Vulnerability of Open Capital Flows: IMF and WB return to Ragnar Nurkse
According to the Washington consensus, open international capital flows were essential to developing countries in order to achieve cheap financing and efficient allocation of resources. In particular, the IMF and the World Bank were stalwart defenders of floating the exchange rate and letting the market forces determine the inflows and outflows of capital of a country.
Classical development economists, such as the Estonian Ragnar Nurkse, pointed out the fragility of relying on external financing as early as 1944 and paradoxically laid the basis for the founding of the Bretton Woods institutions (IMF and World Bank). With Bretton Woods came the managed flow of international capital, but which collapsed in 1968 and led to subsequent liberalization. In receiving aid and loans from the World Bank and IMF, developing countries were pressured to liberalize and open their economies to foreign investors.
After the Asian crisis of 1997, more attention was paid to fragility that arises when foreign investors withdraw capital and local currencies collapse. The problem is especially acute when locals have taken up loans denominated in foreign currencies, thus the depreciation causes their debts to sky-rocket. But it is first recently that mainstream economists have argued for letting developing countries control the capital inflows.
I find it very warming that both the IMF and World Bank seem to have changed tack, and returned to their more Nurksean / Keynesian roots. In this very interesting blogpost, Jamus Lim of the World Bank presents data that out of 189 major capital account liberalizations since 1970, at least 154 have led to a severe financial crisis! He concludes by quoting a recent IMF staff paper.
“Finally, the the selective use (PDF) of capital controls in a broad policy mix may be useful in helping moderate surges in portfolio inflows, especially when they are directed toward debt rather than equity. “
Striking words when coming from Washington indeed. More depressingly though, Estonia seems to have forgotten the lessons from its premier economist.