Journal of Asian Economics 18 (2007) 904–914

Brothers in distress: Revolving capital flows of

Indonesia, Malaysia, and Thailand
Edsel L. Beja Jr.*
Department of Economics, Ateneo de Manila University, Quezon City 1108, Philippines
Received 4 April 2007; received in revised form 27 August 2007; accepted 28 August 2007

Abstract
The paper examines hypothesized linkages between external borrowings and capital flights as
presented in [Boyce, J. K. (1992). The revolving door? External debt and capital flight: Philippine case
study. World Development, 20(3), 335–349]. The results for Indonesia, Malaysia, and Thailand show that
large sums of capital flowed in and out of these economies in a revolving door fashion. The findings suggest
the necessity for sound domestic management as well as effective international involvement in capital
flows.
# 2007 Elsevier Inc. All rights reserved.

JEL classification: F20

Keywords: Capital flight; Indonesia; Malaysia; Thailand

1. Introduction

Scholars have observed that capital is fleeing the developing countries rather than going to
them (e.g., Alfaro, Kalemli-Ozcan, & Volosovych, 2007; Lucas, 1990; Tornell & Velasco, 1992).
Moreover, even though capital flows to developing countries, funds come in the form of short-
term capital or external borrowings that have caused instabilities and crises (e.g., Griffith-Jones,
Montes, & Nasution, 2001; Jomo, 1998; Montes, 1998) and, in turn, capital rush out from their
economies as capital flight (e.g., Lessard & Williamson, 1987; Pastor, 1990; Boyce &
Ndikumana, 2001; Epstein, 2005). This paper presents an analysis of capital flows, particularly
on the linkages between external borrowings and capital flights.

* Tel.: +63 2 4265661; fax: +63 2 4265661.

E-mail address: edsel.beja@gmail.com.

1049-0078/$ – see front matter # 2007 Elsevier Inc. All rights reserved.
doi:10.1016/j.asieco.2007.08.005
 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914 905

In the next sections, the revolving door of capital flows, the empirical procedure, and the
empirical results are discussed, followed by some policy issues. The last section concludes the
discussion.

2. The notion of a revolving door

Boyce and Ndikumana (2003; p. 107) define capital flight (KF) as the ‘‘massive private
outflow of funds’’ from resource-scarce developing countries. This definition can be
operationalized in many ways, but like Boyce & Ndikumana, this paper measures KF as the
net between the officially recorded sources and uses of funds.
Boyce (1992) is the first paper to employ a revolving door model to study the dynamics of
external borrowings and capital flights, particularly in the case of the Philippines. The
subsequent papers are Chipalkatti and Rishi (2001) on India, Ndikumana and Boyce (2003) on
Sub-Saharan Africa, Pincus and Ramli (2004) on Indonesia, Demir (2004) on Turkey, and Beja
(2006a) on the Philippines (henceforth, revolving door papers). Basically, the model posits that
there are direct and indirect factors to external borrowing and capital flight. In the direct
explanation, external borrowings provide the fuel and/or motive for flight, and vice versa. The
contention is that debts are transformed – sometimes instantaneously – from capital inflows to
capital flights. In turn, debt accumulation and the mounting burden of debt servicing (plus the
possibility of a debt default) signal increased risks, thus motivating flights. Meanwhile, a
financial vacuum is created, which must be filled with external resources, so more external
borrowings are taken as a result. Yet the money that fled may return in the form of foreign
investments or debts, disguising the origin of the capital but also benefiting from the
government guarantees against debt defaults in the process. What results is a revolving door
process of debt accumulation and capital flight.
For the indirect explanation, external borrowings and capital flights occur because of
overlapping exogenous factors but not causally linked to each other. For instance, economic
mismanagement results in external borrowing and capital flight, albeit the former is not the cause
of the latter, and vice versa. In a related way, developing countries become highly indebted not
because of capital flight but because of macroeconomic mismanagement. Policy mistakes, rent-
seeking behaviour, and the like induce capital to flee and contribute to the external indebtedness.
Similarly, liberal policies on capital flows lead to unsound investments and over-borrowing due
to the pro-cyclicality in flows. That is, flows are encouraged because of a lax environment that, in
turn, promotes further relaxation and more capital flows. But when the institutions for
governance are weakened or even missing funds can easily end up being pocketed by the
domestic elite (who transfer funds into private accounts abroad), spent on conspicuous
consumption, or out into showcase and unproductive projects that do not generate foreign
exchange for debt servicing. In the end, the indebtedness increases economic risks, which induce
capital flight. Of course, the low levels of human capital, the poorly developed domestic
institutions, or the limited and poor quality of public infrastructures, among others, contribute to
reduce the expected domestic rates of return thereby inducing capital flights even if the domestic
economy is not mismanaged.
The above discussion suggests that there are supply-and-demand dimensions to external
borrowings and capital flights. As such, an effective management of demand and supply factors is
needed to reduce capital flight. Indeed, McKinnon (1991) warned that embarking on premature
deregulation and rapid financial liberalization can result in unwarranted capital flights, unsound
indebtedness, or both as the indirect factors pointed out in the revolving door model can become
906 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914

stronger where governance structures are weak or missing. That is, capital flight occurs because
the conditions allow for it. In this view, sound institutions and instituting reforms in the proper
way can reduce capital flight.
As the revolving door papers point out, the indirect explanation is helpful in explaining the
cross-sectional correlations between external borrowing and capital flight. It remains true that
there is a close year-to-year correlation between external borrowing and capital flight. In some
cases, capital flight persists where macroeconomic conditions are stable. The tight correlations in
the current flows suggest that the direct factors have a strong role in the revolving door process,
while the correlations between the current and past flows mean persistence in external
borrowings and capital flights.

3. Empirics of the revolving door

Incorporating the direct and indirect explanations, the revolving door model can be presented
in structural form, such as

KF ¼ a0 þ a1 CDET þ a2 SDET þ a3 Z þ e1 ;
(1)
CDET ¼ b0 þ b1 KF þ b2 RES1 þ b3 Z þ e2

where the direct explanations are capital flight (KF), net additions to external borrowing (CDET),
external debt stock (SDET), lagged of total international reserves (RES1), while Z represents a
vector of indirect explanations. Dummies for financial liberalization, banking deregulation, the
1997 Asian Crisis, and interaction terms are also included in Z to capture other indirect factors.
Although rudimentary, the interaction terms may capture overlapping linkages between a dummy
variable and the direct linkages or the impact of the continued application of an economic policy
like deregulation or financial liberalization on external borrowing and/or capital flight. The
expected results are a1 and a2 > 0, and b1 and b2 > 0, although a2 < 0 and b2 < 0 are not
precluded. Those for Z can be positive or negative depending on the indicator used. The model is
estimated using two stage least squares procedure to address the simultaneity problem between
KF and CDET following Boyce (1992).1 The stepwise approach is followed in the regressions;
that is, after estimating the basic model, the statistically insignificant indicators are removed from
the model, replaced with alternative indicators, and the revised model is re-estimated until the
best and parsimonious result is obtained.
Estimates of KF are available in Beja (2006b). Other data are taken from the International
Monetary Fund (2005) and World Bank (2005). The indicators for politics and governance were
assembled after a review of the economic histories of the three economies.

3.1. External borrowing and capital flight

CDET [KF] is used for the fuel explanation and SDET [RES1] for the drive explanation of
the revolving door model. SDET and RES1 can also be considered as risk indicators due to
capital flights and external borrowings, respectively.

1
Among the revolving door papers, Pincus and Ramli (2004) employ two stage least squares procedure, Chipalkatti
and Rishi (2001), Demir (2004), and Beja (2006a) employ three stage least squares procedure, and Ndikumana and Boyce
(2003) employ panel regression.
 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914 907

3.2. Economic performance

The lag of economic growth rate (GROW) is used as proxy for economic performance. The lag
of current account balance (CAB), defined as exports net of imports and other current flows, is used
as an alternative indicator to GROW. A positive correlation between GROW and CAB exists
especially for an export-oriented economy. At the same time, reductions in CAB can be interpreted
as a risk indicator of the sustainability of economic growth in the following ways. First, low CAB
implies poorer economic performance. Secondly, negative CAB implies economic adjustment in
the future that can adversely affect future economic performance. Furthermore, if CAB is
dominantly financed by capital inflows (hence economic growth is financed by capital inflows),
there is a high risk for capital flows reversals or stoppage, which lead to a crisis.
Both inflation and budget deficits are not used in the model following the suggestion in
Ndikumana and Boyce (2003). When a significant amount of the production inputs are imported,
domestic inflation is also imported. In fact, it is likely that domestic inflation is predominantly of
the supply-driven variety. The budget deficit is also not used because debt servicing can distort
the fiscal position of the government. It is particularly problematic when indebted countries have
automatic appropriations for debt servicing and principal payments built into the budgets. On the
other hand, budget surplus is similarly problematic when the governments have (significant) off-
budget accounts.

3.3. Rates of return and risk

Differential rates of return (INT), defined as the domestic deposit rate minus the United States
90-day Treasury bill rate, and the change in INT (CINT) are used to capture the expected
domestic returns to capital. They are used as indirect indicators. A positive INT or CINT leads to
a decrease in capital flight, but it may increase external borrowing. Note that they are also risk
variables. RES1 and the accumulation of international reserves (CRES) are used to capture
foreign exchange risks. Large reductions in RES1 or CRES1 suggest dollarization of domestic
assets and thus capital flight.

3.4. Politics and governance

Political and governance indicators are the most difficult indicators to identify. To sharpen the
variables used in the model, resource persons were interviewed in Indonesia, Malaysia, and
Thailand. Dummy variables for political and governance indicators are included in the model, but
note that they are only indirect indicators. Data for direct political indicators like political
freedom and civil liberties do not show sufficient variation over time and, unfortunately, they do
are useful in the statistical analysis.

4. The ties that bind

This section discusses the regression results. Briefly, the results confirm a revolving door
process linking external borrowings and capital flights.2

2
The detailed results are available from the author. The results presented here have homoscedastic-consistent errors
and covariance, following Newey–West correction procedure.
908 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914

4.1. Indonesia

The results confirm debt-fuel and debt-driven capital flight, although SDET is statistically
weak.3 The coefficient on CDET means that 94 cents of a dollar of external borrowing ended up
as capital flight. From an economic point of view, the coefficient on SDET means that there was a
further 3 cents of capital flight because of increased external indebtedness. Accordingly, the total
relationship between the external borrowings and capital flights is almost one-to-one. This result
is not surprising considering that, among the three Southeast Asian economies studied, Indonesia
has the highest external debt to GDP ratio.
For the indirect linkages, the results are not surprising. Robust economic performances
(GROW), increases in international reserves (RES), and higher interest rate differentials (CINT)
show negative correlation with KF. As expected, the 1997 Asian Financial Crisis (AFC) induced
capital flight.4 However, there is no statistical evidence of capital flight hysteresis, suggesting that
capital flight is a short term process in Indonesia:

KF ¼ 6:47 þ 0:94CDET þ 0:03SDET

ws
 0:44GROW1  0:12CINT
s
 0:24RES1
ð3:25Þhs ð9:15Þhs ð1:35Þ ð2:48Þhs ð1:68Þ ð1:77Þs

þ 7:92AFC;
ð2:92Þhs

CDET ¼ 5:77 þ 0:56KF  0:33RES1  0:24GROW1 þ 0:01INT  2:90DER

s
ð3:82Þhs ð3:52Þhs ð4:30Þhs ð2:06Þvs ð0:17Þ ð1:85Þ

þ 0:39DER s KF (2)
ð1:87Þ

Moreover, the results confirm flight-fuelled but not flight-driven external borrowing. The
coefficient on KF means 56 cents of external borrowing ended up as capital flight. On the indirect
linkages, economic performance (GROW1) has a negative correlation with CDET, which means
that robust economic growth enables Indonesia to utilize domestic rather than external funds.
This finding is also consistent with that on RES1: large international reserves enable Indonesia
to rely less on external funds. Of course, Indonesia can generate funds from oil. But the result for
interest rate differentials (INT) is not statistically significant, while banking deregulation (DER)
shows a negative correlation with CDET. With significant interest rate differential, external
borrowings became an attractive option, but the borrowings were moderated during the banking
deregulation period.5 These results are surprising at first glance, but on closer inspection, banking
deregulation actually shifted the borrowing pattern into domestic sources as Bank Indonesia
started to provide credit certificates to domestic borrowers with very attractive rates. But the
interaction of DER and KF reveals that partly because of the capital flight in the deregulation
period, there was steady external borrowing. That is, the availability of domestic credit was not
enough to fill the financial vacuum created by capital flight. In this case, a dollar of capital flight

3
Numbers in parentheses are the t-values. hs means highly significant at 1% confidence interval; vs is very
significant 5% confidence interval; s is significant at 10% confidence interval; and ws is weakly significant at the
range of 15–20% confidence interval. For the KF equation, adj. R2 is 0.89 and F-Stat is 43.55. For the CDET
equation, adj. R2 is 0.74 and F-Stat is 16.15. Pincus and Ramli (2004) found similar results: KF ¼
0:22ð0:46Þ þ 0:62LTDEBTð3:31Þhs þ 0:16CREDITð1:94Þ  0:17INT1 ð2:78Þhs  0:25KF1 ð2:06Þvs adj. R2 = 0.53, F-
Stat = 8.4.
4
D4 = 1 from 1998 to 1999; and D1 = 0 otherwise.
5
D2 = 1 in 1988–1994; and D2 = 0 otherwise.
 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914 909

resulted in 39 cents of external borrowing in the deregulation period, further evidence of a flight-
fuelled process. These seemingly contradictory results can be rationalized as evidence of capital
flows dynamics in the context of the open capital accounts like in Indonesia.

4.2. Malaysia

The results confirm debt-fuelled capital flight but not for debt-driven capital flight.6 The
coefficient for CDET means that 55 cents of each dollar of external borrowing ended up as capital
flight.7 On close inspection, one finds that Malaysia has a low debt-fuelled capital flight because
of its low external debt to GDP ratio.
The results for the indirect linkages are interesting. GROW1 is not statistically significant but
its alternative indicator is: current account balance (CAB1) is positively correlated with KF.
Perhaps because of its small size, the export sector plays a critical role as an engine of economic
growth to Malaysia. But the trade sector is exploited for taking capital out of the country; that is, as
resources are generated with robust trade performances, funds are taken out through export or
import misinvoicing.8 The other coefficients are expected results. The change in the international
reserves (CRES1) shows a negative correlation with KF. There is also statistical evidence that the
New Economic Policy (NEP) and its associated programmes were important factors for the capital
flights between the 1970s and 1980s.9 Interestingly, there is no statistical evidence of a capital flight
hysteresis, indicating that capital flight is a short-term phenomenon even in Malaysia:
KF ¼ 15:20 þ 6:15CDET þ 0:03SDET þ 0:32CAB1  0:36INT  0:29CRES1
ð6:15Þhs ð4:75Þhs ð0:95Þ ð2:21Þvs ð0:94Þ ð1:86Þs

þ 8:69NEP;
ð4:21Þhs

CDET ¼  2:00 þ 0:36KF þ 0:05RES1  0:45CAB1 þ 2:44FIN

ws
þ 5:19NEP
ð0:74Þ ð2:41Þhs ð0:30Þ ð4:90Þhs ð1:53Þ ð2:65Þhs

 1:38AFC  KF (3)
ð2:82Þhs

The results confirm flight-fuelled external borrowing: 36 cents of external borrowing were
induced for a dollar of capital flight. But there is no flight-driven external borrowing. The results
for the indirect variables were expected. Robust economic performance (again, using CAB1) is
negatively correlated with CDET, thus there were 45 cents less external debt for each dollar of
surplus in CAB. Given high savings in Malaysia, the results on CAB suggest that, first, less
external borrowings were undertaken and, second, more domestic funds were available to sustain
economic growth. For RES1, the results suggest that larger reserves translate into better credit
ratings easing external borrowings. Similarly, results on the dummy variables are interesting. For
instance, financial liberalization (FIN) is positively but weakly correlated with CDET, a result

6
For the KF-equation, adj. R2 is 0.64 and F-Stat is 18.77. For the CDET-equation, adj. R2 is 0.68 and F-Stat is 12.03.
7
Although the regression results indicate that SDET is not statistically significant, it can still be argued that from an
economic point of view there is an additional 3 cents of capital flight because of debt accumulation, thus a total of 58 cents
for each dollar of external indebtedness. This figure can be argued to be a low end figure given that capita flight took place
between Malaysia and Singapore stock exchanges in the 1980s, through the Central Limit Order Book system. That is,
purchase of equities were made in Malaysia but sold in Singapore, while the proceeds are retained in Singapore or put into
offshore accounts elsewhere.
8
See related point in Marappan and Jomo (1994).
9
D3 = 1 in 1971–1990; and D3 = 0 otherwise. The NEP ended in 1990. See Jomo (1990) and Khoo (1995).
910 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914

that is consistent with the view that access to external funds was closely controlled by the
authorities, especially in the post Malaysian banking crisis of the 1980s.10 NEP is positively
correlated with CDET, again confirming the view that Malaysia resorted to external borrowing to
finance the NEP and its associated programmes.11 Finally, the result on the interaction of the
1997 Asian Financial Crisis (AFC) and KF shows a negative correlation, suggesting that the
counter-cyclical policies and capital controls contributed to reduce capital flight.12

4.3. Thailand

The results confirm debt-fuelled and debt-driven capital flight, but CDET is statistically
weak.13 From an economic point of view, results mean that 10 cents of capital flight occurred for
each dollar of external borrowing. There is also a further 10 cents of capital flight due to SDET.
As such, from 10 to 20 cents of external borrowing ended up as capital flight. Thus, for the three
Southeast Asian economies, Thailand has the weakest direct linkages on capital flight. Of course,
Thailand had the least amount of capital inflows relative Indonesia and Malaysia.
The results likewise show that robust economic performances (GROW1) and increased
international reserves (RES1) are negatively correlated with KF. The dummy variables and their
interaction terms are not statistically significant except for 1997 Asian Financial Crisis (AFC)
and CDET, suggesting that each dollar of external borrowing induces more than a dollar of
capital flight.14 Thus, in the case of Thailand, 10 cents of external borrowings fuelled capital
flight each year, except between 1997 and 1998 when about US$ 1.20 fuelled capital flight. Only
during those 2 years that the fuel linkages of Thailand exceed those of Indonesia. Still, like
Indonesia and Malaysia, there is no statistical evidence for capital flight hysteresis, again,
indicating that capital flight is a short-term phenomenon.
KF ¼ 6:21 þ 0:12CDET
ws
þ 0:11SDET 0:72GROW1  0:23RES1 þ 1:09CDET s AFC;
ð2:58Þhs ð1:34Þ ð2:53Þhs ð6:11Þhs ð2:37Þvs ð1:77Þ

CDET ¼ 19:02vs þ 0:68KF

ws
 0:73RES1 þ 0:31CDET1  0:90GROW1 þ 1:61INT  FIN
ð2:86Þ ð1:26Þ ð3:59Þhs ð1:60Þs ð1:57Þs ð2:54Þhs

(4)
There is evidence of flight-fuelled external borrowing, but the result is statistically weak. This
result suggests that 68 cents of external borrowing was induced for each dollar of capital flight.
However, there is no evidence of flight-driven linkage. In fact, large international reserves
(RES1) reduced the demand for external borrowing. Lastly, none of the dummy variables nor
the interaction terms were found to be statistically significant except for financial liberalization
(FIN) and interest rate differentials (INT), which suggests that financial liberalization resulted in

10
D1 = 1 from 1971 to 1982 and from 1991 to 2002; and D1 = 0 otherwise.
11
D3 = 1 from 1971 to 1990; and D3 = 0 otherwise.
12
Jomo (1990) pointed out that the impact of the 1998 capital controls might only be a coincidence since by late 1998,
the conditions had improved both in Malaysia and the rest of the world economy (also, interview on September 2004).
Kaplan and Rodrik (2001) stressed that the introduction of the 1998 capital controls gave the Malaysian government
greater autonomy in economic policy, especially in managing capital flows. In effect, the innovation provided the country
with a tool for minimizing the adverse impacts of the crisis and regaining control of the economy. Alternatively, the result
can be interpreted that capital that wanted to flee Malaysia had already left, thus the negative coefficient captures the
reduced amount of resources available for flight.
13
For the KF equation, adj. R2 is 0.78 and F-Stat is 14.53. For the CDET-equation, adj R2 is 0.40 and F-Stat is 6.93.
14
D3 = 1 from 1997 to 1998; and D3 = 0 otherwise.
 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914 911

more external borrowings and that they were facilitated by the prevailing high domestic interest
rates.15 Indeed, large interest rate differentials prevailed in the 1990s. To a degree, the large
differentials explain why private external borrowings expanded to dangerous levels in the 1990s.
This result can also be used to explain why financial liberalization did not bring about its
anticipated benefits, especially lower domestic interest rates, because capital inflows to Thailand
can only be sustained with large interest differentials. Accordingly, the result on CDET1
confirms hysteresis on external borrowing; that is, a dollar of past external borrowing leads to a
further 30 cents of borrowings in the next period. Lastly, robust economic performance
(GROW1) is negatively correlated with external borrowing.

4.4. Some implications of the results

The empirical results confirm the hypothesized revolving door process between external
borrowing and capital flight. The results likewise confirm the indirect linkages, thus highlighting
the importance of sound macroeconomic management of external borrowing and of capital flight.
From a policy point of view, the results suggest that governments are responsible in ensuring that
the external borrowings benefit their economies and not that the funds end up enriching a few
individuals. Governments that misuse borrowed funds are thus liable for the indebtedness of their
economies and must not impose the burden on their societies. If a government does not act to
redress the problem, it is also liable for creating the problem.
But creditors have to assume some responsibilities in managing external borrowings. For
instance, they need to have sounder lending policies and to exert prudence in the disbursement of
funds. Where external borrowings were misused or it cannot be demonstrated that the funds were
actually used in the borrowing country to improve the social conditions of the people, or if the
borrowed funds cannot be traced, or other similar problems, the presumption must be that the
funds have been diverted from the intended applications, and more likely, taken out as capital
flight. If creditors ignore or pretend not to see the situation, or if they do not do something to
redress the situation, or worse, were involved, they too are accountable for the indebtedness of a
country. As such, the legitimacy of external borrowings and the rationale for continuing to honour
external borrowings that society, as a whole, did not benefit from must be questioned.
Therefore, the people have the right to demand from both the governments and creditors for
debt relief. When the borrowings are odious or illegitimate, the debts have to be cancelled. Both
the governments and creditors have the obligation to take the appropriate response to the demand
of the people.
The empirical results on the indirect linkages say that sound macroeconomic management
remains an important goal. When macroeconomic mismanagement, low institutional
development, or poor governance produces weak economic performances, domestic and
foreign investors alike are discouraged and they pull out their capital to move it to safer locations.
This situation in turn induces capital flight and external indebtedness. To realize robust economic
growth, governments must pursue a complementary mix of policies covering, but not limited to,

15
D1 = 1 from 1991 to 2000; and D1 = 0 otherwise. Full financial liberalization was achieved by 1991; the capital
account was opened in late 1990. In 1993, the Bangkok International Banking Facility (BIBF) was introduced in the hope
that it would encourage competition among the domestic commercial banks and give domestic enterprises greater and
cheaper access to finance. BIBF was also expected to facilitate an ‘‘out–out’’ flow of finance (i.e., borrowing from abroad
and on-lending abroad). It turned out, however, that the BIBF encouraged the ‘‘out-in’’ flow of finance (i.e., borrowing
from abroad and on-lending domestically) and lending became predominantly short-term.
912 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914

interest rates, exchange rates, trade, and capital. Even so, the results on the indirect linkages also
suggest that solid macro-organizational foundations are important. Governments have to
strengthen their institutional base including the administrative or bureaucratic capacities so they
can effectively manoeuvre policies to create robust financial and industrial sectors and human
capital that engender economic growth.
Therefore, governments have to be at the centre of policy making and implementation. A
strong and effective government is able to produce economic growths and expand social
welfares. In the management of the macroeconomy, governments have to emphasize domestic
responsibility in setting goals. They have to choose policies that reflect the domestic
characteristics and contexts (e.g., choosing an appropriate monetary policy to encourage
domestic investment), be embedded in their societies to be able to respond to the domestic
pressures, including the provision of social safety nets, yet autonomous to withstand the external
challenges that are counter-productive to realizing robust economic growth and the macro-
organizational fundamentals. For instance, they have to manage external indebtedness, regulate
unproductive activities, and restrain speculative counter-productive to the macroeconomic and
macro-organization goals. Moreover, they have to enable government and private sector
cooperation and allow meaningful participation of the civil society, but vigilance is essential
because such arrangements can be captured by a few individuals to promote their own objectives
instead.
Finally, the results reinforce the need for domestic and international involvements in the
management of capital flows. If external borrowings flow out as capital flight and vice versa,
capital flows generate economic fragilities that increase risks and/or reduce the effectiveness of
macroeconomic policies, especially space for progressive policies that target full employment
and stability. It therefore becomes important to introduce some capital flows management to
address these vulnerabilities.16 That the introduction of the 1998 capital controls insulated
Malaysia from the worst economic problems cannot be doubted, albeit there are issues
concerning corruption and crony politics.17 The purpose of the intervention is not to re-introduce
financial repression that did not bring about useful results in the past but to regain control over
macroeconomic policies and where the economy is heading.
One way that such tools can be used is for directing capital into the tradable or productive
sectors thereby contributing to industrial deepening and pushing the economy to higher growth
trajectories. They can also be used to affect the volume and composition of capital formation in
the country thereby addressing external vulnerabilities that make the economy open to
speculative attacks, panics, and so on. Indeed, deregulation, financial liberalization, and
globalization, and the processes that go with them mean that the institutions for governance are
needed and have to be in place (and therefore need to be enhanced) to smooth the adjustment
processes. The contention is that capital flows management enable governments to regulate
capital that it is effectively applied for the generation of robust macroeconomic performances.

5. Conclusion

The revolving door model posits direct and indirect explanations of external borrowings and
capital flights. The former holds that external borrowings provide the fuel and/or motivation for

16
See details in Epstein, Grabel, & Jomo (2003) and discussion in Chang and Grabel (2004).
17
On Malaysia, see Athukorala (2001), Kaplan and Rodrik (2001), Johnson and Mitton (2003).
 E.L. Beja Jr. / Journal of Asian Economics 18 (2007) 904–914 913

capital flight, and vice versa That is, capital inflows have liquidity effects for capital flights. But
as the external indebtedness worsens, the mounting burden of debt servicing and the possibility of
a debt default signal increased risks, to which investors respond by pulling out their capital. In
this case, external indebtedness has a stock effect. Meanwhile, as capital flight proceeds, there is
a reduction in the available domestic resources to finance economic growth. This situation forces
a country to borrow to replenish lost funds. A process of debt accumulation and capital flight thus
ensues.
The latter explanation holds that external borrowing and capital flight occur because of
exogenous factors that affect them separately. Macroeconomic mismanagement creates risky and
uncertain conditions and capital flight becomes a response to such environments. Macroeconomic
mismanagement also leads to more external borrowing as more risky investments are taken up.
External indebtedness can worsen with corruption, rent-seeking activities, and the like. Similarly,
low human capital, less developed institutions, or poor infrastructures, among others, contribute to
reduce the expected domestic rates of return in the economy, inducing capital flight even if the
domestic economy is not mismanaged. But these explanations cannot account for the close year-to-
year correlation between external borrowings and capital flights.
The revolving door was confirmed for the cases of Indonesia, Malaysia, and Thailand.
External borrowings fuel capital flights, and vice versa. Good indicators for economic growth and
sufficient international reserves discourage external borrowings and capital flights. Higher
interest rate differentials reduce capital flights but can increase external borrowings, in turn,
increase capital flight because of increased indebtedness. Economic reforms like financial
liberalization facilitate external borrowings and capital flights because the requisite institutions
for governance are not in place or not introduced as reforms are instituted. As expected, economic
and financial crises induced capital flights. With financial liberalization, large capital flights
occur when crises happen.
Therefore, given the empirical results, it can be concluded that the revolving door nature of
external borrowings and capital flights sheds light on the nature of capital flows. It adds on to
understanding why capital flees developing countries. More importantly, the revolving door
points to a hollowing out process that ultimately will derail economic growth. Thus, in general,
when a developing economy is already lagging behind on the economic ladder, the revolving
door means that the economy is being pulled further down. Unless governments take up decisive
actions and cooperate with each another in disciplining capital and regaining control of their
macroeconomies, the revolving door ultimately kicks away the economic ladder. In the end,
economies are stock in economic stagnation or inferior trajectories of economic growth.

Acknowledgements

James K. Boyce, Gerald Epstein, Leonce Ndikumana, Jomo K.S., seminar participants at the
Asian Development Bank, and an anonymous referee gave useful suggestions to improve the
paper. Funding was provided by the Program in Applied Economics of the Social Science
Research Council, the Political Economy Research Institute of the University of Massachusetts
Amherst, and the Helenica Foundation. The usual disclaimer applies.

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