Curbing illicit financial flows: How to raise $770bn for African Development

BY: Copenhagen Consensus Centre

If we think about development priorities for the next 15 years – with the Millennium Development Goals expiring in 2015 – adequate nutrition and basic education immediately come to mind. Illicit Financial Flows (IFF) will not be top priority, but in a paper for the Copenhagen Consensus Centre, economist Alex Cobham argues that they are important enough to be included in the post-2015 goals now being debated by the international community.

If we look at the cost of IFF, he clearly has a point: 20 sub-Saharan African countries are estimated to have lost more than 10 per cent  of their GDPs since 1980, while Africa as a whole is still estimated to be losing 3.4 per cent  of GDP, that is, US$76 billion, each year. The Washington-based think tank Global Financial Integrity (GFI) estimates illicit flows to total 10-times the current level of international aid. 

Nigeria offers a particularly egregious example of the problem. The well-respected governor of the central bank, Lamido Sanusi, was suspended for blowing the whistle on an apparent $20bn difference between the country’s recorded oil exports and those reported to the bank.

Illicit cash flows are not necessarily strictly illegal. Money laundering – transferring the proceeds of crime through apparently legitimate channels – is clearly illegal and the subject of stringent checks in the banking sector. Abuse of power by kleptocratic regimes to skim off a country’s wealth into Swiss bank accounts at the expense of the rest of society is morally wrong and often also criminal.

What is less clear-cut is the avoidance of tax; while being legal in the strict sense of the word, this is frowned on by society. Recently, this has become a big story in some countries as multinational companies have, quite legitimately, minimised their tax liabilities by being registered in a low-tax country and declaring their profit there while in practice doing most of their businesses elsewhere.

A recent study by GFI found that between 2002 and 2011, $60.8bn moved illegally into or out of Ghana, Kenya, Mozambique, Tanzania and Uganda, using trade misinvoicing. This practice means that companies alter the value of their exports and imports to justify illicitly moving money in and out of a country. 

The potential average annual tax loss from trade misinvoicing came to about 12.7 per cent  of Uganda’s total government revenue between 2002 and 2011, followed by Ghana (11.0 per cent ), Kenya (8.3 per cent ), and Tanzania (7.4 per cent ), GFI states. This tax revenue could have been invested in development, including education, healthcare, or infrastructure improvements.

While public exposure is often enough for companies to change practices to protect their reputation, Alex Cobham,  research fellow at the Centre for Global Development,  suggests transparency should be achieved via statutory public registers rather than investigative journalism and naming and shaming.

He makes three proposals: To make public full details of company ownership (that is, no Shell companies with the real owners remaining hidden), ensure that there is automatic exchange of tax information between jurisdictions and require multinationals to report on a country-by-country basis. This transparency should greatly reduce illicit transfers. 

Cobham proposes that one of the key targets for the UN system should be “Reduce to zero the legal persons and arrangements for which beneficial ownership infomation is not publicly available.” If this gave just a 10 per cent  reduction in the average losses to IFF in the decade from 2002, the benefit would be $768bn, but reducing current losses by half would raise this to a staggering $7.5tn. 

A wide range of compliance cost have also been estimated, but even using the highest of these ($66bn) with the lowest benefit scenario gives a very attractive benefit-cost ratio: for each dollar spent on the above goal, $13 would be gained.

However, these transparency proposals have to be as closely adhered to universally as possible if there is to be a substantial impact, otherwise more money will simply pass through other channels which remain open. The precedent of the existing anti-money laundering framework is not reassuring.

This system is universally accepted and most countries obey the letter of the law without stemming the flow of illegal money in practice. Even major international banks are sometimes found to have flagrantly flouted the rules. However, these systems are complex and varied and the wider transparency proposals have the benefit of greater simplicity, so perhaps we should be more optimistic about them. 

In an ideal world, it would not be possible for criminals to move their money about with impunity; neither should companies and individuals pay less tax than society deems to be fair in comparison with others. It is now up to us to consider whether it is worth putting scarce resources into trying to make the financial world more ideal, or whether there are better ways to use them.