Widespread misinvoicing in South’s commodity exports

A study released at UNCTAD 14 on misinvoicing of commodity exports suggests that this practice constitutes a major channel of capital flight that is depriving developing countries of much-needed development resources.

by Chakravarthi Raghavan

GENEVA: Trade misinvoicing in the exports of developing countries, especially those heavily dependent on exporting a few primary commodities, appears to be widespread, 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 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”, was written by Professor Leonce Ndikumana of the University of Massachusetts, Amherst, and was released at UNCTAD’s Global Commodities Forum held on 15-16 July as part of UNCTAD 14.

“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% 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,” Kituyi said.

Implications

The results from the study have important implications for research and policy, the paper 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 the 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 the United Nations Commodity Trade Statistics (UN Comtrade) and the IMF’s Direction of Trade Statistics (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 [transnational corporations] 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.”

Subject of interest

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, Cote 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 IMF’s DOTS, which provides 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. The 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. Analysis at the product and partner levels is made possible by the existence of disaggregated data published in the 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 examined in the UNCTAD study 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 the study, Chile, Cote 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 the study on trade misinvoicing in primary commodities.

Findings of the study

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’s 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 the Netherlands. In contrast, the 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:

l     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).

l     Between 1996 and 2014, underinvoicing of oil exports from Nigeria to the US was worth $69.8 billion, or 24.9% of all oil exports to the US.

l     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.

l     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.

l     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.

l     Between 2000 and 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’s 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 data 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, the study says, 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. (SUNS8286)                

Third World Economics, Issue No. 621/622, 16 July – 15 August 2016, pp13-15