Statement 4: Australia's Terms of Trade - Stronger and Less Volatile
Part V: Conclusions and policy implications
A strong and stable terms of trade assists in promoting efficient resource allocation and has a stabilising influence on the domestic economy. It also assists macroeconomic management by reducing inflationary pressures. Increases to the terms of trade raise domestic real income, the purchasing power of exports and domestic welfare.
The world relative price of tradeables is exogenous to Australia, fluctuating according to world demand and supply in an unpredictable fashion. But the composition of the export and import bundles - and hence the terms of trade - is reflective of history, comparative advantage, domestic economic efficiency and demand and supply of Australia's consumers and producers.
Ultimately the private sector determines the composition of exports and imports. While Governments can provide incentives and disincentives to particular production, history shows that the ability to pick products that have a high (and sustained) relative price is limited.
Microeconomic reform has promoted a large change in the dynamics of Australia's market economy, enhancing competition and productivity. Over the last decade, an increasing number of firms have been exposed to international competition. This provides incentives for those firms to operate efficiently, flexibly and to price competitively. In conjunction with enhanced technology - Australia being a relatively heavy exploiter of high technology - this has led to extraordinary productivity growth and rapid growth in per capita real income. This dynamic environment has led to changes in the composition of Australia's export and import baskets and in the range of countries with which Australia trades. The ability to switch between countries - sourcing imports and dispatching exports - is an important additional feature providing some protection from exposure to adverse developments in particular overseas markets.
Sound fiscal and monetary policies have also assisted in providing low and stable inflation, the management of which is aided by more stable terms of trade.
This combination of a more competitive, dynamic and flexible market economy with sound fiscal and monetary policy has assisted in reducing the volatility of the terms of trade. This, in turn, has led to a more stable economic growth path, with the volatility in Australia's GDP growth being much less in the past decade compared with previous decades.
The terms of trade is likely to be more stable in the future because of the diversification of Australia's trade baskets (across products and destinations), the improved insulation of the Australian economy from foreign economic events, and the generally more stable global economy. The increasing importance of ICT and other related products in Australia's imports basket is likely to provide continued strength to the level of Australia's terms of trade.
A key requirement for increased internationalisation is for Australia to maintain sound macroeconomic policies and to continue the pursuit of microeconomic reform. The promotion of research and development (through for example the Government's Backing Australia's Ability - An Innovation Action Plan for the Future), improving human capital through quality education, tax reform to reduce export costs, and further labour market reform are examples of sound policies. In addition to measures that reduce Australia's own business costs, the sponsorship of sound economic policies throughout the world adds a further dimension to terms of trade stability, and ultimately higher economic growth within and outside of Australia.
