Global Financial Integrity

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Want Sustainable Development? Mobilize Domestic Resources, Curtail Illicit Capital Flows

Raymond Baker

This article was originally published by Devex.

How is it that some of the countries endowed with enormous natural resource wealth — like Angola with its huge oil supply, Zambia with its massive copper reserves, or the Democratic Republic of the Congo with its vast mineral deposits — remain some of the poorest nations in the world?

Global Financial Integrity estimates that developing and emerging economies lose nearly one trillion dollars each year in illicit financial outflows, roughly ten times the amount of official development assistance these countries receive.

The overwhelming majority of these illicit flows — the proceeds of crime, corruption, and tax evasion — occur through the misinvoicing of trade transactions. Meanwhile, the problem has an outsized impact on Africa, where the ratio of illicit outflows to GDP is larger than any other region in the world. Even after accounting for recorded transfers — such as exports, imports, foreign direct investment, development assistance or remittances — the continent of Africa is a net creditor to the rest of the world. More capital is flowing out than in.

new GFI report funded by the Danish government and published this week examines illicit financial flows and the impact of trade misinvoicing in five African countries — Ghana, Kenya, Mozambique, Tanzania, and Uganda — all Danish priority countries and long-standing partners in development cooperation.

The over- and under-invoicing of trade channeled at least $60.8 billion illegally into or out of the five nations between 2002 and 2011, hampering economic growth and potentially resulting in billions of lost tax revenue. While — due to data issues, varying customs rates by commodity and sector, and various other factors — it is difficult to assess the true tax revenue loss stemming from trade misinvoicing, the report suggests that the loss to taxpayers may have amounted to a massive 12.7 percent of Uganda’s entire government revenue over the period, followed by Ghana (11 percent), Mozambique (10.4 percent), Kenya (8.3 percent) and Tanzania (7.4 percent).

These numbers should alarm policymakers worldwide.

The potential revenue drain from trade misinvoicing means that Ghana has less money to spend on healthcare, Kenya has less money to devote to education, and Mozambique has less money to invest in infrastructure. Trade misinvoicing is perhaps the most serious economic issue plaguing these countries.

As we prepare to transition into the post-2015 development agenda, illicit financial flows and, specifically, trade misinvoicing must be top priorities for policy makers and researchers. Donors need to fund more research on the specific drivers and consequences of trade misinvoicing in these countries, so government officials can make and implement informed policies to curb the practice, boost government revenues, and foster domestic investment. On the international stage, more must be done to address the opacity in the international financial system that facilitates trade misinvoicing and other forms of illicit flows.

The global movement toward automatic exchange of tax information is a welcome advance to curbing the tax haven secrecy that enables these illicit flows. While the G-20 has agreed to begin exchanging such information by the end of 2015, rich countries must ensure that developing countries, who suffer the most from illicit flows, also benefit from the program. Donors should fund capacity building and technical assistance projects in the developing world to make sure that tax authorities in countries like Ghana, Kenya, Mozambique, Tanzania and Uganda can participate in automatic exchange of information as soon as practicable.

Global efforts are also needed to curb the abuse of anonymous shell companies, another pillar of illicit finance. We applaud the United Kingdom for announcing the creation of a public registry of all U.K. companies — such registries are considered the gold standard in curtailing the nefarious use of anonymous entities. More nations should follow suit. The European Parliament voted overwhelmingly last month in favor of public registries, and one hopes that the European Council will quickly assent to the proposal. Such a move would go a long way toward curbing the terrible flow of dirty money.

Of course, illicit flows are a two-way street, and African nations must likewise improve transparency in their own incorporation processes. Two of the countries analyzed in this study — Kenya and Ghana — are the easiest and fifth-easiest countries in the world, respectively, for money launderers and terrorists to open anonymous shell companies, according to a 2012 study. Any domestic effort to curtail illicit capital flight and boost revenues in Ghana and Kenya should include public registries of beneficial ownership information.

While the precise magnitude and consequences of illicit financial flows in African countries — and throughout the developing world — deserve further analysis, it is clear that such flows are wreaking havoc on the continent. Any sustainable approach to global development has to curtail illicit flows and the mechanisms facilitating them. Only then will we be able to mobilize domestic resources for long-term development.

Raymond Baker is president of Global Financial Integrity, a Washington, D.C.-based research and advocacy organization analyzing illicit financial flows and promoting pragmatic transparency measures in the international financial system as a means to global development and security.