New GFI Report Shows Trade Misinvoicing a Major Problem for Developing Countries
March 4, 2020
A lack of trade integrity results in potentially massive revenue losses – all at a time when most countries are struggling to mobilize domestic resources for development
Global Financial Integrity (GFI) recently released its newest report, “Trade-Related Illicit Financial Flows in 135 Developing Countries: 2008-2017,” finding value gaps in reported international trade of a staggering $8.7 trillion over the ten-year period, 2008-2017, and a gap of $817.6 billion in 2017 alone. The report also found high incidences of trade misinvoicing as a percent of total trade, the highest of which being 46.8 percent of The Gambia’s total trade with all global partners.
Trade misinvoicing is a way of illicitly moving money (value) in or out of a country by hiding it within the regular international commercial trading system. This is done when importers or exporters deliberately falsify the price they declare for goods on the invoices they submit to customs authorities. For example, value can be illicitly moved out of countries by either over-stating the value of imports, or under-stating the value of exports. Conversely, value can be illicitly moved into countries by either over-stating the value of exports, or under-stating the value of imports. Given that only about 2 percent of all global cargo containers are ever physically inspected each year, trade misinvoicing is a well-established way of illicitly transferring value across borders.
Reasons to engage in trade misinvoicing are myriad, including the overriding imperative to move wealth into harder currencies (US dollars, British pounds, etc.), evade tax and/or customs duties, launder the proceeds of criminal activity, circumvent currency controls and shift profits offshore, among others.
GFI detects trade misinvoicing by identifying the “value gaps” or mismatches in reported international trade data. Each year, countries submit official trade reports to the United Nations, the International Monetary Fund and other international organizations documenting their imports and exports over the previous year. GFI analyzes such data to detect mismatches in reporting, which are then summed into value gaps.
For example, one could look at US imports of bananas from Ecuador in 2017: If Ecuador reported exporting $525 million in bananas to the US in 2017, but the US reported only importing $400 million in that year, the difference of $125 million would constitute a value gap, or mismatch, in the officially reported trade data. While there are some perfectly legitimate reasons for why there might be some small degree of mismatches in the official data, GFI believes the vast majority of identified value gaps are proxies for, or indicative of trade misinvoicing activity – meaning that parties in one or both of the countries had falsified the declared prices on their import or export invoices submitted to their customs authorities as a way of illicitly moving value across borders.
The key point for GFI is that some portion of that hidden $125 million could have ended up as additional trade tax revenues for these two governments, but since it was never properly reported, it was never properly taxed. This is GFI’s main concern about trade misinvoicing – the amount of trade taxes that are not being collected by governments, particularly the governments of developing countries which desperately need the revenue in order to finance development, poverty reduction and other critical social spending programs.
A 2018 World Bank report found that efforts to reduce extreme poverty globally have slowed in recent years, “raising concerns about achieving the goal of ending poverty by 2030 and pointing to the need for increased pro-poor investments.” A global turndown in poverty reduction significantly impacts the quality of life for people in countries around the world. Curbing trade misinvoicing could help governments capture more revenues, which could in turn be allocated to social spending programs, and thus improve the lives of their citizens.
Findings
The value gaps identified within the international trade data are examined in four ways: (1) in the bilateral trade between each of 135 developing countries and a set of 36 advanced economies; and (2) in the bilateral trade between each of 135 developing countries and all of their global trading partners. Data was examined over the ten-year period of 2008-2017 both (3) in terms of US dollar values and (4) as a percent of total bilateral trade.
The main findings, all in USD, include:
- The sum of the value gaps identified in trade between 135 developing countries and 36 advanced economies over the ten-year period 2008-2017 equaled $8.7 trillion;
- The sum of the value gaps identified in trade between 135 developing countries and 36 advanced economies in 2017 alone equaled $817.6 billion;
- The developing countries which registered the largest average value gaps in their bilateral trade with the 36 advanced economies over the ten-year period 2008-2017 included: China – with a value gap of $323.8 billion in its trade with the 36 countries; Mexico – $62.9 billion; and Russia – $56.8 billion.
- In terms of looking at the amounts of the value gaps as a percent of total bilateral trade with the 36 advanced economies over the ten-year period, the developing countries which registered the largest average value gaps included The Gambia – with a value gap of 37.3 percent of total bilateral trade; Togo – 30.2 percent; and The Maldives – 27.4 percent.
- The largest value gaps in terms of specific goods traded between the 135 developing countries and the 36 advanced economies over the ten-year period included Electrical Machinery (HS 85) – with a value gap of $7 billion; Mineral Fuels (HS 27) – $113.2 billion; and Machinery (HS 84) – $111.7 billion.
- When looking at the broader set of countries examined, that is, the bilateral trade between each of 135 developing countries and all of their global trading partners, the report finds the developing countries which registered the largest annual average value gaps over the ten-year period included The Gambia – with a value gap of 46.8 percent; The Seychelles – 38.3 percent; and Paraguay – 27.1 percent.
- Value gaps in trade between the five main developing country regions and the 36 advanced economies over the ten-year period found that the largest average sizes of the gaps identified over the 2008-2017 period included the trade between the 36 advanced economies and Asia – at $476.3 billion; Developing Europe – $167.9 billion; and the Western Hemisphere – $131.5 billion.
The Development Impact
Overall, the analysis shows trade misinvoicing is a persistent problem across developing countries, resulting in potentially massive revenue losses – at a time when most countries are struggling to mobilize domestic resources to achieve the internationally-agreed UN Sustainable Development Goals (SDGs). There are just ten years until the 2030 SDG deadline, and countries are facing an urgent lack of funding.
In September 2019, the UN acknowledged “an annual SDG financing gap of $2.5 trillion.” Concomitantly, GFI’s analysis identified total value gaps of nearly $1 trillion in annual global trade between developing and advanced economies. In effect then, by curbing trade-related illicit financial flows, countries could capture more revenue that could in turn be used to finance SDG spending and at the same time, they would also contribute towards achieving SDG16.4.1 – which seeks to curtail global illicit financial flows.
Indeed, a 2016 World Bank blog post acknowledged how integral trade is to achieving the SDGs, as “the movement of goods and services across borders, as well as flows of technology, ideas and people, all enable progress toward ending poverty, improving economic growth and job opportunities, and reducing global inequality.”
There are a host of policy prescriptions governments may implement to promote trade integrity and curtail trade-related illicit financial flows. In particular, GFI recommends governments:
- Make trade misinvoicing illegal where it is not already;
- Strengthen law enforcement capacities of customs authorities;
- Increase customs oversight of free trade zones;
- Establish National Trade Facilitation Committees in line with WTO protocols;
- Create multi-agency teams to address customs fraud, tax evasion and other financial crimes;
- Implement trade misinvoicing risk assessment tools (such as GFI’s GFTrade tool or other similar mechanisms designed to help customs officials check the prices of goods declared on invoices submitted by importers and exporters);
- Expand information-sharing between importing and exporting countries, etc.
Read the report here: “Trade-Related Illicit Financial Flows in 135 Developing Countries: 2008-2017.”