Tue Feb 4

Australia won’t escape the fallout of the Trump trade chaos

Written by Scott French, Senior Lecturer in Economics, UNSW Sydney

In a hectic 24 hours of trade diplomacy, US President Donald Trump has paused his threatened 25% tariffs on US imports from Canada and Mexico,^[1] while keeping 10% tariffs on imports from China.

Australian companies with operations in Canada or Mexico such as Rio Tinto, whose Canadian operations export billions of dollars of aluminium to the US ^[2], have won a temporary reprieve. But the risk of weaker economic growth in China will weigh heavily on companies that export to our largest trading partner.

And Trump has hinted all US imports of aluminium and copper ^[3], including from Australia, may be his next target.

The Treasurer Jim Chalmers said on Tuesday that although Australia is not immune when there are escalating trade tensions, “we are pretty well-placed to navigate them.”^[4]

However, even if Australia manages to stay out of Trump’s sights, Australians cannot expect to come out of a trade war unscathed. Due to the complexity of global supply chains, it is difficult to predict exactly how Australia would be affected, but here are a few key factors that would likely come into play.

Our largest trading partner

About 40% of Australia’s exports go to China, making it the biggest destination by far, according to data for 2023 from UN Comtrade ^[5]. Most of this is Australian iron ore and other minerals that are used in China’s construction and manufacturing sectors.

If Trump’s tariffs further slow the already sluggish ^[6] Chinese economy, this will reduce demand for the goods it buys from Australia.

If China’s demand for iron ore falls significantly, this will not only hurt the Australian mining sector, but it could trigger a fall in the Australian dollar, making the things Australians buy from abroad more expensive.

But the size of the impact of the latest tariffs on China remains to be seen. China has already absorbed the tariffs from the first Trump administration, and the latest increase is much smaller than the 60% tariff he previously proposed ^[7].

Trade diversion

The one positive effect for Australia of US tariffs on other countries is that, because they raise the price of other countries’ exports to the US, they may make some Australian exports more competitive. This is something economists call trade diversion. For example, the tariffs on Canadian aluminium would have shifted US demand toward aluminium produced in Australia.

The tariffs on China will divert relatively little trade to Australia because there is not much overlap between the products China and Australia export to the US.

But China’s retaliatory tariffs could make a significant impact. China responded to the US tariffs imposed during Trump’s first term with tariffs on American wheat ^[8] and other agricultural products. A similar move this time could create an opening for Australian farmers to fill the gap.

But it is not all good news. The US exports diverted away from the Chinese market will also compete with Australian products in other countries. So, while Australian wheat may become more competitive in China, US wheat may displace Australia’s in the Philippines.

A weaker Aussie dollar?

Tariffs also tend to cause the currency of the country imposing them to rise because they reduce demand for goods denominated in foreign currencies.

The flip side is a weaker Australian dollar, which dropped to a five-year low ^[9] after the tariffs were flagged. The currency has now fallen nearly 10% since November.

Again, this raises the cost of imports to Australia, which could lift inflation.

Network disruption

If the tariffs on Canada and Mexico are confirmed in 30 days’ time, the greatest impact will be in the supply chain disruption they will cause.

Analyses of the tariffs Trump imposed on China in 2018 found most of the cost was borne by US businesses ^[10] that use imported inputs. But because North American production networks are so highly integrated, and have been for decades, the effect of tariffs on Canada and Mexico will be much more disruptive to all North American producers.

As economic networks expert Ben Golub explains ^[11], the concern is not just that auto prices will rise, but that if key parts of the production network fail, such as if small but important intermediate suppliers go out of business, the effects of the tariffs could cascade into major disruptions.

Eventually, businesses will develop alternative supply chains, but the short-run pain ^[12] could be considerable.

For Australians, this could mean higher prices and supply disruptions, not just for the products we buy from the US, but for anything that depends on a North American supplier at any stage in the production process.

We are still feeling the effects of the supply chain disruptions caused by COVID, including the jump in inflation in 2021 and 2022 and the subsequent high interest rates and global backlash against incumbent political parties ^[13]. That includes Donald Trump’s return to the Oval Office.

Similar disruptions may be in store if this skirmish becomes a major global trade war ^[14]. Even if Trump’s promised tariffs never actually materialise, we may still see the same effects on a smaller scale because the trade policy uncertainty ^[15] from just the threat of a trade war has similar effects on business activity as actual tariffs.

Whatever transpires, even if Australia can escape direct involvement in a trade war, it cannot escape the shockwaves that reverberate through the global economy. The question is whether it will be a ripple or a tsunami.