Capital Controls Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Capital controls are measures used by governments to restrict the flow of money in and out of a country. There are many forms of capital controls, ranging from administrative requirements for transactions (e.g., allowing transfers of funds only with permits, prohibitions on certain types of transactions) to market-based controls (e.g., a tax on types of transactions, use of multiple exchange rates to discriminate against a class of transactions).

Almost every nation has relied on some form of capital controls at some point in its history, and capital controls became widespread during World War I and continued to be common through the mid-20th century. More recently, economic crises in the 1990s in Brazil, Chile, Colombia, Malaysia, and Thailand led to short-term impositions of capital controls. Where capital controls exist, they play an important part in business decisions about whether to invest in a country since controls can prevent repatriation of the investment and profits.

In an open economy without exchange or capital controls, money flows into an economy when investors perceive opportunities and out when they perceive risks. For example, if a country has higher interest rates than other countries and a stable currency, money will flow into the economy. On the other hand, if investors perceive a risk that a country will devalue its currency, they will seek to shift their money into a more stable currency. Such transactions limit the ability of governments to set monetary and fiscal policies in accordance with domestic political priorities by subjecting them to market discipline. Capital controls allow governments to avoid this financial market discipline.

The capital controls imposed during World War I enabled the belligerent governments to have a higher inflation rate (effectively a tax on wealth) than they could have sustained had investors been able to shift their wealth into nonbelligerent currencies. Proponents of capital controls also argue that they help countries avoid short-term, destabilizing capital inflows and outflows by speculators and facilitate effective taxation by making it harder for the wealthy to shift substantial assets abroad.

Malaysia’s experience in 1998–99 illustrates how capital controls operate. Thailand’s devaluation of its currency in 1997 sparked a widespread financial crisis across Asia, as investors sought security by moving their assets out of Asian currencies. To stop capital being withdrawn from Asian economies, the International Monetary Fund pushed governments in the region to raise interest rates. Because higher interest rates would reduce economic growth by making it more costly to obtain capital, the Malaysian government imposed restrictions on withdrawal of capital in September 1998, banning transfers from domestic to foreign bank accounts and otherwise restricting withdrawal of capital from Malaysia for one year. A few months later the government lifted the ban but imposed a heavy tax on capital withdrawals. The government also fixed the exchange rate for the country’s currency.

By preventing capital withdrawals, the government was able to prevent financial markets from exerting pressure on the fixed exchange rate. Supporters of the policy argued that it bought the government time, allowing the crisis sparked by the Thai devaluation to recede. Opponents argued that it freed the government to abandon needed financial reforms by insulating it from financial market pressures.

Opponents of capital controls note that controls are costly in five important ways. First, capital controls are costly to implement both for governments and for those subject to the controls. For example, Malaysia’s program in the 1990s required highly intrusive financial sector regulations to prevent evasion. Second, controls on capital reduce beneficial transactions as well as harmful ones by making all capital transactions more expensive. Since markets depend on liquidity for their efficient operation, loss of liquidity can result in general welfare losses. Third, the imposition of capital controls itself sends a bad signal to the financial markets about an economy, potentially exacerbating the problems that led to the imposition of the controls in the first place. Fourth, capital controls result in political allocation of valuable rights to make international capital transactions, which can lead to corruption. Finally, by partially insulating economies from financial market pressures, capital controls can undermine efforts at necessary fiscal and monetary policy reforms.

One form of capital control that has gained considerable popular support in recent years is the “Tobin tax,” named after James Tobin, the economist who first proposed it. A Tobin tax would tax short-term capital movements across borders, with the aim of discouraging speculation. Antiglobalization activists around the world have embraced the Tobin tax, as have a number of European and Latin American politicians.

Bibliography:

Akira Ariyoshi et al., Capital Controls: Country Experiences with Their Use and Liberalization (International Monetary Fund, 2000);
Barry Eichengreen, Global Imbalances and the Lessons of Bretton Woods (MIT Press, 2007);
Christopher Neely, “An Introduction to Capital Controls,” Federal Reserve Bank of St. Louis Review (November/December 1999).

This example Capital Controls Essay is published for educational and informational purposes only. If you need a custom essay or research paper on this topic please use our writing services. EssayEmpire.com offers reliable custom essay writing services that can help you to receive high grades and impress your professors with the quality of each essay or research paper you hand in.