Economic and Political Risk Aversions to Illicit Financial Flows: A Rethink of the Portfolio Choice Factors
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Published:
Feb 28, 2023
Keywords:
Illicit Financial Flows, Public Debt, Governance, Sub-Saharan Africa, Misinvoicing
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Abstract
The study examines the long-term causal relationship between public debt, governance quality, and illicit financial flows in sub-Saharan Africa. Annual time series data were gathered from the World Bank Governance Indicators, International Monetary Fund Economic Outlook, and Global Financial Integrity from 2005 to 2014. The approach adopted in the study is in the tradition of the portfolio choice framework of tax evasion, rooted in the investment theory of capital flight. The study finds that there is a negative and statistically significant long-run relationship between governance quality and illicit financial flows. The results also show a negative and statistically insignificant relationship between public debt and illicit financial flows. The findings suggest that weak institutional oversight, poor regulatory quality, corruption, and political crises are important determinants of illicit financial outflows in the region. It concludes that governments need to improve the transparency of financial transactions, including the beneficial ownership of corporate structures and tax information. The results also indicate the need to strengthen institutions such as customs, anti-corruption, and other law enforcement agencies to detect intentional trade misinvoicing as tax evaders exploit loopholes in tax administration peculiar to developing countries. The study is timely as resources are critically needed to rebuild economies in view of the global COVID-19 outbreak and its deleterious effects on low-income countries. The study is also relevant for policymakers as it presents pointers to the factors that proliferate illicit capital outflows from the region.
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Akeliwira, G. A. (2023). Economic and Political Risk Aversions to Illicit Financial Flows: A Rethink of the Portfolio Choice Factors. PanAfrican Journal of Governance and Development (PJGD), 4(1), 110-136. https://doi.org/10.46404/panjogov.v4i1.4484
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Research-based/ Original Articles
This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
References
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Anders, G., Kanyongolo, F., & Seim, B. (2020). Corruption and the impact of law enforcement: Insight from a mixed-methods study in Malawi. The Journal of Modern Africa Studies, 58(3): 315-33.
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Aziani, A. (2018). Illicit financial flows: An innovative approach to estimation. Springer International Publishing. https://doi.org/10.1007/978-3-030-01890-0
Balassone, F., Francese, M., & Pace, A. (2011). Public debt and economic growth in Italy. Bank of Italy Economic History Working Paper, 11. http://dx.doi.org/10.2139/ssrn.2236725
Beja Jr, E. L. (2006). Was capital fleeing Southeast Asia? Estimates from Indonesia, Malaysia, the Philippines, and Thailand. Asia Pacific Business Review, 12(3): 261-283.
Bhagwati, J. (1964). The pure theory of international trade: A survey. The Economic Journal, 74(293): 1-84.
Bhagwati, J. N., Krueger, A., & Wibulswasdi, C. (1974). Capital flight from LDCs: A statistical analysis. Illegal transactions in international trade:148-154. North-Holland. https://doi.org/10.1016/B978-0-444-10581-3.50017-3
Boyce, J. K. (1992). The revolving door? External debt and capital flight: A Philippine case study. World Development, 20(3): 335-349.
Boyce, J. K., & Ndikumana, L. (2012). Capital flight from sub-Saharan African countries: Updated estimates, 1970-2010. Political Economy Research Institute. http://dx.doi.org/10.2139/ssrn.2202215
Boyce, J.K., & Ndikumana, L. (2001). Is Africa a net creditor? New estimates of capital flight from severely indebted sub-Saharan African countries, 1970-96. The Journal of Development Studies, 38(2): 27-56.
Cerra, V., Rishi, M., & Saxena, S. C. (2008). Robbing the riches: Capital flight, institutions and debt. The Journal of Development Studies, 44(8): 1190-1213.
Christensen, J. (2011). The looting continues: Tax havens and corruption. Critical Perspectives on International Business, 7(2): 177-196. https://doi.org/10.1108/17422041111128249
Cohen, J. (1988). The Effect Size. Statistical power analysis for the behavioral sciences. Abingdon: Routledge, 77-83.
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Collier, P., Hoeffler, A., & Pattillo, C.A. (2004). Africa's exodus: Capital flight and the brain drain as portfolio decisions. Journal of African Economies, 13(2): 15-54.
Collin, M. (2020). Illicit financial flows: concepts, measurement, and evidence. The World Bank Research Observer, 35(1), 44-86. https://doi.org/10.1093/wbro/lkz007
Cumby, R. E., & Levich, R. M. (1987). On the definition and magnitude of recent capital flight. NBER Working Paper, (2275). National Bureau of Economic Research: Cambridge.
De Boyrie, M. E., Nelson, J. A., & Pak, S. J. (2007). Capital movement through trade misinvoicing: The case of Africa. Journal of Financial Crime, 14(4): 474-489.
Dooley, M. & Kletzer, K. (1994). Capital flight, external debt, and domestic policies. In federal reserve bank of San Francisco. Economic Review, 3, 30-38.
Dooley, M. (1988). Capital flight: A response to differences in financial risks. IMF Economic Review, 34 (3): 422–436. https://doi.org/10.2307/3867180
Eaton, J. (1987). Public debt guarantees and private capital flight, The World Bank Economic Review, 1(3): 377–395. https://doi.org/10.1093/wber/1.3.377
Fischer, S. (1993). The role of macroeconomic factors in growth. Journal of Monetary Economics, 32(3): 485-512.
Fofack, H., & Ndikumana, L. (2009). Potential gains from capital flight repatriation for sub-Saharan African countries. World Bank Policy Research Working Paper, (5024).
Gankou, J. M., Bendoma, M., & Sow, M. N. (2016). The institutional environment and the link between capital flows and capital flight in Cameroon. African Development Review, 28(1): 65-87. https://doi.org/10.1111/1467-8268.12182
Herkenrath, M. (2014). Illicit financial flows and their developmental impacts: An overview. International Development Policy, 5(3). https://doi.org/10.4000/poldev.1863
Johannesen, N., & Pirttilä, J. (2016). Capital flight and development: An overview of concepts, methods, and data sources. World Institute for Development Economic Research.
Kar, D., & Cartwright-Smith, D. (2009). Illicit financial flows from developing countries: 2002-2006. Global Financial Integrity. http://dx.doi.org/10.2139/ssrn.1341946
Khan, M. M. S., & Ajayi, M. S. I. (Eds.). (2000). External debt and capital flight in sub-Saharan Africa. International Monetary Fund. https://doi.org/10.5089/9781557757913.071
Khan, M., Haque, N. (1985). Foreign borrowing and capital flight: A formal analysis. IMF Economic Review, 32 (3): 606–628. https://doi.org/10.2307/3866741
Law, S. H., Ng, C. H., Kutan, A. M., & Law, Z. K. (2021). Public debt and economic growth in developing countries: Nonlinearity and threshold analysis. Economic Modelling, 98, 26-40.
Le Billon, P. (2011). Extractive sectors and illicit financial flows: What role for revenue governance initiatives? Bergen: Chr. Michelsen Institute, 13(41).
Loungani, M. P., & Mauro, M. P. (2001). Capital flight from Russia. The World Economy, 24(5): 689-706. https://doi.org/10.1111/1467-9701.00376
Meza, O., & Pérez‐Chiqués, E. (2021). Corruption consolidation in local governments: A grounded analytical framework. Public Administration, 99(3): 530-546.
Nakagawa, S., & Cuthill, I. C. (2007). Effect size, confidence interval and statistical significance: A practical guide for biologists. Biological Reviews, 82(4): 591-605.
Ndikumana, L. (2014). Capital flight and tax havens: Impact on investment and growth in Africa. Revue d'économie du développement, 22(2): 99-124.
Ndikumana, L. (2016). Causes and effects of capital flight from Africa: Lessons from case studies. African Development Review, 28(1): 2-7. https://doi.org/10.1111/1467-8268.12177
Ndikumana, L., & Boyce, J. K. (2003). Public debts and private assets: Explaining capital flight from sub-Saharan African countries. World Development, 31(1): 107-130.
Ndikumana, L., & Boyce, J. K. (2011). Capital flight from sub‐Saharan Africa: Linkages with external borrowing and policy options. International Review of Applied Economics, 25(2): 149-170.
Nicolaou-Manias, K. (2018). Review of existing indicators for illicit financial flows and possible alternative indicators for African countries. Available at SSRN 3744703. http://dx.doi.org/10.2139/ssrn.3744703
Patnaik, I., Sen Gupta, A. & Shah, A. (2012). Determinants of trade misinvoicing. Open Economies Review, 23, 891-910. https://doi.org/10.1007/s11079-011-9214-4
Rahman, M., Mustafa, M., & Turpin, L. (2018). Determining illicit financial outflows from sixty developing countries. Journal of Financial Economic Policy, 11(1): 62-81. https://doi.org/10.1108/JFEP-12-2017-0120
Rojas-Suarez, L. (1990). Risk and capital flight in developing countries. Working Paper Number 90/064, International Monetary Fund. https://doi.org/10.5089/9781451962895.001
Tashakkori, A. (2009). Are we there yet? The state of the mixed methods community. Journal of Mixed Methods Research, 3(4): 287-291.
Tax Justice Network. (2015). The Mbeki panel on illicit financial flows: Africa leads the way. Accessed from: Tax Justice Network on 10.10.2022.
Torvik, R. (2009). Why do some resource-abundant countries succeed while others do not? Oxford Review of Economic Policy, 25(2): 241-256.
Transparency International. (2021). Annual report 2021. Accessed from: Publications - Transparency.org, on 20.10.2022.
United Nations Conference on Trade and Development. (2020). Africa could gain $89 billion annually by curbing illicit financial flows. Accessed from: Illicit financial flows | UNCTAD, on 12.10.2022.
United Nations Development Programme. (2017). Women and natural resources. Accessed from: United Nations Development Programme (undp.org), on 29.09.2022.
United Nations Economic Commission for Africa. (2015). Illicit financial flows: Report of the High-Level Panel on illicit financial flows from Africa. Addis Ababa. U.N.ECA. Accessed from: https://hdl.handle.net/10855/22695, on 18.10.2022.
World Bank. (2017). What are illicit financial flows. Accessed from: Illicit Financial Flows (IFFs) (worldbank.org), on 13.10.2022.
World Customs Organization. (2018). The WCO issues its 2018 illicit trade report. Accessed from: World Customs Organization (wcoomd.org), on 11.10.2022.
Yitzhaki, S. (1974). Income tax evasion: A theoretical analysis. Journal of Public Economics, 3 (2): 201-202. https://doi.org/10.1016/0047-2727(74) 90037-1.
Ahlgren, P., Jarneving, B., & Rousseau, R. (2003). Requirements for a cocitation similarity measure, with special reference to Pearson's correlation coefficient. Journal of the American Society for Information Science and Technology, 54(6), 550-560.
Ajayi, S.I. (1997). An analysis of external debt and capital flight in the severely indebted low-income countries in sub-Saharan Africa. Working Paper Number 1997/068, International Monetary Fund Research Department: Washington DC.
Allingham, M., G., & Sandmo, A. (1972). Income tax evasion: A theoretical analysis, Journal of Public Economics,1(3–4): 323-338. https://doi.org/10.1016/0047-2727(72)90010-2
Anders, G., Kanyongolo, F., & Seim, B. (2020). Corruption and the impact of law enforcement: Insight from a mixed-methods study in Malawi. The Journal of Modern Africa Studies, 58(3): 315-33.
Anuradha S. & Amr R. (2012). Macroeconomic vulnerability in developing countries: Approaches and Issues: Working papers 94, International Policy Centre for Inclusive Growth: Brazil
Asongu, S. A., & Nwachukwu, J. C. (2017). Fighting capital flight in Africa: Evidence from bundling and unbundling governance. Journal of Industry, Competition and Trade, 17(3): 305-323.
Ayamena, H. T., Metseyem, C., & Epo, B. N. (2016). Natural resources and capital flight in Cameroon. African Development Review, 28(1): 88-99.
Aziani, A. (2018). Illicit financial flows: An innovative approach to estimation. Springer International Publishing. https://doi.org/10.1007/978-3-030-01890-0
Balassone, F., Francese, M., & Pace, A. (2011). Public debt and economic growth in Italy. Bank of Italy Economic History Working Paper, 11. http://dx.doi.org/10.2139/ssrn.2236725
Beja Jr, E. L. (2006). Was capital fleeing Southeast Asia? Estimates from Indonesia, Malaysia, the Philippines, and Thailand. Asia Pacific Business Review, 12(3): 261-283.
Bhagwati, J. (1964). The pure theory of international trade: A survey. The Economic Journal, 74(293): 1-84.
Bhagwati, J. N., Krueger, A., & Wibulswasdi, C. (1974). Capital flight from LDCs: A statistical analysis. Illegal transactions in international trade:148-154. North-Holland. https://doi.org/10.1016/B978-0-444-10581-3.50017-3
Boyce, J. K. (1992). The revolving door? External debt and capital flight: A Philippine case study. World Development, 20(3): 335-349.
Boyce, J. K., & Ndikumana, L. (2012). Capital flight from sub-Saharan African countries: Updated estimates, 1970-2010. Political Economy Research Institute. http://dx.doi.org/10.2139/ssrn.2202215
Boyce, J.K., & Ndikumana, L. (2001). Is Africa a net creditor? New estimates of capital flight from severely indebted sub-Saharan African countries, 1970-96. The Journal of Development Studies, 38(2): 27-56.
Cerra, V., Rishi, M., & Saxena, S. C. (2008). Robbing the riches: Capital flight, institutions and debt. The Journal of Development Studies, 44(8): 1190-1213.
Christensen, J. (2011). The looting continues: Tax havens and corruption. Critical Perspectives on International Business, 7(2): 177-196. https://doi.org/10.1108/17422041111128249
Cohen, J. (1988). The Effect Size. Statistical power analysis for the behavioral sciences. Abingdon: Routledge, 77-83.
Collier, P., Hoeffler, A., & Pattillo, C. (2001). Flight capital as a portfolio choice, The World Bank Economic Review, 15(1): 55- 80. https://doi.org/10.1093/wber/15.1.55
Collier, P., Hoeffler, A., & Pattillo, C. (2001). Flight capital as a portfolio choice. The World Bank Economic Review, 15(1), 55-80. https://doi.org/10.1093/wber/15.1.55
Collier, P., Hoeffler, A., & Pattillo, C.A. (2004). Africa's exodus: Capital flight and the brain drain as portfolio decisions. Journal of African Economies, 13(2): 15-54.
Collin, M. (2020). Illicit financial flows: concepts, measurement, and evidence. The World Bank Research Observer, 35(1), 44-86. https://doi.org/10.1093/wbro/lkz007
Cumby, R. E., & Levich, R. M. (1987). On the definition and magnitude of recent capital flight. NBER Working Paper, (2275). National Bureau of Economic Research: Cambridge.
De Boyrie, M. E., Nelson, J. A., & Pak, S. J. (2007). Capital movement through trade misinvoicing: The case of Africa. Journal of Financial Crime, 14(4): 474-489.
Dooley, M. & Kletzer, K. (1994). Capital flight, external debt, and domestic policies. In federal reserve bank of San Francisco. Economic Review, 3, 30-38.
Dooley, M. (1988). Capital flight: A response to differences in financial risks. IMF Economic Review, 34 (3): 422–436. https://doi.org/10.2307/3867180
Eaton, J. (1987). Public debt guarantees and private capital flight, The World Bank Economic Review, 1(3): 377–395. https://doi.org/10.1093/wber/1.3.377
Fischer, S. (1993). The role of macroeconomic factors in growth. Journal of Monetary Economics, 32(3): 485-512.
Fofack, H., & Ndikumana, L. (2009). Potential gains from capital flight repatriation for sub-Saharan African countries. World Bank Policy Research Working Paper, (5024).
Gankou, J. M., Bendoma, M., & Sow, M. N. (2016). The institutional environment and the link between capital flows and capital flight in Cameroon. African Development Review, 28(1): 65-87. https://doi.org/10.1111/1467-8268.12182
Herkenrath, M. (2014). Illicit financial flows and their developmental impacts: An overview. International Development Policy, 5(3). https://doi.org/10.4000/poldev.1863
Johannesen, N., & Pirttilä, J. (2016). Capital flight and development: An overview of concepts, methods, and data sources. World Institute for Development Economic Research.
Kar, D., & Cartwright-Smith, D. (2009). Illicit financial flows from developing countries: 2002-2006. Global Financial Integrity. http://dx.doi.org/10.2139/ssrn.1341946
Khan, M. M. S., & Ajayi, M. S. I. (Eds.). (2000). External debt and capital flight in sub-Saharan Africa. International Monetary Fund. https://doi.org/10.5089/9781557757913.071
Khan, M., Haque, N. (1985). Foreign borrowing and capital flight: A formal analysis. IMF Economic Review, 32 (3): 606–628. https://doi.org/10.2307/3866741
Law, S. H., Ng, C. H., Kutan, A. M., & Law, Z. K. (2021). Public debt and economic growth in developing countries: Nonlinearity and threshold analysis. Economic Modelling, 98, 26-40.
Le Billon, P. (2011). Extractive sectors and illicit financial flows: What role for revenue governance initiatives? Bergen: Chr. Michelsen Institute, 13(41).
Loungani, M. P., & Mauro, M. P. (2001). Capital flight from Russia. The World Economy, 24(5): 689-706. https://doi.org/10.1111/1467-9701.00376
Meza, O., & Pérez‐Chiqués, E. (2021). Corruption consolidation in local governments: A grounded analytical framework. Public Administration, 99(3): 530-546.
Nakagawa, S., & Cuthill, I. C. (2007). Effect size, confidence interval and statistical significance: A practical guide for biologists. Biological Reviews, 82(4): 591-605.
Ndikumana, L. (2014). Capital flight and tax havens: Impact on investment and growth in Africa. Revue d'économie du développement, 22(2): 99-124.
Ndikumana, L. (2016). Causes and effects of capital flight from Africa: Lessons from case studies. African Development Review, 28(1): 2-7. https://doi.org/10.1111/1467-8268.12177
Ndikumana, L., & Boyce, J. K. (2003). Public debts and private assets: Explaining capital flight from sub-Saharan African countries. World Development, 31(1): 107-130.
Ndikumana, L., & Boyce, J. K. (2011). Capital flight from sub‐Saharan Africa: Linkages with external borrowing and policy options. International Review of Applied Economics, 25(2): 149-170.
Nicolaou-Manias, K. (2018). Review of existing indicators for illicit financial flows and possible alternative indicators for African countries. Available at SSRN 3744703. http://dx.doi.org/10.2139/ssrn.3744703
Patnaik, I., Sen Gupta, A. & Shah, A. (2012). Determinants of trade misinvoicing. Open Economies Review, 23, 891-910. https://doi.org/10.1007/s11079-011-9214-4
Rahman, M., Mustafa, M., & Turpin, L. (2018). Determining illicit financial outflows from sixty developing countries. Journal of Financial Economic Policy, 11(1): 62-81. https://doi.org/10.1108/JFEP-12-2017-0120
Rojas-Suarez, L. (1990). Risk and capital flight in developing countries. Working Paper Number 90/064, International Monetary Fund. https://doi.org/10.5089/9781451962895.001
Tashakkori, A. (2009). Are we there yet? The state of the mixed methods community. Journal of Mixed Methods Research, 3(4): 287-291.
Tax Justice Network. (2015). The Mbeki panel on illicit financial flows: Africa leads the way. Accessed from: Tax Justice Network on 10.10.2022.
Torvik, R. (2009). Why do some resource-abundant countries succeed while others do not? Oxford Review of Economic Policy, 25(2): 241-256.
Transparency International. (2021). Annual report 2021. Accessed from: Publications - Transparency.org, on 20.10.2022.
United Nations Conference on Trade and Development. (2020). Africa could gain $89 billion annually by curbing illicit financial flows. Accessed from: Illicit financial flows | UNCTAD, on 12.10.2022.
United Nations Development Programme. (2017). Women and natural resources. Accessed from: United Nations Development Programme (undp.org), on 29.09.2022.
United Nations Economic Commission for Africa. (2015). Illicit financial flows: Report of the High-Level Panel on illicit financial flows from Africa. Addis Ababa. U.N.ECA. Accessed from: https://hdl.handle.net/10855/22695, on 18.10.2022.
World Bank. (2017). What are illicit financial flows. Accessed from: Illicit Financial Flows (IFFs) (worldbank.org), on 13.10.2022.
World Customs Organization. (2018). The WCO issues its 2018 illicit trade report. Accessed from: World Customs Organization (wcoomd.org), on 11.10.2022.
Yitzhaki, S. (1974). Income tax evasion: A theoretical analysis. Journal of Public Economics, 3 (2): 201-202. https://doi.org/10.1016/0047-2727(74) 90037-1.