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.


Illicit Financial Flows and Development

3 Marys show how to improve GFI’s latest flagship report on illicit financial flows

It’s not often one needs to call on an English Queen, a tidiness guru and a spooky sailing ship to help determine what is wrong with the latest update on illicit financial flows from Global Financial Integrity and how it can be improved. But now is the time. Seeing GFI’s report on illicit financial flows in 2006-2015 though three Marys’ eyes does just that.

Mary Contrary would say what GFI needs in future is more Marie Kondo and less Mary Celeste. That way, GFI can constructively contribute to the illicit financial flows research agenda.

Finance reform

The new “buy now, pay later” schemes need to be regulated

There has been a bizarre debate in Australia on whether “buy not, pay later” services like Afterpay and Zip Money should be regulated. No surprise that some in the industry suggest not. Policy advisers and politicians, as well as the media, seem at sixes and sevens … distracted by what? Fintech gobbledygoop?

But it is essential that Responsible Lending and other rules be applied to products like Afterpay.

The services are obviously a provision of credit, even though the borrower is not charged interest if the debt is paid off on schedule. In essence, under the current model with “pay later” the interest is paid by all the retail consumers who do not use the service. This is a monstrous imposition, surreptitiously applied.

It gets worse. There seems nothing to stop retailers offering exclusive discounted prices to “pay later” shoppers, subsidised even further by those who pay up front.

Retailers who allow use of “pay later” services should be required to fully recover the cost of that service from a surcharge on prices paid by their “pay later” customers.

Of course, this is what also should have been required of retailers who allow use of credit cards. The sloppiness in regulation of credit cards at the purchase point is obvious. Some retailers do the right thing and apply a surcharge for use of a credit card (though it is hard to see how some surcharges line up with the likely actual cost to the retailer resulting from the use of a credit card). But the other retailers, who do not apply a surcharge for use of a credit card, are all implicitly transferring the initial cost of the credit provision to those customers who do pay up front. That is unfair and sneaky.

Illicit Financial Flows and Development

Review of “South Africa: Potential Revenue Losses Associated with Trade Misinvoicing”, Global Financial Integrity, November 2018

This little review seeks to explain the evolution in the methods Global Financial Integrity (GFI) uses to make trade misinvoicing estimates, and its new focus on “potential revenue losses”. GFI has taken a very one-sided approach to potential revenue losses, only counting the taxes it implies are not paid as a result of its estimates of trade misinvoicing behaviours but ignoring the extra taxes that would be paid were its estimates of trade misinvoicing accurate. The net revenue outcome would be much more balanced.

Illicit Financial Flows and Development

3-part series on Illicit Financial Flows: Making Sense of Confusion

My 3-part series on Illicit Financial Flows is now complete. Hopefully it adds to the prospects of making real progress towards curbing illicit financial flows. Part III runs through the ways existing economic policies tend to increase – rather than reduce – illicit financial flows and suggests several ways policies could be made more coherent, so that countries can achieve development and still curb illicit financial flows. It also advocates that the IMF should step up to a leadership role in this search for coherence.

Part I.    Search for Meaning. 13 March 2018.

Part II.   Count the Devils. 27 July 2018.

Part III. Tackle the Drivers. 12 October 2018.

China's financial development

China Financial Summit 2018

A China Financial Summit 2018 was held in Beijing in association with a large innovation exhibition, CHITEC. The session I was invited to address (as a former chief economist for ASIC) was on listing on the Australian stock market. My speaking notes, my slides and a surprisingly good staged photo. It will be interesting to see if there is increasing interest amongst Chinese companies, large or smaller, in listing on the Australian stock markets (ASX, NSX or SSX) over the next year.

Illicit Financial Flows and Development, Tanzania

Tanzania country study of illicit financial flows

The project was commissioned by the Bank of Tanzania and funded by the Government of Norway. It involved 5 one-month visits to Tanzania, four months of research off-site (at least!), copious fact-finding and research (including into how others have estimated illicit financial flows), and many meetings in Tanzania with government, agencies and the private sector. Dr Ameth Soloum Ndiaye was the International Technical Adviser and hails from from University of Dakar, Senegal. I was International Project Manager. The report was submitted to Bank of Tanzania in early 2016, after presentation to the project’s Advisory Board in December 2015. The report is not being published.

I learned a lot about how such illicit financial flow country studies might best be undertaken in future. The UN Sustainable Development Goals (especially Goal 16, target 4) are likely to drive the need for a common research approach. In my view, it would be best if this approach focused on crime-based activities that lead to net cross-border resource losses and can be seen (and thus resonate) in-country. I am keen to discuss how this might be done, as well as why approaches deployed in multinational and country studies to date have been inadequate or misleading.

Australia, Finance reform

Murray drops ball on regulatory reform

The Report of the Financial System Inquiry led by David Murray was published on 7 December 2014. This is my comment, focused on regulatory reform, the topic of my paper earlier this year for the Australian Centre for Financial Studies.

“David Murray and his committee have put their energies into the urgent, the de-risking of Australia’s banks and the avoidance of the more obvious risks mounting in superannuation, but seem to have had no energy left to take on the important, the longer-term need to reform the regulators.

As far as the regulatory architecture goes, the Financial System Inquiry makes almost no significant recommendations. So virtually all the predictable weaknesses will be sustained into the next crisis. The Murray Inquiry has fallen into the same trap as the rather more revolutionary Campbell Inquiry, which failed to recommend a regulatory architecture that would limited the likelihood or extent of the next crisis. The Wallis regulatory architecture got Australia through the GFC, but only with a Wallis-free-market-philosophy-busting taxpayer guarantee of the banks. Luckily the bill was never crystalised.

The informality and clubbish weaknesses of the Council of Financial Regulators (CFR, an in-house committee of ex-officio heads of the regulatory agencies) are to be maintained, so the potential for stronger regulatory oversight has been lost. The recommendation for a new Financial Regulator Assessment Board, with ex-post review responsibilities (a revitalisation of the almost unknown Financial Sector Advisory Council, bolstered by a secretariat in Treasury) surely is only a bandaid. While the RBA and APRA have been goaded into talking more positively about macroprudential policies through the course of the FSI, the absence of any recommended change to the CFR (no independent chair and no explicit responsibility for macroprudential policy) means the likelihood of actual implementation of any macroprudential policies is now much lower again.

The FSI proposes more tinkering with powers for ASIC, very much the usual mission creep favoured by past inquiries. Defensively, Murray claims he is not recommending extra responsibilities for ASIC, only extra funding and beefed up powers, but undermines that purity by arguing that ASIC’s mandate should take competition explicitly into consideration. ASIC’s decision-making will appear yet slower and more confused and its scope will remain too widely drawn: structurally it remains set up to fail.

About the only ‘improvement’ in the regulatory architecture is another recommended non-change: the Financial Claims Scheme (FCS, a generous ex-post-funded deposit insurance scheme) is recommended to be maintained even in the face of a heightened pretence pre-crisis (for that is surely all that it ever is) that banks will be allowed to fail and taxpayers will not be exposed. Together with continued depositor preference, the maintained FCS will help protect consumers careful enough to use banks, and thereby protect the banks and the banking system (and therefore the essential structure and operations of the Australian financial system) from shadow or non-banks.

The regulators and the Government will be relying on the good sense of the Australian public to keep using the banks through thick and thin. Strangely, Murray make no recommendation to publicise the FCS, so consumers are to be left in the dark, or at least poorly informed, until after the next crisis.”

Illicit Financial Flows and Development, Tanzania

Dar es Salaam inception visit

I have been appointed International Project Manager for a very interesting exercise, an 18-month study of illicit financial flows, by the Bank of Tanzania, the central bank. The project is funded by the Norwegian government. The inception report visit is in October 2014. Dr Ameth Saloun Ndiaye from the University of Dakar, Senegal, is International Technical Advisor. More to follow.

Australia, Scotland

The Scottish referendum

(25/09/2014)  Thank goodness that is over. The high turnout reflected both the very large number of Scots voting with their heart (blame the Corries!) and their more numerous fellow-countrymen, urgently fighting back to contain the threat posed to Scottish welfare and opportunities if the independence push had got up. I wrote this as an Australian-oriented briefing as the results came in:

“So the YES vote in the Scottish referendum did not get up. But we should all pause and think through why Scotland nearly left the UK and the implications for Australia if it had.

Cutting out Scotland, close to 9 percent of the UK in population and GDP, would have diminished the UK in the world order and make it much less likely to continue to actively lead Western nations in the difficult challenges that Nato, the UN and the EU now face. Australia is strongly aligned, often at the forefront in supplying troops and equipment, but cannot itself lead. A bullet dodged.

A YES vote would have been genuinely shocking, unravelling the fabric of the world we wake up to each day. That something as apparently solid can change overnight, igniting what the Economist Intelligence Unit sees as ‘seismic’ economic, political, legal and constitutional repercussions, would have created uncertainty that would raise costs and slow growth (albeit marginally). The uncertainties would have been undoubtedly greatest for those in Scotland and the rest of the UK but, like a stone thrown into a still pond, the waves would reach the furthest shores.

Though the UK has been diminishing in importance for Australia in trade, overtaken by the US, continental Europe and Asia, in 2013 two-way trade between Australia and the UK was a still-consequential $20 billion. More significantly, the UK was Australia’s second largest source of and destination for foreign investment, behind the USA, with total bilateral cross-border investments valued at over $800 billion. The extra costs and uncertainties provoked by Scottish independence would create headwinds: a continuation of the post-GFC outflow of UK investment from Australia, mainly from debt securities, is likely.

Scottish independence would also impose some monetary costs on Australia, mainly renegotiation of the hundreds of treaties and agreements between Australia and the UK. The burden would probably have been contained: most of the new treaties could have been be simple duplicates, one with the rest of the UK and another with Scotland. Even Australia’s flag might have survived, as a remembrance (ever more anachronistic, nonetheless) of its British colonial origins.

But it is non-monetary costs that would be more potent. A vote for independence in Scotland would seem an extreme example of the decline in the legitimacy of democratically elected governments and a catalyst for ever-smaller nations, even verging on gated communities, so like-minded people can get the representation they seek. Secession movements would be encouraged again, as would the ease of jurisdiction-shopping.

On a wider view the lesson from this near-run referendum for the rest of the world is the danger of complacency and its ally, underestimation of risk. The potential for change through the ballot box is now vivid, and everyone must be alive to the risk of underestimating emerging political leaders, especially the successful politician that is not part of the conventional party structures. Some outsiders do win. The Scottish Government’s First Minister Alex Salmond was widely ignored by the leaders of other parties when they gathered in London, in denial about his popular appeal in Scotland because it did not fit their conventional mythology.

The substantial, if not majority, support for Scottish independence results from a dramatic failure of modern Britain to deliver democracy’s core promise of effective governance, as extolled by Francis Fukuyama in his new book Political Order and Political Decay: From the French Revolution to the Present.

Fukuyama presciently warns that no one living in an established liberal democracy should be complacent about the inevitability of its survival. “Democracies exist and survive only because people want and are willing to fight for them; leadership, organisational ability, and oftentimes sheer good luck are needed for them to prevail.”

Whether breaking up the UK could ever be seen as progress is moot, given the blow that Scottish independence would have dealt to the stability and order of the UK that led to civilisation as we know it: a broadening group of nations adhering to common law, democratic process and economic liberalism. The lesson from the vote in Scotland is that nothing is certain and what is valuable has to be fought for.”