Policy Space for Capital Flow Management: An Empirical Investigation

Many in the academic community have identified that some trade and investment treaties restrict the ability of nation states to regulate volatile capital flows to prevent and mitigate financial instability. This paper quantifies the variation across preferential and free trade agreements with respect to their policy space for capital flow management measures. With these data we create a composite score of treaty flexibility and examine the collective level of policy space across the global trade regime. We find that the majority of trade treaties leave significant policy space for regulating cross-border finance in the world economy. South-South treaties tend to have the most policy space, whereas North-South and North-North treaties have less. When weighted by the level of gross domestic product (GDP) and incoming foreign investment however, we find that those treaties with the least amount of policy space for capital flow measures represent 65% of world GDP and 48% of global capital flows. What is more, it appears that the global trend is toward treaties without the policy space for appropriate regulation.