A Development Comparative Approach to Capital Flight; the Case of the Middle East and North Africa, 1970-2002

Capital flight from developing countries represents a lost potential for economic growth and development. In the contemporary literature of development economics, there has been increasing attention to the notion of capital flight. Many analysts have attributed sluggish economic growth and persistent balance of payments deficits in most developing counties to capital flight (Ajayi, 1996). In addition, capital flight has adverse consequences for developing countries. First, the loss of capital through capital flight erodes the domestic tax base and therefore affects income redistribution. Secondly, it reduces a bank’s ability to create money for investment projects.

Most importantly, capital flight contributes to the distribution of income from the poor to the rich (See Pastor, 1990, and Ajayi, 1997). The literature also highlights several routes of capital flight from developing countries. Prime among those are external borrowing and trade mis-invoicing. Also many authors have identified factors that cause capital flight including risk of inflation, taxation, political risk instability, financial repression, weak institutions, ineffectiveness of macroeconomic policies, business cycles, overvaluation of exchange rates, and poor investment climate, to name a few (See, Hermes, Rensink and Murinde, 2002, Schneider, 2003 and Boyce and Ndikumana, 2002).

Several approaches to measuring capital flight have been cited widely such as the hot money measure, the balance of payments approach and the residual approach (See Schneider, 2003, and Hermes, Rensink and Murinde, 2002). However, it is well documented in the literature that most researchers use the residual method to capital flight. The residual approach is more inclusive and therefore gives a measure of capital flight that takes into account most transactions of capital flows between nations including external debt, foreign direct investment, and portfolio investment. The residual method is a broad measure and an indirect approach that is based on the discrepancies between sources of foreign exchange (capital inflows) and uses of those funds (capital outflows). Capital flight, according to this method, comprises the surplus of capital inflows over foreign exchange outflows that are not recorded in government official statistics.