Drivers, destinations, and policy options
By Landry Signé, Mariama Sow, and Payce Madden
Since 1980, an estimated $1.3 trillion has left sub-Saharan Africa in the form of illicit financial flows (per Global Financial Integrity methodology), posing a central challenge to development financing.
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While the international development community often focuses on the amount of aid and investment that enters the African continent, the other part of the balance sheet—the funds exiting the continent—has often been overlooked. Between 1980 and 2018, sub-Saharan Africa received nearly $2 trillion in foreign direct investment (FDI) and official development assistance (ODA), but emitted over $1 trillion in illicit financial flows. These flows, illicitly acquired and channelled out of the continent, continue to pose a development challenge to the region, as they remove domestic resources which could have been crucial for the continent’s economic development.
There is no widely agreed-upon definition of which specific forms of capital movement constitute illicit financial flows. Global Financial Integrity, a non-profit, Washington, DC-based research and advisory organization, defines illicit financial flows as “the illegal movement of money or capital from one country to another.” This narrow definition of illicit financial flows covers activities including hiding the proceeds of crime, channelling funds towards criminal destinations, and evading tariffs and taxes through misreporting of transactions. Wider definitions generally focus on actions that are not strictly illegal, but which are undesirable because they result in reduced tax revenues, including tax avoidance actions such as strategic transfer pricing.
Trade mis-invoicing is one method of laundering money for illegal transfer to another country. It occurs when exporters or importers deliberately misreport the value, quantity, or nature of goods and services in order to evade taxes, take advantage of tax incentives, avoid capital controls, or launder money. Multinational companies regularly evade taxes in countries where they operate, especially in developing countries, through trade mis-invoicing, among other schemes.
As expected, larger economies have higher levels of illicit financial flows. As well, higher taxes and higher inflation lead to higher illicit financial outflows, suggesting that firms seek out relatively more stable or favourable fiscal environments for their funds. Furthermore, emerging and developing economies in Asia and the Middle East have become major destinations for illicit financial flows from Africa. While part of this shift can be explained by the reduction in trade levels with developed economies, the large upsurge of illicit flows to these economies cannot solely be explained by increased trade values.
Impact of illicit financial flows
Illicit financial outflows from Africa are concentrated in a few countries and a few sectors—in particular, the extractive and mining industries. In fact, fuel exporters were responsible for nearly half of the illicit financial flows from Africa between 1970 and 2008. Notably, oil price increases are associated with increases in illicit flows. Moreover, there is a statistically significant relationship between oil exports and illicit financial flows: studies show that for every extra dollar in oil exports, an additional 11 to 26 cents leaves the country in the form of illicit financial flows. In addition, oil is not the sole resource conducive to illicit outflows of capital. In South Africa, the vast majority of illicit capital flows arise out of transfer pricing from the mining sector.
Resource-exporting countries are more prone to exporting large amounts of illicit financial flows due to several factors. First, large exports of oil provide more opportunities for trade mis-invoicing. Second, in oil industries, the line between private and public interests is often blurred, as government officials often own stakes in state-owned companies. Moreover, the funds created from extractive industries provide political leaders with a certain level of independence, then removing the need for accountability from politicians involved in those industries. Third, extractive industries require a high level of expertise, which leads to relatively low levels of competition, creating oligopolies who may collaborate with governments and competitors for contract negotiations, joint ventures, and other arrangements. The low levels of competition can also lead to companies working together to export illicit capital outflows. Finally, resource-rich countries tend to have higher rates of corruption, further compounding challenges associated with illicit financial flows.
Illicit financial flows drain resources that could be used for the continent’s development, meaning that a reduction in illicit financial flows could potentially lead to a corresponding reduction in aid dependence by increasing the availability of domestic resources. While illicit financial flows are a constraint to development financing in Africa, it remains difficult to assess the link between illicit financial flows and poverty reduction, as the channel through which this link materializes is through reduced government funding for poverty reduction programs such as in health and education, or through indirect channels such the negative effect of low investment on incomes.
Illicit financial outflows have been found to have a strong and negative effect on investment rates, notably private investment. In addition to foregone investment, illicit financial flows are presently curtailing Africa’s savings rate. While increased savings can open the door for increased investments in human development, the relationship may be circuitous. A 2015 paper on financing investment in sub-Saharan Africa, for example, finds that human development—coupled with good governance—has a positive impact on savings rates. The paper claims that investments in education and health can lead to a more prosperous economy, which generates larger tax revenues and can increase domestic savings. It is possible that if decreasing illicit financial flows leads to increased savings, then these funds can be reinvested in activities that improve human development, which will in turn improve the savings rate.
Destinations of illicit financial flows from Africa
While good domestic policies are necessary for reducing illicit flows, destination countries also carry part of the responsibility to fight illicit financial flows: tax evasion, for example, though not by definition illegal, can be a key component of illicit financial flows, and is often done by multinationals from advanced economies. Identifying major destination countries can encourage them to take the precautions necessary to reduce the share of illicit financial flows they host.
China hosts the greatest extent of illicit flows, almost twice as much as the second-position United States. Between 1980 and 2018, China hosted 16.6 percent of all estimated illicit flows from sub-Saharan African countries, while the United States hosted 9.1 percent, the United Kingdom 5.4 percent, and India 5.0 percent. Reflecting the drastic increase in China-Africa trade in the past two decades, the majority of China’s illicit financial flows from Africa have occurred in recent years: Our analysis finds that 85 percent of total illicit flows to China have taken place between 2010 and 2018.
Mexico has the highest extent of illicit flows as a percent of trade, at over 50 percent of all trade, followed by Bahrain. Two sub-Saharan African countries—Benin and Niger—are among the top 10 hosts of illicit flows as a percent of trade total illicit financial flows to China have increased commensurately with trade since 2000, while total illicit flows to the US remained fairly constant, increasing slightly in correspondence with an increase in total trade from 2008 to 2011. As a percent of trade, illicit flows to the United States followed a decreasing trend from 2000 to 2018. In contrast, in China, the evolution of illicit financial flows has followed a more complex pattern: As a percent of trade, illicit flows remained below 15 percent from 2006 and 2010, increased dramatically between 2011 and 2014 to a peak of 26 percent in 2014, and then declined to an average of 14 percent from 2015 to 2018.
The change in illicit financial flows as a percent of trade to China during the 2008-2010 period provides insight into the pattern of illicit flows to China over the past two decades. After dropping to their lowest levels in a decade in 2008, coinciding with the global financial crisis, illicit financial flows as a percent of trade toward China increased noticeably after 2010. In the post-crisis era, the Chinese government created a $586 billion stimulus package to minimize the impact of the financial crisis and boost the country’s economy. The package led to a 3.2 percentage point increase in China’s GDP growth and to increased investment, consumption, and trade. Notably, studies have found that, in the period following the adoption of the stimulus package, both experiences and perceptions of corruption in China increased
The stimulus package and the subsequent increase in both trade and corruption could be factors behind the surge in illicit financial flows witnessed in the post-crisis era. At the end of 2012, Chinese President Xi Jinping launched an anti-corruption campaign. To date, the campaign has resulted in the investigation and disciplining of thousands of government officials. Anti-corruption mechanisms in China could have contributed to the decline in illicit financial flows from Africa from their peak in 2014.
Combating illicit financial flows
As the case of China demonstrates, curbing illicit financial flows requires cooperation at the global level. Indeed, the past decade has seen increased effort from the global community toward reducing illicit financial flows. Such efforts range from creating initiatives to curb money laundering to improving the sharing of tax information across countries. One of the first legal instruments created to combat illicit outflows of capital was the United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances of 1988, also known as the Vienna Convention.
This instrument includes rules against money laundering and urges parties to work together to allow for the identification, tracing, and seizure of illicitly acquired financial proceeds. Other notable initiatives include the Financial Action Task Force (created 1998), the Global Forum on Transparency and Exchange of Information for Tax Purposes (created 2009), and the Inclusive Framework on Base Erosion and Profit Shifting (created 2016).
While stopping illicit outflows of capital before they happen is important, repatriating funds that have been smuggled out can also be an important tool to solidify the domestic resource base of African countries. Challenges to repatriation efforts are numerous. For instance, many developing countries lack the judicial capacity necessary to produce legitimate requests for asset recovery. Moreover, differences in legislation between the place where money is laundered and the place where the theft occurs is a hindrance to asset recovery. In addition, there can be a lack of cooperation from developed economies when asked for funds recovery.
One example of successful repatriation of illicit financial outflows comes from Nigeria. In 1998, the country launched the Special Police Investigation to investigate former Nigerian leader General Abacha’s alleged theft of more than $3 billion. Recovering the funds, which were mainly housed in Switzerland, was a tedious five-year process. In 1999, the Nigerian government, then led by President Olusegun Obasanjo, hired the Swiss legal firm Monfrini and Partners to assist in tracing the looted funds. That same year, Swiss authorities issued an asset freezing order, upon receiving a request for mutual legal assistance. Still, repatriating the funds did not happen until 2004 as Swiss authorities were requesting a final forfeiture judgement from the Nigerian courts. Monfrini and Partners argued that Abacha’s funds were obtained illegally, and the final forfeiture requirement was waived.
While this example shows the difficulties that arise in trying to repatriate looted funds, it also shows that African countries can successfully relocate and repatriate illicit outflows from their countries. Then again, this initiative required significant resources from the Nigerian government which smaller African economies may not be able to afford. In September 1999, Obasanjo gave an address to the United Nations General Assembly where he called for the creation of an international convention that will facilitate the repatriation of wealth that was illicitly acquired and kept abroad.
In 2007, the U.N. Office on Drugs and Crime (UNODC) and the World Bank launched the Stolen Asset Recovery (StAR) Initiative. The initiative’s action plans include the creation of a pilot program to help countries recover stolen assets through the provision of legal and technical assistance. This assistance could include helping countries draft requests for mutual assistance, such as the document that led to the freezing of Abacha’s asset in the Nigerian example cited above. Nevertheless, the funds that have been repatriated using some assistance from the initiative stand well below total looted funds. This outcome shows that countries still have difficulty acquiring the funds and support necessary to attempt repatriation requests and other efforts.
Furthermore, between 2006 and mid-2012, OECD members returned only $423.5 million of stolen funds to developing countries, barely affecting the gap of $20 billion – 40 billion smuggled out of said countries annually. In the Nigerian case cited above, only $504 million of the stolen $3 billion was repatriated to Nigeria. In another example, in 2012, Switzerland repatriated $64 million in looted funds to Angola that were allegedly stolen between 2004 and 2012, but, over that period, illicit outflows from Angola to the world amounted to $23 billion. Thus, while repatriation efforts are important, present actions must be scaled up and improved within and across countries to repatriate a more substantial amount of illicit financial outflows.
Over the years, illicit financial flows from Africa have moved away from advanced economies toward emerging economies. Part of this shift can be explained by the reduction in trade levels with developed economies. However, the large upsurge of illicit flows to certain emerging and developing economies in Asia and the Middle East cannot solely be explained by increased trade levels.
While there are initiatives in place to curtail illicit financial flows, many of them stem from advanced economies, including G-20 and OECD countries, and may fail to address the upsurge in illicit flows toward emerging and developing economies. Where emerging economy countries have difficulty launching efforts against illicit financial outflows from their countries, so too will these emerging host countries face enormous challenges in stopping illicit flows or repatriating funds. African policymakers should make more efforts to work with their counterparts in the Middle East and Asia to create policies that address the drain on Africa’s development resources.
While African countries work to halt financial flows before they exit the continent, the global community must also increase and improve repatriation efforts. Well-executed repatriation efforts do bring back stolen financial funds to African countries; such efforts should also be accompanied by additional initiatives or mechanisms designed to deter illicit financial outflows in the first place.