Illicit Financial Flows: The Scourge of the Developing World

01/07/2013 06:23 pm ET | Updated Mar 09, 2013

For most of my professional life, I owned and operated a number of businesses in Nigeria. My partners and I would find a failing company, buy it out, and rebuild it as an efficient, well-run enterprise that turned a profit. We paid our taxes, refused to participate in bribery or corruption, and created jobs.

I am sad to say that when Nigerians look into the future, they do not see the optimism that I experienced back in the 1960s and '70s. Their country has been torn apart not just by civil war, but also by the terrible forces of crime, corruption, and tax evasion. After years of seeing the quality of life for so many people in Nigeria decrease, I decided that I was obligated to do something about it. I founded Global Financial integrity, an organization dedicated to curtailing illicit money leaving countries like Nigeria around the world.

Late last month, we released a new report showing that $5.86 trillion left the developing world due to crime, corruption, and tax evasion from 2001-2010, including $859 billion in 2010 alone. These illicit transfers of money away from developing countries are known as illicit financial flows, and they are one of the least talked about challenges that the world needs to overcome in order to fight global poverty.

Illicit financial flows harm developing countries in three key ways. First, this capital flees the country, robbing the local economy of much-needed investment dollars. Money that stays in a local economy has a macroeconomic multiplier effect: it gets spent and re-spent over and over again. With so much money leaving developing economies, poor countries often have difficulty building the kind of local financial systems and feedback loops necessary for a vibrant economy, entrepreneurship, and the creation of a middle class.

Second, illicit financial flows are untaxed, unrecorded transfers of wealth primarily moving from the world's poorest people to its richest. Instead of some of that money being collected as revenue for local governments and being spent on schools, infrastructure, hospitals, or debt payments, it drives inequality by flowing out to tax havens. Developing countries need to build the basic structures of society that provide services to its people. A middle class economy cannot be built without these services.

Finally, the ease with which illicit money can be moved and hidden fosters sophisticated organized crime. Our prior research shows that illicit financial flows drive underground economies. To make matters worse, underground economies drive illicit financial flows, completing the vicious cycle. This should make sense: as it becomes easier for criminal networks to move large amounts of money, they grow more powerful, and then open up new means of acquiring and moving money out of the country. This explains the scourge of poachers, drug cartels, human traffickers, terrorists, counterfeiters, and all sorts of other illicit industries that seem to be getting worse every day in the developing world.

Our government leaders need to solve this problem. Too many people in Nigeria and elsewhere have suffered too much because of illicit financial flows. While the developing countries can do certain things internally to improve governance and tackle tax evasion and corruption, the problem must be approached at a systemic level by the world community. Western countries like the United States have helped to build a shadow financial system that is designed to efficiently and secretly squirrel away money where no law enforcement authority will ever find it.

The West should do three things right away. First, we should eliminate anonymous shell corporations, so no criminal can hide nefarious actions behind an innocent-sounding Delaware LLC or Cayman Islands trust. Second, we should create a system of automatic tax information exchange, so law enforcement can continue to track the movement of illicit money when it crosses a national border. And finally, we should reform our customs and accounting laws so that fraud at international trade boundaries cannot be manipulated to smuggle money away from local economies.

At heart, I am a capitalist and an entrepreneur. I deeply believe that free market economics is the best way for people in places like Nigeria to fight their way out of poverty. But we cannot allow some people to opt out of the social contract of taxes and laws necessary to build those energetic capitalist economies. Doing so undermines the basic architecture of the system, and it prevents hundreds of millions of people every year from fulfilling their hopes and dreams. We need to free people from the chains of crime, corruption, and tax evasion, and curtail illicit financial flows.

Raymond W. Baker is director of Global Financial Integrity, a Washington-based research and advocacy organization, and author of "Capitalism's Achilles Heel: Dirty Money and How to Renew the Free-Market System."