Capital Rules: The Tensions of Global Finance

With the start of the new decade, most global financial powers are rethinking a previously powerful trend toward liberalizing global finance. In his new book Capital Rules, Professor Rawi Abdelal charts the intellectual, legal, and political history of financial globalization, and the tensions facing today's world economy. Read an excerpt. Key concepts include:
  • The year 1998 was the closest the world has come to establishing a consensus that capital's right to freedom applies always and everywhere.
  • The world looks different to most financial policymakers in the twenty-first century, with many regions, and the United States in particular, adopting ad hoc measures that benefit their own interests but ignore the lessons learned from financial crises in the 1920s and 1930s.
  • The European Commission is the only recognized international financial authority to support complete, unqualified capital mobility.
by Rawi Abdelal
What fuels a global economy? Certainly the easy flow of capital across national boundaries would seem near the top of the list. But financial globalization is not an on/off switch, notes Professor Rawi Abdelal. Different countries and regions impose their own intellectual and legal layers atop cross-border finance and in patterns we have seen before. In his new book Capital Rules: The Construction of Global Finance, Abdelal documents the waxing and waning of international capital controls in the twentieth and twenty-first centuries, and the contest between rules-based globalization authored by European policymakers and the unilateral, ad hoc direction promoted by U.S. financial institutions. This excerpt from the book's conclusion looks at why major financial players other than the European Commission are backing away from the idea of complete, unqualified capital mobility. For an interview with Abdelal about this research, see "How Europe Wrote the Rules of Global Finance."

And so we find ourselves living, once again, in an era of financial openness and mobile capital. It is not the first time and, unless this is the end of history, it will probably not be the last time. We have lived through the end of history more than once, however, and policymakers continue to relearn old lessons about the difficulties of regulation and the risks of liberalization.

The idea that capital ought to flow unrestricted across the globe became the reigning orthodoxy of international finance over the course of the 1980s and 1990s. Yet less than a decade after the financial crises that hit emerging markets in the 1990s, that orthodoxy is already in decline and its reign in question. As a matter of capital flows, global finance is as strong as ever. But when it comes to the norms and rules of global finance, the very ideas and laws that sustain the system, the height of this era of globalization has already been reached.

The globalization of finance, in this sense, reached its peak in the autumn of 1998. The condemnation by the international financial community, and particularly the credit-rating agencies, of Malaysia's capital controls in September 1998 represented the norm of capital mobility at its purest and most liberal. Restrictions of the mobility of capital were deemed inappropriate under any circumstances, even during a financial crisis that began elsewhere; when implemented by a developing country's government frustrated by widespread short-selling in the illiquid market for its currency; amid relatively sound economic fundamentals; when foreign direct investment was exempted from the restrictions; or when accompanied by promises of temporariness. In short, all the exceptions that scholars and policymakers had historically reserved from their embrace of open capital markets were ruled out of bounds. The norm of capital mobility was to be universal and unqualified. Deviation was a powerful signal of heterodoxy, and the markets were ready to interpret such signals accordingly. At that very moment in 1998, the IMF Executive Board and Interim Committee were considering codifying the norm for all 184 members, as had the EU and OECD for their own clubs. That autumn was as close as the world has ever come to a consensus—written and unwritten—that capital's right to freedom applied always and everywhere.

Policymakers understand the international financial system very differently, however, in the first decade of a new century. Caution toward full capital mobility now prevails within the international financial community. The IMF, OECD, and credit-rating agencies have been congratulated, occasionally by one another and themselves, for having "learned" valuable lessons from the emerging market financial crises and their apparent contagious spread; the dangers of embracing hot money instead of longer-term capital flows; and the importance of a country's domestic institutional foundations for sound banking systems as a precondition for full liberalization.

Every organized voice of authority within the international financial system has backed away from embracing complete, unqualified capital mobility except one: the European Union. The European Commission, in contrast, still approaches its accession negotiations just as it always has: Brussels negotiators insist, correctly, that the EU's rules unambiguously forbid all capital controls, and so potential members are obliged to liberalize fully and, if they are to accede soon, rapidly as well.

Outside the EU and OECD, the rest of the world is actually running on what can only be called ad hoc globalization, led by the United States, the consequences of which are potentially problematic for the maintenance of the bargains that sustain the mobility of capital across national borders. Throughout this period, the United States has consistently turned to unilateral decisions and bilateral trade and investment treaties to advance its national interests. It has largely fallen to the Europeans to exercise leadership in the international organizations that write the rules of capital mobility and socialize new members into the norms of openness. With so much of the world outside the rule of liberal Europe and the OECD club of rich countries, such ad hoc globalization effectively undermines the legitimacy of global financial openness as a universal norm. The system—if such a patchwork can be called a system—that actually governs most countries is anything but the work of deliberate design.

The recent evolution of the norms and rules of the international monetary system raises several important questions for scholars, policymakers, and the private financial community. The international financial community has formulated lessons for itself of the crises of the 1990s that, in both principle and language, are nearly identical to those that policymakers believed they had learned from the crises of the 1920s and 1930s. Yet policymakers today describe the prevailing consensus of caution as having emerged from "new information" or "change in the knowledge base." Why, then, is the rediscovery of the lessons of the interwar years, apparently long forgotten or rejected, so frequently described as "learning"? And why has the European Commission uniquely failed to learn the lessons now shared by the IMF, OECD, credit-rating agencies, and U.S. Treasury?