Measuring Political Risk in Emerging Markets (and Vermont)
- By Jon Reidel
For more than a decade, Allison Kingsley worked in international finance specializing in emerging markets, structuring and buying cross-border deals for public firms, and heading up political risk research for a private fund. These projects took her throughout the Middle East, North Africa, and Europe and made her an expert at predicting and managing political risks in foreign investment ventures totaling in the billions of dollars.
When Kingsley left Wall Street and moved to Vermont to begin her career as an assistant professor of management in the School of Business Administration, she noticed some eerily similar business conditions in Vermont to the ones she observed in emerging markets like Kazakhstan, Indonesia and Argentina. Wanting to investigate further, Kinglsey applied some of the tools and methodologies cited in a paper she wrote with Rick Vanden Bergh, associate professor of management in School of Business Administration, that appeared in the August issue of the Academy of Management Perspectives titled “Political Markets and Regulatory Uncertainty: Insights and Implications for Integrated Strategy.”
Kingsley found that Vermont is as politically risky to conduct business in as many emerging markets, based on a variety of measures, including the Political Constraints Index – a non-partisan tool that measures the level of political competition and feasibility of change in policy based on elected officials. Vermont scored poorly and on par with such emerging markets as Sri Lanka and Burundi and is moving in a direction that will “exacerbate risk” for businesses, she says. Other factors taken into account in Kinglsey’s assessment included Vermont’s high corporate income tax rate (12th nationally) and state and local property taxes (sixth); high energy rates; heavy business regulation; and reputation for ideological politics and lack of political competition, which creates uncertainty for private businesses.
“My fundamental argument is that Vermont lacks meaningful competition in its political institutions, making arbitrary policy change more likely,” says Kingsley. “This, in combination with the fact that businesses typically confront vocal, ideology-motivated interest groups increases political risk. Such risk is pronounced in places like Vermont that already have costly policies.”
Research evokes intense response
Kingsley recently shared her findings in a “Creative Corner” article “Is Vermont Politically Risky as an Emerging Market?” in the Sept. 27 issue of the Burlington Free Press. It evoked intense debate and a flood of responses. Her detractors – whom she says were the minority – are in two camps. One argued (hostilely in some cases) that constraining business is a core Vermont value. “In saying so,” says Kinglsey, “they concede by example that there is a significant opposition to business.” The other camp has a more nuanced argument, claiming that there are business success stories in Vermont that disprove Kingley’s argument, offering detailed evidence of businesses that have excelled or capital that has flowed into Vermont.
“In fact, I agree that business can be successful in Vermont or in any politically risky environment,” says Kingsley. “My investment track record shows this. The story is really in how those businesses have been successful. This brings me to the heart of my work with Rick and others. What we have found in the U.S. and emerging markets is that when a business confronts a political environment that is uncompetitive and populated with ideological opposition, it often chooses not to invest. When a business does move forward, simultaneously investing in a costly political strategy to manage the risk is prudent, particularly if that business is on the political radar screen.”
Kingsley also thinks that many of the people who wrote critical responses “have a horse in the game” or are raising capital for companies or are running an organization. “I don’t sit on any Vermont boards. I have no partisan affiliation. I’m not involved in any interest group or involved in any businesses or raising capital. I don’t actually have a conflict of interest.”
Kingsley admits it was difficult to make some of the complex theory in the “Academy of Management Perspectives” article approachable for general consumption in the Free Press. That article concludes that properly assessing a firm’s exposure to regulatory uncertainty helps managers craft an appropriate integrated strategy, and suggests two primary drivers of regulatory uncertainty for firms: ideology-motivated interests opposed to the firm and a lack of competition for power among political actors such as executives and legislators. The latter is confusing to some who would assume that because places like Vermont, for example, are predictably left leaning, that its policies would be easy to predict.
“What government should practice is constrained optimization,” says Kingsley. “It should be optimizing social welfare, which isn’t just a product of social policy, but also a product of economic policy. Vermont does some really good things about constraining business like not allowing billboards. Perhaps that’s anti-business, but its pro-something else that’s meaningful in Vermont. Like any other state, Vermont is entitled to make decisions about what its values are, but there also needs to be an honest discussion about the cost-benefit analysis of those choices.”
As an example of an unpredictable regulatory decision, Kingsley uses the changing of the contractual terms with Vermont Yankee. Although such changes might produce a good outcome from a social welfare perspective, from a policy stability perspective, it shows no resistance on any level of government until other judiciary or institutions at higher levels are forced to challenge the decision, she says.
“What I’d like to see from Vermont is that we’re really thoughtful about what the constraints are that we want on business here, so by virtue of being transparent about our values and constraints and how we’re going to govern, we let the businesses we want to thrive, and that we don’t divert resources to crony capitalism,” she says. “It’s amazing to me that that isn’t the conversation we’re having.”