An analysis of capital flight : the case of Hong Kong

Abstract

This thesis studies capital flight from a short and long run perspective. It is stressed that the distinction between short and long run is important for proper understanding of the movements of real and financial capital. This is particularly relevant for the case of Hong Kong, in which the main motivation is the 1997 uncertainty. The political shock led to a fall in expected profitability and immediately set off a flight of financial capital. In the longer run, and occupying a considerable period of time, the fall in profitability leads to real effects. In the long run, the flight involves real capital. In view of the special nature of the motivation and the responses in the case of Hong Kong, several models are presented to address the issues. These models take into consideration the nature of the economy of Hong Kong and the changes in expectation as a result of the political event. The short run responses are elicited by a portfolio balance model with a high degree of price/wage flexibility. The political disturbance led to an autonomous asset preference shift from domestic to foreign bonds, resulting in a rise in the domestic interest rate and a depreciation of the exchange rate. The output effect is found to be negative in a fixed exchange rate system while it is ambiguous under a flexible rate, depending on the degree of wage indexation. The long run responses are examined in an intertemporal context. Two significant areas of importance are identified and examined. First, the change in the constraints faced by local households which affects the choice of domestic and external wealth accumulation as well as the decision to stay or to emigrate. Second, the expectation of a fall in the marginal productivity of capital and the effects on optimal capital accumulation. The presence of a transition period before the shock occurs and the uncertainty of the timing of the shock are two significant features. The results of these models show that there is a diversity of possible responses to the 1997 uncertainty. However, external asset accumulation is a rational response when there is an increase in pessimism. Moreover, the fall in marginal productivity of capital will eventually lead to a lower equilibrium level of domestic capital stock and consumption. After examining available evidence of capital movements, it is concluded that, during the period from 1983 to 1992, Hong Kong experienced two episodes of short run capital flight, while long run capital flight was an ongoing process throughout that period. The long run process has involved not only substantial increases in the net external asset position but also the emigration of the rich and professionals (human capital). A fall in the rate of domestic investment was also recorded in the same period. A comparison of the case of Hong Kong with those in Latin America shows that there are some similarities regarding short run flight. However, it is the long run flight which is important for the case of Hong Kong. Show more