Political Risk and Political Risk Assessment

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Political Risk and Political Risk Assessment

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• Political Risk Analysis
• Definitions
• Empirical relationships
• Forecasting techniques
• Using risk analysis
• Managing political risks

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• Definition of Political Risk
• Possibility of an unexpected politically-
• motivated event affecting the outcome of an
  investment
• Instability vs. risk
• Classified based on
• - actor responsible
• - nature of effect
• - breadth (micro vs. macro)

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Types of Political Risks
Cause Cause Cause
Result Government Others
Property Loss Confiscation Destruction
Income Loss Discrimination Disruption
de la Torre Neckar (1988), p. 223
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Main Types of Political Risks

• Expropriation
• Forced divestment of equity ownership of a
  foreign direct investor (Minor 1994)
• Peaked in the mid-70s almost nil now
• Mostly Africa till 1980, then Latin America
• Declined since
• Key sectors already nationalized
• Economic need gt 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?

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Main Types of Political Risks (Continued)

• Terrorism
• Terrorist acts infrequent, but spectacular
• - L. America 1 esp. kidnappings
• - U.S. owned corps. Esp. targets, U.S. public
  institutions
• - China, India, Turley, Israel etc.
• -sept 11, Iraq
• Little research-seems to be primarily groups
  denied a voice in legitimate channels
• Symbolism particularly important (MacDonalds,
  etc.)
• 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

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Main Types of Political Risks (Continued)

• Restrictions on Cross-Border Transfer of
  Resources
• Tariffs, NTBs inhibit sourcing, exporting
• FX controls limit repatriation
• Capital controls
• Labour regs
• Taxation Concerns
• Restrictions on transfer pricing
• Unitary taxation policies
• Withholding taxes
• Availability of tax holidays and other incentives

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Main Types of Political Risks (Continued)

• Investment Restrictions
• Sectoral restrictions
• Requirements for JVs, local ownership
• Transparency of licensing procedures
• Requirements for disclosure of technology
• Requirements for forced divestiture
• Operating Restrictions
• limits on expansion, ownership of land, etc.
• Discriminatory access to labour, inputs
• Restrictions on local market access
• Performance requirements (e.g. employment
  export levels, etc.)
• Unequal access to government procurement

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Main Types of Political Risks (Continued)

• Non-Neutrality of the Legal Environment
• Judges or other arbiters insulated from political
  pressure
• International and regional conventions
• International conventions re compensation
• Guarantees of national treatment
• Regulations with Differential Effects on
  Foreigners
• Some may be much harder for foreign companies to
  comply with

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Main Types of Political Risks (Continued)

• 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
• What kind of cross-fire problems associated with
  Iraq wine-makers in the Bordeaux region faced?

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Political RiskEmpirical Relationship

• Most studies examine correlates of
  expropriation
• Minor (1993) no link with stability
• Positive correlations (more risk)
• - extractive, service and key sectors
• - JVs with the host government
• - host countries with pervasive governments
• (hands-on)
• - medium-technology
• - need for scapegoats
• - obsolescing bargains

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Empirical Relationship (Continued)

• Negative correlations (less risk)
• - integrated subsidiaries that depend on rest of
  
• network
• - low/high tech
• - lobbying
• Makhija (1993) information indicating
• convergence of MNC actions and government
• economic objectives

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Forecasting Techniques

• old hands ask experts for gut instinct,
  personal evaluations
• - taps 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

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• The Economist Method
• Political Risk Service (PRS) -- 100 points
• 33 points economic factors
• falling GDP/per capita
• high inflation
• capital flight
• decline in productivity
• raw materials as percentage of exports
• 50 points politics
• bad neighbours
• authoritarianism
• staleness
• illegitimacy
• generals in power
• war/armed insurrection

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The Economist MethodPolitical Risk Service
(PRS) -- 100 points

• 17 points society
• urbanization
• race
• Islamic fundamentalism
• corruption
• ethnic tension

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• Political Analysis
• Expert qualitative studies
• - rational actor-type
• - what is the logical action given goals
• - best if unitary actor and major decision
• - organizational type
• - organizations do what they have always done
• - best for small decisions by bureaucracies
• Political bargaining type
• - who has power and influence where
• - best for fractionated power environments
• Results are best when model fits the
  characteristics of the decision and the
  decision-maker

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• Example of Rational Actor Analysis A Focus on
  Government Foreign Business Relationships
• Examination of FDI costs and benefits
• Benefits Capital inflow, job creation, better
  jobs (?), tax revenue, improved balance of
  payment, technology transfer, training, market
  access
• Costs Branch-plant Syndrome, sovereignty and
  National Security

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Government Actions When Interests Are in
Conflict (Source Head) Issue division of
spoils (assets and future profits) Actions
limit profit repatriation, taxation,
expropriation, force companies to sell off all
or part of a subsidiary below market
value. Issue technology transfer/control/ Actio
ns maximum foreign ownership rules,
joint-venture requirements, investment
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Government Actions When interests are in
Conflicts (Source Head) contd Issue
sourcing of inputs Actions tariffs and quota in
key imported inputs, domestic control
rules Issue contribution to balance of
payments Action export requirements
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• Managing Political Risk (counter moves)
• Insurance from EDC, etc.
• JVs with local or foreign partners
• Local stakeholders
• Structural dependency
• Lobbying
• Planned divestiture with s/t profits
• Integrate with strategy
• Security for expatriates
• 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.