Plugging Africa’s Leak

Moving money in Somaliland. CC Flickr photo by guuleed.Foreign aid programs continue to pour funds into what seems like Africa’s bottomless bucket. Illicit financial flows out of Africa are twice the amount of foreign aid into the region. Between 1970 and 2008, according to a study by Global Financial Integrity (GFI), illicit flows from Africa totaled at least $854 billion, and could reach as high as $1.8 trillion when taking into account missing data from certain countries and other conduits of illicit flows not captured in the study.

Although $1.8 trillion is already an incredible volume of illicit outflows, the actual figure could be higher still. This figure grows if we account for untraceable money generated by smuggling, violations of intellectual property rights, trade in narcotics and other contraband goods, human trafficking, sex trade, and other illegal activities.

Illicit flows have been a consistent and crippling problem in African countries. The GFI study found that illicit funds from the continent continued to ratchet upwards every decade since the 1970s, at an average rate of 12 percent per year. In fact, Africa is a net creditor to the world — it “gives” back to the world through illicit capital flight at least twice, and in some regions thrice, the amount of capital it receives in external assistance. No wonder, then, that this staggering loss of capital seriously hampers Africa’s efforts at poverty alleviation and economic development, decade after decade.

Complicity of Banks

Traditional policy interpretations of “capital flight” do appropriately account for the debilitating effects of the money leaving these countries — money that these countries desperately need to build economic and political foundations. But this antiquated approach does not recognize that banking institutions in the developed world facilitate the absorption of illicit funds.

Illicit flows must be curtailed through a two-pronged approach, which recognizes that both developing and developed countries must do their part in addressing the problem. While developing countries, like those in Africa, currently lack the governance and transparency to effectively regulate and control these outflows, equally at fault are the jurisdictions — mostly developed countries and their Western banking institutions — that not only absorb these illicit funds without hindrance, but actually solicit them through “private investment” banking services. Emerging markets need to implement sound economic policies and improve governance. But developed countries also need to ensure that the financial institutions that absorb these flows are subject to stricter oversight and operate in a more transparent manner.

The drivers of illicit financial flows vary from country to country, but overall transparency in the global financial system would significantly curtail all forms of outflows, by making it harder for tax cheats and other corrupt individuals to siphon off funds from the country. If retained by the region, the astonishing $854 billion estimated to have flown out of Africa would be enough to not only wipe out Africa’s total outstanding external debt of around $250 billion (as of December 2008), but it would also provide around $600 billion for poverty alleviation and economic growth.

Development aid to Africa won’t be effective as long as these illicit outflows continue to grow. Sub-Saharan African countries experienced the bulk of illicit capital leaving the continent, with the West and Central African region registering the largest outflows. The top five countries with the highest outflows were: Nigeria ($240.7 billion), Egypt ($131.3 billion), South Africa ($76.4 billion), Morocco ($41.0 billion), and Algeria ($35.1 billion). Estimates indicate that Africa lost around $29 billion per year from 1970-2008, of which the sub-Saharan region accounted for $22 billion. On average, countries like Nigeria that export oil lost capital at nearly $10 billion per year, far outstripping the $2.5 billion per year lost by the group of countries exporting non-fuel primary commodities. Indeed, these numbers indicate that much of the wealth generated by oil-exporting African countries does not trickle down sufficiently to benefit the nation’s population.

In developing countries that do not or are unable to implement genuine economic reform and better governance, economic growth brings more opportunities for individuals to accumulate illegal wealth and transfer that wealth abroad. In periods where illicit outflows accelerated, oil prices increased, and so did opportunities to mis-invoice trade. In fact, two methods often used to siphon money away from legal and traceable markets involve the under-invoicing and over-invoicing of exports and imports, respectively.

Fixing a Broken Model

The current development paradigm isn’t working. Poverty rates continue to stagnate and even rise, and countries such as Somalia, Sudan, and Zimbabwe continue to struggle as failed states. In fact, the political and economic foundations that typically underlie stable and prosperous countries are absent in most African countries. According to the UN Millennium Development Goals (MDGs), $348 billion is needed to meet the goals by 2010 and $529 billion by 2015. If illicit financial flows are not curtailed, Africa and its donors won’t be able to meet these goals.

Policy measures must be taken to address the factors underlying illicit outflows and also to impress upon the G-20 the need for better transparency and tighter oversight of the international banks and offshore financial centers that absorb these funds. Global Financial Integrity recently launched the G20 Transparency Campaign to enable people around the world to take action on the problem of illicit financial flows. When the G20 meets in Canada this June, this problem must be at the top of the agenda.

Reform of this shadow financial system through greater transparency is in the best interest of not only African countries seeking economic growth, but also the interests of developed countries. Curtailing illicit flows would improve the effectiveness of aid and help graduate African countries from aid dependence to a path of sustained economic development.

FPIF Analyst Karly Curcio is a junior economist at Global Financial Integrity, a program of the Center for International Policy.