What creates confidence in business?

By Manos Schizas, senior policy adviser, ACCA

As trusted business partners and advisers, accountants around the world had front-row seats to the downturn of 2008-9 and to the increasingly fragile recovery since. In many ways, the combined insights of our global membership have more to say about the state of the global economy than any econblogger, and they are, as you no doubt realise, absolutely massive.

Realising that there’s a story to be told here, ACCA has surveyed our members around the world every three months since early 2009 and the poll, known as the Global Economic Conditions Survey (GECS) has now become the largest of its type in the world.

But the story that GECS was created to tell is still ongoing. In fact, with Asia slowing down and Europe in the grips of a full blown sovereign wealth crisis that has so far resisted all attempts at a resolution, the need for better and clearer insights is arguably greater today than in 2009.

For the 12^th edition of the GECS (2011 Q4), we’ve joined forces with IMA (the Institute of Management Accountants) to survey an incredible 3,775 professional accountants around the world. We won’t give away the full findings of the report here; instead as a treat to our blog readers we’ve prepared a slightly different analysis, looking in detail at what factors influence our members’ confidence in the prospects of their organisations.

So, what matters to businesses – what creates confidence? It’s not a question one can ask directly in a survey; people often don’t know the answer themselves. Accountants are of course more familiar than most with the situation on the ground, but it’s hard to say how facts translate into sentiment. At the end of the day, business confidence is as much about that nagging feeling that something is wrong, or the sense that everything will be all right, than about rigorous analysis.

What we’ve done in this case is to ask indirectly. GECS follows 38 different indicators of trading conditions and firms’ responses to them, as well as an index of business confidence. On this occasion, we’ve used one of our favourite types of inductive statistics – ordinal regression analysis – in order to tease out the individual effect of each aspect of the business environments on reported business confidence, and control for business and respondent characteristics. The statistically significant effects we found are as follows:

1. As you might have expected, revenues come first – not the abstract aggregate demand of economists but good old turnover. The effect of revenue on confidence is so much stronger than those of other factors that a comparison based on standardised magnitudes would have been impossible to chart.
2. The next most important factor is the perceived state of the global economy. It is indicative of the poor economic sentiment out there that anyone who doesn’t believe the global economy is going to deteriorate further or doesn’t feel helplessly clueless tends to be more confident about their own organisations as a result. Similarly, the confidence boost experienced by those who believe the global economy is improving is almost exactly as large as the benefit from feeling that it’s simply bottomed out and won’t stagnate. Expectations about the strength of the recovery are, to put it mildly, very low.
3. Next on our ranking is a more dynamic indicator of demand – new orders. When it comes to business confidence, only negative trends in new orders register in the minds of our members; opportunities to increase orders have almost no significant effect. The fact that new orders appear to have less of an impact on confidence than current revenue does not suggest that finance professionals are short-sighted: revenues from new orders are expected in the future and are often uncertain, so in difficult times they are often heavily discounted in business people’s minds.
4. Next comes the effect of that elusive beast, effective government policy: Respondents who felt government was responding very well to the economic environment enjoyed a substantial confidence boost. That said, it is worth remembering that only very positive assessments of government policy appear to influence business confidence. No significant effects were obtained for more cautious or qualified approval.
5. This effect is followed immediately in our ranking by the effect of perceived business opportunities: the strongest effects come from innovation and expansion into new markets. As in previous downturns, the ability to benefit from the way cash-strapped customers change their habits and preferences is also a strong contributor to business confidence, as is the ability to work with one’s supply chain, presumably in search of increased efficiency. Finally, opportunities to invest in quality standards are also a contributor to business confidence, although this effect is much weaker.
6. Domestic fiscal policy ranks beneath most types of business opportunities in terms of its impact on business confidence, and it’s only the effects of austerity that push it this far up the league table. Respondents who expected government spending to ‘fall significantly’ within the next five years suffered a statistically significant loss of confidence as a result.
7. Business sector has effects on confidence of a more or less similar magnitude to austerity. In particular, respondents in accountancy practices from the Big Four to small and medium sized practices (SMPs) appear to be more confident than those in other sectors. Bear in mind that this is after the effects of all other factors discussed here have been stripped out, so it is possible that accountants in practice are simply overconfident.
8. Next on the ranking comes the evil twin of good government ratings: the perception of government incompetence. Those who felt government was doing ‘very poorly’ suffered a significant loss of business confidence and those who felt it was doing ‘poorly’ were also less confident, although this effect was not as strong. Note that there is an asymmetry in the effects of approval and disapproval of government policies: while moderate disapproval has an effect on confidence, moderate approval does not. Governments really can’t win, can they?
9. Next in our hierarchy of confidence drivers comes the availability of capital for investment. Note that, once accounting for this, access to finance in general is not a significant influence on confidence at all.
10. Business size is not a particularly strong influence on business confidence after the effects of business challenges and opportunities have been stripped out but respondents in one sizeband in particular, those with 250 to 999 employees, do appear to be less confident, all other things being equal.
11. Finally, the effect of having financially weak customers may not be as significant as others we have discussed but it does have a significant impact on confidence, as late payments and defaults can threaten business viability.

This ranking is remarkably similar to the one we uncovered when we first tried this analysis three years ago – that’s either a testament to the timelessness of how business works, or of just how little things have changed from 2009 to this day.