The nature of political risks

Traditionally, conflicts between MNCs and host countries have occurred over such issues as conversion of an economy to the style of a specific political system, joint ventures, control of key industries, contribution to balance of payments, national sovereignty, and economic development. Such conflicts are not limited to developing countries. More subtle, yet very real, conflicts exist between MNCs and developed countries.

It is frequently difficult to separate political and economic risks. While government decisions are political by definition, underlying forces behind the decisions may be purely economic. For example, funds to nonresidents may be blocked because of an unexpected shortage of foreign exchange or a long-run deficiency of the foreign exchange, instead of certain types of domestic political pressures. Some government decisions are partly political and partly economic. The United Nations imposed economic sanctions against Iraq in the fall of 1990 because of Iraq's invasion of Kuwait. The Organization of American States imposed economic sanctions against Haiti in 1994 because of Haiti's human rights violations. Finally, the USA and several other Western countries have imposed a variety of economic sanctions against Afghanistan, Cuba, Iran, Libya, and North Korea for many years.

Countrywide political risks depend on three broad groups of variables: political climate, economic climate, and foreign relations. The political climate may be measured by tendencies toward subversion, rebellion, or political turmoil. Multinational investors should consider such factors as levels of political violence, the existence of extreme tendencies among political parties, and recurring governmental crises.

Investment analysts should make an overall assessment of the economic climate to protect foreign investment from political risks. Relevant economic factors include the likelihood of government intervention in the economy, levels of interest and inflation rates, persistent balance-of-payments deficits, levels of foreign debts, and worsening monetary reserves.

Finally, multinational investors should determine the extent to which host countries manifest hostility toward other countries. Important factors here are incidence of conflict with their neighbors, evidence of an arms race, and sizes of defense budgets.

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