OF PRINCIPLES ECONOMICS- STUDY NOTES
CHAPTER 1- LEWIS
Factors such as natural resources, mix of population and the political
system are very important to determining what makes up the Australian
economy.
Economists recognise that political, geographic and multiculturalism
differ Australias economy from those of the rest of the world, however
they are not directly interested in those factors.
Economists use the GDP (Gross Domestic Product) as a measure of
the size of the economy. E.g. AU 04/05 GDP= $789 billion, a.k.a. $39
447 per head of population/ $78,753 per head of population. GDP is
also sometimes used as a measure of welfare.
GDP the total value of all the g&s produced in an economy, with
warning that only the g&s sold and bought in markets are counted
(a.k.a. the black market, unemployed housework, volunteer work are
not counted). This is seen as a problem, as it completely ignores nonmarket activity in the economy.
Another danger in using the GDP as a measurement of economic
activity is that one of the characteristics of Australia and a lot of other
countries of the world is that there has been a huge shift away from
people doing unpaid work towards paid work which has exaggerated
the apparent growth in GDP.
Using the GDP as a measure of standard of living is deficient, as it
does not take into account leisure, the cleanliness of the environment,
as well as the availability and quality of education and health-care
facilities. My e.g.: Whilst Australia has HECS for university study,
American education, except for the very high academic achievers is
paid.
Just as important as the size of the GDP, is its distribution among the
nations population. that everyone is roughly middle class, there
should be no mass poverty and billionaires equality is important.
Economic efficiency- determining how best to allocate resources in
order to obtain the maximum income or welfare of the whole
community.
Equity issues- how best to distribute income among the members of
community e.g. taxation, social welfare and government intervention.
Industry composition: this is the breakdown of total production in the
Australian economy. By far the highest is the service sector 70%,
followed by manufacturing 11.5 %, and the primary sectors: agriculture
and mining, 3.7% and 4.6 % respectively of GDP.
Open economies- those that have a high proportion of their output
devoted to trade.
Closed economies- are those that have a relatively low proportion of
their GDP devoted to trade.
It is convenient to divide the Australian economy into 2 industries:
1.mainly tradeable g&s and non tradeable g&s.
Tradeables are g& s produced in competition with overseas producers.
the proportion of the economy producing tradeables is measured as
a percentage to determine the degree of openness of that particular
economy.
Australias exports (X) and imports (M) make up roughly 23% of GDP.
Market economy- the extent to which an economy is one a.k.a. to what
extent g &s are produced by the private sector or alternatively by
measuring the size of the public sector. measures the extent of
governemnt involvement on the economy.
Government has a crucial role in the economy- involved in
maintenance of law and order, enforcing contracts and providing public
goods such as defence, street lighting etc. also responsible for
redistributing income in the economy, largely through taxation & the
social security system. not all countries have this e.g. Singapore.
Performance- measured as GDP per head.- AU in 2002 ranked 10 th
richest in the world. this measure is not quite reliable as it shouldnt
really be used as a standard of living measure, and also when making
international compariosns since all GDP estimates are in U.S. dollars.
Economic growth- economic growth is the increase of GDP over time
defined as the % change in real GDP over time, where real GDP is the
dollar value of GDP corrected for inflation.
Productivity is the key measure of an economys performance
standard of living will rise if a country obtains more resources. E.g.
gold, iron, ore,gas & oil. Migrants have also brought in skills and
assets.
In long term- the capacity of a country to increase its standard of living
depends on its ability to produce more output with the same or lesser
amount of resources a.k.a. increase its productivity.
The biggest growth has been in communication, due to rapid
technological change and microeconomic reform.
Up to 1994 the growth of productivity in AU has been declining overall
average annual growth in productivity fell from 1.7% 1960/73 to
0.5% 1979/94.
However since 1994, significant increases in productivity were
experienced by AU & OECD countries, a period characterised by
significant technological change associated with the new economy
NE associated with the growth + diffucion of IT +globalization.
Competitiveness- 1 measure of c of the open economy is: real
exchange rate- the nominal exchange rate adjusted for differences in
the price level between AU and overseas. A.k.a. if nominal exchange
rate rises, AU X more expensive and M are cheaper. thus AU
industries less competitive. Also if inflation is greater in AU than
overseas, competitiveness falls.
In general competitiveness can be measured by reciprocal of the real
exchange rate.
Competitiveness may also be measured by how a country rates
according to the factors necessary for competitiveness e.g. surveys
to measure expenditure on research, education, natural resources,
productivity + business performance.
Inflation + unemployment- Macroeconomic measures e.g. inflation rate,
unemployment rate, balance of payments and interest rates.
Macroeconomic factors impact: consumers, firms, industries
specifically those in the open economy. the financial sector is an
essential element in the macroeconomic policy.
Economic growth,inflation +unemployment are major indicators of
macroeconomic performance.
Balance of payments maintenance of low inflation + low
unemployment is often referred to as internal balance. another
measure of macroecon performance is maintaining external balance
a.k.a. economy does not incur persistent balance of payments deficits/
surpluses on the current account which could eventually result in the
economy having to undergo costly adjustments.
Another element to external balance is the degree to foreign
indebtedness.
Microeconomic reform- includes policies such as:
reduction in protection to manufacturing industries
restructuring the taxation system,
reforming union- employer relationships
improving and increasing worker training
reforming public-sector operations and ownership.
It is intended that these policies will remove the elements of
government control that are obstructions to efficiency + competition
To be competitive ultimately means to produce g&s that customers
(both domestic and international) want, at a price and quality at least as
good as foreign producers + it is important to be reliable and punctual
regarding deadlines (deliver on time).
Firms in the open sectors of the economy employ inputs from other
sectors of the economy which may not be open to competition, which is
why the competitiveness of Australian firms depends also on
performance of other sectors of the economy. the most important
input is is labor (human resources) the quality of labor depends on
investment in education and training. Another major input is capital
the growth of capital or investment depends crucially on an efficient
financial sector.
Trade policy- making an economy more open increases
competitiveness.
Of equal importance are the protection policies of other countries of the
world- of primary importance to AU is the freeing up of agricultural
trade in the most recently completed agreements at the World Trade
Oraganization (WTO) the protectionist policies of the European
Union + countervailing policies of the US have serious implications for
AU X.
Taxation policy- taxes are an important element of policy makingprovide the major revenue source for government programs, theyre a
major tool of the fiscal policy, they can be used to even out distribution
of income + can change the patterns of consumption + production.
Macroeconomic policy- it is a policy plagued by conflicts between
objectives which make it extremely difficult to achieve several targets at
once. E.g.increasing the total demand for g & s to reduce
unemployment may raise consumption of imports and hence adversely
affect the current account.
The Commonwealth government can influence macroeconomic
variables through fiscal policy fiscal policy refers to variations in
taxation + public expenditure to influence total production +
consumption of g & s. The major component of GDP is made up of
private consumption + investment.
Another important aspect of private sector spending is savings- the part
of income which has not been consumed. Savings are a major means
by which the economy can build up on its capacity to produce in the
future a.k.a. the means that make investment possible.
Monetary policy refers to variations in the money supply + interest
rates. Changes in monetary policy can have real effects, in that
variables such as consumption and investment are affected. However
monetary policy is more often associated with nominal outcomes, most
importantly the containment of inflation. The RBA (Reserve Bank AU)
conducts monetary policy in order to maintain an inflation target within
the range of 2-3%.
CHAPTER 2 LEWIS
The Australian economy is linked to the rest of the world through
international trade and through international financial markets.
STRUCTURE AND PATTERN OF AU TRADE:78% of AUs total export
earnings 2005- export of goods, with appx 22% coming from export of
services. (export of goods is merchandise and commodity exports,
which is often what exports are discussed in terms of).
Aus merchandise exports has shifted dramatically from traditional
dominance of rural products Textile fibres (mainly wool) only
account for 2.5 % of value of general merchandise exports, compared
to 65% in 1950. during this period coal, ores, fuel & other various
metals have grown from12% to 47% of all merchandise exports
All other non merchandise (incl. Manufactures, machinery, transport
equipment + sugar & beverages) provide a bit above 31% of AU
merchandise exports.
The favoured destinations for export of goods are: Japan (20%- just
under), S-East Asia (12%), China 10% and US slightly over 7%,
European Union (11% more than 1/3 of which goes to the U.K.
The import suppliers of merchandise imports are as follows: leading is
the US 14%, China 13%, Japan 11.5%, South East Asian countries
TOGETHER nearly 17%, the countries of EU provide 23.5 % for which
UK accounts for 1/6 of.
CHANGES: 1950 Exports UK 39%, US 8%, Japan 4%, Imports UK
53%,US 10%, Japan 1%.
Changes are also apparent in the composition of the imports: 1950basic materials 19%, fuels and lubricants, machinery 16% and
transport equipment (10%) and other manufactures (35%). contrast
to now- leading commodity categories of imports: machinery (28%),
transport equipment(12%) & other manufactures 40%. NOTE:
consumer goods now account for 31% of merchandise imports,
compared with 18% in 1950.
Some of the changes in AU trading patterns is directly attributable to
reductions in the high levels of domestic tariff protection given to AU
manufacturing industry throughout the 1960s/70s. other changes
that occurred due to this is the large increase in mineral exports, which
were demand driven, particularly from Japan, as well as other Asian
countries in attempts to rebuild after WW2 & provide infrastructure for
their rapidly growing economies. Another change that occurred was
after UK joined EU in the 1960s this subsequently lowered its demand
for AU products, thus forcing AU to seek alternate markets in US and
Asia. The rapid development of many South Asian Economies in
1980s/90s also contributed to the rising demand for AU minerals and
energy.
COMPARATIVE ADVANTAGE AND FREE TRADE: In AU the largest
share of exports continues to be from the minerals and agricultural
sector, as AU has a comparative advantage in these activities.
The theory of comparative advantage states that a country should
concentrate on goods it can produce more efficiently, the emphasis
there being on relative efficiency.
Even if the country can produce this specific product cheaper, it may
still have to pay. It is crucial to remember that the g&s the countrys
consumers may want are independent of the g&s a country should
produce consumers wants can be satisfied domestically or
internationally.
Trade allows maximum production of g & s + the biggest and cheapest
range of g&s for consumers to choose from. Any attempts by the
government to restrict trade through tariffs & quotas will reduce world
production, employment whilst also reducing the welfare of consumers.
Comparative advantage is determined by the Heckscher-Ohlin theorem
which states that a country will have a comparative advantage in those
g & s that are produced with factors of production that the country has
in relative abundance (a great or plentiful amount of) .
When determining what AU has a competitive advantage in, it is
important to determine what it actually has in relative abundance.
relative abundance in land, energy, mineral deposits, highly
educated labour, natural beauty and fine weather based on these
features it is fair to say AU has a comparative advantage in such
industries as agriculture mining, education services and tourism but not
in basic manufacturing.
It is important to note that comparative advantage changes over time
which suggests that AU should develop new industries/
manufacturing processes to replace the declining industries such as
textiles, clothing and footwear.
In practice countries often trade quite similar goods e.g. AU both trades
and exports goods.- consumers demand variety in consumption.
The export and import of similar products is referred to as intra-industry
trading.
World trade has been growing significantly faster that AU trade due to
world trade in manufactured goods has been growing much faster than
trade in primary commodities + Australia has not developed significant
overseas markets for most of its manufactured goods.
The purchasing power of a countrys exports is indicated by terms of
trade which is the ratio between an index of export prices and an index
of import prices. (commodity terms of trade). this composite index,
measured over different points in time, indicates the direction of
movement in the gains from trade. An improvement in the terms of
trade for any country implies that the country is able to obtain a greater
level of imports for a diminishing volume of exports. Alternatively a
deterioration in the terms of trade indicates that an increased quantity
of exports is required to purchase a given level of imports.
It is important to note when considering time series in regards to these
indices, they ought to be treated with care, because the choice of
starting date may lead to a distorted impression of the underlying
trend.- the most that can really be said with confidence is that terms
of trade are subject to considerable ups and downs .
Australian trade as a proportion of GDP has been growing in 1970
total exports were about 15% of GDP, and even though it has been
subject to quite a few ups and downs it was a little over 20% in 2005.
Proportions are still lower than those of many Australias main trading
partners, which makes Australia semi open in terms of its trading
involvement with the rest of the world. However if openness was to
be measured in terms of the absence of trade barriers Australia would
be mainly classified as an open economy.
TRADING BLOCS AND THEIR EFFECTS: Australias trade has been
injured by the emergence of trading blocs and exclusive trade
agreements in Europe, the US and Asia to which in the case the
Australian interest is of minor importance. Members of these erect
barriers such as tariffs (taxes on imported goods) and quotas against
non-member countries, giving preferential treatment to their own
members this reduces the size of AUs potential markets,
particularly impacting the primary industries such as grains, fruits, meat
and dairy, which would otherwise be quite competitive in international
markets.
The formation of WTO (World Trade Organisation) in 1947 was one of
significance as practically all developed countries and a few developing
ones are signatories to it. Its main aim is to achieve multilateral tariff
reductions. It establishes basic rules for the conduct of international
trade by its member countries limiting arbitrary interference to free
trade and promoting adherence to policies of non-discrimination in
trading relationships, particularly:
Members should not use export subsidies, except on agricultural
products.
There should be no one sided quotas on imports, except where they
threaten market disruption.
Any new/ increased tariffs ,must be offset by reductions in other tariffs.
Reductions in tariffs + other forms of protectionism such as subsidies,
quotas and price guarantees for producers would ultimately lead to
greater levels of production & improved productivity worldwide.
Protection insulates domestic producers from market forces &
overseas competition, leading to inefficient production practices and
higher prices for domestic consumers.
Due to high levels of protection often afforded members of trade blocs
& exclusive trade agreements, their industries produce greater levels of
output than they normally would which results in greater levels of
inefficiently produced output, the surplus of which is sold on world
markets thus depressing the world price.
This reduces export earnings for free trading countries + significantly
increases hardship for 3rd world countries who rely on export earnings
from primary produce and lower lever manufactures.
Problematic Trade agreements include that of the EU and ASEAN
(Association of South East Asian Nations).
Australias free trade agreements: CER- Closer Economic Relations
with 1983, NZ July 2002- Singapore: Singapore Australia Free Trade
Agreement (SAFTA), 2004- US AUSFTA- jan 2005 came into effect.2005 Thailand, ASEAN- AFTA CER Closer Economic Partnership
(CEP).
PROTECTION POLICY IN AU: this policy was initially developed to
protect industries from international competition during their early
stages of development once the industries became established and
efficient, the protection was removed. The problem was under
protection domestic industries felt no need to be efficient, minimise
costs or be internationally competitive.
The tariffs caused various sections of the economy to suffer : the
industries that made Australian made inputs had to pay higher prices
due to cost inefficiencies in the production of those inputs. Industries
relying on imported inputs were disadvantaged as the tariffs placed on
the imported inputs raised domestic production costs.
Tariffs on imports raise the value of the $AU, reducing incomes for
exporters and making imports more expensive.
Ultimately however the burden of tariff protection is borne by
consumers who pay higher prices for the protected goods.
Figures: pg 25-26 tariff reduction policies in Australia making it one of
the most free trading nations in the world.
Balance of Payments- table 2.1 - page 26!!
The BOP is a record of the countrys monetary and asset transfers with
the rest of the world consists of 2 main parts current account+
capital & financial account.
The BOP always balances in the sense that all credits + debits must
sum to zero.
The current account records current monetary transfers between
countries such as payments received for exports and payments made
for imports, interest repayments on loans, and other fund transfers
such as pensioners and migrants funds.
The main cause for Australias persistent current account deficit over
time is the negative net income component. This is a combination of
the profits from overseas investment in Australia going abroad and the
interest repayments by Australians on overseas loans.
The final item on the current account is net current transfers and
includes items such as pensions foreign aid and migrants funds. This
item fluctuates between positive and negative.
The deficit in the current account must be balanced by an inflow of
funds and assets in the capital and financial account. As it is usual
and necessary for a country experiencing considerable development,
AU for most of its short modern history has been a net importer of
capital to both public and private sector investment.
The capital account is usually relatively small and records the transfer
of items such as migrants assets and overseas aid for capital projects.
A positive figure in this would indicate that more capital is being
transferred into AU than is going out.
The financial account records items such as net investment and
changes in the holdings of monetary assets, such as foreign currency
reserves held by the RBA (Reserve Bank of Australia).
Net investment (the difference between overseas investment in AU and
AU investment overseas) is measured by whether it is portfolio, direct
or some other form of investment.
Net direct investment involves the actual purchase of physical assets
or the building of assets (e.g. business, factory, property etc.)
Net Portfolio investment refers to the purchase of shares and other
forms of paper assets.
Other investment captures residual items such as short term bank
deposits.
The distinction between forms of investment can be useful when
evaluating the benefits and possible disadvantages of foreign
investment. It is important to note that investment tends to be very
volatile in nature a.k.a. GENERALISATIONS ABOUT INVESTMENT
FLOWS ARE DIFFICULT.
Other investment includes items such as banking sector borrowing and
official borrowing by the government sector.
Reserve Assets shows changes in the RBAs foreign currency reserves
and reserves held in the International Monetary Fund (IMF).
THE DEFICIT/ SURPLUS ON THE CURRENT ACCOUNT MUST
AWLAYS EQUAL THE SURPLUS/DEFICIT ON THE CAPITAL AND
FINANCIAL ACCOUNT AFTER NET ERRORS AND OMISSIONS ARE
ACCOUNTED FOR.
The Current Account Deficit: a problem or not?
View 1: Says the CAD is of no concern, and irrelevant to economic
policy decisions, as the floating exchange rate regime and flexible
interest rates will always equilibrate international receipts and
payments albeit at high costs to particular entities or sectors from time
to time. relies mainly on the premise that price mechanisms (free
floating exchange rate and flexible interest rate) will always either
induce changes in the overseas trade, income and transfer items so as
to improve the current account and/ or produce enough capital inflow to
accommodate any remaining deficit on the current account. Such
supporters would point to the depreciation of the AU dollar in the late
1990s and into the early 2000s and the consequent increases in
exports as evidence of this view at work. As for debt, in the present AU
situation, it is private sector borrowing which is largely responsible for
the level of overseas indebtedness (in 2005, 89% of total debt). Since
the latter half of the 1990s private sector debt has been increasing
significantly, whilst government debt has reduced significantly in the
same period. If private borrowing is for investment in exp/ imp
replacement industries which turn out to be profitable, in the long run
the borrowings generate foreign exchange earnings/ savings. Similarly
if private borrowing is used for other profitable ventures, this will
generate the means by which borrowings can be repaid. It is argued
that lack of borrowing would mean decline in business investment and
signal a reduction in economic growth and employment. Finally if
private investors make mistakes then it is they who must bear the
ultimate consequences of their obligations to overseas lenders. The
national interest is immune from their behaviour.
View 2: There are national economic interests that transcend the
individual gains and losses arising from currency and interest rate
fluctuations and that, some concept of external balance should be an
objective of economic policy. External balance may here be taken to
mean a broad equality between the international receipts and
payments in a defined period. The first argument of this view is that
all foreign borrowing sooner or later imposes an exchange obligation
on the Australian economy. If foreign borrowings are invested profitably
in export industries or import replacement industries, then foreign
exchange obligations are taken care of. However if borrowings go into
non traded good industries or are used to finance consumption by
Australians, then the economy as a whole must find the means to meet
debt service obligations in foreign currency a.k.a. either improving the
current account or additional borrowing abroad in order to service
earlier debts. Thus an external diseconomy is imposed on the rest of
the community whenever a firm/ person borrows abroad for purposes
which never generate or save foreign currency earnings. A closely
related effect is that any default on foreign debt (whether public or
private) is likely to damage the entire countrys credit rating, thus
raising the interest cost of future borrowings and diminishing the
availability of foreign credit.
Conclusion: The Australian government is one of the very few in the
world with almost zero net debt. In terms of view 1 that AUs floating
exchange rate will automatically eliminate CAD, it is a matter of fact
that AUs floating exchange rate is not a clean float & therefore the
currency may not depreciate sufficiently in the market to clear the
exchanges in the short term or set in motion the internal structural
adjustments necessary to improve the trade balance in the longer term.
It could also happen that a restrictive monetary policy intended to
raise Australian interest rates so as to attract capital inflow in the face
of a CAD, may bolster the exchange rate sufficiently to inhibit domestic
structural adjustment that would have favoured the production of
tradeable goods. Many economists agree that AUs current account
deficit is sustainable and remains relatively low by international
standards.
Foreign Investment in Australia Australian borrowings from
overseas have been substantially greater than equity raisings since the
1980s + net foreign debt has been tending upwards over time the
reason for increase in the levels of foreign debt since the 1980s has
been the removal of restrictions on overseas borrowing.
Floating of the exchange rate which may lead to a depreciation in
the $AU, means if this happens, much of the existing debt will increase,
as more dollars are now subsequently required to make repayments.
Net Foreign Debt was over 50% of GDP in 2005.
The accumulation of capital flows adds up over time to stocks of
foreign investment in AU and stocks of AU investment abroad.
Pros and Cons of Foreign Investment: Are the burdens of foreign
debt and repayment unacceptably high?
The costs of servicing existing foreign investment demand a significant
proportion of the foreign currency earned through exports or raised by
fresh borrowings.
Further Issue whether the level of net foreign debt liabilities is
unbearable in the sense of national welfare.
The question has 2 aspects: 1. Is there some level of foreign
indebtedness which is undesirable as such? 2. Could foreign lenders or
owners behave in managing their assets, in ways which are contrary to
AUs best interests and threaten national sovereignty?
Such questions resolved under general assumption: foreign investment
will normally benefit the recipient country. This is based on the
premise: foreign investment brings a net gain to Australia resulting from
higher labour force productivity achieved through working with more
capital. Added to the fundamental labour productivity gains are
potential further gains to AU in the form of taxation levied on profits
foreign capital, economies of scale and external economies.
Additional foreign investment not likely to have large effect on terms of
trade, but may impact BOP (favourably in the short term, however in
longer term, some unknown and possibly large proportion of foreigners
profits has to be paid abroad risk of capital repatriation.
If a nation contemplates limiting foreign capital inflow due to unease
about the high degree of foreign ownership & control, it is incumbent
upon economists to make apparent the economic costs of such
restrictive action, so that the nation is fully aware of the income
foregone in order to limit foreign investment.
Otherwise overseas investment should only have to face the general
tests of economic behaviour that apply throughout the Australian
Economy.
Principal among these are the pro-competition and anti-monopoly
norms of the ACCC (Australian Competition and Consumer
Commission). Foreign firms must also comply with industrial
relations practices, environmental provisions and criminal law.
Overseas Aid: The official Australian government overseas aid
program, implemented by the Australian Agency for International
Development (AusAID) provided $2.5 billion in overseas aid in 05/06
approximately 1% of total Cmth govt expenditure compared to 40%
of total Cmth govt expenditure spent on welfare and social security in
AU. The official aid provided = $1.70 per week, per Australian or 0.28%
of GDP (higher than current average of developed nations = 0.25% of
GDP).
AusAID is an administratively autonomous agency, located in the
Department of Foreign Affairs and Trade portfolio & reports directly to
the Minister of Foreign Affairs + in 1998 AAC (Aid Advisory Council)
was also established to provide independent reviews of the planning &
delivery of AUs aid.
Overseas aid does have a humanitarian basis, but however also
reflects strategic policy government stated that the objective of its
aid program is to advance AUs national interest by assisting
developing countries to reduce poverty + achieve sustainable
development. In terms of strategic location roughly 80% of AUs aid
goes to areas within Asia and the Pacific, and only 3% goes to Africa,
even though it is the poorest.
AusAID targets priority areas such as governance (largest- 36%
aims to assist overseas governments to manage their own resources
and reduce corruption it includes aid for legal + judicial
development, economic planning, financial management, human rights
and land mine clearing), health 12%, education 14% , social and
economic infrastructure and production.
In the longer term, aid policy relates to assisting developing countries
in the Asia-Pacific Region to build stronger economies, political
understanding + cooperation will be enhanced and growing markets
will provide greater opportunities for trade with AU.
World foreign aid policy has increasingly focused on debt forgiveness
following the World Bank and International Monetary Fund (IMF) 1996
Heavily Indebted Poor Countries (HIPC) initiative unsustainable debt
diverts the resources of poor countries away from the reduction in
poverty and provision of their own social and economic infrastructure.
This has meant many developed countries have cancelled the debts of
poor countries the most significant the July 2005 decision of the G8
leaders to cancel debts for 18th of the worlds poorest countries, many
of which are in Sub-Saharan Africa.
Important: note that debt relief is conditional- recipient countries are
expected to implement specific policies and programs for poverty
reduction, governance and infrastructure.
Exchange Rate System: AUs exchange rate since 1983 has been
largely determined by the demand and supply of AU dollars on
international currency markets (known as a FLOATING EXCHANGE
RATE). The demand and supply of AU dollars depends on factors such
as demand for AU exports and AU demand for imported items, net
foreign investment in AU and currency speculation.
At times, the RBA has itself bought and sold AU dollars to influence
AUs exchange rate this is called a managed float.
Until 1971 $AU was pegged to British Pound between 1971- 1983
$AU was pegged to $US, until in Dec 1983 the decision was made, AU
dollar would no longer be pegged and would be floated on international
currency markets.
In theory a pure/ clean floating exchange rate means: 1.there is no
official intervention to influence the market outcome + 2. The market
always clears, so that from day to day the final exchange rate is the
rate at which supply of the currency on international markets equals the
demand for currency each day.
It is often claimed floating exchange rate system eliminates external
balance as an objective of public policy, which leaves authorities free to
deploy the instruments of both fiscal and monetary policy towards the
objective of internal balance( consisting of 3 components: low
unemployment, low inflation, stable economic growth).
The pressures to adjust the domestic economy in response to
exchange rate changes have borne much more heavily on debtor than
on creditor countries a.k.a. deficit countries have been pressured to
cut domestic expenditure + tolerate rising unemployment, whereas
surplus countries have not been impelled to raise domestic expenditure
and absorb imports.
Increasing pressures also exist across trading blocs for currency
unification (notably the European Union- EU many of its members
adopting the Euro currency in Jan 2001). Such currency blocs diminish
the geographic span of floating exchange rates.
Most economists still agree that in most cases the benefits of floating
exchange rates such as removing economic distortions + allowing
greater domestic policy flexibility, outweigh possible associated
difficulties.
International Competitiveness: Competitiveness varies with changes
in productivity + through changes in the levels of wages + other costs
including interest rates. under the present floating exchange rate,
changes in AUs cost competitiveness with the rest of the world are
reflected in changes in the exchange rate.
If competitiveness falls country experiences fall in exchange rate.
subsequently the lower exchange rate will tend to improve the external
accounts by encouraging exports and making imports more expensive.
Internal competitiveness: the extent to which the economy is able to
expand the production of tradeable goods by diverting resources from
the traded goods sector. impediments to internal competitiveness
are rigid wage structures, restrictive work practices, government
regulations + other factors which microeconomic reform aims to
address.
If competitiveness is high, a country will need to increase national
expenditure, export capital or tolerate a rise in exchange rate.
Trade Policy Directions: A strong theme in recent policy : the opening
up of markets to free trade, given that over the long term the
arguments for industrial protection have failed the test of experience.
Few infant industries have grown up while the others have enjoyed
long term subsidies from taxpayers+ consumers. When industrial
protection is given to manufactures that compete with imports, the
usual result has been that industrial output is bought at the cost of low
productivity and expensive, inferior quality consumer goods. Tariffs on
manufacturing imports have also had the effect of imposing a negative
subsidy on other more efficient sectors e.g. mining & agriculture.
Since the mid 1980s the approach used by govt to face tests of
international competitiveness, with an export oriented outlook in which
encouragement is given to decentralised market based processes of
economic change. involves the removal of protection + regulatory
burdens + the pursuit of pro-competitive policies. The achievement of a
freer domestic market in AU assists competitiveness of AU
producers, encourages direct foreign investment and leads to a
stronger + more resilient economy.
Deregulatory and non-interventionist official policies are most likely to
help AU producers to discover + develop new lines of comparative
advantage + to sustain the old ones, in a world where tradeable goods
account for an increasing share of total output.