Capital Controls, Accumulation of Reserves, and Economic Growth

04/01/2023
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Digest Capital Controls: This is a line graph titled Average foreign Reserves as a Share of GDP. The y-axis is given as a percentage and ranges from 0 to 50 percent, increasing in increments of 10. The x-axis is years and ranges from 1985 to 2019, increasing in increments of 5 until the shift from 2015 to 2019. There are 3 lines of data labeled East Asian countries, Emerging Market Economics, and Advanced Countries. The East Asian Countries line started at around 15 percent in 1985 and increased steadily until around 2010, reaching approximately 45 percent. It declined to 30% by around 2017. The Emerging Market Economies experienced a steady climb from about 15 percent in 1985 to above 30 percent in 2010. It then stagnated until 2015 before experiencing a sharp drop to under 25 percent. The Advanced Countries started at 10 percent in 1985 and hovered below the 10 percent mark without much change until the mid 2000s. In the 2010s, the line passed the 10 percent mark but hovers between the 10 and 15 percent range. The source line reads Source: Researchers’ calculations using data from the International Monetary Fund.

Strong capital controls coupled with foreign reserve accumulation can contribute to growth in real GDP and total factor productivity, particularly in emerging markets.

The effect of capital controls on economic performance is a central question in open-economy macroeconomics. In Catching Up by ‘Deglobalizing’: Capital Account Policy and Economic Growth (NBER Working Paper 30944), Paul Bergin, Woo Jin Choi, and Ju H. Pyun use data from 45 countries from 1985 to 2019 to study how capital controls coupled with reserve accumulation affect the growth rates of real GDP and total factor productivity (TFP).

Drawing on data from the IMF’s International Financial Statistics database, the Penn World Table, the World Bank’s World Development Indicators, and an indicator of the stringency of capital controls across countries and over time, the researchers find that “strategic capital account policies,” capital controls combined with reserve accumulation, are associated with higher growth in real GDP and TFP. They estimate that for countries with strong capital controls, a group that is illustrated by China before 2011, a 1 percentage point increase in the reserves-to-GDP ratio is associated with a 0.41 percentage point rise in the annual real GDP growth rate. The effect is more muted for countries with moderate capital controls, which they describe as similar to those in Korea until 2007. For these countries, a 1 percentage point increase in the reserves-to-GDP ratio translates into a 0.082 percentage point increase in real GDP growth.

With respect to TFP, for a country with very strict capital controls, a 1 percentage point increase in the annual growth rate of the reserves-to-GDP ratio is associated with a 0.23 percentage point rise in annual productivity growth. For a nation with capital controls similar to those of the median emerging market economy in the sample, the effect of faster reserve accumulation is more muted, about 0.14 percentage points of annual TFP growth per percentage point rise in reserve growth. The researchers explore the contribution of productivity growth in various sectors to the rise of economy-wide TFP. They find that nearly all of the effect is due to rising labor productivity in manufacturing. The contribution of rising manufacturing productivity is amplified by a shift in economic activity toward the manufacturing sector in countries with strategic capital account policies.

In interpreting their findings and providing a mechanism that links reserve accumulation with growth, they point out that in the presence of tight capital controls, there is a one-to-one correspondence between the growth of reserves and the level of net exports. Raising export levels requires expansion of the traded goods sector, of which manufacturing is a key component. As labor is reallocated toward this sector, economy-wide average productivity may increase, and there may also be effects through channels such as learning-by-doing that raise TFP in manufacturing and other sectors.

— Linda Gorman