Australia must keep its hands clean and walk the talk on free trade

18 March 2025 | Danielle Wood and Alex Robson

If there is one thing that almost all economists agree upon, it is that tariffs are a harmful form of taxation, hurting both the country that imposes them, as well as the countries whose imports they are imposed upon.

As taxes on imported goods, tariffs are paid mainly by those who buy imports – in other words, the average consumer.

Higher taxes on consumers may raise additional tax revenue, but only by raising the final prices that consumers pay – a puzzling idea during a cost-of-living crisis.

Higher prices may benefit certain local producers, by weakening the competition they face. However, they also tend to increase the prices of intermediate inputs. This hurts other local businesses – including exporters – as well as feeding indirectly into higher consumer prices.

Early modelling by the PC suggests that even the local producers who are meant to benefit in this way from the proposed US tariffs, stand to lose overall, as their exports become more expensive, and they lose market share overseas.

Overall, the costs that higher tariffs create greatly outweigh any benefits. And compared to other taxes, the net economic costs per dollar of revenue raised by higher tariffs tend to be very high.

Using these tools as a retaliatory response to the current environment risks being as much of a dead end as direct tariff increases.

And retaliatory tariff wars – like the ones we are now witnessing – can be even more economically damaging.

Beyond the direct costs of higher prices, trade wars greatly increase uncertainty for businesses and workers. This uncertainty risks spilling over into lower investment in both physical and human capital. In the long run, it risks lower living standards right across the world.

Australia has long known this wisdom. This is why – beginning with Gough Whitlam in the 1970s – we have spent many decades reducing our own tariffs.

Whitlam and his successors from both sides of politics knew that lower tariffs meant that Australians would enjoy a higher standard of living than would otherwise be the case.

It is also why our governments have spent decades contributing to the international consensus for lower trade barriers around the world.

The US’ recent enthusiasm for tariffs, and the wave of response and counter-response they have already generated, has left this consensus in tatters.

So, what should Australia do in response to all of this economic turmoil?

First and foremost, we should remain steadfast in advocating for free trade, including encouraging other countries to avoid the use of tariffs, as well as other measures.

Commission modelling to be released in this year’s annual Trade and Assistance Review (TAR) shows that freer trade would lead to better living standards for all economies concerned.

Importantly, if Australia is going to continue to talk the talk on freer trade, we must also walk the walk: the same modelling suggests that it is not in our national interest to participate in any global tariff war.

Increasing our direct barriers to trade and investment – even if we did so in retaliation – would come at a high cost to our economic growth and living standards. For example, we estimate that if Australia and other countries introduced a 10 per cent tariff in response to a general 10 per cent tariff from the US, then Australian prices would rise 0.2 per cent. Similarly, our GDP would be 0.14 per cent higher if we did not retaliate, even if other countries do.

The government is right to reject this path: international trade and investment are simply too vital to the Australian economy for retaliatory tariffs to be a good option.

And it is unlikely that a first round of tariff retaliation by Australia would be the end of the story. As we have already seen from Canada’s experience, further rounds of retaliatory tariffs on our exports could be imposed in response. Things can quickly spiral out of control.

For Australia, the policy lesson is clear: we should keep our hands clean and resist the temptation to retaliate with self-harming tariff increases of our own. Direct retaliation is a road to nowhere.

For similar reasons, we should avoid the temptation to retaliate indirectly with additional, non-tariff measures.

These measures – which can include subsidies, stronger anti-dumping protections or local content rules – also tend to distort economic outcomes and raise prices for consumers and costs for producers. But they are less transparent than tariffs, which is no doubt part of their appeal.

These so called ‘behind the border measures’ have been on the rise globally and in Australia for many years.

Using these tools as a retaliatory response to the current environment risks being as much of a dead end as direct tariff increases.

The Australian government has so far been disciplined in resisting the siren call of retaliatory tariffs. It should similarly hold the line on the wolf in sheep’s clothing alternatives that could similarly bite our living standards.

This article was written by Chair Danielle Wood and Deputy Chair Alex Robson. It was first published in Australian Financial Review on 18 March 2025.