The Economists Voice Volume Issue Article Should We Still Support Untrammelled International Capital Mobility Or are Capital Controls Less Evil than We Once Believed J Bradford DeLong U C Berkeley delong econ Berkeley EDU Copyright c 2004 by the authors All rights reserved No part of this publication may be reproduced stored in a retrieval system or transmitted in any form or by any means electronic mechanical photocopying recording or otherwise without the prior written permission of the publisher bepress The Economists Voice is produced by The Berkeley Electronic Press bepress http www bepress com ev Should We Still Support Untrammelled International Capital Mobility Or are Capital Controls Less Evil than We Once Believed J Bradford DeLong Summary Fifteen years ago I found it easy to be in favor of international capital mobility the free flow of investment financing from one country to another Then it was easy to preach for an end to all systems of controls on capital that hindered this flow Now it is harder KEYWORDS international finance crises mobility I would like to thank Joe Stiglitz Aaron Edlin Barry Eichengreen and Robert Waldmann for helpful discussions DeLong Untrammelled International Capital Mobility 1 Fifteen years ago I found it easy to be in favor of international capital mobility the free flow of investment financing from one country to another Then it was easy to preach for an end to the systems of controls on capital that hindered this flow Why not free up capital flows to encourage large scale lending from the world s rich countries to the world s poor countries I and others asked Such lending we hoped might cut a generation off the time it would otherwise have taken developing countries economies to catch up to the industrial structures and living standards of wealthier countries More than a century ago large scale borrowing and lending had played a key role in the economic development of the late nineteenth century temperate periphery of Canada the western United States Australia New Zealand Chile Argentina Uruguay and South Africa Why shouldn t it similarly benefit twentieth century developing countries This reasoning seemed compelling then Today however it is much harder for me to support untrammelled international capital mobility I am no longer as sure that capital flows are efficient Too many external costs associated with financial crises and the fact that capital seems to want to flow not from but to where it is already abundant make me fear that my standard economist s model is simply not working Worse yet even if capital flows are efficient it seems increasingly likely that these flows could benefit rich people from poor countries at the expense of the countries themselves including their poor Thus lifting capital controls far from helping the world s poor as many had hoped may actually hurt them The Dream of International Capital Mobility To see why capital mobility has not lived up to our earlier dreams it is important first to describe exactly what those dreams were in the first place Neoliberals like myself saw three important reasons that removing capital controls could potentially improve life in poor countries But history showed that in practice these improvements did not happen as we had hoped First the resulting capital inflows we thought would directly boost production and productivity Capital controls had kept the level of investment in Produced by The Berkeley Electronic Press 2004 2 The Economists Voice Vol 1 2004 No 1 Article 1 peripheral developing countries down or so we believed This seemed to be a very bad thing Higher investment boosts a country s capital stock and thus directly raises labor productivity and wages Second we thought that countries industries and people technological advances and from After all such benefits had been growth of the past two centuries with capital controls removed developing would enjoy the benefits that flow from learning by doing using modern machinery at the heart of so much of the productivity Third capital controls created large scale opportunities for corruption and we hoped that the removal of capital controls would reduce corruption and improve the quality of government in these countries In highly corrupt societies tax rates and the regulatory barriers to starting businesses are idiosyncratically and randomly high Such societies cannot be productive nor equitable Whoever got the scarce permissions to borrow abroad had a good chance of becoming rich and somehow those who got them often turned out to be married to the niece of the vice minister of finance When capital controls are in place people who badly want to move their capital across borders cannot unless they can find some complaisant bureaucrat A well functioning market economy needs to minimize the incentives and opportunities for corruption or it will turn into something worse Together these three reasons seemed to make up an overwhelming case for lifting capital controls The world s system of relative prices is tilted against the poor the products they export are cheap yet the capital goods they must import in order to industrialize and develop are expensive The hope was that this inequity could be at least partially remedied by open capital flow Proof that the Dream Didn t Come True Mexico s Example Working at the U S Treasury in 1993 I naively projected that after NAFTA there would be a net capital flow of some 10 to 20 billion a year to Mexico for decades to come I predicted that investors around the world would now build factories in Mexico where they not only could pay low wages to workers but could enjoy guaranteed tariff free access to the largest consumer market in the world Sadly however it did not turn out that way Here is what s really happening The good part is that Mexican workers and entrepreneurs are gaining experience in export manufactures and exporting http www bepress com ev vol1 iss1 art1 DeLong Untrammelled International Capital Mobility 3 enough to the U S to run a trade surplus But the flip side of the trade surplus is a capital outflow from Mexico to the U S rather than from the U S to Mexico Should capital poor Mexico really be financing a further jump in the capital intensity of the U S economy Why didn t this dream come to fruition There are several basic explanations for the disparity between dream and reality One Problem with the Dream Cash Flow Into Not Out of Rich Countries One basic problem for the
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