The Political Environment facing business

Political Environment (Domestic or Foreign Political Factors) includes any domestic and foreign political factors which may affect the organization’s decision making, planning, implementation and control mechanisms. Marketers have to work within the framework of each country’s ruling parties in which they operate.

Each nation has a unique political culture that:

• reflects the relative importance of the government & stability of the market environment
• determines how the legal system works
• contextualizes individuals’ and corporations’ relationship to the political system

Since, global marketing activities take place within the political environment of countries, any company doing business globally should not only carefully monitor the political culture in the domestic market, but also in host markets.

Political System

A Political system is the complete set of institutions, political organizations, and interest groups, the relationships amongst those institutions, and the political norms and rules that govern their functions. The ultimate test of any political system is its ability to hold a society together.

Ways to Assess Political Systems

Individualistic: People accept the primacy of an individual’s freedom in the political, economic, and cultural realms. The people believe in minimal government intervention.

Collectivist: People reason that the needs of society take precedence over the needs of the individual people believe that it is the government’s role to define the needs and priorities of the country. Collectivist paradigms may be either democratic (as in Japan) or authoritarian (as in China) in nature.

The political ideology refers to the body of constructs, theories, and aims that constitute a sociopolitical program. Pluralism indicates the coexistence of a variety of ideologies within a particular society. Shared ideologies create bonds within and between countries whereas differing ideologies split societies apart.

Types of Political Ideologies

• Democracy: widespread citizen participation in the decision-making and governance processes, either directly or through elected representatives
• Totalitarianism: the monopolization of power by a single agent; opposition is neither recognized nor tolerated. In theocratic totalitarianism, religious leaders are also the political leaders; in secular totalitarianism, the government imposes order via military power.

Features of Contemporary Democratic Systems

In a Democracy, there is freedom of opinion, expression, and the press; there is freedom to organize; there are free elections; there are limited terms for elected officials; there is an independent and fair court system; there is a nonpolitical bureaucracy and defense infrastructure, and the citizens have access to the decision-making process.

Trends in Political Systems

Totalitarian regimes continue to fail as citizens challenge the right of the state to govern. Many who champion democracy truly believe that greater political freedom also leads to economic freedom and higher standards of living.

Differentialism, i.e., the clash of civilizations, refers to the arguments that apparently innate and irreconcilable difference amongst cultures can trigger a backlash against Western ideas regarding political rights and civil liberties.

Understanding Political Risk

Political risk refers to the likelihood that the political climate in a country will change in such a way that a firm’s operating position or investment value will deteriorate. MNEs do their best to effectively deal with the threat of political risk through active and/or passive approaches.

Various types of Political Risks (from least to the most destructive)

• Systemic [a change in public policy]
• Procedural [bureaucratic delays, labor disputes, etc.]
• Distributive [tax and regulatory revisions]
• Catastrophic [random political events]

Leading Sources of Political Risk include Expropriation or nationalization, International war or civil strife, Unilateral breaches of contract, Destructive governmental actions. Harmful actions against people. Restrictions on the repatriation of profits, Differing points of view, Discriminatory taxation policies.

Political Risk

What is Political Risk?

Political risk is the possibility of a change in a country’s political environment or government policy that would adversely affect a company’s ability to operate effectively and profitably (Keegan and Green, 2020).

The presence of political risk means that a foreign firm can lose all its investment or market earnings in another country as a result of political actions on the part of the host government, the firm’s home government, or pressure groups. The political climate of a country is hardly ever static (Gillespie and Hennesey, 2016).

Why Monitor Political Risk?

Politcal risk can deter or encourage a company from investing abroad.

Managers must continually monitor the government, its policies, and its stability to determine the potential for political change that could adversely affect operations of the firm and investment decisions.

There is political risk in every nation but the range of risks varies widely from country to country.

In general political risk is lowest in countries that have a history of stability and consistency.

Its important for managers to understand the different goals and functions of various political systems, to understand the trends in the emergence and diffusion of political systems, to understand the political risks and approaches to managing it, and in general to understand how different political systems affect the conduct of business.

Measuring Political Risk

Crucial factors that firms need to observe as part of assessing Political Risk:

• Change in government policy
• Stability of government
• Quality of host government’s economic management
• Host country’s attitude towards foreign investment
• Host countries relationship to the rest of the world
• Host country’s relationship with the parent company’s home government
• Attitude towards the assignment of foreign personal
• Closeness between government and people
• Fairness and honesty of administrative procedures.

EIU (The Economist Intelligence Unit): War, Social Unrest, Politically Motivated Violence, International Disputes, Change of Government, Corruption, Crime.

BERI (Business Environment Risk Intelligence): Fractionalization of the Political Spectrum. Fractionalizations by Language, Ethnicity, Religion. Coercive Measures required to retain Power. Mentality (Corruption, Nepotism). Social Conditions. Social conflict (demonstration, strikes, street violence). Dependence on major Hostile Power.

Types of Political Risk

• Ownership Risk – refers to property and life
• Operating Risk – refers to disruptions of the ongoing operations of a firm
• Transfer Risk – occurs when companies want to transfer capital between countries

Ownership Risk:

Expropriation

This is the most drastic form of political risk. Official seizure of a foreign company by a government. Compensation is generally provided although often not in a prompt, effective, and adequate manner. If no compensation is provided the action is referred to as confiscation. International law is generally interpreted as prohibiting any act by a government to take foreign property without compensation.

Nationalization

Nationalization is typically broader in scope than expropriation. It occurs when the government takes control of some or all of the enterprises in a particular industry. International law recognizes nationalizations as a legitimate exercise of government power as long as the act satisfies a “public purpose” and is accompanied by “adequate payment”.

Domestication

Also called creeping expropriation. It is a process by which controls and restrictions placed on the foreign firm gradually reduce the control of the owner. These controls include: more products produced locally; gradual transfer of ownership to nationals; promotion of nationals to management positions. Domestications provides the host country with enough control to regulate the activities of the foreign firm carefully. The idea is that negative effects of a firm’s operations in the country are discovered and prompt corrective action can be taken.

Operating Risk:

Local Content Laws

Countries often require a portion of any product sold within the country to have local content: that is to contain locally made parts. Local content requirements are not restricted to less industrialized countries. The European Union has a 45% local content requirement for foreign-owned assemblers.

Import Restrictions

Restrictions on the import of raw materials, machines and other parts are fairly common strategies to force foreign companies to purchase more supplies within the host country and thereby creating markets for the local industry. Although this is done in an attempt to support the local industry the result is often interruption of the operations of established firms.

Price Controls

Essential products such as food, petrol, and cars are often subjected to price controls. These controls can be used by a government during inflationary periods to control the environmental behaviour of consumers or the cost of living.

Tax Controls

Taxes must be classified as a political risk when used as a means of controlling foreign investment. In many cases they are raised without warning and in violation of a formal agreements. In less developed countries where the economy is constantly threatened with a shortage of funds, unreasonable taxation of successful foreign investments appeals to some governments as a convenient and quick way of finding operating funds.

Labour restrictions

In many nations, labour unions are very strong and have great political influence. Using its strength, labour unions may be able to persuade the government to pass very restrictive laws that support labour at costs to business. In Latin America for example, unions are very strong. In Europe, many nations require labour representation on board of directors.

Transfer Risk

Exchange Control: Exchange controls stem from shortages of foreign exchange held by a country. When a nation faces shortages of foreign exchange, controls may be set into place over all movements of capital to conserve the supply of foreign exchange for the most essential uses. A problem for the foreign investor is getting profits and investments into the currency of the home market.

Examples of Political Risks

• The Great Decoupling: The decision by China and the United States to decouple in the Technology Sphere
• BREXIT
• US elections and its testing to democracy
• Discontent in Latin America
• Politics vs. Economics of Climate Change

Covid: Citizens around the world are more optimistic that life will begin to return to normal. The pandemic soon became endemic for advanced industrial economies but most countries had a harder time. The vaccines that have mostly been used in emerging markets offer little protection against infection and less ability than mRNA vaccines to protect against severe illness and death. That will deepen a sense of injustice in the developing world. Continued outbreaks will mean growth in many emerging markets will disappoint, creating a permanent gap in trajectory compared to advanced industrial democracies that further widens global inequality. 

The Great Decoupling: “THE DECISION BY CHINA AND THE UNITED STATES TO DECOUPLE IN THE TECHNOLOGY SPHERE IS THE SINGLE MOST IMPACTFUL DEVELOPMENT FOR GLOBALIZATION SINCE THE COLLAPSE OF THE SOVIET UNION.”

This decoupling will move beyond the handful of strategic technology sectors at the heart of the US-China dispute (semiconductors, cloud computing, and 5G) into a broader array of economic activity. It will affect not just the global tech sector, but a host of other industries and institutions from media and entertainment to academic research, creating a hard-to-reverse business, economic, and cultural divide. Both the US and China have demonstrated they’re willing to weaponize global trade and supply chains. When the two largest economies politicize their most important trading relationships, innovation and supply chain systems become more regional and less global.

Technopolar World

• Your personal information will be hacked. Algorithms fed with biased data will make destructive decisions that affect how billions of people live, work, and love.
• The biggest technology firms are designing, building, and managing an entirely new dimension of geopolitics. In this new digital space, their influence runs deep.
• The problems of digital governance will be magnified. The metaverse (or more accurately, multiple metaverses) in turn will increasingly rely on economic systems based on decentralized blockchain platforms that governments are already struggling to control.
• Governments can fiddle at the margins. The EU will pass new laws in 2022 that put curbs on some big tech business practices. US regulators will advance antitrust cases. China will pressure its tech companies to align with national priorities. And governments will put restrictions on the kinds of data that can leave their borders.

Politics vs. Economics of Climate Change

“THE POLITICS OF CLIMATE CHANGE AREN’T WORKING.” Nation-states have to date failed to implement policies that come close to achieving the goal set by Paris agreement . This will lead to suboptimal corporate decision-making, operational business disruptions, and political instability. Even countries whose political leaders have ambitious climate plans won’t have it easy. Some will face an anti-elite backlash to climate action, as we’ve seen in France. Others will struggle to meet existing high-bar targets, as in Germany.  Politics are on a collision course with a growing percentage of investors, companies, and society at large, which will carry higher costs this year.

How can Companies Handle Political Risk?

Development of a Political Risk Assessment (PRA) System

Who is conducting the analysis?

• Internal unit of the investing firm
• Regional managers of subsidiaries in respective host markets
• External analysts located in the particular geographic regions of interest
• Foreign policy advisors
• BERI Index

Relevant questions that should be addressed in the assessment

• How stable is the host country’s political system?
• How strong is the host governments commitment to specific rules of the game, such as ownership or contractual rights given its ideology and power position?
• How long is the government likely to remain in power?
• If the present government is succeeded by another, how will the specific rules of the game change?
• In light of those effects, what decisions and actions should we take now?

Crucial Factors to Observe: Change in government policy, Stability of government, Quality of host government’s economic management, Host country’s attitude towards foreign investment, Host countries relationship to the rest of the world, Host country’s relationship with the parent company’s home government, Attitude towards the assignment of foreign personal, Closeness between government and people, Fairness and honesty of administrative procedures.

Development of Risk Reduction Strategies

1. Working with Local Partners: Relying on local partners with contacts from the host country’s governing elite. Ranges from placing local nationals on the board of foreign subsidiaries to accepting the substantial capital participation from local investors.

2. Minimizing Assets at Risk: Financing local operations from indigenous banks which have more support from host governments. Diversify assets and markets across many countries. If losses are realized in one market, their impact does not prove devastating to the company as a whole.

3. Buying Political Risk Insurances: Companies can purchase insurances to cover their political risk. One of the ongoing difficulties involving political risk insurance is convincing MNCs that they need it before it is too late. DFC, (formerly known as OPIC), for example, offers political risk insurances in 100 developing countries. The agency covers losses caused by currency inconvertibility, expropriation, war, revolution.

Closing Thoughts

To sum it up, many countries are in a state of political transition. Presently, there is a shift away from totalitarian governments toward more democratic political ideals and freer market principles.

The past several years have brought enormous political changes to the world, changes that are affecting global marketing operations of international firms. These changes have resulted in the opening of many previously closed markets.

However, understanding political risk is key to any investment decision. “To ignore political risk is dangerous. To avoid it is shortsighted. To use it can be very profitable” (Bremmer).

Related: PESTLE analysis explained