This study documents some unintended consequences of the World Trade Organization (WTO) membership by providing evidence on displacement of tariff evasion driven by the WTO accession process. The analysis focuses on the WTO Customs Valuation Agreement (CVA) which limits the discretion of customs officials when it comes to assessing the price of imports. While prior to the WTO accession customs officials are free to use their own judgment or apply minimum or reference prices, after their country joined the WTO they are mandated to accept the invoice price issued by the exporter. If customs officials enjoy discretion with respect to assessing the import price, they may assist importers with tariff evasion in exchange for bribes. Removing such discretion limits their ability to facilitate misrepresentation of import prices. Using data on 15 countries which joined the WTO between 1996 and 2008, we find a positive relationship between underreporting of import prices and the tariff rate, which is expected as the incentive to evade increases with the tariff rate. Importantly, this relationship disappears after a country joins the WTO. This result is consistent with the CVA closing one channel for corrupt behavior. However, we also find that changes to customs valuation procedures induce importers to seek alternative ways of tariff evasion, such as underreporting of quantities and product misclassification. The overall level of evasion remains unchanged.
The World Trade Organization (WTO) with its 164 member countries is one of the most prominent international bodies.1 Although it has formally existed for only two decades, there is a fast growing literature aiming to assess the benefits it brings to its members.2 This literature (reviewed later in the text) has examined whether the WTO membership boosts international trade, raises incomes of its members, eliminates the terms-of-trade-driven restrictions in trade that arise when policies are set unilaterally, or can be used by governments as a commitment device vis-à-vis domestic lobbies.
This paper contributes to the literature by documenting an unintended consequence of the WTO membership—displacement of tariff evasion to alternative channels. It argues that an institutional reform required as a condition of the WTO accession shuts down one channel through which import duties can be evaded. And indeed the evidence suggests virtual elimination of tax evasion through the affected channel. At the same time, the data also indicate greater evasion through alternative channels. The overall level of the evasion appears to be unchanged by the accession process.
The analysis focuses on the WTO Customs Valuation Agreement (Agreement on Implementation of Article VII of the GATT) which countries joining the WTO are expected to implement. Article VII sets the international rules on the methodology that countries must use to value imported goods in order to collect duty.3 Customs value should be based on “actual value”, which is the price of the imported merchandise, or like merchandise, in sales in the ordinary course of trade under fully competitive conditions. Customs value should not be based on value of merchandise of national origin, or arbitrary or fictitious values. Put differently, Article VII prohibits discretion in calculating a dutiable value or calculating a dutiable value on the basis of some external standard, such as a minimum price or a reference price, a practice that used to be widespread in developing countries. Instead the customs officials are obliged to accept the price stated on the invoice issued by the exporter.
By essentially mandating the use of invoices issued by the exporter as the basis for import valuation, Article VII limits the discretion of customs officials. If customs officials are free to use their own judgement when assessing the import price, they may assist importers with tariff evasion in exchange for bribes. Removing such discretion limits their ability to facilitate misrepresentation of import prices. The intended purpose of Article VII is to prevent member countries from eroding tariff concessions granted to other WTO members by overvaluing import flows.
Our study focuses on misrepresentation of the import price and its sensitivity to the tariff rate before and after the WTO accession.5 To capture the misrepresentation of the import price, we follow Javorcik and Narciso (2008) and calculate the difference between the unit value of exports reported by the exporting country and the unit value of imports recorded by the importer (hereafter referred to as the unit value gap). Unit values are measured at the 6-digit level of the Harmonized System (HS) classification. We focus on differentiated products, as it is more difficult for honest customs officials to accurately assess the true price of differentiated products due to their intrinsic features and different qualities, which may give corrupt customs officials a plausible explanation for misrepresenting the true price.6 We focus on three major exporting countries, all of which are developed and relatively uncorrupt economies: Germany, US and France.7 We consider 15 importing countries which joined the WTO between 1996 and 2008. We use trade figures from the UN COMTRADE database and tariff data from the World Bank's WITS database.
Our empirical analysis proceeds in several steps. First, we show that there exists a positive and statistically significant relationship between the unit value gap and the tariff rate. When estimating this relationship we control for country pair, 6-digit HS product and year fixed effects (or alternatively for country-pair-2-digit-HS-code and year fixed effects). Our results are consistent with the underreporting of import prices being greater when the tariff rate is higher. This finding is intuitive as importers wanting to evade paying import duties will have a greater incentive to underreport the price of the imported product if the tariff rate is higher.
Then, we examine whether the relationship between the unit value gap and the tariff rate changes after the WTO accession. This appears to be the case. Our results suggest that the positive link between misrepresentation of the import price and the tariff level disappears after the importing country joins the WTO. In our preferred specification, a ten-percentage-point increase in the tariff rate is associated with a 6.5% larger unit value gap prior to the WTO membership. In the post accession period, there is no statistically significant relationship between the tariff rate and the unit value gap. Thus our findings are 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.
In a series of robustness checks, we show that our results hold when we restrict our sample to products whose tariff did not change around the accession time, products traded both before and after accession, or just large trade flows. We also show that our results are robust to controlling for unobservable importer-exporter-year or importer-exporter-product or exporter-product-year heterogeneity as well as to including non-WTO members in the control group. By conducting an event study analysis, we gain confidence that our results are not driven by confounding trends. We also argue that tariff evasion through underpricing is likely to take place only in differentiated products as it would be very easy to detect in homogenous products. We find no robust link between the unit value gap and the tariff rate in nondifferentiated products either before or after the WTO accession.