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IMF’s Unfinished Business
Joseph E Stiglitz ,
a Nobel laureate in economics, is a professor at Columbia University.
Kevin P Gallagher
is a professor and director of the Global Development Policy Center at Boston University.
JOSEPH E STIGLITZ and KEVIN P GALLAGHER
THE International Monetary Fund (IMF) is showing promising signs of changing with the times. In addition to recognising that climate change poses significant risks to financial stability, it has responded to the pandemic with a major new allocation of special drawing rights (the fund’s reserve asset), while criticising the G20’s inadequate framework for dealing with debt distress. Moreover, in a recent agreement with Argentina, the IMF largely abandoned the kind of austerity programmes that have long plagued its reputation, not to mention undercutting livelihoods around the world.
The IMF will have a chance to take another major step in the right direction when it reviews its stance on capital flow regulation later this month. The original rationale for such regulation, enshrined in the IMF’s Articles of Agreement, was that cross-border capital flows could disrupt international financial markets, the stability of which was the IMF’s raison d’etre .
Yet, ironically, in the IMF’s darker days during the 1980s and 1990s, it made bailout packages conditional on recipients deregulating financial flows, and in the late 1990s, it even tried to change the Articles of Agreement to outlaw capital flow regulation. But the 1997-98 East Asian financial crisis, which resulted largely from capital market deregulation, sidelined that effort.
For many countries, capital flows are important for sustaining investment and growth. But some of the IMF’s own research shows that international capital flows to emerging markets and developing countries (EMDCs) tend to be highly unstable—surging when interest rates are low in the United States, only to undergo “sudden stops” when monetary conditions tighten. While the surges push up exchange rates and encourage EMDC companies and households to borrow excessively, the sudden stops derail growth, weaken exchange rates, and drive debt up to unsustainable levels. The resulting crises take an enormous toll on these countries’ economies and citizens.
Recent advances in economic theory have proven that capital controls can make markets more efficient, not less. In 2011, Anton Korinek published an article in the IMF Economic Review , showing that capital flows generate negative externalities, because individual investors and borrowers are focused only on their portfolios, not on how their decisions may affect financial stability.
The following year, the IMF issued a new “institutional view,” acknowledging that capital flow deregulation is not optimal for most EMDCs, and that capital controls can indeed be effective under certain circumstances. And, to reduce the stigma, it rebranded such regulations as “capital flow management measures” (CFMs).
Yet, the effects of this shift remained limited, owing to resistance from major IMF shareholders, financial lobbies, and intransigent economists inside and outside the institution, who argued for unfettered financial markets and massive bailouts when things went awry. In the end, it became IMF policy to recommend CFMs only as a last resort, after a government had exhausted all other possibilities, even though academic economists and the IMF’s own researchers have shown that capital controls are most effective when they are deployed alongside other policies, not used in isolation.
Even in the early days of the Covid-19 crisis, when EMDCs experienced massive capital flight, which predictably depreciated exchange rates and pushed many countries into debt distress, the IMF remained reluctant to advise countries to regulate capital flows. But things began to change this past December, when the IMF admitted that it should have sanctioned CFMs in its failed Argentina programme.
Another problem, however, is that even as the IMF has slowly changed its own stance on capital controls, trade and investment treaties have further curtailed the countries’ ability to regulate capital flows. A recent study analysing more than 200 trade and investment agreements finds that the majority of those between advanced economies and EMDCs not only prohibit capital controls, but also allow private financial firms to challenge governments directly through dispute settlement bodies that tend to favour the firms. Worse, treaties outlawing capital flow regulation are fast becoming the norm, and cases against governments are on the rise.
At this month’s review, the IMF’s board should press for four reforms to the fund’s capital account policy. First, the IMF must clearly advise member countries to enact permanent regulations, allowing for the rapid deployment of CFMs during surges and sudden stops. Second, it must recommend that CFMs be part of a multipronged approach, rather than used only as a last resort. Third, the IMF should advocate reforms to trade and investment treaties to grant EMDCs more policy leeway for using CFMs. And, fourth, the IMF must set aside time to train its staff to implement these policies in a consistent and even-handed manner.
Given the possibility that interest rate hikes and Russia’s war in Ukraine will trigger massive capital flight and a global debt crisis, it is critical that the IMF embrace capital controls and the role they can play in helping member states mitigate financial instability. The world economy may well depend on it.
Given the possibility that interest rate hikes and Russia’s war in Ukraine will trigger massive capital flight and a global debt crisis, it is critical that the IMF embrace capital controls and the role they can play in helping member states mitigate financial instability.