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

1. Joel Kurtzman Chairman, Kurtzman Group Senior Fellow, Milken Institute Global Edge: Using the Opacity Index to Manage the Risks of Cross-Border Business

2. Approach 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

3. Markets and CountriesIncluded in the Opacity Index Austria Belgium Czech Rep. Denmark Finland France Germany Greece Hungary Ireland Italy Netherlands Norway Poland Portugal Russia Spain Sweden Switzerland Turkey United Kingdom Pakistan Philippines Singapore South Korea Taiwan Thailand China India Hong Kong Indonesia Japan Malaysia Canada United States Egypt Israel Kuwait Lebanon Nigeria Saudi Arabia Argentina Brazil Chile Colombia Ecuador Mexico Venezuela South Africa Australia

4. Two Types of Global Risks • Large-Scale, Low-Frequency Risk Large-scale risks (earthquakes, revolutions, nationalizations) are dramatic and rare but capture attention. • 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.

5. The Impact of Small-Scale Risks Is Big 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.

6. We Call These Small-Scale Risks Opacity 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

7. The Costs of Small-Scale Risks Can Be Measured • 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!

8. What Can We Do With Opacity? • 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

9. The Opacity Index Scores

10. The Opacity Index Scores

11. The Opacity Index Scores

12. The Opacity Index Scores

13. Behaviors Can Be Measured 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)

14. Complexity of Legal Systems • Procedural Complexity Index • Number of filings • Duration • Cost • Employment Laws Index • Flexibility of Hiring Index • Conditions of Employment Index • Flexibility of Firing Index • Aggregate Complexity Index • Average of Procedural Complexity and Employment Laws Index Source: World Bank, Doing Business

15. Sources of Data (General)

16. Sources of Data(Economic and Regulatory)

17. Sources of Data(Economic and Regulatory)

18. Sources of Data(Economic and Regulatory)

19. Sources of Data(Economic and Regulatory)

20. U.S. GDP Growth Source: International Financial Statistics

21. A Brief Period of U.S. Budget Surplus Surplus Deficit Source: U.S. Department of the Treasury, Bureau of the Public Debt

22. Capital Access Index 2006Gauging Entrepreneurial Access to Capital Source: Milken Institute

23. Capital Access Index, 2006 Less access More access Sources: World Economic Outlook, Milken Institute

24. Factors Affecting Financial Market Development • 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)

25. Improved Capital Access Can Add Billions to Emerging Economies Source: Authors’ Calculation based upon Triphon Phumiwasana, (2003)

26. Representative Costs of Opacity Expressed in Percent 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

27. Size of each bubble represents relative GDP Vertical (Y) location of the bubble indicates rate of growth Horizontal (X) location illustrates increasing procedural complexity • Asia • Europe • North America • Latin America • Middle East • Australia • Africa Opportunity Map Opportunity is defined here as a country’s legal and procedural complexity, relative to its overall market size and rate of growth GDP GROWTH RATE (%) Source: CIA World Factbook World Bank, Doing Business The Economist: World in Figures 2002

28. Forgone Finance, Forgone Growth 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.