Part 1: How does domestic institutions affect trade, capital flows, and government policies?

• 1. “How taxing is corruption on international investors?”Review of Econ and Statistics

• 2. “Corruption and FDI: Firm-level Evidence’’• 3. “Transparency and international portfolio positions”

Journal of Finance• 4. “Monetary policies for developing countries: The role of

corruption” R&R with J of Int’l Econ• 5. “Does Insider trading raise stock market volatility?”

Economic Journal• 6. “Domestic crony capitalism and International fickle

capital: Is there a connection” International Finance

• 7. “Offshoring tariff evasion” working paper

Part 2: Explaining institutional quality

• 1. “Natural openness and good government”

• 2. “Do externally imposed reforms work?”

• 3. “Tax rates and tax evasion: evidence from ‘missing trade’ in China”

Journal of Political Economy

Outsourcing Tariff Evasion:Evidence From Hong Kong

As Entrepôt Trader

Raymond Fisman

Peter Moustakerski

and

Shang-Jin Wei

Outsourcing Corruption

• Hong Kong & Entrepôt Trade

• Data

• Results

• Conclusions

Hong Kong as Entrepot: Direct vs. Indirect Imports

USA

HK

China

80%

20%

Indirect trade is prominent in world commerce

• 30+ countries do a significant amt of indirect trade including:

• HK, Macao, Cyprus, Fiji, Senegal, Jordan, Armenia, Seychelles, Honduras, Benin, Montserrat, St. Lucia, and Singapore

Why Indirect Trade?

• Middlemen have a comparative advantage in matching buyers and sellers.

• What is the nature of the comparative advantage?– Better information– Better contract enforcement

• Our alternative explanation – outsourcing evasion

HK: Anecdotal evidence

• “Using unofficial channels, to bring in a 40 foot container of imported fresh fruit from Hong Kong to one of the cities in the Pearl River Delta costs approximately $4,000 to $6,000. ... This amount is usually much less than the price paid when using official channels.” (USDA, 1997)

Fisman and Wei (JPE 2004)

• Use reporting gap to measure tax evasion– Report gap = evasion + noise

• Study the responsiveness of evasion to tax rate

• Finiding: one percentage point rise in tax rate -> 3% increase in evasion

Do Tariffs Affect Evasion?

‘Gap’i = i + *(Tax Rate)i + I

Basic Finding: > 0

Current Paper’s Framework

1. Assume: (a) evasion can only occur by going thro HK(b) Traders are risk-neutral

2. Benefit = τiV

Cost = C + γ(τiV) +ηi

3. Assume ηi is iid and has a cdf of F(.), then Indirect trade ratio = F( (1-γ)τiV-C )

4. If F is uniform, then

Indirect trade ratio = α+βτi + ei

Data – sources

• Tariffs (tariffiy): WITS/UNCTAD

• Direct Exports (TRAINS): dir_exiyc

• Indirect Exports (Smartal): re_exiyc

• Additional Data– Information on tax exempt status of goods (Chinese Customs

statistics, only for 1998)

– Data on Singapore re-exports

Data Coverage

• Years = 1996 – 2001

Indirect Export Ratios and Tariff Rates, by year, 1996-2001 (in percent)

Year Hong Kong Tariff SingaporeRatio Rate Ratio

1996 26 23.6

1997 22.9 22.1

1998 23.9 17.5

1999 22.5 17.1 5.2

2000 21.8 16.9 5.3

2001 20.2 15.8 4.9

Total 22.9 18.8 5.1 

List of Exporting Countries

Country Annual Observations

Argentina 356Australia 1,250Austria 1,789Canada 1,089Czech Republic 645Denmark 797Finland 961France 2,209Germany 2,890Great Britain 2,246Greece 204Hungary 290Indonesia 1,292Ireland 448Italy 2,418

Country Annual Observations

Japan 3,649Korea 3,363Mexico 257Netherlands 1,453New Zealand 426Norway 564Poland 107Portugal 335Slovenia 135Spain 1,279Sweden 1,390Switzerland 1,791Turkey 467United States 3,569

Basic Specification

iyiyiy

Cciyciyc

Cciyc

tariffexdirexre

exre

*)()__(

_

reexport_ratioiy

Basic Specification(Dependent Variable = Indirect-export_ratio)

Tariff 0.250 0.286 0.113

(0.027) (0.044) (0.040)

Time fixed effects Yes Yes YesExporter fixed effects Yes Yes YesIndustry fixed effects No 3-digit 6-digitObservations 27577 27577 27577R-squared 0.02 0.17 0.71

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0 10 20 30 40 50 60 70

1998 Tariff

19

98

Re

-ex

po

rt R

ate

Magnitude of the effect:

• Increase in tariff from 0% to 18% (mean tariff rate) results in higher indirect trade ratio of 5% (relative to the mean of 12%, sd of 0.23)

• Amount of evasion facilitated through re-exports:Evasion = Σ0.25*Tariff*Re-exports

• Deflating by total imports:Evasion Rate ≈ 0.02

Can we rule out plausible alternatives?

1. Does it survive a differenced specification?

2. Does it hold for homogeneous products?

3. Does it hold better for non-exempted products than exempted ones?

4. Does it hold better for HK than for Singapore?

Extensions and Robustness Checks(Dependent Variable = Indirect-export_ratio)

Tariff 0.705(0.100)

∆Tariff 0.169(0.047)

Tariff 2 -0.616(0.134)

Time Fixed Effects Yes YesIndustry Fixed Effects 3-digit HS

Observations 4411 27577R-squared 0.00 0.17

Coincidence of Product Characteristics

• H1: Indirect trade is driven by product characteristics, not by evasion. In particularly, there may be a coincidental correlation b/n product characteristics that render them to be intermediated and their tariff rates.

• H2: Indirect trade is driven by evasion

Test 1: product fixed effectsTest 2: first differenceTest 3: separate homogeneous vs differentiated products

Differentiated vs. Homogeneous Products

Homogeneous Differentiated All ProductsProducts Products

 Tariff 0.173 0.280 0.182

(0.084) (0.096) (0.064)

Differentiated 0.087 *Tariff (0.073)

Fixed Effects Year-Industry (3-digit HS)

Observations 6375 12605 18980R-squared 0.21 0.19 0.18

Tariff-driven legal avoidance

• Ha: HK middlemen may be good at obtaining legal tariff exemptions, not illegal tariff evasion

• Test: Separate products into a highly-exempted group vs a non-exempted group

Effect of Exemptions

Exemption Exemption Exemption Exemption

  <5% <10% >90% >95%

Tariff 0.384 0.440 -0.174 -0.279(0.198) (0.147) (0.220) (0.296)

Fixed Effects Year-Industry (3-digit HS)

Observations 1262 2526 2526 1262R-squared 0.48 0.38 0.36 0.42

Indirect Exports

Singapore vs. Hong Kong via Singapore via Hong Kong

 Tariff 0.003 -0.008 0.276 0.268 0.276 0.270

(0.011) (0.028) (0.057) (0.085) (0.057) (0.084)

SGP Indirect_export_ratio 0.259 0.226 (0.042) (0.047)

Observations 14828 5994 14828 5994 14828 5994R-squared 0.09 0.18 0.22 0.25 0.22 0.26

Conclusion

• Tariff evasion is an important motivation for indirect trade in world commerce

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.4

-40 -30 -20 -10 0 10 20 30

Change in Tariff, 1996-2001

Ch

an

ge

Re

-ex

po

rt R

ate

, 19

96

-20

01