Last week, Brazil announced that it is finally eliminating its most prominent tax on foreign portfolio investment. This reversal is the most recent reminder of the negative effects of capital controls.
Capital controls are measures, sometimes in the form of taxes or fees, that limit the movement of capital into and out of an economy. Championed in Brazil by Finance Minister Guido Mantega, these barriers to foreign investment were supposed to stem the tide of “hot money” flooding into Brazil, and the subsequent appreciation of the Brazilian real. In reality, they limited capital mobility and may have contributed to economic distortions including high inflation, which is currently 6.5 percent.
Mantega’s reversal on capital controls will hopefully mean a more realistic assessment of Brazilian economic policy. The most likely explanation of the run-up of the real was the country’s obsession with commodity exports. The discovery of oil off the southeastern coast in 2006 has contributed to a dramatic expansion of oil exports, which have increased 45 percent since 2002. In addition, the partially state-owned mining giant Vale has become a world leader in mineral extraction and made up 16 percent of Brazilian exports in 2011.
Ultimately, Brazilian backtracking speaks to the long-term futility of capital controls overall, especially during a time when they are considered more and more acceptable. In December, the International Monetary Fund softened its longtime institutional position on the use of capital controls and now sees them as acceptable in some situations.
Mantega’s change of heart on this controversial issue certainly comes at an interesting time. In May, Brazilian president Dilma Rousseff announced an October visit to Washington, and tomorrow the House Ways and Means Committee will hold a hearing on bilateral trade and investment with Brazil. Regardless, one hopes that this will be the first of many steps toward economic freedom.