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Illegal Trade and Capital Flows - An Assessment of Contraband Trade and Capital between India and Sri Lanka

by M. Sarvananthan; Kumaran Book House, Colombo.

Reviewed by Arun Kumar

The book under review covers an important but under-researched topic in economics. Contraband trade and illegal capital movements are of critical importance for most developing economies but given the difficulty of getting reliable data on these aspects of the economy they are either ignored by analysts or referred to in passing.

The book under review is based on the PhD thesis of the author. Much of the data have been generated by the author through surveys and discussions with knowledgeable people. This is creditable given the dangers involved in dealing with people whose activities are illegal to varying degrees.

The book begins with an Abstract (pp ix-x) and a Foreword. It consists of nine chapters including an Introduction, a concluding chapter which also discusses policy options and a theoretical chapter reviewing the literature on the subject.

The remaining chapters are mostly descriptive. The theoretical chapter is comprehensive and giving an account of the treatment of the subject in the existing literature. The book has been written from a Sri Lankan perspective. It holds few lessons for India except the important one that a similar study needs to be done for the Indian economy as well. The book has an extensive and useful bibliography on the subject but the Index is inadequate.

Contraband trade is defined as illicit trade between any two countries (p 1). Contraband trade and illegal capital flows are known to occur between Sri Lanka and many other countries such as Singapore, Dubai, Taiwan, Malaysia, Korea, Japan, Hong Kong and to a great extent with India. The book deals exclusively with Indo-Sri Lanka contraband trade because these two countries are close neighbours and have had centuries-old ties.

However, no data are presented to show the relative importance of illegal trade in the total of such trade (the size of which is also not given). This is important given that Indo-Sri Lanka trade (in the period 1976-1994) is a small per cent of the total trade of each of the two countries (Table 2, p 172).

The study is important in the context of Sri Lanka since it is the first major study on an aspect of its black economy. It has often been argued that official data are incomplete and unreliable due to the acts of omission and commission in estimating the national accounts of any country, especially developing countries. The official data reveal largely the white part of an economy so that any analysis based on this data remains incomplete and policies formulated on this basis tend to fail (Kumar 1999). The attempt in the book to suggest policies based on a more complete data base is a step in the right direction.

The major objectives of this study (p ix, pp 4-5 and p 129) are to analyse the extent, mode, causes and effects of contraband trade and capital flows between India and Sri Lanka, while the secondary objectives are to find out the non-economic factors fuelling Indo-Sri Lanka contraband trade and illegal capital flows. Finally, based on the analysis, some policy options are proposed for Sri Lanka.

The book points out that contraband trade takes place not only to evade import/export tariffs and restrictions on capital transfer but also for a variety of important socio-political and economic reasons. In this sense,it reinforces a point made in Kumar (1999) that the phenomenon of black income generation is not just economic and cannot, therefore, be tackled by economic measures alone. Just as in the case of India (Kumar 1999) so in the case of Sri Lanka, the author concludes (pix and p 10) that in spite of liberalisation, contraband trade and illegal capital transfers have increased in the eighties and the nineties. In this sense,it reinforces the conclusion in Kumar (1999) that controls and regulations are not the causes but the sources of black income generation.

Contraband trade is divided into Two Components: Technical(TCT) and Physical Contraband Trade (PCT). TCT is said to occur due to false invoicing, i.e., under/over invoicing of imports/exports while PCT is defined as complete non-recording of imports/exports. It is unclear that this is an important distinction since the latter is only one aspect of the former. The analytical distinction should have been made between legal and illegal activities (Kumar 1999).

In the case of the latter there will be no recording but in the case of the former, the percentage recording of the trade would lie between 0 and 100.

The methods available to detect TCT, namely, partner country data comparison and unit-price comparison method are critically assessed. In this study, the former method is used because it is claimed to be the more appropriate one. In the case of PCT, the method of comparing production data with consumption, exports/imports and inventory has been rejected (correctly) in favour of the market price comparison method. The reason is the non-availability of the required data for the former.

In the chapter on TCT, the author presents trade data for 19 years from 1976 to 1994 for both India and Sri Lanka from the records of the UN Statistics Division. A total of 1,337 commodities were traded between India and Sri Lanka in both directions.

Among these, 487 commodities were exported and 1,313 were imported by Sri Lanka. Further, 463 commodities were exported as well as imported by Sri Lanka. Sri Lanka's imports from India during this period were around 9 per cent of its total imports, the largest single source of import 9P 32).

To estimate TCT, the partner country data comparison method is used. It is full of pitfalls as noted in the book but this is the best that is feasible. It has been estimated that TCT in Sri Lanka's imports from India during this period was due to over invoicing of imports by Sri Lankan traders. This was the major channel for illicit capital transfer to India. Indian traders under-invoiced their imports. In other words, false invoicing was taking place at both ends.

The author draws the important conclusion that the official trade statistics are highly flawed and he suggests that there is a need to match the official trade data to check the phenomenon. Discussing PCT, the author says that it has been taking place between India and Sri Lanka for a long time.

To detect its extent, market-price comparison method has been used and the estimates made for 1996. Here the expected wholesale market price in Chennai and Colombo were compared with the actual wholesale price in Colombo. In a very detailed presentation, PCT through sea and air routes is separately estimated from Sri Lanka and India. The use of couriers to carry goods, nexus with customs officials, emergence of specialist wholesale dealers, counterfeiting of top brands, involvement of Buddhist clergy and LTTE (very briefly) are described.

In order to calculate the expected wholesale price in Colombo, various duties and costs were added to the CIF value of import price. Even though electronic goods and pharmaceuticals, etc, are also smuggled, four specific goods imported from India were selected for study - sarees, sarongs, stainless steel utensils and ladies' fancy/miscellaneous goods. The actual wholesale prices in Colombo were much higher than the expected wholesale prices in Sri Lanka. For instance,the actual wholesale price in the market in Colombo was 58-71 per cent of the tariff-inclusive prices in the case of sarees.

With regard to the goods exported to India, the author chose two goods (cinnamon and cloves) to detect the PCT. The actual wholesale prices were found to deviate substantially from the expected wholesale price in Chennai. The author links up PCT with movement of illegal capital. He also discusses illegal labour migration and invisible trade and in a separate chapter the smuggling of narcotic drugs.

There are many methodological deficiencies as is likely in any such study but it appears that the illegal trade for Sri Lanka may be larger than the legal trade. The author would have done well to give a table summarising the estimates of contraband trade and illegal capital movements he has so painstakingly arrived at. This would have given an overall picture which does not emerge at present.

Based on the analysis, the author suggests that the policy options are (i) to enforce the law vigorously, (ii) to ignore the contraband trade, and (iii) to eradicate or reduce the causes of contraband trade. As is obvious, the optimal policy would be the third but it is not clear how that is to be achieved. The ethnic conflict is the most important factor in this and that is not easy to resolve.

The book could have been better organised so that more space could be devoted to theoretical discussions. For instance, in places, the tables and chapters are repetitive. For instance, Tables 3 to 6 and 23 to 26 are repetitive and could have been consolidated to save space. The same could be said of Tables 20 and 21.

Among the chapters too, one may point to repetitiveness, like in chapter 4 (pp 40-46). One would have liked to see more of analysis of, for instance, why is there so much fluctuation in the discrepancy (between partner countries) columns in Table 1. Does this large fluctuation throw into doubt the usefulness of the partner country data analysis.

There was a need to point out whether or not the analysis could be extended to draw a macro picture for the Sri Lanka economy. Could the analysis have been extended to other commodities and countries to get an idea of the total of illegal trade and capital flows? Certain statements of facts on pages 2, 22, 31, 52-53, 72 and 128 need to be looked at more carefully.

The major lacuna is that the theoretical discussion in the book is partial since it misses the macro features of contraband trade and illegal capital movements. For instance, the macro economic implications for savings and investment could have been drawn. It is not that the author is unaware of these implications because he refers to them on p.2. The limitation then clearly lies in the framework adopted that does not allow the macro implications to be derived.

Further, if illegal trade is comparable to recorded trade, the loss of tax revenues would be important. It may be inferred from the data on P 131 that this should be around 3.6 per cent of the total tax revenues.

Thus there are major fiscal implications of this trade but it is the lack of an adequate framework that prevents this aspect to be analysed.

This is an important drawback of the literature as a whole and that is why policy-makers and theorists have mostly ignored the black economy and therefore have not been able to incorporate these features into their analysis.

The book under review illustrates that when the black economy is analysed without a complete macro framework, one may arrive at incorrect conclusions. The author while critical of the neo-classical features of the analysis in the existing literature has not been able to escape its clutches. For instance, he seems to approve of the employment generation aspect (p 133) and welfare improving aspect (p 131) of this activity.

A macro analysis would have indicated (as in Kumar 1999) that the black economy does generate employment but in comparison to the situation in which the black economy is converted into the white economy, the employment potential of the economy is reduced. The value of the multiplier is lowered and unproductive investment and waste are increased by the black economy so that the net impact on the economy is negative.

Further, it is clear that the growing criminalisation associated with illegal activities results in important social and political fallouts which can hardly be welfare improving, a point made in general about the black economy in Kumar (1999).

Due to the theoretical weakness, the cause of the phenomenon has also not been correctly identified. As pointed out earlier,the distinction between cause and source has not been used. As suggested in Kumar (1999) the cause is the triad between corrupt businessmen, politicians and the executive.

The triad is critical to any analysis since the phenomenon under study is not episodic but systemic. In India, the criminal link is important but in Sri Lanka's case it is terrorism and 'eelam'. This is not adequately analysed. The index to the book does not even mention LTTE whereas it should have been an important factor of analysis. Due to the ethnic conflict, the social consensus has broken down and this is the cause of the spread of the illegality.

The book misses this substantively but reinforces the analysis in Kumar (1999) that the triad is the cause of black income generation.

Discussion of the link of illegal trade and capital flows with the black economy, the wider phenomenon, is inadequate. This is another methodological problem with the micro-based literature where no overall view can be taken or emerges. How can illegality prevail or remain confined to only one aspect of the economy?

In spite of the drawbacks pointed to above, the book should be welcomed as a pioneering effort and an important contribution to the filling of gaps in economic literature.

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