TAMÁS NOVÁK Global Business Environment Political risks
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 - micro vs. macro
The World economy according to development level Before 1989 Today Developed market economies („first world”) Developed market economies Socialist economies („second world”) Countries in transition Developing countries („third world”) NICs Oil exporting countries 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-70 s; 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 (Mac. Donalds, 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 • l Restrictions on Cross-Border Transfer of Resources § § Tariffs, exporting FX controls limit repatriation Capital controls Labour regulation
Main Types of Political Risks – Taxation Concerns § § § – Restrictions on transfer pricing Withholding taxes Availability of tax holidays and other incentives Investment Restrictions § § § Sectoral restrictions Requirements for JVs, local ownership Transparency of licensing procedures Requirements for disclosure of technology Requirements forced divestiture
Main Types of Political Risks 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 §
Main Types of Political Risks – Non-Neutrality of the Legal Environment Judges or other arbiters insulated from political pressure § International and regional conventions § International conventions on compensation § Guarantees of national treatment § Regulations with Differential Effects on Foreigners Some may be much harder 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 nonproliferation) 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 changes b. Level of violence c. Number of armed insurrections d. 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-ofpayment account
THE MEASUREMENT OF POLITICAL RISK Causes of capital flight 1. ) 2. ) 3. ) Inappropriate economic policies Expectation of devaluation High political risk
Managing Political Risk (counter moves) 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.
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