Sovereign risk is the risk that government policy might adversely affect the value of private investment or private property. In recent years, however, sovereign risk has come the mean the probability of government default on public debt. The government and its supporters rely on that narrow definition but, to be fair, it is that latter definition that most people would have encountered in their studies. So we see this type of article in the Fairfax press:
BlackRock is one of the world’s most important buyers of government bonds, investing $US3.7 trillion worldwide. It says Australia’s carbon tax and the mining tax have had at most a “marginal” impact on perceptions of the country’s risk. More important has been the government’s success in shrinking its budget deficit.
The finding is at odds with a claim made by federal Coalition Treasury spokesman Joe Hockey last August that Labor was “adversely impacting Australia’s sovereign risk profile”.
To be clear – BlackRock’s paper investment in Australia is very safe. I doubt the federal government will defaut on its debt.
If BlackRock, however, were a mining company making real investment in Australia they might have had a very different view – especially in 2010. Just last year the government expropriated the property of tobacco companies and the Australian constitution was too weak to prevent that. This morning we read that other private property isn’t safe either:
Mr Sinclair said there was ”something inherently not right” in having Coca-Cola and Powerade sponsor events like school rugby and junior soccer, and it was a matter of time before tobacco-style bans on direct marketing to children were introduced for unhealthy food.
International investors have become increasingly aware that their property might not be safe within Australia – it is protected by convention and not the constitution. The takings clause is weak – the government can argue that while it is not taking your property for itself it can prevent you from using it. This is an argument that appeals to lawyers but not investors. So the perceived risk of public policy changes destroying investments and property has increased under this government – what an incoming government will do to reduce that risk is unclear. But that is another story.
In the meantime, to avoid confusion perhaps the term ‘regime uncertainty‘ should be substituted for sovereign risk when discussing real investment and not financial investment.
Regime uncertainty is a concept developed by Robert Higgs, that describes a pervasive lack of confidence among investors in their ability to foresee the extent to which future government actions will alter their private-property rights.
Investment not only entails ‘irreversibilities’ or sunk costs, but can be delayed. Investment spending may be highly sensitive to risk in various forms, including uncertainty over future tax and regulatory policy. A major cost of political and economic instability may be its depressing effect on investment.
This uncertainty can arise from many sources, ranging from simple tax-rate increases to the imposition of new kinds of taxes to outright confiscation of private property. Threats can arise from various sorts of regulation, for instance, of securities markets, labor markets, and product markets. The security of private property rights rests not so much on the letter of the law as on the character of the government that enforces, or threatens, presumptive rights.