After the Second World War, advanced economies began an ambitious process toward capital account liberalization, which prioritized the liberalization of trade, the maintenance of fixed exchange rates, and a commitment to current account convertibility. Full capital account liberalization took over 30 years for advanced economies to achieve.
In the past, the pursuit of capital account liberalization—that is, the ability to freely undertake transactions such as foreign direct investment and the purchase of foreign securities—was motivated by different reasons in different countries. In the case of the US and UK, liberalization of capital accounts was motivated largely by their status as global currency reserve issuers and as international financial centers. For Europe, liberalization was driven primarily by the pursuit of European integration and a desire to create a common market.
That was then, this is now. Do these experiences bear any lessons for developing countries that want to pursue capital account liberalization today? Do these models provide a template for countries seeking to internationalize their currencies? Certainly, in an increasingly multipolar world, where the US dollar now shares the stage with the Euro, Yen, and Pound, such questions need to be asked. This is especially true for emerging economies, such as the economic powerhouse of China whose currency, the Renminbi, is taking on ever greater importance in international markets. The Chinese authorities have manifested their desire to see their currency become a major global reserve currency over the longer term, for which China’s capital account would have to be liberalized.
Yet, China’s path to capital account liberalization—should it choose to pursue such a policy—is fundamentally different. According to the most recent Economic Premise, author Jeff Chelsky suggests that China does not seem to have the same political agenda and objectives that provided the initial motivation for liberalization in continental Europe, nor does it have powerful domestic financial interests pushing for liberalization as did the US and UK.
Indeed, as developing countries continue to expand their global economic weight and their currencies start being used intensively abroad, the issue of capital account liberalization will come to the fore. However, the divergent motivations and domestic settings driving capital account liberalization in the EU, UK and US demonstrate that countries liberalize along different paths and for different reasons. Accordingly, for emerging economies such as China and others, we should not necessarily assume a “one-size-fits-all” approach.
First appeared at World Bank Growth and Crisis blog