The Nexus between Capital Flight and Economic Growth. A Panel Data Investigation of the Mediating Role of Inflation (Kenya: 1986-2021)

Abstract

Purpose: This paper investigates whether inflation moderated the relationship between capital flight and economic growth in Kenya. The study attempts to answer one question. Has the effect of capital flight on economic growth been influenced significantly by the inflation rate in Kenya?

Design/methodology/approach – The panel data for the variables under study, collected from World Investment Reports published by World Bank, are analyzed using feasible generalized least squares method to examine the relationship between the dependent and explanatory variables over the period 1987–2018. The interaction effect has been studied to examine the growth impact of FDI in presence of host country characteristics.

Findings – The study found out that foreign portfolio investment outflows, profit repatriations, and inflation rates had no significant effects on economic growth when the interaction variable for inflation was included in the model. Outward foreign direct investment had a significant effect on economic growth when inflation is included in the model as an interaction variable with a positive coefficient indicating they had a positive significant relationship. The interaction variable had a negative but insignificant coefficient indicating that inflation rate did not moderate the relationship between capital flight and economic growth. From the empirical findings, we can infer that capital flight did not constrain resources and subsequently did not affect economic growth negatively. We also find that inflation rate cannot be used to control or moderate the effect of capital flight on the economy and Kenya should not pursue policies geared towards using inflation to moderate this relationship.

Originality/value – The present study provides for the first time comprehensive empirical evidence on the relationship between inflation, economic growth, and the increased rate of capital outflows in Kenya. Therefore, this study would be of prime importance for policymakers.

Originality/value – Very few studies have been conducted to examine the nexus between inflation, capital flight and economic growth in Kenyans financial markets. Assessing the interaction of these variables in Kenya and their impact on economic growth by use of panel data methodology is an original contribution of this paper toward the existing body of knowledge.