By Martin Chrisney, Director, IDAS Institute, KPMG LLP
In an increasingly uncertain and unstable world, countries cannot afford to look backwards to prepare for the challenges ahead. Change happens. Rich and poor countries alike must respond to unexpected shocks and long-term structural shifts, and adapt to new market opportunities and challenges as they arise. The lesson of successful, change-ready countries is that when it comes to being prepared for change, institutions matter.
Economies rise and fall based on the quality of their institutions and the norms and rules they embody. In the post WWII-period, countries such as South Korea, Singapore and Ireland have been able to climb the income ladder by taking advantage of global market opportunities and adapting their institutions; while others that took more rigid, inward-looking approaches fell behind. To assess beforehand if a country’s institutions are prepared for change requires a metric to gauge its capabilities.
Wealth is not enough.
The role of institutions is one of the key factors captured by KPMG’s Change Readiness Index (CRI). (The Change Readiness Index was first published by KPMG in 2013, and the latest index was published in July 2017. It captures primary data from nearly 1,400 in-country interviews and pools 125 variables from secondary sources to provide metrics of change readiness in the three pillars: Enterprise, Government, and People and Civil Society. https://www.kpmg.com/changereadiness)
The CRI tool measures the capacity of countries to adapt to and uniquely take advantage of change. Now in its fourth iteration, the CRI offers a cross-section of data on 136 countries and measures the characteristics that make them more change-ready. Using this data, we can identify the policies and institutions that are found in resilient countries.
A major finding of the CRI is that while wealth matters—the top 10 countries in the index are high-income earners—it is not enough. Notably, natural-resource rich economies do not necessarily perform well. Nor is a singular focus on enterprise capability sufficient. Thirteen of the top 20 countries had lower Enterprise Capability scores in 2017 than in 2015, while 14 out of the 20 improved in People and Civil Society Capability. Among the top 50 countries, Rwanda stands out as an exception (46th place). It performed well above the level predicted by its income based on its continued improvement in Government Capability with strengths in security, fiscal policy and budgeting, regulation and enterprise sustainability.
How can countries become more change-ready?
One way to answer this question is to identify the characteristics of high-performing countries. For example, we can group the countries by their risk profiles—in this case using risk ratings to capture credit risks (see chart below). (Using risk ratings, we can group countries from the least risky—AAA or most creditworthy—to the riskiest. The analysis draws mainly on local-currency ratings since these do not depend on foreign-currency earnings, offering a better reflection of domestic risk factors such as the economy, public institutions, markets, financial stability and threats from natural disasters.)
The quadrants in the Chart are based on the “cut offs” for investment-grade credits and the average CRI for upper-middle-income countries. Not surprisingly, the indices track closely. In general, creditworthy countries are more change-ready. Countries with high change-readiness (Switzerland ranked first, Sweden second and Singapore fourth) have low credit risk (upper NE quadrant); while others have low capability to respond and face high risk (Venezuela 119, Mozambique 116 and Greece 54 in the lower SW quadrant).
Chart:
Which Countries Are Prepared for Change?
Source: KPMG Change Readiness Index, 2017; a composite credit-risk index based on Moody’s Investors Service Local Currency Ratings, Standard & Poor’s Local Currency Rating and the Euler Hermes Country Risk Rating.
Note: The index groups countries in broad rating categories — Aa1/AA+, Aa2/AA and Aa3/AA- are grouped together as Aa, etc.
To move up the scale, countries can learn from those that are more change-ready. That is, a low-performing country can benchmark itself against a better-performing peer. What differentiates these cases? For example, Greece (54 in the CRI ranking) can improve by mirroring more closely characteristics of Hungary (44) (which has a similar GDP per capita) by making specific improvements in its Government and Enterprise pillars: land rights, fiscal policy/budgeting, labor markets, financial sector and macroeconomic framework (see table). Uruguay (29) trails its peer Chile (24) in labor markets, regulation, environmental sustainability, entrepreneurship and the financial sector; yet scores higher on government strategic planning and innovation, research and development. These comparisons reveal that there is no single path or fixed set of policies to build change-readiness. Rather, the elements must be tailored to each case, taking into account the circumstances of the country.
Table:
How to Become More Change Ready:
Benchmarking
Takeaway
Increasingly rapid technological advances, the mobility of people and ideas, and the growing severity of global shocks, such as pandemics and climate-related disasters, will likely favor countries that are able to respond effectively and decisively to change. The evidence from the CRI supports this view and shows that the right mix of policies and institutions builds on a strong foundation of government, enterprise and civil-society capabilities. When governments are effective, markets function well, and civil society has a strong voice; countries have the capabilities necessary to create sustained, inclusive growth.
The main takeaway for policymakers, investors and international financial institutions is that any assessment of a country’s potential should factor in a “forward looking” view on whether it is ready for change. Those countries that are not prepared to adapt and take advantage of opportunities resulting from events and structural shifts will likely be left behind by their global competitors.