Should Developing Countries Restrict Capital Inflows?

Abstract

In the early 1990s, Chile imposed a tax on short-term inflows of foreign capital to control its current-account deficit by reducing the real exchange rate of the peso. The tax reduced capital inflows and increased the maturity of the foreign capital that entered that country, but the preponderance of the evidence is that the impost did not affect the real exchange rate of the peso. Moreover, the tax imposed considerable costs on the Chilean economy. After the 1997-98 financial crisis, some economists and politicians advocated such a tax to effect or preserve macroeconomic stability in developing countries. Aside from "second-best" arguments, imposing such a tax for that purpose can be justified only as a temporary measure to enable countries facing economic or financial crisis to reform and introduce prudential regulation and adequate supervision of their financial systems, but history shows that reforms dissipate as economic and financial conditions improve.