External debt and economic growth in selected sub-Saharan African countries: The role of capital flight

Agyeman, George; Sakyi, Daniel; Oteng-Abayie, Eric Fosu Article External debt and economic growth in selected sub- Saharan African countries: The role of capital flight Research in Globalization Provided in Cooperation with: Elsevier Suggested Citation: Agyeman, George; Sakyi, Daniel; Oteng-Abayie, Eric Fosu (2022) : External debt and economic growth in selected sub-Saharan African countries: The role of capital flight, Research in Globalization, ISSN 2590-051X, Elsevier, Amsterdam, Vol. 5, pp. 1-9, https://doi.org/10.1016/j.resglo.2022.100091 This Version is available at: https://hdl.handle.net/10419/331020 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/bync-nd/4.0/). External debt and economic growth in selected sub-Saharan African countries: The role of capital flight George Agyeman, Daniel Sakyi * , Eric Fosu Oteng-Abayie Department of Economics, Kwame Nkrumah University of Science and Technology, Kumasi, Ghana ARTICLE INFO Keywords: External debt Capital flight Economic growth Africa ABSTRACT The paper estimate an augmented endogenous economic growth model to investigates the extent to which capital flight affects the impact of external debt on economic growth in selected sub-Saharan African countries. The estimations was done with the aid of a dynamic system generalized method of moments technique with data from 2000 to 2015. The direct impact of both capital flight and external debt as well as their combined effect on economic growth was found to be negative and statistically significant. Additionally, the marginal effects results show that a low level of capital flight has no noticeable effect on the negative impact of external debt on economic growth. In contrast, a high incidence of capital flight exacerbates the negative impact of external debt on economic growth. Based on the findings, we conclude that efforts to promote efficient external debt management should focus on reducing capital flight in sub-Saharan African. Introduction One of the significant and current economic issues that have engaged the attention of policymakers across the globe is with the level of the external debt stock and the incidence of capital flight and what factors contribute to their relationship and upward trend in the developing world (Ndikumana & Boyce, 2018). External sources of capital have become an all-important means to achieve sustained economic growth and development by economies. These funding sources are typically contracted to finance capital expenditures that can generate long-term growth and development for the debtor economies. They are usually channeled into the provision of infrastructural facilities that can generate future revenue to help service the external debt stock. External funding also becomes crucial in times of emergency and other unplanned expenditures. The Corona Virus pandemic, which hit the global economy, has also contributed to rising level of external debt stock, especially in Africa (UNCTAD & EDA Report, 2020). Traditionally, sustainable economic growth and development of economies across the globe have depended chiefly on the rate of domestic savings, which propelled strong domestic investment. The sole rationale behind the ever-increasing reliance on external sources of capital in the developing world, especially those in Africa has been the vast investment-savings gap. The inefficient performance of the domestic savings mobilization in both the private and public sectors is the fundamental cause of this problem on the African continent in particular. However, a significant factor that seems to receive less attention and perhaps downplays the efficiency and effectiveness of external debt instruments in achieving targeted growth and development outcomes is the leakage of domestic financing resources through capital flight (Ndikumana & Boyce, 2018; UNCTAD & EDA Report, 2020). Capital flight is simply the situation in which domestic savings and funds meant for domestic investment, growth, and development slip out of the domestic economy to other wealthier ones (Saheed & Ayodeji, 2012). The sub-Saharan Africa (SSA) has been perceived to be heavily indebted as the region’s foreign asset is said to exceed its foreign liabilities. However, these assets are owned by private entities, while the people in Africa own huge liabilities through their government. The amount of funds lost due to capital flight from SSA was estimated at $700billion in real terms and $900billion with an imputed interest earning, which vastly exceeds the total debt stock between 1970 and 2011 (Ndikumana & Boyce, 2011). The story is not different for Africa in general as the continent is coupled with high external debt carrying capacity and high incidence of capital flight. In particular, the continent is estimated to suffer a monumental loss of $88.8 billion to capital flight annually only in the aspect of trade mis-invoicing (UNCTAD & EDA Report, 2020). Foreign borrowing by countries in Africa imposes a double burden on them. Public funds that can be channeled into providing social services like education and health care are committed * Corresponding author. E-mail address: [email protected] (D. Sakyi). Contents lists available at ScienceDirect Research in Globalization journal homepage: www.sciencedirect.com/journal/research-in-globalization https://doi.org/10.1016/j.resglo.2022.100091 Received 22 May 2022; Received in revised form 14 August 2022; Accepted 9 September 2022 Research in Globalization 5 (2022) 100091 2 to debt servicing, and a fraction is used to fuel capital flight. Capital flight has a deteriorating impact on the creation and distribution of wealth and can potentially drain the African economy of vast sums of foreign exchange and domestic sources of funds. Interestingly, external debt and capital flight have become intertwined phenomena. External debt is said to fuel capital flight, and in turn, capital flight further induces more external borrowing (Ndikumana & Boyce, 2018). Ndikumana and Boyce (2018), using a more representative sample of 30 countries in Africa (that constitute approximately 92 % of the continent’s GDP) between 1970 and 2015, realized that, together with interest payments, the continent lost an accumulated amount of $1.8 trillion to capital flight as against a total debt stock of $496.7 billion over the same period. As a resource-scarce continent, this stresses how Africa has lost to the developed world than received from them. These increases in external debt stock and incidence of capital flight may significantly affect the economic growth and development of the continent. It is not surprising that in recent years, the debt stock of Africa has seen a remarkable increase, yet the growth rate has exhibited a declining trend. The overall growth rate of SSA for instance grew by 5.3 % in 2014, 3.19 % in 2015 and 1.43 % in 2016 as against total external debt stock of $432,670.6 billion, $438,686.5 billion and $474,235.5 billion in 2014, 2015, and 2016, respectively (IMF, 2020). Also, the debt-to-GDP ratio of Africa surged from 37 % to 56 % of GDP between 2012 and 2016. Additionally, one-third of the countries in Africa experienced a 20 %-point rise in external debt to GDP between the same period (Kentikelenis, Stubbs, & King, 2016). Previous studies have considered the direct relationship between external debt and economic growth and attributed the negative relationship between the variables to channels such as debt-service cost, credit rationing, debt overhang, total factor productivity, and capital accumulation, among others (Pattillo, Poirson, & Ricci, 2004; Ayadi & Ayadi, 2008; Babu, Kiprop, Kalio, & Gisore, 2014). For instance, Pattillo et al. (2004) in their study of the channels through which external debt affects economic growth of 61 developing countries concluded that doubling external debt reduces growth by about 1 %. Similarly, several studies have considered the direct relationship between capital flight and economic growth where capital flight has mostly been impacting economic growth negatively. This has been attributed to the fact that an increase in the transfer of funds from the domestic economy reduces the available funds and resources required to undertake the production of goods and services in the home country (Orji, Jonathan, Kama, & Onyinye, 2020; Badwan, 2021; Sodji, 2022). Despite vast empirical works that have explored on the subject matter, the role of capital flight and the extent to which it affect the impact of external debt on economic growth is yet to be explored, especially in the context of SSA countries. Therefore, the current study seeks to fill this gap in literature by investigating the moderating role of capital flight in Africa’s external debt-economic growth relationship. In analyzing this phenomenon, a sample of 27 sub-Saharan African countries was selected between 2000 and 2015. The paper estimates an augmented endogenous growth model that ultimately investigates the moderating role of capital flight in the external debt and economic growth relationship while controlling for some essential variables relevant in the economic growth model. To overcome the possible problem of endogeneity, the dynamic system generalized method of moments was employed as estimation strategy. The other sections of the paper include a review of related literature in section 2, the description of the empirical model, data, and estimation procedures in section 3, presentation and discussion of empirical results and their economic implications in section 4, and the conclusion and policy recommendations in the final section. Literature review The connections regarding external debt and capital flight and how each exclusively affects economic growth have received extensive attention and documentation in literature. The recognition has been given to the fact that the flow of external debt has essentially become the predominant driver of capital flight. The literature identifies two main theories that explain the above phenomenonthe indirect linkage theory and the direct linkages theory. The indirect linkage theory asserts that the simultaneous rise in external inflow and capital flight are the consequences of track records of the government’s destructive policies, mismanagement of the economy, policy inconsistency, corruption scandals, and weak domestic institutional structures, among others. On the basis of this theory, indirect factors like declining growth regimes, exchange rates overvaluation, fiscal mismanagement by governments, and others do not only drive capital flight but also engender genuine acquisition of foreign capital. Similarly, surges in external debt often result in risky or reckless investment decisions and excess borrowing. For example, due to weak state structures and mechanisms for the prudent administrative, regulatory framework, many foreign funds contracted are typically siphoned and deposited abroad by domestic elites and bureaucrats to finance their selfish foreign investments. These foreign investments do not yield revenue to the domestic economy since taxes cannot be imposed. This weakens the debt servicing capacity of the government and, therefore, adversely affects the growth of the domestic economy. Therefore, unfavorable domestic conditions are the main drivers of high external debt accumulation and capital flight. Conversely, the direct linkage theory postulates that external debt directly drives capital flight by providing the motive and the means as the requirements to engineering capital flight (Ajayi, 1997). In Mexico and Uruguay, Cuddington (1986) posited that capital flight contemporaneously occurred with high external debts, thus confirming strong liquidity consequences in the two countries. This theory essentially asserts that external funds or capital contracted as loans may provide a fertile ground for capture as loots that corrupt and elite individuals appropriate to finance their private foreign investments. The captured or looted resources, in some instances, do not enter the debtor country at all. Instead, entries and recordings are made in the respective banks for mere accounting purposes. Based on the afore, it is not surprising that external debt and capital flight are linked in four different ways, according to Boyce (1992): debtdriven capital flight, debt-fueled capital flight, flight-driven external debt, and flight-fueled external debt. First, debt-driven capital flight occurs when residents of a country realize that high taxes will accompany significant external debt in the future; therefore, they transfer their domestic assets or finances outside- a situation where external debt drive capital flight. Secondly, the domestic residents transfer the borrowed funds back to the creditor institutions through debt-fueled capital flight where the foreign inflow supplies the means and perhaps the motive of capital flight. According to Kwesi and Kiss (2017), two processes are involved in the debt-fueled capital flight. One, the government of the domestic economy contracts the foreign capital from the creditor institutions, it then makes it available to the public or the residents through investment activities it undertakes in the economy. The domestic residents then transport these resources or funds to finance their foreign investment through legal or illegal channels. The domestic government may loan out the foreign asset to private investors through a local bank. These private investors later transfer the entire or part of the loan facility abroad. In this scenario, external debt provides the fuel for capital flight. Thirdly, with capital flight-driven external debt, the excessive transfer of domestic funds by firms and private investors necessitates the need for their replacement. The willingness of external creditors to respond to demand inflows by residents is backed by the differences in risk and returns opened to both resident and non-resident capital. The excess amount of capital flight creates scarcity of domestic resources required for investment; therefore, to bridge the investment-savings gap, government is compelled to contract more external borrowing. Finally, the capital flight-fueled external debt occurs when the investor/ G. Agyeman et al. Research in Globalization 5 (2022) 100091 3 capitalist tries to arbitrage the risk and returns differentials between domestic and foreign assets by involving in a series of transactions referred to as round-tripping or back-to-back loans. With this linkage, domestic residents dollarize their capital and deposit in a foreign bank and then take a facility from the same bank using it as collateral. Bearing the theoretical considerations in mind, it is not surprising that much empirical literature exists on the relationships between external debt, capital flight and economic growth though the focus is only on the direct link between external debt and economic growth as well as capital flight and economic growth. For instance, Pattillo et al. (2004) looked into the channels through which external debt impacts growth using a dataset on 61 developing economies between 1968 and 1998. The results of the difference and system GMM estimation technique showed that lower debt levels impacted growth positively; however, an inverse association between the variables was detected at higher levels of external debt. The later outcome was attributed to low total factor productivity and capital accumulation. Ayadi and Ayadi (2008) studied the impact of external debt on economic growth by comparative analyses of Nigeria and South Africa between 1994 and 2007. The findings from both the OLS and GLS estimation techniques indicated an inverse impact of external debt on economic growth in the two countries. It was recommended that both countries have prudent utilization and management of their external debt obligation. Babu et al. (2014) studied the impact of external debt on growth in the East Africa Community (EAC), employing panel fixed-effect models to analyze annual panel data between 1970 and 2010. The findings indicated a statistically significant negative impact of external debt on the growth of the EAC, the paper recommended that government should reduce its reliance on external debt in order to promote economic growth. Siddique, Selvanathan and Selvanathan (2016) investigated the role of external debt on economic growth of 40 HIPC economies from 1970 to 2007. Results from the PMG, MG, and the panel ARDL estimations indicated that external debt had positive impact on growth in the short term but a negative and statistically significant impact on economic growth in the long run. It was therefore recommended that after the economic benefits of debt have been reaped in the short run, government must lower its debt levels by cutting down on its spending or increase taxes. Shittu, Hassan, and Nawaz (2018) employed the FMOLS and the dynamic OLS techniques to estimate the nexus between external debt, corruption, and growth in selected five sub-Saharan African countries from the 1990 to 2015 period. The finding indicated a negative relationship between external debt and economic growth which they attribute to the debt overhang effect. They study recommended that rising external debt stock be curtailed by adopting other sources of funding such as easing restrictions on imports of productive asset and increasing exports of valuable goods and services. Udoh and Rafik (2017) examined the drivers and transmission channels of external debt in Malaysia using annual time series data covering 1970 to 2013. The vector error correction model (VECM) was employed to achieve the study’s objective. The results showed a negative relationship between external debt and GDP growth. Capital expenditure was revealed as the channel through which the adverse impact of external debt on GDP growth was transmitted. The study recommended that government embark on policies to ensure quality utilization of external debt instrument through budgeting regulations like the Fiscal Responsibility Act adopted by more advanced countries. Guei (2019) examined the external debt and growth nexus in 13 emerging economies over the 1990 to2016 period. The results of the panel ARDL estimation technique established negative but insignificant effect of external debt on growth in the long run, however a negative and significant relationship was found between external debt and economic growth in the short run. Prudent management of debt accumulation and adoption of monetary policies instead of fiscal ones were recommended for the emerging countries. Hassan and Meyer (2020) analyzed the association between external debt and growth in 30 SSA countries using data between 1985 and 2017 and employing the augmented mean group (AMG) and the common correlated effects mean group CCEMG) estimation techniques. The study established that external debt exerted an inverse impact on growth while mild levels of external debt have a positive effect on growth, but a negative impact is imminent beyond a certain threshold of debt. The cost of debt servicing was identified as the main driver of the negative relationship between external debt and growth. Similarly, Hassan and Meyer (2021) studied the channels of transmission of the relationship between external debt and growth in 30 SSA countries between 1985 and 2019. The system GMM estimation procedure results revealed a non-linear relationship between external debt and economic growth. This effect was attributed to public investment, private investment and total factor productivity. Sharaf (2021) analyzed the asymmetric and threshold effect of external debt on economic growth in Egypt over the 1980 to 2019 period. The results of the Non-linear ARDL model revealed a statistically significant long run negative effect of external debt on economic growth caused by both positive and negative external debt-driven shocks. With external debt-GDP threshold level of 96.7 %, the paper informed the policy makers about the level of external debt that depresses growth in Egyptian economy. Mohsin et al. (2021) studied how external debt impacts economic growth of South Asia from 2000 to 2018 employing the panel OLS and fixed effect models. The study concluded that external debt had negative and significant effect on growth. For policy implication, the paper hinted the need to cut down on demand for foreign debt in addition to the improvement of institutions to alleviate the regressive outcome of external debt on economic growth. In relation to studies regarding the relationship between capital flight and economic growth, Ndiaye (2014) investigated the effect of capital flight on economic growth in the Franc Zone between 1970 and 2010 period. The PMG estimation technique was employed to analyze annual panel data. The study found capital flight to impact the economic growth of the Franc Zone negatively. The paper listed domestic investment, credit to the private sector, and quality of institutions as the main channels through which capital flight negatively affects economic growth in the Franc Zone. Additionally, improved governance, institutional quality, stable political environment, and judicious utilization of public resources were recommended as policy suggestions for monitoring capital repatriation. Refai, Abdelhadi, and Aqel (2015) examined the effects of capital flight and illicit financial flows on economic growth in Jordan with data from 2000 to 2014 period with the aid of the World Bank residual model. The results from cointegration approaches and the error correction model reveal significant negative relationship between capital flight and economic growth. The study attributed this outcome to increased illicit financial flows from the Jordan economy and as a result recommended the return of funds back home and also intensify the fight against corruption. Orji et al. (2020) estimated the relationship between capital flight and economic growth for the period 1981 to 2017 with the aid of the ARDL estimation technique. The study posited that there is statistically significant negative relationship between the aforementioned variables under investigation and recommended that proactive policy measures be instituted to discourage capital flight and make the domestic economies more attractive and safer for domestic investment in order to enhance economic growth. Badwan (2021) established that capital flight has a deleterious impact on the growth prospect of the Palestinian economy. The study employed the OLS technique to analyze data from 2000 to 2020. As a result of the study’s finding, it was recommended that the government ensure favourable grounds for domestic investment in addition to the allocation of external funds to productive areas of the economy. Mac- Carthy, Ahulu, and Thor (2022) investigated the effect of capital flight on Ghana’s economic growth with the aid non-linear ARDL estimation techniques and data from 1976 to 2020. The results revealed that positive (negative) change in capital flight has negative (positive) and significant effect on economic growth. Additionally, it was revealed that the magnitude of the negative effect was much higher than the positive G. Agyeman et al. Research in Globalization 5 (2022) 100091 4 one confirming a detrimental effect of capital flight on economic growth in Ghana. The study recommended that the government focus on policies aimed at recovering such outflow of such funds from corrupt public officials for domestic investment. Sodji (2022) examined the impact of capital flight on economic growth in the West African Economic and Monetary Union (WAEMU) for the period 1970 to 2016. The study reports that capital flight in the region are mainly driven by Ivory coast, Niger, Burkina Faso and Senegal. The study finds from the dynamic fixed effects estimation that, capital flight significantly reduces economic growth. Based on this outcome, the study recommends that the authorities improve on governance, strengthen the quality of institutions, and promote a stable policy environment in order to reduce capital flight. It is interesting to note that although there exist a clear theoretical link for studying the moderation effect of capital flight in the external debt and economic growth relationship, the empirical literature suggests several studies on the subject matter have mainly focused on the direct effects of external debt and capital flight on economic growth. The current study fills this important empirical gap by being the first to establish the moderating role of capital flight in the external debt and economic growth relationship in the context of SSA countries. Methodology The methodology adopted for the study is presented in this section. The methodology has two sub-sections- the empirical model and data, and the other part looks at the estimation technique and procedure. The empirical model To explore the influence of capital flight on the relationship between external debt and economic growth, we were guided by the endogenous growth theory to specify and estimate the dynamic panel growth model in equation (1): lnyi,t−lnyi,t−1=λ+Ωlnyi,t−1+δEXDi,t+θCFi,t+φ(CFi,t*EXDi,t) +∑ n i=1 YiXi,t+ ε i+ τ t+ ν i,t(1) Where lnyi,t denotes real per capita output of selected SSA economy i in time t, the lnyi,t−1 is real per capita output for the previous year, CFi,t denotes capital flight, EXDi,t represents external debt, CFi,t*EXDi,t denotes capital flight-external debt interactive term and Xi,t represents the host of other independent variables such as foreign direct investment (FDIi,t), government spending (GVSi,t), inflation (INFi,t), gross domestic investment (GDI;i,t), control of corruption (CONCORit),and financial developments (FDVi,t). ln represents the log operator. Assuming that the selected SSA countries for the study are heterogeneous in several respects, there is the need to account for time variant fixed factors ( τ t), country-specific characteristics ( ε i), and the white noise error term ( ν i,t). Whereas λ denotes the constant term, Ω is the measure of the speed with which growth converge among sampled SSA countries. Again, δ accounts for the effect of external debt on economic growth when the mean of capital flight is zero, θ is the estimated coefficient which captures the differential effect of capital flight on economic growth when the mean of external debt is zero. Similarly, Yi captures the effects of the other regressors included in the estimation. Likewise, the parameters δ , θ and φ determine the effect of capital flight in the economic growth effect of external debt. As external debt-capital flight theory explains, the two variables are interdependent of the other and this results in estimations of interactive effect. The inclusion of the interaction term in the model makes the impacts of external debt on economic growth a function of reasonable value assumed by flight capital. This therefore changes significantly, the interpretation of the main coefficients of interest (θ and φ). Therefore, for equation (1), φ represents the combined effect of external debt and capital flight on economic growth– where a statistically significant positive coefficient explain that a rise in capital flight enhances the positive effect of external debt on economic growth, δ captures the effect of external debt on economic growth at zero level of capital flight. Though, it is well interpreted in econometric sense, the latter explanation does not make any meaning since capital flight from countries over the period under investigation or study do not have zero values. As a result, the coefficient δ is made meaningful and well explained while maintaining its statistical efficiency (Brambor, Clark, & Golder, 2006; Sala & Trivín, 2014; Egyir, Sakyi, & Baidoo, 2020) by what is known as mean centering the capital flight and external debt variables. This makes it possible to assess δ as a conditional marginal effect of external debt, and the economic growth effect now becomes a function of the mean value of capital flight. Therefore, the entire marginal effect of external debt on growth when capital flight is present is investigated by working on the partial derivative of equation (1) with respect to external debt: ∂ (lnyi,t−lnyi,t−1) ∂ (EXDi,t)=δ+φ*CFi,t(2) Data With reference to data, a panel of 27 selected SSA countries constitutes the sample for the study while the span of data covers the period between 2000 and 2015. The list of countries are reported in Table A1 in the Appendix. With regards to the variables of interest, we used annual changes in real per-capita income as the measure of economic growth, external debt and capital flight were both expressed as a percentage of GDP. Except for capital flight, which was obtained from Ndikumana and Boyce (2018), all data were obtained from the World Bank World Development Indicators (World Bank, 2019). Tables 1 and 2 reports a brief description of the variables and the summary statistics of the Table 1 Variable definition and source of data. Variable Abbreviation Proxy/definition per capita income, real lnyi,t Real per-capita income (constant US$) External debt EXDi,t External debt stock (percentage of GDP) Capital flight CFi,t Capital flight (percentage of GDP) Inflation INFi,t Consumer price index (annual % changes) Gross Domestic investment GDIi,t Gross fixed capital formation (% of GDP) Foreign direct investment FDIi,t Net inflows of FDI (% of GDP) Financial development FDVi,t Banks credit to private sector (% of GDP) Control of corruption CONCORi,t Measure of Public perception on corruption about public office holders Government spending GVSi,t Government final consumption expenditure (% of GDP) Author’s construct. Table 2 Descriptive statistics. Variables N Mean Std. Dev Maximum Minimum lnyi,t 432 2.774 1.036 6.631 0.934 EXDi,t 432 26.042 17.385 81.962 0.459 CFi,t 432 3.36e-06 0.000016 0.0007 0.00043 GVSi,t 432 2.566 0.484 3.254 0.092 FDVi,t 432 0.333 0.253 1.515 −0.425 INFi,t 432 0.117 0.354 5.139 −0.082 CONCORi,t 430 −0.702 0.540 1.217 −1.523 GDIi,t 432 3.002 0.484 4.371 0.092 FDIi,t 432 0.035 0.044 0.359 −0.052 Author’s construct. G. Agyeman et al. Research in Globalization 5 (2022) 100091 5 variables (including those of the control variables, i.e., inflation, government spending, financial development, gross domestic investment, foreign direct investment, and control of corruption), respectively. Estimation procedure The dynamic system generalized method of moments (GMM) (Arellano & Bover, 1995; Blundell & Bond, 1998) estimation technique was used in this study because it outperforms other methods of panel analyses like the pooled ordinary least squares (POLS), fixed effects (FE), random effects (RE), and differenced GMM estimation techniques. Principally, the POLS, FE, and RE approaches are not appropriate to estimate equation (1) since it would result in a misleading regression result of the effect of lnyi,t−1 on lnyi,t−lnyi,t−1. Because the difference of the log of real per capita output is influenced by specific characteristics of countries found in the stochastic error term, the real per capita income has its lag influenced by the error term. As a result, the estimation techniques previously mentioned are ineffective. Additionally, a twoway relationship between the constituent variables and the interactive term is assumed when the interactive term is included in equation (1), making some of the regressors in the model endogenous. For instance, as capital flight can cause external debt so also can external debt influence capital flight and both affect economic growth. The study therefore relied on the use of dynamic system GMM to solve these challenges effectively. This estimation approach is not only more appropriate and efficient, but it also improves efficiency by correcting for possible endogeneity of other independent variables, potential autocorrelations, simultaneity bias, and the high odds of accurately exploiting within and between data changes. However, some specific limitations are embedded in the dynamic system GMM technique. This technique is primarily built for functional relationships that are linear, and so a probable difficulty with estimating equations (1) is anticipated due to the inclusion of the interaction variable. To address this limitation, we employed the difference of the product of the two constituent variables of the interaction term as valid instruments rather than the product of their difference. According to Sala and Trivín (2014), this transformation eliminates the presence of nonlinearity in equation (1) by reducing the multiplicative factor to just one variable. Moreover, the technique allows extra instruments to be utilized, and this reduces the effectiveness of the Hansen tests. To deal with the reduced power of the Hansen test, we follow Roodman’s routine to collapse all instruments generated internally. Finally, the Arellano and Bond (1991) AR (2) test is used to ensure that autocorrelation of order two is corrected. The short and long run analyses is carried out for the specified models. It should be emphasized that, with the exception of the lagged real per capita income, each of the parametric coefficients represents the regressors’ immediate effects on the dependent variable (economic growth). These coefficients are instead referred to as the short-run effects. The permanent effects, also known as the long-run estimates, are then computed for policy recommendation purposes. These long run permanent effects are measures of the extent to which a permanent change in any of the regressors affect the dependent variable in the long term. The study obtains the long-run impacts by employing the delta procedure proposed by Papke and Wooldridge (2005). The delta method involves two main processes: the first step is to estimate the short run coefficient of all the explanatory variables in the model in question, and the second step involves multiplying each of the short run estimates by (1−Ω)−1. Empirical results and discussion This section reports and discusses the economic meaning and implication of the study’s empirical findings. The interpretation and discussion of results cover evidence on the direct short run and long run effects of capital flight and external debt as well as their interaction effect on economic growth in the selected SSA countries. Additionally, the short run and long run marginal effects of external debt on economic growth as capital flight increases is discussed. Direct effect of external debt on economic growth The short run and long run results in relation to the direct effect of external debt on economic growth is shown in Table 3. As evident, the coefficient of external debt is negative and statistically significant at 1 % significance level. These coefficients (i.e., −0.066 (short run) and −0.069 (long run)) implies that when capital flight is at its mean value, a percentage rise in external debt is likely to retard the selected SSA countries economic growth by 0.066 % and 0.069 in the short run and long run periods, respectively, holding the remaining factors constant. The short run and long run coefficients also imply that the long run impact of a 1 % increase in demand for external debt reduces economic growth by a bigger percentage than in the short run. This finding coincides with those of Presbitero (2012) and Egyir et al. (2020) that external debt negatively impacted economic growth in Africa in spite of being an essential form of funding in the external financial market. The rationale is that over accumulation of external debt by African countries has an adverse effect on their economic growth performance and prospect. This finding is further justified by the fact that huge external debt stock and debt-servicing in Africa adversely affect their national savings which negatively affect the rate of growth in stock of capital, innovative ideas and economic growth. It also stipulates that Africa’s sizeable outstanding stock of debt reduces their foreign exchange earnings which could have been channeled into building long term investment projects that are essential for positive economic growth performance. Besides, the negative effect of debt instrument on economic growth could also be attributed to the fact that the borrowed funds are not invested into sustainable and long-term developmental projects with high probability of yielding positive and sustained economic growth. Direct effect of capital flight on economic growth The direct effect of capital flight on economic growth in the selected SSA countries is reported in Table 3. As clearly shown, the effect of capital flight on economic growth is negative and statistically significant at 1 % significance level and implies that when external debt is at its mean value, a percentage rise in capital flight will retard economic growth in the selected SSA countries by 0.044 % and 0.047 % in the short run and long run periods, respectively, holding the remaining Table 3 The direct effect of external debt and capital flight on growth and the moderating role of capital flight in external debt-economic growth relationship. Short-run Long-run Explanatory variables Coefficient SE Coefficient SE Cons −0.227*** 0 0.122 −0.238*** 0.129 lnyi,t−1 0.0441*** 0.013 – – CFi,t −0.044*** 0.014 −0.047*** 0.015 EXDi,t −0.066*** 0.015 −0.069*** 0.017 CF*EXDi,t −0.158*** 0.052 −0.166*** 0.054 FDVi,t 0.160*** 0.031 0.168*** 0.0312 FDIi,t 0.005 0.114 0.0052 0.119 CONCORi,t −0.048 0.048 −0.0051 0.050 INFi,t −0.555*** 0.046 −0.580*** 0.048 GVSi,t 0.057 0.031 0.059 0.032 GDIi,t −0.052 0.027 −0.054 0.028 AR (2) [p. value] 0.265 Hansen [p. value] 0.480 Number of instruments 26 Observations 403 Number of countries 27 Author’s construct. Note: *** represents 1% significance level. G. Agyeman et al. Research in Globalization 5 (2022) 100091 6 factors constant. The difference in the short run and long results also stipulates that a 1 % increase in capital flight induces a greater percentage decrease in economic growth in the long run than in the short run. This presupposes that most of the funds that are required to undertake investment activities to stimulate growth exit the shore of the Africa to other parts of the world. As the literature suggest, this outcome may be attributed to high levels of inflation, high budget deficit, weak currency, mismanagement of the economy, high taxes, corruption and many other factors that are prevalent in most countries in Africa that do not encourage investors to apportion many portfolios into domestic investment. This reduces the available domestic resources needed to undertake production and expand investment, hence affecting economic growth of Africa. This finding gives credence to the study by Ndiaye (2014) and Osei-Assibey, Domfeh, and Danquah (2018) that shows similar negative effect of capital flight on economic growth in Africa. The interaction effects of external debt and capital flight on economic growth The results related to the moderating role of capital flight in the relationship between external debt and economic growth in the selected SSA countries is reported in Table 3. This results reveals that the coefficient of the moderation effect in the short run and long run are −0.158 % and −0.166 %, respectively, and are statistically significant at 1 %. It stipulates that a percentage increase in the extent to which capital flight complements external debt is associated with a 0.158 % and 0.166 % decline in economic growth in the short run and long run periods, respectively. The results also suggest that a 1 % rise in both capital flight and external debt induces a more than proportionate reduction in economic growth in the long run than the short run. Interestingly, the negative moderating effects are much larger in absolute terms as compared to the individual direct effects of capital flight and external debt on economic growth. This finding explains that the growth effect of external debt in Africa can be attributed to the incidence of capital flight on the continent. This outcome confirms the capital flight-driven external debt theory of Boyce (1992) where excess amount of capital flight creates scarcity of domestic resources required for investment that compel government to contract more external borrowing. It also gives credence to the earlier assertion by Sekantsi and Motelle (2018) of the Macroeconomic Economic and Financial Management Institute of Eastern and Southern Africa (MEFMI), that the negative association between external debt and economic growth can be linked to capital flight. Economic interpretation of the results of the control and lagged dependent variables The results of the control and lagged dependent variables employed in the study are also captured in Table 3. As clearly seen, the lag of real per capita income was positive and significant at 1 % level. The estimated coefficient of 0.044 % means that the current real per capita income growth rate depends on its past value positively, a 1 % percent rise in the previous rate of economic growth causes 0.044 % rise in the current economic growth rate. This results however does not explain the conditional convergence of the selected SSA countries and although support the findings of Senadza et al. (2018) contradicts the findings of Egyir et al. (2020). The difference in finding may be attributed to differences in the sampled countries and time period as in the case of 45 African countries was considered for the period 1990 to 2014. Furthermore, at the 1 % level, financial development was found to be positive and statistically significant, with short run and long run coefficients of 0.160 % and 0.168 %, respectively. This implies that an improvement in financial development by 1 % accounted for an increase in economic growth in the short run and long run periods by 0.10 % and 0.16 %, respectively. These results indicate that a well-developed financial market in SSA can drive economic growth positively. This is because it will boost investor confidence and increase access to credit facilities for firms and businesses to undertake the production of goods and services, thereby affecting economic growth positively. This finding coincides with that of Egyir et al. (2020), whose study established finance-led growth in Africa. Similar to the findings of Shittu et al. (2018), the study found the coefficient of inflation to be negative and statistically significant at 1 % level. The coefficient of inflation in the short run and long run are −0.555 % and −0.580 %, respectively. This implies that holding other factors constant, a 1 % increase in inflation accounts for a decline in economic growth in both the short run and long run by the said coefficients. This may be due to the reduction in savings (a fall in investment), a fall in real interest rate, high cost of inputs of production, and others culminating in impacting economic growth negatively. With regard to the remaining coefficients the study found domestic investment, government spending, foreign direct investment and control of corruption to be insignificant and are therefore not important drivers of economic growth in the selected SSA countries. Marginal effects of external debt on economic growth as capital flight increases The discussion of results on the conditional marginal effect of external debt on economic growth in the presence of capital flight is reported in Table 4. As indicated earlier, the main focus of the study and the analysis is centered on the role played by capital flight in affecting the effect of external debt on economic growth in Africa. This was achieved by evaluating the impact of external debt at some reasonable percentile values of capital flight on the selected SSA countries. Aside from this, the estimated coefficients, standard errors, and, more importantly, the confidence intervals are also reported. It must be noted that if the estimated coefficients are significant, they show the percentile levels at which capital flight has complementarity effects on the influence of external debt on economic growth. As shown in Table 4, the results indicate that from the 1 % to 25 % percentile levels, the increase in capital flight was not significant in explaining the negative effect of external debt on economic growth. This means that capital flight did not have any complementarity effect on the negative impact of external debt on economic growth, though the coefficient from 1 % to 10 % percentile levels was positive, with the exception of the 25 % percentile. The complementarity effect of capital flight on the negative impact of external debt on economic growth starts to become increasingly significant from the 50 % percentile levels up to Table 4 Marginal effect of external debt on growth in Africa as capital flight increases. Short run effect of external debt on growth as capital flight increases Percentiles CFi,t Coefficient SE 95 % confidence interval 1 % −0.530 0.178 0.036 −0.057 0.092 5 % -0.0530 0.178 0.036 −0.057 0.092 10 % −0.462 0.007 0.033 −0.611 0.075 25 % −0.261 −0.025 0.024 −0.074 0.025 50 % 0.049 −0.074*** 0.014 −0.104 −0.044 75 % 0.252 −0.102*** 0.016 −0.139 −0.073 90 % 0.409 −0.133*** 0.021 −0.189 −0.091 95 % 0.469 −0.141*** 0.024 −0.189 −0.092 Long run effect of external debt on growth as capital flight increases Percentile CFi,t Coefficient SE 95 % conf. interval 1 % −0.530 0.012 0.038 −0.056 0.093 5 % −0.530 0.012 0.038 −0.056 0.093 10 % −0.462 0.007 0.035 −0.061 0.075 25 % −0.261 −0.026 0.025 −0.076 0.024 50 % 0.049 −0.077*** 0.016 −0.109 −0.046 75 % 0.252 −0.111*** 0.017 −0.145 −0.077 90 % 0.409 −0.137*** 0.022 −0.181 −0.093 95 % 0.469 −0.147*** 0.025 −0.196 −0.098 Source: Author’s construct. Note: *** represents 1% significance level. G. Agyeman et al. Research in Globalization 5 (2022) 100091 7 the 95 % percentile levels. This indicates that in both the short run and long run relatively lower levels of capital flight do not complement the negative effect of external debt on economic growth; rather, a relatively high level of capital flight in the face of high external debt stock largely accounts for the declining trend of economic growth in the selected SSA countries per the findings of the study. The results also suggest that the marginal effect of external debt on economic growth in the presence of capital flight is much larger in the long run than in the short run. This explains the fact that a 1 % rise in capital flight contributes more to the negative effect of external debt on economic growth in the long run as compared to the short run. This is essential for policy consideration due to the fact that the study has established that not only the debt overhang effect, cost of servicing external debt, total factor productivity, capital accumulation and investment as indicated by earlier researchers (see Hassan & Meyer, 2021; Akan & Kanca, 2015; Pattillo et al., 2004; Stone, 2018), are the channels through which external debt exerts its negative impact on growth, instead the complementarity effect of capital flight (particularly at high levels) on the negative impact of external debt on economic growth must be given keen attention in Africa if the continent wants to minimise the negative effect of external debt on economic growth. Robustness and model diagnostics To consider whether our results are robust, we estimated our model without South Africa which is often considered a potential outlier in terms of its economic characteristics. These estimates are reported in Table 5 (short run and long run effects) and Table 6 (marginal effects). Focusing on the key variables of interest (i.e., external debt, capital flight and their interaction effect), it is evident that, in both the short run and long run, the coefficients of external debt (-0.105 and −0.080), capital flights (-0.025 and −0.047), and the interaction term (-0.141 and −0.151) are fairly consistent with the results with South Africa. As evident in Table 6, the story is not different for the marginal effect. In particular, the marginal effects results without South Africa revealed that low levels of capital flight do not compliment the negative effect of external debt on economic growth. Similar with the results of the full sample, these coefficients were not significant from the 1st to 25 % percentile values. But from the 50th to 95th percentile values, they were all negative and statistically significant. This means that with or without South Africa, the negative effect of external debt on economic growth in the selected SSA countries is worsened by the negative effect of capital flights as discussed afore. It is important to emphasise that the validity of the GMM estimations depends crucially on the model diagnostics. Interestingly, all the estimations reveal the absence of second-order autocorrelation as well as the use of valid instruments (see Arellano & Bond, 1991; Roodman, 2009) as evidenced by the diagnostics reported in Tables 4 and 5. This outcome implies policy suggestions can be made based on the results discussed afore. Conclusions remarks The study investigated the moderating role that the incidence of capital flight plays in the external debt and economic growth relationship in selected SSA countries for the period 2000 to 2015. Implementing the dynamic system GMM estimation procedure, the study indicated that capital flight has a negative and significant effect on economic growth. This evidence supports the fact that the transfer of Africa’s scarce resources to finance foreign investment in some safe havens contributes to the poor performance of economic growth in the selected SSA economies. The study also revealed a significant negative relationship between capital flight and economic growth. The interaction effect of capital flight and external debt on growth was found to be negative and statistically significant. The results of the marginal effects estimations confirmed that the high incidence of capital flight is a conduit through which external debt exerts its adverse impacts on the growth of the selected SSA countries. These findings provide a clear picture of how a portion of foreign loans and other domestic resources leave the continent. Therefore, policymakers in Africa must devise a holistic approach to managing their foreign capital and curtail the increase in capital flight in order to achieve targeted long-term growth. Based on the afore summary of the study’s findings, the following are recommended for policy consideration. Sub-Saharan African countries must ensure a vibrant macroeconomic environment where investment and businesses will thrive. This will reduce the rate at which domestic resources find their way out of the continent. Again, sub-Saharan African countries must put in efficient measures to raise enough revenue from the domestic economy and reduce the rate of external borrowing. To achieve this goal, they must prepare a database for all businesses and digitize the tax collection Table 5 The direct effect of external debt and capital flight on growth and the moderating role of capital flight in external debt-economic growth relationship (Without South Africa). Short-run Long-run Explanatory Variables Coefficient SE Coefficient SE Cons 0.144 0.076 −0.299*** 0.140 lnyi,t−1 0.041*** 0.0I7 – – CFi,t −0.025*** 0.014 −0.047*** 0.015 EXDi,t −0.105*** 0.018 −0.080*** 0.017 CF*EXDi,t −0.141*** 0.041 −0.157*** 0.054 FDVi,t 0.095*** 0.044 0.150*** 0.039 FDIi,t −0.002 0.078 −0.032 0.121 CONCORi,t 0.028 0.041 −0.003 0.059 INFi,t −0.486*** 0.041 −0.536*** 0.045 GVSi,t 0.012 0.017 0.067*** 0.034 GDIi,t −0.021 0.022 −0.038* 0.029 AR (2) [p. value] 0.704 Hansen [p. value] 0.722 Number of instruments 23 Observations 388 Number of countries 26 Source: Author’s construct. Note: (lnyi,t−lnyi,t−1) is the dependent variable, ***, * represent 1%, 5% and significance levels, respectively. Table 6 Marginal effect of external debt on growth in Africa as capital flight increases (without South Africa). Short run effect of external debt on growth as capital flight increases Percentiles CFi,t Coefficient SE 95 % confidence interval 1 % −0.530 0.003 0.040 −0.079 0.086 5 % -0.0530 0.003 0.040 −0.079 0.086 10 % −0.462 −0.007 0.037 −0.083 0.068 25 % −0.261 −0.037 0.027 −0.092 0.018 50 % 0.049 −0.084*** 0.016 −0.012 −0.051 75 % 0.252 −0.114*** 0.018 −0.151 −0.078 90 % 0.409 −0.138*** 0.023 −0.186 −0.089 95 % 0.469 −0.147*** 0.026 −0.189 −0.093 Long run effect of external debt on growth as capital flight increases Percentile CFi,t Coefficient SE 95 % conf. interval 1 % −0.530 0.003 0.042 −0.079 0.086 5 % −0.530 0.003 0.042 −0.079 0.086 10 % −0.462 0.007 0.038 −0.083 0.068 25 % −0.261 −0.039 0.023 −0.094 0.016 50 % 0.049 −0.088*** 0.018 −0.122 −0.053 75 % 0.252 −0.119*** 0.019 −0.158 −0.082 90 % 0.409 −0.144*** 0.025 −0.193 −0.096 95 % 0.469 −0.154*** 0.027 −0.208 −0.099 Source: Author’s construct. Note: *** represents 1% significance level. G. Agyeman et al. Research in Globalization 5 (2022) 100091 8 system to prevent tax evasion on businesses, firms, and companies. Moreover, there should be efficient management and monitoring of the utilization of foreign loan facilities. If possible, an independent body must be instituted to exercise a supervisory role in projects and programs for which the debt facilities are earmarked. Also, there should be a broad-based assessment of the key priority areas where the external funds must be channeled into. This will prevent the misallocation of funds into non-productive sectors that do not yield high returns on investment. This will help enhance the debt servicing capacity and reduce the continent’s debt crisis. Besides, governments must endeavor to finance a greater portion of their budget deficit through efficient revenue mobilization from domestic economic activities. This will help reduce the external debt burden and capital flight on the continent. Lastly, in addition to ensuring efficient management of external debt, the continent must commit to checking the channels and drivers of capital flight. To achieve this, the court system and the rule of law must be strengthened to ensure that individuals who siphon and embezzle state funds are made to face the full rigors of the law. Funding This work was not supported by any funding organization. CRediT authorship contribution statement George Agyeman: Conceptualization, Data curation, Formal analysis, Writing – original draft. Daniel Sakyi: Conceptualization, Data curation, Formal analysis, Writing – original draft. Eric Fosu Oteng- Abayie: Conceptualization, Data curation, Formal analysis, Writing – original draft. Declaration of Competing Interest The authors declare that they have no known competing interests or personal relationships that could have appeared to influence the work reported in this paper. Appendix A References Ajayi, M. S. I. (1997). 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Senadza, B., Fiagbe, K., & Quartey, P. (2018). The effect of external debt on economic growth in Sub-Saharan Africa. International Journal of Business and Economic Sciences Applied Research (IJBESAR), 11(1), 61–69. Sharaf, M. F. (2021). The asymmetric and threshold impact of external debt on economic growth: New evidence from Egypt. Journal of Business and Socio-economic Development., 36(3), 258–276. Shittu, W. O., Hassan, S., & Nawaz, M. A. (2018). The nexus between external debt, corruption and economic growth: Evidence from five SSA countries. African Journal of Economic and Management Studies, 43(8), 57–75. Siddique, A., Selvanathan, E. A., & Selvanathan, S. (2016). The impact of external debt on growth: Evidence from highly indebted poor countries. Journal of Policy Modeling, 38(5), 874–894. Table A1 List of countries. Algeria Gabon Egypt Angola Ghana South Africa Burkina Faso Morocco Sierra -Leon Botswana Nigeria Mauritania Burundi Sudan Tanzania Congo Dem. Rep Tunisia Zimbabwe Congo Rep Uganda Malawi Cote d’ivoire Zambia Madagascar Cameroun Ethiopia Kenya G. Agyeman et al.