‘Control mechanisms won’t stop capital flight’

Capital flows out of less developed countries to advanced economies because of corruption and lack of institutional efficiency, which work as push factors, says Dr Zahid Hussain. 

"Control mechanisms won't resist it. Incentives can help you to stop it," says the former lead economist of World Bank Bangladesh. 

His remarks came in response to the findings of a study presented in a session he chaired at the 5th annual economists' conference of the South Asian Network on Economic Modeling (Sanem) in Dhaka on Sunday. 

"Capital outflow is a complex issue. There are push factors, and there are pull factors," he said, stressing the need for further studies to identify the mechanisms to tame it.  

In Bangladesh context, capital flight occurs mostly through trade by mis-invoicing and mis-classification, he pointed out. 

Referring to "stories of Bangladeshis having second homes in Malaysia or in the Begumpara of Canada," he said no matter how well Bangladesh's economy is doing, even if the rate of return is 50 percent and cost of capital is 25 percent, one may not feel safe to keep one's capital at home. 

If the capital is acquired through means which would eventually make it unsafe once "one's connectivity with those in power is gone," it may go out, he explained.  

Here comes the question: What failures of internal governance enabled earning money through illicit means? "So, macroeconomic factors are important, infrastructure is important, but the governance issues are more important than others in countries like Bangladesh," he pointed out. 

Taxation policies, lack of safe banking and institutional transparency, inefficient bureaucracy are among other factors behind the outflow of capital from poor economies.    

Dr Mamta B Chowdhury, senior lecturer at Western Sydney University, summarised the session, saying different estimates suggest that illicit capital outflow from Bangladesh would be between $6 billion and $9 billion. "Where does the money go since Bangladeshis are not known as Greenfield investors like those from India?" she questioned.

Dr Zahid Hussain responded to the presentations of four young economists from Bangladesh, India and Sri Lanka, who studied capital flight, outward foreign direct investment, fiscal policies and fiscal decentralisation.

On the back of his 25 years of work with the government through the World Bank, Dr Zahid noted that in Bangladesh, stabilisation does not play any role in deciding what tax policy should be in the next budget or what level of investment should be there. 

He compared the situation with Western countries, where stabilisation is a major policy objective to identify what measures are needed when an economy is overheated or in fear of recession. 

"I never got a sense that anyone in this country is bothered about those issues. What we worry about most is growth and poverty reduction," he said, explaining why taxation policies matter more in Bangladesh.

Responding to an observation of a researcher from the Bangladesh Bank that public expenditure, if financed by taxation, would not crowd out private investment, Dr Zahid questioned why the new VAT law took seven years to take effect since it was enacted in 2012. It was implemented with some changes that "made it even worse than the one it replaced." 

It is a consumption tax and consumers did not go out to the street to reject it. Then why businesspeople and their forum FBCCI resisted it and had the finance minister approach the upper level to stop or delay its implementation, Dr Zahid wondered. "These are the issues we have to worry about," he concluded.

The breakout session on macroeconomic policies was part of the two-day annual event that brought young economists from South Asian countries.

Bangladesh Bank Deputy Director (research) Ataur Rahman, while elaborating on his paper on "The effects of fiscal policy in Bangladesh," said the government expenditure does not crowd out investment. "It is not going to hurt private investment," he said. 

He spoke on how increased tax hurts private consumption and thus affects economic growth.    

GDNM Godagampala, lecturer of economics at the Sri Lankan University of Peradeniya, studied how domestic taxation and interest rate influence capital flight from developing countries to advanced countries. She said capital outflow squeezes domestic investment, reduces labour productivity and slows GDP growth of developing countries.

"The government should have policies to attract foreign direct investment and simultaneously to stop capital outflow through incentives and innovative projects," she told The Business Standard after the session.

Minakshee Das, a consultant with India's steel ministry, explained why foreign direct investment flows from one region to another. She suggested that the governments of emerging economies should be careful about outward FDI, which, if not monitored, may end up in huge capital outflow.

Sovik Mukherjee, assistant professor of St Xavier's University, Kolkata, while comparing the experiences of fiscal decentralisation in India and China, said higher spending in local governments might reduce poverty but widen inequality.

The two-day conference, organized for the fifth time by Bangladeshi think tank Sanem, is themed on "Institutions for Development." A total of 65 researchers – 27 from India, Sri Lanka and Nepal – have been invited to present papers on macroeconomic issues, trade, climate change, institutional development, labour market, poverty and inequality.