Economics: Test 1 - Free Trade + Protection

Trade

· Trade is when national economies engage in the exchange of g+s

· Exports contribute 25% of Australia's GDP & around 25% of Australia's workers are directly involved in trade-related activities

· Australia is major exporter of resources to the world, including iron ore, coal, natural gas, gold, lithium, & bauxite

· Australia imports large quantities of capital goods, such as machinery, as well as motor vehicles & consumer goods

Immigration

·       Involves the permanent entry & settlement of foreign residents in a country

·       Australia is multicultural nation; immigration has been an important source of skilled labour & has helped boost Australia’s population growth

·       From 2006 – 2020, net overseas migration contributed more each year to Australia’s population growth than natural increase

·       Provides boost to the population, particularly the productive working-age segment, which, in turn, can contribute to the growth of Australia's financial market, narrow the investment savings gap, & support sustainable economic development in the future

·       Immigration attracts a valuable pool of skilled labour from qualified overseas workers who can immediately contribute to human capital development & technological advancement with their diverse range of ideas from around the world that help foster innovation

Tourism

·       International tourism has grown in importance due to improvements in transport and communications

·       Tourism is Australia’s 6^th largest export but largest import

·       More Australians travel overseas than overseas tourists visit Australia

·       When people travel internationally, the host country experiences a boost to revenue & GDP resulting from foreigners spending on local businesses & job opportunities being created across various sectors, including communication, health & education

·       Governments will also be incentivised to invest in local infrastructure such as roads, parks, hospitals, and airports, to attract more tourists

·       Due to travel restrictions & border closures, tourism has naturally declined in the past few years

Investment

·       Refers to the movement of foreign financial capital between economies, various forms such as borrowings, equity, bonds, property purchases, and direct & portfolio investment

·       Australian economy has throughout its history heavily relied on net foreign investment to supplement its domestic savings to help fund its economic development

·       inflows of foreign investment into the Australian economy normally exceeds outflows

·       During 2024, for e.g., foreign investment into Australia was $245 billion, while Australian investment abroad was $142 billion

·       Australia has a relatively small population & does not generate enough savings to fund its investment needs & therefore relies on the inflow of foreign investment

·       Much of the infrastructure, such as transportation systems + communication networks, to support industry is financed from overseas funds

·       The mining and resources sector could not have been developed without foreign investment

·       Mining boom - Australia's high levels of investment & its capacity to undertake many mining projects greatly depend on foreign investments from countries like China & the US, which have sizable populations & surplus savings to invest abroad

·       Without these foreign investments, Australia's ability to fund such projects would be limited by the lack of capital resources

Importance of international trade

·       The Australian economy has always relied on the international sector – not just for the sale of goods + services, but also for funds for investment

·       Australia is a significant exporter of primary commodities (minerals and agricultural products); an importer of manufactured goods; and an importer of financial capital

·       Meant that trade & foreign investment have played a major role in the economic development of the Australian economy

·       Australia has been described as a medium open economy

·       The ‘medium’ refers to the size of the economy in terms of both population and GDP

·       Australia can no longer be described like small as the population has now grown to over 26million and Australia’s annual GDP exceeds $2.5 trillion

·       The ‘open’ means that the movement of g+s and capital is generally unrestricted, that is, they can move freely between Australia and the rest of the world

·       Protectionist policies such as the use of tariffs, subsidies and quotas hamper the free movement of goods and services, & Australia has reduced its level of protection to domestic industry to historically low levels 

Benefits of trade

·       Trade is important because it can expand a nation’s consumption possibilities by proving access to other countries production through imports

·       Exporting increases a nation’s production, while importing increases consumption

·       A country gains when it exports g+s it can produce at a relatively low cost

·       A country also gains when it imports g+s it produces at a relatively high cost

·       Importing allows Australian households to consume g+s that are either not produced in Australia or are too costly to produce

·       Engaging in trade permits increased specialisation, economies of scale, increased productivity and higher real incomes

 

Determinants of trade and trade intensity

·       A country’s level of exports will be determined by a number of factors: the size and structure of the economy, its relative competitiveness and its location

·       Most of the population lives in the northern hemisphere and Australia is isolated

·       Trade intensity ratio – a measure of the sum of exports and imports (of both g+s) as a percentage of GDP

·       Trade intensity = [(X-M)/GDP] x 100

·       Australia has a low trade intensity due to its geographic location

Composition of trade

·       The composition of a country’s trade will reflect its relative advantages in terms of its resource endowment

·       Changes in the composition of Australia’s exports have been:

o   a dramatic decline in rural exports

o   a significant increase in mining sector (minerals and energy) exports

o   a significant decline in manufacturing exports

o   service exports have become larger than either rural or manufactured exports

·       Goods can be classified by the amount of value added in their processing:

·       Primary Goods = raw materials such as iron ore which are used to manufacture other goods (AKA – Intermediate goods)

·       Secondary Goods = goods that have undergone processing/change

·       STMs (simply transformed manufactures) e.g. iron ore becomes steel

·       ETMs (elaborately transformed manufactures) e.g. steel becomes a car or a fridge (AKA – Merchandise)

Manufactured goods are the most significant category of imports, including:
- Refined Petroleum
- Passenger motor vehicles
- Goods vehicles (trucks)
- Telecom equipment (phones and the things that make them work)

• As an individual category, Australia’s largest import is personal travel (Aussie tourists), making up over 10% of imports

Direction of trade

·       There has been a significant shift in the direction of Australia’s trade

·       This shift has been primarily from Europe to the pacific-Asian reigon

·       This reigon has become the dominant trading group for Australia, accounting for over 80% of Australia’s exports and 70% of Australia’s imports

·       Top 4 countries – China, Japan, US and South Korea account for over 50% if Australia’s two-way trade

·       Reasons for the shift include:

o   Geographically, Australia is part of the Asia-pacific reigon but historically Australia has had strong ties with the UK and Europe

o   When the UK joined the European union Australia was forced to establish new markets

o   The Asia-pacific reigon had the advantage of much lower transport costs for Australia compared to Europe

o   Trade Blocs in geographically distant places (EU)

o   Free Trade Agreements between Australia and Asian nations

Australia’s trade policy

·       Australia is a member of many international organisations e.g. World trade organisation (WTO), the G20, Asia-Pacific Economic Cooperation (APEC) and the organisation for economic co-operation and development (OECD)

·       Purpose of participating in these organisations is to increase both trade + investment in order to promote Australia’s long term economic growth & prosperity

Key principles of the WTO

·       Non discrimination – a country should not discriminate between its trading partners, and it should not discriminate between its own and foreign products or services

·       Opening trade – lowering trade barriers to encourage trade; these barriers include tariffs and measures such as import bans or quotas

·       Fair competition – discouraging “unfair” practices, such as export subsidies and dumping products at below normal cost to gain market share

·       Protection of the environment – the WTO permit members to take measures to protect not only public, animal and plant health but also the environment. Members must not use environmental protection measures as a means of introducing discriminatory trade barriers

Free trade agreement

·       A free trade agreement is an international treaty between two or more economies that reduces or eliminates barriers to trade

·       Bilateral FTA is an agreement between two countries

·       Regional FTA involves more than two countries

·       FTA can be discriminatory and go against the ‘most favoured nation’ (MFN) principle of the WTO

·       This principle is based on the idea that countries should treat all their trade partners equally

Trade bloc

·       Trade bloc is a group of countries that agree to reduce trade barriers between themselves but impose barriers on countries outside the ‘bloc’

·       E.g. EU, North American Free Trade Agreement (NAFTA), Association of Southeast Asian Nations (ASEAN)

·       EU is the most powerful trading bloc in the world

·       A trade bloc typically applies a common external tariff on g+s imported from countries outside the bloc

·       Trade creation – removing trade barriers that helps to increase the volume of trade between members

·       Trade diversion – occurs when trade is diverted from a low-cost producer outside the trade agreement, to a higher cost producer within the group

·       Often FTAs will cause trade diversion, rather than trade creation

·       According to the Department of Foreign Affairs and Trade (DFAT) there has been little trade diversion and free trade agreements have been effective in encouraging wider trade liberalization

·       DFAT points out that a practical advantage of FTAs is that they are quicker and easier to negotiate than multilateral agreements because fewer parties are involved

Australia FTAs

·       Currently has 18 free trade agreements with 30 economies

·       Of these 14 are bilateral agreements and 4 are regional

·       ¾ of Australia’s trading markets are now covered by FTAs

·       Examples: ChAFTA 2015 (China and Australia); Australia-India Economic Cooperation and Trade Agreement (ECTA) 2022

·       FTAs increase economic activity and therefore greater employment activities

·       They make it easier for Australian businesses to access foreign markets and they provide Australian consumers better access to access to a wider range of G+S

Under WTO rules FTAs must adhere to two key principles

·       Eliminate tariffs and other trade restrictions on ‘substantially all the trade’ in goods between the member countries

·       Eliminate substantially all discrimination against service suppliers from member countries

Specialisation

·       Specialisation and trade results in higher living standards

·       Teachers, doctors, and miners are all specialists

·       Countries specialise in the production of certain g+s to which they are best suited

·       Alternative to specialisation is self-sufficiency (grow own food, make own clothes)

·       International specialisation and trade is made possible because of the uneven distribution and quality of resources between countries

·       Countries export the surplus production and import those g+s in which they are less efficient at producing domestically

Opportunity cost and relative efficiency

·       Relative efficiency is measured in terms of opportunity cost, which reflects the real cost of production

·       E.g. an accountant may be highly skilled at two tasks – auditing and word processing

·       Should she divide her time between both tasks or employ an assistant to do the word processing, even though she is more efficient than the assistant?

·       In this example, the accountant is said to have an absolute advantage over the assistant in both auditing and word processing, but her relative advantage (comparative advantage) is in auditing

·       At the international level, countries may also possess an absolute advantage and/or comparative (relative) advantage in the production of g+s

·       Countries will be better off if they export g+s in which they possess a comparative advantage and import those g+s in which they have a comparative disadvantage

·       Trade is based on differences in relative cost rather than absolute cost

Concept of absolute advantage

·       Country is said to have an absolute advantage in the production of a g+s over another country is it can produce a greater quantity of that good with its resources (or produce the same quantity with fewer resources)

·       This means that a country with an absolute advantage in a good can produce that good at a lower absolute cost per unit

·       Assumptions of model of absolute advantage:

o   The world consists of 2 countries

o   Each country produces and consumes 2 goods

o   Resources are perfectly mobile

o  Transport costs not considered

Absolute advantage graphs

·       Production possibilities for two countries assuming they devote all their resources to producing either wheat or coffee

·       If Aus only produced wheat its total output would be 10 units and only coffee 5 units

·       Aus is said to have an absolute advantage in the production of wheat, while PNG has an absolute advantage in the production of coffee

·       Before specialisation the ‘world’ production of wheat is 8 units and coffee is also 8 units

·       If both countries specialise in producing the goods in which they have an absolute advantage, then total production will increase

·       Aus will specialise in wheat and PNG in coffee

·       The blue dotted line represents the ‘trading’ frontier for each country based on the rate of exchange 1 wheat = 1 coffee

·       After specializing and trading, each country is able to consume one more unit of both wheat and coffee

·       Aus can now consume at point A* and PNG at B*

Concept of comparative advantage

·       A country is said to have a comparative advantage in producing a g/s if it can produce that g/s at a lower opportunity cost than another country

·       Same assumptions as an absolute advantage

Comparative advantage graph

·       Opportunity cost of producing computers is lower in Jap than Aus

·       Wool suits are relatively cheaper to produce in Aus than Jap

·       Both countries will gain if they specialise on the basis of comparative advantage and then trade their surplus protection

·       After specialisation, total production of both wool suits and computers as increased by 2 units

Gains from specialisation

·       Aus has a lower opp cost in producing wheat (0.5 coffee) compared with PNG (2 coffee), while the opp cost of producing coffee is lower in PNG (0.5 wheat) compared w Aus (2 wheat)

·       This means Aus has a comparative advantage in wheat and PNG has a comparative advantage in coffee

·       This is why specialisation results in an increase in production

Comparative advantage using inputs

·       Country X has an absolute advantage in both products since it takes less hours to produce both products compared to country Y

·       Country X has a comparative advantage in computer production while Y has a comparative advantage in bicycle production

·       In country X opp cost of 1 bicycle = 30/20 = 1.5

·       In country X opp cost of 1 computer = 20/30 = 0.67

·       In country Y opp cost of 1 bicycle = 40/50 = 0.8

·       In country Y opp cost of 1 computer = 50/40 = 1.25

·       Country X has a comparative advantage in producing computers while country Y has a comparative advantage in producing bicycles

Sources of comparative advantage

·       Comparative advantage is determined by the quantity and quality of the nations labour or human resources, natural and capital resources, and by technological progress

·       Comparative advantage can and does change overtime with improvements in technology and productivity

Benefits of international trade (d/s model)

Tariff model

Quota

Subsidy

Anti-dumping protection

·       Dumping occurs when a country or company exports a product at a lower price than what it sells domestically

·       The firm is engaging in unfair competition in order to drive out domestic producers

·       Dumping may also occur when firms have large surpluses they cannot sell in their own market, or their product has been banned due to it being injurious to health/illegal

·       A difficulty w this argument is proving whether dumping is actually taking place

·       Foreign goods may be priced lower bc of productive efficiencies

·       If dumping does cause harm to domestic producers, then temporary protection may deter this type of activity

Infant industry argument

·       Infant industries lack the experience and size to compete effectively against established competitors abroad  

·       It is argued that overtime infant industries will become internationally competitive and develop a comparative advantage

·       Problem w this argument is that protection tends to become LT rather than ST as it was originally designed

·       Infant industry becomes accustomed to operating with very little competition and the incentive to innovate and increase efficiency is removed

Diversification argument

·       If a country completely applied the principle of comparative advantage, then it may specialise in a narrow range of products

·       If all resources were employed in just these industries, then changes in world demand and prices could have significant effects on the economy

·       A country may benefit by diversifying its industrial base

·       Protection may then be justified to establish a range of diversified industries

·       Overtime the industry may increase its efficiency and become competitive so that in the long run, the level of protection could be reduced

·       Argument is weakened by the fact that no countries just have a comparative advantage in 1 or 2 industries

National security (defence) argument

·       Argued that import barriers are necessary to protect those industries that are vital to the economy in case of a wartime emergency

·       Problem with this argument is identifying those industries that are vital to the economy

·       Argument was popular in the era of global conflict but outdated now

Increased employment argument

·       Argument asserts that protection will shift consumers spending from the foreign goods to the domestic good and thus increase employment in the protected industry

·       Employment in the protected industry may rise but employment in other domestic industries will suffer – industries that use the products of the protected industry as inputs will face higher production costs

·       Consumers will also have less to spend on the output of other industries

·       A gain in employment in the protect industry means a loss in other industries

Cheap foreign labour argument

·       It is often claimed that Australian industries need to be protected from countries where wages are much lower

·       This argument could be turned around to say that less developed countries need protection from countries like Australia bc it has superior capital equipment and technology

·       Aus workers receive a higher wage bc their productivity is higher

·       Countries that have an abundance of labour relative to other resources will have a comparative advantage in labour intensive goods

·       Countries like Aus should reap the benefits by importing these goods and producing those goods in which it is relatively more efficient

Favourable balance of trade argument

·       Argued that a trade deficit could be eliminated or reduced by restricting imports through protective measures

·       This argument assumes that there is something wrong with a trade deficit – imports are “bad” and exports are “good”

·       It implies that a trade surplus is favourable, and a trade deficit is unfavourable

·       Protectionist policies designed to decrease imports will cause exports to decrease as well

·       Protection raises the costs of other domestic industries which reduces their competitiveness and therefore their exports

·       Other countries may also retaliate and impose restrictions on their imports

Trade liberalisation

 process of reducing or removing trade barriers between countries

Benefits of trade liberalisation

Increases real incomes + living standards

Increases efficiency through greater competition

Increases productivity through efficient resources allocation

Consumers gain through lower prices, greater variety and quality of goods

Exporters gain through higher prices and increased market access

Domestic producers gain through lower input prices

Enables greater specialisation and economies of scale

Openness to trade & investment is a major catalyst for EG