I am not sure I understand Kevin Drum's argument for capital controls. He seems to be arguing that these controls are a sort of financial speed limit and making an awkward analogy to highway speed limits to justify them.
In a world where I as a taxpayer have to bail out banks, I don't have a huge problem with capital requirements for banks, though this seemingly simply topic is rife with unintended consequences -- I have seen it argued persuasively that the pre-2008 Basil capital requirements helped fuel the housing bubble by giving special preference to MBS in computing capital. In fact, one might argue the same for the sovereign debt crisis, that by creating a huge demand for sovereign debt for bank balance sheets it fueled an unsustainable expansion in such debt.
Anyway, the point of this post was capital controls. Drum quotes this from an IMF report:
19. Indeed, as the recent global financial crisis has shown, large and volatile capital flows can pose risks even for countries that have long been open and drawn benefits from capital flows and that have highly developed financial markets. For example, in several advanced economies, financial supervision and regulation failed to prevent unsustainable asset bubbles and booms in domestic demand from developing that were partly fueled by cheap external financing. Rather than favoring closed capital accounts, these experiences highlight the need for policymakers to remain vigilant to the risks. In particular, there is a constant need for sound prudential frameworks to manage the risks that capital inflows can give rise to, which may be exacerbated by financial innovation.
The logic, then, is that bubbles are exacerbated by inflows of foreign capital so capital controls can keep bubbles from getting worse. I have very little knowledge of international finance, but let me test three thoughts I have on this:
- Doesn't this cut both ways? If bubbles can be inflated by capital inflows, can't they also be deflated by capital outflows? Presumably, if people domestically see the bubble, they would logically look for other places to invest their money. International investments outside of the overheated domestic market are a logical alternative, and such capital flows would act a s a safety valve to reduce pressure on the bubble. So wouldn't capital controls just as likely make bubbles worse, by confining capital within the bubble, as make them better by preventing new capital from outside the country flowing in?
- The implication here is that the controls would be dynamic. In other words, some smart person in government would close the gates when a bubble starts to build and open them at other times. But does that not presupposed the ability to see the bubble when one is in it? Certainly there were a few who pointed out the housing bubble before 2008, but few in power did so. And even if they had seen it, what is the likelihood that they would have pointed it out or taken action? Who wants to be the politician who pops the bubble? Remember the grief Greenspan got for pointing to an earlier bubble?
- Controls on capital inflows tend to be anti-consumer. Yeah, I know, no one in government ever seems to care when they pass protectionist laws that protect 100 tire workers at the cost of higher tires for 100 million drivers. But limiting capital inflows would reduce the value of the dollar, and make anything imported (or made from imported parts or materials) more expensive.