Dancing with the devil: Country size and the incentive to tolerate money laundering

Abstract

The incidence of money laundering, and the zeal with which international anti-money laundering (AML) policy is pursued, varies significantly from country to country, region to region. There are, however, quite substantial social costs associated with a policy of toleration, and this begs the question as to why such a variance should exist. In this paper we claim that, due to the globalisation of crime, if a single country should break the “chain of accountability”, then it will provide a safe haven for criminals and attract the total financial proceeds of crime. Because smaller economies are best able to insulate themselves from the costs of crime, we argue that smaller countries bear only a tiny share of the total costs relative to the potential benefits of investment that money laundering offers, and so have a higher incentive to tolerate the practice compared to their larger neighbours. As such, we claim that the existence of a money laundering market is due to a policy of AML ‘defection’, and that the degree of ‘defection’ depends largely on the size of the country. We present a simple model of policy competition which formalises this intuition, and conclude by exploring a number of policy recommendations which flow from this.