ECONOMIC ISSUES

Australia and the Looming Recession

Insights

What Has Happened?

The latest figures from the Australian Bureau of Statistics, have revealed that our GDP growth declined 0.3% in the March Quarter. This is the first fall since Cyclone Yasi and the Queensland Floods stagnated the economy in March 2011.  In addition to this, GDP per capita has also decreased in the past year, something we have not witnessed since the 2008-09 GFC. With the government predicting that the June Quarter will be considerably worse, Australia will inevitably suffer a technical recession (two consecutive quarters of negative growth).

Our failing economic fundamentals can be largely attributed to the widespread bushfires earlier this year and the COVID-19 pandemic, two crises that facilitated massive reductions to our national household consumption levels. Household consumption has fallen a significant 1.1% in the March Quarter, the largest drop since 1986. It is important to note that households make up roughly 56% of our entire economy. Thus when household consumption suffers, it is likely that our Aggregate Demand (AD = C + I + G + (X - M) and therefore economic growth are at significant risk. Even prior to the corona-virus, spending growth was at a historic low; quite shockingly it has now been 8 years since consumption levels have been above the long term average. Despite our recessive state, Australia’s economic fundamentals compare fairly well relative to global economic standards, with negative growth of 9.8% in China, 5.3% in France, 2.2% in Germany, 2% in the UK and 1.3% in the United States. This is largely due to government expenditure adding 0.3% to GDP growth and (counter-intuitively) imports a substantial 1.3%. While imports actually reduce GDP as money is flowing out of the economy, in the March quarter imports FELL by a greater amount than exports, meaning it raised growth levels.

While government spending has assisted to somewhat stabilise the economy, in order to bounce back from what has been considered “the worst three month period since the 1930s”, there needs to be Aggregate-Supply based growth too. This stipulates a greater level of investment and microeconomic reform.


Syllabus Links

Overview of Economic growth

  • Economic growth refers to an increase in the real value of goods and services that an economy produces over a period of time
  • Measured by changes in Real GDP (the national output of goods and services adjusted for changes in prices over time)
  • Increase in the rate of economic growth provide the means by which a country can raise its level of income and material standard of living 

Aggregate Demand and its Components:

  • Aggregate Demand is a measure of the total level of expenditure in the economy. This is the sum of consumption (C), investment (I), Government Expenditure (G) and  Net Exports (X-M) 
  • AD = C + I + G + (X - M)
  • Aggregate Supply (Y) is a measure of the economy’s total productive capacity. 
  • Y = C + S + T 
  • Y = aggregate supply or national income 
  • C = consumer spending by households 
  • S = saving by households 
  • T = Taxation by government 
  • According to Keynesian economics, aggregate demand is the most important influence on the economy’s output in the short run



The Consumption Function 

  • C = Co + cY 
  • Y = national income 
  • C = Total consumption expenditure 
  • Co = autonomous consumption expenditure 
  • c = marginal propensity to consume  = Change in C/Change in Y 


Sources of economic growth in Australia


Consumption

  • Consumption makes up 60% of AD
  • Main source of economic growth 
  • Main factor is income: higher income allows households to purchase more goods and services. Also increases with the marginal propensity to consume. Factors affecting this:
  • Consumer Expectations: Consumers would spend more if prices are expected to rise, higher real incomes were expected, or they expected future shortage of goods
  • Level of interest rates: Higher interest rates increase the return on savings, thus reducing consumption 
  • Distribution of income: The more equitable the distribution of income, the higher the aggregate consumption and vice versa. This is because lower income earners have a higher average propensity to consume 
  • Level of taxation: Higher consumption taxes such as the GST will discourage consumption


Investment 

  • Investment is expenditure by firms on capital with aim of making profits 
  • Makes up around 20% of AD in Australia 
  • Influenced by:

Cost of capital equipment:

  • Interest rate: fall would make it cheaper to borrow and vice versa. Interest rates represent the opportunity cost of firms owning capital. 
  • Government policies: Related to investment allowances and tax concessions e.g. if businesses can claim higher rates of depreciation on capital equipment this would reduce tax liability and make capital cheaper
  • Price and productivity of labour: Labour is a substitute for capital. Higher wages result in firms using capital instead of labour, resulting in higher investment 

Business expectations:

  • Expected demand for products: Expected future increase would cause purchasing of capital to boost production and satisfy this demand. 
  • General economic outlook- if outlook was of strong economic growth, and prosperity, entrepreneurs would invest in capital equipment as they feel risks of expanding were declining. This is linked to Keynes 'accelerator effect’ - investment would encourage more investment. 
  • Inflation- causes uncertainty of future prices and costs production leading to reduced investment 
  • Level of business profits: Higher profits can be reinvested in capital equipment leading to higher investment


Government Expenditure:

  • Government expenditure (GE) refers to spending on current goods and services by the federal, state and local governments. GE makes up around 20-25% of AD in Australia 
  • Fiscal policy is used to maintain a strong and stable rate of economic growth 
  • GE is affected by automatic stabilisers, as well as discretionary fiscal policy 
  • Automatic stabilisers refer to components of the budget that change with the business cycle, having a counter-cyclical effect. Australia’s progressive income tax system will collect higher revenues during a period of higher economic growth, resulting in lower disposable incomes and lower consumption. A period of higher economic growth is associated with lower unemployment, resulting in lower expenditure on unemployment transfer payments. These automatic stabilisers would decrease AD during an economic boom and vice versa. 


Exports and Imports

  • They each make up around 20-25% of Aggregate Demand.

Influenced by:

  • Overseas and domestic income: Increasing overseas income causes a rise in exports. Increasing domestic income causes a rise in imports. 
  • Exchange rate: Weaker exchange rates means domestic industries are more competitive and products have greater appeal 
  • Consumer tastes and preferences 


Aggregate Supply

Improvements in efficiency and technology

  • Aggregate supply (AS) refers to total productive capacity of the economy; determines long term growth. 

High AS is acquired through:

  • Workers acquiring new skills and better education
  • Adoption of new technology 
  • Discovery of new resources- new mineral and metal deposits exploited to increase exports and increase economic growth 
  • Population growth- increase in population increases workers available 
  • Increased capital- Investment in capital equipment that efficiently replaces labour will increase capacity of firm to produce goods 
  • Government policies- removing rules and regulations in an industry may increase incentives for firms to be more efficient. Reduction in tariffs, corporate tax rate, relaxation of barriers to international investment. 

Three types of efficiencies to be gained from higher AS:

  • Technical efficiency- refers to firms producing output using least cost combination of resources i.e technical optimum
  • Allocative efficiency- resources are directed where they are most productive 
  • Dynamic efficiency- firms adapting to changing economic circumstances through adoption of latest cost reducing technology.

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