Mark Taylor

Emerging ConclusionsMarch 2002

Economies of Conflict:Private Sector Activity in Armed Conflict

Emerging Conclusions

These Emerging Conclusions offer a preliminary analysis of the findingsof four reports from the Economies of Conflict policy research series,which examines the links between private sector activity and armedconflict. In addition, the four reports are presented here in electronicform on an enclosed compact disc. The occasion is the symposium“Economic Agendas in Armed Conflict: Defining and Developing theRole of the UN”, co-organized by the International Peace Academy andProgramme for International Co-operation and Conflict Resolution, andsponsored by the Government of Norway, on 25 March 2002 in NewYork.

These and additional forthcoming reports from the series are availablefrom the PICCR web-site at www.fafo.no/piccr

The Economies of Conflict project is supported by the Government ofNorway.

Institute for Applied Social ScienceP.O.Box 2947 TøyenN-0608 Oslohttp://www.fafo.no/engelsk/

Programme for International Co-operation and Conflict Resolution

Mark Taylor

Emerging Conclusions – March 2002

Fafo

Economies of Conflict: Private Sector Activity in Armed Conflict

Programme for International Co-operation and Conflict Resolution

2

© Fafo Institute for Applied Social Science 2002

Cover page: Agneta KolstadPrinted in Norway by: Centraltrykkeriet AS

3

Contents

Preface ............................................................................................................ 5

1 Introduction ...................................................................................... 7

2 Preliminary Findings ...................................................................... 112.1 Anarchic Exploitation ............................................................................ 122.2 Criminalized Transactions ...................................................................... 152.3 Militarized Production ........................................................................... 172.4 Conflict Commodities ............................................................................ 202.5 Rogue Companies .................................................................................. 232.6 Emerging Conclusions ............................................................................ 25

3 Executive Summaries ..................................................................... 27Dirty Diamonds ............................................................................................ 28Fuelling Conflict ........................................................................................... 33Illicit Finance and Global Conflict ............................................................... 38The Logs of War ........................................................................................... 47

About the Authors ....................................................................................... 53

Appendix: Contents of the Economies of Conflict CD, Version 1 .............. 54

4

5

Preface

These Emerging Conclusions offer a preliminary analysis of the findings of four re-ports from the Economies of Conflict policy research series, a project of Fafo’s Pro-gramme for International Co-operation and Conflict Resolution (PICCR). Thesereports are the first to emerge from the series, which examines the links betweencertain private sector activity and armed conflict.

The four reports presented here in electronic form on compact disc are beingreleased for the first time on the occasion of Economic Agendas in Armed Conflict:Defining and Developing the Role of the UN, a symposium co-organized by the In-ternational Peace Academy and PICCR, and sponsored by the Government ofNorway, on 25 March 2002 in New York. These reports will be released in printedformat in the coming months.

The Executive Summaries of the reports are reproduced below, as is a table ofcontents for the compact disc itself. We have gathered from the authors a numberof related primary and secondary source documents and included these on the com-pact disc in order to provide background and context to the studies and to give thisversion of the compact disc additional utility. Much of what is included on thecompact disc is also available on the Fafo web site at www.fafo.no/piccr, which willbe updated regularly with additional material. Later in 2002, the Economies of Con-flict series will release additional reports on regulatory options, the private securitysector, small arms, and brokers.

It should be emphasised that Economies of Conflict is an analytical policy-orientedproject, aimed at a better understanding of processes and behaviour as the basis forsuggesting policy options. The reports issued as part of the Economies of Conflict seriesdo not seek to accuse or shame particular firms or governments. Rather, the studiesapproach the private economic dynamics involved in armed conflict from withineach sector, asking the question, How does certain private sector activity help sus-tain armed conflict and what can be done about it?

In designing the research programme, PICCR opted for an industry perspec-tive. The industries identified below have been selected based on their identifica-tion in the literature and through practice (as evidenced by on-going work of non-governmental organisations, governments, or multilateral institutions). They are byno means exhaustive of the economic dimensions of war, but they represent someof the industries that are, perhaps, most relevant to the challenges to international

6

peace and security posed by contemporary armed conflicts. Although the studiesdo address illicit activities within licit industries, the project has yet to commissionstudies related to the specifically criminal activities linked to armed conflict (e.g.narcotics, trafficking in human beings, etc.).

As with past PICCR projects, we have chosen an inductive approach, seekingto contribute to these arenas through an analysis of experience and lessons-learned.PICCR commissioned studies from practitioners and researchers engaged in issuesrelated to the industry and war, or the industry and corporate social responsibility,and with a keen sense of what has worked – and what has not worked - in practice.

The Economies of Conflict project was launched in the spring of 2001 and sincethat time we have benefited from the input and support of a growing number ofpeople. Principal among these has been Ambassador Wegger Strømmen at theNorwegian Permanent Mission to the United Nations, who has watched the projectgrow since its inception. Karen Ballentine, Research Coordinator and ProgramAssociate on the International Peace Academy’s project Economic Agendas in CivilWars, has been extremely helpful and, along with the excellent staff at IPA, has madethe Fafo-IPA cooperation on these issues both easy and effective. Our team of re-searchers deserve special thanks, both for their openness to our approach to theresearch task and their willingness to share their knowledge with each other acrossthe seminar table. My thanks also to Leiv Lunde, an advisor on Economies of Con-flict and the author of an upcoming report from the project, for his help and per-spective over the past year, and to Christian Ruge, a PICCR colleague, who has madean invaluable contribution to the project. I am also grateful to the Government ofNorway, which provided financial support for the project, and to those Norwegianofficials who have contributed their perspectives on policy issues. Of course, noneof the above bears responsibility for any inaccuracies or omissions that might occurin these reports. The views and recommendations expressed in these reports, includ-ing this summary of emerging conclusions, are those of the authors alone and donot necessarily reflect the views of Norway, its Government or officials, or Fafo.

These emerging conclusions present a work in progress. Your comments wouldbe welcome and should be directed to pisk@fafo.no.

Mark TaylorProgramme Director, PICCRSeries Editor, Economies of Conflict

7

1 Introduction

Today’s warlords, governments and non-state actors alike, make use of global finan-cial and commodity markets to transform control over natural resources into warfighting capacity. Under the cover of secrecy and unaccountability provided by war,legally or illegally produced commodities are traded on the legitimate, but highlyunregulated, global markets to obtain financial resources, weapons and other ma-teriel needed to sustain the war.

The economic dimensions of wars are not new. Yet, the horrors of recent warsseem to have thrown into stark relief the inadequacy of our attempts to end them.Despite the terrible human cost of the wars of the past decade – millions of liveslost or ruined, societies irrevocably scarred, and economies destroyed – it has be-come increasingly clear that recent wars have far outstripped our ability to bring themto definitive conclusion1 and that the economies of these conflicts may play a cru-cial part in sustaining them.

As a priority for international action, the economic dimensions of conflicts havebeen catapulted to the top of the international agenda by increasing concerns aboutthe dark sides of globalization. Since 11 September 2001, the U.S.-led internation-al effort to target terrorist financing and logistics has underlined the importance ofglobal financial and criminal networks to national and regional security. Today, acommon, global infrastructure of financial services is used to facilitate transactionsinvolving drug money, small arms, diamonds, smuggled timber, the proceeds ofcorruption, human trafficking and terrorist finance. The apparent ease with whichlicit and illicit economic goods and services are able to move between ‘black’, ‘grey’2

and ‘white’ markets has forced governments to seek greater financial sector account-ability. The failures of financial oversight and corporate accountability apparent inthe spectacular bankruptcy of the U.S.-based Corporation Enron have added to a

1 While the number of armed conflicts has dropped since the early 1990s, of those that continue 66per cent were more than 5 years old in 1999 and 30 per cent were more than twenty years old. Inaddition, many conflicts which were suspended in the 1990s – not least in Europe, the Middle East,and Central Asia – have not been resolved; see Dan Smith, Trends and Causes of Armed Conflict, BerghofHandbook for Conflict Transformation (April 2001).

2 The term ‘Grey markets’ is used here in its more generally legal sense, referring to markets whichbridge legal or ‘white markets’ and the trade in illegal ‘black’ market goods.

8

growing sense of uncertainty about the transparency and accountability of firmsoperating internationally.

Concerns about the economic dimensions of international peace and securityappear to be converging with an evolving agenda for greater corporate accountabil-ity. Intense activity is underway in several arenas to better understand and respondto the economic driving forces of violent conflict and war. Governments and mul-tilateral organisations, non-governmental organisations, multinational corporationsand industry associations, have all in recent years launched or participated in initi-atives to study or develop policy options for dealing with economies of armed con-flict. Campaigning NGOs and industry have moved to address private sector linksto conflict through the increasingly significant lens of corporate social responsibil-ity (CSR). Multilateral institutions, including the World Bank, the OECD, and theUnited Nations, have begun to tackle the issue from their own perspectives (mac-ro-economic analysis, global policy co-ordination, sanctions). With this convergencein mind, PICCR’s Economies of Conflict project has been structured to build on thebodies of work that have emerged from these efforts and to provide input to them.3

Summary: Conflict Commodities and Rogue CompaniesWith the rise to prominence of ‘conflict diamonds’, and to a lesser extent ‘conflicttimber’, there is a growing sense that goods produced in an economy torn by armedconflict are, or should be, morally suspect. The tendency to view such goods as ‘con-flict commodities’ is a direct result of an increase in consumer sensitivity resultingfrom successful campaigns on issues related to corporate social responsibility andhuman rights, and the increasing concern that such activities run counter to effortsto maintain international peace and security. It is arguable that an international moraland political norm is gradually emerging which views private sector activity thatsustains armed conflict as unacceptable.

The notion of conflict commodities possesses inherent dangers. Countries de-pendent upon a limited number of exports could face serious economic hardshipshould the ‘conflict commodity’ label taint their product. Companies with legiti-mate investments in such countries face the potential for significant losses and height-ened risk to their reputations. These dangers were recognised early on by

3 For a summary of UN oriented initiatives see, e.g., “Economic Agendas in Armed Conflict: Defi-ning and Developing the Role of the UN”, Background Paper prepared by The International PeaceAcademy and The Fafo Institute for Applied Social Science, on the occasion of a symposium spon-sored by the Government of Norway, Monday, 25 March 2002, New York. A comprehensive look atthe full spectrum of regulatory options relevant for the private sector is being developed for publica-tion as part of the Economies of Conflict series in the Spring 2002; see www.fafo.no/piccr.

9

governments, industry and NGOs concerned about conflict diamonds, and theyhave guided efforts to define the problem and develop remedies.

Despite the risks, there is as yet no agreed definition of what might constitute aconflict commodity. By looking at those commodities already linked to the financ-ing of armed conflict, the Economies of Conflict studies sought to describe thespecific activities involved in the production and marketing of such goods, includ-ing payments processes and related financial services. What emerges is a picture ofconflict commodities as goods exploited to sustain armed conflict and produced orbrought to market by anarchic exploitation, criminalized transactions, and milita-rised production.

The policy communities in the international public and private sectors are en-gaged in trying to identify what mix of private and public policies will be most ef-fective in addressing the role of private sector activity in sustaining armed conflict.Defining complicity and developing policy options now will help member states andcompanies position themselves in relation to a consensus forming around the issueof conflict commodities.

Unfortunately, this is unlikely to be enough.Certain companies, some of a relatively small size but operating international-

ly, continue to use armed conflict as a cover for more or less anarchic exploitation.These companies profit from the fighting and are often connected with the powersat the head of repressive rebels or governments. The activities of these companiesare often crucial to the prosperity or survival of these powers, often in direct con-tradiction to international attempts to make peace.

These are rogue companies, firms that participate in and benefit from the mil-itarization of production, criminalized transactions and anarchic exploitation. Yet,the Economies of Conflict studies identify activities carried out by companies withlegitimate business interests that would fit into these categories. As the activities andconsequences associated with conflict commodities begin to be better understood,and as the consensus around notions of conflict commodities begins to solidify, anumber of companies engaged in otherwise legitimate activities could find them-selves on the wrong side of international opinion.

The Economies of Conflict studies portray a complex range of licit and illicit ac-tivities that result – directly and indirectly - in a number of intended and unintendedconsequences. Judging from the pace of recent policy development, internationalcompanies – and their ‘home’ and ‘host’ states - will need to adopt clear, verifiablepositions on core issues about their operations in situations of armed conflict. Theelaboration of a clearly defined concept of conflict commodities and rogue compa-nies would have considerable utility with regard to private sector CSR initiatives. Itwould help all sides – industry, NGOs, and government – by providing some

10

transparency to the negotiation of agreed standards. The analysis and definitionssuggested below are offered as a departure point in the discussion of these issues.

11

2 Preliminary Findings

The first studies produced under Economies of Conflict reinforce the view that deci-sion-making about private sector activity in armed conflict is mired in significantuncertainty. Practitioners in governments, multilateral organisations, firms andNGOs have few definitive or operational understandings of what might constituteharmful private sector activity in armed conflict.4 Company officers need to knowthe risks involved in certain investment opportunities and, in the context of increas-ing demands for corporate social responsibility, need a better idea where lie the moralor political trip-wires. Practitioners charged with managing international peace andsecurity require operable definitions upon which policy responses can be based.Governments, those home to multinational corporations or those hoping to attractinvestment, need to know about the political and economic implications of certaincompany actions, at home and abroad.

The first four reports in the series - covering the oil, diamond, timber and fi-nancial sectors – describe a complex combination of activities spanning productionprocesses, trade, the provision of services, and touching upon public and privateinstitutions. What emerges is a tentative categorisation of specific activities thatenable - directly and indirectly – rebels or governments to sustain armed conflict.Three categories of activity are described below, followed by an analysis of poten-tially useful definitions of conflict commodities and rogue companies. The findingsare preliminary. The analysis presented here is subject to change based on furtherresearch and the conclusions of additional papers to be published as part of theEconomies of Conflict series in the spring and summer of 2002.

4 See, e.g., Private Sector Actors in Zones of Conflict: Research Challenges and Policy Responses, a reportof the Fafo’s PICCR and the International Peace Academy project on “Economic Agendas in CivilWars.” Thursday, April 19, 2001, International Peace Academy, New York. Rapporteur: Jake Sherman.

12

2.1 Anarchic Exploitation5

Governments and rebels alike make use of global financial and commodity marketsto transform control over natural resources into war fighting capacity. Legally orillegally produced commodities are traded on the legitimate, but highly unregulat-ed, global markets to obtain financial resources, weapons and other materiel need-ed to sustain the war. In all four of the sectors studied to date – diamonds, timber,oil, and financial services – private sector activity consists of a series of transactionswhich often combine the perfectly legal and legitimate with the thoroughly illegalor illicit. More often than not, the borders between these categories are ill defined.

One of the principle reasons for the uncertainty of private economic decision-making in armed conflict is the significant lack of relevant regulatory frameworks.State sovereignty implies that a government is likely to exploit its natural resourcesif it feels the need to mount a military defence, which is usually expensive. But armedconflict usually results in the destruction or weakening of government institutions,which lends itself to loss of administrative effectiveness and de facto sovereignty,6

as well as a direct reduction in transparency and accountability of governments. Thus,while certain activities may be clearly illegal under domestic law, they may not beenforced; many others are simply unregulated. In other cases, the problem of hav-ing to enforce or regulate activities that contribute directly to conflict is solved byhaving them formally legalized.

There is little in the way of international public or commercial law against whichthe legality of private sector activities in armed conflict might be tested or from whichpolicies might be derived. In fact, all of the studies describe a lack of internationalregulation or enforcement related to these activities.7 Together, these domestic andinternational regulatory gaps contribute to the blurring of the definitions of licitand illicit economic activities in armed conflict.

For those involved in armed conflict, the exploitation of resources is made pos-sible by this relatively unregulated or anarchic state of affairs. In some cases, certainindustries seek out such situations:

5 The term ‘exploitation’ is used here in its most general and neutral sense of utilising an object forprofitable ends or to obtain potential benefits.

6 States have asserted a permanent right to sovereignty over their natural resources and wealth. Theestablishment of this right was a particularly important part of statehood for developing countriesemerging from colonial rule. In addition, most governments justify military action as a form of self-defence, a right enshrined in international law.

7 An analysis of the debate around regulatory options is forthcoming as part of the Economies of Conflictseries later in 2002.

13

“The tropical timber industry traditionally engages leaders of countries with largeforest resources and weak institutions. Abiding by ‘local business practices’, itnegotiates deals to extract raw materials as cheaply as possible. This mode ofdoing business suits the warlord economy extremely well…The state of disor-der created by conflict suits the perpetuation of these business practices.” (TheLogs of War, 2002).

Thus, armed conflict in countries can result in a destructive downward spiral of shadybusiness practices and poor governance. But armed conflict can also result from thesedynamics. Governments - of developing and industrialised countries alike - are notalways inclined to govern with transparency and accountability. In fact, “[h]alf theworld’s [diamond] production or more is mined in countries with unstable or se-cretive governments, an almost foolproof recipe for expanded and deepened crim-inality” (Dirty Diamonds, 2002).

This relative anarchy in domestic jurisdictions is mirrored by a largely unregu-lated international financial system. The illicit financial networks imbedded in theinternational financial system facilitate the illicit aspects of the trade in conflictcommodities. The absence of an international regulatory framework, or of agree-ment on universalized domestic regulation, means that at present legitimate bankswould have a hard time trying to avoid handling the proceeds of government cor-ruption or illicit proceeds gained through the exploitation of armed conflict. TheIllicit Finance study finds that money laundering and international financial arbi-trage are crucial in undermining the accountability of domestic governments orprivate companies:

“[f ]inancial transparency is a core structural requirement by which governments,regulators, law enforcement, judiciaries, civil litigants, and journalists can exerciseoversight and insist on the accountability of both important private sector and publicsector actors. Its absence facilitates impunity, which in turn often leads to conflict.”(Illicit Finance, 2002).In the case of the oil industry, most companies find the extremes of anarchic ex-ploitation to be counterproductive. Quite apart from the legal requirements of re-lating to government, oil production requires the security and legal/administrativeguarantees that only governments can provide. Thus, in situations of armed con-flict, oil companies are usually allied with governments. Yet, oil companies can con-tribute to corruption and other governance problems directly related to the growthof oil revenues. A key problem lies in the lack of transparency of oil company pay-ments to governments, which can

“[O]bscure the direction and volume of oil revenue flows. A large influx of easyoil revenue into a non-transparent system invites corruption, in turn creatingincentives to further limit transparency and accountability. Under such

14

conditions, much oil wealth allegedly has disappeared into off-budgetary ac-counts.” (Fuelling Conflict, 2002).

By seeking out weak jurisdictions, or by contributing to the weakening of domes-tic governance, businesses can help to perpetuate or accelerate the deterioration inaccountability. The downward spiral through corruption towards state failure iscaused in part by - and results in - the loss of domestic control over the resource:

“In a developing country with few resources other than vast tracts of forest,control of this natural capital is control of power…Allocation of timber con-cessions becomes a mechanism for rewarding supporters and mobilizing wealthto prop up the existing regime. The result has often been massive corruption andloss of revenue to the state. It has also contributed to the erosion of democraticprinciples as elected politicians and state officials put the rights of companiesbefore those of the population they are supposed to represent. Protected bypowerful allies, timber companies become the de facto resource owners and stateforestry institutions become the clients of the logging extractors rather than viceversa.” (The Logs of War, 2002).

For governments, the loss of territory through armed conflict, or loss of control tofavoured individuals or private companies, results in the loss of effective control overthe resource. What a government may claim by right and what it can actually ex-ploit may be very different: de jure state ownership can be rendered meaningless inpractice by de facto control over the resource by individuals, private companies and/or their political-military allies. If taking or retaining political power in a particularcountry requires control and exploitation of the resource, then investment and pro-duction become the keys to political power and an extension of state sovereignty.Companies can come to play a central role in the political-economy of a conflictand may help determine the effective exercise of state sovereignty.

As made clear in the studies, how companies play these roles depends upon anumber of factors, not least the nature of the investment and industrial activity.Common to all four studies are descriptions of a lack of transparency of transac-tions, a weakening or loss of government control, and the impunity of firms andgovernments, in the proliferation of conflict commodities and the sustainability ofeconomies of armed conflict in general.

Anarchic exploitation is made possible by a lack of governance mechanisms atthe domestic and international levels, described above as a series of regulatory gaps.Poor governance may lead to political instability and conflict, but institutionalweakness may also result from armed conflict, making war a good time to for cer-tain companies to take advantage of poor monitoring and enforcement. These dy-namics, in the context of regulatory gaps, can significantly blur the lines dividing

15

licit and illicit activity. If the private sector can be assumed to prefer low levels ofgovernment interference, a state of war could be said to represent an ideal regulato-ry environment for some industries. But exploitation during armed conflict canpromote corruption, impunity, and the incapacitation of government regulation orcontrol over a countries own natural wealth.

2.2 Criminalized Transactions

Up and down the supply and demand chains - from legal trading in illegally pro-duced commodities, to illegal transfers of perfectly legal revenues – more or less il-licit transactions involved in financing armed conflict help to criminalize procure-ment, marketing and payments.

It is estimated that in 1999 approximately 50 per cent of European Union trop-ical timber imports consisted of illegally logged timber, a figure that is probablyrepresentative of worldwide imports. An estimated 20 per cent of the global dia-mond trade is illicit. In both cases, logs or rough diamonds that are stolen are thenlegally imported to consumer countries. “Surprisingly, there is no law that preventsa European country from importing the products of illegal and ‘conflict’ timberoperations. Indeed, in the industrialised countries of the West, there is no legisla-tion that can prevent this from happening… Timber is, of course, a legally tradablecommodity.” (The Logs of War, 2002). So, too, are rough diamonds.

“At a meeting of the inter-governmental Kimberley Process in Moscow in July2001, the Guinean Delegation unveiled its new certificate of origin, and askedother countries present not to allow, henceforth, the importation of Guineandiamonds without the certificate. The EC representative replied that EU coun-tries could import whatever they want, from wherever they want, and were notbound by any Guinean document. While this suggested an almost willing ac-ceptance of criminality, the EC representative was in fact correct: documents suchas Guinea’s certificate of origin have no standing in international law and nobacking under current trade agreements and regulations.” (Dirty Diamonds,2002).

Central to the problem of the legal importing of illegal commodities are questionsof export and import controls. Both the The Logs of War and Dirty Diamonds re-ports address in some detail the regulatory options for producer and consumer coun-tries, inter-governmental co-operation as well as industry. However, the diamondand timber trades both suffer from the misrepresentation of shipments. In fact, there-labelling of timber shipments, or the ‘blending’ of legal and illegal diamonds

16

during transhipment, are crucial for ensuring the access of illegal diamonds or tim-ber to consumer markets.

Organized crime has been implicated in the activities of all four of the sectorscovered here. Fuelling Conflict reports allegations of covert illicit arms deals andlogistical support provided by an oil company to rebels in coups d’etat in Africa (Fuel-ling Conflict, 2002). For the most part, however, most arms deals involving the oilindustry, while heavily criticized and somewhat murky, appear to have been legal.

The same cannot be said for the diamond and timber trades. The illegal pro-duction and marketing practices of diamonds and timber have proven attractive tocriminal organisations and networks. “The timber trade is characterized by endemiccorruption, links to organized crime and, in numerous instances, to various war-ring factions”(The Logs of War, 2002). Much the same is true for significant parts ofthe diamond industry: “Conflict diamonds are essentially illicit diamonds that havegone septic. They have simply been used for a new purpose - to pay for weapons inrebel wars” (Dirty Diamonds, 2002). Indeed, the regulation gap described belowrepresents an opportunity for dodgy middlemen willing to assume the higher risksof a environment in which contracts are unenforceable.8

The transactions involved in financing armed conflict are similarly criminalized:“Illicit finance is also a key facilitator of civil war…The laundering of the proceedsof crime is a necessary means to carry out the trade in diamonds that has fuelledarmed conflict in Liberia, Angola and Sierra Leone, together with their accompa-nying arms deals and payoffs.” (Illicit Finance, 2002). Central to the effectivenessof illicit financial services, are the licit financial networks across which they oper-ate. In the global financial system, the transformation of money from ‘black’ to‘white’ via ‘shades of grey’ is only marginally more difficult than ‘blending’ diamonds,or mislabelling timber:

“In recent years, with every substantial national, regional, or global failure ofgovernance, a financial scandal has been found in close attendance. Accompa-nying each financial scandal has been the systemic use of banking and financialsecrecy to hide criminal activity. Over the past decade, this pattern has playedout repeatedly in jurisdictions all over the world. Repeatedly, political conflictand major political destabilizing activity, including grand corruption, narcoticstrafficking, arms smuggling, and civil war have been facilitated and sustainedby illicit finance networks embedded in the world’s licit financial services infra-structure.” (Illicit Finance, 2002).

8 More information in this regard will be available in a forthcoming publication on these ‘brokers’to be released as part of the Economies of Conflict series later in 2002.

17

As with the trade in illegal or conflict diamonds or timber, there is no internationalregulatory framework that governs the international financial system as a whole.Regulatory jurisdictions are domestic, and regulators are dependent upon compa-ny transparency and inter-governmental cooperation to obtain oversight over fundsmoved out of their jurisdiction. Offshore banking has made possible the practiceof arbitrage, the practice of structuring international transactions for maximumprofitability and minimum regulatory oversight or risk. While not illegal, arbitragemakes illicit finance possible, as financial institutions can move “their riskiest andleast attractive transactions to jurisdictions that require the least transparency” (Il-licit Finance, 2002).

Rarely are the marketing chains or revenue streams of a conflict commodity orits producer entirely illegal from start to finish. Nor are the supply lines of combat-ants necessarily run as criminal networks, or filled with illegal goods. But experi-ence indicates that to operate effectively, the procurement, marketing and paymentsprocesses related to armed conflict consist of a series of transactions that combinethe perfectly legal and legitimate with the thoroughly illegal or illicit.

The term ‘criminalized transactions’ is suggested here as a potentially usefulanalytical category within which to group some of the illegal, illicit and generallyquestionable transactions that help to fuel armed conflict. Transactions involved inthe economies of armed conflict could be said to be criminalized by their facilita-tion of or profiting from the trade in illegally produced (stolen) commodities; im-proper or unregulated import-export practices (smuggling); the misrepresentation,blending or miss-labelling of conflict commodities (fraud); the diversion of legallyobtained revenues (theft); illicit financial dealings (some arbitrage, all money laun-dering); or the involvement of criminal organizations.

2.3 Militarized Production

The three reports covering extraction industries – diamonds, oil and timber – alldescribe varying degrees of military activity associated with the production of pri-mary commodities. The spectrum of activity ranges from protection of oil installa-tions by security companies, to de facto invasion by state or rebel armies in the pur-suit of natural resources. Although similar patterns emerge across the three sectors,each affected company or community faces conditions specific to its situation. Inall three sectors, however, the evidence suggests that a key relationship betweenproduction and armed conflict is established once production is militarized.

Militarization of production occurs when a commodity becomes of strategicsignificance for a military faction. Rebels in Angola, Sierra Leone and the Democratic

18

Republic of Congo (DRC) have made the control of alluvial diamond mining astrategic military objective. Similarly, rebels movements and government armies inBurma, Cambodia, Liberia, and from Zimbabwe have deployed to secure loggingareas and have facilitated the logging of tropical timber, or carried out the loggingthemselves.

Opportunity is the determining factor in the transformation of rough diamondsinto a strategic commodity. Diamonds, particularly alluvial diamonds, are a “low-volume, high value commodity…[t]hey are highly portable and…readily accessi-ble” (Dirty Diamonds, 2002). Timber is only marginally less so:

“Compared to most forms of resource extraction, logging is a relatively easyactivity, requiring low investment for quick return. A few soldiers with chain-saws and trucks can generate hundreds of thousand of dollars in a relatively shorttime; a well-resourced company can generate hundreds of millions…. In moreextreme cases military intervention in another country is based around the at-tempt to control that country’s resources. For a warring faction in control of forestland, logging is one of the quickest routes to obtain significant funding withwhich to continue the conflict.” (The Logs of War, 2002).

In the case of conflict diamonds, opportunity exists primarily through access toalluvial diamonds: since rough diamonds are “low-volume, high-value” they are moreeasily marketed. Similarly, in their study of conflict timber, The Logs of War findsthat access equals opportunity with respect to tropical timber. However, comparedto rough diamonds, the physical size of the logs makes their marketing more de-pendent upon military control of transportation routes out of the conflict zones, asufficient level of corruption at transit points, and the willingness of otherwise le-gitimate timber companies to launder these logs of war onto the global market.

The military activity associated with oil production does not follow the samepattern as that of diamond and timber production. The relatively high costs involvedin producing and marketing oil mean that, for rebels and governments alike, accessdoes not equal opportunity. For an oil field to represent a revenue opportunity itrequires investment, usually by an oil company. Unlike the diamond and timbersectors, in which production could be profitable to anyone who controls access tothe resource, oil companies – national, multinational or both - are a necessary con-dition for production to take place at all.

In a situation of armed conflict, this places the oil production companies in apotentially pivotal position. Formally, oil companies typically adopt a position ofpolitical neutrality. Yet, their production is a source of revenue for governments andruling elites that depend upon these revenues to finance their war-fighting capaci-ty. In addition, in a number of cases, oil companies have arranged more or less cov-ert arms transfers to host governments, often justified by the companies involved

19

on the grounds of improving the capacity of the host government to provide secu-rity for oil installations.

Oil production in situations of armed conflict usually places investment in harmsway and the company remains at the mercy of the shifting balance of military forc-es during the conflict.9 Oil production requires the investment and the guarantees(contracts, security, etc.) that only an alliance between oil companies and govern-ments can provide. Most companies, dependent upon the host government forconcessions and protection, find governments to be their natural allies:

“Common accusations are that companies have allowed militaries to use airstrips,helicopters, roads and other oil company infrastructure for offensive militarypurposes. In some cases host governments even appear to be using oil companysecurity as a cover for waging military campaigns against political or ethnic en-emies. Some of the most serious accusations levelled against international oilcompanies have involved direct or indirect assistance in procuring weapons forhost country governments, and in some cases even for rebel groups.” (FuellingConflict, 2002).

Thus, the militarization of oil production in armed conflict is indirect. Companiesmay provide logistical or other support - usually to governments - but rebels orgovernment troops are unlikely to be involved in the production of oil, or even themanagement or oversight of production facilities. However, military activity assuresaccess to the resource through the control of territory, provides security to the pro-duction processes and investments, and enables local or regional marketing activi-ties.

In the diamond and timber industries, the nature of the production processmeans that, access to the resource and control of marketing routes are enough tomake them a viable economic activity for rebels and government forces. The extrac-tion of rough diamonds in armed conflict zones is often an informal affair, run al-most entirely by the military power in control of the region. In the timber industry,logging companies play a crucial role, but where they operate they tend to “side withwhoever controls forest territory…in many instances insurgent groups…political,military and criminal groups” (The Logs of War, 2002). Where it occurs, the milita-rization of diamond and timber production is direct, in the sense that state or rebelmilitaries are more often than not integral to the production process.

For all three commodities, exploitation is in large part determined by the extentto which the commodity can be said to have become of strategic value to the forcein question. Usually, the opportunity for profitable exploitation – defined as access

9 The usual exception being off-shore oil installations which can become targets during intra-statewars.

20

to a high value resource and to their markets – is the deciding factor, but invest-ment may also be necessary to make access and marketing viable. Still, the central-ity of military activity to the production of all three of these commodities is hard toavoid. In some cases, where there is ready access to the resource, the military is thecompany and its troops are the labour pool. In others, they operate as sector-wideprotection rackets, determining the production cycles, ‘managing’ or victimisinglabourers and protecting or attacking investments. Over time, and to the extent thata force exercises continuous control of a territory and roads, they can influence pro-duction cycles and determine the viability of investments. This is, in a phrase, mil-itarized production. Production may be considered to have been militarized oncemilitary personnel or military activity become a direct or indirect part of the pro-duction process.

2.4 Conflict Commodities

With the rise to prominence of ‘conflict diamonds’, and to a lesser extent ‘conflicttimber’, there is a growing sense that goods produced in an economy torn by armedconflict are, or should be, morally suspect. Indeed, the activities of companies dealingin such commodities are increasingly viewed as illegal or a challenge to internationalsecurity. The Security Council, through its panels of experts and/or monitoringmechanisms, has described the sanctions busting activities of a number of compa-nies. As described in the reports summarised here, the law courts in a number ofcountries have heard cases involving allegations of dubious and illegal behaviour bymuch larger multinational corporations. The news media in many more countrieshave reported similar activities by otherwise legitimate companies operating inter-nationally, sometimes forcing government action in response.

It is arguable that this activity represents the gradual emergence of an interna-tional moral and political norm under which private sector activity that sustainsarmed conflict is unacceptable. The growing tendency to view certain products as‘conflict commodities’ is a direct result of an increase in consumer sensitivity resultingfrom successful campaigns on issues related to corporate social responsibility andhuman rights. Yet, there is no agreed definition of what constitutes a conflict com-modity.

The definitions that have emerged to date have originated as a result of attemptsto grapple with the role of specific commodities in fuelling armed conflict, mostnotably diamonds. The term ‘conflict diamonds’ was an invention of the media, anattempt to summarize a phenomenon confronting the UN, the industry and NGOs.Like all media shorthand, it has its drawbacks, but its usefulness as a category has

21

been confirmed by the fact that definitions have been suggested both by the UNGeneral Assembly and by the inter-governmental series of meetings, known as ‘theKimberley Process’.

The UN GA defined conflict diamonds as ‘rough diamonds which are used byrebel movements to finance their military activities, including attempts to under-mine or overthrow legitimate governments.’ The Kimberly Process settled on thefollowing:

Conflict Diamonds means rough diamonds used by rebel movements or theirallies to finance conflict aimed at undermining legitimate governments, as de-scribed in relevant United Nations Security Council (UNSC) resolutions inso-far as they remain in effect, or in other similar UNSC resolutions which may beadopted in the future, and as understood and recognised in United NationsGeneral Assembly (UNGA) Resolution 55/56, or in other similar UNGA reso-lutions which may be adopted in future.

Two common aspects of these definitions are immediately apparent. First, both areconcerned with the use of diamonds as a source of finance. This is accurate, as thefinancial exploitation is arguably the single most important role that diamonds playin sustaining armed conflict. However, the definition ignores the impacts of dia-mond wars (battles for control of diamond territory) or the toll which military con-trol of a diamondiferous region may have on the population and how that maycontribute to perpetuating the conflict.

Second, both definitions have a clear pro-state bias. This is to be expected as bothdefinitions have emerged from fora in which states play a dominant role. As alreadynoted, there is nothing in international law that might prevent states from exploit-ing natural resources to finance their war fighting capacity. In fact, principles of statesovereignty entail a responsibility on the part of governments to provide securityand to retain a monopoly on the means violence. Similarly, state sovereignty entailsthe right of a government to exploit its natural wealth to this end. But are all statesor government forces in armed conflict necessarily practicing legitimate productionor exploitation of a resource? Would this hold true for a commodity-financed re-pressive regime, one that put its profits towards maintaining the machinery of re-pression and war?

The definition for ‘conflict timber’ offered by The Logs of War takes a more bal-anced approach. It is based less on the principles of international relations and bet-ter reflects the economic and logistical processes as work:

“For the purposes of this study, conflict timber refers to timber that has beentraded at some point in the chain of custody by armed groups, be they rebelfactions or regular soldiers, or by a civilian administration involved in armed

22

conflict or its representatives, either to perpetuate conflict or take advantage ofconflict situations for personal gain.” (The Logs of War, 2002).

This definition specifically strikes a balance between states and rebels. It seeks todefine conflict timber by virtue of logs having been traded or controlled at somepoint by an armed group or parties to a conflict. However, while true to the realityof conflict timber, this approach to conflict commodities also runs up against statesovereignty, albeit from a different angle from that of conflict diamonds: in a situ-ation of armed conflict, military force will almost certainly be required to ensurethe marketing and possibly also the production of timber. Given the acknowledgedright of a state to exploit its natural resources, it must be assumed that a state’s mil-itary could at some point be involved in timber transactions in, for example, man-aging or securing production or marketing of timber (see militarised productionabove). Governments are unlikely to accept a definition of a conflict commoditythat may prevent it from exercising its right to exploit.

To get around this, The Logs of War qualifies its definition by seeking to ascribeintent. Rebels or government soldiers could be considered to be handling conflicttimber if the trade was intended “to perpetuate conflict or take advantage of con-flict situations for personal gain”. This, too, is more balanced than the conflict dia-monds definitions, which describes the “overthrow” or “undermining” of govern-ments as the sole problematic objective. It is useful, too, because it specificallyidentifies the criminal dimension of “personal gain”, which would almost certainlycapture most repressive elites (assuming “personal gain” includes the use of profitsfor patronage to accrue political power, not just enrichment). But this definitionwould also fall prey to the principles of states rights, which include the right to self-defence if attacked and assumes the right to exploit its natural wealth to this end.“Perpetuating” and “taking advantage” of armed conflict may be morally suspect,but, in a situation of armed conflict, it would difficult to impute this intent to agovernment that asserted its right of self-defence.

What emerges from the Economies of Conflict studies completed to date is that adefinition of conflict commodities should probably be based on activities involvedin the production and marketing of such goods, rather than on the actors involved.The categories outlined above suggest that a definition of a conflict commoditywould include reference to commodities made possible by anarchic exploitation,criminalized transactions and militarised production.

These categories are only preliminary and require further development. Theyappear at first to be far too broad and therefore unlikely to be politically viable.Certainly, further research into industry activities is needed to provide greater clar-ity as to definitions, as well as to identify the approximate volume of trade in con-flict commodities. However, when applied to a particular commodity in the specific

23

context of the armed conflict (e.g. Sierra Leone diamonds, Liberian timber, Suda-nese oil, etc.), these criteria might offer a more specific understanding of the natureof the role of the private sector in sustaining conflict. By identifying activities andtransactions that help sustain armed conflict, such definitions help clarify the na-ture of culpability rather than trying to generalize about the character of parties toa conflict or their private sector allies.

A focus on activities also makes it easier for concerned citizens, shareholders,industry associations and others to hold governments and companies accountablefor their actions. This would enable all concerned – NGOs, multilateral organisa-tions, companies and governments - to develop definitions of complicity in armedconflict that would be relatively transparent and comprehensible across the differ-ent sectors. In using the categories suggested here, the objective should not be tocast the analytical net as widely as possible, but to enhance the predictability ofdemands for regulation or socially responsible corporate behaviour. These catego-ries suggest an ability to refine the analysis to enable characterizations to be madeabout investments and transactions.

2.5 Rogue Companies

Armed conflicts have created a niche market for companies willing to avoid regula-tion and assume greater levels of risk. These companies - some relatively small insize but operating internationally – use conflict as a cover for their operations, orprofit from supplying the combatants, or both. The companies operate illegally inmany cases, but many other times they are not technically in violation of any law.The work of the UN sanctions committees’ independent panels of experts and/ormonitoring mechanisms has shown that they are often closely connected with therepressive powers at the head of rebel movements or governments, often in directcontradiction to UN sanctions, or other efforts to promote security or peace. Theyare, in a sense, rogue companies.

Rogue companies are involved in all three categories of activity that define con-flict commodities: anarchic exploitation, criminalized transactions and militarisedproduction. Yet, the Economies of Conflict studies identify activities carried out bycompanies with legitimate business interests that would fit into these same catego-ries. As the activities and consequences associated with conflict commodities beginto be better understood, and as the consensus around notions of conflict commod-ities begins to solidify, a number of companies engaged in otherwise legitimate ac-tivities could find themselves on the wrong side of international opinion.

24

The Economies of Conflict studies portray a complex range of licit and illicit activi-ties resulting – directly and indirectly - in a number of intended and unintendedconsequences. The elaboration of a clearly defined concept of ‘rogue companies’would have considerable utility with regard to private sector CSR initiatives. It wouldhelp all sides – industry, NGOs, and government – by providing some transparen-cy to the negotiation of CSR and armed conflict standards. Judging from the paceof recent policy developments, it is possible that, sooner rather than later, thoseinternational firms which have taken on CSR initiatives related to human rights orthe environment will have to add the armed conflict lens to their collection of duediligence perspectives. Eventually, companies will need to adopt clear, verifiablepositions on core issues about their operations in situations of armed conflict or riskbeing tarred with the same brush as rogue companies.

As policy and law develop, it is not inconceivable that rogue companies will oneday find themselves named by the Security Council as threats to international peaceand security and treated accordingly. Ultimately, rogue companies could face a rangeof targeted sanctions that would affect their management and operations interna-tionally with a view to influencing their behaviour in relation to one or more armedconflicts. The utility of such measures for the Council might increase if corporatesanctions proved effective in targeting specific economic and political interests, couldbe shown to have relatively minor consequences for civilian populations.

What companies might qualify as rogue companies? To the extent that compa-nies have participated in the conflict sustaining activities outlined above, the as yetsimplistic definition of rogue companies offered here would encompass large partsof the tropical timber industry, a number of international banks, certain compa-nies dealing in rough diamonds, and certain multinational oil companies. Thus, tothe extent that they have handled finances related to armed conflict, certain banksoperating in problematic jurisdictions identified by the OECD’s Financial ActionTask Force (FATF) may qualify as rogue companies. However, a company that loomslarge in the trade in rough diamonds may not qualify as a rogue company if it hasparticipated in attempts to address those aspects of the trade that lend themselvesto the creation of conflict commodities. Similarly, oil companies that have attemptedto deal with aspects of the militarization of oil production – for example, throughimplementation of the Voluntary Principles on Security and Human Rights – may alsobe excluded.

As indicated above, the definition of conflict commodities - and its corollary,rogue companies – may be too broad. For example, the categorisation presentedabove does not distinguish between activities that are directly or indirectly linkedto sustaining conflict. In addition, it remains unclear as to where responsibility liesfor making a determination as to the status of a commodity or a company.

25

The result is that, in the presently fluid policy context, and in the absence of sharp-er definitions of the activities that create conflict commodities, simple participationin the economy of a country in armed conflict could implicate companies involvedin certain industries in the production of conflict commodities as they are definedabove. Clearly, the risk to reputations of companies could present a significant dis-incentive for investment by some companies.

In fact, the risks will continue to rise for all concerned so long as the actions ofthe worst of the rogue companies are not checked and some clarity is not broughtto the debate. For developing countries, where the bulk of some primary commod-ities are to be found, the danger of a foreign investment freeze - driven by fears overdamaged company reputations or brand profiles - may become an increasingly fright-ening possibility. Similarly, industrialised countries – whether primary commodityproducers or not - will need to pay greater attention to the involvement of theircompanies abroad, or risk feeling the political fall-out from actions over which theyhave hitherto had little control. Before the agenda can move much further, howev-er, additional research and dialogue is necessary in order to identify precisely whatactivities would cause a good to be classified as a conflict commodity and a compa-ny to be considered a rogue.

2.6 Emerging Conclusions

• The kinds of activities described in the Economies of Conflict studies completedto date represent significant challenges to the effective exercise of state sovereignty,corporate social responsibility and international peace and security.

• Private sector activity in armed conflict is marked by the convergence of anar-chic exploitation, criminalized transactions, and militarized production.

• Goods exploited to sustain armed conflict and produced or brought to marketby anarchic exploitation, criminalized transactions, and militarized productioncould be described as conflict commodities.

• Companies involved in the production, marketing or payments related to con-flict commodities could be described as rogue companies. Company involvementin the activities related to conflict commodities may be direct or indirect.

• The distinction between licit and illicit goods or transactions is misleading. Inthe production or marketing of goods from armed conflict situations, there areperfectly legal actors involved in dubious transactions, and known criminalsinvolved in legal activity.

26

• While understandable, the moral-political distinction between rebels and statesthat appears in most inter-governmental action in this regard is probably un-helpful for effective policy formulation. The evidence indicates that both stateand non-state actors alike have been engaged conflict sustaining private sectoractivity.

• The complexity of the subject implies that, in the development of analytical tools,priority should be placed on the need for transparency of analysis, rather thanon achieving consensus on definitions.

• Transparency of analysis is probably best achieved through a focus on the activ-ities involved in sustaining conflict, rather than on the actors involved.

• Definitions of conflict sustaining activity should be deployed as analytical toolsand regulation pursued through the appropriate frameworks.

• The complexity of the activities and interests involved indicates that there is nosimple or single regulatory option. The political hurdles, too, suggest govern-ment and business would oppose a simplistic solution. Therefore, an array ofremedies, voluntary as well as coercive, may be required.

• Where regulatory gaps exist, new options will need to be formulated to addressthe problematic activities. These should be developed through multi-party dia-logue.

27

3 Executive Summaries

This section contains the executive summaries of the four reports from the Econo-mies of Conflict series that are included on the compact disk enclosed. These reportswill be published separately in printed format during the spring of 2002.

28

Dirty Diamonds

Ian Smillie

This study examines the origins of conflict diamonds, suggesting definitions andsurveying ways that the diamond trade is linked to armed conflict. The paper looksat how aspects of the trade in rough diamonds help sustain armed conflict and de-scribes attempts to come to grips with the problem by the diamond industry, NGOs,and governments. The effort to develop an international certification system forrough diamonds, known as the ‘Kimberley Process’, is dealt with in detail. By wayof conclusion, the paper reflects on analytical considerations related to understandingthe links between conflict diamonds and armed conflict, asks if conflict diamondsare ‘easier’ to deal with than other commodities, and offers some recommendationsfor future action.

Conflict DiamondsThe term ‘conflict diamonds’ is shorthand to describe a phenomenon researchedand brought to international attention by two NGOs, Global Witness and Partner-ship Africa Canada, and a UN Security Council Expert Panel dealing with Angolain 1999 and 2000. The UN General Assembly has subsequently defined conflictdiamonds as “rough diamonds which are used by rebel movements to finance theirmilitary activities, including attempts to undermine or overthrow legitimate gov-ernments.” An inter-governmental series of meetings, known as ‘the Kimberley Proc-ess’, settled on something more legalistic and less comprehensive:

Conflict Diamonds means rough diamonds used by rebel movements or theirallies to finance conflict aimed at undermining legitimate governments, as de-scribed in relevant United Nations Security Council (UNSC) resolutions inso-far as they remain in effect, or in other similar UNSC resolutions which may beadopted in the future, and as understood and recognised in United NationsGeneral Assembly (UNGA) Resolution 55/56, or in other similar UNGA reso-lutions which may be adopted in future.

Diamonds have an obvious attraction for combatants and the suppliers of theirweapons. Diamonds are a low-volume, high-value commodity. They are highlyportable, they keep their value, and all too often, they are readily accessible. Cus-toms departments in most countries have no capacity to examine diamonds todetermine origins. There is very little government oversight on the internationaltrade, and there is a paucity of consistent, reliable trade and production data that

29

might be used for tracking purposes. Even the legitimate diamond industry has beenshrouded in secrecy for generations.

Half the world’s production or more is mined in countries with unstable or se-cretive governments, an almost foolproof recipe for expanded and deepened crim-inality. The value of rough diamond production was approximately US$7.5 billionin 2000. This was converted into $57.6 billion in diamond jewellery sales, of whichthe diamond content was approximately $13.7 billion. At least 20 per cent of therough diamonds that are sold each year are, in one way or another, ‘illicit’, provid-ing a ready-made cover for the ‘conflict diamonds’ that are the subject of currentinternational interest.

Efforts to Curb the ProblemThe effort to halt conflict diamonds began in 1998, with a UN Security Councilresolution on Angola. UN Security Council embargoes have been proven an effec-tive means of alerting importing countries to the problem of conflict diamonds: thecurrent ban on Liberian diamonds has effectively stopped the laundering conflictand illicit diamonds via Liberia. It has not, however, stopped the flow of conflictdiamonds from Sierra Leone. Sanctions on Angola have also not stopped the flowof diamonds.

The diamond industry, NGOs, politicians, individual governments and theUnited Nations have become engaged in a large and concerted effort to deal withthe issue. For diamond producing countries, many of them developing countries,the resource is crucial for economic development.

For the diamond industry the challenge has been twofold. First, it has a moralobligation to make sure that its product is not tainted. Second, there has been apublic relations problem, fanned by a growing number of churches and NGOs,which have threatened the reputation of the industry and its product. Diamondbourses around the world began developing codes of conduct in 2000. However,while several companies have been named in UN Security Council Reports, littlehas been done, in part because the absence of laws in importing countries outlaw-ing illicit or conflict diamonds means that any industry measures against diamen-taires could be actionable in a court of law.

The Kimberly Process, which has sought to reach agreement on how to deal withconflict diamonds, has faced two unspoken obstacles. One is the potential cost andcomplexity of putting an effective system in place. The second has to do with sta-tistics and international inspection. For some countries diamonds are a ‘strategicmineral’ and as such could not be subject to international inspection. For NGOparticipants, however, self-regulation is a non-starter. By the end of 2001, after tenmeetings, the Kimberly Process had yet to reach an agreement on the precise na-

30

ture of an international certification system. However, the months of negotiationhad resulted in the some consensus on the ‘essential elements’ of a global certifica-tion system:

• Provisions for a certificate of origin;

• Provisions for internal controls in producing, trading and processing countries;

• The creation of a common statistical data base on the trade in rough diamonds;

• A statement on verification of national compliance.

In addition, the World Diamond Council had spelled out its understanding of whatan industry-managed “chain of warranties’ could look like, and had agreed to ex-ternal verification of such a system. Key outstanding issues at the time of writingincluded credible and effective monitoring and co-ordination, and the creation ofa consistent and reliable data base on rough diamond production and trade. Inaddition, there were uncertainties about how and whether the system would con-form to WTO regulations.

Conclusions, Lessons and RecommendationsThe study focuses on the connection between one primary export commodity andconflict. Diamonds did not cause the wars in Angola, Sierra Leone or the DRC.Diamonds entered the story, in all three cases, after the conflicts had begun. Griev-ance, however well or badly justified, was the motivator, and power was the goal.But diamonds became important as a source of financing which helped sustain thewars, and as a contributing factor to the intensity and scope of the fighting.There are no internationally agreed mechanisms to monitor the movement of thishighly portable, accessible and valuable commodity. That is what the KimberleyProcess has sought to develop.

The Kimberley Process was initiated on the premise that only a comprehensiveinternational certification system could be expected to have any serious impact onthe phenomenon. Such a system would include better control in diamond miningcountries, clarity in procedures for shipping diamonds, and controls in trading andprocessing countries. These controls would have to be backed by an independentinternational monitoring system and an international database on trade and pro-duction. An effective international certification system would also help to end theother illicit uses to which diamonds are put, including money laundering.To be effective, attempts to sever the link between rough diamonds and armed con-flict will require the following:

31

• The Kimberley Process should result in a strong mechanism for monitoringnational compliance with minimum standards. Consumer confidence cannotbe based on trust or on haphazard, minimal-review mechanisms. Credible mon-itoring for compliance should be viewed as compulsory and desirable by anycountry wanting to demonstrate that its industry is conflict free.

• The Kimberley Process should come to grips with the issue of, and the need for,global production and trade statistics on rough diamonds.

• The issue of WTO compatibility should be settled, and it should be settled soon.Neither the WTO, nor the GATT, condone or permit theft, war, human rightsviolations and the other abuses that stem from conflict diamonds.

• The certification system should have more authority than can be derived froma voluntary arrangement or from a UN General Assembly resolution. The rele-vance of conflict diamonds for international peace and security are now wellunderstood. Once a system has been finalized and debated by the General As-sembly, it should be forwarded to the UN Security Council for endorsement andglobal application.

The experience of attempting to regulate conflict diamonds via the Kimberly Proc-ess suggests a number of key lessons for those working to regulate commodities whichfuel armed conflict.

On the supply side, the key element is the accessibility of diamonds – a func-tion of security failures, corruption, and state collapse. UN embargoes, new nationallegislation and industry efforts to stop conflict diamonds have had little impact,except to change the routing and covers under which conflict and illicit diamondstravel. On the demand side, industry secrecy, an absence of reliable trade and com-mercial data, and lack of governmental oversight are important factors in generat-ing and nourishing the opportunity that has sustained armed conflict. The fact that20 per cent of the diamond industry is essentially crooked means that channels forthe disposal of conflict diamonds had been established by illicit diamonds prior tothe conflicts. Armed conflict and criminality converged, creating a more ready op-portunity for the emergence of conflict diamonds than might be the case in othercommodities. Effective regulation must address the supply and demand sides of the prob-lem in tandem, addressing both the accessibility of rough diamonds and lack of trans-parency and accountability that enable them to be marketed.

The strength of the Kimberley Process was that it was inclusive. NGOs and seniorindustry executives attended all meetings, and were encouraged to participate as fullyas government representatives. There was no North-South divide: there were as manygovernments from developing countries as there were from the North. And therewas a champion for the issue: the Government of South Africa. Shortcomings in

32

the Kimberley Process may become more obvious with time and distance. Certain-ly, as this paper was being completed in January 2002, the outcome of the processremained unclear. Multilateral processes to discuss the regulation of conflict goods shouldbe as inclusive as possible, integrating the interests of industry, producing and consum-ing states and NGOs.

33

Fuelling Conflict

Phillip Swanson

This report examines how oil and gas industry activities in developing countries maycontribute to or help perpetuate such conflicts. It emphasises the dynamics that canoccur even when oil companies may be attempting to be good “corporate citizens”.

Oil, States and Armed ConflictSome 70% of world oil production currently takes place outside OECD countries,and over 40% outside either the OECD or the Middle East. Investments by majoroil companies can contribute significantly to the GDP and government revenuesof oil-rich developing countries. However, large investments in natural resourceexploitation and export also tend to give rise to a number of negative dynamics inthe economy, government and society of the host country. Even if unintended, thesedynamics can be very powerful, with consequences for social stability.

Governments typically receive oil wealth via several different routes, includingbonuses, royalty payments and income tax. In many cases, a combination of thesepayment methods is used. Together they can be used to obscure the direction andvolume of oil revenue flows. Taxes and other payments related to resource extrac-tion and export by international oil companies often account for well over half ofgovernment revenues in oil-rich developing countries. Access to large and relative-ly easy petroleum revenues can give host governments a false sense of economicsecurity that undermines the need for responsible economic and fiscal management.

A large influx of easy oil revenue into a non-transparent system invites corrup-tion, in turn creating incentives to further limit transparency and accountability.Under such conditions, much oil wealth apparently has disappeared into off-budg-et accounts. Such “looting” of a country’s natural resources by its governing elitescan provide the incentive and means to remain in power.

Given a regime’s dependence upon oil revenues for its power, any threat to suchrevenues is likely to be met with significant resistance. In the short term, host gov-ernments will be concerned about any cut in the flow of oil, which effectively rep-resents a cut in government revenue. In the longer term, oil-dependent governmentsare concerned about the willingness of international oil companies to remain in thecountry. In some cases, the desire to maintain security for oil extraction may leadto the brutal treatment of those opposed to such operations.Whether or not the dynamics suggested are fully or even partly responsible for gov-ernment violence towards its population in a particular case, large oil revenues at

34

least provide the means for a government disposed toward violence to carry out suchactivities with relative impunity. A government’s willingness to resort to the use offorce to protect its continued access to oil revenues is likely to be reinforced by anincreasing estrangement between the government and its citizens. In fact, oil wealthtends to reduce a government’s dependence upon its citizens – corporate or indi-vidual – for tax revenues. When a government depends less on its own citizens forits revenue, it may become less accountable and may depend less upon them for itslegitimacy.

Oil company operations can create or exacerbate tensions between the centralgovernment and oil-producing regions, especially if a disproportionate share ofbenefits is seen to accrue to the former and a disproportionate share of costs to thelatter. Tensions can also arise if the region feels that the central government’s shareof oil revenue is “unfairly” large.

Armed Conflict and the CompanyMost international oil companies have taken a “neutral” stance on the nature of host-country regimes, noting that companies should not get involved in politics. Anumber of NGOs have pointed out that large economic investments provide eco-nomic and political comfort to host countries, including de facto “recognition” ofrogue regimes.

Violence associated with oil company operations most often results from the useof force by government security forces against local protesters who opposed oil in-dustry operations. A number of NGOs, as well as missions by the UN and variousoil company “home” country governments have reported numerous allegations ofviolent human rights abuses committed by government forces in and around oilproducing regions in a number of countries. However, the secrecy surrounding se-curity arrangements that many international oil companies have concluded with hostgovernments makes it difficult to assess company complicity in such activity.

There are also documented cases of human rights abuses by oil company secu-rity forces or by the private forces hired by the oil companies. However, such casesusually are more clear-cut regarding oil company blame. Hopefully, they will alsobe the easiest abuses to avoid in future, since the oil companies presumably havemore control over their own forces.

A number of oil companies have been accused of providing logistical assistanceto government military campaigns against political or ethnic oppositions. Commonaccusations are that companies have allowed militaries to use airstrips, helicopters,roads and other oil company infrastructure for offensive military purposes. In somecases host governments even appear to be using oil company security as a cover forwaging military campaigns against political or ethnic enemies. Some of the most

35

serious accusations levelled against international oil companies have involved director indirect assistance in procuring weapons for host country governments, and insome cases even for rebel groups.

For the oil companies, the direct effects of armed conflict are similar to thoseon other industries, e.g., threats to personnel, installations and supply lines, withthe related costs of protecting each of these aspects of the business. However, onceconflict erupts in a particular region, it usually will be significantly more expensivefor oil companies to abandon their activities than it will be for most other inves-tors. This is due to the large and long-term nature of oil company investments, aswell as the location-specific nature of natural resources.

Oil companies may assume that their operations will be relatively shielded fromcivil conflict, in some cases by all parties to the conflict. Due to the large potentialrevenues that their oil extraction represents, it is not in the parties’ interest to per-mit armed conflict to devastate oil company investments. For a company alreadyheavily invested, a cost-benefit analysis may indicate that the profit from oil extrac-tion could out-weigh the economic costs of doing business in a conflict zone. Forsome companies, armed conflict may be almost a cost of doing business.

One of the most important negative effects of conflict on an oil company nowtakes place in the product and capital markets of the developed world. The threatto company reputation can have negative impacts on profits, share prices and theability to raise capital. Oil companies with easily identifiable brand names at theservice station pump are ultimately vulnerable to the sort of boycott campaigns thatalready have threatened companies in some other industries. Companies also maybe increasingly susceptible to shareholder activism, especially by large institutionalinvestors such as pension funds, many of which have adopted codes of conduct.

Policy Options and InstrumentsBecause oil companies often provide a large portion of host country budgets, theyare among the few entities with potential leverage over such governments. This iswhy some observers see oil companies as potential agents for positive change. How-ever, oil companies face a possible loss of competitive advantage in the event that ahost government decides to punish a company for taking a stand on human rightsissues by rewarding one of its industry competitors. It is conceivable that a coali-tion of companies could form a “united front” for policy reform. However, in sucha case these companies still could face non-cooperation from the growing numberof technically proficient oil companies from developing countries that currently arenot under the same Corporate Social Responsibility (CSR) pressures from NGOs,customers and shareholders.

36

TransparencyOne of the main enabling factors for corruption and diversion of funds to off-budgetmilitary expenditures in host countries is lack of financial transparency. A key find-ing of this study is that a major area for policy focus should be on increasing thetransparency of payments by oil companies to host governments. This would makeit easier for host country citizenry to achieve a better understanding of the amountof money actually received from the development of their natural resources and tohold their governments accountable on this basis. Oil companies should be requiredto make a full public accounting of their payments to individual host countries.

In many cases of alleged violence by government security troops, the foreign oilcompanies involved have either denied knowledge of abuses or insisted that theactions were not approved by the company. However, it is often impossible to as-sess company complicity, or to say whether governments have acted outside securi-ty agreements, since such agreements usually are secret. Companies should committhemselves to making public their security agreements with host countries.

Given the impact of local violence on the security of oil company staff and op-erations, it would seem to be in companies’ best interests to pay more attention tosuch issues. It seems highly unlikely that companies are not already performingvarious risk assessments and assessments of the political or security situation. Com-panies should publicly commit themselves to performing systematic risk assessments basedon those suggested in the Voluntary Principles on Security and Human Rights.

Policy InstrumentsCompanies would seem to have a significant market incentive to respond to or avoidNGO criticism, because negative publicity can damage their image with consum-ers and shareholders. A major drawback with NGO pressure, however, is that it doesnot seem to be applied evenly to all companies. NGOs have targeted those compa-nies they perceive to be most likely to respond to their criticism. The absences orineffectiveness of pressure by NGOs is especially evident when it comes to the large,technically proficient non-OECD oil companies that are offering increasingly cred-ible competition to the majors in developing countries. Many of these currently facecomparatively little pressure from their customers and shareholders to address CSRissues, thus giving NGOs little leverage to affect them commercially.

Voluntary codes of conduct have become an important tool for companies todemonstrate support for particular social principles. However, experience from otherindustries indicates that codes developed by companies or industry associations inisolation often lack legitimacy vis-à-vis outside observers. Governments could playa role in bringing together industry actors and NGOs to work out codes that various

37

parties find acceptable (e.g. the negotiations to establish the “Voluntary Principleson Security and Human Rights”).

Collective action by oil companies may also benefit from the “sponsorship” of arespected international body, such as the UN or the World Bank. Governments andthe oil industry should recognise the value of multilateral institutions such as theUnited Nations or the World Bank in helping to manage collective action problemsand reputational risk. Government and private sector partnerships with multilater-al institutions must reflect the international norms and law that these institutionsembody.

One approach to stimulate companies to provide more information or to im-plement other desired policies would be to make these provisions or policies a re-quirement for receiving certain services provided by or regulated by government.There has been discussion in some countries about expanding criteria for environ-mental conditionality, already in place in some OECD countries, to include strict-er requirements regarding transparency and accountability of payments. There hasalready been some work to co-ordinate action in this area among OECD govern-ments. As an issue for multilateral negotiation, the transparency of payments byinternational oil companies to foreign governments may lend itself to the existingnegotiating framework, along the lines of the OECD anti-bribery convention. Sim-ilarly, stock market listings are in many cases regulated by states, giving governmentsscope for imposing conditions in this area. A major criticism of conditions on stockmarket listings is that they could inadvertently punish the financial centres thatimpose them. However, this collective action problem could be solved by co-ordi-nated action to introduce harmonised legislation in the world’s major financialcentres. Governments should consider the development of mechanisms of positiveconditionality in support of stricter requirements regarding transparency and ac-countability of payments.

38

Illicit Finance and Global Conflict

Jonathan Winer

In recent years, with every substantial national, regional, or global failure of gov-ernance, a financial scandal has been found in close attendance. Accompanying eachfinancial scandal has been the systemic use of banking and financial secrecy to hidecriminal activity. Over the past decade, this pattern has played out repeatedly injurisdictions all over the world. Repeatedly, political conflict and major politicaldestabilizing activity, including grand corruption, narcotics trafficking, arms smug-gling, and civil war have been facilitated and sustained by illicit finance networksembedded in the world’s licit financial services infrastructure.

Structural Consequences of the Globalization of MoneyIn Latin America, Mexico lost a quarter century of economic growth when the pesocollapsed in 1994, amid evidence of drug money laundering and massive high-lev-el corruption. Similar financial catastrophes in which billions went missing attend-ed the collapse of governments in Ecuador, Peru, and most recently, in late 2001and early 2002, Argentina10. Fraudulent pyramid schemes decapitalized nations intransition in Albania, Bulgaria, and Latvia. Kleptocrats stole and then sequesteredthe national wealth of the Congo/Zaire, Indonesia, Nigeria, and Russia using thesame infrastructure of globalized financial services to hide their money. The use ofthe offshore sector to mask large financial losses facilitated the industrial-corporate-governmental corruption that has burdened the economies of Japan, South Koreaand Taiwan. The same global financial infrastructure and major global banks han-dled political slush funds laundered for former German Chancellor Helmut Kohland similar monies for illicit arms trafficking by the son of the late French Presi-dent Francois Mitterand11. Major international banks in Europe, the Americas andthe Middle East processed the funds moved from the Persian Gulf by Al Qaeda and

10 See e.g. The Guardian, "In Argentina Today, the police raid foreign banks, January 18, 2002. "Policein Buenos Aires made dawn raids on foreign banks yesterday as part of an investigation into allega-tions that billions of dollars was smuggled out of Argentina in the days before its financial collapselast month. The investigation into reports that the regime of the former president, Fernando de laRua, allowed $10bn to disappear offshore came as the slide into economic chaos continued with theresignation of the central bank governor, a sharp drop in the stock market and a further decline inthe value of the peso."

11 See e.g. Newsweek, July, 2000, online international edition, "The Kohl Case: Oh, What a TangledWeb: The tale of how Germany's CDU nurtured a system of corrupt finance."

39

Osama bin Laden to terrorist cells around the world, transmitting them by electronictransfers until they became cash delivered by automatic teller machines. Even na-tions with strong anti-money laundering, financial transparency and disclosure lawscontinue to find themselves victimized by regulatory failures, as the recent case in-volving Enron - the seventh largest company in the U.S. prior to its bankruptcy -has vividly demonstrated.

In each case, the common infrastructure of global banking and financial servic-es has been abused by criminals to accomplish serious crimes. Repeatedly, govern-ments, regulators, law enforcement agencies, and the most important and prestig-ious international organizations have found themselves unable to trace illicittransactions after something has gone radically wrong.

Structural Consequences of the Globalisation of MoneyAffluent countries like the members of the G-7 or the European Union may be ableto tolerate and ultimately to shrug off abuse of their financial institutions by crim-inals, fraudsters, corrupt officials, and terrorists who launder hundreds of billionsof dollars per year in illicit funds. For countries in transition and for less developedeconomies, the theft of natural resources or development assistance, capital lossesfrom public funds gone missing, or the perversion of government institutionsthrough bribery, create burdens that are not so easily managed.

Recently, this problem has begun to be recognized within a macroeconomiccontext. In January 1999, International Monetary Fund (IMF) staff issued a reportconcluding that offshore banking centers had played a sometimes “catalytic” rolein recent Asian and Latin American financial crises. The IMF found that globaloffshore assets and liabilities – whose ownership has often been impossible to trace- had grown by over 6 percent annually during the mid-1990s to about $4.8 tril-lion.

The IMF staff working paper found that services provided by such centers, andthe banks, lawyers, accountants, and company formation agents working with them,had contributed to global financial crises by hiding risk and loss in ways that pro-fessional home country supervisors and auditors were unable to penetrate.

• In Argentina, some $3 billion to $4 billion were lost or hidden offshore by April1995;

• In Venezuela, billions in problem loans were moved offshore in 1994;

• In South Korea, insider dealings off-shore circumvented regulatory limits on banklending from 1993 through 1996;

40

12 Lucia Errico and Alberto Musalem, Offshore Banking: An Analysis of Macro-and Micro Pruden-tial Issues, IMF Working Paper (WP/99/5), January 1999.

13 “Economics: Global Finance,” Robert E. Litan, in Managing Global Issues, Carnegie Endowmentfor International Peace, 2001.

14 “Globalization and Fonclit: Welfare, Distribution and Political Unrest,” Ranveig Gissinger and NilsPetter Gleditsch, Journal of World-Systems Research, Vol 5, 2, 1999, 327-365.

• In Thailand, poor lending decisions were “rolled over” offshore from 1993through 1996;

• In Malaysia, some $10 billions in losses were hidden offshore in 1997.

In each case, the IMF found that the offshore sector had created a problem of inad-equate transparency and fragmented regulation, which “increases the potential fordubious activities and contributes to weakening good governance in banks andcorporations.” 12

Impact of Globalization on Political Stability and onAreas of ConflictThere is increasing recognition that globalization has facilitated the growth of localfinancial problems into international ones. Indeed, Robert Litan, an economist atthe Brookings Institution in Washington, describes regional and internationalfinancial contagions as a direct consequence of a “process of globalization [that] hasalso facilitated the transmission of financial crises across national borders.” 13

At least as significant is the role that globalization has played as a process thathas facilitated the transmission of crises of governance across national borders. Thereis also a growing body of academic work analyzing the impact of globalization ondifferent forms of conflict within jurisdictions, including economic conflict, socialconflict, and political conflict, as well as military conflict. For example, a 1999 studyundertaken by Norwegian sociologists Ranveig Gissinger and Nils Petter Gleditschon globalization and conflict used econometric modeling to research the relation-ship between high levels of trade and political stability world-wide between 1965and 1993. The Norwegian researchers found that exports of manufactured goodscreate high levels of welfare and equality, while exports of agricultural products pro-mote poverty and inequality, which in turn become among the factors that lead topolitical instability.14

Separately, an econometric study undertaken for the World Bank by Paul Col-lier and Anke Hoeffler found that an important predictive factor for civil war be-tween 1960 and 1999 is the availability of finance, with primary commodity exports

41

substantially increasing the risk of conflict due to making rebellion economicallyviable.15

Economist Dani Rodrik, a professor at the Kennedy School of Government atHarvard University, has also reviewed the relationship between globalization andconflict. His study found that where governance was weak, the economic changesbrought by globalization increased internal conflicts. Professor Rodrik found that“the world market is a source of disruption and upheaval as much as it is an oppor-tunity for profit and economic growth. Without the complementary institutionsat home - in the areas of governance, judiciary, civil and political liberties, socialinsurance, and of course education – the result is too much of the former and toolittle of the latter.” 16

Financial transparency is a core structural requirement by which governments, reg-ulators, law enforcement, judiciaries, civil litigants, and journalists can exercise over-sight and insist on the accountability of both important private sector and publicsector actors. Its absence facilitates impunity, which in turn often leads to conflict.Jurisdictions that do not have financial transparency, and which do have naturalresources that can be readily exported with minimal accountability, are often thosewhere direct foreign investment and agricultural exports have led to impoverishmentand conflict, rather than development and democracy, as found in the Gissinger/Gleditsch study.

Lack of financial transparency plays a substantial facilitating role when mem-bers of a country’s ruling class steal national wealth, or “grand corruption”. Thecorruption of the Suharto family and crony capitalists in Indonesia, of the Nigeri-an military under Sani Abacha, and of the oligarchs in Russia were all made possi-ble by international bankers. Funds stolen at home were transmitted to offshorehavens in the Channel Islands, the South Pacific and the Caribbean, before com-ing to rest for investment in places like London, Zurich, and New York.

Less recognized, perhaps, has been the role that transnational movements of dirtymoney have played in harming the global environment. For example illegal tradingin ozone-depleting chloroflorocarbons (CFCs) requires the smuggling of not onlythe CFCs but also the money generated by smuggled CFCs. Similarly, when illegallogging takes place in Cambodia, or toxic wastes are dumped in Guyana, the fundsgenerated from those criminal activities are not limited to cash payments in the localeconomy. Smuggling large quantities of illegal timber or toxic wastes across

15 “Greed and Grievance in Civil War,” Paul Collier and Anke Hoeffler, October 21, 2001, Develop-ment Research Group, World Bank.

16 Rodrik, Dani (1997b), Has Globalization Gone Too Far?, Institute for International Economics,Washington, DC., see also Professor Rodrik’s speech, Globalization, Social Conflict and EconomicGrowth, presented to UNCTAD in Geneva on October 24, 1997.

42

international borders requires both falsified shipping documents and payments forthe goods offshore. These payments are in turn moved through the global financialsystem so that criminals can enjoy or reinvest the fruits of their crime.

Human rights, too, have been undermined by the ease with which internation-al criminal organizations have been able to launder their funds across borders. Crim-inal organizations smuggling people across borders need to move funds across bor-ders as well, to bribe officials, to pay off other elements of their infrastructure, andto send remittances back home for further recruitment of their human cargo. Thesame phenomenon is present as an element in the trafficking of women. The wom-en’s economic value is sharply greater at a distance from their original home. Fundsthey generate as sexual slaves have been reinvested in the transborder infrastructurethat enslaved them, laundered across many national borders.

Illicit finance is also a key facilitator of civil war and civic instability. The laun-dering of the proceeds of crime is a necessary means to carry out the trade in dia-monds that has fuelled armed conflict in Liberia, Angola and Sierra Leone, togeth-er with their accompanying arms deals and payoffs. The narcotics trade has longbeen understood as a massive generator of illicit money to be laundered, as well asa generator of corruption and weakened governance. Drug trafficking is also close-ly associated with conflict, and one of the enduring factors in such conflict is thefact that drug funds sustain combatants in civil wars. It is no accident that each ofthe three countries which produce most of the world’s opium and coca crops —Afghanistan, Burma, and Colombia – have ongoing insurrections fuelled by drugmoney.

In short, illicit finance has played and continues to play a role in underminingmany of the goals of the United Nations and international security policy. Dirtymoney laundered through the world’s major financial institutions simultaneouslythreatens democracy, human rights, free markets, the environment, sustainabledevelopment, governance, political stability, and civil society. Contrary to the posi-tion of many banks and bankers, moving money from country to country, disguis-ing its origin, and enabling its use for criminal purposes, is not a morally neutralactivity.

Existing InitiativesAs Brookings Institution economist Robert Litan has recently stated, successfulinternational efforts to regulate cross-border finance generally only emerge in re-sponse to crises.17 The sheer scope of the present anti-money laundering initiatives

17 Litan, id, p. 197.

43

provide some indication that a lack of global financial transparency has created justsuch a crisis, requiring a comprehensive global response.

In the late 1990’s, money laundering became recognized as a global problemrequiring a global response. This response now includes new international instru-ments, such as the 2000 United Nations Convention to Combat TransnationalOrganized Crime and the Second Money Laundering Directive, issued by theEuropean Union in late 2001. It is also includes the rapid development of “nameand shame” sanctions programs. The most important has been that initiated by themember states of the Financial Action Task Force (FATF) against “non-cooperativecountries and territories.” In the first two years that the FATF threatened to limitmarket access to jurisdictions not meeting international standards, most of the nearlytwenty targeted jurisdictions enacted new anti-money laundering laws. The Organ-ization for Economic Cooperation and Development (OECD)’s similar exerciseagainst “unfair tax competition” is having a similar impact on ring-fencing, the strat-egy by which jurisdictions offer unregulated financial services to non-residents thatthey deny to their own citizens. Most recently, the new consensus was demonstrat-ed after September 11 2001. After the United Nations Security Council passed UNResolution 1373, most nations took actions to freeze the assets of a wide range ofterrorists and terrorist organizations, while taking other steps to make themselvesless vulnerable to terrorist finance.

Principle self-regulatory organizations, such as the Basel Committee for Bank-ing Supervision (BGBS), the International Organization of Securities Commissions(IOSCO), and the International Association of Insurance Supervisors (IAIS) havefocused on extending standards for international regulation to cover transparencyissues.18 The new standards have been designed to respond to the major failures ofexisting financial regulation to provide protection against illegal activities. Thesefailures have included:

• Fragmented supervision, within countries by sector, and among countries bynational jurisdiction.

18 See e.g. Statement of the G-7, June 18, 1999; “Strengthening the International Financial Architec-ture,” Report of the G7 Finance Ministers,” June 18–20, 1999; “Financial Havens, Banking Secrecyand Money-Laundering, UN ODCCP, New York, May, 1998; and numerous recent analytic docu-ments of the Basel Committee available on the website of the Bureau of International Settlements(“BIS”).

44

• Exploitation of differences among national laws to use regulatory arbitrage19 tocircumvent more stringent national laws and international standards.

• Secrecy laws that impede the sharing of information among countries and be-tween regulators and law enforcement.

• Inadequate attention to electronic payments in existing anti-money launderingsupervision and enforcement, including “know your customer” rules, whichfocus on currency, even as the world’s financial services businesses rapidly con-tinue their move into E-money.

• The lack of international standards governing key mechanisms used in transna-tional financial transactions, such as international business companies (IBC), off-shore trusts, off-shore insurance and reinsurance companies, and off-shore fundvehicles, including but not limited to hedge funds.

• Minimal due diligence by company formation agents, attorneys, and financialinstitutions in the process of incorporating and licensing of new financial insti-tutions and shell companies and trusts owned by their affiliates.

Over time, the existing international initiatives to respond to these problems arecreating a new global code articulating new international standards for transparen-cy. Each of these initiatives is based on the promise that national financial serviceregulators have the capacity to determine whether their own “local” institutions meetthe standards or not. Under the principle of consolidated supervision, the homecountry regulator of any international financial institution is solely responsible forexercising oversight over the global operations of that institution. Although far frominfallible, over the past ten years the principle of consolidated supervision has provenhelpful by requiring multi-jurisdictional financial institutions to take their homeregulators seriously. In turn, these home regulators are increasingly subject to a com-mon set of standards, such as those established by the Basel Group of Bank Super-visors (“Basel Group”). Over time, these standards have come to promote globalfinancial stability by promoting good practices for banks in their lending andinvestment practices. However, the same system has to date demonstrably failed todo much to protect the world from money laundering.

19 Regulatory and enforcement arbitrage are mechanisms by which private sector entities structuretransactions to avoid the laws of a jurisdiction with stricter standards in favour of a jurisdiction thatis more lax. In the borderless world of global finance, the ability to engage in regulatory arbitragehas grown exponentially. As a result, there has been a corresponding reduction in the ability of do-mestic regulators and law enforcement agencies effectively to enforce local laws on businesses basedin that jurisdiction.

45

There is mounting evidence to justify questioning whether global banks, operatingtransnationally to move money instantaneously across national borders, can be read-ily regulated or supervised by any one country. While these financial institutionsmay have their headquarters nominally based in a single country — typically oneof the G-7 countries, the EU, or Switzerland – they generate profits and carry outactivities on a global basis involving dozens of UN member states. As a result, theyare for many purposes beyond the capacity of any single state to police. The cur-rent “name and shame” exercises have had the salutary effect of forcing some of theworld’s least-adequately regulated jurisdictions to abandon traditional notions ofbank secrecy, and to begin insisting that their financial institutions carry out duediligence and know their customers. But these exercises have not and cannot createcapacity at a national level to assess the meaning and integrity of cross-borderfinancial transactions. It is not reasonable to expect a small jurisdiction that housesa subsidiary of a major international financial institution to fully understand thecross-border transactions engaged in by the subsidiary, let alone by its affiliates orfar-away parent. In practice, even the most sophisticated and best regulated financialcenters, including those of the G-7, European Union, and Switzerland, are similar-ly incapable of exercising adequate oversight over the global enterprises they license.

Developing and Implementing Global Standards:A “White-list” for Global FinanceIn recent years, the proposed solution has been a mixture of public sector regula-tion and private sector self-regulation. Self-regulation has been advocated as a meansby which private institutions subject to market forces will, as a matter of goodbusiness, avoid transactions that could lead to transactional, institutional, or repu-tational risk. However, it is not clear that this approach has been effective. Indeed,the combination of both government regulation and self-regulation has not to dateeffectively discouraged abuse of financial institutions operating globally by drug traf-fickers, terrorists, major financial criminals, corrupt officials, arms smugglers, orsanctioned regimes, let alone those engaged in local armed conflict, timber theft,or other criminal activity.

Today, there is no list that evaluates whether international financial institutionshave complied with basic rules of transparency or integrity. On the “name andshame” side, there is no compilation ranking major international institutions forthe greatest or least laundering of proceeds of drug trafficking, corruption, terroristfinance, illegal logging, toxic waste, human trafficking, or corporate fraud, althoughsuch a ranking might be compiled from court documents, public investigations andpress reports. Nor has there been a list involving a “seal” or “certificate” system by

46

which an institution can be endorsed as having put into place a series of best prac-tices to promote transparency.

Every year, many billions of dollars flow from international organizations andinternational financial institutions through the world’s major international banks.These public funds are deposited and held in these private-sector institutions with-out consideration as to whether these institutions have put into place excellent trans-parency policies and procedures, or minimal ones. Indeed, such funds are deposit-ed and held in private sector institutions that have had no due diligence or knowyour customer principles, if they happen to be located in jurisdictions where suchprinciples are either not required, or are minimally enforced. The value of suchdeposits to the private sector financial institutions is substantial, generating not onlysubstantial fees but the ability to engage in further lending activities of their own,due to the multiplier effect of bank deposits.

To date, the only limitations placed on those holding or benefiting from suchinternational funds has been the obligation of the institutions to adequately accountfor the uses of those funds. Broader obligations, such as requiring a particular bankto have in place strong measures for financial transparency or protection againstmoney laundering, have not been expected of private sector banks by the interna-tional organizations and international financial institutions that deposit their fundsin such institutions. Rewarding private sector institutions who agree to meet highstandards of transparency for the funds they process on a global basis could create asignificant incentive for banks, providing a further weight to existing national efforts.

47

The Logs of War

Global Witness

Timber is an easily exploitable, valuable and readily marketable commodity, and hasbeen the resource of choice in several recent civil and international armed conflicts.

For the purposes of this study, conflict timber refers to timber that has been trad-ed at some point in the chain of custody by armed groups, be they rebel factions orregular soldiers, or by a civilian administration involved in armed conflict or itsrepresentatives, either to perpetuate conflict or take advantage of conflict situationsfor personal gain. Illegal logging is the felling of trees or the export of timber in con-travention of domestic regulations or laws.

Conflict timber is closely linked to the increasingly important issue of illegallogging. Conflict timber is not necessarily illegal, as the legality (or otherwise) oftimber is a product of national laws. However, in practice, conflict timber is usual-ly illegal timber. The nature and the practices of the trades are the same, as are manyof their stakeholders.

The Political-Economy of the Timber TradeIn a developing country with few resources other than vast tracts of forest, controlof this natural capital is control of power. Political circumstances – including theinnate instability of non-democratic political regimes – favour the rapid transfor-mation of this natural capital into more tangible assets. Allocation of timber con-cessions becomes a mechanism for rewarding supporters and mobilising wealth toprop up the existing regime.

The result has often been massive corruption and loss of revenue to the state. Ithas also contributed to the erosion of democratic principles as elected politiciansand state officials put the rights of companies before those of the population theyare supposed to represent. Protected by powerful allies, timber companies becomethe de facto resource owners and state forestry institutions become the clients of thelogging extractors rather than vice versa.

The tropical timber industry traditionally engages leaders of countries with largeforest resources and weak institutions. Abiding by “local business practices”, it ne-gotiates deals to extract raw materials as cheaply as possible. This mode of doingbusiness suits the warlord economy extremely well. As timber revenues are separat-ed from state control, and the resource is exploited in an unsustainable manner,poverty is exacerbated. The seeds of dissent, and of conflict, are sown and overall

48

stability is affected. The state of disorder created by conflict suits the perpetuationof these business practices.

Compared to most forms of resource extraction, logging is a relatively easy ac-tivity, requiring low investment for quick return. A few soldiers with chainsaws andtrucks can generate hundreds of thousand of dollars in a relatively short time; a well-resourced company can generate hundreds of millions. As a result, senior command-ers and politicians begin to bypass such national laws as may be in place to controlforest exploitation. In more extreme cases military intervention in another countryis based around the attempt to control that country’s resources. For a warring fac-tion in control of forest land, logging is one of the quickest routes to obtain signif-icant funding with which to continue the conflict.

Illegal timber operations need to protect themselves, even in peacetime. Thisinvolves the hiring of armed militias and the acquisition of arms. In turn, this mil-itary capability can lead to skirmishes between the company and the local commu-nity, or between the militias of different companies. Logging companies side withwhoever controls forest territory; in many instances this means insurgent groups.High-risk areas, where there is a significant risk of loss of investment, also tend toattract the proponents of organised crime who, it seems, are prepared to accept higherlevels of risk. Revenues generated by natural resources exploited and made possibleby armed conflict fuel the power bases of these political, military and criminal groups,and are a disincentive to bringing about an end to conflict.

Policy RecommendationsThe timber trade is characterised by endemic corruption, links to organised crimeand, in numerous instances, to various warring factions. Despite this, consumingcountries and multilateral agencies, such as the World Bank, display an amazingtolerance for the illegal activities of logging companies.

Timber is, of course, a legally tradable commodity. However, it has been esti-mated by Friends of the Earth UK that, based on 1999 figures, approximately 50%of tropical timber imports into the European Union are illegal. There is no reasonto suppose that worldwide imports are much better. Surprisingly, there is no lawthat prevents a European country from importing the products of illegal, and “con-flict” timber operations. Indeed, in the industrialised countries in the West, there isno legislation that can prevent this from happening.

There are three major impediments to producer and exporter countries address-ing the issues of conflict timber. First, a sovereign government is likely to exploit itsnatural resources if it needs to defend itself. Second, in the case of corrupt govern-ments, the allocation of resultant revenues will almost certainly be opaque, with alarge percentage diverted off-budget for non-state purposes. Third, logging opera-

49

tions, by their very nature, take place in peripheral, frontier regions where estab-lished infrastructure is minimal to non-existent. In peacetime, forest managementbureaucracies often do not act. In times of war, such action is all the more difficult.

TransparencyTransparency is essential to the prevention of illegal logging and the supply of con-flict timber, and should be applied to every stage of a logging operation. Allocationof concessions should be by competitive and technical tender, with the results widelypublicised. Concession boundaries, the allocation of cutting licenses and forest rev-enues accrued to the state should all be publicly available.

If local people had a share of the profits deriving from a logging operation, theywould be inclined to protect their forest from outsiders, insist that it be managedsustainably and, in short, would be the best monitors of the operation. Local com-munities should be included in the decision-making process related to the use of forests.

Enhanced EnforcementIn some examples the logging industry acts as a law unto itself. Forest managementauthorities may need external capacity building to fulfil their mandates. Externalmonitoring, for example in Cambodia and Cameroon, can enable national enforce-ment units to tackle situations which would ordinarily be too sensitive for that coun-try’s nationals. Donor countries need to work with governments to improve and sup-port capacities for detecting and suppressing forest crime.

Legislative ReformLegislation governing forestry practices is often inadequate, at times an outdatedrelict from colonial times unsuited for controlling modern industrial timber extrac-tion. Legislation is only effective in the context of a skilled and independent judici-ary that can impose meaningful (i.e. expensive) penalties on illegal loggers. Experi-ence dictates that the producer country must have ownership of the developmentof the legislation or it is unlikely to take action based on the new law. However,without external pressure experience has shown that producer governments areunlikely to bother to change existing legislation, which more often than not it doesnot adhere to. Donor countries need to work with governments to improve and domes-tic legislation and to ensure judicial capacities for the prosecution of forest crime.

50

Certificates of LegalityThe current lack of international legislation suitable to tackling illegal logging meansthat as soon as illegally obtained timber leaves the borders of the producer country,it is de facto immediately laundered into the legal timber trade. A certificate of le-gality could be awarded by the appropriate authority in the producer country, andbe subject to independent verification. In turn, the certificate would be recognisedin the legislation of signatory consumer countries. All timber imports would needto be accompanied by this certificate, with other imports being impounded. Likeall systems this would be vulnerable to forgeries etc, but monitoring and enforce-ment should minimise this problem. Producer and consumer countries should beginto develop a certificate of legality for timber shipments, in order to distinguish betweenlegal and illegal timber.

Chain of CustodyTagging of timber, bar-coding and transponder technologies need to be used toestablish chains of custody and prevent the admixing of legal and illegal material.Accurate systems of accounting and inventory control are imperative and will re-sult in enhanced revenue collection. Simple computer packages should be developed topermit governments and enforcement agencies to track products from the forest to themarketplace, and overseas.

Consumer and Importer CountriesThere is an overarching need for international legislation governing illegal and con-flict timber. Given that an international agreement of this nature could take manyyears, an interim alternative solution is essential.

A crucial first step would be bilateral cooperation between producer and consumercountries to enforce domestic legislation in both countries. If not already in existence,legislation should be passed in producing countries to outlaw illegal logging. Con-sumer countries should recognise this legislation and a bilateral agreement betweenthe two countries should ban the trade in illegal timber. These bilateral agreementswould form a body of international law that could form the basis of a future mul-tilateral international agreement.

Customs Collaboration – how co-operative enforcement could workIf customs officials were directed to look for illegal logs or timber, or required im-porters to declare the legality of its source, the question would arise as to upon whomwould fall the onus to vouch for the legality of the timber. Importers may be unaware

51

of the preceding processes and authorisations required to export the timber. Ship-ping companies may unknowingly be transporting illegal timber or products. Theexporting country would also be involved in the process since an export certificatemay legitimise the shipment. Consumer country customs controls might follow a“red – amber – green” approach to investigating illegal timber shipments. For ex-ample, exports from countries with known illegal logging problems could be flaggedfor further inspection; information on the shipment could then be exchanged withnational authorities in the producer country. For the purpose of ensuring an efficientcustoms management process, a standard certificate would be desirable.

Also, producer countries should be able to request information concerning thevolume of imported material being declared to a consumer country’s authorities fortaxation purposes. Systems can be developed to promote reciprocal recognition oftrade restrictions, ensuring consuming countries aid compliance with producercountry measures. More effective networks of cooperation should be developed betweenproducer and consumer countries.

Regulating Domestic MarketsA legal requirement could be established in consumer countries that all timber, forestproducts and derivatives that are sold must be produced legally. This would imposea burden on sellers and manufacturers. In addition, there would be internal marketimplications in relation to the European Union since such regulations could placeUK retailers at a competitive disadvantage to retailers in other countries not requiredto prove that their timber had been produced legally. Governments should take meas-ures to ensure that they do not procure any illegal/conflict timber, in the same way thatsome governments have moved to “green” procurement systems.

International ActionCurrently, the international community has no legislative power, other than UNsanctions, to place an embargo on a producer’s timber exports. The UN SecurityCouncil has taken this action only once. In 1992 it was recognised that the KhmerRouge guerrillas in Cambodia were obtaining funding essential to their war effortby trading timber with Thailand. The UN passed resolution 792 which bannedexports of round logs from Cambodia, effective from 1st January 1993. As describedbelow, the ban was effective in undermining the financial basis of the Khmer Rouge,but had several unintended consequences that need to be considered in future bans.

The G8 has taken a strong stance on illegal logging, particularly the five-pointOkinawa statement. The G8 could provide direction to international action. Giventhe pace at which the forests are being destroyed, and the fact that armed conflict

52

and criminality are both driving this destruction and resulting from it, member statesof the G8 and United Nations should consider more immediate and direct measures.

The architects of illegal logging and the conflict timber trade are comprised ofrelatively few very large logging companies. These same companies – the MalaysianSamling and Rimbunan Hijau companies to name but two – crop up again and againin different countries. Their record of illegal logging, dealing with combatants, en-gaging in corrupt practices and human rights abuses is damning. Yet these samecompanies are engaged by the World Bank at the highest level and are selected asthe company to practice the establishment of “model” concession programmes, withWorld Bank funding. It is high time that these companies are regarded and treatedas international pariahs. The presence of companies engaged in illegal logging anywherein there areas of operations should not be tolerated in countries undergoing internation-ally funded forestry reform programmes.

There is no specific treaty that could take on the issue of illegal logging or con-flict in any concrete way. The various fora for discussing forestry issues, such as theUN Forum on Forests (UNFF) do not appear to have any specific mandate to takecomprehensive action to combat illegal logging. The UNFF is supposed to consid-er the prospects for a legal framework on all types of forests within five years. Thiswould provide an obvious forum for global discussion of the issues raised by illegallogging and conflict timber. However, the participants at the UNFF remain divid-ed over whether a forestry convention is needed, let alone any forestry sector spe-cific measures. Any discussion of a forestry convention should include on its agenda theissues of illegal logging and conflict timber.Other instruments discussed in this report include:

• Convention on International Trade in Endangered Species

• The OECD Anti-Bribery Convention

• The World Trade Organisation

• The International Tropical Timber Organisation

• The World Bank and Positive Aid Conditionality

53

About the Authors

Ian Smillie is a development consultant and Research Coordinator for PartnershipAfrica Canada, an organization that has worked on the issue of conflict diamondssince 1999. He served as a member of the UN Security Council Expert Panel onSierra Leone in 2000. He is the author of several books, including Patronage orPart-nership: Local Capacity Building in Humanitarian Crises (Kumarian 2001). He isan Associate of the Humanitarianism and War Project at Tufts University and anAdjunct Professor at Tulane University in New Orleans.

Philip Swanson is a senior economist in the Paris office of ECON Centre for Eco-nomic Analysis, Norway. A specialist on energy sector policy and regulatory mat-ters, his current focus is on corporate social responsibility issues in the oil sector.Philip joined ECON in 1999 from the International Energy Agency, and prior tothat worked in the energy practice of Price Waterhouse in London. Philip has aMaster’s degree in economics from the Johns Hopkins School of Advanced Inter-national Studies.

Mark B. Taylor is the Programme Director of PICCR at the Fafo Institute. Since1997, he has worked primarily on issues related to international responses to con-flict and the reform of UN peace operations. He was Executive Officer - Researchand Special Projects for the UN Special Co-ordinator in the West Bank and GazaStrip (1994 - 95) and has carried out human rights and security analysis in theMiddle East for the UN and non-governmental organisations.

Jonathan M. Winer was U.S. Deputy Assistant Secretary of State for InternationalLaw Enforcement from 1994 through 1999. He currently practices internationalfinancial regulatory law at the firm of Alston & Bird LLP in Washington, D.C.

Global Witness is a London-based non-governmental organisation that focuses onthe links between environmental and human rights abuses, especially the impactsof natural resource exploitation upon countries and their people. Using pioneeringinvestigative techniques, Global Witness compiles information and evidence to beused in lobbying and to raise awareness. Global Witness’ information is used to briefgovernments, inter-governmental organisations, NGOs and the media. GlobalWitness has no political affiliation.

54

Appendix: Contents of the Economies of ConflictCD, Version 1

The compact disc enclosed with these Emerging Conclusions contains the electronicversions of four Fafo reports commissioned as part of the Economies of Conflict pol-icy research into private sector activity and armed conflict.

Full Reports from the Economies of Conflict project

Dirty Diamonds: Armed Conflict and the Trade in Rough DiamondsIan Smillie

Fuelling Conflict: The Oil Industry and Armed ConflictPhilip Swanson

Illicit Finance and Global ConflictJonathan M. Winer

The Logs of War: The Timber Trade and Armed ConflictGlobal Witness

About the authors

About Fafo Programme for International Cooperation and Conflict Resolution

Web Links to project partners and more on the political economy of armedconflict.

Appendix. Documents relevant for the topics covered inEconomies of Conflict.

Private Sector Actors in Zones of Conflict: Research Challenges and PolicyResponses, Fafo and IPA 2001

Economic Driving Forces of Violent Conflict and War, Econ Centre for Eco-nomic Analysis 2001, commissioned by Norwegian Ministry of Foreign Affairs

Reports from UN Independent Panels of Experts

Report of the Panel of Experts appointed pursuant to Security Council resolu-tion 1306(2000), in relation to Sierra Leone

55

Interim report of the United Nations Expert Panel on the Illegal Exploitationof Natural Resources and Other Forms of Wealth of the Democratic Republicof the Congo

Report of the Panel of Experts on the Illegal Exploitation of Natural Resourcesand Other Forms of Wealth of the Democratic Republic of the Congo

Report of the Panel of Experts on Violations of Security Council Sanctionsagainst UNITA, March 10, 2000

Final Report of the Monitoring Mechanism on Angola Sanctions, December21, 2000

Reports from Global Witness

Can Controls Work? A Review of the Angolan Diamond Control System, Dec2001

Conflict Diamonds: Possibilities for the identification, certification andcontrol of Diamonds, May 2000

A Rough Trade; the role of Companies and Governments in the AngolanConflict, December 1998

Chainsaws speaks louder than words, May 2000

The Credibility Gap – and the Need to Bridge it; Increasing the pace of theforestry reform, May 2001

A Crude Awakening – The role of Oil and Banking Industry in Angola’s CivilWar, December 1999

Branching Out Zimbabwe’s Resource Colonialism in Democratic Republic ofCongo

Photos from Global Witness

Mark Taylor

Emerging ConclusionsMarch 2002

Economies of Conflict:Private Sector Activity in Armed Conflict

Emerging Conclusions

These Emerging Conclusions offer a preliminary analysis of the findingsof four reports from the Economies of Conflict policy research series,which examines the links between private sector activity and armedconflict. In addition, the four reports are presented here in electronicform on an enclosed compact disc. The occasion is the symposium“Economic Agendas in Armed Conflict: Defining and Developing theRole of the UN”, co-organized by the International Peace Academy andProgramme for International Co-operation and Conflict Resolution, andsponsored by the Government of Norway, on 25 March 2002 in NewYork.

These and additional forthcoming reports from the series are availablefrom the PICCR web-site at www.fafo.no/piccr

The Economies of Conflict project is supported by the Government ofNorway.

Institute for Applied Social ScienceP.O.Box 2947 TøyenN-0608 Oslohttp://www.fafo.no/engelsk/

Programme for International Co-operation and Conflict Resolution