Capital flight
Encyclopedia
Capital flight, in economics
, occurs when asset
s and/or money
rapidly flow out of a country
, due to an economic event (such as an increase in tax
es on capital
and/or capital holders or the government of the country defaulting
on its debt) and that disturbs investor
s and causes them to lower their valuation of the assets in that country, or otherwise to lose confidence in its economic strength. This leads to a disappearance of wealth
and is usually accompanied by a sharp drop in the exchange rate
of the affected country (depreciation
in a variable exchange rate regime, or a forced devaluation
in a fixed exchange rate
regime).
This fall is particularly damaging when the capital belongs to the people of the affected country, because not only are the citizens now burdened by the loss of faith in the economy and devaluation of their currency, but probably also their assets have lost much of their nominal value. This leads to dramatic decreases in the purchasing power
of the country's assets and makes it increasingly expensive to import
goods.
, is intended to disappear from any record in the country of origin and earnings on the stock of illegal capital flight outside of a country generally do not return to the country of origin.
n cities are probably the most visible example of this phenomenon. Johannesburg
in particular has been abandoned by business moving to northern suburb
s. The flight of capital from central cities to the suburbs that ring them was also common throughout the second half of the twentieth century in the United States
.
(IMF) estimated that capital flight amounted to roughly half of the outstanding foreign debt of the most heavily indebted countries of the world.
Capital flight was seen in some Asia
n and Latin America
n markets in the 1990s. The Argentine economic crisis of 2001 was in part the result of massive capital flight, induced by fears that Argentina
would default
on its external debt
(the situation was made worse by the fact that Argentina had an artificially low fixed exchange rate
and was dependent on large levels of reserve currency
). This was also seen in Venezuela
in the early 1980s with one year's total export income leaving through illegal capital flight.
In the last quarter of the 20th century, capital flight was observed from countries that offer low or negative real interest rate
(like Russia
and Argentina) to countries that offer higher real interest rate (like the People's Republic of China
).
A 2006 article in The Washington Post
gave several examples of private capital leaving France
in response to the country's wealth tax
. The article also stated, "Eric Pinchet, author of a French tax guide, estimates the wealth tax earns the government about $2.6 billion a year but has cost the country more than $125 billion in capital flight since 1998."
A 2008 paper published by Global Financial Integrity
estimated capital flight, also called illicit financial flows
to be "out of developing countries are some $850 billion to $1 trillion a year."
A 2009 article in The Times
reported that hundreds of wealthy financiers and entrepreneurs had recently fled the United Kingdom
in response to recent tax increases, and had relocated in low tax destinations such as Jersey
, Guernsey
, the Isle of Man
, and the British Virgin Islands
.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, occurs when asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s and/or money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
rapidly flow out of a country
Country
A country is a region legally identified as a distinct entity in political geography. A country may be an independent sovereign state or one that is occupied by another state, as a non-sovereign or formerly sovereign political division, or a geographic region associated with a previously...
, due to an economic event (such as an increase in tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
es on capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
and/or capital holders or the government of the country defaulting
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
on its debt) and that disturbs investor
Investor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
s and causes them to lower their valuation of the assets in that country, or otherwise to lose confidence in its economic strength. This leads to a disappearance of wealth
Wealth
Wealth is the abundance of valuable resources or material possessions. The word wealth is derived from the old English wela, which is from an Indo-European word stem...
and is usually accompanied by a sharp drop in the exchange rate
Exchange rate
In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency...
of the affected country (depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
in a variable exchange rate regime, or a forced devaluation
Devaluation
Devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged....
in a fixed exchange rate
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...
regime).
This fall is particularly damaging when the capital belongs to the people of the affected country, because not only are the citizens now burdened by the loss of faith in the economy and devaluation of their currency, but probably also their assets have lost much of their nominal value. This leads to dramatic decreases in the purchasing power
Purchasing power
Purchasing power is the number of goods/services that can be purchased with a unit of currency. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing...
of the country's assets and makes it increasingly expensive to import
Import
The term import is derived from the conceptual meaning as to bring in the goods and services into the port of a country. The buyer of such goods and services is referred to an "importer" who is based in the country of import whereas the overseas based seller is referred to as an "exporter". Thus...
goods.
Legality
Capital flight may be legal or illegal. Legal capital flight is recorded on the books of the entity or individual making the transfer, and earnings from interest, dividends, and realized capital gains normally return to the country of origin. Illegal capital flight, also known as illicit financial flowsIllicit financial flows
Illicit financial flows, in economics, refers to a form of illegal capital flight and occurs when money is illegally earned, transferred, or utilized. This money is intended to disappear from any record in the country of origin, and earnings on the stock of illicit financial flows outside of a...
, is intended to disappear from any record in the country of origin and earnings on the stock of illegal capital flight outside of a country generally do not return to the country of origin.
Capital flight within a country
Capital flight is also sometimes used to refer to the removal of wealth and assets from a city or region within a country. Post-apartheid South AfricaSouth Africa
The Republic of South Africa is a country in southern Africa. Located at the southern tip of Africa, it is divided into nine provinces, with of coastline on the Atlantic and Indian oceans...
n cities are probably the most visible example of this phenomenon. Johannesburg
Johannesburg
Johannesburg also known as Jozi, Jo'burg or Egoli, is the largest city in South Africa, by population. Johannesburg is the provincial capital of Gauteng, the wealthiest province in South Africa, having the largest economy of any metropolitan region in Sub-Saharan Africa...
in particular has been abandoned by business moving to northern suburb
Suburb
The word suburb mostly refers to a residential area, either existing as part of a city or as a separate residential community within commuting distance of a city . Some suburbs have a degree of administrative autonomy, and most have lower population density than inner city neighborhoods...
s. The flight of capital from central cities to the suburbs that ring them was also common throughout the second half of the twentieth century in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
.
Recent examples
In 1995, the International Monetary FundInternational Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
(IMF) estimated that capital flight amounted to roughly half of the outstanding foreign debt of the most heavily indebted countries of the world.
Capital flight was seen in some Asia
Asia
Asia is the world's largest and most populous continent, located primarily in the eastern and northern hemispheres. It covers 8.7% of the Earth's total surface area and with approximately 3.879 billion people, it hosts 60% of the world's current human population...
n and Latin America
Latin America
Latin America is a region of the Americas where Romance languages – particularly Spanish and Portuguese, and variably French – are primarily spoken. Latin America has an area of approximately 21,069,500 km² , almost 3.9% of the Earth's surface or 14.1% of its land surface area...
n markets in the 1990s. The Argentine economic crisis of 2001 was in part the result of massive capital flight, induced by fears that Argentina
Argentina
Argentina , officially the Argentine Republic , is the second largest country in South America by land area, after Brazil. It is constituted as a federation of 23 provinces and an autonomous city, Buenos Aires...
would default
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
on its external debt
External debt
External debt is that part of the total debt in a country that is owed to creditors outside the country. The debtors can be the government, corporations or private households. The debt includes money owed to private commercial banks, other governments, or international financial institutions such...
(the situation was made worse by the fact that Argentina had an artificially low fixed exchange rate
Exchange rate
In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency...
and was dependent on large levels of reserve currency
Reserve currency
A reserve currency, or anchor currency, is a currency that is held in significant quantities by many governments and institutions as part of their foreign exchange reserves...
). This was also seen in Venezuela
Venezuela
Venezuela , officially called the Bolivarian Republic of Venezuela , is a tropical country on the northern coast of South America. It borders Colombia to the west, Guyana to the east, and Brazil to the south...
in the early 1980s with one year's total export income leaving through illegal capital flight.
In the last quarter of the 20th century, capital flight was observed from countries that offer low or negative real interest rate
Real interest rate
The "real interest rate" is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate...
(like Russia
Russia
Russia or , officially known as both Russia and the Russian Federation , is a country in northern Eurasia. It is a federal semi-presidential republic, comprising 83 federal subjects...
and Argentina) to countries that offer higher real interest rate (like the People's Republic of China
People's Republic of China
China , officially the People's Republic of China , is the most populous country in the world, with over 1.3 billion citizens. Located in East Asia, the country covers approximately 9.6 million square kilometres...
).
A 2006 article in The Washington Post
The Washington Post
The Washington Post is Washington, D.C.'s largest newspaper and its oldest still-existing paper, founded in 1877. Located in the capital of the United States, The Post has a particular emphasis on national politics. D.C., Maryland, and Virginia editions are printed for daily circulation...
gave several examples of private capital leaving France
France
The French Republic , The French Republic , The French Republic , (commonly known as France , is a unitary semi-presidential republic in Western Europe with several overseas territories and islands located on other continents and in the Indian, Pacific, and Atlantic oceans. Metropolitan France...
in response to the country's wealth tax
Wealth tax
A wealth tax is generally conceived of as a levy based on the aggregate value of all household holdings actually accumulated as purchasing power stock , including owner-occupied housing; cash, bank deposits, money funds, and savings in insurance and pension plans; investment in real estate and...
. The article also stated, "Eric Pinchet, author of a French tax guide, estimates the wealth tax earns the government about $2.6 billion a year but has cost the country more than $125 billion in capital flight since 1998."
A 2008 paper published by Global Financial Integrity
Global Financial Integrity
Global Financial Integrity is a non-profit, research and advocacy organization located in Washington, DC. GFI advocates and conducts research on national and multilateral policies, safeguards, and agreements aimed at curtailing illicit financial flows and enhancing global development and security...
estimated capital flight, also called illicit financial flows
Illicit financial flows
Illicit financial flows, in economics, refers to a form of illegal capital flight and occurs when money is illegally earned, transferred, or utilized. This money is intended to disappear from any record in the country of origin, and earnings on the stock of illicit financial flows outside of a...
to be "out of developing countries are some $850 billion to $1 trillion a year."
A 2009 article in The Times
The Times
The Times is a British daily national newspaper, first published in London in 1785 under the title The Daily Universal Register . The Times and its sister paper The Sunday Times are published by Times Newspapers Limited, a subsidiary since 1981 of News International...
reported that hundreds of wealthy financiers and entrepreneurs had recently fled the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
in response to recent tax increases, and had relocated in low tax destinations such as Jersey
Jersey
Jersey, officially the Bailiwick of Jersey is a British Crown Dependency off the coast of Normandy, France. As well as the island of Jersey itself, the bailiwick includes two groups of small islands that are no longer permanently inhabited, the Minquiers and Écréhous, and the Pierres de Lecq and...
, Guernsey
Guernsey
Guernsey, officially the Bailiwick of Guernsey is a British Crown dependency in the English Channel off the coast of Normandy.The Bailiwick, as a governing entity, embraces not only all 10 parishes on the Island of Guernsey, but also the islands of Herm, Jethou, Burhou, and Lihou and their islet...
, the Isle of Man
Isle of Man
The Isle of Man , otherwise known simply as Mann , is a self-governing British Crown Dependency, located in the Irish Sea between the islands of Great Britain and Ireland, within the British Isles. The head of state is Queen Elizabeth II, who holds the title of Lord of Mann. The Lord of Mann is...
, and the British Virgin Islands
British Virgin Islands
The Virgin Islands, often called the British Virgin Islands , is a British overseas territory and overseas territory of the European Union, located in the Caribbean to the east of Puerto Rico. The islands make up part of the Virgin Islands archipelago, the remaining islands constituting the U.S...
.
See also
- Sudden stop (economics)Sudden stop (economics)A sudden stop in capital flows is defined as a sudden slowdown in private capital inflows into emerging market economies, and a corresponding sharp reversal from large current account deficits into smaller deficits or small surpluses. Sudden stops are usually followed by a sharp decrease in output,...
- Human capital flight (brain drain)
- Tax exportingTax exportingTax exporting occurs when a country indirectly encourages economic activity to move to another country with a lower tax burden. This is more likely if the economic activity is more mobile....
- Capital strikeCapital strikeCapital strike refers to the withholding of new investment in an economy. A capital strike can occur when banks decide to raise lending standards or minimum loan requirements to individuals and business entities, and decide to sit on cash reserves, rather than take many loan risks, until a later...
- Illicit financial flowsIllicit financial flowsIllicit financial flows, in economics, refers to a form of illegal capital flight and occurs when money is illegally earned, transferred, or utilized. This money is intended to disappear from any record in the country of origin, and earnings on the stock of illicit financial flows outside of a...
External links
- Capital flight after revolution Anarchist view of capital flight
- "Capital Flight" from the Concise Encyclopedia of Economics
- European Network on Debt and Development reports, news and links on capital flight.
- Eurodad: Capital Flight, tax justice and financial regulation
- Global Financial Integrity: Studies and works to curtail illicit capital flight from developing countries.