The dark side of globalisation where the black economy thrives

Diane Coyle on why the G8 is worried about crime
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WHAT is the most pressing issue facing the leaders of the world's eight most powerful countries when they meet in Birmingham this weekend for their annual economic summit? Third World poverty and debt? The Asian financial crisis? India's nuclear tests? All these are jostling for space on the crowded agenda. But more fundamental than any of these is international crime, the dark side of economic globalisation.

Half of the four-page communique from the finance ministers' pre-summit meeting last weekend concerned new initiatives to tackle financial crime, which Gordon Brown, the Chancellor, described as "one of the major challenges of our time".

Because of its very nature there are no firm statistics on the extent of crime, and it is not even obvious what ought to be included in such measures. What the ministers are concerned about is not so much small- scale activity in the informal economy that falls outside the law, generally by evading tax and regulations, even though recent European Union estimates put this as high as a tenth of member countries' GDP in size.

In fact, there is an obvious solution to this supposed problem, namely cutting through red tape and reducing taxes on small-scale enterprise, in order to encourage what ought to be welcome economic activity.

Rather, the G8's real concern is international organised crime, money laundering and drug trafficking, along with large-scale tax evasion by rogue multinationals. This globalised criminal economy is, on any estimate, huge and pervasive. A UN conference in 1994 reckoned global trade in illegal drugs alone was worth $500bn (pounds 300m) a year, bigger than the oil business. Global profits from all criminal activities was put in the region of $750bn to $1 trillion a year. A big proportion of this is laundered and much actually reinvested in legitimate businesses.

The activities involved range from old favourites such as drugs, arms dealing, prostitution and gambling to newer businesses like trafficking nuclear materials and human organs. And the ingenuity, the sheer entrepreneurship, is breathtaking. A fascinating report published earlier this year by the Financial Action Task Force (FATF), an international financial crime squad based in Paris, lists some of the most popular methods of money laundering.

Using bureaux de change is the latest wheeze. The paper gives an example of one based in a small town in Germany. Its owner, "Peter", frequently exchanged around $50,000-worth of high denomination foreign currency notes for low-denomination ones at a local bank, explaining that customers preferred smaller notes. When Germany introduced new regulations requiring the reporting of big cash transactions, Peter, who had a police record relating to dealing in soft drugs, started to change smaller amounts and passed the bureau de change on to a new owner, "Andre". Ironically, the drop in the size of the bureau's transactions made the bank suspicious. A police investigation culminated in the discovery of a drugs-related laundering operation and the arrest of Andre, who had $250,000 sitting in his house. Peter and his family fled abroad.

But the FATF paper notes that all kinds of businesses where cash changes hands are popular with launderers - gambling, art auctions, real estate, for example. And while carrying large amounts of cash stuffed into suitcases across borders is still the norm, the task force has grown concerned about the opportunities offered by new technologies. The internet allows for rapid transactions, anonymity, breaks in the audit trail and an alternative to the traditional banking system. Already one internet-based operation, the "European Union Bank" based in Antigua, has been discovered on the net offering total discretion. The authorities are also worried about the opportunities offered by on-line gambling.

And whereas in a country like Britain, whose criminals seem to have lost their share in export markets just as steadily as its manufacturers, it is easy to dismiss the international crime problem as a distraction from the real issues, the damaging spillovers are more obvious elsewhere. Russia is a glaring example, where the fact that it is hard to run a business that does not engage with the mafia threatens the entire economy. Protection payments are thought to amount to 10-20 per cent of the entire turnover of Russian business - certainly not conducive to growth and investment.

However, even in a G7 country like Japan, organised crime has had a malign impact. The yakuza played a big part in triggering the country's debt crisis which has kept it mired in stagnation by forcing Japanese banks to make unprofitable loans. They have also, incidentally, invested heavily in the US stock market and American real estate.

This gets to the heart of why financial crime matters so much for the G8 leaders. Organised crime is the network business par excellence, thriving under globalisation thanks to all the new opportunities for crossing borders, able to absorb huge amounts of risk and to strike mutually profitable deals with equivalents overseas. It has reached a scale where it threatens the ability of governments to run their monetary and banking policies, and keep their financial markets stable. It is not beyond the ability of the yakuza to trigger a Wall Street crash, for instance. A large part of the G8 economies - and more of some smaller economies - has no official existence and is therefore outside the range of economic policy.

More important, as Berkeley sociologist Manuel Castells points out in the third volume of his epic work, The Information Age (published by Blackwell), is the way extensive criminal business is corroding democratic and market institutions. In one of the periodic bouts of realism to strike the profession, economists are placing increasing emphasis on the role institutions play in determining economic outcomes. It is widely accepted that corruption and cronyism played a significant part in Asia's crisis, for instance. The Chancellor of the Exchequer, with the support of the rest of the G7 and the International Monetary Fund and World Bank, has emphasised the importance of transparency, accountability and good governance in crisis- prevention.

For without a rule of law and reasonably non-corrupt institutions and governments, markets cannot work. It is probably inevitable that vibrant capitalism will always have a criminal element, as misdirected entrepreneurship spots more profitable opportunities than are available in legal activities. It even has a certain perverse glamour, or so the popularity of thrillers and action movies would suggest - more glamour, anyway, than the conventional world of business and finance. It's hard to see Quentin Tarantino going for any dialogue about put options.

But when the criminal element grows too large it eats the foundations of the bulk of the economy from within. It is growing alarmingly now, exploiting more efficiently than any multinational the opportunities afforded by globalisation. If globalisation is going to be able to deliver its potential economic gains, the G8 will have to come up with more effective means of pest control.