Capital Controls: a Political Economy Approach

Abstract

The paper examines the economic consequences of political conflicts that arise when countries implement capital controls. In an overlapping‐generations model, agents vote on whether to open or close an economy to capital flows. The young (workers) receive income only from wages while the old (capitalists) receive income only from savings. The authors characterize the set of stationary equilibria for an infinite‐horizon game. Assuming dynamic efficiency, when the median representative is a worker (capitalist), capital‐importing countries will open (close) while capital‐exporting countries will close (open). These predicted patterns are consistent with data on liberalization policies over time and across various countries.