Capital flight and foreign investment: Two tales from China and Russia

In recent years both Russia and China have experienced capital flight, reportedly on a large scale. In the case of Russia, capital flight has been accompanied by slow growth of inflows of foreign investment. In contrast, China has experienced rapid growth in foreign investment. The differing experiences of Russia and China raise questions about the nature of capital flight in the two countries and about the relationship between capital flight outflows and foreign capital inflows. The Russian experience seems easier to explain, as foreign and domestic investors are behaving in similar ways: neighter group seems keen to invest in the Russian economy. This consistency of behaviour can be explained by the overall investment climate. If the returns to investment are low and risk is relstively high due to economic, political, legal, or regularoty factors, then both foreign and domestic investors will seek to take their savings elsewhere. Under such circumstances efforts to stem capital flight should focus on improving the overall climate for investment, with positive consequences for investment both by residents and foreignerts. Yet the Chinese experience suggests that even in a setting where the economy is experiencing dynamic growth and attracting foreign investors, residents may seek to send their savings abroad. Why is this so? The different behaviour of foreign and domestic investors arises because they face different incentives or receive different returns. In China a variety of factors cause differential returns between foreign and domestic investors. Some of these factors arise because of China's socialist economic legacy. Thus comparison of China and Rusia can yield useful insights. Examining relationships between capital flight and inflows of foreign investment in China and Russia raises further questions. Do inflows of foreign investment facilitate capital flight by increasing the availability of foreign exchange? To what extent are observed inflows of foreign investment financed by savings of foreign origin versus the return of recycling of fled capital? In this paper I explore some such issues. I begin below with a brief discussion of definitions and an evaluation of available statistics.