Unmasking the Financial Secrecy System: How Rogue Capitalism Threatens Democracy
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In 2022, the UK-based Tax Justice Network released its Financial Secrecy Index, which ranks countries by “how intensely the country’s financial and legal system allows individuals to hide and launder money extracted from around the world.” The United States has the dubious distinction of topping that list. With its extensive array of legal loopholes and lax rules, and its weak oversight, the U.S. allows tax cheats, kleptocrats, criminals, and others the means to conceal wealth, obscure ownership, and avoid accountability.
Raymond Baker, a businessman and internationally recognized authority on financial corruption was guest speaker at a May 15th event hosted by the Corporations and Society Initiative at Stanford Graduate School of Business. He came to campus to talk about his new book, Invisible Trillions: How Financial Secrecy Is Imperiling Capitalism and Democracy and the Way to Renew Our Broken System.
Larry Diamond, senior fellow at the Hoover Institution, and Mosbacher Senior Fellow in Global Democracy at the Freeman Spogli Institute for International Studies (FSI) wrote the book’s preface and served as moderator for the discussion. CASI co-faculty director Anat Admati opened the event and explained how she met Baker for the first time late last year at a global anti-corruption conference in Washington, DC.
“Raymond said he was probably the only MBA at this conference, which had thousands of people, and I assured him that I was the only business school professor in the entire place. So, we were both unique in being there at all.”
Baker gave an advanced copy of his book to Admati and asked whether she thought business schools might be ready to engage on the topic.
“I said CASI is ready, so here we are with this event.”
Larry Diamond told the audience that Invisible Trillions is the definitive book on financial secrecy, one that is both highly accessible and constructive. He asked Baker what originally sparked his interest in the subject, and how his thinking has evolved from his 2005 book, Capitalism’s Achilles Heel.
Baker singled out two experiences that occurred early in his business career that shaped his views on cross-border money flows. The first involved a job he took fresh out of Harvard business school in Nigeria. With little idea of what he was getting into, Baker was shocked to learn about transfer pricing, an accounting method used by multinational corporations to shift profits out of the countries where they operate to lower tax jurisdictions in order to reduce overall corporate tax bills.
“That was the first time I had any concept of this,” he explained. “I eventually realized that virtually every foreign company operating in Nigeria was doing the same thing and that Nigerians were doing the same thing, using trade to shift money abroad.”
Another experience involved his purchase of a nearly bankrupt Nigerian manufacturing company that was losing money year after year. Within a year of taking control, Baker said he paid off all of the company’s debts and delivered generous dividends for years thereafter.
“How did we do it?” he asked. “All we did was buy imported raw materials at world market prices. The family [that previously owned the company] had been overpricing the import of raw materials for the specific purpose of shifting money out of the country. We didn't do that. We operated it properly. It turned out to be the most profitable company that I've ever owned.”
Baker said this led to a decades-long fascination with how the capitalist system operates in the shadows, one that will “make money for some people and lose money for others.”
Diamond asked Baker to describe how secrecy works in the global economy.
Baker explained that the capitalist system has created an entire financial secrecy system that uses complex legal structures to hide money, avoid taxes, and clandestinely move wealth around the world. Elements include tax havens, secrecy jurisdictions, disguised or shell corporations, anonymous trust accounts, and donor-advised foundation funds.
“When you go out and make your first $1 billion, you can establish a charitable foundation. You can donate your money to your charitable foundation, and you can designate yourself as the beneficiary of the charity of your foundation paying no taxes along the way.”
Baker said to make the system work, people in richer countries have left loopholes in their national laws that enable money to flow through this financial secrecy system, and ultimately into their economies.
“The United States is the biggest user of the financial secrecy system. A lot of people think it is Switzerland, or the UK, but more of that money flows to us than to any other country."
Diamond added that for people around the world to find holes in the system, they need an integrated and very comprehensive system of enablers such as lawyers, accountants, auditors, and real estate agents. The enablers make money in a way that is permitted by the system through legal channels.
Baker agreed and said there was a simple reason for all this. “We like the money that this system brings into our economies and other wealthier economies. This financial secrecy system that I described is not something that other people have done to us. This is our creation, every part of it.”
But Baker said that while many of the enablers aren’t necessarily breaking the law, the laws have been created and designed to allow the evils of secrecy to happen.
“Let's stop blaming those ‘corrupt’ countries over there. We are the people that have enabled this to go on, and it's the capitalist system buying what it wants and paying the money to the legislators through campaign contributions that are necessary to have what we want.”
Diamond moved on to a major argument that Baker makes in Invisible Trillions; that the financial secrecy system is partially responsible for the rising inequality around the world and the erosion of democracy in many countries, including the U.S.
Baker said the ratio between executive pay and worker pay has risen dramatically over the decades. A recent analysis by the Rand Corporation showed that since 1975, upward redistribution of income has cost American workers $50 trillion, money that would have built a far larger, more prosperous economy.
“Every working-class American, every employee in a major corporation knows this disparity has exploded. That's been a major driving factor in inequality, and it's had an enormous impact on democracy.”
Baker argues that much more global attention must be paid to curbing the excesses of the financial secrecy system. He suggested that the climate change debate presents a good example of how solutions can be achieved. In the 1970s and 80s, scientists and other experts knew that global warming was a reality, he said, but the needle barely moved on significant policy change until former Vice President Al Gore drove the issue into our global consciousness with the documentary, An Inconvenient Truth.
“I wish I had the stature that Al Gore has. I could make more progress with this. We've got to elevate these concerns to the level where they get into the Overton window, the window of understanding that this is a huge threat to the democratic capitalist system.”
Diamond commented that a growing number of businessmen are deeply worried about the trajectory we're on, “people like Warren Buffett, who believe that this level of inequality is not sustainable.”
The best way to solve the problem, Baker declared, is through transparency and accountability.
Baker pointed to the Patriot Act, which was enacted after the September 11th attacks, giving law enforcement powerful, new tools to detect and prevent terrorism. While acknowledging the controversial aspects around privacy, Baker said the act strengthened U.S. anti-money laundering efforts, such as prohibiting banks and broker-dealers from having correspondent accounts for any foreign bank that does not have a physical presence in any country.
“With this blanket prohibition against shell banks, [they] disappeared from the global financial secrecy system. No bank in the world was prepared to risk losing its access to the U.S. financial system by dealing with some other shell bank.”
Baker argued that the U.S. could do the same thing with shell companies “if we had the courage to do so.” He also targeted the need for banking reform. He said that currently banks are required to report suspicious transactions over $10,000 by filing a report with the US Financial Intelligence Agency. Thousands of these reports are filed every day.
“U.S. banks will take every dollar of money that comes across the transom, provided they can come up with some flimsy excuse for doing so, and then simply file a report. This is unworkable.”
Baker went on to say that banks should know exactly where the money is coming from and who the beneficial owners are of those entities that are sending money. Bankers will undoubtedly push back, he said, arguing that this is extremely complicated. For Baker, that line of reasoning doesn’t ring true.
“This is entirely a matter of political will.”
During the question-and-answer period, Baker was asked about enforcement efforts needed to expose and protect against financial secrecy. He was quick to admit, “We're always going to have regulation and enforcement issues. But those demands are lessened in a system that operates with transparency and accountability.”
Baker was also asked about central bank digital currencies and how that might help with greater auditing and tracking on a global basis. He drew a sharp distinction between digital currencies and cryptocurrencies.
“Many central banks around the world are thinking about setting up digital currencies. and I don't see anything wrong with this.” However, Baker said he wasn’t a fan of cryptocurrencies because they operate invisibly with nothing but narrative value.
“They can be talked up, or they can be talked down, but there is no underlying asset that gives them value.”
Both Diamond and Baker believe that independent media have a critical role to play in promoting greater transparency. One example, Diamond said, is the International Consortium of Investigative Journalists whose publication of the Panama Papers exposed the offshore finance industry.
In Diamond’s final summary of the session, he quoted one of James Madison’s fundamental insights [appropriately changing “men” to “people”]:
“If people were angels, we would have no need of government. People are not angels. We're inclined to war; we're inclined to greed. What keeps humanity civil, democratic, and inclined toward progress is democracy, the rule of law, transparency, and accountability.”