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II Capital Flight: Concepts, Measurement, and Issues 11 Capital Flight: Concepts, Measurement, and Issues Michael Deppler and Martin Williamson Until recently, the issues raised by capital outflows on accompanying developments in external liabilities. from developing countries have been overshadowed ln much of the 1970s, for instance. when foreign by the concerns over the growth of their gross external creditors were in effect willing to finance capital flight. debt. In the past few years, however, there has been its harmful effects stemmed more from the distortions an increasing recognition of the significance of these that caused it than from the outflows per se. As foreign capital outflows, reflecting in part greater awareness creditors became increasingly unwilling to lend to of the sheer volume of assets that have been transferred developing countries, however, the private sector's abroad. For the group of capital importing developing demand for foreign assets was effectively "financed" countries, for instance, external assets are estimated through reductions in net imports, a different and much to have amounted to some $500 billion at the end of more serious consequence of capital flight. 1985, of which only $150 billion was accounted for by ln an attempt to shed some light on these matters. official reserves. These countries' total externalassets, this chapter begins by fo cusing on capital flight in the therefore, amounted to well over half of their external way it is most often perceived-as a particular type liabilities. of capital outflow.The first ection defines the concept, In the light of these magnitudes, capital flight has and the chapter goes on to describe and assess the received increased attention as a possible cause for various techniques used to measure capital flight, to the protracted slow growth experienced by many sketch the main trends since the rnid-l970s, and to developing countries in recent years and for the debt identify some of its proximate causes. In the two crisis. Moreover, capital flight has been identified by closing sections a broader view is taken, and the foreign creditors as a justification for not lending to economic implications of capital flight are examined developing countries. A recent Morgan Guaranty within the context of the overall external situation of newsletter noted, for instance, that "Creditors, both developing countries. private and official. are understandably reluctant to provide fresh funds unless the debtors put a stop to the capital flight."t Definition of Capital Flight Capital flight is, however, a somewhat elusive con­ cept. From a conceptual standpoint, it is hard to Although bouts of capital flight have been identified distinguish from those outflows that can be considered for periods dating back to the 17th century, and "normal" transactions, while it is difficult to measure possibly before, there is not yet a generally accepted both empirically because statistics are weak and be­ definition.2 One difficulty in formulating an acceptable cause it requires classifying data according to char­ definition is that "capital flight." in its broadest sense. acteristics that are only loosely and indirectly related covers capital outflows that are motivated by widely to the constructs being measured. FinaiJy. the signif­ different considerations that cannot easily be distin­ icance of capital flight is very much a function of guished empirically. Consequently, a particular defi­ circumstances that reach well beyond the asset trans­ nition of capital flight as comprising the acquisition actions in question. In particular, whether capital flight and holding of certain claims on nonresidents, or as engenders a transfer of real resources hinges largely arising out of investor�· motives for acquiring such 1986). 1 Morgan Guaranty Trust Company (September 1 See Kindleberger (1986) for a historical review. 39 ©International Monetary Fund. Not for Redistribution 11 · CAPITAL FLIGHT: CONCEPTS, MEASUREMENT, AND ISSUES claims, inevitably involves a large element of judg­ funds by entities located in offshore centers in tradi­ ment. The variety of definitions that has been proposed tional centers. Although banks were responding to a reflects, in the main, the variety of observers' judg­ chance to avoid capital impairment-in the form of ments on the line dividing "normal" capital outflows taxation of financial transactions and regulatory re­ and capital flight. quirements on the use of their funds-the large capital Although this distinction cannot be drawn finely, it outflows were not generalJy viewed as capital flight. is clear that while all capital flows are motivated by One reason may be the perception that the banks were endeavors to maximize returns on capital for any given responding to opportunities to increase their profits level of risk, the particular motivation for capital flight rather than to the risks of incurring losses.4 Another is rather more specific. Essentially, it is motivated by may be that the banks involved in these transactions a resident's concern that, if his wealth were held were essentially exchanging assets of similar risk domestically, it would be subject to a substantial loss characteristics, whereas capital flight typically involves or impairment. Fears of capital loss tend to arise from a discrete shift-an exchange of high-risk for low-risk ri sks of expropriation, debt repudiation, or exchange assets in the portfolio of the investor. Lastly, shifting rate depreciation. Fears of capital impairment arise transactions offshore did not result in any significant from the risks of new market distortions-forexample, change in the opportunities and constraints facing the capital controls, taxation, and financial repression­ uJtimate holders of Liabilities and claims, nor did it that would reduce the value of an asset compared with result in a net change in the availability of foreign its value if invested abroad .3 exchange, or net savings, to the country concerned. However, these general concepts are rather difficult This example provides a useful insight into the nature to apply in practice. The concept of a market distortion of capital flight. A capital outflow must be motivated that is sufficiently serious to cause capital flight, for by the owner's concern that, if the capital were retained example, is somewhat elastic, like the concept of as a direct claim on other residents, it would be subject capital flight itself. Many markets are subject to some to a reduction in value that could be avoided by distortion and this is accepted by the participants. acquiring claims on nonresidents. But although a However, ifthe distortions become sufficiently large, necessary condition for flight capital, this is not a then participants are likely to seek to transfer their sufficientcondition. To be classed as capital flight, the activities elsewhere. This transfer might involve simply outflow must also be a response to losses and risks a geographical relocation of transactions; for example, that are perceived to be "large" in relation to the if domestic interest rates on bank deposits are con­ capital deployed. The relatively small differentials trolled and uncompetitive, investors might shift their between rates of return on banks' capital obtainable bank deposits offshore. Alternatively, the transfer in traditional and offshore banking centers are not might involve a shift from one class of transactions to sufficient to justify the resulting capital flows being another. Investors might seek, for example, new do­ treated as capital flight . mestic or foreign financial instruments in preference Capital flight is not, of course, necessarily embodied to domestic financial instruments that are subject to only in a current outflow of capital. It may, as discussed interest rate controls. Similarly, the imposition of a by Dooley, occur when there is a shift in residents' tax on one class of assets might cause holders to shift motives for holding their stocks of foreign assets.5 to less heavily taxed domestic assets (tax-avoidance) Changes in circumstances-prompting fears of the or to transfer their wealth abroad (tax evasion or tax introduction of a tax on domestic financial assets, for avoidance, depending on the legal circumstances). example-may cause investors to reappraise the value To further complicate the matter, a shift of assets of their foreign assets relative to domestic assets; if abroad may or may not involve capita.! flight, as the the expected losses incurred as a result of repatriating following example demonstrates. The emergence of foreign assets were sufficiently large, assets that had favorable tax and regulatory regimes in offshore bank­ previously been accumulated abroad for nonflight pur­ ing centers in the 1970s provided incentives for many poses might be retained abroad for flight reasons. banks to relocate some of their activities from the Consequently, capital flight may occur without any traditional financial centers in industrial countries to current outflow of capital across the exchanges, and, the offshore banking centers. This geographical relo­ by the same token, it may be reversed without any cation was accompanied by massive outflows of funds from the traditional financial centers into the offshore • This view banking centers, which were matched by deposits of distinction possibly owes more to an accountant 's of profit and loss than to the economic concept of loss, for the opportunity cost of failing to transfer banking activities offshore is 1 The term "financial repression"
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