June 11, 2012
WASHINGTON—In their new book, Who Needs to Open the Capital Account? Olivier Jeanne, Arvind Subramanian and John Williamson of the Peterson Institute for International Economics call for new and ambitious rules to regulate international capital flows. Twenty years after the rise of emerging markets finance there has been a distinct shift in attitudes towards international capital flows. Repeated financial crises have moved the pendulum from an enthusiastic embrace of foreign capital to wariness, which the authors think is well-warranted.
Nowhere is this more evident than in the position of the IMF: In 1996 it was a cheerleader for free capital flows, today it is more sympathetic to capital controls. Similarly, the United States in its free trade agreements in the early 2000s circumscribed the ability of partners to use capital controls; now, there is pressure on the administration to clarify that that is not the case.
The new book suggests that this shift does not go far enough. The novelty of the proposal made in the book is twofold. First, in a world where capital and trade flows have become so linked, the book suggests that the asymmetry of the current international regime under which trade is regulated extensively (by the World Trade Organization) but capital flows are unregulated is increasingly untenable.
Like for trade in goods, new international rules are needed to constrain, discipline, and at times legitimize restrictions that countries put on their capital account. For example, the lack of commonly agreed rules implies that capital controls are still marked by a certain stigma, so that the appropriate policies may be pursued with less than optimal vigor.
The second novelty is to highlight that new rules are necessary not just for the situations where capital flows may be too large (for example, Brazil) but also critically where they may not be large enough (for example, China). Through a combination of reserve accumulation and restrictions on inflows, countries can maintain undervaluation and a current account surplus. This has the same economic effects as trade protectionism and undermines the global public good that is free trade. The recent experience with China’s exchange rate illustrates why rules may be necessary to avoid beggar-thy-neighbor trade effects from policies that keep out capital.
Key features of the proposal include a preference for transparent, price-based capital account measures, and a countercyclical tax on certain types of capital flows. The international community could agree on a ceiling on the tax rate to ensure that the harmful effects of controls (if any) would be limited. And for countries, such as China, that maintain excessive controls, there would be a presumption in favor of eliminating them over time. These new rules could be embodied in an international code of good practices developed under the auspices of the IMF.
The policy proposals in the book are based on a theoretical and empirical analysis of capital controls. For example, the case for prudential capital controls is linked to curbing the boom-bust cycle in credit and asset prices. The optimal policy is to impose a countercyclical Pigouvian tax on debt inflows in a boom to reduce the risk and severity of a bust. Interestingly, the optimal tax would fall primarily on the flows (short-term or foreign currency debt) that are the least likely to be conducive to economic growth.
Similarly, the book undertakes new empirical work to show that free capital mobility has little impact on economic development although there is some evidence that foreign direct investment and stock market liberalization may, at least temporarily, raise growth.
Securing international cooperation on these new proposals will not be easy because there will be some loss of sovereignty for some countries in some situations. The book outlines the possible carrots and sticks that might need to be deployed to achieve this cooperation.
The strongest message of this book is perhaps that the debate needs to move beyond whether a new international regime for capital flows is necessary to how this might be accomplished.
Who Needs to Open the Capital Account?
Olivier Jeanne, Arvind Subramanian and John Williamson
ISBN paper 978-0-88132-511-9
April 2012 • 132 pp. • $25.95
About the Authors
Olivier Jeanne has been senior fellow at the Peterson Institute for International Economics since 2008. He is a professor of economics at the Johns Hopkins University and has taught at the University of California Berkeley (1997) and Princeton University (2005–06). He is a research affiliate at the National Bureau of Economic Research (NBER), Cambridge, MA, and a research fellow at the Center for Economic Policy Research, London. From 1998 to 2008 he held various positions in the Research Department of the International Monetary Fund. He has served on the editorial boards of several journals, including the Journal of International Economics and International Journal of Central Banking.
Arvind Subramanian is senior fellow jointly at the Peterson Institute for International Economics and the Center for Global Development. He is the author of Eclipse: Living in the Shadow of China’s Economic Dominance (2011). Foreign Policy magazine named him as one of the world’s top 100 global thinkers in 2011. He was assistant director in the Research Department of the International Monetary Fund, served at the GATT (1988–92) during the Uruguay Round of trade negotiations, and taught at Harvard University’s Kennedy School of Government (1999–2000) and at Johns Hopkins’ School for Advanced International Studies (2008–10). He advises the Indian government in different capacities, including as a member of the Finance Minister’s Expert Group on the G-20.
John Williamson, senior fellow, has been associated with the Institute since 1981. He was project director for the UN High-Level Panel on Financing for Development (the Zedillo Report) in 2001; on leave as chief economist for South Asia at the World Bank during 1996–99; economics professor at Pontifícia Universidade Católica do Rio de Janeiro (1978–81), University of Warwick (1970–77), Massachusetts Institute of Technology (1967, 1980), University of York (1963–68), and Princeton University (1962–63); adviser to the International Monetary Fund (1972–74); and economic consultant to the UK Treasury (1968–70). He is author, coauthor, editor, or coeditor of numerous studies on international monetary and development issues, including Reference Rates and the International Monetary System (2007), and Curbing the Boom-Bust Cycle: Stabilizing Capital Flows to Emerging Markets (2005).
About the Peterson Institute
The Peter G. Peterson Institute for International Economics is a private, nonprofit, nonpartisan research institution devoted to the study of international economic policy. Since 1981 the Institute has provided timely and objective analysis of, and concrete solutions to, a wide range of international economic problems. Support is provided by a wide range of charitable foundations, private corporations and individual donors, and from earnings on the Institute’s publications and capital fund. It celebrated its 25th anniversary in 2006 and adopted its new name at that time, having previously been the Institute for International Economics.