Trading
Away Capital Controls under Bilateral Trade Agreements
Kavaljit Singh
The sinister move by the US
to curb the use of capital controls under the guise of just concluded bilateral
trade agreements with Chile
and Singapore
has not received adequate attention. America’s
economic predominance – and the resulting shape of the global economy - has
long rested on a combination of bullying, threats and inducements, but recent US bilateral trade deals signed with Chile and Singapore hint at something entirely
more sinister. This is because both agreements include strict financial
conditions alongside aggressive safeguards for intellectual property which go
beyond multilateral benchmarks agreed by the World Trade Organization. The fact
that Chile and Singapore have
agreed to surrender the use of capital controls in return for more favorable
market access should set the alarm bells ringing. If bilateral trade deals
banning capital controls become de
rigueur it means a country using them to defend its economy will end up
compensating American investors for the inconvenience.
The US’s insistence on curbing capital controls is baffling
particularly when there has been a rethink in the international policy circles
on capital account liberalization in the aftermath of the Southeast Asian
financial crisis. Even the supporters
of free trade (for instance, Jagdish Bhagwati) are now vociferously advocating the need to
enforce capital controls. The Southeast Asian crisis has emphatically
demonstrated to the world that capital account liberalization is a vexatious
issue with numerous reverberating effects. An open capital account is perceived
as a source of risk rather than benefit. Particularly in the case of the
developing countries, the costs of an open capital account are enormous because volatile capital flows can cause sharp swings in
real exchange rates and financial markets thereby engendering instability in
the financial system and the real economy.
The neoclassical theories assert that capital controls are useless,
ineffective and distortionary. Grounded on flawed
assumptions that markets are perfect and financial and real assets are no
different, the neoclassical theories conclude that capital controls cannot
work. The ground reality is however quite different. Both the developed
and the developing countries have imposed controls on both inward and outward
movements of capital to meet the wider objectives of economic policy,
particularly those related to national development and macroeconomic stability.
Rapid economic development has occurred
amidst tight controls on financial markets in the two most successful cases of
the post World War II period, namely, Japan
and South Korea.
China and India are
experiencing rapid economic growth under a stringent regime of capital
controls. Can anyone buy the argument that growth rates in China would
have been much higher than the present (over 8 per cent) had the country
removed capital controls? Even Malaysia,
which re-imposed capital controls in the aftermath of Asian financial crisis,
has grown faster than other economies in the region. The significant decline in
the use of capital controls corresponded with the breakdown of Bretton Woods system and ascent of neo-liberal ideology in the
1970s. Yet a number of developing countries maintain some kind of capital control despite liberalization and
deregulation of their economies in the last two decades.
Capital controls are indispensable tools in the hands of the developing
countries to protect and insulate the domestic economy from volatile capital
flows and other negative external developments. Even before the eruption of the
Southeast Asian financial crisis, many countries had experienced financial
crisis because their capital account was open. Italy and France had liberalized their
capital account just before the ERM crisis. Similarly, Mexico and the
Southeast Asian countries had undertaken extensive capital account
liberalization in the 1990s. Turkey
and Bolivia
also faced similar consequences with the removal of capital controls. Removal
of capital controls was one of the major factors that perpetuated financial
crisis in Chile
in the early 1980s. With the macro
economy firmly controlled by the “Chicago Boys,” the rapid liberalization of
capital account and financial markets by Pinochet regime was accompanied by
increased capital flight and volatility thereby creating a severe financial
crisis. In the aftermath of the financial crisis, the Chilean authorities
realized the importance of prudential controls and reversed its financial
liberalization agenda.
Unlike Singapore, Chile still
maintains several controls on capital inflows in the form of unremunerated
reserve requirement and a minimum stay of one year in order to discourage
speculative capital inflows. Not only these controls significantly altered the
composition of capital inflows in favor of long-term inflows, but more
importantly, it helped the country to remain protected from the contagion
effects of the Mexican crisis of 1994-95 and the Southeast Asian crisis of
1997. No a mean achievement in the present volatile financial world! These
measures, often cited as successful examples of restricting ‘hot money’
inflows, have even been endorsed by the IMF and the World Bank. It stands to
reason that the probability of occurrence of a financial crisis in Chile and Singapore
would increase manifold with the removal of capital controls as envisaged in
the bilateral trade agreements with the US. So next time, if a financial
crisis on account of sharp reversals of capital flows occurs in Chile or
Singapore, don’t blame the macroeconomic fundamentals or “crony capitalism,”
blame these bilateral trade agreements!
The bilateral trade agreements with Chile and Singapore have to be visualized in
a wider historical context. In the past, the US’s efforts to push ahead its
wider agenda of capital account liberalization and investment liberalization
through multilateral fora had not yielded positive
results. During the GATT Uruguay Round negotiations from 1986 to 1994, a
number of developing countries opposed the US proposal to include a
comprehensive investment agreement on the negotiating agenda. Faced with severe
opposition, the US
advocated the Multilateral Agreement of Investment (MAI) under the aegis of the
OECD in the early 1990s. Largely due to differences among the member-countries
of OECD on certain issues coupled with massive protests by NGOs and labor
unions, the MAI was finally shelved in 1998. During the same period, attempts
at IMF to include convertibility of the capital account in its Articles of
Agreement also lost momentum in the aftermath of the Southeast Asian financial
crisis.
Undoubtedly, the US has been
successful at the WTO in removing
restrictions on capital transactions in certain sectors (for instance, Financial
Services Agreement) whereby the
countries have agreed to a legal framework for cross-border trade and market
access and establishing a mechanism for settling disputes. Yet the US has not been
able to persuade many developing countries to accept a multilateral investment
agreement at the WTO that would incorporate comprehensive capital account
liberalization and investor protection measures, as envisaged under the NAFTA
and MAI. If recent negotiations are any indicator, the proposal to launch a multilateral agreement on investment at
the WTO (as part of Doha round) is unlikely to
be a smooth ride for the US.
In the light of these experiences, the US has perhaps
realized that it is difficult to pursue rapid liberalization agenda in a
multilateral forum. In the post-Southeast Asian financial crisis world, a
blanket approach advocating rapid liberalization is unlikely to succeed.
Whereas a gradual approach aimed at expanding liberalization agenda through
bilateral agreements has better chances of success. A bilateral agreement is
much easier to negotiate, without entailing close scrutiny and opposition by
critics. Can anybody deny that these bilateral agreements would not ultimately
pave the way for launching a more comprehensive multilateral agreement in the
future?
-End-
Source: Asia-Europe Dialogue Project (www.ased.org)