Capital flight: a blight on growth?

The integration of global capital markets has increased the ease with which individuals north and south can move their assets abroad. The scale of ‘capital flight’ from developing countries is of increasing concern. What drives it and what are the consequences? Should, and can, anything be done?

This background report from Queen Elizabeth House commissioned by DFID for the 2000 White Paper on globalisation, defines capital flight as the placing of personal wealth beyond the reach of the appropriate authorities – wealth commonly generated by politicians misappropriating national resources, real estate and currency speculators, tax-dodgers and criminals. The report argues that developed countries should not only do more to repatriate flight capital, but that they should also remove incentives for flight. It urges a more high-profile agenda of policy responses to capital flight and makes practical suggestions for how to do so.

People with wealth in developing countries are attracted towards overseas assets to evade tax, knowing that treasuries find it hard to tax overseas assets in the absence of information provided by host countries. Profits from smuggling and trade in narcotics and arms readily flow to offshore financial centers. Not all such capital is ‘lost’. In many cases (particularly China, Mexico and Russia) flight capital is re-invested in the country of origin, the unscrupulous investor thus gaining both tax exemption and the protected status of foreign investor.

Various approaches to the task of measuring capital flight are analysed and detailed tables of data are presented. Findings include:

• In sub-Saharan Africa and the Middle East 39 percent of domestic investors’ portfolios are held abroad.
• Sudanese assets held abroad exceeds the country’s GNP; Nigeria’s is equal and Kenya’s at around 75 percent. The effect of a return of such (relatively) huge investment flows would be dramatic.
• The estimated average share of total national debt generated by despots in 22 countries which have, or had, entrenched dictatorships is 57 percent.
• ‘Trade-faking’, the deliberate under-invoicing of exports to, and over-invoicing of exports from associated companies to present false accounts and accrue balances overseas, has severely distorting effects for some African countries and India.

A thriving economy with effective institutions and sound policy fundamentals is essential, as are a low level of debt and debt service, a budget deficit consistent with long-term solvency, low inflation and a stable real exchange rate. Further policy implications for curbing capital flight include:

• Strengthening the capacity of the regulatory authorities in host countries to prevent banks from engaging in speculative activities.
• Refining existing double taxation treaties to promote the tax credit system and information exchange: weakness in current international taxation arrangements for foreign investment stimulates capital flight.
• Backing current UK and OECD efforts to regulate offshore financial centres and prevent them as acting as tax havens.
• Providing support to developing country authorities to help record capital account transactions properly so that they are aware of their true external asset and liability position.
• Ensuring that international financial ‘codes and standards’ take into account the need to support developing country authorities in recording capital account transactions.

Source(s):
‘Capital flight: causes, effects, magnitude and implications for development’, background paper commissioned for the DFID White Paper, Eliminating World Poverty: making globalisation work for the poor’ by Valpy FitzGerald and Alex Cobham 2000 Full document.

Funded by: UK Department for International Development

id21 Research Highlight: 30 October 2001

Further Information:
Valpy FitzGerald and Alex Cobham
Queen Elizabeth House
University of Oxford
21 St Giles
Oxford OX1 3LA
UK

Tel: +44 (0)1865 273600
Fax: +44 (0)1865 273607
Contact the contributor: qeh@qeh.ox.ac.uk

Queen Elizabeth House (QEH), UK

Other related links:
'Winners and losers: making the most of globalisation'

'Private capital flows and poverty reduction: incompatible bedfellows?'

'Scrapping capital controls: pro or anti poor?'

See the Centre for the study of Globalisation and Regionalisation for further research

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