Political and economic environments

Proactive globally oriented managers maintain an up-to-date profile of the political and economic environment of the countries in which they maintain operations (or have plans for future investment).

An important aspect of the political environment is the phenomenon of ethnicity – a driving force behind political instability around the world. In fact, many uprisings and conflicts that are thought to be political in nature are actually expressions of differences among ethnic groupings. Often, religious disputes lie at the heart of those differences. Uprisings based on religion operate either in conjunction with ethnic differences (as between Tamils and Singhalese in Sri Lanka) or as separate from them (as between Sunnis and Shias in Iraq).

Many terrorist activities are based on religious differences. Managers therefore need to understand something of the ethnic and religious composition of their host countries in order to anticipate problems of general instability', as well as those of an operational nature, such as effects on the workforce, on production and access to raw materials, and on the market.

Political risk

Researchers risk becoming political prisoners in Indonesia’ said the headline to an article in The Age in 2003. The five-month jail sentence in that year in Indonesia for Australian- based academic researcher Lesley McCulloch sent a clear signal that the Indonesian military’s tolerance for what it regards as foreign interference in domestic issues was at an end. Both McCulloch and McCulloch’s associate, Joy Lee Sadler, an American nurse, were charged with violating a tourist visa.

The official Indonesian embassy website from Canberra makes no mention of what is or is not allowed under tourist visas. Indeed, the notes for tourist destinations and facilities in Aceh are missing. It seems that advice on travel in Indonesia may be divided between what is and what is not politically sensitive: but this suggests the possibility of unwelcome visitors becoming political prisoners – and this seems to be the clear message from Indonesia to foreigners.

Thus managers of international businesses need to investigate the political risks to which they expose their representatives in certain countries – not to mention the implications of those risks for the economic success of the firm.

Political risks are any governmental action or politically motivated event that could adversely affect the long-run profitability or value of a firm. Political systems, arising from the local culture, shape economic systems. Policies by host governments may favor national interests, not market forces. Therefore they may include discriminatory application of laws and government interference in firms' managements. For example, the refusal by the US and Australian governments to sign the Kyoto Protocol was part of a policy lo protect national industrial interests – as was rejection of the euro by the UK and Denmark.

Global corporate leaders argue that their firms are at risk from any political interference anywhere that might lower their profits or lessen their value. But the argument works both ways: commercially driven foreign operations can damage seriously the infrastructure of developing countries. Thus what is seen as political risk for multinationals may be self- defense to host governments or to international watchdog agencies such as Corpwatch.

Sociopolitical risks include not only governmental risks (for instance, having to adapt to the local regulatory environment) but also acts of nationalization and protectionism. Nationalization refers to the forced sale of an MNC's assets to local buyers, with some compensation lo the firm, perhaps leaving a minority ownership with the MNC.

Expropriation, rare in the last decade, occurs when a government seizes and provides inadequate compensation for the foreign-owned assets of an MNC. When no compensation is provided, it is confiscation.

Changes to company investments pose another risk, as does public opinion – for example, expressions of strong nationalism. Managers may find their activities to be at risk from labor union movements, military threats and terrorism. Corruption is another form of risk, as is health. Technological risks include lack of appropriate technology support.

In unstable areas, multinational corporations weigh the risks of nationalization or expropriation. In countries that have a proven history of stability and consistency, the political risk to a multinational corporation is relatively low, while the risk of expropriation is highest in countries that experience continuous political upheaval, violence and change.

An event that affects all foreign firms doing business in a country or region is called a macropolitical risk. In the Middle East, the US invasion of Iraq in 2003 abruptly halted all international business with and within Iraq.

Micropolitical risks affect one industry or company or only a few companies. They have become more common than macropolitical risks. Typically, micropolitical problems with their investments present more difficulty for foreign firms than do major events that are insurable by political risk insurers.

The following list outlines seven typical political risk events common today (and possibly in the future):

1. Expropriation of corporate assets without prompt and adequate compensation

2. Forced sale of equity to host-country nationals, usually at or below depreciated book value

3. Discriminatory treatment of foreign firms in the application of regulations or laws

4. Barriers to repatriation of funds (profits or equity)

5. Loss of technology or other intellectual property (such as patents, trademarks or trade names)

6. Interference in managerial decision making

7. Dishonesty by government officials, including cancelling or altering contractual agreements, extortion demands, and so forth.

Political risk assessment

International companies conduct some form of political risk assessment to manage exposure to risk and to minimize financial losses. Typically, local managers in each country assess potentially destabilizing issues and evaluate their future impact on their company, making suggestions for dealing with possible problems.

Corporate advisers then establish guidelines for each local manager to follow in handling these problems. Classic Blue is an example of an Australian-based international business recovery company. Such firms offer contingency planning assessment to help business people understand and implement particular strategies – for instance, if a pandemic health outbreak should occur.

No matter how sophisticated the methods of political risk assessment become, nothing can replace timely information from people on the front line. In other words, sophisticated techniques and consultations are useful as an addition to, but not as a substitute for, line managers in foreign subsidiaries, many of whom are host-country nationals.

These managers represent the most important resource for current information on the political environment, and how it might affect their firm, because they are uniquely situated at the meeting point of the firm and the host country. Prudent executives, however, weigh the subjectivity of these managers’ assessments and also realize that similar events will have different effects from one country to another. Therefore, an additional technique, the assessment of political risk through the use of computer modeling, is now becoming fairly common.

Managing political risk

After assessing the potential political risk of investing or maintaining current operations in a country, managers face perplexing decisions on how to manage that risk.

On one level, they can decide to suspend their firm's dealings with a certain country at a given point – either by the avoidance of investment or by the withdrawal of current investment (by selling or abandoning plants and assets). On another level, if they decide that the risk is relatively low in a particular country or that a high-risk environment is worth the potential returns, they may choose to start (or maintain) operations there and to accommodate that risk through adaptation to the political regulatory' environment. That adaptation can take many forms, each designed to respond to the concerns of a particular local area:

· Equity sharing: includes the initiation of joint ventures with nationals (individuals or those in firms, labor unions or government) to reduce political risks

· Participative management: requires that the firm actively involve nationals, including those in labor organizations or government, in the management of the subsidiary Localization of the operation: includes modification of the subsidiary’s name, management style and so forth, to suit local tastes. Localization seeks to transform the subsidiary from a foreign firm to a national firm

· Development assistance: includes the firm’s active involvement in infrastructure development (foreign-exchange generation, local sourcing of materials or parts, management training, technology transfer, securing external debt, and so forth).

· In addition to avoidance and adaptation, two other means of risk reduction are dependency and hedging. Methods of keeping the subsidiary and the host nation dependent on the parent corporation include:

· Input control: means that the firm maintains control over key inputs, such as raw materials, components, technology and know-how

· Market control: requires that the firm keep control of the means of distribution (for instance, by only manufacturing components for the parent firm or legally blocking sales outside the host country)

· Position control: involves keeping certain key subsidiary management positions in the hands of expatriate or home-office managers

· Staged contribution strategies: mean that the firm plans to increase, in each successive year, the subsidiary’s contributions to the host nation (in the form of lax revenues, jobs, infrastructure development, hard-currency generation, and so forth).

Finally, even if the company cannot diminish or change political risks, it can minimize potential losses by hedging. For example, political risk insurance is offered by most industrialized countries. The Australian government Export Finance and Insurance Corporation (EFIC) notes that investors and contractors are usually prepared to carry the commercial risk of participating in offshore investments or projects. However, because of the unique nature of political risks, and their potential to expose an investment or project to significant losses, many investors, contractors and lenders take out special insurance to cover them against specified political events. But political risk insurance covers only the loss of a firm’s assets, not the loss of revenue resulting from expropriation. Local debt financing (money borrowed in the host country) can help firms hedge against being forced out of operation without adequate compensation: the firm withholds debt repayment in lieu of sufficient compensation for its business losses.

Multinational corporations also manage political risk through their global strategic choices. Many large companies diversify their operations both by investing in many countries and by operating through joint ventures with a local firm or government, or through local licensees. By involving local people, companies and agencies, firms minimize the risk of negative outcomes due to political events.