International Management

Phatak, Bhagat, and Kashlak

McGraw-Hill/Irwin
International Management

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

Chapter 3

The Political Environment and

Political Risk

McGraw-Hill/Irwin
International Management

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

3-3

Learning Objectives
Describe the components, relationships, and interactions involved in
the political systems model, and explain how the one-nation model
can be extended into a global business context.
Explain the reciprocal nature of the dynamics between political and
economic systems, policies, and relations.
Define and differentiate among the various types of political risk, and
discuss their implications for the multinational firm.
Discuss comprehensive frameworks for assessing political risk, from a
global as well as a single-country perspective.
Understand alternative methods used to hedge against risk from
political and politically-imposed economic changes in a host country.
Understand practical implications of political risk for the manager
working overseas.

3-4

Chapter Topics
Macro-level Environments and Uncertainties
The Political System
The Global Political System
The Interaction Between International Politics and
International Economics
Political Risk and the International Firm
A Global Framework for Assessing Political Risk
Managing International Political Risk

3-5

Table 3-1: Macro-Environmental Uncertainties

Political Uncertainties

War
Revolution
Coup detat
Democratic changes in government

Government Policy Uncertainties

Fiscal and monetary reforms

Price controls
Trade restrictions
Nationalization
Government regulation
Barriers to earnings repatriation
Inadequate provision to public service

3-6

Table 3-1 (contd.)

Macroeconomic Uncertainties

Inflation
Changes in relative price
Foreign exchange rates
Interest rates
Terms of trade

Social Uncertainties

Changing social concerns

Social unrest
Riots
Demonstrations
Small-scale terrorist movements

3-7

Fig 3-1: The Political System

Power
--------------Ideology
Power
--------------Ideology

GOVT.

Power
--------------Ideology

Political
Decisions

3-8

Consensus and Legitimacy

Consensus
Is the widespread acceptance of the decision-making process
in the political system by the individuals and groups in the
system. It is the instrument by which a government itself
becomes legitimized

Legitimacy
Is the use of power of the state by officials in accordance
with prearranged and agreed upon rules. A legitimate act is
also legal, but a lawful command is not always legitimate

3-9

Fig 3-2: Political and Economic Systems

Economic
System

Central Planning

Political
System

Totalitarianism
(Communism)

Democracy

Market Economy
Economic
System

Totalitarianism
(Fascism)

Political
System

3-10

Fig 3-3: Political and Economic Change (1982 - 2002)

European Union
Countries 1982

Democracy

European Union
Countries 2002

Malaysia 2002
Malaysia 1982

Political
Change

Nigeria 1982
Nigeria 2002

Russia 2002

Chile 2002

Russia 1982

Totalitarianism

China 2002
China 1982
Viet Nam 2002
Viet Nam 1982

Central Planning
Economy

Chile 1982

Market

Economic Change

3-11

Political Risk
Political risk is the likelihood that
political forces will cause
unexpected and drastic changes in a
countrys environment that
significantly affect the
opportunities and operations of a
business enterprise

3-12

Types of Political Risk

Country-Specific
Is manifested in the mutual hostility between Israel and
Syria. One would expect that Israeli companies would find
little support in Syria, and the same would apply for Syrian
companies in Israel

Company-Specific
Invokes either a favorable or unfavorable response aimed at a
particular company

Project-Specific
Involves special treatment bestowed on a certain type of
project

3-13

Types of Political Risk (contd.)

Transfer Risk
Is the change in the degree of ease or difficulty experienced
in making transfers of capital, goods, technology, and people
in and out of a country

Operational Risk
Is the impact on the operations of a firm caused by changes
in the governments policies

Ownership Risk
Involves a change in the proportion of equity owned by a
company in a foreign subsidiary

3-14

Fig 3-4: Classification of Types of Risk for

Company A in Country XYZ

Risk Type

RISK

SCOPE

Macro Risk

Micro Risk

Transfer Risk

**

Operational Risk

Ownership Risk
Legend **** = High * = Low

****

3-15

The Political Process

An exhaustive study of the political process would involve the following:
1.
Study the relative power of the dominant groups in the society, and become
familiar with their ideologies
2.
Study the decision-making process in the government
3.
Evaluate the relative strength and bargaining power of the political parties
in the legislative branch
4.
Study who are the key decision-makers in both the legislative and executive
branches of government
5.
Study the path traveled by the government in power over the past several
years in terms of its economic, social, and foreign policies
6.
Evaluate the impacts on the industry and your company of the anticipated
political decisions of the government, i.e. the political risk facing the
industry and company in the host country

3-16

Civil Strife in Host Country :

Mediating Factors

1. Coercive potential
2. Institutionalization
3. Facilitation
4. Legitimacy of the regime

3-17

Fig 3-5: Framework for Assessing Civil Strife

Coercive
Potential

Level of
Perceived
Deprivation

Institutiona
lization

Level of
Civil Strife

Facilitation

Legitimacy
Of the
Regime

Change in
Government or
Governmental Policies

3-18

Ex. 3-1: Staying Safe While Working Overseas

Always remain aware of your surroundings and avoid unusual
circumstances
Walk with authority and purpose while in public areas
Call ahead to notify others of your travel plans or appointments
Alternate your routes to work on a regular basis
Alternate your timing to and from your work location
Avoid wearing American or British flag pins or other insignia in
public
Speak in the native language where youre working

3-19

Fig 3-6: The Environments of

Political Risk
Host Country
Environment

International
Organizations
and Groups

Political Risk

Home Country
Environment

International Events

3-20

Fig 3-7: Managing Political, Legal and

Economic Risk
Direct
Defensive/
Reactive

Proactive/
Merging

Indirect

> Legal Action

> Host Operations
Dependent on Home
> Control Makeup of
Management
> Diversification

> Risk Insurance

> Contingency Planning
> Home Country Govt.
Pressure on Host Govt.

> Joint Ventures

> Licensing Agreements
> Other Host Partners
> Promote Host Goals

> Lobbying Home and

Host Governments
> Corporate Citizenship
in Host Country

3-21

Key Terms and Concepts

Political system
Political forces
Level of perceived deprivation
Coercive potential
Institutionalization and civil strife
Facilitation and civil strife
Regime legitimacy and civil strife
Civil strife
Macro and micro risk
Proactive and reactive hedges
OPIC