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Joel Kurtzman Chairman, Kurtzman Group Senior Fellow, Milken Institute Global Edge: Using the Opacity Index to Manage the Risks of Cross-Border Business Today’s hypercompetition changes the old view of making countries successful • Old view: countries compete on labor costs and raw material endowments • New view: countries compete on a range of issues including: ▪ Access to capital ▪ Social systems and costs ▪ Stability ▪ Overall levels of risk • Opacity Austria Belgium Czech Rep. Denmark Finland France Germany Greece Hungary Ireland Italy Netherlands Norway Poland Portugal Russia Spain Sweden Switzerland Turkey United Kingdom Canada United States Argentina Brazil Chile Colombia Ecuador Mexico Venezuela Egypt Israel Kuwait Lebanon Nigeria Saudi Arabia China India Hong Kong Indonesia Japan Malaysia South Africa Australia Pakistan Philippines Singapore South Korea Taiwan Thailand 1. Large-Scale, Low-Frequency Risk Large-scale risks (earthquakes, revolutions, nationalizations) are dramatic and rare but capture attention. 2. Small-Scale, High-Frequency Risk Small-scale risks are everyday occurrences and are the real bane of business. For business, this is where the real costs lie. While all eyes focus on the large but rare risks, businesses must watch out for the real risks that cost money and time. ▪ Corruption ▪ Legal systems with limited protections ▪ Economic policies that hinder sustained growth ▪ Accounting and governance standards that make it difficult to see inside companies ▪ Regulatory systems that fail to protect investors ▪ These five (CLEAR) factors are sand in the gear of commerce. They are the “everyday risks” of being a global business. What exactly is opacity? ”Opacity is the opposite of transparency. It is the lack of clear, accurate, easily discernible, and widely accepted practices governing the relationships among businesses, investors, and governments. Opacity acts as a brake on commerce, and its presence hampers the smooth operation of business transactions.” Joel Kurtzman and Glenn Yago MIT Sloan Management Review October 2004 Social scientists might call opacity “negative social capital.” Social capital includes institutions and “agreements” that keep a society functioning. It includes elements as diverse as laws, markets and educational institutions. Since opacity is a form of capital, it can be measured. Since opacity is a form of capital, its transformation from negative to positive can be noted and followed. Since opacity is a form of capital, its impact on business and growth can be plainly seen – if leaders want to look! Understand the link between opacity and growth Understand price risk Measure global portfolio risk and balance Create country-based strategies Create new types of portfolios (green, sustainable, peace etc.) Comply with pension fund “screens” Forecast challenges/opportunities Compute minimum-required rates of return Category C L E A R Opacity Index Finland 3 11 23 17 9 13 United Kingdom 20 3 25 33 13 19 Denmark 6 15 21 33 19 19 Sweden 8 24 21 25 19 19 Hong Kong 26 12 14 33 15 20 United States 28 19 27 20 10 21 Australia 19 16 26 33 10 21 Switzerland 20 27 20 25 21 23 Austria 21 11 32 33 17 23 Belgium 28 25 30 17 14 23 Canada 26 17 37 20 16 23 Singapore 15 19 25 50 10 24 Netherlands 16 21 22 38 23 24 Country Category C L E A R Opacity Index Germany 28 14 33 17 32 25 Ireland 33 19 29 38 9 26 Japan 38 24 31 22 22 28 Chile 41 24 30 20 27 29 Israel 33 30 44 20 25 30 Taiwan 47 33 20 40 28 34 South Africa 55 34 28 33 18 34 Spain 39 25 32 50 23 34 Malaysia 55 35 28 30 26 35 Thailand 72 33 29 20 21 35 Portugal 37 26 31 50 32 35 Hungary 51 31 26 50 24 36 France 39 47 33 33 32 37 Country Category C L E A R Opacity Index South Korea 61 35 22 30 37 37 Brazil 47 48 32 40 35 40 Poland 63 35 47 40 19 41 Greece 58 30 36 50 30 41 Czech Republic 61 35 32 44 35 41 Ecuador 64 60 34 25 29 42 Colombia 57 61 45 29 21 43 Italy 52 32 45 63 24 43 Turkey 67 41 27 44 36 43 Mexico 65 60 35 33 25 44 Argentina 65 64 33 30 27 44 Pakistan 75 49 47 33 22 45 Saudi Arabia 61 34 32 33 69 46 Country Category C L E A R Opacity Index Russia 78 44 39 40 31 46 Egypt 71 37 39 40 51 48 India 74 44 49 30 46 48 Nigeria 80 65 48 0 50 49 China 74 39 39 56 43 50 Philippines 75 56 52 33 36 50 Venezuela 75 68 49 30 30 51 Lebanon 83 60 65 44 42 59 Indonesia 82 54 90 22 49 59 Country Every Additional Point on an Opacity Score Yields: • Lower average per capita income (-$986) • Lower net foreign direct investment as a percent of • • • • • • GDP (-1 percent) Lower Capital Access Index Score (-0.06 points) Lower bank assets as a percent of GDP (-4 percent) Lower stock market capitalization as a percent of GDP (-0.9 percent) Lower stock market traded value as a percent of GDP (-0.9 percent) Increase average borrowing interest rate (57 basis points) Increase inflation rate (0.46 percent) 1. Procedural Complexity Index 2. Employment Laws Index 3. Number of filings Duration Cost Flexibility of Hiring Index Conditions of Employment Index Flexibility of Firing Index Aggregate Complexity Index Average of Procedural Complexity and Employment Laws Index Country/Region Latin America & Caribbean Europe & Central Asia Middle East & North Africa South Asia East Asia & Pacific OECD: High income Procedural Complexity Index 70 57 59 55 55 49 Employment Laws Index 61 57 48 49 45 45 Aggregate Complexity Index 66 57 54 52 50 47 83 62 54 79 48 73 64 65 53 61 57 65 50 50 52 38 56 42 51 44 44 39 49 46 41 29 36 29 70 77 79 50 78 50 59 55 61 51 54 36 51 51 47 55 36 49 38 42 36 37 20 22 25 36 28 34 77 70 67 65 63 62 62 60 57 56 56 51 51 51 50 47 46 46 45 43 40 38 35 34 33 33 32 32 Spain Mexico Russia France Brazil Chile Italy Poland Thailand Germany Hungary Czech Republic India Korea, South China Turkey South Africa Ireland Israel Sweden Switzerland Japan Singapore United States Malaysia Australia United Kingdom Canada Source: World Bank, Doing Business Source Code Publication, Source WBRS Regulation and Supervision of Banking Around the World, World Bank SSBG Salomon Smith Barney Guide to World Equity Markets ISSA International Security Services Association Handbook IFAD International Forum on Accountancy Development, GAAP Convergence ICRG International Country Risk Guide, PRS Group TI Corruption Perceptions Index, Transparency International GCR Global Competitive Report, World Economic Forum WBDB Doing Business, World Bank AON Risk Management Updates WBCRS World Bank Survey on Public Credit Registry for Central Banks Type of Data No of Countries for which data are available Source Raw Data 48 WBDB Contract Enforcement Index: How inefficient (formalism) is contract enforcement? Index 48 WBDB Business costs of terrorism (1-7, low is worse) Index 46 GCR Transparency of policy making Index 22 GCR Organized crime costs on business Index 46 GCR Efficiency and transparency of tax system Index 46 GCR Extent of bureaucratic red tape Index 46 GCR Freedom of press Index 46 GCR Raw Data 47 WBDB Questions (E: Effectiveness of Economic Policy) Average days of legal procedure from filing to enforcement Enforce contracts: cost (% GNI per capita) Type of Data No of Countries for which data are available Source Government stability Index 48 ICRG Capital Flows Restriction Index Index 48 Heritage Foundation Government Involvement in Banking and Finance Index Index 48 Heritage Foundation Regulatory Burden Index Index Questions (R: Regulatory Regime) 48 Heritage Foundation Start Business: number of Procedures Raw Data 48 WBDB Start Business: duration (days) Raw Data 48 WBDB Start Business: cost (% GNI per capita) Raw Data 48 WBDB Start Business: min. capital (% GNI per capita) Raw Data 48 WBDB Type of Data No of Countries for which data are available Source Raw Data 48 WBDB Close Business: goals of insolvency Index Index 48 WBDB Can regulators engage in discretionary forbearance? Binary 46 WBRS Can the banking supervisor suspend a bank's directors' decision to distribute dividends, bonuses or management fees? Binary 47 WBRS Is there a central securities and exchange regulator? Binary 39 ISSA Can brokers set their own fees and commissions? Binary 38 ISSA Is there self-regulation of brokers? Binary 23 ISSA Have exchanges established listing requirements? Binary 40 SSBG Questions (R: Regulatory Regime) Close Business: actual cost (% of estate) Type of Data No of Countries for which data are available Source Does the central bank or independent agent (other than the fiscal authority) handle the issuance and settlement of public debt? Binary 45 Country's regulator Is public debt distributed by auction? Binary 45 Country's regulator Is there a system of primary dealers? Binary 45 Country's regulator Is there a central clearinghouse for settlements? Binary 44 Country's regulator Is debt held at a central depository? Binary 34 Country's regulator Is there one or more consumer credit rating agency? Binary 39 WBCRS Regulation of securities exchanges: transparency, effectiveness, role of government, industry intervention (1-7, low is worse) Index 46 GCR Questions (R: Regulatory Regime) Percent Change, Year Ago 5 4 3 2 1 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: International Financial Statistics % of GDP 4 Surplus 2 0 -2 -4 -6 -8 Deficit 1981 1986 1991 Source: U.S. Department of the Treasury, Bureau of the Public Debt 1996 2001 2006 Max = 10 9.0 8.5 Hong Kong 8.0 7.5 7.0 United Kingdom U.S. Mexico India China 6.5 6.0 Brazil 5.5 5.0 4.5 4.0 Source: Milken Institute Russia 70,000 GDP per Capita, US$ 60,000 50,000 y = 6,821x - 21,731 R2 = 0.6308 40,000 30,000 20,000 10,000 0 -10,000 0 1 2 Less access Sources: World Economic Outlook, Milken Institute 3 4 5 6 Capital Access Index 7 8 More access 9 • Level of institutional development, including law and regulation (Boyd and Smith, 1996; Gurley and Shaw, 1955) • Legal origin, shareholder rights and creditor rights (La Porta et al, 1998) • Laws and regulations (Levine, 2002; World Bank, 2001) • Demographics and human capital (Black, 2002) Forgone GDP Growth % Forgone GDP US$ Billions (2006) Mexico 2.63 22.09 Russia 2.50 24.48 Argentina 1.97 4.19 Pakistan 1.70 2.19 India 1.66 14.72 Source: Authors’ Calculation based upon Triphon Phumiwasana, (2003) Finland: -1.83 Brazil: 4.29 UK: -0.44 Czech Rep: 4.56 Sweden: -0.31 Turkey: 4.95 U.S.: 0.00 Mexico: 5.01 Switzerland: 0.40 Saudi Arabia: 5.52 Belgium: 0.42 Russia: 5.64 Germany: 0.86 China: 6.49 Ireland: 1.03 Venezuela: 6.56 Japan: 1.51 Indonesia: 8.54 Size of each bubble represents relative GDP Vertical (Y) location of the bubble indicates rate of growth Horizontal (X) location illustrates increasing procedural complexity Opportunity is defined here as a country’s legal and procedural complexity, relative to its overall market size and rate of growth 10.0% China 8.0% GDP GROWTH RATE (%) India Russia Thailand 6.0% 4.0% United States UK Korea Hong Kong Japan Canada 0.0% Saudi Arabia Kuw ait Taiw an Australia 2.0% UAE Turkey Malaysia Singapore Denmark Ireland Czech Rep South Africa Sw eden Israel Austria Norw ay European Union Greece Poland Chile Egypt Spain Hungary Finland Belgium Mexico Italy France Sw itzerland Brazil Netherlands Asia Europe North America Latin America Middle East Australia Africa Germany -2.0% Source: CIA World Factbook World Bank, Doing Business The Economist: World in Figures 2002 Recent empirical estimates suggest that… Doubling bank credit to the private sector as a percent of GDP in emerging markets could increase annual GDP growth by almost 3 percent. Doubling the trading volume of the stock market in an emerging market could increase annual GDP growth by almost 2 percent.