What is that has prevented a hopeful prospect like Argentina from being a growth powerhouse?
Some observers like to blame the country's currency board arrangement, which pegs the peso to the US dollar and so has meant for a strong national currency. Others say the trouble lies with higher taxes, some of them forced on the country by the International Monetary Fund. Most investors recognise that other, more ephemeral factors are also dragging down the Latin nation. But what are they? And to what degree are they responsible for the damage?
Now five economists and accountants* have come forth with a brief reply on Argentina and other puzzles. The answer, in a letter, is "O".
"O" in this instance stands for opacity, or, the lack of clear information in areas of business, finance or government. With the help of funds from the PricewaterhouseCoopers endowment for the study of transparency and sustainability and heavy crunching by the Milken Institute, the economists isolated five areas that affect international investment and capital markets: corruption, the legal system, economic and fiscal policies, accounting standards and regulatory certainty. Then they combined the results-handily grouping them under the acronym "CLEAR"-to calculate an overall O-Factor for each nation.
The outcomes are sometimes counterintuitive. Everyone, for example, knows it is hard to conduct business in Russia, but is it really worse than working in Venezuela, Uruguay, Egypt or Romania? The answer, according to our authors, is yes-Russia's O-Factor is 84, whereas Venezuela ranked 63, Uruguay 53, Egypt 58, and Romania, 51. Other murky nations include the Czech Republic and China, whose rank is driven to a stunningly high 87 by poor performance in the legal and regulatory realms.
CLEARest of all are the US, at 36, Britain, at 38, and Singapore, the global O-star at 29.
Such O-Factor rankings may not tell all about a country-certainly not about the consequences of quarreling with policemen in Singapore.
Still the O-Factor is useful in a number of ways. The first is that it makes concrete, in a way, the costs that various obscure hassles inflict. Specifically, the authors quantify the cost of opacity in tax terms (treating opacity as if it were a surtax imposed on foreign direct investment through a corporate tax hike). The results dramatise the damage of uncertainty: the difference between, say, Singapore's low 29 and Argentina's relatively high O-Factor of 61 amounts to a 25 percentage point increase in tax on capital invested in Argentina (vs Singapore). Investors in China pay the equivalent of a 46 per cent surtax when they chose to spend their cash there compared with Singapore. (But of course, the prospects for future market share may make that investment worth it).
This suggests a possible solution to the policy dilemma that countries face when they feel they must choose between cutting taxes to attract investment and remaining solvent: countries that feel tax cuts alone can lure foreign investment may be mistaken. Tax cuts, the authors posit, are not always necessary. Indeed, "domestic reforms that reduce opacity may be as effective as a tax cut in boosting domestic investment and attracting foreign investment-without sacrificing tax revenues." (Your author does not agree, but the IMF should like this one).
The authors also quantify the cost of opacity another way: in terms of capital. They note that more opaque countries pay a premium over less opaque ones when they borrow around the world. The find that a one percentage point increase in the O Factor leads to a 25.5 basis point increase in rates investors demand to buy a country's new-issue bonds. (They controlled for other factors, such as deep pockets, in running these calculations).
The O-Factor Study** is of course not the only effort to tackle intangible regulatory and corruption challenges. For years Peter Eigen, one of this study's advisers, used years of experience battling bribery in Africa to build a useful bank of information at his Berlin-based nonprofit, Transparency International. At Harvard, Andrei Shleifer and others have studied the obstacles to business startups, an extremely valuable indicator of a nation's economic prospects.
All of which suggest that all those who obsess on global financial architecture and other grand concepts ought to turn their attention to local capital markets and micro problems. Eroding such hidden costs will do more to defang the "systemic risk" monster than any amount of resort-summit jawboning.
*James R Barth, Auburn University and Milken Institute, Thomas W Hall, Pepperdine University and Milken Institute Joel Kurtzman, PricewaterhouseCoopers Shang-Jin Wei, Brookings Institution Glenn Yago, Milken Institute
© Copyright 2001 Financial Times
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