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Structural and Cyclical Reasons for Australia's CAD

Economics (Year 12) - Balance of Payments

Christian Bien

Structural Reason #1: Terms of Trade

Australia's terms of trade often determine the value of exports and imports. Terms are trade are just the ratio of export prices to import prices. If there is a fall in terms of trade, the trade balance of the current account will be positioned towards a deficit, increasing the overall current account deficit.

Structural Reason #2: Australia's International Competitiveness

Australia's relative international competitiveness determines it's the value of exports. If Australia is highly competitive, such as it has low inflation or lower cost of production, than demand for Australia's exports will increase, increasing the trade balance and lowering the overall current account deficit.

Structural Reason #3: Australia's Global Value Chains

Global value chains mean that components are sourced from around the world and assembled in a central location. If Australia participates in more global value chains, then it is producing more components to be exported, increasing export quantities and the trade balance and lowering the current account deficit.

Structural Reason #4: Income Deficit Associated with Foreign Liabilities

Australia's persistent reliance on foreign investment results in a gradual rise in the income deficit. While the income deficit generally increases during periods of high economic growth, the income deficit is mainly structural in nature as it does not drastically change as economic conditions change and are built up over a number of years.

Cyclical Reason #1: Domestic Economic Growth

A high rate of economic growth will increase the current account deficit as imports and income outflows will increase. Businesses will be more confident in the market, increasing purchases of imported capital to meet future demand while households who are more confident and earning higher incomes, will purchase more imported goods and services, such as overseas holidays. Income outflows will also increase as companies pay higher dividends to overseas stakeholders.

Cyclical Reason #2: Economic Growth of Trading Partners

The economic growth of trading partners determines the demand for Australia's exports. If there is a high rate of economic growth of trading partners, higher demand for Australian exports will increase prices and hence, increasing the value of exports, increasing the trade balance and reducing the current account deficit.

Cyclical Reason #3: Exchange Rate

The exchange rate often influences the value of exports and imports. An increase in the dollar will make exports less competitive and imports more competitive, resulting in a likely effect of decreasing export values as overseas buyers decrease demand and increasing import values as quantities increase from more competitive import prices.

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