Critics of globalization view the free flow ofcapital as economically destabilizing and advocatecapital controls for four main reasons: controlsare intended to guard against volatility, preventfinancial contagion, enable infant financial industriesto develop in domestic markets, and be aneffective measure of last resort that gives governmentsroom in which to breathe while they pursueneeded reforms.
However, the empirical record does not supportthe beliefs of proponents of capital controls.Protecting domestic financial markets and impedingcapital flows have often exacerbated financialcrises and caused contagion. Controls are invariablyused for protectionist purposes rather thandevelopment and to delay reform. Most important,free capital flows, like free trade, dramaticallyimprove a country's prospects for development.
Malaysia, the only country to resort to extensivecapital controls in the midst of the Asianfinancial crisis in 1998, did not benefit from thosedrastic measures. Malaysia's restrictions wereinstituted more than a year after the outbreak ofthe Asian crisis and after the ringgit had fallen by34 percent and the bulk of capital flight had takenplace. Repealed in May 2001, the controls wereused more as a shield for a corrupt governmentand a means of denying economic liberty than asa remedy for Malaysia's woes. Unlike other countriesin crisis in the region, moreover, Malaysia hashad difficulty attracting foreign direct investment.
Developing countries would be better servedby addressing the real causes of financial turmoil.Specifically, countries should fix their unsoundbanking systems by opening their financial sectorsto foreign competition, eliminate governmentguarantees against bank failures, createindependent central banks, and move away frompegged exchange rates and toward floating orfully fixed exchange-rate regimes.