Why Don't Tax Havens Become Industrial Powerhouses

by Mike Kimel

Why Don't Tax Havens Become Industrial Powerhouses

Cross-posted at the Presimetrics blog.

The other day I read somewhere (yet again) that low tax rates encourage development. Which got me to thinking about tax havens. I've noticed that places like the Cayman Islands, for instance, seem to be magnets for hedge funds, but rarely if ever do countries which are mainly known as tax havens become industrial or technological powerhouses. What gives?

Here's my thought… a hedge fund can buy and sell assets in country A from anywhere in the world, provided that it knows that country A has strong property rights, infrastructure, and legal institutions. If it can take advantage of those property rights, that infrastructure, and those legal institutions without paying for them (i.e., if it can free-ride), it can increase its private profits by having others pay for some of its costs.

Of course, a manufacturing, tech, or creative firm can also increase its profits by exporting its costs onto third parties (think externalities) which would make a tax haven ideal for such firms too. And yet, except for some transfer pricing games, for the most part, tax havens simply don't attract or internally generate such firms in large numbers. My theory – it takes something else for that. It takes actually having a sound infrastructure (legal and physical), an educated populace, and a mindset, and these are things which tend to be generated by a not extremely incompetent government.

Your thoughts?

PS. Before the inevitable mention of Hong Kong, construct a Venn diagram of a) former British colonies and b) tax havens.