Financial Transparency Coalition

That Africa is poor is assumed, but rarely well explained. Generally, we—both in terms of those who study these issues and collectively as a society—have accepted the fact that Africa is underdeveloped. Yet this conclusion is neither forgone nor self-evident. Even more infuriating, it is often explained, but never sufficiently explained. That is, there are a lot of competing theories on the subject, but most fail to give a complete picture. Of course, it’s a complicated issue, so it makes sense that no one theory would prove universal. Yet, even with intense academic scrutiny, the picture is incomplete.

A new report by Global Financial Integrity and the African Development Bank may fill in some of these holes. The report, Illicit Financial Flows and the Problem of Net Resource Transfers from Africa: 1980-2009, finds that Africa is a “net creditor to the world,” meaning that, over the period of the study, the continent exported more capital than it received. It is difficult to overstate the importance of these findings in terms of our understanding of the question posed above, that is, Why is Africa poor?

Africa, at least in part, is poor because it is losing more money than it is taking in.

Let’s turn first to the competing explanations for poverty in Africa, then we’ll turn to the report and how it helps to fill some gaps in the economic thinking.

Economists have a lot of different ways to model economic growth (i.e., an expansion of real GDP per capita). Typically, economists think of economic growth as the result of the expansion of human and physical capital, or increased productivity as a result of technological advancements. There are a lot of different explanations for how to achieve these expansions, but the most basic are: productivity growth, quantity of labor, technological advancements, education and training, and quantity of capital.

There are many economic models that consider these factors in some combination, and include several others, to explain or predict economic growth worldwide. One of the most prominent of these is the Solow Growth Model, which explains economic growth using: changes in output per worker, changes in technological progress, the savings rate, the growth of the workforce, the depreciation rate, and the share of capital in output.

This model predicts that growth will be strong among countries with low levels of capital (i.e. developing nations), and countries will tend to converge in terms of output per capita and standard of living. That is, the model predicts that developing nations will eventually catch up with their developed counterparts. This model has done a pretty good job of explaining the experience of many countries, particularly those in Asia such as Japan, Hong Kong, and Singapore.

Yet this model and its competitors are an abysmal failure when it comes to explaining Africa’s growth experience. When modeling growth in Africa, the economic literature is commonly unable to account for Africa’s low growth performance. Not only do the models lack explanatory power, but their predictive power is generally exactly opposite to reality. Indeed, the gap between incomes in Africa and developed countries is not closing as the Solow Model would predict, but rather expanding.

Returning to the models, the heart of our understanding of growth is savings and investment. While not sufficient, a necessary condition for growth is investment: in machines and people. In a closed economy investment comes from savings, which is equal to deferred consumption (people face a trade off between saving and consumption). While most nations in our world are not in closed economies, the national saving rate turns out to be very predictive of a nation’s level of investment.

Economists have long recognized the risks of capital flight—that is the transfer of savings from developing to industrially advanced nations. The literature has noted that these risks include loss of savings or real capital, higher rates of inflation, and changes in exchange rates—all of which can negatively impact economic growth. But these accounts usually only consider only recorded outflows, a glaring omission. As the new report finds, illicit financial flows (i.e. unrecorded flows) were the “main driving force behind the net drain of resources from Africa.” Like, recorded outflows, these IFFs also reduce savings and real capital among nations, but until now, have largely been ignored. The authors also finds that IFFs grew at a much faster rate over the thirty year period than recorded transfers.

As it would turn out, by examining only recorded outflows, economists have minimized this problem—and its likely role in dampening economic growth—for a long time. The full picture thus suggests capital loss may play a much larger role, perhaps even a major role, in Africa’s poverty.

There are lots of viable explanations for Africa’s underdevelopment: corruption and the resource curse, inadequate transportation infrastructure, political instability, poor maritime geography (i.e. landlocked nations), and poorly drawn colonial borders. Yet these explanations ignore the question of capital and investment—arguably one of the most important drivers of economic growth. With the insights from this report, I hope we can add the role of capital flows to this list and, of course, work on solving the problem.