EXCERFFS

International Monetary Fund, "Tougher Measures Needed to Counter Macro Effects of Money Laundering," IMF Survey, July 29, 1996.

[...] Although difficult to measure, the magnitude of the sums involved and the extent of the criminal activities that generate this "income" have implications for both the domestic and the intemational allocation of resources and macroeconomic stability.

Money laundering and measures to counter it have therefore become the focus of intense international attention in recent years. Two IMF Working Papers--by Vito Tanzi, Director of the IMF's Fiscal Affairs Department; and Peter J. Quirk, an Advisor in the IMF's Monetary and Exchange Affairs Department--assess the potential costs of in- ternational money laundering for the world economy and address proposed remedial measures. [...]

Although it is impossible to measure directly the size of the net financial gains that accrue annually to those who engage in these activities worldwide, Tanzi and Quirk offer a"guesstimate" of up to $500 billion, or 2 percent of global GDP. Moreover, the value of the total stock of laundered money is probably much larger than the yearly figme-~rob- ably larger than the GDP of many counlries. According to Quirk, there is empirical evi- dence of large-scale money laundering throughout the group of industrial countries in direct proportion to Interpol data for overall criminal activity in those countries.

The concentration of vast sums of money in laundering operations has generated pro- gressively more sophisticated attempts to launder the assets. Laundering transactions now involve a broad range of financial instruments, including derivatives. And the intermedi- aries have increasingly included such traditional financial institutions as banks and near- banks, brokers and dealers, as well as unconventional and parallel financial markets.

The increasing technical sophistication of the globalized capital market, meanwhile, has helped to grease the wheels of the money laundering machinery. The much larger volume of legitimate capital flowing relatively freely through the world's markets has allowed money of questionable origin to spill unobtrusively into this huge money stream. It is thus often impossible to distinguish between capital movements induced by differ- ences or changes in economic policies and capital movements that reflect attempts to launder money.

Macroeconomie Links to Money Laundering There is currently no theoretical literature on the macroeconomic effects of money laun- dering. Nonetheless, indirect macro-based empirical research and related studies of crime and the underground economy, coupled with the pervasive role of money launder- ing in illegal activity, suggest that money laundering may be sufficiently widespread to exert an independent impact on the macroeconomy. Quirk cites empirical evidence, for example, that money laundering has negatively affected growth in industrial countries. The common theme of the available research, he says, is that if crime, underground activity, and the associated money laundering occur on a sufficiently large scale, policy makers must take them into account.

FINANCIAL CRIME

COMBATING FINANCIAL CRIME AND MONEY LAUNDERING 7

Money launderers generally do not look for the highest rate of return on the money they launder, Tanzi explains, but for the place or investment that most easily allows the recycling of their money---even if this requires accepting a lower rate of return. These movements may well be in directions opposite to those that would be expected on the basis of economic fundamentals. Money may therefore move from countries with good economic policies and activities with higher rates of return to countries with poorer policies and activities with lower rates of return. Thus, because of money laundering the world's capital tends to be invested less optimally than in the absence of such activi- ties. As a consequence of such counterintuitive capital movements, policymakers may be confused about the policies to be pursued and may respond inappropriately. For example, a shift in apparent money demand---owing to money laundering that is nowhere reflected in the data--could have consequences for interest and exchange rate volatility.

At the national level, therefore, large financial flows related to money laundering could influence variables such as exchange rates and interest rates. On the international level, capital movements originating from laundering activities--especially when they are seen as temporary--could have destabilizing effects because of the integrated na- ture of global financial markets. Financial difficulties originating in one center can easily spread to others, thus transforming a national problem into a sympathetic one.

Tanzi and Quirk both emphasize that the development of efficient and stable capital markets requires that participants have full confidence in them. If markets were to be contaminated by money controlled by criminal elements, they would react more dra- matically to rumors and false statistics, thus generating more instability.

The transparency and soundness of financial markets are key elements in the effec- tive functioning of economies, and money laundering can threaten both. Criminally obtained money can corrupt financial market officials, and the damage can be long lasting, because the credibility of markets, though quickly lost, takes a long time to be rebuilt.

Implications for Macroeconomic Policy The large scale of the money laundering problem, its significant effects on financial systems, and the potential impact on economic growth have prompted considerable dis- cussion of the macroeconomic policy implications of anti-laundering effects. Attention has focused, in particular, on the resource cost and benefits of money laundering coun- termeasures. Discussion at the international level has addressed the implications of these measures for exchange control liberalization, prudent supervision of financial systems, anti-tax evasion efforts and legislation. [...]

According to Quirk, the accepted methods of monitoring for money laundering re- quire information on--rather that control of--foreign exchange transactions. The form of information also differs. In countries where they remain in force, exchange controls require information about the economic function of the transaction, while monitoring for money laundering focuses on establishing the identity of individual transactions and the pattern of their transactions.

The main point of potential conflict between anti-laundering measures and exchange decontrol is the effect of the deregulation in vastly increasing the overall volume of international transactions, which provides more opportunity to disguise the sources of

8 TRENDS IN ORGANIZED CRIME ] SPRING 1997

funds. However, the same may be said about the effect of deregulation on economic growth and the growth of financial markets in general; exchange controls, far from checking potentially destabilizing flows, have led to thriving parallel markets with close connections to the underground economy.

What this experience suggests, says Quirk, is not to set back the clock on economic and financial reforms, but to find ways and devote resources to implementing effective anti-money laundering measures ahead of the accelerating pace of financial market development.

Prudential Supervision. In a growing number of countries, banks have become subject to official monitoring and prudential regulation. Some tension arises between such regulation and economic efficiency, because banks must weigh their own internal objectives of profitability and survival against the costs of official intervention. [...]

Money laundering activities can corrupt parts of the financial system and undermine governance of central banks and supervisory authorities. Once a bank manager is cor- rupted, nonmarket behavior can spread into operating areas other than those directly related to the money laundering, which undermines the safety and soundness of the bank. Bank supervisors also can be corrupted or intimidated, reducing the effectiveness of supervision. There is thus a clear need for supervisors to support anti-laundering law-enforcement efforts, but this should not crowd out traditional bank supervision responsibilities. [...]

International Policy Coordination [...] One solution, suggests Tanzi, is for the international community to establish a set of rules that form the basis for full participation by any country in the international finan- cial market. This market should become an exclusive club with benefits and obligations for those wishing to belong. An international convention would establish minimum standards of statistical, banking, prudential, and financial rules that would be binding on all countries. These rules would drastically reduce the differences in domestic regu- lations that encourage and, to some extent, make possible international money launder- ing. The support of the international organizations would need to be enlisted to establish these minimum standards and, subsequently, to monitor and enforce these rules. Puni- tive measures would also have to be introduced, Tanzi adds, to induce all countries to play by the same rules.

The IMF and Money Laundering International money laundering is an obstacle to the IMF's task of maintaining an effec- tively operating international monetary system. The containment of money laundering activities within the context of its broader responsibilities and its resource constraints. As noted in Quirk's statement at a recent FATF meeting, the IMF intends to examine closely the implications of money laundering, emphasizing the following areas:

�9 in countries where an analysis of money laundering is particularly important for understanding the behavior of the macroeconomy (for example, in countries where drugs or other illegal exports are known to be large or where weakness in the fiscal regime encourages money laundering);

�9 in context of international capital market developments; and

COMBATING FINANCIAL CRIME AND MONEY LAUNDERING 9

in the design of IMF-supported economic programs and IMF technical assis- tance, particularly when money laundering appears to be affecting macroeconomic performance.

Reprinted with permission.

Peter J. Quirk, Macroeconomic Implications of Money Laundering, Working Paper, Washington, DC: International Monetary Fund, June 1996.

Mr. Quirk is an Advisor in the IMF's Monetary and Exchange Affairs Department.

Summary Money laundering and measures to counter it have become the focus of an intense international effort. Evaluation of the resource costs and benefits of the countermea- sures depends in part on an understanding of the macroeconomic effects of money laun- dering. The wide range of activities and financial instruments involved in money laundering is not directly observable, and comprehensive, microeconomic-based esti- mates are difficult to compile. Indirect macroeconomic-based techniques that involve estimating the extent of money laundering are, therefore, the focus of most empirical work. This paper introduces an international cross-section econometric examination of the role of money laundering, tax evasion, and employment opportunities in determin- ing monetary behavior, and concludes that money laundering has a significant role. A shift is detected from the use of currency in the 1980s to noncash money laundering in the 1990s.

The economic literature suggests that money laundering can distort economic data and thus distort macroeconomic analysis and policymaking. In addition, there may be direct effects on saving resulting from induced changes in income distribution and from the erosion of confidence in financial markets. The paper reports a first attempt at econo- metric estimation to link differences in economic growth rates among industrial coun- tries to crime as a proxy for money laundering; some evidence is found of a depressant effect on growth.

Finally, the paper examines the implications for economic policymakers. Freedom to

launder money could promote private economic welfare for some while undermining social welfare. Public policy considerations, therefore, suggest anantilaundering role for financial institutions involved in prudential banking supervision, tax evasion moni- toting, statistical reporting, and legislation. However, in order to minimize the negative consequences of macroeconomic efficiency, care must be taken in designing the form of the interventions. [...]

H. Measurement Issues [...] Table 1. Potential Instruments of Money Laundering ~

1. Acceptance of deposits and other repayable funds from the public. 2. Lending. 2 3. Financial leasing.

10 TtENVS tS ORGAmZEV CreME / SPmNC 1997