An (unlikely?) convert to capital controls

Guillermo Calvo is one of our smartest, most insightful thinkers on international finance. I have never thought of him as one who would favor capital controls, and so was surprised to read his contribution to the most recent VoxEU.org publication. Calvo argues that capital controls have a role to play both in minimizing capital flight during the current crisis, and more generally in calmer time: 

5) Liquidity credit lines like the ones implemented by the Fed and the Fund are twoedged swords. On one hand, they may help to stave off a currency/bank run. On the other hand, however, under worldwide deleveraging they could enhance the probability and size of a run....

[Therefore] credit lines should be accompanied by foreign exchange and banking regulations that limit the extent of capital flight.

6) The new Bretton Woods institutions should be more tolerant of controls on capital mobility, especially as those controls centre on limiting the actions of the banking sector.

I had to check back several times to see if the author of these lines was really Guillermo Calvo...

As Keynes once said, "When the facts change, I change my mind. What do you do, sir?"

UPDATE: Calvo explains a bit more:

I am not sure I changed my mind very radically because I also talk about the benefits of capital controls in my old imperfect credibility papers. I admit, however, that I became skeptical about controls (especially on
capital INFLOWS) as I studied Sudden Stops and realized that, for instance, in 1998 Chile had the largest Sudden Stop in LAC despite controls (see my paper with Talvi, NBER 11153).  In the article you refer to, the focus is on capital OUTFLOWS.  The concern is that IN THE CONTEXT OF A GLOBAL CREDIT CRUNCH, high-collateral agents may short domestic currency to relieve their dollar liquidity needs.  This
happened in Brazil, Chile and Peru during the 1998 episode.  To counteract that I basically have in mind banking regulations that would make that sort of shorting more expensive during a GLOBAL CREDIT CRUNCH episode.

More in general, I believe that a financial crisis of the magnitude that we are experiencing is an indication that, at least momentarily, the capital market is seriously dysfunctional.   This is the context in which second-best proposition may be a useful guide to policy.  But don't expect me to start proposing a clever new policy for every second-best triangle I can find !

Comments

[ASH]

Um, did the facts on financial instability and capital controls really change?

[Camiseta]

Maybe is time to blindy support any iniciative that cames from the goverment...

[Per Kurowski]

Let us be very clear, there are two very different types of capital controls.

The controls on capitals going in, and the controls on capitals going out.

I have always been a staunch supporter of controls on the capitals going in, so that our small bathtubs do not spill over when inundated by the waves of the global financial oceans; like those controls used in Chile before these were banned by the free trade agreement with the US.

I have always opposed controls on capital going the way out, as that usually only stops governments from doing what they should do.

Capital flight is frequently the last option for a responsible citizen that loves his country!

[Don the libertarian Democrat]

"As Keynes once said, "When the facts change, I change my mind. What do you do, sir?"

I think that this remark is misunderstood. In this case, he would expect Calvo to change his mind. Next time, when regulations against capital flight cause more harm than good, Calvo will change his mind again. Keynes didn't have a lot of faith in predicting the future.

[Nicholas Shaxson]

Keynes and Harry Dexter White, too, recognised the difficulties of making capital controls effective. They made proposals whereby receiving countries would co-operate in enforcing controls on capital flight. One element of this co-operation would involve the receiving countries sharing information with the countries suffering the outflows: giving the sending countries relevant information about the foreign holdings of the sending countries' citizens. They put this requirement into their initial drafts of the IMF Articles of Agreement. White even suggested that the receiving countries should refuse to accept capital flight without the sending country government's permission. Both proposals were strongly opposed by the US financial community (which had done very well out of capital flight in the 1930s, thank you very much) and their lobbying was successful; the eventual IMF Articles of Agreement were heavily watered down from Keynes' and White's original proposals. Secrecy is one of the most powerful motives/lures for capital flight, so an attempt to increase transparency of cross-border flows would seriously curb it; not only that, it would also lessen the harmful impact of the outflows, by giving the governments that are suffering capital flight the opportunity to tax the income on that lost capital. It would be relatively straightforward to make a strong case, politically (and morally and legally), for a crackdown on cross-border financial secrecy. So why are so few people advovating this so far? Beats me. It would seem like an obvious thing to do.

[Susan Chan]

Henry Paulson has been ridiculed by one or two commentators for his allusion to Keynes' statement that when the facts change, he changes his mind.

But what is so bad about that? Although he came over time to have a well-developed economic theory, Keynes was clearly an advocate during the Great Depression of trying practical steps to fight the Depression until something worked.

We should not today belittle economic policy-makers who, in the face of the greatest financial and perhaps economic crisis since the Depression, try good ideas. It sure beats doing nothing!

One of the most important lessons from Keynes - extremely topical with the G20 meeting about to happen - is the importance of international economic cooperation. As others have been pointing out, Keynes advocated internationally coordinated economic policies (e.g. monetary or fiscal stimulus), and effective international economic institutions like those he helped create at Bretton Woods that would help to provide conflict-reducing and stabilizing management of the international economy. He thought that if this couldbe achieved, then free trade was very desirable. (All this is set out in Donald Markwell's book "John Maynard Keynes and International Relations". He is interesting also on the discussions during WW2 which Nicholas Shaxson refers to, in the creation of the IMF.)

In the face of a wildly unpredictable wave of financial and economic problems - the worst roller-coaster since 1929 - Paulson has helped provide leadership, both nationally and internationally, so far, and we need to strongly encourage the Obama administration to provide strong US leadership in international cooperation over the months and years ahead. I am sure that Keynes would have supported this.

Is it so wrong to allude to the sensible attitude of one of the greatest economists and practical economic policy-makers ever?

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