Emerging markets have fallen victim to unstable capital flows in the wake of the financial crisis. In an attempt to mitigate the accompanying asset bubbles and exchange rate pressures that come with such volatility, a number of emerging markets resorted to capital controls. Although these actions have largely been supported by the International Monetary Fund, some policy-makers and economists have decried capital controls as protectionist measures that can cause spillovers that unduly harm other nations.
Recently-published research shows that these claims are unfounded. According to the new welfare economics of capital controls, unstable capital flows to emerging markets can be viewed as negative externalities on recipient countries. Therefore regulations on cross-border capital flows are tools to correct for market failures that can make markets work better and enhance growth, not worsen it.
Growth in China, it is said, is slowing. GDP growth has reportedly fallen from 9.7 per cent in the first quarter of 2011, to 9.5 per cent in the second quarter, 9.1 per cent in the third and 8.9 per cent in the fourth. Much is being made of these numbers, though the 9.2 per cent average over 2011 is still high and the government has itself attempted to slow the system to rein in inflation.
One can sense an element of schadenfreude here. For too long now China has been showing up the rest of the world with its high rates of growth. This is especially true of the United States, which imports much from China, depends on inflows of capital from that country to finance its deficits, and is always looking for the next country to challenge its global supremacy.
However, if China’s growth is indeed slowing, this is no cause for even the US government to celebrate. A poorly performing China can drag the US down as well. Not just because China, with its large geographical size and population, is the growth pole that prevents the multi-speed global economy from sinking into another crisis. But because China is too important a market for the large multinational corporations that symbolise US economic power.
As members of the Eurozone are now acutely aware, the lack of a sovereign debt restructuring regime is one of the most glaring gaps in the international financial architecture. That said, this summer’s decision by a tribunal of the International Centre for Settlement of Investment Disputes (ICSID), which grants a bilateral investment treaty (BIT) jurisdiction over Argentina’s restructuring of its sovereign debt in the wake of its 2001 financial crisis, shows that a de-facto regime may be arising whereby international investment agreements (IIAs) can serve as a way for disgruntled investors to circumvent debt restructuring. This amounts to mission creep on the part of IIAs. Creeping into such territory is too much to take on for the world of IIAs. Sovereign debt restructuring should be left to national governments and international financial and monetary authorities.
The increasing global economic uncertainty and the prospects of a flight-to-quality, with money flowing out of developing towards developed countries, raise the question of how prepared developing countries are to protect their economies from external shocks in the coming year. But volatility of financial flows also means that, most probably, following capital flight driven by the eurozone crisis emerging markets will again experience a surge in speculative financial inflows. The threat of continued ‘boom and bust’ cycles and lack of responses from international forums like the G20 and the IMF to address global monetary chaos makes the need for central banks to take action even more urgent.
There is a welcome shift in Latin America as countries continue their slow process of acceptance and de-stigmatisation of capital account regulations. In September this year Costa Rica joined the group of countries using these regulations, when it established that short-term foreign loans received by banks and other financial entities will be subject to a holding deposit of 15% of the value of the investment.
The Indian government’s sudden decision to allow hitherto prohibited foreign direct investment in multi-brand retail as well as full ownership in single-brand retail generated huge public outcry, to the extent that the government was forced to pause. One important ally of the government, fearing for her own popularity in the state of West Bengal where she is currently Chief Minister, declared that the policy is temporarily “on hold”, to be greeted only awkward silence from the government. Finally the government was forced to announce that the policy is to be kept on hold until “consensus” is achieved, which certainly seems unlikely at present.
What this episode does show clearly is that this is a highly contentious and potentially very unpopular policy, and that politicians are now getting more aware of this. So despite the raucous support from corporatised media and more subtle but possibly more influential lobbying by big multinational business, this policy could not be easily forced down in the face of massive public outcry.
The G20 meeting in Cannes earlier this month was derailed by the pressing eurozone crisis. Actors were disappointed if they were looking for concrete action on global imbalances and the food crisis, let alone the new global monetary system that French President Nicolas Sarkozyboasted would be the goal of the summit when he first took the helm as host. But behind the scenes, the G20 actually delivered on a set of “coherent conclusions” on the management of speculative capital flows in emerging markets that should not be overlooked, especially by the International Monetary Fund (IMF).
Sarkozy assumed his role as head of the G20 during a period of excessive volatility in global capital markets that continues to this day. Because of loose monetary policy, low interest rates and a slow recovery in the North Atlantic, accompanied by high interest rates and rapid growth in emerging markets, the world’s investors flocked from north to south – to Brazil, Chile, South Korea, Taiwan and others. More recently, in response to eurozone jitters, capital has retreated from emerging markets to the “safety” of the United States – showing how dangerous speculative capital flows can be. New work released by the IMF this week suggests they are picking and choosing their direction from the G20.
During the early 1990s, many Latin American and U.S. analysts expressed concerns about an Asian giant that was buying Brazilian iron ore and investing in Mexican manufacturing, while at the same time showing signs of out-competing Latin American and U.S. firms in the region. That giant was Japan.
Hysteria heightened and academic research accumulated. But today few people worry about Japan’s role in the region—despite the fact that it is a top-five trading partner and has a large diaspora that includes Peru’s Alberto Fujimori, a former (now jailed) Latin American president.
Is history repeating itself? The new source of hand-wringing in the region is China, which, like Japan years earlier, is portrayed by many as stealing Latin American jobs, plundering the region’s resources and creating diplomatic alliances that could erode the rule of law. At the same time, some U.S. observers see China’s inroads as a threat in the U.S.’s backyard.
As the Eurozone crumbles before them, European leaders are begging for help to bailout Greece and create a facility to insure that the crisis doesn’t sweep through Italy, Spain, Portugal and beyond. For the last sixty years the United States would have been the nation to step up and lead with ideas and resources to the rescue. Sadly, the US is nowhere to be found: out of ideas and out of cash. In desperation, Europe has turned to the BRICs. Rather than direct bi-lateral payments, the Brics are starting to say that they prefer to channel their resources through the IMF. Brics shouldn’t let this crisis go to waste.