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Aid in reverse: how poor countries develop

We have long been told a compelling story about the relationship between rich countries
and poor countries. The story holds that the rich nations of the OECD give generously of
their wealth to the poorer nations of the global south, to help them eradicate poverty
and push them up the development ladder. Yes, during colonialism western powers may
have enriched themselves by extracting resources and slave labour from their colonies –
but that’s all in the past. These days, they give more than $125bn (£102bn) in aid each
year – solid evidence of their benevolent goodwill.

This story is so widely propagated by the aid industry and the governments of the rich
world that we have come to take it for granted. But it may not be as simple as it appears.

The US-based Global Financial Integrity (GFI) and the Centre for Applied Research at
the Norwegian School of Economics recently published some fascinating data. They
tallied up all of the financial resources that get transferred between rich countries and
poor countries each year: not just aid, foreign investment and trade flows (as previous
studies have done) but also non-financial transfers such as debt cancellation, unrequited
transfers like workers’ remittances, and unrecorded capital flight (more of this later). As
far as I am aware, it is the most comprehensive assessment of resource transfers ever
undertaken.

 
The flow of money from rich countries to poor countries pales in comparison to the flow
that runs in the other direction

What they discovered is that the flow of money from rich countries to poor countries
pales in comparison to the flow that runs in the other direction.

In 2012, the last year of recorded data, developing countries received a total of $1.3tn,
including all aid, investment, and income from abroad. But that same year some $3.3tn
flowed out of them. In other words, developing countries sent $2tn more to the rest of
the world than they received. If we look at all years since 1980, these net outflows add
up to an eye-popping total of $16.3tn – that’s how much money has been drained out of
the global south over the past few decades. To get a sense for the scale of this, $16.3tn is
roughly the GDP of the United States
What this means is that the usual development narrative has it backwards. Aid is
effectively flowing in reverse. Rich countries aren’t developing poor countries; poor
countries are developing rich ones.

What do these large outflows consist of? Well, some of it is payments on debt.
Developing countries have forked out over $4.2tn in interest payments alone since 1980
– a direct cash transfer to big banks in New York and London, on a scale that dwarfs the
aid that they received during the same period. Another big contributor is the income
that foreigners make on their investments in developing countries and then repatriate
back home. Think of all the profits that BP extracts from Nigeria’s oil reserves, for
example, or that Anglo-American pulls out of South Africa’s gold mines.

But by far the biggest chunk of outflows has to do with unrecorded – and usually illicit –
capital flight. GFI calculates that developing countries have lost a total of $13.4tn
through unrecorded capital flight since 1980.

Most of these unrecorded outflows take place through the international trade system.
Basically, corporations – foreign and domestic alike – report false prices on their trade
invoices in order to spirit money out of developing countries directly into tax havens and
secrecy jurisdictions, a practice known as “trade misinvoicing”. Usually the goal is to
evade taxes, but sometimes this practice is used to launder money or circumvent capital
controls. In 2012, developing countries lost $700bn through trade misinvoicing, which
outstripped aid receipts that year by a factor of five.

 
Multinational companies also steal money from developing countries through “same-
invoice faking”, shifting profits illegally between their own subsidiaries by mutually
faking trade invoice prices on both sides. For example, a subsidiary in Nigeria might
dodge local taxes by shifting money to a related subsidiary in the British Virgin Islands,
where the tax rate is effectively zero and where stolen funds can’t be traced.

GFI doesn’t include same-invoice faking in its headline figures because it is very difficult
to detect, but they estimate that it amounts to another $700bn per year. And these
figures only cover theft through trade in goods. If we add theft through trade in services
to the mix, it brings total net resource outflows to about $3tn per year.

That’s 24 times more than the aid budget. In other words, for every $1 of aid that
developing countries receive, they lose $24 in net outflows. These outflows strip
developing countries of an important source of revenue and finance for development.
The GFI report finds that increasingly large net outflows have caused economic growth
rates in developing countries to decline, and are directly responsible for falling living
standards.

Who is to blame for this disaster? Since illegal capital flight is such a big chunk of the
problem, that’s a good place to start. Companies that lie on their trade invoices are
clearly at fault; but why is it so easy for them to get away with it? In the past, customs
officials could hold up transactions that looked dodgy, making it nearly impossible for
anyone to cheat. But the World Trade Organisation claimed that this made trade
inefficient, and since 1994 customs officials have been required to accept invoiced
prices at face value except in very suspicious circumstances, making it difficult for them
to seize illicit outflows.

Still, illegal capital flight wouldn’t be possible without the tax havens. And when it
comes to tax havens, the culprits are not hard to identify: there are more than 60 in the
world, and the vast majority of them are controlled by a handful of western countries.
There are European tax havens such as Luxembourg and Belgium, and US tax havens
like Delaware and Manhattan. But by far the biggest network of tax havens is centered
around the City of London, which controls secrecy jurisdictions throughout the British
Crown Dependencies and Overseas Territories.

In other words, some of the very countries that so love to tout their foreign aid
contributions are the ones enabling mass theft from developing countries.

The aid narrative begins to seem a bit naïve when we take these reverse flows into
account. It becomes clear that aid does little but mask the maldistribution of resources
around the world. It makes the takers seem like givers, granting them a kind of moral
high ground while preventing those of us who care about global poverty from
understanding how the system really works.

Poor countries don’t need charity. They need justice. And justice is not difficult to
deliver. We could write off the excess debts of poor countries, freeing them up to spend
their money on development instead of interest payments on old loans; we could close
down the secrecy jurisdictions, and slap penalties on bankers and accountants who
facilitate illicit outflows; and we could impose a global minimum tax on corporate
income to eliminate the incentive for corporations to secretly shift their money around
the world.

We know how to fix the problem. But doing so would run up against the interests of
powerful banks and corporations that extract significant material benefit from the
existing system. The question is, do we have the courage?