Markets and Morality

It is fashionable to condemn international financial centres – but before you join in, take a look at what they actually do

The last 50 years have witnessed an unprecedented growth in international trade. Global inflows of foreign direct investment (FDI) have grown threefold in just two decades, from under US$400 billion in 1995 to close to US$1.5 trillion in 2015. As developing countries open up their economies, their share in FDI has increased to 55 per cent of the world total. China, India and Brazil are today some of the top destinations for foreign investment.

This process of globalisation has brought enormous benefits to the world’s poorest. Just in China, 700 million people have been lifted from poverty since 1981. The World Bank announced at the end of last year that, for the first time in recorded history, the share of the global population living in extreme poverty – defined as below US$1.90 in daily disposable income – had dropped below 10 per cent. This is not simply unprecedented – it is astonishing when we consider that this rate stood at 44 per cent just 35 years ago.

Economic integration on a global scale has taken place so rapidly and relentlessly that we tend to take it for granted. The story of humanity in the last 200 years is one of increasing wealth, health and material equality – surely that is the way things were meant to be! In fact, globalisation is intimately related to the growth and expansion of key economic institutions, which took a long time to take hold and which must be preserved for progress to continue.

The first such institution is the reasonably free movement of financial capital. International investors and firms value the security of being able to move their assets in response to changing economic circumstances. Countries that provide this security are more likely to attract international capital. It used to be that most countries around the world – including the UK – tightly controlled the flow of money into and out of their jurisdictions. But since the 1970s, most have done away with capital controls and have performed much better as a result.

The second is an economic environment conducive to profitable economic activity. In the middle of the 20th century, private ownership of capital was forbidden and the profit motive illegal in Eastern Europe, Russia, China and elsewhere. Other countries, Britain among them, had decided to pursue a course of extensive state control of the economy, coupled with high taxes, which made much investment and risk-taking unattractive. However, from the late 1970s a process of deregulation began, which has freed up economies and created new economic opportunities. Coupled with a reduction in trade barriers, deregulation has critically contributed to globalisation and its beneficial effects.

The third key institution is the rule of law, ie the absence of arbitrary government actions and the reliance instead on previously agreed and well-established principles and rules. The rule of law protects investors against expropriation and other threats to the integrity and value of their assets abroad. Without these guarantees, much financial capital would not leave the shores of Europe and North America.

While the last half-century has been characterised by the gradual spread of these institutions, they are far from universal and established in many parts of the world. In particular, courts in developing countries remain slow, unreliable and corrupt. Political instability, as exemplified by Brazil in recent months, often leads to dramatic policy changes in very short periods of time, chasing away international investment. Local bureaucracies can still make the process of creating a business in a developing country onerous and stifling, as is reportedly the case in India.

Fortunately, international investors have devised effective ways to protect themselves against some of these potential drawbacks by using international financial centres. These do not just include Caribbean and Channel Islands, but also Singapore, Hong Kong and other countries which attract international capital that is then deployed elsewhere. Ireland, the Netherlands, the UK and some US states would fall under this category.

IFCs offer a reliable environment in which to domicile investment funds and holding companies. For instance, if a German firm wishes to do business in Argentina, it may well choose to set up a subsidiary in the Cayman Islands, which will in turn own the Argentine arm of the business. There could be many reasons for this choice. Cayman might have a better bilateral investment treaty with Argentina. The Argentine operation might be a joint venture with a Canadian firm, and the two partners might well wish to domicile it in ‘neutral’ and mutually agreeable territory. Or, quite possibly, the German parent might be concerned about the potential for double taxation of the subsidiary’s profits, and Cayman might have effective double taxation treaties with both Germany and Argentina, as well as a favourable tax environment of its own.

The point is that IFCs, contrary to the claims made in a recent letter from 355 economists and activists and coordinated by Oxfam, do serve many useful purposes. Economic and legal institutions are still inadequate in many places, while international governance – such as the international tax system – remains imperfect and can stifle international investment. IFCs exist to overcome these hurdles and thus facilitate the deployment of capital to its most productive uses. Evidently, this is to the benefit of the owners of capital. But it also benefits developing countries which, without investors’ ability to rely on stable and trustworthy IFC legal systems and expertise, might see FDI inflows curtailed.

Much is made of the allegation that IFCs have been used by corrupt politicians and others to evade taxes and launder money. These are illegal activities which both Western and IFC jurisdictions monitor and prosecute. At any rate, they stem from weak governance and cronyism in the countries of origin – Russia, China, Venezuela come to mind – rather than from the activities conducted in financial centres. The overwhelming majority of business transactions conducted in IFCs is perfectly legitimate, legal and conducive to better economic outcomes, not least in the ultimate recipients of international investment.

As my colleague Philip Booth has pointed out,  commentators pay much attention to alleged use of IFCs by corrupt individuals to conceal their legal liabilities, but financial centres also provide a haven for ethical and law-abiding citizens who might be victims of greedy, corrupt and arbitrary governments. Few remember that banking secrecy in Switzerland helped Jews and other prosecuted groups in Nazi Germany to preserve what was theirs. Similarly, the ability to open accounts in IFCs will surely have saved many Venezuelans from seeing some of their assets depleted by the country’s disastrous chavista government.

IFCs facilitate international investment, improving the condition of people in both origin and recipient countries. They help to overcome persistent barriers to global growth, such as weak governance, corruption and investor worries about the security of their capital. They encourage governments to develop policies that will not chase away domestic and foreign capital, whilst also allowing individuals to protect what they own from arbitrary rulers. The benefits of IFCs thus clearly outweigh the comparably few instances of illegal behaviour.

Attacking international financial centres will hinder, not help, the continued growth and prosperity of the world’s poorest countries. International capital mobility has been a central driver of humanity’s recent progress, and IFCs play a fundamental part in it. We should cherish their existence.


This article was first published in IFC Review.

Policy Analyst at the Cato Institute's Center for Monetary and Financial Alternatives

Diego was educated at McGill University and Keble College, Oxford, from which he holds degrees in economics and finance. His policy interests are mainly in consumer finance and banking, capital markets regulation, and multi-sided markets. However, he has written on a range of economic issues including the taxation of capital income, the regulation of online platforms and the reform of electricity markets after Brexit. Diego’s articles have featured in UK and foreign outlets such as Newsweek, City AM, CapX and L’Opinion. He is also a frequent speaker on broadcast media and at public events, as well as a lecturer at the University of Buckingham.

2 thoughts on “It is fashionable to condemn international financial centres – but before you join in, take a look at what they actually do”

  1. Posted 06/11/2017 at 19:39 | Permalink

    Bollocks from beginning to end. Money / Finance only has utility when it flows. Otherwise it is power and the more of it you have the more power you have. And now we know the ratios it is a system well past its sell by date.

  2. Posted 15/11/2017 at 13:49 | Permalink

    Dear John, IFCs are conduits, they accelerate the flow of money, they don’t stockpile it. Your commentary is superficial and wrong headed in equal measure, and your colloquial language it seems to me very aptly describes your own commentary.

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