Executive summaryCapital controls are restrictions made on the in and out movement of capital across the boarders of a country and they take different forms. The report provides the merits of using capital controls for the emerging markets as well as developing economies. A focus has been given on the current state of capital movement freedom in Chile, China, Malaysia, Taiwan and Russia. In the report, potential costs and benefits associated with the use of capital controls are described. In addition, evaluation of the empirical literature on the impact of applying capital controls is made. IntroductionCapital controls take a variety of forms such as quantity-based, price-based or a sole focus on capital movement into and out of the country.
Such restrictions can as well be directed at distinctive forms of capital flows, for instance, at bank loans, portfolio investment and foreign direct investment or at differentiated actors that comprise of governments, banks, companies and individuals. A number of developed countries consider the benefits achieved as a result of free movement of capital across the borders of a country offset the costs and thus, the countries have limited capital control put in place.
However, this is not the case with emerging markets or developing countries where a long-standing debate on the need to have capital control has been observed (Günther 2010). The reports provides the benefits and costs of the capital controls, empirical evidence on the use of capital controls with a focus on the current state of capital movement freedom in Chile, China, Malaysia, Taiwan and Russia. BodyBenefits and costs of using capital controlsMost economists argue that trade in assets or the capital flows contributes substantially to the economic development of a county by enabling the residents to effectively capitalize on the differences.
According to Eichengreen (2003) capital flows allows nations to involve in today’s trade consumption for future consumption to engage them in the inter-temporal trade. Capital inflows provide financial benefits in terms of high-return investment. This in turn contributes to high growth rates. Furthermore, capital inflows when implemented in terms of direct investment contribute to improved technology, management roles as well as access to global networks that entirely raise economic growth and development of a country.
On the other hand, capital outflows enable domestic citizens and organizations to achieve higher return and diversify risk. This reduces the consumption and income volatility rate within the country (Eichengreen 2003). This implies that free movement of capital in and out of the country fosters market discipline, and thus promotes efficient allocation of resources and increased productivity. Therefore, implementation of the capital controls limits a country from achieving such multifaceted benefits. However, free inflow and outflow of capital across the borders of a country involves costs.
This means that countries that depend more foreign financing become vulnerable to the sudden stops within the capital inflows which in turns leads to financial crisis or increased currency depreciations. In addition, free movement of capital complicates the capability of a country to practice its own monetary policy, particularly where fixed exchange rate is involved. Inefficient investment of capital inflows as a result of market distortions leads to overinvestment that creates extra challenges. It is quite clear that capital controls are potential measures to reduce such costs caused by free movement of capital (Günther 2010).