Time For Coordinated Capital Account Controls?

This guest post was submitted by Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics.  Arvind is a leading proponent of the view that we need to rethink capital controls - he sees them as central to meaningful macroprudential regulation going forward.  (He also has an op ed in today’s Financial Times, on climate change, economic development, and the basis for an international agreement.)

The Bretton Woods Committee is organizing a panel (today, Wednesday) on the role of the G-20 in coordinating global growth with speakers from the IMF, US Treasury, and the G-24 group of developing countries.  “Global imbalances” (the US current account deficit, the Chinese current account surplus, etc) will be discussed extensively. But I will also raise the question of whether there is a new imbalance in the world economy that threatens emerging markets, and what they should do about it.

Extraordinarily loose monetary policy and the resulting close-to-zero interest rates in many industrial countries are pushing capital out to emerging markets—Brazil, China, and India—whose growth prospects are buoyant and relatively unaffected by the crisis. Brazil’s currency has appreciated by 30 percent this year, India’s stock market soared by 70 percent, and China is once again furiously accumulating foreign exchange reserves, $62 billion in September.

Now, foreign capital can be good for emerging markets because it brings down the cost of capital for domestic firms, provides finance, facilitates greater investment, and boosts growth. But, as my co-authors and I have shown in two papers, the evidence in favor of foreign capital is awfully hard to find.

In part, this is because foreign capital causes the exchange rate to appreciate which hurts exports, especially in manufacturing, and growth in the long run. Another reason is that domestic financial systems and their regulation are not strong enough to prevent and cope with financial crises that result when foreign capital bolts for the exits.  Time and again we have learnt (or rather failed to learn) that large foreign capital flows to emerging markets are not sustainable (Latin America 1982; Asia 1997-98; and Eastern Europe 2008). Think of this: if sophisticated regulatory systems such as those in the US and Europe cannot avoid financial crises, how much more vulnerable are emerging markets?

So, how should emerging market countries respond? Is it time for them to impose serious restrictions on capital flows?  In answering these questions, two points must be kept in mind: this policy challenge is going to be around for some time, at least as long as the Fed keeps interest rates low; and second, because the cause of the increased flows is common to all countries, namely Fed policy, it will be a policy challenge not just for individual countries but for  emerging markets as a group.

Chile in the early 1990s and Malaysia in the wake of the Asian financial crisis in the late 1990s are the two poster boys for serious capital account restrictions. The evidence on their effects—in limiting flows and preventing currency overvaluation—is contested because restrictions can be circumvented. But Carmen Reinhart and Nicholas Magud suggest that their effects cannot be dismissed.

Going forward, there is the technical question of how best to design restrictions on flows: Should they be price-based or quantity-based? What kinds of flows are best addressed, debt or portfolio? When should they be withdrawn? The IMF should deploy its considerable technical expertise to help answer these questions.

But there is also the political issue of removing the stigma from countries that want to impose serious capital controls. Brazil recently botched its attempt at such controls because the policy action was half-hearted, anxious about the reaction of markets. One possibility could be coordinated restrictions on capital flows action by a set of emerging markets that could be blessed by the G-20.  No doubt this would be risky, perhaps even counter-productive, but in these unusual times no policy option should be off limits, at least for discussion.

By Arvind Subramanian

21 responses to “Time For Coordinated Capital Account Controls?

  1. It’s interesting that certain unnamed professors consider the Big Banks like Goldman Sachs to be very insular. It might also be considered insular if a certain unnamed professor was seeking a relatively large percentage of commentary for his website from the same institute at which he was employed.

  2. One possibility could be coordinated restrictions on capital flows action by a set of emerging markets that could be blessed by the G-20.

    For the time being, why would the G20 be any more interested in helping emerging countries defend themselves from the Fed than the G7 ever was?

    So far it looks like the same old domination.

  3. One other possibility could be coordinated taxation of financial transactions
    - on capital inflows for countries experiencing exchange appreciation:

    http://blogs.ft.com/maverecon/2009/10/time-for-the-ecb-to-get-serious-about-the-overvalued-euro/#comment-328079

    - on outflows for those countries experiencing currency stability problems;
    - on both trades for those willing to raise revenues and reduce use of financial innovation products similar to gambling and toxic.
    If there are unwanted, undesirable or “useless” (like CDS or other speculative derivatives) capital movements there is non need of capital control just fine tune an appropriate taxation of those transactions.

    http://mgiannini.blogspot.com/2009/03/polluter-pays-principle-in-financial.html

  4. My first reaction is bring on the Tobin tax, as M.G. in Progress suggests. Why collaborate with governments which, by definition, are too weak to adequately manage domestic financial regulation? Increase the costs to the investor of making the gamble in the first place. That way, you won’t give developing countries a convenient excuse to use a form of currency devaluation to boost their exports.

  5. The IMF is discredited institution in the very countries Johnson is talking about ‘helping’.

    A better question: why is capital not being invested productively , but wasted in speculation. As capital continues its historic accumulation this is going to be a bigger and bigger problem as long as ‘we’ continue on the private-profit paradigm.

  6. My comment is with regard to productive capital vs speculative capital. The assumption of efficient markets in global financial movements is challenged by the empirical evidence. Purple presents a need for discussion
    on this fact.

  7. “Peterson reached draft age in June 1944, but avoided military service in World War II and in the Korean War.”

    http://en.wikipedia.org/wiki/Peter_George_Peterson

    Also (to use a word favored by Joe Gagnon) “interesting”:

    “In 1969, Peterson was invited by philanthropist John D. Rockefeller 3rd, CFR Chairman John J. McCloy, and former Treasury Secretary Douglas Dillon to chair a Commission on Foundations and Private Philanthropy, which became known as the Peterson Commission. Among its recommendations adopted by the government were that foundations be required annually to disburse a minimum proportion of their funds.

    Bloggers, perhaps you could invite some erudite conspiracy mavens to do some guest posts? There’s is way too much Rockefeller and Council on Foreign Relations and Chicago and legacy of Friend-O’-the-Nazis John McCloy and his buddies in this Peterson Institute world we’re living in here.

    And Simon… you still haven’t told us what you do all day, every day. What is your typical day like? Your academic duties look like they absorb about one week of your year, and the blog, maybe one or two hours per week.

    It’s important that we know who you are and for whom you are providing your service, or, at the very least, lending your name in a “Trumpy” way.

  8. I would like to see a credible and comprehensive cost benefit analysis before moving toward such retrograde measures. It seems to me that the benefits of mobile capital outweigh the damage. This is more a symptom of structural imbalances primarily driven by exchange rate management. If you fix your currency, you also lose your freedom to set domestic monetary policy. Every central bank in the world has got two guns pointed at their head. One is the Fed’s apparently perpetual ZIRP and the other is the Chinese fixed exchange rate policy.
    One one side of the spectrum is Australia with floating exchange rate and independent, non-synchronized rate movement. AUD is of course through the roof. The other end of the spectrum are nations that run rigid or fixed rates, including China and the energy exporters. In between but clustered much nearer to China are most of the other East Asian exporting nations like Korea, Thailand, and Singapore that run dirty-floats. Their currencies have already appreciated against USD and CNY. If the CNY were allowed to appreciate significantly these countries would likely be more willing to allow their currencies to appreciate against USD also. China’s de facto adoption of the US weak dollar policy is basically a free ride to gain short term price competitiveness in other markets.
    But back to the subject of excess capital flooding into some emerging markets. Recently much of the excess capital is from the global orgy of monetary and fiscal stimulus but on a longer term structural basis the excess capital is coming from seemingly perpetual trade imbalances that are heavily driven by protectionist exchange rate management regimes.
    It would be much simpler to limit the amount of foreign exchange reserves any nation could hold. Exceed a certain ratio and it is automatically flagged as trade protection. The capital flow imbalances are primarily driven by the structural trade imbalances.

  9. Here, have some Chinese nourishment!!! It’s sooooo tasty and scrumptious!!! It has a special flavoring called MSG. You don’t know what is MSG?? Why, it’s very simple: M is for Militarism, S is for Subjugation, G is for Godlessness. What?? You don’t like it?!?!?!?! You’re getting a headache…. ?? Don’t worry after some time you will get used to it. Chinese also used to think it was a kind of quiet suffering, but after many years of watching state-owned media (Xinhua) they know that harmony is most important in the society. Just wait……………

  10. This may sound overly ignorant, but it may be the best argument for a new international currency. Of course the benefitees of the current currency misalignment are going to be pretty unhappy if that is done, even as China was expressing its desire for this only a couple of months ago. Currency arbitraguers must be having a field day, but the imbalances are extremely dangerous, and can create bizarre consequences for all economies globally. Perhaps the most fearful thing is my perception of the chaotic results if this goes on long term.

    This upcoming conference had better pay more than lip service to this issue, I’m afraid that the old mealy mouthed communiques issed after each of the recent G-20′s will not be sufficient. Perhaps all of the finance ministers will understand the potential destructive power of this problem and act in concert. Doubtful, but possible.

  11. As someone who comes from a bathtub sized economy (Venezuela) and has suffered from the waves of global oceans breaking over us I can attest to that it hurts and destroys any sort of internal equilibriums. The following is an extract from my “Roping in the herds” published in Daily Journal, Caracas, December 4, 1997

    “Countries like Chile, which have earned the confidence of international markets, limit the inflow of short-term investments. This limitation has definitely not resulted in damage. On the contrary, it has helped increase the confidence of exactly those foreign investors whom the country actually wishes to attract. They are not those that come on a 30-day visa, but rather those that come to invest for the long term.

    It is important to remember that when a foreign investor risks his funds in a country in the long run, installing factories, developing projects, creating employment, and in general acquiring a real presence in the country, his interest in the future of the country becomes much more sincere and similar to that of the nation’s own population. Much more so than the interest of some fund manager sitting in New York or London.

    When we speak of gaining the confidence of foreign investors, we must learn to discriminate among them.”

    Now when I look at the US today I cannot help but to think that, more than Brazil, it is the Fed in the US that should be charging a safe haven tax to anyone buying US treasuries. At least then the US Governments would not reach the erroneous conclusions that the lack of other alternatives investors face, translates into a high confidence in US government actions.

  12. Intelligent FT opinion piece (Forget emissions, focus on research) by Subramanian on global warming and emissions targets.

    “The goal should be that developing countries’ access to…energy services is comparable to that achieved by rich countries at their corresponding stage of development, while exploiting the latest available clean technologies to provide these services.

    “Our key finding is that improvements in technology (or reductions in the emissions-intensity of energy produced and used) at historical rates provide little hope of meeting the broadly agreed global target for emissions to be 50 per cent lower in 2050 than they were in 1990.

  13. I am extemporizing here. Given the exponential growth of technology, including the “aerospace industry,” over the past century this might be a possible scenario.

    China and India develop the infrastructure and technolgy for helium airships for domestic air travel. A useful way to spend their trade surpluses. A potential economic driver.

    Perhaps there are innovations with other gases that are lighter than air that could be used.

  14. Whither Dirigiste State?

  15. NASA? Airships between LA and Seattle by 2020?

  16. Come to think of it. Why are they trying to build a fuel-efficient car economy in the developing world at all. Why not create the best public transit systems in the world.

    Here in Metro Vancouver where I live we are moving to public transit (because the future is heading into wall-to-wall gridlock.) But when you try to “shoe horn” metro lines into the existing urban landscape (designed for cars and not people) sometimes the “fit” is difficult.

    Eg, emerging from a metro station to find the sidewalks are too narrow and the surrounding streets were designed for cars and not pedestrian life. Perhaps there is a “tabula rasa” in developing countries where the city planners can go either way. For cars, or for public transit and pedestrian-oriented cities. But public transit is a solution to global warming.

  17. BRUCE E. WOYCH

    CAPITAL FLOW? CAPITAL CONTROLS? I THINK YOU MUST BE KIDDING? MONETARY POLICY-BABBLE! IT SOUNDS LIKE AN OCEAN WAVE JUST FLOODED IN WITH CURRENCY NOURISHMENT TO BEEF UP ONE BIG AUTONOMOUS ECONOMY UNDER PRUDENT CONSTRUCTIVE POTENTIALS.
    LOOK OUT YOUR WINDOW PLEASE.
    THERE IS NO HEALTHY ECONOMY BEING CONSTRUCTED FROM THIS FICTIVE FLUENCY. THESE ARE GROSS TERMS TO CATEGORIZE A MONETARY ACCOUNTING SYSTEM FOR A GLOBAL FIRM’S FLOW CHART.
    MONEY FLOWS TOWARDS RAW OPPORTUNITY. THE APPEARANCE OF SOME FLOATING MORAL DRIVING FORCE OR AN IMPARTIAL MARKET OFFSETTING LAISSEZ-FAIRE INJUSTICE IS A CONSENSUS MINDSET THAT HAUNTS HISTORIC REALITIES. TYPICALLY THAT REALITY IS A FRENZIED AND FRENATIC FIRE STORM OF BLIND CAPITAL RAMPAGE THROUGH BARGAIN BASEMENT MISERIES LED BY ECONOMIC “HITMEN” AND THE WELL HEALED STRATA OF POLITICAL AND ECONOMIC POSITIONS OF POWER. THE GROSS “FLOW OF CAPITAL” ONLY OBSCURES “EMERGING OR DEVELOPING” {SIC} MARGINAL ECONOMIC MARKETS THAT ARE MOSTLY ONE SIDED VENTURES OF CAPITAL FLIGHT FROM OTHER LOCATIONS STILL ON A WHIRLWIND LOOKOUT AND TOUR OF GLOBAL EXPLOITATION. THE ONLY CAPITAL “CONTROL” THAT IS OF INTEREST FROM THE POLICY SHARKS AT “PETERSON’S CAPITAL” IS THE ONE THAT PROTECTS THE FLOW FROM BACKLASH AND SELF DESTRUCTION. IT IS OBLIVIOUS TO THE WAKE OF ITS DAMAGE THROUGH HISTORY AND SOCIAL CONSEQUENCES.
    WE DON’T NEED “CAPITAL CONTROL” TO ROUGH OUT THE EDGES OF SELF DESTRUCTIVE BRUTE CAPITAL FORCES; WE NEED CAPITAL MANDATES TO EXERCISE RIGHTS OVER THE CONSEQUENCES AND RESPONSIBILITIES OF EXPLOITING CAPITAL LEVERAGE AND DOMINATION OVER THE “SO-CALLED” EXTERNALITIES OF SOCIAL INTEGRITY. AS FAR AS I CAN SEE, THE PETER PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS IS DOING FOR INTERNATIONAL POLICY WHAT THE PETER PETERSON FOUNDATION (NEWLY ESTABLISHED) IS ATTEMPTING TO DO TO OUR DOMESTIC ECONOMY. MAKE IT OVER IN ITS OWN SELF IMAGE AND INTEREST; CREATE POLICY THAT IS TOO PRESTIGIOUS AND CREDIBLE TO QUESTION; DO SELF SERVICE PROGRAM ANALYSIS AND CREATE FRONT GROUPS TO POSITION PROPAGANDA ON WHAT IS BEST FOR EVERONE ELSE. BLACKWELL GLOBALIZATION POLICIES ARE PRETTY MUCH SUGAR COATED AT THE THINK TANKS THEY FINANCE.

  18. BRUCE E. WOYCH

    correction: that should be “Blackstone” not Blackwell and the Peter G. Peterson Foundation or PGPF.

  19. BRUCE E. WOYCH

    blackstone not blackwell

  20. Kevin P. Gallagher

    A coordinated set of capital controls among emerging markets is a very sensible one. However, if one of those countries has a free trade agreement (FTAs) or bi-lateral investment treaty (BITS) with the US such coordination will be difficult. As I’ve noted in a Guardian column earlier this year, US FTAs and BITs make such action illegal.

    Link to column:

    http://www.guardian.co.uk/commentisfree/cifamerica/2009/oct/27/us-colombia-free-trade-obama

    At this writing, South Africa, Russia, Brazil, India, and China are all without FTAs or BITS with the US. However, the US and China have agreed to expedite a BIT and negotiations may begin with Brazil and India.

    Moreover, other nations such as Chile, Singapore, South Korea (pending), and Colombia (pending) all have FTAs with the US.

    The Obama administration has committed to revisiting these agreements. In the wake of the current economic crisis it would be prudent to allow nations the policy space for prudential coordination of capital controls.

  21. BRUCE E. WOYCH

    This is, on balance, an autoritative set of statements for a political advisory on economic policy which, indirectly, speaks to the problems.

    In the first place this appeal to noble prizes (which is central in the article provided by the link) is a false political posture. These awards are bought and paid for by a Swiss Bank and are (like the shadow economy) a fictive prestige grabber. There is no doubt about some merits, but the capture is as clear as the fact that the Devil is an Angel in more than one case.

    In the second place, while I have relative respect for the general agency of the IMF (again in the actual article from the Guardian) it is an established fact that they have a horrific record over two decades in regard to Shock therapies and its capital flow wash out aftermath.

    In the third place, the aggressive and ruthless use of free trade agreements (FTA) has been perpetrated on extremely vulnerable economic foundations often as much like a LBO economic stalk. To claim it is simply out of fashion is insulting. It has permitted grand scale corporations to act like governments and to actually litigate against the subordinating government when they themselves might be guilty of the transgressions of an orchestrated debt trap. There is no world court of arbitration in these matters, it is simply one sided trade dictatorship and manipulation wherever opportunity arises.

    Finally the textbook idea of orchestrated “capital controls” is simply a stopgap not a resolution or solution to decades old abuses. Until mandates are defined in the context of real time community and social accountability (a good neighbor policy gold standard) these “regulatory constraints” merely serve to preserve a system that should be exposed to social and cultural constraints…but are part of an international financial system that is, in reality, a small group of special interest groups preserving the system that serves them so well under universal appeals which from region to region ends in corruptive collapse and socially destructive collusion and contagion.

    Speak to mandates of social responsibility and accountability and your “capital controls” might be credible. Until then it is suspect to “more of the same under another branded name”.