Working Paper Number

2019-12

Journal or Book Title

UMass Amherst Economics Working Papers

Publication Date

2019

Abstract

This paper provides theoretical and empirical insights into the puzzling simultaneous rise in foreign direct investment inflows in Africa and capital flight from the continent over the past decades. Indeed, paradoxically, even as African countries have become more attractive to foreign private capital, they have continued to experience capital exodus in the context of improved economic performance, especially since the turn of the century. This paper explores three questions. First, does foreign direct investment fuel capital flight as has been established in the case of external borrowing? In other words, is there an FDI-fueled capital flight phenomenon akin to debt-fueled capital flight? Second, is natural resource endowment a possible channel for the capital flight-FDI link, given that resource-rich countries tend to be both preferred destinations of FDI and prominent sources of capital flight? Third, does the quality of institutions mitigate the impact of natural resources on capital flight? The paper develops a theoretical model that conceptualizes these linkages and sets the stage for an econometric investigation of these questions. The results from econometric analysis based on a sample of 30 African countries over the period 1970-2015 show that FDI flows are positively related to capital flight, suggesting a possible FDI-fueled capital flight phenomenon. However, there is no evidence for an FDI overhang effect; past stock of FDI has no impact on capital flight. High natural resource rents are associated with high capital flight and the quality of institutions does not mitigate this link. The paper offers some policy insights derived from the empirical results.

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