Capital controls get nod, finally

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IMF'S CHANGE OF MIND: Malaysia's controversial financial measure during 1997 crisis gains credence

THE International Monetary Fund rarely has to own up to being wrong. With its enormous sway over crisis-hit countries desperate for help, the world's principal financial regulator has hardly needed to question its own prescriptions.

That is why the fund's change of mind over capital controls made headlines in business pages everywhere early last month. Bloomberg's coverage of the "institutional view" was typical.

"In a reversal of its historic support for unrestricted flows of money across borders, the Washington-based IMF said controls can be useful when countries have little room for economic policies such as lowering interest rates or when surging capital inflows threaten financial stability," it reported on Dec 4.

"The IMF has cemented a substantial ideological shift by accepting the use of direct controls to calm volatile cross-border capital flows, as employed by emerging market countries in recent years," said the Financial Times.

To those here who have been following the story, none of this was new. Malaysia, of course, famously refused IMF tutelage and used capital controls to stem the 1997 Asian financial crisis.

The government's role is a matter of record. During a visit to Kuala Lumpur last November, IMF managing director Christine Lagarde complimented her hosts for being "ahead of the curve in this area".

Indeed, the IMF began turning a blind eye soon after Malaysia's lead and has been writing thoughtful papers on financial flows in the last few years.

Many countries have since adopted controls of one form or another, if not to stop "hot money" from flooding in and out, then at least to limit its effects, such as in causing asset bubbles and exchange rate volatility.

So what took the IMF so long? The short answer is the sustained resistance of rich-country members in its board committed to the free market bias of the "Washington Consensus". (They are right in insisting that financial liberalisation can be beneficial. But the capital controls conceded by the IMF and exemplified by Malaysia are meant to be targeted and temporary, and called upon only to prevent or mitigate crisis.)

Brazil, in a dissenting opinion, said the IMF still put too much emphasis on capital flows and did not go far enough to free governments to restrain them.

The fund's laboured internal debate shows how difficult it is to reform, and overturn ideology and conventional wisdom in the process even when they are clearly inadequate to the task.

Then prime minister Tun Dr Mahathir Mohamad had to jump bureaucratic and political obstacles, and go beyond his usual circle of advisers to assemble the toolkit for the 1997 crisis.

Iceland had to go through a constitutional contest between president and Parliament, and a change in government, to take the emergency measures to save itself from utter ruin following the 2008 crisis. (Among them were capital controls. That they were resorted to by a wealthy, developed country surely had an influence in steering the fund's U-turn.)

A renowned critic of the IMF at the time was the Nobel laureate Paul Krugman, one of the precious few economists to support Malaysia's "heterodox" response.

"Until the Malaysian experiment, the prevailing view among pundits was that even if financial crises were driven by self-justifying panic, there was nothing governments could do to curb that panic except to reschedule bank debts -- part, but only part, of the pool of potential flight capital -- and otherwise try to restore confidence by making a conspicuous display of virtue," he said in an article for the online magazine Slate in September 1999.

That old imperative of "restoring confidence" is presently incarnated in the post-crisis mania for spending cuts and austerity programmes, the futility of which has given Krugman endless fodder since 2008.

In his New York Times column, reprinted in these pages last Tuesday, he praised the new Japanese government for returning to the Keynesian formula of pump-priming the economy, which is in its third recession in five years. Trying out austerity ended in disaster for the incumbent Democrat Party at last month's elections.

(Pity Greece. By belonging to the eurozone, it disqualifies itself from both economic stimulus and capital controls, and continues up the creek without either paddle.)

If Malaysia was the experiment for capital controls and creative solutions to crisis, then the most keenly watched laboratory of austerity is the United Kingdom (rather than, say, Ireland, which does not have much of a choice, or Latvia, which has demonstrated an astonishing capacity to take the pain).

Writing on economic performance at the mid-point of the Conservative-Liberal Democrat government, John Lanchester had a terse heading for his contribution to the London Review of Books last month: "Let's call it failure."

"As (Chancellor of the Exchequer) George Osborne's autumn statement made clear, the scale and speed and completeness with which things are going wrong are numbing," he said.

"A simple economic stock-take of the coalition's first two-and-a-half years in office would not look very impressive at all," pronounced BBC economics editor Stephanie Flanders on Jan 7.

In its latest Global Economic Prospects last week, the World Bank sounded only slightly less downbeat than it has since 2008, forecasting another bad year for developed countries in 2013.

Because reform is so hard and its opponents so numerous, Malaysia will have a sterling report card to take to the World Economic Forum in Switzerland this week. Since becoming prime minister in 2009, Datuk Seri Najib Razak has initiated one of the most intensive phases of socio-economic transformation in the country's history -- all with a reduced majority in the Dewan Rakyat, and an especially noisy and unyielding opposition.

Malaysia is again in the vanguard. The World Bank stressed that developing countries must start to reform towards sustainable growth and could no longer rely on short-term reactions to depression and crisis in the West.

Lead author Andrew Burns said at the report's release in Washington that the global crisis had sidetracked developing countries from "long-term growth-enhancing reforms that are so necessary".

Hans Timmer, director of the development prospects group at the World Bank, was more direct. "If you don't go back to the reform agenda, you don't have that growth in the future."


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