Davos Secrets: Swiss Trade Opacity and Illicit Flows from Developing Countries

This week the World Economic Forum holds its annual meeting in Davos, Switzerland. As the great and good gather to chart the direction of the global economy, there will be much talk of development, of transparency, and of the importance of trade. In light of our new research showing that Switzerland’s recent emergence as a global commodity trading hub might hide large illicit capital flows, participants may want to raise some questions with their hosts.

Illicit capital flows—money that is moved secretly and usually illegally from one jurisdiction to another—obviously are not reported in official statistics. Nonetheless, there is reason to suspect that they may be very large and damaging to development, with billions of dollars a year moving illegally from developing countries to financial secrecy jurisdictions.  Switzerland, with its long tradition of banking secrecy, would be a potentially appealing place for such activities and our research suggests that this is indeed the case.

Here’s how my co-authors and I think it works. Commodities such as copper, gold, and oil are sold to traders in Switzerland at prices below the world market. The traders then re-sell these commodities at a steep mark-up. In most cases the goods never pass through Switzerland, nor are they processed in any way that would justify the mark-up. The traders and whomever they are in business with are thus able to reap massive profits, skimming off capital that would otherwise have gone to the original exporter.

Estimating the size of these secret flows is tricky. In our paper we use four methods that involve various means of comparing initial Swiss purchase price, the re-export price, and prevailing global prices. Our most conservative estimate is that developing countries lose at least $8 billion a year in illicit flows to Switzerland – more than twice the Swiss aid budget. Our highest estimate is that losses from developing countries to Switzerland exceed $100 billion a year, a number that begins to approach total annual Official Development Assistance (ODA) of about $125 billion. Furthermore we find evidence of even larger illicit flows from Switzerland to other OECD countries, potentially in excess of $500 billion a year.

World Economic Forum host Klaus Schwab has written of his hopes that this year’s Davos meeting, themed ‘The Reshaping of the World: The Consequences for Society, Politics and Business,’ will highlight the risks of inequitable globalisation and the opportunities for collaboration.  Illicit flows such as trade-mispricing and the related problems of tax evasion, money laundering, and corrupt payments, worsen inequality.  And, as philosopher Thomas Pogge points out, inequality in turn makes it harder to control illicit flows, triggering an ‘inequality spiral.’

Illicit capital flows rely on a lack of economic and financial transparency: about the ownership of companies, trusts and foundations; about where economic activity really takes place; and about the real price of traded goods. Systematic mispricing of trade allows money to be laundered, corrupt payments to be made and corporate profits to be illicitly shifted from their originating jurisdiction to another jurisdiction with (much) lower taxes.  

To be sure, Switzerland is not the world’s only secrecy jurisdiction.  It is, however, the world’s leading commodities trading hub, despite the apparent lack of any attributes (such as ports, proximity to the commodity sources, or a large industrial base requiring commodities) that would seem to make it an attractive entreport. What Switzerland does offer is a very high degree of secrecy, sitting atop the Tax Justice Network’s 2013 Financial Secrecy Index.

On Friday evening the Davos agenda includes an event entitled ‘The Secret Is Out - What's Next for Switzerland?’

Switzerland is known for its chocolate, watches and banking sector. But today, with traditional banking secrecy gone, the country has to reinvent itself to retain its competitive advantage. Can Switzerland use this shift to its advantage by creating new markets while continuing to benefit from its pharmaceutical, energy management and tourism industries? How is Switzerland going to create new advantages? What sustainable and innovative sectors should be invested in? What policies should be put forward?

It is surprising that commodity trading does not feature, given its importance to the Swiss economy. Since 2011, receipts from transit trade (trade that is booked through Switzerland but does not physically pass through the country) have replaced receipts from Swiss banks’ financial services abroad as Switzerland’s leading services export. This is the trade for which least information is publicly available – none at all in the UN commodity trade database, Comtrade, which means that over 90% of some developing countries’ declared exports to Switzerland not only do not arrive but are in practice untraceable.

In a speech at Davos last year, British prime minister David Cameron declared that his agenda for the UK presidency of the G8: trade, tax and transparency.  The issues indeed featured prominently at the G8 summit and were taken up as well at the G20 in a year that saw a growing consensus on the importance of tackling illicit capital flows and tax abuse. Major reports published on the issue included those from the Africa Progress Panel and the OECD.  Kofi Annan and Angel Gurría, the heads, respectively, of the Africa Progress Panel and the OECD will be present this year at Davos.

The global transparency agenda is large and complex. Those who travel to Davos this year to participate in the World Economic Forum are right to support it.  A good place to start would be with increased transparency about Switzerland’s role as the world’s largest commodity trade hub.  Perhaps some bold participants in Davos will get the ball rolling by asking what Switzerland plans to do next not about chocolate and watches but about trade transparency.