Abstract
Proceeds from illicit activities percolate into the legal economy through several channels. We exploit international regulations targeting money laundering via the financial sector to identify the flows of “dirty money” into legitimate establishments: business-based money laundering (BBML). Our variant of the monopolistic competition model embeds a drug cartel that channels illicit proceeds into an offshore financial investment and into BBML. Tighter regulations in one channel increase the flow in the other. We use a research design that links U.S. county business activity to the evolution of anti-money-laundering regulations in Caribbean jurisdictions to provide the first empirical evidence of the phenomenon.
Highlights
March 30, 2021 We thank Kevin Starnes and Joseph Fry for outstanding research assistance and we are indebted to Brian Cadena, Terra McKinnish and Danielle Parks for valuable insights
We find that the tightening in AML regulations in the Caribbean islands over the period 2008-2015 caused on average at least a 2.29% increase in the number of establishments due to business-based money laundering (BBML) in exposed counties, conditional on state-year and county fixed effects, plus other controls
An equilibrium is an allocation of final consumption by individuals across sectors and varieties of goods, a total mass of production firms N and BBML firms M, as well as prices of all consumption goods such that: (i) consumers choose the best affordable bundle taking prices as given; (ii) a firm selling legitimate consumer goods of variety i maximizes its profits; (iii) the mass of production firms is such that no additional firm can earn a profit above the entry fee; (iv) the drug cartel chooses an optimal allocation of funds to launder across the production and financial sector; and (v) all markets clear
Summary
Our research agenda belongs to a developing literature on unobserved economic activity. Here we summarize some of the key prior contributions using similar data sources, while other related papers are mentioned in the balance of the text. A third relevant paper is Bayer et al (2020), which used information from the Panama Papers to study whether economic agents in countries with a reported increase in public expropriations of assets and property seizures (presumably tied to greater law enforcement) were more likely to incorporate offshore vehicles They found significant evidence of local links to offshore activities, even within the same month, but primarily in economies with transparent governance. Our analysis is the first to pose this question and to isolate how organizations seeking to wash illicit profits shift into establishing or acquiring legitimate businesses in the wake of greater enforcement This is a difficult effect to identify because the databases leaked by the ICIJ do not directly link such investments to offshore vehicles or shell companies
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