Thank you for the opportunity to submit comments on this important issue. I share many of the concerns raised by other witnesses regarding the investment protections in U.S. trade and investment agreements. As the Director of the Global Economy Project at the Institute for Policy Studies, I have published several relevant reports, drawing on interviews with policymakers and legal experts, as well as individuals directly affected by investor-state cases in the United States and several other countries.[1] My overall view is that reforms of these rules are needed to correct the current imbalance between the broad public interest and the interests of private foreign investors.

This testimony focuses on one particular set of investment protections — the provisions that restrict the use of capital controls. Particularly in light of the current global financial crisis, these provisions deserve much greater attention. My testimony can be summarized with the following three points, elaborated in detail below:

1. The capital control restrictions in U.S. trade agreements and bilateral investment treaties are outmoded. Particularly since the Asian financial crisis of the late 1990s, there has been growing consensus among noted economists that such measures, while not a panacea, can be effective tools for preventing and responding to financial instability.

2. Allowing other governments the authority to apply sensible capital controls is in the interest of the United States. In a globalized world, expanding the policy options to combat financial crisis makes sense for U.S. businesses, workers, and the environment. Eliminating the preferential treatment for foreign investors in current capital transfer rules could also help prevent foreign policy conflicts.

3. Capital control provisions are ripe for reform. The current crisis has opened an important opportunity to construct new rules and institutions that can prevent future crises and advance stable, sustainable development. Allowing governments greater flexibility to use capital controls would be one important step towards that goal, and important precedents exist that could point the way.

Detailed Discussion

1. The capital control restrictions in U.S. trade agreements and bilateral investment treaties are outmoded. The International Monetary Fund (IMF) abandoned its blanket opposition to capital controls after several countries used these measures effectively to avoid the worst impacts of the Asian crisis in the late 1990s.”[2] In recent years, the Fund has advised at least two countries, Bulgaria and Croatia, to strengthen one type of capital control, reserve requirements on capital inflows.[3] And when Iceland imposed controls on capital outflows in the aftermath of the country’s banking sector meltdown, the IMF advised the government “not to lift these restrictions before stability returns to the foreign exchange market.”[4]

A March 2009 IMF report notes that “The existence of capital controls in several countries and structural factors have helped to moderate both the direct and the indirect effects of the financial crisis.”[5] Former IMF chief economist Kenneth Rogoff underscored this point in a New York Times article about India, in which he stated that the country’s stringent capital controls were helping to insulate that nation from the current crisis.[6]

Columbia University economist Jagdish Bhagwati, a strong advocate of trade liberalization, and many others have pointed out that there is little to no evidence that capital account liberalization is necessary for developing countries to attract foreign investment. In fact, six of the top ten non-OECD foreign direct investment recipients (China, Hong Kong, Russia, Brazil, Saudi Arabia, and India) have never signed a U.S. agreement restricting capital controls.[7] In Congressional testimony, Bhagwati charged that the inclusion of capital control restrictions in trade agreements “seems therefore to be ideological and/or a result of narrow lobbying interests hiding behind the assertion of social purpose.”[8]

Rogoff and Bhagwati are among a growing number of prominent economists who are speaking out in support of allowing governments the authority to impose capital controls, including Nobel Prize winners Joseph Stiglitz and Paul Krugman, Harvard University’s Dani Rodrik, and former President of the International Economic Association Guillermo Calvo.[9]

2. Allowing governments the authority to use sensible capital controls is in the economic and foreign policy interest of the United States. Businesses, workers, and the environment in this country are undermined by instability in other parts of the world, as crisis countries purchase fewer U.S. products, cut environmental spending, and expand the global pool of unemployed labor. And when governments are constrained in their use of capital controls, they have few other tools to prevent speculative bubbles or stem panic-driven capital flight. Mexico, for example, has extremely limited authority to apply capital controls under the investment rules in the North American Free Trade Agreement. In the face of massive capital flight (foreign investors withdrew more than $22 billion in the last few months of 2008),[10] the government has struggled to prop up the value of its currency by auctioning off nearly 18 percent of its foreign reserves.[11]

Depleting reserves to fight devaluation not only reduces the funds available for development, it also raises the risk of even further capital flight, as low reserve levels undermine investor confidence. In another attempt to restore confidence, the Mexican government has opened a $47 billion line of credit with the IMF, raising the prospect of another debt crisis that could undermine development and stability in the United States’ southern neighbor for many years to come.

Daniel Tarullo, recently appointed to the Federal Reserve Board, has described the U.S. government’s insistence on including capital control restrictions in trade agreements as not only “bad financial policy and bad trade policy,” but also “bad foreign policy.”[12] In testimony during the debate over the Chile and Singapore free trade agreements in 2003, Tarullo laid out what would likely happen if a government bound by these rules were to use short-term capital controls during a severe financial crisis: “As the country struggles to emerge from its recession…U.S. investors file their claims for compensation. And, of course, under the bilateral trade agreement they are entitled to that compensation. Thus the still-suffering citizens of the country are treated to the prospect of U.S. investors being made whole while everyone else bears losses from an economic catastrophe that has afflicted the entire nation. Regardless of what one thinks of the merits of capital controls, one would have to be naïve not to think that an anti-American backlash would result.”[13]

This gloomy scenario has even greater resonance today, at a time when ordinary taxpayers here and around the world are being asked to shoulder the bulk of the risk and cost of financial recovery. This is an important time to ensure that international rules achieve a proper balance between the public interest and private financial interests.

3. Capital control provisions are ripe for reform.

The investment rules in U.S. trade and investment agreements should be revised to allow governments greater flexibility to use capital controls as one tool for preventing or responding to financial instability. The following is a list of possible reforms, based on existing precedents.

Dispute settlement: Given the sensitive context in which many governments turn to capital control measures, there is a strong argument that the right to investor-state dispute settlement should not apply to capital transfers provisions. At the very least, there should be a government screening process to examine investor claims and prevent those that would have a significantly negative impact on the public interest from moving forward. The U.S. model bilateral investment treaty sets a relevant precedent by requiring that appropriate authorities of the two governments make determinations that are binding on arbitral tribunals with regard to financial services and taxation-related claims.[14]

Balance of payments derogation: Many existing international agreements allow for restrictions on capital transfers in circumstances in which a host country is confronted with a balance of payments crisis. The World Trade Organization’s General Agreement on Trade in Services, the OECD’s Capital Movements Code, and the IMF’s Articles of Agreement allow capital controls in such crisis periods, as long as they are temporary and non-discriminatory.[15] In February 2009, the ASEAN nations also agreed to an investment agreement that includes a balance of payments safeguard, as well as an exception for circumstances in which “movements of capital cause, or threaten to cause, serious economic or financial disturbance in the member state.”[16]

Article 2104 of NAFTA also allows for temporary capital controls in times of “serious balance of payments difficulties.”[17] However, the agreement includes two pages of conditions limiting the use of such measures, even in such crisis periods. For example, governments opting to use this policy tool must agree to enter into consultations with the IMF and adopt the Fund’s policy recommendations on “economic adjustment measures.” This is extremely controversial, as the IMF has been widely criticized in past crises and in the current one for imposing anti-cyclical conditions, such as freezes in stimulatory social spending and unemployment benefits, tax increases, and service rate hikes. Capital control measures under NAFTA must also meet the legal standards of being “no more burdensome than necessary” and “avoid unnecessary damage” to the interests of the other Party. Thus, while NAFTA technically offers a balance of payments exception, the hands of government officials are still quite tightly bound.

Exceptions for crisis periods were further watered down in subsequent U.S. trade agreements and are completely absent from U.S. bilateral investment treaties. The governments of Singapore and Chile reportedly requested waivers for capital control rules during crisis periods in the U.S. trade agreements with those countries. The Bush administration refused, offering only to create special dispute settlement procedures for claims related to capital transfers. Under these procedures, foreign investors can still sue for damages over measures that “substantially impede transfers” – they just need to wait an extra six months before filing their claims. A senior IMF legal counsel called the U.S. refusal to grant such a waiver “draconian” and complained that the rules might interfere with the IMF’s own power to request that a government adopt capital controls.[18]

Broader exception for financial stability measures: Allowing exceptions during times of crisis would be a positive, but insufficient step forward. Many economists argue that capital control measures are most useful if they are enacted “when the sun is shining.” Once the dark clouds of crisis become evident, it can be too late for such controls to be effective.

Chile’s encaje (“strongbox” in Spanish) is often cited as an example of effective use of capital controls through an ongoing policy. Throughout most of the 1990s, the Chilean government subjected capital inflows to a one-year, non-interest paying deposit with the central bank. The deposit requirement varied from 10 to 30 percent, and the penalty for early withdrawal ranged from 1 to 3 percent. Chile faired better than most other Latin American countries during the Mexican peso crisis in 1994 and the Asian crisis a few years later. An IMF research review concluded that the encaje, combined with other financial sector reforms, allowed the government more monetary policy autonomy and shifted the composition of foreign investment from “hot money” towards the longer term.[19] After entering into discussions of a possible trade agreement with the United States, the Chilean government eliminated the encaje in 1998. In recent years, however, numerous countries have used Chilean-style controls on inflows.[20]

One example of a broader exception for capital controls to support financial stability can be found in the Norwegian government’s 2007 model bilateral investment treaty. This agreement allows for restrictions on capital flows when necessary to ensure compliance with laws and regulations concerning financial security or the prevention and remedying of environmental damage.[21] The treaty requires equitable, non-discriminatory and good faith application of the laws. Similar language could be added to the current list of exceptions to the capital control restrictions in U.S. trade and investment agreements.


I would like to thank the Subcommittee for taking on the task of reviewing the investment rules in U.S. trade and investment agreements to ensure that they advance the public interest. This is particularly timely in light of the current financial crisis. The U.S. Congress has a tremendous opportunity to apply lessons from past crises and work with counterparts in other nations to build a more equitable, sustainable, and stable global economy.


[1] See, for example: Sarah Anderson, “Policy Handcuffs in Financial Crisis: How U.S. Trade and Investment Policies Limit Government Power to Control Capital Flows,” (PDF) Institute for Policy Studies, February 2009 and Sarah Anderson and Sara Grusky, “Challenging Corporate Investor Rule,” (PDF) Institute for Policy Studies and Food and Water Watch, April 2007.

[2] Akira Ariyoshi, Karl Habermeier, Bernard Laurens, Inci Otker-Robe, Jorge Iván Canales-Kriljenko, and Andrei Kirilenko, “Capital Controls: Country Experiences with Their Use and Liberalization,” International Monetary Fund, May 17, 2000.

[3] Daria Zakharova1, “One-Size-Fits-One: Tailor-Made Fiscal Responses to Capital Flows,” International Monetary Fund, December 2008.

[4] International Monetary Fund, “Interview with IMF mission chief for Iceland, Poul Thomsen,” December 2, 2008.

[5] International Monetary Fund, “The Implications of the Global Financial Crisis for Low-Income Countries,” March 2009.

[6] Kenneth Rogoff, “Rogoff: The Exuberance of India,” New York Times, January 31, 2009.

[7] UNCTAD, World Investment Report 2008.

[8] Jagdish Bhagwati, “U.S. House of Representatives Committee on Financial Services Testimony Subcommittee on Domestic and International Monetary Policy, Trade and Technology,” April 1, 2003.

[9] See box of quotes from noted economists on pages 10-11 of the report “Policy Handcuffs in Financial Crisis: How U.S. Trade and Investment Policies Limit Government Power to Control Capital Flows,” by Sarah Anderson, Institute for Policy Studies, February 2009. .

[10] Roberto González Amador, “Inversionistas externos sacaron del país $22 mil 190 millones,” La Jornada, Dec. 18, 2008.


[12] Daniel Tarullo, “Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Committee on Financial Services, U.S. House of Representatives,” April 1, 2003.

[13] Daniel Tarullo, “Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Committee on Financial Services, U.S. House of Representatives,” April 1, 2003.

[14] 2004 U.S. Model Bilateral Investment Treaty.

[15] United Nations Conference on Trade and Development, “Transfer of Funds,” 2000.

[16] ASEAN Comprehensive Investment Agreement, February 26, 2009.

[17] North American Free Trade Agreement Final Text, Article 2104.

[18] Deborah Siegel, “Using Free Trade Agreements to Control Capital Account Restrictions: Summary of remarks on the Relationship to the Mandate of the IMF,” 10 ISLA Journal of International Comparative Law, 2004.

[19] Akira Ariyoshi, Karl Habermeier, Bernard Laurens, Inci Otker-Robe, Jorge Iván Canales-Kriljenko, and Andrei Kirilenko, “Capital Controls: Country Experiences with Their Use and Liberalization,” International Monetary Fund, May 17, 2000.

[20] Eduardo Levy Yeyati, Sergio L. Schmukler, Neeltje Van Horen, “Crises, Capital Controls, and Financial Integration,” Policy Research Working Paper 4770, World Bank, November 2008.

[21] Norway model bilateral investment treaty, 2007.

Sarah Anderson is the Director of the Global Economy Project at the Institute for Policy Studies in Washington, DC, and a co-author of the books Field Guide to the Global Economy and Alternatives to Economic Globalization. In 1998 and 1999, she served on the staff of the bipartisan International Financial Institutions Advisory Commission (the “Meltzer Commission”).

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