C

Capital Leakage

Capital leakage, sometimes referred to ascapital flight,occurs when wealth, gen-

erally in the form of investment capital, is moved from the source of its creation to

another location, rather than being reinvested in the original location. This may

happen at a number of scales—from the individual company to an entire country

or region. In the developing world, capital leakage is an issue for many countries,

which may successfully attract Foreign Direct Investment (FDI) in sizable

amounts, only to see most of the profits from that investment siphoned away into

external markets such as foreign stockexchanges, government bonds, insurance

annuities, or even investment in hard assets abroad, such as real estate holdings

or new production facilities like additional factories. For economies that are

attempting to build wealth, this process is problematical, because although invest-

ment in the country creates employment, it does not result in a proportional expan-

sion of the pool of capital and a subsequent rise in investment, meaning that

economic growth falls below levels that would otherwise result from the initial

investment. In other words,sustainable developmentis quite challenging under

conditions where significant capital leakage is occurring.

The domestic capital leaks back toward more developed economies for a variety

of reasons. First, capital flows tend to be directed toward more stable economies

and political systems where the risk of economic loss is lower. Second, investment

opportunities are greater in the developed world, because the stock markets there

offer investment in more established companies, the potential for profits is greater,

stock prices are more stable in many cases, and for a number of other reasons.

Many developing countries do not even have fully functioning domestic equities

and commodities markets, so capital tends to move toward the larger, external

investment markets. Political instability, high tax rates, and unfavorable currency

exchange rates all drive capital towardthe more established markets as well. In

some cases, the amount of capital leaking from the developing world is enormous,

on occasion nearly equal to the entire international debt of some lesser-developed

countries. Capital leakage may take place legally or illegally. Examples of illegal

capital leakage include bribery, evasion of tax payments, falsifying of import/

export documents or invoices, etc.

45