International Business investments are prone to Political Risks. Political risk is referred to as threats to business that decisions, events, and conditions including change of leadership & unrest in a country that would negatively impact the profitability and sustainability of investments owing to political and geopolitical developments.
Political leadership plays a vital role in the stewardship of the Nation. Political ideologies define the destiny of countries. Inter-country political dynamics also play a crucial role, especially in hybrid warfare that impacts economies and businesses. Political freedom also determines the aspect of risk, and we shall discuss the parameters of relevance in this blog.
For any International Business, assessment of the political situation is vital. Many businesses would prefer peaceful & conducive conditions; however, some would do well in hostile cases like arms trading and destructive products. We will restrict our discussions to enterprises that wish to operate in sustainable environments.
The critical political risks in International Business are classified as under:
1. Systematic Risk: These are risks associated with the macro-economic policies of a country. Structural and policy changes impact business, both positively and negatively. Typically, with the change of governments, policies change based on their election manifesto. However, there are specific commitments given to IMF & WTO. It is essential to study these commitments as they are not amenable to change in most cases unless negotiated through consensus.
2. Procedural Risk: Trade is linked to local procedures in a supply chain. It is vital to study the parameters of country-of-origin labels, standards, and customs rules. Non-tariff barriers and their coding are tricky. Sourcing can also be restricted based on country of origin. Local value adds and proportion may also be a matter of complications. Corrupt practices can cause administrative delays. In some cases, administrative delays would be purposeful. All this must be studied as it ultimately results in costs.
3. Distributive Risk: Profit-sharing with local partners and repatriation of funds get restricted in this risk. Governments use their power to dilute profits earned by an MNE. The aspect of creeping expropriation in this risk involves a continual restriction of private property rights gradually over time through regulation, legislation, and taxation, making it difficult for businesses to own property. This is a pattern that needs a study for each country.
4. Catastrophic Risk: This risk is devastating for businesses. These risks disrupt society through civil wars, ethnic discord, illegitimate regimes, an act of war, and terrorism, to name a few. These are risks associated with macro flashpoints. It becomes impossible to continue a business in such situations.
Owing to the above four political risks, it becomes imperative to understand the dimensions of political facets for the successful conduct of International Business. Business models have to be designed to fit the local political circumstances as political risks pose a significant threat to MNE’s.
It is thus safe to say if there is a Nation, there is a political ideology. Political ideologies serve the National, Political Parties, and Leadership interest. A political ideology thus determines the conversion of their core ideas into actions. Mostly the analysis hinges on left-wing Communists and right-wing Nationalists, with Socialists balancing the two ideologies. A political ideology thus is an integrated vision of where the Nation focuses. Nations without Vision are at risk. The ideologies give rise to a political spectrum as real democracies, and ideal totalitarianism systems are an exception.
Democratic systems on one side of the spectrum of radicalism advocate extreme reforms while reactionary advocates preserve norms. Totalitarian describes various degrees of control, with Fascism controlling people’s minds and beliefs and authoritarian regimes controls the state. We can also have religious governments bonded by theocracies, and we can also have kingdoms of Monarchs. Dictators and Juntas are also forms of authoritarian regimes with the essence of military domination. Thus, International Business operates in varying degrees of political freedoms across continents.
Political freedom measures the degree of fairness of elections, freedom of individuals and groups, the rule of law, and freedom of the press. Thus, the legislature, the executive, the judiciary, and the press are the four pillars of democratic freedom. Democracy is based on the participation of people in decision-making. At the same time, the totalitarian system consolidates power in a single agent who controls the political, economic, and social dimensions of a Nation. A totalitarian system usually propagates the collective good of all the only edifice of its survival and sustenance; thus, totalitarianism and collectivism complement each other. It is absolute control of a dictator or a party and regulates all realms of life.
Let us study the dynamics of International Business across the spectrum:
a. Representative: Constitution is the definer, and Voter’s preference is paramount. The business dynamics are fair, and the rule of law operates supreme. This is an ideal environment to conduct business and naturally favors entrepreneurship and innovation. This type of democracy created a foundation for Global Enterprises and Unicorn companies.
b. Multiparty: This a coalition government of three or more parties. They may also govern separately. The situation here can get tricky, with each party having its ideologies. However, there is a common minimum program that they work on, and as long as it suits the business, it is fair to venture into the market.
c. Parliamentary: Citizens elect, and a majority of situational coalition takes charge as the legislative setup. Ministers run the executive branch. This a much safer option as usually the policies are carried forward from previous governments and are an act of the Parliament.
d. Social: Here, the government promotes an egalitarian approach and regulated capitalism. Government intervention is the norm to ensure the wellbeing of its citizens. Some very prosperous economies practice this. A good market to operate in; however, one needs to adapt to government interventions.
a. Authoritarianism: Ensures complete adherence to its ideology with absolute submission to the state. This works as long as people do well and are happy with the state. However, when this goes wrong, unrest can set in, and anarchy can prevail. Rights to Intellectual Property and Assets are always at risk here. The law of the land is designed by the Authoritarian rule subject to change and interpretation.
b. Fascism: A single party controls through force and indoctrination. As long as businesses align with leadership and ideologies, they do well. These regimes can become very hostile towards a business entity and can create immense problems. As long as they enjoy the majority stakes & interest, they are happy to conduct business. However, it is a very unpredictable relationship for sure. It is mostly a Master-Slave arrangement.
c. Secularism: Dissent is tolerated as long as it does not overrun the state. The state grants limited freedom. Communists regimes are an example here. The risk to assets exists, and if unrest sets in, it could lead to catastrophic risks.
d. Theocracy: Here, the government is an expression of religious ideology. Leaders are seen as appointments of the divine entity. Businesses have to align with the religion, and religious ideologies also dictate laws. Local cultures and rituals need to be a part of the MNE culture. This can be very tricky. However, these governments of today allow free areas for MNE’s.
It thus becomes critical as per the above narration to ascertain the state of political freedom. Democracies are useful in the long-run. Totalitarian regimes offer the best short-run option; however, the state’s domination needs to be accommodated. The most significant risk is when civil unrest starts, or the government starts to lose recognition, leading to severe supply chain issues.
The ultimate definer thus is the State of Political Freedom. Freedom House identifies three types of political freedom:
1. A free country: Open political competition and freedom of expression. The pillars of democracy are genuinely free. This is the best market to operate in. The rule of law is supreme here.
2. A partly free country: This exhibits limited liberties and is mired in corruption. Democracy is just a concept that is not practiced as systems are deliberately flawed. It is a risky market for sure.
3. A not free country: There are no political and civil liberties. Communist countries, Monarchy, and Dictatorial regimes fall in this category. They are characterized by flawed international policies and turbulent relations with other countries. They can be desirable markets and can offer excellent stability, but these economies can collapse once the hybrid war’s hostility begins.
Depending on the type of business, one can choose to operate with business models that align with these situations.
I can conclude safely by mentioning that International Business can find opportunities everywhere but is not free of risk, and thus Political environment must be deeply analyzed. However, the ultimate moment of truth is the Vision of the Head of the State. Visionary leaders have created vision communities and thus a Nation led by Vision. It does not matter what form of political ideology it is. If the Vision is authentic and engaging, it is the best country to operate in. These leaders typically have long political careers and carry influence at an international level. Look out for such leaders and invest in countries led by a vision. This the ultimate model of success. Keep a watch on such economies as they will create the best of the business opportunities and provide the required cash for diversification and expansion.
The bottom line is assessing political ideologies, tweaking your business models, and evaluating each political system’s risk. After all, Political ideology and economy are closely linked, and economy and business correlate.
It would thus be good practice to be politically savvy when engaging in International Business.
Copyright 2020 Niket Karajagi International Business Blogs Series.