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5.6 A market-based environmental strategy as an aggregate supply policy
Part 1- The quarterly contribution of immigration to the growth in Australia’s population size
140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 –20,000 –40,000 –60,000
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Jun-17 Jun-18 Jun-19 Jun-20 Jun-21 Total growth Natural increase Net ocerseas migration Source: Australian bureau of statistics, national, state and territory population june 2021 Part 2-How mostly younger immigrants should help to slow Australia’s ageing population and fill labour shortages 16 14 12
Thousands 10 8 4 2 0 0 10 20 30 40 50 60 70 80 90 100+ 2018-19 - Males 2018-19 - Females 2020-21 - Males 2020-21 - Females a. Estimates for 2020-21 are preliminary. see revision status on the methodology page. Source: Australian bureau of statistic, overseas migration 2020-21 financial year 60,000 56,083 50,000 50,083 40,000 Persons 30,000 22,214 20,000 16,169 13,665 10,000
Part 3-Most immigrant chose to locate in the major capital cities where there are often more job opportunities 6 UNCORRECTED PAGE PROOFS 0
Melbourne Sydney Perth Brisbane 2,368 2,113 132 Adelaide Canberra Hobart Darwin
Net overseas migration
a. Population estimates for 2019-20 are preliminary. Source: Regional population, 2019-20 Source: Australian bureau of statistics, migration, australia 2019-20 financial year
Skilled immigration has impacted the labour market by affecting the size and skills of the labour force, its productivity, and the participation rate.
Skilled immigrants have grown the size of the labour market The government’s encouragement of skilled immigration has greatly increased the size of Australia’s labour force (i.e. all those aged 15 and over, who are able and willing to work), reduced labour shortages, and increased the quality of our human capital resources. Without immigration policy, figure 5.18 shows that the overall size of Australia’s labour force (the total supply of labour) would have started to shrink from about 2011–12 onwards. This would have led to even worsening labour bottlenecks, especially skills shortages, leading to higher wage-cost pressures that would have reduced our international competitiveness. In turn, as a less favourable aggregate supply factor (and given our relatively slow growth in productivity), skills shortages would have limited the expansion of productive capacity, aggregate supply, and the potential level of economic, employment and income growth. FIGURE 5.18 How immigration has enabled Australia’s labour force size (millions) to keep growing, despite our ageing population and falling birth rate, thereby easing skills and other labour shortages. 1951 1961 1971 1981 1991 2001 2011 2021 2031 2041 2051 Continued migration No migration Year Labour force size (millions) 6 8 10 12 14 16 Source: © Australian Bureau of Statistics. On average, around 70 per cent of immigrants are classified as skilled. Figure 5.19 part 1 illustrates hypothetically, how the migration program has increased the supply of skilled labour, typically growing the size of the workforce by 100 000–120 000 each year (shown as the increase from S1 to S2). This helps to ease labour shortages. If we assume that nothing else changes (i.e. we make a ceteris paribus assumption), this will tend to slow the growth of wages for skilled workers (shown here as the drop from W1 to W2). In addition, immigrants 4 UNCORRECTED PAGE PROOFS tend to work longer hours and have higher levels of productivity than locals, contributing even more strongly boosting the supply of labour. As a more favourable aggregate supply factor, this should strengthen business expansion, productive capacity, and the potential non-inflationary rate of economic, employment, and income growth.
However of course, immigration doesn’t just grow the supply of labour and skills. Migrants are also consumers (e.g. of food, housing, clothing, education, health), boosting the demand for goods and services and hence also, increasing the demand for labour. Figure 5.19 part 2 assumes that there is no change in the supply of labour due to immigration, but that there is only an increase in labour demand (the rise from D1 to D2). In this case, immigration would put some upward pressure on wages (from W1 to W2) and tend to lower the unemployment rate.
FIGURE 5.19 Using demand–supply diagrams to show Australia’s market for skilled labour before and following immigration. S1 labour (before immigration) S2 labour (increase after immigration) Average wage ($)/hour D1 labour
Q1 Quantity of labour (Q)
W1 E1 W2 E2
Q2
Part 1: How skilled migration grows the supply of labour, eases labour shortages and slows wage costs The hypothetical effects of immigration on the overall supply of labour Part 2: How skilled immigration also increases the demand for labour, creating more jobs and higher wages The hypothetical effects of immigration on the derived demand for goods and services and labour
S1 Average wage ($)/hour E1 D2 for labour (increase after immigration)
E2 W2 W1 UNCORRECTED PAGE PROOFS
D1 for labour (before immigration)
Overall, while immigration has increased the supply of skilled workers in the labour market, it has also increased the demand for labour. In theory, whether immigration ultimately slows or accelerates wage-cost pressures over the short-term or longer term depends partly on whether the rise in the supply of skilled labour is greater or less than the rise in demand.
Labour productivity is an important driver of economic growth and higher real incomes. It is usually measured by GDP per hour worked and closely reflects the skills and levels of training gained through education. Most of the 100 000 to 120 000 immigrants entering each year on permanent visas, are classed as skilled. Indeed, figure 5.20 shows that on average, skilled immigrants have significantly higher levels of education across all age groups, than Australian-born residents. So, it is fair to suggest that the skilled immigration program has helped to increase the quality of Australia’s human capital. It strengthens labour productivity, slows wage costs, and improves business competitiveness and profits, expanding productive capacity, increasing Australia’s aggregate supply and boosting the non-inflationary rate of economic, employment and income growth. FIGURE 5.20 The higher proportion of overseas-born people with a degree or higher qualification by age and gender, relative to those people born in Australia. 10 20 30 40 50 60 15–24 25–34 35–44 45–54 55–64 65+ 15–24 25–34 35–44 45–54 55–64 65+ 15–24 25–34 35–44 45–54 55–64 65+ 15–24 25–34 35–44 45–54 55–64 65+ Male Female FemaleMale Australian born Overseas born Per cent The labour force participation rate The participation rate represents the proportion of the population aged 15 and over, that are in the labour force — either employed or unemployed. Relative to many countries, Australia’s participation rate at around 65–66 per cent is low. For instance, Switzerland’s rate is around 83 per cent, and Qatar and Sweden are at 88 and 89 per cent respectively. The problem with low participation rates is that they reduce the total supply of labour, and limit productive capacity and aggregate supply. What our skilled immigration program has done is to help lift our participation rate. One reason for the higher 90 per cent labour force participation rate amongst our skilled immigrants, is that over 80 per cent are aged less 0 UNCORRECTED PAGE PROOFS than 30 years, compared with an average of around 45 years for Australian-born individuals.
Another explanation is that with higher skill levels and an ability to fill labour shortages, these migrants can more readily gain employment, encouraging higher participation. In turn, this helps enhance Australia’s productive capacity, boost aggregate supply, and grow the potential level of economic, employment and income growth.
5.4.4 The impact of the skilled immigration program on productive capacity, aggregate supply, domestic macroeconomic goals, international competitiveness, and living standards We have seen that the Australian government’s policy of encouraging skilled immigration has many beneficial effects that help to make aggregate supply conditions more favourable for producers of goods and services, growing the economy’s productive capacity. For instance, the entry of skilled migrants has helped to slow the problem of our ageing population and has grown the supply of labour to help fill labour shortages by increasing productivity and the labour force participation rate. The AD–AS diagram shown in figure 5.21 can again be used to illustrate how skilled immigration can help to grow Australia’s labour resources and productive capacity, cause a rise in aggregate supply (notice the increase from AS1 to AS2), and boost the sustainable level of national output (the rise from GDP1 to GDP2). Potentially, this can help strengthen our domestic macroeconomic goals, international competitiveness and material living standards.
FIGURE 5.21 How the encouragement of skilled immigration can help to grow Australia’s level productive capacity, aggregate supply, potential GDP, and average material living standards. General price level (P) Real GDP/national output
GDP2
= increased sustainable rate of economic growth and employment after aggregate supply policies are used
GDP1
= original sustainable rate of economic growth and employment before aggregate supply policiesare used
P1
AD1 = ideal P2 level of spending
Cost inflation Low inflation / price stability AS2 = increased productive capacity following the introduction of successful aggregate supply policies involving skilled immigration
AS1
original productive capacity before aggregate supply policies are applied The impact of skilled immigration on international competitiveness International competitiveness is about local producers being able to sell their quality goods and services profitably at relatively low and attractive prices in various markets, against their foreign rivals. Amongst other things, our firms need access to a skilled and innovative work force to help lift labour productivity. In turn, this will help to hold down domestic labour or wage costs that are currently amongst the highest in the world. UNCORRECTED PAGE PROOFS In addition, immigration can also help local firms to gain greater economies of large-scale production, since it increases the population and size of their domestic market. Here, a firm’s average costs can be spread more thinly as output expands for a now bigger sized market. This means that firms can profitably sell at lower prices, making them more internationally competitive.
5.4.4 The impact of skilled immigration on domestic macroeconomic goals
The government attempts to achieve the ideal situation where there is domestic economic stability — that is, the simultaneous achievement of the goals of low inflation, a strong and sustainable rate of economic growth, and full employment.
Skilled immigration can slow inflation The goal of low inflation means keeping the rise in consumer prices to between 2–3 per cent a year. Assuming that over time, immigration adds more to the supply of labour relative to the demand for labour, our labour shortages (due to an ageing population) should be reduced, and wage costs kept lower than otherwise. The Productivity Commission projected that between 2014 and 2060, immigration may slow wage rises, possibly by 20 per cent, allowing local firms to profitably sell at lower prices.
Another way that skilled immigration of around 100 000–120 000 per year may help to slow cost inflation is that many Australian firms produce on a smaller scale, causing their average unit costs (such as product development, machinery and advertising) to be higher simply because these cannot be spread out more thinly over higher levels of output.
Even so, it is also possible that immigration could contribute to inflationary pressures in specific areas, if it adds to the demand for resources, goods and services, more than it adds to their supply. Here, for example, we might think of the considerable impact that immigration has had in pushing up property prices in our major cities and significantly reducing housing affordability for other Australians. In addition, the extra demand generated by immigration has probably contributed to the rising cost of utilities (electricity, gas, and water).
Skilled immigration can increase the non-inflationary rate of economic growth The government looks to achieve the goals of a strong and sustainable rate of economic growth — that is, the fastest rate of increase in GDP of perhaps around 3 per cent a year, that doesn’t accelerate inflation or undermine the achievement of other economic or environmental goals. Over recent decades, the trend rate of economic growth has been slowing, partly because of weaker productivity, skills shortages, an ageing population, and other structural constraints limiting the growth of the economy’s productive capacity. With this in mind, the encouragement of skilled immigration has helped to fill some of the skills shortages, boost productivity and grow the size of the domestic market so firms can gain better economies of large-scale production, all of which help to strengthen the non-inflationary rate of economic growth.
However, this still leaves unanswered the question about the environmental sustainability of potentially growing GDP at a faster rate. Some economists have drawn attention to the stresses resulting from our exceptionally rapid rate of population growth on water, land for housing, non-renewable natural resources, urban congestion, waste disposal and greenhouse gas emissions. Because skilled migrants alone add on average 100 000–120 000 people every year — equal to a mid-sized city — it accelerates environmental damage making the achievement of net emissions reductions to zero by 2050, even more challenging.
Skilled immigration can help create full employment The government tries to achieve the goal of full employment. This means the lowest rate of unemployment, perhaps around 4.0 to 4.5 per cent of the labour force, that doesn’t accelerate inflation (NAIRU). Although you may hear claims that immigration takes the jobs of locals, this is not likely to be the case with the skilled migration program, because these people often fill the jobs that can’t be covered locally.
Another reason is that by filling labour shortages, it reduces barriers and allows businesses to start up or expand. There is also less pressure on firms to relocate overseas in search of suitable staff. In addition, immigration policy may have helped to reduce our unemployment rate because migrants also become consumers of goods and services (food, housing, holidays, transport, and medicine), adding to aggregate demand, economic activity and the derived demand for labour. This would tend to reduce Australia’s level of cyclical unemployment.
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While there are many positive impacts of the skilled migration program on our living standards, there are also some negative effects:
The effects on material living standards:
Material living standards reflect real per capita GDP and incomes, and the quantity of goods and services consumed. As an aggregate supply policy, the encouragement of skilled immigration has mostly strengthened our economic wellbeing by making conditions more favourable for producers and creating a stronger domestic macroeconomic environment. For example: • It has eased labour shortages that otherwise would be a hurdle limiting business expansion and the growth of new industries that help to grow our productive capacity, and potential GDP, employment, and incomes. • It has helped to boost labour participation rates and productivity, expanding aggregate supply and the noninflationary rate of economic, employment and income growth • It has helped to keep wage costs lower than they otherwise would be, improving the real purchasing power of higher incomes. Economic modelling lends some support for the general economic benefits of immigration, although unfortunately, it fails to single out skilled immigration where benefits are likely to be considerably greater than those for all types of immigration. For example, the 2021 Intergenerational Report estimated that overall, immigration (including those with skills) would cause real GDP to be 4.7 per cent higher by 2060–61. In addition, the Productivity Commission’s 2016 report estimated that if there was ongoing immigration of all types between 2014 and 2060, this would cause Australia’s real GDP per capita to be only 5 per cent higher than having zero net migration: only $5100 per person. Furthermore, projections also show that by slowing ageing and creating a bigger economy, immigration can help strengthen the bottom line of the government’s budget by increasing tax revenue (a greater number of younger taxpayers) more than budget outlays (on the services needed for a bigger population). One offsetting factor on the material side is that the addition on average of 100 000–120 000 skilled migrants each year has contributed to reduced housing affordability, especially for young first-home buyers, by driving up the demand for property, relative to its supply. Additionally, by contributing to shortages in water and energy markets, it has put upward pressure on the cost of living, slowing the purchasing power of incomes and reducing consumption levels. The effects on non-material living standards: Non-material living standards relate to the average quality of everyday life for ordinary Australians — reflecting a host of influences which are often hard to measure. On the one hand, skilled immigration has made for a far more vibrant, creative, innovative, tolerant, rich, and interesting multicultural society, improving our wellbeing. However, there are also some non-material downsides. For instance, there is little doubt that by greatly increasing our population size, immigration has significantly added to work travel times and traffic congestion, reducing leisure and family time. Importantly too, measures show that overall, immigration has contributed to reduced social cohesion with some groups feeling alienated, unwanted, and unhappy.UNCORRECTED PAGE PROOFS 5.4.5 Weaknesses of the policy of encouraging skilled immigration
As we have just seen, skilled immigration as an aggregate supply policy is designed to make conditions more favourable. For example, it has grown the size, skills, and productivity of the labour force, eased labour
shortages and slowed wage costs, thereby growing the economy’s capacity. However, when the policy is used to promote domestic macroeconomic goals and improve living standards, it has some critics: 1. Not a permanent solution: Unless immigration rates keep on rising, it is not a permanent solution to the problems caused by skills shortages with Australia’s ageing population. Immigrants also get old! 2. Economic benefits are relatively small: Modelling presented in the 2021 Intergenerational Report forecast that immigration’s total addition to real GDP and incomes by 2060 was just 4.7 per cent. If correct, some would say that overall, the economic case for immigration is surprisingly weak! 3. Non-material trade-offs or costs: Despite its benefits, immigration undermines some aspects of nonmaterial living standards. For instance, it accelerates our environmental problems and resource depletion, adds to Australia’s greenhouse gas emissions, weakens social cohesion, worsens traffic congestion and overcrowding in capital cities, and reduces the amount of leisure time left to spend with family and friends. 4. Political constraints: While less applicable for the entry of skilled workers, immigration is a political issue because its benefits and costs are not shared evenly. This is likely to influence immigration levels and government policy decisions. Resourceseses Resources Weblink How immigration can help the economy 5.4 Activities
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Track your results and progress Find all this and MORE in jacPLUS 5.4 Quick quiz 5.4 Exercise 5.4 Exercise 1. Describe the key features of Australia’s policy of encouraging skilled immigration. 4 marks 2. Outline the main reasons why Australia needs a policy of encouraging skilled immigration. 2 marks 3. This question is about aspects of Australia’s policy of encouraging skilled immigration as an aggregate supply policy measure that is especially designed to affect the labour market. a. Explain how the Australian government’s skilled immigration policy can be regarded as an important aggregate supply policy that helps to boost Australia’s productive capacity and sustainable rate of economic growth. Use a fully labelled AD–AS diagram to illustrate hypothetically the before and after effects of increased immigration on the economy. 5 marks b. Explain how you would expect Australia’s skilled immigration policy to affect each of the following: i. the size of the population and labour force ii. labour productivity iii. the participation rate iv. the unemployment rate v. the demand for labour vi. the inflation rate UNCORRECTED PAGE PROOFS vii. non-material living standards. 14 marks
4. In 2021, the federal government’s last intergenerational Report was released. One of the challenges identified was that presented by an ageing population. i. Explain what is meant by an ageing population. 2 marks ii. Identify and outline two important economic problems that might be caused by Australia’s ageing population. 4 marks iii. Analyse how skilled immigration might be used to help reduce the impacts of an ageing Australian population. 3 marks 5. Identify and analyse two important effects of the government’s planned increase in the skilled immigration target from 2023–24 to 190 000 per year. 4 marks 6. Outline one important strength and one important weakness of using immigration policy to help promote the goal of a strong and sustainable economic growth. 4 marks
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KEY KNOWLEDGE • trade liberalisation and its short-term and long-term effects on Australia’s international competitiveness, the allocation of resources, aggregate supply, and the domestic macroeconomic goals and living standards.
Source: VCE Economics Study Design (2023–2027) extracts © VCAA; reproduced by permission Trade liberalisation is an aggregate supply policy of the Australian government. Over the last 50 years, this has involved gradually reducing the level of trade barriers that protect local industry from import competition. Trade liberalisation has comprised: • cutting tariffs or the indirect tax that makes imports more expensive for consumers in local markets • reducing subsidies or cash payments that help local firms cover their costs • removing quotas and other restrictions on the type and volume of imports allowed entry into the country • signing up many free trade agreements (FTAs) where there are no tariffs on trade between two countries (bi-lateral FTAs), and regional agreements (FTAs with groups or blocs of countries) • easing other restrictions. Effects of changes in Australia’s exchange rate Effects on the inflation rate Effects on the rate of economic growth Effects on the rate of unemployment Effects on living standards
Effects on the current account balance There are several ways that trade liberalisation as an aggregate supply policy, can help grow efficiency in the allocation of resources over time, and hence boost the economy’s productive capacity, international competitiveness, and the potential rate of economic growth. For example:UNCORRECTED PAGE PROOFS • Reducing protection from import competition encourages specialisation in those areas of production where our comparative cost advantage is greatest, or where the disadvantage is least. Growing efficiency and reducing costs improves our international competitiveness.
• Greater competition from overseas means that local firms are forced to restructure their operations and find ways to raise efficiency and cut their production costs, perhaps by using technology or equipment now imported more cheaply from abroad, so they become more internationally competitive. • Liberalising international trade grows the size of markets allowing local firms to gain more economies of large-scale production where lower unit costs help to strengthen our international competitiveness.
In the long-term, greater competition and efficiency in domestic markets should help boost productive capacity, and raise national output, employment and real average per capita incomes. This creates better domestic macroeconomic conditions, supporting higher living standards for Australians.
Most economists believe that trade liberalisation (i.e. the gradual reduction in the level of government protection of local industry from import competition), helps to increase efficiency in Australia’s use or allocation of resources. Greater efficiency is a good thing because more output can be gained from each input or unit of resources leading to higher real incomes. Of course, while there is agreement amongst most economists that over time, trade liberalisation is the way to go, few deny that this policy may create problems in the shorter term, especially the rise in structural unemployment associated with the closure of those local firms unable to cut their costs, grow efficiency and become more internationally competitive. 5.5.1 The Australian government’s policy of trade liberalisation Like most governments around the world, especially since the 1990s, the Australian government has gradually adopted the policy of trade liberalisation. Essentially, trade liberalisation involves progressively reducing the protection of local industry from import competition. This approach differs from the policy of free trade, which is the complete removal of all forms of government industry protection. UNCORRECTED PAGE PROOFS Figure 5.22 provides a snapshot of the key elements making up the government’s policy of trade liberalisation: • Part 1 reveals the dramatic reduction in general manufacturing tariff rate from around 36 per cent in 1970–71 to less than 0.7 per cent by 2020–21. At the same time the number of FTAs has grown rapidly from just one in 1983 with New Zealand, to a total of 17 in operation or signed up by January 2022.
• Part 2 shows the path towards reduced tariffs in specific Australian industries like white goods (i.e. fridges, washing machines), cars, clothing, and agriculture, so that by 2021, local producers did not depend heavily on tariff protection to survive. • Part 3 provides a timeline for the signing of our impressive array of bilateral and regional FTAs between the first one in 1983, up till the end of 2021.
FIGURE 5.22 Snapshot of the Australian government’s aggregate supply policy involving various aspects of trade liberalisation. Part 1-The development of the Australian government’s trade liberalisation policies involving cutting general tariff rates and signing more FTAs
Rate of tariff protection (percentage) and cumulative number of FTAs 5 10 15 20 25 30 35 40 1970-71 1980-81 1990-91 2000-01 2010-11 2020-21 2030-31 Cumulative number of free trade agreements* General rate of manufacturing tariffs (percentage)
Note: There were 15 FTAs operating in December-2021. However, there are 2 other FTAs- one with the UK that was signed in late 2021 (but awaits ratification by parliament in 2022), and the RCEP or
Regional Comprehensive Economic Partnership Agreement that came into force in January 2022. Part 2-The Australian government's reduction in tariff rates for specific
Effective rate of tariff protection (percentage) 0 20 40 60 80 100 120 140 160 180 1970-71 1980-81 1990-91 2000-01 2010-11 industries over the last 30-50 years 2020-21 2030-31
0 UNCORRECTED PAGE PROOFS
Passenger motor vehicles tariffs (%) Clothing apparel tariffs (%)
White goods Tariffs (%) Agricultural tariffs (%)
Sources: Data for parts 1 and 2 were derived from many sources including AGPS; Industry Commission; 2002 Trade Policy Review for Australia; Productivity Commission, Trade and Assistance Review 2019-20 and other years; DFAT; Budget Review 2006–07; Budget Papers 2008–09 to 2021-22 and other.
Part 3- The growth in the number of Australia’s bilateral and regional free trade agreements (by year entered into force)
Thailand Japan
China Hong Kong
Indonesia
New Zealand United States ASEAN Korea CPTPP Peru UKa
1983 2003 2005 2010 2015 2020 Singapore Chile Malaysia PACER Plus RCEPa Note: There were 15 FTAs operating in December-2021. Apart from all the bilateral trade agreements, there were also regional ones- the CPTPP is the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership, and PACER Plus, or the Pacific Agreement on Closer Economic Relations. In addition, the diagram shows that there were two other FTAs (shown in pink callouts)- that with the UK was signed in late 2021 (but has been awaiting ratification by parliament during 2022), and the RCEP or Regional Comprehensive Economic Partnership Agreement (that is scheduled to come into force in early 2022).
2021 Source: Above diagram from DFAT (2021) reproduced from the Australian government, Productivity Commission, Trade & Assistance Review 2019-20, Fig 3.7, P66, see https://www.pc.gov.au/research/ ongoing/trade-assistance/2019-20 So, let’s now drill down a little into the detail of the Australian government’s aggregate supply policy involving the liberalisation of international trade. Tariff cuts As mentioned, tariffs (also called import duties) represent an indirect tax levied on selected imported goods. In general, tariffs are added onto the price of imports to make them dearer or less attractive to local consumers than the local equivalent good. They limit foreign competition and restrict the total supply of goods sold in local markets, driving up consumer prices. ‘According to critics of agricultural protectionism, consumers and governments in rich countries have paid $350 billion per year supporting agriculture — enough to fly their 41 million dairy cows first class around the world one and a half times.’UNCORRECTED PAGE PROOFS
Source: World Trade Organization.
Because of this, economists mostly believe that high tariffs cause resources to be allocated inefficiently into industries where we have no comparative cost advantage. This type of protection weakens competition. It means that local firms can remain inefficient and uncompetitive, and yet still survive, while local households and
businesses must pay higher prices for these items, reducing their purchasing power and living standards. These costs tend to offset any possible short-term gains from keeping the tariffs, such as an increase in incomes and employment. Additionally, when one country raises its tariffs, this becomes a justification for other nations to retaliate and increase their protection (i.e. a trade war can develop). In turn, this reduces trade volumes, average real incomes, consumption and living standards.
In contrast to high levels of protection, the Australian government’s policy of trade liberalisation with its gradual reduction to near zero tariffs over the past 30–50 odd years (as shown in figure 5.22 on Pxxx), has helped to dramatically improve allocative, technical and dynamic efficiency. Importantly, tariff cuts encourage local firms to become more internationally competitive by forcing them to trim their costs and restructure production operations. Over time, this encourages the faster growth of Australia’s productive capacity, aggregate supply, average real incomes per capita, and hence, living standards.
Reduced net subsidies and other assistance to local producers Subsidies are government cash payments or tax concessions made to local producers and industries designed to help them cover some of their production costs. Using well-targeted industry subsidies can reduce market failure and help solve the underproduction of socially-beneficial goods and services. By increasing allocative efficiency, this can improve society’s general wellbeing. However, despite these exceptions, most economists believe that poorly targeted subsidies (especially permanent ones) can damage allocative efficiency. Unless managed carefully, they can cause resources to be misallocated into areas where local firms have no comparative cost advantage. This slows trade and adds to opportunity costs that reduce a nation’s productive capacity, potential output, employment and incomes, undermining society’s general wellbeing. So, as part of trade liberalisation policy designed to grow efficiency and aggregate supply, the Australian government has generally tried to reduce the value of subsidies to local firms. After a peak of $25 billion a year in 1970–71, there was an overall reduction to around $11 billion by 2020–21, but only if we exclude the dramatic increase during 2020–21–22 due to the introduction of temporary measures to support businesses and help avoid closures during the COVID-19 pandemic and ensuing lockdowns. Abolition of import quotas and licences Import quotas are designed to restrict the supply or quantity of specific types of overseas goods allowed into the country. They act to protect local businesses and limit foreign competition. To achieve a stated volume target, prospective importers must obtain a licence that gives them permission to bring in a certain maximum number of articles of a particular description. Quotas limited the total supply of particular goods in the market, driving up the prices that local firms can charge. They were commonplace in Australia during the 1970s and early 1980s, especially on cars, textiles, footwear, and clothing. However, with the adoption of trade liberalisation as an aggregate supply policy, import quotas were progressively abolished. The last one, applying to cheese, was terminated in 2000–01. Again, this demonstrated that the Australian government believes that, in the long-term, import quota removal and the adoption of freer trade will increase efficiency in resource allocation, boost productive capacity and sustainable economic growth, slow cost inflation and improve international competitiveness, and, ultimately, strengthen our living standards. The increased importance of free trade agreements The Australian government’s aggregate supply policy involving trade liberalisation, is based on the belief that efficiency is generally maximised when resources are allocated to industries where we have a comparative costUNCORRECTED PAGE PROOFS advantage. Over time, specialisation in production based on this principle will not only grow our productive capacity, aggregate supply and competitiveness, but it will also swell the value of international trade. So, with this in mind, the Australian government has been keen to develop export markets abroad by pushing the idea of reducing protectionism and signing many free trade agreements (FTAs). Australia has used its membership of various multinational trading groups (each involving many countries) such as the World Trade Organization
(WTO) to urge all countries to reduce trade barriers. Despite these efforts, progress has been slow due to significant opposition from interest groups.
Given this sluggish pace of multilateral trade reform, Australia has increasingly negotiated bilateral free trade agreements (FTAs) with two or more individual countries, as well as several regional agreements. These agreements reduce or, in most cases, abolish tariffs. For example, by early 2022, we had signed 17 FTAs with 16 operational: • Australia–New Zealand FTA (also known as Closer Economic Relations) commenced in 1983 • Australia–Singapore FTA in 2005 • Australia–Thailand FTA in 2005 • Australia–United States FTA in 2005 • Australia–Chile FTA in 2007 • ASEAN–Australia–New Zealand FTA in 2009 • Malaysia–Australia FTA in 2012 • Korea–Australia FTA in 2014 • Australia–Japan FTA in 2014 • China–Australia FTA in 2015 • Trans-Pacific Partnership (TPP) in 2018 • Australia–Hong Kong FTA in 2020 • Peru–Australia FTA in 2020 • Indonesia–Australia Comprehensive Economic Partnership Agreement in 2020 • The Pacific Agreement on Closer Economic Relations Plus (PACER Plus), in 2020 • Regional Comprehensive Economic Partnership Agreement (RCEP), starts from January 2022 • The Australia-United Kingdom Free Trade Agreement (A-UKFTA), signed December 2021 (but requires parliamentary approval).
FTAs like these have exposed local firms to more intense foreign competition, forcing them to specialise, become more cost efficient and improve their international competitiveness. Over time, these agreements have also helped Australian producers gain access to potentially huge export markets abroad, allowing them to extract greater economies of large-scale production, grow Australia’s share of export sales and incomes, and improve living standards. However, despite the potential benefits over the longer term, FTA’s can also have negative effects in the short-term. For instance, those local firms unable to reduce their costs and become internationally competitive, may be forced to close, leading to job losses.
Trade liberalisation has also necessitated changes to other government policies Trade liberalisation is regarded by economists as an important government aggregate supply-side policy designed to improve efficiency in the use of resources and grow Australia’s international competitiveness and living standards. However, as a direct consequence of adopting trade liberalisation and greater openness, the government has also been forced to adopt other productivity-promoting reforms including the following policy measures: • reforms involving greater deregulation of the labour market to improve productivity and keep wage costs lower • the development of a national competition policy requiring reforms designed to strengthen competition and efficiency of government businesses • taxation reforms, including the lowering of company and personal income tax rates to bolster incentives, profits and business expansion. These and other measures sought to strengthen Australia’s international competitiveness, level of domesticUNCORRECTED PAGE PROOFS economic stability, and general wellbeing. We will see that although trade liberalisation can sometimes have negative effects on some industries, particularly in the short-term, the benefits normally become more apparent over the longer term.
As an aggregate supply policy, trade liberalisation (i.e. lowering the level of protection by cutting tariffs, reducing subsidies, abolishing import quotas and negotiating FTAs) has been under way now for some decades. While reducing protection levels generates significant benefits, especially in the longer term, it can cause problems in the short-term. • Effects in the short-term: As trade barriers come down, imports become cheaper and more attractive to consumers. As a result, local firms that are unable to cut their costs and prices fast enough, find that their sales and profits decline. Some local firms may close — for instance, between 2010–20, some of those involved in the manufacture of cars, textiles, and clothing. Their poor competitiveness was not helped by
Australia’s high labour costs relative to low worker productivity. • Effects in the long-term: Despite short-term pain associated with reduced protectionism, gains surface more over the longer term. As summarised in figure 5.23, the hope is that in theory and in the long-term, these policy measures should help to strengthen Australia’s international competitiveness and living standards so that local firms can sell similar or better-quality goods or services at prices equal to or below that of their foreign rivals.
FIGURE 5.23 Over time, trade liberalisation can help to increase business efficiency, cut costs, and improve the international competitiveness of local firms so they can sell profitably at lower prices in local and foreign markets. Increasing competition from imports of goods and services Encouraging specialisation of their production in areas of comparative cost advantage Ability to sell exports at a lower, more competitive Gaining economies of large–scale production price through larger production volumes made that lower average unit costs possible by selling in massive export markets Restructuring operations, lift efficiency and cut Allowing them to sell at a lower, more competitive their production costs price Gaining access to the latest technology at the Increasing technical efficiency and helping them to lowest cost compete more effectively Encouraging firms to think creatively, provide better service and meet customers changing Helping to strengthen our international needs competitiveness
Forcing them to lower prices and improve quality and service Minimising opportunity costs and allowing them to sell their products more competitively at a lower price Overall, it is extremely difficult to measure the effectiveness of trade liberalisation policies on Australia’s international competitiveness. However, one thing that we do know is that Australia’s international competitiveness ranking has plunged over the past decade. In July 2009, one measure ranked our economy as 5th out of 64 nations, but by 2021, we had sunk to 22nd place. This might suggest that so far over the long-term,UNCORRECTED PAGE PROOFS the government’s policy of trade liberalisation (exposing local firms to stronger competition) has not been as successful domestically in strengthening our competitiveness, as it has been in some other countries. Potential investors also point to specific barriers like Australia’s higher rates of company tax, expensive wages, unreliable and costly infrastructure, expensive borrowing costs, and a weak R&D culture.
As an important government aggregate supply policy, trade liberalisation has helped to lift allocative, technical, and dynamic efficiency, grow Australia’s productive capacity, and increase AS. However, it has created winners and losers. Over the longer term, this policy has generally helped to promote the Australian governments three key domestic macroeconomic goals (i.e. low inflation, a strong and sustainable rate of economic growth, and full employment), even though in the short- to medium-term, there were some downsides. Effect of trade liberalisation on the achievement of low inflation The RBA’s goal of low inflation (keeping the average rise in price around 2–3 per cent per year over the business cycle) is one important domestic macroeconomic goal. Over time, trade liberalisation has increasingly helped to slow Australia’s rate of cost inflation. For example: • Trade liberalisation has led to specialisation in the production of those goods and services where we have a comparative cost advantage. This has caused resources to move into their most efficient use and out of areas of inefficiency and high costs. As a result of greater efficiency, inflation has slowed. • Trade liberalisation (especially FTAs) has grown our access to larger markets abroad, allowing local firms to gain greater economies of scale that cut their average unit costs of production. • Trade liberalisation has allowed local firms to have cheaper input costs. Without tariffs for instance, imported equipment and raw materials purchased overseas will be cheaper. Indeed, the Productivity Commission recently estimated that, despite huge reductions, tariffs still add over $7 billion annually to costs for local manufacturing and service businesses. Over time, reducing tariffs further should therefore ease inflationary pressures. • Trade liberalisation has forced local firms to restructure their operations more efficiently, cut production costs and apply the world’s best practices in their production processes. This has increased dynamic efficiency and also helped to reduce inflationary pressures. It is not surprising that since the start of significant trade liberalisation from the early 1990s, Australia’s average inflation rate has slowed dramatically to around 2 per cent over the last 30 odd years, compared with over 9 per cent during the previous 20 years (1970s–80s). This is shown in figure 5.24. FIGURE 5.24 The probable link between the Australian government’s policy of trade liberalisation and our lower inflation rate. 10 12 9.3 2.0 8 4 2 0 Average annual inflation rate (%) before significant trade libralisation Annual average inflation rate (percentage) Average annual inflation rate (%) since significant globalistation 6 UNCORRECTED PAGE PROOFS (1970–71/1989–90) (1990–91/2020–21) Period of time
Sources: © Reserve Bank of Australia, 2001–2021. All rights reserved. RBA Statistics, Occasional Paper 8A; ABS 5206.0 Table 34.
