US economists advocate capital controls

Well, well, well…..

After the IMF twist in the tale, number of US econs have written an open letter (HT: WSJ Blog) to US government to include capital controls as a policy tool.

We, the undersigned economists, write to alert you to important new developments in the economics literature pertaining to prudential financial regulations, and to express particular concern regarding the extent to which capital controls are restricted in U.S. trade and investment treaties.

Authoritative research recently published by the National Bureau of Economic Research, the International Monetary Fund, and elsewhere has found that limits on the inflow of short-term capital into developing nations can stem the development of dangerous asset bubbles and currency appreciations and generally grant nations more autonomy in monetary policy-making. 

Given the severity of the global financial crisis and its aftermath, nations will need all the possible tools at their disposal to prevent and mitigate financial crises. While capital account regulations are no panacea, this new research points to an emerging consensus that capital management techniques should be included among the “carefully designed macro-prudential measures” supported by G-20 leaders at the Seoul Summit. Indeed, in recent months, a number of countries, from Thailand to Brazil, have responded to surging hot money flows by adopting various forms of capital regulations.

Further, they say all trade agreements should allow implementing these capital controls:

We also write to express our concern that many U.S. free trade agreements and bilateral investment treaties contain provisions that strictly limit the ability of our trading partners to deploy capital controls. The “capital transfers” provisions of such agreements require governments to permit all transfers relating to a covered investment to be made “freely and without delay into and out of its territory.”

Under these agreements, private foreign investors have the power to effectively sue governments in international tribunals over alleged violations of these provisions. A few recent U.S. trade agreements put some limits on the amount of damages foreign investors may receive as compensation for certain capital control measures and require an extended “cooling off” period before investors may file their claims.iii However, these minor reforms do not go far enough to ensure that governments have the authority to use such legitimate policy tools. The trade and investment agreements of other major capital-exporting nations allow for more flexibility.

We recommend that future U.S. FTAs and BITs permit governments to deploy capital controls without being subject to investor claims, as part of a broader menu of policy options to prevent and mitigate financial crises.

Scanning the list of econs, there are some big names – Ricardo Hausmann, Dani Rodrik, Joseph Stiglitz, Arvind Subramanian etc. Apart from 139 US based econs, there are 117 econs from around the world as well. Most of them wrote about using capital controls before as well. But were ignored. Now is their time when the world policymakers are waking up to it.

Then TGS Blog pointed to this superb article from Eduardo Levy-Yayati.  He says one can only judge the effectiveness of capital controls if we knew what would happen without them. As that is difficult to do, we can never be sure.

Levy-Yayati says capital controls are effective as they impose a toll on financial markets. How effective depends on the scale of controls and efficiency depends on the objectives. They should be used as part of the macro-prudential toolkit for being more efficient.

Revival of capital controls in the making…..


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