CAPITAL FLIGHT FROM THE PEOPLE’S REPUBLIC OF CHINA: 1984-I 994 Frank R. Gunter ABSTRACC Since 1985, the foreign debt of the Peoples’ Republic of China has increased at a greater rate then would be explained by changes in the country’s current account, foreign direct investment and reserve holdings. This pattern is consistent with the large scale outflow of financial capital, commonly referred to as capital flight. This study provides a range of estimates for capital flight from the PRC for the period 1984 through 1994 using both Cuddington’s balance of payments and the residual measures. These measures are adjusted to reflect the legitimate assets of the PRC banking industry, m&invoicing of PRC trade with its major trading partners (especially Hong Kong), and the failure of official debt data to capture certain bank transactions. The results are consistent with the view that a combination of high domestic financial transactions costs, inappropriate exchange rates and political uncertainty continue to result in large scale capital flight from China. EL Classification zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONM Number s: #F34,016 I. INTRODUCTION Economic liberalization in the People’s Republic of China (PRC) has been accompanied by a dramatic growth in capital inflows into China. However, there has been increasing concern that a large portion of this capital has flowed out again in the form of capital flight. (See Kaye, 1993; Prybyla, 1994; Wu, 1993, Wall Street Journal, 1994) This study provides both rough estimates of the volume of capital flight over a sample period of 1984 through 1994 as well as an analysis of the possible causes of this flight. The size and large variance of this capital flight are sources of concern since capital flight may contribute to an unnec- essary increase in a country’s foreign debt, undermine the tax base, and even result in a net real capital transfer out of the country (Khan & Ul-Haque, 1985). According to the theory of capital flight, such flight can be viewed as a three-way tradeoff among secrecy, expected returns, and risk (Walter, 1985, 1987). Attempts to increase the secrecy of capital flight, perhaps to reduce the risk of detection of government authorities, will tend to reduce its return and/or increase its risk. Therefore, while perfectly hidden transactions may be possible, the cost in foregone return and increased risk can be quite large. As a result, most capital flight reflects a compromise among secrecy, return, and risk. This element of compromise increases the likelihood that attempts at capital flight will produce indirect evidence of its occurrence. Mrect all correspondence to: Frank R. Gunter, Department of Economics, Lehigh University, Bethlehem, PA 18015. China Economic Review, Volume 7, Number 1,1996, pages 77-96 Copyright Q 1996 by JAI Press Inc. All rights of reproduction in any form reserved. ISSN: 1043-951x.