Bahrain’s civil unrest — which had a one-year anniversary this week — has taken a toll on the local economy and left a deep scar on the Gulf state’s aspiration to become an international financial hub.

A new paper from the Sovereign Wealth Fund Initiative, a research programme at Center for Emerging Market Enterprises (CEME) at the Fletcher School at Tufts University, examines how the political instability of 2011 is threatening Bahrain’s efforts in the past 30 years to diversify its economy and develop the financial centre.

Asim Ali from University of Western Ontario and Shatha Al-Aswad, assistant vice president at State Street, argue in the paper that even before the revolt, Bahrain lagged in building the foundations of a truly international hub in the face of competition from Dubai and Qatar.

Unlike DIFC (Dubai International Financial  Centre) and QFC (Qatar Financial Centre), Bahrain insists upon local labor; currently 70% of employees in its banking and financial services industry are Bahrainis.  Bahrain’s reluctance to hire non-resident  talent  has made  Dubai…an alternative for those investors looking for a centre with more flexible labor practices such as DIFC provide…  The constraints  – a lack of formalized institutional and regulatory structure, along with an ad hoc business environment, underdeveloped infrastructure, and under-supplied skilled workforce – have negatively affected its growth and  potential to become the financial gateway in the Middle East.

Then came the crackdown of protesters.

Its ruling Al-Khalifa family unleashed  a ferocious extra-judicial crackdown against the opposition. It appeared the standard axiom of Gulf ruling families – securing legitimacy and counter-acting political opposition through redistribution of oil wealth – was sorely insufficient to address  citizens’ grievances.  These led not only to international opprobrium of  the  Bahrain government but also made foreign businesses reconsider Bahrain as a financial center – with many foreign business shifting  workers and operations to Dubai… Indeed, confidence in Bahrain as a financial hub took a major blow along with its image as a stable, tolerant and liberal state.