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December 18, 2014

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December 18, 2014

$2 leaving developing countries for every $1 going in – big new report on the state of global financial flows

December 18, 2014
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A very useful new report from Eurodad, published today, provides ‘the most comprehensive review of the quantity of different financing sources available to developing finance cogscountries, and how they have changed over the past decade.’ This in the run up to the big UN summit on financing for development (FfD) in Addis Ababa in July 2015.

Here are some highlights from the exec sum:

‘We have analysed the best available data produced by international institutions, both from the point of view of developing countries as a whole, and for low-income (LICs), lower-middle-income (LMIC) and upper-middle-income countries (UMICs) separately. Unlike other recent analyses, we have not just examined the resources flowing into developing countries, but have also analysed the resources flowing out, identifying the lost resources.

We examine four very different categories of resources:

  • Domestic resources, including domestic investment and government revenue;
  • Lost resources, including illicit financial flows, profits taken out by foreign investors, interest payments on foreign debt and lending by developing countries to rich countries.
  • Inflows of external resources, including international public resources (aid and other official flows), for-profit private flows (foreign direct investment and portfolio investments in stocks and shares) and not-for-profit private flows (including charitable flows and remittances from migrant workers);
  • Debt creating flows, both public and private borrowing by developing countries.

 

One key finding of the report is that losses of financial resources by developing countries have been more than double the inflows of new financial resources since the financial crisis.

Lost resources have been close to or above 10% of GDP for developing countries as a whole since 2008. The main drivers of this are illicit financial flows, profits taken out by foreign investors and lending by developing countries to rich countries. [more on illicit flows, which are increasing much faster than global GDP, here]

infloes_losses_infographic

Our main findings for each category of resource are as follows:

Domestic resources: Domestic resources are far larger than all external financing sources for developing countries, with domestic investment reaching over 33% of GDP and government revenue over 18% in 2012. UMICs have reached $2,700 per capita domestic investment annually, while LICs manage only $165 per capita.

There are low levels of public investment in LICs – 3.5% of GDP in 2011, compared to over 9% in LMICs.

Losses of domestic resources.

  • Outflows of domestic resources represent major losses for developing countries, and have been running at double the inflows of new resources since 2008, as Figure 1 shows.
  • LICs are particularly badly affected, losing more than 17% of GDP in 2012.
  • The largest outflows were illicit financial flows ($634 billion in 2011) and profits repatriated by international investors ($486 billion in 2012).
  • In 2012, developing countries lent $276 billion to rich countries, and paid $188 billion in interest on external debts.
  • Since 2010, repatriated profits have exceeded new inflows of Foreign Direct Investment (FDI), with LICs particularly affected, with outflows of over 8% of GDP.

 

International public resources:

  • Country programmable aid (CPA) levels, while increasing in absolute terms to a high of $96 billion in 2011, have been falling relative to developing country GDP, which has been growing at a faster rate.
  • In LICs, however, aid remains an important resource, with CPA accounting for over 7% of GDP in 2012.

 

International for-profit private flows

  • FDI to developing countries was badly hit by the global crisis and remains below its 2008 peak. Rising GDP means it has fallen as a percentage of GDP from 3.2% in 2008 to 2.1% in 2012.
  • LICs, however, have had steadily increasing amounts of FDI compared to GDP, rising from 2.6% in 2003 to 5.1% in 2012, driven by a small number of countries.
  • For-profit flows can be highly volatile, particularly portfolio equity flows of stocks and shares, which rose sharply for developing countries before the global financial crisis drove them into negative figures in 2008.

 

International not-for-profit flows

  • Remittances from private emigrants to their families back home increased from just over $130 billion in 2003 to more than $350 billion in 2012, although this figure may be due to improvements in data collection.
  • Remittances are particularly important in LICS and LMICs; they represented 7% of GDP in LICs and 4.6% in LMICs in 2012. They are highly concentrated in a small number of countries.

 

Debt-creating flows

  • Since 2006, there has been a sharp increase in new debt taken on by developing countries, driven by LMICs and UMICs.
  • Developing country debt stocks reached their highest level ever in 2012 – $4.8 trillion, according to the World Bank – which was largely driven by increases in indebtedness by private actors.
  • LIC governments have remained heavy net borrowers throughout the period, averaging between 1.3% and 2% of GDP in additional long-term borrowing between 2003 and 2012.

 

And here’s the killer infographic gain_lose_infographic_twitter

13 comments

  1. Duncan, this is an interesting post and an overarching point I’m interested in discussing with students. But, on that $2 amount, it’s not clear to me that inter- or multinational firms ‘taking out’ profits should count as a ‘loss’. As in, I don’t know what the relevant counterfactual is: is it that all the ‘profits’ stay in the country? That seems odd to me because then the firm/shareholders are basically sacrificing residual claimancy and then there would be little incentive to invest in the first place (i.e. the FDI amount in the ‘gains’ bit would be zero).

    Second, it’s also not clear to me why lending to rich countries should count as a loss, rather than as an asset to the developing countries (a promise to repay with interest). Certainly, the money might have been spent by domestic institutions on domestic projects, but I don’t think that a financial institution would get the same interest rate or the same loan guarantees for domestic loans (regardless of the social worth of such investment, which is a separate issue; though it does relate to volatility and domestic risk management).

    If the infographic loses those two categories, then it’s they gain $1 for every $1.07 they lose, which isn’t as much of a headline-catcher (though still deeply worrying). With the re-calculation the majority of the losses come from illicit financial flows.

    1. Hi Simon
      Good questions – here’s my answers, based on the research / thinking I did when writing the report.

      FDI profits: First, the investor makes two gains on a successful investment – the profits yes, but also the increase in value in the shares they hold in the company. So I think it’s far from true that the ‘FDI gains would be zero’ if they didn’t take profits out. Second, we were estimating losses as money that – from the standpoint of the developing country – would be better if it weren’t transferred out of the country. Hence, yes, it would be better if some of that profit was reinvested rather than leaving the country. The fact that outflows of profits have been higher than inflows of new FDI since 2009 also points to the fact that developing countries could certainly do better at gaining a share of this as tax.

      Lending to rich countries – the point here is that they are doing this as an insurance mechanism, by building reserves to protect their currencies and their economies. If there were better systems of regional and global cooperation – a radically improved IMF, or an annual allocation of SDRs – then there would be less need for this.

      The other point to make is that the ‘loss’ category is only a subset of outflows – i.e. there are also outflows of FDI, portfolio investment etc which we do not count as a loss. So the overall balance sheet of money in vs money out is considerably more negative than this.

      Hope these thoughts are helpful. Jesse

      1. This is very interesting. There are other FDI flows to consider. Some foreign companies repatriate significant sums through excessive management fees, licensing, royalty and franchising arrangements as a way of managing the size of their in-country investment and reducing their exposure to profits tax. In an ideal world this would not happen, but companies have a duty to their shareholders to ensure responsible allocation of assets, and there has been an unfortunate history of asset grabbing, renationalisation or other outright theft of foreign controlled corporate assets which any corporate manager will need to take into account.

    2. Your point about treating “profits taken out” and “lending to rich countries” as losses is interesting, all the more so since I don’t see either “taxes on said profits” or “interest on said loans” treated as gains. There must be reasons for this, but whatever they are, the upshot surely is the need to curb illicit financial flows, which surely is a headline-catcher.

    3. Simon, you are confusing assets/liabilities with cash flows. The report is presenting a cash-flow analysis. Your points about the FDI profit repatriation and reserves invested in US Treasuries are about the balance sheet of the country.

      Of course both types of analyses would be important – this is why corporate accounts always produce both. On a balance sheet all those inward private flows would not be counted as a “gain” but as liabilities as well – reflecting the “residual claimancy” as you call it.

      Likewise it is not clear that everything here is like for like. The flows are important from a balance of payments perspective – but then they are not complete, entirely missing export earnings and import expenditure. If we are trying to talk about resources available for “development” investment – then FDI and ODA and remittances (for example) are all wildly different – in purpose, modalities, governance, etc.

      1. Peter, you’re absolutely right. My error for skimming this too quickly before commenting (a failing I chide myself for whenever I do it, so apologies again). Your point about like-for-like is what I ought to have said.

    4. Hi Simon
      Good questions – here’s my answers, based on the research / thinking I did when writing the report.

      FDI profits: First, the investor makes two gains on a successful investment – the profits yes, but also the increase in value in the shares they hold in the company. So I think it’s far from true that the ‘FDI gains would be zero’ if they didn’t take profits out. Second, we were estimating losses as money that – from the standpoint of the developing country – would be better if it weren’t transferred out of the country. Hence, yes, it would be better if some of that profit was reinvested rather than leaving the country. The fact that outflows of profits have been higher than inflows of new FDI since 2009 also points to the fact that developing countries could certainly do better at gaining a share of this as tax.

      Lending to rich countries – the point here is that they are doing this as an insurance mechanism, by building reserves to protect their currencies and their economies. If there were better systems of regional and global cooperation – a radically improved IMF, or an annual allocation of SDRs – then there would be less need for this.

      The other point to make is that the ‘loss’ category is only a subset of outflows – i.e. there are also outflows of FDI, portfolio investment etc which we do not count as a loss. So the overall balance sheet of money in vs money out is considerably more negative than this.

      Hope these thoughts are helpful. Jesse

      1. Jesse, definitely useful and good clarifications. Appreciated.
        I was trying to look up the recommendations from the report and saw the one linked in EN 65. One of the recommendations seems to be: “Recognise capital account regulation as a fundamental policy tool for all countries and remove from all trade and investment agreements any obstacles to these important policies.” (http://www.eurodad.org/files/pdf/5465cb47884c9.pdf) I gladly agree. Though that is true, it’s not clear to me that a concerned developing country government wouldn’t want to invest in US treasuries as an insurance policy against domestic currency fluctuations (perhaps I lack imagination?).

        Also, this a great point in your recommendations: “Ensure a comprehensive mandate for the new intergovernmental tax body, including base erosion and profit shifting, tax and investment treaties, tax incentives, taxation of extractive industries, beneficial ownership transparency, country by country reporting, and automatic exchange of information for tax purposes.”
        I see this as trying to help with the ‘in-flows’ (assuming we could also find ways to make remittances cheaper to transact, I know for my own home country — South Africa — it’s just ludicrously expensive to transfer funds from, e.g. the UK back ‘home’ and I’ve tried to do it using relatively cheaper instruments. This is true with SA which has a relatively sophisticated financial sector. The inefficiencies and transaction costs are much worse elsewhere in Africa (as Duncan blogged earlier this year: http://oxfamblogs.org/fp2p/why-are-africans-getting-ripped-off-on-remittances/) Anyway, thanks, this is good & thought-provoking.

  2. Its important to understand the quantity and quality of these different flows, what drives them and what impacts they have on development, but netting them out together like this into one big headline number does not seem meaningful.

    As Simon Halliday says counting profits repatriated as an altogether bad thing and a hindrance to development is a bit odd.

    The overall premise that having more ‘going out’ than ‘coming is’ a sign that resources for development are being ‘drained out’ has obvious appeal, but does it really stand up as a measure that tells us something real about development?

    The report (table 1) gives a breakdown into country categories and shows that for the poorest developing countries in fact more is coming in than going out:

    For every $1 going into low income countries (like Bangladesh, Chad, Ethiopia, Somalia etc..) 65 c goes out
    For every $1 going into low middle income countries (like Bolivia, India, Mongolia, Ghana, Egypt etc…) 84c goes out

    The overall headline is driven by upper middle income countries (like China, Brazil, Mexico, Turkey etc…) where for every $1 coming in $2.11 goes out.

    So the killer infographic seems a bit Alice-in-Wonderland to me; it implies that emerging economies would be better off if their economies looked more like the poorest developing countries, and that the poorest developing countries should avoid trying to look more like emerging economies…

    1. Hi Maya

      Thanks for the comments. On the figures – just to note that the way you’ve calculated the inflows vs losses for LICs is not the way we did it. We took the average figures 2008-2011 as a percentage of GDP (it’s better to work with these as the raw numbers are calculated based on different numbers of countries, so there are fewer countries in, for example, the figures for interest repayments than in the figures for IFFs. Working with GDP averages controls for this, as they are GDP averages for the countries in the sample.)

      Using these figures, you get a larger loss for LICs than the money that flows in (and you also need to consider that aid is a very large component of the money that flows in for LICs.)

      Anyway, I don’t think that’s the main point you’re making, which is how to interpret them. I would interpret them like this (as I did in my blog.) That the scale of the ‘lost resources’ is not something that any developing country would like. They would prefer to be able to use those resources in a more productive way. So the question becomes what causes these huge lost outflows and what can be done about it, which is what I cover very briefly in the blog. None of them are inevitable, and all of them are linked to failings in the global economic system which can be fixed, I would argue.

      Hope these thoughts are helpful. Jesse

  3. Hi Jesse,

    Thanks for coming back with clarifications. Here are some more:

    1) On your first point, on FDI. You are right, investors can realise a return on their investment both from the annual stream of profits it generates and by selling the asset to someone else. But these are not independent returns. When you sell a productive asset (or a share in it) what you are selling is the right to the future flow of benefits from owning that asset (someone else gets the annual profits) – so reducing the profit also reduces the value that an investor can realise if they cash-out.

    In any case, the overall point still stands –current levels of FDI are driven by expectations of profits, and foreign investors ultimately need to be able to repatriate that profit (so that they can spend it on goods and services in the place where they can consume them). They do reinvest earnings (this is included in the FDI figures), but the idea that any repatriated profits should be viewed as a loss for development, leaves no room for profit-motivated foreign investment at all (even responsible, patient capital etc..). If you ‘plug the leak’ by preventing profit repatriation you will also reduce FDI inflows – which is not what developing countries want.

    2) On your point on how you calculated inflows vs outflows – thanks for clarifying. I am not sure whether it changes the overall point on interpretation of the figures though – Have you looked at the relationship between your metric and development. i.e.: If you construct a league table of countries based on your headline metric ‘for every dollar they gain they lose xx’ how does this ranking relate to development? If countries that loose the most in relation to gains are doing better economically, then the metric may not be meaningful.

    I know you also look at ‘losses’ as a % of GDP in the report, but this confounds symptoms and causes. Poorer countries tend to rely more on FDI as a source of investment, so will have higher repatriated profits as a % of GDP, and illicit flows measures tend to capture high figures related to oil and extractives – so will be higher for countries where primary production dominates over manufacturing & service exports.

    Bringing together the data on all these different resource flows is useful, although aggregating it into a single net figure with the language of ‘leaking’, ‘flooding’, ‘draining’, ‘making a killing’ I think is less so.

    The idea that reducing outflows as a % of GDP is a critical precursor to development is an assumption, rather than something that comes from the data.

    The major thing that I take away from the figures is that poor countries are poor, any which way you look at it. It looks like if you ‘bad’ outflows were eliminated entirely in LICs this would release around $120 per person per year which could go into investment and government spending (compared to over $4,000 per capita currently invested and spent on public services in upper middle income countries). In this context, viewing economies as leaky buckets with flows coming in and going out, seems to entirely miss the point of what is going on inside the bucket to make the economy grow, or not.

    I agree that failings in the global economic system (as well as in national policies) need to be diagnosed and fixed, and this includes measures for transparency, better capital allocation, and environmental and social standards. But advocating and designing these only with a focus on ‘plugging leaks’ rather than enabling economic growth does not seem wise.

    1. Thanks Maya

      Very useful clarifications. A short one in reply. Overall, we are not saying anywhere that the objective is to plug leaks or that this is the solution to development. The point of putting it all into a simple graphic is to show the scale of the problems that developing countries face in terms of making use of external resources, which include how to manage both inflows and outflows. In the context of a debate that is all to often premised on the idea that attracting e.g. more FDI is the solution to development, we are trying to say, yes it’s important, but not if developing countries can’t direct the FDI to where it’s needed most, prevent it from crowding out internal investment, and try to capture a fair share of the profits as tax. Given that for many of the poorest countries FDI is dominated by extractives, where the potential rents to be taken are very high, this last point becomes very important. Nowhere are we saying the point is to reduce lost resources to zero – we are simply saying that the scale of these lost resources points to some very real problems that need to be fixed.

      Anyway, in this edition of the report we aimed to collect the figures together, in the next we will provide a much more in depth analysis – covering many of the points you’ve raised. Look out for that in 2015!

  4. I am impressed by this present article, but little bit disappointed to see that there is not much discussion on Illicit Outflows by domestic investors in collusion with others abroad.

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