In my paper, I define the concept of capital controls, lay out its use throughout history, and provide case studies that proponents and opponents of capital controls point to in their respective argument. I will argue that the removal of capital controls has resulted in massive codependence in the global market and because of this codependency, financial crises such as the eurozone bailout of Greece have become more common. I will also argue that the removal of capital controls has impacted the European political field and has led to a new era of nationalism and “My Country First” attitudes.
In order to make my argument, it is important to establish a few critical definitions. First, “capital controls” are restrictions on the flow of money. Controls can include state restrictions on any of the following: withdrawing cash currency from banks, exchanging money from one currency to another, or selling domestic companies to foreign investors. Controls can also include the requirement of holding periods for overseas investments. Capital controls became an integral part of modern history as part of the Bretton Woods system after World War II and became a major tool used to rebuild the economic systems that collapsed as a cost of war. By the late 1970s into the 1980s, the idea that capital controls are more beneficial for economies than harmful gradually changed. Instead, “free market ideologies took hold. Increasing internationalization of commercial activity (for instance, in the form of multinational corporations) also militated against capital controls.” The demand to enter the global market also increased from a local level to a governmental level and “the desire on the part of the United States and the United Kingdom to be global financial centers, and that of European countries for greater regional integration, implied that barriers to capital movements had to be removed.”
Those in favor of capital controls often argue that these restrictions protect domestic economics and can help a stagnant or failing economy to grow, especially in times of massive crisis. One specific crisis that proponents of capital controls often point to is the Asian financial crisis of 1997-98. This crisis, which affected most of the fastest-growing economies of Asia such as Singapore, Malaysia, and Thailand, was due to a number of reasons. These reasons include: (1) competition from China in the form of cheap labor, especially after the Chinese currency weakened in 1994, (2) crony ties between politicians, banks, and businesses, and (3) policies viewed as optimistic, greedy, and wasteful. During this crisis, Malaysia took a different approach to mitigate itstheir losses than the other affected countries, such as Thailand and South Korea. “Instead of going to the [International Monetary Fund (IMF)], the Malaysian authorities imposed sweeping controls on capital-account transactions, fixed the exchange rate at [Malaysian Ringgit] RM3.80 per USD (a rate that represented a 10 percent appreciation relative to the level at which the ringgit had been trading immediately before the controls), cut interests rates, and embarked on a policy of reflation” on September 1st, 1998. The immediate reactions to Malaysia’s enforcement of capital controls was met with harsh criticisms, especially within the IMF. “An IMF spokesman was quoted as saying ‘the IMF believes that any restrictions imposed on the movement of capital (are) not conducive to building investor confidence.” Still, Malaysia was dedicated to regulating and then effectively banning offshore trading, mainly in fear that there was short-selling of the ringgit in international markets. By the anniversary of Malaysia’s installment of capital controls, interest rates were moderatly reducedrelatively lowered, the exchange rate was stabilized, and investors were still interested in the region. In finality of Malaysia’s transition to a secure economic market, “capital controls worked to revive demand not only because they allowed the government greater monetary and fiscal autonomy, but probably also because they enabled the return of a modicum of stability to financial markets.” Although this seems like an incredible economic bounceback without the use of a market bailout, many opposed to capital controls point to other cases in which markets were able to regroup with the use of these strict controls.
Those who argue against capital controls often argue that the removal of controls and the use of free market economics instead allows for more room for economic growth as global investment and trade has more room to be instituted. An example frequently used is that of Thailand, which also faced the Asian financial crisis in 1997-1998. Whereas Malaysia re-instituted capital controls to excel their economy, Thailand took the orthodox approach and took an IMF bailout of roughly $17.2 billion. This bailout was not without strings attached. In order to receive the money, Thailand had to promise to “float their exchange rates, raise interest rates, tighten fiscal policy (at least initially), and open up their financial markets to foreigners, close troubled banks and financial institutions, and undertake a range of other structural reforms.” While the these requirements seemed like an overwhelming task, Thailand invested their time and resources into this task and in one year after their bailout, the saw their GDP grow over 4 percent in 1999 after sitting at -10.2 at the height of the crisis. Furthermore, it was able to pay back the IMF loan two years before they were due. To critics of capital controls, this proves that capital controls are not necessary for a country to make significant improvements in their economy and can make it easier for countries to re-enter the global market as it furthers trusts with investors.
While both the Thailand case and the Malaysia cases are stark comparisons with one another, what both critics and advocates of capital controls can agree on is that the enforcement and removals of restrictions has been mostly based on political motive. “[John Maynard Keynes and Harry Dexter White] recognized that for most countries, capital mobility would undermine the ability of the government to pursue the demand management policies increasingly expected by the electorate, while also maintaining a fixed exchange rate and avoiding competitive devaluations.” I argue that the cycle of enforcing and removing the controls has gone hand-in-hand with the emergence of nationalism as a political tool. In favoring Eric Hobsbawm’s definition of nationalism in his groundbreaking book Nations and Nationalism since 1780, Nationalism is an ideology that the political and national units should coincide. He further argues that for a nationalist movement to be successful, the nation needs to be imagined, to be of a certain size, and to have a national economy to drive it. He argues, as I do throughout this paper, that the later is the main determining factor.
An area I will focus on for the rest of the paper will be that of Europe, who like Asia, saw a massive economic crash. The initial financial crisis of 2007 and 2008 can often be traced back to the deregulation of economic markets in the U.S., UK, and similar Western European nations in the 1970s and 1980s due to free market economics. When the world economy gave sectors the opportunity to have an open market for countries to deposit money into each others economies freely, “the effect was to liberalise credit (i.e. make it easier to borrow money) and effectively to fuel a massive expansion of personal debt, including mortgage debt.” Banks began to fear their own mortgage accounts would drop and were hesitant to lend any money. This created a huge problem with multi-market confidence. The final nail in the financial coffin began when large U.S. mortgage companies and banks, such as the Lehman Brother Bank began defaulting, and in response, “the U.S. Government declined to step in to save [them], in order to show markets that they could not and would not rescue every troubled financial institutions.” This soon affected Europe as they too had a stake in United States banks. The crisis that flowed into Europe would be known as the European debt crisis.
The European debt crisis, which has also been referred to as the European sovereign debt crisis or the eurozone crisis, was a crisis that took place in the European Union (EU) beginning in 2009. While the reasons for the initial crisis are global, the European sovereign debt crisis began when eurozone member states (such as Spain, Ireland, Portugal, Greece, and Italy) were unable to refinance or repay their government spending debt and were forced to be bailed out by the European Central Bank, the IMF, and the European Financial Stability Facility. While this money initially helped these countries stay afloat and kept their banks open, soon it was realized that Greece needed more than the initial bailout money it received and defaulted on its loan in 2015. According to Simone Foxman, of Business Insider, “this [hurt] economic growth not only in the euro area periphery but in core countries like Germany and France, which have kept their spending under control. While they are to blame for letting [Portugal, Ireland, Italy, Greece, and Spain] spend freely during the good years, not they’re angry.” Foxman’s statement highlights an important point. Whereas the failing of Greek banks has been detrimental to the Greek economy and its citizens, it also proves that there are risks associated with the volatility of capital flows of a free market. Co-dependence amongst markets can create massive problems and Greece’s bailout is only an aspect of it.
Before Greece’s banks defaulted, other countries invested in the country’s economy. For instance, Cyprus was one prime investor that had lent massive amounts of cash to Greece. When the Greek economy began to crash, Cyprus’s banks believed that a bailout would mean massive amounts of money would be pushed into Greece’s economy, so they picked up Greek government bonds. However, when the realization came that Greece was going to default on its debt, Cypriot banks took a dive and realized they owed more than they had. In fact, “they [owed] more money than the country’s GDP.” This had huge implications for Cyprus as they had were losing cash and loosing it quickly. Thus, they had to install capital controls to restrict cash from being withdrawn from banks, as a means to stabilize their economy. The initial crisis scared investors, who once had confidence in their bank security. Today, years later after the crisis and after their own bailout by the IMF, European Commission, and European Central Bank, Cyprus once again has a booming economy.
While it is important to note that domestic economies can turn around if they become impacted by another in the global market, the crisis has scared other countries in the EU as the risk of global dependency become more certain. The United Kingdom is a prime example. Even though the U.K. was affected by the global financial crisis of 2008, it did not have the same fate as Greece. It was still able to stay afloat due to the fact that UK has their own money, the British Pound, to print and regulate whereas Greece was tied down into the Euro. However, Britain was not immune from assisting eurozone’s depreciating nations and helping them from going completely belly up as fellow European Union members. As noted in a 2016 article, “The UK has provided a total of €6.5bn (£5bn) via the EU for two bailouts: €3bn for Ireland in November 2010 and €3.5bn for Portugal in May 2011.” In addition, “when the third Greek bailout was agreed, Greece was also given a short term bridging loan of €7bn from an EU-wide fund which can provide loans to any EU country in financial difficulty. The fund is financed by borrowing again the EU Budget. The UK would have been indirectly liable for around €855 million (£598m) of the loan through its share in the EU budget.” These numbers raised massive concerns for potential voters. Many voters believed the best cause of action would be to exit the European Union in fear that the next financial crisis could sink the United Kingdom next time, especially if they were tied down to the European Union. Those in favor of exiting the European Union began to favor a more solitary fiscal policy. British citizens were tired of feeling they needed to pick up the check when other EU countries’ spending was out of control and with the following of conservation backers, the Vote Leave campaign ignited a wave of support. This campaign argued that Britain lawmakers “should negotiate a new UK-EU deal based on free trade and friendly cooperation. We end the supremacy of EU law. We gain control. We stop sending £350 million every week to Brussels and instead spend it on our priorities, like the NHS and science research.” In many ways, this began the rhetoric of “My country first” that would further progress globally soon after the EU referendum in which the majority of Brits agreed it best to leave the EU, in what is now coined as “Brexit.” Brexit made the ultimate statement that free economic markets do not have to be the final solution for economies to survive and creating more restrictions can be a positive for a country.
Although it has not made the move to exit the European Union as did the UK, Germany is another country that has faced issues with Greece’s bailout demands. While the following quote from Bloomberg’s Editorial Board is lengthy in essence, I believe it states clearly the issue that is caused with free markets in which lending between countries can cause dependency:
“In the millions of words written about Europe’s debt crisis, Germany is typically cast as the responsible adult and Greece as the profligate child. Prudent Germany, the narrative goes, is loath to bail out freeloading Greece, which borrowed more than it could afford and now must suffer the consequences. Let’s begin with the observation that irresponsible borrowers can’t exist without irresponsible lenders. Germany’s banks were Greece’s enablers. Thanks partly to last regulation, German banks built up precarious exposures to Europe’s peripheral countries in the years before the crisis. By December 2009, according to the Bank for International Settlements, Germany banks had amassed claims of $704 billion on Greece, Ireland, Italy, Portugal, and Spain, much more than the German banks’ aggregate capital. In other words, they lent more than they could afford.”
The crisis was therefore in part to large amounts of lending in which both sides were unrealistic about their financial situation. Like the UK, Germany looked at the eurozone crisis as a threat to their economy. A politically party specifically concerned with Germany’s position in the European Union is Alternative for Germany (AfD). Alternative for Germany is a nationalist right-wing party that claimed 12.6% of the vote in the German federal elections of 2017, which equates to more than 90 seats. It was first founded in 2013 as a party that generally challenged the EU bailouts given to Greece and other neighboring countries and discussed reintroducing the Deutschmark. It’s policy against the euro is not unique in its call for all European countries to take back their sovereignty from being apart of the European Union. They argue “more powers must return to the nation states (…) opposing all ‘centralising’ moves in the EU, and anything that smacks of Euro-federalism.” Protectionism, which is the policy of protecting industries created domestically against foreign competition by means of controls such as subsidies and tariffs, is not a new idea. However, it is an unpopular one that has been making a return in political inquiry.
Will Gore of Independent.co.uk argues, “If Brexit was about taking back ‘control’ in a fairly broad sense, then Donald Trump’s victory in the US election sough to rescue ‘protectionism’ from the dictionary of failed economic policies. Both events are now placed at the heart of a broader push back against globalisation. Popular nationalist movements in France, Germany, Italy, and the Netherlands are all aiming to capitalise. Scepticism towards the eurozone, especially in Italy and France, is acute.” This argument points to the fact that there may be a domino effect in the way voters see their economy and further their nation and may vote in such a manner as they still reel from the economic troubles of the past. Furthermore, while the role in conservative, nationalist movements continue as we see in Germany’s Alternative for Germany party, so we see in France’s right-wing National Front, Dutch’s far-right Freedom Party, and the Freedom Party of Austria. These nationalist political parties foster this idea of protectionism and if doing so means leaving the global market or restricting their current place in the world economy, voters will play into “my country first” ideals that have begun to overly saturate European policies.
In conclusion, capital controls have created widespread debate since its creation after the Bretton Woods Conference post-World War II. It was created in a world in which countries, from the United States to every European nation, were focused on revitalizing their economy and focusing on their country rather than a global economic market. This changed, however, two decades later and a free market economy became the norm. Countries became excited at the notion that lending, borrowing, and investing could be done easily and with minimal restriction. The reality that money flows without restriction, however, led to the Asian financial crisis of 1997 and 1998, the global financial crisis in 2009 and further, the Greek bailout in 2015. The idea of protectionism gained momentum in the United Kingdom and due to the increasing conservative body put into power by concerned voters, a referendum to leave the European Union was called. While the vote to exit the EU surpassed that to stay by a small margin, it created a wave a global reactions. Many pro-free market economists believed that Brexit would create a massive issue for Britain’s economy as restrictions would scare off current and potential investors. On the other hand, economic protectionists believed that the move would save Britain from facing a collapsing economy and eurozone responsibility in the brink of another financial crisis. Today, similar European nations are considering their responsibility to protect their country from the risks of globalization. Germany’s Alternative for Germany party and the right-wing movements in the Netherlands, Austria, and France have begun to consider what they may need to give up in favor of staying in the European Union. These parties have garnered votes as they’ve expressed their need for more sovereignty and security in the uncertain global economy. This could mean a re-introduction of capital controls and restrictions that we haven’t seen in more than a half-century, for the sake of protection and the sake of the nation.