The New Market for Tariff Evasion
By imposing uneven tariffs across the globe, the Trump Administration has created new opportunities for evasion arbitrage. Smugglers rejoice!
It isn’t easy being a Chinese manufacturer. You work around-the-clock to export cheap television parts to America. But there are dozens of companies just like yours, all competing to deliver at the lowest price. And, unlike Huáng down the street — total jerk — you didn’t just inherit your father’s company. No. You clawed your way up from the very bottom, back when Shenzhen was a new Special Economic Zone with less than a million residents. You said all the right things. You got drunk with all the right people. And when you started making real money, you dutifully appointed a member of the Communist Party to your Board.1
But it’s never enough. Because even after all that work, and all those cigarette-filled nights running the numbers, you still have a problem: tariffs. The Americans have been slapping a 10% tax on your exports since 2018. And they only do it because their companies can’t compete. Sure, you might have the advantage of forcing your factory workers to assemble parts 30 days a month.2 And yea, you did dump some excess production waste into the local river. But that was, like, one time, and Li was only 13 and still in training. Besides, didn’t American companies do all the same things when they were industrializing? It seems to you that the U.S. tariffs are just an unfair tax, one that punishes your company for being better.
Luckily, there’s a solution. You learn that the U.S. doesn’t apply the same tariffs to television parts imported from Vietnam. So you fly down to the Vietnamese port city of Haiphong to make some new friends. You have drinks. You meet some friendly customs officers. You grease a few palms. And then, a few months later, you start exporting your products to Vietnam, where you friends change the labels on your television parts. Like magic, what was once Made in China has now been Made in Vietnam, bound for the U.S. tariff-free.
You’re not the only company using this strategy. One recent working paper, drawing on firm-level data, estimates that approximately $1.6 billion in Chinese goods were rerouted to the U.S. via Vietnam in 2021.3 We do not have equally precise data on Chinese trade rerouting through other third countries. But aggregate trade data, in addition to criminal investigations, indicates that it occurs regularly through Thailand, Cambodia, Mexico, and other intermediaries.4
But now everything has changed. On April 2nd, the Trump Administration announced the most extreme global tariffs in over a century. China has been hit hard with a 34% increase, bringing their effective total to 54%.5 But they are far from alone. Vietnam (64%), Thailand (37%), Cambodia (49%), and other countries often used for rerouting also face steep increases.6 It isn’t clear if rerouting was purposefully targeted; the White House employed a crude formula to calculate these tariffs.7 But what is clear is that the new tariff regime will completely transform the underlying incentive structure of the global trading system. And, of particular interest to this Substack, that includes the illicit market for tariff evasion.
An Old Game
None of this is particularly new. Tariffs — effectively taxes on imports — have always created incentives to relabel products, reroute trade, or simply smuggle goods under the cover of darkness. In pre-revolutionary France, for example, there were thriving underground markets for circumventing custom duties.8 Coffee, wine, hats, watches, handkerchiefs…all available on the black market. Smugglers, supported by networks of inn keepers, would arrange for transporting these products across borders. And they used innovative techniques to hide their cargo:
Exhibiting great ingenuity, some drivers built false compartments into their coaches. Philippe François, a small landowner from Flanders who had installed several such compartments in his cabriolet, was driving to Paris on the evening of 4 November 1774 when he was stopped at the Saint-Denis customs gate...Asked if he had anything to declare, he replied no, but guards could not help but notice that the sides of the carriage were unusually thick. They inspected the vehicle and discovered secret compartments in which some 347 white-paper packages of snuff, weighing a total of 320 pounds, had been packed.9
Monsieur François was caught. But many smugglers were successful. In fact, it has been estimated that illicit smuggling accounted for 45% of all products exported from England to France in 1784.10 45%! And this was facilitated by highly sophisticated criminal ringleaders. Jean-Baptiste Rathier, one such mastermind, orchestrated an intricate underground network to circumvent 25% duties on calico, a type of heavy cotton textile. Product would travel by carriage, horse, and foot, where it would then be relabeled as another product.11 The full route required paying regular bribes to no less than 23 different customs officers.12 No small feat!
But perhaps no smuggler was more prolific in 18th century France than Louis Mandrin (pictured above). Mandrin, unlike most smugglers, was not satisfied to merely shift contraband across borders. He wanted to control the market. From 1754-55, his gang, whose members had nicknames like Major, Ham, and Pug-Nose, forced their way into small towns and sold their wares in the open.13 Like a military campaign, they pushed deep into French territory, responding to any resistance with guerrilla-style warfare (see map below). But once they established control in the town square, all they wanted to do was sell product — tax free.
This was tariff evasion on steroids. It’s as if a band of armed pirates burst into the New York Stock Exchange, held everyone at gunpoint, and set up a new informal market on the trading floor. And it worked! Mandrin’s gang continued to expand, setting up shop in one town square after another. French newspapers began celebrating him as the “Chief of the Smugglers,” a sort of quasi-Robinhood stealing from the state to, well, sell tax-free goods to the poor.14
Naturally, the French Monarchy was less enthusiastic. It wasn’t just that Mandrin was murdering civilians and violating custom duties. He was also challenging the King’s control over international trade. The Royal Army was dispatched, leading to armed conflict along the Eastern border between France and what was then the independent state of Savoy.15 Eventually, French troops — disguised as peasants — snuck across the border and captured Mandrin in his lair.16 Eager to make an example of Europe’s smuggling kingpin, the authorities sentenced Mandrin to a medieval method of execution: being “broken at the wheel.” I’ll let you google it.
What is striking about these stories is the symbiotic relationship between licit and illicit markets for international trade. The routes taken by Mandrin’s gang, across the mountainous borders of Switzerland and Savoy, were driven by the specific tariffs France applied to imports from both regions. Tariffs shape, in other words, the contours of underground networks. Like a pinball machine, they create distinct bumpers and springs, increasing the likelihood that illicit trade flows in particular directions. The question is: where is the ball heading?
New Opportunities
At first glance, the Trump tariffs are well-designed to avoid evasive tactics. It applies a 10% tariff on all imports, something which cannot be avoided by rerouting goods via third countries.17 And as Timm Betz has theorized, broad tariffs are easier to enforce than product-specific restrictions.18 Steep tariffs have also been imposed on states associated with Chinese rerouting. Peter Navarro, Trump’s Senior Counselor for Trade and Manufacturing, made the connection clear: “We will want to hear from countries including Cambodia, Mexico and Vietnam that you will stop allowing China to evade US tariffs by trans-shipping exports through your countries.”19
But there remain arbitrage opportunities. In addition to the 10% blanket duty on all imports, the Administration has imposed additional country-specific “reciprocal” tariffs which vary wildly. Exporting from Vietnam? Be prepared to pay an extra 46%. But if you export the same product from Brunei, it’s only 24%. As you can see from the map below, these variations exist all across Southeast Asia:20
What do you see here? I see opportunity. There are obvious rerouting trades to be made. If you normally reroute through Vietnam, why not shift your operations to the Philippines where the rate is 26% lower? These are enormous differences, more than enough to justify the trouble of building new contacts and shifting your goods across the South China Sea. You are, of course, still worse off than before, as the new tariff on Philippine imports is now effectively 27% (17% + 10% baseline). If you really want to minimize your import tax exposure, you might go through, say, East Timor, which escaped Trump’s formula with no added tariffs.
Rerouting is, of course, easier said than done. There are variations in enforcement practices and new risks to consider. But if pre-revolutionary French smugglers could do it, so can the world’s modern criminal organizations. And it is worth repeating just how fat the margins are here. Evading, say, a 5% tariff might not be worth the risks of bribing Malaysian customs officers. But when we start talking about 20, 25, 30% differences, the calculation changes.
We can reasonably expect, then, that Trump’s tariffs will trigger dramatic shifts in the illicit market for tariff evasion. This is a problem for the administration, as successful evasion deprives the U.S. of customs revenue and distorts the intended impact of the tariffs (which appears to be trade rebalancing).21 The natural solution is enforcement. Like the French monarchy, Trump can wage war on smuggling. But does the U.S. really have the capacity to enforce these tariffs? And can they still rely on allies — many of whom have also been hit with tariffs — to help?
Enforcement Problems
Tariffs are easier declared than enforced. This was well understood in the “Golden” age of American tariffs Trump wishes to emulate — approximately 1871-1931 when duties on imports exceeded 38%.22 During that period, enforcing import bans and collecting duties was big business. By 1877, the Customs Service was the second largest Federal agency, employing thousands of officers who “sifted through luggage, inspected and weighed cargo, checked papers and documents, collected duties and imposed fines, and made seizures and arrests.”23
But the state didn’t just rely on manpower. It also created specific incentives for customs officers to be thorough. Under the so-called “Moiety System,” officers were entitled to a cut of any fine or forfeitures. And as Peter Andreas explains in his book, Smuggler Nation, this had a dramatic impact on their approach:
These financial incentives encouraged the same sort of overzealous enforcement that had so enraged colonial merchants in their dealings with British customs offices. In one bust alone, the collector of customs at the New York port reportedly pocketed $56,120—more than the annual salary of the U.S. president. The collector was Chester Arthur, who was so notorious for abusing the system that the president asked him to resign…24
Careful readers may recognize the name. Chester Arthur, mysteriously lost to historical obscurity, would go on to become the 21st President of the United States. But before entering politics, he held an equally influential position: Chief Collector of the Port of New York Customs House.
The New York Customs House, tied to the Tammany Hall political machine, had a reputation for corruption. Part of that reputation was attributable to unscrupulous customs officers abusing the Moiety System. Eventually, the Grant Administration abolished the program in 1874.25 This appears to have had an immediate impact on enforcement.26 Revenue from fines, seizures, and other tariff violations plummeted in the proceeding years despite increases in imports:27
But incentivization programs are not the only thing that’s changed about Customs enforcement. We have also seen explosive growth in the volume of global trade and the complexity of transshipment. Each year, more than 11 million shipping containers arrive to American shores, of which 3-5% are inspected.28 Customs employs various methods to narrow their search, including screening registration forms and scanning containers for contraband.29 But these probabilistic sampling techniques can only go so far — there are simply too many containers to search.
And containers aren’t the only problem. In 2020, 32% of cargo — representing about $480 billion in value — arrived non-containerized.30 This includes large equipment shipped individually, like generators, in addition to liquids, grains, and other material transported in bags or pipes. The U.S. Government Accountability Office recently studied 11 seaports and found that existing controls are insufficient for addressing the risks presented by these shipments. One problem is inspection. Imagine, for example, looking for smuggled goods hidden in giant barrels of sand.31
But the problems don’t stop at the U.S. border. Enforcing Trump’s tariffs also requires evaluating whether goods were illegally transshipped, relabeled, or mis-invoiced prior to arriving to American shores. This requires international cooperation. Customs has existing partnerships with foreign agencies. Further, it has established attachés in countries like Singapore, Hong Kong, and Thailand.32 And that would all be great if it weren’t for the fact that Trump also imposed tariffs on these allies.
It is possible that American allies in Southeast Asia will beef up their enforcement in return for reduced levies. But as Canada has learned vis-a-vis cross-border fentanyl trafficking, appeasing Trump is a fool’s errand. And even if the U.S. does successfully coerce these countries into strengthening local enforcement, the relationship will never be the same. Applying massive tariffs to extort your own allies is the definition of cutting off one’s nose to spite one’s face.
For smugglers, this is all very good news. By employing a crude formula to determine country-by-country tariffs, the Trump administration has created a new and exciting market for evasion arbitrage. The U.S. lacks the capacity to monitor its own imports, let alone transshipment occurring via third countries. And, even better, it has angered the very allies whose help is needed to enforce these levies. If Louis Mandrin was alive today, he’d be licking his lips.
Ebehi Iyoha, Edmund Malesky, Jaya Wen and Sung-Ju Wu, Exports in Disguise? Trade Rerouting During the U.S.-China Trade War.
See, e.g., CAROLINE FREUND, The China Wash; Michael Martina and David Brunnstrom, U.S. firms demand crackdown on tariff-evading Chinese importers.
The formula. What is most remarkable is that two factors in the denominator have been set to 4 and 0.25 respectively and multiplied together, equaling one. This renders both factors meaningless to the equation, suggesting they were only included to provide a veneer of methodological sophistication. This is so remarkably rudimentary that it lends credence to the speculative theory that it were produced by ChatGPT.
Michael Kwass, Contraband: Louis Mandrin and the Making of a Global Underground (p. 88).
Ibid, p. 96.
Ibid.
Ibid, p. 107.
Ibid.
Ibid, p. 125.
Ibid.
Ibid.
Ibid.
EO, Regulating Imports with a Reciprocal Tariff to Rectify Trade Practices that Contribute to Large and Persistent Annual United States Goods Trade Deficits. There are product-specific exemptions in a second appendix.
Timm Betz, Tariff Evasion and Trade Policies.
Peter Navarro, Donald Trump’s tariffs will fix a broken system.
Note that this does not include any existing tariffs which may have already been in place.
It appears to be addressing America’s trade imbalances. But some would lead us to believe it is a master plan to devalue the U.S. dollar, transform the global monetary system, and achieve a beautiful U.S. autarky? I don't know…sure.
Peter Andreas, Smuggler Nation: How Illicit Trade Made America, p. 177.
Ibid, 178.
Ibid, 179.
Ibid.
With the natural caveat that we can’t eliminate other possible factors, particularly with such a small set of data.
Ibid; John Dean Gross, The History of Tariff Administration in the United States.
US Customs, Cargo Security and Examinations.
Vivian C. Jones and Marc R. Rosenblum, U.S. Customs and Border Protection: Trade Facilitation, Enforcement, and Security.
I was delighted to find a blog dedicated to sand trade: Global sand trade figures don’t add up.
U.S. Customs, International Initiatives.
Great read, thank you !