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DEVELOPMENT COMPARATIVE APPROACH TO CAPITAL FLIGHT: THE CASE OF THE MIDDLE EAST AND NORTH AFRICA, 1970-2002

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Capital flight from developing countries represents a lost potential for economic growth and development. In the contemporary literature of development economics, there has been increasing attention to the notion of capital flight. Many analysts have attributed sluggish economic growth and persistent balance of payments deficits in most developing counties to capital flight (Ajayi, 1996). In addition, capital flight has adverse consequences for developing countries. First, the loss of capital through capital flight erodes the domestic tax base and therefore affects income redistribution. Secondly, it reduces a bank’s ability to create money for investment projects. Most importantly, capital flight contributes to the distribution of income from the poor to the rich (See Pastor, 1990, and Ajayi, 1997).  The literature also highlights several routes of capital flight from developing countries. Prime among those are external borrowing and trade mis-invoicing. Also many authors have identified factors that cause capital flight including risk of inflation, taxation, political risk instability, financial repression, weak institutions, ineffectiveness of macroeconomic policies, business cycles, overvaluation of exchange rates, and poor investment climate, to name a few (See, Hermes, Rensink and Murinde, 2002, Schneider, 2003 and Boyce and Ndikumana, 2002).  Several approaches to measuring capital flight have been cited widely such as the hot money measure, the balance of payments approach and the residual approach (See Schneider, 2003, and Hermes, Rensink and Murinde, 2002). However, it is well documented in the literature that most researchers use the residual method to capital flight. The residual approach is more inclusive and therefore gives a measure of capital flight that takes into account most transactions of capital flows between nations including external debt, foreign direct investment, and portfolio investment. The residual method is a broad measure and an indirect approach that is based on the discrepancies between sources of foreign exchange (capital inflows) and uses of those funds (capital outflows). Capital flight, according to this method, comprises the surplus of capital inflows over foreign exchange outflows that are not recorded in government official statistics.

Capital flight refers to the significant outflow of financial assets from a country due to various economic and political factors. The Middle East and North Africa (MENA) region has experienced fluctuations in capital flight patterns from 1970 to 2002, influenced by economic development stages and regional dynamics.

1.2 Statement of the Problem

Despite the economic potential of the MENA region, persistent issues of capital flight have hindered sustainable development and economic stability over the decades.

1.3 Objectives of the Study

The main objective of this study is to determine the developmental impacts of capital flight in the MENA region from 1970 to 2002. Specific objectives include:

i. To evaluate the impact of capital flight on economic growth in MENA countries.

ii. To determine the factors driving capital flight in the MENA region during the specified period.

iii. To find out the policy measures that could mitigate capital flight in MENA economies.

1.4 Research Questions

i. What is the impact of capital flight on economic growth in MENA countries from 1970 to 2002?

ii. What factors contributed to capital flight in the MENA region during the specified period?

iii. How does policy intervention affect the mitigation of capital flight in MENA economies?

1.5 Research Hypotheses

Hypothesis I

H0: There is no significant impact of capital flight on economic growth in MENA countries from 1970 to 2002.

H1: There is a significant impact of capital flight on economic growth in MENA countries from 1970 to 2002.

Hypothesis II

H0: There is no significant relationship between economic factors and capital flight in the MENA region from 1970 to 2002.

H2: There is a significant relationship between economic factors and capital flight in the MENA region from 1970 to 2002.

Hypothesis III

H0: Policy measures have no significant effect on mitigating capital flight in MENA economies from 1970 to 2002.

H3: Policy measures have a significant effect on mitigating capital flight in MENA economies from 1970 to 2002.

1.6 Significance of the Study

This study is significant as it contributes to the understanding of capital flight dynamics in the MENA region, providing insights for policymakers to formulate effective strategies for economic stability and development.

1.7 Scope of the Study

The study focuses on the MENA region from 1970 to 2002, examining historical trends and patterns of capital flight and its implications on economic development.

1.8 Limitations of the Study

Limitations include data availability for certain periods, the complexity of measuring informal capital flows, and the diversity of economic and political contexts across MENA countries.

1.9 Definition of Terms

Capital flight: The rapid outflow of financial assets from a country due to economic and political instability.

MENA region: Refers to the Middle East and North Africa, encompassing countries with diverse economic and geopolitical landscapes.

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