1. Economics HSC Topic 2 –Australia’s Place in the Global Economy
Australia’s trade and financial flows
Value, composition and direction of Australasia’s trade and financial flows
Trends in Australia’s trade pattern:
-Direction of trade: The direction of Australia’s trade has changed considerably over
recent decades. In the 1950s, Australia mainly traded with the United Kingdom and
other European countries. In subsequent decades, the direction has shifted and
Japan has become the major buyer of exports. More recently China, South Korea
and ASEAN countries have become increasingly important. This movement away
from United Kingdom was due to their decision to join the EU. Australia then
followed the economies in Asia with highest economic growth rates.
-Composition of Australia’s Trade: Primary industries always been focus of
Australia’s exports as we have a comparative advantage in commodity goods.
(Wheat, wool, beef, coal, iron ore and gold). Less competitive in manufacturing,
importing large quantities of capital goods, and manufactured consumer goods.
Agriculture decreased and minerals increased in importance.
Trends in Financial flows: Although trade flows have increased substantially over recent
years, the rate of growth in financial flows has been much greater as international
businesses have bought Australian assets and invested in Australian businesses, and as
Australian companies have increased their overseas investments. When the exchange
system of fixed exchange rates came to an end in the 1970s, exchange rates around the
world were floated allowing financial flows to grow rapidly. Prior to the deregulation of the
finical sector, most financial flows into Australia were direct investment. Following however
the benefits of Portfolio investment were seen. Foreign equity and debt has increased
dramatically with equity much larger proportion.
Australia’s Balance of Payments
A record of transactions between Australia and the rest of the world, over a period of time.
Money flow IN referred to as a CREDIT (+)
Money flow OUT referred to as a DEBIT(-)
Structure:
-Current Account, debits and credits:
 Net goods (export goods – import goods)
 Net service (export service – import service)
 Net income (credit – debit)
 Secondary Income
-Capital and Financial Account:
Capital Account: Transfers in the form of tied aid(for specific purpose),
purchase and sale of non-financial assets.
Financial Account: Direct Investment, Portfolio Investment, Financial
Derivatives, Reserve Assets.

2. Links between key Balance of Payments categories
Current Account Balance + Capital and Financial Account Balance + Net Errors and omissions = 0
The deficit on the current account = Surplus on the capital and financial account. The strongest
link between the accounts on the balance of payments can be seen on the net primary income
part of the current account. In the long term, a capital and financial account surplus will lead to a
larger deficit on the net primary income account. This is because any foreign capital inflow to
Australia will have to earn a return for its owner and these earning are a debit on the net
primary income account
Trends in the size and composition of Australia’s Balance of Payments
Main focus on the current account deficit, the balance of goods and services and net primary
income.Australia’s current account deficit moves in cycles due to both domestic and international
factors. Influenced by both cyclical and structural factors. Cyclical - those which vary with the level of
economic activity. Structural - factors those which have a persistent or underlying influence on the
BoP(e.g. export base, international competitiveness ,savings).
The balance on goods and services varies from small surpluses to large deficits. Cylical factors that
influence BOGs are the exchange rate, terms of trade (export price index/import price index x 100),
levels of domestic economic growth, international business cycle. Structural influences include
narrow export bade, lacking international competitiveness in manufacturing and capacity
constraints.
The Net Primary Income is the ongoing cause of Australia’s high CAD. Cyclical factors affecting NPI
are exchange rates (size of interest payments), changes in domestic and global interest rates(size of
interest payments made to OS investors), 40% of Australian public share market is foreign
owned(when domestic conditions are good, larger proportion of dividends paid to international
investors). Structural factors include very low levels of national savings and high investment
economy (major export industries in Aus require enormous amounts of capital investment form OS.
Consequences of a high CAD:
- Large build up in foreign liabilities
- Increasing debt servicing cost
- Volatility in exchange rates
- Investors reluctant to invest

3. Exchange rates
An exchange rate is simply the price of one country’s currency in terms of another country’s
currency. Australia has a floating exchange rate determined bu the marker forces of supply and
demand.
Appreciate: increase in value
Depreciate: Decrease in value
Measurement of relative exchange rates
Comparing Australian currency to other currencies is done by stating what the value of one unit of
Australian currency ($1) is relative to another currency. E.g. $A1 will buy US90c. The Trade Weighted
Index (TWI) is a measure of the Australian dollar against a basket of foreign currencies of major
trading partners. These currencies are weighted according to their significance to Australia’s trade
flow. In September each year the RBA amends the TWI based on the volumes of trade for the
previous finical year.
Factors affecting the demand for and supply of Australian dollars
DEMAND SUPPLY
1. Level of Aus to OS interest rates 1. Level of Aus to OS interest rates
2. Investment opportunities 2. Investment opportunities
3. Expectations 3. Speculators
4. Export levels 4. Import levels
5. Commodity prices 5. Domestic income
6. Terms of Trade 6. Domestic competitiveness
7. International competitiveness
Changes in exchange rates – apprectiaton/depreciation
APPRECIATION DEPRECIATON
1. ↑ Aust IR, ↓ o/s IR 1. ↓ Aust IR, ↑ o/s IR
2. ↑ inv opportunities in Aust 2. ↓ inv opportunities in Aust
3. ↑ $commodities 3. ↓ $commods
4. ↑ AustToT 4. ↓ AustToT
5. ↑ int comp levels 5. ↓ int comp levels
6. ↓ inflation 6. ↑ inflation
7. ↑ demand for Aust X 7. ↑ demand for M in Aust
expect of $ ↑ based on forecasts of expect of $ to ↓ based on forecasts of
factors factors
Determination of exchange rates including fixed, flexible peg and floating
-Fixed: keeping the exchange rate at the same level always
-Flexible peg: adjusting the exchange rate value each day and fixing it for 24 hours
-Floating: allowing the forces of supply and demand to determine the exchange rate

4. The influence of the Reserve Bank of Australia on exchange rates
Even though Australia’s exchange rate is primarily determined though the forces of demand
and supply in the FOREX market, it is sometimes necessary for the RBA to intervene in the
marker to prevent large fluctuations in the value of the $AUS which might impact on
investor confidence. Can do this by:
-Dirtying the Float: e.g. to avoid a rapid depreciation of the currency the RBA can
buy $A, putting pressure upward pressure on the exchange rate.
-Monetary Policy: rarely used, indirect e.g. to avoid a rapid deprecation, it may
increase the demand for $A by raising interest rates, increasing intrust rates will
attract more foreign savings which must be converted to $A
The effects of fluctuations in exchange rates on the Australian economy
Changes in the BoP can influence the exchange rate e.g. If the value of imports incressead, while
exports remained unchanged, this would result in a deterioration in the current account deficit.
It would also cause an increase in the supply of $A, resulting in a deprecation of the currency.
Also, because of the deprecation, a given level of financial inflows would be able to buy more
$A. Therefore, the positive balance on the capital and financial account would increase in $A
terms to match the bigger deficit on the Current Account.
POSITIVE APPRECIATION NEG APPRECIATION
More purchasing power ↓ of X profits (cost more less buy)
↓ interest on servicing Deteriorating CAD as ↑ M
↓ $A value on o/s debt ↑M sees ↓ eco growth
↓ inflation pressure as imports are Expensive to invest in Aust
cheaper ↓ value of foreign income
↓ value of foreign assets to Aust
POSITIVE DEPRECIATION NEG DEPRECIATION
Cheaper X CAD Less purchasing power
Expensive M CAD (buy less) Increased servicing
↑ growth More foreign debt
↑ foreign income earned Increased inflation pressure
↑ $AU value of foreign assets
Cheaper to invest in Aust

5. Free Trade and protection
Australia’s policies regarding free trade and protection
History:
-Australia typically has relied heavily on trade
-Historically Aus was one of the most highly protected economies (manufacturing)
-In recent decades Aus had attempted to reduce protection levels, now one of the
most open economies.
Government aims in reducing protection:
-Force domestic businesses to become internationally competitive
-Encourage allocation of resources away from inefficient industries
-Allow Aus to benefit from integration with the global economy, access to more G&S
Government initiatives:
-Gradual decline in average tariff levels 1969-36% 2008-2.5%
-Phasing out of other barriers, such as quotas and subsidies
-Whitlam Gov reduced tariffs by 25% across board in 1973
-comprehensive program of trade liberalisation continued into 1990s
-Today 50% of all goods are tariff free
-Australia’s reduction in protection goes well beyond those recommended by
international trade agreements such as WTO
Australia’s multilateral and bilateral free trade agreements
Australia is very active seeking free trade agreements with other nations.
Bilateral:
-Closer Economic Relations agreement with New Zealand (CERTA), has led to free
trade between the two countries and increased standardisation of laws, business
practices and commercial structures.
-Singapore-Australia Free Trade Agreement (SAFTA) was Australia’s first free trade
agreement with an Asian country. Covers the elimination of tariffs and improves
market access for services exporters such as telecommunications, financial and
professional services.
Multilateral:
-ASEAN-Australian-New Zealand Free Trade Agreement (AANZFTA), covers 21% of
Australia’s trade in goods and services and effectively creates a free trade area for
the included members. Complementary economies.
-Asia Pacific Economic Cooperation forum (APEC), aims for free trade between its
members but has made little progress as there are no binding agreements.

6. The implications of Australia’s policies for individuals, firms and governments
Implications for Australia of protectionist policies of other countries and trading blocs
Just as domestic policies to protect Australian industries have an impact on the Australian
economyso do the policies of other nations to protect their industries. When other countries put
tariffs on Australian goods and services, our exports become less competitive and struggle to
penetrate foreign markets. When other countries subsidise their exports, they raise the supply and
reduce the price of those goods on global markets. The result is that countries like Australia that
compete to sell similar products on global markets have their income reduced. Overall protectionism
reduces that output of the Australian economy.