Capital Flight. The Hidden Hand in Nigeria's Economic Destruction

Table of Contents

“THE PREAMBLE”
“Basic Definitions”

COMPOSITION AND CONSTITUENTS OF CAPITAL FLIGHT
Hawala Transactions
Trade Miss-invoicing

THE IMPLICATIONS OF CAPITAL FLIGHT

CAPITAL FLIGHT: THEORETICAL EXPOSITIONS AND PRAXIS

Conclusions and Recommendations

Works Cited

“THE PREAMBLE”

Aman who mistakes night for daytime should increase his ability to withstand torments from the spirit.

Virtually, all macroeconomic sage, as well as, most scintillating economists stress that Nigeria’s economic somnambulism and financial crunch is consequent upon the following; dwindling of oil price in the international market, undiversified economy, unchecked inflation, high rate of unemployment and a little emphasis on the adverse effect of exchange rate volatility on economic growth, without a clear consideration of how capital flight contributes to the economic mess in Nigeria. Put differently, many scholars have actually exposed how the aforementioned macroeconomic variables are responsible for economic melt-down, but, the backwash of illegal financial exodus (capital flight) on the effeteness of Nigerian economy appears to have been jettisoned.

Capital flight, no doubt, had remained conceptually an elusive phenomenon. This is because it seems unclear what differentiates capital flight from normal capital outflows. So, capital flight is one of the terms that suffer from problems of definition and is therefore prone to various interpretations and applications. In fact, so confused is the term that many researchers in international economics, in attempting to give empirical support become guilty of the concept and as a result thrive on barefoot empiricism and outlandish intellectual circumvention.

“Basic Definitions”

Based on the controversial issues in the definition of capital flight, some analysts perceive capital flight as normal capital outflows. For instance, Schneider, B. (2003) argued that capital flight is the flow of residents’ capitals from domestic country to another due to political and economic risk, Kindleberger (1987) saw capital flight as a real resource transfer motivated by political and economic uncertainties, Cubbington (1986) viewed capital flight as a short term capital outflows. While some others consider capital flight as an abnormal or illegal capital outflows and transaction in situation where traders falsify their trade documents in order to keep their capital abroad. (Schneider, B. 2003)

Also, capital flight is the non-reporting of income earned from claims on non-residents in the balance of payment system in order to escape the control of the home government (Dooley and Kletzer; 1986).

In general, capital outflow from developed countries to developing countries is regarded as foreign investment. On the contrary, Ajayi; 2012) maintained that capital outflows from developing countries to developed nations is regarded as capital flight. Isu (2002) also went further to explain that all private capital outflows from developing countries whether short term or long term are classified as capital flight.

The reason for the above dichotomy is the belief that investors from developed economies are seen as responding to investment opportunities abroad while investors from developing nations are said to be escaping the high risk perceived and felt at home.

However,the Monkey and the Gorilla may claim to be one but the Monkey is Monkey, the Gorilla is Gorilla.Even though, capital flight has a plethora of definition and is subject to confusion based on being normal or abnormal and legal or illegal, we, through exegesis, follow the definition of capital flight given by Bhagwati (1964), Bhagwati et.al (1974) and Schneider (2003) that capital flight is an illegal transaction which occurs when traders keep capital abroad by the falsification of trade documents through deliberate under invoicing of exports and over invoicing of imports to draw conclusion that all illicit financial /capital outflows are called capital flight. This is because capital flight can also be transacted through several other channels such as cash movements or smuggling of goods, antiques, precious gems, Gold, Silver and other Jessicas. Bank transfers and swap arrangements are also possible conduit for capital flight. Similarly, expounding the argument of Ajayi, (2012), Khan and Hague (1987), we add that illegal outflows of capital from any country whether developed or developing are termed capital flight since there is no gain saying that virtually all investors whether from developed or developing economies base their investment decisions on the relative risks and returns at home and abroad. Therefore, investors around the world are rational and will thus search for better risk-return trade-off and portfolio diversification.

In resume’, capital flows, normal or abnormal inject a devastating and deleterious effect on the economy of the source country (Onwioduokit, 2007) cited in Uguru et al (2014). This is why Dooley (1994) and Uguru et.al (2014) maintained that the longer the capital flight remains, the worse are the consequences for economic activities, especially in a country that is heavily dependent on external financing.

COMPOSITION AND CONSTITUENTS OF CAPITAL FLIGHT

Since the most villainous bee would like to be in the midst of friends to be able to conceal its real identity, capital flight as a vehicle of economic devastation is not a standalone. It moves with various junks called the constituents of capital flight. The components of capital flight are as follows; trade miss-invoicing, transfer or transaction mispricing, bulk cash transfers, same-invoice faking, hawala transactions and miss-invoicing of services and other intangibles.

Hawala Transactions

The Arabic word “Hawala” means trust. Hence, hawala transactions are transactions done among two or more parties without promissory notes because the system is heavily based on trust. It is an alternative or parallel remittance system which works outside the circle of banks and other formal financial systems.

Hawala transaction is a popular and informal value transfer system based on the performance and honour of a huge network of money brokers. Simply put, it is an illegal/informal transfer of money without moving it physically leaving no traces or evidences.

Trade Miss-invoicing

Trade miss-invoicing is the primary method for transferring money illicitly across borders which involves deliberately misreporting the value of a commercial transaction on an invoice submitted to the custom. It is a form of Treat Based Money Laundering (TBML). Available statistics show that a significant majority of illicit financial flows (IFFs) from Sub Saharan Africa up to 71.5% or a total of US$ 482-4 billion were due to trade miss-invoicing. However, the volume of money lost in capital flight in Nigeria is the highest in Sub Saharan African countries (Ayadi, 2008).

According to the Global Financial Integrity’s (GFI) country rankings by largest average illicit financial flows 2004-2013, Nigeria ranked 10th out of 149 countries that experienced illicit money outflows within the period with total capital flight averaging 17,304 in millions of nominal U.S dollars.

Exhibit 1.1 shows the breakdown of the total volume of illicit financial outflows, in Nigeria from 2004 to 2013. While exhibit 1.2 shows a run-down of the portion of the total volume of capital flight due to trade miss-invoicing for the period under review.

EXHIBIT 1.1 ILLICIT FINANCIAL FLOWS IN NIGERIA (in millions of nominal U.S dollars)

Source:Global financial integrity’s illicit financial outflows from developing countries (2004-2013).

Exhibit 1-2:Capital flight due to trade miss-invoicing outflows (in millions of nominal U.S dollars)

Source:Global financial integrity

THE IMPLICATIONS OF CAPITAL FLIGHT

The negative consequences of illicit financial outflows clearly unclog our ideology for tenaciously upholding that capital flight is an iniquitous coefficient that propels all other vices that lead to national economic destructions and pandemonium.

Some of the pejorative implications of capital flight are enunciated as follows:

- Capital flight causes a slender in available resources, that is, it makes resourcesscarcer: An unstoppable increase in the illegal movement of capitals (both human and stock of physical capital, including raw cash) out of the Nigerian Economy, in addition to the existing scarce resources would make the total available resources become subnormal and the economy itself will become one of survival of the fittest. It is no longer news that when resources are very scarce, the prices of the available ones will rise dramatically leading to increases in the cost of production. If this happens, cost push inflation will come on to the throne of the economy and if left unabated would lead to stagflation where Nigeria currently finds itself.

Therefore, to control cost push inflation and inherent stagflation, serious checks must be put in place to reduce the rate of capital flight.

- Capital flight Reduces Government Revenues through the Erosion of the Domestic tax base.

Capital flight greatly reduces the efficacy of tax system and also shrinks the tax base by serving as a means for tax evasion. We are conversant with the fact that developing countries (Nigeria inclusive) rely heavily on different types of taxes and tax revenues because they lack well developed financial market that could facilitate the issuance of government securities to finance fiscal deficits.

Furthermore, Governments also have difficulties taxing income earned or wealth held abroad, and this may generate distortions in their revenues. For instance, government may borrow externally to invest in social infrastructural projects such as construction of roads and improvement in power supply system as well as provision of basic amenities such as pipe borne water, hospital centres and schools. These projects, which often have high social values typically cannot be financed by levying direct user charges. Hence, they must be financed by general tax increases. Although, the private sectors are part of the beneficiaries of the project, yet individuals may escape the taxes levied to finance the project by holding much of their increased wealth abroad. Since the ability of the government to tax these wealth is limited, it may encounter debt servicing problems even when it borrows to erect socially beneficial public investment projects.

- Capital Flight Declines Domestic Savings

Domestic savings, particularly, the private sector savings is a major source of developing countries’ savings mobilization pattern and it plays significant role in the Domestic investment process.

In fact, a more mechanistic interpretation of Harrod-Domar model suggests that economists, policymakers, business firms and the government must learn to “SAVE”and invest a greater proportion of their national income in order to grow their economies.

Contrarily, capital flight opposes this motion and goes against the objectives of domestic savings as it moves capital away from domestic economy thereby lowering the economy’s capacity to save. Hence, “when capital heaves, it never comes back.” Our great concern that departed capital never returns is derived from an assumed irreversibility in the allocation of domestic savings. Once the incentives for capital flight exist, and capital outflows occur, it may not be possible to bring about reflow of capital at later date. Capital flight, therefore creates a disincentive for domestic savings.

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