Long Live Jurisdictional Competiton

by Don Boudreaux on March 30, 2009

in Competition, Complexity & Emergence, Regulation

I'm eager to read this latest paper by my co-blogger at Market Correction, Andy Morriss.  Here's the abstract:


The legal regimes of offshore jurisdictions have historically differed
in significant ways from those applicable in onshore jurisdictions.
Inevitably, legal and financial professionals have seized upon these
differences to develop strategies for reducing transactions costs. A
prominent example of such cross-border arbitrage was the routing of
Eurodollar loans through a small group of former Dutch island colonies
in the Caribbean, a practice which peaked in the mid-1980s, when
virtually every major U.S. corporation made interest payments to a
Netherlands Antilles finance subsidiary. The "Antilles sandwich"
strategy exploited the difference between high U.S. withholding tax
rates that applied to interest payments made to most foreign lenders,
and the zero rate of tax that applied to U.S. interest payments made to
residents of the Antilles under its tax treaty with the United States.
Both jurisdictions reaped significant benefits from the strategy until
the United States unilaterally terminated the tax treaty in 1987,
virtually wiping out the Antilles offshore financial sector overnight.
Unfortunately, because of rigidity in its governance structure, the
Antilles' failed to develop alternative financial intermediation
strategies to replace the Antilles sandwich structure before its
demise.


The
rise and fall of the Antilles' offshore financial sector provides
insight into the current struggle between onshore and offshore
governments over the role of offshore financial centers like the
Antilles within the global economy. Concerned about tax evasion by
their residents, onshore jurisdictions including France, Germany, and
the United States are pressing for major changes in offshore
jurisdictions' legal and regulatory regimes that may eliminate
legitimate opportunities for international arbitrage. In such an
environment, offshore financial centers may find it difficult to
survive. In this article, we distill from the Antilles experience a
theory of "regime plasticity" and examine the role that it plays in
allowing offshore financial centers to adapt to changes in the legal
and political environments within which they operate. How offshore
financial centers react, and whether they have learned the lessons of
the Antilles' experience will play a major role in determining the
future of the global offshore financial sector.
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{ 2 comments }

vidyohs March 30, 2009 at 7:18 pm

Given that this is true:

"Both jurisdictions reaped significant benefits from the strategy until the United States unilaterally terminated the tax treaty in 1987, virtually wiping out the Antilles offshore financial sector overnight."

The USA with its unilateral withdrawal tells me that the USA was by far and away the major player.

"the Antilles' failed to develop alternative financial intermediation strategies to replace the Antilles sandwich structure before its demise."

With that in mind what could the Antilles have done to replace the Antilles sandwich structure, where would they have turned, to what, or to whom?

L Burke Files March 31, 2009 at 3:22 pm

Offshore Financial Centers OFC exist because they can craft and economic advantage in law, an advantage over the more ossified locations.

These advantages exist because in some other nation there exists, political instability, political idiocy, or over regulation and taxation. These conditions provide for capital flight and opportunity flight form the offending jurisdiction.

The problem with OFCs are that they are often "One Trick Ponies" for example Bahamas, for Insurance, Cayman for Hedge Funds, Barbados for Private Banks, Nevis for LLCs, Antigua for Gaming. These one trick ponies have excellent depth and knowledge in their fields, but rarely have a second trick. But they are learning as a raft of new enabling legislation is sweeping the OFCs. They have learned that the ultimate risk is political risk.

The problem the OFCs face is economic warfare. The OFC develop an advantage and the developed nations as opposed to out innovating these nimble competitors react with yet more regulations and restrictive rules, accelerating the capital flight as opposed to revering it. It is a lot like beating a horse to move, eventually he will not only stop running, he will turn on you.

The trick now is that it is easier than ever to set up an International Based Business to take advantage of the jurisdictional efficiencies and discard the less efficient. The OFCs are not only more efficient the professionals that inhabit and use these jurisdictions are more innovative, because they can be.

For Developed Nations to rail about OFC and tax cheats – they are missing the economics, most people are setting up offshore because it brings them more freedom, for example the ability to invest in the other 80% of the investment opportunities not available to US residents. The OFC's are also used as a shield for asset protection, primarily against litigation and arbitrary administrative actions.

The OFC's will continue to exist because of the monopolist actions of ossified governments. Also expect more challenges to the rulings of ossified nations in the WTO – like the successful one of Antigua and others involved in gaming.

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