Abstract
Over the recent years illicit financial flows have attracted increasing attention from researchers and policy makers because of their negative effects on poor countries. In 2013 the mostly rich countries’ OECD acknowledged illicit flows as an issue of “central importance”. Since 2003, the Center for Global Development has been publishing the Commitment to Development Index (CDI) which ranks rich countries on their policies which affect poor countries. This paper rationalizes the inclusion of indicators of policies affecting illicit financial flows in the CDI, in addition to the previously included policies of aid, trade, migration, environment, security, technology and investment. It provides a survey of existing approaches to measuring illicit financial flows, discusses possible metrics which could be included in the CDI, evaluates how such indicators might be incorporated into the CDI, and proposes changes to current CDI indicators. The qualitative indicators of the Financial Secrecy Index emerge as the best contribution to the newly renamed and updated finance component of the CDI.
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Notes
Paraphrasing the opening questions of Moran (2012), earlier documented in Moran (2006). Conceptually, Moran (2012) assesses how rich country efforts can make the supposedly good (investment) even better, whereas this article assesses how rich country efforts can make the supposedly bad (illicit flows) somewhat better for poor countries. In a similar way that I am going to argue that not all illicit financial flows are necessarily bad, it also holds that hardly any type of financial flows is necessarily good. For example, the evidence of benefits of foreign direct investment for poor countries is not as strong as commonly thought (Select Committee on Economic Affairs 2012).
The positive role of financial linkages is partially accounted for in the 2012 CDI’s aid and investment components, whereas the negative role of illicit financial flows out of poor countries—largely absent from the 2012 CDI and a topic on which there is generally not much analytical or academic work—is taken up here and has been recently highlighted in a topical book published by the World Bank, Reuter (2012).
Even if the illicit financial flows were somewhat lower than these estimates suggest, they would still be large enough to deserve more attention and curtailing them would still represent a huge opportunity for poor countries. Also, the head of the OECD, Gurría (2008), stated that poor countries could be losing three times the amount they receive in aid because of illicit financial flows in the form of tax evasion and avoidance through tax havens.
The focus here is mostly on the prevention part, mostly because of limited focus and space, but, to some extent, because there seems to be more perspective in reducing the flows rather than recovering the assets, as noted by Peter Reuter on page x of Reuter (2012). Nevertheless, the recovery of assets held illegally abroad, highlighted by the recent mass findings by a number of media organizations and reported, for example, by Leigh (2013) in the Guardian, is an important development issue for poor countries. Asset recovery was recently discussed by Marshall (2013) and it can, in a similar way to preventing future illicit financial flows and therefore increasing the assets, serve as an important source of development finance. Also, successful asset recovery seems to be a very good deterrent of future illicit financial flows.
Baker (2005) estimated that over 60 % of total illicit flows arise from legal commercial activities, and most of the remainder from criminal activities.
Tax evasion breaks the law, tax planning complies with the law and tax avoidance is somewhere in between, following the letter of the law, but not its intentions. The distinction between them is not always clear. Furthermore, of course, there are motivations other than tax behind shifting income abroad such as, as discussed by De Boyrie et al. (2005) or Fuest and Riedel (2012), the threat of expropriation or confiscation of private property, economic and political uncertainty, fiscal deficits, financial repression, or devaluation.
One specific example is analyzed in detailed by Action Aid (2013) and another, the case of Swiss commodity trade, by Cobham et al. (2014). These issues are more systematically discussed in the relevant parts of this paper as well as in OECD (2013d) and more systematic empirical evidence for poor countries is provided, for example, by Fuest and Riedel (2012) and also by Janský and Prats (2014). An earlier example of this analysis is Desai et al. (2004), who find that affiliates of a multinational based near a tax haven in which there is also an affiliate pay the equivalent of a 20 % lower tax rate than they would do otherwise.
One consequence of this can be that the resulting estimates are sometimes considered to be the best available estimates, since no better alternatives exist, but are not considered to be a reflection of the reality. In this and other ways, these methods are similar to those that estimate the losses caused by the existence of a shadow economy—for example, Schneider (2005) estimated that developing countries could lose as much as USD 285 billion.
A somewhat related policy index to the FSI is the Basel Anti-Money Laundering Index, which rates countries according to money laundering and terrorist financing risk, on the basis of components including international organizations’ ratings. Interestingly, the Index includes scores from the FSI (25 %). Because of its composite nature (a further 10 % is for example from the Transparency International’s Corruption Perceptions Index) and a narrow focus on anti-money laundering, the Index does not seem very suitable for calculating illicit financial flows accurately.
This description of the FSI refers to its 2011 edition, but the 2013 edition is not significantly different.
The FSI is not ideal or comprehensive, and an explanation of one of the reasons for this follows. The fact that many financially secret companies based in very secretive jurisdictions through links to other less and less secretive jurisdictions benefit from both from established markets and financial secrecy is a ladder-like aspect of the global financial system that FSI fails to capture. When dealing with illicit financial flows, it is often difficult to distinguish between countries of origin, conduits and ultimate destinations.
For example, Moran (2012) argues that “a tax sparing agreement helps the developing country to attract foreign direct investment by offering a low tax rate or a tax holiday”, whereas the FSI in a draft 2013 methodology (to be available at its website later in 2013) celebrates that “countries wishing to attract foreign investment will not feel compelled to lower the tax rates in the hope of increasing their inward stock of foreign investment”.
In the area of actions to prevent bribery and other corrupt practices abroad, there seems to be a logical consistency between the existing investment indicators and the proposed illicit financial flow components. They both aim to measure the policy efforts of rich countries to prevent bribery and other corrupt practices in poor countries, but largely employ different metrics and therefore rather complement than duplicate or even contradict each other. Furthermore, the two questions of the investment component focused on portfolio investments view them as being generally beneficial for poor countries, for which there is not overwhelming empirical evidence and also international policy consensus is shifting in a different direction. The investment component focuses on inflows in poor countries and the benefits, whereas the proposed finance component stresses flows out of poor countries and challenges and in this way the two components could complement each other, reflecting the fact that the world is, indeed, a complicated place.
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Acknowledgments
This work was supported in part by the Czech Science Foundation (under grant GACR 403/10/1235) and the Center for Global Development. I am grateful for comments on an earlier version to Annie Barton, John Christensen, Julia Clark, Michael Clemens, Alex Cobham, James Henry, Mike Lewis, Markus Meinzer, David Roodman, Nicholas Shaxson, Jan Straka, Francis Weyzig, and two anonymous referees. I am responsible, though, for any errors, omissions or misunderstandings.
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Janský, P. Updating the Rich Countries’ Commitment to Development Index: How They Help Poorer Ones Through Curbing Illicit Financial Flows. Soc Indic Res 124, 43–65 (2015). https://doi.org/10.1007/s11205-014-0779-3
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DOI: https://doi.org/10.1007/s11205-014-0779-3