Trade war threatens global economy

April 2018

Impact on Australia of a global trade war

By Josh Williamson

  • Global trade war risks are rising but can still be contained. The escalation of trade barriers by China raises the risk of a dangerous spiral of ever increasing retaliatory measures that potentially leads to a stagflationary outlook for the global economy.
  • However, our view is that there are sufficient checks and balances to contain the risks of a full blown trade war. Indeed, the real time response of financial markets to trade barriers, including sharp falls in global share prices provides a signal to governments to be wary of continuously escalating measures. The global economy also has good momentum, which for now limits the damage of trade restrictions.
  • OEDC modelling of a 10 per cent increase in tariffs by the US, China and EU. This results in a global GDP fall of 2 per cent from the baseline level after one year, moderating to a fall of 1.5 per cent after three years.
  • Outlook Economics used a large-scale structural macro-econometric model, AUS-M, to examine the impact on Australia of such a trade shock. The simulation showed Australian GDP 0.5 per cent lower after one year and 1.25 per cent lower after three years. These results are similar to reported separate modeling by Global Trade Analysis Project (GTAP) simulation. In AUS-M the inflation rate rises by 0.75 per cent after one year, but is 0.25 per cent below the baseline rate after three years. The unemployment rate rises by 0.25 per cent after one year to a maximum of 0.5 per cent higher after three years. Australia’s real exchange rate falls by 6 per cent after one year and remains 4 per cent lower permanently.
  • But Australia isn’t the worst affected country. GTAP modelling shows Australia fares relatively better than some other economies. In terms of the reduction in GDP China, Korea, Singapore, India and New Zealand experience larger declines. The relative impact on each country reflects the degree of global trade exposure, particularly integration in global supply chains and the ability of domestic demand to generate activity after the trade shock.

% of GDP

  • So while Australia is a medium-sized open economy, we aren’t as trade exposed as some other economies and have far less exposure to the US.

% of GDP

  • The Productivity Commission also looked at the consequences for Australia of a trade war including a 15 per cent increase in tariffs globally. The Commission found that in this pessimistic scenario economic activity would be more than 1 per cent lower, employment would be reduced by 100,000, and nearly 30 per cent of households would experience a fall in purchasing power of at least 4 per cent, with the median weekly income cut by about $A1500 a year.
  • Upside for trade. We believe the modelled results represent a worst case scenario for Australia because it’s based on a US, China and EU trade war. The current trade stand-off is largely between the US and China. Australia still has access to both markets and in March along with 10 other Asia-Pacific nations signed the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP). This covers 23 per cent of all Australian trade and follows the China-Australia Free Trade Agreement signed in 2015 and Korea-Australia FTA signed in 2014. The Regional Comprehensive Economic Partnership (RECP) between the 10 member states of the Association of Southeast Asian Nations is a further positive regional trade initiative with potential benefits for Australia.

Josh is a senior economist for Citi Research Australia

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