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I am particularly grateful to Anupam Basu, Benedicte Vibe Christensen, and Reinold van Til for helpful comments and suggestions. The paper has also benefitted from comments from Robin Kibuka, Soukang Lin, Kazi Matin, and Joseph Nana.
Stolper and Deardorff (1990) provide an informative discussion of smuggling in Africa. Johnson’s theoretical analysis (1987) was explicitly based on border trading in the ECOWAS (Economic Community of West Africa States) region. However, macroeconomic factors do not feature prominently in these studies.
Petroleum is the most important export commodity in both Nigeria and Cameroon. Benin also exports crude oil. Recorded bilateral trade in the region has been small. Nigeria accounted for less than 2 percent of imports in Benin, Cameroon, Chad, and Niger in the early 1990s (see Direction of Trade Statistics, 1992). As mentioned previously, Nigeria lifted prohibition on petroleum exports to West African countries in 1988.
The official and parallel exchange rates were unified in March 1992 in the context of an inter-bank market system.
τ* in this paper is defined as the difference between world price and domestic price. In CFA franc countries, oil taxation is a major part of this difference.
Estimates from Cameroon’s Ministry of Industrial Development and Commerce.
Alternatively, the government runs an oil company. The household sells y to the oil company in each period at the world price, PW, and pays an income tax to the government. The oil company sells oil at home at PN and exports the remaining oil to the world market. Both paradigms are equivalent. As in Johnson (1987), there are three countries in the model: the home country, a neighboring country, and the rest of the world. The largest share of trade of both the home and neighboring country is with the rest of the world.
The smuggling function can be derived as follows. Let π and h(.) be the profit and transaction cost (other than the cost of buying oil at the official gas pump in the home country) schedule of smuggling, h is increasing and convex in x, hx>0;, hxx>0. Solving the smuggler’s profit maximization problem
yields equation (3). Note that a tightening of border controls would shift up the cost schedule.
In a more satisfactory treatment, domestic consumption of oil should be derived from more basic assumptions and could be affected by the relative prices between oil and other goods that enter the consumer’s utility function. This paper abstracts from these complications because added complexities would not alter the basic results of the paper.
For extensive discussion of the monetary implication of the government’s budget constraint, see, for instance, Frenkel and Razin (1987); Bruno and Fisher (1990) discusses the role of expectation and multiple equilibria.
Implicitly we make the assumption of purchasing power parity (PPP). If one believes PPP only holds for the tradable goods, then the equilibrium exchange rate will also depend on the relative price structure in both home and foreign countries (see Dornbusch (1988), Chapter 8). In such a case, equation (7) implicitly assumes a stable relative price structure in both home and foreign countries.
Typically, an economy experiencing financial imbalances may not have adequate official reserves to meet the demand for foreign exchange at a fixed (overvalued) exchange rate. As a result of exchange restrictions imposed by the government in response to such a situation, a parallel market for foreign exchange develops.