Capital flight is an aspect of the debt crisis of developing countries. Indebted countries have often borrowed more money just to finance their debts but, rather than being used to repay these debts, much of this money has been put on deposit in foreign banks by firms and individuals (corruption rearing its ugly head), or has been put into stocks and shares and property.
Capital flight occurs when firms or individuals speculate on the prospect of earning a higher return abroad. This will particularly occur when there is:
- Fear of devaluation / a belief that the exchange rate is overvalued
- High rates of inflation
- A low real rate of interest
- A need to 'launder' money abroad
- A poor domestic investment prospect
Developing countries generally suffer from a shortage of foreign exchange, so capital flight may be a serious financial barrier to development. It is likely to:
- Adversely affect the growth potential of the economy as domestic investment will be reduced by money flowing overseas.
- Reduce government revenues as money held overseas is not subject to tax by the developing country; this will make it more difficult to service debt and will increase the tax burden on people within the economy.
- Cause balance of payments problems on the capital account due to the money outflows.
- Make international agencies less well disposed to provide further financing to service the debts.
- Worsen the distribution of income as the poor will be the group most affected by the measures put in place to meet the country's debt servicing requirements, while the rich will receive interest from the foreign banks to which they have switched their money.
Can capital flight be tackled?
One way to tackle capital flight is for developing countries to impose strict exchange controls, but this would fly in the face of the world-wide movement towards liberalisation of capital markets.
Another approach would be to take measures, through sound economic management, to build investors' confidence, but this may be more easily said than done as people in a position to move money around the globe are often more influenced by 'herd instinct' than anything of a more rational and socially responsible nature.
Read the article Is Africa still a victim of capital flight? and answer the question below. You can do this in the web window below, or follow the previous link to open the article in a new web window.
The article finishes with the question: What do you think? Can Africa end capital flight? Research the issues surrounding capital flight from Africa and prepare your answer to this question