Leading economists urge US to allow use of capital controls

In a letter delivered 31 January, more than 250 US and international economists have urged the Obama administration to reform US trade rules that restrict the use of capital controls. The statement reflects growing consensus among economists that capital controls are legitimate policy tools for preventing and mitigating financial crises. Below is the text of the letter.

WE, the undersigned economists, write to alert you to important new developments in the economics literature pertaining to prudential financial regulations, and to express particular concern regarding the extent to which capital controls are restricted in US trade and investment treaties.

Authoritative research recently published by the National Bureau of Economic Research, the International Monetary Fund, and elsewhere has found that limits on the inflow of short-term capital into developing nations can stem the development of dangerous asset bubbles and currency appreciations and generally grant nations more autonomy in monetary policy-making.i

Given the severity of the global financial crisis and its aftermath, nations will need all the possible tools at their disposal to prevent and mitigate financial crises. While capital account regulations are no panacea, this new research points to an emerging consensus that capital management techniques should be included among the 'carefully designed macro-prudential measures' supported by G20 leaders at the Seoul Summit.ii Indeed, in recent months, a number of countries, from Thailand to Brazil, have responded to surging hot money flows by adopting various forms of capital regulations.

We also write to express our concern that many US free trade agreements [FTAs] and bilateral investment treaties [BITs] contain provisions that strictly limit the ability of our trading partners to deploy capital controls. The 'capital transfers' provisions of such agreements require governments to permit all transfers relating to a covered investment to be made 'freely and without delay into and out of its territory'.

Under these agreements, private foreign investors have the power to effectively sue governments in international tribunals over alleged violations of these provisions. 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.iii However, these minor reforms do not go far enough to ensure that governments have the authority to use such legitimate policy tools. The trade and investment agreements of other major capital-exporting nations allow for more flexibility.

We recommend that future US FTAs and BITs permit governments to deploy capital controls without being subject to investor claims, as part of a broader menu of policy options to prevent and mitigate financial crises.                                                           

Notes

i     For some of the most important recent studies see: Ostry JD, Ghosh AR, Habermeier K, Chamon M, Qureshi MS and Reinhardt DBS (2010). 'Capital Inflows: The Role of Controls'. IMF Staff Position Note, SPN/10/04. Washington, DC, International Monetary Fund. Magud N and Reinhart CM (2006). 'Capital Controls: An Evaluation. NBER Working Paper 11973. Cambridge, MA, National Bureau of Economic Research. Further studies are available upon request.

ii     'Seoul Summit Document', Nov. 12, 2010.

iii    See, for example, Annex 10-E of the US-Peru FTA.

For the list of signatories to the letter, please go to www.ase.tufts.edu/gdae/policy_research/CapCtrlsLetter.html.  

This letter was initiated by the Global Development and Environment Institute, Tufts University (GDAE) and the Washington, DC-based Institute for Policy Studies (IPS).

*Third World Resurgence No. 245/246, January/February 2011, p 27