draining development.pdf - Khazar University

Governance and Illicit Flows 29businessman puts only 4 percent abroad, it is called “lack of confidence”?(Cumby and Levich 1987, quoted in Franko 2003, 89)The obvious answer is that, relative to overall domestic resources,more domestic capital tends to flee for longer from Argentina and Boliviathan from the United States and that this is so because structural uncertaintyabout future investment opportunities is higher in the formereconomies. To prevent relatively scarce capital from voting with its feetin situations of great structural uncertainty, developing countries aremore likely to impose regulatory barriers on free capital movement, thusturning what might simply appear to be good business sense into illegalcapital flight.By focusing on a single broad motive for capital flight, namely, utilitymaximization in the presence of differential policy regimes and investmentrisks, the portfolio approach conflates short-term utility (andprofit) maximization with structural political and economic uncertainties.No systematic distinction is made between the drivers of asymmetricinvestment risks in developing economies, which may range frominflation and exchange rate depreciation to expectations of confiscatorytaxation and outright politically motivated expropriation. Similarly,policy-induced market distortions can range from short-term fiscal andmonetary policies, common to all economies, to policies promotinglong-term structural and institutional changes with much more wideranging(and often more uncertain) implications for future investmentopportunities. This failure to distinguish between different drivers ofcapital flight considerably weakens the effectiveness of the policy implicationsarising from this approach. This consists essentially in the recommendationof market-friendly reforms to eliminate such market distortionson the assumption that these will also minimize asymmetricinvestment risks. If, however, markets do not as yet exist or suffer fromfundamental structural weaknesses, market-friendly reforms may beinsufficient to minimize differential investment risk relative to, forexample, advanced economies.This problem is, in fact, at least partially recognized by advocates ofthis approach. Some authors use a narrow statistical measure of capitalflight, the hot money measure, which limits capital flight to short-termspeculative capital outflows of the private nonbank sector (taken to be