Deeper Dive: HSC Economics Topic 2 Australia's Place in the Global Economy

If you’ve just come off holidays thinking how boring the HSC Economics course is because your school started with Topic 1, I’m here to tell you that’s not gonna be the case for the rest of the year. When I was in year 12 I remember hating Topic 1 simply because of bland or ‘surface-level’ the content felt. I didn’t have any high hopes going into topic 2, but it ended up being my FAVOURITE one. The reason for this is because of how much more deep the content goes along with the fact that it links so much to current affairs.

Today I’ll be breaking down the Topic 2 syllabus so you know exactly what you need to know going into your next exam and the HSC Economics exam.

The main theme of topic 2 is how trade and financial flows (a core concept from Topic 1) relates to pretty much all parts of the Australian economy. The best part about this syllabus is that even though it’s split up into 3 sections, what you learn from one will significantly help you understand what’s going on in the rest.

Syllabus Outcomes for HSC Economics Topic 2

There are 2 main sections in any part of the HSC Economics syllabus, ‘students learn about:’ and ‘students learn to’. Every dot point under the first subtitle in the HSC Economics Syllabus denotes the actual content you should be comfortable with after completing Topic 2. The second subtitle is more useful when it comes to revision, and helps you understand what questions you need to be able to answer near exam time.

In this article, I’ll break down what you need to know for all the content dot points!

Australia’s Trade And Financial Flows

Value, composition and direction of Australia’s trade and financial flows

• Trends in Australia’s trade pattern
• Trends in financial flows - debt and equity

The general theme of this topic is trade and financial flows and how they relate to parts of Australia’s economy. The notes you should have for this section is relatively self explanatory; ensure you can EXPLAIN and ACCOUNT for historical & recent trends in the Australian economy:

• Value of Trade: HOW MUCH have we exported and imported over time?
• Composition of Trade: WHAT sort of goods and services do we export and import?
• Direction of Trade: WHO do we import from and export to?
• Value of Finance: HOW MUCH international borrowing and foreign investment have we undergone?
• Composition of Finance: WHAT is the relative proportion of debt (borrowing) to equity (investment) flows? Within investment, has direct or portfolio investment become more important?
• Direction of Finance: WHO do we undergo international borrowing and foreign investment with the most? And why?

Australia’s Balance of Payments

Structure

• Current Account, debits and credits
• Capital and Financial Account

Links between key Balance of Payments categories

Aceing the balance of payments in the HSC Economics course really comes down to using memorisation techniques that help you understand what’s going on a lot better. The first technique is to draw a diagram of every individual account in the Balance of Payments, which should end up looking something like this:

In this diagram, you should be able to identify examples of transactions for all individual components. Using acronyms and mnemonics can help you with these specifics! For example I like to use the DRIP acronym to remember what goes under the NPY [Net Primary Income] account:

• Dividends
• Rent
• Interest
• Profits

Once you’ve nailed the structure of the BOP, you’ll then need to understand the links between the main accounts. Here are the 2 main ones I suggest you focus on:

1. Why does the sum of all transactions in the BOP equal 0? I.e. CA + KAFA = 0 (Make sure to understand the purpose of net errors and omissions in your study!)
2. How does the double-entry system relate to the financial account and the net primary income account of the BOP?

Trends in the size and composition of Australia’s Balance of Payments:

• International competitiveness, terms of trade, international borrowing, foreign investment
• Effects of these trends on Australia’s Balance of Payments

A much more important part of the BOP is knowing how the Current Account and Capital & Financial Account fluctuate over time; and WHY that’s the case! Here are some important questions you should be asking yourself as a ‘checklist’ for this section:

• What are the recent trends in the Balance of Goods and Services (BOGS)? Why has the trend occurred? (HINT: you might want to link to international competitiveness or terms of trade)
• What are the recent trends in the Net Primary Income Account (NPY) and Capital and Financial Account (KAFA)? What has caused the trend to occur? (HINT: you might want to link to international borrowing, foreign investment, net foreign debt, net foreign equity and net foreign liabilities)
• What are the overall trends in the Current Account?

This is where you really need to know what’s going on in the Australian economy. If you’re a keen observer of the news, you would’ve read up on the RBA’s current cash rate of 0.1%, and how it’s been the topic of debate for a few months now. Having such a low cash rate means that foreign investors are unlikely to deposit their money in the Australian economy, which lowers the surplus on the KAFA and through the double-entry system reduces the deficit on the NPY. This has been one of many reasons for why the Current Account has remained in a persistent surplus since 2019 (after being in deficit for 44 straight years!).

To really smash this topic you need to be able to link events such as the RBA’s monetary policy stance to different parts of the BOP!

Exchange Rates

Measurement of relative exchange rates:

• To other individual currencies
• Trade Weighted Index

You’re probably wondering where exchange rates fit in Topic 2. Well…as we start to consider Australia’s relationship with the rest of the global economy, we need to understand that the currency used in Australia ($AUD) cannot be used really at all when you go overseas. This is where exchange rates come into play; we use them to convert our currency to foreign currency to engage in the flow of trade (buying/selling imports and exports) and finance (investment, borrowing, etc.) - Remember when everyone was buying US stock market shares in 2021? The Australians that did it had to use an exchange rate to do so!

The exchange rate you might’ve seen before looks something like this: $0.71USD/AUD. This is known as a bilateral exchange rate and gives a direct indication of how many foreign currency units can be purchased with ONE Australian dollar. However, this doesn’t really tell us much about how the Australian currency is performing. This is where the Trade Weighted Index comes into play! Here are some key questions you should be able to answer after learning about it:

• Why does the Trade Weighted Index (TWI) exist?

• How does the TWI work?

• Is the TWI or bilateral exchange rate more useful for an economist? And why?

• Will the TWI and bilateral exchange rate always move in the same direction? And if not, why?

• Factors affecting demand for and supply of Australian dollars

• Changes in exchange rates - appreciation/depreciation

The weird thing about exchange rates is that they fluctuate so much every day. If you’ve ever been overseas and are about to exchange your currency you’ll notice the number flickers every few minutes. This is because of real-time changes in supply and demand, which directly increase or decrease the exchange rate.

So, what do YOU need to know for this part? Changes to the demand for and supply of the AUD really boil down to how trade and financial flows change over time. Think about different reasons for WHY you think trade and finance interactions between Australia and the rest of the global economy have occurred! Here’s a good example:

• If you’ve been reading up on environmental issues, you’ll know that COP-26 has been a hot topic for a bit. With all the global pressure in pushing resource use to more sustainable means, Australia’s coal sector has experienced less demand. With less export income being earnt from coal exports, there has been lower demand for the $AUD (required to purchase coal), which has resulted in downward pressure (depreciation) on the $AUD.

Determination of exchange rates including fixed, flexible and managed rates

Although many of the exchange rates we see tend to fluctuate, a select few won’t. This is because each country or region may have it’s own exchange rate system. Fundamentally:

• Fixed exchange rates are CONSTANT
• Managed flexible exchange rates are CONSTANT within a RANGE
• Flexible exchange rates are VOLATILE

As you would’ve guessed Australia’s exchange rate is flexible, and therefore fluctuates a lot everyday! In addition to knowing HOW these systems work, it’s important to understand the pros and cons of each system.

The influence of the Reserve Bank of Australia on exchange rates

The volatility problem with Australia’s exchange rate directly creates a purpose for the Reserve Bank of Australia (RBA) to influence the $AUD to the economy’s advantage. You should be comfortable with the three main methods of intervention:

1. Direct Intervention (Dirtying the Float) - Essentially when the AUD undergoes a massive change in value, the RBA will step into the foreign exchange market as a buyer to ensure it doesn’t collapse (this happened during the GFC).
2. Indirect Intervention (Monetary Policy) - If the RBA makes any changes to the cash rate, it will impact the level of capital flows into Australia and consequently impact the exchange rate (the current 0.1% cash rate is a significant reason for why the $AUD is quite low at $0.71USD/1AUD)
3. Jawboning - If the RBA doesn’t want to waste any resources, they can instead make an announcement about a potential change to the cash rate in the future, causing speculation (but never actually follow up on it!)

The effects of fluctuations in exchange rates on the Australian economy

Just like the Australian economy impacts the $AUD, the value of the exchange rate will impact certain sectors of the economy. There’s a lot of stuff to talk about here, but scaffolding your notes to focus on how a depreciation/appreciation impacts the following will help:

• Economic Growth
• Inflation
• Unemployment
• External Stability
• Foreign Debt
• Balance of Payments
• Structural Change

You could get asked to write an essay on just this dot point, so ensure your notes are stacked with relevant examples and statistics. Thankfully the RBA releases frequent economic snapshots providing information on the above indicators; just like the one below:

Free Trade And Protection

• Australia’s policies regarding free trade & protection

In the final section of topic 2, we narrow our focus on trade flows into the policies that can limit (protection) or increase (free trade) the international flow of goods and services.

Historically, Australia’s trade policies leaned more towards high levels of protection that made it a very closed off economy. If you’ve ever gone into a grocery store you might’ve noticed that imported agriculture (e.g. Kobe beef from Japan) tends to be super expensive - this is due to protection that Australia retains on agriculture. While most imports have become ‘protection-free’ over the years, Australia still retains barriers in key industries making imports very pricey and deterring us from purchasing them.

To ensure you can tick this dot point off your list, you need a thorough understanding of the trends in protection levels for Australia’s key industries (mining, manufacturing, consumer goods, services, etc.).

• Australia’s multilateral and bilateral free trade agreements - (overview of two examples of each type of agreement)

If you’ve been keeping up with Australia’s trade relations you probably have a really good idea of this dot point already. All you need is a few examples of trade agreements that Australia is involved in, and why they might be beneficial or detrimental to the economy. Here are a few you could consider researching:

• ChAFTA
• KAFTA
• JAEPA
• ANZCERTA
• CPTPP
• RCEP
• AANZFTA

The implications of Australia’s policies for individuals, firms and governments

Based on Australia’s stance of free trade and protection in each industry, you should be able to consider how these different groups are impacted. If you’re stuck on how each group is impacted consider the following:

Consumers

• How is their purchasing power impacted?
• How is consumer choice altered?
• How is employment affected?

Firms

• How is competition and productivity impacted?
• How are individual industries impacted differently?
• Does revenue increase or decrease?

Governments

• How is government taxation revenue impacted?
• How is government expenditure impacted?
• How is the overall budget balance impacted?
• Are economic objectives achieved more or less?

Implications for Australia of protectionist policies of other countries and trading blocs

Now you’ll just need to consider the other side of the story; how do global protection policies impact Australia? This part is actually quite topical, especially with rising levels of protection all over the globe. The most recent example being the tariffs China placed on a number of our exports in the past year, including wine which plummeted by 30% in the same time.

You can pretty much use the same questions above to scaffold your notes for this section. To start you off here are some global policies to consider:

• European Union Common Agricultural Policy
• US-China Trade War
• US Tariffs (Steel & Aluminum)
• China-Australia COVID-19 Trade Tensions
• Indian Tariffs (Lentils)

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