Free flows of capital do not increase output but do increase inequality

There was an IMF paper released in April 2018 – The Aggregate and Distributional Effects of Financial Globalization: Evidence from Macro and Sectoral Data – that had a long title but a fairly succinct message. It indicates that the IMF is still in a sort of schizoid process where the evidential base has built up so against the political voice and practice that the IMF has indulged itself as a front-line neoliberal attack dog that elements in its research division are breaking ranks and revealing interesting information. In part, the Brexit debate in Britain has been characterised by economists supporting the Remain argument claiming that free capital flows within Europe (and Britain) are the vehicle for strong output growth and better living standards. They claim that when Britain leaves the EU global capital flows will be more restricted in and out of Britain and that will be damaging. It is really just a rehearsal of the standard mainstream economic claims found in monetary, trade and macroeconomics textbooks. What the IMF paper does is provide what they call a “fresh look at the at the aggregate and distributional effects of policies to liberalize international capital flows” and the researchers find that, “financial globalization … have led on average to limited output gains while contributing to significant increases in inequality”. That is, the pie hasn’t really grown much as a result of all these free trade moves but a growing share is being taken by an increasingly wealthier few. And workers are the losers.

A more accessible version of the paper was published recently by Voxeu (December 2, 2019) – The aggregate and distributional effects of financial globalisation .

The IMF paper is motivated by two factors:

1. That “the efficiency (or output) benefits claimed for capital account liberalization reforms have often proven elusive, that is, difficult to identify in empirical studies”. In other words, often just ideological assertions are made without grounding in facts.

2. “while the fact that trade generates winners and losers is well recognized, the distributional impacts of financial globalization have received less scrutiny.”

The research literature is replete with evidential support for the view that opening up a nation to unfettered financial flows often leads to “financial crisis” and the “pervasiveness of booms and busts”.

In February 1998, Harvard’s Dani Rodrik published a short paper – Who Needs Capital-Account Convertibility? – where he made the point that the ‘boom and bust’ cycles that nations, particularly poorer nations, endure as a result of fluctuations in global capital flows lead to “severe economic crisis the magnitude of which would have seemed inconceivable”.

He was talking at the time about the Asian Financial Crisis of 1997, which devastated the impacted nations.

But he emphasises that while the magnitude of the Asian Crisis was substantial it was “hardly an isolated incident in the history of financial markets”.

He wrote:

Boom-and-bust cycles are hardly a side show or a minor blemish in international capital flows; they are the main story.

The intent of his article was to warn against the “IMFs next major mission the liberalization of capital accounts”. He called an embrace of that mission “sounds genuinely odd”.

He made the case of the introduction and retention of capital controls to prevent unwise short-term borrowing and capital flight.

This is because he considered financial markets to be inherently prone to failure due to “asymmetric information, incompleteness of contingent markets, and bounded rationality (not to mention irrationality)” which means that efficient market theories that abound in the standard New Keynesian framework, and, which led them to ignore the financial sector completely in their analytical frameworks are inapplicable to understanding real world issues.

In that context he concluded that “the benefits of removing capital controls remain to be demonstrated.”

Which ran counter to the IMF mantra and the European elites who had abandoned capital controls under the ‘Single Market’ (Single European Act 1986). the false claims about the effectiveness of the ‘Single Market’ are never far away from the lips of the Remainers in Britain.

Dani Rodrik concluded:

The greatest concern I have about canonizing capital-account convertibility is that it will leave economic policy in the typical “emerging market” hostage to the whims and fancies of two dozen or so thirty-something country analysts in London, Frankfurt, and New York. A finance minister whose top priority is to keep foreign investors happy will be one who pays less attention to developmental goals. We would have to have blind faith in the efficiency and rationality of international capital markets to believe that these two sets of priorities will regularly coincide.

That is a powerful statement and as time has passed, Dani Rodrik has not changed his view much.

In a recent (September 25, 2019) Op Ed – The Puzzling Lure of Financial Globalization – he and Arvind Subramanian state that:

Although most of the intellectual consensus behind neoliberalism has collapsed, the idea that emerging markets should throw their borders open to foreign financial flows is still taken for granted in policymaking circles. Until that changes, the developing world will suffer from unnecessary volatility, periodic crises, and lost dynamism.

They argue that “an important factor in China’s rise was the decision not to open the economy to capital flows”.

The data shows that “(n)early every major emerging-market financial crisis of the past few decades has been preceded or accompanied by surges in capital inflows.”

They note that:

Wealthy elites in several countries – especially in Latin America and South Africa – embraced financial globalization early on because they saw it as offering a useful escape route for their wealth.

And that nations are progressively realising that borrowing in foreign currencies result in “exploding debt burdens whenever the exchange rate weakens by too much”.

The IMF paper (and the Voxeu Op Ed) consider this issue and provide new evidence to support the, now, overwhelming view that free capital flows are not beneficial to nations.

I won’t go into their research design or empirical methodology here. You can access it yourself if interested.

They use “industry-level data” across 149 countries from 1970 to 2010.

They narrow it down to “228 episodes of financial globalisation” (although in the IMF paper they report 224 episodes).

The results (in summary) are:

1. “capital account liberalization episodes … have not had a significant impact on output but have led to a sizeable and statistically significant increase in inequality of about 4 percentage points five years after the liberalization”.

2. To check whether these results reflect the fact that “governments that choose to liberalize the capital account may be more right-wing and less likely to implement redistributive policies”, they add some controls to their statistical framework, and find that their initial results stand (after netting out other possible impacts).

3. They also find that the claim “that inequality (as well as GDP growth) may start to increase before the occurrence of major liberalization episodes” does not hold.

4. “output gains associated with capital account liberalization are small and short-lived, the distributional effects (that is, the effects on the labor share of income) are economically and statistically significant and long-lasting.”

5. “capital account liberalization episodes tend to reduce the labor share in industries with higher external financial dependence” and “in sectors with a higher natural layoff rate.”

6. Where trade unions are strong, the negative impact on the labour share is attenuated.

6. “our findings suggest that countries where a reduction in inequality is an important policy goal may need to design liberalization in a manner that balances the equity impact against the other effects.”

7. “Fiscal redistribution can also help to mitigate the adverse distributional consequences of financial globalization”.

8. “in addition to redistribution, policies could be designed to mitigate some of the anticipated effects in advance-for instance, through increased spending on education and training (so-called pre-distribution policies) to foster greater equality of opportunity.”


While the Voxeu article suggests that the “lure of financial globalisation among policymakers thus remains something of a puzzle”, we should reiterate Subramanian and Rodrik’s statement that the wealthy elites love free capital flows because they can launder money and shunt their wealth around more easily.

There is no puzzle in that.

What all this means is that another plank in the neoliberal consensus that has dominated economic policy making over the last four or so decades is crumbling and in proving to be untenable when confronted with the empirical record.

It is clear that if output growth is not stimulated but inequality rises and the labour share falls, then a few claimants are getting increasingly wealthy at the expense of the rest of us.

That is really what the neoliberal program has been about.

It has aimed to reverse the gains made by the population during the full employment, welfare state era in the post World War 2 era and reclaim a greater share of national income for the elites.

It has been clothed in all sorts of technical justifications that make it seems like we are operating in a TINA world. But the reality is clear – globalisation of financial flows is about power, wealth for a few and criminality rather than advancing the well-being of the vast majority of the population.

The fact that populations have been so benign in the face of all this is a research issue I am currently pursuing.

Why do people support agendas that kick them in the face with such contempt?

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.

This Post Has 22 Comments

  1. “The fact that populations have been so benign in the face of all this is a research issue I am currently pursuing.”
    Brilliant. Politicians in the eurozone are still frightened of foreign investors leaving and project that fear onto voters. Radical left parties are gaining votes, but not enough to make a difference, and they’re increasing the conservative fear by talking about taxing capital.

  2. Unfortunately:
    “Exchange controls simply do not work very well, and the longer they are in place, the worse outcomes they produce. They are easily evaded, and the combination of avarice and ingenuity, upon which modern economics rests, guarantees that evasion routes will be found and agressively persued. Graft and corruption often accompany exchange controls …”
    For details see:
    Dunn – The Misguided Attractions of Foreign Exchange Controls – Challenge 2002

  3. It’s always been confusing to me what the word ‘capital’ means in economics. Sometimes it means actual things like the machines and buildings used to produce things- sort of like the immediate product of Investment spending, rather than the goal of production in general. Sometimes, like in this post, it mostly just seems to be money that is being discussed. What is a good definition of capital?

    Sometimes economists will say that the flip-side of a trade deficit is a capital surplus. Often times it is said in order to minimize perceived negative effects of trade imbalances, at least in my opinion. Is their statement correct?

  4. Maybe I was thinking of a ‘capital account’ surplus rather than a ‘capital surplus’ which goes back to my confusion with the word capital in economics.

  5. Bill, is this sentence correct as written or does it need the ‘not’ I inserted?
    “The IMF paper (and the Voxeu Op Ed) consider this issue and provide new evidence to support the, now, overwhelming view that free capital flows are [not] beneficial to nations.”

  6. Dear Kingsley Lewis (at 2019/12/10 at 2:01 pm)

    Perhaps we should ask Malaysia or more recently Iceland about that.

    best wishes

  7. ‘The fact that populations have been so benign in the face of all this is a research issue I am currently pursuing.

    Why do people support agendas that kick them in the face with such contempt?’

    The fundamental question that maybe only a study of media propaganda and psychopathology can answer. In Britain, two days before an election, we have witnessed a tsunami of misinformation via fake websites, quasi subliminal flashes of disinformation memes and a press that nearly 100% repeats myths about the monetary system. This means that what could be a break with the neo-liberal order will probably be lost. Labour, of course, shoots itself in the foot about tax and five year rolling windows which fuels the opposition despite a great manifesto in many respects.

    It is very depressing. The right wing media pedals Brexit as a stand alone solution relying on magical thinking, as if leaving the EU ALONE is some kind of solution. This is then dressed up in dodgy patriotism and flag waiving. There has been no real explanation of the reasons for leaving the EU plus the fiscal policies needed in conjunction with that just some vague bullshit spin that as soon as we leave there will be a national revival. ‘get-brexit done…get brexit done..get brexit…done..’ with Johnson babbling, burbling, bullshitting, talking blather and bollocks, imperiously not turning up to debates and controlling interviews by uttering a stream of consciousness word salad designed to obliterate any questions.

    Corbyn’s attempt to point to the underlying issues and take the focus of the Leave.Remain polarities seems to have become inaudible.

    Most worrying are the fact that people in the most deprived areas are turning to the Tories like turkeys voting for Christmas whilst shoving the stuffing up their own a*se. One feels the breath of proto-fascism here such has been the effect of an efficient mis- and disinformation machine of . Despite Corbyn, the historic failure of the Left over the last 30 years seems to have carried forward with, of course, a timely intervention by the Chief Rabbi in order to throw largely bogus notions of antisemitism into the mix while Tory racism goes virtually unreported. Add to that a bizarre pro- remain pact between Lib Dems and Greens with greens opposing Labour (and their green Industrial Revolution) in some marginals!!! More fissures and fault lines than in the face of W.H Auden (

    The vacuousness of it all is beyond words now….(apologies for]s hard living through this stuff).

  8. “Why do people support agendas that kick them in the face with such contempt?”

    I’m glad that finally some quality economist is dealing with this theme. I look forward to see the results.

    What evidence has shown me is that people (elite and non-elite) genuinely believe in their failed economic world view.

    Of course, it is easier to believe in something that benefits you – everyone is subjected to bias. If free capital flows are something that favours your wealth, you probably would be more prone to accept a theory that claims that free capital flows are good to the economy/society, and less prone to believe in theories that dispute that claim. And if you are the elite, you probably has more control over economic narrative (through the media or academia or whatever), so your view may spread. But most people are not decieving others on purpose.

    Also, the common non-elite people, like me, are ignorant: they appeal to their intuition without realizing that intuition is not good to grasp economics (and statistics and many other things). They don’t realize that the government doesn’t work like a household. It is an almost impossible task to get free from one’s intuition and face the facts.

  9. Simon Cohen (Dc 10th 21.29)

    One of the fundamental reasons why the ideological force behind MMT has yet to prove its generic superiority over Capitalism can be found in the following Vladimir Lenin quotation.

    “We can and must write in a language which sows among the masses hate, revulsion, and scorn toward those who disagree with us.”

    It is this unremitting pursuit of Marxism’s fundamental enemy that contributes to peoples doubt about its purity and practicable application. It is a shame that MMT is used as such an uncompromising tool in the battle.

  10. I think it comes back to geopolitics only reason to come up with this madness.

    It is as if certain economic departments were tasked with this objective in mind. Now throw their hands up and say what is the problem. We were only doing what we were asked to do. It is easier than sending in a standing army that congress would not vote for.

    The Bremer plan in Iraq was the next step after the blue print in Chile. Neither of these happened by accident some economist or economists put these plans together. Same thing is happening in Argentina today. Remove capital controls borrow in a foreign currency – Neoliberalism 101.

  11. @ Kingsley Lewis

    Special pleading. Pure and simple.

    In the case of Iceland the (“graft and corruption”) boot was spectacularly demonstrated to be on the other foot. But if you want to go on advocating “do nothing” I imagine that no evidence will deter you.

  12. @ Simon Cohen

    Do you want Britain out of the EU or don’t you?

    I think emotion may be clouding your judgment if you don’t mind my saying so (though it’s easier for me since I don’t live in the UK). This was always going to be a one-issue election: “go ahead with Brexit? or not?” What else was to be expected, considering the course of events which has led us into this mess?

    Anything other than the Remain camp’s decisive defeat will be a disaster IMO and the fact that Johnson is the only person likely to deliver that is all that concerns me. I’ll worry about what comes next once the road-block has been shifted – for good.

    “Corbyn’s attempt to point to the underlying issues and take the focus of the Leave.Remain polarities seems to have become inaudible”
    is too kind to Corbyn. He should have stayed true to his roots and his principles. Then at least his integrity would have been intact. To try to “take the focus off the Leave/Remain polarities” was always futile considering that it’s those “polarities” which are the reasons why this election is even happening.

  13. I didn’t write this, a guy on another site did. He isn’t an MMTer.
    But, it says things that you-all ought to think about.
    Please comment on it.

    Samuel Vines wrote, “I have never really liked it when tax is framed as a way to fund the government. All the more since we appear to live in the time when the government is depicted as others, rather than a selected subset of ‘us’ enabling ‘us’ to function as society, appointed by us, executed by us. We forget that funding government, technically, means it is a way to fund us, not them.

    I always thought that tax is a formal acknowledgement that for any production, acquisition or transaction, we all have contributed to it, by setting up a mighty complex of frameworks, safeguards and resources that ultimately underpin your opportunities or windfalls.

    And that tax is simply a contribution or (re)payment for the work that society has put into each and every transaction. Including yours.

    Tax is dues you owe society. It is less an alien levy at gunpoint, but more a rightful claim for the part of society played in creating the product, or the space for the transaction. Tax is a recognition that a return on investment ought to include a return on the (ongoing) investment made by society, and not just pretend it was only something that happened by the power of creators and ‘investors’. Gunpoint comes only into it when people refuse to acknowledge that wider society has been an integral part of ‘your’ product or transaction from the outset to its finalisation. Gunpoint only happens if you refuse to pay the rightful bill for that.

    What level of taxation is fair for a given value, what type of framework is deemed desirable by society, what society thinks is a good balance between cost and created opportunities and safe guards for all, etc, is all a discussion that will never find universal agreement. Sure there is a point at which tax can become daylight robbery, but tax itself isn’t robbery. Sure the framework can suck. But the principle is there. It is up to society to be efficient, cost-effective and fair.

    But depicting tax as a way to pay for government gives power to the perception that a self-made person is indeed clobbered over the head by government for its cost which bears no direct relation to you or your wealth. You are just the randomly assigned juicy target ripe for plucking.

    As it totally obscures that (ongoing) communal investment plays a significant part in all aspects of the self-made wealth creation (or retention) ‘myth’. If you took an extraordinary opportunity (or were just born out of the right vagina) you can also acknowledge fairly the extraordinary contribution that others played by creating the space in which it could happen, it could flourish. The space which kept you and others involved safe and supported. The space which created your customers our counterparts to begin with. The space which also insures we all pick up the tab for you and your cock-ups, by covering the aspects of a spectacular and disastrous fall-out if things had gone really tits up, beyond regular ‘insurance’.

    Depicting tax as a way to pay for government simply isn’t accurate. It is so much more.”

  14. @ Steve_American

    Depicting tax as a way to pay for government simply isn’t accurate. It is so much more

    Whilst there is much to sympathise with in this passage; particularly in regard the taxation of wages or consumption; it is not clear it can provide a calculus for equity in the taxation of profit. The lucky punter enjoying a profit from a transaction need only point to the loss being taken by their competitor to disabuse you of the notion that society’s contribution facilitated the profit. If the profit is to be taxed according to society’s share in the profit, why not the loss subsidised?

    I suspect that those that see taxation of profits as a discouragement or disapprobation of the pursuit of profit have more the right of it.

  15. prof. Mitchell,

    As usual very interesting blog!

    Regarding: “The fact that populations have been so benign in the face of all this is a research issue I am currently pursuing. …”Are you maybe looking at the effect of media on people’s beliefs for that?

  16. @Simon: Agree with everything you’ve written. After a brief flush of hope, now falling into weepy depression. This is very apt and I’ve FB posted and tweeted it: “Most worrying are the fact that people in the most deprived areas are turning to the Tories like turkeys voting for Christmas whilst shoving the stuffing up their own a*se.”

  17. Re- Simon Cohen
    Tuesday, December 10, 2019 at 21:29

    I share your feeling from the 4th para, very depressing but did note on your spelling mistake “…flag waiving.” that maybe things would be better if we did waive some flags.

    “waive wāv►

    transitive verb
    To give up (a claim or right, for example) voluntarily; relinquish. synonym: relinquish.
    transitive verb
    To refrain from insisting on or enforcing (a rule, penalty, or requirement, for example); dispense with.
    transitive verb
    To refrain from engaging in, sometimes temporarily; cancel or postpone.”

    Thanks, John

  18. brendanm wrote:-

    “If the profit is to be taxed according to society’s share in the profit, why not the loss subsidised?

    I suspect that those that see taxation of profits as a discouragement or disapprobation of the pursuit of profit have more the right of it”.

    Completely agree.

    Seems to me that Samuel Vines’s account is cast entirely in terms of a transaction. In which case, how to justify the use of taxation as an instrument aimed at achieving a perceived “good” – such as “fairer” shares of the nation’s wealth? His argument would completely rule out progressive taxation,

    That seems to me to be a fundamental blind-spot which invalidates much else in his thesis that is otherwise sound – as far as it goes. Leaving out that dimension means that as a whole it doesn’t really stand up.

  19. “the fact that people in the most deprived areas are turning to the Tories like turkeys voting for Christmas”
    Check with Craig Murray ( He indicates that the major British media are bending the story a bit.

  20. @ robertH,
    I didn’t read Samual Vives post that way. He said that the rich should be made to pay more taxes because their profits are mostly the result of all the other people in the society. People who built the roads that their raw material use to come to their factories and used to go to the distribution centers, etc. And educated their workers so they could work efficiently, etc.
    This is how I read his words.

  21. Discussion about tax here reminds me that Georgists should support MMT as they are fiercely ‘single-tax’ advocates. In fact they advocate pigouvian taxes because that is how they classify LVT. Their ‘religious’ fervour doesn’t extend to taxation for the purpose of redistribution via taxes on wealth and excessive salaries (which are economic rent).

  22. @ Steve

    I think you’re reading *into* his words something that isn’t there. I don’t see tax as a transaction. It seems to me he sees it exclusively in just those terms: ie, the rich should pay more *because* they’ve benefited more. I think what tax they’re required to pay on therir income is not directly linked to how much they’ve benefited but is aimed at reducing gross (in all senses of that word) disparities in wealth and the power that goes with it.

    Tax in former times was an exaction:- “pay up – or else…” it still is, but nowadays it can be one which is tailored to serve a – constructive, if that’s the intention – social purpose.

    I’m not criticising him: he’s as entitled to his views as anyone else (and his heart’s in the right place). I just don’t see it the same way, that’s all.

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