Property Rights, Political Risk, Federalism
1. What is “political risk”?
2. Assessing political risk, property rights
3. Managing political risk
4. Federalism
• Free trade
• Regulatory conflict and preemption
Property Rights, Investment & Political Risk
What is “political risk”?
What sort of political risks can undermine the value
of a firm’s investment?
Nationalization or “creeping expropriation”
Law or Policy change (regulatory; monetary)
Terrorism/war/civil strife
Example: Oil Industry
Early 20th c: rapid growth of international oil industry
1930s-70s: Latin American nationalizations
1960: OPEC formed
How can firms
contemplating
investment in
developing
countries
predict political
risk?
1960s-70s: Middle east nationalizations
Investing in Developing Countries:
Political Risk
“corporate managers came to view risk analysis as
an ‘ivory tower exercise,’ rooted in academic theory
rather than managerial practice.”
HBS Note on Political Risk
Then how do companies (or their investors or
insurers) decide when political risk is too
great? What characteristics do you think are
correlated with political-legal stability, or
negatively correlated with political risk?
Investing in Developing Countries:
Political Risk
What should investors look for?
1. Veto points in the policy process (e.g., divided
government, separated powers, federalism)?
2. System stability, but peaceful political
change?
3. Strong independent bureaucracy & judiciary?
In other words, “credible commitments against
arbitrary policy changes”.
Like what?
What is a “taking” for constitutional purposes?
Where does this idea come from?
5th Amendment: “Nor shall private property be
taken for public use without just compensation.”
What is a “physical taking”? A “regulatory taking”?
Pa. Coal v. Mahon (1922):
• “government could hardly go on” if
compensation were required for every
diminution of property value caused by
regulation
• “if regulation goes too far it will be recognized
as a taking …”
Standard analysis of regulatory takings in U.S.
Penn Central v. City of NY (1978):
• No “set formula”; is “ad hoc, factual inquiry”
• Economic impact on claimant
• Interference with “distinct investment
backed expectations”
• Character of governmental action
• Legitimacy of public purpose
“Lucas-type” categorical takings:
Lucas v. S.C.Coastal Council (1992)
1986: Lucas purchased lots for $975,000 to develop
high-end resort homes
1988: SC statute prohibited construction on lots
Trial court determined that land now “valueless” (but
had nominal value)
How did the court analyze this problem? Did it use the
Penn Central analysis?
If regulation leaves no “economically beneficial use” of
the property, then is a taking requiring
compensation. Was the land literally valueless?
Lucas v. S.C.Coastal Council (1992)
Is there any exception to the majority opinion’s rule?
The “nuisance exception”: what is it?
Kennedy concurrence: “The common law of nuisance
is too narrow a confine … The state should not be
prevented from enacting new regulatory initiatives
in response to changing conditions, and courts
must consider all reasonable expectations whatever
their source.
Blackmun dissent: “Today the Court launches a
missile to kill a mouse.”
Investing in Developing Countries:
Political Risk
How can corporate managers manage political
risk?
•
Insurance
•
Sharing risk with host nation
Federalism and Government Relations
• Trade
• Multiple regulators
• Boundaries of jurisdiction/authority
• Multiple enforcers
Federalism, Governments & Trade
• Shouldn’t governments protect domestic jobs
and local regulatory standards? Aren’t trade
restrictions sensible and good?
• Domestic mfr can sell product for $9/unit
• Foreign mfrs can sell product in U.S. for $8/unit
• Without trade, domestic mfr goes out of business
• U.S. imposes tariff of $1 per unit on imports
This is fair, right? What’s so great about free trade?
Federalism, Governments & Trade
• Domestic mfr can sell product for $9/unit
• Foreign mfrs can sell product in U.S. for $8/unit
• $1 per unit tariff on imports
If average HH buys 10 units per year (1 million units of
U.S. sales annually), elimination of tariff saves each HH
$10/year ($1 million)
Domestic mfr employees lose their jobs.
$1 million
spent on other goods/services
saved  invested in more productive
companies
Do either of these uses of the $1 million create jobs? As
many jobs? “Good” jobs?
Federalism, Governments & Trade
So if free trade makes most consumers happy
and usually creates wealth, by and large, then
why do governments try to restrict it?
•
Identified losers, unidentified winners
•
Concentrated losers, diffuse winners
•
Strategic, national security issues
•
“Way of life” issues
What about protecting public health, safety and
local community standards and traditions?
EU Commission v. Kingdom of Spain
• Why is the European Comm’n suing Spain?
• Isn’t Spain trying to uphold local standards and local
consumer expectations?
• Why can’t each country have its own standards, its
own definitions of these terms?
• Can I sell brown lard and call it “chocolate” in Spain?
Europe’s Single Market
• Article 28: “Quantitative restrictions on imports
and all measures having equivalent effect shall
be prohibited between Member States.”
• Article 29: “Quantitative restrictions on
exports, and all measures having equivalent
effect, shall be prohibited between Member
States.”
Europe’s Single Market
• Article 30: The provisions of Articles 28 and 29 shall not
preclude prohibitions or restrictions on imports, exports or
goods in transit justified on grounds of public morality,
public policy or public security; the protection of health and
life of humans, animals or plants; the protection of national
treasures possessing artistic, historic or archaeological
value; or the protection of industrial and commercial
property. Such prohibitions or restrictions shall not,
however, constitute a means of arbitrary discrimination or
a disguised restriction on trade between Member States.
Europe’s Single Market -- hypotheticals
• France’s largest wine retailer refuses to stock less
expensive Italian wines.
• Portugal bans the importation of high-level nuclear
waste for disposal.
• French dairy farmers blockade highways on the Belgian
border to prevent the importation of Belgian dairy
products, maintaining the blockade long enough for the
Belgian products to spoil.
U.S. Constitution: The Commerce Clause
Art. II grants Congress the power to “regulate
Commerce with foreign Nations, and among the
several States …”
Does that language limit state power? How?
• Dormant Commerce Clause
• Purpose of clause
• Gibbons v. Ogden (1824)
• Two-step test
The “Dormant” Commerce Clause



May states regulate cross-border
commerce at all?
What can’t states regulate?
City of Philadelphia v. New Jersey
If intrastate and intra-EU protectionism is
so clearly prohibited under U.S. and EU
law, why do member states continue to
enact such legislation?
So is the power of the EU and of the
American national government
overriding and absolute? Are their any
limits to their regulatory power?
Federalism and Allocating Legal Authority:
Drawing Boundaries
 The Federal Government exercises only the
authority allocated to it under Article I, Sec. 8 of
the Constitution
 The Lopez case (1994)
 The European Union has the principle of
“subsidiarity”
Federalism and Allocating Legal Authority:
Supremacy

The Supremacy Clause of the U.S. Constitution
“This Constitution, and the Laws of the United States which
shall be made in Pursuance thereof; and all Treaties made,
or which shall be made, under the Authority of the United
States, shall be the supreme Law of the Land . . .”
 Supremacy of EU law