4. 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)
4
5. Types of Political Risks
Cause
Result
Government
Others
Property Loss
Confiscation
Destruction
Income Loss
Discrimination
Disruption
de la Torre & Neckar (1988), p. 223
5
6. Main Types of Political Risks
a) 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 = > 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?
6
7. Main Types of Political Risks (Continued)
b) 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.)
c) Selective Intervention
Most risks are less dramatic changes in the rules of the
game.
Some areas of government policy affect foreign-owned
7
companies more than most domestic ones
8. 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
8
9. 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.)
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Unequal access to government procurement
10. 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
10
11. Main Types of Political Risks (Continued)
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
What kind of cross-fire problems associated with Iraq winemakers in the Bordeaux region faced?
11
12. Political Risk
Empirical 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”
12
13. 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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14. 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,
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but low-cost, may be helpful for initial screening
16. 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
16
17. The Economist Method
Political Risk Service (PRS) -- 100 points
17 points
society:
urbanization
race
Islamic fundamentalism
corruption
ethnic tension
17
18. 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
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the decision and the decision-maker
19. 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
19
20. 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/
Actions: maximum foreign ownership rules, jointventure requirements, investment
20
21. Government Actions When interests are
in Conflicts (Source: Head) – cont’d
Issue: sourcing of inputs
Actions: tariffs and quota in key imported inputs,
domestic control rules
Issue: contribution to balance of payments
Action: export requirements
21
22. 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 22
and policies.