Capital flight is a situation when businesses or investors eliminate their money from a country. This might be because of economic or political factors like recessions, shaky government, or other sorts of political or financial downturns. Due to such situations, investors might fear the loss of their assets, funds, or investments and therefore, they pull out such investments to invest them at places where it could be more secure.
All in all, it alludes to an economic concept that is portrayed by enormous outflows of capital or monetary resources from the country. It might take place due to an assortment of reasons like a financial or political emergency, imposition of capital control, currency devaluation, or macroeconomic developments that cause a huge negative shift in investors’ feelings.
What is Capital Flight?
Definition: Capital flight is defined as a concept in economics in which enormous outflows of capital, assets, or investments take place from a country because of certain economic and political downturn events that cause negative economic consequences. It takes place when capital, investments, and assets leave a country to find better opportunities and safe conditions in other countries.
There are many reasons for capital flight, yet the primary ones originate from government mediation as money control, political disturbance, or forceful financial strategies. If such rapid capital outflows sustain for the long term, it can keep the country from the money it needs for financial development.
A country might recognize capital flight when the total level of assets and money is negative. For instance, a country might have $3 trillion rolling in from investors but if some other investors eliminate more than $3.5 trillion, the country will face capital flight.
Understanding Capital Flight
The term is used to depict the unexpected withdrawal of capital from nations as well as from specific regions or cities inside a country.
It is essential to specify that capital flights might take place through the withdrawal of domestic as well as foreign capital. Its existence can be brief or keep going for years. It brings about a few adverse results for the impacted country. Even poorer countries experience its ill effects more severely than others because capital absence impedes their developments.
In simple words, capital flight can be understood as a mass migration or large-scale exodus of monetary resources and capital from a country. It occurs because of occasions like prevailing political or financial issues, devaluation of cash, or the burden of capital controls.
Types of Capital Flight
It takes the form of repatriation invested capital and it is mainly done by the foreign investors. For this situation, the outflow of capital should be appropriately reported as per the accounting standards by complying with the laws of the nation.
The illegal capital flight takes place in the form of IFFS i.e. illicit financial flows. Such financial flows vanish from records inside a nation and they do not get back to the country. Illegal capital flights are for the most part connected with nations that force strict capital control policies.
Reasons for Capital Flight
Some of the notable reasons behind the occurrence of capital flights are-
1. Political vulnerability
Different political issues often become the reasons behind capital flights. For instance, a political turmoil may create doubts in the mind of investors about the future prospects of the country. Furthermore, when the government plans for nationalization, it can be a key trigger behind capital flights. Monetary or military aggression against another nation might prompt sanctions by different nations that would also trigger capital outflows.
Financial reasons might likewise set off or trigger capital flight. These reasons incorporate raising taxes or declining interest rates. One such reason can also be the mass migration of rich people and their private capital or private funds.
Some other macroeconomic factors like exchange rate fluctuations can also be one reason behind this. In addition, devaluation of the domestic currency might also lower the confidence of the investors that compel them to remove their capital from a country. Shifting in the investor’s preference is one of the common reasons behind those developing countries that are facing capital flights.
3. Higher Taxes
If a country increases its taxes, it suggests that the incomes of everyone in the country are falling. A huge increase in taxes like 20% suggests future crises that a country might face. Such situations trigger large outflows and hence, it will hamper investors from domestic investment.
4. Currency Manipulation
Some other factors like currency crisis such as currency manipulation by opting for significant levels of money supply might give birth to hyperinflation. It will also devalue the currency in relation to others.
5. Economic Performance
Investors like to go to economies that are growing exponentially. Such countries offer favorable potential for profit. That is why, when a nation goes through negative or slow economic growth, its capital flows to the growth and positive economies.
Effects of Capital Flight
Some of the aftereffects of capital flights are
- Negative Economic Impact
- Lower Investments
- Weakened Currency
- Lower Tax Revenue
- Government Debt, etc
Examples of Capital Flight
Situations of capital flight may be seen in a wide variety of examples around the world. Let us have a look at some of such examples-
1. Asian Crisis
Asian Financial Crisis in 1997 is one of the popular examples of capital flight. At that time, many Asian nations needed to confront an extreme financial crisis because of the breakdown in the exchange rate. These nations lacked foreign reserves, especially the US dollar.
This made it hard for countries that depended on their American currency link. This triggered stocks tumbling, exchange rate plummeting and capital flights taking place. Another example of capital outflows occurred in late 1997 and 1998 in which Korea, Indonesia, Malaysia, Thailand, and the Philippines experienced net capital outflows of $80+ billion that added to one of the most terrible economic declines ever in the region.
2. FrenchWealth Tax
French government came up with a wealth tax in 1989 which goes from 0.5 to 1.5 percent. This tax was payable on a wealth of more than 800,000 euros. It was introduced with an objective to boost tax revenues and decrease disparity.
Though it boosted tax revenues, the tax evasion implied that complete receipts were 28% lower suggests the economist Eric Pichet. In his review, he likewise observed that this wealth tax prompted a capital flight of roughly 200 billion euros during the period 1989 to 2007.
3. Russian Financial Crisis
Russia attacked Ukraine and added Crimea in the year 2014. The outcome was a number of sanctions forced by the West that cost Russia billions. Such sorts of economic vulnerability and political risk implied that investors left the country with $150 billion lost in capital flight.
Simultaneously, a gigantic drop in the price of oil took place that lost near 50% in its worth. We all know that Russia fundamentally depends on oil, and that is why its revenues took a tremendous shot alongside the economy which declined by around 3% in that year 2015.
4. Greek Financial Crisis
In the year 2012, The Greek financial crisis took place and the capital flight kept taking place by 2015 when it arrived at a record. Which could be compared to 33% of its whole economy. Due to this, businesses, as well as governments, couldn’t get credit.
How to Prevent Capital Flight
Due to the severe negative impacts of capital flight, policymakers make effective strategies and systems to forestall or prevent the occurrence of capital flight. One of such techniques is the use of capital control policies.
To forestall legal as well as illegal capital flights, governments and policymakers need to develop a more robust method. It might incorporate the foundation of a well-working political, legal and judicial system that can guarantee political stability.
Additionally, the public authority or the government should execute steps to lessen the degree of corruption that normally adds to illegal capital flight.
Now, it is clear that capital flight takes place when capital or investments quickly stream out of a country, because of political or economic instability. Such negative events cause trust issues in the minds of the investors that compel them to opt for capital outflows.
The occurrence of capital flight prompts a vanishing of wealth from a country. It is typically joined by a sharp drop in the exchange rate of the impacted country. This fall is especially harmful when the capital is related to individuals of the impacted country on the grounds that not only are the residents currently troubled by the economic loss and devaluation of their currency but also their assets have lost a lot of their financial worth.
This will ultimately decline the buying power of the nation’s resources and make it more costly to import products and get any type of foreign facilities. We hope the aforementioned methods of preventing capital flight will help you in understanding the kind of policies that should be used by policymakers of a country.