Pre-World War I Prior to the 19th century, there was generally little need for capital controls due to low levels of international trade and financial integration. In the First Age of Globalization, which is generally dated from 1870 to 1914, capital controls remained largely absent.
World War I to World War II: 1914–1945 Highly restrictive capital controls were introduced with the outbreak of
World War I. In the 1920s they were generally relaxed, only to be strengthened again in the wake of the 1929
Great Crash. This was more an
ad hoc response to potentially damaging flows rather than based on a change in normative economic theory. Economic historian
Barry Eichengreen has implied that the use of capital controls peaked during World War II, but the more general view is that the most wide-ranging implementation occurred after Bretton Woods. An example of capital control in the
interwar period was the
Reich Flight Tax, introduced in 1931 by German
Chancellor Heinrich Brüning. The tax was needed to limit the removal of capital from the country by wealthy residents. At the time,
Germany was suffering economic hardship due to the
Great Depression and the harsh
war reparations imposed after World War I. Following the ascension of the
Nazis to power in 1933, the tax was repurposed to confiscate money and property from
Jews fleeing the state-sponsored
antisemitism.
Bretton Woods era: 1945–1971 At the end of World War II, international capital was caged by the imposition of strong and wide-ranging capital controls as part of the newly created
Bretton Woods system—it was perceived that this would help protect the interests of ordinary people and the wider economy. These measures were popular as at this time the western public's view of international bankers was generally very low, blaming them for the
Great Depression.
John Maynard Keynes, one of the principal architects of the Bretton Woods system, envisaged capital controls as a permanent feature of the
international monetary system, though he had agreed
current account convertibility should be adopted once international conditions had stabilised sufficiently. This essentially meant that currencies were to be freely convertible for the purposes of international trade in goods and services but not for
capital account transactions. Most industrial economies relaxed their controls around 1958 to allow this to happen. The other leading architect of Bretton Woods, the American
Harry Dexter White, and his boss
Henry Morgenthau, were somewhat less radical than Keynes but still agreed on the need for permanent capital controls. In his closing address to the Bretton Woods conference, Morgenthau spoke of how the measures adopted would drive "the usurious money lenders from the temple of international finance". While many of the capital controls in this era were directed at international financiers and banks, some were directed at individual citizens. In the 1960s, British individuals were at one point
restricted from taking more than £50 with them out of the country for their foreign holidays. In their book
This Time Is Different (2009), economists
Carmen Reinhart and
Kenneth Rogoff suggest that the use of capital controls in this period, even more than its rapid economic growth, was responsible for the very low level of banking crises that occurred in the Bretton Woods era. According to Barry Eichengreen, capital controls were more effective in the 1940s and 1950s than they were subsequently.
Post-Bretton Woods era: 1971–2009 By the late 1970s, as part of the
displacement of Keynesianism in favour of
free-market orientated policies and theories, and the shift from the
social-liberal paradigm to
neoliberalism countries began abolishing their capital controls, starting between 1973 and 1974 with the US, Canada, Germany, and Switzerland, and followed by the United Kingdom in 1979. Most other advanced and emerging economies followed, chiefly in the 1980s and early 1990s. During the 1980s, many emerging economies decided or were coerced into following the advanced economies by abandoning their capital controls, though over 50 retained them at least partially. The orthodox view that capital controls are typically harmful was challenged following the
1997 Asian financial crisis. Asian nations that had retained their capital controls such as India and China credited them for allowing them to escape the crisis relatively unscathed.
Malaysia's prime minister
Mahathir Mohamad imposed capital controls as an emergency measure in September 1998, including both strict exchange controls and limits on outflows from
portfolio investments; these were found to be effective in containing the damage from the crisis. In the early 1990s, even some pro-
globalization economists like
Jagdish Bhagwati, and some writers in publications like
The Economist, spoke out in favor of a limited role for capital controls. However, even as many developing world economies lost faith in the free market consensus, it remained strong among Western nations. During the
2008–2011 Icelandic financial crisis, the IMF proposed that capital controls on outflows should be imposed by
Iceland, calling them "an essential feature of the monetary policy framework, given the scale of potential capital outflows". In the latter half of 2009, as the global economy started to recover from the
Great Recession, capital inflows to emerging market economies, especially, in Asia and Latin America, surged, raising macroeconomic and financial-stability risks. Several emerging market economies responded to these concerns by adopting capital controls or macroprudential measures;
Brazil imposed a tax on the purchase of financial assets by foreigners and
Taiwan restricted overseas investors from buying
time deposits. The partial return to favor of capital controls is linked to a wider emerging consensus among policy makers for the greater use of
macroprudential policy. According to economics journalist
Paul Mason, international agreement for the global adoption of Macro prudential policy was reached at the
2009 G20 Pittsburgh summit, an agreement which Mason said had seemed impossible at the
London summit which took place only a few months before. Pro-capital control statements by various prominent economists, together with an influential staff position note prepared by IMF economists in February 2010 (
Jonathan D. Ostry et al., 2010), and a follow-up note prepared in April 2011, In June 2010, the
Financial Times published several articles on the growing trend towards using capital controls. They noted influential voices from the
Asian Development Bank and the
World Bank had joined the IMF in advising there is a role for capital controls. The FT reported on the recent tightening of controls in
Indonesia,
South Korea,
Taiwan, Brazil, and Russia. In Indonesia, recently implemented controls include a one-month minimum holding period for certain securities. In South Korea, limits have been placed on currency forward positions. In Taiwan, the access that foreigner investors have to certain bank deposits has been restricted. The FT cautioned that imposing controls has a downside including the creation of possible future problems in attracting funds. By September 2010, emerging economies had experienced huge capital inflows resulting from
carry trades made attractive to market participants by the
expansionary monetary policies several large economies had undertaken over the previous two years as a response to the crisis. This has led to countries such as Brazil,
Mexico,
Peru,
Colombia, South Korea, Taiwan,
South Africa, Russia, and
Poland further reviewing the possibility of increasing their capital controls as a response. In October 2010, with reference to increased concern about capital flows and widespread talk of an imminent
currency war, financier
George Soros has suggested that capital controls are going to become much more widely used over the next few years. Several analysts have questioned whether controls will be effective for most countries, with
Chile's finance minister saying his country had no plans to use them. In February 2011, citing evidence from new IMF research (Jonathan D. Ostry et al., 2010) that restricting short-term capital inflows could lower financial-stability risks, There was strong counter lobbying by business and so far the US administration has not acted on the call, although some figures such as Treasury secretary
Tim Geithner have spoken out in support of capital controls at least in certain circumstances. Econometric analyses undertaken by the IMF, and other academic economists found that in general countries which deployed capital controls weathered the 2008 crisis better than comparable countries which did not. At the
2011 G-20 Cannes summit, the G20 agreed that developing countries should have even greater freedom to use capital controls than the IMF guidelines allow. A few weeks later, the
Bank of England published a paper where they broadly welcomed the G20's decision in favor of even greater use of capital controls, though they caution that compared to developing countries, advanced economies may find it harder to implement efficient controls. Not all momentum has been in favor of increased use of capital controls however. In December 2011, China partially loosened its controls on inbound capital flows, which the
Financial Times described as reflecting an ongoing desire by Chinese authorities for further liberalization. India also lifted some of its controls on inbound capital in early January 2012, drawing criticism from economist
Arvind Subramanian, who considers relaxing capital controls a good policy for China but not for India considering her different economic circumstances. In September 2012, Michael W. Klein of
Tufts University challenged the emergent consensus that short-term capital controls can be beneficial, publishing a preliminary study that found the measures used by countries like Brazil had been ineffective (at least up to 2010). Klein argues it was only countries with long term capital controls, such as China and India, that have enjoyed measurable protection from adverse capital flows. In the same month,
Ila Patnaik and
Ajay Shah of the
NIPFP published an article about the permanent and comprehensive capital controls in India, which seem to have been ineffective in achieving the goals of macroeconomic policy. Other studies have found that capital controls may lower financial stability risks, Capital controls may have externalities. Some empirical studies find that capital flows were diverted to other countries as capital controls were tightened in Brazil. An IMF staff discussion note (Jonathan D. Ostry et al., 2012) explores the multilateral consequences of capital controls, and the desirability of international cooperation to achieve globally efficient outcomes. It flags three issues of potential concern. First is the possibility that capital controls may be used as a substitute for warranted external adjustment, such as when inflow controls are used to sustain an undervalued currency. Second, the imposition of capital controls by one country may deflect some capital towards other recipient countries, exacerbating their inflow problem. Third, policies in source countries (including monetary policy) may exacerbate problems faced by capital-receiving countries if they increase the volume or riskiness of capital flows. The paper posits that if capital controls are justified from a national standpoint (in terms of reducing domestic distortions), then under a range of circumstances they should be pursued even if they give rise to cross-border spillovers. If policies in one country exacerbate existing distortions in other countries, and it is costly for other countries to respond, then multilateral coordination of unilateral policies is likely to be beneficial. Coordination may require borrowers to reduce inflow controls or an agreement with lenders to partially internalize the risks from excessively large or risky outflows. In December 2012, the IMF published a staff paper which further expanded on their recent support for the limited use of capital controls.
Impossible trinity trilemma The history of capital controls is sometimes discussed in relation to the
impossible trinity (trilemma, the unholy trinity), the finding that its impossible for a nation's economic policy to simultaneously deliver more than two of the following three desirable macroeconomic goals, namely a
fixed exchange rate, an independent
monetary policy, and free movement for capital (absence of capital controls). In the First Age of Globalization, governments largely chose to pursue a stable exchange rate while allowing freedom of movement for capital. The sacrifice was that their monetary policy was largely dictated by international conditions, not by the needs of the domestic economy. In the
Bretton Woods period, governments were free to have both generally stable exchange rates and independent monetary policies at the price of capital controls. The impossible trinity concept was especially influential during this era as a justification for capital controls. In the
Washington Consensus period, advanced economies generally chose to allow freedom of capital and to continue maintaining an independent monetary policy while accepting a
floating or semi-floating exchange rate. == Examples since 2013 ==