Capital Flight and Foreign Direct Investment in Africa: An Investigation of the Role of Natural Resource Endowment

Abstract

This paper aims to provide theoretical and empirical insights into the puzzling simultaneous rise in foreign direct investment inflows in Africa and capital flight from the continent over the past decades. It specifically explores two questions: is FDI a potential driver of capital flight? Is natural resource endowment a possible channel for the capital flight-FDI link? The econometric analysis is based on 32 African countries over the period 1970-2013 using dynamic panel data estimation methods. Three important findings emerge from the analysis. First, while there is no robust evidence that capital flight is fueled by annual FDI inflows (there is no equivalent to debt-fueled capital flight), there is a positive relationship between the stock of FDI and capital flight. Second, natural resource endowment is directly related positively to capital flight and resource endowment is associated with a stronger FDI stock-capital flight link, especially in the case of oil. Third, high-quality institutions somehow weaken the link between FDI and capital flight, although they do not completely eliminate the relationship. The results point to potential gains from improvements in institutional quality in African countries through minimizing the contribution of FDI and natural resources to capital flight.