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Big think: political risk


Manging Political Risk 2009

Like any good academic conference the first order of business is to see if we can improve on Wikipedia or Merriam Webster and define terms.

Political Risk

Political risk is a type of risk faced by investors, corporations, and governments. It is a risk that can be understood and managed with proper aforethought and investment…..

Broadly, political risk refers to the complications businesses and governments may face as a result of what are commonly referred to as political decisions—or “any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives.”[1] . Political risk faced by firms can be defined as “the risk of a strategic, financial, or personnel loss for a firm because of such nonmarket factors as macroeconomic and social policies (fiscal, monetary, trade, investment, industrial, income, labour, and developmental), or events related to political instability (terrorism, riots, coups, civil war, and insurrection).”[2] Portfolio investors may face similar financial losses. Moreover, governments may face complications in their ability to execute diplomatic, military or other initiatives as a result of political risk.

A low level of political risk in a given country does not necessarily correspond to a high degree of political freedom. Indeed, some of the more stable states are also the most authoritarian. Long-term assessments of political risk must account for the danger that a politically oppressive environment is only stable as long as top-down control is maintained and citizens prevented from a free exchange of ideas and goods with the outside world.[3]

Definition 1: Actions of governments that affect the returns to investors.

  • In particular expropriation, breach and abrogation of contracts.
  • Tax law, trade restrictions.
  • But generally not labor, environmental laws.
  • Convertibility restrictions yes, but devaluations no.

Definition 2: Failures of governments to act that affect the returns to investors.

  • Failure to enforce laws, provide a conducive business environment in line with firm’s expectation at the outset of the contract.

Definition 3: Political events that insurance and other risk management strategies can manage.

Inductive reasoning is a great way to arrive at a definition for what political risk is. There’s slightly more here than the pornography standard (know it when I see it), but it is a reactive, rather than a proactive basis for definition. If the concept has any legs, I’d like to see that we can forecast what risk managers can and ought to do, rather than just an exhaustive catalog of what they have done.

Definition 4: Include grassroots political actors, public opinion in consumer markets with above.

David Hobbs in particular suggests that oil companies need to recognize that both host and home polities must consent to and participate in the oil company’s operations, not merely the specific government counterparty that inks the deal.

More on this in a few minutes.

UPDATE– Ganson:

There are no political risks, only mistaken expectations.

UPDATE–Howell:

Political risk is the probability that an investor will lose money due to factors in a society government or its international environment. risk will vary according to the theory applied to projection and measurement. Risk also varies at different investor levels, i.e., for all foreign investors, for a particular industry, for a particular firm, or for a specific project.

Seems to me that nobody so far has a good answer to Ganson. Losses are often calculated against future cash flows and not only existing assets; and these expectations are contextual, professional documents.

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About Ben Mazzotta

Ben Mazzotta is a postdoc at the Center for Emerging Market Enterprises (CEME). His study of the Cost of Cash is part of CEME's research into inclusive growth.

Discussion

One thought on “Big think: political risk

  1. this is great. i just ran into this (weeks later). I’m definitely putting some of this up if you don’t mind.

    Posted by Brian Hasbrouck | November 30, 2009, 9:39 pm

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