Capital mobility and financial repression in Italy, 1960-1990 : a public finance perspective

Abstract

After significant headway towards liberalization of capital movements in the early 1960s, European governments resorted massively to capital controls in the turmoil of the demise of the Bretton Woods system. In some countries (Italy among others), what looked like a temporary backlash against incipient financial globalisation caused an escalation of domestic and external controls, leading to a comprehensive and long-lasting regime of financial repression. Why financial repression was so hard to dismantle, in spite of its widely recognized distortionary impact? Why did governments stick so long to sub-optimal policy instruments? By concentrating on the Italian case, this paper argues that a public finance approach may provide an answer to such questions. More specifically, following the literature on the political economy of capital controls and the fiscal implications of financial repression, the paper suggests that policies increasing revenues from implicit taxation may be regarded as an attempt to postpone the structural change in the established fiscal policy regime that capital liberalization necessarily entailed. As capital controls (and financial repression, more generally) substantially contributed to ease the government's budget constraint under conditions of structural deficit and rapidly rising debt, liberalization was expected to exacerbate fiscal problems. The paper illustrates the policy measures deployed to increase seigniorage revenues, grant implicit subsidies to the government and enforce financial protectionism. It also provides for the first time an estimation of the economic relevance of revenues from financial repression, which proved to be of a magnitude comparable to revenues from seigniorage. High revenues from implicit taxation (relative to GDP) can be considered a rough approximation of the cost of financial liberalization and may explain why the process of financial reform was slow and controversial.