Building capacity to help Africa trade better

Illicit financial flows and political institutions in Kenya


Illicit financial flows and political institutions in Kenya

Illicit financial flows and political institutions in Kenya
Photo credit: AP | Sunday Alamba

The conventional Neoclassical literature views illicit financial flows (capital flight) to be a result of portfolio choice decisions by utility optimizing agents. These flows are seen as a response to changes in an individual’s portfolio bundle arising from the standard risk diversification motive by economic agents due to relative risk incentives and return differentials.

This paper explores a political economy perspective as an alternative explanation to the illicit financial outflows for one African country, Kenya. The authors ask two specific questions: Why has Kenya continued to be characterized by corruption and debt fueled capital outflows, although these stifled its economic development. Are these outflows a result of weaknesses in political institutions that do not constrain the powers of the Executive?

Using unique institutional indices on Kenya, we find evidence that increased arbitrary executive powers are positively associated with illicit financial outflows. That is, in the Kenyan context, prevailing weaknesses in the political institutions do matter for illicit financial flows (rent extraction). This finding is robust to the constraints on the executive from Polity IV Indicators as an alternative indicator of institutions.


Many African economies face tremendous development challenges, which are often aggravated by illicit financial outflows. The drivers of these outflows have been intensely debated in the literature. The typical explanation from the neoclassical economics tradition (henceforth, the conventional economic wisdom) equates these flows to capital flight. It purports that they result from rational reallocation of capital from developing countries in response to the favorable risk–return investment opportunities in the developed world and investors’ desire for portfolio diversification. In this context, the risk-adjusted returns on assets abroad are believed to be higher than those in developing countries. The level of investment risk is believed to be high in developing countries, in part, because of macroeconomic policy distortions, such as overvalued exchange rates, huge fiscal deficits, unfair taxation of capital gains, and interest rate controls under financially repressed markets.

However, recent developments in this field have questioned the conventional wisdom that portfolio motives are the primary drivers of capital flight from developing countries. The political economy literature and the new institutional economics literature suggest that the problem may result from corruption and rent seeking from unconstrained leaders and officials, in a context of extractive political institutions.

This paper explores the political economy view as an alternative explanation to the illicit financial outflows for one African country, Kenya. It aims to specifically answer two related questions: Why has Kenya continued to be characterized by corruption and debt-fueled capital outflows, even though these conditions stifle its economic development? Are these outflows a result of weaknesses in political institutions that leave the Executive unchecked? These questions remain very pertinent not only for Kenya but for other developing countries that are faced with the development challenge of debt-fueled, illicit capital outflows. To this end, this study assesses empirically the role of arbitrary powers of the Executive as a proxy for the influence of weak political institutions on illicit financial outflows. The evidence from this exercise supports the view that the extent of arbitrary executive powers is positively associated with illicit financial outflows. Thus weaknesses in political institutions matter for illicit financial flows (rent extraction) from Kenya. As robustness checks, this research uses constraints on the Executive from Polity IV Indicators as an alternative indicator of institutions. Using these alternative indicators, the study finds a strong support that constraining the Executive’s powers is likely to reduce the magnitude of illicit financial flows from Kenya.

Kenya becomes a particularly interesting ground on which to test the influence of political institutions on illicit capital outflows for a number of reasons. First, for the past four decades of the post-independence period, the country has faced high corruption levels and rent seeking sustained by an entrenched system of political patronage. There is also evidence of several incidences of reported grand corruption scandals involving the transfer of illicit money by the ruling political elites from the late 1970s to the early 21st century. Second, corruption and the illicit capital outflows from Kenya have been a cause for a concern for a number of ordinary Kenyans who remain poor, despite increasing debt acquired in their names by the ruling political elites. Illicit capital outflows and corruption are claimed to have depleted the already meager public resources, led to suboptimal investment and rising debt levels, and undermined tax moral accountability between citizens and the State. They have also added to the growing horizontal inequality within the country. Finally, testing the political economy channel for illicit financial flows is particularly suited for Kenya because of the existence of a unique and novel data set on institutional indices constructed by Letete (2015).

A similar data set is currently being developed for Nigeria. This implies that, in a future companion and comparative study, we will be able to test the political economy hypothesis for Africa’s major oil producer and major culprit for illicit financial flows. Given that illicit financial flows in Africa have been more pronounced in resource-rich countries, such a study would allow us to analyze whether the role of institutions are different in a resource-rich country compared to a resource-poor country. The present paper is therefore a first step towards this comparative study. In this regard, Kenya is interesting because it is the resource-poor (minerals and fuels) African country that exhibits the largest stock of capital flight. During the past four decades, it is estimated that the country lost over US$10.6 billion in accumulated illicit financial flows, a figure that exceeds the country’s stock of debt, which amounts to US$8.4 billion.

Emmanuel Letete is attached to the Department of Economics at the National University of Lesotho, while Mare Sarr is from the School of Economics at the University of Cape Town.

This paper is the product of the Vice-Presidency for Economic Governance and Knowledge Management. It is part of a larger effort by the African Development Bank to promote knowledge and learning, share ideas, provide open access to its research, and make a contribution to development policy.


Email This email address is being protected from spambots. You need JavaScript enabled to view it.
Tel +27 21 880 2010