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How Will the Sanctions Affect Russia?

Posted on March, 2022 | Videos

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As fighting across Ukraine escalates and the world reacts, how will the sanctions affect Russia and can we expect them to be effective?

Maria Perrotta Berlin, Assistant Professor at the Stockholm Institute of Transition Economics (SITE), shares her insights and discusses the potential effects of sanctions against Russia.

For a more in-depth analysis of Russian aggression in Ukraine and the impact of sanctions on Russia and in the region, listen to the FREE Network webinar “The sanctions on Russia, and their impact on the region”.

Disclaimer: Opinions expressed during events, seminars and conferences are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Securing Women’s Safety at the Time of War

Posted on March 8, 2022 | FROGEE PROJECT, News

20220308 Securing Women’s Safety

On this year’s International Women’s Day, we would like to draw attention to the women impacted by the invasion of Ukraine by the Russian Federation. Evidence from other armed conflicts suggests that women are particularly vulnerable both at the site of the war and in displacement, and that gender-based violence heightens in conflict and post-conflict societies. With this in mind, the international community should pay particular attention to protection, support and well-being of affected women in this tragic time.

The invasion of Ukraine by the Russian Federation sets a tragic background for this year’s International Women’s Day. The war has resulted in the loss of human life as well as suffering and displacement of hundreds of thousands of individuals. By March 6th 2022 over 1,5 million people fled Ukraine to neighbouring countries, while Russian forces have indiscriminately targeted Ukrainian towns and cities and failed to establish safety corridors for the civilian population and for humanitarian support. There exists extensive evidence that military conflicts put women at particular risk. This is the case both at the site of direct military confrontation, as well as a consequence of vulnerabilities generated by the need to flee their home. While one is clearly most concerned about the most direct expressions of gender-based violence, such as rape, sexual abuse or beating, we should also bear in mind that gender-based violence often takes the form of non-physical mistreatment, psychological pressure, or limitations on individual freedoms and displacement (Wirtz et al, 2014).

Indeed, the use of sexual violence during armed conflicts is by now broadly understood as a premeditated and deliberate technology of war, rather than the brutal expression of some base instinct triggered by the stress of conflict situations (Skjelsbaek, 2001), and there is evidence that aggressors from societies that are more gender-unequal are more likely to use it (Taylor, 1999; Meger, 2016, Guarnieri and Tur-Prats, 2020). Also, after fleeing conflict zones the spectre of sexual and gender-based violence follows displaced populations: the risk for sexual violence is heightened in refugee camps (Araujo et al, 2019). Further, it has been shown that rates of intimate partner violence during complex emergencies are much higher than rates of wartime sexual violence perpetrated outside of homes (Stark and Ager, 2011), and that domestic violence may be exacerbated by conflict and displacement (Wirtz et al, 2014).

Thus, the international community, the governments of countries which welcome families escaping the war, and the countless organised and improvised support groups, ought to pay particular attention to the risks to the welfare of women at this extraordinary time.

All agencies involved in assisting the Ukrainian population, both within and outside its borders, should be particularly aware of broad aspects of gender-based violence which the international academic community has been stressing for Securing women’s safety at the time of war the last few decades. As the war continues the international community, the governments of the host countries, and the European Union ought to ensure that:

  • Women and vulnerable groups that want or need to leave conflict zones are allowed to do so in a safe way.
  • All perpetrators of violence, including sexual violence, are eventually brought to justice. For this, there should be no question of impunity. For this to be possible safe spaces, infrastructure and reporting practices need to be established and enforced.
  • As per UN Security Council Resolution 1820 (first applied to the Democratic Republic of Congo in 2008) sexual violence ought to be used as part of the designation criteria in sanctions regimes. This implies that “targeted and graduated” measures can be imposed against warring factions who commit rape and other forms of violence against women and girls.
  • Refugee women are involved in the design, management or leadership of gender-based violence protection measures in refugee camps, if such were to be established (UNHCR, 2011)
  • Training programmes concerning gender-based violence, including sexual violence, and available legal mechanisms to prevent it are provided for volunteers, staff and refugees to minimize the risk for fleeing women (Spangaro et al 2013).
  • In the medium and longer term, in case of an inability to return to their homes, host countries facilitate legal work among refugees to avoid a cycle of vulnerability that may lead displaced women to seek precarious means of earning income (Ray et al. 2009).
  • Social support through individual or group therapy and skilled support groups is offered to reduce mental distress (Willman, 2013).

As we await the peaceful end of the invasion of Ukraine and the safe return of hundreds of thousands of families to their homes, may this year’s International Women’s Day be a day of reflection and resolution on appropriate means and strategies to prevent and combat sexual and gender-based violence, both on the scene of the the armed conflict as well as against all women who find refuge from the war in foreign countries.

On March 7th 2022 the FREE Network was planning to host a conference on “Economic and social context of domestic violence” as part of the Forum for Research on Gender Economics (FROGEE). The conference has been postponed until representatives of all the FREE Network institutes can safely participate. The FROGEE project is supported by the Swedish International Development Cooperation Agency (Sida).

References

The Sanctions on Russia, and Their Impact on the Region

Posted on March, 2022 | Videos

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As fighting across Ukraine escalates and the international community reacts, the Stockholm Institute of Transition Economics (SITE) and the FREE Network hosted a webinar “The Sanctions on Russia, and Their Impact on the Region” on 3 March.

Torbjörn Becker, Director of SITE was joined by:

  • Larry Samuelson, Professor at Yale and Cowles Foundation,
  • Lev Lvovsky, BEROC Research Fellow,
  • Nataliia Shapoval, Chairman of KSE Institute,
  • Yaroslava V. Babych, Lead Economist at ISET Policy Institute and
  • Tamar Sulukhia, Director at ISET – International School of Economics

Disclaimer: Opinions expressed during events, seminars and conferences are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Investing, Producing and Paying Taxes Under Weak Property Rights

Posted on February 21, 2022 | Policy Brief

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Oil majors often choose to operate in countries with weak property rights. This may appear surprising, since the lack of constraints on governments may create incentives to renege on initial promises with firms and renegotiate tax payments once investments have occurred and, in the worst case, expropriate the firm. In theory, backloading investments, production and tax payments may be used to create self-enforcing agreements which do not depend on legal enforcement. Using a new dataset covering the universe of oil majors’ assets that started production between 1974 and 1999, we indeed show in a recent CEPR Working Paper (Paltseva, Toews, and Troya-Martinez, 2022) that investments, production and tax payments are delayed by two years in countries with weak institutions relative to countries with strong institutions. Extending the dataset back to 1960 and exploiting the transition to a new world oil order where expropriation became easier, allows us to interpret our estimates as causal. In particular, prior to the transition expropriations were not feasible, due to the omnipresent and credible military threat imposed by the oil majors’ countries of origin. As the new order sat in, a new equilibrium emerged, in which expropriations became a feasible option. This transition incited an increase in expropriations and forced firms to adjust to the new reality by backloading contracts.

The Hold-up Problem

In December of 2006, when the oil price was climbing towards new heights, the Guardian reported that the Russian government was about to successfully force Shell into transferring their controlling stake in a huge liquified gas project back into the hands of the government. While officially this was motivated by environmental concerns surrounding the Sakhalin-II project, most observers agreed that this might be considered a textbook example of the hold-up problem faced by oil firms when investing in countries with limited constraints on the executive. At its core, the hold-up problem refers to the idea that the government may renege on the initial promise and appropriate a bigger share of the pie once investments have been made. Obviously, this is not an oil-specific issue and concerns any type of investment in countries with weak property rights. Academics, who worked on resolving these issues, suggest the use of self-enforcing agreements (Thomas and Worrall, 1994). These agreements use future gains from trade (as opposed to third-party enforcement) to incentivize the governments not to expropriate. And while the theoretical literature has prolifically developed over the last 30 years (Ray, 2002), to the best of our knowledge no empirical evidence has been provided on the use and dynamic patterns of self-enforcing backloaded contracts.

Data and Sample

In Paltseva, Toews and Troya-Martinez (2022), we rely on micro-level data on oil and gas projects provided by Rystad Energy, an energy consultancy based in Norway. Its database contains current and historical data on physical, geological and financial features for the universe of oil and gas assets. We focus on the assets owned by the oil majors (BP, Chevron, ConocoPhilips, Eni, ExxonMobile, Shell, and Total) using all assets that started production between 1960 and 1999, leaving us with a total of 3494 assets. An asset represents a production site with at least one well, operated by at least one firm, and with the initial property right being owned by at least one country. Being able to conduct the analysis on the asset level is particularly valuable since it allows us to control for a large number of confounding factors and rule out several alternative explanations of our main finding.

Moreover, there are three advantages of focusing our analysis on the oil and gas sector in general and the oil majors in particular. First, the sunk investments in the development of oil and gas wells are enormous, making the hold-up problem in the oil sector particularly severe. Second, oil majors have been around for many years since all of them were created before WWII. This provides us with a sufficiently long horizon to capture backloading over time. Third, the majors are simultaneously investing in many countries which provides us the necessary cross-sectional variation in institutional quality. To differentiate between countries with weak and strong institutions, we use a specific dimension from the Polity IV dataset measuring the constraints on the executive. The location of all the assets disaggregated by firm as well as a binary distinction in a country’s institutional quality is shown in Figure 1.

Figure 1. Spatial distribution of assets and institutional quality

Note: Location and ownership of assets are provided by Rystad Energy. The executive constraint indicator is taken from Polity IV and we use the median from the period 1950 to 1975 to define whether the country is considered to have strong or weak institutions. The cut-off of 5 implies that roughly 1/3 of the countries are defined as having strong institutions and roughly 50% of all the assets which started operation between 1950 and 2000 are located in countries with weak institutions.

A Stylized Fact

For the empirical analysis, our variables of interest are investment, production and tax payments normalized by the respective asset-specific cumulative sum over a period of 35 years. The resulting cumulative shares are depicted in Figure 2. We focus on physical production which, in addition to being considered the most reliable measure of an asset’s activity, does not require discounting. Real values of investment and tax payment depict a very similar picture. Most importantly, the dashed lines illustrate that 2/3 of cumulative production shares are reached approximately two years earlier in countries with strong institutions, in comparison to countries with weak institutions. The average asset size does not differ significantly between these groups. Such delays are costly for countries with weak institutions. Our back-of-the-envelope calculation suggests that the average country loses around 120 million US$ per year due to the delayed production and the respective tax payments. We confirm that the two-year delay cannot be explained by geographical, geological or financial confounders such as the location of the well, fuel type or contract features.

Figure 2. Years to reach 66% of cumulative flows in 35 years

Note: We use the Epanechnikov kernel with an optimally chosen bandwidth to plot the cumulative production over the 35-year life span of the asset. We group countries into two groups with weak and strong institutions according to Polity IV. This figure contains assets that started producing between 1975 and 1999.

The Transition to a New World Order

To push towards a causal interpretation of the results, we exploit the global transition to a new world oil order. This change affected the probability of expropriations in countries with weak institutions while leaving countries with strong institutions unaffected. In particular, the post-WWII weakening of the OECD members as political and military actors provides a natural experiment of global proportions. Expropriations are first viewed as impossible due to the military threat of British, French and US armies, and then become possible due to a global movement aiming at returning sovereignty over natural resources to the resource-rich economies. In the words of Daniel Yergin (1993): “The postwar petroleum order in the Middle East had been developed and sustained under American-British ascendancy. By the latter half of the 1960s, the power of both nations was in political recession, and that meant the political basis for the petroleum order was also weakening. […] For some in the developing world […] the lessons of Vietnam were […] that the dangers and costs of challenging the United States were less than they had been in the past, certainly nowhere near as high as they had been for Mossadegh, [the Iranian politician challenging UK and US before the coup d’etat in 1953], while the gains could be considerable.” Consequently, the number of expropriations has grown substantially since 1968, marking the transition to a new world order (Figure 3). However, Kobrin (1980) finds that even during the peak of expropriations in 1960-1976, only less than 5 % of all foreign-owned firms in the developing countries were expropriated. We suggest that this is, at least partly, thanks to the use of backloaded self-enforcing contracts.

Figure 3. Transition to a new world order

Note: Data on firm expropriations across all industries from Kobrin (1984).

Indeed, focusing on the years around the transition to the new world oil order, we show that there have not been any differences in investment, production or tax payments dynamics between countries with weak and strong institutions in the early years of the 1960s. But investment, production and the payments of taxes started experiencing significant delays after 1968 in the countries with weak institutions, using countries with strong institutions as a control. Intuitively, the omnipresence of a credible military threat in response to an expropriation served as an effective substitute for strong local formal institutions and eliminated the need for contracts to be self-enforced and backloaded in countries with weak institutions. Once this threat disappeared, contracts had to be self-enforcing and investment, production and tax payments had to be backloaded to decrease the risk of being expropriated by the governments of resource-rich economies. Theoretically, these initial differences in contract backloading between countries with strong and weak institutions should disappear in the long run, because the future gains from trade need to materialize eventually. We confirm empirically that this point is reached on average 20 years after firms start a contractual relationship with a country.

Conclusion

We provide evidence that oil firms seem to backload contracts in countries with weak institutions. We show that such backloading appears in the data during the transition to a new world order since 1968, when firms were in need of a new mechanism to deal with weak property rights and the risk of expropriations. We estimate the cost of such delays to be around 120 US$ per country and year. While this cost is high, it is important to emphasize that in the absence of such backloading, forward-looking CEOs of oil majors would often choose not to invest in the first place, since they would anticipate the severe commitment problems (Cust and Harding, 2020). Thus, as a second-best, the cost of the backloading may be marginal compared to the value added from trade when oil majors are willing to invest in countries with weak institutions and questionable property rights.

References

 

From East to West: A Paper Curtain in Swedish Foreign News Coverage?

Posted on February 7, 2022 | Policy Brief

Selective Focus Photography of Magazines representing Media Freedom Eastern Europe

How much a country is talked about in the media can determine its place in the public debate. In this brief, we collect data on the mentions of Eastern and Western European countries in the main Swedish newspapers over the past decades. We find consistently more coverage devoted to Western compared to Eastern Europe in the Swedish press. We investigate several factors that could explain this pattern. We find that while Eastern European countries are on average not more geographically distant from Sweden, Sweden tends to have closer trade links with Western European countries. Sweden is more culturally similar to the average Western European country in terms of language, religion and attitudes, cultural values and social norms. Trade relations and cultural proximity are associated with higher media coverage.

The media plays a vital role in modern societies by keeping the public informed and policymakers accountable. Whether and how events are covered by the news determines their relevance in the public debate. There is ample empirical evidence on the agenda-setting power of the news media. For example, Snyder and Strömberg (2010) show that local press coverage affects how informed US voters are about their representatives and in turn how much their politicians work in the interest of their constituencies. Eisensee and Strömberg (2007) find that news coverage affects how much disaster relief the US sends to foreign countries.

In this brief, we study the amount of news coverage devoted to European countries in the Swedish press. We document a systematic difference between Western and Eastern Europe and explore underlying factors that could be important in explaining this East-West divide.

The East-West Divide

We choose the four most widely read Swedish newspapers (Aftonbladet, Expressen, Dagens Nyheter, and Svenska Dagbladet) and use the newspaper database Retriever Research Media Archive to obtain statistics on the number of mentions of each country between 1995 and 2021. A country mention is an article in which the name of a country appears. Since two or more countries can be named in the same article, the total number of mentions does not correspond to the number of articles. As a percentage of all articles published by the four newspapers in 2021, roughly 20% mention at least one of these countries. While this simple measure of news coverage can be informative, it does not take into account many other aspects of a country’s prominence in the news, such as the length of articles, where articles appear, the tone of coverage, etc.

Figure 1 plots the sum of annual number of mentions by region over time. We see a clear difference in the amount of coverage devoted to Eastern and Western European countries. Over the entire time period, the 21 Western European countries were mentioned on average 2.7 times more than the 22 Eastern European countries.

While there does not appear to be a trend in relative coverage, there is considerable variation from year to year. The year when the relative difference in the number of mentions is smallest is 2014. The two most mentioned Eastern European countries in that year were Russia and Ukraine. Coverage likely increased due to the Crimean Crisis, when Russia invaded and annexed the Crimean Peninsula in Southern Ukraine. The relative difference was also low in 2008, coinciding with the Russo-Georgian war in August. In that year, other newsworthy events, such as the Global Financial Crisis or the UEFA European Football Championship, have a more ambiguous effect on relative media coverage.

Figure 1. Country mentions in Swedish newspapers

Note: Countries included in Eastern Europe: Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Latvia, Lithuania, Moldova, Montenegro, North Macedonia, Poland, Russia, Serbia, Slovakia, Slovenia, Ukraine. Countries included in Western Europe: Andorra, Austria, Belgium, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, Liechtenstein, Luxembourg, Malta, Monaco, Netherlands, Norway, Portugal, San Marino, Spain, Switzerland, United Kingdom.

What Explains This Discrepancy Between East and West?

There are a number of potential reasons why some countries systematically receive more attention in the press. In this section, we correlate the mean annual mentions of each country between 2019 and 2021 with different aspects of that country’s relationship with Sweden.

Distance and Population

Figure 2 shows how news coverage of a country depends on its geographic distance to Sweden and its population size. Overall, the further a country is from Sweden, the less that country is covered in the Swedish press. On average, Eastern European countries (in yellow) are covered less than Western European countries (in blue), for a given distance to Sweden. For example, Poland and Germany are both around 1000km away from Sweden, but Germany is mentioned almost twice as often in the Swedish press. As we measure the distance between the most populous city of each country and Stockholm, some of this difference in coverage is driven by the fact that countries sharing a border with Sweden receive extensive coverage. For instance, Denmark, Finland, and Norway are on average covered more than six times as much as Latvia.

Population also plays a role, that is, larger countries (e.g., Germany, Russia, Spain, and Poland) receive more coverage than smaller countries (e.g., Lithuania, Ireland, and Estonia). As Eastern European countries have on average smaller populations than Western European countries, population can partly explain the East-West difference in news coverage. One counterexample is Russia, which has more than twice as many people as France or the UK, but receives less coverage in the Swedish press.

Figure 2. Geographical distance and population

Note: Geodesic distances are calculated between the latitudes and longitudes of the most populous city of each country and Stockholm. Marker sizes are weighted by population averaged over 2019-2021, and fitted line is unweighted. Source: CEPII’s GeoDist dataset (Mayer and Zignago, 2006) and the World Bank. See Figure 1 for a list of countries included.

Trade and GDP

Figure 3 shows that Sweden’s economic relationship with a country affects how much the country features in Swedish news. We find a strong positive correlation of 0.8 between a country’s total trade volume with Sweden and country mentions in Swedish newspapers. As Sweden’s largest trading partners tend to be in Western Europe, this partly explains the relative coverage of East and West. Another factor is the overall size of a country’s economy (as measured by its GDP). Swedish newspapers more commonly mention countries with higher GDP, and these are more likely to be in Western than Eastern Europe.

 Figure 3. Trade and GDP

Note: Trade data are from 2019. Marker sizes are weighted by national GDP, and fitted line is unweighted. GDP figures are averaged over 2019-2021 and measured in current prices, PPP adjusted, international dollars. Source: The World Bank’s WITS database and the IMF World Economic Outlook, October 2021. See Figure 1 for a list of included countries.

Culture

There is a large literature documenting the link between cultural factors and the economic relationship between nations. For instance, studies show that similarities in ancestry, language, religion, norms and values can influence bilateral trade (Melitz, 2008; Guiso et al., 2009) and the diffusion of technology (Spolaore et al., 2009). In this section, we show how the amount of press coverage correlates with differences in language, religion, and values and norms using cultural distance data from Spolaore and Wacziarg (2016).

Figure 4.a shows that Swedish newspapers are more prone to cover countries whose languages are similar to Swedish. The language similarity measure originally developed by Fearon (2003) is based on the prevalence of languages within a country and distance between languages. The distance measure is calculated using linguistic trees provided in Ethnologue. It ranges from 0 (close) to 1 (distant) and reflects the expected number of common linguistic nodes between two randomly chosen individuals from each country and takes into account that countries can be linguistically heterogeneous (for more details, see Fearon 2003). Norway and Denmark are linguistically closest to Sweden, however, these are also two neighboring countries with which Sweden conducts extensive trade. On average, Eastern European countries are more linguistically distant from Sweden, although some Western European countries (such as France and Spain) are as linguistically distant from Sweden as many of the Eastern European countries and receive considerably more press coverage.

The religious distance measure by Spolaore and Wacziarg (2016) is calculated analogously to the linguistic distance measurement. It is based on the prevalence of different religions within a country and the distance between religions. Figure 4.b shows that countries that are religiously different from Sweden receive less coverage in the Swedish media. With the exception of the three Scandinavian countries, Eastern and Western European countries have similar levels of religious distance to Sweden. Based solely on this metric, the Swedish press mentions Eastern European countries less (and Western European countries more) than their religious distance to Sweden would predict.

Figure 4.c shows an index of a country’s cultural proximity to Sweden, that is, its distance in terms of cultural values, attitudes and norms based on average responses to the World Value Surveys from 1981 to 2010 (see Spolaore and Wacziarg, 2016). This cultural proximity index aggregates the Euclidian distances in survey responses between each country and Sweden. The index is standardized so that 0 shows the average country’s cultural distance to Sweden and negative (positive) values indicate above (below) average cultural similarity. Western European countries are significantly closer to Sweden than Eastern European countries based on this measure. As Swedish press coverage is on average declining in a country’s cultural distance to Sweden, this difference in country’s values and attitudes can explain some of the East-West difference in media coverage.

 Figure 4. Cultural distance

Panel a. Linguistic distance

Note: We use the indicator of tree-based weighted linguistic distance from Spolaore and Wacziarg (2016) and originally developed in Fearon (2003). This measure is an estimate of the expected or weighted number of common linguistic nodes between two randomly chosen individuals from each country. The data on language prevalence is compiled from a number of different sources and assembled in Fearon (2003). Countries included in Eastern Europe: Albania, Armenia, Azerbaijan, Belarus, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Latvia, Lithuania, Moldova, Poland, Russia, Slovakia, Slovenia, Ukraine. Countries included in Western Europe: Austria, Belgium, Denmark, Finland, France, Germany (average between East and West Germany), Ireland, Italy, Netherlands, Norway, Portugal, Spain, Switzerland, United Kingdom

Panel b. Religious distance

Note: We use the tree-based weighted religious distance from Spolaore and Wacziarg (2016). This measure is an estimate of the expected distance between the religions of two randomly chosen individuals from each country. See Figure 4.a for a list of included countries.

 Panel c. Distance in cultural values, attitudes, and norms

Note: We use the distance in cultural norms and values from Spolaore and Wacziarg (2016).  This measure is based on all value-related questions from the World Values Survey Integrated Questionnaire from 1981–2010. The mean distance across countries is standardized to zero. See Figure 4.a for a list of countries included.

Conclusion

As the public and policymakers primarily receive information from the mass media, news coverage can have profound effects on public debate and policy decisions. Using data on the content of the four most widely read Swedish newspapers over the past decades, we measure how much the Swedish press covers Eastern and Western European countries. We find that over the past 25 years, there have been 2.7 times more mentions of Western than Eastern European countries. We find that the Swedish press is more likely to mention countries that are geographically closer, more populous, have a larger GDP and more trade with Sweden. Cultural proximity (as measured by language, religion and values, attitudes and social norms) also correlates with higher coverage. These factors are of course not independent from each other. For instance, the other Scandinavian countries with whom Sweden shares a border and a history, are culturally similar to Sweden and some of Sweden’s most important trading partners. They are also some of the countries that are most covered by the Swedish press. Some of these factors, such as sharing similar values, appear to explain the gap in coverage between East and West, while others, such as geographic distance, do not. More recently, concerns over energy security in the EU (see e.g., Le Coq and Paltseva, 2022) and the rise in military tension between Russia and Ukraine illustrate how developments in Eastern Europe can directly affect life here in Sweden. Perhaps it is time for Sweden to pay more attention to her eastern neighbours?

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Paradise Leaked: An Analysis of Offshore Data Leaks

Posted on January 31, 2022 | Policy Brief

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In recent years, there have been several high-profile leaks of documents related to the offshore financial industry, such as the Pandora Papers released last year. Some of the data contained in the leaked documents have now been made public. In this brief, we discuss the advantages and pitfalls of using these data for economic analysis. We show that despite some caveats, there are patterns in these data that can shed light on a secretive industry. For instance, the number of offshore entities linked to a country increases significantly when that country experiences a change in political leadership. By contrast, financial sanctions on a given country result in a reduction in the number of established offshore entities. In the immediate aftermath of the financial crisis, many countries signed bilateral treaties with tax havens in order to promote transparency. Our analysis of the leaked data shows that the overwhelming majority of offshore entities are not governed by these treaties.

“… that I may see and tell of things invisible to mortal sight.”

John Milton, Paradise Lost

Offshore Tax Haven Leaks

Zucman (2013) estimates that household wealth held in offshore tax havens is equivalent to 10% of world GDP. While there are many legitimate reasons for wealthy individuals to use offshore financial services, the secrecy surrounding offshore holdings has also enabled tax evasion and money laundering. The international community has launched several initiatives trying to increase the transparency of offshore wealth holdings. Over the past decade, several large collections of documents from offshore financial service providers have been leaked to the media: Pandora Papers (2021), Paradise Papers (2017/2018), Bahamas Leaks (2016), Panama Papers (2016), and Offshore Leaks (2013). Investigative journalists have used information from the leaks to expose many instances of secretive financial dealings linked to political leaders. Examples from FREE network countries include: the connections between a close ally of Belarussian President Alexander Lukashenko and a gold mining venture in Zimbabwe, the offshore business holdings of past and present Ukrainian presidents and their respective allies, and the wealth of Russian President Vladimir Putin’s close associates and childhood friends (see, for instance, Cosic 2021, Mylovanov and Mylovanova 2016).

The International Consortium of Investigative Journalists (ICIJ) has made public information on more than 800,000 offshore entities that are part of the offshore data leaks (see ICIJ Offshore Leaks database). The data contain information on the names of companies or people who set up offshore entities, their country of origin, the offshore jurisdiction, and the dates of incorporation and deactivation for offshore entities.

What Can We Learn from the Data?

Despite the wealth of information that this database contains, there has been relatively little academic research using the offshore leaks data. Two notable exceptions are Alstadsæter, Johannesen and Zucman (2019), and Londoño-Vélez and Ávila-Mahecha (2021), who link information from the Panama Papers to administrative records from Scandinavia and Columbia, respectively. They find that tax evasion is concentrated among the richest households. Guriev, Melnikov and Zhuravskaya (2021) use the revelation of the Panama Papers to study its effect on perceptions of corruption.

There are several challenges to using the offshore leaks data for systematic data analyses. First, there are both legitimate and illegal uses of offshore financial services, and without further information, it is not possible to distinguish between them. Second, as this information is obtained through leaks at specific offshore services providers, the data are unlikely to be representative of overall offshore financial activity. Third, there is no information on financial transactions, and we do not know the amounts of money involved in the offshore entities. Finally, more sophisticated offshore structures may make it impossible to deduce the ultimate owner of each entity and its country of origin. Especially for the second and third reasons, economists have tended to focus on balance of payments statistics and cross-border bank deposit data when estimating flows to offshore accounts. For example, Andersen, Johannesen, Lassen and Paltseva (2017) show how the oil wealth of countries with weak institutions is diverted into secret offshore accounts. Becker (2019) investigates recent trends in Russian capital flows and shows that a significant share of Russian money flows to Western European banks. See also Nyreröd and Spagnolo (2018, 2021) for discussions of the role of European banks in recent money laundering scandals.

With these caveats in mind, Figure 1 shows the correlation between the number of offshore entities in the data (on the y-axis) and the offshore wealth holdings of each country’s households (on the x-axis) as estimated by Alstadsæter, Johannesen and Zucman (2018). While the chart shows a positive correlation of 0.56 between these two measures, it also illustrates that the number of leaked entities may be a poor proxy for the stock of offshore wealth. Countries with a significant fraction of offshore wealth in European tax havens are underrepresented in the leaks (e.g., France, Germany, and Italy) while the UK, Russia, and Latvia account for a disproportionate share of leaked offshore entities.

Figure 1. Number of offshore entities and estimated offshore wealth

Source: ICIJ Offshore Leaks database, Alstadsæter, Johannesen and Zucman (2018) and authors’ calculations.

Timing of Offshore Entity Creation

While the number of overall leaked entities per country might not be a perfect measure of the amount of offshore wealth, we find that there are systematic patterns in the timing of the creation of offshore entities. In particular, more offshore entities are created when individuals face political uncertainty in their own countries and fewer offshore entities are created by individuals from countries under financial sanctions.

Elections and Change of Leadership

Figure 2 shows the average number of newly incorporated offshore entities linked to a given country (on the y-axis), depending on that country’s political situation. Panel A shows no clear pattern of offshore entities being created by companies or individuals around the time of elections. Elections are often predictable and frequently result in the reelection of the incumbent government. In contrast, Panel B shows a clear increase in the number of offshore entities linked to a country around the time when that country experiences a change in the de facto political leader. Around four months before there is a change in political leadership, the average number of entities created per country per month almost doubles. Offshore entity creation falls back to normal levels typically around half a year following the transition of power. This pattern suggests that wealth leaves countries at times of political uncertainty and is consistent with the findings of Andersen, Johannesen, Lassen and Paltseva (2017) and Earle, Shpak, Shirikov and Gehlbach (2021).

Figure 2. Offshore entity creation and national political situation

Panel a. Elections

Panel b. Change of political power

Source: ICIJ Offshore Leaks database, The Rulers, Elections, and Irregular Governance (REIGN) Dataset and authors’ calculations. A change of power is defined as a change in the de-facto political leader (e.g., due to the incumbent losing an election or the collapse of a coalition government).

International Sanctions

Figure 3 shows the impact of sanctions from the United Nations, European Union, and the United States on the average number of offshore entities linked to a given country (on the y-axis). Panel A shows that when a country is subject to financial sanctions, the number of linked offshore entities created falls to around 10 per year from an average of 25 before the introduction of sanctions. The impact of sanctions can already be seen in the year before the start of the sanctions, which could reflect measurement and reporting errors or anticipation of the sanctions. In contrast, Panel B shows that trade sanctions that are not accompanied by financial sanctions have no significant impact on offshore activities. These charts suggest that financial sanctions may have some impact on how much capital can be moved from countries under sanctions to offshore accounts.

Figure 3. Offshore entity creation and international sanctions

Panel a. Financial sanctions

Panel b. Trade (without financial) sanctions

Source: ICIJ Offshore Leaks database, Global Sanctions Data Base and authors’ calculations.

Promoting Transparency

After the Financial Crisis in 2009, G20 countries compelled offshore tax havens to sign bilateral treaties to allow for the exchange of banking information under the threat of economic sanctions. More than 300 treaties were signed by tax havens that year. The effectiveness of this policy has been debated. For instance, Johannesen and Zucman (2014) show that the treaties lead to a relocation of bank deposits from compliant to less compliant offshore tax havens.

The G20 crackdown required each tax haven to sign at least 12 bilateral treaties. Relative to a comprehensive multilateral agreement, this policy had two limitations. Firstly, it leaves room for the diversion of funds identified by Johannesen and Zucman (2014). Secondly, tax havens were able to choose freely among potential partner countries – regardless of the underlying financial flows. Figure 4 shows that only a small fraction of the entities in the offshore leak database have a country of origin that signed a treaty with the tax haven in which they were incorporated. In addition, the small share of entities that will be subject to treaties suggests that havens did not always sign treaties with the most important counterparts. While the leaked entities may not be representative of offshore finance as a whole, this picture appears inconsistent with the OECD’s claim that “the era of bank secrecy is over” (OECD 2011)

Figure 4. Entity creation by treaty status

Source: ICIJ Offshore Leaks database, treaty events from Johannesen and Zucman (2014) and authors’ calculations.

Conclusion

A series of leaks over the past decade have exposed over 40 million documents related to the secretive offshore financial industry. Information related to over 800,000 offshore financial entities has been made public by the ICIJ. While a few high-profile cases received significant media coverage and gave rise to further investigations, the vast majority of references to networks of individuals, trusts, and shell corporations are difficult to decipher. This brief argues that, collectively, these leaked documents can be informative. They can be used to analyze the reasons for moving money offshore (such as domestic political uncertainty) as well as the constraints individuals face when doing so (such as international sanctions or bilateral treaties on bank secrecy).

In an effort to further increase transparency, 102 jurisdictions committed to a new standard for the automatic exchange of certain financial account information between tax authorities from 2019. Until such reforms are successful, leaks by whistleblowers are likely to remain a valuable source of information on the offshore financial industry.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

What does the Gas Crisis Reveal About European Energy Security?

Posted on January 24, 2022 | Policy Brief

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The recent record-high gas prices have triggered legitimate concerns regarding the EU’s energy security, especially with dependence on natural gas from Russia. This brief discusses the historical and current risks associated with Russian gas imports. We argue that decreasing the reliance on Russian gas may not be feasible in the short-to-mid-run, especially with the EU’s goals of green transition and the electrification of the economy. To ensure the security of natural gas supply from Russia, the EU has to adopt the (long-proclaimed) coordinated energy policy strategy.

In the last six months, Europe has been hit by a natural gas crisis with a severe surge in prices. Politicians, industry representatives, and end-energy users voiced their discontent after a more than seven-fold price increase between May and December 2021 (see Figure 1). Even if gas prices somewhat stabilized this month (partly due to unusually warm weather), today, gas is four times as expensive as it was a year ago. This has already translated into an increase in electricity prices, and as a result, is also likely to have dramatic consequences for the cost and price of manufacturing goods.

Figure 1. Evolution of EU gas prices since Oct 2020.

Source:  https://tradingeconomics.com/commodity/eu-natural-gas.

These ever-high gas prices have triggered legitimate concerns regarding the security of gas supply to Europe, specifically, driven by the dependency on Russian gas imports. Around 90% of EU natural gas is imported from outside the EU, and Russia is the largest supplier. In 2020, Russia provided nearly 44% of all EU gas imports, more than twice the second-largest supplier, Norway (19.9%, see Eurostat). The concern about Russian gas dependency was exacerbated by the new underwater gas route project connecting Russia and the EU – Nord Stream 2. The opponents to this new route argued that it will not only increase the EU’s gas dependency but also Russia’s political influence in the EU and its bargaining power against Ukraine (see, e.g., FT). Former President of the European Council Donald Tusk stated that “from the perspective of EU interests, Nord Stream 2 is a bad project.”.

However, neither dependency nor controversial gas route projects are a new phenomenon, and the EU has implemented some measures to tackle these issues in the past. This brief looks at the current security of Russian gas supply through the lens of these historical developments. We provide a snapshot of the risks associated with Russian gas imports faced by the EU a decade ago. We then discuss whether different factors affecting the EU gas supply security have changed since (and to which extent it may have contributed to the current situation) and if decreasing dependence on Russian gas is feasible and cost-effective. We conclude by addressing the policy implications.

Security of Russian Gas Supply to the EU, an Old Problem Difficult to Tackle

Russia has been the main gas provider to the EU for a few decades, and for a while, this dependency has triggered concerns about gas supply security (see, e.g., Stern, 2002 or Lewis, New York Times, 1982). However, the problem with the security of Russian gas supplies was extending beyond the dependency on Russian gas per se. It was driven by a range of risk factors such as insufficient diversification of gas suppliers, low fungibility of natural gas supplies with a prevalence of pipeline gas delivery, or use of gas exports/transit as means to solve geopolitical problems.

This last point became especially prominent in the mid-to-late-2000s, during the “gas wars” between Russia and the gas transit countries Ukraine and Belarus. These wars led to shortages and even a complete halt of Russian gas delivery to some EU countries, showing how weak the security of the Russian gas supply to the EU was at that time.

Reacting to these “gas wars”, the EU attempted to tackle the issue with a revival of the “common energy policy” based on the “solidarity” and “speaking in one voice” principles. The EU wanted to adopt a “coherent approach in the energy relations with third countries and an internal coordination so that the EU and its Member States act together” (see, e.g., EC, 2011). However, this idea turned out to be challenging to implement, primarily because of one crucial contributor to the problem with the security of Russian gas supply – the sizable disbalance in Russian gas supply risk among the individual EU Member States.

Indeed, EU Member States had a different share of natural gas in their total energy consumption, highly uneven diversification of gas suppliers, and varying exposure to Russian gas. Several Eastern-European EU states (such as Bulgaria, Estonia, or Czech Republic) were importing their gas almost entirely from Russia; other EU Member States (such as Germany, Italy, or Belgium) had a diversified gas import portfolio; and a few EU states (e.g., Spain or Portugal) were not consuming any Russian gas at all. Russian natural gas was delivered via several routes (see Figure 2), and member states were using different transit routes and facing different transit-associated risks. These differences naturally led to misalignment of energy policy preferences across EU states, creating policy tensions and making it difficult to implement a common energy policy with “speaking in one voice” (see more on this issue in Le Coq and Paltseva, 2009 and 2012).

Figure 2. Gas pipeline in Europe.

Source: S&G Platt. https://www.spglobal.com/platts/en/market-insights/blogs/natural-gas/010720-so-close-nord-stream-2-gas-link-completion-trips-at-last-hurdle

The introduction of Nord Stream 1 in 2011 is an excellent example of the problem’s complexity. This new gas transit route from Russia increased the reliability of Russian gas supply for EU countries connected to this route (like Germany or France), as they were able to better diversify the transit of their imports from Russia and be less exposed to transit risks. The “Nord Stream” countries (i.e., countries connected to this route) were then willing to push politically and economically for this new project. Le Coq and Paltseva (2012) show, however, that countries unconnected to this new route while simultaneously sharing existing, “older” routes with “Nord Stream” countries would experience a decrease in their gas supply security. The reason for this is that the “directly connected” countries would now be less interested in exerting “common” political pressure to secure gas supplies along the “old” routes.

This is not to say that the EU did not learn from the above lessons. While the “speaking in one voice” energy policy initiative was not entirely successful, the EU has implemented a range of actions to cope with the risks of the security of gas supply from Russia. The next section explains how the situation is has changed since, outlining both the progress made by the EU and the newly arising risk factors.

Security of Russian Gas Supply to the EU, a Current Problem Partially Addressed

Since the end of the 2000s, the EU implemented a few changes that have positively affected the security of gas supply from Russia.

First, the EU put a significant effort into developing the internal gas market, altering both the physical infrastructure and the gas market organization. The EU updated and extended the internal gas network and introduced the wide-scale possibility of utilizing reverse flow, effectively allowing gas pipelines to be bi- rather than uni-directional. These actions improved the gas interconnections between the EU states (and other countries), thereby making potential disruptions along a particular gas transit route less damaging and diminishing the asymmetry of exposure to route-specific gas transit risks among the EU members. Ukraine’s gas import situation is a good illustration of the effect of reverse flow. Ukraine does not directly import Russian gas since 2016, mainly from Slovakia (64%), Hungary (26%), and Poland (10%) (see https://www.enerdata.net/publications/daily-energy-news/ukraine-launches-virtual-gas-reverse-flow-slovakia.html). The transformation of the gas market organization brought about the implementation of a natural gas hub in Europe and change in the mechanism of gas price formation. It is now possible to buy and sell natural gas via long-term contracts and on the spot market. With the gas market becoming more liquid, it became easier to prevent the gas supply disruption threat.

Second, Europe has made certain progress in diversifying its gas exports. According to Komlev (2021), the concentration of EU gas imports from outside of the EU (excluding Norway), as measured by the Herfindahl-Hirschman index, has decreased by around 25% between 2016 and 2020. While the imports are still highly concentrated, with the HHI equal to 3120 in 2020, this is a significant achievement. A large part of this diversification effort is the dramatic increase in the share of liquified natural gas (i.e., LNG) in its gas imports – in 2020, a fair quarter of the EU gas imports came in the form of LNG. An expanded capacity for LNG liquefaction and better fungibility of LNG would facilitate backup opportunities in the case of Russian gas supply risks and improve the diversification of the EU gas imports, thereby increasing the security of natural gas supply.

However, the above developments also have certain disadvantages, which became especially prominent during the ongoing gas crisis. For example, the fungibility of LNG has a reverse side: LNG supplies respond to variations in gas market prices across the world. This change has intensified the competition on the demand side – Europe and Asia might now compete for the same LNG. This is likely to make a secure supply of LNG – e.g., as a backup in the case of a gas supply default or as a diversification device – a costly option.

In turn, new mechanisms of gas price formation in Europe included decoupling the oil and gas prices and changing the format of long-term gas contracts. The percentage of oil-linked contracts in gas imports to the EU dropped from 47% in 2016 to 26% in 2020. In particular, 87% of Gazprom’s long-term contracts in 2020 were linked to spot and forward gas prices and only around 13% to oil prices (Komlev, 2021). This gas-on-gas linking may have contributed to the current gas crisis: Indeed, it undermined the economic incentives of Gazprom to supply more gas to the EU spot market in the current high-price market. Shipping more gas would lower spot prices and prices of hub-linked longer-term contracts for Gazprom. In that sense, the ongoing decline in Russian gas supplies to the EU may reflect not (only) geopolitical considerations but economic optimization.

Similarly, this new mechanism also finds reflection in the ongoing situation with the EU gas storage. The current EU storage capacity is 117 bcm, or almost 20% of its yearly consumption, and thus, can in principle be effective in managing the short-term volume and price shocks. However, the current gas crisis has shown that this option might be far from sufficient in the case of a gas shortage (see, e.g., Zachmann et al., 2021).  One of the reasons for this insufficiency can be Gazprom controlling a sizable share of this storage capacity (see https://www.europarl.europa.eu/doceo/document/E-9-2021-004781_EN.html). For example, Gazprom owns (directly and indirectly) almost one-third of all gas storage in Germany, Austria, and the Netherlands.  Combining this storage market position with a long-term gas contract structure may also lead to strategic behavior for economic (on top of potential political) purposes.

Last but not least, the EU gas market is likely to be characterized by increased demand due to the green transition agenda (see Olofsgård and Strömberg, 2022). Being the least carbon-intensive fossil fuel, natural gas has an important role in facilitating green transition and increasing the electrification of the economy. For example, Le Coq et al. (2018) argues that gas capacity should be around 3 to 4 times the current capacity by 2050 for full electrification of transport and heating in France, Germany, or the Netherlands. In such circumstances, the EU is not likely to have the luxury to diminish reliance on Russian gas.

Conclusions and Policy Implications

Keeping the above discussion in mind, should the EU try to diminish its dependence on Russian gas to improve its energy security? This may be true in theory, but in practice, this might be too costly, at least in the short-to-medium run.

The current situation on the EU gas market suggests that simply cutting gas imports from Russia is likely to lead to high prices both in the energy sector and, later, in other sectors of the economy due to spillovers. Substituting gas imports from Russia with gas from other sources, such as LNG, is likely to be very costly and not necessarily very reliable. Alternative measures, e.g., improving interconnections between the EU Member States or controlling transit issues via the use of reverse flow technology, are effective but have limited impact. Simply cutting down gas demand is not a viable strategy. Indeed, with the EU pushing for a green transition and the electrification of the economy, the EU’s gas imports may have to increase. Russian gas may play an important role in this process.

As a result, we believe that the solution to keep the security issue of Russian gas supply at bay lies in the area of common energy policy. It is essential that the EU implements and effectively manages a coordinated approach in dealing with Russian gas supplies. The EU is the largest buyer of Russian gas, and given Russian dependency on hydrocarbon exports, such a synchronized approach would give the EU the possibility to exploit its “large buyer” power. While the asymmetry in exposure to Russian gas supply risks among the EU Member States is still sizable, the improvements in the functioning of the internal gas market and gas transportation within the EU make their preferences more aligned, and a common policy vector more feasible. Furthermore, recent EU initiatives on creating “strategic gas reserves” by making the Member States share their gas storage with one another would further facilitate such coordination. Implementing the “speaking in one voice” gas import policy will allow the EU to fully utilize its bargaining power vis-à-vis Gazprom and spread the benefits of new gas routes from Russia – such as Nord Stream 2 – across its Member States.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Environmental Policy in Eastern Europe | SITE Development Day 2021

Posted on January 10, 2022 | Policy Brief

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The need for urgent climate action and energy transformation away from fossil fuels is widely acknowledged. Yet, current country plans for emission reductions do not reach the requirements to contain global warming under 2°C. What is worse, there is even reasonable doubt about the commitment to said plans given recent history and existing future investment plans into fossil fuel extraction and infrastructure development.  This policy brief shortly summarizes the presentations and discussions at the SITE Development Day Conference, held on December 8, 2021, focusing on climate change policies and the challenge of a green energy transition in Eastern Europe.

Climate Policy in Russia

The first section of the conference was devoted to environmental policy in Russia. As Russia is one of the largest exporters of fossil fuel in the world, its policies carry particular importance in the context of global warming.

The head of climate and green energy at the Center for Strategic Research in Moscow, Irina Pominova, gave an account of Russia’s current situation and trends. Similar to all former Soviet Union countries, as seen in Figure 1, Russia had a sharp decrease in greenhouse gas emissions (hereinafter referred to as GHG emissions) during the early 90s due to the dramatic drop in production following the collapse of the Soviet Union. Since then, the level has stabilized, and today Russia contributes to about 5% of the total GHG emissions globally. The primary source of GHG emissions in Russia comes from the energy sector, mainly natural gas but also oil and coal. The abundance of fossil fuels has also hampered investments in renewable resources, constituting only about 3% of the energy balance, compared to the global average of 10%

Figure 1. Annual greenhouse gas emissions per capita

Note: Greenhouse gas emissions are expressed in metric tons of CO2 equivalents. Source: Emissions Database for Global Atmospheric Research (EDGAR).

Pominova noted that it is a massive challenge for the country to reach global energy transformation targets since the energy sector accounts for over 20% of national GDP and 28% of the federal budget. Yet, on a positive note, the number of enacted climate policies has accelerated since Russia signed the Paris Agreement in 2019. One notable example is the federal law on the limitation of GHG emissions. This law will be enforced from the end of 2021 and will impose reporting requirements for the country’s largest emitters. The country’s current national climate target for 2030 is to decrease GHG emissions by 30% compared to the 1990 level. As shown in Figure 1, this would imply roughly a 10 percent reduction from today’s levels given the substantial drop in emissions in the 1990’s.

Natalya Volchkova, Policy Director at CEFIR in Moscow, discussed energy intensity and the vital role it fills in Russia’s environmental transition. Energy intensity measures an economy’s energy efficiency and is defined as units of energy per unit of GDP produced. Volchkova emphasized that to facilitate growth in an environmentally sustainable way it is key to invest in technology that improves energy efficiency. Several regulatory policy tools are in place to promote such improvements like bottom-line energy efficiency requirements, sectoral regulation, and bans on energy-inefficient technologies. Yet, more is needed, and a system for codification and certification of the most environmentally friendly technologies is among further reforms under consideration.

As a Senior Program Manager at SIDA, Jan Johansson provided insights on this issue from an international perspective. Johansson gave an overview of SIDA’s cooperation with Russia in supporting and promoting environmental and climate policies in the country. The main financial vehicle of Swedish support to Russia with respect to environmental policy has been a multilateral trust fund established in 2002 under the European Union (EU) Northern Dimension Environmental Partnership (NDEP). One of the primary objectives of the cooperation has been to improve the environment in the Baltic and Barents Seas Region of the Northern Dimension Area. Over 30 NDEP projects in Russia and Belarus have been approved for financing so far. Seventeen of those have been completed, and the vast majority have focused on improving the wastewater treatment sector.

Johansson also shed light on the differences that can exist between governments in their approach to environmental policy. For example, in the area of solid waste management, Russia prefers large-scale solutions such as landfills and ample sorting facilities. In Sweden and Western Europe, governments have a more holistic view founded on spreading awareness in the population, recycling, corporate responsibility, and sorting at the source.

Environmental Transition in Eastern Europe

In the second part of the conference environmental policies and energy transformation in several other countries in the region were discussed.

Norberto Pignatti, Associate Professor and Centre Director at ISET Policy Institute, talked about the potential for a sustainable energy sector and current environmental challenges in Georgia. The country is endowed with an abundance of rivers and sun exposure, making it a well-suited environment for establishing the production of renewable energy such as wind, solar, and hydro. As much as 95 % of domestic energy production comes from renewable sources. Yet, domestic energy production only accounts for 21% of the country’s total consumption, and 58% of imported energy comes from natural gas and 33% from coal. Furthermore, the capacity of renewable energy sources has declined over the last ten years, and particularly so for biofuel due to the mismanagement of forests. A notable obstacle Georgia faces in its environmental transition is attracting investors. Low transparency and inclusiveness from the government in discussions about environmental policy, along with inaccurate information from the media, has led to a low public willingness to pay for such projects. Apart from measures to overcome the challenges mentioned, the government is currently working on a plan to impose emission targets on specific sectors, invest in energy efficiency and infrastructure, and support the development of the renewable energy sector.

Like Georgia, Poland is a country where energy consumption is heavily reliant on imports and where coal, oil, and gas stand for most of the energy supply. On top of that, Poland faces significant challenges with air quality and smog and a carbon-intensive energy sector. On the positive end, Poland established a government-industry collaboration in September 2021, that recognizes offshore wind as the primary strategic direction of the energy transition in Poland. Pawel Wróbel, Founder and Managing Director of BalticWind.EU, explained that the impact of the partnership will be huge in terms of not only energy security but also job creation and smog mitigation. The plan implies the installation of 5.9 GW of offshore wind capacity by 2030 and 11GW by 2040. Wróbel also talked about the EU’s European Green Deal and its instrumental role in accelerating the energy transition in Poland. By combining EU-wide instruments with tailor-made approaches for each of the member states, the Deal targets a 55% reduction in GHG emissions by 2030 through decarbonization, energy efficiency, and expanding renewable energy generation. Michal Myck, Director of CenEA, highlighted the role of social acceptance in accelerating the much-needed energy transition in Poland. In particular, to build political support, there is a crucial need for designing carbon taxes in a way that ensures the protection of vulnerable households from high energy prices.

Adapting to the European Green Deal will also create challenges for countries outside of the EU, especially if a European Carbon Border Adjustment Mechanisms (CBAM) is put in place in 2026 as suggested. Two participants touched on this topic in the context of Belarus and Ukraine respectively. Yauheniya Shershunovic, researcher at BEROC, talked about her research on the economic implications of CBAM in Belarus. It is estimated that the introduction of CBAM can be equivalent to an additional import duty on Belarusian goods equal to 3.4-3.8% for inorganic chemicals and fertilizers, 6.7-13.7% for metals, and 6.5-6.6% for mineral products. Maxim Fedoseenko, Head of Strategic Projects at KSE, shared similar estimations for Ukraine, suggesting that the implementation of CBAM will lead to an annual loss of €396 million for Ukrainian businesses and a decrease in national GDP of 0.08% per year.

An example of Swedish support to strengthen environmental policies in Eastern Europe was presented by Bernardas Padegimas, Team Leader at the Environmental Policy and Strategy Team at the Stockholm Environment Institute. The BiH ESAP 2030+ project is supporting Bosnia and Herzegovina in preparing their environmental strategy. This task is made more challenging by the country’s unique political structure with two to some extent politically autonomous entities (and a district jointly administered by the two), and elites from the three different major ethnic groups having guaranteed a share of power. The project therefore aims to include a broad range of stakeholders in the process, organized into seven different working groups with 659 members on topics ranging from waste management to air quality, climate change and energy. The project also builds capacity in targeted government authorities, raises public awareness of environmental problems, and goes beyond just environmental objectives: mainstreaming gender equality, social equity and poverty reduction. The project is 80 percent finished and will produce a strategy and action plan for the different levels of governance in the country’s political system.  There is also a hope that this process can serve as a model for consensus building around important but at times contentious policy issues more generally in the country.

Public Opinion and Energy Security

Finally, Elena Paltseva, Associate Professor at SITE, and Chloé le Coq, Professor at the University of Paris II Panthéon-Asses (CRED), shared two joint studies relating to the green transition in Europe.

Recent research shows that individual behavioral change has a vital role to play in the fight against climate change, both directly and indirectly through changes in societal attitudes and policies motivated by role models. A precondition for this to happen is a broad public recognition of anthropogenic climate change and its consequences for the environment. The first presentation by Paltseva and Le Coq focused on public perceptions about climate change in Europe (see this FREE policy brief for a detailed account). Using survey data the study explores variation in climate risk perceptions between Western Europe, the non-EU part of Eastern Europe, and Eastern European countries that are EU members. The results show that those living in non-EU Eastern European countries are on average less concerned about climate change. The regional difference can partly be explained by low salience and informativeness of environmental issues in the public discourse in these countries. To support this explanation, they study the impact of extreme weather events on opinions on climate change with the rationale that people who are more aware of climate change risks are less likely to adjust their opinion after experiencing an extreme weather event. They find that the effect of extreme weather events is higher in countries with less independent media and fewer climate-related legislative efforts, suggesting that the political salience of the environment and the credibility of public messages affects individuals’ perceptions of climate change risks.

The second presentation concerned energy security in the EU, and the impact of the environmental transition. It was argued that natural gas will play an important role in Europe’s green transition for two reasons. First, since the transition implies a higher reliance on intermittent renewable energy sources, there will be an increased need for use of gas-fired power plants to strengthen the supply reliability. Second, the electrification of the economy along with the phasing out of coal, oil, and nuclear generation plants will increase the energy demand. Today, about 20% of EU’s electricity comes from natural gas and 90% of that gas comes from outside EU, with 43% coming from Russia. To emphasize what issues can arise when the EU relies heavily on external suppliers, the presentation discussed a Risky External Energy Supply Index (Le Coq and Paltseva, 2009) that considers the short-term impact of energy supply disruptions. This index assesses not only the importance of the energy type used by a country but also access to different energy suppliers (risk diversification). The index illustrates that natural gas is riskier than oil or coal since natural gas importers in the EU depend to a greater extent on a single or few suppliers. Another crucial component of the security of gas supplies arises from the fact that 77% of EU’s net gas imports arrive through pipelines, which creates an additional risk of transit. Here, the introduction of new gas transit routes (from already existing suppliers) may increase diversification and decrease risks to the countries having direct access to the new route. At the same time, countries that share other pipelines with countries that now have direct access may lose bargaining power vis-à-vis the gas supplier in question, as demand through those pipelines could fall. Le Coq illustrated this point applying the Transit Risk Index developed in Le Coq and Paltseva (2012) to the introduction of the North Stream 1 pipeline. She concluded that the green transition and associated increase in demand for natural gas is likely to be associated with higher reliance on large gas producers, such as Russia, and resulting in energy security risks and imbalance in the EU. One way to counteract this effect is to exercise EU’s buyer power vis-a-vis Russia within the EU common energy policy. While long discussed, this policy has not been fully implemented so far.

Concluding Remarks

This year’s SITE Development Day conference gave us an opportunity to highlight yet another key issue, not only for Eastern Europe, but for the whole world: global warming and energy transformation. Experts from across the region, and policymakers and scholars based in Sweden, offered their perspectives on the challenges that lie ahead, but also highlighted initiatives and investments hopefully leading the way towards a brighter future.

List of Participants

  • Chloé Le Coq, Professor of Economics at the University of Paris II Panthéon-Assas (CRED). Paris, France. Research Fellow at SITE.
  • Maxim Fedoseenko, Head of Strategic Projects at KSE Institute. Kyiv, Ukraine.
  • Jan Johansson, Senior Program Manager, SIDA. Stockholm, Sweden.
  • Michal Myck, Director of CenEA. Szczecin, Poland.
  • Bernardas Padegimas, Team Leader: Environmental Policy and Strategy, Stockholm Environmental Institute. Stockholm, Sweden.
  • Elena Paltseva, Associate Professor, SITE/SSE/NES. Stockholm, Sweden
  • Norberto Pignatti, Associate Professor of Policy at ISET-PI, and Head of the Energy and Environmental Policy Institute at ISET-PI. Tbisili, Georgia.
  • Irina Pominova, Head of Climatwe and Green Energy at the Center for Strategic Research. Moscow, Russia.
  • Yauheniya Shershunovic, Researcher at BEROC, Minsk, Belarus. PhD Candidate at the Center for Development Research (ZEF). Uni Bonn.
  • Natalya Volchkova, Policy Director at CEFIR, Assistant Professor at the New Economic School (NES). Moscow, Russia.
  • Pawel Wróbel, Founder and Managing Director of BalticWind.EU. Poland.
  • Julius Andersson, Researcher at SITE. Stockholm, Sweden.
  • Anders Olofsgård, Associate Professor and Deputy Director at SITE. Stockholm, Sweden.

Global Gender Gap in Unpaid Care: Why Domestic Work Still Remains a Woman’s Burden

FROGEE PROJECT, Policy Brief

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In the wake of the COVID-19 pandemic, numerous reports point to the fact that women are mainly shouldering the burden of increased domestic care duties. But even before the pandemic struck, women performed more than two-thirds of the unpaid domestic care work in both developing and developed countries. The lack of gender parity in the distribution of domestic work is associated with significant economic inefficiencies, as well as considerable social and economic consequences for women – affecting their bargaining power within the household and their labor market outcomes in particular. In the brief, the author reviews the literature on both the economic and sociological factors which perpetuate the pattern of gender disparity in unpaid domestic care work. The author also summarizes the “recognize, reduce and redistribute” policies which could be adopted to help address the problem.

Country Reports

Armenia country report (EN) Armenian language version (AM)
Belarus country report (EN) Belarussian language version (BY)
Georgia country report (EN) Georgian language version (GE)
Latvia country report (EN) Latvian language version (LV)
Poland country report (EN) Polish language version (PL)
Russia country report (EN) Russian language version (RU)
Ukraine country report (EN) Ukrainian language version (UA)

Gender Gap in Unpaid Care: Why Domestic Work Still Remains a Woman’s Burden?

The realities of unpaid care and domestic work have received much attention lately in policy and academic circles, especially in light of the COVID-19 pandemic (Van Houtven et al., 2020; Craig and Churchill, 2020; Duragova, 2020). Recent surveys and reports confirm that while the unpaid household work burden increased for both genders, women around the world ended up shouldering the lions’ share of various household chores and care duties during the pandemic (UN Women, 2020). For many countries, prolonged lockdowns have put a sudden spotlight on the “hidden” side of people’s economic lives, not typically reflected in the national accounts data. Unsurprisingly, among the main issues connected with unpaid care work is the highly gendered division of labor in the “household sector” and its consequences for the emotional and economic well-being of families. In this policy brief, the author explores the current state and the evolution of gender inequalities in unpaid domestic care work worldwide, and discusses the academic literature which addresses the reasons and the consequences behind them. The author also discusses potential policy interventions which could promote greater work-life balance and help advance both social and family-level welfare.

Gender Gaps in Unpaid Care Work

The term unpaid care and domestic work appears under many terminological guises, including “unpaid care work” “unpaid household work”, “unpaid domestic care work” and others. These terms essentially refer to the same phenomenon – unpaid care activities carried out in the household. They include cooking, cleaning, washing, water and fuel collection, shopping, maintenance, household management, taking care of children and the elderly, and others (Addati et al., 2018). For the purposes of this brief I will use the terms interchangeably, relying mainly on “unpaid care”, “domestic work”, or “unpaid domestic care” to describe these activities. While the value of unpaid care work is not included in the national income accounts, it can be tracked by time-use surveys carried out by national statistical offices in many countries. According to the most recent surveys, (Charmes, 2019) more than three quarters (76.4%) of unpaid domestic care work worldwide is done by women, while 23.6% is done by men. In developed countries, the women’s share is somewhat lower (65%), while in developing and emerging economies, women perform 80.2% of unpaid care. Thus, according to the data, even in developed countries women perform around two thirds of the unpaid domestic care work. Currently, no country in the world seems to have achieved gender parity with regard to the unpaid care distribution in households (U.N. Women., 2019).

Is There Evidence of Convergence in Domestic Care Responsibilities?

Given that the first time use surveys in many countries have been conducted only relatively recently, it may be premature to make claims about changes in the distribution of domestic work and a potential closing of the gender gap. However, evidence from countries with a longer history of time use data, in particular the United States, suggests that the way mothers and fathers allocate their time between paid and unpaid work has changed dramatically between 1965 and 2011. In particular, as can be seen from the Figure 1 (from Parker and Wang, 2013), in 2011 women spent 2.6 times (13 more hours per week) more on paid work, while men spend 5 hours less than in 1965. The time spent on childcare increased for both men and women. At the same time, domestic work hours decreased significantly for women, while somewhat increasing for men.

Figure 1. Moms and Dads, the US 1965-2011: Roles Converge, but Gaps Remain

20211221 Gender Inequalities in Unpaid Work Figure 01

Note: Based on adults aged 18-64 with own child(ren) under the age of 18 living in the household. Source: Parker and Wang (2013).

Overall, analysis of time use survey data over a 40-year span shows a degree of convergence in unpaid care work between men and women (Kan et al., 2011; Altintas and Sullivan, 2016). However, as the Kan et al. (2011) study shows, gender inequality is quite persistent over time. In particular, men concentrate their contribution in domestic work to non-routine tasks (i.e. tasks that generally require less time, have definable boundaries and allow greater discretion around the timing of performance than the more routine tasks) such as shopping and domestic travel, while women devote a bulk of their time to routine work (cooking, cleaning, care). Women’s reduction in domestic work time (especially in routine tasks) may be largely due to the advancement of household technologies and higher acceptance/demand for women’s participation in the labor market (Gershuny, 1983, 2004). Thus, it appears that the “low-hanging fruit” of gender equality within households has already been picked, and, going forward, further shifting of domestic care responsibilities will be a more difficult task, even in developed countries.

Factors That Perpetuate Unpaid Domestic Care as Primarily Women’s Responsibility

The factors responsible for perpetuating gender roles in domestic work can be grouped into economic (specialization, comparative advantage) and sociological (habits, traditions, social perceptions) aspects.

The economic arguments that have long been used to explain the unequal division of paid and unpaid care work rely on the theory of comparative advantage and gains from specialization. Starting from the seminal work of Becker (Becker, 1985), economic models of the family suggested that a division of labor within the household is driven by different experiences and choices to invest in human capital. Becker argued that efficient households require specialization and the pattern of specialization can be explained at least in part by the differences in the initial investment in human capital (market skills for men and household skills for women) (Becker, 2009). In this model, men’s advantage in paid market activities is explained by historical reasons stemming in part from the more physical nature of market work. And yet, contemporary authors point out that the nature of work has been changing over time, with less emphasis put on physical, and more on cognitive skills. Likewise, the nature of household production has been changing (Greenwood et al., 2017). Birth control gave families a better way to control the number of children (Juhn and McCue, 2017). These changes should make men and women’s productivity more equal, and consequently reduce the gender gap between men and women in both types of work. And yet, despite the fact that in developed countries women often achieve higher educational attainment then men (Goldin, Katz and Kuziemko 2006; Murphy and Topel, 2014), it has not been enough to eliminate the gender gap in wages and in the division of unpaid domestic work. Moreover, as the study based on 1992 Canadian data by McFarlane et al. (2000) points out, while the wife’s time in housework increases when the husband spends more time in paid work, the opposite is not necessarily true for men (men do not spend significantly more time on household tasks when their wives increase their employment). Alonso et al., 2019, using a sample of 18 advanced and emerging market economies, find that various factors which determine the allocation of time between paid and unpaid work affect men and women asymmetrically. For example, being employed part time vs. full time considerably increases the participation in unpaid work for women, while for men the same increase is statistically insignificant.

Thus, a purely “pragmatic” economic argument for the household division of labor is not sufficient to explain the persistence of the unpaid care gender gap. Other sociological factors, such as gender roles determined by social attitudes and cultural norms, tend to play an important role in household labor division (Coltrane, 2000; Juhn and McCue, 2017). Moreover, one can argue that educational choices of women, which contribute to their “comparative advantage” in household production, are themselves not independent of cultural norms and attitudes. These choices tend to be shaped in early childhood and reflect how much a family would invest in/encourage a girl’s education vs. that of a boy; whether boys are engaged in certain household chores – cooking, cleaning, caring for young children, etc. (UNDP, 2020). For example, the high gender gap in unpaid domestic work in the South Caucasus can be traced to family patterns. According to survey data (CRRC, 2015) in Azerbaijan, around 96% percent of women were taught in childhood how to cook, clean the house or do laundry, while only 35% of men were taught how to cook and clean. In Georgia, close to 90% of women reported being taught how to cook, clean and do laundry, while less than 30% of men on average reported being taught these skills (UNFPA, 2014).

The Social Cost of Gender Inequality in the Unpaid Care Work Allocation

Gender inequality is not just an issue of fairness. Inequality results in considerable resource misallocation, where women’s productive potential is not fully realized. The study by Alonso et al., 2019 estimates the GDP gains associated with a potential reduction in gender inequality in domestic work to the level observed currently in Norway. Countries like Pakistan and Japan, where the initial gender gap is quite sizeable, would gain around 3 to 4 percent of GDP. Another source of inefficiency is occupational downgrading, a situation where women take jobs below their level of qualification (Connolly and Gregory, 2007; Garnero et al., 2013) in order to better balance their home and work responsibilities. The perception of women as being primarily responsible for childcare and domestic labor drives statistical discrimination in the workplace and affects the “unexplained” portion of the gender pay gap (Blau and Kahn, 2017). The pay gap, in turn, perpetuates inequality in the division of domestic labor. Moreover, perception of unequal domestic work allocation is found to be associated with lower relationship satisfaction, depression, and divorce (Ruppaner et al, 2017). In addition, earlier sociological studies found that inequity in the distribution, rather than the amount of work, causes greater psychological distress (Bird, 1999).

Policies to Address the Gender Gap

Given the sizeable economic and social costs associated with the gender gap in unpaid care work, policy makers are paying greater attention to gender equality and ways to promote work-life balance for men and women. Currently, most solutions center around “recognize, reduce and redistribute” types of policies (Elson, 2017).

The “recognize” policies acknowledge the value of unpaid care work done by women through cash payments linked to raising young children (i.e. maternity leave policies). Most countries in the world adopt publicly funded paid maternity leave policies, although the adequacy of maternity leave payments and the duration of such leaves is still a stumbling block for many countries (Addati et al., 2014). Data suggests that maternity leave of no longer than 12 months has a positive effect on maternal employment, while long leaves (over two years) increase career costs for women (Kunze, 2016; Ruhm, 1998; Kleven et al., 2019)

The “reduce” policies, aim at the provision of public services that would reduce the burden of childcare and other forms of unpaid work on women and free up their time for participation in the labor force. Among such policies are investments in publicly funded childcare services (quality pre-schools and kindergartens) and physical infrastructure to support the provision of clean water, sanitation, energy, and public transport. Empirical studies generally find a positive effect of affordable childcare on female employment rates (Vuri, 2016; Lefebvre et al., 2009;  Geyer et al., 2014), but with some caveats – in particular, the subsidies may be less effective for female labor supply if affordable childcare just crowds out other forms of non-parental care (such as informal help from family members) (Vuri, 2016; Havnes and Mogstad, 2011).

Finally, the “redistribute” policies aim to promote the redistribution of household chores and childcare among men and women. Among such policies are initiatives aimed at making flexible and reduced-hour work arrangement attractive and equally available for men and women. (e.g. shifting standard weekly hours to a more family friendly 35 hours per week, as for example in France); active labor market programs aimed at retaining women in the labor market can also help reduce hours devoted to unpaid work (Alonso et al. 2019). Moreover, better labor market regulations (e.g. legislation to regulate vacation time, maximum work hours, etc.) would discourage the long working hours and the breadwinner-caretaker gendered specialization patterns within families (Hook, 2006). Other examples include work-life balance policies recently adopted by the EU (EU Directive 2019/1158), and are aimed at providing paid paternity leave and reserving non-transferrable portions of family childcare leave for men. These policies were found to be effective for both increasing father’s participation in unpaid care and for reducing the gender wage gap within families in a number of country studies (Fernández-Cornejo et al., 2018; Andersen, 2018).

It is important to recognize that more research is needed to identify exactly how and why specific policies may benefit families, and to adapt them to the specific country context. While many of the policies outlined above will not solve the problem of the gender gap overnight, they can be an important first step towards greater global gender equality in the workplace and inside the household.

About FROGEE Policy Briefs

FROGEE Policy Briefs is a special series aimed at providing overviews and the popularization of economic research related to gender equality issues. Debates around policies related to gender equality are often highly politicized. We believe that using arguments derived from the most up to date research-based knowledge would help us build a more fruitful discussion of policy proposals and in the end achieve better outcomes.

The aim of the briefs is to improve the understanding of research-based arguments and their implications, by covering the key theories and the most important findings in areas of special interest to the current debate. The briefs start with short general overviews of a given theme, which are followed by a presentation of country-specific contexts, specific policy challenges, implemented reforms and a discussion of other policy options.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

From Russia with Love?

Posted on December 20, 2021 | Policy Brief

Russia Moscow City representing money laundering

Some recently discovered money laundering schemes have funnelled large amounts of illegal money from former soviet states through European banks. This note briefly describes the evolution of the Anti-Money Laundering (AML) regime for financial institutions, the introduction of which was concurrent with the post-soviet transition and the connected illegal flows of funds. It discusses the effectiveness of the current AML regime – and its ability to detect and seize illegal funds. The brief also highlights some of its deficiencies as well as lack of compliance with its prescriptions. It proceeds to stress that after judging the current framework insufficient, the US recently introduced whistleblower rewards for AML-infringements. Europe might want to follow their lead if it really aims at limiting money laundering.

Introduction

In recent years significant deficiencies in Anti-Money Laundering (AML) compliance have been discovered in some European banks (Spagnolo and Nyreröd, 2021). A notable example is the Danske Bank case that emerged in 2018.   Some have called it the largest money-laundering scandal in history: it is estimated that about $230 billion in suspicious funds went through its Estonian branch between 2007 and 2015.

In several of these cases, the sources of a large fraction of the illicit assets were Russia or other former Soviet states (Shaffer and Cassella, 2020).

Prior to the Danske revelations, several schemes have been uncovered that were aimed at laundering illicit money from former soviet states into the western financial system.

In a classic example going back to 2006, about $230 million were stolen in fraudulent tax refunds perpetrated by officials in Russia and then laundered through Moldova, Latvia and then UK shell companies and banks (Browder, 2009). Famously, the tax lawyer Sergei Magnitsky investigated the theft and testified against the fraudsters and was later put in detention for the same tax theft he was investigating. About a year after he was arrested, Magnitsky passed away after allegedly being tortured and denied medical care. This tragic episode gave rise to the Magnitsky Act, which prohibits persons believed to be involved in the theft to enter the US and access its financial system.

Another famous (and partly related) case is the so-called Russian Laundromat (then Global Laundromat), a scheme estimated to have funneled over $70 billion of illegal money out of Russia, through Latvia, Moldova, and then the UK (Tofilat and Negruta, 2019).

Indeed, Russia is widely considered the country with the largest estimated amount of ‘dark’ money hidden abroad, both as a percentage of GDP and in absolute terms (estimated around $1 trillion by Novokmet et al., 2017).

However, the origin of money laundered in the transition region is not limited to Russia. For example, it is estimated that between 2012 and 2014, about $2.9 billion from Azerbaijan were illegally laundered through UK shell companies and then European banks.

Funds from all these schemes appear to have been transacted through Danske bank (Bruun and Hjejle 2018: 33), Swedbank (Clifford Chance 2020: 123), and other European banks.

This evidence warrants some reflection on the effectiveness of the AML framework, particularly in Europe.

The Current AML Regime

The development of the global AML framework has been largely concurrent with the transition from communism and the connected illegal flows of funds.

The Financial Action Taskforce (FATF) was formed in 1989, after an initiative by the G7. FATF’s mission is to develop policies to combat money laundering and blacklist countries that do not comply. The FATF issued its first recommendations in 1999 and continually updates them, most recently in FATF (2021).

These recommendations set out essential measures that countries should have in place to identify money laundering risks, including regulation on preventive measures for the financial and other sectors, powers and responsibilities for competent authorities, coordination of their actions, and the facilitation of international cooperation (FATF 2021: 7).

AML regulation requires financial institutions to know their customers and engage in due diligence to reduce the risk that they onboard criminals seeking to launder money. Information about suspicious transactions and activities should be forwarded to a national financial intelligence unit, usually the financial police. National Financial Services Authorities (FSAs) are usually responsible for enforcing compliance with AML rules – the “preventive” side of money laundering regulation. The “repressive” criminal law or “enforcement” side of the fight against money laundering is usually enforced by the national financial police (Reuter and Truman 2004, Svedberg Helgesson and Mörth 2018).

There are certainly valid questions to be raised regarding the effectiveness of the current AML framework. While the World Bank estimates that between 2 and 5% of global GDP is laundered annually, it is also estimated that less than 1% of the proceeds of crime laundered via the financial system are currently seized by regulators and law enforcement agencies (UNODC 2011: 7).

At the same time, the framework is quite costly to comply with. There have been six EU Directives related to AML. All require legal implementation and impose new demands on banks and other covered institutions. FATF also requires that its members frequently carry out National Risk Assessments, and countries are also subject to Membership Evaluation Reports which imposes additional costs. Compliance costs for banks are estimated in the billions of dollars (Spagnolo and Nyreröd, 2021), and a whole industry surrounding “AML Compliance” has emerged. Part of these costs, not only monetary ones, end up transferred to bank customers.

From a more rigorous policy evaluation point of view, the AML regime is also problematic. There is a remarkable lack of data for assessing the effectiveness of the framework relative to its objectives (see e.g., Halliday et al. 2014, Levi 2018, Levi et al. 2018, Pol 2018, 2020).

Bank’s Failures

A lack of compliance with this preventative framework has been widespread.  In Sweden, for example, most large banks have been fined for various degrees of AML deficiencies. Similarly, many banks in other European countries received fines from local and US regulators (in the order of billions of dollars) for failing to comply with this framework, including HSBC, Credit Suisse, Deutsche Bank (multiple times), BNP Paribas, MagNet Bank, and Barclays Bank. Since 2016, the US has issued AML-related fines on eight occasions to banks with headquarters in European countries for an aggregate amount of $1.7 billion (mean $217 million fine; data from violationtracker.org).

In the case studies we discuss in Spagnolo and Nyreröd (2021), most forms of internal controls failed to some extent. Whereas external whistleblowing was rare or non-existent, internal whistleblowers did not manage to rectify the problems either.

Simultaneously, there were often clear red flags that should have alerted board members and executives. At Danske Bank group, for example, returns on allocated capital in the non-resident portfolio at their Estonian branch, where a substantial part of the money laundering occurred, hit 402% in 2013, compared with the 6.9% average for the whole group, a clear red flag (Schwartzkopff, 2018).

Supervisor’s Failures

The extensiveness of AML non-compliance cannot only be traced to negligent banks – it also has to do with the ineffectiveness of the enforcement of AML rules by supervising authorities.

In the cases reviewed in Spagnolo and Nyreröd (2021), supervisors appeared by and large aware of at least part of the AML deficiencies. Oftentimes, banks were given warnings by regulators, yet continued to violate the same rules.

For example, both the Danish FSA and the Estonian FSA seem to have had some knowledge of the AML deficiencies at Danske Bank’s subsidiary already in 2007, with little consequences.

Coordination between regulators has also been poor. The Danish FSA argues that the primary AML oversight responsibility for the Estonian branch should be the local FSA (Finanstilsynet, 2019), while the Estonian FSA retorts that European rules are not as clear and that the Danish FSA at least has some responsibility to oversee the branches of Danske Group (Finantsinspektsioon, 2019).

On September 24, 2018, the European Banking Authority (EBA) opened an investigation to assess whether the Danish and Estonian FSAs have violated any European laws. On April 16, 2019, it voted to reject an internal draft into supervisory failings that allegedly identified several shortcomings in how Danish and Estonian authorities supervised Danske bank. (Brunsden 2019). The EBA supervisory board’s decision to close the investigation without adopting any findings drew criticism from a range of senior policymakers and spurred calls for its reform. The EBA has also been criticized for its reluctance to pass judgment on its members (Bjerregaard and Kirchmaier 2019: 38).

Conclusion

The limited regulatory enforcement and compliance with the current AML system are likely to only marginally increase the cost of money laundering for criminals. Policymakers should thus wonder whether the current system is delivering value for money. There could be different ways to improve it. Increased fines for non-compliance may for example induce covered entities to comply with the AML framework to a greater extent.

Moving forward, the inconsistent enforcement of AML rules has led experts and policymakers to suggest centralizing some supervision and enforcement of AML regulation at the EU level (Kirschenbaum and Véron 2018, 2020; Unger 2020; JPP 2019; EC 2020, p.8), and improving information sharing between supervisors.

We believe these measures may not be sufficient for facilitating compliance with AML, while imposing substantial enforcing costs.

One way to increase AML compliance at a relatively low cost could be introducing whistleblower reward programs, as done in the US early this year (Nyreröd and Spagnolo, 2021). These programs offer substantial monetary rewards, often in the order millions of dollars, for information on non-compliance, and have proven extremely effective in combating fraud against the government, tax evasion, and securities fraud. While national EU supervisors may not have sufficient resources or competence to manage such programs, centralized actors such as the European Commission appear able to do so. If we see more centralized supervision, together with increased resources and competence, a well-designed and properly implemented whistleblower reward program may become a highly effective way to fight money laundering in the EU.

References

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Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.