Illicit financial outflows: a pressing African Problem Necessitating a Global Solution Senior Policy Seminar on Capital Flight from Africa 10 & 11 April, Addis Ababa Gamal Ibrahim UNECA

OUTLINE OUTLINE o Context o Concept and definition o Transition from Capital Flight to IFF o Drivers and Composition of IFF o IFF estimates in developing countries o Methodology : measuring IFF o Development impact of IFF o Political Economy of IFF o Conclusion o Key recommendations for policy makers

Context Context  Illicit Financial flows (IFFs) out Africa remain a major concern because of their scale and impact on Africa’s economies, development and governance agenda.  Over US$ 854bn lost to IFF between , a yearly average of about $22bn  IFF on the increase especially in the last decade, with average annual losses of $50bn between 2000 and 2008  Estimates likely understate the true extent of IFF because data are not always available on all forms e.g. smuggling and mispricing of services

Context The vulnerability of African countries to IFF underscores the urgent for a well-coordinated African response to guide regional and national policy- making.The vulnerability of African countries to IFF underscores the urgent for a well-coordinated African response to guide regional and national policy- making. The establishment of the High level Panel on Illicit Financial Flows from Africa, chaired by President Thabo Mbeki, was essentially a response to the urgent need for systematic changes at national, regional, and global levels through greater public pressure and sensitization to secure a strong African voice in the global arenaThe establishment of the High level Panel on Illicit Financial Flows from Africa, chaired by President Thabo Mbeki, was essentially a response to the urgent need for systematic changes at national, regional, and global levels through greater public pressure and sensitization to secure a strong African voice in the global arena

Concept and definition: Capital Flight & IFF Concept and definition: Capital Flight & IFF Capital Flight: an exodus of funds and financial assets abroad to secure better financial returns (Kant, 2002)Capital Flight: an exodus of funds and financial assets abroad to secure better financial returns (Kant, 2002) IFF: funds exiting the country that are illegally earned, transferred or used, at its origin, or during movement of use.(Reuter, 2012 and Kar & Cartwright-smith, 2010)IFF: funds exiting the country that are illegally earned, transferred or used, at its origin, or during movement of use.(Reuter, 2012 and Kar & Cartwright-smith, 2010)

Transition from capital flight to IFF Transition from capital flight to IFF Capital Flight Licit Financial Flows (LFF) Illicit Financial Flows (IFF) Corruption Organized crime Commercial activities Export under invoicing Trade mis- pricing / trade mis-invoicing Import over invoicing Transfer pricing

Drivers of IFF Drivers of IFF

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

IFF Estimates in developing countries IFF Estimates in developing countries

Methodology : Hot Money and Dooley Methods Methodology : Hot Money and Dooley Methods Four Methods: The Hot Money Method: records IFFs through net errors and omissions in payment balances.The Hot Money Method: records IFFs through net errors and omissions in payment balances. The Dooley Method: relies on the privately held foreign assets reported in the balance of payments that do not generate investment income.The Dooley Method: relies on the privately held foreign assets reported in the balance of payments that do not generate investment income.

Methodology : World BANK Residual Method Methodology : World BANK Residual Method The World Bank Residual Method: It Estimates IFFs as the difference between the source of funds (External debt and FDI) and the use of funds (Current account deficit and reserves)The World Bank Residual Method: It Estimates IFFs as the difference between the source of funds (External debt and FDI) and the use of funds (Current account deficit and reserves) Source of funds Use of funds Source of funds Use of funds If IFF < 0 Then there are inward transfers or illicit capital If IFF < 0 Then there are inward transfers or illicit capital

Methodology : IMF-DOTS and UNECA Methods The IMF-DOTS based Trade Mispricing Method(Mostly use in literature): It assesses IFFs by looking at disparities arising from over-invoicing of imports and under-invoicing of exports after adjusting for ordinary price differences.The IMF-DOTS based Trade Mispricing Method(Mostly use in literature): It assesses IFFs by looking at disparities arising from over-invoicing of imports and under-invoicing of exports after adjusting for ordinary price differences.  The UNECA methodology builds on the IMF’s DOTS- based trade mispricing model with minor differences:

Methodology : IMF-DOTS and UNECA Methods Methodology : IMF-DOTS and UNECA Methods UNECA methodology Vs IMF DOTS Methodology Data source used: IMF methodology uses Exports/Imports statistics from DOTS at the country level(aggregated)IMF methodology uses Exports/Imports statistics from DOTS at the country level(aggregated) But UNECA methodology uses UN COMTRADE data which provides bilateral trade information for more than 200 countries - including most African countries - and 5,000 products at the harmonized System 6-digit (HS6) level.But UNECA methodology uses UN COMTRADE data which provides bilateral trade information for more than 200 countries - including most African countries - and 5,000 products at the harmonized System 6-digit (HS6) level.

Methodology : IMF-DOTS and UNECA Methods Methodology : IMF-DOTS and UNECA Methods UNECA methodology vs IMF DOTS Methodology (Cont) Unit of comparison (C.I.F vs F.O.B) Most (if not all) studies using the IMF DOTS methodology interact a fixed coefficient(10%) to get an import F.O.B (in accordance to DOTS practice)Most (if not all) studies using the IMF DOTS methodology interact a fixed coefficient(10%) to get an import F.O.B (in accordance to DOTS practice) But UNECA methodology uses Exports (F.O.B) statistics from UN COMTRADE, while using imports (F.O.B) from BACI dataset (World trade dataset developed by CEPII)But UNECA methodology uses Exports (F.O.B) statistics from UN COMTRADE, while using imports (F.O.B) from BACI dataset (World trade dataset developed by CEPII) In UNECA methodology, time lags exports/imports processes is accounted for, using time taken (World Bank dataset) for export/import between bilateral trade partners.In UNECA methodology, time lags exports/imports processes is accounted for, using time taken (World Bank dataset) for export/import between bilateral trade partners.

UNECA Methodology The analysis focuses only on the trade mispricing branch of the commercial transactions through MNEs;The analysis focuses only on the trade mispricing branch of the commercial transactions through MNEs; UNECA’s methodology is particularly innovative in the way it isolates IFF from the other sources of trade mispricing:UNECA’s methodology is particularly innovative in the way it isolates IFF from the other sources of trade mispricing: o Utilises countries’ exports and imports data from UN COMTRADE at the Harmonized System at 6-digit level and the BACI database; o Model accounts for time lags in exports/imports reporting process Adopts a net approach.

Empirical Evidence Empirical Evidence Africa lost in average US$ 50 billion a year via IFF from trade mis-pricing between 2000 and 2008Africa lost in average US$ 50 billion a year via IFF from trade mis-pricing between 2000 and 2008 Two-third of IFFs were attributed to only two regions between 1970 and 2008: West Africa (38 per cent) and North Africa (28 per cent)Two-third of IFFs were attributed to only two regions between 1970 and 2008: West Africa (38 per cent) and North Africa (28 per cent) Great significance of IFFs from oil-exporting countries dominated by North and West African regions (Nigeria, Egypt, Algeria) and non oil-exporting countries (South Africa, Morocco, Côte d’Ivoire and Ethiopia)Great significance of IFFs from oil-exporting countries dominated by North and West African regions (Nigeria, Egypt, Algeria) and non oil-exporting countries (South Africa, Morocco, Côte d’Ivoire and Ethiopia)

Empirical Evidence Empirical Evidence Top 10 African countries by cumulative IFFs, Source: Based on Kar and Cartwright-Smith(2010) Source: Based on Kar and Cartwright-Smith(2010) #Country US$ Billion Cumulative IFFs ( ) US$ Billion Share in Africa’s total IFFs 1Nigeria % 2Egypt % 3South Africa % 4Morocco % 5Angola % 6Algeria % 7Côte d’ivoire % 8Sudan % 9Ethiopia % 10Congo, Republic %

Empirical Evidence Empirical Evidence More than half (i.e. 56%) of the IFFs from the African continent over the 10 years period (2000 – 2008) comes from oil, precious metals and minerals, ores, iron and steel, and copper. These are highly concentrated in very few countriesMore than half (i.e. 56%) of the IFFs from the African continent over the 10 years period (2000 – 2008) comes from oil, precious metals and minerals, ores, iron and steel, and copper. These are highly concentrated in very few countries Sectors such as edible fruit and nuts, electrical machinery and equipment, fish and crustaceans, apparel and cacao account for (each of them) between 3% and 4% of the total IFFs from the continent.Sectors such as edible fruit and nuts, electrical machinery and equipment, fish and crustaceans, apparel and cacao account for (each of them) between 3% and 4% of the total IFFs from the continent.

Empirical Evidence Empirical Evidence In countries with relatively large amounts of IFFs, there is a concentration in one sector of the economyIn countries with relatively large amounts of IFFs, there is a concentration in one sector of the economy Main destinations of IFF from African countries: developed countries (especially, the United States, Europe, Canada, Japan and Korea) and emerging economies (such as China, India)Main destinations of IFF from African countries: developed countries (especially, the United States, Europe, Canada, Japan and Korea) and emerging economies (such as China, India).

Development Impact of IFF from Africa Development Impact of IFF from Africa Damaging effects of IFFs on African countries include: o Draining resources and tax revenues: Africa lost about US$ 854 billion in IFFs over and continue to lose US$ billion a year; o Stifling growth: If illicit outflows of funds had not taken place, GDP per capita would have been 16 per cent higher (Ndikumana and Boyce, ) o Perpetuating economic dependence and constraining structural transformation: ODA to Africa (US$ 46 billion in 2010) is less than US$ 50 billion lost annually through IFFs. o

Development impact of IFF from Africa Development impact of IFF from Africa IFFs from developing countries: o Prevent governments from providing public services; o Undermine poverty reduction, skewing income distribution and leading to economic and political instability; o Weaken governance; o Decrease public spending on health, education and public infrastructure needed to reach the MDGs: Each additional dollar debt service implies 29 fewer cents spent on public health. An additional infant in Africa dies for every reduction of US$ 40,000 in health spending (Boyce and Ndikumana, 2011)..

Political Economy of IFF Political Economy of IFF IFF undermine the ability of governments to implement economic policies that run against the powerful interest groups that oppose these policiesIFF undermine the ability of governments to implement economic policies that run against the powerful interest groups that oppose these policies Financial globalization has provided a conducive environment for a ‘capital strike’ against undesired taxation or regulatory policies;Financial globalization has provided a conducive environment for a ‘capital strike’ against undesired taxation or regulatory policies; This has wider implications on the nature and the modes of development in Africa and the orientation of the domestic capitalists.This has wider implications on the nature and the modes of development in Africa and the orientation of the domestic capitalists.

Political Economy of IFF Political Economy of IFF The incentives facing economic and political elites have been shaped particularly by the major changes in the global economy that took place since the late 1970s:The incentives facing economic and political elites have been shaped particularly by the major changes in the global economy that took place since the late 1970s: o Financial deregulation and the emergence of the global shadow financial system; o Increased demand for natural resources.

A Global Solution to an African Problem A Global Solution to an African Problem There are various international conventions and agreements that aim to curtail the various forms of illicit financial flows.There are various international conventions and agreements that aim to curtail the various forms of illicit financial flows. Though the scope and breadth of these initiatives comprise a good first step in curtailing IFF, many issues still remain i.e. some countries have not ratified the UNCAC and are therefore not required to cooperate with its mandates; and loopholes in the international legal framework and differences between legislations in the Northern countries and Africa prohibit the effective investigation of IFF.Though the scope and breadth of these initiatives comprise a good first step in curtailing IFF, many issues still remain i.e. some countries have not ratified the UNCAC and are therefore not required to cooperate with its mandates; and loopholes in the international legal framework and differences between legislations in the Northern countries and Africa prohibit the effective investigation of IFF.

A Global Solution to an African Problem A Global Solution to an African Problem One of the important barriers in the search for a global solution to combat IFF is the lack of an institutional home for global governance on these flows which can provide an outlet for policy debate and implementation.One of the important barriers in the search for a global solution to combat IFF is the lack of an institutional home for global governance on these flows which can provide an outlet for policy debate and implementation. Curtailing IFF requires concerted and simultaneous efforts by both Northern and Southern countriesCurtailing IFF requires concerted and simultaneous efforts by both Northern and Southern countries

Conclusion Conclusion Broad-based coalition against IFF;Broad-based coalition against IFF; Curtailing IFF requires concerted and simultaneous efforts by both Northern and Southern countries;Curtailing IFF requires concerted and simultaneous efforts by both Northern and Southern countries; Strengthen regulatory frameworks and build national capacity;Strengthen regulatory frameworks and build national capacity; Strengthen regulation of the domestic banking and finance sector;Strengthen regulation of the domestic banking and finance sector; Encourage economic diversificationEncourage economic diversification Improve institutional frameworks for African countries and support sharing of good practices: i.e. APRMImprove institutional frameworks for African countries and support sharing of good practices: i.e. APRM

Key Policy Recommendations Key Policy Recommendations African leaders should seek strong political commitment from destination countries to strengthen transparency in international financial transactions;African leaders should seek strong political commitment from destination countries to strengthen transparency in international financial transactions; Requiring greater transparency in the banking system, whereby banks would ascertain the identity, source of wealth and country of origin of their depositors and deposits; Requiring greater transparency in the banking system, whereby banks would ascertain the identity, source of wealth and country of origin of their depositors and deposits; Requiring MNCs to report regularly on their employees, sales, financing, tax obligation and payments on a country-by- country basis. Requiring MNCs to report regularly on their employees, sales, financing, tax obligation and payments on a country-by- country basis.

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