WHY CAPITAL CONTROLS ARE NOT ALL BAD / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Why capital controls are not all bad


By Ilene Grabel and Ha-Joon Chang

Published: October 25 2010 13:33

Was it really just over a decade ago that the International Monetary Fund and investors howled when Malaysia imposed capital controls in response to the Asian financial crisis? We ask because suddenly those times seem so distant. Today, the IMF is not just sitting on its hands as country after country resurrects capital controls, but is actually going so far as to promote their use. What about the investors whose freedoms are eclipsed by the new controls? Well, their enthusiasm for foreign lending and investing has not been damped in the least. So what is going on here? In our view, nothing short of the most significant transformation in global financial management of the past 30 years.


Like most transformations, this reform has been gradual. Reform in the IMF view of capital controls actually began soon after the Asian crisis, as countries such as Chile, China and India imposed controls. Most analysts found that these controls were beneficial in key respects. This success led the IMF to soften its hardline stance: it admitted that controls might be tolerable in exceptional cases provided that they were temporary, market friendly and focused strictly on capital inflows. That said, policymakers adopted capital controls at their peril – not least risking condemnation by the Fund and by credit rating agencies, and punishment by international investors.


What was just a trickle of controls before the current crisis is now a flood. Iceland led the way in 2008 as it grappled with its financial implosion. Soon after, a parade of developing countries took action: some strengthened existing controls while others introduced new measures that targeted inflows and outflows. For example, during the crisis China augmented its extensive array of controls, while Indonesia, Taiwan, Peru, Argentina, Ecuador, Ukraine, Russia and Venezuela also introduced controls of one sort or another. In October 2010 alone: Brazil twice raised its tax on foreign investment in fixed-income bonds while leaving foreign direct investment untaxed; Thailand introduced a 15 per cent withholding tax on capital gains and interest payments on foreign holdings of government and state-owned company bonds; and South Korean regulators have begun to audit lenders utilising foreign currency derivatives.


The IMF did not drive this process of reform, but its staff have adjusted their thinking quickly in response to the exigencies of the crisis. One of these is the unforeseen currency appreciation in many developing countries that is a consequence of capital flight from the dismal returns now on offer in wealthy countries. Many recent Fund reports make clear that capital controls are a legitimate part of the policy toolkit. Dominique Strauss-Kahn, the IMF’s managing director, said as much in his recent speech in Shanghai, while the director of the Fund’s western hemispheric department made a case (unsuccessfully) for the use of controls in Colombia in response to the rapid appreciation of its currency. Not your grandfather’s IMF, to be sure.


Capital controls are not a new policy measure, of course. Instead, they were used universally by members of the Organisation for Economic Co-operation and Development (with the exception of the US) and across the developing world after the second world war, and only fell out of favour with the shift toward neo-liberalism in the 1970s. Some of the capital controls of this period were downright draconian in contrast with current practice. Indeed, in South Korea, investors were required until the 1980s to secure government permission for holding foreign currency or exporting capital.


What was forgotten during the neo-liberal era is that many of these explicitly “anti-market” measures helped to promote rapid economic development by increasing financial stability. This is not to say that all controls were successful or that all measures taken to enforce them were appropriate. But that should not distract us from acknowledging their tremendous contributions to unprecedented economic growth and stability during the period.


Those of us who have long advocated systematic financial reform look at current developments with excitement. Countries need the latitude to impose capital controls that meet their particular needs, and it is a relief to see that they are finally getting it after a long period of debilitating neoliberal ideology.


Yet periods of transformation are also potentially dangerous, as countries search individually for solutions to problems of unemployment and insecurity that require collective action. There is therefore a pressing need today for a new international financial architecture that at once promotes national policy autonomy while ensuring that diverse national strategies cohere into mutually beneficial co-ordination. Let us hope that leaders of the Group of 20 economies begin a conversation along these lines at its upcoming meetings in Seoul, and then reach out to the developing world more broadly in a process of building a new international financial framework.


Ilene Grabel teaches at the University of Denver and Ha-Joon Chang at the University of Cambridge. Their joint book is Reclaiming Development. Ha-Joon Chang’s latest book is 23 Things They Don’t Tell You About Capitalism



Copyright The Financial Times Limited 2010.