The world can stop capital flight now

Jomo Kwame Sundaram

KUALA LUMPUR. Curbing capital flight from developing countries is long overdue. New sanctions against Russian oligarchs show this can be done with the requisite political will. Recent research also shows how to more effectively stop capital flight.

Capital flight

Capital flight is widespread, with resource-rich countries more vulnerable. ‘Mis-invoicing’ exports and embezzling export earnings of state-owned mineral companies have been central to such wealth appropriation.

Capital flight is enabled, not only by national conditions, but also by transnational facilitators. Internationally, capital flight is aided by institutions and professional enablers such as bankers, lawyers, accountants and consultants.

Capital should flow to investments yielding the most returns. But economic theory suggests making more depends on appropriating what economists call ‘rents’. These rents may be secured by many means, legal or otherwise.

Developing countries – especially resource-rich economies – are generally more susceptible to abuse. Wealth buys power and influence, enabling further accumulation. Thus, in the real world, natural resource endowments become a curse – not a blessing.

Since the 1990s, the IMF’s sixth Article of Association – authorizing national capital controls – has been ‘flexibly reinterpreted’ by management and staff. Instead of protecting national economies, they have eased transborder capital flows – and flight.

To add insult to injury, advocates falsely claim that more capital will thus flow into, rather than out of developing countries. After all, conventional economic theory insists capital flows from ‘capital-rich’ to ‘capital-poor’ countries.

The reality of capital flowing ‘upstream’ – to rich countries – underscores how mainstream economic textbooks mislead. Clearly, the real world is very different from the one that such economists believe should exist.

Enabling illicit outflows

Unsurprisingly, the wealthy – especially the ‘crooked’ – want to keep their assets abroad – beyond the reach of national authorities, and rivals. As such wealth has often been acquired illicitly, owners want to protect themselves from investigation, prosecution and expropriation.

Capital flight is enabled by transnational financial networks with considerable influence. These involve global banks and financial institutions, auditors and accounting firms, tax lawyers and consulting firms for hire. Along with corporate executives and government officials, they facilitate capital flight, sharing in the spoils.

With both states and markets at their disposal, transnational financial networks successfully overcome national constraints. Prerogatives of national sovereignty are also abused to obscure their transactions and operations from surveillance.

Capital flight is enabled, even incentivized by national environments allowing the wealthy to surreptitiously sneak financial assets offshore. Instead of helping developing countries protect their meagre assets, international financial institutions have facilitated, even worsened the haemorrhage.

Elites influence the law and its enforcement, typically by employing enabling professionals and friendly legislators. After all, laws and governments are neither impartial nor efficient, constantly reshaped by influence, often connected to wealth. Hence, some illicit activities and wealth may be unlawful while others may not be.

National legal jurisdictions have been changed to ease cross-border flows. Rules, norms and practices have been changed to hide wealth transfers from national and international authorities, rules and regulations. Hence, natural resource endowments especially enable capital flight.

Such outflows may even be triply illicit – in terms of mode of acquisition, concealment from tax authorities, and transfer across borders. But not all illicitly transferred flight capital is illicitly acquired. Conversely, illicitly obtained wealth – ‘laundered’ before being transferred abroad legally – is not deemed capital flight.

Some capital flight involveslegally acquired wealth illicitly transferred abroad. This may be reported as trade-related payments on the current account – not involving capital account transfers. They may thus bypass, or even contravene capital controls and foreign exchange regulations.

They strive to evade detection, prosecution, litigation, fines, charges and taxes by various revenue authorities. Illicit foreign exchange outflows secretly transferred abroad and not recorded in official national accounts may not be deemed illegal.

Hence, the volume and significance of capital flight estimates tend to be understated. Capital flight is easier from most developing economies – which have become more open in the last four decades with economic liberalization, often demanded by structural adjustment programmes.

Why stop capital flight?

Transnational corruption – across national borders – undermines governance and national resource mobilization needed to enhance productive investments. But many advocates of opening capital accounts justify capital flight by blaming it on allegedly predatory or incompetent governments.

The international financial system features enabling capital flight often also facilitate tax avoidance and evasion by the wealthy. Thus, capital flight doubly undermines domestic resource mobilization by leaching both investible and government resources.

Transborder capital flows avoid or minimize taxes paid, while hiding beneficiaries’ identities and wealth in secretive offshore tax havens. Government finances are also directly hit when externally borrowed funds, or state-owned enterprises and natural resources are embezzled.

Worse, government or public foreign debt has often been abused to directly finance capital flight. Meanwhile, illicit offshore flight capital goes untaxed. This shifts the tax burden to the middle class and domestic businesses unable to sneak their assets abroad, or to otherwise avoid revenue authorities.

Many developing countries continue to suffer significant resource outflows, largely due to illicit capitalflight. On the trail of capital flight from Africa: The Takers and the Enablers – edited by Leonce Ndikumana and James Boyce – studies this blight in sub-Saharan Africa. The world has much to learn from their forensic analysis.

The volume estimates haemorrhage from African countries since 1970 at US$2 trillion! Of this, almost 30% has been lost in the 21st century. Adding interest, cumulative offshore assets were US$2.4 trillion by 2018 – more than thrice Africa’s external debt!

The West’s piecemeal approach to sanctions targeting individuals is recognized as costly, time-consuming and ineffectual. Instead, the editors recommend a pre-emptive, across-the-board effort to undermine transnational networks enabling illicit financial flows. This should begin with closing financial system loopholes.

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Sri Lankan economic crisis inflicted by self-serving elite

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR. Once deemed a basic human needs success story, Sri Lanka (SL) is now in its worst economic crisis since independence in 1948. Nonetheless, SL’s ‘moment of truth’ now offers lessons for other developing countries.

China scapegoat

SL has just defaulted on its foreign debt for the very first time. Attributing its current predicament to a Chinese ‘debt-trap’ is a new Cold War propaganda distraction – which we will undoubtedly hear much more of.

In this fable, SL is a country caught in a debt trap due to white elephant projects mooted and financed by borrowings from China. Blaming SL’s debt crisis on Chinese loans is not only factually wrong, but also prevents understanding the origins and nature of its current crisis.

Outstanding SL government foreign debt in April 2021 was US$35.1bn. Policy errors have reduced foreign direct investment (FDI), exports and government revenue, changing the composition of its foreign debt for the worst.

Debt to the Asian Development Bank (ADB), World Bank, China, Japan and other bilateral lenders, including India, came to about a tenth each. Borrowing from capital markets – 47%, or almost half – is mainly responsible for its debt unsustainability.

After all, borrowing from multilateral development banks – mainly the World Bank and ADB – and bilateral lenders are mostly on concessional terms, while debt from commercial sources incurs higher interest rates.

Commercial loans tend to be more short term, and subject to stricter conditions. As sovereign bonds or commercial loans become due, their full value must be repaid. External debt servicing costs surge accordingly.

As of April 2021, about 60% of SL’s debt was for durations of less than ten years. The US dollar denominated debt share rose sharply – from 36% in 2012 to 65% in 2019, as Chinese renminbi denominated loans remained around 2%.

Adding government guaranteed debt to state-owned enterprises, total borrowings from China were 17.2% of SL’s total public foreign debt liabilities in 2019. Meanwhile, commercial borrowings grew rapidly from merely 2.5% of foreign debt in 2004 to 56.8% in 2019.

The effective interest rate on commercial loans in January 2022 was 6.6% – more than double that for Chinese debt. Unsurprisingly, SL’s interest payments alone came to 95.4% of its declining government revenue in 2021!

Deep-rooted problems

Following its 2001 recession, SL recovered, before growth declined again after 2012 and the pandemic contraction in 2020. SL also experienced premature deindustrialization, with manufacturing’s GDP share falling from 22% in 1977 to 15% in 2017.

Government tax revenue declined from 18.4% of GDP (1990-92 average) to 12.7% (2017-19), and a 8.4% pandemic nadir in 2020. Non-tax revenue – mainly dividends and profits from public investments – fell from 2.3% of GDP in 2000 to 0.9% in 2015.

SL’s exports-GDP ratio almost halved from 39% in 2000 to 20% in 2010. This took a big hit during the pandemic, dropping to 17% in 2020. From 2000, FDI inflows into SL were between 1.1% and 1.8% of GDP, before falling to 0.5% in 2020.

During 2012-19, the share of International Monetary Fund (IMF) Special Drawing Rights (SDRs) in SL’s debt stock fell from 28% to 14%, as borrowings ballooned! SL’s debt crisis is clearly due to the policy choices of successive governments since the 1990s.

Crisis-prone

In February 2022, SL had only US$2.31 billion in foreign exchange reserves – too little to cover its import bill and debt repayment obligations of US$4 billion.

Its 22 million people face 12-hour power cuts, and extreme scarcities of food, fuel and other essential items such as medicines. Inflation reached an all-time high of 17.5% in February 2022, with food prices rising 24% in January-February 2022. But economic crisis is not new to SL.

As a commodity producer – mainly exporting tea, coffee, rubber and spices – export earnings have long been volatile, vulnerable to external shocks. Foreign exchange earnings have also come from ready-made garments, tourism and remittances, but their shares have grown little over decades.

Since 1965, SL has obtained 16 IMF loans, typically with onerous conditionalities. The last was in 2016, providing US$1.5 billion over 2016-19. Required austerity measures have squeezed public investment, hurting growth and welfare.

Two recent shocks made things worse. First, bomb blasts in Colombo churches and luxury hotels in April 2019 drastically cut tourist arrivals by 80%, squeezing foreign exchange earnings.

Second, the pandemic has damaged not only economic activity, but also foreign exchange reserves, as it often paid monopoly prices to get COVID-19 tests, treatments, equipment, vaccines and other needs.

Tax cuts galore

The ethno-populist policies of the Gotabaya Rajapaksa government – which came to power in 2019 – have added fuel to fire. Successfully mobilizing majority Buddhist Singhala sentiment – against Tamils, Muslims and Christians – he sought political support by cutting taxes on the ‘middle class’.

His government cut taxes across the board, collecting only 12.7% of GDP in revenue in 2017-19 – one of the lowest shares among middle-income countries. Losing about 2% of GDP in revenue, its tax-GDP ratio fell to 8.4% in 2020.

SL’s value-added tax rate was cut from 15% to 8%, while the VAT registration threshold was raised from one to 25 million SL rupees monthly. Other indirect taxes and the ‘pay-as-you-earn’ system were abolished.

The minimum income tax threshold was raised from 500,000 SL rupees annually to three million, with few earning that much! Personal income tax rates were not only reduced, but also became even less progressive.

The corporate income tax rate was cut from 28% to 24%. With a 33.5% drop in registered taxpayers (corporate and individual) between 2019 and 2020, SL’s tax base shrank.

Thus, even more of the population became exempt from direct taxes, increasing government popularity, especially among the middle class. But tax cuts failed to spur investment and growth – despite old claims by Ronald Reagan, Donald Trump and their ‘guru’, Arthur Laffer.

Successive SL governments thus failed to increase tax collection, squeezing government revenue. To finance budget deficits, they increasingly borrowed from international capital markets – at higher commercial rates, with shorter maturities.

As the government cut tax rates and exempted most from paying income tax, government revenue fell. Due to its falling revenue and deteriorating credit rating, the government had to borrow more, at higher interest rates.

Facing fiscal and foreign exchange constraints, the government declared SL a 100% organic farming nation in April 2021. Banning all fertilizer imports – ostensibly to promote ‘agro-ecological’ farming as part of a larger ‘green’ transformation – compounded the looming ‘perfect storm’.

Dropped in November 2021, the policy drastically cut agricultural output, with more food imports becoming necessary. Falling tea and rubber output also reduced export earnings, exacerbating foreign exchange shortfalls.

Evidently, the SL government addressed the economic challenges it faced with ‘populist’ policy choices. Instead of addressing longstanding problems faced, this effectively ‘kicked the can’ down the road, worsening the inevitable meltdown.

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China debt traps in the new Cold War

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR. As China increases lending to other developing countries, ‘debt trap’ charges are growing quickly. As it greatly augments financing for development while other sources continue to decline, condemnation of China’s loans is being weaponized in the new Cold War.

Debt-trap diplomacy?

The catchy term ‘debt-trap diplomacy’ was coined by Indian geo-strategist Brahma Chellaney in 2017. According to him, China lends to extract economic or political concessions when a debtor country is unable to meet payment obligations. Thus, it overwhelms poor countries with loans, to eventually make them subservient.

Unsurprisingly, his catchphrase has been popularized to demonize China. Harvard’s Belfer Center has obligingly elaborated on the rising Asian power’s nefarious geostrategic interests. Meanwhile, as with so much else, the Biden administration continues related Trump policies.

But even Western researchers generally wary of China dispute the new narrative. A London Chatham House study concluded it is simply wrong – flawed, with scant supporting evidence.

Studying China’s loan arrangements for 13,427 projects in 165 countries over 18 years, AidData– at the US-based Global Research Institute – could not find a single instance of China seizing a foreign asset following loan default.

China has been the ‘new kid on the block’ of development financing for more than a decade. Its growing loans have helped fill the yawning gap left by the decline and increasing private business orientation of financing by the global North.

Instead of tied aid pushing exports, as before, it now shamelessly promotes foreign direct investment from donor nations. Unless disbursed via multilateral institutions, China’s increased lending to support businesses abroad has not really helped developing countries cope with renewed ‘tied’ concessional aid.

Grand ‘debt trap diplomacy’ narratives make for great propaganda, but obscure debt flows’ actual impacts. Most Chinese lending is for infrastructure and productive investment projects, not donor-determined ‘policy loans’. Some countries ‘over-borrow’, but most do not. Deals can turn sour, but most apparently don’t.

While leaving less room for discretionary abuse in implementation, project lending typically puts borrowers at a disadvantage. This is largely due to the terms of sought-after foreign investment and financing, regardless of source. Hence, the outcomes of most such borrowing – not just from China – vary.

Sri Lanka

Sri Lanka’s Hambantota Port is the most frequently mentioned China debt trap case. The typical media account presumes it lent money to build the port expecting Sri Lanka to get into debt distress. China then supposedly seized it – in exchange for providing debt relief – enabling use by its navy.

But independent studies have debunked this version. Last year, The Atlantic insisted, ‘The Chinese “Debt Trap” Is a Myth’. The subtitle elaborated, “The narrative wrongfully portrays both Beijing and the developing countries it deals with”.

It elaborated: “Our research shows that Chinese banks are willing to restructure the terms of existing loans and have never actually seized an asset from any country, much less the port of Hambantota”.

The project was initiated by then President Mahindra Rajapaksa – not China or its bankers. Feasibility studies by the Canadian International Development Agency and the Danish engineering firm Rambol found it viable. The Chinese Harbour Group construction firm only got involved after the US and India both refused Sri Lankan loan requests.

Sri Lanka’s later debt crisis has been due to its structural economic weaknesses and foreign debt composition. The Chatham House report blamed it on excessive borrowing from Western-dominated capital markets – not Chinese banks.

Even the influential US Foreign Policy journal does not blame Sri Lanka’s undoubted economic difficulties on Chinese debt traps. Instead, “Sri Lanka has not successfully or responsibly updated its debt management strategies to reflect the loss of development aid that it had become accustomed to for decades”.

As the US Fed tapered ‘quantitative easing’, borrowing costs – due to Sri Lanka’s persistent balance of payment problems – rose, forcing it to seek International Monetary Fund help. Some argue borrowing even more from China is the best option available to the island republic.

To set the record straight, there was no debt-for-asset swap after Sri Lanka could no longer service its foreign debt. Instead, a Chinese state-owned enterprise leased the port for US$1.1 billion. Sri Lanka has thus boosted its foreign reserves and paid down its debt to other – mainly Western – creditors.

Also, Chinese navy vessels cannot use the port – home to Sri Lanka’s own southern naval command. “In short, the Hambantota Port case shows little evidence of Chinese strategy, but lots of evidence for poor governance on the recipient side”.

Malaysia

China has also been accused by the media of seeking influence over the Straits of Malacca, through which some 80% of its oil imports pass. Debt-trap proponents claim Beijing therefore inflated lending for Malaysia’s controversial East Coast Rail Link (ECRL).

The Chatham House report notes, “The real issue here is not one of geopolitics, but rather – as in Sri Lanka – the recipient government’s efforts to harness Chinese investment and development financing to advance domestic political agendas, reflecting both need and greed”.

ECRL was initiated by convicted former Malaysian prime minister Najib Razak. Ostensibly to develop the less developed East Coast of Peninsular Malaysia as part of China’s Belt and Road Initiative, it rejected other less costly, but much needed options.

Borrowings are far more than needed – probably for nefarious purposes. Loan terms were structured to delay repayment – to Najib’s political advantage by ‘passing the buck’ to later generations. But such abuse is by the borrower – not the lender – unless Chinese official connivance is involved.

Non-alignment for our times

There is undoubtedly much room for improving development finance, especially to achieve more sustainable development. Instead of mainly lending to the US, as before, China’s growing role can still be improved. To begin, all involved should respect the United Nations’ principles on responsible sovereign lending and borrowing.

After more than half a century of Western donors’ largely betrayed promises, China’s development finance has significantly improved ‘South-South cooperation’. Meanwhile, sustainable development finance needs – compounded by global warming, the pandemic and Ukraine war – have increased.

After decades of the West denying China commensurate voice in decision making, even under rules it made, its role on the world stage has grown. But instead of working together for the benefit of all, rich countries seem intent on demonizing it. Unsurprisingly, most developing country governments seem undeterred.

As the new Cold War and the scope of economic sanctions spread, collateral damage is undermining development finance and developing countries. To cope with the new situation, developing countries need to consider building a new non-aligned movement for our dark times.

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