10
currency per DM.19 The variable DEP was not included in previous research.
(2) Retaining domestic savings
(2a) Capital controls limit differences between private and social returns
Another argument for capital controls is derived from possible differences between private and social returns.
This argument has been used particularly in relation to direct foreign investment.20 The OECD (1990a,
p. 26) assert: "Whereas a private investor will invest abroad if the after-tax return from foreign assets is
higher than the domestic return, the social return to the home country of the investment may be less than
that of a domestic investment since the employment, production and tax-revenue benefits accrue to the
host country." Capital controls can be used to retain domestic savings at home by reducing the return on
foreign assets (e.g. through the introduction ofan interest equalisation tax) and by limiting access to foreign
assets. Thus, capital controls may raise investment in the domestic economy and, hence, economic growth.
Furthermore, capital controls can be used to influence the distribution of ownership of domestic and foreign
productive assets. With capital export restrictions a larger fraction of domestic assets will be owned by
domestic residents and a smaller fraction of foreign assets will be owned by domestic residents.21 A relevant
indicator for the private return is the productivity in the business sector (PROD). The variable was not
included in previous research. The productivity in the business sector reflects the attractiveness of domestic
financial markets as the potential location of foreign capital. Countries with relatively high productivity
in the business sector are expected to have restrictions on capital import. The unemployment rate (UN)
may be a relevant indicator of social costs. With relatively high unemployment rates more capital export
restrictions are expected to be in place. Again, this variable was not included in previous research.
(2b) Capital controls to maintain internal and external balance
With respect to this argument, the OECD (1990a, p. 27) remarks: "With substantial problems with both
internal and external imbalances, policy concerns may increasingly be expressed in relation to the financing
of government debt accumulation and balance of payments deficits and the size and the composition of
external debt." Capital controls might keep interest rates down so as to reduce the cost of servicing its debt
(Wyplosz, 1988, p. 88). Thus, capital controls may help to smooth and/or delay necessary internal adjustments
to outside pressures. We conjecture that the ratio of general government financial balance to GDP (also
referred to as net lending of the government) (DEF) may be a relevant indicator for the intensity of capital
controls. Governments with large budget deficits relative to GDP are expected to impose more capital export
restrictions to preserve the tax base. This variable was also not included in previous research. Similarly,
governments with large proportions of gross debt relative to GDP (DEBT) are expected to impose capital
export controls.
Others countries have implemented capital controls measures to facilitate the financing of current account
deficits and to influence the structure of such financing. The OECD (1990a, p. 27) argues: "It may also
be felt that exchange controls can support the management of future current account flows resulting from
interest and debt payments. In this connection, restrictive regulations may be advocated with a view to
influencing the sectoral composition and term-structure of foreign debt." The subsequent empirical analysis
will introduce the ratio of current account balance to GDP (CA) as a relevant indicator. We expect countries
with large current account deficits to impose capital export restrictions and countries with large current
account surpluses to impose capital import restrictions. Note however, that countries generally show
asymmetric behaviour with respect to targeting the current account: capital export restrictions with current
19 Evidently, the proxy for Germany is less comparable with the proxy for the other EU countries. Of course, an alternative proxy
expressed in ECU also has its drawbacks. It will be dominated by Germany and it may be difficult to construct due to data availability.
20 Note that this argument is more related to long-term capital movements.
21 Capital controls may be designed to limit foreign ownership of certain sectors of the economy.