Money laundering refers to the various methods used to "disguise" earnings from illegal activities as legitimate, in order to avoid legal repercussions. The term originates from the laundromats owned by the mafia in the United States, which were used as the excuse for the large amounts of money that mafia members earned from underground sources like prostitution and gambling. As an illegal activity, money laundering has a series of negative effects on the economy and society.
Depression of Productivity
Laundered money does not follow the route legitimate funds would normally take, with most being invested in so-called "sterile" investments, as Brent L. Bartlet suggests in his study "The Negative Effects of Money Laundering on Economic Development." Sterile investments are those that do not promote further productivity, such as luxury products like the real estate sector and jewelry. Profit-maximizing enterprises -- from small shops to big corporations -- are deprived of these funds and productivity is inevitably affected.
Misleading Information to Policymakers
Money coming from underground transactions does not appear in official statistics and can give misleading information to domestic and international policymakers. When the flow of money is accurately recorded — since laundered money enters the "formal" sector of the economy — economic decisions are bound to be incorrect, particularly with regards to monetary levels, interest rates, exchange rates and inflation. The result can be mistakes in micro- and macroeconomic policies, with serious effects in the economy's performance.
Loss of Investor Trust
Financial institutions with a record of money laundering cases are in danger of losing trust from potential investors — or even current clients — who are afraid of being defrauded. This can have serious implications on the institution's income, as consumers may choose other more reliable banks or insurance companies. Especially in developing countries, where domestic and foreign investments are essential to stimulate the economy, a breach in confidence can be catastrophic in the long term.
Obstacles for Tracking Illegal Activities
When individuals suddenly acquire large amounts of money inexplicably, it is easier for authorities to become suspicious of illegitimate activities and track down the true source of that income; however, when illegally-earned money is used for legitimate investments (purchases or bank deposits), which later return the money as legal profit (resale or returning after complex bank transfers), it is far more difficult to distinguish between "clean" and "laundered" money and track down the persons involved.