Capital Account - Capital Controls

Capital Controls

Capital controls are measures imposed by a state's government aimed at managing capital account transactions. They include outright prohibitions against some or all capital account transactions, transaction taxes on the international sale of specific financial assets, or caps on the size of international sales and purchases of specific financial assets. While usually aimed at the financial sector, controls can affect ordinary citizens, for example in the 1960s British families were at one point restricted from taking more than £50 with them out of the country for their foreign holidays. Countries without capital controls that limit the buying and selling of their currency at market rates are said to have full Capital Account Convertibility.

Following the Bretton Woods agreement established at the close of World War II, most nations put in place capital controls to prevent large flows either into or out of their capital account. John Maynard Keynes, one of the architects of the Bretton Woods system, considered capital controls to be a permanent part of the global economy. Both advanced and emerging nations adopted controls; in basic theory it may be supposed that large inbound investments will speed an emerging economies development, but empirical evidence suggests this does not reliably occur, and in fact large capital inflows can hurt a nation's economic development by causing its currency to appreciate, by contributing to inflation, and by causing an unsustainable "bubble" of economic activity that often precedes financial crisis. The inflows sharply reverse once capital flight takes places after the crisis occurs. As part of the displacement of Keynesianism in favour of free market orientated policies, countries began abolishing their capital controls, starting between 1973 -74 with the US, Canada, Germany and Switzerland and followed by Great Britain in 1979. Most other advanced and emerging economies followed, chiefly in the 1980s and early 1990s.

An exception to this trend was Malaysia, which in 1998 imposed capital controls in the wake of the 1997 Asian Financial Crisis. While most Asian economies didn't impose controls, after the 1997 crises they ceased to be net importers of capital and became net exporters instead. Large inbound flows were directed "uphill" from emerging economies to the US and other developed nations. According to economist C. Fred Bergsten the large inbound flow into the US was one of the causes of the financial crisis of 2007-2008. By the second half of 2009, low interest rates and other aspects of the government led response to the global crises have resulted in increased movement of Capital back towards emerging economies. In November 2009 the Financial Times reported several emerging economies such as Brazil and India have begun to implement or at least signal the possible adoption of capital controls to reduce the flow of foreign capital into their economies.