Indicators of political instability

To assess a potential marketing environment, a company should identify and evaluate the relevant indicators of political difficulty. Potential sources of political complication include social unrest, the attitudes of nationals, and the policies of the host government.

The breakup of the Soviet Union should not come as a surprise. Human nature involves mono- stasy (the urge to stand alone) as well as systasy (the urge to stand together), and the two concepts provide alternative ways of using resources to meet a society’s needs.²⁹ Monostasy encourages

competition, but systasy emphasizes cooperation. As explained by Alderson, “a cooperative society tends to be a closed society. Closure is essential if the group is in some sense to act as one.” Not surpris- ingly, China, although wanting to modernize its economy, does not fully embrace an open economy, which is likely to encourage dissension among the various groups. For the sake of its own survival, a cooperative society may have to obstruct the dissemination of new ideas and neutralize an external group that poses a threat. China has appar- ently learned a lesson from the Soviet Union’s experience.

A liberated political climate can easily lead to a call of the long-suppressed national minority groups for cultural and territorial independence. The groups’ past conflicts, unsettled but subdued during the communist period, are likely to escalate. Three kinds of conflict may result.³⁰ First, a domestic dispute may escalate into violence that is confined within the boundaries of the country in question. The civil war that started in 1991 between Serbs and Croats inYugoslavia is a good example. Another example is the centuries-old ethnic animosity between Christians in Armenia and Muslims in neighboring Azerbaijan, which led some 600

Armenian nationalists to clash with Soviet soldiers during earthquake rescue efforts in Armenia. Second, an internal dispute may draw interested parties outside the country in question into the conflict. For example, problems in Yugoslavian Macedonia may force Bulgaria and Greece to inter- vene. Finally, the third form of conflict, resulting either from the first two kinds of conflict or from an international dispute, may lead to a direct con- frontation between two countries. Romania and Hungary, which have deep-rooted grievances against each other, could become involved in this form of conflict.

Attitudes of nationals

An assessment of the political climate is not com- plete without an investigation of the attitudes of the citizens and government of the host country. The

nationals’ attitude toward foreign enterprises and citizens can be quite inhospitable. Nationals are often concerned with foreigners’ intentions in regard to exploitation and colonialism, and these concerns are often linked to concerns over foreign governments’ actions that may be seen as improper. Such attitudes may arise out of local socialist or nationalist philosophies, which may be in conflict with the policy of the company’s home-country government. Any such inherent hostility is certain to present major problems because of its relative permanence. Governments may come and go, but citizens’ hostility may remain. This kind of problem may explain why twelve US firms decides to leave El Salvador in the 1980s. Their departure meant the loss of some 20 percent of US capital investment in that country.

Policies of the host government

Unlike citizens’ inherent hostility, a government’s attitude toward foreigners is often relatively short- lived. The mood can alter either over time or with a change in leadership, and it can alter for either better or worse. The impact of a change in mood can be quite dramatic, especially in the short run.

Government policy formulation can affect busi- ness operations either internally or externally (see Marketing Ethics 4.1). The effect is internal when the policy regulates the firm’s operations within the home country. The effect is external when the policy regulates the firm’s activities in another country.

Although an external government policy is irrel- evant to firms doing business in only one country, such a policy can create complex problems for firms doing business in countries that are in conflict with each other. Disputes among countries often spill over into business activities. A company in one country may be prohibited from doing business with other countries that are viewed as hostile.

A company should pay particular attention to election time. Elections post a special problem because of many candidates’ instinctive tendency to use demagoguery to acquire votes. Candidate

MARKETING ETHICS 4.1 A NECESSARY EVIL

The military junta of Myanmar (Burma) is viewed with disdain and disgust in most parts of the world – except by the governments of India and Thailand. While India is the world’s largest democracy, it does not mind doing business with the Myanmar dictator- ship. To India, it is a matter of necessity. India recog- nizes that its two threats, China and Pakistan, supply defense equipment to Myanmar. As a result, it feels compelled to engage Myanmar’s military regime in a friendly way. India has been quiet about the military junta’s policies toward Aung San Suu Kyi and has assisted Myanmar in building crucial border roads.

In spite of worldwide pressure and condemnation, Thailand has refused to join the world community in demanding the Burmese rulers to end their violent oppression of their own people. Thailand’s prime

minister, Thaksin Shinawatra, even stated that he

would side with Myanmar. His deputy prime minister unabashedly proclaimed: “China and Thailand are Burma’s good allies.” This position is surprising, given the Rangoon government’s hostile attitudes toward Thailand. Could it be that the prime minister, who also happens to be a business tycoon, is supporting the Burmese dictators for personal (i.e., business) reasons? As commented by the Bangkok Post, “In the future, when the military dictatorship collapses, as they all do, Thailand will be singled out as a junta- friendly reason for the delay in democracy. This will affect the treatment of Thailand and Thais by the next Rangoon government.”

Sources: “India’s Relations with Burma a Necessary Evil,” Times of India, October 19, 2000; “Editorial: On the Wrong Side of the Burma Issue,” Bangkok Post, September

9, 2003.

activities and tactics can very easily create an unwel- come atmosphere for foreign firms. When French politicians cited the fact that one French worker became unemployed for every five to ten Japanese cars imported, the government held up imported cars when the election was a few weeks away. The industry minister used every conceivable excuse to avoid signing the required certificates.

The use of unfriendly rhetoric before an election may be nothing but a smokescreen, and the “bark” will not necessarily be followed by a “bite.” In such cases, a company need not take drastic action if it is able to see through the election. Ronald Reagan, long an advocate of free trade, became something of a protectionist immediately before his re-election in

1984. After the election, a policy of free trade was reinstituted. Therefore, a company must determine whether early threats are just that and nothing more or whether such threats constitute the political can- didates’ real intention and attitude for the future.

One theory focuses on the cooperation-based relations between MNCs and host government. There are four building blocks that will allow MNCs

to improve their cooperative relationships with gov- ernments: (1) resource commitment, (2) personal relations, (3) political accommodation, and (4) organizational credibility. A study of 131 MNCs in China confirms the importance of these blocks.³¹

One model proposes that organizations may employ three political strategies: information, financial incentive, and constituency building.While an MNC may have a particular global strategy when dealing with governments, its subsidiaries may still have to employ specific activities in host-country contexts. As such, a subsidiary’s response must be consistent with a host country’s characteristics as well as with the imperatives of the headquarters. The more integrated a subsidiary is with its affiliates in a strategic sense, the greater it is integrated with the other subsidiaries in a political sense.³²

ANALYSIS OF POLITICAL RISK OR COUNTRY RISK

Although political scientists, economists, business- people, and business scholars have some ideas about

what political risk is, they seem to have difficulties agreeing both on its definition and on methods to predict danger. Perhaps due to this lack of agree- ment on the definition, many different methods have been employed to measure, analyze, and predict political risks.

Political risk is an uncertainty that stems from the exercise of power by governments and non-gov- ernmental actors. Typical hazards include political instability, politicized government policy, political violence, expropriation, creeping expropriation, contract frustration, and currency inconvertibility.

Some assessment methods are country specific in the sense that a risk report is based on a particular country’s unique political and economic circum- stances. As such, there is lack of a consistent frame- work that would allow comparison across countries. Since an MNC must decide to allocate resources based on potential opportunities and risk associ- ated with each country, a common methodology is essential.

Even when a systematic attempt is made for cross-national comparisons, the methods used vary greatly. Some are nothing more than checklists con- sisting of a large number of relevant issues that are applicable to each country. Other systems rely on questionnaires sent to experts or local citizens in order to gauge the political mood. Such scoring systems, which permit numerical ratings of coun- tries, have gained acceptance. Some institutions have turned to econometrics for this purpose. Marine Midland Bank, for example, uses econo- metrics to rate various countries in terms of eco- nomic risk. The method, however, is not perfect.

To many small- and medium-sized firms, doing their own country-risk analyses is out of the ques- tion because of the cost, expertise, and resources required. However, there are some alternatives that can provide a useful assessment of political risk. One is to interview people who have some know- ledge or experience with the countries of interest, including businesspeople, bankers, and government officials. Molex Inc., a manufacturer of high-tech- nology electrical products, has been able to protect itself by listening to international bankers, lawyers,

and accounting firms. Another method is to rely on the advice of firms specializing in this area. Controlled Risks, a Washington area firm, advises about 400 US companies on the danger of doing business in seventy countries. For fees that can total

$9000 a year, the firm offers information and pro- vides training for executives on how to protect themselves, cope with kidnapping and extortion, and guide their employees in political crises.

Many banks can help their clients to assess busi- ness risks overseas. Bank of America, for example, provides international economic analyses and fore- casts to customers through World Information Services (WIS). Subscribers of WIS receive Country Outlooks, Country Data Forecasts, and Country Risk Monitor. Bank of America uses a ranking system based on a common set of economic and financial criteria to evaluate eighty countries for business risk. In addition to current rankings, a ten- year historical track of each country is also shown. Country Risk Monitor allows risk comparisons of countries with benchmark risk indicators for major country groupings. Updates are regularly provided.

According to one study, in evaluating country creditworthiness, banks use both political instabil- ity and economic variables, with larger weight assigned to economic variables.³³ In other words, perceived country creditworthiness is a function of a country’s economic performances which reflect longer term political stability. The credit ratings are also affected by the two proxies for political insta- bility: armed conflicts and the frequency of changes in the regime.

Another alternative is to subscribe to reports prepared for this purpose. One valuable report is the country credit rating prepared by Institu- tional Investor magazine. Based on a survey of approximately 100 leading international banks con- cerning a country’s creditworthiness and the chance of payment default, rankings are assigned to 100 countries every six months. Greater weight is given to the responses of those banks that have the largest global exposure and which possess the most sophis- ticated systems of risk analysis. Yet the loan prob- lems encountered by the Bank of America and

Citicorp make it clear that the risk-analysis systems used by some of the world’s largest banks are any- thing but foolproof.

Another relatively simple method is based on LIBOR (London Interbank rate). LIBOR, rel- atively risk-free, is the interest rate charged for loans between banks. Nonbank borrowers, of course, have to pay a premium over LIBOR, with the premium (i.e., the spread between the loan rate and LIBOR) indicating the extent of risk involved. A borrower from a country with a high risk of default must expect a high premium. The premium is thus a good indicator of risk because it reflects a lender’s assessment of the country in terms of debt levels and payment records. Since all loans are not comparable, adjustment must be made for volume and maturity. Euromoney magazine has devised a formula to allow for this adjustment, and its formula to compute a country’s spread index is the following:

[(volume X spread) / Euromoney index] / (volume X maturity)

By simply examining the spread index of a particu- lar country and comparing it with those of other countries, an investor can arrive at the conclusion of a degree of risk associated with the country of interest.

Although Euromoney’s and Institutional Investor’s country risk ratings are derived in different ways, the two measures are highly correlated and strongly agree on the creditworthiness of the assessed coun- tries. Both magazines’ ratings can be replicated to a significant degree with a few economic variables. “In particular, both the level of per capita income and propensity to invest affect positively the rating of a country. In addition, high-ranking countries are less indebted than low-ranking countries.”³⁴

One study examined the projections of The Economist, Political Risk Services (PRS), and BERI (Business Environment Risk Intelligence) against losses incurred in the 1987 to 1992 period.The PRS predictors, when decomposed, appeared to be the most reliable. On the other hand, BERI’s projec- tions were superior to The Economist’s.³⁵

One study examined eleven widely used mea- sures of country risk across seventeen countries over nineteen years. According to the results, “com- mercial risk measures are very poor at predicting actual realized risks.” Yet managers still continue to rely on ratings agencies. One reason is that the purchasing cost of this type of information is minis- cule when compared to the amount of FDI to be committed.³⁶

As assessment methods of political risks have become more sophisticated, there has been a shift from the earlier conceptual and qualitative approaches to those that are quantitative and deriv- ative of applied research. There is a need, however, to integrate these two major kinds of approaches.

MANAGEMENT OF POLITICAL RISK

To manage political risk, an MNC can pursue a strat- egy of either avoidance or insurance. Avoidance means screening out politically uncertain countries. In this, measurement and analysis of political risk can be useful. Insurance, in contrast, is a strategy to shift the risk to other parties. This strategy will be covered in detail below.

There are other strategies that MNCs can use to safeguard their foreign investments. They may want to come to an understanding with a foreign gov- ernment as to their rights and responsibilities. They can increase and maintain their bargaining power when their technical, operational, and managerial complexity requirements are not within reach of a host country’s abilities.

In addition, there are several managerial strate- gies which are relevant. A firm may try to gain “con- trol” of the situation through political activities, market power, exchange of threats, vertical integra- tion, and horizontal mergers and acquisitions. Or it may try to gain “cooperation” through long- term contractual agreements, alliances, interlocking directorates, interfirm personnel flows, and so on. Furthermore, it may pursue product and/or geo- graphic diversification to gain “flexibility.” Opera- tional flexibility can also be achieved through flexi- ble input sourcing and multinational production.³⁷