Wednesday, May 12, 2010

Greece: $160 billion lost to illicit outflows

While the world surveys the wreckage of the Greek economy, here is an important analysis from Global Financial Integrity and the Task Force Blog:

"Even as Greece’s debt burden grew ever more onerous, its burgeoning underground economy fueled massive illicit financial flows, or illegal capital flight, out of the country. Based on well-established economic models, Global Financial Integrity (GFI) estimates that over the past decade ending 2009, Greece lost an estimated US$160 billion in unrecorded transfers through its balance of payments."

And at the same time there were illicit inflows, too, worth $96 billion through the misinvoicing of trade transactions, probably as a result of import duty evasion and smuggling:

"All such inflows ever accomplished were to further enrich the corrupt and worsen the distribution of income. The crisis should prompt economists to revisit the issue of illicit inflows.
. .

And then it makes some crucial arguments that go to support our July 2009 blog demolishing the arguments made by the Oxford Centre for Business Taxation (though a more apt name would be the Oxford Centre against Business Taxation) casting aspersions as to the accuracy of GFI's illicit flows.

"Traditionally, economists have netted out the so-called inflows from outflows as if the netting of the two more accurately reflects a country’s net position with regard to these flows. In contrast, GFI’s studies have stressed that netting “inflows” from illicit outflows makes little sense. Not only are (unrecorded) illicit inflows outside the government’s tax net, they cannot be used to sustain high-quality economic growth."

This is extremely important, and it helps explain the world's blindness to illicit flows. Netting out the flows would give a figure of $160 - 96 billion = $64 billion. Whereas instead of netting out (or subtracting one from another), it makes more sense to add the two figures. As the analysis notes:

"Even as Greece “enjoyed” illicit inflows in every single year from 2000-2009 through trade misinvoicing, the country has been pushed to the verge of bankruptcy!"


Now this gets us into an interesting set of questions that have a lot to do with debt sustainability and the IMF's statistical collection, as the GFI analysis' author Dev Kar, a former IMF Senior Economist, explains. While traditional economics have focused on debt to GDP ratios as a measure of debt sustainability, an examination of the flows

"The question naturally arises: how come Greek policy makers and foreign investors never saw the debt crisis coming? The reason is that the debt to GDP ratio is not a tea leaf for an impending debt crisis–debt sustainability entails a much more complicated exercise than can be captured by any single measure. I learned that in my early years at the IMF. Forecasting external debt default is an extremely complicated task.

While economic models often successfully identify countries with external debt crisis after the fact, they remain poor predictors of one. Part of the problem in forecasting debt crisis is that we need to know what the government did with that debt. If debt was used to finance growth enhancing projects such as investments in health and education, infrastructure, or other investments with a rate of return higher than the cost of the debt, an indebted country could very well remain solvent. Apparently, that was not the case in Greece. The government simply used the borrowed money to run an inefficient and bloated public sector even as it failed to collect tax revenues to pay back the loans.

So it is time to start measuring illicit flows properly. And when you do, it is clear that this problem is much bigger than any mainstream economist supposes.

There's more in the article about fiscal deficits, add further important points.

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