More than 250 Economists Call for Trade Reforms to Allow Capital Controls
Kevin P. Gallagher
To see the full economists statement:
For better or for worse, trade policy is back in style. In its first two years, the Obama administration largely steered clear of signing trade treaties. Yet, in his state of the union address last week, the president said he would reinvigorate efforts to pass Bush-era deals with South Korea, Colombia and Panama – as well as pursue a new treaty with numerous Pacific-rim nations.
As the president and Congress evaluate the merits of these treaties, they should see to it that no deal is passed that limits the ability of the US or its trading partners to prevent and mitigate financial crises. Ironically, many of the trading partners involved in these agreements have imposed measures that the treaties would declare illegal. One particular flaw in US treaties is their outdated insistence on prohibiting the use of capital controls to slow the flow of “hot” money.
Citing an emerging consensus in the economics profession and in institutions such as the International Monetary Fund that capital controls are legitimate tools to prevent and mitigate crises, 250 economists from the United States and across the world are this Monday urging the US to reform pending and future treaties to “permit governments to deploy capital controls without being subject to investor claims”.
In the wake of the financial crisis, nations such as Brazil, Indonesia, South Korea, Taiwan and Thailand have all used capital controls to stem the massive inflows of speculative investment entering their economies and wreaking havoc on their exchange rates and asset markets. South Korea, where the won has appreciated by 30% since 2008, has direct limits on foreign exchange speculation, for example, and has also levied an outflows tax on capital gains of foreign purchases of government bonds.
In the runup to the financial crisis, Colombia’s 2007 capital controls required foreign investors to park a percentage of their investment in the central bank, which helped that nation escape some of the damage from the global financial crisis. Chile and Malaysia, two nations that form part of Obama’s newly-planned trade deal with Pacific rim nations, successfully used capital controls in the 1990s to avoid the worst of the damages during crises in that decade.
US trade treaties, however, require that capital be allowed to flow between trading partners “freely and without delay”. Restrictions on the entry and exit of capital violate this standard in absolute terms. Measures that withhold the ability of US investors to move investment out of nations – such as through an outflows tax (South Korea), or by being required to keep capital with a central bank for a minimum period (Colombia) – are of particular concern. Language in US treaties would allow room for such actions to seen as expropriating US investments.
It’s bad enough that the US trade deals outlaw important and prudent financial management. But the agreements also give the enforcement of such bans new teeth by allowing banks and other investors to sue governments directly if the capital controls reduce their profits or restrict their ability to continue speculating.
In response to pressure from members of Congress such as Barney Frank and Carl Levin, a few recent US trade agreements put some limits on the amount of damages foreign investors may receive as compensation for certain capital control measures, and require an extended “cooling off” period before investors may file their claims. In the end, however, nations are still liable under treaty for actions they may take to mitigate crises.
The coalition behind the economists’ statement attests to the fact that there is broad support for reforming US trade treaties’ terms on capital controls. The list includes prominent academic economists who have been supportive of free trade deals, former IMF officials, and some economists affiliated with the pro-trade Peterson Institute for International Economics.
The economists should be listened to: US trade treaties should not be tools for US financial policies that are not only outdated, but actually helped cause the financial crisis in the first place. Allowing flexibility for the use of capital controls to prevent and mitigate crises now has broad support. Our trading partners have been requesting such flexibility for years; granting it would represent one small step toward a more stable financial system.
US banks and investment houses played a role in nearly destroying the global economy. Why should the Obama administration ban the measures that prevent contagion, while giving those same firms the right to sue foreign governments for damages?
Appeared in the Guardian on 1-31-2011
To learn more about capital controls and trade treaties see: