Determinants Of Capital Flight In Nigeria

Project and Seminar Material for Sociology

Abstract

The verity that capital formation is a key to economic development is incontrovertible. Yet capital scarcity is norm in most developing nations like Nigeria. With this in view, this study examines the determinants of capital flight in Nigeria. In executing this crucial study, annual time series data, between 1980 and 2014 is used and error correction model (ECM) is employed after Augmented Dickey Fuller (ADF) unit root tests as well Johansen cointegration analysis has been applied to the variables.

In identifying the determinants of capital flight in Nigeria, the study employs the Residual method of measuring capital flight. Of the six variables modeled as the determinants of capital flight in Nigeria; exchange rate, real interest rate, external debt stock, economic openness and political instability are found to account for capital flight. Real gross domestic product is found not to be a significant determinant of capital flight in the country. The study recommends policy options aimed at abating capital flight as well as raising investment levels in the country.

Chapter One

Introduction

1.1 Background to the Study

According to (Ajilore, 2010) capital flight refers to any illicit movement of capital away from a domestic to a foreign economy. (Ndikumana and Boyce, 2002) also defined capital flight as residents’ capital outflows, excluding recorded investment abroad. ( Schneider , 2003) defines it as that part of outflow of resident capital that is motivated by economic and political uncertainty. This implies that such political uncertainty will involve likely change of government or governmental policies as denoted by country instability and all forms of minor and major changes in the political circumstance of the country.

According to (Noor et al, 2015), the movement of capital from domestic to foreign economy could be normal or economically good if it is of capital export or foreign direct investment. These flows of capital abroad, which are subjected to regulation and do not endanger national economy, would foster economic growth of a nation. However, the illicit movement of capital away from domestic to foreign economy would worsen the capital scarcity problem especially in emerging economies; thus, contributing to economic contraction as well as collapse of the financial markets. Generally, the illicit movement of capital abroad, which is also called capital flight, escapes government taxation and is motivated by economic and political uncertainties.

There are benefits and losses associated with capital flight but the losses far outweigh the gains, especially in the developing economies where it is so rampant. The individuals transferring and the receiving countries benefit while the citizens in the sending economies’ living standard are to an extent retarded from huge capital fight. This can account for persistent low living standard and lack of industrialisation. Capital flight and other illicit financial flows constitute a major constraint to development financing in Africa, a continent that continues to lag behind in most measures of human development (Ajayi and Ndikumana, 2014).

According to (Sachs et al.,2004), low capital thresholds, savings traps, and demographic traps all interact to produce a vicious cycle that keeps poor countries continually mired in poverty. It then appears that capital flight from Nigeria is not only creating problems by way of lost resources, but aggressively compounding already instituted problems.

The evidence in the literature suggests that there are multiple causes of capital flight, including domestic as well as external factors (Ndikumana et al., 2014). On the African side, capital flight is associated with the embezzlement of national resources, including external borrowing and extractive industry revenues, and with corruption and political instability. But external agents and institutions also contribute to capital flight from the continent. Capital flight is facilitated, in particular, by the opacity of the international banking system and by inadequate enforcement of rules on financial transparency and corporate accountability. Trade misinvoicing, an important mechanism for both capital flight and tax evasion, is made possible by inadequate exchange of trade information between African countries and their trading partners. This implies that efforts to stem and prevent capital flight must be organized on both domestic and international fronts.

(Boyce & Ndikumana, 2001) identify corruption as a factor contributing to capital flight. According to them it is political leaders who cause capital flight. They profit from their privileged positions to acquire and transfer funds abroad.

(Lessard and Williansom, 1987) refers to “capital flight” as capital that “runs away” or “flees” abnormal risk at home regardless of whether or not the flight is legal. However, the question of normality (or abnormality) of capital flight existence in any economy of the world becomes perplexing when looking at the level of development of a particular economy i.e. if the economy is a developing or a developed country. Hence, labelling capital outflows from the developing countries “capital flight” while similar flows from the industrialized/developed countries are called “foreign investment” is arbitrary. Thus the distinction between “flight” and normal capital outflow is a matter of degree, much like the difference between a “bank run” and normal withdrawal.

The past decades have witnessed growing attention in academia and in policy circles to the issue of capital flight from developing countries in general and from African countries in particular. Researchers are intrigued by the stunning paradox posed by large-scale capital flows both to and from Africa. While the continent receives a substantial amount of capital inflows in the form of official development assistance, external borrowing and foreign direct investment, it also suffers a heavy financial outflow through capital flight.

In all these, Nigeria has not been excluded as she has received appreciable attention from researchers. Concerns have been expressed about the magnitude, causes and consequences of these capital outflows, not least because the lack of financial resources for appropriate economic development has pushed Nigeria and most other sub-Saharan African (SSA) countries into external borrowing to augment domestic resources in their quest for economic growth. This is evident in the current 2016 federal government budget which has a whooping deficit of ₦2.22 trillion and is likely that this figure will increase as the price of crude oil falls below the budget bench mark of 38 dollars per barrel of crude oil. Also acquisition of foreign assets by residents has escalated even as developing countries search for external borrowings to enhance the inflow of resources.

In Nigeria, one of the unresolved and perturbing macroeconomic problems for the past two decades is the growing rate of capital flight. According to Sanusi, over $20 billion left the country from 2008-2009 as a result of capital flight (Vanguard Newspaper, 2009). This is just one way in which capital flight can adversely affect a country’s economic growth.

(The International Monetary Fund IMF, 1996) reveals that Nigeria suffered a loss of $7,573million between 1972 and 1989 to capital flight. Out of this total, the sum of US$7,362 million was lost between 1972 and 1978 against a capital inflow of $270 million within the same period. (International Financial Corporation, 1998) observed that Nigeria is among many African economies that have achieved significant lower investment levels as a result of capital flight. Such low level investment brought about by high rate of capital flight in Nigeria also has multiplier consequences on other aspect of the economy, including the alarming rate of unemployment as well as pronounced regressive effects on the distribution of wealth in Nigeria. The 2007 United Nation Conference on Trade and Development (UNCTAD) report showed that around $13 billion per year have left the African continent between 1991 and 2004. This represents a huge 7.6% of their annual GDP with Nigeria having external assets 6.7 times higher than her debt stocks. In addition, the total stock of illicit outflows from Nigeria between 2002 and 2011 was put at $142,274 million (Global Financial Integrity). Thus Capital flight has been regarded as a major factor contributing to the mounting foreign debt and inhibiting development efforts in the third world countries (Cuddington, 1986).
From the above, it becomes clear that for developing countries to ride in the fast lane of the growth process and elicit support from international financial institutions there is need for urgent policy action to reverse the capital outflows from their economies. Thus, a better understanding of the determinants of capital flight from Nigeria, as well as reliable measures to achieve possible capital flight reversals, may be a useful starting point in the realistic assessment of the prospects for renewed investment and growth in Nigeria. Thus the relevant question which forms the bane of this study is: what are the determinants of capital flight in Nigeria?

1.2 Statement of the Problem

The Nigerian economy over the years has been marred by periodic booms and bursts as reflected in her unsteady and unsustainable economic growth rates, which is not disconnected from her incessant political/ethnic tensions and instability as well as macroeconomic mismanagement. Notwithstanding, Nigeria has remained an oil rich country, earning an estimated $2.2 million a day in oil revenue and the 12th largest oil producing nation in the world. But the atmosphere of economic mismanagement, instability and political tension has kept the country from achieving its potentials.

(Unegbu, 2011), using World Bank statistics stated that 50% of Nigeria’s 150 million population is unemployed and that at least 71% of Nigerian youths are unemployed. Furthermore, “the UNDP in 2010 ranked the country 80th in a poverty survey of 108 developing nations that focused on severe deprivation. The agency gave Nigeria a Human Poverty Index (HPI) of 37.3, with 35% of the total population living in extreme poverty and more than 67 million of the population docketed as poor according to standard definitions” (Editor Vanguard, 2011). These discouraging indicators in the light of the fact that Nigeria is oil rich are grossly paradoxical and a clear case of what mainstream economics terms “resource curse”.

The above pictures of Nigeria are indication that the country is a developing or better still an underdeveloped economy. However, both the neoclassical and endogenous growth theories predict movement of capital from areas of high concentration with decreasing returns to scale to areas of low concentration, with increasing returns to scale (see Romer, 1996; Agenor, 2000). Yet developing countries like Nigeria continue to suffer massive outflow of development capital leading to the dearth of investment, high level of unemployment and yet an abundance of profitable investment opportunities. Such situation supports (Kalecki, 1955) who asserted that the central macroeconomic issue in a developing economy is that of increasing investment. Nonetheless, investment can only be increased if there is the availability of investible capital via “capital formation” or via capital inflow.

(Ajilore, 2010) records that on the average; more than US$18.8billion worth of capital was exported out of Nigeria annually between 1970 and 2004. He further states that not only is the country loosing substantial amounts of funds that could otherwise be used for development and further stabilization but that capital flight also punishes long term economic growth.

Given these considerations and the obvious fact that capital should flow into a developing country like Nigeria and not otherwise, the big questions remain; what makes capital “flee” from the country?

1.3 Research Questions

Based on the objectives clearly stated in section 1.3 as the motives underlying this research work, the following research questions have been generated as the burning questions that will guide this research work and are expected to be answered at the end of this work.

What are the determinants of capital flight in Nigeria?
Is there a long run relationship between the dependent and the independent variables?

1.4 Objectives of the Study

The main objective of this study is to reveal the determinants of capital flight in Nigeria. Therefore, the specific objectives are:

To reveal the determinants of capital flight in Nigeria.
To establish whether there is a long run relationship between the dependent and the independent variables.

1.5 Research Hypotheses

In line with the objectives of this study, the following hypothesis was formulated:

Changes in key economic variables (debt stock, exchange rate, real interest rate, economic growth rate, political stability and economic openness) do affect capital flight.
There is a long run relationship between the dependent and the independent variables.

1.6 Significance of the Study

The study through its findings and recommendations will help the various arms of government in Nigeria in stemming the outflows of capital from Nigeria to other countries.

The findings will also be of great benefit to future researchers in the field of capital flight in providing relevant literature in building up the course of study.

It will also benefit other scholars and students of Economics and other related fields who may use the findings for academic purposes.

1.7 Scope of the Study

This study shall concern itself with revealing the determinants of capital flight in Nigeria within the period 1980 to 2014. It will also establish whether there is a long run relationship between the dependent and the independent variables used in the research work.

Chapter Five

Summary, Recommendations and Conclusion

Preamble

This chapter presents the summary of major findings of the study, the recommendations made and the conclusions that are drawn, with a view to ensuring that policy makers will be better equipped with relevant policy directions to reverse the ugly trend of mass exodus of scarce capital from the country.

5.1 Summary of Findings

This study examined the determinant of capital flight in Nigeria. In executing the study, error correction mechanism is applied after determining cointegration of variables using the Johansen approach based on vector autoregressive (VAR) model.

From the result of the ECM, which was applied to, six variables – exchange rate, real interest rate, real gross domestic product, debt stock, economic openness and political instability considered as the relevant determinants of capital flight in Nigeria, real gross domestic product was found not to be a determinant of capital flight in Nigeria. Rise in exchange rate, real interest rate and political instability was found to stimulate capital flight in Nigeria. On the other hand more openness though contrary to expectation reduces capital flight.

Following this, the study agrees that there exists long-run relationship between exchange rate, real interest rate, real gross domestic product, debt stock, economic openness and political instability, and capital flight. There is also no adjustment to equilibrium in the model implying that the short-run disequilibrium in the model is not corrected in the long run.

5.2 Policy Recommendations

Policies stand as fundamental instruments for achieving economic outcomes. They could also spell doom if inadequately articulated (Dim & Ndubuisi, 2012). Against this backdrop we cautiously derive policy advice for Nigeria aimed at both quelling capital flight and spurting levels of domestic investment. They are

Control corruption and political strive: the need for this action is of course revealed by the study. By trapping systemic corruption which has proven endemic in Nigeria, residents as well as the outside world will develop more confidence in the economy. Also by capping political strife and instability, there will be more room for prediction which is relevant for business and investment. Owners of capital will fear less about policy reversals which may be harmful to their funds, investments, as well as their profits. In the end, capital flight reduces and domestic investment booms.
Accord sufficient priority to maintaining positive real rate of interest: this is crucial because lower domestic interest rates are inimical to savings and make foreign securities more attractive. But if interest rates are managed to make savings attractive, while not stifling domestic investment, capital flight will be capped and growth of domestic investment will be achieved as well.
Institute sound management of fiscal balance as well as the degree of economic openness: though contrary to theoretical expectation the study found fiscal balance to interact positively with capital flight, we however advice that Nigeria should maintain firm fiscal discipline. Issues of fiscal discipline are already gaining relevance in Nigeria as shown by the fiscal responsibility act (FRA); we commend such move and advice that the government should consolidate such efforts the more. Less fiscal deficit is believed to reduce flight. The positive correlation of flight and fiscal balance in the study is believed to be as result of offsetting forces in the Nigerian economy which limp the positive impact of fiscal balance. Openness also should be managed judiciously. Though found to interact inversely with capital flight, we however warn that being open to the extent that it constitutes a disincentive to the domestic economy will surely stimulate capital flight. Issues of capital controls as well as trade management should indeed be given attention when occasion calls for them.
Tackle sovereign/domestic debt growth: higher debt is found to reduce capital flight though contrary to theory. We however state that when debt gets so high it surely causes serious macroeconomic distortions. The international community begin to fear sovereign default, sovereign debts begin to lose favorable ratings (just like the case of Greece in 2011 and early 2012) and capital begin to flee in droves. Investments do not grow in the wind; it begins to decline as well. Therefore appropriate management of domestic debt stock is essential.
Limp exchange rate volatility: In view of the study findings, we proffer that the government should manage exchange rate effectively. The pressure on exchange rate is indeed high giving that Nigeria is a net importer of manufactured goods and consumables. The view is not that exchange rate should be allowed to appreciate, rather volatility should be curbed. There should be stability that gives room for investment forecast. In so doing, capital flight will be tamed and foreign direct investment as well as portfolio investment will be encouraged.

5.3 Conclusion

The exigency for capital formation in a developing nation like Nigeria can never be over emphasized. Capital flight has been proven in the study to be inimical to this urgent demand. The dearth of investment in Nigeria as well as other developing nations is a valid interpretation for the high level of unemployment, poverty as well as all other inhuman traits that are common in developing nations.

Nigeria is already acclimatized to policy formulation and reformulation. However, the huge penalty capital flight has been observed to impose on Nigeria is an indication that any dream of achieving economic development will not only first quell capital flight, but also in some way, have exported funds repatriated. Repatriation of capital might be impossible, but quelling capital flight is essentially practical. By adopting policy options above and applying them religiously, domestic wealth holders are sure to be swayed to retain their funds at home. Also foreign capital will be attracted since the policy options will engender the needed incentives to attract needed capital for development spending.

The acclivity of capital flight and the consequent diminution of domestic investment in Nigeria call for serious policy concern as well as attention. The proper move is from capping capital flight to surging domestic investment. Policy options that intend to promote domestic investment without giving due consideration to the issue of capital flight and its determinants are doomed to fail. Even when at the onset these policies seem promising, they in time will prove unsustainable.

Indeed, nothing more fitting can end this work other than the incontrovertible fact that capital flight is evil, in fact one of the greatest that can befall a developing nation. It exists to ensure that the goal of trapping income poverty via drastic spurt in the level of domestic investment (and thus employment creation), remains an elusive one. However, by applying the policy options, the evil can be trapped and giving its rightful place – abyss and not the Nigeria economy.

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