What is a 'Leakage'

Leakage is a situation in which capital, or income, exits an economy or system rather than remaining within it. In economics, leakage refers to outflow from a circular flow of income model. In a two-sector model exhibiting a circular flow, all individual income is sent back to employers when goods and services are purchased, and back to employees through wages and dividends, creating a system without leakage.

BREAKING DOWN 'Leakage'

The exit of money from the economy through leakage results in a gap in supply and demand. Leakage occurs when income is taken out through taxes, savings and imports. In retail, leakage refers to consumers who spend money outside of the local market.

Closed circle income streams allow money to flow from businesses to households in a continuous fashion. As households purchase goods within the system, businesses spend money in support of labor needs and business expansion. When consumers choose to take money outside of the close circle, leakage occurs.

Sources of Leakage

Income can leak out of closed systems through a variety of events and mechanisms. Tourism can cause leakage through funds transitioning between those who live in a particular area and chosen tourist destinations. Additionally, tourism-based businesses who have facilities in one area, but hold their headquarters in another, may create leakage as funds are shifted to the headquarters location.

Importing goods can also result in leakage when the goods are considered necessary to support local business or interests. The funds used to purchase the imports leave the immediate area, resulting in an outflow of funds from the home area. Export funds can also result in leakage when those funds are invested in areas other than where the exports are produced which most commonly occurs in multinational business operations.

For example, the import of oil results in funds being directed to the country in which the oil is drilled creating leakage in the importing economy. Additionally, when goods produced in a foreign country, such as the those produced at the Nike, Inc. factory operating as Hunchun Hongfeng Factory Co. Ltd, located in Hun Chun City, Jilin, China, are exported to other countries for sale, a portion of the exporting profits are directed to the headquarters located in the United States. This leads the United States headquarters to profit based on the production of the Chinese facility and creates a point of leakage in Hun Chun City community.

Compensation for Leakage

In Keynesian economics, governments may have to inject cash into the system if leakage causes a shortage of capital. This injection of funds can occur by increasing the level of exports to foreign nations as well as through borrowing funds from investors or foreign governments.

Information Leakage

In regards to information or data, leakage occurs when internal information that was intended to remain private or confidential in nature is released to the public. This can include the accidental or intentional disclosure of information, or the failure to secure the information allowing for incidental exposure.

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