Managing Risk in an Unstable World
By Ian Bremmer
Eurasia Group is a New York based research and consulting
firm that focuses on
political risk analysis and industry research for global markets. The Group has vast expertise on developing
countries in Asia, Latin America, emerging Europe & Eurasia, Middle East and Africa and offers its clients analytical research and consulting on political trends and their impact on business, financial markets and foreign investment climate. Ian Bremmer, the founder president of Eurasia Group, a senior fellow at the World Policy Institute and a columnist for the Financial Times, writes about ‘Managing Risks in an Unstable World, (HBR Jun 05).
Ian Bremmer asserts that making global investment decisions based only on economic data without understanding the political context and its ramifications is not prudent in the present global scenario. Economic risk analysis takes note only of commonly used variables like percapita income, growth and inflation rates, political factors always overlooked. Economics risk analysis tells whether a particular country can pay its debt where as Political risk analysis explains whether the country will pay its debt. Hence accurate information on political climate and developments that take place in brisk pace in every country has to be understood by the investors in correct perspective. A close look on impact of political turmoil and trends in countries like Iran, Russia and Brazil in the recent past stands testimony. Hence strategic investors in foreign markets need to be wise enough to comprehend the signals emanating from the dynamics of political stability or instability in those countries. Economic and political analyses often give different indications. Russia’s market instability in 1998 and Brazil’s dramatic recovery after Lula was elected President in 2002 are classic examples.
Basically there are four reasons why accurate and timely analysis of political factors is important for investment decison makers in foreign markets. First, because of the globalisation processes the international markets are more closely interconnected and the effects of political decisions and aberrations are felt much faster in the world market. Second, the Sept 11 attack on WTC has made US to be more proactively concerned resulting in a more volatile world order, thereby changing the matrix of risk calculations everywhere. Third, there is an upward trend in off shoring by developed countries, which would have varying effects on political climate of off shoring destinations. And the fourth, most important, world economy has become intrinsically dependent on energy states like Russia, Saudi Arabia etc that are troubled by continued political instability.
A nation’s stability is measured by two factors, ability of political leadership to enforce its policies despite risks and, second, capacity to avoid shocks both internal and external. If a nation has both these capabilities then it is more stable. Similarly, stability also depends on how open or closed the political structure is. US owes to its stability to its open-state whereas North Korea, Myanmar & Cuba, perhaps, to their closed structure. An interesting study would be to watch the future trends in China which is stable because of its politically closed-state though they follow an open-state in the economic front.
Immediate concerns to investment strategists is assessing the shock factor i.e. likelihood of a shock? will it occur? and if it occurs, what is at stake? The effects of shocks are different for different countries. For North Korea it may be great whereas in Cuba it may be marginal depending upon what their market offers are.
Measuring political risk factors is a tedious process because of the complexities of the variables. However, analysts have developed a 0-100 scale (from a failed state to a stable democracy) for arriving at political stability of nations based on carefully selected 20 inddicators, according to both structural and temporal components, oraganised into four subcategories i.e. government, society, security and economy and then aggregated to a composite index. As per this India falls in the category of more stable state, Us in the most stable group and countries like Afghanistan, North Korea, etc in the less stable lot. Companies use these analyses for making decisions on type of industry, strategy and risk tolerance profile.
Once companies decide about investments then they have to find ways and means to minimise the risks involved. Some of the measures taken are less R & D efforts in high risk countries with low intellectual property protection, insurance against political turmoil, currency inconvertibility etc. However, high political risk factor in underdeveloped countries is not a major concern since negative shocks cannot unstable them further. For investors looking for greener fields in foreign countries understanding the matrix of economic as well as political risk factors are absolutely inescapable.