What you need to know

Globalisation is the growing integration of economies through trade in goods and services, flows of finance and investment, movement of people, and the spread of technology and ideas. It has been driven by falling transport and communication costs, the removal of trade barriers and the growth of transnational corporations. For Australia, a relatively small open economy, globalisation has meant cheaper imports, bigger markets for exports (especially minerals, energy, agriculture, education and tourism) and access to foreign capital, but also greater exposure to overseas shocks, structural change in industries that could not compete, and debate about inequality and environmental impacts.

Protection is any government policy that gives domestic producers an artificial advantage over imports. The main methods are tariffs (taxes on imports that raise their price), quotas (limits on the quantity imported), subsidies (payments to local producers that lower their costs), local content rules and various standards or regulations used as barriers. Arguments for protection include protecting infant industries, preventing dumping, saving jobs and defence self-sufficiency; the costs are higher prices for consumers, less efficient industries, retaliation and resources trapped in uncompetitive sectors. Since the 1980s Australia has reduced tariffs substantially and pursued free trade through the World Trade Organization (WTO), which sets and enforces trade rules, and through bilateral and regional free trade agreements. The International Monetary Fund (IMF) supports countries with balance of payments difficulties and the World Bank finances development projects.

The exchange rate is the price of one currency in terms of another. Australia has had a floating exchange rate since December 1983, so the value of the Australian dollar (AUD) is set by demand and supply in the foreign exchange market, with the RBA intervening only rarely. Demand for AUD comes from foreigners buying Australian exports, investing in Australia, tourists visiting, and speculators expecting the dollar to rise. Supply of AUD comes from Australians buying imports, investing overseas, travelling abroad and speculators expecting a fall. Key influences are therefore commodity prices, relative interest rates (a higher Australian cash rate attracts capital inflow), relative inflation, economic growth and confidence. An appreciation is a rise in the value of the dollar; a depreciation is a fall.

Australia's trade and financial links with the world are recorded in the balance of payments. The current account records trade in goods and services, primary income (such as interest and dividends paid overseas on foreign investment in Australia) and secondary income (transfers). The capital and financial account records investment flows and borrowing. The two accounts balance: a current account deficit is matched by net financial inflows. The terms of trade compares export and import prices: terms of trade index = export price index ÷ import price index × 100. If export prices rise to 110 while import prices fall to 88, the index is 110 ÷ 88 × 100 = 125, an improvement meaning each unit of exports now buys more imports. Commodity price booms lift Australia's terms of trade, national income and usually the dollar.

Check yourself

1. What is the difference between absolute advantage and comparative advantage?
2. Name two methods of protection and state which one raises government revenue.
3. AUD/JPY = 95. Convert A$400 to yen.
4. AUD/USD = 0.70. Convert US$700 to Australian dollars.
5. The Australian dollar depreciates. What happens to the price Australians pay for imported cars, and to inflation?
6. The export price index is 120 and the import price index is 100. Calculate the terms of trade index.

Answers: 1. Absolute advantage means producing more output per unit of resources; comparative advantage means producing at a lower opportunity cost, and it is comparative advantage that determines the gains from specialisation. 2. Tariffs, quotas, subsidies, local content rules (any two); a tariff raises government revenue. 3. 400 × 95 = ¥38,000. 4. 700 ÷ 0.70 = A$1,000. 5. Imported cars become dearer in Australian dollars, adding to (imported) inflation. 6. 120 ÷ 100 × 100 = 120.