GENESIS OF INSTITUTIONAL THEORIES OF INTERNATIONAL CAPITAL FLOW IN THE CONTEXT OF OFFSHORE ENTERPRISE FUNCTIONING

Mudrak N.

post-graduate student, Department of International Business

Institute of International Relations of Taras Shevchenko National University of Kyiv,

Kyiv, Ukraine

GENESIS OF INSTITUTIONAL THEORIES OF INTERNATIONAL CAPITAL FLOW IN THE CONTEXT OF OFFSHORE ENTERPRISE FUNCTIONING

Summary: The article investigates theoretical approaches to the definition of essence and forms of the international capital movement (ICM), the reasons for their occurrence and their main features. The most typical conceptions of institutional development of global capital movement are considered, their structural classification is proposed based on the motives and economic effects of functioning of the ICM in the context of creation of modern world financial architecture. It has been proved that it is common for all modern theories of capital mobility is recognition that their modification takes place simultaneously with the actual ICM development and evolution. Modern research has shown significant interest in indicative comparative analysis of investment vectors of capital migration in connection with decisions by residents in a capital base country and non-residents in a capital importing country. It has been determined that this scientific interest is caused by the growing positive synergetic effect from combining traditional and offshore schemes for tax optimization of offshore business entities, diversification and integration of national economies, and their modernization under the influence of foreign trade development.

Key words: global economy, offshore, offshorization of economy, offshore financial networks, return policy, derived capital, outflow of capital.

Introduction During the last quarter of the century, ICM peculiarities have contributed to the formation of a global financial and economic environment – a fundamentally new worldwide architecture of commodity and financial flows. Actually, the modern investment flow of foreign capital (inflow and outflow) is carried out thanks to the use of various financial instruments of international money markets (loans, bonds, stocks, currency swaps, debt obligations, Forex, etc.); with capital exports outpacing growth rates of both world commodity exports and industrialized countries’ GDP. These processes have a different impact on the nature (volumes, forms, speed and directions) of the global movement of capital, on the structure of direct and portfolio foreign investments, dynamics of international loans and indicators of average rate of return on investments, expressed in interest rates. All these have led to a change in theoretical views and concepts of ICM and influenced the change in classical views on the internal nature and forms of manifestation of the global movement of capital, thus requiring further research by different theoretical and methodological schools.

Literature Review The most significant studies in this area are developed by domestic scientists I. Burakivsky, V. Dergachev, O. Plotnikov, O. Slosko, O. Stupnytskyy, A. Filipenko, M. Shekhovtsov, O. Shnirkov. They are devoted to the theoretical issues of offshore business organization, features of legal regulation of offshore companies, and tax optimization. Western scientists of the classical school, such as R. Harrod, E. Domar, S. Haimer, E. Chamberlain, R. Vernon, P. Buckley, and others, have made a significant contribution to the ICM theory. Among foreign scientists, it is necessary to highlight the works by such authors as T. Neal [1], H. McCann [2] and A. Zorome [3] where the authors provide theoretical justification and assessment of the impact of offshore business on donor and recipient countries; as well as J. Henry [4], who proposed quantitative and qualitative indicators in assessing the role of offshore entrepreneurship in the current structure of international finance. At the same time, there is a number of unresolved scientific problems regarding theoretical substantiation of current changes in the processes of global capital movement, the study of objective and subjective factors of ICM in the conditions of strengthening regional and transregional integration processes, ensuring coordination and interaction of economic policies of the countries in financial flow regulation.

The Purpose and Objectives of the Paper are to analyse classical theoretical approaches and modern institutional concepts in the definition of the essence and forms of the international capital movement in the conditions of the strengthening globalization processes.

The Research Objective and Results The present stage of the ICM process development is characterized by a number of persistent trends, as follows:

  • the growth rate of export of private capital far outstrips the rate of export of state capital;
  • the United States has become a major capital importer (approximately 5 million Americans are currently employed by foreign owned companies);
  • the intensity of cross-border capital migration within the industrialized countries is growing rapidly (over 70% of all foreign investment is accounted for by industrialized countries) [5].

The aggregate financial assets of countries and international organizations are currently estimated at about 290 trillion dollars according to the calculations of the Financial Stability Board. At the same time, the share of industrialized countries (US, Western Europe and Japan) accounts for 97-98% of the world’s total foreign direct investment, over 90% of portfolio foreign investment (international securities transactions) is carried out by developed countries (currently 5% of Japan’s production capacity , 20% of the United States and 30-40% of Western Europe are outside their national borders). TNCs controlling more than 1/3 of world industrial production and holding about 95% of world patents and licenses annually make foreign investments worth about 2 trillion dollars [6].

At the moment, we are talking about a sufficiently organized and efficient international capital market with well-defined procedures, legislative guarantees and sufficiently high liquidity. The global economic environment formation (1980-2018), the crisis and post-crisis recession of the global economy (1994-2014) have enriched the ICM theory and practice with new phenomena and laws. First, a number of emerging economies have evolved from recipients to powerful investors (in 2007, more investors from emerging markets than those from the developed ones first acquired real assets in OECD countries). In 2008-2009, capital flows between developed and emerging markets were practically aligned, with the latter being characterized not only as highly profitable, but also sufficiently capacious, reliable, liquid, and investment-friendly.

Second, during the global financial and economic crisis of 2008-2009, emerging markets showed less volatility of foreign capital flows compared to developed economies, where there was a significant outflow of capital. There is a gradual process of reviewing the US dollar hegemony in international settlements and borrowings, emissions and reserves; international organizations are structuring quotas and SDR baskets; and banks change requirements for capital adequacy and reserves, derivatives and off-balance sheet commitments. There is a clear correlation between the state of the economy, its growth, liquidity of financial instruments of companies of national scale and ICM development.

Third, the developing countries and their companies (due to the positive surplus in foreign trade) are rapidly expanding international investment, not simply acquiring liquid corporate and state assets, but giving preference to the strategic high-tech assets of developed economies.

In this context, a rapidly developing offshore financial ‘industry’ has played a significant role in increasing the international investment potential.

The ICM evolution (which largely coincides with the stages of development of the world financial system) is divided into five contingent stages based on the degree of mobility and demand for capital which is determined by the nature, forms and peculiarities of its migration between countries (Table 1).

Table 1

ICM Periodization and its Features

Time interval Conditional Name of the Period Distinctive Features
1867-1914 Origination Development of capital turnover arises as a result of equalization of exchange rates for gold
1914-1944 Stagnation Chaos and subsequent control over the movement of capital in order to maintain financial security
1944-1971 Restoration Use of control over the movement of capital in order to protect the national economy
1971-1990 Liberalization in developed countries Formation of banking and stock markets by removing restrictions on capital movement in developed countries
1990-2010 Liberalization in developing countries Encouraging liberalization and inflow of investment in the developing markets, emergence and spread of financial crises
2010- up to date Selective regeneration of ICM regulation Active national regulation and selective capital outflow control in individual emerging markets and in most emerging markets, the development of an international ICM regulatory framework

Source: [7; 8].

If during these five stages (until 2010) there has been a gradual increase in the ICM liberalization processes, the sixth stage of the development of international capital mobility is now characterized by an increase in the processes of electoral control and regulation of capital movement in developing markets, and especially in emerging markets. It is associated with new specific features of international capital export/import. Thus, the new structure of import of capital is characterized by an increasing share of short-term and speculative portfolio investments, as well as a high share of foreign currency borrowings without highly liquid provision, which increases the liability of capital-recipient countries to external financial ‘shocks’. Increased exports of capital from developing net capital export countries to developed countries stimulate selective interest of the first in introduction and expansion of measures to regulate ICM. In this regard, an important indicator related to the dynamics of the ICM is the international investment position of the country that reflects the volume of its financial assets (investments abroad) and liabilities (investments from abroad) to non-residents, as well as their structure for a certain period of time [9, p. 14].

If the investment decisions taken by TNCs to develop global production networks do not coincide with the position of the foreign capital recipient countries, then taking into account and assessment of the key factors and comparative advantages determine where the investors will implement their investment projects. With regard to offshore jurisdiction, among the two most important components that make up the ‘investment climate’ for them – the ‘size of the market’ (the index of global competitiveness) and ‘financial freedom’ (the index of economic freedom index) – the former prevails. It is ‘financial freedom’ that includes indicators such as efficiency assessment of the banking system, independence of the financial sector from state control and intervention, development level of the financial market, which is a ‘potential advantage’ for the countries of the offshore segment of the world economy [10, p. 24].

There are a number of concepts and theories in modern economic literature that explain the reasons and nature of the ICM in different ways. Therefore, by generalizing approaches to determining its causes and mechanism, they can be grouped into the following block: the technological breakdown theory (M. Posner); the portfolio investment theory (R. Harrod and E. Domar); the ‘protective investment’ theory (S. Heimer); the monopoly preferences theory (C. Kindleberger, E. Chamberlain); the appropriation theory (S. Magi); model of the life cycle (R. Vernon); the model of internalization (P. Buckley, M. Keson, A. Rugman, J. Dunning); the capital flight theory (D. Caddington). However, in attempt to explain the migration of capital as a phenomenon and to reveal its nature in the context of formation and development of a modern offshore industry, the author proposes to consider the institutional theories of the ICM based on the theories of neo-Keynesian and neoclassical synthesis. In the early 1950’s P. Samuelson substantiated the need to combine neo-Keynesian and neoclassical schools into a single direction, arguing that such a synthesis would remove the contradiction between aggregate macroeconomics and microeconomics, uniting them into a complementary unity. In the author’s opinion, this kind of synthesis is an instrument in analyzing the benefits of both schools for using the concepts of institutional theory in the context of ICM and formation of national and global systems for regulating international capital transfers.

M. Porter’s model of competitive advantages (1990) is the basis for most of the modern institutional ICM theories. It is based on the following assertions. Firstly, the competitive advantages of any country are determined by the international results of the activities of national firms (the decisive factor of ultimate efficiency is the ability of firms to use the potential of their own country). Secondly, the essential determinants of such ability are grouped in the ‘diamond model’ — a dynamic system of interdependent and mutually causal elements whose interaction leads to the development of competitive advantages of the country in particular industries. Thirdly, the key elements of this model are the corresponding levels of development: production factors, demand of the domestic market for products of major; auxiliary and related industries; and intra-industry competition. In this case, government actions and unforeseen circumstances are considered as additional factors of influence on the system of elements of the model [11].

Porter-Rugman’s model was subsequently based on Porter’s institutional model of competitive advantages. A. Rugman supplemented M. Porter’s model by justifying the idea of ​​a competitive alignment of the ‘diamond’ of national economies as a result of their integration: the components of national preferences are formed under the influence of an external (non-national) economic environment. It is a question of need to determine the relative competitiveness of the national economy on the basis of analysis of relations between the national ‘diamond’ and that of economies of other countries. In this regard, the success of the participation of each individual national economy in the international division of labour in general and in ICM processes, in particular, determines the direct dependence of the competitive advantages of each of its subjects, and ICM, in turn, is determined by the state of the ‘diamond’ (with its constituent parts and the nature of ties within the ‘diamond’ are determined by the national investment climate) [12].

D. Dunning supplemented Porter’s theory, firstly, with one more constituent – multinational business activity as a determinant that influences the dynamics of international division of labour, government domestic and foreign policy, monetary and financial relations, and membership in international and regional associations. Under these conditions, international investment is a key determinant of the national ‘diamond’ and an indicator of its status. Secondly, with conditions that allow foreign investors to take advantage of national or sectoral competitiveness of the country, as well as those that structure the mechanism of optimizing the impact of foreign investment on the development of competitive advantages of each individual state. Third, with the wording of the notion of ‘international investment environment’ which can be improved not only in the plane of economic, but also political efforts [13, pp. 88-144].

In general, the Porter-Rugman-Dunning model is the result of institutional approach to assessing the main components of an investor-friendly and receipient-friendly investment climate. Despite the fact that the model primarily focuses on the assessment of the main components of the latter at the micro level, it is also used to formulate a national investment policy within the IRA in a globalized world [14].

The concept of ‘investment climate’ in ICM theory is notable for its certain complexity with due consideration of all the principles of comparative advantages of individual markets. It includes the following parameters [15]:

a) government policy regarding foreign investments – compliance with international agreements, strength of state institutions, continuity of power, etc .;

b) economic conditions – the general state of the economy, the situation in the monetary, financial and credit systems of the country, the customs regime and conditions of use of labour, the level of national taxation, etc .;

c) the current legislation on companies –procedure for their creation, activity, reporting, international mobility, liquidation; measures regulating or restricting their activities;

d) social components (state, priorities and needs of social development);

e) environmental components.

In the context of development of modern forms of offshore business the appropriation theory [16] is based on the position that the high level of modern process of registration of ownership of all components of investment capital (in this case – technology, achievements in the field of management, firm promotion, etc. .) provides exceptional market advantages and creates conditions for the interest of the recipient country in the capital. According to this theory, since the exceptional advantages themselves do not endanger free competition on the market, but only create conditions for obtaining economic rent, the government, while executing FDI programmes, should refrain from their direct administrative regulation, limited to measures not only of direct economic effect (tax and other benefits), but also legal provision for the economic benefits.

The ‘capital flight’ theory integrates all the considered theories and models and, based on them, explains the reasons for the outflow of capital, proceeding from general neoclassical and institutional positions. In addition to the general reason for the ‘capital flight’in the form of reduction of the rate of return, the outflow of capital may also be adversely affected by the socio-economic situation, high risk of investment, sharp deterioration of the world market situation, etc. However, this theory is underdeveloped so far. For example, this is evidenced by the fact that the term ‘capital flight’ is interpreted in different ways. And this, in turn, affects the results of estimation of the scale of this phenomenon. Thus, D. Caddington [17] characterizes the ‘flight of capital’ as the illegal import and export of short-term private investment of a speculative nature. Other scholars, such as M. Dowley [18] and S. Erbe [19], believe that ‘capital flight’ is such a move of capital from a country that contradicts its national interests and occurs because of the unfavourable investment climate for many domestic capital owners. At the same time, they also emphasize the fact that capital’escapes’ from developing countries, since it often has an illegal origin.

D. Lassard and J. Williamson interpret this phenomenon as a massive and accelerated outflow of significant volumes of capital through legal and illegal channels for different terms and functional purposes of assets. The causes of this phenomenon are economic instability, unfavourable investment climate, risks of national currency depreciation, political instability, and criminal activity. According to their definition, the category of flight of capital is a spontaneous, large-scale, and sudden transfer of resident capital from one country to another (not regulated by the government) with the aim of:

  • saving its value or profitable investment;
  • preventing its expropriation as a result of rising political risks and instability of the national currency in the country;
  • ‘escape’ from high tax rates;
  • gaining a benefit in connection with a higher interest rate on short-term borrowing capital abroad;
  • prevention of losses from inflation;
  • benefitting from exchange rate relations [20].

Based on the analysis of the above definitions and in the context of the importance of the task, the author proposes his own interpretation of the difference between the ‘capital outflow’ and ‘capital flight’. The category capital outflow is a form of movement of capital (funds) from the country (owned by both the state and private owners), which are diverted to other countries in the form of investments, loans, for the purchase of securities and other assets, and are reflected in the capital account in the national balance of payments. It takes into account: capital transfers, direct investments, portfolio investments, financial derivatives, and other investment assets (legal statistics). The net outflow of capital is associated with the objective causes of globalization of the world economy and is defined as the difference between the total volume of outflow of capital abroad and the flow of capital to the country from abroad.

With regard tothe category of ‘capital flight’, the author believes that this is a process of illegal transfer of funds between countries that occurs in violation of their legal norms, rules and restrictions, and is not registered properly. Thus, in modern terms, what is called a single concept of the export of capital in theory is in practice the interweaving of its various streams with different purposes, forms, terms, and even legality. The capital outflow mainly contributes to the development of the world economy and national economies (under certain conditions, ensuring the efficiency of its application in the host country). At the same time, not all international capital flows determine such an impact, and some flows have negative consequences, which recently contributed to adding another important distribution to the classification of the ICM forms as legal and illegal export of capital.

The rapid growth in the last decade of international speculation and the increase in the share of speculative capital forced part of neoclassical economists to oppose the idea of ​​free movement of funds and active regulation of this sphere. J.Tobin initiated this direction and even offered to introduce a 1% tax on foreign exchange operations in order to limit the attractiveness of implementation of illegal and semi-legal financial tranfers. For their part, A. Bhaduri and E. Matsner proposed to introduce a tax on all short-term financial foreign transfers which, in their opinion, would not only enliven world trade and stimulate investment, but also become an additional source of cash revenues to the budget [21].

According to the analysis, the illegal export of capital is only partially accounted for by national statistics when it is masked by legality. For example, this happens when the goods are legally exported (although their value can be distorted), and the proceeds are spent on investment purposes abroad, or when the goods subject to import are paid in advance and the goods are not delivered to the country. These methods of transfer of capital are called ‘grey’, in contrast to ‘black’ methods used to launder dirty money. In this regard, it is the offshore jurisdictions have become target territories of the ICM due to their legal status. On the one hand, with the growth of illegal export of capital in recent decades, the need to counteract it at the national and supranational levels has increased, which makes ICM regulation particularly difficult and relevant in the context of the magnitude and speed of its movement. On the other hand, it is necessary to develop theories explaining the causes and mechanism of these new features of the ICM process.

Conclusions Summarizing the above overview of theories, models and concepts of ICM in the context of development of the modern offshore industry, we note the following. The peculiarities of the latest trends in international investment activity generate a number of new requirements for economic theory, concerning the in-depth study of institutional factors and the subjective motivation of the ICM. First, all modern theories are significantly interested in the comparative analysis of various indicators of investment decisions of residents in the country of capital base and non-residents in the capital importing country. However, according to the author’s analysis, there is an objective level of conventions – each individual theory simplifies the actual situation to some extent, exaggerating certain factors of the ICM and neglecting others. Therefore, only the analysis of all these theories as a whole and in relation to specific offshore jurisdictions can give true understanding of the reasons for the growth of their role as a modern financial instrument for international tax optimization in the ICM system. Secondly, development and change of capital mobility theories correspond to the development and evolution of the ICM itself, while traditional economic schools are sympathetic to the regulation of the ICM in general, especially its exports, although they formulate some necessary conditions for this (inefficient use of capital, existing threats in actions of private resident investors, lack of proportion in the balance of payments). The analysis of economic theories of the ICM and practical measures of its regulation shows that the primary task for each economy in the context of harmonizing the processes of raising capital is its own institutional (available financial and legal institutions) and infrastructure development.

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