Op-ed in the Financial Times
October 25, 2009
© Financial Times
The Brazilian action in imposing a tax on certain kinds of foreign inflows to moderate the rise in its currency is of great importance, substantive and symbolic. The symbolic value lies in signaling an end to an era in which emerging markets were enamored with foreign finance, and in expressing willingness to take action to moderate inflows of foreign finance. Substantively, it is important in increasing the arsenal of weapons that countries can deploy to moderate overheating of their economies. It is a good illustration of the type of measure policymakers can use to arrest incipient asset price overheating.
The International Monetary Fund's response to the Brazilian measure was lukewarm or even mildly negative. A senior official said: "These kinds of taxes provide some room for maneuver, but it is not very much, so governments should not be tempted to postpone other more fundamental adjustments. Second, it is very complex to implement those kinds of taxes, because they have to be applied to every possible financial instrument," adding that such taxes have proven to be "porous" over time in a number of countries.
This response is disappointing not because it is wrong, but because it reflects business as usual in terms of the IMF's intellectual approach to financial globalization. This approach has been to disapprove implicitly of such measures by asking countries to take a lot of complementary action (improving corporate governance, strengthening financial regulations, and so on) in order to preserve foreign flows, considered sacrosanct by the IMF. For emerging market countries; the problem has been that it is not always easy to implement these actions in the short run, so that the practical and pressing issue of what to do with excessive inflows has remained with little guidance from the IMF on appropriate responses.
Taxes on foreign inflows have their problems, but that is not an argument against such measures. No sensible person believes that taxes generally should not be imposed because they can be, and are, evaded. Rather, it should lead to a search for the best ways of designing these measures (Should they be price-based or quantity-based? What kinds of flows are best addressed, debt or portfolio? Over what duration are limits most effective? When should they be withdrawn?) so that the benefits are maximized and risks minimized.
Instead of continuing to throw cold water on such measures, the Fund should view this as an intellectual opportunity. It could continue to be supportive of countries in their pursuit of more open capital flows as a long-term, structural objective. However, it must recognize that surges in capital inflows can pose serious macroeconomic challenges that may require a different cyclical response. For emerging markets, the policy arsenal against future crises must cover measures to restrict credit growth and leverage countercyclically, notably surging capital flows.
The larger reason that the IMF should take the Brazilian measure seriously relates to ideology and narrative. If the global crisis stems, in part, from a belief system that unduly elevated the status of finance, the IMF contributed to sanctifying, implicitly or explicitly, foreign finance. This imposed a big and under-recognized cost for emerging-market countries: If they took actions to restrict capital flows, they risked being seen as market-unfriendly and imprudent in their economic policy. By recognizing that in some instances sensible curbs on inflows might be a reasonable and pragmatic policy response, the Fund can eliminate the market-unfriendly stigma that actions of the Brazilian type might otherwise risk incurring.
Indeed, the fear of this stigma is evident in the recent Brazilian action: The magnitudes are small, and Brazil is at pains to emphasize its temporary nature—both of which make markets take the action less seriously and hence undermine its aims. If this stigma had been absent, the tax on inflows could have been better designed and imposed with greater confidence to ensure its effectiveness.
The world needs a less doctrinaire approach to foreign capital flows. Helping Brazil in its decision last week rather than issuing a negative response would signal that the IMF is playing a constructive role in facilitating this shift.
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