Themes > Current Issues
21.05.2003
The Strange Story of Capital Controls
Jayati
Ghosh
The world
appears to be very strange at the moment. Words are being
distorted, used in completely opposite contexts, leaving
people groping for its true meaning. The most glaring
example, of course, is the US government's use of words in
the context of Iraq war, where 'freedom' has been used to
indicate the process of neo-colonial conquest, and
'democracy' to describe the system of rule by the
conquering power, and its tolerance to looting and
anarchy.
But even when the words themselves have not been completely desecrated by ill-use, there is now a tendency to make statements turn out to be the opposite of what is either intended or actually done. This is certainly the case with a lot of national and international economic policy-making at the moment.
Take the case of capital controls. There was a period, during the last decade, when regulation was a bad word, and liberalization of all kinds was lauded as the best course to pursue in terms of economic strategy. This was also the case for financial liberalization and deregulation in capital markets, both national and international.
However, the experience of intense and more frequent financial crises across the world, especially in some developing countries, has created a more balanced view of the advantages of completely liberalizing capital flows. In fact, there is growing recognition that such liberalization can create more problems than benefits, specially for the markets of developing countries.
This is not just the view expressed by developing countries, such as Argentina and Turkey, that have suffered from financial crises in the recent past. It has also been accepted by the International Monetary Fund (IMF), the international organization that was most active in pushing developing countries to undertake such liberalization. In a recent report, the IMF has accepted that there can be many problems with capital account liberalization, which can create highly volatile flow of capital that destabilize the economy.
The IMF even acknowledged that the process of liberalization has not really helped developing countries get more access to capital. They should have accepted this even earlier. The fact is that in the decade of the 1990s, which was when all countries liberalized massively, developing countries as a group actually got less capital inflow (as a share of GDP) than they did in the 1970s, when capital movements were much more controlled.
At a recent seminar in Berlin, Germany, it was surprising how many people in important positions accepted the need for capital controls. This was reiterated by representatives of the European Union, by central bankers from Germany and legislators from a number of countries across the world. To hear their views expressed at that seminar, you would think that the world is moving to a situation of much greater control over cross-border capital flows.
But the reality is quite the opposite. So far, the evidence everywhere is towards greater liberalization, not more control. And this process is continuing despite the growing recognition that such liberalization is both problematic and dangerous, and confers relatively few benefits.
An economist who has undertaken a comparative study of policies has pointed out that in the 1990s, there is not a single country in the world that has moved towards greater controls, except for temporary controls in the midst of an actual financial crisis. Every country has moved further towards liberalization, even when such liberalization had already led to tragedy once.
This is the case in East Asia, where the earlier controlled financial systems were associated with the success of these economies. The crisis in the late 1990s was substantially caused by the financial liberalization of the early 1990s in the region, but even after the crisis, these countries have typically gone in for further liberalization and allowing foreigners to enter and control their financial systems.
There were some countries, such as Chile, which were applauded by others because of their imaginative use of market-based capital controls that allowed them to survive the contagion effect of crises in Mexico and Argentina. But now Chile has removed all those controls, and is striving to reach the neo-liberal dream of a completely liberalized economy.
In other words, even as economists and policy advisers from across the world and from all ends of the ideological spectrum accept the need for more capital controls, governments are doing precisely the opposite. The Indian government is a case in point. It has moved in the direction of complete capital account liberalization, despite the clear evidence that 'hot' money is currently flowing into the country, with the potential of causing problems later.
It seems inexplicable, flying in the face of both evidence and the current accepted wisdom. The only analogy that comes to mind is that of lemmings marching resolutely towards the sea, towards death by drowning that inevitably awaits them at the end of the march.
But even when the words themselves have not been completely desecrated by ill-use, there is now a tendency to make statements turn out to be the opposite of what is either intended or actually done. This is certainly the case with a lot of national and international economic policy-making at the moment.
Take the case of capital controls. There was a period, during the last decade, when regulation was a bad word, and liberalization of all kinds was lauded as the best course to pursue in terms of economic strategy. This was also the case for financial liberalization and deregulation in capital markets, both national and international.
However, the experience of intense and more frequent financial crises across the world, especially in some developing countries, has created a more balanced view of the advantages of completely liberalizing capital flows. In fact, there is growing recognition that such liberalization can create more problems than benefits, specially for the markets of developing countries.
This is not just the view expressed by developing countries, such as Argentina and Turkey, that have suffered from financial crises in the recent past. It has also been accepted by the International Monetary Fund (IMF), the international organization that was most active in pushing developing countries to undertake such liberalization. In a recent report, the IMF has accepted that there can be many problems with capital account liberalization, which can create highly volatile flow of capital that destabilize the economy.
The IMF even acknowledged that the process of liberalization has not really helped developing countries get more access to capital. They should have accepted this even earlier. The fact is that in the decade of the 1990s, which was when all countries liberalized massively, developing countries as a group actually got less capital inflow (as a share of GDP) than they did in the 1970s, when capital movements were much more controlled.
At a recent seminar in Berlin, Germany, it was surprising how many people in important positions accepted the need for capital controls. This was reiterated by representatives of the European Union, by central bankers from Germany and legislators from a number of countries across the world. To hear their views expressed at that seminar, you would think that the world is moving to a situation of much greater control over cross-border capital flows.
But the reality is quite the opposite. So far, the evidence everywhere is towards greater liberalization, not more control. And this process is continuing despite the growing recognition that such liberalization is both problematic and dangerous, and confers relatively few benefits.
An economist who has undertaken a comparative study of policies has pointed out that in the 1990s, there is not a single country in the world that has moved towards greater controls, except for temporary controls in the midst of an actual financial crisis. Every country has moved further towards liberalization, even when such liberalization had already led to tragedy once.
This is the case in East Asia, where the earlier controlled financial systems were associated with the success of these economies. The crisis in the late 1990s was substantially caused by the financial liberalization of the early 1990s in the region, but even after the crisis, these countries have typically gone in for further liberalization and allowing foreigners to enter and control their financial systems.
There were some countries, such as Chile, which were applauded by others because of their imaginative use of market-based capital controls that allowed them to survive the contagion effect of crises in Mexico and Argentina. But now Chile has removed all those controls, and is striving to reach the neo-liberal dream of a completely liberalized economy.
In other words, even as economists and policy advisers from across the world and from all ends of the ideological spectrum accept the need for more capital controls, governments are doing precisely the opposite. The Indian government is a case in point. It has moved in the direction of complete capital account liberalization, despite the clear evidence that 'hot' money is currently flowing into the country, with the potential of causing problems later.
It seems inexplicable, flying in the face of both evidence and the current accepted wisdom. The only analogy that comes to mind is that of lemmings marching resolutely towards the sea, towards death by drowning that inevitably awaits them at the end of the march.
© MACROSCAN 2003