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534 PA R T V I International Finance and Monetary Policy one by one, Indonesia, Malaysia, South Korea, and the Philippines were forced to devalue sharply Even Hong Kong, Singapore, and Taiwan were subjected to speculative attacks, but because these countries had healthy financial systems, the attacks were successfully averted As we saw in Chapter 8, the sharp depreciations in Mexico, East Asia, and Argentina led to full-scale financial crises that severely damaged these countries economies The foreign exchange crisis that shocked the European Monetary System in September 1992 cost central banks a lot of money, but the public in European countries were not seriously affected By contrast, the public in Mexico, Argentina, and the crisis countries of East Asia were not so lucky: The collapse of these currencies triggered by speculative attacks led to the financial crises described in Chapter 8, producing severe depressions that caused hardship and political unrest CAPI TAL CO N TRO LS Because capital flows were an important element in the currency crises in Mexico and East Asia, politicians and some economists have advocated that emergingmarket countries avoid financial instability by restricting capital mobility Are capital controls a good idea? Controls on Capital Outflows Capital outflows can promote financial instability in emerging-market countries because when domestic residents and foreigners pull their capital out of a country, the resulting capital outflow forces a country to devalue its currency This is why recently some politicians in emerging-market countries have found capital controls particularly attractive For example, Prime Minister Mahathir of Malaysia instituted capital controls in 1998 to restrict outflows in the aftermath of the East Asian crisis Although these controls sound like a good idea, they suffer from several disadvantages First, empirical evidence indicates that controls on capital outflows are seldom effective during a crisis because the private sector finds ingenious ways to evade them and has little difficulty moving funds out of the country.7 Second, the evidence suggests that capital flight may even increase after controls are put into place because confidence in the government is weakened Third, controls on capital outflows often lead to corruption, as government officials get paid off to look the other way when domestic residents are trying to move funds abroad Fourth, controls on capital outflows may lull governments into thinking they not have to take the steps to reform their financial systems to deal with the crisis, with the result that opportunities to improve the functioning of the economy are lost Controls on Capital Inflows Although most economists find the arguments against controls on capital outflows persuasive, controls on capital inflows receive more support Supporters reason that if speculative capital cannot come in, then it cannot go out suddenly and create a crisis Our analysis of the financial crises in East Asia in Chapter provides support See Sebastian Edwards, How Effective Are Capital Controls? Journal of Economic Perspectives, Winter 2000; vol 13, no 4, pp 65 84