The International Monetary Fund has now codified a significant policy shift signaled by statements over the past few years: acceptance of capital controls as legitimate policy tools. Ironically, "trade" policy currently being hatched in Auckland, the site of the current round of Trans-Pacific Partnership negotiations, threatens to move in precisely the opposite direction.
A long and growing list of economists and governments have found capital controls to be an essential component of a policy toolbox to prevent sudden inflows or outflows of speculative “hot money,” the destabilizing impacts of which became manifest in the global financial crisis. Beyond avoiding the crises that emerge when lemmings-like investors decide to pull funds out of a country en masse, capital controls can also be employed in an enduring form for a range of worthy goals. These include preventing asset bubbles, forestalling currency appreciation and export deterioration, controlling inflation, maintaining effective monetary policies in the face of procyclical flows, and ensuring a stable climate for long-term domestic investment.
A paper released this week and approved by the IMF Board (on which the U.S. holds by far the greatest voting power), states the new IMF official policy position: “In certain circumstances, introducing [capital flow management measures] can be useful for supporting macroeconomic policy adjustment and safeguarding financial system stability.”
The newly official position is not a categorical endorsement of capital controls. It states that controls should be “generally temporary,” “should not be used to substitute for or avoid warranted macroeconomic adjustment,” and should be considered as a last resort. Such narrow qualifications have irked countries like Brazil, whose representative on the IMF Executive Board responded to the tepid change by saying, “The extent of the damage that large and volatile capital flows can cause to recipient countries has not been sufficiently recognized.”
Still, the formalized policy shift, which allows the IMF to actually recommend capital controls in its regular doses of policy advice to troubled economies, contrasts starkly with its history of requiring countries to dismantle capital controls as a lending condition during the free-market-fundamentalist 1990s.
Trade policy, by contrast, is still stuck in the ‘90s.
The rules of the World Trade Organization, enshrined in that deregulatory era, bar most uses of capital controls. The transfers provisions in the WTO’s General Agreement on Trade in Services forbid any country that has committed financial sectors to WTO rules from restricting capital flows in those sectors. Under a limited exception, countries can enact capital controls during balance of payments crises, though permitted controls may only apply to capital outflows, must be temporary, and must be deemed “necessary” by a WTO body.
NAFTA-style “free trade” agreements are even worse. These deals prohibit capital controls without even including the WTO’s very limited caveat for balance of payments crises. Further, they allow private investors to directly attack a government’s capital control policy, demanding taxpayer money as compensation, via the notorious and increasingly-used investor-state system. The leaked investment chapter proposed for the TPP replicates these same extreme prohibitions on a policy tool backed by a growing chorus of economists and policymakers.
As the IMF joins that chorus (albeit as one of the more timid singers), U.S. trade officials are left making discordant noises by themselves. Coinciding with the IMF’s release of its U.S.-approved endorsement of capital controls, this week U.S. negotiators in Auckland are pushing other TPP negotiating countries to lock in the proposed TPP prohibition of capital controls.
This irony yields a unique diagnosis: the U.S. suffers from capital controls schizophrenia. It appears that the U.S. officials at the Treasury Department who okayed the IMF policy shift should have a little talk with their counterparts at USTR who are actively undermining said shift.
If they don’t, and if the TPP is allowed to contravene the solidifying consensus that capital controls are legit policy tools, TPP countries who take policy advice from the IMF may find themselves in a baffling predicament. What happens if a TPP member like Chile, which successfully employed capital controls during the 1990s, experiences a surge in destabilizing capital inflows, gets an IMF recommendation to stem the flow, but is bound by the TPP not to? In the 1990s we saw the IMF threaten lending cutoffs for countries that did not adhere to a NAFTA-style system of trade deregulation. Could we now see that same system threaten investor-state attacks for countries that actually adhere to IMF advice?
As the IMF position on capital controls begins to more closely align with the policies of many countries, the views of many economists, and the realities of the post-crisis world, the TPP capital control ban pushed by U.S. trade negotiators becomes an increasingly isolated (and continuously senseless) outlier.