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PC News - August 2017

How should Australia respond to increased global protection?

Rising protectionism within the global economy threatens Australia’s economic wellbeing and future prosperity. A new Commission Research Paper examines the potential impacts on Australia of increased global protection, and outlines policy measures to minimise the impact of this dangerous new trend.

Over many decades, lower barriers to global trade and investment have helped increase growth and prosperity in Australia and elsewhere. However, these gains are at risk of reversing.

The use of tariffs and other protectionist measures has increased in G20 nations since the Global Financial Crisis, and there are clear signs that the protectionist trend could accelerate. US President Donald Trump was elected advocating a return to protectionist trade policies, and proponents of protectionism have been empowered in parts of Europe.

Rising protectionist sentiment elsewhere might lead some to call for a re-think of Australia’s commitment to free trade. The Commission’s analysis shows that this would be a mistake.

Figure 1: Tariffs have fallen markedly since the middle of the 20th century

  • Figure 1: Tariffs have fallen markedly since the middle of the 20th Century.
This figure is a bar chart showing the average tariff level in 1947 and 2011 for select countries. Most countries show a substantial decrease in the average tariff level; Australia’s average tariff decreases from 28 to 3 per cent.

Figure 2: G20 countries have been adopting new trade restrictive measures more quickly than they have been removing old ones

  • Figure 2: G20 countries have been adopting new trade restrictive measures more quickly than they have been removing old ones since October 2008.
This figure is a time series combined bar and line cart showing new G20 trade restrictions as a line, removed trade restrictions as a line and the stock of trade restrictions as bars from 2010 to 2016. The stock of G20 trade restrictions increases from 324 to 1263

    For data sources and notes for the two charts see Productivity Commission 2017, Rising Protectionism: Challenges, Threats and Opportunities for Australia

The Commission has assessed the potential impacts on Australia of significant international increases in protectionism, and the implications of such shifts for Australian policy settings. Key scenarios examined included the effects of:

  • higher US tariffs on imports from China and Mexico
  • introduction, in the US, of border adjustments to the corporate income tax base, whereby revenue from sales overseas would be untaxed and the cost of imported goods would no longer be deductible when calculating taxable income – equivalent to a subsidy for exports and a tax on imports
  • potential global contagion of higher trade barriers, where all countries raise tariffs by 15 percentage points
  • facing such global contagion, Australia:
    • unilaterally maintains current levels of protection
    • cooperates with a group of countries
      such as the Regional Comprehensive Economic Partnership (RCEP) comprising Australia, China, Japan, South Korea, India, New Zealand and the ASEAN countries – to maintain their existing levels of protection
    • joins with that grouping to further reduce trade barriers.

How did the Commission estimate the effects of increased protectionism?

  • Changes in protection affect trade in numerous and complex ways. Mapping these complex interactions is impossible without the aid of models that trace the various channels of impact. The Commission developed two models for its analysis.

    PC Global, which traces trade and capital flows between countries, was used to estimate the impacts on the Australian economy of a number of scenarios of changes in international trade policies.

    PC National was used to look at potential changes in the distribution of income in Australia resulting from global contagion of significant rises in protection. PC National recognises that while households benefit from trade, these benefits are not evenly distributed. For policy purposes, it is important to identify the types of households that bear the costs of trade – in the form of structural adjustment that leads to job losses, for example – so that governments can better design policies that lessen the disruptive impact of trade reform and spread the benefits more widely.

What does the modelling tell us?

The Commission’s key findings include:

  • A US trade war with China and Mexico would lower economic growth in all three countries, and particularly severely in Mexico, unleashing a reorganisation of world trade, but once the dust had settled economic activity in Australia would be little affected.
  • Uncertainty around what might eventuate from rising protectionist sentiment is likely to be impacting already on global trade and investment.
  • The adoption of US border adjustments could have material transitional costs for Australia and other trade partners of the United States, as markets responded to such measures. These disruptions could damage trade relations. However, in the long-term (and noting that exchange rates may not readily or fully adjust)  order adjustments as modelled would likely have little effect on Australia.
  • A repeat of a scenario akin to the experience of the 1930s – with trade barriers significantly higher around the world – would unleash economic  dislocation with the capacity to cause a global recession and put the rules-based global trading system under much strain. Australia wouldn’t escape unharmed.

Significant worldwide increases in protection would have the capacity to cause a global recession. The Commission’s modelling estimates that global trade would
fall by 22 per cent, and global output by nearly 3 per cent – the equivalent of more than a year of global growth at current rates.

Australia would not escape unscathed. Over one per cent of GDP every year and close to 100 000 jobs would be lost, and up to 5 per cent of our capital stock would be mothballed. Living standards would fall across the income distribution.

How would Australian households be affected?

Significant global increases in tariffs would cause lower living standards, on average, in every decile of the income distribution. Households on the median weekly income would face an income cut of about $1500 a year. But not all households would be affected equally.

The average falls mask considerable variation within income deciles. According to the Commission’s modelling, significantly increased global protection would result in lower living standards for nearly 80 per cent of Australian households.

The fall would be relatively small for some households, but nearly 30 per cent of households would experience a fall in purchasing power of at least 4 per cent. For example, a household that spends $2500 a fortnight on goods and services would be worse off by $100 a fortnight.

Figure 3: Global tariff increases would see Australian living standards fall in all income deciles

  • Percentage changes in purchasing power

    Figure 3: Global tariff increases would see average living standards fall in all deciles.  This figure is a bar chart which shows the percentage change in purchasing power by income decile. The first, second and third decile have a 0.3, 1.1 and 1.4 per cent decline each with the remaining deciles spread between a two and three per cent decline.

    Data source: Commission estimates generated using the PC Global and PC National models.

How should government respond?

Pursue further liberalisation

In the event of a global rise in protection, Australia is likely to face intense pressure to lift its own barriers to international trade and investment. The Commission’s analysis shows there would be no economic justification to join such a trade war.

Raising barriers would shrink economic activity and harm employment and  wages. The average Australian would be worse off.

Rather, Australia should continue to pursue freer markets and improve the functioning of the rules based international trading system by:

  • prioritising regional agreements that follow, or work directly towards, WTO ‘most favoured nation’ treatment (under which countries provide equal trade advantages to all their trading partners)
  • promoting the greater use of plurilateral sector specific agreements negotiated in the context of the World Trade Organization
  • pursuing only those trade agreements where there is a strong case that a clear net benefit to Australia will result
  • broadening negotiations over agreements to include parties capable of offering critical assessment, not just involving parties seeking an advantage or protecting a constituency
  • adopting better consultation processes in negotiating agreements, including widening the access of stakeholder groups to draft treaty text on a confidential basis during the negotiation
  • strengthening Australia’s reputation as an attractive destination for international investors through more consistent, transparent and predictable foreign  investment approval processes while preserving our vital national security interests.

To illustrate the potential effects of pursuing further trade liberalisation, the Commission modelled a scenario based on RCEP participants.

Relative to a scenario in which all countries significantly lifted barriers to trade, if RCEP members simply maintained tariffs at current levels in the face of rises
elsewhere, the Commission’s modelling shows that the negative impact on Australia’s income would be largely offset and the drop in living standards smaller by a factor of five. With liberalisation of tariffs, economic activity in Australia would be about 2.5 per cent higher (or more than a year of growth at current levels).

And benefits would be even larger if RCEP countries extended liberalisation efforts to non-tariff barriers and barriers to services trade. A household with the  median weekly gross income of about $1600 a week would be better off by about $44 a week.

Moreover substantial scope still exists to lower existing trade barriers. Estimates of non-tariff barriers and barriers to services trade, while hard to quantify, are typically large.

There is no reason why Australia could not proceed unilaterally. Lowering these barriers would not depend on our trading partners taking similar actions and the benefits would be predominantly and widely distributed across Australian households and businesses.

Enhance resilience and workforce adaptability to economic change

Governments should also pursue broader policies that strengthen the economy’s resilience and the workforce’s adaptability to changes taking place in the global economy, many of which are driven by new technologies. These companion policies can serve to lessen the disruptive impacts of change and create an environment that spreads the benefits of globalisation more widely.

They include education and training policies that aim to build solid foundation skills and enable participation in further training and reskilling for displaced workers; workforce policies that influence how readily firms can adjust the size and composition of their workforce; and macroeconomic stability.

Improve community understanding of the benefits of open markets

Governments need to better engage with the community about the case for free trade, and about policies aimed at managing the costs of adjustment and ensuring the benefits of liberalisation are shared more widely. Sharing better the benefits from persisting with open markets would help to build community
confidence in trade and foreign investment policies.

Figure 4: Removing tariffs and other barriers to trade would increase living standards in Australiaa,b

  • Percentage changes

    Figure 4: Removing tariffs and other barriers to trade would increase living standards in Australia. This figure is a bar chart showing percentage change in Australian economics activity, real income and purchasing power across modelled scenarios. Where Australia increases tariffs, all three measures decline by more than one per cent. When Australia does not increase tariffs, economic activity increases by 0.4 per cent where the other measures still decrease. When RCEP does not increase tariffs economic activity increases by 0.7 per cent and other measures only slightly decline. If RCEP abolishes tariffs, economic activity increases 1.3 per cent and other measures increase slightly. If RCEP abolishes tariffs and reduces NTBs all measures improve significantly.

    a This chart compares five scenarios – from left to right. In the first scenario, Australia, along with the rest of the world, raises tariffs by 15 percentage points.

    In the second scenario, Australia maintains existing tariff levels, while they rise by 15 percentage points overseas.

    In the third scenario, RCEP countries are assumed to maintain existing levels of protection, while all other countries raise tariffs by 15 percentage points.

    In the fourth scenario, RCEP countries are assumed to remove all tariffs applied to all nations.

    The fifth scenario includes all circumstances from the fourth but also decreases non-tariff barriers and regulatory barriers to service trade.

    b Economic activity is defined as real GDP, real income is defined as real GNP and purchasing power is defined as gross domestic absorption adjusted for terms of trade effects.

    Data source: Commission estimates generated using the PC Global model.

Rising Protectionism: Challenges, Threats and Opportunities for Australia

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