INTERNATIONAL BUSINESS ENVIRONMENT

PGBM04

UNIVERSITY OF SUNDERLAND

GOKHAN SAGLAM

129074768

Q3) Examine the main types of political risk to which an international business,

contemplating foreign direct investment, may be exposed. Assess the usefulness of

alternative criteria by which these risks may be evaluated.

Political risk analysis methods and its relation with FDI

For the purpose of this essay political risks and its relation with foreign direct

investment will be identified and critically analysed. Political risks will be analysed based on

international country risk guide and in which political risk divide twelve components and each

component of the political risk consist of some subcomponents. Components of the political

risks are Government Stability, Socioeconomic Conditions, Investment Profile, Internal

Conflict, External Conflict, Corruption, Military in Politics, Religious and Ethnic Tensions,

Law and Order, Democratic Accountability, Bureaucracy Quality. Government stability will

be critically analysed by regarding government unity, legislative strength and popular support

of public. Second component will be evaluated based on socioeconomic conditions of the

country which constitute of unemployment, consumer confidence and poverty. Then,

investment profile of the country will be analysed and evaluated by regarding contract

viability/Expropriation, profits repatriation and payment delays. After, civil war/Coup threat,

terrorism/political violence and civil disorder subcomponents will be exemplified and

evaluated under the main component of internal conflict. External conflict will be analysed

based on war, cross-border conflict and foreign pressures. The corruption degree methods for

any country will be identified and evaluated by regarding FDI. Military in politics will be

analysed and its affects for FDI discussed. Religious and ethnic tension causes and effects for

country reputation by considering foreign investment will be identified and analysed.

Discouraging and encouraging laws for foreign direct investors and stable country view will

be identified and analysed. Democratic accountability will be identified and evaluated by

analysing electoral process and pluralism, civil liberties, the functioning of government,

political participation and political culture to identify the level of full democracies, flawed

democracies, hybrid regimes and authoritarian regimes. Lastly bureaucracy quality step of the

political risk analysis will be analysed based on institutional strength and its effects on foreign

direct investment.

Businesses expect from host countries a stable and security political view and in

relation necessary conditions to establish a company in overseas countries. Political risks

could be interpreted as a non-financial risk but these risks affect the economic climate of

countries from the perspective of investors. Because of that it is important to analyse a host

countries` political situation before investing in there. Political risk focus on changes within

the political factors which are unpredictable and affect the prices of products, goods and

services due to reaction of governments and the other politic groups those may be in host or in

home country (Wafo, 1998). Another definition for political risk suggested by Robock and

Simmonds that there is political risk in foreign investment when there is a problem of running

within business environment which could not be guessed and there are consequence of

political change (1973). Political risk could be analysed under two main subject which are

internal and international risks. In addition, these risks are correlated with each other and the

relationship between them increase progressively due to globalization factor (Morrison,

2009). Also it is necessary to recognise political risk and its sources and analysis by

considering relationship with FDI (Foreign Direct Investment). If businesses want to be

successful in FDI, political risk has to be analysed well because it is founded that host

countries governments` support or/and stable incentives and political ties of firms would

success the business in FDI (Cheng and Chung, 2012). International Country Risk Guide

(ICRG) aim to provide businesses deeply research and analysis of possible risks for

international business operations. In addition, this analysis involve political, economic and

financial risks, also the predominantly component points refer to political risks analysis by

marking the overall points. Political risks consist of 12 components which are Government

Stability, Socioeconomic Conditions, Investment Profile, Internal Conflict, External Conflict,

Corruption, Military in Politics, Religious Tensions, Law and Order, Ethnic Tensions,

Democratic Accountability, Bureaucracy Quality (Busse & Hefeker, 2005).

Political systems may be managed by authoritarian or democratic governments.

Authoritarian government are managed the force of one or more individuals or political party

in where the country forced to run in regarding their ideas and their laws are dictated

(Morrisson, 2009). In this kind of countries business is vulnerable because in a possible leader

changing situation all agreements could be cancelled or suspended. On the other hand,

authoritarian country could be seen less risky than unstable or collapsed democratic one. But,

the fewer risk of the authoritarian country based on pressures while the risk monitoring

system of democratic government are identified and analysed by institutions and political

parties (Morrisson, 2009). Despite authoritarian government system china reformed its

economy as liberal and it provide to be first FDI destination country with 944 projects in

Asia-Pacific region in 2012 according to FDI Report 2013. It is clear that investors look

firstly GDP growth and stability of the country for deciding to enter country (Morrisson,

2009). In democratic systems government institutions have important role from the

perspective of international investors by emphasizing political risks. Three Branches of

government should operate independently which are executives, legislative and judiciary.

Executives mean head of the government which instruct civil departments to implement

national finance, national security and welfare policies (Morrisson, 2009). Legislative is

responsible to enact law. Courts provide justice for individuals and organisations and this

system is called Judiciary. In other words, executives are controlled and limited by legislative

branch that authority are used illegally or excessively at the same time the other branches are

checked concerning their authority limits (Morrisson, 2009). Also this fairly system should be

implemented to provide as well as freedom to civil and political rights, and press. This system

should be in balance and stable to increase reliability of the country for international business

and attract investors. Governments should provide and support political decisions through

civil departments for being member of international institutions such General Agreement on

Tariffs and Trade (GATT), World Trade Organization (WTO) to be seen to foreign investors

more stable and succeed in terms of investing profit should sign liberalization alliances

like Free Trade Agreements (FTAs), Bilateral Investment Treaties (BITs) and Preferential

Trade Agreements (PTAs) (Cheng and Chung, 2012). The other subcomponent of government

stability analysis refers to Popular support (Howell, 2001). Public support is essential and

important for all types of governments to survive whether voluntary or involuntary because

despite theoretical consideration of analysing government stability the main effective factor

the opinion of the public about government.

Socioeconomic conditions constitute of risk components which are unemployment,

consumer confidence, and poverty. The analysis of these components evaluate level of

potential forces at work in public that could cause dissatisfaction and guide to government

action. In other words, socioeconomic conditions may cause to destabilise government regime

based on unrest social and economic conditions of country. China unemployment rank is 139

in the world and the rate is 4.1% (tradingeconomics.com, 2013) and China was first FDI

destination at Asia-Pacific in 2012. It indicate that unemployment rate is positive ly related to

attract foreign investors. The unemployment rate of India was 9.4% in 2008, drop 3.8% in

2012 while the second FDI destination country with 704 projects in Asia-Pacific. It shows that

FDI decrease the unemployment rate in host country. However, FDI cause to unemployment

for home country such Germany and France have been facing unemployment issues based on

outsourcing FDI (Agarwal, 1996). The other component consumer confidence index indicate

the opinion of the consumers about future economy of the country. Moreover, the rating of the

consumer confidence index relevant to customers` purchasing and saving decision and their

spending (Goldblatt, 2013). It means that based on spending decision of consumers foreign

investors may invest in popular industry for successful investment and to earn more profit.

Asia-Pacific`s consumer prefer to spend their money firstly by putting into saving, secondly

holidays/vacations and thirdly new clothes (asia-research.net, 2012).

Investment profile is analysed by considering viability of contracts, possibility of

payment delays and repatriation of profits. Contract enforcement is essential to develop

business relationship. Moreover, successful contract enforcement provide to companies to

achieve more customers and ability for more credibility. It is important for multinational

companies to reach markets and low-cost production in third world countries within

ownership agreements which are wholly-owned subsidiaries and equity joint ventures (EJVs),

or contractual agreements such contractual joint ventures (CJVs). Further, the weak contract

enforcement affect to discourage foreign investors in developing countries (Tao and Wang,

1998). Profit repatriation is important to transfer money to shareholders of foreign companies

without any delays. And during profit repatriation limits on foreign exchange transfer could

be seen which are blocks to capital and profits repatriation, long repatriation delays, limits on

repatriation by net worth, and limits on repatriation by foreign exchange earnings. If foreign

investors cannot get their money out, they recognise investment unsuccessful. If repatriation

is blocked, money has to wait in noninterest bearing account at central bank until block

cancelled and repatriation delays cause currency depreciation in value. The repatriation of

dividends is restricted with allowed percentage of a foreign investment`s net worth. The

remained profit may be reinvested in host country in next year to increase repatriation

allowance. Use of foreign exchange rate was limited by some countries for all purposes such

China was using limitation on foreign investors` foreign exchange usage to the amounts

earned by applying exchange balance requirements (Weigel, 1997).

Civil war, coup threat, terrorism, political violence and civil disorder are regarded to

analysis internal conflict component of political risks according to ICRG (2005). The most

attractive countries for FDI based on internal conflict analysis refers to where there is no

armed or civil group which are resistance to government and the attitude of the government

for tolerating violence against public. Civil war discourage foreign investors, for ex, Turkey

government conflict with Partiya Karkerên Kurdistan (PKK) since more than 30 years which

cause to prevent foreign investment in eastern Anatolia region and south eastern Anatolia

region of turkey where seen the less FDI in comparing with other region of Turkey and the

civil war has been continuing (Foreign direct investment in Turkey, 2011). In addition, civil

wars especially refers to socio-political conditions that involve unrest of the ethnic groups and

expectation freedom for mother languages such as in Turkey. Post and pre political violence

history of host country should be well analysed and anticipated to decide investment location

and its amount (Li, 2006).

External conflict component of political risk analysis refers to foreign action of

governments by considering passive external pressure such diplomatic pressures, trade

restrictions, sanctions and regional disagreement, and active external pressures such cross-

border conflicts. Diplomatic pressure is about imposing some request of any county against

another country. Moreover, this may include relationship of them or about a third country like

US expectation from Russia to apply sanctions against Iran. Consequently, this expectation

could cause to damage countries` financial and political relationship. US put trade embargo

on Vietnam based on the war. However, after war they cancelled embargo due to

globalization and need for low-cost labour and market. It indicate that embargo directly

prevent FDI if it is placed by strong world countries. Businesses expect smooth running

transborder activities for import and export also this should be provided by government to

satisfy foreign investors.

Corruption affect governments` and businesses` reputation by accepting power instead

of ability and impact on economic and financial climate which in turn cause to instable

political process. “Transparency International (2007) defines corruption as the misuse of

entrusted power for private gain” (Morrison, 2007. p.169). According to corruption

Perception Index the central European countries remain still corruption despite reforms and

democratic system because their communist past seen as a disadvantage for businesses

(Morrison, 2007). The relationship between companies and politician especially cause

corruption. In addition, companies subsidise to individuals or parties by aiming to influence

policies and gain benefits. Therefore, often scandals of politician are occurred by taking

money or offering government contract to associate for awarding. The other method for

companies for influencing policies is lobbying which is legally when bribes not and the best

method for business-government relation (Morrison, 2007). Also, monopoly and patronage

within politician or suspiciously relations between business and politics demonstrate out of

control economy and encouraged to growth black market (Howell, 2001).

Military in politics refers to ability degree of military in politics which could mean

that government unable to survive effectively, so country could be recognised not convenient

to prosper foreign investment (Behname, 2012). In democracy politics are elected by public

but if military is involved to politics, it would distort the democratic system. In addition,

military may expect to change policies to increase military budget based on internal or

external conflicts that changing may cause other government budget allowances which are

related with economic environment (Howell, 2001). Also, it indicate that this kind of

situations seen unstable and voluntary from the perspective of foreign investors. The authority

of military to overthrow elected government and setup military regime should be prevented

with legislation for stable economic conditions and attractiveness for FDI.

Religious tension result from single religious group who may expect to amend civil

law with religious one and to prevent ability of other religions about politics and social.

Moreover, it is expected by religious group to apply and perform their religious opinion which

may cause civil war as a result. This expectations could distort legislative, judiciary and

executive branches as well as in education. India has being managing under democracy but

still its political view is interpreted as unstable and temporary due to ethnic and religious

tensions (Morrison, 2007). On the other hand, Greif pointed out that religion has important

role to create trust and support economic exchanges between companies (2006). Trust is more

where same religion is shared than no same religion is shared. Also, it refers to positive effect

of similar religion on trust (Guiso et al., 2009, p.1112). Ethnic tensions involve the volume of

racial, nationality and language diversity. Lower rating is given to countries where public

unwilling and strict to live together. Nevertheless, high rating is given countries where same

diversity valid while public more tolerant and willing (Howell, 2001). In Turkey there is high

ethnic tensions based on unwilling and intolerant of previous governments and some publics

to grant of rights for Kurdish people. This considerations important because public should be

welcoming for foreign investors as well as their abroad employees. However, if minority

could be faced on discrimination, foreign investors hold off from investing.

Law and order mechanism of the country which is judiciary should be impartial to

perform and fairly, and free decisions. In another words, government should has fairly and

transparent judiciary system by applying laws in order that it will attract foreign investors to

host country by aiming to do clear and successfully business. On the other hand, government

promise to foreign investors such “tax incentives, security measures, dispute resolution,

national treatment, and most-favoured-nation treatment” (law.cornell.edu, n.d.). However,

investors should follow the local remedies before attempting to international disputes such

international centre for settlement of investment disputes, multilateral treaties, bilateral

investment treaties, customary international law because at least these institutions could be

accepted under the decision of local judiciary. It indicate that host countries for foreign

investment should be openness for international institutions` decisions for any situation to

implement.

Democratic accountability measures the responsiveness of government for its public.

Also, measurement result could be determined by the help of democracy index that provide

the level of democracy by analysing electoral process and pluralism, civil liberties, the

functioning of government, political participation and political culture to identify the level of

full democracies, flawed democracies, hybrid regimes and authoritarian regimes (Democracy

Index, 2012). Electrical process and pluralism are evaluated by considering free and fair

election system for national legislature, municipal, and head of government, allowance

criteria for suffrage for public and law support to campaign, political parties financial system

transparency etc. (Democracy Index, 2012). Evaluation criterion for civil liberties constitute

of free media, press, internet and government`s political restrictions on them; freedom quality

for protesting, speech and personal life; how extent judiciary independency; the degree of

tolerance about freedom and perform religion (Democracy Index, 2012). The freely and fairly

determined government policies, legislations and expresses of legislations by government

branches; the degree of influence for government from military and security services; the

significance of other forces in political and economic environment, and public confidence on

functioning of government are evaluated to determine function of government (Democracy

Index, 2012). Political participation component involve the degree of minorities voice in

political environment, women number in parliament, voter participation number for election,

and public interest in political news. The perception and consensus of citizens about

democracy and manipulate effect of democracy on economic system and its ineffective public

order perform; leadership character; possibility to prefer military instead government are

analysed to comprise political culture as a whole (Democracy Index, 2012). From most

implemented to less implemented requirements of democratic accountability are Full

democracies, Flawed democracies, Hybrid regimes, and Authoritarian regimes, respectively.

Bureaucracy quality could be recognised by regarding institutional strength which

would keep current policies in acceptable level in possible government change. “Open-

economy macro-policies, in particular, the imposition/removal of capital controls, and

financial repression” may be affected by bureaucracy quality (Bai & Wai, 2000). The ability

of government to gain advantage from financial globalization and the degree of being affected

from financial crisis may be related with its institutional quality (Anghel, 2005). Institutions

find midpoint for trading partners if either try to benefit by breaking contract. Moreover,

institutions concern about property rights, laws, codes of conduct and traditions and they

aimed to decrease instability of exchange and provide effective and efficient relationship to

individuals and organisations (Dahlström& Johnson, 2007). In corrupted bureaucracies

receive permits and licences may be delayed that it result to slow down the investment

processes in a country (Anghel, 2005). Corruption in bureaucracy among government

bureaucrats may cause to increase costs for MNE operations such transaction cost which

result high business expense in host country. In addition, bureaucrats may expect side

payment for export licence also this result proportion of entering for MNE into country and

discourage foreign investors (Dahlström & Johnson, 2007).

As a result, in this essay the political risk analysis and its effect to foreign direct

investors was critically analysed and their relation was identified and exemplified by

regarding Government Stability, Socioeconomic Conditions, Investment Profile, Internal

Conflict, External Conflict, Corruption, Military in Politics, Religious and Ethnic Tensions,

Law and Order, Democratic Accountability, Bureaucracy Quality components. Therefore, it

was recognised that political risk may cause to attract foreign investors or discourage them. In

addition, it is pointed out that the political risk points are given the countries where all

components carried out successful. However, the significant correlation between low risk rate

and FDI volume could not be recognised. It indicate that even the political risk rate lower

countries (such China and India) could be seen better place for FDI from the perspective of

international investors.

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