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Tackling Illicit Financial Flows for Sustainable Development in Africa

Capital flight is a large-scale exodus of financial assets and capital from a nation due to events such as political or economic instability, currency devaluation or the imposition of capital controls. Multinationals increasingly abuse transfer pricing as a mechanism to avoid paying tax. Developing economies are now increasingly aware of these schemes, especially the abuse of transfer pricing.

The majority of losses in Africa come from trade misinvoicing, which is a combination of tax, customs, and trade fraud. This process could entirely be legal or licit. Illicit financial flows have a negative impact on Africa’s development efforts. Every year, an estimated $88.6 billion, equivalent to 3.7% of Africa’s GDP, leaves the continent as illicit capital flight, 44% of Africa’s financial wealth are thought be held offshore, which corresponds to tax revenue losses of €17 billion.

This massive flow of illicit money out of Africa is facilitated by a global shadow financial system comprising tax havens, secrecy jurisdictions, criminal activities, corruption, bribes and transactions from cross-border smuggling. These outflows are nearly as much as the combined total annual inflows of official development assistance, valued at $48 billion, and yearly foreign direct investment, pegged at $54 billion, received by African countries the average from 2013 to 2015.

Development experts have expressed concern that large-scale illicit financial flows from Africa are draining the continent of critical resources necessary to drive development agenda. Africa’s extractive industries are particularly vulnerable to illicit financial flows because of the complex and elaborate global value chains associated with the sector, which often transcend national borders. Tax incentives, used to lure in foreign investment or promote exports, are another source of outflows. Investors can incorrectly claim incentives or shift income to firms that qualify for lower taxes, according to the African Tax Administration Forum.

Tax incentives have a high fiscal cost and reduce resources for public spending on development, without providing a boon to investment. A 2013 World Bank survey of investors found that over 90 percent of investors in Burundi, Tanzania, Rwanda, and Uganda would have invested even if they hadn’t received fiscal or tax incentives.

Extractive industries account for a significant portion of illicit financial flows on the continent. The multi-stage value chain of a commodity offers ample opportunities for aggressive tax avoidance. For instance, during the exploration phase of mining, smaller companies that survey resources might flip their assets to larger companies that will invest in the actual extraction, but that sale of exploration rights to the larger companies often goes without taxation.

In another scenario, mining companies might say that the skills or standards in a host country don’t meet their needs, so they have to import inputs, rather than sourcing locally. The duties that should be paid on these imports are often tax-free.

The figures are staggering: between $1.2 trillion and $1.4 trillion has left Africa in illicit financial flows between 1980 and 2009 roughly equal to Africa’s current gross domestic product, and surpassing by far the money it received from outside over the same period. Illicit financial flows are money earned illegally and transferred for use elsewhere.

The composition of these outflows also challenges the traditional thinking about illicit money. According to estimates by Global Financial Integrity, corrupt activities such as bribery and embezzlement constitute only about 3% of illicit outflows criminal activities such as drug trafficking and smuggling make up 30% to 35% and commercial transactions by multinational companies make up a whopping 60% to 65%.

Meanwhile, UNCTAD predicts that foreign direct investment in Africa will plunge from $45 billion in 2019 to between $25 billion and $35 billion in 2020, with a recovery not expected until 2022. Also, the World Bank has projected that global remittance flows to low and middle income countries will fall by more than $US100 billion this year as a result of the Covid-19 crisis.

Oil exporters have also been hit as global market prices and export revenues have collapsed, and countries dependent upon tourism have similarly seen their incomes suddenly fall. Additionally, for the developing countries that have become increasingly reliant on the remittances of their foreign workers. What’s worse is that, while laid off workers in the advanced economies can often benefit from some type of unemployment insurance, the majority of suddenly-unemployed workers in developing countries cannot, due to high levels of informality in employment. Consequently, tens of millions are facing sudden economic and food insecurity.

Indications are that developing countries will experience serious economic crisis as their exports dry up, foreign investment capital flees and as their companies and governments are unable to raise new funds in current market conditions. In such circumstances, it will be nearly impossible for them to roll over their foreign currency-denominated debt in international capital markets, which could easily lead to large-scale sovereign debt defaults and the value of their currencies crashing.

Economic and monetary sovereignty do not require isolation, but they do require a commitment to economic, social, and ecological priorities, which means mobilizing domestic and regional resources to improve the quality of life on the continent

This means becoming more selective when it comes to foreign direct investment, and export-oriented, extractive industries. It also means prioritizing eco-tourism, cultural heritage, and indigenous industries. Mobilizing Africa’s resources begins with a commitment to full-employment policies (a Job Guarantee program), public health infrastructure, public education, sustainable agriculture, renewable energy, sustainable stewardship of natural resources, and an uncompromising dedication to empowering youth and women via participatory democracy, transparency, and accountability.

There is no lack of initiatives against these financial flows at both African and international levels. Several African governments have ratified international conventions on the matter and adopted legislation on money laundering and counterterrorism. However, the reasons for the illicit financial flows remain, one of them is the extent to which they are integrated into the local economies. In some cases, removing an illicit economy is tantamount to removing an important source of livelihood.

These financial flows are also viewed as self-sustaining, as a result of their interaction with aspects of development and governance. Illicit profits could be used to influence political processes, allowing actors linked to criminal organisations to stay in power and profit from their criminal activity.

Curbing illicit financial flows requires cooperation at the global level. Over the past decades, the global community has begun to undertake a number of initiatives aimed at reducing illicit financial flows, including initiatives to curb money laundering and improve the sharing of tax information across countries. African governments are now establishing robust legislative and administrative frameworks to deal with transfer pricing issues.

At a European level, new tools have recently been set up, such as the implementation of the fourth Anti-Money Laundering directive, and measures requiring multinationals to publish details of their activities on a country-by-country basis, even outside the EU, adopted in July 2017.

While three initiatives 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) have provided strong recommendations and standards for reducing illicit financial flows, implementation has been challenging.

Many African countries and other developing countries lack the resources and capabilities to dedicate to curbing illicit financial flows. The delay of many advanced economies in fully committing to these initiatives has prevented full transparency and contributed to the continuation of harmful tax practices.

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. Recently, the U.S. and the British dependency of Jersey agreed with Nigeria to repatriate more than $300 million stolen by Nigeria’s former military ruler General Sani Abacha.

Challenges to repatriation efforts are numerous, however. 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 developing economies when asked for funds recovery. More needs to be done both to repatriate funds and to halt financial flows before they exit countries.

The relationship between anti-money laundering and anti-corruption strategies is a key issue for developing countries. Corruption and money laundering cannot be effectively addressed solely by the specialised agencies mandated to deal with them. Supportive frameworks and complementary structures, such as other public agencies closely associated with vulnerable sectors, must be involved.

These structures should be familiarised with money laundering risks and typologies and with the important role they can play in gathering intelligence that contributes to the work of financial intelligence units. While Botswana, Tanzania, and Zambia are undermined by lack of human and financial resources and by flaws in enabling legislation.

In order to effectively contain the threat of money laundering as a facilitator of corruption, they need to confront context-based particularities, notably the prevalence of cash transactions in the economy. Governments and donors in developing countries should work to build the capacity of the financial intelligence units and strengthen their collaboration with anti-corruption agencies and with complementary institutions and partners at home and abroad.

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