We who analyze political risk across countries usually look first at big events: terrorism, civil and international war, political repression, uprising, etc. On this, the two extremes of the spectrum are very easy to identify. The stable democracies score high, like the United States or Sweden or Botswana. The other side, such as DR Congo, Somalia, or Pakistan, scores low.

But how do you look into political risk within those relatively stable countries where there is no overt conflict?

You need to get deeper into regulatory risk (the risk that regulations will change), the nitty-gritty of politics (the risk that political disagreements will affect predictable and stable economic environment), regional risk (the risk of political change within certain regions), and wildcard situations (rare but highly consequential events).

In the United States, these factors are showing some movement, as election politics confronts budget politics.

From households to the federal government, the US consistently overspends its budget. The Republicans take the contradictory fiscal position of keeping taxes low but spending gargantuan amounts on overseas wars. Democrats stay reluctant to envision cuts in entitlements and general pork.

As the 2012 election season gathers steam, Republicans and Democrats are sticking to their grounds. Republicans, empowered by the Tea Party spirit, want steep spending cuts without raising taxes. Democrats want higher taxes along with some cuts.

Meanwhile American public debt grows by $40,000 a second.

Many Americans who chant “we are #1” live in a state of denial. As one writer put it, they “think of themselves as rugged individualists in no need of state help, but they take the money anyway in health care and pensions and all the other areas of American life where the federal government spends its cash.”

Unable to find a solution, Congress just keeps on raising that ceiling. In the last ten years, Congress has raised the US debt limit ten times. The public debt has just surpassed the previous limit of 14.29 trillion, and is in dire need of a higher ceiling.

In short, the most powerful country in the world regularly uses extraordinary measures to keep the government functioning.

Both US federal governments and state governments have shut down before. This politics of debt poses an unpredictable financial risk to thousands of large and small companies that do business with the government in almost all sectors imaginable, from healthcare to finance to defense to education to housing and more.

The wildcard situation is a default on US debt obligations. Moodys, the credit rating agency, says the risk of default is low, but not “de minimis.” Expect interest rates to rise anyway.

The short of this story is that the underlying problem is not as economic as it is political. The wrangle among US lawmakers on how to tackle debt raises the risk of regulatory changes as well. And that injects uncertainty into investment decisions: whether one is thinking of buying a home, or deciding to “privatize” one’s retirement pot, or considering setting up a large factory.

The deadline is August 2. I think there’s a 99 percent likelihood that a compromise will be reached, but probably just at the nick of time. Let’s see what happens.


Where should foreign aid go?

The latest World Development Report, the flagship annual publication of the World Bank, proposes that from now on, a much bigger proportion of foreign aid should focus on issues of political conflict and justice.

This might seem natural, given all the wars, violence, terrorism, and displacement around. And political considerations have always influenced aid.

But putting political risk as the central purpose of aid is a sea change.

When the World Bank and other Bretton Woods institutions came about after the Second World War, the initial focus of multilateral aid was infrastructure. After Europe was rebuilt, attention shifted to the “Third World” under the guise of development.

This aid, all the way through the 1980s, strengthened the state much more than the society. There were two reasons for this. First, the Cold War meant that much of multilateral aid really went to prop allies and their offices, even if they were corrupt and brutal dictators. Second, the entire “development project” pushed by the West saw the state as the key dispenser of “development,” be it the provision of healthcare or education or employment.

In the 1990s, large states crumbled under people power, from Berlin to Manila, and donors shifted to the private provision of development. Human development, highlighting individual empowerment, took the scene; NGOs like Brac and Grameen expanded.

The 2000s saw an intensification of the privatization of development to a new level. “Development” was to be achieved through globalization, i.e., foreign trade and investment [1]. This was trickle-down at a world-scale: the state became detached from both planning and provision. Development goals were planned at the international level, and the grand blueprint was set by the UN’s Millennium Development Goals.

In this approach, although implementation was said to be national, the state’s role was mainly at the regulatory level: open up borders and promote an environment conducive to free global enterprise. India in the last decade was the poster child of this approach.

Now we’re back to the future. On the one hand, if conflict is the focus, then multilateral aid will become as political as it was in the height of the Cold War. Even though the potential exists for aid to be distributed on a non-partisan basis to the most conflict-prone parts of the world, history squarely contradicts that promise. Most recently, aid was suspended in Ivory Coast, as a way to punish the autocrat Gbagbo, even though a bloody civil war was raging in the country. The dispensing of aid on political grounds will never be easy.

On the other hand, a conflict focus reinforces the neoliberal idea of development as a global private enterprise. Aid will aim to bring political peace. Once that happens, the hope is that all else will fall in place: MDGs will determine overall targets, the state will (de)regulate to allow private trade and investment to flourish, and development will be the by-product of growth.

The overall logic of conflict and security makes sense. Neither state-led nor private-led development can take place under high political risk. A main challenge will be to ensure that aid is non-political, even though aimed at politically combustive situations. Over the next few blog posts, I will discuss some of the specific challenges and opportunities of targeting foreign aid at reducing political risk.

1. Philip McMichael discusses this changeover from development to globalization in Development and Social Change: A Global Perspective (Pine Forge Press, 2007). Highly recommended.

The US House of Representatives has just conducted hearings on “The Extent of Radicalization in the Muslim Community and That Community’s Response.” The overall premise of the hearings is directly relevant to the subject matter of this blog: local risks posed by the globalization of trends, or in this case, the globalization of extremist concepts.

The hearings were criticized on many levels, including racial profiling, persecution and vilification. The credentials of the chairman, Peter King, have also come under fierce criticism, including his well-known knee-jerk aversion to Muslims. (I call it “knee-jerk” because it is not based on evidence and analysis, but simple assumptions .) 

But my topic of interest here is risk analysis. Radicalization of Muslims was assumed to pose threat to society, and I hoped that the hearings might shed light on that. But after having followed the hearings, I shudder to say: if this represents the standard of risk assessment by the vaunted Committee on Homeland Security, then we have a lot to feel insecure about.

They hearings were one-sided; no “expert” respected by both aisles was invited. They dealt with loose anecdotes. They did not provide, nor methodically analyze, actual data and overall trends, from which one can make an informed and intelligent assessment and forecast. In the end, they were, as James Zogby noted, a “shameful” waste of public resources.

But, the hearings got wide support from the political right. Why? Over the last decade, low-quality media commentary, violent images, and existing prejudices have together created an environment where the word “Islam” automatically connotes high risk to many. No analysis needs to be done; it’s a foregone conclusion that Muslims pose political and security risks.

I’m not just claiming that. There’s ample poll data to show how attitudes toward Muslims have evolved, especially on the political right. But instead of becoming better informed about the true risks, the political right has become ill-informed about the supposed risks, and prone to replace analysis with reactionary judgements. My recent article in The Huffington Post, “The Congressional Hearings That Are Really Needed,” talks about this problem.

The article argues, in sum, that a divergence has happened in America. On one hand, Muslims in America have become more integrated, both in terms of wealth and attitudes, into the mainstream than Muslims in other Western countries. On the other hand, the deteriorating quality of US media has made the majority believe that the opposite is true. What’s really needed are Congressional investigations of these two trends, because that, not wholesale radicalization, is what’s happening in reality. And you can’t do risk analysis without first basing it on real-world trends.

Read the full article here. Comments, feedback, sharing, as always, are welcome.

The revolts on the Arab street have occasioned a renewed interest in the measurement of political risk. And businesses are paying greater attention to political risk analysis. Both are good news. But is it just passing interest, or will this result in real innovations in risk analysis?

Typically, business analyses of political risk have involved a blend of political indices, such as those provided by Freedom House or the Heritage Foundation or the World Bank, with qualitative analysis focused on specific industries. While informative, these dwell on past and ongoing trends and events, which are then extended to forecast the future.

What has lacked is real understanding of theory. Without it, we cannot understand causality, and without knowing “why men rebel” (the title of a classic political science book), we really cannot understand the risk of rebellion and upheaval, let alone forecast it.

The point of departure of risk analysis, therefore, should be theory, especially theories of revolution. This is where political scientists, and social scientists in general, can make a real contribution to a field dominated by actuaries and financial forecasters. 

In this effort, The Economist made excellent inroads recently. Its humorous-but-apt “Shoe-Thrower’s Index” begins with theory, then garners related indicators, and then produces a risk-ordered list of countries in the Middle East. It’s not complete, but it’s a great start.

The Shoe-Thrower’s Index identifies several factors as causal in the chain of rebellion. All these are established by the social sciences. It then attaches different weights to the factors, as shown in the table.

The higher the total for a given country, the greater its risk of political instability. According to this, Yemen, with a score of over 80, is the riskiest country in the region. Next are Libya, Egypt, Syria, and Iraq, all with scores of over 60. UAE, Kuwait, and Qatar are at the lower end of the spectrum.

There are two main weaknesses in this index. First, as The Economist itself admits, it discards factors that are “hard to quantify,” including unemployment information because they’re not comparable across the countries in the region. This quantitative bias is typical of many risk approaches. More qualitative factors such as ideological motivation or support (such as between Islamism or secularism), leanings of leaders (such as between non-violence or violence), leanings of the armed forces, control over governmental employees, and ideas of justice/injustice are important predictors of not just the occurrence of instability but the duration and extent of it.

The Economist also overlooks the fact that some of the indices it uses as sources of quantitative data, such as those of corruption or democracy, are really qualitative information, drawn from people’s subjective perceptions or opinions. These are merely disguised and presented as quantitative data by attaching numbers to survey responses. Pronouncing a flat-out preference for quantitative data, therefore, is misleading.

The second important factor, which can be both quantitiative and qualitative, not included in the index is “resources.” Political scientists have shown that revolts, and specifically democracy movements, are critically dependent on organizational, technological, and infrastructural resources available to protesters. Simply put, without access to technology, such as Twitter, Facebook, or satellite TV channels, all the other “factors” may not have produced the type of instability that is sweeping through the region. Resources allow isolated show-throwing to snowball into concerted political upheaval.

In any case, the type of risk-indexing exercise that The Economist undertook is definitely a solid step in the right direction. To further improve our understanding of political risk, we need to start weighing in additional qualitiative factors.

A lot of worry is making the rounds about “Political Islam.” Some of it is valid, some a function of what may be termed the unknown. But the extreme form of the worry, the one that gets inordinate media time, is nonsense. And as a basis for making policy, it is not just nonsense but downright dangerous.

It goes like this: the West should oppose Islamist parties from gaining power because even if they gain power electorally, they will break down democracy, like the Nazis did in 1932-33. The political risk, therefore, is so great that democracy itself can be opposed on principle.

This conception of political risk does disservice to proper analysis because it is not based on evidence and logic. It is based on prejudice. And that is something that all risk analysts should avoid.

I recently wrote an op-ed piece in The Huffington Post debunking this supposed political risk. Here are some excerpts from that:

For decades, Americans have been peddled a scenario with two scary arguments: Islamist electoral takeover is first of all very likely, and once victorious, Islamist parties would dismantle democracy altogether.

What has happened in reality is quite the opposite.

Across the world’s 47 Muslim-majority countries, 154 national elections were held between 1990 and 2006. Out of these, Islamist parties won only 12 elections.

If we only consider only those elections that were free and fair, that is, a reflection of popular will, then only three resulted in a victory by an Islamist party.

The specter that produces right-wing nightmares has been extremely rare.

What about the second part of the argument? Was democracy reversed in the three cases in which Islamist parties won fair and square?

Read more here to find out.

In the past I’ve touched on the risk of urban unrest (e.g., here). Over the last two years I’ve seen that risk increasing around the world, even though some central banks asserted that the world is on an economic recovery and that the worst of the dangers have passed. That assertion, to me, felt like a sort of ostrich syndrome, by-product of a type of thinking that focuses most energy on economic growth and marginalizes the importance of politics.

Tunisia, Algeria, and today, Egypt are now examples of what I’ve been forecasting: urban political rebellions fueled by issues neglected by the economic status quo.

Tunisia’s Jasmine Revolution was sparked by a young man, Mohamed Bouazizi. He was unable to find a job in Tunisia’s stratified economy, in which a small elite governed with an iron fist, pursuing the philosophy that the government does not owe all that much economically to poorer citizens. He took to selling fruits and vegetables, and even in that, found himself having to pay bribes to corrupt officials. Enough was enough. He doused himself in gasoline and set himself alight. He also set alight a wave of rebellion–the Jasmine Revolution–that overthrew, within a month, a government that had ruled for more than 23 years.

In streets across Algeria, protests against high food prices, corruption, and unemployment have been gaining strength. The government has calculated that in order to survive it needs to accelerate a large public spending program to reduce popular grievances. It remains to be seen whether this suffices. The IMF has warned that to sustain this, Algeria’s economy would need to grow at least 6.5 percent a year.

In Egypt, economic conditions and Mubarak’s decades of sharp political repression have combined into street rebellions. It’s going on as I write: young protesters throwing stones and setting trucks ablaze, and riot police lobbing tear gas and charging the crowds with batons.

What was once a forecasted risk across the region is turning into reality.

One root of this, obviously, is the existence of repressive governments. The other two roots of the anger are the pursuit of conservative economics and the effects of Western foreign policy.

Neoclassical growth-focused economic policy has always discounted the political risks of globalization. In more places than ever before, national economic policy agendas are influenced primarily by a small segment of the financial community and its interests. In the US, Wall Street’s interest to maximize stockholder value has defined its general stance in favor of a small hands-off government. In conversations I’ve had with adherents of neoclassicalism, I’ve often been surprised to see how fanatically this interest is defended as uncompromisable, sacrificed or de-prioritized only at the peril of bringing down the economy.

In most developing countries, the capital market is not as thoroughly organized, nor able to exert such a continuous level of top-grade lobbying power. But the underlying philosophy recognizes growth as the core value. In this philosophy, globalization replaces development. The role of government is to create the conditions under which internal and external exchanges can take place fluently. It is an interest that serves first and foremost the investors and only then the broader public, if it trickles down at all. (Unless you believe in the grand myth that what’s good for investors in invariably good for the populace.)

The problem is not economic growth per se. Growth certainly is needed. The problem is setting Growth up on a pedestal, such that other national priorities are subsumed under it. And this is a world-scale issue. Never has trickle-down theory been so widely accepted within governments across the world. It is much more entrenched now than it was when Ronald Reagan and Margaret Thatcher pursued monetarism as a goal for Western economies. They had to face more vigorous intellectual and policy opposition than what monetarists face today. Neoclassical economics has become established by now not only in the US, but in emerging markets too as an accepted belief that no longer needs defense. (My book, India’s Open-Economy Policy, demonstrated how this ethic or value got entrenched in India in the last decade and a half.)

Promoting growth as value #1 has resulted in a severe neglect of food, healthcare, education, and social stability as direct policy arenas. Governments have taken a backseat in all, believing increasingly that the markets should take care of these. Surprisingly, the mortgage-securities-led recession did not dampen this sentiment. Government’s role here is restricted to performing a bail-out, and not any wider. Government role in food, healthcare, and education have come under fire as instances of big government, whether you consider the Tea Party rant in the US, or public employment in Algeria, or food and fuel subsidies in Jordan.

The political ramifications are stark. The pace of change in Tunisia, for example, has been breathtakingly rapid. As one stunned newspaper editor in Tunis remarked: “Its like night and day, black and white. The changes of the last week have been so huge and rapid, we think we are dreaming.”

America has chosen the right side with a pro-reform and pro-liberty stance in the region. Two aspects of the wider risk picture, however, remains the same. First, citing its security and energy interests, the US has historically suppored most of the Arab repressive regimes that are now in peril. And second, the US has, in the process, lost credibility on the Arab street. According to a 2010 Brookings Institute poll, only 16 percent of the Arab population is hopeful about America’s Middle East policy. In the past, Arab citizens used to dislike US policy but like Americans as a people. The trend has converged dangerously in recent years. A majority now sees both US policy and Americans unfavorably. It’s this majority that’s on the streets now, revolting.

So, we know that monolithic US-backed Arab states face greater political risk. But so does the United States. And mitigation of this particular risk will require a fundamental shift in US foreign policy. Will US policymakers overlook the profound ramifications here, as some Arab tyrants did, to serve narrower interests? Let’s hope not.

In the last post, I wrote primarily about political risks from the allocation of money: the government’s budget on the one hand, and individual income on the other. I argued that political risk in the medium term (5-10 years) will depend on how these two factors combine. In addition, there is one certainty that will raise the risk profile no matter which scenario materializes. This is what today’s post is about: the certainty of America’s population profile.

One type of demographic certainty is rooted in what’s known as the demographic transition theory: As societies become richer, the death rate of its population falls fast, followed much later by a fall in birth rates. Emerging markets experience a surge in people of productive age, which helps them grow real fast when combined with capital accumulation. The mature markets, with falling birth rates, lose their dynamism as the population becomes grayer.

All advanced industrial countries now confront political risks from demographic stagnation. One aspect of this involves resource transfer. Young people need to be taxed more to support rising numbers of the elderly. The elderly tries to keep this support intact by coming out to vote in large numbers during elections. In the US, every general election between 1972 and 2008 elicited greater turnout (%) from the older segments of the population than the younger segments. In the 2008 election, in which youth participation was the highest, 56% of citizens in the 18-44 years age range voted. 66% of citizens in the 45 and above age range voted. The total citizen population in the second category, by the way, exceeds that of the first category. (Calculated from US Census Bureau data.) 

Generational tussle over transfer of resources, therefore, is a certainty. (A side point: the young has tended to vote more for Democrats, and the old for Republicans.

The second aspect of the demographic certainty concerns immigration. In order to remain economically productive, the richer countries have no recourse in the medium term other than importing people from labor-surplus countries. Even though immigrant workers expand the tax base, and therefore the welfare resources available for the older generation, the greater cultural conservatism of the older generation views immigration with hostility. The older generation has voting power. Younger immigrants usually have no voting rights.

Look at Arizona, for example. 83% of the elderly in Arizona are white, and 42% of people under 25 are Hispanic. If they become citizens–a giant “if” for many of them–will they tolerate yielding a good chunk of their income to pay for the hostile elderly? Conversely, as the Economist wonders, will the old want to surrender some of their earnings to pay for public education and state universities where most of the immigrants go? While the outcome of these questions is uncertain, what is certain is that immigration politics will become nasty in an increasing number of states. Arizona, in my opinion, is the tip of the iceberg.

Demographic trends have shifted economic and political power among the states as well. As the Economist notes, “Of the 20 oldest states in 2009, 14 were in the north-east and Midwest. The sunbelt, in contrast, was home to eight of the ten states with the highest concentration of youth.”  The northeast will have fewer congressional seats and less say in presidential elections. Will the sunbelt continue to tolerate federal resource transfers to support the growing elderly in the north? The north will have to keep immigration-friendly policies to ensure an adequate economic base.

The south and the west will experience rapid population growth. The typically more conservative south will experience greater political clashes rooted in both generational and cultural gaps. So these regions will be economically more vibrant but also politically more volatile. The result will be polarization rooted in demography. Let me quote again from the Economist’s article, “One nation, divisible”:

All these conflicting interests are helping to polarise further America’s politics. In the 1976 election … 26% of voters lived in counties where one party won by 20 points or more. In 2008 a whopping 48% of voters did so. Strikingly, less than 400 of America’s 3,141 counties switched parties at the 2008 election. Politicians, like marketers, have become adept at identifying likely customers. “Bringing out the base” is the key to winning. As a result of this polarisation, satisfying a range of constituents is becoming harder. The federal stimulus revealed this well. The bail-out gratified some Wall Street bankers. Aid to state governments mostly helped workers in capital cities. But voters in places with battered housing markets got little benefit from either. James Gimpel, a political scientist at the University of Maryland, notes that areas with high rates of foreclosure, such as suburban Atlanta, were hotbeds of tea-party activism.

To me, greater political conflict, in localities around the US, between an influx of young immigrants and a larger proportion of graying population is a certainty in the medium term. During the national voting season every two years, what will transform the myriad local conflicts into election results is the voting pattern of younger citizens. They have tended to lean slightly closer to their immigrant friends than to their parents and grandparents. Will they continue to do so?