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Scrapping capital controls: pro or anti poor?

Capital account liberalisation (CAL) or the removal of restrictions on the movement of capital across national boundaries, it is claimed, promotes growth and thereby helps the poor. But have the free-marketeers gathered credible evidence? Is scrapping capital controls in the interest of poorer countries and of poor people in those countries?

A study from the University of Oxford’s Queen Elizabeth House shows firstly that the growth benefits of CAL for poorer countries have not been demonstrated, and secondly that the effects on poverty are potentially costly.

A survey of research on the growth effects of CAL concludes that there is no systematic or convincing evidence of benefits. Positive results disappear once initial levels of financial development are accounted for, so that countries with less developed financial markets have little or nothing to gain. Foreign portfolio investment (FPI) goes primarily to middle-income states and has a generally negative impact on long-run growth whilst the impact of foreign direct investment (FDI) is ambiguous.

The paper also considers the channels through which CAL can influence poverty, and in which direction. On one hand, this occurs through changes in government finances, and on the other through changes in domestic industry.

Broadly, the conclusions include:

Liberalisation and the resulting volatility of private capital and official flows reduces developing country finances leading to spending cuts that hit the poor.
Increased macroeconomic instability reduces the employment capacity of developing countries and thus has negative impacts on poverty.

Specific findings regarding government finances are:

Management of capital inflows can be both expensive and destabilising for government finances. This reduces the level and stability (and hence effectiveness) of policy.
‘Market discipline’ also restricts governments’ fiscal policy, whether it is pro-poor or not.
Greater capital mobility reduces governments’ ability to tax capital income, and hence labour is relatively heavily penalised while overall expenditures may be cut back.

Specific findings regarding industry are:

The greater macroeconomic instability associated with CAL may actually reduce investment in industry and hence employment (and growth) prospects.
Sterilisation of capital inflows has meant that government issues dominate the bond market to the exclusion of all other issuers except the largest corporates.
Small and medium-sized enterprises (SMEs) often face stricter credit rationing in liberalised financial markets, despite being responsible for the majority of poorer countries’ employment.
Increased uncertainty about financing threatens the survival of SMEs, with knock-on effects for employment and poverty.

Recommendations include:

IFIs need to shed ideological blinkers and engage in macroeconomic analysis of the poverty impacts of CAL. It must be recognised that the burden of proof is still on the proponents of CAL.
Do potential positive effects of greater credit allocation to more efficient larger firms outweigh the employment costs of reduced credit to SMEs? This growth-poverty trade-off needs to be explored.
Research is needed on the extent of tax competition between countries, tax havens and other avoidance measures and their consequences for development.
Finally, the governments of lower- and middle-income countries need to retain the option of capital controls as part of the toolbox of pro-poor macroeconomic policymaking.

Source(s):
‘Capital account liberalisation and poverty’, Working Paper #70, Queen Elizabeth House, University of Oxford by Alexander Cobham, April 2001 Full document.

Funded by: Bretton Woods Project, Oxfam International

id21 Research Highlight: 26 September 2001

Further Information:
Alex Cobham
Queen Elizabeth House
21 St Giles
Oxford
UK

Tel: +44 1865 273635
Contact the contributor: alex.cobham@qeh.ox.ac.uk

Queen Elizabeth House (QEH), UK

Views expressed on these pages are not necessarily those of DFID, IDS, id21 or other contributing institutions. Unless stated otherwise articles may be copied or quoted without restriction, provided id21 and originating author(s) and institution(s) are acknowledged.

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