Channelizing Afghanistan to Pakistan informal trade into formal channels

PSSP working paper 041, Channelizing Afghanistan to Pakistan Informal Trade into Formal Channels, focuses on assessing the possibility of bringing informal trade from Afghanistan to Pakistan into the legal channels by reducing tariff and tax differentials between Pakistan and Afghanistan. A basic model and illustrative example are presented that encompass the monetary incentives of smugglers and shows possible tariff/tax reductions that bring profits from informal trade below the breakeven point. The effects of price discounting of informally traded products in the Pakistan market and possible under-invoicing by traders are also taken into consideration. The analysis is applied to case studies for LCD TVs and tea, both of which have been identified as smuggling prone items. Very significant reductions are required in the tariff or taxes to eliminate the incentives and make informal trade unprofitable if informal traders are assumed not to sell at a discount.  Under-invoicing exacerbates this challenge, but a more substantial effect comes if there is price discounting by the informal traders. Two additional trade policy issues which could affect informal trade utilizing the APTTA are also briefly considered. First, trade facilitation measures that enhance the efficiency of the APTTA could make it more competitive with trade into Afghanistan through Iran but also may modestly add to the profits of informal traders. Second, we find only very limited scope, in our LCD TV and tea case studies, for a PTA between Afghanistan and Pakistan to channelize informal trade based on utilizing the APTTA and a formal channel coming back into Pakistan.