Sta. Ana coordinates Action for Economic Reforms ( This

piece was published in the March 22, 2010 edition of the BusinessWorld, pages S1/4 to S1/5.

You say you want a revolution
Well you know
We all want to change the world.

The Beatles

Harvard’s Dani Rodik calls it a revolution.  It is a revolution without bullets and armies, without fanfare and trumpets. It’s a quiet revolution—expressed in a resurrected idea.  Actually, it’s old wisdom that was suppressed for several decades by conservative, rigid economic doctrine.  And it is a revolution that is endorsed by no less than the much-maligned International Monetary Fund (IMF).

What is this that Rodrik calls a revolution?  Let’s quote his opening paragraphs in his essay “The End of an Era in Finance,” 11 March 2010 (Project Syndicate):

“In the world of economics and finance, revolutions occur rarely and are often detected only in hindsight. But what happened on February 19 can safely be called the end of an era in global finance.

“On that day, the International Monetary Fund published a policy note that reversed its long-held position on capital controls. Taxes and other restrictions on capital inflows, the IMF’s economists wrote, can be helpful, and they constitute a ‘legitimate part’ of policymakers’ toolkit.”

Rodrik is referring to the paper prepared by the IMF’s Research Department titled “Capital Inflows: The Role of Controls,” co-authored by Jonathan D. Ostry, Atish R. Ghosh, Karl Habermeier, Marcos Chamon, Mahvash S. Qureshi, and Dennis B.S. Reindhart.

This paper endorses capital controls as part of the policy menu emerging market economies like the Philippines can use. Capital controls prevent “exchange rate overshooting (or merely strong appreciations that significantly complicate economic management)” or prevent “asset price bubbles, which can amplify financial fragility and crisis risk.”

The paper’s “key conclusion is that if the economy is operating near potential, if the level of reserves is adequate, if the exchange rate is not undervalued, and if the flows are likely to be transitory, then use of capital controls—in addition to both prudential and macroeconomic policy –is justified.”  The conditions identified by the IMF paper exist in the Philippines.

The IMF paper argues that “[s]uch controls, moreover, can retain potency even if investors devise strategies to bypass them, provided such strategies are more costly than the expected return from the transaction: the cost of circumvention strategies acts as ‘sand in the wheels.’”

A nice thing about the paper is that it argues not on the basis of theory but on the basis of evidence.  To avoid any misinterpretation of the IMF paper through paraphrasing, I prefer to quote it extensively:

“Controls seem to be quite effective in countries that maintain extensive systems of restrictions on most categories of flows, but the present context relates mainly to the reimposition of controls by countries that already have largely open capital accounts. The evidence appears to be stronger for capital controls to have an effect on the composition of inflows than on the aggregate volume (though empirical models linking aggregate inflows to controls are frequently subject to a host of objections, most obviously, simultaneity bias). For example, in the case of Chile and Colombia,
controls do appear to have had some success in tilting the composition of inflows toward less vulnerable liability structures.”

Further, in relation to the current crisis, the IMF paper says:

“[O]ur own empirical results suggest that controls aimed at achieving a
less risky external liability structure paid dividends as far as reducing financial fragility. An interesting twist is that some foreign direct investment (FDI) flows may be less safe than usually thought. In particular, some items recorded as financial sector FDI may be disguising a buildup in intragroup debt in the financial sector and will thus be more akin to debt in terms of riskiness.”

To bolster Rodrik’s point that a revolution has occurred, I may add, that the paper on the role of capital controls supplements another IMF paper titled “Rethinking Marcroeconomic Policy” (12 February 2010). Olivier Blanchard, Giovanni dell’Ariccia, and Paulo Mauro prepared the latter paper. Take note that Blanchard is the IMF’s Economic Counselor and Director of its Research Department.  In short, he’s the IMF’s chief economist.

The paper of Blanchard et al. likewise turns upside down, the dominant views before this, namely: 1) the central bank’s primary attention on inflation targeting, 2) the skepticism about discretionary fiscal policy, and 3) the exclusion of financial regulation as a macroeconomic policy instrument. The paper admits that “the conceptual framework behind macroeconomic policy was so flawed.”

All told, the IMF papers cited above call for greater policy space or flexibility.  They encourage the use of more instruments, including those eschewed before such as discretionary fiscal and regulation tools towards securing different targets, not limited to inflation, for example.

These ideas now championed by the once “neo-liberal” IMF are very relevant to the current Philippine environment.  The global economic recovery (albeit still weak) and the return of investor confidence in the Philippines if the outcome of the forthcoming national elections is credible will result in a massive inflow of foreign investments.  This will further appreciate an already strengthening Philippine peso— which hurts the economy’s real sector. At a time of political transition, the great danger of a hurting economy arising from currency overvaluation is that it creates conditions for destabilization.

We do hope the Bangko Sentral ng Pilipinas and other policy makers have seen the favorable implications of the economic revolution that Rodrik has described.

And we await their action.

You say you got a real solution

Well, you know

We’d all love to see the plan.

The Beatles