How important is managing political risk in the international business context?

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ABSTRACT

How important is managing political risk in the international business context? Due to the global context in which business is conducted today, political risk along with financial and economical risk is relevant in any decision making of starting a business or investing overseas. However I will focus mainly in political risk by identifying the ideas and major key points that literature has. Next I will analyse and compare the key issues found in the literature according to the idea of managing political risk and finally I will concluded by explaining the diverse forms of managing political risk according to the type of investment or entrepreneurship.

INTRODUCTION

Political Risk is undoubtedly one of the key factors analyse by any company when starting business or investing overseas and jointly with economic and financial risk it creates what is known as country risk. "Country risk analysis rests on the fundamental premise that growing imbalances in economic, social, or political factors increase the risk of a shortfall in the expected return on an investment. Imbalances in a specific risk factor map to one or more risk categories." (Meldrum, 2000.) One of the risk categories is: political risk that "refers to the possibility that political decisions or events in a country will affect the business climate in such a way that investors will lose money or not make as much money as they expected when the investment was made." (Howell. 1992)

Managing political risk and all the factors that can 'affect the business climate' (Howell, 1994); is one the key factors that must face managers when predicting or trying to anticipate political risk in any country. Due to the nature of the investment, political risk analysis considers several factors and conducts the analysis depending on the main objective or goal of the entrepreneurship. In the study literature we will find some similarities and differences that will help us understand the concept of managing political risk.

LITERATURE REVIEW and PERSONAL CRITIQUE

Understanding Political Risk is something that due to the importance of emerging markets in the world and the allure of globalisation has made the analysis and assessment of country risk a critical component of valuation in recent years.

In the 1960's and later in the 1970's the world and its way of governance were changing from colonial systems to democratic and independent establishments; the appearances of innovative ways of governance were new in the international context. The permanent clash of western ideals, the post-war era (WWI and WWII), the constant shadow of a cold war, and the turmoils of new economic forces that started to guide country decisions; show that political risk management to investors was underlying and should be taken seriously. A chain of events such as expropriation, confiscation and nationalisation became major concerns to investing companies in developing countries around the world.

"We have moved from a system where western powers, though often democratic at home, were authoritarian and hierarchical in their systems of rule as applied in the developing world. While some new states adopted this style of governance, others chose to depart from it explicitly. To escape from that rigid and elite-centric system, newly independent countries often fell back on support from other governments in the Communist and Socialist worlds. Relying on the ideology of those systems, these new governments often developed political processes that, in representing entire populations, propagated a system in which property governments for the population held ownership, especially of major industries. In order to get from the colonial to the socialist structure, these governments often expropriated and directly interfered with businesses operating within their borders". (Howell, 1994)

Later between the 1980's and 1990's with the decay of the Soviet Union and communism, the consolidation of the European Union, and the hegemony of western ideals such as privatisation and liberalisation represented by the United States, a new globalise economy started and despite the less involvement of the government in the economic forces, the relation between politics and business has created a high impact that must not be underestimated.

According to the literature, by political issues that can involve risk we can understand: "Political means having to do with: a) the governance system of a

country (political structure); b) the nature of particular governors (authority); c) the response of the population to the government (legitimacy); and d) the nature of the society being governed (culture, social phenomena)." (Howell, 1994). There are different ways of analysing the assessment of the mentioned factors by Howell, other authors, companies, private institutions and government organisations. However analysts have found it is not always easy to measure political risk and standardised it. Different interpretations of the context analysis of a country arise and derived on many conclusions. Duncan Meldrum describes that difficulty within interpretations of political risk, "Unfortunately, no comprehensive country risk theory exists to guide the mapping process. In practice, most country-risk services create risk measures using an eclectic mix of economic or socio-political indicators based on selection criteria arising from their analysts' experiences and judgment. The services usually combine a variety of factors representing actual and potential imbalances into a comprehensive risk assessment that applies to a broad investment category" (Meldrum, 2000). Perhaps one of the most commented articles on this matter, on how to measure and what factors must be included when analysing political risk appeared in The Economist 1986 'Countries in Trouble' in which they considered the following variables as key factors when determining the political situation of a country for investors, they also gave to them a maximum negative numerical value.
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Key Points

Negative Points

)

Bad Neighbouring

3

2)

Authoritarianism

7

3)

Staleness

5

4)

Illegitimacy

9

5)

Generals in Power

6

6)

Strife/Warfare

20

7)

Urbanisation

3

8)

Islamic Fundamentalism

4

9)

Corruption

6

0)

Ethnic Confrontation

4

TOTAL POINTS

67

(The Economist)

The 10 points that The Economist brought to analyse political risk have been related and compared with other studies ...

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