Sustainable Development Archives

Hidden in Plain Sight: Illicit Financial Flows

The importance of Illicit Financial Flows (IFFs) in the context of economic development has slowly come to grasp people’s attention. The World Bank defines IFFs as “money illegally earned, transferred, or used that crosses borders.” Since 2006, the Global Financial Integrity (GFI), a Washington, DC-based think tank, has done extensive research on IFFs. Their studies emphasize that the developing world lost $7.8 trillion in IFFs between 2004-2013—whereby $1.1 trillion was lost in 2013 alone. Studies have shown there is a strong correlation between IFFs and higher levels of poverty and economic inequality. The United Nations just passed its first resolution on combatting IFFs, as it is pertinent to achieving the Sustainable Development Goals. This article explores further how IFFs occur, their role in keeping economies from developing—especially in the African continent, and some suggestions to tackle them.

Illicit financial flows are often mistaken as capital flight. This assumption is false because capital flight could be entirely licit. We can group the IFFs in three categories: commercial activities, which account for 65% of IFFs; criminal activities, estimated to be about 30%; and corruption, amounting to around 5%. Trade mis-invoicing is the most common way illicit funds leave developing nations, averaging 83.4%. Trade mis-invoicing means moving money illicitly across borders by misreporting the value of a commercial transaction on an invoice that is submitted to customs. It is carried out by under-invoicing exports and over-invoicing imports. Under-invoicing the value of exports means writing the price of a good as being less than the price actually paid, in order to show reduced profits and then pay less in taxes. Once the good is exported, it will be sold at full price and the excess money will be put in an offshore account. Over-invoicing the value of imports is when the price of a good is listed as being higher than the seller actually intends to charge the client. The excess money is deposited in the importer’s offshore bank account. There is the misconception that IFFs are largely due to corruption when in fact they account only for 5%, as mentioned above. With invoice manipulation of prices, there is no need for bribing anymore.

Another scheme used in IFFs is misreporting the quality or quantity of the traded products and services. According to a report by the United Nations Economic Commission for Africa and the African Union Commission, in 2012, Mozambican records showed a total export of 260,385 cubic meters of timber, while Chinese records alone show an import of 450,000 cubic meters of the same timber from Mozambique. Other strategies consist of creating fictitious transactions (which consists of making payments on goods or services that never materialize), transfer mispricing (which involves the manipulation of prices), and profit shifting (which is popular among corporations looking for favorable tax rates).

Role of IFFs in Keeping Economies from Developing

Illicit Financial Flows act as a barrier to economies from developing and achieving the UN Sustainable Development Goals. Illicit financial outflows—facilitated by secrecy in the global financial system—are bleeding developing countries dry. UNCTAD emphasizes that developing countries will need $2.5 trillion every year until 2030 to achieve their goals on health, nutrition, education and the rest. But pledged capital inflows are only around $1.2 trillion. Preventing or even reducing IFFs can fill this funding gap. Seven out of the past 10 years, IFFs were greater than Official Development Assistance (ODA) and Foreign Direct Investment (FDI) given to poor nations.

The IMF estimates that developing nations lose $200 billion from tax revenues per year due to IFFs, while OECD countries lose $500 billion. Specifically, the United States (US) loses $100 billion annually. Tackling IFFs is in the interest of the US. Even though both developed and developing countries are victims of IFFs, developing countries suffer greater losses.

When it comes to most significant volume of IFFs, Asia is leading by 38.8% of the developing world over the ten years of this study. However, when IFFs are scaled as a percentage of gross domestic product (GDP), Sub-Saharan Africa tops the list averaging 6.1% of the region’s GDP.

At the Seventh Joint Annual Meetings of the ECA Conference of African Ministers of Finance, Planning and Economic Development and African Union Conference of Ministers of Economy and Finance in March 2014 in Abuja, Nigeria, a Ministerial Statement was issued, which states that:

“Africa loses $50 billion a year in illicit financial flows. These flows relate principally to commercial transactions, tax evasion, criminal activities (money laundering, and drug, arms and human trafficking), bribery, corruption and abuse of office. Countries that are rich in natural resources and countries with inadequate or non-existent institutional architecture are the most at risk of falling victim to illicit financial flows. These illicit flows have a negative impact on Africa’s development efforts: the most serious consequences are the loss of investment capital and revenue that could have been used to finance development programmes, the undermining of State institutions and a weakening of the rule of law.”

Former South African president Thabo Mbeki stated at a High-Level Panel on IFFs “Africa is a net creditor to the rest of the world.” The amount of IFFs out of Africa were between $854 billion and $1.8 trillion over the period 1970-2008, according to estimates by GFI. There is a campaign to end IFFs, “Stop the Bleeding”, led by Trust Africa Foundation. Mr. Mbeki stressed that Africa can no longer afford to have its resources depleted through IFFs. On the other hand, illicit financial transfers by African elites paint a different picture. It shows that African elites lack confidence in their own economies. Because they have the privilege to go abroad for education and healthcare, they are less likely to invest in their own countries.

Curbing IFFs

When searching the literature on IFFs, the focus seems to be on developing nations, which are the source. However, there is little focus on the destination countries like Switzerland, Ireland, United Kingdom, etc. A paper by GFI titled “The Absorption of Illicit Financial Flows from Developing Countries: 2000-2006”, discusses that there are two types of destinations for money leaving the developing world. These are offshore financial centers and non-offshore developed country banks. The greatest challenge is getting the money back from the destination countries.

The OECD and the Stolen Asset Recovery Initiative (StAR) surveyed frozen assets held by OECD countries and how much of them were returned to the countries of origin . Between 2010 and June 2012, $1.4 billion of corruption-related assets were frozen and only $147 million was returned.

During the Arab Spring, banks and governments froze billions of dollars held by previous leaders along with their associates from Tunisia, Egypt, and Libya. However, following the Arab Spring, only few assets have been returned and the process of recovering stolen assets is very cumbersome. In order to recover stolen assets, there needs to be solid enough proof that these assets were in fact gained through corruption to begin with.

Illicit financial flows is an issue that plagues the developing world. Nations are denied tax revenues that could be geared towards providing necessities, employment, and economic growth. Nations should hold their financial institutions accountable if they participate in tax evasion activities. There is a need for the creation of financial supervision agencies focused on IFFs. Another suggestion would be the development of a global trade-pricing database so that customs officials are not tricked by false prices. Lastly, the Bank of International Settlement should publish data on international banking assets by country of origin and country of destination in order to better comprehend where IFFs are headed.

Written by Mariamawit F. Tadesse

A Green Job Program Will Help Workers, the Economy, and the Planet

There’s been much talk about Trump’s plan for jobs and infrastructure that entails over one trillion dollars in new spending (without tax increases) and promises to employ thousands of American workers. Because it looks like this would require significant deficit spending, it has drawn stiff criticism: even Trump’s the own conservative supporters have expressed concern.

Among advocates of Keynesian spending and Modern Money Theory (MMT), however, some precautionary excitement can be observed. Their perspective is different because they are unafraid of a government deficit, and in favor of direct job creation. They understand that deficit-spending is not inherently bad, and that the US government will never have to default on its debt. When the economy is not at full employment, increasing the deficit would actually be helpful, not harmful.

A fiscal stimulus aimed at reducing unemployment is timely and necessary. Despite the confidence expressed by the Fed about the latest employment numbers, the situation for those who are jobless is not looking good. One of the reasons for the latest rate hike by the Fed was their positive outlook on unemployment numbers. Chairman Yellen has gone as far as saying that (at 4.6% unemployment rate) we are close to full employment and fiscal stimulus is not necessary to reach that goal.

However, the low official joblessness rate hides the fact that an increasing number of Americans have left the labor force altogether; for example there are currently over 5 million Americans who are not in the labor force but have reported that they want a job. This is where a Job Guarantee program could come in handy. In short, the government would act as an Employer of Last Resort, effectively guaranteeing a job to all of those willing and able to work.

And if Trump uses the deficit-spending towards jobs in infrastructure, it might result in something that resembles the job guarantee policy that America needs**. I argue, however, that the financial feasibility should not be the only criterium for a successful implementation of the job-guarantee. It also has to be sustainable. If we’re going to be at full employment, we have to do it in a way the planet can handle.

The current structure of the economy relies too heavily on fossil fuels, wasteful production methods and non-renewable resources. Unless we change this, sustaining full-employment would result in increasing production, consumption, and waste. My favorite Keynes’ quote is that “In the long run we are all dead.” If we’re talking about a long run of increasing pollution, he will surely be right. As we know, too much of a good thing can be a bad thing. This applies to jobs too. Unless they are green jobs, too many jobs will be bring us environmental destruction.

The issue of the environmental sustainability of a Job Guarantee program has been on my mind since I first heard of the proposal. Mathew Forstater’s Green Jobs proposal was inspirational to my work. In my Master’s thesis, I tweak its existing framework to target environmentally sustainable outcomes. I find that we can transform the Job Guarantee program to ensure its sustainability without increasing its cost. Here’s how:

I set up the program in a way that promotes social enterprise and community development, following the work of Pavlina Tcherneva et al. With the help of social entrepreneurs, NGOs, and Nonprofit Organizations, local communities should decide what projects will be undertaken. For example, communities along the Hudson river could support a program where workers dealt with invasive species such as the zebra mussel and water chestnut. Other localities could handle neighborhood farming, recycling centers, flood containment structures, bike paths, etc.. It’s been found that if the community is involved in determining what projects are taken on, participation levels are higher.

A more detailed account of my proposal and calculations is available upon request, but this is the gist of it: I used an Input-Output model to establish what would be the cost of employing the official U-3 unemployed population into “green” Job Guarantee jobs. That framework accounts for indirect job creation related to the proposal, but not induced employment. What I find is that the US government can, under conservative assumptions, employ all of those who are officially unemployed for around 1.1% of GDP while paying them a $15hr wage. That is about 17% of the annual military budget. The Green Job Guarantee program is projected to cost just under 200 Billion dollars per year in order to ensure employment for 7.8 million people.

As the world economy quickly transitions into a more sustainable state, a shift in the productive structure will occur, rendering some current occupations useless. Workers who are employed in areas like fossil fuel energy generation (the fabled coal workers of the American Midwest for example) will be left without a job and unlikely to find a new one right away. There is no way to predict how quickly this transition will occur: it could be a gradual–albeit fast–process if led by government initiative, a slower and insufficient movement if guided by profit motives, or even a sudden transition caused by widespread popular response to natural disasters.

Given current trends it is safe to assume that the transition to a renewable energy generation and a sustainable economy will occur before the fossil reserves are depleted. Just as the stone age ended before we ran out of stone, the “oil-age” will end before we run out of oil. As such, fossil fuel workers (and those who depend on their consumption) are at risk of losing their jobs in the near future. A Job Guarantee program would allow those workers to not only find employment readily, but also to acquire the on-the-job skills that will allow them an easier transition into the Green economy.

So as we continue to criticize and investigate the means of job-creation proposed by the President-Elect, let’s look beyond the government deficit, and consider the planet, too. Whether you’re afraid of government debt or not, you should be concerned with the destruction of the earth. If we are going to have a public program that aims a generating new jobs and bringing people back into the workforce, then that program should be a Job Guarantee. But, if we’re going to guarantee jobs, the will have to be green. And we have all the tools we need to make that happen.
*Interested in some good work on how to build a sustainable economy? Check out the publications from PERI and the Binzagr Institute for Sustainable Prosperity. Interested in a non-profit that is already doing some great things in that area? Visit GreenWave‘s website and get involved!

** I must make clear that, although Trump’s infrastructure plan might very loosely look like a Job Guarantee program because of its intent, it differs significantly from it because of how it will will be implemented. The president elect’s plan is based on private spending and making concessions to big corporations; it is basically a big giveaway to developers and not a program to ensure full-employment and financial stability.

Carbon Trading, Sustainable Development and Financial Fragility

The response to climate change is one of the most pressing policy issues of our time. Carbon trading assets are currently worth more than $100 billion. This market is expected to reach $3 trillion by 2020. In Stabilizing an Unstable Economy Hyman Minsky notes that the markets for financial assets are inherently unstable, leading to the cyclical behavior of the economic system. How effective then are market-based solutions to solving climate change? It might just be that carbon markets have not reduced environmental instability and may increase financial instability of the entire economic system.

The core of carbon trading isnot trading of physical GHGs, but the trading of the right to emit GHGs and the unit of account is a ton of carbon dioxide equivalent (tCO₂e). The carbon market stems from the Kyoto Protocol, and its specifics are target of discussion as scholars debate about the legal characteristics of the carbon unit. Some countries view it as a commodity while others see it as a monetary currency.

Under the Kyoto Protocol trading mechanisms were made up of three types: international emissions trading, the Clean Development Mechanism (CDM), and Joint Implementation (JI). The European Union Emission Trading System (EU ETS) is the world’s largest carbon market. According to the 2016 ICAP worldwide emissions report, there are 17 emissions trading systems operating around the world, which are currently pricing more than four billion tons of GHG emissions. In 2017, two new systems will be launched: China and Ontario, the former will become the largest of such systems, and will drive worldwide coverage of ETSs to reach seven billion tons of emissions by 2017.

Voluntary markets exchanges (carbon markets outside the Kyoto) are also on the rise because they make trading, hedging and risk management easier by providing liquidity. Furthermore, they develop sophisticated financial instruments such as CER futures, options, and swaps, which will help establish a price forecast for carbon. Some of these markets are the Chicago Climate Exchange (CCX), Multi-Commodity Exchange of India (MCX), and Asian Carbon Trade Exchange.

Sustainable Development

From their foundation, carbon markets have failed to address the underlying root causes of climate change. They divert money from technological investment that will actually reduce the use of fossil fuels towards the financial markets. Furthermore, they are causing instability in the environment through the use of carbon offsets, which have caused massive green grabs to occur in the global South, and through outsourcing emissions to developing nations. Carbon offsets were created by Kyoto to describe emissions reductions projects that are not covered by an ETS. For instance, tree plantations, fuel switches, wind farms, hydroelectric dams…etc.

The world’s richest have over-consumed the planet to the brink of ecological disaster. Instead of reducing emissions within their own countries, they have created a carbon dump in poorer regions. As such, emissions trading system represent the world’s greatest privatization of a natural asset. The Kyoto protocol is set up in a way that carbon sink projects (forests, oceans, etc.) are only accepted when people with official status manage them. Hence, it expands the potential for neocolonial land-grabbing to occur. Rainforest inhabited by indigenous people will only qualify as “managed” under the Kyoto when they are run by the state or a registered private company.

Furthermore, carbon trading has also failed to reduce global GHGs emissions. When a country claims to have reduced its carbon emissions, one must question whether it is by adopting low-carbon technologies, like how Sweden used well-crafted public policies and market incentives to decarbonization, or by outsourcing its emissions to another country, most likely to developing nations. For example, the Chinese government has questioned whether the emissions coming out of Chinese smokestacks were really ‘Chinese’ or should they be accounted to those in Western countries who are consuming Chinese goods or are owned by joint venues with developed countries. The question arose because Europe claimed that it was making progress on climate change based on tabulating the physical locations of molecules. Larry Lohmann phrased it perfectly when he said that Europe’s statistical claim “[conceal[s] an important fact that it has offshored much of its emissions [to China].” Take the UK, it has not in fact reduced its emissions it merely offshored one-third of its emissions by not accounting for emissions of imported goods and international travel.

Carbon markets have had many fraudulent activities within them. In 2002, the UK had a trial emissions trading scheme worth £215 million, which resulted in fraud. Three chemical corporations had been given £93 million in incentives when they had already met their reduction target. Another famous fraudulent activity revolved around international offset projects whereby companies would create GHGs just to destroy them and make money off of the credits.

As nature is being commodified and privatized,the current policies for sustainable development, under the guise of conservation, are alienating the poor from their means of livelihood by securing resources for organizations. These indigenous people — land users — are seen as needing to be saved from their primitive ways and to be educated on utilizing sustainable development within the bounds of the market. If it sounds like colonialism that is because it is.

For example, there exists specific types of green grabs known as conservation enclosures where the market is seen as the best way to conserve biodiversity. Hence, authorities are privatizing, commercializing and commoditizing nature at an alarming rate through payment for ecosystem services to wildlife derivatives. The Convention on Biological Diversity (CBD), a multilateral treaty set up at the 1992 UN Earth Summit has a target the protection of 17 percent of terrestrial and inland water and 10 percent of coastal and marine areas. For instance, Conservation International (CI) pushed the government of Madagascar to protect 10 percent of its territory, while in Mozambique a British company negotiated a lease with the government for 19 percent of the country’s land. President Elizabeth Sirleaf Johnson of Liberia called for the extradition of a British businessman accused of bribery over a $2.2 billion carbon offsetting deal. The deal was to lease one-fifth of Liberia’s forests, which account for 32 percent of its land. In Uganda, a Norwegian company leased land for a carbon sink project, which evicted 8,000 people in 13 villages.

In Oxfam Australia’s 2016 report on land grabs, palm oil has become “responsible for large-scale deforestation, extensive carbon emissions and the critical endangerment of species… India, China and the European Union (EU) are the largest consumers of palm oil globally.” The European Union’s renewable energy policy being a significant driver of global palm oil demand due to its aim to source 10 percent of transport energy from renewable sources by 2020, which has increased its palm oil usage by 365 percent.

Reducing Emissions from Deforestation and Forest Degradation (REDD+) is an effort to create a financial value for the carbon that is stored in forests. It is used to justify green grabbing and is expected to be one of the biggest land grabs in history. By using REDD+ as a conservation mechanism and a financial stream, “the CDB is both legitimating the commodity of carbon itself and helping to create the market for its trade.” The CDB is forming new nature markets along with new nature derivatives whereby investors speculate on future values encompassed in, for instance, species extinction like that of tigers.

Financial Fragility

Hyman Minsky was fully aware that a capitalist system was a monetary system with financial institutions that were prone to instability. Minsky is famous for saying that the strength of capitalism is that it comes in at least 57 varieties. The last and current stage is Money Manager Capitalism, which was made up off highly levered profit- seeking organizations like that of money market mutual funds, mutual funds, sovereign wealth funds, and private pension funds. The financial instability hypothesis argues that the internal dynamics of capitalist economies over time give rise to financial structures, which are prone to debt deflations, the collapse of asset values, and deep depressions. Minsky has always warned, “Stability is Destabilizing.”

Money managers act as agents. They pursue short-term profits by trading instruments that are not easily verifiable, which makes fraud likely possible in carbon markets. The dramatic rise in securitization has opened up national boundaries leading to the internationalization of finance. Securitization within the carbon markets increases the risk of leading to boom-bust cycles. At present, speculators are the major players in carbon trading and their dominance in carbon markets is growing at an alarming rate. Financialization is an important precondition for the rise and operation of carbon offsets. The financial innovation in this scheme is that it uses nature itself as a financial instrument. Moreover, it is selling nature to save it and then saving nature to trade it.

‘Green bonds’ are carbon assets that are sold to the Northern hemisphere, backed by Southern land and Southern public funds. Lohmann shares that financial speculation of collateralized debt obligations (CDOs) are at least based on specifiable mortgages on actual houses while climate commodity or subprime carbon cannot be specified, quantified, or verified even in principle. Even conservatives and Republicans have said, “if you like credit default swaps, you’re going to love carbon derivatives.” It has become apparent that carbon markets are not only driven by trade, but also by speculation. Carbon derivatives are growing at a fast rate as speculators are moving from other assets towards carbon. Whereas once investors bet on the collapse of the US housing market, there are some traders who are betting on the collapse of the carbon credit market.

As more investors, specifically hedge funds, enter the carbon markets, they increase market volatility and create an asset bubble or ‘carbon bubble’. Money managers by acting as agents trade carbons and increase financial fragility. Their income is driven by assets under management and short-term rates of return. Hence if they miss the benchmark, they will lose their clients. So they act on short profit bases by taking risky positions, and carbon trading provides those risks. In brief, using Minsky’s theory, we can predict with confidence that the carbon market is inherently unstable and that in addition to its not achieving its goal of reducing emissions, it is also heading to a financial disaster.

Even though Minsky pushed for regulation when it came to financial markets, regulating carbon markets will not solve the problem. Tighter regulation of carbon markets, particularly secondary and derivative markets is just a Band-Aid solution and will fail to affect fundamental change. Financial markets have had to be bailed out again and again. However, as a British Climate Camp activist said “nature doesn’t do bailouts.” On a global scale, GHG emissions have gone up. There is an offshoring of emissions. The best policy would be eliminating offsets, specifically from the developing world. Furthermore, there needs to be policies that encourage low-carbon technology as used in Sweden. Another policy recommendations would be a harmonized carbon tax.

Written by Mariamawit F. Tadesse
Illustrations by Heske van Doornen