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

Ilene Grabel

In a recent post, I argued that capital controls have become the new normal. This is welcome news to progressives who have long argued that developing countries should have the right to deploy capital controls.  A reasonable question for progressives to ask at this point is why are capital controls breaking out all over?

There are several possible (and no doubt, mutually reinforcing) reasons for the resurgence of controls.

First, on a practical level, they are needed in many countries. Policymakers in the developing economies that are performing well now are using these policies to contain the asset bubbles (and attendant inflationary pressures and currency appreciation) stimulated by the foreign investment that is flooding developing economy markets (itself the consequence of the low interest rates and dim economic prospects of the USA and Europe).

Second, policymakers are using capital controls to create or expand policy space to raise their own interest rates so as to cool overheating economies.

Third, as each country deploys capital controls with no ill effects on investor sentiment and no finger wagging by the IMF, it becomes easier for policymakers elsewhere to deploy the controls they deem appropriate. And they are doing so.

Furthermore and digging into the “why” matter a bit deeper, we should also take note of the fact that IMF research on capital controls has moved quite far this year from the tepid, uneven process of reevaluation that began after the Asian crisis.  By now, many reports by IMF research staff and statements by the institution’s high-level officials have made clear that capital controls are a legitimate part of the policy toolkit, and that they have had positive macroeconomic accomplishments in many countries. This view has been affirmed and elaborated in reports issued by the IMF since February 2010, again in April and May 2010, and as recently as last month.  In a June 2010 speech in Moscow John Lipsky (IMF First Deputy Managing Director) said that “maintaining a pragmatic and open-minded attitude is justified regarding a possible role for capital controls.” Managing Director Dominique Strauss-Kahn also took what he characterized as a publicly agnostic position on Brazil’s capital controls this past fall. And, as Kevin Gallagher notes, the recent views of IMF researchers and the officials that are the public face of the institution mirrors the endorsements of capital controls that have been coming lately from prominent mainstream economists and officials at other multilateral institutions.

This new intellectual openness to capital controls is being affirmed by IMF practice, as I recounted in my previous posting. This is not to say that the IMF has completely rehabilitated itself, of course. As many have argued, it is continuing to advance pro-cyclical macroeconomic adjustment in low-income countries.  But it is undeniable that policy space has been widened for policymakers across many countries who are deploying capital controls without waiting for IMF approval or comment. The proliferation of capital controls in practice may be forcing the IMF to relax its historic opposition to ensure its institutional authority and even relevance.  But the IMF is a complex institution, and it will be important for researchers to explore this case carefully to ascertain just how and why the current crisis is altering the perceptions, influence and status of diverse decision-makers within the organization—building perhaps on the fine grained examinations of decision making at the IMF pioneered by Erica Gould, Jeffrey Chwieroth, Bessma Momani, and Rawi Abdelal. One would expect such an investigation of this historical shift in policy stance to reveal all sorts of conflicting motivations among the heterogeneous IMF staff and stakeholders.

The upshot of all this is that capital controls have become the new normal.  That is welcome news to those of us who have been arguing for some time that developing countries should have the right to pursue capital controls and other developmentalist tools that played such important roles historically, and which today’s liquid, liberalized, unstable and globally integrated financial markets make all the more necessary. In this context, the restrictions on the right to impose capital controls that are embodied in US trade and investment agreements look more like relics of the bad parts of the old normal.

5 Responses to “Capital controls: “The new normal” (Part II)”

  1. Sarah says:

    If I can use this section to ask a question, I’d be grateful to know how ‘capital controls’ relate to so-called protectionism. Are capital controls essentially a type of protectionism for domestic industry (or can they be)? If so, I presume the IMF won’t be drawing that conclusion in public for some time yet!

  2. Kevin P. Gallagher says:

    Excellent piece. For K controls to remain the new normal, they have to work. My concern is that the use of controls has been shunned for so long that there lacks the institutional learning that may be necessary to deploy controls effectively. Think about nations that have run education systems or foreign diplomacy for years–incredible learning by doing effects occur. There are very few nations that still have a long standing commitment to controls. I can’t think of many besides China and India, and to some extent Colombia. In those nations then there are bureaucrats who know what to look for when investors are trying to evade controls, and know how to design controls that target the hot money. Does this rash of nations that has finally flicked the light switch know how to target K controls in an effective manner? Its fairly clear that Brazil’s controls were too weak in November, and they had to stiffen them. Developing nations have figured out that K controls are a key part of the toolkit, now let’s hope they know you to use them.

  3. Ilene Grabel says:

    Sarah, Questions are always welcome!

    Capital controls can and have taken many forms and have also been driven by diverse objectives. In some country (and historical) contexts, capital controls have indeed been used to protect domestic banks from competition with foreign banks (in such cases, policy makers have precluded foreign banks from entering the domestic market and/or have put in place certain measures that govern the terms on which foreign banks can enter into joint operating agreements or other types of partnerships with domestic banks). Also, in some country/historical contexts, capital controls have protected certain domestic industries (e.g.. those that “produce culture,” e.g., publishing, television, film or those sectors that are considered strategic, such as copper, steel, oil) from foreign investment. In all of these instances, you might think of a capital control as a type of protective (or protectionist) policy tool, even though such measures might also be driven by other developmental objectives (such as protecting nationally important industries or firms from foreign takeovers, reducing the likelihood that profits will be taken out of the country by foreign investors, etc.).

  4. Ilene Grabel says:

    Kevin, Thanks for the thoughtful reactions. A couple of thoughts.

    One, time will tell whether the newly-implemented controls will prove effective, and whether policy makers will be able to deploy these controls in a dynamic manner (such that they loosen and tighten them as circumstances warrant). This is a matter that is as much about economic/technocratic ability as it is about politics. In this connection, it is heartening that capital controls in Brazil were adjusted to take into account at least some identified loopholes.

    Two, even if the rash of new capital controls aren’t all initially perfectly designed, monitored and adjusted it is nevertheless significant that policy makers are taking steps in the right direction, steps that they’ve been unable or unwilling to take for some time. And each time another country puts controls in place some type of capital control (and isn’t downgraded by the rating agencies, isn’t vilified in the int’l business press, and isn’t lectured to by the IMF), it makes it easier for other countries to experiment with alternative policies of their own choosing. The process of expanding policy space is a process that unfolds in real time.

    Third, you are right that one of the most noxious effects of the neo-liberal era is that it was part of a larger process of delegitimizing public service and public servants. This means that some of the most skilled technocrats ended up in the private sector, which makes it hard now for some countries to design good economic policies. Certainly I hope that in those countries where this didn’t happen, there will be a process of “learning from others.” Wouldn’t it be nice if policy makers that have experience with managing capital controls were talking with their counterparts? And we might think about ways that progressive economists around the world and economic justice activists might play a role in sharing ideas about the practical matter of how to implement and maintain capital controls where they are most needed. Certainly the fact that multilateral institutions like the Asian Development Bank, various UN agencies, and now even the IMF have been making a case for some types of capital controls might mean that there is a flurry of new research from many quarters about the practicalities of capital controls in the current context.