| Supply Factor |
Theoretical Impact |
Evidence |
| Tariffs |
A tariff is a tax that is levied on an import. In theory, when tariffs fall it should make imports appear relatively more attractive in the short term. This may lead to an increase in the value of imports. The impact on exports is not as clear – a reduction in tariffs can make our trade policies appear more “fair” in the opinions of the international market, and as a result trade with Australia may be encouraged. It is likely that this impact will be a longer term phenomenon.
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Australian tariffs have remained relativey stable for an extended period, and as such it is difficult to assess the impact of a change. We can see that in the mid-1990s as tariffs were lowered the immediate impact was an increase in the CAD ratio. At this stage productivity gains have not been significant for those sectors that are still be protected by tariffs (for example, the automobile industry), and as a result any further reduction will almost certainly result in the loss of jobs. This fact is preventing the federal government from following through on its earlier promise to continue the tariff reduction program.
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| Interest Rates |
Interest rates represent a very significant cost of production. If interest rates fall, suppliers will be more able to produce their goods and services, and so aggregate supply may increase. If the local market has already been saturated then they will have to find a market in the international economy. Australia has excellent resources available to assist a business of any size to do just this. As a result, a fall in interest rates may lead to an increase in exports (especially when you consider that falling interest rates can also lead to a depreciating AUD).
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In 1999/2000 the cash rate was at 6%, and the CAD/GDP ratio was at -5.1%. In the following two years the cash rate was cut to 5% and then 4.5%, and the CAD/GDP ratio fell to -2.7% (the lowest for the period). At the same time the impact on the currency can be seen, as the TWI fell from 53.3 to 49.7.
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| Wages |
Like interest rates, wages represent a cost of production. Over the past 10 years Australian wages have increased every year. However, due to productivity gains real unit labour costs remained fairly stable until 2002/03. Stable wages over an extended period should allow for an improvement in our international competitiveness, and so our ability to export may improve. Higher wages would make it less likely that we will be able to sell our production on the interational market, and so our external stability might suffer.
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In the period prior to 2002/03, stable wages resulted in an improvement in the CAD/GDP ratio. In 1994/5 the CAD/GDP ratio peaked at -6%. The next cyclical peak came in 1998/9, at which time it reached a maximum of -5.7% of GDP. At the other end of the cycle, by 2000/2001 the CAD/GDP ratio fell to -2.7%. This is below the “normal” cyclical low of 3% that the Australian economy has previously experienced. (In 1995/6 the cyclical low was 3.3% of GDP.) Since 2002/03 however, the cycle has once again blown out. The CAD/GDP ratio increased to -6.5% of GDP. This was undoubtedly due, in part, to the increase in real wages experienced during this period.
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| Exchange Rate |
Once again, although the exchange rate is a separate measure of external stability it is also an important determinant of trends in the other factors. A depreciating exchange rate will mean that raw materials that are imported for use in production will be more expensive. This may lead to a fall in aggregate supply. We have already established that there may be an increase in demand when exchange rates fall – to satisfy this demand producers may rely in the short term on clearing existing stocks.
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In 2004/05 the TWI increased to 62.4. At the same time, the CAD/GDP ratio peaked at -6.5%. This suggests that at that time the supply side impact was strong, as producers were willing to import the raw materials necessary to manufacture the products necessary for export. With the increase in imports during this period, the CAD increased despite the booming prices on offer for Australia's exports.
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| Price of Raw Materials |
The price of raw materials will be affected by relative wage rates, interest rates and the exchange rate. When raw materials increase in price, suppliers will be reluctant to allocate resources to the production of this item. They may also pass on this cost increase in the form of higher prices. As a result, an increase in the cost of raw materials may lead to cost inflation, and a decrease in the international competitiveness of Australian businesses.
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Ironically, the largest increase in the price of raw materials (14.4% in 2000/2001) corresponds with the lowest result for the CAD/GDP ratio. This suggests that other factors were more predominant at this stage (such as the under-valued Australian dollar). In fact, the increase in the cost of raw materials can be attributed to the depreciation of the AUD and the introduction of the GST. As exports do not attract the GST, demand for these items was not affected. A more obvious link can be seen in the period 2004-2006. During this period the price of raw materials increased significantly, and the CAD/GDP ratio averaged around -6.0% as a result.
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| Rate of Company tax |
When the company tax rate falls, we would expect that enterprising people will be more likely to commence production, as the opportunity for them to retain the profit that they make is higher. They may then go on to produce a higher quantity, and due to the decrease in tax there will be no upward pressure on prices. Therefore, Australian businesses will have more to sell as exports, and our CAD should improve.
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After June 30th 2000, the company tax rate was lowered in two stages, from 36% to 30%. At the same time, the CAD/GDP ratio fell from a cyclical peak of 5.7% in 1998/9 to 2.7% in 2000/2001. The fall in the company tax rate may have played a small role in this fall.
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Unit 1
Unit 3
