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The Myth of Financial Protectionism: The New (and old) Economics of Capital Controls

Kevin P. Gallagher
PERI Working Paper No. 278
January 2012
Download the working paper.

Unstable global capital flows to developing countries have been characteristic of the world economy in the wake of the global financial crisis. Such flows have triggered asset bubbles and exchange rate appreciation in a number of emerging and developing country markets, especially from 2009 until the Eurozone jitters in the fourth quarter of 2011. In response, some individual nations have deployed capital controls. Resorting to these measures has met a mixed response. On the one hand, institutions such as the International Monetary Fund have supported the use of controls in limited circumstances. On the other hand, there has been a vociferous response by leading politicians, distinguished economists, and in the blogosphere claiming that the use of capital controls amounts to financial protectionism.

This paper argues that such claims are unfounded. Specifically, the paper shows that:

1. There is a longstanding strand of modern economic theory that dates back to Keynes and Prebisch and continues to this day that sees the use of capital controls as essential to financial stability, the ability to deploy an independent monetary policy, and to maintain exchange rate stability.

2. The empirical record has shown that capital market liberalization was not associated with growth in developing countries.

3. In a most recent development, economists have developed a “new welfare economics” of capital controls that sees controls as measures to correct for market failures due to imperfect information, contagion, uncertainty and beyond.

Taken as a whole, rather than the “new protectionism,” capital controls should be seen as the “new correctionism” that re-justifies a tool that has long been recognized to promote stability and growth in developing countries.

Download the full paper: The Myth of Financial Protectionism: The New (and old) Economics of Capital Controls

Read an op-ed in the Financial Times based on this report, Capital controls are not beggar thy neighbour

Watch a video summary of this report from Global Policy TV:

Dr. Kevin Gallagher of Boston University On the New Economics of Capital Controls from GlobalPolicyTV on Vimeo.


Learn more about GDAE's work on capital flows.



The Global Development and Environment Institute’s Globalization and Sustainable Development Program examines the economic, social and environmental impacts of economic integration in developing countries, with a particular emphasis on the WTO and NAFTA's lessons for trade and development policy. The goal of the program is to identify policies and international agreements that foster sustainable development.

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