political risks for international trade

1.0 Introduction

With the increasingly deepening of economic globalization day by day, a company must explore new markets and seek new development opportunities if it wants to hold a place in international competition. However, the company will encounter lots of barriers and challenges while entering the international market. Among them, political risks are a key factor that decides the success or failure of international operation (Click & Weiner, 2010). Political risks are the possibilities of political events in the host country bringing disadvantageous effects on the economic benefits of companies that operate internationally. These events usually include: change of the policy of the host country, change of the regime, social instability, and violent conflicts of the host country, the worsening of political relation between the host country and the mother country, etc. Political risks are a kind of risks that companies frequently encounter in international operation. It not only takes place in various developing countries, but also takes place in developed countries from time to time. This essay firstly discussed the causes for political risks. Then, it analyzed the forms of political risks. Lastly, some strategies are studied to avoid political risks.

2.0 Reasons for the occurrence of political risk

There are many reasons for the occurrence of political risks. According to Kesternich & Schnitzer (2010) reasons can be summarized into three parts:

The first is the conflicts between a company’s objective and the host country’s objective. What a company runs after is the maximization of economic benefits if it carries out international operation and the company attempts to make its shareholders, suppliers, users and creditors satisfied (Kerner & Lawrence, 2014). However, the host country cares about the development of aspects like politics, society, and culture apart from economic development. Therefore, there are frequent conflicts between the two parties. Take the ownership and control for example, the host country does not want some of its pillar industries to be controlled by foreign capital. Thus, many countries will make use of government policy to interfere the way in which multinational companies enter the domestic market.

The second is the conflicts between the operation of a company and the host country’s regulations. Multinational companies are not familiar with the host country’s culture due to cultural differences (Baldacci et al., 2011). This will lead to multinational companies’ maladjustment to some political policies, economic policies and cultural policies of the host country and make them not understand why the host country enacted some laws and executive systems to restrict company operation within its jurisdiction. These measures often bring risks to foreign-funded companies. It can be seen from the reasons that political risks bear a close relationship to the host country’s political system, economic system, culture and law, and that the risks cannot be controlled by international investors.

The third is nationalism. Political instability and religious belief are also significant causes for the political risks that companies will meet in international operation. Nationalism considers that economic development of a country should depend more on the country’s own economic strength and the development of the country’s national industry should be protected in particular (Vidal-Suarez, 2010). The stability of government policy directly affect the length of companies’ operation strategy. Therefore, international operation of companies is affected by political instability. Political instability shows in the change of the regime, frequent occurrence of violent incidents, poor public security. Religious belief easily leads to cultural separation and cultural separation is an important factor of political instability. Therefore, religious belief may result in political instability and cause certain influence on the operation of multinational companies.

3.0 Political risk influence on multinationals

Discriminatory government intervention
Government intervention means a country uses intervening measures in order to realize the preset targets of social and economic development. What should be pointed out is that not all of the government’s intervening measures are taken to foreign companies (Jimenez & Benito-Osorio, 2014). Only discriminatory intervening measures are the main political risks that multinational companies will face. For example, investments are only allowed in the form of joint venture and the percentage of the share of the joint venture held by foreign investor should not exceed a prescribed limit.

Risk of ownership control
Risk of ownership control refers to the host country’s expropriation, confiscation and nationalization of foreign-funded companies. This is more brutal than discriminatory government intervention and its results are more serious (Jimenez & Delgado-Garcia, 2012). According to statistics, this kind of risk was commonplace from the 50s to the 70s of the last century. During this period, more than half of the 100 developing countries nationalized foreign capital and there were altogether 1954 nationalization cases. With the development of economic globalization and increase of economic dependence on each other among countries, this kind of risk has reduced significantly. This is because it is easy for these behaviors to be revenged and they are disadvantageous to attracting foreign capital. Furthermore, the operation after nationalization is not good.

Business risks
The so-called business risk is the losses caused to multinational companies due to the change of economy and trade policy or regulation of foreign economy and trade. These regulating measures usually include local laws, tax policy, restriction of import and export, price regulation and restriction of labor force (Jimenez, 2011). Among them, through local laws, restriction of import and export and restriction of labor force, the host country wants multinational companies to use local resources as far as possible. And tax policy and price regulation are used to restrict multinational companies when the economy is over-heated in the host country. For instance, the labor market of the EU is not open to countries outside the EU. Local labor force should be employed when making investment in the EU. And local employees cannot be fired at will when acquisitions take place in EU countries. A high compensation fee must be paid before firing the present employees.

Risk of violent incidents
Violent incidents mean that the revolution, war and civil strife in the host country cause losses to multinational companies’ property and staff and make them stop operation (Reuveny, 2010). They mainly take place in countries where nationalism is high and national conflicts are intense. For example, the outbreak of Chechen War in November 1999 made the supermarkets run by Chinese companies in Moscow out of stock and causes huge economic losses.

4.0 Strategies to avoid political risks

Localized operation
The so-called localized operation means to employ local management personnel and labor force as far as possible whiling conducting overseas production and operation activities in order to promote the local economy and help the host country handle the issue of employment (Hainz & Kleimeier, 2012). This not only win the good feelings and support of the local government and people, but also ties the interests of the company and the interests of other stakeholders closely to increase the ability to resist risks. For example, in March 2003, many McDonald’s restaurants in Argentina were damaged to different degrees due to the Iraq War. And McDonald’s made a new advertisement for this and the content was: 16 years ago, McDonald’s entered the Argentinean market. Now it has 200 restaurants and 10 000 Argentinean employees work in these restaurants. 400 000 people dine in McDonald’s restaurants every day. 97% of the raw materials used are produced in Argentina. McDonald’s effectively reduced its losses by publicizing the localized operation.

Joint operation by multiple countries
If the product market and raw material supply of a subsidiary in the host country mainly rely on its parent company and subsidiaries from other companies, the cost and difficulty of the host country’s nationalization can be increased. Then, the host country is forced to maintain cooperation with multinational companies (Henisz et al., 2010). Joint operation by multiple countries can reach of the goal of dispersion of political risks. For example, Chrysler controls the supply of key parts of automobile strictly and places the production of 50% of the parts that are not critical in Peru. Other important parts like engine, transmission shaft, and body sheet are manufactured by subsidiaries in Argentina, Brazil and Detroit. Therefore, Chrysler’s investment in each country is affected by subsidiaries in other countries. In this way, Chrysler effectively controls the occurrence of political risks.

Strict technology transfer
Once a company possesses advanced technology, special manufacturing techniques and maintain a monopoly position, it can be invincible. To achieve this, companies can keep the R&D team in the mother country while carrying out international operation. Even the overseas subsidiaries are controlled by the host country, the technological strength of the parent company will not be affected (Kyaw et al., 2011). Restricting technology transfer can reduce the losses caused by political risks to a certain degree. Take the drinks giant Coca Cola for example, the businesses of its subsidiaries in various countries across the globe are mainly packaging and sales. The R&D and production of the critical formula is totally controlled by the parent company in the US. Over the 100 years, the recipe of Coco Cola has never been leaked due to political risks of overseas investment.

Joint venture
To void a single company shouldering too many political risks in cross-national investment, the company can invest in and operate a certain project together with other investors in the host country. Or it can establish a new company with companies in the host country to avoid political risks effectively. At present, joint venture has become the main form for many multinational companies to invest in foreign countries. For example, Ford of America and Toyota of Japan both adopted joint venture to come to other countries (Harvey et al., 2014). This form can increase the host country’s technology and management ability, make up its shortage of capital, and promote the economic level and employment level. Therefore, the host country is willing to accept it. In addition, to share the ownership of a joint venture with local companies in the host country can bind the interests of multinational companies and local companies together. This can reduce the risk of joint venture being expropriated or confiscated because the government of the host country has to take the interests of local companies into consideration and will not abuse its power. Many multinational companies that were solely funded have gradually changed to joint venture to avoid political risks.

Diversification of financing
When making financing decisions, investments from other countries and industries should be attracted by the diversification of financing. Diversified financing of subsidiaries can increase the difficulty of expropriation and nationalization by the host country and reach the goal of dispersing political risks. Companies can issue bonds in the host country and bind the debt of the subsidiaries with the interests of local financial institutions (Meon & Sekkat, 2012). On the one hand, it can reduce the capital investment of multinational companies, and the political risks can be passed onto the host country’s financial institutions when expropriation and nationalization occur. On the other hand, it can decrease the risk of foreign exchange. In addition, when setting up overseas subsidiaries, multinational companies can also invite other countries’ capital to make investment together. Since these financing bodies represent many countries’ interests, the host country has to consider the interests of multiple capital bodies when conducting expropriation and nationalization.

Participate in overseas investment insurance
To tackle political risks of overseas investment, some investment companies and insurance companies offer insurance against political risks in many countries, such as OPIC in the US, Treuarbeit A.G. and Herms Kerditversicherungs A.G. in Germany. Taking out insurance against political risks is a positive preventative strategy. In fields where political risks concentrate, companies can pass political risks to insurance institutions by taking out insurance of various assets in order to focus their effort on businesses without worrying out political risks.

5.0 Conclusion

In the background of economic globalization, large-sized multinational companies have to face the host country’s political risks apart from assuming commercial risks. Political risks cannot be avoided completely. However, companies can reduce political risks’ impact on company operation through some strategies. This essay analyzed the causes for political risks and proposed some counter measures. These measures can reduce political risks’ impact on cross-national operation effectively.

Reference

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