The Australian Economy - Term Paper Example

 The Impact of External Regional Developments and Global Oil Prices Increase in Australia Table of Contents Business Cycle ----------------------------------------------------Pg Determinants of Aggregate Demand ---------------------------Pg The Economic Environment ------------------------------------Pg Government Macroeconomics Policies ------------------------Pg Introduction The Australian economy is the 16th largest economy in the world today, with a GDP of US$ 602 billion in 2004. With per capital GDP of US$ 29,900 (2004), it is placed at the 13th place, above several advanced countries including the Netherlands, France, Germany, and even Britain. Primarily an agricultural country, Australia has made inroads into several sectors over the last few decades, which has placed it among the world’s top economies. Since the recession in the 1990s, Australian economy has enjoyed rapid growth with low rates of inflation and unemployment. Structural reforms taken up in the 1980s, and good macroeconomic policies of the government like deregulation of the financial system, reduction in trade barriers like tariffs, removal of restrictions on foreign investment, creation of competitive markets, and other reforms have made Australia very successful in world trade. Australia has always been a prime exporter of commodities and importer of finished goods. This is the reason for its economic vulnerability to external fluctuations like changes in commodity prices for products like oil and others. The increases in the oil prices right from the energy crisis during the 1970s and more recently in 2005 have drastically affected the economies all over the world. Oil prices have gone up from around $10 per barrel to over $60 per barrel and then to the current prices of around $50 per barrel. These prices could increase further, which is a prime cause of concern for the whole world. This report intends to study the business cycles in the Australian economy, the changes to the components of the aggregate demand in recent years and reasons for these changes. It would also analyze the present status of the Australian economy in terms of energy sources, and whether there is any link between the oil prices and the levels of inflation and unemployment in Australia. It would also discuss the government’s macroeconomic policies in the last two years and recommendations for improving the country’s energy sector. Business Cycles The Australian economy has been quite strong over the last decade. It has grown at an average rate of around 3.6% from 1998 to 20051 and has maintained over 3% growth rates since then. The rate of inflation has also been quite favorable, within the reserve bank target band of around 3% since the 1990s. During 20002-2001, the inflation rate had crossed 6% but has stabilized again at around 4% by 2004-2005. The rate of unemployment has also declined considerably since the 1990s. It had peaked to around 11% during 1993-1995 but has declined considerably since then, coming down to the present levels of around 5%. This has been attributed to the very good level of productivity achieved over the last few years. Australia’s real GDP growth as compared to other OECD countries has also been better in the period 1991-2004. Determinants of Aggregate Demand Aggregate demand is the total demand for goods and services of a country in a particular year. Aggregate demand is a factor of total consumption, investment, government spending, and exports (minus imports) in a given year. The aggregate demand is a very important determinant of the entire economy. It is affected by a number of factors, the main ones being inflation and the government’s policies. For instance, high inflation affects savings and investments, as well as the spending behaviors of consumers. This would affect the aggregate supplies, supply of credit, the exchange rate and the asset prices. The government takes into account the basic indicators like inflation, unemployment from time to time, and determines the fiscal and monetary measures to correct any discrepancies. Inflation and other aggregate demand factors are effected by changes in the prices of imported goods. This also depends on the exchange rate of the Australian dollar. Aggregate demand is a function of consumption, investment, government spending, exports and imports. We shall take a look at the changes in each of these factors. Over the last few years, aggregate demand has grown, but it has been driven more by business investment and not household spending. Strong commodity prices have made business investment more feasible than increased consumer spending. Consumption: there have been many shifts in the spending patterns in Australia over the last three decades. Presently, food, clothing and other related products account for a third or the total customer spending, as compared to a half around 35 years ago. Consumption of services has increased significantly. This is because of the changes in incomes, consumer tastes and habits and development of new and cheaper products because of advances in technology. It can also be attributed to changes in rates of taxation for some goods and services. Increased female participation in workforce, leading to higher disposable incomes, has also led to the changes in consumption patterns over the last few years. Consumption growth was high at the end of 2003 but mellowed down considerably later, due to balance-sheet adjustments in households that reflected low demands for more debts. Increase in employment rates has however, kept the consumption patterns more or less stable. Private consumption was very high throughout 2003-2004, increasing by 1,111 million by the end of the yeari. A main reason for this is the increasing wealth of Australian households. The more wealth of individual household’s, the more the consumption of consumer products. Investments in buildings, structures, equipment and dwelling also steadily rise through 2003-2004ii. Given the knowledge of Australia’s impressive export income the addition of private consumption and investments is considerable enough to constitute a boom. Investment: investment patterns have also changed considerably from what they were around 20 years ago. Australia’s capital flows have increased significantly in the form of foreign investment (from 32% of GDP in 1980s to over 90% of GDP in the 1990s). This has resulted in: lower domestic savings and investment as a percentage of total investment, financial deregulation, and higher Australian investment abroad (from 11% of GDP in the 1980s to 31% of GDP in the 1990s). Many Australian firms have invested in higher production capacities to meet the demands in export markets. Exports and Imports: there has been a rise in the proportion of Australian exports as well as imports. The overall trade share as a percentage of total domestic output is more than 40% now, as compared to around 25% in the 1960s. This is primarily because of advancements in communications and transport sectors. Reductions in trade barriers in other countries due to GATT negotiations, and some unilateral initiatives are responsible for this. The capital market has also become very mobile, due to flexible exchange rate regimes and fewer restrictions on foreign exchange transactions. Domestic aggregate demand has no doubt increased over the last two-three years, and is likely to pick up in the next few years. Credit growth is also good, which would lead to higher aggregate demand. The Economic Environment Oil prices have gone up from around $25 per barrel in April 2003 to over $55 per barrel and have now touched $75 per barrel in some countries. Experts are predicting that the prices may touch $100 per barrel. Increase in oil prices affects the entire economy, because transportation, a key sector, would take a beating. How a country reacts to such external forces depends on how strong its economy is, and how effectively it can absorb the shocks. Crude Oil Prices 1947-2004 (Source: http://www.wtrg.com/prices.htm) The diagram below displays the international price of oil from 1999-2005. Source: adapted from IMF, World Economic Outlook, Sept. 2005 and previous editions The main question here is whether there is any effect on the increasing global oil prices and the rates of inflation, unemployment and the general price levels in Australia. The rate of unemployment is represented in the below graph: The consumer price index can also be represented as: Quarter ending Year 31 March 30 June 30 September 31 December 2005 147.5 148.4 149.8 150.6 2004 144.1 144.8 145.4 146.5 2003 141.3 141.3 142.1 142.8 2002 136.6 137.6 138.5 139.5 2001 132.7 133.8 134.2 135.4 2000 125.2 126.2 130.9 131.3 1999 121.8 122.3 *123.4 124.1 1998 120.3 121.0 121.3 121.9 1997 120.5 120.2 119.7 120.0 1996 119.0 119.8 120.1 120.3 1995 114.7 116.2 117.6 118.5 1994 110.4 111.2 111.9 112.8 1993 108.9 109.3 109.8 110.0 1992 107.6 107.3 107.4 107.9 1991 105.8 106.0 106.6 107.6 1990 100.9 102.5 103.3 106.0 1989 92.9 95.2 97.4 99.2 1988 87.0 88.5 90.2 92.0 1987 81.4 82.6 84.0 85.5 1986 74.4 75.6 77.6 79.8 1985 N/A N/A 71.3 72.7 The price of gasoline is extremely important to factor when determining a companies overhead. A large increase in the price of oil leads to a large increase in costs for many businesses and firms in the economy. This affects the wages of the Australian workforce as well as the cost of products. Private businesses must compensate for increasing cost in the manufacturing and distribution of its goods and services by increasing the consumer price of their goods and services. The price of goods and services will increase as the private sector reacts to increasing cost of oil. As the price of goods increase it is natural for the workforce to demand higher wages to meet the change in cost of living. When the wages of a workforce increase the price of the products will increase as well to compensate for the additional cost of salaries being paid. As both wages and cost of goods and services increase, we have what is known as inflation. The inflation and unemployment trends in Australian have not been too alarming over the past few years. The inflation rate has been more or less steady around the reserve bank target of around 4%. The unemployment rate has in fact declined slightly over the years. This shows that the increasing oil prices do not have a very adverse effect on the Australian economy. There are several reasons for this: the government’s policies, Australian domestic oil reserves, a strong Australian dollar, favorable balance or trade, and so on. In fact, the Reserve Bank of Australia has estimated that the 1979 price of oil is equal to US$100 / barrel today, when adjusted for inflation. However, today’s oil price is around US$75 per barrel. Australia had an oil production of 731,000 bbl/ day in 2001 and 537,500 bbl/ day in 2004. Against this, oil consumption was 796,500 bbl/ day in 2001. Oil exports in 2001 were 523,400 bbl/ day while oil imports were 530,800 bbl/ day. As of 2002, Australia had proven oil reserves of 3.664 billion bbl. Australia is also strong in other energy sources like natural gas, with 33.08 billion cu m in 2001 against a consumption of 23.33 billion cu m in the same year. It did not import any natural gas in 2001 and has proven natural gas reserves of 2.407 trillion cu m as on January 1, 2002. . Australia also has other energy sources like the rich coal deposits in NSW and Queensland and the liquefied natural gas export project in the North West Shelf. AUSTRALIA IS A NET ENERGY EXPORTER. The high prices of oil will only be more beneficial for Australia. LNG and coal production would also add much revenue to Australia’s coffers. Macroeconomic Policies Hence, the increasing oil prices are less likely to result in any monetary or fiscal measures like interest rate changes or tax increases. There would be some changes in household spending as consumers would spend more on gas and save on other purchases. But savings and investments would most likely rise, due to the profits made by the oil companies, pushing the share prices higher. However, if the price of oil rises further and crosses the US$80 mark, there would be adverse effects. The worst predicted is a global recession. This would have its effect on the Australian economy too, especially on the growth rate, because the Australian economy depends greatly on foreign trade. Domestic spending would also be effected as the A$ comes under downward pressure. The market interest rates in Australia have normally increased due to global trends. The share market has also increased by 11% since the beginning of 2006, which is much higher than that in other countries. Credit growth is also favorable, encouraging consumers to take more debt and increase their consumption. There is chance of a higher cash rate and inflation, which the government intends to control by taking up monetary and fiscal measures. In May, the government has increased the cash rate by 25 basis points to 5.75 percent. This has been because of an increase in the consumer price inflation to 2¾ percent in the March quarter. This has been attributed partly to the increasing oil prices. The government’s fiscal policies have been aimed at decreasing the outstanding commonwealth government debt burden. It has also implemented several tax reforms over the last few years, which have kept the economy relatively stable in terms of inflation and unemployment. The best way to tackle the increasing prices of oil so that they do not affect the Australian economy would be to invent in alternative energy sources. Encouraging innovation in the energy sector would have long-term benefits on the economy. Since transport is the major sector to be effected, use of alternative and sustainable methods of transport would be more feasible. Although Australian economy has remained strong in spite of the spiraling oil prices, the government still has to build shock absorbers to offset any further increases. This could be in the form of economic reforms, tax reforms, balancing government spending, monitoring the credit growth and controlling prices of necessary commodities. Interest rates would come under pressure, and this can be controlled by an effective credit policy. References www.budget.gov.au http://www.rba.gov.au/PublicationsAndResearch/StatementsOnMonetaryPolicy/statement_on_monetary_0506.html Maiden, Malcolm, 2004, Oil: under the pump but not over the top; Available at: www.theage.com www.treasury.gov.au www.rba.gov.au www.abs.gov.au www.dfat.gov.au www.wto.org Eslake, Saul, 2006, An Introduction to the Australian Economy, Available at: http://www.anz.com/business/info_centre/economic_commentary/EncycAmericana(2006update).pdf www.axiss.com Read More