Small island nations sometimes find themselves in enviable positions. Those that manage to carve out niches for themselves can very quickly become important and prosperous hubs for various sectors. With generally small populations and sound finances, they can be much more manageable than an industrialised nation of 50 million inhabitants.

But carving out a niche is not a simple process. Several places, particularly in the Caribbean, have tried to turn themselves into financial services hubs, only to find that there is little interest. And those that do find their niche can suddenly find that their economy is overly reliant on the whims of one sector.

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The challenge for these places is to find their competitive advantages, grow from that and then make every possible effort to diversify. This is something that few of these countries have managed to accomplish, but it is a concept where there is definite consensus.

Textbook case

The Cayman Islands is close to the perfect example of how an island economy can leverage its strengths, but perhaps also become too dependent upon one sector. In the 1970s the islands found themselves in the right place at exactly the right time.

The Cayman government believed the market for offshore financial services would grow and introduced legislation making it easier for financial firms to do business there. At the same time, the nearby Bahamas became independent and nervous foreign bankers worried their businesses there were not as safe as before. With the Cayman Islands rolling out the red carpet for them, it was an easy decision to make.

Today the Cayman Islands is the fifth largest banking centre in the world, with an estimated $1500bn in banking liabilities, according to the US government’s accountability office.

Richard Coles, head of Cayman Finance, which represents the country's financial services industry, says that island economies must look at their existing strengths, find niches and expand from there. He cautions that the move by other islands to become financial centres by cutting taxes and red tape is no guarantee of success.

He says: “You have to find a niche for yourself. It’s like any business. If you just slavishly copy someone else’s success, then unless you are very fortunate, the guy who got their first is always going to beat you. And Cayman has been an [international finance centre] for years now, so for another jurisdiction to come in and think they can muscle away the business is really unrealistic.

"For another island to try and do this they need to find another area of the industry that Cayman doesn’t cater to. You need to find your own market.”  

New markets

Tourism is also one of the Caymans’ biggest economic drivers. Mr Coles accepts that one of the main lessons of the financial crisis was that countries cannot become overly reliant on one part of the economy, and as such the government is doing what it can to diversify its sources of revenue.

One effort is to diversify the segments of the financial services industry in which it is involved. Its main financial activities are in hedge funds and banking, but whereas it had been getting more involved in structured finance and securitisation, this is less the case post-2008. What segments will replace structured finance and securitisation remains to seen, but the government is actively moving to find new markets.

Montserrat's challenge

But whereas a little bit of luck and circumstance can help places such as the Cayman Islands, some island economies are victims of both and literally have to start from scratch. This is certainly the case for the tiny Caribbean island of Montserrat, which has a population of 6000. The island was devastated by a largely unreported volcano that erupted in 1995 and has continued spewing lava, albeit at a slower pace today, ever since. The volcano rendered more than half the island completely uninhabitable and covered its capital city Plymouth in 12 metres of ash. An estimated two-thirds of the population left the island.

Similar to the Cayman Islands, Montserrat is also trying to play to its strengths. Tourism was once a huge part of its economy and the government is hopeful that the industry will come back. It is marketing itself as a cheaper option than its more expensive neighbours. The Montserrat Tourism Board is promoting private villas for as low as $700 per week. With the opportunity to see an active volcano, there are also efforts to promote 'geology' tourism.

Insurance target

Montserrat is also, like many other islands in the Caribbean, trying to make forays into the financial services industry, but with a different strategy. Rather than cutting taxes and red tape, the country is targeting the attraction of insurance companies with incoming legislation that will make it easier for them to set up on the island. Dulcie James, commissioner at the Montserrat Financial Services Commission, explains that with the island’s lower cost of doing business, they could have a competitive edge.

She says: “Finance will only develop with the development of the island. International insurance is an area where developed countries have used countries in the Caribbean to register their business because the cost of doing business is less. We see an advantage for us there, but we have to pass the legislation first.”

Monserrat's government is staying active and its financial potential was recently evaluated by a Caribbean financial task force. Ms James says the evaluation came out quite well, and added that the Organisation for Economic Co-operation and Development and the International Monetary Fund would be doing their own assessments later this year relating to Montserrat’s tax regime.

She says: “It’s a busy year for us. We have appointed a consultant to review our laws and hopefully some new legislation will be presented by the end of the year.”