Capital Controls: Mud in the Wheels of Market Efficiency

In the early and mid-1990s, most economists and policymakers supported rapid capital account liberalization for emerging markets. Liberalization was expected to have widespread benefits. It was predicted to increase capital inflows, thereby financing investment and raising growth. Capital inflows—especially in the form of direct investment—would provide improved technology and management techniques, as well as access to international networks, all of which would further increase productivity and growth. Liberalization could facilitate the diversification of risk, thereby reducing volatility in consumption and income. It could also increase market discipline, thereby leading to a more efficient allocation of capital and higher productivity growth. Many countries followed this advice and removed their capital account restrictions. The initial results were generally positive—increased capital inflows, investment booms, and impressive growth performance. But then a series of financial crises affected several emerging markets that had recently removed capital account restrictions, such as Mexico, Thailand, Korea, Russia, and Argentina. In contrast, several Asian countries that had maintained more stringent capital controls—such as China and India—emerged from the Asian crisis relatively unscathed. These experiences caused many people to reassess their previous support for capital account liberalization in emerging markets. Many leading economists and policymakers now support the use of capital controls in some circumstances, especially taxes on capital