Capital Controls

Capital controls restrict the ability of households and businesses to hold assets denominated in foreign currency. Capital controls can restrict either the inflow of capital or the outflow of capital. Restrictions on the inflow of capital can include bans on foreign-owned deposits in domestic banks and thrifts, foreign purchase of domestically issued stocks and bonds, and foreign purchase of tangible capital such as land and plant and equipment. Restrictions on the outflow of capital can prevent citizens from holding foreign currency deposits in foreign banks and thrifts, purchasing stocks and bonds issued in foreign countries, and purchasing land, plant, and equipment in foreign countries.

Governments have various motives for imposing capital controls. In the 1970s, Germany imposed restrictions on the inflow of foreign capital out of concern for the competitiveness of its exports in foreign markets (Allen, 2001, 228). Foreigners purchasing German bonds tended to bid up the value of Germany’s currency in foreign exchange markets. As the value of a country’s domestic currency climbs in foreign exchange markets, its exports become costlier in foreign markets. Germany banned interest payments on large bank accounts held by nonresidents and nonresident purchase of bonds. Germany lifted these restrictions in 1981. Japan, another country concerned about the competitiveness of its exports abroad, banned foreign ownership of Japanese assets until 1980. In 1984, Japan lifted remaining capital controls.

Governments more concerned about currency depreciation are more likely to impose restrictions on the outflow of capital. Currency depreciation can unleash a wave of inflation. It makes foreign imports costlier. The United Kingdom enforced restrictions on capital outflows until 1979. France and Italy restricted capital outflows until 1986 (Allen, 2001, 228). Developing countries may restrict capital outflows because they want to keep capital at home to finance domestic economic development. They may allow their citizens to convert domestic currency into U.S. dollars if the dollars go toward the purchase of a tractor or other piece of capital equipment. They may not allow their citizens to convert domestic currency into U.S. dollars to hold a bank account in a Miami bank.

The United States has been among the countries most inclined to allow the unrestricted inflow and outflow of capital. In the 1960s, however, the United States levied an “interest rate equalization tax” that removed the incentive of U.S. citizens to purchase foreign interest-bearing assets (Allen, 2001, 228). The tax lasted into the 1970s. The North American Free Trade Agreement (NAFTA) provides for the free movement of capital between Canada, Mexico, and the United States with a few exceptions. The United States prohibits foreign ownership of radio stations, and limits the percent of a U.S. airline that can be owned by foreign investors. Mexico prohibits foreign investment in its domestic oil business. In 2005, China make a takeover bid for Unical, a large U.S. oil company. Although Chinese purchase of Unical did not strictly violate U.S. law, China dropped the takeover bid after strong opposition arose in Congress. Opponents of the takeover bid were concerned about the national defense repercussions of letting China own a large stake in the U.S. oil industry.

Part of the trend toward globalization has been the removal of all capital controls by both developed and developing countries. Capital controls as economic policy have now largely lost favor. Some exceptions include cases where national defense may be at risk.