Global trade risks and opportunities

Ian Zhou and Tessa Satherley, Economic Policy

Key issue

Australia is a small open economy heavily reliant on trade for its economic well-being. Volatility in global commodity prices, the international decarbonisation agenda, trade tensions with China, disruptions to global supply chains, and the return of economic nationalism present both risks and opportunities for the Australian economy.

The 47th Parliament may consider the adequacy of existing policies to manage these risks and opportunities.

Trade is central to the Australian economy, and Australian exports represent over 20% of gross domestic product (GDP). Approximately 65% of Australia’s two-way trade occurs with countries in Asia (see the article ‘Australia’s trade in figures’ elsewhere in this Briefing book). Australia’s top 5 two-way trading partners are China, the US, Japan, South Korea, and the UK, with more than half of Australia’s total exports flowing to China, Japan, and South Korea (p. 16). This article surveys some of the major upside and downside risks in those markets that may impact the Australian economy.

Volatility in commodity prices- upside and downside risks

Iron ore, coal, and natural gas are Australia’s top 3 exports. Some economists worry Australia’s export profile lacks diversity and sophistication, reflecting low ‘economic complexity’ and leaving the economy vulnerable to trade tensions with China, changes in Chinese domestic economic conditions, and swings in global commodity prices. However, Australia’s export profile often also has significant upsides for government budgets and economic growth.

Elevated commodity prices have contributed to Australia’s current account surplus for the past 2 years. Iron ore, coal, and natural gas exports contributed $154.4 billion, $63.5 billion, and $49.8 billion respectively to the nation’s export revenue in 2021. The 2022–23 Budget noted that commodity prices (particularly for iron ore and coal) at the time were at near-record levels, supporting strong profitability in the mining and agricultural sectors, with some positive flow-through to the broader economy and Australian Government revenue (p. 5).

Russia’s invasion of Ukraine has dealt a major shock to commodity markets. Russia is a major exporter of raw materials, including natural gas, coal, crude oil, and wheat. The war and associated economic sanctions have disrupted supply of these raw materials and pushed up their prices.

Australia is a major exporter of wheat, coal, and natural gas. Consequently, Australian exporters may benefit from these higher commodity prices (though domestic customers also pay a cost- see the article, ‘Coal, gas and decarbonisation- challenges and policy choices’, elsewhere in this Briefing book). However, Australia’s exporting facilities are already constrained and could face bottlenecks exporting larger volumes.

Experts are divided on whether commodity prices will remain at elevated levels. The Treasury has cautiously forecast that elevated prices are temporary and will decline from March to September 2022 (pp. 63–64).

The Treasury believes strict COVID-19 lockdowns and an economic slowdown in China will depress both demand for Australian goods and global commodity prices (p. 40). Despite the recent Evergrande debt crisis that threatened to bring down the Chinese construction sector, the Chinese Central Government continued an unrelenting regulatory agenda to reduce the high level of indebtedness among property developers. The resulting property sector slowdown, combined with the COVID-19 lockdowns, has depressed demand for Australian iron ore. China is by far Australia’s largest trading partner and accounted for approximately 82% of the total value of Australia’s iron ore exports in 2021. Emerging iron ore facilities in Africa could also add competition and further depress global iron ore prices over the long-term.

If the Treasury forecast regarding commodity prices is borne out, it will negatively impact on the Government’s bottom line, considering that the Australian Government and states and territories receive substantial resources royalties and have been recording windfall revenue gains.

Implications of the global decarbonisation agenda for Australian exports

Although the global commodities price shock is producing an unanticipated terms-of-trade and royalties windfall for Australia over the short term, International Energy Agency (IEA) head Dr Faith Birol has warned, ‘Nobody should imagine that Russia’s invasion can justify a wave of new large-scale fossil fuel infrastructure in a world that wants to limit global warming to 1.5 °C'.

Further, in addition to the impact on our domestic coal, gas, and electricity prices (as explained in ‘Coal, gas and decarbonisation- challenges and policy areas’ in this Briefing book), the current elevated prices make business more expensive for Australian coal and gas exporters’ main overseas customers: coal- and gas-fired electricity generators. It is possible that current high coal and gas prices may therefore trigger or accelerate Indo-Pacific economies’ moves to prioritise energy independence by developing their own fossil energy sources, or to shift to renewables, to the disadvantage of Australian coal and gas exports.

Long-term, global momentum towards decarbonisation has challenging implications for Australia’s current export profile. Australia exports 90% of its black coal production and 74% of its natural gas production. Most is bought by customers in Indo-Pacific countries, in particular Japan, China, South Korea, and India (see the article ‘Australia’s trade in figures’ elsewhere in this Briefing book). All have made significant commitments to reach net zero, including (most recently) India.

The roles of coal and gas in a global transition to net zero are contested. The Intergovernmental Panel on Climate Change (IPCC) has reported that approximately 30% of oil, 50% of gas, and 80% of global coal reserves can never be consumed if warming is to be limited to 2 °C (p. TS-53). The IEA’s Net zero by 2050 report envisages reductions of 90% in coal production, 75% in oil production, and 55% in natural gas production, and no new fossil fuel development beyond projects committed in 2021.

Consistent with these warnings, coal-fired power project cancellations in Asia have increased sharply- largely because of the need for international financing in an environment in which China, Japan, the US, and other members of the G7 have pledged to end financing for unabated coal-fired power projects. The World Bank claims it has made no new coal investments in over a decade and provided ‘zero’ fossil fuel financing in 2021, while the Asian Development Bank has announced a plan to help retire Asian coal-fired power stations early.

In March 2022, the Council of the European Union approved a proposal for a carbon border adjustment mechanism (CBAM). The CBAM, nicknamed a ‘carbon tariff’ by some Australian news outlets, will impose a carbon border levy on certain imports into the EU from ‘less climate-ambitious countries’. If legislated, the CBAM will likely affect Australia’s trade with the EU, particularly in coal, steel, and aluminium. The CBAM is expected to enter into force as early as 2023 in a transitional form, and the associated border levy may fully apply from 2026. In the US, the Biden administration is considering a similar mechanism.

Recent years have also seen increased global investment flows into renewable energy industries, in light of the declining cost competitiveness of coal and gas for electricity generation as the cost of renewables has plunged.

Against this international policy and global finance backdrop, some Australian economists warn of the potential for Australian job losses in fossil fuel-dependent, trade-exposed export industries if other nations continue to pursue their decarbonisation policies- even if Australia imposes no further emissions restrictions domestically.

While the global pursuit of decarbonisation carries obvious potential downsides for Australian coal and gas exports, as well as iron ore exports, it opens other opportunities- for example green steel (made using hydrogen rather than coking coal). Supporters of a pivot into clean energy-focused exports argue Australia has extensive renewable energy resources that could be exploited to help advance global decarbonisation. Furthermore, they argue that although job losses in fossil fuel industries are inevitable, the Government could implement policy measures to compensate those affected.

The Morrison Government made significant investments to begin positioning Australia to capture some of these global clean energy opportunities. It sought to nurture a local clean hydrogen industry under the National hydrogen strategy crafted in partnership with the states and territories, and to grow the critical minerals sector- which provides key inputs for electric vehicle batteries, solar panels, and other technologies- through the Critical Minerals Facilitation Office and Critical minerals strategy. Its National Manufacturing Priorities included ‘resources technology and critical minerals processing’ and ‘recycling and clean energy’ as sectors of strategic importance in which Australia has a comparative advantage.

In contrast, supporters of continued coal and natural gas production believe the fossil fuel industry will remain a significant contributor to the Australian economy well beyond 2030. They believe new coal-fired and gas-fired power plants that are under construction in Asia will create significant locked-in demand for Australian fossil fuels, notwithstanding trade partners’ commitments to reach net zero around mid-century. Fossil fuel export proponents have also argued that if Australia were to withdraw coal and natural gas exports from the Indo-Pacific market, customer countries would simply use more polluting alternatives (though opponents dispute these claims).

Some stakeholders also argue that advances in carbon capture and storage (CCS) technology will make coal ‘cleaner’ and hold the potential for zero-emissions gas-fired power. This could allow Australian fossil fuel industries to ‘have their cake and eat it too’; to profit from ongoing exports and address environmental concerns simultaneously.

The third working group of the IPCC (which focuses on emissions mitigation options) is likely to report that fossil fuels could play a role in climate change mitigation if strategically deployed with CCS, though most global fossil fuel reserves could still never be consumed, to limit their environmental impact (p. 6-45). A role for ‘blue hydrogen’- produced from natural gas via steam methane reforming coupled with CCS- is also contemplated in the Morrison Government’s 2020 and 2021 Low emissions technology statements and the National hydrogen strategy.

The 47th Parliament will need to balance competing domestic interests, while assessing whether fossil fuel export industries have a future in the Australian economy and, if so, what roles they should play (see ‘Coal, gas and decarbonisation- challenges and policy choices’ in this Briefing book).

Trade tensions with China

Despite China being Australia’s largest trading partner, trade tensions fuelled by geopolitical rivalry have threatened to derail the relationship. Over the past 3 years China has banned or increased tariffs on a wide range of Australian goods and services, while seeking alternative sources of iron ore and coal.

The Australian Government’s trade policy to date has been to avoid direct retaliation by encouraging exporters to pivot towards alternative markets and negotiating new free trade agreements (for example with India and the EU). In June 2022 Prime Minister Anthony Albanese declared that Indonesia is central to Australia’s trade diversification away from China, and called on Australian businesses to find opportunities in Indonesia.

A continuation of policy and financial support for domestic critical mineral and manufacturing projects will also serve to reduce Australia’s reliance on China. On the global stage, both Australia and China have initiated disputes (regarding anti‑dumping and countervailing duty measures) against each other at the World Trade Organization (WTO).

The deterioration of Sino-Australian trade relations underscores the fact that geopolitical rivalry can threaten trade and investment links. Put simply, China has used trade sanctions to ‘make an example of Australia’. As Australia becomes more involved in the AUKUS alliance and the Quadrilateral Security Dialogue, the Chinese leadership will almost certainly view Australia as a geopolitical opponent and be more inclined to use economic coercion.

Beijing has shown a pattern of targeting industries that could hurt Australia while causing minimal harm to itself. This poses risks for Australian industries that have historically been heavily dependent on the Chinese market, such as the international education and tourism sectors. Analysts warn a significant reduction in trade with China could result in a reduction in living standards for Australians.

In the 2021 parliamentary inquiry into diversifying Australia’s trade and investment profile, many stakeholders argued the Australian Government should do more to help exporters diversify, especially considering that alternative markets may not deliver the same scale of demand and premiums as the Chinese market.

Looking ahead, incoming Opposition Leader Peter Dutton has argued Australia should defend its liberal values and be prepared to confront Beijing militarily and economically over geopolitical issues, including the defence of Taiwan (officially known as the Republic of China). Australia’s trade relations with China will almost certainly deteriorate further if Australia intervenes in issues that Beijing considers to be its ‘core interests’.

Some stakeholders are hopeful the new Albanese Government will reset relations with Beijing. They believe China is ‘too big and too central to be ostracised’, and Australian policymakers can learn from countries such as Japan or Indonesia in terms of maintaining trade relations with China whilst negotiating over ideological differences. Others are less hopeful, believing a geopolitical showdown is probable or at least plausible, and that Australia should act now to reduce ties with China.

The 47th Parliament will need to balance Australia’s near-term economic interests with security concerns to weigh the best path forward.

Disruptions to global supply chains

Over the past several years, global supply chains have struggled to cope with COVID-19 lockdowns. Prior to the pandemic, global supply chains were generally constructed to maximise efficiency and profit by minimising or eliminating the storage of reserve inventory (known as ‘just-in-time’ inventory management).

Interruptions to the supply of critical intermediate and final products during COVID-19 have prompted public debate about the trade-off between efficient and resilient supply chains. For example, recent COVID-19 containment measures in Shanghai (home to the world’s largest container port) have exacerbated logistics bottlenecks as ships are delayed from unloading and picking up cargos, with flow-on effects across global markets.

China accounts for about 28% of Australia’s total imports, including many parts used in Australian manufacturing. The potential for further COVID‑19 outbreaks in China’s port cities means Australian businesses dependent on Chinese inputs risk longer delays and increased transportation costs.

Some parliamentarians have argued these disruptions to global supply chains highlight the need for Australia to pursue greater supply chain diversification and resilience, with a particular focus on reducing Australian dependence on Chinese inputs. Proposed solutions include ‘onshoring’ and ‘friendly-shoring’, in which businesses would swap ‘risky’ foreign suppliers for suppliers from Australia or allied countries, regardless of any cost disadvantage.

On the other hand, some economists warn that it would be tremendously difficult and expensive to reorganise global supply chains to bypass China, considering how deeply China is integrated in the global economy.

Some analysts have raised the prospect that global supply chains will split into 2 camps, ‘one for China and those associated with it, and another for the US and their friends’. In other words, supply chain disruptions and the US–China strategic rivalry could prompt a fragmentation of the global economy into rival trading blocs, as occurred during the Cold War.

The 47th Parliament will likely need to consider the efficiency versus resilience debate regarding global supply chains, and assess the benefits and costs of policy options for Australia to pursue greater self-sufficiency in its supply chain management.

De-globalisation and the rise of economic nationalism

A general trend towards de-globalisation and potential fragmentation of the current global trade system presents risks and opportunities for Australia.

Conceptually, globalisation encompasses declining barriers to trade, migration, capital flows, foreign direct investment, and technological transfers. De-globalisation refers to increasing barriers to these relatively free flows between countries.

The current global trade system is upheld by various multilateral institutions (for example the WTO) with the objectives of promoting rules-based free trade and economic engagement between countries. Since the end of the Cold War, the global trade system has enabled and facilitated a globalisation of the world economy underpinned by unprecedented free flows of goods and capital (and to a lesser extent, labour).

However, since the late 2000s there has been a notable worldwide backlash against globalisation and free trade, driven by the concerns of those who have been harmed or ‘left behind’. Widening inequality, job losses, and lack of opportunities for domestic workers are frequently raised as the negative consequences of globalisation. Internationally, the backlash manifested most directly in ‘Brexit’ and President Donald Trump’s 2016 electoral victory.

Many developing countries, such as India, have also embraced a self-sufficiency philosophy, becoming disillusioned with the trade and financial liberalisation policies of the ‘Washington Consensus’. Rising protectionism in India threatens to derail the Australia–India Comprehensive Economic Cooperation Agreement.

The COVID-19 pandemic and the war in Ukraine have exacerbated the de-globalisation trend. Countries have resorted to economic nationalism, enacting export restrictions in response to fears of an imminent global energy and food crisis. Trade facilitation tools, such as the international payment system SWIFT, have been ‘weaponised’ and used as a means of sanctioning Russia. Some economists warn that the global trade system could break down under the pressure, with some multilateral institutions supporting the system, including the WTO, already weakened by the unilateralism of the Trump administration and the ongoing Sino-American trade war.

Australia is also experiencing an undercurrent of economic nationalism fuelled by concerns over national security and Australia’s reliance on the Chinese market. Some parliamentarians have called on the Government to enact measures to protect domestic industries. Proposed measures include a ‘Buy Australian Act’, an export tax on iron ore, the expansion of subsidy programs for domestic manufacturers, and Australia’s withdrawal from multilateral institutions.

The call for more protectionist measures has been opposed by influential economists, who argue Australia stands to lose the most from a breakdown of the global trade system. Their reasoning is that economic nationalism in one country can trigger a rise in protectionism elsewhere, leading to a ‘beggar-thy-neighbour’ situation.

As a small open economy, Australia relies on foreign markets being receptive to Australian goods and services. Australia also relies on international trade rules to compete with larger countries on an equal footing. Consequently, advocates of free trade believe Australia should ‘step up’ to lead vital reforms in the WTO to strengthen the global trade system, rather than turning to protectionism.

Over the life of the 47th Parliament some key issues that may emerge for the Australian economy include:

how to operate in a less globalised and potentially fragmented trading world
how to manage the perceived and actual negative consequences of globalisation
whether there is an appetite to pursue and ratify further bilateral or multilateral free trade agreements.

Further reading

Department of Foreign Affairs and Trade, Trade and Investment at a Glance 2021, (Canberra: Department of Foreign Affairs and Trade, 2021).

Joint Standing Committee on Trade and Investment Growth, Pivot: Diversifying Australia’s Trade and Investment Profile (Canberra: Parliament of Australia, 2021).

Productivity Commission, Rising Protectionism: Challenges, Threats and Opportunities for Australia (Canberra: Productivity Commission, 2017).

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