What promotes crony capitalism – Capital controls or capital account liberalization?

Capital controls was a bad word till 2008 and still remains an uncomfortable word for most economists. One allegation out of many against capital controls is that they promote crony capitalism. The powerful incumbents don’t want competition and do all to prevent it. Capital controls is one such measure which prevents foreign capital from investing in new ventures and promote competition.

However, post 2008 people are looking at things differently. They say actually capital flows are part of crony capitalism as well. After all, people who have been pushing for capital flows are the powerful wall street lobby for their own gains. This is not a new argument. Just that it is becoming more popular and that too with people who supported capital flows pre-2008.

Here is AV Rajwade talking about this change of thought:

The other side is whether propagation of a liberal capital account by the IMF since the 1980s is itself the outcome of “crony capitalism”. Many economists think so; it was also the root cause of several financial crises. Economist Jagdish Bhagwati has alleged that foisting a liberal capital account on developing/emerging economies was an example of Wall Street influencing the IMF in that direction with the help of the US Treasury. So has Khairy Tourk, professor of economics at Stewart School of Business, Chicago, in a letter to Financial Times (March 10, 2012): “The 1997 crisis (in East Asia), on the other hand, was a result of an International Monetary Fund policy that reflected Wall Street interests. The US Treasury, in the 1980s, prodded the IMF to push for the immediate liberalisation of the capital account in emerging economies.” (It was precisely to mitigate the influence of the US Treasury on IMF that John Keynes wanted the IMF headquartered away from Washington – he failed.)

The crises in Mexico (1994-95), Brazil and Russia (1998), Argentina (2000-01) among others have the same root cause. As William R White, chairman of the Economic and Development Review Committee of the Organisation for Economic Co-operation and Development, has recently argued: “Hot money, funds that flow from one country to another from investors seeking the highest returns, can wreak havoc – both on the way in and out” (Finance & Development, March 2015). Martin Wolf seems to agree; to quote from The Shifts and the Shocks, his book on the 2008 financial crisis, “No sensible economist would today – after so much painful experience – advise (emerging) countries to simply open their capital accounts to the world and ignore the risks of excessive inflows… falling incentives for the production of tradable goods and services, and severe financial and economic crises.”

Back in 1962, Robert Mundell propounded the “Impossible Trinity”: a fixed/managed exchange rate, the free movement of capital and an independent monetary policy cannot be simultaneously maintained. Since then the scale of cross-border capital flows has increased so enormously that, in the view of Helene Rey, professor of economics at London Business School, this needs to be revised to a dilemma: the belief that “a flexible exchange rate can insulate you from financial shock” as argued by those who target inflation is not realistic; “independent monetary policies are possible if and only if the capital account is managed”. (Finance & Development, June 2015)

It is just such a similar story.

Anything excessively done is problematic. In economics a term/policy measures comes and shows some initial success. Then it become such a strong buzzword that it is recommended for all ills. Such was the case with capital liberalisation as well. We don’t realise that in economics nothing is sacrosanct. All is situation and context specific.

This even becomes a bigger problem in emerging market countries like India as we are just victims of thoughts coming from west. Whatever they propose we tend to dispose without thinking much whether it applies to us or not..


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