Are the Most Business-Friendly Markets the Most Friendly to Investor Portfolios?
July, 08th 2008
Forbes Magazine has come out with its list of "Best Countries for Business" - and Denmark ranks as the worlds most business-friendly market. But unless an investor is looking to set up shop in one of these countries, you wouldnt expect this list to be all that valuable.
After all, its one thing to know that when a company operates in a business-friendly market, its employees and corporate officers will be well treated, and the company itself will be afforded respect. But does that necessarily allow us to predict whether or not investments in that country will appreciate in value?
The truth may actually surprise you.
Okay, its mean to leave you in suspense until the end. You can find out whether a good business climate is correlated with economic growth by comparing the countrys ranking on the Forbes list of 121 countries with its 2007 growth rate.
Yes, 2007 is just one year. Yes, the middle-ranked countries may all be quite close together, with only the top and bottom markets displaying any spectacular differences. And, yes, rich countries are presumably easier places to do business in, and tend to have lower growth rates than poor countries.
Still, youd expect there to be at least some correlation between the ease-of-doing-business ranking and actual economic growth.
But youd be wrong.
The correlation between the ranking on the ease-of-doing-business table and growth rate is plus 0.15. In other words, the lower (less business friendly) you are on the table (the higher your numerical ranking, with 1st being top), the more likely you are to have a high growth rate. If you just look at the top 100 countries, knocking off the true basket cases at the bottom like Zimbabwe, the correlation rises to plus 0.34.
Those arent huge correlations, but they do suggest that business-friendly markets arent particularly good predictors of stock market returns. And its worth examining why.
Countries at the top of Forbes list tend to be very pleasant places to live, with honest bureaucracies, a benign business culture, and an innovative scientific community. They also tend not to be the places with the lowest taxes: The Top 3 countries, six of the Top 10 and 22 of the Top 40 are members of the European Union, notoriously a high-tax enclave.
The United Kingdom is No. 5 on Forbes list. Its a country that is a delightful place to live provided you are well enough paid, but its extraordinarily expensive if you work in or near London, with atrocious infrastructure, high taxes, and lousy weather.
Boosters of Ireland, No. 3 on Forbes list, will claim that Ireland is an exception to this, with a corporate tax rate of only 12.5%. But Irelands top rate of personal income tax is 42%, and the country has a 21% Value Added Tax (VAT), so it can hardly be deemed a capitalists paradise - the country has a substantial number of tax exiles.
While the very richest Irish entrepreneurs are able to control their business empires from tax havens, it is thus difficult for individuals to amass capital, other than by speculating in real estate. Ireland had a very respectable growth rate while capital was cheap and subsidies from the EU plentiful, but its real estate bubble has burst, and the next few years are likely to be grim ones.
Some of the flaws in Forbes listing are apparent when you look at Japan (No. 24), Taiwan (No. 26) and South Korea (No. 37). All three have considerably lower ratings than most European countries, and most Americans would not view them as business-friendly markets, since they are more difficult places for Americans to do business in.
(By comparison, Singapore and Hong Kong, being heavily anglicized, are No. 8 and No. 9 - they are easier places for Americans to work in).
However, local entrepreneurs have no discernable difficulty in any of these countries, which have generally lower taxes than Europe.
As investors, we dont care much how hospitable the local environment is to American expatriates; we can make more money by investing in local companies with shares traded internationally, and not be discriminated against in any way - and thats the beauty of a global stock market.
The difficulty for us as investors arises when property rights are not safe. Russia at No. 86 and Venezuela at No. 115 both have decent growth rates, for example, as both countries have benefited enormously from surging oil prices. However, the Putin/Medvedev governments in Russia, and Hugo Chavezs regime in Venezuela, have both shown they care nothing for private-property rights, foreign or domestic.
As investors, even small foreign investors, we should avoid those countries. If BP PLC (ADR: BP), one of the worlds largest oil companies, can be stripped of its investments in Russia by the simple expedient of denying its top managers work visas - as appears to be happening - we, as small investors, have no hope of being adequately protected.
Finally, there are the true emerging markets, like India (No. 64), China (No. 79) and Vietnam (an extraordinary No. 113, below Uzbekistan and Bolivia.) These countries are all highly corrupt - and are pretty much closed societies, too - so it is difficult for foreign businessmen to operate there. And that means that theyd hardly be characterized as business-friendly markets.
However, unlike Russia and Venezuela, they do not have a guaranteed source of income from oil, meaning they instead have to provide the outside world with products and services that are adequate in quality. Hence, companies from those markets (that have international listings) tend to treat their foreign shareholders with reasonable fairness because their local business owners need continued access to international stock markets.
Most importantly, all three of these countries - India, China and Vietnam - possess growth rates that are among the highest in the world. And since those growth rates are not dependent on potentially volatile commodity exports, these three countries are likely to continue their rapid growth rate well into the future, gradually becoming richer, more-sophisticated and "better places to do business."
Those are the countries to invest in, provided the stocks you buy are reasonably valued. But if your company wants to post you overseas, Forbes is quite right: Choose a business-friendly market like Denmark or Finland.