POLITICAL RISK

Globalization is the name of the game, every business and individual has a direct or indirect connection with it. Even in the tightest locked-up economy, there is a level of dependence with the global economy. Brands and products have managed to break the national frontiers and sail the murky waters of international markets. The 21st century has seen a more regulated and somewhat “fair” and competitive playfield. International organizations, such as the International Monetary Fund (IMF) and the World Trade Organization (WTO), have gained strength while working to ensure a firm and stable environment for trade and payments at a global scale. Smaller, regional organizations also play a strong hand and trade regulations can be found at a country and state level. This colossal amount of regulations and regulators aim, for the most part, to establish a fair environment for the benefit of both the consumers and the companies; yet, these regulations pose great, and sometimes hidden, risks. But these regulatory risks represent one of the many institutional differences companies may face when entering a foreign market.
In order to have a better understanding of the potential political risks, one must study, not only the current state of the targeted area, but also the historical context and analyze examples of other companies in similar situations. Sometimes the industry, or even the area are not the same, but the knowledge gained is still valuable and many points can always be applied. The articles analyzed in this summary serve as broad overview of these risks and examples of companies that have struggled with a wide array of political risks and how some of them have used them in their favor, it gives insight on how to hedge this risks, how to manage them and how to foresee them. * “The new rules of globalization”: In this article, the author talks about “guarded globalization”, a very relevant topic. More noticeable, yet not exclusive, in developing nations, guarded globalization refers to a set of laws and regulations put into effect by governments to regulate multinational companies. The reasons for this regulation can vary; governments looking to protect their own economy and their local businesses (for personal or national interest), to ensure social acceptance of the foreign company and avoid social unrests like the protest in “Tia Maria” mine in 2011 against the multinational Newmont Mining Corporation’s attempt to extract resources. National security is another strong factor that can be appreciated in many countries; telecommunications, food, water and other primary resources are guarded in case of a threat. Big players in global economies can also make changes in order to gain certain advantages; given the power they exercise in a global context, a change on their internal regulations can have dramatic effects in the global market. The author also outlines strategies that executives should keep in mind when analyzing the political risks of foreign markets. * Stay home. As obvious and unwanted as this strategy may seem, the reasoning behind it is very firm. Certain industries cannot or should not expand into foreign markets, such as companies in the arms or defense industry. These industries should look to expand into other sectors; going global may harm their image within their homeland. Governments design regulations and strongly monitors these industries to ensure there is no intelligence leak. * Become more “strategic” at home. Companies should analyze the pros and cons of going into other markets against the pros and cons of possibly gaining strength and becoming valuable in their own country. * Use the state to fight other states. This refers, mainly, to big companies with connections in the governments; they can make use of their own governments in order to help them enter or keep their presence in foreign states. * Strike alliances. Joining ventures can help navigate unknown waters with local players, potentially proving convenient since locals can have connections in the government, helping to speed up certain processes; in contrast, this strategy can also provide a huge downside to a country’s economy, since the creation of alliances can provide incalculable uncertainty due to a sudden change of government in an instable population. * Add value to the state. Certain companies can take advantage of needs from the governments. Melia Hotels International, a Spanish hotel chain that holds more international hotels in Cuba (30) than in any other country, made a deal with the Cuban government that allowed them to build hotels and administer them. The Cuban government, in exchange, would gain a big influx in tourism, develop infrastructure, generate a big number of jobs and stimulate local businesses (all of which were owned by the government back then). This deal had sparks of a joint venture since the government would own a majority of the hotels; yet, Melia Hotels managed to keep the administrative control due to past failures from the government’s attempts to manage hotels. In the current context of Cuba, Melia Hotels may hold an upper hand in the imminent opening of the country by having a strong presence in Cuba and being known and looked up to by the population and local tourist agencies. * Capitalize on state capitalism. Closely linked to the previous point. Stimulating local businesses and hiring locals is a strong strategy since you become a valuable member of the society. Locals will protect a company that empowers them and raises their life standards. Equally, the government will protect a company that generates jobs and fuels their economy. * Become too diversified to fail. Divide et impera “Divide and conquer”. By diversifying you sustain your business by several products; if a regulation takes effect that harms one of them, the others can help support the business and the effect would not be fatal. * Build it so you can stay. Infrastructure is the basic structures and facilities needed for the functional operation of any country. If a company offers a country to help build their infrastructure, when there’s no local possibility to do so, they set themselves as a very valuable member. General Electric is a great example, helping to build Mexico’s Laguna Verde nuclear power plant assured them their presence and technical support for many years. * Anticipating risks. Ultimately, one cannot foresee every variable, every possible outcome or situation; executives and managers dealing with political risk must always be aware of the happenings and changes in foreign fields and be ready for a sudden change in strategy. Adaptation is the key. * “Amway’s President on Reinventing the Business to succeed in China”: This article holds a strong message; in the face of adversity, show good will. It presents the experience Amway, a direct sales company, had in China. China is seen as a golden dream for many companies, its big population and growing economy attracts many industries. When China placed a ban on direct sales due to scammers taking advantage of the method, Amway was put on a tight spot. By outlawing direct sales, the government was hitting Amway hard; direct sales is the everything for companies like Amway, Avon, Mary Kay, Mia Bella Soy Candles and many more. But this challenge proved to be a great opportunity. Amway, instead of complaining to the Chinese government, approached the government and offered its help to create better legislations that would protect the customers and strengthen the direct sales model. This strategy helped them build trust with the government. Amway had to play along and open retail stores, something they had never done before, set up the entire system, from distribution channels to brand advertisement and even manufacture their products in China. If Amway wanted to stay in the market, they had to play by the rules, and the rules involved them applying a model that was the complete opposite of their original one. They did so but remained focused. For four years Amway struggled with this new regulations and worked with the government, showing that they wanted to find a mutually beneficial solution. Once China started looking into entering the WTO, people in the direct sales industry believed that the government would relax on the legislation of the model, it took four more years before these beliefs became reality. Amway resisted for eight years, but the Chinese market proved to be worth it, a market that now represents them more than $4 billion in annual sales. On top of that, Amway developed successful strategies that they have now applied to other markets. Amway’s story shows how a seemingly fatal change can be the opportunity for growth and strengthening of one’s brand by adapting to the rules without losing sight of our founding principles as a company. * “The Hidden Risks in Emerging Markets”: There was a time that multinational companies feared to be overtaken by a host government, to have their assets seized, and their investment lost. The 1970s was the era where companies dealt with the most turmoil in foreign territories and where the seizure of multinational corporations was a common situation. The increase of regulations combined with the need for emerging economies to rely on developed countries for growth, has reduced the risk of seizing company assets to nearly zero in the 1980s. Today, governments have stayed away from the unpopular and maybe unethical approach of taking what rightfully is not theirs, and have found more efficient ways to control foreign investment power in their countries.
Multinational companies now face a new set of oppression: foreign government, rather than the direct seizure of assets, impose new regulatory instruments as a way to control multinational companies from becoming indispensable to their countries. Governments have found more valuable ways to intervene on business prosperity and have created new discriminatory changes that can purposely benefit them under hidden terms found in binding contracts, profit regulations, operational, and financial laws. Furthermore, “inventive politicians” have found ways to circumvent their own country laws and control foreign businesses by embodying a more concerning concept regarded as “policy risk.” Traditional concepts, such as insurance policies and contractual agreements, firms use to mitigate market risk now have a limited value. The new political environment requires companies to be more proactive and urges them to assess a country’s government in a profound and innovative approach. The authors state that hedging policy risk is hard, but by using modern concepts such as communication, social networking, and game theory, companies can better manage policy risk themselves and arrive at a better decision. The New Risk-Management Playbook introduced by the authors consists on “Investing in Goodwill” where companies spend time improving the efficiency of underdeveloped countries. “Framing the Debate” where companies spend more time advertising the potential growth benefits they can bring to the foreign country, and “Finding Political Pressure Points” where companies unite with the politicians of the foreign country to help them use local resources to grow their business. Additionally, it urges companies into “Tapping the Right Flow of Data” to rely on data derived from locals rather than country risk ratings. And lastly but not least “Using Game Theory Strategies” where companies use managers to come together and brainstorm on “influence maps” to depict potential influencers to the country and how a situation can help or hurt the company.
The risk of investing abroad might not justify profits for most companies; but for those willing to encounter and address policy risk, these concepts can help them build a customized in-house playbook to help mitigate risk in a more manageable way. The authors state that combining data mining and modeling technologies with traditional approaches can help companies master the intricacies of political and policy risks to create a powerful source of competitive advantage that last for years. * “Building Political Risk Management Skills in the Middle East”: This article focuses on the new emerging market, MENA (Middle East and North Africa). Unfortunately MENA, in recent times, has become the hotbed of political uncertainty critically affecting their political risk level. In spite of this, some companies have seen opportunities and strengths in the economies in this region. Political issues and terrorism has affected foreign investments, which fell over 50% from $114 billion in 2008 to $38 billion in 2013, with tourism also being hit dramatically. MENA, despite this, offers a wide variety of very appealing opportunities, such as projected population growth to 81% in the next 40 years, improving regulatory environment, with countries such as Saudi Arabia entering WTO, and continuing energy wealth. Countries like Kuwait and Iraq have resources that, at current production rates, can last them for many decades. Additionally, the strategic location of MENA allows this region to benefit from trade between Asia, Africa and Latin America. But navigating this political hotbed can be risky. The author outlines some pointers on how multinational companies can continue to do business in MENA while properly and effectively managing the political risks inherent to this area; these are the following: * Accept and manage political risk, with the realization that these risks are not going to go away soon. Instead of relying on general rankings, some companies have developed their own scoring systems as means to better understand the risk from their particular perspective and level of importance. * Avoid political partnerships with local companies that may have political sway over certain politicians. However tempting, such connections have a tendency to fail, when the government changes or the partner falls out of favor. Better partnerships are where local resources bring specialized knowledge or assets and the foreign company uses its own resources through consultants or its consulate. * Maintain flexible ownership structure; as the Middle East territories expand and evolve their regulations regarding ownership of businesses in their countries, companies present with local partners may want to change their ownerships. This move may be detrimental since the local partner may resent this. In order to minimize recoil and potential damage due to this changes, terms must be clearly spelled out and each party’s expectations should be captured in paper prior to accepting a joint venture. * Hiring local staff can be very beneficial as they bring local expertise and potential business contacts. Utilizing bilingual university graduates can also prove to be a valuable strategy. * Stay the course in the market that you have entered. Although business may look like it is not progressing, it will take years to see returns. Hence businesses must learn to be patient and to adapt to sudden changes. Once a decision has been made to exit a market, reentry might be difficult. If a company does decide to exit, a light physical/legal presence should be left behind so that if it ever decides to restart operations, they can have a good foundation.
“Managing Risk in an Unstable World”: Economic risk analysis focusses on market and data, often ignoring the political risks. Political risks are, redundantly, politically motivated events that can destabilize or stabilize a country, such as the instauration of new laws, military coups, etc. Political risk analysis is sophisticated, multifaceted and abstract in nature. Economic risk analysis is, broadly, a measure of whether a country can pay its debt and political risk is a measure of whether a country will pay its debt. All companies would benefit from accurate and early analysis of the political risks for some reasons; the authors pointed them out as following: * International markets are interconnected more than before. A ripple in one market can send waves into other markets * Some countries in growing numbers, even stable economies such as the U.S., are volatile in terms of global security, presenting a unique set of political risks to multinational companies looking to establish long term investments. * Potential of offshoring, where corporations might find it appealing to shift operations to other countries in light of better opportunities. This may also present several risks. * Political instability in energy producing countries such as Middle East nations, Nigeria etc.
As globalization expands, most companies will be affected by one or two of the above factors. China is an ever present example, in this case due to its widening income inequality, social instability; that might lead to a rebellion which the government seeks to repress by reducing freedom of speech. Political analysts watch a leader’s ability to enact policies, as well as create less ripples himself. Shocks are also a component of political risks, refugee crisis, natural disasters, environmental crises, etc.; yet, these are not absolutes, for example, Saudi Arabia. Some economies are stable because they have an open communication and freedom of expression, such as United States; while some are relatively stable because of the closed loop ruling, such as North Korea. The transition from a closed but stable economy to an open economy can significantly increase political risk; as it happened during the Arab Spring. China is a hybrid system that sparks interest due its police government and, yet, free economic policies.
Corporations have the option to hire political analysts who may be embedded in those countries to give an accurate and real time analysis. Bias is always a hovering factor decision makers should also watch out when analyzing reports. A big part of political risk data is the sprout of demographic and economic points such as, number of assassinations, number of kids going to school, police salaries versus criminal behavior, access to health care, unemployment rates, etc. Comparing these metrics over time, as well as to neighboring nations, can give analysts an idea of whether that nation is stable or not. Different companies use different measures to report stability data. How companies apply such analyses depends on their industry, their strategies and tolerance profile. Authors express, throughout the article how political and economic risk analyses are very important in a world where technology has no borders. * “Hedging Political Risk in China”: In this article the authors advise the readers on basic, yet important, strategies to keep in mind when venturing foreign markets. China, a tempting and rather uncertain market is used to illustrate these strategies. Investors can be vulnerable to spikes in prices, social and/or demographic shock, regional political unrest, and protectionist sentiments. The rapid growth of this nation, the dislocation of tens of millions of people, public anger over land redistribution, and major industrial accidents are examples of the social instability present in this region; added to that is the lack of legal protections like copyrights, as well as reputational risk in their home countries. The strategies suggested involve mindful entrance into these markets from a legislative perspective and closely look into the effects that entering such market can have on your business from a local perspective. The last strategy is, on a nutshell, to be always prepared for the constantly present risks inherent to these markets in the form of: * Creating emergency response plans to circumvent possible crises that could disrupt normal operations. * Develop approaches to recruit and train natives for managerial positions. * Understand, to the best of your capacities and abilities the competition. * Safeguard intellectual property, even beyond legal resources. Investors should be mindful of the many ways in which intellectual property can be lost, including, but not limited to, their own providers and suppliers. * Diversify risk; in this example, China is a big country with many regions and provinces, offering different possibilities. * Develop strategies for exercising corporate social responsibility in order to gain local, and even external, value. * Seek outside perspective to supplement your knowledge, such as independent experts. * Have an exit strategy. It is good to have a plan in place for the worst case scenario, even if you may never need to use it. * “Political Risk in the 21st century”: The author utilizes global significant industries –the aluminum and the bauxite industry- to analyze the complexity of overall levels of political risk and the multidimensional phenomenon it has created. The article exposes the main sources of political risk, for this case, and how different manifestations can arise to cause direct harm to multinational companies. These risks are summarized into: * Preferences and attitudes: government protection over the country’s own interests and how they may change, resulting in contract or legislation changes. * Political institutions: these represent one of the highest levels of political risk because they also are at the mercy of public opinion and social unrest. These institutions, especially in developing countries, struggle to find balance between public and private interest. * The obsolescing bargain mechanism: refers to the ever present possibility of the host country increasing regulatory measures in aim to increase leverage and shift control. * Social-political instability and grievances: refers to civil unrest in the form of religious, ethnic, cultural tensions, as well as other grievances, such as, environmental grievances.
The article moves on, explaining the effects that the above mentioned sources can have by means of certain actors; e.g. governments, foreign organizations, rebel/terrorist organizations, NGOs (Non-Governmental Organizations), and others. The effects generated from the presumed sources are the actual acts of intervention that can cause distress and, in turn, is what makes the analysis of political risk complex. These effects tend to fall within the following categories: * Government intervention in, or regulation of business: such as breach of contract, ban on production, contract reviews, expropriation. * Acts relating to war, terrorism, or social unrest: kidnapping of staff members, production stoppages, terrorist attacks, invasion of property, etc. * Other acts committed by non-governmental actors: can relate to activism from unions, external organizations such as environmental protection agencies, human rights foundations, etc., fraudulent acts from domestic businesses; amongst others.
Overall, the political risk encountered in different industries of the global market is a very intricate task for multinationals to address on its entirety. But understanding the convoluted interaction between causes and effects and the fact that the actor role can be led by a wide array of players, can help a multinational company analyze how risk is generated and target it more efficiently.
All these articles, although different in terms of geography and relative topic, overlap in the importance of understanding the value of knowledge regarding the global market and specific markets when addressing political risk. It is imperative for companies entering other markets to not lose sight of the potential risks to be faced and to look for the most efficient way of facing them. Political risk is presented by certain conditions or events that have happened, are happening and/or could happen that will significantly affect the investment. Political risks are not bi-dimensional factors. All markets are inter-connected to a certain degree, hence, some political risks are hard to foresee. The global market is a massive system that is very sensitive to numerous conditions, in which a minor change can result in enormous alterations in a later stage; from a first glance, the global market gives the impression of a chaotic system given the massive amount of variables. Political risk is a fundamental piece of global management and these articles help cast some light into the dimension and reach of this risk. These articles also share the experience of many companies and how they have overcome unexpected obstacles. Sadly, these success stories are not the norm, many companies fail to conquer the ever changing nature of political risks; that is where the real value of these articles come to work, in the form of knowledge, in the form of understanding the volatility and magnitude of political risks. These articles show ways in which political risks can be analyzed, evaluated, conquered and even turned into a strength. After all, Scientia potential est “Knowledge is power”.