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18
The Obsolescence of Capital
Controls? Economic Management
in an Age of Global Markets
JOHN B.GOODMAN
AND LOUIS W.PAULYJohn Goodman and Louis Pauly explain why countries reduced
controls on capital flows from the late 1970s to the early 1990s
and why various countries did so at different times during this
period. Focusing on the international economy as the fundamental
cause of changes in government policy, Goodman and Pauly argue
that transformations in the structure of global production and
international financial markets made it both possible and desirable
for firms to successfully evade government controls. This made
government attempts to control capital movements more costly
and less effective, and governments eventually abandoned them.
Examining the cases of France, Germany, Japan, and Italy,
Goodman and Pauly conclude that the exact timing of the
abandonment of controls was a function of whether states were
experiencing capital inflows or outflows and, consequently, of
the costs of abandonment.The movement of capital across national borders has long raised sensitive political
questions. Whatever the benefits, international investment complicates national
economic management. Most research on this subject has focused on the causes
and consequences of foreign direct investment. Less studied, but no less important,
are short-term capital flows—those arising from the purchase or sale of financial
instruments with maturities of less than one year. In contrast to investments in
plant and equipment, short-term flows are highly sensitive to interest rate differentials
and exchange rate expectations. Indeed, the mere announcement of a change in
economic policy can trigger massive capital inflows or outflows, undermining the
anticipated benefits of the new policy. For this reason, most governments regularly
resorted to various types of controls on short-term capital movements in the decades
following World War II.
In recent years, however, the world has witnessed a remarkable shift away
from the use of capital controls. In country after country, governments have
abolished controls and dismantled the bureaucratic machinery used to administer