dimanche 1 mai 2011

Summary:The impact of Switzerland's money laundering law on capital flows through abnormal pricing in international trade

This research investigates the effect of money laundering law implemented by Switzerland government on the movement of money from Switzerland to the US. The authors deem that individuals use the international trade as a substitute technique to launder their money by overpricing the imports and under pricing the exports because this technique could be undetectable by the authorities who enact legislation that focuses only on financial institutions. Given that, the authors look into the abnormal pricing in imports and exports and compare the volatility and amounts of capital outflows via trade between the pre-implemented law date and its aftermath. They choose the period 1995-2000 in which there were three dates of money laundering implementation law:
- 10 October 1997: the official date of the federal act.
- 16 March 1998: the Swiss Federal Government decided the MLA (Money laundering act).
- 1 April 1998: the MLA became officially effective.
In fact, the shift of capital from one country to another may be down to many reasons:
- Income tax avoidance: individuals may minimizes/avoid the income tax payment by shifting taxable income from the country in which they earn money to another.
- Capital flight: people may move their money out due to the bad financial and/or political circumstances existed in their country.
- And/or Money laundering is referred as the illegal capital flight or all form of illegal movement of capital in or out of the country as well as the income tax evasion.
Therefore, assuming that the movement of capital is sensitive to the money laundering and not other fundamental/financial reasons has to be proved.
2- Data
Trade data base:
The authors used trade data on monthly basis from the US Merchandise trade data from 1995 to 2000. This data contains information at the transaction level of imports and exports. They took only the transactions that exceed $2500 for exports and $1250 for imports, with the quantity and the item, and all foreign records are converted to US dollar.
At the end, there is a matrix containing each individual transaction of the US export and US import of a particular commodity from or to a specific country. The resulting matrix contain 5 millions cells, within each, the median price, the upper quartile price and the lower quartile price are calculated.
Macroeconomic variables:
These variables are extracted from IMF (international monetary funds) and IFS (international financial statistics) extended from 1995 to 2000.
3- Methodology
The interquartile range price (upper and low quartile interval) is used as a benchmark to determine the abnormal pricing of import/export transaction. In fact, prices outside this interquartile range are considered abnormal. Every import and export transaction between Switzerland and the USA for every month from 1995 to 2000 was analyzed. For each of the months studied the dollar value of capital moved from Switzerland to the USA was determined through over-valued Swiss imports from the USA and under-valued Swiss exports to the USA. The monthly capital outflows were calculated based on interquartile price ranges determined from all USA–Switzerland transactions. Also, the percentage of monthly capital flows were determined by dividing Switzerland’s capital outflows by USA–Switzerland trade. An empirical test was used to gauge the significance impact of the laundering laws of Switzerland on the magnitude of capital flows from Switzerland to US.
For the macroeconomic variables are used to measure the capital flight through trade. This will help to understand the response of capital outflows to the release of the new money laundering law in Switzerland. To do so, the authors adopt two portfolio models:
-Pastor Jr (1990) model:
It assumes that capital flight occurs when individuals transfer their domestic assets abroad once the domestic market become unfavorable. According to him, capital flight can be determined through three major financial variables such as: change in inflation rate, financial incentive for capital flight which calculated by the difference between the US Treasury bill rate and the local deposit rate and finally the degree of overvaluation (measured as the average real exchange rate for the current year relative to an equilibrium value)
-Cuddington (1987) model:
Cuddington model determine the capital flight through the domestic interest rate, foreign interest rate and the domestic inflation rate.
In addition to these variables, the authors added a dummy variable which take the value of 1 for the passage of any money laundering law (noted above).
The results of the trade analysis are contained in Table 2 and Figs. 1 and 2 (See pp 222-223). Table 2 presents the amount and the percentage of Switzerland's capital flows. Figure 1 and 2 show that both the amount and the volatility of capital outflows via trade increased after the implementation of the MLA. This proves that movers of capital used the international trade to launder their money from Switzerland to US.
To outperform this observation, two portfolio models were tested, in which the capital flight is determined by some financial variables and one other dummy variable related to the passage of the laundering law.
Results show that the dummy variable is the only significant determinant of capital flight. For the Pastor model, the Dummy variable is more significant especially for the dates of the passage of MLA. The other variables, incentives for capital flight, change in inflation and the degree of overvaluation are not statically significant and so they don't determine the capital flight of the Switzerland to US.
The second model of Cuddington displays similar results, but not as strong as Pastor's results.
To conclude, the author's results show that the laundering law of Switzerland has a significant impact on capital flights.
5- Sum up
This paper analyzes the impact of the money laundering law of Switzerland on the capital flows via trade. The authors show that abnormal pricing of import and export increased after the passage and enactment of the MLA.
Indeed, pricing transfer to avoid income taxes payment, capital flight or the money laundering can be accomplished through the abnormal pricing of import/export transactions. The abnormal pricing of trade transaction is detected when export/import pricing is out of the interquartile range prices of the global price matrix of trade transactions.
To outperform this observation, the authors analyzed empirically the effect of the money laundering law using two portfolio models in which the capital flight is explained by some financial variables and a dummy variable added for the laundering law passage. Their results show that the capital flight is significantly determined by the dummy variable.
Conclusively, there is a significant impact of the laundering law on capital flights, which is accomplished by abnormal pricing in international trade according to the author analysis.