Economic Instability, Capital Controls, and Bilateral Investment Treaties

Last night I had the privilege of hosting Nobel Laureate Joseph Stiglitz at a roundtable at CFR. His wide-ranging remarks addressed many challenges at the nexus of poverty, inequality, and global economic governance, but one discussion stood out because it echoed and amplified a serious concern I’ve heard raised in a number of other fora over the past few months.

Dr. Stiglitz argued that unregulated capital flows can cause economic instability and financial crises when inflows and outflows are too rapid (called "hot money"), and these crises disproportionately hurt the poor. Yet the current plethora of more than three thousand bilateral investment treaties (BITs) now in force around the world, discussed in my last post, significantly constrain the ability of countries to put in place capital account regulations to guard against the risks of hot money.

The new institutional view of the IMF, issued last December, finally recognized the hot money problem (reversing their long-standing position on this issue):

Capital flows can also pose important risks however. They are volatile and can be large relative to the size of a country’s financial markets or economy. This can lead to booms and busts in credit or asset prices, and makes countries more vulnerable to contagion from global instability. The global crisis is the latest in a series of events that have shown that policymakers need to be vigilant to the risks, while maximizing the benefits of capital flows.

Yet, unfortunately, the now well-entrenched global regime of BITs  prevents countries from putting in place precisely the kinds of sensible regulations to prevent panics and crisis through thoughtful and limited capital controls that the IMF now recommends. An important new report by the Pardee Center at Boston University argues that “many FTAs [Free Trade Agreements] and BITs [Bilateral Investment Treaties] may be significantly incompatible with the ability of nations to deploy CARs [capital account regulations].” This incompatibility is a direct outgrowth of the sweeping provisions against capital controls contained in many investment treaties.

As capital exporting countries increasingly look to policy tools like investment treaties to further the global development agenda and create inclusive and equitable economic growth, the terms of these treaties will need a careful reexamination to ensure that they do not in fact exacerbate economic instability.