Losing Control:Policy Space to Prevent and Mitigate Financial Crises

in Trade and Investment Agreements

Kevin P. Gallagher

Global Development Policy ProgramDepartment of International Relations

Boston Universitykpg@bu.edu

Outline/Main points

• Renewed consensus on capital controls• Trade and investment treaties pose significant

barriers to the effective use of capital controls– US is significant outlier– Three key policy conflicts

• Trading partners offer numerous legitimate policy options

• Reforming trade treaties is in US interests

Capital Controls, Trade, and Investment Agreements

Examples of Capital Controls

Losing Control

Source: Gallagher, Kevin P. (2010), Policy Space to Prevent and Mitigate Financial Crises in Trade and Investment Agreements. G-24 Discussion Paper, Geneva: United Nations.

IMF• IMF Articles have no jurisdiction over the capital

account and therefore nations are free to deploy controls

• In surveillance and country programs IMF staff have implicitly advised nations to open their capital accounts

• “Official” stance is now for the “gradual and sequenced” liberalization of the capital account

• IMF recommends safeguards under certain conditions

WTO-GATS

• Members who have not committed to liberalizing cross-border trade in financial services are free to deploy controls.

• Members with market access commitments must liberalize their capital accounts in order to allow for the financial services to function. Therefore restrictions on inflows or outflows are not permitted.

• Possible exceptions:– Prudential “carve out” (inflows?)– Balance of Payments exception (outflows)

US BITS-FTAs

• Broad definition of investment• Minimum Standard of Treatment• Restrictions on Expropriation • Free Transfers• No Performance requirements• Investor-state Arbitration

US BITs-FTAs

• Require the free transfer of capital “without delay”– Do not permit restrictions on inflows or outflows

of any kind (absolute standard)

• Provide no safeguard or balance-of-payments exceptions– ‘Cool off’ compromise

• One year grace period• Only claim lost investment

Violating US BITS-FTAs

*EU-Chile and Canada-Chile FTAs have controlled entry clauses…

Source: Gallagher, Kevin P. (2010), Losing Control: Policy Space to Prevent and Mitigate Financial Crises in Trade and Investment Agreements. UNCTAD Discussion Paper, Geneva: United Nations (forthcoming).

Other major capital exporters

• China, EU, and Canada– Controlled entry annexes– EU-Chile/Canada-Chile vs. US-Chile

• Japan-South Korea– Flexible balance-of-payments exceptions– OECD-South Korea/Japan-South Korea vs US-

South Korea

Policy Issues

• Proven policies to prevent and mitigate financial crises are forbidden in large parts of trading system.

• Patchwork approach leads to discrimination/distortion.

• Creates incentives to circumvent controls through US

• Problems with overlapping regimes and jurisdictions.

Policy remedies

• Remove short-term debt obligations and portfolio investments from the list of investments covered in treaties

• Create ‘controlled entry’ Annexes• Design a balance-of-payments exception• Clarify that the “Essential Security” exceptions cover

financial crises, and that measures taken by host nations are self-judging.

• Resort to a State-to-State dispute resolution

Capital Controls and US Interests

• US could be found liable for prudential regulations too• Stability helps US exporters and investors have more certainty• Crises could lead to defaults and large losses to US assets and

export markets• Crises can cause contagion that spreads to other US

investment and export destinations• Crises can be politically destabilizing to important US political

allies