Political risk

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v t e

Political risk is a type of risk faced by investors, corporations, and governments that political decisions, events, or conditions will significantly affect the profitability of a business actor or the expected value of a given economic action.^[1] Political risk can be understood and managed with reasoned foresight and investment.

The term political risk has had many different meanings over time.^[2] Broadly speaking, however, political risk refers to the complications businesses and governments may face as a result of what are commonly referred to as political decisions—or "any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives".^[3]

Political risk faced by firms can be defined as "the risk of a strategic, financial, or personnel loss for a firm because of such nonmarket factors as macroeconomic and social policies (fiscal, monetary, trade, investment, industrial, income, labour, and developmental), or events related to political instability (terrorism, riots, coups, civil war, and insurrection)."^[4] Portfolio investors may face similar financial losses.

Moreover, governments may face complications in their ability to execute diplomatic, military or other initiatives as a result of political risk. The field has historically focused on analyzing political risks predominantly in emerging economies, but such risks also exist in developed economies and liberal democracies as well, albeit in different manifestations.^[5] The term is used in the sense of downside risks but political actions or developments can also create upside risks or opportunities for companies and governments.^[6]

A low level of political risk in a given country does not necessarily correspond to a high degree of political freedom.^[7] Indeed, some of the more stable states are also the most authoritarian. Long-term assessments of political risk must account for the danger that a politically oppressive environment is only stable as long as top-down control is maintained and citizens prevented from a free exchange of ideas and goods with the outside world.^[8]

Understanding risk partly as probability and partly as impact provides insight into political risk. For a business, the implication for political risk is that there is a measure of likelihood that political events may complicate its pursuit of earnings through direct impacts (such as taxes or fees) or indirect impacts (such as opportunity cost forgone). As a result, political risk is similar to an expected value such that the likelihood of a political event occurring may reduce the desirability of that investment by reducing its anticipated returns.

There are both macro- and micro-level political risks. Macro-level political risks have similar impacts across all foreign actors in a given location. While these are included in country risk analysis, it would be incorrect to equate macro-level political risk analysis with country risk as country risk only looks at national-level risks and also includes financial and economic risks. Micro-level risks focus on sector, firm, or project specific risk.^[9]

Political risk insurance can be taken out to protect again political risk such as inconvertibility of funds, expropriation, and losses due to violent conflict.^[10] Claims due to political risk decrease with political constraints and increase with changes of political leadership in the country.^[10]