Tuesday, October 16, 2012

The Economics of Government Transparency

Dorothy Chou is a Senior Policy Analyst at Google.

Almost 20 years ago, Francis Fukuyama wrote a book called Trust, which claims that social capital and shared values and ethics create conditions necessary for modern economic growth. He argued that societies that facilitate stronger relationships of trust are able to innovate and scale more effectively than those that do not.

Two factors contributing to trust in society are structural: legal certainty and transparency about how laws are enforced. Together, these elements grow trust in a way that encourages investors to take necessary risks when it comes to businesses and markets. By contrast, when information is incomplete or not readily available, people are unable to make informed decisions or accurate forecasts for the future, making them more risk averse or creating moral hazard.

To see if that theory applies today, the Milken Institute provided us with a preview of data being assembled for the Opportunity Index: Access to Global Capital which will be released in early 2013. To help us look for correlations between measures of government transparency, foreign direct investment, and GDP, they assessed 34 different indicators that fell into four general categories: transparency of business, the political and legal system, the policymaking process and quality of regulation.

Here are a few of their observations about the data from 2011:

  • For all countries, higher scores in the composite and in three of the four transparency categories (business, political and legal system, and policymaking) correlate to both higher GDP per capita and FDI per capita.
  • Among advanced countries, Singapore, New Zealand and Hong Kong remained the best-performing countries in transparency from 2007 to 2011.
  • The U.S. ranking slid from 12th in 2007 to 16th in 2011. Two of the factors behind this decline were increased controls on international capital markets and lower scores on the quality of its credit market/securities exchange regulation.
  • Bahrain, Malaysia and Botswana were the three most transparent emerging and developing countries in 2011.
  • Albania witnessed the greatest jump in transparency scores, improving in all four categories. Its strengths included more disclosure, a lower burden of government regulation, more public trust of politicians, lower costs from terrorism/organized crimes and more transparency in the policymaking process.
  • China and Azerbaijan both improved their transparency rankings by 19 places. China gained ground in all four categories from 2007 to 2011, with the most improvement in transparency of policymaking. Public trust of politicians and a dramatic reduction in time spent paying taxes are other key contributors to China’s success. In Azerbaijan’s case, transparency of doing business and quality of regulations showed the most improvement. Specific strengths were less time/money spent starting a business, better credit/securities market regulation and better investor protections.
When we ran our own analysis of their data, we also found that when even we hold GDP per capita steady, foreign direct investment and greater transparency are highly correlated. And with a few exceptions, increases in transparency also correlated positively with increases of FDI per capita. While it’d be premature to say that increased investment is a direct result of government transparency in all 108 countries in the index, surveys published last year by Booz & Co. showed that legal certainty affects decisions made by angel investors and venture capitalists: 81% of investors said they would be more likely to invest during a “weak economy” with legal certainty than a strong economy without it.

To do your own analysis, check out the index and its underlying data sets in Google Fusion Tables: This is only the beginning of the work that’s being done to quantify what it takes for governments to facilitate growth in the new information economy. Keep an eye out for more from the Milken Institute in the next few months.

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