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Posts Tagged ‘Political Risk’

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.

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Affluent countries have become increasingly interested in softer, fluffier research. David Brooks wrote in the New York Times today that people are more interested in understanding things like happiness, trust, and security–but in ways that are meaningful rather than just by statistics. This shift is not easy though. Brooks writes:

[M]odern societies have developed vast institutions oriented around the things that are easy to count, not around the things that matter most. They have an affinity for material concerns and a primordial fear of moral and social ones.

The attempt anyhow is welcome news to me for two reasons. First, a good portion of my own research, taken from an angle known as social constructivism, makes a case for nuanced understanding of qualitative trends. And second, the areas of application I have worked in, especially in political risk assessment, there is no substitute for qualitative analysis.

To repeat: making the case is not easy. In one of my consulting projects at the United Nations, I heard frequently about a “quick and easy” risk assessment tool–basically an excel sheet–peddled by one of the big five consulting firms. Now there’s a certain structural elegance to assigning hard numbers off the top of your head to something like “potential for protest by opposition,” and then adding all the numbers up, and then concluding country X is riskier to operate than country Y.

But devising good strategy to mitigate risk always involves understanding thoroughly the uncertainties that make up risk. After all, if everything was binary or without uncertain nuances, there would little need to understand risk.

Moreover, in most cases, risk cannot be mitigated by wielding hard, blunt instruments, like simply throwing money or guns at a problem. And that holds even if the problem is something as hard and blunt as terrorism.

That’s why American strategy in reducing risk of terrorism now talks more about smart power and soft power and less about shock and awe. If hard power is about getting others to do what you want, soft power is getting others to want what you want. (This is the classic formulation by Joseph Nye, now Dean at the Harvard Kennedy School.)

Hard power, from Wall Street to Kabul, has been based on hard numbers. Soft power requires dissing out that excel sheet for some time and thinking in terms of narratives, of nuanced if-then statements. That can seem messy; it can seem like more humanities than sciences, but guess which power is more cost-effective and less risky as long term objective.

So, here’s to a softer, more holistic understanding of risk and reward.

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The business of a global organization is ultimately a collection of local realities. Even companies like Lenovo that pride themselves of being a HQ-less networked organization in the end needs to succeed in local markets.

Their success depends on achieving a difficult balance. The first part of this involves enticing the local populace with sharing in a global value. In the 1980s, Levis jeans was attractive to rock music listeners across the world: the brand symbolized a common bond. Apple’s iPod is a contemporary example. One’s local experience becomes part of a global community; and that gives people–though it may sound tacky–a sense of belonging. It’s basically global community created through the local marketplace.

The other part of the equation is the local experience. Call it the global tuned to the local. This is an essential trait, according to a recent Washington Post article, of companies that one “cares about,” that is, companies that create an emotional attachment in their customers. It can’t be measured in numbers, directly at least. It’s amorphous, qualitative, another manifestation of that sense of belonging.

The article identifies four US companies–Starbucks, Apple, Google, and Amazon–that have been globally successful in creating local followers. They, the SAGA, have balanced standard global services and products somehow with an intensely local customer base, and they’ve done it through transforming “some important aspect of contemporary life.” Ledbetter and Weisberg, the authors of the article, go on to note:

Each has had an appreciable impact on our daily routines, taken on a looming presence in popular culture, and often engendered an intensity of feeling more often associated with tastes in entertainment or political views. Together, they have created a new model of business innovation, culture and values.

So while McDonald’s becomes the recipient of anti-globalization political backlash, these companies blend much more easily into their environments. While each company is a giant, to the local customers they don’t seem like “monoliths imposed on other countries from abroad.”

This is the challenge, the benchmark, for global brands: can they create local stakeholders who would provide cultural, emotional, and very importantly, political, support through the turbulence of an increasingly globalized world?

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More than two-thirds of corporate CEOs are optimistic about globalization, believing that cross-border mergers, acquisitions, and business in general will keep on increasing through 2009. Imminent recession in the advanced industrial economies may even increase their spread abroad. Consider these growth projections made by IMF. In 2008 and 2009, the US economy will grow at most by 0.6 percent. China and India will register 9.5 and 8 percent respectively. If you wanted profits and growth, where would you rather be?

Thus we have CEO optimism about globalization despite slowdown in the US. The problem is that politically there are reasons to be cautious. The past few months I have been highlighting what I consider the single biggest gathering risk to doing business across borders: political action. This has several aspects.

First of all, voters in the West have become  cautious about globalization and free markets. The 2007 Pew Global Attitudes Survey (PGAS), involving 45,000 people across 47 countries, reports that people have begun to take a more cautious approach to free markets, compared to 2002. US electoral rhetoric is adding fuel to their fear.

Public Support for GlobalizationSupport for globalization and capitalism have also been decreasing outside the West. The 2007 Globescan survey (see figure on the right) reports a downward trend in 10 of the 18 countries monitored regularly. And this survey was done before the current credit crisis hit the markets to further dampen mood.

Moreover, people in every country surveyed in PGAS (2007) felt a strong need to protect their cultures from foreign influences. This means that globalization will become  expensive, for foreign companies have to strive more, including greater product and service variation, to become accepted locally. My February post, “Enter a market (and be accepted)” talks more about this.

Their fear is heightened by inequality, both real and perceived, which has been increasing across emerging markets. In places like India, mass voters have openly reviled conspicuous consumption by the elite. And foreign influence is seen as agents of this inequality. The global food crisis is compounding matters, and hunger-induced riots are threatening even pro-investment authoritarian governments.

Not only are people becoming wary of foreign investors and traders, but they are expecting more politically from business firms. This expectation will only intensify through the Olympic Games and in the coming years. After criticism of China by the French government, the French supermarket chain Carrefour has been passing tense times, having unwittingly provoked both Chinese nationalists and European human rights activists. The norms of corporate governance are in a period of significant transition, as corporate political responsibility is being added on top of corporate social responsibility. Whether CEOs like it or not, business firms are political actors too, and ignoring this transition will heighten political risk.

So business calculations that go into cross-border strategy need to expand far beyond the traditional financial and legal focus. They will  have to become politically sophisticated, requiring careful analysis and political variables, and informed to a greater degree by local political realities. This coming recession will  likely thrust a demand for greater political action on the part of globally expanding businesses.

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Chief executives have consistently cited backlash against globalization as one of the main risks facing their operations across borders.

We’ve heard about this risk for a decade now. Sometimes they materialize into concrete fights, like the French farmer Jose Bove attacking a McDonalds in Millau in 1999, or rioting in Genoa against the G8 summit in 2001. India has also seen boisterous protests and fights, some of which are detailed in my upcoming book, India’s Open-Economy Policy (London: Routledge, Autumn 2008).

Conventionally, there are two components to mitigating this risk. First, intelligent companies make local-market adjustments, especially on product packaging, messaging, and some times composition, while retaining the advantages of a global brand to the extent possible. Second, they engage in public relations campaigns, either to promote their products and image or to blunt the critics. Sometimes, when things get really bad, they can enlist the protection of the government for their physical properties.

But companies seldom address the structural factors that can minimize local-market risk. In India, for example, the main political risk does not come from physical vulnerability or even cultural imposition. After all, India is one of the most vibrant multi-cultural countries in the world.

The major risk in India and many other emerging markets comes from government regulation and a possible change in political direction toward protectionism–and this even after the government has consistently liberalized the economy and taken a more hands-off approach. Why is this?

Inequality in India is increasing, as is conspicuous consumption by new Indian billionaires. Election outcomes, however, are determined by the poor who are the outstanding majority and most of whom are bypassed by many Indian companies, let alone multinationals. They do not feature in market research, since their wallet size is small.

But they do need to be factor in the political calculations of foreign companies operating in India. Their unhappiness with globalization was one of the main reasons that BJP, a very pro-investment political party, was awarded a thumping defeat in the last national elections.

Confederation of Indian Industry (CII), which is India’s main industry association, is well aware of this risk. A year ago, they wrote in a briefing for the World Economic Forum:

Indian elites have become more globally interconnected, but the poor and lower middle class are still disconnected and not feeling the benefits of globalization and liberalization. The mismatch of interests and/or perceptions of globalization, if negative, could lead to an endogenous backlash, protectionism and social and political tensions.

This is where the problem lies. It is this mismatch of interests that sparks visible anti-globalization backlash. It is also something that democracies such as India will not be able to overlook, especially during election time.

Thinking beyond wallet size. There are ways to mitigate this risk for international businesses. They need innovative PR programs that address what I’m calling their “political market,” which is different from their direct customers. They need to research values and trends in this market. They need to build on and showcase achievements that are consistent with local values and priorities. They need to align their corporate social responsibility efforts with their political marketing efforts. 

Systematic strategy and investment in this will pay off by mitigating one of the key long-term concerns that haunt executives. It will also be able to prepare a new market not just through putting up billboards but through being accepted by locals as an organization of value.

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