Backgrounder: Illicit financial flows

Introduction

1. Financing developmental efforts in Africa has proved to be costly in the past, compelling the continent to rely on external sources. known as overseas development assistance. This type of assistance is often unevenly distributed, unsustainable, and in some cases, damaging to the national economies in the long run. Lessons learned from the Millennium Development Goals have prompted a fresh wave of thinking towards a post-2015 transformative developmental framework designed to ensure self-reliance for Africa. However, a structural transformation agenda will require an adequate, predictable, sustainable and integrated financing mechanism geared towards financing developmental goals (Abugre and Ndomo, 2014). Also, the continent must embark on reforms to capture currently unexplored or poorly managed resources. This includes curtailing illicit financial flows and rather transforming those funds into a powerful tool for enhancing domestic resource mobilization, as a way of furthering the continent’s development.

2. Illicit financial flows are unrecorded capital flows derived from: (a) proceeds of theft, bribery and other forms of corruption by Government officials; (b) proceeds of criminal activities, including drug trading, racketeering, counterfeiting, contraband and terrorist financing; and (c) proceeds of tax evasion and laundered commercial transactions. Estimates from various recent studies including “Financing Africa’s post-2015 development agenda” reveal that, from 1970 to 2008, Africa lost $854 billion to $1.8 trillion in illicit financial flows. The latest progress report of the High-level Panel on Illicit Financial Flows from Africa revealed that the annual average was between $50 billion and $148 billion a year (ECA, 2013). Commercial money (tax evasion and trade and services mispricing) through multinational companies constitute the largest component of illicit financial flows, followed by proceeds from criminal activities and corruption. The loss of funds through illicit financial flows undermines revenue generation and reduces the benefits from economic activities, particularly in the extractive sector (ECA, 2013). It also undermines Africa’s ability to mobilize resources generated by such sectors to fund developmental goals. This has had an adverse welfare and distributional effect on the poor, whose income prospects for employment have dwindled (Kar and Cartwright-Smith, 2010).

Objective

3. The present issues paper aims to:

• Identify, examine and raise awareness about the development challenges that illicit financial flows pose to Africa’s transformation

• Identify important mechanisms, the dynamics and the main challenges to curtailing and redirecting illicit financial flows and their implications for Africa’s economic transformation

• Establish knowledge for anchoring policy change to control and curb illicit financial flows from the continent, as part of structural transformation

• Establish appropriate policy modalities, including the mobilization support for practices that reverse such illicit financial outflows at national, regional and global levels

• Propose policies which promote a better global understanding of the scale of the problem for African economies and encourage the adoption of relevant national, regional and international guidelines and instruments, including safeguards and agreements to redress the situation.

• Draw on country experiences and case studies to examine the nature of illicit financial flows and their effect on development, and tackle the challenges to efforts being made to curb their magnitude and impact.

The broader issues

4. The issue of illicit financial flows is complex and technical in terms of factors relating to origin, destination, scale, modalities, drivers, actors and regulatory responses. The concept of illicit financial flows must be defined clearly, using the right terminology. Indeed, it has often been used interchangeably with capital flight. Capital flight has a legal component, which is registered in the books of the institution making the outward transfer, and an illegal one which is not recorded anywhere. These hidden resources merit the term illicit as they may include unrecorded capital flows that derive from criminal, corrupt (bribery and theft by Government officials) and commercial activities.

5. Money laundering, drug trafficking, racketeering, counterfeiting, dealing in contraband goods and terrorist financing account for 35 per cent of illicit financial flows globally (ECA, 2014). Money laundering was estimated at $1.6 trillion, the illicit drug trade $320 billion and counterfeiting $250 billion. Also, commercial transactions by multinationals, tax evasion, laundered commercial transactions, aggressive tax avoidance through harmful tax holidays, duty waivers and mis-invoicing account for 60 per cent of global illicit financial flows. The remaining 5 per cent of these flows is driven by corruption (theft, bribery and other forms); although the figure could be much higher. This is because corruption is cross-cutting and relates to other illicit financial flows components such as organized crime, drug trafficking, money laundering, tax evasion, trade mis-invoicing, lobbying and transfer pricing by private sector businesses, which are often overlooked. Total annual illicit financial flows, according to the Economic Commission for Africa and others, is estimated at $50 billion. This amount exceeds Africa’s official development assistance. This estimate may well fall short of the actual figure, as accurate data are lacking for all transactions and for all African countries (ECA, 2012).

6. These illicit financial flows have huge repercussions in Africa and pose multiple threats. First, they drain resources and tax revenues by eroding the much-needed tax base for domestic resource mobilization. They also curb domestic savings needed to reduce the continent’s annual $31 billion infrastructure financing gap and tackle climate change and youth employment. Secondly, illicit financial flows lead to governance issues such as resource distribution, which are fraught with rent seeking rather than productivity maximization. This practice can be damaging to the State as it undermines institutions such as banks, financial intelligence units and other legal mechanisms for detecting and prosecuting perpetrators of illicit financial flows. Thirdly, these flows perpetuate Africa’s economic dependence on external aid. This is reflected by the level of official development assistance in Government budget. Indeed, the official development assistance for some countries amounts to 70 per cent of total Government revenue. Lastly, the lack of political will and leadership have helped illicit financial flows to thrive in Africa. The greatest victims are the poor and the vulnerable, as resources which could have been used on poverty reduction and economic growth measures are diverted elsewhere.

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