Capital controls in Cyprus will harm growth and liberty

Countries often impose extreme “temporary” policies in emergencies. In Britain, emergency rent controls, passed in 1917, were not substantially amended until 1988. In the Second World War, emergency exchange controls were imposed and left in place until 1979. Cyprus is now facing its own emergency, as its banking system collapses. But we should be extremely wary of so-called temporary measures, like controls on the movement of capital, designed to ease the crisis.

The EU’s Treaty of Rome is very clear. Article three demands the “abolition... of obstacles to freedom of movement of persons, services and capital”. In fact, this aspiration did not become a reality until the 1990s. Although explicit controls on the movement of capital were abolished quite early in most cases, many countries regulated pension fund and insurance company investment in ways that prevented free movement. However, it is the explicit controls that are draconian.

Capital controls restrict freedom of movement. Individuals have to go through bureaucratic processes to go on holiday and take currency with them. I had South African friends who had problems in the late 1980s when they wanted to emigrate to the UK, but could not bring their savings. Capital controls control people.

They also come with a cost. If Cypriots cannot invest in other countries, they cannot diversify their portfolios or seek higher returns. Diversification is a vital risk management tool and the smaller an economy, the more important diversification is. Indeed, a country running an offshore banking centre, as Cyprus is, simply cannot operate with capital controls – or with the threat of them.

Many of us expected that the creation of the euro would undermine free movement of capital within the EU. The inflationary excesses and investment booms that were bound to arise in some countries, as a single monetary policy was implemented in a diverse economic area, were always likely to create problems that politicians would seek to overcome using exchange controls. But an inflationary boom requires either a deflation correction or an exchange rate adjustment (which is impossible in the Eurozone). Preventing capital from leaving the country will only delay adjustment and prevent its financial sector from restructuring.

Huge numbers of bad loans have been made by Cyprus, including to the Greek government. Bad debts should be recognised and investors should take the consequences so that an orderly restructuring and winding-up of banks can be undertaken. The rest of the Eurozone should not get involved in this process. A case can be made for temporary controls on bank withdrawals to stabilise the situation while haircuts on deposits are made and legal restructuring is undertaken. But these controls must expire after a few weeks. The only role the EU should play is to expel Cyprus from the euro – and ultimately the EU – if it maintains capital controls beyond the end of May.

Philip Booth is editorial and programmes director at the Institute of Economic Affairs, and professor of risk management at Cass Business School.

Read the original City AM article here.

Some of us haven't yet forgotten the 'temporary' exchange controls in the United Kingdom between 1939 and 1979. The first page of the Exchange Control Manual (which at one time comprised 422 pages covering 81 separate Notices that had been issued since 1947) contained a stern admonition that the Manual "should not be made available to the general public". As late as the mid-1960s a Treasury minister said that to transfer money abroad illegally was unpatriotic. But where was the harm if an Englishman who expected a (further) devaluation of sterling were to sell a foreigner pounds in exchange for a foreign currency? If sterling were indeed devalued, it would be the foreigner who lost out: no British citizen would be a penny the worse off. A former governor of the Bank of England said that the British exchange control system was "as stringent, inhibiting and corrupting as any seen in a leading country in peacetime this century." (Perhaps a forerunner of British goldplating of EU restrictions?) The abolition of UK exchange controls in 1979, for which Geoffrey Howe and Nigel Lawson were largely responsible, caused me for the only time in my life (so far) to write to congratulate the Prime Minister on a matter of policy. (It was, of course,. Margaret Thatcher.) It is a shameful for the eurozone to have resurrected such a system, and I doubt if over the weeks and months ahead it will be limited to Cyprus.

Post new comment

The content of this field is kept private and will not be shown publicly.
Type the characters you see in this picture. (verify using audio)
Type the characters you see in the picture above; if you can't read them, submit the form and a new image will be generated. Not case sensitive.

Invest in the IEA. We are the catalyst for changing consensus and influencing public debate.

Donate now

Thank you for
your support

Subscribe to
publications

Subscribe