Center for International Policy

How dirty money thwarts capitalism's true course

By Raymond W. Baker and Jennifer Nordin
Financial Times
Tuesday, October 11, 2005

If smuggling drugs across borders is bad, is smuggling profits across borders through abusive transfer pricing also bad? If tax evasion out of one country is harmful, is the inflow of tax-evading money into another also harmful? If money laundering by terrorists is dangerous, is the use of similar techniques by companies also dangerous?

More than at any time in capitalism's history, our economic system is beset by the tension between what is legal, what is ethical and what serves the common good. This tension points to a fundamental question: which should come first for the global capitalist - maximising profits or pursuing lawful and just business transactions?

Over the past four decades or so, a structure has been perfected that facilitates illegal cross-border financial transactions. This "dirty money" structure consists of tax havens, secrecy jurisdictions, abusive transfer pricing, dummy companies, anonymous trusts, hidden accounts, solicitation of ill-gotten gains, kickbacks and loopholes left in the laws of western countries that encourage incoming criminal and tax-evading funds.

Only the bare outlines of this dirty money structure were available in, say, 1960. Today, perhaps half of cross-border commerce involves parts of this system, often used to generate, shift and hide illicit proceeds. Manymultinational companies and international banks regularly use this structure, which functions by ignoring or skirting customs, tax, financial and money laundering laws. The result is nothing less than the legitimisation of illegality.

If tax evasion was the only consequence of this dirty money structure, some might argue that it serves a useful purpose by maximising profits and shareholder values. But the ugly truth is that this same system aids drug lords, mafia dons and terrorist groups. By our estimate, it moves some Dollars 500bn a year illegally out of developing and transitional economies into western coffers. The Tax Justice Network (UK) estimates that Dollars 11,000bn is stashed away in tax havens and secrecy jurisdictions. The missing trillions further weaken poor countries, contributing to crime, terrorism, destabilisation and deprivation for billions of people.

Why has so much unethical behaviour become business as usual? One explanation is greed, pure and simple. But this does not adequately explain the phenomenon and demeans many in business who believe they are operating in an ethical manner. An overriding commitment to maximising gains, taking priority over other principles, comes closer.

How did we get here? We trace our capitalist roots to the revolutionary concepts of Adam Smith. He articulated the ideas that free and open trade benefits nations, taxation should be fair and predictable and competition should be unfettered by monopolies. Drawing on his primary interest in moral philosophy, his vision for this new economic order anticipated leaders of integrity, prudence, modesty and grace who would operate the free-market system with a sense of justice and fair play.

Unfortunately, Smith's moral sentiments got separated from his economics. The greatest good for the greatest number - "maximising" - became the foundation of utilitarianism, a competing school of thought much more compatible with budding capitalists. A key concern for capitalism in the 21st century is the question of priorities. Will it be maximising before justice or justice before maximising? This is an issue of everyday importance for business people operating globally.

It is fairly easy to do business in foreign countries without breaking laws or perpetrating injustices. It is virtually impossible to do business using tax havens, secrecy jurisdictions, abusive transfer pricing, anonymous entities and secret accounts without breaking laws and perpetrating injustices in many countries.

The free-market system has enormous advantages over any other. Yet the great amount of good that capitalism has wrought disguises the fact that it could accomplish so much more. Making just business transactions a top priority is necessary if capitalism is to achieve its fullest potential and spread prosperity to all. Dismantling the dirty money structure is a crucial first step.

Raymond Baker, author of Capitalism's Achilles Heel: Dirty Money and How to Renew the Free-Market System, is a guest scholar at the Brookings Institution and senior fellow at the Centre for International Policy. Jennifer Nordin is director of economic studies at the Centre for International Policy.