When I learned of The St. Paul Cos.’ decision to move its reinsurance operations and 600 jobs to Bermuda, it reminded me of a question asked by a friend during a tour of the Duluth harbor.
He noticed a ship from Liberia loading coal and a ship from Panama loading wheat. He asked: “Why does a tropical country need coal, and why does Panama need so much wheat?”
The news about the insurer triggered my memory because when a company moves operations to a small Atlantic island, and ships from small tropical countries load coal, the economic dynamic playing out is the same: competition between political jurisdictions.
Whenever that occurs, tough questions follow.
In some cases, such competition promotes economic efficiency. But it can also foster inefficiencies that make society as a whole worse off. Distinguishing between the two outcomes is usually straightforward.
As I explained to my friend, ships flying Liberian and Panamanian flags loading coal or wheat in Duluth has nothing to do with those countries’ imports and everything to do with government competition.
These two countries and others offer easy taxes and regulation to attract ship registrations from around the world and earn fees from vessels whose owners are actually located in the United States, Japan, Germany or other industrialized countries.
Similarly, Bermuda offers low taxation and lax regulations to insurance companies to lure these firms into locating operations in this small island nation.
The measure creates jobs for Bermudan citizens but takes them away from St. Paul, Amsterdam, Frankfurt, New York and Zurich.
We need to be clear that this is largely a phenomenon of competition among government and not one of sleazy business people searching out and conning officials in sleepy, underdeveloped countries.
Yes, the first “flag of convenience” ship registrations may have taken place when ship owners, anxious to avoid taxes and safety regulations, searched out the nations with the most favorable regulatory regimes as a home of registry for their vessels.
But small nations soon learned that offering flags of convenience could be lucrative. Miniature countries such as Malta, Cypress and Vanuatu can earn millions of dollars in registration fees and have hundreds of people employed in sham shipping “offices” if they tailor their maritime regulations to the wishes of ship owners.
The crews of these ships are likely to come from Pakistan, the Philippines or China. The ships will seldom, if ever, enter a port of the nation in which they are registered.
So if working conditions for the sailors are dangerous, unions banned, safety regulations absent, and if the ship piles up on the rocks because the captain was unqualified or the radar broken, no truly Maltese, Panamanian or Liberian citizen or firm will be hurt.
But this covers only the possible downside.
Ship owners initiated a public relations campaign to call such foreign registrations flags of “opportunity” rather than “convenience.” If countries such as Panama and Liberia enforce prudent standards with regard to ocean pollution prevention and vessel safety, the fact that they omit other onerous regulations that reduce efficiency will not hurt the world as a whole.
It becomes a simple case of comparative advantage, moving jobs to where labor is cheap, just like sewing garments in China rather than Manhattan.
In the same way, if Bermuda’s favorable regulation of certain insurance actions increases risk, this is not likely to hurt Bermudan citizens since virtually all of the insured property is located elsewhere in the world. Any default will not be against island residents.
If Bermuda gets insurance operations with its lower labor costs and omission of inefficient regulation, but maintains prudent financial supervision of insurance firms, global society gets more output from the same inputs. As a whole, humanity is better off.
But if Bermuda draws the business because it allows firms to take levels of risk that are inefficient from the point of view of society as a whole, we are worse off.
The situation is no different than when South Dakota governor Bill Janklow went to New York in 1978 to offer major credit card issuers favorable state laws if they would move their credit card operations to his state. Besides guaranteeing no usury law limitations on interest rates, South Dakota law favors credit card banks in a variety of ways.
Am I being exploited or is U.S. society worse off because of these South Dakota policies? Neither, but history may prove me wrong.
Are flag-of-convenience-registered ships responsible for a disproportionate share of pollution or loss of life at sea? There is some evidence that the first is true but the second is not.
Do Bermuda’s seductive insurance regulations help or hurt world society as a whole? That is the subject for several Ph.D. dissertations. As with many uncertain issues, time will probably tell even if scholarly research does not.
That leads us to the most pressing and local facet of the whole jurisdiction-competition debate: Does competition between Minneapolis and St. Paul to furnish a new baseball stadium help or hurt the citizens of these cities, or Minnesota, the U.S. or the world? Now there is a subject for research.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.