The impact of protectionism

Over the years, globalization has liberalized trade significantly, leading to a positive effect on the world economy. While protectionism is not a new trend, it is somewhat surprising to note that most countries do not truly practice free trade – there are always restrictions to some extent in the movement of goods and services in cross border operations.

What constitutes protectionism?

Protectionism attempts to provide an edge to local businesses and traders over global or multinational competitors. Reasons include:

Over the last three years, numerous new protectionist measures were imposed by nations such as US, Russia, India, Argentina, Brazil, Indonesia, Japan, China, UK and Turkey. Some of the common measures includes imposing taxes or duty on goods exported from foreign regions to increase the price of the product. This typically leads to a lower demand in these goods locally and an increase in local supply. Other means of protectionism in trade may include the following:

  • Capping the volume and level of imports allowed or limiting the value of imports permitted into a country in a given time period
  • Intellectual property laws, e.g. patents and copyright protection
  • Administrative and technical barriers to trade including product labelling rules and stringent sanitary standards
  • Preferential policies toward local companies (vendors or producers) in state-funded projects
  • Voluntary export restraints (capping the amount of exports for an agreed time period) and introducing quotas on domestic exports so that a higher price is charged for products due to less supply
  • Subsidies (domestic or export) to augment local production and aid domestic companies in financial distress
  • Import licensing wherein Governments may grant companies a license to import goods
  • Limiting the amount of foreign exchange (transactions) between countries. This is also known as capital controls.
  • Hidden protectionism that includes differential treatment against foreign workers, investors or businesses

Can protectionism increase fraud opportunities?

The effect of protectionism impacts growth of the free world economy, and can also increase fraud and other risks in global industries. For an example, US’ protectionist policy on tax cuts may prompt US companies to bring back their investment in other countries. This can result in almost a reverse takeover, spinning off subsidiaries, and other restructuring activities which can pave the way to increase fraud risks. These include mismanagement, money-laundering, tax evasion, other forms of non-compliance and unethical practices. Further, protectionist policies against jobs outsourced to overseas locations may increase global unemployment levels. This can have an adverse effects such as rising individual misconduct, anti-social and unethical activities, crime (cyber, employee and vendor fraud) as well as terrorism.

In emerging markets, there could be a rise in performance fraud, with senior management looking at ways to window dress profits in an attempt to showcase superior company results. Often, they may try to achieve short term results through incentives. But this could also impact the culture of the organization to a large extent. Protectionism can also lead to unethical business practices and employee behaviour; custodians of governance may have to keep a cautious look out for dubious performers and make sure that business is conducted ethically.

Conclusion

Protectionism can lower the amount of income generated in the importing country, lead to closure of certain industries there because of aggressive pricing wars and even have Governments retaliating through their own domestic policies. With the nuances of trade turning intricate with time, the opportunities and scope for fraud and unethical practices may also see an upsurge with rising protectionism. As the world gets increasingly interconnected, all this can collectively have a snowball effect, which can be detrimental to countries as well as businesses, impacting the basic notion of free world trade.

ManiRanjitham Ponnusamy, Consultant, Forensic & Integrity Services at EY India also contributed to the above post.

Follow @EY_India and track #EYForensic for regular updates


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