NCPA - Daily Policy Digest - Controls on Foreign Capital Allow Rent-Seeking

NATIONAL CENTER FOR POLICY ANALYSIS
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Controls on Foreign Capital Allow Rent-Seeking

The most unloved market of all is the international capital market, in which money sloshes in and out of the United States, Thailand, Brazil and points in between. Critics say speculative "hot money" creates bubbles when it flows into unprepared countries, then pops the bubbles when it rushes out, leaving the local citizenry worse off than before.

Even many economists, generally a free-trade bunch, have some sympathy for capital controls in developing countries.

But economists Raghuram G. Rajan and Luigi Zingales argue that free flows of money across international borders keep a nation's capitalists and politicians honest. For example:

In the early 1980s, Japan's banks effectively forced Japanese companies to borrow from them at high rates by controlling a body that could deny the companies permission to issue bonds.

Once Japanese companies gained the ability to raise funds abroad, the bank-controlled "bond committee" lost its clout and was forced to disband.

Germany, they say, still suffers from a closed financial system in which "misleading investors is not an aberration but a tenet of policy."

Because insider capitalism is naturally conservative, its flaws are clearest in times of rapid change, the authors argue. In allocating capital to growing industries, a closed financial system simply can't compete with U.S.-style venture capitalists, who are willing to take chances on dozens of projects in hopes that one or two will pay off on a grand scale. Controls on the international flow of capital, even those imposed with the best of intentions, will inevitably choke off such dynamism, they contend.

Unfortunately, Rajan and Zingales fear that the pendulum of political support is swinging away from free markets and toward re-regulation, closed borders, and the triumph of entrenched elites.

Source: Peter Coy, "The Real Enemies of Free Markets," Business Week, March 10, 2003; based on Raghuram G. Rajan and Luigi Zingales, "Saving Capitalism From the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity" (New York: Crown Business, 2003).

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