Like veldfire that refuses to die, relaxation of exchange controls has been hotly debated in South Africa since the early 1990s. Gerald Epstein* looks at experiences in other countries.

If you just read the New York Times, watch Fox News, or even listen to National Public Radio, it is easy to believe that there is no alternative to the corporate-led, free market economic policies that have been promoted by the U.S. government, the IMF, and other international organizations. But if you look at the actual policies that successful countries have followed, you find a very different reality: the most successful countries in both the developed and developing world have often followed policies that are quite different from the so-called U.S./IMF-backed ‘Washington Consensus’ of privatization, liberalization and laissez-faire. Actually existing capital controls are an important case in point. Loosely speaking, capital controls refer to taxation and regulation policies that many countries use to limit buying and selling of foreign currency (called exchange controls) and the lending, borrowing and investing of finance across national borders. Whereas the IMF has promoted complete elimination of these controls (called capital account liberalization), many countries retain various kinds of controls over this activity. In fact, many of the countries that avoided the worst effects of recent financial crises – China , India , Malaysia , Chile , Singapore , Taiwan and Colombia – were also the countries that retained some type of capital controls. This happy outcome is no coincidence. A careful study of these cases shows that capital controls played a critical role in helping them avoid the worst excesses of the financial crises that afflicted their neighbours.

While some international capital flows can clearly bring benefits, they can also create at least three types of dangers:

Arbitrage risk: the danger that if a country wants to reduce interest rates to stimulate domestic investment and growth, domestic and foreign capital might leave the country in search of higher interest rates abroad;
Speculative instability: foreign investors can come and go in rapid and massive herds, one month pouring huge quantities of investment into a country, and the next stampeding for the exits, leaving debts and devastated balance sheets in the wake; and
Capital strike: if investors do not like government policies – perhaps because they threaten to tax or regulate the wealthy – investors can take their money and run, or threaten to do so, potentially draining the country of precious foreign exchange reserves or causing the value of the domestic currency to take a nose dive. This recently happened in Brazil in the run-up to the election of President Lula.

The trick, of course, is to design policies that can maximize the benefits a country can receive from capital flows, while minimizing these potential costs. The best capital controls are designed to do just that, and can also be a useful alternative to neo-liberal policies to help countries achieve important objectives. My colleagues and I conducted case studies of the seven countries listed above, and found that by using capital controls, these countries achieved many important goals:

by limiting speculation, capital controls promoted financial stability and thereby prevented the economic and social devastation that is associated with financial crises;
by discouraging short-term inflows, capital controls promoted desirable types of long-term investment;
by reducing the threat of ‘capital strike’, capital controls enhanced the power of domestic macroeconomic and social policy;
by enhancing the power of domestic policy, capital controls, potentially increased democracy by restoring national sovereignty.

Capital controls, when properly designed, can succeed in achieving many of these objectives. So next time you hear that there is no alternative to neo-liberal globalization, don’t believe it. Try some capital controls on for size.

* Epstein is an economist with the Centre for Popular Economics (CPE) in Amherst , Massachusetts . The article is taken from CPE’s periodic publication, Econ-Atrocities.