Out of Africa: Capital Flight
August 26, 2019
by Ben Iorio
“The traditional thinking has always been that the West is pouring money into Africa through foreign aid and other private-sector flows, without receiving much in return. Actually, that logic is upside down – Africa has been a net creditor to the rest of the world for decades.”
–Raymond Baker, Founding President, GFI
Africa is typically portrayed as a continent dependent on foreign aid and private investment, with money flowing from advanced economies into poor African economies. However, new research paints a very different picture. A June 2018 report by the Political Economy Research Institute (PERI) at the University of Massachusetts Amherst examined capital flight from 30 African countries between 1970 and 2015 and documented losses of approximately $1.4 trillion over the 46-year period ($1.8 trillion if lost interest is taken into account). This amount far outweighs both the stock of debt owed by these countries as of 2015 ($496.9 billion), as well as the combined amount of foreign aid all of the countries received over this period ($991.8 billion). The direction of capital flows actually makes the group of African countries a “net creditor” to the rest of the world – a startling conclusion when contrasted against common perceptions about Africa.
What is Capital Flight?
Capital flight occurs when the value of assets and capital is shifted from one country to another, often from a developing country with a relatively weak currency into a more advanced economy with a hard currency such as dollars, pounds, euros, Swiss francs or Japanese yen. This is because many developing countries are often subject to currency devaluations, exchange rate volatility, high rates of inflation, or political instability, all of which can erode the value of assets. In contrast, wealth stored in hard currencies rarely loses it value. Capital flight also occurs when people want to hide money they have gained illicitly, or to avoid paying taxes, resulting in attempts to shift wealth out of the country and into offshore centers and tax havens. Capital flight can occur both licitly, through foreign investors withdrawing profits, and illicitly, via illicit financial flows (IFFs).
From a global perspective, capital flight diverts money and tax revenue from poor countries to rich countries and deprives developing countries of domestic resources needed for achieving the United Nations Sustainable Development Goals in healthcare, poverty, infrastructure and other critical areas of public investment.
Capital Flight & Trade Misinvoicing
GFI estimates that trade misinvoicing is the most common strategy for shifting capital from developing countries to advanced economies. Trade misinvoicing occurs when companies move money illicitly in or out of countries via the commercial trade system by falsifying the prices of goods on import or export invoices. This process not only facilitates illicit flows of capital out of African economies, it also represents a huge loss in taxable revenues and undermines the ability of many countries to build domestic tax bases. A report produced jointly by GFI and the African Development Bank in May 2013 found that illicit financial outflows from Africa between 1980 and 2009 totaled between US$1.22-1.35 trillion.
The PERI report also recognized trade misinvoicing as an important mechanism for capital flight, using data from international debt statistics and the International Monetary Fund’s Direction of Trade Statistics database to estimate a loss of US$1.4 trillion in capital flight. Both the PERI and GFI reports reveal massive capital outflows from Africa resulting from trade misinvoicing- outflows which greatly outweighed what Africa received in the form of aid or foreign private investment over the same period.
Sustained capital flight slowly erodes the tax base of a country in multiple ways. First, shifting capital abroad switches the form from the domestic currency to a foreign one. This increases the supply of the domestic currency on currency markets, thus decreasing the value of that currency relative to others on global currency markets, hurting its exchange rate. It also contributes to the problem of low domestic savings rates, which in turn undermines the ability of governments to scale up public investment and to engage in deficit spending on needed public goods. Less public investment within an economy means less money is available for hiring new workers or increasing production (real GDP). Therefore, capital flight drains an economy through weakening the value of a country’s currency, hurting the domestic banking sector, undermining public investment and the ability of governments to increase real GDP. This has been the case with many African countries for the greater part of a century. As a region held back by high levels of capital flight, it is no wonder that most African nations missed their Millennium Development Goals during the 2000-2015 period.
A Growing Number of Efforts to Reduce Capital Flight
Addressing capital flight requires the cooperation of both developing and developed countries in closing down the international systems that absorb illicit financial flows from Africa. The PERI report noted: “The acceleration of capital flight over the past two decades suggests a need for deep investigation into the structural factors of this phenomenon not only at the origin in search of push factors, but also at the destination to identify potential pull factors.” This means there is a critical role for advanced economies and international institutions to play in addressing the problem of capital flight from Africa.
Specifically, since much of this money is sitting in bank accounts in developed countries and secrecy jurisdictions, developed countries must take concrete steps to reduce such clandestineness and improve transparency and accountability. Additionally, developed countries must cooperate at the international level to address and reduce tax evasion by multinational corporations.
Fortunately, the problem of capital flight is increasingly recognized by the international community and there are a growing number of possible solutions. Such initiatives include proposals to increase trade fraud penalties and to establish “beneficial ownership” legislation so the actual owners of companies are known to authorities. A growing number of countries are adopting the anti-money laundering recommendations of the Financial Action Task Force and signing onto the Addis Tax Initiative, which will all help to prevent capital flight from African nations.
For African governments, a comprehensive list of policy recommendations to reduce capital flight was published in 2018 by the United Nations Economic Commission for Africa (UNECA). In the report, UNECA proposes that governments require multinational corporations to provide comprehensive reporting on their operations, indicate disaggregated financial reporting on by-country or by-subsidiary bases; prepare cost-benefit analyses before allowing them to invest in a country; and that African countries should join voluntary initiatives, such as the Extractive Industries Transparency Initiative. It also proposes that African governments should provide training to empower investigators responsible for combating IFFs; establish greater inter-agency coordination between revenue authorities and ministries of finance in developing countries to build capacity in this area and strengthen transparent procurement procedures.
Capital Flight is both an African and an International Problem
Capital flight is a serious concern for all governments, both developed and developing, as it depletes revenue collections, undermines development initiatives and hinders effective governance. The data increasingly shows that the narrative of Africa as a poor recipient of capital obscures the reality that Africa in fact acts as a net creditor to the rest of the world, and that this is not just an African problem – but rather responsibility lies with both African and developed countries. GFI supports the recommendations listed in UNECA report, and urges governments in Africa, in the advanced economies, and international institutions to implement them. The injustice of the poorest countries in the world sending capital to the richest countries cannot be allowed to continue.
Ben Iorio is a student in Economics at the University of Michigan and a 2019 GFI summer intern.