Africa: The World Can Stop Capital Flight Now

26 April 2022
analysis

Kuala Lumpur, Malaysia — Curbing capital flight from developing countries is long overdue. New sanctions against Russian oligarchs show this can be done with the requisite political will. Recent research also shows how to more effectively stop capital flight.

Capital flight

Capital flight is widespread, with resource-rich countries more vulnerable. 'Mis-invoicing' exports and embezzling export earnings of state-owned mineral companies have been central to such wealth appropriation.

Capital flight is enabled, not only by national conditions, but also by transnational facilitators. Internationally, capital flight is aided by institutions and professional enablers such as bankers, lawyers, accountants and consultants.

Capital should flow to investments yielding the most returns. But economic theory suggests making more depends on appropriating what economists call 'rents'. These rents may be secured by many means, legal or otherwise.

Developing countries - especially resource-rich economies - are generally more susceptible to abuse. Wealth buys power and influence, enabling further accumulation. Thus, in the real world, natural resource endowments become a curse - not a blessing.

Since the 1990s, the IMF's sixth Article of Association - authorizing national capital controls - has been 'flexibly reinterpreted' by management and staff. Instead of protecting national economies, they have eased transborder capital flows - and flight.

To add insult to injury, advocates falsely claim that more capital will thus flow into, rather than out of developing countries. After all, conventional economic theory insists capital flows from 'capital-rich' to 'capital-poor' countries.

The reality of capital flowing 'upstream' - to rich countries - underscores how mainstream economic textbooks mislead. Clearly, the real world is very different from the one that such economists believe should exist.

Enabling illicit outflows

Unsurprisingly, the wealthy - especially the 'crooked' - want to keep their assets abroad - beyond the reach of national authorities, and rivals. As such wealth has often been acquired illicitly, owners want to protect themselves from investigation, prosecution and expropriation.

Capital flight is enabled by transnational financial networks with considerable influence. These involve global banks and financial institutions, auditors and accounting firms, tax lawyers and consulting firms for hire. Along with corporate executives and government officials, they facilitate capital flight, sharing in the spoils.

With both states and markets at their disposal, transnational financial networks successfully overcome national constraints. Prerogatives of national sovereignty are also abused to obscure their transactions and operations from surveillance.

Capital flight is enabled, even incentivized by national environments allowing the wealthy to surreptitiously sneak financial assets offshore. Instead of helping developing countries protect their meagre assets, international financial institutions have facilitated, even worsened the haemorrhage.

Elites influence the law and its enforcement, typically by employing enabling professionals and friendly legislators. After all, laws and governments are neither impartial nor efficient, constantly reshaped by influence, often connected to wealth. Hence, some illicit activities and wealth may be unlawful while others may not be.

National legal jurisdictions have been changed to ease cross-border flows. Rules, norms and practices have been changed to hide wealth transfers from national and international authorities, rules and regulations. Hence, natural resource endowments especially enable capital flight.

Such outflows may even be triply illicit - in terms of mode of acquisition, concealment from tax authorities, and transfer across borders. But not all illicitly transferred flight capital is illicitly acquired. Conversely, illicitly obtained wealth - 'laundered' before being transferred abroad legally - is not deemed capital flight.

Some capital flight involves legally acquired wealth illicitly transferred abroad. This may be reported as trade-related payments on the current account - not involving capital account transfers. They may thus bypass, or even contravene capital controls and foreign exchange regulations.

They strive to evade detection, prosecution, litigation, fines, charges and taxes by various revenue authorities. Illicit foreign exchange outflows secretly transferred abroad and not recorded in official national accounts may not be deemed illegal.

Hence, the volume and significance of capital flight estimates tend to be understated. Capital flight is easier from most developing economies - which have become more open in the last four decades with economic liberalization, often demanded by structural adjustment programmes.

Why stop capital flight?

Transnational corruption - across national borders - undermines governance and national resource mobilization needed to enhance productive investments. But many advocates of opening capital accounts justify capital flight by blaming it on allegedly predatory or incompetent governments.

The international financial system features enabling capital flight often also facilitate tax avoidance and evasion by the wealthy. Thus, capital flight doubly undermines domestic resource mobilization by leaching both investible and government resources.

Transborder capital flows avoid or minimize taxes paid, while hiding beneficiaries' identities and wealth in secretive offshore tax havens. Government finances are also directly hit when externally borrowed funds, or state-owned enterprises and natural resources are embezzled.

Worse, government or public foreign debt has often been abused to directly finance capital flight. Meanwhile, illicit offshore flight capital goes untaxed. This shifts the tax burden to the middle class and domestic businesses unable to sneak their assets abroad, or to otherwise avoid revenue authorities.

Many developing countries continue to suffer significant resource outflows, largely due to illicit capital flight. On the trail of capital flight from Africa: The Takers and the Enablers - edited by Leonce Ndikumana and James Boyce - studies this blight in sub-Saharan Africa. The world has much to learn from their forensic analysis.

The volume estimates haemorrhage from African countries since 1970 at US$2 trillion! Of this, almost 30% has been lost in the 21st century. Adding interest, cumulative offshore assets were US$2.4 trillion by 2018 - more than thrice Africa's external debt!

The West's piecemeal approach to sanctions targeting individuals is recognized as costly, time-consuming and ineffectual. Instead, the editors recommend a pre-emptive, across-the-board effort to undermine transnational networks enabling illicit financial flows. This should begin with closing financial system loopholes.

IPS UN Bureau

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