“Risk arising from political action directed deliberately or inadvertently at individuals, companies, other organizations or governments.”
Then an attempt to classify risks into three categories, direct risks (those aimed at the target person or organization), indirect risks (those with more general aims but which unfortunately can have very serious effects on persons or organizations that they are not particularly aimed at) and a mixed category called direct/indirect.
Political risk is a difficult and complex area in which to apply the basically simple risk management concept of recognises the risk, measure it, find means of controlling or eliminating it and arrange to finance the residual risk.
Before considering the special factors in political risk, it may be helpful to remind one of the general factors that make risk management difficult; such as:
(1) the inter-relationship of many factors making it difficult to determine which are of prime importance and to measure the relative importance of each factor;
(2) the role of people in risk, or more particularly human behaviour. That behaviour can increase or reduce the risk and may be intentional or unintentional;
(3) the “outbreak” character of risks that involve people. Human behaviour is imitative and imitation together with hostile response is increased by today’s instant knowledge;
(4) the emotional character of much human involvement which makes difficult any logical or rational analysis.
All of these difficulties are present in political risk and the potential political risk manager is often faced by a confusing gathering of data that usually does not correlate too well. Thus one who is familiar to such exposures should bear in mind: What and Why and When and How and Where and Who.”
If political risk analysis and control can keep within the framework offered by those six questions it will probably stay integrated and practical.
An attempted classification is shown but like all subjective classifications it has its dangers. For example hijacking is directly located at a particular target such as a particular aircraft and/or its passengers but their involvement as a target is often accidental. The aircraft or airline may happen to be selected either for convenience or to make a particular political point but (except where it is aimed at that airline to force it to take or avoid a particular activity) the attack is often aimed at a government or political organization. The passengers are rarely the direct target; they just happen to have selected and caught the wrong flight. By contrast political breach of contract is usually deliberately aimed. The same doubt will be seen in most of the factors.
Political Risks can be classified as follows:
4) physical assault/abuse
5) libel/slander – rumors
6) strike political or semi-political
7) breach of contract
8) malicious damage
3) unreasonable/unexpected refusal of license/permission
extra taxes/duties/currency control
4) change in law
7) civil commotion
Foreign exchange and inflation risk could also logically be regarded as political risk.
Having listed the types of risks we can consider the leading role and their motives. By selecting out the character we can think through how our company might be vulnerable (either directly or by attack on a group on whom we depend) and the possible sources of attack.
A classification of leading role and motives is shown below. The word “passive” may not express the preferred meaning correctly, it refers to people whose action is a response to their aggravation with the company which has caused them nuisance or loss or they see as harming their environment. In the second category “active” the political activity is separate from the actions of the target company; the company just happens to be in the way.
Political Risk Motives
e) political parties/groups
f) government including “de facto”
g) political extremists/terrorists
h) competitors—local or foreign
i) aggrieved staff/customers/suppliers/neighbours
b) annoyance/irritation/frustration – at company actions and results (personal harm—perceived social harm)
a) political aims
b) change conditions/change society
c) control industry/foreign activity etc.
d) secure popular support
e) raise income
f) penalise certain activities
g) political extremist aims
j) hostility to perceived
This chart begins to show how political risk can be managed. To a lesser or greater extent it is possible to understand the risks and how they arise and take steps to reposition or protect the company.
After identifying the players, the various political risk “games”, and possible motives, it is possible to look at some of the factors in the “game” which influence both the setting and the outcome. Factors in political risk are summarized in a chart. This chart is very important and merits detailed study as it provides a basis for analyzing individual company situations and beginning to develop protective risk management action.
Factors in Political Risk
(1) Awareness of companies
c) financial situation
Companies can increase/decrease risk.
(2) (Perceived/real) actions of companies
a) use of (scarce) resources
b) comment/criticism of local people, organisations, situations
c) environmental results—housing, pay, pollution, noise, traffic, wealth
d) effect on (local) competitors
(3) Political situation
Includes related financial/physical factors such as national debt, taxation, resource depletion.
(4) Agents of political risk (change)
d) support (internal/external)
Note: agents act as “trigger” in already disturbed situations economic/social/political change is inevitable only variables are timing, manner, character, extent remember “epidemic” effect of political risk skills of participants as transitory factor as action/experience teach rapidly.
(5) Difference in
a) social acceptance and attitudes
b) culture (past/present/future)
c) understanding and broad acceptance of law including custom and tradition
d) personal and corporate objectives/ambitions—growth, use of resources, freedom, control
Political risk is founded on these differences and changes continuously through action/reaction and interaction.
a) raw materials/supplies/utilities – power, water etc.
b) skilled labor
e) joint ventures
f) sales/profit/cash dependencies
In the chart are shown the factors that interrelate to produce a political risk. The multinational company decides to enter (or is already located in) a particular country its activities and operations impact on local society and the local economy but there are varying degrees of awareness or concern. Companies can directly influence the risk by the pattern of their operations, management style and local relationships.
The host country has (quite separately) social, economic and political situations which may be stable or unstable. The pace and pattern of change can alter very quickly and the overseas company in this country will be influenced by these changes. The inter-relationship between company and host economy/country is quite complex and the company may be a victim of circumstance.
It is important to notice and understand the role of agents of political change, who act as a “trigger” in a situation which provides them with opportunity. Without a potentially favourable background their actions may be completely ineffective but a skilled “agent of change” can transform a crisis into a revolution or major upset into a crisis. Special notice therefore needs to be taken of the presence of skilled “agents”.
Perhaps the biggest problem in political risk is lack of understanding of differences in culture and custom, including the resulting social, legal and political infrastructure. Behind the apparently most illogical and extreme political or other position there are the cultural, historical and other factors that create such strongly held feelings to understand and cope with them requires relaxed and relatively impersonal analysis. Personal ambition is frequently but not invariably interlinked with strong political or other action.
For the company in a difficult political situation the most acute factor in their exposure is their individual vulnerability and the chart lists some of the factors that increase this exposure.
The options for a company begin with consideration of their presence in a particular country, especially before entry.
- What are the advantages of location?
- What are the perceived risks and what is the expected return?
- How could the risks or return change?
What factors does the return depend on?
Often but not always a potentially high return is linked with a high political risk but having made a decision to enter a country there are various options that will affect the risk. High investment from overseas compared with local borrowing and a degree of local participation will increase the risk.
There is a careful balance in the degree of local management that can be used. Labor and other dependencies need to be reviewed realistically.
- Does the market depend on a particular tax or legislative situation?
Could the supply of labor be dramatically altered by developments already being considered?
- What is the government’s attitude?
- How firm is that attitude?
- Would a change of government change this position?
During the past 20 years a wide range of political risk assessment services have become available with varying intelligence bases.
Some depend on retired politicians and diplomats; others rely heavily on macro-economic analysis. As with other specialist advice it is very dangerous to rely on it with total confidence and without questioning.
If the forecasts of political risk assessors are subjected to critical scrutiny and review it becomes possible to make a realistic assessment of their capability. Good advisers become better under some client pressure; the weak ones get found out.
Where it is necessary to undertake political risk review it is best to use multiple sources and cross-review them. Some journals have a special relevance. Many of the more important serious newspapers review many countries in detail during the year and it may be worth keeping selected cuttings.
Successful operation in most countries requires an acceptable style. Any attempt to put pressure on, especially time pressure, is likely to cause adverse reaction. Many project problems arise because insufficient time and trouble is taken to deal with obtaining the necessary licenses and permission. Perhaps one of the key factors is the choice of expatriate management. Most multinational groups have at least a few managers who genuinely like their country of operation and have the ability to work exceptionally well developing local management and gaining local support. This is more likely to be linked with postings of several years or longer duration rather than the rapid relocation of managers from country to country.