The abrupt collapse of the Mexican peso eight months ago--an event that necessitated a $50 billion international bailout--is still echoing through the world financial system. Now comes a new report from the International Monetary Fund with a surprising--and disturbing--set of recommendations for avoiding similar disasters in the future. The IMF, which has traditionally favored free movement of capital across national borders, is now claiming that there are situations where it is advisable for governments "to influence the level and characteristics of capital inflows." Suddenly, the new role model of the developing world is not Mexico, which openly embraced foreign investment, but countries such as Chile, Colombia, and Malaysia, which impose tight controls on outside capital.
While the idea of imposing capital controls may be tempting, it should be resisted at all costs. True, rapid surges of foreign "hot money" can create headaches for government planners--and rapid outflows can help destabilize an economy, as happened in Mexico. But to focus the blame on foreign investors is to ignore the root cause of most currency crises: flawed government policies. In Mexico, government officials must shoulder the blame for massive foreign trade deficits that fed consumption rather than investment. Likewise, the explosion of Mexico's money supply wasn't caused just by foreign investors but by government officials trying to guarantee a victory by the ruling Institutional Revolutionary Party in the summer elections. Moreover, the IMF report notes that it was Mexican domestic investors who triggered the currency crisis by fleeing the peso.
In this era of quicksilver capital, the model countries should not be those that throw sand in the gears of international finance but those such as Hong Kong and Singapore, which have used foreign capital to bring prosperity to their citizens without resorting to capital controls. Rather, they exercise fiscal and monetary restraint and keep close scrutiny on their banking systems. The International Monetary Fund did no one any favors by lending credence to the idea of capital controls.