Kevin Gallagher: Emerging Markets and the Reregulation of Cross-Border Finance

Since the revival of global capital markets in the 1960s, cross-border capital flows have increased by orders of magnitude, so much so that international asset positions now outstrip global economic output. Most cross-border capital flows occur among industrialized nations, but emerging markets are increasing participants in the globalization of capital flows.

While it is widely recognized that investment is an important ingredient for economic growth, and that capital flows may under certain conditions be a valuable supplement to domestic savings for financing such investment, there is a growing concern that certain capital flows (such as short-term debt) can have destabilizing effects in developing countries.

Boston University’s Associate Professor Kevin Gallagher (an Institute grantee) discusses these issues in his new book, “Ruling Capital”. As Gallagher points out in the book and in the interview below, the 2008 global financial crisis has opened a new chapter in the debate over the proper policy responses to pro-cyclical capital flows. Until very recently certain strands of the economics profession as well as industrialized country national governments and international financial institutions have remained either hostile or silent to regulating capital movements. But there is no longer policy unanimity on this issue, which is in marked contrast to the period during the Asian Financial Crisis, where the so-called “Washington Consensus” dominated policy making in both the developed and developing world, and capital account liberalization remained paramount. Today, as Gallagher points out, a number of emerging economies, including Brazil, Taiwan, and South Korea, have been successfully experimenting with new capital account regulations (CARs) to manage volatile capital flows and managed to remain relatively unaffected by the turbulence brought about as the Fed began the process of unwinding its quantitative easing program. Even the International Monetary Fund (IMF) has come to partially recognize the appropriateness of capital account regulations and has gone so far as to recommend (and officially endorse) a set of guidelines regarding the appropriate use of CARs.

Gallagher develops a theory of countervailing monetary power that shows how emerging markets can and should counter domestic and international opposition to the regulation of cross-border flows, even as he acknowledges powerful attacks from a multiplicity of interests, seeking to undermine those very regulations.