Development Barriers - Capital Flight

In this video we look at some of the causes and consequences of capital flight.

Capital flight can be an important barrier to economic growth and development. Capital flight is the uncertain and rapid movement of large sums of money out of a country. The UK’s Overseas Development Institute (ODI) defines capital flight as "the outflow of resident capital which is motivated by economic and political uncertainty.”

What are the main causes of capital flight?

Most of these link to a collapse in investor confidence:

• Political turmoil and unrest / risk of civil conflict
• Fears that a government plans to take assets under state control – in other words – the threat of nationalisation
• Fears of an increase in corporate tax rates
• Fears that a government might default on their debts
• Exchange rate uncertainty ahead of a possible devaluation of the currency
• Fears over the wider stability of a country’s financial system including the safety of commercial bank deposits

Why is capital flight damaging for a developing economy?

• It leads to currency weakness – an outflow of currency causes the exchange rate to depreciate
• This causes a sharp rise in imported inflation and a rising cost of living
• Higher inflation has regressive effects on poorer households
• Currency weakness and instability makes it more expensive for a government to finance new issues of debt
• It also increases the real value of existing external debts
• Capital flight may leave an economy unable to finance essential imports such as pharmaceuticals, food, animal feed and energy