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Production uncertainty, enforcement, and smuggling: a stochastic model

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  • Scott Fausti

Abstract

A stochastic, joint-product model of smuggling is developed, merging the existing smuggling literature with the literature on competitive firm behaviour under uncertainty. The equilibrium and comparative static results of the model reconcile contradictory results found in the earlier literature concerning how risk and risk preference affect smuggling behaviour. The introduction of stochastic risk demon-strates that the models developed in the earlier smuggling-risk literature overstated (understated) the positive (negative) economic consequences associated with the introduction of smuggling. The analysis reveals that smuggling activity is not dependent on firm risk preference. However. risk preference does affect the amount of trade the smuggling firm will engage in. Government enforcement and tax policy are analysed. Increasing enforcement efforts against smuggling will reduce illegal activity. However, the affect on legal trade is shown to be dependent on whether the firm considers smuggling and legal trade to be complementary or substitute activities. It is demonstrated that the effect of a change in the tax rate on illegal trade is also dependent on whether the firm considers smuggling and legal trade to be complementary or sub-stitute activities.

Suggested Citation

  • Scott Fausti, 1999. "Production uncertainty, enforcement, and smuggling: a stochastic model," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 8(3), pages 279-308.
    • Handle: RePEc:taf:jitecd:v:8:y:1999:i:3:p:279-308
    DOI: 10.1080/09638199900000017
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    References listed on IDEAS

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    1. Jagdish Bhagwati & Bent Hansen, 1973. "A Theoretical Analysis of Smuggling," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 87(2), pages 172-187.
    2. Martin, Lawrence & Panagariya, Arvind, 1984. "Smuggling, trade, and price disparity: A crime-theoretic approach," Journal of International Economics, Elsevier, vol. 17(3-4), pages 201-217, November.
    3. Alan Deardorff & Wolfgang Stolper, 1990. "Effects of smuggling under african conditions: A factual, institutional and analytic discussion," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 126(1), pages 116-141, March.
    4. J. Tobin, 1958. "Liquidity Preference as Behavior Towards Risk," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 25(2), pages 65-86.
    5. Pitt, Mark M., 1984. "Smuggling and the black market for foreign exchange," Journal of International Economics, Elsevier, vol. 16(3-4), pages 243-257, May.
    6. Pitt, Mark M., 1981. "Smuggling and price disparity," Journal of International Economics, Elsevier, vol. 11(4), pages 447-458, November.
    7. Sheikh, Munir A., 1989. "A theory of risk, smuggling and welfare," World Development, Elsevier, vol. 17(12), pages 1931-1944, December.
    8. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
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    Cited by:

    1. Gillespie, Kate, 2003. "Smuggling and the global firm," Journal of International Management, Elsevier, vol. 9(3), pages 317-333.
    2. Bruno Larue & Sébastien Pouliot & Christos Constantatos, 2009. "Exports to Smuggle and Smuggling Technologies," Review of International Economics, Wiley Blackwell, vol. 17(3), pages 476-493, August.
    3. Gideon Yaniv, 2010. "The Red–Green Channel Dilemma: Customs Declaration and Optimal Inspection Policy," Review of International Economics, Wiley Blackwell, vol. 18(3), pages 482-492, August.

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