Are capital controls applied the way they are supposed to be?

by on November 27, 2013 at 2:40 am in Economics | Permalink

It seems the answer is no, they are applied acyclically rather than pro-cyclically to calm down overheating economies.  Here is a new paper by Andrés FernándezAlessandro Rebucci, and Martín Uribe, “Are Capital Controls Prudential? An Empirical Investigation”:

A growing recent theoretical literature advocates the use of prudential capital control policy, that is, the tightening of restrictions on cross-border capital flows during booms and the relaxation thereof during recessions. We examine the behavior of capital controls in a large number of countries over the period 1995-2011. We find that capital controls are remarkably acyclical. Boom-bust episodes in output, the current account, or the real exchange rate are associated with virtually no movements in capital controls. These results are robust to decomposing boom-bust episodes along a number of dimensions, including the level of development, the level of external indebtedness, or the exchange-rate regime. We also document a near complete acyclicality of capital controls during the Great Contraction of 2007-2009.

This relates to what is perhaps the most frequent mistake in economic analysis.  Markets “as we find them” are compared to government policy “as it ought to be,” rather than “government policy as we find it.”  If you had nothing else to do, you could blog that error hundreds of times a day.

You also might wish to sample this 2011 IMF survey on capital controls, which relates the following: “A review of the literature shows that capital  controls (as distinct from prudential CFMs) have little effect on overall flows, although it appears that controls can change the composition of flows. In most cases, controls also have little effect on currency appreciation…A broader review of the experiences of 13 emerging market economies in the 2000s also does not provide unambiguous support for the effectiveness of capital controls and prudential measures.”

Wishing don’t make it so.

1 Max November 27, 2013 at 4:32 am

> Markets “as we find them” are compared to government policy “as it ought to be,” rather than “government policy as we > find it.” If you had nothing else to do, you could blog that error hundreds of times a day

The reverse is also true, you need look no futher than any health care discussion.

2 dan1111 November 27, 2013 at 5:09 am

It is true that every group tends to compare the idealized version of their vision with their opponents’ imperfect real-world policies. Conservatives are not immune from this.

However, it is quite debatable how much of the status quo in American healthcare was “markets” and how much was “government policy”.

3 Adrian Ratnapala November 27, 2013 at 6:15 am

You are right about people idealising their own preferences, but Tyler has fingered something additional. Many technical discussions take ‘Markets “as we find them” [and] government policy “as it ought to be,”’ not because of left-wing ideology but because it just makes sense to ask ‘if the market works like this, then what is the optimal solution’.

However, just because such questions are interesting, it doesn’t mean their answers can be applied directly to the real world. After all, flaws in government are also real, even if they are not relevant to every technocratic debate.

4 Floccina November 27, 2013 at 12:58 pm

The reverse is also true, you need look no further than any health care discussion.

People will say we spend more on health care and get worse results than the other industrialized countries therefore we should mimic them and socialize health care, but we spend more on education and get worse results and that is already socialized. If you socialized healthcare in the USA it is unlikely that life expectancy and healthcare spending will approach that of Italy.

5 Lord November 27, 2013 at 10:44 pm

Or markets as affected by government policy rather than government policy as affected by markets.

6 Rahul November 27, 2013 at 6:59 am

Very frequently I also see people argue using “markets as they ought to be” rather than the more messy reality of “markets as they are”.

7 dead serious November 27, 2013 at 7:17 am


8 Rich Berger November 27, 2013 at 8:22 am

Got some examples?

9 Michael November 27, 2013 at 9:13 am

Sure–every libertarian blog ever.

10 Tommy November 27, 2013 at 9:46 am

Two frequent examples from this blog: Online education and open borders.

11 dan1111 November 27, 2013 at 9:58 am

Can you please explain? I don’t see it.

12 Tommy November 27, 2013 at 10:08 am

The idealized free market (potential) advantages of each are compared to the current, highly regulated market. As explained in other comments on this post, I think it’s a ‘status quo’ vs. ‘solution’ thing.

13 dead serious November 27, 2013 at 11:50 am

Every government regulatory body would be eliminated tomorrow if Rs and libertarians had their way, the assumption being that “the market” would magically remedy instances of fraud, injury, etc.

Post-harm of course, but still. The market is a mystical, but always benevolent force.

14 Floccina November 27, 2013 at 1:02 pm

Interestingly the market for marijuana works pretty well with the only regulation being that it is banned.

15 Ray Lopez November 27, 2013 at 8:25 am

What is the market for lemons? Markets are path-dependent, meaning history plays a role. The sage advice about working hard so you can be kicked upstairs into management and the apocrypal sign on the desk of the French bureaucrat of “never do anything for the first time”, as well as the US Civil War maxim of success being “getting there firstest with the mostest” is based on the historical experience of: (1) innovation does NOT pay, and is risky, better to do nothing radical (also grounded some say in primitive tribal custom, where doing something for the first time was often fatal, better to stick to custom); (2) innovation comes naturally to youth, and later they can be rewarded by being promoted into management where they’ll make more money doing nothing, and (3) patent laws are weak therefore being a first mover is sufficient to win, even if you have to steal somebody else’s idea. I can easily imagine a better world than the one we have if you change these historical assumptions, but the heavy hand of history, as F. Braudel would say, weighs in.

16 Michael November 27, 2013 at 8:31 am

If they’re applied acyclically, sounds like they’re more reactive than proactive. Competent technocrats with sufficient authority and no political motivation would likely be the best answer to this problem.

17 dan1111 November 27, 2013 at 9:11 am

“Competent technocrats with sufficient authority and no political motivation”

Heh. Sounds like technocrats “as they ought to be” rather than technocrats “as you find them”.

18 Michael November 27, 2013 at 9:13 am

Fully agree–the technocrats we get aren’t the technocrats we deserve.

19 marris November 27, 2013 at 1:28 pm

“Competent technocrats with sufficient authority and no political motivation”

Actually, my research shows that an Easter Bunny and Santa Clause tag team is the best answer to this problem. Regression data to follow.

20 Matt November 27, 2013 at 1:41 pm

Agree. And Plato figured this out 2,000 years ago, but people have somehow yet to catch on.

21 Michael November 27, 2013 at 4:55 pm

The problem is everyone thinks they’re qualified to be a philosopher king…and really none of us are.

22 Rich Berger November 27, 2013 at 8:32 am

Markets have bad PR compared to our enlightened government. I think many people see the “market” as some extra-human force, which is the flip-side of the view that “society” is an entity with thoughts and capable of action aside from the individuals comprising it.

Markets are the result of many individuals buying and selling goods and services. It is always easy to find participants who are unhappy because the price was “too low” or “too high”, even if most participants were satisfied with the results. For example, how many times have we heard that Walmart drives mom & pop stores out of business? The reality is that Walmart attracted customers away from those stores due to better deals.

On the other hand, we see the so-called Patient Protection and Affordable Care Act causing chaos in insurance markets, despite its aspirational title. It is turning out to the be the Unaffordable and Unobtainable Care Act, despite the lies and deceptions used by Obama and backed up by a compliant media. The UUCA is a classic example of the top-down command economy, unresponsive to individual choice and liberty, brittle and inflexible. And the UUCA embodies the touching belief in experts which underlies most government actions.

Happy Thanksgiving all!

23 TGGP November 27, 2013 at 8:36 am

This suggests that empirical studies on the effects of capital controls would underestimate their potential benefits if they were correctly applied (however meaningful that is).

24 Ricardo November 27, 2013 at 9:21 am

Although I completely agree with Tyler’s criticism, we should consider an alternative hypothesis: we judge the status quo “as we find it” and any proposed alternative “as it ought to be.” Markets are still the status quo in many areas of American life, with non-market solutions the usual proposed alternatives. Perhaps in 100 years non-market solutions will be the status quo and we will be evaluating them “as we find them,” and we’ll contrast them to markets “as they ought to be.”

25 Philo November 27, 2013 at 10:11 am

“Markets ‘as we find them’ are compared to government policy ‘as it ought to be’, rather than ‘government policy as we find it’.” Markets are seen as congeries of decisionmakers. Governments are in fact similar congeries, but they are seen as unitary decisionmakers. Perhaps governments are a bit more like unitary decisionmakers than are markets, but not enough more to justify ignoring the Public Choice point of view.

26 kebko November 28, 2013 at 2:38 am

If markets today reflected what people thought they “ought to be”, I wouldn’t be able to trade futures contracts in Japan at 3am with this little touchscreen device I carry in my pocket, I wouldn’t be reading this blog post, I wouldn’t be able to send a Christmas present anywhere in the world on the 23rd of December and get it there in time.
Thank goodness markets didn’t just stop at what they “ought to be”. This is true now, more than ever.
What ought markets be doing in 20 years? I could come up with some ideas, but what I can say for certain is that markets, if they are left free to develop, will provide me with things I had never thought to say they ought to do.

27 Yuriy November 28, 2013 at 6:23 am

>This relates to what is perhaps the most frequent mistake in economic analysis. Markets “as we find them” are compared to government policy “as it ought to be,” rather than “government policy as we find it.”
Markets, like the reality, can’t be properly controlled – but the government policy (just as our own actions) could and, indeed, should be.
If all the economy is 100% descriptive (“how it is”), how should we get any idea on economic policy? While concerning any real decision (which, indeed, is mainly not a domain of academic economics), a policy body would appreciate both descriptive and normative (“what should be done about it”) findings. Fully descriptive economics may be interesting, but it’s then as socially useful as is fundamental physics in absence of engineering.
If I remember correctly, the first ever Marginal University course offered not only facts… and was therefore pretty useful.

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