Driving growth

With the economic recovery in a fragile state, international financial centres should be left to conduct business as usual as they aid growth in both the developed and developing economies. By Grant Stein

As essential cogs in the free and efficient movement of international trade and capital flows, international financial centres (IFCs) have made a significant contribution to the growth in global prosperity that we have enjoyed over the past 30 years.

Modern economic theory confirms the vital role that tax-neutral jurisdictions play in global economic development and it is equally vital that global policymakers appreciate fully this relationship. For this reason, a number of law firms in several of the ­leading IFCs came together in late 2009 to form the International Financial Centres Forum (IFCF). The IFCF provides a central resource for balanced and authoritative information to better contribute to the global debate on IFCs, as well as to commission research and correct the many misconceptions which surround the activities of IFCs.

For the good of all

A wide body of academic research supports the proposition that IFCs provide economic benefits for the global economy. Contrary to the popular rhetoric of some G7 politicians and regulators, in a comprehensive study published in the October 2007 Economic Journal, Professor Andrew K Rose of the Haas School of Business of the University of California, Berkeley, and Mark M Spiegel of the International Research ­Division of the Federal Reserve Bank of San Francisco, concluded that IFCs are better characterised as ­symbionts of the G7 ­countries rather than ­parasites. Similarly, Professor James R Hines Jr of the University of Michigan Law School has concluded that in practice IFCs do not divert economic activity from high-tax ­locations in the same regions and that just the opposite is the case.

From a practical standpoint, the ­neutrality that IFCs provide to international investors allows the efficient pooling of investor ­capital without benefiting one investor over ­another. As certain legal and political risks associated with investing in some foreign countries are taken out of the equation, the many ­challenges associated with doing business internationally can be overcome.

The manner in which IFCs help create and preserve jobs in Organisation for ­Economic Cooperation and Development countries in many industries has also been well-documented, but perhaps less ­understood by policymakers and the media alike. By supporting efficient international investment and financing arrangements, offshore structures help facilitate international aircraft sales for companies such as Boeing and Airbus, which become more competitive as a result.

International flows of capital that pass through IFCs benefit G20 countries and developing nations in equal measure.

As stable and effectively regulated ­jurisdictions with high levels of integrity and professional standards, the leading IFCs attract capital from international investors in all parts of the world. These funds are ­subsequently invested into G20 nations as foreign investors support domestic ­opportunities, while the support of foreign opportunities by ­domestic investors directs investment into developing nations. Wealth from emerging nations therefore gains access to the stable and predictable returns of the developed world, while investors in G20 countries gain the ability to invest in emerging markets. IFCs provide the mechanism for both these forms of investment, which will be equally critical to a sustained economic recovery.

Richer for poorer

Highlighting the positive contribution that IFCs make towards economic development in emerging nations, a recent paper from Professor Jason Sharman of Griffith ­University draws on the experiences of China and India to demonstrate that IFCs help to enhance economic growth and reduce poverty in developing countries. This is in contrast to the common misconception that IFCs drain wealth from such nations. Professor Sharman’s paper, ’International Financial Centres and Developing Countries: Providing Institutions for Growth and Poverty Alleviation’, shows that the products and services provided by IFCs help attract domestic and foreign investment in developing countries.

Focusing primarily on China, which since 1978 has witnessed the most successful poverty reduction in history, Sharman said that foreign investment flows, including an increasing amount of outbound investment from China, have been routed primarily through tax-neutral IFCs. Unsurprisingly, Hong Kong has been the greatest source of foreign investment into China, while the British Virgin Islands has consistently been the second-largest investor, and 10 times more Chinese outbound investment passes through Cayman Islands structures than the US.

Sharman concludes that China’s relative openness to IFCs has been a significant contributing factor to the nation’s growth and poverty reduction through lower transaction costs and a more efficient use of capital. As lower transaction costs primarily benefit small- and medium-sized enterprises, which typically face financing obstacles, Sharman argues that there is an even greater impact on poverty reduction.

In tandem with significant strides towards transparency by the leading IFCs, the weight of academic research demonstrates clearly the pivotal role these jurisdictions play in global economic growth and development. At this crucial time, with the international regulatory framework under the spotlight, any ill-conceived attempt to restrict or ­constrain the activities of IFCs threatens to hamper this nascent economic recovery and could potentially undermine global growth for generations to come. n
Grant Stein is global managing partner at Walkers