Objectives of Capital Restrictions

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Capital restrictions are the measures that governments or central banks take to control the flow of foreign money in and out of a country’s economy. Government controls include tariffs, taxes, volume capital restrictions, etc.

Objectives of Capital Restrictions

The main objective of capital restrictions is to help maintain a balance of unstable exchange rates resulting from extremely volatile short-term capital flows.

• Developing countries need to make sure that domestic savings support their investments instead of acquiring assets from foreigners. This should be done to restrict foreign control of domestic resources, such as Canadian companies owning gold mines in African countries.
• Capital inflow brings competition with the potential of forcing domestic companies out of the market. It is important for governments to, on some occasions, restrict capital inflow to boost the growth of domestic industries.
• It is necessary to maintain the authorities’ capability to tax income, wealth, and other financial activities. This is because taxes are crucial sources of government revenues in cases where nations have huge market securities.
• Capital restrictions are also used to control the type of capital influx. Controlling the short-term flow of financial transactions, e.g., imposing taxes on short-term financial transactions, is usually used to restrict short-term money flow. When not limited, it can lead to a sharp change in foreign exchange reserves or even contribute to the extreme exchange rate variability.
• Capital controls preserve the authorities’ capacity to tax domestic financial activities such as income.
• They keep capital flows from interrupting stabilization and structural reform programs.

Governments have controls that either last for a short or long period of time. Short-term controls deal with urgent matters (such as a recession), while long-term controls have proved to be a part of a larger development goal for some profitable trading stories.

Question

Which of the following trade controls is likely to cause the biggest economic gain for a country that is importing?

1. Tariffs
2. Import quotas
3. Export subsidies

Solution

The correct answer is A.

Imposing tariffs will lead to an increase in the government’s revenue whereas import quotas and export subsidies do not usually create direct revenue for a government.