The international response to the crisis in Ukraine has been depressing to watch. It is hard to avoid the conclusion that the west has so far been comprehensively outmanoeuvred by Russia, whose old-school, facts-on-the-ground tactics have been met by a series of feeble and poorly co-ordinated half-measures.
The diplomats dismiss such pessimism. In today’s financially globalised world, they say, there is more to the projection of power than conferences and UN resolutions. As the real measure of their strategy’s success, they point to the revival of modern Russia’s most chronic economic ailment – capital flight.
In the first three months of 2014, $51bn exited Russia, compared to half that a year earlier. In other words the financial markets are doing the diplomats’ job better than they ever could. Investors are voting with their feet. Every dollar of capital fleeing the country is another nail in the coffin of Putin’s policy in the “near abroad”.
The idea that internationally mobile capital has the power to discipline governments – and that this power is benign – is an old one. In the west, it usually crops up in the context of economic policy. The idea is that governments are prone to spend beyond their means and to dole out contracts to their backers and that they generally fail to take the “tough decisions” necessary for long-term economic success. Voters get to punish them for such misdemeanours only every four or five years. The financial markets, by contrast, do it in real time. Their X Factor panel sits in judgement 24 hours a day, with the price of a government’s bonds keeping track of the score.
The diplomats’ excitement is not be-cause they think that Russian capital flight shows up the shortcomings of the Kremlin’s latest budget plans, however. For them, it signifies something much bigger: a major counterweight to Vladimir Putin’s political power. In short, a powerful force for democratisation.
This, too, is an idea with a distinguished pedigree. In the 18th century, Montesquieu observed that since the invention of the bill of exchange – the prototype of the bonds, stocks and currencies traded on today’s international financial markets – Europe’s monarchs had become “compelled to govern with greater wisdom than they themselves might have intended”.
His contemporary the Scottish economist James Steuart put it even more bluntly. The ever-present threat that capital might flee the country, he wrote, was nothing less than “the most effective bridle [that] ever was invented against the folly of despotism”.
The diplomats in Washington and Brussels agree. Yet they should pause before engraving Steuart’s maxim over the gates of the US state department and Berlaymont, the home of the European Commission. Neither the economic nor the political benefits of the international free movement of capital are quite as simple as they look. Both rest on questionable assumptions.
The economic argument relies on the premise that markets accurately assess where capital can most profitably be deployed. The theory suggests, for example, that capital will tend to flow from rich countries – where it is plentiful and therefore earns a low return – to poor ones, where it is scarce and therefore highly productive. What could be more logical than that?
The reality is exactly the opposite. Over the past two decades, capital has tended to flow from poor countries to rich ones and, as the years leading up to the 2008 crisis showed, often into investments that are egregiously wasteful, too. There is, in other words, no economic law of gravity that ensures that capital flows to wherever it would be most productive. In the real world, other factors trump pure financial rationality and so capital often flows uphill.
The political dividend from international capital mobility is more ambiguous still. The unspoken assumption here is that the markets are in essence democratic, while the governments they undermine are corrupt – that’s the reason to applaud the fixing of the bridle to the despot.
What if it is the other way round? What if it is the government that is representative and the forces of capital that are not? Everything hangs on the distribution of wealth. In countries where the ownership of capital is widely dispersed, it may be a fair assumption that investors are a democratic force. But where wealth is concentrated among a tiny elite, it may not hold true at all. Russia is a good example: it is the capital of the country’s oligarchs that is fleeing abroad. The budget option open to the average Russian without a banker in Zurich or an estate agent in London involves a much less exotic itinerary: she buys dollar bills and sticks them under her mattress.
Two hundred and fifty years ago, international capital mobility may indeed have been an innovative force for the eradication of bad government. Today, it is just as often the means for multinational companies to dodge sales taxes or developing-world kleptocrats to siphon off their unearned wealth.
There is also another consideration – particularly for us here in the UK. For every country that capital is fleeing from, there has to be somewhere it is fleeing to.
This month, it was announced that penthouse D in the One Hyde Park development in London has been sold for £140m – unsurprisingly, newspapers reported that the buyer was “thought to be from Ukraine or Russia”. Just a few days earlier, the deputy governor of the Bank of England had warned that the UK’s booming housing market is “dangerous” and “the brightest light” flashing on its dashboard of risks.
An increase in Russian capital flight, I imagine the Bank would agree, is the last thing the UK economy needs.