The single fact that shows how the global financial system fails developing countries
By Jesse Griffiths (22 December 2014)
This will make you angry. After six months crunching all the best data from international institutions, here’s what we found: for every dollar developing countries have earned since 2008, they have lost $2.07. In fact, lost resources have averaged over 10% of their Gross Domestic Product (GDP).
We’re not talking about all flows of money out of developing countries, just the lost resources: money that should have been invested to support their development, but instead was drained out. Twice as much is leaking – or rather flooding – out than the combined inflows of aid, investment, charitable donations and migrant remittances.
The graphic above shows the proportionate losses of resources compared to one dollar of inflows. The figures are in US cents, and are based on the average inflows and losses between 2008 and 2011. The four main lost resources shown in the graphic point to the problems, but also the solutions.
Loss one: corporate tax dodging
The biggest loss was illicit financial flows – money that was illegally earned, transferred or used – which cost developing countries 4.3% of their GDP ($634 billion) in 2011. Most of this involved illegal corporate tax evasion. As there is currently no way of estimating how much more is lost through the aggressive tax avoidance, the real figure lost to corporate tax dodging may be much higher.
Part of the solution is corporate transparency. Companies: tell us who owns you, how you’re structured, and where you make your money and employ your staff so the public – and tax authorities – can check you’re paying your fair share. The European Union made some initial progress last year, forcing banks to open up their books, but much remains to be done. Another solution is to stop the ‘race to the bottom’ that sees governments giving up on taxing corporations – corporate tax rates have been on the slide for years. The UN should take a lead and tackle all these issues head-on in a new global body.
Loss two: foreign investors making a killing
The second biggest loss is the profits extracted from developing countries by foreign investors: totaling 2.3% of their GDP ($486 billion) in 2012. In fact, since 2008, foreign investors have been taking more profits out of developing countries than new investments have been coming in. Foreign investment can provide major benefits to the countries that receive it, but only if it is carefully managed, so that it brings with it skills training, new ideas, and doesn’t push out domestic investment (which, by the way, is several times larger than foreign investment in developing countries.) The scale of the outflows suggests something is seriously wrong.
That’s why we’ve called for a focus on the quality of foreign investment. We need to support developing countries to insist that investors obey social, environmental and human rights standards, to push investors to go where investment is really needed, and to prevent chaos when investors pull money out too rapidly.
Loss three: lending to rich countries (yes, really)
The third biggest loss is the money that developing countries are lending rich countries – mainly the USA – which totaled 1.2% of their GDP ($276 billion) in 2012 (though it has been much higher in previous years, which is why it comes out as a bigger loss in the graphic above). Developing countries have been building very large reserves to protect their economies from external shocks. These reserves take the form of dependable assets, largely the bonds of rich countries. Every time a developing country buys a US Treasury bond it is lending money – at a low interest rate – to the USA.
In theory, developing countries could borrow from the International Monetary Fund (IMF) in times of crisis, but the IMF remains dominated by western countries, and continues to insist ondamaging austerity as a condition of lending. Again, there are solutions on the table. In addition to allowing developing countries to regulate foreign money more tightly, the UN has proposed a form of global quantitative easing, issuing $250 billion new reserve assets every year, with the majority going to developing countries.
Loss four: Paying interest on debts rather than receiving aid
The fourth biggest loss for developing countries is interest repayments on foreign debt, totaling 0.8% of their GDP ($188 billion) in 2012. Let’s leave aside the fact that developing countries would not have had to borrow so much if rich countries had met their promise to devote 0.7% of national income as foreign aid (only five countries have).
The central problem is that there is no mechanism to deal with unsustainable, unfair, or unpayable debts of developing countries. The solution, is elegant, and currently on the table at the United Nations: an independent insolvency regime for states to help reduce their debts in a rapid, orderly and fair manner.
A call to action
It’s clear that the global economic system has been failing developing countries, and the evidence could not be clearer: lost resources are double new inflows, and have been for some years. Many of the solutions are on the table: it’s time to put them into action.