The World BankMAY

2001

PR 72NUMBER 53

ECONOMIC POLICY

Increasing the effectiveness ofpreshipment inspection servicesPreshipment inspection services can improve customs administration, butthey are no substitute for comprehensive reform.

Preshipment inspection refers to the ver- effectiveness of preshipment inspection ser-

ification of unit prices as well as the exam- vices; for a comprehensive assessment of

ination and reporting of the quantity and preshipment inspection issues through

quality of exports before they are shipped 1994, see Low (1995). Preshipmentto the importing country. Preshipment

inspection can help control overinvoicing Use of PreShipment inspection inspection offersor underinvoicing of imports, misclassifi- servicescation of imports, undercollection of taxes The 1993 ratification of the World Trade benefits for customson imports, and misappropriation of Organization'sAgreementonPreshipment

donor funds provided for import support. Inspection gave preshipment inspectors authorities inOther possible benefits of preshipment newlegitimacy in international trade. Since

inspection include monitoring of origin then the number of countries using pre- importing countriesand of compliance with national regula- shipment inspection has increased from 27tions and tariff exemption schemes, bet- to 37, with Africa having the most active

ter data management, technical assistance programs (table 1).

and training, trade facilitation, and con- Perhaps the most striking change in

sumer protection. recent years has been the increase in

Preshipment inspection services can pro- the number of split contracts. While in 1993

vide information that is not readily available Peru was the only Latin American country

to customs authorities in small countries. allowing importers to choose the company

Such services are provided by private com- they wish to employ from a pre-approved

panies in the exporting country. Thus pre- list, in 1999 all Latin American user coun-

shipment inspection can be thought of as a tries had adapted this approach. This change

temporary quasi-privatization or contract- has allowed more providers to participate.

ing out of selected customs functions to Iran's program involves 16 providers of

meet specific objectives. inspection services.

Of the various objectives for customs The shift in preshipment inspection work

reform, trade facilitation is arguably the away from capital flight and overinvoicing

most important for efficiency and growth. toward customs and underinvoicing is

Because of the potential long-term gains reflected in recent contracts. In 1993 all

from reform, governments should focus on active contracts embodied at least a small

implementing an effective program for amount of capital flight work, but today

customs modernization and institutional most contracts focus exclusively on customs

reform, and not view preshipment inspec- work to minimize opportunities for tax eva-

tion services as a substitute for this effort. sion-reflecting today's more liberalizedThis note reviews recent evidence on the capital regimes.

FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK

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TABLE I ACTIVE PRESHIPMENT INSPECTION CONTRACTS, JUNE 1999 weaknesses in customs administration.

Region/country Type of contract Type of competition Wherever feasible, a preferred approachAfficawould combine a relatively open capital

AfricaAngola Customs/foreign exchange Monopoly account (reducing incentives for overin-Benin Customs/foreign exchange Monopoly voicing as a capital flight mechanism), tradeBurkina Faso Customs Monopoly liberalization (reducing incentives forBurundi Foreign exchange Monopoly underinvoicing as a tax evasion mecha-Cameroon Customs Monopoly nism), and local institution building aimedCentral African Rep. Customs Monopoly at improving all customs functions.Comoros Customs/foreign exchange MonopolyC6te d'Ivoire Customs MonopolyCongo, Dem. Rep. Customs Monopoly tution building and structural revenueGhana Customs/foreign exchange Geographic segmentation (4) changes take time. Shorter-term revenueGuinea Customs Monopoly requirements are often pressing in countriesKenya Customs Geographic segmentation (3) that rely on trade taxes as an importantLiberia Customs MonopolyMadagascar Customs/foreign exchange MonopolyMalawi Customs Monopoly views on the effectiveness of preshipmentMali Customs/foreign exchange Monopoly inspection reflect different policy prioritiesMauritania Customs Monopoly as well as a lack of clear empirical evidenceMozambique Customs/foreign exchange Monopoly on impact. Consider the three main func-Niger Customs/foreign exchange Monopoly tions of preshipment inspection.Rwanda Customs MonopolySenegal Customs MonopolySierra Leone Customs Monopoly Disbursement veriicationTanzania/Zanzibara Customs/foreign exchange Monopoly Low (1995) finds that the World Bank's pol-Togo Customs/foreign exchange Monopoly icy of encouraging governments to use pre-Uganda Customs Monopoly shipment inspection-and sometimes

Latin America requiring it as a loan condition-has beenArgentina Customs Importers' choice (6) driven by concerns about the use of donorBolivia Customs Importers' choice (2) funds. This rationale is in line with basicColombia Customs Importers' choice (3)Ecuador Customs Importers' choice (4)Mexico Customs Importers' choice (3) documentation for investment operations.

Paraguay Customs Importers' choice (2) In addition, the desire to ensure the effi-Peru Customs Importers' choice (3) cient use of funds through a trade verifica-

East Asia tion procedure is relevant for loans with

Cambodia Customs Monopoly disbursements that are linked not to thePhilippines Customs Monopoly inputs needed to implement specific invest-

South Asia ments, but rather to balance of paymentsBangladesh Customs Geographic segmentation (3) support through procurement of general

Middle East and North Africa imports. In such cases there is a need to ver-

Iran Quality/quantity Importers' choice (16) ify that prohibited goods are not procured

Europe and Central Asia or that agreed goods are procured. WhereUzbekistan Foreign exchange Monopoly governments have poor statistical capac-

Note: A foreign exchange contract is designed to monitor capital flight. Numbers in parentheses are the ity, preshipment inspection can provide use-

number of service providers, ful evidence. But no study exists on thea. Tanzania and Zanzibar have separate preshipment inspection programs. Tanzania has an exclusive benefits and costs of alternative forms ofcontract with Cotecna covering customs, while Zanzibar has one with SGS covering foreign exchange. disbursement verification.Source: Preshipment inspection companies.

Revenue collectionUsefulness of prshipment Probably the most important reason that gov-inspection services ernments seek preshipment inspection srIn general, preshipment inspection is a sec- vices is to deal with inefficient or corrupt

ond-best policy for countries with serious customs administrations. Such administra-

PREMNOTE 53 MAY 2001

tions introduce distortions through wide- under the World Trade Organization's Pre-spread evasion of trade taxes, either through shipment Inspection Agreement. A plausiblemisspecification of quantity, misclassification explanation is that affected firms must fileof tariff heading, or undervaluation of goods. complaints as identifiable corporate entities,

It is not easy to directly assess the costs and which they may be reluctant to do for fearbenefits of preshipment inspection in this ofjeopardizing commercial relationships.area. Preshipment inspection services are On the other hand, the Indonesia Chai-often introduced at the same time as policy ber of Commerce has argued that preship-reforms affecting revenue collections and ment inspection facilitated trade by speedingcustoms performance, and the full benefits up the de-douanement (clearing of customs)depend on other government actions. More- process. This is an area where further quan-over, many preshipment inspection programs tification of impact would be helpful. Thehave been poorly implemented by adminis- ultimate objective for customs should be a More research istrations that did not want the services because fully integrated export and import systemthey would reduce available rents. based onasingle submission of minimal con- needed to quantify

Although reported revenue savings gen- trol data for all official purposes, backederally exceed preshipment inspection fees- by upgraded information systems and tech- the impact ofwhich are about 1 percent of the value of nical staff trained in risk assessment and pro-inspected goods-case studies suggest that filing (see UN 1995). With recent advances preshipmentthe information provided by preshipment in information technology, automation,inspection companies has often been dis- Internet use and electronic data inter- inspectionregarded, so potential revenue increases change, and business practices such as riskhave not been realized. Revenue collection management systems, such an approachshortfalls of up to 50 percent are reported should be feasible for most countries if thereto have occurred in some countries. is political will for change.

Unless governments consistently use a rec- Overall, for preshipment inspection toonciliation system and act on generated infor- make a positive contribution, it appearsmation, preshipment inspection will not essential to ensure:contribute much to revenue collection. For 0 Transparent procurement rules for thesustainable revenue collection, customs mod- preshipment inspection contract.ernization and institutional reform are also * Preshipment inspection values and clas-needed, and should specify how preshipment sifications are an integral part of importinspection services will be phased out over documents.time. Ideally, this should be a prerequisite * Good use of provided services (with rec-for any country signing a preshipment inspec- onciliation by the ministry of finance astion contract (see Low 1995, ch. 3). a minimum).

*Arbitration provisions to settle disputesTrade facilitation swiftly without holding up goods.Opponents often argue that preshipment * Enhanced competition for service pro-inspection hinders the flow of goods with vision and fee setting (see below).the rest of the world. They point out that atbest, preshipment inspection creates a series Options for increasedof additional costly steps for traders-and corpetitionat worst, results in further costs and delays How can preshipment inspection serviceswhen customs authorities duplicate control be made an effective transitional instrumentfunctions and question the findings of pre- for improving revenue collection and facil-shipment inspectors. The extra cost is itating trade?alleged to be especially burdensome forsmall exporting firms. Competition among service providers

Most evidence in this area is anecdotal, A careful assessment is needed of the bene-and not a single complaint has been lodged fits and costs of parallel competition (split

PREMNOTE 53 MAY 2001

contracts) and serial competition (bidding responsible for customs modernization. Iffor a time-bound monopoly franchise, either the company is successful in customs mod-at the country level or within a certain area). ernization, it closes off far more profitableWith split contracts, the benefits of compe- flows from preshipment inspection work.tition need to be weighed against higher trans- Governments should consider separatingactions costs and possibly perverse incentives. preshipment inspection support from cus-With advances in information and control toms modernization assistance. This doestechnology, the government's transactions not preclude governments from using thecosts in monitoring several suppliers and customs modernization skills of preshipment

ensuring effective reconciliation need not be inspection companies, but merely ensuressignificanty more burdensome. But split con- that a distinct agent be responsible for mod-

tracts can create conflicts of interest, because ernization. That agent could include a

Governments importers may threaten to switch to another preshipment inspection company not par-service provider if they are not assessed suf- ticipating in the country's preshipment

s ho utdt consider ficiently low duty payments. It would be use- inspection work. Such unbundling can facil-

ful to explore why so many Latin American itate different fee structures for distinct linesseparating countries have adopted this model, andwhat of business, making it easier for prices to

other forms of parallel competition might be reflect services rendered.preshipment conducive to increased competition.

For serial competition, the challenge is to Further readinginspection support design and supervise a bidding process that Dutz, Mark. 2000. 'The Use and Usefulness

awards contracts often enough to render the of PSI Services." In Pre-Shipment Inspec-from customs market contestable. With both contract tion: Past Experiences andFutureDirections.

options, termination clauses are desirable for Trade and Enterprise Paper 2. London:modernization poor performance. It would also be desirable Commonwealth Secretariat.

to explore the commercial feasibility of allow- Low, Patrick. 1995. Preshipment Inspection Ser-

assistance ing fuller price competition, where pricing vices. World Bank Discussion Paper 278.reflects actual services rendered rather than Washington, D.C.

the current advalorem practice. For instance, UN (United Nations). 1995. "Customs-

bulk goods such as wheat or petroleum could Facilitation and Control." Trade/WP/

be exempted or should face lower fees. R. 1130. Economic Commission forEurope, Economic and Social Council,

Competition to strengthen customs Working Party on Facilitation of Inter-

administ ration national Trade Procedures, CommitteeEven though preshipment inspection services on the Development of Trade, New York.

are described by the industry as temporary,a number of countries have been using them This note was written cuy Mark Dutz (SeiorEcon-

for more than 10 years without concomitant omist, Development Research Group, Develop-

customs modernization. Although one pos- ment Economics Vice Presidency). It is based onsible solution is to insist on a clearer link Dutz (2000).between preshipment inspection and cus- Ifyou are interested in similar topics, consider

toms reform, there may be a basic conflict of joining the Trade and Competitiveness Thematicinterest in appointing a preshipment inspec- Group. Contact Dorsati Madani, x3 7925, or

tion company as the primary external agent click on Thematic Groups on PREMnet.

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