Preshipment Inspection Services

Preshipment Inspection Services

Preshipment Inspection Services

Patrick Low World Bank Discussion Papersbreak

Copyright 1995 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved anufactured in the United States of America First printing February 1995 Discussion Papers present results of country analysis or research that are circulated to encourage discussion and comment within the development community. To present these results with the least possible delay, the typescript of this paper has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. Some sources cited in this paper may be informal documents that are not readily available. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A. The complete backlist of publications from the World Bank is shown in the annual Index of Publications , which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W, Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'Ina, 75116 Paris, France. ISSN: 0259210X Patrick Low is senior economist in the International Trade Division of the World Bank's International Economics Department. Preshipment Inspection Services 1

Preshipment Inspection Services Library of Congress CataloginginPublication Data Low, Patrick, 1949 Preshipment inspection services / Patrick Low. p. cm. (World Bank discussion papers ; 278) Includes bibliographical references (p. ). ISBN 082133185X 1. Preshipment inspection of exports. I. Title. II. Series. HF1415.L68 1995 658.7'884dc20 9449060 CIPbreak

Foreword Abstract Acknowledgements Executive Summary and Main Recommendations Introduction Chapter I: Preshipment Inspection Services: An Introduction to the Industry The Preshipment Inspection Industry The Basic Mechanics of PSI Control of False Invoicing in Trade Transactions OverInvoicing Imports UnderInvoicing and MisClassifying Imports Monitoring and Control of Tariff Exemption Regimes Other Related Functions of PSI Services Verification of Origin Monitoring of Compliance with National Regulations Data for Statistical Purposes Price Data for a Customs Valuation Data Base Technical Assistance, Technology Transfer, and Training Monitoring of Donor Funds and Foreign Exchange Replenishment Trade Facilitation Consumer Protection Chapter II: PSI Services, International Obligations, and the Criticisms of Exporters Exporter Concerns Regarding PSI The Economic Commission for Europe Preshipment Inspection Services

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Preshipment Inspection Services The Customs Cooperation Council PSIRelated Activities in the United States The International Chamber of Commerce The WTO Agreement on Preshipment Inspection Have the ExporterRelated Complaints about PSI been Answered? Some Suggested Alternatives to Comprehensive PSI The Norwegian Proposal Preshipment Price Verification without Physical Inspection Preshipment Inspection and Procurement Preshipment Inspection and Customs Valuation The Use of Minimum Import Prices Are Price Data Bases an Alternative to PSI? Chapter III: Preshipment Inspection in Practice Data on Preshipment Inspection Interventions Reported Foreign Exchange and Revenue Savings Patterns of PSI Intervention Aspects of the Service and Contract Design Issues Physical Inspections Price Verifications Trade Facilitation Transactions Costs and Delays Postshipment Vulnerability Destination Inspections Complaints and Appeals Monitoring and Auditing of PSI Companies Training Fees Inspection Thresholds, Product Coverage and Exemptions Competition in the PSI Industry Chapter IV: Customs Reform and Preshipment Inspection Corruption, Tax Evasion, and PrincipalAgent Problems Corruption Tax Evasion and PrincipalAgent Problems link link link link link

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Preshipment Inspection Services

Preshipment Inspection Services The Role of ex post Reconciliation Customs Reform Modernization and Integrity Computerization Whither PSI? Summary Conclusions Annex References link link link link link link link link link

Foreword
The success of trade liberalization programs in many countries has raised a secondary set of traderelated issues that counted for little when trade was dominated by quotas, exchange controls, and all manner of administrative interventions. As the costs of restrictive trade policies became increasingly apparent, and a growing number of governments opted for more open, pricebased trade regimes, a number of administrative and institutional questions impinging upon the conduct of international trade came to the fore. Of how much use is it, for example, to eliminate import quotas if customs authorities keep importers waiting for weeks or even months before their goods are cleared? What is the value of tariff reductions if minimum import price regimes establish artificially high unit values as the basis for calculating customs duties? What is the real worth of liberalized trade flows if antidumping duties and other measures of "contingency" protection are used to restore the status quo ante ? The dilution of trade liberalization benefits in these ways doubtless in part reflect a protectionist intent, but administrative shortcomings are also an important part of the story. Questions such as those posed above increasingly preoccupy policy makers, and are receiving greater attention in the World Bank's own policy and research work. Many of these problems involve policy implementation rather than design, and therefore may not be intellectually challenging. But the solutions to them are far more complex. Quotas, exchange controls and excessive tariffs can be done away with at the stroke of a pen, while the reform and modernization of administrative machinery is a delicate and arduous task. Success can be long in coming. The present study examines the efforts of some governments to deal with certain problems of policy implementation, using the services of preshipment inspection (PSI) companies. To a degree, PSI addresses the symptoms and not the causes of policy failure. In that role, PSI can serve a useful purpose, pending the introduction of more fundamental remedies. But many of the benefits of PSI, such as enhanced revenue collection and trade facilitation, will only be realized if governments show the requisite level of commitment. This study covers various aspects of PSI in considerable detail, exploring how it works, what it can do, and what is needed to make it effective. The study makes specific recommendations. But if there is any broad message that the study conveys, it is that successful institutional and administrative reform requires sustained commitment, attention to detail, and vigilance.break

Foreword

Preshipment Inspection Services MASOOD AHMED DIRECTOR, INTERNATIONAL ECONOMICS DEPARTMENT THE WORLD BANK

Abstract
Preshipment inspection services are employed by some thirty governments to address problems associated with overinvoicing and underinvoicing of trade transactions, tariff misclassification, shortfalls in revenue collections from trade taxes, and the management of funds for balance of payments support. In recent years, emphasis has fallen increasingly on revenuerelated issues. This study evaluates PSI services, principally from the perspective of user governments. It concludes that while PSI can be of significant benefit, the realization of those benefits depends crucially on appropriate contract design and the determination of governments to make the system work. Since PSI addresses administrative and institutional shortcomings in user countries, PSI programs should be accompanied by sustained reform efforts that will create the conditions for phasing out reliance on the service.break

Acknowledgements
Many persons provided valuable support to this study, both in a personal and official capacity. Numerous government officials in the casestudy countries spent valuable time discussing their experiences and views in regard to preshipment inspection. Officials of the PSI companies were also generous with their time and supportive of the study, patiently entertaining repeated visits, endless requests for information, and innumerable questions about the finer points of PSI services. The author also benefitted from discussions and communications from officials of the Customs Cooperation Council, Crown Agents, SWIPCO, and members of the Economic Commission for Europe's Working Party on Facilitation of International Trade Procedures. Helpful inputs and comments were also provided by Glen Jenkins and Vince Castonguay (Harvard Institute for International Development), Bert Cunningham (independent customs expert), Judith Taylor (GATT), John Raven (International Express Carriers Conference), Francois Corfmat and Jim Walsh (Fiscal Affairs Department, International Monetary Fund), Arvind Subramanian (Policy Review Department, IMF) and Ian White (consultant). Consultants that contributed to the project with background or country studies included Parvin Alizadeh, Geoffrey Bannister, the CERDI team from France (led by AnneMarie Gourjeon), Tamar Manuelyan, Kip Petersen, Angus Simpson, and Peter Williams. Within the Bank, a number of individuals took an interest in the project, and provided advice, support and in some cases, comments on earlier drafts of the study. These included Azita Amjadi, Philip Birnbaum, Colin Bruce, Tim Condon, Luc de Wulf, Ron Duncan, Brendan Horton, Erika Jorgensen, Ravi Kanbur, Chander Ohri, Dan Parietti, Anand Rajaram, Raed Safadi, Bill Shaw, Hardyal Singh, Raghavan Srinivasan, John Todd, and Sandy Yeats. In particular, Azita Amjadi put in long hours working on the data supplied by the PSI companies. Brendan Horton participated in the work on Indonesia and examined the experience of Cote d'Ivoire with preshipment inspection. Erika Jorgensen participated in the visit to the Philippines. Sandy Yeats, who played a key role in launching the project, was a constant source of advice and support. It is inconceivable that all the individuals mentioned above agree with everything in the study. The views expressed, as well as any errors, are the sole responsibility of the author.break

Executive Summary and Main Recommendations

Abstract

Preshipment Inspection Services Background to the Study The present study has been undertaken in light of the role that the World Bank has played, particularly in Africa, in persuading or requiring borrowing governments to use preshipment inspection services. The primary, although not exclusive, motivation for this policy has been to ensure proper management of import support funds by recipient governments. In light of this objective, as well as the more recent change in emphasis of PSI activities away from foreign exchange concerns and toward revenue issues, there has been growing interest in the question of how far governments are benefitting from PSI services. Twelve countries agreed to participate in this study, and to make available the necessary information to carry out the analysis. These were: Benin, Cameroon, Central African Republic, Cote d'Ivoire, Ghana, Indonesia, Mali, Peru, Philippines, Tanzania, Uganda, and Zambia. The Uses of Preshipment Inspection Some thirty governments worldwide employ the services of preshipment inspection (PSI) companies. These companies are contracted to examine and report on the quantity, quality and unit prices of export goods prior to shipment. Contracts vary as to product coverage, emphasis and priorities, but are generally intended to control, or aid in the control of, any or all of the following traderelated practices: i) overinvoicing of imports; ii) underinvoicing of imports; iii) misclassification of imports; iv) undercollection of taxes due on imports; and v) misappropriation of donor funds provided for import support. Some PSI contracts also call for the performance of similar services on the exports of goods from the contracting country. Additional services or benefits that may be derived from a PSI contract include verification of origin, monitoring of compliance with national regulations, monitoring and control of tariff exemption regimes, data management, assistance in the establishment of a customs valuation data base, technical assistance and training, trade facilitation, and a degree of consumer protection. The scope for benefitting from PSI services in each of these areas is analyzed in the study, along with appropriate alternatives where these exist. Problems of OverInvoicing Most early PSI contracts focused largely on problems of overinvoicing, reflecting the prevalence at that time of exchange controls and foreign currency rationing in PSIusing countries. In more recent years, the liberalization of trade and payments regimes in many of these countries has reduced the motivation for overinvoicing. Liberalization has not, however, eliminated the incentive for such behavior, since overinvoicing can be attractive for reasons other than to capture the foreign exchange scarcity premium. Overinvoicing provides a mechanism, for example, whereby enterprise employees can appropriate company assets for themselves, and where firms can lessen their direct tax liabilities in the country of export. Most PSI contracts still include the requirement to monitor trade transactions for overinvoicing.break

Problems of UnderInvoicing Increasingly, however, the focus of PSI activities has shifted to revenuerelated problems. These concern the incentive for traders to underinvoice imports in order to reduce their tax liabilities. Such behavior may or may not occur with the collusion of tax collection officials in the importing country. Alternatively, tax collectors may defraud the revenue without collusion from traders. In any event, information generated through PSI on the tax liabilities of importers can be used to ensure that the authorities collect taxes due. Relatively high dependency on trade taxes in PSIusing countries increases the incentive for traders to underinvoice and can create difficulty for governments already hardpressed to contain a fiscal deficit. Revenue fraud will occur unevenly, as traders are able and/or willing in varying degrees to indulge in the practice. This creates economic distortions of uncertain magnitude. Governments sometimes add to these distortions by granting tax exemptions to particular groups in response to political pressure a tendency exacerbated by high tax levels. Background to the Study 6

Preshipment Inspection Services Moreover, collection shortfalls make it more difficult for governments to lower taxes, which would allow the economy to benefit from further trade liberalization and move toward a more diversified and efficient tax structure. For all these reasons, governments that contract PSI services should use them to greater effect than appears to have been the case to date in many countries. Exporter Concerns regarding Preshipment Inspection Preshipment inspection activities have been subject to criticism, especially by exporters. These criticisms have related both to the substance of the service and to the performance of the PSI companies themselves. Among the most common complaints raised against PSI were the delays and costs occasioned by PSI interventions, a lack of transparency and accountability in respect of PSI procedures, the absence of an appeals procedure against PSI company decisions, and the absence of uniformity and agreed standards of work. Indeed, some critics viewed PSI simply as another nontariff barrier to trade. This study does not attempt to evaluate directly the substance of these complaints, but reports on the discussions that took place and the manner in which the issues have been addressed. The most obvious direct consequence of exporter dissatisfaction with PSI was the inclusion of the subject in the negotiating mandate of the Uruguay Round, which led to the establishment of the Agreement on Preshipment Inspection within the framework of the new World Trade Organization. The Agreement establishes a number of obligations for user governments, who are responsible for ensuring compliance with the agreement by their contractees, the PSI companies. The commitments relate to such matters as transparency in procedures, maximum times for carrying out PSI operations, standards of inspection, price verification methodologies, and appeals procedures. The governments of exporter countries have also assumed obligations, relating to the nondiscriminatory application of laws and regulations to PSI companies, publication of these laws and regulations, and the provision of technicalcontinue

assistance to user governments. Although the agreement remains to be tested in practice (after the World Trade Organization comes into force), it appears to have addressed the substance of the earlier complaints. Perhaps the greatest significance of the agreement is that PSI has been accepted internationally as a service which governments may legitimately rely upon, while at the same time norms in relation to procedures, standards, accountability and recourse have been established. Some Suggested Alternatives to Preshipment Inspection and Related Issues The study considers various proposed alternatives to PSI, including the socalled Norwegian proposal, destination inspections, the application of minimum import prices, and the use of price data bases. The relationship between PSI and procurement is also examined, along with the issue of PSI and customs valuation, and the role of PSI price verification without physical inspection. The Norwegian proposal envisages cooperation among national customs services in a manner that would largely replicate PSI services at lower cost. While there appears to be merit in such an approach, it would require willingness on the part of customs services of exporting countries to devote the necessary resources to providing such a service. They would also have to accept a degree of responsibility vis vis the customs services of importing countries. Additional problems concern the lack of uniformity in customs nomenclature and in customs valuation methodologies. In the light of these considerations, such an approach is unlikely to work in the near future, but might prove useful eventually, in a context where governments are phasing out reliance on PSI services. Destination inspections, which take place in the country of importation rather than the country of exportation, have been suggested as an alternative to preshipment inspection. In effect, destination inspections closely resemble traditional customs work, the only question being who actually carries out the inspection. As a vehicle for training customs officials in the importing country, or in the context of a program for phasing out PSI, Exporter Concerns regarding Preshipment Inspection 7

Preshipment Inspection Services destination inspections may be desirable. But destination inspections are not a substitute for PSI, and their widespread use alongside a PSI program may undermine the efficiency and security of the latter. Moreover, while PSI makes it possible to undertake physical inspection in the case of all goods, it is generally not feasible to inspect more than a fraction of import consignments at the port of arrival without seriously disrupting trade. The higher incidence of physical inspection possible under PSI may be a distinct advantage in certain circumstances. The study argues strongly against the use of minimum import prices as a valuation mechanism to replace preshipment inspection. Apart from the economic distortions introduced by minimum prices in terms of price/quality relationships, minimum prices can lead to substantial hidden protection margins, even where this is not the intent of the pricesetting authorities. Moreover, the customs valuation rules of the World Trade Organization call for the eventual elimination of minimum import price regimes. Valuation data bases, on the other hand, can play a useful role in valuation work, provided they are used to indicate likely value ranges or to trigger closer examination of particular consignments. If these data bases serve to establishcontinue

fixed unit prices for valuation purposes, they become indistinguishable from minimum price regimes. As far as the relation between procurement and PSI is concerned, the study concludes that while there may be some overlap between the services, they are too different to be substitutable. It does not make much sense for PSI companies to carry out price verification on procured goods and this is recognized in the World Bank's procurement guidelines on goods subject to full international competitive bidding. But there is clearly a case for physical inspection and verification of the tariff classification on procured goods. In the field of customs valuation, the PSI companies will be required to ensure, after certain phasein periods, that they employ valuation methods consistent with the obligations of contracting governments under the customs valuation agreement negotiated in the Uruguay Round. While certain technical issues may arise, these are not likely to present insurmountable problems, nor to require significant modification of existing PSI procedures. On the question of price verification without physical inspection under PSI contracts, there is a clear case for adopting a selective approach to physical inspection over time, based on a combination of random and targeted selection. But the feasibility of adopting selective physical inspection, or eliminating it altogether, without incurring undue revenue risk depends on the ability and willingness of national customs services to fulfill their traditional functions. The latter issue is taken up in the last part of the study. Preshipment Inspection in Practice The study attempts to evaluate PSI services, both quantitatively and qualitatively, through the experiences of user governments. The quantitative analysis relies primarily on data relating to individual inspections, which were provided by the PSI companies for the casestudy countries. While these data were useful in indicating the frequency of PSI interventions and the magnitude of putative savings that resulted, the attempted analysis of the relationship between interventions and various consignment and exporter characteristics proved somewhat inconclusive. It is argued, however, that analysis of this nature, undertaken on a systematic basis, could be a valuable aid to governments and PSI companies in ensuring that the best possible use is made of the service. For the most part, foreign exchange and/or revenue savings reported by the PSI companies exceeded the PSI fee (of around one percent of inspected goods), often by a large margin. But at least on the revenue side, these reported savings, both from value uplifts and tariff reclassification, would only be realized if a national customs service were to act upon the information supplied by the PSI company. Evidence from the casestudy countries suggested that this information was frequently disregarded, thereby rendering PSI a good deal less costeffective than would otherwise have been the case. On the other hand, there may be a deterrent effect from PSI that influences the behavior of traders in ways that do not show up in reported results. If such a deterrent effect could be reliably calculated, it would have to be added intocontinue Preshipment Inspection in Practice 8

Preshipment Inspection Services the calculation of PSI benefits. While PSIgenerated information is being ignored by governments, however, such deterrence is likely to be weak. In light of the kinds of measurement difficulties referred to above, it is impossible to make a reliable estimate of the costs and benefits of PSI services. Rather, an evaluation has to be made by less direct means, through an analysis of what PSI services can offer, prevailing conditions in PSIusing countries, and the degree to which user governments are taking advantage of the service. This is what the present study attempts. Aspects of PSI Services and Contract Design Issues In addition to the proper performance of physical inspection and price verification functions, which are the essence of a PSI service, a number of other aspects of PSI arrangements warrant particular attention. In most cases, attainment of the full benefits of the service depends both on the reliability of the PSI provider and the efficiency and commitment level of the user government. In respect of several of the features of PSI services discussed in the study, appropriate contractual specifications are an important precondition for a good service. One such area relates to product coverage and importerspecific exemptions. All PSI contracts stipulate certain exemptions. At least in the early stages of reliance on PSI, these should be kept to a minimum. Exemptions should always be carefully monitored, as they can undermine the security of a PSI program. All exemptions should be identified ex ante in the PSI contract, in order to prevent discretionary abuse and fraudulent circumvention of the program. Another feature of most contracts is the setting of a threshold below which imports are exempt from PSI requirements. Threshold levels vary, with a typical value lying in the range from five hundred to five thousand dollars. Thresholds are established basically as a costreducing measure, where foreign exchange and revenue risks are smaller. Threshold levels need to be carefully monitored, however, since traders may be tempted to split consignments or make false value declarations in order to avoid preshipment inspection. Trade facilitation can be a key benefit of preshipment inspection, additional to gains accruing in respect of revenue and foreign exchange. Without trade facilitation, PSI represents an unambiguous cost from the point of view of traders. One aspect of trade facilitation is the shortcircuiting of certain customs functions, in circumstances where customs authorities are deliberately delaying and rendering more costly the clearance of goods in order to extract economic rents from traders. An obvious mechanism of facilitation here is for PSI documentation to be used directly for customs clearance. Another mechanism of trade facilitation is the sealing of full container loads by PSI companies at the point of embarkation, so that these shipments can proceed immediately to their final destination with no more than an occasional random customs inspection upon arrival. While certain costs will inevitably accrue to traders as a result of PSI, arrangements should be in place to keep these costs to a bare minimum. Costs will usually be minor if PSI interventions do not cause delays in transacting business or in shipping. In ordercontinue

for this to be possible, PSI companies must be willing to carry out inspections and perform the requisite paperwork promptly. They also need to ensure that PSI documents required for customs clearance are available by the time goods are ready to be cleared. Different techniques are available for ensuring the timely delivery of documents in the vast majority of cases. Governments might consider the use of provisional clearance arrangements in instances where it is genuinely impossible for documents to arrive on time. Even if PSI companies do everything possible to guard against delays, they may still occur. Shippers, for example, may cause customs clearance delays through late delivery of shipping documents. Or traders themselves may be responsible. Delayfree PSI services depend, therefore, on all parties to a trade transaction, as well as the PSI companies and the authorities of the importing country.

Aspects of PSI Services and Contract Design Issues

Preshipment Inspection Services A contractually established complaints and appeals procedure is an important ingredient of a wellfunctioning PSI contract. Only a few PSI contracts currently contain such procedures, and this is an area where improvements could be made. Preshipment inspection interventions will rarely be popular with traders, which strengthens the case for transparency, and the right of recourse in the event that importers wish to contest a valuation or classification decision, or to complain about some aspect of service performance. The establishment of formal administrative procedures to deal with complaints and appeals should ensure evenhanded treatment of all interested parties. Moreover, such arrangements would mirror what has been established under the Preshipment Inspection Agreement in respect of exporters. Preshipment inspection contracts should also provide for the monitoring and auditing of PSI companies, in order to dispel any notion that the firms are unaccountable to their principals. Auditing would focus specifically on establishing the veracity of claims made by firms, in relation to such matters as billing. Monitoring is a more subjective exercise that allows the principal to judge whether the service is yielding value for money. Whereas an audit could be carried out by professional auditors, monitoring is an ongoing exercise that the principal could undertake directly. A prior condition for effective monitoring is a clear contractual stipulation of the PSI firm's reporting requirements. These should be sufficiently detailed to permit a proper assessment not only of contract performance, but also of the results of PSI interventions. Training commitments on the part of PSI companies are usually specified in the contract. In practice, the extent of such training has varied. If governments are to reduce their dependency on PSI services over time, proper training of the national customs service is indispensable. While governments may prefer to entrust overall responsibility for customs training and modernization to a party other than the PSI provider, PSI companies can nevertheless make useful contributions to the training and modernization effort. A source of some contention in the PSI industry is whether contracts should be split, or whether a single PSI provider should be contracted at a given point in time. The argument for splitting is that it engenders competition within the industry. While there is no doubt that the quality of PSI services is enhanced through competition among PSI companies, this study argues that these benefits can be secured through regular competitive tenderingcontinue

procedures, without incurring any of the risks and costs attendant upon contract splits. It is also argued that geographical contract splits do not necessarily foster competition. Contract splitting raises the costs to governments of doing business with PSI providers, complicates efforts to establish an adequate working relationship between national customs authorities and PSI suppliers, reduces the effectiveness of controls over fraudulent behavior by traders and/or customs officials, and is likely to increase the overall cost of PSI services. The integrity of the tendering process for PSI services is important. Anything that compromises the objectivity and technical soundness of tendering, bid evaluation or contract award procedures and decisions will weaken competition on the basis of quality and price, and may impinge negatively on the quality of a contract and the manner in which it is performed. Customs Reform and Preshipment Inspection As the revenue aspects of PSI services become more important, so too does the task of ensuring that national customs services reform and modernize, in order to be able to take full responsibility for their traditional functions and reduce dependency on preshipment inspection. Efforts to understand tax evasion and address it will fail unless the remedies developed recognize that dishonesty may be a characteristic not only of taxpayer behavior, but also of tax collectors. Where there is a propensity for dishonesty, taxpayer decisions to behave fraudulently will be influenced by the amount of tax they are required to pay, the cost of avoiding the tax (in bribes), the probability of detection, and the size of the penalty upon Customs Reform and Preshipment Inspection 10

Preshipment Inspection Services detection. Similarly, tax collectors will be influenced by the relationship between their wages and the return from corruption, bearing in mind the likelihood and the costs of detection. While taxpayer and collector motivations for fraudulent behavior are driven by similar considerations, their respective objective functions interact in a number of different and sometimes complicated ways. If tax collectors are income maximizers, there is no guarantee that higher wages will mitigate corrupt behavior. Thus, while low wages are likely to breed corrupt behavior, raising them is not a sufficient condition for solving the problem. Higher wages must be accompanied by a system of effective monitoring and credible penalties for malfeasance. The principalagent framework of analysis referred to in the study shows how the principal's wishes (the government's) may be frustrated by the agent's behavior (the tax collector's) when the objectives of the two parties diverge and the principal lacks information about what the agent is doing. Preshipment inspection services can largely solve the problem of asymmetric information by providing the principal with detailed information on taxes due. This service eliminates the scope for independent acts of fraud by the taxpayer, provided the collector acts on the information provided and refrains from colluding with the taxpayer to defraud the revenue.break

Both the taxpayer and the collector will be able to indulge in fraud if the principal, despite the informational advantage accorded him by PSI, is unwilling to use this information to stem corruption. Weak government, or a corrupt principal, will frustrate technical solutions to fraud, rendering such services as PSI costly and pointless. The gains from PSI can only be assured under a system of ex post reconciliation, where PSIgenerated information is reconciled against customs records and proof of duty payment, and where the authorities then follow up on any anomalies detected. Hard empirical evidence of the costs of foregoing reconciliation is difficult to come by, but what there is paints a disconcerting picture. Governments in some countries may be foregoing up to half the revenue owed to them, even with preshipment inspection. Customs administrations will never be able to provide adequate services to their principals and the trading community if they are unwilling to modernize. Modernization calls for a number of organizational and procedural changes to the traditional way of doing business, and above all requires automation. Unless modernization is embraced, and serious efforts are made to address fraud and administrative malfeasance, governments are likely to remain dependent on comprehensive PSI services, even in the longterm. Before governments contemplate phasing out PSI, they should first make it work properly. A few basic indicators of readiness should be analyzed before a phaseout program is embarked upon, such as the degree of automation achieved, the ability to generate timely and accurate trade flow and revenue data, the robustness of internal and external quality and honesty controls, and the level of integrity in the system. A phaseout program should be planned with reference to performance criteria, built on explicit targets and performance benchmarks. The possibility of reintroducing PSI should be everpresent in the minds of both the government and the customs authorities.
Main Conclusions and Recommendations

The study concludes that a clear role exists for PSI in some countries, particularly those with a weak customs administration and a poor record in tax collection. In addition, PSI can be used to good effect in addressing overinvoicing, and can assist in foreign exchange management pending the establishment of adequately functioning exchange markets. A range of supplementary or incidental services (see paragraph 2 above) can also be acquired in the context of a PSI contract. However, the record to date of using PSI effectively is disappointing in many countries, especially on the revenue side. This is largely on account of a lack of serious monitoring and followup of information generated through preshipment inspection, and the absence of a satisfactory system of ex post reconciliation. The design and content of PSI contracts also merits careful attention if the full benefits of Main Conclusions and Recommendations 11

Preshipment Inspection Services the service are to be realized. Since preshipment inspection services cover for administrative and institutional weaknesses in user countries, and bearing in mind that PSI is a comparatively costly service, governments should attach priority to the elimination of the underlying weaknesses that render PSI desirable. But PSI should not be dispensed with until those weaknesses have been addressed, throughcontinue

appropriate reforms and modernization programs, and national customs services have shown willing and able to perform their functions adequately. The study contains many detailed recommendations. The most important of these are summarized in general terms below: i) Governments that contract PSI services should ensure that these services yield a real return. This means defining clearly the objectives of the program, paying careful attention to contract design, using fully the information generated by PSI on the price, quantity, and quality of imports, and monitoring the performance of contracts. For revenuerelated PSI services, ex post reconciliation should always be a feature of the contract, and adequate arrangements should be in place to ensure that anomalies detected through the reconciliation are addressed. The product coverage and exemptions from PSI should be contractually specified, and not subject to arbitrary decisions. In addition, contracts must be designed so as to ensure that PSI firms are able to carry out their designated functions, and that the firms are fully accountable to their principals. Contracts should pay attention to trade facilitation measures, the minimization of PSIrelated delays, complaints and appeals procedures, adequate reporting and monitoring/auditing arrangements in relation to contract performance, and training. ii) A government that contracts PSI services in order to improve revenue collections should at the same time institute a credible customs reform and modernization program, designed to prepare the national customs service to assume full responsibility for its traditional functions. iii) The World Bank should continue to encourage governments to use PSI services in cases where administrative weaknesses in the areas of customs administration and foreign exchange management are sufficiently serious to warrant such support. But any recommendation or requirement to use PSI services should also pay careful attention to the issues mentioned in items i) and ii) above.break

Introduction
Preshipment inspection (PSI) services are employed by some thirty governments worldwide. Most PSI programs involve physical inspection of imports in the country of exportation, together with an assessment of the invoice price of the goods to be exported. The objectives and priorities of these programs vary among client governments. The central purposes of PSI, however, are to control false invoicing (overand underinvoicing), to provide governments with precise information on importers' tax liabilities at the frontier, and in some cases, to verify the appropriate use of donor funds. The present study evaluates PSI from two perspectives. One entails an analysis of the nature of the service in terms of what it offers and different ways in which it might be used. The second aspect of the evaluation focuses on how PSI has functioned in practice, taking into account both the service provided and the use made of it by contracting governments. The study attempts to identify the circumstances in which PSI programs are useful in developing countries. It also seeks to specify the essential ingredients of a successful PSI program, both in terms of the kind of services to be supplied and the policy stance required of a user government.

Introduction

12

Preshipment Inspection Services The decision to undertake the study was triggered in part by the fact that the World Bank has often been instrumental in governments' decisions to employ PSI. Moreover, there is a strong geographical concentration of PSI users in Africa, with more than twenty contracts current at the present time. This has aroused particular interest in the Africa Region as to the question whether governments are benefitting from PSI services. The World Bank sought approval from a number of governments using PSI for the inclusion of their countries in this study. Approval was secured for an indepth study of PSI from the following twelve countries: Benin, Cameroon, Central African Republic, Cote d'Ivoire, Ghana, Indonesia, Mali, Peru, Philippines, Tanzania, Uganda, and Zambia. While the study is primarily based on the experiences of these countries, it also draws on information and analysis available from elsewhere. Where possible, the study endeavors to provide quantitative analysis and precision in dealing with the material available. It should be noted, however, that qualitative assessment often proved to be the only viable approach to the issues dealt with in this study. This is because measurement simply proved impossible in addressing some issues. Moreover, it was frequently impossible to isolate different factors giving rise to particular outcomes, and an identifiable counterfactual scenario upon which to build a clear case of causality was often absent. Where evidence for a statement or a conclusion is open to differing interpretations, this has been pointed out. Plan of the Study . The study is organized along thematic lines, and draws from countryspecific experience as appropriate. Given the length of the study, and the fact that readers may be more interested in some parts of it than others, a detailed description follows of the contents of the different chapters and sections. The study comprises four chapters. Chapter I provides briefcontinue

information on the industry, explores the reasons why traders might engage in false invoicing, and explains the nature of PSI and related services. Chapter II reviews the debate that has taken place over the last few years on PSI, with particular reference to discussions in international agencies and among governments. This chapter also examines the Uruguay Round agreement on preshipment inspection and international rules on customs valuation. Chapter III evaluates various aspects of PSI services in practice, as well as some broader issues relating to the performance of PSI contracts. Chapter IV focuses on the clients of the PSI industry, paying particular attention to the question of how well governments have used the services offered. The first and second sections of chapter I describe the main features of the PSI industry and the mechanics of a typical PSI service that a government might contract. The third section of chapter I provides an analysis of the main motivations for false invoicing in trade transactions, and also considers the potential role of PSI services in monitoring and controlling tariff exemption regimes. The discussion focuses first on why traders might be induced to overinvoice, and then considers underinvoicing practices, bearing in mind that a central function of PSI is to control overand underinvoicing practices. Since tariff exemption regimes of various descriptions have proved to be a significant source of revenue leakage in many countries, the discussion in this subsection is about how a PSI service might be used to address the problem in a manner that does not frustrate or unduly delay trade. The fourth section of chapter I briefly describes other, ancillary services that governments might seek if they contract PSI services. These include verification of origin, monitoring of compliance with national regulations, data collection for statistical purposes, price data for a customs valuation data base, technical assistance, technology transfer, and training, monitoring of donor funds and foreign exchange replenishment, trade facilitation, and consumer protection. The focus of chapter II is upon PSI services from the perspective of exporters. The first section of the chapter examines the history of complaints made by exporters against PSI services, and activities of various national and international agencies that arose from these complaints. The section describes the activities of the Economic Commission for Europe, the Customs Cooperation Council, the United States International Trade Commission, and the International Chamber of Commerce. This same section then goes on to analyze the Agreement on Preshipment Inspection negotiated under the auspices of the Uruguay Round, which represented an attempt to Introduction 13

Preshipment Inspection Services address exporter complaints about PSI, and to establish multilateral rights and obligations in respect of both user governments and the governments of exporting countries. The analysis of the PSI agreement specifically examines how far exporter complaints have been addressed in the agreement. The second section of chapter II discusses some suggested alternatives to comprehensive preshipment inspection. One such suggested alternative is the socalled Norwegian proposal, that argues for the replacement of PSI with arrangements under which national customs services fulfil certain exportrelated functions on behalf of each other. The section also examines the relationship between PSI and procurement. Another option covered is the possibility of using price verification services, based either on invoice data or disaggregated trade data. Price verification based on invoice data is akin to PSI without physicalcontinue

inspection, and the issue of selective physical inspection (and selective PSI) is also taken up later in the study. Section 2 of chapter II further contains a fairly lengthy discussion of customs valuation, and the implications of the Uruguay Round agreement on the customs valuation practices of developing countries, and of PSI companies working on their behalf. This subsection is followed by a brief discussion of the problems associated with the use of minimum import prices for customs valuation purposes, which is also sometimes put forward as an alternative to preshipment inspection. Finally, the chapter ends by considering the role of price data bases as a customs valuation tool. Chapter III analyzes the experience of various countries with PSI in some detail, first by examining PSI results data, and then through a thematic discussion of key aspects of PSI services and certain contract design issues. Section 1 of the chapter presents and discusses foreign exchange and revenue savings reported by the PSI companies, and also undertakes a statistical analysis of PSI interventions in order to determine whether any particular patterns emerge in terms of the characteristics of import consignments and the frequency of PSI interventions. Section 2 of chapter III discusses the two principle inspection activitiesphysical inspections and price verification. The next subsection considers ways in which PSI services may be used as a mechanism for facilitating trade, particularly in light of the fact that PSI interventions can easily delay trade. This is followed by an examination of the nature of the transactions costs and delays that can be caused by the PSI process, and how these can be minimized, or in the case of delays, eliminated altogether. The discussion then turns to the question of postshipment vulnerability, which involves the risk that documentary or physical alterations are made between the time that PSI takes place and goods are cleared through customs in the importing country. This is followed by a brief discussion of destination, or postshipment inspection, which has more in common with traditional customs activities than with preshipment inspection. The next three subsections each deal with specific elements that governments might consider including in PSI contractsprocedures through which complaints and appeals can be brought by importers against a PSI company's actions or decisions, arrangements for monitoring and auditing the performance of PSI companies, and the provision of customsrelated training by PSI companies. Various issues relating to service fees payable to PSI companies are then taken up, and this is followed by a consideration of the appropriateness of value thresholds for PSI, and the extent of product coverage and PSI exemptions. Finally, Section 2 takes up the question of competition in the PSI industry, and evaluates arguments about the relative merits of contracting PSI services from more than one PSI company simultaneously, as opposed to relying on a single supplier at any point in time. Chapter IV focuses on how the attitudes and behavior of governments affect the value of PSI services. The emphasis of the chapter is on customsrelated activities and revenue collection, and seeks to specify what is required of governments if they are to make the most of PSI services. The first section involves a somewhat abstract analysis of problems of corruption and tax evasion. This discussion serves as a backdrop to an examination in section 2 of how PSI services can be designed so as to ensure that the information generated by PSIcontinue

Introduction

14

Preshipment Inspection Services companies is used effectively in stemming revenue fraud, which may involve importers and/or government officials. Evidence is presented of significant customs revenue shortfalls in certain countries, which have persisted despite the existence of preshipment inspection. Particular emphasis is given to the role of ex post reconciliation as a means of exploiting PSIgenerated information to combat revenue fraud. The third section of chapter IV discusses the need for customs modernization and reform, including automation, as an antidote to continuing reliance on PSI services. The fourth section then discusses how PSI services might be phased out as national customs authorities prove able and willing to provide an efficient service and guarantee the security of government revenue deriving from taxes on trade.break

Chapter I Preshipment Inspection Services: An Introduction to the Industry

The Preshipment Inspection Industry There are five firms active in the PSI industry, although a number of others sometimes bid on PSI contracts, and may enter the market in the future. The five are BIVAC International of Paris, COTECNA of Geneva, Inchcape Testing Services International (ITSI) of London, Inspectorate America from Houston, and Socit Generale de Surveillance (SGS) of Geneva.1 These companies are either directly involved in commercial inspection of one sort or another, or are affiliated with commercial inspection enterprises.2 The commercial activities, which have been carried on for many years, provide the basis of expertise and the international infrastructure for the government PSI contracts. The largest of the PSI companies, SGS, has over 130 affiliated enterprises, with a presence in more than 140 countries, and employs approximately 30,000 people. The PSI companies are members of the Preshipment Inspection Committee of the International Federation of Inspection Agencies (IFIA), through which members consult and coordinate on certain issues. The prerequisites for membership of the PSI Committee are IFIA membership and possession of at least one government PSI contract. Among its activities, the Committee has established a Code of Practice for Government Mandated Preshipment Inspection. In contrast to commercial inspection work, comprehensive governmentmandated PSI is not a particularly old industry, and was pioneered by SGS in the 1960s. The earliest government contract was signed in 1963 with the Government of Zaire. The industry continues to be dominated by SGS (Table I.1), and new companies only began to secure government contracts in the mid1980s. For the first fifteen years or so of the industry's existence, PSI services were concerned exclusively with capital flight. Exchange controls and foreign exchange rationing were pervasive in developing countries at this time, and governments believed that the overinvoicing of imports was a major vehicle of capital flight. It was not until the Indonesian contract of 1985 that customs work entered the picture. Since then, the emphasis of PSI has shifted dramatically, to the point where concern with overinvoicing has become almost residual, although most current PSI contracts still embody both customs and capital flight work (Table I.1). This change is a clear reflection of policy developments. As more and more countries have dispensed with capital controls and liberalized their trade regimes, governments have become increasingly preoccupied with tax evasion. Before further examining these and other functions of PSI, Table 1.2 gives a rough indication of the significance of PSI services in terms of international trade flows. The numberscontinue 1 COTECNA was purchased by SGS in mid1994. 2 Commercial inspection is not the same as governmentcontracted PSI services. What inspection companies do on behalf of their commercial clients (private sector buyers and sellers) by way of inspection and testing is quite different from inspection in the context of PSI services. Chapter I Preshipment Inspection Services: An Introduction to the Industry 15

Preshipment Inspection Services

TABLE I.1: PSI Contracts (December, 1993) Company and Country with Contract Bivac COTECNA Inspectorate ITSI Benin Bolivia Bolivia Burkina Faso Burundi Cameroon Central African Republic Cote d'Ivoire Ghana Guinea Haiti Indonesia Kenya Madagascar Kenya Mali Mozambique Nigeria Peru Nigeria Peru Nigeria Peru Nigeria Peru Philippines Rwanda Senegal Surinam Tanzania Uganda Zaire Zambia Zanziber SGS Angola Forex Customs/Forex Forex Customs/Forex Forex Customs/Forex Customs/Forex Contract (Customs &/or Forex)

Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Customs/Forex Forex Customs/Forex Customs/Forex Forex Customs/Forex Forex Customs/Forex

Sierra Leone Tanzania Tanzania

Zimbabwe

Source : PSI Companies Notes : a) Forex is an abbreviation for foreign exchange, and refers to capital flight contracts. b) The Central African Republic and Haitian contracts were suspended as of December, 1993, and the Surinam contract was inactive. c) Under the Indonesian, Peruvian and Philippine contracts, capital flight is not adjusted for on invoices, but only reported. Chapter I Preshipment Inspection Services: An Introduction to the Industry 16

Preshipment Inspection Services d) Where countries are listed in more than one column, it is because the PSI contract has been split between two or more firms. TABLE I.2: The Trade of PSIusing Countries PSIusing Country (US$ million) Imports 1990 30749.8 3459.0 90.4 115.4 72.5 2019.4 152.8 3082.0 871.0 .. 1119.9 320.4 337.9 .. 13923.0 .. 782.6 137.6 389.3 146.8 999.2 1263.0 .. 1467.6 4400.7 922.9 165.0 3312.8 .. 33739.2 25553.2 8186.0 1991 29066.2 3971.1 103.4 115.8 91.5 1271.5 133.3 3011.3 992.0 .. 1202.8 343.9 354.1 .. 12071.0 .. 977.0 145.1 393.6 199.6 828.5 1082.0 .. 1779.0 4170.1 760.0 103.1 3307.0 .. 37751.2 28997.2 8754.0 1985 18521.3 658.3 268.9 352.8 189.0 1088.0 112.8 1733.8 729.0 .. 1457.4 465.1 469.0 .. 6204.6 .. 900.0 151.2 945.9 404.0 949.9 545.1 .. 896.6 2792.2 690.0 334.0 1767.4 .. 15700.6 10256.0 5444.6 1990 23286.7 385.5 351.2 593.1 234.6 1637.0 211.3 2098.0 1272.0 .. 2041.4 579.6 618.0 .. 5679.9 .. 1620.4 148.7 1346.0 584.0 999.2 1035.2 .. 1851.4 3913.7 962.7 317.0 2634.0 .. 34877.9 21836.9 13041.0 1991 23759.3 356.9 398.1 601.9 254.3 1448.0 195.6 1671.0 1418.0 .. 2034.3 523.2 638.0 .. 6525.3 .. 1406.6 163.0 1381.3 550.0 828.5 1255.4 .. 2110.0 4179.4 992.4 373.6 2813.4 .. 38013.9 25868.6 12145.3

Exports 1985

Africa Angola Benin Burkina Faso Burundi Cameroon Central African Republic Cote d'Ivoire Ghana Guinea Kenya Madagascar Mali Mozambique Nigeria Rwanda Senegal Sierra Leone Tanzania Uganda Zaire Zambia Zanzibar Zimbabwe Latin America and Caribbean Bolivia Haiti Peru Surinam Asia Indonesia Philippines Memo items

25402.9 2302.0 149.9 70.5 112.0 722.1 91.7 2720.9 633.0 .. 956.8 286.7 176.0 .. 13112.7 .. 481.0 130.3 337.0 386.9 949.9 829.0 .. 954.5 3741.9 672.8 217.0 2852.1 .. 23175.5 18586.7 4588.8

Share of PSI countries in total developing country trade of respective region (%)

Chapter I Preshipment Inspection Services: An Introduction to the Industry

17

Preshipment Inspection Services Africa Latin America & Caribbean Asia 3.0 World Source : World Bank Trade Data Base in the table provide a very crude measure of PSI coverage because not all the imports of PSI users are inspected, and data are not available for all countries that employ PSI services. Nevertheless, the table shows that PSI services cover only some 2 percent of world trade. On the other hand, the SubSaharan African countries, excluding the Republic of South Africa, employing PSI account for nearly half of all that region's trade. The African figures are, however, heavily influenced by the relative size of Nigeria. The Basic Mechanics of PSI There are many variants on the precise modalities of PSI, depending on the practices of the provider, established import procedures, and the contractual requirements of the client. It is useful, however, to provide a brief general explanation of the basics of the system. Although PSI may apply to imports or exports,3 the discussion here focuses on the import side. Preshipment inspection of imports, as the name suggests, is a service performed in the country of export prior to shipment of merchandise to the importing country. Certain aspects of the delivery of the service do, nevertheless, have to be performed in the client country. There are two discrete aspects of the service physical inspection and price verification. The physical inspection is designed to confirm the information provided by the exporter in the sale invoice, the contract, or in terms of any other pertinent details or documentation. The inspection takes place at the site of production, warehousing and/or shipment. The price verification exercise focuses on the declared invoice price of the goods, comparing this with "the price(s) of identical or similar goods offered for export from the same country of exportation at or about the same time, under competitive and comparable conditions of sale, in conformity with customary commercial practices and net of any applicable standard discounts."4 The price verification is undertaken separately from the physical inspection, but may rely in part on confirmation from the physical inspection that the merchandise in question corresponds to the description given in the pro forma invoice. In some contracts, a preliminary price verification exercise is undertaken prior to the physical inspection, and subsequently confirmed in light of the inspection. Preshipment inspection services typically cover all imports, except those explicitly exempted in the contract. Most, if not all, contracts specify a threshold value below which goods are exempt from preshipment inspection. In addition, certain categories of goods, such as newspapers and periodicals, personal effects, diplomatic goods, defense supplies, and freshcontinue 3 For the most part, governments have contracted PSI for imports, not exports, and this is the focus of the present study. However, PSI has been carried out on exports under government contracts at one time or another in Bolivia, Ecuador, Guatemala, Indonesia, Liberia, Paraguay, Peru and Sierra Leone. 4 Article 2.20(b) of the Uruguay Round Agreement on Preshipment Inspection. As discussed later in Chapter II, the price verification rules in the PSI Agreement do not overrule the World Trade Organization's rules on customs valuation. Price comparison under PSI is not designed to ensure that importers are obtaining the best price for the best goods from the best source. To the extent that such "shopping" is contracted out, this would be a procurement function. The relationship between procurement and PSI is discussed later in the study. The Basic Mechanics of PSI 18 2.1 2.1 2.0 1.8 1.9 52.4 3.8 19.2 49.1 3.5 13.6 46.7 3.4 13.5 50.8 4.1 11.0 45.6 3.7 13.2 45.2 3.4 12.6

Preshipment Inspection Services produce are often excluded from inspection requirements. Some of the difficulties raised in relation to exemptions, particularly below a threshold value, are discussed in chapter III. The following is a stylized description of the different steps in the PSI process: 1. Upon deciding to import, the importer completes the necessary documentary formalities of the import authorities, arranges payment procedures with a commercial bank (usually by opening a letter of credit), and notifies the local office of the PSI company of the intention to import. The importer must provide a copy of the pro forma invoice to the PSI company (indicating details of the transaction and origin of the goods) and any other information or documentary requirements specified as part of the PSI company's arrangements with the government . 2. The local office of the PSI company makes a preliminary determination regarding the eligibility of the proposed transaction and transmits an inspection order (usually by electronic means electronic data transfer, or EDT) to its affiliate in the country from which the goods are being shipped . 3. The affiliate contacts the exporter (if contact has not already been made), seeks relevant information about the proposed shipment, and arranges the time and place for a physical inspection. Such information may include proforma invoices, price lists, transport costs, copies of letters of credit, technical literature pertaining to the product, packing lists, information about commissions payable to third parties, and shipping details. The affiliate also undertakes price verification, tariff classification, and any other tasks contractually specified (such as calculating taxes due or ensuring compliance with local regulations, although this may be done in conjunction with the local office) . 4. Upon satisfactory PSI, and production of the final invoice and proof of shipment by the supplier (the latter is not always a prerequisite), the affiliate transmits a Report of Findings (ROF) to the local PSI office in the importing country by EDT. The affiliate also issues an ROF to the seller, which is a negotiable document required in order for the commercial bank in the importing country to authorize release of funds in payment for the goods. In some cases, a customs duty report may be separately furnished. If PSI proves unsatisfactory, the supplier may make the necessary adjustments (for example, to the invoice price in the case of overinvoicing), or the PSI company will issue a nonnegotiable ROF. In cases of underinvoicing, there is no reason to adjust the invoice price, and the PSI company will simply indicate a dutiable value different from the invoice price on the ROF. 5. The local office of the PSI company issues the ROF to the importer for duty payment and customs clearance purposes, and also furnishes copies to the importer's commercial bank, and the relevant government authorities (customs, the central bank, etc.) . 6. The importer (or importer's agent) pays customs duties and taxes due (sometimes to a commercial bank as a prior condition of customs clearance) and clears the goods through customs, with the ROF, proof of payment of taxes due, the import entry form, and other required documents .break

Control of False Invoicing in Trade Transactions The primary functions of PSI are to control the under and overinvoicing of imports (and exports as well in some government contracts). False invoicing occurs for a variety of reasons, only some of which can be influenced by government policy over the shortto medium term. The main motivations for false invoicing are summarized in Box I.1.5 For the present purposes, the discussion focuses on those false invoicing practices involving imports, since this is the main concern of preshipment inspection.6

Control of False Invoicing in Trade Transactions

19

Preshipment Inspection Services The decision whether or not to make a fraudulent price declaration turns on a tradeoff between risk and return. Among the primary objectives of this kind of fraud are the transfer of assets into different currencies or jurisdictions, and the avoidance of taxes. In this respect, an important relationship determining the decision whether to misspecify invoice values is that between the foreign exchange black market premium (where access to foreign exchange is rationed by nonprice means) and the level of taxes to be paid or avoided. If the black market premium is high, this will encourage the overinvoicing of imports. If import duties are high, this will encourage underinvoicing. Following the notation used by Yeats (1991), this relationship can be clarified algebraically. Where ti is the tariff, p is the black market premium (measured as a percentage above the official exchange rate), Vt is the true value of imports, and Vf is the falsified invoice price, the importer's net gain (or loss) on product i (Ni ) will be:

or,

If p > ti , importers have an incentive to overinvoice, and Vf will be greater than Vt . The reverse is true if the black market premium p is less than the tariff ti . Returning to the explanations listed in Box I.1 for false invoicing behavior, it is clear that the relationship captured by equation (2) does not fully explain invoicing decisions in all circumstances. In particular, the overdeclaration of invoice values for the purpose of transferring ownership of the assets of enterprises to their employees presents a situation in which neither the black market premium nor tax rates will influence behavior. The objective in this case is simply to steal the assets of the firm. In most other cases, however, there willcontinue 5 For analytical discussions of false invoicing, see Bhagwati (1964 and 1967), de Mowbray (1988), de Wulf (1981a and 1981b), Walter (1986) and Dornbusch (1987). 6 The discussion here focuses exclusively on false invoicing, although in practice the PSI companies can identify other related practices, such as collusion between importers and exporters to cover the cost of illicit commissions, exporters taking advantage of a lack of market knowledge or a weak financial situation of the importer, and overdeclaration of capital equipment imported as a contribution in kind into a joint venture.

Box I.1: Principal Reasons for False Invoicing Overinvoicing of imports and/or underinvoicing of exports Underinvoicing of imports and/or overinvoicing of exports

1. Capital flight

1. Evade taxes on imports*

Protect asset values Increase returns to assets Reduce uncertainty Control of False Invoicing in Trade Transactions

2. Capture export subsidies

20

Preshipment Inspection Services

2. Black market arbitrage

3. Transfer ownership of assets

4. Evade direct taxes

5. Evade export taxes

6. Transfer illicit funds * Taxes on imports include sales tax, VAT, excises, and whatever other indirect taxes fall on both domestic output and imports, together with import duties and any other import charges. be a tradeoff to consider, either between the value of the black market premium and tax liabilities, or between different kinds of tax liabilities (e.g. profits tax versus import duties).
OverInvoicing Imports

As noted above, capital flight is the expression of a desire to place assets in a different currency and/or under a different jurisdiction. The extent to which capital flight is effected through false invoicing depends in part upon a country's exchange control regime. Three separate cases of import overinvoicing can be distinguished in terms of their relation to the exchange regime. The first is a purely economic case, where capital flight takes place through false invoicing only if exchange controls make this necessary. The second case of overinvoicing arises precisely because of exchange controls. The third category occurs irrespective of the exchange regime because the underlying objective can only be met by declaring a false invoice value. The purely economic motivations for capital flight include the desire to protect the value of assets, to increase the rate of return on assets, and to reduce uncertainty. Real asset values may undermined by currency depreciation. Similarly, high inflation and low interest rates imply a negative real rate of return on investments. Uncertainty might relate to narrowcontinue

economic considerations, such as exchange risk, or could be broader and more political in nature. In a policy environment where exchange controls restrict asset transfer between currencies or jurisdictions, false invoicing is one of the few ways through which capital flight can occur. Where exchange controls do not apply, economic agents will find it easier to transfer assets by more straightforward means, via the banking system. In many developing countries, exchange controls have been removed from the current account, but are retained on the capital account. Under these circumstances, false invoicing may still provide a useful vehicle for asset transfer in terms of what has been described as the purely economic motivation, but not to the degree prevailing under a strict and generalized exchange control regime.

OverInvoicing Imports

21

Preshipment Inspection Services The second case, where exchange controls actually create the false invoicing incentive, arises because these controls induce the establishment of a parallel exchange market, reflecting the difference between the scarcity value of foreign currency and the official exchange rate. By overinvoicing their goods, importers can acquire foreign exchange for sale in the parallel market so as to capture the scarcity premium on foreign currency. This arbitrage will narrow the gap between official and black market exchange rates, and does not imply a reduction in the quantity of foreign exchange available in the country. In the third case, overinvoicing is essential to the underlying objective. Examples of this include the transfer of ownership of assets, avoidance of direct taxes, the desire to declare profits in a different jurisdiction, and transfer of illicit funds. Ownership transfer is a euphemism for theft. It is most likely to occur if management controls and accountability are weak, perhaps more typically in stateowned enterprises, where managers are agents of the government and not of private owners. Avoidance of direct (profit) taxes is possible when a firm can inflate its costs through overinvoicing imported inputs, but any additional burden of higher import tax payments resulting from overinvoicing would have to be offset against a reduction in the direct tax liability. The decision here would also be influenced by the relationship between prospective tax savings and the black market exchange rate premium. The transfer of illicit funds could be undertaken by means other than false invoicing, but the particular attraction of this mechanism is its opacity and the difficulty of detection. Capital flight is difficult to measure, and estimates of the phenomenon vary widely. Claessens and Naud (1993) have reviewed a variety of studies on the subject. They conclude that capital flight occurs more often than commonly assumed, and that countries with smaller income experience more capital flight than they would if capital flight were distributed proportionately to national income. They report on estimates for 84 developing countries, which suggest a pattern of increasing capital flight until 1988, followed by a return in flight capital between 1989 and 1991. Flight capital is estimated to have been between US$100 billion and US$130 billion in 1988 for the 84 countries studied. Looking specifically at trade misinvoicing, the Claessens and Naud paper reports that in the 84 countries studied, underinvoicing of imports predominated after 1981, and thatcontinue

exports were overinvoiced up to 1985 and underinvoiced thereafter. These figures are built up from national aggregates and only capture net capital flight, which becomes negative when import underinvoicing and export overinvoicing exceed import overinvoicing and export underinvoicing. Notwithstanding the significant measurement and interpretative difficulties associated with indicators of this kind, the observation that import underinvoicing predominated after 1981 is consistent with expectations. As exchange controls have been increasingly relaxed in developing countries, misinvoicing has become a less significant vehicle for flight capital. Evidence on the declining use of exchange controls is provided by the International Monetary Fund in a biennial report on exchange and payments systems. The 1992 report states that: " . . .the trend toward liberalization in international payments and transfers has continued. In large part, this stems from a growing recognition that the restrictions involved are an inefficient and counterproductive way to achieve their intended objectives to limit outflows of foreign exchange, protect certain classes of imports or exports, or even raise tax revenue." (IMF, 1992) Capital flight motivated by concern over asset yields and values, or by negative expectations, has probably occurred more and more through regular channels, as the policy environment has been relaxed. But retention of some exchange controls means that misinvoicing may still be a useful capital flight mechanism, even when there is no underlying or prior illegal intent. Obviously, the illegal motives for overvaluing imports persist, independently of the restrictiveness of exchange controls. As reported in chapter III, PSI companies have continued to report adjustments for overinvoicing, despite the relaxation of exchange controls. OverInvoicing Imports 22

Preshipment Inspection Services

UnderInvoicing and MisClassifying Imports

The phenomenon of import underinvoicing is more straightforward than overinvoicing, since it relates entirely to tax evasion. The evasion of taxes on imports may take three forms underdeclaration of the value of a good in collusion with a foreign supplier, forgery of the invoice independently of the supplier, and misclassification of an item under a tariff heading carrying a lower tax rate. When the import value is manipulated, an importer will require access to foreign exchange in order to make up the difference between payment to the foreign supplier authorized through the banking system (per the supplier's invoice) and full payment. In the presence of exchange controls, the relationship depicted in equation (2) above between taxes saved and the cost of acquiring foreign exchange in the parallel exchange market will determine the maximum worthwhile value of an underdeclaration. The lower the black market premium (i.e. less stringent exchange controls), the greater is the attraction of tax avoidance via underinvoicing. If there are no exchange controls, or an importer can misdeclare a tariff classification or independently falsify an invoice, taxes can be evaded without any need tocontinue

purchase foreign exchange in the black market. Neither does this kind of fraud necessarily require collusive behavior on the part of the supplier. The decision whether to behave fraudulently is then determined largely by the effectiveness of collection enforcement and the severity of penalties for tax fraud. Preshipment inspection can catch all three types of action under valuation, misclassification, or invoice forgery. These actions may be undertaken by importers acting alone (with help from suppliers where necessary), or in collusion with tax collectors in customs. If tax collectors are also involved in defrauding the government of tax revenue, and if control mechanisms and enforcement within customs are weak, then revenue leakages could occur without any need for the fraudulent manipulation of invoices or misclassification. Where customs integrity is in question, PSI has a dual role assisting customs in addressing importer fraud, and providing a parallel system of information that permits the government authorities to monitor customs. Just as overinvoicing practices on the import side can be moderated significantly by a policy change (removing exchange controls), so the solution to underinvoicing is to be found partly in policy reforms. One strong candidate for immediate policy action is the modernization and reform of customs services (chapter IV). Longerterm reform efforts should concentrate on the fiscal structure. A notable feature of the fiscal system in many developing countries is its heavy reliance on trade taxes as a source of government revenue (Table I.3). Tariff reform typically focuses on reducing the level and dispersion of tariffs, as well as the number of exemptions granted. Over time, domestic indirect and direct taxes will provide a growing share of total revenue. Meanwhile, however, the revenue collection function of customs is vital for sound economic management. Work undertaken by Pritchett and Sethi (1993b) shows that the efficiency of tariff collection falls as tariff rates increase. On the basis of detailed data from three countries (Jamaica, Kenya and Pakistan), they conclude that actual collection rates (the ratio of tariff revenue to import values) appear to level off when the ad valorem tariff approaches 50 percent. If tariff rates are set above this level, there is little or no addition to revenue. In the case of Kenya, the authors found that collection rates were actually lower on hightariff items than they were on lowtariff items, implying that the Kenyan authorities might collect more revenue by lowering tariffs. The explanation for their result is that as rates increase, more and more exemptions are granted. Political pressure for exemptions will not be applied evenly or as successfully by all economic agents liable to high tariffs, so higher taxes will lead to a greater variation in payment rates. This result is confirmed by Pritchett and Sethi, who find that the variation of collection rates around the official rate increases as the level of the official rate increases. Apart from showing the inherent limitations of a narrow tax base, the analysis emphasizes the economic costs of a narrow base, since higher taxes generate greater distortions by increasing the spread of UnderInvoicing and MisClassifying Imports 23

Preshipment Inspection Services taxes actually paid on specific products.break

Table 1.3: Share of Import Duties in Total Revenue for Selected Countries Country Cameroon Cote d'Ivoire Ghana Indonesia Mali Peru Philippines Tanzania Uganda Zambia Year 1989 1990 1988 1989 1987 1990 1991 1985 1986 1987 Share of Import Duties in Total Revenue (%) 14.0 29.1 35.2 6.4 27.5 18.7 27.9 27.7 67.6 30.1

Source : International Monetary Fund, Government Finance Statistics Yearbook (1992). The Pritchett and Sethi analysis omits a vital aspect of the relation between tax rates and revenue collection efficiency namely, the heightened incentive for evasion generated by larger tax liabilities. This omission was inevitable, since it is impossible to detect undervaluation and misclassification from reported trade and revenue statistics. Just as the demand for exemptions increases with higher tax rates, so does the incentive to indulge in tax evasion. Some evidence of the relationship between higher tax rates and increased evasion was obtained in Tanzania (Box 1.2). The Tanzanian data also demonstrate what is likely to happen to exemptions as tax rates increase, and confirm the relationship observed by Pritchett and Sethi.
Monitoring and Control of Tariff Exemption Regimes

Even at quite modest tariff levels, there will always be some exemptions, linked to the status of the importer (e.g. diplomatic) or to the purpose for which goods have been imported (e.g. for incorporation into exports). The need to control access to exemptions will not disappear with tariff reforms that lower rates and decrease their variance, but the size of the problem and the incentive to secure exemptions fraudulently will diminish. In the meanwhile, many countries face significant control problems related to exemptions. As discussed below, information generated by PSI companies can help to address this problem. Perhaps the most frequently encountered difficulties in this area arise with duty exemptions linked to exports. Recognizing that export diversification and expansion are key to economic development, especially in small countries, most governments try to ensure that exporters acquire imported inputs at world prices. A number of mechanisms exist for exempting exported products from duties on imported inputs, such as duty drawback arrangements andcontinue

Box 1.2: How Tax Increases Can Lower Collection Rates: Evidence From Tanzania In the budget year 1993/94 (commencing July 1, 1993), Tanzania raised its tariffs, changing its fourband structure from 0, 10, 20 and 40 percent Monitoring and Control of Tariff Exemption Regimes 24

Preshipment Inspection Services to 5, 20, 30 and 40 percent. This change increased assessed taxes on imports, before exemptions, from 21.5 percent in the first six months of 1993 to 36.4 percent in the second six months of the same year. Although these figures include sales and excise taxes due, the increase in assessed taxes is attributable entirely to the tariff increase (assuming a constant composition of imports in the first and second six months of 1993). When it came to payable taxes after exemptions, however, the relevant figures for the two sixmonth periods were 17.0 percent and 27.3 percent. What these figures indicate is that with the higher tariffs, exemptions jumped from 4.5 percent to 9.1 percent of the dutiable value of imports.

In Tanzania, PSI companies must issue a tax assessment notice (TAN) indicating tax liabilities for imports, based on the determination resulting from preshipment inspection. The TAN is supposed to be a customs clearance document. The system was not working in a fully satisfactory manner in 1993, and only about 73 percent of imports subject to TANs were in fact meeting this requirement.

Moreover, a significant portion of imports in respect of which TANs had been issued were subsequently cleared through customs without the tax assessment notices. For the whole of 1993, the PSI companies reported that only 32.4 percent of the taxes that should have been paid through the TAN system had actually been paid in this manner. The numbers for the two periods before and after the tariff increase were 41.2 percent and 25.9 percent respectively. Some taxes were paid over to customs outside the TAN system, but since the TAN arrangements ensure that taxes due are fully paid, it is reasonable to assume that importers avoided the TAN arrangements in order to pay less than the full liability. It is therefore significant that the share of taxes paid through the TAN system fell so strongly following the midyear tariff increase.

Finally, information from the TANs indicated that approximately T.Shs. 82,442 million should have been paid, and only T.Shs. 41,320 million was actually collected. This means that Tanzania only managed to collect 50.1 percent of import taxes due (after exemptions) in 1993. Once again, the negative effect of higher taxes on collections is discernible from the fact that 68.4 percent of taxes due were collected in the first half of the year, and only 41.9 percent of taxes due were collected in the second half.

Source : Arvind Subramanian, Tax Assessment Notice System in Tanzania , Policy Development and Review Department, International Monetary Fund, mimeo (March, 1994) Monitoring and Control of Tariff Exemption Regimes 25

Preshipment Inspection Services temporary admission schemes of various kinds. Given a commitment to encourage export activity, Governments generally face a tradeoff between the desire to maintain simple administrative procedures for exporters and the need to protect the revenue. If procedures are too lax, the government's budget may be undermined as exporters (and others) abuse exportrelated privileges by leaking dutyfree goods onto the domestic market. A similar problem exists for some countries where there is a lot of transit trade. Such activity will be especially lucrative where tariffs or restrictions on trade raise domestic prices significantly above world prices.break

Some governments rely on duty drawback arrangements, which are safer from the revenue perspective because exporters pay duties on imported inputs and then reclaim them upon proof of exportation. But drawbacks are worth less to exporters than arrangements where no prior duty payments are required. Moreover, in countries that rely on drawbacks exporters often complain that it takes months to receive the refunds. Where temporary admissions arrangements are used, leakage problems have been considerable in some countries. In Tanzania, for example, private bonded warehouses sprung up with a profusion that made effective customs supervision impossible. Customs officers had no means of checking if goods declared by approved importers as destined for warehouses were actually eligible for importation under bond. Goods moving from the ports of entry to warehouses were frequently unaccompanied by a cargo receipt and landing account. The laxity of these procedures meant that there was no audit trail to follow. Moreover, customs officers were not permanently posted at warehouses, and warehouse owners were often charged with providing the locks for the warehouses themselves. Not surprisingly, in those circumstances customs frequently were not the sole possessors of keys to the warehouses. According to estimates made by one of the PSI companies operating in Tanzania, up to 50 percent of unpaid taxes in 1993 were traceable to goods which had been destined to bonded warehouses, but not subsequently accounted for. In Sri Lanka, the Government's determination to encourage exports led to the creation of several different exportrelated duty exemption schemes (Box I.3). Whereas the problem of insecure bonded warehousing in Tanzania went beyond arrangements for duty free inputs into exports, and included such facilities as privileged access to tax free consumer goods, the revenue leakage problem in Sri Lanka was primarily exportrelated. Few examples exist of PSI company involvement in monitoring duty drawback and temporary admission schemes. In Indonesia, however, PSI has been linked to the duty exemptions regime in two ways. First, special SGS inspection certificates are issued in respect of goods destined for bonded zones, and these special certificates are intended to ensure priority treatment in customs. This generally means that the goods concerned are subject to paper checks only. Goods which are not inspected by the PSI company (usually because they are below the value threshold for PSI) are required to go through a drawback system as opposed to temporary admission arrangements. Second, in addition to the facilitation aspect of PSI involvement, the Indonesian firm SUCOFINDO7 is responsible for maintaining a register system and surveying goods as they leave the export processing zone. These responsibilities also include the establishment of conversion factors. Control procedures are the same whether goods are leaving the zone for salecontinue 7 SUCOFINDO was required to subcontract PSI work to SGS. This arrangement no longer holds, as a new entity, PTSI, is increasingly undertaking PSI on its own account in exporting countries. PTSI is now the official contractor for PSI in Indonesia, and subcontracts to SGS pending the establishment of its own inspection capacity abroad.

Monitoring and Control of Tariff Exemption Regimes

26

Preshipment Inspection Services Box 1.3: ExportRelated Duty Exemptions and Revenue Risk: The Sri Lankan Experience From 1977 onward, Sri Lanka adopted an increasingly exportoriented and marketbased economic development strategy. Generous incentives were introduced to attract capital to the island, especially exportrelated investments.

Over the years, Sri Lanka's Export Development Board has developed five separate duty remission and refund schemes, all of which are available to exporters and indirect exporters (firms supplying exporters). The schemes are as follows:

i) Temporary Importation of Goods for Manufacture and Export (TIEPS) Under this scheme, exporters are authorized to import inputs free of duty without going into bond. The scheme relies largely on selfdeclaration, both in terms of input usage and the technical coefficients (conversion ratios) used for calculating materials used in export production. Controls and verification are particularly difficult in the case of indirect exporters.

ii) Duty Free Replacement of Goods This scheme allows exporters to claim for the dutyfree replacement of dutyinclusive inputs already used in exports. This arrangement is supposed to serve casual exporters, and control is relatively straightforward.

iii) Bonding Scheme for Exporters Exporters are required to place their dutyexempt imported inputs in bond, pending their incorporation into exports. Some control problems relating to the security of goods in bond have been encountered under this arrangement.

iv) Exemption of Fiscal Levies on Capital and Intermediate Goods Benefits are supposed to be proportional to the degree of export orientation, which makes monitoring and control particularly complicated.

v) Customs Duty Rebates A committee has fixed conversion and wastage factors for about 150 products under this scheme.This is the most secure arrangement from a revenue perspective, but worth less to exporters because of delays and costs in securing refunds.

Monitoring and Control of Tariff Exemption Regimes

27

Preshipment Inspection Services

The proliferation of schemes clearly raises administrative costs to the government and complicates control procedurces. But the liberal and fiscally porous TIEPS scheme is not the most generous arrangement avaliable to exporters. Firms registered under the Sri Lankan Board of Investments (BOI) are more privileged still. The precursor of the BOI, the Greater Colombo Economic Commission, used to manage export processing zones on the island, but in the drive to attract investors and promote exports, the government increasingly allowed firms with de facto extraterritorial tax status (as accorded within processin zones) to locate outside the zones. The practical result is tha many of today's BOI firms not only enjoy highly generous tax treatment, but are subject to the most cursory, or even nonexistent administrative controls.

Although evidence is lacking, it has been argued that some firms have located in Sri Lanka not because of returns from exporting, but because of the scope for using exportrelated duty free privileges to make profits through sales in the domestic market. There are no reliable estimates available of how much revenue is foregone through poorly monitored export incentive schemes. Some government officials have suggested, however, that over 10 percent of tariff revenue may go uncollected in the textiles and garment sector alone. in the domestic market8 or for export, although in the former case there are additional tax liabilities. In addition, producers within the zone are permitted to subcontract some processes outside the zone, and in this case additional controls are required to prevent leakages into the domestic market. Are PSI companies well placed to support the efforts of governments to control leakages arising from exportrelated tax privileges? The Government of Sri Lanka has been considering the possibility of hiring a PSI company to provide a system for monitoring and controlling exportrelated duty exemptions. The system would be designed to maintain a remission approach to tax exemption (as opposed to refunds) that would imply minimal interference with export activities and at the same time secure the revenue. The system would be based on computerized stock control, with a data base containing records of all imports of dutyexempt inputs, conversion factors and wastage ratios, and all export records. Such a system would permit the authorities to determine at any time what stocks of dutyexempt inputs a firm should have in hand. An indication of which firms to audit would be provided by an examination of imputed stock levels, and risk profiles of manufacturers would be established to supplement normal random audit procedures. If a firm's imputed stock levels were too high, for example, this could be prima facie evidence that goods were being leaked onto the domestic market. This system would be linked to customs computers, and customs officers would be responsible for the physical inspections required to make the control system credible. In addition to stock audits, occasional physical inspections would be required in respect of imports and exports. The system as described, or something along these lines, could be designed and operated by a number of parties, including customs departments, or private firms and international agencies engaged in programs to automate tax administrations in developing countries. There is no intrinsic reason why these entities could not supply such a service instead of a PSI company. Where PSI companies are particularly useful, however, is in providing an Monitoring and Control of Tariff Exemption Regimes 28

Preshipment Inspection Services independent source of information which will ensure that correct data on the quantity and nature of dutyexempt imports are entered in the system.9 It is physical inspection and not the price verification function of PSI that is important in this context, because the revenue risk derives from misdescription of goods or understatement of quantities, and not from the manipulation of value.break 8 Firms located in export processing zones are permitted to sell 15 percent of their output locally. 9 If the authorities fail to detect fictitious quantities or false descriptions of imported inputs entitled to exemption from duties, then information on imputed stocks generated by the control system is useless from the point of view of revenue security.

Other Related Functions of PSI Services A number of subsidiary services flow naturally from the supply of primary PSI services,10 and may be available at little or no extra cost. Additional services from which governments might wish to benefit have been summarized below under eight separate headings. Many of these are customsrelated, in the sense that they assist customs in the performance of its traditional functions. Others would not normally be provided by a traditional customs service. While many of the services mentioned below might be most efficiently provided by a PSI company if a primary PSI services contract is already in operation, they are essentially of a subsidiary nature, and therefore other suppliers besides the PSI companies could provide them.
Verification of Origin

The origin of products matters to governments whenever imports are treated differentially according to source, whether because of trade preferences, health, sanitary or phytosanitary restrictions, antidumping or countervailing duty actions, or any other similar consideration. The need to identify goods by origin is becoming more widespread, especially with the increase of preferential trading agreements in many parts of the world. Where it is necessary to establish the origin of goods for the above reasons, import authorities normally rely on certification by chambers of commerce, diplomatic missions, or the government of the exporting country. Since PSI companies must examine invoices in order to undertake their inspection and verification functions, it is a relatively simple matter for them to verify the existence of declarations of origin.
Monitoring of Compliance with National Regulations

Preshipment inspection companies can monitor national regulations provided they are supplied with the necessary information by their principals. This is a feature of a number of PSI contracts, normally performed at the first stage of the process, when importers submit documentation (including a pro forma invoice) signalling the intention to import. Control of imports that are prohibited or under a quantitative restriction is straightforward, although it is necessary to ensure that the requisite information is available at every stage of a PSI intervention, since few, if any, deliberate attempts to circumvent import restrictions will be reflected in an invoice.
Data for Statistical Purposes

A major obstacle to sound economic management in many developing countries is the paucity of timely and reliable data. The number of countries that cannot produce recent trade data is surprisingly high, considering that trade statistics should be among the earliest andcontinue 10 Primary PSI services are defined as those already discussed in this chapter, relating to the detection of foreign exchange and revenue fraud via misinvoicing.

Other Related Functions of PSI Services

29

Preshipment Inspection Services easiest that can be reliably generated. Table 1.4 indicates the most recent year in which trade data were reported to the United Nations by selected developing countries.11 Preshipment inspection companies automatically accumulate trade flow data in respect of all the goods they are required to process. For many PSI users, that is a large share of total trade. But in order to compile complete trade statistics, PSI companies would also need to receive copies of all import entries. Apart from the capacity to produce trade statistics, PSI companies could be asked to undertake analyses of such matters as trends in trade flows and the relationship between trade and revenue collections. In most PSIusing countries, governments are not taking advantage of these possibilities to acquire information and analytical support. Peru is an exception in this respect, where regular reports and studies are called for. In the Central African Republic, the PSI company was computerizing all information relating to exemptions and handing it back to customs in a useable form. Some governments may hesitate to seek these kinds of services from a PSI company because of the feeling that such relatively straightforward matters should be attended to internally by the relevant government entities. A more constructive approach might be to seek PSI company cooperation in establishing the local capacity to perform these functions. As noted later, customs training is available from several different sources, and building up data management skills should ideally form part of a larger customs modernization and reform program.
Price Data for a Customs Valuation Data Base

Unit price data generated by PSI companies in the performance of their contractual services belong to the principals. Few customs services seek this information for use in customs valuation work, mainly because they are not adequately automated and do not possess a proper valuation data base. This situation is changing. In the recent Kenyan contract, for example, there is an explicit requirement that all data generated through PSI is supplied to the customs service in machine readable format. Although historical unit price series can be a useful aid to valuation for duty purposes, there is always a risk that an overly rigid use of this information will lead to arbitrary outcomes. This concern becomes more acute the more heterogeneous are the products within a single product description. The underlying problem is that strict use of historical unit prices would lead to a de facto minimum price regime for customs valuation, and fail to reflect numerous factors that can affect prices. Minimum prices are not permitted under GATT valuation rules, except as a transitionary measure (see chapter II). A more enlightened, and widely used, application of historical price data is to establish valuation ranges and shape expectations about prices in approximate terms. Price data generated by PSI interventions couldcontinue 11 The dates in Table 1.4 do not necessarily indicate precisely the latest year for which national statistics are available, but they are suggestive of the long time lags that are often involved in generating trade data.

Table 1.4: The Availability of Developing Countries' SITC Revision 1 Comtrade Statistics as of January 1994 .

Number of Count Statistics Through Countries with Available Information 1992 Argentina, Bangladesh, Belize, Bolivia, Brazil, Bulgaria, Chile, China, Colombia, Cyprus, Ecuador, Egypt, Fiji, French Guiana, Guadeloupe, Guatemala, Honduras, Hong 1992 OECD Imports ($ billion) 372,931.7 Containing Gaps 13

To

44

Price Data for a Customs Valuation Data Base

30

Preshipment Inspection Services Kong, Hungary, Indonesia, Israel, Jordan, Kiribati, Macau, Martinique, Mauritius, Mexico, Morocco, Nicaragua, Taiwan (China), Pakistan, Panama, Papua New Guinea, Paraguay, Phillippines, Reunion, Singapore, Sri Lanka, Thailand, Trinidad/Tobago, Tunisia, Turkey, Uruguay, Venezuela 1991 Algeria, Angola, Barbados, Cameroon, Cook Islands, Costa Rica, Djibouti, Dominica, E1 Salvador, Ethopia, Faeroe Islands, Grenada, India, Jamaica, Madagascar, Malaysia, Netherland Antiles, Oman, Peru, Poland, Qatar, Romania, Senegal, Seychelles, St Lucia, Togo, Tonga, Vanuatu, Zimbabwe Czechoslovakia, Kenya, Libya, Malta, Nepal, Syria Aruba, Brunei, Central African Republic, Cuba, Kuwait, Saudi Arabia Bahamas, Bahrain, French Polynesia, Nigeria, United Republic of Tanzania Congo, Malawi, United Arab Emirates Bermuda, Cote d'Ivoire, Dominican Republic, South African Customs Union Cape Verde, Ghana, Liberia, Sierra Leone 84,781.9 19

28

1990 1989 1988 1987 1986 1985 1884 1983

23,620.0 42,463.9 1,748.6 11,647.6 15,269.4 16,816.6 1,973.9

6 5 3 2 1 3 2 40

6 6 3 2 3 4 4

19,417.1 Afghanistan, American Samoa, AntiguaBarbuda, Benin, Bhutan, British Virgin Islands, Burkina Faso, Burundi, Cayman Islands, Chad, Christmas Islands, Cocos Islands, Comoros, Equitorial Guinea, Falkland Islands, Yeman, Gabon, Gambia, Gibralter, Guam, Guinea, GuineaBissau, Guyana, Haiti, Iran, Iraq, Lebanon, Maldives, Mali, Mauritania, Mozambique, Mymar, New Caledonia, Niger, Rwanda, St. Vicent and the Grenadines, Samoa, Sao Tome & Principe, Somalia, Sudan, Suriname, Tokelau, Turks and Cacos, Tuvalu, Uganda, U.S. Virgin Islands, Zaire, Zambia

48

Source : United Nations Statistical Office prove useful to many governments, especially as customs services develop their own valuation capacity.
Technical Assistance, Technology Transfer, and Training

Preshipment inspection companies generally offer training and technical assistance as part of a PSI package (Chapter III). Indeed, most recent contracts include provision of training as part of the service. While there is no doubt that PSI company personnel possess many of the skills sought by national customs services, it is questionable whether these companies should be expected to provide a full training service at the same time as delivering PSI services. Training should be considered part of a wider modernization and automation program in Technical Assistance, Technology Transfer, and Training 31

Preshipment Inspection Services customs. Viewed in this way, it makes sense for governments to design independent programs for customs reform, and then to call upon PSI company resources for specific training inputs. This approach has proved quite successful in some countries, such as the Philippines, while in others little effort has been made by governments to benefit from training opportunities. Preshipment inspection companies are generally less enthusiastic about training if it does not appear to be part of a larger reform effort. Despite the argument made here that PSI company contributions to training should be defined primarily by third parties responsible for customs reform, it should be borne in mind that training can provide a useful vehicle for breaking down barriers between customs services and PSI providers. Not surprisingly, national customs services are often hostile toward PSI companies, seeing them as usurpers of traditional customs functions. Among some customs officials at least, PSI companies are doubtless seen also as potential spoilers of opportunities for financially profitable collusion with importers, involving understatement of the latter's tax liabilities to the government. Moreover, the fact of hiring a PSI company amounts to a less than subtle statement of the principal's lack of faith in the ability and/or willingness of customs to do its job. It is a challenge for the government, as well as management in customs and the PSI company, to establish a working relationship that ensures value for money from PSI services, maintains morale in customs, and creates incentives to improve customs services. Close cooperation between customs and PSI companies, facilitated through the transfer of skills and technology, will hasten progress toward the establishment of a modernized, efficient and dependable domestic customs service.
Monitoring of Donor Funds and Foreign Exchange Replenishment

In a number of African countries, where World Bank and other donor funds provided as balance of payments support can only be released against proof of appropriate use of earlier disbursements, some difficulty has been encountered by governments in supplying adequate evidence. This is attributable primarily to the poor statistical infrastructure with which governments are attempting to work. Preshipment inspection documentation is being used incontinue

some cases to generate the necessary documentary evidence of importation. It is concern about the management of donor funds that has often prompted the World Bank to insist that governments employ the services of PSI companies. One of the simplest arrangements using PSI data would be for the report of findings (ROF) to serve as evidence of importation. This would be a reasonably secure procedure in situations where the ROF is only issued against proof of shipment. Where proof of shipment is not required, or where smuggling is pervasive and the ROF is only obtained in order to effect payment for imports through the banking system,12 it may be necessary to match ROFs with import entries. In any event, PSI documentation can prove useful as a source of evidence of importation where needed disbursements are being delayed on account of these difficulties. In an increasing number of countries, however, the liberalization of foreign exchange markets is beginning to lessen the need for PSI on these grounds. If market mechanisms can be relied upon to allocate donor funds, and donor funds are untied, PSIgenerated documentation becomes less important as evidence of import transactions.
Trade Facilitation

One of the most frequent criticisms levelled against PSI is that it causes costly delays and constitutes a barrier to trade. This issue is taken up in detail in subsequent chapters. The other side of the coin, however, is the possibility that PSI may actually speed up transactions and facilitate trade. This was clearly the experience of Indonesian importers after SGS was contracted in 1985 (chapter III). There are three principal sources of potential trade facilitation arising from preshipment inspection. One relates to differences in the technical characteristics of PSI Monitoring of Donor Funds and Foreign Exchange Replenishment 32

Preshipment Inspection Services as opposed to traditional customs interventions. The second concerns technological advances in transport which PSI can take advantage of, and the third is about discretionary power in customs. Each of these will be touched upon briefly here, and will be addressed in greater depth later in the study. Preshipment inspection companies can undertake a given degree of physical inspection with greater efficiency than traditional customs services simply because PSI occurs at the stage of loading, whereas inspection upon arrival by customs requires that containers are destuffed and then restuffed.13 This difference is important where the objective is physically to inspect a large proportion of all imports, because risks from fraud are considered large, but will become largely irrelevant as customsrelated fraud diminishes. A customs service can only reasonably expect to inspect physically 510 percent of all consignments (in a moderately busycontinue 12 It will be recalled from the brief description of the PSI process given earlier in this chapter that presentation of the ROF is usually a prerequisite for negotiating the release of funds for the payment of goods. 13 This problem is obviated if customs officers are willing to accompany goods to their final destination to carry out physical inspections. This is a practice that some customs services, such as United States Customs, is unwilling to adopt. Even if inspections are contemplated outside customs premises in importing countries, it would only be practical for most customs services to undertake relatively few of them because of the additional costs involved.

port) without causing significant delays in trade. In many industria countries, physical inspections cover significantly less than 5 percent of all consignments. Customs services that claim to do much more than this by way of physical inspection are probably opening containers and examining a few items near the container doors, rather than undertaking a thorough examination. With PSI, on the other hand, thorough physical inspection can go up to one hundred percent. Thus, where governments consider necessary more than a very modest incidence of physical examination, PSI can facilitate trade. Second, with most trade today containerized (except bulk commodities), it is possible for PSI companies to seal full container loads (FCLs) ex factory, or at the point of embarkation.14 The advantage of this practice is that customs in the importing country can treat sealed FCLs as lower risk consignments and allow them through customs without physical examination.15 Again, the value attached to this feature of PSI is influenced by the desired degree of reliance on physical examination. There are not many examples where PSI companies are contracted, or even encouraged, to seal FCLs, despite the obvious advantage this would imply for many customs services in developing countries. Indonesia is an exception, since sealed FCLs played a major part in Indonesia's trade facilitation success story. Unless contracted to do so, PSI companies tend to be reluctant to verify container seals, since the procedure adds to inspection costs. Moreover, techniques exist for opening containers without breaking the seal, so full cooperation from customs is essential for the system to work well. Third, PSI can facilitate trade in circumstances where contracting for the service is a means of circumscribing poor performance or malfeasance in the national customs service. If imports are unreasonably delayed through inefficiency in customs, or because delays are engineered as rentseeking devices, then any PSI arrangements that shortcircuit such behavior will facilitate trade.
Consumer Protection

Preshipment inspection is sometimes referred to, somewhat misleadingly, as a service that includes in its objectives the protection of consumers. An analogy with customs explains the key difference here between incidental benefits and contracted output. Customs services do not traditionally vouch for quality, but their standard physical and pricerelated interventions might detect quality deficiencies. Similarly, PSI companies might, in the course of their inspections, bring to light irregularities whose detection is of benefit to consumers. Consumer Protection 33

Preshipment Inspection Services Such benefits can take the form both of detecting physical deficiencies and overpricing ("price gouging"). But consumer protection is not part of the service in governmentrelated PSI contracts.break 14 Preshipment inspection companies will not seal consolidated FCLs unless they have inspected the consignments of all the exporters making up the full load. 15 Under a good customs system, these FCLs would still be subject to occasional physical inspection on the basis of a random selection procedure.

In this respect, governmentmandated PSI is quite different from the commercial inspection work that is the mainstay of some PSI companies. Commercial inspection involves verification of a product's qualities, characteristics or performance, and the service is considerably more costly than government PSI work. What the physical inspection under governmentmandated PSI verifies is that the goods presented for shipment correspond to the description provided of them in the pro forma invoice. Although the contractual obligations of PSI companies do not protect the consumer, informed consumers can use PSI companies to protect their interests. By insisting that a supplier includes particular specifications and details on a pro forma invoice, an importer can ensure that the PSI company will be obliged to check that the goods in question conform to these details. An imaginative use of the service in this manner may be one factor, among others,16 that helps to offset what exporters and importers are otherwise likely to regard as an imposition. Finally, in the context of consumer protection considerations, it is perhaps worth briefly mentioning the legal liability question. Preshipment inspection companies define the legal liability in terms of their contractual relationships with governments, and not in relation to the buyers and sellers with whom they interact. This has occasionally caused resentment on the part of importers, when they believe they have lost money on account of error or negligence on the part of a PSI company. In such circumstances, formal legal recourse is unlikely to be successful, unless the case is taken up by the contractor (government). Preshipment inspection contracts usually specify legal liability limits. A commonly encountered limit is ten times the value of the PSI fee.break 16 Other reasons cited by importers as to why PSI might not be considered merely an inconvenience include its trade facilitation effects (as discussed above), and the fact that it "levels the playing field" as between honest and dishonest traders.

Chapter II PSI Services, International Obligations, and the Criticisms of Exporters

Following the presentation in the previous chapter of the menu of services that a government could acquire through a comprehensive PSI contract, the present chapter surveys the debate that has taken place on aspects of PSI in a variety of institutional settings. Preshipment inspection has been the subject of considerable criticism in a number of fora, principally from the perspective of exporters subject to inspection. This chapter discusses the key criticisms that underlie these discussions and give rise to disquiet in exporting countries about the effects of PSI on international trade. It also evaluates some of the suggested alternatives to preshipment inspection. The debate on PSI has taken place principally under the auspices of the United Nations Economic Commission for Europe (ECE), the United States International Trade Commission (USITC), the International Chamber of Commerce (ICC), and, in the last year or two, the Customs Cooperation Council (CCC). A concrete outcome of the earlier discussions within these organizations was the inclusion of PSI on the Uruguay Round agenda and negotiation of the Agreement on Preshipment Inspection. The agreement will be analyzed in this chapter, along Chapter II PSI Services, International Obligations, and the Criticisms of Exporters 34

Preshipment Inspection Services with a number of issues concerning the relation between PSI and procurement, as well as PSI and customs valuation. Exporter Concerns regarding PSI
The Economic Commission for Europe

The first critical discussions of PSI took place in the early 1980s in the ECE's Working Party on Facilitation of International Trade Procedures (WP.4). In September 1982, WP.4 adopted a recommendation on the Discouragement of Preshipment Inspection, which read as follows: "The present trend towards increased inspection of goods for purposes other than phytosanitary, sanitary and veterinary controls causes serious concern because of its implications in the form of costs and delays. This practice should be discouraged; when there is legitimate need for inspection the authorities concerned should accept certificates issued by official control bodies in the country of export."1 continue 1 Recommended Measure 8.2 "Discouragement of preshipment inspection." Item 1.2.9 of the program of work.

The reference to additional costs and delays in this recommendation were only part of a much broader attack on PSI in exporting countries, both at the conceptual and operational level, which reached a peak in the latter half of the 1980s. A strong sense of frustration and helplessness was apparent from exporters' complaints, and in the late 1980s governments started taking these complaints seriously. Most fundamentally, exporters maintained that PSI companies were simply too powerful and too unaccountable. It was argued, for example, in the ECE deliberations that "[b]y undertaking functions normally carried out by governments, PSI companies assume the role of government but do not assume the same responsibilities to conform to international standards" (ECE, 1987). The main complaints against PSI voiced in WP.4 and elsewhere are summarized in Box II.1, and discussed further below. The ECE had been discussing complaints about PSI from the early 1980s. The discussion was based largely on submissions from individual governments, which in turn were a reaction to representations by individual exporters and industry associations. In common with deliberations on the issue in the United States and the ICC, little or nothing was said about the customsrelated or revenue aspects of PSI services. This reflected the fact that PSI contracts in the mid1980s were still predominantly concerned with capital flight and overinvoicing.
Customs Cooperation Council

Only the recent, brief discussions in the CCC have focused on underinvoicing and the customs aspects of PSI services. Indeed, the CCC is only concerned about the customsrelated aspects of preshipment inspection. A document of the CCC's Policy Commission (CCC, 1993) expresses consternation at the implications of PSI for customs: "With the implementation of the GATT Agreement, PSI should cease to be a significant trade issue according to the International Federation of Inspection Agencies (IFIA). While this may be the case, PSI will certainly remain as a very controversial customs issue. The GATT agreement basically addresses the concerns of the exporting countries in relation to the application of PSI. It is not concerned with the plight of the PSI user countries whose revenue institutions are being seriously undermined by the growing use of PSI. It seems likely that when the Uruguay Round is finalized, this PSI agreement will do little to curb the enthusiasm of governments for PSI. It may, in fact, give PSI a new legitimacy and respectability in international trade." Exporter Concerns regarding PSI 35

Preshipment Inspection Services The CCC document acknowledges, however, that PSI services are often contracted by governments because of the perception that national revenue collection institutions are not performing their duties in a satisfactory manner. Having recognized that the performance of customs is a problem, the document goes on to recommend remedial action through improved training and modernization of national customs services. The customsrelated aspects of PSI services are discussed in detail elsewhere in this study. The main purpose of raising the question here is to emphasize that much of the earlier international discussion on PSI focused little on thecontinue

Box II.1: Exporter Complaints Against Preshipment Inspection Complaints made against the operations of PSI companies in the context of ECE, USITC and ICC discussions have been summarized under ten headings:

1.

Extra costs to producers of complying with PSI requirements;

2.

Shipping and payment delays caused by PSI procedures;

3.

Absence of recourse or appeals procedures against PSI decisions;

4.

Commercial risk from inadequate protection of confidential information;

5.

Lack of transparency and accountability in PSI criteria and procedures;

6.

Absence of agreed standards for PSI work;

7.

Discrimination among countries and exporters;

8.

Inadequate price verification methodologies;

9.

Interference of freedom of contract between buyers and sellers;

Exporter Concerns regarding PSI

36

Preshipment Inspection Services 10. Infringement of export country sovereignty. revenuerelated side of PSI activities, but was concerned instead with the complaints of exporters. This is reflected clearly in the Uruguay Round PSI agreement.
PSIRelated Activities in the United States

In the United States, interest in PSI activities burgeoned in the mid1980s, after several Latin American and Caribbean governments Contracted PSI services. These governments wished to act against capital flight occurring through false invoicing, a concern that had been sharpened by the debt crisis. But exporters were angered at the apparent power of PSI companies to prevent goods being sold at prices deemed by the companies' price inspectors to be above prevailing market prices, and alleged that PSI companies were severely damaging their legitimate trade interests. In September 1986, four Florida trade associations petitioned the U.S. government under Section 301 of the Trade Act of 1974,2 demanding that action be taken against five nationsEcuador, Guatemala, Paraguay, Jamaica, and Venezuelafor adopting practices that constituted a barrier to trade.break 2 Section 301 of the Trade Act of 1974 gives the president broad authority to act against the "unreasonable" and "unjustifiable" trade practices of other countries if these adversely affect the interests of the United States.

The petition presented some difficulty, since the U.S. government knew that PSIcontracting governments were attempting to deal with a serious problem. Even if capital flight was seen as a product of mistaken underlying policies, and there were doubts about the efficacy of the PSI solution, it would have been awkward for the United States to attempt, unilaterally, to close off the PSI option to these governments. A solution was found whereby the petition was dropped in return for the adoption of a fivepoint program of action by the administration. The five points were: i) to pursue bilateral consultations with the countries requiring PSI; ii) to pursue multilateral solutions in fora such as GATT; iii) monitor closely the activities of PSI companies in the United States, as well as any complaints against them; iv) consider possible domestic legislation or other appropriate action to limit PSI activities, and v) to request the USITC to conduct a study of PSI practices and their effect on U.S. commerce. In pursuit of this program, the United States raised the PSI issue in the GATT's Committee on Customs Valuation, and supported inclusion of PSI on the negotiating agenda of the Uruguay Round. On the domestic front, legislative proposals covering PSI were considered in the context of preparations for what was to become the 1988 Omnibus Trade and Competitiveness Act. In the end, the Act made no reference to PSI, but the conference report on the legislation urged the administration to continue to study the issue, to pursue it in the Uruguay Round, and to urge exporters and the PSI companies to establish rules "to insure that preshipment inspection activities comport with free and open commerce" (House of Representatives, 1988). The USITC study (USITC, 1987) was a systematic attempt to evaluate PSI programs and their effects. The study was based on the results of public hearings and a questionnaire sent to a sample of 643 exporting firms, of which 513 (80 percent) responded. The answers to questionnaires covered export operations to a total of 25 countries. The questions posed to exporters focused on delays experienced by exporters attributable to PSI, the number and amount of adjustments made as a result of PSI interventions, attitudes and actions of PSI companies, information sought, and costs incurred as result of PSI interventions. The survey revealed significant disquiet among exporters, with 70 percent of the sample reporting strong objections to PSI, and twothirds of these citing specific grievances. Only 19 percent of the sampled firms made favorable comments about preshipment inspection. The major complaints were about delays, additional costs, the absence of a right to appeal decisions, and unreasonable access to confidential information. While it is to be expected that most exporters would see PSI as an irksome intrusion, whether or not they were engaged in fraudulent invoicing, the results of this study cannot be easily dismissed on these grounds.3 Complaints were PSIRelated Activities in the United States 37

Preshipment Inspection Services widespread and specific, suggesting grievances in need of attention.break 3 It should be noted, however, that the information obtained through the USITC questionnaire was not subject to independent corroboration, nor were exporters required to submit supporting evidence for their questionnaire responses.

Indeed, PSI companies have admitted that there were problems, especially with the Latin American contracts, largely because many came on stream in a short period of time, and stretched the resources of the companies. They claim to have improved the efficiency and quality of the service over time. The PSI companies insist, nevertheless, that an evaluation of exporter reactions needs to be tempered by the fact that any regulations or requirements on exporters are bound to be unwelcome, especially where the intervention entails a reduction of selling prices. Moreover, the World Trade Organization (WTO) agreement on PSI directly addresses a number of the complaints made against PSI companies at this time (see below).
The International Chamber of Commerce4

In 1987, the ICC invited the PSI companies, through the Preshipment Inspection Committee of the International Federation of Inspection Companies (IFIA), to a dialogue. By March 1988, IFIA had drawn up a proposed Code of Conduct for Government Mandated Preshipment Inspection. The draft code was to serve as a basis of discussion with the ICC, and it laid down certain principles that defined PSI activities. The principles were to be conditional upon instructions issued by their principals, the contracting governments. Exporters were offered an appeals procedure involving a designated official in each of the PSI companies, or in accordance with the regulations and procedures of the importing country. In March 1988, the ICC also convened an international seminar in Birmingham, England, to which PSI company representatives, government officials and representatives of the private sector were invited. The strength on objections to PSI apparent at the meeting convinced the ICC that the IFIA code was not an adequate basis from which to work. The ICC drew up its own proposal, which, while recognizing the reasons why governments contracted PSI services, asserted that PSI should only continue for such time and with such scope as was necessary to assist developing countries in dealing with fraudulent invoicing. The ICC urged governments to provide the necessary technical assistance to developing countries in order for them to reduce their reliance on PSI services. However, the ICC also wanted governments of exporting countries to find ways of moderating any adverse effects of preshipment inspection. The ICC proposed a regulation that would require PSI firms to be licensed in exporting countries, and the licenses would lay down a series of operating conditions in order to ensure that PSI did not interfere unduly with the conduct of foreign trade or the freedom of contract. Price verification would be permitted, but comparison of prices of goods from the country of export with export prices in other countries, or with prices for shipment from the same country to different destinations, would be prohibited. Moreover, price verification was to include full consideration of actual commercial conditions and terms of sale, and should not relate to the mode of transport or the carrier. Other proposed obligations related to nondiscrimination among countries in the administration of the program, transparency, protection of confidential information, avoidance of delays, and fuller disclosure in explaining decisions.continue 4 The discussion in this section is taken, largely verbatim, from a background report prepared for this study by Peter Williams, formerly of the GATT secretariat.

Spot checks only were to be made of exporters with good records, and independent arbitration procedures were to be established. The International Chamber of Commerce4 38

Preshipment Inspection Services The ICC proposal demonstrated that the ICC did not believe that it was possible to reach a satisfactory agreement with IFIA or the PSI companies. Their position indicated that, while some of the problems of exporters stemmed from the way the companies operated, others were created by the exercise of sovereign power by user governments and that, to deal with these, the countervailing sovereign power of exporting governments would have to be brought into play. Indeed, well before serious multilateral discussions on PSI had been engaged in the GATT, at least two governments had acted unilaterally to control the activities of PSI companies in their territories. In 1983, the Federal Republic of Germany (as it then was) had determined that problems with PSI operations were on the increase, and that price inspections, in particular, were impeding foreign trade and were detrimental to the domestic export industry. A regulation was promulgated in June 1983 requiring PSI companies operating in the country to obtain a license from the Federal Trade Office. The conditions of the license relate to nondiscriminatory treatment for German exporters, factors to be taken into account in price verification, treatment of confidential business information, avoidance of delays, and the right of exporters to comment if their contract prices are not confirmed by the PSI company. In Switzerland, PSI activities carried out on behalf of foreign governments are considered official acts of those states prohibited by Article 271 of the Swiss Penal Code unless official permission has been granted. Such authorization is only granted on a casebycase basis, subject to certain conditions. Preshipment inspection companies operating in Switzerland must be established in the country under Swiss Federal Law and must limit inspections to quality and quantity. Price checks may only be carried out by a designated semiofficial body, the Swiss Office for Commercial Development (OSEC).5
The WTO Agreement on Preshipment Inspection

Growing demand for action to address the PSI question made it relatively easy to inscribe the issue on the GATT negotiating agenda, and this was done in February 1988. While Germany and Switzerland had acted unilaterally, the United States had been reluctant to do so, in part out of concern that restrictions on PSI activities could disadvantage U.S. exporters in relation to those from other countries which allowed the PSI companies free rein. However, the formal proposal to take up PSI in the context of the Uruguay Round came from Indonesia, a PSIusing country which feared that overzealous regulation of PSI at the national level in the exporting country could frustrate the objectives of PSI programs.break 5 It is expected that this arrangement will be terminated in accordance with the WTO Agreement on Preshipment Inspection.

By acceding to a multilateral negotiation on PSI, industrial countries were implicitly acknowledging that they would not challenge the existence of PSI, but rather attempt to establish rules for PSI companies to follow, and regulate their behavior. By agreeing to negotiate, user countries were, on the other hand, accepting some responsibility for the actions of PSI companies under the jurisdiction of exporting countries. But neither side was committing to a specific outcome prior to the negotiations. Most of the obligations of the agreement fall upon user governments, who are expected to ensure that their agents, the PSI companies, respect the relevant provisions. User country obligations are summarized in Box II.2. Exporter countries only have three specific obligations under the agreementnondiscriminatory application of laws and regulations relating to PSI, publication of all laws and regulations, and provision of technical assistance upon request to further the objectives of the agreement. More generally, however, exporting countries have accepted the right of PSI companies to operate within their territories, subject to the terms of the agreement.

The WTO Agreement on Preshipment Inspection

39

Preshipment Inspection Services Several specific features of the agreement are worth noting. Firstly, language in the preamble to the agreement implies that PSI is not considered a permanent feature of developing country trade policy, since the need for PSI is recognized "for as long and in so far as it is necessary to verify the quality, quantity or price of imported goods." Secondly, the nondiscrimination principle in Article 2.1 is less stringent than the GATT's mostfavorednation principle, in the sense that it calls for nondiscriminatory application of PSI, and does not require that all exporters are treated the same. In other words, some products can be exempted from PSI, provided criteria for inclusion or exclusion are objective. It is not so clear whether particular producers can also be excluded on the same basis, although the text would seem to suggest that they can. This is an important issue, because some user governments rely on selective PSI, and more are likely to do so in the future. A selective approach to PSI could mean that different producers of the same product might face dissimilar PSI regimes. The nondiscrimination requirement here would have to be that selection criteria for physical inspection were based on predetermined criteria, whether involving random selection or some kind of risk profiling. Selectivity of this kind is, after all, a basic feature of normal customs work. Thirdly, the PSI agreement explicitly excludes customs valuation from its purview, indicating in a footnote to Article 2.20 that the WTO's rules on customs valuation take precedence over the PSI agreement. As noted above, this in part reflects the emphasis of the agreement on exporter interests, and on capital flight considerations rather than customs issues. On the other hand, it is clear that many of the provisions of the agreement apply regardless of whether the PSI service is focused upon foreign exchange or revenue issues. Finally, the PSI agreement contains independent review procedures (Article 4). If a complaint brought by an exporter has not been settled through the appeals procedure provided in Article 2.21, the issue may be referred to independent review, either by thecontinue

Box II.2: User Country Obligations Under the WTO Agreement on PSI The obligations of user governments under WTO Agreement on Preshipment Inspection are set out below. Article 2 Obligations of User Members Nondiscrimination Procedures and criteria to be objective and applied on an equal basis to all affected exporters. There should be uniform performance of inspection by all inspectors.

Governmental Requirements National treatment to be guaranteed in respect of all laws, regulations and requirements.

Site of Inspection Services to be performed country of export, and only exceptionally in country of manufacture (if different), Standards Inspections to be in accordance with standards defined by seller and buyer, or in the absence of such standards, relevant international standards.

The WTO Agreement on Preshipment Inspection

40

Preshipment Inspection Services

Transparency User governments to ensure that PSI companies are fully transparent and willing to supply information on procedures, government laws and regulations, inspection and verification procedures and criteria, the rights of exporters, and appeals procedures.

Protection of Confidential Information All confidential business information to be adequately protected. PSI companies are not permitted to seek information on data covered by intellectual property rights, unpublished data other than that necessary to demonstrate compliance with regulations and standards, internal costs and pricing, profit levels, and contract terms (unless essential for inspection).

Conflicts of Interest Conflict of interest to be avoided within PSI firms, and between firms and other entities.

Delays PSI firms must respect agreed inspection dates, issue report of findings within 5 days of receipt of final documents, and if requested by exporter, perform preliminary price verification prior to physical inspection and immediately inform exporters of the result (which becomes final unless physical inspection dictates otherwise). PSI companies must also promptly correct any clerical errors.

Price Verification Price verification is undertaken to prevent over and underinvoicing and fraud. In relation to customs, the WTO's customs valuation rules are to apply. Exporters should be permitted to explain prices at any stage of the PSI process.

The basis for price comparison is the price of "identical or similar goods offered for export from the same country of exportation at or about the same time, under competitive and comparable conditions of sale, in conformity with customary commercial practices and net of any applicable standard discounts." Only prices providing a valid basis of comparison are to be used, and PSI companies shall not rely on the price of goods offered for export to different countries of importation to arbitrarily impose the lowest price.

Factors to be considered in the price comparison to include commercial level and quantity of sale, delivery periods and conditions, price escalation clauses, quality specifications, special design features, special shipping or packing specifications, order size, spot sales, seasonal influences, license or other intellectual property fees, and services rendered as part of the contract but not billed separately. Verification of transport charges relate only to agreed price of the mode of transport as indicated in the sales contract.

The WTO Agreement on Preshipment Inspection

41

Preshipment Inspection Services

Price verification cannot be based on the selling price in the country of importation, the price of goods for export from a country other than the country of exportation, the cost of production, or arbitrary of fictitious values.

Appeals Procedures PSI companies must establish specific appeals procedures and inform exporters of them. All appeals must be afforded prompt and sympathetic consideration.

Derogation PSI companies can establish thresholds below which goods are inspected only if they are split consignments, or in exceptional circumstances.K complainant or the PSI company. The independent review process involves the establishment of a panel, which must take a decision within eight working days of the request for an independent review. The panel decision is binding upon the preshipment inspection company and the exporter. The procedures for review are to be administered by an independent entity constituted jointly by an organization representing the PSI companies and an organization representing exporters. The ICC and IFIA have already agreed the necessary administrative arrangements. The independent review feature of the PSI agreement is unprecedented in GATT terms, since it involves a dispute settlement procedure in which both protagonists are private entities. Intergovernmental agreements, such as this one, can only be binding on governments with respect to matters fully within their control. Thus, the obligation on governments under the review procedures is to take "such reasonable measures as may be available to them" (Article 4) in pursuit of the stated objectives.
Have the ExporterRelated Complaints against PSI Been Answered?

Box II. 1 listed the main complaints made against PSI companies. Each of these will be considered briefly, both in relation to the substance of the complaints and the degree to which they have been addressed, especially through the WTO Agreement on Preshipment Inspection. A number of the issues raised here will be further discussed in chapter III, which looks at the experience of the casestudy countries with preshipment inspection. Extra costs to producers of complying with PSI requirements Preshipment requirements inevitably involve some direct costs to exporters. These are primarily the costs of submitting to inspectionsthe personnel and administrative costs required to arrange for inspection, complete paperwork, and so on. The USITC study (1987) estimates that additional personnel costs attributable to PSI amounted to an average of US$ 400.67 per inspected shipment. Courier fees and telephone calls came to another US$ 20.5 per inspected shipment, and other expenses (including travel) amounted to US$ 34.21 per inspected shipment. These are survey data, for which there was no independent corroboration. Even if were to be argued that these estimates overstate true costs, there is no denying that PSI does involve costs for exporters. These costs can, however, be mitigated through increased efficiency in the PSI industry. Shipping and payments delays caused by PSI procedures Just as some costs will be incurred by exporters when they are required to undergo preshipment inspection, so shipping delays are likely to occur. The costs associated with delays provoked by PSI include the opportunity cost of capital tied up in delayed shipments, and charges for letter of credit discrepancies resulting from delayed shipment. The USITC report found that delays of 21 days on Have the ExporterRelated Complaints against PSI Been Answered? 42

Preshipment Inspection Services average were being experienced in countries where PSI was required, compared to only 7 days in nonPSI countries. About 40 percent of all sampled exporters claimed to be affected. Not all of the reported delay was attributable to PSI interventions, since the distinction is between countries requiring PSI and those that do not, and not between shipments that were or were not inspected.break

If 21 days was the representative waiting time for PSI processes out of the United States in 1986, this is certainly not representative of delay times today, either in the United States or other exporting countries. It will be seen from the PSI tracking data presented in chapter III that most shipments clear all PSI processes in less than onefifth of that time. The PSI companies claim that exporters themselves, or sometimes the shippers or forwarding agents, cause delays, but prefer to blame these on the PSI companies. The tracking data can offer a partial answer to the question of who is responsible for particular delays, but the collection and presentation of this information could be improved (see chapter III). As to the costs of delays, the USITC study estimated the cost was US$69.31 on average per inspected shipment. This figure is arrived at by estimating the opportunity cost of capital for the average value of consignment during 20 days. The estimate is obviously high if the delay period is overstated. Other cost estimates, small by comparison because of their infrequent occurrence, were charges for letter of credit discrepancies and demurrage charges at the port of entry (pending arrival of the report of findings). These were estimated at US$ 1.31 and US$ 0.72 respectively per consignment inspected. The USITC estimated that total costs attributable to PSI interventions were US$ 526.72 per inspected shipment. Interpretation of these cost figures is complicated by the fact that the burden of costs varies according to consignment size. Whether or not these figures are a true reflection of what PSI services were like almost 10 years ago, this study argues that with modern communications technology, a dedicated PSI service supplier using appropriate procedures, and cooperative exporters and shippers, delay times associated with PSI can be brought down close to zero. These points are explored further in the next chapter. Absence of recourse or appeals procedures against PSI decisions A repeated complaint against PSI companies is that their decisions cannot be effectively appealed. Exporters have often complained that this onesided circumstance has been made worse by the PSI company practice of announcing the intention to adjust prices after goods have been dispatched for shipment, or even worse, once they are on the high seas. It is not difficult to see how this might happen, since a precondition for issuing the report of findings under many contracts is that evidence of shipment has been supplied.6 In the USITC questionnaires, 35 percent of the respondents whose prices had been questioned said that they were notified of the problem when the final documents (including shipping documents) had been presented to the PSI company. Some 29 percent indicated that they only received an indication of disagreement on the part of the PSI company with the invoice price after the goods had actually been shipped. Another 29 percent indicated that they had beencontinue 6 This is an important security measure to prevent smuggling or nonshipment of goods, but the possibility of dispensing with proof of shipment requirements in order to speed up document flows will be explored in chapter III.

informed of the problem during the preliminary price verification stage. From an exporter's perspective, the practice of withholding information until after shipment is clearly unacceptable. In more recent years, PSI companies seem to have increasingly adopted the approach of undertaking preliminary price verification prior to physical inspection, thus giving the exporter due warning if the invoice price is going to Have the ExporterRelated Complaints against PSI Been Answered? 43

Preshipment Inspection Services be challenged. The invoice price could still be subject to challenge, however, if the physical inspection revealed a discrepancy or additional relevant information. In any event, the WTO agreement on PSI gives exporters the right to request preliminary price verification prior to physical inspection and to be informed of the result. Article 2.20(b)(iv) also obliges the PSI company to provide the exporter with an opportunity to explain the invoice price at any stage in the verification process. In addition, the PSI agreement establishes the appeal and independent review procedures described above. Taken together, these provisions provide exporters with the ability to challenge procedures and decisions, as well as discouraging PSI company officials from taking arbitrary or illconsidered decisions. Commercial risk from inadequate protection of confidential information Although a frequently expressed complaint in ICC and ECE discussions, and in the USITC study, no concrete examples were provided of where PSI companies had actually divulged confidential information and compromised the commercial interests of a firm. Nevertheless, it is natural that there should be such concerns arising from disclosure of sensitive information to third parties. The WTO agreement has addressed this issue in two ways. First, PSI companies are held accountable for the manner in which they handle confidential information. Second, the companies are not entitled to seek certain information considered irrelevant to the performance of PSI functions. Lack of transparency and accountability in PSI criteria and procedures This complaint covers several aspects of PSI operations, from the concrete steps in the inspection and verification process to the methodologies employed. Again, PSI companies seem to have become more sensitive to the importance of providing full information to exporters, not least because this will defuse many potential conflicts and render a more efficient service. Paragraphs 58 of Article 2 of the PSI agreement spell out detailed PSI company obligations in this regard. These include procedural transparency, and full information on procedures, on the legal and regulatory mandate under which a company is operating, on criteria for physical inspection and price verification, and on exporters' rights, including the appeals procedures. The PSI companies are also required to provide information points in their offices. Absence of agreed standards for PSI work This was another general complaint from exporters, reflecting broad frustration with the PSI relationship. Like many of the other problems listed in box II. 1, the PSI agreement seeks to provide remedies, most notably through the provisions on standards in Article 2.4 (box II.2). Discrimination among countries and exporters The intensity of concern about inconsistent and discriminatory treatment is directly proportional to perceptions regarding thecontinue

cost and inconvenience of PSI services to exporters. As costs are lowered through greater procedural efficiency, this is likely to become a less pressing issue. Nevertheless, the demand for fair treatment will always be present, and the nondiscrimination requirement of Article 2.1 in the PSI agreement should provide the necessary protection. As noted above, however, clarification may be required as to whether PSI programs with selectivity features (such as occasional physical examinations) are consistent with the nondiscrimination requirement. Inadequate price verification methodologies Of all the issues raised by exporters against the PSI companies in the discussions referred to above, price verification was the most frequent and vehement complaint. This is perhaps not surprising, since interventions to control capital flight were the predominant feature of most PSI programs at this time, and correcting for capital flight meant obliging exporters to reduce invoice prices. There were two basic complaints on the pricing front. One concerned allowable differences in prices, or in other words, the factors to be considered in accounting for observed differences between an invoice price and a price verifier's notion of the comparable export price. The second was the identification of the markets in which prices were to be observed in establishing the basis for comparison. Exporters considered it unfair to use export prices from other countries, or export prices from the same country to different destinations when making the Have the ExporterRelated Complaints against PSI Been Answered? 44

Preshipment Inspection Services comparison. What they wanted was a comparison based only on sales from the same exporting country to the same importing country. In this way, the extraneous factors influencing export prices in a particular market would be properly factored into the agreement. The PSI companies assert that they never have used export prices from other countries for price comparison purposes. Considering the intensity of complaints about PSI company pricing methodologies, it is surprising that exporters surveyed in the USITC study reported that their prices were challenged in respect of only 3.5 percent of all shipments inspected. Moreover, in 66.8 percent of the cases, the inspection company was persuaded, following provision of additional documentation, that the original price was acceptable. In only 19.5 percent of the cases were prices actually lowered, by an average of 10.5 percent. These issues are further illuminated by the data from this study, presented in the next chapter. The price verification provisions in the WTO agreement on PSI respond to the exporter complaints noted above, although they do fall short of banning outright comparisons with exports to third countries. The agreement lists many adjustment factors to be taken into account when making the price comparison, and also states that consideration should be given to particular factors influencing the market in the importing country. Price comparisons can only be based on goods exported from the same country of supply. The comparison of prices of the same goods destined to different export markets is permitted, but not "to arbitrarily impose the lowest price upon the shipment" (Article 2.20(b)(ii). Moreover, price verification should not take any account of the domestic selling price in the country of importation, nor of production costs. As noted earlier, however, these strictures do not apply when PSI companiescontinue

are assessing value for customs duty purposesthe relevant customs valuation provisions apply instead (see below). Finally, it is worth noting that in some PSI contracts, particularly newer ones, PSI companies no longer oblige exporters to lower their invoice prices when they encounter overinvoicing. Instead, they report the relevant information to their principals, and leave it up to government authorities to decide whether to take the matter up with the importer. The trend of governments making themselves responsible in part reflects reduced concern with capital flight as an economic problem. This approach implies that shipments will occur anyway, and governments will have to decide whether instances of overinvoicing are sufficiently serious or regular to take up the issue with an importer. Where reporting only is required, it is important to ensure that exporters are nevertheless informed of the intention on the part of the PSI company to report overinvoicing, and be given the chance to justify the export price. Interference with freedom of contract between buyers and sellers The argument here is that if a buyer and a seller enter voluntarily into a contract, then the terms of the contract should not be subject to challenge by third parties. This is clearly not a tenable objection, since PSI companies are acting as agents for sovereign governments. Sovereign governments have the right to determine exchange and tax laws and adopt measures to curtail infringement of these laws. The question, therefore, is not about whether contracts are sacrosanct, but rather whether the nature of the intervention is justifiable in terms of other alternatives. Infringement of export country sovereignty Arguments about ways in which PSI companies might infringe upon the sovereignty of governments tend to overlook the fact that governments are free to control the activities of these firms should they so wish. The governments of Switzerland and Germany have done so. The choice of a multilateral approach to comprehensive rules on PSI certainly constituted the exercise of sovereign power by governments. The reason that sovereignty arguments were invoked in the first place is that agents of one government, the PSI companies, were operating in the sovereign territory of another. This could be interpreted as a situation in which a government has attempted to extend the territorial reach of its authority. With the PSI agreement, however, it would seem that this argument is moot, as user governments have been made responsible, Have the ExporterRelated Complaints against PSI Been Answered? 45

Preshipment Inspection Services in terms of multilaterally agreed behavioral norms, for the actions of PSI companies they contract. Some Suggested Alternatives to Comprehensive PSI In view of the kinds of problems discussed above in relation to PSI, as well as the cost of PSI services,7 several suggestions have been made over the years as to alternative approaches. One of these is a proposal by Norway whereby customs services undertake PSItype services on behalf of each other. Second, there has been some debate over the relationshipcontinue 7 The question of costs has been controversial, principally because of the perception that PSI services are too expensive. Fees under comprehensive PSI contracts amount on average to something in the region of 1 percent of the value of inspected goods. This issue is fully discussed in chapter III.

between procurement and PSI, and the question whether these are complements or substitutes. Third, price verification services have been offered, which rely either on raw invoice data, or on disaggregated trade data. These alternatives are briefly evaluated here. A fourth option, which will be discussed in the next chapter, is the use of destination inspection rather than preshipment inspection.
The Norwegian Proposal

The Norwegian Committee on Trade Procedures (NORPRO) outlined a proposed alternative to PSI in a document submitted in July 1992 to the ECE's Working Party on Facilitation of International Trade Procedures (ECE, 1992). The core of the proposal is that the customs authorities of exporting countries should make export declarations, or information contained in them, available to the customs authorities of the importing country. To the extent that exporters are legally liable for these declarations, it is assumed that the information will tend to be accurate. The customs authorities of the exporting country would certify the consistency of any PSIlike document (extract from the export declaration) with the export declaration. Once electronic data transfer between customs services is possible, the requisite information from export declarations could be made immediately available to customs in the importing country. The exporting country customs service could also provide the correct tariff classification should this be required by the authorities of the importing country. Importing governments concerned about correct invoice values and dutiable values would then be able to dispense with preshipment inspection. Would NORPRO's scheme work as a substitute for preshipment inspection?. In principle, it could, if it generates the information required by importing countries to guard against capital flight and collect tax revenues. Such an arrangement would certainly be less expensive than traditional PSI services. However, two basic questions must be asked, and there are a number of practical issues to consider as well. The first question concerns the willingness of national customs authorities to cooperate in this fashion. In order to provide a consistent and reliable service, customs authorities in exporting countries would have to devote extra resources to such an effort. In addition, they would have to be willing to accept a certain degree of liability, at least morally if not legally, if false or misleading information has been certified and passed on to the importing country. They may also be required to act against exporters making false declarations in circumstances where they would have otherwise refrained from doing so. The customs authorities of importing countries would also have to be confident of the reliability of exportingcontinue

country verifications. None of this is impossible, but customs services do seem to be some way still from entering into such demanding forms of cooperation.8 Some Suggested Alternatives to Comprehensive PSI 46

Preshipment Inspection Services The second basic question is whether information exchange would be a secure enough system of control, in the face of some of the problems currently encountered by many PSI using countries. Most countries physically inspect less than one percent of all export consignments. The NORPRO arrangement would, therefore, be a substitute for PSI without physical inspection, unless the requisite resources for physical inspections were made available. If they were, then the arrangements might not be much less costly than PSI services. More generally, a willingness on the part of exporting country customs services to undertake the necessary monitoring and supervision to ensure a secure replacement for a properly functioning PSI arrangement would imply the allocation of nonnegligible resources. Obviously, as the problems creating a need for PSI lessen, there will be less to substitute, and a relatively lowcost and acceptably secure replacement of PSI through interaction among national customs services may become feasible. Among the practical considerations are difficulties associated with customs classification, customs valuation and data transfer. Tariff classification systems are identical internationally only up to six digits on the Harmonized System. Beyond that, the customs authorities of the exporting country would be required to classify using the importing country's nomenclature. At present, countries use different systems of customs valuation, and it cannot be safely assumed that the value reported for export is the same as the value for customs duty purposes. This difficulty will diminish as developing countries move off the Brussels Definition of Value and other systems, and onto the transactions value system. Finally, electronic data interchange (EDI) is only beginning to function among government departments in a few countries, and it is likely to be some years before it becomes generally available. One of the advantages of PSI services is that the companies already use EDI for their many of their PSI operations, and are increasingly looking at ways of linking up electronically with the customs services of user governments. In summary, the NORPRO proposal merits further study. The kinds of problems raised here need to be addressed. It is difficult to envisage the creation of the necessary conditions for the arrangement to work in the near future, but the approach proposed by the Norwegians may prove useful in a context where governments are phasing out their reliance on PSI services.
Preshipment Price Verification without Physical Inspection

Although not strictly a substitute for PSI, the idea is being increasingly discussed of using PSI expertise for price verification without physical inspection, or with limited randomcontinue 8 Examples of cooperation between national customs services along the lines suggested in the NORPRO proposal, seemingly only for statistical purposes, exist on trade between the United States and Canada and between Australia and New Zealand.

and targeted physical inspection. A service based on this concept was offered some years ago by a firm called Trade Audit. The socalled Price Audit System (PAS) involved the electronic transmission of invoice data to the commercial firm located in the exporting country, which would then issue a finding as to whether the invoice price should be modified for customs duty purposes, or on account of overinvoicing. Even though PAS is conceptually equivalent to PSI without physical inspection, it appears that no governments have contracted for the service. Preshipment inspection companies seemed unwilling in earlier years to undertake price verification without physical inspection, but a selective approach to physical inspection has been considered recently in preparatory discussions on some PSI contracts, including those for Kenya and Malawi. As discussed in more detail in chapter IV, selective physical inspection is a step in the direction of reducing reliance on PSI services, as well as a way of reducing costs. The feasibility of adopting selective physical inspection, or eliminating it altogether, without incurring undue revenue risk, depends on the ability and willingness of the national customs services to fulfill Preshipment Price Verification without Physical Inspection 47

Preshipment Inspection Services their traditional functions. It is important to distinguish between price verification without physical inspection under a PSI contract from the straightforward sale of unit price data by PSI companies. In the first case, individual invoices are examined, whereas the second service would amount to supplying information for a price data base. The PSI companies appear unwilling to sell unit price data independently of broader PSI services. This is probably a commercial decision, but there would also be a legal impediment to selling one government the price data generated in the context of a comprehensive PSI service performed for another government.
Preshipment Inspection and Procurement

It has sometimes been argued that procurement services could be a substitute for preshipment inspection. More frequently, the argument has been that where there is procurement, PSI becomes redundant. In effect, procurement and PSI functions are quite distinct, but potentially overlapping. A major difference between the two services is that procurement is performed prior to contract signature, whereas PSI is a postcontractual verification service. Moreover, the suppliers of procurement services are agents of the buyer, while PSI providers interact with traders not as their agents, but as agents of governments seeking to verify the legitimacy of traders' transactions. The menu of potential procurement services spans the entire supply cycle. Services offered include specification of goods to be purchased, advertising and tendering, prequalification selection of bidders, bid evaluation, contract negotiation and placement, technical inspection, shipment and insurance, payment and accounting services, and assistance with receipt, warehousing and distribution of procured goods. The fees for procurement may typically range from anywhere between 3 percent and 8 percent of the value of procured goods, depending on the services required and the size of the procurement contract. Procurement is more expensive than PSI, which generally costs around 1 percent of the value of inspected goods.break

Procurement obviously does more than preshipment inspection. If it is properly performed, a purchaser should be able to secure the best buy on the best terms and conditions available, since it is the procurement agent's job to select among alternatives. The postcontractual nature of PSI, on the other hand, limits the service to a guarantee that the value, description and classification of goods are correctly declared. Preshipment inspection cannot ensure that buyers are obtaining the best value for money only that they are receiving the goods as described in the invoice, and that their value is not fraudulently stated. Procurement agents have sometimes argued that since they vouch for the price and quality of goods, PSI is redundant. This argument is only valid if procurement agents actually carry out the verification functions of PSI, in order to guard against fraudulent behavior on the part of any parties to the transaction in question. For the most part, procurement entities do not possess the inspection networks that PSI companies have developed, and do not offer systematic physical inspection services. If governments hire PSI services because they are concerned about revenue fraud, illegal asset transfers, or capital flight perpetrated through physical misdeclaration, then the fact that goods have been purchased though a supervised bidding procedure or direct contract negotiation9 is unlikely to obviate the need for preshipment inspection. The situation with regard to price verification is more delicate, and this is where procurement and PSI agents are more likely to come into direct conflict. The difficulty is that if PSI price verification leads to a price challenge, this is tantamount to criticism of a procurement agent's professional competence, or worse still, could be interpreted as an implied accusation of malfeasance. A more technical consideration relates to the problem of postbid or postcontractual price negotiations. This is the same problem faced by a PSI agent who is required to adjust an invoice price downward upon detection of overinvoicing, but it is exacerbated in this case by the presence of a procurement agent who has already approved a price on behalf of the principal. A government is Preshipment Inspection and Procurement 48

Preshipment Inspection Services unlikely to welcome the specter of two different agents it has contracted engaging in a dispute about the price of goods that have already been purchased. Indeed, the current World Bank procurement guidelines stipulate that goods subject to full international competitive bidding are to be exempted from PSI price verification (but not physical inspection). If goods that have been professionally procured by an agent are not to be subject to PSI price verification, there is still the question whether it is appropriate for PSI companies to verify the classification of goods. Where a government feels the need to employ PSI services to guard against revenue fraud, and if the goods in question are subject to duties and taxes, then the fact that they have been professionally procured does not eliminate the need for a tariff classification check, even if no price verification exercise is to be performed.break 9 Procurement agents operate either open or selective bidding processes (using international competitive bidding, limited or restricted bidding), or they enter into direct contract negotiation, depending on the nature and value of goods or services to be purchased.

The expertise for verifying tariff classification might be supplied by procurement agents or by PSI agents, but there could be a particular advantage in giving a PSI firm this role. This would be the case where PSI documentation is considered important as a means of checking that the national customs authorities are collecting all duties and taxes due. As discussed elsewhere in this study, a major role for PSI companies is to generate the necessary information for government authorities to ensure that both importers and tax collectors fulfill their functions. As long as governments believe they need PSI, therefore, it would seem to make sense for PSI companies to generate the requisite documentation and verify tariff classification in respect of procured goods in the same way as goods purchased without procurement agents. There could be an exception to these requirements if procured goods are taxexempt.
Preshipment Inspection and Customs Valuation

As noted earlier, the WTO Agreement on Preshipment Inspection states that it is not this agreement, but rather the agreement on customs valuation10 that will regulate PSI price verification activities in respect of customsrelated work. It is unclear what the practical implications will be for PSI companies of bifurcated rules on price verification that is, where the PSI price verification rules apply in the case of overinvoicing and the customs valuation rules apply when underinvoicing is detected. The PSI companies will be answerable in terms of both methodologies, and will presumably have to apply the relevant one to each circumstance. In the customs valuation field, PSI companies will have to apply prevailing valuation rules, and may have to adapt their methodologies and procedures to accommodate the fact that all user governments of PSI services have committed themselves to adopting the WTO valuation agreement. As explained by the Customs Cooperation Council (CCC, 1992), valuation for customs purposes can be based either on a notional or a positive concept. While Article VII of the General Agreement on Tariffs and Trade sets out some general principles on valuation,11 it is the Brussels Definition of Value (BDV) and the transaction value methodology of the 1979 GATT agreement on customs valuation that have dominated valuation practices. The BDV is a notional concept, which defines a "normal price" as the price "payable on a sale in the open market between a buyer and a seller independent of each other." Thus, the BDV relies on the notion of a prevailing market price adjusted for circumstantial factors (such as quantity, nonarmslength transactions, special delivery, special design, etc.). The transaction value, on the other hand, is a positive concept, based on the price "actually paid or payable for the goods when sold for export to the country of importation . . ."break 10 Formally, this is known as the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.

Preshipment Inspection and Customs Valuation

49

Preshipment Inspection Services 11 These principles include the requirement that value is assessed on actual value and not on the value of goods of national origin or on arbitrary or fictitious values. Actual value is defined as the price at which goods are sold or offered for sale in the ordinary course of trade under fully competitive conditions (with appropriate adjustment factors).

In practice, the BDV and transaction value for a given product may turn out to be virtually the same, since in both cases the invoice value will often be accepted as the basis for valuation for customs duty purposes. The fundamental difference is that under the GATT methodology, there is a stronger presumption that the invoice value is the transaction value. The burden of proof for not accepting the invoice value falls more heavily on the customs authorities under the transaction value method than under the BDV, although there has been a partial reversal of the burden of proof under the Uruguay Round agreement, which is otherwise identical in most respects to the GATT agreement. Five secondary methods of valuation are foreseen in the event that all the conditions of transaction value are not met. There are four basic conditions for accepting the transaction value (CCC, 1985). These are that: i) there are no restrictions on the disposition or use of the goods; ii) there is no condition or consideration for which a value cannot be determined; iii) there are no subsequent payments to the seller in respect of the resale, disposal or use of the goods for which an adjustment cannot be made in accordance with the provisions of the transaction value methodology; and iv) the price is not influenced by a relationship. The secondary methods of establishing customs value under the transaction value methodology, which must be applied in a hierarchical order, are described by the CCC as follows (CCC, 1985): " . . . the customs value established at or about the same time for identical goods, the customs value established at or about the same time for similar goods, the selling price in the country of importation of the imported goods, or identical or similar goods, with appropriate deductions, and a value computed from the cost of materials and manufacture, profit and general expenses and transport costs as appropriate . . . Each of the secondary methods . . . is selfcontained and stands on its own, irrespective of how the result may compare with a determination which might have been reached by another method. (There is) a final fallback method under which one of the preceding standards may be applied with greater flexibility or where none can be used any appropriate basis provided it does not conflict with (any) principles and general provisions [of the customs valuation rules]." As noted above, the transaction value methodology was originally formulated in the GATT Customs Valuation Agreement. This agreement was negotiated in the Tokyo Round of multilateral trade negotiations (197379), and came into force shortly after the completion of the negotiations. It was designed to replace the BDV, mainly on the grounds that the latter was imprecise and quite vague on key points, difficult to amend, and gave too much discretion to customs authorities. The GATT valuation Agreement, on the other hand, was seen as more attuned to commercial realities, more precise, more neutral, and less likely to lead to adjustments of invoice values by customs authorities. Many developing countries did not adopt the GATT Customs Valuation Code, preferring to retain the BDV or similar valuation methods. A major concern expressed bycontinue

developing countries was that it would be difficult for customs authorities to dispute false declarations (CCC, 1992). The argument was that the agreement relied too heavily on the good faith of all parties, while underinvoicing was commonplace in many developing countries. A number of specific technical points were identified as problematic, including provisions regarding related parties, identical and similar goods, computed values, and the treatment of royalties and license fees. In addition to the broad concern about fraud, Preshipment Inspection and Customs Valuation 50

Preshipment Inspection Services revenuerelated problems included the treatment of price discounts for sole agents, sole distributros and sole concessionaires, buying commissions, advertising and royalties. Under the WTO, all countries will be required to subscribe to the Customs Valuation Agreement, as modified in the Uruguay Round. In recognition of the difficulties faced by developing countries, two decisions on customs valuation are appended to the WTO agreement one dealing with the burden of proof in circumstances where the truth or accuracy of a declared value is doubted, and the other with minimum values and imports by sole agents, sole distributtors and sole concessionaires. In the first of these decisions, the customs authorities are authorized to demand further information or explanations from importers when they doubt the truth or accuracy of a declaration, and then to reject the invoice value as the transaction value if they are still not satisfied. The importer is entitled to know the reasons, in writing if so desired, why a declaration has not been accepted, and be given a reasonable time to respond. When a final decision is made, the customs administration is required to communicate the decision and the grounds for it to the importer in writing. These arrangements put a larger share of the burden of proof upon importers than the GATT Valuation Agreement and should go some way in assuaging developing country concerns about the scope for challenging invoice values. The second Uruguay Round decision notes that developing countries may be permitted to retain officially established minimum values on a transitional basis if they make a reservation to this effect, and indicates that the Committee on Customs Valuation should give sympathetic consideration to any requests for such a reservation, provided that the party concerned shows good cause. The decision also refers to the fact that governments are entitled to a delay of up to five years in which to implement the agreement, and suggests that this period might be used to address any problems associated with the application of the agreement, including that of imports by sole agents, sole distributors and sole concessionaires. It should be noted that paragraph 1 of Annex III of the WTO agreement acknowledges that developing country governments might, in some circumstances, require a delay longer than five years before applying the agreement. Requests for extensions are to be given sympathetic consideration. What do the customs valuation obligations of developing countries imply for the performance of PSI services? All the countries covered in this study, with the exception of thecontinue

Philippines,12 were using the BDV in 1993. As these countries move to the transaction value system, will the PSI companies have to modify their procedures? While some modification may be required, five points about the interpretation and application of the customs valuation rules warrant mention. First, the invoice value does not have to be treated as the transaction valuethis is merely the starting point. Second, the WTO agreement facilitates price challenges by shifting more of the burden of proof onto the importer when a price is questioned. While the invoice price is accepted as the transaction value more than 90 percent of the time in industrial countries (CCC, 1992), many more challenges are made to invoice prices in developing countries (see Chapter III). This makes the burden of proof a crucial issue. It should be noted, however, that the WTO agreement does require written explanations from the customs authorities when an invoice value is rejected, and this could prove burdensome. Third, Article 17 of the WTO agreement states that nothing in the agreement should be "construed as restricting or calling into question the rights of customs administrations to satisfy themselves as to the truth or accuracy of any statement, document or declaration presented for customs valuation purposes." This provision reiterates the rights of customs authorities (and by logical extension, their contractees) to challenge invoice prices. Fourth, paragraph 7 of Annex III emphasizes that the price actually paid or payable should include all payments actually made or to be made as a condition of sale. This confirms that undervalued invoices can be challenged on the grounds that Preshipment Inspection and Customs Valuation 51

Preshipment Inspection Services the invoice price only reflects part of the price paid to the seller. Finally, PSI companies are the contractees of governments that contract their services, and all their decisions are, strictly speaking, recommendations to their principals. It is the governments that are signatories of the WTO agreement, and they are ultimately responsible for ensuring that the PSI companies act in a manner consistent with the requirements of the agreement. The PSI companies may be required to modify certain practices when their clients adopt the transaction value system, such as undertaking fuller consultation with suppliers when prices are challenged and providing written justification for recommendations. But the agreement does not appear to place any serious obstacles in the way of governments that wish to contract PSI services in support of customsrelated functions. While it remains the case that customs authorities (or their agents) challenge a significant proportion of invoice prices, there is a risk that the new valuation rules could cause delays in customs clearance procedures. On the other hand, there is nothing in the agreementcontinue 12 The Philippines uses an unusual customs valuation system called home consumption value (HCV). Under HCV, the value for duty purposes is the price charged at the first wholesale level in the domestic market of the country of export. Since the domestic price of a good is often higher than the export price, this valuation system is unlikely to conform with Article VII of GATT, which requires that the value for customs purposes should be based on the actual value of imported goods. The HCV system is explicitly ruled out in the WTO Customs Valuation Agreement.

that requires the customs authorities to complete potentially timeconsuming consultative and explanatory obligations prior to the release of merchandise from customs. These procedures could be completed in the context of an ex post review, and goods released upon payment of the amount of taxes assessed by customs on the recommendation of their agents, the PSI companies.
The Use of Minimum Import Prices

As noted above, the WTO agreement on customs valuation contemplates the use by developing countries of minimum import values during a transitional period. No firm timetable is stipulated, and the Committee on Customs Valuation will decide on the period during which governments may avail themselves of this option. The use of minimum import prices has sometimes been advocated as an alternative to preshipment inspection. Apart from the fact that countries will only be able to apply minimum values for a restricted period, there are significant disadvantages to such arrangements. For countries that are liberalizing their trade regimes and seeking to make their economies more responsive to relative world prices and international competition, minimum import prices can act as significant protectionist barriers. There are basically two reasons for this. First, few products enter world trade for which it is easy to obtain a reliable "world" price, and even where this is possible, prices may often change. Minimum import prices are therefore likely to represent approximations, and the process of setting them will open up attractive opportunities for importcompeting interests in the domestic economy wishing to carve out an additional margin of protection. Second, even where a genuine effort is made to identify international prices, product heterogeneity will often force the authorities to rely on average minimum prices that conceal large variations in unit prices. Table II. 1 reproduces some data for ten products provided by PSI companies that demonstrate the problem of price heterogeneity within individual tariff classifications. The range of prices verified under various tariff headings are listed in the table. In addition to the range of unit prices observed, the table shows the average price and the standard deviation within each category. It is clear from these data that significant margins of protection can be concealed by minimum prices. Minimum price schedules developed by customs authorities may well The Use of Minimum Import Prices 52

Preshipment Inspection Services attempt to reduce the heterogeneity problem by further disaggregation, as Pakistan has done (see below), but it is likely to prove timeconsuming and costly to attempt such disaggregation for more than a few product categories or subcategories. In addition to the potential protective effects of minimum import values, Changanaqui and Messerlin (1991) show, in a study of minimum import prices in Uruguay, that there are other perverse economic effects to consider. Minimum import prices reduce price differentials between highpriced and lowpriced goods falling within the same product category. Adverse quality effects result, as there is an incentive for domestic producers to concentrate on the manufacture of lowquality goods, and an inducement for foreign suppliers to shift exports toward higher quality products. In addition to the standard welfare costs and unfavorablecontinue

Table II.1: Price Variability Within Product Categories HS Code Description Observation Period Number of Unit Observations Price Range Average (US$) Price (US$)

Standard D (SD) (US$)

87120020 54075200 55121900 95030020 40111000 40112000 40113000 40115000 n/a 85171000

Bicycles for adults polyester printed fibers Pieces of material Leater toys Tires for cars Tires for trucks Tires for bicycles 4X4 cut wood 386 computers Office telephones

Jan Sep '93 Jan Sep '93 Jan Sep '93 Jan Sep '93 Jan Sep '93 Jan Sep '93 Jan Sep '93 10/92 10/93 3/92/93 One year

76 70 29 30 232 207 36 84 18 47

Unit Kg Kg n/a Unit Unit Unit MBF Unit Unit

20.87 998.19 0.54 2.59 0.01 2.42 0.35 90.00 12.32 144.90 10.70 1,941.00 0.54 10.31 630.00 1,000.00 600.00 9,000.00 26.00 360.00

226.41 1.00 0.98 8.53 32.89 194.01 1.98 743.36 2444.40 122.74

221.41 0.43 0.54 12.75 19.89 145.45 1.58 70.35 2373.11 102.00

Source : Data supplied by PSI companies. distributional implications of raising prices, consumer choice is also likely to be reduced overtime by the pricestandardizing effects of a minimum import price regime. Pakistan has gone further than many countries in applying minimum prices across a broad range of products. The Use of Minimum Import Prices 53

Preshipment Inspection Services Beginning in 1991, Pakistan has relied on a valuation manual, which is produced two or three times a year. The first manual contained 9,637 prices, and the tenth (July, 1993) contains 14,766 prices. Prices are set in consultation with industry and importers. Even if reliable sources are secured for the unit price information, which may be questionable across such a broad range of products, the manual can give little or no guidance on standard adjustment factors such as quantity discounts, quality differentials, payment terms, and a whole range of other possible consignmentspecific elements that determine price. Moreover, the pricesetting exercise upon which the manual depends is at serious risk of political capture by domestic producer interests, leading to high, hidden margins of protection. These are, in effect, the standard criticisms of a minimum import price regime. Regardless of the degree of protectionist intent behind such regimes, their intrinsic costs make them an unattractive alternative to preshipment inspection. The question remains, however, whether a more flexible use of price data bases may not serve as a lowercost option that could replace preshipment inspection in its price verification function.
Are Price Data Bases an Alternative to PSI?

Price data bases are clearly useful valuation tools under the BDV, where the notion of a normal market price underpins the assessment of an invoice price. But can a price data base be used in customs valuation work under the GATT valuation system? Purists might argue that the transaction value methodology precludes the use of a data base because the emphasis is on the conditions and circumstances of the sale in question, and not on price. Restrictions on the use of market price information would, however, be regarded by most valuation experts as an excessively narrow interpretation of the requirements of the GATT agreement. After applying the transaction value methodology for over ten years, many, if not all, industrial countries continue to use price data bases in some of their customs work. Observed unit prices are regarded as valuation ranges, and as a source of guidance when examining a transaction. They do not provide definitive grounds upon which to base a decision. Even if customs authorities were to foreswear the use of valuation data bases, experienced customs officers would carry around notional market prices in their heads. It is important to emphasize, however, that the flexible use of a data base as an aid to duty assessment is quite distinct from reliance on minimum import prices. As noted in chapter I, unit price data generated by PSI companies in the performance of their duties belong to their principals. Increasingly, countries employing PSI may be expected to make use of this information, although the absence of adequate automation in many customs services severely restricts the proper management and use of large data bases.continue

Since a data base only remains useful if it is regularly updated, PSI data serve this purpose for as long as there is a PSI contract in place. This assumes that PSI companies are unwilling to sell price data bases (see above). If a valuation data base is contemplated as a substitute for PSI price verification, the data base must be fed from other information. One obvious source is historical data from a country's own imports. But this source of price information quickly loses validity in the absence of frequent and regular importation of the products concerned. For this reason, customs services often try to supplement the historical price information with information gleaned from market research, price lists, trade publications and so on. Customs services in developing countries often lack the resources and expertise to gather such information on a systematic and reliable basis. In order to supplement national efforts to develop a price data base, a Floridabased firm called Trade Research Institute Inc. offers another source of unit price data. The system relies on highly disaggregated unit price information from the exporting country, in this case the United States. The Trade Research Institute has developed a computer program for processing U.S. export data in order to generate price ranges for individual products. This information could be used by the customs services of importing countries in order to alert them to Are Price Data Bases an Alternative to PSI? 54

Preshipment Inspection Services cases where invoice prices fall outside a preestablished value range (Trade Research Institute, 1993, and Money Laundering Alert, 1993). The parametric characteristics of the unit price ranges can be customized according to the user's wishes. While such a service would augment a price data base that relied on import transactions, it does not use invoicebased information, and therefore involves some of the aggregation problems referred to earlier. In a number of product areas, it also proves difficult to identify an operationally useful price range without excluding a significant proportion of the total observations under a particular product category. This is a problem encountered with any valuation data base, and can only be addressed over time through refinements in product descriptions and classifications, and through a judicious use of the information generated by the system. As countries seek to reduce reliance on PSI services, price data bases will become more important as an aid to customs valuation. But price data bases are not a substitute for PSI, because they are not designed for the same purpose. Preshipment inspection is not only a comprehensive service for supporting a national customs service (aside from its role in detecting overinvoicing), it is also a parallel system of information that permits a government to secure improvements in revenue collection through monitoring both importers and the customs authorities.break

Chapter III Preshipment Inspection in Practice

This chapter assesses the experience of governments using PSI services. It also examines various aspects of PSI contract design, with a view to identifying key contractual commitments most likely to ensure that governments derive maximum benefits from the service. Revenuerelated aspects of PSI services are addressed both here and in the next chapter, dealing with customs issues. Direct assessment of the performance of PSI companies and the benefits of their services is difficult, for two main reasons. First, oftentimes a government will contract PSI services at the same time as undertaking other reforms, making it virtually impossible to determine the explanatory weight to be assigned to individual parts of the policy package. In Indonesia and Peru, for example, significant improvements in customs performance and revenue collections occurred shortly after PSI was introduced along with a number of other reforms. While government officials and other observers state that PSI made a significant contribution to what was achieved in both countries, it is impossible to determine with any precision how much is attributable to this aspect of the broader reform package. Moreover, there is the related issue of what the counterfactual scenario is against which improved performance is to be judged. In other words, what would the situation have been in the absence of preshipment inspection? Second, quantified performance results, such as those reported by PSI companies on foreign exchange and revenue savings, cannot be taken at face value. This is in part because many of the gains from PSI intervention, especially on the revenue side, are only realized if governments act on PSI recommendations. On the other hand, there is no sure basis on which to judge how far the existence of PSI has modified the behavior of importers and tax collectors. The possible deterrent effects of PSI are discussed below. Another consideration is that the reported results do not capture other benefits and costs associated with PSI services. On the benefits side, for example, PSI might have contributed to trade facilitation, to training and technological improvements in national customs services, and to better data management. On the negative side, PSI requirements entail real costs for traders, in terms of ordinary compliance and possibly delays as well. Finally, how should the cost/benefit calculus of PSI be compared with other options? All these issues are addressed in this chapter, insofar as available information permits.

Chapter III Preshipment Inspection in Practice

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Preshipment Inspection Services The analysis that follows is based primarily upon the experience of the countries included in the case study. No attempt has been made, however, to provide a detailed account of what has occurred in each of the countries, as this would have been a timeconsuming and repetitive task. Instead, the approach adopted is thematic, and the discussion draws illustratively on the experiences of individual countries as appropriate. It should also be noted that the situation in several countries may have changed since the relevant field work was undertaken, and this may mean that characterizations of what is occurring are misleading in the light ofcontinue

subsequent events. In such cases, the essentially illustrative nature of much of the countryspecific material included here should beborne in mind. Data on Preshipment Inspection Interventions
Reported Foreign Exchange and Revenue Savings

Table III. 1 summarizes the foreign exchange and revenue savings reported by PSI companies in the case study countries from 1987 to 1992. Where no numbers are reported it is because no PSI contract was in force. The foreign exchange savings are entered as overinvoicing and commission, with the latter representing repatriable commissions (payable to importers) reported by PSI companies to client governments. Revenue savings come from undervaluation and misclassification,1 and the figures reported in the table represent additional revenue chargeable as a result of valuation uplifts recommended by the PSI companies. The percentages in the table are reported savings (revenue and foreign exchange) as a share of total imports inspected. By showing reported savings as a share of imports, it is possible to compare these savings with PSI fees charged to governments for the service. Assuming that PSI fees are around 1 percent of the value of imports inspected (see below), most of the reported savings more than cover the cost of the service. In some cases, such as Zambia and Uganda, reported savings exceed fees by as much as ten times. In other cases, such as Cameroon and Mali, reported savings are much closer to the fee. It is noteworthy that except for one or two African countries (Benin, Cote d'Ivoire2 ), reported revenue savings are significantly greater than foreign exchange savings, suggesting that the greatest potential gains from PSI in terms of measured savings are to be found in the revenue area. In some countries, such as Ghana, Tanzania, Uganda and Zambia, reported revenue savings from corrected tariff classifications are significantly higher than those accruing from the detection of underinvoicing. In others, such as Cameroon, Mali, and Indonesia, the reverse is true.3 No simple explanation exists for these different tendencies. Part of the explanation may lie in the structure of the tariff schedules of different countriesa greater dispersion of tariffs offers greater scope for gains from misclassification. Another factor might be the nature of relationships between suppliers and importers and their willingness to collude. If the relationship is not close, importers would probably find it easier to prevail upon suppliers to manipulate tariff nomenclature rather than coalesce in the false declaration of value. Whatever the explanation, both practices reduce government revenue.break 1 It should be noted that corrected tariff misclassifications can result in higher or lower tax liabilities. The detailed data supplied by PSI companies for this study, however, indicate that only a small number of adjusted classifications implied lower tax liabilities. 2 Until 1993, underinvoicing in Cote d'Ivoire was only reported on a voluntary basis by the PSI company. 3 Potential savings from tariff reclassification are not reported in some contracts, such as the Peruvian one or are lumped in with undervaluation, as in the Philippines.

Data on Preshipment Inspection Interventions

56

Preshipment Inspection Services

Table III.1: Reported Foreign Exchnage and Revenue Savings, 198692 US$ '000 Country 1987 Benin Total imports* Overinvocing Commissions Undervaluation Missclassification Cameroon Total imports* Overinvoicing Commissions Undervaluation Misclassification Central African Republic Total imports* Overinvoicing Commissions Undervaluation Misclassification Cote d'Ivoire Total imports* Overinvoicing Commissions 828,590 16,785 4,905 2.0 0.6 795,883 13,820 2,824 10,267 n/a 1.7 0.4 1.3 837,835 7,186 4,158 1,010 n/a 0.9 0.5 0.2 658,455 5,332 2,246 1,338 n/a 0.8 0.3 0.2 586,266 6,872 2,440 2,775 n/a 1.2 0.4 0.5 700,863 n/a 3,520 2,994 n/a 23,893 n/a 32 60 533 0.1 0.2 2.2 106,849 n/a 50 595 1,940 281,330 1,114 547 850 3,830 0.4 0.2 0.3 1.4 836,619 n/a 1,274 4,063 4,449 0.2 0.5 0.5 720,042 n/a 2,351 9,667 3,769 0.3 1.3 0.5 764,097 n/a 1,249 4,115 2,714 334,168 3,324 210 1,006 n/a 1.0 0.1 0.3 436,850 6,490 140 1,561 n/a % 1988 % 1989 % 1990 % 1991 % 1992 %

1.5

0.4

0.2

0.5 0.4

0.1

0.6 1.8

0.5

Undervaluation 944 0.1 Misclassification n/a (table continued on next page)

0.4

Table III.1 (continued) US$ '000 Country 1987 Ghana % 1988 % 1989 % 1990 % 1991 % 1992

Data on Preshipment Inspection Interventions

57

Preshipment Inspection Services Total imports* Overinvoicing Commissions 461,698 5,875 820 1.3 0.2 457,708 10,933 1,353 3 n/a 2.4 0.3 404,925 9,571 825 215 n/a 2.4 0.2 0.1 n/a 900,444 13,687 2,285 8,258 35,739 1.5 0.3 0.9 4.0 959,921 13,321 2,624 7,440 49,822 1.4 0.3 0.8 5.2 1,069,708 12,955 2,056 5,736 55,935

1 0

Undervaluation 30 Misclassification n/a Mali Total imports* Overinvoicing Commissions Undervaluation Misclassification Philippines Total imports* Overinvoicing Commissions 970,000 n/a 2,769

0 5

255,083 1,016 1,677 4,496 4,424 0.4 0.7 1.8 1.7

289,545 n/a 1,609 8,163 2,429 0.6 2.8 0.8

333,067 n/a 1,236 4,413 1,358

1 0

1,500,000 0.3 6.1 n/a 2,279 66,322 n/a 0.2 4.4

2,112,000 n/a 5,939 78,091 n/a 0.3 3.4

3,402,312 n/a 3,571 163,612 n/a 0.1 4.8

3,421,044 n/a 7,146 198,388 n/a 0.2 5.8

6,854,239 n/a 26,987 682,076 n/a

Undervaluation 58,786 Misclassification n/a Tanzania Total imports* Overinvoicing Commissions 254,762 5,663 1,228

297,938 2.2 0.5 4,818 605 14 n/a 1.6 0.2

358,464 3,885 844 347 n/a 1.1 0.2 0.1

638,562 4,731 1,642 148 n/a 0.7 0.3

145,750 2,297 658 827 4,148 1.6 0.5 0.6 2.8

230,400 913 1,075 1,953 8,660

0 0

Undervaluation n/a Misclassification n/a (table continued on next page)

0 3

Table III.1 (continued) US$ '000 Country 1987 Uganda Total imports* Overinvoicing Commissions 180,391 3,673 227 2.0 0.1 128,088 1,675 318 44 n/a 1.3 0.2 159,471 2,264 360 6 n/a 1.4 0.2 217,700 2,881 1,366 469 11,756 1.3 0.6 0.2 5.4 200,400 1,718 768 320 19,451 0.9 0.4 0.2 9.7 111,600 1,315 653 855 11,224 % 1988 % 1989 % 1990 % 1991 % 1992

Undervaluation 40 Misclassification n/a Indonesia Total imports* 10,682,914

12,335,527

15,753,701

21,780,952

24,183,950

25,752,55 58

Data on Preshipment Inspection Interventions

Preshipment Inspection Services Overinvoicing Commissions 139,000 22,870 1.3 0.2 3.7 0.5 113,000 53,601 457,000 76,000 0.9 0.4 3.7 0.6 138,500 21,617 561,500 96,800 0.9 0.1 3.6 0.6 165,200 45,739 760,100 189,871 0.8 0.2 3.5 0.9 193,800 87,062 785,900 174,716 0.8 0.4 3.2 0.7 190,600 33,384 703,000 213,813

Undervaluation 399,500 Misclassification 51,000 Peru (Yr. to 3/93) Total imports* Overinvoicing Commissions Undervaluation Misclassification Zambia Total imports* Overinvoicing Commissions 302,397 4,416 7,000

3,000,800 n/a n/a 36,420 n/a

411,716 1.5 2.3 5,329 7,907 n/a n/a 1.3 1.9

528,900 7,437 7,417 164 14,663 1.4 1.4 2.8

899,700 6,474 12,353 8,450 25,349 0.7 1.4 0.9 2.8

508,800 6,594 5,249 5,559 42,804 1.3 1.0 1.1 8.4

539,100 4,296 7,854 4,114 43,664

Undervaluation n/a Misclassification n/a

* Total imports is the value of imports inspected, not the total value of the country's imports. How credible are the results reported by the PSI companies? There is no reason to suppose that the reported figures do not reflect PSI interventions, but the question is whether these amounts translated into actual savings for governments.4 On the foreign exchange side, savings reported from overinvoicing would have been realized if PSI companies were contractually required to insist upon the necessary adjustment of invoice prices by suppliers when they detected overinvoicing. This is the case in many existing contracts, although a trend, as in Indonesia and Peru, for example, is only to report overinvoicing to the principal. By their very nature, repatriable commissions can only be reported to governments. Similarly, on the revenue side, valuation uplifts and tariff reclassifications can only occur if the national customs service acts upon the advice of a PSI company. Thus, reported revenue savings, foreign exchange (and income tax) savings from repatriable commissions, and possibly those from overinvoicing as well, remain theoretical until the point that a government acts upon information provided by PSI companies. Evidence presented in chapter IV of the gap between potential and actual revenue collections, together with circumstantial evidence discussed below of partial coverage of PSI services and the nonuse of reports of findings by customs, strongly suggest that PSIgenerated information is frequently ignored by governments. Clearly, this renders PSI services far less effective than they would otherwise be, and undermines the basic rationale for employing a PSI company in the first place. The PSI companies often point out that while their reported savings data may be potential rather than actual, a fuller picture of the benefits of PSI requires that the deterrent effects of the service are taken into account. Deterrence is extremely difficult to measure because there is usually no counterfactual basis on which to judge the deterrent effects of PSI interventions. In logic, however, PSI could be expected to deter overinvoicing and revenue fraud if traders suffered penalties of one sort or another from making false declarations, or if they knew that PSIgenerated information would be systematically used by the principal. If there are no such penalties, and if a probability can be attached to successful misdeclaration, then PSI deterrence will be weak. In many of the casestudy countries, it seems that the poor use made of PSIgenerated information gives rise to fairly ineffective Data on Preshipment Inspection Interventions 59

Preshipment Inspection Services deterrence, and therefore the hidden benefits from this source are probably quite modest in the majority of countries using preshipment inspection. On the other hand, if importers and suppliers know that a PSI company is very likely to detect a false declaration, and they are unwilling to face the stigma of being challenged, they might modify their behavior in spite of the continued existence of a possibility that in the end a false declaration will be accepted. In other words, to the extent that PSI interventions modify perceptions of the likelihood of detection, and given that documentation recording misdeclarations will be generated regardless of whether it is actually used, some traders may indeed change their behavior. While the magnitude of any such effects is largely a matter ofcontinue 4 See the discussion in Chapter I of why foreign exchange "savings" are often a reflection of flawed policy, and why with appropriate exchange rate reforms, a significant part (but not all) of the motivation for overinvoicing may be expected to disappear.

speculation, some circumstantial evidence suggesting a possible deterrent effect from PSI came to light in Benin (Box III.1).
Patterns of PSI Intervention

The PSI companies were requested to provide data for a representative period5 at the consignment level showing: i) all consignments inspected; ii) consignments on which adjustments had been made; iii) nature of the adjustments; iv) product descriptions; v) consignment size (by value); and vi) origin of the consignment. Unfortunately, data were not kept by the PSI companies in a format that readily permitted inclusion of information on taxes due at the consignment level, except for one or two countries in the sample (Tanzania and Indonesiasee below). The purpose of seeking these data was to determine whether particular patterns of intervention by PSI companies were discernible. Was it the case, for example, that goods coming from one destination as opposed to another were more likely to be subject to adjustments on declared invoice values? Or were particular products most likely to be subject to adjustment? If strong relationships could be identified, they would provide some guidance on where the greatest risk lies in terms of revenue or overinvoicing behavior.6 This information could then be fed into decisions about where to concentrate the efforts of PSI, and areas where the service might be phased out at lower risk. Some of the results of the analysis of these statistics are reported here, through graphical representations (Charts 13), detailed countrylevel data7 (Annex Table A.1), and through probit regression equations8 (Table III.2 and Annex Table A.29 ). The results of this analysis are mixed and mostly inconclusive, but client governmentscontinue 5 The larger the country, the shorter the time period to which the data pertained. In all cases, however, the number of observations ran into the thousands. 6 In the statistical analysis involving origin, product category, and consignment size, no distinction was made between overinvoicing and underinvoicing adjustments by the PSI companies. The reason for not making the distinction is that in terms of the particular consignment characteristics under consideration (i.e. origin, product type and size), it is arguable that their explanatory power would be applicable to either form of misinvoicing, depending on prevailing conditions in the importing country. The distinction between underand overinvoicing was made was made, however, in relation to the tariff level data that were available for Indonesia and Tanzania, where the hypothesis is that a higher tax liability is more likely to induce underinvoicing. 7 Annex Table A.1 reports, for 11 of the case study countries, the frequency of PSI interventions in terms of the number of inspections by region and product category, and in terms of the value of inspections by region and Patterns of PSI Intervention 60

Preshipment Inspection Services product category. 8 Probit equations use a dichotomous dependent variable relating to the occurrence or nonoccurrence of an event. In this case, the event is a PSI intervention. The equation seeks to explain the likelihood of a PSI intervention in terms of the characteristics of a consignment (origin, product type, consignment size, tax rate). 9 Annex Table A.2 reports the probit equation results for 11 of the countries included in the study. These results are presented in aggregate form in Table III.2.

might find it worthwhile to ask PSI companies to undertake this kind of analysis on a more thorough and systematic basis. The analysis attempted here is largely based on crosssection data. From the point of view of individual countries, it would be more interesting to analyze time series information over the life of a PSI contract. Such analysis could be useful not only in providing pointers as to where attention should be focused, but also in monitoring the effects of PSI interventions. Box III.1: Indirect Evidence of PSI as Deterrent A special customs regime, known as regime S115, exists in Benin for goods in transit to Nigeria. These goods do not pay any duties or taxes in Benin. The regime has been difficult to administer and has given rise to significant revenue leakage. The existence of regime S115, and the fact that imports entering Benin under this regime were not subject to PSI, meant that S115 imports could be used as a control group against which to compare imports of the same goods that were subject to preshipment inspection.

The authors of the Benin report on PSI compared unit prices for a variety of textile and clothing items, cigarettes and alcohol, and food products. They concluded that in comparison to the same goods subject to inspection, additional undervaluation under regime S115 would have led to a loss of some CFAF 5 billion, which was equivalent to 14.8 percent of total customs revenue in 1992. The authors concluded that the higher incidence of underinvoicing under regime S115 as compared to regular imports offered prima facie evidence of a deterrence effect under PSI.

Supplementary evidence of such behavior came from the fact that in the second semester of 1992, over 86 percent of the imports of secondhand clothing entering Benin without PSI were valued below the minimum import price for duty purposes (valeur mercuriale), while only 23 percent of these same items subject to PSI were similarly valued (i.e. below the minimum import price). Chart 1 reports on the relationship between the frequency of interventions and the origin of goods. The chart shows that for the countries included in the study, the bulk of inspected imports were from Western Europe (41 Patterns of PSI Intervention 61

Preshipment Inspection Services percent), followed by Asia (32 percent), and North America (13 percent). The origin of goods would not be expected, a priori , to provide a significant part of the explanation for PSI interventions. A significant correlation might, on the other hand, be expected if a special relationship were to exist between a significant group of importers and exporters, but this would be unlikely to show up in the aggregate data. It is interesting to note that proportionately, there were a greater number of interventions (in respect of both underand overinvoicing) on merchandise coming from Western Europe, Asia, North America, and the Pacific than there were on goods originating in Latin America, the Middle East, and Eastern Europe. Chart 1 clearly illustrates the differences (see the percentage shares indicated below the horizontal axis in the chart). One possible explanation for this pattern is that PSI companies are better represented in the larger markets, and better equipped to make judgements. In Latin America, the Middle East and Eastern Europe, on the other hand, perhaps the presence of PSI companies is weaker and there is therefore a greater reluctance to challenge invoice prices. It would have been a major task to examine this hypothesis in more depth in the study. The countryspecific data (Table A.1) reproduced in the annex show that there are some exceptions to the overall regional pattern of intervention indicated by the aggregate data.break

Chart 1 : Number of Inspections and Adjustments Based on Region of Export Note: Numbers below the horizontal axis represent number of adjustments as percentage of total inspections per region and numbers above the bar charts represent share of each region in total number of inspections.

Chart 2 focuses on the relationship between PSI interventions and product type. The chart shows that over half (57 percent) of all inspections involved chemicals and machinery, followed by consumer goods (31 percent), food Patterns of PSI Intervention 62

Preshipment Inspection Services (8 percent), and raw materials (4 percent). It would be reasonable to expect that more frequent adjustments would occur with more complex products, as product complexity would abet fraud. Product complexity was assumed to increase from raw materials, through food and consumer goods, to chemicals and transport equipment. The results were surprising, since proportionately, the least differentiated product category, raw materials, was subject to adjustment more frequently than any other product category, followed by chemicals and transport, food, and consumer goods.10 No obvious explanation suggests itself for these results, unless it were to be argued that PSI companies feel more constrained about adjusting prices on complex products because such decisions are more readily open to challenge. This hypothesis is not strongly sustained by the data because the differences in the proportions of adjusted consignments by product category are not large. Once again, the pattern revealed in the aggregate statistics is reflected in the individual country data (Annex Table A.1), although with exceptions in some cases. Chart 3 presents inspection results in terms of consignment size, ranging from zero to US$5,000 at the lower end of the spectrum, to over US$500,000 at the upper end. According to the chart, some 3050 percent of consignments were adjusted across virtually all of the 20 value intervals. A somewhat weak pattern is discernible, however, of proportionately more adjustments being made on high value items, but with the relative value of adjustments being higher at the lower end of the value scale. This suggests relatively fewer interventions on small consignments, but in the context of proportionately greater adjustments in value terms. In general, these data do not lend themselves to strong conclusions about the relationship between consignment size and PSI interventions. Table III.2 summarizes the results of the regressions undertaken on pooled data from the casestudy countries. These regressions use the same data as the charts and annex table discussed above, but offer an alternative way of examining the results of the statistical analysis. The independent variables identified in the table are consignment size (imports), regions from which inspected goods have originated, and product type. For the regions and product categories, dummy variables that assume the value of zero or unity are employed. The omitted variables against which the results relating both to regions and products are reported were, respectively, Western Europe and food.11 The coefficient for the consignment size variable (import) is not significant at the 90 percent level, which confirms the observation made above (in relation to Chart 3) that thecontinue 10 It should be noted that although the frequency of interventions was greater in the case of raw materials (35 percent), the comparable shares for chemicals and transport and for food were similar (33 percent and 31 percent). 11 Because there were two dummy variables in the equation, it was not possible to use the intercept term as the omitted variable. Omitted variables are supposed to be broadly representative of the statistical pattern observed from the data.

Patterns of PSI Intervention

63

Preshipment Inspection Services

Chart 2 : Number of Inspections and Adjustments Based on Product Categories Note: Numbers below the horizontal axis represent numbers of adjustments as percentage of total inspections per product category and numbers above the bar charts are shares of each product category in total number of inspections.

Patterns of PSI Intervention

64

Preshipment Inspection Services

Chart 3: No. of Adjustments as % of Inspections (Per Size of Consignment) Note: Percentages on the right are the values of adjustments in relation to inspected imports.

Table III.2: Pooled Regression Results for Case Study Countries Independent Variables Constant Import North America Western Europe Africa LAC Asia Pacific Middle East Eastern Europe Coefficients 0.46 0.02 0.02 0.18 0.07 0.08 0.09 1.01 0.43 TRatios 37.35*** 1.05 0.81 6.93*** 2.84*** 5.43*** 1.78* 29.06*** 4.01***

Patterns of PSI Intervention

65

Preshipment Inspection Services Raw Materials FoodAgric Consumer Goods ChemicalsTransport ChiSquared 0.15 0.03 0.20 0.20 5.95*** 1.75* 14.11*** 1433.57(10)***

Note: Regions and products are identified by dummies. * 90% level of significance ** 95% level of significance *** 99% level of significance association between the frequency of PSI interventions and consignment size appeared quite weak. While the coefficient for the pooled data (Table III.2) is positive, suggesting a positive relationship between consignment size and PSI interventions, the individual country regressions (Annex Table A.2) do not all conform to this pattern. The relevant coefficient was negative but statistically significant at the 99 percent level for Indonesia, Peru, Central African Republic, and Zambia. Once again, a mixed pattern is observed, which does not provide a basis on which to draw firm conclusions. The results reported in Table III.2 in respect of the regional variable suggest a lower likelihood of PSI adjustment in North America, Africa, Latin America, Asia, the Middle East, and Eastern Europe in relation to Western Europe (the omitted variable against which the other results are reported). The coefficients for Africa, Latin America, Asia, the Middle East, and Eastern Europe are significant at the 99 percent level. The individual country results reported in Annex Table A.2 show some differences, perhaps the most notable of which is that the sign of the coefficient for North America is positive and statistically significant in several countries.12 As far as the producttype analysis is concerned, a similar diversity of statistically significant results between the pooled and individual country data is apparent. As previously noted, data were available for Indonesia and Tanzania which permitted a regression between the frequency of PSI intervention and the level of import taxes due on consignments. A reasonable hypothesis would be that higher tax liabilities would be associated with a greater frequency of PSI intervention to correct for underinvoicing. Once again, a mixed picture emerged. For Indonesia (Annex Table A.2), the coefficient for the tariff is negative and statistically significant. This is a perverse result, suggesting that the higher the level of import taxes, the lower the likelihood of a PSI intervention to correct for underinvoicing. Unexplained factors are clearly influencing the relationship. In the case of Tanzania, on the other hand, the relationship is positive and statistically significant, conforming to the hypothesis that importers facing higher taxes will try harder to avoid them than importers facing lower taxes. A general explanation that could account for a lack of coherent patterns in respect of several variables is that traders are not concerned about being identified by PSI companies as having submitted false invoices. This could be because they face no penalties in such circumstances, or because in any case they intend to bargain with customs officials about their tax liabilities at the frontier. In other words, if PSIgenerated information is not acted upon, particular consignment characteristics are less likely to influence decisions regarding fraudulent behavior than in a situation where the authorities of an importing country use the information supplied by PSI companies. This is the same point discussed above in relation to the deterrent effects of a PSI program. To the extent that this is an explanatory factor, a better variable forcontinue 12 The change in sign relative to the pooled data is consistent with the low level of statistical significance of the North American coefficient in the pooled data.

Patterns of PSI Intervention

66

Preshipment Inspection Services inclusion in the analysis would be one which captured characteristics of traders, but this was not available for the present analysis. Aspects of the Service and Contract Design Issues
Physical Inspections

Little effort was made in this study to evaluate physical inspections, for the simple reason that there is no satisfactory counterfactual upon which to base a judgement of an inspection actually observed. It is unsurprising that the physical inspections witnessed were thorough and carried out to a high professional standard by inspectors who clearly knew their business. But a number of suppliers in different countries asserted that physical inspections were often perfunctory or not undertaken at all. A much more indepth study would be required to evaluate these charges. Logically, PSI firms should be reluctant to underperform on physical inspections (or anything else, for that matter), because of the damage that a poor reputation implies for a firm's commercial prospects. On the other hand, no firm is immune from the risk that its employees will fail to carry out their responsibilities adequately. The issue then is whether employees are properly supervised and sanctioned in the event of malfeasance. This question was not seriously addressed in the study, but again, it is reasonable to assume that the longerterm commercial interests of wellestablished PSI companies would induce a reasonable degree of vigilance in this regard. To give some perspective to this issue, it is worth noting that in 1992, the New York office of SGS was responsible for approximately 61,000 inspections. Even if 99 percent of these inspections had been carried out in a fully satisfactory manner, there would still have been more than 600 inspections that were poorly performed. As with any service industry whose output cannot be judged against fully objective standards, in the way that physical output can be, the most satisfactory approach is to ensure that adequate external monitoring arrangements and performance benchmarks are in place. This question of the transparency and accountability of PSI companies is taken up in more detail below. Strictly speaking, physical inspections by PSI companies frequently go further than a typical customs inspection, since customs do not focus on quality questions unless they directly impinge on the assessment of dutiable value. Preshipment inspection companies, on the other hand, must certify that the physical characteristics of goods conform to the description on the pro forma invoice. As noted earlier, some importers may see PSI as an element of quality control from which they can directly benefit, even though the PSI company has no contractual liability in respect of importers or suppliers. In Peru, for example, a number of importers claimed that PSI had been useful in filtering out some of the "junk" imports that had flooded the country following the opening of the economy to international competition. Substandard pharmaceuticals were mentioned as a case in point. Physical inspection also makes possible the performance of various certification services, relating to such matters as origin and standards compliance, on behalf of the client government.break

Physical inspection is a significant cost element of PSI, accounting for 3050 percent of the total cost of the service. Clearly, physical inspection is the only means of guarding against miscalculation of product characteristics or quantities, but a traditional customs services cannot properly inspect more than a fraction of all imports. Comprehensive physical inspection of all goods subject to PSI is the first element of the service likely to be phased out. This issue is discussed more fully elsewhere.
Price Verifications

As noted in chapter II, PSI companies are in the position of having to apply two different price assessment methodologies one for customs duty purposes, where the customs valuation system of the client government must be applied, and the other for detecting overinvoicing, where the price verification rules of the TO Pre Aspects of the Service and Contract Design Issues 67

Preshipment Inspection Services shipment Inspection Agreement are to be applied. In the majority of cases, where the invoice price is found acceptable, the methodological differences do not matter. In practical terms, whatever the focus of a price verification exercise, PSI companies will rely on unit price information gleaned from past transactions or market information in order to make a judgement whether an invoice value is acceptable. This will be as true for customs valuation under the transaction value methodology as it is for the BAD or for overinvoicing work, both of which explicitly rely on a notion of prevailing market prices. The essential difference is how the information is used, and the presumption is that unit price information is strictly a guideline, or an aid to valuation under the transaction value methodology, and not the basis for making a decision. If unit price information is required for all aspects of PSI price verification activities, where does the information come from? The sources are very similar to those that an adequately equipped national customs service would rely upon. Box III.2 reproduces a list of sources identified by one of the PSI companies in respect of its U.S. operations. Price verifications are typically undertaken separately from physical inspections, by different individuals. A preliminary price assessment is made upon receipt of the pro forma invoice, and the price verifier may call upon the physical inspector to check particular aspects of the consignment if any doubts arise in the preliminary assessment. Typically, in large affiliate offices, price verifiers specialize in particular product areas, building on experience acquired on the job, or perhaps obtained through previous associations. Price verifiers are often former employees in the industry of their specialization, and on occasion, former customs officers. Even within the guidelines of the valuation or price verification system to be applied, there is inevitably some room for subjective judgement. Depending on the product in question, there are varying adjustment factors to be taken into account. Where product categories contain a high degree of heterogeneity, the range within which a judgement about price will be made is broader. Thus, it may be possible to determine a price range for certain paper qualities within a margin of plus or minus 5 percent, whereas secondhand clothes may require a margin of plus or minus 20 percent. Any systematic attempt to assess the price recommendations by PSI companies was well beyond the scope of this study.break

The consultants responsible for the evaluation of PSI in Mali did, however, undertake a detailed examination of a several recommendations made by SAGS in relation to the firm's contract with Mali. They focused on a number of products, including flour, tea, mayonnaise, and monosodium glutamate, and were critical of SAGS recommendations on several counts. These included valuation, classification, quality assessment, and the treatment of transport costs. Only a few cases were examined, and the criticisms in a number of cases were tentative, indicating the need for further information. This exercise indicated the likely existence of a number of problems, but was not exhaustive or representative enough to draw firm conclusions. Moreover, such criticisms can only be adequately evaluated with information and arguments presented by both sides. The inherent difficulty of establishing whether there has been negligence or incompetence in cases like those cited in the Mali an study reinforce the arguments developed below for regular auditing of PSI companies and the establishment of complaints procedures. Box III.2: Information Sources for Price Verification Unit price information for price verification is derived from multiple sources, in constant need of updating. Among the sources typically relied upon are the following:

Market information from commercial sources; Aspects of the Service and Contract Design Issues 68

Preshipment Inspection Services

Published market reports;

Market news;

Prices agreed by authorities;

Publications of trade associations;

Government publications;

Current price lists from manufacturers or suppliers;

Compatible price lists from other sources;

Specialized inhouse knowledge;

Thomas Register;

Newspapers and wire services;

Specialized magazines.
Trade Facilitation

Without trade facilitation benefits, PSI represents an unambiguous cost from the point of view of traders. What kind of trade facilitation can be promoted through PSI operations? Essentially, the facilitation involves the faster completion of customsrelated formalities. One obvious mechanism of facilitation is an arrangement whereby PSI inspectors seal full container loads (FL), and the national customs authorities allow sealed FL to proceed Trade Facilitation 69

Preshipment Inspection Services immediately to their final destination as soon as they have been unloaded at the port of arrival. This arrangement only works if importers can fill containers, or if the containers can be consolidated with consignments from several suppliers and/or importers, provided all the consignments have been subject to pre shipment inspection. Otherwise, the PSI company cannot vouch for all the contents.break

Among the casestudy countries, arrangements for sealing containers exist only in Indonesia, the Philippines and Peru. In none other of the countries was there a provision in the contract for sealing containers. In Peru, most containers are not singlesupplier FL, so benefits from this kind of facilitation have been limited. The situation would likely be the same in many African countries using PSI, but some benefit might accrue from such an arrangement. Container sealing has, by contrast, proved a highly effective measure of trade facilitation in Indonesia and the Philippines. The experience of the Philippines is recorded in Box III.3. A second, albeit related source of potential trade facilitation associated with PSI operations is the reduction of opportunities in customs for slowing down trade transactions. Obviously, the requirement that sealed containers should pass unimpeded through customs is a significant aspect of this, but other measures could also reduce the incentive in customs for holding up goods. This incentive for customs officers to create delays relates to the prospect of receiving "facilitation fees"13 from importers in return for speeding up the clearance process. This kind of practice would clearly be among the leading candidates for attention in a customs reform program. But pending such reforms, PSIassisted facilitation has a useful role to play. The best known case of successful trade facilitation underwritten by a PSI company comes from SS' experience in Indonesia. Since this is an oftquoted and sometimes misunderstood experience, it is worth describing in some detail what occurred. Amid widespread complaints about customs corruption and inefficiency in Indonesia, which was allegedly having a seriously negative effect on the general business climate and the country's economic prospects, President SEATO issued a presidential instruction14 on April 4, 1985 (INSPIRES 4/1985), which among other things, introduced pre shipment inspection arrangements whose effect was to curtail significantly the powers of the customs authorities. A key provision in INSPIRES 4/1985 was the instruction that: "The Directorate General of Customs and Excise shall not inspect, calculate and charge import duty on goods already covered by a PUD, B.o.L., LP and import Duty Receipt, and shall directly permit the clearance of goods from the harbor."15 Pre shipment inspection requirements were to cover virtually all imports except those valued at less than US$ 5,000 and a few items, including crude oil, diplomatic goods, foreign aid, and certain government imports. At the same time, importers of goods exempted from PSI could, if they so wished, request PSI upon their own volition and receive the same customs treatmentbreak 13 This issue, together with broader questions relating to corruption in customs is more fully discussed in Chapter IV. 14 Presidential Instruction No. 4 of 1985 (INSPIRES 4/1985), concerning "Policy on the Flow of Goods to Support Economic Activities". 15 Paragraph 3.f of the Import Procedures contained in INSPIRES 4/1985. A PUD is a Notice of Import Goods for Use, a B.o.L. is a Bill of Lading, and the LP (subsequently termed the LP) is the report of findings of the PSI company.

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Preshipment Inspection Services Box III.3: PSIRelated Trade Facilitation in the Philippines Following continuing complaints from importers about delays in the ports in releasing goods, the customs authorities promulgated a series of trade facilitation measures in Customs Memorandum Order 9692 (CO 9692), issued on August 20, 1992. The most significant of these measures was the instruction that sealed FL were to be cleared straight through customs without physical examination. The only circumstances in which these containers could be stopped were:

If the SAGS seal was broken or tampered with .

If the container was leaking or damaged .

If there were inconsistencies between the number, weight and nature of packages indicated in the customs entry declaration and supporting documents and these same details in the ship's manifest.

If the shipment was covered by alert/hold orders .

If the importers themselves requested inspection because they were in disagreement with the recommendations in the clean report of findings issued by SGS .

According to a study undertaken by customs of 42,718 containers landed in the Philippines between April and November, 1992, there was impressive evidence of improved clearing times. In April, 1992, only 10.3 percent of the containers were released within the first 48 hours after being unloaded. By November, 1992, that number had risen to 26 percent. For those goods released within the first four days (96 hours) after unloading, the relevant figure was 18.6 percent in April, 1992, and 44.9 percent in November, 1992 .

These measures were followed in mid1993 by legislation which removed a final obstacle to full compliance with CO 9692. The new legislation abolished a requirement that 10 percent of all consignments arriving in the Philippines must be inspected by customs. The removal of this requirement enabled customs to speed up further the clearance of goods through the ports, and to adopt more rational criteria for choosing which consignments to subject to physical inspection .

Sources: Manila Chronicle, 12/22/92, p.24, and 3/18/93, p.10; The Manila Times, 1/25/93, p.10. Trade Facilitation 71

Preshipment Inspection Services due to goods for which PSI was obligatory. Along with the introduction of PSI, importers were instructed to pay their duties and taxes directly to commercial banks instead of to customs, and the minimum import price system for certain products was also eliminated. Other steps taken to facilitate trade, also introduced in INSPIRES 4/1985, included provisions to speed up the interisland flow of goods, reduce harbor fees, reduce interisland mooring fees, and reorganize cargo handling procedures. The results of the package of measures, and in particular the use of PSI to reduce discretion in customs, were highly successful from the point of view of importers. Evidence of this was provided by a survey undertaken by the American Chamber of Commerce of Indonesia (AM CHAM). The maincontinue

results of this survey are reported in Box III. 4. This detailed survey on PSI was taken three months after AM CHAM had carried out its January 1990 survey on investment, in which 99 percent of the respondents had registered the opinion that the involvement of SAGS in customsrelated procedures should either be increased or remain the same. Additional evidence of an improved business climate following the introduction of PSI comes from a survey commissioned by SAGS, and carried out by two consultant firms, 741 Indonesia and Business Advisory Indonesia. This survey, carried out in August 1989, indicated that some 63 percent of importers could clear their goods through the ports within less than 4 days after INSPIRES 4/1985 had been introduced, whereas the comparable figure prior to that was only 13 percent. It was also reported that 85 percent of importers paid less in port clearance charges after INSPIRES 4/1985 than they had before, and more than 30 percent of them indicated that they paid between 26 percent and 50 percent less. Finally, about one half of the importers surveyed indicated that their inventory holdings were unchanged as a result of INSPIRES 4/1985, while 39 percent claimed that they had reduced their inventory holdings. While there can be no doubt about the satisfaction of the trading community with Indonesia's PSI arrangements, it was also clear that the government would find it politically awkward to maintain indefinitely what amounted to a quasiprivatization of customs functions. In August 1991, therefore, another presidential instruction (INSPIRES 3/1991) was introduced,16 which returned to customs part of its discretionary authority. Specifically, the Directorate General of Customs and Excise was authorized to reinspect goods that had already been subject to PSI if: i) container seals had been tampered with; ii) there was any leakage or damage; iii) there were any documentary discrepancies; iv) external examination of the packaging indicated that the goods did not conform to their description; v) information or intelligence had been received about a particular consignment; vi) customs had positive proof that the value of a shipment was out of line with the PSI company's advice; and vii) an importer requested a review of the PSI company's decision. There was some evidence that importers believed the new arrangements were again creating the kinds of problems that had initially provoked INSPIRES 4/1985. The evidence came from AM CHAM'S November, 1991 business survey, to which 131 firms responded. In a summary of the survey's results, AM CHAM noted that in the January 1990 survey on investment, there had been virtually unanimous agreement that SAGS activities should either increase or remain the same. In contrast, the latest survey indicated that only 65 percent of the respondents were satisfied with the new customs clearance procedures, and 35 percent said that the new procedures caused problems or delays. A fuller interpretation of these numbers, and explanation of exactly why a significant proportion of importers felt that the new procedures created difficulties for them, are beyond the scope of this study.break 16 Presidential Instruction No. 3 of 1993, concerning "The Policy to Expedite the Flow of Goods for the Promotion of Economic Activities."

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Preshipment Inspection Services

Box III.4: Results of AMCHAM's Survey of PSI in Indonesia The American Chamber of Commerce of Indonesia (AMCHAM) surveyed two hundred of its corporate members in April, 1990, posing a series of questions in regard to the impact of PSI on their operations. Thirty eight percent, or 76 firms, responded to the questionnaire. Question A : Generally, has it taken longer, shorter, or the same amount of time clearing goods from the port of entry in Indonesia since INPRES 4/1985? After INPRES 4/1985 Shorter Same Longer Question B : Do you consider ease of port clearance as one of the top five attractions criteria of foreign investment? Yes No Question C : For your own operations, what do you consider as the three main benefits of the current customs clearance procedures (in order of importance)? Benefit 1 Faster clearance Consistent and defined procedures Less expensive No benefit Inspection at port of shipment % 36 32 20 8 4 Benefit 2 Better planning ability through reliability Less cost Faster clearance times No theft Other % 44 32 16 4 4 Benefit 3 Less cost Faster clearance More consistent with better planning ability SGS personnel professionalism Other No response % 24 4 32 8 16 16 100% 0% 84% 4% 12%

Question D : Assuming that the current customs procedures remain unchanged and SGS involvement is exptended, what measures would you recommend to improve the systems? Recommended improvement to existing system No change required Faster delivery of reports of findings Faster response and inspection time Other Question E : % 44 20 8 28 Recommended improvements to SGS services No response Faster issuing time for reports of findings Quicker inspections Other % 60 16 8 16

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Preshipment Inspection Services If SGS involvement is to be terminated and customs procedures revert to former authority, what impact would you expect this would have on your operations? Slower clearance with more expense A more complete reappraisal of business operations in Indonesia Other Source : American Chamber of Commerce of Indonesia What seems particularly significant about the Indonesian experience with PSI, apart from its impressive results in terms of trade facilitation, is that as soon as the program was modified in order to give back customs some of its authority, there was evidence of a reemergence of clearance problems. To the extent that this evidence represents a generalized picture of deterioration in customs services, it suggests that not enough was done during the period between INSPIRES 4/1985 and INSPIRES 3/1991 to prepare customs for a resumption of its traditional functions. Indeed, it is arguable that a higher level of cooperation and interaction between customs and the PSI companies17 during those years would have led to a less problematic transfer of authority (see chapter IV for a more detailed discussion of this issue).
Transactions Costs and Delays

80% 12% 8%

As noted above, certain deadweight costs arise for exporters and importers as a result of pre shipment inspection. These are additional to the PSI fee, which may be paid by importers or by the contracting government. The nonfee costs can never be reduced to zero, simply because various procedures must be followed by traders in order to comply with PSI requirements. But they can be minor if the system works smoothly. The principal factor that escalates PSI costs for legitimate traders is delay in the performance of services. Indeed, probably the single most important challenge confronting the whole PSI system is the prompt performance of the service in the exporting country, and the timely delivery of reports of findings (Roofs)18 to exporters, importers and the customs authorities. The complaints of exporters and suppliers about PSI were discussed in the previous chapter, where an exercise by the United States International Trade Commission aimed at estimating PSI costs via survey date was reported. No attempt was made in this study to quantify the costs to exporters or importers of PSI interventions. In the destination country, Roofs sometimes do not reach the importer and the customs authorities before goods are ready for clearance. This is most frequent when the goods concerned are coming from a nearby country, or when air transport is used. Where the goods travel faster than the documentation, they will either be delayed in customs, or cleared without PSI documentation. The first of these outcomes is obviously costly and frustrating for importers, and the second defeats one of the central purposes of the whole program. Complaints were made frequently by importers in the casestudy countries about the delays imposed upon them by pre shipment inspection procedures. In Peru, for example, it was alleged that air shipments of spare parts and other emergency supplies were frequently heldcontinue 17 Under Indonesia's PSI arrangements, an Indonesian company, SCOFFING, subcontracts PSI work to SAGS. Since INSPIRES 3/1991, a new company, PSI, has been established by the government, and this company is gradually assuming the PSI functions of SAGS for the Indonesian market. SAGS has small minority share holdings in both SCOFFING and PSI. 18 Under some PSI contracts, an additional document for use in customs clearance is provided. Regardless of whether one or two PSI documents are generated, the delay problem is the same.

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Preshipment Inspection Services up by PSI documentation requirements. In Cameroon, an industrialist said he would go to any lengths necessary to avoid PSI on airfreighted goods, and was usually able to do so by splitting his goods into smaller consignments which were valued at less than the threshold amount for pre shipment inspection. In Zambia, goods from neighboring Zimbabwe often arrived before reports of findings. Uganda experienced a similar problem with goods from Kenya. Delays were also a complaint in Benin, especially during the first year of operation of the PSI contract.19 It is difficult to assess the extent to which PSIinduced delays have been directly responsible for adding to the costs of doing business, or have undermined PSI programs. One problem is identifying the source of any delays. Box III.5 divides the PSI process into seven stages, from triggering the inspection order, to making a request for information, to fixing the inspection date, to carrying out the inspection, to receipt of final documents, to the issuing of the OF, and finally, to receipt of the OF by the exporter, importer and customs authorities. The only stages of the process exclusively under PSI company control are the transmission of data to its affiliate in the exporting country, sending out a request for information to the supplier, issuing the OF after inspection, price verification and receipt of final documents, and making the OF available to the exporter, importer and customs authorities. In every other step, another party besides the PSI company could be responsible for delays. The other party concerned, of course, is the exporter, except at the stage where shipping documents must be supplied by the shipper to the exporter. The PSI companies acknowledge that they may sometimes be responsible for delays, such as in cases where inspections cannot be carried out as soon as a supplier might wish. But they argue that oftentimes suppliers either do not have goods ready for inspection or are dilatory over delivery of documents, and find the PSI company a convenient scapegoat when a buyer complains about delay. In the Philippines, for example, the garment industry complained strenuously over several months in late 1992 and early 1993 about PSIinduced delays, particularly on inputs from Hong Kong and Taiwan, China, where geographical proximity implies short shipping times. In response to these complaints, SAGS reported that on average inspections were being carried out in Hong Kong within 2.5 days of the date requested, and that the delay was attributable in the majority of cases to a request for rescheduling on the part of the exporter. Inspections were taking place on average 3 days prior to shipment, and exporters then took an average of 2 days to submit final documents to SAGS. SAGS then took an average of 1.4 days to issue a ROF, which was delivered to the importer less than a day later. Given that the shipping time to the Philippines was often less than 2 days, it is clear why goods might have arrived before the clearing documents.break 19 As discussed below, the PSIrelated delays are not necessarily attributable to the activities of the PSI companies themselves. In Benin's case, for example, a large part of the problem related to weaknesses in the banking sector.

Box III.5: Sources of Delay in PSI Operations The PSI process can be divided into seven stages, during each of which delays can occur. The steps are as follows:

1.

The importer makes known the intention to import, triggering an inspection order;

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Preshipment Inspection Services 2. The PSI company requests pertinent information from the exporter or supplier;

3.

The exporter or supplier provides the necessary information and requests an inspection;

4.

The PSI company carries out the inspection and price verification;

5.

The final invoice and the shipping documents are submitted to the PSI company;

6.

The PSI company issues its report of findings;

7.

The exporter, importer and customs authorities receive the report of findings.

The time interval between steps 1, 2 and 3 is determined jointly by the PSI company and the supplier. The PSI company's part is straightforward, requiring only transmission of the necessary information to its affiliate office in the country of export and the request for relevant information from the supplier. The request for an inspection date by the supplier is determined by when the goods are ready for inspection.

The interval between steps 3 and 4 also depends on both parties, since the PSI company has to program the inspection and the supplier has to have the goods ready. The time elapsing between steps 4 and 5 will depend in part on whether there has been any disagreement between the supplier and the PSI company. More importantly in most cases, it will also depend upon the speed with which the supplier and the shipper deliver the documents necessary for the preparation of the report of findings.

The PSI company is exclusively responsible for the intervals between steps 5 and 6, and steps 6 and 7. If the PSI company is working efficiently and relies on electronic data transmission, neither interval should be no more than a matter of hours. In the case of Taiwan, China, requests for inspection were submitted on average 3.9 days before the requested date, and 77 percent of the inspections were performed on the date requested. Once again, the delay on those that were inspected on a later date was often to be explained by a rescheduling request from the exporter. Inspections were concluded on average 0.9 days before shipment, and SAGS received shipping documents from the exporter 1.5 days after the vessel sailed. The OF was issued in 1.3 days, and delivered to importers within one day. Using data from a different time period, SAGS also calculated that the average time elapsing between the Transactions Costs and Delays 76

Preshipment Inspection Services shipping date and the delivery of the OF to the importer was four days for Taiwan, China, and just under five days for Hong Kong. For many of these shipments,continue

therefore, Roofs were only available for the clearance of goods some days after they arrived in the Philippines. The proposal offered by SAGS for dealing with the delay problem is discussed below. Finally, SAGS reported that in January and February, 1993, the only sources of origin in respect of which delays were caused on average in both months as a result of waiting for Roofs after goods had arrived were China, Hong Kong and Taiwan, China. In addition, such delays arose in either one or other of these two months in Korea, Thailand and Mac au. By contrast, no delays were recorded (on average) for those two months in respect of 17 other countries in which SAGS carried out inspections. These statistics emphasize that the problem is essentially one of geographical proximity. It will also arise with air shipments from anywhere, although these do not show up in the averages. All the PSI companies now keep tracking data on a consignment by consignment basis that enables them to determine how long each stage of the PSI process took. This information allows the companies to exercise internal control, as well as explain any delays that arise. By way of illustration, Table III.3 reports the average time elapsed during various stages of the PSI process in respect of 330 inspections carried out by COTE on exports from France to Benin during the month of October, 1992. The table shows that less than 10 percent of the total time taken for the whole PSI cycle was attributable to the PSI company (steps 1, 4 and 6). Similarly, data provided by ITS on exports inspected in the United States during the first six months of 1993 indicated that of an average total time of 9.41 days that elapsed between the completion of an inspection and the dispatch of the OF, 7.89 of these days were attributable to exporter delays in supplying final documents, and only 1.52 days to processing by the PSI company. Table III.4 is another example of how tracking data are presented. These data refer to SAGS inspections of goods in Japan destined for Indonesia during the month of May 1993, covering a total of 4,179 Reports of Findings. In many PSI contracts, minimum times are stipulated within which: i) an inspection must be carried out after it has been requested; and ii) a OF issued following completion of all formalities. Typically, these contractual limits may be set at seven or eight days, and five days respectively. The data referred to above suggest that the PSI companies generally do considerably better than that, especially in relation to the inspection. The TO Agreement on Pre shipment Inspection stipulates that user governments must ensure that PSI companies carry out inspections on the day agreed (except in cases of force manure ). The agreement also states that Roofs must be issued within five working days of receipt of final documents, but again, this would be considered a very slow delivery time in terms of existing practice. Also mandated in the PSI agreement if the exporter so requests, is the preliminary price verification undertaken on the basis of the pro forma invoice. Preliminary price verifications are undertaken as a matter of course by the PSI companies, and may be useful in minimizing delays, as an early warning can be given to the exporter of a likely challenge to an invoice price. Even if the PSI companies can show that the bulk of processing time associated with PSI is attributable to supplier reaction times, which is certainly what the data seem to suggest, there is a case for preparing tracking data in a format that more precisely indicates whatcontinue

Table III.3: PSI Processing Times Exports From France to Benin (October 1992, 330 Reports of Findings) Process Number of Working Days Total Days 1. From inspection order to request for Transactions Costs and Delays 379 Average 1.2 77

Preshipment Inspection Services information 2. Exporter returns RFI to local COTECNA office 6,732 3. Notice given by exporter for inspection 4. COTECNA to undertake inspection 5. Exporter to issue final documents 6. COTECNA to issue ROFs TOTAL Of which: COTECNA Exporter (9.3%) (90.7%) 1,704 16,606 5.2 50.3 5,055 951 4,828 374 18,310 20.4 15.3 2.9 14.6 1.1 55.5

Source : COTECNA is occurring at each stage of the process. It is not possible to tell from the COTE data in Table III.3, for example, whether the average of 2.9 days taken by the firm to inspect goods reflect the entire inspection process, or was the delay between being asked to inspect the goods and actually carrying out the inspection. Similarly, the SAGS data do not appear to show precisely how long the supplier took to deliver required documents. Since the time factor is one of the most sensitive aspects of PSI, there would seem to be a case for gathering the data in a uniform manner that allows responsibility for processing times to be allocated precisely to each party to the process. Such information could also be presented regularly to the principal as part of the PSI company's reporting requirements. Moreover, a complaints procedure of the kind suggested below could use this information as the basis on which to consider importer complaints relating to delays. Even if everything possible is done to minimize the time taken to carry out PSI, the problem of the late arrival of PSI documents will persist as long as the practices current in most PSI contracts persist. The tardiness of documentary flows will continue to represent a major weakness of the service, especially in customsrelated PSI programs. In view of this, thecontinue

Table III.4: PSI Processing Times Exports From Japan to Indonesia (May, 1993, 4,179 Reports of Findings) Processing Stage 1. From the request for information to inspection requested 2. From inspection requested to inspection carried out 3. From inspection carried out to inspection report 4. From bill of lading date to final information received 5. From inspection requested to issue of ROF 6. From final information received to issues of ROF Average Number of Days 5.0 0.0 1.9 3.6 9.9 1.4

Source : SGS PSI companies and some of their principals have been thinking of ways of redesigning the PSI process so as to avoid the eventuality of PSI documents arriving later than the goods to which they pertain. There are essentially two approaches to the problem. Transactions Costs and Delays 78

Preshipment Inspection Services First, the idea has been mooted of creating a provisional PSI clearance document that can be delivered before all formalities are completed. In the Philippines, for example, following complaints from the garment industry about delays attributable to the late arrival of PSI documents (see above), SAGS proposed that an advance OF be issued immediately following physical inspection, leaving the completion of other PSI requirements until afterwards.20 In Indonesia, where shipments by air were almost always in the country ahead of the OF, a trial scheme was introduced in respect of air cargo arriving from Singapore. Under the scheme, SAGS sent a notice by fax to Indonesian customs informing them that a consignment had been inspected but that a OF had not yet been issued. This preadvice was supposed to be used by the importer (or clearing agent) to obtain release of the goods, against security posted for estimated taxes due. The importer was then required to present final documents within a certain time. The scheme was quickly abandoned, largely because no instructions were issued to customs and importers were not made aware of the arrangements. The Indonesian authorities did not appear to attach priority to the preadvice system. In the new Kenya PSI contract, the use of provisional clearance documents is contemplated when Roofs do not arrive in time.break 20 Since import duties are prepaid in the Philippines, there was limited concern about revenue risk associated with customs clearance against provisional documentation.

Second, a scheme has been introduced in Zambia whereby the OF accompanies the goods themselves as an integral part of the final invoice. There is a requirement in Zambia that goods can be cleared on a provisional basis without a OF upon payment of an amount slightly in excess of estimated taxes due. The idea was that importers or their agents would then return to customs and regularize the situation once the OF arrived. In practice, customs was levying little or no deposit on goods cleared without Roofs, so importers were not returning to customs. This was the least desirable of all outcomes, since not only was PSI failing to contribute to revenue security, but the pretext of awaiting PSI documentation was actually being used to avoid some or all of the import duties and taxes owing. It was estimated by Zambian Customs in early 1993 that for one reason or another, only about 20 percent of import consignments were being cleared through customs with reports of findings. The proposed solution to this situation was for the PSI inspector to go to the inspection already armed with the results of the preliminary price verification. If the physical inspection proved satisfactory and did not raise any doubts about the price verification, the inspector would affix a label or bar code to the invoice, thereby making it both the final invoice and the clean report of findings. This document would accompany the merchandise, so there could be no question of the goods arriving prior to the report of findings. This is an attractive solution to the problem of short shipping times, provided a system of ex post checking is in place to ensure that the goods were actually shipped. Otherwise, traders could go through PSI in order to acquire the necessary documents to arrange payment for the goods, and then not ship them it is precisely to avoid this eventuality that proof of shipment is usually required before a OF can be issued. The preadvice system of the kind mentioned above in relation to the Philippines, Indonesia and Kenya avoids the risk of nonshipment, but on the other hand, may allow for the release of goods without adequate provision to ensure that duties and taxes are eventually paid in full. A preadvice system may also complicate arrangements for an ex post check (see chapter IV) that all taxes due on imports have actually been received by the appropriate government authorities. Whichever approach is chosen, PSI services will remain deficient, particularly from a revenue security perspective, until all shipments are cleared promptly, on a definitive or provisional basis, with the necessary PSI documentation. It should therefore be a priority to find effective remedies to the temporal limitations of standard PSI services.
Post Shipment Vulnerability

What is to stop exporters from switching goods or altering quantities shipped between the time an inspection occurs and shipment of the goods, or at some stage during shipment? The answer is not very much, except the Post Shipment Vulnerability 79

Preshipment Inspection Services sealing of containers21 or vigilance on the part of national customs services. Some evidence was cited in the Benin study of discrepanciescontinue 21 Apparently, container sealing is not entirely foolproof, since it is possible to remove the side of a container, without breaking the seal, by releasing the hinges. This is a cumbersome process and is unlikely to occur with frequency.

discovered by customs, taking the form of quantity differences. In Ghana, a case was reported where a consignment of 223 metric tons of plastic raw materials was found upon arrival to include a significant number of bags containing factory sweepings and sand. An investigation revealed that the switch was made after inspection. In practice, it appears that product substitution and quantity manipulation have not been a major source of difficulty. It should, of course, be borne in mind that customs services are also vulnerable to this sort of behavior it is not a problem intrinsic to pre shipment inspection, as there always exists the possibility that an invoice description will not match the goods actually delivered. Indeed, given the scope for more extensive physical examination under PSI than in traditional customs work, the incidence of physical fraud should be reduced under pre shipment inspection. Moreover, customs services are less concerned with quality issues per se than PSI companies.
Destination Inspections

Some controversy has arisen as to whether pre shipment inspection is more suited to the needs of governments than post shipment, or destination inspection. In the end, most arguments about PSI versus destination inspection reduce to the question whether PSI or a traditional customs service is preferred. Destination inspections are the same thing as normal customs work, the only question being who actually performs the task. Assuming the alternatives to choose from are a normal PSI service and an equivalent service based on destination inspections carried out by a PSI company or similar entity, there appear to be four basic arguments why PSI might be preferred. First, PSI occurs before the ownership of goods has passed from the seller to the buyer and before shipment, making any necessary corrective actions on behalf of the seller or the authorities easier than they would be in the context of destination inspections. This consideration would be particularly relevant in cases of overinvoicing, both from the point of view of the authorities, and the buyer if he is not involved in a collusive arrangement. A similar argument would apply in the case of fraud perpetrated against a buyer via quantity or quality manipulation. Second, a far greater degree of physical inspection is possible under PSI than in the case of destination inspections, because the former is carried out when goods are being packed or prepared for shipment, while the latter usually necessitates the unloading and reloading of containers a timeconsuming procedure likely to congest the ports unless undertaken on a very selective basis. Third, performing PSI in the market of the exporter gives price verifiers better access to price information when assessing invoice values, and also permits the realization of economies of scale in terms of the specialized skills of PSI personnel. Fourth, PSI generates parallel and independent information on trade flows and taxes owed in a manner that destination inspections cannot. The importance of this feature of PSI is explored further in chapter IV. All the reasons adduced above for preferring PSI to destination inspections lose their validity when the case for PSI loses its validity that is, when customs is performing tobreak

acceptable standards, when buyers are better equipped to look after their own interests, and when overinvoicing becomes less prevalent. Destination Inspections 80

Preshipment Inspection Services What are the advantages of destination inspections? These relate to such matters as training, and skills and technology transfer. A program of destination inspections, jointly performed by the national customs service and a private entity may well prove useful in that context. But destination inspections are not a substitute for pre shipment inspection, for the reasons listed above. Another argument relates to cost, and the possibility that a destination inspection service could be performed at less cost than pre shipment inspection.22 No governments have opted for destination inspections as a substitute for PSI, although a role for destination inspections in the context of reduced reliance on PSI should not be ruled out. For normal PSI operations, a problem arises if the authorities of the importing country permit importers to opt for destination inspections rather than PSI, as this undermines the security and efficiency of the program. If given the opportunity, some importers are likely to opt for destination inspections in the hope of evading taxes. But another obvious motivation for doing so is to avoid transactions costs and delays associated with the PSI process. Efficient delivery of PSI services will weaken the latter motive. The absence of effective strictures against destination inspections in Ghana meant that customs and the PSI company ended up performing an average of 36 such inspections a month during 1992. In the Central African Republic, importers whose goods arrived without a OF were required to pay a fine worth 10 percent of the value of the goods in question. Such an amount is unlikely to be an effective deterrent in many cases. In Cameroon, a fine of 25 percent was levied on the same basis. In Kenya, the new PSI contract envisages fines for the first one or two consignments arriving without a OF, but after that the goods will be returned. Under INSPIRES 4/1985 in Indonesia, goods subject to PSI arriving without the necessary documentation were to be returned forthwith. In the Philippines, such goods are seized and subject to a penalty of 20 percent to 80 percent of their value. In sum, while destination inspections may perform a useful role in some circumstances, they are not a substitute for PSI, and should not be relied upon by default.
Complaints and Appeals

It is perhaps inherent in the nature of PSI that providers of this service will not always be popular. Regulators and monitoring authorities of many varieties find themselves in a similar position. However, complaints about instances of poor performance, highhandedness, and inattentiveness to the needs and problems of traders subject to PSI, were heard on several occasions in the casestudy countries. The problem with these kinds of complaints is that they are difficult, if not impossible, to verify after the event. Such incidents, or versions of them,continue 22 An entity that offers comprehensive destination inspection services to governments has stated that such services would probably cost about half of what PSI costs, but this would depend a great deal on how complete were destination inspections.

may indeed have occurred, but equally they may have been fabricated by traders unhappy about a PSI decision or frustrated in the commission of fraud. There will always be interests wishing to undermine and discredit pre shipment inspection. The PSI companies may not have done enough to take complaints seriously and mount a defense against them. The simplest way to dissipate the illeffects of allegations and rumors is to bring them out into the open. For this reason, it is suggested that future PSI contracts should establish appeals and complaints procedures. Surprisingly, there is very little experience to build upon. The only place where an appeals procedure exists is the Philippines. An Appeals Committee, established in 1987, comprises the Bureau of Customs, the Central Bank, the Department of Trade and Industry, SAGS, and representatives of the private sector. The Committee meets every week to hear cases that have not been resolved through direct informal contacts between the parties involved. There is widespread agreement that the Committee has acted as a useful mechanism for resolving disputes. The main findings of a report on the workings of the Appeals Committee are summarized in Box III.6. Complaints and Appeals 81

Preshipment Inspection Services Importers do not face any extra charges or costs if they appeal, as they are only required to pay what they believe is due on a consignment and then to clear the goods through customs. The importer hands over a 60day postdated cheque for the difference between his liability assessment and that of the PSI company. Less than 2 percent of inspections come to appeal. A number of relatively minor issues might arise about the design of such an arrangement, but experience with the Philippine Appeals Committee suggests that this is a mechanism the should be written into all PSI contracts as a matter of course. There are two other aspects of PSI operations that might justify similar arrangements. These concern relations between national customs services and the PSI company, and complaints about the performance of the service. Taking the relation between customs and the PSI company first, the question whether any kind of formal appeals/complaints procedure is required here depends on the nature of the arrangements established between the parties. If PSI recommendations on valuation and classification are considered advisory in nature, and subject to change by customs under its own internal procedures, then there is probably no need for any formalized appeals or complaints arrangement. The PSI company is, after all, contracted by the government and it is for the principal to decide whether to follow advice received. In Peru, however, a different arrangement is in place, whereby the customs authorities levy fines on the four PSI companies operating there if they consider that an incorrect valuation has been approved, a isstated quantity overlooked, or is classification has occurred. In the year ended March 1993, Peruvian customs fined the PSI companies for 85 infractions, amounting to a total of US$ 142,285. Sixtyone of the 85 infractions were in relation to classification, 9 involved value, 13 were in respect of quantity isspecifications, and 2 concerned reparable commissions. In addition, the Peruvian authorities fined the PSI companies for reissuing certificates (to correct errors). During the year ended March 1993, 1,474 reports of findings were reissued, incurring fines worth US$ 125,290 in total. The usecontinue

of penalties in this manner is one way for principals to control the quality of PSI services. But there is a question of balance. In the absence of an independent appeals procedure, there is little to prevent the Peruvian authorities from acting in an arbitrary manner. If this approach is to be adopted, therefore, it would be desirable that a proper appeals mechanism is also established. Regarding complaints procedures dealing with questions of service performance on the part of PSI companies, there are no precedents to rely upon. An independent body could be established under PSI contracts that would hear complaints from importers, once informal attempts to solve the problem had failed. The advantages of such arrangements are that PSI companies would be made more answerable for their actions, importers would be heard, and rumors and allegations against PSI companies could be disregarded if they had not been the subject of a formal complaint. A complaints body would add transparency to the PSI process, and reduce the scope for tension among the parties involved. Box III.6: The CustomsSGS Appeals Committee in the Philippines At the request of the Commissioner of Customs, a study was undertaken of the activities of the Appeals Committee from JuneNovember, 1992. The study reported on 994 appeals that had been settled during this period. The disposition of cases was as follows: Valuation disputes No report of findings Classification disputes Complaints and Appeals 574 277 129 82

Preshipment Inspection Services Classification & valuation Other Total 7 7 994

Of the valuation and classification cases, 68 percent were resolved in favor of SGS, 20 percent were compromises, and 12 percent were settled in favor of the importer. Of the cases of goods arriving without a ROF, 75 percent were subject to fines and 25 percent were allowed entry without penalty. Finally, arrangements along these lines on the import side of PSI operations would create symmetry with what the WTO Agreement on Preshipment Inspection provides on the export side. The agreement requires user governments to ensure that the PSI companies establish adequate procedures for addressing grievances from exporters. In addition, it sets up an independent review body which makes binding rulings in respect of disputes that cannot be settled informally.
Monitoring and Auditing of PSI Companies

A criticism often heard of PSI operations from outside the industry is that few, if any, arrangements exists for monitoring and auditing PSI firms. The mere existence of the perception that PSI companies are unaccountable gives rise to suspicion and speculation as to the quality and nature of the firms' activities. It is worthwhile distinguishing between auditing and monitoring. Auditing of contract performance is a more specific and formal function, focusing on establishing the veracity of claims made by the firms. An audit would concentrate on such matters as verification that the principal has been billed the correct amount for servicescontinue

rendered. It could also examine the consistency of recommended values and tariff classifications, and undertake a documentary check of reported results. Auditing of this nature could be carried out by a professional auditor, provided the audit targets were made clear. Monitoring, on the other hand, is more difficult to define with precision, as there are several aspects involved. Like auditing, monitoring is designed to serve the principal, and allow him to judge whether he is receiving the service he believes he has paid for. There are three related aspects of monitoring. The first concerns the reporting requirements of the PSI companies. These should be defined in the contract, in terms of what the principal considers it is important to know. Under some PSI arrangements, such as Peru's, the companies are required to make regular detailed reports on several aspects of their activities. In other countries, much briefer reports are submitted and it is questionable whether they are even read. The frequency and substance of reports are for the principal to determine, but they should include data that permits a better statistical analysis than was possible for this study. It would also be for the principal to define any specific monitoring activities to be undertaken, perhaps within the government, or with assistance from an independent external entity. The second aspect is closely related, and does not strictly amount to monitoring. It concerns what might go into a contract besides the reporting requirements, in order to facilitate monitoring by stipulating in detail what is expected of the PSI provider. In a sense, this amounts to automatic or surrogate monitoring, and obviates the need for continuous close scrutiny. If a contract clearly sets service quality standards, for example, or spells out detailed procedures, then poor service can amount to nonperformance of a contract, and is less likely to occur. Finally, another kind of substitute monitoring turns on the appeals and complaints procedures described above. By instituting these procedures, the principal is coopting importers into a monitoring role, once again reducing the need for close monitoring by the principal.

Monitoring and Auditing of PSI Companies

83

Preshipment Inspection Services The PSI companies do not appear to be against the idea of tightening monitoring arrangements and instituting auditing procedures. On the contrary, they see some advantages in the transparency and accountability that this will bring, and the contribution it will make to dispelling concerns about the quality of the service delivered.
Training

In most customsrelated PSI contracts, there is provision for training by the PSI company. The seriousness with which the training component has been taken in different countries has varied considerably. For the most part, this is probably due to the degree of interest the contracting government has in obtaining training from the PSI company concerned. If governments are to reduce their dependency on PSI services over time, they will need to ensure that their customs services are adequately trained. It is argued in the next chapter that an adequate training and customs reform program is a sine qua non of resumption by customs services of their traditional functions.break

An important question is whether the PSI companies should be relied upon for such training. There is little doubt that the companies either have or could quite easily acquire the expertise for this purpose. On the other hand, it might be argued that PSI companies will find themselves in a conflict of interest situation if they are required to train themselves out of a contract. Training and PSI services are, after all, separate activities, although some training could undoubtedly be offered by PSI providers in the context of their daytoday activities. For the most part, customs services relying on PSI should probably link training to broader customs modernization and reform programs, and rely primarily on these programs for training. With such a program in place, a PSI provider could then be asked to make specific contributions to the training effort. It should not be forgotten that customs services using PSI will enjoy a much smoother and more efficient resumption of their functions and responsibilities when the time comes if a good working relationship has been established with the PSI provider. One way to promote that relationship is through training. Seen from this perspective, PSI company participation in training programs could prove useful independently of the substantive utility of training activities. The PSI company training program in the Philippines is one of the most extensive under any PSI contract. Both customs officials and SGS asserted that their joint training courses had played an important role in establishing a closer relationship, which had beneficial consequences for cooperation in other areas of work. The Philippine training program for 1993 is set out in Box III.7.
Fees

The allegedly high cost of PSI services has long been a source of concern for critics of the service. On average, and taking into account both the ad valorem and minimum fee components, the cost of PSI probably averages a little over one percent of the value of imports. Minimum fees vary, but are generally in the region of US$ 200 to US$ 250. A spread of less than 0.3 percent on each side of the one percent figure would cover the vast majority of PSI contracts. Is this expensive? The answer depends entirely on what the fee is being compared with. Customs brokers' fees, for example, are often in the range of one percent of the value of imports processed. Forwarding agents may charge up to 5 percent of the value of freight. Procurement agents charge between 3 percent and 8 percent. The fee for opening a letter of credit ranges from 0.25 percent to 0.5 percent. Confirmation costs for letters of credit depend on the degree of commercial risk involved, but in countries where letters of credit cannot be confirmed by the importer's bank, a fairly typical fee is 3 percent. Just as with PSI fees, judgements about how reasonable these costs are must be weighed with some care. One indirect indicator of whether fees for such services as those mentioned above are within a reasonable range is to consider competitive conditions in the market concerned. If market entry and exit conditions permit a certain degree of competition, fees are unlikely to reach exorbitant levels. In countries where customs clearance agents Training 84

Preshipment Inspection Services are licensed in a restrictive manner, and where importers are prohibited from clearing their owncontinue

goods, for example, brokerage fees tend to be significantly higher than where there is free entry into the market for this service. The market for PSI services is characterized by relative ease of exit and entry, certainly at the level of individual country contracts, and it therefore seems reasonable to assume that there is price competition in the industry. This question is taken up again below. Many customs services assert that with the amount of money paid to PSI companies, they could undertake farreaching reforms. This is undoubtedly true, but does not provide an argument for dispensing with preshipment inspection, as this should wait until the customs service is ready to assume its functions without imposing undue costs on traders or obliging the government to assume an unacceptable level of revenue risk. Box III.7: The Philippine Customs Training Program The Bureau of Customs of the Philippines and SGS organized the following customs training program for 1993: January 11 29: Feb. 15 Mar. 6: March 8 26: May 3 14: June 7 25: August 16 31: Sept. 27 Oct. 15: November 1 19: Nov. 29 Dec. 10: 2nd investigation course 3rd investigation course 1st appraisal/examination course Instructional techniques course 10th general course 1st products course 11th general course 4th investigation course 2nd products course

By way of illustration, the kinds of subjects covered in a general course include trade facilitation, customs controls, powers of officers, classification, valuation, revenue awareness, profiling, physical inspection, security and audit, documentary fraud, control of informants, computerization, and electronic data interchange. An investigation course would deal with such matters as customs offenses, rules of evidence, surveillance, arrest and restraint, intelligence analysis, profiles and indicators, interview techniques, and court procedures. If the savings in revenue and foreign exchange reported by PSI companies were to be taken at face value (see discussion above), PSI would look like excellent value for money in the case of most contracts. However, it is Training 85

Preshipment Inspection Services clear that much of what is reported as savings can only be realized if the government behaves in the requisite manner. On the other hand, there is the deterrent effect to consider as well, and this is almost impossible to estimate. Another factor to consider is the extent of potential savings expected as a function of a government's policies the higher the level of income derived from trade taxes in relation to other sources of revenue, the greater the expectation of returns from preshipment inspection. Similarly, the expected return from PSI will be influenced by the level of revenue collection that would occur in the absence of the service. If the national customs service would fail to collect a significant proportion of revenues due in the absence of PSI, the cost of foregoing the service would be higher than in a situation where PSI can only add a modest amount to revenues. The price paid for PSI is reasonably consistent across countries, and among firms, although the fee on larger contracts tends to be lower than it is on smaller ones. Differences in fees unexplained by contract size probably reflect a variety of factors, including the negotiating acumen of the contracting government and the structure of trade in relation to thecontinue

minimum fee. Could the same services provided by PSI companies be acquired at lower cost? In the discussions above of proposed alternatives, such as unit price data bases and destination inspection, it was concluded that such arrangements are not substitute services. A more interesting question in relation to cost, therefore, is how PSI services might be made more selective as the case for comprehensive coverage weakens. As noted elsewhere, perhaps onethird to a half of the costs of PSI are attributable to physical inspection,23 and this is the first part of the standard PSI package that governments are likely to cut back on when reducing reliance on preshipment inspection. The basic conclusion, then, is that the issue of PSI fees is not usefully addressed in terms of whether they are too high or too low, given the difficulty of making precise statements about what PSI ought to cost. Rather, the cost question should be considered in terms of when the significant expense of a full PSI service is no longer necessary because a government has enhanced its ability to perform the functions for which a PSI company was contracted in the first place. Another question concerning fees is who should pay for PSI services the contracting government or importers. Three different approaches are discernible. First, the contracting government may simply pay for the service out of the general budget. Second, the government may pay the contractee for the service, but charge importers a uniform fee to cover the cost. Third, importers themselves may be responsible for paying the PSI company directly. In most countries, the government pays, but frequently levies a fee on importers. The advantage of having the government pay is that importers of small consignments do not end up paying large fees relative to the value of the consignment because of the minimum fee (see next section). But should the government be levying a uniform fee on importers to meet the costs of preshipment inspection?24 It is arguable that if importers pay, they will be more likely to demand a highquality service, and apply pressure on PSI companies accordingly. On the other hand, a strong case can be made for exempting certain entities from the PSI fee, such as exporters who need access to imported inputs at world prices in order to be competitive. If PSI yields foreign exchange or revenue savings to the government, payment for the service can be covered out of those savings. Perhaps the most straightforward approach is simply for the government to pay for the service out of its general budget. But if budgetary constraints induce governments to charge importers a fee, exporters entitled to temporary admission arrangements or duty drawbacks should be exempt.break 23 The breakdown of costs among different aspects of the service varies considerably according to the source and composition of goods. 24 In GATT legal terms, governments levying a uniform fee may have a problem. A GATT dispute settlement panel found that a uniform customs fee charged by the United States was not consistent with GATT rules, on the grounds that any such fees should reflect the cost of services rendered, and that it was inconceivable that the true cost of services rendered by the customs authorities was equal to a uniform ad valorem amount in respect of every Training 86

Preshipment Inspection Services import consignment.

Inspection Thresholds, Product Coverage, and Exemptions

Preshipment inspection programs can be rendered less effective if many exemptions are permitted from PSI requirements. All contracts specify a number of PSIexempt goods. A typical list of exemptions might include gold, precious stones, objects of art, explosives, pyrotechnic products, ammunition, weapons, live animals, fresh fruits and vegetables, parcel post, trade samples, diplomatic goods, petroleum, books, newspapers and periodicals. In broad terms, factors determining the composition of an exemptions lists include the identity of the importer (government defense supplies, diplomats), perishability of the goods (live animals, fresh fruit and vegetables), lowvalue or fixedprice items (parcel post, trade samples), uniquely priced items (objects of art, precious stones, gold), and few or single importers of homogenous commodities (petroleum). These are welldefined exemptions that generally do not create significant revenue security or capital flight problems. In a few countries, however, much broader exemptions are granted, and tend to undermine the effectiveness of PSI programs. In Cameroon, for example, additional exemptions were granted in respect of all public contracts and government imports, and a range of public and private enterprises that had negotiated contracts with the government. This meant that in 1992, only 63 percent of imports were subject to preshipment inspection. Apart from design weaknesses in the PSI program that lead to an excessively low coverage of PSI,25 poor execution of the program can also impair its benefits. One way this occurs is through the failure of government authorities to ensure that goods entering the country actually meet inspection requirements. In the Central African Republic, for example, it was estimated that for the year ending in June 1992, some 91 percent of imports were subject to PSI, but only 59 percent actually complied with the requirement. In some countries, government officials instruct the PSI company not to examine particular consignments. This kind of discretionary intervention on behalf of specific importers or specific cargoes is clearly damaging to the integrity of a PSI program. In order to reduce the likelihood of this occurrence, PSI companies should ensure that the necessary arrangements are in place to guarantee the timely arrival of reports of findings. This would eliminate one justification often heard for circumventing PSI requirements. But in the end, the integrity of the program depends on the commitment of the user government to make it work. All PSI contracts operate with a threshold value below which goods are exempt from preshipment inspection. Table III.5 lists the threshold values applied under PSI contracts in 1992 for the case study countries. Half of the contracts for these countries have threshold values of US$ 5,000, and the rest are below that figure. In settling upon a threshold value, there is always a tension between cost and convenience on the one hand, and the security of the program on the other.break 25 The exemptions and loopholes referred to here are to be distinguished from planned selectivity in PSI programs, where a client government opts for a more targeted use of PSI services.

Table III.5: Threshold Values under PSI Contracts Country Benin Cameroon Central African Republic Cote d'Ivoire Threshold Value (US$) 4,800 3,200 5,000 5,000 87

Inspection Thresholds, Product Coverage, and Exemptions

Preshipment Inspection Services Ghana Indonesia Mali Peru Philippines Tanzania Uganda Zambia 5,000 5,000 5,000 2,000 500 2,500 2,500 5,000

Source : PSI companies As far as cost is concerned, Table III.6 computes the level of the ad valorem tariff at which maximum possible revenue savings would equal the cost of the service, given the relationship between the threshold inspection value and the minimum fee. Thus, for example, the maximum tariff that could be evaded would have to be 50 percent before full potential savings from PSI could be as great as the cost of the service if the inspection threshold was US$ 500 and the minimum fee was US$ 250. Another way of saying the same thing would be, for example, that the average tariff on goods subject to inspection needs to be greater than 10 percent before it makes sense to set the threshold value as low as US$ 2,500 when the minimum fee is US$ 250.break Table III.6: Threshold Values, Minimum Fees and PSI Savings Minimum Fee (US$) Threshold Value (US$) 150 200 250

"Breakeven" Tariffs (%) 500 2,500 5,000 33 6 3 40 8 4 50 10 5

The breakeven point between costs and potential savings depends on assumptions about the share of total revenue liability likely to be evaded, as well the scope for consignment splitting, and for undervaluation that permits importers to declare goods below the threshold value. The lower the proportion of total revenue liability that it is assumed can be evaded, the higher ad valorem tariffs need to be before the service pays for itself vis vis lowvalue consignments. It seems improbable that importers systematically pay none of the tax due when evasion occurs, or that tax collectors turn in none of the revenue due if they are involved in revenue fraud. On the other hand, if consignment splitting and undervaluation are easier with a higher threshold value, as is generally assumed to be the case, this argues for a lower threshold value. The threshold value under PSI contracts should be periodically reviewed in light of these considerations. Consignment splitting is a perennial problem with thresholds. Whether as a means of avoiding the inconvenience and cost of PSI, as some importers allege to be the motivation, or as a way of evading taxes, consignment splitting has been identified as a significant loophole under many PSI arrangements. In the Philippines, for example, the threshold was US$ 5,000 until 1988, but widespread consignment splitting led the government to reduce the threshold by half. However, the problem appeared to persist, and the threshold was reduced again, from US$ 2,500 to US$ 500. Still concerned with splitting, the authorities established a rule whereby no importer could bring in the same commodity more than once in any 30 day period without submitting to preshipment inspection, and all goods described as used or secondhand always had to be inspected. In Peru and in Tanzania, similar Inspection Thresholds, Product Coverage, and Exemptions 88

Preshipment Inspection Services concerns led to reduced threshold values. In Indonesia, both the PSI company and many government officials believe that contract splitting is rife, although the threshold value has not been lowered. A similar situation prevails in a number of other countries. It is not always easy to observe contract splitting, although some evidence of the practice was obtained in the Mali study. Table III.7 shows how the composition of Malian imports by consignment size changed before and after the introduction of PSI in 1989. A significantly larger share of consignments entered the country with values declared at less than the threshold amount after the introduction of the program. It is possible for a PSI company to monitor splitting activity, but this requires access to all import entries, and not just those covered by preshipment inspection. Another consideration that will influence the threshold value is the composition of imports by consignment size. In many countries using PSI, a significant proportion of imports come in small consignments. Zambian data for seven months ending in January 1993, for example, show that over 20 percent of all consignments entering the country were valued at less than US$ 10,000, but these consignments only accounted for 3 percent of total imports during this period (Table III.8). According to the PSI companies, the relationship observed in the Zambian import data between the composition of consignment size and value is typical of many countries using preshipment inspection.break

Table III.7: The Effect of Threshold Values on Consignment Sizes No. of consignments: Above threshold value (A) Below threshold value (B) Total (T) A/T (%) B/T (%) 1988 2477 1369 3846 64.4 35.6 1989 1531 2171 3702 41.4 58.6 1990 1860 2350 4210 44.2 55.8

Source : Geourjon and Steenlandt (1992) This means that a significant proportion of PSI consignments will be exempt from PSI if the threshold is set at or around US$ 5,000. The threshold issue is less of a problem under contracts where physical inspections are undertaken selectively (chapter IV). If selective physical inspection is carried out on the basis of risk profiles (perhaps combined with some random element), consignment size would be one element in a risk profile, leading to a lower incidence of physical examination in respect of smaller consignments. As with selective physical inspection, the management of revenue risk in the presence of a threshold exemption will be far more effective if national customs authorities and the PSI companies work cooperatively in the design and operation of the system in question.
Competition in the PSI Industry

For many years, SGS was the only firm offering comprehensive PSI services to governments. The competition that has existed since the mid1980s is widely considered, both within and outside the industry, to have provided consumers with a better range of choices and a more clientsensitive delivery of services. The conditions of entry and exit are not onerous in the market for PSI, at least for individual contracts. Fixed costs and infrastructural Competition in the PSI Industry 89

Preshipment Inspection Services requirements within user countries are modest, and external costs can be spread over multiple contracts. This suggests that the market for PSI in a given country is contestable. Despite the fact that the conditions for competition seemingly exist in respect of individual country contracts,26 a lively debate continues as to the nature of competition in thecontinue 26 Entry into the PSI industry is more problematic than access to individual country contracts for established firms because of the international network, expertise and scale of operations a firm must have in order to offer comprehensive PSI services. It is for this reason that firms offering PSI services usually maintain extensive commercial inspection activity as well, although governmentrelated PSI services are in turn crucial to the support of an extensive commercial network.

Table III.8: Composition of Zambian Imports by Consignment Size (July 1992January 1993) Value Range of Consignments (US$) Under 10,000 10,00015,000 15,00020,000 20,00030,000 30,00050,000 50,000100,000 100,000150,000 Over 150,000 TOTAL Number of Consignments 1,571 985 834 1,172 1,561 763 249 382 7,517 Share (%) 20.9 13.1 11.1 15.6 20.8 10.1 3.3 5.1 100 Value (US$ '000) 2,163 2,535 3,008 6,054 12,354 11,277 8,381 27,003 72,775 Share (%) 3.0 3.5 4.1 8.3 17.0 15.5 11.5 37.1 100

Source : PSI company data industry and how it should be promoted. The basic issue is the means by which competition is best assured through parallel or serial operations. In other words, does effective competition require that more than one company should provide PSI services to a client government simultaneously, or should only one company at a time supply a government, while competition is ensured through regular competitive tendering for the service? In Uganda, Ghana, Kenya, Mozambique and Zambia, among other countries, there have been pressures recently to split PSI contracts and award them to more than one firm, on the grounds that this will foster competition and a better service for the client. Three questions to be considered here are whether split contracts are necessary to guarantee competition, whether split or unitary contracts are more efficient from the point of view of user governments and what the cost implications are of splitting contracts. Proponents of split contracts argue that if more than one company is operating simultaneously, the service providers will be more attentive to the client and deliver a bettercontinue

product. A single provider, on the other hand, would be prone to monopolistic behavior, and the client would Competition in the PSI Industry 90

Preshipment Inspection Services suffer accordingly. The validity of this argument is undermined if contracts awarded to single companies are subject to regular renewal through competitive bidding. If contracts were awarded only for two or three years at a time, it seems unlikely that single suppliers would be indifferent to the effect of the quality of their services on the prospects for contract renewal. Indeed, even under parallel competition, the real incentive to offer a good service is the desire to win future contracts, rather than to outperform coproviders in the short term. It seems reasonable to suppose, therefore, that serial competition with regular tendering can allow user governments to benefit from competition among suppliers. Parallel competition can do the same, but only if contracts are regularly contested through competitive bidding. If a contract is split, the typical way of dividing the work is on a geographical basis. This is the basis of the split in all multicompany PSI contracts presently in force, except that of Peru (see below). Even if one were to accept the validity of the argument that parallel contracting enhanced competition, it is doubtful much effective competition is fostered if the companies are operating in entirely different locations. Each company is awarded its own territory under a geographical split, more or less replicating the operating environment that would prevail under a single contract. Another reason for questioning the efficacy of geographical splits is that exporters and importers may be encouraged to change the declared origin of goods in order to choose the most desirable inspection site. This may occur under single company contracts as well, since a company's service standards may vary by location. In countries where the volume of trade is small, PSI companies are unlikely to maintain the same level of expertise as they do in locations with large trade volumes. Evidence of traders redirecting trade, seemingly in response to PSI, was reported in the Mali study (Table III.9). The significant change in the geographical composition of trade reported in Table III.9 (a shift of approximately six percentage points between the EU and a group of three African countries) may be attributable to a range of factors. But it is difficult to believe that the occurrence of this trend at the same time as the introduction of PSI is entirely coincidental. Note that this behavior occurred in a country with a single contract. The question, therefore, is whether split contracts would exacerbate such practices, and no clear evidence exists on this point. If geographical splits do not add much by way of intensifying competition among PSI companies, the question arises as to whether alternative forms of parallel contracting might do better. Peru has hired four PSI companies and permits importers to choose which of the companies they wish to employ. Some reservations have been expressed about this arrangement, on the grounds that it may give rise to perverse competition, such that PSI firms implicitly or explicitly collude with importers and attract business by lowering standards. No evidence of such behavior came to light in the context of this study, but the monitoring requirements falling to the principal under this kind of competitive arrangement are greater than they would be under single contracts or geographical splits. This makes the importer choice approach to fostering competition more expensive in administrative terms. On the other hand, it forces firms to compete directly, and is the only split contract arrangement that really does so.break

Table III.9: PSI and the Redirection of Trade: Evidence from Mali Declared Country of Export or Supply European Union Cote d'Ivoire ) senegal ) Togo ) Other countries Competition in the PSI Industry 91 1989 (% share) 50.6 26.4 1991 (% share) 44.0 32.4

Preshipment Inspection Services 23.0 TOTAL 100 23.6 100

Source : Mali study, p.20 The second question posed above was whether split or unitary contracts were preferable from an efficiency perspective. In other words, if both parallel and serial contracting arrangements can deliver the benefits of competition among companies supplying PSI services, is there any reason to prefer singlesupplier or multiplesupplier contracts? Efficiency arguments militate in favor of using a single firm at any point in time, for two main reasons. The first and most important reason is that the prospects for effective cooperation between PSI providers and national customs authorities, on the basis of mutual trust, are greater in a oneonone relationship than under arrangements where additional parties are involved. As argued elsewhere, a good working relationship between customs and PSI suppliers is essential if PSI is to provide value for money and if countries are to wean themselves off continuing dependence on comprehensive PSI services. The other main efficiency reason for preferring serial competition among PSI companies is that transactions costs for a government will be lower if there is only one supplier. The relevant government authorities can focus on the relationship with a single counterpart without worrying about the need to ensure uniformity among suppliers in procedures, documentation, reporting, and data delivery. Moreover, effective ex post reconciliation (see chapter IV) and data collection and analysis will be considerably easier with a single supplier. An added consideration is that if individual customs officers wish to frustrate ex post reconciliation, they would probably find it easier to do so in the presence of more that one PSI provider. The third question concerned the cost of PSI services. It is unclear whether significant economies of scale exist in the provision of PSI services. Nevertheless, all the PSI companies claim that the larger the volume of business, the lower the fees at which they cancontinue

offer to work. Precise information on fee income was not made available for the casestudy countries,27 so it is not possible to test this proposition. Fee comparisons among countries would in any event be complicated by differences in contract requirements and operating conditions. If it is the case that smaller contracts are performed at higher unit cost than larger ones, as indicated by the PSI companies, then this is presumably either because there are indeed economies of scale in PSI operations, or because of considerations relating to minimum operating size. There must be a minimum contract size below which the quality of PSI services would become unacceptably low. In other words, it is reasonable to assume that at less than some threshold volume of business, PSI companies are less likely to offer high quality services. Governments may, therefore, end up receiving a lower quality product directly as a result of contract splitting. A detailed analysis of company costings would be required in order to determine the critical threshold value. It would vary according to contract requirements, the geographical trade pattern of the country concerned, the composition of trade by commodity and consignment size, and operating conditions in the country. The size of a company and its ability to spread fixed costs would also be a factor. One PSI company suggested that no contract involving less than US$ 500 million in imports subject to PSI (worth approximately US$ 5 million in fee income) should be split. While this may be a useful rule of thumb if governments wish to consider contract splitting, it does not mean that PSI services would be denied to countries with less than that volume of business. Regardless of whether governments choose to split contracts or to rely exclusively on regular tendering of single contracts in order to reap the fruits of competition among PSI companies, the tendering process can have an Competition in the PSI Industry 92

Preshipment Inspection Services important influence on how contracts are subsequently performed. Tendering procedures, bid evaluations and contract award decisions are frequently the subject of contention. There may often be an inclination on the part of unsuccessful bidders to criticize award decisions from which they do not benefit, but complaints and critical observations about contract award procedures and decisions do not necessarily come only from PSI companies. Complaints cover a range of issues, from tender specifications to bid evaluations and the final award decisions. Anything that compromises the objectivity and technical soundness of tendering, bid evaluation and contract award procedures and decisions will weaken competition on the basis of quality and price, and may impinge negatively on the quality of a contract and the manner in which it is performed. In particular, any consideration or subjective factor that drives a wedge between the decision to award a contract and concern over its content and the manner in which it is performed is likely to weaken the commitment of a government to ensure value for money and to take the necessary steps to guard against openended dependency upon PSI services. Proposals on how to protect the integrity and professional quality of procurement decisions is well beyond the scope of this study, but the issue merits further reflection. An ideacontinue 27 Total fee income depends both on the ad valorem and the minimum charges, and the latter vary with changes in the composition of imports by consignment size.

that has been mooted is to involve disinterested parties with technical expertise in the decisions, perhaps by taking PSI procurement offshore. In sum, competition within the PSI industry contributes to a more efficient, responsive and better priced service. Geographical contract splitting is unlikely to have a significant effect on the quality of contract performance, while an importer choice arrangement comes closer to creating competitive conditions. However, contracts of short duration (two or three years),28 combined with appropriate procurement procedures, should create the necessary conditions for client governments to capture the benefits of competitive supply. Contract splitting raises the costs to governments of doing business with PSI providers, complicates efforts to establish an adequate working relationship between national customs authorities and the suppliers of PSI, is likely to reduce the effectiveness of ex post reconciliation and other datarelated tasks, and may increase the cost of the service itself. The key factors that will determine whether a government enjoys the full potential value of PSI services, including from competitive supply conditions are: i) an underlying commitment on the part of the principal to use PSI to its full advantage; ii) careful contract design; iii) integrity and professionalism in procurement; iv) shortduration contracts; and v) adequate auditing and monitoring procedures, including reporting requirements of the PSI company.break 28 The current practice in some PSI contracts of incorporating rollover clauses allowing for automatic extension does not favor competition, whether in unitary or split contracts.

Chapter IV Customs Reform and Preshipment Inspection

Customsrelated activities have become the most important aspect of PSI services for many governments. This reflects diminished exchange controlrelated capital flight in most countries, and the continuing need in many developing countries to secure a significant share of government revenue from trade taxes. This chapter focuses on revenue issues, first by looking at the issues of tax evasion and administrative corruption, and then considering customs reform. What is the role of PSI in dealing with these questions? Revenue gains reported by PSI companies were discussed in Chapter III, together with the patterns of intervention revealed by the detailed PSI data. It was noted that reported gains often failed to translate into real gains for governments. The reasons why Chapter IV Customs Reform and Preshipment Inspection 93

Preshipment Inspection Services the revenue gains from PSI may remain theoretical are explored further here, and some quantitative evidence that this has indeed been the case is also presented. The issue of ex post revenue reconciliation is considered in some detail. The argument is made that reconciliation is an indispensable feature of effective PSI, and yet rarely found in practice. The discussion of customs reform is based on the view that comprehensive PSI services of the kind prevalent today reflect domestic policy failures in need of attention. Unless governments wish to rely indefinitely on private companies to underwrite the ability and willingness of their own administrations to perform customs work, comprehensive reforms are called for. In some countries, serious reform programs are already in place. In others, they are not. Before governments can safely dispense with PSI, or perhaps look to PSItype services for more specialized support, national customs administrations should prove their readiness to secure the revenue and run a modern customs service. The decision as to such readiness will doubtless be political in nature, but certain performance criteria can provide guidance. Corruption, Tax Evasion, and PrincipalAgent Problems
Corruption

An analytical literature has built up over the years on corruption and tax evasion, much of it founded on the work of Becker (1968). Some of this literature is helpful in discussing the practical problems of customs performance in developing countries, and the role of PSI in addressing these problems. The corruption literature has pursued a number of different strands, and no single definition of corruption is generally accepted. For the present purposes, however, it is perhaps sufficient to settle for a rather specific twopart definition, one for taxpayers and the other for collectors. First, taxpayers are corrupt if they try to defraud the revenue through false declarations of their liabilities, with or without collusion from tax collectors. Second, customs officers (and other civil servants) are corrupt when they use conferred monopoly power to extort money from importers, or to collude with them in defrauding the treasury, or find some other means of stealing money from the tax authoritiescontinue

A central theme of the literature is whether corruption should be treated as unequivocally bad, or rather, might be considered an aid to development in certain circumstances. Scott (1967), Huntington (1968), Dwivedi (1971), Beenstock (1979), and Leff (1979), for example, argue that where governments are not working in the public interest, or where wrongheaded policies are causing economic harm, corrupt practices may provide a useful vehicle for circumventing such "distortions." In this view of corruption as facilitator, the practice can have worthwhile economic, organizational and political benefits. Where government policy overrides the price mechanism with a system of administrative rationing, for example, the argument is that bribery may add to efficiency by promoting allocative decisions based on the ability of economic agents to pay. It has also been suggested that political and social cohesiveness might be promoted through illicit economic arrangements whose complicity requirements bind individuals into relationships of mutual dependency. Another argument is that corruption is at bottom a distributional issue, and an expression of relative cultural values not to be condemned out of hand. RoseAckerman (1978), Gould and AmaroReyes (1983), and Klitgaard (1988), on the other hand, stress the negative effects of corruption. Klitgaard, in particular, notes that every argument in favor of corruption is built on the existence of a preexisting organizational or systemic distortion. Apart from the intrinsic social, political and economic costs of corruption perceived in the anticorruption literature, therefore, there is also the broader issue of why underlying policy failures should go unchallenged. Krueger's (1974) work on rentseeking, and Bhagwati's (1982) on directly unproductive profitseeking (DUP) activities show how corruption generates deadweight economic costs and misallocates resources. Not only will government officials extract economic rents from the monopolistic powers conferred upon them by their duties, but economic agents will also burn up resources chasing these rents when they could be otherwise engaged in more profitable activities. Corruption, Tax Evasion, and PrincipalAgent Problems 94

Preshipment Inspection Services It is noteworthy that the work emphasizing the negative aspects of corruption tends to be of a more recent vintage. This reflects the perception that corruption has become sufficiently widespread in a number of developing countries to threaten the basic stability of sociopolitical relations, inhibiting democracy, and engendering a debilitating antidevelopment bias. Corruption, in this view, is associated with powerful externalities, or demonstration effects, which work from the top of the political structure downward, breeding cynicism and a sense of alienation in the population at large. While all of this is doubtless valid, it should also be said that attitudes in the donor community toward corruption in developing countries have changed in the last few years. When support for particular regimes was determined primarily by strategic, geopolitical imperatives linked to coldwar tensions between the major powers, corruption and undemocratic forms of government were rarely a matter of great concern, or of aid conditionality. Although the recent attitudional shift toward a more condemnatory view of corruption can hardly be considered the product of a revelation, it may reflect a lesser degree of cynicism and a willingness to support needed change.break

What is the relevance of all this to the present study? Essentially, it is to emphasize that in a situation where up to half of the taxes that should be collected are unaccounted for (see discussion below on revenue reconciliation for evidence), any arguments predicated on an indulgent or "relativist" view of corruption are misplaced. The economic costs of failing to collect the revenue are palpable. For many of the countries using PSI, revenue from import taxes still represents a huge slice of the government budget.1 The implications of poor collection performance for the government's budget deficit are the macroeconomic part of the story. In the microeconomic context, there are two obvious sources of concern. First, tax rates remain higher than they would be if collection performance were better. Secondly, in addition to sharpening incentives for tax evasion, high taxes generate irresistible demands for exemptions, and, depending on their ability and willingness to influence their tax burdens, competing economic agents end up paying vastly different amounts of tax. Allocative inefficiencies occur under these conditions. While systems such as PSI can be designed to make corruption more difficult, and perhaps contribute to a modification of the propensity for corrupt behavior over time, it would be naive to expect the level of corruption to go to zero. It would also make little economic sense to pursue corruption beyond the point where the marginal benefit of eliminating it is exceeded by the marginal cost of doing so. This suggests that priorities need to be established. In this context, a useful distinction can be made between two kinds of corrupt behaviorone where an official receives payment for doing what he is not supposed to do, and the other where he receives payment for doing what he is supposed to do. This distinction is virtually identical to Klitgaard's (1988) categorization of corruption into illicit and licit behavior. In the customs context, illicit behavioran official receiving payment for doing what he is not supposed to do is limited mostly to revenue fraud, although could involve such activities as allowing the importation of prohibited goods. By contrast, the licit behaviorreceiving payment for fulfilling services that have been contracted foris mostly a matter of facilitation, where required procedures associated with customs clearance are undertaken with greater speed upon payment of a bribe. Direct evidence of these practices is hard to come by, but there is some from Tanzania on facilitation payments (Box IV.1). In addition to the pecuniary costs borne by importers in relation to facilitation, it is probable that these rentgathering activities prolong clearance times because of the inclusion of fatuous processes and checks aimed at extracting more fees from importers. This, in turn, inflates the size of the workforce, implying additional wage costs for the government and the port authorities. For these reasons, it is misleading to characterize facilitation fees merely as an efficiencyenhancing redistributive mechanism. Oncontinue

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Preshipment Inspection Services 1 It is widely accepted that trade taxes are not an efficient means of collecting government revenue, but heavy reliance on these taxes will persist in many developing countries until the tax base can be broadened and direct tax systems developed.

Box IV. 1: Facilitation Payments in Customs Clearance: Evidence From Tanzania In Tanzania, goods can only be cleared through customs by approved clearing agents. Importers are obliged to pay numerous facilitation fees at each stage of the customs clearance procedures. While payment of these fees is necessary to speed up processing and avoid the costs of delays, the fees have become such an entrenched part of customs clearance that it is probably also true that goods may not be cleared at all without such payments.

Because importers do not entirely trust the clearing agents to reveal the truth about how much is paid to clear each consignment, many of them demand a detailed reckoning of these transactions from from agent. An examination of the files of one importer revealed a fairly uniform pattern of facilitation fee payments. Between 50 and 60 discrete payments were made in the clearance process for each consignment, involving the port authorities and customs in respect of physical movement of the goods and documentary requirements. These payments are distinct from any other in relation to valuation frauds and other illicit transactions. The facilitation fees generally involve very small amounts, but cumulatively they become more significant. On two consignments examined in detail, one for goods valued at T.Shs.5 million and other for goods worth T.Shs.4.1 million, the facilitation fees amounted to T.Shs.149,000 and T.Shs.85,000, respectively. These work out to payments of 3 percent and 2.1 percent on the consignments. the other hand, the costs to the government of these practices are probably modest2 compared to the potentially large amounts of revenue that can be lost through the nonpayment of duties and taxes. While properly designed and functioning PSI services can do something about revenue fraud within a relatively short timeframe, systemic reform of the kind necessary to address the licit corruption arrangements described above is a longerterm proposition. Bearing in mind that corruption will not be reduced to zero by any set of policies, these considerations underlie the argument for prioritizing policies toward customsrelated corruption. As argued below, however, reforms required in customs to address revenue fraud are likely to moderate licit corruption as well.
Tax Evasion and PrincipalAgent Problems

Academic work on tax evasion is scarce. Empirical work is even scarcer, given the measurement difficulties intrinstic to the activity. The earliest literature, most notably Becker (1968) and Allingham and Sandmo (1972), is based on a strong asymmetry assumption under which taxpayers are (potentially) dishonest, and tax collectors are honest. These models are probabilistic, building on the proposition that taxpayers will weigh the costs of detection against the benefits of evasion in the decision whether to attempt to defraud the fiscal authorities.break 2 The costs are also likely to be partly offset by the low wages paid to civil servants in many developing countries. Low wages, of course, may well be part of the problem (see next section).

Later work, including that of Lui (1986), Virmani (1987), Chander and Wilde (1992), and Besley and McLaren (1993), relaxes the asymmetry assumption mentioned above, and allows for the possibility that tax collectors as Tax Evasion and PrincipalAgent Problems 96

Preshipment Inspection Services well as taxpayers may be corrupt. This makes tax evasion models much more complex, and has introduced strategic (game theoretic) approaches into the analysis. Game theoretic analysis generally applies a Nashtype bargaining framework to determine when bribes will be paid and how they will be distributed between taxpayers and collectors. Depending on relative bargaining power, tax collectors will either participate in revenue fraud by splitting unpaid taxes with taxpayers, or will simply appropriate the full amount of the tax not handed over to the treasury. The latter outcome arises in circumstances where the taxpayer has zero bargaining power. A closely related situation is one where tax collectors simply extort money from taxpayers, on some pretext that overstates the real liability of the taxpayer. The bargaining element here turns on the ignorance of the taxpayer, or on his being intimidated by the tax collector. Such an outcome is conceptually close to licit corruption, since the collector is extracting a bribe for services he is contractually obliged to perform. This example illustrates the point that the difference between "benign" corruption, involving the payment of facilitation fees, and simple extortion, may be virtually nonexistent at the margin. A third case, involving no consideration of bargaining power, occurs when a collector expropriates tax money without any collusion on the part of the taxpayerthe only requisite here is that the tax collector is dishonest, and has direct access to tax proceeds.3 When the assumption is dropped that tax collectors are always honest, useful insights may also be gained from the analysis of principalagent relationships. Agents (tax collectors) work for, or on behalf of, a principal (the government), but the agents do not necessarily share the same objectives as the principal and may behave in ways inimical to the principal's interests. Moreover, the principal does not always have access to the same information as the agents, and may therefore encounter difficulty in controlling the agents' behavior. The existence of these asymmetries in the objective functions of the principal and the agents, and in access to information, is what can give rise to fraudulent behavior on the part of tax collectors. Principalagent analysis helps to identify the key ingredients of remedial action in the face of collectorrelated tax fraud, regardless of whether the fraudulent behavior requires the collusion of taxpayers. Before exploring further the behavior of tax collectors and the factors that influence their decisions as to whether to engage in fraudulent activity, a brief discussion follows of taxpayer behavior. Let tc be the tariff4 that should be paid by a taxpayer, and let tf be the value of the tariff paid with cheating, subject to the condition that:continue 3 This situation only occurs if taxes are paid in cash or in some other easily negotiable financial instrument. At the time the field work for this study was undertaken, Tanzanian customs authorities were still accepting cash over the counter in payment for import duties and taxes. 4 Tariffs are defined as specific rates, or a fixed charge per unit for these purposes.

Let pm be the probability of detection and dm the size of the penalty. Then the taxpayer's liability if cheating is detected is:

The taxpayer's gain if cheating goes undetected is:

The expected loss per play (transaction) is: Tax Evasion and PrincipalAgent Problems 97

Preshipment Inspection Services

The expected gain per play is:

The expected net gain or loss per play is:

A taxpayer will try to cheat if:

Expression (6) indicates that, with a given risk preference, a taxpayer will seek to defraud the tax authorities if the gains from doing so exceed the tax liability. Whether or not there are gains depends on the taxpayer's estimate of the likelihood of being caught (a probabilistic value between zero and unity), the amount of the tax that is to be paid without fraud, the tax liability with fraud, and the amount of any penalties payable upon detection. Tanzi and Shome (1993), among others, have levelled a number of criticisms against this formulation of a taxpayer's decision about whether or not to attempt fraud. One problem is the impression it gives that raising penalties is a costless way of ensuring compliance. In the extreme, the penalty upon detection could be death. Clearly, penalties cannot be credibly raised without limit. Several of the other commonly made criticisms of the approach implied by expression (6) above can be incorporated in more sophisticated statements of the problem. These include varying attitudes toward risk among taxpayers, the informational assumptions underlying the decision rule, omission of nonpecuniary factors in taxpayers' objective functions (such as social stigma and loss of selfesteem in the event of detection), and the role of time lags in reducing the impact of penalties.break

The decision rule in expression (6) is, in any event, a useful heuristic device, since it identifies key variables with which policymakers must work in addressing revenue fraud. The value of tc is crucial, as higher taxes will be associated with a higher propensity for fraudulent behavior. Indeed, the work of Pritchett and Sethi (1993a and 1993b), discussed in chapter I, shows that there may be evidence of reductions in absolute revenue collections associated with higher statutory tax rates, even when the only source of nonpayment identified is official exemptions. If fraud is added to the picture, such an outcome could prove unexceptional. The obvious policy lesson here is that, standard price elasticity assumptions and quantity effects aside, lower import duties may contribute toward higher revenue collections through reducing the incidence of fraud. The variable tf , the value of the tax liability with fraudulent behavior, is also subject to policy influence.5 First, this amount is directly related to the size of tc . Secondly, to the extent that fraud takes the form of misclassification of tariff headings, the scope for such behavior can be reduced by making the tariff more uniform. Thirdly, investing in the expertise of customs officers will help guard against both undervaluation and misclassification. As noted above, the amount of the penalty for fraudulent behavior, dm , should not be so high as to inhibit its application. But it should be high enough to deter fraud. Penalty provisions are only useful if they represent credible threats, and such credibility cannot be maintained unless the authorities are willing to apply penalties in a consistent and transparent manner.

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Preshipment Inspection Services Certain limitations on penalties should be noted, however, when it comes to customs. A basic problem with penalties in customs is that it is not always easy to establish either fraudulent intent or culpability. Where goods do not appear to be valued at the prevailing market price, the declared value is not armslength, or the price reflects some irregularity, fraud may not be involved. Moreover, misclassification of a product may reflect a genuine error. In such cases, it is unclear that the customs authorities will wish to levy a penalty, or such a high penalty, as they might if they believe fraud has occurred. It is for this reason that many customs services in industrial countries tend not to impose fines simply because a dutiable value or a product classification is changed. On the other hand, irregularities detected in the description, declared quantity or quality of goods are much more likely to be subject to penalties. But even here, it may be the case that the importer is the victim of a swindle perpetrated by the supplier, and not an accomplice in revenue fraud. Since the supplier is outside the jurisdiction of the customs authorities in the importing country, it is not always obvious that it is appropriate to penalize the importer.break 5 The amount of the tax to be avoided may, of course, be the full liability, but it is unlikely that a taxpayer will always be able to avoid all taxes in customs. This is because the most common forms of customs fraud are undervaluation and misclassification, and all liability can only be avoided if an importer can misclassify his merchandise to a duty free tariff heading.

Finally, the value of pm is susceptible to policy intervention, since it is primarily driven by the degree of effective monitoring or audit that occurs. This brings us back to the earlier observation that some of the tax evasion literature is based on the assumption that tax collectors are always honest, which gives greater scope for effective monitoring. If tax collectors are not intrinsically honest, what will influence their decision rules about when to act fraudulently? A tax collector would have an incentive to accept a bribe (or to behave dishonestly without taxpayer collusion) where the expected gain from doing so (EGc ) exceeds the expected loss:

It is assumed that detection leads to dismissal, so the monetary value of the collector's loss is the difference between the discounted value of his future earnings stream (Yp ) and the earnings stream he would expect in alternative employment (Ya ). The collector's expected loss per transaction is:

where Pd is the probability that fraud will be detected. Similarly, if B is the value of the financial gain accruing from dishonest behavior, the expected gain per transaction is:

and there would be an incentive to behave fraudulently if:

Expression (10) suggests that with a given risk preference, a tax collector will engage in dishonest behavior if the expected return from doing so is greater than any anticipated loss in income. The variables driving the collector's Tax Evasion and PrincipalAgent Problems 99

Preshipment Inspection Services decision are similar to those affecting the taxpayerthe size of the potential gain, the likelihood of detection, and the consequences of detection. The interaction between taxpayers and collectors, in terms of expressions (6) and (10), does not appear to have been formally modelled in the literature. It is obvious, however, that significant interactions occur. The probability that a taxpayer is detected for fraud drops (pm is lower) if he can count on collusion from the tax collector. On the other hand, if the taxpayer and collector fail to strike a fraudulent bargain, both run the risk that the other may reveal the attempted fraud (pm could rise for the taxpayer and pd for the collector). The value of the tf variable may increase for the taxpayer (making fraud less likely) if he has to collude with the collector and share the fraudulent gain. On the other hand,continue

if collusion reduces pm , a taxpayer may be emboldened to indulge in greater fraud than he would contemplate in the absence of cooperation with the collector. The size of the collector's B will vary with the taxpayer's tc , as the evasion of higher taxes will require larger bribes. On the other hand, the tf variable for the taxpayer and the B variable for the collector contain independent elements that do not call for collusiona taxpayer may try to defraud the revenue without exercising the option of bribing a collector, and a collector may not need cooperation from the taxpayer if he can perpetrate an independent fraud, or can extort a bribe from the taxpayer. Finally, while dm is exogenous for the taxpayer, the higher the penalty faced by the taxpayer upon detection, the better the opportunity for the collector to bargain away fraudulent gains from the taxpayer. Where does PSI fit into this discussion? Preshipment inspection exerts influence upon pm and pc , provided that information generated by PSI activities is used for proper monitoring, and assuming, of course, that PSI company employees do not themselves enter into collusive games with taxpayers.6 The question of adequate monitoring with the use of PSIgenerated data is taken up below. An important policy variable controlled by the government is Yc , and indirectly, its relationship with Ya . A common observation about the wages received by tax collectors is that they are so low as positively to invite corrupt behavior. The relationship between pay and integrity is extremely important for policy design. Many authors, such as Palmier (1983), Gould and AmaroReyes (1987), and Klitgaard (1989) seem to argue that increasing civil service wages will reduce corruption. The implication here is that corrupt behavior is induced by poor pay, and would therefore disappear if incomes were to rise. This is a strong behavioral assumption, at least in the shortterm, since it requires satisficing rather than maximizing behavior on the part of tax collectors. An original and provocative paper by Besley and McLaren (1993) challenges the view that raising pay will solve customs fraud, focusing on the role of wage incentives as a determinant of fraudulent behavior by tax collectors. The BesleyMcLaren model maximizes the government's net revenue position as a function of wage costs, monitoring costs, and revenue fraud. Tax collectors are divided into two categoriesthe honest and dishonest. Honest collectors put an infinite value on their integrity and cannot be bribed. Dishonest collectors seek to maximize their income and can be induced to behave honestly. Dishonest collector behavior involves collusion with taxpayers to defraud the revenue, and the penalty for detection is dismissal. In order to simplify interpretation, the results of the various scenarios modelled arecontinue 6 There are limits to the extent to which PSI company employees can collude with taxpayers because there is no direct contact between PSI inspectors and price verifiers in the country of origin, and importers in the country of destination. Such collusion would have to be arranged between PSI company officials and exporters or suppliers acting on behalf of the importer. In any event, PSI companies generally maintain their own security measures, such as internal auditing, rotation of personnel, double checking of documentation, and strong penalties for malfeasance.

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Preshipment Inspection Services presented in terms of two variablesthe degree of monitoring undertaken and the level of honesty among collectors. Three different wage regimes are modelled. First, the reservation wage is equal to the collector's opportunity cost, or in other words the wage that the collector could earn in alternative employment. Second, the efficiency wage is above opportunity cost, and embodies a rent component that is supposed to deter corruption. Third, the capitulation wage is below opportunity cost, and factors in the additional income that collectors will receive from fraudulent activity. Each of these regimes is analyzed in terms of its implications for net government revenue. In the model, the reservation wage regime makes sense where monitoring is effective and dishonest tax collectors are dismissed. Moral hazard problems are present under this regime because of the mixture of honest and dishonest collectors. A dishonest collector will always accept a bribe if he is paid the reservation wage, because it is assumed this is the wage he can earn anyway in alternative employment. Over time, however, the dishonest component of the service will be weeded out, leading to increased revenue for the government. Under efficiency wages, the rents associated with higher pay are an inducement to honest behavior. This regime is only effective from a net revenue standpoint if monitoring is strong enough and wage incentives high enough to make corruption a rare occurrence. If monitoring is weak, the efficiency wage that deters dishonesty will be so high that wage costs could exceed collections. The authors' reservations about efficiency wages are built on a scenario in which the government incurs a high wage bill in the face of low collections. An important reason why this might occur is that dishonest collectors are assumed to be income maximizers. The selection or "weeding out" advantages of the reservation wage regime are much weaker, as efficiency wages will continue to attract dishonest as well as honest collectors. If the government pays capitulation wages, only dishonest collectors will be attracted to the service, so nobody will be dismissed for corruption. The government only secures revenue by monitoring collectors, such that their total wage, including income from bribes, equals the reservation wage and tax collectors receive no rents. Under these assumptions, it is not surprising that from a net revenue perspective, a capitulation wage regime often looks more attractive than the alternatives. However, Besley and McLaren cite evidence suggesting that under pay structures in many developing countries which resemble capitulation wage regimes, collectors appear to receive incomes far in excess of the reservation wage, and there is strong demand for tax collector jobs because of these rents. The authors argue that the revenue authorities are behaving suboptimally by allowing capitulation wage earners to receive rents. They suggest that wages in these countries may actually be too high. Carrying this logic further, it would seem that with sufficiently weak monitoring capacity and a pervasive propensity for corruption, tax collector wages may have to go negative before collectors are paid the reservation wage. Paying collectors negative wages is conceptually equivalent to tax farming.break

Tax farming is a collection system under which a government sells off the right to collect taxes to private agents and the taxes they collect constitute payment for their services. Tax farming has a three thousand year history, but has been largely rejected as an inappropriate revenueraising mode in modern societies (Stella, 1992). This is not to say, however, that the idea of privatizing any tax collection functions at all has been discredited. The key justifications for tax farming are that it lowers administrative costs to government and ensures greater tax collection efficiency. Both these arguments are suspect. First, unless the government is willing to ignore equity, justice, and the risk of overzealous tax collection efforts, the farmers need monitoring, which involves administrative costs. In practice, monitoring would be inevitable under tax farming, considering that unlike most private market transactions, paying tax does not constitute voluntary exchange.

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Preshipment Inspection Services Second, it is not obvious why private tax collection bureaucracies are intrinsically more efficient than government,7 especially if there is a lack of real competition among tax farmers. Stella (1992) argues that, in general, there may be a role for privatized tax collection functions where discretion and monitoring requirements are minimal. Indeed, a number of governments today contract out certain tax collection functions, particularly those where the tax liability is predetermined and known to the tax payer, so that tax collectors cannot exercise discretion. Preshipment inspection does not embody the characteristics of tax farming, since PSI companies do not have tax collection rights, and nor are their profits linked to tax receipts.8 By focusing only on the government's net revenue position, the BesleyMcLaren model ignores the sociopolitical costs of corruption. Under efficiency wages, collectors are rewarded for not exercising opportunities to behave dishonestly, and under capitulation wages, collectors are invited to supplement their incomes through corruption. While a reservation wage regime which seeks to augment honesty over time through adequate monitoring and appropriate hiring and firing policies represents the most suitable longterm objective, it may make sense to pay tax collectors efficiency wages in the short and medium term, provided adequate monitoring can be guaranteed. The most useful practical aspect of the BesleyMcLaren model is the precision it gives to the question of monitoring. As long as it is unsafe to assume that honesty is a prevailing behavioral trait among collectors, or that honesty will be secured merely by increasing wages, monitoring is the most crucial shortterm policy variable with which governments should be concerned from a revenue perspective.break 7 Many customs officials argue that widely observed inefficiencies in customs administrations are a reflection of a poorly funded service and inadequate training, rather than the result of any weaknesses intrinsic to the public service. 8 With the exception of one or two contracts, fees received by PSI companies are calculated on the unadjusted value of invoices. Calculating fees on the adjusted value of invoices introduces an unwarranted and potentially perverse adjustment incentive for the PSI companies.

Recent attempts have been made in Africa, notably in Ghana, Uganda, and Zambia, to deal with poor tax collection performance through the establishment of revenue boards.9 The idea behind revenue boards is to free the tax authorities from mainstream civil service constraints, and to introduce higher pay and less restrictive hiring and firing policies in an effort to build a more professional and efficient service. Little material is available to evaluate these efforts. But the lessons of the BesleyMcLaren analysis are certainly pertinent. Adequate monitoring and a proper application of penalties for malfeasance are vital ingredients for success, especially if, as seems to be the case, the wage regime in the revenue boards intends to replicate an efficiency wage scenario. There are two practical questions that need answering about monitoring. First, who is to do it, and second, what happens by way of enforcement once effective monitoring generates the necessary information to run an efficient tax collection system? The BesleyMcLaren model treats the level of monitoring as an exogenous variable in the first instance, but the authors offer an extension to their model that endogenizes monitoring. This involves the establishment of a twotier hierarchy, with the upper tier monitoring the lower one. This feature complicates the model, since an optimal wage strategy must be determined for each tier, and there are several ways in which the tiers might interact, not all of them intuitively obvious. More straightforwardly, the monitoring problem can be thought of in terms of principalagent relations. As already noted, if an agent (the tax collector in customs) does not share identical objectives to those of his principal (the tax authorities), then the principal's objectives may be frustrated. Thus, a tax collector willing to engage in fraudulent practices may reduce the level of revenue collections desired by the treasury. Even if the principal knows that the agent's actions do not reflect his objectives, his monitoring problem involves all the factors Tax Evasion and PrincipalAgent Problems 102

Preshipment Inspection Services discussed above in relation to the incentive structure, access to information, and enforcement mechanisms. In general, agents with an inclination to behave dishonestly will do so with greater ease when they enjoy conferred monopoly power over taxpayers that can be exercised without challenge, a high degree of discretion, and limited accountability to the principal. Klitgaard (1988) has developed a useful taxonomy of five areas of action available to a principal for bringing the agent's behavior more into line with his own objectives, all of which rest on the assumption that the principal's objective is to reduce corruption and improve tax collection efficiency. First, the principal can focus on selection criteria for staff that emphasize honesty as well as competence. Second, the principal can change the disposition of rewards and penalties facing both the agent and his client, the taxpayer. Third, the principal can invest in information and systems technology which increase the likelihood that fraudulent activities will be detected and punished. Fourth, the principal can institute administrative and organizationalcontinue 9 For a discussion of the prerequisites of efficient revenue boards, see Jenkins (1992).

reforms that will reduce the agent's discretionary authority. Finally, the principal can adopt measures and programs designed to modify the agent's attitudes toward fraudulent behavior over time. This list of areas for action clearly contemplates both the short and longterm. Changing the composition of staff, reforming the organization, and conditioning attitudes toward corruption are longerterm objectives. On the other hand, altering rewards and penalties, raising the probability of detection, and introducing administrative modifications all contain elements that could be considered for relatively quick action. Viewed within the above framework, PSI is most relevant to the third pointactions which increase the probability that fraudulent behavior by the agent will be detected.10 In this role, what PSI does is to provide the principal and agent with an independent source of information on taxes due and on precisely how much tax should have been collected from all importers. Turning a moment from the principalagent relationship to the agentclient relationship, it is important to note that PSIgenerated information automatically reduces almost to zero the scope for fraudulent behavior by taxpayers (the client) unless they can act collusively with collectors. For importers to stay in the game, collectors must be willing to "lose" or ignore PSI information contained in reports of findings, which, after all, are supposed to be customs clearance documents. In sum, because of its independence, PSIgenerated information is a potent weapon indeed, if the principal and agent are of a mind to use it. The absence of reconciliation in the vast majority of current PSI contracts raises doubts about governments' inclinations in the matter. This brings us to the final question in this section, regarding the objectives of the principal. It is generally assumed that the principal is committed to systemic reform, improvements in tax collection efficiency, and greater integrity in the customs service. Does this represent reality? In the principalagent analysis, divergent objectives and asymmetric information were the basic impediments to a satisfactory principalagent relationship. The data on import tax liabilities generated through a PSI customs contract goes a long way in addressing the problem of asymmetric information. But if the principal does nothing with this information, there is little point in paying for it. A good illustration of this problem is provided by the Tanzanian experience. Since 1992, the Tanzanian PSI contracts have incorporated ex post reconciliation. The PSI companies have been providing systematic information on the revenue that ought to have been collected in respect of inspected import consignments, and details of where shortfalls have occurred. Yet, as discussed below, by the end of 1993 Tanzania was collecting around half of import duties and taxes due. Information has therefore been available for effective monitoring and Tax Evasion and PrincipalAgent Problems 103

Preshipment Inspection Services vastly improved tax collection efficiency, but for one reason or another the information has not been used. This kind of failure can be thought of as the "political will" factor. Whatevercontinue 10 As discussed elsewhere, PSI companies can also make a contribution in the areas of training and technology transfer, although this is likely to be a subsidiary role.

causes a dearth of political willbe it poor organization, scarce resources, lack of commitment, corruption, or something elseits absence renders all other discussion about reform largely moot. The Role of ex post Reconciliation Several references have already been made in this chapter and earlier in the study to ex post revenue reconciliation under PSI contracts dealing with customs work. There would be no need for reconciliation arrangements of the kind discussed here if government authorities were confident that taxes on imports were by and large being collected. Despite the difficulty of obtaining precise information on revenue shortfalls resulting from official malfeasance, the problem has been widely discussed and is well enough recognized. Before presenting the evidence available from this study on tax evasion in customs, some general observations are made about the reconciliation service itself and how it might work. The essence of reconciliation is that once import formalities have been completed, PSI documentation (the report of findings or customs duty report) should be matched with the import entry and proof of duty payment on each consignment. This reconciliation establishes whether taxes due have been collected, and because PSI documentation is an independent source of information, the system is difficult to circumvent if it is administered properly. If PSIgenerated reports of findings (ROFs) were to become the customs entry documents, the reconciliation would be even easier. Customs should not be responsible for the reconciliation exercise unless the principal can be confident that it will be undertaken in a complete, independent and transparent fashion. A more secure arrangement would be for a third party to do the work. In the few countries where reconciliation is undertaken, it is the PSI company that does it. This is probably the least costly and most efficient approach, and can be seen as an extension of the PSI function. At a later stage, when the system is well established and fully functional, the government may decide to establish its own independent monitoring unit for reconciliation. In order to be able to carry out the task, the PSI company must receive all copies of import entries from customs, and whatever document (it could be the import entry itself) that certifies taxes have been paid. In contracts where there is a value threshold below which consignments are exempted from PSI, the relevant import entries should also be handed over to the PSI company. This would permit the company to undertake systematic analyses of where importers split consignments and underdeclare values in order to escape preshipment inspection. Secondly, if the customs authorities were to supply copies to the PSI company of import entries for exempted goods, this would enable the PSI company to establish a full statistical base on imports. The need for a statistical service of this kind would vary from client to client, but there is a disconcerting number of African countries that either cannot generate detailed trade statistics, or can only do so with time lag running into several years. Evidence on this point is presented in Table I.4 (Chapter I).break

To whom should the PSI company report with the reconciliation results? Obviously, customs must be fully apprised of the reconciliation (in fact, customs receives ROFs in the normal course, and could undertake its own independent reconciliation). But the PSI company should formally report its results, say on a monthly basis, to a designated highlevel officer or committee, perhaps in a finance ministry or central bank, with explicit responsibility for following up on revenue fraud and taking the necessary remedial action. The PSI reconciliation The Role of ex post Reconciliation 104

Preshipment Inspection Services report would include information about duty payment shortfalls revealed by discrepancies between ROFs and import entries, as well as a listing of ROFs that cannot be matched with any import entries. As noted above, unmatched ROFs may point to smuggling. If the principal were seriously committed to making reconciliation work, and if consistently firm action were taken and publicized with respect to all proven cases of malfeasance, it would not be long before taxpayers and collectors modified their behavior. The number of cases to be dealt with would probably fall fairly quickly within a few months. The big question that remains, then, is whether the principal wants the system to work. The results data reported in Chapter III show the PSI companies reporting significant revenue gains for governments as a result of their interventions. It was explained in Chapter III that this information could for the most part be regarded as no more than indicative of partial and/or potential results. The realization of these reported gains requires that customs uses the information on classification, valuation, taxes payable, and so on contained in reports of findings (ROFs). Without reconciliation, it is impossible to know how much of the information is used, and difficult to gauge the dimensions of revenue fraud. Why are data on revenue shortfalls so difficult to come by? Most customs fraud that does not completely circumvent the system via smuggling occurs through: i) physical misspecifications relating to product description, quantity, or quality; ii) undervaluation of goods; and iii) misclassification of goods by tariff heading. Where these frauds are successfully perpetrated they will not be detectable in trade and revenue statistics. A common way of trying to identify revenue shortfalls is to compare statutory tariffs with tariff revenue actually received. This procedure will show where tariff exemptions have been granted, but will not reveal revenue fraud unless this involves something as crude as taking customs duty receipts out of the till. The reason why the common kinds of fraud listed above cannot be detected easily is because of the "double entry" problem underinvoiced values, physical misstatement, and misclassification will be recorded both in the import statistics and the revenue statistics, making the detection of this kind of fraud in an ex post sense most difficult. Followup audits could detect some of this fraud, but coverage is inevitably selective. It should be remembered that it is generally impossible for a customs service to undertake a thorough physical examination of more than 510 percent of all merchandise without causing long delays in customs clearance. The only country in the sample where reconciliation was an integral part of the system was the Philippines. Other countries included as case studies that have reconciliation arrangements are Cote d'Ivoire, Central African Republic, and Tanzania. Others, includingcontinue

Ghana, are contemplating new contracts with reconciliation. But at the end of 1993, the following casestudy countries did not have reconciliation arrangements: Benin, Cameroon, Ghana, Indonesia, Mali, Peru, Uganda, and Zambia.11 The Philippines has been especially concerned about collecting tax revenues at the border, so much so that there is an unusual arrangement whereby importers pay duties to their commercial banks on goods they intend to import on the basis of a pro forma invoice at the time they open a letter of credit. The duties paid over at this stage are only an estimate, especially in view of the Philippines' valuation system based on home consumption values in the country of export (chapter II). The balance of duty owing is paid over prior to clearance of the goods. The total payment made is then systematically reconciled against the ROF in respect of all consignments. There are often small discrepancies, owing to such factors as exchange rate conversions, but SGS reports that now the system is well established and understood by importers and customs, instances of significant revenue shortfalls are rarely detected.

The Role of ex post Reconciliation

105

Preshipment Inspection Services In Zambia, SGS was authorized at the beginning of 1993 to receive import entries from the customs service and undertake an historical reconciliation on a trial basis between these documents and the ROFs. This reconciliation was based on a 15 percent sample of import entries for the first six months of 1993. It revealed that, excluding official import duty exemptions, only 54 percent of all duties due according to the ROFs issued by SGS were actually paid. So, almost half of import duties owing to government were appropriated by taxpayers and collectors. Note that taxpayers by themselves could not practice significant fiscal fraud if the authorities had chosen to use PSIgenerated information to stop them. The Zambian estimate is likely to be an understatement of the true magnitude of the problem because the sample was based only on import entries that could be matched with ROFs, and took no account of ROFs that had not led to imports. Unmatched ROFs indicate possible smuggling, since an importer who plans to smuggle goods into the country would still, under many current contracts, need a ROF in order to trigger the release of payment for the merchandise. Concerned by the findings of the historical reconciliation exercise, the Government of Zambia invited SGS to undertake an experimental reconciliation exercise that would be conducted immediately after goods had been cleared through customs. As reported in Box IV.2, the Zambian exercise was a significant success, demonstrating clearly the value of ex post reconciliation. A reconciliation exercise carried out in Cameroon for the month of January 1993 showed that 22.7 percent of revenue net of exemptions was not being collected. Evidence from Mali, for the period September 1989 to December 1990, indicates that only about half of all inspection orders actually materialized into inspections. Inspection orders are generated by the process of initiating imports, and the absence of corresponding inspections reflects the ability of importers' to circumvent the system in order to avoid paying duties. In Indonesia,continue 11 As discussed below, Zambia introduced a reconciliation arrangement in early 1994.

BOX IV.2: The Positive Effects Ex Post Reconciliation: Zambia's Experience The Government of Zambia assigned SGS to conduct a Pilot Customs Revenue Enhancement project. The project was to run for three months, from January to March, 1994. Under the arrangement, SGS was required to verify that all required import documents had been submitted to customs by importers when they cleared their goods. These documents included the bill of entry, a certified invoice, a duty receipt, and a clean report of findings (CRF) issued by the SGS affiliate in the country of export.

The data on the bill of entry were to be verified against the CRF. The key elements to be checked were the product classification, the value of the goods on which duties and taxes were payable, and the amount of tax received. If necessary, SGS could request a visual verification or physical examination of any consignment. Only after the SGS reconciliation could goods be released from customs control. In order to perform these tasks, SGS placed 25 staff in the country's six main points of entryLivingstone, Chirundu, Lusaka International Airport, Lusaka, Ndola and Kitwe.

Whereas in JanuaryMarch 1993, Kwacha 5.3 billion was collected on imports valued at Kwacha 44.4 billion, in the same three month period in 1994, Kwacha 6.8 billion was collected on imports worth Kwacha 33.5 billion. This means that revenue collection increased from 11.9 percent to 20.3 percentalmost a doubling of the implicit duty rate. Tax rates did not change between the two periods, but information is not available as to how different the composition of imports was in each The Role of ex post Reconciliation 106

Preshipment Inspection Services period. Compositional differences could lead either to an understatement or overstatement of the influence of the reconciliation exercise on duty collections.

By carrying out the reconciliation prior to the release of goods, this experiment ensured that there would be no followup problem on information generated by reconciliation, as experienced in Tanzania (see main text below). On the other hand, the Zambian reconciliation was quite intrusive upon customs, and may for this reason be difficult to sustain for an extended period. The ideal approach would seen to be one where documentary ex post reconciliation could be linked to effective followup arrangements.

The Zambian reconciliation program was also being used to transfer SGS data to the Zambian authorities, and to develop risk profiling in respect of importers, clearing agents, and categories of goods. The reconciliation exercise revealed numerous cases of undervaluation, misclassification, and underdeclared quantities. Moreover, some clearing agents were failing to hand over to the proper authorities the taxes they had collected. Other abuses identified included misuse of dutyfree privileges under investment licenses, weak administration of bonded transit arrangements, illegitimate access to duty free shops, and imports in commercial quantities of new goods purportedly for personal use. approximately 20 percent of all ROFs issued (known as LPSs in Indonesia) in 1992 were never presented to customs for clearance. If it is assumed that all these goods were smuggled into the country, then on the basis of simple averaging procedures, the Government would have lost about US$300 million in customs duties and about US$550 million in valueadded tax, amounting to about 20 percent of what should have been collected. These figures are very approximate, being upwardly biased for one reason and downwardly biased for two others. The upward bias in the revenue loss estimates comes fromcontinue

the fact that not all the goods on which LPSs were issued, but in respect of which no imports were recorded, were necessarily smuggled. A common practice in Indonesia is to split import orders into consignments of less than US$5,000the value threshold under which PSI is no longer a requirement. This is done in the hope of negotiating a lower tax liability in customs. To the extent that this practice rather than pure smuggling accounts for the unrequited LPSs, it is probable that some duties and taxes on these items found their way into the Government's revenue accounts. On the other hand, taxes were probably higher on consignments for which the importers resorted to these subterfuges. This would mean the estimates of revenue shortfalls made on the basis of average taxes payable might be more conservative on this account. The second reason for a downward bias in the estimate of revenue losses is that there is no reconciliation process in place that would catch fraud occurring even in cases where LPSs are issued and used to clear goods. Since INPRES 3 of 1991, which changed the LPS from a final clearance document and gave it a more advisory status, it has become less clear how much collusive customs fraud there is in cases where PSI procedures are not circumvented in the manner described above. Procedures established in 1985 under INPRES 4 for paying taxes due in a commercial bank rather than in customs prior to the clearance of goods have clearly made fraud more difficult. But there is no effective substitute for a proper ex post reconciliation system when PSI data are available to make this possible. The Government of Tanzania instituted a reconciliation system in 1992 (see Box 1.2, Chapter I). It was not well The Role of ex post Reconciliation 107

Preshipment Inspection Services executed, and importers found it easy to circumvent the reconciliation system. Nevertheless, the reconciliation generated useful data. These data show that only 32.4 percent of duties collected in 1993 were actually processed through the reconciliation system, while the rest was paid directly to customs. The deliberate circumvention of the reconciliation arrangement can only be explained by importers' perceptions that they can arrange to pay less duty than that assessed by the PSI companies. The information generated in the context of the reconciliation revealed that approximately 50 percent of duty liabilities net of official exemptions were actually paid into the government's revenue accounts. Tanzania was mentioned above as an example of where a principal's efforts to deal with the lack of information available in relation to agents' activities had come to nothing because of an apparent unwillingness to act on the information provided. Table IV.1 summarizes the evidence described above from the various countries of the likely magnitude of revenue losses to governments resulting from customs fraud. It should be noted that although these data are unusual in that they provide estimates or indications of revenue shortfalls attributable to fraudulent behaviour, they do not identify the distribution of fraudulent gains between importers and tax collectors. How reasonable is it to assume that these results are typical of what would be found in other countries, which either do not use PSI, or use PSI without any kind of reconciliation system? There is no hard information to go on, but to argue that the situation incontinue

TABLE IV.1: Evidence of Revenue Collection Shortfalls in Customs Country Reconciliation Estimated Shortfall 1 (Percent) Yes Comments

Philippines

Reconciliation system secures the revenue at virtually 100 percent Based on a 15% sample over six months Very rough estimate based on unfulfilled inspection orders Based on reports of findings issued that could not be matched to imported goods Estimate based on poorly functioning reconciliation Estimate based on ex post reconciliation for a single month

Zambia Mali

Trial basis No

46 50

Indonesia

No

20

Tanzania

Yes

50

Cameroon

Trial basis

23

1 The estimated revenue shortfall is expressed as a percentage share of revenue actually collected. these countries is not broadly representative of that in many other developing countries would be to challenge a widely held perception. A first step toward eliminating this information gap, and addressing the underlying The Role of ex post Reconciliation 108

Preshipment Inspection Services problem, is to make a credible, fully operational reconciliation arrangement a sine qua non of any customsrelated PSI contract. Customs Reform With or without PSI, customs services in developing countries have to modernize in order to avoid becoming liabilities to the governments and traders they are supposed to serve. There are several reasons why modernization is inevitable. Dramatic technological advances, most notably in containerized transportation and electronic communication, have changed the way enterprises operate, making speed and reliable delivery essential to business success. Greatly increased volumes of trade, against a policy background in most countries thatcontinue

emphasizes trade liberalization, turn an inefficient or dishonest customs service into a serious obstacle to progress. Before open trade policies were more widely adopted, governments were less concerned about barriers that the customs authorities might put in the way of exporters or importers. These were merely additional irritants in a policy environment where quantitative control and high taxes already discouraged trade. Now that trade has become a more central element of the development strategies of so many countries, governments are increasingly unwilling to allow cumbersome and corrupt administrations to be the cutting edge of trade policy, to determine the conditions of access to their markets, or to deprive potential investors of a predictable and costcompetitive operating environment. Since the subject of this study is not customs reform, only brief comments will be made about the basic thrust of the reforms being contemplated or undertaken in different countries. The relevance of this to PSI is obviousas customs services improve, a time comes when the kind of support and honesty checks provided by comprehensive PSI services are no longer necessary. The rest of this chapter explores the preconditions for progressive and constructive disengagement from preshipment inspection.12
Modernization and Integrity

A modern customs service emphasizes trade facilitation and minimal costs and inconvenience to traders. The modernization process can be painful, and call for radical measures, as the experience of Mexico illustrates (Box IV.3). Some traditional customs servicess still attempt to carry out physical inspections on all consignments. This is expensive and timeconsuming, and generally proves ineffective in detecting fraud. Customs officers tend to treat such examinations as routine, and the inspections usually end up amounting to little more than a cursory examination of a few packages near the door of a container. As noted earlier, a major difference between preshipment inspection and customs examinations upon arrival is that PSI can be arranged at the time containers are stuffed, whereas if customs destuffs containers in order to carry out physical inspections, the containers have to be stuffed again before leaving customs (unless customs officers check the goods at their final destination). More modern customs services will typically make physical inspections of anything between one and ten percent of all cargoes, relying on computerassisted targeting and some random checking. Good risk profiling is the key to a successful selective approach. Risk profiles are based on such factors as the identity and past records of the supplier and the importer, the country of origin, the nature of the product, the value of the consignment, and so on. A selective examination policy is typically backed up by postrelease audits, including visits to importers' premises.break 12 The earlier discussion in this chapter on privatization options for tax collection is not repeated here. It is assumed in what follows that governments seek the modernization and improvement of their customs services as the alternative to preshipment inspection.

Customs Reform

109

Preshipment Inspection Services

Box IV.3: Mexico's Customs Reform In 1989, the Government of Mexico undertook a farreaching customs reform. The reform was firmly supported at the highest levels of government, and prompted by the widely shared view that the Mexican customs service was outdated, overmanned, inefficient, and corrupt. A basic feature of the reform was to move from a putative one hundred percent physical inspection to a system of selectivity. The system now works on a random selection of 10 percent of all consignments, backed up by postclearance auditing on the basis of risk profiles. A further 10 percent of consignments selected for inspection are randomly selected for a second inspection by a private firm.

Severe, nonnegotiable penalties are imposed, including criminal court action, when malfeasance is detected on the part of taxpayers or collectors. Brokers have been made jointly responsible for fraudulent declarations. Import duties are no longer paid over to customs officers, but are deposited directly in the bank a measure that is believed to have significantly reduced opportunities for fraud. Operational staff are reassigned at random every 30 days.

The reform also emphasized streamlining and efficiency. The centerpiece of these efforts was full automation of the service, including both data collection and customs clearance. Arrangements for electronic data interchange (EDI) were established, and have become compulsory for certain functions. Customs procedures were also improved, reducing the number of steps required in customs clearance procedures from twelve to five.

The reform was hard on personnel. Between 1989 and 1992, the customs service was reduced from 8,800 to 4,100, and 3,000 of the latter number were new recruits. But the results were dramatic. Clearance times for consignments not selected for physical inspection fell from up to 24 hours to a few minutes. Duty collections doubled in the threeyear period, from 5 percent to 10 percent of nonoil tax income.

Sources :

Francisco Gil Diaz, The Subsidiarity Principle Applied to Tax Administration , Paper for conference on Information Technology and Fiscal Administration, sponsored by Harvard International Tax Program (November, 1992)

Customs Cooperation Council, "Integrity in the Administration of Customs, "Seminar discussion (May, 1993) This approach to customs services requires a high degree of integrity and skill among customs officers, supported Customs Reform 110

Preshipment Inspection Services by a committed and competent management system. The corruption issue has already been extensively discussed in this chapter. It is interesting to note that the Customs Cooperation Council (CCC), whose members are national customs services, has recently acknowledged that a lack of integrity in customs is a problem that must be addressed. The CCC organized a twoday seminar in April, 1993, on integrity in customs, andcontinue

drafted a declaration on the subject.13 The fact that open discussion of customs fraud has become possible at the international level should help in providing constructive remedies. A good deal of the CCC discussion focused on personnel policies, income levels, and administrative procedures as these affect honesty levels in customs services. In organizational terms, functions associated with processing declarations, receiving payment and verifying information should be kept separate. Personnel should be rotated, and discretion kept to a minimum. In a number of developing countries, the transfer of the tax collection function to commercial banks has been found a highly effective measure against fraud. There is widespread concern about low pay levels and the consequences of this in terms of morale, competence, and honesty. As previously discussed, if customs officials are not paid a living wage, they will have little option but to find ways of supplementing their incomes. But it does not follow from this that higher pay will banish corruption. Some customs services, such as in Pakistan and Gabon, pay rewards to officers who detect malfeasance. In Gabon, a customs officer can earn up to three times his salary as bonus, and may also be awarded fine money for uncovering fraud. While such an arrangement increases wages, it may engender the kind of perverse behavior and overzealousness that was discussed above in relation to tax farming. Another approach adopted by some countries, such as Sri Lanka, is to permit customs officers to supplement their incomes through overtime, but this may also adversely affect working habits. Linked to improved pay scales and better status is the question of the penalty system for customs officers discovered acting fraudulently. It may not be necessary to go as far as Hong Kong, which has made it an offense for a customs officer to be unable to account for assets or a lifestyle incompatible with his income, but penalties need to be credible and consistent enough to deter dishonest behavior. Finally, a modern customs service relies on well developed internal and external audit functions.
Computerization

It is impossible to modernize a customs service without computerizing it. Some of the advantages of computerization include easy access to detailed data and information, rapid processing capacity for customs clearance procedures, a reduced need for discretionary decisionmaking by customs officers, effective internal controls and checks against fraud, selection of goods for examination and information for risk profiling, and assistance in randomizing the allocation of customs tasks. The management of information through computers also reduces direct personal contacts between tax collectors and payers that give rise to opportunities for fraudulent collusion. Automation has resulted in dramatic improvements in some customs services, but has proved more difficult to introduce effectively in others. The experience ofcontinue 13 Agenda Item IV of the 29th Session of the Policy Commission of the Customs Cooperation Council, "Integrity in the Administration of Customs," April 56, 1993.

Cameroon, for example, is in many ways the antithesis of a successful automation effort (Box IV.4. The first computerization efforts in customs usually entail simple data capture, permitting the service to generate information on trade flows and revenues. The next step is to use computers for actual processing in customs clearance and for some of the functions mentioned above. Fullyfledged automation entails electronic data Computerization 111

Preshipment Inspection Services interchange (EDI), whereby electronic links are established between the customs, other relevant government authorities, clearing agents, commercial banks, the port authorities, and shippers. All customs business is transacted via these links. The EDI concept is little more than twenty years old, and is found in relatively few countries (see Box IV.5). There are several packages available for the computerization of customs in developing countries, the best known being ASYCUDA, which has been developed by UNCTAD (SahamiMalmberg, 1992). There are few customs services in developing countries that have fully automated customs clearance procedures, and there are many that still have difficulty even in generating reliable and timely trade data. Stories abound of failed computerization programs, or of systems that have been installed only to cease functioning within a short period of time. These experiences emphasize the importance of well planned computerization programs, especially in relation to the procedures upon which automation is to be built, a clear commitment to automation at all levels of the service, and an adequate supply of the necessary technical skills to run and maintain the system once it has been installed (Corfmat, Walsh and Castilla, 1993). Whither PSI? Three interrelated questions must be asked about PSI in the context of customs modernization. First, what criteria should be relied upon to determine when national customs authorities can deliver an acceptable level of service with less reliance on preshipment inspection? Second, how should comprehensive PSI services be phased out? Third, what, if any, role does PSI have in a fully modernized customs system? It would be difficult to specify precise criteria for when customs services no longer need the comprehensive source of independent information and technical expertise offered by PSI companies. One clear indicator of readiness, however, is the existence of a proven computerized system. Automation offers better data capture, greater transparency, and a more effective system of checks on transactions. Where customs cannot even generate timely and accurate trade flow and revenue statistics, let alone undertake automated processing, it is unlikely that an adequate service will be provided in other areas. Second, there is the integrity question. Although it is generally impossible to assess the corruption level of a service with any accuracy, and there is often a reluctance to undertake too explicit a public discussion of the problem, the authorities will always be able to make an informed guess as to the pervasiveness of corruption. In addition, the way customs is organized, the speed with which it delivers services to traders and to its principal, and thecontinue

Box IV.5: Singapore's Tradenet System Singapore customs only began to computerize their operations in the early 1980s. The initial automation program was undertaken in two phases. In the first phase, systems were developed to deal with bank guarantees, permits control, cargo accounting, duty payment, warehouse inventory control, revenue collection and analysis, and interbank giro transfer. In the second phase, the system became part of an EDI network, vastly expanding the range of services offered and the scope for efficiency improvements.

Importers submit their import clearance documents electronically, and customs processes all declarations by the same means. When an importer submits a declaration, Tradenet routes it automatically to the necessary government agencies for approval, and the approval is returned to the Whither PSI? 112

Preshipment Inspection Services importer's electronic mailbox. This procedure normally takes less than half an hour, compared to more than a day before automation. The network can he accessed twenty four hours a day. If goods are not selected for inspection, they can be cleared immediately. Tradenet calculates duties payable and arranges funds transfers through electronic interbank giro transfer. The system also keeps automatic records of inventories in warehouses. The same information network is used by customs for selecting transactions and enterprises for audit. Tradenet, linked to other networks though EDI, is also able to process manifests electronically before goods arrive. Among the most recent innovations are the extension of the network to international users, including in the Netherlands and the United States, for such services as booking cargo space and completing certificate of origin requirements.

The result of this technological sophistication is to develop what Singapore Customs refers to as a "paperless, cashless, and queueless" service. The network handles over 10,000 import declarations a day, at far greater speed than ever before. It has increased productivity by 2030 percent, saved many millions of dollars in paperwork, and reduced the scope for fraud by minimizing direct contacts that would facilitate such behavior and instituting numerous crosschecks within the system. Tradenet and the EDI network have also eliminated the need for more than one entry of data, and drastically reduced the scope for documentary errors.

Source :

Tay Chng Yeow, "TRADENET: The Singapore Customs Experience," Paper prepared for Conference on Information Technology and Fiscal Compliance,sponsored by the Harvard International Tax Program (November, 1992) general level of competence can be assessed without much difficulty. A key question to consider is how far attained levels of service delivery rely crucially on PSI, and whether the withdrawal of PSI will induce backsliding. Turning to the issue of transition, the manner, pace and sequence of withdrawal of PSI services are crucial to the maintenance of quality services and revenue security. The transition will be made much easier, and at lower cost to the principal, if customs and the PSI company have established good working relations. As previously noted, these relations have not always been amicable. This owes in some measure to defensive attitudes in customs and doubtless to resentment at the prospect of losing rents. Communication failures and divergent objectives on the side of the PSI companies have also played their part in some cases.break

There are several ways in which a phased withdrawal from comprehensive PSI services might take place. It is important to recall that all PSI contracts have elements of selectivity from the outset, as a result of the threshold and contractual exemptions. Experience with these exclusions might provide clues as to the best way of phasing in a reduction in PSI services. Selectivity can be thought of in terms of geography, product category, importer identity, revenue risk, or standard selection techniques of the kind discussed above in relation to customs inspections. A geographical criterion would reflect the belief that patterns of fraud or pricing irregularities were linked to the origin of goods. The risk here is that importers might arrange transshipment through exempted countries of origin in order to avoid preshipment inspection (see discussion of this problem in chapter III). Whither PSI? 113

Preshipment Inspection Services

Box IV:4 Some Pitfalls of Computerization: Cameroon's Experience Interviews with various government officials and individuals in the private sector revealed that the customs computer system was considered a major source of fraud and delays in Cameroon's customs clearance procedures. The system itself was somewhat cumbersome and outdated, and experienced fairly frequent breakdowns. But the real problem was the institutional arrangements for the management of the computer system.

Although customs was the only user of the system, another entity responsible to the Ministry of Higher Education CENADI was in charge of the development, maintenance and overall management of the system. Customs had no line of authority over this agency, and even simple data processing needs could only be met by going through cumbersome administrative procedures.

The system had little security, and was allegedly subject to manipulation by CENADI agents who had the capacity to enter the system and make any number of changes to records. They could, for example, doctor manifests, modify values, lose declarations, and cancel records of payments outstanding. While only a few senior customs officials had the authority to make changes in the information registered in the computer system, the lack of controls on the CENADI side made it impossible to hold CENADI officials accountable. Productrelated criteria recognize that fraud is harder to perpetrate with homogeneous products, but here the risk is that importers will misdeclare the tariff nomenclature of products that would otherwise be inspected. Importer identity is a selection criterion that rewards regular importers with a good reputation. Basing selection on revenue risk is a more complex approach that combines several criteria, since the choice of products to be inspected would have to take such factors as tariff levels, consignment size, the nature of products, and importer identity into account. Indeed, a revenue risk criterion is really a multifaceted profiling exercise of the kind a modernized customs service would be undertaking anyway, presumably with assistance from computerized selection routines. Selection by risk profiling would ideally be supplemented by random checks. The process of reducing reliance on PSI may also be satisfactorily achieved by introducing selective physical inspections in the first instance, and continuing with comprehensive price verification. One of the attractions of this approach is its rapid impact on the cost of PSI, as 3550 percent of the cost of PSI is accounted for by the physical inspectioncontinue

side of the service. This approach has been contemplated in some contracts, including those for Kenya and Malawi. Whatever approach is adopted, it should be based on full cooperation between customs and the PSI company, it should be appropriately paced as a function of the readiness of the national customs service, and it should embody clear rules that are sufficiently flexible to respond rapidly to shifting needs. In the interests of Whither PSI? 114

Preshipment Inspection Services transparency, customs should share fully in, if not determine, the specification of selection criteria. Before selectivity is implemented, the principal should have established clear performance benchmarks for customs, in terms of service delivery and revenue collection performance. Reconciliation arrangements would be maintained intact for all consignments subject to PSI, and the PSI company should also be invited to monitor collections on items not subject to PSI during the early part of a phaseout program. For this purpose, the PSI company would need to have continued access to all import entry data. Explicit performance criteria are critical, because there will always be a temptation to assert that the national customs service does not need PSI support without properly scrutinizing the situation. It is assumed that a customs training program will have been in place contemporaneously with PSI, and this program should be adapted to the phaseout program. An interim measure could be, for example, that technical support is provided for destination inspections, either by the PSI company, or the entity responsible for the training program. Once a principal is ready to contemplate phaseout, a properly structured program may be expected to take a number of years, and would be subject to adjustment on the basis of the performance of the national customs service. Even after a phaseout program has been completed, national customs services may well find it worthwhile to contract PSI or surveyor companies for particular kinds of service, or to deal with exceptional circumstances on an adhoc basis. Finally, the third question posed above is whether preshipment services have a longerterm, or even indefinite role. Views here vary. Many customs officials do not like the idea, because it invades their traditional domain. Jenkins (1992), on the other hand, argues that preshipment customs work is desirable from an efficiency standpoint, since customs formalities can be completed before the merchandise even arrives in the importing country. Singapore, with its sophisticated Tradenet technology, can strike a ship's manifest electronically before goods are landed. The Norwegian proposal for an alternative to PSI (chapter II) clearly contemplates a continuing role for preshipment operations. In working toward establishing a stateowned and controlled PSI operation (PTSI), Indonesia appears to contemplate a permanent role for PSI in its national customs regime. Longerterm preshipment customs work would likely be quite different from the traditional service analyzed in this report, because it would emphasize efficiency goals, rather than being designed primarily as a parallel system of information, or as technical support for a poorly functioning national customs service.break

Summary Arguments in mitigation of corruption as a purveyor of efficiency and facilitator are unconvincing when it comes to corruption in customs. The macroand microeconomic costs of revenue fraud can be high, especially where collection shortfalls of the magnitude identified in this chapter are involved. Similarly, petty corruption requiring payment of "facilitation" fees can lengthen service delivery times and add fatuous stages to customs clearance procedures. This kind of corruption may not be as benign as it seems at first sight, since in essence it involves extortion. Governments determined to tackle corruption will never reduce it to zero, nor should they incur the costs of trying to do so. The costs of beating flagrant corruption may be low, but costs rise as the degree of corruption in the system diminishes. Prioritization is called for in addressing the sources of corruption, and revenue fraud is probably the place to start in customs. Preshipment inspection services clearly have a role here. Efforts to understand tax evasion and address it will fail unless the remedies developed recognize that dishonesty may be a characteristic not only of taxpayer behavior, but also of tax collectors. Where there is a propensity for dishonesty, taxpayer decisions to behave fraudulently will be influenced by the amount of tax they are required to pay, the cost of avoiding the tax (in bribes), the probability of detection, and the size of the penalty upon Summary 115

Preshipment Inspection Services detection. Similarly, tax collectors will be influenced by the relationship between their wages and the return from corruption, bearing in mind the likelihood and the costs of detection. While taxpayer and collector motivations for fraudulent behavior are driven by similar considerations, their respective objective functions interact in a number of different and sometimes complicated ways. If tax collectors are income maximizers, there is no guarantee that higher wages will mitigate corrupt behavior. Thus, while low wages are likely to breed corrupt behavior, raising them is not a sufficient condition for solving the problem. Higher wages must be accompanied by a system of effective monitoring and credible penalties for malfeasance. The principalagent framework of analysis shows how the principal's wishes (the government's) may be frustrated by the agent's behavior (the tax collector's) when the objectives of the two parties diverge and the principal lacks information about what the agent is doing. Preshipment inspection services can largely solve the problem of asymmetric information by providing the principal with detailed information on taxes due. This service eliminates the scope for independent acts of fraud by the taxpayer, provided the collector acts on the information provided and refrains from colluding with the taxpayer to defraud the revenue. Both the taxpayer and the collector will be able to indulge in fraud if the principal, despite the informational advantage accorded him by PSI, is unwilling to use this information to stem corruption. Weak government, or a corrupt principal, will frustrate technical solutions to fraud, rendering such services as PSI costly and pointless. The gains from PSI can only be assured under a system of ex post reconciliation, where PSIgenerated information is reconciled against customs records and proof of duty payment. Hard empiricalcontinue

evidence of the costs of foregoing reconciliation is difficult to come by, but what there is paints a disconcerting picture. Governments may be foregoing up to half the revenue owed to them, even with preshipment inspection. Customs administrations will never be able to provide adequate services to their principals and the trading community if they are unwilling to modernize. Modernization calls for a number of organizational and procedural changes to the traditional way of doing business, and above all requires automation. Unless modernization is embraced, and serious efforts are made to address fraud and administrative malfeasance, governments are likely to remain dependent on comprehensive PSI services, even in the longterm. Before governments contemplate phasing out PSI, they should first make it work properly. A few basic indicators of readiness should be analyzed before a phaseout program is embarked upon, such as the degree of automation achieved, the ability to generate timely and accurate trade flow and revenue data, the robustness of internal and external quality and honesty controls, and the level of integrity in the system. A phaseout program should be planned with reference to performance criteria, built on explicit targets and performance benchmarks. The possibility of reintroducing PSI should be everpresent in the minds of both the government and the customs authorities.break

Conclusions
An evaluation of the utility and effectiveness of PSI needs to distinguish among the various functions for which the service might be contracted most importantly, to detect overinvoicing and underinvoicing, to verify the proper use of donor funds, and to provide independent information regarding taxes due on imports. Several other possible uses of PSI were discussed in Chapter I, such as data management, provision of statistics, monitoring of compliance with national regulations and origin requirements, training and technology transfer, trade facilitation, and consumer protection. None of these subsidiary uses of PSI would justify contracting a comprehensive service, Conclusions 116

Preshipment Inspection Services but they should all be taken advantage of if a PSI program is instituted for other reasons. Detection of overinvoicing remains a feature of most PSI contracts. Considering the various reasons why this practice might occur including capital flight in the presence of exchange controls, tax evasion, and theft of company assets it generally makes sense to include a provision for checking on overinvoicing in PSI contracts. Nevertheless, economic policy reforms in many PSIusing countries have substantially reduced or removed a major incentive for overinvoicing, created by exchange controls and foreign exchange rationing. In countries where reforms have taken hold, PSI companies are increasingly being required to report instances of overinvoicing to their principals, rather than requiring adjustment of the supplier's invoice prior to shipment of the goods. The use of PSI as an instrument for ensuring that donor import support funds are used for the purpose they were provided is very similar in substance to the general case for controlling overinvoicing in an economy with foreign exchange rationing. As market mechanisms are developed for disbursing import support funds, the need is lessened for monitoring import transactions. The World Bank's policy of encouraging governments to use PSI, especially in Africa, and sometimes insisting upon it as a loan condition, has been predicated primarily upon concerns about the management of donor funds. Just as marketoriented economic reforms are reducing the incidence of capital flight via false invoicing, and lessening the need for monitoring disbursement of donor funds, so is trade liberalization drawing attention to a different set of problems in a number of countries namely, poorly functioning customs administrations and the distortions introduced by widespread evasion of trade taxes. In recent years, PSI contracts have focused more closely on customsrelated work, dealing with underinvoicing and tax evasion. Even in countries where PSI programs are still needed as a means of controlling capital flight or monitoring donor funds, there are few instances where these contracts do not also include a customs component. This new emphasis in PSI work has meant that this study has concentrated more on revenue fraud and customsrelated PSI activities than on anything else. It is impossible to analyze revenue fraud without recognizing that the problem can arise both from the behavior of traders and of customs officials in the importing country. Thus, the intervention of PSI companies on the revenue side is not simply about enhancing information available to thecontinue

national customs authorities, it is also about generating independent parallel information on border tax liabilities. This PSIgenerated parallel information system enables governments to exert control over tax collection functions within their own bureaucracies. Chapter II of the study focuses on a range of criticisms that have been levelled against the PSI industry over the years, particularly by exporters. These have included complaints about additional costs associated with PSI procedures, shipping delays, a lack of procedural transparency and accountability, the absence of appeals procedures against PSI company decisions or recommendations, discriminatory treatment of suppliers, and questionable methodologies for price verification. To the extent that PSI interferes with and inhibits trade, it becomes another nontariff barrier, and has been treated as such in some discussions of the subject. Efforts have been made, particularly by the U.S. International Trade Commission (USITC), to evaluate exporter complaints using survey questionnaires. The USITC survey gave a useful indication of the difficulties that exporters claimed (not always with full justification) were the fault of PSI companies. This study does not attempt to evaluate the effects of PSI on exporters, but devotes some attention to international initiatives designed to address these issues. The GATT/WTO Agreement on Preshipment Inspection imposes a series of obligations on user governments, requiring them to ensure that PSI companies abide by internationally agreed norms. These norms address virtually all of the complaints raised by exporters, and the agreement also Conclusions 117

Preshipment Inspection Services establishes a framework in which any future complaints could be addressed. The GATT/WTO initiative should, therefore, create the conditions for PSIrelated problems on the export side to be dealt with as they arise. Similarly, the new rules on customs valuation that emerged from the Uruguay Round will regulate PSI company price verification methodologies in respect of customs work, once the new rules have been adopted by PSI users. As for the benefits accruing to governments using PSI, the study reports the results of PSI interventions generated by the PSI companies themselves. These take the form of foreign exchange savings from detection of overinvoicing and unreported repatriable commissions, and revenue savings from the identification of underinvoicing and misclassification. Although the reported results generally exceed the fee costs of PSI services, sometimes by a significant margin, it is impossible to say how far these reported gains actually materialized. This is because the realization of reported savings is almost entirely contingent upon actions by governments (except under contracts where the PSI companies adjust for overinvoicing). Were governments to make better use of PSI, reported results would provide a more accurate indication of the direct benefits of the service. On the other hand, the existence of PSI inspection and price verification may modify the behavior of traders, leading them to refrain from false invoicing and related practices. This deterrent effect is virtually impossible to measure. It is likely to be more significant in circumstances where governments act upon PSIgenerated information, and less so if there is fraudulent collusion between importers and national customs authorities. Additionalcontinue

benefits that might arise from PSI relate to possible trade facilitation effects, and the other subsidiary services mentioned above. It is not much easier to measure precisely the costs of PSI than it is to estimate the benefits. The judgement as to whether PSI represents value for money depends largely on the extent to which user governments take advantage of the service, but also on the principal's perception of the seriousness of the underlying problem to be addressed. It is obvious, for example, that as customs services show more willingness and ability to perform their assigned functions, the costbenefit calculus moves against PSI services. But if poor discipline, limited commitment and low skill levels mean poor performance in customs, properly used PSI services could pay for themselves several times over. Chapter III of the study discusses various contract features and administrative arrangements that influence the effectiveness of PSI services. Among these, trade facilitation opportunities are particularly important. There is scope for facilitating trade through PSI, principally by taking advantage of the additional security the service provides to accelerate customsrelated formalities. Second, transactions costs for traders of PSIinduced delays must be minimized if PSI is not to become a nontariff barrier. While there are several potential sources of delay in the completion of PSI formalities, available evidence suggests that exporters (and perhaps shippers) are often responsible for delays that are attributed to PSI companies. With or without such delays, a major potential weakness of PSI procedures is that PSI documentation sometimes reaches customs authorities later than the merchandise to which it pertains. This is most likely to happen in respect of nearcountry shipments and consignments arriving by air. Where it does occur, either PSIgenerated information is ignored, or customs clearance is delayed. This problem can be addressed through the use of provisional documentation or through arrangements that guarantee timely arrival of final PSI documents. Either way, a secure and efficient PSI service requires that provision is made to ensure that the necessary documentation is available when goods arrive. Third, productspecific and importerspecific exemptions from PSI requirements should be minimal. Lengthy lists of exempted goods can seriously undermine the effectiveness of a program. Similarly, customs officers and Conclusions 118

Preshipment Inspection Services other government officials should not have the discretionary authority to exempt particular consignments from PSI requirements. Where customs reform is sufficiently advanced for a government to contemplate the gradual phaseout of PSI, and more selective physical inspection and price verification requirements, it is important that selectivity should operate on the basis of established criteria, and not ad hoc decisions. Also, value threshold levels below which goods are exempt from PSI should be constantly monitored to guard against undervaluation and consignment splitting. Fourth, contractual arrangements for PSI should incorporate an administrative complaints and appeals procedure through which importers' grievances can be heard and acted upon. This ensures that PSI companies remain responsive to importers, dissipates illwill that might otherwise accumulate, and diminishes opportunities for undermining the effectiveness andcontinue

credibility of PSI services through unsubstantiated allegations of poor service delivery. Such arrangements would be analogous to what the Uruguay Round agreement on preshipment inspection establishes on the export side. Fifth, appropriate monitoring and auditing of PSI contract performance will ensure accountability and transparency. Sixth, competition in the PSI industry is doubtless beneficial to users, but in general, governments are likely to be better served if they employ a single company at a time and then put the contract out to competitive bidding every two to three years. The reasons for preferring serial to parallel competition are that the transactions costs of dealing with a single company are lower, the prospects for fruitful cooperation between customs and a single PSI entity are better, fee costs for the service are likely to be less, and most forms of split contract do not, in any event, engender greater competition among PSI suppliers than regular competitive tendering. Chapter IV of the study is devoted to customs and revenue issues. From this perspective, the study argues that many governments have not taken advantage of the full potential of preshipment inspection. Evidence is presented of significant revenue shortfalls attributable to failure by customs to collect revenues due. Despite the existence of PSI, revenue collection shortfalls of up to 50 percent, net of official exemptions, have occurred in some countries. The immediate solution to this problem lies in a more effective use of PSI services. In the longerterm, thoroughgoing customs reform is a prerequisite for reduced reliance on, and eventual elimination of the need for, PSI as a system of parallel information. As a first step, however, the majority of governments using PSI could make considerably better use of the service than is currently the case. In particular, the absence of a system of ex post reconciliation prevents governments from using the parallel information generated by PSI as an instrument for improving tax collections. Until this is done, there is little prospect of PSI contributing significantly to improved revenue collection. Moreover, if undercollection and related fraud are allowed to persist, this is likely to impinge negatively upon broader customs reform efforts. Part of the explanation for poor customs performance in many countries may be low wage levels. But simply raising incomes will not deal with the problem effective monitoring and modernization are key ingredients of a lasting solution. An explicit link should be made between progress in customs reform and reduced reliance on preshipment inspection. This should involve the establishment of benchmark criteria against which the performance of customs is judged. Customs needs to receive the requisite logisitical and financial support for automation and modernization. As customs shows willing and able to carry out its functions, a programmed withdrawal from PSI can be planned, initially through reduced coverage of physical inspections, and later through selective price verification. The establishment of cooperative working relationships between PSI providers and national customs services will facilitate the transfer of authority back to customs, and minimize revenue risk in the process. The worst possible scenario for PSI users is that they incur the costs of the service, use it in mediocre and careless ways so as to reap very partial, even dubious benefits from it, then dispense with it and return to the Conclusions 119

Preshipment Inspection Services status quo ante .break

Annex
Page Table A.1: Country Specific Data on PSI Interventions Table A.2: Regression Results for Individual Countries Table A.1: Country Specific Data on PSI Interventions Importer Exporter and Products Indonesia N. America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 1296 2148 7 68 12230 990 57 25 0 1218 570 6879 8003 151 563 507 0 4 5491 54 10 0 0 391 232 2326 3600 80 6629 7.7 12.8 0.0 0.4 72.7 5.9 0.3 0.1 0.0 7.2 3.4 40.9 47.6 0.9 100.0 43.4 23.6 0.0 5.9 44.9 5.5 17.5 0.0 0.0 32.1 40.7 33.8 45.0 53.0 39.4 102548974 257713913 1271578 8857457 499046609 28225919 23357562 3842608 0 108225352 48366998 201834748 562648474 3789049 924864620 691301 1592835 0 62035 10296050 86938 52436 0 0 538481 403351 2473106 9318195 48461 12781595 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$) link link

TOTAL 16821 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Peru Bivac N. America W. Europe Africa Annex 13892 7014 43 2666 2337 1 28.6 14.4 0.1 19.2 33.3 2.3 116898915 112344761 2494405 1311842 1475010 184 120 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

Preshipment Inspection Services LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 7980 14276 34 36 98 5244 635 1891 10829 34592 670 1266 4010 0 3 11 1427 120 344 2557 8591 109 11721 16.4 29.4 0.1 0.1 0.2 10.8 1.3 3.9 22.3 71.2 1.4 100.0 15.9 28.1 0.0 8.3 11.2 27.2 18.9 18.2 23.6 24.8 16.3 24.1 282134577 172328665 5149847 4363649 3314339 17322813 90978687 158596136 99100402 365765626 1911118 716351970 12403893 2847741 0 85527 8405 325091 1557743 7171220 2975567 6740828 12336 18457694

TOTAL 48617 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Benin N. America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 165 10359 569 78 1746 0 34 26 0 601 2173 4396 5730 77 53 3468 148 1 424 0 10 3 0 339 681 1020 2067 0 4107 1.3 79.8 4.4 0.6 13.5 0.0 0.3 0.2 0.00 4.6 16.7 33.9 44.2 0.6 100.0 32.1 33.5 26.0 1.3 24.3 0.0 29.4 11.5 0.0 56.4 31.3 23.2 36.1 0.0 31.6 18044582 176828275 35279551 4149301 119535114 0 3081817 562921 0 24927000 131980907 118753384 81820271 0 357481562 817445 3868682 434080 0 6219728 0 5545 6969 0 1952151 5911327 2277034 1211936 0 11352448 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

TOTAL 12977 (table continued on next page )

Annex

121

Preshipment Inspection Services Table A.1 (continued) Importer Exporter and Products Central African Republic North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 9 2778 561 19 430 0 42 3 0 206 585 1254 1782 15 4 1084 33 0 146 0 11 0 0 59 254 379 579 7 1278 0.2 72.3 14.6 0.5 11.2 0.0 1.1 0.1 0.0 5.4 15.2 32.6 46.4 0.4 100.0 44.4 39.0 5.9 0.0 34.0 0.0 26.2 0.0 0.0 28.6 43.4 30.2 32.5 46.7 33.3 283805 65701098 30624043 764026 9109377 0 1229283 54933 0 14091416 21596987 23176038 48753273 148849 107766564 10767 1942564 756901 0 437297 0 2528 0 0 144222 559396 1154210 1277466 14763 3150056 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

TOTAL 3842 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Uganda North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Annex 87 1303 649 10 750 1 37 6 0 119 203 1064 79 947 342 1 247 1 2 2 0 90 135 546 3.1 45.8 22.8 0.4 26.4 0.0 1.3 0.2 0.0 4.2 7.1 37.4 90.8 72.7 52.7 10.0 32.9 100.0 5.4 33.3 0.0 75.6 66.5 51.3 2323388 61845601 88459538 749361 41669052 91863 2139931 399113 0 3643632 24005138 99865887 590227 7055452 3482927 1074 2131443 14689 16440 22362 0 770877 2883489 4279877 122 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

Preshipment Inspection Services Chemicals Unknown 1457 0 850 0 1621 51.2 0.0 100.0 58.3 0.0 57.0 70163191 0 197677848 5380373 0 13314616

TOTAL 2843 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Ghana North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 875 9317 485 162 3923 399 110 91 2 752 1599 4425 8533 55 593 5389 162 3 1388 297 27 30 0 457 891 2180 4330 31 7889 5.7 60.6 3.2 1.1 25.5 2.6 0.7 0.6 0.0 4.9 10.4 28.8 55.5 0.4 100.0 67.8 57.8 33.4 1.9 35.4 74.4 24.5 33.0 0.0 60.8 55.7 49.3 50.7 56.4 51.3 42438926 346354883 27660542 23811778 169499223 5649448 12447221 4773007 17860 23705424 111281101 158401095 337554089 1711178 632652888 4518131 26431940 525078 11824 7802766 381218 16182 39878 0 1678309 7719776 8342710 21809893 176331 39727018 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

TOTAL 15364 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Phillippines North America W. Europe Africa LAC Asia Pacific Annex 1829 1821 15 37 11389 433 997 1213 15 29 2915 262 11.7 11.7 0.1 0.2 73.0 2.8 54.5 66.6 100.0 78.4 25.6 60.5 88172551 104996276 6199899 4582514 268006118 22360525 2834515 1674763 19608 45246 5546900 456474 123 Number of Inspections Number of Adjustments Share of Adjustment Inspections (%) As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

Preshipment Inspection Services Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 47 24 9 728 573 6958 7224 113 45 21 8 305 381 1388 3372 59 5505 0.3 0.2 0.1 4.7 3.7 44.6 46.3 0.7 100.0 95.7 87.5 88.9 41.9 66.5 19.9 46.7 52.2 35.3 3819016 5811212 114141 34165279 48589548 130943146 287119251 3145028 503962252 2836 26374 22547 278511 2515010 3376755 4419306 39683 10629264

TOTAL 15596 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Zambia North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 281 3905 1415 42 1513 8 5001 22 0 673 699 3511 7258 46 227 2895 652 9 846 4 446 9 0 191 253 1325 3291 28 5088 2.3 32.0 11.6 0.3 12.4 0.1 41.0 0.2 0.0 5.5 5.7 28.8 59.6 0.4 100.0 80.8 74.1 46.1 21.4 55.9 50.0 8.9 40.9 0.0 28.4 36.2 37.7 45.3 60.9 41.7 28386145 236348534 55698156 38467770 77614303 1900864 210647555 1008821 0 63934342 110322573 125564787 349299199 951245 650072147 2899582 33350030 3408617 128067 11559432 100775 1672231 150827 0 1314736 1817747 14215531 35748656 172889 53269558 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

TOTAL 12187 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Cameroon Annex 124 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

Preshipment Inspection Services North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 175 11130 208 151 1900 1 98 70 225 506 1628 5009 6659 156 31 2081 9 1 285 0 4 4 44 78 289 695 1376 21 2459 1.3 79.7 1.5 1.1 13.6 0.0 0.7 0.5 1.6 3.6 11.7 35.9 47.7 1.1 100.0 17.7 18.7 4.3 0.7 15.0 0.0 4.1 5.7 19.6 15.4 17.8 13.9 20.7 13.5 17.6 30586015 319407385 24168860 14820827 44736633 7139 10597435 3182315 5148571 14488732 136790788 103733781 195733349 1908529 452655180 320227 4884442 35257 11532 1405663 0 97767 6987 49918 274597 2112225 1069129 3349553 6289 6811793

TOTAL 13958 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Cte d'Ivoire North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 360 13189 367 255 1828 1 377 137 0 430 2819 5426 7771 68 92 1429 11 16 180 0 1 4 0 24 469 464 744 32 1733 2.2 79.9 2.2 1.5 11.1 0.0 2.3 0.8 0.0 2.6 17.1 32.9 47.1 0.4 100.0 25.6 10.8 3.0 6.3 9.8 0.0 0.3 2.9 0.0 5.6 16.6 8.6 9.6 47.1 10.5 18050306 437192851 18285233 13654064 76729087 5832 20058621 3180604 0 19663345 135217654 147797059 280577128 3901413 587156599 302787 8433626 47135 40404 287797 0 2300 9008 0 38449 5403715 1623153 1902512 155226 9123056 Number of Inspections Number of Adjustments Share of Adjustment Inspections (%) As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

TOTAL 16514 (table continued on next page )

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Preshipment Inspection Services Table A.1 (continued) Importer Exporter and Product Tanzania (Customs) North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 4 576 181 0 1089 13 9 5 0 49 103 478 1247 0 1 311 87 0 483 11 0 2 0 30 89 220 556 0 895 0.2 30.7 9.6 0.0 58.0 0.7 0.5 0.3 0.0 2.6 5.5 25.5 66.4 0.0 100.0 25.0 54.0 48.1 0.0 44.4 84.6 0.0 40.0 0.0 61.2 86.4 46.0 44.6 0.0 47.7 1337819 30341951 9422518 0 49460226 1037542 408202 674031 0 4938594 10058582 19217599 58467514 0 92682290 2502 1202241 919980 0 3501278 11944 0 2481 0 266907 1821050 465262 3087207 0 5640427 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

TOTAL 1877 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Tanzania, FOREX North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Annex 58 1357 263 5 942 6 115 27 0 99 712 706 21 237 51 0 367 0 2 2 0 11 6 113 2.1 48.9 9.5 0.2 34.0 0.2 4.1 1.0 0.0 3.6 2.6 25.5 36.2 17.5 19.4 0.0 39.0 0.0 1.7 7.4 0.0 11.1 8.5 16.0 4800021 77310990 16932364 538956 39343878 103499 30648514 2347619 0 39640702 7871650 28891202 28802 12541515 152150 0 592417 0 51221 123021 0 99283 11912 446997 126 Number of Inspections Number of Adjustments Share of Inspections (%) Adjustment As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

Preshipment Inspection Services Chemicals Unknown 1891 6 548 2 680 68.2 0.2 100.0 29.0 33.3 24.5 94374024 1248264 172025841 1928338 2595 2489125

TOTAL 2773 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Tanzania, SSI North America W. Europe Africa LAC Asia Pacific Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown 79 1278 170 4 88 3 7 6 1 65 79 465 1018 9 41 632 25 3 54 1 2 5 1 24 37 202 498 3 764 4.8 78.1 10.4 0.2 5.4 0.2 0.4 0.4 0.1 4.0 4.8 28.4 62.2 0.6 100.0 51.9 49.5 14.7 75.0 61.4 33.3 28.6 83.3 100.0 36.9 46.8 43.3 48.9 33.3 46.7 7344175 78835919 7195919 378407 15612369 686576 3667962 806067 17640 8169235 13582503 27867856 64531870 293571 114545035 72472 1300986 24618 1628 312686 9186 166448 16977 1520 255138 226009 514380 909428 1567 1906522 Number of Inspections Number of Adjustments Share of Adjustment Inspections (%) As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

TOTAL 1636 (table continued on next page )

Table A.1 (continued) Importer Exporter and Products Peru, SSI North America W. Europe Africa LAC Asia Pacific Annex 2266 464 1 1584 156 25 809 216 0 857 26 0 50.3 10.3 0.0 35.2 3.5 0.6 35.7 46.6 0.0 54.1 16.7 0.0 84793272 29302569 10863 45788768 5528384 6881084 4927702 455330 0 2075586 159044 0 127 Number of Inspections Number of Adjustments Share of Adjustment Inspections (%) As % of Number of Inspections Size of Consignment (US$) Value of Adjustments (US$)

Preshipment Inspection Services Middle East E. Europe Unknown Raw Materials Food Consumer Goods Chemicals Unknown TOTAL 0 7 0 150 230 841 3250 32 4503 0 4 0 35 57 179 1631 10 1912 0.0 0.2 0.0 3.3 5.1 18.7 72.2 0.7 100.0 0.0 57.1 0.0 23.3 24.8 21.3 50.2 31.3 42.5 0 3001561 0 26005833 39948535 27765813 81200206 386114 175306502 0 54076 0 238893 2513948 358147 4555090 5660 7671738

Source : PSI Companies Table A.2: Regression Results for Individual Countries Independent Variables Indonesia Constant Import Tariff North America Western Europe Africa LAC Asia Pacific Middle East E. Europe Raw Materials FoodAgric Consumer Goods ChemicalsTransport ChiSquared (table continued on next page ) 0.27 0.08 0.01 0.60 3.98 0.79 0.71 0.83 0.19 3.96 0.62 0.57 0.28 3.98*** 2.13** 9.06 12.88*** 0.05 3.23*** 21.65*** 11.32*** 0.96 0.09 9.00*** 9.55*** 4.70*** 1524.6 (12)*** Coefficients TRatios Peru 0.45 0.53 0.45 1.53 0.56 0.16 4.29 0.89 0.76 0.01 0.03 0.05 11.86*** 5.19*** 22.54*** 3.69*** 24.18*** 8.45*** 0.12 2.97*** 4.49*** 0.08 0.92 1.24 1019.8 (11)*** Coefficients TRatios

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Preshipment Inspection Services Table A.2 (continued) Independent Variables Benin Constant Import North America Western Europe Africa LAC Asia Pacific E. Europe Middle East Raw Materials FoodAgric Consumer Goods ChemicalsTransport ChiSquared (table continued on next page ) 0.53 17.83*** 1.45 10.88*** 0.38 3.52*** 0.25 4.22*** 1.68 4.38*** 0.29 7.76*** 0.59 0.11 0.70 11.65*** 0.16 4.54*** 0.19 5.67*** 571.1 (10)*** 0.34 5.37*** 357.1 (10)*** 0.34 4.90*** 1.81* 0.49 4.46 0.48 2.21** 0.28 2.40** 0.04 0.06 0.92 4.54 1.21 13.66*** 0.09 0.11 2.34 4.44*** 0.27 Coefficients TRatios Central African Republic 0.05 0.81 Coefficients TRatios

Table A.2 (continued) Independent Variables Uganda Constant 0.72 7.50*** Annex 129 Coefficients TRatios Ghana 0.18 11.19*** Coefficients TRatios

Preshipment Inspection Services Import Tariff North America Western Europe Africa LAC Asia Pacific Middle East E. Europe Raw Materials FoodAgric Consumer Goods ChemicalsTransport ChiSquared (table continued on next page ) 0.001 n.a. 0.63 3.13*** 0.52 7.80*** 1.83 3.39*** 1.03 16.95*** 3.38 2.21 6.49*** 1.05 0.13 0.19 0.11 1.95* 0.80 1.81* 1.14 432.9 (11)*** 0.63 0.13 0.02 0.05 4.61*** 2.63*** 0.92 1.55 1074.2 (11)*** 0.08 0.48 0.88 6.84*** 6.70*** 0.56 22.80*** 2.29 9.71*** 0.64 10.54*** 0.05 n.a. 0.06 n.a. 0.25 1.01 n.a. 5.46***

Table A.2 (continued) Independent Variables Philippines Constant Import Tariff North America Western Europe Africa 0.93 0.13 n.a. 0.31 7.19*** 4.55 0.10 0.80 19.21*** 14.71*** 3.09*** n.a. Coefficients TRatios Zambia 1.02 16.65*** 0.19 2.65*** n.a. 0.22 n.a. 2.41** Coefficients TRatios

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Preshipment Inspection Services LAC Asia Pacific Middle East E. Europe Raw Materials FoodAgric Consumer Goods ChemicalsTransport ChiSquared (table continued on next page ) 0.25 0.95 28.03*** 0.22 3.14*** 1.23 1.02 0.42 5.66*** 0.99 16.74*** 0.35 5.95*** 2687.7 (11)*** 0.36 6.13*** 4712.1 (11)*** 0.40 6.63*** 3.80*** 3.00*** 2.02 59.28*** 1.03 3.57*** 0.35 4.38*** 0.84 1.08 1.44 6.40*** 0.48 12.26*** 1.90*

Table A.2 (continued) Independent Variables Cameroon Constant Import Tariff North America Western Europe Africa LAC Asia Pacific 0.90 23.21*** 0.25 n.a 0.13 0.83 5.39*** 1.53 4.30*** 0.13 3.43*** 3.27 0.07 2.69 0.06 0.01 0.21 0.24 1.79* n.a 1.14 0.91 n.a 0.54 0.56 4.14*** 1.93* Coefficients TRatios Cte D'Ivoire 1.02 34.50*** 6.72*** n.a 7.43*** Coefficients TRatios

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Preshipment Inspection Services Middle East E. Europe Raw Materials FoodAgric Consumer Goods ChemicalsTransport ChiSquared (table continued on next page ) 0.88 3.83*** 0.71 2.86*** 0.09 0.15 3.37*** 0.11 2.69*** 219.9 (11)*** 0.32 8.98*** 345.1 (11)*** 1.15 0.53 4.80*** 0.35 9.07*** 0.55 1.57 4.76*** 2.55**

Table A.2 (continued) Independent Variable Tanzania, Customs Constant Import Tariff North America Western Europe Africa LAC Asia Pacific Middle East E. Europe Raw Materials FoodAgric Annex 0.34 0.66 0.01 15.86*** 0.15 0.19 0.13 2.55** 1.02 2.65** 4.36 0.33 0.88 4.21*** 132 0.09 0.86 1.30 4.57*** 0.58 0.26 1.87* 0.95 3.92 0.54 1.86* 0.38 0.16 0.68 0.36 7.14*** 0.08 2.05** 2.17** Coefficients TRatios Tanzania, Forex 1.79 8.10*** 0.30 0.004 7.85*** 2.35** 1.56 1.48 2.34** Coefficients TRatios

Preshipment Inspection Services Consumer Goods ChemicalsTransport ChiSquared (table continued on next page ) 1.26 7.50*** 0.99 6.04*** 519.7 (11)*** 0.93 4.23*** 325.9 (12)*** 0.55 2.47**

Table A.2 (continued) Independent Variables Tanzania, SSI Constant Import Tariff North America Western Europe Africa LAC Asia Pacific Middle East E. Europe Raw Materials FoodAgric Consumer Goods ChemicalsTransport ChiSquared 0.03 0.25 0.09 0.93 8.11*** 0.67 0.29 0.48 0.65 1.00 0.34 0.02 0.005 0.98 2.05** 0.63 1.22 1.64 1.59 0.16 0.04 99.6 (11)*** 0.17 0.88 4.47 0.26 0.12 0.13 0.65 2.60*** 6.49*** 0.11 0.52 0.86 1.24 6.83*** 494.0 (10)*** 0.20 1.24 0.60 Coefficients TRatios Peru, SSI 0.53 0.02 n.a 0.31 4.10 4.94*** 0.22 n.a 4.81*** 0.02 Coefficients TRatios

Note: Regions and products are identified by dummies. 90% level of significance 95% level of significance 99% level of significance

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Preshipment Inspection Services

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Recent World Bank Discussion Papers (continued) No.251 Supply and Demandfor Finance of Small Entelprises in Ghana. Ernest Aryeetey, Amoah BaahNuakoh, Tamara Duggleby, Hemamala Hettige. and William F. Steel Projectizing the Governance Approach to Civil Service Reform: An Institutional Environment Assessment for Preparing a Sectoral Adjustment Loan in the Gambia . Rogerio F. Pinto with assistance from Angelous J. Mrope Small Firms Informally Financed: Studiesftom Bangladesh. Edited by Reazul Islam, J. D. Von Pischke, andJ. M. de Waard Indicatorsfor Monitoring Poverty Reduction. Soniya Carvalho and Howard White Violence Against Women: The Hidden Health Burden. Lori L. Heise with Jacqueline Pitanguy and Adrienne Gern1ain Women's Health and Nutrition: Making a Difference. Anne Tinker, Patricia Daly, Cynthia Green, Helen Saxenian, Rama 136

No.252

No.253 No.254 No.255 No.256

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Preshipment Inspection Services Lakshminarayanan, and Kirrin Gill No.257 Improving the Quality of Primary Education in Latin America: Towards the 21st Century. Lawrence Wolff, Ernesto Schiefelbein, andJorge Valenzuela How Fast is Fertility Declining in Botswana and Zimbabwe? Duncan Thomas and Ityai Muvandi Policies Affecting Fertility and Contraceptive Use: An Assessment of Twelve SubSaharan Countries . Susan Scribner Financial Systems in SubSaharan Africa: A Comparative Study. Paul A. Popiel Poverty Alleviation and Social Investment Funds: The Latin American Experience. Philip J. Glaessner, Kye Woo Lee, Anna Maria Sant' Anna, and JeanJacques de St. Antoine Public Policy for the Promotion of Family Farms in Italy: The Experience of the Fundfor theFormation of Peasant Property. Eric B. Shearer and Giuseppe Barbero SelfEmploymentfor the Unemployed: Experience in OECD and Transitional Economies. Sandra Wilson and Arvil V. Adarns Schooling and Cognitive Achievements of Children in Morocco: Can the Government Improve Outcomes? Shahidur R.Khandker, Victor Lavy, and Deon Filmer World BankFinanced Projects with Community Participation: Procurement and Disbursement Issues. Gita Gopal and Alexandre Marc Seed Systems in SubSaharan Africa: Issues and Options. V. Venkatesan Trade Policy Reform in Developing Countries since 1985: A Review of the Evidence. Judith M. Dean, Seema Desai, andJames Riedel Farm Restructuring and Land Tenure in Reforming Socialist Economies: A Comparative Analysis of Eastern and Central Europe. Euroconsult and Centre for World Food Studies The Evolution of the World Bank's Railway Lending. Alice Galenson and Louis S. Thompson Land Reform and Farm Restructuring in Ukraine. Zvi Lerrnan, Karen Brooks, and Csaba Csaki Small Entelprises Adjusting to Liberalization in Five Aftican Countries. Ron Parker, Randall Riopelle, and William F. Steel Adolescent Health: Reassessing the Passage to Adulthood. Judith Senderowitz

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Preshipment Inspection Services No.273 No.274 Measurement of Welfare Changes Caused by Lorge Price Shifts: An Issue in the Power Sector. Robert Bacon Social Action Programs and Social Funds: A Review of Design and Implementation in SubSaharan Africa. Alexandre Marc, Carol Graham, Mark Schacter, and Mary Schmidt Investing in Young Children. Mary E. Young Managing Primary Health Care: Implications of the Health Transition. Richard Heaver

No.275 No.276

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