# Illicit Activity and Money Laundering from an Economic Growth Perspective: A Model and an Application to Colombia<sup>�</sup>

Edgar Villa<sup>y</sup> , Martha A. Misas<sup>z</sup> and Norman V. Loayza<sup>x</sup> Abstract This paper contributes to the economic analysis of illicit activities and money laundering. First, it presents a theoretical model of long-run growth that explicitly considers illicit workers, activities, and income, alongside a licit private sector and a functioning government. Second, it generates estimates of the size of illicit income and provides simulated and econometric estimates of the volume of laundered assets in the Colombian economy. In the model, the licit sector operates in a perfectly competitive environment and produces a licit good through a standard neoclassical production function. The illicit sector operates in an imperfectly competitive environment and is composed of two di¤erent activities: The ...rst activity produces an illicit good that nonetheless is valuable in the market (for example illicit drugs); the second does not add value to the economy but only redistributes wealth (for example robbery, kidnapping, and fraud). The paper provides a series of comparative statics exercises to assess the e¤ects of changes in government e¢ ciency, licit sector productivity, and illicit drug prices. From the model, the analysis derives a set of estimable macroeconometric equations to measure the size of laundered assets in the Colombian economy in the period 1985 to 2013. The paper assembles a data set whose key components are estimates of illicit income from drug tra¢ cking and common crime. Illicit incomes increased drastically until 2001, reaching a peak of nearly 12 percent of gross domestic product and then decreasing to less than 2 percent by 2013. The decline overlaps not only in a period of high economic growth, but also after the implementation of Plan Colombia. The data set is used to estimate the volume of laundered assets in the economy by applying the Kalman ...lter for the estimation of unobserved dynamic variables onto the derived macroeconometric equations from the model. The ...ndings show that the volume of laundered assets increased from about 8 percent of gross domestic product in the mid-1980s to a peak of 14 percent by 2002, and declined to 8 percent in 2013.

JEL code: O10, O54, K14, K42 Keywords: Crime, Economic Growth, Drug Tra¢ cking, Money Laundering, Colombia

> �This paper is the result of collaboration between the Government of Colombia, members of the Colombian academic community, and the World Bank. We gratefully recognize the UIAF (Colombia), especially director Mr. Luis Edmundo Suarez and deputy director Mr. Javier Gutiérrez for their support. We thank María Camila Castellanos and, especially, Angela Hurtado for their superb assistance in building the data set used in this project; Wilson Martinez, former Prosecutor General of Colombia, for his practical advice; and Claudia Meza-Cuadra for her careful editorial assistance. We gratefully acknowledge the ...nancial and technical support of the World Bank in undertaking and completing this project. In this respect, we are particularly indebted to Yara Esquivel (Senior Financial Specialist), Jean Pesme (Financial Markets Integrity Practice Manager), Luis Serven (Senior Advisor Development Research Group), Emile van der Does de Willebois (Senior Specialist), Eva Gutierrez (Finance and Markets Program Leader), Daniel Lederman (Lead Economist), Barbara Cunha (Senior Specialist), Marjin Verhoeven (Senior Specialist), Quy-Toan Do (Senior Economist), Emily Adeleke (Finance and Markets Specialist), Alfonso García Mora (Practice Manager) and Roberto Aleu Biel (Consultant). We are grateful for the helpful comments of Alvaro Montenegro (Universidad Javeriana, Bogotá), Leonardo Duarte (Universidad Nacional de Colombia), Gonzalo Hernández (Universidad Javeriana, Bogotá), Munir Jalil (Universidad Nacional de Colombia), and Franz Hamman (Banco de la República de Colombia). We also wish to thank Daniel Flechas, Stephany Santacruz, Alejandro Gaviria, and Sebastián Zárate for superb research assistance for this project.

> yAssociate Professor of the International School of Economics and Business Administration. Universidad de La Sabana, Campus Puente del Común. Chía, Colombia. Email: edgar.villa@unisabana.edu.co.

> zAssociate Professor of the Economics Department. Ponti...cia Universidad Javeriana. Calle 40 No. 6-23, Edi...cio Gabriel Giraldo. Email: mmisas@javeriana.edu.co.

> xLead Economist of World Bank, Development Economics. Email: nloayza@worldbank.org.

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