CORRUPTION CAN INCREASE TRADE FLOWS
In high tariff environments where tariffs are in excess of 25-30%, corruption can actually
enhance trade flows between countries, by allowing firms to evade these tariff barriers.
That is the central finding of research by Pushan Dutt and Daniel Traca, presented to
the Royal Economic Society's 2009 annual conference at the University of Surrey.
Currently, only 5-14% of all bilateral trade between countries is subject to tariffs in
excess of 25-30%. But given the current impasse in the Doha Round of trade talks, and
if the current financial crisis triggers a wave of protectionism around the world, this
number may easily rise in the near future.
There are essentially two types of corrupt behaviour around trade. On one hand,
corrupt customs officials request bribes to do what they are supposed to do, which is
clear goods through customs (extortion). On the other hand, they are bribed to do what
they are not supposed to do, allowing firms to avoid formal trade barriers such as tariffs
and quotas imposed on imports (evasion).
Extortion impedes trade flows while evasion increases trade flows. Which effect
dominates depends critically on the extent of formal trade barriers.
In recent years, the impact of corruption in customs has come to the forefront of trade
policy debate. The WTO strongly believes that agreements on trade facilitation will
provide a significant boost to world trade. Trade facilitation discussions have been
undertaken in the Doha Round, in an effort to promote transparency, reduce red tape,
and diminish the scope for corruption in customs.
So is the WTO right in believing that reducing corruption in customs has the potential to
enhance trade flows between counties? This study argues that while corruption
impedes trade in an environment of low tariffs, it may actually be trade enhancing,
when nominal tariffs are high.
The last few years have seen a growing awareness of the crippling effect of corruption
on economic development. Corruption has been shown to reduce economic growth,
distort governmental expenditures, retard investment, reduce the effectiveness of
foreign aid and make poverty alleviation strategies less effective.
These results contrast sharply with earlier notions (advanced by, among others,
Samuel Huntington) that corruption is the grease that keeps the wheels of government
running smoothly. In this view, in a country rife with onerous regulations, the opportunity
to offer bribes allows firms to evade formal regulatory barriers. Similar to deregulation,
this can be welfare improving.
By highlighting the inter-relationship between corruption and the extent of regulatory
barriers, this study consolidates these two strands of the intellectual history of the
effects of corruption (whether corruption is good or bad).
The researchers define two types of corrupt behaviour: on one hand, corrupt customs
officials request bribes to do what they are supposed to do, which is clear goods
through customs; on the other hand, they are bribed to do what they are not supposed
to do, allowing firms to avoid formal trade barriers such as tariffs and quotas imposed
on imports. They call the first type of behaviour extortion, and the second evasion.
Country case studies (such as one of customs in Philippines,) document both types of
behaviour – not only do businesses pay bribes to facilitate legitimate transactions, but
they also use bribes to circumvent official trade barriers. The study shows that the
extortion behaviour acts as a tax on trade and impedes trade flows, while the evasion
aspect, by allowing firms to evade formal trade barriers, increases trade flows. Which
effect dominates depends critically on the extent of formal trade barriers.
The analysis is comprehensive, covering 128 exporters and 126 importers over the
period 1982-2000. These countries account for nearly 95% of all world trade.
The authors examine both overall aggregate trade between pairs of countries and trade
flows disaggregated by sectors. Empirically, they provide strong evidence that the
extortion and evasion effects co-exist – when formal trade barriers are low, the extortion
effect dominates but when trade barrier are sufficiently high, the evasion effect
dominates.
Corruption does tax and impede trade in the majority of cases. But in high tariff
environments where tariffs are in excess of 25-30%, corruption can actually enhance
trade flows between countries, by allowing firms to evade these tariff barriers. In these
countries, the right policy is to reduce the level of tariffs. For them, efforts to reduce
corruption in customs may end up having a detrimental effect on trade volumes.
Currently, only 5-14% of all bilateral trade between countries is subject to tariffs in
excess of 25-30%. But prior to the Uruguay Round, and its attendant tariff reduction,
this number was far higher. More importantly, given the current impasse in the Doha
Round of trade talks, and if the current financial crisis triggers a wave of protectionism
around the world, this number may easily rise in the near future.
ENDS
‘Corruption and Bilateral Trade Flows: Extortion or Evasion?’ by Pushan Dutt (INSEAD)
and Daniel Traca (Solvay Business School, ULB and CEPR)