Understanding the Relationship between Corruption and Illicit Financial Flows

February 28th, 2014

In many ways, both illicit financial flows and corruption are undefined and relative. For that reason, they’re both notoriously difficult to measure. The difficulty in measuring them in the first place may be part of the ambiguity surrounding their connection. Ambiguity aside, however, these concepts are highly interrelated. Here’s how.

“Corruption” can take on a lot of different meanings. FTC member Transparency International (TI) uses the following working definition of corruption: “the abuse of entrusted power for private gain.”

I imagine that definition is purposively vague and inclusive. Corruption isn’t just bribe paying, although that’s often it. It’s not just in business relationships, but also political, social, and even athletic ones. Corruption isn’t necessarily illegal, although usually it is. And in some cases, while it may be illegal, it isn’t always enforced, which makes it legal in practice. 

For TI’s purposes, an ambiguous definition allows more inclusive measurement of this complex phenomenon. To measure it, TI gets around the ambiguity by surveying each nation’s public perception of corruption, rather than trying to define a concrete set of corrupt activities.

Similarly, FTC member Global Financial Integrity measures the amount of money that flows across borders that is illicitly earned or transferred. IFFs are unrecorded, so they are impossible to just observe in tradition datasets. And since GFI can’t ask people how much money they transfer abroad illegally (and get an honest response), they use complicated statistical methods that infer estimates IFFs by finding discrepancies in official statistics.

For the purposes of understanding the link between IFFs and corruption, this post focuses on public sector corruption that generates financial gains. There are various ways public servants can derive financial gain from corrupt activities, including through direct theft and bribery.

Corruption is linked to illicit financial flows to the extent that illicit financial flows serve as a conduit for distancing the proceeds of those financial gains from its criminal source (aka money laundering). Laundering the proceeds of corruption often involves cross-border transfers of money—ranging from a simple wire transfer to a secrecy jurisdiction account to trusts with undisclosed beneficiaries.

However the relationship doesn’t stop there. As Chaikin and Sharman (2009) have pointed out, “corruption and money laundering are symbiotic: not only do they tend to co-occur, but more importantly the presence of one of tends to create and reciprocally reinforce the incidence of the other.”

After understanding this relationship, we come to policy solutions – and that’s where the FTC comes in. All of the FTC issues, either directly or indirectly, address this connection. For example, strengthening beneficial ownership requirements would obstruct venal officials from transferring their illicit funds abroad and depositing them offshore. FTC’s recommendation on trade mispricing likewise would stem some of the proceeds of corruption that are laundered through trade. And FTC’s support for the strengthening of anti-money laundering laws would contribute toward curtailing the tide of money that crosses international borders and enters the banking systems of developed countries.

Written by Ann Hollingshead

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