The Strange Story Of Capital Controls

Jayati Ghosh

THE world is very strange at the moment. Words been corrupted completely by using them to indicate the opposite, so that people no longer no how to separate statements and their true meaning. The most glaring recent example, of course, is the US government’s use of words in the Iraq war, where “freedom” was used to indicate the process of neo-colonial conquest, and “democracy” is now being used to describe the system of rule by the conquering power, and its tolerance of looting and anarchy.

But even when the words themselves have not been completely desecrated by ill-use, there is now a tendency to make statements which turn out to be the opposite of what is either intended or actually done. This is certainly the case with a lot of national and international economic policy-making at the moment.

Take the case of capital controls. There was a period, over the last decade, when regulation was a bad word, and liberalisation of all kinds was lauded as the best course to pursue in terms of economic strategy. This was also the case for financial liberalisation and deregulation in capital markets, both national and international.

BALANCED VIEW

However, the experience of intense and more frequent financial crises across the world, and especially in some developing countries, has created a more balanced view of the advantages of completely liberalising capital flows. In fact, there is growing recognition that such liberalisation can create more problems than benefits, and become a source of major difficulties for developing countries.

This is not just the view expressed in developing countries that have suffered from financial crises in the recent past, such as Argentina, Turkey, and so on. It is actually accepted even by the International Monetary Fund, which was earlier the international organisation that was most active in pushing developing countries to undertake such liberalisation. In a recent report, the IMF has accepted that there can be many problems with capital account liberalisation, which can create highly volatile flow of capital that destabilise the economy.

The IMF even acknowledged that the process of liberalisation has not really helped developing countries get more access to capital. They should have accepted this even earlier. The fact is that in the decade of the 1990s, which was when all countries liberalised massively, developing countries as a group actually got less capital inflow (as a share of GDP) than they did in the 1970s, when capital movements were much more controlled.

At a recent seminar in Berlin, Germany, it was surprising how many people in important positions accepted the need for capital controls. This was reiterated by representatives of the European Union, by central bankers from Germany and legislators from a number of countries across the world. To hear the views expressed at that seminar, you would think that the world is moving to a situation of much greater control over cross-border capital flows.

GREATER LIBERALISATION

But the reality is quite the opposite. So far, the evidence everywhere is towards greater liberalisation, not more control. And this process is continuing despite the growing recognition that such liberalisation is both problematic and dangerous, and confers relatively few benefits.

An economist who has undertaken a comparative study of policies has pointed out that in the past decade, there is not a single country in the world that has moved towards greater controls, except for temporary controls in the midst of an actual financial crisis. Every country has made moves towards further liberalisation, even when such liberalisation has already led to tragedy once.

This is the case is East Asia, where the earlier controlled financial systems were associated with the success of these economies. The crisis in the late 1990s was substantially caused by the financial liberalisation of the early 1990s in the region, but even after the crisis, these countries have typically gone in for further liberalisation and allowing foreigners to enter and control their financial systems.

There were some countries, such as Chile, which were applauded by others because of their imaginative use of market-based capital controls that allowed them to survive the contagion effect of crises in Mexico and Argentina. But now Chile has removed all those controls, and is striving to reach the neo-liberal dream of a completely liberalised economy.

In other words, even as economists and policy advisers from across the world and from all ends of the ideological spectrum accept the need for more capital controls, governments are doing precisely the opposite. The Indian government is a case in point. It has proceeded to go in for major moves which are in the direction of complete capital account liberalisation, despite the clear evidence that hot money is currently flowing into the country, with the potential of causing problems later.

It seems inexplicable, flying in the face of both evidence and the current accepted wisdom. The only analogy that comes to mind is that of lemmings marching resolutely towards the sea, towards the death by drowning that inevitably awaits them at the end of the march.