This blog post was originally published in Triple Crisis.
While doing some archaeological digging into old treaties, I discovered that the Reagan revolutionaries were relative softies on at least one issue — government meddling in capital markets.
The vast majority of the 52 existing U.S. trade agreements and bilateral investment treaties forbid governments from putting controls on capital flows. But buried in the annexes to four Reagan-era treaties, I found exemptions allowing trade partners to apply such controls during financial crises. Capital controls are various measures including (gasp!) taxes designed to prevent speculative bubbles or rapid capital flight.
Tea Partiers should give Obama credit for adhering more strictly to free market orthodoxy on this issue. His officials have made clear they are pushing for a ban on these crisis prevention tools in the Trans-Pacific Partnership (TPP), the first trade deal to be negotiated under Obama’s watch. The eighth round of these nine-party talks is set for September 6-15 in Chicago.
Earlier this year, more than 250 economists sent a letter to the administration urging a re-think. “Given the severity of the global financial crisis and its aftermath, nations will need all the possible tools at their disposal to prevent and mitigate financial crises,” they wrote. Treasury Secretary Timothy Geithner responded by arguing that this was unnecessary because governments could find other ways to deal with volatility. USTR spokeswoman Carol Guthrie confirmed in a Bloomberg interview that U.S. negotiators expect to push for open capital-transfer rules in the Trans-Pacific Partnership negotiations.
That rigid position places the Obama administration to the right not only of Reagan, but also both Bush presidencies and the International Monetary Fund.
After decades of blanket opposition, the IMF now endorses capital controls on inflows of speculative capital under certain circumstances. They have recommended outflows controls in a number of countries facing capital flight, such as Iceland and Ukraine. And they have been even more broadly supportive of emerging market countries that are using controls on inflows to prevent speculative bubbles.
In Brazil, for example, where hot money has driven up the value of the real, the government has imposed a one percent tax on currency derivatives and a six percent tax on foreigners’ purchases of bonds. On August 3, the IMF executive board described the country’s use of capital controls as an “appropriate” tool to manage foreign investment inflows.
A recent IMF report on one of the countries that received a Reagan exception — Bangladesh — credits capital controls with preventing the “global flight to safety” that left so many poor economies in shambles after the crisis erupted in 2008. Bangladesh instead doubled its central bank reserves during that period.
Reagan also allowed crisis-time exceptions in investment treaties with Turkey and Egypt, while a 1985 trade agreement with Israel has no restrictions whatsoever. All three have used these policies in the face of financial volatility.
President George H.W. Bush was no fan of capital controls, but he did allow limited exceptions in the North American Free Trade Agreement and bilateral investment treaties with Sri Lanka and Tunisia. His son’s administration beat back attempts by Singapore and Chile to obtain similar waivers, but softened its stance with South Korea, a country scarred by uncontrolled capital flight in the late-1990s crisis.
Aside from the handful of exceptions, 44 U.S. agreements prohibit capital controls even during a financial collapse. According to the IMF, these deals are outliers. The global norm is to “provide temporary safeguards on capital inflows and outflows to prevent or mitigate financial crises, or defer that matter to the host country’s legislation.” Indeed, as I’ve detailed in this new study, other TPP countries’ existing agreements include broad safeguards.
What can happen without such safeguards? Global corporations and financiers have the power to sue governments that resort to capital controls and demand compensation, even as a nation is reeling from severe economic catastrophe. That’s something Federal Reserve Board member Daniel Tarullo has described as not only “bad financial policy and bad trade policy,” but also “bad foreign policy.”
And yet the Business Roundtable, U.S. Chamber of Commerce, Financial Services Roundtable, and 14 other business groups have called on the administration to reject proposals to permit capital controls under trade agreements.
Thus, while Obama might seem lonely standing so far out on the anti-regulation end of the spectrum on this issue, if he sticks to his guns, he’ll have lots of admirers on Wall Street and in the executive suites.
Sarah Anderson directs the Global Economy Project at the Institute for Policy Studies and served on the Investment Subcommittee of the U.S. State Department’s Advisory Committee on International Economic Policy in 2009.