The author is one of several CIGI-sponsored Canadian university students who attended the INET conference, Crisis and Renewal: International Political Economy at the Crossroads, at Bretton Woods, NH, April 8–11, 2011. Each student was asked to write a short reflection on the conference themes.
In the immediate aftermath of the global financial crisis, capital flowed out of emerging and developing economies, but subsequently began to flow back. The return flows were driven not only by improved economic prospects in emerging and developing countries, but also by the prevailing low interest rates in advanced countries. In the last two years, controls on capital inflows have been implemented in diverse emerging and developing economies that have been trying to avoid an overheating of their domestic financial systems, unacceptable credit risk taking and excessive exchange rate volatility. This surge in foreign capital has led to a renewed debate within academic, policy making and media circles regarding the legitimacy and feasibility of implementing these types of controls.
Examples of recent capital controls include taxes on short-term inflows, unremunerated reserve requirements, quantitative limits and time requirements. Some of these measures would have been frowned on, if not unthinkable, as recently as a decade ago. Nonetheless, the International Monetary Fund (IMF) leadership and staff have chosen to view these measures in a much more sympathetic way than they did during the 1990s. In February 2010, an IMF staff position note startled several observers by declaring that capital controls are now “justified as part of the policy toolkit” (Ostry et al., 2010, 5). But what are the current opportunities and constraints for the adoption of capital controls in emerging markets and developing economies? Are we experiencing a new era in regulatory politics in which the notion of what constitutes a “legitimate” counter-cyclical tool is being considerably reconstituted?
During the 2011 INET conference, there was a general consensus among leading economists that short-term flows of capital are often a major source of volatility in today’s global interconnected economy. They also implied that capital restrictions have entered the policy “bloodstream” and suggested that policy makers involved in international regulatory politics need to establish more comprehensive rules for defining how controls on inflows should be deployed. Many of the panellists agreed that one of the most difficult challenges for emerging and developing economies is to implement policies that, in an environment of global economic imbalances, allow these nations to keep the benefits of foreign investment while avoiding the troubles that might be created by “hot money” inflows.[i]
The conference discussions reflected the gradual shift in mainstream thinking about capital controls on inflows, which before the latest crisis were, by and large, seen in academic and institutional environments as a threat to financial globalization and economic growth. A major contribution of the conference stemmed from the efforts of academics and policy makers to advance theoretical understanding in regard to the links between financial liberalization at the global level, and the rise of new sources of volatility in financial emerging markets. For example, for Andy Haldane, executive director for financial stability at the Bank of England, capturing the present dynamic of surges in foreign capital flows to emerging economies requires a distinct conceptualization. At the INET conference, he explained this dynamic as the “Big-Fish-Small-Pond” (BFSP) problem. The challenge is that financial markets in emerging economies — the small ponds — remain relatively modest; therefore, strong inflows from large, capital-exporting, advanced countries — the big fish — can cause ripples right across the international monetary system (IMS), never more so than in today’s financially interconnected world (Haldane, 2011).
If recent trends continue, the BFSP problem may become more acute over time. The global flow of funds could become an increasingly powerful generator of international financial instabilities. The prospects of this situation have already intensified the debate on appropriate policy responses at the national and international levels. The intensity of ongoing negotiations for reforming the IMS — as well as the density of the networks involved in these discussions — indicate that significant progress vis-à-vis the development of regulatory frameworks for capital controls is not a short-term prospect. In addition, the question many international institutions and academics are now debating is whether controls on inflows should be a complement to countries’ “policy toolkits,” or whether they should be employed only as a last resort.
In the last year, the IMF has taken further steps to address this issue by publishing two documents: an official report presented to the board and a staff position paper. These publications advance a set of guidelines for capital account regulations and recognize some of the benefits that these tools can bring to an economy in cases of financial disruption. The official report also proposes a new nomenclature for capital controls, referring to them as capital flow management (CFMs) measures; however, it recommends that CFMs be used as a last resort, as temporary measures, and that they be non-discriminatory. The latest reports do not give the IMF’s determination of the efficacy of CFMs and, most importantly, there is no explicit recognition for helping nations to enforce controls on inflows when they deem it appropriate to implement these measures.
With more emerging markets now increasingly apt to go in divergent directions when it comes to implementing preventive measures to avoid financial volatility, “it would be certainly desirable if we had a clear set of rules of [the] road for countries, to guide them,” as Andy Haldane remarked at the conference. Nonetheless, there exist crucial political, theoretical and technical factors that for now prevent a broader and more harmonized adoption of capital controls. For example, after a time, investors find ways to evade prudential capital management through derivatives and other instruments; moreover, US trade and investment agreements make capital controls difficult to implement, since the former often explicitly mandate the free flow of capital to and from a country.
Countries may also prefer the implementation of less-political and less-contested alternatives, such as the accumulation of foreign reserves. In principle, reserve accumulation can serve some similar purposes to capital controls, such as avoiding exchange rate appreciation in times of excess liquidity. Moreover, one of the most contentious issues in today’s economic governance relates to whether controls should be temporary or more permanent. Recent academic and institutional studies[ii] have largely focused their attention on the examination of transitory periods. Thus, an aspect that could be further explored in future debates is the fact that the most permanent approaches to capital controls — taken for instance by the Chinese and the Indian governments — may represent in practice a distinct set of policy discussions and technical frameworks for multilateral governance on these issues.
Future CIGI and INET conferences could also benefit from the perspectives of more scholars and policy makers from the South, from countries such as Brazil, who have been actively voicing their opinion and seeking to influence the current discussions about possible reforms to the IMS. In particular, Brazilian officials have recently indicated in diverse forums that they strongly oppose any IMF guidelines that may establish, standardize, prioritize or restrict the range of policy responses of the member countries that are facing large surges in volatile capital inflows.[iii]
Finally, as long as capital flows to emerging and developing markets remain volatile and potentially disruptive, the discussion of capital controls as a critical component of post-2007 international regulatory regimes will continue to develop with regards to these measures. As Andy Haldane suggested during his presentation: “What a difference a decade makes. What a difference a crisis in advanced economies makes.” Although it is increasingly becoming understood that capital controls help markets “get the prices right,” a bigger task is “getting the political economy right” (Gallagher, 2011).
For more information and videos from the INET conference, visit http://ineteconomics.org/initiatives/conferences/bretton-woods/agenda.
[i] See, for example, the presentations of Joseph Stiglitz, Jomo Kwame Sundaranam and Andy Haldane at the 2011 INET Conference. Available at http://ineteconomics.org/initiatives/conferences/bretton-woods/agenda.
[ii] See, for example, Magud et al. (2011) and Ostry et al. (2010).
[iii] See, for example, Brazil’s executive director at the IMF’s comments on these issues in Rastello (2011).
Gallagher, Kevin (2011). “Regaining Control? Capital Controls and the Global Financial Crisis,” PERI Working Papers No. 250.
Haldane, Andrew (2011). The Big Fish Small Pond Problem. Speech given at the Institute for New Economic Thinking Annual Conference, Bretton Woods, New Hampshire, 9 April. Available at www.bis.org/review/r110413a.pdf.
IMF (2011). Recent Experiences in Managing Capital Inflows — Cross-Cutting Themes and Possible Policy Framework. Prepared by the Strategy, Policy, and Review Department, in consultation with Legal, Monetary and Capital Markets, Research, and other Departments. Washington, DC: IMF.
INET (2011). “Crisis and Renewal: International Political Economy at the Crossroads,” Program and Conference Material. Available at: http://ineteconomics.org/initiatives/conferences/bretton-woods/agenda.
Magud, Nicolas, Carmen Reinhart, and Kenneth Rogoff (2011). “Capital Controls: Myth and Reality – A Portfolio Balance Approach,” PIIE Working Papers No. 11-7.
Ostry, Jonathan D., Atish R. Ghosh, Karl Habermeier, Marcos Chamon, Mahvash S. Qureshi, and Dennis B.S. Reinhardt (2010). “Capital Inflows: The Role of Controls,” IMF Staff Position Note. Washington, DC: IMF.
Ostry, Jonathan D., Atish R. Ghosh, Karl Habermeier, Luc Laeven, Marcos Chamon, Mahvash S. Qureshi and Annamaria Kokenyne (2011). “Managing Capital Inflows: What Tools to Use?” IMF Staff Discussion Note. Washington, DC: IMF.
Rastello, Sandrine (2011). “IMF Report on Capital Controls Opposed by Nations Seeking More Flexibility,” Bloomberg News. April 5. Available at: www.bloomberg.com/news/print/2011-04-05/imf-capital-control-proposal-marks-shift-as-brazil-holds-out-with-minority.html.