A Defense of Capital Controls in Light of the Asian Financial Crisis

Abstract

Capital controls are in fashion once again.1 In mid-1997, financial panic raced across Asia, putting controls over short-term capital movements back on the political agenda, just as had happened during the crises in the Southern Cone of Latin America in the late 1970s and early 1980s, the EMS crisis of 1992, and the Mexican crisis of 1994. The fact that those Asian countries that control capital flows most tightly, such as China, Taiwan, and India, have been least affected by financial aspects of the current crisis has not gone unnoticed. Prestigious mainstream economists such as Joseph Stiglitz, Paul Krugman, and Dani Rodrik have called for the use of capital controls to help solve this crisis and avoid future disasters.2 However, if and when this crisis ends, history suggests that the celebration of open global financial markets is likely to return, pushing support for capital controls back to what Keynes called the underworld of economics [see Grabel 1999]. We believe that the case for capital controls is much stronger than the current debate would indicate.3 Permanent capital controls are needed by both developed and developing economies and for both economic and political reasons. In the South, capital controls are required not just to prevent speculative financial cycles and extreme exchange rate instability, but, more importantly, to facilitate the kinds of state-led industrial policies that East Asian countries used to create the only real development success stories of the past 40 years.4 Permanent capital controls are also needed in the North to facilitate the construction of a new era of high employ-