Now Published: “Policies First, Institutions Second: Lessons from Estonia’s Economic Reforms”

Post-Sov AffairsMy new article in Post-Soviet Affairs, co-authored with Steve Fish of the University of California-Berkeley, has just been published online (vol. 31, issue 6).  Below is the abstract:

It has become convention in recent years to treat the building of institutions as the centerpiece of successful economic reform. The case of Estonia challenges this view. Although effective economic institutions eventually arose, Estonia began its transition bereft of the institutions that supposedly serve as the requisites of robust achievement. The institutions only emerged after an ideologically driven core of leaders implemented policies that laid the groundwork. In particular, the imposition of hard budget constraints sidelined political capitalists opposed to the rule of law by severing them from the state subsidies, soft loans, and other privileges on which they thrive. In the absence of a powerful class of political capitalists, Estonian governments were free to forge and continually improve a collection of institutions that sets the country apart among its postcommunist peers. Good institutions are desirable but not necessary for policy reform, and they are better seen as auspicious knock-on effects than as prime movers.

The Laundromat: Europe’s biggest money-laundering operation revealed

It’s impossible to put a number on the amount that Russia’s leaders have stolen from their own state since the days of Gorbachev, when the looting began in full force. But I think we can agree it’s a lot.

For the criminals atop the Russian government, the problem is not how to steal the money, which is rather easy to do, but what to do with it all once it’s been stolen. They would be foolish to keep it inside Russia, where it would be at risk of confiscation in the event of a change in power and the banking system isn’t very sound to begin with.

But moving the money out of the country leaves it vulnerable to law-enforcement in countries where police and prosecutors are actually honest and can’t be leaned upon (in contrast to Russia).

That means they have to launder the funds.  Russia’s kleptocrats have watched Scarface, and so they are aware of the need to create the fiction that their criminal proceeds come from legitimate economic activity.

Money laundering requires two elements to work. First, the schemes need to be sufficiently complex as to bewilder investigators (and, indeed, there are very few law-enforcement agents in the world with the expertise needed to trace dirty money). Second, in the unlikely event that investigators do figure out where and how the money flowed, the ultimate beneficiaries need anonymity.

Enter the offshore system. Offshore banks and law firms provide the specialists needed to move money through multiple shell companies using elaborate financial transactions. The complex transactions shepherd the funds into bank accounts with anonymous ownership, thereby shielding the criminals’ identities. To ensure that foreign law-enforcement cannot possibly recover the money or find out who it belongs to, the bank accounts and shell companies are located in offshore tax havens.

When most people think of “offshore tax havens” they have in mind places like Switzerland or the Cayman Islands. But as Nicholas Shaxson shows in his excellent book Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens, the “offshore” label is potentially misleading. Shaxson points out that any politically-stable jurisdiction where foreigners can evade the rules that would constrain them elsewhere qualifies as an offshore jurisdiction. By this definition, the world’s biggest offshore tax havens are the United Kingdom, the United States, and the European Union.

The EU’s role as a major stash-house for dirty money from Russia is revealed in a recent investigation by the Organized Crime and Corruption Reporting Project (OCCRP), which produces some of the best investigative reporting on corruption and economic criminality. In The Russian Laundromat, the OCCRP lays out what is perhaps the biggest money-laundering operation in the history of Europe. Between 2010 and early 2014, over $20 billion was moved out of Russia through the tiny former Soviet republic of Moldova and into the safety of bank accounts in Latvia, an EU member and growing tax haven for criminals. According to the OCCRP, the money was stolen from the Russian government by corrupt politicians or obtained through organized crime activity. Nineteen banks in Russia were involved in the scheme, some of which are controlled by wealthy and influential figures including Vladimir Putin’s cousin.

The amount of money involved may seem huge, but at the end of the day it’s merely a snippet of the total that has been siphoned away since communism began to crumble in the late 1980s.  The OCCRP investigation nevertheless provides a crucial window into the mechanics by which corrupt Russian officials have been looting the state all these years.

The system is described in all its gory detail on the OCCRP’s website. Those interested in seeing how money laundering really works are encouraged to check it out. The Russian Laundromat is a case study of how the offshore system serves as a great enabler for corrupt state officials and criminal figures around the globe.

Hey, Kim Jong-un, want to donate to a U.S. presidential candidate? Just set up an LLC

Ever since the Supreme Court’s 2010 Citizens United ruling legalized unlimited spending by corporations and unions on U.S. elections, the American political landscape has become increasingly dominated by much-maligned Political Action Committees (PACs), organizations that pool money to promote or defeat certain candidates.

As Yogi Berra reminded us, “In theory there is no difference between theory and practice. In practice there is.” And so it is with PACs, which in theory are completely transparent, subject to strict rules requiring public disclosure of who is giving them money. That’s all well and good if the donors to PACs are actual flesh-and-blood individuals. But if the donors are instead Limited Liability Companies (LLCs) with anonymous ownership, there’s no telling who is financing our elections.

Most U.S. states mandate that LLCs disclose the identities of their owners. But some, like Wyoming, do not even require any corporate records to be kept within the state’s boundaries. So if Kim Jong-un or the Islamic State want to make a campaign donation, all they have to do is set up an anonymous LLC and in turn have it write a check to their favorite PAC – and maybe let the relevant candidate know through back-channels where his bread is really buttered.

For more on the growing role of LLCs in financing U.S. election campaigns, see this excellent report by the Center for Public Integrity, a watchdog focusing on corruption and abuses of power in American politics.

Something extraordinary is happening in Guatemala

Massive corruption in the developing world shouldn’t raise any eyebrows, but it is a rare thing indeed when sitting top-level officials actually get punished for it. This is becoming a real possibility in Guatemala, whose people have long lived under the rule of a corrupt and predatory elite. In recent weeks, dozens of powerful officials have been arrested for various offenses including their alleged involvement in bribery, influence-peddling, and a large-scale customs fraud nicknamed La Linea (after a telephone hotline used by the reported conspirators). The fire is moving closer to the feet of president Otto Pérez Molina, whose son-in-law, Gustavo Martinez, also an important official, was arrested last week for allegedly using his access to the president to solicit bribes.

That such influential incumbents are facing the prospect of punishment at all is the result of the International Commission Against Impunity in Guatemala (CICIG), a U.N.-backed body set up in 2007 to investigate organized crime and train local prosecutors. Having already prosecuted drug barons and an ex-police chief accused of operating a death squad, it is now training its sights on high-level government corruption.

In April, just as the CICIG was announcing its most serious charges yet – those relating to La Linea – Mr. Pérez was deliberating whether to renew the body’s two-year mandate. Thanks to pressure from the United States, he agreed to extend it.

It all goes to show that, in marginal countries where none of the U.N. Security Council members have much interest in helping incumbents stay in power, the possibilities for real justice are indeed endless.

For more on what’s happening in Guatemala along with similar developments in neighboring Honduras, see Louisa Reynolds’ recent article in Foreign Policy (“Are We Witnessing a Central American Spring?”).

Policies First, Institutions Second: Lessons from Estonia’s Economic Reforms

The collapse of communism ushered in widespread hopes that the countries of Eastern Europe would develop democratic regimes and Western-style capitalism. While democracy is alive and well in many countries, most of their economies remain dominated by corrupt and predatory elites who systematically undermine the rule of law.

There is perhaps one exception to this rule, and that is Estonia. A forthcoming article by M. Steven Fish and yours truly locates the roots of Estonian exceptionalism in the policies enacted by its early post-communist governments. These policies hardened budget constraints on business actors – that is, they eliminated the subsidies, sweetheart loans, tax breaks, and other privileges on which political capitalists thrive. Having marginalized opponents of the rule of law, Estonian leaders were free to build an effective set of property rights institutions that make their country the envy of its post-communist peers.