November 30, 2017

Offshore Banking Guards against Tyranny

Tyler Cowen

Holbert L. Harris Chair of Economics at George Mason University
Summary

There are often good reasons for placing money in shadowy accounts abroad.

Confidential, offshore banking is hardly a popular institution. It’s often seen a stand-in for rampant wealth inequality, secrecy and, in some cases, tax avoidance or evasion, even when the money is placed overseas legally. The Panama Papers and Paradise Papers, both large troves of leaked documents about overseas accounts, were considered scandalous, even though the financial institutions involved are legitimate, and many of the accounts haven’t been connected with legal wrongdoing in any way.

Given this background, I’d like to speak up for offshore banking as a significant protection against tyranny and unjust autocracy. It’s not just that many offshore financial institutions, such as hedge funds registered in the Cayman Islands, are entirely legal, but also that the practice of hiding wealth overseas has its upside.

Consider recent developments in Saudi Arabia. In a series of remarkable events, the Saudi government has taken many of the kingdom’s wealthiest individuals hostage in Riyadh hotels, including the Ritz-Carlton, and is negotiating with them for their release. According to some reports, the government is asking for up to 70 percent of their wealth, to raise hundreds of billions of dollars. Presumably if they turn the wealth over, they will be given their freedom. On Tuesday, one of the most senior detained royals, Prince Miteb bin Abdullah, was released after agreeing to pay a $1 billion settlement.

This is a matter of internal Saudi politics, and I’m not suggesting you need to have definite views as to which factions are in the right or wrong. Still, this is a disturbing series of events. From the vantage point of Western liberalism, individuals should be free from arbitrary confiscations of their wealth, connected to threats against their life and liberty, even if those individuals didn’t earn all of that wealth justly or honestly. There is even a “takings clause” built into the U.S. Constitution. On top of these moral issues, such confiscations may scare off foreign investment and slow progress toward the rule of law.

Wealthy Saudis might have been surprised by these particular events, but they knew that their property rights were never fully secure. So many of them placed, or perhaps hid, some of their wealth in offshore banking. In essence, those accounts make it harder for autocratic governments to confiscate resources from their citizens. That in turn limits the potential for tyranny.

A recent study shows which countries are most likely to use offshore banking, as measured by a percentage of their gross domestic product. Perhaps it is no surprise that Saudi Arabia is No. 3 on this list, with its offshore wealth being estimated at more than 55 percent of the country’s GDP. Although offshore banking of this kind is typically confidential, that estimate is based on the geographical distribution of bilateral cross-border bank deposits in offshore centers, and it comes from leading researchers in the area.

The top five countries on this list, measured as a percentage of GDP, are United Arab Emirates, Venezuela, Saudi Arabia, Russia and Argentina, based on estimates from 2007.1 In all of those cases the risk of arbitrary political confiscations of wealth is relatively high. Even if UAE citizens trust their own government, they are sitting in a precarious part of the world. When I consider that list of countries, I don’t think confidential offshore banking is such a bad thing.

Of course, the reality is more complicated. Numbers 10 to 13 on the list are Belgium, the U.K., Germany and France, all with offshore wealth accounting for between 10 percent and 20 percent of their GDP. In those cases, where democratic processes are open and active, I am more worried the offshore accounts are promoting inefficient tax avoidance and illegal tax evasion. The U.S., if you are wondering, is in the middle of the pack with less than 10 percent of GDP held in offshore wealth, slightly below the global average.

Or consider some of the countries that are not major players in the offshore wealth sweepstakes. China and Iran, for instance, have quite low percentages of their GDPs held in offshore accounts, in part because they haven’t been well integrated into global capital markets. (It’s possible, however, that a relatively high share of Chinese offshore wealth is held through shell companies and is undercounted). Are we so sure it would be bad for more Chinese and Iranian wealth to find its way into offshore banks? The upshot would be additional limits on the power of the central leaders to confiscate wealth and to keep political opposition in line. That could either limit oppression or perhaps bring undue political chaos, but it’s an overly limiting picture to imagine the offshore banking institutions as nothing more than an instrument of Western plutocrats.

Perhaps it’s not always an appetizing thought, but in many contexts wealth aids liberty, and the freedom to keep one’s wealth can limit political degeneration.

Notes

  1. The authors of the study believe that calculating these measures for 2007 is the most accurate way to proceed, because in that earlier time shell companies were less of a contaminating influence on the numbers than today.