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Africa: Cash Drain from Poorest Countries
AfricaFocus Bulletin
May 26, 2011 (110526)
(Reposted from sources cited below)
Editor's Note
The 48 countries classified by the United Nations as LDCs [Least
Developed Countries], 33 of which are in Sub-Saharan Africa,
lost a cumulative total of $246 billion in illicit financial
flows over the period from 1990 to 2008, according to a new
report from Global Financial Integrity prepared for the UNDP.
Six of the top ten countries in cumulative outflows were in
Africa, including Angola (#2), Lesotho (#3), Chad (#4), Uganda
(#7), Ethiopia (#9), and Zambia (#10).
While these data are admittedly estimates, and do not allow
tracking where the money goes, they provide substantive evidence
that the sums involved are of a high order of magnitude, almost
certainly over $20 billion a year by 2008. These flows have left
this set of countries with a net financial outflow (including
other "licit" financial transfers, such as aid, investments,
loans, and debt repayments) of $197 billion over the same
period.
It is much more difficult to estimate where the money goes, but
reports last year, also from Global Financial Integrity, note
that they go not only to offshore financial centers but also to
banks in developed countries, both identified as "secrecy
jurisdictions" because of lack of transparency of data on
financial transactions. According to a March 2010 report,
excerpted in another AfricaFocus Bulletin not sent out by e-mail
but available on the web at http://www.africafocus.org/docs11/iff1105b.php, the top three
recipients of such funds were the United States, the Cayman
Islands, and the United Kingdom.
For a previous report on illicit financial flows from Africa,
not limited to LDCs, see "Profiling Cash Drains," at
http://www.africafocus.org/docs10/fin1004.php
For previous AfricaFocus Bulletins on economic issues, visit
http://www.africafocus.org/econexp.php
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Illicit Financial Flows from the Least Developed Countries:
1990-2008
May 2011
Discussion Paper
United Nations Development Programme
E-mail: [email protected] and [email protected]
Web site: http://www.undp.org/poverty and
http://www.undp.org/governance
Acknowledgements
This Discussion Paper has been commissioned by UNDP as a
contribution to the United Nation's IV conference on the Least
Developed Countries (LDCs), Istanbul, Turkey in May 2011. UNDP
warmly welcomes feedback from interested stakeholders on any
aspect of the research and conclusions drawn. It has been
written by Dev Kar, formerly a Senior Economist at the
International Monetary Fund (IMF), and now Lead Economist at
Global Financial Integrity (GFI), Center for International
Policy.
...
Executive Summary
This paper explores the scale and composition of illicit
financial flows from the 48 Least Developed Countries (LDCs).
Illicit financial flows involve the cross-border transfer of
the proceeds of corruption, trade in contraband goods, criminal
activities and tax evasion. In recent years, considerable
interest has arisen over the extent to which such flows may have
a detrimental impact on development and governance in both
developed and developing countries alike.
This issue has been recognised by the UN as important for
development and achievement of the Millennium Development Goals
(MDGs). Illicit capital flight, where it occurs, is a major
hindrance to the mobilisation of domestic resources for
development. In many cases, it significantly reduces the volume
of resources available for investment in the MDGs and productive
capacities. Through the United Nations, the international
community has committed to strengthen national and multilateral
efforts to address it. As the deadline for achievement of the
MDGs draws closer, it is vital understand more about the nature
of this problem and to explore possible policy solutions,
especially for those countries furthest off-track towards the
MDGs.
The study's indicative results find that illicit financial flows
from the LDCs have increased from US$9.7 billion in 1990 to
US$26.3 billion in 2008 implying an inflation-adjusted rate of
increase of 6.2 percent per annum. Conservative (lower-bound)
estimates indicate that illicit flows have increased from
US$7.9 billion in 1990 to US$20.2 billion in 2008. The top ten
exporters of illicit capital account for 63 percent of total
outflows from the LDCs while the top 20 account for nearly 83
percent. Trade mispricing accounts for the bulk (65-70 percent)
of illicit outflows from the LDCs, and the propensity for
mispricing has increased along with increasing external trade.
Empirical research on illicit flows indicates that there are
three types of factors driving illicit flows � macroeconomic,
structural, and governance-related.
The ratio of illicit outflows to Gross Domestic Product (GDP)
averages about 4.8 percent but there is wide variation among
LDCs. Of the top 10 countries with the highest illicit flows to
GDP ratio, four are small island countries, two are landlocked,
and four are neither. In some LDCs, losses through illicit
capital flows outpace monies received in official development
assistance (ODA).
Estimating illicit flows from some LDCs is problematic because
the underlying macroeconomic or partner-country trade data are
either non-existent or spotty due to widespread on-going or
recent conflict and/or weak statistical capacity. Complete
macroeconomic and partner-country trade data were available for
34 LDCs, while 11 report partial data to the IMF and 3 are nonreporters.
The report thus presents an estimate of illicit flows
from some of the non-reporting and partially reporting countries
based on the assumption that illicit flows from these countries
are in the same proportion to GDP as are outflows from other
reporting LDCs with complete data.
The results of this study are indicative but demonstrate a clear
need for further research in this area given the scale of the
development challenges which currently face the Least Developed
Countries and the need to 'think outside the box' and find
innovative development solutions.
The paper presents a number of useful measures LDCs may wish to
consider to curtail the generation and transmission of illicit
financial flows. The international community must also play its
part. However, even where policy measures are well designed and
targeted, lasting improvements in this area can only be achieved
when there is the sufficient political will and leadership to
tackle corruption and some of the root causes of illicit
financial flows.
For the Least Developed Countries, policy recommendations
include measures to address trade mispricing through for
instance systematic customs reform and the adoption of transfer
pricing regulations with commensurate increase in enforcement
capacity. The implementation of specialised software which
helps governments to identify possible incidences of transfer
pricing may also be useful to some governments. Measures to
reform the tax base through the progressive strengthening and
widening of the tax base in order to reduce dependence on
indirect taxes which are more difficult to manage and have
built-in incentives for tax evasion may also be beneficial.
Ultimately tax is the most sustainable source of finance for
development and the long-term goal of poor countries must be to
replace foreign aid dependency with tax self-sufficiency.
However taxation reform must be seen as equitable and fair and
must not unduly burden the poorest.
The international community must also support LDCs' efforts to
curtail the illicit outflow of capital. This includes specific
measures to support LDCs to improve the systematic exchange of
tax information between governments on non-resident individuals
and corporations while the adoption of globally consistent
regulations for transfer pricing could encourage multinational
companies to modify their behaviour towards more transparency
and accountability. The UN's Model Income Tax Treaty refers to
the importance of automatic exchange of information between
national tax authorities in different jurisdictions. In order to
stem tax avoidance by multinational corporations, the
international community could support the development of an
international accounting standard requiring that all multinational
corporations report sales, profits, and taxes paid in
all jurisdictions in their audited annual reports and tax
returns.
UNDP stands ready to support LDCs and other developing countries
in their efforts to curtail illicit financial flows in support
of the MDGs. In particular, it can support countries to
exchange practical information, experience and lessons learned
on ways to tackle this problem.
1. Introduction
This paper explores the possible scale and composition of
illicit financial flows from the 48 Least Developed Countries
(LDCs). Illicit financial flows involve the cross-border
transfer of the proceeds of corruption, trade in contraband
goods, criminal activities, and tax evasion. In recent years,
considerable intellectual interest has arisen over the extent to
which such flows may have development, governance or other
consequences for both developed and developing countries (e.g.,
Baker (2005); Ndikumana and Boyce (2008), among others).
The paper has been commissioned by UNDP as a contribution to the
United Nations IV High Level Conference on the LDCs in 2011.
Its objective is to assess the extent to which illicit financial
flows may represent a significant problem in some LDCs, and if
so, to consider more broadly the policy options available to
governments and the international community to curtail such
flows. It is intended to stimulate further public policy
discussion and its results are indicative only given numerous
difficulties associated with robust data collection and
divergent views over which methodological approach best captures
the true scale of illicit financial flows.
The outcome document from the United Nations 2010 Summit on the
Millennium Development Goals (MDGs) recognises the importance
of this issue for development and the MDGs and commits the
international community to �implement measures to curtail
illicit financial flows at all levels, enhancing disclosure
practices and promoting transparency in financial information.�
The recommendations made in the outcome document of 2010 are in
line with the UN's Monterrey Consensus and Doha Declaration,
which recognise the importance of domestic resource mobilisation
in countries' efforts to raise more resources for the MDGs and
commits governments to address the problem of illicit financial
flows through multilateral and national efforts.
Since the 1960s, the UN has recognised the particular
weaknesses, vulnerabilities and development challenges faced by
the LDCs. There are currently 48 countries classified by the
United Nations as LDCs, 33 of which are in Sub-Saharan Africa,
14 in Asia and one in Latin America and the Caribbean. Many
LDCs share similar structural characteristics, for instance 16
LDCs are landlocked, 10 are small islands, while 22 are neither
(Appendix III, Table 1). LDCs satisfy three separate criteria:
(i) an income per capita of less than US$905 per annum (ii) a
low level of 'human assets' based on indicators of nutrition,
health, education and literacy (iii) and a high degree of
economic vulnerability measured in relation to population size
and remoteness, dependency on agriculture, forestry and
fisheries, exposure to natural disasters, export concentration
and instability in exports.6 The three criteria together seek to
capture the multifaceted nature of development and underscore
the many diverse challenges faced by the world's poorest
governments to develop their economies and improve the lives of
� and opportunities for � their citizens. For several reasons,
many LDCs are lagging behind in achieving the UN's MDG targets.
Intuitively, one can argue that the outflow of illicit capital
may hamper governments' abilities to marshal resources for
economic development, to fund important social programmes, and
to bring better balance between government expenditures and tax
revenues. In addition, illicit flows are typically absorbed into
developed country banks and offshore financial centres. This
paper also explores the issue of potential net resource
transfers out of LDCs � the very same group identified by the
United Nations as most in need of special support measures from
the international community to develop. While the magnitude of
the problem of net resource transfers varies from one LDC to
the next, there is strong evidence that net transfers from the
group are significant and present a serious challenge for
fostering economic development.
...
2. Why Least DeveLoped Countries are Vulnerable to Illicit
Flows
In his Keynote Address at a senior Policy Seminar on
Implications of Capital Flight for Macroeconomic Management and
Growth in Sub-Saharan Africa, South African Reserve Bank,
October 2007, Prof. Njuguna Ndung'u, Governor, Central Bank of
Kenya noted that:
Paradoxically, the accumulation of external liabilities in the
region is mirrored by massive outflows of resources in the form
of capital flight � the voluntary exit of private residents' own
capital for safe haven away from the continent. The latest
estimates published by UNCTAD suggest that capital flight from
Sub-Saharan Africa is fast approaching half a trillion dollars,
more than twice the size of its aggregate external liabilities.
While Governor Ndung'u was referring to developing countries in
Sub-Saharan Africa, most LDCs share certain characteristics
which may be facilitating the cross-border transfer of illicit
capital. A lower domestic savings rate relative to more
developed emerging market countries mean that they are even
more dependent upon external sources of capital to finance
economic development and to fund poverty reduction efforts.
Some researchers have also found a significant link between the
growth of external debt and capital flight � the so-called
revolving door effect.
On the one hand, most LDCs have poorly diversified economies and
rely extensively on a few commodities to generate revenues,
which are in turn subject to large price fluctuations
internationally. On the other, LDCs tend to import a wide
variety of goods due to the poor diversification of domestic
industry. Customs duties on imports and on extractive mineral
exports (where applicable) therefore contribute significantly
to government revenues particularly given that direct income
taxes are low due to a narrow tax base. This has led the IMF to
conclude that: �For the foreseeable future, in any event, the
central lesson is clear: for many developing countries, and
especially the poorest of them, tariff revenue will continue to
be a core component of government finances for many years to
come�.
The IMF report notes that smuggling, defined as importation or
exportation contrary to the law and without paying (or
underpaying) applicable duties, will continue as long as
tariffs are levied. The continuing importance of trade taxes in
developing countries, particularly in the LDCs, thus creates a
significant risk of smuggling.
Furthermore, LDCs typically have limited fiscal space to
mitigate the impact of crises on the poor (such as increasing
joblessness), nor the resources to launch large-scale new
investments in infrastructure to stimulate the economy when
there is an economic downturn. Additionally, significant fiscal
deficits may spur the tax evasion component of illicit financial
flows because higher deficits signal to private markets and
high net worth individuals that taxes would probably have to be
raised to close the revenue gap in the near future. The threat
of higher taxes may result in larger tax evasion through illicit
financial flows from LDCs into tax havens. However, as Sheets
(1997) and others have noted, the empirical evidence on the
adverse impact of fiscal deficits on illegal capital flight is
not very clear.
There are other drivers of illicit financial flows from LDCs
that are by no means unique to them. Kar (2011) found that a
skewed and worsening distribution of income can drive illicit
flows because of the expanding number of higher net worth
individuals in economies with a relatively narrow tax base and
weaker or more corrupt tax collection agencies compared to those
operating in developed countries. The high net worth
individuals then resort to the cross-border transfer of illicit
capital in order to not only shield their growing assets from
applicable taxes but to accumulate, in a clandestine manner,
wealth far in excess of what declared incomes could have
generated.
The other important driver of illicit flows is the size of the
underground economy. A recent comprehensive study of the
underground economy by the World Bank found that it is quite
large in many LDCs. These estimates are likely to be
understated because they typically do not include criminal
activities such as burglary and robbery or trade in contraband
goods such as drugs. Nevertheless, available empirical evidence
point to the fact that the underground economy in LDCs can be a
significant driver of illicit financial flows.
...
4. Illicit Flows and the Least Developed Countries
[This section includes several charts not possible to reproduce
in the AfricaFocus Bulletin format. See the full report at
http://www.gfip.org / direct URL: http://tinyurl.com/3jctbdv]
[Top 20 excerpted from Chart 4: Cumulative IFFs from LDCs by
country, 1990-2008 (US$ million)
Bangadesh 34,790
Angola 34,046
Lesotho 16,823
Chad 15,436
Yemen 11,979
Nepal 9,128
Uganda 8,757
Myanmar 8,535
Ethiopia 8,354
Zambia 6,800
Sudan 6,732
Equatorial Guinea 6,503
Laos 6,062
Liberia 5,863
Guinea 4,928
Malawi 4,171
Djibouti 3,885
Mozambique 3,773
Madagascar 3,746
Congo (DRC) 3,499 ]
4.11. Chart 6 analyses the net cumulative resource transfer from
LDCs to the rest of the world over the period 1990-2008
by estimating the relevant capital inflows and outflows from
LDCs as recorded in countries' balance of payments. The
totality of net recorded transfers (inflows and outflows) is
then compared to unrecorded outflows of illicit capital.
Cumulative inflows and outflows from LDCs vis-�-vis the rest of
the world (keeping signs intact) can be estimated as:
Net recorded transfers = Net Financial Account Balance, FDI, New
loans, Repayments of principal (+US$94 billion)
+ Remittances (+US$118 billion)
- Debt Service payments (US$162 billion)
= +US$50 billion (inflow)
4. 12. If illicit outflows of US$246 billion are 'netted-out',
LDCs show a net resource transfer of about US$197 billion into
the rest of the world (mainly developed countries) over this
period. This is a serious loss of resources which may be
accentuating the development challenge in many LDCs.
5. The Drivers and Dynamics of Illicit Financial Flows
The policy recommendations for curbing illicit financial flows
from a country must necessarily flow from an in-depth study of
the drivers and dynamics of these flows that are specific to
each individual country. This section analyses the broad drivers
and dynamics of illicit financial flows based on empirical
research and is followed by an overview of policy measures
governments may wish to consider in order to restrict the
generation and cross-border transmission of such capital.
Empirical research on illicit financial flows (see Appendix II)
indicate that the factors that drive such flows can be broadly
classified into three categories � macroeconomic, structural,
and governance-related.
...
5.1 Macroeconomic Factors
Owners of illicit capital, which comprise of the proceeds of
crime, bribery, kickbacks, asset stripping, tax evasion, and
illegal activities such as drug trafficking, are typically more
interested in hiding their wealth than in maximising rates of
return. They are also not likely to be worried about future
taxation implied by a rising government budget deficit. That
said, overall macroeconomic conditions do impact a country's
overall business climate which prompts domestic businesses to
retain more capital at home while attracting foreign direct
investment into the country. Ultimately, whether macroeconomic
factors drive illicit flows is an empirical question which
needs to be settled within the context of specific country case
studies.
5.2 Structural Issues
Illicit flows are much more likely to be driven by structural
factors like rising income inequality, faster rates of (noninclusive)
economic growth, increasing trade openness without
adequate regulatory oversight, etc. Where economic growth in
non-inclusive, it may worsen the distribution of income and the
resulting larger number of high net worth individuals may seek
to evade higher taxes if overall governance does not improve.
Hence, fiscal policy measures to fund a social safety system,
combined with investment in health, education and infrastructure
need to be implemented so that growth benefits all income
groups and not just a privileged minority. At the same time, tax
reform needs to focus on widening the tax base and improving
compliance (with an eye on equity) in order to reduce the tax
evasion component of illicit flows. However, tax reform alone
will not succeed in curtailing tax evasion if the quality of
government services does not improve, that is if tax payers
feel that they are not getting their money's worth in terms of
better infrastructure and better access to health, education,
and social services.
5.3 Governance and Corruption
Corruption distorts public policies in that resources are
allocated not based on efficiency or internal rates of return
but in favor of those who are willing and/or able to bribe or
pay kickbacks to public officials. Weak governance spawns public
corruption and encourages corporate malfeasance. Public
corruption typically involves the abuse of authority or trust
for private benefit. But this is a temptation indulged in not
only by government officials but also by rent-seekers in private
enterprises and nonprofit organisations. In general, poor
governance provides greater latitude for corruption, both in the
public and private sectors, so long as the corrupt are
convinced that they are likely to get away with the loot. The
misallocation of resources also hurts the private sector because
infrastructure tends to get neglected even as the corrupt enrich
themselves at the expense of the state. The impact on the poor
is particularly harmful because the siphoning of funds reduces
resources for social programmes and investments in the MDGs.
The state of governance and the extent and type of corruption
will vary considerably from one LDC to the next depending upon
institutional weaknesses, cultural and historical propensities,
economic structure and policies, state of bureaucracy, etc.
Hence, the policies needed to strengthen governance and curtail
the generation of illicit funds would also vary depending on
these factors.
...
7. Concluding Remarks
This paper argues that certain structural characteristics such
as low domestic savings and the resulting aid dependence and
growth in external debt may be driving illicit flows in some
LDCs. The poorest developing countries will continue to rely on
tariff revenues as a major source of revenues given weak
domestic taxation, and as long as such duties are levied,
smuggling will continue. In addition, the significant fiscal
deficits in many LDCs may well be driving tax evasion as higher
deficits signal to private markets that direct and indirect
taxes may have to increase in the medium term in order to close
the gap. Even higher rates of economic growth achieved by some
LDCs in recent years could act as a driver of illicit capital if
growth is not accompanied by a better distribution of income.
The method used to estimate illicit financial flows from LDCs is
based on the World Bank Residual model adjusted for trade
mispricing � a methodology widely used among economists. This
approach was modified in two important ways. First, illicit
inflows are not netted out of outflows. Second, a higher and
lower estimate of illicit flows for each LDC was derived
corresponding, respectively, to those that do not meet certain
conditions and those that do.
Based on this methodology, the study found that illicit
financial flows from many LDCs are significant, both in US
dollar terms and as a percent of GDP. In some LDCs, illicit
financial flows outpace ODA. The results are indicative given
difficulties associated with reliable data collection and the
fact that various methodological approaches exist to measure and
quantify illicit flows. Nevertheless, given the scale of the
development challenges which face the LDCs, these preliminary
results demonstrate a clear need for further work in this area,
especially by the LDCs themselves in collaboration with relevant
multilateral bodies. UNDP stands ready to support LDCs and
other developing countries in their efforts to curtail illicit
financial flows in support of the MDGs. In particular, it can
support countries to exchange practical information, experience
and lessons learned on ways to tackle this problem.
...
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with a particular focus on U.S. and international policies.
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