Capital Flight Essay ⋆ Essays on Controversial Topics ⋆ EssayEmpire

The phenomenon of capital flight refers to the movement of money—as capital—across national boundaries. This can be money leaving one country to be invested in financial assets in another country, or it can be foreign direct investment, whereby a company invests directly into a foreign country’s domestic structures, equipment, and organizations (nonfinancial assets). What makes capital movement “flight” is either the magnitude of the movement or the reason for the movement; that is, that the capital is “fleeing” something. However, no consensus exists on either what this magnitude or these reasons must be for capital movements to constitute flight. Thus, in general, any cross-national movement of capital may be considered capital flight.

When capital moves between countries, opposite economic impacts occur in the two affected countries. There are primarily positive effects for the country that is receiving the invested capital. For them, money is pouring into their economy, pumping it up and expanding economic activity. If the capital is invested only in financial assets, however, the money may just get lost in a speculative bubble of some sort, with no real net benefit for the economy. For the country from which capital is leaving, on the other hand, there are mainly negative effects. Falling investment will tend to retard economic growth, reducing the demand for labor and increasing unemployment. The money flowing to another country is that much money that cannot be used to expand the economy.

A striking example of capital flight is the East Asian financial crisis of 1997. This world region was greatly expanding for a generation leading up to this debacle, with capital pouring in from the rest of the world. At some point, however, investors became wary and started to pull out, trying to jump from what they perceived as a sinking ship. For the five countries of South Korea, Indonesia, Malaysia, Thailand, and the Philippines, the net private capital flow for 1996 was +$93 billion, and in 1997 it dropped to -$12 billion, which represented a 1-year turnaround of $105 billion in capital flowing out of these countries—in other words, capital flight. The economic consequences for these countries were severe. Indonesia’s economy, for example, grew 4.9 percent in 1997 and contracted 13.7 percent in 1998, while Malaysia’s growth rate fell from +7.8 percent in 1997 to -6.8 percent in 1998. Reversals of growth of these magnitudes can only be devastating for an economy. In addition, for these five countries, real wages dropped, unemployment increased significantly, and poverty rates rose dramatically; in Indonesia the poverty rate nearly tripled from 1997 to 1998.

The threat of capital mobility can be used as a tool of capitalists both to keep labor in line and to keep environmental costs in check. If workers demand higher wages and benefits, or better working conditions, the owners of capital can respond by threatening to move to a more congenial location, preferably one with lower wages and more docile workers. Given the extremely unequal distributions of income and wealth in the world, this threat is more than credible. For example, a U.S. worker making $20 per hour is effectively competing against a Chinese worker who makes perhaps 50 cents per hour. If that U.S. worker fights for a wage increase, the Chinese worker may become irresistible to the U.S. manufacturer—50 cents an hour can offset all sorts of financial obstacles to relocating abroad.

Further skewing this asymmetric relationship is the fact that workers do not have the same sort of mobility that capital has. It is legally very difficult and not very desirable to a worker to emigrate to another country simply to find a better job: Animate workers do not have the same mobility as inanimate capital. There is no “labor flight” comparable to “capital flight.” The difficulties encountered by Mexican workers in their movement to the United States underscore this asymmetry.

Within a country, the consequences of capital flight can be quite localized. For example, during the past 20 years U.S. auto companies shut down many assembly plants in Michigan to shift production to low-cost locations abroad. A well-known example of this is the city of Flint. Once a vibrant city where General Motors (GM) employed over 80,000 workers, Flint now has a poverty rate of over 25 percent, an unemployment rate of 12 percent, and only a few thousand workers still at GM. The devastation wreaked by capital flight has been overwhelming in Flint.

The ability of capitalists to move capital freely between countries is enhanced by free trade agreements. For example, the 1994 North American Free Trade Agreement (NAFTA) lifted trade restrictions not only on goods and services but also on capital flows between Mexico, the United States, and Canada. The removal of nearly all cross-border restrictions on both financial investment and foreign direct investment opened the door for capital to go wherever capitalists desired in order to reduce costs and increase profits. Restrictions on the movement of labor, in contrast, were not lifted: Most Mexican workers still have to enter the United States illegally to take advantage of the higher U.S. wages.

One result of NAFTA’s elimination of restrictions on the movement of financial capital was the Mexican financial debacle of 1994. Investors poured money into Mexico in the early 1990s, but with the enactment of NAFTA, it was very easy for these investments to flee Mexico as the speculative bubble burst. Reductions in Mexico’s output and employment followed this capital flight.

The dictates of the free market point toward unrestricted capital mobility. Along with arguing for free trade in goods and services, proponents of the free market generally argue for complete capital mobility. This, in turn, increases the probability of capital flight, especially of the sort associated with financial speculation. Capital flight thus becomes a logical result of international free trade.

Bibliography:

Baker, Dean, Gerald Epstein, and Robert Pollin, eds. 1998. Globalization and Progressive Economic Policy. Cambridge, England: Cambridge University Press.
Krugman, Paul. 2000. The Return of Depression Economics. New York: Norton.
Offner, Amy, Alejandro Reuss, and Chris Sturr, eds. 2004. Real World Globalization. 8th ed. Cambridge, MA: Dollars & Sense.

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