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Title: Financial Crime and Corruption

Author: Samuel Vaknin

Editor: Lidija Rangelovska

Release date: September 23, 2007 [eBook #22747]
Most recently updated: November 9, 2023

Language: English

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*** START OF THE PROJECT GUTENBERG EBOOK FINANCIAL
CRIME AND CORRUPTION ***

Financial Crime and Corruption
2nd EDITION

Sam Vaknin, Ph.D.
Editing and Design: Lidija Rangelovska

A Narcissus Publications Imprint, Skopje 2007

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CONTENTS
I. Slush Funds
II. Corruption and Transparency
III.Money Laundering in A Changed World
IV. Hawala, or The Bank that Never Was
V. Straf - Corruption in Central and Eastern Europe
VI. The Kleptocracies of the East
VII. FIMACO - Russia's Missing Billions

VIII. The Enrons of the East
IX. The Typology of Financial Scandals
X. The Shadowy World of International Finance
XI. Treasure Island Revisited On Maritime Piracy
XII. Legalizing Crime
APPENDIX - Should Drugs be Legalized?
XIII. Begging Your Trust in Africa
XIV. Organ Trafficking in Eastern Europe
XV. Selling Arms to Rogue States
XVI. The Industrious Spies
XVII. Russia's Idled Spies
XVIII. The Business of Torture
XIX. The Criminality of Transition
XX. The Economics of Conspiracy Theories
XXI. The Demise of the Work Ethic
XXII. The Morality of Child Labor
XXIII. The Myth of the Earnings Yield
XXIV. The Future of the Securities and Exchange Commission (SEC)
Section 3 of the Act, titled "Commission Rules and
XXV. Trading from a Suitcase. The Case of Shuttle Trade
XXVI. The Blessings of the Black Economy
XXVII. Public Procurement and Very Private Benefits
XXVIII. Crisis of the Bookkeepers
XXIX. Competition Laws
XXX. The Benefits of Oligopolies
XXXI. Anarchy as an Organizing Principle
XXXII. Narcissism in the Boardroom
XXXIII. The Revolt of the Poor
XXXIV. The Kidnapping of Content
XXXV. The Economics of Spam

XXXVII. The Fabric of Economic Trust
XXXVIII. The Distributive Justice of the Market
XXXIX. The Agent-Principal Conundrum
XL. The Green-Eyed Capitalist
Notes on the Economics of
XLII. Market Impeders and Market Inefficiencies
XLIII. The Pettifogger Procurators
XLIV. Microsoft's Third Front
XLV. NGOs - The Self-Appointed Altruists
XLVII. Quis Custodiet Ipsos Custodes?
XLVII. The Honorary Academic Higher Education for Sale
XLVIII. Rasputin in Transition
XLVIX. The Eureka Connection
L. The Treasure Trove of Kosovo
LI. Milosevic's Treasure Island
LII. Macedonia's Augean Stables,
LIII. The Macedonian Lottery
LIV. Crime Fighting Computer Systems and Databases
After the Rain
LV. The Author

I. Slush Funds
According to David McClintick ("Swordfish: A True Story of Ambition,
Savagery, and Betrayal"), in the late 1980's, the FBI and DEA set up
dummy corporations to deal in drugs. They funneled into these corporate
fronts money from drug-related asset seizures.
The idea was to infiltrate global crime networks but a lot of the money in
"Operation Swordfish" may have ended up in the wrong pockets.
Government agents and sheriffs got mysteriously and filthily rich and the
whole sorry affair was wound down. The GAO reported more than $3.6
billion missing. This bit of history gave rise to at least one blockbuster with
Oscar-winner Halle Berry.
Alas, slush funds are much less glamorous in reality. They usually
involve grubby politicians, pawky bankers, and philistine businessmen -
rather than glamorous hackers and James Bondean secret agents.
The Kazakh prime minister, Imanghaliy Tasmaghambetov, freely
admitted on April 4, 2002 to his country's rubber-stamp parliament the
existence of a $1 billion slush fund. The money was apparently skimmed
off the proceeds of the opaque sale of the Tengiz oilfield.
Remitting it to Kazakhstan - he expostulated with a poker face - would
have fostered inflation. So, the country's president, Nazarbaev, kept the
funds abroad "for use in the event of either an economic crisis or a threat to
Kazakhstan's security".
The money was used to pay off pension arrears in 1997 and to offset the
pernicious effects of the 1998 devaluation of the Russian ruble. What was
left was duly transferred to the $1.5 billion National Fund, the PM insisted.
Alas, the original money in the Fund came entirely from another sale of oil
assets to Chevron, thus casting in doubt the official version.
The National Fund was, indeed, augmented by a transfer or two from the
slush fund - but at least one of these transfers occurred only 11 days after

the damning revelations. Moreover, despite incontrovertible evidence to the
contrary, the unfazed premier denied that his president possesses multi-
million dollar bank accounts abroad.
He later rescinded this last bit of disinformation. The president, he said,
has no bank accounts abroad but will promptly return all the money in these
non-existent accounts to Kazakhstan. These vehemently denied accounts, he
speculated, were set up by the president's adversaries "for the purpose of
compromising his name".
On April 15, 2002 even the docile opposition had enough of this fuzzy
logic. They established a People Oil's Fund to monitor, henceforth, the
regime's financial shenanigans.
By their calculations less than 7 percent of the income from the sale of
hydrocarbon fuels (c. $4-5 billion annually) make it to the national budget.
Slush funds infect every corner of the globe, not only the more obscure
and venal ones. Every secret service - from the Mossad to the CIA -
operates outside the stated state budget. Slush funds are used to launder
money, shower cronies with patronage, and bribe decision makers. In some
countries, setting them up is a criminal offense, as per the 1990 Convention
on Laundering, Search, Seizure, and Confiscation of the Proceeds from
Crime. Other jurisdictions are more forgiving.
The Catholic Bishops Conference of Papua New Guinea and the
Solomon Islands issued a press release November 2001 in which it
welcomed the government's plans to abolish slush funds. They described
the poisonous effect of this practice: "With a few notable exceptions, the
practice of directing funds through politicians to district projects has been
disastrous. It has created an atmosphere in which corruption is thought to
have flourished. It has reduced the responsibility of public servants, without
reducing their numbers or costs. It has been used to confuse people into
believing public funds are the 'property' of individual members rather than
the property of the people, honestly and fairly administered by the servants
of the people.
The concept of 'slush-funds' has resulted in well- documented
inefficiencies and failures. There were even accusations made that funds

were withheld from certain members as a way of forcing them into
submission. It seems that the era of the 'slush funds' has been a shameful
period."
But even is the most orderly and lawful administration, funds are liable to
be mislaid. "The Economist" reported recently about a $10 billion class-
action suit filed by native-Americans against the US government. The
funds, supposed to be managed in trust since 1880 on behalf of half a
million beneficiaries, were "either lost or stolen" according to officials.
Rob Gordon, the Director of the National Wilderness Institute accused
"The US Interior Department (of) looting the special funds that were
established to pay for wildlife conservation and squandering the money
instead on questionable administrative expenses, slush funds and employee
moving expenses".
Charles Griffin, the Deputy Director of the Heritage Foundation's
Government Integrity Project, charges: "The federal budget provides
numerous slush funds that can be used to subsidize the lobbying and
political activities of special-interest groups".
On his list of "Top Ten Federal Programs That Actively Subsidize Politics
and Lobbying" are: AmeriCorps, Senior Community Service Employment
Program, Legal Services Corporation, Title X Family Planning, National
Endowment for the Humanities, Market Promotion Program, Senior
Environmental Employment Program, Superfund Worker Training, HHS
Discretionary Aging Projects, Telecomm. & Info. Infrastructure Assistance.
These federal funds alone total $1.8 billion. "Next" and "China Times" -
later joined by "The Washington Post" - accused the former Taiwanese
president, Lee Teng-hui, of forming a $100 million overseas slush fund
intended to finance the gathering of information, influence-peddling, and
propaganda operations. Taiwan footed the bills trips by Congressional aides
and funded academic research and think tank conferences.
High ranking Japanese officials, among others, may have received
payments through this stealthy venue. Lee is alleged to have drawn
$100,000 from the secret account in February 1999. The money was used to

pay for the studies of a former Japanese Vice-Defense Minister Masahiro
Akiyama's at Harvard.
Ryutaro Hashimoto, the former Japanese prime minister, was implicated
as a beneficiary of the fund. So were the prestigious lobbying firm, Cassidy
and Associates and assorted assistant secretaries in the Bush administration.
Carl Ford, Jr., currently assistant secretary of state for intelligence and
research, worked for Cassidy during the relevant period and often visited
Taiwan. James Kelly, assistant secretary of state for East Asian and Pacific
Affairs enjoyed the Taiwanese largesse as well. Both are in charge of
crafting America's policy on Taiwan.
John Bolton, erstwhile undersecretary of state for arms control and
international security, admitted, during his confirmation hearings, to having
received $30,000 to cover the costs of writing 3 research papers.
The Taiwanese government has yet to deny the news stories.
A Japanese foreign ministry official used slush fund money to finance the
extra-marital activities of himself and many of his colleagues - often in
posh hotel suites.
But this was no exception. According to Asahi Shimbun, more than half
of the 60 divisions of the ministry maintained similar funds. The police and
the ministry are investigating. One arrest has been made. The ministry's
accounting division has discovered these corrupt practices twenty years
before but kept mum.
Even low-level prefectural bureaucrats and teachers in Japan build up
slush funds by faking business trips or padding invoices and receipts.
Japanese citizens' groups conservatively estimated that $20 million in travel
and entertainment expenses in the prefectures in 1994 were faked, a
practice known as "kara shutcho" (i.e., empty business trip).
Officials of the Hokkaido Board of Education admitted to the existence
of a 100 million yen secret fund. In a resulting probe, 200 out of 286
schools were found to maintain their own slush funds. Some of the money
was used to support friendly politicians.

But slush funds are not a sovereign prerogative.
Multinationals, banks, corporation, religious organizations, political
parties, and even NGO's salt away some of their revenues and profits in
undisclosed accounts, usually in off-shore havens.
Secret election campaign slush funds are a fixture in American politics. A
5-year old bill requires disclosure of donors to such funds but the House is
busy loosening its provisions. "The Economist" listed in 2002 the tsunami
of scandals that engulfs Germany, both its major political parties, many of
the Lander and numerous highly placed and mid-level bureaucrats. Secret,
mainly party, funds seem to be involved in the majority of these lurid
affairs.
Italian firms made donations to political parties through slush funds,
though corporate donations - providing they are transparent - are perfectly
legal in Italy. Both the right and, to a lesser extent, the left in France are
said to have managed enormous political slush funds.
President Chirac is accused of having abused for his personal pleasure,
one such municipal fund in Paris, when he was its mayor. But the funds
were mostly used to provide party activists with mock jobs. Corporations
paid kickbacks to obtain public works or local building permits. Ostensibly,
they were paying for sham "consultancy services".
The epidemic hasn't skipped even staid Ottawa. Its Chief Electoral
Officer told Sun Media in September 2001 that he is "concerned" about
millions stashed away by Liberal candidates. Sundry ministers who coveted
the prime minister's job, have raised funds covertly and probably illegally.
On April 11, 2002 UPI reported that Spain's second- largest bank, Banco
Bilbao Vizcaya Argentaria (BBVA), held nearly $200 million hidden in
secret offshore accounts, "which were allegedly used to manipulate
politicians, pay off the 'revolutionary tax' to ETA - the Basque terrorist
organization - and open the door for business deals, according to news
reports".
The money may have gone to luminaries such as Venezuela's Hugo
Chavez, Peru's Alberto Fujomori and Vladimiro Montesinos. The bank's

board members received fat, tax-free, "pensions" from the illegal accounts
opened in 1987 - a total of more than $20 million.
Latin American drug money launderers - from Puerto Rico to Colombia -
may have worked through these funds and the bank's clandestine entities in
the Cayman Islands and Jersey. The current Spanish Secretary of State for
the Treasury has been the bank's tax advisor between 1992-7.
The "Financial Times" reported in June 2000 that, in anticipation of new
international measures to curb corruption, "leading European arms
manufacturers" resorted to the creation of off-shore slush funds. The money
is intended to bribe foreign officials to win tenders and contracts.
Kim Woo-chung, Daewoo's former chairman, is at the center of a
massive scandal involving dozens of his company's executive, some of
whom ended up in prison.
He stands accused of diverting a whopping $20 billion to an overseas
slush fund.
A mind boggling $10 billion were alleged to have been used to bribe
Korean government officials and politicians.
But his conduct and even the scale of the fraud he perpetrated may have
been typical to Korea's post-war incestuous relationship between politics
and business.
In his paper "The Role of Slush Funds in the Preparation of Corruption
Mechanisms", reprinted by Transparency International, Gherardo Colombo
defines corporate slush funds thus: "Slush funds are obtained from a joint
stock company's finances, carefully managed so that the amounts involved
do not appear on the balance sheet. They do not necessarily have to consist
of money, but can also take the form of stocks and shares or other
economically valuable goods (works of art, jewels, yachts, etc.) It is enough
that they can be used without any particular difficulty or that they can be
transferred to a third party.
If a fund is in the form of money, it is not even necessary to refer to it
outside the company accounts, since it can appear in them in disguised form
(the 'accruals and deferrals' heads are often resorted to for the purpose of

hiding slush money). In light of this, it is not always correct to regard it as a
reserve fund that is not accounted for in the books. Deception, trickery or
forgery of various kinds are often resorted to for the purpose of setting up a
slush fund".
He mentions padded invoices, sham contracts, fictitious loans, interest
accruing on holding accounts, back to back transactions with related entities
(Enron) - all used to funnel money to the slush funds. Such funds are often
set up to cover for illicit and illegal self-enrichment, embezzlement, or tax
evasion.
Less known is the role of these furtive vehicles in financing unfair
competitive practices, such as dumping.
Clients, suppliers, and partners receive hidden rebates and subsidies that
much increase the - unreported - real cost of production.
BBVA's payments to ETA may have been a typical payment of protection
fees. Both terrorists and organized crime put slush funds to bad use. They
get paid from such funds - and maintain their own. Ransom payments to
kidnappers often flow through these channels.
But slush funds are overwhelmingly used to bribe corrupt politicians. The
fight against corruption has been titled against the recipients of illicit
corporate largesse. But to succeed, well-meaning international bodies, such
as the OECD's FATF, must attack with equal zeal those who bribe. Every
corrupt transaction is between a venal politician and an avaricious
businessman. Pursuing the one while ignoring the other is self-defeating.
Note - The Psychology of Corruption Most politicians bend the laws of
the land and steal money or solicit bribes because they need the funds to
support networks of patronage. Others do it in order to reward their nearest
and dearest or to maintain a lavish lifestyle when their political lives are
over.
But these mundane reasons fail to explain why some officeholders go on
a rampage and binge on endless quantities of lucre. All rationales crumble
in the face of a Mobutu Sese Seko or a Saddam Hussein or a Ferdinand
Marcos who absconded with billions of US dollars from the coffers of
Zaire, Iraq, and the Philippines, respectively.

These inconceivable dollops of hard cash and valuables often remain
stashed and untouched, moldering in bank accounts and safes in Western
banks. They serve no purpose, either political or economic. But they do
fulfill a psychological need. These hoards are not the megalomaniacal
equivalents of savings accounts. Rather they are of the nature of compulsive
collections.
Erstwhile president of Sierra Leone, Momoh, amassed hundreds of video
players and other consumer goods in vast rooms in his mansion. As
electricity supply was intermittent at best, his was a curious choice. He used
to sit among these relics of his cupidity, fondling and counting them
insatiably.
While Momoh relished things with shiny buttons, people like Sese Seko,
Hussein, and Marcos drooled over money.
The ever-heightening mountains of greenbacks in their vaults soothed
them, filled them with confidence, regulated their sense of self-worth, and
served as a love substitute. The balances in their bulging bank accounts
were of no practical import or intent. They merely catered to their
psychopathology.
These politicos were not only crooks but also kleptomaniacs. They could
no more stop thieving than Hitler could stop murdering. Venality was an
integral part of their psychological makeup.
Kleptomania is about acting out. It is a compensatory act.
Politics is a drab, uninspiring, unintelligent, and, often humiliating
business. It is also risky and rather arbitrary. It involves enormous stress
and unceasing conflict.
Politicians with mental health disorders (for instance, narcissists or
psychopaths) react by decompensation. They rob the state and coerce
businessmen to grease their palms because it makes them feel better, it
helps them to repress their mounting fears and frustrations, and to restore
their psychodynamic equilibrium. These politicians and bureaucrats "let off
steam" by looting.

Kleptomaniacs fail to resist or control the impulse to steal, even if they
have no use for the booty. According to the Diagnostic and Statistical
Manual IV-TR (2000), the bible of psychiatry, kleptomaniacs feel "pleasure,
gratification, or relief when committing the theft." The good book proceeds
to say that " ... (T)he individual may hoard the stolen objects ...".
As most kleptomaniac politicians are also psychopaths, they rarely feel
remorse or fear the consequences of their misdeeds. But this only makes
them more culpable and dangerous.

II. Corruption and Transparency
I. The Facts Just days before a much-awaited donor conference, the
influential International Crisis Group (ICG) recommended to place all funds
pledged to Macedonia under the oversight of a "corruption advisor"
appointed by the European Commission. The donors ignored this and other
recommendations. To appease the critics, the affable Attorney General of
Macedonia charged a former Minister of Defense with abuse of duty for
allegedly having channeled millions of DM to his relatives during the recent
civil war. Macedonia has belatedly passed an anti- money laundering law
recently - but failed, yet again, to adopt strict anti-corruption legislation.
In Albania, the Chairman of the Albanian Socialist Party, Fatos Nano,
was accused by Albanian media of laundering $1 billion through the
Albanian government.
Pavel Borodin, the former chief of Kremlin Property, decided not appeal
his money laundering conviction in a Swiss court. The Slovak daily "Sme"
described in scathing detail the newly acquired wealth and lavish lifestyles
of formerly impoverished HZDS politicians.
Some of them now reside in refurbished castles. Others have swimming
pools replete with wine bars.
Pavlo Lazarenko, a former Ukrainian prime minister, is detained in San
Francisco on money laundering charges.
His defense team accuses the US authorities of "selective prosecution".
They are quoted by Radio Free Europe as saying: "The impetus for this
prosecution comes from allegations made by the Kuchma regime, which
itself is corrupt and dedicated to using undemocratic and repressive
methods to stifle political opposition ... (other Ukrainian officials) including
Kuchma himself and his closest associates, have committed conduct similar
to that with which Lazarenko is charged but have not been prosecuted by
the U.S. government".

The UNDP estimated, in 1997, that, even in rich, industrialized,
countries, 15% of all firms had to pay bribes. The figure rises to 40% in
Asia and 60% in Russia.
Corruption is rife and all pervasive, though many allegations are nothing
but political mud-slinging.
Luckily, in countries like Macedonia, it is confined to its rapacious elites:
its politicians, managers, university professors, medical doctors, judges,
journalists, and top bureaucrats. The police and customs are hopelessly
compromised. Yet, one rarely comes across graft and venality in daily life.
There are no false detentions (as in Russia), spurious traffic tickets (as in
Latin America), or widespread stealthy payments for public goods and
services (as in Africa).
It is widely accepted that corruption retards growth by deterring foreign
investment and encouraging brain drain.
It leads to the misallocation of economic resources and distorts
competition. It depletes the affected country's endowments - both natural
and acquired. It demolishes the tenuous trust between citizen and state. It
casts civil and government institutions in doubt, tarnishes the entire political
class, and, thus, endangers the democratic system and the rule of law,
property rights included.
This is why both governments and business show a growing commitment
to tackling it. According to Transparency International's "Global Corruption
Report 2001", corruption has been successfully contained in private
banking and the diamond trade, for instance.
Hence also the involvement of the World Bank and the IMF in fighting
corruption. Both institutions are increasingly concerned with poverty
reduction through economic growth and development. The World Bank
estimates that corruption reduces the growth rate of an affected country by
0.5 to 1 percent annually. Graft amounts to an increase in the marginal tax
rate and has pernicious effects on inward investment as well.
The World Bank has appointed last year a Director of Institutional
Integrity - a new department that combines the Anti-Corruption and Fraud
Investigations Unit and the Office of Business Ethics and Integrity. The

Bank helps countries to fight corruption by providing them with technical
assistance, educational programs, and lending.
Anti-corruption projects are an integral part of every Country Assistance
Strategy (CAS). The Bank also supports international efforts to reduce
corruption by sponsoring conferences and the exchange of information.
It collaborates closely with Transparency International, for instance.
At the request of member-governments (such as Bosnia- Herzegovina
and Romania) it has prepared detailed country corruption surveys covering
both the public and the private sectors. Together with the EBRD, it
publishes a corruption survey of 3000 firms in 22 transition countries
(BEEPS - Business Environment and Enterprise Performance Survey). It
has even set up a multilingual hotline for whistleblowers.
The IMF made corruption an integral part of its country evaluation
process. It suspended arrangements with endemically corrupt recipients of
IMF financing. Since 1997, it has introduced policies regarding
misreporting, abuse of IMF funds, monitoring the use of debt relief for
poverty reduction, data dissemination, legal and judicial reform, fiscal and
monetary transparency, and even internal governance (e.g., financial
disclosure by staff members).
Yet, no one seems to agree on a universal definition of corruption. What
amounts to venality in one culture (Sweden) is considered no more than
hospitality, or an expression of gratitude, in another (France, or Italy).
Corruption is discussed freely and forgivingly in one place - but
concealed shamefully in another. Corruption, like other crimes, is probably
seriously under-reported and under-penalized.
Moreover, bribing officials is often the unstated policy of multinationals,
foreign investors, and expatriates. Many of them believe that it is inevitable
if one is to expedite matters or secure a beneficial outcome. Rich world
governments turn a blind eye, even where laws against such practices are
extant and strict.
In his address to the Inter-American Development Bank on March 14,
President Bush promised to "reward nations that root out corruption" within

the framework of the Millennium Challenge Account initiative. The USA
has pioneered global anti-corruption campaigns and is a signatory to the
1996 IAS Inter-American Convention against Corruption, the Council of
Europe's Criminal Law Convention on Corruption, and the OECD's 1997
anti- bribery convention. The USA has had a comprehensive "Foreign
Corrupt Practices Act" since 1977.
The Act applies to all American firms, to all firms - including foreign
ones - traded in an American stock exchange, and to bribery on American
territory by foreign and American firms alike. It outlaws the payment of
bribes to foreign officials, political parties, party officials, and political
candidates in foreign countries. A similar law has now been adopted by
Britain.
Yet, "The Economist" reports that the American SEC has brought only
three cases against listed companies until 1997. The US Department of
Justice brought another 30 cases. Britain has persecuted successfully only
one of its officials for overseas bribery since 1889. In the Netherlands
bribery is tax deductible. Transparency International now publishes a name
and shame Bribery Payers Index to complement its 91-country strong
Corruption Perceptions Index.
Many rich world corporations and wealthy individuals make use of off-
shore havens or "special purpose entities" to launder money, make illicit
payments, avoid or evade taxes, and conceal assets or liabilities. According
to Swiss authorities, more than $40 billion are held by Russians in its
banking system alone. The figure may be 5 to 10 times higher in the tax
havens of the United Kingdom.
In a survey it conducted last month of 82 companies in which it invests,
"Friends, Ivory, and Sime" found that only a quarter had clear anti-
corruption management and accountability systems in place.
Tellingly only 35 countries signed the 1997 OECD "Convention on
Combating Bribery of Foreign Public Officials in International Business
Transactions" - including four non-OECD members: Chile, Argentina,
Bulgaria, and Brazil. The convention has been in force since February 1999
and is only one of many OECD anti- corruption drives, among which are
SIGMA (Support for Improvement in Governance and Management in

Central and Eastern European countries), ACN (Anti-Corruption Network
for Transition Economies in Europe), and FATF (the Financial Action Task
Force on Money Laundering).
Moreover, The moral authority of those who preach against corruption in
poor countries - the officials of the IMF, the World Bank, the EU, the
OECD - is strained by their ostentatious lifestyle, conspicuous
consumption, and "pragmatic" morality.
II. What to Do? What is Being Done? Two years ago, I proposed a
taxonomy of corruption, venality, and graft. I suggested this cumulative
definition: a. The withholding of a service, information, or goods that, by
law, and by right, should have been provided or divulged. b. The provision
of a service, information, or goods that, by law, and by right, should not
have been provided or divulged. c. That the withholding or the provision of
said service, information, or goods are in the power of the withholder or the
provider to withhold or to provide AND That the withholding or the
provision of said service, information, or goods constitute an integral and
substantial part of the authority or the function of the withholder or the
provider. d. That the service, information, or goods that are provided or
divulged are provided or divulged against a benefit or the promise of a
benefit from the recipient and as a result of the receipt of this specific
benefit or the promise to receive such benefit. e. That the service,
information, or goods that are withheld are withheld because no benefit was
provided or promised by the recipient.
There is also what the World Bank calls "State Capture" defined thus:
"The actions of individuals, groups, or firms, both in the public and private
sectors, to influence the formation of laws, regulations, decrees, and other
government policies to their own advantage as a result of the illicit and non-
transparent provision of private benefits to public officials".
We can classify corrupt and venal behaviors according to their outcomes:
a. Income Supplement - Corrupt actions whose sole outcome is the
supplementing of the income of the provider without affecting the "real
world" in any manner. b. Acceleration or Facilitation Fees - Corrupt
practices whose sole outcome is to accelerate or facilitate decision making,
the provision of goods and services or the divulging of information. c.

Decision Altering (State Capture) Fees - Bribes and promises of bribes
which alter decisions or affect them, or which affect the formation of
policies, laws, regulations, or decrees beneficial to the bribing entity or
person. d. Information Altering Fees - Backhanders and bribes that subvert
the flow of true and complete information within a society or an economic
unit (for instance, by selling professional diplomas, certificates, or permits).
e. Reallocation Fees - Benefits paid (mainly to politicians and political
decision makers) in order to affect the allocation of economic resources and
material wealth or the rights thereto. Concessions, licenses, permits, assets
privatized, tenders awarded are all subject to reallocation fees.
To eradicate corruption, one must tackle both giver and taker.
History shows that all effective programs shared these common elements:
a. The persecution of corrupt, high-profile, public figures, multinationals,
and institutions (domestic and foreign). This demonstrates that no one is
above the law and that crime does not pay. b. The conditioning of
international aid, credits, and investments on a monitored reduction in
corruption levels. The structural roots of corruption should be tackled rather
than merely its symptoms. c. The institution of incentives to avoid
corruption, such as a higher pay, the fostering of civic pride, "good
behavior" bonuses, alternative income and pension plans, and so on. d. In
many new countries (in Asia, Africa, and Eastern Europe) the very concepts
of "private" versus "public" property are fuzzy and impermissible behaviors
are not clearly demarcated. Massive investments in education of the public
and of state officials are required. e. Liberalization and deregulation of the
economy.
Abolition of red tape, licensing, protectionism, capital controls,
monopolies, discretionary, non- public, procurement. Greater access to
information and a public debate intended to foster a "stakeholder society". f.
Strengthening of institutions: the police, the customs, the courts, the
government, its agencies, the tax authorities - under time limited foreign
management and supervision.
Awareness to corruption and graft is growing - though it mostly results in
lip service. The Global Coalition for Africa adopted anti-corruption
guidelines in 1999. The otherwise opaque Asia Pacific Economic

Cooperation (APEC) forum is now championing transparency and good
governance. The UN is promoting its pet convention against corruption.
The G-8 asked its Lyon Group of senior experts on transnational crime to
recommend ways to fight corruption related to large money flows and
money laundering. The USA and the Netherlands hosted global forums on
corruption - as will South Korea next year. The OSCE is rumored to
respond with its own initiative, in collaboration with the US Congressional
Helsinki Commission.
The south-eastern Europe Stability Pact sports its own Stability Pact
Anti-corruption Initiative (SPAI). It held its first conference in September
2001 in Croatia. More than 1200 delegates participated in the 10th
International Anti- Corruption Conference in Prague last year. The
conference was attended by the Czech prime minister, the Mexican
president, and the head of the Interpol.
The most potent remedy against corruption is sunshine - free, accessible,
and available information disseminated and probed by an active opposition,
uncompromised press, and assertive civic organizations and NGO's. In the
absence of these, the fight against official avarice and criminality is doomed
to failure. With them, it stands a chance.
Corruption can never be entirely eliminated - but it can be restrained and
its effects confined. The cooperation of good people with trustworthy
institutions is indispensable.
Corruption can be defeated only from the inside, though with plenty of
outside help. It is a process of self- redemption and self-transformation. It is
the real transition.
III. Asset Confiscation and Asset Forfeiture The abuse of asset
confiscation and forfeiture statutes by governments, law enforcement
agencies, and political appointees and cronies throughout the world is well-
documented. In many developing countries and countries in transition,
assets confiscated from real and alleged criminals and tax evaders are sold
in fake auctions to party hacks, cronies, police officers, tax inspectors, and
relatives of prominent politicians at bargain basement prices.

That the assets of suspects in grave crimes and corruption should be
frozen or "disrupted" until they are convicted or exonerated by the courts -
having exhausted their appeals - is understandable and in accordance with
the Vienna Convention. But there is no justification for the seizure and sale
of property otherwise.
In Switzerland, financial institutions are obliged to automatically freeze
suspect transactions for a period of five days, subject to the review of an
investigative judge.
In France, the Financial Intelligence Unit can freeze funds involved in a
reported suspicious transaction by administrative fiat. In both jurisdictions,
the fast track freezing of assets has proven to be a more than adequate
measure to cope with organized crime and venality.
The presumption of innocence must fully apply and due process upheld
to prevent self-enrichment and corrupt dealings with confiscated property,
including the unethical and unseemly use of the proceeds from the sale of
forfeited assets to close gaping holes in strained state and municipal
budgets.
In the United States, according to The Civil Asset Forfeiture Reform Act
of 2000 (HR 1658), the assets of suspects under investigation and of
criminals convicted of a variety of more than 400 minor and major offenses
(from soliciting a prostitute to gambling and from narcotics charges to
corruption and tax evasion) are often confiscated and forfeited ("in
personam, or value-based confiscation").
Technically and theoretically, assets can be impounded or forfeited and
disposed of even in hitherto minor Federal civil offenses (mistakes in
fulfilling Medicare or tax return forms) The UK's Assets Recovery Agency
(ARA) that is in charge of enforcing the Proceeds of Crime Act 2002, had
this chilling statement to make on May 24, 2007: "We are pursuing the
assets of those involved in a wide range of crime including drug dealing,
people trafficking, fraud, extortion, smuggling, control of prostitution,
counterfeiting, benefit fraud, tax evasion and environmental crimes such as
illegal dumping of waste and illegal fishing." (!) Drug dealing and illegal
fishing in the same sentence.

The British firm Bentley-Jennison, who provide Forensic Accounting
Services, add: "In some cases the defendants will even have their assets
seized at the start of an investigation, before any charges have been
considered. In many cases the authorities will assume that all of the assets
held by the defendant are illegally obtained as he has a "criminal lifestyle".
It is then down to the defendant to prove otherwise. If the defendant is
judged to have a criminal lifestyle then it will be assumed that physical
assets, such as properties and motor vehicles, have been acquired through
the use of criminal funds and it will be necessary to present evidence to
contradict this.
The defendant's bank accounts will also be scanned for evidence of
spending and any expenditure on unidentified assets (and in some cases
identified assets) is also likely to be included as alleged criminal benefit.
This often leads to the inclusion of sums from legitimate sources and
double counting both of which need to be eliminated".
Under the influence of the post-September 11 United States and the FATF
(Financial Action Task Force on Money Laundering), Canada, Australia, the
United Kingdom, Greece, South Korea, and Russia have similar asset
recovery and money laundering laws in place.
International treaties (for instance, the 1959 European Convention on
Mutual Legal Assistance in Criminal Matters, the 1990 Convention of the
Council of Europe on Laundering, Search, Seizure and Confiscation of the
Proceeds from Crime (ETS 141), and The U.N.
Convention against Corruption 2003- UNCAC) and European Union
Directives (e.g., 2001/97/EC) allow the seizure and confiscation of the
assets and "unexplained wealth" of criminals and suspects globally, even if
their alleged or proven crime does not constitute an offense where they own
property or have bank accounts.
This abrogation of the principle of dual criminality sometimes leads to
serious violations of human and civil rights. Hitler could have used it to ask
the United Kingdom's Assets Recovery Agency (ARA) to confiscate the
property of refugee Jews who committed "crimes" by infringing on the
infamous Nuremberg race laws.

Only offshore tax havens, such as Andorra, Antigua, Aruba, the British
Virgin Islands, Guernsey, Monaco, the Netherlands Antilles, Samoa, St.
Vincent, the US Virgin Islands, and Vanuatu still resist the pressure to join
in the efforts to trace and seize suspects' assets and bank accounts in the
absence of a conviction or even charges.
Even worse, unlike in other criminal proceedings, the burden of proof is
on the defendant who has to demonstrate that the source of the funds used
to purchase the confiscated or forfeited assets is legal. When the defendant
fails to furnish such evidence conclusively and convincingly, or if he has
left the United States or had died, the assets are sold at an auction and the
proceeds usually revert to various law enforcement agencies, to the
government's budget, or to good social causes and programs. This is the
case in many countries, including United Kingdom, United States,
Germany, France, Hong Kong, Italy, Denmark, Belgium, Austria, Greece,
Ireland, New Zealand, Singapore and Switzerland.
According to a brief written by Jack Smith, Mark Pieth, and Guillermo
Jorge at the Basel Institute on Governance, International Centre for Asset
Recovery: "Article 54(1)(c) of the UNCAC recommends that states parties
establish non-criminal systems of confiscation, which have several
advantages for recovery actions: the standard of evidence is lower
("preponderance of the evidence" rather than "beyond a reasonable doubt");
they are not subject to some of the more restrictive traditional safeguards of
international cooperation such as the offense for which the defendant is
accused has to be a crime in the receiving state (dual criminality); and it
opens more formal avenues for negotiation and settlements. This is already
the practice in some jurisdictions such as the US, Ireland, the UK, Italy,
Colombia, Slovenia, and South Africa, as well as some Australian and
Canadian States".
In most countries, including the United Kingdom, the United States,
Austria, Germany, Indonesia, Macedonia, and Ireland, assets can be
impounded, confiscated, frozen, forfeited, and even sold prior to and
without any criminal conviction.
In Australia, Austria, Ireland, Hong-Kong, New Zealand, Singapore,
United Kingdom, South Africa, United States and the Netherlands alleged

and suspected criminals, their family members, friends, employees, and
partners can be stripped of their assets even for crimes they have committed
in other countries and even if they have merely made use of revenues
obtained from illicit activities (this is called "in rem, or property-based
confiscation"). This often gives rise to cases of double jeopardy.
Typically, the defendant is notified of the impending forfeiture or
confiscation of his or her assets and has recourse to a hearing within the
relevant law enforcement agency and also to the courts. If he or she can
prove "substantial harm" to life and business, the property may be released
to be used, though ownership is rarely restored.
When the process of asset confiscation or asset forfeiture is initiated,
banking secrecy is automatically lifted and the government indemnifies the
banks for any damage they may suffer for disclosing confidential
information about their clients' accounts.
In many countries from South Korea to Greece, lawyer- client privilege is
largely waived. The same requirements of monitoring of clients' activities
and reporting to the authorities apply to credit and financial institutions,
venture capital firms, tax advisers, accountants, and notaries.
Elsewhere, there are some other worrying developments: In Bulgaria, the
assets of tax evaders have recently begun to be confiscated and turned over
to the National Revenue Agency and the State Receivables Collection
Agency.
Property is confiscated even when the tax assessment is disputed in the
courts. The Agency cannot, however, confiscate single-dwelling houses,
bank accounts up to 250 leva of one member of the family, salary or
pension up to 250 leva a month, social care, and alimony, support money or
allowances.
Venezuela has recently reformed its Organic Tax Code to allow for: "
(P)re-judgment enforcement measures (to) include closure of premises for
up to ten days and confiscation of merchandise. These measures will be
applied in addition to the attachment or sequestration of personal property
and the prohibition against alienation or encumbrance of realty. During

closure of premises, the employer must continue to pay workers, thereby
avoiding an appeal for constitutional protection".
Finally, in many states in the United States, "community responsibility"
statutes require of owners of legal businesses to "abate crime" by openly
fighting it themselves. If they fail to tackle the criminals in their
neighborhood, the police can seize and sell their property, including their
apartments and cars. The proceeds from such sales accrue to the local
municipality.
In New-York City, the police confiscated a restaurant because one of its
regular patrons was an alleged drug dealer. In Alabama, police seized the
home of a senior citizen because her yard was used, without her consent, for
drug dealing. In Maryland, the police confiscated a family's home and
converted it into a retreat for its officers, having mailed one of the
occupants a package of marijuana.

III.Money Laundering in A Changed World
If you shop with a major bank, chances are that all the transactions in
your account are scrutinized by AML (Anti Money Laundering) software.
Billions of dollars are being invested in these applications. They are
supposed to track suspicious transfers, deposits, and withdrawals based on
overall statistical patterns. Bank directors, exposed, under the Patriot Act, to
personal liability for money laundering in their establishments, swear by it
as a legal shield and the holy grail of the on-going war against financial
crime and the finances of terrorism.
Quoted in Wired.com, Neil Katkov of Celent Communications, pegs
future investments in compliance- related activities and products by
American banks alone at close to $15 billion in the next 3 years (2005-
2008). The United State's Treasury Department's Financial Crimes
Enforcement Network (finCEN) received c. 15 million reports in each of
the years 2003 and 2004.
But this is a drop in the seething ocean of illicit financial transactions,
sometimes egged on and abetted even by the very Western governments
ostensibly dead set against them.
Israel has always turned a blind eye to the origin of funds deposited by
Jews from South Africa to Russia. In Britain it is perfectly legal to hide the
true ownership of a company. Underpaid Asian bank clerks on immigrant
work permits in the Gulf states rarely require identity documents from the
mysterious and well-connected owners of multi-million dollar deposits.
Hawaladars continue plying their paperless and trust- based trade - the
transfer of billions of US dollars around the world. American and Swiss
banks collaborate with dubious correspondent banks in off shore centres.
Multinationals shift money through tax free territories in what is
euphemistically known as "tax planning". Internet gambling outfits and
casinos serve as fronts for narco- dollars. British Bureaux de Change
launder up to 2.6 billion British pounds annually.

The 500 Euro note makes it much easier to smuggle cash out of Europe.
A French parliamentary committee accused the City of London of being a
money laundering haven in a 400 page report. Intelligence services cover
the tracks of covert operations by opening accounts in obscure tax havens,
from Cyprus to Nauru. Money laundering, its venues and techniques, are an
integral part of the economic fabric of the world. Business as usual? Not
really. In retrospect, as far as money laundering goes, September 11 may be
perceived as a watershed as important as the precipitous collapse of
communism in 1989. Both events have forever altered the patterns of the
global flows of illicit capital.
What is Money Laundering? Strictly speaking, money laundering is the
age-old process of disguising the illegal origin and criminal nature of funds
(obtained in sanctions-busting arms sales, smuggling, trafficking in humans,
organized crime, drug trafficking, prostitution rings, embezzlement, insider
trading, bribery, and computer fraud) by moving them untraceably and
investing them in legitimate businesses, securities, or bank deposits. But
this narrow definition masks the fact that the bulk of money laundered is the
result of tax evasion, tax avoidance, and outright tax fraud, such as the
"VAT carousel scheme" in the EU (moving goods among businesses in
various jurisdictions to capitalize on differences in VAT rates). Tax-related
laundering nets between 10-20 billion US dollars annually from France and
Russia alone. The confluence of criminal and tax averse funds in money
laundering networks serves to obscure the sources of both.
The Scale of the Problem According to a 1996 IMF estimate, money
laundered annually amounts to 2-5% of world GDP (between 800 billion
and 2 trillion US dollars in today's terms). The lower figure is considerably
larger than an average European economy, such as Spain's.
The System It is important to realize that money laundering takes place
within the banking system. Big amounts of cash are spread among
numerous accounts (sometimes in free economic zones, financial off shore
centers, and tax havens), converted to bearer financial instruments (money
orders, bonds), or placed with trusts and charities. The money is then
transferred to other locations, sometimes as bogus payments for "goods and
services" against fake or inflated invoices issued by holding companies
owned by lawyers or accountants on behalf of unnamed beneficiaries. The

transferred funds are re-assembled in their destination and often "shipped"
back to the point of origin under a new identity. The laundered funds are
then invested in the legitimate economy. It is a simple procedure - yet an
effective one. It results in either no paper trail - or too much of it. The
accounts are invariably liquidated and all traces erased.
Why is It a Problem? Criminal and tax evading funds are idle and non-
productive. Their injection, however surreptitiously, into the economy
transforms them into a productive (and cheap) source of capital. Why is this
negative? Because it corrupts government officials, banks and their officers,
contaminates legal sectors of the economy, crowds out legitimate and
foreign capital, makes money supply unpredictable and uncontrollable, and
increases cross-border capital movements, thereby enhancing the volatility
of exchange rates.
A multilateral, co-ordinated, effort (exchange of information, uniform
laws, extra-territorial legal powers) is required to counter the international
dimensions of money laundering. Many countries opt in because money
laundering has also become a domestic political and economic concern. The
United Nations, the Bank for International Settlements, the OECD's FATF
(Financial Action Task Force), the EU, the Council of Europe, the
Organisation of American States, all published anti- money laundering
standards. Regional groupings were formed (or are being established) in the
Caribbean, Asia, Europe, southern Africa, western Africa, and Latin
America.
Money Laundering in the Wake of the September 11 Attacks Regulation
The least important trend is the tightening of financial regulations and the
establishment or enhancement of compulsory (as opposed to industry or
voluntary) regulatory and enforcement agencies.
New legislation in the US which amounts to extending the powers of the
CIA domestically and of the DOJ extra- territorially, was rather
xenophobically described by a DOJ official, Michael Chertoff, as intended
to "make sure the American banking system does not become a haven for
foreign corrupt leaders or other kinds of foreign organized criminals".
Privacy and bank secrecy laws have been watered down.

Collaboration with off shore "shell" banks has been banned. Business
with clients of correspondent banks was curtailed. Banks were effectively
transformed into law enforcement agencies, responsible to verify both the
identities of their (foreign) clients and the source and origin of their funds.
Cash transactions were partly criminalized. And the securities and currency
trading industry, insurance companies, and money transfer services are
subjected to growing scrutiny as a conduit for "dirty cash".
Still, such legislation is highly ineffective. The American Bankers'
Association puts the cost of compliance with the laxer anti-money-
laundering laws in force in 1998 at 10 billion US dollars - or more than 10
million US dollars per obtained conviction. Even when the system does
work, critical alerts drown in the torrent of reports mandated by the
regulations. One bank actually reported a suspicious transaction in the
account of one of the September 11 hijackers - only to be ignored.
The Treasury Department established Operation Green Quest, an
investigative team charged with monitoring charities, NGO's, credit card
fraud, cash smuggling, counterfeiting, and the Hawala networks. This is not
without precedent. Previous teams tackled drug money, the biggest money
laundering venue ever, BCCI (Bank of Credit and Commerce International),
and ... Al Capone.
The more veteran, New-York based, El-Dorado anti money laundering
Task Force (established in 1992) will lend a hand and share information.
More than 150 countries promised to co-operate with the US in its fight
against the financing of terrorism - 81 of which (including the Bahamas,
Argentina, Kuwait, Indonesia, Pakistan, Switzerland, and the EU) actually
froze assets of suspicious individuals, suspected charities, and dubious
firms, or passed new anti money laundering laws and stricter regulations
(the Philippines, the UK, Germany).
A EU directive now forces lawyers to disclose incriminating information
about their clients' money laundering activities. Pakistan initiated a "loyalty
scheme", awarding expatriates who prefer official bank channels to the
much maligned (but cheaper and more efficient) Hawala, with extra
baggage allowance and special treatment in airports.

The magnitude of this international collaboration is unprecedented. But
this burst of solidarity may yet fade.
China, for instance, refuses to chime in. As a result, the statement issued
by APEC in November 2001 on measures to stem the finances of terrorism
was lukewarm at best. And, protestations of close collaboration to the
contrary, Saudi Arabia has done nothing to combat money laundering
"Islamic charities" (of which it is proud) on its territory.
Still, a universal code is emerging, based on the work of the OECD's
FATF (Financial Action Task Force) since 1989 (its famous "40
recommendations") and on the relevant UN conventions. All countries are
expected by the West, on pain of possible sanctions, to adopt a uniform
legal platform (including reporting on suspicious transactions and freezing
assets) and to apply it to all types of financial intermediaries, not only to
banks. This is likely to result in...
The Decline of off Shore Financial Centres and Tax Havens By far the
most important outcome of this new-fangled juridical homogeneity is the
acceleration of the decline of off shore financial and banking centres and
tax havens.
The distinction between off-shore and on-shore will vanish. Of the
FATF's "name and shame" blacklist of 19 "black holes" (poorly regulated
territories, including Israel, Indonesia, and Russia) - 11 have substantially
revamped their banking laws and financial regulators.
Coupled with the tightening of US, UK, and EU laws and the wider
interpretation of money laundering to include political corruption, bribery,
and embezzlement - this would make life a lot more difficult for venal
politicians and major tax evaders. The likes of Sani Abacha (late President
of Nigeria), Ferdinand Marcos (late President of the Philippines), Vladimiro
Montesinos (former, now standing trial, chief of the intelligence services of
Peru), or Raul Salinas (the brother of Mexico's President) - would have
found it impossible to loot their countries to the same disgraceful extent in
today's financial environment. And Osama bin Laden would not have been
able to wire funds to US accounts from the Sudanese Al Shamal Bank, the
"correspondent" of 33 American banks.

Quo Vadis, Money Laundering? Crime is resilient and fast adapting to
new realities.
Organized crime is in the process of establishing an alternative banking
system, only tangentially connected to the West's, in the fringes, and by
proxy. This is done by purchasing defunct banks or banking licences in
territories with lax regulation, cash economies, corrupt politicians, no tax
collection, but reasonable infrastructure.
The countries of Eastern Europe - Yugoslavia (Montenegro and Serbia),
Macedonia, Ukraine, Moldova, Belarus, Albania, to mention a few - are
natural targets. In some cases, organized crime is so all-pervasive and local
politicians so corrupt that the distinction between criminal and politician is
spurious.
Gradually, money laundering rings move their operations to these new,
accommodating territories. The laundered funds are used to purchase assets
in intentionally botched privatizations, real estate, existing businesses, and
to finance trading operations. The wasteland that is Eastern Europe craves
private capital and no questions are asked by investor and recipient alike.
The next frontier is cyberspace. Internet banking, Internet gambling, day
trading, foreign exchange cyber transactions, e-cash, e-commerce, fictitious
invoicing of the launderer's genuine credit cards - hold the promise of the
future. Impossible to track and monitor, ex-territorial, totally digital,
amenable to identity theft and fake identities - this is the ideal vehicle for
money launderers.
This nascent platform is way too small to accommodate the enormous
amounts of cash laundered daily - but in ten years time, it may. The problem
is likely to be exacerbated by the introduction of smart cards, electronic
purses, and payment-enabled mobile phones.
In its "Report on Money Laundering Typologies" (February 2001) the
FATF was able to document concrete and suspected abuses of online
banking, Internet casinos, and web-based financial services. It is difficult to
identify a customer and to get to know it in cyberspace, was the alarming
conclusion. It is equally complicated to establish jurisdiction.

Many capable professionals - stockbrokers, lawyers, accountants, traders,
insurance brokers, real estate agents, sellers of high value items such as
gold, diamonds, and art - are employed or co-opted by money laundering
operations. Money launderers are likely to make increased use of global,
around the clock, trading in foreign currencies and derivatives. These
provide instantaneous transfer of funds and no audit trail.
The underlying securities involved are susceptible to market
manipulation and fraud. Complex insurance policies (with the "wrong"
beneficiaries), and the securitization of receivables, leasing contracts,
mortgages, and low grade bonds are already used in money laundering
schemes. In general, money laundering goes well with risk arbitraging
financial instruments.
Trust-based, globe-spanning, money transfer systems based on
authentication codes and generations of commercial relationships cemented
in honour and blood - are another wave of the future. The Hawala and
Chinese networks in Asia, the Black Market Peso Exchange (BMPE) in
Latin America, other evolving courier systems in Eastern Europe (mainly in
Russia, Ukraine, and Albania) and in Western Europe (mainly in France and
Spain).
In conjunction with encrypted e-mail and web anonymizers, these
networks are virtually impenetrable.
As emigration increases, diasporas established, and transport and
telecommunications become ubiquitous, "ethnic banking" along the
tradition of the Lombards and the Jews in medieval Europe may become the
the preferred venue of money laundering. September 11 may have retarded
world civilization in more than one way.

IV. Hawala, or The Bank that Never Was
I. OVERVIEW In the wake of the September 11 terrorist attacks on the
USA, attention was drawn to the age-old, secretive, and globe-spanning
banking system developed in Asia and known as "Hawala" (to change, in
Arabic). It is based on a short term, discountable, negotiable, promissory
note (or bill of exchange) called "Hundi". While not limited to Moslems, it
has come to be identified with "Islamic Banking".
Islamic Law (Sharia'a) regulates commerce and finance in the Fiqh Al
Mua'malat, (transactions amongst people).
Modern Islamic banks are overseen by the Shari'a Supervisory Board of
Islamic Banks and Institutions ("The Shari'a Committee").
The Shi'a "Islamic Laws according to the Fatawa of Ayatullah al Uzama
Syed Ali al-Husaini Seestani" has this to say about Hawala banking: "2298.
If a debtor directs his creditor to collect his debt from the third person, and
the creditor accepts the arrangement, the third person will, on completion of
all the conditions to be explained later, become the debtor.
Thereafter, the creditor cannot demand his debt from the first debtor".
The prophet Muhammad (a cross border trader of goods and
commodities by profession) encouraged the free movement of goods and
the development of markets.
Numerous Moslem scholars railed against hoarding and harmful
speculation (market cornering and manipulation known as "Gharar").
Moslems were the first to use promissory notes and assignment, or transfer
of debts via bills of exchange ("Hawala"). Among modern banking
instruments, only floating and, therefore, uncertain, interest payments
("Riba" and "Jahala"), futures contracts, and forfeiting are frowned upon.
But agile Moslem traders easily and often circumvent these religious
restrictions by creating "synthetic Murabaha (contracts)" identical to
Western forward and futures contracts. Actually, the only allowed transfer

or trading of debts (as distinct from the underlying commodities or goods)
is under the Hawala. "Hawala" consists of transferring money (usually
across borders and in order to avoid taxes or the need to bribe officials)
without physical or electronic transfer of funds.
Money changers ("Hawaladar") receive cash in one country, no questions
asked. Correspondent hawaladars in another country dispense an identical
amount (minus minimal fees and commissions) to a recipient or, less often,
to a bank account. E-mail, or letter ("Hundi") carrying couriers are used to
convey the necessary information (the amount of money, the date it has to
be paid on) between Hawaladars. The sender provides the recipient with
code words (or numbers, for instance the serial numbers of currency notes),
a digital encrypted message, or agreed signals (like handshakes), to be used
to retrieve the money. Big Hawaladars use a chain of middlemen in cities
around the globe.
But most Hawaladars are small businesses. Their Hawala activity is a
sideline or moonlighting operation. "Chits" (verbal agreements) substitute
for certain written records.
In bigger operations there are human "memorizers" who serve as arbiters
in case of dispute. The Hawala system requires unbounded trust.
Hawaladars are often members of the same family, village, clan, or ethnic
group. It is a system older than the West. The ancient Chinese had their own
"Hawala" - "fei qian" (or "flying money"). Arab traders used it to avoid
being robbed on the Silk Road.
Cheating is punished by effective ex-communication and "loss of
honour" - the equivalent of an economic death sentence. Physical violence
is rarer but not unheard of.
Violence sometimes also erupts between money recipients and robbers
who are after the huge quantities of physical cash sloshing about the
system. But these, too, are rare events, as rare as bank robberies. One result
of this effective social regulation is that commodity traders in Asia shift
hundreds of millions of US dollars per trade based solely on trust and the
verbal commitment of their counterparts.

Hawala arrangements are used to avoid customs duties, consumption
taxes, and other trade-related levies.
Suppliers provide importers with lower prices on their invoices, and get
paid the difference via Hawala.
Legitimate transactions and tax evasion constitute the bulk of Hawala
operations. Modern Hawala networks emerged in the 1960's and 1970's to
circumvent official bans on gold imports in Southeast Asia and to facilitate
the transfer of hard earned wages of expatriates to their families ("home
remittances") and their conversion at rates more favourable (often double)
than the government's. Hawala provides a cheap (it costs c. 1% of the
amount transferred), efficient, and frictionless alternative to morbid and
corrupt domestic financial institutions. It is Western Union without the hi-
tech gear and the exorbitant transfer fees.
Unfortunately, these networks have been hijacked and compromised by
drug traffickers (mainly in Afganistan and Pakistan), corrupt officials,
secret services, money launderers, organized crime, and terrorists. Pakistani
Hawala networks alone move up to 5 billion US dollars annually according
to estimates by Pakistan's Minister of Finance, Shaukut Aziz. In 1999,
Institutional Investor Magazine identified 1100 money brokers in Pakistan
and transactions that ran as high as 10 million US dollars apiece. As
opposed to stereotypes, most Hawala networks are not controlled by Arabs,
but by Indian and Pakistani expatriates and immigrants in the Gulf. The
Hawala network in India has been brutally and ruthlessly demolished by
Indira Ghandi (during the emergency regime imposed in 1975), but Indian
nationals still play a big part in international Hawala networks. Similar
networks in Sri Lanka, the Philippines, and Bangladesh have also been
eradicated.
The OECD's Financial Action Task Force (FATF) says that: "Hawala
remains a significant method for large numbers of businesses of all sizes
and individuals to repatriate funds and purchase gold.... It is favoured
because it usually costs less than moving funds through the banking system,
it operates 24 hours per day and every day of the year, it is virtually
completely reliable, and there is minimal paperwork required."
(Organisation for Economic Co-Operation and Development (OECD),

"Report on Money Laundering Typologies 1999-2000," Financial Action
Task Force, FATF-XI, February 3, 2000, at
http://www.oecd.org/fatf/pdf/TY2000 en.pdf ) Hawala networks closely
feed into Islamic banks throughout the world and to commodity trading in
South Asia. There are more than 200 Islamic banks in the USA alone and
many thousands in Europe, North and South Africa, Saudi Arabia, the Gulf
states (especially in the free zone of Dubai and in Bahrain), Pakistan,
Malaysia, Indonesia, and other South East Asian countries. By the end of
1998, the overt (read: tip of the iceberg) liabilities of these financial
institutions amounted to 148 billion US dollars. They dabbled in equipment
leasing, real estate leasing and development, corporate equity, and
trade/structured trade and commodities financing (usually in consortia
called "Mudaraba").
While previously confined to the Arab peninsula and to south and east
Asia, this mode of traditional banking became truly international in the
1970's, following the unprecedented flow of wealth to many Moslem
nations due to the oil shocks and the emergence of the Asian tigers. Islamic
banks joined forces with corporations, multinationals, and banks in the West
to finance oil exploration and drilling, mining, and agribusiness. Many
leading law firms in the West (such as Norton Rose, Freshfields, Clyde and
Co. and Clifford Chance) have "Islamic Finance" teams which are familiar
with Islam- compatible commercial contracts.
II. HAWALA AND TERRORISM Recent anti-terrorist legislation in the
US and the UK allows government agencies to regularly supervise and
inspect businesses that are suspected of being a front for the ''Hawala''
banking system, makes it a crime to smuggle more than $10,000 in cash
across USA borders, and empowers the Treasury secretary (and its Financial
Crimes Enforcement Network - FinCEN) to tighten record-keeping and
reporting rules for banks and financial institutions based in the USA. A new
inter-agency Foreign Terrorist Asset Tracking Center (FTAT) was set up. A
1993 moribund proposed law requiring US-based Halawadar to register and
to report suspicious transactions may be revived. These relatively radical
measures reflect the belief that the al-Qaida network of Osama bin Laden
uses the Hawala system to raise and move funds across national borders. A
Hawaladar in Pakistan (Dihab Shill) was identified as the financier in the
attacks on the American embassies in Kenya and Tanzania in 1998.

But the USA is not the only country to face terrorism financed by Hawala
networks.
In mid-2001, the Delhi police, the Indian government's Enforcement
Directorate (ED), and the Military Intelligence (MI) arrested six Jammu
Kashmir Islamic Front (JKIF) terrorists. The arrests led to the exposure of
an enormous web of Hawala institutions in Delhi, aided and abetted, some
say, by the ISI (Inter Services Intelligence, Pakistan's security services). The
Hawala network was used to funnel money to terrorist groups in the
disputed Kashmir Valley.
Luckily, the common perception that Hawala financing is paperless is
wrong. The transfer of information regarding the funds often leaves digital
(though heavily encrypted) trails. Couriers and "contract memorizers", gold
dealers, commodity merchants, transporters, and moneylenders can be
apprehended and interrogated. Written, physical, letters are still the
favourite mode of communication among small and medium Hawaladars,
who also invariably resort to extremely detailed single entry bookkeeping.
And the sudden appearance and disappearance of funds in bank accounts
still have to be explained. Moreover, the sheer scale of the amounts
involved entails the collaboration of off shore banks and more established
financial institutions in the West. Such flows of funds affect the local
money markets in Asia and are instantaneously reflected in interest rates
charged to frequent borrowers, such as wholesalers. Spending and
consumption patterns change discernibly after such influxes. Most of the
money ends up in prime world banks behind flimsy business facades.
Hackers in Germany claimed (without providing proof) to have infiltrated
Hawala-related bank accounts.
The problem is that banks and financial institutions - and not only in
dodgy offshore havens ("black holes" in the lingo) - clam up and refuse to
divulge information about their clients. Banking is largely a matter of
fragile trust between bank and customer and tight secrecy. Bankers are
reluctant to undermine either. Banks use mainframe computers which can
rarely be hacked through cyberspace and can be compromised only
physically in close co- operation with insiders. The shadier the bank - the
more formidable its digital defenses. The use of numbered accounts
(outlawed in Austria, for instance, only recently) and pseudonyms (still

possible in Lichtenstein) complicates matters. Bin Laden's accounts are
unlikely to bear his name. He has collaborators.
Hawala networks are often used to launder money, or to evade taxes.
Even when employed for legitimate purposes, to diversify the risk involved
in the transfer of large sums, Hawaladars apply techniques borrowed from
money laundering. Deposits are fragmented and wired to hundreds of banks
the world over ("starburst").
Sometimes, the money ends up in the account of origin ("boomerang").
Hence the focus on payment clearing and settlement systems. Most
countries have only one such system, the repository of data regarding all
banking (and most non- banking) transactions in the country. Yet, even this
is a partial solution. Most national systems maintain records for 6-12
months, private settlement and clearing systems for even less.
Yet, the crux of the problem is not the Hawala or the Hawaladars. The
corrupt and inept governments of Asia are to blame for not regulating their
banking systems, for over-regulating everything else, for not fostering
competition, for throwing public money at bad debts and at worse
borrowers, for over-taxing, for robbing people of their life savings through
capital controls, for tearing at the delicate fabric of trust between customer
and bank (Pakistan, for instance, froze all foreign exchange accounts two
years ago). Perhaps if Asia had reasonably expedient, reasonably priced,
reasonably regulated, user- friendly banks - Osama bin Laden would have
found it impossible to finance his mischief so invisibly.

V. Straf - Corruption in Central and Eastern
Europe
The three policemen barked "straf", "straf" in unison. It was a
Russianized version of the German word for "fine" and a euphemism for
bribe. I and my fiancé were stranded in an empty ally at the heart of
Moscow, physically encircled by these young bullies, an ominous
propinquity. They held my passport ransom and began to drag me to a
police station nearby. We paid.
To do the fashionable thing and to hold the moral high ground is rare.
Yet, denouncing corruption and fighting it satisfies both conditions. Such
hectoring is usually the preserve of well-heeled bureaucrats, driving utility
vehicles and banging away at wireless laptops. The General Manager of the
IMF makes 400,000 US dollars a year, tax-free, and perks. This is the
equivalent of 2,300 (!) monthly salaries of a civil servant in Macedonia - or
7,000 monthly salaries of a teacher or a doctor in Yugoslavia, Moldova,
Belarus, or Albania. He flies only first class and each one of his air tickets is
worth the bi- annual income of a Macedonian factory worker. His
shareholders - among them poor and developing countries - are forced to
cough up these exorbitant fees and to finance the luxurious lifestyle of the
likes of Kohler and Wolfensohn. And then they are made to listen to the
IMF lecture them on belt tightening and how uncompetitive their
economies are due to their expensive labour force.
To me, such a double standard is the epitome of corruption.
Organizations such as the IMF and World Bank will never be possessed of a
shred of moral authority in these parts of the world unless and until they
forgo their conspicuous consumption.
Yet, corruption is not a monolithic practice. Nor are its outcomes
universally deplorable or damaging. One would do best to adopt a
utilitarian and discerning approach to it.

The advent of moral relativism has taught us that "right" and "wrong" are
flexible, context dependent and culture- sensitive yardsticks.
What amounts to venality in one culture (Slovenia) is considered no more
than gregariousness or hospitality in another (Macedonia).
Moreover, corruption is often "imported" by multinationals, foreign
investors, and expats. It is introduced by them to all levels of governments,
often in order to expedite matters or secure a beneficial outcome.
To eradicate corruption, one must tackle both giver and taker.
Thus, we are better off asking "cui bono" than "is it the right thing to do".
Phenomenologically, "corruption" is a common - and misleading - label for
a group of behaviours. One of the following criteria must apply: (a) The
withholding of a service, information, or goods that, by law, and by right,
should have been provided or divulged.
To have a phone installed in Russia one must openly bribe the installer
(according to a rather rigid tariff). In many of the former republics of
Yugoslavia, it is impossible to obtain statistics or other data (the salaries of
senior public officeholders, for instance) without resorting to kickbacks. (b)
The provision of a service, information, or goods that, by law, and by right,
should not have been provided or divulged.
Tenders in the Czech Republic are often won through bribery. The
botched privatizations all over the former Eastern Bloc constitute a massive
transfer of wealth to select members of a nomenklatura. Licences and
concessions are often granted in Bulgaria and the rest of the Balkan as
means of securing political allegiance or paying off old political "debts". (c)
That the withholding or the provision of said service, information, or goods
are in the power of the withholder or the provider to withhold or to provide
AND That the withholding or the provision of said service, information, or
goods constitute an integral and substantial part of the authority or the
function of the withholder or the provider.
The post-communist countries in transition are a dichotomous lot. On the
one hand, they are intensely and stiflingly bureaucratic. On the other hand,
none of the institutions functions properly or lawfully. While these
countries are LEGALISTIC - they are never LAWFUL.

This fuzziness allows officials in all ranks to usurp authority, to trade
favours, to forge illegal consensus and to dodge criticism and
accountability. There is a direct line between lack of transparency and
venality. Eran Fraenkel of Search for Common Ground in Macedonia has
coined the phrase "ambient corruption" to capture this complex of features.
(d) That the service, information, or goods that are provided or divulged are
provided or divulged against a benefit or the promise of a benefit from the
recipient and as a result of the receipt of this specific benefit or the promise
to receive such benefit.
It is wrong to assume that corruption is necessarily, or even mostly,
monetary or pecuniary. Corruption is built on mutual expectations. The
reasonable expectation of a future benefit is, in itself, a benefit. Access,
influence peddling, property rights, exclusivity, licences, permits, a job, a
recommendation - all constitute benefits. (e) That the service, information,
or goods that are withheld are withheld because no benefit was provided or
promised by the recipient.
Even then, in CEE, we can distinguish between a few types of corrupt
and venal behaviours in accordance with their OUTCOMES (utilities): (1)
Income Supplement Corrupt actions whose sole outcome is the
supplementing of the income of the provider without affecting the "real
world" in any manner.
Though the perception of corruption itself is a negative outcome - it is so
only when corruption does not constitute an acceptable and normative part
of the playing field. When corruption becomes institutionalised - it also
becomes predictable and is easily and seamlessly incorporated into decision
making processes of all economic players and moral agents. They develop
"by- passes" and "techniques" which allow them to restore an efficient
market equilibrium. In a way, all-pervasive corruption is transparent and,
thus, a form of taxation.
This is the most common form of corruption exercised by low and mid-
ranking civil servants, party hacks and municipal politicians throughout the
CEE.
More than avarice, the motivating force here is sheer survival. The acts of
corruption are repetitive, structured and in strict accordance with an un-

written tariff and code of conduct. (2) Acceleration Fees Corrupt practices
whose sole outcome is to ACCELERATE decision making, the provision of
goods and services or the divulging of information. None of the outcomes
or the utility functions are altered. Only the speed of the economic
dynamics is altered. This kind of corruption is actually economically
BENEFICIAL. It is a limited transfer of wealth (or tax) which increases
efficiency. This is not to say that bureaucracies and venal officialdoms,
over-regulation and intrusive political involvement in the workings of the
marketplace are good (efficient) things. They are not. But if the choice is
between a slow, obstructive and passive-aggressive civil service and a more
forthcoming and accommodating one (the result of bribery) - the latter is
preferable.
Acceleration fees are collected mostly by mid-ranking bureaucrats and
middle rung decision makers in both the political echelons and the civil
service. (3) Decision Altering Fees This is where the line is crossed from
the point of view of aggregate utility. When bribes and promises of bribes
actually alter outcomes in the real world - a less than optimal allocation of
resources and distribution of means of production is obtained. The result is
a fall in the general level of production. The many is hurt by the few. The
economy is skewed and economic outcomes are distorted.
This kind of corruption should be uprooted on utilitarian grounds as well
as on moral ones. (4) Subversive Outcomes Some corrupt collusions lead to
the subversion of the flow of information within a society or an economic
unit.
Wrong information often leads to disastrous outcomes.
Consider a medical doctor or an civil engineer who bribed their way into
obtaining a professional diploma.
Human lives are at stake. The wrong information, in this case is the
professional validity of the diplomas granted and the scholarship
(knowledge) that such certificates stand for. But the outcomes are lost lives.
This kind of corruption, of course, is by far the most damaging.
Unfortunately, it is widespread in CEE. It is proof of the collapse of the
social treaty, of social solidarity and of the fraying of the social fabric.

No Western country accepts CEE diplomas without further accreditation,
studies and examinations. Many "medical doctors" and "engineers" who
emigrated to Israel from Russia and the former republics of the USSR -
were suspiciously deficient professionally. Israel was forced to re-educate
them prior to granting them a licence to practice locally. (5) Reallocation
Fees Benefits paid (mainly to politicians and political decision makers) in
order to affect the allocation of economic resources and material wealth or
the rights thereto.
Concessions, licences, permits, assets privatised, tenders awarded are all
subject to reallocation fees. Here the damage is materially enormous (and
visible) but, because it is widespread, it is "diluted" in individual terms.
Still, it is often irreversible (like when a sold asset is purposefully under-
valued) and pernicious. a factory sold to avaricious and criminally minded
managers is likely to collapse and leave its workers unemployed.
Corruption pervades daily life even in the prim and often hectoring
countries of the West. It is a win-win game (as far as Game Theory goes) -
hence its attraction. We are all corrupt to varying degrees. But it is wrong
and wasteful - really, counterproductive - to fight corruption in CEE in a
wide front and indiscriminately. It is the kind of corruption whose evil
outcomes outweigh its benefits that should be fought. This fine (and
blurred) distinction is too often lost on decision makers and law
enforcement agencies in both East and West.
ERADICATING CORRUPTION An effective program to eradicate
corruption must include the following elements: 1. Egregiously corrupt,
high-profile, public figures, multinationals, and institutions (domestic and
foreign) must be singled out for harsh (legal) treatment and thus
demonstrate that no one is above the law and that crime does not pay. 2. All
international aid, credits, and investments must be conditioned upon a clear,
performance-based, plan to reduce corruption levels and intensity.
Such a plan should be monitored and revised as needed. Corruption
retards development and produces instability by undermining the
credentials of democracy, state institutions, and the political class. Reduced
corruption is, therefore, a major target of economic and institutional
developmental. 3. Corruption cannot be reduced only by punitive measures.

A system of incentives to avoid corruption must be established. Such
incentives should include a higher pay, the fostering of civic pride,
educational campaigns, "good behaviour" bonuses, alternative income and
pension plans, and so on. 4. Opportunities to be corrupt should be
minimized by liberalizing and deregulating the economy. Red tape should
be minimized, licensing abolished, international trade freed, capital controls
eliminated, competition introduced, monopolies broken, transparent public
tendering be made mandatory, freedom of information enshrined, the media
should be directly supported by the international community, and so on.
Deregulation should be a developmental target integral to every program of
international aid, investment, or credit provision. 5. Corruption is a
symptom of systemic institutional failure. Corruption guarantees efficiency
and favourable outcomes. The strengthening of institutions is of critical
importance. The police, the customs, the courts, the government, its
agencies, the tax authorities, the state owned media - all must be subjected
to a massive overhaul. Such a process may require foreign management and
supervision for a limited period of time. It most probably would entail the
replacement of most of the current - irredeemably corrupt - personnel. It
would need to be open to public scrutiny. 6. Corruption is a symptom of an
all-pervasive sense of helplessness. The citizen (or investor, or firm) feels
dwarfed by the overwhelming and capricious powers of the state. It is
through corruption and venality that the balance is restored. To minimize
this imbalance, potential participants in corrupt dealings must be made to
feel that they are real and effective stakeholders in their societies. A process
of public debate coupled with transparency and the establishment of just
distributive mechanisms will go a long way towards rendering corruption
obsolete.

VI. The Kleptocracies of the East
The process of transition from communism to capitalism was largely
hijacked either by outright criminals in budding outfits of organized crime -
or by pernicious and all-pervasive kleptocracies: politicians and political
parties bent on looting the state and suppressing the opposition, sometimes
fatally.
In the past 16 years, industrial production in the economies in transition
tumbled in real terms by more than 60 percent. The monthly salary in the
poorer bits equals the daily wage of a skilled German industrial worker, or
one seventh the European Union's average.
Gross domestic product per capita is less than one third the EU's.
Infrastructure, internal and export markets, state institutions - all crumbled
with dizzying speed.
In some countries - not the least Russia - privatization amounted to a
mass transfer of assets to cronies and insiders, often well-connected
members of the communist nomenclature: managers, members of the
security services and other penumbral figures. Laws were passed and
institutions tweaked to reflect the special interests of these groupings.
"Classical" forms of crime flourished throughout the benighted region.
Prostitution, gambling, drugs, smuggling, kidnapping, organ trafficking and
other varieties of delinquency yielded to their perpetrators billions of
dollars annually. In the impoverished economies of the east, these fantastic
revenues - laundered through off shore accounts - were leveraged by
criminals to garner political favors, to buy into legitimate businesses and to
infiltrate civil society.
None of this is new to Western publics. Rogues and "robber barons" have
always doubled as entrepreneurs.
The oil, gaming and railways industries in America, for instance, owe
their existence to dubious personas and questionable practices. Well into the
17th century, the British sovereign maintained a monopoly on chartering

businesses and awarded the coveted licenses to loyal servants and
obsequious sycophants.
Still, the ubiquity of crime in east Europe and its reach are unprecedented
in European annals. In the void-like interregnum between centrally planned
and free market economies only criminals, politicians, managers, and
employees of the security services were positioned to benefit from the
upheaval.
At the outset of transition, the underworld constituted an embryonic
private sector, replete with international networks of contacts, cross-border
experience, capital agglomeration and wealth formation, sources of venture
(risk) capital, an entrepreneurial spirit, and a diversified portfolio of
investments and revenue generating assets.
Criminals were used to private sector practices: price signals,
competition, joint venturing, and third party dispute settlement.
Crime - alone among all economic activities in communist societies -
obeyed the laws of the free market. Criminals had to be entrepreneurial and
profitable to survive. Their instincts sharpened by - often lethal -
competition, they were never corrupted by central planning.
Deprived of access to state largesse, criminals invested their own capital
in efficiently-run small to medium size enterprises. Attuned to the needs and
wishes of their customers, criminals engaged in primitive forms of market
research, through neighborhood and grassroots "pollsters" and "activists".
They responded with agility and in real time to changes in the patterns of
supply and demand by altering their product mix and their pricing.
They have always been pioneers of bleeding-edge technologies.
Criminals are effective organizers and managers. They excel at enforcing
workplace discipline with irresistible incentives and irreversible
disincentives, at setting targets and at networking. The superior felonious
echelons are upwardly mobile and have a clear career path. Every
management fad - from territorially exclusive franchises to "stock" options -
has been invented by criminals long before they triumphed in the
boardroom.

In east Europe, criminals on all levels, from the organized to the petty,
often substituted for the dysfunctional, or ideologically hidebound organs of
the state. Consider the dispensation of justice. The criminal code of conduct
and court system replaced the compromised and lethargic official judiciary.
Debt collectors and enforcers stood in for venal and incompetent police
forces.
Crime is a growth industry and sustains hordes of professionals:
accountants and lawyers, forgers and cross border guides, weapons experts
and bankers, mechanics and hit-men. Expertise, know-how and acumen,
amassed over centuries of practice, are taught in the criminal universities
known as penitentiaries: roads less traveled, countries more lenient,
passports to be bought, sold, or forged, how-to manuals, goods and services
on offer and demand.
Profit margins in crime are outlandish and lead to feverish wealth
accumulation. The banking system is used both to stash the proceeds and to
launder them. Tax havens, off shore financial institutions and money
couriers - all form part of a global web. Thus cleansed and rendered
untraceable, the money is invested in legitimate activities.
In some countries - especially on the drug path, or on the trail of white
slavery - crime is a major engine of economic growth.
As opposed to the visible sectors of the east's demonetized economies,
criminal enterprises never run out of liquidity and thus are always keen to
invest. Moreover, crime is international and cosmopolitan. It is accustomed
to sophisticated export-import transactions.
Many criminals - as opposed to the vast majority of their countrymen -
are polyglottal, well-traveled, aware of world prices, the international
financial system and demand and supply in various markets. They are
experienced negotiators. In short: criminals are well- heeled international
businessmen, well-connected both abroad and with the various indigenous
elites.
The Wild East in Europe is often compared to the Wild West in America
a century or so ago. The Russian oligarchs, goes the soothing analogy, are
local versions of Morgan, Rockefeller, Pullman and Vanderbilt. But this

affinity is spurious. the United States always had a civic culture with civic
values and an aspiration to, ultimately, create a harmonious and benevolent
civic society.
Criminality was regarded as a shameful stepping stone on the way to an
orderly community of learned, civilized, law-abiding citizens.
This cannot be said about Russia, for instance. The criminal there is, if
anything, admired and emulated. Even the language of legal business in
countries in transition is suffused with underworld parlance. There is no -
and never was - a civic tradition in the countries of eastern Europe, a Bill of
Rights, a veritable Constitution, a modicum of self rule, a true abolition of
classes and nomenclatures. These territories are accustomed to being
governed by paranoiac and murderous tyrants akin to the current crop of
delinquents. That some criminals are members of the new political,
financial and industrial elites (and vice versa) - tends to support this long-
rooted association.
In all the countries of the region, politicians and managers abuse the state
and its simulacrum institutions in close symbiosis with felons. Patronage
and sinecures extend to collaborating lawbreakers. Veritable villains gain
access to state owned assets and resources in a cycle of money laundering.
Law enforcement agencies and the courts are "encouraged" to turn a blind
eye, or even to help criminals eliminate internal and external competition in
their turf.
Criminals, in return, serve as the "long and anonymous arm" of
politicians, obtaining for them illicit goods, or providing "black" services.
Corruption often flows through criminal channels or via the mediation and
conduit of delinquents. Within the shared sphere of the informal economy,
assets are shifted among these economic players. Both players oppose
attempts at reform and transparency and encourage - even engender -
nationalism and racism, paranoias and grievances to recruit foot soldiers.
Fortunately, there is the irrepressible urge to become legitimate.
Politicians, who grope for a new ideological cover for their opportunism,
partner with legitimacy- seeking, established crime lords. Both groups
benefit from a swelling economic pie. They fight against other, less
successful, criminals, who wish to persist in their old ways and, thus,

hamper economic growth. The battle is never won but at least it succeeds to
firmly drive crime where it belongs: underground.

VII. FIMACO - Russia's Missing Billions
Russia's Audit Chamber - with the help of the Swiss authorities and their
host of dedicated investigators - may be about to solve a long standing
mystery. An announcement by the Prosecutor's General Office is said to be
imminent. The highest echelons of the Yeltsin entourage - perhaps even
Yeltsin himself - may be implicated - or exonerated. A Russian team has
been spending the better part of the last two months poring over documents
and interviewing witnesses in Switzerland, France, Italy, and other
European countries.
About $4.8 billion of IMF funds are alleged to have gone amiss during
the implosion of the Russian financial markets in August 1998. They were
supposed to prop up the banking system (especially SBS-Agro) and the
ailing and sharply devalued ruble. Instead, they ended up in the bank
accounts of obscure corporations - and, then, incredibly, vanished into thin
air.
The person in charge of the funds in 1998 was none other than Mikhail
Kasyanov, Russia's current Prime Minister - at the time, Deputy Minister of
Finance for External Debt.
His signature on all foreign exchange transactions - even those handled
by the central bank - was mandatory. In July 2000, he was flatly accused by
the Italian daily, La Reppublica, of authorizing the diversion of the disputed
funds.
Following public charges made by US Treasury Secretary Robert Rubin
as early as March 1999, both Russian and American media delved deeply
over the years into the affair. Communist Duma Deputy Viktor Ilyukhin
jumped on the bandwagon citing an obscure "trustworthy foreign source" to
substantiate his indictment of Kremlin cronies and oligarchs contained in an
open letter to the Prosecutor General, Yuri Skuratov.
The money trail from the Federal Reserve Bank of New York to Swiss
and German subsidiaries of the Russian central Bank was comprehensively

reconstructed. Still, the former Chairman of the central bank, Sergei
Dubinin, called Ilyukhin's allegations and the ensuing Swiss investigations -
"a black PR campaign ... a lie".
Others pointed to an outlandish coincidence: the ruble collapsed twice in
Russia's post-Communist annals. Once, in 1994, when Dubinin was
Minister of Finance and was forced to resign. The second time was in 1998,
when Dubinin was governor of the central bank and was, again, ousted.
Dubinin himself seems to be unable to make up his mind.
In one interview he says that IMF funds were used to prop up the ruble -
in others, that they went into "the national pot" (i.e., the Ministry of
Finance, to cover a budgetary shortfall).
The Chairman of the Federation Council at the time, Yegor Stroev,
appointed an investigative committee in 1999. Its report remains classified
but Stroev confirmed that IMF funds were embezzled in the wake of the
1998 forced devaluation of the ruble.
This conclusion was weakly disowned by Eleonora Mitrofanova, an
auditor within the Duma's Audit Chamber who said that they discovered
nothing "strictly illegal" - though, incongruously, she accused the central
bank of suppressing the Chamber's damning report. The Chairman of the
Chamber of Accounts, Khachim Karmokov, quoted by PwC, said that "the
audits performed by the Chamber revealed no serious procedural breaches
in the bank's performance".
But Nikolai Gonchar, a Duma Deputy and member of its Budget
Committee, came close to branding both as liars when he said that he read a
copy of the Audit Chamber report and that it found that central bank funds
were siphoned off to commercial accounts in foreign banks.
The Moscow Times cited a second Audit Chamber report which revealed
that the central bank was simultaneously selling dollars for rubles and
extending ruble loans to a few well-connected commercial banks, thus
subsidizing their dollar purchases. The central bank went as far as printing
rubles to fuel this lucrative arbitrage. The dollars came from IMF
disbursements.

Radio Free Europe/Radio Liberty, based on its own sources and an article
in the Russian weekly "Novaya Gazeta", claims that half the money was
almost instantly diverted to shell companies in Sydney and London. The
other half was mostly transferred to the Bank of New York and to Credit
Suisse.
Why were additional IMF funds transferred to a chaotic Russia, despite
warnings by many and a testimony by a Russian official that previous
tranches were squandered? Moreover, why was the money sent to the
Central Bank, then embroiled in a growing scandal over the manipulation of
treasury bills, known as GKO's and other debt instruments, the OFZ's - and
not to the Ministry of Finance, the beneficiary of all prior transfers? The
central bank did act as MinFin's agent - but circumstances were unusual, to
say the least.
There isn't enough to connect the IMF funds with the money laundering
affair that engulfed the Bank of New York a year later to the day, in August
1999 - though several of the personalities straddled the divide between the
bank and its clients. Swiss efforts to establish a firm linkage failed as did
their attempt to implicate several banks in the Italian canton of Ticino. The
Swiss - in collaboration with half a dozen national investigation bureaus,
including the FBI - were more successful in Italy proper, where they were
able to apprehend a few dozen suspects in an elaborate undercover
operation.
FIMACO's name emerged rather early in the swirl of rumors and denials.
At the IMF's behest, PricewaterhouseCoopers (PwC) was commissioned by
Russia's central bank to investigate the relationship between the Russian
central bank and its Channel Islands offshoot, Financial Management
Company Limited, immediately when the accusations surfaced.
Skuratov unearthed $50 billion in transfers of the nation's hard currency
reserves from the central bank to FIMACO, which was majority-owned by
Eurobank, the central bank's Paris-based daughter company. According to
PwC, Eurobank was 23 percent owned by "Russian companies and private
individuals".
Dubinin and his successor, Gerashchenko, admit that FIMACO was used
to conceal Russia's assets from its unrelenting creditors, notably the

Geneva-based Mr.
Nessim Gaon, whose companies sued Russia for $600 million. Gaon
succeeded to freeze Russian accounts in Switzerland and Luxemburg in
1993. PwC alerted the IMF to this pernicious practice, but to no avail.
Moreover, FIMACO paid exorbitant management fees to self-liquidating
entities, used funds to fuel the speculative GKO market, disbursed non-
reported profits from its activities, through "trust companies", to Russian
subjects, such as schools, hospitals, and charities - and, in general,
transformed itself into a mammoth slush fund and source of patronage.
Russia admitted to lying to the IMF in 1996.
It misstated its reserves by $1 billion.
Some of the money probably financed the fantastic salaries of Dubinin
and his senior functionaries. He earned $240,000 in 1997 - when the
average annual salary in Russia was less than $2000 and when Alan
Greenspan, Chairman of the Federal Reserve of the USA, earned barely half
as much.
Former Minister of Finance, Boris Fedorov, asked the governor of the
central bank and the prime minister in 1993 to disclose how were the
country's foreign exchange reserves being invested. He was told to mind his
own business. To Radio Free Europe/Radio Liberty he said, six years later,
that various central bank schemes were set up to "allow friends to earn
handsome profits ... They allowed friends to make profits because when
companies are created without any risk, and billions of dollars are
transferred, somebody takes a (quite big) commission ... a minimum of tens
of millions of dollars. The question is: Who received these commissions?
Was this money repatriated to the country in the form of dividends?"
Dubinin's vehement denials of FIMACO's involvement in the GKO market
are disingenuous. Close to half of all foreign investment in the money-
spinning market for Russian domestic bonds were placed through
FIMACO's nominal parent company, Eurobank and, possibly, through its
subsidiary, co-owned with FIMACO, Eurofinance Bank.
Nor is Dubinin more credible when he denies that profits and
commissions were accrued in FIMACO and then drained off. FIMACO's

investment management agreement with Eurobank, signed in 1993, entitled
it to 0.06 percent of the managed funds per quarter.
Even accepting the central banker's ludicrous insistence that the balance
never exceeded $1.4 billion - FIMACO would have earned $3.5 million per
annum from management fees alone - investment profits and brokerage fees
notwithstanding. Even Eurobank's president at the time, Andrei Movchan,
conceded that FIMACO earned $1.7 million in management fees.
The IMF insisted that the PwC reports exonerated all the participants. It
is, therefore, surprising and alarming to find that the online copies of these
documents, previously made available on the IMF's Web site, were
"Removed September 30, 1999 at the request of PricewaterhouseCoopers".
The cover of the main report carried a disclaimer that it was based on
procedures dictated by the central bank and "...consequently, we (PwC)
make no representation regarding the sufficiency of the procedures
described below ... The report is based solely on financial and other
information provided by, and discussions with, the persons set out in the
report. The accuracy and completeness of the information on which the
report is based is the sole responsibility of those persons. ...
PricewaterhouseCoopers have not carried out any verification work
which may be construed to represent audit procedures ... We have not been
provided access to Ost West Handelsbank (the recipient of a large part of
the $4.8 IMF tranche)".
The scandal may have hastened the untimely departure of the IMF's
Managing Director at the time, Michel Camdessus, though this was never
officially acknowledged. The US Congress was reluctant to augment the
Fund's resources in view of its controversial handling of the Asian and
Russian crises and contagion.
This reluctance persisted well into the new millennium. A congressional
delegation, headed by James Leach (R, Iowa), Chairman of the Banking
and Financial Services Committee, visited Russia in April 2000,
accompanied by the FBI, to investigate the persistent contentions about the
misappropriation of IMF funds.

Camdessus himself went out of his way to defend his record and reacted
in an unprecedented manner to the allegations. In a letter to Le Mond, dated
August 18, 1999 - and still posted on the IMF's Web site, three years later -
he wrote, inadvertently admitting to serious mismanagement: "I wish to
express my indignation at the false statements, allegations, and insinuations
contained in the articles and editorial commentary appearing in Le Monde
on August 6, 8, and 9 on the content of the PricewaterhouseCoopers (PWC)
audit report relating to the operations of the Central Bank of Russia and its
subsidiary, FIMACO.
Your readers will be shocked to learn that the report in question,
requested and made public at the initiative of the IMF ... (concludes that) no
misuse of funds has been proven, and the report does not criticize the IMF's
behavior ... I would also point out that your representation of the IMF's
knowledge and actions is misleading. We did know that part of the reserves
of the Central Bank of Russia was held in foreign subsidiaries, which is not
an illegal practice; however, we did not learn of FIMACO's activities until
this year—because the audit reports for 1993 and 1994 were not provided to
us by the Central Bank of Russia.
The IMF, when apprised of the possible range of FIMACO activities,
informed the Russian authorities that it would not resume lending to Russia
until a report on these activities was available for review by the IMF and
corrective actions had been agreed as needed ... I would add that what the
IMF objected to in FIMACO's operations extends well beyond the
misrepresentation of Russia's international reserves in mid-1996 and
includes several other instances where transactions through it had resulted
in a misleading representation of the reserves and of monetary and
exchange policies. These include loans to Russian commercial banks and
investments in the GKO market".
No one accepted - or accepts - the IMF's convoluted post- facto
"clarifications" at face value. Nor was Dubinin's tortured sophistry - IMF
funds cease to be IMF funds when they are transferred from the Ministry of
Finance to the central bank - countenanced.
Even the compromised office of the Russian Prosecutor- General urged
Russian officials, as late as July 2000, to re-open the investigation regarding

the diversion of the funds. The IMF dismissed this sudden burst of rectitude
as the rehashing of old stories. But Western officials - interviews by Radio
Free Europe/Radio Liberty - begged to differ.
Yuri Skuratov, the former Prosecutor-General, ousted for undue
diligence, wrote in a book he published two years ago, that only c. $500
million of the $4.8 were ever used to stabilize the ruble. Even George Bush
Jr., when still a presidential candidate accused Russia's former Prime
Minister Viktor Chernomyrdin of complicity in embezzling IMF funds.
Chernomyrdin threatened to sue.
The rot may run even deeper. The Geneva daily "Le Temps", which has
been following the affair relentlessly, accused, two years ago, Roman
Abramovich, a Yeltsin- era oligarch and a member of the board of directors
of Sibneft, of colluding with Runicom, Sibneft's trading arm, to
misappropriate IMF funds. Swiss prosecutors raided Runicom's offices just
one day after Russian Tax Police raided Sibneft's Moscow headquarters.
Absconding with IMF funds seemed to have been a pattern of behavior
during Yeltsin's venal regime. The columnist Bradley Cook recounts how
Aldrich Ames, the mole within the CIA, "was told by his Russian control
officer during their last meeting, in November 1993, that the $130,000 in
fresh $100 bills that he was being bribed with had come directly from IMF
loans." Venyamin Sokolov, who headed the Audit Chamber prior to Sergei
Stepashin, informed the US Senate of $2 billion that evaporated from the
coffers of the central bank in 1995.
Even the IMF reluctantly admits: "Capital transferred abroad from Russia
may represent such legal activities as exports, or illegal sources. But it is
impossible to determine whether specific capital flows from Russia-legal or
illegal-come from a particular inflow, such as IMF loans or export earnings.
To put the scale of IMF lending to Russia into perspective, Russia's exports
of goods and services averaged about $80 billion a year in recent years,
which is over 25 times the average annual disbursement from the IMF since
1992".
DISCLAIMER Sam Vaknin served in various senior capacities in Mr.
Gaon's firms and advises governments in their negotiations with the IMF.

VIII. The Enrons of the East
Hermitage Capital Management, an international investment firm owned
by HSBC London, is suing PwC (PricewaterhouseCoopers), the biggest
among the big four accounting firms (Andersen, the fifth, is being
cannibalized by its competitors).
Hermitage also demands to have PwC's license suspended in Russia. All
this fuss over allegedly shoddy audits of Gazprom, the Russian energy
behemoth with over $20 billion in annual sales and the world's largest
reserves of natural gas. Hermitage runs a $600 million Russia fund which is
invested in the shares of the allegedly misaudited giant.
The accusations are serious. According to infuriated Hermitage, PwC
falsified and distorted the 2000-1 audits by misrepresenting the sale of
Gazprom's subsidiary, Purgaz, to Itera, a conveniently obscure entity. Other
loss spinning transactions were also creatively tackled.
Stoitransgaz - partly owned by former Gazprom managers and their
relatives - landed more than $1 billion in lucrative Gazprom contracts.
These shenanigans resulted in billions of dollars of losses and a
depressed share price. AFP quotes William Browder, Hermitage's
disgruntled CEO, as saying: "This is Russia's Enron". PwC threatened to
counter-sue Hermitage over its "completely unfounded" allegations.
But Browder's charges are supported by Boris Fyodorov, a former
Russian minister of finance and a current Gazprom independent director.
Fyodorov manages his own investment boutique, United Financial Group.
Browder is a former Solomon Brothers investment banker. Other
investment banks and brokerage firms - foreign and Russian - are
supportive of his allegations.
They won't and can't be fobbed.

Fyodorov speculates that PwC turned a blind eye to many of Gazprom's
shadier deals in order to keep the account.
Gazprom shareholders will decide in June whether to retain it as an
auditor or not. Browder is initiating a class action lawsuit in New York of
Gazprom ADR holders against PwC.
Even Russia's president concurs. A year ago, he muttered ominously
about "enormous amounts of misspent money (in Gazprom)". He replaced
Rem Vyakhirev, the oligarch that ran Gazprom, with his own protégié.
Russia owns 38 percent of the company.
Gazprom is just the latest in an inordinately long stream of companies
with dubious methods. Avto VAZ bled itself white - under PwC's nose -
shipping cars to dealers, without guarantees or advance payments. The
penumbral dealers then vanished without a trace. Avto VAZ wrote off more
than $1 billion in "uncollected bills" by late 1995. PwC did make a mild
comment in the 1997 audit.
But the first real warning appeared only three years later in the audit for
the year 2000.
Andrei Sharonov, deputy minister in the federal Ministry of Economics
said, in an interview he granted "Business Week" last February: "Auditors
have been working on behalf of management rather than shareholders." In a
series of outlandish ads, published in Russian business dailies in late
February, senior partners in the PwC Moscow office made this incredible
statement: "(Audit) does not represent a review of each transaction, or a
qualitative assessment of a company's performance".
The New York Times quotes a former employee of Ernst&Young in
Moscow as saying: "A big client is god.
You do what they want and tell you to do. You can play straight-laced
and try to be upright and protect your reputation with minor clients, but you
can't do it with the big guys. If you lose that account, no matter how
justified you are, that's the end of a career".
PwC should know. When it mentioned suspicious heavily discounted
sales of oil to Rosneft in a 1998 audit report, its client, Purneftegaz,

replaced it with Arthur Andersen.
The dubious deals dutifully vanished from the audit reports, though they
continue apace. Andersen claims such transactions do not require disclosure
under Russian law.
How times change! Throughout the 1990's, Russia and its nascent private
sector were subjected to self-righteous harangues from visiting Big Five
accountants. The hectoring targeted the lack of good governance among
Russia's corporations and public administration alike.
Hordes of pampered speakers and consultants espoused transparent
accounting, minority shareholders' rights, management accessibility and
accountability and other noble goals.
That was before Enron. The tables have turned. The Big Five - from
disintegrating Andersen to KPMG - are being chastised and fined for
negligent practices, flagrant conflicts of interests, misrepresentation,
questionable ethics and worse. Their worldwide clout, moral authority, and
professional standing have been considerably dented.
America's GAAP (Generally Accepted Accounting Practices) - once
considered the undisputable benchmark of rectitude and disclosure - are
now thought in need of urgent revision. The American issuer of accounting
standards - FASB (Financial Accounting Standards Board) - is widely
perceived to be an incestuous arrangement between the clubby members of
a rapacious and unscrupulous profession. Many American scholars even
suggest to adopt the hitherto much-derided alternative - the International
Accounting Standards (IAS) recently implemented through much of central
and eastern Europe.
Russia's Federal Commission for the Securities Market (FCSM)
convened a conclave of Western and domestic auditing firms. The theme
was how to spot and neutralize bad auditors. With barely concealed and
gleeful schadenfreude, the Russians said that the Enron scandal undermined
their confidence in Western accountants and the GAAP.
The Institute of Corporate Law and Corporate Governance (ICLG),
having studied the statements of a few major Russian firms, concluded that
there are indications of financial problems, "not mentioned by (mostly

Western) auditors". They may have a point. Most of the banks that
collapsed ignominiously in 1998 received glowing audits signed by Western
auditors, often one of the Big Five.
The Russian Investor Protection Association (IPA) and Institute of
Professional Auditors (IPAR) embarked on a survey of Russian investors,
enterprises, auditors, and state officials - and what they think about the
quality of the audit services they are getting.
Many Russian managers - as avaricious and venal as ever - now can
justify hiring malleable and puny local auditors instead of big international
or domestic ones.
Surgutneftegaz - with $2 billion net profit last year and on-going dispute
with its shareholders about dividends - wants to sack "Rosexperitza", a
respectable Russian accountancy, and hire "Aval", a little known accounting
outfit. Aval does not even make it to the list of 200 largest accounting firms
in Russia, according to Renaissance Capital, an investment bank.
Other Russian managers are genuinely alarmed by the vertiginous decline
in the reputation of the global accounting firms and by the inherent conflict
of interest between consulting and audit jobs performed by the same entity.
Sviazinvest, a holding and telecom company, hired Accenture on top of -
some say instead of - Andersen Consulting.
A decade of achievements in fostering transparency, better corporate
governance, and more realistic accounting in central and eastern Europe -
may well evaporate in the wake of Enron and other scandals. The forces of
reaction and corruption in these nether lands - greedy managers, venal
bureaucrats, and anti-reformists - all seized the opportunity to reverse what
was hitherto considered an irreversible trend towards Western standards.
This, in turn, is likely to deter investors and retard the progress towards a
more efficient market economy.
The Big Six accounting firms were among the first to establish a
presence in Russia. Together with major league consultancies, such as
Baker-McKinsey, they coached Russian entrepreneurs and managers in the
ways of the West. They introduced investors to Russia when it was still
considered a frontier land. They promoted Russian enterprises abroad and

nursed the first, precarious, joint ventures between paranoid Russians and
disdainful Westerners.
Companies like Ernst&Young are at the forefront of the fight to include
independent directors in the boards of Russian firms, invariably stuffed with
relatives and cronies. Together with IPA, Ernst&Young recently established
the National Association of Independent Directors (NAID). It is intended to
"assist Russian companies to increase their efficiency through introduction
of best independent directors' practices".
But even these - often missionary - pioneers were blinded by the spoils of
a "free for all", "winner takes all", and "might is right" environment. They
geared the accounts of their clients - by minimizing their profits - towards
tax avoidance and the abolition of dividends. Quoting unnamed former
employees of the audit firms, "The New York Times" described how "... the
auditors often chose to play by Russian rules, and in doing so sacrificed the
transparency that investors were counting on them to ensure".

IX. The Typology of Financial Scandals
I. Overview The recent implosion of the global equity markets - from
Hong Kong to New York - engendered yet another round of the semipternal
debate: should central banks contemplate abrupt adjustments in the prices
of assets - such as stocks or real estate - as they do changes in the consumer
price indices? Are asset bubbles indeed inflationary and their bursting
deflationary? Central bankers counter that it is hard to tell a bubble until it
bursts and that market intervention bring about that which it is intended to
prevent. There is insufficient historical data, they reprimand errant scholars
who insist otherwise. This is disingenuous. Ponzi and pyramid schemes
have been a fixture of Western civilization at least since the middle
Renaissance.
Assets tend to accumulate in "asset stocks". Residences built in the 19th
century still serve their purpose today.
The quantity of new assets created at any given period is, inevitably,
negligible compared to the stock of the same class of assets accumulated
over decades and, sometimes, centuries. This is why the prices of assets are
not anchored - they are only loosely connected to their production costs or
even to their replacement value.
Asset bubbles are not the exclusive domain of stock exchanges and
shares. "Real" assets include land and the property built on it, machinery,
and other tangibles. "Financial" assets include anything that stores value
and can serve as means of exchange - from cash to securities.
Even tulip bulbs will do.
In 1634, in what later came to be known as "tulipmania", tulip bulbs were
traded in a special marketplace in Amsterdam, the scene of a rabid
speculative frenzy. Some rare black tulip bulbs changed hands for the price
of a big mansion house. For four feverish years it seemed like the craze
would last forever. But the bubble burst in 1637. In a matter of a few days,
the price of tulip bulbs was slashed by 96%! Uniquely, tulipmania was not

an organized scam with an identifiable group of movers and shakers, which
controlled and directed it. Nor has anyone made explicit promises to
investors regarding guaranteed future profits.
The hysteria was evenly distributed and fed on itself.
Subsequent investment fiddles were different, though.
Modern dodges entangle a large number of victims. Their size and all-
pervasiveness sometimes threaten the national economy and the very fabric
of society and incur grave political and social costs.
There are two types of bubbles.
Asset bubbles of the first type are run or fanned by financial
intermediaries such as banks or brokerage houses. They consist of
"pumping" the price of an asset or an asset class.
The assets concerned can be shares, currencies, other securities and
financial instruments - or even savings accounts. To promise unearthly
yields on one's savings is to artificially inflate the "price", or the "value" of
one's savings account.
More than one fifth of the population of 1983 Israel were involved in a
banking scandal of Albanian proportions. It was a classic pyramid scheme.
All the banks, bar one, promised to gullible investors ever increasing
returns on the banks' own publicly-traded shares.
These explicit and incredible promises were included in prospectuses of
the banks' public offerings and won the implicit acquiescence and
collaboration of successive Israeli governments. The banks used deposits,
their capital, retained earnings and funds illegally borrowed through shady
offshore subsidiaries to try to keep their impossible and unhealthy promises.
Everyone knew what was going on and everyone was involved. It lasted 7
years. The prices of some shares increased by 1-2 percent daily.
On October 6, 1983, the entire banking sector of Israel crumbled. Faced
with ominously mounting civil unrest, the government was forced to
compensate shareholders. It offered them an elaborate share buyback plan

over 9 years. The cost of this plan was pegged at $6 billion - almost 15
percent of Israel's annual GDP. The indirect damage remains unknown.
Avaricious and susceptible investors are lured into investment swindles
by the promise of impossibly high profits or interest payments.
The organizers use the money entrusted to them by new investors to pay
off the old ones and thus establish a credible reputation. Charles Ponzi
perpetrated many such schemes in 1919-1925 in Boston and later the
Florida real estate market in the USA. Hence a "Ponzi scheme".
In Macedonia, a savings bank named TAT collapsed in 1997, erasing the
economy of an entire major city, Bitola.
After much wrangling and recriminations - many politicians seem to
have benefited from the scam - the government, faced with elections in
September, has recently decided, in defiance of IMF diktats, to offer meager
compensation to the afflicted savers. TAT was only one of a few similar
cases. Similar scandals took place in Russia and Bulgaria in the 1990's .
One third of the impoverished population of Albania was cast into
destitution by the collapse of a series of nation- wide leveraged investment
plans in 1997. Inept political and financial crisis management led Albania to
the verge of disintegration and a civil war. Rioters invaded police stations
and army barracks and expropriated hundreds of thousands of weapons.
Islam forbids its adherents to charge interest on money lent - as does
Judaism. To circumvent this onerous decree, entrepreneurs and religious
figures in Egypt and in Pakistan established "Islamic banks". These
institutions pay no interest on deposits, nor do they demand interest from
borrowers. Instead, depositors are made partners in the banks' - largely
fictitious - profits. Clients are charged for - no less fictitious - losses. A few
Islamic banks were in the habit of offering vertiginously high "profits".
They went the way of other, less pious, pyramid schemes.
They melted down and dragged economies and political establishments
with them.
By definition, pyramid schemes are doomed to failure.

The number of new "investors" - and the new money they make available
to the pyramid's organizers - is limited.
When the funds run out and the old investors can no longer be paid, panic
ensues. In a classic "run on the bank", everyone attempts to draw his money
simultaneously. Even healthy banks - a distant relative of pyramid schemes
- cannot cope with such stampedes.
Some of the money is invested long-term, or lent. Few financial
institutions keep more than 10 percent of their deposits in liquid on-call
reserves.
Studies repeatedly demonstrated that investors in pyramid schemes
realize their dubious nature and stand forewarned by the collapse of other
contemporaneous scams. But they are swayed by recurrent promises that
they could draw their money at will ("liquidity") and, in the meantime,
receive alluring returns on it ("capital gains", "interest payments",
"profits").
People know that they are likelier to lose all or part of their money as
time passes. But they convince themselves that they can outwit the
organizers of the pyramid, that their withdrawals of profits or interest
payments prior to the inevitable collapse will more than amply compensate
them for the loss of their money. Many believe that they will succeed to
accurately time the extraction of their original investment based on - mostly
useless and superstitious - "warning signs".
While the speculative rash lasts, a host of pundits, analysts, and scholars
aim to justify it. The "new economy" is exempt from "old rules and archaic
modes of thinking". Productivity has surged and established a steeper, but
sustainable, trend line. Information technology is as revolutionary as
electricity. No, more than electricity. Stock valuations are reasonable. The
Dow is on its way to 33,000. People want to believe these "objective,
disinterested analyses" from "experts".
Investments by households are only one of the engines of this first kind
of asset bubbles. A lot of the money that pours into pyramid schemes and
stock exchange booms is laundered, the fruits of illicit pursuits. The
laundering of tax-evaded money or the proceeds of criminal activities,

mainly drugs, is effected through regular banking channels. The money
changes ownership a few times to obscure its trail and the identities of the
true owners.
Many offshore banks manage shady investment ploys.
They maintain two sets of books. The "public" or "cooked" set is made
available to the authorities - the tax administration, bank supervision,
deposit insurance, law enforcement agencies, and securities and exchange
commission. The true record is kept in the second, inaccessible, set of files.
This second set of accounts reflects reality: who deposited how much,
when and subject to which conditions - and who borrowed what, when and
subject to what terms.
These arrangements are so stealthy and convoluted that sometimes even
the shareholders of the bank lose track of its activities and misapprehend its
real situation.
Unscrupulous management and staff sometimes take advantage of the
situation. Embezzlement, abuse of authority, mysterious trades, misuse of
funds are more widespread than acknowledged.
The thunderous disintegration of the Bank for Credit and Commerce
International (BCCI) in London in 1991 revealed that, for the better part of
a decade, the executives and employees of this penumbral institution were
busy stealing and misappropriating $10 billion. The Bank of England's
supervision department failed to spot the rot on time. Depositors were -
partially - compensated by the main shareholder of the bank, an Arab
sheikh. The story repeated itself with Nick Leeson and his unauthorized
disastrous trades which brought down the venerable and veteran Barings
Bank in 1995.
The combination of black money, shoddy financial controls, shady bank
accounts and shredded documents renders a true account of the cash flows
and damages in such cases all but impossible. There is no telling what were
the contributions of drug barons, American off-shore corporations, or
European and Japanese tax-evaders - channeled precisely through such
institutions - to the stratospheric rise in Wall-Street in the last few years.

But there is another - potentially the most pernicious - type of asset
bubble. When financial institutions lend to the unworthy but the politically
well-connected, to cronies, and family members of influential politicians -
they often end up fostering a bubble. South Korean chaebols, Japanese
keiretsu, as well as American conglomerates frequently used these cheap
funds to prop up their stock or to invest in real estate, driving prices up in
both markets artificially.
Moreover, despite decades of bitter experiences - from Mexico in 1982 to
Asia in 1997 and Russia in 1998 - financial institutions still bow to fads and
fashions. They act herd-like in conformity with "lending trends". They shift
assets to garner the highest yields in the shortest possible period of time. In
this respect, they are not very different from investors in pyramid
investment schemes.
II. Case Study - The Savings and Loans Associations Bailout Also
published by United Press International (UPI) Asset bubbles - in the stock
exchange, in the real estate or the commodity markets - invariably burst and
often lead to banking crises. One such calamity struck the USA in 1986-
1989. It is instructive to study the decisive reaction of the administration
and Congress alike. They tackled both the ensuing liquidity crunch and the
structural flaws exposed by the crisis with tenacity and skill. Compare this
to the lackluster and hesitant tentativeness of the current lot. True, the crisis
- the result of a speculative bubble - concerned the banking and real estate
markets rather than the capital markets. But the similarities are there.
The savings and loans association, or the thrift, was a strange banking
hybrid, very much akin to the building society in Britain. It was allowed to
take in deposits but was really merely a mortgage bank. The Depository
Institutions Deregulation and Monetary Control Act of 1980 forced S&L's
to achieve interest parity with commercial banks, thus eliminating the
interest ceiling on deposits which they enjoyed hitherto.
But it still allowed them only very limited entry into commercial and
consumer lending and trust services.
Thus, these institutions were heavily exposed to the vicissitudes of the
residential real estate markets in their respective regions. Every normal

cyclical slump in property values or regional economic shock - e.g., a
plunge in commodity prices - affected them disproportionately.
Interest rate volatility created a mismatch between the assets of these
associations and their liabilities. The negative spread between their cost of
funds and the yield of their assets - eroded their operating margins. The
1982 Garn-St. Germain Depository Institutions Act encouraged thrifts to
convert from mutual - i.e., depositor-owned - associations to stock
companies, allowing them to tap the capital markets in order to enhance
their faltering net worth.
But this was too little and too late. The S&L's were rendered unable to
further support the price of real estate by rolling over old credits,
refinancing residential equity, and underwriting development projects.
Endemic corruption and mismanagement exacerbated the ruin. The bubble
burst.
Hundreds of thousands of depositors scrambled to withdraw their funds
and hundreds of savings and loans association (out of a total of more than
3,000) became insolvent instantly, unable to pay their depositors. They were
besieged by angry - at times, violent - clients who lost their life savings.
The illiquidity spread like fire. As institutions closed their gates, one by
one, they left in their wake major financial upheavals, wrecked businesses
and homeowners, and devastated communities. At one point, the contagion
threatened the stability of the entire banking system.
The Federal Savings and Loans Insurance Corporation (FSLIC) - which
insured the deposits in the savings and loans associations - was no longer
able to meet the claims and, effectively, went bankrupt. Though the
obligations of the FSLIC were never guaranteed by the Treasury, it was
widely perceived to be an arm of the federal government.
The public was shocked. The crisis acquired a political dimension.
A hasty $300 billion bailout package was arranged to inject liquidity into
the shriveling system through a special agency, the FHFB. The supervision
of the banks was subtracted from the Federal Reserve. The role of the the
Federal Deposit Insurance Corporation (FDIC) was greatly expanded.

Prior to 1989, savings and loans were insured by the now- defunct
FSLIC. The FDIC insured only banks. Congress had to eliminate FSLIC
and place the insurance of thrifts under FDIC. The FDIC kept the Bank
Insurance Fund (BIF) separate from the Savings Associations Insurance
Fund (SAIF), to confine the ripple effect of the meltdown.
The FDIC is designed to be independent. Its money comes from
premiums and earnings of the two insurance funds, not from Congressional
appropriations. Its board of directors has full authority to run the agency.
The board obeys the law, not political masters. The FDIC has a
preemptive role. It regulates banks and savings and loans with the aim of
avoiding insurance claims by depositors.
When an institution becomes unsound, the FDIC can either shore it up
with loans or take it over. If it does the latter, it can run it and then sell it as
a going concern, or close it, pay off the depositors and try to collect the
loans.
At times, the FDIC ends up owning collateral and trying to sell it.
Another outcome of the scandal was the Resolution Trust Corporation
(RTC). Many savings and loans were treated as "special risk" and placed
under the jurisdiction of the RTC until August 1992. The RTC operated and
sold these institutions - or paid off the depositors and closed them. A new
government corporation (Resolution Fund Corporation, RefCorp) issued
federally guaranteed bailout bonds whose proceeds were used to finance the
RTC until 1996.
The Office of Thrift Supervision (OTS) was also established in 1989 to
replace the dismantled Federal Home Loan Board (FHLB) in supervising
savings and loans. OTS is a unit within the Treasury Department, but law
and custom make it practically an independent agency.
The Federal Housing Finance Board (FHFB) regulates the savings
establishments for liquidity. It provides lines of credit from twelve regional
Federal Home Loan Banks (FHLB). Those banks and the thrifts make up
the Federal Home Loan Bank System (FHLBS). FHFB gets its funds from
the System and is independent of supervision by the executive branch.

Thus a clear, streamlined, and powerful regulatory mechanism was put in
place. Banks and savings and loans abused the confusing overlaps in
authority and regulation among numerous government agencies. Not one
regulator possessed a full and truthful picture. Following the reforms, it all
became clearer: insurance was the FDIC's job, the OTS provided
supervision, and liquidity was monitored and imparted by the FHLB.
Healthy thrifts were coaxed and cajoled to purchase less sturdy ones.
This weakened their balance sheets considerably and the government
reneged on its promises to allow them to amortize the goodwill element of
the purchase over 40 years. Still, there were 2,898 thrifts in 1989. Six years
later, their number shrank to 1,612 and it stands now at less than 1,000. The
consolidated institutions are bigger, stronger, and better capitalized.
Later on, Congress demanded that thrifts obtain a bank charter by 1998.
This was not too onerous for most of them. At the height of the crisis the
ratio of their combined equity to their combined assets was less than 1%.
But in 1994 it reached almost 10% and remained there ever since.
This remarkable turnaround was the result of serendipity as much as
careful planning. Interest rate spreads became highly positive. In a classic
arbitrage, savings and loans paid low interest on deposits and invested the
money in high yielding government and corporate bonds. The prolonged
equity bull market allowed thrifts to float new stock at exorbitant prices.
As the juridical relics of the Great Depression - chiefly amongst them,
the Glass-Steagall Act - were repealed, banks were liberated to enter new
markets, offer new financial instruments, and spread throughout the USA.
Product and geographical diversification led to enhanced financial health.
But the very fact that S&L's were poised to exploit these opportunities is
a tribute to politicians and regulators alike - though except for setting the
general tone of urgency and resolution, the relative absence of political
intervention in the handling of the crisis is notable. It was managed by the
autonomous, able, utterly professional, largely a- political Federal Reserve.
The political class provided the professionals with the tools they needed to
do the job.

This mode of collaboration may well be the most important lesson of this
crisis.
III. Case Study - Wall Street, October 1929 Also published by United
Press International (UPI) Claud Cockburn, writing for the "Times of
London" from New-York, described the irrational exuberance that gripped
the nation just prior to the Great Depression.
As Europe wallowed in post-war malaise, America seemed to have
discovered a new economy, the secret of uninterrupted growth and
prosperity, the fount of transforming technology: "The atmosphere of the
great boom was savagely exciting, but there were times when a person with
my European background felt alarmingly lonely. He would have liked to
believe, as these people believed, in the eternal upswing of the big bull
market or else to meet just one person with whom he might discuss some
general doubts without being regarded as an imbecile or a person of
deliberately evil intent-some kind of anarchist, perhaps".
The greatest analysts with the most impeccable credentials and track
records failed to predict the forthcoming crash and the unprecedented
economic depression that followed it. Irving Fisher, a preeminent
economist, who, according to his biographer-son, Irving Norton Fisher, lost
the equivalent of $140 million in today's money in the crash, made a series
of soothing predictions. On October 22 he uttered these avuncular
statements: "Quotations have not caught up with real values as yet ... (There
is) no cause for a slump ... The market has not been inflated but merely
readjusted..".
Even as the market convulsed on Black Thursday, October 24, 1929 and
on Black Tuesday, October 29 - the New York Times wrote: "Rally at close
cheers brokers, bankers optimistic".
In an editorial on October 26, it blasted rabid speculators and compliant
analysts: ``We shall hear considerably less in the future of those newly
invented conceptions of finance which revised the principles of political
economy with a view solely to fitting the stock market's vagaries.'' But it
ended thus: "(The Federal Reserve has) insured the soundness of the
business situation when the speculative markets went on the rocks.''
Compare this to Alan Greenspan Congressional testimony this summer:

"While bubbles that burst are scarcely benign, the consequences need not be
catastrophic for the economy ... (The Depression was brought on by)
ensuing failures of policy".
Investors, their equity leveraged with bank and broker loans, crowded
into stocks of exciting "new technologies", such as the radio and mass
electrification. The bull market - especially in issues of public utilities - was
fueled by "mergers, new groupings, combinations and good earnings" and
by corporate purchasing for "employee stock funds".
Cautionary voices - such as Paul Warburg, the influential banker, Roger
Babson, the "Prophet of Loss" and Alexander Noyes, the eternal Cassandra
from the New York Times - were derided. The number of brokerage
accounts doubled between March 1927 and March 1929.
When the market corrected by 8 percent between March 18-27 -
following a Fed induced credit crunch and a series of mysterious closed-
door sessions of the Fed's board - bankers rushed in. The New York Times
reported: ``Responsible bankers agree that stocks should now be supported,
having reached a level that makes them attractive.'' By August, the market
was up 35 percent on its March lows. But it reached a peak on September 3
and it was downhill since then.
On October 19, five days before "Black Thursday", Business Week
published this sanguine prognosis: "Now, of course, the crucial weaknesses
of such periods — price inflation, heavy inventories, over-extension of
commercial credit — are totally absent. The security market seems to be
suffering only an attack of stock indigestion... There is additional
reassurance in the fact that, should business show any further signs of
fatigue, the banking system is in a good position now to administer any
needed credit tonic from its excellent Reserve supply".
The crash unfolded gradually. Black Thursday actually ended with an
inspiring rally. Friday and Saturday - trading ceased only on Sundays -
witnessed an upswing followed by mild profit taking. The market dropped
12.8 percent on Monday, with Winston Churchill watching from the
visitors' gallery - incurring a loss of $10-14 billion.

The Wall Street Journal warned naive investors: "Many are looking for
technical corrective reactions from time to time, but do not expect these to
disturb the upward trend for any prolonged period."
The market plummeted another 11.7 percent the next day - though
trading ended with an impressive rally from the lows. October 31 was a
good day with a "vigorous, buoyant rally from bell to bell". Even
Rockefeller joined the myriad buyers. Shares soared. It seemed that the
worst was over.
The New York Times was optimistic: "It is thought that stocks will
become stabilized at their actual worth levels, some higher and some lower
than the present ones, and that the selling prices will be guided in the
immediate future by the worth of each particular security, based on its
dividend record, earnings ability and prospects. Little is heard in Wall Street
these days about 'putting stocks up.'" But it was not long before irate
customers began blaming their stupendous losses on advice they received
from their brokers. Alec Wilder, a songwriter in New York in 1929,
interviewed by Stud Terkel in "Hard Times" four decades later, described
this typical exchange with his money manager: "I knew something was
terribly wrong because I heard bellboys, everybody, talking about the stock
market.
About six weeks before the Wall Street Crash, I persuaded my mother in
Rochester to let me talk to our family adviser. I wanted to sell stock which
had been left me by my father. He got very sentimental: 'Oh your father
wouldn't have liked you to do that.' He was so persuasive, I said O.K. I
could have sold it for $160,000. Four years later, I sold it for $4,000".
Exhausted and numb from days of hectic trading and back office
operations, the brokerage houses pressured the stock exchange to declare a
two day trading holiday.
Exchanges around North America followed suit.
At first, the Fed refused to reduce the discount rate. "(There) was no
change in financial conditions which the board thought called for its
action." - though it did inject liquidity into the money market by purchasing
government bonds. Then, it partially succumbed and reduced the New York

discount rate, which, curiously, was 1 percent above the other Fed districts -
by 1 percent.
This was too little and too late. The market never recovered after
November 1. Despite further reductions in the discount rate to 4 percent, it
shed a whopping 89 percent in nominal terms when it hit bottom three years
later.
Everyone was duped. The rich were impoverished overnight. Small time
margin traders - the forerunners of today's day traders - lost their shirts and
much else besides. The New York Times: "Yesterday's market crash was
one which largely affected rich men, institutions, investment trusts and
others who participate in the market on a broad and intelligent scale.
It was not the margin traders who were caught in the rush to sell, but the
rich men of the country who are able to swing blocks of 5,000, 10,000, up
to 100,000 shares of high-priced stocks. They went overboard with no more
consideration than the little trader who was swept out on the first day of the
market's upheaval, whose prices, even at their lowest of last Thursday, now
look high by comparison ...
To most of those who have been in the market it is all the more awe-
inspiring because their financial history is limited to bull markets".
Overseas - mainly European - selling was an important factor. Some
conspiracy theorists, such as Webster Tarpley in his "British Financial
Warfare", supported by contemporary reporting by the likes of "The
Economist", went as far as writing: "When this Wall Street Bubble had
reached gargantuan proportions in the autumn of 1929, (Lord) Montagu
Norman (governor of the Bank of England 1920-1944) sharply (upped) the
British bank rate, repatriating British hot money, and pulling the rug out
from under the Wall Street speculators, thus deliberately and consciously
imploding the US markets. This caused a violent depression in the United
States and some other countries, with the collapse of financial markets and
the contraction of production and employment. In 1929, Norman
engineered a collapse by puncturing the bubble".
The crash was, in large part, a reaction to a sharp reversal, starting in
1928, of the reflationary, "cheap money", policies of the Fed intended, as

Adolph Miller of the Fed's Board of Governors told a Senate committee, "to
bring down money rates, the call rate among them, because of the
international importance the call rate had come to acquire. The purpose was
to start an outflow of gold - to reverse the previous inflow of gold into this
country (back to Britain)." But the Fed had already lost control of the
speculative rush.
The crash of 1929 was not without its Enrons and World.com's. Clarence
Hatry and his associates admitted to forging the accounts of their
investment group to show a fake net worth of $24 million British pounds -
rather than the true picture of 19 billion in liabilities. This led to forced
liquidation of Wall Street positions by harried British financiers.
The collapse of Middle West Utilities, run by the energy tycoon, Samuel
Insull, exposed a web of offshore holding companies whose only purpose
was to hide losses and disguise leverage. The former president of NYSE,
Richard Whitney was arrested for larceny.
Analysts and commentators thought of the stock exchange as decoupled
from the real economy. Only one tenth of the population was invested -
compared to 40 percent today. "The World" wrote, with more than a bit of
Schadenfreude: "The country has not suffered a catastrophe ... The
American people ... has been gambling largely with the surplus of its
astonishing prosperity." "The Daily News" concurred: "The sagging of the
stocks has not destroyed a single factory, wiped out a single farm or city lot
or real estate development, decreased the productive powers of a single
workman or machine in the United States." In Louisville, the "Herald Post"
commented sagely: "While Wall Street was getting rid of its weak holder to
their own most drastic punishment, grain was stronger. That will go to the
credit side of the national prosperity and help replace that buying power
which some fear has been gravely impaired".
During the Coolidge presidency, according to the Encyclopedia
Britannica, "stock dividends rose by 108 percent, corporate profits by 76
percent, and wages by 33 percent. In 1929, 4,455,100 passenger cars were
sold by American factories, one for every 27 members of the population, a
record that was not broken until 1950.
Productivity was the key to America's economic growth.

Because of improvements in technology, overall labour costs declined by
nearly 10 percent, even though the wages of individual workers rose".
Jude Waninski adds in his tome "The Way the World Works" that
"between 1921 and 1929, GNP grew to $103.1 billion from $69.6 billion.
And because prices were falling, real output increased even faster." Tax
rates were sharply reduced.
John Kenneth Galbraith noted these data in his seminal "The Great
Crash": "Between 1925 and 1929, the number of manufacturing
establishments increased from 183,900 to 206,700; the value of their output
rose from $60.8 billions to $68 billions. The Federal Reserve index of
industrial production which had averaged only 67 in 1921 ... had risen to
110 by July 1928, and it reached 126 in June 1929 ... (but the American
people) were also displaying an inordinate desire to get rich quickly with a
minimum of physical effort".
Personal borrowing for consumption peaked in 1928 - though the
administration, unlike today, maintained twin fiscal and current account
surpluses and the USA was a large net creditor.
Charles Kettering, head of the research division of General Motors
described consumeritis thus, just days before the crash: "The key to
economic prosperity is the organized creation of dissatisfaction".
Inequality skyrocketed. While output per man-hour shot up by 32 percent
between 1923 and 1929, wages crept up only 8 percent. In 1929, the top 0.1
percent of the population earned as much as the bottom 42 percent.
Business-friendly administrations reduced by 70 percent the exorbitant
taxes paid by those with an income of more than $1 million. But in the
summer of 1929, businesses reported sharp increases in inventories. It was
the beginning of the end.
Were stocks overvalued prior to the crash? Did all stocks collapse
indiscriminately? Not so. Even at the height of the panic, investors
remained conscious of real values. On November 3, 1929 the shares of
American Can, General Electric, Westinghouse and Anaconda Copper were
still substantially higher than on March 3, 1928.

John Campbell and Robert Shiller, author of "Irrational Exuberance",
calculated, in a joint paper titled "Valuation Ratios and the Lon-Run Market
Outlook: An Update" posted on Yale University' s Web Site, that share
prices divided by a moving average of 10 years worth of earnings reached
28 just prior to the crash. Contrast this with 45 on March 2000.
In an NBER working paper published December 2001 and tellingly titled
"The Stock Market Crash of 1929 - Irving Fisher was Right", Ellen
McGrattan and Edward Prescott boldly claim:
"We find that the stock market in 1929 did not crash because the market
was overvalued. In fact, the evidence strongly suggests that stocks were
undervalued, even at their 1929 peak".
According to their detailed paper, stocks were trading at 19 times after-
tax corporate earning at the peak in 1929, a fraction of today's valuations
even after the recent correction. A March 1999 "Economic Letter"
published by the Federal Reserve Bank of San-Francisco wholeheartedly
concurs. It notes that at the peak, prices stood at 30.5 times the dividend
yield, only slightly above the long term average.
Contrast this with an article published in June 1990 issue of the "Journal
of Economic History" by Robert Barsky and Bradford De Long and titled
"Bull and Bear Markets in the Twentieth Century": "Major bull and bear
markets were driven by shifts in assessments of fundamentals: investors had
little knowledge of crucial factors, in particular the long run dividend
growth rate, and their changing expectations of average dividend growth
plausibly lie behind the major swings of this century".
Jude Waninski attributes the crash to the disintegration of the pro-free-
trade coalition in the Senate which later led to the notorious Smoot-Hawley
Tariff Act of 1930. He traces all the important moves in the market between
March 1929 and June 1930 to the intricate protectionist danse macabre in
Congress.
This argument may never be decided. Is a similar crash on the cards?
This cannot be ruled out.
The 1990's resembled the 1920's in more than one way.

Are we ready for a recurrence of 1929? About as we were prepared in
1928. Human nature - the prime mover behind market meltdowns - seemed
not to have changed that much in these intervening seven decades.
Will a stock market crash, should it happen, be followed by another
"Great Depression"? It depends which kind of crash. The short term
puncturing of a temporary bubble - e.g., in 1962 and 1987 - is usually
divorced from other economic fundamentals. But a major correction to a
lasting bull market invariably leads to recession or worse.
As the economist Hernan Cortes Douglas reminds us in "The Collapse of
Wall Street and the Lessons of History" published by the Friedberg
Mercantile Group, this was the sequence in London in 1720 (the infamous
"South Sea Bubble"), and in the USA in 1835-40 and 1929-32.
IV. Britain's Real Estate The five ghastly "Jack the Ripper" murders took
place in an area less than a quarter square mile in size. Houses in this
haunting and decrepit no man's land straddling the City and metropolitan
London could be had for 25-50,000 British pounds as late as a decade ago.
How things change! The general buoyancy in real estate prices in the capital
coupled with the adjacent Spitalfields urban renewal project have lifted
prices. A house not 50 yards from the scene of the Ripper's last - and most
ghoulish - slaying now sells for over 1 million pounds. In central London,
one bedroom apartments retail for an outlandish half a million.
According to research published in September 2002 by Halifax, the UK's
largest mortgage lender, the number of 1 million pound homes sold has
doubled in 1999-2002 to 2600. By 2002, it has increased elevenfold since
1995.
According to The Economist's house price index, prices rose by a further
15.6% in 2003, 10.2% in 2004 and a whopping 147% in total since 1997. In
Greater London, one in every 90 homes fetches even a higher price. The
average UK house now costs 100,000 pounds. In the USA, the ratios of
house prices to rents and to median income are at historic highs.
One is reminded of the Japanese boast, at the height of their realty
bubble, that the grounds of the royal palace in Tokyo are worth more than
the entire real estate of Manhattan. Is Britain headed the same way? A

house - much like a Big Mac - is a basket of raw materials, goods, and
services. But, unlike the Big Mac - and the purchasing power index it
spawned - houses are also investment vehicles and stores of value. They
yield often tax exempt capital gains, rental income, or benefits from
occupying them (rent payments saved). Real estate is used to hedge against
inflation, save for old age, and speculate. Prices of residential and
commercial property reflect scarcity, investment fads, and changing moods.
Homeowners in both the UK and the USA - spurred on by aggressive
marketing and the lowest interest rates in 30 years - have been refinancing
old, more expensive, mortgages and heavily borrowing against their
"equity" - i.e., against the meteoric rise in the market prices of their abodes.
According to the Milken Institute in Los Angeles, asset bubbles tend to
both enhance and cannibalize each other.
Profits from surging tradable securities are used to buy property and
drive up its values. Borrowing against residential equity fuels
overvaluations in fervid stock exchanges. When one bubble bursts - the
other initially benefits from an influx of funds withdrawn in panic from the
shriveling alternative.
Quantitatively, a considerably larger share of the nation's wealth is tied in
real estate than in the capital markets.
Yet, the infamous wealth effect - an alleged fluctuation in the will to
consume as a result of changing fortunes in the stock exchange - is equally
inconspicuous in the realty markets. It seems that consumption is correlated
with lifelong projected earnings rather than with the state of one's savings
and investments.
This is not the only counter-intuitive finding. Asset inflation - no matter
how vertiginous - rarely spills into consumer prices. The recent bubbles in
Japan and the USA, for instance, coincided with a protracted period of
disinflation. The bursting of bubbles does have a deflationary effect,
though.
In a late 2002 survey of global house price movements, "The Economist"
concluded that real estate inflation is a global phenomenon. Though Britain
far outpaces the United States and Italy (65% rise since 1997), it falls

behind Ireland (179%) and South Africa (195%). It is in league with
Australia (with 113%) and Spain (132%).
The paper notes wryly: "Just as with equities in the late 1990s, property
bulls are now coming up with bogus arguments for why rampant house-
price inflation is sure to continue.
Demographic change ... Physical restrictions and tough planning laws ...
Similar arguments were heard in Japan in the late 1980s and Germany in
the early 1990s - and yet in recent years house prices in these two countries
have been falling. British house prices also tumbled in the late 1980s".
They are bound to do so again. In the long run, the rise in house prices
cannot exceed the increase in disposable income. The effects of the bursting
of a property bubble are invariably more pernicious and prolonged than the
outcomes of a bear market in stocks. Real estate is much more leveraged.
Debt levels can well exceed home equity ("negative equity") in a downturn.
Nowadays, loans are not eroded by high inflation. Adjustable rate
mortgages - one third of the annual total in the USA - will make sure that
the burden of real indebtedness mushrooms as interest rates rise.
The Economist (April 2005): "An IMF study on asset bubbles estimates
that 40% of housing booms are followed by housing busts, which last for an
average of four years and see an average decline of roughly 30% in home
values. But given how many homebuyers in booming markets seem to be
basing their purchasing decisions on expectations of outsized returns-a
recent survey of buyers in Los Angeles indicated that they expected their
homes to increase in value by a whopping 22% a year over the next decade-
nasty downturns in at least some markets seem likely".
With both the equity and realty markets in gloom, people revert to cash
and bonds and save more - leading to deflation or recession or both. Japan
is a prime example of such a shift of investment preferences. When prices
collapse sufficiently to become attractive, investors pile back into both the
capital and real estate markets. This cycle is as old and as inevitable as
human greed and fear.

X. The Shadowy World of International Finance
Strange, penumbral, characters roam the boardrooms of banks in the
countries in transition. Some of them pop apparently from nowhere, others
are very well connected and equipped with the most excellent introductions.
They all peddle financial transactions which are too good to be true and
often are. In the unctuously perfumed propinquity of their Mercedesed,
Rolex waving entourage - the polydipsic natives dissolve in their irresistible
charm and the temptations of the cash: mountainous returns on capital,
effulgent profits, no collaterals, track record, or business plan required.
Total security is cloyingly assured.
These Fausts roughly belong to four tribes: The Shoppers These are the
shabby operators of the marginal shadows of the world of finance. They
broker financial deals with meretricious sweat only to be rewarded their
meagre, humiliated fees. Most of their deals do not materialize.
The principle is very simple: They approach a bank, a financial
institution, or a borrower and say: "We are connected to banks or financial
institutions in the West. We can bring you money in the form of credits. But
to do that - you must first express interest in getting this money. You must
furnish us with a bank guarantee / promissory note / letter of intent that
indicates that you desire the credit and that you are willing to provide a
liquid financial instrument to back it up.". Having obtained such
instruments, the shoppers begin to "shop around". They approach banks and
financial institutions (usually, in the West). This time, they reverse their
text: "We have an excellent client, a good borrower. Are you willing to lend
to it?" An informal process of tendering ensues. Sometimes it ends in a
transaction and the shopper collects a small commission (between one
quarter of a percentage point and two percentage points - depending on the
amount).
Mostly it doesn't -and the Flying Dutchman resumes his wanderings
looking for more venal gulosity and less legal probity.

The Con-Men These are crooks who set up elaborate schemes ("sting
operations") to extract money from unsuspecting people and financial
institutions. They establish "front" or "phantom" firms and offices
throughout the world. They tempt the gullible by offering them enormous,
immediate, tax-free, effort-free, profits. They let the victims profit in the
first round or two of the scam. Then, they sting: the victims invest money
and it evaporates together with the dishonest operators. The "offices" are
deserted, the fake identities, the forged bank references, the falsified
guarantees are all exposed (often with the help of an inside informant).
Probably the most famous and enduring scam is the "Nigerian-type
Connection". Letters - allegedly composed by very influential and highly
placed officials - are sent out to unsuspecting businessmen. The latter are
asked to make their bank accounts available to the former, who profess to
need the third party bank accounts through which to funnel the sweet fruits
of corruption. The account owners are promised huge financial rewards if
they collaborate and if they bear some minor-by- comparison upfront costs.
The con-men pocket these "expenses" and vanish. Sometimes, they even
empty the accounts of their entire balance as they evaporate.
The Launderers A lot of cash goes undeclared to tax authorities in
countries in transition. The informal economy (the daughter of both
criminal and legitimate parents) comprises between 15% (Slovenia) and
50% (Russia, Macedonia) of the official one. Some say these figures are a
deliberate and ferocious understatement. These are mind boggling amounts,
which circulate between financial centres and off shore havens in the world:
Cyprus, the Cayman Islands, Liechtenstein (Vaduz), Panama and dozens of
aspiring laundrettes.
The money thus smuggled is kept in low-yielding cash deposits. To
escape the cruel fate of inflationary corrosion, it has to be reinvested. It is
stealthily re- introduced to the very economy that it so sought to evade, in
the form of investment capital or other financial assets (loans and credits).
Its anxious owners are preoccupied with legitimising their stillborn cash
through the conduit of tax-fearing enterprises, or with lending it to same.
The emphasis is on the word: "legitimate". The money surges in through
mysterious and anonymous foreign corporations, via off-shore banking
centres, even through respectable financial institutions (the Bank of New

York we mentioned?). It is easy to recognize a laundering operation. Its
hallmark is a pronounced lack of selectivity.
The money is invested in anything and everything, as long as it appears
legitimate. Diversification is not sought by these nouveau tycoons and they
have no core investment strategy. They spread their illicit funds among
dozens of disparate economic activities and show not the slightest interest
in the putative yields on their investments, the maturity of their assets, the
quality of their newly acquired businesses, their history, or real value.
Never the sedulous, they pay exorbitantly for all manner of prestidigital
endeavours. The future prospects and other normal investment criteria are
beyond them. All they are after is a mirage of lapidarity.
The Investors This is the most intriguing group. Normative, law abiding,
businessmen, who stumbled across methods to secure excessive yields on
their capital and are looking to borrow their way into increasing it. By
cleverly participating in bond tenders, by devising ingenious option
strategies, or by arbitraging - yields of up to 300% can be collected in the
immature markets of transition without the normally associated risks. This
sub-species can be found mainly in Russia and in the Balkans.
Its members often buy sovereign bonds and notes at discounts of up to
80% of their face value. Russian obligations could be had for less in August
1998 and Macedonian ones during the Kosovo crisis. In cahoots with the
issuing country's central bank, they then convert the obligations to local
currency at par (for 100% of their face value). The difference makes,
needless to add, for an immediate and hefty profit, yet it is in (often
worthless and vicissitudinal) local currency. The latter is then hurriedly
disposed of (at a discount) and sold to multinationals with operations in the
country of issue, which are in need of local tender. This fast becomes an
almost addictive avocation.
Intoxicated by this pecuniary nectar, the fortunate, those privy to the
secret, try to raise more capital by hunting for financial instruments they
can convert to cash in Western banks. A bank guarantee, a promissory note,
a confirmed letter of credit, a note or a bond guaranteed by the Central
Bank - all will do as deposited collateral against which a credit line is

established and cash is drawn. The cash is then invested in a new cycle of
inebriation to yield fantastic profits.
It is easy to identify these "investors". They eagerly seek financial
instruments from almost any local bank, no matter how suspect. They offer
to pay for these coveted documents (bank guarantees, bankers' acceptances,
letters of credit) either in cash or by lending to the bank's clients and this
within a month or more from the date of their issuance. They agree to
"cancel" the locally issued financial instruments by offering a "counter-
financial- instrument" (safe keeping receipt, contra-guarantee, counter
promissory note, etc.). This "counter-instrument" is issued by the very
Prime World or European Bank in which the locally issued financial
instruments are deposited as collateral.
The Investors invariably confidently claim that the financial instrument
issued by the local bank will never be presented or used (which is true) and
that this is a risk free transaction (which is not entirely so). If they are
forced to lend to the bank's clients, they often ignore the quality of the
credit takers, the yields, the maturities and other considerations which
normally tend to interest lenders very much.
Whether a financial instrument cancelled by another is still valid,
presentable and should be honoured by its issuer is still debated. In some
cases it is clearly so. If something goes horribly (and rarely, admittedly)
wrong with these transactions - the local bank stands to suffer, too.
It all boils down to a terrible hunger, the kind of thirst that can be quelled
only by the denominated liquidity of lucre.
In the post nuclear landscape of this part of the world, a fantasy is shared
by both predators and prey. Circling each other in marble temples, they
switch their roles in dizzying progression. Tycoons and politicians,
industrialists and bureaucrats all vie for the attention of Mammon. The
shifting coalitions of well groomed man in back stabbed suits, an
hallucinatory carousel of avarice and guile. But every circus folds and every
Luna park is destined to shut down. The dying music, the frozen accounts
of the deceived, the bankrupt banks, the Jurassic Park of skeletal industrial
beasts - a muted testimony to a wild age of mutual assured destruction and
self deceit.

The future of Eastern and South Europe. The present of Russia, Albania
and Yugoslavia.

XI. Treasure Island Revisited On Maritime Piracy
The rumors concerning the demise of maritime piracy back in the 19th
century were a tad premature. The scourge has so resurged that the
International Maritime Board (IMB), founded by the International Chamber
of Commerce (ICC) in 1981, is forced to broadcast daily piracy reports to
all shipping companies by satellite from its Kuala Lumpur Piracy Reporting
Center, established in 1992 and partly funded by maritime insurers. The
reports carry this alarming disclaimer: "For statistical purposes, the IMB
defines piracy and armed robbery as: An act of boarding or attempting to
board any ship with the apparent intent to commit theft or any other crime
and with the apparent intent or capability to use force in the furtherance of
that act. This definition thus covers actual or attempted attacks whether the
ship is berthed, at anchor or at sea. Petty thefts are excluded, unless the
thieves are armed".
The 1994 United Nations Convention on the Law of the Sea defines
piracy as "any illegal acts of violence or detention, or any act of
depredation, committed by individuals (borne aboard a pirate vessel) for
private ends against a private ship or aircraft (the victim vessel)".
When no "pirate vessel" is involved - for instance, when criminals
embark on a ship and capture it - the legal term is hijacking.
On July 8, 2002 seven pirates, armed with long knives attacked an officer
of a cargo ship berthed in Chittagong port in Bangladesh, snatched his gold
chain and watch and dislocated his arm. This was the third such attack since
the ship dropped anchor in this minacious port.
Three days earlier, in Indonesia, similarly-armed pirates escaped with the
crew's valuables, having tied the hands of the duty officer. Pirates in small
boats stole anodes from the stern of a bulk carrier in Bangladesh. Others, in
Indonesia, absconded with a life raft.
The pirates of Guyana are either unlucky or untrained.

They were consistently scared off by flares hurled at them and alarms set
by vigilant hands on deck. A Colombian band, riding a high speed boat,
attempted to board a container ship. Warring parties in Somalia hijacked yet
another ship in June 2002.
A particularly egregious case - and signs of growing sophistication and
coordinated action - is described in the July 1-8, 2002 report of the IMB:
"Six armed pirates boarded a chemical tanker from a small boat and stole
ship's stores. Another group of pirates broke in to engine room and stole
spare parts. Thefts took place in spite of the ship engaging three shore
security watchmen." Piracy incidents have been reported in India, Malaysia,
Philippines, Thailand, Vietnam, the Red Sea, the Gulf of Aden, Nigeria,
Brazil, Colombia, Dominican Republic, Ecuador, Peru, Venezuela.
According to the ICC Year 2001 Piracy Report, more than 330 attacks on
seafaring vessels were reported in 2001 - down by a quarter compared to
2000 but 10 percent higher than 1999 and four times the 1991 figure. Piracy
rose 40 percent between 1998 and 1999 alone.
Sixteen ships - double the number in 2000 - were captured and taken over
in 2001. Eighty seven attacks were reported during the first quarter of 2002
- up from 68 in the corresponding period the year before. Seven of these
were hijackings - compared to only 1 in the first quarter of 2001. Nine of
every 10 hijacked ships are ultimately recovered, often with the help of the
IMB.
Many masters and shipowners do not report piracy for fear of delays due
to protracted investigations, increased insurance premiums, bad publicity,
and stifling red tape.
The number of unreported attacks in 1999 was estimated by the World
Maritime Piracy Report to be 130.
According to "The Economist", the IMO believes that half of all
incidents remain untold. Still, increased patrols and international
collaboration among law enforcement agencies dented the clear upward
trend in maritime crime - even in the piracy capital, Indonesia.
The number of incidents in the pirate-infested Malacca Straits dropped
from 75 in 2000 to 17 in 2001 - though the number of crew "kidnap and

ransom" operations, especially in Aceh, has increased. Owners usually pay
the "reasonable" amounts demanded - c. $100,000 per ship.
Contrary to folklore, most ships are attacked while at anchor.
Twenty one people, including passengers, were killed in 2001 - and 210
taken hostage. Assaults involving guns were up 50 percent to 73 - those
involving mere knives down by a quarter to 105. Piracy seems to ebb and
flow with the business cycles of the host economies. The Asian crisis,
triggered by the freefall of the Thai baht in 1997-8, gave a boost to East
Asian maritime robbers. So did the debt crises of Latin America a decade
earlier. Drug transporters - armed with light aircraft and high speed
motorboats - sometimes double as pirates during the dry season of crop
growth.
Pirates endanger ship and crew. But they often cause collateral damage as
well. Pirates have been known to dump noxious cargo into the sea, or tie up
the crew and let an oil tanker steam ahead, its navigational aides smashed,
or tamper with substances dangerous to themselves and to others, or cast
crew and passengers adrift in tiny rafts with little food and water.
Many shipowners resorted to installing on-board satellite tracking
systems, such as Shiploc, and aircraft-like "black boxes". A bulletproof life
vest, replete with an integral jagged edged knife, was on display in the
millennium exhibition at the Millennium Dome two years ago. The
International Maritime Organization (IMO) is considering to compel
shipowners to tag their vessels with visibly embossed numbers in
compliance with the Safety of Life at Sea Convention.
The IMB also advises shipping companies to closely examine the papers
of crew and masters, thousands of whom carry forged documents. In 54
maritime administrations surveyed in 2001 by the Seafarers' International
Research Centre, Cardiff University in Wales, more than 12,000 cases of
forged certificates of competency were unearthed.
Many issuing authorities are either careless or venal or both. The IMB
accused the Coast Guard Office of Puerto Rico for issuing 500 such
"suspicious" certificates. The Chinese customs and navy - especially along

the southern coast - have often been decried for working hand in glove with
pirates.
False documents are an integral - and crucial - part of maritime piracy.
The IMB says: "Many of the phantom ships that set off to sea with a cargo
and then disappear are sailed by crewmen with false passports and
competency certificates. They usually escape detection by the port
authorities. In a recent case of a vessel located and arrested in South-East
Asia further to IMB investigations, it has emerged that all the senior
officers had false passports. The ship's registry documents were also false".
As documents go electronic and integrated in proprietary or common
cargo tracking systems, such forgery will wane. Bolero - an international
digital bill of lading ledger - is backed by the European Union, banks,
shipping and insurance companies. The IMO is a proponent of a technology
to apply encrypted "digital signatures" to electronic bills of lading. Still, the
industry is highly fragmented and many ships and ports don't even possess
rudimentary information technology. The protection afforded by the likes of
Bolero is at least five years away.
Pirates sometimes work hand in hand with conspiring crew members (or,
less often, stowaways). In many countries - in East Asia, Latin America,
and Africa - Coast Guard operatives, corrupt drug agents, and other law
enforcement officials, moonlight as pirates. Renegade members of British
trained Indonesian anti-piracy squads are still roaming the Malacca Straits.
Pirates also enjoy the support of an insidious and vast network of
suborned judges and bureaucrats. Local villagers along the coasts of
Indonesia and Malaysia - and Africa - welcome pirate business and provide
the perpetrators with food and shelter.
Moreover, large tankers, container ships, and cargo vessels are largely
computerized and their crew members few. The value of an average vessel's
freight has increased dramatically with improvements in container and oil
storage technologies. "Flag of convenience" registration has assumed
monstrous proportions, allowing ship owners and managers to conceal their
identity effectively. Belize, Honduras, and Panama are the most notorious,
no questions asked, havens.

Piracy has matured into a branch of organized crime.
Hijacking requires money, equipment, weapons, planning, experience
and contacts with corrupt officials. The loot per vessel ranges from $8
million to $200 million.
Pottengal Mukundan, Director of ICC's Commercial Crime Services
states in an IMB press release: "(Piracy) typically involves a mother ship
from which to launch the attacks, a supply of automatic weapons, false
identity papers for the crew and vessel, fake cargo documents, and a broker
network to sell the stolen goods illegally. Individual pirates don't have these
resources.
Hijackings are the work of organized crime rings".
The IMB describes the aftermath of a typical hijacking: "The Global
Mars has probably been given a new name and repainted. Armed with false
registration papers and bills of lading, the pirates - or more likely the mafia
bosses pulling the strings - will then try to dispose of their booty. The vessel
has probably put in to a port where the false identity of vessel and cargo
may escape detection.
Even when identified, the gangs have been known to bribe local officials
to allow them to sell the cargo and leave the port".
Such a ship is often "recycled" a few times. It earns its operators an
average of $40-50 million per "cycle", according to "The Economist". The
pirates contract with sellers or shipping agents to load it with a legitimate
consignment of goods or commodities. The sellers and agents are unaware
of the true identity of the ship, or of its unsavory "owners/managers".
The pirates invariably produce an authentic vessel registration certificate
that they acquired from crooked officials - and provide the sellers or agents
with a bill of lading. The payload is then sold to networks of traders in
stolen merchandise or to gullible buyers in a different port of destination -
and the ship is ready for yet another round.
In January 2002, the Indonesian Navy has permanently stationed six
battleships in the Malacca Straits, three of them off the coast of the
secessionist region of Aceh. A further 20-30 ships and 10 aircraft conduct

daily patrols of the treacherous traffic lane. Some 200-600 ships cross the
Straits daily. A mere 50 ships or so are boarded and searched every month.
The Greek government has gunboats patrolling the 2 miles wide Corfu
Channel, where yachts frequently fall prey to Albanian pirates. Brazil has
imposed an unpopular anti-piracy inspection fee on berthing vessels and
used the proceeds to finance a SWAT team to protect ships and their crews
while in port. Both India and Thailand have similar units.
International cooperation is also on the rise. About one third of the
world's shipping traffic goes through the South China Sea. A conference
convened by Japan in March 2000 - Japanese vessels have become favored
targets of piracy in the last few years - pushed for the ratification of the
International Maritime Organisation's (IMO) 1988 Rome Convention on the
Suppression of Unlawful Acts against the Safety of Maritime Navigation by
Asian and ASEAN countries.
The Convention makes piracy an extraterritorial crime and, thus, removes
the thorny issue of jurisdiction in cases of piracy carried in another
country's territorial waters or out on the high seas. The Comite Maritime
International - the umbrella organization of national maritime law
associations - promulgated a model anti-piracy law last year.
Though it rejected Japan's offer for collaboration, in a sharp reversal of
its previous policy, China started handing down death sentences against
murderous pirates.
The 13 marauders who seized the Cheung Son and massacred its 23
Chinese sailors were executed five years ago in the southern city of
Shanwei. Another 25 people received long prison sentences. The - declared
- booty amounted to a mere $300,000.
India and Iran - two emerging "pirates safe harbor" destinations - have
also tightened up sentencing and port inspections. In the Alondra Rainbow
hijacking, the Indian Navy captured the Indonesian culprits in a cinematic
chase off Goa. They were later sentenced severely under both the Indian
Penal Code and international law. Even the junta in Myanmar has taken
tentative steps against compatriots with piratical predilections.

Law enforcement does not tolerate a vacuum. "The Economist" reports
about two private military companies - Marine Risk Management and
Satellite Protection Services (SPS) - which deploy airborne mercenaries to
deal with piracy. SPS has even suggested to station 2500 former Dutch
marines in Subic Bay in the Philippines - for a mere $2500 per day per
combatant.
Shipowners are desperate. Quoted by "The Economist", they "suggest
that the region's governments negotiate the right for navies to chase pirates
across national boundaries: the so-called 'right of hot pursuit'. So far, only
Singapore and Indonesia have negotiated limited rights.
Some suggest that the American navy should be invited into territorial
waters to combat piracy, a 'live' exercise it might relish. At the very least,
countries such as Indonesia should advertise which bits of their territorial
waters at any time are patrolled and safe from pirates. No countries
currently do this".

XII. Legalizing Crime
Also Read: Narcissists, Ethnic or Religious Affiliation, and Terrorists
"Those who have the command of the arms in a country are masters of
the state, and have it in their power to make what revolutions they please.
[Thus,] there is no end to observations on the difference between the
measures likely to be pursued by a minister backed by a standing army, and
those of a court awed by the fear of an armed people".
Aristotle (384-322 BC), Greek philosopher "Murder being the very
foundation of our social institutions, it is consequently the most imperious
necessity of civilised life. If there were no murder, government of any sort
would be inconceivable. For the admirable fact is that crime in general, and
murder in particular, not simply excuses it but represents its only reason to
exist ... Otherwise we would live in complete anarchy, something we find
unimaginable ..".
Octave Mirbeau (1848-1917), The Torture Garden The state has a
monopoly on behaviour usually deemed criminal. It murders, kidnaps, and
locks up people.
Sovereignty has come to be identified with the unbridled - and exclusive
- exercise of violence. The emergence of modern international law has
narrowed the field of permissible conduct. A sovereign can no longer
commit genocide or ethnic cleansing with impunity, for instance.
Many acts - such as the waging of aggressive war, the mistreatment of
minorities, the suppression of the freedom of association - hitherto
sovereign privilege, have thankfully been criminalized. Many politicians,
hitherto immune to international prosecution, are no longer so.
Consider Yugoslavia's Milosevic and Chile's Pinochet.
But, the irony is that a similar trend of criminalization - within national
legal systems - allows governments to oppress their citizenry to an extent
previously unknown.

Hitherto civil torts, permissible acts, and common behaviour patterns are
routinely criminalized by legislators and regulators. Precious few are
decriminalized.
Consider, for instance, the criminalization in the Economic Espionage
Act (1996) of the misappropriation of trade secrets and the criminalization
of the violation of copyrights in the Digital Millennium Copyright Act
(2000) - both in the USA. These used to be civil torts.
They still are in many countries. Drug use, common behaviour in
England only 50 years ago - is now criminal.
The list goes on.
Criminal laws pertaining to property have malignantly proliferated and
pervaded every economic and private interaction. The result is a
bewildering multitude of laws, regulations statutes, and acts.
The average Babylonian could have memorizes and assimilated the
Hammurabic code 37 centuries ago - it was short, simple, and intuitively
just.
English criminal law - partly applicable in many of its former colonies,
such as India, Pakistan, Canada, and Australia - is a mishmash of
overlapping and contradictory statutes - some of these hundreds of years old
- and court decisions, collectively known as "case law".
Despite the publishing of a Model Penal Code in 1962 by the American
Law Institute, the criminal provisions of various states within the USA
often conflict. The typical American can't hope to get acquainted with even
a negligible fraction of his country's fiendishly complex and hopelessly
brobdignagian criminal code. Such inevitable ignorance breeds criminal
behaviour - sometimes inadvertently - and transforms many upright citizens
into delinquents.
In the land of the free - the USA - close to 2 million adults are behind
bars and another 4.5 million are on probation, most of them on drug
charges. The costs of criminalization - both financial and social - are mind
boggling. According to "The Economist", America's prison system cost it

$54 billion a year - disregarding the price tag of law enforcement, the
judiciary, lost product, and rehabilitation.
What constitutes a crime? A clear and consistent definition has yet to
transpire.
There are five types of criminal behaviour: crimes against oneself, or
"victimless crimes" (such as suicide, abortion, and the consumption of
drugs), crimes against others (such as murder or mugging), crimes among
consenting adults (such as incest, and in certain countries, homosexuality
and euthanasia), crimes against collectives (such as treason, genocide, or
ethnic cleansing), and crimes against the international community and
world order (such as executing prisoners of war). The last two categories
often overlap.
The Encyclopaedia Britannica provides this definition of a crime: "The
intentional commission of an act usually deemed socially harmful or
dangerous and specifically defined, prohibited, and punishable under the
criminal law."
But who decides what is socially harmful? What about acts committed
unintentionally (known as "strict liability offences" in the parlance)? How
can we establish intention - "mens rea", or the "guilty mind" - beyond a
reasonable doubt? A much tighter definition would be: "The commission of
an act punishable under the criminal law." A crime is what the law - state
law, kinship law, religious law, or any other widely accepted law - says is a
crime. Legal systems and texts often conflict.
Murderous blood feuds are legitimate according to the 15th century
"Qanoon", still applicable in large parts of Albania. Killing one's infant
daughters and old relatives is socially condoned - though illegal - in India,
China, Alaska, and parts of Africa. Genocide may have been legally
sanctioned in Germany and Rwanda - but is strictly forbidden under
international law.
Laws being the outcomes of compromises and power plays, there is only
a tenuous connection between justice and morality. Some "crimes" are
categorical imperatives.

Helping the Jews in Nazi Germany was a criminal act - yet a highly
moral one.
The ethical nature of some crimes depends on circumstances, timing, and
cultural context. Murder is a vile deed - but assassinating Saddam Hussein
may be morally commendable. Killing an embryo is a crime in some
countries - but not so killing a fetus. A "status offence" is not a criminal act
if committed by an adult.
Mutilating the body of a live baby is heinous - but this is the essence of
Jewish circumcision. In some societies, criminal guilt is collective. All
Americans are held blameworthy by the Arab street for the choices and
actions of their leaders. All Jews are accomplices in the "crimes" of the
"Zionists".
In all societies, crime is a growth industry. Millions of professionals -
judges, police officers, criminologists, psychologists, journalists, publishers,
prosecutors, lawyers, social workers, probation officers, wardens,
sociologists, non-governmental-organizations, weapons manufacturers,
laboratory technicians, graphologists, and private detectives - derive their
livelihood, parasitically, from crime. They often perpetuate models of
punishment and retribution that lead to recidivism rather than to to the
reintegration of criminals in society and their rehabilitation.
Organized in vocal interest groups and lobbies, they harp on the
insecurities and phobias of the alienated urbanites.
They consume ever growing budgets and rejoice with every new
behaviour criminalized by exasperated lawmakers. In the majority of
countries, the justice system is a dismal failure and law enforcement
agencies are part of the problem, not its solution.
The sad truth is that many types of crime are considered by people to be
normative and common behaviours and, thus, go unreported. Victim
surveys and self-report studies conducted by criminologists reveal that most
crimes go unreported. The protracted fad of criminalization has rendered
criminal many perfectly acceptable and recurring behaviours and acts.
Homosexuality, abortion, gambling, prostitution, pornography, and suicide
have all been criminal offences at one time or another.

But the quintessential example of over-criminalization is drug abuse.
There is scant medical evidence that soft drugs such as cannabis or
MDMA ("Ecstasy") - and even cocaine - have an irreversible effect on brain
chemistry or functioning.
Last month an almighty row erupted in Britain when Jon Cole, an
addiction researcher at Liverpool University, claimed, to quote "The
Economist" quoting the "Psychologist", that: "Experimental evidence
suggesting a link between Ecstasy use and problems such as nerve damage
and brain impairment is flawed ... using this ill-substantiated cause- and-
effect to tell the 'chemical generation' that they are brain damaged when
they are not creates public health problems of its own".
Moreover, it is commonly accepted that alcohol abuse and nicotine abuse
can be at least as harmful as the abuse of marijuana, for instance. Yet,
though somewhat curbed, alcohol consumption and cigarette smoking are
legal. In contrast, users of cocaine - only a century ago recommended by
doctors as tranquilizer - face life in jail in many countries, death in others.
Almost everywhere pot smokers are confronted with prison terms.
The "war on drugs" - one of the most expensive and protracted in history
- has failed abysmally. Drugs are more abundant and cheaper than ever. The
social costs have been staggering: the emergence of violent crime where
none existed before, the destabilization of drug- producing countries, the
collusion of drug traffickers with terrorists, and the death of millions - law
enforcement agents, criminals, and users.
Few doubt that legalizing most drugs would have a beneficial effect.
Crime empires would crumble overnight, users would be assured of the
quality of the products they consume, and the addicted few would not be
incarcerated or stigmatized - but rather treated and rehabilitated.
That soft, largely harmless, drugs continue to be illicit is the outcome of
compounded political and economic pressures by lobby and interest groups
of manufacturers of legal drugs, law enforcement agencies, the judicial
system, and the aforementioned long list of those who benefit from the
status quo.

Only a popular movement can lead to the decriminalization of the more
innocuous drugs. But such a crusade should be part of a larger campaign to
reverse the overall tide of criminalization. Many "crimes" should revert to
their erstwhile status as civil torts. Others should be wiped off the statute
books altogether. Hundreds of thousands should be pardoned and allowed to
reintegrate in society, unencumbered by a past of transgressions against an
inane and inflationary penal code.
This, admittedly, will reduce the leverage the state has today against its
citizens and its ability to intrude on their lives, preferences, privacy, and
leisure. Bureaucrats and politicians may find this abhorrent. Freedom loving
people should rejoice.

APPENDIX - Should Drugs be Legalized?
The decriminalization of drugs is a tangled issue involving many separate
moral/ethical and practical strands which can, probably, be summarized
thus:
(a) Whose body is it anyway? Where do I start and the government
begins? What gives the state the right to intervene in decisions pertaining
only to my self and contravene them?
PRACTICAL:
The government exercises similar "rights" in other cases (abortion,
military conscription, sex)
(b) Is the government the optimal moral agent, the best or the right
arbiter, as far as drug abuse is concerned?
PRACTICAL:
For instance, governments collaborate with the illicit drug trade when it
fits their realpolitik purposes.
(c) Is substance abuse a personal or a social choice? Can one limit the
implications, repercussions and outcomes of one's choices in general and of
the choice to abuse drugs, in particular? If the drug abuser in effect makes
decisions for others, too - does it justify the intervention of the state? Is the
state the agent of society, is it the only agent of society and is it the right
agent of society in the case of drug abuse?
(d) What is the difference (in rigorous philosophical principle) between
legal and illegal substances? Is it something in the nature of the substances?
In the usage and what follows? In the structure of society? Is it a moral
fashion?
PRACTICAL:

Does scientific research support or refute common myths and ethos
regarding drugs and their abuse?
Is scientific research influenced by the current anti-drugs crusade and
hype? Are certain facts suppressed and certain subjects left unexplored?
(e) Should drugs be decriminalized for certain purposes (e.g., marijuana
and glaucoma)? If so, where should the line be drawn and by whom?
PRACTICAL:
Recreational drugs sometimes alleviate depression.
Should this use be permitted?

XIII. Begging Your Trust in Africa
The syntax is tortured, the grammar mutilated, but the message - sent by
snail mail, telex, fax, or e-mail - is coherent: an African bigwig or his heirs
wish to transfer funds amassed in years of graft and venality to a safe bank
account in the West. They seek the recipient's permission to make use of his
or her inconspicuous services for a percentage of the loot - usually many
millions of dollars.
A fee is required to expedite the proceedings, or to pay taxes, or to bribe
officials - they plausibly explain. A recent (2005) variant involves payment
with expertly forged postal money orders for goods exported to a transit
address.
It is a scam two decades old - and it still works. In September 2002, a
bookkeeper for a Berkley, Michigan law firm embezzled $2.1 million and
wired it to various bank accounts in South Africa and Taiwan. Other victims
were kidnapped for ransom as they traveled abroad to collect their "share".
Some never made it back. Every year, there are 5 such murders as well as 8-
10 snatchings of American citizens alone. The usual ransom demanded is
half a million to a million dollars.
The scam is so widespread that the Nigerians saw fit to explicitly ban it
in article 419 of their penal code. The Nigerian President, Olusegun
Obasanjo castigated the fraudsters for inflicting "incalculable damage to
Nigerian businesses" and for "placing the entire country under suspicion".
"Wired" quotes statistics presented at the International Conference on
Advance Fee (419) Frauds in New York on Sept. 17, 2002: "Roughly 1
percent of the millions of people who receive 419 e-mails and faxes are
successfully scammed. Annual losses to the scam in the United States total
more than $100 million, and law enforcement officials believe global losses
may total over $1.5 billion".
According to the "IFCC 2001 Internet Fraud Report", published by the
FBI and the National White Collar Crime Center, Nigerian letter fraud cases
amount to 15.5 percent of all grievances. The Internet Fraud Complaint

Center refers such rip-offs to the US Secret Service. While the median loss
in all manner of Internet fraud was $435 - in the Nigerian scam it was a
staggering $5575. But only one in ten successful crimes is reported, says
the FBI's report.
The IFCC provides this advisory to potential targets: ? Be skeptical of
individuals representing themselves as Nigerian or other foreign
government officials asking for your help in placing large sums of money in
overseas bank accounts. ? Do not believe the promise of large sums of
money for your cooperation. ? Do not give out any personal information
regarding your savings, checking, credit, or other financial accounts. ? If
you are solicited, do not respond and quickly notify the appropriate
authorities.
The "419 Coalition" is more succinct and a lot more pessimistic: 1.
"NEVER pay anything up front for ANY reason. 2. NEVER extend credit
for ANY reason. 3. NEVER do ANYTHING until their check clears. 4.
NEVER expect ANY help from the Nigerian Government. 5. NEVER rely
on YOUR Government to bail you out".
The State Department's Bureau of International Narcotics and Law
Enforcement Affairs published a brochure titled "Nigerian Advance Fee
Fraud". It describes the history of this particular type of swindle: "AFF
criminals include university-educated professionals who are the best in the
world for nonviolent spectacular crimes. AFF letters first surfaced in the
mid-1980s around the time of the collapse of world oil prices, which is
Nigeria's main foreign exchange earner. Some Nigerians turned to crime in
order to survive. Fraudulent schemes such as AFF succeeded in Nigeria,
because Nigerian criminals took advantage of the fact that Nigerians speak
English, the international language of business, and the country's vast oil
wealth and natural gas reserves - ranked 13th in the world - offer lucrative
business opportunities that attract many foreign companies and
individuals".
According to London's Metropolitan Police Company Fraud Department,
potential targets in the UK and the USA alone receive c. 1500 solicitations a
week. The US Secret Service Financial Crime Division takes in 100 calls a
day from Americans approach by the con-men. It now acknowledges that

"Nigerian organized crime rings running fraud schemes through the mail
and phone lines are now so large, they represent a serious financial threat to
the country".
Sometimes even the stamps affixed to such letters are forged. Nigerian
postal workers are known to be in cahoots with the fraudsters. Names and
addresses are obtained from "trade journals, business directories, magazine
and newspaper advertisements, chambers of commerce, and the Internet".
Victims are either too intimidated to complain or else reluctant to admit
their collusion in money laundering and fraud. Others try in vain to recoup
their losses by ploughing more money into the scheme.
Contrary to popular image, the scammers are often violent and involved
in other criminal pursuits, such as drug trafficking, According to Nigeria's
Drug Law Enforcement Agency. The blight has spread to other countries.
Letters from Sierra Leone, Ghana, Congo, Liberia, Togo, Ivory Coast,
Benin, Burkina Faso, South Africa, Taiwan, or even Canada, the United
Kingdom, Oman, and Vietnam are not uncommon.
The dodges fall into a few categories.
Over-invoiced contract scams involve the ostensible transfer of amounts
obtained through inflated invoices to the bank account of an unrelated
foreign firm. Contract fraud or "trade default" is simply a bogus order
accompanied by a fraudulent bank draft (or fake postal or other money
order) for the products of an export company accompanied by demand for
"samples" and various transaction "fees and charges".
Some of the rackets are plain outlandish. In the "wash- wash" confidence
trick people have been known to pay up to $200,000 for a special solution
to remove stains from millions in defaced dollar notes. Others "bought"
heavily "discounted" crude oil stored in "secret" locations - or real estate in
rezoned locales. "Clearing houses" or "venture capital organizations"
claiming to act on behalf of the Central Bank of Nigeria launder the
proceeds of the scams.
In another twist, charities, academic institutions, nonprofit organizations,
and religious groups are asked to pay the inheritances tax on a "donation".
Some "dignitaries" and their relatives may seek to flee the country and ask

the victims to advance the bribe money in return for a generous cut of the
wealth they have stashed abroad. "Bankers" may find inactive accounts
with millions of dollars - often in lottery winnings - waiting to be
transferred to a safe off-shore haven. Bogus jobs with inflated wages are
another ostensible way to defraud state- owned companies - as is the sale of
the target's used vehicle to them for an extravagant price. There seems to be
no end to criminal ingenuity.
Lately, the correspondence purports to be coming from - often white -
disinterested professional third parties.
Accountants, lawyers, directors, trustees, security personnel, or bankers
pretend to be acting as fiduciaries for the real dignitary in need of help. Less
gullible victims are subjected to plain old extortion with verbal intimidation
and stalking.
The more heightened public awareness grows with over- exposure and
the tighter the net of international cooperation against the scam, the wilder
the stories it spawns. Letters have surfaced recently signed by dying
refugees, tsunami victims, survivors of the September 11 attacks, and
serendipitous US commandos on mission in Afghanistan.
Governments throughout the world have geared up to protect their
businessmen. The US Department of Commerce, for instance, publishes the
"World Traders data Report", compiled by US embassy in Nigeria. It
"provides the following types of information: types of organizations, year
established, principal owners, size, product line, and financial and trade
references".
Unilateral US activity, inefficacious collaboration with the Nigerian
government some of whose officials are rumored to be in on the deals,
multilateral efforts in the framework of the OECD and the Interpol,
education and information campaigns - nothing seems to be working.
The treatment of 419 fraudsters in Nigeria is so lenient that, according to
the "Nigeria Tribune", the United States threatened the country with
sanctions if it does not considerably improve its record on financial crime
by November 2002. Both the US Treasury's Financial Crime Enforcement
Network (FINCEN) and the OECD's Financial Action Task Force (FATF)

had characterized the country as "one of the worst perpetrators of financial
crimes in the world". The Nigerian central bank promises to get to grips
with this debilitating problem.
Nigerian themselves - though often victims of the scams - take the
phenomenon in stride. The Nigerian "Daily Champion", proffered this
insightful apologia on behalf of the ruthless and merciless 419 gangs. It is
worth quoting at length: "To eradicate the 419 scourge, leaders at all levels
should work assiduously to create employment opportunities and people
perception of the leaders as role models. The country's very high
unemployment figure has made nonsense of the so-called democracy
dividends. Great majority of Nigerian youthful school leaver's including
University graduates, are without visible means of livelihood... The fact
remains that most of these teeming youths cannot just watch our so-called
leaders siphon their God-given wealthy. So, they resorted to alternative
fraudulent means of livelihood called 419, at least to be seen as have
arrived... Some of these 419ers are in the National Assembly and the State
Houses of Assembly while some surround the President and governors
across the country".
Some swindlers seek to glorify their criminal activities with a political
and historical context. The Web site of the "419 Coalition" contains letters
casting the scam as a form of forced reparation for slavery, akin to the
compensation paid by Germany to survivors of the holocaust. The
confidence tricksters boast of defrauding the "white civilization" and
unmasking the falsity of its claims for superiority. But a few delusional
individuals aside, this is nothing but a smokescreen.
Greed outweighs fear and avarice enmeshes people in clearly criminal
enterprises. The "victims" of advance fee scams are rarely incognizant of
their alleged role. They knowingly and intentionally collude with self-
professed criminals to fleece governments and institutions. This is one of
the rare crimes where prey and perpetrator may well deserve each other.

XIV. Organ Trafficking in Eastern Europe
A kidney fetches $2700 in Turkey. According to the October 2002 issue
of the Journal of the American Medical Association, this is a high price. An
Indian or Iraqi kidney enriches its former owner by a mere $1000.
Wealthy clients later pay for the rare organ up to $150,000.
CBS News aired, five years ago, a documentary, filmed by Antenna 3 of
Spain, in which undercover reporters in Mexico were asked, by a priest
acting as a middleman for a doctor, to pay close to 1 million dollars for a
single kidney. An auction of a human kidney on eBay in February 2000
drew a bid of $100,000 before the company put a stop to it. Another auction
in September 1999 drew $5.7 million - though, probably, merely as a prank.
Organ harvesting operations flourish in Turkey, in central Europe, mainly
in the Czech Republic, and in the Caucasus, mainly in Georgia. They
operate on Turkish, Moldovan, Russian, Ukrainian, Belarusian, Romanian,
Bosnian, Kosovar, Macedonian, Albanian and assorted east European
donors.
They remove kidneys, lungs, pieces of liver, even corneas, bones,
tendons, heart valves, skin and other sellable human bits. The organs are
kept in cold storage and air lifted to illegal distribution centers in the United
States, Germany, Scandinavia, the United Kingdom, Israel, South Africa,
and other rich, industrialized locales. It gives "brain drain" a new, spine
chilling, meaning.
Organ trafficking has become an international trade. It involves Indian,
Thai, Philippine, Brazilian, Turkish and Israeli doctors who scour the
Balkan and other destitute regions for tissues. The Washington Post
reported, in November 2002, that in a single village in Moldova, 14 out of
40 men were reduced by penury to selling body parts.
Four years ago, Moldova cut off the thriving baby adoption trade due to
an - an unfounded - fear the toddlers were being dissected for spare organs.

According to the Israeli daily, Ha'aretz, the Romanians are investigating
similar allegations in Israel and have withheld permission to adopt
Romanian babies from dozens of eager and out of pocket couples.
American authorities are scrutinizing a two year old Moldovan harvesting
operation based in the United States.
Organ theft and trading in Ukraine is a smooth operation.
According to news agencies, in August 2002, three Ukrainian doctors
were charged in Lvov with trafficking in the organs of victims of road
accidents. The doctors used helicopters to ferry kidneys and livers to
colluding hospitals. They charged up to $19,000 per organ.
The West Australian daily surveyed in January 2002 the thriving organs
business in Bosnia-Herzegovina. Sellers are offering their wares openly,
through newspaper ads.
Prices reach up to $68,000. Compared to an average monthly wage of
less than $200, this is an unimaginable fortune.
National health insurance schemes turn a blind eye.
Israel's participates in the costs of purchasing organs abroad, though only
subject to rigorous vetting of the sources of the donation. Still, a May 2001
article in a the New York Times Magazine, quotes "the coordinator of
kidney transplantation at Hadassah University Hospital in Jerusalem (as
saying that) 60 of the 244 patients currently receiving post-transplant care
purchased their new kidney from a stranger - just short of 25 percent of the
patients at one of Israel's largest medical centers participating in the organ
business".
Many Israelis - attempting to avoid scrutiny - travel to east Europe,
accompanied by Israeli doctors, to perform the transplantation surgery.
These junkets are euphemistically known as "transplant tourism". Clinics
have sprouted all over the benighted region. Israeli doctors have recently
visited impoverished Macedonia, Bulgaria, Kosovo and Yugoslavia to
discuss with local businessmen and doctors the setting up of kidney
transplant clinics.

Such open involvement in what can be charitably described as a latter
day slave trade gives rise to a new wave of thinly disguised anti-Semitism.
The Ukrainian Echo, quoting the Ukrinform news agency, reported, on
January 7, 2002, that, implausibly, a Ukrainian guest worker died in Tel-
Aviv in mysterious circumstances and his heart was removed. The Interpol,
according to the paper, is investigating this lurid affair.
According to scholars, reports of organ thefts and related abductions,
mainly of children, have been rife in Poland and Russia at least since 1991.
The buyers are supposed to be rich Arabs.
Nancy Scheper-Hughes, an anthropologist at the University of California
at Berkeley and co-founder of Organs Watch, a research and documentation
center, is also a member and co-author of the Bellagio Task Force Report on
Transplantation, Bodily Integrity and the International Traffic in Organs. In
a report presented in June 2001 to the House Subcommittee on International
Operations and Human Rights, she substantiated at least the nationality of
the alleged buyers, though not the urban legends regarding organ theft:
"In the Middle East residents of the Gulf States (Kuwait, Saudi Arabia,
and Oman) have for many years traveled to India, the Philippines, and to
Eastern Europe to purchase kidneys made scarce locally due to local
fundamentalist Islamic teachings that allow organ transplantation (to save a
life), but prohibit organ harvesting from brain-dead bodies.
Meanwhile, hundreds of kidney patients from Israel, which has its own
well -developed, but under-used transplantation centers (due to ultra-
orthodox Jewish reservations about brain death) travel in 'transplant tourist'
junkets to Turkey, Moldova, Romania where desperate kidney sellers can be
found, and to Russia where an excess of lucrative cadaveric organs are
produced due to lax standards for designating brain death, and to South
Africa where the amenities in transplantation clinics in private hospitals can
resemble four star hotels.
We found in many countries - from Brazil and Argentina to India, Russia,
Romania, Turkey to South Africa and parts of the United States - a kind of
'apartheid medicine' that divides the world into two distinctly different
populations of 'organs supplies' and 'organs receivers'."

Russia, together with Estonia, China and Iraq, is, indeed, a major
harvesting and trading centre. International news agencies described, five
years ago, how a grandmother in Ryazan tried to sell her grandchild to a
mediator. The boy was to be smuggled to the West and there dismembered
for his organs. The uncle, who assisted in the matter, was supposed to
collect $70,000 - a fortune in Russian terms.
When confronted by the European Union on this issue, Russia responded
that it lacks the resources required to monitor organ donations. The Italian
magazine, Happy Web, reports that organ trading has taken to the Internet.
A simple query on the Google search engine yields thousands of Web
sites purporting to sell various body parts - mostly kidneys - for up to
$125,000. The sellers are Russian, Moldovan, Ukrainian and Romanian.
Scheper-Hughes, an avid opponent of legalizing any form of trade in
organs, says that "in general, the movement and flow of living donor organs
- mostly kidneys - is from South to North, from poor to rich, from black and
brown to white, and from female to male bodies".
Yet, in the summer of 2002, bowing to reality, the American Medical
Association commissioned a study to examine the effects of paying for
cadaveric organs would have on the current shortage. The 1984 National
Organ Transplant Act that forbids such payments is also under attack. Bills
to amend it were submitted recently by several Congressmen. These are
steps in the right direction.
Organ trafficking is the outcome of the international ban on organ sales
and live donor organs. But wherever there is demand there is a market.
Excruciating poverty of potential donors, lengthening patient waiting lists
and the better quality of organs harvested from live people make organ sales
an irresistible proposition. The medical professions and authorities
everywhere would do better to legalize and regulate the trade rather than
transform it into a form of organized crime. The denizens of Moldova
would surely appreciate it.

XV. Selling Arms to Rogue States
Also Read Russian Roulette - The Security Apparatus
In a desperate bid to fend off sanctions, the Bosnian government banned
yesterday all trade in arms and munitions. A local, Serb-owned company
was documented by the State Department selling spare parts and
maintenance for military aircraft to Iraq via Yugoslav shell companies.
Heads rolled. In the Republika Srpska, the Serb component of the
ramshackle Bosnian state, both the Defense Minister Slobodan Bilic and
army Chief of Staff Novica Simic resigned. Another casualty was the
general director of the Orao Aircraft Institute of Bijeljina - Milan Prica. On
the Yugoslav side, Jugoimport chief Gen Jovan Cekovic and federal Deputy
Defense Minister Ivan Djokic stood down.
Bosnia's is only the latest in a series of embarrassing disclosures in
practically every country of the former eastern bloc, including all the EU
accession candidates.
With the crumbling of the Warsaw pact and the economies of the region,
millions of former military and secret service operators resorted to peddling
weapons and martial expertise to rogue states, terrorist outfits, and
organized crime. The confluence - and, lately, convergence - of these
interests is threatening Europe's very stability.
Last week, the Polish "Rzeczpospolita" accused the Military Information
services (WSI) of illicit arms sales between 1992-6 through both private
and state-run entities. The weapons were plundered from the Polish army
and sold at half price to Croatia and Somalia, both under UN arms embargo.
Deals were struck with the emerging international operations of the
Russian mafia. Terrorist middlemen and Latvian state officials were
involved. Breaching Poland's democratic veneer, the Polish Ministry of
Defense threatened to sue the paper for disclosing state secrets.

Police in Lodz is still investigating the alarming disappearance of 4
Arrow anti-aircraft missiles from a train transporting arms from a factory to
the port of Gdansk, to be exported. The private security escort claim
innocence.
The Czech Military Intelligence Services (VZS) have long been
embroiled in serial scandals. The Czech defense attaché to India, Miroslav
Kvasnak, was recently fired for disobeying explicit orders from the minister
of defense.
According to Jane's, Kvasnak headed URNA - the elite anti-terrorist unit
of the Czech National Police. He was sacked in 1995 for selling Semtex, the
notorious Czech plastic explosive, as well as weapons and munitions to
organized crime gangs.
In late August, the Czechs arrested arms traffickers, members of an
international ring, for selling Russian weapons - including, incredibly,
tanks, fighter planes, naval vessels, long range rockets, and missile
platforms - to Iraq. The operation has lasted 3 years and was conducted
from Prague.
According to the "Wall Street Journal", the Czech intelligence services
halted the sale of $300 million worth of the Tamara radar systems to Iraq in
1997. Czech firms, such as Agroplast, a leading waste processing company,
have often been openly accused of weapons smuggling. "The Guardian"
tracked in February a delivery of missiles and guidance systems from the
Czech Republic through Syria to Iraq.
German go-betweens operate in the Baltic countries. In May a sale of
more than two pounds of the radioactive element cesium-137 was thwarted
in Vilnius, the capital of Lithuania. The substance was sold to terrorist
groups bent on producing a "dirty bomb", believe US officials quoted by
"The Guardian". The Director of the CIA, John Deutsch, testified in
Congress in 1996 about previous cases in Lithuania involving two tons of
radioactive wolfram and 220 pounds of uranium-238.
Still, the epicenters of the illicit trade in weapons are in the Balkan, in
Russia, and in the republics of the former Soviet Union. Here, domestic
firms intermesh with Western intermediaries, criminals, terrorists, and state

officials to engender a pernicious, ubiquitous and malignant web of
smuggling and corruption.
According to the Center for Public Integrity and the Western media, over
the last decade, renegade Russian army officers have sold weapons to every
criminal and terrorist organization in the world - from the IRA to al- Qaida
and to every failed state, from Liberia to Libya.
They are protected by well-connected, bribe-paying, arms dealers and
high-level functionaries in every branch of government. They launder the
proceeds through Russian oil multinationals, Cypriot, Balkan, and Lebanese
banks, and Asian, Swiss, Austrian, and British trading conglomerates - all
obscurely owned and managed.
The most serious breach of the united international front against Iraq may
be the sale of the $100 million anti- stealth Ukrainian Kolchuga radar to the
pariah state two years ago. Taped evidence suggests that president Leonid
Kuchma himself instructed the General Director of the Ukrainian arms sales
company, UkrSpetzExport, Valery Malev to conclude the deal. Malev died
in a mysterious car accident on March 6, three days after his taped
conversation with Kuchma surfaced.
The Ukrainians insist that they were preempted by Russian dealers who
sold a similar radar system to Iraq - but this is highly unlikely as the
Russian system was still in development at the time. the American and
British are currently conducting a high-profile investigation in Kyiv.
In Russia, illegal arms are traded mainly by the Western Group of Forces
in cahoots with private companies, both domestic and foreign. The Air
Defense Army specializes in selling light arms. The army is the main source
of weapons - plastic explosives, grenade launchers, munitions - of both
Chechen rebels and Chechen criminals. Contrary to received opinion,
volunteer- soldiers, not conscripts, control the arms trade. The state itself is
involved in arms proliferation. Sales to China and Iran were long classified.
From June, all sales of materiel enjoy "state secret" status.
There is little the US can do. The Bush administration has imposed in
May sanctions on Armenian and Moldovan companies, among others, for
aiding and abetting Iran's efforts to obtain weapons of mass destruction.

Armenian president, Robert Kocharian, indignantly denied knowledge of
such transactions and vowed to get to the bottom of the American
allegations.
The Foreign Policy Research Institute, quoted by Radio Free
Europe/Radio Liberty, described a "Department of Energy (DOE) initiative,
underway since 1993, to improve 'material protection, control and
accountability' at former Soviet nuclear enterprises. The program enjoys
substantial bipartisan support in the United States and is considered the first
line of defense against unwanted proliferation episodes."
"As of February 2000, more than 8 years after the collapse of the USSR,
new security systems had been installed at 113 buildings, most of them in
Russia; however, these sites contained only 7 percent of the estimated 650
tons of weapons-usable material considered at risk for theft or diversion.
DOE plans call for safeguarding 60 percent of the material by 2006 and the
rest in 10 to 15 years or longer".
Russian traders learned to circumvent official channels and work through
Belarus. Major General Stsyapan Sukharenka, the first deputy chief of the
Belarusian KGB, denied, in March, any criminal arms trading in his
country. This vehement protest is gainsaid by the preponderance of
Belarusian arms traders replete with fake end-user certificates in Croatia
during the Yugoslav wars of secession (1992-5).
Deputy Assistant Secretary of State Steven Pifer said that UN inspectors
unearthed Belarusian artillery in Iraq in 1996. Iraqis are also being trained
in Belarus to operate various advanced weapons systems. The secret
services and armies of Ukraine, Russia, and even Romania use Belarus to
mask the true origin of weapons sold in contravention of UN sanctions.
Western arms manufacturers lobby their governments to enhance their
sales. Legitimate Russian and Ukrainian sales are often thwarted by
Western political arm-twisting.
When Macedonia, in the throes of a civil war it was about to lose,
purchased helicopter gunships from Ukraine, the American Embassy leaned
on the government to annul the contracts and threatened to withhold aid and
credits if it does not succumb.

The duopoly, enjoyed by the USA and Russia, forces competitors to go
underground and to seek rogue or felonious customers. Yugoslav scientists,
employed by Jugoimport and other firms run by former army officers, are
developing cruise missiles for Iraq, alleges the American administration.
The accusation, though, is dubious as Iraq has no access to satellites to
guide such missiles.
Another Yugoslav firm, Brunner, constructed a Libyan rocket propellant
manufacturing facility. In an interview to the "Washington Post",
Yugoslavia's president Vojislav Kostunica brushed off the American
complaints about, as he put it disdainfully, "overhauling older-generation
aircraft engines".
Such exploits are not unique to Yugoslavia or Bosnia. The Croat security
services are notorious for their collusion in drug and arms trafficking,
mainly via Hungary.
Macedonian construction companies collaborate with manufacturers of
heavy machinery and purveyors of missile technology in an effort to recoup
hundreds of millions of dollars in Iraqi debts. Albanian crime gangs collude
with weapon smugglers based in Montenegro and Kosovo. The Balkan -
from Greece to Hungary - is teeming with these penumbral figures.
Arms smuggling is a by-product of criminalized societies, destitution,
and dysfunctional institutions. The prolonged period of failed transition in
countries such as Yugoslavia, Macedonia, Bosnia, Moldova, Belarus, and
Ukraine has entrenched organized crime. It now permeates every legitimate
economic sphere and every organ of the state.
Whether this situation is reversible is the subject of heated debate. But it
is the West which pays the price in increased crime rates and, probably in
Iraq, in added fatalities once it launches war against that murderous regime.

XVI. The Industrious Spies
By: Dr. Sam Vaknin Also published by United Press International (UPI)
The Web site of GURPS (Generic Universal Role Playing System) lists
18 "state of the art equipments (sic) used for advanced spying". These
include binoculars to read lips, voice activated bugs, electronic imaging
devices, computer taps, electromagnetic induction detectors, acoustic
stethoscopes, fiber optic scopes, detectors of acoustic emissions (e.g., of
printers), laser mikes that can decipher and amplify voice-activated
vibrations of windows, and other James Bond gear.
Such contraptions are an integral part of industrial espionage. The
American Society for Industrial Security (ASIC) estimated a few years ago
that the damage caused by economic or commercial espionage to American
industry between 1993-5 alone was c. $63 billion.
The average net loss per incident reported was $19 million in high
technology, $29 million in services, and $36 million in manufacturing.
ASIC than upped its estimate to $300 billion in 1997 alone - compared to
$100 billion assessed by the 1995 report of the White House Office of
Science and Technology.
This figures are mere extrapolations based on anecdotal tales of failed
espionage. Many incidents go unreported.
In his address to the 1998 World Economic Forum, Frank Ciluffo,
Deputy Director of the CSIS Global Organized Crime Project, made clear
why: "The perpetrators keep quiet for obvious reasons. The victims do so
out of fear. It may jeopardize shareholder and consumer confidence.
Employees may lose their jobs.
It may invite copycats by inadvertently revealing vulnerabilities. And
competitors may take advantage of the negative publicity. In fact, they keep
quiet for all the same reasons corporations do not report computer
intrusions".

Interactive Television Technologies complained - in a press release dated
August 16, 1996 - that someone broke into its Amherst, NY, offices and
stole "three computers containing the plans, schematics, diagrams and
specifications for the BUTLER, plus a number of computer disks with
access codes." BUTLER is a proprietary technology which helps connect
television to computer networks, such as the Internet. It took four years to
develop.
In a single case, described in the Jan/Feb 1996 issue of "Foreign Affairs",
Ronald Hoffman, a software scientist, sold secret applications developed for
the Strategic Defense Initiative to Japanese corporations, such as Nissan
Motor Company, Mitsubishi Electric, Mitsubishi Heavy Industries, and
Ishikawajima-Harima Heavy Industries. He was caught in 1992, having
received $750,000 from his "clients", who used the software in their civilian
aerospace projects.
Canal Plus Technologies, a subsidiary of French media giant Vivendi,
filed a lawsuit last March against NDS, a division of News Corp. Canal
accused NDS of hacking into its pay TV smart cards and distributing the
cracked codes freely on a piracy Web site. It sued NDS for $1.1 billion in
lost revenues. This provided a rare glimpse into information age, hacker-
based, corporate espionage tactics.
Executives of publicly traded design software developer Avant! went to
jail for purchasing batches of computer code from former employees of
Cadence in 1997.
Reuters Analytics, an American subsidiary of Reuters Holdings, was
accused in 1998 of theft of proprietary information from Bloomberg by
stealing source codes from its computers.
In December 2001, Say Lye Ow, a Malaysian subject and a former
employee of Intel, was sentenced to 24 months in prison for illicitly
copying computer files containing advanced designs of Intel's Merced
(Itanium) microprocessor. It was the crowning achievement of a
collaboration between the FBI's High-Tech squad and the US Attorney's
Office CHIP - Computer Hacking and Intellectual Property - unit.

U.S. Attorney David W. Shapiro said: "People and companies who steal
intellectual property are thieves just as bank robbers are thieves. In this
case, the Itanium microprocessor is an extremely valuable product that took
Intel and HP years to develop. These cases should send the message
throughout Silicon Valley and the Northern District that the U.S. Attorney's
Office takes seriously the theft of intellectual property and will prosecute
these cases to the full extent of the law".
Yet, such cases are vastly more common than publicly acknowledged.
"People have struck up online friendships with employers and then lured
them into conspiracy to commit espionage.
People have put bounties on laptops of executives. People have disguised
themselves as janitors to gain physical access," Richard Power, editorial
director of the Computer Security Institute told MSNBC.
Marshall Phelps, IBM Vice President for Commercial and Industry
Relations admitted to the Senate Judiciary Committee as early as April
1992: "Among the most blatant actions are outright theft of corporate
proprietary assets. Such theft has occurred from many quarters:
competitors, governments seeking to bolster national industrial champions,
even employees.
Unfortunately, IBM has been the victim of such acts".
Raytheon, a once thriving defense contractor, released "SilentRunner", a
$25,000-65,000 software package designed to counter the "insider threat".
Its brochure, quoted by "Wired", says: "We know that 84 percent of your
network threats can be expected to come from inside your organization....
This least intrusive of all detection systems will guard the integrity of your
network against abuses from unauthorized employees, former employees,
hackers or terrorists and competitors".
This reminds many of the FBI's Carnivore massive network sniffer
software. It also revives the old dilemma between privacy and security. An
Omni Consulting survey of 3200 companies worldwide pegged damage
caused by insecure networks at $12 billion.
There is no end to the twists and turns of espionage cases and to the
creativity shown by the perpetrators.

On June 2001 an indictment was handed down against Nicholas
Daddona. He stands accused of a unique variation on the old theme of
industrial espionage: he was employed by two firms - transferring trade
secrets from one (Fabricated Metal Products) to the other (Eyelet).
Jungsheng Wang was indicted last year for copying the architecture of the
Sequoia ultrasound machine developed by Acuson Corporation. He sold it
to Bell Imaging, a Californian company which, together with a Chinese
firm, owns a mainland China corporation, also charged in the case. The web
of collaboration between foreign - or foreign born - scientists with access to
trade and technology secrets, domestic corporations and foreign firms, often
a cover for government interests - is clearly exposed here.
Kenneth Cullen and Bruce Zak were indicted on April 2001 for trying to
purchase a printed or text version of the source code of a computer
application for the processing of health care benefit claim forms developed
by ZirMed.
The legal status of printed source code is unclear. It is undoubtedly
intellectual property - but of which kind? Is it software or printed matter?
Peter Morch, a senior R&D team leader for CISCO was accused on March
2001 for simply burning onto compact discs all the intellectual property he
could lay his hands on with the intent of using it in his new workplace,
Calix Networks, a competitor of CISCO.
Perhaps the most bizarre case involves Fausto Estrada. He was employed
by a catering company that served the private lunches to Mastercard's board
of directors. He offered to sell Visa proprietary information that he claimed
to have stolen from Mastercard. In a letter signed "Cagliostro", Fausto
demanded $1 million. He was caught red-handed in an FBI sting operation
on February 2001.
Multinationals are rarely persecuted even when known to have colluded
with offenders. Steven Louis Davis pleaded guilty on January 1998 to
stealing trade secrets and designs from Gillette and selling them to its
competitors, such as Bic Corporation, American Safety Razor, and Warner
Lambert. Yet, it seems that only he paid the price for his misdeeds - 27
months in prison. Bic claims to have immediately informed Gillette of the
theft and to have collaborated with Gillette's Legal Department and the FBI.

Nor are industrial espionage or the theft of intellectual property limited to
industry. Mayra Justine Trujillo-Cohen was sentenced on October 1998 to
48 months in prison for stealing proprietary software from Deloitte-Touche,
where she worked as a consultant, and passing it for its own.
Caroll Lee Campbell, the circulation manager of Gwinette Daily Post
(GDP), offered to sell proprietary business and financial information of his
employer to lawyers representing a rival paper locked in bitter dispute with
GDP.
Nor does industrial espionage necessarily involve clandestine, cloak and
dagger, operations. The Internet and information technology are playing an
increasing role.
In a bizarre case, Caryn Camp developed in 1999 an Internet-relationship
with a self-proclaimed entrepreneur, Stephen Martin. She stole he
employer's trade secrets for Martin in the hope of attaining a senior position
in Martin's outfit - or, at least, of being richly rewarded.
Camp was exposed when she mis-addressed an e-mail expressing her
fears - to a co-worker.
Steven Hallstead and Brian Pringle simply advertised their wares -
designs of five advanced Intel chips - on the Web.
They were, of course, caught and sentenced to more than 5 years in
prison. David Kern copied the contents of a laptop inadvertently left behind
by a serviceman of a competing firm. Kern trapped himself. He was forced
to plead the Fifth Amendment during his deposition in a civil lawsuit he
filed against his former employer. This, of course, provoked the curiosity of
the FBI.
Stolen trade secrets can spell the difference between extinction and
profitability. Jack Shearer admitted to building an $8 million business on
trade secrets pilfered from Caterpillar and Solar Turbines.
United States Attorney Paul E. Coggins stated: "This is the first EEA case
in which the defendants pled guilty to taking trade secret information and
actually converting the stolen information into manufactured products that
were placed in the stream of commerce. The sentences handed down today

(June 15, 2000) are among the longest sentences ever imposed in an
Economic Espionage case".
Economic intelligence gathering - usually based on open sources - is both
legitimate and indispensable. Even reverse engineering - disassembling a
competitor's products to learn its secrets - is a grey legal area. Spying is
different. It involves the purchase or theft of proprietary information
illicitly. It is mostly committed by firms. But governments also share with
domestic corporations and multinationals the fruits of their intelligence
networks.
Former - and current - intelligence operators (i.e., spooks), political and
military information brokers, and assorted shady intermediaries - all
switched from dwindling Cold War business to the lucrative market of
"competitive intelligence".
US News and World Report described on May 6, 1996, how a certain Mr.
Kota - an alleged purveyor of secret military technology to the KGB in the
1980's - conspired with a scientist, a decade later, to smuggle
biotechnologically modified hamster ovaries to India.
This transition fosters international tensions even among allies.
"Countries don't have friends - they have interests!" - screamed a DOE
poster in the mid-nineties. France has vigorously protested US spying on
French economic and technological developments - until it was revealed to
be doing the same. French relentless and unscrupulous pursuit of purloined
intellectual property in the USA is described in Peter Schweizer's "Friendly
Spies: How America's Allies Are Using Economic Espionage to Steal Our
Secrets." "Le Mond" reported back in 1996 about intensified American
efforts to purchase from French bureaucrats and legislators information
regarding France's WTO, telecommunications, and audio-visual policies.
Several CIA operators were expelled.
Similarly, according to Robert Dreyfuss in the January 1995 issue of
"Mother Jones", Non Official Cover (NOC) CIA operators - usually posing
as businessmen - are stationed in Japan. These agents conduct economic
and technological espionage throughout Asia, including in South Korea and
China.

Even the New York Times chimed in, accusing American intelligence
agents of assisting US trade negotiators by eavesdropping on Japanese
officials during the car imports row in 1995. And President Clinton
admitted openly that intelligence gathered by the CIA regarding the illegal
practices of French competitors allowed American aerospace firms to win
multi-billion dollar contracts in Brazil and Saudi Arabia.
The respected German weekly, Der Spiegel, castigated the USA, in 1990,
for arm-twisting the Indonesian government into splitting a $200 million
satellite contract between the Japanese NEC and US manufacturers. The
American, alleged the magazines, intercepted messages pertaining to the
deal, using the infrastructure of the National Security Agency (NSA). Brian
Gladwell, a former NATO computer expert, calls it "state-sponsored
information piracy".
Robert Dreyfuss, writing in "Mother Jones", accused the CIA of actively
gathering industrial intelligence (i.e., stealing trade secrets) and passing
them on to America's Big Three carmakers. He quoted Clinton
administration officials as saying: "(the CIA) is a good source of
information about the current state of technology in a foreign country ...
We've always managed to get intelligence to the business community. There
is contact between business people and the intelligence community, and
information flows both ways, informally".
A February 1995 National Security Strategy statement cited by MSNBC
declared: "Collection and analysis can help level the economic playing field
by identifying threats to U.S. companies from foreign intelligence services
and unfair trading practices".
The Commerce Department's Advocacy Center solicits commercial
information thus: "Contracts pursued by foreign firms that receive
assistance from their home governments to pressure a customer into a
buying decision; unfair treatment by government decision-makers,
preventing you from a chance to compete; tenders tied up in bureaucratic
red tape, resulting in lost opportunities and unfair advantage to a
competitor. If these or any similar export issues are affecting your company,
it's time to call the Advocacy Center".
And then, of course, there is Echelon.

Exposed two years ago by the European Parliament in great fanfare, this
telecommunications interception network, run by the US, UK, New
Zealand, Australia, and Canada has become the focus of bitter mutual
recriminations and far flung conspiracy theories.
These have abated following the brutal terrorist attacks of September 11
when the need for Echelon-like system with even laxer legal control was
made abundantly clear.
France, Russia, and 28 other nations operate indigenous mini-Echelons,
their hypocritical protestations to the contrary notwithstanding.
But, with well over $600 billion a year invested in easily pilfered R&D,
the US is by far the prime target and main victim of such activities rather
than their chief perpetrator.
The harsh - and much industry lobbied - "Economic Espionage (and
Protection of Proprietary Economic Information) Act of 1996" defines the
criminal offender thus: "Whoever, intending or knowing that the offense
will benefit any foreign government, foreign instrumentality, or foreign
agent, knowingly" and "whoever, with intent to convert a trade secret, that
is related to or included in a product that is produced for or placed in
interstate or foreign commerce, to the economic benefit of anyone other
than the owner thereof, and intending or knowing that the offense will ,
injure any owner of that trade secret": "(1) steals, or without authorization
appropriates, takes, carries away, or conceals, or by fraud, artifice, or
deception obtains a trade secret (2) without authorization copies, duplicates,
sketches, draws, photographs, downloads, uploads, alters, destroys,
photocopies, replicates, transmits, delivers, sends, mails, communicates, or
conveys a trade secret (3) receives, buys, or possesses a trade secret,
knowing the same to have been stolen or appropriated, obtained, or
converted without authorization (4) attempts to commit any offense
described in any of paragraphs (1) through (3); or (5) conspires with one or
more other persons to commit any offense described in any of paragraphs
(1) through (4), and one or more of such persons do any act to effect the
object of conspiracy".
Other countries either have similar statutes (e.g., France) - or are
considering to introduce them. Taiwan's National Security Council has been

debating a local version of an economic espionage law lat month. There
have been dozens of prosecutions under the law hitherto. Companies - such
as "Four Pillars" which stole trade secrets from Avery Dennison - paid fines
of millions of US dollars.
Employees - such as PPG's Patrick Worthing - and their accomplices
were jailed.
Foreign citizens - like the Taiwanese Kai-Lo Hsu and Prof. Charles Ho
from National Chiao Tung university - were detained. Mark Halligan of
Welsh and Katz in Chicago lists on his Web site more than 30 important
economic espionage cases tried under the law by July last year.
The Economic Espionage law authorizes the FBI to act against foreign
intelligence gathering agencies toiling on US soil with the aim of garnering
proprietary economic information. During the Congressional hearings that
preceded the law, the FBI estimated that no less that 23 governments,
including the Israeli, French, Japanese, German, British, Swiss, Swedish,
and Russian, were busy doing exactly that. Louis Freeh, the former director
of the FBI, put it succinctly: "Economic Espionage is the greatest threat to
our national security since the Cold War".
The French Ministry of Foreign Affairs runs a program which commutes
military service to work at high tech US firms. Program-enrolled French
computer engineers were arrested attempting to steal proprietary source
codes from their American employers.
In an interview he granted to the German ZDF Television quoted by
"Daily Yomiuri" and Netsafe, the former Director of the French foreign
counterintelligence service, the DGSE, freely confessed: "....All secret
services of the big democracies undertake economic espionage ... Their role
is to peer into hidden corners and in that context business plays an
important part ... In France the state is not just responsible for the laws, it is
also an entrepreneur. There are state-owned and semi-public companies.
And that is why it is correct that for decades the French state regulated the
market with its right hand in some ways and used its intelligence service
with its left hand to furnish its commercial companies ... It is among the
tasks of the secret services to shed light on and analyze the white, grey and

black aspects of the granting of such major contracts, particularly in far-off
countries".
The FBI investigated 400 economic espionage cases in 1995 - and 800 in
1996. It interfaces with American corporations and obtains investigative
leads from them through its 26 years old Development of Espionage,
Counterintelligence, and Counter terrorism Awareness (DECA) Program
renamed ANSIR (Awareness of National Security Issues and Response).
Every local FBI office has a White Collar Crime squad in charge of
thwarting industrial espionage. The State Department runs a similar outfit
called the Overseas Security Advisory Council (OSAC).
These are massive operations. In 1993-4 alone, the FBI briefed well over
a quarter of a million corporate officers in more than 20,000 firms. By
1995, OSAC collaborated on overseas security problems with over 1400
private enterprises. "Country Councils", comprised of embassy official and
private American business, operate in dozens of foreign cities. They
facilitate the exchange of timely "unclassified" and threat-related security
information.
More than 1600 US companies and organization are currently
permanently affiliated wit OSAC. Its Advisory Council is made up of
twenty-one private sector and four public sector member organizations that,
according to OSAC, "represent specific industries or agencies that operate
abroad. Private sector members serve for two to three years. More than fifty
U.S. companies and organizations have already served on the Council.
Member organizations designate representatives to work on the Council.
These representatives provide the direction and guidance to develop
programs that most benefit the U.S. private sector overseas. Representatives
meet quarterly and staff committees tasked with specific projects. Current
committees include Transnational Crime, Country Council Support,
Protection of Information and Technology, and Security Awareness and
Education".
But the FBI is only one of many agencies that deal with the problem in
the USA. The President's Annual Report to Congress on "Foreign Economic
Collection and Industrial Espionage" dated July 1995, describes the

multiple competitive intelligence (CI) roles of the Customs Service, the
Department of Defense, the Department of Energy, and the CIA.
The federal government alerts its contractors to CI threats and subjects
them to "awareness programs" under the DOD's Defense Information
Counter Espionage (DICE) program. The Defense Investigative Service
(DIS) maintains a host of useful databases such as the Foreign Ownership,
Control, or Influence (FOCI) register. It is active otherwise as well,
conducting personal security interviews by industrial security
representatives and keeping tabs on the foreign contacts of security cleared
facilities. And the list goes on.
According to the aforementioned report to Congress: "The industries that
have been the targets in most cases of economic espionage and other
collection activities include biotechnology; aerospace; telecommunications,
including the technology to build the 'information superhighway'; computer
software/ hardware; advanced transportation and engine technology;
advanced materials and coatings, including 'stealth' technologies; energy
research; defense and armaments technology; manufacturing processes; and
semiconductors. Proprietary business information-that is, bid, contract,
customer, and strategy in these sectors is aggressively targeted. Foreign
collectors have also shown great interest in government and corporate
financial and trade data".
The collection methods range from the traditional - agent recruitment and
break ins - to the technologically fantastic. Mergers, acquisitions, joint
ventures, research and development partnerships, licensing and franchise
agreements, friendship societies, international exchange programs, import-
export companies - often cover up for old fashioned reconnaissance.
Foreign governments disseminate disinformation to scare off competitors -
or lure then into well-set traps.
Foreign students, foreign employees, foreign tourist guides, tourists,
immigrants, translators, affable employees of NGO's, eager consultants,
lobbyists, spin doctors, and mock journalists are all part of national
concerted efforts to prevail in the global commercial jungle. Recruitment of
traitors and patriots is at its peak in international trade fairs, air shows,
sabbaticals, scientific congresses, and conferences.

On May 2001, Takashi Okamoto and Hiroaki Serizwa were indicted of
stealing DNA and cell line reagents from Lerner Research Institute and the
Cleveland Clinic Foundation. This was done on behalf of the Institute of
Physical and Chemical Research (RIKEN) in Japan - an outfit 94 funded by
the Japanese government. The indictment called RIKEN "an instrumentality
of the government of Japan".
The Chinese Ministry of Posts and Telecommunications was involved on
May 2001 in an egregious case of theft of intellectual property. Two
development scientists of Chinese origin transferred the PathStar Access
Server technology to a Chinese corporation owned by the ministry. The
joint venture it formed with the thieves promptly came out with its own
product probably based on the stolen secrets.
The following ad appeared in the Asian Wall Street Journal in 1991 -
followed by a contact phone number in western Europe: "Do you have
advanced/privileged information of any type of project/contract that is
going to be carried out in your country? We hold commission/agency
agreements with many large European companies and could introduce them
to your project/contract. Any commission received would be shared with
yourselves".
Ben Venzke, publisher of Intelligence Watch Report, describes how
Mitsubishi filed c. 1500 FOIA (Freedom of Information Act) requests in
1987 alone, in an effort to enter the space industry. The US Patent office is
another great source of freely available proprietary information.
Industrial espionage is not new. In his book, "War by Other Means:
Economic Espionage in America", The Wall Street Journal's John Fialka,
vividly describes how Frances Cabot Lowell absconded from Britain with
the plans for the cutting edge Cartwright loom in 1813.
Still, the phenomenon has lately become more egregious and more
controversial. As Cold War structures - from NATO to the KGB and the
CIA - seek to redefine themselves and to assume new roles and new
functions, economic espionage offers a tempting solution.
Moreover, decades of increasing state involvement in modern economies
have blurred the traditional demarcation between the private and the public

sectors.
Many firms are either state-owned (in Europe) or state- financed (in Asia)
or sustained by state largesse and patronage (the USA). Many businessmen
double as politicians and numerous politicians serve on corporate boards.
Eisenhower's "military-industrial complex" though not as sinister as once
imagined is, all the same, a reality. The deployment of state intelligence
assets and resources to help the private sector gain a competitive edge is
merely its manifestation.
As foreign corporate ownership becomes widespread, as multinationals
expand, as nation-states dissolve into regions and coalesce into
supranational states - the classic, exclusionary, and dichotomous view of the
world ("we" versus "they") will fade. But the notion of "proprietary
information" is here to stay. And theft will never cease as long as there is
profit to be had.

XVII. Russia's Idled Spies
Also Read" The Industrious Spies Russian Roulette - The Security
Apparatus
On November 11, 2002, Sweden expelled two Russian diplomats for
spying on radar and missile guidance technologies for the JAS 39 British-
Swedish Gripen fighter jet developed by Telefon AB LM Ericsson, the
telecommunications multinational. The Russians threatened to reciprocate.
Five current and former employees of the corporate giant are being
investigated.
Ironically, the first foreign buyer of the aircraft may well be Poland, a
former Soviet satellite state and a current European Union candidate.
Sweden arrested in February 2001 a worker of the Swiss- Swedish
engineering group, ABB, on suspicion of spying for Russia. The man was
released after two days for lack of evidence and reinstated. But the weighty
Swedish daily, Dagens Nyheter, speculated that the recent Russian
indiscretion was in deliberate retaliation for Swedish espionage in Russia.
Sweden is rumored to have been in the market for Russian air radar designs
and the JAS radar system is said by some observers to uncannily resemble
its eastern counterparts.
The same day, a Russian military intelligence (GRU) colonel, Aleksander
Sipachev, was sentenced in Moscow to eight years in prison and stripped of
his rank.
According to Russian news agencies, he was convicted of attempting to
sell secret documents to the CIA. Russian secret service personnel, idled by
the withering of Russia's global presence, resort to private business or are
re- deployed by the state to spy on industrial and economic secrets in order
to aid budding Russian multinationals.
According to the FBI and the National White-collar Crime Center,
Russian former secret agents have teamed with computer hackers to break

into corporate networks to steal vital information about product
development and marketing strategies. Microsoft has admitted to such a
compromising intrusion.
In a December 1999 interview to Segodnya, a Russia paper, Eyer
Winkler, a former high-ranking staffer with the National Security Agency
(NSA) confirmed that "corruption in the Russian Government, the Foreign
Intelligence Service, and the Main Intelligence Department allows Russian
organized criminal groups to use these departments in their own interests.
Criminals receive the major part of information collected by the Russian
special services by means of breaking into American computer networks".
When the KGB was dismantled and replaced by a host of new acronyms,
Russian industrial espionage was still in diapers. as a result, it is a
bureaucratic no-man's land roamed by agents of the GRU, the Foreign
Intelligence Service (SVR), and smaller outfits, such as the Federal Agency
on Government Communications and Information (FAPSI).
According to Stratfor, the strategic forecasting consultancy, "the SVR
and GRU both handle manned intelligence on U.S. territory, with the
Russian Federal Security Service (FSB) doing counterintelligence in
America. Also, both the SVR and GRU have internal counterintelligence
units created for finding foreign intelligence moles." This, to some extent, is
the division of labor in Europe as well.
Germany's Federal Prosecutor has consistently warned against $5 billion
worth of secrets pilfered annually from German industrial firms by foreign
intelligence services, especially from east Europe and Russia. The
Counterintelligence News and Developments newsletter pegs the damage at
$13 billion in 1996 alone: "Modus operandi included placing agents in
international organizations, setting up joint-ventures with German
companies, and setting up bogus companies. The (Federal Prosecutor's)
report also warned business leaders to be particularly wary of former
diplomats or people who used to work for foreign secret services because
they often had the language skills and knowledge of Germany that made
them excellent agents".
Russian spy rings now operate from Canada to Japan.

Many of the spies have been dormant for decades and recalled to service
following the implosion of the USSR.
According to Asian media, Russians have become increasingly active in
the Far East, mainly in Japan, South Korea, Taiwan, and mainland China.
Russia is worried about losing its edge in avionics, electronics,
information technology and some emerging defense industries such as laser
shields, positronics, unmanned vehicles, wearable computing, and real time
triple C (communication, command and control) computerized battlefield
management. The main targets are, surprisingly, Israel and France.
According to media reports, the substantive clients of Russia's defense
industry - such as India - insist on hollowing out Russian craft and installing
Israeli and west European systems instead.
Russia's paranoid state of mind extends to its interior.
Uralinformbureau reported earlier in 2002 that the Yamal- Nenets
autonomous okrug (district) restricted access to foreigners citing concerns
about industrial espionage and potential sabotage of oil and gas companies.
The Kremlin maintains an ever-expanding list of regions and territories with
limited - or outright - forbidden - access to foreigners.
The FSB, the KGB's main successor, is busy arresting spies all over the
vast country. To select a random events of the dozens reported every year -
and many are not - the Russian daily Kommersant recounted in February
2002 how when the Trunov works at the Novolipetsk metallurgical combine
concluded an agreement with a Chinese company to supply it with slabs, its
chief negotiator was nabbed as a spy working for "circles in China". His
crime? He was in possession of certain documents which contained
"intellectual property" of the crumbling and antiquated mill pertaining to a
slab quality enhancement process.
Foreigners are also being arrested, though rarely. An American
businessman, Edmund Pope, was detained in April 2000 for attempting to
purchase the blueprints of an advanced torpedo from a Russian scientist.
There have been a few other isolated apprehensions, mainly for "proper",
military, espionage. But Russians bear the brunt of the campaign against
foreign economic intelligence gathering.

Strana.ru reported in December 2001 that, speaking on the occasion of
Security Services Day, Putin - himself a KGB alumnus - warned veterans
that the most crucial task facing the services today is "protecting the
country's economy against industrial espionage".
This is nothing new. According to History of Espionage Web site, long
before they established diplomatic relations with the USA in 1933, the
Soviets had Amtorg Trading Company. Ostensibly its purpose was to
encourage joint ventures between Russian and American firms. Really it
was a hub of industrial undercover activities. Dozens of Soviet intelligence
officers supervised, at its peak during the Depression, 800 American
communists. The Soviet Union's European operations in Berlin
(Handelsvertretung) and in London (Arcos, Ltd.) were even more
successful.

XVIII. The Business of Torture
Also Read The Argument for Torture
On January 16, 2003, the European Court of Human Rights agreed -
more than two years after the applications have been filed - to hear six cases
filed by Chechens against Russia. The claimants accuse the Russian
military of torture and indiscriminate killings. The Court has ruled in the
past against the Russian Federation and awarded assorted plaintiffs
thousands of euros per case in compensation.
As awareness of human rights increased, as their definition expanded and
as new, often authoritarian polities, resorted to torture and repression -
human rights advocates and non-governmental organizations proliferated. It
has become a business in its own right: lawyers, consultants, psychologists,
therapists, law enforcement agencies, scholars and pundits tirelessly peddle
books, seminars, conferences, therapy sessions for victims, court
appearances and other services.
Human rights activists target mainly countries and multinationals.
In June 2001, the International Labor Rights Fund filed a lawsuit on
behalf of 11 villagers against the American oil behemoth, ExxonMobile, for
"abetting" abuses in Aceh, Indonesia. They alleged that the company
provided the army with equipment for digging mass graves and helped in
the construction of interrogation and torture centers.
In November 2002, the law firm of Cohen, Milstein, Hausfeld & Toll
joined other American and South African law firms in filing a complaint
that "seeks to hold businesses responsible for aiding and abetting the
apartheid regime in South Africa ... forced labor, genocide, extrajudicial
killing, torture, sexual assault, and unlawful detention".
Among the accused: "IBM and ICL which provided the computers that
enabled South Africa to ... control the black South African population. Car
manufacturers provided the armored vehicles that were used to patrol the

townships. Arms manufacturers violated the embargoes on sales to South
Africa, as did the oil companies. The banks provided the funding that
enabled South Africa to expand its police and security apparatus".
Charges were leveled against Unocal in Myanmar and dozens of other
multinationals. In September 2002, Berger & Montague filed a class action
complaint against Royal Dutch Petroleum and Shell Transport. The oil
giants are charged with "purchasing ammunition and using ... helicopters
and boats and providing logistical support for 'Operation Restore Order in
Ogoniland'" which was designed, according to the law firm, to "terrorize the
civilian population into ending peaceful protests against Shell's
environmentally unsound oil exploration and extraction activities".
The defendants in all these court cases strongly deny any wrongdoing.
But this is merely one facet of the torture business.
Torture implements are produced - mostly in the West - and sold openly,
frequently to nasty regimes in developing countries and even through the
Internet. Hi-tech devices abound: sophisticated electroconvulsive stun guns,
painful restraints, truth serums, chemicals such as pepper gas.
Export licensing is universally minimal and non-intrusive and completely
ignores the technical specifications of the goods (for instance, whether they
could be lethal, or merely inflict pain).
Amnesty International and the UK-based Omega Foundation, found more
than 150 manufacturers of stun guns in the USA alone. They face tough
competition from Germany (30 companies), Taiwan (19), France (14),
South Korea (13), China (12), South Africa (nine), Israel (eight), Mexico
(six), Poland (four), Russia (four), Brazil (three), Spain (three) and the
Czech Republic (two).
Many torture implements pass through "off-shore" supply networks in
Austria, Canada, Indonesia, Kuwait, Lebanon, Lithuania, Macedonia,
Albania, Russia, Israel, the Philippines, Romania and Turkey. This helps
European Union based companies circumvent legal bans at home.
The US government has traditionally turned a blind eye to the
international trading of such gadgets.

American high-voltage electro-shock stun shields turned up in Turkey,
stun guns in Indonesia, and electro-shock batons and shields, and dart-firing
taser guns in torture- prone Saudi Arabia. American firms are the dominant
manufacturers of stun belts. Explains Dennis Kaufman, President of Stun
Tech Inc, a US manufacturer of this innovation: ''Electricity speaks every
language known to man. No translation necessary. Everybody is afraid of
electricity, and rightfully so.'' (Quoted by Amnesty International).
The Omega Foundation and Amnesty claim that 49 US companies are
also major suppliers of mechanical restraints, including leg-irons and
thumbcuffs. But they are not alone. Other suppliers are found in Germany
(8), France (5), China (3), Taiwan (3), South Africa (2), Spain (2), the UK
(2) and South Korea (1).
Not surprisingly, the Commerce Department doesn't keep tab on this
category of exports.
Nor is the money sloshing around negligible. Records kept under the
export control commodity number A985 show that Saudi Arabia alone spent
in the United States more than $1 million a year between 1997-2000 merely
on stun guns. Venezuela's bill for shock batons and such reached $3.7
million in the same period. Other clients included Hong Kong, Taiwan,
Mexico and - surprisingly - Bulgaria. Egypt's notoriously brutal services -
already well-equipped - spent a mere $40,000.
The United States is not the only culprit. The European Commission,
according to an Amnesty International report titled "Stopping the Torture
Trade" and published in 2001: "Gave a quality award to a Taiwanese
electro-shock baton, but when challenged could not cite evidence as to
independent safety tests for such a baton or whether member states of the
European Union (EU) had been consulted. Most EU states have banned the
use of such weapons at home, but French and German companies are still
allowed to supply them to other countries".
Torture expertise is widely proffered by former soldiers, agents of the
security services made redundant, retired policemen and even rogue
medical doctors. China, Israel, South Africa, France, Russia, the United
kingdom and the United States are founts of such useful knowledge and its
propagators.

How rooted torture is was revealed in September 1996 when the US
Department of Defense admitted that ''intelligence training manuals'' were
used in the Federally sponsored School of the Americas - one of 150 such
facilities - between 1982 and 1991.The manuals, written in Spanish and
used to train thousands of Latin American security agents, "advocated
execution, torture, beatings and blackmail", says Amnesty International.
Where there is demand there is supply. Rather than ignore the
discomfiting subject, governments would do well to legalize and supervise
it. Alan Dershowitz, a prominent American criminal defense attorney,
proposed, in an op- ed article in the Los Angeles Times, published
November 8, 2001, to legalize torture in extreme cases and to have judges
issue "torture warrants". This may be a radical departure from the human
rights tradition of the civilized world. But dispensing export carefully
reviewed licenses for dual-use implements is a different matter altogether -
and long overdue.

XIX. The Criminality of Transition
Lecture given at the Netherlands Economic Institute (NEI) on 18/4/2001
Human vice is the most certain thing after death and taxes, to paraphrase
Benjamin Franklin. The only variety of economic activity, which will surely
survive even a nuclear holocaust, is bound to be crime. Prostitution,
gambling, drugs and, in general, expressly illegal activities generate c. 400
billion USD annually to their perpetrators, thus making crime the third
biggest industry on Earth (after the medical and pharmaceutical industries).
Many of the so called Economies in Transition and of HPICs (Highly
Indebted Poor Countries) do resemble post-nuclear-holocaust ashes. GDPs
in most of these economies either tumbled nominally or in real terms by
more than 60% in the space of less than a decade. The average monthly
salary is the equivalent of the average daily salary of the German industrial
worker. The GDP per capita - with very few notable exceptions - is around
20% of the EU's average and the average wages are 14% the EU's average
(2000). These are the telltale overt signs of a comprehensive collapse of the
infrastructure and of the export and internal markets. Mountains of internal
debt, sky high interest rates, cronyism, other forms of corruption,
environmental, urban and rural dilapidation - characterize these economies.
Into this vacuum - the interregnum between centrally planned and free
market economies - crept crime. In most of these countries criminals run at
least half the economy, are part of the governing elites (influencing them
behind the scenes through money contributions, outright bribes, or
blackmail) and - through the mechanism of money laundering - infiltrate
slowly the legitimate economy.
What gives crime the edge, the competitive advantage versus the older,
ostensibly more well established elites? The free market does. When
communism collapsed, only criminals, politicians, managers, and
employees of the security services were positioned to benefit from the
upheaval. Criminals, for instance, are much better equipped to deal with the

onslaught of this new conceptual beast, the mechanism of the market, than
most other economic players in these tattered economies are.
Criminals, by the very nature of their vocation, were always private
entrepreneurs. They were never state owned or subjected to any kind of
central planning. Thus, they became the only group in society that was not
corrupted by these un-natural inventions. They invested their own capital in
small to medium size enterprises and ran them later as any American
manager would have done. To a large extent the criminals, single handedly,
created a private sector in these derelict economies.
Having established a private sector business, devoid of any involvement
of the state, the criminal-entrepreneurs proceeded to study the market.
Through primitive forms of market research (neighbourhood activists) they
were able to identify the needs of their prospective customers, to monitor
them in real time and to respond with agility to changes in the patterns of
supply and demand. Criminals are market-animals and they are geared to
respond to its gyrations and vicissitudes. Though they were not likely to
engage in conventional marketing and advertising, they always stayed
attuned to the market's vibrations and signals. They changed their product
mix and their pricing to fit fluctuations in demand and supply.
Criminals have proven to be good organizers and managers. They have
very effective ways of enforcing discipline in the workplace, of setting
revenue targets, of maintaining a flexible hierarchy combined with rigid
obeisance - with very high upward mobility and a clear career path. A
complex system of incentives and disincentives drives the workforce to
dedication and industriousness. The criminal rings are well run
conglomerates and the more classic industries would have done well to
study their modes of organization and management. Everything - from sales
through territorially exclusive licences (franchises) to effective "stock"
options - has been invented in the international crime organizations long
before it acquired the respectability of the corporate boardroom.
The criminal world has replicated those parts of the state which were
rendered ineffective by unrealistic ideology or by pure corruption. The
court system makes a fine example. The criminals instituted their own code
of justice ("law") and their own court system. A unique - and often

irreversible - enforcement arm sees to it that respect towards these
indispensable institutions is maintained. Effective - often interactive -
legislation, an efficient court system, backed by ominous and ruthless
agents of enforcement - ensure the friction-free functioning of the giant
wheels of crime. Crime has replicated numerous other state institutions.
Small wonder that when the state disintegrated - crime was able to replace it
with little difficulty. The same pattern is discernible in certain parts of the
world where terrorist organizations duplicate the state and overtake it, in
time.
Schools, clinics, legal assistance, family support, taxation, the court
system, transportation and telecommunication services, banking and
industry - all have a criminal doppelganger.
To summarize: At the outset of transition, the underworld constituted an
embryonic private sector, replete with international networks of contacts,
cross-border experience, capital agglomeration and wealth formation,
sources of venture (risk) capital, an entrepreneurial spirit, and a diversified
portfolio of investments, revenue generating assets, and sources of wealth.
Criminals were used to private sector practices: price signals, competition,
joint venturing, and third party dispute settlement.
To secure this remarkable achievement - the underworld had to procure
and then maintain - infrastructure and technologies. Indeed, criminals are
great at innovating and even more formidable at making use of cutting edge
technologies. There is not a single technological advance, invention or
discovery that criminals were not the first to utilize or the first to
contemplate and to grasp its full potential. There are enormous industries of
services rendered to the criminal in his pursuits. Accountants and lawyers,
forgers and cross border guides, weapons experts and bankers, mechanics
and hit-men - all stand at the disposal of the average criminal. The choice is
great and prices are always negotiable. These auxiliary professionals are no
different to their legitimate counterparts, despite the difference in subject
matter. A body of expertise, know-how and acumen has accumulated over
centuries of crime and is handed down the generations in the criminal
universities known as jail- houses and penitentiaries. Roads less travelled,
countries more lenient, passports to be bought, sold, or forged, how to
manuals, classified ads, goods and services on offer and demand - all

feature in this mass media cum educational (mostly verbal) bulletins. This is
the real infrastructure of crime. As with more mundane occupations, human
capital is what counts.
Criminal activities are hugely profitable (though wealth accumulation
and capital distribution are grossly non- egalitarian). Money is stashed away
in banking havens and in more regular banks and financial institutions all
over the globe. Electronic Document Interchange and electronic commerce
transformed what used to be an inconveniently slow and painfully
transparent process - into a speed-of-light here-I-am, here-I-am-gone type
of operation. Money is easily movable and virtually untraceable. Special
experts take care of that: tax havens, off shore banks, money transactions
couriers with the right education and a free spirit. This money, in due time
and having cooled off - is reinvested in legitimate activities. Crime is a
major engine of economic growth in some countries (where drugs are
grown or traded, or in countries such as Italy, in Russia and elsewhere in
CEE).
In many a place, criminals are the only ones who have any liquidity at
all. The other, more visible, sectors of the economy are wallowing in the
financial drought of a demonetized economy. People and governments tend
to lose both their scruples and their sense of fine distinctions under these
unhappy circumstances. They welcome any kind of money to ensure their
very survival. This is where crime comes in. In Central and Eastern Europe
the process was code-named: "privatization".
Moreover, most of the poor economies are also closed economies. They
are the economies of nations xenophobic, closed to the outside world, with
currency regulations, limitations on foreign ownership, constrained (instead
of free) trade. The vast majority of the populace of these economic wretches
has never been further than the neighbouring city - let alone outside the
borders of their countries. Freedom of movement is still restricted.
The only ones to have travelled freely - mostly without the required
travel documents - were the criminals. Crime is international. It involves
massive, intricate and sophisticated operations of export and import,
knowledge of languages, extensive and frequent trips, an intimate
acquaintance with world prices, the international financial system, demand

and supply in various markets, frequent business negotiations with
foreigners and so on. This list would fit any modern businessman as well.
Criminals are international businessmen. Their connections abroad coupled
with their connections with the various elites inside their country and
coupled with their financial prowess - made them the first and only true
businessmen of the economies in transition. There simply was no one else
qualified to fulfil this role - and the criminals stepped in willingly.
They planned and timed their moves as they always do: with shrewdness,
an uncanny knowledge of human psychology and relentless cruelty. There
was no one to oppose them - and so they won the day. It will take one or
more generations to get rid of them and to replace them by a more civilized
breed of entrepreneurs. But it will not happen overnight.
In the 19th century, the then expanding USA went through the same
process. Robber barons seized economic opportunities in the Wild East and
in the Wild West and really everywhere else. Morgan, Rockefeller, Pullman,
Vanderbilt - the most ennobled families of latter day America originated
with these rascals. But there is one important difference between the USA at
that time and Central and Eastern Europe today. A civic culture with civic
values and an aspiration to, ultimately, create a civic society permeated the
popular as well as the high-brow culture of America. Criminality was
regarded as a shameful stepping stone on the way to an orderly society of
learned, civilized, law-abiding citizens. This cannot be said about Russia,
for instance. The criminal there is, if anything, admired and emulated. The
language of business in countries in transition is suffused with the criminal
parlance of violence. The next generation is encouraged to behave similarly
because no clear (not to mention well embedded) alternative is propounded.
There is no - and never was - a civic tradition in these countries, a Bill of
Rights, a veritable Constitution, a modicum of self rule, a true abolition of
classes and nomenclatures.
The future is grim because the past was grim. Used to being governed by
capricious, paranoiac, criminal tyrants - these nations know no better. The
current criminal class seems to them to be a natural continuation and
extension of generations-long trends. That some criminals are members of
the new political, financial and industrial elites (and vice versa) - surprises
them not.

In most countries in transition, the elites (the political- managerial
complex) make use of the state and its simulacrum institutions in close
symbiosis with the criminal underworld. The state is often an oppressive
mechanism deployed in order to control the populace and manipulate it.
Politicians allocate assets, resources, rights, and licences to themselves, and
to their families and cronies. Patronage extends to collaborating criminals.
Additionally, the sovereign state is regarded as a means to extract foreign
aid and credits from donors, multilaterals, and NGOs.
The criminal underworld exploits the politicians.
Politicians give criminals access to state owned assets and resources.
These are an integral part of the money laundering cycle. "Dirty" money is
legitimized through the purchase of businesses and real estate from the
state.
Politicians induce state institutions to turn a blind eye to the criminal
activities of their collaborators and ensure lenient law enforcement. They
also help criminals eliminate internal and external competition in their
territories.
In return, criminals serve as the "long and anonymous arm" of
politicians. They obtain illicit goods for them and provide them with illegal
services. Corruption often flows through criminal channels or via the
mediation and conduit of delinquents. Within the shared sphere of the
informal economy, assets are often shifted among these economic players.
Both have an interest to maintain a certain lack of transparency, a
bureaucracy (=dependence on state institutions and state employees) and
NAIRU (Non Abating Internal Recruitment Unemployment).
Nationalism and racism, the fostering of paranoia and grievances are
excellent tactics of mobilization of foot soldiers. And the needs to dispense
with a continuous stream of patronage and provide venues for the
legitimization of illegally earned funds delay essential reforms and the
disposal of state assets.
This urge to become legitimate - largely the result of social pressure -
leads to a deterministic, four stroke cycle of co-habitation between
politicians and criminals. In the first phase, politicians grope for a new

ideological cover for their opportunism. This is followed by a growing
partnership between the elites and the crime world. A divergence then
occurs. Politicians team up with legitimacy-seeking, established crime
lords. Both groups benefit from a larger economic pie. They fight against
other, less successful, criminals, who wish to persist in their old ways. This
is low intensity warfare and it inevitably ends in the triumph of the former
over the latter.

XX. The Economics of Conspiracy Theories
Barry Chamish is convinced that Shimon Peres, Israel's wily old
statesman, ordered the assassination of Yitzhak Rabin, back in 1995, in
collaboration with the French. He points to apparent tampering with
evidence. The blood- stained song sheet in Mr. Rabin's pocket lost its bullet
hole between the night of the murder and the present.
The murderer, Yigal Amir, should have been immediately recognized by
Rabin's bodyguards. He has publicly attacked his query before. Israel's
fierce and fearsome internal security service, the Shabak, had moles and
agents provocateurs among the plotters. Chamish published a book about
the affair. He travels and lectures widely, presumably for a fee.
Chamish's paranoia-larded prose is not unique. The transcripts of Senator
Joseph McCarthy's inquisitions are no less outlandish. But it was the
murder of John F.
Kennedy, America's youthful president, that ushered in a golden age of
conspiracy theories.
The distrust of appearances and official versions was further enhanced by
the Watergate scandal in 1973-4.
Conspiracies and urban legends offer meaning and purposefulness in a
capricious, kaleidoscopic, maddeningly ambiguous, and cruel world. They
empower their otherwise helpless and terrified believers.
New Order one world government, Zionist and Jewish cabals, Catholic,
black, yellow, or red subversion, the machinations attributed to the
freemasons and the illuminati - all flourished yet again from the 1970's
onwards. Paranoid speculations reached frenzied nadirs following the
deaths of celebrities, such as "Princess Di".
Books like "The Da Vinci Code" (which deals with an improbable
Catholic conspiracy to erase from history the true facts about the fate of
Jesus) sell millions of copies worldwide.

Tony Blair, Britain's ever righteous prime minister denounced the "Diana
Death Industry". He was referring to the tomes and films which exploited
the wild rumors surrounding the fatal car crash in Paris in 1997. The
Princess, her boyfriend Dodi al-Fayed, heir to a fortune, as well as their
allegedly inebriated driver were killed in the accident.
Among the exploiters were "The Times" of London which promptly
published a serialized book by Time magazine reports. Britain's TV
networks, led by Live TV, capitalized on comments made by al-Fayed's
father to the "Mirror" alleging foul play.
But there is more to conspiracy theories than mass psychology. It is also
big business. Voluntary associations such as the Ku Klux Klan and the John
Birch Society are past their heyday. But they still gross many millions of
dollars a year.
The monthly "Fortean Times" is the leading brand in "strange phenomena
and experiences, curiosities, prodigies and portents". It is widely available
on both sides of the Atlantic. In its 29 years of existence it has covered the
bizarre, the macabre, and the ominous with panache and open-mindedness.
It is named after Charles Fort who compiled unexplained mysteries from
the scientific literature of his age (he died in 1932). He published four
bestsellers in his lifetime and lived to see "Fortean societies" established in
many countries.
A 12 months subscription to "Fortean Times" costs c. $45.
With a circulation of 60,000, the magazine was able to spin off "Fortean
Television" - a TV show on Britain's Channel Four. Its reputation was
further enhanced when it was credited with inspiring the TV hit series X-
Files and The Sixth Sense. "Lobster Magazine" - a bi-annual publication - is
more modest at $15 a year. It is far more "academic" looking and it sells CD
ROM compilations of its articles at between $80 (for individuals) and $160
(for institutions and organizations) a piece. It also makes back copies of its
issues available.
Its editor, Robin Ramsay, said in a lecture delivered to the "Unconvention
96", organized by the "Fortean Times": "Conspiracy theories certainly are
sexy at the moment ...

I've been contacted by five or six TV companies in the past six months -
two last week - all interested in making programmes about conspiracy
theories. I even got a call from the Big Breakfast Show, from a researcher
who had no idea who I was, asking me if I'd like to appear on it ...
These days we've got conspiracy theories everywhere; and about almost
everything".
But these two publications are the tip of a gigantic and ever-growing
iceberg. "Fortean Times" reviews, month in and month out, books, PC
games, movies, and software concerned with its subject matter. There is an
average of 8 items per issue with a median price of $20 per item.
There are more than 186,600 Web sites dedicated to conspiracy theories
in Google's database of 3 billion pages. The "conspiracy theories" category
in the Open Directory Project, a Web directory edited by volunteers,
contains hundreds of entries.
There are 1077 titles about conspiracies listed in Amazon and another
12078 in its individually-operated ZShops. A new (1996) edition of the
century-old anti-Semitic propaganda pamphlet faked by the Czarist secret
service, "Protocols of the Learned Elders of Zion", is available through
Amazon. Its sales rank is a respectable 64,000 - out of more than 2 million
titles stocked by the online bookseller.
In a disclaimer, Amazon states: "The Protocols of the Learned Elders of
Zion is classified under "controversial knowledge" in our store, along with
books about UFOs, demonic possession, and all manner of conspiracy
theories".
Yet, cinema and TV did more to propagate modern nightmares than all
the books combined. The Internet is starting to have a similar impact
compounded by its networking capabilities and by its environment of
simulated reality - "cyberspace". In his tome, "Enemies Within: The Culture
of Conspiracy in Modern America", Robert Alan Goldberg comes close to
regarding the paranoid mode of thinking as a manifestation of mainstream
American culture.
According to the Internet Movie Database, the first 50 all time hits
include at least one "straight" conspiracy theory movie (in the 13th place) -

"Men in Black" with $587 million in box office receipts. JFK (in the 193rd
place) grossed another $205 million. At least ten other films among the first
50 revolve around a conspiracy theory disguised as science fiction or
fantasy. "The Matrix" - in the 28th place - took in $456 million. "The
Fugitive" closes the list with $357 million. This is not counting "serial"
movies such as James Bond, the reification of paranoia shaken and stirred.
X-files is to television what "Men in Black" is to cinema.
According to "Advertising Age", at its peak, in 1998, a 30 seconds spot
on the show cost $330,000 and each chapter raked in $5 million in ad
revenues. Ad prices declined to $225,000 per spot two years later, according
to CMR Business to Business.
Still, in its January 1998 issue, "Fortune" claimed that "X- Files" (by then
a five year old phenomenon) garnered Fox TV well over half a billion
dollars in revenues. This was before the eponymous feature film was
released. Even at the end of 2000, the show was regularly being watched by
12.4 million households - compared to 22.7 million viewers in 1998. But X-
files was only the latest, and the most successful, of a line of similar TV
shows, notably "The Prisoner" in the 1960's.
It is impossible to tell how many people feed off the paranoid frenzy of
the lunatic fringe. I found more than 3000 lecturers on these subjects listed
by the Google search engine alone. Even assuming a conservative schedule
of one lecture a month with a modest fee of $250 per appearance - we are
talking about an industry of c. $10 million.
Collective paranoia has been boosted by the Internet.
Consider the computer game "Majestic" by Electronic Arts. It is an
interactive and immersive game, suffused with the penumbral and the
surreal. It is a Web reincarnation of the borderlands and the twilight zone -
centered around a nefarious and lethal government conspiracy. It invades
the players' reality - the game leaves them mysterious messages and "tips"
by phone, fax, instant messaging, and e-mail. A typical round lasts 6 months
and costs $10 a month.
Neil Young, the game's 31-years old, British-born, producer told
Salon.com recently: "... The concept of blurring the lines between fact and

fiction, specifically around conspiracies. I found myself on a Web site for
the conspiracy theory radio show by Art Bell ... the Internet is such a
fabulous medium to blur those lines between fact and fiction and
conspiracy, because you begin to make connections between things.
It's a natural human reaction - we connect these dots around our fears.
Especially on the Internet, which is so conspiracy-friendly. That was what
was so interesting about the game; you couldn't tell whether the sites you
were visiting were Majestic-created or normal Web sites..".
Majestic creates almost 30 primary Web sites per episode.
It has dozens of "bio" sites and hundreds of Web sites created by fans and
linked to the main conspiracy threads.
The imaginary gaming firm at the core of its plots, "Amin-X", has often
been confused with the real thing. It even won the E3 Critics Award for best
original product...
Conspiracy theories have pervaded every facet of our modern life. A.H.
Barbee describes in "Making Money the Telefunding Way" (published on
the Web site of the Institute for First Amendment Studies) how conspiracy
theorists make use of non-profit "para-churches".
They deploy television, radio, and direct mail to raise billions of dollars
from their followers through "telefunding". Under section 170 of the IRS
code, they are tax-exempt and not obliged even to report their income.
The Federal Trade commission estimates that 10% of the $143 billion
donated to charity each year may be solicited fraudulently.
Lawyers represent victims of the Gulf Syndrome for hefty sums.
Agencies in the USA debug bodies - they "remove" brain "implants"
clandestinely placed by the CIA during the Cold War. They charge
thousands of dollars a pop.
Cranks and whackos - many of them religious fundamentalists - use
inexpensive desktop publishing technology to issue scaremongering
newsletters (remember Mel Gibson in the movie "Conspiracy Theory"?).

Tabloids and talk shows - the only source of information for nine tenths
of the American population - propagate these "news". Museums - the UFO
museum in New Mexico or the Kennedy Assassination museum in Dallas,
for instance - immortalize them. Memorabilia are sold through auction sites
and auction houses for thousands of dollars an item.
Numerous products were adversely affected by conspiratorial smear
campaigns. In his book "How the Paranoid Style Flourishes and Where it
Comes From", Daniel Pipes describes how the sales of Tropical Fantasy
plummeted by 70% following widely circulated rumors about the sterilizing
substances it allegedly contained - put there by the KKK. Other brands
suffered a similar fate: Kool and Uptown cigarettes, Troop Sport clothing,
Church's Fried Chicken, and Snapple soft drinks.
It all looks like one giant conspiracy to me. Now, here's one theory worth
pondering...

XXI. The Demise of the Work Ethic
"When work is a pleasure, life is a joy!
When work is a duty, life is slavery".

Maxim Gorky (1868-1936), Russian novelist, author, and playright
Airplanes, missiles, and space shuttles crash due to lack of maintenance,
absent-mindedness, and pure ignorance.
Software support personnel, aided and abetted by Customer Relationship
Management application suites, are curt (when reachable) and unhelpful.
Despite expensive, state of the art supply chain management systems,
retailers, suppliers, and manufacturers habitually run out of stocks of
finished and semi-finished products and raw materials. People from all
walks of life and at all levels of the corporate ladder skirt their
responsibilities and neglect their duties.
Whatever happened to the work ethic? Where is the pride in the
immaculate quality of one's labor and produce? Both dead in the water. A
series of earth-shattering social, economic, and technological trends
converged to render their jobs loathsome to many - a tedious nuisance best
avoided. 1. Job security is a thing of the past. Itinerancy in various McJobs
reduces the incentive to invest time, effort, and resources into a position that
may not be yours next week.
Brutal layoffs and downsizing traumatized the workforce and produced
in the typical workplace a culture of obsequiousness, blind obeisance, the
suppression of independent thought and speech, and avoidance of initiative
and innovation. Many offices and shop floors now resemble prisons. 2.
Outsourcing and offshoring of back office (and, more recently, customer
relations and research and development) functions sharply and adversely
effected the quality of services from helpdesks to airline ticketing and from
insurance claims processing to remote maintenance.
Cultural mismatches between the (typically Western) client base and the
offshore service department (usually in a developing country where labor is

cheap and plenty) only exacerbated the breakdown of trust between
customer and provider or supplier. 3. The populace in developed countries
are addicted to leisure time. Most people regard their jobs as a necessary
evil, best avoided whenever possible. Hence phenomena like the permanent
temp - employees who prefer a succession of temporary assignments to
holding a proper job. The media and the arts contribute to this perception of
work as a drag - or a potentially dangerous addiction (when they portray
raging and abusive workaholics). 4. The other side of this dismal coin is
workaholism - the addiction to work. Far from valuing it, these addicts
resent their dependence. The job performance of the typical workaholic
leaves a lot to be desired. Workaholics are fatigued, suffer from ancillary
addictions, and short attention spans. They frequently abuse substances, are
narcissistic and destructively competitive (being driven, they are incapable
of team work). 5. The depersonalization of manufacturing - the
intermediated divorce between the artisan/worker and his client -
contributed a lot to the indifference and alienation of the common industrial
worker, the veritable "anonymous cog in the machine".
Not only was the link between worker and product broken - but the bond
between artisan and client was severed as well. Few employees know their
customers or patrons first hand. It is hard to empathize with and care about
a statistic, a buyer whom you have never met and never likely to encounter.
It is easy in such circumstances to feel immune to the consequences of one's
negligence and apathy at work. It is impossible to be proud of what you do
and to be committed to your work - if you never set eyes on either the final
product or the customer! Charlie Chaplin's masterpiece, "Modern Times"
captured this estrangement brilliantly. 6. Many former employees of mega-
corporations abandon the rat race and establish their own businesses - small
and home enterprises. Undercapitalized, understaffed, and outperformed by
the competition, these fledging and amateurish outfits usually spew out
shoddy products and lamentable services - only to expire within the first
year of business. 7. Despite decades of advanced notice, globalization
caught most firms the world over by utter surprise. Ill- prepared and fearful
of the onslaught of foreign competition, companies big and small grapple
with logistical nightmares, supply chain calamities, culture shocks and
conflicts, and rapacious competitors. Mere survival (and opportunistic
managerial plunder) replaced client satisfaction as the prime value. 8. The

decline of the professional guilds on the one hand and the trade unions on
the other hand greatly reduced worker self-discipline, pride, and peer-
regulated quality control. Quality is monitored by third parties or
compromised by being subjected to Procrustean financial constraints and
concerns.
The investigation of malpractice and its punishment are now at the hand
of vast and ill-informed bureaucracies, either corporate or governmental.
Once malpractice is exposed and admitted to, the availability of malpractice
insurance renders most sanctions unnecessary or toothless.
Corporations prefer to bury mishaps and malfeasance rather than cope
with and rectify them. 9. The quality of one's work, and of services and
products one consumed, used to be guaranteed. One's personal
idiosyncrasies, eccentricities, and problems were left at home. Work was
sacred and one's sense of self-worth depended on the satisfaction of one's
clients. You simply didn't let your personal life affect the standards of your
output.
This strict and useful separation vanished with the rise of the malignant-
narcissistic variant of individualism. It led to the emergence of idiosyncratic
and fragmented standards of quality. No one knows what to expect, when,
and from whom. Transacting business has become a form of psychological
warfare. The customer has to rely on the goodwill of suppliers,
manufacturers, and service providers - and often finds himself at their whim
and mercy. "The client is always right" has gone the way of the dodo. "It's
my (the supplier's or provider's) way or the highway" rules supreme.
This uncertainty is further exacerbated by the pandemic eruption of
mental health disorders - 15% of the population are severely pathologized
according to the latest studies. Antisocial behaviors - from outright crime to
pernicious passive-aggressive sabotage - once rare in the workplace, are
now abundant.
The ethos of teamwork, tempered collectivism, and collaboration for the
greater good is now derided or decried. Conflict on all levels has replaced
negotiated compromise and has become the prevailing narrative.

Litigiousness, vigilante justice, use of force, and "getting away with it"
are now extolled. Yet, conflicts lead to the misallocation of economic
resources. They are non- productive and not conducive to sustaining good
relations between producer or provider and consumer. 10. Moral relativism
is the mirror image of rampant individualism. Social cohesion and
discipline diminished, ideologies and religions crumbled, and anomic states
substituted for societal order. The implicit contracts between manufacturer
or service provider and customer and between employee and employer were
shredded and replaced with ad-hoc negotiated operational checklists.
Social decoherence is further enhanced by the anonymization and
depersonalization of the modern chain of production (see point 5 above).
Nowadays, people facilely and callously abrogate their responsibilities
towards their families, communities, and nations. The mushrooming rate of
divorce, the decline in personal thrift, the skyrocketing number of personal
bankruptcies, and the ubiquity of venality and corruption both corporate and
political are examples of such dissipation. No one seems to care about
anything. Why should the client or employer expect a different treatment?
11. The disintegration of the educational systems of the West made it
difficult for employers to find qualified and motivated personnel. Courtesy,
competence, ambition, personal responsibility, the ability to see the bigger
picture (synoptic view), interpersonal aptitude, analytic and synthetic skills,
not to mention numeracy, literacy, access to technology, and the sense of
belonging which they foster - are all products of proper schooling. 12.
Irrational beliefs, pseudo-sciences, and the occult rushed in to profitably fill
the vacuum left by the crumbling education systems. These wasteful
preoccupations encourage in their followers an overpowering sense of
fatalistic determinism and hinder their ability to exercise judgment and
initiative. The discourse of commerce and finance relies on unmitigated
rationality and is, in essence, contractual. Irrationality is detrimental to the
successful and happy exchange of goods and services.

XXII. The Morality of Child Labor
From the comfort of their plush offices and five to six figure salaries,
self-appointed NGO's often denounce child labor as their employees rush
from one five star hotel to another, $3000 subnotebooks and PDA's in hand.
The hairsplitting distinction made by the ILO between "child work" and
"child labor" conveniently targets impoverished countries while letting its
budget contributors - the developed ones - off-the-hook.
Reports regarding child labor surface periodically.
Children crawling in mines, faces ashen, body deformed.
The agile fingers of famished infants weaving soccer balls for their more
privileged counterparts in the USA. Tiny figures huddled in sweatshops,
toiling in unspeakable conditions. It is all heart-rending and it gave rise to a
veritable not-so-cottage industry of activists, commentators, legal eagles,
scholars, and opportunistically sympathetic politicians.
Ask the denizens of Thailand, sub-Saharan Africa, Brazil, or Morocco
and they will tell you how they regard this altruistic hyperactivity - with
suspicion and resentment.
Underneath the compelling arguments lurks an agenda of trade
protectionism, they wholeheartedly believe.
Stringent - and expensive - labor and environmental provisions in
international treaties may well be a ploy to fend off imports based on cheap
labor and the competition they wreak on well-ensconced domestic
industries and their political stooges.
This is especially galling since the sanctimonious West has amassed its
wealth on the broken backs of slaves and kids. The 1900 census in the USA
found that 18 percent of all children - almost two million in all - were
gainfully employed. The Supreme Court ruled unconstitutional laws

banning child labor as late as 1916. This decision was overturned only in
1941.
The GAO published a report last week in which it criticized the Labor
Department for paying insufficient attention to working conditions in
manufacturing and mining in the USA, where many children are still
employed. The Bureau of Labor Statistics pegs the number of working
children between the ages of 15-17 in the USA at 3.7 million. One in 16 of
these worked in factories and construction. More than 600 teens died of
work-related accidents in the last ten years.
Child labor - let alone child prostitution, child soldiers, and child slavery
- are phenomena best avoided. But they cannot and should not be tackled in
isolation. Nor should underage labor be subjected to blanket castigation.
Working in the gold mines or fisheries of the Philippines is hardly
comparable to waiting on tables in a Nigerian or, for that matter, American
restaurant.
There are gradations and hues of child labor. That children should not be
exposed to hazardous conditions, long working hours, used as means of
payment, physically punished, or serve as sex slaves is commonly agreed.
That they should not help their parents plant and harvest may be more
debatable.
As Miriam Wasserman observes in "Eliminating Child Labor", published
in the Federal Bank of Boston's "Regional Review", second quarter of 2000,
it depends on "family income, education policy, production technologies,
and cultural norms." About a quarter of children under-14 throughout the
world are regular workers. This statistic masks vast disparities between
regions like Africa (42 percent) and Latin America (17 percent).
In many impoverished locales, child labor is all that stands between the
family unit and all-pervasive, life threatening, destitution. Child labor
declines markedly as income per capita grows. To deprive these bread-
earners of the opportunity to lift themselves and their families incrementally
above malnutrition, disease, and famine - is an apex of immoral hypocrisy.
Quoted by "The Economist", a representative of the much decried
Ecuador Banana Growers Association and Ecuador's Labor Minister,

summed up the dilemma neatly: "Just because they are under age doesn't
mean we should reject them, they have a right to survive. You can't just say
they can't work, you have to provide alternatives".
Regrettably, the debate is so laden with emotions and self- serving
arguments that the facts are often overlooked.
The outcry against soccer balls stitched by children in Pakistan led to the
relocation of workshops ran by Nike and Reebok. Thousands lost their jobs,
including countless women and 7000 of their progeny. The average family
income - anyhow meager - fell by 20 percent.
Economists Drusilla Brown, Alan Deardorif, and Robert Stern observe
wryly: "While Baden Sports can quite credibly claim that their soccer balls
are not sewn by children, the relocation of their production facility
undoubtedly did nothing for their former child workers and their families".
Such examples abound. Manufacturers - fearing legal reprisals and
"reputation risks" (naming-and-shaming by overzealous NGO's) - engage in
preemptive sacking.
German garment workshops fired 50,000 children in Bangladesh in 1993
in anticipation of the American never-legislated Child Labor Deterrence
Act.
Quoted by Wasserstein, former Secretary of Labor, Robert Reich, notes:
"Stopping child labor without doing anything else could leave children
worse off. If they are working out of necessity, as most are, stopping them
could force them into prostitution or other employment with greater
personal dangers. The most important thing is that they be in school and
receive the education to help them leave poverty".
Contrary to hype, three quarters of all children work in agriculture and
with their families. Less than 1 percent work in mining and another 2
percent in construction.
Most of the rest work in retail outlets and services, including "personal
services" - a euphemism for prostitution. UNICEF and the ILO are in the
throes of establishing school networks for child laborers and providing their
parents with alternative employment.

But this is a drop in the sea of neglect. Poor countries rarely proffer
education on a regular basis to more than two thirds of their eligible school-
age children. This is especially true in rural areas where child labor is a
widespread blight. Education - especially for women - is considered an
unaffordable luxury by many hard-pressed parents. In many cultures, work
is still considered to be indispensable in shaping the child's morality and
strength of character and in teaching him or her a trade. "The Economist"
elaborates: "In Africa children are generally treated as mini-adults; from an
early age every child will have tasks to perform in the home, such as
sweeping or fetching water. It is also common to see children working in
shops or on the streets. Poor families will often send a child to a richer
relation as a housemaid or houseboy, in the hope that he will get an
education".
A solution recently gaining steam is to provide families in poor countries
with access to loans secured by the future earnings of their educated
offspring. The idea - first proposed by Jean-Marie Baland of the University
of Namur and James A. Robinson of the University of California at
Berkeley - has now permeated the mainstream.
Even the World Bank has contributed a few studies, notably, in June,
"Child Labor: The Role of Income Variability and Access to Credit Across
Countries" authored by Rajeev Dehejia of the NBER and Roberta Gatti of
the Bank's Development Research Group.
Abusive child labor is abhorrent and should be banned and eradicated.
All other forms should be phased out gradually. Developing countries
already produce millions of unemployable graduates a year - 100,000 in
Morocco alone. Unemployment is rife and reaches, in certain countries -
such as Macedonia - more than one third of the workforce. Children at work
may be harshly treated by their supervisors but at least they are kept off the
far more menacing streets. Some kids even end up with a skill and are
rendered employable.

XXIII. The Myth of the Earnings Yield
In American novels, well into the 1950's, one finds protagonists using the
future stream of dividends emanating from their share holdings to send their
kids to college or as collateral. Yet, dividends seemed to have gone the way
of the Hula-Hoop. Few companies distribute erratic and ever-declining
dividends. The vast majority don't bother. The unfavorable tax treatment of
distributed profits may have been the cause.
The dwindling of dividends has implications which are nothing short of
revolutionary. Most of the financial theories we use to determine the value
of shares were developed in the 1950's and 1960's, when dividends were in
vogue. They invariably relied on a few implicit and explicit assumptions: 1.
That the fair "value" of a share is closely correlated to its market price; 2.
That price movements are mostly random, though somehow related to the
aforementioned "value" of the share. In other words, the price of a security
is supposed to converge with its fair "value" in the long term; 3. That the
fair value responds to new information about the firm and reflects it -
though how efficiently is debatable. The strong efficiency market
hypothesis assumes that new information is fully incorporated in prices
instantaneously.
But how is the fair value to be determined? A discount rate is applied to
the stream of all future income from the share - i.e., its dividends. What
should this rate be is sometimes hotly disputed - but usually it is the coupon
of "riskless" securities, such as treasury bonds.
But since few companies distribute dividends - theoreticians and analysts
are increasingly forced to deal with "expected" dividends rather than "paid
out" or actual ones.
The best proxy for expected dividends is net earnings. The higher the
earnings - the likelier and the higher the dividends. Thus, in a subtle
cognitive dissonance, retained earnings - often plundered by rapacious
managers - came to be regarded as some kind of deferred dividends.

The rationale is that retained earnings, once re-invested, generate
additional earnings. Such a virtuous cycle increases the likelihood and size
of future dividends. Even undistributed earnings, goes the refrain, provide a
rate of return, or a yield - known as the earnings yield. The original
meaning of the word "yield" - income realized by an investor - was
undermined by this Newspeak.
Why was this oxymoron - the "earnings yield" - perpetuated? According
to all current theories of finance, in the absence of dividends - shares are
worthless. The value of an investor's holdings is determined by the income
he stands to receive from them. No income - no value. Of course, an
investor can always sell his holdings to other investors and realize capital
gains (or losses). But capital gains - though also driven by earnings hype -
do not feature in financial models of stock valuation.
Faced with a dearth of dividends, market participants - and especially
Wall Street firms - could obviously not live with the ensuing zero valuation
of securities. They resorted to substituting future dividends - the outcome of
capital accumulation and re-investment - for present ones.
The myth was born.
Thus, financial market theories starkly contrast with market realities.
No one buys shares because he expects to collect an uninterrupted and
equiponderant stream of future income in the form of dividends. Even the
most gullible novice knows that dividends are a mere apologue, a relic of
the past. So why do investors buy shares? Because they hope to sell them to
other investors later at a higher price.
While past investors looked to dividends to realize income from their
shareholdings - present investors are more into capital gains. The market
price of a share reflects its discounted expected capital gains, the discount
rate being its volatility. It has little to do with its discounted future stream of
dividends, as current financial theories teach us.
But, if so, why the volatility in share prices, i.e., why are share prices
distributed? Surely, since, in liquid markets, there are always buyers - the
price should stabilize around an equilibrium point.

It would seem that share prices incorporate expectations regarding the
availability of willing and able buyers, i.e., of investors with sufficient
liquidity. Such expectations are influenced by the price level - it is more
difficult to find buyers at higher prices - by the general market sentiment,
and by externalities and new information, including new information about
earnings.
The capital gain anticipated by a rational investor takes into
consideration both the expected discounted earnings of the firm and market
volatility - the latter being a measure of the expected distribution of willing
and able buyers at any given price. Still, if earnings are retained and not
transmitted to the investor as dividends - why should they affect the price of
the share, i.e., why should they alter the capital gain? Earnings serve merely
as a yardstick, a calibrator, a benchmark figure. Capital gains are, by
definition, an increase in the market price of a security. Such an increase is
more often than not correlated with the future stream of income to the firm -
though not necessarily to the shareholder. Correlation does not always
imply causation.
Stronger earnings may not be the cause of the increase in the share price
and the resulting capital gain. But whatever the relationship, there is no
doubt that earnings are a good proxy to capital gains.
Hence investors' obsession with earnings figures. Higher earnings rarely
translate into higher dividends. But earnings - if not fiddled - are an
excellent predictor of the future value of the firm and, thus, of expected
capital gains. Higher earnings and a higher market valuation of the firm
make investors more willing to purchase the stock at a higher price - i.e., to
pay a premium which translates into capital gains.
The fundamental determinant of future income from share holding was
replaced by the expected value of share- ownership. It is a shift from an
efficient market - where all new information is instantaneously available to
all rational investors and is immediately incorporated in the price of the
share - to an inefficient market where the most critical information is
elusive: how many investors are willing and able to buy the share at a given
price at a given moment.

A market driven by streams of income from holding securities is "open".
It reacts efficiently to new information. But it is also "closed" because it is a
zero sum game. One investor's gain is another's loss. The distribution of
gains and losses in the long term is pretty even, i.e., random. The price level
revolves around an anchor, supposedly the fair value.
A market driven by expected capital gains is also "open" in a way
because, much like less reputable pyramid schemes, it depends on new
capital and new investors. As long as new money keeps pouring in, capital
gains expectations are maintained - though not necessarily realized.
But the amount of new money is finite and, in this sense, this kind of
market is essentially a "closed" one. When sources of funding are
exhausted, the bubble bursts and prices decline precipitously. This is
commonly described as an "asset bubble".
This is why current investment portfolio models (like CAPM) are
unlikely to work. Both shares and markets move in tandem (contagion)
because they are exclusively swayed by the availability of future buyers at
given prices.
This renders diversification inefficacious. As long as considerations of
"expected liquidity" do not constitute an explicit part of income-based
models, the market will render them increasingly irrelevant.

XXIV. The Future of the Securities and Exchange
Commission (SEC)
Interview with Gary Goodenow

In June 2005, William H. Donaldson was forced to resign as Chairman of
the Securities and Exchange Commission (SEC). The reason? As the New
York Times put it: "criticism that his enforcement was too heavy-handed".
President Bush chose California Rep. Christopher Cox, a Republican, to
replace him.
Gary Langan Goodenow is an attorney licensed to practice in the State of
Florida and the District of Columbia. The Webmaster of
www.RealityAtTheSEC.com, he worked at the Miami office of the SEC for
about six years, in the Division of Enforcement.
His experience is varied. As a staff attorney, he investigated and
prosecuted cases enforcing the federal securities laws. As a branch chief, he
supervised the work of several staff attorneys. As a Senior Trial Counsel, he
was responsible for litigating about thirty enforcement cases at any one time
in federal court. As Senior Counsel, he made the final recommendations on
which cases the office would investigate and prosecute, or decline.
He describes an experience he had after he left the SEC. "I represented an
Internet financial writer with a Web site that touted stocks, Mr. Ted Melcher
of SGA Whisper Stocks. The SEC sued Ted because as he was singing the
praises of certain stocks in his articles, he was selling them into a rising
market. He got his shares from the issuers in exchange for doing the
promotional touting. Unfortunately for him, the SEC and the Department of
Justice made an example of his case, and he went to jail".
Q. The SEC is often accused of lax and intermittent enforcement of the
law. Is the problem with the enforcement division - or with the law? Can

you describe a typical SEC investigation from start to finish? A. The
problem lies with both.
At the SEC, the best argument in support of a proposed course of action
is "that's what we did last time". That will inevitably please the staff
attorney's superiors.
SEC rules and regulations remind me of an old farmhouse that has been
altered and adapted, sometimes for convenience, other times for necessity.
But it has never been just plain pulled down and rebuilt despite incredible
changes around it. To the uninitiated, the house is rambling with hidden
passages, dark corners, low ceilings, folklore and horror stories, and
accumulations of tons of antique rubbish that sometimes no one - not even
some SEC Commissioners - can wade through.
Wandering from room to room in this farmhouse are the SEC staff.
Regretfully, I found that many are ignorant or indifferent to their mission, or
scornful of investors' plight, too addicted to their petty specializations in
their detailed job descriptions, and way too prone to follow only the well-
trodden path.
They are stunned by the rapidity, multiplicity, immensity and intelligence
behind the scams. Their tools of research, investigation and prosecution are
confusingly changed periodically when Congress passes some new
"reform" legislation, or a new Chairman or new Enforcement Director
issues some memo edict on a "new approach".
Staff attorneys typically bring investors only bad news and are numbed
by the latters' emotional reactions, in a kind of "shell shock". The SEC lost
one quarter of its staff in the last two years. The turnover of its 1200
attorneys, at 14%, is nearly double the government's average.
One SEC official was quoted as saying "We are losing our future - the
people who would have had the experience to move into the senior ranks".
Those that stay behind and rise in the ranks are often the least inspired. At
the SEC enforcement division, one is often confronted with the "evil of
banality".
The SEC is empowered by the Securities Act of 1933 and the Securities
Exchange Act of 1934 to seek injunctive relief where it appears that a

person is engaged or about to engage in violations of the federal securities
laws. This is a civil remedy, not a criminal law sanction. Under well-settled
case law, the purpose of injunctive relief is deterrence, rather than
punishment, of those who commit violations. Investors do not know that,
and are uniformly shocked when told.
The "likelihood requirement" means that, once the Commission
demonstrates a violation, for injunctive relief it needs only show that there
is some reasonable likelihood of future violations. "Positive proof' of
likelihood, as one court demanded, is hard to provide. At the other extreme,
I had one former Commissioner tell me that, as he understood the law, if the
person is alive and breathing, the Commission enforcement staff can show
likelihood of future violations.
The broad powers of the federal courts are used in actions brought by the
Commission to prevent securities violators from enjoying the fruits of their
misconduct. But because this is a civil and not a criminal remedy, the SEC
has a unique rule where defendants can consent to an injunction without
"admitting or denying the allegations of the complaint". This leads to what
are called "waivers", and I submit that "waivers" are the fundamental flaw
in U.S. securities laws enforcement.
In a nutshell, here is the problem. A "fraudster" commits a fraud. The
Commission sues for an injunction.
The fraudster consents to the injunction as per above. The Court then
orders the fraudster to "disgorge" his "ill gotten gains" from the scam,
usually within 30 days and with interest.
In most cases, the fraudster doesn't pay it all and the Commission moves
to hold him in civil contempt for disobeying the Court's order. The fraudster
claims to the Court that it is impossible for him to comply because the
money is gone and he is "without the financial means to pay". The
Commission then issues a "waiver" and that's the way many cases end.
Thus both sides can put the case behind them. The fraudster agrees to the
re-opening of the case if he turns out to have lied.
This procedure is problematic. The Commission typically alleges that
these fraudsters have lied through their teeth in securities sales - but is

forced to accept their word in an affidavit swearing that they have no
money to pay the disgorgement. So the waivers are based on an assumption
of credibility that has no basis in experience and possibly none in fact.
Moreover, the Division of Enforcement has no mechanism in place to
check if the fraudster has, indeed, lied. After the waiver, the files of the case
get stored. The case is closed. I don't know if there's even a central place
where the records of waivers are kept.
In the six years I was at the Commission, I never heard of a case
involving a breach of waiver affidavit. I doubt if one has ever been brought
by the Commission - anywhere. UPI ought to do a Freedom Of Information
Act Request on that.
Something similar happens with the Commission's much vaunted ability
to levy civil penalties. The statute requires that a court trial be held to
determine the egregiousness of the fraud. Based on its findings, the court
can levy the fines. But, according to some earlier non- SEC case law, a
fraudster can ask for a jury trial regarding the amount of the civil penalties
because he or she lack the means to pay them. U.S. district courts being as
busy as they are, there's no way the court is going to hold a jury trial.
Instead, the fraudster consents to a court order "noting the
appropriateness of civil penalties for the case, but declining to set them
based on a demonstrated inability to pay". Again, if the fraudster lied, the
Commission can ask the Court to revisit the issue.
Q. Internet fraud, corporate malfeasance, derivatives, off- shore special
purpose entities, multi-level marketing, scams, money laundering - is the
SEC up to it? Isn't its staff overwhelmed and under-qualified? A. The staff
is overwhelmed. The longest serving are often the least qualified because
the talented usually leave.
We've already got the criminal statutes on the books for criminal
prosecution of securities fraud at the federal level. Congress should pass a
law deputizing staff attorneys of the Commission Division of Enforcement,
with at least one-year experience and high performance ratings, as Special
Assistant United States Attorneys for the prosecution of securities fraud. In

other words, make them part of the Department of Justice to make criminal,
not just civil cases, against the fraudsters.
The US Department of Justice does not have the person power to pursue
enough criminal securities cases in the Internet Age. Commission attorneys
have the expertise, but not the legal right, to bring criminal prosecution. The
afore-described waiver system only makes the fraudsters more confident
that the potential gain from fraud outweighs the risk.
I'd keep the civil remedies. In an ongoing fraud, with no time to make out
a criminal case, the Commission staff can seek a Temporary Restraining
Order and an asset freeze. This more closely resembles the original intent of
Congress in the 1930s. But after the dust settles, the investing public
deserves to demand criminal accountability for the fraud, not just waivers.
Q. Is the SEC - or at least its current head - in hock to special interests,
e.g., the accounting industry? A. "In hock to special interests" is too explicit
a statement about US practice. It makes a good slogan for a Marxist law
school professor, but reality is far subtler.
By unwritten bipartisan agreement, the Chairman of the SEC is always a
political figure. Two of the five SEC Commissioners are always Democrats,
two Republicans, and the Chairman belongs to the political party of the
President. I am curious to see if this same agreement will apply to the
boards established under the Sarbannes-Oxley Act.
Thus, both parties typically choose a candidate for Chairman of
impeccable partisan credentials and consistent adherence to the "party line".
The less connected, the less partisan, and academicians serve as
Commissioners, not Chairmen.
The Chairman's tenure normally overlaps with a specific President's term
in office, even when, as with President Bush the elder following President
Reagan, the same party remains in power. SEC jobs lend themselves to
lucrative post-Commission employment. This explains the dearth of "loyal
opposition". Alumni pride themselves on their connections following their
departure.
The Chairman is no more and no less "in hock" than any leading member
of a US political party. Still, I faulted Chairman Pitt, and became the first

former member of SEC management to call for his resignation, in an Op/Ed
item in the Miami Herald. In my view, he was impermissibly indulgent of
his former law clients at the expense of SEC enforcement.
Q. What more could stock exchanges do to help the SEC? A. At the risk
of being flippant, enforce their own rules. The major enforcement action
against the NASDAQ brokers a few years ago, for instance, was toothless.
Presently, Merrill Lynch is being scrutinized by the State of New York, but
there is not a word from the NYSE.
Q. Do you regard the recent changes to the law - especially the Sarbanes-
Oxley Act - as toothless or an important enhancement to the arsenal of law
enforcement agencies? Do you think that the SEC should have any input in
professional self-regulating and regulatory bodies, such as the recently
established accountants board? A. It remains to be seen. The Act establishes
a Public Accounting Oversight Board ("the Board"). It reflects one major
aspect of SEC enforcement practice: unlike in many countries, the SEC
does not recognize an accountant/client privilege, though it does recognize
an attorney/client privilege.
Regrettably, in my experience, attorneys organize at least as much
securities fraud as accountants. Yet in the US, one would never see an
"attorneys oversight board". For one thing, Congress has more attorneys
than accountants.

Section 3 of the Act, titled "Commission Rules and
Enforcement", treats a violation of the Rules of the Public Company
Accounting Oversight Board as a violation of the '34 Act, giving rise to the
same penalties. It is unclear if this means waiver after waiver, as in present
SEC enforcement. Even if it does, the Rules may still be more effective
because US state regulators can forfeit an accountant's license based on a
waived injunction.
The Act's provision, in Section 101, for the membership of said Board
has yet to be fleshed out. Appointed to five- year terms, two of the members
must be - or have been - certified public accountants, and the remaining
three must not be and cannot have been CPAs. Lawyers are the likeliest to
be appointed to these other seats. The Chairmanship may be held by one of
the CPA members, provided that he or she has not been engaged as a
practicing CPA for five years, meaning, ab initio, that he or she will be
behind the practice curb at a time when change is rapid.
No Board member may, during their service on the Board, "share in any
of the profits of, or receive payments from, a public accounting firm," other
than "fixed continuing payments," such as retirement payments. This
mirrors SEC practice with the securities industry, but does little to tackle
"the revolving door".
The Board members are appointed by the SEC, "after consultation with"
the Federal Reserve Board Chairman and the Treasury Secretary. Given the
term lengths, it is safe to predict that every new presidential administration
will bring with it a new Board.
The major powers granted to the Board will effectively change the
accounting profession in the USA, at least with regards to public
companies, from a self-regulatory body licensed by the states, into a
national regulator.
Under Act Section 103, the Board shall: (1) register public accounting
firms; (2) establish "auditing, quality control, ethics, independence, and

other standards relating to the preparation of audit reports for issuers;" (3)
inspect accounting firms; and (4) investigate and discipline firms to enforce
compliance with the Act, the Rules, professional standards and the federal
securities laws. This is a sea change in the US.
As to professional standards, the Board must "cooperate on an on-going
basis" with certain accountants advisory groups. Yet, US federal
government Boards do not "co- operate" - they dictate. The Board can "to
the extent that it determines appropriate" adopt proposals by such groups.
More importantly, it has authority to reject any standards proffered by
said groups. This will then be reviewed by the SEC, because the Board
must report on its standards to the Commission every year. The SEC may -
by rule - require the Board to cover additional ground. The Board, and the
SEC through the Board, now run the US accounting profession.
The Board is also augments the US effort to establish hegemony over the
global practice of accounting. Act Section 106, Foreign Public Accounting
Firms, subjects foreigners who audit U.S. companies - including foreign
firms that perform audit work that is used by the primary auditor on a
foreign subsidiary of a U.S. company - to registration with the Board.
I am amazed that the EU was silent on this inroad to their sovereignty.
This may prove more problematic in US operations in China. I do not think
the US can force its accounting standards on China without negatively
affecting our trade there.
Under Act Section 108, the SEC now decides what are "generally"
accepted accounting principles. Registered public accounting firms are
barred from providing certain non-audit services to an issuer they audit.
Thus, the split, first proposed by the head of Arthur Anderson in 1974, is
now the law.
Act Section 203, Audit Partner Rotation, is a gift to the accounting
profession. The lead audit or coordinating partner and the reviewing partner
must rotate every 5 years. That means that by law, the work will be spread
around. Note that the law says "partner", not "partnership". Thus, we are
likely to continue to see institutional clients serviced by "juntas" at
accounting firms, not by individuals. This will likely end forever the days

when a single person controlled major amounts of business at an accounting
firm. US law firms would never countenance such a change, as the
competition for major clients is intense.
Act Section 209, Consideration by Appropriate State Regulatory
Authorities, "throws a bone" to the states. It requires state regulators to
make an independent determination whether Board standards apply to small
and mid-size non-registered accounting firms. No one can seriously doubt
the outcome of these determinations. But we now pretend that we still have
real state regulation of the accounting profession, just as we pretend that we
have state regulation of the securities markets through "blue sky laws". The
reality is that the states will be confined hence to the initial admission of
persons to the accounting profession. Like the "blue sky laws", it will be a
revenue source, but the states will be completely junior to the Board and the
SEC.
Act Section 302, Corporate Responsibility For Financial Reports,
mandates that the CEO and CFO of each issuer shall certify the
"appropriateness of the financial statements and disclosures contained in the
periodic report, and that those financial statements and disclosures fairly
present, in all material respects, the operations and financial condition of
the issuer". This may prove problematic with global companies. We have
already seen resistance by Daimler-Benz of Germany.
Act Section 305: Officer And Director Bars And Penalties; Equitable
Relief, will be used by the SEC to counterattack arguments arising out of
the Central Bank case. As I maintained in the American Journal of Trial
Advocacy, the real significance of the Supreme Court decision in Central
Bank was that the remedial sanctions of the federal securities laws should
be narrowly construed.
Well, now the SEC has a Congressional mandate. Federal courts are
authorized to "grant any equitable relief that may be appropriate or
necessary for the benefit of investors". That is an incredibly broad
delegation of rights, and is an end run around Central Bank. I was surprised
that this received no publicity.
Lastly, Act Section 402, Prohibition on Personal Loans to Executives,
shows how low this generation of US leadership has sunk. President Bush

has signed a law that makes illegal the type of loans from which he and his
extended family have previously benefited.
Tacitly, the Act admits that some practices of Enron were not illegal inter
se. Act Section 401, Study and Report on Special Purpose Entities, provides
that the SEC should study off-balance sheet disclosures to determine their
extent and whether they are reported in a sufficiently transparent fashion.
The answer will almost certainly be no, and the Board will change GAAP
accordingly.
Q. Does the SEC collaborate with other financial regulators and law
enforcement agencies internationally? Does it share information with other
US law enforcement agencies? Is there interagency rivalry and does it
hamper investigations? Can you give us an example? A. The SEC and other
regulators - as well as two House subcommittees - have only very recently
begun considering information sharing between financial regulators.
This comes too late for the victims of Martin Frankel, who, having been
barred for life from the securities industry by the SEC and NASD in 1992,
simply moved over to the insurance industry to perpetrate a scam where
investors have lost an estimated $200 million dollars.
Had the state insurance regulators known this person's background, he
would have been unable to set up multiple insurance companies. Failure to
share information is a genuine problem, but "turf" considerations generally
trump any joint efforts.

XXV. Trading from a Suitcase. The Case of
Shuttle Trade
They all sport the same shabby clothes, haggard looks, and bulging
suitcases bound with frayed ropes. These are the shuttle traders. You can
find them in Mongolia and Russia, China and Ukraine, Bulgaria and
Kosovo, the West Bank and Turkey. They cross the border as "tourists",
sometimes as often as 10 times a year, and come back with as much
merchandise as they can carry in their enormous luggage. Some of them
resort to freight forwarding their "personal belongings".
They distort trade figures, smuggle goods across ill- guarded borders,
ignore international treaties and conventions and, in short, revive moribund
economies.
They are the life-blood and the only manifestation of true
entrepreneurship in swathes of economic wastelands.
They meet demands for consumer goods unmet by domestic
manufacturers or by officially-sanctioned importers.
In recognition of their vital role, the worried Kyrgyz government held a
round table discussion last summer about the precarious state of
Kyrgyzstan's shuttle trade.
Many former Soviet republics have tightened up their border controls. In
May last year, Russian officials seized half a million dollars worth of shuttle
goods belonging to 1500 traders. When two million dollars worth of goods
were confiscated in a similar incident in fall 2001, eight Kyrgyz traders
committed suicide.
The number of Kyrgyz shuttle traders dropped in 2002 to 300,000 (from
500,000 in 1996). The majority of those who remain are insolvent. Many of
them emigrated to other countries. The shuttle traders asked the government
to legalize and regulate their vanishing trade and thus to save them from
avaricious and minacious customs officials.

Even prim international financial institutions recognize the survival-value
of shuttle trade to the economies of developing and transition countries. It
employs millions, boosts investments in transport and infrastructure, and
encourages grassroots capitalism. The IMF - in the 11th meeting of its
Committee on Balance of Payments Statistics in 1998 - officially
recognized shuttle trade as a business activity to be recorded under "goods".
But there is a seedier and seamier side to shuttle trade where it interfaces
with organized crime and official corruption. Shuttle trade also constitutes
unfair competition to legitimate, tax and customs duties paying enterprises -
the manufacturers of textiles, shoes, cigarettes, alcoholic drinks, and food
products. Shuttled goods are not subject to health and safety inspections, or
quality control.
According to the March 27th 2002 issue of East West Institute's "Russian
Regional Report", the value of Chinese goods shuttled into the borderlands
of the Russian Far East is a whopping $50 million a month.
China benefits from the serendipitous proceeds of these informal exports
- but is unhappy at the lost tax revenues.
EWI claims that Russian banks in the region (such as DalOVK,
Primsotsbank, and Regiobank) are already offering money transfer services
to China. DalOVK alone transfers $1 million a month - a fortune in local
terms. But even these figures may be a serious under-estimate. The trade
between Khabarovsk Territory in Russia and Heilongjiang Province in
China - most of it in shuttle form - was $1.5 billion in 2001. The bulk of it
was one way, from China to Russia.
Shuttle trade is even more prominent between Iraq and Turkey. The
Anatolia News Agency expected it to increase to $2 billion in 2002. By
comparison, the official exports of Turkey to Iraq amount to $800 million.
The then prime minister Bulent Ecevit himself stated to the Ankara Anatolia
news agency: "We have provided necessary support to increase shuttle
trade".
"The Economist" reports about the flourishing "petty trade" between
China and Vietnam. Western and counterfeit goods are smuggled to bazaars

in Vietnam, owned and operated by Chinese nationals. The border between
these two erstwhile enemies opened in 1990.
This led to the rise of criminal networks which involve border guards and
policemen.
Another hot spot is the Balkan. In a report dated July 2001, the Balkan
Information Exchange describes the "Tulip Market" in Istanbul. Vendors are
fluent in Russian, Bulgarian and Romanian and most of the clients are East
European. They buy wholesale and use special vans and buses to transport
the goods - mainly textiles - northwards, frequently to destinations in the
Balkan. This kind of trade is estimated to be worth $8 billion a year - more
than one quarter of Turkey's official exports.
Bulgarian customs officials, border patrols, and policemen form part of
these efficient rings - as do their Macedonian and, to a lesser extent, Greek
counterparts. The Sofia- based Center for the Study of Democracy thinks
that a third of the Bulgarian workforce (i.e., c. 1 million people) may be
involved. Many of the traders maintain mom-and- pop establishments or
stalls in public bazaars, where members of their family sell the goods.
Some of the merchandise ends up in Serbia, which was subjected to UN
sanctions until lately. Fuel smuggling on bikes and other forms of sanctions
busting have largely ended but they have been replaced by cigarettes,
alcohol, firearms, stolen cars, and mobile phones.
The Serbian authorities often round up and deport Bulgarian shuttle
traders, provoking furious resentment in Bulgaria. Headlines like "(Serbian)
Policemen take away our countrymen's money" and "Serbs searching
(Bulgarian) women's genitals for money" are pretty common. The
Bulgarians are embittered. They used to smuggle medicines and fuel into
embargoed Serbia - only to be abused by Serb officials now, that the
embargo has been lifted.
East European buyers used to reach as far as India where they shopped
wholesale in winter. Russians used to buy readymade clothes, leather goods,
and cheap jewelry in New Delhi and elsewhere and sell the goods in the
numerous flea markets back home.

To finance their purchases, they used to sell in India Russian cosmetics
and consumer goods such as watches, cameras, or hair dryers. But the 1998
financial crisis and sub-standard wares offered by unscrupulous Indian
traders put a stop to this particular venue.
Governments are trying to stem the shuttle trade. The Russian news
agency, ITAR-TASS, reports that Sergei Stepashin, the dynamic chairman
of the Russian Audit Chamber (and a former short-lived prime minister of
Russia) is bent on tightening the cooperation between member states of the
Shanghai Cooperation Organization.
The audit agencies of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan
and Uzbekistan will exchange information and strive to control the thriving
shuttle trade across their porous borders. China and Russia are poised to
sign a bilateral accord regarding these issues in October.
The WPS Monitoring Agency reported last November that the Economic
Development and Trade Ministry of Russia intends to treat cargos of more
than 50 kilos as a consignment of commercial goods, subject to import
tariffs (on top of the current tax of 30 percent).
The Ministry claimed that shuttle trade accounts for up to 90 percent of
all imported goods "in certain spheres" (e.g., furs). As late as 1994,
Russians were allowed to import up to $5000 of duty-free goods in their
accompanied baggage - a relic of communist days when only the privileged
few were allowed to travel.
Up to 2 million Russian citizens may be engaged in shuttle trade and the
value of "gray" goods may be as high as $10 billion annually. Goods from
Turkey alone amounted in 2002 to $1.5-2 billion, according to then vice-
premier Viktor Khristenko, but shuttle traders also operate in the United
Arab Emirates, Syria, Israel, Pakistan, India, China, Poland, Hungary, and
Italy.
A set of figures published for the first quarter of 2001 shows that shuttle
trade amounted to $2.6 billion, or 8 percent of Russia's total foreign trade.
Shuttle traded goods made up 1.5 percent of exports - but a full quarter of
imports.

But the shuttle trade's coup de grace may well be EU enlargement.
Already a new "iron curtain", comprised of visas and regulations, is rising
between EU candidates and other East European and Balkan countries.
Consider the EU's eastern boundary. More than a million people cross the
busy Ukrainian-Polish border every month. Enhanced regulation on the
Polish side and new, IMF-inspired, tax laws on the Ukrainian side - led to a
massive increase in corruption and smuggling. Truck owners now bribe
customs officials to the tune of $300 per vehicle, according to a January
2001 report by CEPS.
The results are grave. Following the introduction of these new measures,
cross border traffic fell by 50 percent and unemployment in the Polish
border zones jumped by 40 percent in 2002 alone. It has since doubled. The
IMF and the EU are much decried by the Polish minority now trapped in
Western Ukraine.
The situation is likely to be further exacerbated with the introduction of a
reciprocal visa regime between the two countries. Shuttle trade may be
decimated by the resulting bureaucratic bottlenecks.
Still, it may no longer be needed now that Poland acceded to the EU.
Shuttle trade thrives on poverty. It arbitrates between inefficient markets. It
satisfies unrequited demand for goods. The single market ought to rid
Europe of all these distortions - and, thus, most probably of this makeshift
though resilient solution, the shuttle trader.

XXVI. The Blessings of the Black Economy
Some call it the "unofficial" or "informal" economy, others call it the
"grey economy" but the old name fits it best: the "black economy". In the
USA "black" means "profitable, healthy" and this is what the black
economy is. Macedonia should count its blessings for having had a black
economy so strong and thriving to see it through the transition. If
Macedonia had to rely only on its official economy it would have gone
bankrupt long ago.
The black economy is made up of two constituent activities: 1. Legal
activities that are not reported to the tax authorities and the income from
which goes untaxed and unreported. For instance: it is not illegal to clean
someone's house, to feed people or to drive them. It is, however, illegal to
hide the income generated by these activities and not to pay tax on it. In
most countries of the world, this is a criminal offence, punishable by years
in prison. 2. Illegal activities which, needless to say, are also not reported to
the state (and, therefore, not taxed).
These two types of activities together are thought to comprise between
15% (USA, Germany) to 60% (Russia) of the economic activity (as
measured by the GDP), depending on the country. It would probably be an
underestimate to say that 40% of the GDP in Macedonia is "black". This
equals 1.2 billion USD per annum. The money generated by these activities
is largely held in foreign exchange outside the banking system or smuggled
abroad (even through the local banking system).
Experience in other countries shows that circa 15% of the money "floats"
in the recipient country and is used to finance consumption. This should
translate to 1 billion free floating dollars in the hands of the 2 million
citizens of Macedonia. Billions are transferred to the outside world (mostly
to finance additional transactions, some of it to be saved in foreign banks
away from the long hand of the state). A trickle of money comes back and is
"laundered" through the opening of small legal businesses.

These are excellent news for Macedonia. It means that when the macro-
economic, geopolitical and (especially) the micro-economic climates will
change - billions of USD will flow back to Macedonia. People will bring
their money back to open businesses, to support family members and just to
consume it. It all depends on the mood and on the atmosphere and on how
much these people feel that they can rely on the political stability and
rational management. Such enormous flows of capital happened before: in
Argentina after the Generals and their corrupt regime were ousted by
civilians, in Israel when the peace process started and in Mexico following
the signature of NAFTA, to mention but three cases. These reserves can be
lured back and transform the economy.
But the black economy has many more important functions.
The black economy is a cash economy. It is liquid and fast. It increases
the velocity of money. It injects much needed foreign exchange to the
economy and inadvertently increases the effective money supply and the
resulting money aggregates. In this sense, it defies the dictates of "we know
better" institutions such as the IMF.
It fosters economic activity and employs people. It encourages labour
mobility and international trade. Black economy, in short, is very positive.
With the exception of illegal activities, it does everything that the official
economy does - and, usually, more efficiently.
So, what is morally wrong with the black economy? The answer, in brief:
it is exploitative. Other parts of the economy, which are not hidden (though
would have liked to be), are penalized for their visibility. They pay taxes.
Workers in a factory owned by the state or in the government service
cannot avoid paying taxes. The money that the state collects from them is
invested, for instance, in infrastructure (roads, phones, electricity) or used
to pay for public services (education, defence, policing). The operators of
the black economy enjoy these services without paying for them, without
bearing the costs and worse: while others bear the costs. These encourages
them, in theory to use these resources less efficiently.
And all this might be true in a highly efficient, almost ideal market
economy. The emphasis is on the word "market". Unfortunately, we all live

in societies which are regulated by bureaucracies which are controlled (in
theory, rarely in practice) by politicians. These elites have a tendency to
misuse and to abuse resources and to allocate them in an inefficient manner.
Even economic theory admits that any dollar left in the hands of the private
sector is much more efficiently used than the same dollar in the hands of the
most honest and well meaning and well planning civil servant.
Governments all over the world distort economic decisions and misallocate
scarce economic resources.
Thus, if the goals are to encourage employment and economic growth -
the black economy should be welcomed. This is precisely what it does and,
by definition, it does so more efficiently than the government. The less tax
dollars a government has - the less damage it does. This is an opinion shares
by most economists in the world today. Lower tax rates are an admission of
this fact and a legalization of parts of the black economy.
The black economy is especially important in times of economic
hardships. Countries in transition are a private case of emerging economies
which are a private case of developing countries which used to be called (in
less politically correct times) "Third World Countries". They suffer from all
manner of acute economic illnesses. They lost their export markets, they are
technologically backward, their unemployment skyrockets, their plant and
machinery are dilapidated, their infrastructure decrepit and dysfunctional,
they are lethally illiquid, they become immoral societies (obligations not
honoured, crime flourishes), their trade deficits and budget deficits balloon
and they are conditioned to be dependent on handouts and dictates from
various international financial institutions and donor countries.
Read this list again: isn't the black economy a perfect solution until the
dust settles? It enhances exports (and competitiveness through imports), it
encourages technology transfers, it employs people, it invests in legitimate
businesses (or is practised by them), it adds to the wealth of the nation
(black marketeers are big spenders, good consumers and build real estate),
it injects liquidity to an otherwise dehydrated market. Mercifully, the black
economy is out of the reach of zealous missionaries such as the IMF. It goes
its own way, unnoticed, unreported, unbeknownst, untamed. It doesn't pay
attention to money supply targets (it is much bigger than the official money
supply figure), or to macroeconomic stability goals. It plods on: doing

business and helping the country to survive the double scourges of
transition and Western piousness and patronizing. As long as it is there,
Macedonia has a real safety net. The government is advised to turn a blind
eye to it for it is a blessing in disguise.
There is one sure medicine: eliminate the population and both
unemployment and inflation will be eliminated.
Without the black economy, the population of Macedonia would not have
survived. This lesson must be remembered as the government prepares to
crack down on the only sector of the economy which is still alive and
kicking.
Operational Recommendations The implementation of these
recommendations and reforms should be obliged to be GRADUAL. The
informal economy is an important pressure valve for the release of social
pressures, it ameliorates the social costs inherent to the period of transition
and it constitutes an important part of the private sector.
As we said in the body of our report, these are the reasons for the
existence of an informal economy and they should be obliged to all be
tackled: ? High taxation level (in Macedonia, high payroll taxes); ? Onerous
labour market regulations; ? Red tape and bureaucracy (which often leads to
corruption); ? Complexity and unpredictability of the tax system.
Reporting Requirements and Transparency ? All banks should be obliged
to report foreign exchange transactions of more than 10,000 DM (whether
in one transaction or cumulatively by the same legal entity). The daily
report should be submitted to the Central Bank. In extreme cases, the
transactions should be investigated. ? All the ZPP account numbers of all
the firms in Macedonia should be publicly available through the Internet
and in printed form. ? Firms should be obliged by law to make a list of all
their bank accounts available to the ZPP, to the courts and to plaintiffs in
lawsuits. ? All citizens should be obliged to file annual, personal tax returns
(universal tax returns, like in the USA). This way, discrepancies between
personal tax returns and other information can lead to investigations and
discoveries of tax evasion and criminal activities. ? All citizens should be
obliged to file bi-annual declarations of personal wealth and assets
(including real estate, vehicles, movables, inventory of business owned or

controlled by the individual, financial assets, income from all sources,
shares in companies, etc.). ? All retail outlets and places of business should
be required to install - over a period of 3 years - cash registers with "fiscal
brains". These are cash registers with an embedded chip. The chips are built
to save a trail (detailed list) of all the transactions in the place of business.
Tax inspectors can pick the chip at random, download its contents to the tax
computers and use it to issue tax assessments. The information thus
gathered can also be crossed with and compared to information from other
sources (see: "Databases and Information Gathering"). This can be done
only after the full implementation of the recommendations in the section
titled "Databases and Information Gathering". I do not regard it as an
effective measure. While it increases business costs - it is not likely to
prevent cash or otherwise unreported transactions. ? All taxis should be
equipped with taximeters, which include a printer. This should be a
licencing condition. ? Industrial norms (for instance, the amount of sugar
needed to manufacture a weight unit of chocolate, or juice) should be
revamped. Norms should NOT be determined according to statements
provided by the factory - but by a panel of experts. Each norm should be
signed by three people, of which at least one is an expert engineer or
another expert in the relevant field. Thought should be dedicated to the
possibility of employing independent laboratories to determine norms and
supervise them. ? Payments in wholesale markets should be done through a
ZPP counter or branch in the wholesale market itself. Release of the goods
and exiting the physical location of the wholesale market should be allowed
only against presentation of a ZPP payment slip.
Reduction of Cash Transactions ? Cash transactions are the lifeblood of
the informal economy. Their reduction and minimization is absolutely
essential in the effort to contain it. One way of doing it is by issuing ZPP
payment (debit) cards to businesses, firm and professionals. Use of the
payment cards should be mandatory in certain business-to-business
transactions. ? All exchange offices should be obliged to issue receipt for
every cash transaction above 100 DM and to report to the Central Bank all
transactions above 1000 DM. Suspicious transactions (for instance,
transactions which exceed the financial wherewithal of the client involved)
should be duly investigated. ? The government can reduce payroll taxes if
the salary is not paid in cash (for instance, by a transfer to the bank account

of the employee). The difference between payroll taxes collected on cash
salaries and lower payroll taxes collected on noncash salaries - should be
recovered by imposing a levy on all cash withdrawals from banks. The
banks can withhold the tax and transfer it to the state monthly. ? Currently,
checks issued to account-holders by banks are virtually guaranteed by the
issuing banks. This transforms checks into a kind of cash and checks are
used as cash in the economy. To prevent this situation, it is recommended
that all checks will be payable to the beneficiary only. The account-holder
will be obliged to furnish the bank with a monthly list of checks he or she
issued and their details (to whom, date, etc.). Checks should be valid for 5
working days only. ? An obligation can be imposed to oblige businesses to
effect payments only through their accounts (from account to account) or
using their debit cards. Cash withdrawals should be subject to a withholding
tax deducted by the bank. The same withholding tax should be applied to
credits given against cash balances or to savings houses (stedilnicas).
Alternatively, stedilnicas should also be obliged to deduct, collect and
transfer the cash withdrawal withholding tax. ? In the extreme and if all
other measures fail after a reasonable period of time, all foreign trade
related payments should be conducted through the Central Bank. But this is
really a highly irregular, emergency measure, which I do not recommend at
this stage. ? The interest paid on cash balances and savings accounts in the
banks should be increased (starting with bank reserves and deposits in the
central bank). ? The issuance of checkbook should be made easy and
convenient. Every branch should issue checkbooks. All the banks and the
post office should respect and accept each other's checks. ? A Real Time
Gross Settlement System should be established to minimize float and
facilitate interbank transfers.
Government Tenders ? Firms competing for government tenders should
be obliged to acquire a certificate from the tax authorities that they owe no
back-taxes.
Otherwise, they should be barred from bidding in government tenders
and RFPs (Requests for Proposals).
Databases and Information Gathering ? Estimating the informal economy
should be a priority objective of the Bureau of Statistics, which should
devote considerable resources to this effort. In doing so, the Bureau of

Statistics should coordinate closely with a wide variety of relevant
ministries and committees that oversee various sectors of the economy. ?
All registrars should be computerized: land, real estate, motor vehicles,
share ownership, companies registration, tax filings, import and export
related documentation (customs), VAT, permits and licences, records of
flights abroad, ownership of mobile phones and so on. The tax authorities
and the Public Revenue Office (PRO) should have unrestricted access to
ALL the registers of all the registrars. Thus, they should be able to find tax
evasion easily (ask for sources of wealth- how did you build this house and
buy a new car if you are earning 500 DM monthly according to your tax
return?). ? The PRO should have complete access to the computers of the
ZPP and to all its computerized and non-computerized records. ? The
computer system should constantly compare VAT records and records and
statements related to other taxes in order to find discrepancies between
them. ? Gradually, submissions of financial statements, tax returns and
wealth declarations should be computerized and done even on a monthly
basis (for instance, VAT statements). ? A system of informants and
informant rewards should be established, including anonymous phone calls.
Up to 10% of the intake or seizure value related to the information provided
by the informant should go to the informant.
Law Enforcement ? Tax inspectors and customs officials should receive
police powers and much higher salaries (including a percentage of tax
revenues). The salaries of all tax inspectors - regardless of their original
place of employment - should be equalized (of course, taking into
consideration tenure, education, rank, etc.). ? Judges should be trained and
educated in matters pertaining to the informal economy. Special courts for
taxes, for instance, are a good idea (see recommendation below). Judges
have to be trained in tax laws and the state tax authorities should provide
BINDING opinions to entrepreneurs, businessmen and investors regarding
the tax implications of their decisions and actions. ? It is recommended to
assign tax inspectors to the public prosecutors' office to work as teams on
complex or big cases. ? To establish an independent Financial and Tax
Police with representatives from all relevant ministries but under the
exclusive jurisdiction of the PRO. The remit of this Police should include
all matters financial (including foreign exchange transactions, property and
real estate transactions, payroll issues, etc.). ? Hiring and firing procedures

in all the branches of the tax administration should be simplified. The
number of administrative posts should be reduced and the number of tax
inspectors and field agents increased. ? Tax arrears and especially the
interest accruing thereof should be the first priority of the ZPP, before all
other payments. ? All manufacturers and sellers of food products (including
soft drinks, sweetmeats and candy, meat products, snacks) should purchase
a licence from the state and be subjected to periodic and rigorous
inspections. ? All contracts between firms should be registered in the courts
and stamped to become valid. Contracts thus evidenced should be
accompanied by the registration documents (registrar extract) of the
contracting parties. Many "firms" doing business in Macedonia are not even
legally registered.
Reforms and Amnesty ? A special inter-ministerial committee with
MINISTER-MEMBERS and headed by the PM should be established. Its
roles: to reduce bureaucracy, to suggest appropriate new legislation and to
investigate corruption. ? Bureaucracy should be pared down drastically.
The more permits, licences, tolls, fees and documents needed - the more
corruption. Less power to state officials means less corruption. The One
Stop Shop concept should be implemented everywhere. ? A general
amnesty should be declared. Citizens declaring their illegal wealth should
be pardoned BY LAW and either not taxed or taxed at a low rate once and
forever on the hitherto undeclared wealth.
The Tax Code ? To impose a VAT system. VAT is one the best
instruments against the informal economy because it tracks the production
process throughout a chain of value added suppliers and manufacturers. ?
The Tax code needs to be simplified. Emphasis should be placed on VAT,
consumption taxes, customs and excise taxes, fees and duties. To restore
progressivity, the government should directly compensate the poor for the
excess relative burden. ? After revising the tax code in a major way, the
government should declare a moratorium on any further changes for at least
four years. ? The self-employed and people whose main employment is
directorship in companies should be given the choice between paying a
fixed % of the market value of their assets (including financial assets) or
income tax. ? All property rental contracts should be registered with the
courts. Lack of registration in the courts and payment of a stamp tax should

render the contract invalid. The courts should be allowed to evidence and
stamp a contract only after it carries the stamp of the Public Revenue Office
(PRO).
The PRO should register the contract and issue an immediate tax
assessment. Contracts, which are for less than 75% of the market prices,
should be subject to tax assessment at market prices. Market prices should
be determined as the moving average of the last 100 rental contracts from
the same region registered by the PRO. ? Filing of tax returns - including
for the self- employed - should be only with the PRO and not with any other
body (such as the ZPP).
Legal Issues ? The burden of proof in tax court cases should shift from
the tax authorities to the person or firm assessed. ? Special tax courts should
be established within the existing courts. They should be staffed by
specifically trained judges. Their decisions should be appealed to the
Supreme Court. They should render their decisions within 180 days. All
other juridical and appeal instances should be cancelled - except for an
appeal instance within the PRO.
Thus, the process of tax collection should be greatly simplified. A tax
assessment should be issued by the tax authorities, appealed internally
(within the PRO), taken to a tax court session (by a plaintiff) and, finally,
appealed to the Supreme Court (in very rare cases). ? The law should allow
for greater fines, prison terms and for the speedier and longer closure of
delinquent businesses. ? Seizure and sale procedures should be specified in
all the tax laws and not merely by way of reference to the Income Tax Law.
Enforcement provisions should be incorporated in all the tax laws. ? To
amend the Law on Tax Administration, the Law on Personal Income Tax
and the Law on Profits Tax as per the recommendations of the IRS experts
(1997-9).
Customs and Duties ? Ideally, the customs service should be put under
foreign contract managers. If this is politically too sensitive, the customs
personnel should be entitled to receive a percentage of customs and duties
revenues, on a departmental incentive basis. In any case, the customs
should be subjected to outside inspection by expert inspectors who should
be rewarded with a percentage of the corruption and lost revenues that they

expose. ? In the case of imports or payments abroad, invoices, which
include a price of more than 5% above the list price of a product, should be
rejected and assessment for the purposes of paying customs duties and other
taxes should be issued at the list price. ? In the case of exports or payments
from abroad, invoices which include a discount of more than 25% on the
list price of a product should be rejected and assessment for the purposes of
paying customs duties and other taxes should be issued at the list price. ?
The numbers of tax inspectors should be substantially increased and their
pay considerably enhanced. A departmental incentive system should be
instituted involving a percentage of the intake (monetary fines levied, goods
confiscated, etc.). ? The computerized database system (see "Databases and
Information Gathering") should be used to compare imports of raw
materials for the purposes of re-export and actual exports (using invoices
and customs declarations). Where there are disparities and discrepancies,
severe and immediate penal actions should be taken. Anti- dumping levies
and measures, fines and criminal charges should be adopted against
exporters colluding with importers in hiding imported goods or reducing
their value. ? Often final products are imported and declared to the customs
as raw materials (to minimize customs duties paid). Later these raw
materials are either sold outright in the domestic or international markets or
bartered for finished products (for example: paints and lacquers against
furniture or sugar against chocolate). This should be a major focus of the
fight against the informal economy. I follow with an analysis of two
products, which are often abused in this manner. ? I study two examples
(white sugar and cooking oil) though virtually all raw materials and foods
are subject to the aforementioned abuse. ? White Sugar is often imported as
brown sugar.
One way to prevent this is to place sugar on the list of LB (import licence
required) list, to limit the effective period of each licence issued, to connect
each transaction of imported brown sugar to a transaction of export, to
apply the world price of sugar to customs duties, to demand payment of
customs duties in the first customs terminal, to demand a forwarder's as
well as an importer's guarantee and to require a certificate of origin. The
same goes for Cooking Oil (which - when it is imported packaged - is often
declared as some other goods). ? All payments to the customs should be
made only through the ZPP. Customs and tax inspectors should inspect

these receipts periodically. ? All goods should be kept in the customs
terminal until full payment of the customs duties, as evidenced by a ZPP
receipt, is effected.
Public Campaign ? The government should embark on a massive Public
Relations and Information campaign. The citizens should be made to
understand what is a budget, how the taxes are collected, how they are used.
They should begin to view tax evaders as criminals. "He who does not pay
his taxes - is stealing from you and from your children", "Why should YOU
pay for HIM?" "If we all did not pay taxes- there would be no roads,
bridges, schools, or hospitals" (using video to show disappearing roads,
bridges, suffering patients and students without classes), "Our country is a
partnership - and the tax-evader is stealing from the till (kasa)" and so on.
* The phrase "Gray Economy" should be replaced by the more accurate
phrases "Black Economy" or "Criminal Economy".

XXVII. Public Procurement and Very Private
Benefits
In every national budget, there is a part called "Public Procurement".
This is the portion of the budget allocated to purchasing services and goods
for the various ministries, authorities and other arms of the executive
branch. It was the famous management consultant, Parkinson, who once
wrote that government officials are likely to approve a multi-billion dollar
nuclear power plant much more speedily that they are likely to authorize a
hundred dollar expenditure on a bicycle parking device.
This is because everyone came across 100 dollar situations in real life -
but precious few had the fortune to expend with billions of USD.
This, precisely, is the problem with public procurement: people are too
acquainted with the purchased items. They tend to confuse their daily,
household-type, decisions with the processes and considerations which
should permeate governmental decision making. They label perfectly
legitimate decisions as "corrupt" - and totally corrupt procedures as "legal"
or merely "legitimate", because this is what was decreed by the statal
mechanisms, or because "this is the law".
Procurement is divided to defence and non-defence spending. In both
these categories - but, especially in the former - there are grave, well
founded, concerns that things might not be all what they seem to be.
Government - from India's to Sweden's to Belgium's - fell because of
procurement scandals which involved bribes paid by manufacturers or
service providers either to individual in the service of the state or to
political parties.
Other, lesser cases, litter the press daily. In the last few years only, the
burgeoning defence sector in Israel saw two such big scandals: the
developer of Israel's missiles was involved in one (and currently is serving a
jail sentence) and Israel's military attache to Washington was implicated -
though, never convicted - in yet another.

But the picture is not that grim. Most governments in the West succeeded
in reigning in and fully controlling this particular budget item. In the USA,
this part of the budget remained constant in the last 35(!) years at 20% of
the GDP.
There are many problems with public procurement. It is an obscure area
of state activity, agreed upon in "customized" tenders and in dark rooms
through a series of undisclosed agreements. At least, this is the public image
of these expenditures.
The truth is completely different.
True, some ministers use public money to build their private "empires". It
could be a private business empire, catering to the financial future of the
minister, his cronies and his relatives. These two plagues - cronyism and
nepotism - haunt public procurement. The spectre of government official
using public money to benefit their political allies or their family members -
haunts public imagination and provokes public indignation.
Then, there are problems of plain corruption: bribes or commissions paid
to decision makers in return for winning tenders or awarding of economic
benefits financed by the public money. Again, sometimes these moneys end
in secret bank accounts in Switzerland or in Luxembourg. At other times,
they finance political activities of political parties. This was rampantly
abundant in Italy and has its place in France. The USA, which was
considered to be immune from such behaviours - has proven to be less so,
lately, with the Bill Clinton alleged election financing transgressions.
But, these, with all due respect to "clean hands" operations and
principles, are not the main problems of public procurement.
The first order problem is the allocation of scarce resources. In other
words, prioritizing. The needs are enormous and ever growing. The US
government purchases hundreds of thousands of separate items from
outside suppliers. Just the list of these goods - not to mention their technical
specifications and the documentation which accompanies the transactions -
occupies tens of thick volumes. Supercomputers are used to manage all
these - and, even so, it is getting way out of hand. How to allocate ever
scarcer resources amongst these items is a daunting - close to impossible -

task. It also, of course, has a political dimension. A procurement decision
reflects a political preference and priority. But the decision itself is not
always motivated by rational - let alone noble - arguments. More often, it is
the by product and end result of lobbying, political hand bending and
extortionist muscle. This raises a lot of hackles among those who feel that
were kept out of the pork barrel. They feel underprivileged and
discriminated against. They fight back and the whole system finds itself in a
quagmire, a nightmare of conflicting interests. Last year, the whole budget
in the USA was stuck - not approved by Congress - because of these
reactions and counter-reactions.
The second problem is the supervision, auditing and control of actual
spending. This has two dimensions: 1. How to make sure that the
expenditures match and do not exceed the budgetary items. In some
countries, this is a mere ritual formality and government departments are
positively expected to overstep their procurement budgets. In others, this
constitutes a criminal offence. 2. How to prevent the criminally corrupt
activities that we have described above - or even the non criminal
incompetent acts which government officials are prone to do.
The most widespread method is the public, competitive, tender for the
purchases of goods and services.
But, this is not as simple as it sounds.
Some countries publish international tenders, striving to secure the best
quality in the cheapest price - no matter what is its geographical or political
source. Other countries are much more protectionist (notably: Japan and
France) and they publish only domestic tenders, in most cases. A domestic
tender is open only to domestic bidders.
Yet other countries limit participation in the tenders on various
backgrounds: the size of the competing company, its track record, its
ownership structure, its human rights or environmental record and so on.
Some countries publish the minutes of the tender committee (which has to
explain WHY it selected this or that supplier). Others keep it a closely
guarded secret ("to protect commercial interests and secrets").

But all countries state in advance that they have no obligation to accept
any kind of offer - even if it is the cheapest. This is a needed provision: the
cheapest is not necessarily the best. The cheapest offer could be coming
from a very unreliable supplier with a bad past performance or a criminal
record or from a supplier who offers goods of shoddy quality.
The tendering policies of most of the countries in the world also
incorporates a second principle: that of "minimum size". The cost of
running a tender is prohibitive in the cases of purchases in small amounts.
Even if there is corruption in such purchases it is bound to cause less
damage to the public purse than the costs of the tender which is supposed to
prevent it! So, in most countries, small purchases can be authorized by
government officials - larger amounts go through a tedious, multi-phase
tendering process. Public competitive bidding is not corruption-proof: many
times officials and bidders collude and conspire to award the contract
against bribes and other, noncash, benefits. But we still know of no better
way to minimize the effects of human greed.
Procurement policies, procedures and tenders are supervised by state
auditing authorities. The most famous is, probably, the General Accounting
Office, known by its acronym: the GAO.
It is an unrelenting, very thorough and dangerous watchdog of the
administration. It is considered to be highly effective in reducing
procurement - related irregularities and crimes. Another such institutions
the Israeli State Reviser. What is common to both these organs of the state
is that they have very broad authority.
They possess (by law) judicial and criminal prosecution powers and they
exercise it without any hesitation. They have the legal obligation to review
the operations and financial transactions of all the other organs of the
executive branch. Their teams select, each year, the organs to be reviewed
and audited. They collect all pertinent documents and correspondence. They
cross the information that they receive from elsewhere. They ask very
embarrassing questions and they do it under the threat of perjury
prosecutions. They summon witnesses and they publish damning reports
which, in many cases, lead to criminal prosecutions.

Another form of review of public procurement is through powers granted
to the legislative arm of the state (Congress, Parliament, Bundestag, or
Knesset). In almost every country in the world, the elected body has its own
procurement oversight committee. It supervises the expenditures of the
executive branch and makes sure that they conform to the budget. The
difference between such supervisory, parliamentary, bodies and their
executive branch counterparts - is that they feel free to criticize public
procurement not only in the context of its adherence to budget constraints
or its cleanliness - but also in a political context. In other words, these
committees do not limit themselves to asking HOW - but also engage in
asking WHY. Why this specific expense in this given time and location -
and not that expense, somewhere else or some other time. These elected
bodies feel at liberty - and often do - intervene in the very decision making
process and in the order of priorities.
They have the propensity to alter both quite often.
The most famous such committee is, arguably, the Congressional Budget
Office (CBO). It is famous because it is non-partisan and technocratic in
nature. It is really made of experts which staff its offices.
Its apparent - and real - neutrality makes its judgements and
recommendations a commandment not to be avoided and, almost
universally, to be obeyed. The CBO operates for and on behalf of the
American Congress and is, really, the research arm of that venerable
parliament. Parallelly, the executive part of the American system - the
Administration - has its own guard against waste and worse: the Office of
Management and Budget (OMB).
Both bodies produce learned, thickset, analyses, reports, criticism,
opinions and recommendations. Despite quite a prodigious annual output of
verbiage - they are so highly regarded, that virtually anything that they say
(or write) is minutely analysed and implemented to the last letter with an air
of awe.
Only a few other parliaments have committees that carry such weight.
The Israeli Knesset have the extremely powerful Finance Committee which
is in charge of all matters financial, from appropriations to procurement.

Another parliament renowned for its tight scrutiny is the French
Parliament - though it retains very few real powers.
But not all countries chose the option of legislative supervision. Some of
them relegated parts or all of these functions to the executive arm.
In Japan, the Ministry of Finance still scrutinizes (and has to authorize)
the smallest expense, using an army of clerks. These clerks became so
powerful that they have the theoretical potential to secure and extort
benefits stemming from the very position that they hold. Many of them
suspiciously join companies and organizations which they supervised or to
which they awarded contracts - immediately after they leave their previous,
government, positions. The Ministry of Finance is subject to a major reform
in the reform-bent government of Prime Minister Hashimoto. The Japanese
establishment finally realized that too much supervision, control, auditing
and prosecution powers might be a Pyrrhic victory: it might encourage
corruption - rather than discourage it.
Britain opted to keep the discretion to use public funds and the clout that
comes with it in the hands of the political level. This is a lot like the
relationship between the butter and the cat left to guard it. Still, this
idiosyncratic British arrangement works surprisingly well.
All public procurement and expenditure items are approved by the EDX
Committee of the British Cabinet (=inner, influential, circle of government)
which is headed by the Ministry of Finance. Even this did not prove enough
to restrain the appetites of Ministers, especially as quid pro quo deals
quickly developed. So, now the word is that the new Labour Prime Minister
will chair it- enabling him to exert his personal authority on matters of
public money.
Britain, under the previous, Tory, government also pioneered an
interesting and controversial incentive system for its public servants as top
government officials are euphemistically called there. They receive, added
to their salaries, a portion of the savings that they effect in their
departmental budgets. This means that they get a small fraction of the end
of the fiscal year difference between their budget allowances and what they
actually spent. This is very useful in certain segments of government
activity - but could prove very problematic in others. Imagine health

officials saving on medicines, or others saving on road maintenance or
educational consumables. This, naturally, will not do.
Needless to say that no country officially approves of the payment of
bribes or commission to officials in charge of public spending, however
remote the connection is between the payment and the actions.
Yet, law aside many countries accept the intertwining of elites - business
and political - as a fact of life, albeit a sad one. Many judicial systems in the
world even make a difference between a payment which is not connected to
an identifiable or discernible benefit and those that are.
The latter - and only the latter - are labelled "bribery".
Where there is money - there is wrongdoing. Humans are humans - and
sometimes not even that.
But these unfortunate derivatives of social activity can be minimized by
the adoption of clear procurement policies, transparent and public decision
making processes and the right mix of supervision, auditing and
prosecution. Even then the result is bound to be dubious, at best.

XXVIII. Crisis of the Bookkeepers
The Future of the Accounting Profession Interview with David Jones
On May 31, 2005, the US Supreme Court overturned the conviction of
accounting firm Arthur Anderson on charges related to its handling of the
books of the now defunct energy concern, Enron. It was only the latest
scene in a drama which unfolded at the height of the wave of corporate
malfeasance in the USA.
David C. Jones is a part-time research fellow at the Center for Urban
Development Studies of the Graduate School of Design, Harvard
University. He has been associated with the University since 1987 when he
retired from the World Bank, where he served as financial adviser for water
supply and urban development.
He had joined the World Bank, as a senior financial analyst, in 1970,
after working as a technical assistance advisor for the British Government
in East Africa. He began his career in British local government. He is a
Chartered Public Finance Accountant and a Chartered Certified Accountant
(UK). He is the author of "Municipal Accounting for Developing
Countries" originally published by the World Bank and the Chartered
Institute of Public Finance and Accountancy (UK) in 1982.
Q: Accounting scandals seem to form the core of corporate malfeasance
in the USA. Is there something wrong with the GAAP - or with American
accountants? A: Accounting is based on some fundamental principles.
As I say at the beginning of my textbook, the accountant "records and
interprets variations in financial position ... during any period of time, at the
end of which he can balance net results (of past operations) against net
resources (available for future operations)".
Accountancy includes the designing of financial records, the recording of
financial information based on actual financial transactions (i.e.,
bookkeeping), the production of financial statements from the recorded

information, giving advice on financial matters, and interpreting and using
financial data to assist in making the best management decisions.
Simple as these principles may sound, they are, in practice, rather
complicated to implement, to interpret and to practice. About 80% of the
transactions require only about 20% of the effort because they are
straightforward and obvious to a book-keeper, once the rules are learned.
But - and it is a big but - the other 20% or so of transactions require 80%
of the intellectual effort. These transactions are most likely to have major
impacts on the profit and loss account and the balance sheet.
My colleagues and I, all qualified accountants, have heated discussion
over something as simple as the definition of a debit or a credit. Debits can
be records of either expenses or assets. The former counts against income in
the statement of profit and loss. The latter is treated as a continuing resource
in a balance sheet. It is sometimes gradually allocated (expensed) against
income in subsequent years, sometimes not.
A fundamental problem with the financial reporting of WorldCom, for
example, was that huge quantities of expenses were misallocated in the
accounts as assets.
Thus, by reducing expenditures, profit appeared to be increased. The
effect of this on stock values and, thereby, on executive rewards are
secondary and tertiary outcomes not caused directly by the accountancy.
Another example concerns interest on loans that may have been raised to
finance capital investment, while a large asset is under construction, often
for several years.
Some argue that the interest should be accounted for as part of the capital
cost until the asset is operational. Others claim that because the interest is
an expense, it should be charged against that year's profits. Yet, the current
year's income includes none of the income generated by the new asset, so
profit is under-stated. And what if a hydro- electric power station starts to
operate three of its ten turbines while still under construction? How does
one allocate what costs, as expenses or assets, in such cases? Interestingly,
the Generally Accepted Accounting Principles (GAAP) require that
"interest during construction" be capitalized, that is included in the cost of

the asset. The International Accounting Standards (IAS) prefer expensing
but allow capitalization. From an economic viewpoint, both are wrong - or
only partially right! The accountancy profession should get together to
establish common practices for comparing companies, limiting the scope
for judgment. Accountants used to make the rules in the USA and elsewhere
until the business community demanded input from other professionals, to
provide a more "balanced" view.
This led to the establishment of the Financial Accounting Standards
Board (FASB), with non-accountants as members. The GAAP has been
tempered by political and business lobbying. Moreover, accounting rules
for taxation purposes and applied to companies quoted on stock exchanges
are not always consistent with the GAAP.
Accountants who do not follow the rules are disciplined.
American accountants are among the best educated and best-trained in
the world. Those who wish to be recognized as auditors of significant
enterprises must be CPAs. Thus, they must have obtained at least a finance-
related bachelor's degree and then have passed a five-part examination that
is commonly set, nation-wide, by the American Institute of Certified Public
Accountants (AICPA). To practice publicly, they must be licensed by the
state in which they live or practice. To remain a CPA, each must abide by
the standards of conduct and ethics of the AICPA, including a requirement
for continuing professional education.
Most other countries have comparable rules. Probably the closest
comparisons to the USA are found in the UK and its former colonies.
Q: Can you briefly compare the advantages and disadvantages of the
GAAP and the IAS? A: It is asserted that the GAAP tend to be "rule-based"
and the IAS are "principle-based." GAAP, because they are founded on the
business environment of the USA are closely aligned to its laws and
regulations. The IAS seek to prescribe how credible accounting practices
can operate within a country's existing legal structure and prevailing
business practices.
Alas, sometimes the IAS and the GAAP are in disagreement. The two
rule-making bodies - FASB and IASB - are trying to cooperate to eliminate

such differences.
The Inter-American Development Bank, having reviewed the situation in
Latin America, concluded that most of the countries in that region - as well
as Canada and the EU aspirants - are IAS-orientated. Still, the USA is by far
the largest economy in the world, with significant political influence. It also
has the world's most important financial markets.
Q: Can accounting cope with derivatives, off-shore entities, stock options
- or is there a problem in the very effort to capture dynamics and
uncertainties in terms of a static, numerical representation? A: Most, if not
all, of these matters can be handled by proper application of accounting
principles and practices.
Much has been made of expensing employee stock options, for instance.
But an FASB proposal in the early nineties was watered down at the
insistence of US company lobbyists and legislators.
How to value stock options and when to recognize them is not clear. A
paper on the topic identified sixteen different valuation parameters. But
accountants are accustomed to dealing with such practical matters.
Q: Can you describe the state of the art (i.e., recent trends) of municipal
finance in the USA, Europe, Latin America (mainly Argentina and Brazil),
and in emerging economies (e.g., central and eastern Europe)? A: There are
no standard practices for governmental accounting - whether national,
federal, state, or local. The International Federation of Accountants (IFAC)
urged accountants to follow various practices. It subsequently settled
mainly on accrual accounting standards.
Some countries - the UK, for local government, New Zealand for both
central and local government - use full accrual at current value, which is
beyond many private sector practices. This is being reviewed in the UK.
The central government there is introducing "resource-based" accounting,
approximating full accrual at current value.
The US Governmental Accounting Standards Board has recently
recommended that US local governments produce dual financial reports,
combining "commercially- based" practices with those emanating from the
truly unique US "fund accounting" system.

In my book I recognized that fixed assets are being funded less and less
entirely by debt, private sector accounting practices increasingly intrude
into the public sector, and costs of services must be much more carefully
assessed.
Q: Are we likely to witness municipal Enrons and World.com's? A: We
already have! Remember the financial downfall and restructuring of New
York City in the seventies.
Other state and local governments have had serious defaults in USA and
elsewhere. Shortcomings of their accounting, politicians choosing to ignore
predictive budgeting, borrowing used to cover operating expenditures -
similar to WorldCom. In the case of the New York City debacle, operating
expenditures were treated as capital expenditures to balance the operating
budget.
More recently, I testified to the US Congress about Washington DC,
where the City Council ran up a huge accumulated operating deficit, of c.
$700 million. It then sought Congressional approval to cover this deficit by
borrowing.
Even more recently, the State of Virginia decided to abolish the property
tax on domestic vehicles. This left a huge gap in the following year's
current budget. The governor proposed to use a deceptive accounting device
and to set up a separate - and, thus not subject to a referendum - "revenue"
bond-issuing entity (shades of Enron's "Special Purpose Entities"). The
bonds were then to be serviced by expected annual receipts from the
negotiated tobacco settlement, at that time not even finalized. This crazy
and illegal plan was abandoned.
The fact that both accounting and financial reporting for local
governments are very often in slightly modified cash-based formats adds to
the confusion. But these formats could be built on. Indeed, in the very tight
budgetary situations facing virtually every local government, it is essential
that cash management on a day- to-day basis be given high priority.
Still, the system can be misleading. It produces extremely scant
information on costs - the use of resources - compared with expenditures
(i.e., cash-flows). More seriously, cash accounting allows indiscriminate

allocation of funds between capital and recurrent purposes, thus permitting
no useful assessment of annual or other periodic financial performance.
A cash-based system cannot engender a credible balance sheet. It
produces meaningless and incoherent information on assets and liabilities
and the ownership, or trusteeship, of separate (or separable) funds. It is not
a sound system of budgetary control. When year-end unpaid invoices are
held over, it creates a false impression of operating within approved
budgetary limits. Thus, local government units can run serious budgetary
deficits that are hidden from public view merely by not paying their bills on
time and in full! A cash accounting system will not reveal this.
Still, moving to an accrual system should be done slowly and cautiously.
Private sector experience, in former Soviet countries, of changing to accrual
accounting was administratively traumatic. Their public sector systems may
not easily survive any major tinkering, let alone an - eventually inevitable -
full overhaul. Skills, tools, and access to proper professional knowledge are
required before this is attempted.
Q: Can you compare municipal and corporate accounting and financing
practices as far as governance and control are concerned? A: In corporate
accounting practice, the notional owners and managers are the shareholders.
In practice, through the use of proxies and other devices, the real control is
normally in the hands of a board of directors. Actual day to day control
reverts to the company chairmen, president, chief executive or chief
operating officer. The chief financial officer is often - though not
necessarily - an accountant and he or she oversees qualified accountants.
The company's accountants must produce the annual and other financial
statements. It is not the responsibility of the auditors whose obligation is to
report to the shareholders on the credibility and legality of the financial
statements. The shareholders may appoint an audit committee to review the
audit reports on their behalf. The audit is carried out by Certified Public
Accountants with recognized accounting credentials. Both the qualified
accountants in the audit firm and those in the corporation are subject to
professional discipline of their accounting institutions and of the law.
In local government accounting practice, the public trustees and
managers are normally a locally elected council. Often, the detailed control

over financial management is in the hands of a finance committee or
finance commission, usually comprised only of elected members.
Traditionally, only the elected council may take major financial
decisions, such as approving a budget, levying taxes and borrowing. Actual
day to day control of a local government may be by an executive mayor, or
by an elected or appointed chief executive. There normally is a chief
financial officer, often - though not necessarily - an accountant in charge of
other qualified accountants.
It is the responsibility of the accountants of the local government to
produce the annual and other financial statements. It is not the
responsibility of the auditors whose obligation is to report to the local
elected council on the credibility and legality of the financial statements.
The council may appoint an audit committee to review the audit reports
on their behalf, or they may ask the finance committee to do this.
However, it is quite common, in many countries, for local government
financial statements to be audited by properly authorized public officials.
Auditors should be qualified, independent, experienced, and competent.
Audits should be regular and comprehensive. It is unclear whether or not
public official auditors always fulfill these conditions.
In the United Kingdom, for example, there is a Local Government Audit
Commission which employs qualified accountants either on its own staff or
from hired accountancy firms. Thus, it clearly follows high standards.
Q: How did the worldwide trend of devolution affect municipal finance?
A: Outside of the former Soviet Union and Eastern Europe, municipal
finance was not significantly affected by devolution, though there has been
a tendency for decentralization. Central governments hold the purse- strings
and almost all local governments operate under legislation engendered by
the national, or - in federal systems - state, governments. Local
governments rarely have separate constitutional authority, although there
are varying degrees of local autonomy.
In the former Soviet Empire, changes of systems and of attitudes were
much more dramatic. Local government units, unlike under the former
Soviet system, are not branches of the general government. They are

separate corporate bodies, or legal persons. But in Russia, and in other
former socialist countries, they have often been granted "de jure" (legal)
independence but not full "de facto" (practical) autonomy.
There seems to be an unwillingness to accept that the two systems are
intended to operate quite differently. What is good for a central government
is not necessarily equally good for a local government unit. For example,
the main purpose of local government is to provide public services, with
only enough authority to perform them effectively. It is almost always the
responsibility of a central or state government to enact and enforce the
criminal and civil law. Local by-laws or ordinances are usually concerned
only with minor matters and are subject to an enabling legislation.
Moreover, they may prove to be "ultra vires" (beyond their powers) and,
therefore, unconstitutional, or at least unenforceable.
It may be appropriate, under certain circumstances, for a central
government to run budgetary deficits, whether caused by current or capital
transactions. In local government units, there is almost always a necessity to
distinguish between such transactions. Moreover, in most countries, local
government units are required by law to have balanced budgets, without
resort to borrowing to cover current deficits.
A corporate body (legal person), whether a private or a public sector
entity, has a separate legal identity from the central government and from
the members, shareholders, or electorate who own and manage it. It has its
own corporate name. Typically, its formal decisions are by resolution of its
managing body (board or council). Written documents are authenticated by
its common seal. It may contract, sue and be sued in its own name. Indeed,
unless specifically prevented by law, it may even sue the central
government! It may also have legal relationships with its own individual
members or with its staff. It is often said to have perpetual succession,
meaning that it lives on, even though the individual members may die,
resign or otherwise cease their membership.
While a corporation owes its existence to legislation, a local government
unit is established, typically, under something like a "Local Government
Organic Law".

Corporate status differs fundamentally from that of (say) government
departments in a system of de-concentration.
Permanent closure or abolition of a municipal council, or indeed any
change in its powers and duties, would almost always require formal legal
action, typically national parliamentary legislation.
A local government unit makes its own policy decisions, some of which,
especially the financial ones, often require approval by a central
government authority. Still, the central government rarely runs, or manages,
a local government unit on a daily basis. The relationship is at arms length
and not hands on. A local government unit usually is empowered to own
land and real estate. Sometimes, public assets - such as with roads or
drainage systems - are deemed to be "vested in" the local authority because
they cannot be owned in the same way as buildings are.
Q: Local authorities issue bonds, partake in joint ventures, lend to SME's
- in short, encroach on turf previously exclusively occupied by banks, the
capital markets, and business. Is this a good or a bad thing? A: Local
governments are established to provide services and perform activities
required or allowed by law! Normally, they won't seek or be permitted to
engage in commercial activities, best left to the private sector.
However, there have always been natural monopolies (such as water
supply), coping with negative economic externalities (such as sewerage and
solid waste management), the provision of whole or partial public goods
(such as street lighting, or roads) and merit goods (such as education,
health, and welfare), and services that the community, for economic or
social reasons, seeks to subsidize (such as urban transport). Left to the
private marketplace, these services would be absent, or under- supplied, or
over-charged for.
Such services are wholly or partially financed by local taxation, either
imposed by local governments, or by central (or state) taxation, through a
grant or revenue- sharing system. What has changed in recent years is that
local governments have been encouraged and empowered to outsource
these services to the private sector, or to "public-private" partnerships.

Charges for services, and revenues from taxation cover current operating
expenditures with a small operating surplus used to partly fund capital
expenditure or to service long, or medium term debt, such as bond issues
secured against future revenues. Commercial banks, because of their
tendency to lend only for relatively short periods of time, usually have a
relatively minor role in such funding, except perhaps as fiscal agents or
bond issue managers.
Other funding is obtained via direct - and dependence- forming - capital
grants from the central or state government. Alternatively, the central
government can establish a quasi-autonomous local government loans
authority, which it may wholly or partially fund. The authority may also
seek to raise additional funds from commercial sources and make loans on
reasonable terms to the local governments.
Third, the central government may lend directly to local governments, or
guarantee their borrowing. Finally, local governments are left to their own
devices to raise loans as and when they can, on whatever terms are
available. This usually leaves them in a precarious position, because the
market for this kind of long and medium term credit is thin and costly.
Commercial banks make short term loans to local governments to cover
temporary shortages of working capital. If not properly controlled, such
short-term loans are rolled over and accumulate unsustainably. That is what
happed in New York City, in the seventies.
Q: In the age of the Internet and the car, isn't the added layer of municipal
bureaucracy superfluous or even counterproductive? Can't the center - at
least in smallish countries - administer things at least as well? A: I am quite
sure that they can. There are many glaring examples of mismatches of sizes,
shapes and responsibilities of local government units. For example, New
York, Moscow and Bombay are each single local government units. Yet,
they each have much bigger populations than many countries, such as New
Zealand, the republics of former Yugoslavia, and the Baltic states.
On the other hand, the Greater Washington Metropolitan Area comprises
a federal district, four counties and several small cities. The local
government systems are under the jurisdictions of two states and the federal
government. Each of the two states has a completely different traditions and

systems of local governance, emanating from pre-independence times.
Accordingly, the local government systems north and east of the Potomac
River (which flows through the Washington area) are substantially different
from those to the south and west.
Finally, the Boston area, a cradle of U.S. democracy, is governed by a
conglomerate of over 40 local government jurisdictions. Even its most
famous college, Harvard, is in Cambridge and not in Boston itself. Many of
the jurisdictions are so small (Boston is not very big by U.S. standards) that
common services are run by agencies of the State of Massachusetts.
The problem of centralizing financial records would, indeed, be relatively
simple to solve. If credit card companies can maintain linkages world-wide,
there is no practical reason why local government accounts for (say) a city
in Macedonia could not be kept in China. The issue here is quite different. It
revolves around democracy, tradition, living in community, service delivery
at a local level, civil society, and the common wealth. It really has very little
to do with accountancy, which is just one tool of management, albeit an
important one.

XXIX. Competition Laws
A. THE PHILOSOPHY OF COMPETITION The aims of competition
(anti-trust) laws are to ensure that consumers pay the lowest possible price
(=the most efficient price) coupled with the highest quality of the goods and
services which they consume. This, according to current economic theories,
can be achieved only through effective competition. Competition not only
reduces particular prices of specific goods and services - it also tends to
have a deflationary effect by reducing the general price level. It pits
consumers against producers, producers against other producers (in the
battle to win the heart of consumers) and even consumers against
consumers (for example in the healthcare sector in the USA). This
everlasting conflict does the miracle of increasing quality with lower prices.
Think about the vast improvement on both scores in electrical appliances.
The VCR and PC of yesteryear cost thrice as much and provided one third
the functions at one tenth the speed.
Competition has innumerable advantages: a. It encourages manufacturers
and service providers to be more efficient, to better respond to the needs of
their customers, to innovate, to initiate, to venture. In professional words: it
optimizes the allocation of resources at the firm level and, as a result,
throughout the national economy.
More simply: producers do not waste resources (capital), consumers and
businesses pay less for the same goods and services and, as a result,
consumption grows to the benefit of all involved. b. The other beneficial
effect seems, at first sight, to be an adverse one: competition weeds out the
failures, the incompetents, the inefficient, the fat and slow to respond.
Competitors pressure one another to be more efficient, leaner and meaner.
This is the very essence of capitalism. It is wrong to say that only the
consumer benefits. If a firm improves itself, re-engineers its production
processes, introduces new management techniques, modernizes - in order to
fight the competition, it stands to reason that it will reap the rewards.
Competition benefits the economy, as a whole, the consumers and other

producers by a process of natural economic selection where only the fittest
survive. Those who are not fit to survive die out and cease to waste the rare
resources of humanity.
Thus, paradoxically, the poorer the country, the less resources it has - the
more it is in need of competition.
Only competition can secure the proper and most efficient use of its
scarce resources, a maximization of its output and the maximal welfare of
its citizens (consumers).
Moreover, we tend to forget that the biggest consumers are businesses
(firms). If the local phone company is inefficient (because no one competes
with it, being a monopoly) - firms will suffer the most: higher charges, bad
connections, lost time, effort, money and business. If the banks are
dysfunctional (because there is no foreign competition), they will not
properly service their clients and firms will collapse because of lack of
liquidity. It is the business sector in poor countries which should head the
crusade to open the country to competition.
Unfortunately, the first discernible results of the introduction of free
marketry are unemployment and business closures. People and firms lack
the vision, the knowledge and the wherewithal needed to support
competition. They fiercely oppose it and governments throughout the world
bow to protectionist measures. To no avail. Closing a country to
competition will only exacerbate the very conditions which necessitate its
opening up. At the end of such a wrong path awaits economic disaster and
the forced entry of competitors. A country which closes itself to the world -
will be forced to sell itself cheaply as its economy will become more and
more inefficient, less and less competitive.
The Competition Laws aim to establish fairness of commercial conduct
among entrepreneurs and competitors which are the sources of said
competition and innovation.
Experience - later buttressed by research - helped to establish the
following four principles: 1. There should be no barriers to the entry of new
market players (barring criminal and moral barriers to certain types of

activities and to certain goods and services offered). 2. A larger scale of
operation does introduce economies of scale (and thus lowers prices).
This, however, is not infinitely true. There is a Minimum Efficient Scale -
MES - beyond which prices will begin to rise due to monopolization of the
markets. This MES was empirically fixed at 10% of the market in any one
good or service. In other words: companies should be encouraged to capture
up to 10% of their market (=to lower prices) and discouraged to cross this
barrier, lest prices tend to rise again. 3. Efficient competition does not exist
when a market is controlled by less than 10 firms with big size differences.
An oligopoly should be declared whenever 4 firms control more than 40%
of the market and the biggest of them controls more than 12% of it. 4. A
competitive price will be comprised of a minimal cost plus an equilibrium
profit which does not encourage either an exit of firms (because it is too
low), nor their entry (because it is too high).
Left to their own devices, firms tend to liquidate competitors (predation),
buy them out or collude with them to raise prices. The 1890 Sherman
Antitrust Act in the USA forbade the latter (section 1) and prohibited
monopolization or dumping as a method to eliminate competitors. Later
acts (Clayton, 1914 and the Federal Trade Commission Act of the same
year) added forbidden activities: tying arrangements, boycotts, territorial
divisions, non-competitive mergers, price discrimination, exclusive dealing,
unfair acts, practices and methods.
Both consumers and producers who felt offended were given access to
the Justice Department and to the FTC or the right to sue in a federal court
and be eligible to receive treble damages.
It is only fair to mention the "intellectual competition", which opposes
the above premises. Many important economists thought (and still do) that
competition laws represent an unwarranted and harmful intervention of the
State in the markets. Some believed that the State should own important
industries (J.K. Galbraith), others - that industries should be encouraged to
grow because only size guarantees survival, lower prices and innovation
(Ellis Hawley). Yet others supported the cause of laissez faire (Marc
Eisner).

These three antithetical approaches are, by no means, new. One led to
socialism and communism, the other to corporatism and monopolies and the
third to jungle- ization of the market (what the Europeans derisively call:
the Anglo-Saxon model).
B. HISTORICAL AND LEGAL CONSIDERATIONS Why does the
State involve itself in the machinations of the free market? Because often
markets fail or are unable or unwilling to provide goods, services, or
competition.
The purpose of competition laws is to secure a competitive marketplace
and thus protect the consumer from unfair, anti-competitive practices. The
latter tend to increase prices and reduce the availability and quality of goods
and services offered to the consumer.
Such state intervention is usually done by establishing a governmental
Authority with full powers to regulate the markets and ensure their fairness
and accessibility to new entrants. Lately, international collaboration
between such authorities yielded a measure of harmonization and
coordinated action (especially in cases of trusts which are the results of
mergers and acquisitions).
Yet, competition law embodies an inherent conflict: while protecting
local consumers from monopolies, cartels and oligopolies - it ignores the
very same practices when directed at foreign consumers. Cartels related to
the country's foreign trade are allowed even under GATT/WTO rules (in
cases of dumping or excessive export subsidies). Put simply: governments
regard acts which are criminal as legal if they are directed at foreign
consumers or are part of the process of foreign trade.
A country such as Macedonia - poor and in need of establishing its export
sector - should include in its competition law at least two protective
measures against these discriminatory practices: 1. Blocking Statutes -
which prohibit its legal entities from collaborating with legal procedures in
other countries to the extent that this collaboration adversely affects the
local export industry. 2. Clawback Provisions - which will enable the local
courts to order the refund of any penalty payment decreed or imposed by a
foreign court on a local legal entity and which exceeds actual damage
inflicted by unfair trade practices of said local legal entity. US courts, for

instance, are allowed to impose treble damages on infringing foreign
entities. The clawback provisions are used to battle this judicial aggression.
Competition policy is the antithesis of industrial policy.
The former wishes to ensure the conditions and the rules of the game -
the latter to recruit the players, train them and win the game. The origin of
the former is in the 19th century USA and from there it spread to (really
was imposed on) Germany and Japan, the defeated countries in the 2nd
World War. The European Community (EC) incorporated a competition
policy in articles 85 and 86 of the Rome Convention and in Regulation 17
of the Council of Ministers, 1962.
Still, the two most important economic blocks of our time have different
goals in mind when implementing competition policies. The USA is more
interested in economic (and econometric) results while the EU emphasizes
social, regional development and political consequences. The EU also
protects the rights of small businesses more vigorously and, to some extent,
sacrifices intellectual property rights on the altar of fairness and the free
movement of goods and services.
Put differently: the USA protects the producers and the EU shields the
consumer. The USA is interested in the maximization of output at whatever
social cost - the EU is interested in the creation of a just society, a liveable
community, even if the economic results will be less than optimal.
There is little doubt that Macedonia should follow the EU example.
Geographically, it is a part of Europe and, one day, will be integrated in the
EU. It is socially sensitive, export oriented, its economy is negligible and its
consumers are poor, it is besieged by monopolies and oligopolies.
In my view, its competition laws should already incorporate the
important elements of the EU (Community) legislation and even explicitly
state so in the preamble to the law. Other, mightier, countries have done so.
Italy, for instance, modelled its Law number 287 dated 10/10/90
"Competition and Fair Trading Act" after the EC legislation. The law
explicitly says so.
The first serious attempt at international harmonization of national
antitrust laws was the Havana Charter of 1947. It called for the creation of

an umbrella operating organization (the International Trade Organization or
"ITO") and incorporated an extensive body of universal antitrust rules in
nine of its articles. Members were required to "prevent business practices
affecting international trade which restrained competition, limited access to
markets, or fostered monopolistic control whenever such practices had
harmful effects on the expansion of production or trade". the latter included:
a. Fixing prices, terms, or conditions to be observed in dealing with others
in the purchase, sale, or lease of any product; b. Excluding enterprises from,
or allocating or dividing, any territorial market or field of business activity,
or allocating customers, or fixing sales quotas or purchase quotas; c.
Discriminating against particular enterprises; d. Limiting production or
fixing production quotas; e. Preventing by agreement the development or
application of technology or invention, whether patented or non-patented;
and f. Extending the use of rights under intellectual property protections to
matters which, according to a member's laws and regulations, are not within
the scope of such grants, or to products or conditions of production, use, or
sale which are not likewise the subject of such grants.
GATT 1947 was a mere bridging agreement but the Havana Charter
languished and died due to the objections of a protectionist US Senate.
There are no antitrust/competition rules either in GATT 1947 or in
GATT/WTO 1994, but their provisions on antidumping and countervailing
duty actions and government subsidies constitute some elements of a more
general antitrust/competition law.
GATT, though, has an International Antitrust Code Writing Group which
produced a "Draft International Antitrust Code" (10/7/93). It is reprinted in
II, 64 Antitrust & Trade Regulation Reporter (BNA), Special Supplement at
S-3 (19/8/93).
Four principles guided the (mostly German) authors: 1. National laws
should be applied to solve international competition problems; 2. Parties,
regardless of origin, should be treated as locals; 3. A minimum standard for
national antitrust rules should be set (stricter measures would be welcome);
and 4. The establishment of an international authority to settle disputes
between parties over antitrust issues.

The 29 (well-off) members of the Organization for Economic
Cooperation and Development (OECD) formed rules governing the
harmonization and coordination of international antitrust/competition
regulation among its member nations ("The Revised Recommendation of
the OECD Council Concerning Cooperation between Member Countries on
Restrictive Business Practices Affecting International Trade," OECD Doc.
No. C(86)44 (Final) (June 5, 1986), also in 25 International Legal Materials
1629 (1986). A revised version was reissued. According to it, " .Enterprises
should refrain from abuses of a dominant market position; permit
purchasers, distributors, and suppliers to freely conduct their businesses;
refrain from cartels or restrictive agreements; and consult and cooperate
with competent authorities of interested countries".
An agency in one of the member countries tackling an antitrust case,
usually notifies another member country whenever an antitrust enforcement
action may affect important interests of that country or its nationals (see:
OECD Recommendations on Predatory Pricing, 1989).
The United States has bilateral antitrust agreements with Australia,
Canada, and Germany, which was followed by a bilateral agreement with
the EU in 1991. These provide for coordinated antitrust investigations and
prosecutions.
The United States thus reduced the legal and political obstacles which
faced its extraterritorial prosecutions and enforcement. The agreements
require one party to notify the other of imminent antitrust actions, to share
relevant information, and to consult on potential policy changes.
The EU-U.S. Agreement contains a "comity" principle under which each
side promises to take into consideration the other's interests when
considering antitrust prosecutions. A similar principle is at the basis of
Chapter 15 of the North American Free Trade Agreement (NAFTA) -
cooperation on antitrust matters.
The United Nations Conference on Restrictive Business Practices
adopted a code of conduct in 1979/1980 that was later integrated as a U.N.
General Assembly Resolution [U.N. Doc. TD/RBP/10 (1980)]: "The Set of
Multilaterally Agreed Equitable Principles and Rules".

According to its provisions, "independent enterprises should refrain from
certain practices when they would limit access to markets or otherwise
unduly restrain competition".
The following business practices are prohibited: 1. Agreements to fix
prices (including export and import prices); 2. Collusive tendering; 3.
Market or customer allocation (division) arrangements; 4. Allocation of
sales or production by quota; 5. Collective action to enforce arrangements,
e.g., by concerted refusals to deal; 6. Concerted refusal to sell to potential
importers; and 7. Collective denial of access to an arrangement, or
association, where such access is crucial to competition and such denial
might hamper it. In addition, businesses are forbidden to engage in the
abuse of a dominant position in the market by limiting access to it or by
otherwise restraining competition by: a. Predatory behaviour towards
competitors; b. Discriminatory pricing or terms or conditions in the supply
or purchase of goods or services; c. Mergers, takeovers, joint ventures, or
other acquisitions of control; d. Fixing prices for exported goods or resold
imported goods; e. Import restrictions on legitimately- marked trademarked
goods; f. Unjustifiably - whether partially or completely - refusing to deal
on an enterprise's customary commercial terms, making the supply of goods
or services dependent on restrictions on the distribution or manufacturer of
other goods, imposing restrictions on the resale or exportation of the same
or other goods, and purchase "tie-ins".
C. ANTI - COMPETITIVE STRATEGIES Any Competition Law in
Macedonia should, in my view, excplicitly include strict prohibitions of the
following practices (further details can be found in Porter's book -
"Competitive Strategy").
These practices characterize the Macedonian market.
They influence the Macedonian economy by discouraging foreign
investors, encouraging inefficiencies and mismanagement, sustaining
artificially high prices, misallocating very scarce resources, increasing
unemployment, fostering corrupt and criminal practices and, in general,
preventing the growth that Macedonia could have attained.
Strategies for Monopolization Exclude competitors from distribution
channels. - This is common practice in many countries. Open threats are

made by the manufacturers of popular products: "If you distribute my
competitor's products - you cannot distribute mine. So, choose." Naturally,
retail outlets, dealers and distributors will always prefer the popular product
to the new. This practice not only blocks competition - but also innovation,
trade and choice or variety.
Buy up competitors and potential competitors. - There is nothing wrong
with that. Under certain circumstances, this is even desirable. Think about
the Banking System: it is always better to have fewer banks with bigger
capital than many small banks with capital inadequacy (remember the TAT
affair). So, consolidation is sometimes welcome, especially where scale
represents viability and a higher degree of consumer protection. The line is
thin and is composed of both quantitative and qualitative criteria.
One way to measure the desirability of such mergers and acquisitions
(M&A) is the level of market concentration following the M&A. Is a new
monopoly created? Will the new entity be able to set prices unperturbed?
stamp out its other competitors? If so, it is not desirable and should be
prevented.
Every merger in the USA must be approved by the antitrust authorities.
When multinationals merge, they must get the approval of all the
competition authorities in all the territories in which they operate. The
purchase of "Intuit" by "Microsoft" was prevented by the antitrust
department (the "Trust-busters"). A host of airlines was conducting a drawn
out battle with competition authorities in the EU, UK and the USA lately.
Use predatory [below-cost] pricing (also known as dumping) to eliminate
competitors. - This tactic is mostly used by manufacturers in developing or
emerging economies and in Japan. It consists of "pricing the competition
out of the markets". The predator sells his products at a price which is lower
even than the costs of production. The result is that he swamps the market,
driving out all other competitors. Once he is left alone - he raises his prices
back to normal and, often, above normal.
The dumper loses money in the dumping operation and compensates for
these losses by charging inflated prices after having the competition
eliminated.

Raise scale-economy barriers. - Take unfair advantage of size and the
resulting scale economies to force conditions upon the competition or upon
the distribution channels. In many countries Big Industry lobbies for a
legislation which will fit its purposes and exclude its (smaller) competitors.
Increase "market power (share) and hence profit potential".
Study the industry's "potential" structure and ways it can be made less
competitive. - Even thinking about sin or planning it should be prohibited.
Many industries have "think tanks" and experts whose sole function is to
show the firm the way to minimize competition and to increase its market
shares. Admittedly, the line is very thin: when does a Marketing Plan
become criminal? Arrange for a "rise in entry barriers to block later
entrants" and "inflict losses on the entrant". - This could be done by
imposing bureaucratic obstacles (of licencing, permits and taxation), scale
hindrances (no possibility to distribute small quantities), "old boy networks"
which share political clout and research and development, using intellectual
property right to block new entrants and other methods too numerous to
recount.
An effective law should block any action which prevents new entry to a
market.
Buy up firms in other industries "as a base from which to change industry
structures" there. - This is a way of securing exclusive sources of supply of
raw materials, services and complementing products. If a company owns its
suppliers and they are single or almost single sources of supply - in effect it
has monopolized the market. If a software company owns another software
company with a product which can be incorporated in its own products -
and the two have substantial market shares in their markets - then their
dominant positions will reinforce each other's. "Find ways to encourage
particular competitors out of the industry". - If you can't intimidate your
competitors you might wish to "make them an offer that they cannot
refuse". One way is to buy them, to bribe the key personnel, to offer
tempting opportunities in other markets, to swap markets (I will give you
my market share in a market which I do not really care about and you will
give me your market share in a market in which we are competitors). Other
ways are to give the competitors assets, distribution channels and so on

providing that they collude in a cartel. "Send signals to encourage
competition to exit" the industry. - Such signals could be threats, promises,
policy measures, attacks on the integrity and quality of the competitor,
announcement that the company has set a certain market share as its goal
(and will, therefore, not tolerate anyone trying to prevent it from attaining
this market share) and any action which directly or indirectly intimidates or
convinces competitors to leave the industry.
Such an action need not be positive - it can be negative, need not be done
by the company - can be done by its political proxies, need not be planned -
could be accidental. The results are what matters.
Macedonia's Competition Law should outlaw the following, as well:
'Intimidate' Competitors Raise "mobility" barriers to keep competitors in the
least-profitable segments of the industry. - This is a tactic which preserves
the appearance of competition while subverting it. Certain segments,
usually less profitable or too small to be of interest, or with dim growth
prospects, or which are likely to be opened to fierce domestic and foreign
competition are left to the competition. The more lucrative parts of the
markets are zealously guarded by the company. Through legislation, policy
measures, withholding of technology and know-how - the firm prevents its
competitors from crossing the river into its protected turf.
Let little firms "develop" an industry and then come in and take it over. -
This is precisely what Netscape is saying that Microsoft is doing to it.
Netscape developed the now lucrative Browser Application market.
Microsoft was wrong in discarding the Internet as a fad. When it was found
to be wrong - Microsoft reversed its position and came up with its own
(then, technologically inferior) browser (the Internet Explorer). It offered it
free (sound suspiciously like dumping) to buyers of its operating system,
"Windows". Inevitably it captured more than 30% of the market, crowding
out Netscape. It is the view of the antitrust authorities in the USA that
Microsoft utilized its dominant position in one market (that of the Operating
Systems) to annihilate a competitor in another (that of the browsers).
Engage in "promotional warfare" by "attacking shares of others". - This
is when the gist of a marketing, lobbying, or advertising campaign is to
capture the market share of the competition. Direct attack is then made on

the competition just in order to abolish it. To sell more in order to maximize
profits, is allowed and meritorious - to sell more in order to eliminate the
competition is wrong and should be disallowed.
Use price retaliation to "discipline" competitors. - Through dumping or
even unreasonable and excessive discounting. This could be achieved not
only through the price itself. An exceedingly long credit term offered to a
distributor or to a buyer is a way of reducing the price.
The same applies to sales, promotions, vouchers, gifts.
They are all ways to reduce the effective price. The customer calculates
the money value of these benefits and deducts them from the price.
Establish a "pattern" of severe retaliation against challengers to
"communicate commitment" to resist efforts to win market share. - Again,
this retaliation can take a myriad of forms: malicious advertising, a media
campaign, adverse legislation, blocking distribution channels, staging a
hostile bid in the stock exchange just in order to disrupt the proper and
orderly management of the competitor. Anything which derails the
competitor whenever he makes a headway, gains a larger market share,
launches a new product - can be construed as a "pattern of retaliation".
Maintain excess capacity to be used for "fighting" purposes to discipline
ambitious rivals. - Such excess capacity could belong to the offending firm
or - through cartel or other arrangements - to a group of offending firms.
Publicize one's "commitment to resist entry" into the market.
Publicize the fact that one has a "monitoring system" to detect any
aggressive acts of competitors.
Announce in advance "market share targets" to intimidate competitors
into yielding their market share.
Proliferate Brand Names Contract with customers to "meet or match all
price cuts (offered by the competition)" thus denying rivals any hope of
growth through price competition.
Secure a big enough market share to "corner" the "learning curve," thus
denying rivals an opportunity to become efficient. - Efficiency is gained by

an increase in market share. Such an increase leads to new demands
imposed by the market, to modernization, innovation, the introduction of
new management techniques (example: Just In Time inventory
management), joint ventures, training of personnel, technology transfers,
development of proprietary intellectual property and so on. Deprived of a
growing market share - the competitor will not feel pressurized to learn and
to better itself. In due time, it will dwindle and die.
Acquire a wall of "defensive" patents to deny competitors access to the
latest technology. "Harvest" market position in a no-growth industry by
raising prices, lowering quality, and stopping all investment and advertising
in it.
Create or encourage capital scarcity. - By colluding with sources of
financing (e.g., regional, national, or investment banks), by absorbing any
capital offered by the State, by the capital markets, through the banks, by
spreading malicious news which serve to lower the credit- worthiness of the
competition, by legislating special tax and financing loopholes and so on.
Introduce high advertising-intensity. - This is very difficult to measure.
There could be no objective criteria which will not go against the grain of
the fundamental right to freedom of expression. However, truth in
advertising should be strictly imposed. Practices such as dragging a
competitor through the mud or derogatorily referring to its products or
services in advertising campaigns should be banned and the ban should be
enforced.
Proliferate "brand names" to make it too expensive for small firms to
grow. - By creating and maintaining a host of absolutely unnecessary
brandnames, the competition's brandnames are crowded out. Again, this
cannot be legislated against. A firm has the right to create and maintain as
many brandnames as it wishes. The market will exact a price and thus
punish such a company because, ultimately, its own brandname will suffer
from the proliferation.
Get a "corner" (control, manipulate and regulate) on raw materials,
government licenses, contracts, subsidies, and patents (and, of course,
prevent the competition from having access to them).

Build up "political capital" with government bodies; overseas, get
"protection" from "the host government". 'Vertical' Barriers Practice a
"preemptive strategy" by capturing all capacity expansion in the industry
(simply buying it, leasing it or taking over the companies that own or
develop it).
This serves to "deny competitors enough residual demand". Residual
demand, as we previously explained, causes firms to be efficient. Once
efficient, they develop enough power to "credibly retaliate" and thereby
"enforce an orderly expansion process" to prevent overcapacity Create
"switching" costs. - Through legislation, bureaucracy, control of the media,
cornering advertising space in the media, controlling infrastructure, owning
intellectual property, owning, controlling or intimidating distribution
channels and suppliers and so on.
Impose vertical "price squeezes". - By owning, controlling, colluding
with, or intimidating suppliers and distributors, marketing channels and
wholesale and retail outlets into not collaborating with the competition.
Practice vertical integration (buying suppliers and distribution and
marketing channels).
This has the following effects: The firm gains a "tap (access) into
technology" and marketing information in an adjacent industry. It defends
itself against a supplier's too-high or even realistic prices.
It defends itself against foreclosure, bankruptcy and restructuring or
reorganization. Owning suppliers means that the supplies do not cease even
when payment is not affected, for instance.
It "protects proprietary information from suppliers" - otherwise the firm
might have to give outsiders access to its technology, processes, formulas
and other intellectual property.
It raises entry and mobility barriers against competitors.
This is why the State should legislate and act against any purchase, or
other types of control of suppliers and marketing channels which service
competitors and thus enhance competition.

It serves to "prove that a threat of full integration is credible" and thus
intimidate competitors.
Finally, it gets "detailed cost information" in an adjacent industry (but
doesn't integrate it into a "highly competitive industry"). "Capture
distribution outlets" by vertical integration to "increase barriers".
'Consolidate' the Industry Send "signals" to threaten, bluff, preempt, or
collude with competitors.
Use a "fighting brand" (a low-price brand used only for price-cutting).
Use "cross parry" (retaliate in another part of a competitor's market).
Harass competitors with antitrust suits and other litigious techniques.
Use "brute force" ("massed resources" applied "with finesse") to attack
competitors or use "focal points" of pressure to collude with competitors on
price. "Load up customers" at cut-rate prices to "deny new entrants a base"
and force them to "withdraw" from market.
Practice "buyer selection," focusing on those that are the most
"vulnerable" (easiest to overcharge) and discriminating against and for
certain types of consumers. "Consolidate" the industry so as to "overcome
industry fragmentation".
This arguments is highly successful with US federal courts in the last
decade. There is an intuitive feeling that few is better and that a
consolidated industry is bound to be more efficient, better able to compete
and to survive and, ultimately, better positioned to lower prices, to conduct
costly research and development and to increase quality. In the words of
Porter: "(The) pay-off to consolidating a fragmented industry can be high
because... small and weak competitors offer little threat of retaliation".
Time one's own capacity additions; never sell old capacity "to anyone
who will use it in the same industry" and buy out "and retire competitors'
capacity".
A Note on the Spiteful Application of Competition Laws In many
developing countries and countries in transition from Communism to
capitalism, competition laws are used to reward cronies or to damage

opponents. The discriminatory and partial application of such laws and
regulations sustains networks of patronage and cements political-economic
alliances.
This abuse of the rule of Law and the regulatory regime is further
compounded by the seething pathological envy that is typical of erstwhile
egalitarian societies now exposed to growing income inequalities. The mob,
business rivals, political parties, and the populace at large leverage
competition laws to tear down businesses and humiliate entrepreneurs
whose success grates on their nerves and provokes their unbridled jealousy.

XXX. The Benefits of Oligopolies
The Wall Street Journal has recently published an elegiac list: "Twenty
years ago, cable television was dominated by a patchwork of thousands of
tiny, family-operated companies. Today, a pending deal would leave three
companies in control of nearly two-thirds of the market.
In 1990, three big publishers of college textbooks accounted for 35% of
industry sales. Today they have 62% ... Five titans dominate the (defense)
industry, and one of them, Northrop Grumman ... made a surprise
(successful) $5.9 billion bid for (another) TRW ... In 1996, when Congress
deregulated telecommunications, there were eight Baby Bells. Today there
are four, and dozens of small rivals are dead. In 1999, more than 10
significant firms offered help-wanted Web sites. Today, three firms
dominate".
Mergers, business failures, deregulation, globalization, technology,
dwindling and more cautious venture capital, avaricious managers and
investors out to increase share prices through a spree of often ill-thought
acquisitions - all lead inexorably to the congealing of industries into a few
suppliers. Such market formations are known as oligopolies. Oligopolies
encourage customers to collaborate in oligopsonies and these, in turn, foster
further consolidation among suppliers, service providers, and
manufacturers.
Market purists consider oligopolies - not to mention cartels - to be as
villainous as monopolies. Oligopolies, they intone, restrict competition
unfairly, retard innovation, charge rent and price their products higher than
they could have in a perfect competition free market with multiple
participants. Worse still, oligopolies are going global.
But how does one determine market concentration to start with? The
Herfindahl-Hirschmann index squares the market shares of firms in the
industry and adds up the total. But the number of firms in a market does not
necessarily impart how low - or high - are barriers to entry. These are
determined by the structure of the market, legal and bureaucratic hurdles,

the existence, or lack thereof of functioning institutions, and by the
possibility to turn an excess profit.
The index suffers from other shortcomings. Often the market is difficult
to define. Mergers do not always drive prices higher. University of Chicago
economists studying Industrial Organization - the branch of economics that
deals with competition - have long advocated a shift of emphasis from
market share to - usually temporary - market power. Influential antitrust
thinkers, such as Robert Bork, recommended to revise the law to focus
solely on consumer welfare.
These - and other insights - were incorporated in a theory of market
contestability. Contrary to classical economic thinking, monopolies and
oligopolies rarely raise prices for fear of attracting new competitors, went
the new school. This is especially true in a "contestable" market - where
entry is easy and cheap.
An Oligopolistic firm also fears the price-cutting reaction of its rivals if it
reduces prices, goes the Hall, Hitch, and Sweezy theory of the Kinked
Demand Curve. If it were to raise prices, its rivals may not follow suit, thus
undermining its market share. Stackleberg's amendments to Cournot's
Competition model, on the other hand, demonstrate the advantages to a
price setter of being a first mover.
In "Economic assessment of oligopolies under the Community Merger
Control Regulation, in European Competition law Review (Vol 4, Issue 3),
Juan Briones Alonso writes: "At first sight, it seems that ... oligopolists will
sooner or later find a way of avoiding competition among themselves, since
they are aware that their overall profits are maximized with this strategy.
However, the question is much more complex. First of all, collusion without
explicit agreements is not easy to achieve. Each supplier might have
different views on the level of prices which the demand would sustain, or
might have different price preferences according to its cost conditions and
market share. A company might think it has certain advantages which its
competitors do not have, and would perhaps perceive a conflict between
maximising its own profits and maximizing industry profits.
Moreover, if collusive strategies are implemented, and oligopolists
manage to raise prices significantly above their competitive level, each

oligopolist will be confronted with a conflict between sticking to the tacitly
agreed behaviour and increasing its individual profits by 'cheating' on its
competitors. Therefore, the question of mutual monitoring and control is a
key issue in collusive oligopolies".
Monopolies and oligopolies, went the contestability theory, also refrain
from restricting output, lest their market share be snatched by new entrants.
In other words, even monopolists behave as though their market was fully
competitive, their production and pricing decisions and actions constrained
by the "ghosts" of potential and threatening newcomers.
In a CRIEFF Discussion Paper titled "From Walrasian Oligopolies to
Natural Monopoly - An Evolutionary Model of Market Structure", the
authors argue that: "Under decreasing returns and some fixed cost, the
market grows to 'full capacity' at Walrasian equilibrium (oligopolies); on the
other hand, if returns are increasing, the unique long run outcome involves
a profit-maximising monopolist".
While intellectually tempting, contestability theory has little to do with
the rough and tumble world of business.
Contestable markets simply do not exist. Entering a market is never
cheap, nor easy. Huge sunk costs are required to counter the network effects
of more veteran products as well as the competitors' brand recognition and
ability and inclination to collude to set prices.
Victory is not guaranteed, losses loom constantly, investors are forever
edgy, customers are fickle, bankers itchy, capital markets gloomy, suppliers
beholden to the competition. Barriers to entry are almost always formidable
and often insurmountable.
In the real world, tacit and implicit understandings regarding prices and
competitive behavior prevail among competitors within oligopolies.
Establishing a reputation for collusive predatory pricing deters potential
entrants.
And a dominant position in one market can be leveraged into another,
connected or derivative, market.

But not everyone agrees. Ellis Hawley believed that industries should be
encouraged to grow because only size guarantees survival, lower prices,
and innovation. Louis Galambos, a business historian at Johns Hopkins
University, published a 1994 paper titled "The Triumph of Oligopoly". In it,
he strove to explain why firms and managers - and even consumers - prefer
oligopolies to both monopolies and completely free markets with numerous
entrants.
Oligopolies, as opposed to monopolies, attract less attention from
trustbusters. Quoted in the Wall Street Journal on March 8, 1999, Galambos
wrote: "Oligopolistic competition proved to be beneficial ... because it
prevented ossification, ensuring that managements would keep their
organizations innovative and efficient over the long run".
In his recently published tome "The Free-Market Innovation Machine -
Analysing the Growth Miracle of Capitalism", William Baumol of
Princeton University, concurs. He daringly argues that productive
innovation is at its most prolific and qualitative in oligopolistic markets.
Because firms in an oligopoly characteristically charge above-
equilibrium (i.e., high) prices - the only way to compete is through product
differentiation. This is achieved by constant innovation - and by incessant
advertising.
Baumol maintains that oligopolies are the real engines of growth and
higher living standards and urges antitrust authorities to leave them be.
Lower regulatory costs, economies of scale and of scope, excess profits due
to the ability to set prices in a less competitive market - allow firms in an
oligopoly to invest heavily in research and development. A new drug costs
c. $800 million to develop and get approved, according to Joseph DiMasi of
Tufts University's Center for the Study of Drug Development, quoted in
The wall Street Journal.
In a paper titled "If Cartels Were Legal, Would Firms Fix Prices",
implausibly published by the Antitrust Division of the US Department of
Justice in 1997, Andrew Dick demonstrated, counterintuitively, that cartels
are more likely to form in industries and sectors with many producers. The
more concentrated the industry - i.e., the more oligopolistic it is - the less
likely were cartels to emerge.

Cartels are conceived in order to cut members' costs of sales. Small firms
are motivated to pool their purchasing and thus secure discounts. Dick
draws attention to a paradox: mergers provoke the competitors of the
merging firms to complain. Why do they act this way? Mergers and
acquisitions enhance market concentration.
According to conventional wisdom, the more concentrated the industry,
the higher the prices every producer or supplier can charge. Why would
anyone complain about being able to raise prices in a post-merger market?
Apparently, conventional wisdom is wrong. Market concentration leads to
price wars, to the great benefit of the consumer. This is why firms find the
mergers and acquisitions of their competitors worrisome. America's soft
drink market is ruled by two firms - Pepsi and Coca- Cola. Yet, it has been
the scene of ferocious price competition for decades. "The Economist", in
its review of the paper, summed it up neatly: "The story of America's export
cartels suggests that when firms decide to co-operate, rather than compete,
they do not always have price increases in mind. Sometimes, they get
together simply in order to cut costs, which can be of benefit to consumers".
The very atom of antitrust thinking - the firm - has changed in the last
two decades. No longer hierarchical and rigid, business resembles self-
assembling, nimble, ad- hoc networks of entrepreneurship superimposed on
ever- shifting product groups and profit and loss centers.
Competition used to be extraneous to the firm - now it is commonly an
internal affair among autonomous units within a loose overall structure.
This is how Jack "neutron" Welsh deliberately structured General Electric.
AOL-Time Warner hosts many competing units, yet no one ever instructs
them either to curb this internecine competition, to stop cannibalizing each
other, or to start collaborating synergistically. The few mammoth agencies
that rule the world of advertising now host a clutch of creative boutiques
comfortably ensconced behind Chinese walls. Such outfits often manage
the accounts of competitors under the same corporate umbrella.
Most firms act as intermediaries. They consume inputs, process them,
and sell them as inputs to other firms. Thus, many firms are concomitantly
consumers, producers, and suppliers. In a paper published last year and
titled "Productive Differentiation in Successive Vertical Oligopolies", that

authors studied: "An oligopoly model with two brands. Each downstream
firm chooses one brand to sell on a final market. The upstream firms
specialize in the production of one input specifically designed for the
production of one brand, but they also produce he input for the other brand
at an extra cost. (They concluded that) when more downstream brands
choose one brand, more upstream firms will specialize in the input specific
to that brand, and vice versa. Hence, multiple equilibria are possible and the
softening effect of brand differentiation on competition might not be strong
enough to induce maximal differentiation" (and, thus, minimal
competition).
Both scholars and laymen often mix their terms.
Competition does not necessarily translate either to variety or to lower
prices. Many consumers are turned off by too much choice. Lower prices
sometimes deter competition and new entrants. A multiplicity of vendors,
retail outlets, producers, or suppliers does not always foster competition.
And many products have umpteen substitutes. Consider films - cable TV,
satellite, the Internet, cinemas, video rental shops, all offer the same
service: visual content delivery.
And then there is the issue of technological standards. It is incalculably
easier to adopt a single worldwide or industry-wide standard in an
oligopolistic environment.
Standards are known to decrease prices by cutting down R&D
expenditures and systematizing components.
Or, take innovation. It is used not only to differentiate one's products
from the competitors' - but to introduce new generations and classes of
products. Only firms with a dominant market share have both the incentive
and the wherewithal to invest in R&D and in subsequent branding and
marketing.
But oligopolies in deregulated markets have sometimes substituted price
fixing, extended intellectual property rights, and competitive restraint for
market regulation.
Still, Schumpeter believed in the faculty of "disruptive technologies" and
"destructive creation" to check the power of oligopolies to set extortionate

prices, lower customer care standards, or inhibit competition.
Linux threatens Windows. Opera nibbles at Microsoft's Internet Explorer.
Amazon drubbed traditional booksellers. eBay thrashes Amazon. Bell was
forced by Covad Communications to implement its own technology, the
DSL broadband phone line.
Barring criminal behavior, there is little that oligopolies can do to defend
themselves against these forces. They can acquire innovative firms,
intellectual property, and talent. They can form strategic partnerships. But
the supply of innovators and new technologies is infinite - and the resources
of oligopolies, however mighty, are finite.
The market is stronger than any of its participants, regardless of the
hubris of some, or the paranoia of others.

XXXI. Anarchy as an Organizing Principle
The recent spate of accounting fraud scandals signals the end of an era.
Disillusionment and disenchantment with American capitalism may yet lead
to a tectonic ideological shift from laissez faire and self regulation to state
intervention and regulation. This would be the reversal of a trend dating
back to Thatcher in Britain and Reagan in the USA. It would also cast some
fundamental - and way more ancient - tenets of free-marketry in grave
doubt.
Markets are perceived as self-organizing, self-assembling, exchanges of
information, goods, and services. Adam Smith's "invisible hand" is the sum
of all the mechanisms whose interaction gives rise to the optimal allocation
of economic resources. The market's great advantages over central planning
are precisely its randomness and its lack of self-awareness.
Market participants go about their egoistic business, trying to maximize
their utility, oblivious of the interests and action of all, bar those they
interact with directly.
Somehow, out of the chaos and clamor, a structure emerges of order and
efficiency unmatched. Man is incapable of intentionally producing better
outcomes.
Thus, any intervention and interference are deemed to be detrimental to
the proper functioning of the economy.
It is a minor step from this idealized worldview back to the Physiocrats,
who preceded Adam Smith, and who propounded the doctrine of "laissez
faire, laissez passer" - the hands-off battle cry. Theirs was a natural religion.
The market, as an agglomeration of individuals, they thundered, was surely
entitled to enjoy the rights and freedoms accorded to each and every person.
John Stuart Mill weighed against the state's involvement in the economy in
his influential and exquisitely-timed "Principles of Political Economy",
published in 1848.

Undaunted by mounting evidence of market failures - for instance to
provide affordable and plentiful public goods - this flawed theory returned
with a vengeance in the last two decades of the past century. Privatization,
deregulation, and self-regulation became faddish buzzwords and part of a
global consensus propagated by both commercial banks and multilateral
lenders.
As applied to the professions - to accountants, stock brokers, lawyers,
bankers, insurers, and so on - self- regulation was premised on the belief in
long-term self- preservation. Rational economic players and moral agents
are supposed to maximize their utility in the long-run by observing the rules
and regulations of a level playing field.
This noble propensity seemed, alas, to have been tampered by avarice
and narcissism and by the immature inability to postpone gratification. Self-
regulation failed so spectacularly to conquer human nature that its demise
gave rise to the most intrusive statal stratagems ever devised. In both the
UK and the USA, the government is much more heavily and pervasively
involved in the minutia of accountancy, stock dealing, and banking than it
was only two years ago.
But the ethos and myth of "order out of chaos" - with its proponents in
the exact sciences as well - ran deeper than that. The very culture of
commerce was thoroughly permeated and transformed. It is not surprising
that the Internet - a chaotic network with an anarchic modus operandi -
flourished at these times.
The dotcom revolution was less about technology than about new ways
of doing business - mixing umpteen irreconcilable ingredients, stirring well,
and hoping for the best. No one, for instance, offered a linear revenue
model of how to translate "eyeballs" - i.e., the number of visitors to a Web
site - to money ("monetizing"). It was dogmatically held to be true that,
miraculously, traffic - a chaotic phenomenon - will translate to profit -
hitherto the outcome of painstaking labour.
Privatization itself was such a leap of faith. State owned assets -
including utilities and suppliers of public goods such as health and
education - were transferred wholesale to the hands of profit maximizers.
The implicit belief was that the price mechanism will provide the missing

planning and regulation. In other words, higher prices were supposed to
guarantee an uninterrupted service.
Predictably, failure ensued - from electricity utilities in California to
railway operators in Britain.
The simultaneous crumbling of these urban legends - the liberating
power of the Net, the self-regulating markets, the unbridled merits of
privatization - inevitably gave rise to a backlash.
The state has acquired monstrous proportions in the decades since the
Second world War. It is about to grow further and to digest the few sectors
hitherto left untouched. To say the least, these are not good news. But we
libertarians - proponents of both individual freedom and individual
responsibility - have brought it on ourselves by thwarting the work of that
invisible regulator - the market.

XXXII. Narcissism in the Boardroom
The perpetrators of the recent spate of financial frauds in the USA acted
with callous disregard for both their employees and shareholders - not to
mention other stakeholders. Psychologists have often remote-diagnosed
them as "malignant, pathological narcissists".
Narcissists are driven by the need to uphold and maintain a false self - a
concocted, grandiose, and demanding psychological construct typical of the
narcissistic personality disorder. The false self is projected to the world in
order to garner "narcissistic supply" - adulation, admiration, or even
notoriety and infamy. Any kind of attention is usually deemed by narcissists
to be preferable to obscurity.
The false self is suffused with fantasies of perfection, grandeur,
brilliance, infallibility, immunity, significance, omnipotence, omnipresence,
and omniscience. To be a narcissist is to be convinced of a great, inevitable
personal destiny. The narcissist is preoccupied with ideal love, the
construction of brilliant, revolutionary scientific theories, the composition
or authoring or painting of the greatest work of art, the founding of a new
school of thought, the attainment of fabulous wealth, the reshaping of a
nation or a conglomerate, and so on. The narcissist never sets realistic goals
to himself. He is forever preoccupied with fantasies of uniqueness, record
breaking, or breathtaking achievements. His verbosity reflects this
propensity.
Reality is, naturally, quite different and this gives rise to a "grandiosity
gap". The demands of the false self are never satisfied by the narcissist's
accomplishments, standing, wealth, clout, sexual prowess, or knowledge.
The narcissist's grandiosity and sense of entitlement are equally
incommensurate with his achievements.
To bridge the grandiosity gap, the malignant (pathological) narcissist
resorts to shortcuts. These very often lead to fraud.

The narcissist cares only about appearances. What matters to him are the
facade of wealth and its attendant social status and narcissistic supply.
Witness the travestied extravagance of Tyco's Denis Kozlowski. Media
attention only exacerbates the narcissist's addiction and makes it incumbent
on him to go to ever-wilder extremes to secure uninterrupted supply from
this source.
The narcissist lacks empathy - the ability to put himself in other people's
shoes. He does not recognize boundaries - personal, corporate, or legal.
Everything and everyone are to him mere instruments, extensions, objects
unconditionally and uncomplainingly available in his pursuit of narcissistic
gratification.
This makes the narcissist perniciously exploitative. He uses, abuses,
devalues, and discards even his nearest and dearest in the most chilling
manner. The narcissist is utility- driven, obsessed with his overwhelming
need to reduce his anxiety and regulate his labile sense of self- worth by
securing a constant supply of his drug - attention. American executives
acted without compunction when they raided their employees' pension
funds - as did Robert Maxwell a generation earlier in Britain.
The narcissist is convinced of his superiority - cerebral or physical. To
his mind, he is a Gulliver hamstrung by a horde of narrow-minded and
envious Lilliputians. The dotcom "new economy" was infested with
"visionaries" with a contemptuous attitude towards the mundane: profits,
business cycles, conservative economists, doubtful journalists, and cautious
analysts.
Yet, deep inside, the narcissist is painfully aware of his addiction to
others - their attention, admiration, applause, and affirmation. He despises
himself for being thus dependent. He hates people the same way a drug
addict hates his pusher. He wishes to "put them in their place", humiliate
them, demonstrate to them how inadequate and imperfect they are in
comparison to his regal self and how little he craves or needs them.
The narcissist regards himself as one would an expensive present, a gift
to his company, to his family, to his neighbours, to his colleagues, to his
country. This firm conviction of his inflated importance makes him feel
entitled to special treatment, special favors, special outcomes, concessions,

subservience, immediate gratification, obsequiousness, and lenience. It also
makes him feel immune to mortal laws and somehow divinely protected
and insulated from the inevitable consequences of his deeds and misdeeds.
The self-destructive narcissist plays the role of the "bad guy" (or "bad
girl"). But even this is within the traditional social roles cartoonishly
exaggerated by the narcissist to attract attention. Men are likely to
emphasise intellect, power, aggression, money, or social status. Narcissistic
women are likely to emphasise body, looks, charm, sexuality, feminine
"traits", homemaking, children and childrearing.
Punishing the wayward narcissist is a veritable catch-22.
A jail term is useless as a deterrent if it only serves to focus attention on
the narcissist. Being infamous is second best to being famous - and far
preferable to being ignored.
The only way to effectively punish a narcissist is to withhold narcissistic
supply from him and thus to prevent him from becoming a notorious
celebrity.
Given a sufficient amount of media exposure, book contracts, talk shows,
lectures, and public attention - the narcissist may even consider the whole
grisly affair to be emotionally rewarding. To the narcissist, freedom, wealth,
social status, family, vocation - are all means to an end.
And the end is attention. If he can secure attention by being the big bad
wolf - the narcissist unhesitatingly transforms himself into one. Lord
Archer, for instance, seems to be positively basking in the media circus
provoked by his prison diaries.
The narcissist does not victimise, plunder, terrorise and abuse others in a
cold, calculating manner. He does so offhandedly, as a manifestation of his
genuine character.
To be truly "guilty" one needs to intend, to deliberate, to contemplate
one's choices and then to choose one's acts.
The narcissist does none of these.

Thus, punishment breeds in him surprise, hurt and seething anger. The
narcissist is stunned by society's insistence that he should be held
accountable for his deeds and penalized accordingly. He feels wronged,
baffled, injured, the victim of bias, discrimination and injustice.
He rebels and rages.
Depending upon the pervasiveness of his magical thinking, the narcissist
may feel besieged by overwhelming powers, forces cosmic and intrinsically
ominous. He may develop compulsive rites to fend off this "bad",
unwarranted, persecutory influences.
The narcissist, very much the infantile outcome of stunted personal
development, engages in magical thinking. He feels omnipotent, that there
is nothing he couldn't do or achieve if only he sets his mind to it. He feels
omniscient - he rarely admits to ignorance and regards his intuitions and
intellect as founts of objective data.
Thus, narcissists are haughtily convinced that introspection is a more
important and more efficient (not to mention easier to accomplish) method
of obtaining knowledge than the systematic study of outside sources of
information in accordance with strict and tedious curricula. Narcissists are
"inspired" and they despise hamstrung technocrats.
To some extent, they feel omnipresent because they are either famous or
about to become famous or because their product is selling or is being
manufactured globally.
Deeply immersed in their delusions of grandeur, they firmly believe that
their acts have - or will have - a great influence not only on their firm, but
on their country, or even on Mankind. Having mastered the manipulation of
their human environment - they are convinced that they will always "get
away with it". They develop hubris and a false sense of immunity.
Narcissistic immunity is the (erroneous) feeling, harboured by the
narcissist, that he is impervious to the consequences of his actions, that he
will never be effected by the results of his own decisions, opinions, beliefs,
deeds and misdeeds, acts, inaction, or membership of certain groups, that he
is above reproach and punishment, that, magically, he is protected and will
miraculously be saved at the last moment. Hence the audacity, simplicity,

and transparency of some of the fraud and corporate looting in the 1990's.
Narcissists rarely bother to cover their traces, so great is their disdain and
conviction that they are above mortal laws and wherewithal.
What are the sources of this unrealistic appraisal of situations and events?
The false self is a childish response to abuse and trauma.
Abuse is not limited to sexual molestation or beatings.
Smothering, doting, pampering, over-indulgence, treating the child as an
extension of the parent, not respecting the child's boundaries, and burdening
the child with excessive expectations are also forms of abuse.
The child reacts by constructing false self that is possessed of everything
it needs in order to prevail: unlimited and instantaneously available Harry
Potter-like powers and wisdom. The false self, this Superman, is indifferent
to abuse and punishment. This way, the child's true self is shielded from the
toddler's harsh reality.
This artificial, maladaptive separation between a vulnerable (but not
punishable) true self and a punishable (but invulnerable) false self is an
effective mechanism. It isolates the child from the unjust, capricious,
emotionally dangerous world that he occupies. But, at the same time, it
fosters in him a false sense of "nothing can happen to me, because I am not
here, I am not available to be punished, hence I am immune to punishment".
The comfort of false immunity is also yielded by the narcissist's sense of
entitlement. In his grandiose delusions, the narcissist is sui generis, a gift to
humanity, a precious, fragile, object. Moreover, the narcissist is convinced
both that this uniqueness is immediately discernible - and that it gives him
special rights. The narcissist feels that he is protected by some cosmological
law pertaining to "endangered species".
He is convinced that his future contribution to others - his firm, his
country, humanity - should and does exempt him from the mundane: daily
chores, boring jobs, recurrent tasks, personal exertion, orderly investment of
resources and efforts, laws and regulations, social conventions, and so on.
The narcissist is entitled to a "special treatment": high living standards,
constant and immediate catering to his needs, the eradication of any friction

with the humdrum and the routine, an all-engulfing absolution of his sins,
fast track privileges (to higher education, or in his encounters with
bureaucracies, for instance). Punishment, trusts the narcissist, is for
ordinary people, where no great loss to humanity is involved.
Narcissists are possessed of inordinate abilities to charm, to convince, to
seduce, and to persuade. Many of them are gifted orators and intellectually
endowed. Many of them work in in politics, the media, fashion, show
business, the arts, medicine, or business, and serve as religious leaders.
By virtue of their standing in the community, their charisma, or their
ability to find the willing scapegoats, they do get exempted many times.
Having recurrently "got away with it" - they develop a theory of personal
immunity, founded upon some kind of societal and even cosmic "order" in
which certain people are above punishment.
But there is a fourth, simpler, explanation. The narcissist lacks self-
awareness. Divorced from his true self, unable to empathise (to understand
what it is like to be someone else), unwilling to constrain his actions to
cater to the feelings and needs of others - the narcissist is in a constant
dreamlike state.
To the narcissist, his life is unreal, like watching an autonomously
unfolding movie. The narcissist is a mere spectator, mildly interested,
greatly entertained at times.
He does not "own" his actions. He, therefore, cannot understand why he
should be punished and when he is, he feels grossly wronged.
So convinced is the narcissist that he is destined to great things - that he
refuses to accept setbacks, failures and punishments. He regards them as
temporary, as the outcomes of someone else's errors, as part of the future
mythology of his rise to power/brilliance/wealth/ideal love, etc. Being
punished is a diversion of his precious energy and resources from the all-
important task of fulfilling his mission in life.
The narcissist is pathologically envious of people and believes that they
are equally envious of him. He is paranoid, on guard, ready to fend off an
imminent attack.

A punishment to the narcissist is a major surprise and a nuisance but it
also validates his suspicion that he is being persecuted. It proves to him that
strong forces are arrayed against him.
He tells himself that people, envious of his achievements and humiliated
by them, are out to get him. He constitutes a threat to the accepted order.
When required to pay for his misdeeds, the narcissist is always disdainful
and bitter and feels misunderstood by his inferiors.
Cooked books, corporate fraud, bending the (GAAP or other) rules,
sweeping problems under the carpet, over- promising, making grandiose
claims (the "vision thing") - are hallmarks of a narcissist in action. When
social cues and norms encourage such behaviour rather than inhibit it - in
other words, when such behaviour elicits abundant narcissistic supply - the
pattern is reinforced and become entrenched and rigid. Even when
circumstances change, the narcissist finds it difficult to adapt, shed his
routines, and replace them with new ones. He is trapped in his past success.
He becomes a swindler.
But pathological narcissism is not an isolated phenomenon. It is
embedded in our contemporary culture.
The West's is a narcissistic civilization. It upholds narcissistic values and
penalizes alternative value- systems. From an early age, children are taught
to avoid self-criticism, to deceive themselves regarding their capacities and
attainments, to feel entitled, and to exploit others.
As Lilian Katz observed in her important paper, "Distinctions between
Self-Esteem and Narcissism: Implications for Practice", published by the
Educational Resources Information Center, the line between enhancing self-
esteem and fostering narcissism is often blurred by educators and parents.
Both Christopher Lasch in "The Culture of Narcissism" and Theodore
Millon in his books about personality disorders, singled out American
society as narcissistic.
Litigiousness may be the flip side of an inane sense of entitlement.
Consumerism is built on this common and communal lie of "I can do
anything I want and possess everything I desire if I only apply myself to it"
and on the pathological envy it fosters.

Not surprisingly, narcissistic disorders are more common among men
than among women. This may be because narcissism conforms to
masculine social mores and to the prevailing ethos of capitalism. Ambition,
achievements, hierarchy, ruthlessness, drive - are both social values and
narcissistic male traits. Social thinkers like the aforementioned Lasch
speculated that modern American culture - a self-centred one - increases the
rate of incidence of the narcissistic personality disorder.
Otto Kernberg, a notable scholar of personality disorders, confirmed
Lasch's intuition: "Society can make serious psychological abnormalities,
which already exist in some percentage of the population, seem to be at
least superficially appropriate".
In their book "Personality Disorders in Modern Life", Theodore Millon
and Roger Davis state, as a matter of fact, that pathological narcissism was
once the preserve of "the royal and the wealthy" and that it "seems to have
gained prominence only in the late twentieth century".
Narcissism, according to them, may be associated with "higher levels of
Maslow's hierarchy of needs ...
Individuals in less advantaged nations .. are too busy trying (to survive)
... to be arrogant and grandiose".
They - like Lasch before them - attribute pathological narcissism to "a
society that stresses individualism and self-gratification at the expense of
community, namely the United States." They assert that the disorder is more
prevalent among certain professions with "star power" or respect. "In an
individualistic culture, the narcissist is 'God's gift to the world'. In a
collectivist society, the narcissist is 'God's gift to the collective".
Millon quotes Warren and Caponi's "The Role of Culture in the
Development of Narcissistic Personality Disorders in America, Japan and
Denmark": "Individualistic narcissistic structures of self-regard (in
individualistic societies) ... are rather self-contained and independent ... (In
collectivist cultures) narcissistic configurations of the we-self ... denote
self-esteem derived from strong identification with the reputation and honor
of the family, groups, and others in hierarchical relationships".

Still, there are malignant narcissists among subsistence farmers in Africa,
nomads in the Sinai desert, day laborers in east Europe, and intellectuals
and socialites in Manhattan. Malignant narcissism is all-pervasive and
independent of culture and society. It is true, though, that the way
pathological narcissism manifests and is experienced is dependent on the
particulars of societies and cultures.
In some cultures, it is encouraged, in others suppressed. In some societies
it is channeled against minorities - in others it is tainted with paranoia. In
collectivist societies, it may be projected onto the collective, in
individualistic societies, it is an individual's trait.
Yet, can families, organizations, ethnic groups, churches, and even whole
nations be safely described as "narcissistic" or "pathologically self-
absorbed"? Can we talk about a "corporate culture of narcissism"? Human
collectives - states, firms, households, institutions, political parties, cliques,
bands - acquire a life and a character all their own. The longer the
association or affiliation of the members, the more cohesive and conformist
the inner dynamics of the group, the more persecutory or numerous its
enemies, competitors, or adversaries, the more intensive the physical and
emotional experiences of the individuals it is comprised of, the stronger the
bonds of locale, language, and history - the more rigorous might an
assertion of a common pathology be.
Such an all-pervasive and extensive pathology manifests itself in the
behavior of each and every member. It is a defining - though often implicit
or underlying - mental structure. It has explanatory and predictive powers.
It is recurrent and invariable - a pattern of conduct melding distorted
cognition and stunted emotions. And it is often vehemently denied.

XXXIII. The Revolt of the Poor
The Demise of Intellectual Property?

In 1997, I published a book of short stories in Israel. The publishing
house belongs to Israel's leading (and exceedingly wealthy) newspaper. I
signed a contract which stated that I am entitled to receive 8% of the
income from the sales of the book after commissions payable to
distributors, shops, etc. A few months later (1997), I won the coveted Prize
of the Ministry of Education (for short prose). The prize money (a few
thousand DMs) was snatched by the publishing house on the legal grounds
that all the money generated by the book belongs to them because they own
the copyright.
In the mythology generated by capitalism to pacify the masses, the myth
of intellectual property stands out. It goes like this: if the rights to
intellectual property were not defined and enforced, commercial
entrepreneurs would not have taken on the risks associated with publishing
books, recording records, and preparing multimedia products. As a result,
creative people will have suffered because they will have found no way to
make their works accessible to the public. Ultimately, it is the public which
pays the price of piracy, goes the refrain.
But this is factually untrue. In the USA there is a very limited group of
authors who actually live by their pen.
Only select musicians eke out a living from their noisy vocation (most of
them rock stars who own their labels - George Michael had to fight Sony to
do just that) and very few actors come close to deriving subsistence level
income from their profession. All these can no longer be thought of as
mostly creative people. Forced to defend their intellectual property rights
and the interests of Big Money, Madonna, Michael Jackson,
Schwarzenegger and Grisham are businessmen at least as much as they are
artists.

Economically and rationally, we should expect that the costlier a work of
art is to produce and the narrower its market - the more emphasized its
intellectual property rights.
Consider a publishing house.
A book which costs 50,000 DM to produce with a potential audience of
1000 purchasers (certain academic texts are like this) - would have to be
priced at a a minimum of 100 DM to recoup only the direct costs. If
illegally copied (thereby shrinking the potential market as some people will
prefer to buy the cheaper illegal copies) - its price would have to go up
prohibitively to recoup costs, thus driving out potential buyers. The story is
different if a book costs 10,000 DM to produce and is priced at 20 DM a
copy with a potential readership of 1,000,000 readers. Piracy (illegal
copying) should in this case be more readily tolerated as a marginal
phenomenon.
This is the theory. But the facts are tellingly different. The less the cost of
production (brought down by digital technologies) - the fiercer the battle
against piracy. The bigger the market - the more pressure is applied to
clamp down on samizdat entrepreneurs.
Governments, from China to Macedonia, are introducing intellectual
property laws (under pressure from rich world countries) and enforcing
them belatedly. But where one factory is closed on shore (as has been the
case in mainland China) - two sprout off shore (as is the case in Hong Kong
and in Bulgaria).
But this defies logic: the market today is global, the costs of production
are lower (with the exception of the music and film industries), the
marketing channels more numerous (half of the income of movie studios
emanates from video cassette sales), the speedy recouping of the investment
virtually guaranteed. Moreover, piracy thrives in very poor markets in
which the population would anyhow not have paid the legal price. The
illegal product is inferior to the legal copy (it comes with no literature,
warranties or support). So why should the big manufacturers, publishing
houses, record companies, software companies and fashion houses worry?
The answer lurks in history. Intellectual property is a relatively new notion.
In the near past, no one considered knowledge or the fruits of creativity (art,

design) as "patentable", or as someone's "property". The artist was but a
mere channel through which divine grace flowed.
Texts, discoveries, inventions, works of art and music, designs - all
belonged to the community and could be replicated freely. True, the chosen
ones, the conduits, were honoured but were rarely financially rewarded.
They were commissioned to produce their works of art and were salaried, in
most cases. Only with the advent of the Industrial Revolution were the
embryonic precursors of intellectual property introduced but they were still
limited to industrial designs and processes, mainly as embedded in
machinery. The patent was born. The more massive the market, the more
sophisticated the sales and marketing techniques, the bigger the financial
stakes - the larger loomed the issue of intellectual property. It spread from
machinery to designs, processes, books, newspapers, any printed matter,
works of art and music, films (which, at their beginning were not
considered art), software, software embedded in hardware, processes,
business methods, and even unto genetic material.
Intellectual property rights - despite their noble title - are less about the
intellect and more about property. This is Big Money: the markets in
intellectual property outweigh the total industrial production in the world.
The aim is to secure a monopoly on a specific work. This is an especially
grave matter in academic publishing where small- circulation magazines do
not allow their content to be quoted or published even for non-commercial
purposes. The monopolists of knowledge and intellectual products cannot
allow competition anywhere in the world - because theirs is a world market.
A pirate in Skopje is in direct competition with Bill Gates. When he sells a
pirated Microsoft product - he is depriving Microsoft not only of its income,
but of a client (=future income), of its monopolistic status (cheap copies can
be smuggled into other markets), and of its competition-deterring image (a
major monopoly preserving asset). This is a threat which Microsoft cannot
tolerate. Hence its efforts to eradicate piracy - successful in China and an
utter failure in legally- relaxed Russia.
But what Microsoft fails to understand is that the problem lies with its
pricing policy - not with the pirates. When faced with a global marketplace,
a company can adopt one of two policies: either to adjust the price of its
products to a world average of purchasing power - or to use discretionary

differential pricing (as pharmaceutical companies were forced to do in
Brazil and South Africa).
A Macedonian with an average monthly income of 160 USD clearly
cannot afford to buy the Encyclopaedia Encarta Deluxe. In America, 50
USD is the income generated in 4 hours of an average job. In Macedonian
terms, therefore, the Encarta is 20 times more expensive.
Either the price should be lowered in the Macedonian market - or an
average world price should be fixed which will reflect an average global
purchasing power.
Something must be done about it not only from the economic point of
view. Intellectual products are very price sensitive and highly elastic. Lower
prices will be more than compensated for by a much higher sales volume.
There is no other way to explain the pirate industries: evidently, at the right
price a lot of people are willing to buy these products. High prices are an
implicit trade-off favouring small, elite, select, rich world clientele. This
raises a moral issue: are the children of Macedonia less worthy of education
and access to the latest in human knowledge and creation? Two
developments threaten the future of intellectual property rights. One is the
Internet. Academics, fed up with the monopolistic practices of professional
publications - already publish on the web in big numbers.
I published a few book on the Internet and they can be freely downloaded
by anyone who has a computer or a modem. The full text of electronic
magazines, trade journals, billboards, professional publications, and
thousands of books is available online. Hackers even made sites available
from which it is possible to download whole software and multimedia
products. It is very easy and cheap to publish on the Internet, the barriers to
entry are virtually nil. Web pages are hosted free of charge, and authoring
and publishing software tools are incorporated in most word processors and
browser applications. As the Internet acquires more impressive sound and
video capabilities it will proceed to threaten the monopoly of the record
companies, the movie studios and so on.
The second development is also technological. The oft- vindicated
Moore's law predicts the doubling of computer memory capacity every 18

months. But memory is only one aspect of computing power. Another is the
rapid simultaneous advance on all technological fronts.
Miniaturization and concurrent empowerment by software tools have
made it possible for individuals to emulate much larger scale organizations
successfully. A single person, sitting at home with 5000 USD worth of
equipment can fully compete with the best products of the best printing
houses anywhere. CD-ROMs can be written on, stamped and copied in
house. A complete music studio with the latest in digital technology has
been condensed to the dimensions of a single chip. This will lead to
personal publishing, personal music recording, and the to the digitization of
plastic art. But this is only one side of the story.
The relative advantage of the intellectual property corporation does not
consist exclusively in its technological prowess. Rather it lies in its vast
pool of capital, its marketing clout, market positioning, sales organization,
and distribution network.
Nowadays, anyone can print a visually impressive book, using the above-
mentioned cheap equipment. But in an age of information glut, it is the
marketing, the media campaign, the distribution, and the sales that
determine the economic outcome.
This advantage, however, is also being eroded.
First, there is a psychological shift, a reaction to the commercialization of
intellect and spirit. Creative people are repelled by what they regard as an
oligarchic establishment of institutionalized, lowest common denominator
art and they are fighting back.
Secondly, the Internet is a huge (200 million people), truly cosmopolitan
market, with its own marketing channels freely available to all. Even by
default, with a minimum investment, the likelihood of being seen by
surprisingly large numbers of consumers is high.
I published one book the traditional way - and another on the Internet. In
50 months, I have received 6500 written responses regarding my electronic
book. Well over 500,000 people read it (my Link Exchange meter registered
c. 2,000,000 impressions since November 1998). It is a textbook (in
psychopathology) - and 500,000 readers is a lot for this kind of publication.

I am so satisfied that I am not sure that I will ever consider a traditional
publisher again. Indeed, my last book was published in the very same way.
The demise of intellectual property has lately become abundantly clear.
The old intellectual property industries are fighting tooth and nail to
preserve their monopolies (patents, trademarks, copyright) and their cost
advantages in manufacturing and marketing.
But they are faced with three inexorable processes which are likely to
render their efforts vain: The Newspaper Packaging Print newspapers offer
package deals of cheap content subsidized by advertising. In other words,
the advertisers pay for content formation and generation and the reader has
no choice but be exposed to commercial messages as he or she studies the
content.
This model - adopted earlier by radio and television - rules the internet
now and will rule the wireless internet in the future. Content will be made
available free of all pecuniary charges. The consumer will pay by providing
his personal data (demographic data, consumption patterns and preferences
and so on) and by being exposed to advertising. Subscription based models
are bound to fail.
Thus, content creators will benefit only by sharing in the advertising
cake. They will find it increasingly difficult to implement the old models of
royalties paid for access or of ownership of intellectual property.
Disintermediation A lot of ink has been spilt regarding this important
trend.
The removal of layers of brokering and intermediation - mainly on the
manufacturing and marketing levels - is a historic development (though the
continuation of a long term trend).
Consider music for instance. Streaming audio on the internet or
downloadable MP3 files will render the CD obsolete. The internet also
provides a venue for the marketing of niche products and reduces the
barriers to entry previously imposed by the need to engage in costly
marketing ("branding") campaigns and manufacturing activities.

This trend is also likely to restore the balance between artist and the
commercial exploiters of his product. The very definition of "artist" will
expand to include all creative people. One will seek to distinguish oneself,
to "brand" oneself and to auction off one's services, ideas, products,
designs, experience, etc. This is a return to pre- industrial times when
artisans ruled the economic scene.
Work stability will vanish and work mobility will increase in a landscape
of shifting allegiances, head hunting, remote collaboration and similar
labour market trends.
Market Fragmentation In a fragmented market with a myriad of mutually
exclusive market niches, consumer preferences and marketing and sales
channels - economies of scale in manufacturing and distribution are
meaningless.
Narrowcasting replaces broadcasting, mass customization replaces mass
production, a network of shifting affiliations replaces the rigid owned-
branch system. The decentralized, intrapreneurship-based corporation is a
late response to these trends. The mega-corporation of the future is more
likely to act as a collective of start-ups than as a homogeneous, uniform
(and, to conspiracy theorists, sinister) juggernaut it once was.

XXXIV. The Kidnapping of Content
http://www.plagiarism.org and http://www.Turnitin.com

Latin kidnapped the word "plagion" from ancient Greek and it ended up
in English as "plagiarism". It literally means "to kidnap" - most commonly,
to misappropriate content and wrongly attribute it to oneself. It is a close
kin of piracy. But while the software or content pirate does not bother to
hide or alter the identity of the content's creator or the software's author -
the plagiarist does.
Plagiarism is, therefore, more pernicious than piracy.
Enter Turnit.com. An off-shoot of www.iparadigms.com, it was
established by a group of concerned (and commercially minded) scientists
from UC Berkeley.
Whereas digital rights and asset management systems are geared to
prevent piracy - plagiarism.org and its commercial arm, Turnit.com, are the
cyber equivalent of a law enforcement agency, acting after the fact to
discover the culprits and uncover their misdeeds. This, they claim, is a first
stage on the way to a plagiarism-free Internet- based academic community
of both teachers and students, in which the educational potential of the
Internet can be fully realized.
The problem is especially severe in academia. Various surveys have
discovered that a staggering 80%(!) of US students cheat and that at least
30% plagiarize written material. The Internet only exacerbated this
problem.
More than 200 cheat-sites have sprung up, with thousands of papers
available on-line and tens of thousands of satisfied plagiarists the world
over. Some of these hubs - like cheater.com, cheatweb or cheathouse.com -
make no bones about their offerings. Many of them are located outside the
USA (in Germany, or Asia) and at least one offers papers in a few
languages, Hebrew included.

The problem, though, is not limited to the ivory towers. E- zines
plagiarize. The print media plagiarize. Individual journalists plagiarize,
many with abandon. Even advertising agencies and financial institutions
plagiarize.
The amount of material out there is so overwhelming that the plagiarist
develops a (fairly justified) sense of immunity. The temptation is
irresistible, the rewards big and the pressures of modern life great.
Some of the plagiarists are straightforward copiers. Others substitute
words, add sentences, or combine two or more sources. This raises the
question: "when should content be considered original and when -
plagiarized?". Should the test for plagiarism be more stringent than the one
applied by the Copyright Office? And what rights are implicitly granted by
the material's genuine authors or publishers once they place the content on
the Internet? Is the Web a public domain and, if yes, to what extent? These
questions are not easily answered. Consider reports generated by users from
a database. Are these reports copyrighted - and if so, by whom - by the
database compiler or by the user who defined the parameters, without
which the reports in question would have never been generated? What
about "fair use" of text and works of art? In the USA, the backlash against
digital content piracy and plagiarism has reached preposterous legal,
litigious and technological nadirs.
Plagiarism.org has developed a statistics-based technology (the
"Document Source Analysis") which creates a "digital fingerprint" of every
document in its database. Web crawlers are then unleashed to scour the
Internet and find documents with the same fingerprint and a colour-coded
report is generated. An instructor, teacher, or professor can then use the
report to prove plagiarism and cheating.
Piracy is often considered to be a form of viral marketing (even by
software developers and publishers). The author's, publisher's, or software
house's data are preserved intact in the cracked copy. Pirated copies of e-
books often contribute to increased sales of the print versions. Crippled
versions of software or pirated copies of software without its manuals,
updates and support - often lead to the purchase of a licence. Not so with
plagiarism. The identities of the author, editor, publisher and illustrator are