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When capital flows rapidly out of a country, usually because something happens which causes investors suddenly to lose confidence in its economy. (Strictly speaking, the problem is not so much the money leaving, but rather that investors in general suddenly lower their valuation of all the assets of the country. ) This is particularly worrying when the flight capital belongs to the country’s own citizens. This is often associated with a sharp fall in the exchange rate of the abandoned country’s currency.
Industry:Economy
Government-imposed restrictions on the ability of capital to move in or out of a country. Examples include limits on foreign investment in a country’s financial markets, on direct investment by foreigners in businesses or property, and on domestic residents’ investments abroad. Until the 20th century capital controls were uncommon, but many countries then imposed them. Following the end of the Second World War only Switzerland, Canada and the United States adopted open capital regimes. Other rich countries maintained strict controls and many made them tougher during the 1960s and 1970s. This changed in the 1980s and early 1990s, when most developed countries scrapped their capital controls. The pattern was more mixed in developing countries. Latin American countries imposed lots of them during the debt crisis of the 1980s then scrapped most of them from the late 1980s onwards. Asian countries began to loosen their widespread capital controls in the 1980s and did so more rapidly during the 1990s. In developed countries, there were two main reasons why capital controls were lifted: free markets became more fashionable and financiers became adept at finding ways around the controls. Developing countries later discovered that foreign capital could play a part in financing domestic investment, from roads in Thailand to telecoms systems in Mexico, and, furthermore, that financial capital often brought with it valuable human capital. They also found that capital controls did not work and had unwanted side-effects. Latin America’s controls in the 1980s failed to keep much money at home and also deterred foreign investment. The Asian economic crisis and capital flight of the late 1990s revived interest in capital controls, as some Asian governments wondered whether lifting the controls had left them vulnerable to the whims of international speculators, whose money could flow out of a country as fast as it once flowed in. There was also discussion of a “Tobin tax” on short-term capital movements, proposed by James Tobin, a winner of the Nobel Prize for economics. Even so, they mostly considered only limited controls on short-term capital movements, particularly movements out of a country, and did not reverse the broader 20-year-old process of global financial and economic liberalization.
Industry:Economy
A method of valuing assets and calculating the cost of capital (for an alternative, see arbitrage pricing theory). The capital asset pricing model (CAPM) has come to dominate modern finance. The rationale of the CAPM can be simplified as follows. Investors can eliminate some sorts of risk, known as residual risk or alpha, by holding a diversified portfolio of assets (see modern portfolio theory). These alpha risks are specific to an individual asset, for example, the risk that a company’s managers will turn out to be no good. Some risks, such as that of a global recession, cannot be eliminated through diversification. So even a basket of all of the shares in a stock market will still be risky. People must be rewarded for investing in such a risky basket by earning returns on average above those that they can get on safer assets, such as treasury bills. Assuming investors diversify away alpha risks, how an investor values any particular asset should depend crucially on how much the asset’s price is affected by the risk of the market as a whole. The market’s risk contribution is captured by a measure of relative volatility, beta, which ¬indicates how much an asset’s price is expected to change when the overall market changes. Safe investments have a beta close to zero: economists call these assets risk free. Riskier investments, such as a share, should earn a premium over the risk-free rate. How much is calculated by the average premium for all assets of that type, multiplied by the particular asset’s beta. But does the CAPM work? It all comes down to beta, which some economists have found of dubious use. They think the CAPM may be an elegant theory that is no good in practice. Yet it is probably the best and certainly the most widely used method for calculating the cost of capital.
Industry:Economy
The ratio of a bank’s capital to its total assets, required by regulators to be above a minimum (“adequate”) level so that there is little risk of the bank going bust. How high this minimum level is may vary according to how risky a bank’s activities are.
Industry:Economy
Money or assets put to economic use, the life-blood of capitalism. Economists describe capital as one of the four essential ingredients of economic activity, the factors of production, along with land, labor and enterprise. Production processes that use a lot of capital relative to labor are capital intensive; those that use comparatively little capital are labor intensive. Capital takes different forms. A firm’s assets are known as its capital, which may include fixed capital (machinery, buildings, and so on) and working capital (stocks of raw materials and part-finished products, as well as money, that are used up quickly in the production process). Financial capital includes money, bonds and shares. Human capital is the economic wealth or potential contained in a person, some of it endowed at birth, the rest the product of training and education, if only in the university of life. The invisible glue of relationships and institutions that holds an economy together is its social capital.
Industry:Economy
The amount a company or an economy can produce using its current equipment, workers, capital and other resources at full tilt. Judging how close an economy is to operating at full capacity is an important ingredient of monetary policy, for if there is not enough spare capacity to absorb an increase in demand, prices are likely to rise instead. Measuring an economy’s output gap – how far current output is above or below what it would be at full capacity – is difficult, if not impossible, which is why even the best-intentioned central bank can struggle to keep down inflation. When there is too much spare capacity, however, the result can be deflation, as firms and employees cut their prices and wage demands to compete for whatever demand there may be.
Industry:Economy
Eating people is wrong. Eating your own business may not be. Firms used to be reluctant to launch new products and services that competed with what they were already doing, as the new thing would eat into (cannibalize) their existing business. In today's innovative, technology-intensive economy, however, a willingness to cannibalize is more often seen as a good thing. This is because innovation often takes the form of what economists call creative destruction (see Schumpeter), in which a superior new product destroys the market for existing products. In this environment, the best course of action for successful firms that want to avoid losing their market to a rival with an innovation may be to carry out the creative destruction themselves.
Industry:Economy
A market in which supply seems plentiful and prices seem low; the opposite of a seller's market.
Industry:Economy
The long-run pattern of economic growth and recession. According to the Center for International Business Cycle Research at Columbia University, between 1854 and 1945 the average expansion lasted 29 months and the average contraction 21 months. Since the Second World War, however, expansions have lasted almost twice as long, an average of 50 months, and contractions have shortened to an average of only 11 months. Over the years, economists have produced numerous theories of why economic activity fluctuates so much, none of them particularly convincing. A Kitchin cycle supposedly lasted 39 months and was due to fluctuations in companies' inventories. The Juglar cycle would last 8—9 years as a result of changes in investment in plant and machinery. Then there was the 20-year Kuznets cycle, allegedly driven by house-building, and, perhaps the best-known theory of them all, the 50-year kondratieff wave. Hayek tangled with Keynes over what caused the business cycle, and won the Nobel Prize for economics for his theory that variations in an economy's output depended on the sort of capital it had. Taking a quite different tack, in the late 1960s Arthur Okun, an economic adviser to presidents Kennedy and Johnson, proclaimed that the business cycle was "obsolete". A year later, the American economy was in recession. Again, in the late 1990s, some economists claimed that technological innovation and globalization meant that the business cycle was a thing of the past. Alas, they were soon proved wrong.
Industry:Economy
How the people who run companies feel about their organizations' prospects. In many countries, surveys measure average business confidence. These can provide useful signs about the current condition of the economy, because companies often have information about consumer demand sooner than government statisticians do.
Industry:Economy
