Illicit money flows as motives for FDI

Abstract

We examine the role of FDI in facilitating money laundering and illegal capital flight, focusing on transition economies' FDI outflows because they largely reflect current investment decisions rather than the inertia of past decisions. We estimate a model of FDI outflows in which illicit money flows influence the volume of FDI directed toward countries considered to be centers of money laundering. We show that traditional models of FDI are not able to account for these investment flows and that our results are robust when additional explanatory variables such as host country tax rates, governance, corruption, and cultural differences between the home and host country are included in the model. We estimate that 6 to 10% of total FDI outflows and over 20% of FDI to money-laundering countries from our sample were made to facilitate illicit money flows.

The costs of moving money across borders and the volume of capital flight: the case of Russia and other CIS countries

“…The liberalization of the financial sector allows for more recorded capital outflows, but it also opens up new channels for illicit and unobserved capital flows as well (Perez et al 2011). The results are also interesting for policy makers in that they show that a sufficiently repressive trade and financial system can stem even strongly motivated capital flight, something seen in our estimates of capital flight from countries such as Belarus.…”

“…Moreover, as Harrigan et al (2002, p. 207) note, this 6 Thus Cyprus, a leading destination for capital flight, is each year one of the major sources of FDI inflows into Russia; in Ukraine, Cyprus and the Virgin Islands, another haven for illicit capital flows, account for nearly 20% of the stock of all foreign direct investment in the country. See Perez et al (2011) for additional evidence. 7 See Chang et al (1997) and Hermes et al (2002) for various methods for measuring capital flight.…”

“…At the other end of the spectrum is money laundering, transactions that hide the illegal origin of the funds and convert them into legal income (Reuter and Truman 2004;Perez et al 2011). Money laundering involves illegality in two ways.…”

Outward FDI from the USA and host country financial transparency

“…Perez, Brada, and Drabek 2012;Brada, Drabek, and Perez 2012). Perez, Brada, and Drabek (2012) speculate that FDI from transition economies is attractive as a means of moving funds offshore for a variety of reasons. Host countries tend to be more restrictive of portfolio investment, especially if they fear experiencing 'hot money' effects.…”

“…Buchanan (2004) and Perez, Brada, and Drabek (2012) argue that when the amount of money generated through illegal means is small, the financial system can be used to hold and move this money without raising Downloaded by [University of California Santa Barbara] at 08:14 21 June 2016 suspicion relatively easily by setting up numerous bank accounts, using surrogates, and creating false identities. Some may argue that because the work of Perez, Brada, and Drabek (2012) deals with transition economies as the source countries of FDI while our paper employs the USA as the source country, many of their conjectures about money laundering are more plausible than in the case of the USA, as the USA is more capable of tracing much of the illicit funds. While there is, in fact, much credence to this argument, consider, however, that the proceeds available for money laundering in the USA from tax evasion have been estimated at $262.2 billion; cocaine trafficking, $61.3 billion; fraud (nonarson), $59.3 billion; heroin trafficking, $17.6 billion; prostitution, $14.7 billion; loan sharking $14 billion; and marijuana trafficking $13.5 billion (Reuter and Truman 2004).…”