How we learned to stop worrying and love capital controls: From Cyprus, to Iceland, to Brazil

Ilene Grabel

There’s a political cartoon that I’ve had in mind these days when I think about recent changes in the international political economy of capital controls.  Picture a sailboat in stiff winds on rough seas. The wind in the sails is labeled something like “Cyprus, Iceland, Brazil, China, or the Global South.” The boat is labeled “S.S. Capital Controls.” The International Monetary Fund’s (IMF) Managing Director Christine Lagarde is at the tiller, and she barks at her worry-stricken shipmate—“No, don’t trim the sails!” But we also see that the ship is trailing its anchor, which is labeled  “Neoliberalism.”

I begin with this image because I think it captures well the conflicted processes surrounding capital controls during the current global financial crisis.  Many extraordinary things have happened during the crisis. One is that we’ve come to learn an awful lot about countries like Iceland and Cyprus, countries that we could safely say weren’t even at the periphery of any discussions of the global financial system until 2008.  Another is that capital controls (so long anathema to neo-liberals) have been successfully “re-branded” as a tool of prudential financial management, even within the corridors of the IMF.  In a recent paper, I examine the myriad factors that have enabled this re-branding.  As with most rebranding exercises there is uncertainty about whether the framing will prove sufficiently sticky, especially in the context of tensions and countervailing impulses at the IMF and elsewhere.

The re-branding of capital controls has occurred against a broader backdrop of change and uncertainty.  This involves unfolding transformations within the IMF; changes in its relationships to increasingly assertive governments in the global South; a new willingness to undertake innovation in financial architectures in the developing world; a reduction in the degree of hubris and monotheism in the economics profession; the uncertain and lagging recovery in the US and Europe; and the unfolding game of “whack a mole” that characterizes crisis response efforts in Europe.  This state of affairs—which I have elsewhere termed “productive incoherence”–constitutes the broader environment in which thinking and practice on capital controls is now evolving [see Grabel, 2011].  By productive incoherence I refer to the proliferation of responses to the crisis by national governments, multilateral institutions, and the economics profession that to date have not congealed into a consistent, singular approach to capital controls.  The term productive incoherence is intended to signal the absence of a unified, consistent, universally applicable (new) view on capital controls.  The present incoherence is, in my view, productive because it has widened the space around capital controls to a much greater degree than in the years that followed the East Asian crisis of 1997-98 Then, we should recall, controls were regarded as a dangerous and even desperate measure that policymakers pursued only at grave peril to their fragile economies.

How are we to account for this extraordinary ideational and policy evolution on capital controls during the current crisis? As I argue in a recent paper there are five factors that must appear in any comprehensive account of the evolving re-branding of capital controls during the current crisis. These include: (1) the rise of increasingly autonomous developing states, largely as a consequence of their successful responses to the Asian financial crisis; (2) the increasing self confidence and assertiveness of their policymakers in part as a consequence of their relative success in responding to the current crisis at a time when many advanced economies faltered badly; (3) a pragmatic adjustment by the IMF to an altered global economy in which its influence has been severely restricted; (4) the intensification of the need for capital controls by countries at the extremes—i.e., not just those that faced implosion (such as Iceland and now Cyprus) and thereby threatened cross-national contagion, but also and far more importantly by those that fared “too well” during the current crisis–countries such as Brazil, Peru, Costa Rica, Uruguay, South Korea, Indonesia, the Philippines, and Thailand, all of which have attracted vast pools of foreign investment that have induced unwelcome currency appreciation; and (5) changes in the ideas of academic economists and among IMF staff.  In this same paper I also explore tensions that have emerged in conjunction with the re-branding of capital controls. Paramount in this regard are the efforts by IMF staff and some academic economists to “domesticate” the discussion and use of capital controls, in part by the implementation of (something akin to) a “code of conduct” to regulate and constrain capital account interventions.

The ultimate outcome of this rethinking of capital controls by the IMF and the economics profession more broadly is uncertain, of course. However, it seems unlikely to me that the pendulum will swing back in the direction of reifying capital liberalization. Too many countries have deployed capital controls during the crisis for business as usual to be restored.  Countries like Cyprus and Iceland couldn’t wait for the IMF to respond to their controls on capital outflows (so rapid was their implosion). Of course Cyprus is particularly interesting since its experience reveals not only the incompetence of European Union (EU) and IMF officials in missing the incredible money laundering-induced bloat of the country’s financial system and the obvious consequences for the country’s banking system of the massive write down of Greek sovereign debt. Cyprus’ experience also shows that the EU’s tight strictures on the use of capital controls by member countries goes out the window during a crisis. (These strictures are contained in Articles 63-66 of the Lisbon Treaty of the EU; see especially Articles 63 and 65.)

Stepping aside from Cyprus, the experiences of many other countries during the crisis makes it harder to go back to the pre-2008 view of capital controls. Iceland also deployed stringent controls on capital outflows as soon as its economy imploded in 2008. Indeed, the IMF urged the country’s policymakers to strengthen and expand the scope of these measures. Iceland’s controls were supposed to be temporary, but that label hardly applies to controls that the Fund now acknowledges will need to be in place until 2015. And then there is the matter of the large number of countries that are using controls to cool off the tide of capital inflows and currency appreciation pressures. These countries do not need to worry about whether the IMF (or foreign investors or the credit rating agencies for that matter) gives its blessing to their capital controls.

Whether the IMF’s new openness on capital controls fades with the crisis may not matter in the end insofar as the institution has been rendered less relevant as it faces increasingly autonomous and assertive developing country members—some of which are now among its lenders.  It is, in my view, critical that efforts be made to maintain and expand the opportunity that has emerged in the crisis environment for national policymakers to experiment with capital controls and other measures.  Hence, the pressing policy challenge today is to construct a regime that provides for substantial national policy autonomy while managing cross-border spillover effects. This certainly suggests abandoning the strictures on policy space in bilateral, regional and multilateral agreements since many of these (such as the pending Trans-Pacific Partnership) preclude capital controls.  At the same time it is also critically important that if such a regime does involve some type of coordination, it must involve capital source and recipient countries, and a genuinely even-handed acknowledgement that monetary policies and capital controls have global spillover effects that are can be positive and negative.  In this regard, the same factors that have contributed to the rebranding of capital controls as prudent capital flow management techniques—the diminished influence and pragmatic adjustment of the IMF in the context of rising autonomy and confidence of leading development states, coupled with increased open-mindedness and new research within economics—might also contribute to the construction of a viable, flexible and permissive capital controls regime that is consistent with the goals of managing economic instability, promoting economic development and maximizing policy space.

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One Response to “How we learned to stop worrying and love capital controls: From Cyprus, to Iceland, to Brazil”

  1. […] recent years, there has been a re-branding of capital controls as an acceptable policy tool (see Figure 1. from the Economist). The IMF has […]