International Political Risks
Many Sources, Many Types
In Transition and Less Industrialized Economies Business Challenges Differ
Developed Economies Transition and Less Industrialized Economies
Internal Management Problems
Problems/Pressures from the Environment
Sources of Political Risk for Foreign Investors
National
Governments in host and home Governmental countries
International
International Organizations (e.g. IMF)
Societal
Local civil society in host and home countries (e.g. labor union)
Transnational civil society and social movements (e.g. Greenpeace Int’l)
The Traditional Concern -- Nationalization
Nationalization is the appropriation of private assets by a national government According to the United Nations – nationalization with prompt and adequate compensation is the sovereign right of every nation, but it is still a problem for companies. Most prominent in the 1960s and 1970s in an effort to exert national sovereignty
– Extractive industries (petroleum, metals, minerals) were a common target – In countries with a socialist agenda, much broader impact
After the Cold War, rapid decline in nationalization
– 1975 – 83 cases of expropriation; between 1981 and 1992 – only 11 cases in total.
Current Political Risk Concerns
A Variety of Sources and Strategies to Affect Corporations
Creeping expropriation
When the government changes the rules and makes profit impossible
– A case: Alliant Techsystems, Inc. (Belarus) 1996 – Charge: The government of Belarus seized plant and property in a manner that amounted to indirect expropriation. – Methods: 1) The government required that the company sell its products only to Belarusian enterprises. Export opportunities could not be pursued. That limited profit potential of plant. 2) The government restricted other processing to the most labor intensive sectors of the business, which were also the least profitable. – The government forced strategic decisions that prevented Alliant Techsystems from maintaining profitability. – The company received $5.9 million compensation from OPIC, which provided insurance for the investment
Contract Repudiation
Terms of operating arrangements are changed or renegotiated once their operations are in place and have proved successful.
– Additional taxes may be imposed – Staffing requirements may be set to increase employment
Firms with large fixed investments are vulnerable due to the “hostage” effect. They cannot credibly threaten to withdraw. Firms with stable technologies are vulnerable because locals could take over the operation without need for continuing foreign technology transfer.
Contract Repudiation, cont.
Often occurs when there is an “obsolescing bargain” – when the large risk occurs upfront (such as with petroleum exploration). When the gamble pays off and operations are underway, other parties forget the risk taken and only see the high return. They resent the initial terms of the bargain as too generous. Example: Pakistan (1998) Government threatened to cancel electricity contracts of 21 foreign investors unless they reduced their rates. May have the effect of creeping expropriation, but in the short term – issue of contract repudiation.
Bribery and Corruption
Costs are a direct loss; bribes can amount to 3% of total costs. Not insurable.
– Cost of bribes often passed on to customers; so, income transfer from customers to powerful officials.
Refusal to participate can lead to substantial business penalties including illegal fines and even prison terms.
– Example, manager put in jail in India because there was no rocking horse in the corporate childcare center as was the law. Released when rocking horse was bought.
Important Note
For US corporations, paying a bribe to a government official or agent of the government, either directly or indirectly, knowingly or unknowingly, is illegal under the Foreign Corrupt Practices Act.
Political Pressure in a Democratic System
Spread of democracy increases popular criticism of foreign investors.
– Opposition parties may use attacks on foreign investors as nationalistic position to gain voter support.
Do they follow through? Often not. Presidential candidate Lula (Brazil) used significant anti-business rhetoric, but when he won, he did not change the system significantly. BJP (Indian political party) accused foreign energy investment of malfeasance to gain fame, but was very pro-business in office.
– But pro-business opposition can also provide protection against government arbitrary policies, such as tariff increases. – Evidence is that business grows faster under democracies even though many believe that suppressive authoritarian regimes are more favorable to business.
Other Government driven effects
Cross-border resource disputes
Sanctions in case of political disputes
– Becoming more common as resource shortage, such as water, become critical – Example: appropriation of water upriver by a government may restrict ability to generate electricity in other areas – Restriction of trade to press a government to change policy – Example: embargo on trade with Iraq prior to 2003
Growth of Quasi-Political Actors
Increasing violence based on ethnic and religious conflicts. Generally groups are trying to establish political domain.
– Widespread violence in 15 of the world’s 20 least developed nations (UNDP). In a 2001 survey of the mining industry, 78% answered they withdrew from sound investments because of policy instability, in particular armed conflict. – Violence often expands beyond national boundaries as groups try to draw attention to efforts or target foreign corporations that seem to support government in power.
Threats from local business
Local business interests use political connections to secure favorable treatment over foreign firms.
– A method of resistance to market liberalization – many local business people became wealthy during the period of protected markets and do not want to eliminate protectionist policies
Examples of results: governments require foreign investors to have local partners or keep foreigners entirely from some “critical” sectors; enact licensing procedures that delay investment Positive point: Companies knew conditions before they committed much capital
– When liberalization occurs, locals still try to create adverse political conditions.
Examples of results: Prevent foreign firms from winning government contracts, which in less industrialized countries can be substantial portion of economy. Try to slow licensing and other approvals for foreign firms to decrease their relative efficiency. Now, companies invest and then local firms lobby for changes.
Increasing Action by NGOs
Increased international coordination of NGO action
– Small, low resource interest groups in less industrialized countries gain power through coordination with industrialized country NGOs. Example: nascent unions in Indonesia work through establishes unions in US and Europe.
NGOs have found direct action against corporations more effective than efforts to change laws and regulations
– Example: efforts to change slaughterhouse practices through legal efforts were slow; direct action against McDonalds created faster result.
Typical NGO actions
Boycotts
– Example: Boycott Nike campaign (through 1990’s) to press company to improve labor practices.
Adverse publicity
– Example: AIDS activists launched aggressive campaign against pharmaceutical companies for high prices of antiretroviral drugs.
Lawsuits
– Example: Daimler-Chrysler sued by International Labor Rights fund under the Alien Tort Claims Act over complicity in death and torture of union workers in Argentina during the 1970’s and 80’s.
Political Risk from “Other” organizations
Expansion of organized crime (particularly discussed in Eastern Europe) can lead to intimidation, shake-downs, systematic fraud. Individual actions with political repercussions are becoming more common with new opportunities for publicity (e.g. web sites) and availability of resources for violence (e.g. French farmer José Bové bulldozed a McDonald’s restaurant to protest globalization of agriculture).