Political Risk: a Review and Reconsideration

This paper has three objectives: First, to review the literature dealing with the assessment and evaluation of political risk by managers in international firms. Second, to build upon this literature by extending and more precisely defining the concept in a manner that facilitates integration into the planning or decision-making process. Last, the paper attempts to suggest fruitful directions for future research. When you enter an endeavor unsuccessfully then the planning was incorrect. The risk was above the gains and you stumble along the way... Sagacity, ingenuity, planning .. it involves much weighing, odds against failure, odds against gain. (Doc Graham in Terkel [60]) * While there has been increasing academic interest in the intersection of politics and INTRODUCTION international business, it is still a relatively new and loosely defined field. It would appear worthwhile to review and summarize what has been accomplished thus far and to look toward future needs. This paper will attempt to serve that end by focusing upon one of the more salient issue areas: the political risk associated with foreign investment. It has three specific objectives: to review the existing literature, to build upon this literature by attempting to define more precisely the concept of political risk, and to suggest fruitful directions for future research. Although the term "political risk" occurs frequently in the international business literaPOLITICAL ture, agreement about its meaning is limited to an implication of unwanted conseRISK quences of political activity. It is most commonly conceived of in terms of (usually host) government interference with business operations. Weston and Sorge's [64] definition is representative: "[P]olitical risks arise from the actions of national governments which interfere with or prevent business transactions, or change the terms of agreements, or cause the confiscation of wholly or partially foreign owned business property" (p. 60). Similarly, Aliber [2], Baglini [4], Carlson [11], Eiteman and Stonehill [16], Greene [23], The Journal of Commerce [28], Lloyd [41], and Smith [56] all explicitly or implicitly define political risk as governmental or sovereign interference with business operations. This rather widespread conception of political risk in terms of government interference with private investment has important normative implications which will be discussed in the next section. A second major cluster of authors defines political risk in terms of events-either political acts, constraints imposed upon the firm, or some combination of both. While there are differences among them, Greene [19, 20], Hershbarger and Noerager [27], Nehrt [44], Rodriguez and Carter [47], Van Agtmael [62], and Zink [66] all equate political risk with either environmental factors such as instability and direct violence or constraints on operations such as expropriation, discriminatory taxation, public sector competition, and the like. Others-such as, Daniels [13], Dymsza [14], and Brooke and Remmers [9]-do not explicitly define the concept but rather note that the political environment (or the environment in general) is a source of business risk for the firm. Robock, Root, and Haendel and West have considered the concept of political risk in considerable detail. Robock [46] suggests the following operational definition: ... political risk in international business exists (1) when discontinuities occur in the business *Stephen J. Kobrin is Associate Professor of Management at the Sloan School of Management at M.I.T. His research interests involve the relationship between international business and the political and social environment. The author would like to thank Gene Carter, Joseph LaPolombara, Donald Lessard, Bernard Mennis, Stewart Myers, David Parker, Franklin Root, and Gerald West as well as several anonymous referees for their criticism of his ideas and earlier drafts of this paper. He suspects, that in more than one instance, they would consider their efforts less than successful. This article is drawn from a longer working paper which contains a considerably more detailed review of the literature. 67 Palgrave Macmillan Journals is collaborating with JSTOR to digitize, preserve, and extend access to Journal of International Business Studies www.jstor.org ® environment, (2) when they are difficult o anticipate and (3) when they result from political change. To constitute a 'risk' these changes in the business environment must have the potential for significantly affecting the profit or other goals of a particular enterprise. (p. 7) The concepts of discontinuity and direct effects on the enterprise are central to Robock's definition. He notes that while all political environments are dynamic, changes which are gradual and progressive and are neither unexpected nor difficult to anticipate do not constitute political risk. He then clearly differentiates between political instability and political risk: "... political fluctuations which do not change the business environment significantly do not represent risk for international business .... Political instability, depending upon how it is defined, is a separate although related phenomenon from that of political risk" (p. 8). Robock also distinguishes between "macro risk" where political events result in constraints on all foreign enterprise (for example, Cuba in 1959-1960) and "micro risk" which affects only "selected fields of business activity or foreign enterprises with specific characteristics" (p. 9). Root [50] defines political risk in terms of the: ... possible occurrence of a political event of any kind (such as war, revolution, coup d'etat, expropriation, taxation, devaluation, exchange controls and import restrictions) at home or abroad that can cause a loss of profit potential and/or assets in an international business operation" (p. 355). Root emphasizes the difference between uncertainty and risk (drawing both normative and positive implications), attempts to separate political from other environmental risks, and develops several useful taxonomies. In a second paper [51] Root concludes that the distinction between political and economic risks breaks down at the experiential level as a result of the "... interdependence of economic and political phenomena: [p. 3]. Still, an attempt at that distinction is made; [A]n uncertainty is political if it relates to (a) a potential government act. . ., or (b) general instability in the political/social system" (p. 4). Root also categorizes political uncertainties in terms of the manner in which they affect the firm: (1) transfer-uncertainty about flows of capital, payments, technology, people, etc.; (2) operational-uncertainties about policies that directly constrain local operations; and (3) ownership/control-uncertainties about policies relating to ownership or managerial control (p. 357). He suggests that transfer and operations uncertainties flow primarily from political/economic events and ownership/control from political/social. Haendel and West [24] focus upon a distinction between risk and uncertainty: between "the probability of occurrence of an undesired political event[s] and the uncertainty generated by inadequate information concerning the occurrence of such an event[s]" (p. 44). Thus, political risk is defined as the "risk or probability of occurrence of some political event[s] that will change the prospects for the profitability of a given investment" (p. xi). (They later note explicitly that political risk is both investor and investment