Published online by Cambridge University Press: 13 June 2011
Between the late 1970s and the early 1990s, after decades of trying to limit short-term international capital movements, advanced industrial states moved decisively in the direction of decontrol. What has driven this remarkable policy convergence? The answer lies not in ideological change or shifts in relative political power, but in the prior development of international financial markets and in the increasing globalization of business. In a policy environment fundamentally reshaped by these factors, financial institutions and multinational firms were able to threaten or implement strategies of evasion and exit. Thus, the usefulness of controls declined as their effective costs rose sharply. In this light, the cases of Japan, Germany, Italy, and France are examined. The analysis points to the tightening link between short-term capital movements and foreign direct investment, issues that have long been treated as conceptually distinct. It also underlines the intricate connection between national policies governing capital movements and those aimed at managing international financial markets.
1 See, e.g., Frieden, Jeffry, “Invested Interests: The Politics of National Economic Policies in a World of Global Finance,” International Organization 45 (Autumn 1991)Google Scholar; Webb, Michael C., “International Economic Structures, Government Interests, and the International Coordination of Macroeconomic Adjustment Policies,” International Organization 45 (Summer 1991)Google Scholar; and Mathieson, Donald J. and Rojas-Suarez, Liliana, “Liberalization of the Capital Account: Experiences and Issues,” IMF Occasional Papers Series 103 (March 1993).Google Scholar
3 Three distinct views that have framed much of the subsequent theoretical debate can be found in Keohane, Robert O. and Nye, Joseph S., Power and Interdependence: World Politics in Transition (Boston: Little Brown, 1977)Google Scholar; Katzenstein, Peter, ed., Between Power and Plenty: Foreign Economic Policies of Advanced Industrial Countries (Madison: University of Wisconsin Press, 1978)Google Scholar; and Gourevitch, Peter, Politics in Hard Times: Comparative Responses to International Economic Crises (Ithaca, N.Y.: Cornell University Press, 1986).Google Scholar
4 Helen Milner has made a compatible argument with regard to trade policy; see Milner, , Resisting Protectionism: Global Industries and the Politics of International Trade (Princeton: Princeton University Press, 1988).Google Scholar
5 See Article VI, sections 1 and 3, of the IMP'S original Articles of Agreement. John May nard Keynes, the chief British spokesman at the Bretton Woods conference and the chief opponent of the American view, bluntly explained this to Parliament: Not merely as a feature of the transition, but as a permanent arrangement, the plan accords to every member government the explicit right to control all capital movements. What used to be heresy is now endorsed as orthodox… It follows that our right to control the domestic capital market is secured on firmer foundations than ever before, and is formally accepted as a proper part of agreed international agreements. Quoted in Gold, Joseph, “International Capital Movements under the Law of the International Monetary Fund,” IMF Pamphlet Series 21 (1977), 11.Google Scholar
6 OECD, Code of Liberalization of Capital Movements (Paris: OECD, October 1986)Google Scholar, articles 1, 3,7.
7 See Conybeare, John, U.S. Foreign Economic Policy and the International Capital Markets: The Case of Capital Export Controls, 1963–74 (New York: Garland, 1988).Google Scholar For relevant back ground, see Cairncross, Alec, Control of Long-Term International Capital Movements (Washington, D.C.: Brookings Institution, 1973)Google Scholar; and Lamfalussy, Alexandre, “Changing Attitudes towards Capital Movements,” in Changing Perceptions of Economic Policy: Essays in Honor of the 70th Birthday of Sir Alec Cairncross (London: Methuen, 1981).Google Scholar
8 A separate article could, of course, easily be devoted to an examination of the most prom inent explanations for the explosive development of the international capital markets in the 1960s. For purposes of analyzing subsequent decisions to remove capital controls, the growth of the Euro-markets is treated as exogenous. For background, see O'Brien, Richard, Global Financial Integration (London: Pinter, 1992)Google Scholar; Bryant, Ralph, International Financial Intermediation (Washington, D.C.: Brookings Institution, 1987)Google Scholar; Strange, Susan, Casino Capitalism (London: Basil Blackwell, 1986)Google Scholar; Odeli, John S., U.S. International Monetary Policy (Princeton: Princeton University Press, 1982)CrossRefGoogle Scholar; and Cohen, Benjamin J., Organizing the World's Money (New York: Basic Books, 1977).CrossRefGoogle Scholar
9 See Fleming, , “Domestic Financial Policies under Fixed and Floating Exchange Rates,” IMF Staff Papers 9 (1962)Google Scholar; Mundell, , “The Monetary Dynamics of International Adjustment under Fixed and Flexible Exchange Rates,” Quarterly journal of Economics 74 (May 1960)Google Scholar: and idem, “Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates,” Canadian Journal of Economics and Political Science 29 (November 1963).
10 The Mundell-Fleming conclusion that a government has no control over monetary policy under such conditions depends on the assumption that sterilization does not or cannot occur. Evaluating the effectiveness of sterilization is a complicated matter. See Goldstein, Michael, Have Flexible Exchange Rates Handicapped Monetary Policy? Special Papers on International Economics, no. 14 (Princeton: Princeton University, International Finance Section, 1980), 36–38.Google Scholar
11 Johnson, Harry G., “The Case for Flexible Exchange Rates, 1969,” in Baldwin, Robert E. and David Richardson, J., eds., International Trade and Finance (Boston: Little, Brown, 1974), 367–68.Google Scholar
12 See Corden, W. M., Inflation, Exchange Rates, and the World Economy: Lectures on Inter national Monetary Economics, 2d ed. (Chicago: University of Chicago Press, 1980)Google Scholar, chaps. 4–6.
14 Goodman, John B., Monetary Sovereignty: The Politics of Central Banking in Western Eu rope (Ithaca, N.Y.: Cornell University Press, 1992), 18.Google Scholar
15 See Yoffie, David B., Beyond Free Trade: Governments, Firms, and Global Competition (Boston: Harvard Business School Press, 1993).Google Scholar
16 Julius, De Anne, Global Companies and Public Policy: The Growing Challenge of Foreign Investment (New York: Council on Foreign Relations, 1990).Google Scholar
17 Graham, Edward M., “The Determinants of Foreign Direct Investment: Alternative Theories and International Evidence” (Manuscript, Institute for International Economics, Washington, D.C., October 15, 1991.)Google Scholar
18 Hirschman, Albert O., Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States (Cambridge: Harvard University Press, 1970)Google Scholar; for a more recent argument regarding the effects of mobility of investment on public policy, see Reich, Robert, “Who Is Us?” Harvard Business Review 48 (January-February 1990).Google Scholar
19 In conceptual terms, the burden of capital controls falls most heavily upon fixed factors of production. Thus, labor, presumably one of the intended beneficiaries of expansionary policies that necessitate capital controls, might ultimately pay the heaviest cost.
20 The link between controls on short-and long-term flows depends upon the mobility of savings and investment. For any country, aggregate savings and investment must ultimately be equal. Imposing capital controls has the effect of reducing savings and therefore investment. The extent to which investment declines depends upon the mobility of production. If production is mobile, a drop in savings will lead to a parallel decline in investment. If production is immobile, then companies will pay higher interest rates to attract available savings. Investment will decline, but by a lesser amount. On the mobility of savings and investment, see Feldstein, Martin and Horioka, Charles, “Domestic Savings and International Capital Flows,” Economic Journal 90 (June 1980)Google Scholar; Feldstein, Martin, “Domestic Savings and International Capital Movements in the Long Run and the Short Run,” European Economic Review 21 (1983)Google Scholar; Bayoumi, Tamim, “Savings-Investment Correlations: Immobile Capital, Government Policy, or Endogenous Behavior,” IMF Staff Papers 37 (July 1990)Google Scholar; and IMF staff, “Determinants and Systemic Consequences of International Capital Flows,” IMF Occasional Paper Series 77 (March 1991).Google Scholar
21 See Frieden (fn. 1 ).
22 On the structural power of business, see Lindblom, Charles, Politics and Markets: The World's Political and Economic Systems (New York: Basic Books, 1977)Google Scholar; and Stopford, John and Strange, Susan, Rival States, Rival Firms: Competition for World Market Shares (Cambridge: Cambridge University Press, 1991).CrossRefGoogle Scholar
23 Bundesbank, Deutsche, “Freedom of Germany's Capital Transactions with Foreign Countries,” Monthly Report of the Deutsche Bundesbank 37 (July 1985), 16–17.Google Scholar
24 On the problems of capital inflows and imported inflation, see Emminger, Otmar, The D-Mark in the Conflict between Internal and External Equilibrium, 1948–1975, Princeton Studies in International Finance, no. 122 (Princeton: Princeton University, International Finance Section, 1977)Google Scholar; and Wadbrook, William Pollard, West German Babnce-of-Payments Policy: The Prelude to European Monetary Integration (New York: Praeger, 1972).Google Scholar
25 Michael Kreile, “West Germany: The Dynamics of Expansion,” in Katzenstein (fn. 3), 213; and Kennedy, Ellen, The Bundesbank: Germany's Central Bank in the International Mon etary System (London: Chatham House, 1991).Google Scholar
27 For a thorough analysis of domestic policy decisions and international economic developments in 1977 and 1978, see Putnam, Robert D. and Randall Henning, C., “The Bonn Summit of 1978: A Case Study in Coordination,” in Cooper, Richard N. et al., Can Nations Agree? Issues in International Economic Cooperation (Washington, D.C.: Brookings Institution, 1989).Google Scholar
29 Emminger (fn. 24).
31 We are indebted to Louis Wells for clarification on this point.
32 See Pauly, Louis W., “Regulatory Politics in Japan: The Case of Foreign Banking,” East Asia Papers, no. 45 (Ithaca, N.Y.: Cornell East Asia Program, 1987), 47–61.Google Scholar
33 Economist, February 2, 1985, p. 69.
36 Allen, Christopher S., ”Domestic Politics and Private Investment: Financial Regulation in West Germany and the United States,” Research Reports, no. 2 (Washington, D.C.: American Institute for Contemporary German Studies, 1990).Google Scholar
37 For institutional background and comparative assessment, see Wade, Robert, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton: Princeton University Press, 1990)Google Scholar; and Deyo, Frederic C., ed., The Political Economy of the New Asian Industrialism (Ithaca, N.Y.: Cornell University Press, 1987).Google Scholar
38 By 1973 reserves had reached U.S. $12 billion. Bank of Japan, Economic Statutics Annual (1984)Google Scholar, Table 135.
39 Horne, James, Japan's Financial Markets (Sydney: George Allen and Unwin, 1985), 145Google Scholar and Appendix 1. For a detailed discussion of the domestic struggle against revaluation, see Angel, Robert C., Expfoining Economic Policy Failure: Japan in the 1969–71 International Monetary Crisis (New York: Columbia University Press, 1991).Google Scholar On the sensitivity of the exchange rate question, see also Randall Henning, C., “Finance, Industry, and External Monetary Policy” (Manuscript, Institute for International Economics, Washington, D.C., September 1991). 40Google Scholar Frances Rosenbluth, McCall, Financial Politics in Contemporary Japan (Ithaca, N.Y.: Cornell University Press, 1989), 55.Google Scholar Note that the pattern repeated itself in 1979.
41 See Schmiegelow, Michele, “The Reform of Japan's Foreign Exchange and Foreign Trade Control Law: A Case of Qualitative Economic Policy,” in Schmiegelow, , ed., Japan's Response to Crisis and Change in the World Economy (Armonie, N.Y.: M. E. Sharpe, 1986).Google Scholar
42 Bank of Japan, Babnce of Payments Monthly, and Ministry of Finance, Monthly Finance Review, cited in Lincoln, Edward J., Japan: Facing Economic Maturity (Washington, D.C.: Brookings Institution, 1988), 248.Google Scholar
43 Note that insurance against the perceived negative consequences of too-rapid decontrol was provided in various ways, including the retention of “notice” requirements tailored to particular types of transactions, an insistence that capital outflows take place through “designated financial institutions” (two hundred domestic as well as foreign financial institutions resident in Japan), impediments to overseas investments by individuals resident in Japan, and graduated implementation timetables. Such techniques promised simultaneously to deflect foreign criticism and to allow time for domestic institutional adjustments to occur.
44 Pauly, Louis W., Opening Financial Markets: Banking Politics on the Pacific Rim (Ithaca, N.Y.: Cornell University Press, 1988)Google Scholar, chap. 4.
45 The causal importance of foreign governmental pressure is not easy to gauge. The U.S. government has not been shy about claiming credit for liberalization moves by Japan. For its own reasons, not the least of which is undoubtedly to shift the blame for moves that have not been universally popular at the domestic level, the Japanese government has often been willing to go along with this assessment. Astute observers have argued that liberalization is, in truth, unlikely in the absence of a sufficiently well developed domestic consensus but that foreign pressure can sometimes help nudge that consensus along. See Calder, Kent E., “Japanese Foreign Economic Policy Formation: Explaining the Reactive State,” World Politics 40 (July 1988).Google Scholar On the changing balance between the government and the private sector, see Pempel, T. J., “The Unbundling of Japan, Inc.: Changing Dynamics of Japanese Policy Formation,” Journal of Japanese Studies 13 (Summer 1987)Google Scholar; and Samuels, Richard, The Business of the Japanese State (Ithaca, N.Y.: Cornell University Press, 1987).Google Scholar
46 An indication of the underlying trend is provided in a bilateral Japan/U.S. comparison. In 1985 Japanese intermediaries in the United States accounted for assets totaling U.S. $178 billion; by the end of 1989 that figure had increased to $421 billion. In contrast, U.S. intermedianes in Japan accounted for assets of $18.6 billion in 1985 and $18.8 billion in 1989. U.S. Department of the Treasury, National Treatment Study (Washington, D.C.: Department of the Treasury, 1990), 208.Google Scholar
47 Note that the overseas bond activity of Japanese companies rose from ¥806.7 billion in 1980 to ¥5.3 trillion in 1988. Tokyo Stock Exchange statistics cited in Jackson, James K., “Foreign Access to Japan's Capital Markets,” in U.S. Congress, Joint Economic Committee, Japan's Economic Challenge (Washington, D.C.: GPO, 1990), 152.Google Scholar
49 By the mid-1980s central government debt totaled 42$ of GNP; the comparable ratio for the United States was 45$. See Bank of Japan-Money Market Study Group, “Japan's Short Term Money Market and Its Issues” (Mimeo, Bank of Japan, June 8, 1990); and Shinkai, Yoichi, “The Internationalization of Finance in Japan,” in Inoguchi, Takashi and Okimoto, Daniel, eds., The Political Economy of Japan: The Changing International Context (Stanford, Calif.: Stanford University Press, 1988), 251.Google Scholar
50 Note, however, the persistent lag with regard to direct investment inflows, especially those connected with acquisitions of existing assets. See Encarnation, Dennis J. and Mason, Mark, “Neither MITI nor America: The Political Economy of Capital Liberalization in Japan,” International Organization 44 (Winter 1990)Google Scholar; and Graham, Edward and Krugman, Paul, Foreign Direct Investment in the United States, 2d ed. (Washington, D.C.: Institute for International Economics, 1991).Google ScholarPubMed
51 Calder, Kent, Crisis and Compensation (Princeton: Princeton University Press, 1988), 479–80Google Scholar; on the role of the Liberal Democratic Party in this regard, see Rosenbluth, Frances McCall, “Japan's Response to the Strong Yen: Party Leadership and the Market for Political Favors,” in Curtis, Gerald, ed., Coping with Change: New Directions in Japan's Foreign Policy (New York: M. E. Sharpe, 1993).Google Scholar
53 Jurgensen, Philippe and Lebegue, Daniel, Le Trésor et la politique financière, fase. 3 (Paris: Les Cours de Droit, 1984), 48–64.Google Scholar
55 The effects of the Socialist program on capital flows are found in Bauchard, Philippe, La guerre des deux roses (Paris: Grasset, 1986)Google Scholar; Beaud, Michel, Le mirage de la croissance, vol. 1 (Paris: Syros, 1983)Google Scholar; and Hall, Peter, Governing the Economy: The Politics of State Intervention in Britain and France (New York: Oxford University Press, 1986)Google Scholar, chap. 8.
57 Mitterrand's advisers realized that domestic expansion at a time when France's major trading partners were in recession would increase the current account deficit and hence lead to more pressure against the franc. However, they expected the world economy to recover by the end of 1981 and counted on that recovery to restore a current account surplus. See Putnam, Robert D. and Bayne, Nicholas, Hanging Together: The Seven-Power Summits (Cambridge: Harvard University Press, 1984), 150.Google Scholar
58 On the evolution of Mitterrand's economic policies, see Bauchard (fn. 55); Beaud (fn. 55); Fontcneau, Alain and Muet, Pierre-Alain, La gauche face à la crise (Paris: Presses de la Fondation National des Sciences Politiques, 1985)Google Scholar; and Loriaux, Michael, France after Hegemony: International Change and Domestic Reform (Ithaca, N.Y.: Cornell University Press, 1991)Google Scholar, chap. 8.
59 Mélitz, Jacques, “Monetary Policy in France,” in Fratianni, Michele and Salvatore, Dominick, eds., Handbook of Monetary Policy (Westport, Conn.: Greenwood Press, 1993)Google Scholar, chap. 10.
61 Some firms sought to escape the wave of nationalization and the subsequent loss of control. The most prominent example was Paribas, the large financial holding company, whose CEO, Pierre Moussa, sought to sell majority control of the company to investors in Switzerland and Luxembourg. Bauchard (fn. 55), 68.
62 Interviews with French government officials, Paris, June 1988. See also holtz, Wayne Sand and Zysman, John, “1992: Recasting the European Bargain,” World Politics 42 (October 1989).Google Scholar The government's subsequent assessment of the position of French financial firms is reported by Pierre Achard, “Le marché unique de 1992: perspectives pour les banques, les assurances, et le système financier français” (Report of the Ministries of Economy, Finance, and Privatization, December 1987).
63 Cited in Euromoney, September 1987, 143.
64 See Bauchard (fn. 55), chaps. 3, 4.
65 Mélitz (fn. 59). See also Oliver, Peter and Bache, Jean-Pierre, “Free Movements of Capital between the Member States: Recent Developments,” Common Market haw Review 26 (1989).Google Scholar
67 For a broader discussion of the economic policies pursued in this period, see Salvati, Michele, “The Italian Inflation,” in Lindberg, Leon W. and Maier, Charles S., eds., The Politics of Inflation and Economic Stagnation (Washington, D.C.: Brookings Institution, 1985)Google Scholar; and Flanagan, Robert J., Soskice, David W., and Ulman, Lloyd, Unionism, Economic Stabilization, and Incomes Policies (Washington, D.C.: Brookings Institution, 1983)Google Scholar, chap. 9.
68 Spaventa, Luigi, “Two Letters of Intent: External Crises and Stabilization Policy, Italy, 1973–1977,” in Williamson, John, ed., IMF Conditionality (Washington, D.C.: Institute for International Economics, 1983).Google Scholar
69 Financial Times, November 5, 1983, and April 4, 1985.
72 Solomon, Steven, “Freeing Up Italian Finance,” Institutional Investor (November 1986), 308.Google Scholar
73 Financial Times, October 25, 1985, and April 24, 1986.
75 In 1985 the archbishop of Brescia was arrested at Milan airport for trying to take $20,000 in Italian currency on a Christmas mission to Africa. Ibid., 376.
78 On the decline of the power of organized labor in Italy, see Flanagan, Soskice, and Ulman (fn. 67), chap. 9.
79 Solomon (fn. 72); and Kirkland, Richard I. Jr, “A New Dose of Capitalism Turns Italy Around,” Fortune, April 14, 1986, p. 98.Google Scholar
80 Macleod (fn. 74).
81 For a prescient argument in this vein, see Cohen, Benjamin J., “Capital Controls and the U.S. Balance of Payments: Comment,” American Economic Review 55 (March 1965).Google Scholar
82 On the relationship between the capacities and resources of government institutions and their influence on policy-making, see, e.g., Steinmo, Sven, Thelen, Kathleen, and Longstreth, Frank, eds., Structuring Politics: Historical Institutionalism in Comparative Analysis (Cambridge: Cambridge University Press, 1992)CrossRefGoogle Scholar; March, John G. and Olsen, Johan P., Rediscovering Institutions: The Organizational Basis of Politics (New York: Free Press, 1989)Google Scholar; John Ikenberry, G., Reasons of State: Oil Politics and the Capacities of American Government (Ithaca, N.Y.: Cornell University Press, 1988)Google Scholar; Hall (fn. 55); Katzenstein, Peter J., Small States in World Markets (Ithaca, N.Y.: Cornell University Press, 1985)Google Scholar; and Zysman, John, Governments, Markets and Growth: Financial Systems and the Politics of Industrial Change (Ithaca, N.Y.: Cornell University Press, 1983).Google Scholar
83 A number of scholars have argued, for example, that Italian institutions—characterized by a weak executive, an inefficient bureaucracy, and the existence of multiple political parties—have made it impossible for any government to take the actions necessary to strengthen the national economy. See, e.g., Di Palma, Giuseppe, “The Available State: Problems of Reform,” in Lange, Peter and Tarrow, Sidney, eds., Italy in Transition (London: Frank Cass, 1980)Google Scholar; and Alan R. Posner, “Italy: Dependence and Political Fragmentation,” in Katzenstein (fn. 3).
84 Undertaken by a larger body, the study was released as Group of Ten, International Foreign Exchange Markets: A Report to the Ministers and Governors by the Group of Deputies (n.p., April 1993).
85 See Kratochwil, Friedrich V., Rules, Norms, and Decisions (Cambridge: Cambridge University Press, 1989)CrossRefGoogle Scholar, chap. 7; Ruggie, John Gerard, ed., Multilateralism Matters: The Theory and Praxis of an Institutional Form (New York: Columbia University Press, 1992)Google Scholar; and Pauly, Louis W., “The Political Foundations of Multilateral Economic Surveillance,” International Journal 47 (Spring 1992).Google Scholar
Full text views reflects PDF downloads, PDFs sent to Google Drive, Dropbox and Kindle and HTML full text views.