Financial Repression Isn't What It Used To Be
When rich countries act poor, something fundamental has shifted
Across the globe, governments are quietly building walls around your savings. Britain forces pension funds into domestic investments. China blocks capital flight whilst flooding export markets. Europe scrambles to stop its money flowing to America. Even the US, despite its privileged position, is designing new ways to direct foreign capital toward national priorities.
What looks like scattered policy responses is actually a coordinated shift toward something economists call financial repression—the deliberate channelling of domestic savings into state-chosen investments, regardless of returns. We've seen this playbook before the economy became globalised in the 1980s. Now it's coming back again.
The implications are profound. Your pension, your savings, your investments—all increasingly subject to political rather than market forces. The post-war free-market order is giving way to something entirely different from what we experienced over the past five decades: strategic capital management where governments, not markets, decide where money flows.
Let's examine how this transformation is unfolding—and what it means for the decade ahead 👇
1/ Financial repression emerges when developed economies face decline
In 2019, I wrote a provocative essay arguing that Europe had become a developing economy. To me, countries like France and Germany had succeeded during the age of oil, automobiles, and mass production but were clearly falling behind in the age of computing and networks.
This observation led me to examine the playbook by which developing economies succeed, which in turn led me to Joe Studwell's landmark book How Asia Works. It documents how Japan, South Korea, Taiwan, and Mainland China—then developing economies—achieved rapid growth through coordinated industrial policies, including something known as “financial repression”.
Financial repression refers to government mechanisms that channel domestic savings into national projects, even when foreign investments offer higher returns. These mechanisms include capital controls, regulatory mandates, negative real interest rates, and required purchases of government bonds. In the presence of financial repression, banks function as instruments of state policy rather than profit-maximising enterprises. Citizens effectively subsidise national development through below-market returns.
Developing economies offer compelling examples of financial repression delivering positive outcomes. South Korea directed household savings into building giant, profitable export powerhouses such as Samsung and Hyundai. Mainland China channelled domestic capital into infrastructure and manufacturing while maintaining capital controls. In these contexts, individual returns were sacrificed for collective advancement within a clear development agenda.
What makes the European case different is the context. Back in the 20th century, East Asian countries were building up from a lower base, pushing towards industrial modernity. Their use of financial repression helped them rise—both economically and technologically.
Europe, by contrast, already reached the technological frontier once. Its recent turn to similar tools marks not a drive for catch-up growth, but an attempt to soften decline.
When financial repression appears in a previously advanced economy, it no longer signals ambition—it signals retreat. For Asia, it was a lever for moving forward. For Europe, it is a way of managing stagnation. This change reveals a deeper truth: the tools of development, when adopted by former leaders, no longer carry the same meaning. They reveal a shift in status—from shaping the future to struggling to keep up.
2/ Financial repression rests on two factors: how much capital is available and how its returns compare
Understanding when governments implement financial repression requires examining two variables: (i) capital availability and (ii) return competitiveness. The interaction between these factors determines whether markets can function freely or require intervention.
Consider four scenarios:
When capital is abundant and returns competitive, markets work without interference. Germany in the 1990s exemplified this: strong domestic savings funded profitable manufacturing investments. Government involvement remained minimal, in the great tradition of Germany’s ordoliberalism, limited to promoting patient capital through tax incentives. This isn't financial repression but standard economic policy.
When capital is scarce but returns attractive, foreign investment flows naturally. Israel's technology sector demonstrates this dynamic. Despite limited domestic savings, high returns drew international venture capital after the Yozma programme provided initial catalyst funding. Market signals sufficed because profits justified risks.
Scarce capital combined with weak returns requires different tools. China's special economic zones in the 1980s offered tax breaks, infrastructure, and regulatory exemptions to attract foreign investment. The government subsidised returns to compensate for otherwise unattractive risk-adjusted yields. This represents competitive subsidisation, not classical financial repression.
The fourth scenario triggers true financial repression: abundant domestic capital seeking yields exceeding what domestic markets offer. Japan since the 1990s occupies this position. Without controls, savings would flow abroad, destabilising both currency and financial system. Regulatory requirements forcing banks and pensions to hold government bonds become essential to prevent capital flight.
Academic research confirms this pattern. Economists Carmen Reinhart and Belen Sbrancia show that financial repression historically emerges when governments need to manage debt while domestic returns lag global alternatives. Political economists V. Chari, Alessandro Dovis, and Patrick Kehoe model how capital controls become optimal precisely when domestic returns fall below international options while savings remain high.
This framework reveals why financial repression isn't about funding gaps, which markets resolve through price adjustment. Instead, it addresses the specific problem of abundant domestic capital that would flee if permitted. The policy prevents efficient allocation because efficiency itself threatens stability and blocks the country from pursuing certain national goals.