Dealing with capital flows

The opinion page of the Financial Times is suddenly making more sense. 

Seriously, one of the benefits of writing a piece like this is that it gets you lots of intelligent responses.  Here is one that appeared in my e-mail box:

Are you a Kennedy Fag?  
re: Int'l capital flows
First: gas tax???    Second: Send the memo to E. Asia ??     WTO ???
Why not just a global currency standard, with some flexible rigidity?

That is meant as a compliment, right?

I better stick to my blog, where comments are always civil and well-informed.

UPDATE:  Martin Wolf has a comment on our oped, which includes a plug for his new book.  He says he is closer to the Rodrik-Subramanian view than he was five years ago ("When the facts change, I change my mind -- what do you do, sir?") and makes three points:

First, this is a matter for individual countries to decide. Capital account liberalisation should neither be forced on countries nor should they be prevented by others. Outside advisers, including official advisers, should analyse the pros and cons against the particular circumstance of the country concerned and offer advice on the feasibility of the set of policies proposed.

Second, capital inflows are not a substitute for an adequate level of domestic savings. Promoting the latter is an important policy priority (though not to the excessive levels now seen in China).

Third, countries should normally discourage domestic borrowing in foreign currency, unless they adopt the foreign currency for domestic monetary use. Otherwise, countries should restrict capital inflow to direct investment, portfolio equity and domestic-currency-denominated lending. The fact that the US borrows in dollars makes the consequences of the crisis smaller and the ease of dealing with it far greater.

I am on board with all three.

Comments

[Per Kurowski]

When Rodrik and Subramanian say that one should not be “too optimistic about the potential of prudential regulation to stem excessive risk-taking” they are more right than they have ever imagined in their wildest dreams or wildest hypothesis.

In fact, it was precisely the running away from the risks, forced upon the financial market by the regulators through their minimum capital requirements for the banks and that was based exclusively on risk-assessments carried out by the regulator’s own outsourced risk overseers, the credit rating agencies that set us up to all what is currently happening.

But I must acknowledge that the risk that is present when everyone follows down the same path of knowledge is not really the typical risk that PhDs think about.

[Per Kurowski]

Having for more than thirty years argued about the dangers for the bathtubs of a small economies to lie completely open next to the global financial oceans exposed to their tsunamis I could not but fully agree with the general direction indicated by Dani Rodrik Arvind Subramanian in their “Why we need to curb global flows of capital”.

Having said that I would much rather use the term “slow” than “curb” because it is the speed of how the financial resources move that causes the most damages.

[jb]

So what are the arguments against a Tobin Tax?

[th]

I am surprised by the extent to which Dani wants to emphasise the role of capital flows in the current US crisis.

If we assume the bubble has been in housing and credit markets (hard to argue US equities have been in a recent bubble given valuations) then foreign purchases would have needed to play a significant role in lowering US interest rates. While there is no doubt something to that, other factors can explain low US bond yields (the 'conundrum' a couple of years back) which may have been more significant than foreign purchases. (See Jonathan Wright's work).

Other significant factors in the current crisis (e.g. mis-selling, the role of the credit rating agencies etc...) do not seem related to capital flows.

A new model of financial globalization may be needed, but I don't see that the recent US crisis is strong supporting evidence.

[SteveB]

A great article. You state that an increase in East Asian currencies should be done unilaterally, if necessary. How in practice could our nation accomplish that?

[Eco]

Dani,

I am simpathetic to your and Arvind's thesis, but I must warn you that it will be misread and potentially feed into very bad economic policies down South, where those fond of capital levies are stopped short by the threat of capital outflows (e.g. in Brazil).

It happened before. Your message on the benefits of a competitive exchange rate was recently read in Brazil as in favor of lax monetary policies, even in face of very expansionary fiscal policies. The point you made that fiscal policies could contribute to an undervalued currency was completely lost among Brazilian economists of the left (whose every waking thought calls for a renewed struggle to avoid letting the economy plunge into a new Great Depression).

[nicholas shaxson]

Generally good article, as far as it goes, but a criticism of certain aspects of it is contained here: http://taxjustice.blogspot.com/2008/02/capital-flows-be-braver-and-dont-forget.html The blog ends like this: "In summary, we like Rodrik's and Subramanian's latest piece. But we urge its authors to factor secrecy more centrally into their analyses, and to be braver about what might now be possible." Comments welcome in return.

[robertdfeinman]

Someone reads FT and then writes semi-literate emails?

This would make an interesting subject for study by a sociologist or education philosopher. Are schools turning out people who can read, but not write?

[Mark Koyama]

There is an good response to the FT piece, by my co-blogger here
http://oxonomics.typepad.com/oxonomics/2008/02/in-defence-of-c.html#more

The post ends by asking: 'doesn’t citing capital flows as causative in episodes of turmoil overlook the microeconomic decisions that ultimately bring these phenomena about?'

[Butter]

The article would make someone think that economists have one arm.

"Financial globalisation has not generated increased investment or higher growth in emerging markets." - How then do you respond to the lead article by Mr. Henry in this quarter's JEL? Have you been making the same mistakes he warns us of when running your data?

"Countries that have grown most rapidly have been those that rely least on capital inflows." -Probably because they have a more developed domestic financial sector.

"Nor has financial globalisation led to better smoothing of consumption or reduced volatility." - The enhanced ability to borrow must in some way enhance one's ability to smooth consumption. Volitility is a real problem and one worth having an intelligent discussion on, which you seem, at times, capable of. But just to play devil's advocate, I think that most African countries would be happy to have a fiancial crisis because it would imply that someone had bothered to invest there in the first place.

"If you want to make an evidence-based case for financial globalisation today, you are forced to resort to indirect and speculative arguments." - See neoclassical economic theory and the article referenced above.

[Dani Rodrik]

Butter (I know a cat by that name)--

Don't take my word for it. Listen to Ken Rogoff et al. from their paper on "Financial Globalization: A Reappraisal":

"In Table 3A, we provide an overview of the empirical literature that aims to establish a causal relationship between financial openness and growth. While some of these studies conclude that there are growth benefits associated with international financial integration, the majority of them tend to find no effect or a mixed effect (results that are not robust across alternative specifications) for developing countries. This confirms our claim that, if financial integration has a positive effect on growth, it is apparently not robust, especially once the usual determinants of growth are controlled for."

[Emmanuel]

Dr. Rodrik, I posted a reply to your article together with Dr. Subramanian on Martin Wolf's blog which featured this discussion. Though I am skeptical of the proposals you have outlined, I hope to have done so in a civil and well-informed way :-)

http://blogs.ft.com/wolfforum/2008/02/we-must-curb-international-flows-of-capital/#comments

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Recently the online game Runescape instituted a version of capital curbs. It is trying to combat the exchanging of real world money for runescape world goods. I think such a community would be a great place to experiment with various economic regulation. Right now they have a system that effectively limits the opportunities for trading real world items for runescape world items, but this has also severely hampered the runescape economy. This despite the fact that they have a near perfectly efficient market at their disposal.

Again, I realize its not exactly consequential, and the game is run as a for profit enterprise so I don't think they should be offered charity. I still think it offers a great chance for studying regulations and markets if some one of enough stature approaches them.

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