The Whole World is an Emerging Market
Uncertainty, volatility and correlations have crept into advanced economies giving rise to a dangerous mix of political risks and social upheaval typically reserved for emerging markets. According to Ian Bremmer, one of the early pioneers of political risk consulting, an emerging market is a place where politics matters nearly as much as economics. By this measure, the whole world is an emerging market. Decision makers must now contend with this reality developing an entirely new yardstick for how they navigate their organizations through turbulent times.
The improbable Brexit outcome is but one large scale example of politics mattering nearly as much as economics. In this case, many stalwart British firms, including the global risk leader, Lloyd’s, are confronted with a high degree of uncertainty. In Lloyd’s case, like other UK-based financial services firms, the prospect of losing access to the EU’s 28 country common market, including pass porting rights for products and services, represents a strategic and operational setback.
In the best case, investments will be made in securing regulatory concessions over the coming years as the UK’s new Prime Minister, Theresa May, aims to invoke Article 50 as soon as March, 2017 hastening the UK’s exit.
In the worst case, which looks increasingly likely, Lloyd’s may have to uproot parts of its operations from the City of London, as it has intimated, to find alternate markets granting a more favorable and predictable operating environment. This is notable because since Lloyd’s was founded in a London teahouse in 1688, it has withstood virtually every shock of the modern era while remaining staunchly British. There is nothing to suggest that a decidedly global Lloyd’s will not weather the Brexit storm just as well.
Brexit, however, is not the only example of the emerging market paradox affecting advanced economies. Well before the Brexit vote, the U.S. lost its vaulted AAA credit rating and has yet to regain it due to bitter partisanship and political point scoring at the expense of the economy. Both of these examples have affected the global economy in some insidious ways. In the first day after the Brexit vote for example, global markets suffered the worst one-day drop in history whipping off $2 trillion in market value.
Political uncertainty is now the order of the day and extreme, once unlikely, events are now becoming common place making it difficult for firms to shelter themselves even in the places they call home. Indeed, one of the toughest knocks endured by the otherwise stalwart Apple, was the EU’s ruling that its Irish tax inversions were not legal. Apple remains in a bitter contest (alongside its Irish hosts) with EU regulators about its surprise $14.5 billion tax liability. Arguably, this surprise shock is in no small measure motivated by a change in the political climate, rather than by economic factors, as Apple clearly invested in Ireland with the consent of the Irish government and under prevailing tax laws.
Another example is the backlash against platform companies like Uber and Airbnb, which are confronted by increasingly activist regulators around the world, including in their home state of California. While these types of firms provoke a battery of new laws in the wake of their disruptive growth, much of the ire and sharpened knives appear to be driven by political point scoring rather than sensible regulation. As Uber, Lyft and Google aim to remove the driver from their value chain with the advent of autonomous vehicles, it would be safe to expect more adverse market responses in the coming years.
Turkey’s surprise coup is yet another example of a country that has been a consistent recipient of inward investment, driven by multinationals establishing their regional headquarters there based on a comparatively favorable political risk environment. Yet the surprise coup revealed how many firms were exposed, did not have contingency plans and much of the invested capital and business continuity risks were unhedged by traditional insurance instruments.
In no small measure the advanced markets are doing comparatively well due to a flight to safety. However, ‘the best of the worst alternatives’ does not make for sound economic policy. Political risk has crept into a wide array of U.S. government operations, including the 2015 shutdown of the U.S. Export-Import Bank, on which many a U.S. exporter depends for trade credit and financing. Despite being a profit center for the U.S. government that largely supports small to medium sized enterprises, EXIM’s shutdown is but another example of political risk affecting advanced economies. Many international investors are looking to both the UK and the U.S., traditionally large net recipients of inward investments, with the type of trepidation usually reserved for opaque emerging markets.
The bitterly partisan U.S. presidential election has surely stalled the growth of inward investments in the U.S. until the electoral outcome is cleared. This partisanship and the consequent uncertainty the market faces in reading U.S. attitudes is not resolved singularly by the occupant of the Oval Office. People are also looking to the House, Senate and state governments for the comforting signs of political and social predictability on which investment flows depend. Across much of the U.S., as in the UK and Europe, the cross-border investor is confronted with an unfamiliar terrain. Some U.S. states have passed legislation making them unfriendly investment destinations even for U.S. companies from more liberal parts of the country. The incessant rise of indiscriminate mass casualty events on both sides of the Atlantic also raise physical security concerns that are atypical of advanced economies.
As a result, especially since the “cash is king” mantra from the global financial crisis has made weary investors hoard their money rather than deploy capital, we are seeing an increase in counter-intuitive negative yield investments. For some large investment funds, going south of the Mediterranean is a line too far into opaque markets heavily laden with political risks – as conventional wisdom would hold. Arguably, losing money in Europe is more palatable than putting capital at risk in non-traditional investment destinations. With political risk being an inescapable global phenomenon, status quo and remaining “sheltered” in advanced economies may prove to be nearly as perilous as investing around the world.
Better understanding and leveraging of financial instruments such as political risk insurance can help put a fixed price on uncertainty and move risk from being a cost of doing business to a catalyst for growth. Mr. Bremmer’s near daily media appearances suggest political risk is here to stay. Firms would be wise to heed his warnings, while at the same time taking deliberate steps to financially hedge their global activities.