Illicit financial flows: What losses for international development?
Putting the IFF agenda in action at the country level. Part 2 of 9
Illicit financial flows (IFF) became an international concern in the late 2000s and are now an established policy concern in the development context. Still, policy makers have yet to address important questions about putting anti-IFF programs into practice. This second blog post in our series discusses a key assumption that policymakers often make — that IFF create a “loss” for development at the country level.
Fredrik Eriksson is a lawyer with extensive experience from private sector research, policy analysis, evaluations, strategy development, and consultancy work — mostly on anti-corruption and governance issues. He leads the U4 Innovation Lab and private sector research.
Other posts in this series
- IFF definitions–crucial questions
- This post: IFF: What losses for international development?
- IFF and country level legitimacy
- The blind spots in anti-IFF strategies
- Strategies for effective anti-IFF efforts
- Coordinating an attack on secrecy
- Rethinking policies to remove secrecy
- Expanding the role of corruption in IFF
- Country-level IFF research for counter-IFF support
Policy makers and international donors frequently talk about IFF creating a loss for development (see High Level Panel on Illicit Flows from Africa; OECD; World Bank). But what does this really mean? As discussed in our last post , the term “illicit financial flows” can be interpreted in several ways (GFI). Perhaps not all IFF lead to development losses. Furthermore, even if IFF do lead to losses, how should those losses influence development policies?
Thinking about development loss
Policy makers make two arguments for why IFF lead to development loss. First, IFF are not taxed since they are illegally “hidden” or are of illegal origins. Thus, such funds (or financial capital, depending on definition used) cannot be taxed, which leaves the government with taxing the legitimate and transparently reported economic activities. Importantly, a government can use its tax revenues to benefit development in three ways:
1. By saving them (eg to improve domestic access to capital needed for domestic economic activities).
2. By investing them (eg in a development project with the expectation that it is profitable or useful for society).
3. By consuming them (eg by purchasing goods or services).
Second, IFF travel abroad where they cannot benefit society in their country of origin. For example, the OECD recently defined economic harm resulting from IFF as follows (emphasis added):
“Direct or indirect harm to the economy by: diverting funds that otherwise would be directed to the legitimate economy; causing the state to divert resources to prevent and respond to criminally motivated harm, or to treat or compensate its victims. Indirect damage to the economic, investment and entrepreneurship climate, as well as to competitiveness.” (OECD)
Alternative assumptions
Nonetheless, these two arguments rely on assumptions that may not always hold: (i) untaxed funds do not benefit the economy, (ii) developing governments will effectively use additional tax revenues for development, and (iii) funds flowing out of a country provide no development benefit.
Consider the following counterarguments:
1. Untaxed funds can still benefit the economy
Illegal activities are not taxed, for obvious reasons. Thus, they arguably do not result in lost tax revenues (Matfess and Mikaucic). Therefore, the development “loss” cannot be lost tax revenues that could be used for development. If the funds were later used for legal activities, the government could certainly tax these “second generation” activities. The government might willingly accept these tax revenues, even if they resulted from IFF.
So does the loss instead refer to the savings, investments, and consumption domestic criminals might have made if they had not transferred their illicit proceeds of crime abroad? Or does it refer to the harmful consequences of criminal activities on development itself?
Does the loss to development refer to the savings, investments, and consumption domestic criminals might have made if they had not transferred their illicit proceeds abroad?
Furthermore, not all illicit funds are transferred abroad. Illicit funds could be kept at home and used to strengthen the “economic, investment and entrepreneurship climate, as well as . . . competitiveness” (see OECD, p2). This is most likely to occur where the government has good control of corruption: There is little — if any — political corruption, and the state functions impartially and effectively (Booth et al.; Kelsall).
2. Governments don’t always use tax revenues effectively, especially in countries where political corruption reigns
The fact that the government collects tax revenues does not mean development is increasing. In the developing world, corruption is often the norm rather than the exception. Patron-client relationships dominate power relationships, which means individual-based rules dominate over impersonal, impartial rule of law (Mungiu-Pippidi).
It seems unrealistic to expect IFF to decline considerably before a government or society has substantially reduced corruption.
It seems unrealistic to expect IFF to decline considerably before a government or society has substantially reduced corruption. But even if that could occur at societal and administrative level, as long as corruption is considerable at the political level we would be naïve to expect the increased government revenues from reduced IFF to tangibly improve the development climate (Khan and Jomo; Whitfield and Therkildsen; Booth et al.). The risk that funds collected by government would be misused is simply too high (Jimu). Political realities in developing countries rarely fit ‘neutral’ governance ideals and all the fantastic improvements that could be achieved if only there was alignment.
3. Funds transferred across borders might result in development “gains” for recipient countries
Finally, even if IFF leave a developing country that could make use of them, those funds may very well enter another developing country that needs them. Consider the case of secrecy jurisdictions. These countries or territories “provide[] facilities that enable people or entities escape or undermine the laws, rules and regulations of other jurisdictions elsewhere, using secrecy as a prime tool” (Tax Justice Network, p10).
For countries with few options for economic diversification, the cost of transparency may be very high.
Countries adopt secrecy mechanisms based on their own political and economic realities (UNODC; Findley et al.; Matfess and Mikaucic). They cater to a need to hide the identities of people who benefit from proceeds of crime and other illegal acts. They also hide the amounts and the proceeds themselves. At the same time, these countries or territories benefit by receiving such inflows if they can contribute to savings, investments or consumption that generate social and economic benefits (Findley et al., 2015). For countries or territories with few options for economic diversification, the cost of transparency (which would halt these inflows) may therefore be very high. Yet, discussions of the development loss of IFF rarely consider how these IFF benefit other countries or territories.
Determining development loss
The assumption that the size of cross-border IFF transfers captures the actual loss to development appears inaccurate.
In short, determining actual IFF-caused “loss” for development is not a straightforward analysis. It may be hard to know whether IFF usage actually benefits development in the country of destination — or if the government in the country of origin would do a better job of spending those funds. A general answer is not possible as the diversity of circumstances influencing that are simply too many. In any case, the assumption that the size of cross-border IFF transfers captures the actual loss to development appears inaccurate. Instead, policymakers should consider the following questions:
- Should development loss relate only to the funds’ country of origin? Or should it involve a broader analysis including the recipient country or global society as a whole?
- What data and other factors (both inside and outside the country of origin) can we use to determine actual loss?
- What country-specific factors enable IFF to harm development?
The answers will help determine what constitutes development loss. Then, policymakers can develop policies targeted at minimising or even eliminating these losses. For example, current anti-IFF policies focus on outflows, and neither the losses nor benefits from inflows are known. Such knowledge could inform both policy feasibility and strategy.
A sharper picture
Many anti-IFF advocates argue for a focus on beneficial ownership and transparency. However, for some countries, it may be that less transparent corporate structures are not actually causing development losses. In fact, they may even facilitate development gains in secrecy jurisdictions. If that is the case, how to reconcile the gains in one country at the expense of another? And how to win the argument that development has to be funded through other means when trying to convince a responsible government? How can the cost of changing policy be offset?
How do we reconcile the gains in one country at the expense of another?
A first step in developing a strategy to improve the situation is to know what those gains are, as well as the factors and dynamics that make it possible. Knowing which factors cause development loss or gains can inform alternative options where a certain country’s political or governance circumstances make stopping outflows difficult. Knowing the system dynamics may help identify the components easiest to change to disrupt the system.
Of course, this is not a debate devoid of values. What is an uncacceptable cost to one country is the opposite to another. Some argue that legal arms trade is an acceptable cost. Development based on extensive use of non-degradable plastics, consumption of non-renewable energy, and agriculture resulting in soil degradation, ground water pollution and the extinction of insects are apparently also acceptable costs. Consensus on the acceptable means of development is unlikely, which means politics and strategy matter if a change is desirable. Development at any cost is unreasonable and unacceptable to the international community, despite of how developed countries themselves may have arrived at their current status. The means of development do indeed matter, but that does in no way diminish the need to understand reality in order to figure out how to change it. Broad assumptions about the general value and feasibility of policies sometimes obscure that reality, leaving out alternative options and reality-based theories for how to achieve a positive change.
Broad assumptions about the general value and feasibility of policies sometimes obscure the reality of how development happens.
What do you think?
What considerations and information do you think we need at country level to determine when there is a loss for development? And how should policy makers and practitioners relate to it? Please share your thoughts in responses below.
Other posts in this series
- IFF definitions–crucial questions
- This post: IFF: What losses for international development?
- IFF and country level legitimacy
- The blind spots in anti-IFF strategies
- Strategies for effective anti-IFF efforts
- Coordinating an attack on secrecy
- Rethinking policies to remove secrecy
- Expanding the role of corruption in IFF
- Country-level IFF research for counter-IFF support
References
Booth, D., Development as a Collective Action Problem: Addressing the Real Challenges of African Governance (London: ODI, 2012).
Findley, M. G., Nielson, D. L. and J. C. Sharman, Global Shell Games: Experiments in Transnational Relations, Crime, and Terrorism (Cambridge, UK: Cambridge University Press, 2014).
Findley, M. G., Nielson, D. and J. C. Sharman, “Causes of Noncompliance with International Law: A Field Experiment on Anonymous Incorporation,” American Journal of Political Science 59: 146–161 (2015).
GFI, “Illicit Financial Flows,” GFI website (2017).
High Level Panel on Illicit Flows from Africa, Illicit Financial Flow: Report of the High Level Panel on Illicit Financial Flows from Africa (UNECA, 2015).
Jimu, I., “Managing Proceeds of Asset Recovery: The Case of Nigeria, Peru, the Philippines and Kazakhstan,” Working Paper no. 6 (Basel: Basel Institute of Governance, 2009).
Kelsall, T., Business, Politics and the State in Africa: Challenging the Orthodoxies on Growth and Transformation (London: Zed Books, 2013).
Khan, M. H. and K. S. Jomo (eds.), Rents, Rent-Seeking and Economic Development: Theory and Evidence in Asia (Cambridge, UK: Cambridge University Press, 2000).
Matfess, T. and M. Mikaucic (eds.), Beyond Convergence: World Without Order (Washington: Center for Complex Operations, 2016).
Mungiu-Pippidi, A., The Quest for Good Governance: How Societies Develop Control of Corruption (Cambridge, UK: Cambridge University Press, 2015).
OECD, Illicit Financial Flows from Developing Countries: Measuring OECD Responses (Paris: OECD, 2014).
OECD, “Illicit Financial Flows: Illicit Trade and Development Challenges in West Africa (Forthcoming Report),” (Paris: OECD, 2017).
Tax Justice Network “Financial Secrecy Index 2015: Methodology,” (Tax Justice Network, 2015).
UNODC, The Globalization of Crime: A Transnational Organized Crime Threat Assessment (Vienna: UNODC, 2010).
Whitfield, L. and O. Therkildsen, “What Drives States to Support the Development of Productive Sectors? Strategies Ruling Elites Pursue for Political Survival and Their Policy Implications,” DIIS Working Paper 2011: 15 (Copenhagen: Danish Institute for International Studies, 2011).
World Bank, “Illicit Financial Flows (IFF),” Brief (World Bank, 7 July 2017).
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