54. Memorandum From the Director of the Office of Management and Budget (Shultz) to the Members of the Council on International Economic Policy1


  • The Capital Control Programs

Each of these programs imposes costs on U.S. business and financial institutions and, through them, on the economy as a whole.

The programs were enacted and have been maintained despite these costs on the grounds that they achieve a result: an improved balance-of-payments position for the United States.

Some have argued that the costs are such as to suggest relaxation of the programs despite the presumed result. This point of view highlights the importance of the costs.

There are additional arguments against retaining the controls. The ability of these programs to achieve substantial and desirable results is questioned. If this argument is correct, then the balance of payments argument is irrelevant and, in view of the undoubted costs, the programs should be abandoned. Material presented in the attached memorandum leads me to that point of view.

George P. Shultz



Controls on capital outflows from the United States were designed as temporary measures to deal with short-term problems in the U.S. balance of payments during the mid-1960s.

Three programs are now in effect:

The Interest Equalization Tax, designed to restrict the sale of foreign securities in the United States;
The Voluntary Foreign Credit Restraints Program, designed to restrict the availability to foreigners of banking services in the United States; and
Foreign Direct Investment Program, designed to restrict U.S. financing of foreign direct investments by U.S. firms.

The President has pledged himself to “bring an end to self-defeating controls on investment at the earliest possible time.”

This memorandum reviews the reasons why I believe it is timely to redeem the President’s pledge.

Estimates of Effectiveness of Individual Programs

The balance of payments is not necessarily determined by trade and capital flows in the direct and predictable way which casual reasoning suggests.

As a result of the format in which the accounts are conventionally arranged, the flow of reserves happens to be the last item listed in the international financial accounts. The assumption that this residual account will be the one to absorb the impact whenever there is a change in some other account is unwarranted. It is equally plausible that one of the other accounts will respond.

For example, it is by no means clear that a reduction in the outflow of U.S.-owned capital will have any effect on the flow of reserves. A priori, any number of accounts could absorb the change. In particular, economic reasoning suggests that the closest substitute category (foreign capital flows) will take up the slack. To the extent that capital from one source is a close substitute for capital from another, the reduction in U.S. capital outflows should be offset by an equal reduction in foreign capital inflows. There is no reason to expect that capital controls would, in any significant sense, actually reduce the net outflow of reserves.

Compliance with the administrative regulations under the control program appears to have been satisfactory. However, the Office of Foreign Direct Investment believes that the longer the controls are in effect, and as costs of compliance to U.S. business rise, compliance problems will grow more serious. In any case, nominal compliance with regulations is not the major test of effectiveness of the programs. Effectiveness is best measured by:

  • —The degree to which balance of payments gains are offset by losses resulting from nonregulated transactions induced by the control;
  • —The relevance of the controls, given the role of the United States in the international monetary system.

I am aware of three direct attempts to estimate the balance-of-payments effects of specific parts of the U.S. capital control programs. These studies are summarized below:

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The Interest Equalization Tax

In his study, Cooper2 compared movements in controlled and uncontrolled capital flows before and after the inception of the IET. He found that net purchases of taxable securities fell by $500 million between the half year just preceding proposal of the tax and a year later. This effect was completely offset by increases in U.S. direct investment, long-term lending by banks, and short-term lending by banks and others. As it happened, the U.S. balance of payments hardly improved despite a $2.7 billion increase in the surplus on goods and services. Cooper therefore concluded that the IET “failed in its broader objective of improving the U.S. balance of payments.”

The Voluntary Foreign Credit Restraint Program

Laffer3 developed two empirical relationships relating capital flows to economic variables using monthly statistics prior to the inception of the VFCRP. Under test, these two relationships proved to be accurate predictors of both private U.S. short-term capital outflows and foreign private short-term capital inflows.

Based on data for the sixteen months following the inception of the VFCRP, the same relationships were then used to estimate the effects of the program on short-term capital flows.

The graph below displays the cumulative balance-of-payments effects reported by Laffer. According to the graph, outflows of U.S. private short-term capital were definitely retarded. These favorable balance-of-payments effects were, however, by early 1966, almost precisely offset by compensating unfavorable movements in private foreign short-term capital flows.

[Omitted here is the graph illustrating the conclusion.]

This led Laffer to conclude that:

… The net effects of the VFCRP on the U.S. balance of payments seem to be quite negligible. In fact, for a long time, the VFCRP appears to have cost the United States in terms of foreign exchange, and only after a year or more in operation were the net effects on the U.S. official settlements balance of payments non-negative. Therefore, the ostensible success of this program with respect to U.S. capital flows appears to have been negated by foreign capital flows.

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The Foreign Direct Investment Program

The CPR4 Study came to the following conclusions:

The available statistics regarding the OFDI program … cast doubt on the extent to which the program actually restricts direct foreign investment today. The figures set forth show that U.S. firms have never invested the full amount permitted by OFDI quota….

Of course, not all of these allowables can be utilized by individual firms. However, even after taking this wastage into account, it is clear that generous investment allowables are available in most cases to U.S. firms wishing to expand their investments abroad….

These facts naturally raise questions as to why we need a direct investment control program, costing about $3 million per year to administer, plus much larger amounts in compliance costs incurred by the firms subject to OFDI controls.

The Cost of Capital Controls

Although there is no precise measure of the costs of maintaining capital controls, the type of costs and their significance in the aggregate are evident:

  • —The prestige costs to our country of unsuccessful attempts to manipulate our balance of payments via controls;
  • —The administrative costs to the Government in running the program, and to the private sector in complying with it;
  • —The economic costs resulting from the inefficient reallocation of resources by business and financial institutions as they respond to the program;
  • —The commercial costs of lost business for U.S. financial institutions as other countries develop their own financial intermediaries;
  • —The political costs to the Administration of continuing an unpopular program.

An Overall Assessment

From an economic point of view, there is no reason to expect the capital control programs to succeed. When Americans are inhibited from transmitting capital abroad, it is logical that foreigners will do the investing in their place. As a consequence, foreigners will reduce their U.S. investments. There is no reason to expect that net capital flows (or reserves) will change one way or the other as a result of these programs.
Detailed studies of the capital control programs have uncovered absolutely no evidence of any effect on the balance of payments.
The programs impose severe administrative costs on both government and business; they misallocate resources; and they penalize [Page 131] Americans for transacting freely with foreigners. Ironically, they have no demonstrable favorable effects.
The common and primary purpose of the capital control programs is to stem the net outflow of U.S. official reserve assets by obstructing American investments and loans to foreigners. All available evidence suggests that these programs cannot and have not accomplished or even worked towards this purpose.
  1. Source: National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 218, CIEP. No classification marking. Sent through Peterson. The memorandum is the attachment to Document 55.
  2. Richard N. Cooper: “The Interest Equalization Tax: An Experiment in the Separation of Capital Markets,” paper # 78, Economic Growth Center, Yale University, 1967. [Footnote in the source text.]
  3. Arthur B. Laffer: “Short-Term Capital Movements and the Voluntary Foreign Credit Restraint Program,” unpublished paper, University of Chicago, 1969. [Footnote in the source text.]
  4. Center for Political Research: Federal Control of Foreign Direct Investments, research report, May 11, 1970. [Footnote in the source text.]