Wednesday, February 13, 2013

Development of the Cayman Islands as a Banking Center -- paper commentary

Tomorrow at George Mason's Philosophy Politics and Economics (PPE) seminar series, Prof. Andrew Morriss of U. Alabama law school will be coming to present his paper, "Creating Cayman as an Offshore Financial Center: Structure & Strategy since 1960", written with Tony Freyer (also of University of Alabama). The paper is still in a draft stage but quite good, although unfortunately, not easily available online (yet). These are my comments upon reading it.

From the paper, I understood there to be three main causal factors which led to financial market development on the Cayman Islands:

1. Relative independence granted by Britain which allowed institutional experimentation

2. As a seafaring nation there was limited ability to tax the locals directly. Instead they used indirect taxes like import duties and stamps, which stalled the growth of redistributive government and encouraged flexible policy

3. Historical timing. In the 1950s better transport and communication technology were becoming available, and the government encouraged access through air/sea travel. This allowed the banking sector to flourish even though it was far from population centers in Europe, which might not have been possible 50-100 years earlier.

One question this invites: Why not Jamaica? The two islands were administratively linked for many years, but Jamaica took a much different development path. The 1960 Companies Law is some explanation because it encouraged company registration in Cayman rather than Jamaica. The authors also note that Jamaica had a more racially-divisive independence movement while Cayman had been racially mixed for a long time, but this "shock" in the 1960s seems inadequate to explain their full divergence.

I'd argue that the Cayman Islands went into finance because they were so small. Lacking much land, population, or other resources besides access to the ocean, Cayman had few other choices but to adopt capital-intensive industries. Jamaica, on the other hand, has more arable land and also tourism revenue which made banking less of a necessity. I'm sure there's more richness that could be added to this story by someone with more expertise in the region.

I thought the section on development of the medical malpractice insurance market in the 1970s was interesting. While the authors use "crisis" to describe the U.S. insurance market of the 1970s there are several journal articles from around that time which contest that framing, and arguably the insurance market in the 1980s was more crisis-like than the 1970s. Malpractice insurance (especially for non-medical professions, like lawyers) was offered primarily by Lloyd's of London or other "boutique" insurers prior to the 1970s, so nearly any increase in tort claims might be classed a "crisis." I can see why a market opened for more foreign providers as demand for insurance increased, but I don't get a full story from the paper as to why the Cayman insurance sector benefited dis-proportionally (if indeed, they did).

Aside from this, the level of detail and description regarding the Cayman Islands as a tax haven, conflicts with the IRS, fighting laundered drug money, and so on is very impressive. Their conclusion, which emphasized the role of stable institutions in allowing Cayman to offer diverse financial services, summed this up nicely. The authors successfully make their point that strong institutions, rather than shady practices or corruption, were the foundation of the Cayman Islands' success. I just wish there had been more of a comparative element which could have contrasted Cayman against some similar nation to show more concretely how those constitutional differences mattered.

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