James K. Boyce and Léonce Ndikumana

This is part 1 of a five-part series, drawn from Political Economy Research Institute (PERI) working paper No. 361, “Strategies for Addressing Capital Flight,” by James K. Boyce and Léonce Ndikumana, available here. The paper is forthcoming in Capital Flight from Africa: Causes, Effects and Policy Issues, S.I. Ajayi, and Leonce Ndikumana, eds. (Oxford University Press, 2014), accessible here.

Understanding types of capital flight

Private capital stashed abroad by Africans is not a homogeneous pool of resources. Some of it is clean capital, licitly acquired and licitly transferred, but a substantial part is illicit by virtue of its mode of acquisition and/or transfer.

As can be seen in Table 1, African private wealth held abroad includes some capital that was honestly acquired in Africa and legally transferred abroad as capital outflows duly recorded in national statistics in the country of origin. This is clean capital. Some legally acquired capital is transferred abroad by clandestine means, however, circumventing regulations and reporting requirements on the cross-border movement of capital. The motivations for such transfers include tax evasion, as well as more legitimate concerns about the security of property rights or illegitimate taxation. We refer to this as smuggled capital, and it is one component of capital flight.

Table 1: Legal and Illegal Capital Held Abroad

Acquisition →

↓ Transfer Legally acquired Illegally acquired

(stolen assets) Legally transferred Clean capital Laundered capital Illegally transferred

(capital flight) Smuggled capital Dirty capital

Illegally acquired capital originates from corruption, theft, bribery, counterfeit, trafficking of illegal goods and services, and other illicit transactions. The perpetrators of these economic and financial crimes have two additional motives for moving their stolen assets out of the country: to conceal evidence of their crimes, and to hide the proceeds where they are less likely to be recovered by legal authorities, and more accessible should they find it prudent to move abroad themselves.

In some cases, stolen assets find their way into the country’s legal financial system, either by taking advantage of the laxity of controls or by corrupting the officials responsible for verifying the origins of the funds. This laundered capital may then exit the country using legal routes. Because outflows of laundered capital are recorded in the official statistics—despite the illicit origins of the funds—they not enter into measured capital flight.

Although domestic money laundering makes it easier to move funds out of and back into the country, it entails risks and transaction costs, and it exposes assets to the view of tax authorities. For these reasons, most illegally acquired capital that leaves the country of origin does so clandestinely. This is what we call dirty capital. The strong correlations between capital flight and external borrowing, and between capital flight and natural resource extraction, suggest that dirty capital constitutes a substantial fraction of total African capital flight.

Strategies to reduce capital outflows must be cognizant of the differences among these forms of capital held abroad, as the owners of these assets are likely to respond in differing ways to various incentives and regulatory measures. Strategies for stemming outflows of clean capital should be part of a broader package of policies aimed at encouraging domestic investment and private capital inflows. These policies will help keep capital at home and encourage Africans to repatriate their capital held abroad. They are also relevant to strategies to prevent capital smuggling, since it is important to understand why African holders of honestly acquired wealth may prefer foreign assets over domestic assets. Another strategy, again relevant to both clean capital and smuggled capital, is the use of capital controls.

Illegally acquired capital, in contrast, requires a completely different approach. Measures focusing on investment incentives and portfolio choice are ill-suited for addressing the problem of capital that is fleeing the scene of its criminal origins. For such capital, the strategies must instead use legal measures to deter illicit acquisition of capital and to seize and repatriate stolen assets. These require international cooperation among banking, law enforcement, and judicial authorities as well as national efforts.

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