5.7 Strengths and weaknesses of using aggregate supply policies — review

So, while the adoption of trade liberalisation policies is not the only cause of Australia’s reduced inflationary pressures (there were also other aggregate supply-side government policies that helped such as tax reform, outlays on education and deregulation of the labour market), it is likely to have been one important contributing factor. In other words, cutting tariffs and subsidies, as well as signing more FTAs, has strengthened competition in domestic markets, helping to promote the goal of low inflation.

Effect of trade liberalisation on the achievement of strong and sustainable economic growth Another core macroeconomic objective of the federal government is to promote the goal of strong and sustainable economic growth. This is defined as the fastest average rate of growth in real GDP, around 3 per cent per year, that does not significantly accelerate inflation and is consistent with achieving other economic and environmental goals.Trade liberalisation should strengthen the economically sustainable rate of growth in several ways, particularly over the medium- to longer term: • Trade liberalisation leads to greater production specialisation in areas of comparative cost advantage, leading to a more efficient allocation of resources involving lower opportunity costs. This means there is more output gained from the same or fewer inputs, thereby growing Australia’s production possibility frontier or productive capacity. This increases the potential, non-inflationary rate of GDP growth. • With trade liberalisation, local businesses need to restructure their operations more efficiently to allow them to survive stronger competition from imports and become more internationally competitive. This allows for an increase in productive capacity and hence the potential rate of economic growth. • Trade liberalisation has allowed our local firms to access better equipment, materials, and technology at a lower cost, creating the more favourable aggregate supply conditions needed to grow Australia’s GDP at a faster rate. • Trade liberalisation has grown the size of Australia’s export market, turbocharged sales and encouraged firms to boost production levels and expand GDP. By increasing the non-inflationary rate of GDP and employment growth, trade liberalisation has helped to boost real national incomes. This has improved average real disposable income and consumption per head, and thus material living standards. For instance, one comprehensive investigation concluded that trade liberalisation had delivered a rise in average family incomes over the two decades since trade liberalisation, of around $3900 per family per year by adding 1.8 per cent to real GDP (Benefits of Trade and Trade Liberalisation by DFAT and Centre for International Economics). Again, over the medium- to long-term, at least some of the rise in average real disposable incomes per head might be attributable to the Australian government’s policy of trade liberalisation. However, despite the longer term benefits of stronger economic growth, in the shorter term, in some ways, trade liberalisation may have slowed Australia’s rate of economic growth. The main reason is that certain local firms and industries have been unable to cut their costs quickly enough by restructuring their operations more UNCORRECTED PAGE PROOFS efficiently. This forced some companies to close due to low profits. Here we might think of recent casualties like firms in the car industry, textiles, clothing and footwear, and low-end manufacturing.

The goal of full employment is one of the three domestic macroeconomic objectives of the federal government. This is defined as the lowest rate of unemployment, perhaps around 4.0–4.5 per cent of the labour force, that does not greatly accelerate inflation (NAIRU).

So, what effect has the policy of trade liberalisation had on Australia’s unemployment rate? This is a difficult question to answer. However, the impact does seem to depend on whether we consider the short-run or the longterm period.

Starting with the longer term, there are several ways that trade liberalisation has helped to create more jobs and keep the unemployment rate lower: • Over time, by boosting efficiency and slowing domestic inflation, trade liberalisation may help to make local businesses more internationally competitive than otherwise, enabling them to increase their sales in domestic and foreign markets. This should lead to higher production levels and more jobs. • Trade liberalisation, especially FTAs, have created bigger markets for our exports broad, allowing for increased sales and business expansion. This creates job vacancies and helps to lower unemployment. • Trade liberalisation allows local firms to reduce their average unit costs of equipment and materials, gaining greater economies of large-scale production. This is a favourable aggregate supply factor that enhances business competitiveness and profitability, again reducing business closures and structural unemployment.

However, despite the benefits of trade liberalisation over time, the main criticisms of trade liberalisation both in Australia and elsewhere, is that in the shorter term, the policy can prevent the growth of infant industries that face higher start-up costs, destroy others that are uncompetitive and cause higher levels of structural unemployment amongst trade-exposed firms and industries that cannot remain competitive.

5.5.4 The effects of trade liberalisation on living standards While mostly positive, trade liberalisation as an aggregate supply policy has had some mixed effects on Australia’s material and non-material living standards, partly reflecting the area of the economy, and the time period being considered: • Material living standards relate to the annual quantity of goods and services consumed by each person. They are affected by the level and distribution of the nation’s GDP and incomes, and the extent to which society’s wants are met or satisfied. • Non-material living standards or the quality of daily life, could be affected by many things including personal happiness, freedom, life expectancy, stress, the level of cultural enrichment, crime rates, and a clean and sustainable environment for current and future generations to enjoy. In the longer term, trade liberalisation has encouraged international competitiveness and business expansion, created more jobs and lowered unemployment. This has led to higher real per capita incomes, consumption and material living standards. In addition, by expanding export markets and sales abroad and by lowering structural unemployment over the long-term, trade liberalisation has helped to support various aspects of non- material living standards including greater happiness, reduced social isolation, possibly less crime, improved physical and mental health outcomes, and less financial stress and family conflict. However, as previously mentioned, over the short- to medium-term, both material and non-material living standards could be undermined. This is most likely amongst those employed in trade exposed industries that are unable to restructure operations and use resources more efficiently, leading to business closures and structural unemployment. In these industries, lower employment and incomes not only cut consumption and materialUNCORRECTED PAGE PROOFS living standards, but also undermine non-material wellbeing by adding to stress and unhappiness amongst the unemployed, weakening their mental and physical health outcomes, adding to tensions in relationships and causing social isolation.

We have now looked at the ways trade liberalisation has helped to lift allocative, technical and dynamic efficiency, growing Australia’s productive capacity and increasing AS. As a result, it should have supported the achievement of the government’s three key domestic macroeconomic goals (i.e. low inflation, a strong and sustainable rate of economic growth, and full employment) and ultimately, better living standards. Even so, particularly in the short-term, trade liberalisation, has some downsides: • Trade-offs exist: Trade liberalisation does involve significant trade-offs in exchange for greater efficiency in the use of resources. For instance, faced with stiffer competition, some jobs have been lost in industries unable to lift their efficiency and cut costs, pushing up unemployment. In addition, increased foreign competition may have discouraged the start-up of trade, particularly infant industries that have higher initial costs when getting into a market. Moreover, by encouraging greater international specialisation in areas of comparative cost advantage, Australia has been more exposed to significant disruptions in supply chains brought on by international tensions or war, and global pandemics like COVID-19. Having lost some of our key manufacturing industries, we now find ourselves unable to provide the basic goods and services needed to maintain living standards. Additionally, there are environmental trade-offs associated with excessive international specialisation in production. Countries producing crops, for instance, tend to develop monocultures that further damage soil fertility, and there is also a growing level of CO2 emissions accelerating climate change, from the dramatic rise in sea and air transport. These would not occur to the same extent with greater localisation of production. • Political constraints: Because some groups gain more than others from trade liberalisation, governments can face political constraints and opposition both in the parliament and among voters. As a result, policy may be softened or delayed, reducing the economic benefits flowing from greater efficiency. • Long time lags: Trade liberalisation has taken Australia many years to implement, and we are still not there yet. It offers no quick fix as a way of boosting efficiency. Resourceseses Resources

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Track your results and progress Find all this and MORE in jacPLUS 5.5 Quick quiz 5.5 Exercise 5.5 Exercise 1. Define the term, trade liberalisation. 2 marksUNCORRECTED PAGE PROOFS 2. One aspect of trade liberalisation for Australia has been the rapid growth in the number of FTAs.

Explain the nature of bilateral FTAs and why are they potentially important for Australia. 2 marks 3. Explain how trade liberalisation as a policy can beneficially impact Australia’s aggregate supply. 4 marks

4. Since the 1990s, the policy of trade liberalisation has gained pace. Explain how you would expect Australia’s policy of trade liberalisation to beneficially affect each of the following: 5 x 2 marks a. Australia’s international competitiveness b. The inflation rate c. The sustainable rate of economic growth d. The unemployment rate e. General living standards 5. Explain how the short-term effects of the Australian government’s policy of trade liberalisation may differ from the longer-term effects, for each of the following: 3 x 2 marks a. The potential rate of economic growth b. The rate of unemployment c. Material and non-material living standards 6. Despite Australia and China having a free trade agreement, during 2020 and 2021, China decided to impose trade restrictions on the entry of some of Australia’s exports including barley, beef, cotton, timber, iron ore, copper, wine, and coal. Explain the likely effects of this decision on Australia’s domestic macroeconomic conditions. 4 marks Fully worked solutions and sample responses are available in your digital formats. 5.6 A market-based environmental strategy as an aggregate supply policy KEY KNOWLEDGE • one market-based environmental policy and its short-term and long-term effects on aggregate supply, intertemporal efficiency and living standards. Source: VCE Economics Study Design (2023 – 2027) extracts © VCAA; reproduced by permission Like it or not, we can’t escape the growing reality that there is a close link between the environment and living standards, both now and into the future! So far in this topic we have studied how aggregate supply policies can be used to make conditions more favourable for individuals and businesses producing goods and services, so they are more willing and able to lift output, increasing the potential, non-inflationary rate of economic, employment and income growth. This, in turn, creates conditions that are favourable for better living standards. However, it’s not just about using aggregate supply policies to grow the overall capacity or potential size of the economy. These policies also need to consider whether higher output, particularly of some types of goods, is sustainable. More specifically, whilst faster non-inflationary rates of growth in GDP may be economically sustainable right now, there is the still the nagging thought that all this is not environmentally sustainable so that future generations will not be able to enjoy the living standards we currently appreciate. So, when promoting better aggregate supply conditions, it is also vital that government policy makers, businesses and consumers take a far broader and longer term view of the concept of sustainability and consider the question of intertemporal efficiency in the use of resources — that is, where there is an appropriate and equitable balance between using Australian and global resources for immediate, as opposed to future use. So, in seeking to expand the economy’s capacity, attention must be paid to the type of goods and services produced and consumed, and how these are made. For environmental sustainability, the extra production andUNCORRECTED PAGE PROOFS consumption that we generally seek to encourage using aggregate supply policies, also need to minimise environmental harm. They need to avoid worsening market failure associated with the depletion of nonrenewable natural resources and the abuse of environmental or common access resources like the air we breathe, the water we drink, and the oceans we fish. Failure to act appropriately will cause worsening carbon emissions and climate change, undermining our material and non-material living standards.