Capital flight and foreign direct investment in Africa: An investigation of the role of natural resource endowment

Abstract

This paper aims to provide theoretical and empirical insights into the puzzling simultaneous rise in foreign direct investment (FDI) inflows in Africa and capital flight from the continent over the past decades. It specifically explores two questions: Is FDI a potential driver of capital flight? And, is natural resource endowment a possible channel for the capital flight-FDI link? The econometric analysis is based on 32 African countries over the period 1970-2013 using dynamic panel data estimation methods. Three important findings emerge from the analysis. First, while there is no robust evidence that capital flight is fuelled by annual FDI inflows (there is no equivalent to debt-fuelled capital flight), there is a positive relationship between the stock of FDI and capital flight. Second, natural resource endowment is directly related positively to capital flight and resource endowment is associated with a stronger FDI stock-capital flight link, especially in the case of oil. Third, high-quality institutions somehow weaken the link between FDI and capital flight, although they do not completely eliminate the relationship. The results point to potential gains from improvements in institutional quality in African countries through minimizing the contribution of FDI and natural resources to capital flight.

Determinants of Capital Flight in the East African Community

“…A strong economic growth signals higher expected returns on domestic investment which induces further domestic investment and thus reduces capital flight. In addition, a high and sustained economic growth also gives confidence to domestic investors about the institutional and governance environment of the country which encourages domestic investment while reducing incentives for capital flight (Schneider, 2003).The result is consistent with the findings of Ndikumana and Sarr (2016)econometric analysis on the role of natural resource endowment on capital flight based on 32 African countries over the period 1970-2013.…”

“…The magnitude of East Africa Community Member States' capital flight is staggering both in absolute monetary values and in relative GDP. According to Ndikumana and Sarr(2016), on average, EAC lost US $23.28 billion between 1988 to 2015 alone. However, if this capital would have been invested locally in income earning infrustructuresduring that period, it would have aided to minimize the debt burden since the region would have accummulated significant amount of capital to help in serving its economic development projects.…”

Governance and the capital flight trap in Africa

“…First, the expected signs from trade and FDI on capital flight cannot be easily established because they are contingent on whether FDI is limited to a few economic sectors or broad-based. Notwithstanding, it is very likely that trade and financial globalisation are associated with capital flight because of among others: more avenues for accounting malpractices like transfer mispricing (Ndikumana & Sarr, 2016;Asongu & Amankwah-Amoah, 2018). Second, very high inflation, for the most part, positively influences capital flight because it is associated with a negative economic/investment outlook as well as uncertainty in investment return.…”

Relationship between corruption and capital flight in Kenya: 1998-2018

“…It was also four times higher than the US$40-60 billion required every year to meet the Sustainable Development Goals (SDGs) by 2030 (Waris and Fröberg, 2011). Capital flight from Africa has been denoted as an illustration of the Lucas paradox (Lucas, 1990) (Ndikumana and Sarr, 2016). Ndikumana and Boyce (2018) gives evidence that African countries lose more through capital flight than they receive in the form of aid or foreign private investment.…”