Capital Mobility and Distributional Conflict in Chile, South Korea, and Turkey

Kurtuluş Gemici

• Publisher: Routledge
• Year: 2020
• Print ISBN: 9781032336244
• eBook ISBN: 9780429762079
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Political Ideologies
• Index: Politics & International Relations

Why did many emerging countries pursue risky financial opening policies in a reckless manner, even after the painful example of the Latin American debt crisis? Unlike trade liberalization, which has mostly been beneficial in emerging countries, the removal of capital controls has led to boom-bust patterns in many countries. It is not simply driven by class or sectoral interests, nor is it just a result of ideational changes in policy-making circles, or international pressure. Gemici argues that to fully understand the motivation for these policies, we need to take into account distributional struggles prior to their enactment.

In this book, Gemici shows that conflictual distributional relations significantly increase the likelihood of capital account liberalization. Through in-depth comparative case studies, he also demonstrates that countries which liberalize in the most comprehensive manner tend to be the countries characterized by a high degree of distributional conflict. The case studies – Argentina, Chile, South Korea, and Turkey – have been chosen to maximise variation in distributional relations and to escape regional clustering, showing quite different trajectories of capital account liberalization.

This will be of great interest to readers in sociology, international political economy and heterodox economics, as well as specialists in the countries examined.

1 Introduction

Distribution relations and capital mobility

On December 18, 2006, the recently installed military government in Thailand announced its plan to implement controls on capital inflows, effective the next day.¹ An unpleasant chain of events followed the Thai government’s announcement of capital controls. Within one day, Bangkok’s SET index dropped by 15 percent, and the Thai markets showed signs of financial crisis. The Thai administration revoked capital controls on December 19, in a move the Financial Times called “an astonishing retreat” and “a new record in short-lived economic strategies.”² Within two days, the Thai government learned the bitter lesson that hot money can leave almost as easily as it comes and that the economic consequences of its mass flight are perilous.

Perhaps, the Thai authorities were “intent on committing financial hara-kiri,” as suggested by a financial expert on the Asia-Pacific markets.³ The real reason was the fact that the baht rose to levels unseen since the Asian financial crisis.⁴ Such appreciation hurt Thai exports and was a major source of economic concern for the Thai government.⁵ The objective of the government was made clear by the Thai finance minister, Pridiyathorn Devakula, who called the controls “a historic effort to counter speculative pressure on the baht.”⁶

In hindsight, it is easy to recognize how hazardous the Thai authorities’ intervention into financial markets was. At the time, it was estimated that foreign investors owned 30 percent of the Thai stock market, in stocks worth $50bn.⁷ The amount of foreign investment that entered Thailand until December 2006 was estimated to be around $13bn.⁸ Obviously, under such circumstances, any macroe-conomic decision that prompts foreign investors to leave is a dangerous bargain. Yet, in virtually all emerging economies, hot money—money that can come and go with ease, money that is fluid and dynamic—reached record amounts in the 1990s and 2000s. Hence, it is no wonder that, in the days following the Thai debacle, the Korean deputy Finance Minister Kim Sung-jin preventively announced that “Seoul has unlimited resources to bring currency stability.” Similarly, Rhee Yeung-kyun, the Assistant Governor of the Central Bank of Korea, announced that “The Bank of Korea won’t take any ‘artificial’ measures such as capital controls to help curb appreciation in the won.”⁹ With $234bn in foreign currency reserves, the Korean economy was much sounder and stronger than the Thai economy, but there was no point in stirring up trouble.¹⁰

1 “Thailand acts to aid its currency,” The International Herald Tribune, December 19, 2006. The control was a 30 percent unrenumerated reserve requirement on new foreign currency deposits, similar to the Chilean encaje of the early 1990s.

2 “Thailand retreats on investment controls,” December 20, 2006.

3 “Thailand retreats on investment controls,” Financial Times, December 20, 2006.

4 “Baht will hurt export targets,” The Nation (Thailand), December 18, 2006.

5 “A Government haunted by 1997 panicked into protecting the baht,” The Times (London), December 20, 2006.

6 “Thais put baht under tight capital controls,” Financial Times, December 19, 2006.

7 “Thailand retreats on investment controls,” Financial Times, December 20, 2006.

8 “Thai U-turn amid fears of meltdown in Asia,” The Guardian, December 20, 2006.

9 “Seoul has ‘unlimited’ resources to bring currency stability,” The Korea Herald, December 23, 2006.

10 “Disarray in Thailand as stocks and baht fall; Government tries to win back markets,” The International Herald Tribune, December 22, 2006.

Thailand’s botched attempt to introduce capital controls underlines the severe constraints and risks imposed by the free mobility of capital across national borders. In this book, I examine how international capital mobility was deregulated in emerging economies. I argue that distribution relations played a fundamental role in bringing about the free flow of capital across the borders of emerging economies. Freedom of capital mobility was most perilous when portfolio and debt flows, which often amounted to funds that are oriented toward short-term gains, were among the types of capital flows that got liberalized. This book shows that such a liberalization trajectory ended up being disastrous for emerging economies and that conflictual distribution relations paved the way for this type of risky liberalization.

Which type of capital mobility?

A globalized international financial system with high degree of capital mobility embodied a momentous sea change in the international economy. To understand why, we need to briefly delve into the history of capital flows since the end of the nineteenth century.

Orthodox liberalism characterized the world economy between 1870s and 1914. Its two economic pillars were the gold standard and the self-regulating market (Polanyi, 2001 [1944]). Under the gold standard, the value of a national currency was fixed to a certain amount of gold: economic actors could convert their currency assets into gold at a fixed, predetermined rate as long as the gold reserves of the monetary authority were sufficient. The rates of exchange among national currencies were fixed, and the flow of gold among nations served as the adjustment mechanism if a currency became over- or under-appreciated.

The interwar world economic order stood in stark opposition to the international economic cooperation of the nineteenth century. After the First World War, for a brief period of time, exchange rates floated with no gold convertibility and no controls on international capital flows (Eichengreen, 1996). This resulted in grave economic consequences: capital flows—largely of speculative nature—exacerbated the existing imbalances rather than acting as an adjustment mechanism (Bernanke, 1993; Nurkse, 1944). Partially as a response to the failing Gold Standard, the international monetary system was reestablished in the second half of the 1920s in a hybrid form, the Gold-Exchange Standard, where countries held their reserves both in gold and foreign exchanges that could be converted into gold (e.g., sterling). The Gold-Exchange Standard lacked the international cooperation necessary for its smooth functioning and was plagued by inherent instabilities (Eichengreen, 1996). It collapsed with the Great Depression, which led to national autarky and protectionism in the world economy.

The postwar economic order established at the Bretton-Woods conference reflected the painful experiences of the interwar period and opted for “embedded liberalism,” a compromise between market forces, international economic cooperation, regulation, and interventionism in economic governance (Ruggie, 1983, 209). The architects of the Bretton-Woods system viewed the free flow of capital across nations as dangerous and undesirable (as opposed to the Gold Standard, which, in theory, treated capital flows as an adjustment mechanism); they rejected capital account convertibility and allowed controls on capital flows (Block, 1977; Helleiner, 1994). Exchange rates were fixed to the U.S. dollar, the reserve currency, which was convertible to gold at a fixed rate. The International Monetary Fund (IMF) was established to provide international liquidity and oversee balance of payments problems (Hirschman, 1980). The Bretton-Woods system embraced economic interventionism. In advanced industrialized countries, this took the form of the state assuming the role of Keynesian demand management, active involvement in areas where markets failed, and provision of social welfare services. In developing countries, disbelief in market forces led to import substitution industrialization (ISI) enabled by protectionist trade measures (Toye, 2003).

The Bretton-Woods system was a success in terms of international stability (Mann, 2012, 136–41), but it faced tensions arising from increasing international competition, mounting U.S. deficits, and the rise of Eurodollar markets (Block, 1977; Helleiner, 1994; Wandschneider, 2008; Germann, 2013). These increasing pressures led to its collapse and to the emergence of a new international financial system where exchange rates of major countries floated against each other. The collapse of the Bretton-Woods system marked a turning point; the last three decades of the twentieth century saw the rise of neoliberalism, a series of significant transformations in the social and economic structure of developed and developing countries, where the pendulum—once again—swung toward market rationality and a curtailed role of the state in economic life (Harvey, 2005; Fourcade-Gourinchas and Babb, 2002).

The painful experiences of the past were forgotten in the 1980s and 1990s (Abdelal, 2007). Thus, capital account liberalization and the mobility of capital became the new norm and accepted wisdom. (Capital account liberalization— financial opening—is the removal of restrictions on the movement of liquid capital assets into and out of a country. Full capital account liberalization, i.e., capital account convertibility, implies no restrictions on the purchase of capital assets abroad by residents of the country and on the purchase of domestic capital assets by foreign nationals. As such, it leads to the financial integration of a country with the rest of the world.) In most developing and emerging countries, controls on international capital transactions were effective until the second half of the 1980s (some minor partial liberalization measures notwithstanding). After this date, one country after another began the removal of capital controls that culminated in a substantial level of financial openness and integration with the world by the end of the 1990s (Kaminsky and Schmukler, 2003; Miniane, 2004; Williamson and Mahar, 1998). As can be seen in Figure 1.1, by the end of the 1990s, a substantial majority of emerging countries took a long and difficult series of reforms culminating in open financial markets (Abiad et al., 2010; Miniane, 2004; Williamson and Mahar, 1998).¹¹

Figure 1.1 Average Capital Account Openness in 24 Emerging Countries, 1973–2005.

Source: Abiad et al. (2010).

11 Calculations for this set of countries are based on the capital account liberalization measures developed by Abiad et al. (2010). Higher values indicate greater capital account openness. See Appendix D for a discussion of measuring capital account openness and a comparison between available measures. Countries in this set are: Argentina, Brazil, Chile, China, Colombia, Egypt, India, Indonesia, Israel, Jordan, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, South Africa, South Korea, Sri Lanka, Taiwan, Thailand, Turkey, Venezuela, and Zimbabwe.

However, the steady march toward capital account liberalization evident in the overall trend hides that there is significant variation in the timing and type of capital account liberalization emerging countries pursued. Figure 1.2 presents the trajectory and scope of capital account liberalization in 24 emerging countries between 1973 and 2005. As can be seen in this figure, while the majority of these 24 countries moved toward greater financial openness over time, the timing of the reforms varied considerably. Furthermore, while some countries like Argentina and Turkey liberalized both capital inflows and outflows at a rapid pace in the early 1990s, this is far from the norm among emerging countries. For instance, Brazil, Chile, India, and Taiwan were gradual in their approach to capital account liberalization. These countries eschewed rapid opening of their capital account and were selective in the type of capital movements that they allowed.

Figure 1.2 Trajectory of Capital Account Liberalization in 24 Emerging Countries, 1973–2005.

Source: Abiad et al. (2010).

Both the timing and the type of capital account liberalization are crucial in understanding the effects of financial opening on emerging countries (Kaminsky and Schmukler, 2008). Financial opening pursued when the global financial markets are awash in liquid capital is much more likely to lead to greater financial integration with the rest of the world compared to financial opening at a period of scarce liquidity.¹² The type of capital account liberalization that an emerging country pursues might be even more consequential than its timing. Studies show that foreign direct investment, debt flows, and portfolio investment have vastly different impacts on emerging countries (Bosworth et al., 1999; Köse et al., 2009). In particular, only foreign direct investment is associated with welfare-enhancing productivity gains, whereas portfolio investment and debt flows such as syndicated bank loans have a tendency to boost consumption rather than production (Gra-bel, 1996). Such use of funds borrowed from the rest of the world often makes developing and emerging countries more indebted. Furthermore, there is compelling evidence that relying on debt flows leads to financial fragility (Angkinand et al., 2010; Kaminsky and Schmukler, 2008; Bosworth et al., 1999; Prasad et al., 2007).

While there is a voluminous literature on capital account liberalization, the majority of existing studies on the politics of capital account liberalization do not differentiate bet...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• List of figures
• List of tables
• Preface
• 1 Introduction: distribution relations and capital mobility
• 2 Boom, crash, restraint: the politics of taming Capital flows in Chile
• 3 Embracing hot money, rejecting cold money in South Korea
• 4 Premature financial opening and boom-bust cycles in Turkey
• 5 Conclusion
• Appendix A: distribution and economic growth
• Appendix B: capital mobility and social interests
• Appendix C: perils of capital account liberalization
• Appendix D: measuring capital account openness
• Appendix E: list of interviewees
• Bibliography
• Index