Capital Flight and Economic Growth in the Franc Zone
Introduction The implications of capital flight for economic growth have received increasing attention from a number of researchers. In recent years, considerable interest has focused on the extent to which capital flight could have a harmful impact on economic development (UNDP, 2011). According to Ajayi (1995), slower growth and persistent balance of payments deficits in most developing countries have been attributed to capital flight. Indeed, high levels of capital flight pose serious challenges to the mobilization of domestic resources to support investment and economic growth in Africa (Fofack and Ndikumana, 2009, 2010). In addition, the UNDP (2011) regards the extent of capital flight as constituting a major obstacle to the mobilization of domestic resources for development, thereby implying that capital flight aggravates resource constraints and serves to hinder long-term economic growth (Beja, 2007). Accordingly, the extent of capital flight from developing countries acquires significance and poses a serious threat to sustainable economic growth, particularly in Africa (Ayadi, 2008). As Boyce and Ndikumana (2001) observe, many poor countries lose more resources to capital flight than they pay in debt service. This chapter aims to contribute to the debate on this issue by testing the impact of capital flight on economic growth. The theory of capital flight holds that the phenomenon is caused both by private actors and public authorities (Ndikumana and Boyce, 2003, 2008, 2011b; Ajayi, 2007; Ndiaye, 2009a, 2011). First, according to these writers, capital flight arises when private actors respond to macroeconomic uncertainty, political and institutional uncertainty, an underdeveloped financial system and the prospect of higher returns abroad.2 In a portfolio choice context (Collier et al., 2004), all of these factors increase the risk of loss of real value of private agents’ domestic assets, obliging them to shift the composition of their portfolios toward foreign assets. As private agents transfer their savings abroad, private investment declines. Accordingly, by reducing the amount of private investment, capital flight could reduce economic growth. Second, capital flight may be caused by public authorities in a context of poor governance and weak institutions (Ajayi, 1992; Awung, 1996; Loungani and Mauro, 2000; Ndikumana and Boyce, 2003; Le and Rishi, 2006; Cerra et al., 2008; Ndiaye, 2009a, 2011). According to these writers, in such a context,
corrupt authorities profit from their privileged positions to accumulate personal fortunes abroad (Boyce and Ndikumana, 2001). Those fortunes held abroad come from domestic public resources. Therefore, capital flight attributable to public authorities reduces public resources, which in turn reduces public investment, thereby reducing economic growth. The motivation for this study relates to the fact that capital flight diverts resources that could have been invested to create wealth in the country of origin. Accordingly, capital flight has a potentially adverse effect on economic growth. The question of the impact of capital flight on economic growth merits particular attention for Franc Zone (FZ) countries for a number of reasons. First, one of the characteristics of the FZ is the existence of a fixed exchange rate between the CFA franc and the euro. This exchange rate fixity implies that FZ countries cannot adjust their exchange rates, making economic growth highly sensitive to real shocks (Savvides, 1996), a situation that encourages capital flight. Moreover, capital flight exerts pressure on the exchange rate by increasing demand for foreign currency to channel wealth abroad (Ndikumana, 2003). Capital flight thus increases the probability of devaluation of the national currency (Ndikumana and Boyce, 2011a), a factor that causes capital flight by encouraging investors to shift the composition of their portfolios toward foreign assets (Cuddington, 1986, 1987). A second characteristic of the FZ is the principle of free movement of capital. Liberalization of the capital account increases the FZ countries’ vulnerability to fluctuations in capital flows, in particular by providing legal channels for capital flight (Ariyoshi et al., 2000). The free movement of capital in the FZ therefore facilitates capital flight. Ultimately, these FZ characteristics – i.e., the fixed exchange rate and liberalization of the capital account – positively influence capital flight in the FZ, which is found to be massive and increasing. Indeed, according to the most recent estimates, capital flight in FZ countries3 over the period 1970-2010 reached a remarkable US$127.2 billion, representing 123.7 percent of GDP (Boyce and Ndikumana, 2012).4 At the same time, in terms of comparison, the estimates of Boyce and Ndikumana (2012) show that capital flight in FZ countries is quite substantial compared to capital outflows from other sub-Saharan African countries. According to Boyce and Ndikumana (2012), three FZ countries are also among the ten Sub-Saharan African countries with the largest total capital flight over the period 1970-2010: Côte d’Ivoire ranked third (US$56 billion or 244.4 percent of GDP); Gabon ranked seventh (US$25.5 billion or 192.9 percent of GDP); and Cameroon ranked tenth (US$20 billion or 89 percent of GDP). The eleventh Sub-Saharan African country was the Congo, with US$19.9 billion in flight capital, representing 165.5 percent of GDP. In the econometric literature, authors are unanimous in recognizing the adverse effects of capital flight on economic growth transmitted through several channels: Lessard and Williamson (1987); Boyce (1992); Ajayi (1995, 1997); Chipalkatti and Rishi (2001); Fedderke and Liu (2002); Greene (2002); Menbere (2003); Červená (2006); Beja (2007); Ayadi (2008); Forgha (2008); Cerra et al. (2008); Lan (2009); Gusarova (2009); Ndikumana (2003, 2009); Ndiaye (2009b); Fofack and Ndikumana (2009, 2010); Yalta (2010); Bakare (2011); Ndikumana and
Boyce (2011a). In regard to these studies, this study makes two contributions to the literature. First, it provides the most up-to-date estimates of capital flight in FZ countries available in the literature. Second, it contributes to a better understanding of the role of capital flight in explaining poor performance in terms of economic growth in the zone. The remainder of this chapter or organized as follows: the second section reviews the literature on the relationship between capital flight and growth, and establishes the conceptual and analytical framework for capital flight. The third section examines the stylized facts on capital flight and economic growth in FZ, and provides an econometric estimate of the effect of capital flight on growth in the FZ. The fourth section concludes the chapter and discusses policy implications.