2 July 2018

Silver lining in trade wars’ dark clouds

The following article first appeared in The Australian newspaper on 2 July 2018.

Australia could benefit from increased demand for its agricultural products, among others.

Trade tensions are on the rise, spooking markets in East and West. The surrounding uncertainties could darken the economic outlook. However, there could also be opportunities for Australia.

Uncertainty partly stems from not knowing how many policy adjustments will be made. A raft of measures have already been taken by the US, including the raising tariffs on solar panels, washing machines, steel and aluminium. Further tariff increases are set to come into effect for a range of US imports from China from 6 July. These measures have, in turn, led to reciprocal tariffs barriers  being raised in other countries, including in Europe and China.

Nonetheless, although there is considerable uncertainty, when summed together, the measures taken so far are not expected to have a significant impact on global growth. However, if further measures were taken and, in particular, if protectionist measures are ramped up in automotive trade, as the US Administration is currently exploring, the effect on global growth could be noticeably larger. This is partly because of the size global trade in automobiles and also the complexity of the supply changes for automotive parts, which often stretch across many countries.

Another key uncertainty is the effect that these measures may have on business confidence, which is very hard to quantify. Trade policy changes could easily delay businesses investment and hiring decisions.

Further escalation of a trade tensions would be a significant downside risk to global growth. For example, the IMF estimates that a 10% effective increase in import tariffs between the US and the rest of the world could lead to a fall in global trade of around 1% and knock 0.5% off global growth.

For Australia, what happens to global growth matters a great deal, given that the country has a highly open economy that tends to ride the global growth waves. The recent lift in global growth, which has supported commodity prices, has been a key driver of the pick-up in economic momentum that Australia is currently enjoying.

Clearly, if rising trade tensions were to completely derail global growth it would be hard to see Australia escaping without damage. However, it is also worth keeping in mind that in the absence of a significant effect on global growth, the shifting trade policy landscape could present also present Australia with opportunities.

First up, Australia only has a small overall trade exposure to the US, with only 4% of Australia's exports going directly to the US. Australia has also been exempted from the US tariffs on steel and aluminium.

The key for Australia is how China might be affected, given that 30% of Australia's exports go directly to China. On this, it is important to consider that the bulk of Australia exports to China are driven by China's domestic demand, rather than inputs into its manufactured exports.

Demand for Australia's iron ore, coking coal and base metal exports is mostly driven China's infrastructure and housing construction industries, as well as, increasingly, its Belt and Road initiative for supporting construction in other countries. Australia's exports of thermal coal and liquefied natural gas are driven by Asia's demand for energy, which is mostly for domestic use as rapid urbanisation continues.

China's growth has also already become much more driven by its domestic demand than by trade in recent years. HSBC's China economists estimate that 90% of China's growth has been domestically driven over the past three years. In addition, in response to slower growth in trade, history has also shown that China has a lot of policy levers to pull to support growth in domestic demand. This could also include bolstering its spending on Belt and Road initiatives thus supporting commodity demand.

Australia is also increasingly exporting services, such as education and tourism, to Asia, and China in particular.

If trade tensions rise between the US and China rise this could present Australia with an opportunity in this area. The four countries that are a large exporters of education services are the US, the UK, Canada and Australia. If, for example, fewer Chinese students were to choose to go to the US, Australia could become an increasingly attractive alternative. A part of the Australia's burgeoning tourism connections with China also reflects parents and other family members visiting Chinese international students while they study in Australia.

It is also worth keeping mind that even though services exports are a smaller share of the dollar value of Australian exports than commodity exports, they are a larger share of value-added. This is partly because international students that move to Australia spend on a range of goods and services, including housing, retail and personal services while the live here. Becoming an international student in Australia is also often a pathway to migration, which then boosts local population and economic growth.

Australia could also benefit from increased demand for its agricultural products if China seeks to diversify its purchase of agricultural products.

There are clearly risks to global and local growth from escalating trade wars. However, there are also likely to be some opportunities for Australia if businesses and policymakers are able to seize them. Perhaps a silver lining to a potential dark cloud.