Capital Controls Re-Examined: The Case for Smart Controls

24 Pages Posted: 8 Sep 2006

See all articles by Jarita Duasa

Jarita Duasa

International Islamic University of Malaysia (IIUM) - Faculty of Economic and Management Sciences

Paul Mosley

University of Sheffield - Department of Economics

Abstract

The global financial crisis which began in east Asia in 1997 is not over, neither is the inquest into its implications for adjustment policy. In the wake of this crisis, we focus here on the role of capital controls, which formed a much publicised part of the crisis-coping strategy in one country (Malaysia) and, less openly, were also deployed by other crisis-afflicted countries. Evaluation so far has examined different target variables with different estimation methods, generally concentrating on efficiency and stability indicators and ignoring equity measures; it has also typically treated 'control' as a one-zero dummy variable, ignoring the 'quality' of intervention and in particular the extent to which efficiency gains are obtained in exchange for controls. Partly because of these limitations, the literature has reached no consensus on the impact of controls; however, it is moving over towards acknowledging that the quality and type of controls is important, as well as their intensity. We propose an approach in which the government plays off short-term political security against long-term economic gain; the more insecure its political footing, the greater the weight it gives to political survival, which is likely to increase the probability of controls being imposed. The modelling of this approach generates a governmental 'policy reaction function' and an impact function for controls, which are estimated by simultaneous panel-data methods across a sample of thirty developing and transitional countries between 1980-2003, using, for the period since 1996, the 'new' IMF dataset which differentiates between controls by type.

We find that controls appear to cause increases in income equality, and are significantly associated with political insecurity and relatively low levels of openness to trade. They do not, in our analysis, materially influence the level of whole-economy productivity or GDP across the sample of countries examined, although they do influence productivity in particular sectors. But the dispersion around this central finding is wide: the tendency for controls to depress productivity by encouraging rent-seeking sometimes is, and sometimes is not, counteracted by purposive government policy actions to maintain competitiveness. Whether or not this happens is vital, on both efficiency and equity grounds. We make the case for 'smart' capital controls - controls which are time-limited and contain an inbuilt incentive to increased productivity.

Suggested Citation

Duasa, Jarita and Mosley, Paul, Capital Controls Re-Examined: The Case for Smart Controls. The World Economy, Vol. 29, No. 9, pp. 1203-1226, September 2006, Available at SSRN: https://ssrn.com/abstract=929202 or http://dx.doi.org/10.1111/j.1467-9701.2006.00837.x

Jarita Duasa (Contact Author)

International Islamic University of Malaysia (IIUM) - Faculty of Economic and Management Sciences ( email )

P.O. Box 10
Kuala Lumpur, 53100
Malaysia

Paul Mosley

University of Sheffield - Department of Economics ( email )

9 Mappin Street
Sheffield, S1 4DT
United Kingdom

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