Africa and the Perversities of International
Capital Flows
By
Howard Stein
Professor, DAAS
University of Michigan
howstein@umich.edu
Introduction
• Neoclassicals inside and outside of the IFIs in 80s
and 90s pushed for unfettered movement of
capital flows –funds would flow from rich
countries with low marginal productivity to poor
countries with high marginal productivity.
• Promised gains in investment and productionAfrican embraced financial globalization
Introduction
• Removed restrictions on capital accounts
• Open up to FDI
• Privatized state assets including selling banks to
foreigners
• Built stock markets
• Accumulated reserves
• Under encouragement, supervision and financial
support of IFIs
Introduction
• Promised gains not realized
• Opposite occurred-funds flowed from poor
African countries to the rich
• Mainstream Economists refer to this as the “Lucas
Paradox” based on his 1990 article which pointed
to this phenomenon.
• Lucas and mainstream economists have used
variety of explanations to explain away the
paradox.
Introduction
• Including differences in labor productivity
countering differences in marginal productivity of
capital, introducing human capital into total
capital measures, differences in sovereign risk,
property right issues, etc.
• All have in common one belief-once an
impediment or two are addressed then system will
behave as neoclassical economics predicts
Introduction
• This paper rejects that premise in favor of one that
points to a systemic explanation that focuses on
the power asymmetries inherent in the structure of
international flows
• We have witnessed a three decade project in
creating a system I refer to as the global
financialization imperative.
Introduction
• First is the attempt to commodify all products or
services that have any use value.
• Second is financialization or the attempt to reduce
all value that is exchanged (whether tangible,
intangible, future or present promises, etc.) either
into a financial instrument or a derivative of a
financial instrument.
Introduction
• Third is to allow the unfettered movement of
private financial institutions and their products
into every corner of the globe by demobilizing the
capacity of nation-states to impede or restrict their
activities while building institutions that provide a
common platform of accessibility.
Introduction
• Domestic financial flows everywhere become part
of global flows and are tapped as component parts
of the accumulation strategies of large financial
corporate organizations and their wealthy clients.
Increasingly official and private flows are blurred
and closely interconnected.
Introduction
• Financial liberalization and its associated
legitimizing theories have been embedded into the
dictums and practices of the international aid
community for decades.
• They have used their power and resources to alter
the terrain for global capital with perverse
consequences.
Introduction
• The idea of perversion is very different than a
paradox which assumes that flows are
contradictory to what we would expect.
• In fact, the result is not surprising given the
underlying structure of power.
Introduction
• The idea of perversion here is ethical-where the
poorest in the world are financially supporting the
wealthiest
• where capital flows have pushed African
economies into perverse economic structures
• where human needs become subservient to the
whim of the accumulation strategies of hedge
funds
• where debt generation has fueled massive capital
flight
Part I
Financialization of Commodities
UNCTAD Study-2011
• “The mid-2000s marked the start of a trend of
steeply rising commodity prices, accompanied by
increasing volatility. The prices of a wide range
of commodities reached historic highs in nominal
terms in 2008 before falling sharply in the wake
of the financial and economic crisis. Since mid2009, and especially since the summer of 2010,
global commodity prices have been rising again.”
• http://www.unctad.org/en/docs/gds20111_en.pdf
Commodity Price Movements (IMF,
2011)
Commodity Price Volatility (IMF,
2011)
Possible Causes of Volatility
• rapidly growing emerging economies
• growing urbanization
• growing middle class with changing dietary
habits, including an increasing appetite for meat
and dairy products
• expansion of biofuels
• conversion of land use from crops
• impact of climate changeood to crops for biofuel
production has also affected the
Financialization of Commodities
• “However, these factors alone are not sufficient to explain recent
commodity price developments; another major factor is the
financialization of commodity markets. Its importance has
increased significantly since about 2004, as reflected in rising
volumes of financial investments in commodity derivatives markets
– both at exchanges and over the counter (OTC). This phenomenon
is a serious concern, because the activities of financial
participants tend to drive commodity prices away from levels
justified by market fundamentals, with negative effects both on
producers and consumers.”-UNCTAD, 2011
Financialization of Commodities
• The term “financialization of commodity trading”
indicates the increasing role of financial motives,
financial markets and financial actors in the
operation of commodity markets.
• Heart of global finance-managing of vast amounts
of wealth from rich people in hedge funds run by
large global financial conglomerates
Implications
• Commodity markets are being driven not by
fundamentals of producers and end users but by
other factors--view that commodities are a good
hedge when the value of the dollar falls which
lowers the value of global commodities in nondollar terms.
Implications
• Also issue of herdism-the tendency of individuals
to mimic the actions of a larger group, rather than
acting independently and on the basis of their own
information.
• Rapid movements in and out of markets with
terrible consequences to people
Not just oil!
Food Prices 2011-2011
Index Mundi, 2011
The Ethics of Financialization
• For Alan Knuckman, there is hardly a nicer place
than the CBOT trading floor. "This is capitalism
in its purest form," the commodities expert raves.
"This is where millionaires are made.“
• How he makes money doesn't make any
difference to Knuckman. He draws no distinctions
among commodities like petroleum, silver or food
products. "I don't believe in politics," he says. "I
believe in the market, and the market is always
The Ethics of Financialization
• How does he feel about exploding food prices?
• The age of cheap food is over," predicts
Knuckman, noting that this can't be such a bad
thing for US citizens. "Most Americans eat too
much, anyway."
• http://www.spiegel.de/international/world/0,1518,
783654,00.html-”How Global Investors Make
Money Out of Hunger”
Part II
Orthodoxy and African
Liberalization
Mainstream Arguments
• The key function of financial systems in the
saving-investment-growth relationships is to act
as an effective conduit for the mobilization and
allocation of loanable funds; and the
transformation and distribution of risks and
maturities.
Mainstream Arguments
• In the mainstream literature, the role of capital
markets in providing efficient and transparent
price signals and liquidity in the secondary market
for equities and bonds is emphasized as
mechanisms for vigorous portfolio arbitrage of
bond- and shareholders
Mainstream Arguments
• Extending these lines of arguments spatially to
cross-border financial transactions and
intermediation, effects of financial globalization
on economic development and world `welfare’
are tacitly assumed to be positive through the
same saving-investment-growth nexus.
Mainstream Arguments
• Thus, financial globalization is seen to ensure an
efficient intermediation between saving and
investment on a global scale (Rousseau and Sylla
2001).
• An intertemporal borrowing/lending model as
applied to cross-border trade in capital is
popularly used as a theoretical model for showing
welfare gains from net resource transfer arising
from increased financial openness and free capital
mobility.
Mainstream Arguments
• With opening up to international borrowing, a
capital-poor developing country is able to
• a) divert resources to more future production by
undertaking extra investment at a lower world
interest rate; and
• b) enjoy higher current consumption, as its
saving-investment resource gap (and hence, the
emerging current account deficit) is being filled
by foreign saving (Obstfeld and Rogoff 1996).
Mainstream Arguments
• In short, the intertemporal model of capital trade
is used to show benefits from financial
globalization in allowing capital to seek out its
highest rewards while providing means for
consumption smoothing and insurance against
shocks.
Mainstream Arguments
• In the extreme version of the neo-classical world
with perfect information and no transaction cosst,
once impediments to free capital mobility are
removed, funds are seen to flow from low
marginal product of capital-rich countries to high
marginal product of capital-poor countries as the
capital market works to equalize risk-adjusted
marginal products of capital across borders.
Mainstream Arguments
• In particular, as the interest rate parity condition
dictates, financial globalisation ensures asset
markets to gravitate towards an equilibrium in
response to risk-adjusted relative returns, even if
instantaneous price adjustments are often
prevented because international traded assets are
imperfect substitutes in their risk characteristics
under real world conditions.
Mainstream Arguments
• Consequently, it is claimed that as financial
globalization proceeds, an efficiency in global
resource allocation increases, while developing
countries emerge as a winner, benefiting from
higher investment and consumption with lower
interest rates as well as from an opportunity of
global risk sharing.
Mainstream Arguments
• This is precisely the perspective embedded in
arguments by Stanley Fischer and other senior
IMF officials as they pushed for an amendment to
the Articles of Agreement which would make
capital account liberalization a prerequisite for
IMF membership
Mainstream Arguments
• …free capital movements facilitate a more
efficient global allocation of savings, and help
channel resources into their most productive uses,
thus increasing economic growth and welfare.
From the individual country’s perspective, the
benefits take the form of increases in both the
potential pool of investable funds, and the access
of domestic residents to foreign capital markets…
Mainstream Arguments
• ”And just as current account liberalization
promotes growth by increasing access to
sophisticated technology, and export competition
has improved domestic technology, so capital
account liberalization can increase the efficiency
of the domestic financial system.(Fischer, 1997).
Integrating Africa into Global FlowsStock Markets
• With these neoclassical formulations in mind, the
IMF and other donors pursued an active agenda to
build stock markets while removing capital
account restrictions.
• In 1980, prior to the start of era of structural
adjustment, there were only three stock exchanges
in sub-Saharan Africa (Kenya, Nigeria and South
Africa).
• In 2011 there were 22 exchanges covering 31
countries in SSA.
Integrating Africa into Global FlowsStock Markets
• Most have been organized after the beginning of
the Asian Crisis when the logic of capital account
liberalization came into question even within the
IMF.
• In all exchanges covering 21 countries in Africa
were established in 1997 and after many with the
support of foreign assistance
Integrating Africa into Global FlowsStock Markets
• Few have any restrictions on the foreign purchase
and sale of stocks.
• For example T.Rowe Price’s Africa and Middle
East Fund lists investments in stocks in a dozen
SSA countries
Integrating Africa into Global FlowsFDI
• The World Bank’s FDI project in Africa has
deliberately pushed countries into privatization
and a minimalist and uniform regulatory and legal
framework aimed at encouraging countries to
follow their comparative advantage in resource
extraction.
• A particular emphasis in the effort over the past
two decades or more was on reforms aimed at
attracting FDI to the mining sector in Africa
Integrating Africa into Global FlowsFDI
• Chilean Standard in World Bank influential 1992
mining document: “Chile has been the most
successful of the countries surveyed. The
economy is completely free and there are virtually
no restrictions on foreign exchange. Foreign
investment is permitted under general legislation
and there is no discrimination between local and
foreign ownership.
Integrating Africa into Global FlowsFDI
• “ Neither is there a specific law governing
investment in mining…mining rights have all the
attributes of property rights being freely
mortgageable transferable, and protected by the
constitution against confiscation…Effective
Taxation Rates are the lowest of all countries
studied
Integrating Africa into Global FlowsFDI
• Closest to this was 1986 and 2006 mining acts of
Ghana designed with assistance of the World
Bank which becomes the standard pushed by the
Bank in other African countries (Campbell, 2008)
Integrating Africa into Global FlowsFDI and Stock Exchanges
• In African countries resource industries have a
heavy representation on local stock exchanges
which both opens up the resources to further
financialization while also providing a mechanism
for FDI to liquidate their assets.
Integrating Africa into Global FlowsFDI and Stock Exchanges
• Ghana 37 stocks listed on the exchange--Two
completely dominate the exchange AngloGold
Ashanti Limited and Tullow Oil PLC-all other
stock only 15% of the total of the two. AngloGold
Ashanti is the largest holding in T.Row Price’s
Africa and Middle East Fund and accounts for
4.3% of their total portfolio ..
•
Source: Murinde, 2009
Murinde, 2009
Part III
Flows and Their Perversities
FDI Flows
• Marginalization then a resurgence almost all due
to oil –but always oil and other resource focused
FDI dominates
• During the 1980-85 period 52% of the total
excluding South Africa went to the four oil
exporting countries Angola, Nigeria, Cameroon
and Congo.
• By 1985 to 1990, two oil producers Angola and
Nigeria, alone were attracting more than 50% of
the FDI to SSA excluding South Africa rising in
92 to 97 to 57%.
FDI Flows
• By 2005 there was a significant recovery of
Africa’s share of DC FDI flows to around 8.5 %
of total-quadrupling.
• The vast majority of the increase in inflows went
to the traditional oil exporters Nigeria and Angola
along with new oil producers like Sudan and
Equitorial Guinea.
•
FDI Flows
• In all roughly 78% of the 16.1 billion increase in
inflows to non S. African SSA from 2000 to 2005
went to these four countries-same 2005-08.
• The focus of the FDI flows was having a
profound impact on the structure of exports
perversely returning SSA to a colonial structure of
pure extraction.
FDI Flows
• Such FDI--limited economic and developmental
benefits because they usually do not
• stimulate general, broad-based development;
• significantly expand employment opportunities
• diversify exports;
FDI Flows
• facilitate meaningful transfer of technology to
recipient countries except for the limited purpose
of more profitable resource extraction.
• And due to the structure of taxation encouraged
by the World Bank, the revenue generated tends
to be rather limited.
Foreign Bank Ownership
• The relaxation of foreign ownership regulations
has also had a large impact in the composition of
banking in Africa.
• The rapid foreign takeover of banking assets
where the Bank and Fund dominated policy
formation is no coincidence. In many countries
Bank and Fund sponsored financial liberalization
which had emphasized privatization to domestic
banks led to financial crises.
Foreign Bank Ownership
• Following these crises banks were either sold off
to foreign owners or new licenses were issued to
foreign banks. Increasingly the Bank and Fund
began to see foreign ownership as the best route
to prevent or even cure a financial crisis (Stein,
2010)
Foreign Bank Ownership
Foreign Bank OwnershipConsequences
Reserves
• In additional dimension of the perverse nature of
global finance can be found in the statistics on
reserves.
• The increasing and high level of global financial
instability associated with globalization has
driven countries toward a form of self-insurance
by dramatically increasing reserves.
• African countries are no exception.
Reserves-More Perversion…
• The vast majority of these funds are kept in
financial assets in developed countries thus
perversely financing the standard of living of rich
countries.
• Based on the rule of thumb of reserves of 3
months of imports, one can calculate a rough
measure of excess reserves which went from
$10.9 billion in 2000 to $75.3 billion 2009 or a
more than seven fold increase.
Reserves-More Perversion…
• This is not insignificant.
• 2009 -- 40% of gross capital formation in SSA or
roughly $90 for every man, women and child in
SSA.
• In Nigeria, in 2008 the excess reserves were 270
per cent of gross capital formation or roughly
$315 for every person in Nigeria in a country
where 67% of the population live on less than a
$1.25 per day
Non-FDI Flows to SSA-overall
• Overall the figures for non-equity non-FDI private
flows to SSA as whole were dismal between 1996
and 2001 and amounted to an outflow of 4.9
billions dollars as private banks stopped lending
to SSA instead pulling money out of the
continent.
• Rise in 2007-large bond issue to Gabon and
Ghana but at very high interest rates-large outflow
again in 2009
Non-FDI Flows to SSA-Equity
• In 2006 non S.African SSA equity flows began to
rise and peaked at nearly 2 billion dollars.
• However, we can see from the figures from 2006
to 2009 there was actually a net outflow of equity
capital of more than 700 million dollars.
• In other words the stock market was used as a
vehicle for capital export.
Odious Debt and Capital Flight
• Rapid Proliferation of Debt as seen in Table
Eleven associated with failed neoliberal lending
in 80s and 90s
• Some debt relief through HIPC and MDRI, but
problem is much of it is odious debt which has
helped fuel capital flight
Odious Debt and Capital Flight
• Odious debt-incurred by regimes and military
dictators often for their personal enrichment rather
for the interests of the nation
• In the perverse world of international finance,
nations are held responsible for debt that did not
benefit them.
Odious Debt and Capital Flight
• Moreover, the problem is systemic. The process
that generates debt also fuels capital flight.
• There are willing participants both within African
countries and in the private banks in the
developed world who generate large fees and
interest returns on the loans and deposits.
Odious Debt and Capital Flight
• International financial institutions are also driven
by success criteria measured by the quantity of
loans and were driven by the political priorities
of the US to lend to corrupt military governments
with ties to the West-famous case of IMF and
World Bank loans to Mbutu of Zaire
• Ndikumana and Boyce (2003) examine data from
28 African countries covering the period 1970 to
1996 and estimate that every dollar of additional
debt generated 80 cents of additional capital
Odious Debt and Capital Flight
• Four different linkages between loans and capital
flight debt-fueled capital flight; flight-fueled
foreign lending; debt-motivated capital flight and
flight-driven foreign lending.
Odious Debt and Capital Flight
• So how much capital flight has occurred and how
does it compare to debt levels?
• Ndikuma and Boyce (2011) use a methodology
to measure the degree of unrecorded capital flight
from Africa.
• Their starting point arises from the observation of
the huge divergence between the balance of
payments data of African countries and the World
Bank’s Global Development Finance Data on
changes in the stock of debt.
Odious Debt and Capital Flight
• Overall they start with changes in external debt in
debt tables add net foreign direct investment
subtract the current account deficit (surplus is
negative) subtract change in reserves add
adjustment for export misinvoicing (positive sign
indicates underinvoicing) add adjustment for
import mininvoicing (positive sign indicates net
overinvoicing negative net underinvoicing-eg.
Smuggling) and adjustment for unrecorded
transfers. remittances.
Conclusions-Beyond Orthodoxy
• From an institutional perspective, the challenge of
finance in the poorly formed markets of
developing countries and in a world of rapid
global flows is much more profound than simply
the issue of bonds vs. stocks vs. bank lending as
a financial source for productive investment.
Conclusions-Way Forward
• Financial flows can be seen as a series of
domestic and international circuits that intersect
among themselves and with the real flows of
commodity and productive resources.
Institutionally, each flow has a set of internally
concatenating capacities, incentives, norms,
regulations and organizations.
Conclusions-Way Forward
• Each flow can also be defined relative to other
flows which helps to give them scope, content and
meaning.
• A shift in the institutional dimensions of any one
flow such as the regulations or capital account
liberalization has direct implications to the nature
of the interaction with other flows and can create
the perverse results discussed above.
Conclusions-Way Forward
• New Institutions must be put in place to connect
the financial and real flows in the economy
• This is not possible where internal financial flows
are being dictated by the vagaries and priorities of
external flows.
Conclusions-Way Forward
• Controls must be firmly in place and can take
many forms and will depend on country specific
conditions and capacities (trip wires and speed
bumps, Tobin type taxes on financial transactions,
taxing, limiting or setting reserve requirements on
some transactions, restrictions on currency
convertibility, etc.)
Conclusions-Way Forward
• Industrialization and agriculture have suffered
badly in this system, yet they are essential to the
development process in Africa
• Africa needs new industrial and agricultural
policies with new financial institutions to support
them -take the example of industrial policy
Industrial Policy and Finance
• State financial organizations are essential.
• At the heart of many of the industrial policy instruments
are state capacities to direct financial flows toward
productive private sector enterprises. .
• Simply as Stigliz (1989, 1994) has pointed out in the
poorly developed financial markets in developing
countries there will be a profound difference between the
social value of lending and the private benefits.
Industrial Policy and Finance
• Banks, if left to their own devices will gravitate to
finance projects with short turnover, lower working
capital, and lower risk (such as financing imports or
government paper) avoiding more developmentally
enhancing projects such as manufacturing which has a
higher working capital, and much greater risk.
• States must create incentives to encourage private
bankers to support loans which have greater social and
economic benefit. In the early stages, before bankers see
that loans can be both socially beneficial and profitable,
states will need to be involved with risk sharing.
Industrial Policy and Finance
• In the absence of the socialization of private risk, it is
difficult to see how private investment and accumulation
can occur to spur African industry.
• There are many options for ensuring that the criteria for
subsidization or access to funds are being realized and
are consonant with industrial policy objectives (Koreanstyle policy loans, Japanese main bank system, businessgovernment councils, planning agencies, partial state
ownership of banks, developmental banks, etc.).
• Each of these implies the creation of particular types of
state capacities.
New Economic Thinking
• While some types of perversions occur quietly
behind bedroom doors with both parties enjoying
the results, this type of perversion has millions of
victims.
• The moment is ripe for new thinking in
economics so we can begin to understand and
reverse the crimes and perversions of the global
economy.
New Economic Thinking
• Thanks to the Cambridge Trust for
New Thinking in Economics for
organizing and sponsoring this
conference.