Global Financial Integrity

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Illicit Financial Flows and their Impact on Development

Raymond Baker

Convened by the Government of Norway

Remarks by Raymond W. Baker
United Nations
New York

Secretary Stenhammer, Ambassador Lovald, Eva Joly, David Spencer, ladies, and gentlemen.

Thank you very much for convening this opportunity to discuss cross-border illicit financial flows and their impact on development.

2007 marks the 46th year of my involvement in the developing countries. I lived 15 years in Nigeria and over more than 30 additional years have now done business or research in some 60 developing and transitional economies. Across these years I have become a critic of corruption and poor governance and weak institutions in many countries. Having said this, I have become an even stronger critic of our—the West’s—facilitating role in corruption, poor governance, and weak institutions in many poorer countries. This has been the driving force of my interest for years.

This afternoon I would like to talk about the illicit financial structure that facilitates the movement of illicit money across borders and the harmful impact this structure and these financial flows have on poverty alleviation and economic growth.

Let us first of all get a simple picture of global poverty and inequality fixed in our thinking. Whether analyzed in currency exchange rates or in purchasing power parity, the picture of global income disparity is similar. Seventy to 90 percent of global income accrues to the top 20 percent of the world’s population, leaving only ten to 30 percent of global income for the bottom 80 percent of the world’s population.

As I go on to talk about illicit financial flows and the structure that supports the movement of these flows, it is important to understand that the primary motivation for this phenomenon is the shift of money from poor to rich, out of the hands of the 80 percent into the hands of the 20 percent, out of the countries where 80 percent of the world’s population lives into the countries where 20 percent of the world’s population lives.

So let us focus on the structure that supports cross-border illicit financial flows. Illicit money is money that is illegally earned, illegally transferred, or illegally utilized. If it breaks laws in its origin, movement, or use, it merits the label.

Illicit money comes in three forms—1) the proceeds of bribery and theft by government officials, 2) the proceeds of criminal activities including drugs, racketeering, and terrorist financing that combined slosh around the globe in the hundreds of billions of dollars, and 3) the proceeds of tax evasion and laundered commercial transactions.

Since the 1960s we in the West have built and expanded an entire global structure to facilitate the movement of illicit money across borders. There were a few elements of this structure available before the 1960s, but they were quite modest and not widely used.

The evolution of the structure took off in the 1960s for two reasons. First, this was the decade of independence. Between the late 1950s and the end of the 1960s, 48 countries gained their independence from colonial powers. Some of the economic and political elites in these countries wanted to take their money out by any means possible, and we in the West were very creative in providing mechanisms for the movement of flight capital out of poorer countries.

Second, the 1960s marked the decade when corporations began to spread their flags all across the planet. Yes, there were international businesses before then, but typically an international oil company or trading company had operations in only 12 or 15 foreign locales. The great thrust to spread all over the globe took off in the 1960s and has continued up to the present time. Many multinational corporations use abusive transfer pricing and tax evasion techniques to move profits across borders at will.

For these two reasons—decolonization and the spread of multinational corporations—the 1960s marked the point when the development of this structure took off in earnest.

This illicit financial structure now comprises a number of elements:

  • Tax havens   These are places where you can set up a non-functioning entity and then you can sell to this entity and it can sell to other entities, and you can structure the pricing in such a way that all or most of the profits are earned in the tax haven entity and it does not have to pay or pays only minimal taxes on such profits. There are now 72 tax havens around the world.
  • Offshore secrecy jurisdictions   These are places where you can establish these entities behind nominees and trustees such that no one knows who are the real owners and managers.
  • Disguised corporations   These disguised corporations now number in the millions around the world.
  • Anonymous trust accounts   You can establish trust accounts behind nominees and trustees, so that no one knows who are the donors to such trust accounts.
  • Fake foundations   You can set up a charitable foundation, donate money to this foundation, and then designate yourself the beneficiary of the charity of this foundation.
  • False documentation   Used in all sorts of trade and capital transactions.
  • Falsified pricing   Mispricing of imports and exports in international trade is by far the most frequently used part of this illicit financial structure. Indeed, abusive transfer pricing has become normalized in the activities of multinational corporations.
  • Money laundering techniques   Specialized devices for shifting disguised funds across borders.
  • Holes left in western laws   To facilitate the movement of money through this illicit financial structure and ultimately into our western economies.

All three forms of illicit money—the proceeds of bribery and theft, criminal activity, and commercial tax evasion—use this structure. It was developed by us in the West originally for the purpose of moving flight capital and tax evading money. In the late 1960s and 1970s, drug dealers stepped into these same structures to move their illicit money across borders. In the 1980s and 1990s, other racketeers, seeing how easy it was for the drug dealers, also stepped into these same structures to move their illicit money across borders. In the 1990s and in the current decade, terrorist financiers, again seeing how easy it was for drug dealers and other racketeers to do it, they too stepped into these same channels to move their illicit money across borders. Drug kingpins, criminal syndicate heads, and terrorist masterminds did not invent any new ways of shifting illicit money across borders. They simply stepped into the channels we had created for moving flight capital and tax evading money across borders.

Now perhaps you are thinking that anti-money laundering laws are supposed to take care of this problem. Well, yes and no. Many nations leave major gaps in their anti-money laundering legislation. For example, the United States bars only the incoming proceeds of drugs, bribery, and terrorism. It remains legal to bring into this country the proceeds of other kinds of racketeering, handling stolen property, credit fraud, counterfeiting, contraband, slave trading, alien smuggling, trafficking in women, environmental crimes, all forms of tax evading money, and more. All that can come legally into the United States. Most European countries have somewhat tighter laws on the books. Having said this, no western country does a particularly good job of enforcing a rigorous anti-money laundering regime.

For the first time in the 200-year run of the free market system, we in the West have created and expanded an entire integrated global financial structure the basic purpose of which is to shift illicit money from poor to rich.

We estimate that $1 to $1.6 trillion a year of illicit money moves across borders. We think this estimate is conservative, as do others who look at such figures. This $1 trillion a year or more and the structure that facilitates its movement is the biggest loophole in the global free-market system.

 Now, let us turn again to poverty and inequality. This $1 trillion or more a year and the structure that facilitates its movement is not only the biggest loophole in the global free-market system, it is also the most damaging economic condition affecting developing and transitional economies. It drains hard currency reserves, heightens inflation, reduces tax collection, worsens income gaps, cancels investment, hurts competition, and undermines trade. It leads to shortened lives for millions of people and deprived existences for billions more. Within the economic realm, as distinguishable from political affairs or environmental constraints, nothing else approaches the harmful effects of massive outflows of illicit money from poor countries to rich countries.

Of the $1 to $1.6 trillion of illicit money we estimate moves yearly across borders, we further estimate that half of it—$500 to $800 billion a year—comes out of developing and transitional economies. These are countries that often have weak legal and administrative structures.

Of the three categories of cross-border illicit money, the proceeds of bribery and theft are the smallest, at only about three percent of the global total. Criminal activity produces about 30 to 35 percent of the global total. The commercial component, driven by falsified pricing of imports and exports, is by far the largest component, at some 60 to 65 percent of the global total.

What I and my colleagues at Global Financial Integrity seek to do is get reality on the table. Reality is that there is a massive outflow of illicit money from developing and transitional economies, by our estimates some $500 to $800 billion a year. Compare this to foreign aid: foreign aid has been running about $50 to $80 billion a year through the 1990s and into the current decade. $50 to $80 billion of foreign aid in; $500 to $800 billion of illicit money out. In other words, for every $1 that we have been generously handing out across the top of the table, we in the West have been receiving back an estimated $10 under the table. There is no way to make this formula work for anyone, poor or rich.

Now let me close with two points. First, we don’t ask you to accept our numbers or our evaluation of the impact of such numbers on poorer countries. On the contrary, we ask you to do your own numbers. We ask the World Bank and the UN and other international institutions to do their own analysis of this extraordinarily damaging phenomenon.

Second, the Government of Norway has made such a request of the World Bank and has offered to fund a study of illicit financial flows and their impact on development. We are most grateful indeed for this courageous step by the Government of Norway and look forward to contributing in any way we can to this effort. This is one of the most important contributions we can together make toward achieving poverty alleviation, growth, and security for the majority of people in our shared world.