Modelling has indicated that Australia’s economy could benefit slightly from the US tariff debacle, as long as it doesn't impose retaliatory tariffs of its own.

New Productivity Commission (PC) modelling has determined that US tariffs could have a small, positive effect on Australia’s economy, discounting the high uncertainty stoked by erratic global trade policy, which could pose risks to Australia’s growth.

“Australia’s prosperity has been built on free and open trade. The proposed tariffs are likely to have a relatively small direct effect on us, but the global uncertainty they’ve brought about could affect living standards in Australia and around the world,” PC deputy chair Dr Alex Robson said.

The report found that Australia would be best-placed to weather a global trade war by abolishing any existing tariffs, and continuing to lobby for free global trade.

“Further retaliatory escalation could spiral into a broader trade war, which would bring serious consequences for Australia and the world,” Robson said.

“Australia can promote long-term economic stability by continuing to talk the talk – and walk the walk – on free and open trade.”

While the volatility and unpredictability of US trade policy have negative implications for global investment, PC modelling indicated that Australia’s relatively low tariff rate means it could reap modest benefits from US tariff settings.

“Since the tariffs levied on Australia are low relative to other countries, the tariffs make US imports from Australia relatively cheaper. American consumers would shift their import demand from other countries toward Australia,” the report found.

“Additionally, lower US demand for other imports decreases the global price of imports from other countries, reducing the cost of imported inputs to Australian production.”

The report noted that high tariff rates would also likely cause an outflow of capital from the US and high-tariffed nations, directing more investment towards stable countries such as Australia.

Despite the relatively upbeat tariff outlook for Australia, the PC noted that their modelling excluded the effects of global economic uncertainty, which could drag Australia’s economy down.

“The speed and frequency of these changes, their varying scope and the range of justifications under emergency executive powers, contribute to a new environment where perceptions are that trade policies could change significantly, at any time and without warning,” the report warned.

In a high-uncertainty environment, firms often delay investment decisions, opting for a ‘wait and see’ approach to avoid making costly mistakes amid a rapidly changing trade environment. This acts as a brake on investment, dampening economic growth.

Furthermore, the PC did not model the impacts of tariffs being imposed on Australian sectors more exposed to the US market, such as pharmaceuticals.

On Wednesday (AEST), Trump flagged that the US could impose tariffs up to 200 per cent on pharmaceuticals, which would take a direct hit to Australia’s exports.

In assessing trade barriers, the PC also delved into Australia’s industry subsidies under the Future Made in Australia Act, which it warned could distort trade if not designed properly, albeit not as badly as retaliatory tariffs would.

“While well-designed industry policy can offer benefits, when poorly designed it can be costly for governments, act as a form of trade protection and distort the allocation of Australia’s resources,” commissioner Catherine de Fontenay said.

“This underscores the critical need for transparency, ongoing evaluation and review and clear exit strategies.”

Regardless, the FMIA could be an opportunity to address market failures, especially those relating to carbon emissions.

“[Well-designed industry policy] presents an opportunity to address persistent market failures, such as unpriced carbon externalities and innovation spillovers, thereby accelerating the transition to a net zero economy in the absence of economy-wide pricing mechanisms,” the report said.

In addressing climate-related market failures, the PC said that economy-wide market-based methods, such as a carbon price, would be economically preferable to industry subsidies.

“Market based approaches to emissions reductions create incentives for a broad range of businesses to support the ordering of emissions abatement and innovation activity in a way that gives scope for higher cost abatement to become less costly and drives productivity improvements over time,” the report noted.

It acknowledged that economy-wide pricing mechanisms such as a carbon tax may be “infeasible” for Australian policymakers to implement.

“In that case, industry policy like FMIA – if guided with disciplining frameworks – can, in principle, help correct these shortcomings and guide industry towards decarbonisation.”

The Productivity Commission indicated that Australia’s FMIA industry policy could deliver on its promises, but would have to be held accountable to ensure Australian taxpayers were getting value for money.

“Industry policy initiatives come with risks that require careful policy design and implementation,” the commission warned.

“Poorly designed industry policy can be costly for governments, act as a form of trade protection and distort the allocation of Australia’s resources towards activities that Australia is not best placed to undertake.”