AZ-Neu

Gerald Epstein
Political Economy Research Institute, University of Massachusetts1

The current financial crisis has brought capital controls – and more generally, capital management techniques, that is the combination of exchange controls, capital controls and prudential regulations - back into fashion, and it’s high time. Had appropriate controls over the international sale of dangerous financial products and the speculative flows of foreign capital been widely in place, more countries would probably have been better protected from the financial fallout of the crisis, as were India and China who intensively applied such techniques. Iceland might not have melted down and Ireland might not have fallen off a cliff.
We have been here before. Laissez-faire approaches to international capital flows contributed to the collapse of the 1930’s. In the aftermath of the Depression and the ensuing, catastrophic Second World War, governments in most of the world -- with the reluctant blessing of the newly created International Monetary Fund (IMF) -- adopted government controls (exchange and capital controls) to manage the international flows of money and capital. For at least the first three decades following the Second World War, controls over the international flow of capital became the norm in most of the world and helped to support the so-called ‘Golden Age’ of economic growth in the post World War II period. Over time, and under pressure from financial interests, governments began to relax restrictions on the international flow of capital and money. Then, the chickens came home to roost. In 1997, the so-called Asian financial crisis hit, creating havoc in many highly successful Asian countries. This disaster was soon followed by the Russian financial crisis. And then a series of crises occurred culminating in the great financial crisis of 2007-2009.
In the face of the current crisis, countries are now trying to apply a wide array of capital management tools to protect their economies from the financial forces that brought the world economy to its knees. The IMF, in a turnaround from several decades of practice, is grudgingly accepting some of these attempts, demonstrating that when reality bites, even the IMF has to respond.
The table presents a summary of objectives and types of capital management techniques that have been used in practice. As one can see, there are many important objectives that governments pursue with capital management techniques and many tools that governments have at their disposal to achieve these goals.

There has been extensive study of countries’ motivations for adopting such instruments and the outcomes (costs and benefits) associated with them. Some useful lessons emerge from this work:
First and most generally, capital management techniques can contribute to currency and financial stability, macro- and microeconomic policy autonomy, stable long-term investment, and sound current account performance. There may also be some costs associated with these techniques, such as the fact that they can create space for corruption. But well-structured controls minimise these costs.
Second, successful implementation of controls over a significant period of time depends on the presence of strong fundamentals and a sound policy environment. The former include a relatively low debt ratio, moderate rates of inflation, sustainable current account and fiscal balances, consistent exchange rate policies; the latter public sectors that function well enough to be able to implement coherent policies (administrative capacity), and governments that are sufficiently independent of narrow political interests to be able to maintain some degree of control over the financial sector (state capacity).
Third, it is important to note that causation works both ways: from good fundamentals to successful capital management techniques, and vice versa. Good
fundamentals are important to the long-run success of capital management techniques because they reduce the stress on these controls and thereby enhance the chance that they will be successful. On the other hand, capital management techniques also improve fundamentals by helping to prevent risky financial strategies, excessive debt levels, currency mismatches, and speculative investments.
Fourth, the dynamic aspects of capital management techniques are perhaps their most important feature. Dynamic aspects mean that controls can be put on and taken off, and tightened and loosened as circumstances require. Policy makers need to retain the ability to implement a variety of management techniques and alter them as circumstances warrant.
Fifth, capital management techniques work best when they are coherent and consistent with the overall aims of the economic policy regime, or -- better yet -- when they are an integral part of a national economic vision. This vision does not have to be one of widespread state control over economic activity. Singapore is a good example of an economy that is highly liberalised in some ways, but where capital management techniques are an integral part of an overall vision of economic policy and development.
Sixth, there is no single ‘best practice’ when it comes to capital management techniques. They need to be tailored to the particular country, goals and circumstances. Luckily there is a broad menu of techniques that can be applied.
Of course, capital management techniques are no panacea for economic problems, and they will not work well unless they are part of an overall, appropriate framework of economic management. For countries navigating the treacherous waters of international finance, however, they can be useful – even necessary – components of the macroeconomic toolkit.

1. The author thanks his co-authors and colleagues James Crotty, Ilene Grabel, Arjun Jayadev, and Jomo K.S. for their contributions to his understanding of capital management techniques and for their work, on which he draws liberally here. Of course, they are not responsible for any errors

Further reading
Epstein, Gerald, Ilene Grabel and Jomo K.S. (2005) ‘Capital management techniques in developing countries,’ in Gerald A. Epstein (ed.) Capital Flight and Capital Controls in Developing Countries, Edward Elgar: Northampton, MA.
Grabel, Ilene (2004) ‘Trip Wires and Speed Bumps: Managing Financial Risks and Reducing
the Potential for Financial Crises,’ in Developing Economies G-24 Discussion Paper Series. United Nations, No. 33, November.
Neely, Christopher J. (1999) ‘An introduction to capital controls,’ Review (Federal Reserve Bank of St. Louis), 81 (6): 13-30.
Ocampo, Jose Antonio (2002) ’Capital-account and counter-cyclical prudential regulations in developing countrie,’ UNU, WIDER.