Economic consequences of capital flight

Latest data of the Swiss central bank shows that Bangladeshi nationals' deposits with various Swiss banks rose to 8.85 per cent year-on-year in 2015 to an astounding Tk 44.23 billion (550.85 million Swiss francs). The amount had stood at Tk 42.83 billion in 2014, 36.02 per cent up from the previous year. It was Tk 31.49 billion in 2013 and Tk 19.91 billion in 2012. In another report, titled 'Illegal Financial Flows from Developing Countries: 2004-2013',  recently published by the Washington- based research institute Global Financial Integrity (GFI), Bangladesh stands at 26th in the list of 149 developing countries in terms of flight of capital including money laundering. With a whopping $5.59 billion siphoned off every year, more than $57 billion was taken out of the country illicitly between 2004 and 2013. Sadly, all this information has been revealed just when Bangladesh has been desperately looking for local and foreign investment.
Capital flight has become a serious concern for Bangladesh's struggling economy. The amount siphoned off every year is approximately 15 per cent of the country's national budget and almost 3.0 per cent of the gross domestic product (GDP). Capital flight occurs when assets or money rapidly flow out of a country due to an event of economic consequence. Such events could be when businesses and individuals feel insecure because of rising political tension and they shift their money out of the country or an increase in taxes on capital or capital holders or otherwise lose confidence in its country's economic strength. Also it occurs when foreign investors may choose to withdraw their money if they feel insecure or expect a hike in taxes on their investments.  Then another form of capital flight comes from foreign aid and loan intended to build the country's infrastructure but corrupt politicians, government officials and businessmen keep their commissions and kickbacks from such deals in foreign banks.  
It is a common understanding that businesses tend to avoid unstable and conflict-prone areas and countries where cost of doing business is high. In the World Bank report 'Doing Business 2016: Measuring Regulatory Quality and Efficiency', Bangladesh dropped two positions to 174 in the ranking of the ease of doing business due to regulatory reforms and also because of weak and poor infrastructure, entrepreneurs are not very keen in making investment. Rather they prefer to invest their money in safe and secure places.  Countries like the United Kingdom, the United States, Canada, Malaysia, Thailand and Dubai are offering one of the best investment schemes and second-home options, and hence many, including Bangladeshis, are migrating to these countries as 'investors'. Due to foreign exchange restrictions, officially it is very difficult for businessmen to take money out of Bangladesh for investment or buying property abroad and hence the rate of illicit flow from Bangladesh has risen no less than 33 per cent, as reported by the GFI.
Different studies show that 'capital flight' is related to tax evasion, money laundering and black money. The exact amount of black/undisclosed money in our economy cannot be determined, but the Finance Minister in his post-budget press briefing said, it is "at least 40 per cent of our gross domestic product (GDP)". The overall size of the GDP at constant market price for the FY16 stood at Tk. 8,830,544 million which was Tk. 8,248,624 million in the FY15. Based on the Finance Minister's citation, the amount of undisclosed money in our economy is at least Tk.3, 532,217 million.  People in our country, who possess black money or undisclosed income (legal or illegal), think that, they should have more freedom to invest their money abroad and as such they do not have to pay any tax on investment.
Money laundering is the process of concealment of the origins of illegally obtained money, typically by means of transfers involving foreign banks or legitimate businesses. According to Richard McDowell, money launderers are not interested in profit generation from their investments but rather in protecting their proceeds. They invest their funds in activities that are not necessarily economically beneficial to the country. One of the most serious microeconomic effects of money laundering is felt in private sector. Money launderers often use front companies, which co-mingle the proceeds of illicit activity with legitimate funds, to hide the ill-gotten gains. In some cases, front companies are able to offer products at prices below what it costs the manufacturer to produce. Therefore, front companies have a competitive advantage over legitimate firms that draw capital funds from financial markets. This makes it difficult, if not impossible, for legitimate business to compete against front companies with subsidised funding, a situation that can result in the crowding out of private sector business by criminal organisations. The management principles of these criminal enterprises are not consistent with traditional free market principles of legitimate business, which results in further negative macroeconomic effects (McDowell, 2001).
However, the term 'capital flight' generally does not encompass criminal proceeds but instead refers to commercial and private funds being moved from one country to another. The distinction between its legal and illegal manifestations is, the legal component of capital flight is generally after-tax money that is properly documented, as it passes across borders, and it remains on the books of the entity from which it is transferred. Such free market operations are accepted as largely beneficial to investment, trade and development, leaving aside the question of the utility of short-term capital controls. The illegal component of flight capital is quite different; illicit financial flows consist of money earned illegally and then transferred for use elsewhere. The money is usually generated from criminal activities, corruption, tax evasion, bribes and smuggling. Furthermore, it is improperly documented which means that it disappears from the records in the country of its origin. The motivations for these two forms of flight capital differ. The legal component is normally fleeing to safety and can be expected to return to the country of origin when investment conditions are attractive. The illegal component is fleeing to secrecy, to be accumulated in a hidden manner, and it rarely returns to the country of origin.
Legal capital flight becomes illegal when some multinational companies evade taxes through misuse of a mechanism, known as 'transfer pricing.' Transfer price is the price at which divisions of a company transact with each other for goods or services. It takes place when two related companies - such as a parent company and a subsidiary, or two subsidiaries controlled by a common parent - engage in international trade with each other for goods and services. Sometimes, related entities of a multinational firm show artificially high prices for an imported product or service in an attempt to deflate profits to evade taxes. This practice is known as 'transfer mis-pricing.' Several studies show that about 61 per cent of the illicit outflows from Bangladesh occur through trade mis-invoicing, and as such the country loses a huge amount of tax money because of the abuse of the transfer pricing mechanism by foreign firms. The Global Financial Integrity (GFI) said a total of $34.12 billion between 1990 and 2008, and more than $16 billion (Tk.1.28 trillion) during 2002-2011, had been illegally taken out of Bangladesh. It means the country lost around $1.8 billion a year in capital during this period, causing the tax authority to lose a huge amount of revenue.
This illicit financial flow has an adverse impact on our economy. According to the GFI report; the illicit outflows ate away 1.1 per cent of the country's GDP while the per capita loss stood at $6.84. The loss could fund 58.9 per cent of the country's expenditure on education or 30.1 per cent on health care. The costs of this financial haemorrhage have been significant for Bangladesh as it has heightened income inequality and jeopardised employment prospects. On an average, $5.59 billion was siphoned out a year, and in 2013 alone, the country witnessed illegal flight of capital to the tune of $9.66 billion. To put matters into perspective, this figure is three times the amount of foreign direct investment (FDI) Bangladesh has received in the last so many years.  The report also said in the area of human development, there is an inverse relationship between illicit outflows of funds and a country's ranking on the UN's annual Human Development Index. This negative relationship might be caused by a significant loss of domestic resources as tax that could have been collected by the government, or capital that could have been retained by the economy had trade mis-invoicing not taken place. Also there appears to be a strong connection between high levels of illicit financial flows and the poverty gap. A plotting of illicit outflows against the number of people living on $1.25 per day and those living on $2 per day shows that when illicit financial flows are high, poverty rates are high. For example, in the absence of capital flight, income per capita would have been 1.5 per cent higher than it is and the poverty rate nearly 2 percentage points lower than it is.
Now the question is, if we let the trend continue, can we imagine what sort of impact it would have on our economy? In a country like ours, where actually the wealth of the nation is concentrated in the hands of a small group of rich people, if a good portion of them decide to stop business activity and shift their wealth and business to some other country, our economy will fall into deep trouble. Businesses and factories will be shut down, creating unemployment; law and order will deteriorate; the real-estate sector will surely collapse; demand for foreign currency will go up, which can cause the domestic currency to fall in value, which in turn can lead to tremendous instability and harm the entire economy.
Therefore, before things become uncontrollable and the country goes into deep crisis, the sticky issue of graft has to be tackled head on. During the last few years, along with political unrest, the brutal murders of free-thinkers, bloggers, publishers and attacks on minorities and foreigners have created tension and panic among local and foreign investors. And it appears that the trend set in the past on handling such issues by the government is discouraging.  Our leaders must realise that political violence and business insecurity not only contribute to 'flight of capital' but also to 'flight of human capital' (brain drain). It should, therefore, be the government's responsibility to create a healthy atmosphere in the country and bring back confidence of investors for capital to stay 'in', not go 'out' of Bangladesh.
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