1. Using the Opacity Index to Manage the Risks of Cross-Border Business
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 Countries Included 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
China
India
Hong Kong
Indonesia
Japan
Malaysia
Pakistan
Philippines
Singapore
South Korea Taiwan
Thailand
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
Country
Category
Opacity Index C L E A R
Finland 3 11 23 17 9 13
United Kingdom 20 25 33 19
Denmark 6 15 21
Sweden 8 24
Hong Kong 26 12 14
United States 28 27 10
Australia 16
Switzerland
Austria 32
Belgium 30
Canada 37
Singapore 50
Netherlands 22 38

10. The Opacity Index Scores
Country
Category
Opacity Index C L E A R
Germany 28 14 33 17 32 25
Ireland 19 29 38 9 26
Japan 24 31 22
Chile 41 30 20 27
Israel 44
Taiwan 47 40 34
South Africa 55 18
Spain 39 50 23
Malaysia 35
Thailand 72 21
Portugal 37
Hungary 51 36
France

11. The Opacity Index Scores
Country
Category
Opacity Index C L E A R
South Korea 61 35 22 30 37
Brazil 47 48 32 40
Poland 63 19 41
Greece 58 36 50
Czech Republic 44
Ecuador 64 60 34 25 29 42
Colombia 57 45 21 43
Italy 52 24
Turkey 67 27
Mexico 65 33
Argentina
Pakistan 75 49
Saudi Arabia 69 46

12. The Opacity Index Scores
Country
Category
Opacity Index C L E A R
Russia 78 44 39 40 31 46
Egypt 71 37 51 48
India 74 49 30
Nigeria 80 65 50
China 56 43
Philippines 75 52 33 36
Venezuela 68
Lebanon 83 60 42 59
Indonesia 82 54 90 22

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)
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

16. Sources of Data (Economic and Regulatory)
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
Business costs of terrorism (1-7, low is worse) 46
GCR
Transparency of policy making 22
Organized crime costs on business
Efficiency and transparency of tax system
Extent of bureaucratic red tape
Freedom of press
Enforce contracts: cost (% GNI per capita) 47

17. Sources of Data (Economic and Regulatory)
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
Heritage Foundation
Government Involvement in Banking and Finance Index
Regulatory Burden Index
Start Business: number of Procedures
Raw Data
WBDB
Start Business: duration (days)
Start Business: cost (% GNI per capita)
Start Business: min. capital (% GNI per capita)

18. Sources of Data (Economic and Regulatory)
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
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? 47
Is there a central securities and exchange regulator? 39
ISSA
Can brokers set their own fees and commissions? 38
Is there self-regulation of brokers? 23
Have exchanges established listing requirements? 40
SSBG

19. Sources of Data (Economic and Regulatory)
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 45
Country's regulator
Is public debt distributed by auction?
Is there a system of primary dealers?
Is there a central clearinghouse for settlements? 44
Country's
regulator
Is debt held at a central depository? 34
Is there one or more consumer credit rating agency? 39
WBCRS
Regulation of securities exchanges: transparency, effectiveness, role of government, industry intervention (1-7, low is worse)
Index 46
GCR

20. U.S. GDP Growth Updated for GC 2007 Real GDP growth, quarterly
Source: International Financial Statistics

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

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

23. Less access More access
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
Forgone GDP
Growth %
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
Institutional Risk indicators detail:
What are real risks?
Can they be prices?
Where are they?
When unenforceable property rights exist due to the absence of institutional infrastructure of laws and markets, wide differences in the marginal product of capital can exist.
Since countries cannot borrow against their labor force (because labor cannot be used as collateral for loans), they cannot build sufficient physical capital stocks to prevent emigration.
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. Opportunity Map
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
Asia
Europe
North America
Latin America
Middle East
Australia
Africa
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.
T. Phumiwasana, 2002