Nicolas Meisel ( meiseln@afd.fr
)
2 April 2014
Mo Ibrahim Governance School on
Governance for Development in Africa

• Introduction: provide a few analytical tools to understand key mechanisms and insertion of SSA in
FG.
• Framework: Capitalism and financial globalisation
(FG)
• Assessing the impact of FG on economic and political development: theory & evidence
• Concerning features of FG: tax competition, capital flight and tax havens
• Conclusion: Way forward
• Bibliography
• Discussion
2

• Capitalism is based on market economy but came much later and is more than market economy
• Market economy paradigm = exchange among equals. Price signals  S=D. Markets self regulating in competitive equil. Engines of growth=Division of labour ; economies of scale ; technological progress. Main policy recommendation: separate econonomic sphere from politics.
• Capitalism = force of accumulation. Because money
= power & No limit to desire of power, capitalism is not self regulating. Not converging to any ideal model. Inequality is its essence (social well-being not an obj). Separation of econ and pol impossible
 objective = effective regulation.
3

• Development trajectory determined by interaction between organisations (firms, states, etc) and institutions
(formal = rules of the econ & pol game; informal = representations & beliefs) at all scales.
• Capitalist growth is global in its logic of accumulation AND enshrined in local structures. Possible to have acceleration in one part of the world AND deceleration in another
• A historical process fed by its own contradictions
(expansion, crises, innovation…).
• Instability is the rule, stability the exception.
• Finance = central mediation of capitalist history, must resort to it to borrow, invest, employ labour, expand K; dominant financial centres capture value (power shifting between Venice, Antwerp, Amsterdam, London, New York,
Hong Kong…). Financial markets = money making money.
Pb: greed has no bound. Self regulation cannot exist.
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• 1944: Bretton Woods monetary system. Obj = stability.
Fixed parities +USD-gold convertibility. Finance under state controls in segmented national financial systems. Control of key prices= wages (w), goods, interest rates (i), x-rates.
• 1960s: increasing tensions due to end of reconstruction + accumulation of USD outside US
• 1971: Start of FG with the exit of BW by Nixon (end of dollar-Gold convertibility)  floating exchange rates & full
K mobility
• 1970s: recycling of petro-dollars  overlending to 1st & 3rd world (public and private loans). Race between p, w & i in
Western World  stagflation.
• 1980: Dramatic rise in US i to curb p and definitely transfer power from borrowers to lenders  Debt crisis  structural adjustment plans: macro ‘stabilisation’ ; liberalisation of K account; and privatisation of public util.

• Standard justification for FG: if free to circulate, K flows from S-rich-low-growth to S-poor-high-growth countries.
• LICs need foreign K to grow because S-constrained
(same fundamental justification since the 1950s!)
• Financial opening will
– Raise S, reduce financing costs (better risk allocation and increased liquidity reduces cost of K)
– Develop domestic financial market (entry of foreign banks, increased competition, better credit allocation)
– Smooth output and consumption volatility
– Introduce market discipline in all macro policies: spur fiscal discipline, monetary policy, and institutional reforms
– Attract FDI (intl markets confidence & business climate)
– Raise domestic investment and growth
6

Evidence (1): Saving and investment rates have actually
declined with financial integration in SSA (source: WDI)
Gross S and I in LA (% of GDP) Gross S and I in SSA (% of GDP)
35
30
25
20
15
Epargne brute
Investissement
10
1960 1970 1980 1990 2000
35
30
25
Epargne brute
Investissement
20
15
10
1960 1970 1980 1990 2000
7

Gross S and I in South Asia (% of GDP)
35
30
25
20
Epargne brute
Investissement
15
10
1960 1970 1980 1990 2000
But not in ASIA
45
40
35
30
25
20
15
10
1960
Gross S and I in East Asia (% of
GDP)
1970 1980 1990
Epargne brute
Investissement
2000
8

Rodrik and Subramanian (2009) find no correlation between long-run growth and intensity of cross-border capital flows, neither in level …
9

Confirming (Prasad et alii, 2007 ; Gourinchas and Jeanne, 2007) : Countries that have grown most rapidly are those that rely less, not more, on foreign K!
« For any given level of I, the more that is financed by domestic savings, the
10 greater the long-run growth » Rodrik (2009)

• Facilitated external borrowing may actually relax, not
increase, macro discipline and fiscal constraint for longer periods than possible otherwise; ↑ future adjustment costs
• Y, C and income volatility ↑ with FG (Kose et al, 2007)
• Insufficient absorption capacity  Risk of overborrowing through domestic financial institutions  Poor I perf +
Speculative asset bubbles → priv & public debt → boost C
 inflation + CA deficit  ↑ risk of K flow reversal (sudden stops) and financial crises (Mex 1994, Thai 1997, Arg 2001)
• Classic answer: “inappropriate regulatory, prudential, supervisory structures”
• Pb: endless list; unfeasible; not strategic : ignores trade-offs
& resource constraints (other reforms may be more urgent) ; historically unjustified (post-45 Europe, Korea, China).
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• Appreciation of the real exchange rate
(overvaluation) hampering diversification in tradables
• Increase of real x-rate  loss of profitability and competitiveness of tradable goods sector which is the key sector to foster endogenous growth 
Disincentive to invest in non traditional tradable sectors  I demand for tradables diminishes and productive capital accumulation actually recedes
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Net private flows (loans,
FDI, portfolio) and overvaluation 1970-2004.
Source: Rodrik (2009)
Undervaluation of the real exchange rate and growth
(panel of 5-year averages
1980-84 & 2000-04)
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Decomposition of growth into ‘ within sectors ’ and structural
change between sectors, 1990-2005
SSA: Growth-reducing structural change - Constrast with Asia
0.05
0.04
0.03
0.02
0.01
-0.01
-0.02
0
Latin America
Africa
Asia
High-income structural within
• Economic development requires systematic reallocation of factors of production from lowproductivity, low skill & technology, decreasing returns sectors to higher-productivity, increasing returns sectors.
Figure 8 -
2005
Disindustrialisation in SSA: Manufacturing Value Added (% du GDP)
Source: McMillan and Rodrik (2011). Regional averages are unweighted averages for countries for which data are available.
1980
To observe a particularly egregious case of growth-reducing structural change, turn to
PMA 12,7
(Figure 9). The sector with the largest relative loss in employment over
PMA africains
PMA asiatiques above-average productivity. Most of this reduction in manufacturing employment took place
Autres PED
12,1
1990-2005 is manufacturing, which also happens to be the largest sector among those with
14,2
21,1 during the 1990s, under the Argentine experiment with hyper-openness. Even though the decline
1990
11,0
10,7
11,8
22,1
2000
9,8
7,4
12,7
23,0
2009
9,5
6,6
14,4
24,8
14 in manufacturing was halted and partially reversed thanks to a competitive currency during the recovery following the financial crisis of 2001-2002, this was not enough to change the overall picture for the period 1990-2005. By contrast, the sector experiencing the largest employment gain is community, personal, and government services, which has a high level of informality and

• Impact on cost of capital: Atrophy of tradable sectors may worsen current account deficits and trigger a lasting dependence on foreign K to cover them, hence reinforcing perceived vulnerabilities and increasing cost of K.
• Impact on labour and demand for democracy:
Historically industrialisation has promoted wage earners, formalisation and taxation of labour incomes, & contributed to develop welfare state
• If desindustrialisation slows down middle class formation, it may well suppress an essential historical constituency behind the D for democracy
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• Increased instability
• Overliquidity, esp. since
2000s (see graphe)
• Boost in consumption ;
• Appreciation of real x-rate even in countries with large
CA deficits! contrary to
Mundell Fleming std model
• Reduction of domestic I in tradables (decreasing returns on domestic I)
 Impact on growth = O
 Sounds familiar?
Variation of real exchange rate horizontally and current account vertically for 30 emerging countries
(2003-2007). Source: WEO,
IBS.
16

Source : Institute of international finance (2010)
17

Explanation: LICs suffer more from investment constraints than from saving constraints
• If an economy suffers from a lack of I demand, financial opening is not likely to impact domestic I positively because I is not responding to market conditions
(decreasing function of r)
• Low demand for domestic I in tradables may be due to:
– Low social return of K bec. human K, skills, infras and social welfare limited by inadequate gov capacities
– Poor I appropriability due to weak institutions (eg property rights) or enforcement capacities of the state
• Tradable sectors suffer the most from weak institutions
& learning externalities (implicit tax, on top of x-rate appreciation)
 Putting the emphasis on I rather than on S as a main constraint entails completely different prescription = invest in public infras, public goods and public services
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• Tax rebates ; 5-year holiday... schemes encouraged by WB (DB) to attract FDI
• Esp & ironically recommended “because you do not provide investors with key public infras” so they won’t come unless offered tax breaks
• Individual ad hoc treatments that increase fiscal policy complexity (IMF opposition)
• Race to the bottom in corporate income tax (no limit to the process)
• Pb: Not part of integrated fiscal, employment, skill devt, and industrial strategy.
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• FG reduces returns on domestic I in tradables but ↑ incentives for K flight (returns on foreign I ↑)
– Certain skills imported with FG = fin., legal, fiscal and private banking.
– Much easier to send money abroad than invest in risky industrial venture for export markets.
– Much safer to protect assets abroad from predation, taxation, expropriation, competitors, etc.
– NB: origin of funds may be licit or illicit : proceeds from privatisations; kickbacks on gov loans; procurement contracts; transfers from public accounts…
– Csq: tax evasion by elites (reduced fiscal space) and inequality
20

Stock of capital flight by country, 2008
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• KF figures by Ndikumana & Boyce 2011 > Henry 2012
• KF = BoP residual (K inflows – uses) + trade misinvoicing
(underinvoice X– overinvoice M) + unrecorded remittances.
• 2010: accumulated stock (39 African countries) since 1970 =
$1700bn >> Debt = 280bn. Collier (2001): 40% of Africa’s private wealth is held abroad.
• Nigeria, Algeria, Morocco, Egypt, Angola, Cote d’Ivoire…
• Csq: Africa net creditor to the rest of the world
• However important difference: public L but private A!
• Negative impact of K flight on domestic I
• Negative impact on growth = -2.4% (average) ; -0,8 (median)
• On tax = 1700bn*3%=51bn (earnings per year)*30% (marginal income tax rate) = 15Bn per year of lost revenues
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• KF from SSA = equal to the sub-continent’s total GDP
• Equal to 10 years of Africa’s infrastructure investment needs
• Equal to the wealth of Africa’s 100,000 “High Net Worth
Individuals”
• Direct impact on inequality: rich do not pay tax ; real distribution of income and even more of wealth far more skewed than current inequality stats (underestimation of Gini) as very rich underreported in both HH surveys & tax accounts
• Indirect impact on inequality and democracy : rich do not contribute to public infrastructure provision ; do not create local demand ; do not push for better institutions.
• Elites’ incentives disconnected from ordinary citizens: do not have to account for their deeds and can increase their wealth independently of their people’s fate.
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• 60% of KF due to debt = debt fueled KF ; and debt fuels KF as well = KF and external overborrowing = twin problems
• Zaire: ‘(…) In this office [the Presidency], no distinction is made between state expenditures and personal needs. (…)
Impossibility of control of frauds means that there is not any –
I repeat any – chance on the horizon that the numerous
creditors of Zaire will recoup their funds.’ E. Blumenthal
(1982), Zaire: Report on its international financial credibility.
• FT, 12 May 1997: Senior banker quoted: ‘How Mobutu built up his $4bn fortune: Zaire Dictator plundered IMF loans’
• Mobutu: the first African president received by Bush Sr
• WB loans to Nigeria 1984-94 = $4.6bn
• Responsibility of lenders  “Odious debt” by odious gvt
• Today: KF accelerating ; China’s 2004-2010 $14bn Resource backed non transparent loans + IMF optimistic projections
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Public foreign borrowing now conditional to IMF
Debt sustainability analysis
IMF stress tests of debt sustainability in poor indebted countries recognizing lenders ’ responsibility to prevent new crises  green, yellow, red.
Limits: only external public D, missing donors; IMF position
Growth hypotheses are a key parameter of debt dynamics : d t
= b pt
+ d t-1
(1+i)/(1+g) ; and easy to control
Annual average growth rate of GDP (historical, source WEO) and DSA hyp.
SENEGAL
1986-2006 1994-2006 2000-2006 2007-2012 2013-2027
3,2 3,9 4,0 5,5 5,0
MADAGASCAR
1986-2006 1996-2006 2001-2006
2,3 3,3 2,1
2007-2027
7,0
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• Off-shore secrecy jurisdictions
• About 80 such places
• With between USD 20 and 30.000 bn of accumulated assets from developing countries under management (thus with hyp of 3% of return=
600-1000 Bn incomes)
• Hyp = 30% Marginal income tax  180-300Bn annual lost tax revenue
• 50% of banks cross border deposit and credit operations ; 1/3 of FDI
• Organised and controlled by 50 largest banks
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• Main effective governance scale until today = national.
Largely ineffective in front of today’s global challenges
• « As long as the world economy remains politically divided among different sovereign and regulatory authorities, global finance is condemned to suffer from deformations far worse than those of domestic finance » (Rodrik).
• Incompatibility triangle: democ – econ integration
(globalisation) - sovereign nation-states
• Global financial capitalism requires global regulation to protect itself from its excesses. Regulatory institutions need to be protected from market mechanisms. Politics must rule finance.
 New forms of governance required and emerging: multiscale, from national to global, to help democracy survive
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• P. Gourinchas & O. Jeanne (2007), Capital Flows to Developing
Countries: The Allocation Puzzle, NBER Working Paper.
• E. Prasad, R. Rajan, A. Subramanian (2007), Foreign Capital and
Economic Growth, Brookings papers on economic activity
• A. Kose, E. Prasad, M. Terrones (2007), Growth and Volatility in an
Era of Globalisation, IMF Staff Papers
• D. Rodrik & A. Subramanian (2009), Why did Financial Globalisation
Disappoint, IMF Staff Papers
• J. Henry (2012), The Price of Offshore Revisited, Tax Justice Network
• L. Ndikumana & J. Boyce (2011), Africa’s Odious Debts: How foreign loans and capital flight bled a continent
• N. Shaxson (2011), Treasure Islands: Tax havens and the men who stole the world
• R. Baker (2005), Capitalism’s Achille’s Heel: Dirty Money and How to
Renew the Free Market System
• T. Piketty (2014), Capital in the 21st Century
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