The End of an Era in Finance
Dani Rodrik*
2010-03-11
CAMBRIDGE – In the world of economics and finance, revolutions occur rarely and
are often
detected only in hindsight. But what happened on February 19 can safely be
called the end of an era in global finance.
On that day, the International Monetary Fund published a policy note that
reversed its long-held position on capital controls. Taxes and other
restrictions on capital inflows, the IMF’s economists wrote, can be helpful,
and they constitute a “legitimate part” of policymakers’ toolkit.
Rediscovering the common sense that had strangely eluded the Fund for two
decades, the report noted: “logic suggests that appropriately designed controls
on capital inflows could usefully complement” other policies. As late as
November of last year, IMF Managing Director Dominique Strauss-Kahn had thrown
cold water on Brazil’s
efforts to stem inflows of speculative “hot money,” and said that he would not
recommend such controls “as a standard prescription.”
So February’s policy note is a stunning reversal – as close as an
institution can come to recanting without saying, “Sorry, we messed up.” But it
parallels a general shift in economists’ opinion. It is telling, for example,
that Simon Johnson, the IMF’s chief economist during 2007-2008, has turned into
one of the most ardent supporters of strict controls on domestic and
international finance.
The IMF’s policy note makes clear that controls on cross-border financial
flows can be not only desirable, but also effective. This is important, because
the traditional argument of last resort against capital controls has been that
they could not be made to stick. Financial markets would always outsmart the
policymakers.
Even if true, evading the controls requires incurring additional costs to
move funds in and out of a country – which is precisely what the controls aim
to achieve. Otherwise, why would investors and speculators cry bloody murder
whenever capital controls are mentioned as a possibility? If they really
couldn’t care less, then they shouldn’t care at all.
One justification for capital controls is to prevent inflows of hot money
from boosting the value of the home currency excessively, thereby undermining
competitiveness. Another is to reduce vulnerability to sudden changes in
financial-market sentiment, which can wreak havoc with domestic growth and
employment. To its credit, the IMF not only acknowledges this, but it also
provides evidence that developing countries with capital controls were hit less
badly by the fallout from the sub-prime mortgage meltdown.
The IMF’s change of heart is important, but it needs to be followed by
further action. We currently don’t know much about designing capital-control
regimes. The taboo that has attached to capital controls has discouraged
practical, policy-oriented work that would help governments to manage capital
flows directly. There is some empirical research on the consequences of capital
controls in countries such as Chile, Colombia, and Malaysia,
but very little systematic research on the appropriate menu of options. The IMF
can help to fill the gap.
Emerging markets have resorted to a variety of instruments to limit
private-sector borrowing abroad: taxes, unremunerated reserve requirements,
quantitative restrictions, and verbal persuasion. In view of the sophisticated
nature of financial markets, the devil is often in the details – and what
works in one setting is unlikely to work well in others.
For example, Taiwan’s
use of administrative measures that rely heavily on close monitoring of flows
may be inappropriate in settings where bureaucratic capacity is more limited.
Similarly, Chilean-style unremunerated reserve requirements may be easier to
evade in countries with extensive trading in sophisticated derivatives.
With the stigma on capital controls gone, the IMF should now get to work on
developing guidelines on what kind of controls work best and under what
circumstances. The IMF provides countries with technical assistance in a wide
range of areas: monetary policy, bank regulation, and fiscal consolidation. It
is time to add managing the capital account to this list.
With this battle won, the next worthy goal is a global financial transaction
tax. Set at a very low level – 0.05% is a commonly mentioned rate – such a
tax would raise hundreds of billions of dollars for global public goods while
discouraging short-term speculative activities in financial markets.
Support for a global financial-transaction tax is growing. A group of NGOs
have rechristened it the “Robin Hood tax,” and have launched a global campaign
to promote it, complete with a deliciously biting video clip featuring British
actor Bill Nighy (www.robinhoodtax.org).
Significantly, the European Union has thrown its weight behind the tax and
urged the IMF to pursue it. The only major holdout is the United States, where
Treasury Secretary Tim
Geithner has made his distaste for the proposal clear.
What made finance so lethal in the past was the combination of economists’
ideas with the political power of banks. The bad news is that big banks retain
significant political power. The good news is that the intellectual climate has
shifted decisively against them. Shorn of support from economists, the
financial industry will have a much harder time preventing the fetish of free
finance from being tossed into the dustbin of history.
Copyright: Project Syndicate,
2010. http://www.project-syndicate.org/commentary/rodrik41/English
________________________________
* Professor of
Political Economy at Harvard University’s
John F. Kennedy School of Government, is the first recipient of the Social
Science Research Council’s Albert O. Hirschman Prize. His latest book is One
Economics, Many Recipes: Globalization, Institutions, and Economic Growth.
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