In a recent Financial Times op-ed, Michael Pettis argued that the US should impose capital controls. In his view, the traditional view according to which capital inflows necessarily lower domestic interest rates and spur productive investment is based on a misunderstanding of how capital flows affect modern economies. This might have been true for rapidly growing developing economies with high investment needs and limited domestic savings, where foreign capital truly relieved a saving constraint. However, since the breakdown of the Bretton Woods system, modern financial systems can expand credit largely unconstrained. In this environment, capital inflows into advanced economies like the US, do not primarily finance new, productive investments.
In the modern context, capital inflows often lead to an increase in household or fiscal debt. Policymakers use this credit growth to sustain domestic demand and prevent recessions that would otherwise be caused by the leakage of demand abroad due to trade deficits. This is a "beggar thy neighbour" dynamic -- a term coined by Joan Robinson, and the reason she appears in the FT piece, even though she was referring to competitive depreciation and trade restrictions, not capital flows -- where trade deficits are caused by shifts in spending to foreign goods, forcing domestic businesses to reduce output. Further, this reliance on rising household or fiscal debt to absorb foreign capital inflows and the resulting trade deficits is unsustainable in the long run. It leads to rising debt levels and distorted economic structures. He concludes that restricting capital inflows would directly address the problem of aligning a country's external position with its domestic needs.
There are many problems with these views. On a theoretical level, he does suggest, as Vicky Chick in a paper that Lance Taylor liked and used in his courses, in the earlier period savings was necessary for investment. Essentially Say's Law. That is certainly not the case. Even in the 19th century, with less developed financial markets, banks had the ability to create credit, and savings (a flow) did not finance investment. Also, interest rates do not depend on the capital flows and the available funds, and are essentially an exogenous variable controlled to a great extent by the monetary authority (that was true in the past too).
More importantly, it is unclear that the external situation of the US, indebted in its own currency is unsustainable. What is the problem that this would be solving? There is no fiscal problem either, irrespective of the downgrade of US debt by Moody's recently (Standard & Poor's and Fitch had done it years ago). In fact, capital controls would affect the international role of the dollar and would be a major misstep, since it would directly affect the ability of foreigners to use dollars, and restrict its use in international financial markets. Not that this would have any chance of happening with Bessent, a Wall Street operator, as Treasury Secretary.
Private debt (not public) is considerably more dangerous than public debt, since when the government gets indebted, if it uses the money to promote growth, it directly affects its ability to pay back the debt, since its revenue is tied to the level of economic activity. That is why public debt tends to fall not by cutting spending and promoting adjustment and reducing the amount of debt, but by promoting growth and reducing the relevance of debt with respect to ability to repay. So, Pettis is not incorrect in noting that the US has depended more on private debt, which is riskier. But capital controls would do little to limit this dynamic. Policies that expand the remuneration (wages) of the people at the bottom (i.e. better income distribution) and that are more lenient with private debtors would have better results.
Regulation of financial markets too should play a role. In particular, the predatory lending practices that are still rampant in the US more than a decade and half after the 2008-9 financial crisis. But in all fairness, if there is something the US can do to grow faster and avoid financial problems, it would simply be more spending (perhaps a mix of infrastructure and social transfers) and lower interest rates. One can hope.
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