Pirate Bankers, Shadow Economies

Corruption isn't an issue that Jacob Zuma, the current president of the African National Congress - South Africa's liberation party - is particularly enthusiastic about. Until prosecutors dropped charges in early April, Zuma stood accused of three dozen counts of corruption, graft, fraud, and racketeering related to a rigged multibillion-dollar arms deal. He was alleged to have accepted 783 payments from French arms multinational Thint via his financial advisor Shabir Sheik, who was later convicted for graft, fraud, and corruption. Sheik has since emerged from prison, serving just 28 months of his 15-year term.

In Africa, political power is often used as a "get out of jail free" card, immunizing the venal political elite through various mechanisms. Transparency International, the global corruption watchdog renowned for its annual Corruption Perceptions Index(CPI), argues that corruption is especially rampant in Africa. TI defines corruption as the "abuse of entrusted power for private gain," a notion limited to the governing bodies in developing countries.

But this is only half the story. A respectable financial army plays an invaluable role in a global shadow economy. A coterie of bankers, accountants, and lawyers - based in "transparent" London, New York, and Singapore - serve as the agents of tax havens and offshore financial centers, and they're backed by multilateral financial institutions. Corrupt government leaders get away with graft much more easily and more frequently because of these international financial enablers.

Capital Flight

According to Global Financial Integrity's Raymond Baker, a leading capital flight expert, an estimated $900 billion is siphoned from underdeveloped regions each year. Since the 1970s, Africa has experienced a loss of $600 billion in capital flight, a considerable portion derived from odious loans that commercial and development banks provided to despotic regimes. Harvard economist James Henry argues that that more than $1 trillion worth of loans "disappeared into corruption-ridden projects or was simply stolen outright."

Facilitating this theft are the IMF and World Bank's structural adjustment programs through tax competition, liberalized trade, and natural resources auctioned piecemeal to corporations. These multilateral institutions made it easier for politicians and corporations to acquire capital and then spirit it out of the country.

"The IMF pushed the Washington Consensus, pushed free trade for corporations, providing them with market access and minimum impediments in Africa such as tax competition," said Richard Murphy, director of Tax Research LLP. "The IMF helped companies not to pay their taxes. They got it horribly wrong."

Despite TI's emphasis on corrupt political environments - which has since become the definition of corruption - less than 5% of capital flight comes from this narrow category, according to Murphy. A much larger portion of capital flight, 30%, derives from garden-variety crimes like drug trafficking and money laundering. Multinational internal mispricing, meanwhile, constitutes an astounding 60% of illicit flight.

"TI has got it all wrong," stated Murphy. "Transfer mispricing constitutes the largest portion of flight capital." But even when capital flight happens because of corruption narrowly understood, like bribery, where does the money end up? Probably tax havens and places like Switzerland, which zealously protects the privacy of its depositors. Though Sudan, Chad, Equatorial Guinea and Zimbabwe rank near to last on CPI's list of 180 countries, Switzerland comes in at a pristine fifth place. "The idea that Switzerland has a clean economy is a joke. It is a dirt-driven economy," said Murphy.

Shadow Economies

Tax justice was billed as the "big issue" of the recent G20 meeting in London, a gathering of the largest economies in the world. By targeting Switzerland and numerous island economies, Prime Minister Gordon Brown conveniently shifted attention away from UK crown dependencies and overseas territories, accounting for more than a quarter of all tax havens worldwide.

And London is the head office.

"Tax havens are little more than booking centers. I've seen transactions where all the decisions are made in London, but booked in havens," stated an official of Britain's Serious Fraud Office, to John Christensen, cofounder of the Tax Justice Network and former economic advisor to Jersey, one of the world's leading tax havens - and a UK crown dependency.

High-net-worth individuals have already secreted away more than $11.4 trillion, Christensen estimates, resulting in a loss of over $250 billion in taxes each year, minus corporate profits declared in tax havens.

The presence of tax havens, guaranteeing protection and discretion to corrupt political elites and economic criminals, directly undermines democracy and development, manipulating legal vacuums in unanticipated ways.

"The IMF is in favor of the highly flawed incentive of tax holidays. Many countries have lost huge sums of revenue, because tax incentives undermine revenue base of developing countries," said Christensen. "Corporations prefer weak governments that are anxious to secure investments, and despotic governments," he stated.

Over 60% of global trade occurs in unobserved vacuums. The Organization for Economic Cooperation and Development (OECD), composed of 27 high-income countries, have decided to focus on these conduits as well as the exotic islands, thus marginalizing and absolving structural exploitation, the lax regulation, and the culture of secrecy, all of which underpins the larger OECD economies such as London.

The strength of offshore hubs - an intricate labyrinth that facilitates flight and protects the corrupt through obscuring transparency, depends on the lack of automatic exchange of information between countries experiencing capital flight and those on the receiving end. After intensive lobbying by the international financial community, the IMF removed just such a provision on information exchange from the final drafts of its Article of Agreement. Presently, governments are only able to interrogate havens when already in possession of data related to illicit financial transactions and assets. The power of offshore hubs expanded when the IMF paved the way for capital account liberalization in the late 1970s. Cross-border flows increased eightfold. Unlike tax havens, offshore hubs relocate at the first sign of financial regulation. This is often done via costly flee clauses. The move to target and regulate tax havens, which range from shell companies to conduit markets to hedge funds, shouldn't detract from the importance of regulating offshore hubs as distinct entities.

Going after the Real Corrupters

During his days on the throne, according to the Tax Justice Network's John Christensen, former Nigerian dictator Sani Abacha had a standing order to transfer $15 million from state coffers to his Swiss bank account each day, resulting in a personal fortune of $3-$5 billion. One hundred banks (including Citigroup) knowingly protected Abacha and facilitated his plunder. Since the early 1990s, the population of Nigerians living on less than one dollar per day has increased by 10%.

Nigeria's economy is largely dependent on hydrocarbon contracts, which is the root of the problem. "Hydrocarbon contracts in particular are very secretive, especially with regards to taxation, and it is difficult to get evidence of payment, with many political parties and politicians receiving payment on the side," said Christensen.

Nigeria isn't the only country subject to opaque transactions and capital flight. Wall Street's $56 trillion tumble was triggered by toxic assets traded in the shadow economy. Suddenly, the spotlight in the United States fell on discretely marketed tax havens and powerful multinationals, many of them on the receiving end of taxpayer-subsidized bail-out funds. The Government Accountability Office reported that 83 of the top 100 corporations maintained multiple subsidiary units in tax havens.

The key to addressing corruption in the broadest sense is through country-by-country reporting. Such reports reveal the presence of multinationals in each country, trade names, financial performance, physical assets, the number of employees, sales to third parties, and intra-group trading, profits, and tax payments to the governments in each location. "Country-by-country reporting already works in the US where states all have different corporate taxes," stated Murphy. "It would allow us to 'look through' havens, and if nothing of value is added there, we can simply ignore it and tax the companies where performance is happening."

The automatic exchange of information in conjunction with country-by-country reporting would bolster accountability by precipitating automatic sanctions on havens, disincentivising capital flight and corruption. In doing so, the magnifying glass of transparency would fall on unchecked and unregulated shadow economies in developed and developing countries alike.

Now that would be an economic revolution.