Current account surplus swings back into view

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Australia currently has a current account deficit of approximately 4.2% of GDP in 2015. Michael Blythe, chief economist of Commonwealth Bank of Australia believes that Australia may reach a current account surplus in the coming year. Under the assumption that the government reaches their budget targets to return to a surplus, investment into mining decreases and the housing market does not continue to grow as quickly as it has previously, the savings/investment gap would decrease. Furthermore, substantial rises in resource export volumes have been scheduled for the next few years. If commodity prices stabilise, the trade deficit will shrink and can turn into a surplus. Chinese tourists visiting Australia have also contributed rising export inflows. Finally the net income deficit has shrunk which presents a real possibility that Australia may reach a current account surplus.

How does this relate to the HSC syllabus?

HSC Topic 2 – Australia’s Place in the Global Economy

  • Australia has a current account deficit which is mainly composed to a deficit in the net primary income account. The persistence of the current account deficit is mainly attributed to the large gap between savings and investment in Australia contributing to the net primary income deficit.
  • A current account surplus is anticipated as a result of an expectation that the deficit in the net primary income account will decrease and the balance of goods and service will experience a surplus.
  • The savings and investment gap is expected to decrease over the coming years as a result of:
    • Slowing growth of the housing market. The growth of the housing market saw households borrow more to finance the purchase of property in Australia and at the same time, save less. Therefore, Australia had a low household savings ratio. This means that if any investment was required, Australia would most likely not have enough domestic savings to fund the investment and must turn to international sources. These international borrowings appear as a credit on the capital and financial account when received but need to be repaid with interest which is a debit on the net primary income account. Slowing growth of the housing market means that households would likely be saving more and borrowing less to purchase property which increases the household savings ratio and increases the available domestic savings to finance investment.
    • Slowing growth of the mining sector. Since the mining sector is experienced less growth than previously observed, Australia is investing less money into mining businesses. This decreases investment required in the economy which helps to close the investment and savings gap.
    • The government achieves its budget surplus objectives. When the government has experiences a budget deficit, it needs to borrow to finance the shortfall. As a result, the government also needed to access private savings over the past few years. Since the government is perceived as safer (more creditworthy) than businesses, it is usually the first to access domestic savings which makes the pool of domestic savings smaller for businesses. This has meant that businesses turned to international sources of financing which needed to be repaid as debits on the net primary income account. Achieving a budget surplus would mean that the government would not need to use domestic savings and leave a wider pool of funds for investment by businesses.
  • The balance of goods and services was negative in 2015 as a result of falling commodity prices which meant that each unit of Australian commodity exports was sold for less revenue. This meant that the credits on the balance of goods and services was smaller.
  • The balance of goods and services is expected to improve:
    • There have been substantial increases in the volume demanded for Australia’s exports which have been locked in through contracts for the next few years (in particular LNG exports). Since export revenue = export quantity × export prices, credits on the balance of goods and services are expected to increase.
    • Assuming that prices do not decline any further, Australia may be able to earn more revenue for the same amount of exports provided.
    • There is been an inflow of Chinese tourists who typically spend more than other tourists. Since tourism is an export, spending by these Chinese tourists are recorded as a credit on the balance of goods and services.

Negative gearing: What is it and why does it matter?

The Labor government’s plan to limit negative gearing

As of late, there has been much debate surrounding Labor’s plan to limit negative gearing. More specifically, implementation of this plan means that negative gearing will only apply to new homes purchased after July 1 2017. The Turnbull government, on the other hand, has proposed a plan to cap income-tax deductions from negative gearing at $20 000 per year.

These proposals have been met with criticism since announced.

What is negative gearing?

To understand why this discussion has been taking place, we need to first understand what negative gearing is.

Negative gearing is a mechanism allows home owners to reduce their tax liabilities when their mortgage payments exceed the rent they receive from that property. Since the investor has more expenses (mortgage payments) than they have income (rent payments) from the property, this is recognised as a loss. Given that the government allows for tax credits on losses, a home owner can reduce the amount of tax payable on their income.

How does this relate to the HSC syllabus?

Arguments for negative gearing reforms:

  • Inequality of wealth: People who are able to afford to buy property and gain the benefits of negative gearing are usually those with higher income and wealth. As people with high income continue to buy property, property prices will increase as demand increases. Since lower income earners will struggle to buy property, there will be more dispersion in the wealth of high and low income earners, deepening the inequality of wealth in Australia (Preliminary Topic 6 – Government and the Economy; HSC Topic 3 – Economic Issues).
  • Inequality of income: Since lower income earners would find it more difficult to buy property as a result of higher property prices, low income earners would not be able to offset their income using negative gearing. Higher income earners, however, would be able to partially offset their tax liabilities which increases the inequality of income between low and high income earners (Preliminary Topic 6 – Government and the economy; HSC Topic 3 – Economic Issues).
    • Remember the difference between income and wealth. Income is a ‘flow concept’ which describes the money earned over a period of time, while wealth is a ‘stock concept’ which describes the value of assets held at a single point in time.
  • The government bears the cost of negative gearing. Modelling performed by the Parliamentary Budget Office shows that the plan to limit negative gearing will raise $7 billion a year. This will help contribute to the government’s objective to reach a budget surplus (Preliminary Topic 6 – Government and the Economy; HSC Topic 4 – Economic Policies and Management).
  • Since the negative gearing reforms would not apply to new property, there is likely to be an increase in construction of new homes. This is because there is a greater incentive to purchase new homes as opposed to existing homes, increase their demand. This would may lead to an increase in demand for raw materials to build houses such as bricks, concrete and plumbing services.
  • The increase in demand for raw materials for houses and construction related services may lead to a decrease in unemployment in this sector since labour is a derived demand (Preliminary Topic 4 – Labour Markets; HSC Topic 3 – Economic Issues). This effect would be increasingly relevant to remote areas where there is potential to build more property, reducing unemployment in those areas.
  • Movement towards more remote ‘fringe’ areas could see the people moving away more dense urban areas. This will allow for more population growth without overcrowding which will contribute to improving Australia’s quality of life (HSC Topic 1 – The Global Economy).

Arguments against negative gearing reforms:

  • Implementation of the negative gearing reforms will deter investment into the property market, especially for existing homes. The housing sector is currently contributing significantly to economic growth in Australia. Discouraging investment into the property sector will most likely cause investor confidence to plummet which can damage the valuation of Australia’s financial markets (Preliminary Topic 5 - Financial Markets).
  • Some investors buy property to improve them and then sell or rent them. Decreasing investment in existing property will decrease in demand for the same goods and services to repair existing properties. If the decrease in demand for bricks, concrete, plumbing services etc. to repair existing property is greater than the increase in demand for these goods to build new property, there will be an increase in the unemployment rate (Preliminary Topic 4 – Labour Markets; HSC Topic 3 – Economic Issues).
  • Since negative gearing will curb demand for property, property prices will decrease. While this may be beneficial for people buying homes, those who already own homes will experience a decrease in wealth as their property values decline (HSC Topic 3 – Economic Issues).

Further reading

How to fix negative gearing with less ‘political angst’ Tax reformers forget budget repair (Ross Gittins)

For: Negative gearing plan worth $7bn a year in a decade: Labor

Against: Labor negative gearing plans will send investors into a panic Home loan gurus John Symond and Mark Bouris slam negative gearing changes Labor’s negative gearing plan could hit margin lending Negative gearing plans: recipe for ‘substantial, prolonged’ home price falls

Unemployment climbs back to 6 per cent

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Australia’s unemployment rate has increased from 5.8% in December to 6% in January as jobs growth slowed while new people joined the labour force. The number of full time employees fell while the number of part time employees increased.

How does this relate to the HSC syllabus?

  • New people have joined the labour force which has seen the participation rate remain steady at 65.2% (Preliminary Topic 4 – Labour Markets; HSC Topic 3 – Economic Issues). Given that there are less jobs but the participation rate remains the same, unemployment has increased.
  • The growth of part-time hires and decrease of full time employees reflects Australia’s casualisation of labour trend (Preliminary Topic 4 – Labour Markets; HSC Topic 3 – Economic Issues).
  • It is argued that since the momentum in the labour market has been decreasing, the RBA may need to loosen monetary policy. Loosening monetary policy (decreasing the cash rate) will make it cheaper for businesses to borrow funds for investment, helping these businesses to grow and add to economic growth. Since labour is a derived demand, growth in these businesses will lead to an increase in demand for labour which will help to decrease the unemployment rate.

Road user charges to replace fuel taxes within 10 years

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The Australian Infrastructure Plan intends to change the way governments plan and fund infrastructure. It is projected that the reform could boost productivity and increase economic growth by nearly $3,000 per household by 2040. Implementation of the plan will see economic activity in smaller cities such as Adelaide and Hobart increase and quality of life increase for Australia as a whole.

Aspects of the reform include:

  • Incentives for skilled migrants to choose to live in smaller capital cities e.g. Adelaide and Hobart
  • Replacing vehicle and fuel taxes with road user charges
  • Increasing the charge for public transport
  • Privatisation of NBN
  • Improving freight infrastructure

How does this relate to the HSC syllabus?

  • The proposed plan is a form of microeconomic policy. Improvement in infrastructure will cause an increase in aggregate supply and boost efficiency as roads and freight infrastructure are improved to transport goods and services (HSC Topic 4 – Economic Policies and Management).
  • Privatisation of NBN would most likely make the service more efficient as it NBN operates more as a private business rather than a government entity (Preliminary Topic 6 – Government and the Economy). This would reduce costs for the business which may be passed onto consumers in the form of lower prices. Previous examples of privatised businesses that subsequently operated more efficiently are Australia Post, Sydney Water and Telstra.
  • Imposing road user charges and higher prices on public transport, however, will be met with opposition. Increased prices will contribute to increases in the cost of living in Australia. Due to the long impact lag of microeconomic policy, the benefits of the reform such as the $3000 cost savings may not be seen for years (in this case until 2040) (HSC Topic 4 – Economic Policies and Management).
  • Some road user charges are designed to discourage uses of certain classes of vehicles or fuel sources, the government decreases the negative externalities from using more highly polluting vehicles (Preliminary Topic 6 – Government and the Economy, HSC Topic 3 – Economic Issues).

Theresa Dang THERESA DANG

Theresa Dang is an economics mentor at Keystone Education. She attended Sydney Girls High and achieved an ATAR of 99.70 in 2012. She is now studying Commerce and Law at the University of Sydney. She has experience in a global technology firm and a mutual fund.

Gary Liang GARY LIANG

Gary Liang is the founder and director of Keystone Education. He attended Sydney Boys High and achieved an ATAR of 99.95 in 2012. He achieved 5 state ranks in Mathematics, Mathematics Ext 1, Mathematics Ext 2, Chemistry and Economics. He is now studying Economics and Science (Advanced Mathematics) at the UNSW Australia, where he is the recipient of four scholarships.

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