In the face of rising global tensions the free flow of direct investment capital across borders is in dispute. The self-evidence of free capital movements since the start of the euro can no longer be taken for granted. Concerns have emerged about the intentions of foreign investors acquiring domestic key industries. Supervisors are asking probing questions about the provenance of money flows.
As we discuss these issues we should
not lose sight of the strictly regulated world where we come from
and the tremendous efforts it took to liberalize. Many have forgotten
the post-World War world in which borders were largely closed for
international capital movements. Many countries applied negative
exchange control systems where all cross-border capital transactions
were prohibited unless explicitly permitted. Nowadays, citizens and
corporations are free to move capital in and out of the country. This
is a great achievement.
Over time there has been a major shift
in the assessment of the pros and cons of free capital flows. In the
Treaty of Rome it was felt that one needed to tread carefully. A
safeguard clause confined the obligation to liberalize capital
movements ‘to the extent necessary to ensure the proper functioning
of the Common Market’. When in the early 1970s the Bretton Woods
system of fixed exchange rates collapsed, it was widely believed that
capital controls were needed to maintain a measure of exchange rate
stability among countries with diverging economic performance.
For a time the stabilizing role
attributed to capital controls outweighed the textbook costs of
controls. Controls helped countries to avoid downward pressure on the
exchange rate and preserve a degree of national monetary policy
autonomy. Controls also helped keep domestic savings at home, channel
savings towards priority industrial sectors and avoid the takeover of
domestic companies by foreign interests. However, their effectiveness
was questioned as they were easily circumvented by increasingly
sophisticated financial markets.
The establishment of the European
Monetary System in 1979 marked a new beginning, as did the switch to
liberal policies in the Anglo-Saxon world. Official thinking evolved
and from 1983 on liberalization of capital movements was on the
European agenda after an absence of more than a decade. Freedom of
cross-border capital movements was seen as forcing economic
discipline and convergence of policies: countries could no longer
hide behind the protective shield of capital controls follow
go-it-alone policies as this would be punished by financial markets.
Freedom of cross-border capital flows became a sine qua non
for European monetary integration. When Greece abolished controls in
1994 the liberalization of capital movements in Europe was completed.
Germany at the time was the driving
force behind the idea that liberalization of capital movements should
be applied erga omnes, i.e. in a non-discriminatory fashion.
The deutsche mark was an international reserve currency and such
status was not compatible with common EU restrictions vis-à-vis
third countries. Likewise, the euro should be a freely tradeable
international currency. Other member states felt that reciprocity
should be maintained as a negotiating tool with respect to third
countries, in particular vis-à-vis Japan which at that time was seen
as a threat for a level playing field and for increased foreign
influence in the financial services sector.
Japan in the 1980s restricted the share
of foreign ownership in various industries. International pressure
to end unfair trading practices intensified, led by the US which was
concerned about the huge bilateral trade deficit with Japan.
Eventually Japan was forced to open up. The trade system came out of
that dispute in a much stronger fashion once a deal was reached in
which Japan took co-responsibility for the international monetary
system. There are striking parallels to the situation vis-à-vis
Most economic motives for controlling
capital movements no longer apply as the incompatible triangle of
having free capital flows, exchange rate stability and monetary
policy autonomy is resolved by the introduction of the euro. At the
same time, national security and crucial infrastructure motives have
become more forceful. The political agreement reached on an EU
framework for screening foreign direct investment reflects this
changed international climate.
It is important that the investment
screening proposals on the table do not infringe upon the acquis of
free capital flows and adhere to the erga omnes principle.
Liberalization of capital movements overall has been a success and it
has proven a catalyst for further economic reform and the
establishment of the European Economic and Monetary Union (EMU).
Economic interests should not be mixed with national security
concerns and investment screening should not become an extension of
In parallel with investment screening
procedures one could envisage more effective alternatives which would
address concerns of both security and reciprocity. The incoming
European Commission could focus on the negotiation of a bilateral
investment treaty between the EU and China where mutual access rules
can be agreed. The political basis could be laid in a EU-China Summit
in which state aid rules are also placed on the agenda. This would
help ensure that Europe remains open to the outside world and
European corporations operate on a level playing field.