Is Foreign Direct Investment Driving Capital Flight from Africa?
Leonce Ndikumana says African countries need to adopt development strategies that encourage domestic investment
SHARMINI PERIES, EXECUTIVE PRODUCER, TRNN: It’s the Real News Network. I’m Sharmini Peries coming to you from Baltimore.
For a long time now mainstream economists have argued that for a developing country to develop economically it is necessary for the country to seek foreign investment or FDI, foreign direct investment, as it is usually referred to. In other words, developing country governments should seek to make their countries attractive to foreign capital in order to require the FDI that will allow the country to develop economically. This would mean a low tax burden and as little regulation as possible for investors.
With us to discuss the findings of a recent study is Leonce Ndikumana. Leonce is a director of the foreign policy program at Political Economy Research Institute, known as PERI, and co-author of “Capital Flight from Sub-Saharan African Countries.” [Correction: Study title is Capital Flight and Foreign Direct Investment in Africa] And if you wish to read further about this study you will find a direct link to it just below the player. Thanks so much for joining us, Leonce.
LEONCE NDIKUMANA: Thank you very much.
PERIES: So Leonce, first of all, let’s do this in two parts. In the first part let’s take up the research, the context of the research, and in the second part we’ll look at the policy recommendations you make as a result of the research.
NDIKUMANA: Thank you. That makes sense, very good.
PERIES: So, Leonce, let’s establish some context as to the study. First of all, what are the debates in economics that are going on in terms of FDI and what is the debate, first?
NDIKUMANA: Yes. So, thank you very much again for the opportunity to talk about this study which is a joint work with my colleague Mare Sarr, professor of economics at University of Capetown, and it’s a study that we did in the context of a broader project by the UN [inaud.] that’s trying to look at various aspects of development linked to the management of natural resources.
In this particular case, the context is that if you look at the past three decades, mostly the past two decades, what has been happening in African countries and other developing countries is an acceleration, a clear acceleration of foreign direct investment into these countries mainly directed to natural resources. At the same time we have seen, especially since the turn of the century, an increase in growth rates, economic growth rates in these countries. But again, at the same time we see a standing paradox whereby as more capital is coming into African countries there is an acceleration of capital fleeing the continent. So, capital flight has accelerated in the past two decades even as economic growth has increased and foreign direct investment has increased.
So, that prompted our interest in looking at the interplay between the three phenomena: One, the fact that FDI has increased over the past two decades, and that capital flight has also accelerated, but also the fact that the growth acceleration has been driven by the resource boom. So, you have seen resource rich countries benefit from commodity price increases prior to the recession even after the recession, although now we are in a phase of decrease in commodity prices.
PERIES: Give us some examples of the kinds of foreign direct investments that are taking place in the area of natural resources.
NDIKUMANA: Yes. So, we have heard and rad about the fact that natural resource-rich countries in Africa, countries rich in oil, minerals have attracted a massive amount of investments from both traditional partners in the West, Europe, US, but also emerging, what we call emerging partners in the emerging markets: China, Brazil, India. We have heard stories about big, massive investments, for example in the Democratic Republic of Congo, by China in exchange for construction of infrastructure. So, China gets access to mining concessions in exchange for building infrastructure.
We know the oil rich countries like Angola have been prime destinations, again, of investment from China, but also Nigeria, one of the biggest oil producers in the continent, even in the world, is a major destination of foreign direct investment. At the same time, so we have a clear case where natural resource rich countries are prime destinations of foreign direct investment. But those same countries I mentioned: Angola, Democratic Republic of Congo, Nigeria, could add Congo, Cameroon, also countries that feature prominently on the list of high capital flight.
So, that prompted our interest in looking at the linkages between capital flight and FDI and whether this may be intermediated by natural resources.
PERIES: And give us some highlights, in terms of your findings.
NDIKUMANA: So, the main findings are quite interesting. As we would have expected, we see a positive relationship between capital flight and FDI. But, interestingly enough, the relationship varies depending on whether we look at the flow, the annual flows of FDI or the [stock] of FDI. This is basically a follow up to our analysis where we have looked in the past about the linkages between capital flight and external capital inflows in the form of external borrowing where, especially my colleague Jim Boyce, we have found that external borrowing tends to fuel capital flight in the sense that some of the money that’s borrowed by the countries ends up leaving capital [inaud.]. It ends up leaving the country.
So the question we pursued here was whether FDI behaves the same way. Is it the case that annual inflows of FDI leads to annual outflows of unrecorded capital, or capital flight. We find that that relationship is weak in the case of FDI so that there is no contemporaneous, positive relationship between capital flight and FDI. But, we find avery, very strong relationship between the stock of FDI and capital flight, which prompts us to think of, that the relations between FDI and capital flight may be indirect. Here we look at the indirect linkages, channel which may establish this linkage between capital flight and FDI and we look at the role of FDI, of natural resources.
So, natural resources clearly, in our analysis, lead to capital flight in the sense that countries that are heavily endowed in natural resources also are exposed to high capital flight. This link can be direct, in the sense that the revenue from natural resources embezzled and channeled out of the country clandestinely into secret destinations in the form of private works. The relationship could also be indirect in the sense that endowment in natural resources creates incentive for [red seeking] on both domestic leaders and investors.
And this is especially important in the case of African countries where we see that natural resources are dominated by foreign, multinational corporations. This is different from other regions. For example, [inaud.] even the Middle East. In the Middle East, the majority of oil exporting companies are actually owned by nationals or governments of these countries. That’s different from Africa, where the majority of [inaud.] institutions are foreign, which creates a general front for not only tax evasion but also the siphoning out of the revenue from natural resources out of the country in the form of capital flight.
It also creates opportunities for ransacking on the part of governments, especially because of the high degree of discretion that the governments enjoy in the management of natural resources. So, in a country where you have bad institutions, lack of transparency, that leads to risk of corruption, ransacking, which will them establish a [mechanism] for channeling wealth out of the country in the form of private assets. So, that explains why we would find this high correlation between the so-called capital flight, the so-called foreign assets, FDI, and capital flight in countries that have high natural resources.
The third finding that comes out of our study is that good quality of institutions tends to mitigate this positive relationship between FDI and capital flight and that, again, our suspicion is that because in a country that is led by governments that have good institutions, transparency, accountability, that would reduce ransacking in the natural resource exploitation. That would reduce ransacking. That would reduce tax evasion. That would reduce smuggling of private wealth out of the country and therefore minimizing the likelihood of FDI promoting capital flight, which has some interesting implications.
For countries that have high natural resources, for them to benefit from this natural resource endowment in terms of promoting development, they would need to establish good, transparent institutions that enforce accountability and transparency in the management of revenue from natural resources.
PERIES: Right. So then, Leonce, if your research establishes a correlation between FDI and capital flight and cannot establish a definite cause of capital flight, speculate for us why there’s a correlation between FDI and capital flight. What might be causing capital flight?
NDIKUMANA: The correlation basically says that where we find high FDI we also find high capital flight. That could be because, as I indicated, when you look at the countries that attract the most FDI, it’s also the countries that have high natural resources, but unfortunately, [sadly] enough in the case of African countries, the countries that also feature prominently in terms of high natural resource endowment also feature prominently in bad governance. Therefore you have a corrosive environment where natural resources are exploited in an opaque environment and therefore generate revenue which is appropriated by the leaders or their private associates and ends up being channeled abroad secretly, outside of the official capital account transaction established by the government.
So, the sense we make out of this result is that bad governance in countries with high natural resource environment establishes that positive linkage between FDI and capital flight whereabout because high natural resources attract FDI, bad governance establishes, creates incentives and opportunities to embezzle the proceeds of natural resources and channel them, into foreign, private asset, private wealth held abroad in the form of capital flight.
PERIES: Right. All right, Leonce, so this seems to me a good place to pause and then we can come back and discuss what are the policy implications and what could be done to correct this. So, thank you for joining me for now.
NDIKUMANA: Thank you very much.
PERIES: And thank you for joining us on the Real News Network.
SHARMINI PERIES, EXECUTIVE PRODUCER, TRNN: It’s the Real News Network. I’m Sharmini Peries, coming to you from Baltimore.
In part one of this interview we are doing at this time with Leonce Ndikumana from U-Mass Amherst, we talked about a recently published paper that he co-authored, in which he questions the relationship between foreign investment, natural resources and capital flight. In the second part of the interview we are going to take a closer look at the policy recommendations that resulted from the research he did.
So, thank you for joining us again, Leonce.
NDIKUMANA: Thank you very much for another chance to talk about this paper.
PERIES: So, Leonce, the link between attracting foreign investment or foreign direct investment and capital flight, as your paper finds, what do these findings mean for economic policy?
NDIKUMANA: These findings are actually very relevant for economic policy. They have strong implications for how African countries use their policy tools to stimulate economic development. One of the arguments in the literature has always been that African countries should seek actively and aggressively to promote and incentivize foreign direct investment as a way of compensating and bridging the gap between domestic savings and their needs for investment.
But this is not easily done, in the sense that as countries try to incentivize FDI through the conventional means of reducing taxes, giving tax holidays, taxes on imports, on capital imports or on imports of [inaud.], that has a cost. There are two costs to it. One is revenue losses for the government. That means that the government is going to mobilize less revenue from economic activity. The argument is that the revenue lost at the investment stage will be gained when the companies become, start producing and the economic base increases and the tax base is going to increase.
The second loss is indirect, in the sense that as the governments try very hard to incentivize FDI they actually often, and very frequently significantly, end up discouraging domestic investment because they put domestic investments at a disadvantage with vis-a-vis foreign investors. Definitely if a domestic company wants to invest in agribusiness or in farming, in manufacturing, they have to compete with foreign investors who have tax holidays for 15, 20 years. It’s impossible to compete. That’s [what] you see in many countries in Africa where domestic investors being discouraged from investing in interesting sectors.
They end up basically finding ways of coming back as foreign investors. You hear those cases many comes. A Kenyan investor will go to, will find a Ugandan business operator who comes to invest in Kenya with Kenyan capital but a Ugandan face and vice versa. That creates a very distorted investment environment.
At the same time, what is very clear is that FDIs tend to seek very high reproductive and profitable sectors like oil, minerals and salt. In those sectors there is no need to go too far to [inaud.] to invest because the profit rates are very, very high, and when countries give 20, 25 tax holidays it’s generally not justified or not counting financing perspective.
The other thing that tends to happen is that because the government are so generous at providing for tax incentives, what you see is that foreign companies are perpetually into tax holidays. So, Company X gets a tax holiday for 15 years. Before the 15 years are over the company is sold to another company, Y, which gets another 15 years of tax holiday, and many times the investors are the same.
So, it’s really an environment where countries in Africa are losing out the opportunity to leverage their potential in natural resources. So, that calls really for revisiting the investment strategies that countries adopt in African countries. My sense is that the strategies should seek to incentivize investment, both foreign and domestic, and certainly not put at a disadvantage domestic investment.
PERIES: And how could a government actually do that? I was recently in Zambia and I noticed that when you are driving through Zambia all you see is large number of Chinese government corporations that are there working, Chinese private investments as well, all in exchange for, say, building the infrastructure, the roads to some of the natural resource sites that they now hold leases for. So even the infrastructure contributions that they’re making is really in their own interests so that they can actually drive the, in this case, nickel out of the country.
Now, what recommendations does your research have for foreign governments that are trying to tackle this issue which is very real? I mean, they need the infrastructure support but they also would like to stimulate local investment but they don’t have a means of doing it because they lack the resources to do it.
NDIKUMANA: Yes. So, excellent point. So, let’s be clear. In our paper and in all our research what we try to be clear about is that the fact that African Countries have vast natural resources is an advantage. It’s not a curse. It’s not a disadvantage. But, there are conditions that are required for African Countries to take advantage of this natural resource endowment. One is that in arranging the contracts with foreign direct investors in the country they need to be sure that they get a high share of the profits that accrue from natural resource exploitation.
Secondly, they have to do the best to maximize the benefits to the private sector, to the domestic private sector, the economy at large through what I call increasing the local content of the natural resource exploitation and investment. One, by doing the maximum to use material that’s created in the country when they build those infrastructure, when they build the [inaud.] to exploit natural resources incentivize the investment by nationals through joint ventures by nationals, through joint ventures or investments, second.
Third, by leveraging the revenue from natural resources to diversify the economy. So, the governments should make, create incentives for this revenue that’s coming from natural resources to be reinvested in creating new activities. Fourth, it’s by encouraging development of what we call valued change so that countries stop exporting raw material, so that countries begin to process their material domestically. That creates value. That creates employment. That creates new activities around natural resource exploitation.
The other thing is that the problem when you think about natural resources overall, the issue is not natural resource abundance. The issue is natural resource dependence, in the sense that the countries depend on a narrow set of natural resources which are not creating value and not creating spillover effect in the rest of the economy. African countries are not going to do it on their own in terms of preventing capital flight from natural resources.
It is important that the global community also comes down on secrecy jurisdictions, banking secrecy and illicit financial flaws in general and tax evasion by multinational corporations. In the end, these corporations have responsibilities not only in African countries where they operate but also in countries which are their host, where they are headquartered. The multinational corporations have the obligations to pay taxes where they operate, which is in Africa, and you find that many, many cases you have seen: Many case studies have been done, investigative reports that show that these multinational corporations pay little to no taxes in African countries because they play with lack of transparency, lack of coordination in terms of tax regimes between African countries and their trading partners so that these multinational corporations inflate their costs in African countries which deflates, underestimates their profits, and [they] pay no taxes while they are generating huge amount of profits at the company level.
PERIES: So then, what do you say to countries like Venezuela, Bolivia, countries that are resource rich and there’s a lot of foreign investments and those foreign investments, in the case of Venezuela, for example, in terms of the oil industry, they have introduced policy to have a larger share of the profits coming out of those contracts but at the same time, you know, they are highly dependent on that foreign investment because they actually don’t have the capacity to extract the oil on their own, so they are at least dependent, and I know this has been critiqued and you actually make this link with what’s going on in Latin America. So then, what are countries to do based on your research when it comes to needing to extract their natural resources but heavily dependent on foreign governments, I mean, foreign investments?
NDIKUMANA: Yes. So, I think that, in terms of the strategy to develop natural resources, over time there will always be a combination between foreign capital and domestic capital. Foreign technical technology and domestic technical capacity. What is missing now is that balance. We find that in African countries, Latin American countries, it’s way too much of foreign everything. Technology, even the human capital is foreign. As you told me, you were in Zambia. You find that it is foreign companies, foreign workers doing things actually domestic workers could do. That the responsibility in this case is in the hands of the local governments–
PERIES: –To demand it, do demand it of their–
NDIKUMANA: –To demand that foreign companies should use local human capital, local inputs whenever they are available. It’s not acceptable to find a Chinese or a Russian, American, European worker plowing roads or screwing screws and hammering nails when an Ethiopian, a Burundian, a Ugandan, an Angolan can do it. So, that–
PERIES: –And this kind of labor force development requires large investments from the government and these corporations in order to train the labor necessary to work, because when I was in Zambia I asked this question from various policymakers, and they said that they don’t have the resources for this kind of training and development of their workforce.
NDIKUMANA: Yes, but that’s, that is a little bit of exaggeration. I told you, I can see why a Chinese company would bring a top engineer to design the whole scheme of investment. I see no reason why they would bring somebody, all the workers to do the painting. I mean, Ethiopians, Burundians and Angolans, they can do the painting. They can do the screwing. They can do the plowing and all that.
At the same time, in terms of the capacity building, what is needed is for these African countries which are lucky enough to have natural resources, because actually they are lucky, is to design investment strategies where the revenue generated from these resources goes into building infrastructure but also developing human capacity. Decide what is the share of the revenue that goes into education, especially in science and technology. Decide how much revenue is going to go into financing capital investment, capital infrastructure, and then decide how much of the revenue needs to be invested in long term saving, sovereign wealth funds, as we call them.
Many countries many times have committed the sin of consuming too much during research booms, and they find themselves ill-prepared to deal with situations where the prices collapse, like now. So, countries that are prudent, that have a prudent management system of their natural resources have found that it is very, it comes handy when prices collapse as we had in 2007-2008. They are able to go into their revenue, their reserves and finance their current and capital expenditures.
So, a good savings strategy, a good human capital development strategy and a good public infrastructure strategy. That’s what they need.
PERIES: And they need to stop some of the capital flight. Is there a way of doing that?
NDIKUMANA: To stop the capital flight first of all is to increase transparency in the management of revenue from natural resources, Natural resources belong to the public. The first thing that should be done is that the management of natural resources, the contracts signed by multinational corporations with the government should be made public so that the public knows which site is being exploited by who and what the share of the revenue that goes to government and how much has been collected every year. That will be, that will go a long way in reducing the leakages of government revenue from natural resources.
The other strategy is to require also multinational corporations to report on their operations and then their profits on a country by country basis, not at the company level, so that if a company is operating in Angola we know how much turnover they made there, how much revenue they generated and how much taxes was paid. Transparency is paramount to changing the environment so that, to limit capital flight.
PERIES: Leonce, a lot to discuss here and a lot of great recommendations for developing nations. I thank you for joining us today and I hope to continue this discussion at another time. Thank you.
NDIKUMANA: Thank you very much.
PERIES: And thank you for joining us on the Real News Network.
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