Postwar Capital Flight and Inflation

Abstract

This article provides empirical evidence on the effects of inflation on postwar capital flight flows. It tests the hypothesis that inflation has a positive differential effect on capital flight in postwar economies. It uses a new panel dataset of 77 developing countries, of which 35 experienced at least one episode of war between 1971 and 2000. The rest enjoyed peace throughout this period. Ordinary Least Squares, Generalized Least Squares, Within-Group and Arellano-Bond estimation methods are applied to four capital flight measures — Cline, World Bank, Morgan Guaranty and Dooley. The results support the research hypothesis: in postwar economies, a percentage point increase in the inflation rate is associated with a differential increase in annual capital flight flows of about 0.005 to 0.01 percentage points of GDP. This constitutes the positive differential impact of inflation on capital flight after war. This finding is robust to alternative specifications of the capital flight equation, the different measures of capital flight and econometric estimation methodologies. Given the average level of capital flight flows and the high and sustained inflation rates in some postwar economies, the overall effect could be substantial. The implication is that low inflation helps to curb capital flight in postwar economies.