Capital controls: “The new normal” (Part I)

Ilene Grabel

Like many progressive economists, I’m addicted to economics and business news. These days one phrase is repeated constantly—“The new normal.” Indeed, National Public Radio’s show, “Planet Money” recently featured a story on this omnipresent phrase.  The new normal is shorthand for features of a dismal new economic reality to which the (investing) public must adjust. The new realities of our era include lower rates of return on stocks, bonds and real estate; larger government budget deficits which precipitate higher inflation rates; sluggish (and even negative) rates of growth in rich countries; and a shift in economic (and political) power to the world’s dynamic developing countries.

But another new normal has flown in under the pundit’s radar screen. This new normal is the proliferation of capital controls, which are being implemented rather widely across the developing world.

And I am pleased (and frankly, surprised) that these policies have not caused criticism to rain down on the policymakers who put them in place.  Indeed, in some cases they’ve been greeted with silence, and in others, with tacit acceptance of their necessity and prudence.  This reception contrasts sharply with the gloom and doom scenarios that were evoked after Malaysia imposed stringent capital controls during the Asian financial crisis of 1997-98.  More recently, capital controls in Thailand were reversed quickly after their implementation (following a coup in 2006) after they triggered massive capital flight.  The “nothing to get excited about” reception that capital controls are receiving these days makes it easier for other countries to follow suit. The normalization of capital controls is the single most important way in which policy space for development has widened in several decades.

Capital controls refer to a range of policies that are designed to manage international capital flows.  They can and have taken many forms in various countries over time. For example, they have involved restrictions on foreign investment in certain sectors or assets, minimum stay requirements on foreign investment, taxes on foreign investment, restrictions on access to the domestic or foreign currencies and on holding bank accounts outside the country, etc. Capital controls were the “old normal” in the decades that followed WWII. At that time, they were widely understood by academic economists, policymakers and officials at multilateral institutions to be an essential tool of economic management in all countries.  And, even in the neo-liberal 1990s and early 2000s, some developing countries maintained capital controls—most famously, Chile and Malaysia, but also China, India, Colombia, Thailand, and a few others. After the Asian crisis (and by the early 2000s), the center of gravity in the economics profession and even among researchers at the IMF had largely shifted from an unequivocal, fundamentalist opposition to all types of capital controls to a tentative, conditional acceptance of the macroeconomic utility of some types of capital controls (i.e., temporary, market-friendly controls on capital inflows) under some circumstances (i.e., when the economy’s fundamentals were mostly sound).  Thus began the tepid, gradual and definitely uneven process by which capital controls began to be normalized conditionally by economic researchers.  But despite the signs that the seeds of an intellectual evolution had been planted, it must be acknowledged that there was push back from stalwarts in the academic wing of the profession, as well as a curious disconnect between the research of IMF staff and advocacy for capital account liberalization by the institution’s economists when they worked in the field with countries in distress. And hence, despite the modest intellectual progress on capital controls that began in the early 2000s, the success of capital controls was still seen as anomalous to certain country cases.  Policymakers in the developing world continued to deploy them only at their own peril (e.g., risking downgrades by credit rating agencies).

But something happened on the way out of the global financial crisis. Policymakers have been quietly imposing a variety of capital controls, often marketing them with Madison Avenue savvy simply as prudential tools (akin to what Epstein, Grabel and Jomo KS termed “capital management techniques”).  For example, last month Indonesia announced what its officials term a “quasi capital control” that governs short term investment in the country, South Korea announced controls on banks’ currency derivative positions, Argentina announced stricter controls on US dollar purchases, and Venezuela imposed new controls on access to foreign currency. In October 2009, Brazil imposed capital controls via a tax on portfolio investment.  In December 2009, Taiwan also imposed new restrictions on foreigners’ access to some kinds of bank deposits (and China also put some new controls in place). Iceland implemented stringent controls just after its economy imploded in 2008, and the October 2008 stand by arrangement with the IMF made a very strong case for their necessity. There have also been reports of new capital controls under discussion in India and in China (with the latter being aimed at deterring investors from betting on an end to its peg to the US dollar).  The “market’s response” to these various controls—a surprising silence and, in some cases, tacit approval.  The response by economists at the IMF has been in the same vein.

And so it is that capital controls have quietly become another element of the new normal.

In a follow up post, I will explore the reasons why capital controls are breaking out all over.