Question

A booming economy can attract financial capital inflows, which promote further growth. However, capital can just as easily flow out of the country, leading to economic recession. Is a country whose economy is booming because it decided to stimulate consumer spending more or less likely to experience capital flight than an economy whose boom is caused by economic investment expenditure?

a) More likely
b) Less likely
c) Equally likely
d) Depends on other economic factors

Answer 1

A country whose economy is booming due to investment in real capital is less likely to experience capital flight than a country whose boom is based on stimulating consumer spending. Investment-driven growth typically leads to sustainable income and is more attractive to investors, reducing the risk of capital flight and economic recession.

Step-by-step explanation:

When considering the likelihood of capital flight, it is essential to assess the nature of economic growth. A country whose economy is booming due to stimulus in consumer spending may be more vulnerable to capital flight as this often involves short-term borrowing that may not generate sustainable income. Conversely, economic investment expenditure leads to growth that is investment-stimulated, whereby borrowed funds are used to finance real capital investment that can create long-term income and facilitate debt repayment.

An investment-stimulated economy is generally less likely to experience capital flight compared to one buoyed by consumer spending. This is because investment in productive assets often leads to enhanced productive capacity and stronger economic fundamentals, which can be more attractive to both domestic and foreign investors. Histories of economic ups and downs, such as in the East Asian Tigers and European nations like Greece, illustrate the potential volatility associated with capital flows, emphasizing the importance of the underlying reasons for economic growth.