draining development.pdf - Khazar University

The Practical Political Economy of Illicit Flows 459deeply intertwined. In the poorest countries, illicit capital flows contributeto a vicious circle of weak and illegitimate domestic capitalism.(Potential) domestic capitalists expatriate much of their capital andinvest only limited amounts in the domestic economy. They have inadequateincentives to nurture the domestic institutions that would protectand encourage private investment. They therefore continue to face anarray of incentives to keep much of their capital overseas, and capitalistenterprise remains suspect and politically vulnerable, in part because ittypically has a high foreign component. The more large-scale privateinvestment is seen to be an indigenous activity, the more quickly it willbecome legitimate and the more likely property rights will be respected.All else being equal, a reduction in illicit flows is likely to lead to higherdomestic investment.The phenomenon of illicit capital flows is systemic in two senses.First, political and economic variables interact closely. Second, they doso on a global canvas (see the section on globalization). The apparentlyinternal issues of weak institutions in poor countries both contribute tothe prevalence and adverse effects of illicit flows and are partly caused bythese flows. The appropriate policy response is not to focus only on theseputatively domestic political and institutional problems, setting aside forlater the problem of controlling and reducing illicit international flows.This is because the causation also works the other way: illicit flows exacerbatedomestic political and institutional problems. Better global regulationof illicit flows should benefit both the polities and the economiesof the poorest, weakest states.PerspectiveMainstream economics tells us that international capital mobility canbring many benefits and that we need to scrutinize carefully any argumentfor restricting it, even where it is in some sense illicit. Equally, it isnow widely accepted that, in the highly financialized contemporaryglobal economy, excessive international financial mobility can do damage.It has become conventional wisdom that capital accounts should beliberalized slowly and that it may make sense to tax and discourageshort-term capital inflows. One basis for these arguments is that theeconomies of smaller, poorer countries with relatively weak economic