Achilles Heel: Capital Flight

Theodor writes*

An historical free trade agreement (FTA) came into effect on January 1 2021. With 54 member states, it is the largest FTA in the world. The United Nations Economic Commission for Africa believes the African Continental Free Trade Area (ACFTA) will grow the share of intra-African trade from the current average of 12% to 15-25% by 2040.

What could hamper this huge trade potential? Capital exports.

Global Justice Now estimates that African countries exported $41 billion in 2015. The main driver of capital outflows are Illicit Financial Outflows (IFOs). As of 2017, IFOs were 1.2 times larger than all aid, FDI, and private sector loans, combined.

What do IFOs look like? In 2017, there were $68 billion of IFOs, of which $48 billion exited via trade misinvoicing, i.e., intentionally misreporting the value of goods or services on invoices submitted to customs. Other tools enabling IFOs include tax havens and goods-based money laundering.

What factors drive capital flight? The capital flight literature highlights external debts, aid, and risk-corrected investing, but the most important factors relevant to the ACFTA are trade in natural resources (NR) and the political environment. In both cases, the government holds extensive responsibility. Evidence has shown that the trade of NR has been used to enable IFOs, mostly through various forms of trade misinvoicing.

While it is very difficult to promote good governance of NR, resource-endowed governments are losing tax revenue needed to finance the implementation of the ACFTA. NR being one of Africa’s main exports, needs to be one of the main IFO channels to be actively confronted, as it will take time to reduce the continent’s economic reliance as its main export good. Political stability on the other hand is addressed in the ACFTA agreements and remains one of the main concerns of the African Union and the literature on the ACFTA. Therefore, managing political stability will not only have a positive effect in ensuring a good political environment but will also reduce IFOs and therefore grow the tax revenue of African governments.

What is then the relation between IFOs and the ACFTA? IFOs account for most African capital flight. African governments will have to invest heavily to make the ACFTA a successful project. Costs include the crucially needed expansion of infrastructure to enable intra-African trade, the costs of financing the headquarters and administration (to be built in Nigeria or Ethiopia), and compensating larger members for trade losses.

Bottom Line: If African countries do not tackle IFOs, then inadequate tax revenues risk undermining the ACFTA.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

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