Chart of the Week: Shrinking Policy Space in International Trade Treaties

By Samantha Igo

After two years of severe economic stress from the COVID-19 pandemic, economies are just beginning to recover as international leaders make use of a variety of policy tools. However, capital flow management measures (CFMs), a key tool that could support economic recovery, remain out of reach for many.

In 2012, the International Monetary Fund (IMF) developed an Institutional View encouraging countries to deploy CFMs, or taxes and quantitative limits on the flow of money across borders that can slow speculative or unstable borrowing and lending, in the face of crisis, and even, in some cases, to prevent one from happening. But there was no parallel shift in international trade policy, and countries have since become locked in trade agreements that obstruct usage of CFMs. In short, international trade rules are on a collision course with domestic priorities and policymaking.

In March 2022, the IMF is set to revisit its Institutional View on CFM tools, marking a crucial opportunity to re-align international systems and expand policy space for cross-border financial regulation.

A new journal article published in the Journal of International Economic Law from a team of researchers at the Boston University Global Development Policy Center reveals the extent to which preferential and free trade agreements constrain government policymaking and provides recommendations to reserve policy space for CFMs.

This Chart of the Week, Figure 5 from the article, demonstrates how global trade treaties are trending toward less policy space in maintaining financial stability.

To visualize characteristics of treaties between 1991 and 2018, the authors correlated treaty flexibility with a four-color scale, wherein green treaties allow almost all CFM policies and red treaties allow very few with minimum exceptions and strict enforcement measures. In the middle, orange treaties tend to restrict most capital flow management, while still maintaining ample safety valves in the context of a crisis. Yellow treaties are usually narrower in scope and have no recourse to investor-state dispute settlements (ISDS).

The study ultimately finds that the strictest trade treaties govern most of the global economy, with countries amounting to 65 percent of global gross domestic product (GDP) in restrictive trade agreements. What is more, when the treaties are divided by level of development, those that have both high-income and low- or middle-income parties (North-South treaties) have the lowest proportion of flexibility. Negotiating power imbalances between Global North and Global South countries exacerbate existing inequalities and already limited policy space – a critical hindrance for emerging market and developing countries seeking to stabilize their economies following COVID-19 while simultaneously investing in climate resiliency.

The results emphasize a concerning trajectory if capital flows aren’t liberalized. International trade treaties will continue to obstruct national governments from making key policy decisions to deliver public goods, financial stability and climate resiliency to their constituents – and at a moment when flexibility is more important than ever.

As leaders stare down the growing crises of debt and climate, it is time to reconcile the tension between the growing web of international trade rules and economic best practices.

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