Capital Flight, Illicit Flows

Capital flight is hard to define precisely. It is not quite the same as another widely used term – illicit financial flows – but there is a big overlap. Both terms are useful.

When people hear the term ‘capital flight’ they often think of money running away from a country to a ‘haven’ abroad, in the process doing harm to the home economy and society. The money may flee for various reasons: to escape tax, criminal investigation, risk and economic turbulence, confiscation, currency risk, or in pursuit of higher returns elsewhere. It is often, perhaps usually, illicit.

These are useful ways to think about capital flight. One good definition is “the transfer of assets abroad to reduce loss of principal, loss of return, or loss of control over one’s financial wealth due to government-sanctioned activities.” This definition makes two things immediately clear. First, they involve the concepts of ‘escape’ and ‘elsewhere’ – which are foundational for our understanding of what tax havens or secrecy jurisdictions are. Second, capital flight is intensely political, involving the relationships between government and wealthy citizens. This is all about class power, wealth, conflict and the state.

The term illicit financial flows is commonly defined as the cross-border movement of money that is illegally obtained, transferred, or used. The term has limitations because by definition it excludes many important phenomena such as abusive activities that may not necessarily involve lawbreaking. Yet it also has a big advantage: whereas the word ‘flight’ in capital flight puts the spotlight on the (developing) countries that are victims of the phenomenon, suggesting that the onus is on them to  address the problems, ‘illicit financial flows” does a better job of clarifying that this is a two-way street, involving the victim countries and the tax havens receiving it.

How big is the problem? Various studies exist. We would highlight two here.

The Price of Offshore, Revisited. James S. Henry, estimating $21-32 trillion in unreported, largely untaxed private wealth sitting offshore in 2010. For a sample of 139 mostly low-middle income countries, aggregate external debts were $4.1 trillion in 2010. But add their foreign reserves and the offshore private holdings of their wealthiest citizens, the picture flips into reverse: these countries had aggregate debts of minus $10.1-13.1 trillion, collectively making them major net creditors to the world. The report highlights the close relationship between these countries’ taking out large loans and subsequent capital flight, often within weeks of the loans being received. It also highlights the role of ‘hidden’ flight that does not involve outflows, but instead involves the growth of untaxed assets offshore.

Capital Flight from Sub-Saharan African Countries, 1970 – 2010 – James K. Boyce, Léonce Ndikumana. The 33 countries covered by this report lost a total $814 billion dollars from 1970 to 2010, for an accumulated capital stock (factoring in modest interest payments) of $1.06 trillion in 2010. This far exceeds their external liabilities of $189 billion, also making the region a “net creditor” to the rest of the world. The problem is that the assets are held by a small number of wealthy individuals, while their debts are shouldered by their populations through their governments.