Should businesses get compensation when policy changes?

Do businesses really think policy never changes?

The way they act when a change is proposed makes you think they never realised democracies worked like that.

House_of_Representatives,_Parliament_House,_Canberra

The mining industry would have us believe a mining tax on surging profits was impossible to anticipate.

The car lease industry feign they never dreamed the law might remove their favourable tax treatment.

The steel makers pretend charging for carbon was completely inconceivable.

The tunnel-makers insist they couldn’t foresee a world in which their tunnel wasn’t wanted.

Businesses who stand to lose from policy changes kick up a fuss about how they’ve been blind-sided.  All too often we are taken in by their sob stories. And we retreat from making policy changes we want.

Is this pretending part of the cut and thrust of political debate? It surely is. And yes, we can still make change over the sounds of protest when we really, really need to. For example, the government reintroducing fuel excise levy indexation.

Furthermore, change is costly. If we changed the rules every five minutes, that would make life hard for everyone. There has to be a balance.

But the pace of change in our society could be too slow if we take every business complaint at face value. Many business models depend on the status quo. This graph is a mock-up of why they might defend that status quo, and why that might be less than ideal for society at large.

costs of change
The horizontal axis shows rate of change. Think of that as bills passing the Senate. The vertical axis shows the payoff.

This graph shows a world in which policy change happens too slowly if we let businesses with an investment in the status quo drive policy.

So how do we bridge this gap? We want businesses to invest based on the current laws. But we also want the freedom to change those laws as soon as they are no longer useful.

I think there is a case for policy change insurance. That way if a law is changed that puts a business in the red, they can be compensated, but the taxpayer doesn’t have to be on the hook for it. If they don’t buy policy change insurance? Well they obviously weren’t too worried about that particular law!

Policy change insurance would be cheap to come by for laws that are rock solid. $0.01 a year would buy insurance against the government appropriating your land.

But if your business depends on something else, like funding for dodgy vocational education courses, then your insurance will be much more expensive.

tax reform constipation
An insurance company’s worst nightmare?

Prices in the insurance market would signal to firms what laws are more likely to change. Insuring against a one percent change in tax rates would be expensive. Insuring against a 20 per cent change would be cheaper.

That price signal should mean much less complaining when dubious programs are axed, and also signal to government which laws business honestly thought were steady. It makes both sides more honest.

The existence of this market should allow society to change its laws more often, if it wanted. In some ways I can’t believe it doesn’t already exist.  You can buy Sovereign Risk insurance if you operate in especially heinous jurisdictions, but there seems to be nothing for Australia.

(Perhaps it doesn’t exist because there’s no actual demand? That’d suggest we put even less stock in the bleating of ACCI et al.)

Further savings would come to businesses because they could sack their lobbyists. Of course, the ultimate lobbyists in this new model would be the insurers. They would become the most conservative institutions in history. Every law change would rip money straight from their pockets Strict laws against political donations from insurers would have to be enacted. Laws would also have to ban former MPs from ever working for insurers, etc.

Does this model make sense? Are there any reasons why policy change insurance wouldn’t work? Or reasons why it doesn’t exist already? Is it just simpler for government to pay compensation instead? Is my basic thesis that the pace of change is too low completely wrong? Please share your thoughts below!

The real sovereign risk is that people are no longer sovereign

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.

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Source: Google trends

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:

“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.