TAMÁS NOVÁK Global Business Environment

Political risks

• Possibility of an unexpected politically-motivated event affecting the outcome of an investment• Instability vs. risk• Classified based on

- actor responsible- nature of effect- micro vs. macro

Definition of Political Risk

The World economy according to development level

Before 1989 Today

Developed market economies Developed market economies („first world”)

Socialist economies Countries in transition(„second world”)

NICsDeveloping countries Oil exporting countries(„third world”) Middle income countries

Low income countries LDCs

Types of Political Risks

Cause

Result Government Others

Property Loss Confiscation Destruction

Income Loss Discrimination Disruption

Source: de la Torre & Neckar

Main Types of Political Risks

a) Expropriation “Forced divestment of equity ownership of a foreign direct investor”.

Peaked in the mid-70s; almost nil now Mostly Africa till 1980, then Latin America Declined since:

-Key sectors already nationalized-Economic need = > privatization-Regulate rather than expropriate

Many hosts have joined MIGA (Multilateral Investment Guarantee Agency)

Some controversy over future:- is free enterprise here to stay, or will there be a backlash when

privatization, etc. fails to provide widespread benefits?

Main Types of Political Risks

b) Terrorism Terrorist acts infrequent, but spectacular- - L. America: kidnappings; U.S. public

institutions- - China, India, Turkey, Israel etc.- Groups denied a voice in legitimate channels Symbolism particularly important (MacDonalds, etc.)

Main Types of Political Risks

c) Selective Intervention• Most risks are less dramatic changes in the

rules of the game.• Some areas of government policy affect

foreign-owned companies more than most domestic ones Restrictions on Cross-Border Transfer of

Resources Tariffs, exporting FX controls limit repatriation Capital controls Labour regulation

Main Types of Political Risks

– Taxation ConcernsRestrictions on transfer pricingWithholding taxesAvailability of tax holidays and other incentives

– Investment RestrictionsSectoral restrictionsRequirements for JVs, local ownershipTransparency of licensing proceduresRequirements for disclosure of technologyRequirements for forced divestiture

Main Types of Political Risks

Operating Restrictionslimits on expansion, ownership of land, etc.Discriminatory access to labour, inputsRestrictions on local market accessPerformance requirements (e.g. employment & export

levels, etc.)Unequal access to government procurement

Main Types of Political Risks

– Non-Neutrality of the Legal EnvironmentJudges or other arbiters insulated from political

pressureInternational and regional conventionsInternational conventions on compensationGuarantees of national treatment

Regulations with Differential Effects on ForeignersSome may be much harder for foreign companies to

comply with

Main Types of Political Risks

d) “Crossfire” Problems Activities may lead to international or home country

sanctions or consumer boycotts against the country or firms that deal there

human rights abuses (e.g. imprisonment, torture or murder of political opponents; use of prison labor; persecution of minority groups; not abiding by election results)

conflicts with neighboring countries lack of concern for the environment, endangered species, etc. disregard for international agreements (e.g. re nuclear non-

proliferation) the misuse of social issues as means of protectionism

Forecasting Techniques

• “old hands” = ask experts for personal evaluations• expertise, but may be dated, subjective or irrelevant

• “grand tour” = send executives for personal visits• access to top decision makers, first-hand exposure, but

superficial may hear self-interested pleading

• quantitative• Delphi: obtain expert views, aggregate and give to same

experts for chance to revise their views given what others think; repeat until consensus. Tends towards “conventional” predictions. Econometric: use historical data, macro-orientation, but low-cost, may be helpful for initial screening

THE MEASUREMENT OF POLITICAL RISK

1. Political factors measured by:a. Frequency of government

changesb. Level of violencec. Number of armed

insurrectionsd. Conflict with other states

THE MEASUREMENT OF POLITICAL RISK

Economic Factors

1. Indicators of political unrest

a. Rampant inflation

b. Extreme balance of payment deficits

c. Slowed growth of per capita GDP

THE MEASUREMENT OF POLITICAL RISK

Subjective Factors

1. Profit Opportunity Recommendation

2. Political Risk and Uncertain Property Rights

THE MEASUREMENT OF POLITICAL RISK

Capital Flight

a. Definition:

the export of savings by a nation’s citizens because of safety-of-

capital fears.

b. Measurement: use the balance-of- payment account

THE MEASUREMENT OF POLITICAL RISK

Causes of capital flight

1.) Inappropriate economic policies

2.) Expectation of devaluation

3.) High political risk

Insurance JVs with local or foreign partners Local stakeholders Structural dependency Lobbying Planned divestiture with profits General rule: make the costs to the government of an undesirable move to the firm very costly. Provide “incentives” for appropriate government regulations and policies.

Managing Political Risk (counter moves)