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 ofcapital. 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" is used in a broad sense in this economicaUy equivalent to a loss, although such "losses" are not paper to refer to the losses occurring to asset holders occasioned directly entered on balance sheets.

by aU types of distortions imposed on the domestic financial system. 5 Dooley (19!!6).

40 ©International Monetary Fund. Not for Redistribution Measuring Capital Flight capital reflows to the country in which the capital enabled them to remain net capital importers and to owner resides. pursue their development plans without serious dis­ The above analysis suggests that capital flight may ruption. However, as foreign creditors became un­ be defined as the acquisition or retention of a claim willing to undertake further lending to many of these on nonresidents that is motivated by the owner's countries in the wake of the debt crisis, governments concern that the value of his asset would be subject more forcefully confronted the opportunity costs of to discrete losses if his claims continued to be held continued private capital outflows.At this point, capital domestically.6 Capital flight is not necessarily a prob­ flight, and the stocks of private foreign assets that had lem from the individuaJ's point of view; indeed, it been acquired earlier, began to be systematicaJly offers the capital owner the opportunity to protect his described as a problem. wealth from expected losses, and is therefore welfare­ Recognizing the existence of a problem and appre­ improving from his perspective. However, the avoid­ ciating its extent, however, are rather different matters. ance of losses by some residents may merely shift the In this context, it is important to distinguish between burden to others, either individually or, in aggregate, "normal" capital outflows and capital flight. As argued to society. When these costs become unacceptable­ above, "normal'' capital outflows comprise all out­ usuaUy to the authorities-capital flight is viewed as flows that are not motivated by the attempt to avoid a problem. The problem with capital flight is, therefore, large losses. Normal outflows, therefore, include those not so much that there is a capital outflow, nor that resulting from households' attempts to maximize re­ there is a shift in sentiment for retaining outstanding turns through international portfolio diversification: stocks of fo reign assets abroad; the problem is. rather, enterprises' efforts to promote trade through providing that resources escape those who seek to exercise some export credits, accumulating working balances abroad, degree of control over how the fu nds may be used. and investing directly in the acquisition of productive ln general, governments have wanted to have some capacity abroad; and commercial banks' efforts to control over the disposition of private capital because expand their activities through accumulating deposits they take a broader, and sometimes more optimistic, with foreign correspondent banks and acquiring claims view of the returns obtainable on domestic investments on nonresidents through portfolio and direct invest­ than does the private sector, calculating social rates ment. 8 Clearly, one would not wish to overstate the of return on domestic investments that are often higher magnitude of the problem of capital flight by incor­ than the equivalent private rates of return. They porating those normal outflows in a measure of capital perceive, therefore . social gains from inhibiting private Right. capital outflows. Consequently, many governments have imposed controls on capital outflows, with the intention of increasing the domestic savings available Measuring Capital Flight for domestic investment. Moreover, many govern­ ments have been willing to offer guarantees to foreign This discussion of the definition of capital fiight creditors and to pay market-related rates of return in suggests that a motivation-based definition is likely to order to attract inflows of foreign savings that would have Limitations, both conceptually and empirically. further increase the resources available for develop­ Indeed, capital flight is inordinately difficult to mea­ ment. sure. Its relationship to capital outflows, as noted The experience of the 1970s and 1980s indicates above, llinges on motives and perceptions that are that, despite governments' use of capital controls and both difficult to measure and subject to abrupt shifts moral suasion, private individuals in some developing in response to changing circumstances. Hence. very countries have for a long period exported capital in narrow measures that might be appropriate for certain order to avoid the foreign currency losses associated countries or in certain circumstances might be wholly with holding wealth in domestically issued financial unrealistic for other countries or in other circum­ assets.7 Governments tolerated these private outflows stances. The approach taken in this study is to consider for several reasons, the main one being that the a variety of measures that are representative of current countries retained ready access to foreign loans. This empirical work on capital Right. with a view to finding a statistical measure that most closely corresponds to the motivation-based definition discussed above. The 6 Alternatively. one could rephrase this definition in terms of a estimates of capital flight produced by others on the class of risks which pertain to a resident's claims on other residents and which are not compensated with an adequate risk premium. Khan and Haque (1985). for example, define capital flight in terms of residents' attempts to avoid some broadly defined .. expropriation 8 Outward direct investment from developing countries is dis­ risk."' cussed in, for example. Lecraw (1977). International Monetary Fund 1 Sec Williamson (1987). (1985), and Mattione ( 1985).

41 ©International Monetary Fund. Not for Redistribution 11 • CAPITAL FLIGHT: CONCEPTS. MEASUREMENT. AND JSSUES

basis of these various measures are not reproduced Chart l. Measures of CapitaJ Flight: Sectoral here since, as Cum by and Levich found. significant Coverage of Foreign Assets differences in results may be attributed to differences in data used by the various analysts.11 I. Official sector Four measures of capital flight are examined: (I) a (a) Monetary broad measure. defined as the identified acquisitions authorities Short-term long-term of externaJ assets except official reserves. plus re­ I corded errors and omissions in the balance of payments I Offioal reserves I accounts. Errors and omissions are thus implicitly I I I attributed in their entirety to capital transactions that I 1 can be regarded as capital flight; 0 (2) a private claims I I measure, defined as the acquisition of external claims Other assets by the private sector (which includes deposit banks I No a I and the nonbank private sector). including recorded (b) nb n� I errors and omissions:'' (3) a narrow measure. defined official I as net short-term capital outflows of the nonbank 11. Private sector I private sector plus recorded errors and omissions. a I ' Whole I ('('OilOfllY measure which views capital flightas essentially similar (c) Deposit bank I 1 to "hot money" flows:12 and (4) a derived measure. I Broad I defined as that part of the whole economy's stock of measure I (d) I foreign assets that does not yield a recorded investment EqUity ' investment I PrivJie income, a measure which therefore encompasses both cla1m; capital outflows and shifts in the motives for holding measure (e) Nonbanks. stocks of fo reign assets.13 other These measures obviously differ significantly in their l I analytical content. In the first place, the first three I (Q Errors and Narrow omissaons I - are, strictly speaking. measures of capitaJ outflows, I measure with no attempt to distinguish between flight and I nonflight components. The underlying assumption of this approach is that it is reasonable to impute a motive Memorandum to certain types of asset transactions at the time they Estimated stocks of foreign assets at end 1985 (billions of US$) occur. Judgments differ as to which set of transactions Countries Countries are the most likely vehicle for capital flight, hence the with without recent recent important differences in the sectoral coverage of the Capital Of which: debt- debt- three measures (Chart 1). lmponing servicing servicing The narrow measure is restricted to the identified Countries' problems problems

acquisitions of short-term fo reign assets by the non­ Total 511 278 233 bank private sector plus the errors and omissions Official 187 75 Ill recorded in balance of payments statistics. The pre­ Monetary authorities 166 66 101 Official reserves 150 55 95 sumption here is that capital flight is essentiaJiy a Other 16 11 6 short-run, ''hot money" phenomenon. and that a large Nonbank official 20 9 11 number of capital flight transactions are hidden from Private 324 203 122 Deposit banks 75 24 51 Equity investment 9 6 3 Nonbank other 130 87 43 9 Cumby and Levich (1986) and Nolling (1986) compare various estimates of capital Right. Examples of important studies based on Errors and omissions 111 86 25 particular measures are noted below. as appropriate. 1 10 This definition corresponds to that used by the World Bank Excluding offshore banking centers. (1985). Erbe (1985), and Rodriguez (1986), for example. ll is measured statistically as a residual-gross capital inflows less the the authorities and will only appear residually as errors current account deficit less the acquisition of official reserves. and omissions in balance of payments statistics.14 The 11 This definition corresponds to Conesa (1986). 12 This corresponds to the approach of Cuddington. 1' The inclusion of cumulated recorded errors and omissions data " The nonllight stock of foreign capital is estimated as the from balance of payments statistics is common in the literature on capitalized value of recorded investment income credits. using an capital flight because these data are generally believed to pertain to appropriate interest rate; flight capital is therefore computed as the the unrecorded asset transactions. However. this presumption may difference between total foreign as sets and the stock of non11ight be incorrect. as will be discussed below. (Dombusch ( 1985) measures capital. This method follows the approach proposed by Dooley capital flight as a '·hot money" ftow, but excludes the errors and (1986). omissions item.)

42 ©International Monetary Fund. Not for Redistribution Measuring Capital Flight private claims measure has a broader coverage and is a bank deposit'? This omjssion of the acquisition of designed to capture any outflow of capital ftjght that real and long-term financial assets is a serious short­ originates from the private sector;15 it includes, in coming of the narrow measure. addition to the assets covered by the narrow measure, Another conceptual weakness in these three mea­ the foreign assets of deposit banks. outward equity sures is that they are only able to measure capital investments (direct and portfolio investment) and the flight embodied in a capital outflow, and fail to identify long-term assets of the nonbank sector.'11 In principle, the flight occurring when asset holders change their the broad measure incorporates a still wider range of motive for retaining abroad their outstanding stocks foreign asset transactions, because it includes the non­ of foreign assets. Indeed, the broad and private claims reserve asset transactions of the monetary authorities measures are formulated in such a way as to eliminate and the asset transactions of the nonbank official the possibility of considering how shifts in investors' sector. At first glance, the inclusion of these public sentiments might cause capital flight. since by definition sector asset transactions appears odd, since for most all stocks of private foreign assets recorded by these purposes it is not usual to consider the public sector measures are viewed as having been accumulated by as participating in capital flight. In practice, however, fljght capital. However, this is inherently implausible the non-reserve asset transactions of the monetary because, as noted above, while all private foreign authorities and of the nonbank official sector. which assets may at the limit be considered potential flight does not include public enterprises, are usually rela­ capital, it is evident that some assets are not originally tively small for most countries; thus the sectoral accumulated for flight reasons. A measure covering coverage of the broad measure is often equivalent to this aspect of capital flight would clearly be advanta­ that of the private claims measure." Moreover, there geous. are significant statistical advantages that stem from [n an attempt to avoid these conceptual problems, the superior availability of data on thjs measure, and Dooley proposes the "derived" measure of capital these more than offset the problems caused by the fljght as that part of a country's stock of foreign assets inclusion ofa small number of public asset transactions. which does not yield a recorded inflow of investment The main conceptual weakness of these three mea­ income credits.1s The presumption here is that only sures of capital flight is their inability to distinguish the retention of investment income abroad-or at least between outflows motivated by fear of loss and those its retention outside the reach of the authorities of the caused by other reasons, which leads to inaccurate country in which the asset owner resides-is indicative measurement. The broad and private claims measures, of flight concerns. An asset owner may wish to protect for example, include as capital flight private capital his property and investment income from domestic outflows that promote external commercial relations, taxation, for example, or he may wish to avoid sur­ both trade and financial. Conversely, the nan·ow mea­ rendering his foreign exchange revenues from invest­ sure is probably too restrictive; it includes nonftight ment income to the monetary authorities. perhaps short-term transactions and, more important, omits because of fears of an imminent depreciation; he can capital fljghteff ected through acquisitions of long-term obviously avoid both types of losses (and other losses) assets, which may be relatively close substitutes for by accumulating foreign assets and retaining the con­ the short-term assets included in this measure. Is the sequent investment income beyond the jurisdiction of acquisition of a house or an equity portfolio in the his authorities. United States, for example, any less capital flight than This measure is intuitively appealing on conceptual grounds for a number of reasons. First, capital flight ,, including nonfinancial public enterprises which. because they measured in this way becomes a clearly distinct ele­ are often motivated by the same economic considerations as their private sector counterparts, are hereafter included in the private ment of the private sector's stock of fo reign assets sector for analytical and statistical purposes. and allows for the fact that some private capital ·� Some measures based on the private claims approach introduce outflows and some private fo reign asset-holdings are certain restrictions on the types of private claims that are included. Morgan Guaranty Trust (February/March 1986), for example, ex· not motivated by flight considerations. Second, the eludes the foreign assets of the resident banking system. presumably measure captures capital flight that does not involve on the grounds that these interbank deposits are a necessary element current exchange transactions and therefore aJiows for in international financial intermediation and are not motivated by flight considerations. the shifts in investors· sentiments that do not neces­ 17 For the (net) capital importing developing countries, the growth sarily result in capital flows. And third. the measure of the foreign assets held as non-reserve assets by the monetary incorporates an estin1ate of the government's loss of authorities and by the nonbank official sector probably accounted for some 9112 percent of the growth of total assets covered by the control over resources-the investment income that is broad measure between the end of 1974 and the end of 1985; at the not subject to domestic taxation and the foreign cur- end of 1985 these public sector assets were equivalent to 10 percent of the total assets held by the sectors covered by the "broad" measure. See the memorandum item to Chart l. ·� Dooley (1986).

43 ©International Monetary Fund. Not for Redistribution ll · CAPITAL FLIGHT: CONCEPTS. MEASUREMENT. AND ISSUES

rency accruals that are not made available to the cannot be confident that annual changes in stocks of authorities for reserve-management purposes, for ex­ debt necessarily reflect accurately the underlying cap­ ample. The measure therefore is useful in indicating ital movements. The private claims measure, which is the extent to which capital flight might cause budgetary based primarily on directly measured stocks offoreign or reserve-management problems for the authorities assets, as recorded in the Fund's money and banking and thereby lead them to view flight as a problem. statistics, is prone to error because these statistics However, this measure, too, is conceptually unsat­ inadequately record the stocks of claims held by the isfactory in some respects. The acquisition of foreign resident nonbank sector on the nonresident nonbank assets does not cease to be a problem or cease to be sector. Moreover, unlike the debt data used in the capital flight merely because the reinvestment abroad broad measure. the data on stocks of private claims of the investment income earned on those assets is cannot be adjusted for valuation changes; this must reported to the relevant authorities in the capital be considered a serious deficiency when using the data exporting country. lf, for example, a resident were to to analyze developments in capital flight during a period report the investment income earned on foreign assets characterized by pronounced exchange rate fluctua­ to the authorities. but reinvest the income abroad, he tions among the currencies of the main industrial would eliminate his scope for tax avoidance, but would countries. not eliminate the opportunities to avoid other forms The narrow measure is subject to particularly pro­ of capital loss or impairment, such as losses caused nounced measurement problems because of the patchy by an exchange rate depreciation or by severe domestic coverage of the short-term asset transactions of the financial repression. However, the measure is empir­ "other" sector (which is the nonofficial, nondeposit ically useful for constructing estimates of the minimum bank sector) in national balance of payments statistics. level of capital Right, since it seems unlikely that the Furthermore, the assumption that the recorded errors assets it includes would have been acquired as a result and omissions item in national balance of payments of ··normal'' capital flows. Thus, the derived measure statistics pertains mainly to unrecorded asset trans­ can be used in conjunction with one of the other actions may be incorrect if. as Gulati argues, the measures of capital outflows to delineate statistically systematic outflow under this item is primarily attrib­ an upper and lower bound within which actual capital utable to tariff- and quota-evasions by importers .20 flight probably fa lls.19 The upper bound (or maximum The derived measure is particularly sensitive to the potential flight-motivated asset transactions) can be accuracy of the balance of payments statistics on defined by one of the broader measures of capital investment income credits, the choice of the interest outftow, and the lower bound by the derived measure. rate used to capitalize the investment income credits, These conceptual differences between the fo ur mea­ and the assumption that all assets yield a market rate sures, and especially the differences in coverage, of return. Since the interest rate cannot be measured naturally lead to different estimates of capital flight. directly, a proxy interest rate series must be con­ In general, one might expect the broad measure to structed carefully in the light of the limited available produce the highest estimate, fo llowed by the private information on the composition of the relevant stocks claims and the narrow measures, in that order, with of interest-bearing foreign assets. Any deviation of the the ranking of the derived estimate being dependent proxy series from the underlying interest rate series on the measure of outflows to which it is applied. is likely to result in large errors in the stock estimates, However, data problems can be large enough to offset because the interest rate series is used to capitalize differences in coverage and produce an unexpected the stream of recorded investment income. ordering of the estimates. FinaUy, capital flight is a surreptitious activity that The most serious data problems affecting the four is likely to be particularly prone to mismeasurement. measures discussed here stem from limitations in the Accordingly, the estimates presented below should be sectoral disaggregation of money and banking statis­ viewed as orders of magnitude only and interpreted tics, and shortcomings in national balance of payments with caution. They are based on staff estimates com­ statistics. The broad measure, for example, is partic­ piled from the money and banking data shown in ularly sensitive to the accuracy of data on external InternationalFinancial Statistics, balance of payments debt, since these data, suitably adjusted for valuation effects, are used to measure external borrowing. How­ ever, the quality of the debt data is such that one lll Gulati (1985. 1986). This qualification applies also, either ex­ plicitly or implicitly, to the broad and private claims measures. although the problem is less significant for these measures because 19 Note that because capital ftight is unlikely to originate from the bulk of the capital outflows that are included are not attributable either the monetary authorities or the nonbank o(ficial sector, the to the errors and omissions item. whereas for many countries, the derived measure probably has roughly the same sectoral coverage errors and omissions constitute the greater part of the outflows as the private claims measure. covered by the narrow measure.

44 ©International Monetary Fund. Not for Redistribution Developments in Capital Flight

Table 1. Capital Importing Developing Countries: Summary Estimates of Capital Outflows and Capital Flight, 1975-85 (ln billions of U .S. doUars)

1975-78 1979-82 1983-85 Increase from End-1974 to (Annual averages) End-1985 in Stocks Outstanding

Capital importing countries

Capital outflows Broad measure 15.3 30.0 17.9 235 Private claims 15.5 33.2 25.3 271 Narrow measure 6.7 22.3 9.2 153

Capital flight, "derived measure" and: Broad measure 5.6 26.4 12.5 165 Private claims 5.8 29.6 19.9 201 Countries with recent debt-servicing problems Capital outflows Broad measure 10.5 26.7 7.4 171 Private claims 10.3 23.2 13.7 175 Narrow measure 4.8 19.8 6.5 124

Capital flight, "derived measure" and: Broad measure 5.0 20.7 9.3 131 Private claims 4.8 17.2 15.6 135 Countries without recent debt-servicing problems

Capital outflows Broad measure 4.8 3.4 10.5 64 Private claims 5.2 10.1 J 1.7 96 Narrow measure 1.9 2.5 2.7 28

Capital flight, ''derived measure" and: Broad measure 0.6 5.7 3.1 34 Private claims 1.0 12.4 4.3 66

Note: Data may not sum to totals owing to rounding errors. Data and country classifications are from International Monetary Fund. World Economic Owlook. International Financial Statistics. and Balance of Paymems Yearbook. Capital outflows from the offshore sectors of the offshore banking centers are excluded. data from the Balance of Payments Ye arbook, and the broad, private claims, and narrow measures are debt data from the World Economic Outlook.21 viewed as measures of capital outflows rather than capital flight, with the latter term being reserved for estimates based on the derived measure. Needless to Developments in Capital Flight say, in interpreting the following estimates, the reader should make due allowance for the reservations ex­ This section presents a range of estimates for broad pressed above concerning the measurability of capital groups of developing countries for the period 1975- flight, and reservations to be discussed regarding its 85. In line with the discussion in the preceding section, interpretation. emphasis is given to the so-called broad and private Capital outflows have been a prominent feature of claims measures of capital outflows, but estimates on the external situation of capital importing developing the narrow basis are also presented. Further, extensive countries for a considerable number of years. For the use is also made of the derived measure to attempt to group as a whole, outflows over the 11 years to 1985 distinguish between the flight and nonflightcomponent appear to have amounted to roughly $250 billion (Table of any outflow. Indeed. in the balance of this study, 1). The broad measure points to a somewhat lower figure ($235 billion) and lhe private claims measure to

21 See Williamson (1987). The interest ra te used to capitalize a somewhat higher one ($271 billion).22 Thus, while investment income for use in the derived measure is a weighted the shortcomings of the basic data are considerable, average of the Eurodollar rate in London on three-month deposits (LIBOR) and the U.S. Government bond yield on three-year maturities. in order to aUow for differences in the maturities of the 22 This is the inverse of the relationship one would expect between foreign claims held by residents of developing countries. These the two estimates since the broad measure includes the "non­ weights were more or less arbitrarily set at five sixths and one sixth, monetary" official sector. The result is due to inconsistencies respectively. The composite rate is lagged six months to allow for between, on the one hand, the debt and balance of payments lags in the responsiveness of interest payments to interest rates. statistics and, on the other, money and banking statistics.

45 ©International Monetary Fund. Not for Redistribution 1I • CAPlTAL FLIGHT: CONCEJYfS, MEASUREMENT. AND ISSUES these two estimates are sufficiently close and their The broad measure points to an estimate of$165 billion statistical underpinnings sufficiently independent to and the private claims measure to one of some $200 warrant the conclusion that capital outflowsfrom these billion.23 Both estimates are highly sensitive to as­ countries have almost certainJy been in the range of sumptions regarding the investment income that the $200-$300 billion. These are large sums by any stan­ outflows ought to have recorded. To the extent that dard. A figure of $250 billion over the years 1975-85 the rate of return on nonflight foreign assets has been would have been about a third of the increase in these overestimated, the capital flight estimates will be on countries' external debt over the period and about the high side and conversely if the rate of return has three fifths of the cumulated financing obtained from been underestimated. Nevertheless, even after allow­ private creditors. Viewed in flow terms, an average ance for these uncertainties, it seems clear that capital annual outflow of $23 billion would have been equiv­ flight has been large, perhaps $150-$200 billion for the alent to 61/2 percent of merchandise imports. 1975-85 period as a whole. By the same token, how­ The pace of these capital outflows varied consider­ ever, it should also be noted that, at least as estimated ably over the period under review. They averaged here, the nonflight component of capital outflows has some $15 biUion a year in the relatively tranquil years also been large. Although amounting probably to under immediately fo llowing the first oil price increase and half the outflows, nonflight capital outflows neverthe­ the 1974-75 recession (1975-78). With the onset of the less appear to have been in the order of $50-$ 100 second round of oil price increases, the steep rise in billion over the period, a magnitude which underscores international interest rates, and the extended global once again the need to discriminate among various recession, the rate of capital outflows doubled to some types of outflows. $30 billion per annum, an amount equivalent to about The pace of capital flight from capital importing 8 percent of export earnings and about half of new developing countries varied by considerably more than borrowings from private creditors. With the onset of that of the overall capital outflows during the period the debt crisis in 1982 and the reduced availability of under review. Capital flight, according to the derived foreign exchange, however, capital outflows receded definition, amounted to a relatively modest $5 billion significantly, perhaps to two thirds their fo rmer rate. a year over the 1975-78 period, or only about a third Nevertheless, capital outflowsappear to have remained of the aggregate outflows. With the upheavals of the large, both in absolute terms (some $20 billion per late 1970s and early l980s, however, capital flight annum) and relative to flows of new lending from accelerated sharply, to some $25-$30 billion a year, private creditors. or about five sixths of the total outflows. The pace How much of these outflows can properly be attrib­ slackened in 1983-85. but to an uncertain extent. The uted to capital flight? ln the view of some observers, estimates based on the private claims measure suggest all outflows other than those that increase official a fairly modest deceleration to $20 billion per annum reserves are viewed as capital fiight. As was suggested while the broad measure points to a somewhat sharper earlier, however, capital outflows reflecta wide variety deceleration to some $12-$13 billion a year. Both of motives. Some, such as trade credits and working estimates, however, represent significantly larger frac­ balances, are essential lubricants of international com­ tions of the corresponding aggregate capital outflow merce that are sanctioned by governments and ought measures than those for the mid-1970s, suggesting that not to be considered as capital flight. Other flows. on capital flight remained proportionately high. Moreover, the other hand, are flight, prompted by a desire to flight became a much larger proportion of the accom­ avoid the effects of domestic financial repression or panying capital inflows. Indeed, both estimates of expected exchange rate depreciations, or simply tax­ capital flight account for all of the contemporaneous ation. It is, however, very difficult in practice either to separate these various motives or, assuming that vAs noted earlier, the stock of flight capital is estimated residuaUy were possible, to translate the resulting categories into as the difference between the specified stock of foreign assets and meaningfuJ statistical criteria. The approach espoused the estimated stock of nonfiight assets arrived at by capitalizing above, therefore, is to distinguish flight from nonftight investment income receipts. For this purpose, one requires invest­ ment income estimates corresponding to the assets encompassed outflows on the basis of whether or not they yield a by the various outflow measures. In fact, however. only aggregate recorded stream of investment income credits. If they investment income series areavailable. Moreover. lhose data include do not, the flowsare viewed as capital flight, whereas, the income earned on reserve assets , assets that are not included in any of the outflow measures. Accordingly. capital flight has been if they do, they are viewed as being a normal feature estimated by broadening the outflow-based asset estimates to include of international commerce. the stock of reserve as sets and deducting from that total the On this basis, it appears that perhaps three fifths of capitalized value of investment income. One implication of this procedure is that the difference between the broad and private the capital outflows from capital importing countries claims measures of capital flight is just equal to the difference over the period 1975-85 can be viewed as capital fiight. between the broad and private claims measures of capital outflows.

46 ©International Monetary Fund. Not for Redistribution Causes of CapitaJ Flight

flow of financing from private creditors, which aver­ exceeded recorded capital outflows during some sub­ aged $13 billion per annum over the period. periods, indicating a shift in private investors' reasons Just as the scale of capital outflows from capital for holding assets abroad.24 On the other hand, capital importing developing countries has varied considerably flight from countries in Asia and the Middle East over time, so has it varied across countries. This is accounted for about one third and one quarter, re­ demonstrated by comparing the estimates for the spectively, of capital outflows from these regions countries classified for World Economic Outlook pur­ during 1975-85, indicating that non1ligbt considerations poses as having experienced debt-servicing difficulties were paramount in explaining outflows. Nevertheless, with those for countri es not so classified. Not surpris­ even these regions experienced significant levels of ingly, the estimates indicate that tile debt-servicing flight at some points in this period: capitaJ flight more problem countries accounted for about two thirds of than fu lly explained capital outflows from Asia in the cumulative outflow of capital of the entire group 1979-82 and from the Middle East in 1983-85. The of capital importing countries over the period 1975- estimates for Europe are similar to those for Africa, 85, even though they account for only about 40 percent but otherwise Europe appears to be something of an of the group's exports of goods and services. Further, exception to the overall pattern since the general level the problem countries accounted for an even more of outflows from this region remained relatively sub­ disproportionate share of capital flight according to dued. The explanation may be structural, for it was the derived measure over the period (closer to three generally the centrally planned countries of Eastern fo urths). This proportion rose somewhat fu rther for Europe that experienced debt problems. The private the most recent period covered in Table I, with capitaJ sector of these economies is neither as prominent as flight among the problem countries having receded in many other countries nor is it generally as fu lly relatively less over the past few years than among the integrated with the world's financial markets as the non-problem countries. private sector in, say, the Western Hemisphere . It is important to note, however, that while capital outflows and capital flight appear to have been partic­ ularly prominent among countries that did in the end Causes of Capital Flight experience debt-servicing difficulties, such outflows were not limited to these countries. Thus, capital The discussion in the first section suggested that outflows among countries that avoided debt-servicing capital flight is a particular form of internationaJ port­ difficulties are estimated to have cumulated to some­ folio diversification, and that not all foreign asset thing of the order of $75 billion-equivalent to one transactions are flight motivated. Clearly, all portfolio half of the amount received from private creditors over diversification is motivated by investors' efforts to the period . Moreover, although the estimates diverge obtain the maximum risk-adjusted return on their significantly, it is apparent that capital flight as mea­ capital, but at some point along the spectrum of asset sured here was a significant problem for countries that transactions, flight occurs as investors attempt to avoid avoided rescheduling as well as for those that did not. discrete losses. When seeking the causes of capital The regional pattern of capital outflows and capital flight, the difficulties of determining the borderline flight also reflected the underlying financial character­ between nonfligbt and flight-motivated transactions istics of the regions during 1975-85. Using for sim­ must therefore be borne in mind and the existence of plicity an average of the broad and private claims a large indeterminate zone must be recognized. In measures, it is evident that, with allowance for differ­ attempting to distinguish between the factors that drive ences in the scale of the various regions' external nonflight and flight transactions, it is perhaps useful transactions, the countries in the region most troubled to approach the problem from both ends of the spec­ by debt problems, the Western Hemisphere. were also trum of asset transactions, outlining first the causes the main source of capital outflows over the period. that definitely do or do not cause flight before moving Indeed, in absolute terms the outflows from the West­ to a discussion of the causes of the transactions tnat. ern Hemisphere were larger than for all other regions lie in the indeterminate zone.z5 combined. By contrast, as a percentage of exports, outflows were smallest in Asia, probably the region least troubled by debt problems (Table 2). 24 For example, capital flight was 30 percent greater than capital outflows for Africa in 1979-82 and for the Western Hemisphere in The driving force behind the capital outflows from 1983-85. Africa and the Western Hemisphere was capital flight. � The few empirical studies of the determinants of capital flight Capital flight accounted for over four fifths of the are not particularly helpful in clarifying what prompts flight since the data problems cause the respective authors to heavily qualify outflows from countries in the Western Hemisphere their empirical conclusions. See. for example, Conesa (1986). Cud­ and Africa during 1975-85 as a whole, and actually dington (1985, 1986), Dooley ( 1986), and Williamson (1987).

47 ©International Monetary Fund. Not for Redistribution li · CAPITAL FLIGHT: CONCEPTS, MEASUREMENT. AND ISSUES

Table 2. Capital Importing Developing Countries-by Region: Summary Estimates of Capital Outflows and Capital Flight, 1975-85 (Annual averages, except as noted)

Increase from End-1974 to End-1985 in Stocks 1975-78 197�2 1983-85 Outstanding'

Capital outHows (In billions of U.S. dollars) Africa 2.9 2.8 2.5 30.4 Asia 3.2 4.6 6.5 50.6 Europe 1.3 0.9 3.2 18.1 Non-oil Middle East 1.0 3.4 1.9 23.1 Western Hemisphere 7.1 19.9 7.5 131.0

(In percentage of exports of goods and services) Africa 5.7 3.2 3.3 3.9 Asia 3.6 2.4 2.8 2.8 Europe 4.0 1.5 5.0 3.3 Non-oil Middle East 6.7 11.0 5.8 8.3 Western Hemisphere 12.0 16.6 6.1 12.0

Capital tligbt2 (In billions of U.S. dollars)

Africa 1.7 4.1 1.8 28.5 Asia - 0.8 7.0 -2.2 18.3 Europe l.l 2.7 3.0 24.0 Non-oil Middle East 0.2 -0.7 2.7 6.2 0 Western Hemisphere 3.7 14.7 1 1 . 106.6 (In percentage of exports of goods and services) Africa 3.3 4.6 2.3 3.6 Asia -0.9 3.7 - 0.9 1.0 Europe 3.3 4.8 4.7 4.4 Non-oil Middle East 1.5 -2.1 8.2 2.2 Western Hemisphere 6.2 12.2 8.8 9.8

Note: Both outHows and flight data are expressed as an average of the levels indicated by the broad and private claims measures. 1 Total change in stock is shown as percent of exports of goods and services during 1975-85. 2 Based on the derived measure.

Factors causing increases in private capital outflows, The growth of trade also causes capital outflows. but not flight, include the growth of private wealth, Enterprises engaged in trade will wish to increase their external trade, and external financial integration. In­ stocks of working balances held abroad; export growth creases in private wealth are generally associated with may involve the provision of suppliers' credits to increases in private holdings of financial claims on importers; and direct and portfolio investment abroad nonresidents, because ri sk-minimization considera­ may be stimulated by resident enterprises' willingness tions argue in favor of investors holding an interna­ to promote their external trade through integration tionally diversified asset portfolio, and because inter­ with nonresident private enterprises. The growth of national diversification of assets, by broadening the the capital importing countries' total external trade, range of assets available to the investors, enables them which averaged 9 percent annuaLly in dollar terms to tailor the structure of their portfolios efficiently to during 1975-85 , would consequently be expected to reflect individual preferences for ri sks and retums.26 lead to significant increases in nonftight capital out­ If the growth of real output could be taken as indicative flows. One factor underpinning these commerce­ of the growth in real wealth, and if the elasticity of related outflows was that domestic financial markets demand for foreign claims with respect to total wealth were often less efficient than financial markets abroad, were unity, then the 4Y4 percent annual growth aver­ and domestic residents and enterprises therefore shifted aged by the capital importing countries during 1975- abroad some of their financial transactions in order to 85 would be expected to cause roughly similar growth reduce costs. Profitable opportunities in international of real private foreign assets. financial intermediation also cause nonflight capital outflows from financial enterprises. Such opportunities 26 Assuming that rates of return on financial assets are imperfectly are exploited by resident commercial banks, necessi­ correlated internationally. See Grubel (1968) for a theoretical state­ ment of the issue, and Williamson (1987) for empirical evidence on tating increases in deposits at correspondent banks imperfectly c.orrelated in terest rates. abroad, and perhaps an expansion into overseas offices

48 ©International Monetary Fund. Not for Redistribution Causes of Capital Flight and branches via outward direct and portfolio invest­ fo reign assets for a sample of 66 capital importing ment. The capital flows that accompany these various developing countries widened from about 2 percentage efforts to exploit international differences in compar­ points in 1977-78 to, on average, around 20 percentage ative advantage are clearly at the nonflight end of the points during 1979-82 (Table 3).28 The combination of spectrum of international asset transactions. highly attractive interest differentials in fa vor of fo reign EquaUy clearly, some asset transactions are entirely assets and the strongly negative real interest rates flight motivated . Domestic social pressures, for in­ typifying domestic fiaancial assets issued by many stance, may stimulate capital flight because of the capital importing countries was an important contrib­ increases in risks and the losses that they impose on utory factor to the surge in both capital outflows and certain classes of assets or asset holders. Social per­ capital flight during 1979-82.29 However, not all coun­ secution of minority religious or racial groups, for tries were equaUy affected by the change in U .S. example, is a persistent theme in the history of capital interest rates; in particular, countries that took steps flight; and capital flight inevitably ensues when the to maintain the international competitiveness of their domestic social structure breaks down to the extent domestic financial assets and thereby eliminated this that there is an outbreak of civil war. Similarly, changes type of loss to holders of domestic assets fo restalled in circumstances that are external to a country may this source of capitaU flight. cause it to experience capital flight. Increases in Another externaldevelopment that may have caused international political tensions and outbreaks of war capital ftight. depending on countries' circumstances, are likely to stimulate capital ftight from the affected was the growth of internationalfinancial intermediation countries, and perhaps from their regional neighbors. during the 1970s and 1980s. As noted above, this And shifts in exogenous economic circumstances­ growth facilitated investors' efforts to diversify their large changes in the terms of trade, for instance­ asset portfolios internationally for nonflight reasons. cause residents to reappraise the attractiveness of the But in doing so, the costs of domestic financial repres­ domestic economic environment unless domestic eco­ sion and the inefficiencies of the domestic capital nomic policies are promptly adjusted to reflect the market were highlighted for residents of many coun­ change in the external environment. Similarly, changes tries. To the extent that financial integration was in domestic economic policies, such as attempts to accompanied by financial innovations that effectively increase taxes on private capital, clearly stimulate weakened national barriers to capital mobility, the capital flight. These policy changes are discussed in increase in international financial integration probably more detail below. encouraged and facilitated capital flight. In this context Turning now to the large gray area of factors that it is interesting to note that commercial banks, who cause capital outflows and may also cause flight, it is tend to decry the aggregate level of capital flight, are evident that judgments must be fo rmulated on a case­ themselves competing for deposits from flight­ by-case basis as to whether any particular change in motivated investors resident in developing countries. external or domestic circumstances causes a capital Changes in domestic economic circumstances, how­ outflow or capital flight. ever, are also frequently sources of capital flight. Of On the external side, shifts in economic policy particular note is the impact of governments' economic abroad can engender capital outflows and. at one policies on investors· willingness to hold domestically remove, capital flight. The changes in U .S. policies issued assets, because fiscal,monetary, exchange rate, that led to the sharp rise in U.S. interest rates in the and structural policies can quickly affect the expected early 1980s, for example, widened interest differentials returns and risks associated with holding claims on between domestic financial assets issued by capital residents. importing countries and foreign financial assetsin favor Fiscal policy impinges directly on post-tax rates of of the latter (after allowing for exchange rate move­ return on assets. Income taxes on interest, profits. and ments). Moreover, the introduction of international dividends and property taxes on private wealth intro- banking facilities in the U.S. during the early 1980s had the effect of reducing U.S. taxes on certain Due care should be exercised when interpreting these data, nonresident investors, and thereby fu rther shifted 28 however, because the samples are weighted by GDP and shifts in relative post-tax rates of return in favor of fo reign policies or circumstances of the largest countries may result in assets.27 In part because of this change in U .S. financial changes to the aggregate data that do not accurately reflect the changes affecting all countries in the sample. Moreover, the actual policies, the average post-tax differential in fa vor of change in the exchange rate is counted as part of the financial return, whereas it is the ex ante expected return that is relevant for portfolio allocation decisions.

27 Although it should be noted that the U .S. was largely responding � Real interest rates on one-year time deposits became increas­ to earlier changes in other countries' willingness to ease the tax ingly negative between 1977-78, when real rates were -3 percent, burden on nonresident investors. and 1979-82, when real rates averaged -5 percent (Table 3).

49 ©International Monetary Fund. Not for Redistribution 11 · CAPITAL FLIGHT: CONCEPTS. MEASUREMENT. AND ISSUES

Table 3. Capital Importing Developing Countries: Selected Economic Indicators, 1975-85 (Changes, in percent. except where otherwise indicated)

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

Real GDP 5.1 4.2 6.2 5.7 4.8 4.6 3.1 2.0 1.7 4.8 4.1

- 3.3 0.8 28.8 28.9 4.8 . 7.1 -0.9 Total merchandise trade (in dollars) .1 17.2 15.7 8 4 -2.4 Central government fiscal deficit (in percent of GDP) 3.5 3.5 3.1 3. 1 3.1 2.9 3.9 4.8 4.6 3.6 3.6 Public and publicly guaranteed long-term debt (in percent of GDP) 13.0 15.2 16.2 17.3 17.5 17.0 18.7 21.6 25.0 26.1 29.5

Broad money 27.6 33.7 31 .6 29.6 35.6 37.1 37.6 38.2 44.0 56.8 55.9 2 23.2 22.5 19.9 23.6 29.6 28.6 27.3 37.9 44.3 46.9 Consumer prices I. I Interest rates (in percent)'

Domestic real rate' -6.2 -2.8 -3.8 -2.4 -4.1 -8.3 -6. 1 - 1.6 -4.4 -2. 4 Nominal differential in favor of foreign assets1 72.6 18.8 1.8 4.1 17.4 12.6 16.5 44.0 30.5 20.2 Exchange rates Real effective rate -4.3 -0.1 -2.6 -5.1 0.3 2.0 6.0 -4.1 - 6.2 -1.5 -5.8 Black market premium on official 88.7 8.5 80.4 rare• 370.0 348.9 106.5 89.8 73.4 43.7 7

Sources: International Monetary Fund, World Economic Outlook, and International Fi nancial Statistics. 1 Calculated for a sample of 66 countries. 2 Nominal interest rate on one-year time deposits less ra te of increase in consumer prices. l LIBOR, adjusted for observed changes in the official exchange rate. minus domestic nominal interest rate on one-year time deposits; weighted by current dollar values of GDP. • Ratio of black market exchange rate to official exchange rate, weighted by current dollar values of GDP. Calculated for a sample of 40 countries. duce a distortion as compared to market rates of liabilities because of tbe government's need to service return. Because such distortions are absent or are its debt. Large current fiscal deficits may cause resi­ negligible in countries that implement "tax haven" dents to fear that tax rates will be increased, perhaps policies, fiscal policies in countries that include taxes to confiscatory levels, in order to meet fu ture debt on wealth and on income from wealth therefore intro­ service obligations. ln this context it is noteworthy duce a wedge between the post-tax rates of return on that for the capjtal importing countries the ratio of domestic assets and the rates of return on assets issued public and publicly guaranteed debt to GDP more than in tax havens. Moreover, if the tax wedge is sufficiently doubled between 1975 and 1985. implying a corre­ large, differentials may also appear vis-a-vis the post­ sponding increase in residents' contingent tax ljabilities tax rates of return on assets issued by non-tax haven (Table 3). It is reasonable to suppose that during the countries. Clearly. the larger the tax wedge and the period in which debt increased rapidly some residents greater the confidentialityattaching to the transactions, of these countries acted to protect the fo reign currency the greater the incentive for the private sector to shift value of their wealth from the expected increases in its assets to tax havens and to countries that impose the tax wedge by shifting part of their wealth abroad . low taxes on assets and on incomes from assets. And the historically high debt-to-GDP ratios that have The structure of the tax system may also induce been recorded since 1982 may in part explain why capital outflows. Taxation policies that bear more large stocks of flight capital, some of which were heavily on residents than nonresidents may induce accumulated for other reasons prior to 1982, continued large and offsetting capital flows. Some countries, for to be retained abroad even after some of the initial example, tax residents' investment income from do­ causal factors had been corrected. mestic assets. but provide tax relief on interest paid In e�treme cases, residents may have feared that on liabilities to nonresidents. This type of tax structure fiscal deficits would persist at levels that could threaten provides residents with an Lncentive to simultaneously the public sector's ability to service its liabilities. Fears acquire claims on and liabilities to nom·esidents in would then have been aroused that the public sector order to maximize post-tax rates of return on wealth. would at some point take measures to reduce its real Fiscal policy also influences investors' expectations debt service burden through repudiation, default, or as to fu ture taxes. Fiscal deficits that are financed by the monetization of liabilities denominated in domestic borrowing, for example, imply increases in future tax currency. Such developments would raise the per-

50 ©International Monetary Fund. Not for Redistribution Implications of Capital Flight ceived riskiness of holding claims on all residents of depreciations; asset holders were therefore able to such countries, not just the public sector. because of avoid significant capital losses-amounting to a cu­ the externalities that would be associated with the mulative 19 percent of their capital during 1982-85- public sector's efforts to cope with its debt problem. by shifting resources abroad in 1979-8 l. and particu­ Consequently. domestic and fo reign creditors would larly in 1981. attempt to reduce their claims on residents. both public More generally, exchange rate policies that are and private sector, and residents would attempt to perceived as inconsistent with fiscal and monetary protect the fo reign currency value of their wealth by policies give rise to strong incentives for residents to acquiring flight-motivated claims on nonresidents.30 acquire fo reign assets. The exchange rate policies Monetary policy, like fiscal policy, may also be a introduced in a number of Western Hemisphere de­ source of capital flight, most often as a result of an veloping countries in the late 1970s, for example. are inflexible interest rate policy or lax control of the viewed by some observers as having provided private monetary aggregates. Interest rate policies prompt speculators with the possibility of achieving large capital flight when domestic interest rates are held at capital gains almost risk free because of the incon­ rates that are unattractive to domestic savers, because sistencies between the exchange rate policy and the domestic interest rates are usually then at levels which implementation of fiscal and monetary policies.32 create an interest differential in fa vor of fo reign assets The authorities' policies vis-a-vis financial markets (after adjusting for expected exchange rate changes). are also important when analyzing the causes of capital The resulting outflowsare likely to be viewed as capital tlight because asset-holders are sensitive to the changes flight by governments unable to finance their fiscal in rates of return and risks on domestic assets that plans. The consequent increases in monetary financing can be caused by structural adjustments. Policy changes of deficits will lead to inflation and a further incentive that are likely to lead to capital flight are typically to capital flight as real interest yields faiJ further and those that are associated with an intensification of the domestic currency depreciates. financial repression. including raising taxes on domes­ The stance of monetary policy in the capital im­ tic financial intermediation, imposing high reserve porting countries was clearly an important explanatory requirements on banks, interest rate ceilings, quotas factor underlying the capital tlight of 1979-82. During on credit allocation that provide insufficient credit to this period the growth of broad money increased the private sector. and resorting to greater use of the substantially. inflation accelerated, and domestic in­ inflation tax. The intensification of any of these dis­ terest rates became increasingly negative in real terms tortions prompts residents to reappraise their willing­ despite an increase in nominal international interest ness to seek financial intermediation services io the rates.31 Residents were therefore confronted with the domestic economy. and is likely to drive some residents choice of accepting large losses in real terms if they to seek financial intermediation offshore. held claims on residents-amounting to an average 5 While data on some forms of financial repression percent annually during 1979-82 (Table 3)-or sub­ are difficult to obtain. one can use the data on inflation stantially positive real rates of return on foreign as­ and on real interest rates on domestic financial assets sets-amounting to some l?Vz percent annually. after as illustrative of the extent of financial repression. By taking into account exchange rate movements. these measures, financial repression increased in the Expectations of fu ture exchange rate movements capital importing countries between 1975-78 and 1979- play a particularly powe1ful role in generating cross­ 82, and this probably stimulated flight. Financial border capital flows. In particular. exchange rate repression almost certainly continued to motivate policies that imply short-run real appreciations of a strong! y investors' portfolio allocation decisions during currency often prompt private capital outflows as 1983-85, as inflation accelerated further. to 43 percent residents seek to avoid capital losses when the over­ annually, and real interest rates remained negative. valuation is conected. The real appreciation of the albeit less negative than in 1979-82 (Table 3). capital importing countries' exchange rates during I 979-8 1, for example, was obvious! y inappropriate Implications of Capital Flight and unsustainable in view of the inflationaryconditions in those countries. as was shown by the subsequent As noted earlier, concerns about capital flight are grounded in a number of considerations. including the 10 See Ize and Ortlz ( 1987) for a formal model of I he effects of stated unwillingness of certain creditors to provide fiscal deficits on capital flight. and for a discussion of the relevance fu nds that might simply end up financing capital place­ of these issues to Mexico. 11 The growth of broad money accelerated from 30V! percen1 ments abroad by the wealthier strata of the country in annuaUy during 1975-78 to 37 percent annually during 1979-82: similarly . inflation increased from 20V> percent annually to 27 percent n See Dornbusch ( 1985) and Harbcrgcr !1985) for a detailed over the same period (Table 3). discussion of the experience of individual countries.

51

©International Monetary Fund. Not for Redistribution 11 • CAPITAL FLIGHT: CONCEPTS. MEASUREMENT. AND ISSUES question. The fundamental economic concern about Chart 2. Capital Importing Developing Countries: capital flight, however. is that it reduces welfare in Net Borrowing and Capital Flight the sense that it leads to a net loss in the total real resources available to an eco]lomy for investment and 80 growth. That is, capital flight is viewed as a diversion of domestic saving away from financing domestic real 70 + investment and in fa vor of foreign financial investment. As a result, the pace of growth and development of 60 f t + / Net borrowing rom the economy is retarded from what it otherwise would pril'are <;redirors1 50 have been. ... These perspectives on capital fljghtare well fo unded. 40 + and certrunly have been the operative ones over the past few years. These are not, however, necessary 30 consequences of capital flight per se. For these con­ sequences to fo llow, another condition must also be 20 met, namely, that nonresidents be unwilling to indi­ rectly finance the capital flight through the acquisition 10 of offsetting cJajrns on the country in question. 0 L------� Over much of the period under review, there was 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 an underlying willingness of nonresidents to invest in ' Data plotted refer to "other net borrowing" estimates shown in 1987. developing countries. Net lending by private creditors World Economic Outlook, April Table 40. p. 168. increased rapidly throughout the second half of the z Data plotted are centered three-year moving averages of the average of the broad and private claims measures of capital flight 1970s. Indeed, private fo reign creditors were suffi­ shown in Table I. ciently willing to invest in these economies to finance substantial increases in both real resources transfers desires to reduce transactions costs. FinaJiy, some of and the demand for foreign assets (Chart 2). Presum­ the outflows reflected capital flight as residents sought ably, this reflected a positive assessment by those to avoid the wedge introduced by domestic policies creditors of the prospects of the economies in question between the underlying rate of return on capital in and a view that, adjusted for risk, these claims would these economies and the real return paid to resident yield returns at least as favorable as those available holders of domestic financial assets. Indeed, these on alternative placements. Fundamentally, these views policies. which often resulted in financial repression, were consistent with the classical notion-borne out excessive fiscal deficits. inflation taxes, and unrealistic by the statistics for a number of countries-that rates exchange rates, were often such as to make fo reign of return on capital ought to be higher in developing assets signjficantly more attractive than domestic as­ than industrial countries because of the relative scar­ sets. lt is these considerations-considerations per­ city of capital in developing countries. taining to the return to private residents rather than It might be argued that foreign creditors could to that of nonresidents or to the underlying prospects usefully have cross-checked their fa vorable perspec­ of the economy-that motivated the capital outflows. tives on the economies in question with those of Under these circumstances, where both resident and residents, who were seemingly intent instead on ac­ nonresident investors retained an essentially positive quiring external rather than domestic claims. To do perspective on the prospects for an economy, capital so, however, would be to misinterpret the motivations flight can perhaps best be viewed as reflecting the behind the capital outflows. As explained earlier, the internationalization of the intermediation between do­ capital flightof the 1970s can be substantially explruned mestic savings and investment-an internationalization on the basis of considerations that have little to do that was given impetus by national policies that dis­ with the underlying rate of return on capital in the criminated against resident holders of domestic assets country concerned. Some of the outflows stemmed and by the parallel explosion in the provision of from the requirements of international commerce, international intermediation services. As a result, do­ outflows that presumably enhanced the return on mestic savings went offshore, but returned, often in capital invested in the tradable goods sector. Some of the form of increased bank claims on national govern­ the outflows were motivated by ordinary portfolio ments. Consequently, the implications for the real diversification considerations. Similarly, as the advent economy of this "intermediated" form of capital fught of offshore banking centers made offshore financial tended to be smaller than they would otherwise have intermediation more efficient than onshore interme­ been, at least in the short run. While there was a diation, some of the outflows stemmed from residents' grossing up of both claims and liabilities, the net effect

52 ©International Monetary Fund. Not for Redistribution Implications of Capital Flight on the balance of payments and the exchange rate was However, given the postulated willingness of off­ Limited. For the same reason, the pool of resources shore intermediaries to act as intermediaries among available for domestic investment was also probably residents, the adverse implications of capital flight just little changed so that the underlying growth path of described may not have been very evident. They take the economy was, for a time at least, largely unaffected. a long time to build up to a level where they become The policies that underpinned the tlight component noticeable and a priority concern of national authori­ of the outflows were of course harmful to these ties. Accordingly, concerns regarding capital flight economies. They led to distortions and rnisallocations were somewhat muted during the 1970s. Those that of resources that necessarily weakened growth relative were expressed tended to be with reference to partic­ to what it otherwise would have been. More funda­ ular countries at times when they experienced balance mentally, however, capital flight would in time increase of payments difficulties. that is at times when foreign external indebtedness and contribute to changing the creditors were less accommodating. perspectives of foreign creditors, a change which would This generally low-key view of capital flight was have highly adverse implications for these economies. reversed in the 1980s, especially in the aftermath of Even before the onset of financing constraints, the debt crisis. As foreign creditors became increas­ capital tlight is Likely to have adverse implications for ingly unwilling to lend to developing countries. they the public finances and the allocation of resources. in effect also became unwilling to serve as the inter­ Thus, capital flight is likely to raise the carrying costs mediaries between domestic savers and investors. That of public debt for two reasons. First, the exchange is, while foreign banks continued to accept deposits rate risk borne by private residents when they hold from developing country residents. they no longer domestic assets is effectively shrtted to the public were willing to acquire the offsetting claims, and capital sector as the intermediation of domestic savings be­ flight became immediately translated into a loss of comes internationalized. Second, foreign creditors are resources. The real resources available to the economy unlike! y to accept the imposition of the domestic taxes for investment and growth-already shrunken by weak or uncompetitive interest rates that were typically purchasing power of exports, high debt service pay­ imposed on domestic financial assets in many capital ments, and the virtual cessation of private lending­ importing countries so that the internationalization of shrank further as a result of outflows through the intermediation is again likely to raise public sector capital account. borrowing costs. Capital tlight is also likely to lead to This is a much more serious situation than the an erosion of the tax base because it removes resources "churning" of claims that prevailed in the 1970s. At from the government's tax jurisdiction, and thereby root, it reflects a fundamental shift in the perception weakens public revenues. Further, capital tlight may of creditors of the expected returns on investments in have led the public sector to undertake a larger share the country in question. Under these circumstances, of investment than it might otherwise have done. it can no longer be presumed that capital flight is Because the internationalization of intermediation motivated primarily by differentials in favor of foreign tended to result in increases in private fo reign claims assets stemming from ill-advised financial policies. offset by increases in public liabilities, the share of Rather, the presumption must be that, just as fo reign domestic investment controlled by the public sector savers drastically altered their perceptions of expected may have increased. This tendency may have been returns on investments in the country concerned. so fu rther exacerbated by official actions intended to did domestic savers. As a result, neither residents nor ensure that profits from new, externally financed in­ nonresidents wished, at the margin, to acquire claims vestments not be lost through further capital flight and on the affected economies. Consequently, residents be available for debt service payments. Finally, capital became obliged to exchange real resources in order to flight may have had regressive effects on income effect their desired acquisitions of foreign assets. distribution. The shifting of private wealth beyond the This shift from the "churning" type of capital flight government's tax jurisdiction probably led to a shifting in the period to 1981 to the net real resource transfer of the tax burden away from the internationally mobile form of capital flight that is evident since then has had factor of production, capital, and onto the less mobile a number of implications, all of them unpleasant. In factors of production, labor, and land. On balance, the first place, capital flight under these circumstances although assessment is difficult, such a shift in the tax invariably leads to additional unwanted pressures on burden is likely to be regressive.33 the foreign exchange markets. As a result, the au­ thorities are forced offtheir intended path for official

n The regressive effect of capital Jlight depends mainly on the ratio of land to capital in the asset portfolios of the rich and on the reaction of the government to the loss of taxes on capital. If land government fully offsets the lost capital taxes by increased land is a large component of the asset portfolios of the rich and if the taxes, any regressive impact of capital fiight would be minimized.

53

©International Monetary Fund. Not for Redistribution U • CAPJTAL FLIGHT: CONCEPTS, MEASUREMENT, AND ISSUES reserves or the exchange rate and thereby forced to balance of advantage probably favors the rectptent reconsider monetary and fiscal policies in a context of country, otherwise residents would not have been diminishing growth prospects and accelerating infla­ willing to incur the net increase in liabilities to non­ tion. Typically, these dilemmas prompt the authorities residents. But the issue is not clear cut, and govern­ to adopt more restrictive policies than they would ments of recipient countries (Switzerland, for example) have pursued in the absence of capital flight. Sepa­ have sometimes resorted to controls on capital inflows rately, the private sector's appetite for fo reign assets in order to reduce the domestic social costs of being is likely in and of itself to lead to a curb in domestic a "safe haven." spending since its demand for foreign assets can only Turning to the implications of capital flight for be satisfied through increases in net exports. Overall, national policies, the starting point must be the reali­ therefore, real growth in the capital flight country is zation that such flight emanates from distortions that likely to falter. Moreover, the loss might well carry must be eliminated or at least eased if flight is to be over into the medium term. In the circumstances curbed. Accordingly, a first implication for policies is postulated, it is likely that the funds in flight are at the that national authorities need to adjust policies so as expense of private sector investment. so that capital to avoid the pronounced discrimination against resident flight might impair medium-term growth prospects as holders of domestic assets that has been so prevalent well. among developing countries. In order to mobilize and Finally, it is to be noted that the "intermediated" retain domestic savings, savers must be remunerated outflows of the early period contributed to the "real" at rates that are more in line with those available capital flight of the 1980s and exacerbated its conse­ internationally. Avoidance of financial repression to­ quences. The intermediated outflows led to increases gether with the development of an efficient system of in gross indebtedness which contributed significantly domestic financial intermediation would seem to be to the adverse shift in the perceptions of investors as especially useful in achieving this objective and in regards countries' creditworthiness. Moreover, the reducing countries' vulnerability to flight in the future. nonflight outflows of the 1970s led to large accumu­ Shifting to wholJy market-determined interest rates lations of assets abroad which, when sentiments may of course be unrealistic for some countries in the changed, were readily transformable from nonflight to near term, for instance because of the undeveloped flight assets. Thus, although the consequences of the character of their financialmarket s. Nonetheless, even intermediated outflows were secondary throughout the in these cases, policies need to correct the large 1970s, they helped both to trigger the changing per­ negative real rates of return that have sometimes spectives of the 1980s and to effect a negative real characterized domestic financialinstruments. It is only transfer once sentiment changed. once those negative rates are substantially eliminated Capital flight has, of course, implications for the that one can reasonably expect a sustained reduction capital receiving country as well as for the capital in the capital flight. exporting country. The consequences of an inflow of A second implication is the need to adopt policies flight capital are largely the mirror image of those for to keep the exchange rate in line with the expectations the flight country. To the extent that flight inflows are of the private sector. Capital flight has repeatedly been associated with the internationalization of financial prompted over the years by the expectations of resi­ intermediation, the commensurate capital outflowswilJ dents that they could avoid large losses on their ensure that resource-transfer implications are minimal, domestic currency-denominated assets if these were although welfare gains would be achieved through converted into fo reign currency at some point prior to residents' acquisitions of the range of domestic and the expected depreciation. In principle, of course, this foreign assets that they wish to hold. When "real" cause of capital outflows could be eliminated by simply capital flight occurs, however, recipient countries ob­ letting the exchange rate float. Moreover, a floating tain a net inflow of foreign savings from the flight rate would automatically neutralize the effects on country, whose real resource counterpart is achieved capital flows of distortions elsewhere in the economy, through a trade deficit, or at least through a reduction such as the regulation of domestic interest rates, and in the recipient's surplus compared to what otherwise thereby reduce incentives for flight. In practice, how­ would have been implied by the balance of economic ever, most countries exercise some control over the fo rces. By the same token. the capital inflows would path of the exchange rate, a control that opens avenues be likely to depress interest rates. and increase do­ for private gain and capital flight. In these circum­ mestic absorption in the recipient country, thereby stances, financial policies need to be carefully con­ setting in motion economic adjustments which, if trolled to keep the exchange rate in line with expec­ sufficiently large, could prove costly for the recipient tations, a requirement which goes hand-in-hand with country's tradable and nontradable goods sectors. The the need to pursue sound financial policies.

54 ©International Monetary Fund. Not for Redistribution Implications of Capital Flight

The financial policies required to keep capital flight attaching to transactions with offshore banking centers. in check are very familiar. In most cases, there is a Another view is that tax-evading capital flight, like need to keep fiscal deficits at prudent levels in order other forms of capital flight, reduces public revenues to avoid triggering expectations of increased taxation, and creates a distortion of its own. Making up the tightened capital controls, and acceleration of inflation, revenue from other taxes or increasing existing taxes each of wruch would lead to a prompt reassessment on capital wiU further distort the allocation of re­ of the exchange rate. It is especially important to keep sources. In this view, therefore, the solution is to a rein on inflationary expectations since, besides in­ control tax-evading capital flight using the same reg­ stigating capital flight by building up expectations of ulatory means that are used to control other forms of exchange rate depreciation, they also tend to magnify tax evasion. the distortive effect of financial market regulations. It Which of these two views is to be preferred in any is therefore important that monetary policy and the particular case is likely to depend heavily on the financingof the budget play a stabilizing role by keeping perceived mobility of domestic capital. In countries the growth of the monetary aggregates on a stable and where financial markets are at a rudimentary stage of in most cases decreasing path. development, capital mobility is likely to be perceived Needless to say, the reasons for adopting more as quite low. ln these countries, the authorities' desire market-oriented structural policies and orthodox fi­ to maximize public revenues, minimize the borrowing nancial policies extend far beyond considerations re­ cost of the public debt and, at one remove, increase lating to capital flight. The case for market-oriented the resources available for investment and growth is structural policies rests rather on the generalized likely to lead them to a reliance on regulations and improvement in resource allocation they would permit. capital controls. In countries where financial markets While one consequence of market interest rates might are better developed, however, the case for gearing well be increases in the public sector's borrowing costs policies to the low tax solution is stronger, especially and increased fiscal pressure, any adverse implications over the longer term. In these countries, the explosion from this source would be overshadowed by the of offshore international intermediation services has benefits in the form of increased investor confidence, rendered increasingly ineffective the regulations and improved efficiency of investment, and faster growth. capital controls that have supported taxation differ­ This in turn would lead to increasingly buoyant tax entials in the past. The private sector has proved itself revenues. Similarly, while cautious financial policies willing and able to circumvent such controls when are important to efforts to reduce capital flight, their necessary in order to protect the real purchasing power main benefit would of course bein terms of the creation of its wealth from significant loss. of an economic environment that would facilitate The case for using capital controls to curb capital economic growth on the basis of increased investments flight is, of course, more general than is suggested by of voluntarily-mobilized domestic and foreign savings. the considerations of tax evasion alone. The starting This requires, in the first instance, the adoption of an point is the view that, because of externalities, the appropriate mix of fiscal, monetary , and exchange rate social rate of return on domestic investment is higher policies, and a willingness to quickly adjust policies than the private rate of return. Consequently, invest­ to changes in the domestic and foreign economic ment spending needs to be pushed to the point where environment. the marginal cost of fu nds is equated to the social While market-determined interest rates and ex­ rather than the private rate of return-an expansion change rates would go far toward eliminating capital that can, in this view, be achieved by bottling up flight, they would not eliminate flight stemming from investable funds at home through use of controls. This outright tax avoidance. As noted earlier, capital flight view is buttressed by the conviction that the produc­ originates in part in the desire of the private sector to tivity of investment in developing countries is greater avoid taxes, including the more implicit forms of than that in industrial countries so that there is an taxation such as those associated with inflation and underlying economic case for attempting to maximize the discrimination against resident holders of domestic investment in developing countries. In some countries, assets. As regards the avoidance of direct forms of capital controls are also justified on the basis of infant taxation, the proper corrective action is less clear cut. industry arguments-that controls are necessary dur­ One view is that it is a mistake to attempt to tax capital ing the transition period while the domestic financial to begin with. Given the fungibility of loanable funds, sector is being built up to be competitive in the global attempts to tax domestic capital at rates significantly market for intermediation services. higher than those applicable elsewhere are bound to The use of capital controls is also justified on the fail. In this view, this consideration is especially basis of more short-run considerations. The main one pertinent today given the efficiency and confidentiality is that controls are useful in preventing transitory

55 ©International Monetary Fund. Not for Redistribution U • CAPTTAL FLIGHT: CONCEPTS, MEASUREMENT. AND ISSUES

strains and stresses in financial markets and, at one tensions. Accordingly, governments might consider remove, private sector expectations from filteringfor­ collecting and tracking the relevant data more system­ ward into the balance of payments, exchange rates, atically. In retrospect, it is clear that it would have inflation, and the real economy. The premise of course been advantageous to pay this signal greater heed than is that the disturbances are random and non-system­ it actually received. However, care needs to be ex­ atic. If so, controls may be effective in the short run ercised in the interpretation of such data. One reason in countries with underdeveloped financial markets. is, of course, that the available data are typically very In point of fa ct, however, the disturbances are more imperfect measures of capital flight. Another reason, likely to stem from inconsistencies in financialpolicies however, is that the interpretation of the data hinges as governments seek to achieve a multiplicity of short­ on the surrounding circumstances. For instance, at

run objectives that are not always easily reconcilable. any point in time, certain distortions may be large but Under these conditions, controls substitute for the not reflected in capital outflows because of a recent required correction to policies and are unlikely to be real exchange rate change. By the same token, "real" effective. Indeed, the increasing tension brought about capital flight may be associated with much smaller by the controls, on the one hand, and the inconsistency observed outflows than "intermediated" capital flight. of policies, on the other, is, in the absence of policy However, this is more likely to reflect the difficulty of adjustments, likely to generate expectations of a further effecting the real transfer rather than any differential tightening of controls. It is expectations of this type in the tensions underlying the two flows. Hence, while which in the past have led to some of the most capital flight data can be useful as a warning signal for pronounced bouts of capital flight. Thus, even in the policy, such data will often be misleading unless it is short run, controls are unlikely to be effective unless assessed within the context of a comprehensive anal­ they are buttressed by reasonably sound financial ysis of the factors underlying the outflows. policies to begin with. In sum, the policies that are likely to be most The usefulness of capital controls over the longer effective in curbing capital flight are, in the main, the term in the sense of whether they increase the avail­ same market-oriented and cautious policies that can ability of real resources for development is also ques­ be justified on much wider grounds. Such policies tionable. In the first place, the proponents of controls minimize the distortions and disturbances that tend to make insufficient allowance for the adverse prompt capital flight and are over the long run likely effects controls have on resource a.llocation and the to be the most effective. A final question, however, is level of saving. In addition, these arguments tend to whether such policies are likely to be equally effective Jose sight of the implications of controls for the against the "intermediated" and "real" forms of availability of fo reign saving. In the long term, the capital flight observed in the 1970s and 1980s, respec­ allocation of global savings among countries is pre­ tively. Clearly, the preferred policies are likely to be sumably governed by the perceived marginal efficiency quite effective in curbing "intermediated" flight. The of investment in the various countries, with the allo­ willingness of foreign creditors to invest in the country cation being such as to equate returns at the margin. in that case makes it clear that the flight is primarily Hence, given some dependence on fo reign creditors, due to the wedge brought about by government policies attempts to increase investment in one country through between the return to savers and the return on in­ controls on outflows are likely todrive down the return vestments. Elimination of that wedge will eliminate on investment and prompt foreign investors to seek the need for the external intermediation at the levels more profitable opportunities elsewhere. On balance, seen in the 1970s and hence that source of capital therefore, controls on capital flight-while they may, flight. Indeed, it might well be expected that, under depending on circumstance, retain domestic savings these circumstances, past capital flight would be that would otherwise have gone elsewhere-are un­ repatriated. likely to increase the overall availability of real re­ "Real" capital flight, however, is not necessarily sources over the long term. Indeed, since controls are rooted only in domestic distortions. As noted earlier, likely to lead to a perceived leftward shift in the this form of capital flight stems rather from an under­ marginal efficiency of investment schedule for that lying unwillingness of both foreign and, at the margin, country, they would probably reduce the availability domestic savers to invest in the economy in question. of real resources. The adoption of sound policies would certainly con­ Information on capital flight can be useful to the tribute to easing the country's difficulties. It would authorities as a signal of the degree of distortion that curb that part of the outflow stemming, for example, exists in the economy and of the need to adjust policies. from any misalignment of the exchange rate. It would As was seen earlier, the ebb and flow of capital flight also significantly improve prospective rates of return over the years has, in part, been proportional to those on investments in that economy, a shift that might be

56 ©International Monetary Fund. Not for Redistribution References

sufficient to offset the bearish views of investors and creditworthiness through higher growth. As such, real lead to a resumption of voluntary lending by both capital fught is a part of the much wider set of issues foreign and domestic creditors. associated with the debt situation and the need to However, the intractability of the debt problem and restore growth in the developing world-issues that the evident unwillingness of private Fo reign creditors are beyond the scope of the present paper. Like those to lend to a range of developing countries suggest that issues, however, real capital flight in the sense just the belated adoption of sound national policies may described needs to be addressed within a coUaborative not in itself always be sufficient to eliminate real capital framework, tailored to each country's circumstances. flight. Existing levels of indebtedness may be such as that deals simultaneously with the reluctance of both to continue to discourage investors, be they domestic residents and nonresidents to invest in the country in or foreign, and thereby sap the potential for improved question.

References

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Explanations, Prince ton Studies in International Finance agers and Policymakers. ·• in International Debt and the 58 (Princeton, New Jersey: Princeton University, 1986). Developing Countries, ed. by Gordon W. Smith and

___, "Economic Determinants of Capital Flight: An John T. Cuddington (Washington: World Bank. 1985). Econometric Investigation,·· in Capital Flight: The pp. 236-57. Problem and Policy Responses. ed. by Donald R. International Monetary Fund, ''Foreign Private Investment Lessard aod John Williamson (Washington: Institute for in Developing Countries," Occasional Paper 33 (Wash­ International Economics, June 1987). ington, January 1985).

Cumby, R. and R. Levich. "On the Definition and Magnitude ___, GovernmentFinance Statistics, Vol. 9 (Washington: of Recent Capital Flight," in Capital Flight: The Problem IMF. 1985).

and Policy Responses. ed. by Donald R. Lessard and ---· Balance of Payments Statistics Yearbook. Vol. 37 John Williamson (Washington: Institute for International (Washington: IMF. 1986).

Economics, June 1987). ___, International Financial Statistics Yearbook (Wash­ Dooley, Michael P.. "Country-Specific Risk Premiums. ington: IMF, 1986). Capital Flight and Net Investment Income Payments in ___ , World Economic Owlook (Washington: IMF. Oc­ Selected Developing Countries'' (unpublished. Inter­ tober 1986). national Monetary Fund, March 1986). Ize. Alain and Guillermo Ortiz, "Fiscal Rigidities, Public Dornbusch, Rudiger, "External Debt, Budget Deficits and Debt and Capital Flight," Su{[( Papers. International Disequilibrium Exchange Rates.·· in lntemational Debt Monetary Fund (Washington). Vol. 34 (June 1987). pp. and the Developing Coumries, ed. by Gordon W. Smith 31 1-32. and John T. Cuddington (Washington: World Bank, Katz. Menachem, "Impact of Taxation on International 1985), pp. 213-35. Capital Flows: Some Empirical Results ... in Taxation. Duwendag, Dietor, "'KapitaJtluchtaus Entwick.Jungslandern: Inflation and Interest Rates, ed. by Vito Tanzi (Wash­ Schatzprobleme und Bestimmungsfaktoren, ·• in Die ln­ ington: International Monetary Fund. 1984). ternationale Schuldenkrise: Ursachen, Konsequenzen, Khan, Mohsin S. and Nadeem Ul Haque, "Foreign Borrow­

Historische Erfahrungen, ed. by Armin Gutowski (Ber­ ing and Capital Flight: A Formal Analysis," Staff lin: Duncker & Humblot, 1986). Papers, International Monetary Fund (Washington), Erbe. Susanne, "The Flight of Capital from Developing Vol. 32 (December 1985), pp. 606-28. Countries," lntereconomics (Hamburg), Vol. 20 (No­ Kindleberger, Charles P .. "Capital Flight-A Historical vember 1985), pp. 268-75. Perspective," in Capital Flight: The Problem and Policy Grubel, Herbert G., "Internationally Diversified Portfolios: Responses, ed. by Donald R. Lessard and John Wil­ Welfare Gains and Capital Flows," American Economic liamson (Washington: Institute for International Eco­ Review (Nashville. Tennessee), Vol. 58 (December 1968). nomics. June 1987). pp. 1299-3 14. Lecraw, D., "Direct Investment by Firms from Less De­ Gulati, S.K.. "Capital Flight Through Faked Trade Invoices: veloped Countries," Oxfo rd Economic Papers (Oxford), A Statistical Note·· (unpublished, Columbia University, Vol. 29 (November 1977). pp. 442-57. May 1985). Mattione. Richard P., OPEC's lm1estments and the Inter-

57 ©International Monetary Fund. Not for Redistribution 11 · CAPITAL FLIGHT: CONCEPTS, MEASUREMENT, AND ISSUES

national Financial System (Washington: The Brookings Responses, ed. by Dooald R. Lessard and John Wil­ Institution, 1985). liamson (Washington: Institute for International Eco­ Morgan Guaranty Trust Company, World Financial Markets nomics, June 1987). (New York: March and September 1986). Williamson, Martin C., ''Acqujsition of Foreign Assets by Nolling, Wilhelm, "Combating Capital Flight from Devel­ Developing Countries, 1970-84: Empirical Evidence," oping Countries," Jnrereconomics (Hamburg), Vol. 21 International Monetary Fund Working Paper (Washing­ (May 1986), pp. 117-23. ton, fo rthcoming).

Rodriguez, M. A .• "Consequences of Capital Flight for Latin World Bank, World Development Report (New York: Oxford America" in Capital Flight: The Problem and Policy University Press, 1985).

58 ©International Monetary Fund. Not for Redistribution