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Heuristics and biases of Brazil cost: the impact of classification of goods on decision-making

The impact of classification of goods on the decision-making process of parties interested in doing business in Brazil.

quinta-feira, 14 de abril de 2022

Atualizado às 14:17

 (Imagem: Arte Migalhas)

(Imagem: Arte Migalhas)

"Brazil Cost" is not a new term. Companies and investors are familiar with it, since it refers to the increased operational costs associated with doing business in Brazil. Despite being a well-known expression, most studies and articles analyze only the economic consequences of bureaucracy and lack of  infrastructure in Brazil. However, "Brazil Cost" does not solely affect the price tag, but also the decision-making process.

 The shortage of articles covering behavioral consequences demonstrates how Paul Samuelson's "value-free" approach shaped the study of Economics, focusing on complex mathematical models and setting emotions aside. Adam Smith, in his Theory of Moral Sentiments, had already examined the concept of pain and pleasure. However, this would only be included in mathematical models after the Prospect Theory, published in 1979 by Daniel Kahneman and Amos Tversky.

After the Prospect Theory, the study of the impact of emotion on decision-making processes, which began with Bernoulli's unintentional discovery of the risk aversion bias, led to the uncovering of thousands of biases and heuristics.

Beyond the great amount of heuristics and biases, a single situation can trigger a number of cognitive biases, which makes it far more difficult to specifically determine which one influences the decision-making process the most on and, therefore, the final decision itself.

However, the lack of certainty of how much a specific bias or heuristic influences a final decision, does not impede the possibility of being conscious about which come into play. For any analysis, it is vital to narrow down the hypothesis, focusing on a specific case or situation, such as the classification of goods, for example.

The classification of goods directly impacts international trade, affecting developed and developing countries alike. The result can be limited to an increase in customs tariffs increase, but can also escalate and compromise treaties, leading to mutual sanctions or even an embargo. Therefore it is very important to understand not only its economic consequences, but also which biases and heuristics it is related to and how these impact the decision-making process involving international trade.

Trading is a very ancient activity, directly connected to the evolution of society. However, it was only after World War II that there began the creation of standards to harmonize the classification of goods, enabling its worldwide use. The effort to establish a harmonized system reached its peak in 1983, when the WCO - World Customs Organization approved the HS - Harmonized Commodity Description and Coding System.

According to the WCO, more than 200 countries employ the HS, covering 98% of the international trade. Brazil established, alongside with Argentina, Paraguay, Uruguay and Venezuela, the Mercosur Common Nomenclature, MCN/HS, derived from the full implementation of the Harmonized Commodity Description and Coding System.

The Harmonized Commodity Description and Coding System and the Mercosur Common Nomenclature solved part of the problem, establishing classification standards to harmonize the classification of goods and the determination of the corresponding customs tariffs. However, according to the WCO database, between origin and destination, certain goods can have their classification changed up to 17 times.

Nowadays, classification change is one of the biggest challenges of Brazil cost, leading to unexpected tariff increase or even cargo apprehension. The problem demonstrates the difficulty of a three-point communication between manufacturers, trading companies and Brazilian customs agents, which sometimes struggle to agree about the appropriate classification. As a result, the classification of goods, initially established by legislators, is directed to the CARF - Council of Tax Appeals or even the Judiciary, originating long-lasting millionaire cases.

In Brazil, most disputes involving classification issues are directed to CARF, which decides if the given classification is appropriate. Depending on the decision, customs tariffs can be lowered, sustained or even increased, impacting on the logistics and retail prices. When tariffs are increased, customers and companies can appeal to the judiciary, which gives the final verdict on CARF's decision.

An article published in 2021 by Fernanda Valente and Bárbara Mengardo assembles controversial cases involving classification of goods in Brazil. These are only a few of the cases pointed out by the researchers: "Are rubber bullets and gas grenades weapons or pyrotechnic articles?" "Are Cereal Bars confectionary products or cereal flake?" "Are CROCS waterproof shoes or rubber sandals?" "Boombox amplifies the energy or the sound?" "Are Oil Rigs vessels?".

The controversial cases involving classification of goods in Brazil demonstrate that "Brazil cost" does not only involve bureaucracy and lack of  infrastructure, but also legal certainty, especially when it comes to customs tariffs. The tariff increase along the operation directly impacts the relation between customers and trade companies, once they are unable to foresee the final cost and, therefore, establish the price in advance.   

 As a result, both parties are driven towards uncertainty, facing unknown risks and unclear loss, similar to the sure gains and sure losses studied by Kahneman and Tversky. The certainty effect "contributes to risk aversion in choices involving sure gains and to risk seeking in choices involving sure losses". However, fear and sense of duty also play an important role in this equation.

The rationality of taxpayers, in this case consumers and trading companies, is strongly related to the fear of getting caught and the duty to obey. While taxpayers with a great sense of duty tend to overestimate the risk of getting caught, taxpayers with a greater temptation to cheat are more inclined to estimate the expected utility of objective audit probabilities.

At this point, it is important to remember, as stated by professor Devin Pope, Standard Economics should not be forgotten, nor should they be replaced by Behavioral Economics. However, putting behavior into perspective could provide an accurate 95% confidence interval of logistic costs predictions.


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Pedro Henrique Vieira Greca Monteiro

VIP Pedro Henrique Vieira Greca Monteiro

Advogado formado pelo IBMEC/RJ e pesquisador na área de Finanças Comportamentais. Autor do livro "Tributário Cognitivo Comportamental - Introdução ao Tema"


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