Political Risk
and Political Risk Assessment
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Political Risk Analysis
 Definitions
 Empirical relationships
 Forecasting techniques
 Using risk analysis
 Managing political risks
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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)
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Types of Political Risks
Cause
Result
Government
Others
Property Loss
Confiscation
Destruction
Income Loss
Discrimination
Disruption
de la Torre & Neckar (1988), p. 223
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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?
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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
companies more than most domestic ones
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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
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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
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
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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?
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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”
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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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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
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low-cost, may be helpful for initial screening
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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
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The Economist Method
Political Risk Service (PRS) -- 100 points
17 points
society:
urbanization
race
Islamic fundamentalism
corruption
ethnic tension
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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
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
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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
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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
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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.