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 Developed market economies („first world”) Socialist economies Countries in transition („second world”) NICs Developing countries Oil exporting countries („third world”) 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 Expropriation “Forced divestment of equity ownership of a foreign direct investor”. 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?

Main Types of Political Risks 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 (MacDonalds, etc.)

Main Types of Political Risks 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 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 for 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 for foreign companies to comply with

Main Types of Political Risks “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

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-of- payment account

THE MEASUREMENT OF POLITICAL RISK Causes of capital flight 1.) Inappropriate economic policies 2.) Expectation of devaluation 3.) 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.