Foreign aid has become a key cornerstone of governments’ budget in developing countries like Ethiopia. Despite the widely believed narration of Western governments aiding the developing world, there are concrete arguments showing that it is, in fact, the developing world that is supporting the development of the Western world. According to a 2014 report, Africa receives about USD133.7 billion each year from official aid, grants, loans to the private sector, and remittances, among others.
Firoze Manji, a Kenyan expert on International development, argues that some USD191.9 billion is extracted from the continent in the form of debt repayments, multinational company profits, illicit financial flows, brain drain, illegal logging, and fishing. “And more recent figures put the outflow much higher—at over USD218 billion. In other words, Africa suffers a net loss of more than USD85 billion every year. Such a net outflow suggests that far from the West aiding Africa, it is Africa that is aiding the West,” he goes on to conclude.
As stated above, illicit financial flow is one of the ways in which the already scarce capital of poor African states is siphoned off to the rich countries of the West. There is no immutable or conventionally agreed term to express the transfer and use of illegally earned money.
However, there are two widely accepted terms: capital flight and Illicit financial flow. For this article, I chose the term illicit financial flow (IFF) rather than capital flight as the latter fails to characterize the act explicitly as an illegal undertaking. According to the World Bank Group (WBG): “illicit financial flow refers to cross-border movement of capital associated with illegal activity or more explicitly, money that is illegally earned, transferred or used that crosses borders.”
Global studies conducted in 55 developing countries using Hot Money Narrow’s (HMN) estimation tool from 2002 to 2011 showed that USD5.4 trillion was taken away in illicit forms. As per a report issued by GIF in 2014, estimates for developing countries using the World Bank’s residual method reached one trillion dollars yearly. When we investigate statistics on Africa, United Nations Economic Commission for Africa (UNECA) estimates of IFF show that, African countries had lost up to USD407 billion from trade mispricing practices between 2001 and 2010 alone.
Though these figures may vary because of the complicated nature of illicit financial flows, constraints on data availability, and application of different estimation models and their ability to capture IFF, we can recognize that it has reached significant levels.
Despite the variation of figures according to data source and model choice, the scale of IFF and its impact on economic growth is difficult to ignore in developing countries like Ethiopia. Ethiopia was ranked eighth in sub-Saharan Africa in terms of total capital flight worth 25 billion dollars between 1970 and 2010. The huge amount of money stated in the findings indicates IFF’s potential impact on growth, macroeconomic stability, income inequality, and on peace and security issues.
The factors that contribute to the tremendous illicit flow of capital include: policy and regulatory inconsistencies; weak institutions; limited oversight, accountability and rule of law; entrenched vested interests; and the absence of transparent economic and governance processes. All these factors are noticeably the identifying characteristics of developing countries. Macro-level symptoms of large IFFs can be illustrated through practices like corruption, organized crime, illegal exploitation of natural resources, fraud in international trade, and tax evasion.
Correspondingly, in Ethiopia also, macroeconomic instability—budget deficits and exchange rate devaluation, interest rate manipulation, political instability, and corruption are found to be reasons for IFF.
Estimations of IFF using trade miss-invoicing depict that, on average, Ethiopia is losing more than 2.1 billion dollars a year and in total USD33 billion from 2000-2015. The other estimation result using HMN, which only captures a minimum amount of IFF, shows the magnitude of IFF, on average, around USD242.5 million and in total USD3.8 billion from 2000-2015.
In determining the impact of IFF on the Ethiopian economy, a one percent increase in IFF decreases economic growth by 2.79Pct. Each year, Ethiopia’s GDP can only correct or recover 27.9Pct of shocks raised by IFF in the years between 2000 and 2015. Therefore, 3.54 years are needed to totally recover from the negative impact of illicit financial flow for every year between 2000 and 2015.
To curb the magnitude of IFF and its impact on economic growth at a national level, the first action should be institutionalizing efforts to study the channels for IFF and contextualizing or developing a better model which can capture the magnitude of IFF. Such an institution would help decrease proxy data and push all actors towards providing better information on transactions and magnitudes of IFF. Furthermore, the institution can also be a center of excellence in these areas of study.
Secondly, designing controlling and auditing mechanisms that promote traceability and openness of trans-boundary trade activities is very important. This method would help avoid illegal activities which are intended to generate money. As a consequence, in addition to using capital to energize development activities, it would also help a country secure peace and stability to sustain economic growth.
Thirdly, a holistic and collaborative approach is important to curb IFF. Establishing global dynamic collaboration with capital flight destination countries is a necessary condition to tackle IFF. Since the nature of the crime transcends national borders, pooling the resources of countries and putting in place a collaborative system to address the issue would better serve efforts to combat it.
Domestically, it’s also important to have a holistic approach. For an approach to be holistic, it must understand the motives for IFF which can be classified as push and pull factors. Push factors may include illegal activities such as corruption and tax evasion, inflation, and macro-economic instability. Pull factors are factors that motivate actors to engage in acts of IFF, such as exchange rate advantages or evading inflation. Therefore, addressing these problems with a holistic and dynamic collaboration is necessary to tackle IFF.
Above all, it must be well-understood that IFF eats into a country’s effort to reduce poverty and enhance equitable wealth distribution. It robs poor nations of their valuable capital and helps further enrich the rich. Towards breaking this centuries-old relation between the developing and developed nations, the poor need to come together to trace their illicit financial flows.
8th Year • Dec.16 – Jan.15 2020 • No. 81