Rethinking capital controls: When should we keep an open mind?

• Author: Kenneth S. Rogoff
• Position: IMF Economic Counsellor and Director of the IMF's Research Department

As a relatively new arrival to the IMF, I cannot bear firsthand witness to who said what, when, during the buildup to the 1990s Asian debt crisis. Was the IMF as guilty of ramming accelerated capital account liberalization down countries' throats as is sometimes alleged? A wide polling of "old-timers" yields mixed results. Overall, my sense is that whereas certain antiglobalization polemics grossly overstate the charge, it still has some currency. At the very least, in some of its routine surveillance missions during the early to mid-1990s and in some of its technical assistance advice, the IMF was not forceful enough when it warned countries with weak financial systems and inadequate macroeconomic frameworks that they were opening up to short-term borrowing from abroad too quickly.

These days, everyone agrees that a more eclectic approach to capital account liberalization is required. But what should it be? How can developing countries drink from the waters of international capital markets without being drowned by them?

To begin with, we should acknowledge that this is a tough question, and we should be humble about what we know and don't know. This doesn't mean that we have to toss out the first welfare theorem of economics-which espouses the virtues of competitive markets-and agree with those antiglobalists who have never met a capital control they didn't like. After all, capital controls often breed corruption and always engender distortions. Human ingenuity usually ensures that their effectiveness is eroded over time, through avoidance and evasion. And to sustain effective capital controls indefinitely, a government has to be prepared not only to intervene heavily throughout the trade and financial system-a policy that has highly undesirable side effects-but it must also be disciplined enough (which few are) to limit excessive capital inflows during boom times.

Don't discourage FDI or equities

Which types of capital flows are we talking about controlling? Certainly not foreign direct investment (FDI), which tends to be by far the most stable form of external finance and is often accompanied by transfers of foreign managerial skills and technology. And, hopefully, not foreign holdings of equities, which provide great benefits in terms of risk sharing. True, sudden reversals by foreign investors can be a problem...