Capital Control - Explained

What are Capital Control Measures?

Updated at June 27th, 2021

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What is Capital Control?Why is Capital Control Important?The Debate Over Capital Controls Real World Example Academic Research on Capital Control

What is Capital Control?

Capital control refers to a set of measures and procedures taken by the government, Federal Reserve, Central Bank, or other bodies to control the inflow and outflow of foreign capital in an economy. Any regulatory measure targeted at limiting the amount of foreign capital (money) that can be brought into or taken out of a country is a form of capital control. The most common capital control measures are; transaction taxes and tariffs, volume restriction and prohibition, market forces (which pertain to the trade of securities), among other measures.

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Why is Capital Control Important?

Capital control measures may be targeted at an entire economy or limited to a particular industry, sector or field. For instance, when market-based forces are used as capital control, they only affect the security market and foreign exchanges. Regulating the flow of money generated from the capital markets into and out of a countrys account is an essential practice every government must embrace. Capital control can be done by the government through its agencies and regulatory bodies or by the Central bank or Federal Reserve. When capital control measures are taken, they limit the acquisition fo foreign assets by citizens and the purchase of domestic assets by aliens or foreigners. The following are some vital points to know about capital control;

Capital control refers to a set of measures take by a government through its agencies or regulatory bodies to control in inflow and outflow of foreign capital in an economy.
The Central Bank or Federal Reserve can also take capital control measures in the form of fiscal policies to regulate financial flows from the capital market.
Through monetary policy, the government of a country enacts capital controls.
Examples of capital control measures are taxes, tariffs, outright prohibition, restrictions, among others. Capital control measures limit the ability of citizens to buy foreign assets and the ability of foreigners to buy domestic assets.

The Debate Over Capital Controls

There has been a long-standing debate over capital controls between the proponents and critics of capital control maintain that such measures guarantee the safety of an economy, critics of capital control argue that it retards the growth and efficiency if the economy. In many countries, liberal capital control measures are used while some governments embrace strict capital control measures. The capital control approach that countries also take is determined by the current situation of the economy in relation to the inflow and outflow of foreign capital in the economy. For instance, when the government perceives an assault on its currency or the presence of capital crisis, stricter capital control measures might be used.

Real World Example

Government, Central banks, Federal Reserves and other regulatory bodies often utilise capital control measures to prevent the aftermath of economic crisis. Usually, after an economic crisis, there is a high tendency that citizens would be more attracted to foreign assets and foreigners would want to generate funds form a domestic country.

Academic Research on Capital Control

Capital control measures: A new dataset, Fernndez, A., Klein, M. W., Rebucci, A., Schindler, M., & Uribe, M. (2015).Capital control measures: A new dataset(No. w20970). National Bureau of Economic Research. We present and describe a new dataset of capital control restrictions on both inflows and outflows of ten categories of assets for 100 countries over the period 1995 to 2013. Building on the data first presented in Martin Schindler (2009), and other datasets based on the analysis of the IMFs Annual Report on Exchange Arrangements and Exchange Restrictions, this dataset includes additional asset categories, more countries, and a longer time period. We discuss the manner in which we translate the information in the AREAER into a usable data set. We also characterize the data with respect to the prevalence of controls across asset categories, the correlation of controls across asset categories and between controls on inflows and controls on outflows, the aggregation of the separate categories into broader indicators, and the comparison of our dataset with other indicators of capital controls.
Capital control, debt financing and innovative activity Czarnitzki, D., & Kraft, K. (2009). Capital control, debt financing and innovative activity.Journal of Economic Behavior & Organization,71(2), 372-383. The present paper discusses the effects of dispersed versus concentrated capital ownership on investment into innovative activity. While the market for equity capital might exert insufficient control on top managements behavior, this weakness may be mitigated by a suitable degree of debt financing. We report the results of an empirical study on the determinants of innovative activity measured by patent applications. Using a large sample of German manufacturing firms, we find that companies with widely held capital stock are more active in innovation, i.e. weakly controlled managers show a higher innovation propensity. However, the higher the leverage the more disciplined the managers behave.
Corporate control contests and capital structure Harris, M., & Raviv, A. (1988). Corporate control contests and capital structure.Journal of financial Economics,20, 55-86. This paper explores the determinants of corporate takeover methods (proxy fights versus tender offers) and their outcomes and price effects. We focus on the effect of leverage on the takeover method and outcome. The model predicts, for example, that the target's stock price appreciates less following a successful proxy contest than in a successful tender offer. In addition, we obtain several other results on price effects and on the capital structure changes that accompany contests for corporate control. Some of our results are compared with the existing empirical evidence.
Capital control measures: A new dataset Fernandez, A., Klein, M. W., Rebucci, A., Schindler, M., & Uribe, M. (2016). Capital control measures: A new dataset.IMF Economic Review,64(3), 548-574. This paper presents a new data set of capital controls by inflows and outflows for 10 asset categories in 100 countries during 19952013. Building on the data inSchindler (2009)and other data sets based on the analysis of the IMFsAnnual Report on Exchange Arrangements and Exchange Restrictions(AREAER), this data set covers additional asset categories, more countries, and a longer time period. The paper discusses in detail the construction of the data and characterizes them with respect to the prevalence and correlation of controls across asset categories and between inflow and outflow controls, the aggregation of the separate categories into broader indicators, the experience of some particular countries, and the comparison of these data with others indices of capital controls.
The allocation ofcontrolrights in venturecapitalcontractsHellmann, T. (1998). The allocation of control rights in venture capital contracts.The Rand Journal of Economics, 57-76. Venture capitalists often hold extensive control rights over entrepreneurial companies, including the right to fire entrepreneurs. This article examines why, and under what circumstances, entrepreneurs would voluntarily relinquish control. Control rights protect the venture capitalists from hold-up by the entrepreneurs. This provides the correct incentives for the venture capitalists to search for a superior management team. Wealth-constrained entrepreneurs may give up control even if the change in management imposes a greater loss of private benefit to them than a monetary gain to the company. The model also explains why entrepreneurs accept vesting of their stock and low severance.

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