Renting Institutions to Combat Corruption

Paul Romer: The latest post in our E-seminar series of contributions from economists and other experts comes from Kris James Mitchener of Hoover Institution and Santa Clara University and Noel Maurer of Harvard Business School. They write about several case studies in which countries that struggled with corrupt customs agencies successfully used external institutions to clean them up and increase revenue collection.

Corruption is a serious problem for governments in the developing world. In states where corruption is rampant, it is very hard to build a coalition to stamp it out. Such corruption is particularly pernicious when it affects the revenue-collecting functions of the state: in addition to the deadweight costs corruption imposes on society, corruption in revenue collection reduces the state’s ability to offer fiscal incentives to public officials to obey the law. The recent experience of Angola suggests that a troubled nation can reduce corruption and increase revenue collection by adopting external institutions. Angola outsourced customs collections to Crown Agents, a British nonprofit with expertise in public financial management. In so doing, the country tripled its tariff revenue in the span of a few years, all the while reducing its tariff rates.

The case of Angola suggests that a nation can reduce corruption and collect more public revenues if it is willing to relinquish sovereignty in some limited and well defined capacity to either a low-corruption government or a private organization with a strong reputation for honest management. Officials from Crown Agents face a completely different set of incentives from officials in a high-corruption government. Crown Agents employees risk losing attractive high-wage career paths and damaging the credibility of their organization should they decide to engage in or tolerate corrupt behavior. Because the agents faced face incentives to maximize revenue collection and punish corrupt behavior, Angola was able to break the corruption equilibrium in customs, generate public revenue, and show the way to further reforms.

Why would the leader of a state ever agree to relinquish sovereignty to foreign agents? First, using outsiders reduces the power of officials within the state to expropriate rents. This can engender stability because it impedes the collection of resources that can be used to form coalitions to displace (sometimes violently) an existing government. Second, the use of outsiders increases the resources available to the central government, which it can use to provide public goods or increase its coercive power over violent opponents and potential violent opponents. Greater revenue can also be used as a basis for greater foreign borrowing, such that small increases in state revenue can be leveraged into much larger increases in state resources. Third, using outsiders to manage reforms can increase transparency. These three features can go a long way towards solving political wars of attrition.

The example from Angola is not exceptional. Both history and recent experience suggest that countries can adopt external institutions to affect positive internal reform. In the early 20th century, several Central American and Caribbean countries ran into trouble in repaying their sovereign loans, in part because they were unable to collect sufficient revenues from their customhouses, the main source of state finance at this time.¹

At the turn of the 20th century, leaders in the Dominican Republic could not control customs officials, who regularly skimmed off the revenues, often using them to finance violent challenges to the central government. In 1904, President Carlos Morales and his successor, Ramón Cáceres, requested that the U.S. government take over the administration of the country’s customs. The U.S. provided only a small management team, roughly ten individuals. Locals continued to provide the vast majority of customs personnel, and the local government remained in charge of setting tariff rates and other customs legislation.² Other “customs receiverships” followed in Nicaragua and Haiti. In all three countries, revenues jumped. In fact, revenues increased even after interest and principal payments were restarted on the countries’ public debt. These Caribbean countries effectively “rented” U.S. institutions, which had successfully administered its own customs houses and which had developed a reputation for relatively apolitical public administration.

Today, several nations are doing much the same thing—contracting out customs collection, although in the modern case, it is to Crown Agents. In addition to Angola, the governments of Mozambique, Latvia, Kosovo, Macedonia and Bulgaria contracted Crown Agents to run their customs services. In Angola and Mozambique, Crown Agents took over direct control of the customs service. In Kosovo, the U.N. Mission in Kosovo (UNMIK) officially took over customs, with Crown Agents as prime contractor. In Latvia, Macedonia and Bulgaria, Crown Agents managed the creation and operation of anti-corruption inspection teams.³ As with the U.S. customs receiverships of the early twentieth century, the vast majority of the customs officials remained locals. The primary difference is that the American agents of the early-20th century were part of the U.S. government, whereas Crown Agents employees are following careers within a nonprofit development organization.⁴

The Crown Agents for Oversea Governments and Administrations did not develop its expertise and reputation as a private organization. Rather, it developed as part of the public administration of the British Empire. The first “Joint Agents General for Crown Colonies” were appointed in 1833 to handle customs and revenue for the U.K.’s crown colonies and those protectorates that chose to use its services. With the transformation of the British Empire into the Commonwealth, the agency did more and more of its work with sovereign governments, and its 1993 annual report suggested that this fact “might make it more desirable for the ownership of the Crown Agents to reflect a wider base than that of the U.K. Government.” The Crown Agents Act of 1995 transferred it from Britain’s Department for International Development (DFID) to a private foundation consisting of representatives from a broad range of NGOs and the U.K. government. In a sense, then, the new quasi-private entity used its reputation as an efficient British tax collector (established during the Age of Empire) to win contracts today.⁵

Outsourcing customs management to Crown Agents succeeded in dramatically increasing customs revenue. In Angola, revenue jumped more than 50% in the first year of operation (2001), doubled in two, and tripled by 2004, a time during which oil prices remained low and Angola lowered tariffs to meet GATT commitments.⁶ Mozambique saw a similar increase.⁷ In Bulgaria, revenues jumped 19% the quarter in which the Crown Agents-led teams began operation.⁸ Crown Agents has, in fact, succeeded where a different and less-intrusive form of outsourcing, pre-shipment inspection (PSI), has shown more mixed results. Under PSI, governments contract a private company to inspect and value imports in the port of embarkation and report those valuations to the government. Both Angola and Mozambique turned to Crown Agents after poor experiences with PSI.

Countries can take on otherwise intractable institutional challenges when they invite the help of outsiders. In the case studies described here, countries leveraged external institutions to tackle corruption in the collection of customs. In so doing, the governments enhanced revenue streams and gave themselves additional capacity with which to address chronic underfunding of public investment or other obstacles to sustained economic development.

Notes

¹ Kris James Mitchener and Marc Weidenmier, “Empire, Public Goods, and the Roosevelt Corollary,” Journal of Economic History 65 (September 2005), 658 92 and NBER Working Paper 10729.

² Noel Maurer and Kris Mitchener, “A History of Customs Receiverships.” Unpublished Working Paper, Harvard Business School, November 8, 2008. For more on market reaction to the establishment of customs receiverships, see Laura Alfaro, Noel Maurer, and Faisal Ahmed, “Lawsuits and Empire: On the Enforcement of Sovereign Debt in Latin America,” Law and Contemporary Problems (forthcoming).

³ For details about the Bulgarian operation, see Clive Leviev Sawyer, “The untouchables and the untouchables,” The Sofia Echo, 24 September 2007, accessed on 21 December 2009.

⁴ In addition to its customs work, Crown Agents advises (and often, in effect, manages) government agencies over a wide range of countries. Most of its financing comes from Britain’s Department for International Development (DFID), although it also receives funding from various other governments, primarily the European Union and Japan.

⁵ The organization assumed the name “Crown Agents for the Colonies” in 1863 and took its current title in 1954.

The 1993 annual report of Crown Agents further recommended: “As an alternative, the Board therefore recommended that the business and assets of the Crown Agents should be transferred to a specially formed foundation.” (See Hansard House of Commons Debates, volume 261, Session 1994-95, Tuesday 6 June 1995, column 71.) In 1995, the British Parliament began transferring control of the organization to an independent board, the Crown Agents Foundation, consisting of representatives from the British government and BritishNGOs. The Crown Agents Act of 1995 ensured that Crown Agents remained a non-profit.

Why then did London bother privatizing the agency? The reason was twofold. First, transforming Crown Agents into an NGO freed the organization from burdensome public procurement rules. Second, and more importantly, severing the de jure ties with the U.K. government made it easier for the organization to receive funding from third countries (including the European Union) and operate in more nations.

⁶ Crown Agents, Customs Expansion & Modernisation Programme—Angola, Sutton, UK, 2008, p. 11.

⁷ Crown Agents, Customs Reform Programme 1997 2006: The modernisation of Alfândegas de Moçambique, Sutton, UK, 2007.

⁸ Crown Agents, Bulgaria Customs Modernization Programme, 2002 2006, Sutton, UK, 2006.