1.1 Background to the Study

Countries have been known to develop through the accumulation of savings that have been profitably invested to yield returns and increase production in different sectors of the economy. Such investments could be social or soft in outlook (housing, health and education), while others are infrastructural or hard (transport, power and water), and yet others are purely economic, which the private sector undertakes for private capital accumulation. This has made monetary authorities promote the domestic savings within the economy, since it seems that the primary source of finance for investment is savings. Such accumulated capital has been allowed to freely flow from their countries to others over the years and this has been on for centuries. Such capital flows however became quite pronounced during the nineteenth century, especially during the upheavals in Europe, between the countries and continents of the Northern Hemisphere.  At that time, capital moved from those countries of Europe to the Americas in search of higher returns (Cardoso and Dornbush, 1989).


Following a retreat to nationalism and redirection of resources to winning the two world wars, capital flows between countries resumed after the World War increasing gradually to the level it has assumed in recent times. The process of financial globalization, and some other factors, from which every economic unit attempts to maximize returns, seems to have accentuated this trend as capital flows and movement became more fluid and pronounced after Second World War, especially from the 1960s.  The trend of movements from the countries of the North to the South existed up to the early 1970s but has been later replaced with a South to North trend. While capital flows within the Western world seemed to have been continuous overtime, the case of capital flows out of the Less Developed Countries to the Western world became noticeable from the early 1980s. Since then, these unusual flows have become a source of concern because of the macroeconomic challenges facing these countries, and as a result of the paucity of much needed capital to develop and promote growth in these countries.  This unusual flows of capital from poor to rich countries is termed capital flight


Capital flight specifically refers to the movement of money from investments in one country to another in order to avoid country-specific risks (such as hyperinflation, political turmoil and anticipated depreciation or devaluation of the currency), or in search of higher yield. Capital flight has become an issue in recent times in the Nigerian financial environment such that three national dailies (The Guardian, Daily Vanguard and The Sun) ran editorials on it between April 11th and 20th 2010. Flights of capital in Nigeria manifest themselves in many ways, among which is the country’s loss of an estimated sum of $95 million (₦655.46 million at $1/₦145.00) as payments to counterparties outside the country over the last twenty years (between 1986 – 2006) due to lack of indigenous technology (see –  The Guardian editorial of 8th of February, 2007.  Empirical studies of the Nigeria situation reveal that a total nominal sum of $107 billion of Nigerian assets was reported to have flown out of the country according to Lawanson (2007) for  the period of 1970 to 2001, while Collier et al (2003) estimates capital flight out of Nigeria to be about $75 billion for the period of 1970 – 2000. These two figures are far from being close, because of the numerous reasons and different estimates of capital flight, the fact that capital flight continued unabated and the different estimation methods adopted by each of the studies.


Trillions of US$ (dollars) move around the world in response to the stimuli of return and safety (IMF, 2006). The International Monetary Fund further reports that offshore held assets amounted to some $11.6 trillion and income from such assets was $866 billion as at year end 2005. As a result of this, about $255 billion is lost in tax revenue regularly by countries suffering from capital flight – being a proof of the effect and the challenge of capital flight. The IMF has expressed concern over this issue: “….in light of the conventional wisdom suggesting that capital normally flows from capital-rich (developed) and mature markets to capital-scarce (developing), emerging markets”.


An estimate of capital flight at this period is important in order to know the relationship existing between it and domestic investment in Nigeria.  While many studies have been done on the topic, very few of these studies have been undertaken in relation to investment by Nigerians themselves. The studies of Ajayi (1990) which covered the period between 1970 and 1989 need a revisit. The studies of Onwudoukit (2001) did not provide any estimate and that of Lawanson (2007), was basically on capital flight with no relation to any other economic variable. These studies provided estimates to show the impact of trade misinvoicing or trade faking.   The producer price compounded figures for trade misinvoicing were put at $316,888 million ($316.9 billion) and $436,092.3 million ($436 billion) by Morgan Trust and World Bank respectively as at 2001 using the residual methods. These figures are at variance with Collier’s, and need some clarifications. However, none of these studies empirically studied capital flight with its impacts on investment in the domestic economy.


The uses to which capital in flight are  deployed are many, and became noticeable when developing countries’ holdings of earning assets in form of Certificate of Deposits (CDs), real estate or negotiable bonds became significant and could no longer be ignored (Cardoso and Dornbush, 1989). Nigeria, a country with a large poor population is classed among the developing countries of the world, though she earns much foreign exchange from crude oil exports, she is still in need of capital to develop, maintain and upgrade her infrastructure. Nevertheless, the country has been faced with continuous outflow of capital, which has made some scholars conclude a priori that the country is facing capital flight challenges.


Capital flight studies are so important to emerging financial markets that it has become difficult to have a uniform definition or estimates because of peculiarities of each country. Each study finds a definition for its country of study. While it can result from an immediate and spontaneous reaction to the changes in the economic circumstances of a country, it can also be a continuous challenge. The components of the capital fleeing the country need to be fully analyzed, their routes need to be known and the legitimacy or otherwise of these routes, as well as their residency status and the methods adopted for it.


For these reasons, there are many definitions and estimations, which are included in the works of Cuddington (1986), Morgan Trust and Banking Company (1987), Cumby and Levich (1987) to Lessard and Williamson (1987). Each of the definitions has its own peculiar way of measuring or estimating capital flight and the various components that make it. Each of these definitions is not exactly like any other one. This is one reason researchers in this area would calculate many figures to form a band that suggests that, capital flight for a specific country, is between one estimate and the other.

Since the methods adopted for capital flight appear to be discrete and assisted by domestic and foreign financial institutions through which these funds leave, the degree of openness and transparency of such transactions are limited. This has made the topic even more interesting, and discussions unending, especially against the backdrop of lack of capital resources for various investment needs in the economy. Walters (2002) describes capital flight and other flows as follows: “International flows of direct and portfolio investments under ordinary circumstances are rarely associated with the capital flight phenomenon. ‘….rather, it is when capital transfers by residents conflict with political objectives that the term ‘flight’ comes into general usage.” This description becomes instructive in the light of macroeconomic changes in Nigeria in the past seven to ten years (2000 – 2007). Walters describes capital movements as activities involving:

  1. Transfers via the usual international payments mechanisms, regular bank transfers are easiest, cheapest and legal.
  2. Transfer of physical currency by the bearer (smuggling) is more costly, and for many countries illegal.
  3. Transfer of cash into collectibles or precious metals, which are then transferred across borders.
  4. Money laundering, the cross-border purchase of assets that are then managed in a way that hide the movement of money and its owners, and
  5. False invoicing in international trade transactions.


Meanwhile, within the domestic economy, the importance of investment has been realised by successive administrations long time ago, especially of foreign direct investment. This has made many successive governments to do something about the encouragement of its inflow. Various governments have encouraged inflow of foreign investment through policies enunciations rather than concrete steps to implement policies formulated and establish a culture of encouraging domestic investments by residents as a way of life.  Various administrations have employed public image-makers to polish Nigeria’s image, with the heads of government travelling around the world to canvass for foreign investors. In addition, various laws have been enacted to establish institutions and special units (such as Nigeria Investment Promotion Council) to foster economic and investment growth, among many others that have been done to encourage investments but to no avail.


Investment in the domestic economy by indigenous investors has been low because of the preference to invest outside the economy. There are various reasons for this preference. Successive governments’ efforts to improve and encourage domestic investment by indigenous investors have not yielded the desired results; but have showed deeper interest in the encouragement of inflows of Foreign Direct investment (FDI) into the economy. While the advantages of FDI in terms of its additions in form of entrepreneurial possibilities, advantages, marketing and managerial expertise that come with it cannot be overlooked, the failures of domestic investment promotions is disturbing and cannot encourage economic growth and development. However, the promotion of Foreign Direct Investment inflows to the detriment of domestic investment is inappropriate since charity should begin at home. Meanwhile, the encouragement of domestic investment in the face of various daunting risks has proved to be impossible and has been unsuccessful.


Domestic investment is only possible with aggregated domestic savings which itself is a function of the level of income. However, the rate of investment vis a vis growth has proved to be negligible. Uchendu (1993) found that there is a positive but low correlation between savings and investment in Nigeria. The Nigeria financial environment records low savings resulting from low income; low income itself is as a result of low investment which can only generate low savings – thereby forming a vicious circle. Given that the available domestic resources are the only sources of investment, then the rate of investment committed would be low. However, other sources of investment, such as foreign inflows of capital can be used to supplement domestic investment.


1.2       Statement of the Problem

Capital flight reduces domestically available investible capital. Domestic investment is expected to have a negative correlation with capital flight. Given that inflows of Foreign Direct Investment (FDI) should complement domestic capital, capital flight has constituted a problem. Domestic investment of either autonomous or induced type was not considered in earlier studies in relation to capital flight. In spite of governments’ continuous campaigns for foreign investors to invest in the domestic economy, capital flight has continued unabated. This raises a concern on the effect of capital flight on domestic investment.  Where previous studies were done on capital flight, they were not specific on Nigeria. Investments that lead to increase in capital formation for the economy and act as the foundation for infrastructure or framework for the development of the country cannot be made in the face of inadequate capital.


Capital flight being a challenge to domestic investment is exacerbated by the process of financial globalisation that enables capital to move freely between countries. Since capital seeks the best avenue where it can earn the highest return given a level of assumed risks, the domestic investment environment has not been clement enough for investment. Financial globalisation, in some cases, has rendered some national governments’ monetary policies ineffective. Since financial globalisation connotes the liberalisation of the capital account, it enables capital to move in and out of the domestic economy with reduced level of restrictions. Emerging economies that have been forced to open up their economies have faced episodes of capital flight as results of financial globalisation induced crises. Countries that that liberalise their capital accounts are more prone to financial crashes or at least financial volatility because of the multifarious impacts of unrestricted capital flows involving them. Studies of financial globalisation induced volatility and flights of capital have generally left Nigeria out even where less prominent countries like Namibia were empirically investigated.  Financial globalisation is expected to impact negatively against capital flight as a result of inflow of capital into the economy. This is expected to boost domestic income and lead to financial and real development. But its effects in those countries have not been so productive but have rather brought market failures.


Capital flight has been caused partly by lack of confidence by domestic investors in the economy and has encouraged domestically generated capital to flee from the economy. While foreign capital that has been invested in the economy can leave after some time if the investors’ objectives are achieved, domestically generated capital flowing offshore should generate and report returns. However, a situation that encourages domestically generated capital to find solace and investment grounds abroad leave much to be desired. The concern here is that the level of autonomous investment that should be undertaken suffers because capital has relocated out of the economy. Given the level of infrastructural deficit (the main situate of autonomous investment) facing the country, the required capital to construct, replace and rehabilitate infrastructure is either not domestically available or would be sourced at some expense. A second issue on resident capital is that per capita income goes down as capital flees. This reduces per capita income productivity. The scenarios generate macroeconomic challenges for policymakers as to how to retain resident capital in the economy in the face of competing real rates of return in developed and mature financial markets.


The study of capital flight and aggregated financial savings in the investment process is important since a cycle has been established between income, savings and investment. The loss of investment that happens when capital flight occurs means equally that some savings are lost to the economy. Research on capital flight seems not have reached this point of discourse. Since income is also a strong determinant of savings, the impacts of this scenario on financial savings under the golden rule level of capital in conditions of capital outflows and flight is also a financial concern. The golden rule level of capital is defined as a steady state with the highest level of consumption that benevolent policymakers should achieve for individual’s well being. With this, the rate of investment is detrimentally affected especially under increased domestic consumption propelled by population increases. This ultimately affects further capital formation. The role and the impact of the exchange rate is in the process is exemplified by the understanding that capital in the domestic economy has alternative uses in capital formation



1.3       Objectives of the Study

The major objective of this study is to analyse the impact of capital flight on the Nigerian domestic investment in a financially globalising world, with the aim of finding out if capital flight can increase through financial globalisation and thereby reduce domestic investment in the process. The specific objectives are:

  1. To examine the relationship between capital flight and domestic investment, and sum up the challenges posed by capital flight to domestic investment during the period of financial globalization in Nigeria.
  2. To evaluate the impact of capital flight on financial savings since it is the primary source of financing investment.
  3. To find out the type of capital flight and estimates that is more significant and therefore relevant to Nigeria.
  4. To investigate the role of the nominal exchange rate and its impact in encouraging capital outflows and domestic investment in the economy.


1.4       Research Questions

To achieve the earlier stated objectives, the following research questions become pertinent:

  1. What is the existing relationship between domestic investment and capital flight in Nigeria?
  2. Given that capital flight and outflows have continued as proved by earlier studies, how has this affected domestic savings that drive investment
  3. With the export performance in the period from 2000 to 2007, especially of the petroleum sector and prices of other commodities that resulted in a seemingly buoyant accumulation of external reserves. What has happened to capital fight?
  4. What is the impact of the incidence of capital flight in the era of financial globalisation indicated by a high level of openness and capital account liberalisation?
  5. With the uneven level of development between the different countries of the world, and especially the developed countries and Nigeria, how can Nigeria limit further capital leakage out of the economy when the return-risk dimensions in investment paradigm are taken into account?
  6. What is the role of the exchange rate in the capital flight process, given that the flotation of the currency has been on since 1986 when the currency has been on managed float?
  7. With continuous flights of domestic capital from the economy, how has domestic investment in Nigeria fared within the current financial globalisation period?




1.5       Statement of Hypotheses

  1. H0: Capital flight has not significantly affected domestic financial savings in Nigeria.


  1. H0: Risk in the macroeconomic conditions of the country does not have a long run relationship with capital flight out of the economy.


  1. H0: There is no significant relationship between the process of financial globalization and capital flight out of the country.


  1. H0: Capital flight in the Nigerian economy does not have a significant relationship with domestic investment.


1.6 Significance of the Study

Given the fact that capital flight is an established phenomenon in the Nigerian economy (Ajayi 1992, Onwuodokit 2000, Collier et al 2003 and Lawanson 2007), the understanding of its major negative impact on investment in Nigeria is important. The need to empirically investigate the relationship that exists between capital flight and investment cannot be overemphasised. Various studies have always concluded a priori that capital flight brings about the lack of investible funds in the economy and pushes the country to seek external resources to meet developmental needs (Ajayi, 2000). The implications arising from this would bring about a decision that would enable resident capital to be profitably invested in the economy rather than having to seek alternative investment outlets outside. This area has not been addressed by any previous study on Nigeria, though some studies have been done on other countries. It is believed that this study bridges this gap.


Financial globalisation has become an observable fact following the liberalisation of most countries’ capital accounts and especially the floating of the exchange rates. This study investigates the impact of the financial globalisation process on capital flight in Nigeria. Nigeria had to implement the floatation of the Naira as part of the cross-conditionality of the International Monetary Fund to secure support for its Structural Adjustment Programme (SAP) in 1985/1986. Also, this study enables the understanding of the impact of the adoption of a floating exchange rate regime on capital flight and empirically tests if the process has had negative or positive impact on capital flight in Nigeria. In the process, the determinants of the financial globalisation and the current status of Nigeria can be easily understood.


The study brings out the effect of accumulation of reserves on capital flight out of Nigeria. Also the use of the reserves over the years can be fully understood, and the possible more productive ways to direct the reserves in future years.  For instance, the external reserves of Nigeria which have gone up to about $60 billion in 2007 had dropped to less than $30 billion dollars as at December 2010.

The literature is replete with the various estimates and definitions of capital flight. Though all point to the same direction that capital is lost to the economy suffering from capital flight, the peculiar definition that best fits the Nigerian type of flight can be fully understood as a result of this study.  The study brings to light the many estimates or definitions most relevant to Nigeria. This will avail policymakers the opportunity to direct efforts at how to eliminate the challenge in the most effective way possible

Nigeria is presently overwhelmed with the infrastructural deficit that has impeded the development of the country and its transformation into an industrial economy. In addition, the economy has constantly lost resources to capital flights over the years. The study will help bring policy makers back to the issues that need to be addressed in order to attract further capital inflows in FDI and retain resident capital domestically and thereby reduce capital flight out of Nigeria.

It is arguable if capital flight has increased the depletion of external reserves which seem to the hallmark of emerging economies among which Nigeria has been classed of recent. The external reserves of the country steadily increased through accumulation and good performance of the commodity sector of the economy especially petroleum from 2004. The ostensible reason for the maintenance of high level of reserve was for liquidity and as measure to attract FDI. In spite of seeming progress of this classification by Goldman Sachs (2003), capital flight has continued unabated especially without the attraction of corresponding quantum of foreign investment and capital into the economy. In spite of the view of some studies that that capital flight should not result from high level of reserves as it should increase the confidence level of the foreign direct investor, the reverse has been the case. Nigerian external reserve has been high at over $60 billion as at 2007 but has steadily reduced to about $33 billion by December 2010 without corresponding increase of FDI inflows.


Different definitions exist for capital flight by different studies using different estimates.  The three commonest definitions are those of the World Bank (essentially from Cuddington), Dooley and Morgan Trust Banking Company which all came out in 1986. Though the different estimates point to the fact that capital flight estimates are country-specific, it nevertheless require that attention be paid to a specific definition that may allow the country to deal with the problem using the particular and the  most significant estimates. The most significant determinants can then be used to unravel the main issues that need to be focused on in the search for the solution to the problem of capital flight in Nigeria.  Noteworthy also is the fact that the literature has also began to make a distinction between illegal and legal capital fight.


1.7       Scope of the Study

This study is centred on Nigeria and there is no comparison with the estimates of capital flight and its incidence with those of the Latin American (LATAM) countries, and a number of emerging economies of the world among those of South East Asia. Capital flows occur from countries to countries throughout the world and can become a concern when the flow becomes heavy and is enough to disrupt the financial system.  When the quantum of capital flows is continuous, it becomes capital flight as capital flees either to safety or to secrecy. As a result, of this, nearly all countries are involved in the capital flows management attempting to avoid heavy flows that degenerate into capital flight. Cursory references may be made. However, this is done to investigate if the case of Nigeria is significantly different. Data from 1970 – 2007 are to be used in the study. The period covers both pre-globalisation and globalisation years. Also attempt is made to find the long run relationship for these periods in the analysis.


1.8       Outline of the Study

The study is arranged in five chapters. Following after this chapter (chapter one) is the review of extant literature on the main concepts. Definitions of capital flight and its various dimensions, concepts of open macroeconomics and capital account liberalisation area are discussed before concepts of domestic investment and financial globalisation.  These concepts are narrowed down to Nigeria with available empirical studies. In addition, the empirical literature that pertains to Nigeria is reviewed. The importance of net errors and omissions as used in the Balance of Payments are discussed. The influence of the international banking and offshore financial markets especially within the context of the ECOWAS and Nigeria banking institutions are also discussed. The impact of illegally acquired wealth from corruption by public officials and private agents, which leads to capital flight, is also put in perspective.  The causes and routes of capital flight in Nigeria are reviewed. The chapter will also review the scenarios of capital flight around the world and its impacts on such other flows as foreign debt and aid.


Chapter three presents the theoretical framework, research methodology adopted and the raison d’être for each method. This consists of explanation of data sources, details of the data transformation and model specification adopted in this study. The choice of secondary sources of data and its transformation are explained. Chapter four presents all the results, starting with the stationarity tests. The regression estimates, interpretation of results and the discussions of other findings that are of interest in the study are also included.  Finally, chapter five summarises the study and recommendations are made and subsequently conclusion is drawn.



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