In addition, quantitative restrictions can undermine the development of financial markets and the quality of financial intermediation if protection reduces intermediaries' incentive to innovate and introduce new and better financial products. This, in turn, can undermine economic growth and development over the long term. Protection generates a price difference across markets. If the price difference is large enough, arbitrage through circumvention of controls is likely to take place in any market. Again, this incentive is strongest when prohibitions are applied to capital flows.
Controls increase circumvention and smuggling.
Various studies and anecdotes on foreign exchange rationing and other types of controls in a number of countries confirm that this is what happens. The debate on capital controls should take into account the lessons learned from experience with international trade policy. It is not a coincidence that tremendous efforts were made to replace quantitative restrictions with tariffs in agriculture and many other sectors during the Uruguay Round negotiations. A similar case can probably be made for capital flows and controls more generally. In this context, it might be worth comparing the restrictions applied by Chile until September 1998 with those introduced by Malaysia in the same month.