Capital flight

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Capital flight, in economics, occurs when assets or money rapidly flow out of a country, due to an event of economic consequence. Such events could be an increase in taxes on capital or capital holders or the government of the country defaulting on its debt that disturbs investors and causes them to lower their valuation of the assets in that country, or otherwise to lose confidence in its economic strength.

Economics Social science that analyzes the production, distribution, and consumption of goods and services

Economics is the social science that studies the production, distribution, and consumption of goods and services.

Asset economic resource, from which future economic benefits are expected

In financial accounting, an asset is any resource owned by the business. Anything tangible or intangible that can be owned or controlled to produce value and that is held by a company to produce positive economic value is an asset. Simply stated, assets represent value of ownership that can be converted into cash. The balance sheet of a firm records the monetary value of the assets owned by that firm. It covers money and other valuables belonging to an individual or to a business.

Money Object or record accepted as payment

Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular 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 sometimes, a standard of deferred payment. Any item or verifiable record that fulfils these functions can be considered as money.

Contents

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.

In modern monetary policy, a devaluation is an official lowering of the value of a country's currency within a fixed exchange-rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to a foreign reference currency or currency basket. The opposite of devaluation, a change in the exchange rate making the domestic currency more expensive, is called a revaluation. A monetary authority maintains a fixed value of its currency by being ready to buy or sell foreign currency with the domestic currency at a stated rate; a devaluation is an indication that the monetary authority will buy and sell foreign currency at a lower rate.

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 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 and acquire any form of foreign facilities, e.g. medical facilities.

In economics, nominal value is measured in terms of money, whereas real value is measured against goods or services. A real value is one which has been adjusted for inflation, enabling comparison of quantities as if the prices of goods had not changed on average. Changes in value in real terms therefore include the effect of inflation. In contrast with a real value, a nominal value has not been adjusted for inflation, and so changes in nominal value reflect at least in part the effect of inflation.

Purchasing power is the amount of goods and services that can be purchased with a unit of currency. For example, if one had taken one unit of currency to a store in the 1950s, it would have been possible to buy a greater number of items than would be the case today, indicating that the currency had a greater purchasing power in the 1950s. Currency can be either a commodity money, like gold or silver, or fiat money emitted by government sanctioned agencies.

Discussion

Legality

Capital flight may be legal or illegal under domestic law. 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 flows, 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. It is indicated as missing money from a nation's balance of payments. [1]

Illicit financial flows, in economics, are a form of illegal capital flight that occurs when money is illegally earned, transferred, or spent. This money is intended to disappear from any record in the country of origin, and earnings on the stock of illicit financial flows outside a country generally do not return to the country of origin.

The balance of payments, also known as balance of international payments and abbreviated B.O.P. or BoP, of a country is the record of all economic transactions between the residents of the country and the rest of the world in a particular period of time. These transactions are made by individuals, firms and government bodies. Thus the balance of payments includes all external visible and non-visible transactions of a country. It is an important issue to be studied, especially in international financial management field, for a few reasons.

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 African cities are probably the most visible example of this phenomenon as a result of high crime and violence rates in black majority cities, and 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 likewise as a result of crime and violence in inner cities.

South Africa Republic in the southernmost part of Africa

South Africa, officially the Republic of South Africa (RSA), is the southernmost country in Africa. It is bounded to the south by 2,798 kilometres (1,739 mi) of coastline of Southern Africa stretching along the South Atlantic and Indian Oceans; to the north by the neighbouring countries of Namibia, Botswana, and Zimbabwe; and to the east and northeast by Mozambique and Eswatini (Swaziland); and it surrounds the enclaved country of Lesotho. South Africa is the largest country in Southern Africa and the 25th-largest country in the world by land area and, with over 57 million people, is the world's 24th-most populous nation. It is the southernmost country on the mainland of the Old World or the Eastern Hemisphere. About 80 percent of South Africans are of Bantu ancestry, divided among a variety of ethnic groups speaking different African languages, nine of which have official status. The remaining population consists of Africa's largest communities of European, Asian (Indian), and multiracial (Coloured) ancestry.

United States Federal republic in North America

The United States of America (USA), commonly known as the United States or America, is a country comprising 50 states, a federal district, five major self-governing territories, and various possessions. At 3.8 million square miles, the United States is the world's third or fourth largest country by total area and is slightly smaller than the entire continent of Europe, which is 3.9 million square miles. With a population of over 327 million people, the U.S. is the third most populous country. The capital is Washington, D.C., and the most populous city is New York City. Most of the country is located contiguously in North America between Canada and Mexico.

Countries with resource-based economies experience the largest capital flight. [2] A classical view on capital flight is that it is currency speculation that drives significant cross-border movements of private funds, enough to affect financial markets. [3] The presence of capital flight indicates the need for policy reform. [4]

A resource-based or natural-resource-based economy is that of a country whose gross national product or gross domestic product to a large extent comes from natural resources.

Speculation is the purchase of an asset with the hope that it will become more valuable in the near future. In finance, speculation is also the practice of engaging in risky financial transactions in an attempt to profit from short term fluctuations in the market value of a tradable financial instrument—rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, dividends, or interest.

Financial market generic term for all markets in which trading takes place with capital

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Securities include stocks and bonds, and precious metals.

Examples

Ratio of German assets in tax havens to German GDP. The "Big 7" shown are Hong Kong, Ireland, Lebanon, Liberia, Panama, Singapore, and Switzerland. German GDP in tax havens.png
Ratio of German assets in tax havens to German GDP. The "Big 7" shown are Hong Kong, Ireland, Lebanon, Liberia, Panama, Singapore, and Switzerland.

In 1995, the International Monetary Fund (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 Asian and Latin American markets in the 1990s. Perhaps the most consequential of these was the 1997 Asian financial crisis that started in Thailand and spread though much of East Asia beginning in July 1997, raising fears of a worldwide economic meltdown due to financial contagion.

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." [6]

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." [7]

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. [8]

In May 2012 the scale of Greek capital flight in the wake of the first "undecided" legislative election was estimated at €4 billion a week [9] and later that month the Spanish Central Bank revealed €97 billion in capital flight from the Spanish economy for the first quarter of 2012.

In the book La Dette Odieuse de l'Afrique: Comment l'endettement et la fuite des capitaux ont saigné un continent (Amalion 2013), Léonce Ndikumana and James K. Boyce argue that more than 65% of Africa's borrowed debts do not even get into countries in Africa, but remain in private bank accounts in tax havens all over the world. [10] Ndikumana and Boyce estimate that from 1970 to 2008, capital flight from 33 sub-Saharan countries totalled $700 billion. [11]

In the run up to the British referendum on leaving the EU there was a net capital outflow of £77 billion in the preceding two quarters, £65 billion in the quarter immediately before the referendum and £59 billion in March when the referendum campaign started. This corresponds to a figure of £2 billion in the equivalent six months in the preceding year. [12]

See also

Related Research Articles

Money laundering Process of transforming profits of crime and corruption into ostensibly legitimate assets

Money laundering is the illegal process of concealing the origins of money obtained illegally by passing it through a complex sequence of banking transfers or commercial transactions. The overall scheme of this process returns the money to the launderer in an obscure and indirect way.

Deficit spending Spending in excess of revenue

Deficit spending is the amount by which spending exceeds revenue over a particular period of time, also called simply deficit, or budget deficit; the opposite of budget surplus. The term may be applied to the budget of a government, private company, or individual. Government deficit spending is a central point of controversy in economics, as discussed below.

An offshore bank is a bank regulated under international banking license, which usually prohibits the bank from establishing any business activities in the jurisdiction of establishment. Due to less regulation and transparency, accounts with offshore banks were often used to hide undeclared income. Since the 1980s, jurisdictions that provide financial services to nonresidents on a big scale, can be referred to as offshore financial centres. Since OFCs often also levy little or no tax corporate and/or personal income and offer, they are often referred to as tax havens.

The debt of developing countries refers to the external debt incurred by governments of developing countries, generally in quantities beyond the governments' ability to repay. "Unpayable debt" is external debt with interest that exceeds what the country's politicians think they can collect from taxpayers, based on the nation's gross domestic product, thus preventing it from ever being repaid. The debt can result from many causes.

The Mexican peso crisis was a currency crisis sparked by the Mexican government's sudden devaluation of the peso against the U.S. dollar in December 1994, which became one of the first international financial crises ignited by capital flight.

A wealth tax is a levy on the total value of personal assets, including bank deposits, real estate, assets in insurance and pension plans, ownership of unincorporated businesses, financial securities, and personal trusts. Typically, liabilities are deducted from an individual's wealth, hence it is sometimes called a net wealth tax.

In finance, leverage is any technique involving the use of debt rather than fresh equity in the purchase of an asset, with the expectation that the after-tax profit to equity holders from the transaction will exceed the borrowing cost, frequently by several multiples⁠ ⁠— hence the provenance of the word from the effect of a lever in physics, a simple machine which amplifies the application of a comparatively small input force into a correspondingly greater output force. Normally, the lender will set a limit on how much risk it is prepared to take and will set a limit on how much leverage it will permit, and would require the acquired asset to be provided as collateral security for the loan. For example, for a residential property the finance provider may lend up to, say, 80% of the property's market value, for a commercial property it may be 70%, while on shares it may lend up to, say, 60% or none at all on certain volatile shares.

A vulture fund is a hedge fund, private equity fund or distressed debt fund, that invests in debt considered to be very weak or in default, known as distressed securities. Investors in the fund profit by buying debt at a discounted price on a secondary market and then using numerous methods to gain a larger amount than the purchasing price. Debtors include companies, countries, and individuals.

A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults. Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy.

Eurodad organization

Eurodad is a network of 47 non-governmental organisations from 20 European countries. Eurodad and its members make up a network, this network researches and works on issues that are related to debt, development finance and poverty reduction.

The Russian financial crisis hit Russia on 17 August 1998. It resulted in the Russian government and the Russian Central Bank devaluing the ruble and defaulting on its debt. The crisis had severe impacts on the economies of many neighboring countries. Meanwhile, James Cook, the senior vice president of The U.S. Russia Investment Fund, suggested the crisis had the positive effect of teaching Russian banks to diversify their assets.

Modern Monetary Theory also known as neo-chartalism, a macroeconomic theory

Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly for the government and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. MMT is an evolution of chartalism and is sometimes referred to as neo-chartalism.

The following outline is provided as an overview of and topical guide to finance:

Financial management focuses on ratios, equities and debts. It is useful for portfolio management, distribution of dividend, capital raising, hedging and looking after fluctuations in foreign currency and product cycles. Financial managers are the people who will do research and based on the research, decide what sort of capital to obtain in order to fund the company's assets as well as maximizing the value of the firm for all the stakeholders. It also refers to the efficient and effective management of money (funds) in such a manner as to accomplish the objectives of the organization. It is the specialized function directly associated with the top management. The significance of this function is not seen in the 'Line' but also in the capacity of the 'Staff' in overall of a company. It has been defined differently by different experts in the field.

Raymond W. Baker American businessman

Raymond W. Baker is an American businessman, scholar, author, and "authority on financial crime." He is the founder and president of Global Financial Integrity, a research and advocacy organization in Washington, DC working to curtail illicit financial flows.

The National Asset Management Agency is a body created by the government of Ireland in late 2009, in response to the Irish financial crisis and the deflation of the Irish property bubble.

Offshore financial centre corporate-focused tax havens

An Offshore Financial Centre or OFC is defined as a country or jurisdiction that provides financial services to nonresidents on a scale that is incommensurate with the size and the financing of its domestic economy. "Offshore" does not refer to the location of the OFC, but to the fact that the largest users of the OFC are nonresident. The IMF lists OFCs as a third class of financial centre, with International Financial Centres (IFCs), and Regional Financial Centres (RFCs); there is overlap.

Leonce Ndikumana

Léonce Ndikumana, of Burundian origin, is a Professor of Economics and specialist in African economy development, macroeconomics, external debt and capital flight.

Graciela Kaminsky is a Professor of Economics and International Affairs at George Washington University and a Faculty Research Associate at the National Bureau of Economic Research. Kaminsky studied Economics at the Massachusetts Institute of Technology where she received her Ph.D. In 1984 she did a brief research stay at the Argentine Central Bank, later in 1985 she moved to San Diego as an assistant professor at the University of California. In 1992 she worked on the Board of Governors of the US Federal Reserve System, later in 1998 she was appointed a full professor at George Washington University where she works at the Elliot School of International Affairs. Kaminsky has been a visiting scholar at the Bank of Japan, the Bank of Spain, the Federal Reserve Bank of New York, the Hong Kong Monetary Authority, and the Central Bank of France.

References

  1. Ajayi, S. Ibi; Léonce Ndikumana (2015). Capital Flight from Africa: Causes, Effects, and Policy Issues. Oxford University Press. p. 3. ISBN   0198718551 . Retrieved 5 January 2017.
  2. Epstein, Gerald A. (2005). Capital Flight and Capital Controls in Developing Countries. Edward Elgar Publishing. p. 11. ISBN   9781781008058 . Retrieved 5 January 2017.
  3. McLeod, Darryl (2002). "Capital Flight". In David R. Henderson (ed.). Concise Encyclopedia of Economics (1st ed.). Library of Economics and Liberty. OCLC   317650570 , 50016270 , 163149563
  4. Ul Haque, Nadeem; Pakistan Institute of Development Economics (2009). Brain drain or human capital flight. Pakistan Institute of Development Economics. p. 3. ISBN   969461130X . Retrieved 5 January 2017.
  5. Shafik Hebous (2011) "Money at the Docks of Tax Havens: A Guide", CESifo Working Paper Series No. 3587, p. 9
  6. Moore, Molly; "Old Money, New Money Flee France and Its Wealth Tax"; Washington Post Foreign Service; July 16, 2006; Page A12
  7. Illicit Financial Flows From Developing Countries: 2002-2006, Dev Kar and Devon Cartwright-Smith, 2008
  8. Hundreds of bosses flee UK over 50% tax, The Times, December 13, 2009
  9. Ambrose Evans-Pritchard (16 May 2012).Greek Euro exit looms closer as banks crumble. The Telegraph. Retrieved 5 January 2017.
  10. La Dette Odieuse de l'Afrique: Comment l'endettement et la fuite des capitaux ont saigné un continent ISBN   978-2-35926-022-9
  11. "RPT-AFRICA MONEY-Should Africa challenge its "odious debts?"". Reuters. 15 March 2012.
  12. Ed Conway (7 June 2016). EU: Osborne Warning Over Capital Flight Cost. Retrieved 4 January 2017.