FT.com / Comment & analysis / Comment - We must curb international flows of capital
Dani Rodrik and Arvind Subramaniam have a very strange post at the Economists Forum in which they compare regulating capital flows to gun control:
If the risk-taking behaviour of financial intermediaries cannot be regulated perfectly, we need to find ways of reducing the volume of transactions. Otherwise we commit the same fallacy as gun control opponents who argue that “guns do not kill people, people do”. As we are unable to regulate fully the behaviour of gun owners, we have no choice but to restrict the circulation of guns more directly.
Naturally, this rests on the assumption that it is easier to control guns than to control behavior. I'd say that's rather in dispute. But I suppose it does make a good metaphor for the rest of the article, as they go on to point at the various hiccups in global capital markets, and urge us to staunch the flow of international capital:
What this means is that financial capital should be flowing across borders in smaller quantities, so that finance is “primarily national”, as John Maynard Keynes advised. If downhill and uphill flows are both problematic, capital flows should be more level.
Having noted that governments find it hard to manage international capital flows, they go on to recommend an even more unlikely international regulatory regime:
First, some variant of petrol tax in the main oil-importing countries (including the US, China and India) is essential to cut demand and reduce oil prices and hence the current account surpluses of oil exporters. That such measures should be taken for environmental reasons or that they would reduce the size of sovereign wealth funds only adds to their attractiveness. Second, some appreciation of east Asian currencies is necessary to reduce their surpluses. Even though undervaluation is a potent instrument for promoting growth in low-income countries in general, at this juncture self-interest on both sides calls for an orderly unwinding of current account imbalances.
This appreciation can be achieved either unilaterally or, if necessary, multilaterally through the World Trade Organisation, as a recent Peterson Institute paper has proposed.
Measures needed for when capital flows downhill are likely to take a different form. When appetite for emerging market debt is strong, neither prudential regulation nor macroeconomic policies does much to stem capital inflows. Developing nations need to rely on a broader set of instruments, targeting the capital account directly. Deposit requirements on capital inflows and financial transaction taxes are some of the tools available.
To really cut down on OPEC surpluses, that oil tax would have to cover most of the world--otherwise, the supplies will just flow elsewhere, reducing the OPEC curent account surpluses, but probably not enough to bring them into balance. It would also have to be very, very high--you may have noticed that $100 a barrel oil has had a surprisingly modest impact on American consumption. Not to mention, every time anyone even talks about raising the gas tax by even a tiny amount, Americans scream like Edith Piaf being vivisected. That's when politicians try to sell the tax on relatively popular grounds, like environmentalism or energy independence. Can you imagine a congressman trying to explain that we need a $2.00 a gallon oil tax in order to balance out international capital flows?
Given the chaos at the WTO, I am, to say the least, skeptical that it will be able to pull off a complicated revaluation of Asian currencies. Presumably, the east Asians will have something to say about all this.
And given the history of capital controls in the developing world, I'm pretty reluctant to urge more of them. Yes, Chile and Malaysia and a handful of other countries managed them all right. In most places, they are badly implemented--or well implemented, from the perspective of a rent-seeking bureaucrat.
Proposals like this might well work if the world were run by the Harvard economics department. Unfortunately, they're all busy being the Harvard economics department, and so the world is being run by politicians instead.