The Economic Foundation of the Walker Model: The Gravity Model by Prof. Dr. Brigitte Unger

1
The Economic Foundation of the Walker Model The
Gravity Model by Prof. Dr. Brigitte Unger  

• Presentation prepared for the Conference on
  Tackling Money Laundering, organized by the
  Utrecht University School of Economics, 2nd and
  3rd November 2007

2
Overview

• Why I chose for the Walker Model
• A Revised Walker Model Measured for the
  Netherlands
• The Theoretical Underpinning of the Model The
  Gravity Model
• Lessons from modern trade theory
• Future Challenges

3
1. The Walker Model

• A pioneer study from 1994
• Allows for a framework to measure money
  laundering per country and worldwide
• Is a positive example for interdisciplinary work
  between criminology and economics
• Recently updated (Walker 2005)
• Is based on a solid model of economic theory

4
The Walker Model

• consists of two parts of which the second part
  is the controversial one in the debate on money
  laundering
• The proceeds from domestic crime that are being
  laundered
• The proceeds from foreign crime that flow into a
  country for laundering

5
2. A Revised Walker Model Percentage of World
Criminal Money Flowing into a country X (the
Netherlands)

•  

Country X, countries yi i1...n
Attractivenessf(GDP per capita, BankSecrecy,
AntimoneylaunderingPolicy, SWIFTmember, Financial
Deposits,-Conflict,-Corruption,-Egmont
Group. Distance deterrencef(Language,colonial
background,trade,physical distance)
6

2. ATTRACTIVENESS top 31 out of 220 countries
Unger et al 2006
Unger et al 2006

• Walker 1995
• 1.Luxembourg
• 2.US
• Switzerland
• Caymen Islands
• Austria
• 6.Netherlands
• Liechtenstein
• Vatican
• 9.UK
• Singapore
• Hong Kong
• Ireland
• Bermuda
• Bahamas
• Norway

Walker 1995
16. Iceland Canada Portugal Denmark Sweden Monaco
Japan Finland Germany New Zealand Belgium Italy Fr
ance Cyprus Czech Republic Latvia
16. Australia Isle of Man Vatican France San
Marino Germany 22.Netherlands Italy Finland Greece
Japan Malta Sweden 29.US Denmark 31.UK

• 1.Luxembourg
• Bermuda
• Switzerland
• Caymen Islands
• Norway
• Hong Kong
• Austria
• Liechtenstein
• Belgium
• Aruba
• Jersey
• Iceland
• Canada
• Ireland
• Singapore

7
2.Flows of Dirty Money Into the Netherlands
Other Countries Criminal Money Flowing into the
Netherlands
Laundering depends on Attractiveness and on
Distance Language,colonial background, trade,
physical distance
14,5 bill Euro
US
from Dutch crime
US, Russia,Italy Germany, UK, France..
UK
Dutch Antilles, ,
Russia
4 bill
Netherlands
Colombia
Netherlands
Germany
Turkey
Spain
Through flow
18,5 bill
Money Laundering in the Netherlands about 5 of
Dutch GDP
8
3. The Theoretical Underpinning of the Walker
Model3.1. Newtons Apple

• Fij G MiMj/ (Dij)2
• Fij...Attractive Force between object i and j
• Mi....Mass of object i
• Mj ..Mass of object j
• Dij...Distance between object i and object j
• G...Gravitational constant
• In 1687, Newton proposed the Law of Universal
  Gravity, which held that the attractive force
  between two objects i and j depends on their
  masses, the square distance between these objects
  and a gravitational constant.

9
3. The Theoretical Underpinning of the Walker
Model3.2. Tinbergens Old Gravity Model of 1962

• Fij G Mi a Mj ß / Dij ?
• The export flows from country i to country j
  depend on the GDP of both the exporting and
  importing country and the distance between them.
• Note that if a, ß 1and ? 2, then this is the
  same as the original Newton formula
• Fij G MiMj/ (Dij)2

10
3. The Theoretical Underpinning of the Walker
Model3.3. The Gravity Model in Modern Trade
Theory

• The trade flows from country i to country j
  Fij sijMj
• Where sij is the share of country js income Mj
  spent for goods from country i.
• sij g(mi, ni, Dij) / S g (ml, nl, Dlj)
  miquality of goods of country I
• ni.variety of goods of country i
• Dijdistance between country I and j
• This share increases if country i produces a
  greater variety of goods (ni) or a higher quality
  of goods (mi). This share also decreases with
  distance.
• Depending on the trade theory used, either mi1
  (which means all products from a country have the
  same average quality) or ni1 (each country
  exports only one single good).
• Under the assumption that mi1 and that all
  firms q are of the same firm size, the number of
  products ni Mi/q. The higher the income of the
  country, the more products will be produced, and
  the larger the firms size in the country, the
  less variety will be produced (monopolistic trade
  models, Dixit Stiglitz).

11
3. The Theoretical Underpinning of the Walker
Model3.3. The Gravity Model in Modern Trade
Theory contd

• If mi1 and all firms q are of the same firm
  size, the number of products ni Mi/q.
• The higher the income of the country, the more
  variety of products, the larger the firms size in
  the country, the less variety (monopolistic trade
  models).
• After some modification, follows
• sij Mi Dij ? Rj where Rj 1/ S l (Ml,
  Dlj ?) and
• from this follows Newtons-Tinbergens formula
• Fij Rj MiMj / Dij ?

12
3. The Theoretical Underpinning of the Walker
Model3.4. Walkers Model is a Modern Gravity
Model

• Fij Rj Mi a Mj ß / Dij ?
• Fij/Mi Attractiveness j /Distance ij2 where
• Fij/Mi (GNP/capita)j (3BSjGAjSWIFTj-3CFj
  CRj 15)/ Distance ij2
• Where GNP/capita is GNP per capita, BS is
  Banking Secrecy, GA is Government Attitude, SWIFT
  is SWIFT member, CF is Conflict, CR is
  Corruption.
• If one compares this to the original gravity
  model, Walker assumes, Rj (3BSjGAjSWIFTj-3CF-CR
  j15) and Mj(GNP/capita) j. He has divided the
  flow formula by Mi (the proceeds of crime).

13

4. Lessons from Modern Trade Theory

• Tinbergens ad hoc formula was progressively
  micro-founded.
• Anderson (1979), showed that the gravity model
  was evident in expenditure share models
• Helpman (1984) and Bergstrand (1985)
  demonstrated that the gravity model could also be
  derived from models of trade in differentiated
  products.
• Deardorff (1998) showed that a suitable modelling
  of transport costs produces the gravity equation
  as an estimation, even for the Heckscher-Ohlin
  model.
• Helliwell (2000), Head (2003) role of distance,
  colonial background, language

14

4. Lessons from Modern Trade Theory

• The role of distance
• It is a proxy for transport costs
• it indicates the time elapsed between shipment
• - damage or loss of the good (ship sinks in
  the storm)
• spoiling of the good
• loss of the market (purchaser unable to pay once
  it arrives)
• It stands for transaction costs (searching for
  trading opportunities, establishment of trust
  between partners)
• It stands for cultural distance
• (clashes in negotiation style, language)
  Countries that speak the same language will
  trade twice to three times as much as pairs that
  do not share a common language (Helliwell 2000)
• Role of borders, overestimation of effective
  distance when one takes capital coordinates

15
4. Future Challenges

• better micro-foundation of the Walker model
• cooperation with criminologists for studying
  criminal behavior
• Variables in the attractiveness indicator still
  arbitrary
• weights of variables in attractiveness and
  distance indicator still arbitrary
• It was a long way from Tinbergens ad hoc formula
  to the micro foundation by modern trade theory.
  Similar is needed for criminal flows

16
THANK YOU !
Prof. Dr. Brigitte Unger Utrecht School of
Economics Janskerkhof 12 3512BL Utrecht The
Netherlands 31-(0)30-253-9809 B.Unger_at_econ.uu.nl