International Competition, Real Exchange Rates and Absolute Cost Advantage: An Empirical Investigation of the Australian Economy

Two dominant theories shape the prevailing approaches to international trade and the behavior of real exchange rates. The first is the Purchasing Power Parity theory, which serves as the foundational theoretical assumption for most models predicting the behavior of real exchange rates. The second is the theory of Comparative Advantage, which explains the dynamics and outcomes of international trade. Both theories are rooted in the quantity theory of money and suggest that economies engaging in international trade should tend to converge in terms of international competitiveness and to maintain a balanced external trade. However, economic reality often refutes this assumption, with some economies exhibiting persistent trade surpluses and others chronic trade deficits. This paper seeks to explain this phenomenon through the lens of classical political economy. It employs the classical approach to analyzing the behavior of real exchange rates and the theory of absolute cost advantage, which are grounded in the labor theory of value. Additionally, this approach is empirically examined in the context of the Australian economy, which has demonstrated remarkable performance in external trade in recent years. Finally, based on the preceding analysis, new, effective strategies for exchange rate and trade policy are proposed.