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In a run-down warehouse on the outskirts of the scruffy Paraguayan border town of Ciudad del Este, stacks of battered confiscated cardboard boxes containing all manner of goods – imitation Spiderman figures poke out of one box, others are loaded with pirate DVDs and cigarettes – are awaiting incineration.

Nearby, the latest catch – genuine merchandise this time, but impounded for tax evasion and due for auction – is being unloaded, overseen by district attorney Luis Munurriaga. The warehouse’s contents represent just a fraction of the illegal activity that goes on in this town at the “triple frontier” of Paraguay, Brazil and Argentina, he says.

Ciudad del Este, a notorious hub of smuggling and counterfeit activity in South America, is also at the centre of concerns over money laundering, drugs trafficking, arms trading and even terrorist financing.

Fighting smuggling and the counterfeit trade in Paraguay is a delicate business, given the extent of the problem, Mr Munurriaga says. “We can’t go after just anyone; poor people here depend on jobs linked to this business to survive. But when companies complain we have to take action.”

With an informal economy estimated at about half of GDP that is nourished by endemic corruption – Mr Munurriaga says only 5 per cent of imported goods are declared at customs – it is an uphill struggle. “There are people in power who protect the big businessmen.”

In Transparency International’s 2005 corruption perceptions index, Paraguay came 144th out of 159 countries – a marked improvement from 2004, when it came sixth from last.

Héctor Guerin, a veteran local journalist who has survived four assassination attempts for persistently denouncing corruption, agrees that things are improving. “The foundations have been laid for the formalisation of the economy, and that is an achievement of this government,” he said.

But it is only the beginning, he says, citing the case of Southern Cross, Sony’s local distributor that is accused of evading $180m (€141.5m, £95.2m) in taxes in the past two years. Although it is now paying taxes, Mr Guerin says its first contribution was just $1.5m.

The formalisation of the economy is being underpinned by key tax reforms implemented since President Nicanor Duarte Frutos’s government won elections in 2003, including the introduction of income tax and lower taxes on businesses to encourage payment, while increasing penalties for evasion.

“A large part of the companies that used to evade taxes have decided to start paying. It’s now a good business to operate legally; the risks of staying on the margins are very great,” says Jorge Von Horoch, deputy economy minister.

Tax receipts have increased by 80 per cent under this government, while the tax base has widened by 30 per cent – although tax income still only accounts for 12 per cent of GDP. Furthermore, in two and a half years counterfeit goods worth around $30m have been seized.

Government efforts are being supported by the US – where many of the companies affected by the counterfeit business in Ciudad del Este are based – through an initial $34m loan to attack impunity and informality in the economy.

But far-reaching change will also require greater help from Brazil, the immediate destination of the vast majority of Ciudad del Este’s trade. Tighter border controls and lower import tariffs would eliminate incentives to illegal activity.

Nevertheless, Paraguay’s underlying problem of corruption is inescapably homegrown. In a recent interview with the FT, Mr Duarte said it would take Paraguay 15-20 years of institutionalisation “to put a stop to the old story that we are a nation of counterfeiters and smugglers”. After nearly four decades of dictatorship under Alfredo Stroessner ending in 1989, successive governments have been guilty of “multiplying and perfecting the vices inherited from Stroessner”.

Only two months ago, Mr Duarte’s predecessor Luis Gonzalez Macchi was sentenced to prison for six years, charged with the illegal transfer of $16m from the central bank. Corruption among government officials and the judiciary is a serious obstacle.

But Mr Duarte says the private sector is no better. “Corruption is like tango, it is a dance for two. If there is a corrupt customs official it is because there is a businessman who is rewarding him; if there is a serious tax evader it is because there is a bureaucrat who is being bribed.”

Nevertheless, Mr Duarte is aware of the difficulties ahead: “What we have done so far is little faced with the magnitude of the challenge of giving up practices that have practically become ingrained in our culture and are considered normal.”

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