Capital Controls: Consequences of Financial Liberalisation

The issues of capital controls and financial crises have been widely debated in economic literature. Some economists argue that controls on capital are becoming difficult to maintain, especially in a liberalising financial system. Coy et al. (1998) argue that capital controls are unlikely to work well in a world moving toward financial liberalisation, as the controls will have a negative impact on the investment atmosphere. Cooper (1999) advocates the deregulation of capital controls as he believes that financial liberalisation aims to allow unrestricted movement of capital among free economies, and people should also be able to place their assets wherever they prefer. In other words, financial liberalisation aims at promoting comparative advantages and development by attracting foreign investment funds.

Capital controls may have different meanings to different people. Khor (1998) and Crotty and Epstein (1999) refer to capital controls as any policy designed to limit or redirect capital account transactions. Bakker (1996) defines it as any government measures to restrict or bar the sending of capital outside a country. Neely (1999) argues that these broad definitions suggest that it will be difficult to generalise about capital controls because they can take many forms and may be applied for various purposes. Edwards (1999) argues that the use of capital controls does not restrict only the export of capital but also includes a limit on incoming funds from foreign sources. In other words, he argues that capital controls imply prohibitions on the export of capital by either residents or non-residents as well as to a variety of controls on financial and investment processes applicable to residents and non-residents. In principle, we define capital controls as any policy or restriction prohibiting residents and non-residents from freely moving financial capital and investment into or out of a country. Examples of capital controls include outright prohibitions on certain types of foreign investment, quantitative restrictions on foreign ownership of domestic firms, limits or prohibitions on holdings by firms or individuals of foreign exchange-denominated assets, and requirements that capital entering the country must remain for a specified time.