GOVERNANCE EQU I TA BLE GROW T H, FI N A NCE & I NST I T U T IONS NOT ES Customs Reform in Developing Countries – Time for a Rethink? Yannis Arvanitis Gael Raballand © 2023 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202- 522- 2625; e-mail: pubrights@worldbank.org. >>> Contents Acknowledgements 4 1. Introduction 5 2. Defining the Key Issues Related to Customs Reforms 6 in Developing Countries 3. Lessons from Practitioners 10 4. Concluding remarks 13 >>> Acknowledgements The authors thank the participants of the World Bank Global Tax Program Webinar on Customs Administrations’ Role in State Building in FCSs for the discussion that stimulated the production of this note. The authors would also like to thank Aloke Dutt, Charles Kunaka, Tuan Minh Le, and Ceren Ozer for very useful comments and suggestions to the draft. Some of underlying support to customs reforms in Africa is sup- ported by the World Bank’s Global Tax Program. For questions, contact Gael Raballand, graballand@worldbank.org. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 4 1. >>> Introduction Customs have been at the core of development concerns, especially in developing countries. In this context, customs are developmentally important to the extent that they sit at the intersection between fiscal imperatives—due to their revenue collection potential and trade-related preroga- tives—and security implications. Security imperatives usually trump other considerations in con- flict-affected countries and introduce an additional layer of complexity to the reforms supported by the World Bank. Reforming customs is a complicated endeavor. In addition to the diverse areas covered, the closeness of customs to resources (whether linked to generated revenues or goods traded) makes customs prone to corrupt practices. These same resources are often tied to specific stakeholders, implying very often a rather complex political economy dimension. Large traders are usually politicians, parliamentarians, or other high-net-worth individuals with a degree of power to block reforms (Walther 2009 and Raballand and Knebelmann 2020). This note proposes some possible approaches to customs reforms in developing countries, low-income countries (LICs) in particular. It is intended to help practitioners within the World Bank and other development partners to better understand the key aspects and peculiarities of customs reforms, with the ultimate goal of supporting them in framing their design. However, it is not intended to be comprehensive. Rather, it serves as a “how-to” guide for those not particularly familiar with the topic. It also complements a growing stock of academic pieces linked to cus- toms,1 as well as findings from other operational evaluations (World Bank 2019). It also brings together practical experiences and feedback from practitioners. Ensuing complexities entail many pitfalls when considering customs reforms, including calls for guidance with the policy engagement framework. In addressing this need, the present note begins with a narrative to define the main stakes of customs reforms. As such, it questions some of the usual assumptions. The main lessons learned are then presented, drawing on dozens of real-word experiences and then offering some tips in the form of “dos and don’ts.” 1. For a comprehensive literature review focusing on the trade facilitation aspect of customs, see Go (2018). Other key papers are cited in the note with the intention of providing readers with a comprehensive stock of literature on the subject. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 5 2. >>> Defining the Key Issues Related to Customs Reforms in Developing Countries Tax and customs agencies in developing countries have the potential to contribute to a stronger fiscal position and increased revenue collection (or, conversely, present a downward risk to it). The literature shows that citizens consent to pay taxes in exchange for public goods (Brautigam, Fjeldstad, and Moore 2008; Tilly 2009), particularly as favorable views of current government performance are found to be positively correlated with more tax-compliant attitudes (Boly, Nan- delenga, and Oduor 2020; Isbell 2017). As such, taxation—including at the borders—constitutes a crucial part of the social contract between the citizens and the state (Prichard 2019). Consider- ing the large share of revenues collected by customs in developing countries,2 fairness as per- ceived by taxpayers is key. This is even more pressing to the extent that customs are effectively a key state actor, especially in remote areas. 2. Note that customs collect VAT in general and then assist tax authorities in effectively auditing refunds (notably for VAT, when relevant). The issue is even more pertinent in countries where tax and customs are integrated institutionally. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 6 The key role of customs in developing countries • Revenue collection. The revenue collection potential of customs is crucial, especially for LICs. In those coun- Customs administrations are typically assigned three key tries, customs collect from 30 to 60 percent of total tax roles in developing countries: revenues, which makes them a key source of domestic trade facilitation, revenue collection, and ensuring import se- revenue mobilization. curity at the borders.3 In some instances, these roles can be further expanded in fragile and conflict-affected countries, and • Import security. In numerous countries, customs are in this regard, trade facilitation and revenue collection may responsible for controlling the quality and standards of play a secondary role (Box 1). imports (for example, counterfeits, health/quarantine con- trols). There is also a dimension linked to supply chain • Trade facilitation. This is defined as policy measures that security based on a fear that the vulnerability of modern “aim to reduce the costs of border crossing trade outside supply chains can be misused (Grainger 2011). of traditional market access policy tools such as tariffs” (Go 2018). BOX 1: The Expanded Role of Customs in Fragile Situations In a review of the role of customs in (post-) conflict regions, Cantens and Raballand (2017) suggest that customs outposts can act as service providers and intelligence-gathering agencies. For instance, smuggling can be tolerated for reasons beyond corruption, which may include the avoidance of riots or creating social instability by applying the same tax burden to all. Such a facilitator or mediator role is crucial in remote and conflict-affected areas, not least because it keeps the state in the equation—thereby helping it to restore its authority over the longer term. Reform impetus On the revenue side, part of the impetus is found in the domestic revenue mobilization agenda, notably in Africa. This comes Over time, there have been different trends influencing amid growing concerns over the financing of social services customs’ reforms. The growing globalization of supply chains, in a post-pandemic and highly indebted area.6 In addition the geographic fragmentation of production, and just-in-time to decreasing revenue losses, the related transparency manufacturing4 have intensified trade patterns5 (Peterson imperative is of key importance for donors supporting reforms. 2017). As a corollary, the increased desire to further integrate Lastly, the continuous strengthening of international trade Africa into global value chains (AfDB 2017) provides grounds and customs frameworks/conventions provides a normative for customs reforms on the continent. Regional integration goalpost and incentives for administrative and process and the formation of customs unions are also exerting adaptations.7 pressures for reforms. To a large extent, these are linked to the trade facilitation role of customs, which is underpinned by competitiveness and growth concerns. 3. In numerous countries, customs serve as a driver and leader in whole-of-government approaches to border management. 4. Just-in-time manufacturing refers to production processes that minimize inventories or processing production times to meet on-the-spot demand. 5. For reference, intermediate goods, that is, goods used to produce a final product, tallied 51 percent of the world’s trade in 2021 (WTO 2022). 6. On average, revenues collected by customs are estimated to be on average 30 percent or more of total revenues (WCO data quoted in World Bank 2019). 7. Starting in 1974 with establishment of the International Convention on the Simplification and Harmonization of Customs Procedures (the Kyoto Convention), norms have been set for customs reforms. In 1999, revisions were made to cater to information technology (IT) advancements. In 2005, the Framework of Standards to Secure and Facilitate Trade (SAFE) was included, as well as some later revisions (2007 and 2017). EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 7 Sources of bottlenecks Reform channels Political interference is a key concern in customs, not least The expected impacts of customs reforms are measured in because it typically offers well-paying jobs, as well as rent- relation to the three abovementioned roles by indicators such seeking opportunities (Fjeldstad, Filho, and Raballand as an increase in revenues, decrease in clearance times, 2020). For instance, experience in Tunisia shows that tariff or seizures of smuggled goods or narcotics. However, the evasion was higher in firms linked to the Presidency (Rijkers, channels for such impacts are usually linked to organizational Baghdadi, and Raballand 2017). In Guinea-Bissau, most of and behavioral changes, which can take various forms, as the political establishment holds links to the cashew trading follows: businesses. In this context, cashews account for about 90 percent of total export revenues of the country. In addition • Improve the ethics and decrease collusion and corruption to political patronage, customs officials are also under the between customs brokers and some customs officials influence of family ties, kinship, and social relations. Social (Cantens and Raballand 2010; Faure-Grimaud, Laffont, redistribution imperatives come into play and are not easy to and Martimort 2003). debunk, sometimes due to cultural and social ties (Fjeldstad, Filho, and Raballand 2020). • Reduce the discretionary powers of customs officials9 (Raballand and others 2012). Another key issue in advancing customs reforms concerns the difficulty in implementing anti-corruption reforms. First, it is • Decrease the distrust between customs and private difficult to prove a lack of integrity, especially in environments operators by smoothing procedures and controls to a where data are missing and controls are lacking (Fjeldstad, degree.10 Filho, and Raballand 2020). Second, in settings where political appointments at the front line are numerous, the controls by • Improve cooperation with other bodies—for example, the heads of customs become more complex. Therefore, tax authorities or other controlling agencies at borders. improving the situation becomes even more complex (Cantens Cooperation and coordination failures between agencies and Raballand 2010). are key to understanding trade facilitation bottlenecks (Go 2018 Te Velde and Razzaque 2013). The multiplicity of actors involved in the face of complex laws and procedures adds a layer of complication. A key difference • Facilitate a regional approach to tackle national between customs and other revenue-raising agencies is bottlenecks.11 that relationships between officials and traders are usually managed through third parties (brokers). This in turn adds another layer of exposure for corruption, as well as a layer of stakeholders to manage during a reform process.8 Further, the spatial dispersion of customs officials across a territory renders controls and reform monitoring more difficult. This makes more complex the typical principal/agent approach, which is already challenged in countries plagued by widespread corruption (Persson, Rothstein, and Teorell 2013). 8. Cantens and others (2014) describe the role of brokers, especially informal brokers, including how they can contribute to blocking reforms in low governance countries. 9. This relates to the street-level bureaucrat concept in the extreme (Lipsky 1980). 10. A case in point concerns pre-shipment inspections, which are an example of measures underpinned by customs/private operators’ distrust. There are mixed reviews regarding the introduction of such schemes, as in the case of Argentina or Indonesia, where it led to increases in undervaluation practices (Anson and others 2006). 11. Such an approach has been widespread in Africa, usually with limited impact, mainly due to political economy factors. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 8 Reform entry points in practice improvements in customs performance—both in terms of revenue growth and clearance time reduction13 (Raballand Approaches taken to facilitate these changes can have an and others 2017). Indeed, this echoes earlier, similar results organizational or functional focus, meaning a different way to in Cameroon (Cantens, Raballand, and Bilangna 2010; WCO structure human resources. In many countries, customs are 2014). To a large extent, incentives play a complementary role an entity on their own, whereas in others, they are joined with to capacity building insofar as, without motivation, capacity tax officials or even the armed forces. Within customs, reforms building can yield limited results. Conversely, the contrary can focusing on organizational features typically delve into the happen, especially in places where motivations are misguided separation of roles and responsibilities between operations, toward corrupt practices to begin with, resulting in stakeholders the streamlining of decision-making, customer service who are incentivized to use official channels. orientation, and controls (Pérez Azcárraga and others 2022). Moreover, since the end goal of such reforms is a change Engagement with customs also often takes the shape of in behavior of customs officers and private companies, capacity-building activities—which are understood by the change management appears to be critical over the course World Customs Organization to mean the development or of the reforms. Resistance to reforms is usually common, acquisition of “skills, competencies, tools, processes and and therefore it needs to build on allies within and outside the resources”—in alignment with the key principles set forth institution and has to be gradual. in the Kyoto Protocol (WCO 2003), as well as with other international and regional standards. Beyond the normative The modernization of border operations is important, notably goalposts, capacity building is crucial to keep pace with the the use of information technology (IT) systems or new evolution of modern technology. Importantly, it also empowers expensive equipment. Indeed, it is often at the core of customs officials in interpreting regulatory frameworks (Widdowson reforms projects. There is evidence that the introduction of 2008). information and communication technology (ICT) systems, such as the Automated System for Customs Data (ASYCUDA), Recent work concerning incentives has shown positive has been accompanied by increased revenues (Cantens, results when they are included as part of customs reforms. Raballand, and Bilangna 2010), as well as by decreased trade In Madagascar, for instance, the introduction of individual costs (Moisé and Sorescu 2013). This effectively reduced the performance contracts12 for customs inspectors in the port amount of time spent at borders (Diagne 2010; Hillberry and of Toamasina, together with continuous data mining and Zhang 2015). monitoring (to detect corrupt practices), led to dramatic 12. The team aspect of incentives is also equally important and has been taken into account in those schemes as well, but it is more difficult to implement.. 13. This experiment suggests once more the absence of a tradeoff between the revenue-raising and trade facilitation roles of customs. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 9 3. >>> Lessons from Practitioners The previous sections provided a brief overview of customs reform issues highlighting the vari- ous types of reforms. The overall focus has usually been on transplanting reform schemes and approaches on investment in information technology from developed countries, with a focus on formal trade facilitation at the expense of understanding the revenue and sometimes the security imperatives of developing countries. This has been rather disappointing.14 Both the literature and experience within the World Bank Group highlight a series of lessons (sometimes well-known but usually forgotten) that can guide practitioners in approaching cus- toms reform issues in LICs. Those lessons, which also related to broader public sector reforms, can be grouped into two broad categories: (1) invest in knowledge upfront and relationships across the reform cycle, and (2) keep ambitions realistic when designing customs reforms. 14. According to Andrews, Pritchett, and Woolcock (2017), isomorphic mimicry is “the tendency of governments to mimic other governments’ successes, replicating process- es, systems, and even products of the ’best practice’ examples.” In essence, it refers to the confusion of form and function. International frameworks, such as the Kyoto Convention and SAFE, are important goalposts. However, they should not represent the desirable achievements per se. The capacity to deliver on these reforms, as well as the incentives to do so, must be gauged well in advance to avoid such a phenomenon. In the case of fragile and conflict-affected situations, the best achievable outcomes are not necessarily those linked to best practices or normative goalposts. Rather, they can be more subtly linked to other considerations (Box 1) (Cantens and Raballand 2017). EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 10 Lesson 1: Invest in knowledge upfront and ensure success. For instance, coordination with the police relationships across the reform cycle. and ministries of finance can be key to addressing illicit financial flow issues. The exchange of information with Investing in statistics is key to generating operationally relevant tax authorities is also very important.16 knowledge. For instance, it is key to conducting studies on trade facilitation and mirror statistics, as they will help to Thinking in bureaucratic silos must also be avoided. gauge issues and monitor progress. Relationships are an Infrastructure, competition policies, and other binding important element of trust between stakeholders in the reform constraints such as geography matter for customs reforms. process and practitioners, for whom this note is intended. To Trade and transport infrastructure largely determines flows the extent that external assistance is brought to help conduct and ease of trade, whereas geography can pose various reforms, this brings in practitioners as actors within the constraints. For instance, landlocked countries rely on road political economy of the reform process. Relationships help transportation, with the possibility of multiple checkpoints. in conveying messages, ensuring ownership, and ensuring a As for competition policy, it can equally affect the ways and costs better understanding of the overall context.15 of trading. First, global trade policies and geopolitical trends may affect World Trade Organization (WTO) approaches, With this approach in mind, it is important to study trade which can require adaptation from customs (Pérez Azcárraga bottlenecks and dynamics before engaging in a reform effort. and others 2022). Second, stances over a protective or loose Therefore, it will be important to focus on political economy competition policy will imply different customs postures vis-a- and coordination. vis their border security roles. • Political economy is at the core of customs reforms. Not thinking in a silo can also mean embedding customs Policymaking involves bargaining among various interest in the broader civil service reforms—especially if there is a groups. A key variable in this process is the relative broad political will. Such reforms in Rwanda and Georgia power of each group (or individual), which ultimately showed that the signaling from key leaders of a “new order” influences outcomes (World Bank 2017). To the extent mattered, and that it also created a sense of fairness across that large traders are usually politicians (or tied to the administrations. This can also allow for taking whole-of- political establishment), policies to alter the status quo in government approaches, with commitments from other bodies customs administrations require a thorough stakeholder to cooperate (Fjeldstad, Filho, and Raballand 2020). analysis and political economy review. In other words, an understanding of the prevailing logic is necessary Moreover, the introduction of any scheme under a reform before trying to address problems related to customs and program should consider the possibility of displacing the issue gauge the degree of political will for reforms. This requires it initially aimed at resolving. In attempts to tackle the lack of engaging with officials and representatives of the private trust between customs officials and private stakeholders, the sector, including brokers, importers, and exporters. introduction of pre-shipment inspections led to occurrences of crime displacement in Colombia and the Philippines. In other • Coordination and cooperation with other agencies is cases, it increased in undervaluation, such as in Argentina equally important. Indeed, this is part of the political and Indonesia (Go 2018). economy as well. Customs cannot operate on its own to 15. Relationship building usually requires an upfront investment in time and a physical presence to support a long-term reform program. 16. A case in point relates to oil-producing countries, where tax authorities have a hard time estimating deductibles by companies that tend to overinflate them to decrease their tax bills. Through interconnections and cross-checking with customs, tax administrations could share information concerning the costs of importing inputs, tools, and materials intended for oil operations. From an institutional effectiveness perspective, the effectiveness of controls and the degree of information asymmetry between countries and oil companies are largely related to the ability to coordinate and exchange information between taxes and customs authorities (Arvanitis and Coulibaly 2022). Such cooperation is also key to checking oil exports for royalty and taxation purposes. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 11 Lesson 2: Keep ambitions realistic when organizational processes can be co-opted by vested interests designing reforms. (Chalendard and others 2023), thus leading to new forms of corruption, as well as limited effects on petty corruption (Addo Practitioners must carefully think about the mix of reform and Avgerou, forthcoming). Ultimately, capacity and incentives entry points (see section on the lesson 1) between IT and are the two core parameters to take into consideration before functional/HR issues on the one hand and accountability on engaging with new ICT. the other. Organization- and IT-related activities tend to be favored (Barbone and others 1999), as donors generally face A similar argument applies for new equipment. Buying a stronger opposition for anti-corruption measures (Cantens scanner will not necessarily be a solution when the problem and Raballand 2010). Another explanation can lie in the fact concerns valuation more than smuggling. This is not to say that IT and equipment tend to lead to higher disbursement that they are not useful; however, they must be prioritized rates than softer components of projects, thereby resulting in after careful consideration. Also, general modernization and an implicit bias toward hardware. automation require both skills and workers, as well as— sometimes—new legislation. This implies more costs, which It is rather easy to fall into the trap of unwarranted should be accounted for in projects and reform programs (Go modernization and equipment. Countries often seek systems 2018). upgrades, for example, from Sydonia++ to Sydonia World. Advances seen in neighboring places and “computerization It is also important to consider that trade facilitation and often become an end instead of a tool in many tax [and revenue generation in low-income countries are not mutually customs] administrations” (Barbone and others 1999, quoted exclusive. Thus, there is no tradeoff between collecting in Cantens and Raballand 2010). The first question to ask revenues and trade facilitation, as shown on all occasions of is whether the current system is used effectively, and, if not, customs reforms in Africa (Raballand and others 2009).17 why not. In Cameroon’s experience, for instance, automation- As the cases of Cameroon and Madagascar have shown, related gains could not be sustained as stakeholders learned the introduction of carefully crafted financial incentives the system’s loopholes (Cantens, Raballand, and Bilangna yielded positive results.18 However, their mere introduction is 2010). A similar experience is drawn from Ghanaian Customs, insufficient; they need to be accompanied by a series of key where IT configurations in the early stages and related activities for monitoring and adjusting along the way. 17. On a lighter note, this is exemplified by Adam Smith, the father of free trade, during his tenure as a customs comptroller for 12 years. Anderson, Shughart, and Tollison (1985) argue that this does not contradict his precepts for the free flow of goods. Rather, it pragmatically exemplifies the importance of trade facilitation and revenue collection in accordance with his fourth canon of taxation—that is, the minimization of private and public costs of taxation. 18. Combining financial and non-financial and individual and team-based. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 12 4. >>> Concluding remarks Reforms are a complex endeavor, and customs reforms particularly so. This is due to the density of vested interests that they embody. To a large extent, reforming customs is more of an art than a science, not least because it is as much about behavior as about capacity or organization. This note highlights a series of lessons intended to help practitioners frame their approaches and maximize benefits. It also aims to prevent the World Bank and other development partners from undertaking sometimes flawed operations with counterproductive outcomes. Finally, at the time when tax fairness and fiscal contracts19 are now more often discussed in developing countries, customs modernization reforms can also contribute towards a fairer and better tax system by increasing effective taxation towards high-price consumer goods and less on basic food products. 19. Fiscal contracts are based on an exchange of revenues for service delivery. 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Adobe Stock. https://stock.adobe.com/pt/images/smart-technology-logistics-concept-businessman-touching-virtual-screen-world- map-of-global-logistics-network-distribution-air-cargo-trucking-rail-transportation-online-goods-orders-worldwide/568667082 World Bank Photo Collection: Blaise Diagne international airport. https://www.flickr.com/photos/worldbank/52152032869/ World Bank Photo Collection: Customs controls on the border of Armenia. https://www.flickr.com/photos/worldbank/7468959146/ Adobe Stock. https://stock.adobe.com/pt/images/container-ship-in-import-export-and-business-logistics-by-crane-trade-port-ship- ping-cargo-to-harbor-aerial-view-from-drone-international-transportation-business-logistics-concept/239772735 Adobe Stock. https://stock.adobe.com/pt/images/working-women-happy-staff-worker-enjoy-work-checking-container-for-delivery-in- logistic-industry/483256456 Adobe Stock. https://stock.adobe.com/pt/search?k=customs%20control%20zone&search_type=default-asset-click&asset_ id=181322923 EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 16