Capital Account Liberalisation in China: Learning Lessons Boston, CEGI, February 13, 2014 Panel: Managing Capital Flows in China Draft Background Presentation prepared by Jan Kregel, Levy Economics Institute

Is “Managing’ the right question? Three Aspects: 1 The Paradox of Capital account liberalization as a policy recommendation 2 The “Framing” of the policy recommendation 3 The Operation of the policy recommendation

The Paradox Countries with “failed” macro policies: external deficits, fiscal deficits, hyper inflation, exchange rate collapse Primarily Latin America Countries with “good” macro policies, external balance, fiscal balance, stable inflation, stable exchange rates Primarily in Asia BOTH RECEIVE THE SAME POLICY RECOMMENDATION: LIBERALISE CAPITAL FLOWS!

The Frame The Solution to the Paradox: Both sets of countries’ policies are considered to impede the operation of the market mechanism, are inefficient and waste resources It is presumed that the market can resolve these problems But there is no definition of what a “capital” market is, or what is traded in these markets And Policy tends to mistake instruments (opening markets) with objectives Capital market liberalization becomes an objective in itself, irrespective of whether it furthers other objectives: stable growth of income and jobs

The Application Policies are recommended in bilateral or multilateral negotiations Japan-US Latin America-IMF/WB Asia-IMF/WB/US They are usually meant to remedy bi-lateral international imbalances In fact they remedy problems in the developed countries not in the developing countries that are forced to introduce liberalization

The Outcome Japan — Liberalisation under pressure from produced the opposite of the expected results, and then a boom followed by stagnation Korea — Liberalisation produced a financial crisis independent of the crisis in SE Asia Both sacrificed financial stability and growth in the aftermath of crises caused by capital liberalization

What should be “managed”? Chinese conditions resemble those of Japan and Korea The law of unintended consequences is likely to apply (or markets will not operate to produce optimal allocation of resources) Capital outflows and exchange rate volatility likely to result, making internationalisation of the RMB difficult Unlikely to make firms more efficient

What was wrong with Chinese growth strategy? Excessive reliance on investment Excessive reliance on exports Excessive savings (foreign savings are clearly not needed) “Management” of capital flows needed to rebalance from I + NX to C + G AND keep growth and employment stable Will “managing” capital market liberalization allow this?