Political Risk

Political risk refers to the probability of loss for commercial market direct investment activity that can be attributed causally to noncommercial, or specifically governmental, politically motivated events or decisions. Originally, and still often, termed country risk or sovereign risk by analysts and business leaders, the events or decisions at issue are traditionally related to concerns surrounding the likelihood of expropriation or nationalization of a single business or an entire industry, currency inconvertibility or restrictions on convertibility, restrictions on transfer or repatriation of profits, and war or civil disturbances, related to a government's activities or decrees. Additional, more recent concerns include a wide range of nonmarket and governmentsanctioned or officially sponsored episodes, such as restrictions on export of goods or services produced, corruption (including but not limited to bribery and extortion), mistreatment of citizens (human rights), and terrorism (state or antistate in origin). Political risk analyses can then refer strategically to probabilistic losses associated with all three stages of an investment business plan: entry into a new market (initial direct investment activity), continuation in a current market (including expansion, merging, or contraction of ongoing business), and exit from a market (winding up the business and selling off assets in an orderly fashion).

While the probabilities for losses related to all such events or decisions could be calculated for investments in one's home country, the notion of political risk is typically applied only to direct investment activity in a host country—that is, where one is not a citizen. Likewise, while these calculations can be made by companies whose homes are is in either developed or developing countries, for investments targeting developed or developing host countries, the vast majority of political risk analyses are generated by or on behalf of businesses based in developed countries seeking to invest in developing host countries.

Although discussion and assessment of nonmarket risks when doing business abroad have been traceable since the beginnings of cross-border trade in the ancient world, formal political or country risk analysis as we know it today historically grew out of the mid-20th-century needs of businesses in the extractive industries, such as mining, and oil and gas companies to calculate the risks associated with operating in relatively unknown and potentially politically unstable regions of the world. Since such companies had to go where the resources were located, they needed some means to help determine whether the investment required would likely yield acceptable returns. Experience suggested that whether returns would indeed be acceptable would only be calculated properly if nonmarket risks could be folded into their business plans. It was not enough, for example, to discover an oil field with sufficient proven reserves to be profitable after explorations were conducted if its operations subsequently would be expropriated once the plant was built and functioning as planned, or if the recovered oil was restricted to host-country use at government-mandated subproduction cost prices, or if profits could not be converted into one's home currency and repatriated.

Attempts to calculate and address these concerns have led (and continue to lead) to some normatively perverse incentives and outcomes: Generally, political risks are easier to identify and key political actors more amendable to influence under dictatorships than democracies, where transparency is limited and reforms are difficult to enforce, and managing risks and opportunities in such environments suggests that government stability is more desirable than overall economic growth for the country. Corruption is consequently a closely related concern, especially since empirical studies hint at but fail clearly to establish direct negative impacts between decisions by corrupt regimes of whatever political stripe concerning business investments and a country's economic development. See, for example, the work of Transparency International through its annual Corruption Perceptions Index for data related to business perceptions.

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