Australia’s inconspicuous position in the US trade war
Further escalation of the US trade war seems inevitable, but Australia is in a good position to avoid tariffs, or minimize their economic impact.
US President Trump’s election campaign centred on import tariffs as a key plank of his economic policy, but for months the details were unclear. Last weekend we finally saw the US aiming its first shots in the trade war – at its closest neighbours, Canada and Mexico. They are to have a 25% tax imposed on their exports to the United States. Strategic rival China was also hit with 10–15% tariffs. While subsequent diplomatic efforts by the Mexican President and the Canadian Prime Minister secured a 30-day delay, expected to be used to flesh out further details of the economic deal with the US, further escalation of the US trade war seems inevitable.
Looking at how the US trade war might impact Australia, fortunately, we do not seem to be the US President’s target. And for good reasons. First, Australia runs a trade deficit with the United States, meaning that the United States exports significantly more to Australia than Australia exports to the United States. Second, Australia’s trade flows with the United States are very small in comparison to Canada, Mexico, China and the EU. Indeed, goods imports from the United States represent around 2% of Australian GDP, while goods exports are around 1% of GDP. Services trade flows between the two countries are worth around 0.5% of Australian GDP in each direction. These numbers would be orders of magnitude smaller when measured against the size of the US economy.
And third, the composition of Australia’s exports to the US is quite broad, which implies that there is no specific US industry that would strongly benefit from trade restrictions imposed on Australia. Interestingly, the biggest component of Australia’s exports to the US is agricultural products, mainly meat, which should be able to find other markets if needed. In contrast, iron ore, coal and LNG – the Big 3 Australian exports – comprise only a small share. Meanwhile, Australia’s imports from the United States are more concentrated in the category of machinery and transport equipment – it accounts for a half of the total goods inflow from the United States. So while it is not impossible to imagine the United States targeting Australian agricultural goods inflows in order to protect the US local produce, it would risk getting equivalent levies on their exports of cars, industrial machinery and electronics that are in total worth a few times more.
Unfortunately, this does not mean that Australia is immune to risks from the US trade war, even if its exports to the United States are not taxed directly. US tariffs will make their domestic production more expensive, and, as they pass on those costs to their exports, USD prices for the US-produced goods and services Australia imports will go up. All else equal, that could add further to prices here to the extent that there are not alternative sources of these items, including domestically.
The exchange rate response also matters. We have already seen that financial markets were bidding the USD higher in anticipation of the Trump’s victory in the US Presidential Elections and expectation of some steps against US major trading partners. This pushed the most currencies’ exchange rates against the USD lower, including the AUD. From its peak in late September/early October the AUD has lost around 10% of its value against the USD, and on a trade-weighted basis it was down 6.5% before recovering somewhat more recently. If a large-enough depreciation is sustained for a longer period, it can add to domestic inflationary pressures. And beyond the financial market impacts, higher economic uncertainty and weaker economic confidence in response to higher global trade tariffs might also prove to be a meaningful dampener of growth in Australia.
Looking more broadly, the main impact from rising tariffs on the Australian economy is likely to be indirect, i.e. from other countries hit by the US tariffs. A larger global economic slowdown would knock down Australian GDP growth. But looking at individual countries and our trade exposures at more granular level, Australia appears to be well positioned. Our exposures to the US though Canada and Mexico are small. Each represents less than 1% of our international trade in goods. For now, that leaves China as the main transmission channel. It is the number one destination for Australia’s exports receiving about a third of total Australian goods outflow.
Looking at the composition of that flow, iron ore accounts for around 60% of what we send to China. We highlighted previously that China reached peak levels of steel production around 2020–21, and since then it has been on a slight downward trend. A peaking in steel demand per person is a common pattern when countries reach the level of economic development that China has now reached. The slight downward trend mostly reflects structural factors relating to lower housing and infrastructure investment driven by falling population and lower income growth. In the trade war context that might be good news for us. Even if the US import tariffs slow the externally facing part of the Chinese economy materially, our key export flow mostly goes to domestic demand, including construction. While still on a gradually easing path, in line with the secular forces, this might be more resilient to conditions in China’s export sector.
Coal and LNG probably have more cyclical demand, as it drives generation of power needed for industrial production. But their shares in our exports to China are much smaller relative to iron ore. Japan is the top destination for these commodities, while India and South Korea are also significant. They are not fully immune to the US tariffs, nobody is in this day and age, given that they run trade surpluses with the US. However, it should be fair to say that they do not appear to be at the top of Trump’s list of target countries, suggesting that the risks to Australian exports they pose is also lower.
Finally, it is worth considering a scenario where Australia might be hit with import tariffs as part of a broader universal levy applied to all US imports. In a standard trade destruction/trade diversion framework, that should decrease total US imports, with production shifting onshore. The overall level of global trade would decrease, but some of the exports previously flowing into the US would find their way to other markets. This point is particularly relevant for Australia, given that most of its exports are commodities that can be readily redirected to markets elsewhere – though perhaps at a lower price. The impacts for more differentiated products such as specialist manufactured goods and for services are harder to assess. These would depend on how sensitive US domestic demand is to changes in import prices, and how readily these more differentiated exports can be redirected to other markets with different regulatory frameworks and consumer expectations. But given a relatively small share of these products, if we exclude more severe scenarios of a synchronized global slowdown, the overall hit to Australia’s GDP should be small.
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