Here is the dramatic graph from the United Nation’s annual stocktake of the world economy – the World Economic Situation and Prospects (WESP) report.
After crunching all the numbers, the UN’s top finance experts calculate that, in net terms (finance inflows minus finance outflows), developing countries as a whole have been exporting money to the developed world at least since 2004. Of course, as the graph above shows, there are variations among countries, and regions – notably East and South East Asia, but this is a pretty dramatic conclusion – though not out of line with Eurodad’s own number crunching a couple of years ago.
How do they make this calculation? The first important point is that they are only counting what they call ‘financial flows’, which excludes ODA (Overseas Development Assistance or ‘aid’) and other public flows such as government borrowing, as well as remittances from migrants working overseas. These are obviously important – with ODA being a net positive flow (though small compared to the overall total) and remittances being an increasingly large flow (though concentrated in certain countries). If you want to see what the picture looks like overall, take a look at my earlier report attempting to estimate the overall balance sheet.
What’s the UN counting?
So what the UN is really counting are two things. First, the enormous amounts of money that developing countries have been lending to rich countries for many years through building their reserves. (Basically they buy assets in rich countries, and “in the first quarter of 2016, 64 per cent of official reported reserves were held in assets denominated in US dollars”).
Second, private flows – made up of foreign direct investment (FDI, investing in existing companies or starting new ones), portfolio investment (buying and selling stocks and shares), and other investment - mainly international bank claims (I’ll explain that in a minute). Overall, the UN estimates that these private flows created a net outflow of $431 billion in 2016 (down from an outflow of $446 billion in 2015). While FDI dropped significantly, it still “has tended to be more stable and longer-term than the other types of cross-border finance” (though FDI has its own problems, as I’ve noted before).
The real culprits are portfolio investment (worth minus $218 billion for developing countries in 2016, this flow has been negative for five of the past ten years) and ‘other investment’. We know that portfolio flows tend to be highly volatile as it’s easy to dump stocks if you’re in trouble or you think the country you bought them in is likely to be. So what about this ‘other investment’, which caused an outflow of $422 billion from developing countries in 2016, the 6th year in a row this figure has been negative? I can’t find a detailed breakdown of the UN’s figures, but the report suggests that this is mainly made up of ‘international bank claims’ – in other words the net total of how much foreign banks owe/are owed in developing countries, plus what is owed in the domestic banking system in foreign currencies. It would take time to analyse the reasons behind this, and the UN report only briefly outlines some hypotheses: hopefully they’ll go into more detail in future.
What does it all mean?
So what should we make of this disturbing data? The first obvious conclusion is that we should be very concerned about what is happening with private financial flows, and we should be supportive of developing countries that want to use sensible tools to manage these flows (which sometimes they are denied by trade and investment treaties). We should also take the quality of private financial flows much more seriously – it seems to me that it matters a lot more to make sure private financial flows are long term and non-volatile than to get behind the all-too-often-heard exhortation to concentrate public efforts on leveraging larger quantities of private finance.
The second obvious conclusion is that developing countries are very sensibly trying to insulate themselves from the risks of a volatile global financial environment. However, this comes with a very large cost, not least through tying up large amounts of precious public finance in reserves. The root cause of this is the lack of faith in any international mechanisms to help developing countries out should they face a crisis – the International Monetary Fund (IMF) lost all credibility during the Asian financial crisis at the end of the last century, and other sensible institutions, such as a fair and transparent insolvency system for governments – a debt-workout mechanism – are lacking.