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Jeffrey M. Chwieroth

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"Chwieroth gives us an in-depth and fair account of what the staff of the International Monetary Fund came to believe about freedom of capital flows and, more importantly, why the IMF holds those beliefs and how its views have evolved over the past six decades. Capital Ideas will be a valuable source for researchers studying one of the key economic policy issues of our time."--James M. Boughton, author of Silent Revolution: The International Monetary Fund, 1979-1989

"This is a fascinating and important book that every student of the International Monetary Fund should read and absorb. Chwieroth buttresses his argument with impressive interview and archival research and poses a serious challenge to previous scholarship about the liberalization of global finance."--Randall Stone, University of Rochester

"What works so well about Capital Ideas is Jeffrey Chwieroth's commitment to understanding historical change and to the very challenging task of getting inside the 'black box' that is the International Monetary Fund. Chwieroth convincingly knocks down some cherished assumptions about international financial institutions and international organizations more broadly. This is a most interesting book and it is likely to be widely read and become a standard work in the field."--Timothy J. Sinclair, University of Warwick

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Capital Ideas

PRINCETON UNIVERSITY PRESS

Contents

List of Figures and Tables...................................................................................................ixPreface......................................................................................................................xiList of Abbreviations........................................................................................................xviiChapter One Introduction....................................................................................................1Chapter Two Normative Change from Within....................................................................................23Chapter Three Capital Ideas and Capital Controls............................................................................61Chapter Four Capital Controlled: The Early Postwar Era......................................................................105Chapter Five The Limits and Hollowness of Keynesianism in the 1960s.........................................................121Chapter Six Formal Change and Informal Continuity: The Reform Negotiations of the 1970s.....................................138Chapter Seven Capital Freed: Informal Change from the 1980s to the Mid-1990s................................................147Chapter Eight Capital in Crisis: Financial Turmoil in the Late 1990s........................................................187Chapter Nine Norm Continuity and Organizational Legitimacy from the Asian Crisis to the Subprime Crisis.....................226Epilogue A Subprime "Crisis" for Capital Freedom?...........................................................................255Index........................................................................................................................301

Chapter One

Few issues have attracted as much controversy as the removal of controls on international capital flows—a process known as capital account liberalization. The International Monetary Fund has been at the center of this controversy. The formal rules of the IMF provide member states with the right to use capital controls, and these rules have not changed significantly since the organization was founded in 1945. But informally, among many staff within the Fund in the 1980s and 1990s, capital controls, once part of economic orthodoxy, became identified as an economic heresy. Although liberalization was not encouraged indiscriminately, the belief that the free movement of capital was desirable—what I call the norm of capital freedom—became the new orthodoxy.

Critics of the Fund have subsequently charged it with encouraging governments to liberalize their controls prematurely, thereby precipitating the wave of financial instability that swept much of East Asia in 1997–1998 before moving on to Russia and Latin America. Critics also used this wave of financial instability to renew charges that the Fund was promoting "one size fits all" policies that ignored the different circumstances of its member states. Without a careful examination of the evidence, many critics of the Fund have jumped to the conclusion that the IMF staff uniformly advocated capital account liberalization. In examining a critical case of how international organizations (IOs) work and evolve, this book shows that many of these criticisms are unfounded.

While the staff shared a belief that capital freedom was desirable in the abstract long run, they conducted a vigorous internal debate about how to proceed toward this goal. To put it differently, though the staff adopted the norm of capital freedom in the 1980s and 1990s, they disagreed about how this norm should be interpreted and applied. As I discuss more fully below, this finding not only has important empirical implications for critics of the IMF, it also has important theoretical implications for scholars seeking to understand the behavior of IOs. Existing scholarly accounts of IOs, as well as critics of the IMF, devote insufficient attention to the possibility that a norm, once adopted, can be subject to a struggle over its interpretation and application. This book seeks to strengthen our understanding of IOs in general and the IMF in particular by bringing these important battles over norm interpretation and application into sharper focus.

Within the halls of the IMF these debates over norm interpretation and application took the form of a struggle between "gradualists" and supporters of a "big bang." Gradualists emphasized sequencing (i.e., ensuring that certain supporting policies and institutions are in place before additional liberalizing measures are undertaken), while big-bang proponents argued for a rapid move to liberalization. In addition, though both groups generally agreed that controls on capital outflows were inappropriate, gradualists viewed temporary controls on inflows as legitimate in some circumstances, whereas big-bang proponents saw even selective restraints on capital mobility as outside the boundaries of legitimate policy. As a result, though the staff collectively shared a belief in the long-run desirability of liberalization, they often offered conflicting analyses and recommendations on how to proceed toward it.

In the mid-1990s, big-bang proponents gained the upper hand within the Fund, and their informal advocacy of liberalization converged with an initiative to amend the IMF Articles of Agreement to give the Fund the formal mandate to promote liberalization as well as fuller jurisdiction over the capital account policies of its members. In granting the Fund fuller jurisdiction over the capital account, the initiative would have prohibited governments from imposing virtually all types of controls without Fund approval and would have committed governments to liberalizing existing controls. The amendment also would have enabled the IMF, for the first time in its history, to include capital account liberalization as a condition for accessing its financial resources.

In the event, the initiative failed. Proponents of the big-bang approach and the amendment saw their efforts undermined by the financial crises in Asia and beyond. Although the financial crisis that struck Mexico in 1994–1995 had moderated support for the big-bang approach, it was the Asian crisis, which many attributed to "disorderly liberalization" undertaken without regard to sequence, that played a decisive role in discrediting this interpretation and application of the norm of capital freedom. Since the Asian crisis the IMF has been much more cautious in encouraging liberalization, emphasizing sequencing and bestowing greater legitimacy to selective restraints on capital mobility.

Nonetheless, in the decade between the Asian and subprime crises, a period of norm continuity within the Fund, the tacit presumption was that the main risks to financial stability lay with poor fundamentals and institutions within emerging markets, thus placing the onus largely on these countries. Among emerging markets this norm interpretation and application generated much resentment. Emerging markets were encouraged to adjust their policies and implement structural reforms in line with universalist standards and codes that were largely Anglo-American in content, even though emerging markets had little, if any, input into the design of these standards and codes. Within the...