# **3.3. Behind-the-Border Issues and Other Sources of Costs**

# **_Corruption, Governance, Transparency, and the Business Environment_**

Recent research has focused on the channels through which institutions impact trade. Anderson and Marcouiller (2002) find that weak institutions act as significant barriers to international trade. Trade transactions are inherently risky due to, for example, imperfect contract enforceability that goes along with weak institutional regimes. The authors use World Economic Forum data to construct an index of the strength of institutions that support trade, focusing on contract enforcement and the existence of impartial and transparent government policies.

Weak institutions are evident in widespread corruption at various points in the supply chain. The empirical evidence supports the view that trade costs are an important determinant of extortion and evasion behaviors. Gatti (2004) uses data on corruption and trade policy to show that higher trade costs—in this case, tariff rates—are indeed associated with a higher level of corruption. Focusing on the evasion mechanism, Fisman and Wei (2004) measure the difference between declared export and import values in bilateral trade between Hong Kong and the Chinese mainland. They find that higher tariff rates are associated with larger differences in declared values, which is highly suggestive of an important evasion effect.

A recent working paper by Dutt and Traca (2007) provides preliminary evidence on the importance of extortion and evasion in regard to the impact on bilateral trade flows. Using a gravity model, they show that the trade inhibiting effect of corruption depends on the level of trade costs. The authors show that the extortion effect dominates when tariffs are low, but becomes less important as they increase. Moreover, the data also appear to support the proposition that the trade impeding effects of tariffs are lower in more corrupt countries. This finding is consistent with the existence of an evasion mechanism. As tariff rates increase, firms in corrupt countries can limit their impact by making side payments to customs officials.

Francois and Manchin (2007) measure institutional quality through the lens of economic freedom, focusing on aspects such as the size of government, freedom of trade, the protection of property rights, and business regulation. They find that strong institutions are associated with increased trade at both the intensive and extensive margins.

Helble, Shepherd, and Wilson (2007) conduct empirical investigations of the role of transparency in trade, focusing on the Asia-Pacific region. They use a combination of “objective” and perception-based indicators to produce composite measures of importer and exporter transparency. Their measures cover two fundamental dimensions of transparency: predictability and simplification. To capture the former, they consider data such as administrative favoritism, dispersion of tariff rates, extent of tariff bindings, and uncertainty surrounding import times. Simplification of a country’s trade regime is analyzed using variables including the time taken to import, the number of agencies an importer must deal with, the extent of trade barriers other than published tariffs, and the prevalence of trade-related corruption. Transparency, particularly as it relates to the import regime, can be a significant factor in promoting bilateral trade. Helble et al. (2007) find that improving import transparency in Asia-Pacific Economic Cooperation 18