Conceptualizing C apital Flight: A Systems Perspective
Muhammad Azeem Qureshi
Associate Professor
Oslo Business School, Oslo and Akershus University College, Oslo, Norway
Basit Rizwan
Norwegian School of Economics (NHH) Bergen, Norway
Umar Burki
Associate Professor
Buskerud and Vestfold University College, Norway
1. Introduction
It is generally agreed that understanding a problem is a major and most important step towards
solving it. To better understand the problem of capital flight, we present a casual loop diagram
(CLD) that integrates many of the available theories about capital flight in a cobweb of cause and
effect relationship to holistically conceptualize this problem. The existing studies try to explain
the problem from a single country perspective and try to identify its causes like indebtedness
(Ndikumana and Boyce 2011), weak institutions and political systems including taxation and
other laws (Schjelderup, Cappelen et al. 2009), and expropriation, inflation, or
devaluations (Rojas-Suarez 1990). We draw analogy to the story of the blind men and an
elephant’ originated in India and observe that all these studies are partial representation of the
system. We argue that CLD provides a necessary template to conceptually map the existing
theories to fully understand the problem to develop a holistic, integrated and unified policy
framework at global level. The objective of this effort is to provide a template to identify a
comprehensive set of variables of relevance so that sovereign states agree to develop an
integrated and unified measuring and reporting system like SNA of UN.
2. Causal Loop Diagram
Existing literature agrees on the socio-economic costs of capital flight to the sovereign states but
lack of unified perspective constrains a unified policy response to better manage this problem.
One must appreciate the complex network of feedbacks within and among different parts of an
economy through a variety of channels (Rana 2003; Kraev and Akolgo 2005) and globalization
makes this complexity multifold. The complexity of a system arises not from the number of
components in the system structure but their interaction in feedback loops and delays (Sterman
2000). We embed different identified causes of capital flight to present their organic relationships
found in literature (Rojas-Suarez 1990; Schjelderup, Cappelen et al. 2009; Ndikumana and Boyce
2011) as aCLD in Figure 1.
For example, it is argued that based on higher expected inflation residents will move their capital
abroad because the domestic assets held by them will have less value due to higher inflation. But
this is half of the truth because once capital flight is triggered it will shrink the tax base reducing
the government revenue stream that will create budget deficit, and to fix this problem
governments will take some monetary measures, they will either try to fix it by borrowing
domestically which will cause the domestic interest rate to go up or they will print money , both
of these measure will increase the money supply and increase money supply will make inflation
to go even higher next time around (Dooley 1988; Ajayi 1992; Anthonya and Hallettbc 1992;
Vos 1992). Another effect of reduction in tax base will be that the investors will expect future tax
rate to go up creating e a strong incentive for them to move their capital abroad.
Another main reason for capital flight is global differences in tax regimes, especially between tax
havens and rest of the world. Literature tell us that investors move their capital abroad to
countries with low tax rate but considering transfer pricing and over/under invoicing of large
businesses having parent company registered in tax haven the problem magnifies manifold
depriving the originating countries of large stream of tax revenues. The problem does not end
here. The money that is transferred out of these countries through tax evasion and transfer pricing
can come back as foreign direct investment (FDI) to take further advantages for example in
developing countries low wages, low tax rate, some tax privileges or even cheaper natural
resources. This is double looting because the money in the first place belong to the country which
has been transferred to tax havens and later it comes to (possibly the same country) as FDI and
again eam high returns on that investment due to privileges and cumulative capital again flows to
tax havens hurting the host country twice in the process. Moreover, it is very hard to track the
source of money because of secrecy in these tax havens.
blue and red are some variables identified in literature
Figure 1: Causal Loop Diagram
3. Conclusion
A number of different methods are used to measure the capital flight but they are more or less
different variants of The World Bank’s Residual method. Different studies have identified a
number of different causes of capital flight. Nevertheless, we identify lack of unified
information/reporting framework (like SNA) and a Capital Flight Index (CFI) that could be used
as a single indicator for the measurement of capital flight as a major shortcoming in the existing
efforts. We argue that CFI will not only provide a holistic explanation of the phenomenon rather
than every country’s own perspective but will also a comparable database of all countries and
regions to help inform policy makers across the globe. We advocate an integrated global policy
framework because the policies deemed best when considered in isolation (one country) are
rendered inefficient when implemented in a complex feedback system and in combination of
different best policies (many countries independently) (Sterman 2000).
As Albert Einstein rightly pointed out that “any intelligent fool can make things bigger and more
complex... It takes a touch of genius and a lot of courage to move in the opposite direction”. This
will be true for the CFI because it will make a single point focus for policy makers to measure the
extent of capital flight from their own country. Policy maker will not be lost in technical details
of different current models that are used until today but using CFI they can measure and
benchmark their own target as they deem reasonable for the economy.
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“http://en.wikipedia.org/wiki/Blind_men_and_an_elephant
