draining development.pdf - Khazar University

Governance and Illicit Flows 59in the political settlement. This methodology allows us to derive someuseful policy conclusions in the case of intermediate developers. By contrast,the use of the illicit flow terminology involves significant dangersin the case of fragile countries. Policy makers should at least be explicitlyaware of this.In this section, we discuss a sequential approach for the identificationof feasible policy interventions to address illicit capital outflows that satisfyour definition and that occur in intermediate developers.Assume that a particular capital outflow from an intermediate developeris illicit according to our definition. The core policy concern here isa microlevel assessment of how any particular set of measures to restrictthe illicit capital outflow affects the macrodynamics of the economy andsociety in question. While our assessment about the nature of an illicitflow has taken into account the indirect effects of blocking the flow, theimplementation of any policy almost always gives rise to unintendedconsequences, and all the indirect effects may not be understood. Moreoften than not, policy failure is the failure to take such unintended consequencesinto account ex ante.An illustration of such unintended consequences, in this case pertainingto the international regulation of financial flows, is provided by Gapper’sanalysis (2009) of the Basel Accords I (1998) and II (2004), whichwere designed to regulate global banks essentially by setting higher capitaladequacy standards and improving the measurement of leverage.Ironically, these standards inadvertently accelerated rather than mutedfinancial engineering by banks, in particular the securitization of riskymortgage debts. The accords raised the threshold of responsible banking,but simultaneously created incentives to find a way around thethresholds that would prove more disastrous to the global economy. AsGapper remarks (2009, 1), “it would be wrong to throw away the entireBasel framework . . . because global banks found ways to game the system.”The obvious implication is that one must strengthen rather thanthrow away existing regulations.More generally, in our view, an effective policy response to illicit flowsrequires a step-by-step, sequential assessment of the macrolevel effects ofblocking particular capital flows. To illustrate what this entails in the caseof an intermediate developer, consider the example provided by Gulati(1987) and Gordon Nembhard’s analysis (1996) of industrialization