Joel Kurtzman cuts to the chase when it comes to managing global risk.

During his years as an international economist for the United Nations, Joel Kurtzman, the persuasive closing speaker at the IAMC Spring 2008 Professional Forum in Phoenix, won India's Indira Gandhi Prize for his work negotiating between that nation and Union Carbide Corp. after the Bhopal disaster. That experience is among many that singularly qualify him to evaluate risk environments around the globe.

Last year, he and Milken Institute colleague Glen Yago devised the Opacity Index, which "measures the costs and preponderance of high-frequency, low-impact risks resulting from corruption, a lack of due process, poor regulatory enforcement, and non-standard reporting practices, each of which adds substantial costs to global business." Those costs, he has said, "operate like sand in the gears of commerce."

Ned Hill Source: The Milken Institute

Before getting into the particulars of the world at large, however, the admitted optimist brought a bit of perspective to the roiled domestic front.

"At end of World War II, The U.S. was 40 percent of the world economy," he said. "In the last 60 years, when the world has grown so immensely, we're still a third of the global economy. What would have thrown us into a depression in the past, we now roll over like a speed bump ... There is a lot of capital formation around the world. We're not growing, with the rest of the world left behind, but the whole world is growing together."

The U.S. continues to be the largest recipient of capital outflows, ahead of China, he asserted, while predicting that the "debacle" in the housing market would only dent GDP by 0.8 percent when all is said and done. Oh, and one more thing:

"There is still extremely low unemployment," he said, "just around 5 percent. It wasn't that long ago that people thought 5 percent unemployment was full employment."

While there may be a credit crunch, there is no capital crunch, he said. He's seen it firsthand in the Middle East, where he's been visiting for 25 years.

"My first trip to Dubai was when the airport had a canvas top," he said. "The biggest industry was selling cassette tape recorders and tapes, and the tallest building was three stories. The ruler of Abu Dhabi was still meeting his constituencies in a canvas tent. And the only program on TV at that time, in black and white, was of the ruler giving his dispensations and licenses, one at a time."

Today, of course, there's a virtual Manhattan being built before our eyes.

"There is a trillion dollars in the Abu Dhabi investment arm," he said. "Another $200 billion in a private equity firm. And that's just one country. Pension funds have $21.6 trillion. Mutual funds have $19.3 trillion. Insurance, $18.5 trillion. And petrodollars are between $3.4 trillion and $3.8 trillion. Every morning in these countries, they get down on their knees and thank the U.S. for its massive debt, because where in the world are they going to put this money?"

Similar notes can be sounded about the wealth of other low-population, high-capital nations such as Norway and Singapore, in addition to countries such as China, Japan, Taiwan and the Republic of Korea, where there is massive cumulative capital looking for a home.

"So it's coming here," said Kurtzman. "A good indicator of that was when the finance minister of the UAE at the beginning of the month [April 2008] said the UAE is going to continue to peg its currency to the dollar. That does not have to do with oil. It has to do with capital ... they want to bring it here."

They're bringing it for multiple reasons, including inflation in their home countries and the opportunity to invest it through private equity and government debt abroad. But it all adds up to one question in the end: Where is the safest place?

Joel Kurtzman addresses the Phoenix Forum's Wednesday general session.

In many cases, the answer is the U.S., despite the roadblocks presented by some of its regulations.

"In some cases, the U.S. has over-regulation, such as Sarbanes-Oxley," said Kurtzman. "That cost is a risk. It's not that it's bad legislation in theory — it's just that, in practice, it's too onerous."

But the U.S. is blessed with having had stability in its financial institutions, social systems and courts for a very long time. Meanwhile, the rest of the world changes so rapidly that assumptions must be checked at the door.

"The old view was that countries competed on labor costs and raw materials," he said. "But what we're learning is they don't compete on that alone. China, in fact, has seen its wage costs go up. I asked if a software engineer was having it written in Bangalore, and he said, 'No, in the Ukraine.'"

Similarly, he said, perceptions of the Middle East are often of the lumpy variety, without differentiating among individual nations or individual people's world views. He cited, for instance, an executive he met in Abu Dhabi who found numerous points of agreement with Israel, and the strong ties between upper-level fund managers and the places such as Boston where U.S. higher-education institutions trained them.

A network of capital flows illustrates those ties. But a given nation's relative transparency or opacity can disrupt that network. Thus, the impetus behind the Opacity Index. Mexico, said Kurtzman, offers a prime example of why such a measure is needed.

"I'm an expert witness in a case in Mexico where a large trucking company in the U.S. purchased a large trucking company in Mexico, to take advantage of NAFTA," he said."The idea was to have seamless integration and have distribution centers across the entire NAFTA region. They made a $300-million acquisition in Mexico, another acquisition in Canada, and it looked very good. A major accounting firm's opinion said everything done by the Mexican authorities conforms to GAAP.

"Eighteen months later, after having made the investment, it turned out the Mexican accounting was fraudulent - so well done the Big Four firm was unable to find out what actually happened," said Kurtzman. "The acquirer now has to bail out the Mexican firm, at a cost of $1 million a month. Three distribution centers in Mexico were losing money, even though the accounting [audit] said they were making money. A traditional analysis of risk in Mexico doesn't go into this. It goes to the macro level, the political situation and reforms of President Fox. They don't go into the accounting standards, the nitty gritty."

That kind of small-scale, high-frequency risk is what Kurtzman and Yago's index studies, by focusing on a set of factors defined by the acronym "CLEAR": Corruption; Legal systems with limited protections; Economic policies that hinder sustained growth; Accounting and governance standards that make it difficult to see inside companies; and Regulatory systems that fail to protect investors. In fact, today, Mexico's accounting standards are helping the country inch upward in the rankings, to No. 32 out of 48 nations studied.

Finland, with its crystal-clear reporting standards, tops the latest Opacity Index rankings, followed by Hong Kong, Singapore, Sweden and Australia. As for the bottom 10, Kurtzman offers plenty of reasons why China, for instance, comes in at No. 41.

"In some cases, the U.S. has over-regulation, such as Sarbanes-Oxley. That cost is a risk. It's not that it's bad legislation in theory - it's just that, in practice, it's too onerous."

Latest Index Shows U.S. Falling, Singapore Rising

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"In China, there are two or three sets of books," he said. "The first set you show to the government for taxes. The second set you show to your partner. And the third are the real books."

He said much of the $60 billion of foreign direct investment (FDI) annually entering China is "going in very naively." This time, Exhibit "A" is a large networking router company whose leader discovered that Chinese-made products were based on software and hardware concepts stolen from his firm.

"In the US, there would be a court case; the manufacturer would be penalized in some way; and the U.S. owner of the patents and other IP [intellectual property] could go about his business," Kurtzman said. "But the Chinese were very shrewd - they market and sell the products in Malaysia, India, Taiwan and other countries where U.S. courts don't have jurisdiction and where court systems are so weak that the original producer of the product won't be able to fight.

"But he went and filed a court case and hired lawyers," Kurtzman continued. "It sat for a long time, and finally he was called in, before the case was heard, to the judge's chambers. The judge said, 'Let's go for a walk. We know what your issues are, but the problem is that on the Chinese-company side, if you really bring this to court, and you have witnesses, the witnesses could disappear. And that would be a bad thing for your conscience. So I'd suggest you work out something with the Chinese company.'"

That kind of thing happens nowhere in the U.S. but on "The Sopranos," said Kurtzman. Even worse, he said, if a judgment is actually in your favor, in China 60 percent of all monetary judgments are never paid. In Hong Kong, conversely, a legal system descended from British common-law standards "works beautifully," he said.

The Opacity Index assigns Denmark, Austria and Ireland 16 points each in its latest edition, tying them for sixth place. The Philippines, at 43rd, comes in with 47 points. Kurtzman says each point in the index equates to a $986 cost in per capita GDP. Even with a high risk, the returns may be worth it, he said, but you have to know.

"Understanding opacity means we can price risk, understand the link to growth, measure global portfolio risk and balance and compute minimum required rates of return," he explained, as he launched into a litany of candid verbal snapshots. Among them were a poor and slow-moving legal system in France (which the country has seemingly overcome in vaulting from No. 26 to No. 14 in the latest Opacity Index); continuing difficulty in firing people in Germany, despite reforms; lack of enforcement in Mexico; and bribery issues, among others, in South Korea, Saudi Arabia, China, Russia and Indonesia.

Even so, he reiterated, potentially high returns in some of these fast-growing nations may make such risks worth a company's while. Access to capital may mean a very specific thing to a corrupt official. But it means something else entirely when you're talking about a nation's openness to financial resources and the growth such openness engenders.

"There is a high correlation between access to capital and opacity scores," said Kurtzman. "Improved access can add billions of dollars to emerging economies."

Including what may be the re-emergence of the U.S. economy, he said.

"The U.S. is a strong, strong platform. We have a lot of friends in the world, largely because they were educated here, and they admire our economy," he said. "We have to be very careful to avoid the hype, to simply follow everyone into China without adequately assessing what the risks are. Those risks can be extremely unfortunate and expensive. If you understand that, you can make wise, long-term decisions about where to locate."

--Adam Bruns