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Exploring the Possible Impacts of Hosting an Oversized Financial Centre

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Exploring the Possible Impacts of Hosting an Oversized Financial Centre The Finance Curse: exploring the possible impacts of hosting an oversized financial centre John Christensen,1 Tax Justice Network, Chesham, U.K. Nicholas Shaxson,2 Tax Justice Network, Berlin, Germany Contact author: John Christensen – [email protected] Draft: Not for quoting Abstract. The paradoxical situation whereby resource rich countries depending on earnings from natural resources like oil and gas can frequently suffer lower economic growth, higher inequality and poverty, elevated corruption, and stronger political repression than their resource-poor peers is recognised and widely known. It is sometimes known as the Paradox of Poverty from Plenty, or the Resource Curse. This paper explores a similar, related phenomenon that seems to afflict some countries with whose financial centres have grown very large in relation to the domestic economy. Emerging evidence suggests that Beyond a certain point, growth of the financial services sector harms the host country in various ways, including lower long-term growth, greater inequality, a propensity towards rent-seeking and accompanying loss of genuine productivity and entrepreneurial and other skills, corruption and state capture. Citing case study material from several jurisdictions hosting oversized financial centres – notaBly Cyprus, Jersey and the United Kingdom – the paper explores how economic 1 John Christensen directs the global activities of the Tax Justice Network. He is a former economic adviser to the States of Jersey. 2 Nicholas Shaxson is author of Poisoned Wells: The Dirty Politics of African Oil and Treasure Islands: Tax Havens and the Men Who Stole the World. - 1 - crowding-out, brain drain and financialisation create path dependencies that reinforce a tendency for financial services interests to dominate the domestic political, economic and cultural landscape, to the detriment of other sectors. This combination of economic and political capture, or ‘country capture’, creates a phenomenon that we have termed the Finance Curse. In many important respects, this phenomenon resembles the Resource Curse. Keywords: Offshore Financial Centres, Resource Curse, Finance Curse, State capture, Economic capture, Crowding-out Paper type: Research paper Originality / value: This paper tackles a topical and under-researched suBject. Drawing on the authors’ combined decades of investigative work on Both resource- dependent and finance-dependent economies, the paper draws attention to a political and economic phenomenon that is contriButing to a harmful reshaping of the global economy. 1. Introduction. Worldwide, financial services have expanded significantly in recent decades, both at the level of domestic economies and through the development of the international and offshore financial economy which emerged following the creation of the Euromarkets, initially in London in the late 1950s. For many years, domestic financial expansion was widely assumed to Benefit the development of a local economy, almost without limit. Indeed, every economy needs an - 2 - infrastructure of financial services to provide Banking, insurance, accounting and other financial intermediary services: a financial ‘utility’ at the service of the rest of the economy. Many small island economies (SIEs), defined here as places having a population of less than 1.5 million, have purposefully Based their development strategies on hosting large financial centres, Based on providing ‘offshore’ services (Hampton and Christensen, 1999; Brittain-Catlin, 2005). The assumption that hosting a large financial centre is Broadly Beneficial to the host economy also appears to Be supported By comparative national income statistics which consistently show finance- dependent economies to Be among the world's wealthiest countries, on a per-capita basis (see table 1). Yet this long-received wisdom jars with the finance-related disasters that have Beset many countries since the gloBal financial crisis (GFC) emerged in 2008. Furthermore, fresh research from the International Monetary Fund (IMF), the Bank for International Settlements (BIS) and other sources, suggests that above a certain size relative to the domestic economy, growth in a domestic financial centre tends not to Benefit the host economy, and may well Be harmful (Arcand et al, 2012; Cechetti and Kharroubi, 2012; Kedrosky and Stangler, 2011, Pagano, 2012). As summarised By Stephen Cecchetti, co-author of recent BIS research: “Beyond a certain point, financial development is bad for an economy. Instead of supplying the oxygen that the real economy needs for healthy growth, it sucks the air out of the system and starts to slowly suffocate it.” (Cecchetti, 2012.) This is not just a question of economic growth. For example, Britain performs worse on most major human development indicators – economic inequalities, infant mortality, mental illness, drug aBuse, oBesity and health outcomes, incarceration rates, social - 3 - moBility, teenage Births, child well-being – than Germany, Sweden, Canada and most of its rich-country peers (Wilkinson, R., Pickett, K, 2010). Which raises the question of whether the many trillions of dollars that flow into and through the City of London3 – on some measures the world’s largest financial centre - are contributing to or detracting from the population's overall wellBeing. Financial sector hyper-development can Be particularly acute in the case of small jurisdictions. While the financial services sector in Britain contribute less than ten percent of GDP (House of Commons, 2011,) it is recorded at over 40 percent in the case of the British Channel Island of Jersey, a leading offshore financial centre (TJN, 2011). On Jersey, the financial sector directly employs nearly a quarter of the economically active population, rendering the island and its workforce massively dependent on a single, globally moBile sector, and politically captive to the interests of a powerful and very vocal special interest loBBy (Hampton and Christensen, 1999; Shaxson, 2011). Setting aside the issue of whether or not tax havens serve a useful or predatory role in the gloBal economy, Table 1 Below would seem to support the view that hosting a large financial services industry is a viaBle development option for small and remote jurisdictions with few or no areas of comparative advantage in the productive sectors. Within a single generation finance transformed the Cayman Islands from a small, isolated fishing community into Being the fifth largest financial centre in the world, fifteenth overall in the league taBle of national income per capita. Table 1: Financial Services - A passport to development? 3 By “City of London” we are using the popular term which refers to the UK Financial Services Industry as a whole, rather than the narrower meaning which refers to the “Square Mile” of financially-dominated real estate near the Bank of England in central London. - 4 - Rank Country/ Jurisdiction GDP per capita (USD) (at purchasing power parity) 1 Qatar $98,900 2 Liechtenstein $89,400 3 Luxembourg $80,600 4 Bermuda $69,900 5 Singapore $59,700 6 Jersey $57,000 7 Falklands $55,400 8 Norway $53,400 9 Brunei $49,500 10 Hong Kong $49,400 11 United States $48,300 12 United AraB Emirates $47,700 13 Guernsey $44,600 14 Switzerland $44,500 15 Cayman Islands $43,800 16 Gibraltar $43,000 17 Netherlands $42,000 18 Kuwait $41,700 19 Austria $41,600 20 Ireland $40,800 Source: CIA World Factbook, 2012. Blue indicates a finance dependent economy. Red indicates a resource dependent economy. But the prospect that table 1 suggests, that financial sector development will make your country rich, is far from the full story. For one thing, correlation is not causation: capital and financial services activity are attracted to jurisdictions that are already well developed and consequently regarded as safe and staBle. Second, whose interests does financial services serve: locals or outsiders? Is it the case that sections of the indigenous local population are either recruited into administrative and clerical positions or provide downstream services in the construction, retail and hospitality sectors, while the lion’s share of economic - 5 - Benefits flow to (usually white, male) expatriates? And if so, to what extent does providing jobs and wealth for transient expatriates constitute ‘national development? Does national income per capita data mask an increased vulneraBility to economic dependence on a gloBally moBile sector prone to crisis and external political intervention to tackle the harm caused By, say, money laundering and tax avoidance? Does high per-capita income in finance-dependent economies actually correspond to Better human development? Figure 1 Below provides a contrasting story. Using data from the United Nation’s Human Development Index (HDI), which ranks countries according to a measure that combines education, life expectancy and income per capita), the UNDP puBlishes a statistic called ‘Gross National Income (GNI) per capita rank minus HDI rank.’ This rank aims to assess whether the developmental potential of headline economic growth is Being transformed into tangiBle education and health Benefits at ground level. A negative outcome indicates that the country’s wealth may not Be feeding through into genuine human development. In this case figure 1, which takes only those countries exhiBiting high or very high human development, reveals a striking pattern of relatively poor performance not only among resource dependent economies (viz. Kuwait, Oman and Qatar as worst-performers),
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