Since the 1960s, several small states have diversified away from their traditional primary areas of production and export into the export of commercial services; the two major concentrations being offshore finance and tourism/travel. This week I shall examine some aspects of the experiences of those that have become renowned as offshore financial centres (OFCs).
The boom in offshore finance (OFCs)
In a report prepared for the British government, Edwards (1998) had estimated the stock of wealth held in OFCs at US $6 trillion. Today it is probably closer to US$10 trillion. This development started in earnest four decades ago, in the 1960s. Most of the small economies in this business are located on the outskirts of Europe (for example the Isle of Man, the Channel Islands, Malta and Cyprus), in the Caribbean, and the Pacific and Indian Oceans. The two principal holders of this wealth are transnational corporations (TNCs) and very wealthy individuals.
Studies have identified three major factors as contributing to the explosive growth of holding wealth offshore. One has been the technological advance in information storage, retrieval and communications, which has made it practical to maintain instantaneous contact with one's financial wealth, irrespective of the geographical distance where it is located. The second has been the liberalisation and de-regulation of financial markets worldwide, which has made it easier to move one's wealth at will. And, the third has been the cooperative environment of small states, which have leaned over backwards to attract and promote this industry to their shores.
The attraction of small states
The question readers may ask is why has this industry concentrated so heavily in small states? The answer is that the attraction is clear if one's motives are secrecy and the maximisation of financial rewards. Small states have offered secrecy from the authorities in other jurisdictions so as to maximise the incentive to conduct business in the dark. They have also offered minimal or no taxation (tax-havens) and little or no supervision and regulation of these funds. But all this would mean little, if small states did not also offer political stability.
Much of the promise of political stability derived from the fact that most of the small states had a dependency or other similar relation to a former colonial power. The former colonial powers took a benign, if not encouraging outlook to this development; to the point that some researchers have claimed that the dependent small states were 'managing,' if not manipulating their relations with the colonial power.
Today these states offer a variety of financial services. A recent study by Hampton and Christensen (2002) points out that some pride themselves on offering all types of services, much like a one-stop agency. Others have developed specializations in sectors like captive insurance (for example Bermuda) company registration (for example, the British Virgin Islands) and trust management and securitisation (for example Jersey).
The structure of OFCs
The study referred to has identified the emergence of three main types of OFCs. One type it has described as "functional." By that it is meant that actual financial activities take place, not merely book entries. There are therefore active branches of financial institutions with personnel operating them located in these states. These functional OFCs would employ at least 12 per cent of the labour force and contribute 25 per cent or more to the small states' GDP. At the other extreme there are the 'notional' OFCs. These are shell operations. They have no local structures and very few local operatives. In general these contribute less than 3 per cent of the local employment and less than 10 per cent of the small states' GDP. In between these two extremes there are OFCs, described as 'compound' where both elements of the functional and notional OFCs are to be found.
The four-headed hydra
If the colonial powers that patronised the small states where OFCs have flourished contributed substantially to the booming industry, in recent times, however, their support has been transformed into considerable hostility, and strong initiatives against the industry have been mounted. These initiatives have been reportedly driven by four major concerns.
The first of these is the concern the developed countries have expressed, through the OECD against the so called 'harmful tax competition,' which OFCs promote. The second is the claim that OFCs have become vehicles for 'money-laundering' activities by narcotics and other criminal interests. The third is that the OFCs hamper the process of global financial regulation and make international financial crisis management more difficult. And, the fourth follows from the heightened terrorist concerns, following on the events of 9/11 and their aftermath. All four concerns have merged and the offshore finance industry now faces a very severe crisis, as it runs the risk of being legislated out of existence. That is, there is a real prospect that the institutional/legal distinction between offshore and inshore financial centres could disappear.
Harmful tax competition
Over the years a number of major intergovernmental bodies and agencies have taken aim at harmful tax competition caused by the OFCs. A significant number of the small states affected do not have direct representation in the fora where the industry is being scrutinised because of their dependency status. Among the lead bodies and agencies in this regard are the OECD (referred to above), the Group of Seven (G7), the European Union (EU) and the United Nations Office for Drug Control and Crime Prevention. As the Hampton and Christensen study observes, the British Government has found itself "representing" the interests of its 'Overseas Territories and Crown Dependencies,' which it encouraged to diversify in this manner. Under pressure from its OECD partners, it has moved against those centres located within its jurisdiction.
One factor leading to this development has been a number of dramatic scandals and bank failures in these jurisdictions, the BCCI case being perhaps the most notorious. In June 2000 the OECD named 35 'tax havens' as engaged in harmful tax practices, 17 of which were located in the Greater Caribbean. Those identified were given one year to agree to undertake a major restructuring of their tax policies and to provide tax and other financial information on request to the national authorities of other countries. Those that did not comply were threatened with sanctions.