January 12, 2004

The Lost[?] Promise of International Capital Flows

Those of us card-carrying neoliberals who pushed for large-scale opening of capital flows in the early 1990s had a particular vision of the future in our minds' eyes--a vision of the future did not come to pass. We looked at how extraordinarily strongly the world's system of relative prices was tilted against the poor: how cheap were the products that they exported, and how expensive were the capital goods made in the post-industrial core that they needed to import in order to industrialize and develop. "Why not free up capital flows and so encourage large-scale lending from the rich to the poor?" we asked. Such large-scale lending might cut a generation off the time it would take economies where people were poor to converge to the industrial structures and living standards of countries where people were rich. Certainly such large-scale borrowing and lending had played a key role in the economic development of the late-nineteenth century temperate periphery--Canada, the western United States, Australia, New Zealand, Chile, Argentina, Uruguay, and South Africa--more than a century ago.

But the future we saw did not come to pass. Instead of capital flowing from rich to poor, it flowed from poor to rich--and overwhelmingly in recent years into the United States of America, whose rate of capital inflow is now the largest of any country, anytime, anywhere. Central banks that sought to keep the values of their home currencies down so that their workers could gain valuable experience in exporting manufactures to the post-industrial core, first-world investors who feared sending their money down the income and productivity gap after the crises of Mexico '95, East Asia '97, and Russia '98, techno-enthusiasts chasing the returns of the American technology boom, the third-world rich who thought a large Deutsche Bank account would be a good thing to have in case something went wrong and they suddenly had to flee the country in the rubber boat (or the Learjet)--all of these fueled the flow of money into the United States, which was thus enabled to invest much more than it managed to save. The U.S. economy became, and remains, a giant vacuum cleaner, soaking up all the world's spare investible cash.

And so those of us who still wish to be card-carrying flag-waving advocates for international capital mobility are reduced to two and only two arguments. First, and most important, capital controls create the setting for large-scale corruption. People who badly want to move their capital across borders can't--unless they can find some complaisant bureaucrat. A well-functioning market economy needs to minimize the incentives and opportunities for corruption or it will turn into something worse. Second, perhaps the inflow of capital into America was and is justified: perhaps there is something uniquely valuable about investments in America today. (But in that case, if these investment opportunities are so great, why aren't Americans themselves saving more--both privately and publicly--to take advantage of them?)

1960-85 was the era in which development was to be financed by public institutions like the World Bank because market failures and distrust of governments made it very hard for poor countries to borrow on the private market. 1985-2000 has been the era in which development was to be financed by private lending to countries that had adopted the market-friendly and market-conforming policies that were supposed to lead to high returns and rapid growth. The first era was not one of unqualified success. And looking at the reverse inflow of capital into the United States, I cannot say that the second era has been one of unqualified success either. It is very nice that Mexican workers and entrepreneurs are gaining experience in export manufactures, and exporting enough to the U.S. to run a trade surplus. But the flip side of the trade surplus is the capital outflow. Should capital-poor Mexico really be financing a further jump in the capital intensity of the U.S. economy?

It is not possible for a card-carrying neoliberal like me to wish for any but the most minor of controls to curb the most speculative of capital flows. Capital markets can get the allocation of investment badly wrong, but governments are likely to get it even worse, and the incentives to corrupt bureaucrats do need to be kept as low as possible. But the hope for a repetition of the late nineteenth-century experience, in which core investors' money gave peripheral economies the priceless gift of cutting decades off the time needed for successful economic development, has--so far--proved vain.

Posted by DeLong at January 12, 2004 11:58 PM | TrackBack

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