Australian Trade Dynamics: 1980-2024

• Australia's two-way trade flow (exports minus imports) has increased from 27% of GDP in 1980 to 45% of GDP in 2024.
• Trade liberalization policies implemented in the 1980s and 1990s, involving the removal of protectionist policies, contributed to this increase.
• Increased participation in Free Trade Agreements (FTAs) has also played a role.

Composition of Trade Flows - Exports

• Commodities accounted for 33% of exports in the 1990s, rising to 54% in the 2020s.
• Manufactured goods represented 13% of exports in the 1990s, decreasing to 9% in the 2020s.
• Agricultural goods made up 23% of exports in the 1990s, declining to 10% in the 2020s.
• Services accounted for 15% of exports in the 1990s, increasing to 20% in the 2020s.

Resource Exports

• The surge in commodity exports showcases the growing trade relationships with industrializing emerging economies.
• Australia holds the world's largest iron ore reserves, with 50 billion tonnes, representing 28% of global reserves.
• Australia has the fourth-largest coal reserves, with 149 million tonnes, which is 14% of global reserves.
• Australia's mining infrastructure ranks among the most advanced globally.
• High monetary and time costs associated with mining infrastructure create a competitive moat for Australia in exporting commodities.
• A competitive moat translates to high barriers to enter the Australian mining sector due to the extensive time and capital required for mining infrastructure.
• The early 2000s global commodities boom led to a significant inflow of foreign investment into Australia's mining sector, totaling $4.66 trillion as of 2023, and 86% of Australia's mining industry is foreign-owned.
• LNG exports increased by 83% from 2020-2022, driven by shifts to clean energy in Asia.
• Lithium exports increased by 355% from 2020-2022, due to the global surge in electric vehicle production.
• Copper exports increased by 43% from 2020 to 2022, due to increased demand in green technologies.

Manufactured Goods Exports

• The decline in manufacturing exports reflects the reallocation of resources from previously protected industries.
• Australia lacks international competitiveness in high value-added areas due to reasons like high minimum wage ($23/hour), small population (26 million), and higher energy costs (electricity costs are 110% higher than China).

Agricultural Exports

• Other OECD countries often provide more subsidies to their agricultural industries compared to Australia, which makes the Australian agricultural industry less protected.
• Subsidies account for 20% of farmers' income in OECD countries, compared to only 2% in Australia.

Service Exports

• Australia is shifting towards a service-based economy, but the majority of exports are still commodities.
• 88% of Australia's workforce is employed in services, services only account for 20% of export base.
• Tourism is expected to increase from $45 billion in 2019 to $60-70 billion by 2030.
• Finance is expected to grow from $5.5 billion in 2022 to $8 billion by 2030.
• Education is expected to increase from $40 billion in 2019 to $50 billion by 2030.

Imports

• Capital goods accounted for 17% of imports in the base year 1990 and 18% in the base year 2020.
• Service goods represented 22% of imports in 1990 and 23% in 2020.
• Consumer goods accounted for 14% of imports in 1990 and increased to 28% in 2020.
• Intermediate goods represented 40% of imports in 1990, decreasing to 32% in 2020.
• Intermediate goods are imported and used in manufacturing other goods
• Composition for imports has remained relatively stable.

Imports Cont.

• Imports for consumer goods have increased over time, reflecting Australia's lack of comparative advantage in manufacturing, including:
• Electronics: %15.2 Billion
• Clothing and Textiles: $7.8 Billion
• Toys, Games and Sporting Goods: $4.3 Billion
• Industrial Machinery: $3.7 Billion
• Household Appliances: $1.6 Billion
• The high volume of intermediary goods prior to the 2000s reflected the practice of firms importing intermediate goods/partially assembled goods and completing final production in Australia to adhere to Local Content Rules.
• The removal of local content rules has allowed businesses to move their production processes overseas to save costs in a process called offshoring.
• Offshoring is the practice of moving a business process to another country, typically to reduce costs.
• Local Content Rules (LCR) are government policies that require a certain percentage of a product's value (i.e., materials, manufacturing, or assembly) to be completed in its country.

Direction of Trade Flows

• Australia has shifted away from high-income countries to emerging economies in Asia, but still relies on high-income countries.

Trade Direction Timeline

• 1950s: Predominantly traded with Europe and the UK due to historical ties.
• 1960s: Japan's strong GDP growth led to a surge in demand for Australia's resources.
• 1970s: The UK's entry into the EEC led to a decline in trade with Europe and a shift towards Asian markets.
• The EEC (European Economic Community) aimed to improve economic integration between European countries, caused a loss of preferential trade agreements due to UK previous trade arrangements with Australia due to being apart of the Commonwealth.
• 1980s: Sustained demand from Japan and increased trade with China.
• 1990s: China's rapid industrialization increased demand for commodities.
• 2000s: China joining WTO in 2001 led to a surge in demand for raw materials, became a complementary economy with Australia (countries have something to offer each other).
• 2020s-Present: China accounts for 33% of Australia's 2-way trade in 2023, but trade disputes highlighted vulnerabilities and overreliance on China during COVID, leading to Australian efforts to diversify export destinations.
• Narrow export base
• Narrow export destinations

Value of Composition of Financial Flows

• Australia's value of financial flows increased from $420 billion (1990) to $7 trillion (2019), due to deregulation of financial markets during the 1970s and 1980s, and the introduction of electronic trading platforms.
• Direct Investment (FDI) was $8 Billion in 1990 and $758 Billion in 2024.
• Portfolio Investment (FPI) was $25 Billion in 1990 and $1.3 Trillion in 2024.
• Foreign Direct Investment (FDI) occurs when an investor acquires at least 10% of a company's shares or assets, giving them significant control or influence over the business operation in the foreign country.
• Foreign Portfolio Investment (FPI) is when an investor holds less than 10% of a company's shares, typically involving stocks, bonds, or other securities.
• Prior to financial market deregulation, FDI flows dominated, with FPI, flows rapidly growing, outperforming growth in FDI by approximately 6 times since 1980.

Net Foreign Liabilities

• Australia's net financial obligation to the rest of the world.
• NFL = NFD + NFE

NFD

• Net Foreign Debt (NFD): The net stock of loans owed to foreigners.
• Debt Investment into Australia (DI) - Debt investment abroad (DO) (DI-DO)
• Debt investment in: Foreign investors or governments lend money to Australian entities.
• Debt investment out: Australian investors purchasing debt securities abroad.

NFE

• Net Foreign Debt (NFD): The net stock of equity owned by foreigners.
• Equity investment into Australia (EI) - Equity investment abroad (EO) (EI-EO)
• Equity investment in: Foreign investors buy stakes in Australian businesses through direct ownership or stocks.
• Equity investment out: Australian investors buy stakes in foreign businesses or international markets either through direct investment or stocks.

Relationship

• NFD and NFE are direct opposites (i.e., NFD = -NFE) resulting in NFD + NFE = 0.
• An increase in NFD leads to a proportional change in NFL.
• An increase in NFL doesn't always lead to an increase in NFD, it could come from NFE and doesn't affect the country's NFD.
• Australia's NFL has fallen to 32% of GDP in recent year.
• Australia historically experienced a Savings-Investment gap resulting in Australia borrowing from foreign sources causing a CAD.
• National savings has increased since 2019, decreasing reliance on foreign investors and decreasing NFL.
• Superannuation caused increased mandatory contribution rate from 3% (1992) to 11.5% (2024).
• A widened NFE position led to more individuals undertaking larger equity investments abroad.
• A shift from investment to production phase mining led to a decline in mining sector investment, with fewer equity investments recorded in Australia.
• With the long-term depreciation of the AUD, depreciations in the AUD contributes to a valuation effect on NFE, leading to a widening of the NFE asset position and a fall in NFL.
• A depreciation increases the value of assets denominated in AUD.

Balance of Payments (BOP)

• Records all financial transactions between Australia and the rest of the world over a specific period.

Structure of the Balance of Payments

• Current Account (CA): Records non-reversible transactions (flow of goods, services, and income).
• Records non-reversible transactions between Australia and the rest of the world, specifically the flow of goods, services, and income • Capital and Financial Account (KAFA): Records reversible financial transactions (money and investments).

The Current Account consists of:

• Balance on Goods and Services (BOGS): Net good and services exports (X-M)
• Net Primary Income (NPY): Income from working and financial investments (e.g., wages, interest repayments, dividends)
• Net Secondary Income (NSY): Non-market transfers (transactions where one party provides something without receiving anything in return, such as unconditional aid or workers' remittances). Current Account Balance = BOGS + NPY + NSY • Capital and Financial Account (KAFA): Records reversible financial transactions between Australia and the rest of the world.

KAFA consists of:

• Capital Account: Records capital transfers, intangible assets, and rights.
  • e.g. Debt forgiveness, conditional aid, intellectual property, brand names, copyrights, trademarks, rights for mining or fishing
• Financial Account: Records transactions with ownership change of Australia's assets/liabilities (any investments).
• Direct Investment: Investor capital investment has >10% share.
• Portfolio Investment: debt or equity investment <10%
• Financial Derivatives: Contracts
• Reserve Assets: Assets held by the Reserve Bank.
• Other Investments: Transactions that don't fit into others accounts.
• Under a floating exchange rate system:
• CA + KFA + Net Errors and Omissions = 0

KFA

• KFA surplus = CAD
• CA and KFA are supposed is =0, however if not, net errors and omissions balance out the equation to = 0.

Demand and Supply of AUD

• Demand for AUD: Represented by transactions where foreign residents require AUD -- Exports of Goods and Services (X) -- Credits in the NPY and NSY (Y credits)

• • Capital and financial inflows (K credits)

• Supply of AUD: Represented by transactions where Australian residents require foreign currency.

• • Imports of Goods and Services (M)
• • Debits in the NPY and NSY (Y debits)
• • Capital and financial outflows (K debits)

• Under a floating exchange rate: Demand for AUD = Supply for AUD X + Y_credits + K credits = M + Y_debits + K debits

• Credit: Occurs when money flows IN to Australia

• Debit: Occurs when money flows OUT of Australia

Factors Affecting the BOP

• Australia has historically recorded a savings-investment gap due to national savings being insufficient to fund domestic investment opportunities.
• STRUCTURAL FACTORS AFFECTING PRIMARY INCOME:
• • Savings-Investment Gap -- Increased foreign debt and equity investment leads to high level of financial account credits, which in turn leads to debits on the NPY due to servicing costs. -- CYCLICAL FACTORS AFFECTING PRIMARY INCOME
• -Interest Rate Differentials, is the difference in long-term interest rates between Australia and other advanced economies.
• -Positive Interest Rate Differential: Interest rates in Australia are higher than abroad, attracts foreign capital inflows as investors seek higher returns.
• -Short term: Increase in net credits in Financial Account ---Long term: Servicing costs on debt and equity investment leads to increase in net debits on NPY
• -Negative Interest Rate Differential: Interest rates abroad are higher in Australia, contributes to a net decrease in Financial Account credits and a net increase in NPY debits

Domestic Business Cycle

-- Booming Business Cycle: Foreign-owned businesses have increased profits, then distribute dividends to shareholders, creating a debit in NPY. -- Sluggish Business Cycle: Reduced outflow of primary income due to reduced or no dividends repayments causes reduction to 0 debit in NPY.

• Global Business Cycle -- Booming Business Cycle: Businesses abroad have increased profits increasing credit in NPY. -- Sluggish Business Cycle: Businesses abroad have reduced profits → retain earnings and not issuing dividends → no credit in NPY -- Exchange Rates (VALUATION EFFECT): Movements in the exchange rate can impact the value of net foreign liabilities (NFL), affecting servicing costs and level of net debits on the NPY. -- Depreciation of Currency: Leads to a net decrease in the value of foreign liabilities, decreasing the servicing costs (90% of Australia is denoted in AUD/hedged → the value of the foreign liabilities shift with the value of the AUD so if depreciation of currency, deprecation of foreign liabilities). -- Appreciation of Currency: Leads to a net increase in the value of foreign liabilities, increasing servicing costs

Factors Affecting BOGS

• -STRUCTURAL FACTORS AFFECTING BOGS -- Narrow Export Base, Australia's reliance on iron ore, coal, and LNG, leaves exports vulnerable to global demand, commodity prices, or shifts in trade relationships.
• CYCLICAL FACTORS AFFECTING BOGS -- Terms of Trade (ToT) is an index measuring relative movements in the price of a country's exports to the price of its imports. ToT Index = (Export Price Index/Import Price Index) * 100 Increase in export prices index and a decrease in the import price index results in improvements in the ToT and increase credits in the BOGS. -- Exchange Rates Influences BOGS.

AUD Depreciation

• Exports become cheaper for foreign buyers leading to increased export revenue and imports become more expensive leading to decreased import spending.
• Improves BOGS if exports > imports
• • Also affected by J-curve effect: both exports and imports are initially inelastic. --- Short-Term: BOGS worsen from imports becoming more expensive, while exports stay the same due to time-lag.
• -- Long-Term: Adjust to cheaper exports and more expensive imports, causes BOG improvement.
• • Domestic Business Cycle: --- Upturn: High incomes and consumer confidence increases import spending increase BOGS debits. Downturn: Import spending decreases and decrease BOGS debits.
• International Business Cycle:
• -Upturn: Increased export demand increase credits in BOGS.
• -Downturn: Less exports, decrease credits BOGS.

Trends in the Current Account

• • Historical Trends
• CAD reached 4% in the 1980s.
• • The CAD caused structural reforms to increase exports as Australia was in a net import position.
• -- CAD caused by commodity price volatility.
• -- The CAD could have been prevented because of savings-investment gap
• • Over time between 1980s and 2010s the CAD fluctuated in line with export growth.
• • Since 2010s the CAD has made long-term improvements.
• In 2019, the country when to an all-time surplus.
• During 2019 to 2021 the CAD was getting wider.
• As the calendar shifts to the middle of the 2020s countries like Australia returned to a CAD.

Trends in the BOGS

• HISTORICAL TRENDS IN THE BOGS -- An initial surge during the 2000s global commodities boom -- A later upswing since 2016-
• -Rising commodity prices led to long-term improvements
• • Shift from investment to production phase of mining sector ->
• • Sustained global demand for Australian's commodities exports (e.g. industrialization of Chinese economy 2000s-10s) -> strong export income

DETERIORATION IN BOGS

-Falling commodity prices

• • Iron ore
• -Thermal coal -Slow down in china
• • Australian exports to China have falling
• Increased BOGS Debits
• • The value of imports has risen by 7% Australia's energy imports have risen
• • supply chain disrupted due to the war with Russia

Trends in the NPY

--HISTORICAL TRENDS IN THE NPY Australia has recorded a net foreign liability position (The Liability outweigh the returns) Australia has historically recorded a NPY deficit Foreign liabilities can be decomposed into debt and equity.

Other

RECENT TRENDS IN THE NPY

• Has experienced a net outflow of capital --Australia's status as a net capital exporter has contributed to a decline in levels of NFL
• • in theory should contribute to decline in interest In reality , NPY deficit has worsened

Trends in the KFA

HISTORICAL TRENDS IN THE KFA

• • Australia had recorded a influx of capital RECENTLY Net increase in key for deficts
• As key for moves to largest deficits
• The pitch ford stated that if CAD is a result of savings then there is no need to worry.
• • Stated that CAD actually benefited since its shows that you would still benefit.
• • The pitchforths theorem says that you save at that money is saved by consent, meaning that the risks associated with is known.

Cad

International funds state that 4% is where CAD is UNSUSTAINABLE medium-run , 6% long-term interest Rate Premiums

• A large AD indicated High levels of foreign liabilities ->
• Debt rate-
• In extreme cases if you pay premiums it could lead to debt rate.
• Leaders the debt sustainability problem Loss of Investor
• Shifts in attitudes of global markets towards

• rapid appreciation\

Foreign Invest.

• Can attract fdi because it signal it to a stable country.
• Also, it can improve the stability

Exchange rates:

• An exchange rate is the value of a country
• exchange rates are crucial for international trade.
• The forex markets facilitate those transactions

2 more exchange rates:

• Appreciation: a increase in the value
• Deprecation: A decrease in the value

Bilateral Rate;

• Direct One of the currencies
• Indirect: The amount that the currency can buy Trade weighted Rates Trade weight Rates are calculated through the transaction used.
• eg use ddd 8.7 % of markets are nominated

Factors Affect.

• Demand side 3
• Exports
• Terms of trade
• increase in the tomt increase in
• Price competitiveness, the higher it is the more they want to buy. Taste, and the more people love the more u would buy. Capital inflows- capital flows- domestic flows Availability of domes. Increase in investment increase demand. speculative activity-

factors impacting supply for AUD

Domestic and Foreighn

• In terms of demand it can increase supply for AUSD

Level of capital

The lower it is the harder time the exchange rate had/

Flooting Exchange rate:

• Val is determined by supply and demand, Demand for aud represents foriegns ability to purchase

In increase is:

Inc demand for AUD Decrease in supply Apprication is caused by;

• Decrease in demnads
• increase Supply of AUD
• • Accurate Messuire and underyling value . Shows gov trus
• external schocks

Indirects

• Higer Vol: the more that the value moves the more expensive.
• Suject. More over
• Srong doalr causes lower exports

Curv

WEAK DOLLAR HELPS PUCHERSISG POWER: J Curve

• Trade balance and long time
• More demand

Dvaluationd

Decrese in value to exchange rate

• To devalue central bank sells domesic and buys ofreign

Benefits

Certainity = stabilisied

Cons.

• Can be hacked
• Needs Intervenion

managed excange reates

fix at some initial value

If mkts push currencys central bank invetes.

• If vaole is lower If val is higer- central bank de valuses to buy

INFLUENCE

rba obiligaitons The reserve bank board will best contribute to:

• It keeps stability from Maintains fall employment
• Rba influence exchange rates Directy: buying
• Indiere

The RBA is dirty; RBA

• Prevent repaid appreciation
• and
• Indirect interation

Exchange Rates Movements

IMPORTED INFLATION

• Movements in exchange rates affect the price of both exports and imports A depreciation decreases the price of foreign currency terms
• The price of goods in domestic markets doesn't change; only the relatives price,
• --E.g Aussie

FOREIGHN investment

• Exchange rate movements influence investment and the cost of seviing debt
• Investment abroad and inters. To creditors import

Austalina is an. Export

• • Impact

NPY

Depreciation of SA; does not impact due to valuation effect Decreseas Impact

• Val Ndy