Political Environment of IB

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Political Environment of IB

• Collectivism vs. individualism (economic freedom)
• The state must manage enterprises if they are to
  benefit society as a whole.

• Democracy vs. totalitarianism (political
  freedom)
• - a single political party, individual, or
  group of individuals monopolize the political
  power and do not permit opposition.

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Index of Economic Freedom, 2002
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Political risk

• Political risk
• The risk or probability of occurrence of some
  political event(s) that will change the prospects
  for the profitability of a given investment.
• Examples
• Mass expropriation, changes in taxation, price
  control, environmental regulations, and
  constraints aimed directly at foreign firms (such
  as limitations on repatriation of capital,
  expatriate employment, and foreign ownership, and
  local content regulations).

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Measures for political risk

• The Economist rankings - countries in trouble
• Business Environment Risk Intelligence (BERI)
  Political Risk Index
• Political risk Service (PRS)

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The Economist 1986 rankings - countries in trouble

• Politics 50, Econ 33, Social 17. Higher
  scores indicate higher risk.
• Politics
• being near a superpower or troublemaker (3)
• Authoritarianism (7)
• longevity of regime (5)
• generals in power (6)
• war/armed insurrection (2)
• Illegitimacy (9)
• Society
• pace of urbanization (3)
• Islamic fundamentalism (4)
• Corruption (6)
• Ethic tension (4)
• Econ Falling GDP per capita, Inflation, Foreign
  debt as a proportion of GDP, Decline in food
  production per capita, raw materials as a high
  percent of exports.

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Business Environment Risk Intelligence (BERI)
Political Risk Index

• since 1987, 70 experts
• 7 points to each of the following 10 variables.
  Plus 30 bonus points
• Higher scores indicate lower risk.
• Internal causes of political risk

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• External causes of political risk
• Symptoms of political risk

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Political Risk Service (PRS)

• Since 1979, 250 experts, cover 199 countries as
  of 1993. Projection is adjusted for alternative
  future governments.
• Variables
• political turmoil probability actions that do
  not fully adhere to laws or social norms.
• Equity restriction
• Personnel/procurement interference
• Taxation discrimination
• Repatriation restriction
• Exchange controls
• Tariff and non tariff barrier imposition
• Payment delays (limitations on movement of funds)
• Fiscal/monetary expansion
• Labor cost expansion
• International borrowing liability

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How well do these measures work?

• Howell and Chaddick (1994) compare the
  projections of these three measures against
  losses incurred in the 87-92 period.
• The Economist index
• Correlations 0.33.
• Stepwise regression explains 44 of variance in
  losses.
• Most important variables

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• BERI
• Correlations 0.51
• Stepwise regression explains 53 of variance in
  actual losses
• Most important variables
• PRS
• Correlations 0.57
• Stepwise regression accounts for 74 of variances
  in actual losses
• Most important variables

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Business response to political risks
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Business response to political risks (conti.)
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More on political risk

• Government credibility - the reliability of the
  institutional framework as perceived by private
  entrepreneurs

• Government corruption the abuse (or misuse) of
  public power for private (personal) benefit.

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Coping with corruption in foreign markets

• Costs of corruption
• Direct Bribes, bureaucratic delays, avoidance,
  direct unproductive behavior, engaged with
  organized crime.
• Indirect reduced investment, reduced and
  distorted public expenditures, macroeconomic
  weakness and instability, weak infrastructure,
  misdirected entrepreneurial talent, socio-econ
  failure.

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Two dimensions of Corruption

• Pervasiveness (or level) the number and
  frequency of transactions that involve illicit
  activities.
• Arbitrariness lack of coordination among corrupt
  agents.