Exploding net errors and omissions as a capital flight phenomenon: the case of Slovakia

ABSTRACT

This article empirically explores determinants of net errors and omissions (NEO) of Slovakia during the 1997–2014 period, with emphasis on the 2008–2014 sub-period when a distinct downturn in the NEO time series is observed. Given the statistically significant link between the evolution of foreign direct investments and NEO, we cannot rule out possible prevalence of tax optimization as a part of capital flight phenomenon in developed countries. Our findings also suggest that services sector plays a pivotal role in determining the adverse NEO development in the post-2008 period. However, given the absence of detailed bidirectional data for trade with services, role of misinvoicing practices in the Slovak balance of payments statistics might not be further investigated. Our results further strengthen the call for a deeper understanding of forces driving the NEO evolution in other developed and developing countries suffering from capital flight phenomenon.

KEYWORDS:

• Net errors and omissions (NEO)
• balance of payments
• illicit capital flows
• balancing item

JEL CLASSIFICATION:

• F32
• F41

Acknowledgement

This work was supported by the Slovak Scientific Grant Agency under Grant APVV-15-0666 “Capital flight and its impact on the Slovak economy”.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Export and import of services are used in logarithmic form in all subsequent models in order to ensure I(1) properties.

² The UN Comtrade database, while including bilateral trade with services, suffers from two shortcomings relevant to this type of study. Firstly, data are provided only on annual basis and, secondly, coverage for Slovakia as a trade partner is very limited. The OECD database on bilateral trade with services provides a very interesting source of data, however, the annual frequency does not allow for inclusion of the export and import misinvoicing factor for Slovakia into regressions as calculated using mirror statistics with procedure described in Global Financial Integrity reports. Additionally, bilateral data available for main trading partners still suffer from various inconsistencies (negative values for import, etc.). More disaggregated analysis of mirror statistics per top trade partners still highlights some very striking features that definitely deserves full attention in future research. However, at this stage it is difficult to assign these inconsistencies to statistical errors or deliberate faking of trade statistics by reporters.

³ Slovak republic belongs to countries with less developed financial system in comparison to most advanced economies. According to World Bank data, the extent of banking sector size as capture by credit-to-GDP ratio represents only half (49.9%) of the overall size in the EU (100%) or Euro Area (92.9%) in 2014. Similar ratio is observed in Hungary, Czech republic or Poland. Other CEE countries perform even worse fluctuating around 30%.

Additional information

Funding

This work was supported by the Slovak Scientific Grant Agency under Grant APVV-15-0666 “Capital flight and its impact on the Slovak economy”.