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Out of Africa: Tax evasion, capital flight and debt
by John Weeks
28 April 2014

Though thoroughly documented, the fact that illegal capital flight and tax evasion far exceed inflows of development assistance and direct investment for sub-Saharan countries is rarely noted in the mainstream media. Even modest steps toward limiting capital flight would imply a substantial reduction in external indebtedness. I recently returned from Zambia and Tanzania, where in different ways these losses of potential development finance loomed large.

Zambia is a major exporter of copper and has been since the British established themselves as colonial masters early in the 20th century. In those bye-gone days, the colonial masters had a grand scheme: 1) Southern Rhodesia (now Zimbabwe) would be a white-settler state like the nearby and larger South Africa; 2) Northern Rhodesia (now Zambia) would be a mineral exporter; and 3) Nyasaland (now Malawi) would produce the food for the mines.

To achieve this plan, the colonial authorities severely limited farming by Africans in Zambia, restricting income alternatives and thereby facilitating a low-wage labor supply. By definition Africans did the unskilled work and Europeans held the skilled jobs with astronomical pay differentials that favored the latter. After a struggle involving relatively little violence compared to what would occur in Zimbabwe, independence came in 1964 under the leadership of one of Africa’s great figures, Kenneth Kaunda, whom I was fortunate enough to meet several years ago. In 1969 his government nationalized the mines and so they remained for over twenty years.

As a result of gathering economic woes, “KK”, as he is universally known in Zambia, suffered electoral defeat in 1991 by Fredrick Chiluba. With the enthusiastic backing of the World Bank and the IMF Chiluba would preside over one of the world’s great kelptocracies. Among the impressively shady deals of the Chiluba government was the privatization of the mining sector, a privatization designed by the World Bank.

The privatization of mining anywhere brings with it a de facto license for tax evasion unless governments are extraordinarily vigilant. The best known of the tax scams is “transfer pricing”, in which companies under-invoice the export value of the ore. For example, if a month’s production is $10 million at world prices, the company reports it to the host government as seven million. A sharp-eyed government might catch this game by checking out the prices on the London Metals Exchange for the quality of the ore claimed by the company.

Any mildly crooked multinational can transfer-price, and mining companies have tricks unique unto themselves. Their more effective scam is to misrepresent the quality of the ore. For example, recently a British mining expert claimed that the largest copper company in Zambia regularly under-reports by half the copper content of the ore it exports. Getting away with claiming two percent copper content when the true figure is double that amount results in a tidy tax saving. Prevention requires a government official carrying out tests in every company to verify content claims. Thanks to World Bank and IMF budget conditionalities, the Zambia government rendered such officials redundant during the Chiluba years.

So, how much difference does it make? Consider this official statistics report Zambia exporting more than $8 billion in copper ore in 2012. If the copper content of the ore was under-reported by fifty percent - well, we are talking about a lot of tax evasion. My own estimate is that the annual loss of public revenue is as large as the total tax collected by the government from all other sources.

From Lusaka in Zambia I traveled to Arusha in northern Tanzania to attend a conference on capital flight. Capital flight is a multi-faceted scam that includes the false pricing and false reporting of export and import values plus many other corporate tricks. World Bank and IMF pressures on African governments to “liberalize” trade and “de-regulate” cross-border money flows can justifiably claim to facilitate bleeding countries of foreign exchange.

Liberalization and de-regulation are policy “reforms” that legalize financial fraud and money laundering scams. The justification for this legalization of the illegal is that it will encourage investment inflows. By making it easy to send your money out, you are more likely to bring it in. The argument is a close kin to asserting that allowing companies to fire workers more easily prompts those companies to hire more workers. The reality is that when workers are easier to fire, companies fire them. When a company finds it easier to abscond with the capital flight loot, that is what they do.

What can we do to reduce the annual billions of dollars seeking a compliant money laundry that flee countries to escape taxation or come from criminal activities? Several advocacy organizations are on the case. The central approach of these organizations is that policy changes in the high income countries will go far to prevent tax avoidance and capital flight from countries such as Zambia. The world’s largest havens for capital flight are London and New York.

Changing policy in the high income countries serves neither as an effective deterrent nor an enforceable alternative to aggressive policies in the source countries. Farmers do not leave chicken coops open in the hope that no one will let the chickens roost elsewhere. They keep the coop closed. Similarly, the necessary first step to reduce capital flight and tax avoidance in any country, developed or underdeveloped, is strict policies vigorously enforced.

We should all hope that the leaders of the G8 countries will adopt policies to make tax avoidance more difficult, though the likelihood is slim at best. Better is to expose the role of the IMF and World Bank in advocating and even requiring policy changes in developing countries that facilitate tax avoidance. Failing success in changing IMF and World Bank policies, governments throughout the developing world should reject their advice and act on their own.

In February I was in Zambia working with the central bank, Bank of Zambia, on designing policies to limit capital flight. An essential first step, the Zambian government requires that all foreign exchange transactions be reported ot the central bank. However, this is a long way from the most effective measure - re-nationalization of the copper companies.

John Weeks is author of the recently published, Economics of the 1%: How mainstream economics serves the rich, obscures reality and distorts policy, Anthem Press.

John Weeks

Professor Emeritus, SOAS, University of London