Applied Political Risk Analysis

by

Llewellyn D. Howell

• LAST REVIEWED: 27 July 2016
• LAST MODIFIED: 27 July 2016
• DOI: 10.1093/obo/9780199846740-0101

Introduction

Political risk is the probability (a forecast, not a prediction and not a description) that some political factor like an ethnic dispute, a popular response to government repression, or a government decision on control of private enterprise, will result in a loss of some kind to a foreign enterprise operating in a country. The term political risk refers to the possibility that political decisions or political or social events in a country will affect the business climate in such a way that investors will lose money or not make as much money as they expected when the investment was made. Political risk involves asking experts on the country or specialists to describe a country’s political environment as it is defined in one of several well-vetted models used to project risk, mainly for business management and insurance purposes. Political risk as a field includes the work of practitioners and scholars who give a significant portion of their time to Political Risk Analysis. Critical for anyone who works this subject is fieldwork. That is, in order for the scholar to have some sense of what is going on at the juncture point (the subject country), they have to have spent some time there and have some sense of the culture and politics of the country. For most models, the forecast (one year, eighteen months, five years) is the important piece of political risk analysis, since current descriptions are of little use to foreign investors. In most cases, the forecast is done solely with human intelligence. Country experts are asked to give their assessments of risk in five years on the basis of a 1–7 or 1–10 scale on each of a set of variables. The cumulative scores translate into a country rating that is the basis of advice. Political Risk Assessment is that advice, given before the investment breaks ground. That is the point where, especially, some form of political risk insurance is purchased (expropriation, civil war, or sea piracy, for example) or protection is arranged with a security company on the advice of a political risk analyst or executive with commensurate skills—not after the war has started or political interference with the company has commenced. Not everyone in the field of political risk analysis needs to have had extensive field experience in the country but they all must have some understanding of what the final product is—advice about the future—and hopefully some in-country experience. Political risk analysis cannot be a wholly academic subject. Events data or mega-datasets don’t help here or even an in-depth reading of the New York Times. Theory can aid the process (every company providing political risk advice has some model it works from, if the advice is worth anything) but can’t be the sole experience of the political risk scholar. Political risk analysis is a true blend of groundwork and academia. It is important to distinguish “Political Risk” from “Country Risk.” Country risk includes, in various proportions, financial risk and economic risk. Country risk analysts frequently use macro-level datasets and have no field experience. They can work from afar, whereas political risk analysts have to work close up (i.e., with country-specific or even project-specific data). Many of the younger scholars that are interested in political risk analysis are still establishing themselves in theory and methods and are building careers requiring publications and professional papers. Political risk analysts are more likely to be working for companies that are investing abroad, for insurance companies, or for banks, and are grinding out position papers rather than academic papers.

General Overview

Virtually all of the political risk models rely on theories that have been composed in the academic world and their data come from human input (expert data) derived from the knowledge and experience of country experts, then converted into systematic entries (i.e., quantitative data) that are then translated into numerical forecasts. Political Risk Analysis is not just a description of specified current conditions, as many see it. It is, instead, a forecast—a projection—of what those conditions will be—individually and in combination—one year or eighteen months or five years from now. If there is any profession like that of a political risk analyst, it is that of a meteorologist. They project the political weather conditions and advise the user on whether to take an umbrella or not when they go out the next day. It’s not about whether it is raining now; it is about whether it will rain tomorrow. It’s a tough task in either field. It’s about probabilities, not predictions. Practitioners and academic specialists provide the human input that ultimately becomes a rating for a country like Malaysia, like a BBB, or B-, or a sixty-seven out of one hundred. These ratings are considered by investors looking at Malaysia or some other country (including the United States) to determine what they should be willing to pay as interest on loans, what kind of risk insurance they should buy, or how they should physically protect themselves.

• Howell, Llewellyn D., ed. The Handbook of Country and Political Risk Analysis. 5th ed. East Syracuse, NY: PRS Group, 2013.

  Presents a variety of models for political and country risk analysis that are currently in use as advisories to foreign investors. The models range from long-standing methods like Control Risks and the International Country Risk Guide (ICRG) to front end efforts like that of Virtual Research Associates and the Eurasia Group Global Political Risk Index. This textbook is intended for classroom use and reference on the nature of political and country risk assessment.