Draining development: illicit flows from Africa

Since 1970, Africa has lost at least $854 billion through capital flight which is not only enough to wipe out the continent’s total external debt of $250 billion but leaving around $600 billion for poverty alleviation

Menelaos Agaloglou
20 October 2014

Illicit flows are difficult to measure due to lack of reliable data. Global Financial Integrity in 2008 reported that Africa has lost between $854 billion and $1.8 trillion in the last four decades.

The flows seeking higher returns are directed towards western financial institutions and the process is being facilitated by tax havens, trade mispricing (by overpricing imports and underpinning exports on customs documents, residents can illegally transfer money abroad), fake foundations and money-laundering techniques.

Sometimes it is a response to economic and political instability or to high taxes placed on international trade. Frequently it is a way of hiding the illegal accumulation of wealth owed to corruption or criminal activity. Additionally, massive illicit flows can also be a reaction to a defaulting government debt or to a lost confidence on the economic strength of the country.

These outflows of capital seriously harm the efforts for poverty alleviation and socio-economic development. In the first place, investment has decreased, yielding negative implications for job creation, improvement of infrastructure and industrialization.

Illicit flows of money harm economic growth by stifling private capital formation and causing the tax base to remain narrow. Since it drains hard currency reserves, it encourages poor countries to borrow money from abroad making their debt crisis worse and curtailing public investment further. This burden is paid more by the poor since high levels of unemployment and increased inflation affects them more. Illicit flows increase inequality that can lead to political tensions and further poverty.

Interestingly, Africa has become a net creditor to the world despite its global image as an inactive recipient of aid and loans. It has the highest share of private external assets among developing regions. Since 1970, Africa has lost at least $854 billion through capital flight which is not only enough to wipe out the continent’s total external debt of $250 billion but leaving around $600 billion for poverty alleviation and pro poor growth.

Africa is the largest recipient of aid in the world. Vast amount of resources are being spent every year with the task of achieving poverty reduction and meeting the Millennium Development Goals.

But what’s the point of sending money in the region if the region sends it back? For the region as a whole, illicit outflows outpaced official development assistance by a ratio of around 2:1. Taking other statistics into account, developing countries lose at least $10 through illegal flight for every $1 they receive via the aid regime. It is logical to conclude here that it would have been more beneficial to keep the locally produced wealth and invest it in the continent rather than waiting for aid from abroad to safeguard basic needs.

A serious inquiry that needs further investigation is what exactly this amount (between $1 trillion and $2 trillion) being lost means in terms of schools, hospitals and infrastructure. For example, the Education For All 2011 report stated that current aid levels fall short of the $16 billion required annually to close the external financing gap in low-income countries.

This crime kills the economic chances of the region. In 1970 it sent abroad 2% of Africa’s GDP, in 1987 it sent abroad 11% and 8% of its 2007 GDP. Illicit outflows from Africa grew at an average 12% a year over the four decades. To have a chance to meet the Millennium Development Goals, African countries must attack the illicit outflow and try to recover what is now held abroad. If the amount lost could be returned, then development can be achieved painlessly with local resources finally putting an end to aid dependency.

Economic growth without reform that can keep the wealth locally reinvested will lead to more illicit capital flight, and not to less. Sub Saharan Africa had high growth-rates over the last decade. Illicit outflows have also increased during this period. If the resources gained from growth cannot be invested locally then pro poor growth will not be achieved and the continent will continue suffering from extreme poverty. The region crucially needs diversification of its economy, research and development in relation to its agriculture and an expansion of its social services both in urban and rural areas. Only locally-led efforts, with local resources, can succeed in bringing prosperity.

Former South African president Mbeki blamed multinational companies for the flow of capital out of Africa, whereas other people are blaming the growing African elite for wanting higher returns for their money. The alternative view is that this economic problem of the outflow of money is just one of the consequences of the real problem that generates all others: in many African countries, governments (even the whole apparatus of the state) lack legitimacy, and their policies and actions do not represent the whole of society but special groups with economic and political power. In most African countries there is no bargain among groups; just the imposition of power by a small elite.

An effective state can tax its citizens with a political settlement, a rational consensus between state and citizens whereby taxes will be used to further guarantee and protect their interests. At this point we can start perceiving the problem of illicit flows more as a political problem and less an economic one. It is necessary for African societies to address their weak state legitimacy by becoming more open political units, which will integrate the different groups from the societies they supposedly lead. On the other hand businessmen, in order to keep their wealth inside their countries, need to be sure that they will profit with a positive real rate of interest. Serious macroeconomic policies, such as lower fiscal deficits, low inflation and reduced monetary expansion need to follow.

In conclusion, capital flight places the whole burden of solving the problem upon African countries. However one views the problem, either as an economic or a political one, the burden is placed on these societies to solve problems through their own efforts.

It is true that African financial institutions are the smallest and least developed in the world. It is also true that they are not transparent - probably a symptom of their connection with the political establishment which also lacks credibility among the locals. But credibility, transparency and legitimacy are central ideas to development. It would be wiser to start our development discussions from these basics rather than wasting more resources and time setting more and more millennium goals.

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