The Economics Profession, the IMF, and the New Pragmatism on Capital Controls
Today IMF staff economists and leading academic economists have taken steps toward elaborating a theoretical and empirical case for capital controls.
Neoclassical Economics and Capital Controls
Two views on capital controls have predominated among academic economists who advocate neoliberalism. The first, and minority view, is associated with libertarian thought. From the libertarian perspective, controls are a violation of investor rights. The case against them is therefore impervious to new empirical evidence or a change in economic conditions. In contrast, neoclassical welfarist critics have long held that capital controls are counterproductive.
The neoliberal case against capital controls seems to have lost some of its luster during the global crisis, though some ardent defenders have been left standing. For instance, in a discussion of inflow controls, Mexico’s Central Bank Governor Carstens said: “[C]apital controls ... don’t work, I wouldn’t use them, I wouldn’t recommend them” (Carstens 2015). In the same speech he indicted outflow controls: “when investors come in [to a new country] they first look to see where the exit is and if it doesn’t exist, they won’t come in.” 1 3 Some neoliberals (as we have seen earlier) have rebuked the IMF for its support of capital controls in Brazil and Iceland, and others, such as Cline (2010), have rebuked the IMF for its new acceptance of controls. The conservative US think tank, the Heritage Foundation, has been sharply critical of the IMF’s recent acceptance of capital controls, and in an issue brief highlights with horror a 2012 speech made by the IMF’s Lagarde in praise of Malaysia’s 1998 controls (Olson and Kim 2013). 
Despite this notable camp of holdouts, we find evidence within neoclassical thought of a new pragmatism as concerns capital controls. Prior to the global crisis, neoclassical economists almost universally held that controls were costly interventions in the market because they raise the cost of capital, especially for small and medium-sized firms, and generate costly evasion strategies (Forbes 2005; Edwards 1999). Capital controls were therefore imprudent since developing countries could hardly afford new sources of inefficiency and distributional disparities.
Recent research in neoclassical economics challenges the critique by emphasizing the negative externalities associated with highly liberalized international financial flows, particularly in the absence of international coordination of monetary policies. The research has helped to legitimize capital controls, particularly targeted, temporary controls, and some of this research also offers support for international policy coordination and/or regulations on capital flows in both source and recipient countries.
There are three dimensions to the new academic research. The first strand is associated with the work of Korinek (2011), and is termed the “new welfare economics of capital controls.” It assumes that in an environment of uncertainty, imperfect information and volatility, unstable capital flows have negative externalities on recipient economies (see also, Aizenman 2009). In this approach liberalized short-term capital flows are recognized to induce ambient risk that can destabilize economies. Inflow controls induce borrowers to internalize the externalities of risky capital flows, and thereby promote macroeconomic stability and enhance welfare (Korinek 2011).
A second strand of research, associated with Korinek (2011, 2014) and Rey (2014, 2015), emphasizes the way in which capital controls protect developing countries from the international spillover effects of monetary policy in wealthy countries, and it explicitly takes up the absence of multilateral mechanisms to coordinate monetary, capital control, and other prudential policies. Research by Korinek and Rey provides rigorous academic support for the claims of Brazil’s Mantega and India’s Rajan (among others) regarding currency wars and spillover effects. An article in the Economist put the connection between these spillover effects and capital controls quite clearly: “QE has helped to make capital controls intellectually respectable again” (Economist 2013).
Korinek (2013) argues that the negative international spillover effects of expansionary monetary policy during the global crisis highlights the need for multilateral coordination. An IMF Staff Discussion Note (in which Korinek is one of the authors) extends these themes (Ostry et al. 2012). The report argues that the coordination of capital controls between source and recipient is welfare improving since the costs of controls increase at an increasing rate with the intensity of controls. Thus, a more efficient outcome is to spread the costs of controls across countries so that no one country shoulders all of the costs. In a similar vein, using data from 1995 to 2012, Ghosh et al. (2014) find that imposing capital controls on both source and recipient countries can achieve a larger decrease in the volume of flows, or the same decrease with less intrusive measures on either end. Thus, international coordination achieves globally more efficient outcomes, and what they term costly ‘capital control wars’ can be avoided.
Rey’s (2014, 2015) work is also motivated by the unwelcome international spillover effects of wealthy country monetary policy. These spillover effects necessitate use of targeted capital controls on inflows and outflows, particularly since she sees international coordination on monetary policy spillovers as being “out of reach.” Capital controls are necessary to protect developing countries from what she terms the ‘global financial cycle,’ i.e., the instability triggered by large, sudden inflows associated with carry trade activity and their equally sudden exit (ibid). In a lecture at the IMF, former Federal Reserve Chair Bernanke criticized Rey and Mantega by name for being too willing to portray policymakers in developing countries as “passive objects of the effects of Fed policy decisions” (Bernanke 2015, especially pp. 24, 30, 33, 36, 44), and argued that international cooperation on monetary policy was neither necessary nor appropriate. Bernanke (ibid.) endorsed the use of targeted capital controls to tackle the unwelcome international spillover effects of monetary policy, though he also noted the importance of regulatory and other macroprudential measures.
Other neoclassical economists have wrestled with the international spillover effects of monetary policy and capital controls during the crisis.
Nobel Laureate Michael Spence wrote of the troubling ‘financial protectionism’ that was occasioned by expansionary monetary policy in rich countries. He (and his co-author) worried that such financial protectionism would accelerate as the era of cheap capital came to a close (Dobbs and Spence 2011). But despite characterizing controls as financial protectionism, Spence spoke favorably about their utility in developing countries during a 2010 speech at the Reserve Bank of India. There he called capital controls on such flows “essential as part of the process of maintaining control” in developing countries, and also noted that most of the high growth developing countries have had capital controls (Spence 2010).
A third strand of new neoclassical research is empirical and substantiates the theoretical claims of the welfarist approach. Ghosh and Qureshi (2016) review a large body of empirical evidence that shows that inflow controls change the composition of capital inflows and do not discourage investors. Even Forbes, a long-standing critic of controls, finds that Brazilian taxes on foreign purchases of fixed-income assets between 2006 and 2011 achieved one of its key goals of reducing the purchase of Brazilian bonds (Forbes et al. 2011). Another type of empirical work involves ‘meta analysis’ of a large volume of existing studies. Magud and Reinhart (2006) find that inflow controls enhanced monetary policy independence, altered the composition of inflows, reduced real exchange rate pressures, and did not reduce the aggregate volume of net inflows. (See also the survey in Magud et al. 2011, which includes studies conducted in the early years of the global crisis.)
Empirical research by economists outside the profession’s mainstream reaches beyond the tepid, conditional endorsement of capital controls that we find in the recent work of neoclassical economists (e.g., Epstein 2012; Erten and Ocampo 2013; Gallagher 2014; Grabel 2015b). Erten and Ocampo (2013) provide what is perhaps the most expansive support for the achievements of a range of capital controls, including those on outflows. Using data from 51 emerging and developing economies from 1995 to 2011, they find that capital controls that target inflows, outflows, and foreign exchange-related measures were associated with lower foreign exchange pressures, and reduced exchange rate appreciation. They also find that these three types of measures enhanced monetary policy autonomy, that increasing their restrictiveness in the run-up to the global crisis reduced the growth decline during the crisis (and thereby enhanced crisis resilience), and that countries that used these measures experienced less overheating during post-crisis recovery when a new surge in capital inflows occurred.
-  Recall that (as earlier noted) Carstens (2015) spoke more catholically about controls in January2016.
-  Adair Turner, former chair of the UK’s Financial Services Authority, takes note of the enduringresilience of the liberalization ideal despite empirical evidence (Turner 2014). Ghosh and Qureshi(2016) root the demonization of inflow controls in a guilt by association’ with outflow controls.They endorse the former, whereas they distance themselves from the latter, which they see as broadbased and difficult to reverse.