Macri Imposed Capital Controls: When Will Argentina Learn Its Lesson?

To say that the Argentinian economy is not performing well is an understatement. Peso depreciation began in 2018, and ever since, Argentina has been on a downward spiral with no end in sight. Earlier this month, Argentinian President Mauricio Macri reinstated capital controls as a short-term emergency measure in the hopes that it will improve the deteriorating state of the Argentinian economy.

Before continuing, it would be prudent to define what a capital control is. A capital control is a measure taken by a government or central bank to limit the flow of foreign capital in or out of a country. They can take the form of tariffs, transaction taxes, volume restrictions, or outright bans. I had to consult my macroeconomic policy textbook from graduate school (Caves et al., 2007, p. 516), but capital controls have four possible aims:

• To discourage capital outflows in the even of a balance-of-payment crisis
• To discourage capital inflows in the aggregate, before a crisis
• To modify the composition of capital inflows, in particular to discourage short-term banking inflows, relative to other inflows
• To decouple domestic interest rates from foreign rates, with the aim of restoring some monetary independence

Let's jump back to capital controls in an Argentinian context. Prior to Macri getting elected, the capital controls were bad enough where 10 percent of Argentinian adults were buying dollars on the black market. About half of educated, middle-class adults were doing so (Schiumerini and Steinberg, 2019). Macri made a big deal of it during his 2015 presidential campaign. When he removed the capital controls shortly after his election, his decision to do so was very popular (Steinberg and Nelson, 2019). What happened Macri's election and now that he would change his mind?

Macri's initial removal of capital controls showed a break from the previous administration and a push for reform. While it provided a short-term boost of investor confidence, the Argentinian government was still borrowing a lot of money to finance its debts. Budgetary shortfalls combined with inflation and a drought that messed with Argentina's agricultural sector made matters worse, which is why the peso devalued as much as it did. The IMF-backed loan plan was not enough to stabilize the economy. As such, Macri lost the primary election (PASO) on August 11, which triggered another round of peso-selloffs because people weren't exactly confident in a Peronist government led by the leadership that got Argentina into this mess in the first place. Even if the capital controls could stabilize the peso, it does not look good for Macri's reelection chances. Macri's choice is based on his perception of stabilizing the economy along with politics.

Now that we understand the political calculus behind the decision, I have a more policy-focused question: do capital controls work? This is not a debate you see in economically developed countries because they do not need those controls. After, the globalization and integration of financial markets diminishes the need to use them. Conversely, capital controls are more common among developing countries, such as Argentina, precisely because their capital reserves are lower and their economies are more susceptible to volatility.

There are some who think capital controls succeed (Landy and Schiavone, 2018; Levy Yevati, 2011), some who think they fail (e.g., Alfaro et al., 2017; Pasricha et al., 2015; Alfaro, 2015; Carvalho and Garcia, 2006; Forbes, 2005), some who think that it depends on it being implemented short-term (e.g., Davis and Presno, 2014) or the level of short-term capital flows (Magud et al., 2011), and those at the OECD found contradictory results (OECD, 2016). The Federal Reserve Bank of San Francisco found that capital controls work better on capital inflows than outflows (Magud et al., 2007, p. 21). As for foreign exchange liquidity specifically, the Bank for International Settlements conducted some research. While capital controls reduce the cost component of FX market liquidity, they also make the market more vulnerable to order flow imbalances (Cantú García, 2017).

In the vein of the research being more ambiguous, I feel a certain ambivalence about capital controls. On the one hand, I know a country such as Argentina has not reached the level of economic maturity to do away with capital controls. Perhaps removing them suddenly as opposed to gradually was a mistake for Argentina. It is disconcerting because Argentina has cooperated with the IMF and has used other standard policy instruments to try to abate the peso devaluation.

On the other hand, not needing them shows a maturity of a given economy. I worry that capital controls are like putting a Band-Aid on a cold in that it is a short-term fix to a long-term, structural problem. As we saw with Malaysia, capital controls were used to cover up corruption and ineffective monetary policy. By limiting convertibility, the value of assets is diminished. Viewing the economy as a zero-sum game is as erroneous when discussing goods and services as it is when discussing capital.

There is an argument to be made that the success is conditional and situational, especially if implemented as a short-term solution. Even if a theoretically successful capital control could be implemented in practice, I worry that Argentina's monetary history and how Argentinians have turned to the underground market in the past would diminish the argument. At best, Macri's capital controls are going to be a temporary stop-gap that won't do too much if he cannot get a handle of the macroeconomic fundamentals.