Capital control
Encyclopedia
Capital controls are measures such as transaction taxes
and other limits or outright prohibitions, which a nation's government can use to regulate the flows into and out of the country's capital account
.
Types of capital control include exchange controls
that prevent or limit the buying and selling of a national currency at the market rate, caps on the allowed volume for the international sale or purchase of various financial assets, transaction taxes such as the proposed Tobin tax
, minimum stay requirements, requirements for mandatory approval, or even limits on the amount of money a private citizen is allowed to remove from the country. There have been several shifts of opinion on whether capital controls are beneficial and in what circumstances they should be used.
Capital controls were an integral part of the Bretton Woods system
which emerged after World War II and lasted until the early 1970s. This period was the first time capital controls had been endorsed by mainstream economics
. In the 1970s free market economists became increasingly successful in persuading their colleagues that capital controls were in the main harmful. The US, other western governments, and the international financial institutions (the International Monetary Fund
(IMF) and World Bank
) began to take an increasingly critical view of capital controls and persuaded many countries to abandon them.
After the Asian Financial Crisis of 1997–98, there was a shift back towards the view that capital controls can be appropriate and even essential in times of financial crisis, at least among economists and within the administrations of developing countries. By the time of the 2008–09 crisis, even the IMF had endorsed the use capital controls as a response. In late 2009 several countries imposed capital controls even though their economies had recovered or were little affected by the global crisis; the reason given was to limit capital inflows which threatened to over-heat their economies. By February 2010 the IMF had almost entirely reversed the position it had adopted in the 80s and 90s, saying that capital controls can be useful as a regular policy tool even when there is no crisis to react to, though it still cautions against their overuse. The use of capital controls since the crises has increased markedly and proposals from the IMF and G20 have been made for international coordination that will increase their effectiveness. The UN, World Bank and Asian Development Bank all now consider that capital controls are an acceptable way for states to regulate potentially harmful capital flows, though concerns remain about their effectiveness among both senior government officials and analysts working in the financial markets.
. In the 1920s they were generally relaxed, only to be strengthened again in the wake of the 1929 Great Crash
. This was more an ad hoc response to potentially damaging flows rather than based on a change in normative economic theory. Economic historian Barry Eichengreen
has implied that the use of capital controls peaked during World War II, but the more general view is that the most wide ranging implementation occurred after Bretton Woods.
An example of capital control in the inter war period was the flight tax introduced in 1931 by Chancellor Brüning
. The tax was needed to limit the removal of capital from the country by wealthy residents. At the time Germany
was suffering economic hardship due to the Great Depression
and the harsh war reparations
imposed after World War I. Following the ascension of the Nazis
to power in 1933, the tax began to raise sizeable revenue from Jews who emigrated to escape state sponsored anti Semitism.
At the end of World War II, international capital was "caged" by the imposition of strong and wide ranging capital controls as part of the newly created Bretton Woods system
- it was perceived that this would help protect the interests of ordinary people and the wider economy. These measures were popular as at this time the western public's view of international bankers was generally very low, blaming them for the Great Depression
.
Keynes, one of the principal architects of the Bretton Woods system, envisaged capital controls as a permanent feature of the international monetary system, though he had agreed current account
convertibility should be adopted once international conditions had stabilised sufficiently This essentially meant that currencies were to be freely convertible for the purposes of international trade in goods and services, but not for capital account transactions. Most industrial economies relaxed their controls around 1958 to allow this to happen.
The other leading architect of Bretton Woods, the American Harry Dexter White
and his boss Henry Morgenthau
were somewhat less radical than Keynes, but still agreed on the need for permanent capital controls. In his closing address to the Bretton Woods conference, Morgenthau spoke of how the measures adopted would drive "...the usurious money lenders from the temple of international finance". Following the Keynesian Revolution
, the first two decades after World War II saw little argument against capital controls from economists, though an exception was Milton Friedman
. However, from the late 1950s the effectiveness of capital controls began to break down, in part due to innovations such as the Eurodollar
market. According to Dani Rodrik
it is unclear to what extent this was due to an unwillingness on the part of governments to respond effectively, as compared with an inability to do so. Eric Helliner has argued that heavy lobbying from Wall St bankers was a factor in persuading US authorities not to exempt the Eurodollar market from capital controls. From the late 1960s the prevailing opinion among economists began to switch to the view that capital controls are on the whole more harmful than beneficial.
While many of the capital controls in this era were directed at international financiers and banks, some were directed at individual citizens. For example in the 1960s British
families were at one point restricted from taking more than £50 with them out of the country for their foreign holidays.
In their book This Time Is Different economists Carmen Reinhart
and Kenneth Rogoff
suggest that the use of capital controls in this period, even more than its rapid economic growth, was responsible for the very low level of banking crises that occurred in the Bretton Woods era.
in favour of free market orientated policies and theories, countries began abolishing their capital controls, starting between 1973 - 1974 with the U.S., Canada, Germany and Switzerland and followed by Great Britain in 1979. Most other advanced and emerging economies followed, chiefly in the 1980s and early 1990s. During the period spanning from approximately 1980 - 2009, known as the Washington Consensus
, the normative opinion was that Capital controls were to be avoided except perhaps in a crises. It was widely held that the absence of controls allowed capital to freely flow to where it is needed most, helping not only investors to enjoy good returns, but also helping ordinary people to benefit from economic growth. During the 1980s many emerging economies decided or were coerced into following the advanced economies by abandoning their capital controls, though over 50 retained them at least partially.
The then orthodox view that capital controls are a bad thing was challenged to some extent following the 1997 Asian Financial Crisis. Asian nations that had retained their capital controls such as India and China could credit them for allowing them to escape the crisis relatively unscathed. Malaysia's prime minister Mahathir bin Mohamad
imposed capital controls as an emergency measure in September 1998, both strict exchange controls and limits on outflows from portfolio investments
- these were found to be effective in containing the damage from the crisis.
In the early nineties even some pro-globalization
economists like Jagdish Bhagwati
and some writers in publications like The Economist
spoke out in favour of a limited role for capital controls. But while many developing world economies lost faith in the free market consensus, it remained strong among western nations.
which reversed the previously prevailing orthodoxy.
During the 2008–2011 Icelandic financial crisis, the IMF proposed that capital controls should be imposed by Iceland, calling them "an essential feature of the monetary policy framework, given the scale of potential capital outflows."
In the latter half of 2009, as the crisis eased and financial activity picked up, several emerging economies adopted limited capital controls to protect against potential negative effects of capital inflows. This included Brazil
imposing a tax on the purchase of financial assets by foreigners and Taiwan
restricting overseas investors from buying Time deposit
s.
The partial return to favour of capital controls is linked to a wider emerging consensus among policy makers for the greater use of Macroprudential policy
. According to economics journalist Paul Mason
, international agreement for the global adoption of Macro prudential policy was reached at the 2009 G-20 Pittsburgh summit
- an agreement which Mason said had seemed impossible at the London summit
which took place only a few months before.
Pro capital control statements by various prominent economists, together with a February 2010 report by the IMF have been hailed as an "end of an era" and said to represent a reversal of the IMF's long held position that capital controls should be used in crises only.
However the IMF warn that capital controls are not always appropriate and should not be used as an alternative to the more challenging policy changes needed to address the root cause of economic problems.
In June 2010 The Financial Times published several articles on the growing trend towards using capital controls. They noted influential voices from the Asian Development Bank
and World Bank
had joined the IMF in advising there is a role for capital controls. The FT reported on the recent tightening of controls in Indonesia, South Korea, Taiwan, Brazil and Russia. In Indonesia recently implemented controls include a one-month minimum holding period for certain securities. In South Korea limits have been placed on currency forward positions. In Taiwan the access that foreigner investors have to certain bank deposits has been restricted. The FT cautioned that imposing controls has a downside including the creation of possible future problems in attracting funds.
By September 2010, emerging economies had experienced huge capital inflows resulting from carry trades made attractive to market participants by the expansionary monetary policies
several large economies had undertook over the previous two years as a response to the crisis. This has led to countries such as Brazil, Mexico, Peru, Colombia, Korea, Taiwan, South Africa, Russia and Poland further reviewing the possibility of increasing their capital controls as a response.
In October, with reference to increased concern about capital flows and widespread talk of an imminent Currency war
, financier George Soros
has suggested that capital controls are going to become much more widely used over the next few years.
But several analysts have questioned whether controls will be effective for most countries, with Chile
's finance minister saying his country had no plans to use them.
In February 2011, over 250 economists headed by Joseph Stiglitz wrote to the Obama administration asking them to remove clauses from various bilateral trade agreements that allow the use of capital controls to be penalised. There was strong counter lobbying by business and so far the US administration has not acted on the call, although some figures such as Treasury secretary Tim Geithner have spoken out in support of capital controls at least in certain circumstances.
Econometric analyses by the IMF and academic economists found that in general countries which deployed capital controls weathered the 2008 crisis better than comparable countries which did not.
In April 2011 the IMF published its first ever set of guidelines for the use of capital controls.
– the finding that its impossible for a nation's economic policy to simultaneously deliver more than two of the following three desirable macroeconomic goals: 1) A fixed exchange rate
, 2) an independent monetary policy
, 3) free movement for capital (absence of capital controls).
In the first age of globalization, governments largely chose to pursue a stable exchange rate while allowing freedom of movement for capital- the sacrifice was that their monetary policy was largely dictated by international conditions, not by the needs of the domestic economy. In the Bretton woods period governments were free to have both generally stable exchange rates and independent monetary policies at the price of capital controls. The impossible trinity concept was especially influential during this era, as a justification for capital controls. In the Washington consensus period, advanced economies generally chose to allow freedom of capital and to continue maintaining an independent monetary policy while accepting a floating
or semi floating exchange rate.
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Full freedom of movement for capital and payments has so far only been approached between individual pairings of states which have free trade agreements and relative freedom from capital controls, such as Canada and the U.S., or the complete freedom within regions such as the European Union
, with its "Four Freedoms"
and the Eurozone
. During the first age of globalization that was brought to an end by World War I, there were very few restrictions on the movement of capital, but all major economies except for Great Britain and the Netherlands heavily restricted payments for goods by the use of current account controls such as tariff
s and duties
.
Financial transaction tax
A financial transaction tax is a tax placed on a specific type of financial transaction for a specific purpose.This term has been most commonly associated with the financial sector, as opposed to consumption taxes paid by consumers. However, it is not a taxing of the financial institutions themselves...
and other limits or outright prohibitions, which a nation's government can use to regulate the flows into and out of the country's capital account
Capital account
The current and capital accounts make up a country's balance of payment . Together these three accounts tell a story about the state of an economy, its economic outlook and its strategies for achieving its desired goals...
.
Types of capital control include exchange controls
Foreign exchange controls
Foreign exchange controls are various forms of controls imposed by a government on the purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by nonresidents.Common foreign exchange controls include:...
that prevent or limit the buying and selling of a national currency at the market rate, caps on the allowed volume for the international sale or purchase of various financial assets, transaction taxes such as the proposed Tobin tax
Tobin tax
A Tobin tax, suggested by Nobel Laureate economist James Tobin, was originally defined as a tax on all spot conversions of one currency into another...
, minimum stay requirements, requirements for mandatory approval, or even limits on the amount of money a private citizen is allowed to remove from the country. There have been several shifts of opinion on whether capital controls are beneficial and in what circumstances they should be used.
Capital controls were an integral part of the Bretton Woods system
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
which emerged after World War II and lasted until the early 1970s. This period was the first time capital controls had been endorsed by mainstream economics
Mainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...
. In the 1970s free market economists became increasingly successful in persuading their colleagues that capital controls were in the main harmful. The US, other western governments, and the international financial institutions (the International Monetary Fund
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
(IMF) and World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
) began to take an increasingly critical view of capital controls and persuaded many countries to abandon them.
After the Asian Financial Crisis of 1997–98, there was a shift back towards the view that capital controls can be appropriate and even essential in times of financial crisis, at least among economists and within the administrations of developing countries. By the time of the 2008–09 crisis, even the IMF had endorsed the use capital controls as a response. In late 2009 several countries imposed capital controls even though their economies had recovered or were little affected by the global crisis; the reason given was to limit capital inflows which threatened to over-heat their economies. By February 2010 the IMF had almost entirely reversed the position it had adopted in the 80s and 90s, saying that capital controls can be useful as a regular policy tool even when there is no crisis to react to, though it still cautions against their overuse. The use of capital controls since the crises has increased markedly and proposals from the IMF and G20 have been made for international coordination that will increase their effectiveness. The UN, World Bank and Asian Development Bank all now consider that capital controls are an acceptable way for states to regulate potentially harmful capital flows, though concerns remain about their effectiveness among both senior government officials and analysts working in the financial markets.
Pre World War I
Prior to the 19th century there was generally little need for capital controls due to low levels of international trade and financial integration. In the first age of globalisation which is generally dated from 1870–1914, capital controls remained largely absent.World War I to World War II: 1914 - 1945
Highly restrictive capital controls were introduced with the outbreak of World War IWorld War I
World War I , which was predominantly called the World War or the Great War from its occurrence until 1939, and the First World War or World War I thereafter, was a major war centred in Europe that began on 28 July 1914 and lasted until 11 November 1918...
. In the 1920s they were generally relaxed, only to be strengthened again in the wake of the 1929 Great Crash
Wall Street Crash of 1929
The Wall Street Crash of 1929 , also known as the Great Crash, and the Stock Market Crash of 1929, was the most devastating stock market crash in the history of the United States, taking into consideration the full extent and duration of its fallout...
. This was more an ad hoc response to potentially damaging flows rather than based on a change in normative economic theory. Economic historian Barry Eichengreen
Barry Eichengreen
Barry Eichengreen is an American economist who holds the title of George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley, where he has taught since 1987...
has implied that the use of capital controls peaked during World War II, but the more general view is that the most wide ranging implementation occurred after Bretton Woods.
An example of capital control in the inter war period was the flight tax introduced in 1931 by Chancellor Brüning
Heinrich Brüning
Heinrich Brüning was Chancellor of Germany from 1930 to 1932, during the Weimar Republic. He was the longest serving Chancellor of the Weimar Republic, and remains a controversial figure in German politics....
. The tax was needed to limit the removal of capital from the country by wealthy residents. At the time Germany
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...
was suffering economic hardship due to the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
and the harsh war reparations
World War I reparations
World War I reparations refers to the payments and transfers of property and equipment that Germany was forced to make under the Treaty of Versailles following its defeat during World War I...
imposed after World War I. Following the ascension of the Nazis
Nazi Germany
Nazi Germany , also known as the Third Reich , but officially called German Reich from 1933 to 1943 and Greater German Reich from 26 June 1943 onward, is the name commonly used to refer to the state of Germany from 1933 to 1945, when it was a totalitarian dictatorship ruled by...
to power in 1933, the tax began to raise sizeable revenue from Jews who emigrated to escape state sponsored anti Semitism.
The Bretton Woods Era: 1945–1971
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
- it was perceived that this would help protect the interests of ordinary people and the wider economy. These measures were popular as at this time the western public's view of international bankers was generally very low, blaming them for the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
.
Keynes, one of the principal architects of the Bretton Woods system, envisaged capital controls as a permanent feature of the international monetary system, though he had agreed current account
Current account
In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...
convertibility should be adopted once international conditions had stabilised sufficiently This essentially meant that currencies were to be freely convertible for the purposes of international trade in goods and services, but not for capital account transactions. Most industrial economies relaxed their controls around 1958 to allow this to happen.
The other leading architect of Bretton Woods, the American Harry Dexter White
Harry Dexter White
Harry Dexter White was an American economist, and senior U.S. Treasury department official, participating in the Bretton Woods conference...
and his boss Henry Morgenthau
Henry Morgenthau, Jr.
Henry Morgenthau, Jr. was the U.S. Secretary of the Treasury during the administration of Franklin D. Roosevelt. He played a major role in designing and financing the New Deal...
were somewhat less radical than Keynes, but still agreed on the need for permanent capital controls. In his closing address to the Bretton Woods conference, Morgenthau spoke of how the measures adopted would drive "...the usurious money lenders from the temple of international finance". Following the Keynesian Revolution
Keynesian Revolution
The Keynesian Revolution was a fundamental reworking of economic theory concerning the factors determining employment levels in the overall economy. The revolution was set against the then orthodox economic framework: neoclassical economics....
, the first two decades after World War II saw little argument against capital controls from economists, though an exception was Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
. However, from the late 1950s the effectiveness of capital controls began to break down, in part due to innovations such as the Eurodollar
Eurodollar
Eurodollars are time deposits denominated in U.S. dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve. Consequently, such deposits are subject to much less regulation than similar deposits within the U.S., allowing for higher margins. The term...
market. According to Dani Rodrik
Dani Rodrik
Dani Rodrik is a Turkish economist and Rafiq Hariri Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University, teaching in the School's MPA/ID Program. He has published widely in the areas of international economics, economic development, and...
it is unclear to what extent this was due to an unwillingness on the part of governments to respond effectively, as compared with an inability to do so. Eric Helliner has argued that heavy lobbying from Wall St bankers was a factor in persuading US authorities not to exempt the Eurodollar market from capital controls. From the late 1960s the prevailing opinion among economists began to switch to the view that capital controls are on the whole more harmful than beneficial.
While many of the capital controls in this era were directed at international financiers and banks, some were directed at individual citizens. For example in the 1960s British
Great Britain
Great Britain or Britain is an island situated to the northwest of Continental Europe. It is the ninth largest island in the world, and the largest European island, as well as the largest of the British Isles...
families were at one point restricted from taking more than £50 with them out of the country for their foreign holidays.
In their book This Time Is Different economists Carmen Reinhart
Carmen Reinhart
-External links:*...
and Kenneth Rogoff
Kenneth Rogoff
Kenneth Saul "Ken" Rogoff is currently the Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard University. He is also a chess Grandmaster.-Early life:...
suggest that the use of capital controls in this period, even more than its rapid economic growth, was responsible for the very low level of banking crises that occurred in the Bretton Woods era.
Transition period and Washington consensus: 1971 - 2009
By the late 1970s, as part of the displacement of KeynesianismPost-war displacement of Keynesianism
The Post-war displacement of Keynesianism was a series of events which from mostly unobserved beginnings in the late 1940s, had by the early 1980s led to the replacement of Keynesian economics as the leading theoretical influence on economic life in the developed world...
in favour of free market orientated policies and theories, countries began abolishing their capital controls, starting between 1973 - 1974 with the U.S., Canada, Germany and Switzerland and followed by Great Britain in 1979. Most other advanced and emerging economies followed, chiefly in the 1980s and early 1990s. During the period spanning from approximately 1980 - 2009, known as the Washington Consensus
Washington Consensus
The term Washington Consensus was coined in 1989 by the economist John Williamson to describe a set of ten relatively specific economic policy prescriptions that he considered constituted the "standard" reform package promoted for crisis-wracked developing countries...
, the normative opinion was that Capital controls were to be avoided except perhaps in a crises. It was widely held that the absence of controls allowed capital to freely flow to where it is needed most, helping not only investors to enjoy good returns, but also helping ordinary people to benefit from economic growth. During the 1980s many emerging economies decided or were coerced into following the advanced economies by abandoning their capital controls, though over 50 retained them at least partially.
The then orthodox view that capital controls are a bad thing was challenged to some extent following the 1997 Asian Financial Crisis. Asian nations that had retained their capital controls such as India and China could credit them for allowing them to escape the crisis relatively unscathed. Malaysia's prime minister Mahathir bin Mohamad
Mahathir bin Mohamad
Tun Dr. Mahathir bin Mohamad . is a Malaysian politician who was the fourth Prime Minister of Malaysia. He held the post for 22 years from 1981 to 2003, making him Malaysia's longest serving Prime Minister. His political career spanned almost 40 years.Born and raised in Alor Setar, Kedah, Mahathir...
imposed capital controls as an emergency measure in September 1998, both strict exchange controls and limits on outflows from portfolio investments
Portfolio (finance)
Portfolio is a financial term denoting a collection of investments held by an investment company, hedge fund, financial institution or individual.-Definition:The term portfolio refers to any collection of financial assets such as stocks, bonds and cash...
- these were found to be effective in containing the damage from the crisis.
In the early nineties even some pro-globalization
Globalization
Globalization refers to the increasingly global relationships of culture, people and economic activity. Most often, it refers to economics: the global distribution of the production of goods and services, through reduction of barriers to international trade such as tariffs, export fees, and import...
economists like Jagdish Bhagwati
Jagdish Bhagwati
Jagdish Natwarlal Bhagwati is an Indian-American economist and professor of economics and law at Columbia University. He is well known for his research in international trade and for his advocacy of free trade....
and some writers in publications like The Economist
The Economist
The Economist is an English-language weekly news and international affairs publication owned by The Economist Newspaper Ltd. and edited in offices in the City of Westminster, London, England. Continuous publication began under founder James Wilson in September 1843...
spoke out in favour of a limited role for capital controls. But while many developing world economies lost faith in the free market consensus, it remained strong among western nations.
Post Washington Consensus: 2009 and later
By 2009, the global financial crisis had caused a resurgence in Keynesian thought2008–2009 Keynesian resurgence
In 2008 and 2009, there was a resurgence of interest in Keynesian economics among policy makers in the world's industrialized economies. This has included discussions and implementation of economic policies in accordance with the recommendations made by John Maynard Keynes in response to the Great...
which reversed the previously prevailing orthodoxy.
During the 2008–2011 Icelandic financial crisis, the IMF proposed that capital controls should be imposed by Iceland, calling them "an essential feature of the monetary policy framework, given the scale of potential capital outflows."
In the latter half of 2009, as the crisis eased and financial activity picked up, several emerging economies adopted limited capital controls to protect against potential negative effects of capital inflows. This included Brazil
Brazil
Brazil , officially the Federative Republic of Brazil , is the largest country in South America. It is the world's fifth largest country, both by geographical area and by population with over 192 million people...
imposing a tax on the purchase of financial assets by foreigners and Taiwan
Taiwan
Taiwan , also known, especially in the past, as Formosa , is the largest island of the same-named island group of East Asia in the western Pacific Ocean and located off the southeastern coast of mainland China. The island forms over 99% of the current territory of the Republic of China following...
restricting overseas investors from buying Time deposit
Time deposit
A time deposit is a money deposit at a banking institution that cannot be withdrawn for a certain "term" or period of time...
s.
The partial return to favour of capital controls is linked to a wider emerging consensus among policy makers for the greater use of Macroprudential policy
Macroprudential policy
Macroprudential policy is a concept in the banking regulation and supervision literature which has to do with defining conditions which can result in financial instability and how to prevent such outcomes through public policy.-Origin:...
. According to economics journalist Paul Mason
Paul Mason
Paul Mason may refer to:* Paul Mason , British television news correspondent* Paul Mason , American author* Paul Mason , British footballer* Paul Mason , Canadian canoeist and cartoonist...
, international agreement for the global adoption of Macro prudential policy was reached at the 2009 G-20 Pittsburgh summit
2009 G-20 Pittsburgh summit
The 2009 G-20 Pittsburgh Summit was the third meeting of the G-20 heads of state in discussion of financial markets and the world economy.The G-20 is the premier forum for discussing, planning and monitoring international economiccooperation....
- an agreement which Mason said had seemed impossible at the London summit
2009 G-20 London summit
The 2009 G-20 London Summit is the second meeting of the G-20 heads of state in discussion of financial markets and the world economy, which was held in London on 2 April 2009 at the ExCeL Exhibition Centre. It followed the first G-20 Leaders Summit on Financial Markets and the World Economy, which...
which took place only a few months before.
Pro capital control statements by various prominent economists, together with a February 2010 report by the IMF have been hailed as an "end of an era" and said to represent a reversal of the IMF's long held position that capital controls should be used in crises only.
However the IMF warn that capital controls are not always appropriate and should not be used as an alternative to the more challenging policy changes needed to address the root cause of economic problems.
In June 2010 The Financial Times published several articles on the growing trend towards using capital controls. They noted influential voices from the Asian Development Bank
Asian Development Bank
The Asian Development Bank is a regional development bank established on 22 August 1966 to facilitate economic development of countries in Asia...
and World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
had joined the IMF in advising there is a role for capital controls. The FT reported on the recent tightening of controls in Indonesia, South Korea, Taiwan, Brazil and Russia. In Indonesia recently implemented controls include a one-month minimum holding period for certain securities. In South Korea limits have been placed on currency forward positions. In Taiwan the access that foreigner investors have to certain bank deposits has been restricted. The FT cautioned that imposing controls has a downside including the creation of possible future problems in attracting funds.
By September 2010, emerging economies had experienced huge capital inflows resulting from carry trades made attractive to market participants by the expansionary monetary policies
Quantitative easing
Quantitative easing is an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective. A central bank buys financial assets to inject a pre-determined quantity of money into the economy...
several large economies had undertook over the previous two years as a response to the crisis. This has led to countries such as Brazil, Mexico, Peru, Colombia, Korea, Taiwan, South Africa, Russia and Poland further reviewing the possibility of increasing their capital controls as a response.
In October, with reference to increased concern about capital flows and widespread talk of an imminent Currency war
Currency war
Currency war, also known as competitive devaluation, is a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency. As the price to buy a particular currency falls, so to does the real price of exports from the...
, financier George Soros
George Soros
George Soros is a Hungarian-American business magnate, investor, philosopher, and philanthropist. He is the chairman of Soros Fund Management. Soros supports progressive-liberal causes...
has suggested that capital controls are going to become much more widely used over the next few years.
But several analysts have questioned whether controls will be effective for most countries, with Chile
Chile
Chile ,officially the Republic of Chile , is a country in South America occupying a long, narrow coastal strip between the Andes mountains to the east and the Pacific Ocean to the west. It borders Peru to the north, Bolivia to the northeast, Argentina to the east, and the Drake Passage in the far...
's finance minister saying his country had no plans to use them.
In February 2011, over 250 economists headed by Joseph Stiglitz wrote to the Obama administration asking them to remove clauses from various bilateral trade agreements that allow the use of capital controls to be penalised. There was strong counter lobbying by business and so far the US administration has not acted on the call, although some figures such as Treasury secretary Tim Geithner have spoken out in support of capital controls at least in certain circumstances.
Econometric analyses by the IMF and academic economists found that in general countries which deployed capital controls weathered the 2008 crisis better than comparable countries which did not.
In April 2011 the IMF published its first ever set of guidelines for the use of capital controls.
The impossible trinity trilemma
The history of capital controls is sometimes discussed in relation to the Impossible trinityImpossible trinity
The Impossible Trinity is a trilemma in international economics suggesting it is impossible to have all three of the following at the same time:...
– the finding that its impossible for a nation's economic policy to simultaneously deliver more than two of the following three desirable macroeconomic goals: 1) A fixed exchange rate
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...
, 2) an independent monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
, 3) free movement for capital (absence of capital controls).
In the first age of globalization, governments largely chose to pursue a stable exchange rate while allowing freedom of movement for capital- the sacrifice was that their monetary policy was largely dictated by international conditions, not by the needs of the domestic economy. In the Bretton woods period governments were free to have both generally stable exchange rates and independent monetary policies at the price of capital controls. The impossible trinity concept was especially influential during this era, as a justification for capital controls. In the Washington consensus period, advanced economies generally chose to allow freedom of capital and to continue maintaining an independent monetary policy while accepting a floating
Floating exchange rate
A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency....
or semi floating exchange rate.
Free movement of capital and payments
European Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...
, with its "Four Freedoms"
Four Freedoms (European Union)
The European Union's Internal Market seeks to guarantee the free movement of goods, capital, services, and people – the EU's four freedoms – within the EU's 27 member states.The Internal Market is intended to be conducive to increased competition, increased specialisation, larger...
and the Eurozone
Eurozone
The eurozone , officially called the euro area, is an economic and monetary union of seventeen European Union member states that have adopted the euro as their common currency and sole legal tender...
. During the first age of globalization that was brought to an end by World War I, there were very few restrictions on the movement of capital, but all major economies except for Great Britain and the Netherlands heavily restricted payments for goods by the use of current account controls such as tariff
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
s and duties
Duty (economics)
In economics, a duty is a kind of tax, often associated with customs, a payment due to the revenue of a state, levied by force of law. It is a tax on certain items purchased abroad...
.
Arguments in favour of free capital movement
Pro free market economists claim the following advantages for free movement of capital:- It enhances the general economic welfare by allowing savings to be channelled to their most productive use.
- By encouraging foreign direct investment it helps developing economies to benefit from foreign expertise.
- Allows states to raise funds from external markets to help them mitigate a temporary recession.
- Enables both savers and borrowers to secure the best available market rate.
- When controls include taxes, funds raised are sometimes siphoned off by corrupt government officials for their personal use.
- HawalaHawalaHawala is an informal value transfer system based on the performance and honor of a huge network of money brokers, which are primarily located in the Middle East, North Africa, the Horn of Africa, and South Asia...
-type traders across Asia have always been able to evade currency movement controls - Computer and satellite communicationCommunications satelliteA communications satellite is an artificial satellite stationed in space for the purpose of telecommunications...
technologies have made Electronic funds transferElectronic funds transferElectronic funds transfer is the electronic exchange or transfer of money from one account to another, either within a single financial institution or across multiple institutions, through computer-based systems....
a convenience for increasing numbers of bank customers.
Arguments in favour of capital controls
Pro capital control economists have made the following points.- Capital controls may represent an optimal Macroprudential policyMacroprudential policyMacroprudential policy is a concept in the banking regulation and supervision literature which has to do with defining conditions which can result in financial instability and how to prevent such outcomes through public policy.-Origin:...
that reduces the risk of financial crises and prevents the associated externalities. - Global economic growth was on average considerably higher in the Bretton Woods periods where capital controls were widely in use. Using Regression analysisRegression analysisIn statistics, regression analysis includes many techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables...
, economists such as Dani RodrikDani RodrikDani Rodrik is a Turkish economist and Rafiq Hariri Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University, teaching in the School's MPA/ID Program. He has published widely in the areas of international economics, economic development, and...
have found no positive correlation between growth and free capital movement. - Capital controls limiting a nation's residents from owning foreign assets can ensure that domestic credit is available more cheaply than would otherwise be the case. This sort of capital control is still in effect in both India and China. In India the controls encourage residents to provide cheap funds directly to the government, while in China it means that Chinese businesses have an inexpensive source of loans.
- Economic crises have been considerably more frequent since the Bretton Woods capital controls were relaxed. Even economic historians who class capital controls as repressive have concluded capital controls, more than the period's high growth, were responsible for the infrequency of crisis. Studies have found that large uncontrolled capital inflows have frequently damaged a nation's economic development by causing its currency to appreciate, by contributing to inflation, and by causing unsustainable economic booms which often precede financial crises - caused when the inflows sharply reverse and both domestic and foreign capital flee the country. The risk of crisis is especially high in developing economies where the inbound flows become loans denominated in foreign currency, so that the repayments become considerably more expensive as the developing country's currency depreciates. This is known as original Sin (economics)Original Sin (economics)Original sin is a commonly used metaphor in economics literature. It was proposed by Barry Eichengreen, Ricardo Hausmann, and in a series of papers to refer a situation in which "most countries are not able to borrow abroad in their domestic currency."...
.
See also
- Price control
- Bretton Woods SystemBretton Woods systemThe Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
- Impossible trinityImpossible trinityThe Impossible Trinity is a trilemma in international economics suggesting it is impossible to have all three of the following at the same time:...
- Mundell-Fleming modelMundell-Fleming modelThe Mundell–Fleming model, also known as the IS-LM-BP model, is an economic model first set forth by Robert Mundell and Marcus Fleming. The model is an extension of the IS-LM model...
- Financial repressionFinancial repressionFinancial repression is a term used to describe several measures which governments employ to channel funds to themselves which in a deregulated market would go elsewhere. Financial repression can be particularly effective at liquidating debt....
- Macroprudential policyMacroprudential policyMacroprudential policy is a concept in the banking regulation and supervision literature which has to do with defining conditions which can result in financial instability and how to prevent such outcomes through public policy.-Origin:...
Further reading
- States and the Reemergence of Global Finance (1994) by Eric Helleiner - Chapter 2 is excellent for the pre WWII history of capital controls and their stenghening with Bretton Woods. Remaining chapters cover their decline from the 60s through to early 90s. Extensive further reading is given for those interested in the history of capital controls.
External links
- Christopher J. Neely, An introduction to capital controls (PDF), Federal Reserve Bank of St. Louis Review, November/December 1999, pp. 13–30
- James Oliver, What are Capital Controls?, University of Iowa Center for International Finance & Development
- Ethan KaplanEthan KaplanEthan Kaplan is currently an Assistant Professor of Economics at the University of Maryland. Before that, he was a Visiting Assistant Professor of Economics at the University of California, Berkeley and an Assistant Professor of Economics at the Institute for International Economic Studies at...
, Dani RodrikDani RodrikDani Rodrik is a Turkish economist and Rafiq Hariri Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University, teaching in the School's MPA/ID Program. He has published widely in the areas of international economics, economic development, and...
(2001) Did the Malaysian capital controls work? NBER Working Paper No. 8142 - Bryan Balin, India’s New Capital Restrictions: What Are They, Why Were They Created, and Have They Been Effective? The Johns Hopkins University, 2008
- José Antonio Cordero and Juan Antonio Montecino, Capital Controls and Monetary Policy in Developing Countries, Center for Economic and Policy ResearchCenter for Economic and Policy ResearchThe Center for Economic and Policy Research is a progressive economic policy think-tank based in Washington, DC, founded in 1999. CEPR works on Social Security, the US housing bubble, developing country economies , and gaps in the social policy fabric of the US economy.According to its own...
, April 2010 - Kevin Gallagher, Regaining control - detailed paper on the use of capital controls post WWII, with emphases on the increased use after the 2008 crises, UMassUniversity of Massachusetts AmherstThe University of Massachusetts Amherst is a public research and land-grant university in Amherst, Massachusetts, United States and the flagship of the University of Massachusetts system...
, 2011 - Anton Korinek (2011), The New Economics of Prudential Capital Controls (PDF), University of Maryland, 2011