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Three major reasons for China's capital flight
Hu Shaojiang

The official 'China Youth', in a rare move, recently carried an article that discussed the subject of China’s capital going overseas. By borrowing data from an investigation by the State Foreign Currency Management Bureau, this article authored by Tong Dahuan disclosed that between 1997 and 1999 the accumulated capital flow overseas had reached USD $53 billion. This sum equals 60% of foreign direct investment during these two years, and approaches about 6% of China’s one-year GNP. It is generally assumed that, due to the difficulty of calculating such capital flow and political reasons, this official figure is far below the actual amount of capital smuggled out of the country. Some unofficial financial institutions estimate that the actual amount for the capital smuggled overseas during these two years should be around USD $100 billion.

As a developing nation that needs capital for construction, a large volume of capital flow overseas is not a healthy phenomenon. From the perspective of society’s need for capital investment, China is still far from reaching the saturation point for investment. Statistics show that over the past two decades, with an average annual investment growth rate above 20% and a GNP growth rate of 8%, the domestic economy can produce about seven million jobs each year. Namely, a million jobs requires more than 1% economic growth rate and 3% investment growth rate. A conservative estimation will put the number of China’s current unemployment around 250 million people. Therefore, a large volume of investments and a high economic growth rate are desperately needed to reduce the burden of unemployment. From the angle of capital supply, because China remains a nation with surplus labor and shortage of capital, a high capital return for the investment should be anticipated. Under such circumstances, normal capital flow should move into China, not the other way round.

What factors, then, have caused such capital to flow out of China instead of remaining inside for higher return? There are at least three reasons that should not be overlooked.

One reason is that the capital that comes from undisclosed sources or unjustified means is usually smuggled overseas very quickly. Corruption in the Chinese government is common and public secret. In recent years, in the absence of democracy and transparency by the media, while economic reform toward market economy has improved people’s living standard, the Party and government officials as well as the management in state-run companies are also given a great opportunity to divide public assets for private ownership. As the economic growth slows down and all sorts of economic and social conflicts intensify, the discontent of the populace has also gradually grown. Those social worms that have chewed out an enormous amount of public property are fully aware that they have become the targets of the public’s discontent, and they have grown to be concerned for the safety of their collected wealth. These people’s constant effort to move their wealth overseas is an important reason why the phenomenon of capital smuggling is becoming more serious.

A second reason is that China’s policy for the manufacturing industry and its market structure are not rational. In China, the majority of the economic fields are still monopolized by state capital, and the most obvious fields include telecommunications, railroad transportation, aviation, banking, and the insurance industry. Within these domains, state enterprises enjoy receiving high profits while consumers are situated in a completely passive position. Much of the private capital developed over the past twenty years still cannot enter these fields to compete or seek development. After entry into WTO, the Chinese government is being forced to gradually open these fields to foreign capital, but its tight grip on domestic private capital that restrains it from entering these fields has not been loosened. Such policy does not allow domestic private capital to find fair investment opportunities in China, and so it seeks opportunities overseas.

A third reason is that the state still enjoys too much power in economic life, and its economic activities are not legalized, which has increased the operation costs for domestic private capital and forced it to flee the Chinese market. The management power in the hands of government officials at all levels is enormous in land use, capital flow, and market control. While this enables officials to have more room to seek fortune with their power, it also increases the uncertainty of private capital investment’s hidden costs and capital return. Hence, a large volume of capital has been driven out of China to countries of rule of law with low hidden costs and little uncertainty, which has become a natural option for private capital.

History has shown that simply by controlling capital account to prevent capital from going overseas is not effective, as this requires comprehensive measures such as adjustment of policy for the manufacturing industry, limiting the government’s power, establishing a legalized economic management system, allowing transparency through the media, and materializing democracy in society. At this point, the Chinese government does not seem to have such determination to do that.

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