Capital Controls: A Leftist Proposal? Recent Experience and the Contribution of Keynes

and Others∗

André de Melo Modenesi (modenesi.eco@globo.com)

Lecturer at the Department of Economics of the Ibmec and PhD student at the Institute of Economics at

Federal University of Rio de Janeiro (IE/UFRJ)

Rui Lyrio Modenesi (modenesi@bndes.gov.br)

Economist at the Brazilian Development Bank (BNDES) and former lecturer at the Department of Economics

of the Fluminense Federal Universtity (UFF) and of the Catholic University of Rio de Janeiro (PUC-Rio)

Keywords: Capital Controls, Experiences in Capital Controls, Right and Left Dichotomy, Keynes

Abstract To label as leftist authors who defend capital controls is a misconception. Such labeling uses the Borsa economicist criterion, which reduces the dichotomy between Right and Left to a distinction between economic liberalism and interventionism. Yet, under the Borsa criterion, those authors cannot be called left-wing. The interventionism underlying the defense of capital controls, as pioneered by Keynes and developed by Tobin, Stiglitz and Rodrik, is not the product of ideological conviction favoring the indiscriminate interference of the State in the economy. To call capital controls a practice typical of left-wing governments is also a misinterpretation. Among the countries using capital controls in the nineties – Chile, China, India and Malaysia – only the Chinese may be called leftist. The other countries’ political panorama is more complex than may suppose those who believe in a simple and direct relationship between capital controls and the political thought of governments practicing them. The discussion should be stripped of its political bias: capital controls are not inherent to the ideology of their defenders and to the political leanings of the governments that adopt them.

May 2006

∗ The authors are grateful to João Sicsú for his contribution. Any errors or omissions are our own. The views expressed in this paper are those of the authors and do not necessarily represent those of the IBMEC and the BNDES.

Introduction

Capital controls are often dismissed as a left-wing option – a label obviously intended for

disparagement, as can be clearly seen in the words of Professor A.C. Pastore, former president of the

Central Bank of Brazil:

“Defenders of capital controls are mostly left-wing economists who would control capital flows in several ways. (...) I have been an opponent of heterodoxy for more than 40 years and am therefore perfectly justified in calling for an IOF [tax on financial operations] for capital inflows, at a time when these short-term flows are generating distortions and reducing the efficacy of the monetary policy, without being accused of leaping onto the bandwagon of the stupid leftist point of view which says that the control of capital flows leads to a more efficient monetary policy” (Pastore, 2005; italics added).

The present article intends to find out up to what point capital controls may be seen as a leftist

proposition. The next two sections will present the concepts of Right and Left and of capital-control

mechanisms. Following this, we will roughly sketch the ideological profile and show the

contributions of the main defenders of capital controls, as pioneered by Keynes and developed by

Tobin, Stiglitz and Rodrik. The fourth section describes the main instances of the use of capital

controls in the 1990s: Chile, China, India and Malaysia. Our final conclusion is that capital controls

have been wrongly labeled a left-wing policy and that the prime reason for their adoption is not

ideological but pragmatical.

1. The Dichotomy between Right and Left: from the French Revolution to the Present

The Right vs. Left dichotomy goes back to the French Revolution. It first appeared in the

Constitutional Assembly of 1789-1791, where members were either i) conservative representatives

defending the monarchy and its historical prerogatives; or ii) progressive representatives demanding

profound changes in the political order, beginning with the separation of state power into three

autonomous but harmonized spheres: the Legislative, the Executive and the Judiciary. The idea of a

non-unitary power was in itself a political revolution and a historic milestone that set the foundation

of modern political order: the Constitutional State or State of Right, a forerunner of the Democratic

State of Right.

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The champions of democratic thought summarized their views in the “one vote, one man”

slogan, meaning one vote for each citizen. In the course of the debate on what should be each

power’s attributions – an apportionment that would radically limit the King’s executive clout – one

specific issue achieved watershed importance: the maintenance of the monarch’s veto power

regarding the decisions of the Legislative. This debate placed the conservative constituents, who

favored the maintenance of the royal prerogatives, on the right-hand seats of the Speaker, whilst the

reformers, who aimed to suppress the King’s veto right, sat on the left.

Conservatives have since then been called rightists, whereas those who defend political changes

are tagged as leftists. The historical permanence of this dichotomy had its component meanings

modified as a result of changes in the ideological and political fields. The Russian Revolution of

1917 led to the creation, in 1922, of a confederation of socialist countries, the Union of Soviet

Socialist Republics (USSR). After World War II, the USSR imposed socialism on the whole of

Eastern Europe, which thus came under its political and economic hegemony.

The world was divided into two politically and economically antagonistic blocks: i) the socialist

world, representing the Left at a global level; and ii) the capitalist world, with the USA as its

hegemonic power and standing as the main obstacle to communist expansion and, consequently,

leading the right-wing block. The permanent tension between the two new global powers led to what

was called the Cold War, a phenomenon reflecting, from the military viewpoint, the 20th century’s

emblematic dispute between the capitalist Right and the socialist Left. The Right vs. Left dichotomy

was thus strengthened and mirrored in global geopolitics.

By the end of the century, with the fall of the Berlin Wall and the beginning of the globalization

process, this dichotomy was intensely questioned, especially regarding its usefulness. Nevertheless,

it did not lose its descriptive utility. Bobbio (2001) retrieves the essence of the dichotomy’s meaning

by proposing a criterion based on the historic political ideal of equality:

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“The difference between Right and Left is revealed in the fact that, for a left-wing person, equality is the rule and inequality the exception. (...) for a right-wing person, the opposite is true, or, that is to say, inequality is the rule, and in order to be accepted, a relationship based on equality must be duly justified” (Bobbio, 2001, p. 23).

A few years later, Bobbio set forth a more contemporary version of his criterion, with the

purpose of accounting for new demands issued from several groups who identify themselves as

excluded – for reasons of ethnicity, gender, immigrant status, and so on. He reaffirmed his criterion

under new clothing, choosing as reference the political ideal of inclusion, yet warning that “one

should not say that the Left includes all and the Right excludes all, but that the Left’s rule is

inclusion, save for exceptions, and that the Right’s rule is exclusion, save for exceptions” (Bobbio,

2001, p. 23).

The Right x Left dichotomy is not limited to the opposition between liberals and interventionists,

as proposed by Borsa. For him, the dichotomy becomes meaningless under the globalization

process, and all that is left to distinguish its two elements is “the way capitalist development is

managed. According to the Right, the State should not interfere with the market. The Left claims

that the State should guide and rule the market” (Borsa, 1998, p. 618).

Bobbio refuses Borsa’s classification, arguing that there is a sphere of human action ruled not by

the market but by other institutions and by non-economic criteria such as those of a political nature:

“I believe the exact opposite has happened; in other words, the distinction is not dead and buried, but as alive and kicking. Only those who believe in the market’s permeability and expects from it the solution to all the problems resulting from civic coexistence can believe that there is only one road to globalization, that of the total mercantilization of human relations. The wider the market, the greater the problems it generates or cannot solve” (Bobbio, 2001, p. 15).

Borsa’s proposal is economicist reductionism: an attempt to reduce a political dichotomy (Right

vs. Left) to an economic dichotomy (economic liberalism vs. statism). One distinction, however,

does not supplant the other. Both can undoubtedly coexist and be combined to create new

categories of a double political and economic nature. There can be right-wing or left-wing economic

liberalism, as well as right-wing or left-wing interventionism. In short, the Right vs. Left dichotomy

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retains its explanatory efficacy and should not be confused with the distinction between economic

liberalism and economic statism.

We must note that, in defining the political stand of the authors and governments here analyzed,

we will appeal to features that are ruled by political common sense, and are consecrated by use. We

will therefore not enter into the theoretical or conceptual validity of these ad hoc classifications.

There are two commonly used classifications for describing the political stand of citizens or political

entities: i) the Right/Center/Left triad; and ii) the Right/Center-Right/Center/Center-Left/Left

pentiad. Based on the latter, we will define the ideological stand of the author proposing capital

controls (section 3) and of countries having recently adopted them (section 4).

2. Capital Controls: A Synthesis

2.1. Background

The first experiences in capital controls date back to the 16th Century, when Spain and France

restricted gold and silver exports under bullionism, one of the practices of mercantilism – the

“system” of economic policy characteristic of early modern nation-states. Following these primitive

forms, only in the 20th century did capital controls flourish. After the Great Depression and in the

forties, restrictions to the flow of capitals were adopted by the major economies – with few

exceptions, such as the USA, Canada and Switzerland.

The Bretton Woods Conference established the convertibility of current transactions – the

unrestricted use of international reserves for the foreign trade of goods and services – but not of

capital transactions. Article VI of the IMF’s Articles of Agreement, still in force, allows the adoption

of controlling measures in the face of sustained capital outflows: “A member may not use the

Fund’s general resources to meet a large or sustained outflow of capital (...), and the Fund may

request a member to exercise controls to prevent such use of the general resources of the Fund.”

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In the seventies and eighties, restrictions on international capital flows were abolished in

developed countries. In the nineties, financial liberalization reached developing economies. Despite

this, Chile, China, India and Malaysia felt compelled to use capital controls.

2.2. Definition

Capital controls is a phrase used to describe the adoption of any instrument that to any degree

limits the free flow of capital between a country and the rest of the world. It is an ample concept

that includes a wide range of interventionist instruments, such as taxes upon capital flows and

administrative measures restricting it. One may apply them to all the items of the capital-account or

only to certain types of financial operations, such as portfolio investments, usually seen as

undesirable because of their higher volatility.

Capital controls may be effected through: i) incentive mechanisms implemented via the market –

measures that induce agents to take certain type of action based on their own interests; or ii)

administrative measures (or quantitative controls) that exert a direct rule upon capital flows.

In the first case, agents are encouraged (or discouraged) to take (or from taking) certain kinds of

action seen as desirable (or undesirable) by the policymakers, and there is no need for any measure

that interferes with the free operation of the capital market. Usually, authorities impose a transaction

cost upon capital flows under the guise of taxation. In Chile, compulsory deposits redeemable after a

one-year period were withheld on the inflow of capital. This encouraged capital to stay in the

country for a minimum period, with investors redeeming their deposits only after this period, when

the funds left the country.

In the second case, agents are forbidden (or required) from taking (or to take) some kind of

action, seen as undesirable (or desirable) by the policymakers, through the imposition of measures

directly restricting capital flows and, consequently, obstructing the free functioning of the market.

Forbidding the inflow of short-term capital is a common instance.

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As controls based on incentive mechanisms do not limit the free operation of the market, they

are considered by many as being preferable to restrictive administrative measures.

From the operational standpoint, controls may be created upon i) the inflow or ii) the outflow of

capital effected by i) residents or ii) non-residents.

One should stress the distinction proposed by Cooper (1999) between controls and restrictions to

capital flows. The latter includes only measures that do not establish barriers specifically aimed at

capital flows, such as limitations to foreign indebtedness by domestic agents, with a view to

reducing the financial system’s currency mismacthes. This is a point, as it excludes from capital

controls prudential regulation measures, which may be adopted for distinct reasons.

As regards the rationale or motivation for their adoption, capital controls may be i) permanent or

ii) temporary. In the first case, it is considered that the costs of financial integration with the rest of

the world exceed the benefits thereof. Therefore, the capital-account (or some of its itens) must be

kept under control. In the second case, financial liberalization is seen as desirable – as its benefits

would exceed its costs – and it is considered that controls must therefore exist only until the

establishment of the necessary prior conditions that will allow the country to fully benefit from the

opening of its capital-account. As soon as the economy is ready to benefit from the advantages of

financial integration, controls must be removed. This is the IMF’s present stand.

2.3. The Case for Financial Liberalization

Defenders of financial liberalization argue that: i) it promotes the efficient capital allocation (or

the optimal use of the world’s economic resources), to the special benefit of developing countries

that, due to scarcity, would receive a positive capital flow in the quest for larger returns; ii) it

contributes to the adjustment of the balance-of-payments in economies that show a current-account

deficit, with foreign capital constituting a major source of its financing; and iii) it requires greater

governmental discipline, for capital will flow to countries with solid macroeconomic fundamentals.

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It is furthermore argued that capital controls: iv) limit individual liberty and work against the

ideal of a free society; and v) are inefficient and therefore innocuous, since economic agents will

find legal loopholes. It should be remarked that this last argument is incompatible with the others: if

controls were innocuous, they would be unable to restrict individual liberty, to jeopardize economic

efficiency and so on.1

As a rule, proponents of financial liberalization put a stress upon allocative efficiency

improvement. This argument is based on the theory of comparative advantages, much as the

arguments used to defend commercial liberalization: just as free trade promotes optimum global

allocation of productive resources, the free flow of capital determines an efficient allocation of

capital between countries. This is the main argument used by the IMF.

2.4. The Case against Financial Liberalization

Defenders of capital controls hold that measures restricting capital flows: i) give more autonomy

to macroeconomic domestic policies; ii) result in greater financial stability by eliminating an

important channel of contagion in the event of an external crisis; iii) are necessary in order to avoid

the overvaluation of domestic currency in times of excessive international liquidity, thus preserving

the competitiveness of exports; iv) allow taxation of capital revenues, thus making possible a

distributive tax policy, by barring domestic agents from transferring funds to countries with lower

taxation; and v) may be used as instruments of industrial policy in shaping the structure of internal

supply, whilst encouraging the inflow of foreign direct investments (FDI) for specific sectors.

As a rule, defenders of capital controls note that they increase the autonomy of monetary policy

by allowing the existence of a domestic and foreign interest rates differential. In this way, interest

rates are preserved as an important economic policy tool (encouraging economic growth or

stabilizing prices, for instance). It is thus possible to blend the engagement in anti-inflationary

1 Carvalho (2002, pages 237-40) lingers longer on this issue.

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monetary policy with the preservation of domestic production competitiveness, as in Chile (see

subsection 4.1). In a free capital mobility situation these objectives become incompatible:

maintaining the domestic interest rate above the foreign rate would attract a large flow of foreign

capital, which in turn would lead to the appreciation of domestic currency (details in subsection 3.1)

3. Authors Who Defend Capital Controls

Amongst the defenders of capital controls, one should note J.M. Keynes, H.D. White, J. Tobin,

P. Davidson, J. Kregel, D. Rodrik and J. Stiglitz. The sixty-year period in which these authors

developed their contributions may be broken down into three paradigmatic moments.

Keynes broke new ground when he criticized financial liberalization in Bretton Woods (1944),

defending the non-convertibility of the capital-account. Although his proposal for the restructuring

of the international monetary system was put aside in favor of the White Plan, elaborated by the

USA representative, IMF by-laws envisage only the convertibility of the current-account and grant

members the right to adopt capital controls when there is a threat of sustained capital outflows.

After the collapse of the Bretton Woods system and the resulting adoption of floating exchange

rates by major industrialized economies, Tobin redeemed Keynes’ arguments for capital controls,

pointing out the loss of monetary policy autonomy that resulted from the intensification of short-

term capital flows in the mid-seventies.

The nineties were marked by the increased evolution of the financial globalization process,

typified by the drastic intensification of international capital flows, tending to form a sole world

market for currencies, bonds and credit. The belief that the free flow of capital would result in

greater efficiency in capital allocation and would thus greatly benefit developing countries did not

materialize. On the contrary, what we saw was a succession of financial crises, precisely in those

developing countries that would supposedly benefit the most from financial liberalization: Mexico,

Southwest Asia, Russia, Brazil and Argentina. It is in this context that we should consider the

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contributions made by Stiglitz and Rodrik, who understand that the existence of market failures

justifies the adoption of capital controls.

3.1. Keynes: Reforming Capitalism in Order to Preserve It

Before Mundell’s (1963) and Fleming’s (1962) contributions – affirming that in an economy

with a fixed exchange rate and perfect capital mobility the domestic interest rate is equal to the

foreign interest rate – Keynes (1930) warned that in the gold-standard system capital-account

liberalization would jeopardize monetary policy autonomy. He proposed capital controls to preserve

the autonomy of monetary policy2: “control of capital movements, both inward and outward, must

be a permanent feature of the post-war system” (Keynes, CW, vol. XXV, p. 86).

Keynes was a reformer and never suggested that there should be a profound or radical re-

orientation of the capitalist system. The adoption of capital controls, as well as the engagement in

counter-cyclical fiscal policy, aims at ensuring the smooth functioning of capitalism. In both cases,

economic interventionism should not be seen as the result of an anti-liberal mindset which Keynes

did not have. They are pragmatic measures adopted for the attainment of a specific result that the

market cannot spontaneously achieve.

The increase in public spending was to be justified as a solution to chronic unemployment,

which, as it spread during the Great Depression, threatened the capitalist system by furthering the

advance of socialism. Because he feared seeing the Marxist prophecy come true, Keynes justified

the setting aside of orthodox liberalism:3

“Whilst, therefore, the enlargement of the functions of government (…) would seem to a nineteenth-century publicist or to a contemporary American financer to be a terrific encroachment on individualism, I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative” (Keynes, 1973, p. 380; italics added).

2 His contribution generated a line of economists – such as Davidson (1997 and 2004) and Kregel (2004) – who justify capital controls on the basis of the fundamental uncertainty concept. 3 The most common and mechanicist interpretation of Marx (1986) calls for a succession of modes of production, in which the last stage would be the substitution of Communism for Capitalism.

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Capital controls are necessary in order to guarantee autonomy in the setting of interest rates, one

of the main instruments of macroeconomic policy. In its absence, monetary policy could not be used

anti-cyclically and, as a consequence, policymakers would be waiving an important tool in the war

against unemployment. It was a measure to allow capitalism to “hand over the rings in order to save

the hand”, justifiable as a need and not as a decision resulting from political or ideological

convictions. In short, capital controls (as well as “the enlargement of the functions of government”)

were necessary to fight the main threat to the capitalist system – mass unemployment. This was the

principle guiding Keynes’ proposal in Bretton Woods:

“Freedom of capital movements is an essential part of the old laissez-faire system and assumes that is right and desirable to have en equalization of interest rates in all parts of the world. It assumes, that is to say, that if the rate of interest which promotes full employment in Great Britain is lower than the appropriate rate in Australia, there is no reason why this should not be allowed to lead to a situation in which the whole of the British savings are invested in Australia, subject only to different estimations of risk, until the equilibrium rate in Australia has been brought down to the British rate. In my view the whole management of the domestic economy depends upon being free to have the appropriate rate of interest without references to the rates prevailing elsewhere in the world. Capital control is a corollary to this. Both for this reason and for the political reasons given above, my own belief is that the Americans will be wise in their own interest to accept this conception” (Keynes, CW, vol. XXV, p. 149).

Indeed, Americans were “wise in their own interests to accept” that there was a need for

controlling capital flows – or else they might become an additional source of disturbance,

jeopardizing foreign trade. At this point, the Keynes-White dispute was superseded by a

convergence of interests: “It would seem to be an important step in the direction of world stability if

a member government could obtain the full cooperation of other member governments in the control

of capital flows” (White apud Boughton, 1998, p. 40).

White is considered the IMF’s intellectual architect: the institution’s by-laws incorporated the

core of his plan. He was Chief International Economist of the U.S. Treasury and was appointed the

IMF’s first American Executive Director by President Truman (Republican Party). One could never

call him a leftist.

Although the political profile of the precursor of capital controls – in its modern form – is

complex enough, Keynes cannot be called a leftist. On the contrary. He was opposed to Labour,

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England’s most important left-wing party. Moreover, Sir John Maynard Keynes, created a lord by

Queen Elizabeth for his services to the British Empire, openly took sides with the intellectual and

political elite of the bourgeoisie:

“Ought I, then, to join the Labour Party? Superficially that is more attractive. But looked at closer, there are great difficulties. To begin with, it is a class party, and the class is not my class. If I am going to pursue sectional interests at all, I shall pursue my own. When it comes to the class struggle as such, my local and personal patriotism, like those of everyone else, except certain unpleasant zealous ones, are attached to my own surroundings. I can be influenced by what seems to me to be justice and good sense; but the class war will find me on the side of educated bourgeoisie” (Keynes, CW, vol. IX, p. 297).

Besides, he was radically opposed to Leninism and an acerbic critic of Marx and Socialism, two

of the great icons of the Left in his time:

“For me, brought up in a free air undarkened by the horrors of religion, with nothing to be afraid of, Red Russia holds too much which is detestable (…) I am not ready for a creed which does not care how much it destroys the liberty and security of daily life, which uses deliberately the weapons of persecution, destruction, and international strife. (…). How can I accept a doctrine which sets up as its bible, above and beyond criticism, an obsolete economic textbook [Marx’s Das Kapital] which I know to be not only scientifically erroneous but without interest or application for the modern world? How can I adopt a creed which, preferring the mud to the fish, exalts the boorish proletariat above the bourgeoisie and the intelligentsia who, with whatever faults, are the quality in life and surely carry the seeds of all human advancement? (…) It is hard for an educated, decent, intelligent son of Western Europe to find his ideals here [in Russia], unless he has first suffered some strange and horrid process of conversion which has changed all his values (Keynes, CW, vol. IX, p. 258; italics added).

3.2. Tobin: Preserving the Autonomy of Monetary Policy

Tobin (1978) proposed “an internationally uniform tax on all spot conversions of one currency

into another”, with a view to discouraging the speculative flow of short-term capital. Early in

seventies he warned that the intensity and volatility of these flows could seriously jeopardize a

country’s macroeconomic performance – even with a floating exchange rate – especially by

reducing the autonomy of monetary policy:

“National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exchanges, without real hardship and without significant sacrifice of the objectives of national economic policy with respect to employment, output, and inflation. Specifically, the mobility of financial capital limits viable differences among national interest rates and thus severely restricts the ability of central banks and government to pursue monetary and fiscal policies appropriate to their internal economies” (Tobin, 1978, p. 154).

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From the microeconomic viewpoint, he also pointed out the negative impact of exchange rate

volatility: oscillations in the exchange rate unbalance relative prices and affect the competitiveness

of import and export sectors.

Tobin’s proposal, however, may not be interpreted as the product of an interventionist, anti-

liberal or leftist stand. In a recent interview, he rejected the anti-globalization movement (identified

with the Left), took a favorable stand as regards free trade and expressed his support to the IMF, the

World Bank and the WTO (the so-called Bretton Woods institutions, created for the service of

capitalism and therefore identified with the Right4):

“I have absolutely nothing with those anti-globalization rebels. Of course I am pleased; but the loudest applause is coming from the wrong side. Look, I am an economist and, like most economists, I support free trade. Furthermore, I am in favor of the International Monetary Fund, the World Bank, the World Trade Organization. They’ve highjacked my name [in order to criticize globalization]” (Tobin, 2001).

Tobin has never been a political activist and has spent the greater part of his professional life

researching and lecturing at Yale University. In 1961-1962 he was a Member of President

Kennedy’s Council of Economic Advisers. He was Chairman of the American Economic

Association in 1970-71 and was awarded the Nobel Prize in 1981.

3.3. Stiglitz and Rodrik: Correcting Financial Market Failures

Stiglitz e Rodrik represent a group of authors who emphasize the existence of financial market

failures and reject the validity of the efficient-market hypothesis (EMH) required to validate the

benefits of financial liberalization. Incompleteness of markets and asymmetric information

jeopardize the existence and stability of competitive equilibrium. In this situation, the free operation

of the market doesn’t necessary lead to a Pareto efficient equilibrium. For these economists, capital

controls aim at correcting a market failure that invalidates the main argument for financial

liberalization, which is the promotion of an efficient capital allocation.

4 In the strictest sense, only the IMF and the World Bank may be called Bretton Woods institutions. During World War II, the USA and Great Britain led the creation of the International Trade Organization (ITO). Although the ITO was not established at that time, it resulted in the General Agreement on Tariffs and Trade (GATT), which until the mid-nineties undertook negotiations for the reduction of trade barriers. In the so-called Uruguay Round (1986-1994), it was decided that GATT’s Secretariat would become the Secretariat of the World Trade Organization (WTO), created in 1995. It is in this wider sense that we consider the WTO a Bretton Woods institution.

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Indeed, Rodrik (1998) pointed out the inadequacy of the parallel drawn between the goods and

services market and the financial market, used in arguing that financial liberalization, similarly to

trade liberalization, improves efficiency. He identifies several failures that put at risk the perfect

operation of capital markets, making capital controls a second-best solution.

Stiglitz (2002) observed that the high volatility of capital flows generates negative externalities

that place economic performance in risk. Large capital outflows, in devaluating domestic currency,

worsen the solvency of companies indebted in foreign currency. Alternatively, massive capital

inflows, overvaluating domestic currency, hamper the competitiveness of domestic production. This

has a negative effect upon the performance of the exporting sector. Thus, the greater its participation

in the GNP, the lesser the economic growth. In this case, exporters (and, in the last instance, the

people) are penalized by decisions made not by them, but by investors (domestic and foreign), thus

creating a negative externality. To minimize the effects of its high volatility, he defends capital

controls:

“Since rapid capital flows into or out of a country cause large disturbances, they generate what economists call ‘large externalities’ (…). Such flows lead to massive disturbances to the overall economy. Government has the right, even the obligation, to take measures to address such disturbances” (Stiglitz, 2002, p. 124; italics added).

Stiglitz became one of the most vocal critics of the accelerated and intense financial

liberalization sponsored by the IMF. In his opinion, this was the main specific cause of the Asian

crisis. He goes on further to conclude that the good economic performances of China and India

(countries that did not succumb to the nineties crises) are to be explained also by their having

practiced capital controls: “It is no accident that the two large developing countries spared the

ravages of the global economic crises – India and China – both had capital controls” (Stiglitz, 2002,

p. 125).

Stiglitz’s and Rodrik’s stand for capital controls is no gratuitous and indiscriminate aggression to

the free operation of the market, and should be understood in context. They defend capital controls

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in the face of evident market failures and of the devastating impact of the Asian crisis. Like Keynes

– whose work must be understood in the context of the 30’s harsh Depression realities – these

authors cannot be labeled as anti-liberal for proposing topical interventionist measures in order to

correct evident market failures.

4. Recent experiences in Capital Controls: Chile, China, India and Malaysia

In the opposite direction, as regards the capital-account liberalization, Chile and Malaysia

adopted capital controls in the 1990s. China and India did not bend to the pressure, mainly from the

IMF, in favor of a greater mobility of capital. They still set considerable restrictions upon the capital

account, although some liberalization measures have been taken. These experiences are related

below, focusing on main measures and political context.5

4.1. Chile

4.1.1 – Political Panorama

Capital controls were used in Chile during the administration of Patricio Aylwin (1990-1994)

and of Eduardo Frei Ruiz-Tagle (1994-2000), both of whom belong to the Christian Democratic

Party (PDC). The PDC was born from the Falange Nacional (FN), a propaganda agency of the

Conservative Party, from which it broke away to become a new party. After good results in the 1957

parliamentary elections, the FN fused itself with other forces also identified with the social thought

of the Catholic Church and opposed to economic liberalism and fascist and communist

totalitarianism, thus forming the PDC. Their programme was for reform and social change, and in

the eighties they became the country’s major political force.

The PDC is considered a centrist party and is the main opponent of the Socialist Party of Chile

(PSC), considered a leftist party. In 1973, a military coup extinguished political parties, which only

returned to the scene in 1988, by means of a coalition led by the PDC, with active participation of 5 For further details, see Ariyoshi (2000) and Nadal-De Simone (1999).

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Aylwin and Frei. A popular plebiscite resulted in dictator Pinochet being voted out of the

Presidency. Rid of the ultra-rightist dictatorship, the Coalition of Parties for Democracy elected

Aylwin president in 1989. In the following election, PDC Chairman Eduardo Frei – who was

chosen by the coalition over PSC candidate Ricardo Lagos – was elected President. Lagos attained

the presidency in 2000 by defeating Joaquín Lavín, the candidate of the Independent Democratic

Union (UDI), Chile’s major right-wing party.

4.1.2. Principal Measures

In the early nineties, due to a surge in capital inflows, Chile adopted controls – mainly upon the

inflow of short-term capital and based on an incentive mechanism. The purpose was to give

policymakers greater autonomy, so that they could conciliate a tight monetary policy aimed at

reducing inflation – meaning domestic interest rates higher than abroad – with the preservation of

domestic production competitiveness, threatened by the predictable appreciation of the domestic

currency that would result from the massive inflows of capital.

With a view to reducing the inflow of volatile short-term capital and/or to increasing their term

of permanence in the country, the 20-30% compulsory Unremunerated Reserve Requirement (URR)

on foreign loans – except for trade credits – and on fixed-income securities, was instituted in 1991.

This was the main measure adopted: a so called asymmetric Tobin tax, i.e., applied only to the

inflows, but not to the outflows of capital. In the first year, the URR covered around 50% of total

gross inflows and by 1998, when it was suspended, it covered one-half of that percentage. As part of

supporting policies, starting in the early 1990’s, a liberalization of capital outflows was

implemented, while FDI was exempted from the URR.

Other measures taken were: i) of an administrative nature, such as the imposition of a minimum

stay requirement for direct and portfolio investments; and ii) of a regulatory nature, such as the

requirement of a minimum risk level from the taker of funds and a minimum maturity period for

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bonds placed abroad by companies. In July 1998, with the retraction of the international capital flow

following the Asian crisis, the URR was first reduced and then, three months later, extinguished.

The one-year minimum stay requirement was eliminated in 2001.

The imposition of capital controls was therefore the act of a coalition government led by the

PDC, a centrist party, with the leftist PSC as its main opposition. Capital-account liberalization,

begun under the Frei administration, was continued by President Lagos, the main leader of the

Chilean Socialist Party.

The Chilean experience categorically refutes the thesis that capital controls are exclusively a

leftist initiative: they were practiced by a government led by a centrist party, and financial

liberalization was furthered even more by a party seen as left-wing.

4.2. China

4.2.1. Political Panorama

The Popular Republic of China was created in 1949 as a Socialist state. Imposed by a revolution,

the Chinese regime reproduced the model instituted by the USSR, which organized the communist

movement in a planetary scale in the Third Communist International (Comintern), an entity

congregating Communist Parties from around the world. As we saw in Section 1, after the end of

World War II the USSR incorporated Eastern Europe, forming a socialist block to confront the

capitalist block, in what was called the Cold War, or armaments race, between the two powers –

Right and Left – disputing global political and economic hegemony. The implantation of socialism

in China was supported by the USSR until 1960, when the two countries drifted apart because of

political and ideological differences.

The Constitution erected socialism and democratic centralism as its mainstays, with the

Communist Party as the sole party and one of the holders of state power. The regime was only

formally democratic. In fact, it was authoritarian: government officials and Communist Party

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members were indistinguishable. The new regime isolated the country: no political alliances were

made, and the closing-up of the economy was also partly the result of the blockade by the USA and

their allies, suspended only in 1971.

In the 1990s, a process of reform and economic opening was in place, with a view to building a

socialism with Chinese characteristics – an unparalleled experience in accelerated growth and

profound economic changes. This process integrated state planning and the market, social and

private property, protectionism and foreign opening, regulation and deregulation.

4.2.2. Principal Measures

In spite of this drawn-out process of reform and opening-up of the economy, China still controls

its capital-account, especially by means of administrative approvals and quantitative restrictions to

capital flows. In 1996, the country adopted the convertibility of current transactions, but capital

flows underwent only limited liberalization, maintaining restrictions regarding: i) access to the

domestic market by foreign investors; ii) foreign investments by residents; iii) foreign loans; and iv)

direct offshore investments.

These measures favored long-term capital flows and FDI, which amounted to 98% of the capital-

account between 1990 and 1996. It is believed that, among other factors, the ample foreign

exchange reserves and the relatively closed capital account regime helped explain the economy’s

reduced vulnerability to external shocks. In order to avoid the devaluation of its currency (the yuan)

during the Asian crisis of 1997-98, capital controls were strengthened by stricter administrative

measures, aimed mostly at holding down the illegal outflow of capital disguised as current

transactions payments.

China is the best example of capital controls adopted by a leftist (authoritarian) regime, a nation

from the former socialist block. Yet, through a complex process of political, economic and social

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transformation, the country has since the nineties liberalized capital controls, which had been briefly

strengthened during the Asian crisis.

4.3. India

4.3.1. Political Panorama

India is a “democratic, secular, socialist and autonomous republic” which, following its

independence (1947) and until 1997 was ruled by a majority government from the Indian National

Congress party (INC). In 2004 the INC returned to power by means of a center-left coalition also

supported by two communist parties and thus forming a solid political and parliamentary base.

Nationalist in its origin, and sympathetic towards socialism, the INC is nowadays characterized by a

social-democratic ideology with populist nuances. In other words, it holds a center-left position,

with the communist and socialist parties on its left and its great rival, the Bharatiya Janata Party

(BJP), on its right. Capital controls are a historical item in the INC programme, which supported a

foreign policy of non-alignment vis-à-vis the two superpowers of the second half of the 20th century

– in spite of having closer ties to the USSR.

Created in 1980, the BJB is the champion of the country’s Hindu majority and defends market

economy and conservative social policies. It came to power in 1997 and yet lost it few months later.

For two years, government was exercised by unstable party coalitions. In 1999, the BJP, leading a

newly created coalition – the National Democratic Alliance – won the elections, bringing political

instability to an end and consolidating a period of political-party maturity for Indian democracy. In

2004, the INC achieved an historic victory, taking its situationist opponents by surprise.

4.3.2. Principal Measures

Since 1991, India has been promoting economic reforms of a liberalizing nature and drifting

away from its interventionist and inward-looking tradition. A gradual process was started in the

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direction of the liberalization of foreign capital flows, which had been historically controlled by

administrative measures.

Until then, FDI was submitted to a selective policy of case-by-case approvals, portfolio equity

investments were usually forbidden, and outward investments by residents were under strict control.

External commercial borrowing was also subject to prior examination of priorities and short-term

credit was allowed exclusively for trade financing. Deposits in the domestic banking system were

allowed to non-resident Indians, as a means of permitting the repatriation – by nationals and Indian-

owned overseas corporate bodies – of earnings from abroad, in the form of bank deposits.

The 1990 reforms resulted in: i) the slight loosening of restrictions to the inflow of capital; ii)

encouragement of FDI; iii) discouragement of short-term capital inflows; and iv) the generation of

future indebtedness inflows (such as deposits in foreign currency by non-resident Indians).

Remaining under administrative control were the outflow of capital and the inflow and outflow of

short-term capital.

The beginning of the present decade saw the liberalization of debt-generating operations, with a

limited loosening of restrictions on capital outflows. As in China’s case, the effects of the 1997-

1998 Asian crisis seem to have been lessened by a lower vulnerability to external shock, made

possible by India’s strong foreign exchange reserves position and also by its capital-control policy,

centered on longer terms for foreign financing.

India is thus, on the one hand, an exemplary historical experience in the adoption of capital

controls by a democratic center-left government which flirted with socialism without aligning itself

with the then existent socialist block. On the other hand, it paradigmatically contradicts the

viewpoint that right-wing governments necessarily adopt financial liberalization policies: the

government led by the right-wing ADN coalition as a rule maintained capital controls between 1999

and 2004.

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4.4. Malaysia

4.4.1. Political Panorama

Malaysia is formally a parliamentary monarchy in which the Head of State is chosen amongst

the sultans of the nine peninsular states for a five-year term, and also rules on the Islamic religion.

The Prime Minister is chosen amongst the representatives of the party holding a majority of the

Chamber of Deputies’ seats. Islamic Law is on an equal status with the Constitution, and is applied

by the states to Muslims. The dominant political party is the United Malays National Organization

(UMNO), which, since the country’s independence (1957) rules in coalition with other parties,

mainly the Chinese-Malaysian Association and the Indian Malaysian Congress, representing the

Chinese and Indian ethnic groups.

From 1981 to 2003 there was just one Prime Minister, Mahatir Bin Mohamad, who undertook

the rapid transformation of the economy and led the country in its becoming one of the most

powerful in East Asia: from 1988 to 1997 the growth rate exceeded 10% and social indicators

became comparable to those of developed countries. Although the regime was formally democratic,

Mahati’s government was in fact authoritarian. It controlled the media and the judiciary power and

used Islamic values to suppress troublesome opponents, such as Vice Prime Minister Anwar

Ibrahim, accused of sodomy and abuse of power by Mahatir himself and sentenced to six years in

jail. Mahatir postured as a defender of “Asian values” and of an authoritarian state capitalism,

attacking the USA for its individualistic and liberal doctrine.

4.4.2. Principal Measures

In 1994, Malaysia controlled the inflow of capital and, during the 1997-1998 financial crisis, its

outflow. First, excessive international liquidity led to the adoption of controls mainly administrative

to contain the inflow of short-term capital – attracted by the difference between domestic and

foreign interest rates – and the appreciation of its currency, the ringgit. The main measure was the

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elimination of remuneration on foreign bank’s investments in domestic assets. Furthermore, bank

indebtedness abroad was limited.

During the Asian crisis, a varied arsenal of measures was used to stop the loss of funds and the

consequent devaluation of the domestic currency, under pressure from sustained capital outflows.

Discarding policies recommended by the IMF, the country faced the crisis by taking measures which

would not jeopardize its economic-growth momentum, and which contemplated: the lowering of

interest rates; the broadening of credit; the increase of public spending; and a fixed exchange rate

after a 50% devaluation.

Three sets of measures were adopted. The first one aimed at eradicating the offshore ringgit

market and eliminating the supply of money that might be used by speculators to take positions

against the ringgit (leading to its depreciation). The repatriation of funds legally maintained offshore

by residents was thus determined and banks were forbidden from operating abroad with ringgit. The

second set of measures aimed at barring the outflow of resident and non-resident capital, especially

by: i) forbidding non-residents from repatriating funds derived from the sale of Malaysian financial

assets; and ii) limiting the remittance of dollars abroad (by residents), and conditioning it to the flow

of dollars entering the country (from non-residents). Lastly, short-term portfolio investments were

discouraged and the scaled outflow of foreign capital was made possible.

Malaysia, only formally a constitutional parliamentary monarchy, is a case of capital controls

under a right-wing authoritarian regime. Controls were first used in the context of excessive

international liquidity and later as a reaction to the sustained capital outflow resulting from the

Asian crisis. This is the most evident example showing that practical, as opposed to ideological

reasons, can justify capital controls.

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Conclusion

To tag the defenders of capital controls as left-wing is a double misconstruction. In the first

place, because such tagging is based on a Borsa-type economicist criterion that reduces the Right vs.

Left dichotomy to the economic liberalism vs. interventionism distinction. This criterion does not

clarify the problem being discussed. It improperly implies in reducing an exclusively political

dichotomy to an exclusively economic distinction. Ever since it was conceived, the idea of Left is

related to the ideal of equality amongst citizens that constitutes the basis of the Democratic State of

Right, and does not refer to the degree of state intervention in the economic field.

Secondly, even under the Borsa criterion, those authors cannot be categorically labelled as

leftists. The economic interventionism underlying their defense of capital controls is not the fruit of

an ideological conviction favoring widespread and indiscriminate intervention in the economy by

the State. In other words, they do not hold it as imperative that the “State should guide and rule the

market”, a criterion used by Borsa in defining the Left.

On the contrary, the main authors proposing capital controls are not interventionist. Their

argument is that capital controls are a tool to be used topically and with pragmatic justification, that

is to say, under specific economic circumstances: i) during the thirties’ Depression and the advance

of socialism, Keynes, a liberal in the broad sense, merely intended to reform Capitalism; ii) by

reason of the growth of speculative capital flow, Tobin aimed at preserving the autonomy of

monetary policy; and iii) Stiglitz and Rodrik wished to remedy financial market failures, the

consequences of which were specially dramatic during the Asian crisis.

To label capital controls as a practice typical of left-wing governments is also incorrect. Among

the five main countries using capital controls in the nineties, only the Chinese government may be

called left-wing. The political panorama in the other countries is much more complex than is

supposed by those who believe there is a simple and direct relationship between capital controls and

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the political stand of governments practicing them. Table 1 shows there is no correspondence

between capital controls and types of government or such governments’ political orientation.

Table 1 – Political Profile of Countries Practicing Capital Controls: 1990’s

Country Chile China India Malaysia Form of Government

Presidentialism Parliamentarism Parliamentarism Constitutional Parliamentarist Monarchy

Political Orientation

Center Left: socialist Center-Left and Center-Right Coalitions

Right: authoritarian

The Chilean experience categorically contradicts the thesis saying that capital controls are an

exclusively leftist initiative: i) they were instituted by a centrist government that is the main

opponent of the PSC, a historically left-wing party; and ii) the liberalization of the capital-account

has been furthered by Lagos, who belongs to the left-wing PSC. In India, capital controls continued

to be practiced notwithstanding the political changes that took place in the nineties. They were

maintained both by governments led by the traditional center-left party, the INC, and by center-right

coalition governments. Malaysia is a case in which capital controls were adopted by a right-wing,

formally democratic, but in fact authoritarian, government. The country refused to submit to the

orthodox policies for recessive adjustment recommended by the IMF.

In brief, Keynes wanted only to reform capitalism, Tobin wished to preserve monetary policy

autonomy, and Stiglitz and Rodrick to compensate for failures in the globalized financial market:

these definitively are not and have never been the objectives of the Left anywhere in the world. Let

it be said that Keynes was the 20th century’s greatest economist, and that Tobin and Stiglitz were

awarded the Nobel Prize for Economics. One could not call them fools or anything of the sort. In

Chile, capital controls were practiced by governments seen as centrist; in China, by leftist

governments; in India, by center-left and center-right coalitions; in Malaysia, by an authoritarian

Right. There is definetely no relationship between political stand and capital controls: neither the

Left is necessarily favorable to control, nor is the Right necessarily favorable to capital-account

liberalization.

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We must conclude that the discussion should be stripped of its political bias: capital controls

do not depend, as a proposal, on the ideology of authors championing them; neither, as an actual

economic measure, on the political orientation of governments adopting them.

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