More on capital controls from writers less lazy than me!

That's right: more productive corners of the intertubes have been busy covering the ongoing debate on capital controls. As our readers might recall, the IMF reversed it's long standing opposition to their use, accepting them as part of a macroeconomy's "policy toolkit." Dani "master of development policy" Rodrik referred to the IMF's policy change as "the end of an era of finance." True Stuff.

Well that was sooooo a few months ago.

Now Ilene Grabel over at Triple Crisis quite correctly points out that capital controls have become part of the "new normal" of the aftermath of the financial crisis. In other words, what was considered sacrilege before the world downturn has been, if not openly endorsed, for the most part accepted:

"But something happened on the way out of the global financial crisis. Policymakers have been quietly imposing a variety of capital controls, often marketing them with Madison Avenue savvy simply as prudential tools (akin to what Epstein, Grabel and Jomo KS termed “capital management techniques”)...The “market’s response” to these various controls—a surprising silence and, in some cases, tacit approval. The response by economists at the IMF has been in the same vein... And so it is that capital controls have quietly become another element of the new normal."

Also, Kavaljit Singh over at Vox has a very nice column reviewing new capital controls to curb volatility and increasing speculative financial flows in South Korea and Indonesia:

These new curbs are in response to growing concerns over short-term capital inflows. Given the historically low levels of interest rates in most developed countries, Indonesia has received large capital inflows since 2009. Unlike other Asian economies such as Singapore and Malaysia, the Indonesian economy showed some resilience during the global financial crisis. Despite hiccups in the financial markets, the Indonesian economy registered a positive growth of 6.0% in 2008 and 4.5% in 2009, largely due to strong domestic consumption and the dominance of natural resource commodities in its export basket... Yet due to the massive speculative capital inflows, the Indonesian authorities remain concerned that its economy might be destabilised if foreign investors decide to pull their money out quickly... Analysts believe that these policy measures may deter hot money inflows into the country and monetary policy may become more effective. Yet they expect tougher measures in the future if volatility in capital flows persists.

In anycase, quit hanging around here and go read these two excellent pieces yourself.

Ideological Labels Are Fun: Colombia and Chile

Did you know that, despite simplistic labels to the contrary, the US' favorite client state actually is not the free-market paragon most people think? That's right, I'm talking about the supposedly "free-market" darling Colombia, which according to a new Inter-American Development Bank (IADB) working paper has been pursuing extensive industrial policies for quite some time.

The economic merits of these policies aside, this underscores that just because a country has a horrible human rights track record and is in the State Department's pocket, it doesn't necessarily mean it's also "neoliberal." In other words, the media (especially up north) likes to assume Colombia is "market-friendly" simply because it is US-friendly and has signed a handful of Free Trade Agreements. But in reality it has also been pursuing fairly heterodox policies for a while.

One obvious example of this is Colombia's long-running affair with capital controls. As maladjusted has pointed out before, Colombia's regulations on international capital flows are currently the highest in the region. During the 1990s, when South America regained access to international capital markets and all the cool kids on the block were liberalizing, Colombia had smart regulations in place to tax inflows. This helped reduce flow volatility, prevented excessive exchange rate appreciation and lengthened the maturity of foreign liabilities (which lowers the likelihood of experiencing a financial crisis).

In any case, the point is that when it comes to labeling a country's economic policy, what's accurate is seldom the same as what is politically sexy. The truth in South America has always been more nuanced than "neoliberal countries grow, leftist countries don't."

A natural parallel in this regard is the case of Chile, which to much fanfare staked out claims to first world status last year when it was officially admitted to the OECD. The conventional narrative holds that Allende's socialist policies were destroying the country before the free-market champion Pinochet took power and, with help from the Chicago boys, set the foundations for the country's future prosperity. But, of course, the reality isn't so simple.

Chile hasn't prospered because of pure neoliberalism. It has prospered because of resource nationalism (even Pinochet was smart enough to keep the state-owned copper company, CODELCO), the state promotion of exports (salmon, wine, and virtually every other major export success have received extensive gov. assistance) and, on the macroeconomic level, well devised capital controls (Chile is actually the paradigmatic example of success in this area).

Whatever.

Dichotomies challenged. Reality trumps ideological labeling. And I'm a closet post-modernist. The End.

More IMF public support for capital controls

Following up on maladjusted's weekend update, Nicolas Eyzaguirre, the IMF's top guy for the western hemisphere, said yesterday that the Fund supports the use of controls on capital inflows to prevent unwanted currency appreciation and potential overheating. Now, this isn't breaking news, but it's certainly nice to see someone high up reiterate this position, especially after the Global Financial Stability report released a couple weeks ago seemed to backtrack a bit.

In any case, Mr. Eyzaguirre had this to say:

In some cases, exchange rate flexibility, good fiscal discipline, and a prudent set of macro prudential policies, may not be enough to avoid an over-expansion or a potential bubble. Thus, we do not bar or disapprove the potential contribution of carefully designed taxes on capital inflows that may have a role in complementing the policy toolkit—although we should always bear in mind that these kinds of more orthodox responses do have their limitations.

And he should know too, having worked at Chile's Central Bank during the 1990s when the country implemented its own well known capital controls.

The IMF's new position on capital controls is by no means groundbreaking. It actually follows the consensus in the academic literature quite closely and can essentially be summed up with this nice flow chart (click to enlarge):

If you face a surge of capital inflows (as many developing countries are facing today due to low interest rates in the north) you should first consider if your currency has room to appreciate. If this isn't the case, then you should consider if reserve accumulation is desirable and if inflation is a problem, then you should attempt sterilization. But sterilization can prove too expensive, in which case capital controls become a useful policy option. Of course, if inflation isn't a problem you can just lower interest rates to discourage the inflows from coming at all.

This is all very right, but there are certainly a lot of caveats in the IMF's position--enough to make one wonder how often the Fund will actually recommend the use of capital controls during its consultations with its member countries. For instance, the Fund insists on overstating the problem of the evasion of controls by sophisticated financial actors and has also warned that controls cause distortions.

Now, of course any regulation is only as good as its regulators. But nevertheless, no matter the extent of sophistication of your financial sector, evading controls always entails a cost, which is exactly what controls are supposed to do. In fact, most empirical studies have found controls effective to the extent that they manage to "segment" the domestic financial market from the international market--meaning there's a wedge between domestic and international interest rates or between the price of stocks traded in both markets. And very frequently, this is the case even in countries where critics have claimed that controls were evaded.

IMF backpedals its endorsement of capital controls

Maladjusted's readers may know that after being snubbed by developing countries because of its horrible policy advise, the IMF had a midlife crisis and was forced to do a little soul searching. But right when it was on the brink of utter irrelevance, the global financial crisis hit and the ailing institution was given a new lease on life. In the process, headed by french "socialist" DSK, the IMF began reevaluating many of its long held dogmas.

Most recently, the IMF came out in favor of using short-term controls on capital inflows. This was considered a BIG FUCKING DEAL, and rightly so, but the details of how this would translate into actual policy were anything but clear. So now it shouldn't exactly come as a surprise that the IMF seems to be softening it's support for capital controls--that is, taxes and restrictions on moving capital across national borders.

A little background might be in order.

Throughout the '80s and '90s, the IMF encouraged developing countries to liberalize their financial markets and to do it fast. Free market types basically believed that doing this would promote the efficiency of financial markets, channeling funds to where they were needed most and thus leading to better economic growth.

Well, at the beginning of the '90s many developing countries began to liberalize and, due to a combination factors, were faced with massive inflows of foreign capital. To simplify, the US Fed had pushed interest rates down to help the US recover from a recession, prompting investors to look elsewhere for places with higher rates. At the time, Latin America was just such a place. Moreover, apart from having high interest rates, most countries in the region had spent the last decade--the lost one--pursuing neoliberal reforms that investors perceived favorably.

In any case, countries that had been cutoff from international capital markets for years suddenly experienced a huge surge of foreign capital inflows. The problem, however, was that when it comes to capital flows you really can have too much of a good thing. It quickly became apparent that these large flows of foreign capital carried significant risks and posed a challenge to macroeconomic management.

One side effect of capital inflows is that it puts pressure on your currency to appreciate and for many of these countries, which were pursuing an export-led development strategy, this was a big problem.

Many of these countries were also concerned with a loss of monetary policy independence, meaning that the abundance of foreign money was pushing interest rates down despite the wishes of central banks to keep them high in order to fight inflation.

Policy makers were also concerned that these large inflows could make countries more vulnerable to financial crises. In particular, Latin American banks took advantage of all this cheap foreign money and borrowed excessively short-term and in foreign currencies, which put them at risk if the inflows were to stop and the currency to collapse.

The point of this story is that one country in particular managed to juggle all these problems quite well and it did so using capital controls. This country also happens to be the free market darling Chile (Colombia and Brazil have used similar controls with varying degrees of success).

Another famous success story comes from Southeast Asia during the Asian financial crisis. Facing massive capital flight, Malaysia broke with the IMF and imposed temporary controls on capital outflows to prevent it's economy from collapsing. Its economy proceeded to recover rapidly.

Whatever. So now, in spite of mounting evidence and it's own endorsement, the IMF is warning that capital controls could cause significant distortions:

"Since the use of capital controls is advisable only to deal with temporary inflows, in particular those generated by external factors, they can be useful even if their effectiveness diminishes over time... However, the decision to implement capital controls should consider their distortionary effects not just on the individual country, but also on the global economy in the event their use were to become widespread."

To be fair, there's nothing wrong with this statement. Controls on capital inflows shouldn't be used as an excuse to avoid pursuing meaningful macroeconomic adjustments and if controls become widespread they might slow global recovery (a rather large claim backed by little evidence). But it's clear that there are actors within the IMF trying to prevent capital controls from becoming standard policy. So before we rush to the conclusion that the IMF is seriously reconsidering it's long-held policy stances, we should wait to see how it's endorsement of capital controls translates into actual policy.