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Sustaining open capital accounts: international norms and domestic institutions: a comparison between Peru and Colombia

Leiteritz, Ralf J. (2010) Sustaining open capital accounts: international norms and domestic institutions: a comparison between Peru and Colombia. PhD thesis, The London School of Economics and Political Science (LSE).

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Financial liberalization programs have been adopted by many countries in Latin America during the past twenty years. Opening the economy to inflows and outflows of capital – ‘opening the capital account’ – has been a key part of these programs. Many economists have heralded capital account liberalization as a ‘fast track’ to economic growth and efficiency in developing countries, partly due to the way that it tightens the constraints on governments and disciplines them to avoid ‘bad’ policies. Others, however, have emphasized the dangers of capital account openness, such as its close relationship with financial crises and the substantial risks it poses for macroeconomic stability. While some governments have sustained the opening of their capital account over decades, others have reversed course after only a short time. The existing literature has focused on the adoption of capital account liberalization, but has neglected to consider the reasons for its durability or fragility. My dissertation addresses the question of why different countries have sustained their opening of the capital account to different degrees and for different periods. The central argument is that the sustainability of capital account openness is determined by domestic informal institutions. By informal institutions I refer to the shared understandings or rules among a country’s policymaking and business elites about legitimate economic policies. Whether capital account openness is sustained over time depends on the extent of domestic agreement as to whether capital controls continue to be effective and legitimate, or whether they have lost their effectiveness and legitimacy as instruments of macroeconomic policymaking. Not only is my dissertation the first study of the sustainability of capital account openness, it is the first to emphasize the importance of informal institutions as distinct from formal ones. The next question refers to the factors that determine the content of domestic informal institutions, such that they favor capital account openness in some countries, and are much more equivocal in others. My answer emphasizes the legacy of pre-liberalization state-business relations. Capital account openness is unlikely to be sustained over time if the export-oriented sector of the economy – concerned about a stable and competitive exchange rate – preserves its leverage over national policymaking. Conversely, capital account openness tends to become a durable policy if economic actors benefitting from capital mobility and largely unaffected by exchange-rate issues dominate state-business relations. After the introduction, Chapter 2 describes the essential elements of capital account policy and explains the methodological approach of the dissertation. Chapter 3 provides an overview of the literature to explain capital account policy. It distinguishes between interest-based, institutionalist, and ideas-based approaches located at different levels of analysis. This review highlights a notable gap in the literature. Analyses of the role of informal institutions at the domestic level are conspicuously lacking. My dissertation seeks to fill this analytical lacuna. Chapter 4 analyzes the international campaign for capital freedom, personified by the International Monetary Fund. How did the push for capital account liberalization come into being at the international level, and how has the capital account policy discourse within the IMF evolved until the present time? Ultimately, the attempt to transform capital freedom into an international norm was not successful. The effects of the Asian financial crisis in 1997-98 within and outside the IMF undermined the international norm campaign, symbolized by the failure of the attempt to change the IMF’s Articles of Agreement in order to give the organization the legal mandate over member-states’ capital account policies. However, the IMF still subscribes to the idea that the free movement of capital is a desirable policy for all countries. Yet country responses have been very different. Chapters 5 and 6 examine the link between IMF prescriptions and domestic policy outcomes, fleshing out the central argument with case studies of Peru and Colombia, respectively, in the time period from 1990 to the present day. Both countries shared similar economic challenges, a national community of elite economists convinced of free-market principles, and outside pressure from the IMF. At the start of the liberalization period in the early 1990s, both switched from a largely closed to a largely open capital account. However, due to the effect of different informal institutions based on different state-business relations, Peru and Colombia then followed different paths. The two cases serve to illustrate that, in the broader context of financial liberalization, socially shared understandings about legitimate economic policies reinforce or constrain the impact of international norms, thus making – or breaking – attempts at economic reform. Scholars interested in explaining the sustainability of neoliberal economic reforms and the impact of international norms and ideas on domestic policy choices ignore the role of domestic informal institutions at their peril. Traditional approaches focused on material interests, formal political and economic institutions, and global norms and ideas fail to account for the variation of capital account policy in an age of mobile capital. Paying heed to the change and continuity of shared understandings about legitimate economic policies is key to understanding both the influence of international norms on domestic policy, and the durability or fragility of economic reforms. In order to become institutionalized in the domestic political economy, international norms setting out to diffuse free-market policies must encounter a social context in which alternative development strategies have lost their legitimacy.

Item Type: Thesis (PhD)
Additional Information: © 2010 Ralf J. Leiteritz
Library of Congress subject classification: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
Sets: Departments > International Development
Supervisor: Wade, Robert H. and Shadlen, Ken

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