TWN Info Service on WTO and Trade Issues (Jul16/15)
20 July 2016
Third World Network

UNCTAD-14: Wide-spread misinvoicing in South's commodity exports
Published in SUNS #8286 dated 20 July 2016

Geneva, 19 July (Chakravarthi Raghavan*) -- Trade misinvoicing in developing country-exports, especially in those heavily-dependent on exporting a few primary commodities, and consequent loss in their export earnings, related to capital flight and tax evasions, appears to be wide-spread, according to a study prepared for UNCTAD.

Trade misinvoicing is thought to be one of the largest drivers of illicit financial flows from developing countries, with consequent loss of lose precious foreign exchange receipts, tax, and income that might otherwise fill their resource gaps and could be spent on development.

The study, "Trade Misinvoicing in Primary Commodities in Developing Countries: The cases of Chile, Cote d'Ivoire, Nigeria, South Africa and Zambia (UNCTAD/SUC/2016/2)," is by Professor L้once Ndikumana, University of Massachusetts, Amherst for UNCTAD's Commodity division, and was released in Nairobi on Monday (18 July) at the Commodities Forum there.

"This research provides new detail on the magnitude of this issue, made even worse by the fact that some developing countries depend on just a handful of commodities for their health and education budgets," UNCTAD's Secretary-General, Mukhisa Kituyi said at the Forum in releasing the study.

Commodity exports may account for up to 90 percent of a developing country's total export earnings, he said, adding that the study generated fresh lines of enquiry to understand the problem of illicit trade flows.

"Importing countries and companies, which want to protect their reputations, should get ahead of the transparency game and partner with us to further research these issues," Dr. Kituyi said.

The study suggests there is need for further focussed research at country and global levels, coordination of data gathering and statistics at national and international levels, and the need for an investigation into the role of Transnational Corporations (TNCs) involved in the exploitation, export and import of commodities, as well as the role of (tax and bank) secrecy jurisdictions in facilitating trade misinvoicing.

In its conclusions and recommendations, the study says, it provides strong reasons for further investigations on the motives of trade misinvoicing in primary commodities. It has important implications for research and policy; demonstrates a substantial need for improving trade statistics, with urgent attention paid to data gathering at the product and partner levels, coordination between national statistics and international statistical databases such as UN Comtrade and the IMF's Directions of Trade Statistics (DOTS).

"Tax evasion," the study says, "is a possible motive for the large degree of export overinvoicing observed in most countries in the sample (except Chile). It is also possible that in some cases of export overinvoicing (as in trade with the Netherlands), products may end up in other destinations than the ones listed in official records, probably in tax havens for the purpose of tax evasion.

Export overinvoicing could also be motivated by the attempt of exporters to take advantage of tax incentives aimed at promoting export-oriented activities. Tax evasion could be a motive for the observed substantial import smuggling, as in the case of oil in Nigeria, where oil seems to be entering the country illicitly. These conjectures need to be further investigated at country and product levels, the study adds.

"Foreign exchange and capital account controls," says the study "could also be a motive for trade misinvoicing. However, the increasing volume of trade misinvoicing in recent years is puzzling, given the steady move towards capital account openness and liberalization of currency markets in all the countries in the sample, as in most developing countries. The question remains whether these reforms have been effectively implemented and enforced to reduce the incentives for smuggling of foreign currency.

"The persistence of trade misinvoicing implies that there are important structural and institutional factors that drive this practice. It cannot simply be that illegal trade persists under the cover of legal trade; in some cases, trade misinvoicing constitutes too large a share of total trade to be disguised by legal trade."

This is the case of gold exports from South Africa. The question is whether illegal gold trade is disguised behind legal trade of other products. Answering this question would require investigating whether gold exporters are also involved in exports of other major products so that gold smuggling takes place under the cover of legal trade in other products.

The results from this study have important implications for research and policy, the study says.

First, the fact that exports of primary commodities are concentrated by product and market could be a blessing in disguise. Export concentration implies that policy efforts could be focussed on a limited number of products and partners to increase the effectiveness of reforms.

In each country, the government and its development partners should be able to identify which products and export destinations need to be scrutinized when investigating trade misinvoicing.

Second, the analysis in this study demonstrates a substantial need for improving trade statistics. In particular, improvements are urgently needed in data gathering at the product and partner levels, and there should be coordination between national statistics and international statistical databases such as UN Comtrade and the IMF' DOTS. This will require scaling up both financial and technical assistance to developing countries to help improve human capacity as well as the infrastructure for the compilation and management of trade statistics.

"Third, the results from this study highlight the need for an investigation into the role of TNCs involved in the exploitation, export and import of commodities, as well as the role of secrecy jurisdictions in facilitating trade misinvoicing.

"Such an investigation may shed light on the mechanisms of export overinvoicing and import smuggling. Enhanced transparency in global trade is indispensable, especially through coordinated enforcement of the rules on country-by-country reporting by TNCs at the global level."

One of the issues in the heavily square bracketed "draft Outcome document" under negotiations at the Committee of the Whole (COW), relates to future work in UNCTAD on taxation, and it is being strongly opposed by the developed countries, many of whom (according to the study) appear to be conduits for TNCs in tax-avoidance schemes and parking of such earnings in secrecy-ridden tax-havens.

The analysis in the study shows patterns of trade misinvoicing on exports to China, Germany, Hong Kong (China), India, Italy, Japan, the Netherlands, Spain, Switzerland, the UK, US, and more.

The study in its introduction notes that the problem of trade misinvoicing has generated increasing attention in the research and policy communities, gaining particular traction through the current debates on illicit financial flows, since trade misinvoicing continues to be used as a key mechanism of capital flight and illicit financial flows from developing countries.

The study provides empirical evidence on the magnitude of trade misinvoicing in the particular case of primary commodity exports from five natural-resource-rich developing countries: Chile, C๔te d'Ivoire, Nigeria, South Africa and Zambia.

This sample comprises four resource-dependent developing countries and a more diversified resource-rich middle-income country (South Africa). It covers a representative sample of products in the three main categories of primary commodities: oil and gas; minerals, ores and metals (copper, gold, iron ore, silver and platinum); and agricultural commodities (cocoa). The inclusion of two copper exporters in the sample makes it possible to compare and contrast patterns of copper misinvoicing between two countries and over time.

Estimates of trade misinvoicing have been based, traditionally and primarily, on bilateral trade data published in the Direction of Trade Statistics (DOTS) of the International Monetary Fund (IMF), providing aggregate values of imports and exports between a country and its trading partners.

More recently, there has been growing interest in investigating trade misinvoicing at more disaggregated levels, at sector and product levels, and by trading partner. This interest is motivated by two major factors. First is the presumption that some products may be more frequently smuggled and mispriced than others based on their idiosyncratic characteristics. Second, there may be variations among trading partners with regard to transparency and enforcement of trade recording rules that may generate differences in trade misinvoicing across partners. The analysis at the product and partner levels is made possible by the existence of disaggregated data published in the United Nations Commodity Trade Statistics (UN Comtrade) Database, which provides time series on imports and exports broken down by product, country and trading partner. Such an analysis produces valuable insights about the sources, directions and patterns of trade misinvoicing.

The data show heavy concentration of exports both by product and by partner. With the exception of South Africa, the export baskets of the other countries in this sample Chile, C๔te d'Ivoire, Nigeria and Zambia exhibit a heavy dependence on two or three primary commodities; South Africa has a more diversified export basket, though it is also rich in natural resources. These stylized facts illustrate the relevance and appropriateness of the sample selected for this study on trade misinvoicing in primary commodities.

The results from the analysis show substantial levels of trade misinvoicing in all five countries covered by the study, but the patterns vary substantially across countries, products and trading partners. Some interesting patterns and contrasts emerge.

At the product level, while trade in copper exhibits pervasive and large amounts of overinvoicing in Chile, the results for Zambia show substantial underinvoicing, as well as considerable overinvoicing in trade with Switzerland and the United Kingdom. Iron ore and gold exports from South Africa exhibit systematic underinvoicing. Relatively little gold appears in South Africa' export data, although the country's trading partners record substantial amounts of gold imports from South Africa. Exports of oil from Nigeria and silver and platinum from South Africa show mixed results - both underinvoicing and overinvoicing.

At the partner level, the Netherlands presents the most peculiar case, with systematic export overinvoicing in trade with all the countries in the sample and for all the products. In other words, exports registered as going to the Netherlands cannot be traced in the bilateral trade data of Netherlands. In contrast, trade of Germany with all the countries and products in the sample exhibits export underinvoicing. The results generally show a close correlation between export concentration by destination and the extent of trade misinvoicing.

An UNCTAD press release on the findings of the study said:

* Between 2000 and 2014, underinvoicing of gold exports from South Africa amounted to $78.2 billion, or 67% of total gold exports. Trade with the leading partners exhibited the highest amounts: India ($40 billion), Germany ($18.4 billion), Italy ($15.5 billion), and the UK ($13.7 billion);

* Between 1996 and 2014, underinvoicing of oil exports from Nigeria to the United States was worth $69.8 billion, or 24.9% of all oil exports to the US;

* Between 1995 and 2014, Zambia recorded $28.9 billion of copper exports to Switzerland, more than half of all its copper exports, but these exports did not show up in Switzerland's books;

* Between 1990 and 2014, Chile recorded $16.0 billion of copper exports to the Netherlands, but these exports did not show up in the Netherlands' books;

* Between 1995 and 2014, Cote d'Ivoire recorded $17.2 billion of cocoa exports to the Netherlands, of which $5.0 billion (31.3%) did not show up in the Netherlands books; and

* Between 2000-2014, underinvoicing of South Africa's iron ore exports to China was worth $3 billion.

It is clear that export misinvoicing is an important channel of capital flight from these countries. At the product level, the puzzling case of gold exports from South Africa, where the country' official statistics report very little gold exports while substantial amounts appear in its leading trading partners' records, needs further investigations at both ends. It does not appear to be a simple matter of undervaluation of the quantities of gold exported, but rather a case of pure smuggling of gold out of the country.

Second, similar products show different misinvoicing patterns across exporting countries, even with the same partners. In Chile, there is systematic and massive export overinvoicing of copper, while that for Zambia show both underinvoicing and overinvoicing of copper exports. It would be worth investigating the sources of these differences, in particular, whether these disparities arise from differences in trade regulation regimes, tax regimes or capital control regimes between the two countries.

Puzzling results also emerge at the trading partner level. Trade with the Netherlands presents a peculiar case, with systematic and substantial export overinvoicing. It appears that primary commodities exported to the Netherlands never dock in the Netherlands. The question is whether this is the outcome of smuggling or incorrect reporting of the residence of the buyers. Answering this question may require an investigation at the company level.

The results provide strong reasons for investigating the motives of trade misinvoicing in primary commodities. Tax evasion is a possible motive for the large degree of export overinvoicing observed in most countries in the sample (except Chile). It is also possible that in some cases of export overinvoicing (as in trade with the Netherlands), products may end up in other destinations than the ones listed in official records, probably in tax havens for the purpose of tax evasion. Export overinvoicing could also be motivated by the attempt of exporters to take advantage of tax incentives aimed at promoting export-oriented activities. Tax evasion could be a motive for the observed substantial import smuggling, as in the case of oil in Nigeria, where oil seems to be entering the country illicitly. These conjectures need to be further investigated at country and product levels.

Foreign exchange and capital account controls could also be a motive for trade misinvoicing. However, the increasing volume of trade misinvoicing in recent years is puzzling, given the steady move towards capital account openness and liberalization of currency markets in all the countries in the sample, as in most developing countries. The question remains whether these reforms have been effectively implemented and enforced to reduce the incentives for smuggling of foreign currency.

The persistence of trade misinvoicing implies that there are important structural and institutional factors that drive this practice. It cannot simply be that illegal trade persists under the cover of legal trade; in some cases, trade misinvoicing constitutes too large a share of total trade to be disguised by legal trade. This is the case of gold exports from South Africa. The question is whether illegal gold trade is disguised behind legal trade of other products. Answering this question would require investigating whether gold exporters are also involved in exports of other major products so that gold smuggling takes place under the cover of legal trade in other products.

The results from this study highlight the need for an investigation into the role of TNCs involved in the exploitation, export and import of commodities, as well as the role of secrecy jurisdictions in facilitating trade misinvoicing. Such an investigation may shed light on the mechanisms of export overinvoicing and import smuggling. Enhanced transparency in global trade is indispensable, especially through coordinated enforcement of the rules on country-by-country reporting by TNCs at the global level. (* Chakravarthi Raghavan, Editor-emeritus, contributed this report) +