Illicit financial flows: Outflows of capital have cracked the $1 trillion plateau
Illicit Financial Flows From Developing Countries: 2004-2013 by Dev Kar and Joseph Spanjers, Global Financial Integrity
This report, the latest in a series of annual reports by Global Financial Integrity (GFI), provides estimates of the illicit flow of money out of the developing world—hereafter referred to as illicit financial flows (IFFs) or illicit outflows—from 2004 to 2013, the most recent ten years for which data are available.
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The study finds that during this ten-year period, the developing world as a whole lost US$7.8 trillion (see Table X1). In real terms, these flows increased at 6.5 percent per annum (see Chart 2). After a slowdown during the global financial crisis, illicit outflows have been rising, topping US$1 trillion since 2011 and reaching a new peak of US$1.1 trillion in 2013 (see Table X1).
GFI measures illicit financial outflows using two sources: 1) deliberate trade misinvoicing (gross excluding reversals or GER) and 2) leakages in the balance of payments (hot money narrow or HMN). Trade misinvoicing is the primary measurable means for shifting funds out of developing countries illicitly. Over the ten-year time period of this study, an average of 83.4 percent of illicit financial outflows were due to the fraudulent misinvoicing of trade (see Table X2, Chart 7).
This report nearly triples the number of countries—from 19 to 56—for which a more precise trade misinvoicing calculation is used by comparing those countries’ trade to that of individual advanced economies, rather than to advanced economies as a group or to the world as a whole. Data on trade between individual developing and advanced countries are preferable to trade data showing flows between the former and an aggregate of the latter. This is because traders do not misinvoice exports or imports vis-à-vis a group. They always misinvoice their transactions relative to a specific country. So an “advanced country” group is nothing but a statistical artifact—no such group exists in the minds of traders.
This expansion revises the aggregate illicit flows figures upwards compared to GFI’s two most recent annual reports; for example, the total IFF figure for 2012 has risen 4.5 percent since our most recent publication (see Table A). Aside from the expanded coverage, no other methodological changes were introduced in this report relative to GFI’s two most recent annual updates. Changes in the IFF estimates presented herein are otherwise due to regular revisions of the underlying data by country statistical agencies and the IMF.
Asia remains the region of the developing world with the most significant volume of illicit financial flows, comprising some 38.8 percent of the developing world total over the ten years of this study. Asia is followed by the Developing Europe region (25.5 percent), the Western Hemisphere (20.0 percent), Sub-Saharan Africa (8.6 percent), and the MENA+AP (Middle East, North Africa, Afghanistan, and Pakistan) region at 7.1 percent (see Chart 3).
Similarly, Asia saw the fastest growth rate in illicit financial flows from 2004 to 2013, registering an average annual increase of 8.6 percent over that period. Developing Europe and the MENA+AP regions followed (each increasing at an average annual rate of 7.0 percent) and were in turn followed by the Western Hemisphere (3.4 percent) and Sub-Saharan Africa (3.0 percent; see Chart 2).
Sub-Saharan Africa tops the list when illicit financial flows are scaled as a percentage of gross domestic product (GDP), with illicit financial outflows averaging 6.1 percent of the region’s GDP. Developing Europe follows at 5.9 percent of GDP, Asia at 3.8 percent, the Western Hemisphere at 3.6 percent, and MENA+AP at 2.3 percent (see Table E).
The report also compares illicit financial flows to official development assistance (ODA) and foreign direct investment (FDI). illicit financial flows have exceeded those measures—combined—for seven of the ten years of this study. Despite these substantial recorded inflows, the continued growth of unrecorded, illicit outflows has a pernicious impact on development aspirations in many countries. For example: for every dollar of ODA that entered the developing world in 2012, ten dollars flowed out illicitly.
Given the particularly high level of illicit flows due to trade misinvoicing, this report includes a special section that examines the phenomenon in the context of trade based money laundering (TBML) in drug-producing and/or drug-trafficking states. By comparing trade misinvoicing figures to total trade in drug-producing and drug-trafficking states, there are indications that drug traffickers may be using trade misinvoicing to shift ill-gotten gains.
This year, illicit financial flows became part of development orthodoxy in the UN’s Sustainable Development Goals and at the Financing for Development Conference in Addis Ababa. World leaders still have much to do to curb the opacity in the global financial system that facilitates these outflows. GFI recommends a number of steps that governments and other international regulators can take to develop greater financial transparency and curtail illicit outflows.
- Governments should establish public registries of verified beneficial ownership information on all legal entities, and all banks should know the true beneficial owner(s) of any account opened in their financial institution.
- Government authorities should adopt and fully implement all of the Financial Action Task Force’s anti-money laundering recommendations; laws already in place should be strongly enforced.
- Policymakers should require multinational companies to publicly disclose their revenues, profits, losses, sales, taxes paid, subsidiaries, and staff levels on a country-by-country basis.
Tax Information Exchange
- All countries should actively participate in the worldwide movement towards the automatic exchange of tax information as endorsed by the OECD and the G20.
- Customs agencies should treat trade transactions involving a tax haven with the highest level of scrutiny.
- Governments should significantly boost their customs enforcement by equipping and training officers to better detect intentional misinvoicing of trade transactions, particularly through access to real-time world market pricing information at a detailed commodity level.
- The indicator for SDG goal 16.4 should be country-level estimates of illicit outflows related to misinvoiced trade and other sources based on currently available data, and the International Monetary Fund or another qualified international institution should conduct and publish the analysis annually.
- Governments should sign on to the Addis Tax Initiative to further support efforts to curb illicit financial flows as a key component of the development agenda.
The massive outflows of illicit capital shown in this study are likely to adversely impact domestic resource mobilization and hamper sustainable economic growth. As such, it is necessary to consider the role of illicit outflows in any discussion of the development equation. We should not only look at the volume of resources flowing into developing countries but also the illicit leakages of capital from the balance of payments and trade misinvoicing. Governments and international organizations must strengthen policy and increase cooperation to combat this scourge.
- The corrosive impact illicit financial flows (IFFs) have on economic progress and poverty alleviation efforts became part of development orthodoxy in 2015. In July, the Addis Ababa Action Agenda of the Third International Conference on Financing for Development was adopted and commits all nations to “redouble efforts to substantially reduce illicit financial flows by 2030, with a view to eventually eliminating them.”1 Furthermore, noting the report of the High Level Panel on Illicit Financial Flows from Africa,2 the Addis Action Agenda invites “appropriate international institutions and regional organizations to publish estimates of the volume and composition of illicit financial flows.”3 Global Financial Integrity’s Illicit Financial Flows from Developing Countries: 2004-2013 is just that: an estimate of the volume and composition of illicit financial flows at the country level and disaggregated by type.
- The United Nations adopted the Sustainable Development Goals (SDGs) in September, which includes, in Goal 16.4, a target that countries will “by 2030, significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organized crime.”4 This statement, coupled with that seen in the Addis Action Agenda, underscores the international community’s recognition of the severity of the illicit flows challenge and its embrace of efforts to tackle illicit flows in order to promote development and vigorous societies.
- illicit financial flows are illegal movements of money or capital from one country to another. GFI classifies such flows as illicit if the funds crossing borders are illegally earned, transferred, and/or utilized.5 If the flow breaks a law at any point, it is illicit.
- The primary tool for transferring illicit financial flows is trade misinvoicing—according to this report, trade misinvoicing accounted for 83.4 percent of measurable illicit financial flows on average (see Chart 7), an average of US$654.7 billion per year. The misinvoicing of trade is accomplished by misstating the value or volume of an export or import on a customs invoice. Trade misinvoicing is a form of trade-based money laundering made possible by the fact that trading partners write their own trade documents, or arrange to have the documents prepared in a third country (typically a tax haven), a method known as re-invoicing. Fraudulent manipulation of the price, quantity, or quality of a good or service on an invoice allows criminals, corrupt government officials, and commercial tax evaders to shift vast amounts of money across international borders quickly, easily, and nearly always undetected.
- This study only covers misinvoicing of goods trade. We do not include estimates of misinvoicing involving services trade due to the lack of bilateral trade data on services, which has been a growing component of world trade. This is an important reason why these estimates of illicit flows from developing countries are likely to be under- rather than overstated.
- By their nature, illicit financial flows are typically intended to be hidden. Given this, even those types of illicit flows that can be measured can be difficult to estimate with complete precision. Additionally, there are some forms of illicit flows that cannot be picked up using available economic data and methods. For example, cash transactions, same-invoice faking, misinvoicing in services and intangibles, and hawala transactions are simply not registered directly in available economic data. Thus, we characterize the estimates presented here as likely to be very conservative. Nonetheless, they fill a critical gap in the literature and amply demonstrate the scale of the problem.
- The volume of illicit outflows is staggering and expanding quickly. Growing at an average annual rate of 6.5 percent and topping US$1 trillion since 2011 (see Chart 1), illicit financial flows are a development challenge that merits serious attention and action from domestic and international policymakers towards improving financial transparency.
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