Capital Leakage

Capital leakage, sometimes referred to as capital flight, occurs when wealth, generally 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 stock exchanges, 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 investment in the country creates employment, it does not result in a proportional expansion 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 development is 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 toward the 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.