Effects of Money Laundering on Economy

Effects on Economic Growth

1. Direct Effects: Money laundering distorts the investments and depresses the productivity. Diverting resources to less-productive activity, and by facilitating domestic corruption and crime, which in turn depress economic growth. For developing countries, the diversion of such scarce resources to less productive domestic assets or luxury imports is a serious detriment to economic growth.

2. Effect on Corporate competitiveness and Taxation: Money laundering has a bearing on taxation and small business competition. Laundered money is usually untaxed, meaning that the rest of the people ultimately have to make up the loss in tax revenue. Furthermore, legitimate small businesses cannot compete with money laundering-front businesses that can afford to sell a product cheaply because their primary purpose is to clean money, not turn profit.

3. Effect on Interest and Exchange Rates: Money Laundering has adverse consequences on the interest rates and the exchange rate volatility particularly in developing nations and dollarized nations. It complicates the government effort to manage the economic policies. It affects the income distribution, contaminated the legal transactions, and has potential to destabilize the economy by inefficient movements, which reduces the GDP growth.4. Effect on Foreign Investment: Although developing economies cannot afford to be too selective about the sources of capital they attract, but postponing action is dangerous. There is a damping effect on foreign direct investment when a country’s commercial and financial sectors are perceived to be subject to the control and influence of organized crime. For business friendly environment these impedances have to be weeded out.

Effects on Financial Sector

Since financial institutions are critical to economic growth, reputation and confidence plays an important part in the developing countries.

1. Customer Confidence: Reputation and integrity are valuable assets of a financial institution and the perceived risk to depositors and investors from institutional fraud and corruption is an obstacle to such trust. When customers are defrauded by the corrupt individuals within the institutions it causes loss of business for the financial institutions. Prudential risks to bank soundness, contamination effects on legal financial transactions, and increased volatility of international capital flows and exchange rates due to unanticipated cross-border asset transfers.

2. Dampening of Entrepreneurial environment: Strong financial systems are incubators of entrepreneurial growth. For developing nations, technological change is often associated with the investment and new machinery. To adopt the more productive technologies from advanced nations requires entrepreneurship. At the most fundamental level, innovation and technology thrive when property rights are clear and taxes and other drains on profits (such as corruption) are low and predictable.

3. Investment: The nations in which crime and corruption are prevalent, investors are reluctant to invest and obtain the ownership.

4. Money Laundering erodes financial institutions themselves due to vulnerability to corruption by criminal elements seeking to gain further influence over their money-laundering channels.

Effect of Money Laundering on Cost of Capital:

When Money Laundering takes place, the capital is reduced due to which the supply curve of capital moves towards the left. In this case due to the scarcity of the capital (credit crunch even when the central bank is infusing cash in the financial system) available the cost of capital increases.

As can be seen from the various money-laundering mechanism typologies reports, money laundered through channels other than financial institutions is often placed in what are known as

"sterile" investments, or investments that do not generate additional productivity for the

broader economy.

Effect on Four Wheels of Growth

A developing country requires vast amount of capital and accumulation of capital requires a sacrifice of current consumption over many years. When money laundering takes place, the capital is depleted over the time. The money which could have been used to increase the productivity of the labour is now diverted by the antisocial elements to suffice their selfish interests. The lack of capital reduces the improvement of human resources and technology.

Developing countries are concerned with the quality of labour available. Quality of the labour can be increased by improving health and imparting skills by providing education. Money laundering indirectly affects the labour productivity by providing them low capital to improve the skills and improve the health.

Social and political costs of money laundering, if left unchecked or dealt with ineffectively, are serious. Organised crime can infiltrate financial institutions, acquire control of large sectors of the economy through investment, or offer bribes to public officials and indeed governments.

The economic and political influence of criminal organisations can weaken the social fabric, collective ethical standards, and ultimately the democratic institutions of society. In countries transitioning to democratic systems, this criminal influence can undermine the transition. Most fundamentally, money laundering is inextricably linked to the underlying criminal activity that generated it. Laundering enables criminal activity to continue.

To increase the Aggregate Production Function technological enhancement have to be done in the economy. Innovation of new product and services improve the productivity of the economy. When the availability of the capital is less then investment in R&D becomes difficult. Money laundering impedes the rate of output growth.

In all Output, Q= =Tf(K,L,R) is reduced by the corrupt Monet laundering practices

References:

http://www.fatf-gafi.org/

www.centralbank.org.