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Political Risk

Economic Map of the World: Emerging Markets and Developed Markets

as of June 2006

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Perception of expropriation risk

Increased perception (based on real experience) of greater risk in foreign operations

Sources of risk: Direct source: war, revolution, and civil violence

Indirect source: government policy change (expropriation or nationalization of ownership; regulation of behavior; restrictions on sourcing or remission of earnings)

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What is expropriation?

Used interchangeably with nationalization

An act whereby government takes into ownership of, by compulsion if necessary, private property for a public use

Two types: Mass expropriation: nationalization of most or all

foreign property

Selective expropriation: forced divestment of a single firm to the nationalization of an entire industry. This is to achieve specific political-economic objectives

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Expropriation cases

Russia Bolsheviks revolution in November 1917

new government monopolized banking, abolished private ownership of land and natural resources, and confiscated properties of foreign firms

damage to foreign investors

total losses were over $84 million – equivalent of $1,025 billion in 2003 dollars

major investors then: France (33%); Britain (23%); Belgium (14%) and U.S. (5%) firms (e.g., Kodak and GE)

very few foreign firms could be reimbursed. FDI not permitted until the collapse of the Soviet Union at the end of the 1980s

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World War Ibetween the Triple Entente

(Britain, France and Russia) and Central powers (Germany, Austria-Hungary and Ottoman Empire) in July 1914

each side investigated ownership of firms on their territory, then took over those firms ultimately held by “enemy”

both sides took not only physical assets but also intellectual property, such as patents

wartime expropriations of German corporate assets in Britain reached nearly $8 million – equivalent of $98 mil in 2003 dollars

Expropriation cases

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World War I (continued)until U.S. entry into the War in July 1917, little damage to

U.S. (German) firms in German (U.S.) territories

since U.S. entry into the War in 1917, each of U.S. and German forbade trading goods, payment and remittance of money with the other side and its allies

trade sanctions developed to compulsory appointment of administrator in firms owned by “enemy”, forced liquidating or selling them to local firms, abrogation of trademarks, patents, copyrights

the Bayer brand, Aspirin, and its trademark were sold to Sterling Drug in the U.S. after the War. Bayer had to pay $1 billion to reacquire the right to use the trademark in the U.S. in 1994

Expropriation cases

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Bolivia

during the 1930s, tensions between Standard Oil and the Bolivia government

in 1937, the Bolivia government charged Standard with fraud and expropriated Standard’s assets, valued $1 million to $2 million – equivalent of $ 12.7 million to $25.5 million in 2003 dollars

the State Department of U.S. decided to deny financial or technical support for Bolivia until Standard was compensated

in 1942, Bolivia compensated Standard with $1.7 million, and immediately U.S. granted $25 million development program to Bolivia

Expropriation cases

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Mexico once one of the world’s largest oil producers, thanks to foreign

entrepreneurs

in 1917, the Mexican Constitution declared ‘Mexican state was the rightful owner of the country’s suboil’ (Calvo Doctrine)

in 1937, the Mexican government determined that foreign oil companies were making higher profits and could afford to raise wages and provide social benefits

the government required foreign-owned oil firms to replace foreign drillers with Mexican technicians and to offer extensive social benefits such as supplying library, night and day-schooling for workers and their families and first-class medical services.

Expropriation cases

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Mexico (continued) oil firms protested against the high cost.

on March 1, 1938, the Mexican Supreme Court found the oil firms guilty, and ordered them to adopt the changes within six days - which they failed to do so

on March 18, 1938, Mexican government nationalized oil firms including Royal Dutch Shell and Standard Oil

U.S. oil firms filed complaints to the State Department of U.S.

in 1943, the compensation package ($309.4 million in 2003 dollars) was settled between Mexican government and oil firms

Expropriation cases

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World War II in September 1939, war broke out in Europe

combatants again moved to take control of firms owned by their enemies

in Germany and occupied Europe, Germans converted all U.S.-owned factories and properties into wartime production plants. American parent companies could not protest s their foreign subsidiaries were corporations chartered under laws of countries in which they were operating

in December 1942, U.S. entered the war. Immediately, Germany and Japan took control over the U.S. MNEs in their territories

some of U.S. firms were sold

companies that were not sold by the Germans were often completely destroyed

Expropriation cases

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China in October 1949, communists took power on mainland China

China has been a major host economy until then

British firms alone held $840 million – equivalent of $6.48 billion in 2003 dollars

US-owned power companies did utility operations

though no immediate expropriation of foreign firms like Soviet Union, ‘hostage capitalism’ era continued

foreign firms were put under the direction of planned economy, and were not allowed to close down

many firms had to remit funds from Hong Kong to pay higher wages and taxes than those for Chinese local firms

Expropriation cases

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Cuba in February 1959, Fidel Castro came to power

between 1959 and 1960, U.S.-owned sugar industry was expropriated

in June 1960, Cuba requested ESSO and Texaco refineries to process Soviet crude oil. The oil companies refused. Then, Cuban government expropriated them

in retaliation, U.S. imposed sanctions against Cuba

the largest loss suffered by a single investor was $136.3 million – equivalent of $837 million in 2003 dollars

as of now, no U.S. company has received compensation for its expropriated investments in Cuba

Expropriation cases

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Natural resources in Emerging Markets in the 1970s in the 1970s, emerging market governments expropriated most of the

foreign-owned companies involved in mining, oil, and utilities

between 1970 and 1975, there were 335 acts of expropriations.

Africa (43.2%), Latin America (32.7%), Asia (6.8%), and Middle East / N. Africa (17.3%)

especially, Algeria took more of its FDI than any other less developed countries between 1956 and 1972 as much as $1,746 million in foreign investments

between 1967 and 1972, Algeria nationalized Standard Oil after Arab-Israeli war, took control of Getty Petroleum Company of U.S., and two French oil firms

Expropriation cases

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Classified as: firm-specific

country-specific

global

MNCs need to identify, measure, and manage political risk

Political risk

“We’ve considered every potential risk except the risks of

avoiding all risks.”

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Classification of political risk

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Assessing political risk

Done at two levels: macro

micro

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Predicting firm-specific risk (micro risk):assess the political stability of a country

anticipate the effect of political changes on activities of a specific firm

Different foreign firms have different degrees of vulnerability

Assessing political risk

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Predicting country-specific risk (macro risk):analyze the historical stability of the country in

question

will these trends persist?

Challenging to predict

Assessing political risk

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Predicting global-specific risk:difficult to predict

expect to see new indices devoted to ranking terrorist threats and environmental threats

Assessing political risk

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Global-specific risks: Starbucks

Starbucks found itself an early target of the anti-globalist movement

The company appeared to be yet another American cultural imperialist

Late 1990s - global prices for coffee plummeted; and Starbucks was criticized for not improving life for the coffee growers

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Global-specific Risks: Starbucks

Growing pressure for sustainable development and social responsibility from consumer segments

2000: Starbucks introduced “Fair Trade” coffee to help improve the living standards of coffee growers