An unintended consequence of WTO membership

Beata Javorcik, Gaia Narciso 05 September 2013

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The WTO with its 158 member countries is one of the most prominent international bodies. Becoming a member of the club often involves extensive and sometime politically difficult policy changes. For instance, the median time gap between the application and the accession reached 71 months for countries that joined after 1995 (Tang and Wei 2011).

But what do nations gain from WTO membership? Researchers have asked whether it boosts international trade, raises incomes, eliminates terms-of-trade-driven trade restrictions, or can be used by governments as a commitment device vis-à-vis domestic lobbies.

New research: WTO membership and tariff fraud

Our recent study contributes to this literature by documenting an unintended consequence of WTO membership (Javorcik and Narciso 2013). The analysis focuses on the WTO Customs Valuation Agreement (Agreement on Implementation of Article VII of the GATT) which sets the international rules on the methodology that countries must use to value imported goods in order to collect duty. We argue that implementation of Article VII resulted in limiting discretion of customs officials in terms of assessing unit values of goods. While prior to WTO accession they were free to use minimum or reference prices, after having joined the WTO they were mandated to accept the invoices issued by the exporter. This limited the scope for negotiation between importers and customs officials and the ability to misrepresent import prices.

Our study shows that this institutional reform has effectively shut down one channel of import-duty evasion. Dishonest importers have responded by relying more heavily on alternative evasion channels, such as undercounting quantities and product misclassification.

To formally test for this hypothesis we follow the methodology of Fisman and Wei (2004). We use data on 15 countries which joined the WTO between 1996 and 2008. This is a diverse group of countries including among others Armenia, Cape Verde, China, Ecuador and Saudi Arabia. We focus on imports from the US, Germany and France. We calculate the discrepancy in the unit values of imports as reported by the exporter and the importer and find that there is a positive relationship between the tariff rate and misrepresentation of import prices prior to WTO accession. This relationship disappears after the country joins the WTO. This finding is consistent with the WTO Customs Valuation Agreement limiting the discretion of customs officials in terms of assessing the price of imported goods, which makes it much more difficult for corrupt officials to cooperate with dishonest importers to evade duty payments. Our smoking gun is the case of Ecuador which asked for a five-year transition period to implement the Customs Valuation Agreement. We find that the positive relationship between the unit value gap and the tariff rate is unaffected by WTO membership during the transition period, but it disappears once the transition period is over.

Removing the opportunity to underreport prices seems to have induced importers to use alternative evasion methods. More specifically, our analysis shows that in the post-accession period there is a positive and statistically significant relationship between underreporting of import quantities and the tariff rates. The magnitude of the estimated effect is quite large. A ten-percentage-point increase in the tariff rate is associated with a 10.2% increase in the quantity gap. No such relationship was observed prior to WTO accession. We also examine tariff evasion through misclassification of imports by controlling for tariffs on similar products. The relationship between tariff on similar products and underreporting quantities becomes stronger after WTO accession.

Conclusions

In sum, our results suggest that the institutional reform mandated by WTO accession resulted in shutting down one channel of tariff evasion, but at the same time has led to greater evasion through alternative channels. Thus the evidence is consistent with strong displacement of an illicit activity. The issues addressed in our paper are highly salient in the light of the recent 2013 G8 meeting in Northern Ireland which put transparency, tax evasion and trade as the main items in the agenda.

References

Fisman, R and S-J Wei (2004), "Tax Rates and Tax Evasion: Evidence from "Missing Imports" in China", Journal of Political Economy 112(2): 471-500.

Javorcik, B and G Narciso (2013), “Accession to the World Trade Organization and Tariff Evasion”, CEPR Discussion Paper 9592.

Tang, M-K & S-J Wei, 2009. "The Value of Making Commitments Externally: Evidence from WTO Accessions," Journal of International Economics, 78(2): 216-229.

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Topics:  International trade

Tags:  WTO, tariff evasion, smuggling

Professor of Economics, University of Oxford; and ITRE Programme Director, CEPR

Assistant Professor at Trinity College Dublin

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