Are Illicit Financial Flows Draining Development?

December 11, 2012

Yes, but not necessarily in the way most people think. Peter Reuter addressed this question at the Center for Global Development last week based on research in Draining Development? Controlling Flows of Illicit Funds from Developing Countries – a volume that he edited for the World Bank. It is clearly the most thorough assessment to date in assessing the channels by which illicit flows affect development.It seems obvious that illicit financial flows are draining funds from developing countries that could otherwise be used to invest in productive enterprises, provide public services, or boost aggregate domestic demand. Yet, a few examples show the unexpected twists this story can take. Illicit financial inflows may be a bigger problem than outflows for countries that supply the world’s drug trade – through mechanisms like exchange rate appreciation. Also, the countries with the largest illicit outflows – such as China, Saudi Arabia, Mexico and Russia – are hardly the ones that come to mind when thinking about developing nations starved for domestic capital.Focusing on countries where kleptocrats have plundered national treasuries and built personal fortunes from oil and mineral contracts seems to provide a clearer indictment. However, here too, Reuter points out a policy conundrum: are illicit financial flows a lever for policy or simply a symptom of corruption? Put differently, if the world were able to close off the channels for illicit financial flows, would these kleptocrats behave differently?  Would they steal less? Would they use ill-gotten funds domestically in ways that promote development? Would they invent new ways to send money overseas?Illicit financial flows are a problem for world governance. Hiding financial transactions facilitates tax evasion in developed and developing countries alike. It creates problems for macroeconomic policies and financial regulation, and assists terrorists and criminal organizations who can only function by hiding their activities. And, yes, it makes life much easier for politicians, bureaucrats and business people in developing countries who want to extract bribes and shelter them overseas. There is only so much the developed world can do to promote better governance in developing countries; after all, developed countries don’t have such a great track record of addressing corruption at home – whether it comes to Super PACs in the US or Berlusconi’s comeback after conviction on tax fraud. But we can make a big difference if rich and powerful countries were to stop protecting and enforcing repayment of odious debt; hindering recovery of stolen assets; allowing multinationals to make facilitation payments; and hiding oil and mineral royalty payments from public view. Reuter’s work serves to reinforce the call to action coming from many quarters by giving a more nuanced view of the phenomenon and outlining a more useful research agenda – a challenge that CGD is beginning to tackle as explained by Owen Barder. Reuter’s presentation and book also draw attention to this responsibility of the rich when he notes (p. 487):

These funds do not mysteriously disappear from developing countries. In large part, they flow into legitimate and, often, even highly respected financial institutions in the developed world. Thus, governments of the rich countries that serve as the domicile for many of the recipient banks can … more forcefully push the institutions to ensure they are not taking in illicit flows.


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.