Offshore Financial Centers: a viable strategy for small states?

UNRISD Researchers Byung-Jin Ha and Naren Prasad presented ”Offshore Financial Centres” as a Development Strategy on "Social Development and Peace" at the International Small Islands Studies conference "Islands of the World X" on Jeju Island, Korea on 27 August.

Ha pointed out how some islands have embarked on a strategy of setting up offshore financial centers (OFCs) as a way to promote economic development. In the near-term this has shown positive results, in terms of improved income, employment and other benefits such as additional revenue for the government and other indirect linkages to the economy. However, OFCs present many negative challenges such as money laundering and other criminal activities.

Although tax advantages are generally the biggest reason for the use of OFCs, it is not the intent of OFCs. Instead such centers perform various functions in the world economy, including wealth protection from onshore inflation rates or political instability, the avoidance of regulation, and a desire for the freedom of operation for business. Most OFCs have a history of political stability and strong local economies, which helped to build their reputation as safe havens. OFCs have proved to be essential to the business of multinational corporations, trade financing, and insurance as they mitigate risk and provide efficient handling of foreign exchange between banks and corporations.

To counter the negative aspects of OFCs, small islands have come under intense pressure from international initiatives such as the OECD initiative on harmful tax competition, G7’s Financial Action Task Force and the FSF, UNODC, the EU and international NGOs. These organizations are working on enacting tighter laws and impose stricter supervision to prevent financial crimes. OFCs have made a commitment to implement the OECD programme to eliminate harmful tax practices.

Ha concluded that despite the fact that the international initiatives pose challenges for some OFCs, a bright future for small islands’ OFCs is predicted due to the continued strong demand for the services they provide. The removal of OFCs may improve domestic tax receipts but would generate significant repercussions in the global corporate community. Despite international restrictions on some of the offshore businesses, the demand for financial services is increasing the importance of OFCs to the global financial market, which is likely to continue.