Foreign Investments And The Management Of Political Risk

Dan Haendel

• Publisher: Routledge
• Year: 2019
• ISBN:
  9780429726651
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

This volume focuses on the efforts that multinational enterprises (MNEs) can and must make to evaluate and deal with the political risks they confront in host countries. After discussing various aspects of the relationships between MNEs and host countries, the author considers the definitional and conceptual issues of political risk. He examines th

1
Cooperation and Conflict: The MNEs, LDCs, and the United States

During the 1950s and 1960s U.S.-based multinational enterprises (MNEs) experienced a phenomenal rate of growth. This expansion resulted largely from investments in industrialized countries rather than from investments in the less developed countries (LDCs). Since 1971, however, the rate of expansion has declined markedly.¹

The global recession of the mid-1970s has significantly lowered the expectations of corporate earnings and returns on both domestic and foreign investments. The LDCs have been viewed as increasingly risky, perhaps because of the decline of the market price for many of their key raw materials as well as the increased political turbulence in the world generally. For multinational enterprises seeking to generate profits in the current era of low economic growth, complete information about their foreign investment environment is likely to have a substantial impact on their earnings and corporate strength.

U.S. corporations usually view foreign investments as riskier than investments in the United States, in large part because of the uncertainty of the political environment in the host country. In fact, Henry Kissinger has noted the importance of this factor by suggesting that the development of some ground rules within which private investment can operate is the key to expanding private investment in the LDCs.²

Since World War II, business conditions have fluctuated markedly in many countries of the world, particularly in the LDCs. Much of this fluctuation can be attributed to underlying political factors. In many LDCs the drive to stimulate the growth of the gross national product (GNP) has often led to policies unfavorable to international investment. These measures have included (1) the expropriation of public utilities; (2) government investment in, and subsidies for, “bottleneck” industries; (3) agricultural reform; (4) restrictions on imports, exports, and capital flows; (5) requirements on reinvestment of profits and on the ratio of foreign to domestic equity; (6) compulsory subcontracting, as well as a number of steps that many of these states consider essential.

The business environment in many LDCs has also been influenced by a number of other politically inspired factors. New wage and labor laws—frequently enforced in particular against foreign-owned enterprises—have driven up costs, often while real dollar profits have been held constant either by government restrictions or by continuing inflationary spirals and devaluations. Basic shifts in political philosophy—from the loose capitalism of the colonial era to a welfare state philosophy—have taken their toll on investors—for example, the confiscations in Chile, Peru, and Cuba. In other countries, such as Argentina, Uruguay, and Libya, external conflicts and domestic turbulence have victimized not only holdings but also the very lives of MNE personnel.

The list of politically induced investment and business losses is extensive. However, there is an almost equally long list of large and windfall profits resulting from political decisions—such as tax holidays, attractive exemptions from other restrictions, and subsidies from governments interested in attracting industry.

The mounting record of investment losses and failures notwithstanding, few companies conduct much political risk analysis. Among those that do, evaluations tend to be based on such simplistic distinctions as to whether a country is considered “safe” and its leaders “friendly” to the United States. Clearly, however, the political issues that affect foreign investors frequently have little to do with the country’s system of government or its liking for the U.S. government.

The initial reaction of a good businessman when faced with an unacceptable risk is to avoid it completely. If he does decide to confront it, he will probably seek either to reduce that risk or to transfer the burden to a third party. For many years U.S. corporations were relieved of some political risk by “gunboat diplomacy” and other forms of government intervention. Some corporations, especially in Latin America, also used direct methods to reduce political risk. When methods of direct intervention became more and more counterproductive, American businessmen sought other government sanctions to deter threats to their investments abroad. For example, the Hickenlooper and Gonzalez amendments, respectively, mandate an aid cutoff or a negative vote by the United States on loan applications in international financial institutions against a country that expropriates a U.S. firm without just compensation.

In the postwar era, a coincidence of the broad economic interests of the American business community and the political interests of the U.S. government, such as the rebuilding of the war-shattered countries of Western Europe and Japan, led in 1948 to a government insurance program. The types of risks covered by the program were gradually expanded so that the Agency for International Development (AID) was eventually offering insurance to private U.S. investors against the risks of inconvertibility of assets, expropriation, and war, revolution, or insurrection.

During the 1950s and 1960s this insurance program was extended to cover investments in the LDCs as well. In the Foreign Assistance Act of 1969, Congress authorized the creation of OPIC, which assumed operation of AID’s private investment incentive programs, including the insurance program. OPIC’s overall purpose, as defined in that act, was to “mobilize and facilitate the participation of U.S. private capital and skills in the economic and social progress of less developed friendly countries and areas, thereby complementing the development assistance objectives of the United States.” OPIC has sought to make investment in LDCs more attractive by enabling U.S. investors to view investment there on a more competitive basis with alternative opportunities in more developed areas. Thus, OPIC seeks to serve directly the government’s dual policy goals. It provides a form of assistance to the developing countries by assisting in the flow of U.S. investment, especially capital investment; at the same time, it seeks to ensure that the United States maintains both its market share in these developing economies and an adequate supply of raw materials.

The availability of relatively inexpensive insurance has enabled some MNEs to concentrate on the purely economic risks they face in foreign investment and to pay less attention to the problem of political risk. As a result, the tools they use to gauge the economic costs and benefits of proposed foreign investments have become relatively well developed and sophisticated. By the same token, the tools they use to analyze the political “costs and benefits” of proposed investments can only be described as primitive.

Partly because of the lack of demand, the academic community has had little motivation to develop analytical tools useful in attacking the problem of political risk to foreign investments. Political scientists have virtually ignored the problem. What little scholarly writing there has been on the subject has generally come from professors of business who have recognized the growing importance of the problem. This does not mean that the would-be investor, worried about political threats to his investment, cannot find help. There is no shortage of people willing to sell their services. Former intelligence and Foreign Service officers, consulting firms, and “confidential” newsletters, for example, are abundantly available. If the would-be investor is willing to devote the time, he can get a mass of data and opinion from various government bodies, such as the Departments of the Treasury, Commerce, and State. His problem, then, is how to separate the relevant from the irrelevant and to come up with a synthesis requisite to his particular needs. In other words, data are useless— and quite often debilitatingly confusing—unless there is a framework for applying them. And that framework must be custom-tailored to the firm’s exposure. Even though there has been an increased effort to tackle the political risk problem, some of these attempts leave many corporate executives unsatisfied. We will present various efforts in Chapter 4, with particular emphasis on works that seek to bridge the gap between political analysis and the needs and concerns of foreign investors.

The problem for the investor is compounded by the fact that everyone has his own interpretation of “political risk.” Moreover, OPIC’s focus on inconvertibility, expropriation, and war risks has tended to obscure the many “lesser” political risks that may seriously threaten an investment—the more or less subtle changes in a host country’s political conditions that can significantly affect the investment climate.

In short, the study of political risk has been blocked by complacency, confusion, and an inordinate preoccupation with the “cataclysmic” risks—all to the detriment of a concerted approach to the broader problem. But the Overseas Private Investment Act of 1974 indicated a likely change in attitudes. Because they would shoulder a greater portion of the risk burden, corporate investors would have to pay more attention to a rigorous assessment of political risk. Since OPIC is legally required to transfer some of its insurance functions to the private insurance industry, the latter now has to improve its ability to analyze, define, measure, and forecast political risk. Even though the “privatization” mandate has been terminated, the congressional restrictions on OPIC and the limited capacity of the private insurance industry in essence force the MNEs to act as self-insurers. Consequently, the MNEs must themselves undertake explicit and systematic analysis and management of their political risk.

Clashing Interests of the MNEs and LDCs

In this chapter, we explore the economic and political relationships between MNEs and LDCs that give rise to the need for a more systematic method to evaluate, measure, and forecast political events that affect investment considerations. One actual corporate experience is useful in introducing the discussion of MNE-LDC relations.

The experience of Dow Chemical Company in Chile during the Allende period is a dramatic illustration of how one corporation assessed and calculated political risk, dealt with uncertainty, responded to political challenges, and modified its decision-making processes in view of this experience.³ At the invitation of the Christian Democratic government, Dow contracted in 1966 to build a plastics complex, Petrodow, in a joint venture with the Chilean government. In 1970, as the plastics plant neared completion, Salvador Allende was elected president of Chile. The president of Dow Latin America, David Schornstein, reacted to the news by purchasing a copy of Karl Marx’s Communist Manifesto to “refresh his memory about their attitudes.” As a decision-maker, he had to choose whether to continue pouring money into Chile or to cut Dow’s losses and liquidate the enterprise. The argument that Dow would not be able to operate effectively in Chile if Allende came to power and that Dow should therefore cut its operation was rejected. The head of Dow’s Chilean operations argued successfully that Dow should remain in Chile as long as possible. He pointed out that Dow had put only $6 million in cash into the venture and had raised the rest of its investment through loans guaranteed by the Chilean government. With some luck, he argued, the Petrodow plants could be completed and most of Dow’s cash outlays recouped from profits before drastic change occurred. In brief, the decision was “to stay and try to milk the thing for whatever it might be worth.”⁴

In April 1971 the Chilean government informed Dow that it wished to renegotiate the Petrodow agreement to increase the government’s ownership from 30 to 51 percent. Dow politely rejected the offer, having no intention of altering its policy of avoiding joint ventures in which it did not have management control. Following months of inconclusive negotiations, government-inspired strikes at Dow’s facilities, and growing chaos in the Chilean economy and political system, the government seized Dow’s properties.

A visit by the president of Dow Latin America with Allende’s minister of economics had no results. A Chilean court eventually ruled that the expropriation was illegal, but it had no power to enforce its ruling. Dow reconciled itself to the loss of its properties and turned its attention to collecting on the expropriation insurance it had taken out with OPIC. After Allende’s overthrow in September 1973, the new military government invited Dow to return to its operations in Chile. Dow carefully weighed the offer, since accepting it meant the voiding of its insurance claim against OPIC, and decided to return.

Although Dow executives still believe that their original decision to enter Chile was correct, they now give greater weight than before to political factors that bear on their investment decisions.⁵ In early 1974 Dow established an ad hoc committee of five or six executives with the task of keeping management alert to any political shifts that could sour potential investment or damage existing ones. This committee seeks to provide the president of Dow Latin America and the board of Dow Chemical with detailed, up-to-date information about the economic, social, and political conditions of every Latin American country in which Dow operates or would like to operate. The committee’s reports are drawn from field trips and from interviews with government officials, scholars, and executives of other U.S. companies doing business in the various countries. Dow claims it is simply a coincidence that the reports of the Economic, Social, and Political Committee are referred to by the group’s initials— ESP.⁶

Therefore, as a result of its experience, Dow is not only more sensitive to the political pitfalls of its overseas investments, but it is also instituting a more systematic mode of political information gathering and evaluation that goes beyond the mere intuitive judgment of its executives. Although Dow’s “ESP” apparently has not brought any sophisticated techniques of political analysis to bear on the measurement of political risk, at the very least it has sought to maximize the use of the available political information in order to estimate the risk more accurately.

MNEs and Political Risk

Not all MNEs have had experiences like Dow’s; of those that have, not all have inaugurated explicit procedures for assessing the impact of political factors on investment. Most MNE decision-makers make informed guesses about the likely influence of political factors in the LDCs. They are aware of the fundamental interests that bring MNEs and LDCs together and split them apart. They are sensitive to the fears in the LDCs about the potential for economic, political, and social domination that their investments represent. Yet the task of coping with political considerations that may affect their investment is often difficult for corporate decision makers, because of several underlying conflicts between their corporate objectives and those of the host governments of many LDCs.

The host government of an LDC is usually concerned primarily with economic growth, the mobilization of its population, and political independence. As one author noted, “nationalistic sentiments expressed by a desire for greater economic self-sufficiency frequently inhibit and restrain the operations of multinational firms…. This increased concern over foreign economic domination will be the most challenging problem facing the multinational businessman in the 1970’s.”⁷

In many instances, economic nationalism has grown out of the political nationalism that in many LDCs represents a reaction to the colonial past. Among political elites in many newly independent states, resentment of past economic domination has become distrust of the MNE.

Host countries often treat MNEs involved in extractive industries differently from those engaged in manufacturing—a distinction that has been supported by the United Nations since 1962. Extractive industries cannot relocate as easily as many manufacturing firms can; they must operate where the natural resources exist. But even manufacturing plants may be severely restricted by the costs associated with relocating.

Foreign ownership of natural resources raises serious political, economic, in addition to psychological issues in the host country. The United States has recently begun to feel the uneasiness of foreign investment, such as that of Arab “petrodollars”—despite the difference between ownership and the actual exercise of control. Nevertheless, the major concessions by U.S. MNEs to host country resentment have been to “maintain a low profile, employ local nationals in managerial positions where possible and to otherwise seek to mollify the natives.”⁸

A World Bank survey has revealed that in recent years most exploration expenditures have been made in the industrialized countries and that private firms are reluctant to invest in LDCs, primarily because of political risk. For example, U.S. firms prefer to develop a copper deposit with less than one-half percent richness in ...

Table of contents

• Cover
• Half Title
• Series Page
• Title
• Copyright
• Dedication
• Contents
• List of Figures
• List of Tables
• Foreword
• Preface
• Introduction
• 1. Cooperation and Conflict: The MNEs, LDCs, and the United States
• 2. The U.S. Government and American Foreign Investment
• 3. Political Risk: Identifying and Defining the Issue
• 4. Recent Efforts To Analyze and Measure Political Risk
• 5. Monitoring and Integrating Political Risk
• 6. The Management of Political Risk
• 7. Conclusion and Summary
• Appendix A: A Political System Stability Index
• Appendix B: Investment Insurance Programs of the Industrial Countries
• Notes
• Index