Until the mining tax debacle of 2010/11, the term sovereign risk was used in Australian political discourse very sparingly. The term traditionally refers to a government not paying back a loan, but now is used for all sorts of situations where government is a risk to someone’s business.
Now “Sovereign Risk” is not applied to Africa or Greece, but has become a political weapon to be wielded on policies – or indeed entire governments – with which one is unhappy. For example:
- Damaged by growing sovereign risk (2011)
- Warning. Gillard’s Australia makes investment risky (2012)
- This unholy tripe (2012):
“BHP Billiton, Rio Tinto and most other world minerals and energy groups have now concluded that Australia is one if the most dangerous places in the world to invest. We are going to see a capital strike of immense proportions, which will take a long time and much effort to reverse. And when it is reversed miners will still require much greater returns from Australia because of the demonstrated sovereign risk of investing here.”
and
Most recently, the concept of Sovereign Risk has been used in a debate over whether contracts for a big road tunnel called east-west link can be torn up. This is a specific kind of sovereign risk, unlike the mining tax issue, where the sovereign is also party to your contract.
But the way governments work these days is in partnership with companies. From welfare to infrastructure via defence and health, government has become more and more entwined with private sector suppliers and implementers.
Governments should avoid flip-flopping, because it will raise the cost of contracting. But where policy change is desirable, changing contracts is also desirable. To fetishise sovereign risk is in many cases to say that policy change cannot happen.
If we make sovereign risk our key yardstick, a horrible political trick will become possible.
Say Labor is about to lose an election and the Libs are promising some expensive policy. All Labor has to do is enter into an expensive contract the Liberals have to honour. Then the Libs can’t implement their promise without going into debt. Liberals look bad, Labor gets back into power.
The Age has found experts who say tearing up the contract for the east-west link would not be a big issue: “Labor could tear up East West Link contract if it wins election”
To me that is obvious. There’s a big difference between cancelling a contract before any work has been done, and reneging on paying a bill after the fact. The latter is clearly bad for a state’s reputation. The former should be acceptable, given some compensation for preparatory work.
The Greens say they’d tear up contracts. Labor says that even though it opposes building the $8 billion road, it would honour the contracts. (The latter position is seen by some as a way of Labor eating their cake and having it too. They don’t actually want to be seen to deprive people of a new road.)
Sovereign risk in contracting with the government is one thing. But blaming the government for changing laws that hurt your business is another.
Anyone doing business in a democracy should know the law is fluid. A smart person can tell what laws might be about to change. (Tobacco supply laws – likely. Tariffs on textiles and clothing – unlikely).
Just as people manage their lives through changes to road rules and tax laws, so companies must manage their business around possible law changes. If a business exists to exploit one small loophole, like selling fireworks in the ACT, then their cost of capital should be higher than a business like Woolworths that will be more resilient to any single legal change.
Of course, changes to law can make investments worthless.
Of course prospective changes to law raise companies’ risk, and thereby their cost of capital.
Of course companies will try to make the legal environment as stable as possible – that delivers the biggest bump to their bottom line.
So of course they want to make the concept of sovereign risk current and valid.
We see this most vividly in the provisions of the trans-pacific partnership, a proposed trade deal that could let multinational entities sue the states in which they operate for any law change that hurts their investments.
But these companies should remember why they are headquartered in New York and Sydney, not in Beijing, or Havana. In the long run, a functioning democracy is the best environment for stable investments, and in a fast-changing world, policy change needs to be rapid too.
The real sovereign risk is that people are no longer sovereign.
Thomas the Think Engine 