Not news: Most capital flows are not developmental


Ben D. Kritz

A recently released United Nations report, “World Economic Situation and Prospects 2017” (WESP 2017), makes an observation that has attracted a bit of attention from academia and non-governmental organizations, but which is completely unsurprising: Most of the capital flows in the developing world are actually flowing the wrong way, and where they are finding their way to developing countries, they are almost never used for actual “development.”

What the authors of the report found particularly alarming is that net resource transfers from developing countries to the developed world—a well-known contradiction in economics known as the Lucas Paradox—have increased over the past couple of years, “a multi-year reversal in global flows [that]has not been seen since 1990,” the report said.

By the numbers, reverse capital flow peaked at $800 billion in 2008, when the global financial crisis erupted, then moderated through 2015. Last year, however, they increased again, reaching nearly $500 billion.

While some regard the persistence of the Lucas Paradox as an indication of exploitation, direct resource transfer is largely the fault of the developing economies themselves, rather than exploitative foreign interests.
The main sources of the negative net resource transfers are investments abroad in safe instruments, primarily low-yielding US Treasury bonds. The UN report noted that in the first quarter of last year, 64 percent of official reserves among those economies in the “developing” or “transition” categories were held in dollar-denominated assets, an increase from 61 percent at the end of 2014.

The authors of the report point out that this amounts to an unfavorable trade-off: Developing countries can avoid currency appreciation due to rising foreign reserves, which has negative implications for exports and remittances, by investing abroad, but incur significant opportunity costs in the sense that the capital cannot then be applied to develop infrastructure, or fund social investments in things like education and health care.

Data from the African Development Bank was provided as an example: According to the bank, African countries held, on average, between $165.5 billion and $193.6 billion in reserves between 2000 and 2011, an amount that was considerably higher than the estimated infrastructure financing gap of $93 billion per year. This, the bank said, amounted to a social cost for holding the reserves of between 0.35 percent and 1.67 percent of GDP across the continent.

What is somewhat infuriating about the UN perspective is that it certainly seems to pin most of the blame for unfavorable capital flows on the developing world, but conveniently fails to acknowledge that it is the international financing framework imposed by the developed world that has handcuffed would-be recipients of developmental capital flows into a somewhat self-defeating conservative fiscal management approach.

One big reason for the problem is the bias of the international financial system toward the US dollar as the preferred reserve currency. The second is the demand of the developed world that developing countries “get their financial houses in order” by reducing external debt and accumulating huge foreign reserves as safety nets. To be fair, the developing world, particularly countries in this part of the world that were snakebitten by the Asian financial crisis in 1997-1998, didn’t need much convincing.

The UN report notes, however, that for many developing or transition economies, which would include the Philippines, the approach that has been faithfully followed for a couple of decades is retarding development.
We see it here every day, in infrastructure that is being quickly overwhelmed – the population’s income is rising quickly enough to allow a lot of people to afford smartphones, cars and all manner of electrical appliances, but the corresponding infrastructure can’t be expanded fast enough to accommodate them.

More people can afford schools for their children and better health care through private providers, but much of the capital the state needs to develop services for the still sizeable population that cannot is tied up by unhelpful macro-scale accounting. As a result, the absolute number of impoverished people is declining, but income inequality is growing rapidly, and poverty, while affecting fewer people, is becoming an increasingly difficult condition to solve because it is rapidly deepening.

The conclusion to all of this, which the UN report makes without suggesting what should be done, is that a comprehensive overhaul of the international system is needed. Ironically, the recent trend of increasing nationalism and trade protectionism, about which the UN has been the biggest alarmist, may actually help repair a system that seems to have outlived its usefulness for most of the world.


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