Political economy of capital account liberalisation??

Jeff Chelsky has this nice insight on why capital account liberalization (CAL) took place in developed economies. Most of us think it was economics but Chelsky points there were some interesting political economic reasons as well.

Bretton Woods did not have CAL in its agreement:

Exclusion of capital account convertibility from the original Bretton Woods architecture, (and the IMF’s Articles of Agreement (1945), specifically) reflected several factors: (i) the relative importance of current account transactions in overall global financial flows between countries; (ii) the desire for fixed exchange rates to avoid competitive devaluations; and (iii) British fear of large-scale repatriation of overseas sterling balances, (particularly from India and Argentina). These factors help explain why the right to impose capital controls was explicitly embedded in the original IMF Articles. Keynes, in particular, considered the right to control capital movements as a permanent rather than transitional arrangement (James 1996, 38). The right to regulate capital, particularly short-term capital, was subsequently included in the European Economic Community’s Treaty of Rome (1957).

CAL started surfacing in the pursuit to build one Europe:

The establishment of codified CAL frameworks was at least initially driven largely by the pursuit for European integration and the desire to establish a single market. The objective was formally set out in 1950 by the Organization for European Economic Cooperation (OEEC)—precursor to the Organisation for Economic Co-operation and Development (OECD). But the Treaty of Rome, which established the European Economic Community, provided for freedom of capital movement within Europe “only to the extent necessary to ensure the proper functioning of the Common Market.” This was in contrast to free movement of goods, services, and people. The CAL objective was partial, restricted to longer-term “productive” capital (for example, foreign direct investment [FDI]), and was maintained by the OECD following its creation in 1961.

Unlike Europe which was careful in CAL, Anglo Saxon countries like US and UK were more open to CAL as their currencies were reserve currencies:

The apparent contradiction between the establishment of multilateral frameworks for CAL and the prevalence of capital controls in advanced economies for much of the 30 years following the end of the war reflects, to some extent, differences
in approach to CAL between the (largely) Anglo Saxon countries, which tended to pursue more rapid unilateral liberalization, 4 and continental Europe (most clearly embodied by  France), which pursued a more managed, codified, and institutional approach. 

Anglo Saxon countries tended to pursue CAL unilaterally. For the United Kingdom and the United States, this partly reflected their status as global financial centers and, in the case of the United States, as the predominant reserve currency issuer, with powerful domestic financial interests supporting CAL

 The major change in Europe came from France acceptance of CAL. France did not support CAL but as capital controls did not work in 1980s, it allowed CAL. Once French gave in, rules were changed to make CAL a valid goal for all developed economies:

As noted, momentum for CAL (particularly of short-term flows) picked up in the late 1980s following the reversal of French opposition to full CAL, which came in response to France’s unsuccessful experience with capital controls in the early part of the decade. In 1986, reflecting changed French views, the EC proposed adopting as liberal as possible a capital account regime. In 1988, it adopted a directive6 enshrining the principle of full CAL between member states while retaining a time-bound safeguard clause. In 1991, the Maastricht Treaty solidified commitment to CAL.7 In 1989, the OECD code was amended to include virtually all capital flows, explicitly acknowledging that full CAL was a valid goal and the hallmark of a fully developed economy. This change validated earlier CAL by states such as the United Kingdom, the United States, Germany, and Canada; it also served as an impetus to CAL for other members, and as an inducement to more ambitious CAL, including in countries seeking OECD membership in the 1990s. By 2005, the more liberal regime governed 70 to 80 percent of world capital flows (Abdelal 2007, 12). 

Interesting…

The author goes onto expand the logic to China. He says for China the same reasoning does not apply and China unlikely to push for CAL. However, over a period of time CAL may become important as Renminbi becomes reserve currency and China develops its fin system:

The experiences of advanced economies have limited parallels to China’s situation. China does not seem to possess the  same political agenda and objectives that provided the initial motivation for CAL in continental Europe, nor are there similarly powerful domestic financial interests pushing for CAL (including of short-term flows) such as those in place in both the United States and the United Kingdom. However, over time, these may emerge as China allows greater internationalization of its currency and develops its private domestic financial sector. This suggests that the pace of China’s CAL might most effectively be accelerated through reforms that contribute to the development and empowerment of supportive domestic constituencies, including among savers, consumers, and the domestic (that is, mainland) private financial sector.

The more you read of such stuff the more perplexed you are. As Krugman says time and time again that macroeconomics entered dark age in 1970s ignoring the importance of fiscal policy in recessions. Similarly, how the field has marginalized the role of politics in economic decisions is also amazing. The field has been left to political scientists and it is assumed politics hardly plays a role in economic decisions.  The reality is a lot different. We can always argue/debate over whether govt. should play any role in economics but to assume it does not is just plain ignorance of reality.

 

 

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