The Determinants of Offshore Financial Center Investment

An offshore financial center (OFC) is generally defined as a jurisdiction in which the financial sector is disproportionately larger than the domestic economy. OFC's offer significant tax and regulatory advantages as well as providing clients from unstable countries with international banking services. For a country with a large degree of outward OFC investment, tax collections are likely to be lower and accurate risk assessment becomes more difficult. What factors determine which countries have investors that more heavily utilize OFC's than others? I assess this question using a panel data set covering 63 source countries investing in over 200 foreign jurisdictions. I find that there tends to be less outward OFC investment from countries with more economic freedom and low levels of corruption. In particular, a one standard deviation increase in economic freedom is predicted to reduce the share of foreign investment that goes to OFC's by 8-12 percentage points, while a similar increase in the control of corruption is predicted to reduce OFC investment by nearly 6 percentage points. OFC investment tends to be higher in countries with strong enforcement of regulations, suggesting that investors in these countries turn to OFC's since they cannot bypass these regulations domestically. There is also some evidence that countries compete indirectly with OFC's, being forced to lower taxes or face a flight of capital to these jurisdictions