Illicit financial outflows: a Illicit financial outflows: a pressing African Problem pressing African Problem

Necessitating a Global SolutionNecessitating a Global Solution

Senior Policy Seminar on Capital Flight from Senior Policy Seminar on Capital Flight from AfricaAfrica

10 & 11 April, Addis Ababa10 & 11 April, Addis Ababa

Gamal IbrahimGamal IbrahimUNECAUNECA

OUTLINEOUTLINE o ContextContext

o Concept and definition Concept and definition

o Transition from Capital Flight to IFF Transition from Capital Flight to IFF

o Drivers and Composition of IFFDrivers and Composition of IFF

o IFF estimates in developing countriesIFF estimates in developing countries

o Methodology : measuring IFF Methodology : measuring IFF

o Development impact of IFFDevelopment impact of IFF

o Political Economy of IFFPolitical Economy of IFF

o ConclusionConclusion

o Key recommendations for policy makers Key recommendations for policy makers

ContextContext Illicit Financial flows (IFFs) out Africa remain a Illicit Financial flows (IFFs) out Africa remain a

major concern because of their scale and impact on major concern because of their scale and impact on Africa’s economies, development and governance Africa’s economies, development and governance agenda.agenda.

Over USOver US$$ 854bn lost to IFF between 1970-2008, a 854bn lost to IFF between 1970-2008, a yearly average of about yearly average of about $22bn$22bn

IFF on the increase especially in the last decade, IFF on the increase especially in the last decade, with average annual losses of $50bn between 2000 with average annual losses of $50bn between 2000 and 2008and 2008

Estimates likely understate the true extent of IFF Estimates likely understate the true extent of IFF because data are not always available on all forms because data are not always available on all forms e.g. smuggling and mispricing of servicese.g. smuggling and mispricing of services

ContextContext

• The vulnerability of African countries to IFF The vulnerability of African countries to IFF underscores the urgent for a well-underscores the urgent for a well-coordinated African response to guide coordinated African response to guide regional and national policy-making. regional and national policy-making.

• The establishment of the High level Panel on The establishment of the High level Panel on Illicit Financial Flows from Africa, chaired by Illicit Financial Flows from Africa, chaired by President Thabo Mbeki, was essentially a President Thabo Mbeki, was essentially a response to the urgent need for systematic response to the urgent need for systematic changes at national, regional, and global changes at national, regional, and global levels through greater public pressure and levels through greater public pressure and sensitization to secure a strong African sensitization to secure a strong African voice in the global arenavoice in the global arena

Concept and definition: Concept and definition: Capital Flight & IFFCapital Flight & IFF

•Capital FlightCapital Flight: : anan exodus of funds exodus of funds and financial assets abroad to secure and financial assets abroad to secure better financial returns (Kant, 2002)better financial returns (Kant, 2002)

• IFF: IFF: funds exiting the countryfunds exiting the country that are that are illegallyillegally earned, transferred or used, at earned, transferred or used, at its origin, or during movement of use.its origin, or during movement of use.(Reuter, 2012 and Kar & Cartwright-(Reuter, 2012 and Kar & Cartwright-smith, 2010)smith, 2010)

Transition from capital flight Transition from capital flight to IFFto IFF

Capital Flight

Licit Financial

Flows (LFF)

Illicit Financial

Flows (IFF)

Corruption

Organized crime

Commercial activities

Export under

invoicingTrade mis-

pricing / trade mis-invoicing

Import over invoicing

Transfer pricing

Drivers of IFFDrivers of IFF

Composition of IFF (globally)Composition of IFF (globally)

Source: Baker (2005), quoted by Kar and Cartwright-Smith (2010).Source: Baker (2005), quoted by Kar and Cartwright-Smith (2010).

5%

35%

60%

Corruption(bribery and embezzlement of national wealth)

Criminal activities(trade in drugs, weapons and people)

Commercial transactions through MNCs

IFF Estimates in developing IFF Estimates in developing countriescountries

Methodology : Hot Money and Methodology : Hot Money and Dooley MethodsDooley Methods

Four Methods:Four Methods:

• The Hot Money Method:The Hot Money Method: records IFFs records IFFs through net errors and omissions in through net errors and omissions in payment balances.payment balances.

• The Dooley Method:The Dooley Method: relies on the relies on the

privately held foreign assets reported in privately held foreign assets reported in the balance of payments that do not the balance of payments that do not generate investment income.generate investment income.

Methodology : World BANK Methodology : World BANK Residual MethodResidual Method

• The World Bank Residual Method: The World Bank Residual Method: It Estimates It Estimates IFFs as the difference between the source of IFFs as the difference between the source of funds (External debt and FDI) and the use of funds (External debt and FDI) and the use of funds (Current account deficit and reserves)funds (Current account deficit and reserves)

Source of fundsSource of funds Use of fundsUse of funds

• If IFF < 0If IFF < 0 Then there are inward transfers or Then there are inward transfers or illicit capital illicit capital

]Re....[)](..[ servesBalanceCAnetFDIDebtExternalIFF

Methodology : IMF-DOTS and Methodology : IMF-DOTS and UNECA MethodsUNECA Methods

• The IMF-DOTS based Trade Mispricing The IMF-DOTS based Trade Mispricing

Method(Mostly use in literature): Method(Mostly use in literature): It assesses It assesses

IFFs by looking at disparities arising from IFFs by looking at disparities arising from

over-invoicing of imports and under-invoicing over-invoicing of imports and under-invoicing

of exports after adjusting for ordinary price of exports after adjusting for ordinary price

differences.differences.

The UNECA methodology builds on the IMF’s DOTS- The UNECA methodology builds on the IMF’s DOTS-

based trade mispricing model with minor differences:based trade mispricing model with minor differences:

Methodology : IMF-DOTS and Methodology : IMF-DOTS and UNECA MethodsUNECA MethodsUNECA methodology Vs IMF DOTS Methodology UNECA methodology Vs IMF DOTS Methodology

Data source used:Data source used:

•IMF methodology uses Exports/Imports statistics IMF methodology uses Exports/Imports statistics from DOTS at the country level(aggregated) from DOTS at the country level(aggregated)

•But UNECA methodology uses UN COMTRADE But UNECA methodology uses UN COMTRADE data which provides bilateral trade information data which provides bilateral trade information for more than 200 countries - including most for more than 200 countries - including most African countries - and 5,000 products at the African countries - and 5,000 products at the harmonized System 6-digit (HS6) level.harmonized System 6-digit (HS6) level.

Methodology : IMF-DOTS and Methodology : IMF-DOTS and UNECA MethodsUNECA MethodsUNECA methodology vs IMF DOTS Methodology (Cont)UNECA methodology vs IMF DOTS Methodology (Cont)

Unit of comparison (C.I.F vs F.O.B)Unit of comparison (C.I.F vs F.O.B)

•Most (if not all) studies using the IMF DOTS methodology Most (if not all) studies using the IMF DOTS methodology interact interact a fixed coefficient(10%)a fixed coefficient(10%) to get an import F.O.B (in to get an import F.O.B (in accordance to DOTS practice) accordance to DOTS practice)

•But UNECA methodology uses Exports (F.O.B) statistics But UNECA methodology uses Exports (F.O.B) statistics from UN COMTRADE, while using imports (F.O.B) from BACI from UN COMTRADE, while using imports (F.O.B) from BACI dataset (World trade dataset developed by CEPII)dataset (World trade dataset developed by CEPII)

•In UNECA methodology, time lags exports/imports In UNECA methodology, time lags exports/imports processes is accounted for, using time taken (World Bank processes is accounted for, using time taken (World Bank dataset) for export/import between bilateral trade dataset) for export/import between bilateral trade partners. partners.

UNECA MethodologyUNECA Methodology• The analysis focuses only on the trade The analysis focuses only on the trade

mispricing branch of the commercial mispricing branch of the commercial transactions through MNEs;transactions through MNEs;

• UNECA’s methodology is particularly innovative UNECA’s methodology is particularly innovative in the way it isolates IFF from the other in the way it isolates IFF from the other sources of trade mispricing:sources of trade mispricing:

o Utilises countries’ exports and imports data from UN Utilises countries’ exports and imports data from UN COMTRADE at the Harmonized System at 6-digit level COMTRADE at the Harmonized System at 6-digit level and the BACI databaseand the BACI database;;

o Model accounts for time lags in exports/imports Model accounts for time lags in exports/imports reporting process Adopts a net approachreporting process Adopts a net approach..

Empirical EvidenceEmpirical Evidence• Africa lost in average Africa lost in average USUS$ $ 50 billion a year via IFF 50 billion a year via IFF

from trade mis-pricing between 2000 and 2008from trade mis-pricing between 2000 and 2008

• Two-third of IFFs were attributed to only two Two-third of IFFs were attributed to only two regions between 1970 and 2008: West Africa (38 regions between 1970 and 2008: West Africa (38 per cent) and North Africa (28 per cent)per cent) and North Africa (28 per cent)

• Great significance of IFFs from oil-exporting Great significance of IFFs from oil-exporting countries dominated by North and West African countries dominated by North and West African regions (Nigeria, Egypt, Algeria) and non oil-regions (Nigeria, Egypt, Algeria) and non oil-exporting countries (South Africa, Morocco, Côte exporting countries (South Africa, Morocco, Côte d’Ivoire and Ethiopia)d’Ivoire and Ethiopia)

Empirical EvidenceEmpirical Evidence

Top 10 Top 10 African countries by cumulative IFFs, African countries by cumulative IFFs, 1970-20081970-2008

Source: Based on Kar and Cartwright-Smith(2010)Source: Based on Kar and Cartwright-Smith(2010)

# Country Cumulative IFFs (1970-2008) USUS$ Billion$ Billion

Share in Africa’s total IFFs

1 Nigeria 217.7 30.5%

2 Egypt 105.2 14.7%

3 South Africa 81.8 11.4%

4 Morocco 33.9 4.7%

5 Angola 29.5 4.1%

6 Algeria 26.1 3.7%

7 Côte d’ivoire 21.6 3.0%

8 Sudan 16.6 2.3%

9 Ethiopia 16.6 2.3%

10 Congo, Republic

16.2 2.3%

Empirical EvidenceEmpirical Evidence

• More than half (i.e. 56%) of the IFFs from the More than half (i.e. 56%) of the IFFs from the African continent over the 10 years period African continent over the 10 years period (2000 – 2008) comes from (2000 – 2008) comes from oil, precious metals oil, precious metals and minerals, ores, iron and steel, and copperand minerals, ores, iron and steel, and copper. . These are highly concentrated in very few These are highly concentrated in very few countriescountries

• Sectors such as edible fruit and nuts, electrical Sectors such as edible fruit and nuts, electrical machinery and equipment, fish and machinery and equipment, fish and crustaceans, apparel and cacao account for crustaceans, apparel and cacao account for (each of them) between 3% and 4% of the total (each of them) between 3% and 4% of the total IFFs from the continent.IFFs from the continent.

Empirical EvidenceEmpirical Evidence

• In countries with relatively large amounts of In countries with relatively large amounts of IFFs, there is a concentration in one sector of IFFs, there is a concentration in one sector of the economythe economy

• Main destinations of IFF from African countries: Main destinations of IFF from African countries: developed countries (especially, the United developed countries (especially, the United States, Europe, Canada, Japan and Korea) and States, Europe, Canada, Japan and Korea) and emerging economies (such as China, India)emerging economies (such as China, India).

Development Impact of IFF from Development Impact of IFF from AfricaAfricaDamaging effects of IFFs on African countries include: Damaging effects of IFFs on African countries include:

o Draining resources and tax revenues:Draining resources and tax revenues: Africa lost Africa lost about about USUS$ 854 billion$ 854 billion in IFFs over and continue to in IFFs over and continue to lose lose USUS$ 50-148 billion a year$ 50-148 billion a year; ;

o Stifling growth:Stifling growth: If illicit outflows of funds had not If illicit outflows of funds had not taken place, GDP per capita would have been taken place, GDP per capita would have been 16 per 16 per cent higher cent higher (Ndikumana and Boyce, 2008-2011)(Ndikumana and Boyce, 2008-2011)

o Perpetuating economic dependence and Perpetuating economic dependence and constraining structural transformation:constraining structural transformation: ODA to ODA to Africa (Africa (USUS$ 46 billion in 2010)$ 46 billion in 2010) is less than is less than USUS$ 50 $ 50 billion lost annually through IFFs.billion lost annually through IFFs.

o

Development impact of IFF from Development impact of IFF from AfricaAfrica

IFFs from developing countries:IFFs from developing countries:

o Prevent governments from providing public services;Prevent governments from providing public services;

o Undermine poverty reduction, skewing income Undermine poverty reduction, skewing income distribution and leading to economic and political distribution and leading to economic and political instability;instability;

o Weaken governance;Weaken governance;

o Decrease public spending on health, education and Decrease public spending on health, education and public infrastructure needed to reach the MDGs: public infrastructure needed to reach the MDGs: Each Each additional dollar debt service implies 29 fewer cents additional dollar debt service implies 29 fewer cents spent on public healthspent on public health. . An additional infant in Africa An additional infant in Africa dies for every reduction of dies for every reduction of USUS$ 40,000 in health $ 40,000 in health spending spending (Boyce and Ndikumana, 2011).(Boyce and Ndikumana, 2011).

• ..

Political Economy of IFFPolitical Economy of IFF

• IFF undermine the ability of governments to IFF undermine the ability of governments to implement economic policies that run against implement economic policies that run against the powerful interest groups that oppose these the powerful interest groups that oppose these policiespolicies

• Financial globalization has provided a Financial globalization has provided a conducive environment for a ‘capital strike’ conducive environment for a ‘capital strike’ against undesired taxation or regulatory against undesired taxation or regulatory policies;policies;

• This has wider implications on the nature and This has wider implications on the nature and the modes of development in Africa and the the modes of development in Africa and the orientation of the domestic capitalists.orientation of the domestic capitalists.

Political Economy of IFFPolitical Economy of IFF • The incentives facing economic and political The incentives facing economic and political

elites have been shaped particularly by the elites have been shaped particularly by the major changes in the global economy that took major changes in the global economy that took place since the late 1970s: place since the late 1970s:

o Financial deregulation and the emergence of Financial deregulation and the emergence of the global shadow financial system;the global shadow financial system;

o Increased demand for natural resources.Increased demand for natural resources.

A Global Solution to an African A Global Solution to an African ProblemProblem• There are various international conventions and There are various international conventions and

agreements that aim to curtail the various agreements that aim to curtail the various forms of illicit financial flows.forms of illicit financial flows.

• Though the scope and breadth of these Though the scope and breadth of these initiatives comprise a good first step in initiatives comprise a good first step in curtailing IFF, many issues still remain i.e. curtailing IFF, many issues still remain i.e. some countries have not ratified the UNCAC and some countries have not ratified the UNCAC and are therefore not required to cooperate with its are therefore not required to cooperate with its mandates; and loopholes in the international mandates; and loopholes in the international legal framework and differences between legal framework and differences between legislations in the Northern countries and Africa legislations in the Northern countries and Africa prohibit the effective investigation of IFF.prohibit the effective investigation of IFF.

A Global Solution to an African A Global Solution to an African ProblemProblem

• One of the important barriers in the search for One of the important barriers in the search for a global solution to combat IFF is the lack of an a global solution to combat IFF is the lack of an institutional home for global governance on institutional home for global governance on these flows which can provide an outlet for these flows which can provide an outlet for policy debate and implementation.policy debate and implementation.

• Curtailing IFF requires concerted and Curtailing IFF requires concerted and simultaneous efforts by both Northern and simultaneous efforts by both Northern and Southern countriesSouthern countries

ConclusionConclusion• Broad-based coalition against IFF;Broad-based coalition against IFF;

• Curtailing IFF requires concerted and Curtailing IFF requires concerted and

simultaneous efforts by both Northern and simultaneous efforts by both Northern and

Southern countries; Southern countries;

• Strengthen regulatory frameworks and build Strengthen regulatory frameworks and build

national capacity;national capacity;

• Strengthen regulation of the domestic banking Strengthen regulation of the domestic banking

and finance sector;and finance sector;

• Encourage economic diversificationEncourage economic diversification

• Improve institutional frameworks for African Improve institutional frameworks for African

countries and support sharing of good practices: countries and support sharing of good practices:

i.e. APRMi.e. APRM

Key Policy RecommendationsKey Policy Recommendations• African leaders should seek strong political African leaders should seek strong political

commitment from destination countries to commitment from destination countries to strengthen transparency in international financial strengthen transparency in international financial transactions;transactions;

• Requiring greater transparency in the banking Requiring greater transparency in the banking system, whereby banks would ascertain the system, whereby banks would ascertain the identity, source of wealth and country of origin of identity, source of wealth and country of origin of their depositors and deposits;their depositors and deposits;

• Requiring MNCs to report regularly on their Requiring MNCs to report regularly on their employees, sales, financing, tax obligation and employees, sales, financing, tax obligation and payments on a country-by-country basis.payments on a country-by-country basis.

THANK YOU FOR YOUR THANK YOU FOR YOUR ATTENTION !!!!!!ATTENTION !!!!!!