Capital flight

Question 1

Introduction

Answer 1

Introduction: Capital flight occurs when assets or money rapidly flow out of a country, usually due to an event or economic consequence. Capital flight was seen in some Asian and Latin American markets in the 1990s. The Argentine economic crisis of 2001 was in part the result of massive capital flight, induced by fears that Argentina would default on its external debt.

Question 2

Three points

Answer 2

Loss of tax revenue

Foreign currency gap

Savings gap

Question 3

Tax revenue point

Answer 3

Loss of Tax Revenue: Movement of assets out of a country can lead to a loss of revenue from taxes that are levied on asset holdings. A loss of tax revenue can itself lead to other potential barriers – reduced spending on infrastructure projects, or on educational programmes – which might result in reduced international competitiveness.

Question 4

Tax revenue evaluation

Answer 4

Evaluation: However one might question the size of the impact on tax revenue on developing economies. Difficulties in collecting direct taxes have led to many developing economies relying more heavily on indirect taxes and import duties. As such the overall impact on budgets will be insignificant.

Question 5

Currency gap point

Answer 5

Foreign currency gap: Capital flight causes a foreign currency gap. This is where LEDCs struggle to afford imports of foreign produced capital because of a lack of foreign currency. Structural change models suggest that development requires movement away from production of primary products to manufacturing or the tertiary sector. Those countries that have seen significant development (such as India and Brazil for example) have achieved this through utilising an increasingly skilled workforce. However movement to these types of markets relies upon capital. Without it, it is more likely to be forced into primary product production

Question 6

Currency gap evaluation

Answer 6

Evaluation: Is a focus on the production of primary products so problematic? LEDCs may maintain a comparative advantage in these products. Some products also exhibit higher YED (such as blueberries produced in Chile) which suggest that revenues will rise as global incomes rise. Therefore specialisation in these products may still make economic sense and allow these countries to maximise foreign currency income.

Question 7

Savings gap point

Answer 7

Savings gap: Capital flight can create a savings gap. The movement of money savings to be held in other countries reduces money deposits in banks within the country. This reduces the liquidity of bans and pushes up lending rates. As a result this reduces the ability of firms to access finance to purchase capital. A lack of capital caused means that a country can exhibit lower productivity compared to other countries. This increased cost of production leads to reduced international competitiveness. This could lead to reduced income from exports and a foreign currency gap.

Question 8

Savings gap evalauation

Answer 8

Evaluation: If LEDCs specialise in labour intensive production in which they might have a comparative advantage, a lack of capital may not inhibit them too much. For example, China, Vietnam and Bangladesh have been highly successful in exporting garment and textiles products which have been manufactured using highly labour intensive techniques with limited capital.