See minutes 5-28 for talk.
Keynote Speech to Vermont CFA Society Annual Meeting: "Changing Rules, New Risks: The Impact of Global Politics on Investing"
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 Kingsley’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 Kingsley, “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 Kingsley’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.
Published: Burlington Free Press, Creative Corner, September 27, 2012.
I am not an expert on Vermont but I understand emerging markets. What I hear about doing business in Vermont is eerily similar to what I hear about doing business in Kazakhstan, Argentina, or Indonesia. Businesses here talk about state policies like high corporate taxes, high energy costs, arduous permitting, and extensive regulations that make investing in Vermont unattractive. Quietly, businesses share their dismay at the revolving door of state bureaucrats in favored Vermont businesses and anti-business interest groups. It’s no surprise then to hear that businesses worry about whether the state government will simply “change its mind” on everything from their tax rates and future expansion plans to fundamental contractual terms.
I’m too new to Vermont to know whether or how much of this is true. I suspect many factors are at play in explaining business-government relations in Vermont and, independent of politics, why doing business in Vermont is difficult (e.g. location, population). I also see evidence of pockets of success in the Vermont economy, like agricultural entrepreneurialism. That said, when I apply a few established tools to analyze Vermont’s political environment for business, Vermont seems as politically risky as many emerging markets. Why is that?
Let’s start with the policies. What we know from emerging markets is that capital flows to the most attractive destination. In the US, Vermont’s corporate income tax rate is the twelfth highest, and state and local property taxes are the sixth highest. In terms of energy, Vermont has one of the highest energy rates in the US. Although there is no state-level measure for business regulation and permitting, one experienced entrepreneur told me that getting a business started in Vermont requires navigating “a labyrinth of Byzantine rules.”
Vermont’s ideological politics are also at play. Existing research finds that political risk increases for business as more ideologically-motivated interest groups oppose them. Groups with ideological agendas have strongly felt preferences, tend to leverage public pressure effectively, and typically focus on politically salient or “hot” issues. In Vermont, anecdotal evidence suggests that businesses largely confront interest groups distrustful of the private sector and hostile to business interests. Environmentalist and anti-growth groups opposed the Circ-Williston highway proposal that IBM advocated. Walmart battled VNRC and buy-local groups for 18 years in St. Albans. Employee unions fought Fletcher Allen. VPIRG and NEC confronted Vermont Yankee and Entergy.
Vermont is moving in a direction that will exacerbate risk. Extensive research in business and politics has found that environments characterized by a lack of political competition introduce significantly more uncertainty for private businesses. When countries are run by heavy-handed autocrats or elections are dominated by one party, leaders face few constraints on arbitrary policy change. Increasingly, Vermont lacks any political competition: the executive, legislative, and judicial branches are dominated by one party that holds significant majorities and winning margins in each branch.
In political risk analysis, a nonpartisan tool used widely to measure political competition is the Political Constraints Index (POLCON) which ranges from 0 to 1. The higher a government’s POLCON score, the more veto players can constrain arbitrary policy making. If we model policy risk in Vermont using POLCON, Vermont’s 2012 score is 0.45 out of 1.00. This places Vermont in the same policy (in)stability category as countries like El Salvador, Sri Lanka, Burundi, Panama, and Mali. In the US, Vermont ranks in the bottom quartile of states. Admittedly, POLCON is an imperfect tool when applied to U.S. states, but it is instructive: we’ve learned from emerging markets that even a small increase in political constraints generates sizable improvements in GDP and capital investment.
What becomes clear then is that Vermont’s politics interact with its ideology-motivated opponents to create an environment of significant policy uncertainty for private business. This uncertainty makes investing in Vermont unattractive for new and existing businesses and puts their business sustainability at risk. We know the stories of Suss Microtec and Tubbs Snowshoes, we've seen how GE Healthcare and IBM have chose not to expand offices or fabrication plants locally, and we hear how Dealer.com and other IT businesses may be enticed by better incentives in other states. While I don’t know enough about any of these cases to be confident in their application, they do beg the question - What businesses might have moved here, stayed here, or grown here had our business environment been more attractive? How much better off could Vermont be if the state had a little less hostility toward business and a little more political competition?
Allison F. Kingsley, Ph.D.