Capital controls offer growth from more stable world

Kevin P. Gallagher

Gillian Tett (“Fears of worse to come fuel debate over capital controls”, December 16) highlights the new and important Bank of England paper on capital flows and financial crises that argues how cross-border capital flows continue to plague the world economy and will continue to do so in alarming ways to 2050. The Bank rightly argues for cross-border regulation and co-ordination on capital flows – traditionally referred to as capital controls.

Traditionally, policymakers and the financial press would shudder when talk of regulating cross-border flows arises. Many have made the wrong analogy to trade, where tariffs are seen as distortionary to economic activity and thus a drag on potential growth. New research in economic theory and in econometric evidence shows that capital account regulations can make markets work better and that such regulations are effective. As the Bank of England notes, if nations co-ordinated such regulation they might work even better.

In the August issue of the International Monetary Fund Economic Review, economist Anton Korinek shows how, in an environment of uncertainty, imperfect information and volatility, capital account regulations are more analogous to Pigouvian taxes that actually correct for a market failure rather than cause a distortion. In other words, capital controls are “correctionist” not “protectionist”.

These theoretical advances come on the heels of a mountain of evidence by the IMF and the National Bureau of Economic Research that shows how developing countries that have used regulations were among the least hard hit during the crisis and have been stemming the tide ever since. This is truly amazing given that all the burden has been on capital recipient nations, not nations that are the source of the problem.

Like the Bank of England suggests, if industrialised countries co-ordinated with emerging market countries and, as Keynes said, regulated capital on “both ends”, the world would be a much more stable place for growth and prosperity.

This piece was originally published in the Financial Times.

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