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Foreign Policy
Foreign Policy
Comment
Charles G. Davidson, Ben Judah

The Dirty Secrets of Capitalism Are Undermining Democracy

Beneath the surface of our financial system lies an unseen world worth trillions of dollars. Among today’s threats to democracy, it is one of the gravest and least acknowledged. A metastasizing culture of tax avoidance by corporations and the wealthy has weakened national values, institutions, and goals across the West while fueling inequality and empowering the enemies of democracy at home and abroad. Governments need to take dramatic action to close down this parallel financial system, criminalize its enablers, and reassert their sovereignty.

Only recently have headline-making insider leaks such as the Panama Papers (2016), Paradise Papers (2017), and Pandora Papers (2021) begun to lay bare the system’s workings. Millions of documents became available detailing the offshore dealings of companies such as Apple, Facebook, McDonald’s, and Walt Disney, as well as people such as British royals, former U.S. Commerce Secretary Wilbur Ross, and former International Monetary Fund chief Dominique Strauss-Kahn. The totality of these revelations shows massive tax avoidance, the concealment of kleptocratic loot, and the systemic avoidance of the rule of law. These leaks have given us only a keyhole view into a much bigger industry, which the economist James Henry estimates at more than $50 trillion.

To achieve their ends, wealthy elites and corporations create complexity through intricate webs of shell companies and incite competition between tax jurisdictions to offer the lowest rates. They then capture politicians by offering financial incentives to look the other way. When necessary, the rich and powerful use coercion—threatening any politicians who might act against secrecy. These methods stop national governments from curbing the industry.

A sobering example of this contrived complexity can be found at 650 Fifth Avenue in New York City. Here, a combination of U.S. laws and hired enablers allowed the Islamic Republic of Iran—one of the four countries on the U.S. State Department’s official list of state sponsors of terrorism—to conceal for 22 years its ownership of a Manhattan skyscraper, which the country used to violate sanctions. This story—its latest wrinkle is a 2019 ruling by a federal appeals court allowing Iran to keep the building—perfectly illustrates how the United States hamstrings itself with its own laws.

The United Kingdom has seen similar absurdities. In Edinburgh, a run-down social-housing apartment was found to have been used as an address by no fewer than 530 Scottish limited partnerships, corporate entities favored by criminals for their ability to provide anonymity. The address was also linked to $1 billion robbed from the East European nation of Moldova, roughly 12 percent of its GDP at the time. Once again, it was British laws that permitted, created, and fostered an environment where such vehicles could be used to plunder a struggling country.

Wealthy individuals and powerful corporations repeatedly choose to value secrecy over sovereignty, at the expense of the rule of law. The system requires legislation and tax arrangements that keep domiciled assets in legally fictitious locations free from taxation and discovery, and the real owners’ identities hidden. Financial secrecy also relies on domestic authorities legally permitting and even accrediting enablers—lawyers, accountants, bankers, incorporation agents, cryptocurrency vendors—whose business is hiding assets. Finally, the whole machine can run only if entities cloaked by the secrecy system are accorded full ability to operate within their chosen jurisdictions, where, if anything goes wrong, they can claim redress. Thus, the financial-secrecy system is entirely dependent on what it strives to undermine.

It is no wonder that distrust of elites and their covert, self-dealing financial machinations is helping to fuel a growing public distrust toward democracy and its institutions. Fifty-eight percent of Americans tell pollsters that they are dissatisfied with the way democracy is going, while a shocking 85 percent believe that the U.S. political system either needs a major or complete overhaul. The basis of the social contract, the principle that all are subject to the law, has been broken.

Populist movements—from Occupy Wall Street to the election of Donald Trump and Brexit—have been born from this rejection of fundamental democratic principles. Across the European continent, populist parties have been gaining vote share. The rise of populism has seen the far right come to power in Italy under Prime Minister Giorgia Meloni, and the far right is polling well in Germany and France. The financial-secrecy system is making democratic societies across the West less stable.

It is also undermining the West’s ability to compete with authoritarian powers and protect Western political institutions. Many modern-day autocrats and authoritarians sustain their regimes with what is to them a “best of both worlds” business model: They can impose authoritarianism at home while parking their looted assets abroad under the aegis of the Western rule of law.

Russia under its kleptocratic president, Vladimir Putin, is a case in point. For decades, Russian elites have used London real estate to launder their cash while paying legions of British law firms, banks, and consultants to provide services that facilitate corruption. In letting all this go on under British laws and on British soil, the U.K. government has by action and inaction been lending aid and comfort to Russian autocracy.

Likewise, China’s exploitation of the financial-secrecy system undercuts Western democracies’ efforts in an intensifying great-power competition. In the United States, the Biden administration calls for a “new Washington consensus” built around supply-line security, the reshoring of manufacturing, and green industrial policy. Not one of these policy goals will be met if secrecy is permitted to rob every value or technological chain of transparency. Without transparency, U.S. sanctions for, say, the theft of computer chip intellectual property will become an instrument that is clumsy and full of holes. Similarly, the U.S.-China Economic and Security Review Commission has warned that it will be unable to detect and properly scrutinize Chinese investments in U.S. technology firms if the identities of these firms’ true owners are obscured.

Western governments are lagging. Despite the Biden administration’s December 2021 launch of the U.S. Strategy on Countering Corruption and Congress’s passage of the Corporate Transparency Act, U.S. action is still insufficient (and mostly a failure so far). British officials have promised that the three crown dependencies and the 14 British overseas territories will be required to set up beneficial-ownership registries, but the deadlines have been pushed back. And the EU has taken a step backward, with the European Court of Justice issuing a recent opinion limiting the accessibility of beneficial-ownership registries.

Reclaiming Western sovereignty will require a concerted campaign to reject the financial-secrecy system. First, the existence and malign consequences of financial secrecy must be explained and broadcast as widely as possible. Then, systematic financial secrecy—its ills put on display—must be rendered unacceptable. The United States anchors global capitalism, and it must take a leading role. So must the United Kingdom, whose far-flung network of tax satellites has been estimated to account for 40 percent of all tax losses faced by other countries. Finally, there must be EU buy-in since Brussels wields immense regulatory power and the EU includes such notorious financial-secrecy hotspots as Luxembourg.

Capitalism with secrecy—in other words, capitalism without transparency, integrity, and accountability—is undermining liberal democracy. What is at stake is not only whether capitalism and democracy can be restored to a mutually reinforcing dynamic, but whether the West will continue to succeed as states and societies.

A full version of this essay appears in the October issue of the Journal of Democracy.

 

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