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Topic 3:Political and Economic Risk
BUSE 608
International Business
KAAU, 2011-12
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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
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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?
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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
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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
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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?
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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
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Government Intervention
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)
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Government Intervention
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
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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
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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
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