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.