Global Edge:Using the Opacity Index to Manage the Risks of Cross-Border Business

Joel Kurtzman

Chairman, Kurtzman Group

Senior Fellow, Milken Institute

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

Canada United States

Australia

South Africa

China IndiaHong KongIndonesiaJapanMalaysia

ArgentinaBrazil ChileColombiaEcuadorMexicoVenezuela

EgyptIsraelKuwaitLebanonNigeriaSaudi Arabia

AustriaBelgiumCzech Rep.Denmark FinlandFranceGermanyGreece

HungaryIrelandItaly NetherlandsNorway PolandPortugal

RussiaSpainSwedenSwitzerlandTurkeyUnited Kingdom

PakistanPhilippinesSingaporeSouth Korea TaiwanThailand

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

Country

CategoryOpacity Index

C L E A R

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

Opacity IndexC L E A R

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

Opacity IndexC L E A R

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

Opacity IndexC L E A R

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

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 Number of filings Duration Cost

2. Employment Laws Index Flexibility of Hiring Index Conditions of Employment

Index Flexibility of Firing Index

3. Aggregate Complexity Index Average of Procedural

Complexity and Employment Laws Index

Country/ Region

Procedural Complexity

I ndexEmployment Laws I ndex

Aggregate Complexity

I ndexLatin America & Caribbean 70 61 66Europe & Central Asia 57 57 57Middle East & North Africa 59 48 54South Asia 55 49 52East Asia & Pacific 55 45 50OECD: High income 49 45 47

Spain 83 70 77Mexico 62 77 70Russia 54 79 67France 79 50 65Brazil 48 78 63Chile 73 50 62I taly 64 59 62Poland 65 55 60Thailand 53 61 57Germany 61 51 56Hungary 57 54 56Czech Republic 65 36 51India 50 51 51Korea, South 50 51 51China 52 47 50Turkey 38 55 47South Africa 56 36 46I reland 42 49 46I srael 51 38 45Sweden 44 42 43Switzerland 44 36 40J apan 39 37 38Singapore 49 20 35United States 46 22 34Malaysia 41 25 33Australia 29 36 33United Kingdom 36 28 32Canada 29 34 32

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

Questions (E: Effectiveness of Economic Policy)Type of

Data

No of Countries for which data are available

Source

Average days of legal procedure from filing to enforcement

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

Enforce contracts: cost (% GNI per capita) Raw Data 47 WBDB

Questions (R: Regulatory Regime)Type of

Data

No of Countries for which data are available

Source

Government stability Index 48 ICRG

Capital Flows Restriction Index Index 48Heritage

Foundation

Government Involvement in Banking and Finance Index

Index 48Heritage

Foundation

Regulatory Burden Index Index48

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

Questions (R: Regulatory Regime)Type of

Data

No of Countries for

which data are available

Source

Close Business: actual cost (% of estate) 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)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 45Country's regulator

Is public debt distributed by auction? Binary 45Country's regulator

Is there a system of primary dealers? Binary 45Country's regulator

Is there a central clearinghouse for settlements? Binary 44Country'sregulator

Is debt held at a central depository? Binary 34Country'sregulator

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

0

1

2

3

4

5

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Percent Change, Year Ago

Source: International Financial Statistics

200620011996199119861981

4

2

0

-2

-4

-6

-8

% of GDP

Surplus

Deficit

Source: U.S. Department of the Treasury, Bureau of the Public Debt

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0Max = 10

U.S.

Hong Kong

China

Russia

Brazil

India

United Kingdom

Mexico

Source: Milken Institute

y = 6,821x - 21,731

R2 = 0.6308

-10,000

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

0 1 2 3 4 5 6 7 8 9

Capital Access Index

GD

P p

er

Ca

pit

a,

US

$

Less access More accessSources: World Economic Outlook, Milken Institute

• 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

UK: -0.44

Sweden: -0.31

U.S.: 0.00

Switzerland: 0.40

Belgium: 0.42

Germany: 0.86

Ireland: 1.03

Japan: 1.51

Brazil: 4.29

Czech Rep: 4.56

Turkey: 4.95

Mexico: 5.01

Saudi Arabia: 5.52

Russia: 5.64

China: 6.49

Venezuela: 6.56

Indonesia: 8.54

Denmark

Malaysia

Sw itzerland

Turkey

China

Netherlands

India

Thailand

Kuw ait

Poland

Russia

Sw edenSouth Africa

France

Brazil

Italy

Germany

Mexico

Spain

Greece

UAE

United States

UK Japan

Australia

CanadaSingapore

Taiw an

Finland

Saudi Arabia

Ireland

Israel

Norw ayAustria Belgium

Korea

HungaryCzech Rep

European Union

Egypt ChileHong Kong

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Size of each bubble represents relative GDPVertical (Y) location of the bubble indicates rate of

growthHorizontal (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

AsiaEuropeNorth AmericaLatin AmericaMiddle EastAustraliaAfrica

GD

P G

RO

WT

H R

AT

E (

%)

Source: CIA World FactbookWorld 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.