Measuring Smuggling Through the Gravity Equation and the Mimic Model: Evidence from the Republic of Moldova

Abstract

Smuggling represents a critical, unobservable challenge for emerging economies, particularly the Republic of Moldova, hindering fiscal stability, market functionality, and progress toward European Union integration. While existing literature often relies on either statistical discrepancy or Multiple Indicators Multiple Causes (MIMIC) models, this article introduces an original, integrated methodological approach to measure the phenomenon. The study combines the theoretically rigorous Structural Gravitational Equation (SGE) with the MIMIC model, applied for the first time to the Moldovan context over the period 2010–2024. The SGE first forecasts "expected" legitimate bilateral trade flows with 29 partners, generating statistically significant deviations (residuals) that capture unexplained trade (illicit activity). These residuals are then incorporated as a key endogenous indicator within the MIMIC framework, alongside structural causes such as weak governance capacity and significant excise duty differences. Smuggling is treated as a latent phenomenon shaped by institutional and fiscal determinants and reflected in observable indicators such as mirror trade gaps, excise differentials, seizures/fraud cases, and gravity-based anomalies. The gravity model is estimated with PPML-HDFE to obtain expected flows and anomalies; these, together with mirror gaps and excise differentials, enter a MIMIC system that recovers a standardized index of smuggling intensity. The findings confirm that low institutional quality and tax differentials significantly stimulate illicit flows, with excise differences being the most potent driver. Results indicate that governance improvements and excise alignment reduce illicit trade, while fiscal and labor market pressures increase it. Robustness checks confirm stability across indicator sets, lag structures, and sectoral gravity runs. The resulting synthetic index of smuggling magnitude provides a robust and consistent quantitative tool for policymakers, offering an empirical foundation to develop targeted, sustainable fiscal and anti-corruption measures necessary for stability, good governance, and international development goals. JEL: F17; UDC: 339.19:330.4(478)