What is a leak?
Flight refers to capital or income that leaves an economy or a system rather than staying there. In economics, the term refers to exits from a circular revenue stream model. In a two-sector model with a circular flow, all individual income is returned to employers when goods and services are purchased, and returned to employees in the form of wages and dividends. This cycle creates a leak-free system.
How does the leak work?
Leaks cause money to exit an economy and cause a gap in the supply and demand chain. Leaks occur when taxes, savings, and imports remove income from the system. In the retail sector, the leak refers to consumers who spend money outside the local market. Businesses in such an economy must find other ways to increase their revenues.
Closed-circuit income flows allow money to flow from businesses to households on a continuous basis. Businesses spend money to support labor needs and business development as households purchase goods through the system. A leak occurs when consumers choose to withdraw money outside the closed circle.
Key points to remember
- The capital that leaves an economy or a system rather than staying in the system is a leak.
- The funds spent on taxes, deposited in savings or used to buy imported products will create leaks.
- Export funds can cause leakage when these funds are invested in areas other than those where exports are produced.
Income can escape from closed systems through various events and mechanisms. Tourism can cause leaks through the transition of funds between those who live in a particular area and selected tourist destinations. In addition, tourism businesses that have facilities in one area but have their headquarters in another may create leaks when funds are transferred to the headquarters.
Importing goods can also cause leakage when the goods are deemed necessary to support local business or interests. The funds used to buy imports leave the immediate area, which leads to an exit from the area of origin.
Export funds can cause leakage when these funds are invested in areas other than those where exports are produced. This most often occurs in multinational business operations.
Information or data leaks occur when internal information that must be kept private or confidential is made public. This disclosure may include accidental or intentional disclosure of information, or an inability to secure information, which leads to exposure.
Compensation for leaks
Keynesian economic theory, developed by John Maynard Keynes, asserts that recessions depend on total demand in an economy of final goods and services. Governments may therefore need to take action to stimulate their economies by injecting liquidity into their systems when leaks cause a shortage of capital. This injection of funds can be achieved by increasing the level of exports to foreign countries, or by borrowing funds from foreign investors or governments.
A real example of a leak
The goods are produced at the Nike, Inc. (NKE) factory operating under the name of Hunchun Hongfeng Factory Co. Ltd. in Hun Chun City, China. When exported to other countries for sale, part of the export profits go to the head office located in the United States.
Ultimately, the profits of the American headquarters based on the production of the Chinese factory, which creates leaks in the community of Hun Chun City.