Capital Flight and Human Development in Africa

Capital flight from Africa has been recently put at the forefront of the development policy debate. In addition to the recent work by Ndikumana and Boyce (2011), Global Financial Integrity (2010) and The World Bank (2011), the United Nations Economic Commission for Africa has just established a High-Level Panel on Illicit Financial Flows from Africa headed by Thabo Mbeki, former president of South Africa. The role of the Panel is to “determine the nature, pattern, scope and channels of illicit financial outflows from the continent; sensitize African governments, citizens, policy makers, political leaders and development partners to the problem; mobilize support for putting in place rules, regulations, and policies to curb illicit financial outflows; and influence national, regional and international policies and programmes on addressing the problem of illicit financial outflows from Africa.”

Capital flight is often conceived as being determined by differences in the risk-adjusted rates of return on capital (Collier et al, 2001). Capital flight would then correspond to large legal or illicit outflows of financial resources due to high political or economic instability in the originating country or higher returns on investment in the destination country. This perspective misses an important component relevant to capital flight from Africa: financial outflows resulting from the illicit appropriation of resources through theft, plundering of public resources, corruption, and trade mispricing.

Capital flight affects human development through several channels. First is the narrow association between capital flight and debt. For every dollar of Africa’s external debt, more than 50 cents leave the country the same year in the form of capital flight (Ndikumana and Boyce, 2011). The repayment of such public debt by African populations reduces their capacity to increase spending on health, education, infrastructure, and other services to improve lives.  If the amounts used every year to repay Africa’s external debts were spent on programmes and projects to reduce infant mortality, they could prevent the deaths of 70 000 infants every year (Ndikumana and Boyce, 2011).

Capital flight also deepens inequality. The people benefiting from capital flight are the elites who engage in trade mispricing of imports and exports or those who have the power to unlawfully appropriate and transfer resources abroad. Almost all the people engaging in capital flight in Africa are among the 10% richest segment of the population (Ngaruko, 2012). Even in countries where capital flight is mainly driven by portfolio considerations, it is the wealthy who benefit as they have access to foreign investment instruments that average citizens do not (Rodriguez, 2004; Vespignani, 2008). Capital flight in Africa is also associated with poor governance. Corruption increases capital flight by discourages domestic investment by increasing risk and uncertainty in the domestic economy. As a result, domestic agents are better off investing abroad, increasing capital flight and depriving countries of jobs and other social benefits from domestic investment (Le and Rishi, 2006). Corruption helps the elite to unlawfully take public or private assets and transfer them abroad. The country’s leaders have  little incentive to develop the domestic economy and social services. Access to foreign health and education services makes the elite immune to the dangers of poor domestic social services which the majority of the population has to rely on. Therefore, by improving governance and the rule of law, practices that foster capital flight are restricted.

Investment is one of the most important conduits through which capital flight affects human development. If flight capital was saved and invested in the domestic economy of the country of origin it would increase income per capita and help to reduce poverty. In Nigeria and Angola, for example, this would imply additional investment of $10.7 billion and $ 3.6 billion per year, respectively in the period 2000 to 2008. If only a quarter of the stock of flight capital from Africa was repatriated to the continent for investment, Africa’s ratio of domestic investment to GDP would increase from 19% to 35%, giving the continent one of the highest investment rates (Fofack and Ndikumana, 2010). Income growth resulting from this additional investment would reduce poverty, as shown later in this chapter.

The missing capital could have a more direct impact on livelihoods by being invested in  infrastructure which is high on Africa’s priority list: job creation, better access to schooling, health care, clean water; information and socio-political inclusion could all come out of the better use of the capital in infrastructure. If all capital flight from Africa in 2008 had been invested in MDG-related projects, it could have covered 55% to 68% of the additional resources needed that year to close the financing gap to achieve the targets of halving poverty; reaching gender equality as well the education and health-related Goals (Atisophon et al., 2011).

Table 2 provides some statistics to show the magnitude of capital flight and income and poverty levels in three groups of countries: oil-rich countries, all resource-rich countries and non-resource-rich countries. Due to the presence of large outliers in the data, medians are used instead of means.

Note: The first two variables with stars (All flows of capital flight) include negative flows.

Oil-rich countries experience the most capital flight, almost ten times the size of all capital flight in non-resource-rich countries.

Indeed, in this group of countries, capital flight in the 2000s was about three times higher than its level in the 1990s and 1980s. Interestingly, the level of poverty in resource-rich countries is the same as in non-resource-rich countries; poverty reduction was even faster in the latter group of countries.

The argument that investing flight capital boosts human development is based on the premise that more capital would generate higher incomes and hence lower poverty and improve human development. Although this view appears to be widely shared today, it has not always been like that.  In the past (e.g. Devarajan et al., 2001; 2003) some argued that neither public nor private investment would be productive in Africa due to poor economic policies such as distorted foreign exchange markets -- illustrated by high black market premiums --, and high public sector deficits. Factors such as high political instability also explain the weak relationship between investment and economic growth. Given the low productivity of investment in Africa in the past, these authors also suggested that the level of investment in Africa was too high, not too low. Hence, the suggestions were that capital flight may be a rational response to low rates of return at home due to these negative factors (Devarajan et al, 2001). Do the economic facts on the ground support this view?  

Even though low productivity of investment has penalized economic growth in Africa, new evidence invites a more nuanced view of the relationship between investment and growth in the continent. To start with, the studies that formed the basis for the controversial conclusion that Africa does not need more investment have been challenged on methodological grounds (Jomo et al., 2011). Moreover, over the last ten years, the continent has recorded growth rates around 5% of GDP on average (AfDB et al., 2011b). It is difficult to conceive that higher investment, including through FDI from emerging economies, have not played a role in achieving this performance. Recent data shows that internal structural changes including more political stability, macroeconomic as well as microeconomic reforms have fueled “an African productivity revolution” which explains a large part of the continent’s recent growth. Between 2000 and 2007, total productivity increased by 2.7% per year, on average (McKinsey & Company, 2010). In addition, the efficiency of investment in Africa could have been even higher if the continent had been able to raise the substantial resources required to invest in sectors that boost investment productivity such as power generation. As Africa continues to invest in economic modernization, particularly in infrastructure, growth is expected to remain strong. Investing flight capital could help to accelerate this economic modernization. Hence, Africa needs more not less investment (Fosu et al., 2011).

The following simulations illustrate how much additional poverty would be cut if all flight capital was invested and how this would affect the goal of halving poverty by 2015. Table 3 summarises the results based on the ICOR methodology first and then on capital stock (see Box 4.1. for the methodology). Both approaches show that investing flight capital in Africa would lead to faster poverty reduction.

Table 4.3 suggests that investing flight capital in the originating countries could have increased income per capita by an additional 3 to 5 percentage points per year in the full sample; some country groups would experience even higher income growth. This increase in income would have had a very strong effect on poverty reduction. Headcount poverty could have declined by 4 to 6 additional percentage points in Sub-Saharan Africa between 2000 and 2008. One lesson from Table 2 is that the pattern of capital accumulation is more important to the growth process than investment alone. For example, several countries including Burundi, Central African Republic, Democratic Republic of Congo and Côte d’Ivoire failed to improve their human development partly because over the years, they destroyed part of their capital stock instead of building it. The combination of high capital flight and slow capital accumulation further limits countries’ efforts towards poverty reduction and human development.

Table 3 compares the level of poverty in 2015 if the 1999-2008 rate of poverty reduction is maintained against how much it could be cut if flight capital had been invested in the economy.

Note: The actual annual rate of poverty reduction is based on the change in poverty headcount between 1999 and 2008; the rate is used to calculate the projected poverty headcount in 2015.

If the current trend in poverty reduction continues until 2015 the sample countries, as a group, will miss the target of halving poverty against 1990 levels.  The rate of poverty in 2015 will be 8% higher than what it should be if the MDG were to be met. Non-resource-rich countries will meet the target and even exceed it by 3 percentage points. If capital flight had been converted into investment, the countries in the sample, as a group, and all three groups, would meet the target of halving poverty by 2015. Non-resource-rich countries would experience the best performance and exceed the goal by almost 7 percentage points.

The fact that non-resource-rich countries would reduce poverty faster than resource-rich countries, despite the fact that countries with oil and other commodities have better finances suggests that poverty reduction and general human development do not just depend on the availability of finances even though they help to achieve success. Other factors such as pro-human development policies are important determinants of success. As the data in the next section shows, progress in human development has been faster in some of the poorest African countries than in relatively rich countries.

Even though Sub-Saharan Africa remains the region with the lowest human development index, there is progress that needs to be sustained and even speeded up. Rwanda, the country with the fastest growth in human development, has shown that the right policies can significantly improve the lives of people. Several other countries such as Ethiopia, Ghana and Uganda have experienced rapid progress too. However there are limits to what policy alone can achieve. Major financing is needed to reach and sustain high rates of growth of human development. Given the size, countries need to combine ODA, remittances, FDI and tax revenue. Capital flight, despite the huge sums involved, has not yet been mobilized. If Africa could reverse capital flight and repatriate and invest even a part of the estimated USD 700 billion held abroad, the continent could accelerate progress in human development.

This chapter has shown that capital flight out of Africa is undermining the continent’s efforts to reduce poverty. If the lack of financial resources was the only constraint to human development, investing flight capital from Africa with the same efficiency that has characterized real investment would have reduced headcount poverty by an additional 4 to 6 percentage points. With this performance, African countries as a group would halve extreme poverty by 2015 in line with the MDGs. Using flight capital could also help African countries make substantial progress on improving education, and health infrastructure.  Stemming capital flight and encouraging repatriation of the finance should be part of African strategies to promote the quality of life of their people. It is ironic that poor African countries that are struggling to mobilize resources have vast financial resources that they cannot access as they are hidden abroad. As the actors involved in capital flight are in and outside Africa, international cooperation will be needed to find a lasting solution to this problem. Current efforts in Europe and the United States to curb tax evasion have illustrated the reticence of some countries benefiting from these flows to root out illicit financial transfers. So Africa should expect resistance to efforts to repatriate capital. African countries should take advantage of the current international consensus around the need to eliminate extreme poverty by increasing pressure for the repatriation of illicit capital to fight poverty. Africa’s improved investment and political climate are signals that such resources will be used more efficiently than in the past.

Given the right political will in Africa, a number of actions could be taken to stem capital flight. First, it would be useful to undertake detailed studies at country level to identify the magnitude, causes and main destinations of capital flight, including assessing the magnitude of illicit flows. Second, once the phenomenon is better understood, specific policies to counter capital flight could be put in place. For example, generalizing shipment inspections as an integral part of import and export procedures would reduce capital flight due to trade mispricing. Undertaking external public debt audits would help to determine what part of the debts is odious, would help decision-making about selective debt repudiation. Third, improvement in governance and the rule of law, particularly government transparency in terms of financial inflows and how they are used, would undermine secrecy surrounding capital flows to and from Africa, a situation that has allowed capital flight to flourish. In this regard, the international community should make “Publish What You Pay” a core principle of corporate governance to be applied by multinational corporations negotiating large investment contracts with African countries. Fourth, African states with the help of the international community, should take advantage of the “Stolen Asset Recovery Initiative” to push for the repatriation of stolen assets. Finally, African countries could consider granting time-limited amnesty to citizens willing to repatriate assets held unlawfully in foreign countries. This has been successfully tried by a number of countries, including Italy.