Measuring African capital flight

Published on Pambazuka News, by Léonce Ndikumana and James K. Boyce, December 21, 2011.

Africa is bleeding money, as capital flows into the private accounts of African elites and their accomplices in Western financial centres, write Léonce Ndikumana and James K. Boyce, in an excerpt from their new book. 

In March 2010, the African Union and the UN Economic Commission for Africa jointly convened the annual Conference of African Ministers of Finance in Lilongwe, Malawi, around the theme of ‘Promoting high level sustainable growth to reduce unemployment in Africa’. The agenda included a high level session on ‘the phenomenon of illicit financial flows from Africa and its devastating impact on development prospects’. [1] This reflected increasing recognition that capital flight poses a major development challenge for African countries. The issue is at the heart of discussions of development finance, transparency in public resource management, and the sustainability of external borrowing.

The magnitude of African capital flight is staggering both in absolute monetary values and relative to GDP. For the thirty-three sub-Saharan African countries for which we have data, we find that more than $700 billion fled the continent between 1970 and 2008. If this capital was invested abroad and earned interest at the going market rates, the accumulated capital loss for these countries over the thirty-nine-year period was $944 billion. By comparison, total GDP for all of sub-Saharan Africa in 2008 stood at $997 billion. [2] Comparisons to Asia and Latin America have found that capital flight from Africa is smaller in sheer dollar terms, but larger relative to the size of the African economy. [3]

READING THE HIDDEN BALANCE OF PAYMENTS:

Measurement of capital flight poses daunting challenges, and requires some rather sophisticated statistical detective work. Funds that are acquired illegally, or funnelled abroad illegally, or both, are not entered into the official accounts of African countries. At the same time, the perpetrators of capital flight benefit from the complicity of bankers and other operators who assist in the placement of the funds in foreign havens. The identities of asset holders are often concealed through proxies and by taking advantage of legal screens available in bank secrecy jurisdictions. Nevertheless, researchers have made substantial progress in developing ways to estimate the magnitude of capital flight. This section reviews the methods used in this book. [4]

RESIDUAL MEASURES OF CAPITAL FLIGHT: … //

… CAPITAL FLIGHT AND TAX REVENUE:

Sub-Saharan African governments badly need tax revenue to bridge the large deficits in the provision of public goods, including not only infrastructure but also health and education. [34] Some resource-rich countries have seen revenue gains thanks to natural resource booms, but these may prove to be transient. Meanwhile, very few non-resource-rich African countries have recorded sustained increases in revenue. [35]

Countries with higher capital flight tend to have lower tax revenue, as can be seen in Figure 2.3. There are two reasons for this negative relationship. First, capital flight directly erodes the tax base by subtracting from it private wealth and income earnings on that wealth. Second, high capital flight is symptomatic of an environment characterized by corruption and weak regulation, circumstances that both promote capital flight and undermine tax administration. (In contrast, if capital flight were motivated primarily by a desire to escape high taxes, one would expect the opposite correlation: countries with less tax revenue would tend to have less capital flight.)

If we look at the ‘tax effort’ – the ratio of the actual tax revenue to the potential revenue based on the country’s economic structure and level of development – we find that actual tax performance in sub-Saharan Africa generally remains well below potential, and that resource-rich countries tend to perform even worse in this respect than resource-scarce countries. [36] In the case of Nigeria, for example, when oil rents are excluded, the tax effort index is 0.44, meaning that the country is generating only 44 per cent of its potential tax revenue from non-oil sectors. In Angola, the corresponding index is 0.39. Natural resource revenues are often poorly mobilized, too. In the Democratic Republic of Congo, for example, it is reported that gold exports can reach up to one billion dollars a year, but these exports generate a negligible $37,000 in tax revenue. [37]

Rampant tax exemptions contribute to low revenues. Often exemptions are awarded not on the basis of the criteria set by the law – which typically aim to stimulate private economic activity, for example by means of tax incentives – but rather on the basis of the political influence of individuals and firms. As a result, tax revenue may not follow the expansion of private sector activity and private wealth. A case study on Ethiopia, where resource inflows to the private sector are increasing but the proceeds from corporate taxation are declining, estimates that the revenue forgone through exemptions doubled between 2005 and 2007. [38] At the same time, Ethiopia has a relatively high nominal income tax rate, which may contribute to greater tax fraud. Taxes that are high in theory thus can be low in practice, owing to both legal exemptions and illegal evasion.

Capital flight has substantial adverse distributional effects, too, exacerbating gaps between rich and poor. The rich, by virtue of the fact that they hold a larger share of their assets abroad, are shielded from the wealth effects of devaluation of the national currency. Indeed, they may benefit from devaluation, as this allows them to reap windfall gains if they bring some of their capital back into the country. Since capital flight itself puts pressure on the exchange rate, it increases the likelihood of this exchange rate effect.

At the same time, by depressing government tax revenue, capital flight adversely affects the poorer segments of the population who depend most heavily on publicly funded services. For example, when the government is unable to provide adequate medical supplies and qualified health personnel for public hospitals, the poor who cannot afford the alternative of going to private clinics suffer the most. The same goes for education.

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