Why lift capital controls?
The author states that economies of the wealthier and developed countries employ open capital accounts, which means that minimal control measures exist on the market for foreign investment and lending. Developing countries depend heavily on foreign financing to maintain market stability. Theoretically, if they were to lift capital controls and open their markets, the influx of foreign investment would help accelerate the economic growth of the country. In addition, greater foreign investment usually leads to improved macroeconomic and financial policies as well as improved short-term access to financing. When utilizing open capital accounts, policymakers must exercise good judgment in order to maintain investors whereas when capital controls are in place, investors are restricting from moving their monies in the short run. The lifting of capital controls can help to reduce budget deficits, money growth and inflation.
Costs of Lifting Capital Controls
Moreno analyzes the costs/benefits of lifting capital controls from two perspectives. First, an open market leaves a country economical vulnerable to investor whims and possible catastrophe should there be a global crisis due to environmental or political factors. Currency crises have been linked to shocks to “global interest rates, inflation and capital flows. Vulnerabilities include the sudden withdrawal of funds resulting from decisions made by investors because of boom and bust cycles and the mismatching of maturities or currencies, which results in the liquidation of the economy.
The second cost the author mentions is the restrictions due to greater openness that are referred to as “the impossible trinity.” The “Impossible Trinity” does not allow for a country to maintain an open capital account, peg the exchange rate or adopt an independent monetary policy and makes it more difficult for developing countries to execute a stabilizing economic policy.
The chain reaction that results when developing countries are exposed to some of the vulnerabilities mentioned above can bee seen with the East Asian financial crisis of the 1990’s. Below is a diagram expanding on the domino affect:
Do Benefits Outweigh the Costs?
Studies show that the benefit of an open market differs by country and there is a direct correlation between economic growth and the wealth of that country. According to the article, advanced and developing countries tend to have lower capital controls resulting in faster real GDP or total factor productivity growth and those countries with higher and stricter capital controls will have a slower real GDP or TFP. There are conflicting studies that differ when attempting to draw a relationship between capital controls and less discerning macroeconomic policies. More recent studies have shown that economies with capital controls do “contribute more to crises than does the greater vulnerability to shocks that result from openness,” which results from “less prudent” economic policies.
Case Studies: Chile and Malaysia
Ringgit: Currency of 100 sen, formerly Malaysian dollar
