Marc Venhaus | 6th April 2016

During the last six decades, the sovereign right of states to use capital controls (i.e., governmental regulation on the in- and outflow of money), has moved from an orthodox policy during the era of ‘embedded liberalism’ (1944-1973) to a punished heresy during the era of neoliberalism (1980-2008) and, partially, went back to orthodoxy again in the aftermath of the Global Financial Crisis (GFC), the era of post-neoliberalism (2008-?). However, whether sovereignty over global flows of capital will be revived in the long run still remains to be seen.

(Photo credit: Martin Terber | Flickr)

Era of Embedded Liberalism (1944-1973)

Under the impression of two devastating world wars and the Great Depression of the 1930s, representatives from 44 nations gathered in Bretton Woods, United States, in 1944 with the aim to set up a framework for a new monetary and financial global order. Strongly influenced by ideas of British economist John Maynard Keynes, the participating states not only decided to return to an open free trade system, but also agreed upon a central novelty: henceforth, governments would attain the sovereign right to regulate the in- and outflow of especially speculative money by means of capital controls, conducted under the observation of the International Monetary Fund (IMF) as a global umpire (Helleiner, 1995). This was a game-changing turn from heresy to orthodoxy, since the view that previously predominated was that fully liberalized capital markets were superior. As a result, ‘embedded liberalism’ (Ruggie, 1982) emerged as an statist-liberalist compromise that would tame destabilizing market forces and establish a prosperous and peaceful global economy. Today, the time of Bretton Woods (1944-1973) is often perceived as a ‘golden age of capitalism’ due to the fact that nations all over the world experienced relative economic stability and high growth-rates (Marglin & Schor, 1992). Yet, the system had a central flaw: the US, as the hegemonic state, right from the start seemed to be a little more sovereign than the rest of the states. Hence, in 1974, Washington single-handedly deconstructed the system after strong economic competitors had emerged and the established rules no longer were serving its interests (Helleiner, 1995). By abandoning capital controls and, subsequently, forcing other nations to follow suit, the US was able to play out its trump card: striving for capital markets.

Era of Neoliberalism (1980-2008)

After a short recalibration of the new rules of the game, neoliberalism emerged as a new paradigm around 1980 and was exported from the US (and Britain) to all corners of the world (Harvey, 2007). Not only were Keynesian ideas pushed aside as useless and inefficient, but it was also believed that capital controls were a harmful distortion of the free interplay of markets. So to say, they turned heretical again. Hence, a largely Anglo-Saxon mission began to fully batter down the sovereign right of states to control capital, conducted in the interest of finance and under the mantra of ‘one-size fits all’. With increasing exposure to global capital, countries were gradually transformed from economically sovereign into ‘competition states’ (Cerny, 1997). This implied that their independence to use macroeconomic policies became significantly constrained, as they had to prevent a sudden withdrawal of funds. At the same time, the world market became more volatile and inequality reached new heights as finance-led growth accelerated at the price of real economic growth (Eichengreen, 2008). It all culminated in 1997, when the IMF considered not only to delete, but also to delegitimize, the right for states to set up capital controls in its original Articles of Agreement (Chwieroth, 2009). This was also the year when the speculation-generated East Asian Crisis rocked the markets. The IMF, along with Washington, worsened the situation by demanding pro-capital concessions from the affected states (Wade & Veneroso, 1997). Yet, norm-deviant China, still holding onto capital controls, was mostly spared, Thus, new debates about the benefits of capital controls began to blossom. However, an even larger crisis had to come before the topic was fully back on the agenda.

Era of Post-Neoliberalism (2008-?)

In 2008, the GFC hit the neoliberal heartland itself and quickly spread out through unrestricted global capital markets, which now worked as a dangerous and destabilizing transmission belt for the catastrophe (Reinhart & Rogoff, 2011). The dire situation not only shattered the quasi-religious belief in efficient and self-equilibrating financial markets, but also opened a ‘window of opportunity’ for globally concerted sovereign state action in the form of (Neo-Keynesian) interventionism. Once again it was capital controls that helped China to dampen the occurring shock waves and sustain its growth momentum throughout the crisis, thereby gaining significant argumentative strength. Finally, even the US-prone IMF began to re-evaluate and destigmatize capital controls (Ostry et al., 2010) in view of new scientific evidence and under the applause of several leading scholars (Rodrik, 2010; Gallagher, 2010). Thus, capital controls officially returned as an optional part of the macroeconomic toolkit, for which reason states – at least theoretically – regained regulative room to maneuver (Grabel, 2013). Nonetheless, in an already largely financialized world economy, not many states applied them out of fear that investors would punish the pioneers. Accordingly, it still remains to be seen if capital controls have returned as a permanent – that is to say, orthodox – feature. Especially because a new global consensus is not yet in place, the pro-finance lobby is rallying its troops again. Furthermore, the US and many others largely continue to function under a slightly modified version of the hazardous pre-crisis rules (post-neoliberalism).

Conclusion

The devastating effects of the GFC have proven that the regulation of speculative capital can be both beneficial and stabilizing for states. Still, it has become highly problematic to put the financial genie back into the bottle, especially once it has been unleashed and strong vested interests have been created. Hence, the future will show whether states will be able to overcome collective action problems by reaching a new global consensus in regard to sovereign rules on regulating capital flows or whether the neoliberal Ungeist will return once more with full force – pushing back sovereignty as a defensive shield against speculation.

Bibliography:

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