The paradox of capital flow. Are developing countries in the process of financing rich countries?
Development Aid Decolonization Series, Episode 2:
This is a puzzle for economists: instead of capital flows from developed countries to developing countries, they appear to go in the opposite direction. Therefore, every year, hundreds of billions of dollars are smuggled from developing countries to rich countries, including Switzerland.
This content was published on October 11, 2021 – 4:25 p.m. July,
I announced this springexternal link The Organization for Economic Co-operation and Development says that more than $160 billion, equivalent to the gross domestic product of a European country such as Hungary: an “unprecedented” amount that developed countries allocate to official or official development assistance (ODA).external link) in 2020.
In this year of the pandemic, half of the donor countries have increased their contributions to help the least developed countries cope with the health crisis. This is the case of Switzerland, which secured $3.5 billion, about 9% more than the amount it saved in 2019.
Even before the global health crisis, official development assistance was on the rise, more than doubling in value since 2000, despite the crisis of 2008. On average, USD 120 billion was disbursed each year, totaling more than about USD 2,500 billion over twenty years, which is roughly equal to the annual gross domestic product of France.
However, a large number of experts underestimate the size of the aid granted by member states of the Organization for Economic Cooperation and Development. Because many of them, especially Switzerland, do not provide enough funds in relation to their international obligations (SWI swissinfo.ch devoted an article to this issue below). Although DAC members aim to set aside 0.7% of their gross national income for ODA of a public nature, this share did not exceed 0.32% in 2020.
According to some, it could also be maintaining the idea that money flows one-way from donor countries to developing countries, when things are not so simple. This was written, for example, by Jason Haykelexternal linka British expert specializing in economics, politics and global inequality, in the Guardian newspaperexternal link In 2017: “We are being told a story from the distant past (…) [مفادها] Rich countries in the Organization for Economic Cooperation and Development generously donate their wealth to poor countries (…) in order to (…) improve them in the field of development. (…) This novel is so widespread (…) that we have begun to take it for granted. However, rich countries receive far more inflows from emerging countries than are diverted in the opposite direction.
Permanent disability
Of course, development aid is not intended as a financial compensation for all existing inequalities between developed and developing countries, but this is “a very small thing considering the magnitude of the imbalance”, according to Rachid Bouhia.external linkEconomist at the United Nations Conference on Trade and Developmentexternal link (UNCTAD), based in Geneva.
In addition to being responsible for economic issues in the Department for Globalization and Development Strategies, he is a co-author of the briefingexternal link Published in spring 2020, it is one of the most recent works on this topic.
Details of the approved methodology
The United Nations Conference on Trade and Development (UNCTAD) graph shows the net transfer of financial resources, i.e. the sum of resource inflows and investment from abroad, minus the sum of resource outflows (including increases in foreign exchange reserves and repayments to foreign investors). The methodology used was adopted by the United Nations in the eighties of the last century.
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The note shows that the total amount of financial flows leaving developing countries is much higher than those entering them from rich countries (be it development aid, foreign direct investment or even trade flows).
A phenomenon from which Switzerland also benefits
Since the phenomenon is global, it is not possible to assess to what extent Switzerland has benefited from it separately. However, thanks to its position as a leading economic center and its advantages (from trade surplus, stable currency, safe financial assets, etc.), Switzerland “has many characteristics” to attract foreign financial flows and to be one of the countries that benefit from the system, according to Rachid Bouhya.
As one of the world’s largest raw material trading centers and home to many multinational corporations active in developing countries, Switzerland is also vulnerable to attracting illicit financial flows (see explanation below). That’s why NGOs, such as Global Financial Integrity, are calling on him to do moreexternal linkwhich criticizes its banking and tax system which, in its opinion, is still “unfair”.
In context, Gilles Carbonier mentionedexternal link. ». According to the professor, “It would be in Switzerland’s interest to play a leading role and try to put an end to the chaos.”
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Rachid Bouhia states that this phenomenon “contradicts neoclassical economic theory, according to which capital should naturally flow from rich countries to countries suffering from a capital deficit. It also shows that some of the development models that have been prominent in recent decades have not only failed, but have also caused a lot of fragility.”
The publication also notes that capital flight is the result of several factors, but is particularly linked to “financial fragility arising from the external debt of developing countries”.
Some countries, which are encouraged to borrow abroad for development purposes, have reached such high levels of indebtedness that they have found themselves in a spiral: interest payments and profit transfers are given priority over income.
Statistics show in this contextexternal link Compiled by the British NGO Debt Jubilee Campaign, which campaigns to reduce the South’s debts, the proportion of income spent on paying off foreign debt is rising. For example, the share approaches 60% in Gabon and 46% in Angola, compared to 3-4% in most Western European countries and 0.4% in Switzerland.
Rachid Bouhia also noted the trade balance deficit suffered by many developing countries, which import more than they export or export raw materials whose prices fluctuate greatly.
The economist stated, explaining that “many countries failed to develop their industry sufficiently to be able to export to developed countries and remained stuck in the “cycle of poverty”, he said.
It is worth noting that there is another factor: “In order to protect themselves from risks, developing countries have embarked on a race to accumulate foreign currencies, especially dollars.” This means that capital will leave the country that buys these currencies and enter the country that produces them.
Tens of billions of illegal money flows
Thus, the accumulated deficit of developing countries between 2000 and 2017 approached 11,000 billion dollars, of which 500 billion dollars was for 2017 alone (more than three times more than the total official development aid for that year).
These figures are official figures that do not take into account illicit financial flowsexternal link (Indicated as FFI, added to UNCTAD chart for clarity). These latter flows cover part of criminal business, money laundering, tax evasion, etc. But especially from legal trade “whose accounts are falsified (…) with the aim of manipulating taxes”, according to Gilles Carbonier, professor at the High Institute for International and Development Studies .
Simply put: some multinational corporations manipulate invoices so that they can report lower profits to the tax authorities in the developing countries where they are made, and then report them to countries where taxes are lower, as in the case of Switzerland.
In general, it is impossible to accurately quantify illicit financial flows. The Organization for Global Financial Integrity appreciatesexternal link, a non-governmental organization, that its annual value represents 20% of total trade in emerging countries with developed economies. As for Gilles Carbonier, who conducts research on this topic, he is sure that “the phenomenon is not that big, but it remains a real problem”. In this way, tens or even hundreds of billions of dollars avoid any possibility of being allocated to development.
Not everything is black or white
Based on this observation, economist Liliana Rojas Suarez callsexternal link To avoid hasty conclusions. As this honorary assistant at the Center for Global Development in Washington points out, aggregate methodologies cannot capture the specific situation of countries or complicate exchanges. And she confirms that these numbers don’t rise to the level of analysis, as she says, “They tell us a story to start the analysis.”
Liliana Rojas Suárez, who specializes in the relationship between financial flows and development, emphasizes the importance of monitoring these flows in terms of quality, not just quantity. In other words, the demonization of capital outflow is in principle (except illegal) meaningless. He says that investments, which are crucial for development, require a large transfer of resources. As for the debts, “what really matters is knowing whether the funds that were borrowed were allocated to activities that lead to growth and job creation” or not.
On the other hand, adds Liliana Rojas Suarez, the outflow of capital can be a “positive thing”, for example if the state decides to repay the loan before a certain deadline, it will also lead to the outflow of huge funds.
One conclusion, multiple methods
Also, the same symptoms may require several diagnoses, as different policies for rebalancing capital transfers are discussed within international organizations. As for the two priorities, for Liliana Rojas Suárez, they are the fight against illegal flows on the one hand and the increase of transparency regarding loans between countries on the other.
In this sense, he cites the example of loans, often with confidentiality clauses, that China agreed to grant to African countries under the New Silk Road.external link. The macroeconomist believes that only transparency allows us to know whether these huge loans are really more of a privilege than a trap.external link.
The expert believes that “loan contracts must be published, and we must know what their terms are, in order to assess whether they really benefit the state”. [النامية] And don’t expose them to excessive debt accumulation.
For its part, the United Nations Conference on Trade and Development (UNCTAD) supports some forms of protection, in addition to increasing development assistance, with the aim of helping developing countries to develop their industrial sector. The organization also calls for greater capital controls, “to mitigate the impact of investments that flow in and out without contributing to real development,” as Rashid Bouhia explained.
On the other hand, the United Nations Conference on Trade and Development has been calling for the allocation of SDRs for a long time, and it finally succeeded in realizing its request at the end of August 2021: the International Monetary Fund announced a record injection into the global economy of 650 billion dollars.external linkOf which 275 billion will go to developing countries.
Rachid Bouhia confirms that such measures, which until recently were a taboo subject in organizations such as the International Monetary Fund, are beginning to resonate. Is this an indication that the pandemic has brought about change? The near future is enough to answer this question.
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