Does Policy Space Impact Global Capital Flows?

• In Event: What Trade Agreements Accomplish

Abstract

Capital controls are an important policy tool that countries can use to weather financial crises by halting or mitigating capital flight. While neoliberal economics previously preached the importance of open capital accounts, the IMF now recognizes the importance of capital controls and recommends that countries maintain some independence over these policies. Some trade and investment treaties, however, restrict a country’s policy space for managing capital flows. Free trade agreements (FTAs) in particular have increasingly been including clauses governing the movement of capital. This study builds on research by Thrasher, Sklar, and Gallagher (2020), who developed a scoring system for FTAs to quantify the variation in policy space for capital flow controls. They find that policy space has shrunk over time, but has this had a discernible effect on capital movement? Do these regulations actually restrict government policies? Using bilateral investment data from the IMF’s Coordinated Direct Investment Survey (2009-2020), I examine how the diffusion of these clauses through the FTA network impacts investment flows with special attention paid to shifts in investments during local financial crises.

Author

• Sarah Sklar, Boston University