Capital Flight: International Trends and China's Problem

Author: Yang Haizhen
Publisher:
Publishing Date: 2005-03-01
Features: Capital flight can be said to be one of the main triggers of the debt crisis in Latin American countries in the 1980s, the 1994 Mexican financial crisis, and the 1997 Southeast Asian monetary crisis. At the same time, it has also become one of the basic indicators for measuring a country's creditworthiness. The World Bank has already adopted different estimation methods to estimate capital flight in all developing countries from 1971 to 1991 in 1993. Many international financial institutions and banks have used the scale of capital flight as an important indicator to measure lending risks. Traditionally, the analysis of capital flows between developed and developing countries is based on the following basic assumption: developing countries generally face the problem of capital scarcity, so the marginal productivity of capital in developing countries is higher than that in developed countries, attracting capital from developed countries to flow into developing countries. Although these studies are extremely valuable for the borrowing decisions of developing countries, they are difficult to explain the phenomena that occurred before the early 1980s debt crisis in Latin American countries, before the 1990s Mexican financial crisis, and before the Southeast Asian financial crisis, when foreign capital flowed in while domestic residents transferred a large amount of accumulated foreign assets abroad. Due to these phenomena, the study of capital flight has attracted significant attention from the international economics community since the 1980s. After the Southeast Asian financial crisis, people deeply reflected on the causes of this crisis. Many economists believe that the premature opening of capital markets and the lagging financial regulation in Southeast Asian countries were the main reasons for this crisis, and accordingly, they argue that China's failure to open its capital markets is the fundamental reason why China avoided being involved in this crisis. However, it is not optimistic to assume that China will not experience such a financial crisis simply because its capital markets have not been opened. Undoubtedly, the opening of capital markets facilitates the rapid flight of large amounts of short-term capital when the economic situation of a country reverses, exacerbating the depth of the crisis. But under the condition of capital markets not being open, capital flight can still occur through hidden or indirect means. Since the implementation of the reform and opening-up policy, China has experienced a steady and year-on-year growth in the inflow of foreign capital, but at the same time, China has also been experiencing a continuous increase in capital outflow. Especially since the 1990s, the scale of China's capital flight has grown sharply. In 1995, China's capital outflow accounted for 2% of global capital flight, ranking as the 8th largest capital supplier in the world and the largest foreign investor in developing countries. In 1997, China's capital flight reached $40 billion, accounting for a higher proportion of its GDP than Mexico in 1995 during the financial crisis and South Korea in 1997 during the financial crisis. China did not experience an international payment crisis mainly because of its sound macroeconomic environment, which allowed China to maintain a large inflow of foreign direct investment. Additionally, China has maintained substantial trade surpluses in recent years, and its foreign exchange reserves are ample, thereby masking the severity of the issue. If the inflow of foreign direct investment in China decreases or reverses, and China's export earnings capacity declines, the direct consequence of large-scale capital flight could be an international payment crisis, endangering foreign investors' confidence in China's investment, triggering a reversal of foreign investment, further endangering the stability of the financial system, and the consequences would be unthinkable. From the perspective of international investors, since the investment risk in developing countries is generally higher than in developed countries, the return on capital flowing into developing countries must be higher than the international average return to compensate for the investment risk. Even if the capital that has flown out returns in the future, its return may not be sufficient to cover the cost of using foreign capital, let alone many of the capital that has flown out has no chance of returning. Furthermore, capital flight has the following negative effects on a country's economy: , the direct effect of capital flight is to reduce domestic investment, lower future potential economic growth, and even reduce current economic growth, hindering the economic development of developing countries and lowering people's living standards; second, capital flight can also disrupt the stability of exchange rates and interest rates, reducing the monetary authority's ability to control the money supply; third, capital flight may lead to "intermediary offshoreing," increasing domestic investment and financing costs, weakening the domestic financial system, reducing the competitiveness of domestic financial institutions, and causing financial system instability; fourth, capital flight can also lead to an unreasonable distribution of income from most domestic asset holders to a small number of foreign asset holders, which is extremely harmful to the healthy development of the domestic economy; fifth, capital flight can lead to structural fiscal deficits and rising inflation, and this structural deficit does not arise from excessive public spending but from the role of the public sector in the debt crisis and the publicization of private debt ②; sixth, the final result of capital flight is not only the loss of domestic capital but also possibly the loss of domestic entrepreneurial resources, which will severely affect the future development of countries that have experienced capital flight. Therefore, systematically studying the theoretical motivations of capital flight, analyzing and summarizing the problems and countermeasures of countries that have experienced capital flight, conducting in-depth empirical research on China's capital flight issue, exploring the motivations and effects of China's capital flight, and proposing corresponding countermeasures to suppress China's capital flight, have significant theoretical and practical value. For this purpose, Professor Yang Haizhen of the "Virtual Economy and Finance Research Center" at the Management School of the Graduate University of the Chinese Academy of Sciences has taken on the research topic "Theoretical Research on Capital Flight and Analysis of China's Capital Flight Problem." This is also a project supported by the National Natural Science Foundation of China (Project No.: 70173013). Professor Yang has long been concerned with the field of "The Theory and Effects of International Capital Flow." Since 1999, she has been researching capital flight, and this manuscript is the result of five years of dedicated research by Professor Yang. Overall, the research focus of the manuscript aligns with China's actual situation and has a certain forward-looking nature. The content is rich, convincing, and the data is detailed, with a rigorous writing style, making it a highly professional manuscript that has strong reference value for China's financial system and even the entire macroeconomic system. Capital flight can be said to be one of the main triggers of the debt crisis in Latin American countries in the 1980s, the 1994 Mexican financial crisis, and the 1997 Southeast Asian monetary crisis. At the same time, it has also become one of the basic indicators for measuring a country's creditworthiness. The World Bank has already adopted different estimation methods to estimate capital flight in all developing countries from 1971 to 1991 in 1993. Many international financial institutions and banks have used the scale of capital flight as an important indicator to measure lending risks.