Understanding Capital Flight - Term Paper Example

Outline Research Question: Why havent we shot down the lethal weapon on capital flight? Preliminary answer Capital flightis a complex issue with various dynamics involving many stakeholders that have no cooperation. It is also an issue that compound many problems within it. Outline of essay Understanding capital flight Capital inflows ad foreign exchange outflows: From the onset of the third world debt crisis, capital flight has been utilized to capital outflows from residents of developing countries. Domestic investors in developing countries felt that their governments would favor foreign debt as opposed to the internal debt obligations. Human cost of debt/external debt versus capital flight: The relationship that exists between human cost of debt and capital flight is a vicious cycle. In other words, capital flight and debt are related. Developing nations grappling with foreign debt Political factors/ risk: Political risk is also a factor that determines capital flight. The uncertainty in groups about whom or which group will be in control in the future brings about political risk where capital flight thrives. Governance issues and criminality: Governance and political actors play an important role in the determination of capital flight. In terms of governance, regimes play an important role in the determination of capital flight. Dictatorial regimes are likely to cause capital flight because among other things, they make local investment environment in a country unpredictable and unsafe for investment. Why havent we shot down the lethal weapon on capital flight? The term capital flight has no widely accepted definition. However, the widespread use of the term refers to widespread currency speculation especially when it causes cross-border movement of private funds that are large enough to affect national financial markets. The differences put on light and normal capital flows has been an issue of degree rather than a well-established measurement. Capital fight is normally considered as a symptom of financial crisis as opposed to its cause. However, it is significant to point out that issues of devaluation can cause capital outflows. In this case, capital flight can cause financial stability. The most important question that this paper tackles is why havent we shot down the lethal weapon on capital flight? Episodes of capital flight often occur when exchange rates are unstable. For example, in the 1920s and 1930s, the failure of the gold standard led to several attacks on the French Franc and German mark. Likewise, in the late sixties when the Bretton Woods system of fixed exchange rates broke down, the U.S tried to defend the dollar with capital controls and preventing the trial by foreign backs to convert of dollars to gold. This means that the problem of capital flight is worsened by unstable exchange rates. In the last few years, the world has faced many problems with respect to the financial meltdown. Because of this, the exchange rates were unstable often shifting because of the effect of financial difficulties. This is one of the reasons that have made the war on capital flight very difficult. From the onset of the third world debt crisis, capital flight has been utilized to capital outflows from residents of developing countries. Domestic investors in developing countries felt that their governments would favor foreign debt as opposed to the internal debt obligations. This issue is different with the experience that domestic investors experienced with direct foreign investment when domestic assets were not under threat as opposed to foreign-owned assets. When capital flight occurs, there is no easy way of dealing with it because it is a serious problem. Following the financial instability of the war period, the international monetary fund was established to help countries that had foreign exchange problems. This system did not work effectively and such countries are still trying to overcome the problem by returning too fixed rates using a modest scale. This means that solving the problem of capital flight goes beyond issues of looking into the monetary policies of certain countries just as the IMF has done over the years. Here Ticker writes an important point that “one of the main ironies of existing critiques of the invisibility of peripheral perspectives on world politics is that they are conducted more for a core audience than for the periphery” (Tickner 641). Countries have tried solving the issue of capital flight through the use of capital controls. However, imposing controls has proved to be counter-productive because they have brought about other problems such as reducing the confidence in local markets and making it difficult for flown market to return to normalcy. Capital controls have encouraged the growth of black markets for foreign currency. The people who export and import goods export money by overstating their export earning The other method that has been applied to solve the issue of capital flight has been to make domestic currency more attractive by making it undervalued relative to other currencies and also by ensuring that local interests remain on a high level. However, this method has created more problems because it makes imported goods very expensive and discourages domestic investment. Such a move is detrimental to the economy of a country because it seeks to address the problem of capital flight by introducing other problems. Therefore, despite the fact that this method has been applied especially in developing countries, it has not addressed the problem yet. Here, Cammack notes, “primitive accumulation’ – the historical process of divorcing producers from the means of production which produces both capital, and a proletariat” thus promoting the possibility of a capital flight (Cammack 127). The relationship that exists between human cost of debt and capital flight is a vicious cycle. In other words, capital flight and debt are related. Most developing nations borrow funds from developed nations such as the USA. This has lasted for long now and such developing nations have a lot of debt to pay. Borrowing of foreign debts was massive during the 1970s and 1980s and it brought a tough wave of capital flight ever recorded in history. It is true that by the 1990s, capital flight debt was more than all the foreign debt owed by third world countries. In addition, important information to note is that private investors in 139 middle-income countries had a total of about $7.3 trillion to $9.3 trillion in untaxed offshore wealth. This was an amount that was over and above the aggregate external debt owed by these countries. Because of these factors, such countries lose tax revenues of more than $ 200 billion every year and incur more debts to compensate for those losses. When this happens, it clearly shows that the problem of capital flight is difficult to tackle (Gillespie 1502). The debt problem does not just face developing nations only. In recent times, some European nations have faced an increase in public debt levels and severe funding pressure. It is clear that debt crises cause sovereign default that affect output and lead to exclusion from foreign capital markets for several years, which is a bad thing for the economy of a country. Debt crises also cause an increase in the cost of borrowing, something that mostly happens with developing nations. All these factors combine to bring about output contractions, which affect the economy of the countries involved and increase the level of capital flight. In the case of debt-fueled capital flight, the flow of capital in a country from outside provides the resources and the motive for capital flight. This means that borrowed funds are transferred through government borrowing and sold to citizens within the country who transfer the money abroad either legally or illegally. In such a case, the government becomes the source of foreign exchange. Another way of doing it would mean that government lends funds to private borrowers who transfer their abroad meaning that external borrowing fuels capital flight. Most developing nations, for instance in Africa has seen the human debt rise from the 1980s to present. These debts have an impact on economic performance and investment in these countries and directly influence capital flight (Gillespie 1502). In case of debt driven capital flight, foreign borrowing brings about capital flight through encouraging debt crisis, deterioration of investment climate and worsening macroeconomic conditions in a country. It is also important to understand that capital flight also induces foreign borrowing by draining national foreign exchange and forcing a government to seek financial help from abroad. Having seen the fact that capital flight has a link with human debt in a dual-causal manner, it is clear that solving the long-standing problem of capital flight is difficult. This is because it means that countries especially developing countries must first pay all their debts to be able to solve the problem of capital flight, yet human debt is not the only causal factor. In the current age, many developing nations are still facing an increase in their external debt as opposed to a reduction. Therefore, repaying the external debt is not an option that could be considered soon as one of the important and needed ways to solve the capital flight problem (Jones 1500). Despite the fact that developing nations are highly hit by the capital flight problem, they have failed to respond effectively. For example, one way to solve capital flight would mean that a government in a developing nation should implement strategies to improve domestic investment climate. This is because legally acquired assets abroad should be repatriated through domestic returns high relative to foreign returns. However, the investment environment in such countries are very unfavorable for investment initiatives because of factors such as high interest rates, poor electricity provision, high taxes and lack of political good will among others. This is one of the reasons why it has been difficult to solve capital flight (Tickner 637). Another problem in solving capital flight entails illegally acquired assets that are held abroad. These are done to evade the law. Owners of such assets will only be enticed to invest locally if they are guaranteed immunity against prosecution for fraud and other penalties related to unpaid taxes. However, considering such a move will prove detrimental because it will mean that governments will be rewarding malfeasance. Another way would be to impound the assets and repatriate them forcefully. However, this poses a problem of the difficulty to obtain the identities of owners of the capital especially from centers that have rigid and strong customer privacy protection. To effectively deal with capital flight in this sense would mean that developing countries get cooperation from international financial centers, nations and their governments. However, this is very difficult because of international law concerns and the lack of cooperation especially from nations where such illegal capital helps run or grow their economies. This shows the difficulty that developing nations have faced in their initiatives to fight capital flight especially when the relationship between such countries and those where the illegal capital are located. It becomes difficult to get cooperation from them (Cammack 130). Governance and political actors play an important role in the determination of capital flight. In terms of governance, regimes play an important role in the determination of capital flight. Dictatorial regimes are likely to cause capital flight because among other things, they make local investment environment in a country unpredictable and unsafe for investment. For example, during Ferdinand Marcos’ dictatorial regime in the Philippines, the national debt had grown up to about $ 30 billion and has plundered the national treasury of more than $ 10 billion. Corrupt regimes are also responsible for capital flight. For example, almost half of the financial resources borrowed by 33 sub-Saharan African countries got out of those countries in the same year they were borrowed. Gillespie notes “Over $700 billion fled between 1970 and 2008, far in excess of the region’s foreign debts of $175 billion” (Gillespie 1503). These monies ended up in private accounts with the banks that had provided the debts. This capital falls to the hands of private individuals and companies while the public become liabilities. Corrupt political regimes and politicians often seen in developing nations divert the loans borrowed to fund their own investments mostly out of the countries that borrowed the money. Developing countries suffer the deprivation of local investment capital and the required tax revenues that can be used to run their economies are stolen leaving these countries in helpless situations. Corrupt political leaders and influential businesspersons in such countries take advantage of the funds allocated through foreign debt in turn increasing the capital flight in those countries (Gillespie 1503). Political risk is also a factor that determines capital flight. The uncertainty in groups about whom or which group will be in control in the future brings about political risk where capital flight thrives. Political risk causes economic uncertainty especially on future economic policies that touch on crucial aspects such as taxation. This often occurs in developing nations where there are weak systems of property rights that allow groups to have common access to domestic capital markets of other groups. This encourages capital flight through the attempt of a group to place wealth beyond the reach of another group. Other issues of governance that influence capital flight are weak economic environments and political instability. These aspects trigger differential and unsound macroeconomic variables such as high inflation rates, government budget deficits and overvalued exchange rates. These factors are directly linked to capital flight. Aside from corruption and dictatorship, when poor governance allows for criminal activity to flourish, capital flight could be the result. Criminal activities ranging from drug dealing, prostitution, fraud, laundering and other economic crimes generate a lot of money. This happens especially in developed nations especially when regulators and politicians are involved or are bribed in the process. To safely guard the funds generated from such initiatives, the recipients use the poor governance and financial system to move the money and hide it through illegal activities. Mostly, laundering such large sums of money is done through foreign institutions and companies where money is deposited in the financial system of the home country through a ‘shell’ organization. This is how capital flight comes in and represents one of the difficult issues to address in dealing with the problem (Gillespie 1504). Among the political factors, that affect capital flight is economic freedom, which should encourage domestic investment and increase protection against expropriation. However, economic freedom reduces bureaucratic and legal obstacles to capital flight by making it easy to move capital and also the freedom to travel abroad. Political risk can only be a useless factor in capital flight when government budget is effectively balanced and in an environment where there is assured capital availability. With the above issues stated, it is clear that the fight against capital flight has not been easy and does not promise to be easy. However, there are proposals that seek to address the issue. For example, the Tax Justice Network (TJN), an international organization advocates for the curtailment of the offshore secrecy authorities and for the end of tax evasion and bank secrecy. Gillespie notes, “corrupt dictators and other elites strip their countries’ financial assets and relocate them to these offshore financial centres” (Gillespie 1504). This would ensure that corrupt leaders, criminal business moguls and dictators who encourage capital flight through debt-fueled capital flight are stopped. Non-Governmental organizations and NGO groups such as EURODAD have also come up with proposals for the adoption of new debt procedures with level playing ground between creditors and debtors. Over a long period of time, debt negotiations are always favoring lenders interests at the cost of debtors. This causes unsustainable debts that cannot be prevented because debtors need the financial assistance. As such, lenders get to arm-twist borrowers to suit their interests no matter how bad they affect the capital flight. Despite the fact that this might take some time, it is a promising initiative. International agenda has also shown interest in approaches to debt resolution. For example, UNCTAD established the Principles on Responsible Lending and Borrowing to guide foreign debt and human rights issues (Gillespie 1504). In conclusion, capital flight can be defined as the difference between capital inflows ad foreign exchange outflows. Capital flight is directly related to human cost of debt. The problem of capital debt is a serious issue that has and is still facing serious challenges because of several factors such as unstable exchange rates, corrupt regimes, criminal activities, poor and weak local investment environments, lack of cooperation among countries and greater economic freedoms among other aspects. For this issue to be solved adequately, the above issues must be solved to achieve and adequate and sustainable solution. Works cited Cammack, Paul. "Attacking the global poor." New Left Review 13 (2003): 125-134. Gillespie, Peter. Lethal Liabilities: The Human Costs of Debt and Capital Flight. Third World Quarterly, Vol. 34, No. 8, 2013, 1502-1504. Jones, Tim. "Debt and Power: global injustices and grassroots alternatives." Third World Quarterly 34.8 (2013): 1497-1498. Tickner, Arlene B. "Core, periphery and (neo) imperialist International Relations." European Journal of International Relations 19.3 (2013): 627-646. Read More