Three lessons on the hidden cost of corruption – for the West

A guest blog by Sigrún Davíðsdóttir

Corruption and corrupt business practices have often been portrayed as a problem only endured by poor countries, of little consequence to the developed West. The three following stories show that this is a wrong-headed, old-fashioned understanding, reflecting earlier times when corruption was poorly understood. By now, we should all know better.

The first story could still be happening in corrupt countries, whether Italy or Russia, where corruption and organised crime prevents people from turning their dreams into a job-creating engine. The second story shows how the West is actively enabling corrupt people in poor countries to stay in power, undermining democracy, economic development, stability and wealth creation – and also harming the West, directly and indirectly. The third story shows that it’s mistaken to think of offshore as far away from Western countries: on the contrary, offshore is onshore in the West, creating a space that enables corruption and threatens financial stability.

Lesson 1: the hidden cost of lost opportunities

Marina (not her real name) was born and still lives in Monte Santo, the heart of Napoli, Italy: a neighbourhood immersed in smuggled cigarettes and counterfeit goods — which are signs of the Camorra, the local mafia. One day, many years ago, I asked her how, apart from these things, one sensed the presence of the Camorra. “Oh, you sense it for real the day you set up business here. And no matter what they tell you: they all pay,” pointing at the small enterprises lining the streets, from motorbike repairs to small cafés.

She told me her story.

In Monte Santo the narrow alleys, lined with laundry hung out to dry, are only for those on foot and the vespas that zoom around everywhere. The doors and low windows open right into the kitchens leading to the rest of these tiny flats, frequently housing large families. The ceilings are low, the dwellings small: they are hot in summer, and damp in winter. As in Paris and many other big cities of the 18th and 19th century, the larger flats with big windows, high ceilings and views are above, inhabited by those with better means.

Marina is now in her late sixties. Her husband belongs to a past she doesn’t much talk about; she has two daughters and has helped raise her granddaughter whose father is never mentioned. There is no complaining though. She is content with her lot; she has worked hard, in the last decades as a housekeeper for families in the neighbourhood where both husband and wife are educated and work. And Marina has provided well for, from the point of view of the Catholic church, her irregular family.

But there is one thing Marina still regrets: her lost dream.

In her early twenties Marina wanted to set up a hair salon. She is good with her hands and she has the best thing a hairdresser can have, apart from skills: she is chatty, warm and funny. She had figured out she could learn her trade by working in a salon, then she would set up her own in Monte Santo, and hire two or three girls from the neighbourhood. So far, so easy.

But then she thought further.

Once having set up a salon some guys would have shown up – “it’s always like that,” she says – and they would make her understand that they expected her to pay them for being left alone. “That’s the thing. I couldn’t bear that the money I earned with my own hands would go to this scum of the earth who hadn’t done anything to earn my money.”

So instead of setting up her own business Marina has always worked for others. Which is why there was never “Marina’s Hair Salon,” never any girls in the neighbourhood employed at her salon. The unemployment rate in the province of Napoli is 25.8%, in Italy 11.4% where youth unemployment is at 36.7%. The Italian labour market is characterised by small enterprises.

Marina isn’t alone in living with a lost dream; there could be thousands like her in Italy, millions in the whole world. Multiply that with two or three, the girls who would have worked for her, let’s say for the average three years; that’s twenty to thirty jobs over thirty years. But these numbers are never calculated as part of the cost of corruption because, well, how can you calculate the lost dreams, the cost of opportunities lost because of corruption?

Lesson two: the hidden cost of the corruption the West enables

During the Global Summit to end sexual violence in conflict I was lucky enough to interview Shirin Ebadi, one of the speakers. A lawyer from Iran, born in 1947, Ebadi was awarded the Nobel Peace Prize in 2004 “for her efforts for democracy and human rights… especially… for the rights of women and children.”

In 1969 Ebadi became the first Iranian woman to serve as a judge but was degraded to a clerical job following the Islamic Revolution in 1979. In effect she was out of job until 1991 when she was allowed to practice as a lawyer. During her years out of work she concentrated on studying, writing books and the work that was later acknowledged by the Prize.

The 2009 elections in Iran led to a revolution. She was abroad at the time; her office was raided and when the new powers realised she was abroad her husband was arrested and tortured. Her sister was also arrested – though neither she nor husband had anything to do with Shirin Ebadi’s work. Her staff members were arrested and her assets confiscated. “Yet I was neither a member of a party nor a political leader,” said Ebadi who couldn’t return to Iran after these events.

She is small of stature, with lively eyes. Her soft voice contrasts her harsh and stark message. At the time we spoke, in the summer of 2014, Iraq was a destabilised country and Syria already war-torn. After dwelling on the theme of the conference I asked her what should, in her view, be the role of the West in the democratisation in her part of the world. She didn’t hesitate in answering: the people need to take the initiative themselves; if foreign powers try to force through changes from the outside it will only lead to social upheaval and unrest. But she knew precisely what the West must not do.

“The West mustn’t support the dictators,” says Ebadi. “The Iranian government (in 2014) is very corrupt. Where do you think the dirty money goes? Well, it goes to London, Switzerland and similar places.”

Ebadi explained the mechanism of corruption: corrupt government use corrupt means to get hold of money but this money is of little use inside the country; it must be moved abroad for investments against a rainy day, or to buy weapons, or whatever. At home, it’s only properly of use when brought back home as laundered funds, unconnected to the corrupt activities at home.

“Don’t take this money,” was Ebadi’s message to the West. “The best help from the West to democratise corrupt countries is by not helping dictators and corrupt governments by accepting their ill-gotten funds.”

The hidden cost of taking money from dictators is delayed democratisation, stunted economic growth, instability and often war suffered by the inhabitants in corrupt countries as developed countries like Britain and the US allow dirty funds to flow into their banks, property and other investments, exactly meting the needs of the corrupt regimes. A recent Guardian story of Gaddafi funds invested in Scotland is an example of just this kind of flows of corrupt funds into the West.

Ironically, this sadly undermines the West’s own aid to these countries: part of these funds is lost to corruption, indeed because the funds can be channelled to secure accounts in the West. The lost funds undermine both the direct effect of aid and the soft power that aid brings the donors. How to calculate the costs to poor countries when the West helps their corrupt regimes to make use of their corrupt funds? And how to calculate the direct and indirect cost to the West of lost aid and delayed democratisation and ensuing economic development of large parts of the world?

Lesson three: the cost of offshore in reality being onshore

Until the banking collapse in October 2008, Icelanders had seen their country as free of corruption. Iceland was at the top of Transparency International Corruption Perceptions Index. But the events in October 2008 changed this perception, as the economic booms was scrutinised and investigated, most thoroughly so in a unique report, the so-called SIC report, published in 2010.

Only a corrupt mentality, and flawed surveillance could inter alia allow the largest shareholders of the three largest banks and their fellow travellers to become the largest borrowers in these same banks. Much of this business activity was done abroad – assets were bought and sold mostly in Denmark and Britain, funded by the Icelandic banks’ foreign subsidiaries – and behind all of this was a galaxy of offshore companies, as I’ve described before.

The dirty deals and much of the offshoring was done through Luxembourg: it speaks volumes about the lamentable state of affairs in Luxembourg that although assisting Icelandic authorities in their investigations, Luxembourg authorities have conducted no investigations to speak of into the operations of Icelandic banks and others in Luxembourg. Europe can’t rid itself of financial misconduct without a thorough spring cleaning in Luxembourg.

The offshorisation of the Icelandic economy took off in the late 1990s. Its unique aspects are how quickly it permeated the whole of Iceland – and it reached far beyond the tycoons and their closest associates. A man selling a small business around 2006 told me his banker had convinced him the best option was to move the funds offshore. A fisherman who sold his boat for what then amounted to €150.000 was so in awe of suddenly having a private banker that he didn’t question the offshoring; only after the collapse did it dawn on him that he had bought into something far too complicated for his needs, finally costing him a small fortune just to get out of it.

The same happened to hundreds of other fairly well-off Icelanders. An untold story of the Icelandic boom is that the banks did in some cases use clients’ offshore companies for trades in the banks’  own interest, at times passing on losses to the clients.

There have been many shocks and after-shocks from Iceland losing 90% of its banking system in a matter of three days in October 2008. The Panama papers have recently given further reason to think back, bringing three things to mind.

• First, participants in many deals, big or small, funded by the banks, were companies under unclear ownership, effectively hiding who was buying, selling and profiting as offshore companies threw an opaque shroud over these deals. This set aside takeover rules; rules on lending to related parties; and other rules that should ensure a fair play in a transparent market.
• Second, after the 2008 collapse Icelandic tax authorities took action against a couple of hundred Icelanders who used credit cards in Iceland, linked to their foreign bank accounts, without paying due tax in Iceland. Leaked offshore information, which the Icelandic tax authorities bought last year and now the Panama papers have prompted directors at Inland Revenue in Iceland to state that over the years most offshore companies were either insufficiently or not at all accounted for in tax returns.
• Third, what all of this activity had in common was that bankers, accountants and lawyers in Iceland or working for Icelandic entities abroad were familiar with all of these set-ups because they instigated or knew of them.

The effect of all of this was, what I have earlier described as a rule-and-regulation free bubble within Iceland, i.e. wealthy individuals could choose to operate within this bubble, unperturbed by rules and regulation and the social pact. In the end, this bubble threatened financial stability and Iceland was, partly because of this, thrown into a turmoil, which still affects Iceland though the economy is again booming.

In a small economy and small country like Iceland this rule-and-regulation free space is fairly easy to spot. Such a space is however not unique to Iceland. This is what offshore means in the West – a rule-and-regulation free space for those who have access to it via their wealth and the many enablers. How to estimate the cost not only of unpaid tax but of skewing the business community, creating an unfair competition between those who adhere to the onshore rules and those who don’t?

Sigrún Davíðsdóttir is an Icelandic journalist, broadcaster and writer