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A Whole Bunch of Prominent Economists Backs the Use of Capital Controls

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A letter signed by over 250 economists opposing restrictions on capital controls is more of a shot across the bow than it might appear to be. The letter with signatories appears here, and it includes highly respected trade and development economists like Ricardo Hausmann, Dani Rodrik, Joe Stiglitz, and Arvind Subramanian; we are reproducing the text below:

Secretary Hillary Rodham Clinton
U.S. Department of State
2201 C Street NW
Washington, D.C. 20520

Secretary Timothy Geithner
Department of the Treasury
1500 Pennsylvania Avenue, NW Washington, D.C. 20220

Ambassador Ron Kirk
Office of the United States Trade Representative
600 17th Street NW
Washington, DC 20508
Dear Secretary Clinton, Secretary Geithner, and Ambassador Kirk:

We, the undersigned economists, write to alert you to important new developments in the economics literature pertaining to prudential financial regulations, and to express particular concern regarding the extent to which capital controls are restricted in U.S. trade and investment treaties.

Authoritative research recently published by the National Bureau of Economic Research, the International Monetary Fund, and elsewhere has found that limits on the inflow of short-term capital into developing nations can stem the development of dangerous asset bubbles and currency appreciations and generally grant nations more autonomy in monetary policy-making.

Given the severity of the global financial crisis and its aftermath, nations will need all the possible tools at their disposal to prevent and mitigate financial crises. While capital account regulations are no panacea, this new research points to an emerging consensus that capital management techniques should be included among the “carefully designed macro-prudential measures” supported by G-20 leaders at the Seoul Summit.ii Indeed, in recent months, a number of countries, from Thailand to Brazil, have responded to surging hot money flows by adopting various forms of capital regulations.

We also write to express our concern that many U.S. free trade agreements and bilateral investment treaties contain provisions that strictly limit the ability of our trading partners to deploy capital controls. The “capital transfers” provisions of such agreements require governments to permit all transfers relating to a covered investment to be made “freely and without delay into and out of its territory.”

Under these agreements, private foreign investors have the power to effectively sue governments in international tribunals over alleged violations of these provisions. A few recent U.S. trade agreements put some limits on the amount of damages foreign investors may receive as compensation for certain capital control measures and require an extended “cooling off” period before investors may file their claims.iii However, these minor reforms do not go far enough to ensure that governments have the authority to use such legitimate policy tools. The trade and investment agreements of other major capital-exporting nations allow for more flexibility.

We recommend that future U.S. FTAs and BITs permit governments to deploy capital controls without being subject to investor claims, as part of a broader menu of policy options to prevent and mitigate financial crises.

This letter is at odds with a longstanding project of major financial firms: to allow them to move money across borders with no muss or fuss. This was the dream of Citibank’s Walter Wriston, who perversely was not deterred by the large losses his bank incurred in its sovereign lending misadventures of the late 1970s. It became a matter of policy in the Rubin/Summers Treasury Department.

Although the danger of destabilizing “hot money” inflows has been well recognized since the Asian crisis of 1997, the thrust of US policy has been to continue to push for more capital markets liberalization, particularly in emerging economies. Yet the evidence has continues to mount that a high level of international capital movements isn’t merely a potential threat to developing markets, but to economic stability. As we’ve pointed out repeatedly, the Carmen Reinhart/Kenneth Rogoff work on financial crises showed a strong correlation between high levels of international funds flows and banking crises.

The odd, and telling bit in the debate is the unwitting concession to financiers embedded in the existing terminology: capital controls. It incorrectly implies that money is every and always stateless, and any effort to restrict it is unnatural. But truly stateless commodities are highly transportable, high density stores of value whose content can be readily verified: think diamonds (at least pre the era of synthetic diamonds), gold, platinum. But despite their obvious value, what someone receives in exchange if one transports them across borders is very much in doubt, not just due to price fluctuations but also to the difficulties of finding a trustworthy party who would convert the commodity into local currency at a fair rate.

In other words, we’ve all gotten so used to being able to change money, use credit cards, and suck local currency out of ATMs when traveling abroad that we’ve forgotten that this has been put in place with government support. And it has come more recently in some countries than others. I recall running into a McKinsey colleague in the Hong Kong airport in 1985. He was astonished to see that the foreign exchange booths would exchange Indian rupees. The rupee then was a controlled currency; that sort of operation was in theory impermissible. But Hong Kong was always a bit lawless, and this was probably a small scale enough operation so as to fly under any official radar.

But so far, we have been talking about money, and the conversion of currency in a personal/retail context. By contrast, “capital” carries with it the idea of investment. Money is not being moved simply to get it into another country (well it might be if you are a drug dealer or the leader of a banana republic planning your exit strategy) but to put it to work. That in turn means you expect some sort of legal protection in the recipient country, ideally as good as the natives get (again note we accept the idea of equal protection under the law in some contexts and not others, so this is not a given).

But what about movement of funds between countries? How exactly is this a matter of rights? For individuals, as with our drug lord example, the reason for trying to move it abroad is almost certainly not legitimate; it’s to escape prosecution and taxation. The US takes the view that the income of its citizens, no matter where earned, is subject to US taxation. Governments lose significant amounts of money due to corporate gaming of tax regimes. Nicholas Shaxson, in his new book Treasure Islands, argues that poor African nations are actually capital exporters. They lose more in tax revenues via arranging their affairs so as to show income in low tax jurisdictions (often with little in the way of real operations there) than they gain in foreign aid.

Now as the letter above acknowledges, international treaties have effectively given investors the right to move funds without restriction into certain types of instruments. But look at the implicit logic, and it’s one that actually goes back to discussions early in the history of the US over whether Congress should charter a bank (yes, Virginia, pre-revolutionary America thrived without banks).

The opponents of the bank charter were concerned about potential abuses that could result from concentrated power.

The bank advocates, most notably Robert Morris, took a very revealing position: they argued that the government had the right to grant privileges, but not to take them back. It amounted to arguing that economic interests extended to private actors somehow became their property, and that any reversal of these grants was not simply an act of bad faith, but was theft.

Yet we routinely accept the rescinding of government privileges of various sorts; consider the 1990s “end of welfare as we know it” or the expected reductions in pensions of state employees. But when large commercial interests obtain valuable economic rights, reining them back when they are found to impose undue costs on others is depicted in a completely different light. Restricting them isn’t framed neutrally, as, say, a revision, but as a “control” when the prevailing ideology treats that as a “c” word.

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33 comments

  1. Foppe

    I wonder if the administration won’t just ignore them. Unrestricted capital flows are so much part and parcel of today’s big companies, and so important to the profitability of all the world’s banks (as well as institutional investors and Buffett-type unpatriots who have funded quite a bit of the growth we’ve seen over the past 60 years in Asia (wonder why the countries in Asia that grew first were all US protectorates or British (ex)colonies? I bet it has something to do with that) that even talking about having read this letter will likely cause a shitstorm of people warning that the economy will become unstable unless we have this liquidity or somesuch.

    1. streetman

      Basically agree with you, but with respect, capital flowed to the former British colonies in Asia where the rule of law still governed trade and property rights, and didn’t where it was usurped by dictators or communist regimes (see also sub-Saharan Africa).

      Of course, in practice the U.S. denies capital inflows all the time, most notably recently for “strategic” or national security reasons, so it’s a tool we will retain anytime it suits us. Likewise China; you might be able, with many restrictions, to make an investment there, but good luck repatriating your profits easily. The always brilliant Rogoff and Reinhart are quite correct (witness Iceland), and individual countries’ ability to employ capital restrictions is important enough not to be neutered by trade agreements.

  2. Bruce

    Why dont we just all have a government savings accounts at the Government Bank, with a nice long form to fill out if we want to withdraw any “cash”, and automatic electronic deposit into said bank of all transactions via the Government Clearing Company, and a Government Debit Card for use in all transactions.

    That way Daddy –who always knows best– can make sure we children don’t go astray…..

  3. F. Beard

    I note the confusion of “money” with “capital”. “Capital” is such things as human talent, skills, energy, technology, etc. “Money” can buy or rent capital but is not itself capital.

    So we really should speak of “money controls” rather than “capital controls.”

    1. F. Beard

      Pardon me Yves, I see you do make the distinction between money and capital but in a different manner. The issue is a hot button for me and I was hasty. My apologies.

    2. hermanas

      @F.Beard.
      ““Capital” is such things as human talent, skills, energy, technology, etc.”
      Thanks, that clarifies the loss unemployment means to the economy.

  4. dave

    I think I’m noticing a pattern in these posts:

    A) Was government involved somewhere, anywhere, in any degree, in some matter (in this case currency, from which you could make the jump to pretty much all commerce in society)?

    …if yes then…

    B) Government has full control to do whatever it wants and people simply have to accept it without complaining about rights, especially property rights. Since government is the “will of the people” this is always and everywhere the right decision. (forgetting for a second that there is no such thing as the “will of the people”)

    Look, I don’t have a fundamental problem with international capital controls. I suppose it could be a useful policy tool in certain circumstances. And I don’t think its a fundamental property right that society needs to function.

    However, the logic above is wearing a little thin. Government, by virtue of having the guns and therefore being the ultimate source of law enforcement in a society, will always satisfy condition A. Does it naturally flow that we should accept anything the government decides to do, simply because some guys got 50%+ of the population to vote for them. Or should we acknowledge that condition A is not satisfactory reason to grant the government complete control. That we have certain rights as citizens, including in many cases property rights, that are protected by more fundamental principals and therefore not subject to the whims of electoral majorities.

    1. liberal

      That we have certain rights as citizens, including in many cases property rights, that are protected by more fundamental principals and therefore not subject to the whims of electoral majorities.

      While rights shouldn’t always and everywhere be subject to majoritarian whims, you’re coming close to the idea that there is such a thing as a “fundamental” right to property divorced from government.

      There’s no such thing whatsoever. Property, as opposed to mere possession, is defined by government. No government, no property.

      1. dave

        “While rights shouldn’t always and everywhere be subject to majoritarian whims, you’re coming close to the idea that there is such a thing as a “fundamental” right to property divorced from government.

        There’s no such thing whatsoever. Property, as opposed to mere possession, is defined by government. No government, no property.”

        ____________________

        All rights are defined by governments. Rights only exist if you have the power to protect them and as the sole arbiter of the use of force government is the only entity that can enforce rights. You don’t even have a right to your life without government, murder is prosecuted by the state.

        So, the question then is what rights we as citizens demand. At the countries founding we decided to have a constitutional democracy, rather then a pure democracy, because we recognized that certain rights guaranteed to citizens, whether there was a electoral majority in favor of them or not, enhanced our well being as a society. Among these where guarantees of life, liberty, and property.

        Yves argues here, and often, that the fact that government is necessary for civil society thus grants it the power to make the rules as it sees fit, because ultimately no person could protect themselves or their property without it. If you ask me, the price she is asking for that protection is too high. Being afforded the basic protections of law and order by the state does not grant it the right to take what it will of my property and person. The power of the state is vast, and our only protection as individuals is to place concrete limits on that power.

        1. liberal

          Being afforded the basic protections of law and order by the state does not grant it the right to take what it will of my property and person.

          That’s not even the beginning of what the state gives you as a property holder.

          The most important property is land. Our notion of justice in property is that people are entitled to the fruit of their labor, or what they trade for the fruit of their labor. Land’s not the fruit of anyone’s labor, and indeed, the (unimproved) value of land is NOT generated by the landowner in his role as landowner.

          So, to the extent you own land, the state is actually giving you a privilege—a state-generated and -granted privilege—to infringe on the liberty of others by denying them access to the land.

          Yeah, yeah, you paid for it. So what? Slave owners paid for their slaves; doesn’t mean they weren’t stealing the slaves’ labor. Same thing for land ownership. To the extent that the state isn’t charging you for the benefit via land taxes, you’re a beneficiary of that very state power you decry.

          The power of the state is vast, and our only protection as individuals is to place concrete limits on that power.

          It’s a cost/benefit thing. I don’t see how the infringement on liberty in well-designed capital controls whose goal is to stop hot flows of short-term capital is anything close to the benefit of stopping economic meltdowns. More generally, whether, and to what degree, state power should be limited depends on the situation, not just on vague principles.

          1. dave

            Yes, if we go back far enough I’m sure you can concoct a case for how all property in the world is ill gotten. We stole the country from the Indians, etc. etc. I’m not totally hardened to trying to make amends for past wrongs, but there is a statue of limitations on these claims. Its a pretty big leap of faith to say that if I buy a house I’m in hock to the state for whatever they desire for my privilege of owning the land its on.

            I’ve already made my stance on capital controls clear.

            On to the crux of the matter:
            “More generally, whether, and to what degree, state power should be limited depends on the situation, not just on vague principles.”

            Of course. And in this specific matter it may make sense, but Yves’s fuzzy logic (you benefit from the state in some way so the state can do whatever it wants and you have no moral grounds to stand on) can and has been used to promote a lot more then modest capital controls. We must be careful with property, property is the material manifestation of individuals, families, and groups efforts in life and to take it is to take a piece of ones time on this earth.

            It should be noted that “vague principles” are quite useful as there are many aspects of governance where history shows that “well designed” plans are difficult or impossible to implement, and so a general restriction on the states ability can itself maximize the well being of society, even if it occasionally seems inconvenient to electoral majorities.

          2. attempter

            Yes, if we go back far enough I’m sure you can concoct a case for how all property in the world is ill gotten. We stole the country from the Indians, etc. etc. I’m not totally hardened to trying to make amends for past wrongs, but there is a statue of limitations on these claims.

            I’m sure we’re all very grateful for how graciously you concede that “etc. etc.” may conceivably be true, and how you’re not totally hardened against some modest amends for any legitimate* claims. Especially since we “concocted” the case.

            *Who writes your talking points, Joe Biden? In case you didn’t notice, the likes of you are looking like buffoons before the eyes of the world these days.

            ..but there is a statue of limitations on these claims.

            Who says? I know criminals say that, and I couldn’t care less what they say. Nor do you have God’s anointment anymore. So who says, other than criminal muscle?

            Democratic human beings don’t believe that. The dispossessed don’t believe that. Those who understand how irrational and depraved is the very concept of land propertarianism, let alone its brutal practice, don’t believe that. Those who know we have a human right to cultivate the land don’t believe that. Quite the contrary.

            So who says?

        2. liberal

          Rights only exist if you have the power to protect them and as the sole arbiter of the use of force government is the only entity that can enforce rights.

          Yes, the state’s role as essentially having a monopoly on legitimate violence is important here. But it’s not the main or only thing. The main thing is that through the state, these rights are defined and secured for all. That is to say, with no state, what you consider rights are only your own preferences, with only you to defend them. With a state, the rights are recognized and defended by all.

          1. dave

            “Yes, the state’s role as essentially having a monopoly on legitimate violence is important here. But it’s not the main or only thing. The main thing is that through the state, these rights are defined and secured for all. That is to say, with no state, what you consider rights are only your own preferences, with only you to defend them. With a state, the rights are recognized and defended by all.”

            This statement is true with some revisions. The state has a monopoly on force, but whether it is legitimate or not is entirely a matter of opinion. Even electoral majorities are not grounds to determine whether action is “legitimate”. Since there is no way to define legitimacy of physical violence and little to stop the state from engaging in illegitimate violence (that elections are not sufficient in and of themselves should be apparent) we take great care as a society to limit the states ability to carry out acts of violence or to threaten people with them so as to affect behavior.

      2. fish

        You don’t even have a right to your life without government, murder is prosecuted by the state.

        You are not just stupid…you are extra special Cass Sunstein stupid.

        1. dave

          How so?

          Rights only exist if you can protect them. If you can’t your rights do jack shit for you, they are just ideas. Ideas don’t keep you alive, only concrete action taken in defense of ideas makes them rights, and that concrete action must have the backing of force.

          1. ChrisPacific

            This is effectively the old “might makes right” argument. I think it misses some important elements.

            I would say that rights are defined by social contract, explicit or implicit, and governments are the mechanism by which society enforces those contracts. They convert implicit rights based on social norms (you have the right to walk down the street in safety without somebody deciding to randomly kill you) into explicit ones (random killings are illegal and those engaging in them will be harshly punished).

            While the government has a monopoly on force and thus theoretically the power to impose any standard it sees fit, it can only be successful in the long run if it’s accurately representing the will of the people. Governments that try to enforce ‘rights’ that the population overwhelmingly does not want or believe in end up weakened or overthrown. We have several examples of exactly this in the news right now.

            In brief, ideas are not secondary to enforcement – they underpin the whole thing.

            Having said all that I have some sympathy with your original point (I don’t agree with the statement that the reasons individuals have for moving funds internationally are typically not legitimate, for example) but I’m not sure you are helping your argument with the followups.

    2. liberal

      However, the logic above is wearing a little thin.

      Examples? You admit yourself that in this particular case, government “interference” might be warranted.

    3. F. Beard

      Or should we acknowledge that condition A is not satisfactory reason to grant the government complete control. That we have certain rights as citizens, including in many cases property rights, that are protected by more fundamental principals and therefore not subject to the whims of electoral majorities. dave

      I assert, without proof, that if money were implemented ethically in a given country that “capital” inflows would not be a problem for that country.

      But since we don’t have ethical money creation anywhere (that I know of) then capital controls are a necessary evil.

      One cannot be 1/2 a libertarian wrt money creation.

    4. Charlie

      The liberal argument for government control/intervention/regulation to make things more fair and the conservative argument that eccessive control/intervention/regulation stiffles creativity and progress doesnt mean squat when you have the profit takers in control of the government. The wealth and resources of this nation are being redistributed from the majority into the hands of the minority against the wishes and will of the majority.

  5. Cedric Regula

    As usual economists examine what the sum of 2+2 is, and conclude there is a 49% chance it equals 3 and a 51% chance it equals 5, no chance it equals 4, but we’ll use 4 for theoretical and modeling purposes.

    The countries that just started using capital controls now, and given the verbal green light to do so in the last G20 meeting, are doing so because their currencies are appreciating and they fear the negative impact on exports.

    Then China always had capital controls to enable very cheap and effective pegging of the RMB to the dollar. The main reason the other Asian countries began using capital controls is they became uncompetitive with China in Asian markets(the US isn’t always the Center of the Universe).

    And capital flows come in different flavors. It can buy sovereign bonds, corporate stocks and bonds, or be FDI from a corporation investing in a subsidiary or a bank doing whatever lending it may have an appetite for.

    Any one of these inflows can put upward pressure on a currency, and under a sudden reversal, put pressure on the central banks’ foreign reserves to supply the sudden demand to convert back out of local currency.

    So far, countries doing capital controls are taxing flows on stock and government bonds (Brazil, Korea, Asian tigers. Korea is taxing government bond yield at 16% !!!!).

    Historically, the most damaging form of capital flow to foreign emerging economies has come from bank FDI. We are seeing now that the most damaging capital flow to the developed world is corporate FDI to the emerging world.

    The fix we get so far from export driven economies is to tax stock and bonds, but FDI is fine. What ever happened to global re-balancing?

    If it’s taxes the US is worried about, the foreign tax on cap gains and interest is deductible from your US tax computation. This means we shift tax collections offshore away from the Treasury. But good luck figuring out corporate international accounting.

    So, just what is the problem that economists think they are addressing? Floating currencies? Re-balancing? Mal-investment or predatory lending? Outsourcing and offshoring? Speculative currency attack on small central banks? Mercantilism?

    One size can’t fit all.

  6. income tax calculator guy

    “That we have certain rights as citizens, including in many cases property rights, that are protected by more fundamental principals and therefore not subject to the whims of electoral majorities.” Well put Dave….. well put

    1. liberal

      Terribly put, actually, as one of the most important purposes of government is to define and secure property in the first place.

  7. Hugh

    A society has an expanding or contracting but always finite pool of resources. Government oversees how these resources are moved and distributed throughout society. It does so based on the rather nebulous notion of a social contract. I say nebulous because the laws do not define this contract rather it provides the guides to the laws. Markets are just a mechanism for resource distribution based on laws, enforced by government, and founded on the principles of the original contract.

    Now if a small group manipulates the laws to concentrate society’s resources in their hands, the many have a right to effect their own re-distribution of resources to bring that distribution back in line with the principles of the social contract.

    What we see nowadays is a distortion of this model. It does contain absolute rights but these rights are held at the level of the social contract not the laws. That is you don’t have an absolute right to property or the money you have accumulated. You do have a right to your life, a roof over your head, and a fair share of society’s resources.

    In class warfare, the wealthy few maintain that upward transfers of society’s resources are sacrosanct, the playing out of natural law, but that any downward transfers are unnatural theft and communism: socialist government is taking your money out of your pockets!

    Where we are now is a place where the vast majority of our society’s resources have been usurped by a tiny minority. The social contract has been broken. It was government of the few that did this. Ultimately, it must be government of the many that restores the contract. There are many dangers to this but the only threat in this process is to those who would keep, not their, but our wealth and resources.

  8. John Drake

    Capital controls will only be for the Plebes…the Elites will be able to move their wealth around with impunity. The rest of us, once the SHTF, will be unable to take advantage of international banking, moving capital to less affected environments, cross borders (Mexico/Canada) without declarations of some kind, will be subject to forfeture and seizure of any assets, and will face prison terms for any attempts at capital preservation. Case in point, the man who had his gold seized trying to cross the border into Mexico. Up to now, this has been legal – as is traveling with gold on airplanes to foreign destinations, etc. Can’t have the Plebes making use of the Elites benefits and laws, now can we?

    1. Ina Deaver

      My concern exactly! It makes it much harder for the plebes to flee the country when it becomes obvious that the game is hopelessly rigged and we can never get ahead. You can’t have the useful plebes get out of the country because they can see the problem clearly, now can you? You’d be left with just the stupid plebes, and they do lower quality work. At least make those who would take useful skills with them lose all that they’ve worked for: the ones who are diligent will have a tough time doing that.

      God, the number of valuable lives that hesitation to flee without your worldly possessions has cost.

  9. steelhead23

    Folks, this thread gives me a headache. I read ideological rants of libertarians (Dave) and feel like we cannot understand each other because we speak different languages. For a nation to wish to control the amounts of hot money flowing into the country seems like appropriate behavior to me. It is aimed at protecting the nation’s citizens, which I believe even libertarians would support. So, if Brazil is charging a fee on hot money inputs, is this suppressing the rights of the individual in the US who wants the currency value hedge and the 11% bond rate, or is it protecting the rights of Brazilian citizens from excessive inflation? To be clear, this is a matter of sovereignty. Many, including many libertarians, fear a global leftward revolution resulting in a New World Order, yet, they adhere strongly to the fait accompli of global corporatization and champion the rights of entreprenuers and investors to suck as much money as possible out of global labor. Am I missing something? In the vernacular of Ms Sarah Palin, WTF?

    1. streetman

      Nope, you’re not missing anything. I don’t know what “global corporatization” means, but there’s a lot of confusion about the idea of capitalism and free markets becoming global (good), and globalization in general (in my opinion, bad). A truly globalized economy will likely result in a reversion to the mean standard of living…and I don’t think those of us in historically rich countries will enjoy the results. In the meantime, capital controls will inevitably be misapplied (the modern era’s version of Smoot-Hawley protectionism), and those countries will probably suffer the consequences, but I agree with you that it’s their sovereign right to do so and trade agreements shouldn’t include restrictions on this. It’s a right we exercise when we want to, as well. And yes, I’m a libertarian…

  10. Dirk van Dijk

    There are some fundimental rights that the gov’t can not ligitmately trample on, regardless if that government is democratically elected. Those are fundimental human rights. There are also priviledges that the government (particularly a government that is ligitamate, i.e. derives its powers from the consent of the governed) can grant or take away. In every area there are exceptions to rights. Fire in a crowded theater etc.

    However, I think it is useful to think of a target or concentric circles for determining how compelling the state need has to be before it can intererfere ligitmately. At the center would be ones mind and thoughts, which also means what you can express and what you can read, the next layer out would be your body, then your intamate and family relationships, and still further out your property.

    Somehow, the ability to move unlimited amounts of money accoss boarders strikes me as pretty far from the center of the bullseye.

  11. Ellsworth Luiz

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