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July 2, 2010

Honesty for Hire

A few countries have found a way to stop graft and foster political stability: hire foreigners to collect their revenue. By Kris James Mitchener and Noel Maurer.


Corruption is a serious problem for governments in the developing world. In states where corruption is rampant, building a coalition to stamp it out is very hard. 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.

But there is a way for a troubled nation to reduce corruption and increase revenue collection: adopt external institutions. Angola, to give a recent example, outsourced its customs collections to Crown Agents for Oversea Governments and Administrations, a British nonprofit with expertise in public financial management. In so doing, the African nation tripled its tariff revenue in the span of a few years even as it reduced its tariff rates.

Angola’s case suggests that a nation can reduce corruption and collect more public revenues if it is willing to relinquish sovereignty in some limited, well-defined capacity to either a low-corruption government or a private organization with a strong reputation for honest management. Crown Agents officials 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 had an incentive to maximize revenue collection and punish corrupt behavior, Angola was able to break the corruption equilibrium in customs, generate greater public revenue, and show the way to further reforms.

If the agents tolerated corrupt behavior, they would risk losing attractive, high-wage career paths and damaging the credibility of their organization.

Money aside, why would the leader of a state agree to relinquish sovereignty to foreign agents? First, using outsiders reduces the power of officials within the state to expropriate rents. This reduction can engender stability—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 can provide more public goods or increase its coercive power over actual and potential violent opponents. Greater revenue can also permit 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.

A Different set of interests

Angola’s example is not exceptional. Both history and recent experience suggest that adopting external institutions can foster internal reform.

In the early twentieth century, several Central American and Caribbean countries had trouble repaying their sovereign loans, in part because they were unable to collect sufficient revenues from their customhouses, the main source of state finance at the time. 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 United States provided a small management team, approximately ten individuals, while locals continued to provide the vast majority of customs personnel. The local government remained in charge of setting tariff rates and other customs legislation. Other “customs receiverships” followed in Nicaragua and Haiti.

Crown Agents uses its reputation, built during the Age of Empire, to win contracts today.

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” institutions from the United States, which had successfully administered its own customhouses and developed a reputation for relatively apolitical public administration.

Today, several nations do much the same thing when they employ Crown Agents, the British nonprofit. In addition to Angola, the governments of Mozambique, Latvia, Kosovo, Macedonia, and Bulgaria have contracted with Crown Agents to run their customs services. In Angola and Mozambique, Crown Agents took over direct control of the customs service. In Kosovo, the United Nations mission 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. 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 twentieth century were part of the U.S. government, whereas Crown Agents employees work for a nonprofit development organization.

AN ECHO OF THE BRITISH EMPIRE

Crown Agents 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 United Kingdom’s crown colonies and those protectorates that chose to use its services. With the transformation of the British empire into the Commonwealth, the agency worked increasingly with sovereign governments, and its 1993 annual report suggested that this shift “might make it more desirable for the ownership of the Crown Agents to reflect a wider base” than that of the British government.

The Crown Agents Act of 1995 transferred it from Britain’s Department for International Development to a private foundation consisting of representatives from a broad range of nongovernmental organizations and the British government. In a sense, the new quasi-private entity uses its reputation as an efficient British tax collector (established during the Age of Empire) to win contracts today.

In the early twentieth century, several Caribbean countries effectively “rented” institutions from the United States to collect customs fees. Revenues jumped.

Why did London privatize the agency? First, transforming Crown Agents into a nongovernmental organization freed the organization from burdensome public procurement rules. Second, and more important, severing the de jure ties with the British government made it easier for the organization to receive funding from third countries (including the European Union) and operate in more nations.

Outsourcing customs management to Crown Agents led to dramatically increased customs revenue for its new clients. In Angola, revenue jumped more than 50 percent in the first year of operation (2001), doubled in two years, and tripled by 2004, during a time when oil prices remained low and Angola lowered tariffs to meet commitments under the General Agreement on Tariffs and Trade. Mozambique saw a similar increase. In Bulgaria, revenues jumped 19 percent during the quarter in which teams led by Crown Agents began operating. 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 with 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.

Clearly, inviting the help of outsiders can help countries take on otherwise intractable institutional challenges and overcome obstacles to sustained economic development.


Kris James Mitchener was a W. Glenn Campbell and Rita Ricardo-Campbell National Fellow at the Hoover Institution for 2009–2010 and 2010–2011 at the Hoover Institution.


Noel Maurer is an associate professor at the Harvard Business School.

Special to the Hoover Digest.

Available from the Hoover Press is Crony Capitalism and Economic Growth in Latin America: Theory and Evidence, edited by Stephen Haber. To order, call 800.935.2882 or visit www.hooverpress.org.