2. Q3) Examine the main types of political risk to which an international business,
contemplating foreign direct investment, may be exposed. Assess the usefulness of
alternative criteria by which these risks may be evaluated.
Political risk analysis methods and its relation with FDI
For the purpose of this essay political risks and its relation with foreign direct
investment will be identified and critically analysed. Political risks will be analysed based on
international country risk guide and in which political risk divide twelve components and each
component of the political risk consist of some subcomponents. Components of the political
risks are Government Stability, Socioeconomic Conditions, Investment Profile, Internal
Conflict, External Conflict, Corruption, Military in Politics, Religious and Ethnic Tensions,
Law and Order, Democratic Accountability, Bureaucracy Quality. Government stability will
be critically analysed by regarding government unity, legislative strength and popular support
of public. Second component will be evaluated based on socioeconomic conditions of the
country which constitute of unemployment, consumer confidence and poverty. Then,
investment profile of the country will be analysed and evaluated by regarding contract
viability/Expropriation, profits repatriation and payment delays. After, civil war/Coup threat,
terrorism/political violence and civil disorder subcomponents will be exemplified and
evaluated under the main component of internal conflict. External conflict will be analysed
based on war, cross-border conflict and foreign pressures. The corruption degree methods for
any country will be identified and evaluated by regarding FDI. Military in politics will be
analysed and its affects for FDI discussed. Religious and ethnic tension causes and effects for
country reputation by considering foreign investment will be identified and analysed.
Discouraging and encouraging laws for foreign direct investors and stable country view will
be identified and analysed. Democratic accountability will be identified and evaluated by
analysing electoral process and pluralism, civil liberties, the functioning of government,
political participation and political culture to identify the level of full democracies, flawed
democracies, hybrid regimes and authoritarian regimes. Lastly bureaucracy quality step of the
political risk analysis will be analysed based on institutional strength and its effects on foreign
direct investment.
Businesses expect from host countries a stable and security political view and in
relation necessary conditions to establish a company in overseas countries. Political risks
could be interpreted as a non-financial risk but these risks affect the economic climate of
countries from the perspective of investors. Because of that it is important to analyse a host
countries` political situation before investing in there. Political risk focus on changes within
the political factors which are unpredictable and affect the prices of products, goods and
services due to reaction of governments and the other politic groups those may be in host or in
home country (Wafo, 1998). Another definition for political risk suggested by Robock and
Simmonds that there is political risk in foreign investment when there is a problem of running
within business environment which could not be guessed and there are consequence of
political change (1973). Political risk could be analysed under two main subject which are
internal and international risks. In addition, these risks are correlated with each other and the
relationship between them increase progressively due to globalization factor (Morrison,
3. 2009). Also it is necessary to recognise political risk and its sources and analysis by
considering relationship with FDI (Foreign Direct Investment). If businesses want to be
successful in FDI, political risk has to be analysed well because it is founded that host
countries governments` support or/and stable incentives and political ties of firms would
success the business in FDI (Cheng and Chung, 2012). International Country Risk Guide
(ICRG) aim to provide businesses deeply research and analysis of possible risks for
international business operations. In addition, this analysis involve political, economic and
financial risks, also the predominantly component points refer to political risks analysis by
marking the overall points. Political risks consist of 12 components which are Government
Stability, Socioeconomic Conditions, Investment Profile, Internal Conflict, External Conflict,
Corruption, Military in Politics, Religious Tensions, Law and Order, Ethnic Tensions,
Democratic Accountability, Bureaucracy Quality (Busse & Hefeker, 2005).
Political systems may be managed by authoritarian or democratic governments.
Authoritarian government are managed the force of one or more individuals or political party
in where the country forced to run in regarding their ideas and their laws are dictated
(Morrisson, 2009). In this kind of countries business is vulnerable because in a possible leader
changing situation all agreements could be cancelled or suspended. On the other hand,
authoritarian country could be seen less risky than unstable or collapsed democratic one. But,
the fewer risk of the authoritarian country based on pressures while the risk monitoring
system of democratic government are identified and analysed by institutions and political
parties (Morrisson, 2009). Despite authoritarian government system china reformed its
economy as liberal and it provide to be first FDI destination country with 944 projects in
Asia-Pacific region in 2012 according to FDI Report 2013. It is clear that investors look
firstly GDP growth and stability of the country for deciding to enter country (Morrisson,
2009). In democratic systems government institutions have important role from the
perspective of international investors by emphasizing political risks. Three Branches of
government should operate independently which are executives, legislative and judiciary.
Executives mean head of the government which instruct civil departments to implement
national finance, national security and welfare policies (Morrisson, 2009). Legislative is
responsible to enact law. Courts provide justice for individuals and organisations and this
system is called Judiciary. In other words, executives are controlled and limited by legislative
branch that authority are used illegally or excessively at the same time the other branches are
checked concerning their authority limits (Morrisson, 2009). Also this fairly system should be
implemented to provide as well as freedom to civil and political rights, and press. This system
should be in balance and stable to increase reliability of the country for international business
and attract investors. Governments should provide and support political decisions through
civil departments for being member of international institutions such General Agreement on
Tariffs and Trade (GATT), World Trade Organization (WTO) to be seen to foreign investors
more stable and succeed in terms of investing profit should sign liberalization alliances
like Free Trade Agreements (FTAs), Bilateral Investment Treaties (BITs) and Preferential
Trade Agreements (PTAs) (Cheng and Chung, 2012). The other subcomponent of government
stability analysis refers to Popular support (Howell, 2001). Public support is essential and
important for all types of governments to survive whether voluntary or involuntary because
despite theoretical consideration of analysing government stability the main effective factor
the opinion of the public about government.
4. Socioeconomic conditions constitute of risk components which are unemployment,
consumer confidence, and poverty. The analysis of these components evaluate level of
potential forces at work in public that could cause dissatisfaction and guide to government
action. In other words, socioeconomic conditions may cause to destabilise government regime
based on unrest social and economic conditions of country. China unemployment rank is 139
in the world and the rate is 4.1% (tradingeconomics.com, 2013) and China was first FDI
destination at Asia-Pacific in 2012. It indicate that unemployment rate is positively related to
attract foreign investors. The unemployment rate of India was 9.4% in 2008, drop 3.8% in
2012 while the second FDI destination country with 704 projects in Asia-Pacific. It shows that
FDI decrease the unemployment rate in host country. However, FDI cause to unemployment
for home country such Germany and France have been facing unemployment issues based on
outsourcing FDI (Agarwal, 1996). The other component consumer confidence index indicate
the opinion of the consumers about future economy of the country. Moreover, the rating of the
consumer confidence index relevant to customers` purchasing and saving decision and their
spending (Goldblatt, 2013). It means that based on spending decision of consumers foreign
investors may invest in popular industry for successful investment and to earn more profit.
Asia-Pacific`s consumer prefer to spend their money firstly by putting into saving, secondly
holidays/vacations and thirdly new clothes (asia-research.net, 2012).
Investment profile is analysed by considering viability of contracts, possibility of
payment delays and repatriation of profits. Contract enforcement is essential to develop
business relationship. Moreover, successful contract enforcement provide to companies to
achieve more customers and ability for more credibility. It is important for multinational
companies to reach markets and low-cost production in third world countries within
ownership agreements which are wholly-owned subsidiaries and equity joint ventures (EJVs),
or contractual agreements such contractual joint ventures (CJVs). Further, the weak contract
enforcement affect to discourage foreign investors in developing countries (Tao and Wang,
1998). Profit repatriation is important to transfer money to shareholders of foreign companies
without any delays. And during profit repatriation limits on foreign exchange transfer could
be seen which are blocks to capital and profits repatriation, long repatriation delays, limits on
repatriation by net worth, and limits on repatriation by foreign exchange earnings. If foreign
investors cannot get their money out, they recognise investment unsuccessful. If repatriation
is blocked, money has to wait in noninterest bearing account at central bank until block
cancelled and repatriation delays cause currency depreciation in value. The repatriation of
dividends is restricted with allowed percentage of a foreign investment`s net worth. The
remained profit may be reinvested in host country in next year to increase repatriation
allowance. Use of foreign exchange rate was limited by some countries for all purposes such
China was using limitation on foreign investors` foreign exchange usage to the amounts
earned by applying exchange balance requirements (Weigel, 1997).
Civil war, coup threat, terrorism, political violence and civil disorder are regarded to
analysis internal conflict component of political risks according to ICRG (2005). The most
attractive countries for FDI based on internal conflict analysis refers to where there is no
armed or civil group which are resistance to government and the attitude of the government
for tolerating violence against public. Civil war discourage foreign investors, for ex, Turkey
government conflict with Partiya Karkerên Kurdistan (PKK) since more than 30 years which
cause to prevent foreign investment in eastern Anatolia region and south eastern Anatolia
region of turkey where seen the less FDI in comparing with other region of Turkey and the
5. civil war has been continuing (Foreign direct investment in Turkey, 2011). In addition, civil
wars especially refers to socio-political conditions that involve unrest of the ethnic groups and
expectation freedom for mother languages such as in Turkey. Post and pre political violence
history of host country should be well analysed and anticipated to decide investment location
and its amount (Li, 2006).
External conflict component of political risk analysis refers to foreign action of
governments by considering passive external pressure such diplomatic pressures, trade
restrictions, sanctions and regional disagreement, and active external pressures such cross-
border conflicts. Diplomatic pressure is about imposing some request of any county against
another country. Moreover, this may include relationship of them or about a third country like
US expectation from Russia to apply sanctions against Iran. Consequently, this expectation
could cause to damage countries` financial and political relationship. US put trade embargo
on Vietnam based on the war. However, after war they cancelled embargo due to
globalization and need for low-cost labour and market. It indicate that embargo directly
prevent FDI if it is placed by strong world countries. Businesses expect smooth running
transborder activities for import and export also this should be provided by government to
satisfy foreign investors.
Corruption affect governments` and businesses` reputation by accepting power instead
of ability and impact on economic and financial climate which in turn cause to instable
political process. “Transparency International (2007) defines corruption as the misuse of
entrusted power for private gain” (Morrison, 2007. p.169). According to corruption
Perception Index the central European countries remain still corruption despite reforms and
democratic system because their communist past seen as a disadvantage for businesses
(Morrison, 2007). The relationship between companies and politician especially cause
corruption. In addition, companies subsidise to individuals or parties by aiming to influence
policies and gain benefits. Therefore, often scandals of politician are occurred by taking
money or offering government contract to associate for awarding. The other method for
companies for influencing policies is lobbying which is legally when bribes not and the best
method for business-government relation (Morrison, 2007). Also, monopoly and patronage
within politician or suspiciously relations between business and politics demonstrate out of
control economy and encouraged to growth black market (Howell, 2001).
Military in politics refers to ability degree of military in politics which could mean
that government unable to survive effectively, so country could be recognised not convenient
to prosper foreign investment (Behname, 2012). In democracy politics are elected by public
but if military is involved to politics, it would distort the democratic system. In addition,
military may expect to change policies to increase military budget based on internal or
external conflicts that changing may cause other government budget allowances which are
related with economic environment (Howell, 2001). Also, it indicate that this kind of
situations seen unstable and voluntary from the perspective of foreign investors. The authority
of military to overthrow elected government and setup military regime should be prevented
with legislation for stable economic conditions and attractiveness for FDI.
Religious tension result from single religious group who may expect to amend civil
law with religious one and to prevent ability of other religions about politics and social.
Moreover, it is expected by religious group to apply and perform their religious opinion which
6. may cause civil war as a result. This expectations could distort legislative, judiciary and
executive branches as well as in education. India has being managing under democracy but
still its political view is interpreted as unstable and temporary due to ethnic and religious
tensions (Morrison, 2007). On the other hand, Greif pointed out that religion has important
role to create trust and support economic exchanges between companies (2006). Trust is more
where same religion is shared than no same religion is shared. Also, it refers to positive effect
of similar religion on trust (Guiso et al., 2009, p.1112). Ethnic tensions involve the volume of
racial, nationality and language diversity. Lower rating is given to countries where public
unwilling and strict to live together. Nevertheless, high rating is given countries where same
diversity valid while public more tolerant and willing (Howell, 2001). In Turkey there is high
ethnic tensions based on unwilling and intolerant of previous governments and some publics
to grant of rights for Kurdish people. This considerations important because public should be
welcoming for foreign investors as well as their abroad employees. However, if minority
could be faced on discrimination, foreign investors hold off from investing.
Law and order mechanism of the country which is judiciary should be impartial to
perform and fairly, and free decisions. In another words, government should has fairly and
transparent judiciary system by applying laws in order that it will attract foreign investors to
host country by aiming to do clear and successfully business. On the other hand, government
promise to foreign investors such “tax incentives, security measures, dispute resolution,
national treatment, and most-favoured-nation treatment” (law.cornell.edu, n.d.). However,
investors should follow the local remedies before attempting to international disputes such
international centre for settlement of investment disputes, multilateral treaties, bilateral
investment treaties, customary international law because at least these institutions could be
accepted under the decision of local judiciary. It indicate that host countries for foreign
investment should be openness for international institutions` decisions for any situation to
implement.
Democratic accountability measures the responsiveness of government for its public.
Also, measurement result could be determined by the help of democracy index that provide
the level of democracy by analysing electoral process and pluralism, civil liberties, the
functioning of government, political participation and political culture to identify the level of
full democracies, flawed democracies, hybrid regimes and authoritarian regimes (Democracy
Index, 2012). Electrical process and pluralism are evaluated by considering free and fair
election system for national legislature, municipal, and head of government, allowance
criteria for suffrage for public and law support to campaign, political parties financial system
transparency etc. (Democracy Index, 2012). Evaluation criterion for civil liberties constitute
of free media, press, internet and government`s political restrictions on them; freedom quality
for protesting, speech and personal life; how extent judiciary independency; the degree of
tolerance about freedom and perform religion (Democracy Index, 2012). The freely and fairly
determined government policies, legislations and expresses of legislations by government
branches; the degree of influence for government from military and security services; the
significance of other forces in political and economic environment, and public confidence on
functioning of government are evaluated to determine function of government (Democracy
Index, 2012). Political participation component involve the degree of minorities voice in
political environment, women number in parliament, voter participation number for election,
and public interest in political news. The perception and consensus of citizens about
democracy and manipulate effect of democracy on economic system and its ineffective public
7. order perform; leadership character; possibility to prefer military instead government are
analysed to comprise political culture as a whole (Democracy Index, 2012). From most
implemented to less implemented requirements of democratic accountability are Full
democracies, Flawed democracies, Hybrid regimes, and Authoritarian regimes, respectively.
Bureaucracy quality could be recognised by regarding institutional strength which
would keep current policies in acceptable level in possible government change. “Open-
economy macro-policies, in particular, the imposition/removal of capital controls, and
financial repression” may be affected by bureaucracy quality (Bai & Wai, 2000). The ability
of government to gain advantage from financial globalization and the degree of being affected
from financial crisis may be related with its institutional quality (Anghel, 2005). Institutions
find midpoint for trading partners if either try to benefit by breaking contract. Moreover,
institutions concern about property rights, laws, codes of conduct and traditions and they
aimed to decrease instability of exchange and provide effective and efficient relationship to
individuals and organisations (Dahlström& Johnson, 2007). In corrupted bureaucracies
receive permits and licences may be delayed that it result to slow down the investment
processes in a country (Anghel, 2005). Corruption in bureaucracy among government
bureaucrats may cause to increase costs for MNE operations such transaction cost which
result high business expense in host country. In addition, bureaucrats may expect side
payment for export licence also this result proportion of entering for MNE into country and
discourage foreign investors (Dahlström & Johnson, 2007).
As a result, in this essay the political risk analysis and its effect to foreign direct
investors was critically analysed and their relation was identified and exemplified by
regarding Government Stability, Socioeconomic Conditions, Investment Profile, Internal
Conflict, External Conflict, Corruption, Military in Politics, Religious and Ethnic Tensions,
Law and Order, Democratic Accountability, Bureaucracy Quality components. Therefore, it
was recognised that political risk may cause to attract foreign investors or discourage them. In
addition, it is pointed out that the political risk points are given the countries where all
components carried out successful. However, the significant correlation between low risk rate
and FDI volume could not be recognised. It indicate that even the political risk rate lower
countries (such China and India) could be seen better place for FDI from the perspective of
international investors.
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