Eastern Europe is a suitable environment for this study for three reasons. First, the weakness of its institutions, including the customs service, makes it prone to tariff evasion. For instance, in a 1999 survey 51% of firms in Romania, 45% in Lithuania and 44% in Ukraine believed that there was a need to make “additional payments” when dealing with customs.<sup>4</sup> Second, trade liberalization taking place during the period under study gives us a significant variation in tariff rates across time and across products. As illustrated in Table A1 in Appendix I, during the period under study the average tariff rate in Poland declined from 11.8% to 1.9%. The corresponding figures for Hungary were 12.9% and 5.6%, while for Russia the change was from 12.1% to 10.4%. Third, as all but two of the countries in the sample were preparing for their accession to the European Union during the time under study, the changes in their tariff rates were determined by the pre-accession agreements (European Agreements) and thus are not subject to endogeneity problems.

Taking Fisman and Wei’s work as our starting point, we analyze the sensitivity of tariff evasion to tariff rates and identify the type of products which are subject to greater evasion. We use data on ten Eastern European countries over the time period 1992-2003. We measure the trade gap as the difference between the value of exports from Germany to each country in the sample as reported by Germany and the value of imports from Germany as reported by each importing country. Considering the same trading partner for all importers in the sample ensures that the export data are measured consistently. We choose to focus on German exports, as Germany was a major trading partner of all countries in the sample accounting for 31% of total imports in the Czech Republic, a quarter of imports in both Hungary and Poland and 19% in Slovenia. The lowest share of German imports was registered in Ukraine where they accounted for only 9% of the total (see Table A2 in Appendix I). The trade figures come from the United Nations’ COMTRADE database and are available at the product level (6-digit category in the Harmonized System (HS) classification HS1988/92). Depending on the country, our data set includes information on between 1,433 and 2,785 products for years between 1992 and 2003. The tariff data, applied by each importing country to imports from Germany, measured also at the 6-digit HS level, have been obtained from the UNCTAD’s TRAINS database.

We find a positive and significant relationship between the tariff level and the trade gap. This relationship holds for 8 out of 10 countries as well as for the pooled sample. It is robust to including 6- digit product dummies and country-year fixed effects. The responsiveness of the trade gap to the tariff level is found to be the highest for Ukraine and the Russian Federation, both of which appear to have a

> 4 The data come from the Business Environment and Enterprise Performance Survey (BEEPS), conducted jointly by the World Bank and the European Bank for Reconstruction and Development. The statistics pertain to the percentage of firms which answered “always,” “mostly,” “frequently,” “sometimes” or “seldom” to the question “How frequently do firms in your line of business have to pay some irregular "additional payments" to deal with customs and imports?”

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