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Global Capital Rules
It’s official. The International Monetary Fund has put its stamp of approval on capital controls, thereby legitimizing the use of taxes and other restrictions on cross-border financial flows.
Not long ago, the IMF pushed hard for countries – rich or poor – to open up to foreign finance. Now it has acknowledged the reality that financial globalization can be disruptive – inducing financial crises and economically adverse currency movements.
So here we are with yet another twist in the never-ending saga of our love/hate relationship with capital controls.
Under the classical Gold Standard that prevailed until 1914, free capital mobility had been sacrosanct. But the turbulence of the interwar period convinced many – most famously John Maynard Keynes – that an open capital account is incompatible with macroeconomic stability. The new consensus was reflected in the Bretton Woods agreement of 1944, which enshrined capital controls in the IMF’s Articles of Agreement. As Keynes said at the time, “what used to be heresy is now endorsed as orthodoxy.”
By the late 1980’s, however, policymakers had become re-enamored with capital mobility. The European Union made capital controls illegal in 1992, and the Organization for Economic Cooperation and Development enforced free finance on its new members, paving the way for financial crises in Mexico and South Korea in 1994 and 1997, respectively. The IMF adopted the agenda wholeheartedly, and its leadership sought (unsuccessfully) to amend the Articles of Agreement to give the Fund formal powers over capital-account policies in its member states.
As long as it was developing countries that were whipsawed by global finance, it was fashionable to blame the victim. The IMF and Western economists argued that governments in Mexico, South Korea, Brazil, Turkey, and elsewhere had not adopted the policies – prudential regulations, fiscal restraint, and monetary controls – needed to take advantage of capital flows and prevent crises. The problem was with domestic policies, not with financial globalization, so the solution lay not in controls on cross-border financial flows, but in domestic reforms.
Once the advanced countries became victims of financial globalization, in 2008, it became harder to sustain this line of argument. It became clearer that the problem lay with instability in the global financial system itself – the bouts of euphoria and bubbles, followed by the sudden stops and sharp reversals that are endemic to unsupervised and unregulated financial markets. The IMF’s recognition that it is appropriate for countries to try to insulate themselves from these patterns is therefore welcome – and comes none too soon.
But we should not exaggerate the extent of the IMF’s change of heart. The Fund still regards free capital mobility as an ideal toward which all countries will eventually converge. This requires only that countries achieve the threshold conditions of adequate “financial and institutional development.”