For sources, you may only use readings assigned in class.Follow instruction and Provide me with plagiarism report Question is attached below

– Chinua Achebe, Home and Exile, 2000 To our families 1 Introduction As the Concorde lifted off the Gbadolite runway in June 1989, Joseph Mobutu had reasons to feel happy. Backed by generous international patronage, above all from the United States, he was one of the longest-ser ving heads of state in the world. His rule had brought impressive changes to Gbadolite, his home village in the far north of Zaire: his opulent palace, an airport big enough for the supersonic aircraft to come and go, an electric power plant to ser vice them both. His rule had also brought great wealth to Mobutu himself. In a classi fied memo, the US State Department had estimated his fortune at $5 billion. 1 Mobutu publicly claimed a more conser vative $50 million. Whatever the true number – most likely, somewhere in between – it was an impressive haul in a countr y where the average person lived on 60 cents a day. In Washington, DC, where the Concorde was carr ying him, Mobutu would meet his old friend George Bush, the new president of the United States. He would be the first African ruler to be received by Bush in the White House. The diplomatic grapevine reported that Bush’s way ward son, George W., was starting to take an interest in politics. Maybe one of Mobutu’s sons would take note and follow suit. But Mobutu had reasons to feel just a little anxious, too. The Cold War was drawing to a close, and without it America might have less use for one of its ‘oldest and most solid friendships in Africa’, as President Reagan so graciously put it during Mobutu’s 1986 visit to the White House. 2 To placate his tiresome critics in the US Congress – those whose goodwill could not be purchased with lavish hospitality in his Gbadolite palace, including wine flown in from Paris at a cost of $400 a bottle 3 – Mobutu was being pressed to ease political repression at home. This would entail risks. But the risks would be greater for his opponents, 2 should they mistake his forbearance for liberty, than for Mobutu himself. Mobutu’s more pressing worries were financi al. Zaire’s exter- nal debts now amounted to $9 billion. The countr y’s creditors, alarmed by the dismal state of the economy and the disarray in public finances, were loath to lend more. Payments on past loans were overdue. If the International Monetar y Fund (IMF), headquartered in Washington, could be persuaded to come to the rescue with a new loan, this would not only clear Zaire’s IMF arrears but also provide the seal of approval that would convince other creditors to reschedule, too. Getting a new IMF loan wouldn’t be easy. A decade before, the Fund had installed its own staff members at the Bank of Zaire. The journal Foreign Affairs called this unusual step an effort to ‘limit the hemorrhage of capital occurring both through the Zairian politico-commercial class as well as foreign mercantile groups’, and predicted rightly that it would ‘inevitably bring the group into conflict with the powerful political figures who are involved in capital flight’. 4 The results had not been happy. Er win Blumenthal, the German central banker who led the IMF team, produced a scathing report that concluded that the ‘impossibility of control over frauds’ meant that there was ‘not any – I repeat any – chance on the horizon that the numerous creditors of Zaire will recoup their funds’. 5 In 1987, the IMF nevertheless approved a new loan to Zaire under pressure from the US government, over strong objections by senior staff and a rare dissenting vote by three members of the Fund’s twenty-four-member executive board. This was among the decisions that prompted the resignation of David Finch, director of the IMF’s exchange and trade relations department, who publicly decried ‘the intrusion of political factors’ into Fund lending and warned that ‘balance-of-payments assistance in such conditions is indistinguishable from political support’. 6 Last year, no less a personage than Michel Camdessus, the managing director of the IMF, told a newspaper that much of the debt problem of developing countries was due to corruption.

Intr 1 Zai re’s president Joseph Mobutu was the first African head of state to be received by President George H. W. Bush in the White House, in June 1989 (George Bush Presidential Librar y and Museum) 4 ‘There are people there whose limitless egoism pushes them to deposit their money overseas,’ he declared, ‘which incurs a terrible flight of capital.’ Mobutu denounced such criticism as ‘scandal- ous’, offering his own investments in Gbadolite as evidence that African leaders keep their money at home, not in foreign bank accounts. 7 Despite these annoyances, Mobutu still had friends in high places. In addition to President Bush he could count on his long-time con fidant, Jacques de Groote, now an executive direc- tor at the IMF and World Bank. 8 Earlier in the year Mobutu had enlisted the ser vices of Washington lobbyist Edward van Kloberg III, paying him a retainer of $300,000 a year to secure favourable press coverage of Mobutu as a reliable US ally and to belittle his increasingly vocal American detractors as ‘a cabal of left-wing extremists and homosexuals’. 9 In the end, Mobutu’s Washington visit was a resounding suc- cess. At the White House, President Bush lauded him as ‘one of our most valued friends’ on the entire continent of Africa, and announced that Zaire had taken ‘the constructive step of sign- ing an economic policy reform agreement with the International Monetar y Fund’. 10 The IMF came through with $187 million in fresh lending. The World Bank chipped in $87 million more, lifting Zaire’s cumulative debt to the Bank to more than $900 million. § While Mobutu was once again shaking the money tree in Wash- ington, one of this book’s authors, Léonce Ndikumana, a junior university lecturer in Burundi, Zaire’s neighbour, was witness- ing historic changes in his countr y. The ‘wind from the West’ was invigorating long-standing popular demands for democratic opening in Burundi and across Africa. In September 1988, Léonce joined twenty-six Burundian intellectuals in signing an open letter to President Pierre Buyoya, urging the government to stop army killings of civilians in the northern communes of Ntega and Marangara, and to begin a transition to democratic rule. This seemingly simple exercise in democracy was deemed an offence to the nation, and it earned Léonce and six other signatories Intr 5 five months of solitar y con finement in the notorious maximum- security prison of Mpimba. The open letter, which cited well-documented facts about in- discriminate killings in the north of the countr y and suggested positive ways to find solutions to ethnic conflict by addressing its root causes, threw the government off balance. It attracted atten- tion in the resident diplomatic community and internationally, being seen as an opportunity to launch a national debate to initiate a transition towards an open and inclusive political system. The government came under pressure to release the jailed signataires. In the books of international human rights organizations, such as Amnesty International, Léonce joined the ranks of those referred to as ‘prisoners of conscience’. This attention helped to secure his release from prison in Februar y 1989. Léonce emerged from prison with an enhanced thirst to better understand the relationships between development and politics in African countries. He wished to better understand the role of the Western powers in Africa’s economy and politics. Above all, he wanted to understand why the people of countries like neighbouring Zaire, a darling of the Western aid donors, could remain so poor while their countr y was so rich. Upon his release, Léonce was appointed Chief Finance Officer and then Director of Finance and Administration at the University of Burundi. He won a fellowship from the US Agency for Interna- tional Development to pursue doctoral studies in economics at Washington University in St Louis in the United States. This was an opportunity to pursue his quest for greater understanding of African development challenges. He seized it, and left Burundi in August 1990. § At the time of Mobutu’s rewarding trip to Washington, DC, the second author of this book, James Boyce, was writing a book on the development strateg y that had been pursued in the Philippines under Ferdinand Marcos. Like Mobutu, Marcos was an authoritarian ruler backed for many years by the United States – until his overthrow by the ‘People’s Power’ revolution Intr 6 of Februar y 1986. His regime, like Mobutu’s, ran up enormous debts to foreign creditors. When Marcos was airlifted into his Hawaiian exile aboard a US Air Force jet, he left behind a Philippine external debt of more than $28 billion. This foreign borrowing ostensibly had been undertaken to advance the countr y’s economic development, but in practice it had done little to improve the well-being of ordinar y Filipinos. Average incomes remained virtually stagnant during his two-decade rule, and many of the poorest Filipinos saw their real incomes decline. 11 Meanwhile, Marcos and his cronies accumu- lated fortunes. Millions of dollars in looted funds were eventually traced to bank accounts in Switzerland and other havens, but the best indicator of the scale of the looting came in 1988 when Marcos, his health deteriorating, reportedly offered $5 billion to the new government to be allowed to return to the Philippines to die. 12 His offer was refused. Not all of the money borrowed by the Marcos regime was siphoned into foreign bank accounts. The biggest single item in the Philippine debt, for instance, was a nuclear power plant built at a cost of more than $2 billion, including interest, a price that the Marcos government’s own Secretar y of Industr y charac- terized as ‘one reactor for the price of two’. 13 Loans to finance the reactor came from the US Export-Import Bank and from a private bank syndicate led by Citibank and American Express. 14 The price tag was inflated by multimillion-dollar kickbacks – more politely termed ‘commissions’ – paid to Marcos associates on contracts to build the reactor. In the end the nuclear plant never produced a kilowatt of electricity, among other reasons because it turned out to have been built in a seismic zone with a high earthquake risk. From the standpoint of the national economy, the project was a colossal waste of borrowed money. But from the standpoint of those who pocketed the kickbacks, the project was a brilliant success. The useless nuclear power plant was simply a social transaction cost of pursuing their personal objective: the transformation of public debts into private assets. In an effort to better understand the linkages between foreign Intr 7 loans and capital flight in the Philippines, Boyce used statisti- cal methods that had recently been developed by researchers at the World Bank and elsewhere to estimate the total amount of capital flight from the Philippines in the Marcos era. He arrived at a staggering result: $13 billion (in 1986 dollars); more than $19 billion if imputed interest earnings on flight capital were included in the total. By the latter measure, capital flight was equivalent to roughly two-thirds of the countr y’s total foreign debt. Investigating the relationship further, Boyce analysed the cor- relations between year-to-year variations in capital flight and year- to-year variations in foreign borrowing. He found that one dollar of additional foreign borrowing was associated with 54 cents of additional capital flight in the same year. He concluded that a ‘revolving door’ linked debt to capital flight in the Philippines, and that a substantial fraction of borrowed funds had quickly exited the countr y. Boyce presented his findi ngs in a monograph published in 1990 by the Philippine Institute of Development Studies, an agency of the countr y’s planning ministr y. 15 The study helped to fuel debate in the Philippines over how to deal with the foreign debt legacy of the Marcos era. The Freedom from Debt Coalition, a Philippine civil society organization, argued that debts arising from loans that had been diverted to illegitimate uses ought to be repudiated. Some senior government officials, including the countr y’s planning minister, agreed. Others, including the central bank governor, maintained that the government should seek to remain in the good graces of international creditors by ser vicing all the inherited debts. 16 Boyce cited precedents in international law for the repudiation of ‘odious debts’, and suggested that if the government adopted such a strateg y it could greatly ease its debt burden. But the Philippine government opted instead for the strateg y of dutiful debt ser vice, spending vast sums in the ensuing years to ser vice foreign debts incurred in the Marcos era. § The collaboration that produced this book began in the mid- 1990s at the University of Massachusetts, Amherst, where both Intr 8 of the authors were teaching. Ndikumana, having completed his doctorate in economics at Washington University, had joined the UMass faculty; Boyce was chairing the economics department. In Zaire, the Mobutu regime was coming to its bitter end. Mobutu’s relationships with his external backers had deterio - rated after his 1989 visit to Washington. Calling for an end to US assistance to the regime in March 1991, US Congressman Stephen Solarz, a member of the House subcommittee on Africa, declared that Mobutu ‘has established a kleptocracy to end all kleptocracies, and has set a new standard by which all future international thieves will have to be measured’. 17 US develop - ment assistance, apart from food aid, was terminated in June 1991. 18 The IMF issued an official declaration of non-cooperation in Februar y 1992, making Zaire ineligible for further borrowing, and suspended the countr y’s voting rights in 1994. 19 At home, the war to succeed Mobutu and to seize control of the countr y’s rich mineral resources was under way. 20 Over the next decade it would claim as many as five million lives – more than any other conflict since the Second World War. 21 Mobutu fled his homeland in May 1997, as rebel forces closed in on the capital, Kinshasa. Four months later he died in exile in Morocco. The countr y he left behind was in economic ruin, political turmoil, and facing a massive humanitarian crisis. He also left behind a foreign debt that by that time, counting interest arrears, had swollen to $14 billion. As the regime unravelled, we began to investigate the relation- ship between Zaire’s debt and the capital flight the countr y had experienced under Mobutu’s rule. In an article titled ‘Congo’s odious debt’, published in the journal Development and Change in 1998, we estimated that capital flight from Zaire during the Mobutu regime amounted to $12 billion, a sum nearly equivalent to the total external debt passed to the successor government of the Democratic Republic of the Congo (DRC), as the countr y was renamed after Mobutu’s overthrow. In the article, we provided documentar y evidence that the creditors knew, or should have been aware, that a large fraction of their loans had gone into Intr 9 the pockets of Mobutu and his coterie rather than bene fiting the Congolese people.

Expanding our investigation of capital flight to other sub- Saharan African countries, we then wrote a second piece, ‘Is Africa a net creditor?’, which appeared in the Journal of Development Studies in 2001. We found that capital flight from twenty- five low-income African countries over the 1970–96 period amounted to $193 billion (and to $285 billion including imputed interest earnings). Comparing this to the $178 billion external debt of the same set of countries, we concluded that Africa was a net creditor to the rest of the world: the external assets of these countries exceeded their external debts. The key difference between the two, of course, is that the assets are in the hands of private individuals, whereas the debts are public, a liability of the African people through their governments. We were grati fied when this article won the Dudley Seers Memorial Prize, named after the distinguished British economist. In a third piece, ‘Public debts and private assets’, published in World Development in 2003, we extended our estimates to thirty African countries and statistically analysed the relationship bet ween outflows of capital and inflows of external borrowing. We found that for ever y dollar of loan inflows, as much as 80 cents flowed back out as capital flight in the same year. These findi ngs suggested that, to a substantial extent, African capital flight has been debt fuelled. Some of the policy implications of our findi ngs were spelled out in ‘Africa’s debt: who owes whom?’, published in 2005 in a book edited by Gerald Epstein, Capital Flight and Capital Controls in Developing Countries. There we made the case that African countries have compelling ethical, economic and legal grounds for invoking the doctrine of odious debt and repudiating liabilities that cannot be demonstrated to have bene fited the populace. In 2007, we made a keynote presentation at the Senior Policy Seminar on Capital Flight from Sub-Saharan Africa organized by the Association of African Central Bank Governors, the Reser ve Bank of South Africa, and the World Bank, in Pretoria, South Intr 10 Africa. In this presentation we extended our quantitative analysis up to the year 2004, and discussed the case for selective repudia- tion of debts that financed capital flight – a policy proposal that has now moved from the ‘radical fringe’ to gain a hearing in the corridors of power both in Africa and in the international financi al institutions. 22 Papers based on our presentation subsequently appeared in the International Review of Applied Economics and the African Development Review. 23 § Drawing upon more than a decade of research, this book updates our analysis of the relationship between foreign loans and capital flight. We have tried to present our findi ngs in language that is accessible to lay readers. Readers interested in more technical treatments can refer to the scholarly publications mentioned above and listed in the bibliography. Our analysis is based on the experience of sub-Saharan Africa during the last four decades, but the issues we address in this book are not exclusive to Africa. The parallels between the Philip- pines under Marcos and Zaire under Mobutu already have been suggested above. The revolving door linking foreign loans to capital flight has spun widely throughout the developing world.

Writing on Latin America, economist Manuel Pastor described cases where ‘an investor could draw a publicly-guaranteed external loan cheaply, and ship his/her own resources abroad to acquire foreign assets’. 24 James Henr y, the former chief economist for the international consulting firm McKinsey & Company, obser ved that in some cases borrowed funds were deposited directly into private accounts in the same foreign banks that initiated the loan:

‘the entire cycle is completed with a few bookkeeping entries in New York’. 25 In Chapter 1, we provide examples that illustrate the role of foreign banks both as lenders of funds diverted abroad and as safe havens for flight capital. We examine the parallel between foreign loans in Africa and the ‘liar loans’ in US mortgage markets that precipitated the 2008 financi al meltdown. And we document the magnitude of the negative net transfers that occur when debt Intr 11 ser vice payments by African countries surpass the inflow of new money from fresh loans. Chapter 2 traces the statistical detective work that is required to measure capital flight, and presents evidence that Africa is a net creditor to the rest of the world in that its external assets exceed its external debts. The assets are private, while the debts are public. Wealthy individuals hold the assets. The African people as a whole hold the debts through their governments. Chapter 3 examines linkages between foreign loans and capital flight, and presents quantitative evidence that much of Africa’s capital flight has been debt fuelled; that is, loans from foreign creditors to African governments wound up as private assets held abroad by individual Africans. In Chapter 4, we document some of the human cost of this phenomenon, analysing the impact of debt ser vice payments on public health expenditures and thereby on health outcomes such as infant mortality. In Chapter 5 we conclude by discussing what can be done. We make the case for new policies and institutions, building upon the legal doctrine of odious debt, that would lift the current burden of ser vicing debts from which the public derived no bene fit, and would change incentive structures in the international financi al architecture so as to promote responsible behaviour by lenders and borrowers in the future. We seek to demonstrate in this book that the diversion of foreign borrowing into capital flight is not simply a matter of misdeeds by a few corrupt officials, abetted by a few complacent or complicit bankers. Rather it is the product of systemic flaws in the international financi al arrangements that govern borrowing and lending. The problem cannot be cured simply by identify- ing bad actors and weeding them out. The solution will require fundamental reforms that change the framework of incentives and opportunities in global finance.

Intr 12 1 | T ales from the shadows of inter national finance In the simpli fied world of introductor y economics textbooks, credit markets provide a valuable and straightfor ward ser vice: they move money from savings into investments. The savers lend their money and are rewarded with interest. The investors borrow money on the expectation that the returns to their investment will cover the cost of interest payments. Banks connect the sup- ply and demand sides of the credit market, and for this ser vice, known as financi al intermediation, they earn remuneration in two forms: fees, and the spread between the interest rates they pay on deposits and receive on loans. In this textbook world, all is what it seems. Borrowers act in good faith, taking loans only when their expected bene fits exceed expected costs. Bankers exercise due diligence, issuing loans only when they expect the borrower to repay. And no one would lend hundreds of millions of dollars to the Mobutu regime in 1989. In the real world, matters are not so simple. Mobutu was a particularly flamboyant exemplar of a much broader class of individuals who have spun debts contracted in the name of the state into personal wealth, much of it stashed abroad. These individuals are aided and abetted by bankers who are willing and eager to make loans to governments with few questions asked, while at the same time courting deposits from ‘high net worth individuals’ who skim the borrowed funds into private accounts. In the shadows of international finance, large sums of money routinely slip across borders, beneath the surface of officially recorded transactions and outside the box of the standard eco- nomics textbooks toolkit. To understand the realities of African development and underdevelopment, we must peer into these shadows. 13 Masters of disasters When compelled to acknowledge the diversion of public loans into private pockets, international creditors sometimes seek solace in the thought that at least a fraction of their loans was used legitimately. ‘If you take the amount of 30 percent loss,’ a sen- ior World Bank official told political scientist Jeffrey Winters, ‘it means 70 cents [on the dollar] got used for development after all.

That’s a lot better than some places with only 10 cents on the dollar.’ In testimony before the US Senate Committee on Foreign Relations in 2004, Winters explained that ‘places with only 10 cents on the dollar’ was a reference to ‘certain Bank clients in Africa where nearly all of the loan funds are misallocated, diverted, unaccounted for, or simply stolen’. 1 If these loans vanished without a trace, they would simply bypass the vast majority of Africans, with no impact on their well-being. From their perspective the loss would merely be what economists call an ‘opportunity cost’, forgone development that could other wise have been financed with the missing money. But the costs to the people of Africa go well beyond missed oppor tunities. The use of foreign loans for illegitimate private gains distorts both the politics and the economies of African countries.

It bolsters the power of corru pt elites, and in so doing enhances their ability to manipulate government policies to advance their interests above those of their countr ymen. And because these are loans, not grants or outright gifts, they leave behind a legacy of debt-ser vice obligations that often persist long after the individuals who pro fited from the deals have departed from the scene. The outcome is disastrous for African development. But it is lucrative for individual players on both sides of the credit market. As a result, private incentives are not aligned with the public good. A few examples will illustrate how this disjuncture has revealed itself in Africa.

Nigeria: the price of soft financial management The decade from 1984 to 1994 saw ‘the most rampant corruption and governmental dysfunction in Nigeria’s histor y’, in the words of Steve Berkman, T 14 former lead investigator in the World Bank’s anti-corruption and fraud investigation unit. The World Bank ought to know: it loaned Nigeria $4.6 billion during this period. 2 One of the recipients of World Bank loans was Nigeria’s National Electric Power Authority (NEPA), the government agency responsible for generating and delivering electricity throughout the countr y. NEPA nominally had 4,700 megawatts of power- generati ng capacity by 1989, but its peak load was less than half that amount at 1,900 megawatts. Even that load could not be delivered on a reliable basis, forcing many firms and households to invest in their own backyard generators. Nigerians joked that NEPA stood for ‘No Electric Power Anytime’ (its successor, the Power Holding Company of Nigeria, or PHCN, was quickly re- branded ‘Problem Has Changed Name’). Berkman explains why NEPA nevertheless chose to expand further its generating capacity: A new power-generating station can cost hundreds of millions of dollars, and that translates into large kickbacks for those in government who can facilitate contract awards and smaller kickbacks for those involved in super vising the civil works and procuring supplies and equipment. It can also result in lucra- tive subcontracts for shell companies owned by government officials, their relatives, and close associates – subcontracts in which payments are received for ser vices not rendered or for material and equipment supplied at grossly inflated prices. 3 In addition to bid-rigging and kickbacks, Berkman describes other practices that were commonplace in Nigeria: the procure- ment of unnecessar y goods and ser vices ‘for the sole purpose of facilitating these activities’; the parking of funds in accounts from which interest earnings were then siphoned; and the creation of ‘phony documents to cover up the diversion of funds from government accounts to private accounts’. 4 Procedural safeguards for disbursement of World Bank project loans could be ‘easily breached’, Berkman reports, ‘through the submission of fraudu- lent documents to support the withdrawal applications’. In the case of ‘structural adjustment loans’, which were not tied One 15 to speci fic projects but rather ser ved as carrots for implementation of economic policy reforms prescribed by the Bank, there were even fewer controls on where the money went. Berkman wr yly characterizes such loans as ‘an excellent device to move a lot of money with a minimum of effort and without any accountability after ward’. 5 These problems persisted under General Sani Abacha, who ruled Nigeria from 1993 to 1998. Abacha accumulated personal wealth estimated by the World Bank at $2 billion to $5 billion. 6 Nigerian president Olusegun Obasanjo would subsequently charge that Abacha ‘siphoned $2.3 billion from the Treasur y, awarded contracts worth $1 billion to front companies, and took $1 billion in bribes from foreign contractors’. 7 A 2007 World Bank review of public expenditure management in Nigeria finds that financi al reporting and monitoring remain a ‘ver y weak area’, leaving the government ‘open to diversion of funds and outright corruption’. The review concludes that this state of affairs is not accidental, but instead is the result of deliberate decisions: ‘These de ficiencies are not technical so much as environmental, insofar as for many years “soft” financi al management has been part of how the Federal Government has wanted to run its affairs.’ 8 Soft financi al management afflicted Nigeria’s use of both for- eign loans and oil revenues. ‘Nigeria owes $34 billion, much of it in penalties and compound interest imposed on debts that were not paid by the militar y dictatorships of the 1980s and early 1990s,’ finance minister Ngozi Okonjo-Iweala obser ved in Januar y 2005. ‘We make annual debt repayments of more than $1.7 billion, three times our education budget and nine times our health budget.’ Terming this situation ‘unsustainable’, Okonjo-Iweala called for debt cancellation. 9 Two months later, the Nigerian House of Representatives passed a resolution calling for a halt to external debt-ser vice payments on the grounds that the countr y’s economy had been ‘devastated by a series of militar y regimes from 1984 to 1999 who stole billions of dollars from state coffers’. 10 In October 2005, spurred by the outcr y in Nigeria, the Paris T 16 Club of creditor countries agreed to write off $18 billion of the $30 billion debt owed by the government to official lenders, led by the governments of Britain, France, Germany and Japan. As part of the deal, the government agreed to repay the other $12 billion, or roughly 40 cents on the dollar. Since the debt by that time included $4 billion in interest arrears, this was equivalent to 46 cents per dollar on the original loan amounts. If it is true that ‘only 10 cents on the dollar’ went into bona fide development, the Nigerian people did not get an enviable bargain. In Januar y 2006, eighteen US Congressmen called on the US Export-Import Bank and the US Agency for International Devel- opment to waive repayment of the $400 million they were still owed under the Paris Club deal. ‘Much of Nigeria’s debt can be considered odious,’ they wrote to the US Treasur y Secretar y, ‘given the fact that the original loans were made to authoritar- ian regimes – many of which were then looted while interest and penalties accumulated.’ 11 Nigerian critics expressed similar reser vations about the deal. But buoyed by high oil prices, the Nigerian government paid the final instalment of the $12 billion in April 2006, thereby completing the largest single transfer of wealth to foreign creditors in African histor y.

Congo-Brazzaville: oil-backed loans Some African petroleum- exporting countries and creditors have forged an even tighter nexus between foreign loans, capital flight and oil. In 1979 the Republic of Congo (Congo-Brazzaville) took its first ‘oil-backed loan’ – a loan collateralized by a lien on future oil exports. The creditor was Elf, the French oil company. In the years that followed, oil-backed loans, often carr ying much higher-than-average interest rates, became popular among private creditors, oil companies and African rulers. To circumvent IMF strictures against this irregular borrowing, as well as to facilitate transfers into private accounts, oil-backed loans are often concealed by routing them through offshore enti- ties. French researcher Maud Pedriel-Vassière describes the modus operandi:

One 17 The scheme is substantially the same in ever y case. First, one or several offshore companies receives a loan at preferential inter- est rates from a bank or buyer of crude oil. Then, these offshore companies lend to the sovereign state at signi ficantly higher rates. The difference between the interest rates is ultimately collected by the original creditor, while the representatives of the regime and their close associates receive a juicy commis- sion, as do various other middlemen. 12 Banks that have provided oil-backed loans to the Republic of Congo include Crédit Agricole, Crédit Lyonnais and Banque Paribas. 13 The exorbitant interest rates on oil-backed loans in effect mean that creditors are able to obtain crude oil at a cost considerably below the world market price. In 1993, desperate for cash to pay state salaries as its oil exports were going to ser vice its earlier oil-backed loans, Congo’s government took a fresh $150 million loan from the US-based firm Occidental Petroleum, to be repaid with 50 million barrels of oil: a price of $3 per barrel at a time when the world market price was $17 per barrel. 14 Political instability, exacerbated by the government’s chronic fiscal crisis, soon spiralled into a civil war that claimed thousands of lives. Arms for both sides were financed through oil-backed loans. ‘Rather than contributing to the welfare of the Congolese population,’ an unpublished 2001 IMF report obser ved, ‘the pro- ceeds from oil-collateralized borrowing may have been used to finance combat operations during the civil war.’ 15 In the words of the former head of Elf, ‘Thousands of Congolese died, and now the sur vivors must pay for the arms that killed their loved ones.’ 16 Ver y little of Congo-Brazzaville’s oil revenue – which accounts for 70 per cent of national income – has trickled down to the countr y’s ordinar y citizens. But the ruling elite has enjoyed a lavish lifestyle. Global Witness, the London-based organization that investigates abuses in the exploitation of natural resources, has documented the European shopping sprees of Denis Christel Sassou Nguesso, the son of Congo’s president and head of the state agency that sells the countr y’s oil. He spent thousands of T 18 dollars per month at shops like the Parisian fashion house Louis Vuitton, billing his expenses to offshore companies that ‘appear to have received, with other shell companies, money related to Congo’s oil sales’. 17 Mr Sassou Nguesso’s shopping tabs became public information as a result of litigation by creditors known as ‘vulture funds’, which specialize in buying ‘distressed debt’ on secondar y markets at a steep discount from its face value. These creditors, which are often hedge funds, then pursue legal actions in an effort to recover the face value, or something closer to it, with the aim of netting a handsome pro fit.18 In this case, the creditors were seeking to prove that the government was concealing oil revenues that instead could have been used to repay the debts. Since 1990 private creditors have extracted more than $500 million in settle- ments and court judgments from the Republic of Congo. 19 As of 2008, Congo-Brazzaville’s external debt stood at almost $5.5 billion. In a nation of 3.6 million people, this amounted to more than $1,500 per person. That same year, according to World Bank data, 74 per cent of the countr y’s population lived on less than $2 per day. 20 Gabon: The Bongo system In Libreville, the capital of Gabon, elegant glass and marble palaces line Omar Bongo Triumphal Boulevard. These edi fices were constructed at a cost of $500 mil- lion by President Omar Bongo, who ruled the countr y for four decades until his death in a Barcelona hospital in 2009. 21 A few months after wards a New York Times reporter visiting Libreville described the grim scene behind the palaces – ‘shacks and shanties stretching to the horizon, dirt roads and street vendors eking out a living selling cigarettes and imported vegetables’. The extreme juxtaposition of wealth and poverty in Gabon is a legacy of what its people call the ‘Bongo system’, succinctly de fined by the Times as ‘forsaking roads, schools and hospitals for the sake of Mr.

Bongo’s 66 bank accounts, 183 cars, 39 luxur y properties in France and grandiose government constructions in Libreville’. 22 In response to a legal complaint filed by three non- governmental One 2 R epublic of Congo’s President Denis Sassou Nguesso welcomed French President Nicolas Sarkozy to Brazzaville in 2009 (Associated Press) 20 organizations, in 2007 the French police identi fied multiple bank account s held by Bongo at BNP Paribas and Crédit Lyonnais. The police enquiries also revealed that Bongo’s wife had purchased a luxur y automobile at a cost of 326,000 euros (nearly half a million dollars), drawing the funds directly from the Gabonese treasur y. 23 Eight years earlier, in 1999, the US Senate Permanent Sub - committee on Investigations revealed that Bongo also held multiple personal accounts in the international private banking unit of New York-based Citibank. More than $130 million had passed through these accounts – located in the Channel Islands, New York, London, Paris, Luxembourg and Switzerland – in the preceding fifteen years. 24 Citibank responded to these revelations by closing the Bongo accounts, explaining to the Subcommittee on Investigations that it did so ‘because of the cost of answering questions about them, rather than because of speci fic concerns about the source of funds or the reputational risk’. 25 During Bongo’s rule, Gabon – or more accurately, the countr y’s political elite – received billions of dollars in revenues from oil exports. Remarkably little of this windfall was invested in the countr y’s development. Today Gabon has more kilometres of oil pipelines than it does of paved roads. 26 Gabon’s oil revenues were supplemented by foreign loans, notably in the late 1970s and 1980s when the 650-kilometre trans-Gabon railway was constructed at a final cost of roughly $4 billion. 27 The World Bank refused to lend money to build the railway on the grounds that the project was economically unviable.

Declaring that ‘even if we have to deal with the devil, we will deal with the devil’, Bongo turned instead to commercial creditors, who were happy to lend the money at market rates. 28 Together with the Inga-Shaba hydroelectric project in Mobutu’s Zaire, the trans-Gabon railway became one of Africa’s most famous white elephants – costly schemes ‘stimulated by desire for political prestige and ready access to foreign financi ng’, in the words of a former US aid official, resulting in ‘massive external debt for little development impact’. 29 White elephant projects have attractions apart from vanity:

One 3 Frenc h president Valér y Giscard d’Estaing received Gabon’s president Omar Bongo in Paris in November 1977 (Agence France Press) 22 they create opportunities for some serious graft. Gabon’s budget allocations for transportation and other public ser vices were im- pressive. ‘But in reality, it was actually about 20 per cent of what was on paper,’ an aid official con fided to the New York Times. ‘The rest was embezzled.’ 30 The commercial banks that provided loans to Gabon’s govern- ment included Banque Nationale de Paris (BNP), Crédit Lyonnais and Citibank – banks in which Bongo himself held personal ac- counts. 31 BNP chaired the steering committee of Gabon’s ‘London Club’ of commercial bank creditors, and Citibank ser ved as the group’s agent bank. 32 Citibank loans to Gabon helped to finance the purchase of equipment for the trans-Gabon railway as well as the purchase of aircraft for the national airline. 33 At the time of the US Senate hearings in 1999, the chief compliance officer for Citibank Private Bank stated, ‘The Private Bank never has had a strateg y to link efforts to get or retain a head of state’s personal business in order to develop other business in that countr y.’ 34 He neglected to mention whether there was any link in the reverse direction, whereby lending to a government opened the door to private banking for the same government’s senior officials. As of 2008, Gabon’s external debt stood at almost $2.4 billion. In a nation with a population of 1.4 million, this amounted to more than $1,600 per person. According to the World Health Organization, 77 Gabonese children per 1,000 die before reaching their fifth birthday – triple the rate in Botswana, a countr y with roughly the same per capita national income. 35 Subprime Africa Why did creditors make billions of dollars in loans to regimes whose leaders put their personal economic interests ahead of their countries’ economic development? Why did they fail to exercise due diligence by seeking to ensure that their loans were used for bona fide purposes, invested in projects whose returns would enable borrowing countries to pay them back with interest? If the answer were simply incompetence on the part of some One 23 lenders who were duped by irresponsible borrowers, we would expect to see differential outcomes, not systemic failures. Creditors who made unsound loans would lose their money, and either learn their lessons or exit the business. Over time, the invisible hand of the market would relentlessly weed out incompetence, and productive loans would be the rule rather than the exception. The fact that Africa’s public debts piled up, year after year, even as capital flight drained African economies and made timely and full repayment of these debts an impossibility, tells us that the problem was not simply creditor ignorance or ineptitude.

These were transactions among consenting adults. The creditors were not naive babes in the woods. They included sophisticated international financi al institutions (IFIs), such as the World Bank and the International Monetar y Fund, the world’s most pow- erful governments, and the world’s biggest commercial banks.

The creditors knew, or should have known, the score. And they continued to lend. To understand why, we need to look into the structure of incentives on the lender side of credit markets. In both official in- stitutions and private banks, these incentives elevated short-term lending targets above long-term repayment prospects. The result was a phenomenon known as ‘loan pushing’. 36 What counted was the quantity of loans, not their quality. Within the official lending institutions – the IFIs and the bilateral aid agencies and export credit agencies – there were (and still are) powerful incentives for loan officers to move the money. In part this stems from the use-it-or-lose-it syndrome in government agencies that are subject to annual budget cycles:

failure to use appropriated funds by the end of the fiscal year may trigger reduced appropriations the following year. But even at the IFIs, which are to some extent insulated from the vagaries of legislative calendars, individual staff members know that their performance will be judged above all by their success in making loans. A loan officer who delays loans, or withholds them alto- gether from a willing borrower owing to concerns about leakage of the money into private pockets, is not on the fast track to a T 24 promotion. On the contrar y, such recalcitrance is certain to annoy borrower governments, and their complaints may reach the ears of one’s superiors. In 1992, an internal evaluation by the World Bank’s Portfolio Management Task Force (known as the ‘Wapenhans report’ after its leader) found that 37.5 per cent of Bank projects completed in 1991 could be categorized as failures, up from 15 per cent a decade before. Wapenhans concluded that the presence of an ‘approval culture’ at the Bank contributed to this trend. 37 Obser ving that subsequent evaluations at the African De- velopment Bank, Asian Development Bank and Inter-American De velopment Bank had all reached similar conclusions, the 1998 World Bank study Assessing Aid frankly summed up the situa- tion: ‘Securing loan approvals was a more powerful motivator for staff than working to ensure project success or larger develop- ment goals.’ 38 Disbursements of funds are ‘easily calculated and tended to become a critical output measure’, the study’s authors explained. ‘Agencies saw themselves as being primarily in the business of dishing out money, so it is not surprising that much went into poorly managed economies – with little result.’ 39 A further motive for lending by official creditors – a motive that again is independent of the loan’s productive impact in the borrowing countr y – is export promotion. In the case of export credit agencies (ECAs) such as the US Export-Import Bank, this is, in fact, the explicit primar y objective. But it has also been a signi ficant motive in bilateral official development assistance, the importance of which is reflected in correlations between the aid disbursements and donor exports. 40 Multilateral creditors are also aware of the political salience of export contracts: the World Bank, for example, maintains state-level procurement records in the USA ‘in order to facilitate lobbying of Congress by corpora- tions winning Bank contracts’. 41 Similar incentives propelled lending by commercial banks, with the added spark of the pro fit motive. Much private credit took the form of syndicated loans, a financi al innovation dating from petrodollar recycling in the wake of the OPEC oil price One 25 increases of the 1970s. Syndicated loans drew funds from groups (‘syndicates’) of banks that were organized on a loan-by-loan basis by lead banks, typically headquartered in New York, London or Paris. Many of these loans had floating interest rates indexed to the London Interbank Offered Rate (Libor), the rate at which banks lend to each other. Some examples of syndicated loans are given in Table 1.1. The spread – the difference between the interest rate charged to the borrowing countr y and Libor – brought pro fits to the syn- dicate participants over the term of the loan. But more immediate grati fication came upfront in the form of loan origination fees. These could be booked as pro fits in the same financi al quarter that the loan was issued. A 1.5 per cent fee on a $100 million loan would amount to $1.5 million, a tidy sum. This was taken off the top from the money disbursed to the borrower. The lead banks passed a slice of this upfront money – formally known as a ‘participation fee’ – to other syndicate members, the percent- age slice var ying with the size of their commitment. 42 Bankers informally called these participation fees ‘juicers’. In Selling Money, an illuminating account of his experiences as an international loan officer for regional American banks in the 1970s and early 1980s, S. C. Gw ynne recalls receiving a stream of telexes from lead banks seeking to ‘sell down’ participation in syndicated loans. ‘The volume of such telexes at Cleveland Trust was astonishing in those years,’ he recalls. ‘It was common to arrive at the office and find a pile of “bedsheet” telexes covering my desk, offering millions of dollars in loan participations, all wanting quick replies.’ 43 ‘Many of the participating banks’, according to syndication expert Robert P. McDonald of Chase Manhattan, ‘had no firm underst anding of whom they were lending to; ver y few performed any type of credit analysis and practically none had a tactical and/ or strategic marketing plan delineated by geography.’ 44 ‘Volume’, Gw ynne remarks, ‘was all that mattered.’ 45 Export promotion entered into lending decisions by commer- cial banks, too, when the exporters who stood to bene fit from T table 1.1 Examples of syndicated loans Countr y Year Amount Lead and manager banks Zaire 1974 $22,264,043 American Express International Banking Corporation Crédit Commercial de France Sudan 1974 $200,000,000 Crédit Commercial de France Banq ue Nationale de Paris Banq ue Arabe et Internationale d’Inv estissement Gabon 1976 $20,000,000 American Express International Banki ng Corporation Citicorp International Bank Ltd Wells Fargo Bank International Côte 1976 $50,000,000 Citicorp International Bank Ltd d’Ivoire Brandt s Ltd Chase Manhattan Ltd Amex Bank Ltd Bank of Montreal First Chicago Ltd Merrill Lynch International Bank Ltd Kenya 1979 $200,000,000 National Westminster Bank Group Bank of Montreal Bank of Tokyo Ltd Barc lays International Group Chase Manhattan Banking Group Citicorp International Group Deut sche Bank Compagnie Financière Luxembourg First Chicago Ltd Fuji Bank Ltd Manufact urers Hanover Ltd Midl and Bank Ltd Royal Bank of Canada Standard Chartered Bank Nigeria 1981 $308,000,000 Midl and Bank Ltd BankAmerica International Group Barc lays Bank Group Croc ker National Bank Fuji Bank Ltd Mit sui Trust and Banking Company Ltd Orion Royal Bank Ltd Source : Tombstones appearing in Euromoney, June 1974, pp. 45, 74; May 1976, p. 71; August 1976, p. 3; August 1979, p. 54; December 1981, p. 125 27 the loan were important bank customers. For example, Gw ynne recounts how the Cleveland Trust Company was drawn into the international lending business: ‘As a big-league corporate bank, Cleveland Trust had big-league corporate clients, and most of these clients had signi ficant overseas operations.’ These clients ‘not only needed but expected the bank to finance their inter- national trade’. 46 As long as juicy fees were flowing freely, few bankers worried much about future repayment difficulties. Citibank chairman Walter Wriston assured his fellow bankers that ‘sovereign nations don’t go bankrupt’. 47 Meanwhile, successful young loan officers moved from bank to bank, leapfrogging up the salar y scale. If the quality of loans eventually turned out to be a problem, they could rest easy in the knowledge that by that time it would be someone else’s problem. The per verse incentives for pushing loans to Africa and other developing countries in Latin America and Asia sound eerily fam - iliar in the wake of the 2008 subprime mortgage meltdown in the United States, which triggered the world’s worst economic crisis since the depression of the 1930s. The incentives in the US financi al system that spawned this crisis bear a close resemblance to those that drove profligate lending to developing countries in the 1970s and 1980s. For subprime mortgage lenders in the USA, the overriding aim again was to move the money. ‘They didn’t care about the quality of the mortgage,’ explains Professor Nouriel Roubini of New York University. ‘They were caring about maximizing their volume, and getting a fee out of it.’ 48 Once again, the intoxicating appeal of upfront fees pushed any concerns about loan repayment difficulties out of sight and out of mind. ‘As long as the music is playing, you’ve got to get up and dance,’ the chief executive officer of Citigroup merrily explained to the Financial Times in 2007. ‘We’re still dancing.’ 49 Once again, short-run greed trumped long-run prudence. ‘The pro fits from reckless activities were simply too tantalizing and titanic to pass up for many of the executives running these insti- tutions,’ explains Gretchen Morgenson, financi al correspondent T 28 of the New York Times. ‘The take-the-money-and-run mentality ran amok.’ 50 Per verse incentives are not con fined to the lender side of international credit markets, as we have seen. On the borrower side, too, foreign loans were subject to what economists call a ‘principal-agent’ problem: an agent who is supposed to act on behalf of others (the principals) instead may put his own self- interest first . In loans to Africa and other developing nations, the people were the principals and top government officials were the agents. Officials borrowed in the name of the government, lined their own pockets and those of their cronies, and left the people with the debts. Diverse methods were used to channel funds from foreign loans to African governments into private pockets. We have already seen several examples: kickbacks and padded procurement contracts in Nigeria, oil-backed loans in the Republic of Congo, direct transfers from public accounts in Gabon. Another popular technique was public expenditure for ‘ghosts’ – fictitious roads, schools, soldiers, and so on. In Uganda, for example, officials reported in 2010 that medical supplies were being ostensibly delivered to some hundred non-existent facilities, including seven ‘ghost hospitals’ in the capital, Kampala. 51 Having diverted borrowed funds into their own pockets by such ruses, well-connected Africans could readily find foreign bankers who were willing and able to assist in moving the loot into hidden accounts abroad. In doing so, they took advantage of bank secrecy jurisdictions, also known as ‘tax havens’ – the same network of financi al institutions that is used not only by narcotics traffickers and other criminals seeking to hide their pro fits but also by large corporations seeking to evade taxation. The players in the international tax haven network include major banks. Citigroup, for example, has 427 subsidiaries in ‘tax havens or financial privacy jurisdictions’ around the world, according to a 2008 report by the US Government Accountability Office, including ninety in the Cayman Islands alone. 52 The term ‘capital flight’ focuses attention on the exodus of One 4 Citibank chairman Walter Wriston offered the assurance that ‘sovereign nations don’t go bankrupt’ (Tufts University, Digital Collections and Archives) 30 funds from African countries, but as financi al journalist Nicholas Shaxson remarks in his book Treasure Islands, ‘each flight of capital out of Africa must have a corresponding inflow somewhere else’. 53 The bankers who provide safe havens for flight capital again reap lucrative spreads and fees for their ser vices. At a conference on capital flight and Third World debt held in Washington, DC, in 1986, Austrian banker Erhard Fürst obser ved that foreign de- positors in Swiss banks often received negative interest returns, ‘implying that they were willing to pay a substantial premium for security’. 54 In these respects, too, the pathologies of international finance hav e not been con fined to Africa and other low-income nations. ‘The lines between thiever y and patriotism, between private advan - tage and the national interest, became impossibly blurred,’ wrote Fintan O’Toole in his 2010 book Ship of Fools. 55 O’Toole was writing not about Nigeria, or Congo, or Gabon, but about the debt crisis engul fing his own countr y, Ireland. Africa’s debt trap The 1998 World Bank study’s conclusion that much aid to developing countries went into poorly managed economies ‘with little result’ is only half true. Multimillion-dollar loans always have results, even if not the ones that were ostensibly intended. One notable result of the lax lending by official and private creditors to Africa has been the phenomenon of debt-fuelled capital flight. Some of this flight capital wound up in private accounts at the same banks that arranged the loans. ‘The bor- rowers stole the money and the lenders helped them steal it,’ in the blunt words of Brookings Institution scholar Raymond Baker. ‘In my judgment this is the ugliest chapter in international commerce since slaver y.’ 56 This dual bank–client relationship is illustrated in the case of Gabon by President Omar Bongo’s personal accounts at BNP, Crédit Lyonnais and Citibank. All three banks played important roles in syndicated loans to the government (see the ‘tombstones’ reproduced in Figure 1.1). In the next two chapters we document One 1.1 Examples of tombstones announcing syndicated loans to Gabon.

Source : Euromoney, October 1975, p. 34; July 1974, p. 86. 32 the magnitude of African capital flight and its relationship to foreign loans. A second, and more evident, result of subprime lending to Africa was the accumulation of large foreign debts. This has resulted in the ongoing drain of the continent’s scarce resources into external debt ser vice payments. The total foreign debt of the thirty-three sub-Saharan African countries analysed in this book – those for which adequate data are available – is shown in Figure 1.2. Here and throughout the book we use 2008 dollars so as to depict real trends without the distorting effects of inflation. From less than $50 billion (in 2008 dollars) in 1970, the debt rose sharply through the late 1980s, and then more gradually until it peaked at over $250 billion in 1995.

Since then the debt stock has declined to about $180 billion, owing to debt repayments and write-offs coupled with relatively modest new lending. The composition of sub-Saharan Africa’s external debt by type is shown in Figure 1.3. In 2008, roughly half the total was long- term debt to official creditors: 22 per cent was held by bilateral 1.2 T otal debt stock, thirty-three sub-Saharan African countries ($ billion, in constant 2008 dollars) Source : World Bank, World Development Indicators and Global Development Finance database. Converted to 2008 dollars using the GDP deflator as reported in the World Bank’s World Development Indicators. 1970 1975 1980 1985 1990 1995 2000 20050 50 100 150 200 250 300 Billion 2008$ One 33 creditors; 15 per cent by the World Bank; 1 per cent by the IMF; and 9 per cent by other official multilateral creditors. Another 27 per cent was held by private creditors as long-term debt; and an additional 26 per cent was short-term debt, most of it also owed to private creditors. 57 The composition of Africa’s debt has varied over time. The share of private creditors peaked on the eve of the debt crisis that struck developing countries in 1983, which led to a sharp contrac- tion of new lending by commercial banks. Private long-term debt shrank from 36 per cent of the total in 1982 to only 18 per cent in 2004, after which its share rose, mainly by virtue of write-offs of bilateral debts by official creditors. Since 1983, new loans have come mostly from the official creditors, allowing African countries to ser vice their debts to private creditors, paying them off or at least slowing the rate at which they fell into arrears. In effect, public money from the governments of industrialized countries thus helped to bail out the private creditors – again presaging a pattern that would recur in the wake of the subprime crisis in the United States. 58 Meanwhile capital flight from Africa continued, as we document in the next chapter. ‘It is the Western taxpayers 1.3 De bt by creditor in sub-Saharan Africa, 2008 Source : World Bank, World Development Indicators and Global Development Finance database Short-term Debt (26%) Bilateral Creditors (22%) Private Creditors (27%) World Bank (15%) IMF (1%) Other Multilateral Creditors (9%) Tales from the shadows 34 who are paying it out over the table,’ Raymond Baker explained to a New York Times reporter in 1999, ‘and the private banks who take it back under the table.’ 59 The ten sub-Saharan African countries with the largest external debts in 2008 are listed in Table 1.2. South Africa tops the list with an external debt of almost $42 billion, followed by Sudan, Angola, Côte d’Ivoire, the Democratic Republic of Congo and Nigeria, all of which owed more than $10 billion. Debts for each of the thirty-three countries covered in this book are reported in Appendix Table A.1, together with the ratio of external debts to gross domestic pro - duct (GDP). In several countries debt exceeds GDP, with Zimbabwe havi ng the dubious distinction of the highest ratio at 186 per cent. table 1.2 External debt: the top ten (sub-Saharan African countries, 2008) Countr y US$ billion South Africa 41.9 Sud an 19.6 Angol a 15.1 Côte d’Ivoire 12.6 Congo, Dem. Rep. 12.2 Nigeri a 11.2 Kenya 7.4 Tanzania 5.9 Congo, Rep. 5.5 Zimbabwe 5.2 Source : World Bank, World Development Indicators and Global Development Finance database As Africa’s external debt grew, so did its outflow of debt ser vice: interest payments and principal repayment. Figure 1.4 shows the trend in debt ser vice payments since the early 1970s, again in constant 2008 dollars. From less than $1 billion per year in the early 1970s, debt ser vice payments from the thirty-three sub- Saharan African countries have risen to more than $10 billion per year since 1994, with a peak outflow of $20 billion in 2006.

One 35 Figure 1.5 shows the trend in net transfers for all thirty-three countries in the same period. The net transfer is the difference between inflows from new borrowing and outflows from debt ser vice payments on past loans. Positive net transfers to Africa – 1.4 External debt ser vice payments ($ billion, in constant 2008 dollars; three-year moving average) Source : World Bank, World Development Indicators and Global Development Finance database 1970 1975 1980 1985 1990 1995 2000 20050 5 10 15 20 25 Billion 2008$ 1.5 N et transfer ($ billion, in constant 2008 dollars; three-year moving average) Source : World Bank, World Development Indicators and Global Development Finance database 1970 1975 1980 1985 1990 1995 2000 2005-10 -5 0 5 10 15 20 25 Billion 2008$ Tales from the shadows 36 when new money exceeds debt ser vice payments – peaked in the late 1970s. For the past quarter-centur y, however, the average value of the net transfer to sub-Saharan Africa has been approximately zero. In other words, the inflows from new international lending have roughly offset the outflows to ser vice debts incurred in earlier years. When a countr y experiences a negative net transfer – as has happened to many African nations since the mid-1990s – it actually pays more in debt ser vice than it receives in new money. In such periods, foreign loans are a net drain on the economy, siphoning resources away from investment and consumption. For example, in the period 2000–08, the Democratic Republic of Congo (former Zaire) experienced a negative net transfer of $1.4 billion. Over this same period, the negative net transfer from the Republic of Congo amounted to $1.2 billion; from Gabon it was $4.2 billion.

Nigeria saw a negative net transfer of more than $20 billion from 2000 until its 2006 Paris Club debt deal, on top of a $16 billion negative net transfer in the previous decade. 60 The negative net transfer is not merely a possibility: it is a mathematical certainty, in the absence of debt write-offs. Loans must be repaid with interest. For a time, a rising tide of new lending can enable borrowers to meet their debt ser vice obliga- tions with money to spare, resulting in a positive net transfer.

But African countries, like individuals, cannot borrow ever-larger sums for ever. When the new money fails to cover debt ser vice payments on old money, the era of negative net transfers begins. If foreign loans were invested productively, yielding a rate of return sufficient to repay them with interest, a countr y’s economy would still be better off during the era of negative net transfers than if it had never borrowed. But if, instead, the loans were squandered on ill-conceived projects or diverted into capital flight, the countr y is worse off once the net transfer turns negative than if it had never borrowed in the first place. In Africa, the latter has not been the exception but the rule. For some African countries, the burden of negative net trans- fers has been eased if not eliminated by ‘debt relief ’ offered by One 37 creditors. For example, French president François Mitterrand an- nounced in 1989 that France would write off $2.6 billion in bilateral debts owed by low-income African countries. 61 Some countries, such as Nigeria, have negotiated debt write-downs from the Paris Club of official creditors as a whole. Such concessions contributed to the modest decline in sub-Saharan Africa’s total debt since the mid-1990s, shown in Figure 1.2, although the conditions attached by creditors to debt relief have often been controversial. 62 More importantly, for the purposes of the present book, debt write- offs do not address the fundamental weaknesses in international finance that generated repay ment problems in the first pl ace. Debt relief can treat the symptoms, but not the disease.

T 60 3 | The revolving door At first blush it may seem paradoxical that foreign lenders sent billions of dollars to African governments at the same time as private Africans were sending billions out as capital flight. In a simple textbook world, both would respond similarly to local economic conditions. If the investment climate is favourable, foreign dollars flow in and local dollars stay at home. If it is not, foreign lending dries up and local capital departs in search of higher returns. Once we move beyond textbook economics to real-world econo - mies, the paradox begins to lift. In the real world, not all capital is acquired by honest means – some is accumulated through fraud, kickbacks, padded contracts, briber y and outright theft. And in the real world, not all movements of capital across international borders are declared to monetar y authorities – some moves via trade misinvoicing, clandestine wire transfers and suitcases of smuggled cash. This is why the balance-of-payments accounts typically do not, in fact, balance, as discussed in Chapter 2, and it is what enables us to calculate capital flight as the missing- money residual. These two phenomena – the illicit acquisition of capital and the illicit movement of capital – are interconnected. Individuals who obtain wealth by questionable means are not inclined to leave their money in plain sight where it may attract inconvenient scrutiny. They are unlikely to be scrupulous about paying taxes on this wealth and any earnings it generates. And they generally find it prudent to ship a substantial fraction of the loot out of the countr y to ‘safe havens’ that are insulated from unwelcome changes in the political climate at home. Foreign loans can be an important source of illicit wealth, and hence of capital flight, for reasons explored in Chapter 1. 61 On both sides of international lending agreements there are per- verse incentives: borrowers who contract liabilities in the name of the public with the aim of siphoning funds into private assets, and creditors driven by the imperative to ‘move the money’ and comforted by the prospect of bailouts when their loans go sour.

The result can be a revolving door, in which money flows in from foreign lenders and flows back out as capital flight. How widespread is this phenomenon? In this chapter we inves- tigate the extent to which capital flight from sub-Saharan Africa has been fuelled by foreign borrowing. We do this by examining the statistical relationship between the two.

Debt-fuelled capital flight Capital flight can be linked to foreign borrowing in four ways. These are depicted in Table 3.1. The tightest linkages occur when one directly fuels the other: that is, when the same money flows in and out through the revolving door. In the case of debt-fuelled capital flight, our primar y concern in this book, loans from foreign creditors to African governments finance the accumulation of private wealth via the illicit mechanisms described in Chapter 1:

the diversion of funds from public accounts into private account s, kickbacks (or more politely, commissions) on government con- tracts, inflated procurement costs, ghost projects, and so on. The bene ficiaries of these loan-siphoning arrangements then park part or all of the proceeds in safe havens abroad.

table 3.1 Linkages between foreign borrowing and capital flight De bt → Capital flight Capital flight → Debt Motive and means De bt-fuelled capital flight Flight-fue lled foreign borro wing Motive only De bt-driven capital flight Flight- driven foreign borro wing In the case of flight-fuelled foreign borrowing, a similar direct link operates in the reverse direction: private wealth holders T 62 first move funds into an offshore bank account, and then they ‘borrow’ back the money from the same bank, a phenomenon known as ‘round-tripping’ or a ‘back-to-back loan’. This technique was pioneered by the American organized crime financier Meyer Lansky in the 1930s as a way to launder money in Switzerland, the aim being to conceal the origins of the funds in question from suspicious government authorities. Lansky’s clients reaped a fringe bene fit, too: interest payments on these pseudo-loans were tax-deductible. 1 In developing countries today, where foreign loans to private borrowers generally come with an explicit or implicit guarantee that the government will assume the liability should the borrower default, a further attraction to the round-tripper is the prospect of shifting the resulting debt on to the government.

In most of sub-Saharan Africa, foreign loans to private borrowers (even with public guarantees) have been relatively rare, so this phenomenon is likely to have been less widespread than in many Asian and Latin American countries. In addition to these direct linkages, there are more indirect ones, again running in both directions. In the case of debt-driven capital flight, foreign borrowing provides a motive for capital flight but not the actual money. The motive comes from the actual and anticipated economic impacts of the debt. In the short run, the influx of borrowed money pushes up the value of the domestic currency. But over the long run, as the stock of debt grows, so does the prospect that the net transfer will turn negative, leading to eventual depreciation of the domestic currency. By moving capital into hard currency accounts offshore while the value of the local currency is arti ficially inflated, the flight capitalist not only insures against this exchange-rate risk but also stands to reap a pro fit in the event of devaluation. Similarly, a large and growing debt overhang may raise fears among the wealthy that increased taxes or other regulations will reduce the value of asset s held domestically, motivating them to send money abroad. Finally, in the case of flight-driven foreign borrowing, capital flight generates demand for replacement funds that are borrowed from foreign lenders. On the borrower side, as the tax base is T 63 sapped by capital flight, African governments may seek foreign loans to finance expenditures. On the creditor side, the short-run incentives for loan-pushing, described in Chapter 1, coupled with the long-run expectation of bailouts, explain why lenders are willing to lend money even as private Africans move money in the opposite direction. Insofar as these linkages are in operation, we expect to find a positive correlation between capital flight and foreign debt – the precise opposite of what we might expect in the simpli fied world of textbook economics, where all capital movements are legitimate and all economic actors, whether official creditors, commercial banks or high net worth Africans, respond to similar incentives in deciding where to put their money. Figure 3.1 shows the correlation across African countries be- tween the cumulative stock of 1970–2008 capital flight and the stock of external debt in 2008, with both expressed as percentages of GDP to control for differences in the size of the different countries’ economies. This picture is consistent with the proposi- tion that capital flight and external debt are indeed intertwined. 2 3.1 Cumu lative capital flight and external debt, 1970–2008 Sources : Capital flight stock (with imputed interest earnings) from Table A.2; external debt and GDP (2008) from World Bank, Global Development Finance database. B B B B B B B B B BB B B B B B B B B B B B B B B B BB B B B B B 0 200 400 600 800 1,000 1,200 0 25 50 75 100 125 150 175 200 Capital flight stock (% of GDP) Debt stock (% of GDP) The revolving door 64 How much money spins through the revolving door? A key differ- ence between the direct and indirect effects of foreign borrowing on capital flight lies in the timing of these effects. In the case of debt-fuelled capital flight (and its cousin, flight-fuelled foreign borrowing), the revolving door spins quickly, and we can expect to find a strong year-to-year correlation between inflows of foreign borrowing and outflows of capital flight. In the case of debt-driven capital flight (and its cousin, flight-driven foreign borrowing), by contrast, the relationship is cumulative: it is the total stocks of external debt and capital flight which drive each other, so there is no compelling reason to expect tight year-to-year correlations between annual flows in both directions. Assume, for example, that an African countr y adds to its debt stock in a given year, but that it borrows less than it did in the previous year. We expect debt-fuelled capital flight to decrease, too, as there is less money coming through the revolving door. But we expect debt-driven capital flight to increase, as the debt overhang grows. This difference makes it possible to use statistical tools to distinguish between direct and indirect linkages and to estimate their respective magnitudes. In econometric studies published in the professional journals World Development and the International Review of Applied Economics, we have estimated the magnitude and statistical signi ficance of both sorts of effects in sub-Saharan Africa. 3 First, we investigated the effects of current borrowing – that is, annual inflows that add to the countr y’s total stock of external debt – on year-to-year variations in capital flight. Secondly, we investigated the effects of the total debt stock on capital flight. The results suggest that foreign loans have indeed fuelled capital flight in the short run, and that the accumulated stock of debt drives additional capital flight in the long run. We find that for ever y dollar of foreign loans to sub-Saharan Africa, roughly 60 cents flow back out as capital flight in the same year. In other words, we find statistical evidence of debt-fuelled capital flight on a large scale. We also find that ever y one-dollar increase in the stock of external debt is associated with 2–4 cents of additional capital flight annually in subsequent years. In other words, we find T 65 statistical evidence that debt-driven capital flight is a signi ficant drain on African economies as well.

As a further statistical test of these relationships between capi- tal flight and external borrowing, we carried out the same exercise using a different proxy measure of private wealth held abroad by Africans: the deposits held by African individuals and firms in Western banks (formally, these are called ‘external positions of reporting banks vis-à-vis the non-bank sector’). 4 These officially recorded holdings in Western banks represent only a fraction of African capital flight. They omit non-bank financi al assets such as stocks and bonds, real estate and other non- financi al property, holdings in non-Western banks, and Western bank accounts in which the African identity of the depositor is concealed, as well as capital flight that was used to finance overseas consumption rather than being saved. For all these reasons, the proxy measure is much smaller than our measure of total capital flight. For the thirty-three African countries in our study, recorded bank deposits in 2008 amounted to $42.1 billion, or 5.7 per cent of cumulative real capital flight in the 1970–2008 period (reported in Table A.2). 5 Using this proxy measure, we again found that both annual inflows of foreign loans and the total stock of external debt have positive and statistically signi ficant effects on capital flight. As expected, the estimated magnitude of the effects is smaller: one dollar of new borrowing is associated with between 2 and 17 cents of deposits by Africans in foreign banks in the same year, and with about one extra cent of additional deposits annually in subsequent years. The positive relationship between capital flight and external borrowing is thus evident even when we use this quite restrictive proxy measure for capital flight.

Capital flight as portfolio choice? Not all capital that flees Africa was illicitly acquired. Some capital flight involves outflows of honestly acquired assets. In textbook economics, such capital movements are attributed to portfolio choices by investors seek- ing to maximize risk-adjusted returns to capital. 6 The rates of return are expected to equalize across countries and markets, T 66 assuming that economic agents have access to complete informa- tion and that transactions costs are negligible. In such a world, systematic capital outflows from Africa would imply that returns to capital are systematically higher abroad. To assess the extent to which Africans hold funds abroad as a result of relative rate-of-return considerations, we examined the statistical relationship between capital flight and the difference in interest rates, adjusted for inflation, between African countries and the rest of the world. Using the short-term US Treasur y bill rate as a proxy for the world interest rate, we found no statisti- cally signi ficant effect of the interest rate differential on capital flight. 7 We conclude, therefore, that African capital flight cannot be explained adequately by conventional portfolio choice theor y. Moreover, if the rate of return to capital is lower in African countries than in the industrialized countries – or if investment is riskier in Africa, so that risk-adjusted returns are lower – this should discourage foreign lenders as well as domestic investors.

As economist Manuel Pastor puts it, ‘If the investment climate in a countr y is negative enough to push out local capital, why would sav v y international bankers extend their own capital in the form of loans?’ 8 This paradox points to the existence of what economists call ‘asymmetric risk’. 9 Domestic capital may face a greater risk of seizure, particularly if it has been obtained by questionable means and if political circumstances change so as to reduce the owner’s degree of protection. Meanwhile, foreign capital may be guar- anteed against this risk by the government or by international institutions. 10 Under these circumstances, private Africans may find it in their interest to invest abroad, even as foreign creditors find it pro fitable to issue loans to African governments. When the mean- ing of ‘portfolio choice’ is expanded to encompass these ver y dif- ferent motives for borrowing and investing, we can reconcile the phenomena of simultaneous foreign borrowing and capital flight.

Foreign aid: less likely to fuel capital flight? In addition to loans, African countries also receive external funding in the T 67 form of grant s from aid donors. In fact, for low-income African countries, grants and official loans with a high ‘grant element’ (by virtue of below-market interest rates) make up the bulk of their external financi ng. African countries have experienced capital flight even as they received substantial amounts of foreign aid. 11 It is therefore natural to ask whether the two are related. In a multi-countr y study of the effects of official development aid on capital flight, economists Paul Collier, Anke Hoeffler and Catherine Pattillo found that at low levels, aid tends to deter cap - ital flight, but that at high levels, aid tends to induce greater capital flight. 12 They calculate that the turning point at which the inducement effect starts to dominate the deterrent effect is beyond the obser ved aid levels for most of the African countries in their sample, implying that aid to Africa is not associated with more capital flight. Yet aid is a lootable resource, much like other forms of public external borrowing. Donors cannot fully monitor its use, either because it is practically difficult or because they do not wish to put pressure on a particular government for political reasons. As a result, corrupt government officials and their cronies can and sometimes do embezzle aid and channel the funds abroad. Zaire under Mobutu is a case in point. 13 Given the substantial share of official loans in the debts of African countries, our results do not support the view that aid has been immune from the operation of the revolving door. We also find that capital flight tends to be like bad grass in the field: once it has become rooted, it is hard to get rid of it. Our statistical studies show that countries that have experienced high levels of capital flight in the past tend to experience higher capital flight in subsequent years. This suggests that capital flight may be habit-forming, making it unlikely that any improvements in the investment climate will lead to its rapid disappearance.

The greasy spigot: oil and capital flight Revenues from the extraction of natural resources can also ser ve as fuel for capital flight. These revenues come in three T 68 main forms: first , as ‘signature bonuses’, one-time payments by multinational enterprises in return for development rights; secondly, as royalties or taxes on oil and mineral exports; and thirdly, as resource-backed loans, such as the oil-backed loans described in Chapter 1. The Angolan government, for example, is reported to have received $879 million in signature bonuses from oil companies in the year 1999 alone; about $3 billion per year in oil taxes in 2000 and 2001; and about $3.5 billion in oil-backed loans over the same two years. 14 The oil-backed loans from private creditors allowed the government to circumvent the efforts of the World Bank and the IMF to make further lending conditional on greater accountability and transparency in revenue management. 15 To this end, the state oil company Sonangol set up offshore accounts into which income from Angolan oil exports was deposited; the oil-backed loans were repaid directly from these accounts, entirely bypassing the countr y’s domestic financi al system. 16 ‘Because of high interest rates, typically 2 percentage points above Libor [the London inter-bank offer rate], and safe repayment structures,’ the Financial Times reported, ‘the banks’ appetites for these oil-backed loans are voracious.’ 17 Oil revenues allowed senior Angolan leaders to amass vast per- sonal assets overseas. A 2002 IMF report, leaked to the press after its publication was blocked by the Angolan government, found that more than $900 million in oil revenues had gone missing from state coffers in 2001 – roughly three times the total value of humanitarian aid to Angola – and that $4 billion had disappeared in the previous five years. 18 In the same year, the non-governmental organization Global Witness traced $1.1 billion from Angolan oil revenues to a single bank account in the British Virgin Islands. 19 To investigate the role of oil’s greasy spigot in African capital flight, we compiled countr y-speci fic data on annual oil exports and added this to our statistical analysis of the determinants of the magnitude of capital flight. The relationship is positive and statistically signi ficant: for each extra dollar in oil exports, we estimate that an additional 11 to 26 cents leave the countr y as T 69 capital flight. 20 This comes on top of the capital flight fuelled by foreign borrowing, including oil-backed loans. We also examined the impact of non-oil mineral exports. In this case, we do not find a statistically signi ficant relationship. Why the difference? The countries in our sample that are rich in mineral resources, but not oil, are a diverse group that includes Botswana, South Africa, Mozambique, Zambia, Ghana and Guinea.

Several of these countries have relatively strong records in terms of both economic growth and revenue mobilization, compared to oil-rich countries like Nigeria, Angola and the Republic of Congo. 21 We suspect that the difference can be traced more to the institutional characteristics of these countries than to intrinsic characteristics of the resources themselves. In other words, there may be no inherent reason to expect that oil revenues are neces- sarily more prone to capital flight than other mineral revenues. In theor y, and sometimes perhaps in practice, resource-backed loans can be an effective vehicle to finance bona fide develop- ment rather than capital flight. China, which recently overtook Japan as the world’s second-largest economy, bene fited from this type of finance from the same economic superpower it has now surpassed: three decades ago the Chinese government obtained more than $10 billion in Japanese loans to fund construction of railways, ports and electrical power infrastructure, agreeing to repay the loans with shipments of oil, coal and minerals. 22 Today China is entering into similar arrangements with a number of African countries. As of 2004, China became Africa’s second-leading trade partner after the European Union. 23 Since then, China has provided about $14 billion in resource-backed infrastructure loans to African countries, including an oil-backed loan to the Republic of Congo, a loan to the Democratic Republic of Congo (DRC) to be repaid with exports of copper and cobalt, and a loan to Ghana to be repaid in shipments of cocoa beans. 24 An attractive feature of these loans is that the infrastructure investments, built by a combination of Chinese and African labour, provide a tangible counterpart to the resources being extracted from Africa. In exchange for the copper and cobalt, for example, T 70 the DRC gets railways, roads and other public goods. For ordinar y Congolese people, the near-barter-trade arrangement means that they can see, feel and touch the proceeds of the transaction.

They may regard this as a better deal than what they had under colonial rule, when Belgium got the Congo’s resources and all the countr y had to show for the digging of its precious metals was mounds of dirt. It also looks good compared to oil-backed loans from Western bankers to African governments, the counterparts of which are cash in secret offshore accounts or guns to suppress the regime’s opponents. Another attraction of the resource-backed loans is that they allow African countries to access finance that other wise would not be available. For African countries classi fied as low-income countries (LICs), market loans are typically out of reach, and their ability to access concessional loans from official creditors is con- strained by quotas and by conditionalities that penalize countries with poor ‘institutional performance’. 25 These LICs can become trapped in a vicious circle of low institutional capacity, finan - cing constraints and low capacity to improve their institutions.

Resource-backed loans may offer one way out of this impasse. These loans are not immune to pathologies that have plagued other foreign loans to African governments, however. A National Assembly inquir y in the DRC reported in 2010 that more than $23 million in signature bonuses on the copper-backed loan had been stolen. 26 And there is concern, particularly among Western govern- ments, that the Chinese loans will support corrupt and authoritar- ian regimes. But as Deborah Brautigam, author of The Dragon’s Gift, a study of Chinese investment in Africa, points out, ‘the West also supports such regimes when it advances its interests’. 27 Other creditors are getting into the business of resource-backed lending to Africa, too. For example, shortly after China’s Export- Import Bank extended $2 billion in credit to Angola in 2004, Stan - dard Chartered Bank followed with another $2.25 billion oil-backed loan, drawing criticisms from civil society groups for the lack of transparency surrounding the deal. 28 In addition to China, other ‘emerging partners’ are lining up to enter this sector. Thus India T 71 and Brazil have signed or announced oil-for-infrastructure loans in several African countries. 29 From the perspective of economic development, this growing trend raises the question of whether African countries are ready to engage in a way that maximizes their share of the income from natural resource endowments and puts this income to productive use. The partners certainly have a strateg y of engagement with Africa. The question is: does Africa have one, too? 30 Foreign loans: the good, the bad and the capital-star ved Before concluding this chapter, we want to make it clear what our analysis is and is not saying about foreign loans. The evi- dence presented in this chapter has demonstrated that there is a strong link between external financi ng and capital flight via the phenomenon of debt-fuelled capital flight. The evidence indicates that a substantial fraction of the funds that African governments have secured from lending institutions and development partners either never made it to Africa or were diverted into the private pockets of politically influential individuals and their associates.

For this reason, a substantial fraction of Africa’s debt can be considered ‘odious’, in that the people of Africa have no moral or legal obligation to repay loans that did not ser ve bona fide purposes. We return to this issue in the final chapter of the book. Our analysis does not suggest, however, that all loans go into capital flight or that all debt is odious. Africa’s landscape is cer- tainly replete with examples of inefficient use of foreign loans; African fields count plenty of (dead) ‘white elephants’, and as we have seen, much of the borrowed money came to rest outside of Africa. At the same time, many good things have happened on the continent thanks to aid and external borrowing. Roads have been built, linking markets and reducing the cost of doing business.

Children have been educated, clinics have been constructed in rural areas, and mosquito nets have been distributed in malaria- infested areas, all with external support. Ample testimonies as to the bene fits of aid, including official lending, can be found in various areas, especially in health and T 72 education. For children born in low-income households in Africa, aid allows them to attend school, and allows some of them to move up the social ladder to become national leaders and even to reach the global stage. An example can be found right here in this book – one of the authors, Léonce Ndikumana, is a product of donor-funded public education from high school all the way to graduate school. The stor y began in 1972, as Burundi was ex- periencing a wave of bloody ethnic violence that took the life of his father. Having just completed elementar y school in Martyazo in southern Burundi, Léonce was one of seven students from his school who were selected to attend the Ecole Normale de Rutovu, a high school sponsored by Canadian Catholic brothers. The op - portunity to attend high school in Rutovu marked the beginning of a successful educational experience that would eventually lead Léonce to the University of Burundi and then to Washington Uni- versity in St Louis in the United States. The economics department at the University of Burundi at that time, along with the science departments and the medical school, was well equipped thanks to grants from bilateral aid donors. Léonce’s graduate school was also funded by a grant from the US Agency for International Develop - ment. Similar stories can be told of the majority of Burundian intellectuals, most of whom come from modest upbringings and would not have been able to afford higher education. It is also the stor y of many Africans in other countries whose upward social mobility was made possible by aid to education. Foreign loans and aid are valuable to the extent that they are put to good use. In principle, and at times in practice, foreign loans and grants can help African countries implement national development plans by filling the gap between domestic revenue and the costs of development projects. For example, in 2009, when Botswana faced a financi ng shortfall due to declining export revenues in the wake of the global economic crisis, the government approached the African Development Bank for the first time to request a $1.5 billion budget-support loan. This loan allowed the government to meet its recurrent expenses and to finance planned infrastructure projects that other wise would have had to be postponed.

T 73 Yet without the right incentives and good management, loans can and often do yield bad results, as we have seen, funding wasteful expenditures and financi ng private wealth accumulation. For this reason, some analysts and donors have taken the view that development assistance should be universally preconditioned on ‘good governance’. This solution poses a quandar y in countries with weak governance institutions, including countries coming out of civil wars or at risk of violent conflict. In these settings, inadequate aid can exacerbate hardship and societal tensions, but misguided or misused aid can exacerbate these, too. Aid can yield positive results if it helps to build effective and sustainable institutions. 31 In the majority of African countries, aid currently is not enough to meet the massive investment needs. It is difficult to achieve meaningful development results if aid only trickles in small and unpredictable amounts. Low-income African countries, in par- ticular, find themselves in a problematic situation: they receive inadequate aid and at the same time conditionalities imposed by the international financi al institutions impede their access to private capital markets to raise additional funds. Yet some of these countries are now demonstrating the capacity to raise substan- tial amounts of financi ng from domestic and international bond markets. Ghana recently raised $750 million through Eurobond issues to finance infrastructure. Similarly, the Kenyan government’s domestic-currency infrastructure bond issue was oversubscribed by a large margin. There are clear needs for development financi ng across Africa today. The choices are not (or need not be) simply between bad loans or no loans. Good loans are possible, too. But making this possibility a reality will require systemic reforms in lending practices by financi al institutions, and in the management and use of external resources by African governments. The solution is not to ‘pull the plug’ on African countries, but to plug the leaks and fix the per verse incentives that have sapped the effectiveness of loans and aid in the past.

T 74 4 | The human costs Capital flight drains resources from Africa. So does debt ser vice on loans that financed capital flight. The human costs of this drain can be glimpsed at the Centre Hospitalier Universitaire de Brazzaville, the main hospital in the Republic of Congo, where patients are carried up and down the stair wells on people’s backs because broken lifts have not been repaired. A French researcher grimly obser ves, ‘Only the morgue operates at full tilt.’ 1 In 2005 Congo’s government spent $101 million on external debt ser vice – more than it spent on public health. The Republic of Congo is one of five African countries where child mortality increased between 1990 and 2008. 2 Only 6 per cent of children sleep under mosquito nets that protect against malaria, the disease that accounts for one in five of all childhood deaths in Africa. 3 Congo is not alone. Across sub-Saharan Africa, many govern- ments today spend more on debt ser vice than on health for their people.

Africa’s quiet violence In the decades since independence, violent conflicts have taken the lives of many Africans. Between 1960 and 2005, Africa experienced about 1.6 million battle deaths. 4 The toll is multi- plied by deaths due to war-related disease and star vation and the breakdown of healthcare systems. For example, including deaths from these causes, the war in the Democratic Republic of Congo claimed an estimated 5.4 million lives from 1998 to 2008, making it the world’s deadliest conflict since the Second World War. 5 In recent years, the number of violent conflicts in Africa and the associated death toll have subsided. We can hope that this trend will continue in the future, and that war will recede as a cause of human suffering and death. 5 ‘ The main teaching hospital here is in such disrepair that many patients have to pay freelance porters for pigg yback rides up and down the stairs to get X-rays. It costs $2 a flight, each way,’ the New York Times reported from Brazzaville in December 2007 (New York Times) 76 But the continent continues to wage an equally devastating battle against the quiet violence of needless disease and hunger. The majority of deaths in Africa are caused by diseases that are preventable and curable with existing medicines and technolog y. Each year, for example, nearly one million children under the age of five die from malaria worldwide. About 75 per cent of them are Africans. 6 Diarrhoea and pneumonia, both curable diseases, together account for 35 per cent of Africa’s child deaths. Apart from the human cost, the economic impacts of these diseases are also large. It has been estimated, for example, that Africa loses more than $12 billion of GDP ever y year owing to malaria. 7 Why? Malaria has been virtually eradicated in many places in the world. Premature death rates from other diseases have been greatly reduced elsewhere. But in Africa programmes for preven- tion and cure either do not exist or are inadequately funded. It may be true, as economist Jeffrey Sachs has remarked, that Africa is ‘really unlucky when it comes to malaria: high tem- peratures, plenty of breeding sites, and mosquitoes that prefer humans to cattle’. 8 But the real cause of the failure to conquer malaria in Africa is not bad luck; it is insufficient funding for prevention and treatment. Fewer than one in five African children sleep under mosquito-proofed nets. Until recently, as Sachs notes, malaria rarely figured on the agenda of Africa’s international aid partners: ‘Malaria was not on the policy radar screen. The IMF and World Bank were apparently too busy arguing for budget cuts and privatization of sugar mills to have much left to deal with malaria.’ 9 In addition to inadequate international funding, national re- sources are poorly managed. The problem is particularly striking in the case of resource-rich countries. In Equatorial Guinea, for example, the low coverage of anti-malaria programmes contrib- utes to high mortality rates, especially among children. Malaria mortality in Equatorial Guinea is more than twice the African average. 10 While the people battle disease, the countr y’s elite squanders the nation’s oil wealth on personal luxuries. Teodorin F 77 Obiang, the president’s son, is reported to have a $35 million mansion in Malibu, California, as well as multiple foreign bank accounts. 11 In 2011 Global Witness reported that he had commis- sioned plans for a 118-metre ‘super yacht’ complete with its own cinema, restaurant, bar and swimming pool. The yacht’s price tag would be $380 million, three times Equatorial Guinea’s annual budget for health and education combined. 12 In a similar vein, Global Witness reports that one month of private spending by Denis Christel Sassou Nguesso, the son of the Republic of Congo’s president, could have paid for vaccinations against measles for more than 80,000 Congolese babies. 13 Measles is a leading cause of child deaths in his countr y. Water-borne diseases are a major cause of ill health and deaths in Africa, especially among children. This is a result of lack of access to clean drinking water and sanitation facilities. In Nigeria, for example, only 58 per cent of the population has access to clean drinking water sources, despite the countr y’s oil wealth. 14 Only 34 per cent of Africa’s population had access to sanitation facilities in 2008, only a slight improvement on 30 per cent in 1990. In Latin America, by contrast, the corresponding figure is 87 per cent. As a result of inadequate funding from both national and international sources, Africa has too few health facilities, and those that exist do not have adequate equipment or personnel.

Africa on average has only eleven nurses and midwives per 10,000 inhabitants, less than half the world average of twenty-eight. 15 Access to the ser vices and facilities that do exist is grossly unequal. Rural households often live far from health facilities, and the poor in general are at a disadvantage since they cannot afford to pay for private healthcare. In Côte d’Ivoire, for example, among the richest fifth of families, 95 per cent of childbirths are attended by skilled health staff; among the poorest fift h the figure is less than 30 per cent. In Nigeria, the corresponding ratios are 86 per cent for the top fifth of households, and only 8 per cent for the poorest fifth. 16 Ever y year millions of children worldwide die before reac hing T 78 their fifth birthday. UNICEF reports that ‘malnutrition is a con- tributing factor in more than half these young deaths’, and that more than half die at home owing to lack of access to health facilities. 17 Thanks to medical progress, child mortality worldwide has declined by more than a half in the past five decades, from 20 million deaths in 1960 to 8.8 million in 2008. But progress has been ver y slow in sub-Saharan Africa, which has the highest child death rates. 18 In 2008, the continent lost 86 babies for ever y 1,000 births (see Table 4.1).

table 4.1 Infant mortality (deaths per 1,000 live births) Region 1980 2008 % change 1980–2008 Sub-Saharan Africa 115 86 –25.2 South Asia 114 58 –49.1 Middle East & North Africa 94 29 –69.2 East Asia & Paci fic 54 23 –57.4 Latin America & Caribbean 63 20 –69.2 Eastern Europe & Central Asia 53 19 –64.1 High-i ncome (OECD) 12 5 –58.3 Source : World Bank, World Development Indicators database The 2010 Millennium Development Goals (MDG) Global Moni- toring Report obser ves, ‘Sub-Saharan Africa has 20 percent of the world’s children under age five, but 50 percent of all child deaths.’ 19 Only Seychelles and Cape Verde have reached the MDG target of 45 deaths per 1,000 children, and only a handful of African countries are expected to reduce child mortality to this level by 2015. Historical evidence demonstrates that while growth in income helps to improve health outcomes, income alone is not enough. 20 Major public initiatives, such as water puri fication and supply, installation of sanitation systems, the draining of swamps, and mass vaccination campaigns, historically have played a key role in progress in health. For example, it is estimated that as much F 79 as half of the reduction in mortality in the first third of the twentieth centur y in the United States was a result of water puri- fication alone. 21 This underscores the importance of public health expenditure in Africa. On average, sub-Saharan African governments are currently spending $25 per person annually on healthcare (Table 4.2). This is less than half the amount spent in the Middle East and North Africa, and less than 1 per cent of public healthcare expenditure per person in the OECD countries. In some African countries per capita public spending on health care is in the single digits: at the bottom are Guinea at $2/year, Sierra Leone at $4/year and Ethiopia at $5/year (see Appendix Table A3).

table 4.2 Public health expenditure (annual average, 2005–07) Region Public health expenditure US$ per person Share of GDP (%) Sub-Saharan Africa 25.6 2.7 South Asia 8.5 1.1 East Asia & Paci fic 36.0 1.8 Middle East & North Africa 64.8 2.8 Latin America & Caribbean 186.9 3.3 Eastern Europe & Central Asia 207.6 3.6 High-i ncome (OECD) 2602.2 7.0 Source : World Bank, World Development Indicators database In 2008 the MDG Africa Steering Group estimated that the continent needed an additional $10 billion per year by 2010 to im- prove health systems and reach the MDG targets in child mortality and maternal health. Another $17 billion per year was needed to finance programmes in Africa for the control of the major killer diseases. 22 In 2007 total international aid to the health sector in Africa amounted to $3.4 billion. 23 In Figure 4.1 we show the relationship between public health expenditure and infant mortality for the thirty-three countries in our study in the period 2005–07. Statistical analysis indicates that T 80 one infant’s life is saved for ever y $40,000 in extra spending on public health. 24 One million dollars in additional public health expenditure in sub-Saharan Africa thus translates into twenty- five fewer infant deaths.

When debt ser vice is bad for your health Many African countries devote a signi ficant share of their scarce public revenues to paying external debt ser vice. Much of the debt being ser viced was used to finance capital flight, as we saw in the last chapter. Debt ser vice payments represent the third and final act in the tragedy of debt-fuelled capital flight. In the first two acts – foreign borrowing in the name of the public, and diversion of part or all of the money into private assets abroad – there is no net loss of capital from Africa. What comes in simply goes back out again.

It is when African countries start to repay these debts that the resource drain begins. Sub-Saharan African governments as a whole today are spend- ing roughly the same amount on debt ser vice as they spend on public health (see Table A3 in the appendix). In other words, if 4.1 Infant mortality and public health expenditure, 2005–07 Source : Authors’ calculations using data from the World Bank’s World Development Indicators database B B B B BB BB BBBBBB B BB B BBB B B B B B B B B BB B B 0 20 40 60 80 100 120 140 160 180 1 10 100 1,000 Infant mortality (per 1,000 live births) Public health expenditure per capita ($) – log scale Four 81 all the subcontinent’s external debts were cancelled, and all the saved money allocated to healthcare, this would double health spending. The result undoubtedly would be greatly improved health outcomes for the African population in general and for the poor in particular. In practice, of course, there is not a simple one-to-one relation- ship between debt ser vice and public health spending. Healthcare is only one among many possible alternative uses for the money currently spent to repay foreign debts. To gauge the extent to which debt ser vice payments actually are associated with less public health spending, we need to examine the behaviour of African governments, or what economists would call the ‘revealed preferences’ of fiscal policy-makers. Total debt ser vice payments from the thirty-three countries in our capital flight analysis averaged $19.2 billion in the years 2005–07. Figure 4.2 depicts the relationship between each coun- tr y’s debt ser vice and public health expenditures in these years.

Examining the correlation between the two, we find that each additional dollar paid in debt ser vice is associated with 29 cents 4.2 Pu blic health expenditure and debt ser vice (percentages of GDP, 2005–07) Source : Authors’ calculations using data from the World Bank’s World Development Indicators database B B B B B B B BB B BBB B B B B B B B B B B BBB B B B B 0 1 2 3 4 5 6 0 2 4 6 8 10 Public health expenditure/GDP Debt service/GDP The human costs 82 less spent on public health. 25 We estimate therefore that public health expenditures in these countries as a whole would have been $5.6 billion higher in the absence of debt-ser vice payments. The high levels of deaths in Africa from preventable and cur- able diseases are largely a result of lack of resources. These are in short supply, much below the needs. Moreover, the limited resources that exist are poorly managed and unequally distributed, compounding the problem. But when resources for healthcare are scaled up and well managed, the gains can be impressive.

Several African countries, including Ethiopia, Rwanda, Tanzania and Zambia, have reduced malaria by as much as 50 per cent, for example, simply by distributing mosquito nets. 26 Efforts to secure more funding for public health in Africa will require a multi-pronged approach. Internally, it will require mobilizing more domestic resources and increasing budgetar y allocations to health systems. Externally, it will require raising more aid explicitly targeted at projects and activities that improve healthcare. It also will require curbing capital flight, launching strategies to recover Africa’s stolen wealth, and staunching the ongoing drain of financi al resources through debt ser vice. The importance of the latter measures is clear when we make the con- nections between capital flight, debt ser vice and health outcomes.

Connecting the dots As we have documented in this chapter, debt-ser vice payments force African governments to reduce public health expenditures.

We estimate that one more dollar spent on debt ser vice means 29 fewer cents spent on health. Less public health expenditure means that fewer clinics are built, less medicine is available in hospitals and pharmacies, and fewer healthcare workers can be employed. To illustrate the human cost, we examined the correlation between public health expenditure and infant mortality. We found that each additional $40,000 of health spending is associated with one less infant death. Putting these results together, we can calculate the impact F 83 of debt ser vice on infant mortality. A million-dollar increase in debt ser vice reduces government health expenditures by about $290,000. This translates into seven more infant deaths. For ever y $140,000 that sub-Saharan Africa pays in external debt ser vice, another African baby dies. This is a conser vative estimate of the human costs of debt ser vice. It omits other impacts of lower public health expenditure:

higher mortality among children aged one to five (infant mortality refers only to the first year of life), higher premature deaths of older children and adults, and effects of non-fatal illnesses. It also leaves out human costs associated with the other 71 cents that are lost with each dollar of debt ser vice (apart from the 29 cents in forgone public health expenditure) owing to reduced spending on education, infrastructure and other public goods. In Chapter 3 we showed that for ever y dollar of foreign bor- rowing by African governments in the 1970–2008 period, roughly 60 cents left the countr y in the same year as capital flight. This means that four of the seven infant deaths associated with each million dollars of debt ser vice can be attributed to loans that funded capital flight. Applying this ratio to the $19.2 billion annual debt ser vice paid in 2005–07, we conclude that debt-fuelled capital flight resulted in 77,000 excess infant deaths per year. These numbers give new meaning to the phrase ‘blood money’. They illuminate the enormous human costs that Africa is suffering as a result of its financi al haemorrhage, as public and private actors at home and abroad contrive to smuggle money overseas while mortgaging the continent’s resources. Asking African countries to mobilize more domestic resources and to use them better to improve the well-being of their people is only part of the development stor y. So is asking donors to provide more aid for investments in healthcare and other human needs in Africa. The other part of the stor y, equally if not more important, is the urgent need to find ways to keep Africa’s resources onshore and to use them to improve the lives of the African people.

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