To successfully fight illicit financial flows …

… countries need to achieve policy coherence, especially in their settings for key macroeconomic and structural economic policies. This is a tough task. Progress has been and is going to be patchy. So far in 2019 there seems to been some steps forward in reforming international corporate tax arrangements and ownership transparency and in domestic resource mobilisation in developing countries, but also some clear steps back in moves away from trade and exchange rate liberalisation, including by the US.

To help focus on what needs to be done, this is my contribution to the OECD’s report on Policy Coherence for Sustainable Development 2019, (in its Chapter 4), under the heading “Promoting policy coherence in the fight against illicit financial flows”:

“This contribution explores how promoting policy coherence in tackling illicit financial flows (SDG target 16.4) can help countries develop in a more sustainable manner. …

A coherent approach to curbing IFF involves rigorously seeking policies that curb IFF and help countries develop. It means more international co-operation, more clear thinking and giving up on free-riding. This change in attitude can only come through strong political commitment at the highest level to drive rigorous analysis from an IFF perspective of the existing entrenched incoherencies in policy settings, at country level and internationally and take corrective actions. Perversely, many existing policy settings and approaches encourage, rather than discourage, IFF. Examples of common developing-country incoherence in policy settings that drive IFF include:

  • Choosing an uncompetitive exchange rate regime supported by hard controls over access to foreign currency, which create ‘black markets’, promoting corruption and capital flight.

  • Continuing waste in government spending, which undermines support for paying taxes.

  • Heavily taxing some activities but not others, undermining respect for tax laws and perpetuating the informal economy.

  • Rules making it harder to engage in international trade, e.g. onerous clearance processes or restraints on trade finance.

  • Setting in-country prices away from world market prices to protect industries or consumers, but which induces smuggling and corruption.

  • Limiting the tenor/security of property rights, leading firms and individuals to maximise short-term profits instead of investing for the longer-term and defending their rights.

The classic example of incoherence in policy from an IFF perspective relates to exchange rate regimes. With the IMF absent from the issue, many seem to think that exchange rate flexibility and easing in exchange controls has increased IFF, flowing “at the push of a button”. Anti-IFF reports often call for tightening exchange controls or more effective enforcement. However, fixed exchange rates and tight capital controls are shown to be worse for development and for IFF, driving debt crises and leading to black markets for foreign currency that breed criminality and corruption in accessing foreign exchange at the official, overvalued, rate. By contrast, flexible exchange rate regimes help countries avoid overvaluation and the risk of running out of reserves. Anyone seeking foreign currency has to find a willing seller at the market rate and the central bank can stay uninvolved. Black markets fade away and the legal market works to reduce crime and corruption.

The international approach to currency manipulation is also incoherent. Taking an ill-formed mercantilist view, the international community frowns on countries deliberately weakening their currency. However, the exchange rate setting that does most to curb illicit outflows would be such a weak currency whereas an uncompetitively strong currency increases illicit financial outflows. Fortunately, for the quest to curb IFF, in practice unfair manipulation has been difficult to prove.”

Quite a lot of this seems applicable to any review of 2019’s policy settings.