Responses to political risks

Forecasting political risk is critical to an MNC in deciding on a particular project. The MNC can protect itself against political risks with government insurance policies and guarantee programs. Chapters 13 and 14 have described these in some detail.

Defensive measures before investment There are three types of defensive measures before investment: concession agreements, planned divestment, and adaptation to host-country goals.

Many host countries have recently increased their surveillance of foreign operations within their borders. An MNC ought to negotiate concession agreements to minimize subsequent polit ical risks. The concession agreement spells out contractual obligations of the foreign investor and the host government. Careful negotiations may result in contracts that address such critical issues as provision for arbitration of disputes, funds remittances, transfer prices, local equity participation, method of taxation, price controls, the right to exports, and limitations on nationality of personnel.

Planned divestment has been frequently suggested as one of the most important preinvest-ment strategies in order to avoid subsequent operational restrictions and expropriations. Planned divestment provides for the sale of majority ownership in foreign affiliates to local nationals during a previously agreed-upon period of time. Planned divestment is often a necessary condition for entry into foreign markets, or it may be imposed on already existing companies.

The concession agreement specifies the rights and responsibilities of both the foreign company and the host country, but it is often revised to adapt to changing host-country priorities. When the foreign company sticks to the legal interpretation of its concession agreement, the host-country government uses pressures in areas not covered by the agreement. If these pressures do not work, the host-country government reinterprets the agreement to obtain changes from the foreign company. Thus, it is advisable for MNCs to voluntarily adapt to changing host-country priorities whenever possible.

Defensive measures after investment Once managers have decided to invest and take preinvestment defensive measures, they can use several operating strategies to cope with political risks. We have grouped them for convenience into two categories: strategies that are necessary to be a good citizen of the host country and strategies to alleviate political risks. In addition, joint ventures can be used to diffuse political risks.

Many foreign affiliates attempt to harmonize their policies with their host-country priorities and goals. They may hire an increasing number of local persons for positions initially held by representatives of the parent-company management. They may share ownership with host-country private or public companies. They may develop and use local sources of supply for their raw materials and component requirements. They may try to export their products to bolster host-country reserves of foreign exchange.

Many operational policies and organizational approaches can be used to alleviate political risks. MNCs may maintain technological superiority over local companies and other competing foreign firms. The challenge here is to introduce technological improvements into the host country on a continuing basis. An MNC may integrate individual subsidiaries into a worldwide production and logistical system through highly interrelated international operations. Under such an integration, a subsidiary alone cannot operate or compete successfully, as is the case in the petroleum industry. Control of key patents and processes, joint-venture arrangements, capitalization with a thin equity base and a large local debt proportion, and control of key export markets for a subsidiary's products are examples of policy actions that can alleviate political risks.

Joint ventures with local partners have been frequently suggested as one answer to national demands for an ownership share in certain industries. A joint venture can improve the public image of a subsidiary, provide more capital, and deter operational restrictions. Joint ventures with investors from a number of different countries, such as the USA, Italy, and the UK, can make operational restrictions extremely costly, because they could distress private investors in all three countries and thus impair good economic relations with these national groups of business executives.

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