This was the title of
the workshop presented as part of the 'Seminario Internacional
de Macroeconomia Para o Desenvolvimento' (International
Seminar on the Macroeconomics of Disinvestment) at
the Federal University, Rio de Janeiro, Brazil, on
29 January, 2003.
The workshop was presented by 'O Instituto de Economia
da UFRJ' (Institute of Economics, Federal University,
Rio de Janeiro) and IDEAs (International Development
The workshop, which was presided over by Franklin
Serrano (UFRJ, IDEAs), had three sessions-two in the
morning and one in the afternoon. The first session
concentrated on theoretical problems regarding free
capital flows, and the second on international experiences.
The afternoon session focussed on the economic policies
of Brazil. The audience mainly comprised people with
an academic background, the majority being students
and teachers of economics.
Franklin Serrano, as the first speaker at the first
session, offered an analysis and critique of the bi-polar
exchange rate regime. Though the bi-polar vision has
suffered a disaster in recent times, modern economic
theory has been unable to bridge the gap. Given the
recent developments in developing economies and the
tendency for central banks to fix an internal rate
higher than the equilibrium so as to attract foreign
capital, the existing fixed and flexible exchange
rate models do not work any more, and fiscal and monetary
policies have lost their uses as described in traditional
At a theoretical level, Serrano explored the Mundell–Fleming
model with a different interest rate treatment. The
use of exchange rate devaluation, under a floating
exchange rate regime, as a mechanism for adjustment
tends to lead to worse devaluation as it adds to the
internal–external gap. Earlier, the speed with
which the capital account adjusted was always slower
than the speed with which the commodity account adjusted.
Now, with capital mobility being very high and with
the increase in importance of short-term capital,
there is no time-gap or lag between commodity and
capital account adjustments. Movement from a fixed
to a flexible exchange rate regime does not essentially
address this problem. So, moving from one to the other
does not solve the problem that free and fast capital
mobility imposes on the economic system. The solution,
Serrano suggested, is to take things slowly and not
go in for drastic and hasty financial liberalization.
The next speaker, Prabhat Patnaik (Jawaharlal Nehru
University, New Delhi, India), highlighted the fact
that a major fallacy of neoliberal policies is the
failure to distinguish between stock and flow decisions.
The fact that individuals make a concrete decision
regarding the form in which to hold their savings
has been ignored by neoliberal economists since they
work with an implicit assumption of full employment
where all savings are invested. Under this assumption,
a higher interest rate is said to automatically lead
to higher savings and therefore higher investments.
Simultaneously, given a savings schedule, increase
in public investment actually crowds out private investment
by adjusting the interest rate, keeping employment
(already full) unchanged.
Patnaik suggested that this idea is fallacious because
savings and income (Y) change simultaneously and therefore
assuming a fixed savings pool and fixed (full) employment
is erroneous. With fiscal policy, it is possible to
increase savings, and therefore employment. Neoliberal
economics needs to recognize that stock and flow decisions
simultaneously determine equilibrium savings and investment.
Governments in developing countries, urged Patnaik,
should go in for expansionary policies like distribution
of foodgrains stock, expansion and utilization of
industrial capacity, rather than let the private sector
replace its activities.
In the context of free capital flows, the Mundell–Fleming
model, for example, had suggested that interest rates
would be equal everywhere. But, Patnaik pointed out,
in reality this is not so, since capital always prefers
to go to the north rather than to the south. Therefore,
the south always has to pay a premium on its interest
rate. A higher interest rate will tend to reduce private
investment. It will also make government borrowing
unsustainable if the growth rate is lower than the
interest rate. Therefore government expenditure has
to be reduced, and government investment and subsequently
the growth rate will fall, as will private investment.
An additional problem is that the rate of interest
never, by itself, determines capital inflow.
In any case, increased capital flow has its own problems.
Higher capital flows may go towards replacing domestic
private sector investment, that is, it may actually
cause domestic deindustrialization. If this capital
inflow can be used to finance private domestic or
government investments, there would not be a problem.
But usually this does not happen. In addition, borrowing
short-term funds for financing long-term investments
is quite unlikely. Further, the fact that foreign
exchange reserves will also be used up might mean
heading towards a crisis in the long run.
On the other hand, under a flexible exchange rate,
if capital inflow increases, the real exchange rate
appreciates and foreign capital gets a higher return
compared to government investments. This creates contractionary
movements in the economy. But the reverse is not completely
true. When capital flows out the exchange rate does
not depreciate so much, since expectations regarding
the real exchange rate going down are much higher
as real wages (and therefore workers' demand) cannot
fall so much. So the expansionary process does not
really take place to a large extent and, in addition,
government intervention in such cases may actually
set in motion a deflationary process.
The second session in the morning started off with
an introduction to IDEAs by Jomo K.S. (University
of Malaysia, IDEAs). After describing the organization,
its objectives and aspirations, he invited the audience
to visit the official website. He then went on to
speak about three issues surrounding financial liberalization
(FL)—first, the consequence of FL; second, the
process by which FL creates a net capital outflow;
and finally, the question of capital management.
The consequences of FL have been many. First, except
for brief time-periods in Asia and Latin America,
there has been an overall outflow of capital from
the developing countries. Second, the lower costs
of funds that were promised as a benefit of FL have
not been realized. Third, financial deepening was
supposed to reduce risks. This has happened, but because
of new financial instruments, the likelihood of systemic
risk has in fact increased. Financial capital inflow
has also generated a strong deflationary impact since
capital inflows are very sensitive to consumer price
inflation and therefore governments have generated
a strong tendency to control inflation. However, as
country experiences show, the higher the extent of
inflation targeting, the lower has been the growth
rate. Finally, international financial liberalization
has undermined the possibility of development finance
that is long-term in nature.
The phenomenon of net capital outflow that has taken
place as a result of FL has in turn its own sources
and consequent complications. Firstly, asset price
bubbles have occurred more, and more but this does
not contribute to development. Secondly, with the
availability of cheap credit, consumer binges by the
rich have become a common phenomenon, but again, this
kind of spending is not related to development. Thirdly,
there has been a suggestion that overinvestment occurs
as a result of increased availability of capital,
but the speaker did not quite agree with this view.
Fourthly, so far the prudence that has been exercised
has meant that central banks have increased their
reserves to offset these flows. So, contrary to common
perceptions, there are no increases in actual stocks.
Jomo went on to stress the need for capital management
and detailed the considerations that should be borne
in mind while doing so. First, capital controls have
historically been followed in many countries, and
more recently in Malaysia. Emphasizing the rationale
of 'national interest', he pointed out that in Brazil
this was a viable option in the interests of the national
business community. Second, the discussion must now
go beyond the realm of whether to have 'capital control
or not', but to 'what kind' of capital control. Types
of capital control, given their historical associations
and therefore the vocabulary used, are very important.
The role of political coalitions or social forces
is also crucial in this regard.
Third, the degree of market-friendliness is important.
Controls in India, China and Taiwan Province of China,
for example, seem much more market-friendly and effective
compared to those in Chile and Columbia. Fourth, policy-makers
need to differentiate between portfolio flows and
FDI, and to encourage the latter but not the former.
The type of FDI also represents an important policy
choice. Fifth, capital controls need to decide whether
to control inflows and outflows, and distinguish between
the interests of citizens and the corporate sector.
Sixth, policies regarding mergers and acquisitions
need to be clarified. Finally, structuring exemptions
so as to effectively signal incentives and disincentives
is another factor to be taken into account.
Jomo ended by stressing the need for careful discussions
between policy formulators and people with a detailed
and nuanced knowledge of the subject.
Carlos Medeiros (UFRJ, Brazil), the next speaker,
discussed the impact of liberalization on income distribution
in Latin America, especially Brazil.
Latin America was characterized by an acute dollar
shortage in the eighties, which was reversed in the
nineties. However, over-availability of foreign funds
actually did not increase economic growth nor did
it increase the stability of the system; rather, it
gave rise to higher volatility and other problems
like the import of bubbles and a succession of other
investments. The domestic interest rate was cut to
attract foreign capital over this period.
The effect of all this on income, argued Medeiros,
was adverse. Income growth per capita in Latin America
was a low 1.4 per cent, though Chile recorded higher
growth. Productivity and employment growth as well
as the investment ratio were low, with a high disparity
between and within sectors (for example, between agriculture
and industry). Over 1990–98, there was high
mass migration from Latin America, especially Mexico,
the Dominican Republic and El Salvador. Both government
and private employment also fell sharply in most countries,
including Brazil and excepting Chile.
Empirical analyses, though limited by data constraints,
shows that over this period, inequality increased
significantly in Argentina, Chile, Mexico, Bolivia,
Colombia, Peru and Venezuela, while it stayed high
but stable in Brazil. Poverty too increased in Argentina,
Mexico and Venezuela. A hollowing out of the middle
earners has been a major trend in all of Latin America,
and is especially intense in Brazil. This reflects
the deindustrialization of labour force. Severe concentration
of income at the top is another major characteristic
of Latin America. Real minimum wages at the end of
the nineties was less than that paid at the beginning
of the eighties in all countries in this region, with
the exception of Chile, Colombia and Brazil.
The devaluation of human capital in Latin America
was associated with unstable growth and consumer booms,
both of which were a fall-out of the liberalization
process. As a result of the regime of high interest
rates, income has been concentrated in the new rentier
class of bond-holders. There has been a strong polarization
process that has created positive income effects only
for the rich and the corporate sector, more importantly.
This has changed the power relations in favour of
the private sector as opposed to the public sector.
In the labour market, inequality of distribution in
salaries has come about as a result of increased disaggregation
of the labour market. Public sector jobs and trade
unions, on which the middle and the poorer classes
are dependent, are becoming less important. At the
same time, except in telecommunications, other investments
have failed to confer any benefits to the ordinary
The next speaker was Reinaldo Gonsalves from UFRJ,
Brazil. He discussed the reasons or needs for using
capital control as an instrument of macroeconomic
management, as well as the critical issues that must
be kept in mind while implementing capital control.
First, capital control is necessary for decreasing
interest rates in Brazil and in the rest of Latin
America. Second, it is also necessary for controlling
public debt in the hands of non-residents and residents
of foreign descent, because a high public debt ends
up in sterilizing public resources. Third, capital
control is the key to long-term development for making
available long-term funds and to keep away external
resources from strategic sectors. Fourth, it is required
for preventing domestic savings from going out, which
would have a negative impact on the rate of development.
At present smaller companies are unable to get international
funds and also pay a much higher interest rate, which
poses a strategic inconsistency problem in the development
model. Fifth, drugs and arms trafficking have increased
as a result of capital account liberalization, even
in Brazil. This issue, related to political and social
parameters, is of great significance, the speaker
emphasized. Cases of corruption and decay in the political
and social system are a fall-out of the present system
of financial liberalism.
But while setting up a system of capital control,
certain factors need to be kept in mind. Capital control
in Brazil needs to go hand-in-hand with credit control
as a permanent policy. It also needs to be coordinated
with some FDI control. An appropriate mix of macroeconomic
policies (fiscal, credit and exchange rate policies)
that are compatible and consistent with capital control
must also be put in place. Simultaneously, a strategic
level of foreign reserves must be maintained for facing
crisis situations. In the Brazilian situation, capital
control is a key factor that could bring forth development
and macroeconomic balance. In addition, de-dollarization
of public debt is a very important issue.
Gonsalves placed great emphasis on capital control,
since the goods and services sector is more difficult
to control as restrictions there are perceived as
real and strong interference. Finally, the speaker
reminded the audience that international policies
and coordination between countries are very important.
Capital control, since it affects the financial elite,
is a difficult political option. It is also necessary
to be cautious towards and discerning of the type
of advice that is forthcoming from bodies that have
vested interests, like the World Bank, as well as
other forms of the large economic elite.
In the afternoon session, Fernando Cardim de Carvalho
of UFRJ focussed attention on the economy of Brazil.
He started off by discussing how the question of 'imposition'
of capital control, as opposed to the removal of existing
controls, is a very tricky one, since the very mention
tends to trigger off adverse economic behaviour. There
is also a great difference between the formal impact
of capital control and its real effects.
Moving to Brazil, he discussed how the Brazilian economy
is supposed to have significant controls but in effect,
does not. This is so because although the legislation
required is already in place it is not really implemented.
The government's task is therefore simpler and requires
only an implementation of those legal provisions.
The speaker next drew attention to 'two major issues'.
The first concerned the question of moving from a
fixed to a floating exchange rate system. He suggested
that this would not by itself solve the problem. The
concept of equilibrium does not work because in the
event of a devaluation, expectations regarding that
devaluation will make the rate higher. A floating
exchange rate offers no solution to the volatility
generated by capital flows.
The second question was whether controls have to be
permanent or not. The major reasons cited for control
are two. First, they will help the domestic market
by reducing the domestic interest rate, as has happened
in Malaysia. In the case of Brazil, one needs to wait
and see whether that will work. But it is the second
reason that provides the need to have permanent controls
in Brazil, Carvalho argued. In Brazil, as in Mexico
and Thailand, the major problem with capital flows
since 1998 is that it is the residents who take funds
out with them. These include not only the rich but
also the middle class, who are free to invest abroad
through foreign banks. The change in the nature and
the greater potential for damage of the capital flow
problem has now made it imperative that the controls
be permanent. Political autonomy is also a must for
Finally, capital controls must cover the plugging
of investments abroad, for which the law was already
in place. Restrictions need to be imposed on both
inflow and outflow (on luxury spending abroad on the
basis of foreign exchange scarcity). Financial companies
also need tight legislation for stricter control of
their investments abroad. Learning along the way and
coping with adverse public opinion are of utmost importance.
Coping with the increasing pressures from the IMF
is another task the government must train itself to
The last speaker, Ricardo Carneiro (UNICAMP), concentrated
on the political aspects of the issue under discussion.
Carneiro, who has been a long-time economic advisor
to President Lula, pointed out the difficulties faced
by even a leftist government, of following a policy
such as capital control. The government could fix
the interest rate but since it had no controls over
the exchange rate, this was discarded. There is, in
reality, no autonomy for macroeconomic management.
But this does not mean that Brazil has to live without
a development path in the absence of capital control.
Brazil can try to exert some control over the interest
rate, though it is difficult. It can also use semi-economic
institutions for this purpose. In addition, the state,
which has a tax-base of 34 per cent of the population,
can try to effectively allocate the tax resources.
The government can, as a matter of policy, hinder
certain types of systems, say outflows, by creating
bureaucratic hurdles rather than by obvious or direct
Carneiro stressed the need for a gradualist approach
towards achieving the ends that a country like Brazil
obviously needs to pursue. Given the complications
of the current predicament in which Brazil finds itself,
the speaker was keen to highlight the use of cautious
methods that can achieve the apparently impossible
task of keeping the people and organizations like
the IMF happy at the same time.
The audience came up with detailed questions on many
of the issues discussed—on country experiences
(especially in Asia and a comparison of that with
Brazil), on the validity of the Tobin Tax, on technical
methods and measures used for calculating income inequalities.
Questions on President Lula's apparently soft stand
on economic appointments and policies in Brazil dominated
the afternoon session. The workshop generated a lot
of interest and discussion, some of which continued
even afterwards, on the issue of financial capital
flows, which is a major concern for developing countries