AN ECONOMICS ESSAY ASSIGNMENT FROM UNIVERSITY OF NEW SOUTH WALES
Iron Ore Price Fall and Australian Government’s Policy Responses
1 INTRODUCTION
Iron ore is a specific type of raw material which is primarily used in the heavy industry. However, we’ve seen that its global price decline has severely affected the Australian economy as a whole. How does this happen?
There are many possible reasons why the price fell. They include oversupply issues, pressure from the share rout in China – and consequential overreaction from Australia, and others (The Sydney Morning Herald, 2015). This is a global phenomenon which Australia cannot be held responsible on itself, and thus, a proper macroeconomic policies by the government is essential. But what are they? What is proper? We need to look at the impacts this price fall has done to the economy in order to accurately analyse the existing and appropriate measures.
2 THE IMPACT OF PRICE DECLINE
2.1 ON AUSTRALIAN MACROECONOMICS FACTORS
One of the channels in which iron ore price decline affects Australia is through its terms-of-trade (TOT) (Reserve Bank of Australia, 2015). Defined as a nation’s ratio of export price to import price, TOT can be seen as how much import a nation can afford relative to its export. It was driven down by more than 50% from its peak in 2011, and 30% below the long term average (ABC News, 2016).
When Australian TOT falls, the economy is importing more than its exporting (in value), thus it will attack the Australian Dollar by putting a downward pressure on its exchange rate. This will have consequential effect, which will be discussed further in section 2.2 and 2.3. See Figure 1 in the appendix to see the decline in AUD/USD exchange rate.
Tax revenue is also hit by the price decline (The Australian Government Budget, 2016). With Australia as a major iron ore producer, this means its national income is more sensitive to the change of price. With mining contractors, mining businesses, and other companies in general experiencing a decline, their tax liability will also fall, and thus reducing government’s corporate tax income. Why this fact has come about will be discussed in the next section 2.2: on productions and businesses.
2.2 ON PRODUCTIONS AND BUSINESSES
Companies and businesses have been directly affected by the price decline, particularly in the mining sector. The most high profile case are IMX resources (The Australian, 2014) and BHP Billiton (The Australian, 2015).
Cairn Hills Iron Ore project in South Australia has ceased operation due to the price pressure, and IMX Resources’s operating company working on the mine, Termite Resources, has been placed under administration. Similarly, BHP Billiton cut 17,000 employees – which amounts to 14% of its workforce due to the iron ore price plummet.
Dividend cuts from the mining sector’s contraction is also an issue. Significant foreign investments in the Australian mining sector (Reserve Bank of Australia, 2015), requires much of the dividends to be paid in USD. However, as a result of AUD depreciation discussed in section 2.1., companies started to cut their dividends. This impacts not just the mining sector, but any company that has significant foreign investment in their shares. As a result, even common Australian citizens will feel the impact. This will be discussed in the next section 2.3: on households.
2.3 ON HOUSEHOLDS
The Macroeconomics impact discussed in section 2.1 and its consequence to businesses in section 2.2 trickled problems down to the household level through several channels. However, the most important ones are exchange rate, interest rate and dividend cuts.
Declining exchange rate affects household directly by attacking their capacity to purchase imported goods, invest in foreign assets, and visit overseas. Ceteris paribus, the amount of money they need to spend will increase – thus pressuring their living standard down.
Another channel of attack can come through their income in dividend cuts and interest rate cuts – a business and government response to the price shock. These will lower their income from both normal bank deposits and from investment in companies.
3 EXISTING POLICY RESPONSES
We’ve seen in Section 2 what the declining price has done to the Australian economy and its citizens. The government has responded accordingly to the shock, but just how appropriate are they?
3.1 MONETARY POLICY
The Reserve Bank of Australia’s swift response to the price decline is cutting the interest rate down (Reserve Bank of Australia, 2015). As seen from Figure 2 in the appendix, cash rate has been steadily cut down since 2012, and even more so since the downwards iron ore price shock. Indeed, this serves as a counter-measure to a contracting economy, but the impact to households has been severe, as discussed in section 2.3.
3.2 FISCAL POLICY
As discussed in section 2.1., the tax revenue Australia can collect has plummeted due to the iron ore price shock, particularly from Western Australia (Australian Financial Review, 2015). The resulting fiscal policy response is cutting benefits to household and increasing borrowings (Reserve Bank of Australia, 2015). Although indeed necessary, the resulting impact to household and national current account will be felt for years to come.
4 CONCLUSION
The Australian economy has suffered from the global price shock, and the government has responded accordingly. Their responses, however, has left households as the primary shock absorber – as discussed in Section 3.
In order to compensate for this in the future, the government must be forward-looking and gradually reintroduce household benefits. Measures should also be taken to stabilize the AUD exchange rate, as Section 2 and Section 3 showed how much households and businesses have suffered. This can be done by increasing national productivity through investment in technology.
Note that this is something to be done gradually, not overnight – for rushing in the short-term will only toy around with household and businesses expectations, which are too delicate and unreliable for us to tamper with – as we’ve seen in the Global Financial Crisis.
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