Chapter 4: Australia’s trade and financial flows
Multiple choice
1. c
2. d
3. a
4. a
5. a
6. d
7. c
8. b
9. a
10. c
11. b
12. a
13. c
14. c
15. d
16. a
17. b
18. c
19. b
20. b
Short answer questions
1.
a) Terms of trade measures the relative movements in the price’s of an economy’s imports and exports over a period of time.
b) The movement in terms of trade between year 2 and year 3 has declined.
c) Two recent trends:
- Financial flows have been increasing significantly in comparison to trade flows, nearly doubling in the last decade.
- Portfolio investments have dramatically risen, almost tripling the growth of direct investment inflows since 1980’s.
d) The impact of an improvement in the terms of trade on the balance on goods and services is that it suggests that Australia is either receiving more value for its exports in comparison to imports or import prices have lessened in comparison to export prices. This indicates a reduction in the value of import expenses for Australia or an increased in value for its exports relative to imports which both lead to an increase in credit in the current account which is an improvement to the balance of goods and services
e) The impact of the recent changes in Australia’s trade composition and direction in the current account deficit is that Australia’s export base heavily consists of primary industry commodities and of a narrow base trade, this means that Australia’s exports have become very susceptible to volatility in the global market. As seen in 2009 when Australia’s export prices significantly decreased due to the global financial crises. Furthermore, Australia has experienced an increased in consumption of finished consumer goods which indicates that Australia’s import expenditure have increased relative to exports which has assisted in further reducing Australia’s balance on goods and services, increasing Australia’s current account deficit. However, in the recent decades Australia has increased its global competitiveness through its shift in its direction of trade, focusing mainly on East Asia and the pacific region which has enabled Australia to attain access to countries such as China which are one of the fastest growing regions in the economy. These in the long-run will significant assist in the improvement in Australia’s balance on good and services through greater demand for Australia’s exports due to boom in Asian pacific economies.
2.
a) The current account is measured as a percentage of GDP as it allows for comparison of different current accounts of economies that range in sizes as it is measured through GDP.
b) The difference between net income account and financial account is that net income account is a componenet that records all non reversible transaction in the current account that are of servicing cost on financial assets such as interest repayments and dividends. Whilst, financial account is the transaction between Australia and the rest of the world, consist of direct and portfolio investments etc.
c) Two recent trends in Australia’s current account deficit are:
- Australia’s CAD has significantly increased every year, currently over 50% in recent years.
- Australia’ CAD is almost always a deficit and hardly ever a surplus.
d) The causes of Australia’s persistent current account deficits are due to structural and cyclical causes.
Structural causes are one of the main causes of Australia’s persistent CAD as Australia has a narrow trade base which means that over the years Australia’s import expenditure has increased significantly in comparison to exports, Australia’s finished consumer imports have increased significantly, whilst, exports have been left behind due to more markets ability to produce primary goods. Australia’s net income also plays a major part in Australia’ persistent CAD, as due to Australia’s high domestic investment levels but low national (household) savings, there is of a significant gap between domestic investment and savings which lead Australia to borrow funds from overseas. This significantly increases Australia’s foreign liabilities, resulting to a net income deficit which serves to worsen and increase Australia’s CAD. Cyclical causes are another major factor of Australia’s CAD; Australia’s terms of trade are very susceptible to international and business cycle. For instance, a downturn in the international cycle will decrease Australia’s demand for exports. This is evident during the Global financial crisis in 09 where Australia experienced very low exports due to significant drop in global demand for Australia’s exports due to GFC. Also, domestic cycle is another persistent cause of Australia’s CAD, as an upturn in the domestic business cycle means that there is greater income and consumer spending, which will lead to greater aggregate demand. In recent years, there has been greater demand for finished consumer imports in Australia which serves to increase import expenditure and worsen Australia’s persistent CAD.
3.
a) calculate net foreign liabilities:
net foreign liabilities + net foreign equity
= 680 billion
b) The difference between net foreign debt and net foreign liabilities is the net foreign debt is the total amount of loans Australia owes, minus what the rest of the world owes to Australia and foreign liabilities are the total of stocks, assets etc. that Australia owes to the rest of the world.
c) The relationship between net foreign liabilities and balance of payments is that net foreign liabilities consist of all stocks and assets that Australia owes to the world over a period of time and the balance of payments is all the financial transactions that occur between Australia and rest of the world. For instance, when Australia borrows funds from overseas to fund for an investment, it will be recorded in the balance of payments as a direct investment credit. This will then increase net foreign liabilities as Australia now would have to pay the debt back as well as the incurred interest repayments.
d) The impacts of a high current account deficit on the Australian economy will lead to a reduction in Australia’s economic and international growth rates. A high CAD will lead to a significant decline in Australia’s economic growth rate as import expenditure will far exceed exports, meaning there are greater leakages than injections in the economy. This then will lead to a shortage of domestic funds and will leave Australia no choice but to burrow large sums of money overseas so that leakages will be matched with sufficient injections. This in turn raises Australia’s foreign liabilities and significantly increases Australia’s serving costs in the future. A high CAD will also lead to a reduction in Australia’s international growth rate as a high CAD decreases Australia’s global competitiveness as foreign investors are more reluctant to lend or invest in Australia due to its high CAD levels which may lead to volatility in the exchange market due to depreciation of dollar. However, in some cases Australia’s high CAD reflect favorable circumstances for some as it reflects Australia’s stability with its persistent high CAD.