Preferential Trade, Mis-invoicing and Capital Flight

This paper examines how preferential trade policy affects the degree of capital flight. It builds up a three-country preferential – non-preferential trade model where low or zero tariff prevails in the preferential trade channel and higher tariff is exercised in the nonpreferential trade channel. We show that the preferential trade channel is likely to encourage capital flight and non-preferential trade channel is conducive for illegal transactions in foreign exchange in the local market. We attempt to crosscheck our result with the Mexico – US and Canada and Mexico – Japan trade data.