividends must be paid to foreign investors reducing domestic income and


increasing debits in the Current Account.

• Profits are also paid to the foreign investors again adding to the CAD

• Some loss of control over domestic companies will result in increased foreign
direct investment

Level and distribution of Foreign Investment in Australia:


-There is a large level of foreign investment in Australia this has been mainly because of
foreign investment in Australia though MNC's

-The major distribution 58% in portfolio investment, 23% direct investment, 15%
investment liabilities, 4% from financial derivatives

The leading foreign investors into Australia:

• USA and UK are the two main investors

• USA account for 27% of the total

• UK 26% of the total


• in

• Japan 5% of the total

• Netherlands accounts for 2% of the total

• Hong Kong 2% of the total

• Singapore 2% of the total


Structural Changes in the Australian Economy:

• Structural changes refers to changes in the economy’s structure of production


and level of technological progress as economic developments takes place

• Australian primary industries such as agriculture and mining have come more
efficient and capital intensive and the extra resources have been release to the
services industry
• Structural change can contribute to the balance of payments, the efficient use of
resources and the latest use of technology has lead to the growth in Australia’s
primary industries. Hence, has increased the international competiveness and
increased exports resulting in greater revenue

• This revenue reduces the CAD, this was evident during the global resources boom
from 2004-2007 which caused a rise in commodity prices from which Australia
benefited via increased income for exports

Chapter 2- Exchange Rates:

Measurement of relative exchange rates:


Exchange rate: The rate at which a unit of domestic currency is exchanged for a given
amount of foreign currency
Also known as:

• The price of one currency quote in terms of another


• Also an asset price due to the trade in currency
• Is a measure of relative value or purchasing power

Money is exchanged in:


• The foreign exchange market (forex market)
• Spot market: The cash market for foreign exchange conversation, Forward
market: Trade In derivatives or future contracts

Methods of quotation:
Indirect method: Is the rate of exchange between a unit of domestic currency and the
equivalent amount of foreign currency

Eg: $A.1.00 is equal to $US0.90

• Gives the price of one Australia dollar in the foreign exchange market

• Is the method used by the media

Direct method: Is the number of units of domestic currency needed purchase a unit of
foreign currency
Eg: $A 1.11 is equal to $US1.00

• Exchange rates can be determined by the market forces of supply and demand
(floating or flexible exchange rate) or fixed by a government’s central banking
authority
• Australia went from a flexible peg exchange rate to a floating exchange rate in
1983
• Before 1983, the dollar was pegged to the British pound

Bilateral or Cross rates: Is the measure of the value of a unit of domestic currency
relative to another currency, usually a major trading partner

Eg: the Australian dollar relative to the US dollar, Japanese Yen, Euro or UK pound

Changes in relative exchange rates measure the rise and fall in the Australian dollars
relative purchasing power against other currencies.

Appreciation: A rise in purchasing power of the Australian dollar/currency, leading to an


increase in the value of the currency

Depreciation: A fall in purchasing power of the Australian dollar/currency, leading to a


decrease in the value of the currency

Trade Weighted Index (TWI): Is a measure of the value of the Australian dollar against a
basket of foreign currencies of major trading partners. These currencies are weighted
according to their significance to Australia’s trade frequency/flows

• Measures general changes in the value of the Australian dollar rather than
specific changes against one currency
• Measures Australian dollars against a basket of currency of Australia's major
trading partners (22 nations) compare with a base
• The currencies of countries that are more prominent in Australia's trade are given
a higher weighting so they have a greater influence on the TWI
• Seen as a more accurate measure because it is trade weighted and related to
changes in the balance of payments

Factors affecting the demand for and supply of Australian dollars:


Demand:
Demand for Australian dollars is a derived demand. It is derived from demand for the
country's exports of goods and services.
***The demand for $A is represented by all those people who wish to buy $A***
Money going IN = demand

• The size of financial flows into Australia from foreign investors who wish to
invest in Australia
• The level of Australian interest rates relative to overseas interest rates (A
higher interest rate in Australia makes it more attractive for investing, hence
increases the demand for $A)
• The availability of investment opportunities (If more opportunities for
investors to start a new business or buy into an existing one, the demand for
$A would increase)

• Expectations of a future appreciation of $A (The $A will increase the current


demand for $A by speculators, hence will contribute to the future expected
appreciation)

• Deregulation of markets

• The demand for Australian exports:


• Changes in commodity prices and terms of trade can have an immediate
impact (A rise in commodity prices and improvements in the terms of trade
are associated with an increase in Australian exports, hence rise in the
demand for the $A)
• International competitiveness of domestic exporters and Australia’s inflation
rate affects the demand of $A (If domestic firms are competitive in the world
markets and the Australian inflation is low, exports will be relatively cheaper
and hence attract more foreign buyers)
• Changes in global economic conditions will influence the overseas demand
for exports (The demand for Australian exports is dependent on the growth
rates of Australia’s trading partners. When the world economy is on an
upturn, demand and prices for Australia’s exports rise)
• Changes in tastes and preferences of overseas consumers will also affect in
the demand for Australia’s exports
Supply of $A is represented by all those people who wish to sell $A
• The level of financial flows out of Australia by Australian investors who wish to
invest overseas (withdrawing of $A) and will need to sell $A to purchase foreign
currency
• The level of Australian interest rates relative to overseas interest rates (Lower
Australian interest rates will make it investing overseas more attractive,
hence increase the supply of $A, as more money is being withdrawn)
• The availability of investment opportunities (Greater investment
opportunities overseas will increase financial flows out of Australia, hence
increase the supply of $A)
• Speculators who expect the value of $A to go down will sell their $A, hence
increasing supply and contributing to the suspected depreciation
• Exchange rate is affected by the domestic demand for imports as Australian
importers have to sell $A in order to obtain foreign currency to make import
payments
• Influenced by level of domestic income (As income rises the demand for
imports will rise as people can afford to spend more on income, hence
increasing the supply of $A, caused by increased economic growth in the
economy)
• Domestic inflation and the competitiveness of domestic firms that compete
with imports (If the domestic inflation is higher and the importing competing
firms are uncompetitive, imports will be cheaper than domestic products,
hence demand for imports will be higher)
• Changes in tastes and preferences (If consumers have an increasing tastes
and preference for imports, they will buy more, hence increases the supply of
$A)

Changes in exchange rates:

Under a floating exchange rate there are two main types of movements that can occur,
appreciation and depreciation. These movements result in a change in equilibrium.

Appreciation (increase): A rise in the value or purchasing power of an exchange rate and
may be caused by an increase in demand for $A or a decrease in supply of $A

Depreciation (decrease): A fall in the value or purchasing power of an exchange rate and
maybe caused by a decrease in demand and an increase in supply

Appreciation of $A

Figure 5.2 shows the appreciation of the $A against the $US


• Any increase in demand for $A (shifts the demand curve to the right from D1 to
D2) will increase the price of $A in terms of $US (cause an appreciation of the $A)
• Any decrease in supply of $A (shift in the supply curve to the left, from S1 to S2)
would also cause an appreciation. The appreciation is shown in both graphs as an
increase in the value of the $A from $US 80 cents to $US 90 cents
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 (cause a
depreciation of the $A)
Likewise, any increase in supply of $A (shifts 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 $A from US 80 cents to $US 70 cents
Appreciation Depreciation
An increase in Australian interest rates or A decrease in Australian interest rates or
decrease in overseas interest rates increase in overseas interest rates
Improved investment opportunities in Deteriorating in investment opportunities in
Australia or deteriorating in foreign investment Australia or improvement in foreign
opportunities opportunities
A rise in commodity price and an improvement A fall in commodity prices and a deterioration
in Australia’s terms of trade in Australia’s terms of trade
An improvement in Australia’s international A deterioration in Australia’s international
competitiveness competitiveness
Lower inflation in Australia High inflation in Australia
Increased demand for Australia’s exported Increase demand for imported goods and
goods and services services
Expectation of a currency appreciation Expectation of a currency depreciation

Exchange Rates and the Balance Of Payments:


The equilibrium exchange rate in a floating exchange rate is established when the
demand and the supply for Australian dollars are equal
• Equilibrium occurs where: Demand for Australian dollars = Supply of Australian
dollars
This means that the demand for Australian dollars is equal to the sum of receipts
associated with exports, net income credits and capital inflow in the balance of
payments. The supply of Australian dollars is equal to the sum of payments associated
with imports, income debits and capital outflow in the balance of payments
• Exports + Income Credits + Capital Inflow = Imports + Income Debits + Capital
Outflow
By rearranging Equation 2, we get Equation 3, which suggests that the current account
balance must be equal (but opposite in sign) to the capital and financial account
balance, under a floating exchange rate system
• Capital & Financial Account Balance
• Current Account Balance)
• (Exports – Imports) + (Income Credits – Income Debits) = Capital Outflow –
Capital Inflow

Relationship between Balance of Payments Outcome and Exchange Rates:


Current Account Outcome Capital and Financial Account Exchange Rate
Outcome
1: Current Account Surplus Capital and Financial Account Appreciation
Deficit
2: Current Account Deficit Capital and Financial Account Depreciation
Surplus

Determination of Exchange rates including fixed, flexible and managed rates:


Floating/Flexible Exchange Rate:
In December 1983 the Australian government floated the Australian dollar. Prior to this
time the exchange rate operated under a managed flexible peg system. The change was
made because the floating system was seen to be:

-The most efficient method of determining the value of the Australian currency
-The expose the Australian economy to international competitive pressures
-To allow for more effective and independent monetary policy within a deregulated
financial environment

Under a clean float, (no government intervention) the exchange rate is determined
solely by the forces for supply and demand for Australian dollars. The balance of
payments will be zero

Advantages and Disadvantages:


Advantages:
• Would lead to a more realistic market price for the currency that reflected the
fundamentals of the Australian economy (economic growth, inflation,
unemployment)
• Would discourage destabilising speculation about the future value of the
currency if it was not fixed by the government
• Ability to pursue more effective monetary policy with a floating exchange rate
• Floating exchange rate would provide some insulation properties for the
Australian economy from external real and financial shocks by moving to new
market equilibriums. These changes would indicate as signals to exporters,
importers and the government that structural policy changes will be needed to
maintain international competitiveness
• The Floating exchange rate system is consistent with Australia’s major trading
partners, hence allows greater global capital market integration

Disadvantages:
• Increased volatility over time, caused by changes in exchange rate expectations
• Floating exchange rate can be subject to sudden shifts in market sentiment,
causing the exchange rate to deviate from its long run equilibrium path
• Exchange rate can “overshoot”, occurs when a currency appreciates or
depreciates in value by more than it is anticipated to
• “overshooting” can be caused by a “bandwagon effect” as speculators follow
market trends, causing the exchange rate to become volatile
Fixed Exchange Rate:

• Under a fixed exchange rate system the government or the RBA, the central bank
would set the exchange rate

• A fixed exchange rate is depicted in the image above, in this case the official rate
has been set at $A1 = US 90 cents (Above the US 80 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 (Q1 Q2) at a price of $US 90 cents
• If the central bank fixed the exchange rate above equilibrium it would have to
buy $A to limit supply. If those set rate below equlbirium they would need to sell
$A to reduce demand
• A fixed exchange rate system does not imply that the rate will stay at the same
level all the time. The government may decide to change the rate because of
adverse effects on the economy. For example if the currency is overvalued
exporting industries will become less internationally competitive, affecting
international trade and the balance of payments

• A Devaluation of a currency occurs when there is deliberate action taken by a


government to decrease the value of the forex market

• Alternatively a Revaluation occurs when there is deliberate action taken by


government to increase the value in the forex market. Imports rise as they
become cheaper

Advantages of a fixed exchange rate:

• Certainty about the immediate short term value of the exchange rate, assists
exporters and importers in their decision making

Disadvantages of a fixed exchange rate:

• Speculation increases since the exchange rate is not market determined,


speculators may buy AUD’s if they are undervalued or sell if they are
overvalued to make profits. This destabilises the rate and forces RBA or
government to revalue or devalue the currency

• Reserve bank has to hold large foreign exchange reserves to keep the
exchange rate at its pre determined value

Managed/ Pegged Exchange Rate:


• Similar to flexible in that it is “pegged” or “adjusted” to a major trading partner’s
currency or even to the TWI
• In a pegged system the RBA or government would set the exchange rate daily,
keeping it in a “target band” or “intervention zone”
• The government or RBA would intervene if the exchange rate higher or below the
pegged rate
The influence of the Reserve Bank of Australia on Exchange Rates:
The RBA can influence exchange rates directly ie by buying of selling currency in foreign
exchange market. This is called “dirtying the float”

-By reducing supply of Australian dollars will put upward pressure on exchange rates-
appreciate
-By increasing supply of Australian dollars it will put downward pressure on exchange
rates- depreiciate
The RBA can also influence exchange rates indirectly by changing domestic interest rates.
Increasing interest rates will generally lead to an inflow of investment funds. This
method while possible is really used due to the impacts it would have on the domestic
economy such as increasing inflation

Reasons for intervention:

-When pressure is put on economic growth and the balance of payments because our
exchange rate is out of line with other countries due to the effects of inflation and high
levels of foreign debt

-To correct inefficiencies due to speculation

-To correct excessive depreciation which could lead to increased import costs leading to
higher domestic inflation and increased foreign debt

Unsterilised and Sterilised intervention:


Domestic Interest Rates:
To increase the domestic interest rates, the government/RBA buys the Australian
dollars and sells government securities; this reduces the supply of the Australian dollars
and increases the exchange rate
To decrease domestic interest rates, the government/RBA sells the Australian dollars
and buys back government securities; this increases the supply of Australian dollars
and decreases the exchange rate
Sterilised Intervention:
This occurs when the government/RBA goes back and adjusts the domestic interest rates
so that there is no change in the domestic interest rates due to a change in the exchange
rate
When the RBA offsets exchange rate intervention by buying or selling Australian dollars
to reduce the dollar it will sell bonds to decrease money supply in Australian domestic
market. Therefore:

• If the government sells foreign currency and buys $A to reduce the supply of $A,
causing a appreciation of $A, the government would have to go back into the
domestic market and buy back the “government securities” and sell the $A to
offset the reduction in supply of $A

• If the government buys foreign currency and sells $A to increase the supply of
$A, causing a depreciation of $A, the government would have to go back into the
domestic market and sell the “government” securities to buy back the $A to
offset the increase in supply of $A

Unsterilised Intervention:
This occurs when the government/RBA does not go back and adjust the domestic
interest rates. This means that there will be a change in the domestic interest rates
• If the government sells foreign currency and buys $A to reduce the supply of $A,
causing a appreciation of $A, without sterilisation the domestic interest rates
would rise

• If the government buys foreign currency and sells $A to increase the supply of
$A, causing a depreciation of $A, without sterilisation the domestic interest rates
will fall

The effects of fluctuations in exchange rates on the Australian Economy:


Valuation Effect: Is where an appreciation (or depreciation) of the currency causes an
immediate decrease (or increase) in the Australian value of foreign debt that is
borrowed in foreign currencies
Appreciation:
Positive Effects Negative Effects
Australian consumers enjoy increased By increasing the value of the $A in terms of
“purchasing power”- they can buy more other currencies, Australia’s exports become
overseas produced goods with the same more expensive on world markets and
quantity of $A therefore more difficult to sell, leading to a
decrease in export income and a deteriorating
of the CAD in the medium term
An appreciation decreases the interest Imports will be less expensive, encouraging
servicing cost on Australia’s foreign debt import spending and worsening Australia’s
because Australians can buy more foreign CAD. Domestic production of import subsidies
currency with Australian dollars. This would is likely to fall
reduce outflow on the net income component
of the current account in future years and help
reduce Australia’s CAD
An appreciation will also reduce the $A value Foreign investors will find it more expensive to
of foreign debt that has been borrowed in the invest in Australia, generally leading to lower
foreign currency “valuation effect” financial inflows. However, financial inflows
may continue if foreign investors expect the
currency to continue rising
Inflationary pressures in Australia will be An appreciation reduces the $A value of
reduced as exports become cheaper. This is foreign income earned on Australia’s
likely to reduce pressure on the RBA to raise investments abroad and would cause an
interest rates to defend its inflation target deterioration in the net income component of
the CAD
An appreciation will also reduce the value of
the foreign assets in Australian dollar terms
High import spending and reduced export
revenue will reduce Australia’s growth rate
Depreciation:
Positive Effects Negative Effects
By decreasing the value of the $A in terms of Australia’s consumers suffer reduced
other currencies, Australia’s exports become “purchasing power”- This means they can buy
cheaper on world markets and therefore fewer overseas produced goods with the same
easier to sell, leading to an increase in export quantity of $A
income and an improvement in Australia’s CAD
in the medium term. This boosts the
competiveness of exports and hence Terms of
Trade will also improve
Imports will be more expensive, discouraging Depreciation increases the interest servicing
import spending and potentially improving cost on Australia’s foreign debt because
Australia’s CAD. Domestic production of Australia can buy less foreign currency with its
import substitutes should also rise domestic currency with which to pay interest.
This increases the income outflow on the net
income component on the current account
and hence increases the CAD
Lower import spending and greater export A depreciation will also raise the level of
revenue will increase Australia’s growth rate foreign debt that has been borrowed in foreign
but this maynot happen if Australia is unable currency as expressed in Australian dollar
to replace its import with domestically terms “valuation effect”
produced goods
A depreciation increase the $A value of foreign Inflationary pressures in Australia will increase
income earned on Australia’s investments as imports would now be more expensive. This
abroad and would cause an improvement in may increase pressure on RBA to raise interest
the net income component of the CAD rates to defend its inflation target
A depreciation will also increase the value of
foreign assets in Australian dollar terms-
“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

Chapter 3- Protection in Australia:


Australia’s Policies regarding free trade and protection:
Protection: Any artificial benefit given by governments to domestic industries to protect
them from international competition

• Australia has had a long history of protection in the manufacturing sector

• Problems associated with protection have lead governments to reduce tariff


protection, these problems included:

• Greater inefficiency
• Increased misallocation of resources
• Australia being less internationally competitive
• Reduced standards of living

• 1973 The Whitlam government announced a 25% reduction in all tariffs to lower
prices and stimulate greater industry efficiency

• Late 1970’s and 1980’s protection increased in response to intensified


competition experienced by come domestic industries

• 1988 The Hawke government commenced a comprehensive trade liberalisation


program which continued over the next decade

• Today nearly half all imported goods and tariff free and only mostly
manufactured goods are subject to the 5% tariff

• In 2008, Australia’s tariff level was 2.5% and is similar to other industrialised
countries such as USA (1.5%) and EU (1.7%)

• Tariffs on imported goods increase the price at which those goods are sold in
Australia and allow the domestic producers of similar products to raise their
prices

• When other methods of protection such as subsidies are also taken into account,
Australia is one of the least protected economies in the world

• Over 07-08 period Australia had the lowest agricultural protection in OECD
nations

Rent seeking behaviour: When industries attempt lobby to win favourable treatment
from the government through maintenance of protective assistance or asking for more
assistance by using the argument that higher imports will mean loss of jobs in local
manufacturing
• Australia’s subsidy programs include: New Car Plans for a Greener Future and
Innovation Package for textile, clothing and footwear industries

• These are provided so that these firms can undergo structural changes to be
competitive with foreign imports

Nominal rate of assistance: The percentage difference between the price the domestic
producer receives with protection and the price the producer would receive in the
absence of protection

Effective rate of assistance: The amount of protection received expressed as a


percentage of the domestic value added to production

Plan Industries: Are industries that are making structural changes to them, clothing,
textiles and clothing, given special arrangements so they can be more competitive with
imported goods

Why the government reduces protection:


• Force domestic industries to become internationally competitive by exposing
them to competition from imported goods
• Encourage resources to move away from firms that cannot improve their
competitiveness to those who can become more competitive (comparative
advantage)
• Allow Australia to benefit from greater integration with the global markets to
give consumers and business greater access to goods and services at the lowest
possible price
• Promote structural change in the economy with the long term aim of
encouraging firms to be more efficient and produce what the global economy
demands hence increase economic growth
Australia’s multilateral and bilateral free trade agreements – (overview of two examples of
each type of agreement)
THESE WERE DIFFERENT TO THE UNILATERAL APPROACH AS IT INVOLVED
AUSTRALIA MAKING TRADE AGREEMENTS WITH OTHER NATIONS RATHER THAN
TRYING TO INCREASE INTEGRATION OF AUSTRALIA INTO THE FOREIGN MARKETS
BY ITSELF

The decision to reduce protection was due to the belief that it would increase
international competition and promote free trade

Australian governments have actively negotiated many trade agreements with trading
partners eg:
Why????

• To negotiate more favourable, gain access to overseas markets


• Assist Australian producers to gain access to foreign markets
• The products would also be cheaper as the tariffs would decrease, allows more
competition into the markets and lower the prices

Bilateral Trade Agreements:


AUSTFA (Australia – United States Free Trade Agreement):
• Was signed in 2005 and was an agreement to reduce tariff and non tariff barriers
to trade in agriculture, manufactured goods, services, investment and intellectual
property
• Both nations reduced most tariffs to almost zero in 2005
• Remaining non tariff areas such as textiles and clothing will be phased out to zero
by 2015
• For beef and dairy exports, tariff quotas were increased in the USA to allow
increased import of Australian beef into the US markets
• Have increased manufactured exports to USA
• AUSFTA could increase Australia’s GDP between 0.4% - 0.7% within ten years of
operation
• Services trade is estimated to grow by 6% because of reduction in regulations
and rules
• AUSFTA has benefited USA though increased manufactured and service exports
whilst Australia’s exports have increased by a lesser margin
ANZCERTA (Australia New Zeal Closer Economic Relations Trade Agreement):
Major Objectives:
• Strengthen the broader economic relationship between Australia and New
Zealand
• Develop closer economic relations between the two countries through a
mutually beneficial expansion of free trade
• Eliminate trade barriers to Australia and New Zealand in a gradual and
progressive manner with a minimal level of disruption
• Develop trade between Australia and New Zealand under conditions of fair
competition
• Resulted in tariff and non tariff barriers in all goods
• Facilitated the restructuring of manufacturing industries in both countries
• Both nations have agreed to reduce protection on manufactured goods from the
rest of the World
• Greater competition, specialisation and lower consumer prices have resulted
• Led to free flow of labour and capital resources between the two countries
• Improved resource allocation in both countries and more open to trade
• In 2009-09 period Australia purchased 3.2% of New Zealand exports whilst New
Zealand purchased 3.7% of Australian exports

Multilateral Trade Agreements:

WTO (World Trade Organisation):


-WTO (World Trade Orgnisation) is a forum for nations to negotiate and enforce
agreements on the conduct of international trade and related matters
-Evolved out of the GATT which Australia was heavily involved in
-WTO oversees around 60 trade agreements on trade matters such as trade in goods,
services and intellectual property
-WTO require all member governments to apply their trade rules in a consistent,
transparent and non discriminatory way
Key Features include:
The Most Favoured Nation Rule requires that WTO members must grant to all its trading
partners the conditions it grants to its “most favoured” trading partner
The National Treatment Rule requires that countries should set conditions for imported
goods and services no less favourable than those for domestically produced goods
Countries must “bind” their tariffs and other barriers, and the country is “bound” by
these levels
Transparently rules requires other member countries to make their trade laws and
regulations publically available
APEC (Asia Pacific Economic Co-operation):
• Australia was a founding member
• APEC is a discussion forum on trade policy issues and aims at closer trade and
investment links in the Asia Pacific Region
• Represents 54% of world GDP and 44% of World Trade
• “Open Regionalism” where reductions in trade barriers take place on a non
discriminatory bases by liberalising trade between members, but not
discriminating against non APEC members
• Average tariff levels across APEC members have fallen to nearly 3% in 2004

Advantages and Disadvantages of Multilateral and Bilateral Trade Agreements:


Advantages:
• Can lead to increased integration between other nations and Australia

• Increased integration means lowering of trade barriers, due to increased


competition in the domestic
• markets due to imports from other nations, market prices decrease as
competition increases

• Can increase capital and technological flows into Australia via other nations

• Can increase financial flows due to increased imports resulting

• Increase in market access

Disadvantages:
• May lead to “dumping” if one nations has a greater comparative advantage in
producing one product compare to the other nation

• The local producers may have to shut down due to them not being able to
compete with the foreign imports, decrease in profits for local producers

• Some nations may have a greater say in the decisions that will be made by the
nations, such as the WTO, the more advanced economies will have a greater
share and this can disadvantage the smaller economies, again can result in a
greater sense of dumping

• Infant industries might not be able to keep with the increased competitions in
the market; this can prevent local manufactures from entering the product
market due to fear of being shut down from foreign imports

The implications of Australia’s policies for individuals, firms and governments:


Effects on firms:
-Reduced protection in import competition industries will shrink unless they are able to
improve their competitiveness
-Production in some sectors can cease altogether such as manufacturing of consumer
electronics, this is because they require relatively low skilled labour, and the advanced
economies cannot compete with the low wages in developing nations, hence are sent
“off shore”
-Firms will be forced to undergo restricting such as:
• Consolidating their manufacturing to one plant
• Eliminating less profitable production lines
• Find exporting opportunities due to local business decreasing
• Reducing staff levels
• Adopting new technologies
-Low domestic tariffs mean that low input costs for firms and hence will be able to offer
lower prices and local firms can be more internationally competitive due to a reduction
in price, TOT can increase
-This is evident as removal of tariffs on inputs such as farm machinery has improved the
competitiveness of Australia’s agricultural industries
- Enhanced productivity and efficiency in competition with exports
-Reduces prices and costs to compete comparatively

-Textile, Clothing and Footwear, steel and personal motor vehicle (PMV) industries have
experienced restricting and rising levels of structural unemployment
-Firms need the latest technology and substitute’s capital for labour to achieve higher
productivity

GFC and Protection on Firms:

-During the GFC Australia increased protection to protect local industries

-The government announced a $ 6.2 billion package for the Automotive industry
between 2009 and 2021

-$747 million of subsidies were spent on textiles clothing and footwear industries

Effects on individuals:
• Unemployment can rise as a result of restructuring and cuts in local production
• People in import competing industries will be the most effected
• People manufacturing areas such as Victoria and South Australia, where few
alternative sources of employment exist, unemployment rates have risen
dramatically
• Also due to the reduction in jobs, it is harder for these individuals to get new jobs
• Structural unemployment occurs as a result of this decrease in protection, their
skills do not match the job vacancies in the economy
• Most jobs losses are low skills and due to limited skills these cannot be easily
transferred to other workplaces
• The government is forced to fund retraining programs to help workers made
redundant through these structural changes due to a reduction in protection
• However in the long term, after structural change the demand for workers may
increase as domestic firms become more internationally competitive and hence
expand
• Consumers with be able to have access to move variety of goods at cheaper
prices, consumer price index has estimated to fall by 3.8%
• Reduced protection has allowed greater options and access to different products
coming in from all around the world
• Higher competition between domestic and international firms leads to an
improvement in living standards because consumers are looking for higher
quality goods, therefore the global market has to keep up with the demand of
consumers

Effect on governments:
Reduction in protection ---> cutting of tariffs ------> reduction in government revenue as
it provides indirect tax revenue to the government
Government expenditure is required to assist firms undergoing structural adjustment
process through unemployment benefit schemes, retraining programs and even financial
support due to “rent seeking behaviour” eg: motor car and textile industries
Governments can lose votes by pursuing policies to reduce protection due to loss of jobs

Implications for Australian protectionist policies of other countries and trading blocs:
The Uruguay Round - GATT:
• -The absence of the GATT codes for trade in agricultural commodities left
Australia in a vulnerable position because US wheat subsides and EU wheat
subsidies denied market access to Australian wheat exporters and depressed
global wheat prices and cut export return to Australian farmers
• -Non tariff forms of protection such as “voluntary export restraints” and “anti
dumping” measures penalised producers like Australia in favour of less efficient
producers such as US and EU, led to trade diversion from Australia
• GATT Implications:
• -GATT agreement on trade in agriculture resulted in reduction in agricultural
subsidies, reducing in quotes to tariffs and reduced by 35%
• -GATT agreements on trade and services brought trade in services such as
finance, insurance, banking, technology and entertainment under WTO rules
• -GATT agreement on intellectual property led to new framework in
trademarks and copyrights
• -GATT agreement on manufactured goods lead to tariffs being cut by 15%
• Benefits to Australia suggested an increased output and faster growth export
volumes than import volumes and capital investment was projected to rise in all
sectors
Main Implications of Uruguay Round:
• The scaling down of agricultural subsidies in the EU and USA

• Governments subsidising agriculture were forced to adhere to the WTO rules on


agriculture

• Increased market access for trade in services was a boost for Australia’s service
exports

• The GATT was replaced by the WTO which has greater powers to monitor and
control world trade, hence more benefits for Australia in terms of equality and
greater say

Overall the WTO has greater power to monitor and control world trade, some of the
significant powers include:
• The WTO has powers extending to goods, services and intellectual property
rights
• The WTO has greater power to limit the use of anti-dumping actions
• The WTO can use sanctions/penalties to resolve trade disputes
• The WTO can restrict government support for industry through control over
subsidies

Doha Round:
• In agriculture: negotiating for the complete elimination of agricultural export
subsidies

• In manufacturing: negations for greater market access for exports than the
average 15% cut in tariffs negotiated at the Uruguay round

• In services, Australia is seeking improved access to overseas markets in areas


such as business, finance and education

Deadlock in DOHA:
• EU was unwilling to cut agricultural subsidies by more than an average 50%,
whilst Australia and other countries wanted a cut of at least 60%
• The USA was unwilling to cut its farm subsidies from US$20b to US$15 b per year
• Developing countries such as Brazil and India wanted to exclude many industrial
and consumer products (cars and electrical goods) from tariff cuts and not open
to their markets to overseas competition from other developing as well as
developed nations
• The unwillingness of EU and USA to cut agricultural subsidies and improve
market access to developing countries represent the greatest impediment to
global free trade and economic development