New book
By Pablo Bortz (Guest blogger)*
After the breakdown of the Bretton Woods regime and the subsequent deregulation in capital flows around the globe, the movement of financial assets and liabilities has increased several times faster than trade and GDP growth. While still mainly concentrated between advanced countries, financial flows to emerging and developing economies (EDEs) have been rising at an exponential rate, particularly in the last two decades. However, public external debt (as per cent of GDP) has been on a downward trend in the 2000s (though the trend has been slightly reversed since the 2008 crisis), with a larger proportion being denominated in domestic currency, but attracting more non-resident private investors (Arslanalp and Tsuda 2014). The other big story of the last fifteen years, notwithstanding, is quite different: private external debt has been on a marked rise. As Akyüz (2014) reviews, the share of private debt denominated in a foreign currency has increased sharply, and that is not the only concerning feature observed in the data. Avdjiev et al (2014) notice the importance of private non-bank lenders in in the external financing of many emerging countries, and the role of overseas affiliates of EDEs corporations established in off-shore financial centers, rendering its recording more difficult. And though cross-border bank lending still represents the larger share of total external borrowing, there has been a fast increase in the issuance of debt securities by the private non-banking sector of EDEs and its off-shore affiliates (Butzen et al 2014), a more volatile kind of flow, together with portfolios investment.
Far too numerous crises in emerging (and some advanced) economies have been preceded by explosions in private foreign borrowing, starting from the 1970s in Latin America, and continuing during the 1990s also in Latin America and (above all) South-East Asia, as told by Palma (2001). And in the last decade we have seen the burst of the Eurozone, also triggered by sharp increases in foreign indebtedness (Storm and Naastepad 2016). Financial fragility is not the sole cause of these crises and the lasting damage they leave behind. As I mention in my recent book (Bortz 2016), private foreign borrowing turn the odds of wage bargaining against labor, lowering the wage share and putting aggregate demand in a more fragile standing. Motives for this result abound: the impact of higher indebtedness and debt servicing on firms’ balance sheet (costs that firms try to pass on consumers); the fact that mounting foreign borrowing and capital inflows are matched by financial deregulation that stimulates alternative outlays other than capacity-building investment; and because they are tied to the rise of sectors such as the FIRE sector (financial, insurance and real state) lowering aggregate productivity, among other reasons. Jayadev (2005), Stockhammer (2009) and Furceri and Loungani (2015) all find empirical support for these hypothesis.
After amending in 1997 its Articles of Agreement, requiring member countries to liberalize their capital account, the IMF has joined the large chorus of voices calling for capital controls, although in the most muted way possible (IMF 2012, p. 2). Calls for restoring capital controls rise across the economic spectrum, from authors with a more orthodox point of view such as Hélène Rey (2013) to non-mainstream economists such as Vernengo and Rochon (2000), Epstein (2005), Bibow (2011), Gallagher (2014), Grabel (2015), among many others. International institutions such as UNCTAD have been at the frontier of the debate (UNCTAD 2001, 2014), and even recent research by IMF staff has dwelled into the topic (Ostry et al 2011, Canuto and Ghosh 2013).
It is within this context that I suggest a novel proposal for consideration, the implementation of which should obviously reflect the particularities of each economy. What I propose is a refundable tax on foreign private borrowing, that discourages speculative borrowing in favor of productive investment. The basic idea is simple: companies should pay a tax when they borrow abroad, either through banks, issuing debt securities, when they borrow from their home companies or off-shore affiliates. That tax would be reimbursed if firms can prove that these credits have been used to fund productive investment.
This proposal is particularly fit to counter lending and borrowing between affiliates, a common channel to facilitate transfers of funds in times of need with disregard of the economic conditions of the country. For instance, it was one of the major channels by which affiliates in EDEs transferred large amounts of foreign currency to their home companies in developed countries during the 2008 financial crisis and the Eurozone crisis.
Implementation aspects raise a couple of questions of which I am fully aware. First, there is the need to define precisely what “productive investment” stands for: does it include software licenses and patents? Second, the State would require the administrative capabilities to verify the companies’ claims on the nature of their borrowing, while assuring that banking funds are indeed available in the domestic market (perhaps through public banks and/or development banks). However, the main intention of this proposal is to pass the burden of the proof to firms rather than the State. A further issue to be discussed concerns cross-border bank lending. The scheme should discriminate in favor of foreign lending for investment purposes, though its implementation would involved more thoughts and efforts in its design.
This proposal should not be thought of as a substitute for more specifically-FDI-oriented policies. There may well be different and valid reasons for countries to discourage FDI, and this measure does not stand in its way. It is not incompatible with other typical capital control measures such as unremunerated reserve deposits on financial investments or measures that restrict capital flights. This proposal is just one instrument, perhaps a modest one, to try to curb speculative borrowing by firms, particularly in foreign currency, an ever-increasing practice which offers negligible benefits and which adds to headwinds when foreign reserves are needed the most (Chui et al 2014).
*Pablo G. Bortz is currently Professor at the National University of San Martin. He is the author of Inequality, Growth and ‘Hot’ Money, published by Edward Elgar. With the usual caveats, the author thanks Edgardo Torija Zane for our fruitful discussions on this proposal.
References
Akyüz, Y. (2014): Internationalization of finance and changing vulnerabilities in emerging and developing economies, Discussion Paper No. 217, United Nations Conference on Trade and Development, Geneva.
Arslanalp, S. and Tsuda, T. (2014): Tracking global demand for emerging market sovereign debt, Working Paper No. 14/39, International Monetary Fund, Washington, DC.
Avdjiev, S., Chui, M. and Shin, H.S. (2014): Non-financial corporations from emerging market economies and capital flows, BIS Quarterly Review 2014, December, pp. 67–77.
Bibow, J. (2011): Permanent and selective capital account management regimes as an alternative to self-insurance strategies in emerging-market economies, Working Paper No. 683, Levy Economics Institute of Bard College, Annandale-on-Hudson.
Bortz, P. (2016): Inequality, Growth and ‘Hot’ Money, Edward Elgar, Cheltenham.
Butzen, P., Deroose, M. and Ide, S. (2014): Global imbalances and gross capital flows, National Bank of Belgium Economic Review 2014, September, pp. 41–60.
Canuto, O. and Ghosh, S. (eds) (2013): Dealing with the Challenges of Macro Financial Linkages in Emerging Markets, World Bank, Washington, DC.
Chui, M., Fender, I. and Sushko, V. (2014): Risks related to EME corporate balance sheets: the role of leverage and currency mismatch, BIS Quarterly Review 2014, September, pp. 35–47.
Epstein, G. (ed) (2005): Capital Flight and Capital Controls in Developing Countries, Edward Elgar, Cheltenham UK.
Furcer, D. and Loungani, P. (2015): Capital account liberalization and inequality, Working Paper No. 15/243, International Monetary Fund, Washington, DC.
Gallagher, K. (2014): Ruling Capital: Emerging Markets and the Re- regulation of Cross-Border Finance, Cornell University Press, Ithaca, NY.
Grabel, I. (2015): The rebranding of capital controls in an era of productive incoherence, Review of International Political Economy, Vol. 22 (1), pp. 7-43.
International Monetary Fund (2012): The liberalization and management of capital flows: an institutional view, International Monetary Fund, Washington, DC.
Jayadev, A. (2005): Financial liberalization and its distributional conse- quences: an empirical exploration, Ph.D. dissertation, University of Massachusetts Amherst.
Ostry, J.D., Ghosh, A.R., Habermeier, K., Laeven, L., Chamon, M., Qureshi, M.S. and Kokenine, A. (2011): Managing capital flows: what tools to use?, Staff Discussion Note No. 11/06, International Monetary Fund, Washington, DC.
Palma, J.G. (2001): Three-and-a-half cycles of ‘mania, panic, and (asymmetric) crash’: East Asia and Latin America compared, in H.J. Chang, J.G. Palma and D.G. Whittaker (eds): Financial Liberalization and the Asian Crisis, Palgrave, Basingstoke.
Rey, H. (2013): Dilemma not trilemma: the global financial cycle and monetary policy independence, Proceedings of the Economic Symposium of the Federal Reserve Bank of Kansas City, Jackson Hole, WY.
Stockhammer, E. (2009): Determinants of functional income distribution in OECD countries, IMK Studies No. 05/2009, Hans Böckler Stiftung, Düsseldorf.
Storm, S.T.H. and Naastepad, C.W.M. (2016): Myths, mix-ups and mishandlings: understanding the Eurozone crisis, International Journal of Political Economy, Vol. 45 (1), pp. 46-71.
UNCTAD (2001): Trade and Development Report, UNCTAD, Geneva.
UNCTAD (2014): Trade and Development Report, UNCTAD, Geneva.
Vernengo, M. and Rochon, L.P. (2000): Exchange rate regimes and capital controls, Challenge, Vol 43 (6), pp. 76-92.
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