Capital control

Capital controls are residency-based measures such as transaction taxes, other limits, or outright prohibitions that a nation's government can use to regulate flows from capital markets into and out of the country's capital account. These measures may be economy-wide, sector-specific (usually the financial sector), or industry specific (for example, “strategic” industries). They may apply to all flows, or may differentiate by type or duration of the flow (debt, equity, direct investment; short-term vs. medium- and long-term). Capital controls are residency-based measures such as transaction taxes, other limits, or outright prohibitions that a nation's government can use to regulate flows from capital markets into and out of the country's capital account. These measures may be economy-wide, sector-specific (usually the financial sector), or industry specific (for example, “strategic” industries). They may apply to all flows, or may differentiate by type or duration of the flow (debt, equity, direct investment; short-term vs. medium- and long-term). Types of capital control include exchange controls that prevent or limit the buying and selling of a national currency at the market rate, caps on the allowed volume for the international sale or purchase of various financial assets, transaction taxes such as the proposed Tobin tax on currency exchanges, minimum stay requirements, requirements for mandatory approval, or even limits on the amount of money a private citizen is allowed to remove from the country. There have been several shifts of opinion on whether capital controls are beneficial and in what circumstances they should be used. Capital controls were an integral part of the Bretton Woods system which emerged after World War II and lasted until the early 1970s. This period was the first time capital controls had been endorsed by mainstream economics. In the 1970s free market economists became increasingly successful in persuading their colleagues that capital controls were in the main harmful. The USA, other western governments, and multilateral financial institutions such as the International Monetary Fund (IMF) and World Bank began to take a critical view of capital controls and persuaded many countries to abandon them to facilitate financial globalization. The Latin American debt crisis of the early 1980s, the East Asian financial crisis of the late 1990s, the Russian ruble crisis of 1998–99, and the global financial crisis of 2008, however, highlighted the risks associated with the volatility of capital flows, and led many countries — even those with relatively open capital accounts — to make use of capital controls alongside macroeconomic and prudential policies as means to dampen the effects of volatile flows on their economies. In the aftermath of the global financial crisis, as capital inflows surged to emerging market economies, a group of economists at the IMF outlined the elements of a policy toolkit to manage the macroeconomic and financial – stability risks associated with capital flow volatility. The proposed toolkit allowed a role for capital controls. The study, as well as a successor study focusing on financial-stability concerns stemming from capital flow volatility, while not representing an IMF official view, were nevertheless influential in generating debate among policy makers and the international community, and ultimately in bringing about a shift in the institutional position of the IMF. With the increased use of capital controls in recent years, the IMF has moved to destigmatize the use of capital controls alongside macroeconomic and prudential policies to deal with capital flow volatility. More widespread use of capital controls, however, raises a host of multilateral coordination issues, as enunciated for example by the G-20, echoing the concerns voiced by John Maynard Keynes and Harry Dexter White more than six decades ago. Prior to the 19th century there was generally little need for capital controls due to low levels of international trade and financial integration. In the first age of globalisation which is generally dated from 1870–1914, capital controls remained largely absent. Highly restrictive capital controls were introduced with the outbreak of World War I. In the 1920s they were generally relaxed, only to be strengthened again in the wake of the 1929 Great Crash. This was more an ad hoc response to potentially damaging flows rather than based on a change in normative economic theory. Economic historian Barry Eichengreen has implied that the use of capital controls peaked during World War II, but the more general view is that the most wide ranging implementation occurred after Bretton Woods. An example of capital control in the interwar period was the Reich Flight Tax, introduced in 1931 by Chancellor Heinrich Brüning. The tax was needed to limit the removal of capital from the country by wealthy residents. At the time Germany was suffering economic hardship due to the Great Depression and the harsh war reparations imposed after World War I. Following the ascension of the Nazis to power in 1933, the tax was repurposed to confiscate money and property from Jews fleeing the state-sponsored anti-Semitism. At the end of World War II, international capital was 'caged' by the imposition of strong and wide ranging capital controls as part of the newly created Bretton Woods system—it was perceived that this would help protect the interests of ordinary people and the wider economy. These measures were popular as at this time the western public's view of international bankers was generally very low, blaming them for the Great Depression. Keynes, one of the principal architects of the Bretton Woods system, envisaged capital controls as a permanent feature of the international monetary system, though he had agreed current account convertibility should be adopted once international conditions had stabilised sufficiently. This essentially meant that currencies were to be freely convertible for the purposes of international trade in goods and services, but not for capital account transactions. Most industrial economies relaxed their controls around 1958 to allow this to happen. . The other leading architect of Bretton Woods, the American Harry Dexter White, and his boss Henry Morgenthau, were somewhat less radical than Keynes, but still agreed on the need for permanent capital controls. In his closing address to the Bretton Woods conference, Morgenthau spoke of how the measures adopted would drive 'the usurious money lenders from the temple of international finance.' Following the Keynesian Revolution, the first two decades after World War II saw little argument against capital controls from economists, though an exception was Milton Friedman. However, from the late 1950s the effectiveness of capital controls began to break down, in part due to innovations such as the Eurodollar market. According to Dani Rodrik it is unclear to what extent this was due to an unwillingness on the part of governments to respond effectively, as compared with an inability to do so. Eric Helleiner has argued that heavy lobbying from Wall Street bankers was a factor in persuading American authorities not to subject the Eurodollar market to capital controls. From the late 1960s the prevailing opinion among economists began to switch to the view that capital controls are on the whole more harmful than beneficial.