In the 1990s, mainstream development theorists and aid agencies finally began to accept the reality that if they wanted to know why some states fail, or why so many countries are tormented by persistent poverty, they needed to factor corruption into their equations. The Berlin-based Transparency International (TI), founded in 1993, deserves much of the credit for this shift. TI launched the first of its famous Corruption Perceptions Index (CPI) series in 1995, and the Financial Times took the cue by nominating that year as the International Year of Corruption. The World Bank, which had previously all but banished the “c” word from its policy documents, followed TI’s lead after its President, James Wolfensohn, accepted in a landmark 1996 speech that the Bank needed to deal with “the cancer of corruption.” Now the Bank considers corruption to be the single greatest obstacle to economic and social development in the world. The ripple effect from this change of heart has magnified the profile of the problem throughout the diverse fields of international development policy.
By any measure, this is good news. As many iconoclastic critics of business-as-usual development policy argued as long as half a century ago, ignoring the broad social and political frameworks within which economic policy exists is like expecting a fish tank to hold water without a bottom or sides.11. See, for example, Peter Thomas Bauer, Economic Analysis and Policy in Underdeveloped Countries (Cambridge University Press, 1957). Corruption is universal, but its forms vary considerably across different societies. One would have thought, therefore, that serious social scientists and practitioners of economic development policy would have factored it into their understanding early on.
They did not, however, thanks in large part to the way that academic economics shifted theoretical gears and methodologies after World War II. What had always been called political economy solidified its separation into political science and an economics profession, which was driven toward macro approaches in an effort to “harden” itself methodologically. The result was a sharp positivist, quantitative bias that by definition ruled out serious consideration of factors that could not be readily measured—corruption being, almost by definition, such a factor. To this bias was soon added what can only be called a condescending deference to newly independent countries: It was considered impolite, as well as unhelpful to certain parochial institutional interests, to delve too deeply into untoward behavior by the elites of newly sovereign and proud countries.
This explains, at least to some degree, the otherwise astonishing fact that it took half a century to acknowledge the role corruption plays in the dysfunctional economies of so many poor countries. It explains why the OECD’s Anti-Bribery Convention entered into force only in 1999, and the UN Convention against Corruption not until 2003. In many developed countries, bribes were tax-deductible until just a few years ago. Whether it was grasping kleptocrats stealing billions from the state or disheveled policemen extorting bribes at roadblocks, the problem should have been diagnosed and dealt with decades earlier.
Not only has the world been slow to wake up to the problem of corruption in development, the World Bank and others leading the global fight against corruption have yet to accept the full and very inconvenient implications of this shift in thinking. The time is long overdue to re-imagine what we mean by corruption and to launch phase two in the battle against it. The task is not just to recognize the importance of a “supply side” to corruption, involving bribe-givers as well as bribe-takers; it is also about dramatically expanding our understanding of what the supply side has come to include in a rapidly changing, globalizing world. Only after our understanding has caught up with reality will we be able to adequately answer a question that has long puzzled economists: Why does so much money flow from poor countries to rich ones when, for both rational and ethical reasons, it ought to flow the other way?
Several recent developments suggest that a more mature understanding of the problem and the early stages of a phase-two response are already in train. A seismic shift came this past November when Cobus de Swardt, the new head of Transparency International, said that his organization would embark on a “second wave” of corruption campaigning to direct more attention to the responsibilities of Western governments and companies, and highlight their role in international corruption. The World Bank has recently dipped its toes into these waters, too. Last September, the Bank and the UN Office on Drugs and Crime launched the Stolen Assets Recovery initiative, which focuses on returning ill-gotten gains deposited abroad to their countries of origin. More generally, we see signs of an awakening among a variety of media, non-governmental and other groups about the harm caused by massive illicit financial flows and facilitating secrecy jurisdictions. We seem to be at the start of a long process that, if successfully pursued in the face of bitter opposition by vested interests, will ultimately accelerate global development and improve security for poor and rich countries alike.Something Is Missing
We have a ways to go to match our understanding of corruption to a world of accelerating change. Corruption harms three main sets of actors: businesses, governments and citizens, especially the poor. The corruption concerns of these three sets of actors overlap significantly, but they are not identical. The dominant mode of thinking about corruption is shaped around the concerns of businesses. For that reason it tends to focus heavily on bribery, while ignoring much bigger problems.
For example, Transparency International’s Corruption Perceptions Index has not caught up to TI’s new resolve to surf the second wave. It draws heavily on opinion within the business community. While it does provide an invaluable ranking for investors trying to assess country risk, it is of little use to the citizens of oil-rich Nigeria, for example, to be informed by the CPI that their country is among the world’s most corrupt. Nigerians and others like them want to know where their money has gone.
Consider the brutal Nigerian president Sani Abacha, who died in 1998, allegedly in the company of Indian prostitutes, but not before he had raked off billions of dollars of oil money from state coffers. Or to take a more recent example, we now know more or less how relatives and associates of the former Kenyan President Daniel arap Moi diverted hundreds of millions of dollars into their pockets through a web of shell companies, secret trusts and other evasive structures. Two jurisdictions that happily soaked up the embezzled wealth of both regimes are worth highlighting: Switzerland and the United Kingdom. “The UK authorities and banks”, the BBC reported after a bit of the money was eventually returned, “were found to have been even less cooperative than the Swiss, despite the latter’s long and sullied reputation for protecting allegedly stolen assets.” But despite these scandals and many similar crimes that have yet to surface, the latest CPI ranks Switzerland and the United Kingdom as among the world’s “cleanest.” Swiss and British rulers may be personally clean, but what about Swiss and British bankers, lawyers, accountants and, yes, even some lesser officials, who handled and harbored these stolen funds? In aiding and abetting grand theft and national-scale looting, they were knowingly complicit in, and therefore a necessary part of, the corruption process.What Is Corruption?
It is fine that the CPI helps clean businesses assess the risk in doing business abroad, but what about some help for everyone else? To fight corruption that hurts governments and citizens as well as businesses, we need a comprehensive practical definition of it. The “official” development world is not there yet.
The World Bank defines corruption as “the abuse of public office for private gain.” The restricted focus and the obsession with the public sector illustrated by this definition is both arbitrary and insufficient. Transparency International says that corruption is “the abuse of entrusted power for private gain.” This definition is better, as it could be used more broadly, but in practice it is usually interpreted in a narrow way, notably by focusing on the public sector, particularly on bribery. Four classes of examples show why these definitions are inadequate.
First, during the dot-com euphoria of the late 1990s, Wall Street investment banks offered stocks in “hot” initial public offerings (IPOs) to corporate executives, who in return would then direct their own companies’ business to these banks. Meanwhile, the bank analysts wrote glowing reports about the IPOs, while privately referring to them with terms like POS (piece of shit). The aim was to induce an inflow of corporate business and generate big fees. A second example is the widespread practice of illegal market rigging: Private companies build up secret monopolistic positions using shielded offshore structures to hide the fact that several apparently unrelated parties are in fact related and are colluding to fix prices. Neither class of cases involves public office or entrusted power. However, the first arguably involves a form of bribery, while the second violates laws of most Western countries.
Third, consider the byzantine Elf Affair, an eight-year judicial investigation launched by the French investigating magistrate Eva Joly that has been described as Europe’s biggest corruption investigation since the Second World War. The “Elf Affair” involved, among many other things, oil money from the African subsidiaries of the then-French state oil company Elf Aquitaine being routed via tax havens and used to covertly finance French political parties and offshore slush funds in support of French diplomatic objectives around the world. The Elf Affair was echoed by the BAE Systems scandal, involving alleged corruption in British arms sales to Saudi Arabia. This was another thoroughly transnational undertaking linking oil-producing and oil-consuming countries, in which British Prime Minister Tony Blair invoked the “national interest” as a reason for allowing alleged corruption to go uninvestigated and unpunished. These affairs, too, which have provoked widespread disaffection among French and British voters, do not fit the standard corruption definitions because they are not primarily motivated by private gain, but by national security and policy considerations.
Fourth, many think corruption is always illegal. Not so. In the 1990s, Angola operated a system of multiple exchange rates through which well-connected officials could change local currency into dollars at a highly preferential exchange rate, effectively getting dollars on the cheap. Then they changed the dollars back into local currency on the black market, pocketing the difference. This amounted to free money for oil-rich elites, limited only by the number of hours in the day and the energy individuals had to indulge their greed. Although entirely “legal”, the scheme was clearly corrupt, and it hurt citizens unable to queue up in that particular line. The point is that the system itself was corrupt, not just the actors, and it was not illegal because the same actors who created the scheme and benefited from it were also the ones who determined what was and was not legal.
If standard definitions fail to tell us what corruption really is, then what new definition do we need, and how should we create it? We should, above all, trust our intuition. Just as Potter Stewart was sure he knew pornography when he saw it, even if he could not define it precisely, so corruption should be defined as whatever corrupts: We know it when we see it.
We can do better than that, however. As a first step, we need to expand the geography of corruption. This is because corruption has not only a demand and a supply side, but also a host of intermediaries who facilitate the murky deeds. The sensible general strategy for fighting the international drug trade by tackling users, suppliers and middlemen is applicable to the global struggle against corruption. Thus, it makes no sense to see corruption through the prism of discrete, country-level problems. For example, the CPI ranks the countries of Africa as the primary locus of corruption, but it ignores the global infrastructure of international financial secrecy that has helped bleed trillions of dollars in illicitly generated money not only out of Africa but also out of the Middle East, Latin America and Russia into the financial centers of the richest countries in the world.
This reflects one of the most important fault lines in the ongoing process of financial liberalization, and it shows vividly why we need to see the big picture to deal even with the small snapshots. While capital has become almost totally mobile, the ability to police cross-border flows of illicit money remains severely constrained. International borders act like semi-permeable membranes, letting the crooks and the dirty money through while stopping the forces of law and order seeking to foil them. “The magistrates are like sheriffs in the ‘spaghetti westerns’ who watch the bandits celebrate on the other side of the Rio Grande”, said Eva Joly after the Elf Affair. “They taunt us and there is nothing we can do.” She was furious about the blocking role played by numerous tax havens, most especially “the City of London, that state within a state that has never transmitted even the smallest piece of usable evidence to a foreign magistrate.”22. Joly, Notre affaire à tous (Les Arènes, 2000).
Beyond scaling up our perspective to the global level, we also need to pay attention to systems and processes, not just individuals. And we need to include consequences, not just methods. Corruption always involves narrow interests abusing the common good. It always includes insiders using guarded information operating with impunity. And it always corrodes institutions, worsens absolute poverty and inequality, and ultimately undermines faith in the rules and systems that are supposed to promote the public interest. Thus, a better basic definition of corruption would go something like this: Corruption is the abuse of public interest and the undermining of public confidence in the integrity of rules, systems and institutions that promote the public interest.
This definition is not limited to developing country kleptocrats and rogue officials, but makes room for a much broader array of actors and their facilitating activities. It also suggests a rubric for rich and poor to find common cause in fighting this global scourge.
That said, it helps to use the noun “corruption” sparingly and instead to emphasize the verb “to corrupt.” Using the verb shifts our focus away from situations, people, isolated acts and finger-wagging, and toward examining underlying systems, relationships and processes. Markets and governments are built on trust, and the undermining of trust is arguably the greatest danger that confronts global markets today. Globalization can be a force for good, but it is tainted by a widespread perception that the system is rigged against ordinary folks. If countries retreat into protectionism, as some fear will happen, the sense of unfairness that stems from corrupting influences in the international financial system will have been a major contributing factor.
There are many consequences of refining our perceptions of corruption. One is that tax evasion is identified as a form of corruption, even if it does not involve the abuse of public office or entrusted power. While those people and institutions dedicated to tackling corruption today tend to focus on the theft of certain types of public assets, tax evasion is generally overlooked even though evaded taxes are stolen public assets, too. Tax evasion also looks very much like more traditionally defined forms of corruption because it involves abusive activity at the intersection between the public and the private sectors. It allows sections of society to bypass accepted norms, and provides one set of rules for the rich and well-connected, and another set for the poor and weak. It involves insiders operating in secret, without restraint. It corrodes governments.
Furthermore, the proceeds of tax evasion, along with the proceeds of bribery and criminal activities, use exactly the same mechanisms and subterfuges as they shift across borders: dummy corporations, shielded trusts, anonymous foundations, falsified pricing, fake documentation and more, all abetted by a supporting array of mainstream bankers, lawyers and accountants. Dirty money in many forms welcomed by the United States and Europe allows the proceeds of drug trafficking, racketeering, corruption and terrorism to tag alongside. These are parallel rails on the same tracks coursing through the global financial system.
Tax evasion is also the tail of a much larger creature: the cross-border capital flows that underlie it. The secrecy that facilitates tax evasion and other crimes is one of the most important reasons why capital flows out of capital-starved economies, a fact that orthodox economic theories cannot explain.
Expanding our definition of corruption will also change priorities in the field of foreign aid. Taxes, not aid allowances, are the most important and the most sustainable sources of finance for developing countries, whose long-term goal must be to replace foreign aid dependency with tax self-reliance. Aid makes governments accountable to donors; taxes make governments accountable to their citizens, and tax evasion undermines this basic pillar of civil accountability. As South African Finance Minister Trevor Manuel recently noted: “It is a contradiction to support increased development assistance, yet turn a blind eye to actions by multinationals and others that undermine the tax base of a developing country.”33. Address to the forum on tax administration, Cape Town, South Africa, January 10, 2008.
And it is not just developing countries that suffer from tax evasion. Take the case of GlaxoSmithKline, which paid $3.1 billion after it settled a dispute with the U.S. Internal Revenue Service in September 2006 over transfer mispricing, the practice by which related subsidiaries of companies deliberately misprice internal transactions so as to cheat tax authorities. If tax evasion in all its forms is brought into the corruption debate, that means tackling the international infrastructure that allows developing and developed countries alike to be cheated of not just their taxes but of investment capital that exits to the secrecy jurisdictions.Magnitudes and Measurements
There may be a clear theoretical case for launching a phase two battle against corruption, properly defined, but is it really worth pursuing? How big is the problem?
Precise measurement of corruption in all its forms is difficult: Transnational illicit financial flows and abusive tax practices are fragmented, hard to define and cocooned in a pervasive culture of secrecy. But if we start with a few things we know or can make educated guesses about, it will become apparent that the scale of this phenomenon is staggering.
According to the OECD, more than half of all cross-border trade is routed through tax havens.44. French Finance Minister Dominique Strauss-Kahn, in a speech to the Paris Group of Experts in March 1999, quoted in John Christensen and Mark Hampton, “All Good Things Come to an End”, The World Today (August/September 1999). Use of tax havens has increased as a share of global trade since then. The World Bank’s Stolen Asset Recovery initiative estimates the cross-border flow of proceeds from criminal activities, corruption and tax evasion at between $1 trillion and $1.6 trillion per year, about half of which comes from developing and transitional economies. This dwarfs foreign aid, which totaled about $50 billion a year through the 1990s and is about $100 billion today. So we have $50–100 billion of aid flowing into poor countries, and $500–800 billion of dirty money flowing out. In other words, for every dollar Western governments have been handing out across the top of the table, crooked Western banks, businesses and middlemen of various descriptions have been taking back up to ten dollars of illicit proceeds under the table.
On a different tack, the Tax Justice Network, using data from Boston Consulting, McKinsey, Merrill Lynch/Cap Gemini and the Bank for International Settlements, estimates that the world’s high net-worth individuals hold around $11.5 trillion offshore, generating potential tax losses of $250 billion annually. This conservative estimate includes both legal and illegal tax dodges but excludes many other kinds of abusive financial flows. Even if one believes that the tax rates of some countries are extortionary, there is no excuse for, in effect, stealing public money that poorer citizens will end up having to replace. Tax evasion on such a scale is not only stealing from governments, it is stealing from ordinary people’s futures in an act of reverse-Robin Hoodism.What To Do
Now that we better understand the problem and grasp its magnitude, the questions turn to policy. What should we do as individual nations and as a global community? A look at the past will perhaps provide some guidance.
Policy has tended to trail behind galvanizing events. The U.S. Foreign Corrupt Practices Act (FCPA) of 1977 followed both the Watergate scandal, which helped create the right political climate, and a series of investigations revealing that more than 400 corporations had admitted paying $300 million to foreign government officials to win projects. Yet the FCPA did not trigger a decisive shift in global policy debates, since other countries did not follow America’s lead. After 1977, companies from Germany, France, Britain and other countries still did business as before, gleefully corrupting foreign and domestic officials to steal contracts from under the noses of their more squeamish American competitors. It seemed inconceivable that genuine global cooperation on corruption was possible. What is more, the presence of secrecy jurisdictions allowed American companies to drive a coach and horses through the FCPA by enabling foreign corruption to continue to take place under the veil of offshore operations.
The Cold War played a powerful role, too. During that era, many on the Left, as well as others racked by post-colonial guilt, sought to blame rich countries and rich corporations for poverty and conflict in places like Nigeria, Indonesia and Nicaragua. Many on the Right argued that corruption was acceptable because it “greased the wheels” of international trade and capitalism and was therefore, at least within certain limits, a good thing. The World Bank and IMF, for example, and Western governments more generally, put institutional interests above all else, concluding that slinging mud at senior politicians in poor countries was no way to make friends and keep the Soviets at bay. Today, happily, the corruption portfolio transcends the old ideological divide. After being embraced at the World Bank by Wolfensohn and his left-liberal chief economist Joseph Stiglitz, it was also championed with gusto by Paul Wolfowitz from the opposite end of the policy spectrum, although not without serious institutional resistance.
Nonetheless, some echoes of past obstacles are still with us. Many non-governmental organizations see a focus on international financial flows and secrecy jurisdictions as a distraction from what they want: aid instead of better mobilization of domestic resources. At the same time, the old “corruption greases the wheels of business” argument lives on, as illustrated by a February 2007 Economist article that reported favorably on tax havens and the secrecy jurisdictions that host them. That being the case, it is not surprising that a modern equivalent of the FCPA such as the Financial Action Task Force, which ostensibly seeks to crack down on tax haven abuse, has failed to seriously dent the problem and, indeed, has helped legitimize the illegitimate.
Nonetheless, change is afoot. Just as Watergate helped usher in a propitious climate for an anticorruption thrust in America in the 1970s, big changes now underway are likely to sustain and accelerate the shift toward a phase-two attack on corruption. Senator Barack Obama’s backing for the Stop Tax Haven Abuse Act and an aggressive approach by the Internal Revenue Service against the Swiss banking giant UBS, which is suspected of facilitating tax evasion by wealthy Americans, are symptomatic of a changing political climate in the United States. Revelations in February that wealthy Europeans have been using accounts in Liechtenstein to evade taxes have contributed to a powerful mood shift against tax havens in Europe. In the past few months, OECD governments have also started discussing how they can cooperate on regulation and financial affairs. If the current subprime mess and evolving credit crunch are believed to be the leading edge of a deep, destabilizing global economic crisis, then we may expect greater resolve and cooperation in rectifying the huge imbalances in the global economy. That resolve will sooner or later transform the corruption debate, for there is no way to rectify the problem without addressing the corruption issue root and branch.
Of course, it won’t be easy. Powerful vested interests have a lot to lose from cleaning up the current state of global capitalism. But the rest of us have even more to lose if we don’t. If global capitalism cannot be rendered essentially fair, then it is unlikely to be sustainable in a world where formerly marginalized people are rapidly emerging from eons of political ignorance and passivity. We either join together to fix this problem, or it will surely “fix” us.