Assessing Internal Political Risk

The Political and Legal Environment for International Business Introduction Both the political system of a country and its accompanying legal system are national institutions: they spring from the nation state as an autonomous entity, which governs its population and enacts law to carry out its public tasks.

For businesses, these institutions play a continuing role. They regulate its formation, its governance, its business activities, its relations with stakeholder and its duties to communicate with regulatory authorities and the public.When a business embarks on international expansion, far from leaving national institutions behind, it encounters new political and legal frameworks in each country it enters. Although the patchwork of national authorities might well seem dated in a globalized world, it remains an essential reality for international managers.

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International business has consistently emphasized the need to both understand the political dimension regarding the management of overseas activities and include inter country differences and changes in political environments when researching strategic initiatives and expansion activities of international firm.Politics and political interest are powerful forces in every country throughout the world, and their ability to support or disrupt business operations is of major interest to the global manager. Only through an understanding of the fundamental elements and dynamics of political systems can one adequately appreciate their effects on the multiple operating environments facing the global firm and properly assess the degree of politically imposed risk involved in commencing or continuing operations in each.Policymakers and managers must have the tools to assess the extent of political and regulatory risk faced by a given investment project in a given country. The political system The political system consists of a set of “players” each with its own unique set of aspirations and goals, which are often in conflict with those of other “players” in the system. The government is only one of many players in this system, although a key one, as it alone has the legitimacy to make authoritative decisions and to enforce those decisions by force.The other key players in the system are the various significant groups that exist in a society.

Examples of societal groupings are labour unions, environmental activist organisations, special-interest groups, and religious organisations, finally , groups, including various terrorist organizations, exist that conduct illegal activities. Social groupings and organizations of all types accord more power and responsibility to some members than to others. Each of these groups has a certain amount of power it can exert to control and influence the behaviour of other groups and of various host governments.The organisation’s politics consists of the interplay for power and status, which often takes place outside formal structures. The power of each group is derived from the total number of people who are firmly committed to the group’s ideals and goals and from the group’s stockpile of key financial, technical, and human resources. What distinguishes these organisations from politics at the national level is that they are all limited to the organisation itself, whereas national politics concerns the people, goals and structures which govern an entire nation state.

The political system of any state consists of the structures and processes by which it is governed. Some are formal such as the way governments are put in place and derive legitimacy, but much is less formal, such as grassroots actions on the part of the citizens. Political Risk Political risk refers to uncertainties associated with location and exercise of power within a country and from forces outside its borders.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. ” Political risks are the likelihood that political forces will cause unexpected and drastic changes in a country’s environment that significantly affects the opportunities and operations of a business enterprise.This definition of political risk puts emphasis on political forces as being the primary determinants of political risk in a country’s environment. The likelihood of political change is referred to as political hazard. Countries in which the government do not show consistency in the pattern of their decision making are more likely to be perceived as having higher political hazard and therefore being riskier than those in which the government’s decision show a pattern of consistency.

Two major emerging economies ————India and china———— are cases in point. Since 990, the Indian government has embarked on a slow but steady program of opening the huge Indian market to foreign competition and investments. Although, in the opinion of many observers, the rate at which the Indian government is opening up the market is rather slow, the political risk perceived by firms doing business in India is moderate to low. In contrast, China which also has a huge market potential for many business firms, has made much bigger strides in opening the market to foreign firms.

However, the perception of the degree of political risk is much higher in China than in the case of India.This is because China as yet does not have an effective legal system, a reliable commercial code that establishes the rules of commercial interactions and obligations do not exist, and decisions made by one agency of the government re often negated by decisions of some other agency. Individual citizens and businesses alike value stability and security, as necessary conditions for achieving their goals.

In any society, the centres of political power and the ways in which power is exercised affect the economic climate.Assessing their impact in terms of political risk is important for businesses, especially when contemplating investment in new location. Types of Political Risks The impact of political decision can be felt in three different ways: 1.

Transfer risk: this is the change in the degree of ease or difficulty experienced in making transfers of capital, goods, technology, and people into and out of a country. Capital controls include restrictions placed on the remittance of money to and from a country through foreign exchange controls.For instance, government controls over the flow of goods into a country through quotas and high tariffs. Technology transfers may be constrained by government policy. Similarly, most countries require work visas for foreigners, while some place limits on the number of foreign nationals who can be employed in a company, thereby limiting the free flow of human resources among the subsidiaries of international companies. 2. Operational risk: this is the impact on the operations of a firm caused by changes in the government’s policies.For example, the enforcement of strict new environmental protection legislation may cause a firm to shift its production site from one location to another within a country or to another country altogether.

3. Ownership risk: this involves a change in the proportion of equity owned by a company in a foreign subsidiary. Until the late 70s, the nature of the ownership risk experienced by international companies was predominantly negative. Countries that had become independent from the bondage of colonialism———– called for economic independence and self sufficiency.

This ideology fomented a wave of nationalisation, expropriation, or forced divestment of foreign companies in such countries as India, Egypt, Zambia and Indonesia. Since the late 1990s, however, there has been a rise in the wave of sentiment in favour of foreign enterprise. Foreign companies that were once asked to divest their share of the equity in foreign subsidiaries are now being asked to increase their share to a majority or wholly owned status.

The Scope of Political Risk The scope of transfer, operational and ownership risk may range from macro to micro.Macro risk and micro risk can be looked at as the two ends of a continuum. Macro risk affect the full spectrum of firms and businesses operating in a host country. One can conceive of macro risk as risk in which all private enterprise is confiscated or nationalized, as was the case when Cuba became a communist country. In a macro risk of lesser scope, only foreign companies are nationalized. At the other extreme are micro risks, which may entail a specific action against a specific company by a group or government. It may also affect specific business activity exclusively e.

g. he pressure put on Coca-Cola by the Indian government to reveal its secret syrup formula. Risks within the political system The stable authoritarian country may seem to present fewer risks than the turbulent or fragmented democratic one.

But the stability of an authoritarian state rest oc coercion, while the democratic state relies on its independent institutions to provide a backdrop of stability, within which pluralist politics operate. Physical security is a concern of all businesses but especially those with large sites or vulnerable operations, as in the extraction industries.A prospective investor in manufacturing may be presented with a choice among emerging markets, such as India, a Central European country or China. Note: prospective investors look first at the country’s economic environment. If GDP growth is healthy and seems to be sustainable, this constitutes a strong argument for entering the country. All three examples have healthy economic growth, developing market economies and growing consumer markets.

But in terms of political systems, they are very different.India is a democracy, but its political scene is volatile and unstable, fuelled by social and ethnic tensions, and religious strife. It also has a tradition of a strong state role in economic development, which has deterred investors in the past. The new EU states of central Europe have formal democracies, but as yet they do not function smoothly in practice.

A high turnover rate in governments ministers militates against continuity in government policy towards business, which is important for investors. Corruption and bureaucracy are also obstacles in these states.China has pressed forward with liberal economic reforms although its political system is authoritarian. On the surface, china seems relatively stable, and its leaders have welcomed foreign investors, but restrictions and government interference are continuing risks.

Social unrest lurks beneath the surface, as prosperity has not benefitted all segments of the population. For companies entering the country, these are the considerations which should be taken into account. They may seem to pose little threat to the country’s stability but they constitute political and legal risk.In authoritarian states, power is often personalized. When individual office holders change, any goodwill built up with previous individuals is lost.

Policies may change and an activity which was approved previously may no longer be acceptable. Vulnerability to the apparent whims of persons in authority is one of the aspects of countries with weak rule of law. Corruption can pose a risk in almost any state. Despite reforms and democratic transition, corruption remains a drawback in many European countries and African countries.Established democracies also suffer from corruption, often related to donations to political parties from businesses. Major companies typically contribute money to candidates and parties, with the implication that they are seeking to influence policies or gain favours. Organizations of all description, including companies, NGOs and interest groups regularly lobby democratic governments for policies and laws they wish to see adopted. For the company which gains tangible benefits from its lobbying or financial contributions to politicians, the risk is that if illegality later emerges, he company, including the individuals involved will suffer reputational damage.

Companies doing business where political risk is high weigh up the potential benefits against the uncertainties. International political risks The political environment of every country is influenced by its relations with other countries, both neighbours in its region and countries further afield; such as trading partners. As has been seen, national economies vary greatly in the size and global reach of their firms. similarly, countries differ markedly in their political power at international level.