Session 1iii BUSE608

8/13/2019 Session 1iii BUSE608

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DR SAJJAD HAIDER

Topic 3:Political and Economic Risk

BUSE 608

International Business

KAAU, 2011-12


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DR SAJJAD HAIDER

Learning Outcomes

Understand the post-war trends in political economy which

have shaped the current international business environment

Identify and evaluate the key political/legal and economic risks

facing international businesses

Analyse the advantages and disadvantages of the Single

European Currency from an international business perspective

Critically assess the political/legal and economic risksspecifically in developing countries


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Political Risk

Political and economic risk are linked because

economic and legal systems are a function of

political ideology, so

political systems in different countries have a

major bearing on the degree of risk facing

international businesses


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Political Risk

Political systems can be assessed according to two

related dimensions

The degree to which they emphasise collectivism asopposed to individualism

The degree to which they are totalitarian or

democratic


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Political Risk

Collectivist societies stress the primacy of collective goalsover individual goals

In collectivist political systems, the needs of society as awhole are, therefore, viewed as being more important thanindividual rights

Individualistic societies stress that individuals should havefreedom in their economic and political pursuits

Individualism, therefore, translates into an advocacy for

democratic politics and free market economics


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Political Risk

Totalitarianism is a form of government in which one politicalparty exercises absolute control and opposing politicalparties are prohibited

Totalitarian regimes can exist at either end of the politicalspectrum, so they can be extremely left-wingor right-wing

In democratic societies citizens periodically elect individualsto represent their views, and those politicians formgovernments to make decisions on behalf of the electorate



Political Risk

Collectivist societies normally operate under

totalitarian regimes, although there are

exceptions, e.g. Japan Individualistic societies normally operate under a

system of democratic government, although there

are exceptions, e.g. Russia?



Political Risk

The post-war trend has been towards individualism anddemocracy, key examples being: the break-up of the SovietBloc; the spread of democracy in Asia and Latin America

The main reasons for this trend have been: totalitarianregimes have failed economically; IT communicationsdevelopments have lessened the ability of governments tocontrol information available to their domestic citizens;emerging middle-classes have pressed for democratic

reforms



Political Risk

Hill argues that the optimal politico-economic system is astate in which individual aspirations can be fulfilled withoutgovernment interference, in which there is democracy, and

in which there is a free market economy with a lack ofbarriers to trade and investment

While there are many examples which would support thisview, as Hill would categorise the USA

there are significant exceptions, particularly in Asia such asJapan, South Korea, Taiwan and China



Government Intervention

The post-war trend of the lowering of barriers to

trade and investment, promoted by GATT and the

WTO, has had a significant impact on internationalbusiness

However, many countries still intervene in

international trade and investment

If the argument in favour of open markets is socompelling, why do they do it?



Government Intervention Reasons for government intervention in trade and

investment are as follows:

Protecting jobs and (infant) industries For national security

Furthering foreign policy objectives

Protecting consumers

Influencing human rights/environmental issues




Forms of intervention:

Tariffs a tax levied on imports

Subsidies a government payment to a domestic producer

Import Quotas - restrict the amount of goods which can beimported

Voluntary Export Restraints (VER) impose limits on exportsfrom a particular country (e.g. Japanese cars into the USA inthe 1990s)




Local Content Requirements calling for a proportion ofmanufacturing to be produced domestically, and for aproportion of the inputs to the product/service to be

sourced locally Anti-Dumping Policies to prevent products to be sold at

below production costs in other markets

Administrative Policies to make it difficult for imports to

enter a country



Politico-Legal Risk

Critical aspects of politico-legal risk include:

Protection (or non-protection) of Property Rights

Protection (or non-protection) of Intellectual Property

Rights

Contract Law

Product Safety and Product Liability Protection



Political Risk Summary

Political ideology will influence economic and trade policies and,

therefore, it is critical that the degree of political risk in

particular countries is assessed by international businesses Despite the trend towards free trade and investment, many

governments still impose barriers which have a negative impact

on international businesses and

the political risks to international business will be greaterwhere there is a high degree of government intervention


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Economic Risk

Economic risks may originate from political risks, becauseeconomic/trade policies have a political derivation

Economic risks may arise from the mismanagement of a

countrys economymanifested by factors such as:

Levels of inflation

Levels of government debt

both affecting the value of the international businesssassets and profits in that country


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Economic Risk

Economic risks can be categorised as follows:

Costs not present in domestic business

Foreign exchange risks

Operations risks


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Costs of International Business

Additional costs:

Trading costs e.g. import duties, distribution agents

Travel/relocation costs e.g. use of expatriate

managers Local market costs e.g. government regulations,

product/service modifications


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Foreign Exchange Risks

Transaction Exposure currency uncertainty due tothe time lag between contract and settlement

Economic Exposure exporters/importers vulnerable

to currency movements due to economic policyeffects

Translation Exposure in translating earnings andassets from foreign currencies into domestic

currencies


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Operations Risks

The critical factors are as follows:

Government policies on trade and investment by

international businesses in their country Infrastructure quality utilities and transportation

networks

Labour supply and quality

Raw material/components supply and quality


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The Single European Market

This was established in 1992, with the following forecast

benefits:

Lowering the cost of doing business in Europe Giving European firms the opportunity to gain economies of

scale

Increasing competition, and therefore benefitting the

consumer


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The Euro

The Euro was established as a Single Currency within theEuropean Union in 1999, and other currencies were

withdrawn on 1/1/2002

The Single Currency had been adopted by 12 out of the

then 15 EU member countries, with the UK a significantexception

In 2004 there were 10 new countries joining the EU (and

two more in 2007) taking the number of Euro Zone

member states to 15


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Advantages of the Euro

For businesses, elimination of foreign exchangerisks (within the European Union)

For consumers, greater price transparency

and increased competition which should drive

prices lower

The potential for the development of a pan-

European capital and financial market


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Disadvantages of the Euro

Loss of national sovereignty in terms of

implementing appropriatemonetary policies

Forcing countries outside the

optimal currencyareato adopt disadvantageous economic

policies

Creating political pressures which may,

paradoxically, militate against political unity


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Euro Notes

The early experience of the Euro was a significant fall in

value against the dollar but, since 2002/3 strengthened to

above its starting level, reaching a high of about $1.60 in

July 08 The strengthening of a currency means that exports from

the particular country/zone become more expensive in

other markets, reinforcing the point that, in this case,

while its existence has removed currency risks within thezone, externally they still prevail


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Economic Risk in Developing Countries

The process followed by countries in transition in moving

towards democratic political systems and free market

economies has involved the following:

Internal economic liberalisation abolition of pricecontrols and scaling down of subsidies

Introduction of competition through deregulation and

privatisation, and allowing inward FDI

Establishment of the rule of law property protection andcontract enforcement


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Economic Risk in Developing Countries Taking the Soviet Bloc as a representative example, the

pace and intensity of this process has varied enormously

The success of the process has also shown significantvariations, with Russia a good example of the potential

benefits to international businesses against the reality of

the considerable risks which remain in such economies in

transition


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The Russia Example

Mid 80s

Beginning of market liberalisation as an attempt torevive faltering Soviet Union Economy

with improving links with the West

Early 90s

Pressures for political reform brought the downfall ofCommunist rule and break-up of their Soviet Union intoindependent republics


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The Russia Example

Mid 90s

Further economic liberalisation, including allowing

private enterprise, dismantling state controls,

privatising state owned enterprises So, Russia (with its 150m people) - and its vast oil

and gas reserves - became a potentially attractive

market for Western companies

BUT


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The Russia Example

Late 90s

Privatisation has remained slow and the still large Stateowned sector has needed increased government financialsupport

Corruption remained rife

Business law remained inadequate

The country defaulted on much of its foreign debt, andinflation was a major problem

30% of its population remained below the officialsubsistence level


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The Russia Example

The political and economic changes initiated in Russia in

the early 1990s prompted many international companies

to enter the Russian market

The potential offered by this significant market must,

however, be assessed in relation to the remaining risks and

many Western firms are still sceptical about the

risk:reward ratio of investing in such an uncertain climate


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Analysis of Political and Economic Risk Prior to conducting business transactions with other

countries, international businesses should thoroughly

assess the political and economic risks which exist in these

markets

Franklin R Root, in Entry Strategies for International

Markets provides a model by which international

managers may evaluate the political and economic risks in

individual countries which can be set out as follows


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Economic Risk Summary

Economic risk to international businesses may be linked to thepolitical ideology of the country in question

Specific economic risks exist in relation to: costs not present in

domestic business; foreign exchange; and operations The Euro is a prime example of an attempt to lessen the degree

of currency risk which companies face in conductinginternational business

Economic risk may be significantly greater in developingcountries, particularly if they are economically mismanaged


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Overall Summary

Internationally businesses face a plethora of risks both

politico-legal and economic, with many of the latter

deriving from the political beliefs and resulting policies of

the particular government

Such risks may be evaluated using the Root model which

identifies hurdles and decision points in relation to

entering foreign markets

Session 1iii BUSE608

Documents

Transcript of Session 1iii BUSE608