What are tariffs? And what does Trump’s plan mean for Australia?

Since Donald Trump’s election victory, there has been growing speculation about his tariff plans and what they could mean for the United States, Australia and the global economy.

The question ‘what is a tariff’ and the related ‘who pays it’ both saw a sharp increase in Google searches in the US in the days after the election.

Since then, Trump has announced intentions to place 25 per cent tariffs on Mexico and Canada, an additional 10 per cent tariffs for China, and has threatened a range of other countries with large increases.

Tariffs, simply put, are taxes on imports.

Wesley Widmaier is a Professor at the ANU Coral Bell School of Asia Pacific Affairs, with research interests in US politics and international political economy.

“Historically, tariffs are meant to provide a comparative advantage to domestic producers,” he says.

Widmaier explains that if, hypothetically, there were two cars – one from the US and the other from Canada and both were priced at $10,000 – a 100 per cent tariff would make the Canadian car more expensive and the American one cheaper by comparison.

“That’s what they’re meant to do,” he says.

“They can also be a source of industrial policy. Whether you’re going back to textiles in early 19th century America, through to  quantum or AI development today, tariffs may be used to provide insulation from competition in capturing the new commanding heights of the global economy.”

Who pays?

The question of who pays, then, may not be the only one to be asking. Comparative increases in the price of foreign imports for US consumers are an aim of the policies. But would tariffs spur on American industry and increase the number of jobs available?

Take car production in the US. Currently, the sector accounts for around three per cent of America’s gross domestic product (GDP) and directly employs 1.7 million people.

But the process for building an American car involves moving materials, parts and finished products across the border to Mexico at various points in its creation. The back and forth can be for efficiency reasons such as balancing low labour costs and the availability of specialist knowledge.

“If you’re protecting auto-manufacturers in the United States with a tariff, for example, cars go back and forth for production over the southern Mexican border five, six or seven times,” Widmaier says.

“You’re creating incentive to keep manufacturing on American soil, and you are creating an opportunity for more American jobs. But there can be negative ripple effects if producers seek to avoid tariffs by relocating more production to the Mexican side of the border.”

The US, in this scenario, is helped by the fact that trade represents a relatively low percentage of gross domestic product (GDP) – 27.04 per cent in 2022, compared to 48.08 per cent in Australia.

The likelihood of disaster depends on how other countries react to increases in US tariffs. If they respond with similar raises, the situation could devolve into trade wars.

“If it becomes a tit-for-tat dynamic where things start to spiral – where countries engage in beggar-thy-neighbour tariff increases to get advantage over one another – then global trade declines and global welfare declines,” Widmaier says.

“My sense is other countries have more to lose than the US, and they’re probably going to be more cautious.”

What does this mean for Australia?

While some countries might respond to tariffs with their own increases, others could attempt negotiations to exclude their key exports from import tax increases.

Widmaier suggests Trump’s 2.0 tariff plan could be a part of a negotiating ploy.

“Nixon did something similar back in 1971, he imposed an across-the-board 10 per cent tariff,” he says. “But this lasted only a little more than three months.”

Although a trade war situation would certainly hurt Australia, we have negotiated tariff carve outs before, ensuring the continuation of our usual exporting to the US in otherwise uncertain times.

In his first presidential term Trump announced a global tariff of 25 per cent on steel and 10 per cent on aluminium. After months of lobbying, Australia and Argentina achieved an exemption from tariffs – with the US instead placing quotas or volume limits on steel and aluminium imports.

For the rest of the world, the steel and aluminium tariffs were maintained, and later increased under the Biden administration.

On a phone call with Trump following his recent election win, Prime Minister Anthony Albanese observed it would be in Washington’s interest to “trade fairly” with Australia, pointing to America’s existing trade surplus – meaning that the US exports more in value to Australia than it imports.

America’s trade deficits and surpluses were often used by Trump to justify tariffs in his first term. It was also an argument reportedly used by former prime minister Malcolm Turnbull to support Australian exemptions to steel and aluminium tariff increases.

In the past, Trump has also conflated the defence spending of other nations – particularly European countries – with their trade relationships with the US. In an interview with Sky News on the Australia-US alliance, Defence Minister Richard Marles emphasised Australia’s record-spending on defence.

While we can learn from Trump’s past approach to tariffs, this doesn’t mean history will repeat itself.

Is this unprecedented?

Trump’s apparent penchant for import taxes is not unusual for a US President.

In the past, the US has used tariffs as both a protectionist policy for its burgeoning industry and as a form of tax revenue.

In the 1930s, following the stock market crash, the government introduced the Smoot-Hawley Tariff Act to protect American farmers, but instead prompted retaliatory tariffs from other countries, exacerbating the impacts of the Great Depression. Lowering tariffs in favour of free trade became the norm after this.

“The conventional wisdom was that Smoot-Hawley and protectionism was a major cause of the Great Depression. Smoot-Hawley took the Great Crash – the stock market bubble bursting – and turned it into a global depression,” Widmaier says.

“When everyone else winds up raising their tariffs to limit their imports from abroad, you lower global trade, you lower output and you raise prices in some ways, because things become more expensive when you import.”

The post-war establishment of mechanisms such as the General Agreement on Tariffs and Trade successfully lowered tariffs on global manufacturing. Lower taxes on imports went on to create circumstances where Chinese manufacturing could thrive, and the narratives of discontent within Trump’s riled-up voting base could flourish.

“You can see the seeds of some of today’s problems,” Widmaier says.

“Since 1945, with all the imperfections, it has been a world of generally reducing tariffs and barriers to trade… With the beginning of the 21st century, China entered into the World Trade Organisation (WTO) – some call it the “China shock” – which saw a huge increase in low-cost manufacturing labour and Chinese exports. People say this led to a loss of between one and two million US jobs. The narrative is that this was a big factor in leading to the rise of Trump and global populism.”

While tariffs have long been a conventional tool for US presidents, Trump’s protectionism is still unusual in the way his rhetoric wields trade in an effort to manage issues such as immigration, crime and drugs.

“If you’d asked me why countries use tariffs, I would not have said to limit migration or imports of fentanyl, which is what Trump’s demanding from the Mexicans,” Widmaier says.

“Trump’s very aware of the importance of getting the narrative and capturing people’s imagination. So, it could be that he’s standing up, thumping the podium to get the headline but then backing away when no one’s paying attention.

“Trump has used this flexing of the threat of economic warfare and gotten some results in the past.”

And if the threat of across-the-board tariffs is a negotiating ploy, it will take careful manoeuvring from countries like Australia to ensure it doesn’t devolve into the worst-case scenario – inducing a protectionist trade war.