# **4.2 Factors affecting the components**

Consider first the discrepancy in the actual trade flow. Actual imports can differ from actual exports only if a shipment does not arrive (e.g., a ship is redirected during its voyage or its cargo is lost at sea) or if transport time causes a shipment to arrive in the importing country in the next calendar year. If a shipment does not arrive at all, then there is a one-time, negative discrepancy in the year the product was exported: reported imports are less than reported exports. If the shipment arrives but not until the next calendar year, then there is a negative discrepancy in the year the product was exported and a positive discrepancy the following year when the product is imported.

Regarding the second component of the discrepancy, measurement error, we have already mentioned two factors that tend to reduce its impact on the data we analyzed: the data cleaning process by EFI staff, and the exclusion of reported trade flows of less than 100 m<sup>3</sup> . But we do not expect these factors to completely eliminate measurement error. In section 5.1, we explain how we used the raw and cleaned data from EFI to develop a measure of potential measurement error. We also explain how we investigated misclassification of the species group of sawnwood (i.e., whether it is NC or C), which could reflect either measurement error or an intentional act by importers or exporters.

Finally, consider the third component, discrepancies due to unreported imports or exports. Isolating this component is the principal objective of our econometric analysis. Appendix 7 contains a technical description of our model of this component. We sketch only the main features here. The model is premised on the assumption that companies underreport the amount they import or export, whether by falsifying customs forms or by circumventing customs authorities altogether, when doing so enables them to evade some costly government regulation. Import tariffs, export taxes, and nontariff barriers are obvious examples. Companies that engage in illegal logging practices, such as harvesting prohibited species or exceeding annual allowable cuts, might also underreport exports to avoid detection.

Companies face a probability of being caught if they underreport the amount traded, and if they are caught they suffer a penalty (e.g., a fine). The probability of being caught is assumed to be higher if: (i) they underreport a greater amount, and (ii) the country they are exporting from or importing to has a higher quality of governance. Companies select the amount of underreporting that balances the expected reduction in regulatory costs (e.g., payments of import or export duties) if they are not caught against the penalty they must pay if they are caught. Assuming that duties are a principal regulation that companies seek to evade, the model implies that the discrepancy due to unreported imports and exports is a function of import and export prices, import and export duties, fines on unreported imports and exports, and quality of governance in exporting and importing countries.

# **4.3 Implications for observed discrepancies in Romania**

According to this model of intentional underreporting, a negative discrepancy implies that illegal activities are greater in the importing country (imports are underreported more than exports, hence the discrepancy is negative), while a positive discrepancy implies the opposite (exports are 11