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Illicit Financial Flows SPOTLIGHT 13 Illicit financial flows In spring 2016, 11.5 million confidential documents but transferred out of the country illegally to evade were leaked from a private legal firm based in Pan- taxes or currency controls. There are many different ama. News of the leak quickly spread worldwide. sources of illegally earned IFFs, ranging from drug The documents contained information on assets held trafficking to embezzlement. IFFs can be classified in offshore companies in more than 40 countries based on whether the actors involved are criminal by wealthy individuals, including public officials.1 organizations, individuals, or corporations (Janský Although holding assets in a tax haven is not illegal 2013). Table S13.1 presents a few examples. per se, the prevailing sentiment expressed in newspa- Although estimates of the size of IFFs are contro- per articles and the reaction from the public mainly versial, the consensus among development scholars took the form of condemnation and criticism of a and practitioners is that IFF outflows on average practice interpreted as powerful economic and polit- actually exceed official development assistance in ical elites concealing taxable income from domestic developing countries (Herkenrath 2014). fiscal authorities, with the assistance of the financial systems of many developed countries. Rethinking the approach to IFFs What are IFFs? IFFs deprive developing countries of resources that These undisclosed accounts are one manifestation could be used at least partially for redistribution, of what has become known as illicit financial flows for financing public goods, and for fostering private (IFFs). The definitions of IFFs vary, but there are two investments in local businesses. In doing so, IFFs main interpretations of what makes these financial support existing inequalities and are particularly det- 2 flows illicit (see Epstein 2005, 7). The normative rimental to the poor. IFFs are also deeply connected interpretation suggests that financial flows become to the governance process. Corruption and embezzle- illicit not only because they hinder development, ment thrive in environments in which accountability but also because they are deemed “illegitimate from to citizens is low, which in turn weakens trust in state the perspective of an existing consensus about the institutions. Tax evasion—a manifestation of a lack social (developmental) good” (Blankenburg and Khan of cooperation in society—is fueled by a state’s lack 2012, 32). of commitment to using resources for the delivery of The legal interpretation, on which the empirical public goods. That lack of commitment in turn under- literature on IFFs is predominantly built, suggests mines the outcome legitimacy of the state, which is that IFFs refer to money that is earned, transferred, based on the delivery of public services. Criminality or used in contravention to existing law. In some also flourishes in environments in which trust is cases, this could mean money that is earned legally low and the state fails to provide the means for large WDR 2017 team, based on inputs from Peter Reuter. population groups to effectively participate in the 278 | World Development Report 2017 Table S13.1 Actions generating illicit financial flows Source of earnings Money legally earned Money illegally earned Criminal • Drug trafficking organizations • Human smuggling Actors Individuals • Tax evasion • Corruption involved • Evasion of currency controls • Embezzlement Corporations • Tax evasion • Violation of intellectual property rights • Profit shifting • Illegal exploitation of natural resources Source: WDR 2017 team. legitimate economy. The WDR 2017 framework sheds indeed been recognized as more difficult to overcome light on how to think about approaching reforms to than any legal, institutional, or operational issues in combat IFFs. this context (Stephenson and others 2011). Think not only about the form of Think not only about the rule of law, institutions, but also about their functions but also about the role of law As discussed in chapter 1, importing forms of institu- Incumbents may appear to be complying with inter- tions is not enough to change the facts. Kenya is often national laws and regulations to gain legitimacy, cited as a major destination for the proceeds from while continuing to do business as usual. One impor- piracy in the Indian Ocean and a key transit point for tant requirement of the FATF Anti-Money Launder- terrorist funds to neighboring Somalia. Seeking to ing (AML) regime is to facilitate requests for informa- fight illicit financial activities, especially money laun- tion and cooperation from nations that are pursuing dering and terrorism financing, Kenya established the money laundering cases involving another country’s Financial Reporting Centre (FRC) in 2012. Although nationals (Recommendations 35–40). Most nations creating the FRC enabled Kenya to be removed from have adopted statutes and regulations that conform the list of countries that could be sanctioned for non- to the FATF rules. However, authorities in many compliance by the Financial Action Task Force (FATF), countries have a history of dragging out the pro- little else seems to have changed.3 There was substan- cess of cooperation for so long that, in fact, the laws tial evidence of high-level corruption in the Kenyan are effectively nullified. For example, countries may government at that time, and yet no cases were delay responding to requests by other countries made brought against senior officials for violating money under the aegis of Mutual Legal Assistance (MLA) laundering regulations. To make the FRC meaningful, about where illicit funds are hidden (Chêne 2008). On the administration would have had to pursue many of the other hand, using delays to deny politically moti- its own senior members. vated requests from developing countries through the MLA may be fair in systems that are essentially Think not only about capacity building, corrupt (Terracol 2015). but also about power asymmetries The lack of capacity of developing countries to man- age complex laws and regulations is often cited as A way forward the source of their difficulties in curbing IFFs. Some Fighting the illicit flow of capital abroad is an impor- developing countries do not have any transfer pricing tant development concern. In 2009 Switzerland rules, thereby ensuring that a multinational corpo- returned US$93 million to Peru from the accounts of ration operating in their jurisdiction can transfer as Vladimiro Montesinos, the de facto chief of intelli- much of its profits elsewhere as it wishes.4 However, gence and main adviser to former Peruvian president the low capacity of developing countries is often Alberto Fujimori (1990–2000). In 2004 the Philippines based on power: it is in the interest of someone to recovered US$683 million from the Swiss accounts of keep capacity low because it allows them to extract Ferdinand and Imelda Marcos, the former president rents (Leite 2012). Lack of political incentives has and first lady of the Philippines (1965–86). In both Illicit financial flows | 279 cases, the money recovered would have been enough 3. The FATF is an intergovernmental body established in to fill at least 25 percent of the nation’s poverty gaps 1989 by the ministers of its member jurisdictions to in the same year.5 set standards and promote effective implementation In the aftermath of the 2016 legal document leak of legal, regulatory, and operational measures for described earlier, the top five European economies combating money laundering, terrorist financing, and other threats related to the integrity of the inter- (France, Germany, Italy, Spain, and the United King- national financial system. Currently, it comprises 35 dom) announced actions to improve information member jurisdictions and two regional organizations sharing in order to fight tax evasion and money (the European Commission and the Gulf Cooperation laundering. Of these economies, the United Kingdom Council). As for the situation in Kenya, Findley, Niel- plays a particularly important role in this respect son, and Sharman (2014) find that in that country it because a number of its Overseas Territories and is easier than elsewhere to open an anonymous shell Crown Dependencies, such as the British Virgin company, one of criminals’ preferred devices for Islands and Jersey, derive a substantial share of their transferring money internationally. gross domestic product (GDP) from providing finan- 4. Multinational corporations are often the initiating cial nonresident depositor services. Recently, all such actors in these matters. See, for example, Global offshore jurisdictions have joined this initiative and Witness (2006). 5. WDR 2017 team estimates, based on the World Bank started to implement rising transparency standards. and United Nations Office on Drugs and Crime’s Panama has also recently taken steps to strengthen its StAR (Stolen Asset Recovery Initiative) database and tax transparency and financial integrity frameworks. the World Bank’s World Development Indicators Fundamental reforms that seemed imaginary just 10 (database). According to the StAR, recovered assets years ago are now being discussed as active proposals amounted to US$5 billion in the 15 years up to 2011 by powerful bodies such as the G-7, G-20, and Organ- (Brun and others 2011). Although “currently no single isation for Economic Co-operation and Development tool or process can effectively establish a comprehen- (OECD). These proposals
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