What are ‘capital controls’?

Capital controls are limits on the amount of money that can be brought into (or out of) a country. We often talk about moving about stuff, and people, moving across borders – economics is full of debates about how to trade things between countries. But limits on moving money are often a little more under the radar. Partly, this is because there are now relatively few capital controls left in the world. Some countries, like China, still take them seriously, but for the most part, you can now take as much money as you want and invest it in another country the blink of an eye.

But this wasn’t always the case. After the Second World War most countries had pretty strict controls on who could take what money where. The idea was mainly to help keep tabs on the financial system: countries didn’t want their banks to take all their money and invest it into another (more profitable) country.

Today that’s mostly gone. In the 1970s and 1980s, capital controls became pretty unpopular, as more and more economists started thinking that free trade and fewer government restrictions were the best way to grow the world economy. In practice, new technology like computers also made capital controls a lot harder to enforce. International organizations like the International Monetary Fund played a big role in getting countries to lift their capital controls, so now you can take your life savings and invest in on the other side of the world and not think twice about it.

So, which system is better?

One argument against controls is that they keep money from going where it’s needed most. Without controls, investors have more choices of where best to put their money, and businesses, countries and entrepreneurs have more places where they can get funding. Capital controls can also be a big problem for poorer countries who would rely on savings from other countries to fund big investment projects that will help them develop. Those missing funds between what a country has and what it needs to grow is sometimes called the savings gap.

Capital controls can also be designed to affect how quickly money comes into a country. Economists talk about both long and short term capital flows. Long term flows are when money is invested in projects where it’s stuck for a number of years. Short term flows on the other hand can stay in the country for a matter of days, or even hours! These fast flows are also sometimes called hot money. Hot money is usually speculative, in the sense that traders are betting on short term changes in things like interest rates or exchange rates, rather than trying to invest in good business proposals.

Short flows can be a big problem, especially for developing economies. Big surges of foreign money coming into, and then leaving, a country creates a lot of instability. These flows have been linked to banking crises like the East Asian financial crisis in the late 1990s. Longer term flows have their critics too; they give foreigners more control over the local economy and a lot of times don’t do as much for development as people would like.

Still, many countries find themselves stuck in a bit of a dilemma. On one hand they need to attract foreign capital in order to finance new projects that will improve their economies. But on the other hand, keeping the doors open to capital flows can be risky, and isn’t even guaranteed to help with development.