During the early 1990s, the Russian Federation went through a very rapid privatization process and reforms in the banking, finance, political and administrative sectors. These events were accompanied by capital flight on a massive scale and made the country vulnerable to money laundering.

Since the beginning of the transition period, the Russian government has made efforts to control capital flight in two ways: first by attempting to modify Russia’s financial system and currency regulations; and second by developing state controls over foreign trade. However, these measures have been ineffective because of the absence of legal frameworks and institutional capacities that can oversee these developments.

Wintrobe (1998), Loungani and Mauro, 2001 P. Loungani and P. Mauro, Capital flight from Russia, World Economy 24 (2001, May) (5), pp. 689–706.Loungani and Mauro (2001), Pleines (2001), and Mulino (2002) have argued that attempts to block capital flight through capital controls after the August 1998 crisis brought both positive and negative consequences. Loungani and Mauro (2001) argue that the attempt to curb capital flight only worked in the short-term while possibly bringing about “considerable costs through increased corruption.” Mulino (2002) concurs with this view and adds that a possible benefit of the attempt to curb capital flight was the short-term mitigation of the volatility in the Russian capital market.

The authors further argue that in order to curb any sort of capital flight the Russian government needs to focus on more medium-term reforms rather than short-term solutions. In order to be successful, the medium-term strategies would require improving governance and macroeconomic performance, as well as to strengthening the banking system, issues that because of political and socio-economic conditions the Russian government has not been able to accomplish.

Schemes for exporting capital through foreign trade, one that relies mainly on the mispricing of goods, was first reported to have been used in Russia during the 1991–1993 period. According to Tikhomirov (1997), exported Russian goods were deliberately priced lower, while the imported goods were priced deliberately higher with the exporter usually receiving an additional payment from his foreign partner through a money transfer to his private account in a foreign bank or through an unregistered (cash) payment in Russia. As the Russian government took steps to regulate trade deals, double invoicing schemes became the favorite form of capital flight within the Russian Federation. Häkämies (1999) and Schelin (2001) point out that double invoicing is a serious threat to the Russian economy because it allows organized crime to penetrate the legal business environment. According to Kause (2000), the Russian government estimates that in the late 1990s, in one year alone, the country lost, in taxes and customs revenues, close to six billion Euros.

Government authorities of developed and developing countries, as well as international lending agencies, are interested in detecting abnormal pricing for several reasons. First, abnormal international trade prices may be related to lack of knowledge of world-wide prices, income tax evasion, customs duty fraud, capital flight, and money laundering activities. In addition, over-invoiced import prices may serve also as a justification for excessively high domestic prices in countries where price controls exist and could conceal illegal commissions that are hidden in the inflated prices. Under-invoiced export prices, on the other hand, may be used to avoid or reduce export surcharges in countries where they exist.

Second, abnormal price detection may serve as a means of promoting efficiency in a government’s procurement transactions. Economic growth and development are severely hindered when necessary import commodities related to economic development and the welfare of the citizens are purchased at over-invoiced prices; while, the export of domestic goods at prices lower than arm’s length prices may result in sub-optimal revenue flows to the country and its industries.

Capital flight is a major problem in many countries, including Russia. Several factors may contribute to international capital flight: economic uncertainty, fiscal deficits, financial repression, devaluation and the threat of expropriation, and potential confiscation of wealth. These are compounded by country differences in tax rates, inflation, risk of default on government obligations, and, political risk and instability. Capital flight tends to erode the country’s tax base, increases public deficit, reduces domestic investment and destabilizes financial markets.

Tikhomirov (1997) studies the origins, mechanisms and impact of capital flight in the post-Soviet Russia. The author bases his study on the belief that the level of capital flight, through trade, can be estimated by calculating the difference between Russian export/import prices and the existing world prices for the same commodities. The author ascertains that although this method does not include the capital that is liable to be exported using other methods (e.g., barter trade and sham credit, among others) it may still provide an insight into the extent of the problem.

Data used in the study are the Russian average contract and average world prices for listed commodities published in the quarterly bulletin of the Russian Government Center of Economic Analysis (Tsentr ekonomicheskoi kno’yukturi) and the official estimate of Russian exports for the same commodities published in the annual statistical handbooks of the Russian Statistical Committee (Goskomstat) for the years 1992–1995. The results are then compared to those provided by other private and governmental institutions.

Even though the author cautions that the results may be biased due to the lack of reliable data, he reports that Russian government estimates (between $35 and $400 billion for the years 1990 through 1995) are at least three to six times lower than the actual capital exports. The results also demonstrate that the rates of capital flight are directly related to the lifting of the state control over exports of various commodities. In addition, the study reports that a considerable part of capital is being illegally exported from Russia to the U.S. through trade operations between the Russian Far Eastern regions, which is rich in resources, and U.S. West-Coast states, which is considered to be rich in money. Other countries that are used by Russia to export its capital are Cyprus, United Kingdom, Switzerland, The Netherlands, Germany and Denmark.

A different study by Abalkin and Whalley (1999) supports many of the results obtained by Tikhomirov (1997). The results of the study were obtained from a joint project on capital flight undertaken by the Institute of Economics based in Moscow and the Center for the Study of International Relations of the University of Western Ontario in Canada. The team used the Russian Federation balance of payments data compiled by the Bank of Russia. In order to quantify the amount of capital flight from Russia, the authors divided their 1992–1997 period in two (1992–1993 and 1994–1997). This step was needed because of the non-availability of comparable data for the same variables in both periods. The 1992–1993 period was studied by examining the volume of U.S.-returned revenues from exports and the volume of contraband exports of goods. Capital flight during this period was estimated between $56 and $70 billion.