learn.stleonards.vic.edu.au€¦ · Web viewEconomics. Update. . Issue 2. May 2014. Timmee Grinham. Suzanne Cory High School. The purpose of the Economics Update is to provide teachers

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EconomicsUpdate

www.commpap.com

Issue 2May 2014

Timmee GrinhamSuzanne Cory High School

The purpose of the Economics Update is to provide teachers and their students with contemporary examples which can be applied to the relevant key knowledge points from Areas of Study 2 of the VCE Unit 3 Economics Study Design.

A focus on Unit 3, Area of Study 2 - An introduction to macroeconomics and the five economic goals

shrank). While this period recession-free period is historically unprecedented, during the period of the Global Financial Crisis, Australia did experience a trough, where the rate of economic growth slowed to less than 0.2% for the September and December quarters of 2008 and only 1.1% for the year to the end of June2009. This is shown in the chart below, with the trough in the business cycle being followed by stronger growth in real GDP towards Australia’s long run trend (average) rate of approximately3%. It is also worth noting that the current growth rate of 2.7% annual increase in GDP is below Australia’s long term average rate of growth (the long-run trend rate of growth indicated by the horizontal line on the chart).

Growth in real GDP per annum (trend)

Having focused on microeconomics and the role of the market in Area of Study 1, AOS 2 introduces students to the concept of macroeconomics, the key economic concepts of the business cycle, aggregate supply and aggregate demand, and then focuses on the five economic goals of the Federal government. It is believed that achieving these five goals can help to maximise the living standards of Australians.In this Update we will first focus on issues related to the nature and purpose of economic activity. Then we will examine some of the current factors influencing the achievement of each of the five economic goals: Low inflation

• Strong and sustainable economic growth• Full employment• External stability

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• Equity in the distribution of income

The business (economic) cycleThe business (or economic) cycle refers to the observed economic phenomenon that the level of economic activity (as measured by growth in GDP) tends to experience cyclical fluctuations. Sometimes the economy grows strongly, with high levels of growth in GDP that are above average. However, at other times, the economy grows less strongly, or may even shrink in size, experiencing negative rates of economic growth. Economists have identified that, over an extended period, economies often follow a pattern of booms (peaks), downturns, troughs and recoveries in economic growth. Booms tend to be associated with very high rates of growth in production, while troughs are

associated with very low rates of growth in production.

As students of Economics, you will be aware that Australia has not experienced a recession since the early 1990s, where a recession is defined as two consecutive quarters of negative economic growth (six months during which the size of the economy actually

Despite the relatively strong rate of growth over 2011-12 (asAustralia and the world emerged from the GFC), Australia is still considered to be in the recovery phase of the business cycle, with the immediate period ahead not expected to deliver strong rates growth. With factors such as consumer and business uncertainty, fiscal consolidation ( as the government tightens the budget by cutting spending and considering new revenue measures) and the fall in commodity prices all exerting downward pressure on their respective components of AD, real GDP is expected to be below trend for some time.Material and non-material living standardsThe chart below depicts the quarterly movement in real GDP per capital (per person), which is the most commonly used measure of material living standards. Real GDP per capita is considered a useful measure of material living standards as it provides an indication of the average income earned by each Australian for that period of time (obviously averaged out equally across the whole population). It therefore provides an indication of the change in purchasing power for Australians on average.

Copyright @ CPAP All rights reserved

CPAP Economics Update 2 2014

2Copyright @ CPAP All rights reserved

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Real GDP per capita (quarterly growth)

Period of falling material living standards

The chart highlights that Australians experienced a fall in material living standards during the economic downturn of 2008-9, as the growth in GDP per capita was negative. Since then, there has only been one quarter (December 2012) where real GDP per capita has not been positive. Accordingly, since June 2009, the statistics support the argument that material living standards have increased, despite below trend rates of growth in real GDP. In other words, economic growth has been high enough to boost material living standards over the past year, and for most of the past four years.As you will have learned in your classes, non-material living standards are much more difficult to measure, and they include all of those quality of life factors that cannot be measured by GDP, or even real GDP per capita. This highlights a major limitation of GDP as a measure of changes in national welfare or overall living standards. The ABS publication Measures of Australia’s Progress (MAP) attempts to overcome some the difficulties to provide a more all-encompassing measure of changes in our quality of life. In fact, the subtitle on the latest MAP document is simply ‘Is life in Australia getting better?’The latest release of the MAP occurred in November

2013, with the major results reproduced below in the ‘MAP dashboard’. As the Dashboard Legend indicates, the Dashboard provides a snapshot of performance in a number of key areas across society, the economy, the environment and governance (our political system and its operation). A tick indicates an improvement (progress) in the measure, a cross a deterioration (regress), a wave, not much change, and a question mark that there is insufficient data collected to make a conclusion about this area. Overall, the MAP Dashboard reveals that Australia has made progress over recent years in a number of areas, such as better health outcomes, healthier environments for inner suburban residents and greater participation in community decision making (governance). However, the outcome has not been that positive for protection of the natural environment and a resilient economy. The number of question marks in the dashboard indicates that there are still a number of key aspects of our quality life in the areas of society, environment and government on which the ABS does not collect data. On balance, the ABS concluded that:The latest release of MAP shows us that overall, Australia is in pretty good shape with more progress or little movement, than regress, which is a great result.

ABS Director, Fiona Dowsley

Introduction to economic goalsThe following discussion of the five key economic goals that form the bulk of Area of Study 2 of Unit 3 will provide much data on the current performance of the Australian economy, and you will be asked to come to your own conclusions as to the current performance of the Australian economy, and just where the country might be heading in the ‘business cycle’.Some economists refer to the simultaneous achievement of the three goals of low inflation, strong and sustainable economic growth and full employment as ‘domestic economic stability’ or‘internal stability’.Strong and sustainable economic growth

Economic growth refers to any increase in the amount or level of national production that has occurred over time. As discussed earlier, the most common measure of economic growth used in Australia is the growth in real Gross Domestic Product (GDP), which is the real final market value of all goods and services produced in the economy over that period of time.Sustainable versus strong growth?

In Australia, a ‘sustainable’ rate of economic growth is considered to be one that does not cause inflation to rise to unacceptable levels, nor cause significant external pressures on the economy (such as a blow-out in the current account deficit or net foreign debt) or lead to the overuse of natural resources. At the same time, economic growth needs to be ‘strong’ (high) enough that it supports strong employment growth and growth in real GDP per capita, thus resulting in improving material living standards on average. It is important as students of economics that you understand that the government is not aiming for ‘growth at all costs’, but needs to ensure that economic growth is both strong and sustainable – neither too high nor too low.

A strong and sustainable rate of economic growth in Australia is generally considered to be within the range of 3% to 3.5% per annum. Whether economic growth is considered sufficiently strong will also depend on our performance relative to international growth rates, as



when they are sluggish, a lower rate of economic growth in Australia may be considered acceptable.The most recent GDP figures available in Australia are for the December 2013 quarter. The chain volume GDP (the most commonly used measure of real GDP growth, which removes the effects of inflation) increased by 0.7% in the December quarter. This means that, at the end of the December quarter, the total value of everything produced in Australia was 0.7% higher in real terms than the level of production for the quarter ending in September

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2013. The annual growth in real GDP for 2013 was 2.7% in trend terms. The quarterly growth figures over the past four year are shown in the chart below:

Growth in real GDP (quarterly trend)

1.2 %

protestors in NSW re RIO Tinto rejection.jpgAn example of where economic growth can work in tandem with sustaining the natural environment came in a new report detailing the economic and environmental costs of anti-wind farm laws to Victoria, which was released in April this year. It found

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that laws restricting the growth of the wind farm sector in parts ofVictoria have cost jobs and investment opportunities. A key finding was that there has been an estimated loss of 490 construction and 64 ongoing jobs (for the life of the wind farm), as well as the numerous flow-on effects - an estimated $10.5m worth of economic activity to rural economies. Projects worth over $864 million in the past three years alone have either been lost or scrapped due to the anti-wind farm laws. (See http://www.foe.org.au/ for further information) . The restrictions on the growth of wind farms is largely based on the alleged negative impact on the health of nearby residents, as well as the claim that they are a ‘blight on the landscape’ according to some. The benefits of removing

These statistics show that economic growth in Australia has beenimproving, but below the levels that we would consider to be both strong and sustainable (approximately 3.5% growth in GDP per annum). Apart from the final two quarters of 2011, Australia’s rate of economic growth over the last four years has been a concern for the Federal government. In fact, growth rates have been at a belowaverage 0.7% quarterly rate for the latest three quarters. This rate of growth is considered insufficient to provide for acceptable growth in jobs, incomes and living standards into the future, particularly as Australia’s population growth over the year to the end of September 2013 was almost 2%. However, the good news is that our current annual growth rate of 2.7% is faster than most other countries in the OECD (Organisation for Economic Co-operation and Development, a group of the world’s developed economies) and more than twice the average OECD rate of 1.2%.Case studies: examples of factors impacting on sustainable rates of growth

In early April 2014, Rio Tinto’s bid to expand its Mount Thorley Warkworth open-cut coal mine in New South Wales’ Hunter Valley was rejected by the Supreme Court on the basis that the economic benefits would be outweighed by the costs to the environment and the region. The case was brought on appeal from the NSW Land and Environment Court in 2013, which had found that economic models relied upon to support the investment did not take into account the environmental and social costs of the proposed mine expansion. Rio Tinto lamented the fact that the rejection would result in lost economic opportunities (in terms of lost production, exports and jobs), while residents of the region and environmentalists celebrated the decision as one that protected society and the environment. The case highlights the tension in the relationship between economic growth and sustainable development, where unrestrained growth in economic activity might be good in economic terms, but could come with substantial costs that ultimately impact negatively on overall welfare or living standards of Australians.

restrictions, however, are both economic (greater construction and jobs) and environmental (cleaner energy production and reduced carbon emissions). In this respect, the removal of restrictions that are designed to protect particular stakeholders could pave the way for development that stimulates economic growth in a sustainable way.

Factors influencing future rates of economic growth

In addition to studying the factors currently affecting Australia’s economic growth (this will be covered towards the end of this Update), the VCE course also requires students to be aware of factors that may affect Australia’s future rates of economic growth.

The role of the mining boom, and more broadly the mining sector, in the strength of the Australian economy in recent years is almost certainly something you will have heard about. While the mining sector boomed as a result of extraordinary growth in commodity prices and the terms of trade (a ratio of export prices to import prices), this understandably triggered large scale mining investment in Australia over many years as the higher prices encouraged producers to seek ways to increase supply. The increase in mining investment included the building of new mines or expansion of capacity in existing ones. Once the terms of trade boom ended (as commodity prices fell), many economists expected that the growth in real GDP would immediately suffer. However, this has not occurred to the extent anticipated. The reason for this is that the‘investment phase’ of the mining boom gave way to the ‘production phase’ of the mining boom. In short, this means that once the new mines and/or expansion of capacity was completed, the mining companies were able to extract significantly more minerals from the ground, boosting sales volumes. The increased volumes have been big enough to boost export values, despite a fall in prices, and this has helped to make the net exports component of AD the major contributor to growth in GDP in the most recent quarter. As we can see, lower volumes sold at higher prices during the commodity price boom,



have been replaced by higher volumes sold at (relatively) lower prices, resulting in an overall increase in the value of the exported commodities. This is expected to continue in the coming quarters.The most recent GDP figures show a fall in business investment spending. Business investment spending represents a decision to spend on capital that will help expand production into the future, including buying new machines and equipment, new factories, or building new mines. The reduction in business investment spending is a result of the reduction in mining investment as the terms of trade deteriorate. It also reflects low levels of investment by non- mining sectors of the economy, as producers in other sectors



choose not to increase their investment levels. As a result, the persistent question for economic growth in Australia into the future is: Where will the economic growth come from once the production phase of the mining boom slows down?Another major factor that is likely to constrain growth in the future is the negative impact of fiscal consolidation. While detailed discussion of the effects of fiscal (budgetary) policy will be held over until Update 3, it is worth highlighting some key points here. The Federal Coalition government is determined to reduce the size of the budget deficit by implementing spending restraint, such as the withdrawal of government spending programs (e.g. reduced expenditure on welfare) and increases in the tax burden (e.g. possible increases in individual tax rates and broadening the base or increasing the rate of the GST). After its election to office in late2013, the Coalition government appointed several senior business and ex-political figures to conduct a Commission of Audit which examined possible policy initiatives to help constrain government spending and assist in returning the budget to surplus in 2023-24. The May 2014 release of the Commission’s recommendations has provided the government with a number of possible options. Currently, there is much speculation as to what, precisely, the changes will be to spending and taxes when the 2014-15 Budget is delivered by the Treasurer, Joe Hockey, later in May.While many of the proposals of the Commission of Audit

have implications for equity (covered later in this Update), it is fair to say that a more aggressive approach to budget tightening will restrict rates of economic growth in the short term and is designed to make economic growth more sustainable into the future.Other factors affecting future rates of growth will be considered when covering demand and supply factors later in the Update.Low inflation goal

Inflation is a sustained increase in the general or average price level over time. The Reserve Bank of Australia (RBA) is the government body that tries to ensure Australia’s currency maintains its value in terms of its purchasing power over goods and services. This translates as a goal of achieving low inflation. The RBA’s specific goal is to contain the increase in consumer price inflation, as measured by the Consumer Price Index (CPI), to within a target band of 2-3% on average over the course of the economic cycle. Many economists consider low inflation to be the most important of the five economic goals, at least in part because its achievement is seen as a precondition for the achievement of each of the other goals. The effects of high inflation are also highly detrimental for overall living standards.The latest figures for inflation were released by the ABS on the 23rd April, for the March quarter of 2014. Consumer prices, as measured by the CPI (referred to as headline inflation) rose by 0.6% in the quarter. For the year ending in March 2014, the headline CPI rose by 2.9%. This is close to the top of the RBA’s target band for inflation. The two most popular measures of underlying inflation, the trimmed mean and the weighted median, rose 2.6% and 2.7% respectively. The ABS differentiates between the headline CPI rate of inflation, which includes all price

changes, and underlying inflation, which excludes more volatile and short-term price movements, and also the outlying price movements - those prices that increase by the most (highest 15%) or the least (bottom 15%).The most significant price rise for the year to end of March 2014 was for alcohol and tobacco (+6.8%), with the tobacco price increase being caused by the federal excise tax increase from the1st of December 2013. However, this price rise was excluded from the underlying measures, since, as explained above, it was one of the ‘outlying’ price movements. Despite the value of the Australian



dollar (AUD) falling to below USD0.90 in the latter part of 2013 (it has risen back above USD0.90 today), it remains relatively high by historical standards. The high dollar has helped to reduce inflationary pressure across the Australian economy, working to dampen inflationary pressure in terms of both demand and cost inflation.The relatively-high AUD affects the demand side of the economy because domestically-produced goods and services are less competitive with foreign-produced (imported) goods and services. The rising relative price of Australian exports and the falling relative price of imports will work to reduce spending on domestically- produced goods and services, reducing the Consumption and Investment components of Aggregate Demand, as well as decreasing the Net Exports component. Together, all of these effects reduce demand inflation pressures. In Australia in recent times, the high AUD has also created pressure on exporting and import-competing industries to raise their efficiency (sometimes simply by reducing their costs) or risk failing. In other sectors, such as retail, the rise of e-commerce, along with heightened international competition, have both served to help keep prices down, and there is evidence that retailers continue to cut back prices to keep consumers spending. This indicates that, rather than increase prices as costs rise, businesses are absorbing any cost increases (and accepting lower profit margins), because they believe the market will not bear price increases, due to relatively weak economic conditions.

On the supply side, the higher dollar has a beneficial impact on cost inflation, by reducing the costs of production for many Australian producers, as there is a reduction in the costs of imported capital equipment and imported intermediate products. These intermediate products are inputs into the production process that are purchased by producers from overseas and then transformed before being sold to customers. Weak global growth has also contained inflation in those countries from which Australia imports, further reducing cost inflation pressures. Furthermore, the lower prices of imported products for consumption (such as clothing, shoes, books, overseas tourism and whitegoods like fridges and microwaves) contribute directly to reducing the inflation rate as measured by the CPI, since price changes of these items are counted as part of the CPI data collection.Both lower global inflation and the high dollar have reduced what economists refer to as imported inflation – when foreign inflation enters an economy via the increase in the price of imports.

Further evidence of the role of the high dollar in containing inflation can be seen by comparing the price rise of ‘tradables’ and ‘non- tradables’ in recent CPI figures. Tradables are, generally, those products that can be traded across international borders and the prices of which are largely determined on the world market. Examples of tradable goods whose prices have been falling are

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furniture, computing equipment and clothing. Non-tradables are those products that cannot be readily traded across international borders and the prices of which are largely determined in the domestic market. Examples are electricity, take away food, medical services and housing.Overall, the high dollar has ensured that the price of tradables has been growing at a much slower rate than

increase from one year prior in March 2013. As can be seen in the chart below, the unemployment rate trended downwards from a high of 5.8% in mid-2009, falling to hover around 5% in early2011, before beginning a slow but steady upward drift throughout2012 and 2013.

Unemployment and Participation ratesthe price of non-tradables. For example, in the March quarter of 2014, there was 0.4% growth in tradables prices compared to0.7% growth in non-tradables. Over a longer time period, this trend of a large gap between price rises in tradables and non- tradables is evident in the following chart:

Relatively high price rises for goods that are non-tradables

Tradables vs non-tradables inflation

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The participation rate (the percentage of the working age population that is in the labour force) has continued to trend down from highs of close to 66% in 2010 to 64.7% in March 2014. This largely reflects an ageing population as older Australians who lose their jobs decide to stop looking for work and/or enter retirement. It is also a response to growing unemployment, as more people decide to stop actively looking for work in a weaker labour market as it becomes more difficult to find employment. This highlights one key relationship between the unemployment and participation rates.

Price falls for tradables caused by a high AUD

making imports cheaper and containing price rises

for domestic goods competing against imports

Source: CPAP Study Guide to VCE Economics (8th edition), page 70

Full employment goal

The goal of full employment is often referred to as a situation where there is no cyclical unemployment (resulting from inadequate AD). This does not mean that full employment will be where there is a zero rate of unemployment, as economists

It should be noted that because unemployment rates are calculated and released monthly, there is quite a bit of what economists refer to as ‘noise’ around the unemployment rate. That is, the unemployment rate fluctuates up and down on a monthly basis. It is for this reason that the ABS prefers to focus on the trend estimate rather than the seasonally adjusted. The chart below compares both estimates of unemployment, with the trend estimate clearly stripping away the monthly volatility. What is most notable about the recent trend in the unemployment rate is that it is on a very discernable upward trend, as the labour market has weakened.

Unemployment

assume that there will always be some ‘natural’ unemployment in a market-based economy. This will include unemployment that is a result of structural factors, such as those who cannot find employment due to outdated skills (structural unemployment), people moving between jobs (frictional unemployment), seasonal factors and unemployment that results from people not being able to receive a job offer due to personal or physical characteristics or circumstances (hard-core unemployment). The goal is to reduce to a minimum all types of unemployment, and specifically to avoid any cyclical unemployment.

It is suggested that the full employment goal involves the attainment of the lowest unemployment rate possible

before inflation begins to accelerate, sometimes referred to as the NAIRU – non-accelerating inflation rate of unemployment, and recent Treasury estimates have put this rate at approximately 4.75% unemployment. It is fair to say that if the economy is growing at around its optimal rate, then it is likely that unemployment will be close to the NAIRU as cyclical unemployment is likely to be avoided.

As of March 2014, the unemployment rate (seasonally adjusted) was 5.8%. This represented a decrease of 0.3 percentage points from the February 2014 figure of 6.1 %, but a 0.2 percentage point



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Labour force underutilisation

Despite it being the focus of economists and the government at the time of its monthly release, it is important to remember that the unemployment rate has limitations in its ability to measure labour market conditions. Firstly, the unemployment rate does not include those people who are working, but would prefer to be working more hours. As you will have learnt, to be considered unemployed, a person needs to have been actively seeking and available for



work, and to not have worked in paid employment for one hour or more during the week surveyed. Therefore, the unemployment rate can be considered to ‘disguise’ the level of ‘underemployment’– those who are working more than one hour a week but want to work more hours than they receive in their current employment.

This limitation of the unemployment rate has led the ABS to develop another useful statistic that gives an insight into the impact of this‘disguised unemployment’ – the labour force underutilisation rate. Figures for the labour force underutilisation rate are provided quarterly by the ABS. They are calculated by measuring the number of unemployed people plus the number of those underemployed (who would prefer to work more hours, but are not counted as unemployed), as a proportion of the labour force. For the quarter ending February 2014, the labour force underutilisation rate was 13.5%. This figure is one percentage point higher than for the same time one year earlier, reflecting that Australia’s labour force is increasingly being underutilised - not being used to its full capacity.

A rising labour force underutilisation rate is consistent with a relatively flat economy and growing unemployment, where some firms continue to employ staff, but reduce their hours in the short term. It will be worth observing if, over the course of 2014, if the economic growth rate continues to be below trend,, we see a rise in the labour force underutilisation rate without any significant increase in the unemployment rate.

External stability

The VCE Economics course requires that students have an understanding of the ways in which Australia’s international transactions are measured, along with the factors that have influenced those transactions over the past four years.

Although, as with some other goals, there is no objective measure or target for the goal of ‘external stability’, Australia should be able to meet its financial obligations that result from transactions with the rest of the world, without jeopardising economic growth or other economic goals. This requires a sustainable current account deficit and a serviceable net foreign debt.

There have been two key factors influencing Australia’s external stability in recent years. Both our terms of trade (TOT) and our exchange rate have had an enormous effect on our whole economy over that time, and they have also impacted heavily on external financial transactions, including the trade balance and the current account deficit.

Australia’s trade balance is the difference between the value of what we export and the value of what we import. The balance on current account is the difference between the value of all receipts of a current nature (including the value of receipts for exports and incomes and other transfers received from abroad) and all the debits of a current nature (including the value of our imports and incomes and other transfers paid to abroad).

It is important to note that, while the trade balance affects the balance on current account, the current account balance also includes other transactions which are not classified as exports or imports. In Australia, the balance on current account has consistently been in deficit (below zero) for several decades. This is despite the fact that Australia’s trade balance has often been in surplus over that time. That is, over that time, there have been periods when the value of our exports of goods and services has outweighed the value of our imports of goods and services. The reason for the persistence of a current account deficit (CAD)



even with a trade surplus is that one component of the balance on current account, the ‘net income balance,’ is always in deficit, and the magnitude of that deficit outweighs any surplus on the trade balance.

As a result, you may have noticed that rather than discuss the‘balance on current account’, many economists simply use the shorthand of referring to the CAD, as over time it has come to be recognised that Australia suffers from a structural CAD. Nevertheless, a worsening in the trade balance will also see a further deterioration in the current account deficit.

One measure of achieving external stability for the Australian economy is keeping the current account deficit at a sustainable level, and this is considered by some to be below around 5-6% of GDP. This in turn should help to contain the net foreign debt to a serviceable level, whereby the country’s foreign debt can be repaid without causing problems for the domestic economy.

As can be seen in the chart below, the CAD improved over 2013, falling to below 3% of GDP. This is largely due to an improving trade balance (the value of exports increasing at a faster rate than the value of imports). The most recent figures, for the December quarter 2013, show that the CAD decreased by $2.4B (19 per cent) to $10.1B. Exports of goods and services rose $2.6B (or 3 per cent) and imports of goods and services fell $304m, helping to push the Balance on Goods and Services (BOGS –shown as Net goods and services in the chart below) into a small surplus ($247m) for the first time since 2011. This is highlighted in the chart below:

Source: ww w .abs.g o v .au

The chart also confirms that Australia’s Current Account balance remains in deficit because of a persistently large deficit on the Net primary incomes account, shown by the dotted line in the chart which, while falling from a high of around -$15B in 2010, was still large at -$10B in 2013.

Australia’s international investment position represents the value of Australia’s net indebtedness to overseas interests in the form of either debt or equity. Debt to overseas interests (often referred to as simply ‘foreign debt’) is direct borrowings/ loans from foreign-based lender, whereas foreign equity refers to overseas ownership of Australian assets, whether by holding shares in a company or full foreign ownership of an entity. When we refer to

‘net’ foreign debt and equity, it means the value of of foreign lending to Australia and foreign ownership of Australian assets minus Australian lending to overseas and Australian ownership of foreign assets. Australia’s international investment position was $829.8B at 31 December 2013, a decrease of $15.7B on 30 September2013 but trending up overall during the last four years. Australia’s



net foreign debt increased by $34.3B to $852.9B over this time, showing that we continue to borrow much more from overseas than we lend overseas. However, net foreign equity (e.g. investment in shares across countries) improved to a position of $23.1B where, for the first time in many years, Australia’s ownership of foreign assets (such as shares) exceeds the ownership of Australian assets by foreigners. This is highlighted in the chart below, where the light grey line shows net foreign equity.

Free trade

Source: ww w .abs.g o v .au

Over the course of 2013-14, the CAD has improved as a result of a much better trade balance, despite the continuing fall in the TOT. At first glance, this appears odd. However, it can be explained by a closer examination of the two key variables impacting on export values – prices and volumes. While the TOT has negatively affected export values as a result of the price effect (i.e. lower prices received for any given volume of exports), this has beenAs part of studying the economic goal of external stability, you

will consider the costs and benefits associated with free trade. Free trade refers to the movement of goods and services between countries without any restrictions such as tariffs, quotas or subsidies paid to local producers. Free trade is the opposite of protectionism. Australia concluded negotiations on an Economic Partnership Agreement with Japan in early April, which followed the successful conclusion of a Free Trade Agreement with Korea. Both agreements provide for significant reductions in Japanese and South Korean tariffs applying to Australian agricultural and resource producers (e.g. dairy, beef, sugar and horticulture) in return for a reduction in Australian tariffs on Japanese and Korean manufactured goods (such as cars and vehicle components, electronics and household appliances). The movement towards freer trade allows all countries to specialise in the production of those products in which they have a comparative advantage, reducing costs and prices and facilitating an increase in international trade (both exports and imports) which ultimately benefits consumers and has the potential to improve Australia’s trade balance.

A selection of factors affecting internal and external stability over recent yearsTerms of Trade

The improvement in Australia’s external position over 2013 reverses the country’s relatively poor performance over 2012. The two key contributors to the poor trade performance over 2012 was the deteriorating terms of trade (TOT) and the persistently high level of the exchange rate. [The TOT is an index that measures the

ratio of the average prices received for exports relative to the average price paid for imports.] While the TOT remain high compared to the long run averages (see chart below), the fall since 2011 has been significant, reflecting a fall in the global price of commodities. While the volume of Australian exports rose over 2012, the value of those exports fell in 2012 because of a reduction in export prices.



offset by volume effect. As discussed earlier, the quantity or volume of exports has increased significantly as a result of the investment phase of the mining boom making way for the production phase of the boom. During the period of a very high and rising TOT, mining companies invested heavily in new capital/infrastructure that increased the capacity of theirmines. Once the investment was complete, the mines were able to lift production volumes and increase sales. While they are receiving lower prices per tonne of ore, they are selling significantly more because of increased capacity, with the overall effect being an increase in export values and an improvement in the BOGS and CAD.

The impact of the falling terms of trade on economic growth was discussed earlier. In terms of the impact on full employment, it has been one of those factors impacting negatively on employment due to the lower incomes earned and the slower rate of growth in AD that resulted. In relation to the low inflation goal, the lower TOT has helped to reduce demand inflationary pressure, given that it has reduced incomes and AD.

The exchange rate

The persistently high Australian dollar caused a fall in the relative price of imports compared to domestically produced goods and services, which increased in the demand for imports. In addition, it made all Australian exports relatively less attractive, furthering reducing exports demand. Overall, the high dollar has worked in tandem with a falling TOT to negatively impact on the CAD over recent years. However, as the chart below illustrates, the exchange rate fell below USD0.90 over the course of 2013, helping improve competitiveness and provide a boost to net exports.



Overall, the relatively high exchange impacted negatively on economic growth and full employment. However, it is one of the factors that has helped to maintain downward pressure on inflation. This occurs because, as discussed earlier, the high dollar induced a fall in the cost of both consumer imports and capital/intermediate imports, reducing pressure on final prices and assisting RBA efforts to achieve its low inflation goal.

Over 2014, the dollar has risen above USD0.90 to sit at USD0.93 as at early May 2014. While this is lower than the lofty levels of 2012-13, it is still relatively high and many commentators, including the RBA, consider that it remains above its ‘fundamental value’. This suggests that it is likely that the AUD exchange rate will fall further over the year(s) ahead, which should help to stimulate Net Exports and reduce the CAD (as well as providing a boost to economic growth).

Overseas rate of growth

The chart below highlights the improvement in the rates of growth in global economies over the course of 2013, particularly the growth experienced in the economies of Australia’s major trading partners. This has helped to increase net export demand, which not only reduces the CAD, but stimulates AD and economic growth. With respect to employment and inflation, stronger overseas growth should have been a factor helping to create more Australian jobs and simultaneously add to inflationary pressure.

High household savings ratio

The RBA has referred to the importance of the rising household saving ratio in Australia as a contributor to reduced inflationary pressures since the mid-2000s. The chart shows that the household savings ratio has risen to above 10%, from approximately 5% in2008-9. This means that for any given level of income, households are saving more and spending less. The relatively high savings rate reflects household caution and reduces Consumption demand in the economy. This helps to contain inflation, but has a negative impact on the goals of full employment and strong and sustainable economic growth. Higher savings have also helped to slow the growth in Australia’s net foreign liabilities (net foreign debt and net foreign equity), as we will have less reliance on foreign funds to fund our current account deficit.

The cost of labour (wage price index)

Over the most recent period, there has been a noticeable fall in the wage price index to levels not seen in 15 years. This reflects a relatively weak labour market, with demand for labour low relative to the supply of labour. It has been positive for Australian businesses, helping to contain costs of production and facilitating a fall in prices in order to attract demand.

Interest rates

Interest rates in Australia are at historically low levels, primarily due to the heavy loosening of monetary policy by the RBA over recent years. The benchmark target cash rate was reduced over 2013 to a low of 2.5%, which has helped to reduce all other interest rates in the economy. This is highlighted in the chart below, with the cash rate



and 90-day bank bill rate both falling significantly since2011. The RBA has aggressively loosened monetary policy because it has felt that inflation was under control and, in accordance with its charter, switched its attention to growth and jobs. This low cash rate has combined with even lower market rates of interest over 2014 as bank funding costs have come down, enabling them to reduce rates on some loan products independent of RBA policy changes.



Equity in the distribution of incomeWhen considering the goal of equity in income distribution, it is important to remember that the goal is not about achieving equality – everyone receiving the same or similar levels of income. Instead, the government’s equity goal is to ensure the incomes earned and received by Australians are ‘massaged’ or ‘manipulated’ so that three important sub-goals can be achieved:

• Australians have sufficient income to purchase goods and services that enable them to have a dignified standard of living, so that households can afford goods and services that allow them to live in our affluent and modern society with some ‘dignity’ and ‘self-respect’.

• Ensuring there are no persons or households in Australia experiencing absolute poverty, where they can’t afford to purchase goods and services necessary for survival.

• Ensuring huge or obscene inequalities in incomes are avoided, such that the social and economic costs of inequality do not exceed the benefits.

The latest statistics from the ABS (Cat 6523.0 - Household Income and Income Distribution, Australia, 2011-12) are summarised in the table below. They reveal that the share of total household income received by low and middle income households has grown since2009-10, from 19.8% of total (equivalised) household income to20.1%, while the share received by high income households has fallen from 40.2% to 39.5%. This builds on the improvement in the distribution of income that was reported between 2007-8 and2009-10 and is also reflected in the fall in the Gini coefficient from0.336 in 2007-8 to 0.329 in 2009-10 and to 0.320 in 2011-12. As you will have learnt in class, if the Gini coefficient moves closer to zero, this indicates a more equal distribution of income. These results suggest that the distribution of income has become more equal over the past four years.

Share of Equivalised disposable household income

2003–04 2005–06 2007–08 2009–10 2011–12

Lowest quintile

% 8.0 7.8 7.3 7.4 7.5

Second quintile

% 12.8 12.7 12.3 12.4 12.6

Third quintile % 17.6 17.4 16.9 17.0 17.3

Fourth quintile % 23.2 23.0 22.6 23.0 23

Highest quintile

% 38.4 39.2 41.0 40.2 39.5

All persons 100.0 100.0 100.0 100.0 100Gini coefficient

0.306 0.314 0.336 0.329 0.320

OECD Report ‘Society at a Glance 2014’

However, despite an apparent improvement in the share of income received by the lower quintiles, the news on equity in the distribution of income in Australia has not all been positive in recent years.

In its report, the OECD (Organisation for Economic Cooperation and Development) has found that relative poverty increased in Australia between 2007-2010, with 14.4 per cent of the population earning incomes below 50% of median equivalised household income. This compared with the OECD average of 11.3 per cent.

It also reported that Australia’s distribution of household disposable income was more inequitable than the OECD average, with a Gini-coefficient of 0.33 during that period slightly higher than the coefficient for the OECD of 0.31. Even with the Gini coefficient falling to 0.320 in 2011-12, Australia’s income distribute remains more unequal than the OECD average. Interestingly, South Africa reported the highest Gini-coefficient of 0.70 and Iceland the lowest with 0.24. You can read the report at h t tp://ww w .oecd.o r g/els/ socie t y ataglance.htm



Factors affecting the distribution of income

The VCE Study Design requires students to consider factors that influenced the distribution of income over recent years. Some the factors that are helping to improve equity in income distribution include:

• The generous tax cuts that (some argue) more than compensated lower income households for the regressive effects of the new carbon tax in 2012.

• The introduction of the National Disability Insurance Scheme in 2013. The NDIS (Disability Care) is a deliberately redistributive policy as it involves the collection of tax from those whose taxable income is above the minimum required to pay the Medicare Levy and redistributing this money in the form of service provision to those in Australia in need of support.

• The increase in the luxury car tax.

Some the factors that are likely to have reduced equity in income distribution include:

• The increasing casualisation of the labour force which means that more and more workers may not be receiving sufficient hours of work to sustain a comfortable standard of living.

• The introduction of the carbon tax (in isolation) and its impact on electricity prices in particular, as expenditure on energy makes up a significant proportion of spending for lower income households.

• The increase in other indirect taxes, such as the higher tobacco excise and its regressive effects, which particularly impact on those on lower incomes who have higher rates of smoking.

• Growth in the rate of unemployment – as was noted above, the rate of unemployment has trended upwards in recent years. As the rate of unemployment rises, a larger number of people will move from receiving factor incomes (such as wages and salaries) from their employment to the considerably-lower transfer incomes available from Newstart (unemployment benefits).

• Slower growth in real wages(as outlined above).• Reducing the superannuation tax concessions

available for very high income earners (those earning more than$300,000).

Possible budget changes and equity – Commission

of Audit and the 2014-15 Budget

With the 2014-5 budget due to be handed down in a couple of weeks, there are a number of (anticipated) changes to taxation that will have implications for equity. The Commission of Audit, established in October 2013, was asked to provide advice to the



Government on how best to ensure budget spending is as efficient and as well targeted as possible. Its report, released on the 1st of May, made it clear that its recommendations were made with a view to protecting the truly disadvantaged:

‘Government should protect the truly disadvantaged and target public assistance to those most in need.’

The Commission made 64 recommendations across a range of Commonwealth Government activities and programmes that would help to reduce the deficit and deliver a surplus of 1 per cent of GDP by 2023-24. While none of these recommendations has yet been formally accepted or earmarked for implementation by the government, a number of recommendations, if adopted, will impact on equity. Some of the Commission’s recommendations, along with mooted tax changes that are expected to be announced in the Budget include:The expected increase in tax rates (or ‘debt tax’) for those earning more than $80,000;

• Possible increase in the rate of GST;• Possible broadening of the GST base;• The introduction of a Medicare co-payment of $15;$;• The inclusion of the family home in the pension means test;• Raising the pension age to 70;• Better targeting of Family Tax Benefit A and removing

Family Tax Benefit B• Reducing the generosity of the Abbott paid

parental scheme and using the savings for increased child care funding;

• Freezing the minimum wage for 10 years at 44% of Average

Weekly Earnings (or $622 per week);• Large scale public sector jobs cuts;• Privatisation of government business enterprises such as

Australia Post and the NBN;• Removing the entitlement to the unemployment

benefit for those young persons (22-30) not prepared to relocate in search of jobs;

[Italicised dot points are some of the Commission of Audit recommendations]

As students of economics, you are encouraged to pay close attention to the upcoming Budget for its implications for all of the economic goals into the future.

REVIEW QUESTIONS1. Explain what is meant by ‘business cycle’.2. Explain whether Australia has experienced growth in

material living standards since early 2008. Use

evidence to support your answer.3. Explain why Australia is considered to be ‘in good

shape’ in terms of overall living standards. Use evidence to support your argument.

4. Explain what is meant by ‘domestic economic stability’ or

‘internal stability’.5. Discuss whether Australia has achieved its goal of

strong and sustainable rates of economic growth over the past year.

6. Explain how the rejection of Rio Tinto’s coal mine expansion in NSW highlights the tension in the relationship between economic growth and sustainable development.

7. Explain how anti-wind farm laws highlight the relationship between economic growth and sustainable development.

8. Explain what is meant by the expression ‘the investment



phase of the mining boom gave way to the production phase of the mining boom’ and outline the impacts of this change for economic growth in Australia into the future.

9. Explain how ‘fiscal consolidation’ is expected to impact on future rates of economic growth.

10. Define the Federal government’s economic goal of ‘low inflation’.

11. Distinguish headline inflation from underlying inflation and identify the most recent rates for both measures.

12. Discuss whether the rise in tobacco prices stemming from the increase in the government’s tobacco excise would affect underlying inflation.

13. Explain why the relatively high Australian dollar is helping to keep inflation in the Australian economy at bay. Refer to both the demand-side and supply-side (cost) effects.Distinguish‘tradables inflation’ from ‘non-tradables inflation’ and explain why these two types of inflation have risen at significantly different rates since 2011.

14. Define the terms ‘full employment’ and ‘NAIRU’.15. Explain why the current seasonally adjusted

unemployment rate of 5.8% (as of March 2104) might not fully reflect current labour market conditions.

16. Discuss why the ABS prefers to use the ‘trend’ measure of

distribution of income has become more equal since 2007-8.

30. Discuss two factors that may have had a negative impact on equity in the distribution of income over recent years.

31. Discuss two factors that may have had a positive impact on equity in the distribution of income over recent years.

32. Select three recommendations from the Commission of Audit

Report and discuss the implications for equity.Memorable quotesOn the basis of this assessment, the Board’s judgement was that monetary policy was appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the 2–3 per cent inflation target.

RBA minutes April 2014

We will secure prosperity by getting the Budget back under control, cutting waste and reducing debt to keep interest rates as low as possible and to protect the Australian economy from economic shocks.

ww w .libe r al.o r g.au/ou r -plan/budget

I don’t think you could make the case that there is a budget crisis......because I don’t think we need to urgently get the budget back to surplus.

unemployment as opposed to the ‘seasonally adjusted’measure.

17. Describe the trend in both the participation and unemployment rates over the past year, making reference to the charts provided.

18. Explain why the trend in the participation rate since early

2013 has helped to maintain downward pressure on the unemployment rate. In your answer, refer to ‘hidden unemployment’.

19. Define the labour force underutilisation rate and explain how it is likely to change relative to the unemployment rate if the economy enters another economic downturn.

20. Explain what is measured by the ‘trade balance’. Did Australia have a positive trade balance (‘trade surplus’) or negative trade balance (‘trade deficit’) for February 2013?

Paul Bloxham, HSBC Chief Economist

In this case, the audit report is softening us up for the budget by raising the spectre of a much tougher budget than we’re likely to get. It’s Joe Hockey getting ready to leave unsaid: See, I let you off lightly......Audit reports are never put into practice because they are commissioned from worthies who make radical proposals no politician hoping for re- election would ever implement. The cuts we do see in the budget will have been worked up by the professionals: Treasury and Finance.

Ross Gittins, The Age 2 May 2014

In essence, many programs designed to reduce the rich-poor gap will be cut by the government on the recommendation of a committee largely representing the key drivers of this gap. Put another way, a very wealthy elite will be at the forefront of recommending that ordinary Australians make do with $300 billion less (if media reports are right) in public spending.

21. Explain the difference between the trade balance (or balance on goods and services), the current account balance. Define the terms of trade explain how it is different to the trade balance.

Mark Trifft, The Age 1 May 2014

It is also essential that the Commonwealth government live within its means and begin to pay down debt.

22. Explain how a deterioration of the terms of trade (as seen since 2011) has impacted Australia’s CAD over that time.

23. Discuss one factor that contributed to the improvement in the

CAD over the most recent quarter.24. Define net foreign liabilities, distinguishing Net Foreign Debt

(NFD) from Net Foreign Equity (NFE).25. Discuss how Australia might benefit from its recent

free-trade deals with Japan and South Korea.26. Explain why the CAD has improved as a result of a

much better trade balance, despite the continuing fall in the TOT. [Hint: refer to the investment phase of the booming making way for the production phase of

the boom.]27. Explain how each of the following have impacted on the

achievement of the government goals over recent years:• Overseas growth• Household savings behaviour• The wage price index• Interest rates

28. Explain why the government’s goal of equity in the distribution of income is not the same as achieving equality in income distribution.

29. Provide evidence to support the contention that Australia’s



Terms of reference, National Commission of Audit (Oct 2013)

This Report – Towards Responsible Government – examines the Commonwealth’s finances. We provide advice and recommendations on what we believe should be done now to ensure that spending is placed on a sustainable long-term footing. Our recommendations will help to achieve savings sufficient to deliver a surplus of 1 per cent of GDP by 2023-24.

First Report of the National Commission of Audit (May 2014)

No-one has ever achieved growth simply by austerity, but equally the approach of simply ignoring the gaping hole in public finances in many countries has reached the limits of its credibility. We need a refocused conversation, around doing things that spur growth potential, which would mean, among other things, that the accommodative policies of central banks could get more traction.

RBA Governor, Glenn Stevens, Speech to the American Chamber of Commerce (Qld) Brisbane - 3April 2014

By now the proverbial pet shop residents are all talking about this: where will the growth come from after the mining investment boom ends? I suspect that plenty of the people who never thought the mining boom would do much to boost growth are among those asking the question of what will replace it as a source of growth.

RBA Governor, Glenn Stevens, Speech to the American Chamber of Commerce (Qld) Brisbane - 3April 2014

Australia has concluded negotiations on an historic Economic Partnership Agreement with Japan, our second biggest trading partner. This historic agreement is good for the Austral- ian economy, good for jobs, good for farmers and good for consumers.

The HON. Andrew Robb AO MP, Minister for Trade and Investment



Applied economic exerciseRead the section of the OECD’s Better Life Index relating to Australia reproduced below, and answer the question that follow.How’s Life?Australia performs very well in many measures of well-being, as shown by the fact that it ranks among the top countries in a large number of topics in the Better Life Index.

Money, while it cannot buy happiness, is an important means to achieving higher living standards. In Australia, the average household net- adjusted disposable income per capita is 31 197 USD a year, more than the OECD average of 23 938 USD a year. But there is a considerable gap between the richest and poorest – the top 20% of the population earn almost six times as much as the bottom 20%.

In terms of employment, over 72% of people aged 15 to 64 in Australia have a paid job, above the OECD employment average of 65%. Some 78% of men are in paid work, compared with 67% of women. People in Australia work 1,728 hours a year, less than most people in the OECD who work 1,765 hours. Another key measure, however, is how many people work very long hours. About 14% of employees work very long hours, much higher than the OECD average of 9%, with 21% of men working very long hours compared with just 6% for women.

Having a good education is an important requisite for finding a job. In Australia, 74% of adults aged 25-64 have earned the equivalent of a high-school (qualification), close to the OECD average of 75%. This is truer of men than women, as 76% of men have successfully completed high-school compared with 73% of women. This difference is higher than the OECD average and suggests women’s participation in higher education could be strengthened. In terms of the quality of its educational system, the average student scored 514 in reading literacy, maths and science in the OECD’s Programme for International Student Assessment (PISA). This score is higher than the OECD average of 497. On average in Australia, girls outperformed boys by 8 points, slightly below the average OECD gap of 10 points.

In terms of health, life expectancy at birth in Australia is almost82 years, two years higher than the OECD average of 80 years. Life expectancy for women is 84 years, compared with 80 for men. The level of atmospheric PM10 – tiny air pollutant particles small enough to enter and cause damage to the lungs – is 13.1 micrograms per cubic meter, considerably lower than the OECD average of 20.1 micrograms per cubic meter. Australia also does well in terms of water quality, as 93% of people say they are satisfied with the quality of their water, higher than the OECD average of 84%.

Concerning the public sphere, there is a strong sense of community and high levels of civic participation in Australia, where 93% of people believe that they know someone they could rely on in time of need, higher than the OECD average of 89%. Voter turnout, a measure of public trust in government and of citizens’ participation in the political process, was 93% during recent elections; this figure is the highest in the OECD where the average is 72%. There is little difference in voting levels across society; voter turnout for the top 20% of the population is an estimated 94% and for the bottom 20% it is an estimated 92%, a much narrower difference than the OECD average gap of 11 percentage points and suggesting there is broad social inclusion in Australia’s democratic institutions

In general, Australians are more satisfied with their lives than the OECD average, with 83% of people saying they have more positive experiences in an average day (feelings of rest, pride in accomplishment, enjoyment, etc. ) than negative ones (pain, worry, sadness, boredom, etc.). This figure is higher than the OECD average of 76%.Questions

1. Identify the evidence in the article that suggests that income inequality exists in Australia.

2. Evaluate the following statement: ‘Australian workers are better off compared to in other comparable countries’.

3. Explain why the suggestion is made that women’s participation in higher education could be strengthened.

4. Identify the evidence that suggests Australia is a healthier country to live in compared to the many other OECD countries.

5. Provide a plausible explanation for Australia having the



highest voter turnout in the OECD.6. In the context of material versus non-material living

standards in Australia, provide at least three pieces of evidence to support the following contention: ‘Australia might not be the richest country in the OECD, but we are better off in a whole lot of other ways.’

Every effort has been made to trace and acknowledge copyright. The author and CPAP would like to thank the RBA for use of charts used throughout this Update. The publisher would welcome any information from parties who believe that copyright infringement has occurred. CPAP Updates purchased by schools include a copyright licence permitting one CPAP Update to be copied for each student in that class. In the case of two classes, a second licence must be purchased. In the case of three classes, a third licence must be purchased.

Documents

learn.stleonards.vic.edu.au€¦ · Web viewEconomics. Update. . Issue 2. May 2014. Timmee Grinham. Suzanne Cory High School. The purpose of the Economics Update is to provide teachers