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Working Paper 275 - Illicit Financial Flows and Political Institutions in Kenya
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. We 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.