It is now well known that many countries which depend on earnings from natural resources like oil have failed to harness them for national development. In many cases it seems even worse than that: for all the hundreds of billions of dollars sloshing into countries like oil-rich Nigeria, for instance, such places seem to suffer more conflict, lower economic growth, greater corruption, higher inequality, less political freedom and often more absolute poverty than their resource-poor peers. This paradox of poverty from plenty has been extensively studied and is known as the Resource Curse.
This book asks whether some countries with oversized domestic financial centres may be suffering from a similar, and related, phenomenon.
We find strong evidence that the answer is yes – and not just for reasons related to the global financial crisis that erupted in 2007/8. Perhaps more surprisingly, this phenomenon that we are calling the Finance Curse is similar in many ways to the Resource Curse: there are big overlaps in both their causes and their effects.
The Finance Curse has been evident for decades – and if untreated it may well endure for years or even decades after the latest crisis has blown over.
Every economy needs its financial plumbing, and for decades academic studies suggested that bigger is generally better when it comes to financial sector growth. The crisis has called all that research into question. New evidence is starting to emerge from the IMF, the Bank for International Settlements and others, revealing that above a certain size, finance turns bad.
Our book, drawing on our many years of hands-on experience of both resource-dependent countries and finance-dependent ones, goes far beyond the boundaries of their research to create an unprecedented comprehensive body of evidence about the perils of oversized finance.
Despite the trillions flowing into and through the City of London, for instance, Britain performs worse on major human development indicators – inequality, infant mortality, poverty, and more – than Germany, Sweden, Canada and most of its other rich-country peers. Each ailment has many explanations, but oversized finance appears to be a major contributor.
The Finance Curse is a story about “Country Capture” – where an oversized financial sector comes to control the politics of a finance-dependent country and to dominate and hollow out its economy. Some elements of this ‘capture’ are already well understood but our book introduces a wide range of new ideas and analysis.
In large finance-dependent countries such as Britain or the United States, the Finance Curse’s causes and effects are masked by background noise in large, raucous democracies. But in the small finance centres and tax havens such as the Cayman Islands or Cyprus, these complexities are stripped away and the phenomenon is laid bare in purer, more crystallised forms which are easier to see and understand.
The tax havens, which we have studied extensively, carry important lessons — and warnings — for larger finance-dependent countries.
This book starts with a brief overview of the Resource Curse. The main sections that follows, on the Finance Curse, start by looking at the most important and most widely publicised claims made by defenders of large financial sectors.
We then examine these claims in turn and reveal why nearly all of them are wrong. Along the way we expose catastrophic errors in studies that claim to demonstrate to policy makers the ‘contribution’ of finance.
Next, we show that not only is the ‘contribution’ of finance usually much smaller than advertised, but it is worse than that: a wide and diverse range of harms flow from having an overly large financial centre. One can plausibly say that for many countries, the net ‘contribution’ of finance is likely to be negative – in some cases strongly so.
The picture is — of course — not a simple one. Many of these effects, particularly the political ones, cannot be quantified. The political damage is probably more acute in small countries hosting financial centres, while in larger countries such as Britain or the United States the damage is probably felt more heavily in economic terms.
And just as some resource-rich countries like Norway or Chile seem to have successfully avoided or managed the Resource Curse, some finance-dependent countries like Switzerland or Luxembourg seem to have tempered or even avoided the Finance Curse.
But some countries such as Britain and the United States genuinely do seem cursed by their oversized financial centres. A sector widely regarded as the Goose that Lays the Golden Eggs often turns out to be a very different bird: a Cuckoo in the Nest, crowding out, hollowing out and undermining other economic sectors. Very often, the interests of the financial centre conflict directly with the national interest.
Our analysis has profound implications. Financiers routinely cry ‘don’t tax or regulate us too much or you will be ‘uncompetitive’ and we will run away to Geneva or London or Hong Kong’ – and far too often the politicians quail and give them what they want. These threats and fears are perhaps the most important reasons why it is so hard to regulate finance appropriately, and why big banks are bigger and potentially more dangerous today than before the crisis erupted.
Our Finance Curse thesis cuts through this Gordian knot. Taking it on board puts power right back in the hands of democratically elected officials. If too much finance is harmful, then it makes clear political and economic sense to regulate and tax this sector appropriately. If the end result is less financial activity, then that will be beneficial. It is therefore absolutely not necessary to participate in the ‘competitive’ race on lower standards of financial regulation, and the obvious course of action is national leadership on better standards, even in the absence of collective international agreements.
Finally, this is not a book about how global financial centres can transmit damage to other countries, important though that subject is. It is about how an over-sized financial sector can harm its own host country.
Copyright 2013 Nicholas Shaxson and John Christensen