draining development.pdf - Khazar University

28 Draining Developmentthe early 1980s, a growing consensus emerged about the difficulty ofisolating specific determinants of abnormal capital outflows ex ante(Dooley 1986; Khan and Ul Haque 1985; Vos 1992). While there wassome agreement on basic characteristics of abnormal outflows (that theytend to be permanent, not primarily aimed at asset diversification, andnot generating recorded foreign exchange income), the original effort toidentify the characteristics of abnormal capital outflows was replaced bydefinitions of capital flight in terms of a single-core driver, perceived differentlyby different approaches (Dooley 1986, 1988; Cuddington 1987).Capital flight as portfolio choiceFirst, the portfolio approach adopts standard models of expected utilitymaximization by rational economic agents to explain capital flight as aportfolio diversification response to higher foreign returns relative todomestic returns on assets (Khan and Ul Haque 1985; Lessard and Williamson1987; Dooley 1988; Collier, Hoeffler, and Pattillo 2001). Morespecifically, this involves a counterfactual comparison of after-tax domesticand foreign returns, adjusted for a range of variables, such as expecteddepreciation, volatility of returns, liquidity premiums, and various indicatorsof investment risk, including indexes of corruption. In this view,capital flight is caused by the existence of market distortions and asymmetricrisks in developing countries (relative to advanced economies).The underlying market-theoretical model of economic developmentbuilds on four core premises: (1) economic behavior relevant to capitalflight is correctly described by expected utility maximization, (2) marketsexist universally (and thus can be distorted), (3) individual agents possessthe ability to compute the probabilities of investment risk globally and onthe basis of counterfactual investment models, and (4) computable probabilitiescan be attached to all events.These are obviously fairly restrictive assumptions in any case. In thepresent context, however, the most important conceptual drawback isillustrated by the following remark of a Brazilian economist:Why is it that when an American puts money abroad it is called “foreigninvestment” and when an Argentinean does the same, it is called “capitalflight”? Why is it that when an American company puts 30 percent of itsequity abroad, it is called “strategic diversification” and when a Bolivian