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The politics of capital flight: exit and exchange rates in Latin America*

Published online by Cambridge University Press:  26 October 2009

Jonathan Crystal
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Extract

The capacity to transfer wealth abroad had long served wealth-holders as a potent restraint on state encroachment. The creation of movable wealth, Montesqueau wrote in the eighteenth century, meant that ‘rulers have been compelled to govern with greater wisdom than they themselves might have intended’. In the years since then, new technology and increasing interdependence have greatly magnified this capability; one recent book argues that the increased mobility of capital and growing integration of economies means that all governments ‘have lost the vestiges of unchecked economic sovereignty’ and that they ‘must concede to the implied threats of quicksilver capital’ When enormous quantities of wealth travel across the world with a single tap of a computer key, a country risks paying heavy costs if it adopts the wrong policies. So if the nation-state is not yet dead, it appears to be severely weakened in its ability to pursue measures at odds with the wishes of mobile-asset holders

Type
Research Article
Information
Review of International Studies , Volume 20 , Issue 2 , April 1994 , pp. 131 - 147
Copyright
Copyright © British International Studies Association 1994

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References

1 Cited in Hirschman, Albert O., Essays in Trespassing: Economics to Politics and Beyond (Cambridge, MA, 1981), pp. 255Google Scholar.

2 McKenzie, Richard B. and Lee, Dwight RQuicksilver Capital: How the Rapid Movement of Wealth Has Changed the World(New York, 1991), pp. xiGoogle Scholar, 12.

3 See Lessard, Donald R. and Williamson, John (eds.), Capital Flight and Third World Debt (Washington, DC, 1987)Google Scholar. Gulati, Sunil (‘Capital Flight: Causes, Consequences, and Cures’, Journal of International Affairs, 42 (Fall 1988), p. 168)Google Scholar lists seven different definitions. Observers disagree about (among other things) whether to take into account the motives of capital holders, the magnitude or temporal nature of the outflow as well as its legality, and whether there is a corresponding simultaneous inflow.

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8 The difference, according to Lessard and Williamson (Capital Flight, p. 202), is that foreign investment seeks better opportunities abroad while capital flight escapes high risks at home. While both decisions are based on a comparison of relative returns and risks, the authors argue that rejecting the distinction would be ‘excessively purist’.

9 Susanne Erbe, ‘The Flight of Capital from Developing Countries’, Intereconomics, November/December (1985), p. 275. Emphasis added.

10 Lessard and Williamson (eds.), Capital Flight, p. 203.

11 Why is this? Briefly, high inflation means that people expect all prices to rise, including the price of foreign exchange (that is, the exchange rate is expected to depreciate). This increases the expected return to foreign currency and thus demand for it will increase leading to excess supply of home money. If rates were free to move, the current exchange rate would depreciate; when they are not, in the absence of a devaluation, the home currency becomes overvalued (Krugman, Paul R. and Obstfeld, Maurice, International Economics: Theory and Policy (Boston, 1988), pp. 334, 372)Google Scholar.

12 Cuddington, Capital Flight, pp. 12–13.

13 Simply adding a risk premium is often not a viable option because of underdeveloped capital markets and financial repression. A more difficult question is why sophisticated international bankers would not share the same pessimistic assessment of local conditions but instead, during this period, continue extending loans. The answer is that LDC governments guaranteed repayment of international loans (which were dollar denominated) whereas local investors did not feel nearly as secure about the safety of their assets (see Pastor, ‘Capital flight’, p. 7).

14 ‘An Exodus of Capital is Sapping the LDC Economies’, Business Week, 3 October 1983, p. 132.

15 See Hirschman, Albert, Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States (Cambridge, MA, 1970)Google Scholar, for the original framework.

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19 Pastor, ‘Capital Flight’. He suggests this could result from enhanced domestic investment opportunities resulting from increased consumption which outweigh higher labour costs. He therefore rejects the ability of IMF programmes to attract capital back from overseas.

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22 Maxfield, Governing Capital, p. 17.

23 John Cuddington, ‘Macroeconomic Determinants of Capital Flight: An Econometric Investigation’, in Lessard and Williamson (eds.), Capital Flight, pp. 85–100. As we shall see, an overvalued exchange rate will not always automatically lead to capital flight.

24 Maxfield, Governing Capital, p. 13.

25 Frieden, Jeffry, ‘Classes, Sectors, and Foreign Debt in Latin America’, Comparative Politics, 21 (October 1988), pp. 1–20CrossRefGoogle Scholar; Frieden, Jeffry, ‘Invested Interests: The Politics of National Economic Policies in a World of Global Finance’, International Organization, (1991), pp. 425–52CrossRefGoogle Scholar.

26 While debate rages over actual numbers, these relative magnitudes are widely agreed upon. See Cumby and Levich, ‘On the Definition and Magnitude’, for a comparison of different estimates.

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29 Foxley, Alejandro, Latin American Experiments in Neo-conservative Economics (Berkeley, 1983), p. 16Google Scholar.

30 Cuddington, ‘Capital Flight’, p. 24; Dornbusch, Rudiger and Carlos, Juan de Pablo, ‘Debt and Macroeconomic Stability in Argentina’, in Sachs, Jeffrey D. (ed.), Developing Country Debt and the World Economy (Chicago, 1989), pp. 37–56Google Scholar.

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34 Pastor, ‘Capitl Flight’, pp. 11, 14.

35 Maxfield, Governing Capital, p. vii.

36 Pastor, ‘Capitl Flight’, p. 11.

37 Lessard and Williamson, Capitl Flight, p. 195.

38 Erbe, ‘The Flight of Capital’, p. 275; Cumby and Levich, ‘On the Definition and Magnitude’, p. 49.

39 See Hawley, James PDollars and Borders (Armonk, NY, 1987)Google Scholar for a discussion on how US capital controls led to financial innovations (e.g. Eurodollars) which only exacerbated American difficulties.

40 Despite her advocacy of controls, Maxfield does recognize the importance of exchange rate policy in accounting for these differences, though I believe she understresses this point.

41 Elina A. Cardoso and Albert Fishlow, ‘The Macroeconomics of the Brazilian External Debt’, in Sachs (ed.), Developing Country Debt, pp. 83, 86; Coes, Donald V ‘Trade, International Payments, and Brazil's Economic Growth’, Latin American Research Review, 26 (1991), p. 176Google Scholar.

42 Frieden, ‘Classes, Sectors’, p. 6.

43 For Frieden, the second factor results directly from the first. Because labour has been relatively weak, Brazilian capitalists were able to pursue sectoral interests and seek government assistance. In more polarized societies, capital is so concerned with maintaining property rights, specific interests are subordinated (‘Classes and Sectors’, p. 4).

44 Frieden, ‘Classes and Sectors’, p. 6.

45 Kaufman, The Politics of Debt, p. 11.

46 Domestic industry, however, did oppose the government after the 1979 rise in interest rates forced the regime to pursue contractionary economic policy (Frieden, ‘Classes and Sectors’, pp. 6–7).

47 Coes, ‘Trade, International Payments’, p. 178.

41 Elina A. Cardoso and Albert Fishlow, ‘The Macroeconomics of the Brazilian External Debt’, in Sachs (ed.), Developing Country Debt, pp. 83, 86; Coes, Donald V ‘Trade, International Payments, and Brazil's Economic Growth’, Latin American Research Review, 26 (1991), p. 176Google Scholar.

42 Frieden, ‘Classes, Sectors’, p. 6.

43 For Frieden, the second factor results directly from the first. Because labour has been relatively weak, Brazilian capitalists were able to pursue sectoral interests and seek government assistance. In more polarized societies, capital is so concerned with maintaining property rights, specific interests are subordinated (‘Classes and Sectors’, p. 4).

44 Frieden, ‘Classes and Sectors’, p. 6.

45 Kaufman, The Politics of Debt, p. 11.

46 Domestic industry, however, did oppose the government after the 1979 rise in interest rates forced the regime to pursue contractionary economic policy (Frieden, ‘Classes and Sectors’, pp. 6–7).

47 Coes, ‘Trade, International Payments’, p. 178.

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50 Maxfield, Governing Capital, pp. 174–9.

51 It is suggestive that Colombia, which was the other major Latin American country to avoid capitl Flight, had an extraordinarily cohesive national bourgeoisie (Anglade, Christian and Fortin, Carlos (eds.), The State and Capital Accumulation in Latin America (London, 1985), pp. 288–9)CrossRefGoogle Scholar.

52 Pastor, ‘Capitl Flight’, p. 3.

53 The Stale and Capital Accumulation, p. 278.

54 Whitehead, Laurence, ‘The Adjustment Process in Chile: a Comparative Perspective’, in Thorp, Rosemary and Whitehead, Laurence (eds.), Latin American Debt and the Adjustment Crisis (London, 1987), p. 157Google Scholar.

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56 Whitehead, ‘The Adjustment Process’, p. 120.

57 Foxley, Latin American Experiments, p. 16.

58 See Edwards, Sebastian and Edwards, Alejandra Cox, Monetarism and Liberalization: The Chilean Experiment, 2nd edn (Chicago, 1991), pp. 35–40Google Scholar for a more detailed explanation of these policies and the economic theory behind them. This policy was later the inspiration for Argentina's programme mentioned above.

59 For one thing, the law of one price, which was the theory behind the government's strategy, works only for competitive markets of tradable standardized commodities. Secondly, though, unlike Argentina, Chile had controlled its fiscal deficit, it still maintained a wage indexation system which, though part of a comprehensive policy which contained labour, still contributed to perpetuating inflation (Edwards and Cox Edwards, Monetarism, p. 36; Sheahan, Patterns of Development, p. 225; Foxley, Latin American Experiments, p. 104).

60 Frieden, ‘Classesand! Sectors’, p. 8.

61 Sheahan, Patterns of Development, p. 226. Whitehead, ‘The Adjustment Process’, pp. 145–6.

62 Frieden, Jeffry, ‘Winners and Losers in the Latin American Debt Crisis: the Political Implications’, in Stallings, Barbara and Kaufman, Robert (eds.), Debt and Democracy in Latin America (Boulder, CO, 1989), p. 31Google Scholar.

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64 Edwards and Cox Edwards, Monetarism, p. 216.

65 Hirschman, Exit, Voice and Loyalty, p. 37.

66 Maxfield, Governing Capital, pp. 187–8.

67 ‘Heterodox’ is not the same as ‘populist’. The former refers to a policy where the state plays a more active role in regulation and investment decisions and more emphasis is placed on distribution and employment (see Stallings and Kaufman, Debt and Democracy, p. 2) but the ultimate goal may still be stabilization whereas populism's main objective is to promote the interests and increase the income of urban groups. On the subject of definitions, ‘orthodoxy’, as used throughout this paper, is defined by Stallings and Kaufman as ‘market-oriented approaches … that emphasize fiscal and monetary restraint, reduction in the size of the state sector, liberalization of trade restrictions, and collaboration with creditors’ (p. 2).

68 Jose Pablo Arellano and Joseph Ramos, ‘Chile,’ in Lessard and Williamson, Capitl Flight, p. 160.

69 Maxfield, Governing Capital, p. 166. Incidentally, given the structural and historical determinants of Maxfield's argument, it is difficult to see what good her concluding policy recommendations could do since they are bound to be frustrated in a country with a strong bankers‘ alliance (if they are tried at all).

70 Hartlyn, Jonathan and Morley, Samuel (eds.), Latin American Political Economy: Financial Crisis and Political Change (Boulder, CO, 1986), p. 48Google Scholar.

71 Frieden, ‘Invested Interests’, is an important exception.

72 Maxfield, Governing Capital, p. 25.

73 Cited in Glynn and Koenig, ‘The Capitl Flight Crisis’, p. 305.

74 Indeed, it was the ‘ideologically fickle’ foreign banks who required sovereign guarantees. David Felix, ‘On Financial Blowups and Authoritarian Regimes in Latin America’, in Hartlyn and Morley (eds.), Latin American Political Economy, p. 96.

75 See Kaufman, ‘Industrial Change’, and Haggard, Pathways, Chs 2 and 7 for representative discussions on the politics of ISI.

76 Haggard, ‘Inflation’, p. 240. For similar reasons, East Asian countries were able to undertake a restrictive monetary policy to prevent inflation in the 1970s. Thus, unlike the Latin American LDCs, they were not faced with entrenched inflation nor tempted to use exchange rate policies to reduce price levels. See Lin, Chinag-yuan, Latin America versus East Asia (Armonk, NY 1989), p. 196Google Scholar.

77 Dornbusch, Rudiger, Exchange Rates and Inflation (Cambridge, MA, 1988), p. 253Google Scholar.

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79 Cuddington, ‘Capitl Flight’, p. 221.

80 ‘Trade, International Payments’, p. 176.

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83 The Economist, in a 8 June 1991 article entitled ‘The Latin Market Comes to Life’ noted that ‘Sleek private enterprises are replacing the corrupt state-owned borrowers of yore’.