The WTO has warned that the reduction in global trade could be bigger than that following the GFC in 2008 – see graph below. For countries to start reducing the volume of imports because export volumes have been decreasing is not seen as the right way forward. With countries dependent on the global supply chain for PPE and pharmaceuticals, it would be wrong to focus on being self-sufficient in these essential products.
As Martin Wolf of the FT pointed out the issue is not with trade but a lack of supply. Export restrictions merely relocate the shortages, by shifting them to countries with the least capacity. The natural response might be to become more self-sufficient in every product but free trade and globalisation does have its advantages:
The current account deficit narrowed over the year to March 2020, to $-8.4 billion (-2.7% of GDP) – see graph from ASB. This was expected especially as the fall in tourism was offset by the solid trade in goods. Tourist spending was down 8.3% whilst transport services declined by 9.4%. Travel spending overseas by New Zealander’s (imports) was down 9.7% for travel services and 5.1% for transport. The narrowing of the deficit often coincides with a downturn in the economy as there is weaker domestic demand for foreign products and services by consumers and the business sector. Covid-19 has magnified the downturn and there is more pain to come for the domestic economy. Below are some notes on the Balance of Payments which is part of NCEA Level 2 and CIE AS/A2 courses
Balance of Payments consists of 3 accounts – Current Account, Capital Account and Financial Account:
1. Current Account – this consist of 4 accounts:
Trade in Goods – also know as visibles. E.G. Manufactured goods, Semi-finished goods, energy products, raw material, consumer goods and capital goods. The difference between visible exports (+) and imports (-) is sometimes known as the ‘Balance of Trade’.
Trade in Services – Invisibles. E.G. Tourism, Banking, Shipping and Transport, Education, etc. The difference between invisible exports (+) and imports (-) is Balance on Services.
Net Income – measures two main flows of income into and out of NZ: the compensation of employess – wages and salaries and investment income – Interest Profits and Dividends coming into NZ from NZ assets owned overseas matched against the outflow of profits and other income from foreign owned assets located within NZ.
Net current transfers – relates to transfers of money between countries by central government and other economic agents. E.G. Germany is a net contributor to European Union (EU) Institutions. Other items include foreign aid, military grants and money transfers.
2. Capital Account – this account is of minor consequence relative to the NZ Balance of Payments as a whole. The transactions recorded here involve transfers of ownership of fixed assets and also migrants transfers. Funds brought into NZ by new immigrants are recorded as capital account credits, whilst any funds sent by NZ residents who are emigrating to other countries are debits in the capital account.
3. Financial Account – there are 2 main components of this account:
Direct Investment Flows – relates to FDI – Foreign Direct Investment. E.G. if Toyota invest money in a car plant in NZ this would be an inflow of direct investment. Similarly, when Carter Holt Harvey invest money overseas this will result in an outflow of direct investment from NZ.
Portfolio Investment Flows – consider the sale and purchase of NZ shares and government securities. E.G. when an overseas investor buys shares on the NZ stock market, there will be an inflow of portfolio investment. When overseas investor sell shares or securities, there is an outflow.
Balance of Payments and Current Account
In theory the BOP should always balance. The sum of the current account, capital account and financial account balances should be zero. In reality however, this is never the case as it is impossible to record accurately every single transaction that takes place. An additional item known as net errors or omissions, or balancing item, is added to the BOP to ensure that the accounts balance. You can see below that a further $2,600m is required to make the accounts balance – this is referred to as “Net errors and omissions”
Although a few years old now the video below is a good example of dumping – where the exporting country is able to lower its prices below that of the domestic price in the market it is selling into. Useful to show when teaching barriers to trade.
The U.S. spends approximately $37 billion dollars a year on foreign aid – just under 1% of our federal budget. “The Foreign Aid Paradox” zeroes in on food aid to Haiti and how it affects American farming and shipping interests as well as Haiti’s own agricultural markets. The fact that the US dump rice exports on the Haitian market below the equilibrium price severely affects the revenue of local farmers. Should there be a trade-not-aid strategy for developing countries? Below is a very good video from wetheeconomy
The trade-not-aid strategy is based on the idea that if developing countries were able to trade more freely with wealthy countries, they would have more reliable incomes and they would be much less dependent on external aid to carry out development projects. International trade would raise incomes and living standards as poor countries would be able to export their way to economic development by selling their products to rich countries eager to buy their goods.
Tourism accounts for approximately 10% of GDP but the forecast doesn’t look good even with the success of eliminating Covid-19. NZ growth totalled $40.9bn last year of which $16.2bn – 5.8% GDP – came from tourism – see graph below. Tourism also helped the retail and hospitality sectors to the tune of $11.2bn – 4% GDP. But there are a number industries which have been hit hard by the lack of tourism due to Covid-19. The food and beverage industry relies on tourism and it accounts for 24% of the total food and beverage serving services.
Of visitors to New Zealand the three main ones are:
Australia – 23%
Rest of Asia – 13%
New Zealand is more exposed to tourism than a lot of other countries; we rely more heavily on this sector for employment, income and GDP. In 2019, 229,566 people were directly employed in tourism (8.4% of the labour force). This is a significant portion of the labour market and is considerably higher than many other countries. It has estimated that 100,000 jobs could be lost in the tourism sector as a result COVID-19 – that is 40% of those employed in the sector. On 22nd April 2020 visitor numbers fell to zero – see graph below – as a result of the border closures. However the lockdown has given the tourism sector the chance to restructure the sector into a more sustainable model and be less reliant on overseas visitors. But the future is very fragile.
Arrivals to New Zealand
Source: ANZ Research – New Zealand Weekly Focus – 25th May 2020
As COVID-19 absorbs most of the headlines worldwide there are other concerns in the UK like Brexit. The farming industry has been impacted by both:
COVID-19 – shutdown of the service that serves the farming industry – 1/3 of the lamb market has gone.
Brexit – a deal needs to be negotiated with the EU.
Brexit and lamb exports to the EU – when the UK was part of the EU it was part of a custom union where there was no tariff between member states but there was a Common External Tariff (CET) which meant that countries outside the EU have to pay the same tariff when they export into any EU member state. For Britain leaving the EU without a deal has serious consequences for the farming sector. Over 90% of lamb exports in the UK have gone to the EU but with no longer being a member state the industry will no have to pay a CET which will undoubtedly make UK exports more expensive in the EU market. The FT visit a farm in Wales to look at the importance of the Brexit negotiations – a lamb is valued around £80 but if the EU charges the going rate of tariff between 40-80% that would bring up the price of lamb to between £112 – £144 in EU countries. This would make it very hard for farmers to remain financially viable. Furthermore it is not just the farming sector as the UK’s overall trade with the the EU is significant:
2018 – 45% of all UK exports go to the EU – $291bn 2018 – 53% of all UK imports from the EU – $357bn
The UK produces approximately 60% of what is required to feed its population with the remainder being imported. The UK’s £110bn-a-year agriculture and food sector is deeply integrated with Europe relying on the bloc for agricultural subsidies of £3.1bn ($4bn) under the CAP – Common Agricultural Policy (explained later in the post). The government has promised to pay the equivalent of the CAP subsidies up to 2022, no one is certain what will happen after that. There lies ahead some major challenges in the UK and not just for the farming sector. The video from the FT below is very useful for explaining the impact of trade barriers and CET.
What is CAP?
At the outset of the EU, one of the main objectives was the system of
intervention in agricultural markets and protection of the farming
sector has been known as the common agricultural policy – CAP. The CAP
was established under Article Thirty Nine of the Treaty of Rome, and its
objectives – the justification for the CAP – are as follows:
1. Raise and maintain farm incomes, through the establishment of high
prices for food. Such prices are often in excess of the free market
equilibrium. This necessarily means support buying of surpluses and
raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the
efficiency of all units. To reduce the number of farms and farmers
especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self
sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.
CAP Intervention Price
An intervention price is the price at which the CAP would be ready to
come into the market and to buy the surpluses, thus preventing the
price from falling below the intervention price. This is illustrated
below in Figure 1. Here the European supply of lamb drives the price
down to the equilibrium 0Pfm – the free market price, where supply and
demand curves intersect and quantity demanded and quantity supplied
equal 0Qm. However, the intervention price (0Pint) is located above the
equilibrium and it has the following effects:
1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the
horizontal distance AB which is the excess of supply above demand at the
3. In buying the surplus, the intervention agency incurs costs equal to
the area ABCD. It will then incur the cost of storing the surplus or of
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.
The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.
Throughout most of its four decades of existence, the CAP has had a
very poor public relations image. It is extremely unpopular among
consumers, and on a number of occasions it has all but bankrupted the
Below is a very good video from the FT outlining the latest disagreement between the USA and Saudi Arabia. Since 2017 both Saudi Arabia and Russia have been working together to prop up oil prices but have had a falling out over Saudi Arabia’s insistence on cutting oil supplies by 1.5 million barrels per day.
China the biggest importer of oil has cut back on oil consumption because of the coronavirus outbreak was bringing the economy to a standstill. Oil prices had their biggest one-day fall since the 1991 Gulf Crisis – some are expecting prices to go to $20 a barrel. What is at the heart of the fallout? Russia’s anger over sanctions targeted at its oil giant, Rosneft Trading. Washington imposed the sanctions last month over its continued support in selling Venezuela’s oil. Moscow was hoping to get Riyadh on its side to inflict economic pain on US shale producers, who Moscow feels have been getting a free ride on the back of OPEC+ production cuts. Shale production has pushed the United States into the number one spot as the world’s biggest producer of oil. Moscow hopes it could lead to the collapse of some of those businesses, if oil prices remain below $40 a barrel.
From The Economist YouTube channel – a good overview of the US China Trade War. After joining the WTO, China became an economic superpower. But people had expected the country to also become more like a Western capitalist economy. That didn’t happen. America now claims that China achieved its growth by not playing fair. Are those claims justified?
The Trump administration has been using tariffs or taxes on imported goods to try to force the Chinese to change their ways. In July 2018 America imposed tariffs of 25% on $34bn worth of Chinese products. That almost doubled the average tariff rate on Chinese imports from 3.8% to 6.7%. And it’s American firms that have to pay that tax. But with every increase from America, came an increase from China. Since the start of the trade war China has more than doubled its average tariff rate. America’s has tripled. The fight has become overtly political because China’s tariffs are hitting President Trump’s voter base. Many counties where Trump won in the 2016 election were here in the Great Plains and these are the counties most affected by China’s tariffs.
I have blogged quite a few times about the ‘Resource Curse’ but what about the ‘Trade Partner Curse’? New Zealand has been renowned for its primary exports but is it a concern that a third of every dollar earned in the primary sector comes from China. Dr Robert Hamlin (University of Otago) stated that based on experience no more than 20% of revenue should be earned from one source to ensure a buffer against changes in terms of trade and the economic conditions in the favoured country of destination.
Higher Terms of Trade – would be beneficial because the country needs fewer exports to buy a given number of imports. Lower Terms of Trade – country must export a greater number of units to purchase the same number of imports.
New Zealand which is traditionally dependant on primary exports usually faces instability which arises from inelastic and unstable global demand especially from China. By relying on the Chinese market, New Zealand exposes itself to greater risk of recessions in that market which may reduce in the demand for New Zealand products. Having numerous export markets means that there isn’t such exposure to economic volatility. Furthermore, countries that are commodity dependent or have a narrow export basket usually faces export instability which arises from inelastic and unstable global demand. The 2018-19 Ministry for Primary Industries’ Situation and Outlook report stated that from the year to June 2019 – total primary exports = $46.3bn but when you look at the breakdown from which country you get the worrying sign that more trade is going to China and less to other countries – essentially China is crowding out other markets:
China – $14.4bn Australia – $4.5bn USA – $4.2bn EU – $3.1bn Japan – $2.6bn
In 2017 China accounted for 24% of all New Zealand’s trade exports (see above). China also was the top export destination for New Zealand primary sector – 24% of primary sector exports went to China – by value: 25% of dairy, 43% of forestry, 31% of seafood and 21% of red meat.
China is taking a long-term approach to secure food supplies for its growing population by also buying NZ processing companies, giving it control of the supply chain. The reliance on China comes with risks that its economy remains strong. A downturn in their economy could have implications for New Zealand’s primary sector so it is important to have a diversified portfolio.
Below is a mindmap showing the causes and effects of a fall in the value of a currency. Also looks at how it improves the current account. Good for revision purposes when dealing with exchange rates and trade. Might be useful for the upcoming CIE exams. Adapted from CIE A Level Revision by Susan Grant.
Been doing some revision courses and today we looked at the TWI and floating exchange rates. The exchange rate measures the external value of the NZ$ in terms of how much of another currency it can buy. For example – how many pounds, US dollars or Euros you can buy with NZ$1000. The daily value is determined in the foreign exchange markets (FOREX) where billions of $s of currencies are traded every hour.
A large percentage of the dealing in currencies is purely speculative, that is to say, people trading dollars, yen, euros and sterling seeking to make a profit (or capital gain) from small fluctuations in currency values.
Trade Weighted Index (T.W.I.)
An index that measures the value of $NZ in relationship to a group (or “basket”) of other currencies. The currencies included are from NZ’s major export markets i.e. Australia, USA, Japan, Euro area, UK. – $A, $US, ¥, €, £. Each of the currencies included in the TWI is “weighted” according to how important exports to that country are (= % of total exports)
From the TWI we can see if the $NZ has appreciated or depreciated against our major trading partners currencies overall.
Free, Fluctuating, or Floating Exchange Rates In a free market the rate of exchange is determined by the market forces of supply and demand. Where these conditions apply the exchange rate is said to free, fluctuating or floating. Therefore the following have a great impact on the rate of exchange in a free market:
An increase in the demand for the $NZ will result from more people wanting get or buy $NZ.
Increase in the value of exports
Increase in tourists traveling to NZ
Increase in foreign investment in NZ (buying assets / companies / depositing savings)
Increase in NZer’s taking out loans overseas
An increase in the supply for the $NZ will result from more people wanting get or buy other currencies (as they have to supply $NZ to the market to get the other currencies)
Increase in the value of imports
Increase in NZer’s travelling to other countries
Increase in NZ investment overseas
Increase in NZer’s repaying loans made overseas
Other Factors Effecting $NZ with a Floating Exchange Rate
Relative Inflation Rates e.g. if NZ’s inflation rate is higher than other countries then the price NZ’s exports will become relatively more expensive and NZ will lose competitiveness and exports will fall.
Income of countries NZ trades with e.g. Australia is in a recession – NZ exports
Tastes and Preferences e.g. world news, current events, fashion, trends, popularity effecting NZ’s exports e.g. Sept 11th and an increase in tourists to NZ
Access to Overseas Market e.g. trade restrictions (protectionist policies e.g. tariff, quotas and regulations) placed on NZ exports by other countries governments.
Relative Interest Rates e.g. if interest rates in NZ are higher than in other countries, then this will attract people to save in NZ banks, creating demand for the $NZ.