Political Risk and International Business - Literature review Example

Political Risk and International Business Political Risk and International Business When organizations enter or plan to enter international market or foreign countries they have to focus on a variety of factors. These can be anything from competitors to environmental to political factors, however, they may or may not become an obstacle for organization’s operations and overall business in that particular country / market. Alike few other factors, the impact of political risks on international business is direct and adverse. International business faces various political and country risks / challenges in the country they operate. The purpose of this paper is to discuss how political risk can arise for international businesses. Furthermore, the paper will critically evaluate the different mechanisms that can be used to manage the risks. Business executives are often more conservative regarding investments cross borders. This is due to the fact that the political pressure and risks are comparatively greater in that certain region. The multinationals which have offices in various parts of the world or in different countries, have to sometime alter their objectives and policies because of the political risks that may harm and affect the business of the company immediately after its launch or on a longer run. Additional risks are increased when a business decides to operate internationally, it has to focus on a variety of elements before launching its business operations in any other country as if it these elements are avoided initially they may become an obstacle for the business on a longer run (Bulan et al., 2009). International businesses are usually associated with the chief risks of foreign exchange, social risk, financial, and political risk. If these risks are not catered and resolved by the companies initially then the chances to generate sustainable revenue and stand affirm in the market are usually less. The nature of these political actions varies from adverse to highly detrimental. This may refer to a mass destruction caused by an industrial revolution or to a monetary policy such as policies, laws, or regulations that may restrict transactions or movement of capital from host to the native country (Baylis et al., 2013). Political risks are majorly divided into two types - macro and micro risks. Macro risks include all the negative actions that have equal impact on all foreign organizations; this refers to embezzlement or insurrection. On the contrary, micro risks includes the detrimental actions which have the ability to harm only a certain industrial area or business; this refers to wrongdoing by a public official and prejudicial actions against the international business from the host country. If the organizations are not prepared to face these political challenges then the chances to lose handsome revenues and heavy amounts of investments are usually high (El-Sayegh, 2008). The basic purpose to expand the business cross borders is to make revenue and earn profit. However, organizations have to go through a lot in order to enter an international market or any other country and earn profit. Once any corporation starts working internationally it is then known as Multi-National Corporation (MNC). Nationalization and deprivation are some other issues, which an organization may face while entering in any other country. The term nationalization refers to the takeover of the privately owned companies, industries, or resources without compensating them. It becomes quite complex for organizations and multi nationals to invest in foreign countries where nationalization is one of the political risks. Many past examples can be evidenced to balance the argument; that nationalization have brought great business empires to the surface, for example the government of Bolivia nationalized the country’s oil and gas industry in 2006 whereas in 2009, Venezuela decided nationalize its banks (Jackson & Deeg, 2008). Another major reason that may endanger the international business because of the political risk is because of the gradual expropriation. The term refers to the act by the government of the host country to immediately seize the assets and capital of the international business / enterprise / corporation, specifically. This is a gradual and slow process in which the government targets a certain company by removing the property rights, or increasing the taxes so that the business may become less profitable. There are certain other challenges which the international corporations have to come across in order to deal with gradual expropriation and to lower the political and country risk (Jackson & Deeg, 2008). In order to avoid the political and country risks, international business should do research before launching their business cross borders i.e. in foreign lands. If the multi national will learn about the cultural diversity of the country, its political stability and its financial capability etc., then the chances are greater that it will face the political pressure and will undergo political risks. Furthermore, these companies can also take help from consultants and analysts who can guide them before entering any international market. In this manner, these international businesses can certainly avoid the countries that have high political risks. Furthermore, the companies can also come up with short term and long-term strategies in order to combat with any kind of risk that may occur in an international investment (Baylis et al., 2013; Büthe & Milner, 2008). Despite of the fact that the investor is aware of the risks that are associated with the international investment and is willing to take it then the sound solution is to adopt for political risk insurance. Through this option, multinational corporations can purchase the best and specialized political risk insurance by doing research. This approach will help the organization to cover the loss in case of any unfortunate event occurs. This does not at all mean that the multi national will be compensated with the loss immediately after the incident. The company has to go through numerous procedures in order to determine the extent to which the business was affected and have to wait for months and even years before any compensation is made (El-Sayegh, 2008). When the business policies of the host country are suddenly or unexpectedly changed by its government then the percentage of political risks on the international business increases. There is no limit to the policy changes and these changes can include anything. They can call for a legal limit to revenue generation, limit to international trade, prevention of international trade etc. On the contrary, governments might introduce excessive funds and increased taxes on trades and import export etc. These policy reforms are going to have a collective effect on the revenues and the profits of the company; as the company will be paying handsome taxes to the government or it will have reduced import / export and trade to and from the host country (El-Sayegh, 2008). It has been studied that multinationals that engage in businesses and financial activities cross borders are likely to be affected in terms of their profit then predicted. It is almost impossible to determine the revenue rate exactly. Furthermore, the rickety prediction of revenue generation can also make the business challenging. It has been observed that despite of the great many disadvantages of the international business and threats and challenges imposed by the political risks, international businesses continues to open new exciting opportunities for markets with decreased resource cost and increased cost effectiveness. The corporation can overcome the political risks if it rightly utilizes the information and research and formulate a strategy and implement it. Furthermore, it should also know that whether or not the advantages are greater than the disadvantages and that the market is flexible / lucrative enough to allow the company to bear and make up for the losses (Holburn & Zelner, 2010). Doing business internationally has many advantages therefore the political risks should not be considered as an obstacle in fact it should be solved through a proper strategy and scheme. It should be noted that one country does not have every industry. Some countries are specialized in certain field while others are specialized in others. For example, if one country is expert at making steel, while the other is good at making consumer products, then the investor should know which country to enter and where to invest. Majority of these companies are located outside the United States of America; mostly in India, Bangladesh, Brazil, South Korea, etc. where the labor is comparatively cheaper. Compared to the United States, than there are more than a dozen stock markets, which are greater and are outside the US and have companies that are of particular importance. Out of these companies, most of them are working in an extensive proliferating economy that has the tendency to generate high revenues. Multinational can also expand their business by investing in such foreign companies and can diversify their business agglomeration (Luo et al., 2010). It has been noticed that the foreign rate of shares and the United States never work in harmony. When one is low, the other one is usually high and vice versa. In technical terms, such international markets lack correlation and that uncorrelated association between the company and the market increases the risks exerting political pressure on it. Despite of this fact, United States is considered as a hub for trade and import and export business for investors from across the world. The international shares and the United States not always move in conflicting direction and have flexible stock rates (Luthans & Doh, 2012). Furthermore, it should be noted that investors have to focus on the fact that there are certain risks associated with international stocks. These risks also include political risks as well. Talking about the beginners, then there is an exchange risk connected with the international stocks. Considering the example of the United States then an investor from US will face flexible exchange rates of the currency of United States i.e. US $. The US $ is of vital significance and will lead to a deviated amount of revenue than forecasted. In simple words, if the currency of the country in which the investor is investing goes up against US $ then the investment will strengthen but if the case is the other way around then the investor will have to face loss (McKellar, 2012). Other than the currency fluctuations the country risks that are linked with the political risks are also important to discuss. It should be noted that a number of countries are affected by political, social, and economic instability. For this reason, it becomes difficult for international corporations to invest in these markets / countries (McKellar, 2012). It has been studied through numerous researches that a misconception is observed among the masses, which illustrates that it is believed that investing in native country is challenging than to invest internationally. International governments have different techniques of reporting, taxation, and scrutiny. It is said that under any scenario, the international corporation is not supposed or asked to present the details or information regarding its operations or finances in the country whereas the case with the US companies is different. Multinational furthermore uses different method for assessing their finances; in simple words, it makes the overall stock analysis very confusing (Matten & Moon, 2008). Price differentiation is observed in different parts of the world. If one product is considered as a luxury in one part of the world then in the other part of the world it may be considered as a basic. This suggests that price is the most important factor and the core factor in mechanism of economics and international business (Piekkari et al., 2009). Another political risk associated with international business is of the governmental debt. For example if someone has some mortgage issues and is bankrupted then he has to adopt payment plan in order to avoid these issues. Similarly, if an entire country is bankrupted and is challenged with debt issues then it has to find ways to pay those debts. Furthermore, such scenarios will directly affect the economy of the country and will also have impact on the international business as the government regarding loans for new projects, etc. will impose strict laws. This political pressure will harm the operations and revenue generations of the company on a longer run (Piekkari et al., 2009; Okereke et al., 2009). It should be noted that there are different kinds of debt. One is the government debt and the other one is the sovereign debt. Government debt refers to the payment made in domestic currency while the payments made in foreign currency is known as sovereign debt. In the case of sovereign debt, the loan is guaranteed by the country where the business is conducted or the country that has issued the loan (Vogel, 2008). International corporations and investors have to check and weigh the risks that are involved in that particular investment, before buying a government’s sovereign debt. Majority of the countries have risk free debts such as the United States, whereas on the contrary the risk involved in the debts of the underdeveloped countries are comparatively greater. For this reason, the multinationals have also to focus on the stability of the government as it also imposes a great political threat on their business. Since, the chances of such government of going into bankruptcy are greater therefore the investors have to consider their decision of investing or entering the market. The debt is rated as AAA and AA, the safe status for the investors. Majority of the investors prefer investing in the US $ or the UK pound Sterling as these are trusted and known currencies in the world. Furthermore, these currencies have noticed less fluctuations then other currencies. For this reason, many multinational corporations avoid entering into developing countries as the risks are comparatively greater. In terms of currency, they have a shorter track record and they are strongly vulnerable to fluctuations in the stock market (Thomas, 2010). Furthermore, one major reason behind the political risks is the contractual frustration that occurs between the parties. This termination is due to the unpredictable scenarios that practically make the contract impossible. The reason behind the changes in scenarios can be many and may include, interference from third party, change of government, etc. Devaluation, Screening for political risks, analysis of political risks are some other kinds of political risks that may harm the international business and operations (Schwind, 2007). Another issue is of inflation. It can be defined as the rate at which general price of consumer goods increases and the power of purchasing decreases. This is, however, different from the price differentiation and its rise and fall. The reason behind inflation is not an increase in a particular item or particular service; it arises because of the increase in prices of the overall / majority of goods or services, affecting the entire economy and the international business as well. This exerts pressure on the demand and supply curve disturbing the economy of that country. The government then takes steps to overcome the economic problems by increasing taxes and other reforms, which are not favorable for the international investors (Rugman & Collinson, 2009). The need is to completely understand the political risks and how they affect the international business. Once multinationals and investors have identified risks and threats that are imposed by it then it will be easy for them to formulate strategies and how to deal with them on ongoing basis. Furthermore, it is also necessary that the multinational willing to enter international markets should also understand and acknowledge macro and micro political risk environment. The leaders at these corporations should also diversify the political risks (Piekkari et al., 2009; El-Sayegh, 2008). In order to conclude the above discussion, it could be inferred that businesses across the globe are trying to expand their operations in order to earn profits and generate revenues. For this reason, they are entering into international markets. The companies that are involved in doing business internationally are known as multinational companies (MNCs). The basic purpose of these entities is to make profit. However, by operating in different countries there operations are subject to different rules, laws, policies and regulations enforced by every country. These policies and laws may sometime become a challenge for international businesses to follow and this could harm their operation and profit immediately or on a longer run. Such risk to the business is termed as a political risk that has been discussed in this report. Political risks associated with the international business have comparatively adverse effects on business operations and its revenue generation ability. The government of any country can change its policy at any time and may introduce new policies or can increase taxes, limit trade, etc. which could result in a major loss or disruptions for any multination business operating in that country. It is suggested after a detailed discussion of political risks that businesses need to perform extensive research in order to overcome these political risks, and must take help of analysts who can guide them about country with suitable conditions to enter i.e. which have low political risks. Furthermore, the company can also take help of insurance companies to safeguard their assets and also secure the future if their business operations. Thus, investing in a foreign country is a important step to taken on the competitive market conditions in the local market. However, if all necessary and proactive steps are taken by multinationals and investors, then chances to suffer loss because of political risks can decrease. 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