a Guatemalan airline

I got my first practical exposure to the phenomenon of capital flight when I started to work on Wall Street.  It came from a creative colleague at work who gave me a prospectus to read for a bond issue from a Central American airline.  Kind of like a puzzle, he asked me what I thought was unusual.

I had no idea what was going on…

…until he pointed out four things:

–the company was family-owned,

–it bought planes outright rather than leasing them (a much more expensive way of operating),

–it would sell perfectly serviceable planes when they were two or three years old and replace them with brand-new ones, plowing all the firm’s cash flow into this effort (again, very inefficient), and

–the planesalwaysspent the night in foreign airports, mostly in the US.

On the surface, this behavior seems crazy.

But think about it.  Most of the family wealth was tied up in the planes; they spent most of their time outside the country.

Perfect in case of a sharp change in the political winds.  And not obvious enough a move to catch the sitting government’s eye.

The airline was the family’s vehicle for capital flight (no puns intended).

two sides of one coin

“Brain drain” is the term coined in the UK for emigration of its highly skilled and educated citizens to the US after World War II.  It has become synonymous with the flight of human capital in general.

The term “capital flight” typically refers to the flight of financial capital.

why does capital flee a country?

Three main reasons:

–political repression, actual or feared

–limited economic prospects in the home country

–high taxes, either on current earnings or on accumulated wealth.

examples

politics

In the early 1980s, China announced it would not renew the UK lease on Hong Kong.  Therefore, the colony would revert to Chinese rule in 1997.  The UK then said it would not grant citizenship to anyone in Hong Kong (because they wouldn’t like the harsh UK climate).  So Hong Kong citizens began to look for other places in the Commonwealth to obtain passports and shift their wealth.

economic prospects

Emigration from Europe to the US post-WWII is a prime example of this phenomenon.  New Zealand or the Australia of twenty years ago might be others.

taxes

There has been a steady flow of people out of high-tax states in the US like California and New Jersey into neighboring areas like Nevada and Pennsylvania, where levies are lower. For decades, Ireland has attracted multinational corporations by offering very low tax rates.  One of the planks in the electoral platform of Mr. Hollande, the new head of government in France, was to raise income taxes on yearly earnings of over €1 million to 75%.  Reportedly, real estate agents in the UK have seen a surge in interest in London residences from French buyers.

fighting capital flight:  closing the borders

Generally speaking, there are two ways to stop capital flight/brain drain:  fix the problems that are causing the flight, or forcibly prevent capital from leaving.

Practically speaking, then, there’s only one way–closing the borders.

For financial capital, a government does this by limiting the amount of foreign currency a holder of the domestic currency can buy, or the amount of local currency he can transport out of the country.

For human capital, a country can restrict the ability of citizens, or their families, to leave.  In addition, a potential emigrant has to have someplace to emigrate to, which can make this issue a lot more complicated.

Tomorrow:  the situation in Greece.