Financial Job Flight

Peter J. Wallison, the Arthur F. Burns Fellow in Financial Policy Studies, notes that the Democrats have been very vocal in opposing free trade agreements--blaming these agreements for loss of domestic manufacturing jobs--but have not paid any attention to the drastic flight of financial markets out of the United States that has resulted from excessive regulation and litigation risk. He suggests that this bias results from Democrats catering to unions and trial lawyers--two important constituency bases.

Arthur F. Burns Fellow
Peter J. Wallison
As their primary campaign moved to the Rust Belt states, Hillary Clinton and Barack Obama directed much of their rhetoric against the North American Free Trade Agreement (NAFTA) and free trade in general. In Ohio, Pennsylvania, and Indiana, which together control 371 pledged delegates--almost 10 percent of the Democratic delegate vote--many voters' chief concerns involve the exodus of jobs from the region over the past decade. Although 7.2 million jobs have been created in the United States between January 2000 and January 2008--a growth of about five and a half percent--these three states have not benefited from the economic boom. During this period, Pennsylvania, Indiana, and Ohio lost a net of 37,300 jobs, gaining service sector jobs but losing a total of 609,200 manufacturing jobs.

Many of these job losses reflect global reallocations of manufacturing under well-known principles of comparative advantage; the U.S. is losing manufacturing jobs but gaining jobs in other sectors--mostly the knowledge industries--where it can produce most efficiently in comparison with other countries. But the Democratic party's refrain for many years--following the lead of its union constituency--has been to attack free trade for the losses it creates, but not to recognize the gains. In truth, this is special interest politics, since job losses have been disproportionately in union jobs while the gains from free trade have been in sectors that are not unionized.

Although there is little data to indicate exactly why manufacturing jobs are disappearing, NAFTA has become a perennial scapegoat. Often ignored is the fact that NAFTA has benefited certain industries and even the states with net job losses: last year, for example, the top export markets for Ohio, Pennsylvania, and Indiana were Mexico and Canada.

If greater regulation of the securities business does, in fact, result from the Bear Stearns case, it will only increase the costs and reduce the innovativeness of U.S. securities firms, creating further obstacles to a U.S. recovery of its former position.

The Democratic candidates' attachment to the narrow interests of the unions becomes very clear when one compares their flailing against NAFTA with their apparent lack of concern about the loss of jobs in the financial industries, which are largely not unionized. From March 2006 to January 2008, the financial industry in the United States has lost a net of 69,000 jobs, more than the net loss of jobs in Pennsylvania, Indiana and Ohio over the past eight years. Yet there has not been a word about these losses from the Democratic candidates or influential Democrats in Congress. This is especially odd in light of the fact that Senator Clinton is one of the Senators from New York, the state where the financial industry is centered, and the other Senator from New York, Charles Schumer, is one of the most powerful members of the Democratic majority in the Senate and a member of the Senate committee that has jurisdiction over the financial industry in the United States.

If greater regulation of the securities business does, in fact, result from the Bear Stearns case, it will only increase the costs and reduce the innovativeness of U.S. securities firms, creating further obstacles to a U.S. recovery of its former position.

Why have these losses occurred? In the past few years, four reports by respected groups--the U.S. Chamber of Commerce, the Financial Services Roundtable, the Committee on Capital Markets Regulation, and even Senator Schumer (who sponsored a report with New York City mayor Michael Bloomberg)--have warned about the gradual loss of financial business to foreign markets. These studies note that the United States is losing its preeminence in the world's financial markets because of excessive regulation and the high litigation risks associated with private class actions. The current turmoil in the financial markets has little to do with this issue. All these studies point to excessive regulation of securities issuers--not broker-dealers like Bear Stearns--or substantial litigation costs of securities issuers as the source of the loss of U.S. financial dominance. Indeed, the inevitable loss of confidence in U.S. financial markets as a result of the Bear Stearns collapse will only exacerbate the adverse trends that these reports highlight. If greater regulation of the securities business does, in fact, result from the Bear Stearns case, it will only increase the costs and reduce the innovativeness of U.S. securities firms, creating further obstacles to a U.S. recovery of its former position.

The most up-to-date information about the current trend away from the United States comes from the report of the Committee on Capital Markets Regulation, a group of academics and market experts assembled by Hal Scott of Harvard Law School. The December 2007 report, focusing on the public securities markets, shows that the trend away from the United States began in 2005--as the costs of the highly regulatory, post-Enron Sarbanes-Oxley Act were sinking in--and is growing more pronounced. One of the most stunning statistics in the report is the proportion of all initial public offerings by U.S. companies that were made solely overseas (primarily in London). The number was negligible before 2005 and a little over 1 percent in 2006. According to the new report, it was slightly over 4 percent in 2007. The fact that U.S. companies would feel it necessary to offer their shares to the public for the first time in a foreign market speaks volumes about conditions in the United States today.

Other data in the committee's report are equally worrisome: The U.S. share of global market capitalization, which had been an average of 43.6 percent between 1990 and 2005, was 37.9 percent in 2006 and 35.2 percent in 2007; equity raised by foreign issuers in the U.S. private markets, which averaged 6.8 percent of the equity raised in the U.S. public markets for the years 2000-2005, was at 31.2 percent in 2006; and 12.4 percent of foreign companies delisted from U.S. markets in 2007, compared to an average of 5.2 percent between 1997 and 2005.

The Bloomberg-Schumer report, of which Senator Schumer was a co-sponsor, contains some of the most forceful and persuasive statements in any of the reports about the twin threats of costly regulation and severe litigation risk. Both are cited as factors in the growing trend away from U.S. capital markets, with particular effect on New York. Among the most trenchant points are these:

  • "The legal environments in other nations, including Great Britain, far more effectively discourage frivolous litigation. While nobody should attempt to discourage suits with merit, the prevalence of meritless securities lawsuits and settlements in the U.S. has driven up the apparent and actual cost of business--and driven away potential investors."
  • "Empirical evidence certainly suggests that litigation has become an important issue: 2005 set a new high for the number of securities class-action settlements in the U.S., and for the overall value of these settlements. Of course, many of these cases addressed the legitimate claims of investors and consumers in situations of notable corporate wrongdoing. However, in aggregate, some of the unique characteristics of the U.S. legal environment are driving growing international concerns about participating in U.S. financial markets--concerns heightened by recent cases of perceived extraterritorial application of U.S. law."
  • "The SEC should make use of its broad rulemaking and exemptive powers to deter the most problematic securities-related suits. For example, the SEC could invoke Section 36 of the Securities Exchange Act of 1934, which effectively allows it to exempt companies from certain onerous regulations where it deems such exemptions to be in the public interest."
  • "Legislative reform is also needed to address the long-term, structural problems that underpin the trend toward increasing litigation in the securities industry. Congress should thus consider legislative means of addressing concerns around the quantity and unpredictability of litigation relative to other countries."
  • "Lately . . . the regulatory environment that has served the United States so well in the past has begun to work against itself. The increasing pace of innovation and new product development in financial services has meant that responsiveness and flexibility have become ever more important features of regulation. Yet against this need for speed comes regulators' obligation to protect investors and customers, which has hampered efforts to respond quickly to the ever-changing needs of business and the rapidly evolving nature of risk in the markets. While the United States has struggled to balance rapid innovation with consumer and investor protection, other financial markets--most notably London--have grown faster and been nimble enough to adapt their own regulatory regimes to be responsive to businesses, while still safeguarding customers and investors."
  • "Not surprisingly, the vast majority of interviewees and survey respondents strongly believe that the pendulum of regulation in the United States has swung too far in recent years. An increasingly heavy regulatory burden and a complex, cumbersome regulatory structure with overlaps at the state and national levels is causing an increasing number of businesses to conduct more and more transactions outside the country. For many executives, London has a better regulatory model: it is easier to conduct business there, there is a more open dialogue with practitioners, and the market benefits from high-level, principles-based standards set by a single regulator for all financial markets."

With all this data demonstrating the flight of capital out of the United States, one would expect that the Democratic candidates would be as worried about the wave of job losses that seem to have resulted from excessive regulation and litigation risk as they claim to be about the job losses associated with NAFTA and free trade. But the job losses in the financial industry are not union jobs, and the financial industry is not one of the interest groups that is clustered around the Democratic Party.

There may be an additional explanation. Senator Schumer heads the Senate Democratic Campaign Committee, which collects substantial contributions from the trial lawyers--a group who would be hurt by any curb on the private securities class actions which account for most of the litigation risk faced by foreign companies that offer their shares in the United States. In 2006, for example, lawyers contributed $85.6 million to Democratic political committees or candidates and $35.3 million to Republican committees. The American Association for Justice, the successor to the American Trial Lawyers Association, contributed $2.7 million (95%) to Democrats and $120,950 (4%) to Republican candidates. That tells you something about whom the trial lawyers see as buttering their bread. Obviously, if the Democratic Congress were to take some action that restrained securities class actions, these contributions would dry up.

It is hard to avoid the conclusion, then, that the Democrats are highly sensitive to domestic job losses when one of their major interest groups--in this case trade unions--is adversely affected. But when the interests of another Democratic Party interest group, the trial lawyers, would be hurt by a change in policy that would help a U.S. industry and U.S. employees, the Democratic Party and Democratic politicians have little interest.

Peter J. Wallison is the Arthur F. Burns Fellow in Financial Market Studies at AEI. Karen Dubas, a research assistant at AEI, assisted Mr. Wallison in the preparation of this article.

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