The correlates of international financial‐center status

• Author: Nachiket Shah,Barry Eichengreen
• Published date: 01 February 2020
• Date: 01 February 2020
• DOI: http://doi.org/10.1111/roie.12441

62

|

wileyonlinelibrary.com/journal/roie Rev Int Econ. 2020;28:62–81.

© 2019 John Wiley & Sons Ltd

1

|

INTRODUCTION

The geography of international financial centers is very much in play. The United Kingdom’s planned

exit from the European Union raises the question of whether London will maintain its preeminence

and, if not, what other centers might take its place (see, e.g., Brennan, 2018; Roberts, 2018). Chinese

officials have promoted international use of the renminbi with the goal of enhancing Shanghai’s po-

sition as a global financial center, but the success of their efforts remains to be seen (Eichengreen &

Kawai, 2015; Han, 2018). Hong Kong has sought to maintain its role as the leading financial entrepôt

between China and the rest of the world by encouraging mainland companies to list on its stock ex-

change and by establishing a “Stock Connect” through which Chinse investors can purchase shares

(Pan, He, Sigler, Martinus, & Derudder, 2018). European governments and companies meanwhile are

pondering options for relocating financial business away from New York in order to avoid penalties

for noncompliance with U.S. sanctions (Geranmayeh & Batmanghelidj, 2018).1

All this makes it timely to review what we know about international financial‐center status.

Scholars from different disciplines have adopted varying perspectives on this question. Economic

historians such as Cassis (2006) emphasize the importance of historical trade links, historical finan-

cial links, and historical financial development. Economists point in addition to the role of geogra-

phy and technology. They highlight the advantages of a network of information and communications

Received: 4 March 2019

|

Revised: 8 July 2019

|

Accepted: 26 July 2019

DOI: 10.1111/roie.12441

ORIGINAL ARTICLE

The correlates of international financial‐center

status

BarryEichengreen

|

NachiketShah

Department of Economics,University of

California, Berkeley, California

Correspondence

Barry Eichengreen, Department of

Economics, University of California,

530 Evans Hall #3880, Berkeley, CA

97420‐3880.

Email: eichengr@econ.berkeley.edu

Funding information

We thank the Clausen Center at the

University of California, Berkeley for

financial support

Abstract

We consider the correlates of international financial‐center

status. Our estimates point to the flexibility, transparency,

and stability of the economic and social environment as

determinants of financial center‐status. They point also to

roles for monetary and financial stability, financial open-

ness, financial scale and development, technology and size

of government. We draw out the implications of this analysis

for the future prospects of actual and aspiring international

financial centers such as London, New York, and Shanghai.

|

63

EICHENGREEN aNd SHaH

links for completing a high volume of financial transactions and thereby reaping economies of scale

(Lee, Alford, Cresson, & Gardner, 2017). They single out geography as a factor influencing access

to that network (Eichengreen, Lafargette, & Mehl, 2016). They emphasize the information content

of financial assets—whether securities are information sensitive, in which case they are apt to be

traded in multiple centers close to their originators, or information insensitive, in which case trading is

more likely to concentrate in a small handful of venues to leverage thick‐market externalities (Gehrig,

1998). Economic geographers (e.g., Faulconbridge, 2004; Parr & Budd, 2000) incorporate all of these

factors and suggest in addition that individual financial centers constitute part of a larger network

whose collective properties should be taken into account.

The corresponding empirical literature is less than conclusive. Reed (1980), Michie (1991),

Schenk (2002), Lai (2006), and Elliott (2011) present case studies of individual financial centers, but

the generality of their findings remains unclear. Alternatively, Kayral and Karan (2012) and Moosa,

Li, and Jiang (2016) consider survey‐based ratings of competing international financial centers. They

compare different financial centers at a point in time, attempting to identify the determinants of the

attractiveness of those centers as measured by the surveys in question. For the most part, however, they

have obtained few robust results.

This paper extends the comparative approach of this last set of studies. Rather than limiting the

analysis to a single point in time, it assembles an annual panel of financial center ratings spanning a

decade. More data make for more statistical power and more definitive results.

The estimates point to the flexibility, transparency and stability of the economic and social en-

vironment as determinants of financial‐center status. Financial centers are more attractive when the

country in which they are located ranks high on the Heritage Foundation's index of economic freedom.

They are more attractive when the host country rates higher on the World Economic Forum's index of

global competitiveness. They are more attractive when corruption in the host country is less pervasive.

A second set of variables points to the importance of monetary and financial stability. Financial

centers are more attractive when the host‐country government has a higher sovereign rating from com-

mercial credit rating agencies. According to some regressions, they are more attractive when inflation

is low and stable.

A third cluster of variables captures the importance of financial scale and development. Financial

centers are more attractive when located in a country where equity‐market capitalization as a share

of GDP is higher, reflecting the existence of larger and better‐developed financial markets. Relatedly,

financial centers are more likely to be situated in large countries, whose residents are apt to generate a

large volume of financial transactions, indicative of the importance of economies of scale and scope.

Technology also matters. Financial centers are apt to be located where internet usage is higher,

consistent with the emphasis in some pertinent literature on the importance of information, commu-

nications, and data‐processing technology. They are more attractive when situated in countries where

high‐tech products constitute a relatively large share of manufactured exports, consistent with a role

for the technological sophistication of the economy more generally.

Finally, there is at least some indication that financial centers tend to be situated in countries with

larger governments. Government is a source of contract‐enforcement services and property rights

protections valued by investors, and under‐resourced public sectors are less able to provide them. In

addition, relatively open economies have larger governments, as established in previous studies (e.g.,

Alesina & Wacziarg, 1998; Rodrik, 1998). A large public sector can help to buffer the citizenry from

external shocks, with positive implications for the sustainability of openness. Given the value that in-

ternational investors attach to de facto openness, the size of the public sector is thus another plausible

indicator of the attractiveness of a financial center.