draining development.pdf - Khazar University

50 Draining Developmentprofitability and absent policies to correct market failures could paradoxicallymake economic performance worse by reducing the incomesof nationals. Capital flight in these contexts is not necessarily damagingin terms of direct effects on growth, and the indirect effects may also notbe negative unless we optimistically believe that blocking these flows willforce the government into adopting the appropriate policies for tacklingmarket failures. Because this is an unlikely scenario, it would be misleadingto classify these financial outflows as illicit. There is an importantpolicy implication: developing countries need to design policies toaddress low productivity and to absorb new technologies. Attempting toblock financial outflows without solving these problems will not necessarilyimprove social outcomes.A different and even more obvious case is one in which capital flightis induced by the presence of bad policies such as the protection ofdomestic monopolies that disadvantage investors who are not politicallyconnected or privileged with monopoly rights. In this situation, if capitalleaves the country, the direct effects may appear to be damaging in thesense of lost investment, but may not be if domestic investment opportunitiesare poor. The problem is not the capital flight, but the growthreducingarrangements that induce it. Blocking financial outflows could,in an extreme case, lead to the consumption of capital by some investorsbecause profitable investment opportunities may be unavailable. Theindirect effects of blocking financial outflows in this context may alsonot be positive, and the financial outflow is not usefully described asillicit. The appropriate response would be to remove some of the underlyingrestrictions on investment.Finally, a particularly interesting set of cases concerns financial outflowsassociated with activities that are directly growth-sustaining, buthave significant negative effects on a society’s political settlement and,therefore, on long-run growth through indirect effects. A classic exampleis the business associated with narcotics and drugs. For many countries,including relatively developed countries like Mexico, the income fromthe production and marketing of drugs is a significant contributor tooverall economic activity. By some measures, there could be a significantpositive effect on growth as a direct effect. However, given the legalrestrictions on the business in many countries, the activity inevitablyinvolves criminality and massive hidden rents that disrupt the under-