Saturday, April 19, 2008

Six hundred billion drained from Africa

New research has just emerged from the University of Massachusets, Amherst, about the astonishing scale of capital flight from Africa. As the research on 40 African countries estimates:

Real capital flight over the 35-year period amounted to about $420 billion (in 2004 dollars) for the 40 countries as a whole. Including imputed interest earnings, the accumulated stock of capital flight was about $607 billion as of end-2004.

(At the bottom of this blog, we link this to an important but often forgotten piece of world history, using the proposals of two wise men to offer pointers for the future.)

Money that flows out of Africa as capital flight generally stays out. The total external debt of these countries in 2004 amounted to "only" $227 billion, leading to another staggering figure. As the researchers put it:

Their net external assets (accumulated flight capital minus accumulated external debt) amounted to approximately $398 billion over the 35-year period.

The same authors, Léonce Ndikumana and James Boyce, very recently presented a brief summary of their research in the latest edition of Tax Justice Focus; this is the full research document. It also updates earlier research by the authors looking at the period 1970-1996. The new report continues:

Over the past decades, African countries have been forced by external debt burdens to undertake painful economic adjustments while devoting scarce foreign exchange to debt-service payments. On the other hand, African countries have experienced massive outflows of private capital towards Western financial centers. Indeed, these private assets surpass the continent’s foreign liabilities, ironically making sub-Saharan Africa a “net creditor” to the rest of the world.

But there is one absolutely crucial difference between the assets and the liabilities:

The subcontinent’s private external assets belong to a narrow, relatively wealthy stratum of its population, while public external debts are borne by the people through their governments.

It continues:

Some of the private assets held abroad by Africans may well be legally acquired. But the legitimacy of a significant part of these assets is questionable. This is especially the case for the wealth held by African political and economic élites in international financial centers that provide the coveted secrecy of banking operations. Recently, international pressure on Swiss banks has uncovered large sums of money belonging to former African rulers including Sani Abacha of Nigeria and Mobutu of the Congo. (former Zaïre). These may be only the tip of the iceberg of looted African national resources.

Capital flight is notoriously hard to define, but it generally means an outflow of capital that is not part of normal commercial transactions from a country where capital is relatively scarce (see this for more details). There are several reasons for capital flight, but tax evasion and a desire to grow rich secretly are among the most powerful incentives. This is a massive blight on the continent. Capital flight diverts scarce resources away from domestic investment and other productive activities; and it results in lost taxes for African governments - which are important not only from the point of view of lost revenue, but in terms of the institution-building imperative that we have already remarked upon (the Economist recently noted this point: "the well-off have less incentive to lobby for reforms at home if they are free to store their wealth overseas".) Capital flight accelerates the outflow of human capital too; it has pronounced negative effects on the distribution of wealth within countries; it compounds the debt crises. (By 2000, the report says, debt service amounted to 3.8% of GDP for sub-Saharan Africa as a whole, while they spent just 2.4% of GDP on health in that year.)

The authors rightly conclude that this research underlines the need for greater debt repatriation and forgiveness, but add:

Repatriation of illicit capital and the prevention of future illicit outflows will require a concerted effort by the international political and financial community to increase transparency and accountability in international banking practice.

This report contains many other important things, including country-by-country tables of their estimates; new econometric evidence on the links between external borrowing and capital flight ("out of every dollar of new borrowing, as much as 60 cents left the country in the form of capital flight the same year"); indications that capital flight from Africa constitutes a heavier burden than on other developing regions, even if the absolute volumes are lower; and more.

The authors also contributed to a 2005 book on capital flight which includes some fascinating history:

The neglect of capital flight in current debates is striking given the attention it received at the 1944 Bretton Woods conference, (which) is said to have laid the foundations for today's financial order and many reformers today talk of the need for a 'renewed Bretton Woods vision' The Bretton Woods architects saw the regulation of capital flight as a key pillar of the international financial order they hoped to construct.

The two principal Bretton Woods architects, Harry Dexter White and John Maynard Keynes, were principally worried about large-scale capital flight from war-devastated European countries to the US, destabilising them and turning some of them towards the Soviet bloc. They recognised the difficulties in exerting capital controls, and they addressed these with a further proposal, as the book explains:

They argued that controls on capital would be much more effective if the countries receiving that flight capital assisted in their enforcement. In their initial drafts of the Bretton Woods agreement, both Keynes and White required the governments of receiving countries to share information with the governments of countries using capital controls about foreign holdings of the latter's citizens. White went further in his draft to suggest also that receiving countries should refuse to accept capital flight altogether without the agreement of the sending country's government.

Both of these proposals were strongly opposed by the U.S. financial community which had profited from the handling of flight capital in the 1930s . . . in the face of this opposition, the final IMF Articles of Agreement contained watered-down versions of Keynes' and White's roposals. Co-operation between countries to control capital movements was now merely permitted, rather than required.

The replacement of one word with another has had nothing less than catastrophic consequences for the world's poor. As TJN's John Christensen and David Spencer argued in their recent Financial Times comment piece, referring to the fact that information on tax matters is only exchanged between countries on request:

In other words, you must know what you are looking for before you request it. This is shockingly inadequate. We need the automatic exchange of tax information between jurisdictions and all developing countries must be included.

The UN Report by the High-Level Panel on Financing for Development of June 2001 (also known as the Zedillo Report, after Chairman Ernesto Zedillo, former President of Mexico) also called for a mechanism for multilateral sharing of tax information. The report said "developing countries would stand to benefit especially from technical assistance in tax administration and tax information sharing that permits the taxation of flight capital."

This shift alone would likely do more good for Africa than all foreign aid combined. The time has come to resuscitate the proposals of the two grand old men of global finance.

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