OFFSHORE FINANCIAL CENTRES
BEST STRATEGY FOR ISLAND ECONOMIES
Janna Rogers*, Sarah Baldwin** and Jerome L. McElroy***
Abstract. This study briefly reviews the post-war development of offshore financial centres (OFCs) hosted
by small island economies (SIEs). It tests the Bertram and Poirine (2007) hypothesis that SIEs diversified
toward offshore finance (and tourism) outperform those without OFCs. Using mean difference analysis
across 25 socio-economic and demographic variables, two profiles are constructed comprising 30 OFC
and 26 non-OFC SIEs. Results show that the former are significantly more economically and socially
advanced than the latter, with higher per capita income and tourist activity and lower unemployment rates
and less dependence on agriculture. In addition, the OFC hosts are more demographically progressive
with markedly higher life expectancy and lower fertility and infant mortality. The more dynamic OFC islands
are also characterized by heavy immigration while their non-OFC counterparts exhibit chronic emigration.
Provisional regression analysis of the OFC sample indicates the most significant correlates with OFC
success are favourable health indicators, international service specialization and strong immigration.
*
**
***
Janna Rogers is a graduate of St Mary’s College Notre Dame, Indiana, USA.
Sarah Baldwin is a graduate of St Mary’s College Notre Dame, Indiana, USA.
Jerome L. McElroy is Professor of Economics, Department of Business Administration and Economics, Saint Mary’s
College, Notre Dame, Indiana, USA
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OFFSHORE FINANCIAL CENTRES
THE BEST STRATEGY FOR ISLAND COMMUNITIES
Janna Rogers, Sarah Baldwin and Jerome L. McElroy
Introduction
“The increasing fluidity of financial systems in conjunction with advancements in telecommunications support the seamless
movement of assets and capital from place to place.” (Cobb, 2001: 161)
Although Offshore Financial Centres (OFCs) initially emerged in the 1920s, they became a significant phenomenon in the postwar era, particularly in the small insular dependencies, with the support of their mainland metropolitan patrons for strengthening
their revenue base (Hampton, 1996). Originally, for example, the United Kingdom (at the instigation of the City of London)
encouraged the overseas development of OFCs as a sound diversification strategy to reduce territorial dependence on grantsin-aid and to replace income-inelastic colonial exports with income-elastic international services. Their expansion was fostered
by advances in telecommunications and the deregulation of international finance with the extension of the Eurocurrency
market outside Europe. As sovereign states attempted to control capital flows through high reserve requirements and taxes,
multinationals and financial institutions began after the 1970s to set up offshore branches in the Caribbean, Latin America, the
Pacific and Southeast Asia (Zorome, 2007).
Although traditionally there has been a dearth of in-depth study of OFCs due partly to “the absence of good data with which to
examine the activities of financial institutions in OFCs” (FSF, 2000: 8), recent research has expanded paralleling the phenomenal
growth of OFCs since the 1970s. It is estimated that offshore deposits have grown from $50 billion in 1970 (Hampton and
Christensen, 2002: 1658) to roughly $12 trillion in 2013 (TJN, 20l3). Several authors have variously attempted to gauge the
global scale of the offshore financial industry. For example, in 1999 Hampton and Abbott (1999:1) estimated that “as much as
half of the world’s stock of money either resides in or is flowing through tax havens.” More recently in 2013, the Tax Justice
Network (2013) calculated that roughly a third of all global financial assets are held offshore.
This rapid growth has not escaped the purview of island scholars. For example, Baldacchino and Milne (2000) first pointed
out the comparative advantage that OFCs hold for small island economies (SIEs). Later, Bertram and Poirine (2007) concluded
that the most affluent SIEs were relatively diversified, and the most successful possessed diversified OFC and high-value
tourism economies. On the other hand, Hampton and Christensen (2007) argue that the tourism cum finance strategy is not
sustainable in the long run because both industries compete for the same capital and labour resources. They opine that the
emergence of offshore finance in small island tourist economies (SITEs) creates a type of “Dutch Disease” effect that, over time,
marginalizes the visitor industry. Because of the limited and conflicting nature of the research available, a renewed examination
of island economies hosting OFCs is warranted.
Scope
In 2012, global receipts from international tourism (excluding transport) exceeded one trillion dollars and international tourists
exceeded one billion arrivals (WTO, 2013). The role of tourism in sustaining SIEs is well known and studied (McElroy, 2006;
Baldacchino, 2010). The current study will assess Bertram and Poirine’s claim that SIEs hosting OFCs and tourism are more
socio-economically and demographically advanced than those that do not. It is a preliminary assessment, however, because the
study does not control for either the extent or type of tourism. The analysis simply compares socio-economic and demographic
impact of the presence or absence of offshore finance in island economies. Two analyses are planned. In the first case, 30
small islands (less than 3 million in population) with OFCs will be compared with 26 non-OFC small islands across over a
number of socio-economic and demographic indicators employing means difference analysis. In the second case, regression
analysis will be used to provisionally isolate the most significant variables that correlate with OFC success. The flow of the paper
will include four sections: a review of the relevant literature, an explanation detailing the methodology, a discussion of the results,
and finally a conclusion summarizing the findings and providing suggestions for further research.
Literature
Early research focused on OFC definitions, lists and characteristics. A variety of lists were developed based on different
definitions. Some focused on types of preferential tax regimes (OECD, 2012), others on various regulatory criteria (FSF, 2000),
or the relative size of the financial sector, i.e. the high ratio of net financial services exports to GDP (Zorome, 2007), or a more
comprehensive set of criteria (TJN, 2007). According to the Tax Justice Network (2007: 10), “There does not exist a single
unambiguous definition of a tax haven or OFC.” What is clear is that both share three common elements: financial secrecy, a
favourable (light) regulatory environment, and low or zero tax rates for non-resident and foreign-owned legal entities.
Bank of Valletta Review, No. 48, Spring 2014
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OFFSHORE FINANCIAL CENTRES
THE BEST STRATEGY FOR ISLAND COMMUNITIES
Janna Rogers, Sarah Baldwin and Jerome L. McElroy
This early work also identified the prominence of island jurisdictions as OFC hosts (MEAD, 2000). Presently the Bahamas is the
leading ship registry jurisdiction, Bermuda is the second leading host for captive insurance companies, the Caymans are the
leading centre for hedge funds, and the British Virgin Islands (BVI) is the leading host for international businesses (Clegg and
Gold, 2011). In addition, a number of studies enumerated the characteristics of successful OFCs (Cobb, 2001). They included
political stability, often a political relationship with an onshore jurisdiction, the crafting of attractive legislation acceptable to both
local and international officials, a cadre of local professionals who can develop the trust of overseas professionals and global
regulators, so-called “institutional thickness” (Amin and Thrift, 1993), and a sophisticated telecommunication infrastructure that
minimizes transaction costs and maximizes economies of scale for multinationals.
Island studies scholarship has consistently emphasized two conflicting veins of analysis in relation to the growth potential of
(OFCs): a dominant stream favouring OFCs as a positive pillar of development, often one of the few competitive advantages
available to small island jurisdictions; and a subdominant, more cautionary strain emphasizing the long-run weaknesses of the
offshore model and its implicit amoral consequences as a drain on state revenues which in turn undermine the sustainability of
welfare regimes.
In the first case, Prasad (2003) was the first to empirically demonstrate the positive correlation between financial services and
per capita GDP in a case study of Barbados. However, he cautioned that “financial centres alone do not ensure economic
growth ... tourism must be developed first” (2003: 64). In other words, tourism’s transport and communications infrastructure
play an important symbiotic role in OFC gestation. Next, with the development of his PROFIT model, Baldacchino (2006)
provided a theory of how OFCs emerge particularly in small sub-national island jurisdictions, namely by using their jurisdictional
discretion to manipulate their ties with their metropolitan patrons to carve out finance, banking and other insular niches in the
global economy.
Bertram and Poirine (2007) advanced Baldacchino’s work in their data-rich cross-country evaluation of nine different insular
growth strategies to fund imports. They concluded that the tourism cum offshore combination was the most successful on the
basis of per capita income levels. In a similar vein, Baldacchino and Niles (2011: 60) later argued that the best insular economic
combination was the triad of political affiliation, offshore finance and high quality tourism. Other authors, noting the global
dominance of Caribbean OFCs and their relative proximity to financial centres in North America and Europe, in contrast to the
remoteness of Pacific islands, have also emphasized the importance of favourable geography in the growth of offshore finance
in particular, and in the development of SIEs in general (McElroy and Medek, 2012; McElroy and Parry, 2010).
In the second case, Hampton and Christensen (2007) represent the main voices of dissent. In a case study of Jersey, they
argue that although OFCs and tourism are symbiotic industries—they share favourable location, infrastructure and political
stability—offshore finance over time inevitably crowds out and marginalizes tourism. More recently, the authors emphasize how
OFC development creates so-called “path dependence.” This describes a situation according to Scott (2001: 367) (quoted
in Hampton and Christensen, 2011: 170) whereby “early choices or actions . . . bias subsequent development in favour of
particular outcomes.” Hampton and Christensen (2011: 171-172) explain this by arguing “that hosting OFCs does not lead
to transferable knowledge gains or increasing entrepreneurial flair . . . ,” but rather toward limited diversification and nonsustainable development in the long run.
A chorus of other critics has emerged since the late 1990s, particularly in the post-recession era of fiscal austerity (Sachs,
2013). They have accused tax havens and OFCs of money laundering to service drug runners and arms traders, massive tax
evasion and terrorist financing (Vlcek, 2008), and pushed for improved transparency, information exchange and compliance
with international tax standards (Owens, 2009). This intensifying scrutiny has become a polarizing issue, with some island
representatives charging that the crackdown is an excuse to blame the SIEs for the global financial crisis (UN, 2009). On the
other hand, tax researchers estimate the U.S. and Europe lose over $200 billion in potential taxes each year and the developing
world loses close to $800 billion (Tax Gap Reporting Team, 2009). Clearly the global political climate has become increasingly
hostile. According to Jessop (2013), the “austerity-weary electorate have had enough of those individuals or companies that
are able to move huge sums offshore through low tax environments in ways that aggressively avoid or evade scrutiny.”
The clampdown has produced some negative effects on the growth of offshore activity. For example, new tax and financial
regulations created in the past decade have stripped tax havens and OFCs of some of their attractive assets. As a result, four
former OFCs have permanently closed down: Nauru, Niue, Marshall Islands and Tonga (Hampton and Christensen, 2011).
On the other hand, raising tax rates has had the favourable effect of helping the islands address their own budgetary deficits
(McFadden, 2012; ¬The Economist, 2012). In addition, the promise of a number of islands to provide more transparent
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OFFSHORE FINANCIAL CENTRES
THE BEST STRATEGY FOR ISLAND COMMUNITIES
Janna Rogers, Sarah Baldwin and Jerome L. McElroy
information exchange to help combat tax evasion suggests current OFCs seek a more stable footing for the future (Winning,
2013). Finally, whatever the impact of increased tax scrutiny on long-run OFC sustainability, this paper attempts to empirically
determine whether SIEs containing OFCs are in fact more economically and demographically progressive in the short run than
their non-OFC counterparts.
Methodology
The methodology adopted in this study was developed in four steps: (1) selecting a number of small island jurisdictions, each
having less than three million in resident population, (2) clustering this sample into OFC and non-OFC subgroups, (3) selecting
the variables employed in constructing the two socio-economic and demographic profiles, and (4) choosing the appropriate
statistical analysis. Although arbitrary, this cut off follows the pioneers in the literature (Armstrong et al., 1998; Armstrong and
Read, 2006; and Baldacchino, 2010). In the first case, 56 islands were selected that met the size criterion and for which
adequate data were available. Second, a list of 33 islands hosting OFCs was taken from the most consistent, standard and upto-date source, the OECD’s 2012 Progress Report. They were identified as small-island jurisdictions implementing internationally
agreed upon tax practices. Three were dropped because they very recently closed down (Hampton and Christensen, 2011).
The SIEs hosting OFCs included the following 30 island jurisdictions: Anguilla, Antigua and Barbuda, Aruba, the Bahamas,
Bahrain, Barbados, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Curacao, Cyprus, Dominica, Grenada,
Guernsey, Iceland, Isle of Man, Jersey, Malta, Mauritius, Montserrat, St. Kitts and Nevis, St. Lucia, St. Vincent and the
Grenadines, Samoa, Seychelles, Saint Maarten, Turks and Caicos, US Virgin Islands, and Vanuatu. The remaining non-OFC
SIEs included the following twenty-six jurisdictions: American Samoa, Cape Verde, Comoros, Falklands, Federated States of
Micronesia, Fiji, French Polynesia, Guam, Jamaica, Kiribati, Maldives, Marshall Islands, Nauru, New Caledonia, Niue, Northern
Marianas, Palau, St. Helena, St. Pierre and Miquelon, São Tomé and Príncipe, Solomon Islands, Timor-Leste, Tokelau, Tonga,
Trinidad and Tobago, and Tuvalu.
Third, 25 socio-economic and demographic variables were chosen to construct OFC and non-OFC profiles. Twenty-one were
taken from The World Factbook (CIA, 2013) and included the following demographic variables: area, population, population
density and the growth rate, birth rate, death rate, median age, net migration, infant mortality, life expectancy, literacy, and the
political status of an island, affiliated or sovereign. The economic variables included: GDP purchasing power parity, per capita
GDP, the percentage of GDP from the agriculture and service sectors, percentage of unemployment, number of paved airport
runways, number of kilometres of paved roads, number of mobile phones and per capita electricity consumption. Three other
economic variables were taken from The Compendium of Tourism Statistics (WTO, 2011) to measure tourist activity, namely
the ratio of total visitors (overnight plus day-trippers) to the local population, per resident visitor expenditure, and the number of
hotel rooms per square kilometre. Finally, because of the importance of geography in island development, Great Circle Distance
(GCD) was taken from Armstrong and Read (2006). GCD is the distance from each island’s capital city to the nearest of three
major origin markets in Brussels, Washington D.C. and/or Los Angeles, and Tokyo.
Fourth, to best contrast the OFC and non-OFC profiles, a two-sample means test was used across the variables to calculate
the statistical differences between the two groups. Prior research suggests OFC islands will outperform the non-OFC islands
because of higher social welfare levels and diversified service sector-led economies, in particular international tourism. Assuming
the hypothesis is correct, further regression analysis will be employed to reveal the dominant characteristics associated with
OFC success.
Results
In the majority of cases, the means difference analysis confirmed the hypothesis that OFCs broadly exhibited greater economic
advantages and higher human resource endowments than their non-OFC counterparts. Table 1 contrasts the data for the two
groups, showing the average values for the 25 variables. After conducting the two-sample means tests, the quantified p-values
revealed 12 indicators as statistically significant at the 0.05 level or better, and an additional three variables significant at the
0.10 level. In terms of economic achievement, OFC islands record a per capita GDP (US$) of $25,793, over twice that of nonOFCs islands ($12,188). Statistically significant at the 0.10 level, OFCs level of unemployment (9.98%) is half the unemployment
rate of non-OFCs (18.2%), a trend common in economies which diversify away from the traditional agricultural sector toward
a labour-intensive service sector. As predicted by Hampton and Christensen (2007), the importance of the agriculture sector’s
contribution to GDP was considerably lower for OFCs than for non-OFCs, i.e. 3.4% versus 17.9 percent. This suggests that,
although there are exceptions, the former have made significantly more progress than the latter in restructuring and diversifying
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THE BEST STRATEGY FOR ISLAND COMMUNITIES
Janna Rogers, Sarah Baldwin and Jerome L. McElroy
their colonial economies.
Table 1
OFC and Non-OFC Profiles
Variables
OFCs
Area (km squared)
Population
Non-OFCs
P-value
4,831
4,763
0.985
237,117
381,501
0.310
Population Density
412
204
0.037*
Population Growth Rate (%)
.88
.644
0.421
Birth Rate (per 1000)
14.09
18.9
0.047*
Death Rate (per 1000)
6.62
4.88
0.080**
Infant Mortality (per 1000)
10.22
21.3
0.005*
Life Expectancy
76.74
72.2
0.001*
Median Age
34.28
26.5
0.000*
Net Migration (per 1000)
3.44
-7.63
0.000*
Literacy (%)
94.46
91.42
0.229
.533
.615
0.544
5,358,789,333
4,194,823,077
0.564
25,793
12,188
0.002*
Political Status
2
GDP Purchasing Power
Parity (US$)
Per Capita GDP (US$)
Percentage of GDP
• Agriculture
3.44
17.9
0.006*
77.76
67.1
0.004*
Unemployment (%)
9.98
18.2
0.056**
No. Paved Airports
3.4
5.4
0.321
•
Services
Paved Roads (km)
1.040
759
0.457
No. Mobile Phones
288.281
413,090
0.504
Per Capita Electricity
Consumption (kWh)
5.832
4,800
0.745
Tourism Pop./ Island Pop
8.71
1.46
0.001*
Tourism S/ Residents (US $)
5.203
1,107
0.003*
0.090**
Rooms/km2
15.5
5.0
Great Circle Distance
3892
5840
0.11*
Notes:
1. One asterisk (*) indicates statistical significance at the 0.05 levels or better;
Two asterisks (**) indicate statistical significance between 0.05 and 0.10
2. Measured as 0 for dependent and 1 for independent.
Not surprisingly, service sector activity was a major GDP contributor for both OFC and non-OFC islands, but predictably the
OFCs were significantly more service-oriented-77.8% vs. 67.1%-because of their heavy focus on tourism and offshore finance.
The extent of tourism development is particularly evident in the OFC island subgroup. For example, the gross ratio of tourists
to the local population is roughly six times greater in the OFC destinations than in the non-OFC islands, i.e. 8.7 versus 1.5.
In addition, average per resident tourist spending is over four times higher in the former than in the latter, i.e. $5,203 versus
$1,107. Finally, the average number of hotel rooms per square kilometre is three times larger in the OFC isles than in their nonOFC counterparts, 15.5 versus 5.0, indicating tourism is much more visible across the insular landscape in the former than in
the latter. On the other hand, there were no significant differences between the two island groupings on two standard tourism
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Janna Rogers, Sarah Baldwin and Jerome L. McElroy
infrastructure measures, the extent of paved roads and the number of paved airport runways. However, OFC hosts were
significantly closer to their metropolitan origin markets than their non-OFC neighbours as measured by great circle distance:
3,892 versus 5,840 km. This favourable geography partially explains the relative tourist intensity of the OFC islands as well as
the establishment of offshore services on the islands they inhabit. This tourism intensity, however, makes it difficult to precisely
tease out the specific contribution of offshore presence alone to the relative affluence of the OFC island group.
Consistent with their greater level of economic development, the demographic maturity and human resource advancements are
more progressive in OFC islands when compared to non-OFC counterparts. For instance, OFCs average a significantly higher
life expectancy (76.7 years) than the non-OFCs (72.2 years), and they exhibit an infant mortality rate (10.2) approximately half
that of non-OFCs (21.3). Although both island groups are similar in area, averaging less than 5,000 km2, OFCs demonstrate
twice the population density of non-OFCs (412 vs. 204), in part a reflection of their heavier focus on labour-intensive tourism
and offshore banking. The results also indicate that OFCs average a more mature population, a median age of 34.3 years, an
8-year difference from the median age of non-OFCs (26.5 years), implying a higher population share of working-age adults, a
characteristic associated with more buoyant economies. The OFCs average crude birth rate (14.1) is significantly lower than
the average non-OFC rate (18.9), a result due to the former’s considerably higher level of affluence. On the other hand, the
average OFC crude death rate is significantly higher, i.e. 6.6 versus 4.9, probably largely due to the OFCs` older population
structure. Although previous research (McElroy and Sandborn, 2005) comparing dependent and sovereign Caribbean and
Pacific islands had stressed the influence of political status on socio-economic performance, jurisdictional status was an
insignificant variable in the present study since roughly a dozen politically affiliated islands were included in both OFC and
non-OFC island groupings. Finally, net migration significantly discriminates the two island groups, with OFCs averaging 3.4
immigrants per 1,000 population while non-OFCs average 7.6 emigrants. This suggests the former possess dynamic labourimporting economies that have passed through the migration transition while the latter remain sluggish chronic labour-exporters
(Guan and McElroy, 2013).
After confirming the basic conclusion of Bertram and Poirine (2007) and others that SIEs specializing in offshore finance and
tourism are more successful than their insular counterparts, a provisional attempt was made, employing regression analysis,
to further identify the characteristics most associated with that success in the 30-island OFC subgroup. Per capita GDP was
used as the dependent variable to measure economic performance, and a large number of independent variables were used
to represent various economic, demographic and health conditions in OFC islands. After a number of multiple regression
experiments were conducted, the best-fitting equation is presented in Table 2. Results of this preliminary analysis suggest that
over half of the variation in OFC-island per capita income is associated with three statistically significant characteristics. These
are: (1) good health as measured by low infant mortality, (2) specialization in international services (tourism, offshore finance) as
measured by their contribution of services to GDP, and (3) strong in-migration, a feature of a robust economy. The provisional
model further suggests that these three factors contribute to the economic success of OFC host islands, as measured by per
capita GDP, and are as well partly the result of that same success.
Table 2
Regression Results
OFC Dependent Variables
Coefficient
SE
T-stat
P
Constant
-15933.0
24546.0
-0.65
0.523
Infant Mortality
-1468.9
588.7
-2.50
0.020
Net Migration
714.1
342.4
2.08
0.049
720.4
270.9
2.66
0.014
Service/GDP
R2(adj.)=52.3%
F stat=10.49
Conclusion
This study addressed the claim that small islands hosting OFCs outperform those without. A sample of 56 small islands (less
than 3 million in population) was clustered into two groups: 30 islands with OFCs and 26 without. Through mean difference
analysis two extensive profiles were constructed across 25 socio-economic and demographic variables. The results confirmed
that OFC islands were clearly more affluent and demographically and socially advanced than their non-OFC counterparts. For
example, the OFCs boasted statistically significantly higher per capita income, life expectancy, median age, tourist arrivals and
spending, and the percent services in GDP than their non-OFC neighbours. Likewise, in contrast to the non-OFC islands, the
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Janna Rogers, Sarah Baldwin and Jerome L. McElroy
OFCs recorded lower unemployment, fertility, infant mortality, distance to major original markets, and the percentage of GDP
in agricultural production. Such outcomes tend to confirm the basic conclusion of Bertram and Poirine (2007) that hosting
OFCs is a superior economic strategy at least in the short run. This study was provisional, however and did not control for the
influence of tourism and precisely measure the contributions of offshore finance alone. Nevertheless, these robust empirical
results along with suggestions in the literature indicate offshore presence is a fruitful area of further research.
On the other hand, the current stigma associated with tax havens and the increased international demand for offshore finance
transparency may weaken future OFC prospects. As the literature review demonstrated, the past two decades have marked
a shift in the global attitudes towards OFCs. Much of this harsher environment has been brought on by the budgetary crises
in the developed countries exacerbated by the Great Recession and its aftermath. As a result, the more stringent regulatory
climate has forced many insular OFCs to reform their tax codes and modify their bank secrecy practices and thus risk losing
some of their global financial comparative advantage. As a consequence, the long-term future of these OFCs is unclear in part
because such SIEs have so few diversification options. According to Hampton and Christensen, 2022: 178), “In many cases,
we would suggest that the outlook for small island hosts of offshore finance is bleak as there is scant evidence of the existence
of a practical or realistic alternative ‘Plan B.’” What is clear, however, is that international pressure is likely to be sustained, the
growth of OFCs will be restricted, and further research will be warranted.
Some new directions might include the following: (1) more rigorously controlling for the influence of tourism to precisely identify
the contribution of offshore finance to island welfare, (2) investigating whether there are differences in performance between
OFCs in different oceanic regions, and (3) mounting a series of case studies to determine whether offshore development in fact
does marginalize tourism through some form of “Dutch Disease” effect.
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