LONDON (TrustLaw) – China was the developing country worst hit by illicit financial outflows between 2000 and 2009 inclusive, losing an estimated cumulative $2.74 trillion, according to a report U.S.-based research and advocacy organisation Global Financial Integrity (GFI) published on Thursday.
The report surveyed a total of 157 countries. TrustLaw spoke to Dev Kar, lead economist at GFI and one of the report’s authors about why the estimates are probably on the conservative side, how the global economic crisis has affected illicit financial flows and the relationship between oil and corruption.
What surprised you most about the results of the report?
The thing that really stands out about the report is that there was a sharp dip in illicit flows in 2009. But we should not get the impression that this sharp fall is because of anything that the countries are doing in terms of economic reform or improvements in governance, the dip happened because of the ongoing financial crisis.
Can that be proved with economic models?
That can be proved through economic models. That’s basically what we did in our Principal Components Analysis which sheds light on the factors that could have been responsible for bringing down illicit flows. For example, if you look at the source of funds versus the use of funds – which is at the heart of one of the models – the source of funds are basically new loans that countries contract and foreign direct investment which flows into developing countries. Both of these are significant and both of these items underwent a significant decline in 2009 as a result of the financial crisis. On the other hand, the use of funds, the surplus of oil exporting countries and China, both of those surpluses have declined and so when surpluses decline, illicit outflows also decline sharply.
How would the likes of the UK and the United States have fared had the report looked at developed countries too?
That’s a very interesting question but a very complicated question. It’s complicated because, at least as far as the United States is concerned, I would hesitate to apply the World Bank Residual model (the model used to compile the report). Economists can apply the trade-mispricing model whereby exporters and importers shift money out of the country by deliberately manipulating customs invoices. That is a fact and Europe also has its share of those illegal cases involving traders. But the problem comes with the source of funds concept which is underlying the World Bank Residual Model. The reason I would hesitate to apply that model in the case of the U.S. is that the U.S is in a unique position. It’s sitting on a domestic currency in the U.S. dollar which is a unique liquid asset in the world and basically it can print liquidity. The fact that, for instance, most people would agree that the U.S. has a debt problem that is approaching 100 percent of GDP, yet the rate of return on U.S. Treasury bonds is actually going down, not up.
Where are these illicit financial flows mostly going?
What we can look at is the process data that is compiled by the Bank for International Settlements, the international organisation that is based in Basel, Switzerland. But that data is severely limited, they only have data on bank deposits in current accounts, not in non-bank financial institutions. Non-bank financial institutions consist of investment banks, hedge funds, and those institutions that deal with derivatives. We don’t have the data on those non-bank financial institutions. We only have the IMF data on cash deposits by the private sector into current accounts. We also don’t have data on withdrawals, we only have deposit data. If we don’t have data on withdrawals, it’s very hard to estimate how much of those illicit funds are really making their way into alternative forms of assets. If we had even a gross idea of the withdrawals, then we could say OK, so much percentage could be going out into other types of investment – we don’t have that. There’s no data on other investments like real estate, gold, other precious metals, art objects, luxury cars and all those kind of things. So, it’s very hard to map illicit flows, almost impossible to map the entirety of illicit flows into those assets. The sliver of those deposits, bank deposits into current accounts, is only a sliver of the entirety of illicit assets and nobody has any information on this.
Conservative estimates ranked Poland tenth, with illicit financial outflows averaging $16 billion a year from 2000 to 2009. Why is it so high in the list?
One has to remember that Poland went through a tough period of transition from a controlled East European Soviet-era type of economy. Until recently, maybe about 10-15 years ago, the economy was in transition but they’ve since done better. But I’m not convinced that the people (there) have that much confidence in the future that they won’t be revisited by those trickier times. So there could be an element of that playing out in Poland.
The report states that the Middle East and Africa experienced the most rapid growth in illicit financial outflows during the first decade of this century. Why was that?
There’s a Middle Eastern economist whose name is Almounsor and he has a study out in this book called “Capital Flight and Capital Controls in Developing Countries.” In that paper, Almounsor says they found a link between illicit outflows and oil prices. When oil prices are increasing, it tends to drive the outflows of illicit capital. Now there’s also a governance issue, many of those countries don’t have democracy, there’s very little accountability and the oil sector is basically cornered by the ruling class and the fact remains that, until very recently, oil prices have been going up. So, all these factors together translate into pretty sizable current-account surpluses in these countries, which again translates into very large illicit outflows.
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