Download Crime, driven by the profit motive, offers higher monetary returns in

Crime, driven by the profit motive, offers higher monetary returns in order to
compensate the criminal for the risk of detection and the hazard of punishment.
Realising this, many countries prevent criminals from spending their ill-gotten gains
in the legitimate economy; and in doing so make a distinction between legal and
illegal monies in terms of substitutability. This distinction, we argue, has two effects:
firstly, it implies that the profitability of crime is reduced and the supply of crime
experiences an adverse shock; and, secondly, that a demand for money laundering
services is created. These services, we suggest, aim to conceal the true origin of funds,
to subvert the 'crime-stopping' efforts of the state, and make it possible to invest or
consume the gains of crime. Supplying such services, clearly, is profitable as
criminals are willing to 'invest' their resources for less than the interest rate on legal
capital. An arbitrageur can exploit this interest rate difference, but to do so he must
circumvent anti-money laundering regulation. Costs therefore increase with the
degree of financial transparency, and so we suggest that the state can indirectly
control the quantity of money laundering by setting the standards for financial
transparency. In a closed economy, we show that these standards will usually be high
so as to discourage crime; but in an open economy policy-makers may hope that
domestic arbitrageurs profit largely from crime abroad, and so we demonstrate a
variant of the "beggar-thy-neighbour" policy in relation to criminal monies. This
illustrates the global public good dimension of the money-laundering problem; where
we suggest that low standards of financial transparency do not merely affect money
laundering, but all sectors of the economy. In particular, poor standards are likely to
encourage diversion of assets in businesses, lead to poor supervision of companies
and hence reduce the quality of governance, encourage directly unproductive, profitseeking activities etc. Because, in our framework, the state has only a single policy
instrument, these side effects are an inescapable consequence of courting profits from
money laundering. Clearly, countries with a large legal-economy sector are, therefore,
most affected. This provides, we suggest, a rationale for the claim that money
laundering is most prevalent amongst small-island economies.