Illicit financial flows an ethical, legal challenge

Esther Dzviti Mapungwana economist

Illicit financial flows have been a major problem for most countries, especially developing countries. Cross-border capital movements for the purposes of concealing illegal activities and evading taxes continue to pose major challenges to developing countries. These activities deny the country concerned desperately required resources for private and public investment and in so doing, hamper potential economic development and growth. Some research has shown that illicit financial flows are also directly linked to dominant party-political interests resulting in failing compromised state institutions and increasing corruption.

The definition of illicit financial flows (IFFs) has been varying but the general sentiment  is that IFFs refer  to cross-border movements of capital associated with illegal activity or more explicitly, money that is illegally earned, transferred or used that crosses borders. Some argue that a definition for illicit financial flows that is less contentious especially among international institutions excludes tax avoidance out of IFF definition. According to the World Bank, the concept of IFFs are emerging as a powerful and constructive umbrella to bring together previously disconnected issues. The term emerged in the 1990s and was initially associated with capital flight. The concept of IFFs has been largely looked upon as a legal matter but recent arguments have observed the concept also as an ethical issue.

The United Nations Conference on Trade and Development (Unctad) earlier this year published a report titled —  Tackling Illicit Financial Flows for Sustainable Development in Africa. One of the sections in the report focused on the analysis of export under invoicing (that is, a positive trade gap) as it is the most relevant conduit for IFFs in the context of primary commodity exports from Africa. The report stated that trade under invoicing is often motivated by exporting Multinational Enterprise (MNE) incentives to shift foreign exchange abroad to settle foreign transactions, to pay for smuggled goods or to avoid foreign exchange controls (Uneca, 2015; Unctad, 2016). Global Financial Integrity (2019) notes that globally, sub-Saharan Africa has the highest propensity for trade under-invoicing and is the only region in which outflows exceed inflows. In 2015, IFFs (as reported in United Nations Comtrade) were estimated at US$45 billion and illicit outflows were equal to US$23 billion. The present report’s estimate of US$40 billion in export under-invoicing is based on the net export gap and is the sum of all positive individual country estimates in 2015 (covering 21 African countries and the eight selected commodity groups). Despite significant differences in methodologies for trade-related illicit outflows from the continent, some convergence on findings exist; IFFs are large, have increased over time and trade in primary extractive commodities is a major contributor.

The report added that trade statistics reported by developed countries are generally more accurate and thus discrepancies in partner-country trade statistics are mainly driven by trade-related IFFs from developing countries. Therefore, the mirror trade gap is usually calculated vis-à-vis developed countries only and then scaled up by their share in total trade. This does not allow for the analysis of intra-African discrepancies nor account for the fact that although primary commodities are still traded in Europe, the latter is no longer the largest consumer. Another concern is attributing partner-country trade gaps as being directly linked to illicit flows, which has been widely criticised in the literature for being too simplistic. Other sources of error being of a purely logistical nature have gained insufficient weight in recent discussions.

The average trade value, meaning the sum of all trade values divided by the number of observations, of extra-continental African trade is seven times as large as intra-African trade, US$63 million versus US$8,5 million. The maximum trade value for extra-continental African trade is seven times as large as for intra-African trade. Imports recorded by the rest of the world stemming from the continent are on average larger than exports recorded by African countries.

“Some general trends emerge. First, the trade gap for gold from South Africa (since 2011) has a significant impact on the overall African trade gap. South Africa has a distinctive trade recording system, as illustrated by the observed gold trade reporting. Gold from South Africa, for historic reasons, had no trading partner country assigned before 2011. Since then, gold has been reported in the United Nations Comtrade, and therefore included in this report, even though the reporting of this commodity remains special (Ndikumana and Boyce, 2019). Second, all high-value commodities, gold, platinum and diamonds (for example, from Eswatini, Lesotho, South Africa and the United Republic of Tanzania) tend to have a positive trade gap, whereas petroleum and copper exports tend to exhibit a negative one. In fact, all major petroleum exporting countries (Algeria, Angola, Nigeria and Tunisia) to some extent have large negative export trade gaps, with the exception of Egypt, which has a large positive gap. On average, iron, aluminium and manganese also have positive export gaps,” the report stated

The magnitude of trade mispricing in Africa based on a range of estimates varies from US$30 billion to US$52 billion per annum. The scarcity of available geological information in Africa and the resulting information asymmetry between mining companies that have the means to acquire private information about reserves and Governments makes the extractive sector particularly prone to illicit outflows. There are only rough estimates of potential reserves available on the continent, as significant information gaps impede robust data collection on mineral and metal resources in Africa (World Bank, 2017b). As noted for gold, high-value low-weight commodities are especially prone to smuggling. With rapidly rising demand, the risk of smuggling of rare earth minerals is increasing and their improved governance should be a policy priority for well-endowed countries and requires comprehensive geological surveys.

There have been existing solutions to IFFs related challenges, in addition to engagement through existing mechanisms IFFs is a matter of ethics. These ethical concerns are recognised by all stakeholders, including MNEs, involved in the fight against IFFs. In the African context, the emphasis on ethics is apparent in the African Peer Review Mechanism. The Mechanisms methodology includes a corporate governance thematic area and an objective on ensuring ethical conduct within organizations, which seeks to address corruption and illicit flow of funds.

The impact and incident of IFFs has been felt in Africa. In Zimbabwe IFFs reduce domestic resources and tax revenue needed to fund poverty-reducing programmes and infrastructure. IFFs reduce resources, but they are also symptomatic of other issues that constrain poverty reduction and shared prosperity, such as vested interests and weak transparency and accountability.

Fighting IFFs requires strong international cooperation and concerted action by developed and developing countries in partnership with the private sector, civil society and citizens as well. IFFs need to be viewed in both legal and ethical perspectives. Legal in the sense of misrepresentation of information to “steal” country based resources, and ethical in terms of depriving current and future generations to the national wealth and heritage. It cannot be denied that the same solutions needed to tackle IFFs go hand in glove with solving corruption. The question that still remains is that these issues are well known, well researched and some of them are well-documented, but solving the problems is still a challenge

Ethics or psychological based policy recommendations are usually rare in resolving economical concepts because of the difficulty in quantifying the variables in place. Focusing on the encouragement and the advocacy of good ethical behaviour is an important step to discoursing illicit behaviour. Promoting the benefits and incentives of better ethical behaviour for current and future generations as well as the legacy it leaves for those who have acted in an ethical manner can, to an extent, encourage better trade. The discouragement of self-indulgence and self-centeredness for the good of others and the implementer’s satisfaction are areas that can have a positive impact.

Finally citizen participation in information gathering around trade and the natural resource is vital. As citizens, we need to participate more in the matters of natural resource distribution and trade as well as demand the correct and accurate data and information on the trade levels. It seems that most players get away with IFFs activities because nobody demands accuracy  and accountability of information regarding the trade of natural resources and nobody  questions the gaps that will be existing probably because of fear of the unknown hence silence on the matter prevails and this silence will enable the existing environment of IFFs longer than desired. The more accurate information is required and requested the more difficult it may become to continue to conduct some but not all IFFs activities.

Mapungwana is an economist. These weekly New Perspectives articles are co-ordinated by Lovemore Kadenge, an independent consultant and past president of the Zimbabwe Economics Society. — kadenge.zes@gmail.com or mobile +263 772 382 852.