Capital Controls - a la Russe.

The Russian money-laundering scandal continues to spread. First, it was said to be a few rogue bankers in New York. From there, it spread to Europe. Since the IMF played a role in the foreign exchange, which somehow found its way into private hands and then abroad, its credibility is at stake. Republican critics of the IMF on Capitol Hill are sharpening their knives. And the U.S. isn't the only place where the IMF's image been tarnished. Clearly, it's time to look for radical solutions to the money flow out of Russia.

Despite the many well-known counter-arguments, there's no way around it: the IMF should require that Russia adopt effective and stringent foreign exchange regulation and capital controls as a condition for further aid. While this would not necessarily stop the thieves, it would stop them from taking the money out of the country. That would cut their profits and ensure that the stolen money would at least still be invested in Russia, rather than in French real estate along the Cote d' Azur.

Admittedly, controls are the persona non grata of international financial policy. First, they are associated with the failed international financial system of the post-WW I period. Between 1919 and 1945, most European countries adopted a bewildering variety of laws to inhibit the movement of funds between countries. These laws severely retarded European commerce, possibly worsening the Depression. As a result, the system established after WW II was designed to restore "convertibility," or the ability to trade foreign exchange freely.

The second argument against capital controls comes from the Latin American experience in the '70s and '80s, when the existence of capital controls allowed some countries to avoid correct macroeconomic policy changes for too long. When the economic imbalances finally got out of hand, the adjustment required was more painful than it would have been had the foreign exchange markets been able to discipline policymakers. In many cases, capital controls favored the wealthy, enabling privileged citizens to circumvent capital controls, while those of more modest means could not.

Given this track record, it's no wonder that many policymakers oppose controls and that the U.S. Treasury, which, by necessity, found itself on the front lines of the Latin American battles, is particularly suspicious of them. Yet, the Russian case is different. In addition to forcing pilfered money to stay within Russia, controls would allow the West to aid Russia to successfully complete the transition to a market economy, for which an incorruptible, professional civil service and a rules-based approach to regulation are vital. Russia's lack of these has crippled attempts to privatize the economy. Moves toward a free market have often been accompanied by sweetheart deals masked by a fog that individual Russians cannot penetrate. Capital controls will provide the first evidence that the big as well as the small are subject to the same rules. While nobody can instantly establish law and order throughout Russia, the IMF can - and should - insist that it be established in foreign exchange markets.

Some claim that the IMF has no right to limit the ability of Russians to invest where they see fit. There's no reason, however, why the West, in providing aid to Russia, should not be willing to force Russians to invest in their own country. Aid providers should expect citizens of the recipient country to help build up the country's assets, even if a "rational" investor would not keep money there. And if powerful Russians keep their investments in the country, they will have a strong incentive to adopt the reforms necessary to insure long-term growth.

Of course, controls can't substitute for proper macroeconomic policy and financial reform. Not to allow that would be to repeat the Latin American mistake, and with the same likely results - eventual disaster. To prevent this, the IMF must maintain, and even strengthen, its traditional macroeconomic conditionality. Russia must still get its public spending under control, keep money growth at a reasonable level, and make steps towards other reforms. Capital controls are a temporary way to jump-start public administration and to restore the credibility of the IMF, and, for that matter, Russian public finances.

History notes that capital controls can work. The designers of the Bretton Woods agreement that created the IMF wanted countries to allow the free movement of capital as quickly as possible. But they understood that simply changing the laws immediately would hinder, rather than help, economic development. Major European countries such as Germany and France were not expected to immediately allow full convertibility of their currencies. Instead, they maintained controls over the outflow of capital for some time after the war, with the IMF's blessing. It was understood that these countries were aiming to remove the controls. They did so eventually - but only when conditions were right.

Stephan G. Richter is president of Washington. DC's TransAtlantic Futures.