A summary version is also available.
The executive summary of this report says:
The literature on “flight capital” is rich and varied but far from thorough or complete. The term flight capital is most commonly applied in reference to money that shifts out of developing countries, usually into western economies. Motivations for such shifts are usually regarded as portfolio diversification or fears of political or economic instability or
fears of taxation or inflation or confiscation. All of these are valid explanations for the phenomenon, yet the most common motivation appears to be, instead, a desire for the hidden accumulation of wealth.
Flight capital takes two forms—legal and illegal. Legal flight capital is calculated in the Hot Money Method of analysis as portfolio investment and other short-term investments, but not including longer-term foreign direct investment. Legal flight capital is recorded on the books of the entity or individual making the transfer, and earnings from interest, dividends, and realized capital gains normally return to the country of origin.
Illegal flight capital is intended to disappear from any record in the country of origin, and earnings on the stock of illegal flight capital outside of a country do not normally return to the country of origin. Illegal flight capital can be generated through a number of means that are not revealed in national accounts or balance of payments figures, including trade mispricing, bulk cash movements, hawala transactions, smuggling, and more.
While there is a clear conceptual difference between legal and illegal flight capital, the statistical distinction between the two can be difficult. Furthermore, available data are often incomplete or erroneously entered in developing country accounts. This report relies on available data without making a judgment as to its accuracy.
We utilize several methodologies and data bases to estimate both the legal and illegal components of flight capital, namely the Hot Money, Dooley, and World Bank Residual Methods, IMF Direction of Trade Statistics, and the International Price Profiling System. To the data that emerge from these methodologies we apply a series of filters and exclusions as we strive to present robust yet conservative estimates.
Some researchers are comfortable using the terms “recorded” and “unrecorded” but uncomfortable using the terms “legal” and “illegal” or “licit” and “illicit.” We argue that by far the greater part of unrecorded flows are indeed illicit, violating the national criminal and civil codes, tax laws, customs regulations, VAT assessments, exchange control requirements and banking regulations of the countries out of which unrecorded/illicit flows occur. To make the following analysis straightforward, we treat recorded flight capital as legal and unrecorded flight capital as illegal, recognizing that there is some interplay between the two.
We particularly want to address the transition from the term illegal flight capital to the term “illicit financial flows.” Illicit money is money that is illegally earned, transferred, or utilized. If it breaks laws in its origin, movement, or use it merits the label. Flight capital is an expression that places virtually the whole of the problem upon the developing countries out of which the money comes. It suggests, without quite saying so, that it is almost entirely their responsibility to address and resolve the concern. The expression illicit financial flows does a better job of clarifying that this phenomenon is a two-way street. The industrialized countries have for decades solicited, facilitated, transferred, and managed both licit and illicit financial flows out of poorer countries. This reality is becoming increasingly understood, and the growing global use of the term illicit financial flows contributes toward this end.
Our best estimate is that illicit financial flows out of developing countries are some $850 billion to $1 trillion a year. We believe this estimate is conservative. It does not include, for example, major forms of value drainages out of poorer countries not represented by money, namely:
1) Trade mispricing that is handled by collusion between importers and exporters within the same invoice, not picked up in mispricing models based on IMF Direction of Trade Statistics, a technique utilized extensively by multinational corporations,
2) The proceeds of criminal and commercial smuggling such as drugs, minerals, and contraband goods, and
3) Mispriced asset swaps, where ownership of commodities, shares, and properties are traded without a cash flow.
We hope to include more of these omissions in future studies.
We welcome comment on methodologies, filters, exclusions, and other aspects of this analysis, and in particular we welcome additional studies of the reality of illicit money shifting out of developing countries. We believe that any responsible analysis will produce estimates of staggering magnitude, underlining the task ahead in curtailing this critical global problem.
Global Financial Integrity thanks Dev Kar and Devon Cartwright-Smith for their considerable contributions to this report.
