Smuggling and parallel markets for exports

This article proposes a model of smuggling consistent with the coexistence of firms involved in strictly legal trade with firms involved in smuggling. A framework is presented in which a firm's degree of risk aversion and the level of government enforcement are the determining factors in the decision of the firm to smuggle or not to smuggle. The model demonstrates that smuggling must be welfare enhancing or all smuggling activity will end.

This article also provides a theoretical analysis of the effect enforcement has on smuggling and welfare. Increased enforcement is shown to have a negative effect on welfare. Government enforcement is assumed to have two policy instruments it can use to combat smuggling: (1) the probability of detection and (2) the monetary penalty. The relative effectiveness of government enforcement instruments in deterring smuggling is shown to be dependent on the degree of firm risk aversion.