Aid in Reverse: Facts or Fantasy?

This article originally appeared in edited form on The Guardian, Global Development Professionals Network. The unabridged version is available below.

A comment piece published in the Guardian earlier this week argued that for every $1 of aid that developing countries receive, they lose $24 in net outflows. The piece, by Jason Hickel, which draws on a report by Global Financial Integrity (GFI) concluded that “poor countries don’t need charity. They need justice.” Rich countries, he argues, should act to stopthe massive flow of capital that the writer believes is being drained from poor countries.

The 1 to 24 figure is shocking and morally compelling. But it isn’t true. To understand why, first it is helpful to get a sense of scale. For many poor countries 24 times the aid they receive would be a huge number. In Bangladesh where aid is 1.3% of gross national income (GNI) it would be almost a third of the economy. In Ethiopia where aid is 6% of GNI it would be about one and a half times the size of the whole economy. Can it really be possible that such massive amounts of capital are being generated in poor countries each year?

In fact Hickel’s calculation has very little to do with poor countries. The definition of 'developing countries' he uses includes all developing, emerging and transition economies such as China, Russia, Saudia Arabia, Kuwait and Malaysia as well as five OECD members states and several EU countries. That many of these countries have more capital going out than coming in is not news. It is already well known that over past decades many developing and emerging economies, particularly in Asia and the oil producing Middle East, have followed a policy of running trade surpluses and building up foreign currency reserves as well as outward investments.

For the poorest developing countries the opposite situation is true—more capital comes in through aid, foreign direct investment, loans etc, than goes out through interest payments, profits by foreign investors or to stock up reserves. This includes the least developed countries, ‘heavily indebted poor countries’ and most countries in sub-Saharan Africa. Comparing the amount of capital that large emerging economies such as China and Saudi Arabia use to build up foreign currency reserves with the amount that mainly smaller poorer economies receive in aid is meaningless. This is not ‘aid in reverse’. It is nothing to do with aid.

The second thing to understand is that 90% of the total which Hickel thinks is draining out is based on an estimate by GFI that is not widely accepted as credible. GFI argue that by doing simple calculations on mismatches found in publicly available trade statistics they are able to detect massive unrecorded flows of capital escaping from developing countries, particularly through a type of customs fraud called “trade misinvoicing”. However the IMF and the UN who collate these statistics warn that they cannot be interpreted this way. Ordinary, legal trade such as shipments that go through transit hubs tend to produce asymmetries which can be misinterpreted as misinvoicing in two different directions at once. For example cocoa exported from Cote d’Ivoire bought by a Dutch trading company will be reported as an export to the Netherlands, but in practice it could be held in a bonded warehouse in Amsterdam before being shipped on to a chocolate manufacturer in Germany. This ordinary, legal shipment would produce mismatches in the trade data that will be interpreted as an illicit flow of finance out of Cote d’Ivoire (with Germany as the beneficiary) and at the same time an illicit flow into Cote d’Ivoire (with the Netherlands as the source) (this is something similar to the well known Rotterdam effect in European trade statistics).

GFI deals with the problem of apparent illicit flows going in opposite directions by assuming that all the mismatches which could interpreted as flows out of developing countries are real and ignoring the somewhat larger total of mismatches that could be interpreted as flows going into developing countries. They argue that makes sense since ‘there is no such concept as net crime. However this does not solve the problem of not being able to differentiate between crime and ordinary legal trade in the first place. It simply produces large numbers (most of which relate to major emerging economies in Asia and Europe where the underlying trade flows and therefore the scale of gaps and mismatches are larger).

Hickel then triples this number, as a proxy for other types of illicit flow for which GFI has no data at all.

Although large estimates based on mismatches in the trade data have often been quoted in development debates, they are increasingly being questioned. Volker Nitsch, a Professor of International Economics at Darmstadt University in Germany reviewed GFI’s misinvoicing calculations and concluded that the numbers have “no substantive meaning.” DFID Senior Anti-corruption advisor, Phil Mason told the International Development Committee last year that the figures were not credible. A study published by the UN University World Institute for Development Economics Research compared different methods of measuring illicit capital flight and concluded that methods were imperfect, and ran the risk of misinterpreting ordinary investments.

Those who work on addressing corruption and criminality in practice have long given up on trying to develop a global total for illicit flows. Even if the amount is nowhere near the figure that Hickel has invented we know that grand corruption and organised crime are real and serious barriers to development in many countries, and often the loot is stashed in rich countries. Customs fraud is one route, and it is also a method used by those evading taxes as well as by drug traffickers and other criminals. However this channel has perhaps been overemphasised because of the large estimates attached to it. Kleptocrats  tend to use a simpler method for hiding the proceeds of grand corruption; they wire the money directly to accounts set up in the name of anonymous shell companies.

Hickel argues that donor countries should not be seen as ‘good guys’ for contributing aid, but as ‘bad guys’ for enabling illicit financial flows. But it is naïve to always cast rich countries in the starring role. Rich countries should enforce anti-bribery rules, and take more effective action to prevent anonymous companies being used as getaway vehicles. Aid should be transparent and focused on outcomes, but it will never be the main protagonist.The private sector is neither a hero or a villain, but enabling real investment is critical. We can also support institutional reforms in developing countries which seek to mobilise domestic resources, such as through enhancing tax collection, improving public procurement , better natural resource governance and enabling public scrutiny of revenues and budgets. The experience is that there are no easy solutions, and progress requires humility, attention to detail, and willingness to learn from new evidence. We shouldn’t let wishful thinking about imaginary sums of money in very poor countries get in the way of this.