Tuesday, October 12, 2010

Policy Preferences over Capital Controls

. Tuesday, October 12, 2010

Sebastian Mallaby has a new op-ed in the Financial Times about the difficulty of reversing financial globalization. While that may be true, Mallaby makes some pretty crazy claims on the path to this conclusion.

First, Mallaby suggests that a growing preference for increased capital restrictions among policy makers in US and Europe signals an end to consensus among the richest economies that capital mobility creates growth. By comparing the policy response (and rhetoric) of today to the response to the Asian and Latin American crises of previous decades, Mallaby points out that while the IMF, the US, and the EU pushed capital account openness before, they are now more willing to entertain the idea that capital account openness might be too risky. But, in the past the US and Europe weren't the states having difficultly financing their current account deficits. It makes sense that the US and Europe will now be more open to some measures of capital account restraints since they may want to keep investment from going abroad. And, this policy preference may well be temporary - when macro imbalances are corrected, the US and Europe may be perfectly willing to support unfettered capital account openness once more.

Second, in talking about US animosity towards China, Mallaby offers this policy advice:

Equally, proposals to prevent Chinese capital from flowing into the western economies have a clear appeal. China's peg, and the associated capital exports, distort the world economy; and years of patient diplomacy have failed to resolve the problem. Retaliating against China via trade sanctions would be reckless, since doing so would spread the existing currency war into the trade realm. So why not apply a more proportionate sanction? China already prevents foreigners from buying its bonds, so what is wrong with preventing China from buying US Treasuries? (emphasis added)

Wait, what? The last thing the US wants to do is to cut off a major buyer of its debt!

Rather than characterizing the return of capital controls as an indication that policymakers are moving towards a new consensus on the perils of globalized finance, it may be far more helpful to think about the conditions under which governments will advocate barriers to financial flows.

Finally, while the incentives for making it difficult for domestic capital to exit are pretty straightforward, it is less clear what drives governments to erect barriers to foreign sources of investment. Mallaby mentions Brazil's new tax on foreigners holding domestic securities. What drives these policy choices? Might it be that emerging economies may want to limit the rate of capital inflows since inward investment can easily overwhelm a small economy? If so, would that preclude advanced industrial economies from enacting such barriers?


Policy Preferences over Capital Controls
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