Africa is estimated to lose substantial resources through illicit financial flows (IFFs).
These flows originate from several sources: revenues from illegal activities, tax avoidance, abusive profit-shifting, trade mis-invoicing, corruption, and others.
IFFs divert resources from social development and raise serious problems for financing development in Africa. These risks have been recognized in the 2030 Agenda for Sustainable Development, specifically in target 16.4 of the Sustainable Development Goals (SDGs).
The Addis Ababa Action Agenda on financing for development also calls for redoubling efforts to substantially reduce IFFs by 2030.
The Action Agenda invites the “appropriate international institutions and regional organizations to publish estimates of the volume and composition of illicit financial flows.”
However, there is no globally-accepted methodology to monitor IFFs. The lack of reliable, objective evidence can hinder policy interventions and undermine possibilities to tackle the problem.
Gold accounts for 77 per cent of the US$40 billion worth of under invoiced extractive commodity exports from Africa, according to UNCTAD research. Diamonds represent 12 per cent and platinum 6 per cent.
According to the Economic Development in Africa Report 2020, the developmental consequences of illicit financial flows (IFFs) from Africa are severe.
The report estimates that in 2015, US$40 billion left the continent clandestinely, an estimate that only covers trade-related IFFs and can bundle in some elements other than IFFs.
UNCTAD defines IFFs as “cross-border financial flows that are illicit in origin, transfer or use.” They can be generated by many activities, “including criminal ones like illegal markets, corruption or smuggling, and commercial ones like tax evasion or aggressive tax avoidance through trade mis-invoicing or profit-shifting to lower tax-jurisdictions.”
Measuring illicit activities is difficult and only little data is available, so researchers measure the channels, such as trade or financial transactions that are used to transfer funds abroad.
There are three main channels for illicit transactions including the physical smuggling of goods or currency and, more importantly, financial and trade transactions. The first two channels leave no trace in trade records, which are used as a basis for the estimation in the report.
According to the report, extractive commodity exports from Africa constituted more than 50 per cent of total African exports from 2000 to 2018.
The report uses the mirror trade gap method to look at different extractive commodity groups and trade along the value chains. This is by identifying differences in how two trading partners record the same trade flow.
This method allows for broad coverage of countries and products but has significant caveats. The UNCTAD Handbook of Statistics notes many reasons why exports from country A are not equal to imports recorded by country B for the same trade flow.
These differences are largely driven by commodity-specific value chains, trade recording and trading practices rather than solely domestic conditions, and steps that may not be captured by trade statistics, such as transit trade, bonded warehousing or value-added processing in a duty-free zone.
To infer on export under-invoicing from the results, the trade gap needs to be persistent and positive and other valid statistical and logistical reasons for asymmetries be accounted for.
The report makes explicit links to trade valuation, recording of international trade statistics and addresses issues due to merchanting, processing and trading of commodities along their value chain to account for some of the asymmetries arising in bilateral statistics.
The mirror trade gap is summed over all trading partners aiming to correct some degree of destination mismatch and groups similar products together to correct for some degree of product misclassification.
US$40 billion of under-invoiced exports
The report finds that the US$40 billion worth of under-invoiced extractive commodity exports from Africa are concentrated in extra-continental, rather than intra-African, trade.
Gold exports from Africa represented 77 per cent of the total, followed by diamonds (12 per cent) and platinum (6 per cent). This underlines the concentration of export under-invoicing on exports of high-value, low-weight commodities. The remaining commodities covered, such as petroleum and base metals, together represented only 5 per cent of the total.
Commodities with a persistent and positive trade gap are, therefore, at risk of illicit outflows.
The concentration of export under-invoicing in a few high-value, low-weight commodities offers new insights for researchers and policymakers analysing trade mis-invoicing, and IFFs more broadly.
Studying how the structure and incentives of the international gold market contribute to export under-invoicing, for example, is relevant to all gold-exporting countries in Africa, whatever their local conditions.
Trading practices vary by commodity, resulting in different mirror trade gap results. For example, metals are typically stored in one of the many bonded warehouses of the London Metal Exchange, leaving a negative gap in bilateral trade records, i.e. where the export value is larger than import value.
Due to the limitations in trade data, the report did not use negative export gaps to infer on trade-related IFFs even if they could include illicit activity.
Because of their dependence on commodity exports, African countries are especially prone to illicit outflows through export under-invoicing.
Previous research notes that illicit trade in extractive resources can undermine peace and security, landing countries in a “conflict trap” and stalling development for decades. Recognizing these interlinkages, Sustainable Development Goal 16 includes IFFs, alongside other indicators for peace, justice and strong institutions.
Improving the recording of trade statistics along key commodity value chains and publicly available geological information is essential to understanding and curbing financial leakages linked to extractive commodity exports.
Customs enforcement could be enhanced by analysing transaction-level data to see where the mirror trade gap flags high risk of export under-invoicing.
Last year, IMPACT documented how registered traders and exporters are providing a sheen of legality by declaring a small percentage of their gold exports while pocketing massive profits from the illicit trade.
In the report, “The Intermediaries: Traders Who Threaten the Democratic Republic of Congo’s Efforts for Conflict-Free Gold,” these traders thwart attempts to disrupt their scheme by reconfiguring their operations across the region when necessary or by creating phantom entities.
IMPACT notes that this, then, means that gold smuggled out of DRC and flowing onto the legal international gold market –into consumer products—is potentially tied to criminality, money laundering, armed groups and human rights abuses.
The illicit gold trade is not happening unnoticed since the United Nations Group of Experts on the DRC (UN Group of Experts) says that most of the country’s gold is being smuggled out of the country. Estimates from 2013 by the Group show that as much as 98 per cent of the country’s gold left the country undeclared. With the chaos in the sector, reports show that DRC-based armed groups and criminal networks continually profit from the mineral.
IMPACT has found that despite efforts by the DRC government and international actors to introduce traceability and due diligence for artisanal gold supply chains in DRC, the illicit trade appears to be booming.
Only a fraction of gold production is exported legally, denying the DRC government revenues from the under-declared quantities since all duties and taxes are not paid to authorities.