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Why China Lost About $3.8 Trillion To Capital Flight In The Last Decade

Inside Asia
Frank R. Gunter
Mr. Gunter is a professor of economics at Lehigh University and a senior fellow at the Foreign Policy Research Institute.
This article is more than 4 years old.

Over the last decade, an estimated $3.8 trillion in capital has left China. Net foreign direct investment over the same period of time has amounted to $1.3 trillion, leaving the country with a net loss.

To reduce capital flight, the Chinese government as developed a complex system of capital controls. But these actions haven’t stemmed the losses because they’re based upon three myths that distort our understanding of the causes and possible cures of Chinese capital flight.

Myth #1: expected depreciation of the yuan

The first myth is that the major driver of recent capital flight is the expectation of yuan depreciation. Based on this assumption, Chinese portfolio holders seek to convert yuan into dollars or other currencies in order to profit from the expected depreciation.

However, between 2005 and 2014 there was an almost 25% appreciation of the yuan to 6.14 yuan per dollar and yet capital flight accelerated from $125 billion in 2005 to $484 billion in 2014.

Myth #2: Economic and political troubles

Another myth is that recent increases are driven by economic concerns (the slowdown in China’s real economic growth) or political ones (the recent anticorruption efforts by President Xi Jinping to discipline senior Communist Party leadership).

Yet, from 2004-2010, China experienced both high real economic growth and political stability and still capital flight per year almost doubled.

High and low estimates of Chinese capital flight

Myth #3: Capital controls are the cure

The third myth is that if capital flight gets too large, Chinese authorities can reduce it by imposing controls. However, we only need to look back to 1998 to see that generally stricter capital controls only affected the preferred method of capital flight without substantially changing the volume. Capital flight using financial transactions fell about $105 billion in the five years following the 1998 rules while capital flight using trade mis-invoicing increased by $95 billion during the same period.

What, then, explains the acceleration of capital flight since 2005?

Rise of riches—and inequality

In one generation, China has transitioned from one of the most egalitarian states in the world to one of the most unequal. While Chinese government estimates of income and wealth inequality are state secrets, Forbes reports that there are 400 billionaires in China, second only to the 540 billionaires in the United States. Combined with the country’s millionaires, it appears that less than 0.5% of the population controls wealth equal to 25-33% of China’s GDP.

How much of this wealth is ill-gotten is difficult to estimate but it is believed that the origin of many recent fortunes in China is from legally ambiguous sources. One piece of information that has been revealed by the ongoing corruption crackdown is that many newly rich persons are closely related to high government officials.

Chinese wealth holders face a decision. They can stay in the country and run the risk of imprisonment and confiscation of their wealth in the next possibly politically-motivated anti-corruption investigation. Or they can seek to move “my children, my money, myself” out of China.

Moving out of China

Direct evidence of the importance of migration as a motive for capital flight is difficult to find, but there are several occurrences that are consistent with this hypothesis.

In 2011, the Chinese Central Bank estimated that about 18,000 government officials had left the country taking almost $7 million each. A survey from the same period showed that about 60% of rich Chinese wanted to migrate. And, there is strong Chinese interest in the U.S. EB-5 program and the Canadian equivalent that leads to permanent residency for foreigners that make at least a $500,000 investment in infrastructure. According to the U.S. State Department, almost 84% of all 2015 EB-5 visas were issued to persons from mainland China. This represented a minimum of $4.1 billion total investment.

The number of Chinese students in colleges outside China has also grown sharply over the last decade. In the U.S., the number of college students from China has increased about 500% to 304,000 in 2015—at a total annual cost of tuition, room and board of $10-$15 billion. Many of these students want to stay in the U.S. after graduation, but not only to avoid capital loss. There is an increasing shortage of well-paid jobs for college graduates in China as well as health concerns related to air pollution.

Reducing migration? 

Assuming migration is a major reason for capital flight, China has a few good options to reduce the desire to leave the country. China could strengthen the rule of law to substantially reduce both corruption and arbitrary anti-corruptions prosecutions, though that may be seen as an unacceptable restriction on Communist Party initiatives.

Or the government could aggressively seek to raise the overall quality of life in China both by improving the environment and ensuring high paid employment opportunities for educated Chinese.

Unfortunately, these initiatives will take a decade or more, and, in the meantime, China will continue to lose more than $500 billion a year in capital flight.