corruption and evasion, we need to know what sort of factors contribute to those conditions discussed above being present or not. Of the four suggestions, it’s undoubtedly the first, successfully implementing ex-post reconciliation, which is the most difficult to ensure and the most important for success. It has been suggested by Mark Dutz in a recent note on PSI, that there is a broad consensus that unless governments consistently use ex-post reconciliation and act on the information it generates, there is little hope for PSI to be useful in combating corruption and evasion.<sup>14</sup> However, the fundamental question is, not whether or not ex-post reconciliation is important. It obviously is. Rather, what reformers need to know is how does one ensure that an expost reconciliation is carried out? Previous authors, such as Low, have implied that simply introducing a PSI contract may serve to eliminate the information asymmetries between the government and customs.<sup>15</sup> Simply altering the formal rules of the game by requiring PSI and ex-post reconciliation may work in a situation in which third-party enforcement of contracts is reliable. However, it is a well known fact that many developing country Customs Agencies are highly independent of other braches of government, making it extremely difficult for the Ministry of Finance to “require” anything. What we need to ask is, how should the government go about ensuring that PSI will work given that they cannot simply force Customs to comply with a PSI contract and given the existing institutional framework (or, alternatively, should a PSI contract be used at all). Simply introducing a PSI contract into a situation will often do nothing if the incentives of Customs Agents do not align with those of the Ministry of Finance. Unless incentives are credibly changed so that parties to a PSI contract benefit by those actions which support ex-post reconciliation, either it won’t take place, or, it will be prohibitively costly to enforce.

Thus, there are two basic conclusions from the literature on PSI which must be addressed. The first is that PSI should be used in countries with weak institutions, and the second is that in order for PSI to work there must be a successful ex-post reconciliation. Whether or not these two requirements are compatible is an open issue. In the next section, I develop a model to investigate under what institutional conditions successful ex-post reconciliation will be possible.

# **Section 2:  The Model**

We can model the PSI relationship using the tools of the New Institutional Economics.<sup>16</sup> We define Institutions to be the formal and informal rules of the game along with their enforcement characteristics. Thus, requiring Customs Agents to engage in ex-post reconciliation in a PSI contract is an example of a formal rule. Likewise, the levels of punishments and rewards associated with corruption, evasion, or, honesty are

> 14 Mark Dutz, “Observations on the Use and Usefulness of Pre-Shipment Inspection (PSI) Services.”

> 15 Low, xvii.

> 16 The following is based on Douglass North. Institutions, Institutional Change, and Economic Performance, (Cambridge, CUP:  1990).

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