“Competitive” financial regulation

As with tax wars, countries are constantly offering ever more cosy arrangements and inducements to attract financial services providers, their money, and their arrangements for managing their money. It is another race to the bottom.

So countries like the United Kingdom, Ireland or Luxembourg seek to tempt foreign money by providing opportunities to escape domestic financial regulation elsewhere. The two words – ‘escape’ and ‘elsewhere’ are foundational for our understanding of what “offshore” means.

As one player loosens rules to tempt the money, others follow suit, to stay in the ‘race.’

The race to the bottom is not just on normal financial regulation, but on levels of tolerance for dirty money. This race is profoundly harmful, from any reasonable perspective one can think of. This is race is perhaps the most important single reason why financial sectors around the world have grown so large and powerful, and have been able to ‘capture’ policy making in countries around the world.

This process is often called financial regulatory ‘competition’. But, as with tax wars, this has nothing at all to do with competition in a marketplace. Relax rules to attract the money – and financiers benefit. But rules are there for good democratic reasons: relaxing them comes at a cost to society, borne by others.

Having a ‘competitive’ financial centre may seem like a good idea – up to the point where you think about what it actually means. It turns out that ‘competitive’ financial regulation means lax financial regulation. This ‘competition’ between financial centres is always harmful. The United Kingdom has learned to its great cost than when your financial centre wins the race, everyone else loses, at home and abroad. (Read more here for a short summary.)

Tension in the ‘competitive’ model

What is true for financial regulation is true for dirty money. And this helps illustrate a tension in the business model.

On the one hand, financial centres wish to portray themselves as clean, co-operative, transparent, trustworthy and well-regulated. On the other hand, they also face incentives to move in exactly the opposite direction, to attract as much dirty and questionable money (or the structures for owning that money). To manage these contradictory pressures – to take dirty money, while appearing clean – they perform carefully stage-managed theatres of probity, combined with a business model that can be crudely summarised as: “we will not steal your money – but we will turn a blind eye if you steal someone else’s.”

But there is a more important tension at play.

Leaving aside the question of financial crises and the build-up of risks through ‘competitive’ financial deregulation, research now overwhelmingly shows that – particularly for large economies – growth in the size of a country’s financial sector, above a certain size, is harmful for economic growth, and it leads to ‘political capture’ of jurisdictions, not to mention greater inequality, the ‘crowding out’ of alternative economic sectors, and oceans of rent-seeking. Read more about all this here.

In summary, the global race on financial regulation is devastating. But even seen purely from the perspective of an individual country, it makes no sense at all to engage in the race.