NOTE NUMBER 347 97220 viewpoint PUBLIC POLICY FOR THE PRIVATE SECTOR JUNE 2015 Risk Management in Customs Ana M. Fernandes, Benefits of Customs Reform: The Evidence from Albania T r a d e a n d C o m p e t i t i v e n e s s G l o b a l P r a ct i c e Russell Hillberry, and Alejandra Mendoza Research into th e e c o no m ic im p a c t o f a c us t o m s r e f o r m in A l b a n i a Alcántara shows the p romis e o f t he b r o a d e r t r a d e f a c ilit a t io n r e f o r m e f f o r t s This note is the result of that are gaining m o m e nt um in d e v e lo p ing c o unt r ie s wo r ld wi d e . T h e collaboration between the research summa r iz e d in t his no t e f ind s t ha t s ig nif ic a nt ly r e d u c e d World Bank Group’s Trade and Competitiveness Global rates of p hysica l ins p e c t io n o f im p o r t s hip m e nt s in Alb a nia r e d u c e d Practice and the World the le ngth and v a r ia b ilit y o f c us t o m s c le a r a nc e t im e s a nd in c r e a s e d Bank Research Group. Ana M. Fernandes and imp ort f lows. M o r e o v e r , t he r e f o r m s ind uc e d c ha ng e s in t he Russell Hillberry are senior comp osition of t r a d e a nd f a v o r e d im p o r t s f r o m p r e f e r e nt ia l t r a d i n g economists, and Alejandra Mendoza Alcántara is a p artne rs in the Eur o p e a n U nio n. consultant, all with the Evaluating trade facilitation reform management reforms in customs and other tech- World Bank Group. Developed country governments and interna- nical agencies in the Western Balkans in conjunc- Research underlying this tional aid agencies have devoted substantial tion with the South East Europe Trade Logistics note has been supported by resources to supporting trade facilitation reform Project. This note summarizes the findings of the governments of Canada, in developing countries.1 From 2006 to 2011, the two-year study, “Trade Effects of Customs Norway, Sweden, the United for example, governments and donors disbursed Reform, Evidence from Albania,” which com- Kingdom, and the United over $1.2 billion in official development assis- bined field research with the use of administra- States through the Impact tance to support trade facilitation efforts (WTO tive customs data (Fernandes, Hillberry, and Program of the World Bank 2013). Substantial additional commitments have Alcántara 2015). THE WORLD BANK GROUP Group’s Trade and been made since 2013 when the World Trade In recent years, the Albanian customs author- Competitiveness Global Organization’s Trade Facilitation Agreement ity has employed risk management systems to Practice, the Multi-Donor was signed in Bali. Despite these sizable expen- dramatically reduce the number of physical Trust Fund for Trade and ditures, there is very little hard evidence about inspections it conducts. Risk management Development, and the the impacts of specific trade facilitation reforms. combines information technology with statis- Strategic Research The World Bank Group has begun to con- tical targeting procedures to sharply reduce Partnership on Economic duct evaluations of trade facilitation reforms. the frequency with which goods are physically Development. The Investment Climate Impact Program and inspected. Reduced numbers of inspections lower the Trade and International Integration Unit of the time that a typical shipment spends under the Development Research Group (both World the control of border agencies. The research in Bank Group organizations) are evaluating risk the World Bank study is the first to evaluate the R i s k M anagement A ttract an a g eFm i ng DeI nHtow usD i nM uCch tooem tom s sI n Bvee n se tf m it C lC e sn t o f imus at o emM s aR tt eo ef rr ? m: The Evidence from Alb baania trade impacts of sizable changes in inspection country, the inspection type (a simple check of probabilities by a customs agency (Fernandes, documents or a physical inspection), the date Hillberry, and Alcántara 2015). It thus provides of the submission of administrative documents, a case study for understanding the link between the date of the release of goods from customs, reduced inspections and increased trade. The import value and weight, and penalties paid for Albanian experience can provide insights as to customs infractions. The study used the data to how the broader Trade Facilitation Agreement investigate year-to-year changes in the probability reform efforts may fare. of physical inspection, time spent in customs, and the value and composition of imports. 2 Fewer inspections reduce clearance times The methodology used for the analysis Albania is pursuing membership in the European was developed by economists Christian Volpe Union (EU) and has undertaken substantial Martincus and Alejandro Graziano of the Inter- reforms in many areas of policy to satisfy impor- American Development Bank, and Jerónimo tant preconditions for entry. Because the EU Carballo of the University of Maryland and allows free movement of goods among member described in a forthcoming article (Martincus, states, one of the preconditions for Albanian Carballo, and Graziano 2015). The methodol- membership is substantial improvement in ogy allows the effects of reduced inspections Albania’s ability to manage the flow of imported on customs clearance time to be isolated from goods. A central component of the reform efforts other effects on clearance time and trade pat- in pursuit of this goal has been the adoption of terns, such as shipment characteristics used by modern risk management systems in customs. the risk management system, demand shocks, With EU technical and financial assistance and or changes in tariffs.3 This isolation allowed the oversight,2 Albania has rapidly improved its risk analysis to estimate causal impacts of reduced management capabilities, leading to a sharp clearance times on import levels and on the com- decline in the number of inspections conducted position of imports. by Albanian customs. From 2007 to 2012, the period covered Reduced delays mean increased trade by the World Bank Group study, the share of The key message is that Albania customs reform Albania’s import consignments that were physi- had statistically significant short-term positive cally inspected fell sharply, from 43 percent to effects on imports. The inferred cost savings to 12 percent. The average time spent in customs the private sector were modest but real. also declined, and the value of imports increased. ■■ The median number of days a shipment was The operational methods employed in risk man- expected to spend in Albanian customs fell agement—especially the practice of conducting by 7 percent when the probability it would be many physical inspections at random—offer an inspected dropped below 50 percent. This was opportunity to establish causal links among the case for about 21 percent of the shipments changes in inspection regimes, in customs clear- in the sample during the period 2007 to 2012. ance time, and in import outcomes. ■■ A 7-percent reduction in median days in cus- toms generated a 7-percent increase in the Drawing meaning from the data value of annual imports by a particular firm of The objective of the study was to evaluate the a particular product from a particular source impacts of the substantial reduction in physical country. This estimate of the causal relation- inspections by the Albanian customs authori- ship between time in customs and imports ties on time spent in customs and on import gives a sense of the order of magnitude that activity. The Albanian customs agency provided can be attributed to this type of reform even administrative data tracking individual import though the ratio would not always be one-to- transactions for the period of the study. This one as it was here. highly disaggregated data included a numeric ■■ The reduction of inspections had an impact identifier for each importing firm, a “harmonized on import value that was roughly equivalent to system” eight-digit product code, the exporting an across-the-board tariff reduction of approx- imately 0.36 percentage points, the study esti- a customs agency. Evidence on the effects of risk mates. The implied cost savings, however, are management in border inspections is valuable much larger than for a tariff cut of that size. because many developing countries are plan- The estimate suggests that the reforms saved ning to implement risk management reforms as the private sector approximately $12 million one of their commitments under the 2013 Bali in 2012 in reduced trade costs. Agreement. The study’s estimate that the increase ■■ The decline in customs clearance time related in imports due to the reform is roughly equivalent to improved inspections practices led to stron- to the effect of a 0.36 percentage-point tariff cut ger growth in imports from high-income coun- provides a useful way to compare risk manage- 3 tries and from preferential trading partners, ment reforms and other trade policy changes. especially EU members, primarily because The Bank Group study estimated that the imports from the EU were more sensitive to reform saved the Albanian private sector approxi- time savings than imports from other high- mately $12 million in 2012, or about $4.33 per income countries.4 Albanian citizen. Annual savings of roughly ■■ Separate results for 2007–09 and 2010–12 indi- that magnitude should be expected going for- cate that the sensitivity of customs clearance ward if risk management continues to operate time to inspections falls over time, while sen- smoothly. These estimates represent the benefits sitivity of imports to customs clearance time of the reform. A full cost-benefit analysis would rises. The first finding suggests that as reforms weigh these against the costs of implementa- proceeded, the time required to process goods tion. In many developing countries—including subject to random inspection fell. The second Albania—the budgetary costs of reform are par- finding may indicate that firms rearranged tially offset by international aid flows. their supply chains in a manner that made The Albanian customs agency was able to their imports more time-sensitive, as the firms sharply reduce its inspection rate in a short period came to understand that the probability of of time. While several factors likely contributed to a delay in customs had fallen substantially.5 this success, low (and falling) Albanian tariffs may ■■ The reforms increased the quantity of imports have been a particularly important factor. Low and average unit prices, as well as the number tariffs reduce the incentive for tariff evasion and of shipments per year. The increase in aver- the harm to the government of successful evasion. age unit prices likely reflects increases in the One lesson for other governments considering quality of goods imported into Albania. this reform is that risk management in customs ■■ There is evidence of reform-induced growth will likely be more successful when preceded by along extensive margins of trade, defined as tariff reductions. A study of similar risk manage- the number of importing firms (per product- ment reforms in a high-tariff environment would country pair) and the number of source coun- be useful to further assess the importance of low tries (per firm-product pair). tariffs for success. ■■ Lower inspection rates reduced the variabil- Finally, in Albania and elsewhere, other agen- ity of time spent in customs (not only the cies also inspect imports, including agencies expected amount of time spent in customs), that certify compliance with food safety, animal which in turn led to significant import growth. health, and environmental protection standards. Declines in inspections apparently reduced Relative to the customs agency, these technical uncertainty about the time spent in customs, agencies oversee trade in fewer products, but they and this had a beneficial impact on imports. have very different enforcement objectives and ■■ There is little evidence to suggest that the inspect at much higher rates. In many develop- reforms had differential impacts on imports of ing countries, the adoption of risk management time-sensitive goods or on differently sized firms. systems by these and other technical agencies that operate at national borders has not yet been Conclusion fully implemented. While the estimates in the This study is the first to evaluate the trade impacts study offer some insights into the likely trade of sizable changes in inspection probabilities by effects of risk management reforms in technical R i s k M anagement i n C u s tom s B e n e f i t s o f C u s t o m s R e f o r m : T h e E v i d e n c e f r o m A l b a n i a imports from the EU responded more to a given reduc- agencies, the reforms to Albanian customs that tion in clearance times than imports from other high- drove the variation used in the study’s analysis income countries (that is, they had a higher elasticity to are similar in nature only to that which would be changes in inspection time). required of a country that was newly integrating 5. For example, the adoption of just-in-time (JIT) inven- risk management into its customs agency—not its technical agencies. Therefore the context is tory methods would likely make imports more sensitive viewpoint to time delays. It is likely that such methods are not sufficiently different to warrant additional studies feasible when inspection levels are high, but firms may that focus specifically on the effects of reform in have introduced them as inspection levels fell. Adop- is an open forum to technical agencies. tion of JIT would be consistent with the estimates in the encourage dissemination of Bank Group study, but the study did not develop any public policy innovations direct evidence on the adoption of particular methods for private sector–led and of supply chain management. market-based solutions for Notes development. The views 1. Trade facilitation refers broadly to the infrastructure, published are those of the institutions, regulations, policies, procedures, and References authors and should not be services that allow firms to conduct international trade For a full list of references and further reading, see attributed to the World transactions in either goods or services on time and at Fernandes, Hillberry, and Alcántara 2015. Bank or any other affiliated low cost. organizations. Nor do any 2. Other international organizations, including the Fernandes, Ana, Russell Hillberry, and Alejandra of the conclusions represent World Bank Group, also provided technical and finan- Mendoza Alcántara. 2015. “Trade Effects of Customs official policy of the World cial support for the reforms. Reform: Evidence from Albania.” Policy Research Bank or of its Executive 3. The specific econometric methodology used is a Working Paper 7210, World Bank, Washington, DC. Directors or the countries two-stage least squares instrumental variables estimation Martincus, Christian, Jerónimo Carballo, and Alejandro they represent. model that includes fixed effects for importing firms, Graziano. 2015. Forthcoming. “Customs.” Journal of products, and countries to control for nonrandom International Economics. To order additional copies sources of variation in inspection activity and for other WTO (World Trade Organization). 2013. Fourth Global contact Jenny Datoo, factors that might have affected Albanian imports dur- Review of Aid for Trade 2013: Connecting to Value managing editor, ing the reform episode. Chains. Geneva: World Trade Organization. Room F 5P-504, The World Bank, 4. It does not appear that the reduction in inspection 1818 H Street, NW, probabilities or the amount of time spent in customs Washington, DC 20433. was larger for imports from the EU than imports from other high-income countries. Rather, it seems that Telephone: 001 202 473 6649 Email: jdatoo@worldbank.org Produced by Carol Siegel Printed on recycled paper This Note is available online: http://www.worldbank.org/fpd/publicpolicyjournal