Seminar On

Corruption, Illicit Financial Flows and

Governance Ethics in AfricaJune 1, 2011

PhD in Public Management and PolicySchool of Graduate Studies, Department of Public Management and Policy,

College of Management, Information and Economic SciencesAddis Ababa University

Instructor: BT Costantinos, PhDA

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An Overview Of Corruption• Corruption may be defined as the abuse of

public position for personal gain or for the benefit of an individual or group to whom one owes allegiance.

• Corruption is a two-way process, involving members of both the public and private sector, who are engaged in illegal, illegitimate and unethical actions

• Corruption is a symptom of weakness in political, social, legal and economic systems.

• Corruption manifests itself in various forms: – Personal, Political, Institutional,

Administrative, Grand and Petty Corruption – Bribery, nepotism, cronyism, patronage,

fraud, and embezzlement

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Causes of Corruption

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• Political Factors - Corruption levels are linked to the strength of civil liberties, particularly • the level of press freedom,• the level of structured, active political competition• the strength of civil society and independence of the

media.• Citizens must have the ability to learn about their

government’s activities and take action accordingly.• Legal Factors - • the quality of a country’s legal system • effective anti-corruption laws, • Finally, effective laws depend on the credibility and

ability of the police and judiciary to act against corrupt practices.

• In situations where these conditions are not met, corruption is liable to spread rapidly.

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• Bureaucratic Factors – higher regulatory and state bureaucratic interventions in

the economy, where government imposes huge regulations, there is greater opportunity for officials to subvert them.

– where public officials are unaccountable over the provision of a public service or the application of regulations and fees.

• Economic Factors – – Where governments create monopolistic economic

settings. – State power creates opportunities for public officials to

promote their own interests, if economic policies are developed, implemented and monitored in a manner that is not participatory, transparent and accountable.

• Transnational Factors – Corruption has strong transnational dimensions. – Some countries that are “hopelessly corrupt” had

systemic corruption introduced during colonial periods.

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Consequences Of Corruption

• Political Consequences– Corruption is insidious, attacking governance and national stability

– Corruption is a form of extortion that marginalizes citizens.

– Fosters contempt for public service and political cynicism – Corruption distorts decision-making, resulting in the

wrong projects & shifts services away from those who need them.

• Economic Consequences– One of the most visible consequences of corruption is its

impact on a country’s economic development – Corruption compromises the achievement of sustainable

development objectives. – Bribing and rent-seeking result in additional business

costs, a burden to small entrepreneurs, and the misallocation of human capital and talent.

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– The continuous attention demanded of business by corrupt officials also threatens economic productivity.

– Competition becomes focused on the highest bribe, thereby denying the public the advantages of a competitive marketplace.

– The poor bear the heaviest burden in such situations, reinforcing extreme gaps between rich and poor.

• Social Consequences – All of the political and economic consequences

discussed above have significant social impacts. The “culture of corruption” results in the demoralization of a country’s population,

– Leading to a lack of confidence in the state and its institutions, and,

– In extreme situations, the collapse of the state itself. Corruption violates the public trust and erodes social capital.

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Positive Side of Corruption

Praising the Curse • Corruption is bad but new school of thoughts are

emerging regarding the good sides; • The impacts of corruption depend on the strength or

weaknesses of institutions and governance • For nations that have failed to establish and

consistently enforce rule of law and efficient bureaucracy, corruption may do a better job

• Corruption may be considered a useful substitute for a weak rule of law and virtually inefficient bureaucracy

• When the value of behaving corruptly (Productive transactions) is substantially greater than the cost of corruption, in the short run, it provides an efficient solution.

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• True, when Corruption results in permanent rent-seeking behavior, it is economically restrictive, but it can also expand economic activities in some cases.– For example, by private citizens bribing officials to

evade bad laws, economic efficiency may increase.– All laws may not necessarily lead to efficiency and

fair use of resources and authorities are not necessarily legitimate

– Corruption may break such systems and authorities. – The moral and ethical element of corruption is

destructive but seemingly positive side is also short run.

• There are evidences that many corrupt activities substitute the missing or misguided laws, and inefficient bureaucratic systems.

• Direct attacks on corruption can be costly battles that will be resisted when corruption plays an expansionary role in a nation.

• Introduction– Illicit Finance/Illicit Money is illegally earned and

intentionally taken out of a country of origin, with the purpose of hiding its source

• An Overview of IFF from Developing Countries– Massive outflows of illicit money from developing countries

– IFF is $859 billion to $1.06 Trillion a year - 2002-2006• Sources of IFF are estimated as follows:

– 3% is from bribery and theft by govt. officials – 30-35% is from criminal activities such as drug trafficking,

human trafficking etc

– 60-65% is from tax evasions through trade mispricing 9

Illicit Financial Flows

(IFF) from Africa

Origin and Means of Illicit Financial Flows (IFF) from Africa

• Since the 1960’s, former colonizers and new neo-colonizers motivated local rulers because of uncertainty of remaining in power to stash money out of Africa

• The following were common means of IFF : Trade mispricing, Bulk cash movement, Hawala , Smuggling and growth of MNCs– Shifting profit from one country to another through

fake intra-company transactions between branches a MNC,

– International tax heavens,– Secrecy jurisdictions in which many corporations

are disguised – Fake charitable organizations,

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Channels for IFF and Methods of Estimation

• Capital flight takes two forms:– Legal: it is recorded on official records– Illegal: unrecorded as it violates existing rules and

regulations (tax laws, banking regulations…)

• GFI’s focused on two channels for the IFF:– External Accounts –Mispricing of Trade Transactions

• Two methods for estimating IFF– The World Bank Residual Method: compares

sources of external funds with usage of these funds

– The Trade Mispricing Model: Measures IFF through trade mispricing data 11

• The World Bank Residual Method – uses external accounts of the country to measure

IFF – compares sources of external funds with usage of

these funds– The difference being IFF– Sources of funds include: Countries inflow of capital,

which consists:• The net public sector external debt (source: WB’s data base)

• Net inflow of the FDI

–Use of Funds include:• Funds used to finance the current account deficit and

• Addition to the central bank reserve• Thus, excess of inflows/sources over recorded

uses of funds, represents illicit capital outflow

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2. The Trade Mispricing Model– Measures IFF through trade mispricing data– It compares developing countries export data with

what the world imported from them; and their import data with what the world exported to them

– Mispricing: • discrepancies between trade data of importing &

exporting parties after insurance and freight adjustment s• Could also result in negative figure suggesting illicit

inflows

• Limitations of the models:– Both the World Bank Residual Method and the Trade

Mispricing models could not fully capture illicit outflows mainly due to reasons such as: smuggling which bypasses records, complications and collusions between parties, in the case of mispriced invoices and so on. Thus the methods result in understated figures of outflows

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GFI’s Report on IFF from Africa• GFI’s report showed there was massive illicit financial

outflows from Africa to western financial institutions • From 1970-2008, illicit financial outflows from Africa

totaled $854 billion - $1.8 trillion• Regional analysis was conducted for the 53 African states,

on decennial basis (1970s, 1980s, 1990s, and 2000-2008)• Regional Groupings were as follows:

– North Africa (5 countries)

– Sub Saharan Africa (SSA): (48 countries)• Horn of Africa (5 countries)

• Great Lakes, (6 countries)• Southern Africa, (14 countries)• West and Central Africa (23 countries)• Fuel Exporters (8 countries) (Nigeria, Sudan,…)• Non Fuel Primary Commodity Exporters (13 countries) (DRC,

Namibia,…) 14

Conclusion: – The bulk of IFF: West and Central Africa - Oil

exporters are the top in the list in SSA– Arica lost around $29 billion per year over the

period of 1970-2008; – The ratio of IFF to ODA is estimated to be 2:1 -

Africa’s position to the rest of the world should be a creditor’s rather than a debtor

– Ethiopia ranks 6th with a cumulative out flow for the period from 1970-2004.

– Impacts of Illicit Financial Outflows• Drain hard currency reserves and heighten inflation• Undermine trade and investment, reduce tax

collection• Widen income-gaps and worsen poverty …

– Hence, economic growth without global good governance results in increased IFF which destroys development efforts and worsen poverty. 15

Combating corruption: Tailoring the Fight against Corruption to Country Governance circumstance • Cognizant of the disastrous impact of corruption, not

surprisingly, there has been a growing global movement to condemn corrupt practices, that has resulted in the removal of some national leaders.

• In addition, governments and agencies have devoted substantial resources to fighting corruption in recent years.

• Despite these efforts, however, it is not clear that the incidence of corruption has declined perceptibly, especially in highly corrupt countries. Why?

• This section of the seminar paper is basically intended to raise discussion towards addressing of such question of why (despite such efforts, the incidence of corruption remains significantly unchanged)

 

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Anti corruption model propounded by Anwar Shah

• The governance level of the country is considered as a vital determinant of the anti corruption strategies to be adopted– Putting differently, the model try to explain the governance-

corruption nexus and asserted that the success of various anti corruption strategies heavily depend on the governance environment of the country in which they adopted

– The rational of the model to focus on governance-corruption nexus is that corruption itself is the symptom of failed governance. Hence, the solution should consider such underlying root cause of corruption

– The model was developed based on deep investigation and analysis of causes and cures of corruption from both conceptual and empirical perspectives

– The author tries to delineate causes and cures of corruption from various theoretical perspectives particularly that of public choice theory, principal- agent model, neo institutional economics and new public management.

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• As per the WB study, the root causes of rampant corruption in the countries under study were:– Clintelism: the legitimacy of the state as a

guardian of public interest is contested, – rule of law is weakly embedded, – accountability are ineffective: electoral process,

bill of right, citizen charter, auditor general, media and judiciary independency etc are weak or non existence

– lack of commitments on part of national leaders – data from both conceptual and empirical perspective

attested that the root cause of corruption is that of the disease of dysfunctional governance.

The 2004 World Bank study (the case of Guatemala, Philippines, Latvia, Pakistan, Kenya and Tanzania)

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• The model shows that such strategies to combat corruption in developing nations (where governance is weak and corruption is rampant) are either irrelevant or have low impact.

• Hence, the model argued that the pecking order of anti corruption policies or strategies in developing nations where governance is weak and corruption is rampant should be:– Establish rule of law, – Strengthen institutions of participation and

accountability, – Establish citizens’ charter, – Limit government intervention, – Implement economic policy reforms

Strategies in States with week Governance Institutions

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Raising public awareness via media and seminar(not relevant)

Justifications:- In countries with weak governance, corrupt

practices and agents are generally well known.

- Neither the general public nor honest public officials feel empowered to take a stand against corruptors and even fear being victimized.(clintelism is the norm)

- Public officials may be aware of corruption but unwilling or unable to take action because of incentive problems in countries with weak governance. (absences of rule of law, accountability and transparency are incentives)

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Anti Corruption and Watch Dog Agencies (not relevant)

Justifications: • Nations with weak governance and with endemic

corruption, anticorruption agencies may extort rents. (Kenya and Pakistan)

• Neither the general public nor honest public officials feel empowered to take a stand against corruptors and even fear being victimized.(bribe and kickback)

• Their detection and prosecution tends to focus on lower level functionaries (rule of law not applied to higher officials and even in some countries like Pakistan they don’t have a mandate to detect higher level officials and military)

•  Evidences suggest that they misused as a tool of political victimization( ex. In Kenya Malawi, sera lion, Nigeria, Tanzania and Uganda researches attested such problem and the ineffectiveness of these institutions)

 

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Increasing public sector wage (negligible)

Justifications: • may have a positive impact on petty corruption

but generally where governance is weak, wage-based strategies are not likely to have a significant impact on civil service corruption.

• Income from corrupt acts is dominant in amount even in case of petty corruption;

• No or little impact in grand corruption• In corrupt societies public positions are often

purchased by borrowing money from family and friends.

• Raising public sector wages simply raises the purchase price and subsequent corruption efforts to repay loans.

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Decentralization(low with medium relevance)

Justification: • There is evidence that decentralization can be an

effective antidote to corruption, because it increases the accountability of public authorities to citizens.

• But decentralization creates hundreds of new public authorities, each having powers to tax, spend, and regulate that are liable to abuse in environments where governance is weak.

• As the World Bank’s analysis of the Philippines in the 1990s shows, decentralization may multiply rather than limit opportunities for corruption if it is implemented under the wrong circumstances.

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The Model’s Conclusion• Anticorruption strategies are unlikely to

succeed unless they recognize the pecking order of reforms.– The first order of priorities should be establishing

the rule of law, strengthening institutions of participation and accountability, and establishing a citizens’ charter of basic legal rights, including access to public services standards and limiting government interventions and implementing economic policy reforms should be part of this package.

– The second order of priority should be clarifying the roles and responsibilities of various orders of government and introducing performance-based accountability to hold government to account for service delivery performance.

– The third order of priority should be implementing policies dealing with detection and punishment of corruption

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1. Abeba Beyene PhD GSR/6318/03; 2. Alazar Amare, PhD GSR; 3. Ayenachew Aseffa PhD GSR/6319/03; 4. Berhanu Temesgen PhD GSR/6316/03; 5. Bikila Hurissa PhD GSR/6314/03; 6. Girmaw Assemie PhD GSR/6320/03; 7. Nega Wubie PhD GSR/6312/03; 8. Sewagegne Delele PhD GSR/6321/03; 9. Tamrat Getachew PhD GSR/6317/03; 10.Yetnayet Ayele PhD GSR/6315/03

Thank you