Impact of capital flight on economic performance of selected developing economies: A comparative analysis

Capital flight from the capital-scarce developing economies has been found to be very extensive in the empirical literature over the last few decades. While earlier studies have focused on the measurements and determinants of capital flight, there has been a growing interest in recent years in analyzing the impact of capital flight on the macroeconomic performance of these developing economies. Most of the recent studies are country-specific or region-specific, and consequently, cross-country and inter-regional comparison of the extent and impact of capital flight relying on a unique approach of capital flight is absent. The study is an attempt to approach this gap. It uses the World Bank's residual approach with necessary modifications to appear at the capital flight series of 38 developing economies from four developing regions, namely Asia, Africa, Latin America, and transition economies during 1981-2019. It then proceeds to examine the impact of capital flight on the per capita output growth of these economies individually resorting to the ARDL Bounds Testing approach which facilitates both the inter-country and inter-regional comparison of the impact of capital flight on the per capita output growth of developing economies. The study suggests that though capital flees from the developing economies is very high in the Latin American economies, the problem is acute in developing Africa in terms of the share of capital flight in GDP. The scenario does not alter when the impact of capital flight on the per capita output growth of different developing regions is compared based on the selected economies. In terms of the mean value of negative significant coefficients of capital flight, the growth faltering effect of capital flight is found to be very severe in developing Africa, which is nearly one and half times higher than developing Asia and two times higher than developing Latin America. The overall impact of capital flight on the per capita output growth of Transition economies is negative. The study performs a separate growth regression for Turkey incorporating RER misalignment along with capital flight. It finds the RER of Turkey misaligned throughout the sample period producing six alternating periods of overvaluation and undervaluation. According to the commonly accepted argument that anticipated undervaluation of currency of a country motivates domestic residents to hold their assets abroad and thereby causes capital flight, Turkey experiences the largest amount of capital flight during the 2010s throughout which its RER remains undervalued. It is obvious from the findings that RER misalignment and capital flight have an adverse impact on the per capita output growth of Turkey. Most importantly, undervaluation that promotes per capita output growth also gives incentive to capital flight that has an adverse impact on per capita output growth. Clearly, capital flight is working as an obstacle to achieving the desired development goals of capital-scarce developing countries. Therefore, results of the study have important policy implications. Government and monetary authorities should pursue policies that will confirm a favorable investment climate and good governance along with the development of domestic human capital which will not only retain domestic capital but also create a reverse flow of capital to these capital-scarce regions.