1. 1 Political Risk and Political Risk Assessment

2. 2 Political Risk Analysis  Definitions  Empirical relationships  Forecasting techniques  Using risk analysis  Managing political risks

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4. 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)

5. 5 Types of Political Risks Cause Cause ResultGovernmentOthers Property Loss ConfiscationDestruction Income Loss DiscriminationDisruption de la Torre & Neckar (1988), p. 223

6. 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?

7. 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 -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 companies more than most domestic ones

8. 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

9. 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.)  Unequal access to government procurement

10. 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

11. 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 non- proliferation) - the misuse of social issues as means of protectionism What kind of cross-fire problems associated with Iraq wine- makers in the Bordeaux region faced?

12. 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”) (“hands-on”) - medium-technology - need for scapegoats - “obsolescing bargains”

13. 13 Empirical Relationship (Continued)  Negative correlations (less risk) - integrated subsidiaries that depend on rest of network network - low/high tech - lobbying  Makhija (1993): information indicating convergence of MNC actions and government convergence of MNC actions and government economic objectives economic objectives

14. 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, but low-cost, may be helpful for initial screening

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16. 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 authoritarianismstalenessillegitimacy generals in power war/armed insurrection

17. 17 The Economist Method Political Risk Service (PRS) -- 100 points 17 points society: urbanizationrace Islamic fundamentalism corruption ethnic tension

18. 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 the decision and the decision-maker

19. 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

20. 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, joint- venture requirements, investment

21. 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

22. 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 and policies.