While open, outward-oriented trade has benefited the EU since its inception, growing geopolitical tensions, technological developments and greater economic competition have highlighted the risks inherent in certain economic dependencies.
The ongoing impact of the Covid-19 pandemic and Russia’s invasion of Ukraine is sounding the alarm on taking economic security more seriously, says Vanya Petrova, senior analyst at the Center for the Study of Democracy (CSD), a Europe-based public policy institute.
Risks to economic security are worsened by the problem of illicit financial flows (IFFs) across south-eastern Europe, according to a report published by the think tank Global Initiative. Estimated to be worth more than $1tn a year globally, the report warns that IFFs through the western Balkans prevail on a staggering scale.
Since the outbreak of war in Ukraine, there are heightened concerns about the capacity for authoritarian regimes to use economic policy as an extension of their security policy. Issues with governance in the western Balkan countries specifically — characterised by weak rule of law, corruption and political interference — magnify problems further, Ms Petrova says.
Money laundering
Many features across the region make it an ideal target for IFFs and money laundering, according to the report. Worsened by de-risking in the banking sector, the region’s environment of dependent financialisation adds to problems, with concerns that the banking sector in its peripheral economies is likely to elicit these types of activities.
“IFFs in the Balkan region are manifold, multi-directional and comparatively large with regards to the percentage of gross domestic product (GDP),” says Ms Petrova, author of the report. Illicit outflows constitute 3–5% of global GDP, yet IFFs in the Balkans are estimated to make up at least 6% of the region’s GDP, with certain countries in the region as high as 7–8%.
This reflects countries’ varying vulnerabilities, heightened by institutional weakness and corruption. Even more so now, the screening of Russian strategic investments in the Balkans — predominantly linked to Russian state-owned companies and oligarchic networks — is essential, says the report.
Illicit finance stems from three main sectors: corruption related crime, organised crime and tax evasion — each flowing through various channels. Among money laundering and cash smuggling, trade mispricing is the most prevalent channel used in eastern Europe, reflecting the international preference. A total 70% of global IFFs stem from trade mispricing, Ms Petrova says.
How can you counter something which you don’t fully understand?
Yet, little is known about the true scale and scope of IFFs in the region. “How can you counter something which you don’t fully understand?” Ms Petrova asks, urging that more research and better data are essential to build a nuanced understanding of IFFs. As well as a lack of knowledge, widespread use of cash and weak regulation adds to the difficulty in tackling IFFs in south-eastern Europe. And the large informal economies in the western Balkans continue to facilitate illicit cash flows into the licit economies of the region, a problem which has been exacerbated by the war in Ukraine.
Significant sums of cash are trafficked across south-eastern European borders, typically in euros, although Ms Petrova says there has been an increase in other currencies being confiscated — like the Norwegian and Danish krone, and Swedish krona. Regardless of currency, only a small amount of trafficked cash is detected by border officials — a reflection of capacity and regulatory issues.
Stronger oversight needed
Regulation that enables better transparency and knowledge about beneficial ownership must be strengthened, given the prevalence of illicit finance coursing through shell companies, Ms Petrova says. Better regulation governing investment screening is also essential. In the past year, many European countries have been tightening up their investment screening mechanisms. Yet, some EU member states, such as Bulgaria, still rely on rudimentary sectoral screening mechanisms.
The EU’s foreign direct investment regulation manages investment screening, which establishes a co-operation mechanism for FDI screening among the European Commission (EC) and EU member states. Although its regulation encourages member states to adopt and implement these types of mechanisms, it is not a requirement to establish a national mechanism — as Bulgaria shows.
Moreover, the problem of IFFs applies to outward direct investment too, a natural progression for companies — shell or otherwise — if domestic markets become saturated and better opportunities lie abroad. Ms Petrova advocates for outbound investments to be screened more effectively. Currently, intelligence, data and technology — together with illicit finance — “leak out” through outbound investments, she says.
Sanctions must also be enforced more seriously, Ms Petrova adds. Accelerating the integration of the Balkans into the rollout of the new European Anti-Money Laundering Authority would bolster efforts to prevent individuals and companies from evading sanctions and maintaining access to funds. As the Ukraine war highlights, this is especially true if financial actors use cryptocurrency (such as the digital ruble) together with other fintech platforms to circumvent sanctions and finance military operations.
While some risks in the Baltic banking sector have been addressed, new risks continue to evolve, predominantly in the fintech space. For example, as Lithuania’s fintech sector continues to develop, so too do the region’s emerging risks, especially against the backdrop of the Ukraine war and Russian sanctions. With Lithuania’s platform for electronic money (e-money) institutions and payment solutions for non-residents, regional individuals and institutions can better avoid sanctions and, in turn, add to the torrent of illicit finance streams.
Stemming the tide
Transparency and understanding about the volume of cash flowing throughout the region is lacking, says the report, and cases of cash smuggling over the past year illustrate the breadth of the problem. More attention must also be given to the crypto sphere, the report argues, especially due to the Balkans’ comparatively low levels of compliance with international standards concerning the risks from virtual assets.
However, the lack of data about IFFs should not delay governments from taking action. “The EU should establish an evidence-gathering mechanism capable of verifying the existence of capture practices across various economic sectors and regulatory institutions,” Ms Petrova suggests.
“Stemming IFFs requires a whole-of-government approach to assess the overall problem, understanding the extent and origin of flows, their routes and destinations, together with regional and country-specific dynamics,” she adds.
The EU has made efforts toward this in recent years, adopting investment screening mechanisms, an anti-subsidy policy, a carbon border adjustment mechanism and an anti-coercion instrument.
As part of ongoing efforts, the EC and the High Representative published a Joint Communication on a European Economic Security Strategy earlier this year. It focuses on minimising the risks of problematic economic flows stemming from wider geopolitical tensions and technological shifts. But without adequate regulatory measures, preserving a high level of economic openness means that the EU and wider region still have a price to pay: the ubiquity of IFFs.
