What are capital controls? Definition and meaning

Capital controls are measures taken by a country’s authorities to limit how much capital (money) flows in and out. Measures are usually taken by the government or the nation’s central bank, and may include tariffs, volume restrictions, as well as outright legislation.

Developing countries, which generally have lower capital reserves and are more susceptible to volatility, tend to have more capital controls compared to the advanced economies.

However, controls may be imposed directly or indirectly by rich countries. Canada, for example, has often been unwilling to allow its natural resources companies to be acquired by Chinese investors.

Leaders often forget that their citizens will always find a way of doing what they want (through the black market).

Some controls have a minimum-stay requirement, i.e. money invested has to stay in the country for at least a specific period. This occurred in Chile at the end of the last century.

Capital controls can affect the value of a currency, the availability of imported raw materials and finished products, as well as equities and bonds. Even the availability of locally-made products can be affected if access to foreign currency to buy some necessary parts is restricted.

Types of capital control may include limits on how much money a citizen is allowed to take abroad, exchange controls that restrict (or even completely prevent) the purchase and sale of a national currency at the market rate, and limits on financial assets sales to foreign entities. Financial assets are intangible assets such as stocks, bonds and bank deposits.

Even critics of capital controls sometimes backtrack

Most leaders of democratic nations are critical of capital controls, saying they do more harm than good.

However, these apparent commitments to free market principles often melt away when a financial crisis hits, as occurred with the Latin American debt crisis in the early 1980s, the Russian ruble crisis of 1998/99, the East Asian financial meltdown of the late 1990s, and the global financial crisis of 2007/8 and Great Recession that followed.

Europe has seen three instances of capital controls since 2008, one in Iceland in 2008, the Republic of Cyprus (2013-2015), and Greece (2015).

Arguments for capital controls

  • – Global economic growth was much higher after WWI, during the Bretton Woods period, when controls were widely used in most of the world. When free capital movement became more widespread after the 1970s, global growth slowed down.
  • – Domestic credit is available more cheaply when residents’ ownership of foreign assets is limited.
  • – Since WWII, economic crises have been significantly more frequent during periods of free capital movement than when capital controls were common worldwide.
  • – Even economic historians who are against capital controls have acknowledged that they have helped reduce the frequency of crises.
  • – Free capital movement contributes to boom & bust cycles which undermine a country’s economic growth prospects.

Arguments against capital controls

  • – Free capital movement allows savings to be channeled to their most productive use.
  • – Controls deprive developing economies of foreign investments and expertise.
  • – In a freer system, governments and corporations can raise funds from overseas markets to help them cope more effectively with a temporary recession.
  • – When controls exist, both borrowers and savers are unable to get the best available market rate.
  • – When controls include taxes, the money raised is often stolen by corrupt government officials for their own personal use.
  • – When controls are imposed, black market activity grows considerably. Often, the black market exchange rate becomes the ‘official rate’ because nobody trusts government figures and policy. This has occurred in Venezuela, where local and international media quote the black market rate for the Bolivar (its currency).
  • – Many economists say controls are really an excuse to postpone reforms.