PROSPERING ON CRIME:
MONEY LAUNDERING AND FINANCIAL CRISES

Guilhem Fabre

 

In 1998 , the International Monetary Fund estimated that illicit funds, worldwide, amount to between $800 billion and $2 trillion -- two to five per cent of the world’s GDP. These facts are no longer a great surprise. Leading journals have recently published articles on the magnitude and processes of money laundering. The incredulity of those who act as if they are just discovering corruption in emerging nations brings to mind the police officer in Casablanca who is shocked to find gambling in a casino.  Instead of condemning such open secrets, public officials ought to investigate how illicit profits are recycled into the legal economy – the consequences of prospering on crime. What, for example, is the relationship among offshore companies recycling “dirty money,” the Central Bank of Russia, the Bank of New York, governments of developing countries and the vicissitudes of international financial aid ? The answer is hardly self-evident. But an increasing body of evidence suggests that there is a link between money laundering and financial crises.

The post-Cold War financial system rests on two assumptions that fracture one another.  The first is that free capital flows – like international trade -- optimize the allocation of global resources.  This assumption is dubious, both theoretically and empirically. Although the massive increase in direct foreign investments has contributed to economic development in the South, the larger bank loans and other short-term financial have produced the opposite effect, diverting investment from productive sectors to areas of potentially rapid capital appreciation, such as highly speculative stock markets and real estate.  This damages the export competitiveness of developing countries, the supposed basis for repaying foreign loans.  Moreover, increasingly frequent recourse to foreign loans for the purpose of financing public debt (supposedly to reduce the risk of inflation) aggravated the risk of currency crises and default on loans in Mexico, Russia and Turkey.

The second assumption is that the legal and institutional infrastructure that enabled free financial flows between North American, Europe and Japan were of secondary importance.  In the post-Cold-War euphoria, decision-makers accepted uncritically the idea of a self-regulating market.  They underestimated the importance of legal standards that were instrumental to the development of the capitalist economy over the last two centuries as well as the significant burden imposed by the lack of such institutions in transitional economies.  The co-existence of free international capital flows and national institutional and regulatory systems created a void in which transnational economic and financial delinquency flourished.  Transitional economies privatized state-owned firms without allowing market competition or creating necessary institutional and legal infrastructure for effective markets.  Tax evasion accounts for the most important share of crime; however, other problems include capital flight in countries where exchange controls are inadequate, counterfeiting (which represents, according to the OECD, 6 percent of world commerce), insurance fraud, and contraband.  Thus, corruption grows with new opportunities in North-South exchange, and in the legal void of countries in transition, which, while instituting privatization policies, accept the market economy’s idea of profit but not the complementary ideal of market competition.