VoxEU Column Macroeconomic policy

Are capital controls effective? Firm-level evidence from Brazil

Capital controls are back in fashion. This column discusses new firm-level evidence from Brazil showing that capital controls segment international financial markets, reduce external financing, and lower firm-level investment. They disproportionately affect small, non-exporting firms, especially those more dependent on external finance. This suggests that macro-finance models focusing on aggregate variables are missing an important dimension by abstracting from firm-level heterogeneity. 

There is a renewed debate in academic and policy circles about the merits of international capital mobility. While free capital mobility brings many potential welfare gains, it also entails significant risks. As part of the larger debate about financial globalisation, the extent to which policymakers should allow foreign capital to flow into their economies remains a controversial issue particularly in the context of the massive foreign capital inflows that emerging markets have experienced following the global financial crisis of 2008-2009.

A growing body of theoretical literature characterises environments where limits to capital mobility are desirable. Whilst being second best remedies, capital controls are seen as a means to promote financial stability or improve macroeconomic adjustment in economies with nominal rigidities and suboptimal monetary policy (see the references in Fernandez et al. (2013) for a detailed bibliography). On the policy side, in December 2012, the IMF released an official statement endorsing the use on capital controls. “For countries that have to manage the risks associated with inflow surges or disruptive outflows, a key role needs to be played by macroeconomic policies, as well as by sound financial supervision and regulation, and strong institutions. In certain circumstances, capital flow management measures can be useful. They should not, however, substitute for warranted macroeconomic adjustment.” The swing in the academic and policy pendulum from advocating capital account liberalisation in the late 1980s and early 1990s to seeing capital controls as desirable in the aftermath of the Global Financial Crisis has not been lost on emerging-market governments who have increasingly taken to imposing a wide variety of controls on international capital flows.

While the case for capital controls rests on promoting prudential controls designed to mitigate the volatility of foreign capital inflows, there is also an implicit aspect of controls that is protectionist in nature aimed at maintaining persistent currency undervaluation. For example, in September 2010, the Finance Minister of Brazil, Guido Mantega, used the term ‘currency war’ to describe the efforts of nations to devalue their currencies in order to augment the competitiveness of their exports in international markets. In particular, Mantega blamed the monetary policies of the world’s major central banks (Wheatley and Garnham 2010).

New evidence from Brazil

In a recent paper we evaluate the effects of capital controls on firm-level stock returns and real investment using data from Brazil (Alfaro et al. 2014). We focus on Brazil as a case study for various reasons. Brazil has implemented a series of controls on capital flows in the last 5 years. The stock market in Brazil is well developed and the country also has firm-level export data that allow us to examine both the firm-level response to capital flows as well as the impact of capital controls on the competitiveness of exporting firms. Finally, the Brazilian case has been seen as a poster child for the recent policy changes (Jeanne et al. 2013). Table 1 provides a detailed list of the recent controls implemented in Brazil.

Table 1. Capital controls in Brazil, 2008-2012

Source: Adapted from Baumann, B A and K P Gallacher (2012), "Navigating Capital Flows in Brazil and Chile", Initiative for Policy Dialogue Working Paper Series, Columbia University, June.
Note: IOF (Imposto Sobre Operações Financeiras) is a tax placed on financial transactions.

Theory suggests that the imposition of capital controls can drive up the cost of capital and curb investment (Stulz 1999, Chari and Henry 2004). Credit constraints at the firm level are also more likely to bind for firms that are more dependent on external finance (Rajan and Zingales 1998, Forbes 2007a). In particular, if production is associated with fixed costs and dependent on external finance, financial constraints at the firm level become relevant. Firms with easier access to external finance or greater access to low-cost funds may be able to overcome the barriers associated with these fixed costs and experience increased investment and sales. Capital controls, on the other hand, can increase uncertainty while reducing the availability of external finance, which can lower investment at the firm level.

We use an event study methodology around the dates when the various capital control measures were announced using stock prices and firm level data from Datastream. The data points to a significant decline in cumulative abnormal returns for Brazilian firms following the imposition of capital controls on equity flows in 2008-2009 consistent with an increase in the cost of capital. Large firms and the largest exporting firms appear less negatively affected compared to external-finance-dependent firms, and capital controls on equity have a more negative announcement effect than those on debt. Finally, real investment at the firm level falls significantly in the aftermath of the controls.

In related work, Forbes (2007a), for example, shows that during the Chilean encaje in the 1990s, smaller traded firms experienced significant financial constraints.  Forbes (2007b) uses an Euler-equation framework to show that during the Chilean encaje, smaller traded firms experienced significant financial constraints. These constraints decreased as firm size increased. See also Forbes (2007b). 

Our results also complement recent evidence that the implementation of capital controls does not seem counter-cyclical or prudential in nature as prescribed by the growing recent theoretical macro literature.  If anything they are acyclical (Fernandez et al. 2013).  Similarly with data that differentiates between capital controls on different categories of assets, Klein (2012) finds that with a few exceptions, there is little evidence of the efficacy of capital controls on the growth of financial variables, the real exchange rate, or GDP growth casting doubts about assumptions behind recent calls for a greater use of episodic controls on capital inflows.

Concluding remarks

The rationale for capital controls policy measures range from macro-prudential efforts to reduce the volatility of foreign capital inflows to a protectionist stance on maintaining the competitiveness of the external sector. Overall, the evidence in our paper suggests that capital controls segment international financial markets, increase the cost of capital, reduce the availability of external finance, and lower firm-level investment. Further, the results have implications for macro-finance models that focus on aggregate variables to examine the optimality of macro-prudential regulation and abstract from heterogeneity at the firm level. In particular, the evidence in this paper suggests that capital controls disproportionately affect small, non-exporting firms, especially those more dependent on external finance.


Alfaro L, A Chari and F Kanczuk (2014), “The Real Effects of Capital Controls: Financial Constraints, Exporters, and Firm Investment”, NBER Working Paper No. 20726.

Chari, A and P B Henry (2004), “Risk Sharing and Asset Prices: Evidence from a Natural Experiment”, Journal of Finance 59(3): 1295–1324, 06.

Fernández A, A Rebucci and M Uribe (2013), "Are Capital Controls Prudential? An Empirical Investigation," NBER Working Paper No. 19671.

Forbes, Kristin J. 2007a. “One Cost of the Chilean Capital Controls: Increased Financial Constraints for Smaller Traded Firms”, Journal of International Economics 71(2): 294–323.

Forbes, K J (2007b), “The Microeconomic Evidence on Capital Controls: No Free Lunch,”, in Edwards, S (ed.)  Capital Controls and Capital Flows in Emerging Economies: Policies, Practices, and Consequences, Chicago: University of Chicago Press.

Jeanne O, A Subramanian and J Williamson (2012), “Who Needs to Open the Capial Account?", Peterson Institute for International Economics, Washington D.C.

Klein, M (2012), “Capital Controls: Gates Versus Walls”, NBER Working Paper No. 18526.

Rajan, R G and L Zingales (1998), “Financial Dependence and Growth”, The American Economic Review 88(3): 559–586.

Stulz, R M (1999), “Globalization of Equity Markets and the Cost of Capital”, Working paper. Dice Center, Ohio State University.

Wheatley, J and P Garnham (2010), “Brazil in ‘currency war’ alert”, Financial Times, September 27

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